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 December 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 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 February 12, 2004.
Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X )
INDEX
Page
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Part I. Financial Information
Item 1. Unaudited Financial Statements:
Balance Sheet as of December 31, 2003................... 3
Statements of Operations for the three and six months
ended December 31, 2003 and 2002 ................... 4
Statements of Cash Flows for the six months
ended December 31, 2003 and 2002................... 5
Notes to Financial Statements........................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ................ 14
Risk Factors............................................ 28
Item 3. Controls and Procedures................................. 33
Part II Other Information
Item 4. Submission of Matters to a Vote of Security Holders..... 34
Item 6. Exhibits and Reports on Form 8-K........................ 34
Exhibit Index ........................................................ 34
Signatures ........................................................ 35
Exhibits ........................................................ 36
Item 1. Unaudited Financial Statements
eGames, Inc.
Balance Sheet
(Unaudited)
December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents $ 1,787,278
Accounts receivable, net of allowances of $1,275,596 1,107,807
Inventory, net 738,352
Prepaid and other expenses 335,219
-----------
Total current assets 3,968,656
Furniture and equipment, net 36,170
-----------
Total assets $ 4,004,826
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 754,826
Accrued expenses 529,257
-----------
Total current liabilities 1,284,083
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 1,268,469
Accumulated deficit (7,226,136)
Treasury stock, at cost - 231,900 shares (501,417)
-----------
Total stockholders' equity 2,720,743
-----------
Total liabilities and stockholders' equity $ 4,004,826
===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Operations
(Unaudited)
Three months ended Six months ended
December 31, December 31,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net sales $ 2,115,561 $ 1,945,817 $ 4,168,033 $ 3,804,973
Cost of sales 892,630 741,291 1,710,815 1,621,094
----------- ----------- ----------- -----------
Gross profit 1,222,931 1,204,526 2,457,218 2,183,879
Operating expenses:
Product development 140,696 101,941 267,086 204,747
Selling, general and
administrative 589,534 648,810 1,191,818 1,294,102
----------- ----------- ----------- -----------
Total operating expenses 730,230 750,751 1,458,904 1,498,849
----------- ----------- ----------- -----------
Operating income 492,701 453,775 998,314 685,030
Interest (income) expense, net (1,466) 11,688 3,517 30,162
----------- ----------- ----------- -----------
Income before income taxes 494,167 442,087 994,797 654,868
Provision for income taxes 22,913 - 0 - 45,197 - 0 -
----------- ----------- ----------- -----------
Net income $ 471,254 $ 442,087 $ 949,600 $ 654,868
=========== =========== =========== ===========
Net income per common share:
- Basic $ 0.05 $ 0.04 $ 0.10 $ 0.07
====== ====== ====== ======
- Diluted $ 0.04 $ 0.04 $ 0.09 $ 0.06
====== ====== ====== ======
Weighted average common shares
outstanding - Basic 9,989,337 9,989,337 9,989,337 9,989,337
Dilutive effect of common share
equivalents 831,090 535,797 684,845 428,102
----------- ----------- ----------- -----------
Weighted average common shares
outstanding - Diluted 10,820,427 10,525,134 10,674,182 10,417,439
=========== =========== =========== ===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Cash Flows
(Unaudited)
Six months ended
December 31,
-------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income $ 949,600 $ 654,868
Adjustment to reconcile net income to net cash
provided by operating activities:
Stock-based compensation 25,332 62,319
Depreciation, amortization and other non-cash items 8,993 22,233
Provisions for product returns, price markdowns, bad debts
and inventory obsolescence, net of adjustments 1,153,452 718,191
Changes in items affecting operations:
Accounts receivable (989,524) (1,107,187)
Prepaid and other expenses (97,983) 55,673
Inventory (362,037) (161,524)
Accounts payable 181,729 295,673
Accrued expenses (80,612) (138,856)
----------- -----------
Net cash provided by operating activities 788,950 401,390
----------- -----------
Cash flows from investing activities:
Purchases of furniture, equipment and other assets (25,909) (4,127)
----------- -----------
Net cash used in investing activities (25,909) (4,127)
----------- -----------
Cash flows from financing activities:
Repayments of credit facility/bank debt - 0 - (420,000)
Repayments of note payable - 0 - (33,522)
----------- -----------
Net cash used in financing activities - 0 - (453,522)
----------- -----------
Net increase (decrease) in cash and cash equivalents 763,041 (56,259)
Cash and cash equivalents:
Beginning of period 1,024,237 700,109
----------- -----------
End of period $ 1,787,278 $ 643,850
=========== ===========
Supplemental cash flow information:
Cash paid for interest $ 5,475 $ 31,321
=========== ===========
Cash paid for income taxes $ 29,986 $ - 0 -
=========== ===========
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
publishes, markets and sells value-priced consumer entertainment PC software
games. PC software games today are sold in most mass-merchant and specialty
retail stores. Our product line enables us to serve consumers 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 distributed primarily through third-party distributors on a non-exclusive
basis who service mass-merchant and specialty retailers. We also sell our
products directly to certain 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. The word "customer " as used in this
document refers to third-party distributors and retailers, as compared to the
word "consumer," which refers to the end consumer shopping at retail stores or
over the Internet.
Liquidity
As of December 31, 2003, we had stockholders' equity of $2,721,000 and working
capital of $2,685,000. For the three and six months ended December 31, 2003, we
earned net income of $471,000 and $950,000, respectively. Additionally, as of
December 31, 2003, we had a cash balance of $1,787,000 representing a $763,000
cash increase from June 30, 2003.
From the first quarter of fiscal 2002 until September 2003, when we entered into
a new credit facility agreement, we did not have access to a credit facility and
had been dependent entirely on cash flow from operations to meet our financial
obligations. Our ability to maintain positive cash flow remains essential to our
survival as a going concern, because our access to this credit facility is
limited to the lesser of $500,000 or 75% of our qualified accounts receivable.
As of December 31, 2003, we had not utilized any of this credit facility,
although we were eligible to draw up to $500,000 under this credit facility,
based on qualified accounts receivable as of that date. Positive cash flow
depends upon a variety of factors, including the timing of the collection of
outstanding accounts receivable, the creditworthiness of our primary
distributors and retailers, sell-through of our products to consumers, and the
costs of producing and marketing such products.
There are significant challenges that we will need to successfully manage in
order to be able to fund our operations in the future. These challenges include,
but are not limited to: maintaining acceptable payment terms with our vendors;
and maintaining timely receivable payments from a concentrated group of
customers. For example, our liquidity would be severely impacted if Atari, and
to a lesser extent EB Carlson, Take Two Interactive, Jack of All Games, or
CompUSA, did not make payments on a timely basis, or if other business
conditions caused them to fail to pay us. Additionally, our accounts payable
have historically increased substantially during our first and second fiscal
quarters (third and fourth calendar quarters) when we increase the amount of
inventory we purchase to meet anticipated customer orders for the back to school
and holiday selling seasons. If we are not paid timely by our customers during
the period following this seasonal increase in inventory purchases, we may have
difficulty paying our vendors in a timely manner, which would then significantly
impact our ability to continue normal operations.
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
products to consumers, 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 or price markdowns and a lack of customer
replenishment orders for these products. As a result of these factors, we may
not be able to maintain positive cash flow. Additional 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 stockholder
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, 2003 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.
Fair Value of Financial Instruments
The recorded amounts of accounts receivable and accounts payable at December 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.
Accounts Receivable, net
Accounts receivable is reflected at the amount we expect to ultimately collect
from outstanding customer balances, and is shown on our balance sheet net of
allowances for product returns, price markdowns and bad debts. The adequacy of
these allowances is reviewed at the end of each reporting period and any
necessary adjustments to these allowances are made through additional provisions
for: product returns and price markdowns (reflected as a reduction to net
sales); and customer bad debts (reflected as an operating expense). Actual
product returns, price markdowns and bad debts are recorded as reductions to
these allowances as well as reductions to the customers' individual accounts
receivable balances (see Note 2).
