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, 2003
|_| 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: 9,989,337 shares of common stock, no
par value per share, as of May 14, 2003.
Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X )
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements:
Balance Sheet as of March 31, 2003....................... 3
Statements of Operations for the three months and nine
months ended March 31, 2003 and 2002 ................ 4
Statements of Cash Flows for the nine months
ended March 31, 2003 and 2002....................... 5
Notes to Financial Statements............................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................. 15
Risk Factors............................................. 31
Item 3. Controls and Procedures.................................. 36
Part II Other Information
Item 6. Exhibits and Reports on Form 8-K......................... 37
Exhibit Index ......................................................... 37
Signatures ......................................................... 38
Certifications ......................................................... 39
Exhibits ......................................................... 41
Item 1. Financial Statements
eGames, Inc.
Balance Sheet
(Unaudited)
As of
March 31,
ASSETS 2003
-----------
Current assets:
Cash and cash equivalents $ 361,762
Accounts receivable, net of allowances totaling $988,344 1,066,420
Inventory 410,145
Prepaid and other expenses 152,363
-----------
Total current assets 1,990,690
Furniture and equipment, net 30,598
-----------
Total assets $ 2,021,288
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current and total liabilities:
Accounts payable $ 224,092
Accrued expenses 709,502
-----------
Total current liabilities and total liabilities 933,594
Stockholders' equity:
Common stock, no par value (40,000,000 shares authorized;
10,221,237 issued and 9,989,337 outstanding) 9,179,827
Additional paid-in capital 1,226,507
Accumulated deficit (8,817,223)
Treasury stock, at cost - 231,900 shares (501,417)
-----------
Total stockholders' equity 1,087,694
-----------
Total liabilities and stockholders' equity $ 2,021,288
===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Operations
(Unaudited)
Three months ended Nine months ended
March 31, March 31,
-------------------------- --------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net sales $ 1,530,983 $ 3,626,289 $ 5,335,956 $ 7,887,730
Cost of sales 579,817 1,910,678 2,200,911 4,244,652
----------- ----------- ----------- -----------
Gross profit 951,166 1,715,611 3,135,045 3,643,078
Operating expenses:
Product development 108,240 91,987 312,987 312,559
Selling, general and administrative 591,483 680,806 1,885,585 2,216,076
----------- ----------- ----------- -----------
Total operating expenses 699,723 772,793 2,198,572 2,528,635
----------- ----------- ----------- -----------
Operating income 251,443 942,818 936,473 1,114,443
Interest expense, net 6,330 31,416 36,493 104,159
----------- ----------- ----------- -----------
Income before income taxes 245,113 911,402 899,980 1,010,284
Provision (benefit) for income taxes (51,007) - 0 - (51,007) 800
----------- ----------- ----------- -----------
Net income $ 296,120 $ 911,402 $ 950,987 $ 1,009,484
=========== =========== =========== ===========
Net income per common share:
- Basic $ 0.03 $ 0.09 $ 0.10 $ 0.10
=========== =========== =========== ===========
- Diluted $ 0.03 $ 0.09 $ 0.10 $ 0.10
=========== =========== =========== ===========
Weighted average common shares outstanding
- - Basic 9,989,337 9,989,337 9,989,337 9,989,337
Dilutive effect of common stock
equivalents 10,309 - 0 - 9,720 - 0 -
----------- ----------- ----------- -----------
Weighted average common shares outstanding
- - Diluted 9,999,646 9,989,337 9,999,057 9,989,337
=========== =========== =========== ===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Cash Flows
(Unaudited)
Nine months ended
March 31,
--------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income $ 950,987 $ 1,009,484
Adjustment to reconcile net income to net cash
provided by operating activities:
Depreciation, amortization and other non-cash items 120,041 111,639
Provisions for product returns, price markdowns,
bad debts and inventory obsolescence 939,579 1,060,174
Sell-through of prior year's customer advance payments - 0 - (1,636,503)
Changes in items affecting operations:
Restricted cash - 0 - 30,000
Accounts receivable (1,125,363) (297,902)
Prepaid and other expenses (41,296) 80,381
Inventory (4,318) 2,318,887
Accounts payable (108,991) (1,528,177)
Customer advance payments - 0 - (1,042,742)
Accrued expenses (114,751) 846,025
----------- -----------
Net cash provided by operating activities 615,888 951,266
----------- -----------
Cash flows from investing activities:
Purchases of furniture and equipment (7,685) (27,341)
Purchases of other assets - 0 - (1,375)
----------- -----------
Net cash used in investing activities (7,685) (28,716)
----------- -----------
Cash flows from financing activities:
Proceeds from credit facility/bank debt - 0 - 280,000
Repayments of credit facility/bank debt (840,000) (420,000)
Redemption of common stock warrant (50,000) - 0 -
Proceeds from note receivable - 0 - 90,000
Repayments of trade notes payable - 0 - (468,779)
Repayments of note payable (56,550) (46,801)
Repayments of capital lease obligations - 0 - (90,184)
----------- -----------
Net cash used in financing activities (946,550) (655,764)
----------- -----------
Net increase (decrease) in cash and cash equivalents (338,347) 266,786
Cash and cash equivalents:
Beginning of period 700,109 25,737
----------- -----------
End of period $ 361,762 $ 292,523
=========== ===========
Supplemental cash flow information:
Cash paid for interest $ 38,211 $ 108,321
=========== ===========
Cash received from income tax refunds $ 51,007 $ - 0 -
=========== ===========
Non cash investing and financing activities:
Conversion of selected accounts payable to trade notes payable $ - 0 - $ 484,080
=========== ===========
See accompanying notes to financial statements.
eGames, Inc.
Notes to Financial Statements
1. Summary of Significant Accounting Policies
Description of Business
eGames, Inc. is a Pennsylvania corporation incorporated in July 1992 that
develops, publishes, markets and sells primarily value-priced consumer
entertainment PC software games. Our product line enables us to serve customers
who are seeking a broad range of high-quality, value-priced PC software,
distributed on CD-ROM media and also electronically via the Internet. In North
America, our products are usually distributed through third-party distributors
on a non-exclusive basis who service mass-merchant retailers, in addition to
direct relationships that we have with certain specialty and PC software
retailers. In territories outside North America, our products are distributed
through third-party distributors that license our PC software content for their
own manufacture and distribution within specific geographic territories.
Liquidity
As of March 31, 2003, we had stockholders' equity of $1,088,000 and working
capital of $1,057,000. For the three and nine months ended March 31, 2003, we
earned net income of $296,000 and $951,000, respectively. Additionally, as of
March 31, 2003, we had a cash balance of $362,000 representing a $338,000
decrease in cash for the first nine months of fiscal 2003.
Since the first quarter of fiscal 2002, we have not had access to a credit
facility, and have been dependent entirely on cash flow from operations to meet
our financial obligations. Our ability to achieve and maintain positive cash
flow is essential to our survival as a going concern. Our ability to do this
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 our products, the development and
sell-through of our products to consumers, and the costs of developing,
producing and marketing such products. We believe that our proj
cted cash and
working capital balances may be sufficient to fund our operations through June
30, 2003, but there are significant challenges that we will need to successfully
manage in order to be able to fund our operations through that period of time
and beyond. These challenges include, but are not limited to: agreeing to and
maintaining acceptable payment terms with our vendors; and maintaining an
acceptable speed of our receivable collections from customers. Additionally,
there are market factors beyond our control that could also significantly affect
our operating cash flow. The most significant of these market factors is the
market acceptance and sell-through rates of our current products to consumers,
and the growth of the consumer entertainment PC software market, and in
particular our share of that market. If any of our software titles do not sell
through to consumers at the rate anticipated, we could be exposed to additional
product returns and a lack of customer replenishment orders for these products,
which could severely reduce the accounts receivable that we would be able to
collect from such retailers or distributors of our products. As a result of
these factors, we may not be able to achieve or maintain positive cash flow.
Outside financing to supplement our cash flows from operations may not be
available if and when we need it. Even if such financing were available from a
bank or other financing source, it may not be on terms satisfactory to us
because of the dilution it may cause or other costs associated with such
financing.
Basis of Presentation
The accompanying unaudited interim financial statements were prepared in
accordance with generally accepted accounting principles for interim financial
information as promulgated in the United States of America. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. The Notes to Financial Statements included in our Form 10-KSB for
the fiscal year ended June 30, 2002 should be read in conjunction with the
accompanying statements. These statements include all adjustments that
management believes are necessary for a fair presentation of the statements.
These interim operating results are not necessarily indicative of the results
for a full year. Certain dollar amounts discussed within the "Notes to Financial
Statements" have been rounded to the nearest thousand ("000").
Fair Value of Financial Instruments
The recorded amounts of accounts receivable and accounts payable at March 31,
2003 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.
Inventory
Inventory, consisting primarily of finished goods, is valued at the lower of
cost or market. Cost is determined by the first-in, first-out method (FIFO).
Furniture and Equipment
Furniture and equipment are stated at cost. Depreciation is calculated on the
straight-line method over the estimated useful lives of the assets ranging from
three to five years.
Leasehold improvements have been fully amortized on the straight-line method
over the shorter of the lease term or estimated useful life of the assets.
Maintenance and repair costs are expensed as incurred.
Long-Lived Assets
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.
Intangible Assets
As of March 31, 2003, we had intangible assets totaling $741,000, which costs
have been fully amortized. These assets resulted primarily from the purchase of
software rights, and their expense is amortized, on a straight-line basis, over
no more than a three-year period. For the three and nine months ended March 31,
2003, we did not record any amortization expense, compared to $5,000 and $15,000
for the three and nine months ended March 31, 2002, respectively.
Revenue Recognition
Product Sales:
- --------------
We distribute the majority of our products through third-party distributors to
mass-merchant retailers and directly to certain specialty and PC software
retailers. These retailers have traditionally sold consumer entertainment PC
software products. The distribution of our products is governed by distribution
agreements, direct sale agreements or purchase orders, which generally allow for
product returns and price markdowns. We recognize revenues from product
shipments to these types of customers that traditionally have sold consumer
entertainment PC software products at the time title to the inventory passes to
these customers, less a provision for anticipated product returns and price
markdowns. The provision for anticipated product returns and price markdowns is
based upon, among other factors: historical product return and price markdown
results, analysis of customer provided product sell-through and field inventory
data when available to us, and review of outstanding return material
authorizations. 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
sales transaction. Most of our customers require shipping terms of FOB
destination, which results in the title to our product passing at the time when
the customer actually receives our product.
We recognize product sales to these customers that traditionally have sold
consumer entertainment 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 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 the product returns and price markdowns can be reasonably estimated
at the time of sale. While we have no other obligations to perform future
services subsequent to shipment, we provide telephone customer support as an
accommodation to purchasers of our products and as a means of fostering customer
loyalty. Costs associated with this effort are insignificant and, accordingly,
are expensed as incurred.
We recognize revenues for product shipments to drug store retailers and
distributors, who have not traditionally sold consumer entertainment PC software
products, when our products actually sell through to the end consumer at these
retail locations and not at the time we ship our products to these drug store
retailers or distributors, or when the right of return no longer exists for
product shipments to a drug store retailer or distributor. During fiscal 2002,
we transitioned our prior direct distribution relationships with drug store
retailers to a licensing relationship with a third-party distributor, United
American Video ("UAV"), which assumes the responsibilities and costs of order
processing and receivable collections, inventory production, distribution,
promotion and merchandising of our products to these drug store retailers. We
recognize licensing revenues, which are reflected in net sales, based upon
contractual royalty rates applied to the licensees' net sales of our software
titles during the reporting period.
Provision for Product Returns and Price Markdowns:
- --------------------------------------------------
We currently distribute the majority of our products through third-party
distributors to mass-merchant retailers and directly to certain specialty and PC
software retailers, which retailers have traditionally sold consumer
entertainment PC software products. The distribution of our products is governed
by distribution agreements, direct sale agreements or purchase orders, which
generally allow for product returns and price markdowns. The provision for
anticipated product returns and price markdowns is based upon, among other
factors, our analysis of historical product return and price markdown results,
product sell-through results at retail store locations, current field inventory
quantities at distributors' warehouses and at retail store locations,
introduction of new and/or competing software products that could negatively
impact the sales of one or more of our current products, and outstanding return
material authorizations. The adequacy of our allowance for product returns and
price markdowns is reviewed at the end of each reporting period and any
necessary adjustment to this allowance (positive or negative) is reflected
within the current period's provision. At the end of each reporting period, the
allowance for product returns and price markdowns is reflected as a reduction to
the accounts receivable balance reflected within our balance sheet.
