-----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, Bl7z1DchaybLodxYDMwGx+lyFPq8Kdp42dMQ6bkOP2wZgkDDFcRlRTjwDv6gKFcb GYBNfK2+3bgcVodOHH6pDw== 0000948703-06-000004.txt : 20060515 0000948703-06-000004.hdr.sgml : 20060515 20060515123810 ACCESSION NUMBER: 0000948703-06-000004 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060515 DATE AS OF CHANGE: 20060515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EGAMES INC CENTRAL INDEX KEY: 0000948703 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 232694937 STATE OF INCORPORATION: PA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 033-95122 FILM NUMBER: 06838576 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 q32006-10qsb.txt EGAMES, INC. 10QSB (QUARTER ENDED MARCH 31, 2006) U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2006 |_| 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 ( ) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ( ) No (X) 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: 11,724,193 shares of common stock, no par value per share, as of May 12, 2006. Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X ) INDEX Page Part I. Financial Information ---- Item 1. Unaudited Financial Statements: Balance Sheet at March 31, 2006 ......................... 3 Statements of Operations for the three and nine months ended March 31, 2006 and 2005 ....................... 4 Statements of Cash Flows for the nine months ended March 31, 2006 and 2005 ....................... 5 Notes to Financial Statements............................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................. 12 Item 3. Controls and Procedures ................................. 25 Part II Other Information Item 6. Exhibit Listing ......................................... 26 Exhibit Index ......................................................... 26 Signatures ......................................................... 27 Exhibits ......................................................... 28 Item 1. Unaudited Financial Statements eGames, Inc. Balance Sheet (Unaudited) March 31, ASSETS 2006 - ------ ----------- Current assets: Cash and cash equivalents $ 1,483,306 Accounts receivable, net 1,009,662 Inventory, net 956,348 Prepaid and other expenses 339,068 ----------- Total current assets 3,788,384 Furniture and equipment, net 30,375 Goodwill 420,000 Intangible assets 24,089 ----------- Total assets $ 4,262,848 =========== LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Current liabilities: Accounts payable $ 474,367 Accrued expenses 448,621 ----------- Total current liabilities 922,988 ----------- Stockholders' equity: Common stock, no par value (40,000,000 shares authorized; 11,956,093 issued and 11,724,193 outstanding) 9,179,827 Additional paid-in capital 2,114,477 Accumulated deficit (7,453,027) Treasury stock, at cost - 231,900 shares (501,417) ----------- Total stockholders' equity 3,339,860 ----------- Total liabilities and stockholders' equity $ 4,262,848 =========== See accompanying notes to financial statements. eGames, Inc. Statements of Operations (Unaudited)
Three Months Ended Nine Months Ended March 31, March 31, --------------------------- --------------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Net sales $ 1,264,898 $ 1,459,623 $ 3,712,963 $ 4,550,082 Cost of sales 711,223 646,116 2,093,648 2,056,508 ----------- ----------- ----------- ----------- Gross profit 553,675 813,507 1,619,315 2,493,574 Operating expenses: Product development 164,788 101,894 376,308 444,887 Selling, general and administrative 647,875 660,969 1,809,777 1,879,634 ----------- ----------- ----------- ----------- Total operating expenses 812,663 762,863 2,186,085 2,324,521 ----------- ----------- ----------- ----------- Operating income (loss) (258,988) 50,644 (566,770) 169,053 Interest income, net 11,370 2,007 31,778 4,834 ----------- ----------- ----------- ----------- Income (loss) before income taxes (247,618) 52,651 (534,992) 173,887 Provision for income taxes - 0 - 6,483 - 0 - 16,784 ----------- ----------- ----------- ----------- Net income (loss) ($ 247,618) $ 46,168 ($ 534,992) $ 157,103 =========== =========== =========== =========== Net income (loss) per common share: - Basic ($ 0.02) $ 0.00 ($ 0.05) $ 0.02 ====== ====== ====== ====== - Diluted ($ 0.02) $ 0.00 ($ 0.05) $ 0.01 ====== ====== ====== ====== Weighted average common shares outstanding - Basic 11,724,193 10,655,108 11,416,555 10,291,370 Dilutive effect of common share equivalents - 0 - 375,041 - 0 - 700,962 ---------- ---------- ---------- ---------- Weighted average common shares outstanding - Diluted 11,724,193 11,030,149 11,416,555 10,992,332 ========== ========== ========== ==========
See accompanying notes to financial statements. eGames, Inc. Statements of Cash Flows (Unaudited)
Nine Months Ended March 31, -------------------------- 2006 2005 ---------- ----------- OPERATING ACTIVITIES: - --------------------- Net income (loss) ($ 534,992) $ 157,103 Adjustment to reconcile net income (loss) to net cash (used in) provided by operating activities: Stock-based compensation 58,333 56,972 Depreciation 24,265 27,151 Changes in operating assets and liabilities: Accounts receivable, net (740,494) 738,025 Inventory, net (62,582) (118,668) Prepaid and other expenses (25,384) 124,162 Accounts payable 317,775 (240,934) Accrued expenses 38,981 (265,349) ----------- ----------- Net cash (used in) provided by operating activities (924,098) 478,462 ----------- ----------- INVESTING ACTIVITIES: - --------------------- Purchases of furniture and equipment (4,758) (11,689) ----------- ----------- Net cash used in investing activities (4,758) (11,689) ----------- ----------- FINANCING ACTIVITIES: - --------------------- Dividend payments to common stockholders - 0 - (163,601) Proceeds from exercise of stock options - 0 - 229,642 ----------- ----------- Net cash provided by financing activities - 0 - 66,041 ----------- ----------- Net (decrease) increase in cash and cash equivalents (928,856) 532,814 Cash and cash equivalents: Beginning of period 2,412,162 1,742,224 ----------- ----------- End of period $ 1,483,306 $ 2,275,038 =========== =========== Supplemental cash flow information: Cash paid (refunds received) for income taxes ($ 34,000) $ 137,040 =========== ===========
See accompanying notes to financial statements. eGames, Inc. Notes to Financial Statements (Unaudited) 1. Summary of Significant Accounting Policies Description of Business eGames, Inc. ("eGames", "our", "us", or "we") is a Pennsylvania corporation incorporated in July 1992 that publishes, markets and sells PC software games. Historically, we have focused on publishing affordable software games for the PC platform only, and selling the greatest volume of our PC games in mass-market retail stores. We have explored the possibility of publishing games for other gaming platforms, such as consoles and hand-held devices, and have determined at this time to focus on publishing for the PC platform only because of the greater amount of cash and other resources that would be required to pursue publishing titles for other gaming platforms. Our current strategy is to begin shifting our focus to publishing higher quality, higher-priced PC games, in addition to our value-priced jewel case PC titles, and look more aggressively at opportunities to tap into the growing sales of casual and hardcore PC games via the Internet, in addition to maintaining a strong retail presence. In North America, our PC games are distributed primarily through third-party software distributors who service mass-merchant and major retailers. In territories outside North America, we license our PC games to third-party software distributors who are responsible for the manufacture and distribution of our PC games within specific geographic territories. We promote the eGames(TM), Cinemaware(R) and Cinemaware Marquee(TM) brands in order to generate customer loyalty, encourage repeat purchases and differentiate our software products to retailers and consumers. Basis of Presentation The accompanying unaudited interim financial statements were prepared in accordance with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, these financial statements do not include all information and disclosures required by generally accepted accounting principles in the United States for complete financial statements. These financial statements include all adjustments that management believes are necessary for a fair presentation of the financial statements. These interim operating results are not necessarily indicative of the results for a full year. The accompanying financial statements should be read in conjunction with the audited financial statements and notes thereto contained in our Form 10-KSB for the fiscal year ended June 30, 2005. Amounts discussed within the "Notes to Financial Statements" have been rounded to the nearest thousand ("000") dollars. Fair Value of Financial Instruments The recorded amounts of cash and net accounts receivable at March 31, 2006 approximate fair value due to the relatively short period of time between origination of the instruments and their expected realization. All liabilities are carried at cost, which approximate fair value for similar instruments. Cash and Cash Equivalents For purposes of the statements of cash flows, we consider all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Accounts Receivable, net Accounts receivable is reflected net of allowances for product returns, price markdowns and customer bad debts. The adequacy of these allowances is reviewed throughout each reporting period and any necessary adjustments to these allowances are reflected within the current period's provisions for product returns and price markdowns (reflected as a reduction to gross sales); and customer bad debts (if any, reflected as an operating expense). Actual product returns, price markdowns and customer bad debts are recorded as reductions to these allowances as well as reductions to the customers' individual accounts receivable balances (see Note 2). Inventory, net Inventory, net consists primarily of finished goods and is valued at the lower of cost or market. Cost is determined by the first-in, first-out method (FIFO). Furniture and Equipment, net Furniture and equipment, net is stated at cost and net of accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets ranging from three to five years (see Note 5). Long-Lived Assets, net In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we record impairment losses on long-lived assets, including intangible assets, used in operations when the fair value of those assets, less the cost to sell, is lower than our carrying value for those assets. Goodwill and Other Intangible Assets Goodwill is the excess purchase price paid by an acquiring company for identified intangible and tangible net assets. Intangible assets usually consist of trademarks, intellectual property, non-compete agreements, customer lists and acquired technology. SFAS No. 142, "Goodwill and Other Intangible Assets" requires that purchased goodwill and intangibles with indefinite lives not be amortized. Rather, goodwill and intangible assets with indefinite lives are subject to at least an annual assessment for impairment by applying a fair-value-based test. SFAS No. 142 requires a two-step approach to testing goodwill for impairment for each reporting unit. The first step tests for impairment by applying fair value-based tests at the reporting unit level. The second step (if necessary), measures the amount of impairment by applying fair value-based tests to individual assets and liabilities within each reporting unit. Revenue Recognition Product Sales ------------- We distribute the majority of our products through third-party software distributors to North American mass-merchant and major retailers and directly to certain PC software retailers. The distribution of our products is governed by purchase orders, distribution agreements, or direct sales agreements, most of which allow for product returns and price markdowns. We recognize revenues from product shipments to most software distributors and retailers at the time title to our inventory transfers to the distributor or retailer, less a provision for anticipated product returns and price markdowns. However, if we determine that we are not able to estimate an appropriate provision for product returns and price markdowns for any retailer or distributor, we then recognize revenues for product deliveries to these retailers or distributors on a consignment basis. Title to our products usually transfers to software distributors and retailers upon their receipt of our products, because retailer and distributor purchase orders typically reflect shipping terms of FOB destination. In order to recognize revenues associated with customer purchase orders having terms of FOB destination, we perform sales cut-off tests, in which we obtain proof of deliveries for product shipments made during the last two weeks of a reporting period from the freight companies that deliver our products to our retail and distribution customers. Revenues and costs associated with product shipments received by our customers after the end of a reporting period and having FOB destination terms are excluded from the current period's operating results and are deferred until the subsequent reporting period. We recognize revenues in accordance with the criteria of SFAS No. 48 at the time title to our inventory passes to software distributors or retailers, based on the following: the selling price is fixed at the date of sale; the buyer is obligated to pay us; title of the product transfers to the buyer; the buyer has economic substance apart from us; we do not have further obligations to assist the buyer in the resale of the product; and product returns and price markdowns can be reasonably estimated at the time of sale. After product deliveries to our distribution and retail customers are made, we do not provide any further services or materials that are essential to our products' functionality. However, we do provide basic telephone and web-based support as a means of improving consumer satisfaction and brand loyalty. We also have relationships with certain software distributors for product distribution to various retailers based on consignment and sell-through agreements. Accordingly, revenues from product shipments pursuant to these types of agreements are only recognized to the extent that the distributor has reported to us that our product has actually sold through to consumers. Provision for Product Returns and Price Markdowns ------------------------------------------------- Our provision for anticipated product returns and price markdowns (reflected as a reduction to gross sales) is primarily based on our analysis of: historical product return and price markdown results; current product sell-through activity at retail store locations; current field inventory quantities at distributors' warehouses and at retail store locations; the length of time that products have been released at retail along with their estimated remaining retail life; outstanding return material and price markdown authorizations; the introduction of new and/or competing software products that could negatively impact the sales of one or more of our current products; and the extent to which quantities of products with higher retail price points or unproven game genres remain in the retail channel. The adequacy of our allowance for product returns and price markdowns is reviewed throughout each reporting period and any necessary adjustment to this allowance is reflected within the current reporting period's provision. At the end of each reporting period, the allowance for product returns and price markdowns is reflected as a reduction to our gross accounts receivable. At March 31, 2006, the allowance for product returns and price markdowns amounted to 39% of our gross accounts receivable. Historically, the allowance for product returns and price markdowns has represented a large percentage of our gross accounts receivable because we continue to have product return and price markdown exposure for the software units related to paid receivables while these units remain in the retailers' stores or in the retailers' or distributors' warehouses. Until physical software units sell through to consumers, or are returned to us, we continue to evaluate our product return or price markdown exposure for these previously sold units while these units remain in the retail channel. During reporting periods, through retailer and distributor provided reports, we have regular and timely visibility of product sell-through activity and remaining quantities of our titles in the retail channel that help us assess our exposure for future product returns and price