-----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, QNp7h/w11uvPiuWl5OcQDpQcQ3kwt2/bTvr6rsxbQlsyN9B6M6QZUgq8Lbk10CJW HiTfyUz6p2ws6BkWUojU1Q== 0000948703-02-000007.txt : 20020415 0000948703-02-000007.hdr.sgml : 20020415 ACCESSION NUMBER: 0000948703-02-000007 CONFORMED SUBMISSION TYPE: 10QSB/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20020326 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/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-27102 FILM NUMBER: 02586604 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/A 1 form10qsba123100.txt FORM 10QSB\A FOR THE PERIOD ENDED 12/31/2000 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB/A (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, 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 February 12, 2001. Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X ) EXPLANATORY NOTE eGames, Inc. (the "Company") is amending its Form 10-QSB to restate its interim financial statements for the three and six month periods ended and as of December 31, 2000, and has revised it interim financial statements for the three and six month periods ended December 31, 1999 for comparative purposes, to address certain revenue recognition issues. The Company has concluded, based upon receipt of delayed reporting of sell-through results from its food and drug retailers, that it does not have the ability to make reliable estimates of product returns for shipments to food and drug retailers in accordance with SFAS No. 48, "Revenue Recognition When the Right of Return Exists," and the additional guidance provided in the SEC's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." This Form 10-QSB/A reflects the sale of the Company's products to its food and drug retailers on a product sell-through basis to the end consumer. The Company previously recognized revenue upon shipment of its products to its customers and recorded an allowance for product returns at the time of shipment. The revenues, product costs and royalty costs relating to product shipments to food and drug retailers have been restated in this Form 10-QSB/A to reflect this change in revenue recognition policy for shipments to food and drug retailers. In addition, net sales associated with product shipments to customers that traditionally have sold PC software products are recognized at the time that title passes to the customer. Such net sales have been restated in this Form 10-QSB/A because the Company determined in fiscal 2001 that certain of such product sales provided that title passed to the customer only upon receipt of the Company's product by the customer, and that, therefore, net sales could only be recognized upon the customer's receipt of such product shipments. This Form 10-QSB/A includes changes to the (i) Financial Statements and (ii) Management's Discussion and Analysis of Financial Condition and Results of Operations. INDEX Page ------ Part I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheet as of December 31, 2000............. 3 Consolidated Statements of Operations for the three and six months ended December 31, 2000 and 1999 ....................... 4 Consolidated Statements of Cash Flows for the six months ended December 31, 2000 and 1999............................... 5 Notes to Consolidated Financial Statements..................... 6-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ....................... 11-19 Signatures ............................................................... 20 Item 1. Financial Statements eGames, Inc. Consolidated Balance Sheet (Unaudited)
As of December 31, ASSETS 2000 - ------ ------------ Current assets: Cash and cash equivalents $ 62,707 Accounts receivable, net of allowances totaling $2,215,581 2,758,524 Inventory 4,256,023 Prepaid royalties and other expenses 524,767 Net current assets of discontinued operation 530,208 ------------ Total current assets 8,132,229 Furniture and equipment, net 219,989 Intangibles and other assets, net 64,874 Net long term assets of discontinued operation 224,750 ------------ Total assets $ 8,641,842 ============ LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Current liabilities: Note payable $ 58,480 Accounts payable 2,989,269 Customer advance payments 926,766 Revolving credit facility 1,050,000 Accrued expenses 1,215,102 Deferred revenues 45,000 Capital lease obligations 282,732 ------------ Total current liabilities 6,567,349 Note payable, net of current portion 89,843 ------------ Total liabilities 6,657,192 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 (7,741,584) Treasury stock, at cost - 231,900 shares (501,417) Accumulated other comprehensive loss (55,133) ------------ Total stockholders' equity 1,984,650 ------------ Total liabilities and stockholders' equity $ 8,641,842 ============
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, ------------------------- -------------------------- 2000 1999 2000 1999 ------------------------- -------------------------- Net sales $ 2,590,453 $ 3,091,300 $ 3,735,327 $ 5,652,936 Cost of sales 1,413,188 1,259,498 2,164,192 2,263,775 ----------- ----------- ------------ ----------- Gross profit 1,177,265 1,831,802 1,571,135 3,389,161 Operating expenses: Product development 176,325 220,745 357,472 463,592 Selling, general and administrative 1,548,259 1,526,085 2,988,385 2,878,354 ----------- ----------- ------------ ----------- Total operating expenses 1,724,584 1,746,830 3,345,857 3,341,946 ----------- ----------- ------------ ----------- Operating income (loss) (547,319) 84,972 (1,774,722) 47,215 Interest expense, net 23,370 6,197 30,723 9,907 ----------- ----------- ------------ ----------- Income (loss) from continuing operations before income taxes (570,689) 78,775 (1,805,445) 37,308 Provision (benefit) for income taxes (39,638) 149,000 (11,792) 245,000 ----------- ----------- ------------ ----------- Loss from continuing operations (531,051) (70,225) (1,793,653) (207,692) Discontinued operation (Note 4): Income from discontinued operation, net of income tax provision (benefit) for three months of $5,357 and $3,106, and for six months of ($19,668) and ($3,598) 89,072 97,474 67,656 160,707 ----------- ----------- ------------ ----------- Net Income (loss) ($ 441,979) $ 27,249 ($ 1,725,997) ($ 46,985) =========== =========== ============ =========== Net Income (loss) per common share: - Basic ($ 0.05) $ 0.00 ($ 0.18) $ 0.00 =========== =========== ============ =========== - Diluted ($ 0.05) $ 0.00 ($ $0.18) $ 0.00 =========== =========== ============ =========== Weighted average common shares outstanding - Basic 9,749,975 9,697,486 9,749,975 9,665,729 Dilutive effect of common stock equivalents - 0 - 437,493 - 0 - - 0 - ----------- ----------- ------------ ----------- Weighted average common shares outstanding - Diluted 9,749,975 10,134,979 9,749,975 9,665,729 =========== =========== ============ ===========
See accompanying notes to the consolidated financial statements. eGames, Inc. Consolidated Statements of Cash Flows (Unaudited)
