U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB/A
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-27102
eGames, Inc.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-2694937
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
2000 Cabot Boulevard West, Suite 110
Langhorne, PA 19047-1811
(address of Principal executive offices)
Issuer's Telephone Number, Including Area Code: 215-750-6606
Not Applicable
(Former name, former address and former
fiscal year, if changed since last report.)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes ( X ) No ( )
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ( ) No ( )
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 9,749,975 shares of common stock, no
par value per share, as of November 10, 2000.
Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X )
EXPLANATORY NOTE
eGames, Inc. (the "Company") is amending its Form 10-QSB to restate its interim
financial statements for the three month period ended and as of September 30,
2000, and has revised its interim financial statements for the three month
period ended September 30, 1999 for comparative purposes, to address certain
revenue recognition issues. The Company has concluded, based upon receipt of
delayed reporting of sell-through results from its food and drug retailers, that
it does not have the ability to make reliable estimates of product returns for
shipments to food and drug retailers in accordance with SFAS No. 48, "Revenue
Recognition When the Right of Return Exists," and the additional guidance
provided in the SEC's Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements." This Form 10-QSB/A reflects the sale of the Company's
products to its food and drug retailers on a product sell-through basis to the
end consumer. The Company previously recognized revenue upon shipment of its
products to its customers and recorded an allowance for product returns at the
time of shipment. The revenues, product costs and royalty costs relating to
product shipments to food and drug retailers have been restated in this Form
10-QSB/A to reflect this change in revenue recognition policy for shipments to
food and drug retailers. In addition, net sales associated with product
shipments to customers that traditionally have sold PC software products are
recognized at the time that title passes to the customer. Such net sales have
been restated in this Form 10-QSB/A because the Company determined in fiscal
2001 that certain of such product sales provided that title passed to the
customer only upon receipt of the Company's product by the customer, and that,
therefore, net sales could only be recognized upon the customer's receipt of
such product shipments.
This Form 10-QSB/A includes changes to the (i) Financial Statements and (ii)
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheet as of September 30, 2000............. 3
Consolidated Statements of Operations for the three months
ended September 30, 2000 and 1999 .......................... 4
Consolidated Statements of Cash Flows for the three months ended
September 30, 2000 and 1999..................................... 5
Notes to Consolidated Financial Statements...................... 6-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................ 10-15
Signatures ............................................................ 16
Item 1. Financial Statements
eGames, Inc.
Consolidated Balance Sheet
(Unaudited)
As of
September 30,
ASSETS 2000
------ ------------
Current assets:
Cash and cash equivalents $ 271,863
Accounts receivable, net of allowances totaling $1,986,702 2,669,775
Inventory 2,483,234
Prepaid royalties and other expenses 366,111
Net current assets of discontinued operation 339,734
-----------
Total current assets 6,130,717
Furniture and equipment, net 231,750
Intangibles and other assets, net 81,615
Net long term assets of discontinued operation 240,768
-----------
Total assets $ 6,684,850
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Note payable $ 56,713
Accounts payable 1,444,503
Customer advance payments 1,008,589
Revolving credit facility 500,000
Accrued expenses 1,063,149
Convertible subordinated debt 150,000
Capital lease obligations 5,210
-----------
Total current liabilities 4,228,164
Note payable, net of current portion 105,243
-----------
Total liabilities 4,333,407
Stockholders' equity:
Common stock, no par value (40,000,000 shares authorized;
9,981,875 issued and 9,749,975 outstanding) 9,134,234
Additional paid-in capital 1,148,550
Accumulated deficit (7,299,606)
Treasury stock, at cost - 231,900 shares (501,417)
Accumulated other comprehensive loss (130,318)
-----------
Total stockholders' equity 2,351,443
-----------
Total liabilities and stockholders' equity $ 6,684,850
===========
See accompanying notes to the consolidated financial statements.
eGames, Inc.
Consolidated Statements of Operations
(Unaudited)
Three months ended
September 30,
--------------------------
2000 1999
----------- -----------
Net sales $ 1,144,874 $ 2,561,636
Cost of sales 751,004 1,004,277
----------- -----------
Gross profit 393,870 1,557,359
Operating expenses:
Product development 181,147 242,847
Selling, general and administrative 1,440,125 1,352,269
----------- -----------
Total operating expenses 1,621,272 1,595,116
----------- -----------
Operating loss (1,227,402) (37,757)
Interest expense, net 7,353 3,710
----------- -----------
Loss from continuing operations before income taxes (1,234,755) (41,467)
Provision for income taxes 27,846 96,000
----------- -----------
Loss from continuing operations (1,262,601) (137,467)
Discontinued operation (Note 4):
Income (loss) from discontinued operation, net of
income tax benefits of $25,025 and $6,705 (21,416) 63,233
----------- -----------
Net loss ($1,284,017) ($74,234)
=========== ===========
Net loss per common share:
- Basic ($ 0.13) ($ 0.01)
=========== ===========
- Diluted ($ 0.13) ($ 0.01)
=========== ===========
Weighted average common shares outstanding - Basic 9,749,975 9,633,973
Dilutive effect of common stock equivalents - 0 - - 0 -
----------- -----------
Weighted average common shares outstanding - Diluted 9,749,975 9,633,973
=========== ===========
See accompanying notes to the consolidated financial statements.