markdowns. Prepaid and Other Expenses Prepaid and other expenses represent advance payments made to third parties for items such as licensing of software and intellectual properties used in our products, estimated tax payments, certain insurance coverage, retail market reporting, certain advertising costs and various service contracts. Prepaid and other expenses are usually expensed as operating expenses on a straight-line basis over the period of time covered by a contract. Advance licensing and royalty payments are usually expensed as cost of sales at the higher of the contractual or effective rate (see Notes 4 and 7). Tax payments are reflected as income tax expense when appropriate. We continually evaluate the recoverability of our advanced licensing and royalty payments by reviewing the information available about each title and the underlying licensed content. In particular, we evaluate the expected future sales of a title or potential subsequent titles containing the same licensed content based on current and potential sales programs, along with historical sell-through results of similar titles to consumers. For titles that have achieved distribution into their intended retail channels, we charge to cost of sales the remaining capitalized costs we determine to be non-recoverable in future periods. In the rare circumstance that a title does not achieve distribution into its intended retail channels, we charge to product development expense the remaining capitalized costs we determine to be non-recoverable in future periods. Capitalized costs determined to be non-recoverable are expensed in the reporting period in which the decision is reached by management that recoverability of these costs in future periods is unlikely. Income Taxes We use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for net operating loss and credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Computation of Net Income (Loss) per Common Share Net income (loss) per common share is computed in accordance with SFAS No. 128, "Earnings per Share". Basic earnings per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during each period. Diluted earnings per share is computed by dividing net earnings by the weighted average number of common shares and common share equivalents ("CSE's") outstanding during each period that we report net income. CSE's may include stock options and warrants using the treasury stock method. Management's Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities. Estimates and assumptions are made in: determining allowances for inventory obsolescence, product returns, price markdowns and customer bad debts; disclosure of contingent assets and liabilities; initial valuation and subsequent measurement of goodwill and other intangible assets; evaluating the recoverable value of advanced licensing and royalty payments at the end of the reporting period; in addition to determining the amounts of revenues and expenses recognized during each reporting period. We recognize the critical nature and potential impact from making these and any other estimates and attempt to make reliable estimates, based upon the information available to us as of any reporting period. However, we also recognize that actual results could differ from any of our estimates and that such differences could have either a negative or positive impact on future financial results. 2. Accounts Receivable, net Accounts receivable, net consists of the following: Accounts receivable, gross $ 1,658,000 Allowance for product returns and price markdowns (648,000) ------------ Accounts receivable, net $ 1,010,000 ============ 3. Inventory, net Inventory, net consists of the following: Raw materials - warehouse $ 265,000 Finished goods - warehouse 636,000 Finished goods - consignment 160,000 Product returns - retailer and distributor locations 62,000 ------------ Inventory, gross 1,123,000 Allowance for obsolescence (167,000) ------------ Inventory, net $ 956,000 ============ 4. Prepaid and Other Expenses Prepaid and other expenses consist of the following: Royalties $ 163,000 Federal tax 58,000 Insurances 56,000 Other expenses 27,000 Retail market reporting 25,000 Prepaid advertising 10,000 ------------ Prepaid and other expenses $ 339,000 ============ 5. Furniture and Equipment, net Furniture and equipment consists of the following: Furniture and equipment, gross $ 363,000 Accumulated depreciation (333,000) ------------ Furniture and equipment, net $ 30,000 ============ 6. Accrued Expenses Accrued expenses consist of the following: Vacation accrual $ 109,000 Marketing promotions 84,000 Royalties 60,000 Professional fees 50,000 Customer credit balances 40,000 Relocation and travel 34,000 State taxes 28,000 Other 24,000 Charities 20,000 ------------ Accrued expenses $ 449,000 =========== 7. Commitments and Contingencies Our 5,000 square foot office facility located in Langhorne, Pennsylvania is occupied under an operating lease through September 30, 2010. Additionally, we currently rent certain office equipment through various operating lease agreements. For the quarters ended March 31, 2006 and 2005, total rent expense amounted to $21,000 for both quarters. During the nine months ended March 31, 2006 and 2005, total rent expense amounted to $66,000 and $64,000, respectively. At March 31, 2006, we had future operating lease commitments of $238,000 scheduled to be paid as follows: $64,000 in less than one year; $152,000 in one to three years; and $22,000 in three to five years. Under various licensing agreements with third-party software developers, we are required to pay royalties for the use of licensed content in our products. Most of these licensing agreements require us to make advance royalty payments to these developers prior to the time we recognize any net sales of software titles containing this licensed software content. As of March 31, 2006, we had future commitments to pay $88,000 in advance licensing and royalty payments in less than one year to various third-party licensors and software developers. As part of a public relations campaign intended to support and promote our brands and the retail releases of our new higher priced PC game titles, at March 31, 2006 we had $22,000 in commitments relating to a professional services agreement with a public relations firm. 8. Credit Facility In December 2005, we renewed our credit facility agreement with Hudson United Bank ("HUB"), which matures on December 1, 2006. This credit facility was established to provide working capital for our operations. Amounts outstanding under this credit facility are charged interest at one-half of one percent above HUB's current prime rate and such interest is due monthly. Our access to these funds is limited to the lesser of $750,000 or seventy-five percent of qualified accounts receivable, which are defined as invoices less than ninety days old and net of any allowances for product returns, price markdowns and customer bad debts. As of March 31, 2006, we had not utilized any of this credit facility, and we had access to the full $750,000 amount under this credit facility, based on the prescribed calculation of seventy-five percent of qualified accounts receivable as of that date. The credit facility is secured by all of the Company's assets and requires us, among other things, to maintain certain financial covenants that are tested quarterly. 9. Concentration of Customers We continue to have a concentration of customers consisting of a few large software distributors and retailers. Historically, Atari, Inc. ("Atari") has represented our primary software distributor servicing the North American mass-merchants and other major retailers. In December 2005, we began to transition the majority of our mass-merchant retail distribution to Take-Two Interactive Software ("Take Two"), which has distributed our titles into the office superstore and discount warehouse retail channels for several years. During the three months ended March 31, 2006, Atari accounted for $277,000 of net sales, or 22% of net sales, compared to the three months ended March 31, 2005, when Atari accounted for $804,000 of net sales, or 55% of net sales. During the three months ended March 31, 2006, Take Two accounted for $281,000 of net sales, or 22% of net sales, compared to the three months ended March 31, 2005, when Take Two accounted for $61,000 of net sales, or 4% of net sales. We anticipate that Take Two will continue representing a growing percentage of our net sales and net accounts receivable in future periods, while at the same time Atari's share of our business will most likely continue to decline. During the nine months ended March 31, 2006, Atari accounted for $1,200,000 of net sales, or 32% of net sales, compared to the nine months ended March 31, 2005, when Atari accounted for $2,281,000 of net sales, or 50% of net sales. During the nine months ended March 31, 2006, Take Two accounted for $405,000 of net sales, or 11% of net sales, compared to the nine months ended March 31, 2005, when Take Two accounted for $178,000 of net sales, or 4% of net sales. At March 31, 2006, Atari's net receivable balance was $151,000, or 15% of our total net accounts receivable, compared to Take Two's net accounts receivable of $322,000, or 32%, of our total net accounts receivable. 10. Accounting for Stock-Based Compensation Effective July 1, 2002, we adopted within our financial statements the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" by applying the fair value method prospectively for stock options grants made on or after that date. On January 1, 2003, we adopted the provisions of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". During the three months ended March 31, 2006 and 2005, we recognized stock-based compensation expense within our financial statements of $21,000 and $20,000, respectively, and during the nine months ended March 31, 2006 and 2005, we recognized stock-based compensation expense within our financial statements of $58,000 and $57,000, respectively. 11. Operations by Reportable Segment and Geographic Area 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 products, geographic areas and major customers. Based on our organizational structure, we operate in only one geographic area, which is North America, and only one reportable segment, which is publishing consumer entertainment gaming software titles. 12. Goodwill and Other Intangible Assets At March 31, 2006, we had goodwill of $420,000, which related to the acquisition of substantially all of the assets of Cinemaware, Inc. in October 2005. The acquired assets consisted principally of goodwill, intellectual property and contract rights. We intend to use the acquired Cinemaware assets for developing, publishing and branding higher-priced game titles for the PC and possibly for other gaming platforms in the future. In consideration for the Cinemaware assets, eGames issued to Cinemaware 817,439 shares of its common stock valued at $300,000 based on the average closing stock price of the eGames' common stock for the ten trading days that ended on October 12, 2005 and warrants (valued at $120,000 using the Black-Scholes valuation model) to purchase 300,000 shares of eGames common stock. At March 31, 2006, we also had other intangible assets of approximately $24,000 relating to the Company's trademark registration activities with the United States Patent and Trademark Office. As of March 31, 2006, we had not recorded any expense relating to goodwill or other intangible assets based upon our evaluation that no impairment has occurred. 13. Advertising Costs We generally expense advertising costs (such as in-store circulars and point of sale materials) as incurred, except for production costs associated with media campaigns (such as print ads, online banner ads and video loops) which would be recognized as prepaid assets (to the extent these items were paid in advance) and expensed during the period in which the ad or video loop is first released to consumers. During the three months ended March 31, 2006 and 2005, advertising expenses totaled $27,000 and $9,000, respectively. During the nine months ended March 31, 2006 and 2005, advertising expenses amounted to $32,000 and $25,000, respectively. 14. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment" which revised SFAS No. 123, "Accounting for Stock-Based Compensation". This statement supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation expense relating to such transactions be recognized in the statement of operations. The revised statement became effective during the first interim period beginning after June 15, 2005. The adoption of SFAS No. 123 (revised 2004) did not have a material impact on our financial statements. In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4". SFAS No. 151 amends the guidance in Accounting Research Bulletin ("ARB") No. 43, "Restatement and Revision of Accounting Research Bulletins", Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and requires that those items be recognized as current-period charges. SFAS No. 151 also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 became effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 did not have a material impact on our financial statements. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This Quarterly Report on Form 10-QSB contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements made in this Quarterly Report on Form 10-QSB, other than statements of historical fact, including statements regarding industry prospects and future results of operations or financial position, are forward looking. We use the words "believe", "expect", "anticipate", "intend", "will", "should", "may" and similar expressions to identify forward-looking statements. These forward-looking statements are subject to business volatility, economic risk, and world events, which are inherently uncertain and difficult to predict. Our actual results could differ materially from management's expectations due to such risks. We will not necessarily update information if any forward-looking statement later turns out to be inaccurate. In particular, these forward-looking statements include, among others, statements about: - Our shifting focus to publishing higher quality, higher-priced PC game titles, and looking more aggressively at opportunities to sell our titles via the Internet; - The continuing impact on our financial results of decreasing retail shelf space for value-priced PC games and increased competition in this category; - Our anticipated release of two higher-priced PC titles during our fourth fiscal quarter; - Our expectation that product development expenses, licensing fees and advance royalty payments will increase compared to prior periods and we will incur higher costs for promotional efforts in future periods as we publish higher-priced PC game titles, and seek to develop our own titles; - Our attempts to seek incremental revenues through licensing, alternative retail channels and in-statement advertisers; - Our expectation that Take Two Interactive will continue representing a growing percentage of our net sales and net accounts receivable in future periods, while at the same time Atari's share of our business will most likely continue to decline; - Our plans to expand Internet sales by significantly revamping our existing websites into a gaming destination `portal;' - Our expectation that we will continue to receive product returns from retailers that are then sold to inventory liquidators at discounted prices; - Our provision for product returns and price markdowns, as a percentage of related gross sales, trending higher for the foreseeable future; - Our expectation that we will incur sales incentives and promotional costs from software distributors and retailers at an increasing rate for the foreseeable future; - Our expectation that we will continue to dispose of excess and slow moving inventory through our liquidation and discount channels; - The impact on our liquidity if Atari or Take Two were unable or unwilling to make receivable payments to us in a timely manner; - Continued monitoring of Atari's payment trends to us in order to avoid unanticipated collection issues as our distribution through Atari decreases; - Increased competition for retail shelf space for mid-range priced PC games to which we intend to shift our focus; and - The possibility that we may need to seek additional funds to provide financing for our strategy of publishing higher quality, and higher-priced, game titles for the PC. The following important factors, as well as those factors discussed under "Factors Affecting Future Performance" in our Form 10-KSB for the fiscal year ended June 30, 2005, could cause our actual results to differ materially from those indicated by the forward-looking statements contained in this report: - the market acceptance and successful sell-through results for our value priced and mid-range priced products at retail stores and via the Internet; - the continued successful business relationship between us and our primary distributors to major mass-market retailers; - the amount of shelf space major mass-market retailers allocate to our products; - the amount of unsold product that is returned to us by retailers and distributors; - the amount of price markdowns granted to retailers and distributors; - our ability to accurately estimate the amount of product returns and price markdowns that will occur and the adequacy of the allowances established for such product returns and price markdowns; - our ability to collect outstanding accounts receivable and establish an adequate allowance for customer bad debts; - the ability to deliver products in response to customer orders within a commercially acceptable time frame; - downward pricing pressure; - fluctuating costs of developing, producing, distributing and marketing our products; - our ability to license or develop quality content for our products on commercially-viable terms; - our ability to develop new higher-priced products and successfully enter the new market segment for higher-priced products; - our ability to control our costs and expenses in connection with implementing our new strategy; - our ability to fund our strategy of publishing higher quality and higher-priced game titles for the PC and developing our own PC game titles; - and increased competition. Overview The following overview identifies certain recent trends and events in our business. We believe that an understanding of these trends and events is important in order to understand our results for the three and nine months ended March 31, 2006, as well as our future results. This overview is not intended to be exhaustive, nor is it intended to be a substitute for the detailed discussion and analysis provided elsewhere in this Form 10-QSB, including the remainder of "Management's Discussion and Analysis of Financial Condition and Results of Operations," or the financial statements and the related notes. Amounts, other than percentages, discussed within the "Management's Discussion and Analysis of Financial Condition and Results of Operations" have been rounded to the nearest thousand ("000") dollars. About eGames eGames, Inc. ("eGames", "our", "us", or "we") is a Pennsylvania corporation incorporated in July 1992 that publishes, markets and sells PC software games. Historically, we have focused on publishing affordable software games for the PC platform only, and selling the greatest volume of our PC games in mass-market retail stores. We have explored the possibility of publishing games for other gaming platforms, such as consoles and hand-held devices, and have determined at this time to focus on publishing for the PC platform only because of the greater amount of cash and other resources that would be required to pursue publishing titles for other gaming platforms. Our current strategy is to begin shifting our focus to publishing higher quality, higher-priced PC games, in addition to our value-priced jewel case PC titles, and to look more aggressively at opportunities to tap into the growing sales of casual and hardcore PC games via the Internet, in addition to maintaining a strong retail presence. In North America, our PC games are distributed primarily through third-party software distributors who service mass-merchant and major retailers. In territories outside North America, we license our PC games to third-party software distributors who are responsible for the manufacture and distribution of our PC games within specific geographic territories. We promote the eGames(TM), Cinemaware(R) and Cinemaware Marquee(TM) brands in order to generate customer loyalty, encourage repeat purchases and differentiate our software products to retailers and consumers. Significant Trends and Events in our Business Publishing of Higher Quality and Higher-Priced Games for the PC --------------------------------------------------------------- Our current strategy is to offset the impact from the decrease in retail shelf space being allocated to value-priced PC software by publishing higher quality, higher-priced PC game titles. During our third fiscal quarter, we released three higher-priced PC titles, Space Rangers 2: Rise of the Dominators, Buccaneers Bounty, and Neighbors From Hell: On Vacation, under our new brand, Cinemaware Marquee. During the fourth fiscal quarter, we expect to release two higher priced PC titles, Darwinia and Moscow to Berlin: Red Siege, both under the Cinemaware Marquee brand. We expect our future product development costs to increase compared to prior periods, due to the increased complexity of game play and additional quality control procedures that are required to bring to market these more technically sophisticated games. We also expect these costs to increase as we implement plans to begin to develop our own new game titles, using both external and internal development resources. Additionally, higher quality software content for these gaming platforms generally requires higher licensing fees and advance royalty payments, and we therefore expect our future licensing and advanced royalty payments to significantly increase over prior periods and represent a greater use of available cash as we bring such products to market. As we begin to publish higher priced titles for the PC, we expect to incur greater costs and cash expenditures for promotional efforts, such as print ads, online banner ads, in-store circulars, video loops, public relations and slotting fees, to support the retail and online releases of these higher quality titles competing at higher price points. Decrease in Retail Shelf Space for Value-Priced PC Software Combined with Increased Competition in this Market Segment Has Impacted Our Sales ------------------------------------------------------------------- The reduced amount of shelf space allocated to our category of products in retail stores has continued to impact our net sales. We continue to see indications that the amount of retail shelf space being allocated to PC software games at the $9.99 retail price point is decreasing, and we expect this trend to continue negatively impacting our results for the foreseeable future. Additionally, competition in the core value-priced casual game genres has increased in recent periods, which has also had an impact on our net sales as it becomes more competitive to secure retail shelf positions for these titles. We continue to seek incremental licensing opportunities and pursue increased sales at alternative retail channels such as discount retailers and in-statement advertising providers. We are also seeking to license or develop higher-priced, unique casual game content in order to compete more effectively in these markets. We cannot predict whether these initiatives will be effective in increasing net sales. Concentration of Customers -------------------------- We continue to have a concentration of customers consisting of a few large software distributors and retailers. Historically, Atari, Inc. ("Atari") has represented our primary software distributor servicing the North American mass-merchants and other major retailers. In December 2005, we began to transition the majority of our mass-merchant retail distribution to Take-Two Interactive Software ("Take Two"), which has distributed our titles into the office superstore and discount warehouse retail channels for several years. During the three months ended March 31, 2006, Atari accounted for $277,000 of net sales, or 22% of net sales, compared to the three months ended March 31, 2005, when Atari accounted for $804,000 of net sales, or 55% of net sales. During the three months ended March 31, 2006, Take Two accounted for $281,000 of net sales, or 22% of net sales, compared to the three months ended March 31, 2005, when Take Two accounted for $61,000 of net sales, or 4% of net sales. We anticipate that Take Two will continue representing a growing percentage of our net sales and net accounts receivable in future periods, while at the same time Atari's share of our business will most likely continue to decline. During the nine months ended March 31, 2006, Atari accounted for $1,200,000 of net sales, or 32% of net sales, compared to the nine months ended March 31, 2005, when Atari accounted for $2,281,000 of net sales, or 50% of net sales. During the nine months ended March 31, 2006, Take Two accounted for $405,000 of net sales, or 11% of net sales, compared to the nine months ended March 31, 2005, when Take Two accounted for $178,000 of net sales, or 4% of net sales. At March 31, 2006, Atari's net receivable balance was $151,000, or 15% of our total net accounts receivable, compared to Take Two's net accounts receivable of $322,000, or 32%, of our total net accounts receivable. Critical Accounting Policies and Estimates Our significant accounting policies and methods used in the preparation of the Financial Statements are discussed in Note 1 of the Notes to Financial Statements. We believe our policies for revenue recognition, inventory valuation and recoverability of advanced licensing and royalty payments require us to make significant judgments and estimates that could materially affect the amount of revenue we recognize, the cost of sales we expense, and the reported net values for inventory, accounts receivable, prepaid and other expenses. Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make judgments and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates for product returns, price markdowns, customer bad debts, inventory obsolescence, recoverable values of advanced licensing and royalty payments, income tax expense, contingencies and litigation risks. We base our estimates on historical experience and on various other factors and assumptions that we believe are appropriate. Actual results may differ from these estimates under different assumptions or conditions. Revenue Recognition (Net Sales, Product Returns and Price Markdowns) -------------------------------------------------------------------- We distribute the majority of our products through third-party software distributors to North American mass-merchant and major retailers and directly to certain PC software retailers, most of which have traditionally sold consumer entertainment PC software titles. The distribution of our products is governed by purchase orders, distribution agreements or direct sale agreements, most of which allow for product returns and price markdowns and have shipping terms of FOB destination. For product shipments to most software distributors and retailers, we record a provision for product returns and price markdowns as a reduction to gross sales at the time the title of our product transfers to the distributor or retailer. However, if we determine that we are not able to estimate an appropriate provision for product returns and price markdowns for any retailer or distributor, we then recognize revenues for product deliveries to these retailers or distributors on a consignment basis as described below. We also have relationships with certain software distributors for product distribution to various retailers based on consignment and sell-through agreements. Accordingly, revenues from product shipments pursuant to these types of agreements are only recognized to the extent that the distributor has reported to us that our product has actually sold through to consumers. Key Assumptions Our provision for anticipated product returns and price markdowns is based on the assumptions we make after evaluating various factors, including: our analysis of historical product return and price markdown results; current product sell-through activity at retail store locations; current field inventory quantities at distributors' warehouses and at retail store locations; the length of time that products have been released at retail along with their estimated remaining retail life; the introduction of new and/or competing software products that could negatively impact the sales of our current products; outstanding return material and price markdown authorizations; and the extent to which units of products with higher price points or unproven genres remain in the retail channel. The adequacy of our allowance for product returns and price markdowns is reviewed throughout each reporting period and any necessary adjustment to this allowance is reflected within the current reporting period's provision. Significant management judgments and estimates must be made and used in order to determine how much revenue can be recognized in any reporting period. Material differences may result in the amount and timing of our revenue for any period if management's judgments or estimates for product returns or price markdowns prove to be insufficient or excessive compared to actual results. Inventory Valuation ------------------- Our inventory valuation policy requires management to make estimates and assumptions about the recoverability of the carrying value of inventory at the end of each reporting period and cost of sales expensed during each reporting period. The individual components of our software titles that are usually reflected in our net inventory valuation include some combination of the manufactured costs of: CD's; jewel cases; box packaging; print materials; manuals; posters; novelty items; assembly; and other miscellaneous items particular to specific titles. Our inventory could be valued differently at the close of any reporting period and the amount of expense recorded as cost of sales during any reporting period could differ, if management's judgments or estimates of provisions for the potential impairment of inventory value are insufficient or excessive when compared to actual results. Key Assumptions Our provision for inventory obsolescence is based on the assumptions we make after evaluating the remaining value of existing inventory units (consisting of unsold warehouse units, consignment units and estimated product return units), which involves: assessing the remaining product life of existing titles based on how long the titles have been released at retail; analyzing the trend of current product sell-through activity to consumers for existing titles; identification of competitors' new products with greater capabilities or more recognizable brands that could replace or shorten the lifecycles of our existing titles; assessing the potential for litigation that may affect our ability to sell existing titles containing certain product content; monitoring expiration dates of licensing agreements with software developers for content within existing titles; and tracking the current market value for remaining units of discontinued titles based on recent sales of similar products to inventory liquidators and discount retailers. Although we attempt to accurately match production requirements of our products to forecasted consumer demand, at the end of a product's lifecycle we usually have some level of excess inventory units that need to be disposed of through liquidation sales. If we cannot liquidate such inventory, or if we are unable to sell any remaining units due to legal or other reasons, we would then write down the remaining inventory value to zero. The adequacy of our allowance for inventory obsolescence is reviewed throughout each reporting period, and any adjustments are reflected in the current period's provision for inventory obsolescence. Advance Licensing and Royalty Payments -------------------------------------- We make advance licensing and royalty payments to third party software developers and other licensors for the licensing of software content and intellectual properties for use within our PC software titles. These advance payments are initially classified on our balance sheet as "Prepaid and other expenses", and are then usually expensed within the "Cost of sales" category of our Statements of Operations at the greater of the contractual or effective royalty rate. Key Assumptions We continually evaluate the recoverability of our advance licensing and royalty payments by reviewing the information available about each title and the underlying licensed content in existing titles. In particular, we evaluate the potential future sales of a title or subsequent titles containing the same licensed content based on current and potential sales programs, along with historical sell-through results of a title and similar titles, if any, to consumers. For titles that have achieved distribution into their intended retail channels, we charge to cost of sales the remaining costs we determine to be non-recoverable in future periods. In the rare circumstance that a title does not achieve distribution into its intended retail channels, we charge to product development expense the remaining costs we determine to be non-recoverable in future periods. Non-recoverable costs are expensed in the reporting period in which management determines that it is not likely that we will be able to recover these costs in future periods. Results of Operations The following discussion should be read together with our Financial Statements and Notes beginning on page 3. Three and Nine Months Ended March 31, 2006 and 2005 Net Sales For the three months ended March 31, 2006, net sales decreased by $195,000, or 13%, to $1,265,000, compared to $1,460,000 for the same quarter a year earlier. This decrease in net sales resulted from a $172,000 decrease in net sales to North American software distributors, and primarily related to the declining distribution of eGames' value-priced line of PC software games, compared to the year ago quarter, which resulted from a substantial reduction in retail shelf space allocated to PC software games at the $9.99 retail price point. As a result of these changes at retail, demand for the eGames value-priced PC titles has continued to decrease as competition for title placement in these reduced retail PC software sections has dramatically increased. For the nine months ended March 31, 2006, net sales decreased by $837,000, or 18%, to $3,713,000, compared to $4,550,000 for nine months ended March 31, 2005. This decrease in net sales resulted from a $968,000 decrease in net sales to North American software distributors (due to similar factors impacting the three month results), which was partially offset by a $77,000 increase in net sales made directly to various North American retailers and a $71,000 increase in licensing revenues. The following table represents the Company's net sales by distribution channel for the three and nine months ended March 31, 2006 and 2005, respectively: Net Sales by Distribution Channel (rounded to the nearest thousand) --------------------------------- Three Months Ended March 31, --------------------------------------