Inventory, net
Inventory, net 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) (see
Note 3).
Furniture and Equipment, net
Furniture and equipment, net 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 (see Note 5).
Leasehold improvements, net 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, net
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," we record
impairment losses on long-lived assets, including intangible assets, used in
operations when the fair value of those assets, less the cost to sell, is lower
than our carrying value for those assets.
Revenue Recognition
Product Sales:
- --------------
We distribute the majority of our products through third-party distributors to
mass-merchant retailers and directly to certain 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, all of which generally allow for product
returns and price markdowns. We recognize revenues from product shipments to
these distributors or retailers that traditionally have sold consumer
entertainment PC software products at the time title to our inventory passes to
these distributors or retailers, less a provision for anticipated product
returns and price markdowns. Title passes to most of these distributors and
retailers upon receipt of the product by these customers, because most of these
customers require shipping terms of FOB destination. In order to recognize
revenues associated with customer purchase orders having terms of FOB
destination, as part of our sales cut-off tests, we obtain proof of deliveries
from the freight companies that deliver our products to our customers for
product shipments made during the last two weeks of a reporting period. The
results of the sales cut-off tests are reviewed by our Controller, Chief
Financial Officer and independent auditors before the reporting period's
earnings release is distributed. Based on the results of the sales cut-off
tests, any revenues and cost of revenues associated with product shipments
received by our customers after the reporting period and having FOB destination
terms are excluded from the current period's operating results.
We recognize product sales to the customers that traditionally have sold
consumer entertainment PC software products in accordance with the criteria of
SFAS No. 48 at the time title to our inventory passes to these distributors or
retailers, based on the following: the selling price is fixed at the date of
sale, the buyer is obligated to pay us, title of the product transfers to the
buyer, the buyer has economic substance apart from us, we do not have further
obligations to assist the buyer in the resale of the product and the product
returns and price markdowns can be reasonably estimated at the time of sale.
After deliveries to our distribution and retail customers are made, we do not
provide any further services or materials that are essential to our products'
functionality. However, we do provide basic telephone and web-based customer
support to consumers who purchase our products as a means of fostering consumer
satisfaction and loyalty. Costs associated with our customer support effort
usually occur within one year from the period we recognize revenue and these
costs have continued to be minimal (averaging about 1% of net sales). These
costs to render our customer support services, which are comprised of the salary
and related costs of our one customer support representative, are expensed in
the period incurred and are reflected within the Statements of Operations as
operating expenses under "Selling, general and administrative."
For product shipments to distributors or retailers that have not traditionally
sold consumer entertainment PC software products, we recognize revenues based
upon retailer reported product sell-through to consumers and not at time of
product shipment to these types of distributors and retailers. As a result, no
provision for anticipated product returns and price markdowns relating to these
types of sales is recorded.
During the quarter ended December 31, 2003, we entered into a relationship with
a new third-party distributor that expanded our product distribution into
certain office superstores, which distribution was governed by a consignment
sales agreement. Accordingly, revenues from product shipments pursuant to this
arrangement are only recognized to the extent the third-party distributor has
reported to us the actual product sell-through to end consumers at these office
superstore retailers.
Provision for Product Returns and Price Markdowns:
- --------------------------------------------------
Our provision for anticipated product returns and price markdowns is based upon,
among other factors, our analysis of: historical product return and price
markdown results; current product sell-through results at retail store
locations; current field inventory quantities at distributors' warehouses and at
retail store locations; outstanding return material authorizations; and the
introduction of new and/or competing software products that could negatively
impact the sales of one or more of our current products. 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 on our
balance sheet.
During the three months ended December 31, 2003 and 2002, our provisions for
product returns and price markdowns for customers that have traditionally sold
consumer entertainment PC software products (inclusive of inventory liquidation
distributors) were $726,000 and $354,000, respectively, or 26% and 16% of
related gross sales, respectively.
During the six months ended December 31, 2003 and 2002, our provisions for
product returns and price markdowns for customers that have traditionally sold
consumer entertainment PC software products (inclusive of inventory liquidation
distributors) were $1,034,000 and $670,000, respectively, or 20% and 15% of
related gross sales, respectively.
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 usually
expensed on a straight-line basis over the period of time covered by a contract,
except for advance licensing payments, which are expensed at contractual rates
based on the net sales of the related software title containing the licensed
software or intellectual property (see Note 4).
Marketing Costs, Sales Incentives and Promotional Costs
Marketing costs reflected as operating expenses, such as advertising fees and
display costs, are expensed as incurred or when shipped to a customer. These
costs were $21,000 and $18,000 for the three months ended December 31, 2003 and
2002, respectively and were $44,000 and $37,000 for the six months ended
December 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 $168,000
and $52,000 for the three months ended December 31, 2003 and 2002, respectively,
and were $194,000 and $62,000 for the six months ended December 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 $48,000 for the three months
ended December 31, 2003 and 2002, respectively, and were $48,000 and $100,000
for the six months ended December 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 per Common Share
Net income per common share is computed in accordance with SFAS No. 128,
"Earnings per Share". Basic earnings per share is computed by dividing net
earnings by the weighted average number of common shares outstanding during each
period. Diluted earnings per share is computed by dividing net earnings by the
weighted average number of common shares and common share equivalents ("CSE's")
outstanding during each period that we report net income. CSE's may include
stock options and warrants using the treasury stock method.
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 10).
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 uncollectible accounts receivable), in
addition to 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 also recognize that actual results could differ from any of our estimates and
such differences could have either 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 No. 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
adopted the disclosure provisions of this statement effective January 1, 2003.
In March 2003, the Emerging Issues Task Force published Issue No. 00-21
"Accounting for Revenue Arrangements with Multiple Deliverables" (EITF 00-21).
EITF 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it performs multiple revenue generating activities and
how to determine whether such an arrangement involving multiple deliverables
contains more than one unit of accounting for purposes of revenue recognition.
The guidance in this Issue is effective for revenue arrangements entered in
fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 on July
1, 2003 did not have any impact on our financial statements.
2. Accounts Receivable, net
Accounts receivable, net consists of the following:
Accounts receivable, gross $ 2,384,000
Allowance for product returns (1,057,000)
Allowance for price markdowns (211,000)
Allowance for bad debts (8,000)
-----------
Accounts Receivable, net $ 1,108,000
===========
3. Inventory, net
Inventory, net consists of the following:
Raw materials $ 153,000
Finished goods 503,000
Product returns, estimated 223,000
---------
879,000
Allowance for inventory obsolescence (141,000)
---------
Inventory, net $ 738,000
=========
4. Prepaid and Other Expenses
Prepaid and other expenses consists of the following:
Advance royalties $ 195,000
Prepaid insurance expenses 81,000
Prepaid federal income taxes 20,000
Retailer slotting fees 9,000
Other expenses 30,000
---------
Prepaid and Other Expenses $ 335,000
=========
5. Furniture and Equipment, net
Furniture and equipment, net consists of the following:
Furniture and equipment $ 930,000
Accumulated depreciation (894,000)
---------
Furniture and Equipment, net $ 36,000
=========
6. Accrued Expenses
Accrued expenses consist of the following:
Accrued compensation $ 224,000
Accrued royalties 116,000
Customers with credit balances 45,000
State income taxes 45,000
Accrued public accountant fees 33,000
Accrued marketing promotion costs 21,000
Other accrued expenses 45,000
---------
Accrued Expenses $ 529,000
=========
7. Dependence on One Major Distributor
Atari, Inc. ("Atari") is our primary North American distributor serving the
major mass-merchant retailers in North America, such as Wal-Mart, Target, and
Best Buy, among others. During the three months ended December 31, 2003 and
2002, Atari accounted for $1,385,000 and $1,066,000 in net sales, or 65% and 55%
of net sales, respectively. During the six months ended December 31, 2003 and
2002, Atari accounted for $2,954,000 and $2,058,000 in net sales, or 71% and 54%
of net sales, respectively.