Six months ended December 31, -------------------------- 2000 1999 ----------- ----------- Cash flows from operating activities: Net loss ($1,725,997) ($ 46,985) Adjustment to reconcile net loss to net cash used in operating activities: Depreciation, amortization and other non-cash items 118,012 164,313 Loss from discontinued operation (67,656) (160,707) Changes in items affecting operations: Restricted cash - 0 - 17,560 Accounts receivable (463,019) (1,001,282) Prepaid royalties and other expenses (317,439) (104,953) Inventory (1,824,563) (423,410) Accounts payable 1,003,555 316,982 Customer advance payments 926,766 - 0 - Accrued expenses 499,284 826,987 Deferred revenues 45,000 - 0 - ----------- ----------- Net cash used in operating activities (1,806,057) (411,495) ----------- ----------- Cash flows from investing activities: Purchase of furniture and equipment (37,248) (64,686) Purchase of software rights and other assets (4,980) (1,225) ----------- ----------- Net cash used in investing activities (42,228) (65,911) ----------- ----------- Cash flows from financing activities: Proceeds from exercise of warrants and options - 0 - 247,543 Proceeds from borrowings under revolving credit facility 2,250,000 250,000 Repayments of borrowings under revolving credit facility (1,200,000) (250,000) Repayments of convertible subordinated debt (150,000) - 0 - Repayments of note payable (26,500) (24,078) Repayments of capital lease obligations (6,342) (2,552) ----------- ----------- Net cash provided by financing activities 867,158 220,913 Effect of exchange rate changes on cash and cash equivalents (3,630) 1,798 Net cash used in discontinued operation (91,714) (200,502) ----------- ----------- Net decrease in cash and cash equivalents (1,076,471) (455,197) Cash and cash equivalents: Beginning of period 1,139,178 1,313,853 ----------- ----------- End of period $ 62,707 $ 858,656 =========== =========== Supplemental cash flow information: Cash paid for interest $ 39,411 $ 20,722 =========== =========== Cash paid for income taxes $ - 0 - $ 236,000 =========== =========== Non cash investing and financing activities: Acquisition of furniture, equipment and other current assets through capital leases $ 294,070 $ 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. During the first quarter of fiscal 2001, the Company adopted the Emerging Issues Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives". Accordingly, net sales amounts for current and prior periods reflect the reclassification of consumer and retailer rebate costs, from selling, general and administrative expenses to net sales. 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 previously wholly-owned subsidiary, which due to the sale of this operation in May 2001, the relevant balances and transactions have been presented as a discontinued operation. All inter-company balances and transactions have been eliminated. Revenue Recognition Product Sales: - -------------- The Company previously recognized revenue upon shipment of its products to its customers and recorded an allowance for product returns. The Company has concluded, based upon receipt of delayed reporting of sell-through results from its food and drug retailers, which have not historically sold consumer PC software products, that the Company does not have the ability to make reliable estimates of product returns for shipments to food and drug retailers in accordance with SFAS No. 48, "Revenue Recognition When the Right of Return Exists" and the additional guidance provided in the SEC's Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements". Accordingly, the Company's revenues in fiscal 2001 and 2000 associated with product shipments to food and drug retailers are recognized based on the timing of the actual sell-through of the Company's products to the end consumer at the retail location as reported to the Company from the respective food and drug retailer. Revenues associated with the Company's product shipments to its customers that traditionally have sold consumer PC software products (i.e., mass merchant retailers or distributors serving such retailers) are recognized at the time title to the inventory passes to these customers, less a historically based provision for anticipated product returns. The Company determined in fiscal 2001 that certain of its product sales to these customers provided that title passed to the customer only upon receipt of the Company's product by the customer and that, therefore, net sales could only be recognized upon the customer's receipt of such product shipments. Title passes to these customers either upon shipment of the product or receipt of the product by these customers based on the terms of the sale transaction. Notes to Consolidated Financial Statements (continued) Customers generally have the right to return products purchased from the Company. The Company recognizes product sales to its customers who traditionally have sold consumer PC software products, in accordance with the criteria of SFAS No. 48, at the time of the sale based on the following: the selling price is fixed at the date of sale, the buyer is obligated to pay the Company, title of the product transfers to the buyer, the buyer has economic substance apart from the Company, the Company does not have further obligations to assist the buyer in the resale of the product and the returns can be reasonably estimated at the time of sale. While the Company has no other obligations to perform future services subsequent to shipment, the Company provides telephone customer support as an accommodation to purchasers of its products and as a means of fostering customer loyalty. Costs associated with this effort are insignificant and, accordingly, are expensed as incurred. Allowance For Product Returns and Price Markdowns: - -------------------------------------------------- The Company distributes the majority of its products through several third-party distributors and directly to national and regional retailers. The distribution of these products is governed by distribution agreements, direct sale agreements or purchase orders, which generally allow for product returns and price markdowns. For shipments to its customers that have traditionally sold consumer PC software products, the Company records an allowance for returns and markdowns as a reduction of gross sales at the time title of the products pass to the customer. This allowance, which is reflected as a reduction of accounts receivable, is estimated based primarily upon historical experience. During the quarters ended December 31, 2000 and 1999, the Company's provisions for product returns and price markdowns for customers that have traditionally sold consumer PC software products were approximately $862,000 and $473,000 or 42% and 17% of related gross shipments, respectively. During the six months ended December 31, 2000 and 1999, the Company's provisions for product returns and price markdowns for customers that have traditionally sold consumer PC software products were approximately $1,087,000 and $1,041,000 or 33% and 17% of related gross shipments, respectively. Customer Advance Payments Although the Company recognizes revenue from food and drug retailers based on the timing