eGames, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
Three months ended
September 30,
---------------------------
2000 1999
------------ -----------
Cash flows from operating activities:
Net loss ($ 1,284,017) ($ 74,234)
Adjustment to reconcile net loss to net cash used
in operating activities:
Depreciation, amortization and other non-cash items 57,740 79,802
(Income) loss from discontinued operation 21,416 (63,233)
Changes in items affecting operations:
Restricted cash - 0 - 17,560
Accounts receivable (369,152) (1,569,790)
Prepaid royalties and other expenses (158,478) (38,108)
Inventory (419,014) (316,878)
Accounts payable (544,282) 725,002
Customer advance payments 1,008,589 - 0 -
Accrued expenses 346,456 361,214
------------ -----------
Net cash used in operating activities (1,340,742) (878,665)
------------ -----------
Cash flows from investing activities:
Purchase of furniture and equipment (10,249) (29,210)
Purchase of software rights and other assets (1,730) (245)
------------ -----------
Net cash used in investing activities (11,979) (29,455)
------------ -----------
Cash flows from financing activities:
Proceeds from exercise of warrants and options - 0 - 110,000
Proceeds from borrowings under revolving credit facility 750,000 - 0 -
Repayments of borrowings under revolving credit facility (250,000) - 0 -
Repayments of note payable (12,866) (11,966)
Repayments of capital lease obligations (1,343) (1,722)
------------ -----------
Net cash provided by financing activities 485,791 96,312
Effect of exchange rate changes on cash and cash equivalents (7,260) 3,148
Net cash provided by discontinued operation 6,875 44,771
------------ -----------
Net decrease in cash and cash equivalents (867,315) (763,889)
Cash and cash equivalents:
Beginning of period 1,139,178 1,313,853
------------ -----------
End of period $ 271,863 $ 549,964
============ ===========
Supplemental cash flow information:
Cash paid for interest $ 14,423 $ 11,194
============ ===========
Non cash investing and financing activities:
Acquisition of furniture and equipment
through capital leases $ 11,550 $ 26,809
============ ===========
See accompanying notes to the consolidated financial statements.
eGames, Inc.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim consolidated financial statements were
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The Notes to Consolidated Financial Statements included in
the Company's Form 10-KSB for the fiscal year ended June 30, 2000 should be read
in conjunction with the accompanying statements. These statements include all
adjustments the Company believes are necessary for a fair presentation of the
statements. The interim operating results are not necessarily indicative of the
results for a full year.
During the first quarter of fiscal 2001, the Company adopted the Emerging Issues
Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives".
Accordingly, net sales amounts for current and prior periods reflect the
reclassification of consumer and retailer rebate costs, from selling, general
and administrative expenses to net sales.
Description of Business
eGames, Inc. (the "Company"), a Pennsylvania corporation incorporated in July
1992, develops, publishes, markets and sells a diversified line of personal
computer software primarily for consumer entertainment. The Company targets the
growing market of home personal computer ("PC") users who value full-featured,
value-priced and easy-to-use entertainment software. The Company's sales are
made through various national distributors on a non-exclusive basis in addition
to direct relationships with certain national and regional retailers. The
Company's products generally sell at retail for under $15, a price point that is
intended to generate impulse purchases in mass market shopping environments.
Consolidation
The consolidated financial statements include the accounts of the Company and
its previously wholly-owned subsidiary, which due to the sale of this operation
in May 2001, the relevant balances and transactions have been presented as a
discontinued operation. All inter-company balances and transactions have been
eliminated.
Revenue Recognition
Product Sales:
- --------------
The Company previously recognized revenue upon shipment of its products to its
customers and recorded an allowance for product returns. The Company has
concluded, based upon receipt of delayed reporting of sell-through results from
its food and drug retailers, which have not historically sold consumer PC
software products, that the Company does not have the ability to make reliable
estimates of product returns for shipments to food and drug retailers in
accordance with SFAS No. 48, "Revenue Recognition When the Right of Return
Exists" and the additional guidance provided in the SEC's Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements". Accordingly,
the Company's revenues in fiscal 2001 and 2000 associated with product shipments
to food and drug retailers are recognized based on the timing of the actual
sell-through of the Company's products to the end consumer at the retail
location as reported to the Company from the respective food and drug retailer.