We have continued to increase our product distribution through Atari to these
major mass-merchant retailers by increasing the number of our titles carried and
the number of stores within each retailer's chain of stores that carry these
titles.
Our financial condition and ability to continue as a going concern could be
significantly affected in the event that we would lose our distribution
capability through Atari. However, product distribution to these retailers is a
competitive business within itself and there are other distributors who also
serve these leading national retail chains. These alternative distributors could
potentially distribute our products to these retailers if, for example, Atari
chose to discontinue distributing our titles or if any of these retailers
decided to discontinue their relationship with Atari. We can provide no
assurance, however, that we would be able to secure agreements with such
alternative distributors on commercially reasonable terms or at all.
8. Commitments and Contingencies
Our 5,000 square foot office facility located in Langhorne, Pennsylvania is
occupied under an operating lease that is scheduled to expire on September 30,
2007. Additionally, we currently rent certain office equipment through various
operating lease agreements. Net rent expense incurred under our operating leases
was $21,000 and $20,000 for the three months ended December 31, 2003 and 2002,
respectively and $42,000 and $38,000 for the six months ended December 31, 2003
and 2002, respectively.
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
$240,000 and $231,000 for the three months ended December 31, 2003 and 2002,
respectively, and $465,000 and $456,000 for the six months ended December 31,
2003 and 2002, respectively. Additionally, most of these licensing agreements
require us to make advance royalty payments to these developers prior to the
time we recognize any net sales of software titles containing this licensed
software content. We have commitments to pay $155,000 in advance royalty
payments to various software developers under such agreements. Included in this
$155,000 is our remaining obligation to pay Greenstreet Software Limited, a
U.K.-based company that also licenses and distributes our products, an advance
royalty of $40,000 for the licensing of one of its PC software titles by August
2004.
In conjunction with the launch of a new software title, RealAge Games & Skills,
we have an existing contract for the license of a trademark that required us to
make the second of two $50,000 advance royalty payments by May 2004, regardless
of actual royalties earned. During February 2004, we satisfied this obligation
with a discounted payment of $45,000. The first $50,000 advance royalty payment
was made to this licensor during fiscal 2003 upon signing the contract, and the
remaining un-expensed portion of this first payment is classified on our
December 31, 2003 balance sheet within "Prepaid and other expenses".
These guaranteed royalty and licensing commitments are expected to be funded by
cash flows generated through anticipated income from operations.
9. Licensing Revenues and Internet Sales
Licensing revenues for the three months ended December 31, 2003 and 2002, were
$121,000 and $145,000, respectively, or 6% and 8%, respectively, of net sales,
compared to the six months ended December 31, 2003 and 2002 when licensing
revenues were $222,000 and $251,000, respectively, or 5% and 7%, respectively,
of net sales.
Internet sales accounted for 4% and 3%, respectively, of net sales for the three
months ended December 31, 2003 and 2002, and 3% of net sales for each of the
six-month periods ended December 31, 2003 and 2002.
10. Accounting for Stock-based Compensation - Transition and Disclosure, per
SFAS No. 148
As of December 31, 2003, we had one existing stock-based employee compensation
plan, which was adopted, amended and restated during 1995. This Plan, known as
our 1995 Amended and Restated Stock Option Plan (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 relating to stock option grants 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. Therefore, the cost related to stock-based employee
compensation included in the determination of net income for the three and six
months ended December 31, 2003 and 2002, respectively, 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.
Additionally, the stock-based employee compensation included in the table below
for the three and six months ended December 31, 2002 does not include $5,000 and
$16,250, respectively, in stock-based compensation expense reflected in those
periods' net income, due to being related to a common stock warrant issued to a
non-employee third-party (Fleet Bank).
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
for the three and six months ended December 31, 2003 and 2002, respectively, if
the fair value method had been applied to all outstanding stock option grants
during those periods.
Three Months Ended Six Months Ended
December 31, December 31,
--------------------- ---------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported $ 471,000 $ 442,000 $ 950,000 $ 655,000
Add: Stock-based employee compensation expense included
in reported net income, net of tax effects 17,000 23,000 25,000 46,000
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
stock option grants, net of tax effects (17,000) (74,000) (26,000) (154,000)
--------- --------- --------- ---------
Pro forma net income $ 471,000 $ 391,000 $ 949,000 $ 547,000
========= ========= ========= =========
Net income per common share:
- - Basic, as reported $ 0.05 $ 0.04 $ 0.10 $ 0.07
====== ====== ====== ======
- - Basic, pro forma $ 0.05 $ 0.04 $ 0.10 $ 0.06
====== ====== ====== ======
- - Diluted, as reported $ 0.04 $ 0.04 $ 0.09 $ 0.06
====== ====== ====== ======
- - Diluted, pro forma $ 0.04 $ 0.04 $ 0.09 $ 0.05
====== ====== ====== ======
11. Credit Facility
In September 2003, we entered into a $500,000 credit facility agreement with
Hudson United Bank ("HUB"), which matures on December 1, 2004. Amounts
outstanding under this new credit facility will be charged interest at one-half
of one percent above HUB's current prime rate and such interest is due monthly.
Our access to these funds is limited to the lesser of $500,000 or seventy-five
percent of qualified accounts receivable, which are defined as invoices less
than ninety days old and net of any allowances for product returns, price
markdowns or bad debts. The credit facility is secured by all of the Company's
assets and requires us, among other things, to maintain the following financial
covenants to be tested quarterly: a total liabilities to tangible net worth
ratio of 1.25 to 1.00 and a tangible net worth requirement of $1.5 million. As
of December 31, 2003, we were in compliance with each of those covenants. This
credit facility was established to provide working capital for our operations.
As of December 31, 2003, we had not utilized any of this credit facility,
although we were eligible to draw up to $500,000 under this credit facility,
based upon qualified accounts receivable as of that date.
12. 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 its products,
geographic areas and major customers.
Based on our organizational structure, we operate in only one geographic area,
which is North America, and one reportable segment, which is publishing consumer
entertainment software for personal computers.
13. Listing of Our Common Stock
Our common stock trades on the OTC Bulletin Board under the symbol EGAM. We
periodically review our alternatives with respect to listing on an exchange or
dealer quotation system, such as the American Stock Exchange or the Nasdaq
SmallCap Market. At this time we do not meet all of the criteria for listing on
these markets. We will, therefore, from time to time continue to evaluate our
available alternatives to the OTC Bulletin Board.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-QSB contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. All statements made in this Quarterly Report on
Form 10-QSB, other than statements of historical fact, including statements
regarding industry prospects and future results of operations or financial
position, are forward looking. We use the words "believe", "expect",
"anticipate", "intend", "will", "should", "may" and similar expressions to
identify forward-looking statements. These forward-looking statements are
subject to business volatility, economic risk, and world events, which are
inherently uncertain and difficult to predict. Our actual results could differ
materially from management's expectations due to such risks. We will not
necessarily update information if any forward-looking statement later turns out
to be inaccurate. In particular, these forward-looking statements include, among
others, statements about:
- our continued efforts to look for opportunities to expand the
distribution of our products and our expectation that our gross
profit margin may be reduced as distribution expands;
- expectations regarding continued reduced sales to CompUSA and
Jack of All Games, as compared to prior periods;
- our ability to enter into agreements with other distributors, to
the extent that our relationship with Atari is discontinued in the
future;
- the receipt of additional quantities of discontinued product
titles back from retailers that will need to be liquidated through
sale to liquidation distributors and liquidators;
- the continued reduction of licensing revenues, as compared to
prior periods;
- our anticipated Internet sales during the remainder of fiscal 2004
and the expansion of on-line registration programs of our retail
products;
- expectations regarding our provision for product returns and price
markdowns as a percentage of related gross sales and continued
increases in rebates and slotting fees;
- our intent to focus our distribution efforts on software titles at
value-price points ($9.99), versus higher price point products;
- anticipated reductions in product costs as a result of future
price concessions from manufacturing vendors;
- our ability to increase net sales to Atari for the remainder of
fiscal 2004 to arrive at an annual increase of 20% to 25% compared
to fiscal 2003 net sales to Atari; and
- our ability to fund our operations based on our projected cash and
working capital balances.