During the three months ended March 31, 2003 and 2002, our provision for product
returns and price markdowns for customers that have traditionally sold consumer
entertainment PC software products (inclusive of inventory liquidation
distributors) were $222,000 and $132,000, respectively, or 13% and 9% of related
gross sales, respectively.
During the nine months ended March 31, 2003 and 2002, our provision for product
returns and price markdowns for customers that have traditionally sold consumer
entertainment PC software products (inclusive of inventory liquidation
distributors) were $892,000 and $657,000, respectively, or 15% of related gross
sales during both periods.
Customer Advance Payments
Prior to our fiscal 2002 agreements with two drug store retailers and our
decision to stop distributing our products directly to drug store retailers and
distributors, we had recognized revenue from drug store retailers and
distributors based on the timing of the actual sell-through of our products to
end consumers. Additionally, we previously received payments from these drug
store retailers or distributors in advance of our products being sold to the end
consumer at drug store retail locations. These payments had been recorded as
customer advance payments on our balance sheet until such time as the products
were actually sold through to end consumers. After the products had sold through
to end consumers, or agreements were reached with a drug store retailer or
distributor that eliminated all further right of return, the customer advance
payment amount was recorded as revenue.
Prepaid and Other Expenses
Prepaid and other expenses represent advance payments made to third parties for,
among other things, items such as licensing of software and intellectual
properties used in our products, maintenance contracts, certain insurance
coverage and retailers' slotting fees. Prepaid and other expenses are expensed
at contractual rates or on a straight-line basis over the period of time covered
by a contract.
Marketing, Sales Incentive and Promotional Costs
Marketing costs reflected as operating expenses, such as advertising fees and
display costs, are charged to expense as incurred or when shipped to a customer.
These costs were $9,000 and $57,000 for the three months ended March 31, 2003
and 2002, respectively, and $46,000 and $291,000 for the nine months ended March
31, 2003 and 2002, respectively.
Sales incentives, such as rebates and coupons, that we grant retailers or
consumers are recorded as reductions to net sales as incurred, and were $22,000
and $2,000 for the three months ended March 31, 2003 and 2002, respectively, and
$84,000 and $176,000 for the nine months ended March 31, 2003 and 2002,
respectively.
Promotional costs, such as slotting fees required by certain retailers, are
recorded as reductions to net sales on a straight-line basis over the
contractual period. These costs were $16,000 and $11,000 for the three months
ended March 31, 2003 and 2002, respectively, and $116,000 and $53,000 for the
nine months ended March 31, 2003 and 2002, respectively.
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 (loss) per share is computed by dividing
net earnings (loss) by the weighted average number of common shares outstanding
during each period. Diluted earnings (loss) per share is computed by dividing
net earnings (loss) 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.
Accounting for Stock-Based Compensation
As of 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 for stock option grants made on or after that date. For stock
option grants made prior to July 1, 2002, we recognized stock-based compensation
using the intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). As of
January 1, 2003, we adopted the provisions of SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" (see Note 11 below for
additional information).
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, including allowances for inventory obsolescence, product returns,
price markdowns and bad debts (from un-collectible accounts receivable), and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
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 recognize that actual results could differ from any of our estimates and such
differences could have a negative or positive impact on future financial
results.
New Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure -- an Amendment of FASB Statement No.
123". SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an entity that
voluntarily changes to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects on reported net
income and earnings per share and the entity's accounting policy decisions with
respect to stock-based employee compensation. Certain of the disclosure
requirements are required for all companies, regardless of whether the fair
value method or intrinsic value method is used to account for stock-based
employee compensation arrangements. This amendment to SFAS 123 became effective
for financial statements for fiscal years ended after December 15, 2002 and for
interim periods beginning after December 15, 2002. Accordingly, we have adopted
the disclosure provisions of this statement in the current quarter of fiscal
year 2003.
During fiscal 2002, we adopted Emerging Issues Task Force ("EITF") Issue 00-25,
"Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products", which requires that certain promotional costs, such as
slotting fees charged by retailers, be reclassified as reductions to net sales,
as opposed to being reflected as operating expenses. Accordingly, net sales
amounts for prior periods reflect the reclassification of expenses, such as
slotting fees, from selling, general and administrative expenses to a reduction
of net sales. For the three months ended March 31, 2003 and 2002, these amounts
were $16,000 and $11,000, respectively, and for the nine months ended March 31,
2003 and 2002, these amounts were $116,000 and $53,000, respectively.
EITF Issue 00-25 was subsequently codified by EITF Issue 01-9, "Accounting for
Consideration Given by a Vendor to a Customer (Including a Reseller of the
Vendor's Products)". We do not expect any other recently issued accounting
pronouncements to have a significant impact on our results of operations,
financial position or cash flows.
2. Accounts Receivable, net
Accounts receivable consists of the following:
Accounts receivable, gross $2,054,764
Allowance for product returns (721,877)
Allowance for price markdowns (175,969)
Allowance for bad debts (90,498)
----------
Accounts receivable, net $1,066,420
==========
3. Inventory
Inventory consists of the following:
Raw materials $ 117,697
Finished goods 271,418
Product returns 131,844
----------
520,959
Allowance for inventory obsolescence (110,814)
----------
Inventory $ 410,145
==========
4. Prepaid and Other Expenses
Prepaid and other expenses consists of the following:
Advanced royalty fees $ 63,310
Prepaid insurance expenses 62,466
Other expenses 26,587
----------
Prepaid and other expenses $ 152,363
==========
5. Furniture and Equipment, net
Furniture and equipment consists of the following:
Furniture and equipment $ 904,506
Accumulated depreciation (873,908)
----------
Furniture and equipment, net $ 30,598
==========
6. Accrued Expenses
Accrued expenses consist of the following:
Accrued payroll, bonus and vacation expenses $ 229,620
Customers with credit balances 120,995
Accrued royalty fees 88,271
Accrued marketing promotion costs 82,899
Accrued professional fees 52,677
Other accrued expenses 135,040
----------
Accrued expenses $ 709,502
==========
7. Lease Obligations
Our 5,000 square foot office and development facility located in Langhorne,
Pennsylvania is occupied under an operating lease that is scheduled to expire on
September 30, 2004. Additionally, we currently rent certain office equipment
through various operating lease agreements. Net rent expense incurred under our
operating leases was $21,000 for both three month periods ended March 31, 2003
and 2002, respectively, and $59,000 and $84,000 for the nine months ended March
31, 2003 and 2002, respectively.
Our future payments for operating leases are as follows:
Period Amount
- ---------------------------------------------------------------------
Remaining three months of fiscal 2003 $ 16,000
Fiscal 2004 63,000
Fiscal 2005 29,000
Fiscal 2006 19,000
Fiscal 2007 and thereafter 28,000
--------
Total Lease Obligations $155,000
========
8. Dependence on Large Customer
We now rely primarily on a concentrated group of large customers, due to the
decision, during fiscal 2002, to cease distributing our products directly to
drug store retailers and refocus our efforts on distributing products to
mass-merchant retailers that have traditionally sold value-priced consumer
entertainment PC software. The majority of our current sales are to
mass-merchant retailers, and distributors serving such retailers, and in
particular to Atari, Inc. (Atari was formerly known as Infogrames, Inc.). Atari
is our primary North American distributor that services the major mass-merchant
retailers in North America, such as Wal-Mart, K-Mart, Target and Best Buy, among
others. In the event that we lose our distribution capability through Atari, it
would significantly harm eGames' financial condition and our ability to continue
as a going concern. During the three months ended March 31, 2003 and 2002, Atari
accounted for $1,115,000 and $599,000, respectively, in net sales, or 73% and
17% of net sales, respectively. During the nine months ended March 31, 2003 and
2002, Atari represented $3,173,000 and $1,792,000, respectively, in net sales,
or 59% and 23% of net sales.
9. Commitments and Contingencies
Under various licensing agreements with third-party software developers, we are
required to pay royalties for the use of licensed content in our products.
Royalty expense under such agreements, which is recorded in cost of sales, was
$196,000 and $343,000 for the three months ended March 31, 2003 and 2002,
respectively, and $651,000 and $798,000, respectively, for the nine months ended
March 31, 2003 and 2002, respectively.
We finance our Directors and Officers Liability and Employment Practice
Liability insurance policies with a third-party financing company. We record
this expense monthly on a straight-line basis over the period covered by the
relevant insurance policies. During the three months ended March 31, 2003 and
2002, we recorded $36,000 and $24,000 in related insurance expense and made
related payments of $15,000 and $29,000, respectively. During the nine months
ended March 31, 2003 and 2002, we recorded $105,000 and $71,000 in related
insurance expense and made related payments of $145,000 and $86,000,
respectively. On August 1, 2002, we obtained one-year replacement policies for
this insurance coverage for a total cost of $145,000. As of March 31, 2003, we
had no remaining payment obligation relating to these insurance policies.
Additionally, we had $48,000 of previously made payments reflected in the
Balance Sheet under "Prepaid and other expenses", which amount will be expensed
monthly on a straight-line basis from April 2003 through July 2003.
We have a retirement plan covering substantially all of our eligible employees.
The retirement plan is qualified in accordance with Section 401(k) of the
Internal Revenue Code. Under the plan, employees may defer up to 15% of their
pre-tax salary, but not more than statutory limits. We match 50% of each dollar
contributed by all participants. Our matching contribution to this plan was
$18,000 and $20,000, respectively, for the three months ended March 31, 2003 and
2002. During the nine months ended March 31, 2003 and 2002, our matching
contributions were $40,000 and $43,000 respectively. Our matching contributions
vest in fifty percent increments over a two-year period, beginning on the first
day of an individual's employment.
As a result of an agreement with the third-party to which we sold our United
Kingdom subsidiary in May 2001, we have purchase obligations for 50,000 units of
consumer entertainment PC software from this third party for fiscal 2003 and
2004, at a delivered cost of $1.50 per unit, for a total annual commitment of
$75,000 during each of those fiscal years. As of March 31, 2003, we had not
purchased any of this fiscal year's annual commitment.
10. Major Customers, International Sales, Worldwide Licensing Revenues and
Internet Sales
During the three months ended March 31, 2003, one major customer, Atari,
accounted for 73% of net sales, compared to the three months ended March 31,
2002, when two major customers, Walgreen Company and Atari, accounted for 58%
and 17% of net sales, respectively. During the nine months ended March 31, 2003,
one major customer, Atari, accounted for 59% of net sales, compared to the nine
months ended March 31, 2002, when two major customers, Walgreen Company and
Atari, accounted for 39% and 23% of net sales, respectively.
International net sales (including both licensing revenues and product net
sales) represented 3% and 1%, respectively, of net sales for the three months
ended March 31, 2003 and 2002. For both nine-month periods ended March 31, 2003
and 2002, international net sales represented 4% of net sales. For both
three-month periods ended March 31, 2003 and 2002, licensing revenues comprised
100% of international net sales, and for the nine months ended March 31, 2003,
licensing revenues amounted to 98% of international net sales compared to 63% of
international net sales during the prior year comparable period.
Worldwide licensing revenues represented 4% and 1%, respectively, of net sales
for the three months ended March 31, 2003 and 2002, and accounted for 6% and 3%,
respectively, of net sales for the nine months ended March 31, 2003 and 2002.
Internet sales accounted for 3% and 2%, respectively, of net sales for the three
months ended March 31, 2003 and 2002, and also represented 3% and 2%,
respectively, of net sales during the nine months ended March 31, 2003 and 2002.