Revenues associated with the Company's product shipments to its customers that
traditionally have sold consumer PC software products (i.e., mass merchant
retailers or distributors serving such retailers) are recognized at the time
title to the inventory passes to these customers, less a historically based
provision for anticipated product returns. The Company determined in fiscal 2001
that certain of its product sales to these customers provided that title passed
to the customer only upon receipt of the Company's product by the customer and
that, therefore, net sales could only be recognized upon the customer's receipt
of such product shipments. Title passes to these customers either upon shipment
of the product or receipt of the product by these customers based on the terms
of the sale transaction.
Notes to Consolidated Financial Statements (continued)
Customers generally have the right to return products purchased from the
Company. The Company recognizes product sales to its customers who traditionally
have sold consumer PC software products, in accordance with the criteria of SFAS
No. 48, at the time of the sale based on the following: the selling price is
fixed at the date of sale, the buyer is obligated to pay the Company, title of
the product transfers to the buyer, the buyer has economic substance apart from
the Company, the Company does not have further obligations to assist the buyer
in the resale of the product and the returns can be reasonably estimated at the
time of sale. While the Company has no other obligations to perform future
services subsequent to shipment, the Company provides telephone customer support
as an accommodation to purchasers of its products and as a means of fostering
customer loyalty. Costs associated with this effort are insignificant and,
accordingly, are expensed as incurred.
Allowance For Product Returns and Price Markdowns:
- --------------------------------------------------
The Company distributes the majority of its products through several third-party
distributors and directly to national and regional retailers. The distribution
of these products is governed by distribution agreements, direct sale agreements
or purchase orders, which generally allow for product returns and price
markdowns. For shipments to its customers that have traditionally sold consumer
PC software products, the Company records an allowance for returns and markdowns
as a reduction of gross sales at the time title of the products pass to the
customer. This allowance, which is reflected as a reduction of accounts
receivable, is estimated based primarily upon historical experience. During the
quarters ended September 30, 2000 and 1999, the Company's provisions for product
returns and price markdowns for customers that have traditionally sold consumer
PC software products were approximately $225,000 and $568,000 or 18% and 18% of
related gross shipments, respectively.
Customer Advance Payments
Although the Company recognizes revenue from food and drug retailers based on
the timing of the actual sell-through of the Company's products to the end
consumer, the Company may receive payments from these food and drug retailers in
advance of such products being sold to the end consumer. These payments are
recorded as customer advance payments in the Company's Consolidated Balance
Sheet until such time as the products are actually sold through to the end
consumer. After the products are sold through to the end consumer, the customer
advance payment amount is recorded as revenue. In the event that the Company
receives customer advance payments that ultimately exceed the actual product
sell-through of the Company's products to the end consumer at such retailers,
the Company would owe these retailers such excess amounts.
Prepaid Royalties
Prepaid royalties represent advance payments made to licensors of software and
intellectual properties used in the Company's products. Prepaid royalties are
expensed at contractual royalty rates based on net product sales.
Marketing and Sales Incentive Costs
Marketing costs for which the Company pays its resellers, such as slotting and
advertising fees, are charged to expense as incurred and were approximately
$370,000 and $239,000 for the quarters ended September 30, 2000 and 1999,
respectively.
Sales incentive costs, such as rebates and coupons, that the Company offers to
the retail consumer are recorded as reductions to net sales as incurred and were
approximately $108,000 and $45,000 for the quarters ended September 30, 2000 and
1999, respectively.
New Accounting Pronouncements
During the first quarter of fiscal 2001, the Company adopted Emerging Issues
Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives".
Accordingly, net sales amounts for current and prior periods reflect the
reclassification of consumer and retailer rebate costs, from selling, general
and administrative expenses to net sales.
Notes to Consolidated Financial Statements (continued)
Additionally, the Company has evaluated its revenue recognition policies based
upon Staff Accounting Bulletin 101 "Revenue Recognition" and related amendments
and interpretations. Accordingly, the Company determined it should recognize
revenues for fiscal 2001 and 2000 associated with product shipments to food and
drug retailers based on the timing of the actual product sell-through activity
to the end consumer of the Company's products at these retail locations and not
at the time the Company ships its products to these food and drug retailers. The
Company made this decision following its determination that it was not able to
adequately estimate, at time of product shipment, the amount of product returns
for product shipments to food and drug retailers. Revenues associated with the
Company's product shipments to its customers that traditionally have sold
consumer PC software products (such as mass-merchant retailers, or distributors
servicing such retailers) are recognized at the time title to these products
passes to these customers, less a historically-based provision for anticipated
product returns.
The Company is currently evaluating the potential impact of Emerging Issues Task
Force ("EITF") 00-10 "Accounting for Shipping and Handling Fees and Costs". This
pronouncement will become effective by the Company's fourth quarter of fiscal
2001. The Company does not expect the adoption of EITF 00-10 to have a
significant impact on its results of operations, financial position or cash
flows.
2. Comprehensive Loss
On July 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income".
This Statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income (loss) is computed as follows:
Three Months Ended
September 30,
2000 1999
------------ ------------
Net loss ($ 1,284,017) ($ 74,234)
Other comprehensive income (loss):
Foreign currency translation adjustment (61,120) 18,829
------------ ------------
Comprehensive loss ($ 1,345,137) ($ 55,405)
============ ============
3. Common Stock
On October 26, 1998, the Company's Board of Directors authorized the Company to
purchase up to $1,000,000 of its shares of Common Stock in open-market purchases
on the Nasdaq SmallCap Market. During the quarter ended September 30, 2000 the
Company did not purchase any shares of its Common Stock. As of September 30,
2000, the Company had acquired 231,900 shares of its Common Stock, with an
approximate cost of $501,000, pursuant to its stock repurchase program.
4. Discontinued Operation
On May 11, 2001, the Company sold eGames Europe Limited, its wholly-owned
subsidiary located in the United Kingdom, to a non-related third-party. The
Company has reflected the relevant activity and account balances for this
operation as a discontinued operation within each of the respective financial
statements included in this report. The Company received $300,000 in net
proceeds, which approximated the discontinued operation's net book value. The
net proceeds consisted of: $150,000 in cash provided at closing, $120,000 in a
note receivable to be payable in twelve monthly payments of $10,000 each, and
$30,000 in cash held in escrow to be released to the Company, pending any
unresolved claims, six months following the closing of the sale. The amounts in
the accompanying consolidated financial statements and footnotes have been
reclassified for all periods presented to give effect to the discontinued
operation.
Notes to Consolidated Financial Statements (continued)
Net sales for the discontinued operation for the quarters ended September 30,
2000 and 1999 were approximately $590,000 and $576,000, respectively. The income
(loss) from the discontinued operation was approximately ($21,000) and $63,000
for the quarters ended September 30, 2000 and 1999, respectively, which amounts
were net of income tax benefits of approximately $25,000 and $7,000,
respectively.
Included in the Company's Consolidated Balance Sheet for September 30, 2000,
were net current assets of discontinued operation totaling approximately
$340,000, primarily comprised of accounts receivable, which were partially
offset by accounts payable and accrued expenses. Additionally, in the Company's
Consolidated Balance Sheet for September 30, 2000 were net long term assets of
discontinued operation totaling approximately $241,000, primarily comprised of
un-amortized goodwill related to the prior acquisition of this discontinued
operation during fiscal 1999 and certain furniture and equipment costs.
5. Operations by Reportable Segments
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information" establishes standards for reporting information about an
enterprise's operating segments and related disclosures about its products,
geographic areas and major customers.
Based on the Company's organizational structure and its presentation of the
discontinued operation, the Company operates in only one reportable segment,
which is publishing interactive entertainment software for personal computers.
6. Revolving Credit Facility
On August 9, 2000, the Company entered into a $2,000,000 revolving credit
facility ("new credit facility") with a commercial bank, which expires on
October 31, 2001. This new credit facility replaced the $1,500,000 revolving
credit facility that it previously had with another commercial bank. Amounts
outstanding under this new credit facility are charged interest at one-half of
one percent above the bank's current prime rate and such interest is due
monthly. The new credit facility is collateralized by substantially all of the
Company's assets. The new credit facility requires the Company, among other
things, to maintain certain financial ratios, such as: a minimum working capital
balance of $1,500,000 and a maximum senior debt to effective net worth ratio of
1.50 to 1.00. Additionally, this new credit facility has a minimum effective net
worth covenant starting at $3.1 million at June 30, 2000 and increasing by
$150,000 quarterly to a $3.7 million requirement at June 30, 2001. As of
September 30, 2000, the Company was not in compliance with the minimum effective
net worth covenant and the maximum senior debt to effective net worth covenant.
This new credit facility was established to provide, among other things,
additional working capital to support the Company's anticipated growth. As of
November 13, 2000, the Company had a $500,000 outstanding balance under this new
credit facility.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The accompanying consolidated financial statements as of September 30, 2000
include the accounts of eGames, Inc. (the "Company") and its previously
wholly-owned subsidiary that is presented as a discontinued operation. Dollar
amounts discussed within the Company's "Management's Discussion and Analysis of
Financial Condition and Results of Operations" have been rounded to the nearest
thousand ('000).
Forward-Looking Statements
This Quarterly Report on Form 10-QSB/A and in particular Management's Discussion
and Analysis of Financial Condition and Results of Operations contains
forward-looking statements about circumstances that have not yet occurred,
including, without limitation, statements regarding the Company's
Store-In-A-Store program resulting in the longer-term placement of the Company's
products in the food and drug retail channel, which is intended to increase
sales volume within this channel and decrease the rate of product returns due to
longer product exposure on retailers' product shelves; the level of the
Company's international net sales remaining at between 5 % and 10% of the
Company's consolidated net sales for the remainder of fiscal 2001; the Company's
efforts to increase distribution of its products via the Internet; the payment
of certain promotional costs resulting in increased sell-through rates for the
Company's products during short-term promotional programs; the ability of the
Company's Store-in-a-Store program to reduce promotional expenses, as a
percentage of sales, due to more product sales being non-promotional in nature;
the sufficiency of the Company's cash and working capital balances to fund the
Company's operations for the foreseeable future; the expectation that certain
new accounting pronouncements will not have a significant impact on the
Company's results of operations, financial position or cash flows; as well as
other statements including words such as "anticipate", "believe" or "expect" and
statements in the future tense. These forward-looking statements are subject to
business and economic risks, and actual events or the Company's actual future
results could differ materially from those set forth in the forward-looking
statements due to such risks and uncertainties. The Company will not necessarily
update information if any forward looking statement later turns out to be
inaccurate.