of the actual sell-through of the Company's products to the end consumer, the Company may receive payments from these food and drug retailers in advance of such products being sold to the end consumer. These payments are recorded as customer advance payments in the Company's Consolidated Balance Sheet until such time as the products are actually sold through to the end consumer. After the products are sold through to the end consumer, the customer advance payment amount is recorded as revenue. In the event that the Company receives customer advance payments that ultimately exceed the actual product sell-through of the Company's products to the end consumer at such retailers, the Company would owe these retailers such excess amounts. Prepaid Royalties Prepaid royalties represent advance payments made to licensors of software and intellectual properties used in the Company's products. Prepaid royalties are expensed at contractual royalty rates based on net product sales. Marketing and Sales Incentive Costs Marketing costs for which the Company pays its resellers, such as slotting and advertising fees, are charged to expense as incurred and were approximately $402,000 and $365,000 for the quarters ended December 31, 2000 and 1999, respectively and were approximately $772,000 and $604,000 for the six months ended December 31, 2000 and 1999, respectively. Sales incentive costs, such as rebates and coupons, that the Company offers to the retail consumer are recorded as reductions to net sales as incurred and were approximately $205,000 and $317,000 for the quarters ended December 31, 2000 and 1999, respectively and were approximately $313,000 and $362,000 for the six months ended December 31, 2000 and 1999, respectively. Notes to Consolidated Financial Statements (continued) Permanent Racking and Fixture Costs The Company has included the costs of all long-term racking and fixtures already shipped to retail stores for use in its Store-In-A-Store ("SIAS") program within the Balance Sheet classification of "Prepaid royalties and other expenses". The Company expenses these costs over a one-year period from the date the racks are placed into use at retail locations. As of December 31, 2000, the Company had $184,000 of these costs reflected in the "Prepaid royalties and other expenses" section of its Balance Sheet. Any costs relating to permanent racking and fixtures not yet in use at retail locations are classified in the inventory section of the Company's Balance Sheet, and as of December 31, 2000 these costs amounted to $109,000. New Accounting Pronouncements During the first quarter of fiscal 2001, the Company adopted Emerging Issues Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives". Accordingly, net sales amounts for current and prior periods reflect the reclassification of consumer and retailer rebate costs, from selling, general and administrative expenses to net sales. Additionally, the Company has evaluated its revenue recognition policies based upon Staff Accounting Bulletin 101 "Revenue Recognition" and related amendments and interpretations. Accordingly, the Company determined it should recognize revenues for fiscal 2001 and 2000 associated with product shipments to food and drug retailers based on the timing of the actual product sell-through activity to the end consumer of the Company's products at these retail locations and not at the time the Company ships its products to these food and drug retailers. The Company made this decision following its determination that it was not able to adequately estimate, at time of product shipment, the amount of product returns for product shipments to food and drug retailers. Revenues associated with the Company's product shipments to its customers that traditionally have sold consumer PC software products (such as mass-merchant retailers, or distributors servicing such retailers) are recognized at the time title to these products passes to these customers, less a historically-based provision for anticipated product returns. The Company is currently evaluating the potential impact of Emerging Issues Task Force ("EITF") 00-10 "Accounting for Shipping and Handling Fees and Costs". This pronouncement will become effective by the Company's fourth quarter of fiscal 2001. The Company does not expect the adoption of EITF 00-10 to have a significant impact on its results of operations, financial position or cash flows. 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 Six Months Ended December 31, December 31, ------------------------- ------------------------- 2000 1999 2000 1999 ----------- ----------- ----------- ----------- Net income (loss) ($ 441,979) $ 27,249 ($1,725,997) ($ 46,985) Other comprehensive income (loss): Foreign currency translation adjustment 75,185 (8,778) 14,065 10,051 ----------- ----------- ----------- ----------- Comprehensive income (loss) ($ 366,794) $ 18,471 ($1,711,932) ($ 36,934) =========== =========== =========== ===========
Notes to Consolidated Financial Statements (continued) 3. Common Stock 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 had 90 calendar days, or until February 8, 2001, to regain compliance with this Rule. On February 7, 2001, the Company requested a hearing before a Nasdaq Listing Qualifications Panel, which stayed the delisting of the Company's common stock from the Nasdaq SmallCap Market pending the Panel's decision. The Company's hearing had been scheduled for March 23, 2001. The Company did not attend the scheduled hearing because management did not believe that it had sufficient evidence to present to the hearing board, as of March 23rd, that would have caused them to further stay the Company's de-listing. Accordingly, effective April 2, 2001, the Company's common stock began trading on the OTC Bulletin Board under its existing symbol EGAM. The Company's common stock had traded on the Nasdaq SmallCap Market since October 1995. 4. Discontinued Operation On May 11, 2001, the Company sold eGames Europe Limited, its wholly-owned subsidiary located in the United Kingdom, to a non-related third-party. The Company has reflected the relevant activity and account balances for this operation as a discontinued operation within each of the respective financial statements included in this report. The Company received $300,000 in net proceeds, which approximated the discontinued operation's net book value. The net proceeds consisted of: $150,000 in cash provided at closing, $120,000 in a note receivable to be payable in twelve monthly payments of $10,000 each, and $30,000 in cash held in escrow to be released to the Company, pending any unresolved claims, six months following the closing of the sale. The amounts in the accompanying consolidated financial statements and footnotes have been reclassified for all periods presented to give effect to the discontinued operation. Net sales for the discontinued operation for the quarters ended December 31, 2000 and 1999 were approximately $768,000 and $612,000, respectively and for the six months ended December 31, 2000 and 1999 were $1,359,000 and $1,189,000, respectively. The income from the