11. Accounting for Stock-Based Compensation - Transition and Disclosure, per
SFAS No. 148
As of March 31, 2003, we had one existing stock-based employee compensation
plan, which was adopted, amended and restated during 1995. This Plan is known as
our 1995 Amended and Restated Stock Option Plan (the "1995 Plan"). At our fiscal
2000 Annual Meeting of Stockholders, the shareholders of our company approved an
amendment to increase the number of shares available for issuance under the 1995
Plan from the 1,950,000 shares of common stock previously approved to a total of
2,950,000 shares. The 1995 Plan is administered by the Board of Directors and
provides for the grant of incentive stock options and non-qualified stock
options to employees and eligible independent contractors and non-qualified
stock options to non-employee directors at prices not less than the fair market
value of a share of common stock on the date of grant.
Prior to July 1, 2002, we accounted for all stock option grants under the
recognition and measurement provisions of APB Opinion No. 25, "Accounting for
Stock Issued to Employees", and related Interpretations. No stock-based employee
compensation cost is reflected in net income before fiscal 2003, as all stock
option grants had an exercise price equal or greater than the market value of
the underlying common stock on the date of grant. 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. Stock option
grants under the 1995 Plan vest over periods ranging from six months to three
years. Therefore, the cost related to stock-based employee compensation included
in the determination of net income for fiscal 2003 is less than that which would
have been recognized if the fair value based method had been applied to all
stock option grants since the original effective date of SFAS No. 123.
As of January 1, 2003, we adopted the provisions of SFAS No. 148, "Accounting
for Stock-Based Compensation - Transition and Disclosure". Accordingly, the
following table illustrates the effect on net income and net income per share if
the fair value method had been applied to all outstanding stock option grants in
each period.
Three Months Ended Nine Months Ended
March 31, March 31,
--------------------- ----------------------
2003 2002 2003 2002
---------- --------- ---------- ----------
Net income, as reported $ 296,120 $ 911,402 $ 950,987 $1,009,484
Add: Stock-based employee compensation expense
included in reported net income, net of tax effects 24,959 - 0 - 71,028 - 0 -
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
stock option grants, net of tax effects (36,470) (69,057) (190,644) (232,297)
---------- ---------- ---------- ----------
Pro forma net income $ 284,609 $ 842,345 $ 831,371 $ 777,187
========== ========== ========== ==========
Net income per common share:
- - Basic, as reported $ 0.03 $ 0.09 $ 0.10 $ 0.10
========== ========== ========== ==========
- - Basic, pro forma $ 0.03 $ 0.08 $ 0.08 $ 0.08
========== ========== ========== ==========
- - Diluted, as reported $ 0.03 $ 0.09 $ 0.10 $ 0.10
========== ========== ========== ==========
- - Diluted, pro forma $ 0.03 $ 0.08 $ 0.08 $ 0.08
========== ========== ========== ==========
12. Bank Debt Repayment and Warrant Redemption
On January 16, 2003, we repaid the remaining $420,000 principal balance
outstanding on our term loan with Fleet Bank (the "Bank"), together with accrued
interest, in full satisfaction of all obligations under the November 2, 2001
forbearance agreement and underlying loan documents. Additionally on January 16,
2003, we redeemed the warrant we issued to the Bank in connection with the
forbearance agreement for $50,000.
13. 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 our products,
geographic areas and major customers. Based on our organizational structure, we
operate in only one geographic and one reportable segment, which is "publishing
consumer entertainment PC software products".
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 about
circumstances that have not yet occurred, including, without limitation,
statements regarding:
- our anticipated provisions for product returns and price markdowns;
- our anticipated sell-through rates for new higher price point products;
- the expectation that the majority of our product sales for the
foreseeable future will be through third-party distributors, as opposed
to direct-to-store retail distribution;
- the expected percentage of net sales to Atari, Inc. (formerly known
as Infogrames, Inc.) for the remainder of fiscal 2003;
- the expected percentage of international net sales that will be
comprised of licensing revenues for the remainder of fiscal 2003;
- the belief that the transition from direct distribution
relationships with drug store retailers to a licensing agreement
with United American Video (UAV) will result in higher gross
profit margins;
- the belief that for the remainder of fiscal 2003, the majority of
our net sales generated at North American non-traditional software
retail locations will be through the licensing agreement with UAV,
which should cause net sales to North American non-traditional
software customers to decrease significantly, on a comparative
basis to prior year periods, but enable us to earn higher profit
margins;
- our expectation that future licensing revenue from UAV will decrease;
- expected worldwide licensing revenues for the remainder of fiscal 2003;
- our expectation that international net product sales will represent
less than 1% of net sales for the remainder of fiscal 2003;
- the creation of programs designed to increase sales of our products via
the Internet;
- expected Internet sales for the remainder of fiscal 2003;
- the belief that reclamation costs will remain at the reduced levels
experienced to date in fiscal 2003 for the foreseeable future;
- the expectation that royalty rates required by software developers will
continue to increase for the foreseeable future;
- the belief that our fiscal 2003 gross profit margin should represent
approximately 60% of net sales during that twelve month period;
- the expectation that there will be no significant change in the number
of employees we employ during the remainder of fiscal 2003;
- our expectation that for the remainder of fiscal 2003, most of our
investing activities will relate to upgrades to our computer network;
- our belief that projected cash and working capital balances may be
sufficient to fund our operations through June 30, 2003;
- the expectation that certain new accounting pronouncements will not
have a significant impact on our results of operations, financial
position or cash flows;
- and 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 our actual future results could differ materially from those
set forth in the forward-looking statements due to such risks and uncertainties.
We will not necessarily update information if any forward looking statement
later turns out to be inaccurate.
The following important factors, as well as those factors discussed under "Risk
Factors" at pages 31 to 35 in this report, 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
products at retail stores, particularly at North American
mass-merchant retailers where consumer entertainment PC software
has traditionally been sold;
- the continued successful business relationship between us and
Atari, as one of our largest customers and the distributor to
Wal-Mart, K-Mart, Target, and Best Buy, among others;
- our ability to accurately estimate sell-through volume when
products are shipped to, or received by, a customer that has
traditionally sold consumer entertainment PC software;
- the amount of unsold product that is returned to us by retail stores
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;
- the successful sell-through of our new higher price point products,
in all retail channels where they are sold;
- the continued success of our current business model of selling,
primarily through third-party distributors, to a concentrated number of
select mass-merchant, specialty and PC software retailers;
- our ability to control the manufacturing and distribution costs of our
software titles;
- the success of our distribution strategy, including the ability to
continue to increase the distribution of our products into key
North American mass-merchant retailers and to enter into new
distribution and direct sales relationships on commercially
acceptable terms;
- the allocation of shelf space for our products in major retail chain
stores;
- the ability of our international product distribution to earn a royalty
and the ability of licensors to pay us such royalties;
- our success in achieving additional cost savings and avoiding
unanticipated expenses for the remainder of fiscal 2003;
- our ability to collect outstanding accounts receivable and establish an
adequate allowance for bad debts;
- 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 our products;
- our ability to license or develop quality content for our products;
- the success of our efforts to increase website traffic and product
sales over the Internet;
- consumers' continued demand for value-priced consumer entertainment PC
software;
- increased competition in the value-priced software category;
- and various other factors, many of which are beyond our control.
Risks and uncertainties that may affect our future results and performance also
include, but are not limited to, those discussed under the heading "Risk
Factors" in the Company's Form 10-KSB for the fiscal year ended June 30, 2002,
as filed with the Securities and Exchange Commission and also posted on the
Company's website, www.egames.com.
Critical Accounting Policies
- ----------------------------
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 accounting policies with respect to revenue
recognition and the valuation of inventory involve the most significant
management judgments and estimates. 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 estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an on-going basis, we evaluate our estimates,
including those related to product returns, price markdowns, bad debts,
inventory obsolescence, income taxes, contingencies and litigation. We base our
estimates on historical experience and on various other assumptions that we
believe are reasonable under the circumstances. Actual results may differ from
these estimates under different assumptions or conditions.
Revenue Recognition (Net Sales, Product Returns and Price Markdowns)
Significant management judgments and estimates must be made and used in order to
determine when revenues 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 based upon actual results. These differences, if
material, would significantly affect our operating results and financial
condition in any given period.
We distribute the majority of our products through third-party distributors to
mass-merchant retailers and directly to certain specialty and PC software
retailers. These retailers have traditionally sold consumer entertainment PC
software products. The distribution of our products is governed by distribution
agreements, direct sale agreements or purchase orders, which generally allow for
product returns and price markdowns. For product shipments to our customers that
have traditionally sold consumer entertainment PC software products, we record a
provision for product returns and price markdowns as a reduction of gross sales
at the time title of the product passes to the customer.
The provision for anticipated product returns and price markdowns is based upon
many factors, including our analysis of historical product return and price
markdown results, product sell-through results at retail store locations,
current field inventory quantities at distributors' warehouses and at retail
store locations, introduction of new and/or competing software products that
could negatively impact the sales of one or more of our current products,
outstanding return material authorizations, and the extent to which new products
with higher price points or unproven genres are being launched. The adequacy of
our allowance for product returns and price markdowns is reviewed at the end of
each reporting period and any necessary adjustment to this allowance (positive
or negative) is reflected within the current period's provision. At the end of
each reporting period, the allowance for product returns and price markdowns is
reflected as a reduction to the accounts receivable balance reflected within our
balance sheet.
During the three months ended March 31, 2003 and 2002, our provision for product
returns and price markdowns for customers that have traditionally sold consumer
entertainment PC software products (inclusive of inventory liquidation
distributors) were $222,000 and $132,000, respectively, or 13% and 9% of related
gross sales, respectively.
During the nine months ended March 31, 2003 and 2002, our provision for product
returns and price markdowns for customers that have traditionally sold consumer
entertainment PC software products (inclusive of inventory liquidation
distributors) were $892,000 and $657,000, respectively, or 15% of related gross
sales during both periods.
Based on the current trends of our product sell through activity to consumers
and the tight inventory controls being maintained by retailers and distributors,
we anticipate our overall fiscal 2003 provision for product returns and price
markdowns to range from 12% to 15% of related gross sales. Among other things, a
factor that we will continue to closely evaluate in determining our provision
for anticipated product returns and price markdowns will be the consumer
sell-through results of our higher price point products that were first
introduced during the first quarter of this fiscal year. We also expect to begin
selling several newly developed higher price point products during the fourth
quarter of this fiscal year. The sale of such products, with a targeted retail
price point of $19.99, represents a departure from our typical value-priced
product offering to the casual gamer that has historically been retail priced at
about $9.99, and accordingly represent a greater risk of requiring additional
price markdowns if these products do not sell-through to consumers at
anticipated rates.
We recognize revenues from product shipments to customers that have
traditionally sold consumer entertainment PC software products in accordance
with the criteria of SFAS No. 48, "Revenue Recognition When the Right of Return
Exists," 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 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 the returns can be reasonably estimated at the time of sale. 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. Most of
our customers require shipping terms of FOB destination, which results in the
title to our product passing at the time when the customer actually receives our
product.
We recognize revenues for product shipments to customers that have not
traditionally sold consumer entertainment PC software products (primarily drug
store retailers and distributors) when our products actually sell through to the
end consumer at these retail locations and not at the time we ship our products
to these drug store retailers or distributors, or when the right of return no
longer exists for product shipments to a drug store retailer or distributor.
During fiscal 2002, we transitioned our direct distribution relationships with
drug store retailers to a licensing relationship with a third-party distributor,
United American Video ("UAV"), which assumes the responsibilities and costs of:
order processing and receivable collections, inventory production, distribution,
promotion and merchandising of our products to these drug store retailers. We
recognize licensing revenues, which are reflected in net sales, based upon
contractual royalty rates applied to the licenses' net sales of our software
titles during the reporting period.
Inventory Valuation
Our accounting policy for inventory valuation requires management to make
estimates and assumptions as to the recoverability of the carrying value of our
inventory that affect the reported value of inventory and cost of sales for any
reporting period. Differences may result in the valuation of our inventory at
the close of any reporting period and the amount reflected as cost of sales
during any reporting period, if management's judgments or estimates with respect
to provisions for the potential impairment of inventory value prove to be
insufficient or excessive based upon actual results. These differences, if
material, would significantly affect our operating results and financial
condition.