The following important factors, as well as those factors discussed under "Risk
Factors" at pages 28 to 33 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;
- our continued successful business relationship with Atari, our
distributor to Wal-Mart, Target, and Best Buy, among other
retailers;
- the amount of unsold product that is returned to us by retail
stores and distributors;
- the amount of price markdowns granted to retailers and
distributors;
- our ability to accurately estimate the amount of product returns
and price markdowns that will occur and the adequacy of the
allowances established for such product returns and price
markdowns;
- the successful sell-through to consumers of our new higher price
point products, in all retail channels through which 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 products;
- 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 (retail facings) for our products in
major retail chain stores;
- the ability to earn royalties through our international product
distribution under licensing agreements and the ability of our
licensees to pay us such royalties within agreed upon terms;
- 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 worldwide;
- our ability to deliver products in response to customer orders
within a commercially acceptable time frame;
- downward pricing pressure and increased competition in the
value-priced software category;
- our ability to control the costs of producing and marketing our
products on commercially reasonable terms or at all;
- our ability to license 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;
and various other factors, many of which are beyond our control.
Product, Industry and Market Data
- ---------------------------------
eGames publishes and markets a diversified line of Family Friendly(TM),
value-priced consumer entertainment PC software games to the value-priced
consumer, mostly through third-party distributors to major mass-merchant,
specialty and computer software retailers. We secure the rights to publish PC
software games through licensing agreements with third-party PC software
developers. We do not develop PC software games internally, but we pay royalties
to third-party game developers based on a percentage of net revenues for each
licensed PC game. On average we release sixteen to twenty software titles per
year, which number is primarily driven by retailer shelf reset requirements and
the current projected remaining life of our titles in distribution. Our titles
have historically had a product lifecycle of six to twelve months. Our product
content is also frequently repackaged in subsequent collections that has the
potential to extend the product content lifecycle to as much as two years or
more.
Our core titles within the PC software market include Mahjongg, game
collections, card & board games, Solitaire, puzzles and word games. We use
industry market data from sources such as NPD Techworld to understand current
trends in the PC market place (such as game genres realizing increased or
decreased consumer demand and sales trends for the overall PC software market),
our market position relative to other publishers, and how our titles are selling
to consumers compared to our competitors' products. According to NPD Techworld
data for December 2003, while the overall PC software industry decreased by 23%
in unit sales compared to December 2002, our unit sales increased by 32%
compared to December 2002. Industry-wide, overall PC software retail sales
decreased by 4% during calendar 2003, compared to calendar 2002, while unit
sales decreased by 9.5% from 2002 to 2003, according to NPD Techworld. In the
value-priced segment ($14.99 and under) of the PC game category, NPD Techworld
reported that three eGames titles were in the top ten during December 2003,
including DROP! at number 3, 251 Games Collectors' Edition at number 4, and Card
& Board 2 at number 5. Data from our distributors and retailers indicated that
sell-through of our products to consumers during December 2003 increased by more
than 40% compared to sell-through of our products during December 2002. We view
this increase in product sell-through to consumers as a positive reflection on
the market acceptance of our products during our most important selling season.
There is, however, no way to predict with any certainty whether this increased
product sell-through trend to consumers will continue.
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 judgments and estimates that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our estimates,
including estimated product returns, price markdowns, bad debts, inventory
obsolescence, income taxes, contingencies and litigation risks. 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 how much revenue can be recognized in any reporting period. Material
differences may result in the amount and timing of our revenue for any period if
management's judgments or estimates for product returns or price markdowns prove
to be insufficient or excessive compared to actual results. 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 PC software retailers. These
retailers have traditionally sold consumer entertainment PC software products.
The distribution of our products is governed by purchase orders, distribution
agreements or direct sale agreements, all of which generally allow for product
returns and price markdowns. For product shipments to distributors or retailers
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 these distributors or
retailers.
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, current product sell-through results at retail store
locations, current field inventory quantities at distributors' warehouses and at
retail store locations, the 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 our gross accounts receivable balance
and is reflected in "Accounts receivable, net of allowances" on our balance
sheet.
Historically, the allowance for product returns and price markdowns has
represented a substantial portion of our gross accounts receivable. This occurs
because we have product return exposure relating to paid receivables while the
products relating to these receivables remain in the retailers' stores or in the
retailers' or distributors' warehouses. Until the physical products are actually
returned to us, or sell through to end consumers, we continue to evaluate our
product return or price markdown exposure for these units remaining in the
retail channel. During these time periods, through customer-provided reports, we
have regular and timely visibility of the sell-through results for each title to
help us estimate our exposure for product returns or price markdowns.
Additionally, since the beginning of fiscal 2003, we have experienced consistent
sales growth to distributors and retailers that have traditionally sold consumer
entertainment PC software games, so that our overall allowance for and exposure
to product returns and price markdowns has increased as a function of having
more total units of our products (combined with higher average selling prices
for those units) in the traditional PC software retail channel.
We recognize revenues from product shipments to distributors and retailers 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." Revenue is recognized at the time titles passes to these
distributors and retailers based on the following: the selling price is fixed at
the date of sale; the buyer is obligated to pay us; title to 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
most of these distributors or retailers upon receipt of the product by these
distributors or retailers, because most of our distributors and retailers
require shipping terms of FOB destination. In order to recognize revenues
associated with customer purchase orders having terms of FOB destination, as
part of our sales cut-off tests, we obtain proof of deliveries from the freight
companies that deliver our products to our customers for product shipments made
during the last two weeks of a reporting period. The results of the sales
cut-off tests are reviewed by our Controller, Chief Financial Officer and
independent auditors before the reporting period's earnings release is
distributed. Based on the results of the sales cut-off tests, any revenues and
cost of revenues associated with product shipments received by our distributors
or retailers after the reporting period and having FOB destination terms are
excluded from the current period's operating results.
For product shipments to distributors or retailers that have not traditionally
sold consumer entertainment PC software products, we recognize revenues based
upon retailer reported product sell-through to consumers and not at time of
product shipment to these types of distributors and retailers. As a result, no
provision for anticipated product returns and price markdowns relating to these
types of sales is recorded.
During the quarter ended December 31, 2003, we entered into a relationship with
a new third-party distributor that expanded our product distribution into
certain office superstores, which distribution is governed by a consignment
sales agreement. Accordingly, revenues from product shipments pursuant to this
arrangement are only recognized to the extent the third-party distributor has
reported to us the actual product sell through to end consumers at these office
superstore retailers.
Inventory Valuation
- -------------------
Our accounting policy for inventory valuation requires management to make
estimates and assumptions about the recoverability of the carrying value of
inventory, which 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 of
provisions for the potential impairment of inventory value are insufficient or
excessive when compared to actual results. These differences, if material, would
significantly affect our operating results and financial condition.
We are exposed to product obsolescence because of the relatively short product
life cycles - averaging six to twelve 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. When this occurs, we attempt to liquidate
these excess quantities of remaining inventory, frequently at closeout prices
below their original manufactured costs. If we cannot liquidate such inventory,
or if we are unable to sell any remaining units due to legal or other reasons,
we then write down the remaining value to zero. The adequacy of our allowance
for inventory obsolescence is reviewed at the close of each reporting period,
and any adjustments (positive or negative) are reflected in the current period's
provision.
Results of Operations
The following discussion should be read together with our Financial Statements
and Notes beginning on page 3. The word "customer" as used in this document
refers to third-party distributors and retailers, as compared to the word
"consumer", which refers to the end consumer shopping at retail stores or over
the Internet.