The following important factors, among others discussed elsewhere in this
report, could cause the Company's actual results to differ materially from those
indicated by the forward-looking statements contained in this report: the market
acceptance of the Company's Store-in-a-Store program in the food and drug retail
channel and the sustainability of the program over time; the ability of the
Store-in-a-Store program to secure longer-term shelf space for the Company's
products; whether the longer-term placement of the Company's products at retail
will result in better sell-through rates and therefore fewer returns from the
food and drug retail channel; the market acceptance and successful sell-through
results for the Company's products at retail stores and the ability of the
Company to accurately estimate sell-through volume when an order is shipped to,
or received by, a customer that has traditionally sold PC software; the amount
of unsold product that is returned to the Company by retail stores; the
Company's ability to accurately predict the amount of product returns that will
occur and the adequacy of the reserves established for such returns; the
Company's ability to continue to implement its Store-in-a-Store program on
commercially acceptable terms; the success of the Company's distribution
strategy, including its ability to enter into new distribution and direct sales
relationships on commercially acceptable terms; the allocation of adequate shelf
space for the Company's products in major retail chain stores; the Company's
ability to negotiate lower product promotional costs in its distribution and
retail relationships; the Company's ability to collect outstanding accounts
receivable and establish adequate reserves for un-collectible receivables;
increased selling, general and administrative costs, including increased legal
expenses; the continued increase in the number of computers in homes in North
America and the world; the ability to deliver products in response to orders
within a commercially acceptable time frame; downward pricing pressure;
fluctuating costs of developing, producing and marketing the Company's products;
the Company's ability to license or develop quality content for its products;
the Company's ability to access alternative distribution channels and the
success of the Company's efforts to develop its Internet sales; consumers'
continued demand for value-priced software; increased competition in the
value-priced software category; and various other factors, many of which are
beyond the Company's control. Risks and uncertainties that may affect the
Company's future results and performance also include, but are not limited to,
those discussed under the heading "Risk Factors" in the Company's Annual Report
on Form 10-KSB for the fiscal year ended June 30, 2000 as filed with the
Securities and Exchange Commission and other documents filed with the
Commission.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Results of Operations
Three Months Ended September 30, 2000 and 1999
Net Sales
Net sales for the quarter ended September 30, 2000 were $1,145,000 compared to
$2,562,000 for the quarter ended September 30, 1999, representing a decrease of
$1,417,000 or 55%. The $1,417,000 decrease in net sales was primarily
attributable to the Company's decrease in net sales to its North American
distribution and retail customers of $1,296,000 and $221,000, respectively.
These net sales decreases were partially offset by increases in the Company's
net sales to North American food and drug retailers and international customers
of $52,000 and $48,000, respectively.
The Company's net sales to North American traditional software distributors
decreased by $1,296,000, while net sales to North American traditional software
retailers decreased by $221,000. These net sales decreases resulted in large
part from industry-wide reductions of PC software inventory levels held by North
American software retailers and distributors.
During fiscal 2001, the Company has continued to increase its distribution
efforts to North American food and drug retailers, in an attempt to offset some
of the previously discussed net sales decreases to its North American
traditional software retail and distribution customers. During fiscal 2001, the
Company established its first "Store-in-a-Store" entertainment software display
sections in approximately 4,000 food and drug retail stores. The establishment
of these Store-In-A-Store software display sections within certain national and
regional food and drug retail stores is intended to help secure longer-term
placement of the Company's products in this retail channel, with the goal of
increasing product sell through volume at these food and drug retailers while
decreasing the rate of product returns due to longer product exposure on these
retailers' product shelves
The Company's international net revenues, inclusive of both product net sales
and royalty revenues, for the quarter ended September 30, 2000 increased by
$48,000 compared to the same period a year ago. As a percentage of net sales,
the Company's international net revenues represented 11% and 3% of the Company's
net sales for the quarters ended September 30, 2000 and 1999, respectively. The
Company anticipates that international net revenues will range from 5% to 10% of
the Company's consolidated net sales for the remainder of fiscal 2001.