We are exposed to product obsolescence due to the relatively short product life
cycles (averaging six to twenty-four months) of our consumer entertainment PC
software products. From time to time, our competitors may introduce new
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of our existing products, which would require us to
write-down the value of such inventory. Additionally, from time to time, we have
been subject to litigation or threatened litigation involving product content,
which has caused certain products to no longer be saleable. License agreements
with third-party software developers for product content may also expire before
such inventory has been sold. Although we attempt to accurately match production
requirements of our products to forecasted consumer demand, we may from time to
time produce an amount of inventory of a product that exceeds the eventual
consumer demand for such product, causing us to liquidate these excess
quantities of remaining inventory at close out prices to customers below the
carrying costs net of our provision for obsolescence. The adequacy of our
provision for inventory obsolescence is reviewed at the close of each reporting
period, and any adjustments (positive or negative) are recorded when deemed
necessary.
Results of Operations
Three Months ended March 31, 2003 and 2002
Net Sales
- ---------
For the three months ended March 31, 2003, net sales decreased by $2,095,000, or
58%, to $1,531,000 compared to $3,626,000 for the same quarter a year earlier.
This $2,095,000 decrease in net sales resulted from a $2,281,000 net product
sales decrease to North American non-traditional software retailers and
distributors, which decrease was partially offset by a $167,000 increase in net
product sales to North American traditional software retailers and distributors
and a $19,000 increase in worldwide licensing revenues.
The following tables represent our net sales by distribution channel and by
major customer for the three months ended March 31, 2003 and 2002, respectively.
Net Sales by Distribution Channel
---------------------------------
Three Months ended
-------------------------
March 31, March 31, Increase
Distribution Channel 2003 2002 (Decrease)
- ------------------------------------------------------------------ ----------- ----------- ------------
North American non-traditional software retailers and distributors $ 44,000 $ 2,325,000 ($ 2,281,000)
North American traditional software retailers and distributors 1,425,000 1,258,000 167,000
Worldwide licensing revenues 62,000 43,000 19,000
- ------------------------------------------------------------------ ----------- ----------- ------------
Net Sales $ 1,531,000 $ 3,626,000 ($ 2,095,000)
=========== =========== ============
Net Sales by Major Customer
---------------------------
Three Months ended
-------------------------
March 31, March 31, Increase
Customer 2003 2002 (Decrease)
- ------------------------------------------------------------------ ----------- ----------- ------------
Walgreen Company $ - 0 - $ 2,115,000 ($ 2,115,000)
Atari, Inc. (formerly Infogrames, Inc.) 1,115,000 599,000 516,000
Various inventory liquidation customers 27,000 283,000 (256,000)
All other customers and worldwide licensing revenues 389,000 629,000 (240,000)
- ------------------------------------------------------------------ ----------- ----------- ------------
Net Sales $ 1,531,000 $ 3,626,000 ($ 2,095,000)
=========== =========== ============
The $2,281,000 net product sales decrease to North American non-traditional
software retailers and distributors resulted primarily from the $2,115,000 net
sales decrease to the Walgreen Company. During the three months ended March 31,
2003, we did not recognize any revenue attributable to the Walgreen Company.
This resulted from our decision in fiscal 2002 to stop distributing products
directly to drug store retailers in our attempt to focus on higher margin sales
to retailers having a history of successfully merchandising value-priced
consumer entertainment PC software.
During the three months ended March 31, 2002, we entered into an agreement with
the Walgreen Company, which among other things, eliminated any right of product
return and allowed us to recognize $2,115,000 in net product sales which had
been deferred in accordance with our revenue recognition policy requiring us to
recognize sales relating to product shipments to food and drug store retailers
and distributors based on reported product sell-through to consumers. For
additional information regarding the impact of this agreement on our financial
results, please refer to the discussion below under "Impact From Agreements with
Various Retailers and Distributors".
During the fourth quarter of fiscal 2002, we transitioned from our direct
distribution relationships with drug store retailers to a higher-margin
licensing agreement with United American Video ("UAV"). Through this agreement,
we earn licensing revenues based on contractual royalty rates applied to UAV's
net sales during each reporting period from product shipments of eGames software
titles that UAV has manufactured. UAV incurs all production, sales, distribution
and fulfillment costs related to the sales of eGames software titles to these
retailers. Due to recent changes at UAV, and potential changes to their sales
strategy in the drug store retail channel, we expect licensing revenue from UAV
to decrease for the foreseeable future.
During the three months ended March 31, 2002, we recognized $90,000 in net
product sales relating to shipments of physical products to UAV, which amount is
reflected within net product sales to North American non-traditional software
retailers and distributors for that period. During the remainder of fiscal 2003,
we anticipate that the majority of our net sales generated at North American
non-traditional software retail locations will be through our licensing
agreement with UAV. We believe that this relationship will continue to cause our
net sales to North American non-traditional software retailers and distributors
to decrease, on a comparative basis to prior year periods, but should enable us
to earn higher profit margins on these licensing revenues compared to our
historically low margins on product sales to drug store retailers, as long as
UAV continues to successfully sell our products and pay the royalties due to us
on such sales within the terms of our licensing agreement.
The $167,000 net product sales increase to North American traditional software
retailers and distributors resulted primarily from the $516,000 net sales
increase to Atari, which was partially offset by net sales decreases to
inventory liquidation customers and certain office superstore customers. During
the three months ended March 31, 2003, we were able to increase, compared to the
same period a year ago, the number of retail facings (designated positions for
our software titles within a retailer's shelf space) at mass-merchant and
specialty retailers such as Wal-Mart, K-Mart, Target and Best Buy. Product
distribution to these customers, which have historically been successful in
merchandising consumer entertainment PC software, improved as a result of our
increased sales focus on these retailers combined with previous product
sell-through results.
For the three months ended March 31, 2003, net product sales to North American
third-party distributors represented 86% of net sales, compared to 31% of net
sales during the same quarter a year ago. For the foreseeable future, we expect
to continue selling the majority of our products through third-party
distributors, such as Atari, as opposed to direct-to-store distribution to
retailers, which usually include higher order fulfillment costs related to EDI
order processing and other additional costs associated with direct-to-store
shipments. In addition, many mass-market retailers such as Wal-Mart will not
purchase PC software products directly from us, and require us to distribute our
products through one of their approved distributors (such as Atari).
During the three months ended March 31, 2003, one major customer, Atari,
accounted for 73% of net sales, compared to the three months ended March 31,
2002, when two major customers, Walgreen Company and Atari, accounted for 58%
and 17% of net sales, respectively. For the remainder of fiscal 2003, we that
anticipate net product sales to Atari will continue to represent greater than
50% of our net sales.
Worldwide licensing revenues increased by $19,000 for the three months ended
March 31, 2003 compared to the same period a year ago. This increase was
primarily driven by the $18,000 revenue increase associated with our German
licensee (Rondomedia) who has achieved favorable sales growth in its respective
market. Worldwide licensing revenues represented 4% and 1%, respectively, of net
sales for the three months ended March 31, 2003 and 2002.
International net sales (exclusively comprised of licensing revenues)
represented 3% and 1%, respectively, of net sales for the three months ended
March 31, 2003 and 2002. For the remainder of fiscal 2003, we anticipate that
international net sales will continue to be primarily comprised of licensing
revenues, with less than 1% of these sales potentially being from physical
product shipments.
Internet sales accounted for 3% and 2%, respectively, of net sales for the three
months ended March 31, 2003 and 2002, and we anticipate this percentage
remaining relatively constant for the remainder of fiscal 2003. During fiscal
2003, we have continued supporting various programs designed to increase net
sales of our products over the Internet, including continuously updating and
improving our websites and adding an on-line registration feature to our retail
products, which is designed to increase our database of registered users who are
interested in receiving promotional offers about our products and drive
additional consumer traffic to our websites.
Cost of Sales
- -------------
Cost of sales for the three months ended March 31, 2003 were $580,000 compared
to $1,911,000 for the three months ended March 31, 2002, representing a decrease
of $1,331,000 or 70%. This cost of sales decrease was caused primarily by
decreases of:
o $1,130,000 in product costs;
o $147,000 in royalty costs;
o $81,000 in provision for inventory obsolescence;
o $53,000 in freight costs; and
o $23,000 in other cost of sales.
These cost of sales decreases were partially offset by a $103,000 increase in
reclamation costs (associated with product returns) due to a reclamation credit
being issued during the prior year's quarter as part of an agreement we reached
with a major drug store retailer. We believe that reclamation costs will remain
at minimal levels for the foreseeable future as we continue to focus on
distributing our products to traditional software retailers and distributors,
from whom we continue to experience lower product return rates.
The $1,130,000 decrease in product costs was caused primarily by the overall net
sales decrease from the prior year period. Product costs also decreased because
we stopped distributing low margin third-party software products to drug store
retailers as part of promotional displays also containing our software products,
combined with fewer low margin inventory liquidation sales.
The $147,000 decrease in royalty costs was caused by the decrease in net sales,
which was partially offset by a higher average royalty rate associated with net
sales of newly acquired titles. We anticipate royalty rates for new products to
continue rising for the foreseeable future as competition for a limited amount
of quality content continues to increase.
The $81,000 decrease in the provision for inventory obsolescence also resulted
from our decision to discontinue distributing software products to drug store
retailers. During fiscal 2002, our products did not sell through to consumers at
drug store retailers at the rates we had anticipated. Much of the product costs
associated with products returned from drug store retailers had to be scrapped
due to the short product life cycle of this inventory combined with the extended
period of time it took these retailers to return products to us. During fiscal
2003, we have not experienced the same high level of inventory obsolescence that
occurred in fiscal 2002. We believe the primary reason for this cost improvement
is our focus on increasing product distribution to traditional software
retailers and distributors servicing such retailers, where our products remain
on the retailers' store shelves longer and product sell-through results to
consumers have historically been better than we experienced with drug store
retailers. Additionally during fiscal 2003, in order to reduce working capital
requirements and to conserve cash, we have maintained lower inventory levels
(reduced number of active titles and reduced on hand quantities per title),
which has reduced the potential for overproducing inventory stock that would
possibly have to be scrapped at a later date.
The $53,000 decrease in freight costs was due to the overall reduction in
product shipments combined with product shipments now being made to a more
concentrated group of retail and distribution customer locations. Additionally,
fiscal 2003 freight costs continue to benefit from the reduction in product
returns largely attributable to our fiscal 2002 decision to discontinue
distributing software products to drug store retailers, and from a more cost
effective direct-to-store order fulfillment process for our customers requiring
this service.
The $23,000 decrease in other cost of sales related primarily to reduced tool
and die costs, warehousing costs, packaging costs and direct-to-store handling
costs.
Gross Profit Margin
- -------------------
Our gross profit margin for the three months ended March 31, 2003 increased to
62.1% of net sales from 47.3% of net sales for three months ended March 31,
2002. This 14.8% increase in gross profit margin was caused by cost decreases,
as a percentage of net sales, as follows:
o 19.6% in product costs;
o 1.1% in provision for inventory obsolescence;
o 0.4% in freight costs; and
o 0.1% in other cost of sales.
These costs decreases were partially offset by a 3.3% increase, as a percentage
of net sales, in royalty costs due to a greater proportion of net sales being
related to royalty sensitive titles compared to the prior period that had a
greater proportion of third-party finished good titles, which costs were
reflected in product costs during that period. Additionally, we experienced a
3.1% increase, as a percentage of net sales, in reclamation costs due to the
agreement previously discussed within the "Cost of Sales" section.
The 19.6% decrease in product costs, as a percentage of net sales, was caused
by:
o Increased sales of higher-priced consumer entertainment PC gaming
software titles;
o Discontinuation of low margin sales of third-party publisher software
titles to drug store retailers; and
o Decreased low margin inventory liquidation sales of end-of-lifecycle
software products.
The reasons for the percentage of net sales decreases in inventory obsolescence,
freight and other cost of sales are discussed under "Cost of Sales," above.