Three Months Ended December 31, 2003 Compared to the Three Months Ended
December 31, 2002
Net Sales
- ---------
For the three months ended December 31, 2003, net sales increased by $170,000,
or 9%, to $2,116,000 compared to $1,946,000 for the same quarter a year earlier.
The $170,000 increase in net sales resulted from a $211,000 increase in net
product sales to traditional software distributors and retailers due mostly to
increased distribution of our software titles to major North American
mass-merchant and specialty retailers served by our largest distributor, Atari.
The $211,000 net sales increase to traditional software distributors and
retailers was partially offset by decreases in licensing revenues and in net
product sales to inventory liquidation distributors and retailers and
non-traditional software distributors and retailers.
The following tables represent our net sales by distribution channel and
customer for the three months ended December 31, 2003 and 2002, respectively:
Net Sales by Distribution Channel
=================================
Three Months ended
December 31,
-------------------------
Increase %
Distribution Channel 2003 2002 (Decrease) Change
- ------------------------------------------------------------------------------------------------------
Traditional software distributors and retailers $ 1,941,000 $ 1,730,000 $ 211,000 12%
Licensing revenues 121,000 145,000 (24,000) (17%)
Inventory liquidation distributors and retailers 54,000 68,000 (14,000) (21%)
Non-traditional software distributors and retailers - 0 - 3,000 (3,000) (100%)
- ------------------------------------------------------------------------------------------------------
Net Sales $ 2,116,000 $ 1,946,000 $ 170,000 9%
=========== =========== ========= ==
Net Sales by Customer
=====================
Three Months ended
December 31,
-------------------------
Increase %
Customer 2003 2002 (Decrease) Change
- ------------------------------------------------------------------------------------------------------
Atari $ 1,385,000 $ 1,066,000 $ 319,000 30%
Licensees, various 121,000 145,000 (24,000) (17%)
EB Carlson 100,000 - 0 - 100,000 *
CompUSA 92,000 210,000 (118,000) (56%)
Internet 87,000 60,000 27,000 45%
Take Two Interactive 81,000 - 0 - 81,000 *
Jack of All Games 72,000 149,000 (77,000) (52%)
Inventory liquidators, various 54,000 68,000 (14,000) (21%)
Other 124,000 248,000 (124,000) (50%)
- ------------------------------------------------------------------------------------------------------
Net Sales $ 2,116,000 $ 1,946,000 $ 170,000 9%
=========== =========== ========= ==
*Percentage change is not meaningful because no net sales recorded in prior
period.
Increased distribution of our software titles to major North American
mass-merchant and specialty retailers served by our largest distributor, Atari,
was the major factor contributing to the $211,000 increase in net product sales
to traditional software distributors and retailers. Our net product sales to
Atari increased to $1,385,000 for the current quarter, which represented a
$319,000 or 30% increase over our net product sales to Atari during the same
quarter a year ago. During the three months ended December 31, 2003, an
increased number of eGames titles have been sold at retailers such as Wal-Mart,
Target, Best Buy, Shopko, Musicland and Meijer (distributed through Atari) and
Circuit City (distributed through EB Carlson) compared to the same period last
year. Also during the three months ended December 31, 2003, we established new
business relationships at a number of retailers, including Office Max, Office
Depot and Sam's Club (distributed through Take Two Interactive) and BJ's
(distributed through EB Carlson). One of our primary objectives in fiscal 2004
and beyond is the continued expansion of product distribution at current retail
customers, as well as our continued pursuit of new channels of distribution on
terms profitable to eGames. As we have expanded our product distribution, our
gross profit margin has been negatively impacted by the competitive retail
environment, and this gross profit margin erosion may continue as our product
distribution expands.
During fiscal 2004, we have reduced the number of our titles distributed to
CompUSA, our largest direct retail customer, to a level that we believe is more
productive on a per title basis, but this change has caused lower net product
sales to CompUSA compared to prior periods. These reduced sales to CompUSA are
expected to continue for the remainder of fiscal 2004. Additionally during
fiscal 2004, we decided not to continue certain less profitable fiscal 2003
sales programs with our largest Canadian distributor (Jack of All Games), which
we expect will continue to negatively impact our net sales comparisons between
fiscal 2004 and fiscal 2003.
Distribution of our products to retailers that have historically been successful
in merchandising consumer entertainment PC software has increased as a result of
strong product sell through activity to consumers at these retailers' stores.
These retailers typically designate the distributor that they want us to use for
the distribution of our products to their stores, and in certain instances
retailers have decided to have us distribute software products directly to them.
Distribution to these retailers is a competitive business within itself and
there are other distributors who also serve these leading national retail
chains. If Atari chose to discontinue distributing our titles or if any of these
retailers decided to discontinue their relationship with Atari, another
distributor could potentially distribute our products to these retailers. We can
provide no assurance, however, that we would be able to secure agreements with
such alternative distributors on commercially reasonable terms or at all.
During the three months ended December 31, 2003, our net sales were categorized
as follows:
o 78% of product shipments to traditional software distributors,
including Atari, EB Carlson, Take Two Interactive and Jack of
All Games;
o 9% of product shipments made directly to traditional software
retailers, such as CompUSA;
o 6% of licensing revenues;
o 4% of product shipments and downloads to consumers through the
Internet; and
o 3% of product shipments to various inventory liquidators.
This compares to the three months ended December 31, 2002, when our net sales
were categorized as follows:
o 64% of product shipments to traditional software distributors,
including Atari and Jack of All Games;
o 22% of product shipments made directly to traditional software
retailers, such as CompUSA;
o 8% of licensing revenues;
o 3% of product shipments and downloads to consumers through the
Internet; and
o 3% of product shipments to various inventory liquidators.
During the three months ended December 31, 2003 and 2002, we had one major
distributor, Atari, that represented 65% and 55%, respectively, of net sales.
(See "Our success depends on continued viable business relationships with key
distributors and retailers" and "A significant part of our sales come from a
limited number of customers" under "Risk Factors," page 29).
During the quarter ended December 31, 2003, we had $54,000 in sales to inventory
liquidation distributors and retailers, compared to $68,000 of such sales during
the quarter ended December 31, 2002. Throughout fiscal 2004, as retailers
continue to periodically reset the mix of software titles on their store shelves
(usually on a quarterly basis), we expect to receive additional quantities of
discontinued titles back from the retail channel that will then need to be
liquidated (along with any remaining quantities of these titles already in our
warehouse) through sales to liquidation distributors and retailers.
Licensing revenues for the three months ended December 31, 2003 and 2002, were
$121,000 and $145,000, respectively, or 6% and 8%, respectively, of net sales.
This $24,000 decrease in licensing revenues was primarily due to licensing
revenue decreases from Rondomedia in Germany and UAV in the United States.
Licensing revenues are generated primarily from sales made by our international
distributors under a series of licensing agreements covering various territories
outside of North America, with the majority of our licensing revenues
originating from the United Kingdom, Germany, Australia and Brazil. During
fiscal 2004, we believe that licensing revenues will probably continue to run
below prior year periods and may represent approximately 5% of net sales for all
of fiscal 2004.
Internet sales accounted for 4% and 3%, respectively, of net sales for the three
months ended December 31, 2003 and 2002. We anticipate that Internet sales could
represent about 3% of our net sales during the remainder of fiscal 2004. During
the first quarter of fiscal 2004, we launched a new e-commerce system, which was
intended to increase the profitability of our Internet sales. In conjunction
with the launch of this new system, we have revamped the look of our websites
and we will continue to improve the more popular features of our websites,
including our free online game arcade, in order to drive web traffic and sales
on our websites. Additionally, during the quarter ended December 31, 2003, our
Internet sales benefited from the launch of our new title "RealAge Games &
Skills" through a series of web-based advertising promotions. We plan to
continue expanding on-line registration programs of our retail products in order
to increase our database of registered users who are interested in receiving
promotional offers about our products.