On May 11, 2001, the Company sold its wholly-owned subsidiary "eGames Europe
Limited", located in the United Kingdom, to a non-related third-party. By
affecting this sale, the Company transitioned the majority of its international
product distribution efforts to a licensing revenue model, whereby the Company
no longer bears the working capital risk of supporting these multi-country
product sales efforts, but will earn a royalty fee based upon net product sales
covered under various licensing arrangements with third-party developers. The
Company has reflected the net sales activity for this operation as a
discontinued operation within the Company's Consolidated Statements of
Operations. Net sales for the discontinued operation for the quarters ended
September 30, 2000 and 1999 were $590,000 and $576,000, respectively.
During fiscal 2000, the Company completed its transition from publishing
shareware-based PC game software titles to publishing full-release PC game
software titles. There were no net sales of shareware-based software titles
during the quarter ended September 30, 2000 compared to $90,000 of net sales of
such titles during the quarter ended September 30, 1999.
The Company has initiated several programs designed to increase the sale of its
products over the Internet, including: the roll-out of an improved and expanded
website; improvement of its electronic distribution capabilities by further
developing and expanding its affiliation with Digital River, a leading
distributor of digital software over the Internet; and incorporation of
user-friendly on-line functionality into its products. Sales of the Company's
products via the Internet for the quarters ended September 30, 2000 and 1999
were $52,000 and $21,000, respectively, or 5% and 1% of the Company's net sales,
respectively.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Most of the Company's non-exclusive arrangements with its traditional software
distributors and retailers allow for product returns or price markdowns. During
the quarters ended September 30, 2000 and 1999, the Company's provision for
product returns and price markdowns relating to product shipments to its
traditional software customers totaled $225,000 and $568,000, or 18% and 18% of
related gross shipments, respectively.
Although the Company has experienced an increase in product shipments to food
and drug retailers, the majority of these product shipments have been
"promotional" in nature, meaning that the Company's products were merchandised
in those retail stores for only six to eight weeks. As a result of this short
promotional period, the Company has experienced a higher and more unpredictable
rate of product returns from food and drug retailers compared to product return
rates from traditional software retailers and distributors where the Company's
products typically have a longer period of time to sell through to end
consumers.
Cost of Sales
Cost of sales for the quarter ended September 30, 2000 were $751,000 compared to
$1,004,000 for the quarter ended September 30, 1999, representing a decrease of
$253,000 or 25%. This $253,000 decrease in cost of sales was caused primarily by
decreases in product costs and royalty fees of $195,000 and $113,000,
respectively, that were associated with the decrease in net product sales. These
decreases were partially offset by increased distribution, packaging and
reclamation costs of $60,000 largely associated with the Company's product
shipments to food and drug retailers. Most of the revenues related to these
product shipments have been deferred until such time as product sell-through to
the end consumer is reported to the Company by the food and drug retailer.
Product costs consist mainly of replicated compact discs, printed materials,
protective jewel cases and boxes for certain products.
Gross Profit Margin
The Company's gross profit margin for the quarter ended September 30, 2000
decreased to 34.4% of net sales from 60.8% of net sales for the quarter ended
September 30, 1999. This 26.4% decrease in gross profit margin was caused
primarily by an increase in product costs of 14.1%, as a percentage of net
sales, due largely from the Company's: discounting of sales prices of certain
software titles with consumer and retailer discounts and rebates; discounting of
sales prices of end-of-life-cycle and time-sensitive legal settlement related
products; and sales of newly-developed promotional titles with lower per unit
margins. Also negatively impacting the Company's gross profit margin was a 12.2%
increase, as a percentage of net sales, in distribution, packaging and
reclamation costs, largely associated with the Company's product shipments to
food and drug retailers, which related revenues were deferred until such time
(if ever) that these products sales to the end consumer are reported to the
Company by the food and drug retailer.
Operating Expenses
Product development expenses for the quarter ended September 30, 2000 were
$181,000 compared to $243,000 for the quarter ended September 30, 1999, a
decrease of $62,000 or 26%. This decrease was caused primarily by a $45,000
decrease in salary and related costs due to headcount reductions among the
Company's technology-related staff and no employee bonus accrual for the quarter
ended September 30, 2000.
Selling, general and administrative expenses for the quarter ended September 30,
2000 were $1,440,000 compared to $1,352,000 for the quarter ended September 30,
1999, an increase of $88,000 or 7%. This $88,000 increase was caused primarily
by an $85,000 increase in marketing promotional expenses associated primarily
with the increase in product shipments to food and drug retailers and the
additional costs charged by traditional software retailers and distributors to
support sales of the Company's products relating to the increased competition
for retail shelf space. These promotional costs incurred with food and drug
retailers are intended to increase the sell-through rate of the Company's
products during the short-term promotional programs that these retailers offer
periodically to their customers, as well as expand the longer-term placement of
the Company's products in the food and drug channel through the Company's
Store-in-a-Store program. This program is intended to reduce promotional
expenses, as a percentage of net sales, due to more product sales having a
longer selling period at these retail locations. Additionally, the Company
continues to experience higher promotional costs in the traditional software
retail channels due to increased competition for shelf space and the related
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
expenses charged by retailers and distributors to promote and support sales of
the Company's products.