Increase % Distribution Channel 2006 % 2005 % (Decrease) Change - ------------------------------------------------------------------------------------------- Software Distributors $ 845,000 67% $ 1,017,000 70% ($ 172,000) (17%) Software Retailers 162,000 13% 135,000 9% 27,000 20% Licensing 157,000 12% 176,000 12% (19,000) (11%) Internet 68,000 5% 96,000 7% (28,000) (29%) Inventory Liquidators 33,000 3% 36,000 2% (3,000) (8%) - ------------------------------------------------------------------------------------------- Totals $ 1,265,000 100% $ 1,460,000 100% ($ 195,000) (13%) =========== ==== =========== ==== ========= ===
Nine Months Ended March 31, --------------------------------------
Increase % Distribution Channel 2006 % 2005 % (Decrease) Change - ------------------------------------------------------------------------------------------- Software Distributors $ 2,306,000 62% $ 3,274,000 72% ($ 968,000) (30%) Software Retailers 510,000 14% 433,000 10% 77,000 18% Licensing 494,000 13% 423,000 9% 71,000 17% Internet 212,000 6% 242,000 5% (30,000) (12%) Inventory Liquidators 191,000 5% 178,000 4% 13,000 7% - ------------------------------------------------------------------------------------------- Totals $ 3,713,000 100% $ 4,550,000 100% ($ 837,000) (18%) =========== ==== =========== ==== ========= ===
Software Distributors --------------------- For the three months ended March 31, 2006, net sales to software distributors that serve North American mass-merchants and other retailers amounted to $845,000, which represented a decrease of $172,000 or 17% compared to the three months ended March 31, 2005. This decline in net sales to software distributors was caused primarily by a $527,000 decrease in net sales to Atari, which was partially offset by a $220,000 net sales increase to Take Two, along with net sales increases to our Canadian software distributors of $83,000 and various other software distributors totaling $52,000. These net sales changes resulted from a declining amount of retail shelf space being allocated to value-priced PC games, our recent transition from Atari to Take Two as our primary North American distributor, and improved Canadian distribution, compared to the same quarter last year. For the nine months ended March 31, 2006, net sales to software distributors that serve North American mass-merchants and other retailers amounted to $2,306,000, which represented a decrease of $968,000 or 30% compared to the nine months ended March 31, 2005. This decline in net sales to software distributors resulted from net sales decreases of $1,081,000 to Atari and $125,000 to Canadian software distributors, which net sales decreases were partially offset by a $227,000 net sales increase to Take Two. Software Retailers ------------------ For the three months ended March 31, 2006, net sales made directly to software retailers totaled $162,000, representing a $27,000 increase compared to the three months ended March 31, 2005. This increase resulted primarily from a $37,000 net sales increase to CompUSA, which was partially offset by a $10,000 net sales decrease to various retailers. For the nine months ended March 31, 2006, net sales made directly to software retailers totaled $510,000, representing a $77,000 increase compared to the nine months ended March 31, 2005. This net sales increase was due to a $177,000 increase in net sales to various discount retailers, which was partially offset by a $46,000 net sales decrease to CompUSA and a $54,000 net sales decrease to various other retailers. Licensing --------- For the three months ended March 31, 2006 and 2005, we realized licensing revenues of $157,000 and $176,000, respectively, which represented 12% of net sales for both quarters. This $19,000 decrease in licensing revenues resulted from a $69,000 decrease in international licensing revenues, which was partially offset by a $50,000 increase in licensing revenues generated in the United States. For the nine months ended March 31, 2006 and 2005, we realized licensing revenues of $494,000 and $423,000, respectively, which represented 13% and 9%, respectively, of net sales. This $71,000 increase in licensing revenues related to increased licensing revenues generated in the United States, partially offset by lower international licensing revenues. Internet -------- For the three months ended March 31, 2006 and 2005, Internet sales were $68,000 and $96,000, respectively, and for the nine months ended March 31, 2006 and 2005, Internet sales were $212,000 and $242,000, respectively. Additionally, over the next nine months we plan to explore opportunities to expand our Internet sales by significantly revamping our existing websites into a gaming destination 'portal'. Inventory Liquidators --------------------- Net sales to inventory liquidators consist of sales of residual inventory units of titles that have been discontinued (in part or entirely) at traditional software retail stores. As retailers routinely change the mix of software titles displayed on their store shelves, we expect to continue receiving discontinued titles back from the retail channel that will then need to be liquidated, along with any quantities of those titles remaining in our warehouse. The amount of inventory liquidation sales vary, period to period, and are usually made at discounted prices with no right of product return or price markdown. For the three months ended March 31, 2006 and 2005, net sales to inventory liquidators were $33,000 and $36,000, respectively, while for the nine months ended March 31, 2006 and 2005, net sales to inventory liquidators were $191,000 and $178,000, respectively. Product Returns and Price Markdowns ----------------------------------- Until physical units of our products are returned to us from software distributors or retailers, or until these units sell through to consumers, we continue to evaluate our product return and price markdown exposure for the software units we previously sold to software distributors and retailers. Based on various assumptions, including shorter product lifecycles, more competitive titles in our core game genres, continued reduction of retail shelf space allocated to $9.99 retail priced PC software games and our plan to continue publishing more higher priced PC games in upcoming periods, we anticipate our provision for product returns and price markdowns, as a percentage of related gross sales, to trend higher for the foreseeable future. During the three months ended March 31, 2006 and 2005, our provision for product returns and price markdowns relating to gross product sales to software distributors and retailers amounted to $277,000 and $338,000, respectively, or 19.0% and 20.6%, respectively, of related gross product sales. During the nine months ended March 31, 2006 and 2005, our provision for product returns and price markdowns relating to gross product sales to software distributors and retailers amounted to $753,000 and $978,000, respectively, or 18.2% and 18.8%, respectively, of related gross product sales. Sales Incentives and Promotional Costs -------------------------------------- In order to maintain retail shelf space for our titles at certain retailers, we incur sales incentives and promotional fees from software distributors and retailers, such as distributor pricing rebates and retailer slotting fees, which are recognized as reductions to gross sales. We anticipate that sales to software retailers and distributors that charge such fees will continue to increase, relative to those retailers and distributors that do not charge such fees, and so we expect to incur these types of reductions to gross sales at an increasing rate for the foreseeable future. For the three months ended March 31, 2006 and 2005, our sales incentives and promotional costs were $139,000 and $113,000, respectively, or 9.5% and 6.9%, respectively, of related gross product sales. For the nine months ended March 31, 2006 and 2005, our sales incentives and promotional costs were $379,000 and $353,000, respectively, or 9.2% and 6.8%, respectively, of related gross product sales. Cost of Sales Cost of sales consists of the following costs that are associated with publishing PC games: product costs; royalty costs incurred with third parties for licensing product content or other intellectual properties; freight and handling costs; inventory obsolescence provision, and other costs such as tooling, labeling, sorting and reclamation. The following table represents our cost of sales for the three and nine months ended March 31, 2006 and 2005:
March 31, % of March 31, % of Increase % 2006 net sales 2005 net sales (Decrease) Change - ------------------------------------------------------------------------------------------------- Three months ended $ 711,000 56.2% $ 646,000 44.3% $ 65,000 10.1% Nine months ended $ 2,094,000 56.4% $ 2,057,000 45.2% $ 37,000 1.8%
During the three months ended March 31, 2006, cost of sales increased by $65,000 compared to the prior year's three month period and resulted from an 11.9% increase in cost of sales, as a percentage of net sales, which was partially offset by lower costs related to the decrease in net sales. The 11.9% increase in cost of sales, as a percentage of net sales, was due to an 8.7% increase in product costs, as a percentage of net sales, traceable to sales of: o Titles sold at substantial price discounts as required by certain retailers and distributors to secure retail shelf positions; o Titles containing "value added" components such as multiple CD's, posters, manuals and novelty items related to game themes; and o End-of-lifecycle titles to discount retailers and distributors at sales prices below standard wholesale and distributor prices. Additionally, we experienced a 3.2% increase in all other cost of sales, as a percentage of net sales, which related to cost increases, as a percentage of net sales, of: tooling for new box designs; CD sorting for discount retailers; anti-piracy software for higher-priced box titles; and freight expense related to consignment shipments which revenues were deferred until such time that the product sells through to consumers. During the nine months ended March 31, 2006, cost of sales increased by $37,000 compared to the prior year's nine month period and resulted from similar factors that impacted the three-month results. Product Development Product development expenses consist of personnel costs related to product management, content acquisition, quality assurance testing, packaging design and website administration, along with outside services for product ratings, language localization, additional quality assurance testing and website infrastructure maintenance, as well as non-recoverable costs related to titles that did not achieve distribution into their intended retail channels. The following table represents our product development expenses for the three and nine months ended March 31, 2006 and 2005:
March 31, % of March 31, % of Increase % 2006 net sales 2005 net sales (Decrease) Change - ------------------------------------------------------------------------------------------------- Three months ended $ 165,000 13.0% $ 102,000 7.0% $ 63,000 61.8% Nine months ended $ 376,000 10.1% $ 445,000 9.8% ($ 69,000) (15.5%)
The $63,000 increase in product development expenses for the three months ended March 31, 2006 resulted from higher costs associated with developing and supporting our new higher priced Cinemaware Marquee box titles. These costs were incurred for quality assurance testing, language localization, website and animation development, and ESRB product ratings, along with increased salary related costs traceable to additional employees hired to support these efforts and travel expenses incurred to search for new product content for upcoming titles. The $69,000 decrease in product development expenses for the nine months ended March 31, 2006 related to the non-recurrence of the prior year's $122,000 write-off of capitalized costs related to the RealAge Games & Skills title, which was partially offset by cost increases similar to the categories described in the three month results. As we continue to implement our strategy of publishing higher quality, and higher-priced PC game titles, we expect our product development expenses to increase due to the increased complexity of game play, additional quality control and language localization required, additional development of game specific websites, and other procedures required to bring these more technically sophisticated games to market. In future periods, we may also incur increased product development costs as we seek to develop our own PC game titles. Selling, General and Administrative Selling, general and administrative expenses consist primarily of personnel related costs, insurance costs, stock-based compensation expense, professional service fees for legal, accounting and public relations, advertising costs, as well as occupancy costs including rent, utilities and phones, and other administrative expenses. The following table represents our selling, general and administrative expenses for the three and nine months ended March 31, 2006 and 2005:
March 31, % of March 31, % of Increase % 2006 net sales 2005 net sales (Decrease) Change - ------------------------------------------------------------------------------------------------- Three months ended $ 648,000 51.2% $ 661,000 45.3% ($ 13,000) (2.0%) Nine months ended $ 1,810,000 48.7% $ 1,880,000 41.3% ($ 70,000) (3.7%)
The $13,000 decrease in selling, general and administrative expenses for the three months ended March 31, 2006 resulted from $65,000 in lower legal and litigation expenses related to intellectual property matters experienced in the year ago quarter, which was partially offset by cost increases in: public relations of $21,000, advertising of $18,000, capital stock tax of $7,000 and recruiting fees of $6,000. The $70,000 decrease in selling, general and administrative expenses for the nine months ended March 31, 2006 was attributable to the same factors that impacted the three month results, in addition to a decrease in independent sales agent commissions due to declining sales at retailers where such commissions are incurred. As we continue to publish higher priced titles for the PC, we expect to incur greater promotional costs, such as print and online banner ads, in-store circulars, video loops, and public relations, in order to support the retail and online releases of these higher quality titles competing at higher price points. Interest Income, net The following table represents our net interest income for the three and nine months ended March 31, 2006 and 2005:
March 31, % of March 31, % of Increase % 2006 net sales 2005 net sales (Decrease) Change - ------------------------------------------------------------------------------------------------- Three months ended $ 11,000 0.9% $ 2,000 0.1% $ 9,000 n/m Nine months ended $ 32,000 0.9% $ 5,000 0.1% $ 27,000 n/m
Provision for Income Taxes The following table represents our provision for income taxes for the three and nine months ended March 31, 2006 and 2005:
March 31, % of March 31, % of Increase % 2006 net sales 2005 net sales (Decrease) Change - ------------------------------------------------------------------------------------------------- Three months ended $ - 0 - - 0 - % $ 6,000 0.4% ($ 6,000) n/m Nine months ended $ - 0 - - 0 - % $ 17,000 0.3% ($ 17,000) n/m
Net income (loss) The following table represents our net income (loss) for the three and nine months ended March 31, 2006 and 2005:
March 31, % of March 31, % of Increase % 2006 net sales 2005 net sales (Decrease) Change - ---------------------------------------------------------------------------------------------------- ----------- Three months ended ($ 248,000) (19.6%) $ 46,000 3.2% ($ 294,000) n/m Nine months ended ($ 535,000) (14.4%) $ 157,000 3.5% ($ 692,000) n/m
Weighted Average Common Shares For the three months ended March 31, 2006, the weighted average common shares outstanding on a diluted basis increased to 11,724,193, compared to 11,030,149 for the three months ended March 31, 2005. This 694,044 increase in the diluted basis calculations of weighted average common shares resulted from the issuance of the Company's shares of common stock related to the exercise of common stock options, combined with the weighted average of the common shares issued in October 2005 to Cinemaware, Inc., partially offset by the common stock equivalents included in the year ago quarter's calculation due to that period's net income. For the nine months ended March 31, 2006, the weighted average common shares outstanding on a diluted basis increased to 11,416,555, compared to 10,992,332 for the nine months ended March 31, 2005. This 424,223 increase in the diluted basis calculations of weighted average common shares resulted from similar factors that affected the three-month calculations. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment" which revised SFAS No. 123, "Accounting for Stock-Based Compensation". This statement supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25 and requires that the compensation expense relating to such transactions be recognized in the statement of operations. The revised statement became effective during the first interim period beginning after June 15, 2005. The adoption of SFAS No. 123 (revised 2004) did not have a material impact on our financial statements. In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4". SFAS No. 151 amends the guidance in Accounting Research Bulletin ("ARB") No. 43, "Restatement and Revision of Accounting Research Bulletins", Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) and requires that those items be recognized as current-period charges. SFAS No. 151 also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 became effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 did not have a material impact on our financial statements. Liquidity and Capital Resources At March 31, ------------------------- 2006 2005 Change --------------------------------------- Cash and cash equivalents $ 1,483,000 $ 2,275,000 ($ 792,000) =========== =========== ========== Percent of total assets 34.8% 51.7% ==== ==== Nine Months Ended March 31, ------------------------- 2006 2005 Change ---------------------------------------- Cash (used in) provided by operating activities ($ 924,000) $ 478,000 ($ 1,402,000) Cash used in investing activities (5,000) (11,000) 6,000 Cash provided by financing activities - 0 - 66,000 (66,000) ---------------------------------------- Net (decrease) increase in cash and cash equivalents ($ 929,000) $ 533,000 ($ 1,462,000) =========== =========== =========== Changes in Cash Flow, Operating Activities During the nine months ended March 31, 2006, we had $924,000 in cash used in operating activities compared to $478,000 in cash provided by operating activities for the nine months ended March 31, 2005. The $924,000 in cash used in operating activities for the nine months ended March 31, 2006 resulted from increases in net accounts receivable of $741,000 and inventory of $63,000, along with the $535,000 net loss realized during this period, which cash uses were partially offset by cash sources from increases in accounts payable of $318,000 and accrued expenses of $39,000, along with $58,000 in recorded stock compensation expense. Accounts Receivable, net ------------------------ At March 31, 2006, net accounts receivable totaled $1,010,000, compared to $269,000 at June 30, 2005. This $741,000 increase in net accounts receivable resulted from an $883,000 increase in gross accounts receivable that was partially offset by a $142,000 increase in the allowance for product returns and price markdowns. The increase in gross accounts receivable resulted primarily from a higher level of gross sales invoiced during the three months ended March 31, 2006 compared to the three months ended June 30, 2005, combined with lower receivable collections during the three months ended March 31, 2006 compared to the three months ended June 30, 2005. The increase in the allowance for product returns and price markdowns resulted from lower actual product returns and price markdowns processed during the nine months ended March 31, 2006 compared to the provision for product returns and price markdowns recorded during this same period. Generally, we have been able to collect net accounts receivable in the ordinary course of business, but periodically we have experienced slowness in distributor and retailer receivable collections. Throughout each reporting period, we communicate with distributors and retailers in order to expedite their payments of past due amounts or to process receivable credits for authorized product returns and price markdowns. Since we do not hold any collateral to secure payment from any of our customers and because most of our customers have the right to return products and receive price markdowns that can be used to reduce their receivable payments to us, the realizable value of our net accounts receivable is continually reviewed in order to help anticipate future liquidity issues that could result from our inability to collect a net receivable balance in the normal course of business. Concentration of Customers -------------------------- Historically, Atari has represented the majority of our net accounts receivable and related cash receipts. In December 2005, we began to transition the majority of our North American mass-merchant retail distribution to Take-Two Interactive Software ("Take Two"), which has distributed our titles into the office superstore and discount warehouse retail channels for several years. We anticipate that Take Two will continue representing a growing percentage of our net sales and net accounts receivable in future periods, while at the same time Atari's percentage of our business should continue to decrease. We believe that our ability to collect, in a timely manner, the net account receivable owed by Take Two and Atari, will be significant for us to be able to meet our financial obligations and to fund our operations for the foreseeable future. Over the upcoming quarters as our distribution through Atari decreases, we will continue to monitor their payment trends in order to avoid unanticipated collection issues. At March 31, 2006, Take Two's net accounts receivable totaled $322,000, or 32%, of our total net accounts receivable, compared to Atari's net accounts receivable of $151,000, or 15%, of our total accounts receivable. During the nine months ended March 31, 2006, we collected $1,040,000 in receivable payments from Atari and $126,000 in receivable payments from Take Two, which represented 36% and 4%, respectively, of our total accounts receivable collections during that period. Inventory, net -------------- During the nine months ended March 31, 2006, our net inventory value increased by $63,000, or 7%, and was a result of increased inventory shipments into the retail channel under consignment sales agreements of units that have not yet sold through to consumers as of March 31, 2006. Additionally, we are continuing to convert units of excess and slower moving inventory into cash through product sales to inventory liquidators and discount retailers. At March 31, 2006, this second tier of inventory represented approximately 25% of our total net inventory value, and based on the information currently available to us, we believe that the current carrying values of this inventory approximate the cash we anticipate receiving in future periods. Prepaid and other expenses -------------------------- During the nine months ended March 31, 2006, our prepaid and other expenses increased by $25,000, which related to annual payments for corporate insurances and retail market research, partially offset by a refund of prepaid federal taxes. Accounts Payable ---------------- During the nine months ended March 31, 2006, our accounts payable increased by $318,000, due to increased inventory purchases of higher costing box titles that contained additional value-added components (posters, manual, multiple CD's, and novelty items related to game themes) to help support a higher retail value to consumers. Accrued Expenses ---------------- During the nine months ended March 31, 2006, our accrued expenses increased by $39,000, as a result of increases in marketing promotions, royalties and relocation costs, which were partially offset by a decrease in the amount of customer accounts receivable credit balances reclassified to current liabilities. Changes in Cash Flow, Non-Operating Activities During the nine months ended March 31, 2006, we had net cash used in investing activities of $5,000 for equipment purchases for our computer network, compared to $11,000 in net cash used in investing activities during the year ago period for similar expenditures. During the nine months ended March 31, 2006, we had no financing activities compared to the nine months ended March 31, 2005, when we had $66,000 in cash provided by financing activities related to cash proceeds received from the exercise of options to purchase shares of the Company's common stock, that was partially offset by cash dividend payments to shareholders of the Company's common stock. Credit Facility In December 2005, we renewed our credit facility agreement with Hudson United Bank ("HUB"), which matures on December 1, 2006. This credit facility was established to provide working capital for our operations. Amounts outstanding under this credit facility are charged interest at one-half of one percent above HUB's current prime rate and such interest is due monthly. Our access to these funds is limited to the lesser of $750,000 or seventy-five percent of qualified accounts receivable, which are defined as invoices less than ninety days old and net of any allowances for product returns, price markdowns and customer bad debts. As of March 31, 2006, we had not utilized any of this credit facility, and we had access to the full $750,000 amount under this credit facility, based on the prescribed calculation of seventy-five percent of qualified accounts receivable as of that date. The credit facility is secured by all of the Company's assets and requires us, among other things, to maintain certain financial covenants that are tested quarterly. Contractual Obligations and Commitments We occupy our 5,000 square foot office facility located in Langhorne, Pennsylvania under an operating lease that is scheduled to expire on September 30, 2010. Additionally, we currently rent certain office equipment through various operating lease agreements. At March 31, 2006, we had future operating lease commitments of $238,000, as reflected in the table below. Under various licensing agreements with third-party software developers, we are required to pay royalties for the use of licensed content in our products. Most of these licensing agreements require us to make advance royalty payments to these software developers prior to the time we recognize any net sales of software titles containing this licensed content. As we continue to implement our strategy of publishing higher quality, and higher-priced game titles for the PC, and seek opportunities to publish titles for other gaming devices, we expect our advance royalty payments to significantly increase and represent a greater use of available cash. At March 31, 2006, we had future commitments to pay $88,000 in advance licensing and royalty payments to third-party licensors and software developers as reflected in the table below. As part of a public relations campaign intended to support and promote our brands and the retail releases of our new higher priced PC game titles, as of March 31, 2006 we had $22,000 in commitments relating to a professional services agreement with a public relations firm. The following table represents a summary of our off-balance sheet contractual obligations and commitments at March 31, 2006, which we expect to fund by cash flows from operations.
Payments Due by Period -------------------------------------------------------------- Less than 1-3 3-5 More than Contractual Obligations Total 1 year years years 5 years - -------------------------------------------------------------------------------------------- Operating leases $ 238,000 $ 64,000 $ 152,000 $ 22,000 $ - 0 - Advance royalties 88,000 88,000 - 0 - - 0 - - 0 - Public relation services 22,000 22,000 - 0 - - 0 - - 0 - - -------------------------------------------------------------------------------------------- Totals $ 348,000 $ 174,000 $ 152,000 $ 22,000 $ - 0 - ========= ========= ========= ======== =======
Liquidity Risk Our ability to achieve positive cash flow remains essential to our survival as a going concern because access to our existing credit facility is limited to the lesser of $750,000 or 75% of our qualified accounts receivable. As of March 31, 2006 we had access to the full $750,000 amount under this credit facility, based on the prescribed calculation as of that date. In particular, our ability to achieve positive cash flow depends upon a variety of factors, including the timing of the collection of net accounts receivable, the creditworthiness of our software distributors and retailers, sell-through of our products to consumers, and the costs of developing, producing, distributing, marketing and promoting our software titles. There are significant challenges that we will need to continue to successfully manage in order to fund our operations in the future. These challenges include, but are not limited to, maintaining commercially viable relationships with our distributors and retailers, collecting timely receivable payments from our concentrated group of distributors and retailers, managing timely retail release of higher costing games in order to recoup upfront payments within projected cash-flows and maintaining acceptable payment terms with our trade vendors. For example, our liquidity would be significantly impacted if Take Two or Atari, for any reason, did not make receivable payments to us on a timely basis. Additionally, there are factors beyond our control that could significantly affect our operating cash flow. The most significant of these factors is the increased liquidity risk we face from the increased level of advanced royalties, advertising, development and product costs we plan to spend for our new higher priced box titles. If one or more of these higher priced titles do not achieve sufficient retail success, then our ability to recoup these costs would be greatly reduced and our liquidity could be materially impaired. Another risk we face is the potential for further reductions or the complete elimination of the shelf space allocated to $9.99 retail priced PC software games at major retailers where our products are sold. Additionally, as retailers continue to increase the proportion of their shelf space displaying higher-priced gaming titles, we could experience a similar reduction in retail shelf space for $19.99 and $29.99 mid-range priced PC software games that we intend to sell, as retailers make more room for console titles and PC game titles priced at $39.99 and higher, and respond to increased sales of mid-range priced PC games via the Internet. If either of these situations were to occur, then our cash flow and future financial prospects could be significantly impacted. Also, if any of our software titles do not sell through to consumers at a rate acceptable to retailers, we could then be exposed to unanticipated product return and price markdown credit requests that could then be used by distributors and retailers to reduce their future receivable payments to us. This could also cause a reduction in retailer and distributor replenishment orders for our products. If we experienced a negative trend in any of these factors, we may not be able to achieve positive cash flow. Also, as we implement our strategy of publishing higher quality, and higher-priced game titles for the PC, we may need to seek additional funds to provide financing for: - - increased advanced royalty payments or substantial content acquisition costs needed to obtain higher quality software games; - - greater product development costs to either internally develop titles utilizing the Company owned intellectual properties or to complete additional quality assurance tests on third party titles acquired for retail release; and - - larger marketing expenditures to more aggressively promote the retail and online releases of higher priced titles. Additional outside financing to support our operations may not be available if and when we need it. Even if such financing was available from a bank or other financing source, such financing may cause significant stockholder dilution or may have other significant costs associated with such financing. Listing of Our Common Stock Our common stock trades on the OTC Bulletin Board under the symbol EGAM. We have considered applying for listing on an exchange, such as the American Stock Exchange, but at this time we do not meet the standards for listing. Item 3. Controls and Procedures (a) Disclosure Controls and Procedures. Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of March 31, 2006 (the "Evaluation Date"). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of the Evaluation Date, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed in our reports filed or furnished under the Exchange Act are recorded, processed, summarized and reported, within the periods specified in the SEC's rules and forms. We believe that a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. (b) Changes in Internal Control over Financial Reporting. There have not been any changes in our internal control over financial reporting during the quarter ended March 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Part II. Other Information Item 6. Exhibit Listing The following exhibits are being filed or furnished as part of this Quarterly Report on Form 10-QSB: Exhibit Number Description of Exhibit - -------------- ---------------------- 10.1+ Distribution Agreement dated November 15, 2005 between Gathering of Developers, Inc., a division of Take-Two Interactive Software Inc., and eGames, Inc. 31.1 Certification of Gerald W. Klein as President and Chief Executive Officer of eGames, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Thomas W. Murphy as Vice President and Chief Financial Officer of eGames, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Gerald W. Klein as President and Chief Executive Officer of eGames, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Thomas W. Murphy as Vice President and Chief Financial Officer of eGames, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. - -------------------------------------------------------------------------------- + Indicates confidential treatment requested as to certain portions, which portions were omitted and filed separately with the Securities and Exchange Commission pursuant to a Confidential Treatment Request. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. eGames, Inc. (Registrant) Date: May 15, 2006 /s/ Gerald W. Klein ------------ --------------------------------- Gerald W. Klein, President, Chief Executive Officer and Director Date: May 15, 2006 /s/ Thomas W. Murphy ------------ ------------------------------------ Thomas W. Murphy, Chief Financial Officer and Chief Accounting Officer Exhibit 31.1 Certification ------------- I, Gerald W. Klein, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of eGames, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 15, 2006 ------------ /s/ Gerald W. Klein ------------------------------------- Gerald W. Klein President and Chief Executive Officer (Principal Executive Officer) Exhibit 31.2 Certification ------------- I, Thomas W. Murphy, certify that: 1. I have reviewed this quarterly report on Form 10-QSB of eGames, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 15, 2006 ------------ /s/ Thomas W. Murphy ---------------------------- Thomas W. Murphy Chief Financial Officer (Principal Financial Officer) Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of eGames, Inc. (the "Company") on Form 10-QSB for the quarter ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Gerald W. Klein, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, based on my knowledge, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Gerald W. Klein - ------------------------------------- Gerald W. Klein President and Chief Executive Officer Date: May 15, 2006 ------------ The foregoing certification is being furnished to the Securities and Exchange Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is not being filed as part of the Report or as a separate disclosure document. Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of eGames, Inc. (the "Company") on Form 10-QSB for the quarter ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Thomas W. Murphy, Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, based on my knowledge, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Thomas W. Murphy - ----------------------- Thomas W. Murphy Chief Financial Officer Date: May 15, 2006 ------------ The foregoing certification is being furnished to the Securities and Exchange Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is not being filed as part of the Report or as a separate disclosure document. EX-10 2 ex101q3-0610qsb.txt DISTRIBUTION AGREEMENT - GATHERING OF DEVELOPERS EXHIBIT 10.1 DISTRIBUTION AGREEMENT Distribution Agreement (the "Agreement") dated November 15, 2005, between Gathering of Developers, Inc., a Texas corporation (the "Distributor") a division of Take-Two Interactive Software Inc., located at 622 Broadway, New York, NY 10012 and eGames, Inc., a Pennsylvania corporation (the "Vendor") located at 2000 Cabot Boulevard West, Suite 110, Langhorne, PA 19047. WHEREAS, the Vendor creates, develops, publishes and/or produces software, video games and/or related computer products compatible with computers and game consoles, including, the titles specifically identified on Exhibit A for the specified platforms identified on Exhibit A (the "Platforms"); WHEREAS, the Vendor has agreed to retain the Distributor as a distributor of the Vendor for each title identified on Exhibit A (the "Title") in the territory set forth on Exhibit A (the "Territory"), and the Distributor has agreed to act in such capacity for the Vendor in such Territory on and subject to the terms and conditions set forth in this Agreement; and WHEREAS, the Distributor and the Vendor may establish a specific program with respect to certain retailers set forth on Exhibit B to this Agreement (the "Retail Program Addendum"). NOW, THEREFORE, in consideration of the foregoing and the mutual agreements contained herein (the receipt and adequacy of which are acknowledged), the parties agree as follows: 1. Grant of Rights. ---------------- (a) For purposes of this Agreement, "Products" shall mean the finished units of each Title including all applicable manuals and packaging. The Vendor hereby appoints the Distributor as a non-exclusive distributor of the Products in the Territory and the Distributor accepts such appointment for the purpose of distributing, marketing and selling the Products in the Territory. During the term, Distributor may distribute the Products to retailers identified on Exhibit A as "Distributor Retailers" through any and all means, including without limitation, standard retail channels, and orders made via the Internet, but fulfilled off-line. (b) Distributor shall have right, for advertising, publicity and promotional purposes, to perform any Title publicly and to permit the public performance thereof. Distributor shall have right to use all artwork, textual material and other materials used for or by Vendor in connection with such Title, including advertising, packaging and wrapping materials created by Vendor in connection therewith. (c) The Vendor grants to the Distributor the right to use any names of or trademarks associated with or embodied in each Title or any reproduction or simulation thereof and the script, speech, images, characters, characterizations, designs, graphics, artwork, and other characteristics associated with each Title as well as the name of each Title, in connection with the distribution, promotion and sale of the Products in the Territory. The Distributor agrees to comply with all reasonable instructions of the Vendor relating to the form and manner in which such names and trademarks shall be used and refrain from contesting the title of the Vendor to such names and/or trademarks. The Distributor acknowledges that the Vendor is the owner of such names and/or trademarks and that nothing in this Agreement shall give the Distributor any ownership or other interest in such names and/or trademarks or the goodwill associated therewith. 2. Sale and Supply of Products. ---------------------------- (a) Distributor shall in its sole discretion determine when or in the manner in which or from whom it shall solicit sales and purchase orders for the Products from the retailers identified on Exhibit A as "Distributor Retailers". - ----------------------- Note: Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, portions of Sections 4 and 6 and Exhibit B of this Distribution Agreement have been omitted. The omitted information is marked with brackets and asterisks [**]. The omitted information has been filed separately with the Securities and Exchange Commission. (b) During the term of this Agreement, the Vendor shall use commercially reasonable efforts (x) to market, advertise and promote each Title in the Territory, and (y) to supply the Distributor with the quantity of Products for distribution, as may be requested from time to time. (c) The Vendor shall supply, at no charge fifty (50) samples of each Product to the Distributor for use by the Distributor's employees and not for resale. (d) Distributor will not be responsible for, and shall not have to pay for any (i) manufacturing, packaging, assembly costs, and royalties to PC manufacturers or any other costs associated with manufacturing and developing the Product and/or (ii) expenses associated with advertising, marketing and promoting each Title initiated by Vendor. Vendor or the developer of any Title shall be responsible for, at their respective expense, to provide technical support for such Title in accordance with customary industry standards. 3. Vendor Representations and Warranties. -------------------------------------- (a) The Vendor represents and warrants that (i) Vendor has the right to enter into this Agreement; (ii) Vendor has good, marketable and transferable title to each Title and all Products, free from encumbrances; (iii) the Products delivered to the Distributor will be subject to the Vendor's standard warranty terms as such are communicated in writing to the Distributor and to end users from time to time, (iv) the Product will be finished units of each Title that are in good and saleable condition and in conformity with the documentation provided; (v) Vendor has the necessary intellectual property and all related rights in each Title; (vi) no Title infringes on any patents, copyrights, trademarks, trade names, trade secrets or any other intellectual property rights of a third party; (vii) there are no suits or proceedings pending or threatened with respect to and/or concerning any Title which allege an infringement of the proprietary rights of any third party; and (viii) the Title and Products will be in compliance with all applicable laws and regulatory requirements, including without limitation, ESRB compliance, packaging and labeling requirements, language requirements, and country of origin requirements. (b) The Vendor agrees that the terms and conditions on which the Products are made available to the Distributor from time to time during the term of this Agreement shall not be any less favorable to the Distributor than those terms and conditions on which the Products are made available to any other distributor that sells Vendor's Products to the same retailers to which Distributor sells Vendor's Products. 4. Prices and Payment Terms. ------------------------- (a) "Standard Wholesale Price" shall mean Vendor's normal and published wholesale price for the Product. "Distributor Wholesale Price" means the Standard Wholesale Price less the following items: (1) [**] percent ([**]%) of Standard Wholesale Price for Product with a Manufacturer Suggested Retail Price above $[**] per unit or [**] percent ([**]%) of Standard Wholesale Price for Product with a Manufacturer Suggested Retail Price $[**] or less; and (2) such other allowances, adjustments and deductions as are identified on Exhibit B from time to time with respect to certain retailers (if any). The prices to be paid by the Distributor to Vendor for each Product are set forth on Exhibit A (less deductions on Exhibit B (if any)). The Distributor shall, at all times, be free to unilaterally establish its own resale prices and terms with respect to all Products and advertise and or otherwise merchandise such prices and terms independently in advertisements and/or merchandising programs. (b) The Vendor shall extend credit to Distributor and shall provide the Distributor with an invoice (based on the Distributor Wholesale Price) in respect of each purchase order issued by the Distributor to the Vendor. Distributor shall pay Vendor's invoices no later than [**] ([**]) days after receipt of goods. In addition, if any Distributor payment pursuant to this Agreement is received by the Vendor in less than [**] ([**]) days after the invoice date, then Distributor shall be entitled to a discount of [**]% off the related invoices paid at that time. - ----------------------- [**] Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, these portions of Sections 4(a) and 4(b)of this Agreement have been omitted. The omitted information has been filed separately with the Securities and Exchange Commission. (c) If for any reason, a credit balance or portion of a credit balance exists for a period of thirty (30) days in favor of Distributor, or on expiration or the earlier termination of this Agreement, Vendor shall immediately reimburse Distributor the credit balance or remaining portion of the credit balance in cash. (d) In the event that Vendor reduces the Standard Wholesale Price (as defined in Exhibit A) of a Title at a retailer serviced by Distributor, Exhibit A shall be amended to recompute the Distributor Wholesale Price based on the reduced Standard Wholesale Price. In addition, Vendor shall promptly issue a credit to Distributor for the difference between the Distributor Wholesale Price charged to Distributor on or prior to the date the reduced Standard Wholesale Price is first offered and the new reduced Distributor Wholesale Price for all units of the related Product remaining in the Distributor's warehouse and at retailers' locations serviced by the Distributor on the date the reduced Standard Wholesale Price is first offered. ("Price Markdown"). (e) If Distributor and another distributor both market and/or sell Vendor's Title to the same retailer, Vendor shall not offer a lower price to such other distributor for the same Title to be sold to the same retailer. 