Product Returns and Price Markdowns
- -----------------------------------
During the three months ended December 31, 2003 and 2002, our provisions for
product returns and price markdowns for customers that have traditionally sold
consumer entertainment PC software products were $726,000 and $354,000,
respectively, or 26% and 16% of related gross sales, respectively. During the
quarter ended December 31, 2003, we increased our provision for product returns
and price markdowns because of poor sell-through results of certain higher
priced ($19.99 retail priced) box titles that did not achieve the product sell
through results to end consumers that we had expected.
Our distribution of titles with a $19.99 retail price represents a departure
from our typical value-priced product offering to the casual gamer with a retail
price of $9.99. These higher priced titles represent a greater risk of price
markdown exposure if they do not sell through to consumers at estimated rates.
Accordingly, based upon historical and recent trends in our product sell-through
rates to consumers of our core titles retail priced at $9.99 and our higher
priced box titles retail priced $19.99, we anticipate our overall fiscal 2004
provision for product returns and price markdowns could be approximately 20%
of related gross sales.
Sales Incentives and Promotional Costs
- --------------------------------------
Sales incentives and promotional costs, such as rebates and slotting fees, were
$184,000 and $100,000 for the three months ended December 31, 2003 and 2002,
respectively. These fees have continued to increase during fiscal 2004 over
prior periods as a result of increased distribution of our products at retailers
who make these fees (recognized as reductions to net sales) a prerequisite for
gaining and then maintaining shelf space for products supplied by their vendors.
Because we currently plan to increase our distribution at these retailers and to
continue looking for incremental distribution opportunities, we expect these
types of fees to continue negatively impacting our net sales, gross profit and
gross profit margin.
Cost of Sales
- -------------
Cost of sales for the three months ended December 31, 2003 were $893,000
compared to $741,000 for the three months ended December 31, 2002, representing
an increase of $152,000 or 21%. This cost of sales increase was caused primarily
by increases of:
o $117,000 in product costs (software titles consisting of one or more
CD's, print material, security sensor tag, jewel case and
box packaging);
o $47,000 in provision for inventory obsolescence; and
o $9,000 in royalty costs.
These cost of sales increases were partially offset by cost of sales decreases
of:
o $9,000 in freight costs; and
o $12,000 in other cost of sales.
The $117,000 increase in product costs was caused primarily by an increase in
sales of box titles containing two to six compact disks (CD's), compared to the
prior year's period, when most of our titles contained one CD. Additionally, we
experienced higher product costs because of the new requirement by certain
mass-merchant retailers to have security sensor tags included in software
packages.
The $47,000 increase in the provision for inventory obsolescence resulted from
our determination that additional quantities of titles that had been
discontinued by various retailers needed to be revalued to liquidation sales
values below their previous carrying costs.
Gross Profit Margin
- -------------------
Our gross profit margin for the three months ended December 31, 2003 decreased
to 57.8% of net sales from 61.9% of net sales for the three months ended
December 31, 2002. The 4.1% decrease in gross profit margin was caused by cost
increases, as a percentage of net sales, of:
o 3.8% in product costs; and
o 2.2% in provision for inventory obsolescence.
These cost of sales increases, as a percentage of net sales, were partially
offset by cost of sales decreases, as a percentage of net sales, of:
o 0.7% in freight costs;
o 0.5% in royalty costs; and
o 0.7% in other cost of sales.
The reasons for the percentage of net sales increases and decreases in these
cost categories are discussed under "Cost of Sales," above. Based on the
sell-through results we have experienced with our higher priced box products,
and the higher costs that are associated with these products, we plan to control
product costs by reducing the distribution of higher priced products during the
remainder of fiscal 2004, and to focus more of our distribution efforts on
software at the $9.99 retail price point. We also expect our product costs to
benefit in the future from price concessions from our manufacturing vendors,
particularly in the cost for us to include security sensor tags in our products.
Operating Expenses
- ------------------
Product development expenses for the three months ended December 31, 2003 were
$141,000 compared to $102,000 for the three months ended December 31, 2002, an
increase of $39,000 or 38%. This $39,000 increase was caused primarily by
increased costs in outside services to upgrade our website and fees to obtain
industry ratings for our software products, in addition to an increase in salary
and related costs.
Selling, general and administrative expenses for the three months ended December
31, 2003 were $589,000 compared to $649,000 for the three months ended December
31, 2002, a decrease of $60,000 or 9%. As a result of various cost saving
initiatives, we have continued to achieve cost savings across various
categories. The primary cost reductions were:
o $26,000 in salary and related costs;
o $23,000 in professional services and outside labor costs;
o $20,000 in bad debt expense; and
o $11,000 in stock-based compensation expense related to the
valuation of stock options and warrants.
These cost decreases were partially offset by cost increases of:
o $15,000 in public relations costs related to a new product launch;
and
o $5,000 in other various operating expenses.
The $26,000 decrease in salary and related costs was caused by a reduction in
headcount that occurred in late fiscal 2003, and was partially offset by salary
and bonus increases that became effective during early fiscal 2004.
The $23,000 decrease in professional services and outside labor costs resulted
from non-recurring legal and accounting costs incurred in the prior year's
quarter, in addition to decreased support and consulting costs relating to our
EDI system.
Interest (Income) Expense, Net
- ------------------------------
Net interest (income) for the three months ended December 31, 2003 was ($1,000)
compared to net interest expense of $12,000 for the three months ended December
31, 2002, an improvement of $13,000. This $13,000 improvement in net interest
(income) was due to the elimination of our previous bank debt, combined with
interest income earned on our higher average cash balance during the three
months ended December 31, 2003.
Provision for Income Taxes
- --------------------------
During the three months ended December 31, 2003, our provision for income taxes
was $23,000 compared to no provision for the quarter ended December 31, 2002.
The current quarter's provision related to the estimated taxable income from
various states net of available state operating loss carry-forwards, and no
estimated taxable income calculated for federal income tax purposes because of
remaining federal net operating loss carry-forwards ("NOL's"), which were
sufficient to offset estimated taxable income for federal income tax purposes
for the quarter ended December 31, 2003.
Net Income
- ----------
As a result of the factors discussed above, our net income for the three months
ended December 31, 2003 was $471,000 compared to $442,000 for the same quarter a
year earlier, an increase in net income of $29,000, or 7%.
Weighted Average Common Shares
- ------------------------------
The weighted average common shares outstanding on a diluted basis increased by
295,293 for the three months ended December 31, 2003 to 10,820,427 from
10,525,134 for the three months ended December 31, 2002. The current quarter's
increase in the diluted basis calculation of weighted average common shares
resulted from including additional common share equivalents, compared to the
prior year's quarter, due to more common share equivalents being "in the money"
or having an exercise price less than the average market price of our common
shares during the current quarter.
Six Months Ended December 31, 2003 Compared to the Six Months Ended
December 31, 2002
Net Sales
- ---------
For the six months ended December 31, 2003, net sales increased by $363,000, or
10%, to $4,168,000 compared to $3,805,000 for the six months ended December 31,
2002. The $363,000 increase in net sales resulted from a $717,000 increase in
net product sales to traditional software distributors and retailers. The
$717,000 net sales increase to traditional software distributors and retailers
was partially offset by a $247,000 decrease in net product sales to inventory
liquidation distributors and retailers, a $78,000 decrease in net product sales
to non-traditional software distributors and retailers, and a $29,000 decrease
in licensing revenues.