Our gross profit margin continued to benefit from our decision to discontinue
distributing products directly to drug store retailers. Based on our business
model of servicing, primarily through third-party distributors, a more
concentrated group of mass-merchant, specialty and PC software retailers, and
assuming that our existing overall product sell-through to consumers and product
return rates from customers remain at current levels, we believe that our
overall fiscal 2003 gross profit margin should represent approximately 60% of
net sales during that twelve month period. Factors continuing to potentially
impact our fiscal 2003 gross profit margin are, among other things:
o Controlling the manufacturing and distribution costs of our titles;
o Retailer and consumer acceptance of our higher-priced PC game software
titles;
o Third-party licensees' success in distributing our titles to
international customers and drug store retailers;
o Establishing successful titles at higher retail price points to
compensate for developer royalty rate increases;
o Inventory liquidation sales yielding below normal profit margins needed
to support cash requirements; and
o Price markdowns and other consumer and retailer incentives to improve
product sell-through to consumers.
Operating Expenses
- ------------------
Product development expenses for the three months ended March 31, 2003 were
$108,000 compared to $92,000 for the three months ended March 31, 2002, an
increase of $16,000 or 17%. This $16,000 cost increase resulted from the
increase in the utilization of outside services and contractors needed to
address short-term development initiatives including, among other things: the
introduction of new retail titles and additional Internet functionality on our
websites.
Selling, general and administrative expenses for the three months ended March
31, 2003 were $592,000 compared to $681,000 for three months ended March 31,
2002, a decrease of $89,000 or 13%. As a result of various cost saving
initiatives we implemented during fiscal 2002, we continued to achieve cost
savings in various categories, the primary ones being:
o $48,000 in marketing promotional expense;
o $51,000 in professional service expense;
o $27,000 in depreciation and amortization expense; and
o $10,000 in other selling, general and administrative expense.
These cost decreases were partially offset by cost increases of:
o $22,000 in insurance related costs; and
o $25,000 in stock compensation expense related to the valuation of
stock options and warrants.
The $48,000 decrease in marketing promotional expense resulted primarily from
our decision to discontinue distributing software products directly to drug
store retailers. Previously, we had incurred significant merchandising, display
and other promotional costs in order to support our distribution strategy with
drug store retailers. For the remainder of fiscal 2003, we anticipate that our
marketing promotional expenses will continue to trend lower compared to prior
year periods.
The $51,000 decrease in professional service expense resulted primarily from
reduced litigation issues and consulting arrangements, combined with decreased
accounting fees compared to the prior year period.
The $27,000 decrease in depreciation and amortization expense resulted from
replacing older assets at a slower rate than these assets are being expensed.
The $22,000 increase in insurance related costs resulted primarily from a
substantial increase in Directors and Officers' Liability insurance.
The $25,000 increase in stock compensation expense related to the monthly
straight-line expensing over the vesting periods of the value assigned to the
stock options granted to employees and non-employee directors during fiscal
2003. As of 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 for stock option grants made on or after that
date.
Interest Expense, Net
- ---------------------
Net interest expense for the three months ended March 31, 2003 was $6,000
compared to $31,000 for the three months ended March 31, 2002, a decrease of
$25,000. This $25,000 decrease was due to the decrease in the average
outstanding balance of our previous bank debt, which was repaid as of January
16, 2003, and had carried a floating interest rate of prime plus 3%.
(Benefit) Provision for Income Taxes
- -----------------------------------
During the three months ended March 31, 2003, we recognized a ($51,000) benefit
for income taxes that resulted from income tax refunds received during this
period wherein there was no previously recorded deferred income tax asset,
compared to no benefit for income taxes in the same period a year earlier.
Net Income
- ----------
As a result of the factors discussed above, our net income for the three months
ended March 31, 2003 was $296,000 compared to $911,000 for the same period a
year earlier, a decrease in net income of $615,000.
Weighted Average Common Shares
- ------------------------------
The weighted average common shares outstanding on a diluted basis increased by
10,309 for the three months ended March 31, 2003 to 9,999,646 from 9,989,337 for
the three months ended March 31, 2002. The current period's increase in the
diluted basis calculation of weighted average common shares resulted from
additional common stock equivalents ("CSE's"), compared to the same period last
year. The diluted basis calculation for the three months ended March 31, 2002,
excluded common stock equivalents due to their anti-dilutive impact caused by no
CSE's being "in the money" or having an exercise price less than the average
price of the Company's stock during that period.
Impact From Agreements with Various Retailers and Distributors
- ---------------------------------------------------------------
During the three-month period ended March 31, 2002, we entered into an agreement
with one of our largest drug store retail customers, which among other things,
eliminated any right of product return and allowed us to recognize net product
sales of $2,115,000 and net income of $1,122,000. During the three months ended
March 31, 2003, we entered into similar agreements with other retailers and
distributors, which allowed us to recognize net product sales of $39,000 and net
income of $27,000. These amounts had been deferred in accordance with our
revenue recognition policy requiring us to recognize sales relating to product
shipments to food and drug store retailers based on reported product
sell-through to consumers.
Results of Operations
Nine Months ended March 31, 2003 and 2002
Net Sales
- ---------
For the nine months ended March 31, 2003, net sales decreased by $2,552,000, or
32%, to $5,336,000 compared to $7,888,000 for the same period a year earlier.
The $2,552,000 decrease in net sales resulted from a $3,965,000 net product
sales decrease to North American non-traditional software retailers and
distributors, combined with a $105,000 decrease in net product sales to
international distributors, which decreases were partially offset by a
$1,410,000 increase in net product sales to North American traditional software
retailers and distributors and a $108,000 increase in worldwide licensing
revenues.
The following tables represent our net sales by distribution channel and by
major customer for the nine months ended March 31, 2003 and 2002, respectively.
Net Sales by Distribution Channel
---------------------------------
Nine Months ended
-------------------------
March 31, March 31, Increase
Distribution Channel 2003 2002 (Decrease)
- ------------------------------------------------------------------ ----------- ----------- ------------
North American non-traditional software retailers and distributors $ 117,000 $ 4,082,000 ($ 3,965,000)
North American traditional software retailers and distributors 4,901,000 3,491,000 1,410,000
International software distributors 5,000 110,000 (105,000)
Worldwide licensing revenues 313,000 205,000 108,000
- ------------------------------------------------------------------ ----------- ----------- ------------
Net Sales $ 5,336,000 $ 7,888,000 ($ 2,552,000)
=========== =========== ============
Net Sales by Major Customer
---------------------------
Nine Months ended
-------------------------
March 31, March 31, Increase
Customer 2003 2002 (Decrease)
- ------------------------------------------------------------------ ----------- ----------- ------------
Walgreen Company $ - 0 - $ 3,069,000 ($ 3,069,000)
Rite Aid Corporation - 0 - 512,000 (512,000)
UAV - 0 - 407,000 (407,000)
Atari, Inc. 3,173,000 1,792,000 1,381,000
CompUSA 356,000 137,000 219,000
Jack of All Games 283,000 181,000 102,000
Various inventory liquidation customers 328,000 696,000 (368,000)
All other customers and worldwide licensing revenues 1,196,000 1,094,000 102,000
- ------------------------------------------------------------------ ----------- ----------- ------------
Net Sales $ 5,336,000 $ 7,888,000 ($ 2,552,000)
=========== =========== ============
The $3,965,000 net product sales decrease to North American non-traditional
software retailers and distributors resulted primarily from net product sales
decreases to the Walgreen Company, Rite Aid Corporation and UAV of $3,069,000,
$512,000 and $407,000, respectively. During the nine months ended March 31,
2003, we did not recognize any net product sales attributable to these drug
store retailers and distributor. This resulted from our decision in fiscal 2002
to stop distributing products directly to drug store retailers in our attempt to
focus on higher margin sales to retailers having a history of successfully
merchandising value-priced consumer entertainment PC software.
During the nine months ended March 31, 2002, we recognized revenue attributable
to these drug store retailers and distributors based upon reported product
sell-through results to consumers at these retailers' store locations.
Additionally, during the three months ended March 31, 2002, we entered into an
agreement with the Walgreen Company, which among other things, eliminated any
right of product return and allowed us to recognize $2,115,000 in net product
sales. These sales had been deferred in accordance with our revenue recognition
policy requiring us to recognize sales relating to product shipments to food and
drug store retailers and distributors based on reported product sell-through to
consumers. For additional information regarding the impact of this agreement on
our financial results, please refer to the discussion below under "Impact From
Agreements with Various Retailers and Distributors".
During the nine months ended March 31, 2002, we recognized $407,000 in net
product sales relating to shipments of physical products to UAV, our licensee
distributing products to the drug store channel, which amount is reflected
within net product sales to North American non-traditional software customers
during that period. During fiscal 2003, we expect the majority of our net sales
generated at North American non-traditional software retail locations will be
through our licensing agreement with UAV. We believe that this relationship will
continue to cause our net sales to North American non-traditional software
retailers and distributors to decrease significantly, on a comparative basis to
prior year periods.
The $1,410,000 net product sales increase to North American traditional software
retailers and distributors resulted primarily from net sales increases to Atari,
CompUSA and Jack of All Games of $1,381,000, $219,000 and $102,000,
respectively. During the nine months ended March 31, 2003, we continued to
increase, compared to the same period a year ago, our product distribution at
certain mass-merchant and specialty retailers such as Wal-Mart, K-Mart, Target
and Best Buy. Partially offsetting the net sales increase to traditional
software customers during this period was the $368,000 decrease in net sales of
end-of-lifecycle products to various inventory liquidation customers compared to
the same period a year earlier.
For the nine months ended March 31, 2003, net product sales to North American
third-party distributors represented 75% of net sales, compared to 42% of net
sales during the same period a year earlier. For the foreseeable future, we
expect to continue selling the majority of our products through third-party
distributors, such as Atari in the United States market and Jack of All Games
within the Canadian market, as opposed to direct-to-store distribution to
retailers, which usually include higher order fulfillment costs.
During the nine months ended March 31, 2003, one major customer, Atari,
accounted for 59% of net sales, compared to the nine months ended March 31,
2002, when two major customers, Walgreen Company and Atari, accounted for 39%
and 23% of net sales, respectively. For the remainder of fiscal 2003, we
anticipate that net product sales to Atari will continue to represent greater
than 50% of our net sales.
The $105,000 decrease in net product sales to International software
distributors resulted from our transition to higher margin licensing
distribution agreements covering non-North American territories from lower
margin physical product distribution agreements within these markets. As a
result, our international net product sales represented less than 1% of net
sales for both of the nine-month periods ended March 31, 2003 and 2002. For the
remainder of fiscal 2003, we anticipate that international net product sales
will continue to represent less than 1% of net sales.
The $108,000 increase in worldwide licensing revenues resulted from the $106,000
revenue increase associated with our primary North American licensee (UAV) and
our German licensee (Rondomedia). During the nine months ended March 31, 2003,
worldwide licensing revenues accounted for 6% of net sales compared to 3% of net
sales for the comparable prior year's nine-month period. Based on current
trends, and in particular the anticipated continued decrease in licensing
revenues from the United Kingdom and other key territories, we expect worldwide
licensing revenues to represent approximately 5% of net sales for all of fiscal
2003.
During fiscal 2003, we have continued supporting various programs designed to
increase the net sales of our products over the Internet. Internet sales
accounted for 3% of net sales for the nine months ended March 31, 2003, compared
to 2% of net sales for the same period last year. We anticipate Internet sales,
as a percentage of net sales, to remain near 3% for the remainder of fiscal
2003.
Cost of Sales
- -------------
Cost of sales for the nine months ended March 31, 2003 were $2,201,000 compared
to $4,245,000 for the nine months ended March 31, 2002, representing a decrease
of $2,044,000 or 48%. This cost of sales decrease was caused by decreases of:
o $1,541,000 in product costs;
o $186,000 in provision for inventory obsolescence;
o $147,000 in royalty costs;
o $105,000 in freight costs; and
o $65,000 in reclamation and other cost of sales.
The $1,541,000 decrease in product costs was caused primarily by the overall net
sales decrease from the prior year period. Product costs also decreased because
we stopped distributing low margin third-party software products to drug store
retailers that had required these titles to be part of promotional displays also
containing our software products, combined with a decrease in low margin
inventory liquidation sales during the same period a year ago.