Interest Expense, Net
Net interest expense for the quarter ended September 30, 2000 was $7,000
compared to $4,000 for the quarter ended September 30, 1999, an increase of
$3,000. The $3,000 increase was primarily due to the utilization of $500,000
under the revolving credit facility for the quarter ended September 30, 2000.
Provision for Income Taxes
Provision for income taxes for the quarter ended September 30, 2000 was $28,000
compared to $96,000 for the quarter ended September 30, 1999, a decrease of
$68,000 or 71%. This $68,000 decrease in the provision for income taxes was
primarily due to the $1,193,000 increase in the Company's loss from continuing
operations before income taxes for the quarter ended September 30, 2000.
Loss from Continuing Operations
As a result of the various factors discussed above, the Company recognized a
$1,263,000 loss from continuing operations for the quarter ended September 30,
2000, compared to a $137,000 loss from continuing operations for the quarter
ended September 30, 1999, an increase of $1,126,000 in a loss from continuing
operations.
Income (Loss) from Discontinued Operation
The (loss) from discontinued operation for the quarter ended September 30, 2000
was ($21,000), net of a $25,000 income tax benefit, compared to income from
discontinued operation for the quarter ended September 30, 1999 of $63,000, net
of a $7,000 income tax benefit, resulting in an $84,000 decrease in income from
discontinued operation. This $84,000 decrease was caused primarily by a $141,000
increase in operating expenses largely associated with increased marketing
promotion costs to support product sales, which was partially offset by
increases in gross profit and income tax benefit of $39,000 and $18,000,
respectively.
Net loss
As a result of the factors discussed above, net loss increased to $1,284,000 for
the quarter ended September 30, 2000 from a net loss of $74,000 for the quarter
ended September 30, 1999, an increase in net loss of $1,210,000.
Weighted Average Common Shares
The weighted average common shares outstanding on a diluted basis increased by
116,002 for the quarter ended September 30, 2000 to 9,749,975 from 9,633,973 for
the quarter ended September 30, 1999. This 116,002 increase in weighted average
common shares outstanding was caused primarily by an increase in the number of
common stock shares outstanding during the current period. Common stock
equivalents ("CSE's") were excluded from the weighted average shares
calculations due to their anti-dilutive impact caused by both quarter's net
losses.
Liquidity and Capital Resources
As of September 30, 2000, the Company's cash and working capital balances were
$272,000 and $1,903,000, respectively, and the Company's total stockholders'
equity balance at September 30, 2000 was $2,351,000.
Net cash used in operating activities was $1,341,000 and $879,000 for the
quarters ended September 30, 2000 and 1999, respectively. The $1,341,000 in net
cash used in operating activities resulted primarily from the Company's net loss
of $1,284,000 for the current quarter. Additional items contributing to the
$1,341,000 in net cash used in operating activities were increases in accounts
receivable of $369,000 and inventory of $419,000 and a $544,000 decrease in
accounts payable, which net cash uses were partially offset by cash sources of
$1,009,000 in customer advance payments and $346,000 in increased accrued
expenses. The $1,009,000 in customer advance payments approximates the amount of
customer payments from food and drug retailers that have exceeded the amount of
revenue recognized by the Company relating to the actual product sell through of
the Company's products to the end consumer reported by food and drug retailers.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Net cash used in investing activities for the quarters ended September 30, 2000
and 1999 was $12,000 and $29,000, respectively. The $12,000 in net cash used in
investing activities resulted from purchases of $10,000 in furniture and
equipment and $2,000 in other assets.
Net cash provided by financing activities for the quarters ended September 30,
2000 and 1999 was $486,000 and $96,000, respectively. The $486,000 in net cash
provided by financing activities reflects net proceeds from the Company's
borrowing of $750,000 under the revolving credit facility, which was partially
offset by repayments of this borrowing under the revolving credit facility, note
payable and capital lease obligations of $250,000, $13,000 and $1,000,
respectively.
Net cash provided by the Company's discontinued operation for the quarters ended
September 30, 2000 and 1999 was $7,000 and $45,000, respectively.
As September 30, 2000, the Company had received $1,009,000 in customer payments
from certain food and drug retailers for products shipped to such retailers
prior to the sale of such products to the end consumer being reported to the
Company from these retailers. These payments are recorded as customer advance
payments in the Company's Consolidated Balance Sheet until such time that these
retailers report to the Company that the products are actually sold to the end
consumer. After the products are sold through to the end consumer, the customer
advance payment amount is recorded as product revenue. In the event that the
Company receives customer advance payments that ultimately exceed the actual
product sell-through of the Company's products to the end consumer at such
retailers, the Company would owe these retailers such excess amounts. The
Company's management believes that it is highly likely that the ultimate product
sell-through of the Company's products will be substantially less than the
customer advance payment balances for these food and drug retailers. If these
retailers request that the Company repay this liability, it would likely result
in a serious liquidity issue for the Company.