The following tables represent our net sales by distribution channel and
customer for the six months ended December 31, 2003 and 2002, respectively:
Net Sales by Distribution Channel
=================================
Six Months ended
December 31,
-------------------------
Increase %
Distribution Channel 2003 2002 (Decrease) Change
- ------------------------------------------------------------------------------------------------------
Traditional software distributors and retailers $ 3,892,000 $ 3,175,000 $ 717,000 23%
Licensing revenues 222,000 251,000 (29,000) (12%)
Inventory liquidation distributors and retailers 54,000 301,000 (247,000) (82%)
Non-traditional software distributors and retailers - 0 - 78,000 (78,000) (100%)
- ------------------------------------------------------------------------------------------------------
Net Sales $ 4,168,000 $ 3,805,000 $ 363,000 10%
=========== =========== ========= ===
Net Sales by Customer
=====================
Six Months ended
December 31,
-------------------------
Increase %
Customer 2003 2002 (Decrease) Change
- ------------------------------------------------------------------------------------------------------
Atari $2,954,000 $2,058,000 $ 896,000 44%
Licensees, various 222,000 251,000 (29,000) (12%)
CompUSA 185,000 277,000 (92,000) (33%)
EB Carlson 175,000 - 0 - 175,000 *
Jack of All Games 126,000 210,000 (84,000) (40%)
Internet 126,000 104,000 22,000 21%
Take Two Interactive 81,000 - 0 - 81,000 *
Inventory liquidators, various 54,000 301,000 (247,000) (82%)
Other 245,000 604,000 (359,000) (59%)
- ------------------------------------------------------------------------------------------------------
Net Sales $ 4,168,000 $ 3,805,000 $ 363,000 10%
=========== =========== ========= ===
*Percentage change is not meaningful because no net sales recorded in prior
period.
Increased distribution of our software titles to major North American
mass-merchant and specialty retailers served by our largest distributor, Atari,
was the major factor contributing to the $717,000 increase in net product sales
to traditional software distributors and retailers. Our net product sales to
Atari increased to $2,954,000 for the six months ended December 31, 2003, which
represented a $896,000 or 44% increase over our net product sales to Atari
during the six months ended December 31, 2002. Based on our current estimates
for the remainder of fiscal 2004, we believe that our overall fiscal 2004 net
sales to Atari may increase by approximately 20% to 25% compared to fiscal 2003
net sales to Atari.
During the six months ended December 31, 2003, our net sales were categorized as
follows:
o 82% of product shipments to traditional software distributors, including
Atari, Jack of All Games and EB Carlson;
o 9% of product shipments made directly
to traditional software retailers, such as CompUSA;
o 5% of licensing revenues;
o 3% of product shipments and downloads to consumers through the
Internet; and
o 1% of product shipments to various inventory liquidators.
This compares to the six months ended December 31, 2002, when our net sales were
categorized as follows:
o 61% of product shipments to traditional software distributors, including
Atari and Jack of All Games;
o 19% of product shipments made directly to traditional software retailers,
such as CompUSA;
o 8% of product shipments to various inventory liquidators;
o 7% of licensing revenues;
o 3% of product shipments and downloads to consumers through the
Internet; and
o 2% of product shipments made directly to non-traditional software
distributors and retailers.
During the six months ended December 31, 2003 and 2002, we had one major
distributor, Atari, that represented 71% and 54%, respectively, of net sales.
During the six months ended December 31, 2003, we had $54,000 in sales to
inventory liquidation distributors and retailers, compared to $301,000 in such
sales during the six months ended December 31, 2002.
Licensing revenues for the six months ended December 31, 2003 and 2002, were
$222,000 and $251,000, respectively, or 5% and 7%, respectively, of net sales.
This $29,000 decrease in licensing revenues was primarily due to licensing
revenue decreases from UAV and Fundever in the United States, Anasoft in Brazil
and Rondomedia in Germany, which were partially offset by licensing revenue
increases from GSL in the United Kingdom and Atari in Australia.
Internet sales accounted for 3% of net sales for each of the six-month periods
ended December 31, 2003 and 2002, respectively.
Product Returns and Price Markdowns
- -----------------------------------
During the six months ended December 31, 2003 and 2002, our provisions for
product returns and price markdowns for distributors and retailers that have
traditionally sold consumer entertainment PC software products were $1,034,000
and $670,000, respectively, or 20% and 15% of related gross sales, respectively.
During the six months ended December 31, 2003, we increased our product returns
and price markdown provision because of poor sell-through results of certain
higher priced ($19.99 retail priced) box titles that did not achieve the product
sell-through results to end consumers that we had expected.
Sales Incentives and Promotional Costs
- --------------------------------------
Sales incentives and promotional costs, such as rebates and slotting fees, were
$242,000 and $162,000 for the six months ended December 31, 2003 and 2002,
respectively. We expect these types of fees to continue having a negative impact
on our net sales, gross profit and gross profit margin.
Cost of Sales
- -------------
Cost of sales for the six months ended December 31, 2003 were $1,711,000
compared to $1,621,000 for the six months ended December 31, 2002, representing
an increase of $90,000 or 6%. This cost of sales increase was caused primarily
by increases of:
o $92,000 in provision for inventory obsolescence;
o $41,000 in product costs; and
o $9,000 in royalty costs.
These cost of sales increases were partially offset by cost of sales decreases
of:
o $28,000 in freight costs; and
o $24,000 in other cost of sales.
The $92,000 increase in the provision for inventory obsolescence resulted from
our determination that additional quantities of certain titles that had been
discontinued by various retailers needed to be revalued to estimated inventory
liquidation sales values that were below their previous carrying costs.
The $41,000 increase in product costs was caused primarily by an increase in
sales of titles containing additional CD's compared to the prior year period,
along with the additional costs associated with the new requirement by certain
mass-merchant retailers to have security sensor tags included in software
packages. These increases in product costs were partially offset by a product
cost decrease related to a reduction in sales of higher costing inventory
liquidation titles during the current six-month period compared to the prior
year's period.
The $28,000 decrease in freight costs was due to the decrease in direct-to-store
EDI product shipments to computer software and office superstores, in addition
to an increase in cost effective product shipments to a concentrated group of
retailers' and distributors' locations.
Gross Profit Margin
- -------------------
Our gross profit margin for the six months ended December 31, 2003 increased to
59.0% of net sales from 57.4% of net sales for the six months ended December 31,
2002. The 1.6% increase in gross profit margin was traceable to cost decreases,
as a percentage of net sales, of:
o 1.1% in product costs;
o 1.0% in freight costs;
o 0.9% in other cost of sales; and
o 0.8% in royalty costs.
These cost of sales decreases, as a percentage of net sales, were partially
offset by a cost of sales increase, as a percentage of net sales, of 2.2% in the
provision for inventory obsolescence.
The reasons for the percentage of net sales increases and decreases in these
cost categories are discussed under "Cost of Sales," above.
Operating Expenses
- ------------------
Product development expenses for the six months ended December 31, 2003 were
$267,000 compared to $205,000 for the six months ended December 31, 2002, an
increase of $62,000 or 30%. This $62,000 increase was caused primarily by
increased costs in outside services to upgrade our website and obtain industry
ratings for our software products, in addition to an increase in salary and
related costs.
Selling, general and administrative expenses for the six months ended December
31, 2003 were $1,192,000 compared to $1,294,000 for the six months ended
December 31, 2002, a decrease of $102,000 or 8%. As a result of various cost
saving initiatives, we have continued to achieve cost savings across various
categories. The primary cost reductions were:
o $62,000 in professional services and outside labor costs;
o $43,000 in bad debt expense;
o $37,000 in stock-based compensation expense related to the valuation of
stock options and warrants; and
o $23,000 in salary and related costs.
These cost decreases were partially offset by cost increases of:
o $55,000 in public relations costs related to a new product launch; and
o $8,000 in other various operating expenses.
The $62,000 decrease in professional services and outside labor costs resulted
from non-recurring legal and accounting costs incurred in the prior year's
six-month period, in addition to decreased consulting costs relating to our EDI
system along with reduced administrative support.
The $43,000 decrease in bad debt expense was traceable to the continued
improvement in the collectibility of our accounts receivable balances, compared
to the same period last year.