discontinued operation was approximately $89,000 and $97,000 for the quarters ended December 31, 2000 and 1999, respectively, which amounts were net of income tax provisions of approximately $5,000 and $3,000, respectively. The income from the discontinued operation was approximately $68,000 and $161,000 for the six months ended December 31, 2000 and 1999, respectively, which amounts were net of income tax benefits of approximately $20,000 and $4,000, respectively. Included in the Company's Consolidated Balance Sheet for December 31, 2000, were net current assets of discontinued operation totaling approximately $530,000, primarily comprised of accounts receivable, which was partially offset by accounts payable and accrued expenses. Additionally, in the Company's Consolidated Balance Sheet for December 31, 2000 were net long term assets of discontinued operation totaling approximately $225,000, primarily comprised of un-amortized goodwill related to the prior acquisition of this discontinued operation during fiscal 1999 and certain furniture and equipment costs. 5. Operations by Reportable Segments SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" establishes standards for reporting information about an enterprise's operating segments and related disclosures about its products, geographic areas and major customers. Based on the Company's organizational structure and its presentation of the discontinued operation, the Company operates in only one reportable segment, which is publishing interactive entertainment software for personal computers. Notes to Consolidated Financial Statements (continued) 6. Revolving Credit Facility 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 credit facility was established to provide, among other things, additional working capital to support the Company's operations. 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 covenants, 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 had an initial minimum effective net worth covenant starting at $3.1 million at June 30, 2000, which increases by $150,000 quarterly to a $3.7 million requirement at June 30, 2001. Effective net worth is defined as the Company's stockholders' equity less its intangibles and other assets. As of December 31, 2000, the Company was not in compliance with the maximum senior debt to effective net worth ratio and minimum effective net worth covenants. The bank has waived the Company's non-compliance with these covenants at December 31, 2000. The Company believes that it will continue to be in non-compliance with the already identified covenants through June 30, 2001 and is currently working with its bank on a mutually agreeable resolution to the non-compliance issue. As of February 12, 2001, the Company had a $950,000 outstanding balance under this credit facility and continued to have full access to the remaining balance available under this $2,000,000 credit facility. 7. Liquidity 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 timeliness of product returns and the Company's ability to resell such products after return; 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, many 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. 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. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The accompanying consolidated financial statements as of December 31, 2000 include the accounts of eGames, Inc. (the "Company") and its previously wholly-owned subsidiary that is presented as a discontinued operation. Dollar amounts discussed within the Company's "Management's Discussion and Analysis of Financial Condition and Results of Operations" have been rounded to the nearest thousand ('000). Forward-Looking Statements This Quarterly Report on Form 10-QSB/A 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 between 5 % and 10% 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 Company's intention to reduce the use of outside professional service vendors in order to continue to cut future operating expenses; the transition of the Company's international product distribution to a licensing model, and the ability of this new model to earn a royalty for the Company; the possibility of customer advance payments exceeding the actual product sell-through at retail stores, and the resulting requirement that the Company be required to repay these retailers; the sufficiency of the Company's cash and working capital balances to fund the Company's operations; 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 to, or received by, a customer that has traditionally sold PC software; 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 reduce outside professional vendors costs; the success of the Company's international product distribution to earn a royalty for the Company and the ability of licensors to pay the Company such royalties; 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 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" 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 December 31, 2000 and 1999 Net Sales Net sales for the quarter ended December 31, 2000 were $2,590,000 compared to $3,091,000 for the quarter ended December 31, 1999, representing a decrease of approximately $501,000 or 16%. The $501,000 decrease in net sales was primarily attributable to the Company's decrease in net sales to its North American traditional software distributors and retailers of $1,212,000 and a decrease in net sales to international customers of $6,000. These net sales decreases were partially offset by an increase in the Company's net sales to North American food and drug retailers of $717,000. The Company's net sales to North American traditional software distributors and retailers decreased by $1,212,000. These net sales decreases resulted in large part from industry-wide reductions of PC software inventory levels held by North American software retailers and distributors. Market factors that negatively affected net sales to the North American traditional consumer software retailers included: distribution partners reducing their inventories by decreasing their replenishment orders for the Company's products; increased competition in the value-priced segment of the consumer software marketplace as several major software publishers initiated price cuts on previously higher-priced products; overall slower sales of PC game software in traditional retail software channels; and, certain office superstores reducing their selection of value-priced consumer software products, requiring the Company to increase its return provisions for the three months ended December 31, 2000. The Company's net sales to North American food and drug retailers increased by $717,000 compared to the same quarter a year ago. During fiscal 2001, the Company has continued to increase its distribution efforts to North American food and drug retailers, in an attempt to offset some of the previously discussed net sales decreases to its North American traditional software retail and distribution customers. During fiscal 2001, the Company established its first "Store-in-a-Store" entertainment software