On August 9, 2000, the Company entered into a $2,000,000 revolving credit
facility ("new credit facility") with a commercial bank, which expires on
October 31, 2001. This new credit facility replaced the $1,500,000 revolving
credit facility that it previously had with another commercial bank. Amounts
outstanding under this new credit facility are charged interest at one-half of
one percent above the bank's current prime rate and such interest is due
monthly. The new credit facility is collateralized by substantially all of the
Company's assets. The new credit facility requires the Company, among other
things, to maintain certain financial ratios, such as: a minimum working capital
balance of $1,500,000 and a maximum senior debt to effective net worth ratio of
1.50 to 1.00. Additionally, this new credit facility has a minimum effective net
worth covenant starting at $3.1 million at June 30, 2000 and increasing by
$150,000 quarterly to a $3.7 million requirement at June 30, 2001. As of
September 30, 2000, the Company was not in compliance with the minimum effective
net worth covenant and the maximum senior debt to effective net worth covenant.
This new credit facility was established to provide, among other things,
additional working capital to support the Company's anticipated growth. As of
November 13, 2000, the Company had a $500,000 outstanding balance under this new
credit facility.
The Company's ability to achieve and maintain positive cash flow depends upon a
variety of factors, including the timeliness and success of the collection of
outstanding accounts receivable, the creditworthiness of the primary
distributors and retail customers of the Company's products, the continuing
retail demand for value-priced PC game software, the development and
sell-through of the Company's products, the costs of developing, producing and
marketing such products, and various other factors, some of which are beyond the
Company's control. In the future, the Company expects its cash and working
capital requirements to be affected by each of these factors. The Company
believes cash and working capital balances, in addition to the Company's
revolving credit facilities mentioned above, will be sufficient to fund the
Company's operations for the next twelve months. However, there can be no
assurances that the Company will be able to achieve and maintain a positive cash
flow or that additional financing will be available if and when required or, if
available, will be on terms satisfactory to the Company.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
On November 10, 2000, the Company received notification from Nasdaq that its
common stock had failed to maintain a minimum bid price of $1.00 over a period
of 30 consecutive trading days as required for continued listing on the Nasdaq
SmallCap Market as set forth in Marketplace Rule 4310 (c) (4) (the "Rule"). In
accordance with Marketplace Rule 4310 (c) (8) (B), the Company had 90 calendar
days, or until February 8, 2001, to regain compliance with this Rule. On
February 7, 2001, the Company requested a hearing before a Nasdaq Listing
Qualifications Panel, which stayed the delisting of the Company's common stock
from the Nasdaq SmallCap Market pending the Panel's decision. The Company's
hearing had been scheduled for March 23, 2001. The Company did not attend the
scheduled hearing because management did not believe that it had sufficient
evidence to present to the hearing board, as of March 23rd, that would have
caused them to further stay the Company's de-listing. Accordingly, effective
April 2, 2001, the Company's common stock began trading on the OTC Bulletin
Board under its existing symbol EGAM. The Company's common stock had traded on
the Nasdaq SmallCap Market since October 1995.
New Accounting Pronouncements
During the first quarter of fiscal 2001, the Company adopted Emerging Issues
Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives".
Accordingly, net sales amounts for current and prior periods reflect the
reclassification of consumer and retailer rebate costs, from selling, general
and administrative expenses to net sales.
Additionally, the Company has evaluated its revenue recognition policies based
upon Staff Accounting Bulletin 101 "Revenue Recognition" and related amendments
and interpretations. Accordingly, the Company determined it should recognize
revenues for fiscal 2001 and 2000 associated with product shipments to food and
drug retailers based on the timing of the actual product sell-through activity
to the end consumer of the Company's products at these retail locations and not
at the time the Company ships its products to these food and drug retailers. The
Company made this decision following its determination that it was not able to
adequately estimate, at time of product shipment, the amount of product returns
for product shipments to food and drug retailers. Revenues associated with the
Company's product shipments to its customers that traditionally have sold
consumer PC software products (such as mass-merchant retailers, or distributors
servicing such retailers) are recognized at the time title to these products
passes to these customers, less a historically-based provision for anticipated
product returns.
The Company is currently evaluating the potential impact of Emerging Issues Task
Force ("EITF") 00-10 "Accounting for Shipping and Handling Fees and Costs". This
pronouncement will become effective by the Company's fourth quarter of fiscal
2001. The Company does not expect the adoption of EITF 00-10 to have a
significant impact on its results of operations, financial position or cash
flows.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
eGames, Inc.
(Registrant)
Date: March 26, 2002 /s/ Gerald W. Klein
-------------- --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: March 26, 2002 /s/ Thomas W. Murphy
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Thomas W. Murphy, Chief Financial
Officer and Chief Accounting Officer