The $186,000 decrease in the provision for inventory obsolescence also resulted
from our decision to discontinue distributing software products to drug store
retailers. During fiscal 2002, our products did not sell through to consumers at
drug store retailers at the rates we had anticipated. Much of the product costs
associated with products returned from drug store retailers had to be scrapped
due to the short product lifecycle of this inventory combined with the extended
period of time it took these retailers to return products to us. We believe the
primary reason for this cost improvement is our focus on increasing product
distribution to traditional software retailers and distributors servicing such
retailers, where our products remain on the retailers' store shelves longer and
product sell-through results to consumers have historically been better than we
experienced with drug store retailers.
The $147,000 decrease in royalty costs was caused by the decrease in net sales,
which was partially offset by a higher average royalty rate associated with net
sales of newly acquired titles.
The $105,000 decrease in freight costs was due to the overall reduction in
product shipments combined with an increase in cost effective product shipments
to a more concentrated group of retail and distribution customer warehouses.
Additionally, fiscal 2003 freight costs have benefited from the reduction in
product returns largely attributable to our fiscal 2002 decision to stop
distributing software products to drug store retailers.
The $65,000 decrease in reclamation and other cost of sales, resulted primarily
from our decision to discontinue distributing software products to drug store
retailers with whom we had previously experienced high product return rates,
combined with cost reductions in warehousing, packaging and direct-to-store
handling costs.
Gross Profit Margin
- -------------------
Our gross profit margin for the nine months ended March 31, 2003 increased to
58.8% of net sales from 46.2% of net sales for the nine months ended March 31,
2002. The 12.6% increase in gross profit margin was caused by cost decreases, as
a percentage of net sales, as follows:
o 12.2% in product costs;
o 2.0% in provision for inventory obsolescence;
o 0.4% in freight costs; and
o 0.1% in reclamation and other cost of sales.
In particular, the 12.2% decrease in product costs, as a percentage of net
sales, was caused by:
o Discontinuation of low margin sales of third-party publisher software
titles to drug store retailers;
o Decreased low margin inventory liquidation sales of end-of-lifecycle
software products; and
o Increased sales of higher-priced consumer entertainment PC gaming
software titles.
The reasons for the percentage of net sales decreases in the provision for
inventory obsolescence, freight costs, reclamation costs, and other cost of
sales are discussed under "Cost of Sales," above.
These cost of sales decreases, as a percentage of net sales, were partially
offset by a 2.1% increase, as a percentage of net sales, in royalty costs due to
higher royalty rates being associated with current period's software titles,
combined with a larger proportion of net sales being related to internally
published titles that require us to pay a royalty compared to the prior
nine-month period that included a larger proportion of finished good products
purchased from third-party publishers that did not cause us to incur a royalty
obligation.
Operating Expenses
- ------------------
Product development expenses for the nine months ended March 31, 2003 were
$313,000 and represented no change from the amount for the nine months ended
March 31, 2002.
Selling, general and administrative expenses for the nine months ended March 31,
2003 were $1,886,000 compared to $2,216,000 for the nine months ended March 31,
2002, a decrease of $330,000 or 15%. As a result of various cost saving
initiatives we implemented during fiscal 2002, we continued to achieve cost
savings in various categories. The primary cost reductions were:
o $245,000 in marketing promotional expenses;
o $79,000 in depreciation and amortization expense;
o $66,000 in cash discount expense;
o $58,000 in professional service expense; and
o $41,000 in other operating expenses.
These cost decreases were partially offset by cost increases of:
o $72,000 in salary related costs; and
o $87,000 in stock compensation expense related to the valuation of
stock options and warrants.
The $245,000 decrease in marketing promotional expenses resulted primarily from
our decision to discontinue distributing software products directly to drug
store retailers.
The $79,000 decrease in depreciation and amortization expense resulted from not
replacing aging assets at historical rates in an effort to conserve cash. For
the remainder of fiscal 2003, equipment expenditures are anticipated to be
primarily associated with upgrading our internal computer network systems.
The $66,000 decrease in cash discount expense was caused because we no longer
experience the 2% to 3% in cash discounts required by drug store retailers
associated with their receivable payments.
The $58,000 decrease in professional service expense resulted from reduced
litigation issues and consulting arrangements, combined with decreased
accounting fees compared to the same nine-month period, a year ago.
The $41,000 decrease in other operating expenses resulted from cost savings in
various categories, such as: building rent expense, bad debt provision and
tradeshow costs.
The $72,000 increase in salary related costs resulted from a $106,000 increase
in accrued employee bonus expense, which was partially offset by $34,000 in
other salary related savings. We believe that we have now structured our
employee workforce to a level that most effectively supports our projected
operations for the foreseeable future, and we do not anticipate a significant
decrease or increase in the number of employees during the remainder of fiscal
2003.
The $87,000 increase in stock compensation expense was comprised of $16,000 in
expense relating to the common stock warrant issued to Fleet Bank during fiscal
2002 (and subsequently redeemed on January 16, 2003) and $71,000 in expense
relating to the stock options granted to employees and non-employee directors
during the first nine months of fiscal 2003. As of 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 for stock option
grants made on or after that date.
Interest Expense, Net
- ---------------------
Net interest expense for the nine months ended March 31, 2003 was $36,000
compared to $104,000 for the nine months ended March 31, 2002, a decrease of
$68,000. This $68,000 decrease was due to the decrease in the average
outstanding balance of our bank debt, which was repaid on January 16, 2003, and
had carried a floating interest rate of prime plus 3%.
(Benefit) Provision for Income Taxes
- ------------------------------------
During the nine months ended March 31, 2003, we recognized a ($51,000) benefit
for income taxes that resulted from income tax refunds received during this
period wherein there was no previously recorded deferred income tax asset,
compared to a $1,000 provision for income taxes during the same period a year
earlier.
Net Income
- ----------
As a result of the factors discussed above, our net income for the nine months
ended March 31, 2003 was $951,000 compared to a $1,009,000 for the same period a
year earlier, a decrease in net income of $58,000.
Weighted Average Common Shares
- ------------------------------
The weighted average common shares outstanding on a diluted basis increased by
9,720 for the nine months ended March 31, 2003 to 9,999,057 from 9,989,337 for
the nine months ended March 31, 2002. The current period's increase in the
diluted basis calculation of weighted average common shares resulted from
additional common stock equivalents ("CSE's"), compared to the same period last
year. The diluted basis calculation for the nine months ended March 31, 2002,
excluded common stock equivalents due to their anti-dilutive impact caused by no
CSE's being "in the money" or having an exercise price less than the average
price of the Company's stock during that period.
Impact From Agreements with Various Retailers and Distributors
- ---------------------------------------------------------------
During the nine month period ended March 31, 2002, we entered into an agreement
with one of our largest drug store retail customers, which among other things,
eliminated any right of product return and allowed us to recognize net product
sales of approximately $2,115,000 and net income of $1,122,000. During the nine
months ended March 31, 2003, we entered into similar agreements with other
retailers and distributors, which allowed us to recognize net product sales of
$120,000 and net income of $108,000.
Liquidity and Capital Resources
At March 31, 2003, we had $1,057,000 in working capital and $1,088,000 in
stockholders' equity, compared to $94,000 in working capital and $99,000 in
stockholders' equity at June 30, 2002.
At March 31, 2003, we had $362,000 in cash compared to $700,000 at June 30,
2002. This $338,000 decrease in cash resulted from $947,000 in net cash used in
financing activities and $7,000 in net cash used in investing activities, which
cash uses were partially offset by $616,000 in net cash provided by operating
activities.
For the nine months ended March 31, 2003, net cash provided by operating
activities was $616,000 compared to net cash provided by operating activities of
$951,000 for the nine months ended March 31, 2002. The $616,000 net cash
provided by operating activities during the current period was caused by cash
sources of:
o $951,000 in net income;
o $940,000 in provisions for product returns, price markdowns, bad
debts and inventory obsolescence; and
o $120,000 in depreciation, amortization and other non-cash items.
Partially offsetting these cash sources were cash uses of:
o $1,125,000 in increased accounts receivable;
o $115,000 in decreased accrued expenses;
o $109,000 in decreased in accounts payable; and
o $46,000 in increased prepaid expenses and inventory.
For the nine months ended March 31, 2003, net cash used in investing activities
was $7,000 compared to $29,000 in net cash used in investing activities for the
nine months ended March 31, 2002. For the remainder of fiscal 2003, we
anticipate investing activities to relate mostly to additional upgrades to our
computer network's hardware and software.
For the nine months ended March 31, 2003, net cash used in financing activities
was $947,000 compared to net cash used in financing activities of $656,000 for
the nine months ended March 31, 2002. The $947,000 net cash used in financing
activities for the current period resulted from $840,000 in repayments of bank
debt, $50,000 in the redemption of the common stock warrant issued to Fleet Bank
and $57,000 in repayments of a note payable.
On July 23, 2001, Fleet Bank (the "Bank") notified us that due to our violation
of the financial covenants under our credit facility as of June 30, 2001, and
the material adverse changes in our financial condition, the Bank would no
longer continue to fund the $2,000,000 credit facility. On November 2, 2001, we
entered into an agreement with the Bank to pay off the credit facility's
outstanding balance of $1,400,000 over a twenty-two month period. The agreement
provided that the remaining outstanding balance owed under the credit facility
was to be repaid by July 31, 2003 in monthly installments, with interest at the
prime rate plus three percent. On January 16, 2003, we repaid the remaining
$420,000 principal balance outstanding on this term loan, together with accrued
interest, in full satisfaction of all obligations under the November 2, 2001
forbearance agreement.
As part of the November 2, 2001 forbearance agreement, we issued a warrant to
the Bank for the purchase of 750,000 shares of our common stock. The warrant was
exercisable until October 31, 2006 at an exercise price of $0.09 per share, and
a separate registration rights agreement provided that the Bank had demand
registration rights that began on November 1, 2002. On January 16, 2003, we
redeemed this warrant from the Bank for $50,000.
Contractual Obligations and Commitments
- ---------------------------------------
In the normal course of obtaining additional product content, we continually
enter into licensing agreements with third-party software developers that
require us to pay quarterly royalty fees, based upon net sales of our software
titles containing licensed content. Additionally, most of these agreements
require us to make advance payments (primarily advanced royalty fees) to these
developers prior to us recognizing any net sales of software titles containing
this licensed software content. As of March 31, 2003, we had commitments to pay
$95,000 to various developers for advanced developer payments under such
agreements.
Our 5,000 square foot office and development facility located in Langhorne,
Pennsylvania is occupied under an operating lease that is scheduled to expire on
September 30, 2004. Additionally, we currently rent certain office equipment
through various operating lease agreements.
As a result of an agreement with the third-party to which we sold our United
Kingdom subsidiary in May 2001, we have purchase obligations for 50,000 units of
consumer entertainment PC software from this third party for fiscal 2003 and
2004, at a delivered cost of $1.50 per unit, for a total annual commitment of
$75,000 during each of those fiscal years. As of March 31, 2003, we had not
purchased any of this fiscal year's annual commitment.
The following table represents a summary of contractual obligations and
commitments as of March 31, 2003.