display sections in 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 help secure longer-term placement of the Company's products in this retail channel, with the goal of increasing product sell through volume at these food and drug retailers while decreasing the rate of product returns due to longer product exposure on the retailers' product shelves. The Company's international net revenues, inclusive of both product net sales and royalty revenues, for the quarter ended December 31, 2000 decreased by $6,000 compared to the same period a year ago. As a percentage of net sales, the Company's international net revenues represented approximately 6% and 5% of the Company's net sales for the quarters ended December 31, 2000 and 1999, respectively. The Company anticipates that international net revenues will range from 5% to 10% of the Company's consolidated net sales for the remainder of fiscal 2001. On May 11, 2001, the Company sold its wholly-owned subsidiary "eGames Europe Limited", located in the United Kingdom, to a non-related third-party. By affecting this sale, the Company transitioned the majority of its international product distribution efforts to a licensing revenue model, whereby the Company no longer bears the working capital risk of supporting these multi-country product sales efforts, but will earn a royalty fee based upon net product sales covered under various licensing arrangements with third-party developers. The Company has reflected the net sales activity for this operation as a discontinued operation within the Company's Consolidated Statements of Operations. Net sales for the discontinued operation for the quarters ended December 31, 2000 and 1999 were $768,000 and $612,000, respectively. The Company has continued to implement programs designed to increase sales of its products over the Internet, including: entering into cross-promotional agreements with larger, high-profile companies to offer coupons for discounts for the Company's products on websites and in newsletters; continual improvements and updates to its website and electronic distribution capabilities; and incorporation of optional, user-friendly on-line functionality into its products. Net sales of the Company's products via the Internet for the quarters ended December 31, 2000 and 1999 were $43,000 and $37,000, respectively, or approximately 2% and 1% of the Company's net sales, respectively. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Most of the Company's non-exclusive arrangements with its traditional software distributors and retailers allow for product returns or price markdowns. During the quarters ended December 31, 2000 and 1999, the Company's provisions for product returns and price markdowns relating to product shipments to its traditional software customers totaled approximately $862,000 and $473,000, or 42% and 17% of related gross shipments, respectively. This $389,000 increase in the provision for product returns and price markdowns relating to product shipments to its traditional software customers was primarily associated with the Company's office superstore customers that returned products in connection with their transition away from value-priced casual gaming software titles. Although the Company has experienced an increase in product shipments to food and drug retailers, the majority of these product shipments have been "promotional" in nature, meaning that the Company's products were merchandised in those retail stores for only six to eight weeks. As a result of this short promotional period, the Company has experienced a higher and more unpredictable rate of product returns from food and drug retailers compared to product return rates from traditional software retailers and distributors where the Company's products typically have a longer period of time to sell through to end consumers. Cost of Sales Cost of sales for the quarter ended December 31, 2000 were $1,413,000 compared to $1,259,000 for the quarter ended December 31, 1999, representing an increase of $154,000 or 12%. This $154,000 increase in cost of sales was caused primarily by a $215,000 increase in the provision for inventory obsolescence primarily caused by the discontinuance of various end of lifecycle products and the scrapping of unsold, date-sensitive consumer income tax software that the Company distributed to many of its food and drug retailers, and a $110,000 increase in the Company's distribution, packaging and reclamation costs largely associated with the Company's product shipments to food and drug retailers. Most of the revenues related to product shipments to food and drug retailers have been deferred until such time as product sell through to the end consumer is reported to the Company by the food and drug retailer. These costs of sales increases were partially offset by decreases in product costs and royalty costs of $149,000 and $22,000, respectively, primarily related to the decrease in the Company's net sales for the quarter ended December 31, 2000. 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 December 31, 2000 decreased to 45.4% of net sales from 59.3% of net sales for the quarter ended December 31, 1999. This 13.9% decrease in gross profit margin was caused primarily by an increase in provision for inventory obsolescence of 8.4%, as a percentage of net sales, primarily caused by the discontinuance of various end of lifecycle products and the scrapping of unsold date-sensitive consumer income tax software that the Company distributed to many of its food and drug retailers, a 5.3% increase, as a percentage of net sales, in the Company's distribution, packaging and reclamation costs largely associated with certain revenues being deferred until such time (if ever) that these products sales to the end consumer are reported to the Company by the food and drug retailer, and a 4.5% increase, as a percentage of net sales, in product costs related to sales of third-party publisher software titles. These decreases to the Company's gross profit margin were partially offset by a 4.8% decrease in the product costs associated with the sales of Company published software titles. Operating Expenses Product development expenses for the quarter ended December 31, 2000 were $176,000 compared to $221,000 for the quarter ended December 31, 1999, a decrease of $45,000 or 20%. This decrease was caused primarily by a 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 December 31, 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 December 31, 2000 were approximately $1,549,000 compared to approximately $1,526,000 for the quarter ended December 31, 1999, an increase of approximately $23,000 or 2%. This $23,000 increase was caused primarily by increases in salary related costs and bad debt expense of $80,000 and $55,000, respectively, which costs increases were partially offset by decreases in public corporation expense and professional service expense of $75,000 and $45,000, respectively. The $80,000 increase in salary related expense was primarily related to increase sales and marketing resources needed to support the growing number of customer accounts