5. Orders; Shipping and Reports. ----------------------------- (a) All purchase orders issued by the Distributor for Products shall be sent by facsimile to the Vendor at its offices specified by Vendor's information set forth herein. The Vendor shall verify all orders by return facsimile or e-mail within 24 hours of receipt of the purchase order from Distributor. Verification shall specify the expected shipping date as well as any back ordered Products. Unless otherwise agreed to by Distributor, Vendor agrees to ship products within two (2) business days following the date of each purchase order for all the units of the Product that are available in stock as of the date of the purchase; provided, however, that, if the Vendor must produce inventory to fulfill the purchase order, Vendor agrees to ship products within two (2) business days following the delivery of the Products from manufacturer. Distributor shall be entitled to change and amend any Purchase Order at any time prior to shipment by Vendor and in the event of a breach pursuant to Section 7(c)(ii). (b) All Products and other materials shall be shipped by Vendor F.O.B. Distributor's warehouse, freight prepaid and allowed. The Vendor will pay all costs related to the transportation of the Products and any related materials to the Distributor's warehouse designated on each Purchase Order, including without limitation, costs of transportation, terminal fees, duties and tariffs. With the exception of returns set forth in Section 6(a) below, the Distributor will pay all costs related to the transportation of the Products to the Vendor's warehouse that is designated on each return material authorization form "RMA" issued by Vendor, including without limitation, costs of transportation, terminal fees, duties and tariffs. (c) Title and risk of loss with respect to a shipment of Products shall pass to the Distributor pursuant to the shipment terms once such shipment of Products is received at the Distributor's warehouse specified in the purchase order. Distributor must notify Vendor of any count discrepancies no later than five (5) business days from date of Distributor's receipt of Products, and any related invoice adjustments will be made by Vendor to the Distributor's invoice at that time. Risk of loss upon the Distributor's return of the Products to the Vendor shall pass to Vendor based on shipping terms in the related RMA. (d) Distributor shall use its commercially reasonable efforts to provide to Vendor a report once a month detailing Distributor's balances of warehouse inventory and field inventory on-hand and retail sell-through activity by title. 6. Return of Products. ------------------- (a) Distributor may return to Vendor, at Vendor's expense any Product that is damaged, contains a manufacturing defect or does not comply with the requirements set forth in Section 3(a) above, for a refund in cash or full credit, as determined by Distributor in its sole discretion. (b) Distributor shall have the right to return Vendor's Products to Vendor and receive full credit for the value of the Distributor Wholesale Price less Price Markdown (if any) for such Products. Distributor's right to return Product will expire [**] ([**]) months after Distributor discontinues the distribution of any such Product. Vendor will apply all returned product credits to its receivable account with Distributor, as a reduction to the amount owed by Distributor to Vendor. If for any reason, a credit balance exists for a period of [**] ([**]) days in favor of the Distributor, Vendor shall reimburse Distributor the credit balance remaining in cash. With the exception of returns set forth in Section 6(a) above, Distributor shall bear freight expenses from Distributor's warehouse for the return of Products. (c) For any Product returned under this Agreement, Distributor shall request, in writing, an RMA from Vendor. Vendor shall provide an RMA within ten (10) days of receipt of that written request. If no RMA is received within such 10-day period, Distributor may charge Vendor storage fees for the specific Products listed in the Distributor's RMA request. All RMA's issued by Vendor to Distributor will be valid for 30 days after issuance, after which time, any uncompleted RMA will be cancelled. 7. Term of Agreement and Termination. ---------------------------------- (a) This Agreement shall become effective on the date set forth above and shall continue for a period of three (3) years or until termination pursuant to this Section 7. This Agreement shall renew at the end of the initial term and each renewal term for an additional 12-month period, unless notice is provided by either party to the other at least sixty (60) days prior to the end of the applicable term. (b) In the event of a material breach of this Agreement by a party and such material breach is not cured by such party within thirty (30) days of written notice (the "Cure Period"), the non-breaching party shall have the right to terminate this Agreement. Nothing contained herein shall in any way limit any notifying, non-breaching party's other rights and remedies under this Agreement or at law or equity. (c) Without prejudice to any other rights or remedies available to Distributor, Distributor shall have the right, in its sole discretion, to immediately terminate this Agreement upon written notice to Vendor in the event of the occurrence of any one or more of the following (i) the Vendor breaches the representations and warranties set forth in Section 3(a) and such breach is not cured within fifteen (15) days, (ii) Vendor fails to deliver a shipment pursuant to Section 5(a) and such failure is not cured within fifteen (15) days; or (ii) Vendor makes any assignment for the benefit of creditors or files a petition in bankruptcy or is adjudged bankrupt or becomes insolvent or is placed in the hands of a receiver or if the equivalent of any of the proceedings or acts referred to in this clause, though known and/or designated by some other name or term in any country comprising the Territory shall occur. (d) Either party shall have the right to terminate this Agreement for convenience and without cause at any time upon one hundred and twenty (120) days prior written notice. In the event of a termination pursuant to this Section 7(d), neither party shall be liable to the other because of such termination for any damages including without limitation, compensation, reimbursement, or damages on account of loss of prospective profits or anticipated sales on account of expenditures, investments, leases or commitments in connection with the business or goodwill of the non-terminating party, or for any other reason flowing from such termination. Notwithstanding termination of this Agreement for any reason or expiration of the term, Distributor shall have the continuing right to market and distribute the Product for a period of six (6) months after the effective date of such termination and/or the Distributor shall have the right to return to the Vendor all or any portion of the Product within six (6) months after the effective date of such termination for a full refund in cash. 8. Confidentiality. During the term of this agreement, each party will have access to, and may have imparted and may from time to time impart to the other certain confidential information relating to technical and marketing aspects of the other's business, including but not limited to price lists, release dates, price changes, technical specifications of Products, sales plans, and customer lists, all of which information shall be deemed proprietary and are trade secrets. Both parties agree that they shall not, until the later of the expiration of the term of this agreement or until such time as the information - ----------------------- [**] Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, this portion of Sections 6(b) of this Agreement has been omitted. The omitted information has been filed separately with the Securities and Exchange Commission. is made public either directly or indirectly, by the party originally responsible for disclosing the information to the other party, make known to any person, firm or corporation other than a party to this agreement, use for itself (other than for fulfilling the obligations hereunder) or for the benefit of a third party any of the foregoing information. These obligations shall not apply to any information that is required to be disclosed in the context of an administrative, regulatory or judicial process or review, as may be required by law or as may be agreed to by mutual consent of the parties hereto. 9. Indemnification. ---------------- (a) Each party does hereby indemnify, defend and hold harmless the other party (the "Indemnified Party") and such Indemnified Party's subsidiaries, affiliates, officers, employees and approved and permitted licensees and assigns from any and all loss and damage (including, without limitation, reasonable fees and disbursements of counsel incurred by such Indemnified Party in any action or proceeding between the parties or between any party and any third party or otherwise) arising out of or in connection with any breach of any of the warranties, representations, duties, obligations of or agreements made by the indemnifying party under this Agreement, and agrees to reimburse the Indemnified Party on demand, for any payment made or loss suffered with respect to any claim or act to which the foregoing indemnity applies. The foregoing shall apply to any direct claim by Indemnified Party against the indemnifying party. Each party shall have the right to participate at its own expense and by its own counsel in the defense of any such claim, and in such event, the parties hereto shall cooperate with each other in the defense of any such action, suit or proceeding hereunder. Distributor shall be entitled to offset any amounts or other payments due to Vendor under this Agreement against any sums owed by Vendor to Distributor. (b) IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER UNDER OR IN CONNECTION WITH THIS AGREEMENT FOR ANY LOSS OF PROFIT OR ANY OTHER COMMERCIAL DAMAGE INCLUDING; WITHOUT LIMITATION, INCIDENTAL, CONSEQUENTIAL, SPECIAL, EXEMPLARY, PUNITIVE OR OTHER INDIRECT DAMAGES OF ANY NATURE, FOR ANY REASON WHATSOEVER INCLUDING, WITHOUT LIMITATION, A BREACH OF THIS AGREEMENT, THE EXPIRATION OR ANY TERMINATION OF THIS AGREEMENT, WHETHER SUCH LIABILITY IS ASSERTED ON THE BASIS OF CONTRACT, TORT (INCLUDING NEGLIGENCE OR STRICT LIABILITY) OR OTHERWISE, EVEN IF A PARTY HAS BEEN WARNED OF THE POSSIBILITY OF SUCH DAMAGES. 10. Miscellaneous. -------------- (a) Force Majeure. No party shall be responsible for delays or failure of performance resulting from acts beyond the reasonable control of such party, including without limitation, acts of God, acts of war, governmental regulations, power failures, floods, earthquakes or other disasters. (b) Survival. Sections 4, 6, 7, 8, 9 and 10 shall survive the termination of this Agreement for any reason. (c) Notices. All notices and other items from one party to the other hereunder will, be addressed to the address and information set forth in this Agreement, or to such other address as the addressee may designate in writing. Any notice shall be sent by certified or registered mail, return receipt requested (and in the case of notices sent to or from a location outside the United States, by air mail), by personal delivery or by commercial overnight delivery service, and by facsimile to the facsimile number of the party to be served and shall be deemed complete when deposited in any United States mail box addressed as aforesaid, except that (i) all materials personally delivered shall be deemed served when actually received by the party to whom addressed, and (ii) commercial overnight delivery service materials shall be deemed served on the business day following the day of delivery to the commercial overnight delivery service company. (d) Independent Contractor. Nothing in this Agreement shall be construed to constitute either party as the partner, joint venturer, agent, employee or affiliate of the other, it being intended that the parties shall remain independent contractors and neither party shall be liable for the obligations, liabilities or representations of the other. The Distributor shall not describe or hold itself out as an agent of the Vendor, nor describe itself other than as a distributor of the Vendor. (e) Governing Law. This Agreement shall be construed under the internal laws of the State of New York, without regard to its choice of law provisions. Each party agrees that the state and/or federal courts located in the County of New York shall have exclusive jurisdiction over any dispute arising hereunder. Vendor waives any objection it may have to such venue. In the event any dispute, claim, question or difference arises with respect to this Agreement or its performance, enforcement, breach, termination or validity, the parties hereto shall use their best efforts to settle the dispute. To this end, they shall consult and negotiate with each other, in good faith and understanding of their mutual interests, to reach a just and equitable solution satisfactory to both parties. (f) Headings. The division of this Agreement into Sections and the insertion of headings are for the convenient reference only and are not to affect its interpretation. (g) Amendments. No supplement, modification, amendment, waiver, termination or discharge of this Agreement shall be binding, unless executed in writing by a duly authorized representative of each party to this Agreement. (h) Waiver. No waiver of any of the provisions of this Agreement shall be deemed to constitute a waiver of any other provision (whether or not similar); nor shall such waiver be binding unless executed in writing by the party to be bound by the waiver. No failure on the part of the Vendor or the Distributor to exercise, and no delay in exercising any right under this Agreement shall operate as a waiver of such right; nor shall any single or partial exercise of any such right preclude any other or further exercise of such right or the exercise of any other right. (i) Entire Agreement. This Agreement constitutes the complete and entire agreement of the parties and supersedes all previous communications, oral or written, and all other communications between them relating to the subject matter hereof. There are no representations, warranties, conditions or other agreements, express or implied, statutory or otherwise, between the parties in connection with the subject matter of this Agreement, except as specifically set forth herein and the Vendor and the Distributor have not relied and are not relying on any other information, discussion or understanding in entering into and completing the transactions contemplated by this Agreement. Exhibit A and Exhibit B (if any) form a part of this Agreement and to the extent that the terms or conditions in such exhibits are in conflict with the terms or conditions in this Agreement, the terms and conditions in such exhibits will govern. (j) Assignment. This Agreement shall be binding upon and enure to the benefit of the Vendor and the Distributor and their respective successors, heirs, personal representatives and permitted assigns. No party shall have the right to assign this Agreement or any of its rights or obligations hereunder without the prior written consent of the other party and any attempted assignment shall be null and void; provided that (x) Distributor party shall be permitted to assign this Agreement and its rights and obligations (in whole or in part) to a subsidiary or affiliate of Distributor party without the consent of Vendor and (y) either party shall be permitted to assign this Agreement and its rights and obligations pursuant to a merger, sale of substantially all of the assets or stock or other similar type transaction. (k) Severability. If any provision of this Agreement shall be deemed by an arbitrator or any count of competent jurisdiction to be invalid or void, the remaining provisions shall remain in full force and effect. (l) Counterparts; Facsimile Signature. This Agreement may be executed in one or more counterparts, each of which when taken together, shall be deemed to constitute one and the same instrument. Facsimile signatures on this Agreement shall be deemed originals for all purposes. (m) No Third Party Beneficiaries. Nothing in this Agreement is intended or shall be construed to give any person, other than the parties hereto (and Distributor's parent and subsidiaries), any legal or equitable right, remedy or claim under or in respect of this Agreement or any provision contained herein. (n) Exhibits. The exhibits and schedules referred to in this Agreement are attached to and are incorporated herein in their entirety by reference. IN WITNESS WHEREOF, the parties have executed this Agreement on the date specified below. Gathering of Developers, Inc., Distributor - ------------------------------------------ By: Name: Title: Date: Address: 622 Broadway New York, NY 10012 Phone/Fax# 646-536-2842/646-536-2928 eGames, Inc., Vendor - -------------------- By: Name: Title: Date: Address: Phone/Fax# Federal Tax ID Number: EXHIBIT A --------- PRODUCT SUBMISSION FORM ADDENDUM COMPLETE ONE FORM FOR EACH TITLE VENDOR: eGames, Inc. Reference Distribution Agreement / Addendum Dated: November 15, 2005 Product Information: - -------------------- Title: Territory: [United States] [North America] Distributor Retailers: - ---------------------------------- ------------------------------------------ Release Date: Genre: Platform: ESRB Rating: Platform: Package: [Box] [Jewel Case -or- Jewel Case Box] OS: Format: [CD] [DVD] [Other]: - ---------------------------------- ------------------------------------------ Vendor Part Number: 12 Digit UPC code: Vendor shall pay any and all fines associated with incorrect UPC information submitted ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- - - - ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- Dimensions and Weights: Vendor shall pay any and all fines associated - ------------------------ with incorrect Quantity, Dimension or Weight information submitted Pallet (HxWxD): Carton Quantity: Unit (HxWxD): Pallet Carton Qty: Carton (HxWxD): Unit Weight: Pallet Weight: Carton Weight: Pricing Information: - ------------------- Standard Wholesale Price: $ Distributor Wholesale Price: $ , subject to further adjustment pursuant to Section 4(b) and with respect to sales by Distributor pursuant to specific retailer programs identified on Exhibit B. Manufacturer's Suggested Retail Price: $ Except as expressly modified by the terms of this addendum, the underlying agreement shall remain in full force and effect. Submitted By: - ------------ eGames, Inc., Vendor Gathering of Developers, Inc., Distributor Signature: Signature: ---------------------- ---------------------- Name: Name: ---------------------- ---------------------- Title: Title: ---------------------- ---------------------- Date: Date: ---------------------- ---------------------- EXHIBIT B --------- RETAIL PROGRAM ADDENDUM VENDOR: eGames, Inc. Reference Contract / Addendum Dated: November 15, 2005 Retail Program for: [**] Territory: United States Program Terms: DISTRIBUTION Defective Allowance: A [**]% of Standard Wholesale Price Defective Allowance ("DFA") to be deducted by Distributor. The DFA deduction will be adjusted to the actual Defective Return Percentage ("DFP") at the end of every calendar quarter. Product can be returned to Vendor or Destroyed On-Site ("DOS"). Retailers that DOS defective product rather than return defective product to Distributor will receive 100% credit. Vendor may audit the product in Distributor's warehouse prior to DOS within 15 days of receiving written notice from Distributor. Retailer DOS audit based on retailer claim summaries which generally indicate the product title, retailer SKU, and quantity. Catastrophic Defect: Regular DFA does not cover catastrophic defective product. Catastrophic defined as a DFP greater than [**] ([**]%) of gross purchases on a title-by-title basis. Market Development Funds ("MDF"): [**]% of Standard Wholesale Price will be deducted by Distributor on a per unit basis for costs associated with the marketing and merchandising of each Title. Vendor understands they will be approached to participate in various programs on a case-by-case basis. New Store Allowance ("NSA"): [**]% of Standard Wholesale Price will be deducted by Distributor for all products ordered by Retailer for new store opening inventory (initial new store order only). The NSA applies only to the products ordered by the new store for the specific new store only. Returned Product Fee: [**]% of Standard Wholesale Price will be deducted by the Distributor for each unit of product returned by the Retailer ("Retailer Returns"). Retailer Mandated Source Tagging: Vendor will be responsible for the installation of Sensor Security Tags on the Product. If Vendor fails to deliver Product to Distributor with the proper security tags installed, a flat rate of $[**] USD per unit will be deducted by Distributor for the installation of Sensor Security Tags on such Vendor product shipped to the Retailer. Vendor agrees to provide Distributor with a completed Product Submission Form Addendum (Exhibit A) for each Product shipped to the Retailer prior to this agreement by anyone other than the Distributor. Upon return from the Retailer of Product sold to Retailer by anyone other than the Distributor: 1. Distributor shall have the right to return Vendor's Products to Vendor and receive full credit for the value of the Standard Wholesale Price only for the number of units returned to the Distributor by the Retailer that exceed the number of units that Distributor has shipped to the Retailer. 2. Vendor will issue an RMA to Distributor pursuant to Section 6(c) of the underlying agreement. Rebate and Incentive Programs: Distributor will deduct any amounts deducted by Retailer in conjunction with rebate and/or incentive programs offered by the Vendor to the Retailer or End-User. Except as expressly modified by the terms of this addendum, the underlying agreement shall remain in full force and effect. eGames, Inc., Vendor Gathering of Developers, Inc., Distributor Signature: Signature: ---------------------- ---------------------- Name: Name: ---------------------- ---------------------- Title: Title: ---------------------- ---------------------- Date: Date: ---------------------- ---------------------- - ----------------------- [**] Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, this portion of Exhibit B - Retail Program Addendum - attached to this Agreement has been omitted. The omitted information has been filed separately with the Securities and Exchange Commission. EXHIBIT B --------- RETAIL PROGRAM ADDENDUM VENDOR: eGames, Inc. Reference Contract / Addendum Dated: November 15, 2005 Retail Program for: [**] Territory: United States Program Terms: DISTRIBUTION Defective Allowance: A [**]% of Standard Wholesale Price Defective Allowance ("DFA") to be deducted by Distributor. The DFA deduction will be adjusted to the actual Defective Return Percentage ("DFP") at the end of every calendar quarter. Product can be returned to Vendor or Destroyed On-Site ("DOS"). Retailers that DOS defective product rather than return defective product to Distributor will receive 100% credit. Vendor may audit the product in Distributor's warehouse prior to DOS within 15 days of receiving written notice from Distributor. Retailer DOS audit based on retailer claim summaries which generally indicate the product title, retailer SKU, and quantity. Catastrophic Defect: Regular DFA does not cover catastrophic defective product. Catastrophic defined as a DFP greater than [**] percent ([**]%) of gross purchases on a title-by-title basis. Catastrophic includes product with substandard packaging. Merchandise Placement Fee: A one time Merchandise Placement Fee ("MPF") is charged by the Retailer on a per Title basis (and will be deducted by Distributor on the same basis) for each Title the Retailer orders to be placed and sold in more than [**] ([**]) of the Retailer's locations. For Titles ordered and shipped during the period between January 1 and September 30, the MPF, if applicable, shall be $[**] per Title. For Titles ordered and shipped during the period between October 1 and December 31, the MPF, if applicable, shall be $[**] per Title. Titles packaged in a Jewel Case or Jewel Case Box are not subject to MPF. For purposes of clarification, the Distributor shall be entitled to deduct the MPF from payments to Vendor if the MPF is applicable to the Title and has been incurred. Market Development Funds ("MDF"): Either [**]% of Standard Wholesale Price will be deducted by Distributor on a per unit basis for costs associated with the marketing and merchandising of each Title. Or [**]% of Standard Wholesale Price will be deducted by Distributor on a per unit basis for costs associated with marketing and merchandising of each Title with a Manufacturer Suggested Retail Price of $[**] or less and not subject to MPF set forth above. Vendor understands they will be approached to participate in various programs on a case-by-case basis. New Store Allowance ("NSA"): [**]% of Standard Wholesale Price will be deducted by Distributor for all products ordered by Retailer for new store opening inventory (initial new store order only). The NSA applies only to the products ordered by the new store for the specific new store only. Markdown of Product for Clearance: In lieu of the return of sellable inventory by Retailer, a deduction of [**]% of Standard Wholesale Price, but not to exceed the difference between the Distributor Wholesale Price less applicable MDF and $0.00, will be made by the Distributor for each unit of remaining sellable inventory in the possession of the Retailer ("Field Inventory"). All remaining sellable Field Inventory of said title will then become the responsibility of the Retailer and will not be returnable. Returned Product Fee: [**]% of Standard Wholesale Price will be deducted by the Distributor for each unit of product returned by the Retailer ("Retailer Returns"). Vendor agrees to provide Distributor with a completed Product Submission Form Addendum (Exhibit A) for each Product shipped to the Retailer prior to this agreement by anyone other than the Distributor. Upon return from the Retailer of Product sold to Retailer by anyone other than the Distributor: 1. Distributor shall have the right to return Vendor's Products to Vendor and receive full credit for the value of the Standard Wholesale Price only for the number of units returned to the Distributor by the Retailer that exceed the number of units that Distributor has shipped to the Retailer. 2. Vendor will issue an RMA to Distributor pursuant to Section 6(c) of the underlying agreement. Rebate and Incentive Programs: Distributor will deduct any amounts deducted by Retailer in conjunction with rebate and/or incentive programs offered by the Vendor to the Retailer or End-User. Except as expressly modified by the terms of this addendum, the underlying agreement shall remain in full force and effect. eGames, Inc., Vendor Gathering of Developers, Inc., Distributor Signature: Signature: ---------------------- ---------------------- Name: Name: ---------------------- ---------------------- Title: Title: ---------------------- ---------------------- Date: Date: ---------------------- ---------------------- - ----------------------- [**] Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, this portion of Exhibit B - Retail Program Addendum - attached to this Agreement has been omitted. The omitted information has been filed separately with the Securities and Exchange Commission. EXHIBIT B --------- RETAIL PROGRAM ADDENDUM VENDOR: eGames, Inc. Reference Contract / Addendum Dated: November 15, 2005 Retail Program for: [**] Territory: United States Program Terms: DISTRIBUTION Defective Allowance: A [**]% of Standard Wholesale Price Defective Allowance ("DFA") to be deducted by Distributor. The DFA deduction will be adjusted to the actual Defective Return Percentage ("DFP") at the end of every calendar quarter. Product can be returned to Vendor or Destroyed On-Site ("DOS"). Retailers that DOS defective product rather than return defective product to Distributor will receive 100% credit. Vendor may audit the product in Distributor's warehouse prior to DOS within 15 days of receiving written notice from Distributor. Retailer DOS audit based on retailer claim summaries which generally indicate the product title, retailer SKU, and quantity. Catastrophic Defect: Regular DFA does not cover catastrophic defective product. Catastrophic defined as a DFP greater than [**] percent ([**]%) of gross purchases on a title-by-title basis. Catastrophic includes product with substandard packaging. Market Development Funds ("MDF"): [**]% of Standard Wholesale Price will be deducted by Distributor on a per unit basis for costs associated with the marketing and merchandising of each Title. Vendor understands they will be approached to participate in various programs on a case-by-case basis. New Store Allowance("NSA"): [**]% of Standard Wholesale Price will be deducted by Distributor for all products ordered by Retailer for new store opening inventory (initial new store order only). The NSA applies only to the products ordered by the new store for the specific new store only. Returned Product Fee: [**]% of Standard Wholesale Price deduction will be deducted by the Distributor for each unit of Vendor's inventory returned by the Retailer ("Retailer Returns"). Vendor agrees to provide Distributor with a completed Product Submission Form Addendum (Exhibit A) for each Product shipped to the Retailer prior to this agreement by anyone other than the Distributor. Upon return from the Retailer of Product sold to Retailer by anyone other than the Distributor: 1. Distributor shall have the right to return Vendor's Products to Vendor and receive full credit for the value of the Standard Wholesale Price only for the number of units returned to the Distributor by the Retailer that exceed the number of units that Distributor shipped to the Retailer. 2. Vendor will issue an RMA to Distributor pursuant to Section 6(c) of the underlying agreement. Rebate and Incentive Programs: Distributor will deduct any amounts deducted by Retailer in conjunction with rebate and/or incentive programs offered by the Vendor to the Retailer or End-User. Except as expressly modified by the terms of this addendum, the underlying agreement shall remain in full force and effect. eGames, Inc., Vendor Gathering of Developers, Inc., Distributor Signature: Signature: ---------------------- ---------------------- Name: Name: ---------------------- ---------------------- Title: Title: ---------------------- ---------------------- Date: Date: ---------------------- ---------------------- - ----------------------- [**] Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, this portion of Exhibit B - Retail Program Addendum - attached to this Agreement has been omitted. The omitted information has been filed separately with the Securities and Exchange Commission. EXHIBIT B --------- RETAIL PROGRAM ADDENDUM VENDOR: eGames, Inc. Reference Contract / Addendum Dated: November 15, 2005 Retail Program for: [**] Territory: United States Program Terms: DISTRIBUTION Defective Allowance: A [**]% of Standard Wholesale Price Defective Allowance ("DFA") to be deducted by Distributor. The DFA deduction will be adjusted to the actual Defective Return Percentage ("DFP") at the end of every calendar quarter. Product can be returned to Vendor or Destroyed On-Site ("DOS"). Retailers that DOS defective product rather than return defective product to Distributor will receive 100% credit. Vendor may audit the product in Distributor's warehouse prior to DOS within 15 days of receiving written notice from Distributor. Retailer DOS audit based on retailer claim summaries which generally indicate the product title, retailer SKU, and quantity. Catastrophic Defect: Regular DFA does not cover catastrophic defective product. Catastrophic defined as a DFP greater than [**] ([**]%) of gross purchases on a title-by-title basis. Market Development Funds ("MDF"): [**]% of Standard Wholesale Price will be deducted by Distributor on a per unit basis for costs associated with the marketing and merchandising of each Title. Vendor understands they will be approached to participate in various programs on a case-by-case basis. New Store Allowance ("NSA"): [**]% of Standard Wholesale Price will be deducted by Distributor for all products ordered by Retailer for new store opening inventory (initial new store order only) when distributor is charged this fee. The NSA applies only to the products ordered by the new store for the specific new store only. Returned Product Fee: [**]% of Standard Wholesale Price will be deducted by the Distributor for each unit of product returned by the Retailer ("Retailer Returns"). Vendor agrees to provide Distributor with a completed Product Submission Form Addendum (Exhibit A) for each Product shipped to the Retailer prior to this agreement by anyone other than the Distributor. Upon return from the Retailer of Product sold to Retailer by anyone other than the Distributor: 3. Distributor shall have the right to return Vendor's Products to Vendor and receive full credit for the value of the Standard Wholesale Price only for the number of units returned to the Distributor by the Retailer that exceed the number of units that Distributor has shipped to the Retailer. 4. Vendor will issue an RMA to Distributor pursuant to Section 6(c) of the underlying agreement. Rebate and Incentive Programs: Distributor will deduct any amounts deducted by Retailer in conjunction with rebate and/or incentive programs offered by the Vendor to the Retailer or End-User. Except as expressly modified by the terms of this addendum, the underlying agreement shall remain in full force and effect. eGames, Inc., Vendor Gathering of Developers, Inc., Distributor Signature: Signature: ---------------------- ---------------------- Name: Name: ---------------------- ---------------------- Title: Title: ---------------------- ---------------------- Date: Date: ---------------------- ---------------------- - ----------------------- [**] Pursuant to a request for confidential treatment submitted to the Securities and Exchange Commission, this portion of Exhibit B - Retail Program Addendum - attached to this Agreement has been omitted. The omitted information has been filed separately with the Securities and Exchange Commission. -----END PRIVACY-ENHANCED MESSAGE-----