Developer Operating Purchase
Payments Due by Period Commitments Leases Obligations Totals
- ------------------------------------- ----------- ---------- ----------- ---------
Remaining three months of fiscal 2003 $ 95,000 $ 16,000 $ 75,000 $ 186,000
Fiscal 2004 - 0 - 63,000 75,000 138,000
Fiscal 2005 - 0 - 29,000 - 0 - 29,000
Fiscal 2006 - 0 - 19,000 - 0 - 19,000
Fiscal 2007 and thereafter - 0 - 28,000 - 0 - 28,000
- ------------------------------------- ----------- ---------- ----------- ---------
Totals $ 95,000 $ 155,000 $ 150,000 $ 400,000
=========== ========== =========== =========
Liquidity Risk
- --------------
Since the first quarter of fiscal 2002, we have not had access to a credit
facility, and have been dependent entirely on cash flow from operations to meet
our financial obligations. Our ability to achieve and maintain positive cash
flow is essential to our survival as a going concern. Our ability to do this
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 our products, the development and
sell-through of our products to consumers, and the costs of developing,
producing and marketing such products. We believe that our projected cash and
working capital balances may be sufficient to fund our operations through June
30, 2003, but there are significant challenges that we will need to successfully
manage in order to be able to fund our operations through that period of time
and beyond. These challenges include, but are not limited to: agreeing to and
maintaining acceptable payment terms with our vendors; and maintaining an
acceptable speed of our receivable collections from customers. Additionally,
there are market factors beyond our control that could also significantly affect
our operating cash flow. The most significant of these market factors is the
market acceptance and sell-through rates of our current products to consumers,
and the growth of the consumer entertainment PC software market. If any of our
software titles do not sell through to consumers at the rate anticipated, we
could be exposed to additional product returns and a lack of customer
replenishment orders for these products, which could severely reduce the
accounts receivable that we would be able to collect from such retailers or
distributors of our products. As a result of these factors, we may not be able
to achieve or maintain positive cash flow. Outside financing to supplement our
cash flows from operations may not be available if and when we need it. Even if
such financing were available from a bank or other financing source, it may not
be on terms satisfactory to us because of the dilution it may cause or other
costs associated with such financing.
New Accounting Pronouncements
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure -- an Amendment of FASB Statement No.
123". SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for an entity that
voluntarily changes to the fair-value-based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
statement to require prominent disclosure about the effects on reported net
income and earnings per share and the entity's accounting policy decisions with
respect to stock-based employee compensation. Certain of the disclosure
requirements are required for all companies, regardless of whether the fair
value method or intrinsic value method is used to account for stock-based
employee compensation arrangements. This amendment to SFAS 123 became effective
for financial statements for fiscal years ended after December 15, 2002 and for
interim periods beginning after December 15, 2002. Accordingly, we have adopted
the disclosure provisions of this statement in the current quarter of fiscal
year 2003.
During fiscal 2002, we adopted Emerging Issues Task Force ("EITF") Issue 00-25,
"Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products", which requires that certain promotional costs, such as
slotting fees charged by retailers, be reclassified as reductions to net sales,
as opposed to being reflected as operating expenses. Accordingly, net sales
amounts for prior periods reflect the reclassification of expenses, such as
slotting fees, from selling, general and administrative expenses to a reduction
of net sales. These costs were $16,000 and $11,000 for the three months ended
March 31, 2003 and 2002, respectively, and $116,000 and $53,000 for the nine
months ended March 31, 2003 and 2002, respectively.
EITF Issue 00-25 was subsequently codified by EITF Issue 01-9, "Accounting for
Consideration Given by a Vendor to a Customer (Including a Reseller of the
Vendor's Products)". We do not expect any other recently issued accounting
pronouncements to have a significant impact on our results of operations,
financial position or cash flows.
FACTORS AFFECTING FUTURE PERFORMANCE
Risk Factors
- ------------
Our business is subject to many risks and uncertainties that could affect our
future financial performance. The following discussion highlights some of the
more important risks we have identified, but they may not be the only factors
that could affect future performance.
In fiscal 2002 we earned net income of $2,181,000 compared to the $5,933,000 net
loss we incurred in fiscal 2001. Prior to those periods, we earned approximately
$253,000, $463,000 and $1,253,000 in fiscal 2000, 1999 and 1998, respectively.
We began operations in July 1992, and experienced significant losses from
inception through the end of fiscal 1997. Prior to fiscal 1998, we funded our
operations mostly through proceeds from our initial public offering of common
stock in October 1995 and through the sale of preferred stock in private
offerings in November 1996, and January and April 1997, in addition to proceeds
from the exercise of various common stock warrants and stock options. We have
since funded our business activities from cash generated from operations and
bank borrowings. Currently, we do not have access to any bank borrowings.
Our accumulated deficit at June 30, 2002 was $9,768,000. Even though we achieved
modest profitability in fiscal 2002, given current market conditions in the
United States in general, and the effects from the significant loss we sustained
in fiscal 2001, there can be no assurance that we will be profitable in fiscal
2003 and beyond. Our operations today continue to be subject to all of the risks
inherent in the operation of a small business, which has liquidity problems in a
highly competitive industry dominated by larger competitors. These risks
include, but are not limited to, development, distribution and marketing
difficulties, competition, and unanticipated costs and expenses. Our future
success will depend on our ability to be profitable in the development,
marketing and distribution of our current and future software products.
We have experienced severe liquidity problems. On July 23, 2001, Fleet Bank (the
"Bank") notified us that due to our violation of the financial covenants under
our credit facility as of June 30, 2001, and the material adverse changes in our
financial condition, the Bank would no longer continue to fund the $2,000,000
credit facility. On November 2, 2001, we entered into a forbearance agreement
with the Bank to pay off the credit facility's outstanding balance of $1,400,000
over a twenty-two month period. The remaining outstanding balance owed under the
credit facility was to be repaid by July 31, 2003 in monthly installments, with
interest at the prime rate plus three percent.
On January 16, 2003, we repaid the remaining $420,000 principal balance
outstanding on our term loan with the Bank, together with accrued interest, in
full satisfaction of all obligations under the November 2, 2001 forbearance
agreement. Additionally on January 16, 2003, we redeemed from the Bank the
warrant associated with the forbearance agreement for $50,000.
While we no longer carry any bank debt, we also do not currently have access to
a credit facility. Our ability to continue operations requires us to generate
sufficient cash flow from operations to fund our business activities. In the
past we have experienced dramatic fluctuations in cash flows, so we cannot be
sure we will be able to continue achieving sufficient cash flows to fund our
operations.
We may need additional funds. Our capital requirements are currently funded from
the cash flow generated from product sales. If we are not able to achieve cash
flow from operations at a level sufficient to support our business activities,
we may require additional funds. Our current financial condition and our poor
financial performance in fiscal 2001 could adversely affect our ability to
obtain additional financing and could make us more vulnerable to industry
downturns and competitive pressures. Additionally, we may only be able to raise
needed funds on terms that would result in significant dilution or otherwise be
unfavorable to existing shareholders. Our inability to secure additional funding
when needed, or generate adequate funds from operations, would adversely impact
our long-term viability.
Our success depends on continued viable business relationships with key
distributors and retailers. Many of the largest mass-market retailers have
buying relationships with certain distributors, and these retailers often will
only buy consumer entertainment PC software from such distributors. Our
financial condition could be materially harmed if these distributors were
unwilling to distribute our products. Additionally, even if the distributors are
willing to purchase our products, distributors are frequently able to dictate
the price, timing and other terms on which we can distribute our products to
such retailers. We also may not be able to distribute our products directly to
key retailers on terms that we consider commercially acceptable. If we cannot
negotiate sales terms with these retailers that are commercially acceptable, we
may then choose to distribute our products to such retailers through a large
distributor, such as Atari, which would further concentrate our sales to only a
few large customers. Our inability to negotiate commercially viable distribution
relationships with significant retailers and distributors, or the loss of, or
significant reduction in sales to, any of our key distributors or retailers,
would adversely affect our business, operating results and financial condition.
A significant part of our sales come from a limited number of customers. Due to
our decision during fiscal 2002 to discontinue selling our consumer
entertainment PC software products directly to drug store retailers and
distributors and to focus instead on selling our products to mass-merchant,
specialty and PC software retailers that have traditionally sold value-priced
consumer entertainment PC software, we now rely primarily on a concentrated
group of large customers. The majority of our current sales are to
mass-merchant, specialty and PC software retailers, and distributors serving
such retailers, and in particular to Atari. Atari is our primary North American
distributor that services the major mass-merchant retailers in North America,
such as Wal-Mart, K-Mart, Target, and Best Buy, among others. Our net sales to
Atari during the fiscal year ended June 30, 2002 were $2,311,000 and represented
21% of our total net sales. During the nine months ended March 31, 2003, our net
sales to Atari accounted for 59% of our overall net sales. We anticipate that
net sales to Atari may represent greater than 50% of our total net sales during
fiscal 2003. Accordingly, we expect to continue depending upon a limited number
of significant customers, and in particular Atari, for the foreseeable future.
Most of our customers, including Atari, may terminate their relationship with us
at any time. In the event that we lose our distribution capability through Atari
or any of our other large customers, it would significantly harm our financial
condition and our ability to continue as a going concern.
We may experience customer payment defaults and uncollectible accounts
receivable if our distributors' or retailers' businesses fail or if they
otherwise cannot pay us. Distributors and retailers in the consumer
entertainment PC software industry and in mass-market retail channels can and
have experienced significant fluctuations in their businesses and many of these
businesses have failed. These business failures have increased and may continue
to increase as a result of economic conditions in the United States. The
insolvency or business failure of any significant retailer or distributor of our
products would significantly harm our business, operating results and financial
condition. Our sales are typically made on credit, with terms that vary
depending upon the customer and the nature of the product. We do not hold
collateral to secure payment. We maintain an allowance for bad debts for
anticipated uncollectible accounts receivable which we believe to be adequate.
The actual allowance required for any one customer's account or on all of the
accounts receivable in total, may ultimately be greater than our allowance for
bad debts at any point in time. The failure to pay an outstanding receivable by
a significant customer would significantly harm our business, operating results
and financial condition.
Our customers have the right to return our products and to take price markdowns,
which could reduce our net sales and results of operations. Most of our customer
relationships allow for product returns and price markdowns. We establish
allowances for future product returns and price markdowns at the time of sale
for traditional software retail customers and distributors servicing such
retailers. These allowances are based on historical product return and price
markdown results with these types of customers, product sell-through information
and channel inventory reports supplied by these retailers and the distributors
that serve them, among other factors. Our sales to these customers are reported
net of product return and price markdown provisions. Actual product returns and
price markdowns could exceed these anticipated amounts, particularly for new
products released during the 2003 fiscal year that have higher price points than
our typical $9.99 jewel case products, which would negatively impact our future
results of operations.
Our operating results fluctuate from quarter to quarter, which makes our future
operating results uncertain and difficult to predict. Our quarterly operating
results have varied significantly in the past and will likely vary
significantly in the future depending on numerous factors, many of which are not
under our control. Fluctuations in quarterly operating results will depend upon
many factors including:
o seasonality of customer buying patterns;
o the size and rate of growth of the consumer entertainment PC software
market;
o the demand for our typical value-priced and new higher-priced PC
software products;
o product and price competition;
o the amount of product returns and price markdowns;
o the timing of our new product introductions and product enhancements
and those of our competitors;
o the timing of major customer orders;
o product shipment delays;
o access to distribution channels;
o product defects and other quality problems;
o product life cycles;
o ability to accurately forecast inventory production requirements;
o international royalty rates and licensing revenues; and
o our ability to develop and market new products and control costs.
Products are usually shipped within days following the receipt of customer
orders so we typically operate with little or no backlog. Therefore, net sales
in any reporting period are usually dependent on orders booked, shipped and
received by our customers during that period.
We are exposed to seasonality in the purchases of our products. The consumer
entertainment PC software industry is highly seasonal, with sales typically
higher during the first and last calendar quarters (our second and third fiscal
quarters). This is due to increased demand for PC software games during and
immediately following the holiday buying season. Delays in product development
or manufacturing can affect the timing of the release of our products, causing
us to miss key selling periods such as the year-end holiday buying season. If we
miss product deliveries during these key selling periods, or if our products are
not ready for shipment to meet the holiday buying season, our net sales and
operating results would be adversely affected. Additionally, if our products do
not adequately sell-in to our customers' retail locations or sell-through to
consumers at these retail locations during the holiday buying season, our
financial results for the entire fiscal year would be adversely affected.