being serviced by the Company. The $55,000 increase in bad debt expense was necessary as certain of the Company's customers have begun to show some potential weakness in being able to repay their outstanding receivable balance with the Company. In January 2001, the Company effected a 25% reduction in its workforce in order to save an estimated $150,000 in salary and related expenses per quarter. The Company is also reducing its utilization of outside professional service vendors in order to continue to cut operating expenses going forward. Interest Expense, Net Net interest expense for the quarter ended December 31, 2000 was approximately $23,000 compared to approximately $6,000 for the quarter ended December 31, 1999, an increase of approximately $17,000. The $17,000 increase was primarily due to the increased utilization of the revolving credit facility for the quarter ended December 31, 2000 compared to the same period a year earlier. Provision (Benefit) for Income Taxes (Benefit) for income taxes for the quarter ended December 31, 2000 was ($40,000) compared to a provision for income taxes of $149,000 for the quarter ended December 31, 1999, a decrease in the provision for income taxes of $189,000. This $189,000 decrease in the provision for income taxes was primarily due to the $649,000 increase in the Company's loss from continuing operations before income taxes for the quarter ended December 31, 2000. Loss from Continuing Operations As a result of the various factors discussed above, the Company recognized a $531,000 loss from continuing operations for the quarter ended December 31, 2000, compared to a $70,000 loss from continuing operations for the quarter ended December 31, 1999, an increase of $461,000 in losses from continuing operations. Income from Discontinued Operation Income from discontinued operation for the quarter ended December 31, 2000 was $89,000, net of a $5,000 income tax provision, compared to income from discontinued operation for the quarter ended December 31, 1999 of $97,000, net of a $3,000 income tax provision, resulting in an $8,000 decrease in income from discontinued operation. This $8,000 decrease was caused by increases in operating expenses and provision for income taxes of $6,000 and $2,000, respectively. Net Income (loss) As a result of the factors discussed above, net (loss) increased to ($442,000) for the quarter ended December 31, 2000 from net income of $27,000 for the quarter ended December 31, 1999, a decrease in profitability of $469,000. Weighted Average Common Shares The weighted average common shares outstanding on a diluted basis decreased by 385,004 for the quarter ended December 31, 2000 to 9,749,975 from 10,134,979 for the quarter ended December 31, 1999. This 385,004 decrease in weighted average common shares outstanding was caused primarily by a decrease in common stock equivalents resulting from the Company's recording of a net loss for the quarter ended December 31, 2000. Such common stock equivalents were excluded from the diluted shares calculation, because their inclusion would have had an anti-dilutive effect. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Results of Operations Six Months Ended December 31, 2000 and 1999 Net Sales Net sales for the six months ended December 31, 2000 were $3,735,000 compared to $5,653,000 for the six months ended December 31, 1999, representing a decrease of $1,918,000 or 34%. The $1,918,000 decrease in net sales was primarily attributable to the Company's decrease in net sales to its North American traditional software distributors and retailers of $2,729,000, which net sales decrease was partially offset by net sales increases to North American food and drug retailers of $769,000 and to international customers of $42,000. The Company's net sales to North American traditional software distributors and retailers decreased by $2,729,000 during the six months ended December 31, 2000 compared to the same period a year ago. This decrease resulted in large part from industry-wide reductions of PC software inventory levels held by North American software retailers and distributors. The Company's net sales to North American food and drug retailers increased by $769,000 during the six months ended December 31, 2000 compared to the same period a year ago. As discussed above, during fiscal 2001, the Company has continued to increase its distribution efforts to North American food and drug retailers, in an attempt to offset some of the previously discussed net sales decreases to its North American traditional software retail and distribution customers. The Company's international net revenues, inclusive of both product net sales and royalty revenues, for the six months ended December 31, 2000 increased by $42,000 compared to the same period a year ago. As a percentage of net sales, the Company's international net revenues represented approximately 7% and 4% of the Company's net sales for the six months ended December 31, 2000 and 1999, respectively. The Company anticipates that international net revenues will range from 5% to 10% of the Company's consolidated net sales for the remainder of fiscal 2001. On May 11, 2001, the Company sold its wholly-owned subsidiary "eGames Europe Limited", located in the United Kingdom, to a non-related third-party. By affecting this sale, the Company transitioned the majority of its international product distribution efforts to a licensing revenue model, whereby the Company no longer bears the working capital risk of supporting these multi-country product sales efforts, but will earn a royalty fee based upon net product sales covered under various licensing arrangements with third-party developers. The Company has reflected the net sales activity for this operation as a discontinued operation within the Company's Consolidated Statements of Operations. Net sales for the discontinued operation for the six months ended December 31, 2000 and 1999 were $1,359,000 and $1,189,000, respectively. Net sales of the Company's products via the Internet for the six months ended December 31, 2000 and 1999 were $95,000 and $58,000, respectively, or approximately 3% and 1% of the Company's net sales, respectively. Most of the Company's non-exclusive arrangements with its traditional software distributors and retailers allow for product returns or price markdowns. During the six months ended December 31, 2000 and 1999, the Company's provision for product returns and price markdowns relating to product shipments to its traditional software customers totaled approximately $1,087,000 and $1,041,000, or 33% and 17% of related gross shipments, respectively. This $46,000 increase in the provision for product returns and price markdowns relating to product shipments to its traditional software customers was primarily associated with the Company's office superstore customers that returned products in connection with their transition away from value-priced casual gaming software titles. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Cost of Sales Cost of sales for the six months ended December 31, 2000 were $2,164,000 compared to $2,264,000 for the six months ended December 31, 1999, representing a decrease of $100,000 or 4%. This $100,000 decrease in cost of sales was caused primarily by decreases in product costs and royalty costs of $342,000 and $137,000, respectively, which largely related to the decrease in the Company's net sales for the six months ended December 31, 2000. These costs of sales decreases were partially offset by a $209,000 increase in the provision for inventory obsolescence primarily caused by the discontinuance of various end of lifecycle products and the scrapping of unsold date-sensitive consumer income tax software that the Company distributed to many of its food and drug retailers, and a $170,000 increase in the Company's distribution, packaging and reclamation costs largely associated with the Company's product shipments to food and drug retailers. Certain revenues related to these product shipments have been deferred until such time as product sell through to the end consumer is reported to the Company by the food and drug retailer. 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 six months ended December 31, 2000 decreased to 42.1% of net sales from 60.0% of net sales for the six months ended December 31, 1999. This 17.9% decrease in gross profit margin was caused primarily by an increase in provision for inventory obsolescence of 6.1%, as a percentage of net sales, due to the discontinuance of various end of lifecycle products and the scrapping of unsold date-sensitive consumer income tax software that the Company distributed to many of its food and drug retailers, a 7.3% increase, as a percentage of net sales, in the Company's distribution, packaging and reclamation costs largely as a result of certain revenues being deferred until such time (if ever) that these products sales to the end consumer are reported to the Company by the food and drug retailer, and a 3.6% increase, as a percentage of net sales, in product costs associated with the sales of third-party publisher software titles. Operating Expenses Product development expenses for the six months ended December 31, 2000 were $358,000 compared to $464,000 for the six months ended December 31, 1999, a decrease of $106,000 or 23%. This $106,000 decrease was caused primarily by a decrease in salary and related costs due to headcount reductions among the Company's technology-related staff and no employee bonus accrual for the six months ended December 31, 2000. Selling, general and administrative expenses for the six months ended December 31, 2000 were approximately $2,988,000 compared to approximately $2,878,000 for the six months ended December 31, 1999, an increase of approximately $110,000 or 4%. This $110,000 increase was caused primarily by increases in marketing promotion costs, salary related costs and bad debt expense of $168,000, $98,000 and $41,000, respectively, which cost increases were partially offset by decreases in public corporation expense of $148,000 and in depreciation and amortization expense of $44,000. The $168,000 increase in marketing promotion costs was associated with the Company's increased distribution efforts with food and drug retailers and the additional costs charged by traditional software retailers and distributors to support sales of the Company's products relating to the increased competition for retail shelf space. The $98,000 increase in salary related expense was primarily related to additional sales and marketing resources needed to support the growing number of customer accounts being serviced by the Company. The $41,000 increase in bad debt expense was necessary as certain of the Company's customers have begun to show some potential weakness in being able to repay their outstanding receivable balance with the Company. Interest Expense, Net Net interest expense for the six months ended December 31, 2000 was $31,000 compared to $10,000 for the six months ended December 31, 1999, an increase of $21,000. The $21,000 increase was primarily due to the increased utilization of the revolving credit facility for the six months ended December 31, 2000 compared to the same period a year earlier. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Provision (Benefit) for Income Taxes (Benefit) for income taxes for the six months ended December 31, 2000 was approximately ($12,000) compared to a provision for income taxes of approximately $245,000 for the six months ended December 31, 1999, a decrease in the provision for income taxes of approximately $257,000. This $257,000 decrease in the provision for income taxes was primarily due to the $1,843,000 increase in the Company's loss from continuing operations before income taxes for the six months ended December 31, 2000. Loss from Continuing Operations As a result of the various factors discussed above, the Company recognized a $1,794,000 loss from continuing operations for the six months ended December 31, 2000, compared to a $208,000 loss from continuing operations for the six months ended December 31, 1999, an increase of $1,586,000 in losses from continuing operations. Income from Discontinued Operation Income from discontinued operation for the six months ended December 31, 2000 was $68,000, net of a $20,000 income tax benefit, compared to income from discontinued operation for the six months ended December 31, 1999 of $161,000, net of a $4,000 income tax benefit, resulting in a $93,000 decrease in income from discontinued operation. This $93,000 decrease in income from discontinued operation was caused primarily by an increase in operating expenses of $149,000 largely associated with increased marketing promotion costs to support product sales. This increase in operating expenses was partially offset by increases of $40,000 in gross profit and $16,000 in income tax benefit. Net loss As a result of the factors discussed above, net loss increased to $1,726,000 for the six months ended December 31, 2000 from net loss of approximately $47,000 for the six months ended December 31, 1999, a decrease in profitability of $1,679,000. Weighted Average Common Shares The weighted average common shares outstanding on a diluted basis increased by 84,246 for the six months ended December 31, 2000 to 9,749,975 from 9,665,729 for the six months ended December 31, 1999. This 84,246 increase in weighted average common shares outstanding was caused primarily by an increase in the number of common shares outstanding during the six months ended December 31, 2000. Common stock equivalents ("CSE's") were excluded from the weighted average shares calculations due to their anti-dilutive impact caused by the net losses for both six-month periods. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Liquidity and Capital Resources As of December 31, 2000, the Company's cash and working capital balances were $63,000 and $1,565,000, respectively, and the Company's total stockholders' equity balance at December 31, 2000 was $1,985,000. Net cash used in operating activities was $1,806,000 and $411,000 for the six months ended December 31, 2000 and 1999, respectively. The $1,806,000 in net cash used in operating activities resulted primarily from the Company's net loss of $1,726,000. Additional items contributing to the $1,806,000 in net cash used in operating activities were increases in inventory, accounts receivable and prepaid expenses of $1,825,000, $463,000 and $317,000, respectively. These net cash uses were partially offset by cash sources of $1,004,000 in increased accounts payable, $927,000 in increased customer advance payments, $499,000 in increased accrued expenses, $118,000 in depreciation, amortization and other non-cash items and $45,000 in increased deferred revenues. The $927,000 in customer advance payments approximates the amount of customer payments from food and drug retailers that have exceeded the amount of revenue recognized by the Company relating to the actual product sell through of the Company's products to the end consumer reported by food and drug retailers. Net cash used in investing activities for the six months ended December 31, 2000 and 1999 were $42,000 and $66,000, respectively. The $42,000 in net cash used in investing activities resulted from purchases of $37,000 in furniture and equipment and $5,000 in other assets. Net cash provided by financing activities for the six months ended December 31, 2000 and 1999 were $867,000 and $221,000, respectively. The $867,000 in net cash provided by financing activities reflects net proceeds from the Company's borrowing under the revolving credit facility of $2,250,000, which was partially offset by repayments of the borrowing under the revolving credit facility, convertible subordinated debt, note payable and capital lease obligations of $1,200,000, $150,000, $27,000 and $6,000, respectively. Net cash used in the Company's discontinued operation for the six months ended December 31, 2000 and 1999 was $92,000 and $201,000, respectively. The $92,000 in net cash used in the Company's discontinued operation resulted primarily from $90,000 in net cash used in operating activities. As December 31, 2000, the Company had received $927,000 in customer payments from certain food and drug retailers for products shipped to such retailers prior to the sale of such products to the end consumer being reported to the Company from these retailers. These payments are recorded as customer advance payments in the Company's Consolidated Balance Sheet until such time that these retailers report to the Company that the products are actually sold to the end consumer. After the products are sold through to the end consumer, the customer advance payment amount is recorded as product revenue. In the event that the Company receives customer advance payments that ultimately exceed the actual product sell-through of the Company's products to the end consumer at such retailers, the Company would owe these retailers such excess amounts. The Company's management believes that it is highly likely that the ultimate product sell-through of the Company's products will be substantially less than the customer advance payment balances for these food and drug retailers. If these retailers request that the Company repay this liability, it would likely result in a serious liquidity issue for the Company. 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. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) As of December 31, 2000, the Company was not in compliance with the maximum senior debt to effective net worth ratio and minimum effective net worth covenants. The bank has waived the Company's non-compliance with these covenants at December 31, 2000. The Company believes that it will continue to be in non-compliance with the already identified covenants through June 30, 2001 and is currently working with its bank on a mutually agreeable resolution to the non-compliance issue. As of February 12, 2001, the Company had a $950,000 outstanding balance under this credit facility and continues to have full access to the remaining balance available under this $2,000,000 credit facility. 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. 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 had 90 calendar days, or until February 8, 2001, to regain compliance with this Rule. On February 7, 2001, the Company requested a hearing before a Nasdaq Listing Qualifications Panel, which stayed the delisting of the Company's common stock from the Nasdaq SmallCap Market pending the Panel's decision. The Company's hearing had been scheduled for March 23, 2001. The Company did not attend the scheduled hearing because management did not believe that it had sufficient evidence to present to the hearing board, as of March 23rd, that would have caused them to further stay the Company's de-listing. Accordingly, effective April 2, 2001, the Company's common stock began trading on the OTC Bulletin Board under its existing symbol EGAM. The Company's common stock had traded on the Nasdaq SmallCap Market since October 1995. New Accounting Pronouncements During the first quarter of fiscal 2001, the Company adopted Emerging Issues Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives". Accordingly, net sales amounts for current and prior periods reflect the reclassification of consumer and retailer rebate costs, from selling, general and administrative expenses to net sales. Additionally, the Company has evaluated its revenue recognition policies based upon Staff Accounting Bulletin 101 "Revenue Recognition" and related amendments and interpretations. Accordingly, the Company determined it should recognize revenues for fiscal 2001 and 2000 associated with product shipments to food and drug retailers based on the timing of the actual product sell-through activity to the end consumer of the Company's products at these retail locations and not at the time the Company ships its products to these food and drug retailers. The Company made this decision following its determination that it was not able to adequately estimate, at time of product shipment, the amount of product returns for product shipments to food and drug retailers. Revenues associated with the Company's product shipments to its customers that traditionally have sold consumer PC software products (such as mass-merchant retailers, or distributors servicing such retailers) are recognized at the time title to these products passes to these customers, less a historically-based provision for anticipated product returns. The Company is currently evaluating the potential impact of Emerging Issues Task Force ("EITF") 00-10 "Accounting for Shipping and Handling Fees and Costs". This pronouncement will become effective by the Company's fourth quarter of fiscal 2001. The Company does not expect the adoption of EITF 00-10 to have a significant impact on its results of operations, financial position or cash flows. 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: March 26, 2002 /s/ Gerald W. Klein -------------- -------------------- Gerald W. Klein, President, Chief Executive Officer and Director Date: March 26, 2002 /s/ Thomas W. Murphy -------------- -------------------- Thomas W. Murphy, Chief Financial Officer and Chief Accounting Officer -----END PRIVACY-ENHANCED MESSAGE-----