The consumer entertainment software market is highly competitive and changes
rapidly. The market for consumer entertainment PC software is highly
competitive, particularly at the retail shelf level where a constantly
increasing number of software titles are competing for a shrinking amount of
shelf space. Retailers have a limited amount of shelf space on which to display
consumer entertainment PC software products. There is intense competition among
consumer entertainment PC software publishers for shelf space and promotional
support from retailers. As the number of PC software titles continues to
increase, the competition for shelf space continues to intensify, resulting in
greater leverage for retailers and distributors in negotiating terms of sale,
including price discounts and product return policies. Also, our larger
competitors may have more leverage than us to negotiate more and
better-positioned shelf space than us. Our retail and distribution customers
have no long-term obligations to purchase our products, and may discontinue
purchasing our products at any time. If any of our large customers stopped
buying our products or significantly reduced their purchases, our sales would
significantly decrease.
Increased competition for acquiring the licensing rights to quality consumer
entertainment PC software content has compelled us to agree to make increasingly
higher advance royalty payments and, in some cases, to guarantee minimum royalty
payments to content licensors and PC software game developers. If the products
subject to these advances and minimums do not generate sufficient sales volumes
to recover these costs, our financial results would be negatively impacted.
Our present or future competitors may also develop products that are comparable
or superior to ours. Our competitors may offer higher quality products, lower
priced products or adapt more quickly than us to new technologies or evolving
customer requirements. Our competitors typically have more financial resources
to spend on marketing promotions, licensing recognizable brands, and advertising
efforts. Competition is expected to intensify. In order to be successful in the
future, we must be able to respond to technological changes, customer
requirements and competitors' current products and innovations. We may not be
able to compete effectively in this market, which would have an adverse effect
on our operating results and financial condition.
We depend on the market acceptance of our products, and these products typically
have relatively short product life cycles. The market for consumer entertainment
PC software has been characterized by shifts in consumer preferences and short
product life cycles. Consumer preferences for entertainment PC software products
are difficult to predict and few products achieve sustained market acceptance.
New products we introduce may not achieve any significant degree of market
acceptance, or the product life cycles may not be long enough for us to recover
advance royalties, development, marketing and other promotional costs. Also, if
a product does not sell-through to consumers at a rate satisfactory to our
retail or distribution customers, we could be forced to accept substantial
product returns or be required to issue additional price markdowns to maintain
our relationships with these distributors and retailers. We may also lose retail
shelf space if our products do not sell-through to consumers at satisfactory
rates. Failure of new products to achieve or sustain market acceptance or
product returns or price markdowns results in excess of our expectations would
adversely impact our business, operating results and financial condition.
We are vulnerable to rapid technological change that could make our products
less marketable. Frequent new product introductions and enhancements, rapid
technological developments, evolving industry standards and swift changes in
customer requirements characterize the market for our products. Our future
success depends on our ability to continue to quickly and efficiently develop
and introduce new products and enhance existing products to incorporate
technological advances and responses to customer requirements. If any of our
competitors introduce products more quickly than us, or if they introduce better
products than ours, then our business could be adversely affected. We may also
not be successful in developing and marketing new products or enhancements to
our existing products on a timely basis. Our new or enhanced products may not
adequately address the changing needs of the marketplace. From time to time, our
competitors may announce new products, capabilities or technologies that have
the potential to replace or shorten the life cycles of our existing products.
Announcements of currently planned or other new products by competitors may
cause customers to delay their purchasing decisions in anticipation of such
products, which could adversely affect our business, liquidity and operating
results. Additionally, technological advancements in computer operating systems
that cause our products to be obsolete or not to function as expected would
adversely affect our financial results if product returns exceeded our reserves,
and inventory was deemed valueless (and exceeded our allowance for inventory
obsolescence).
Our common stock has experienced low trading volumes and other risks on the OTC
Bulletin Board. In April 2001, our common stock was delisted from the Nasdaq
SmallCap Market as a result of our failure to maintain a minimum bid price of
$1.00 over a period of 30 consecutive trading days. Our stock then began trading
on the OTC Bulletin Board under the existing symbol EGAM. In March 2002, our
common stock was not eligible to be traded on the OTC Bulletin Board because we
were not current with our reporting requirements under the Securities Exchange
Act of 1934, as amended (the "1934 Act"). In April 2002, our common stock was
again traded on the OTC Bulletin Board, when we became current with our 1934 Act
filings.
We may not be able to continue to maintain the trading of our stock on the OTC
Bulletin Board, which later this year will begin implementing listing standards
and an application approval requirement to transition to the new Bulletin Board
Exchange (BBX) trading system. The BBX trading system will also require listing
fees. Even if we are successful in maintaining trading of our stock on the OTC
Bulletin Board or the BBX, many stocks traded on the OTC Bulletin Board have
experienced extreme price and trading volume fluctuations. These fluctuations
are often unrelated or disproportionate to the operating performance of
individual companies. Our stock price may be adversely affected by such
fluctuations, regardless of our operating results. Additionally, many common
stocks traded on the OTC Bulletin Board are thinly traded, such as our common
stock, which would make it difficult to sell our stock. If we are not eligible
to list our common stock for trading on the BBX, our stock will then be traded
on the Pink Sheets, which may have even less trading volume potential and more
price fluctuations than the OTC Bulletin Board.
We have experienced increased regulation of our product content and features.
Due to the competitive environment in the consumer entertainment software
industry, we have and will continue to incorporate features into our products,
such as an Internet browser-like interface, advertising technology and on-line
consumer registration capabilities, to differentiate our products to retailers,
provide value-added features to consumers, and to potentially increase website
traffic and create new revenue streams based on advertising and promotional
opportunities. These features may not enhance the product's value, and in fact
such features may detract from a product's value if they are not accepted in the
marketplace or if new regulations governing the Internet and related
technologies are enacted which impact these features.
We may have difficulty protecting our intellectual property rights. We either
own or have licensed the rights to copyrights on our products, manuals,
advertising and other materials. We also hold trademark rights in our corporate
logo, and the names of the products owned or licensed by us. Our success depends
in part on our ability to protect our proprietary rights to the trademarks,
trade names and content used in our principal products. We rely on a combination
of copyrights, trademarks, trade secrets, confidentiality procedures and
contractual provisions to protect our proprietary rights. These initiatives to
protect our proprietary rights require us to use internal resources as well as
outside legal counsel. We may not have sufficient resources to adequately
protect our intellectual property rights, and our existing or future copyrights,
trademarks, trade secrets or other intellectual property rights may not be of
sufficient scope or strength to provide meaningful protection or commercial
advantage to us. Also, in selling our products, we rely on "click-through"
licenses that are not signed by licensees and, therefore, may be unenforceable
under the laws of certain jurisdictions. In addition, the laws of some foreign
countries do not protect our proprietary rights, as do the laws of the United
States. Our inability to sufficiently protect our intellectual property rights
would have an adverse effect on our business and operating results.
Policing unauthorized use of an easily duplicated and broadly disseminated
product such as computer software is very difficult. Software piracy is expected
to be a persistent problem for the software industry for the foreseeable future.
Software piracy is a much greater problem in certain international markets. If a
significant amount of unauthorized copying of our products were to occur, our
business, operating results and financial condition could be adversely affected.
We may incur substantial expenses and be required to use our internal resources
to defend infringement claims, and settlements may not be favorable or
attainable. We may from time to time be notified that we are infringing on the
intellectual property rights of others. Combinations of content acquired through
past or future acquisitions and content licensed from third-party software
developers will create new products and technology that may give rise to claims
of infringement. In recent years, we have incurred significant defense costs and
utilized internal resources in defending trademark and copyright claims and
lawsuits. Other third parties may initiate infringement actions against us in
the future. Any future claims could result in substantial costs to us, and
diversion of our limited resources. If we are found to be infringing on the
rights of others, we may not be able to obtain licenses on acceptable terms or
at all, and significant damages for past infringement may be assessed, or
further litigation relating to any such licenses or usage may occur. Our failure
to obtain necessary licenses or other rights, or the commencement of litigation
arising from any such claims, could materially and adversely affect our
operating results.
We are exposed to the risk of product defects. Products we offer can contain
errors or defects. The PC hardware environment is characterized by a wide
variety of non-standard peripherals, such as sound and graphics cards, and
configurations that make pre-release testing for programming or compatibility
errors difficult and time-consuming. Despite the extensive testing performed by
our quality assurance personnel, new products or releases may contain errors
discovered after shipments have commenced, resulting in a loss of or delay in
market acceptance or widespread product recalls, which would adversely affect
our business, operating results and financial condition.
We depend on key management and technical personnel. Our success depends to a
significant degree on the continued efforts of our key management, marketing,
sales, product development and operational personnel. The loss of one or more
key employees could adversely affect our operating results. We also believe our
future success will depend in large part on our ability to attract and retain
highly skilled management, technical, marketing, sales, product development and
operational personnel. Competition for such personnel is intense, and, due to
our limited resources and size, we may not be successful in attracting and
retaining such personnel.
We may experience unique risks with our international revenues and distribution
efforts. International net revenues, including both product net sales and
licensing revenues, represented 4% of our net sales for the fiscal year ended
June 30, 2002, compared to 6% of our net sales for the fiscal year ended June
30, 2001. We anticipate that in fiscal 2003 our international business will
continue to be transacted primarily through third-party licensees, which is
subject to some risks that our domestic business is not, including: varying
regulatory requirements; difficulties in managing foreign distributors;
potentially adverse tax consequences; and difficulties in collecting delinquent
accounts receivable. Additionally, because our international business is
concentrated among a small number of third-party distributors, the business
failure of any one of these distributors, and the resulting inability to collect
outstanding licensing receivables, could have a material adverse effect on our
financial condition.
Item 3. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Within 90 days prior to
the date of this report, we carried out an evaluation, under the supervision and
with the participation of our Chief Executive Officer and Chief Financial
Officer (together, the "Certifying Officers"), of the effectiveness of our
disclosure controls and procedures (as defined in the Securities Exchange Act of
1934 Rules 13a-14(c) and 15-d-14(c)). Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that as of the date
of the evaluation, our disclosure controls and procedures were effective to
ensure that the information required to be disclosed in the reports that we file
or submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms.
(b) Changes in internal controls. There were no significant changes in our
internal controls or in other factors that could significantly affect our
disclosure controls and procedures subsequent to their evaluation.
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On April 28, 2003, the Company filed a report on Form 8-K regarding a press
release announcing its third quarter fiscal 2003 financial results.
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 14, 2003 /s/ Gerald W. Klein
------------ --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: May 14, 2003 /s/ Thomas W. Murphy
------------ --------------------
Thomas W. Murphy, Chief Financial
Officer and Chief Accounting Officer
CERTIFICATIONS
I, Gerald W. Klein, President and Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-QSB
of eGames, Inc.;
2. Based on my knowledge, this quarterly 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 of the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and
other financial information included in this
quarterly 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 quarterly
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-14 and 15d-14) for the
registrant and have:
a) Designed such disclosure controls and procedures 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
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other Certifying Officer and I have
disclosed, based on our most recent evaluation, to
the registrant's auditors and the audit committee of
registrant's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other Certifying Officer and I have
indicated in this quarterly report whether there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 14, 2003
/s/ Gerald W. Klein
Gerald W. Klein
President and Chief Executive Officer
CERTIFICATIONS
I, Thomas W. Murphy, Chief Financial Officer and Chief Accounting Officer,
certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eGames,
Inc.;
2. Based on my knowledge, this quarterly 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 of the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly 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 quarterly 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-14 and 15d-14)
for the registrant and have:
a) Designed such disclosure controls and procedures 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 quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c) Presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other Certifying Officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other Certifying Officer and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ Thomas W. Murphy
Thomas W. Murphy
Chief Financial Officer and
Chief Accounting Officer
Exhibit 99.1
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 three and nine months ended March 31, 2003 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, 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.
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
/s/ Gerald W. Klein
Gerald W. Klein
President and Chief Executive Officer
May 14, 2003
Exhibit 99.2
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 three and nine months ended March 31, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Thomas
W. Murphy, Chief Financial Officer and Chief Accounting 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, 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 theReport fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
A signed original of this written statement required by Section 906 has been
provided to the Company and will be retained by the Company and furnished to the
Securities and Exchange Commission or its staff upon request.
/s/ Thomas W. Murphy
Thomas W. Murphy
Chief Financial Officer and Chief Accounting Officer
May 14, 2003