The $55,000 increase in public relations costs resulted from costs associated
with the launching of a new software title, RealAge Games & Skills, which
occurred during the six months ended December 31, 2003.
Interest Expense, Net
- ---------------------
Net interest expense for the six months ended December 31, 2003 was $4,000
compared to $30,000 for the six months ended December 31, 2002. This $26,000
decrease in net interest expense was due to the elimination of our previous bank
debt, combined with interest income earned on our higher average cash balance
during the first six months of fiscal 2004.
Provision for Income Taxes
- --------------------------
During the six months ended December 31, 2003, our provision for income taxes
was $45,000 compared to no provision for the six months ended December 31, 2002.
The current period's provision related to the estimated taxable income from
various states net of available state operating loss carry-forwards, and no
estimated taxable income calculated for federal income tax purposes because of
remaining federal net operating loss carry-forwards ("NOL's"), which were
sufficient to offset estimated taxable income for federal income tax purposes
for the six months ended December 31, 2003.
Net Income
- ----------
As a result of the factors discussed above, our net income for the six months
ended December 31, 2003 was $950,000 compared to $655,000 for the six months
ended December 31, 2002, an increase in net income of $295,000, or 45%.
Weighted Average Common Shares
- ------------------------------
The weighted average common shares outstanding on a diluted basis increased by
256,743 for the six months ended December 31, 2003 to 10,674,182 from 10,417,439
for the six months ended December 31, 2002. The current period's increase in the
diluted basis calculation of weighted average common shares resulted from
including additional common share equivalents, compared to the prior year's six
month period, due to more common share equivalents being "in the money" or
having an exercise price less than the average market price of our common shares
during the six months ended December 31, 2003.
Liquidity and Capital Resources
At December 31, 2003, we had $2,685,000 in working capital and $2,721,000 in
stockholders' equity, compared to $1,727,000 in working capital and $1,746,000
in stockholders' equity at June 30, 2003.
At December 31, 2003, we had $1,787,000 in cash compared to $1,024,000 at June
30, 2003. This $763,000 increase in cash resulted from $789,000 in net cash
provided by operating activities, which was partially offset by 26,000 in net
cash used in investing activities.
For the six months ended December 31, 2003 and 2002, net cash provided by
operating activities was $789,000 and $401,000, respectively. The $789,000 in
net cash provided by operating activities during the six months ended December
31, 2003 resulted primarily from the $950,000 in net income earned during this
period. Additional sources of cash provided by operations were from increases
of:
o $1,154,000 in provision for product returns, price markdowns, bad debts
and inventory obsolescence;
o $182,000 in accounts payable;
o $25,000 in stock-based compensation; and
o $9,000 in depreciation and amortization.
Partially offsetting these cash sources were cash uses incurred from:
o $990,000 in increased accounts receivable;
o $362,000 in increased inventory;
o $98,000 in increased prepaid and other expenses; and
o $81,000 in decreased accrued expenses.
For the six months ended December 31, 2003 and 2002, net cash used in investing
activities was $26,000 and $4,000 respectively. The $26,000 in net cash used in
investing activities during the six months ended December 31, 2003 related to
hardware and software upgrades to our computer network. For the remainder of
fiscal 2004, we anticipate investing activities to continue relating to these
types of expenditures.
For the six months ended December 31, 2003, we had no financing activities
compared to the six months ended December 31, 2002 when we had net cash used in
financing activities of $454,000.
In September 2003, we entered into a $500,000 credit facility agreement with
Hudson United Bank ("HUB"), which matures on December 1, 2004. Amounts
outstanding under this new credit facility will be charged interest at one-half
of one percent above HUB's current prime rate and such interest is due monthly.
Our access to these funds is limited to the lesser of $500,000 or seventy-five
percent of qualified accounts receivable, which are defined as invoices less
than ninety days old and net of any allowances for product returns, price
markdowns or bad debts. The new credit facility is secured by all of the
Company's assets and requires us, among other things, to maintain the following
financial covenants to be tested quarterly: a total liabilities to tangible net
worth ratio of 1.25 to 1.00 and a tangible net worth requirement of $1.5
million. As of February 12, 2004, we were in compliance with each of those
covenants. This new credit facility was established to provide working capital
for our operations. As of February 12, 2004, we had not utilized any of this new
credit facility, although we were eligible to draw up to $500,000 under this
credit facility, based upon qualified accounts receivable as of that date.
Contractual Obligations and Commitments
- ---------------------------------------
Our 5,000 square foot office facility located in Langhorne, Pennsylvania is
occupied under an operating lease that is scheduled to expire on September 30,
2007. Additionally, we currently rent certain office equipment through various
operating lease agreements. Net rent expense incurred under our operating leases
was $42,000 and $38,000 for the six months ended December 31, 2003 and 2002,
respectively.
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
$465,000 and $456,000 for the six months ended December 31, 2003 and 2002,
respectively. Additionally, most of these licensing agreements require us to
make advance royalty payments to these developers prior to the time we recognize
any net sales of software titles containing this licensed software content. We
have commitments to pay $155,000 in advance royalty payments to various software
developers under such agreements. Included in this $155,000 is our remaining
obligation to pay Greenstreet Software Limited an advance royalty of $40,000 for
the licensing of one of its PC software titles by August 2004.
In conjunction with the launching of a new software title, RealAge Games &
Skills, we have an existing contract for the license of a trademark that
required us to make the second of two $50,000 advance royalty payments by May
2004, regardless of actual royalties earned. During February 2004, we satisfied
this obligation with a discounted payment of $45,000. The first $50,000 advance
royalty payment was made to this licensor during fiscal 2003 upon signing the
contract, and the remaining un-expensed portion of this first payment is
classified on our December 31, 2003 balance sheet within "Prepaid and other
expenses".
These guaranteed royalty and licensing commitments are expected to be funded by
cash flows generated through anticipated income from operations.
The following table represents a summary of our off-balance sheet contractual
obligations and commitments.
Payments Due by Period
--------------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year years years 5 years
- --------------------------------------------------------------------------------------
Operating leases $ 231,000 $ 62,000 $ 119,000 $ 50,000 $ - 0 -
Advance royalties 155,000 143,000 12,000 - 0 - - 0 -
Trademark license 45,000 45,000 - 0 - - 0 - - 0 -
- --------------------------------------------------------------------------------------
Total $ 431,000 $ 250,000 $ 131,000 $ 50,000 $ - 0 -
========= ========= ========= ======== =========
Liquidity Risk
- --------------
From the first quarter of fiscal 2002 until September 2003, when we entered into
our new credit facility agreement, we did not have access to a credit facility
and had been dependent entirely on cash flow from operations to meet our
financial obligations. Our ability to achieve and maintain positive cash flow
remains essential to our survival as a going concern because our access to this
credit facility is limited to the lesser of $500,000 or 75% of our qualified
accounts receivable. Our ability to do this depends upon a variety of factors,
including the timing of the collection of outstanding accounts receivable, the
creditworthiness of our primary distributors and retailers, sell-through of our
products to consumers, and the costs of developing, producing and marketing such
products.
There are significant challenges that we will need to successfully manage in
order to be able to fund our operations in the future. These challenges include,
but are not limited to: agreeing to and maintaining acceptable payment terms
with our vendors; and maintaining timely receivable payments from our
concentrated group of customers. For example, our liquidity would be severely
impacted if Atari, and to a lesser extent EB Carlson, Take Two Interactive, Jack
of All Games, or CompUSA, did not make payments on a timely basis, or if other
business conditions caused them to fail to pay us. Additionally, our accounts
payable have historically increased substantially during our first and second
fiscal quarters (third and fourth calendar quarters) when we increase the amount
of inventory we purchase to meet anticipated customer orders for the back to
school and holiday selling seasons. If we are not paid timely by our
distribution or retail customers during the period following this seasonal
increase in inventory purchases, we may have difficulty paying our vendors in a
timely manner, which would then significantly impact our ability to continue
normal operations.
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
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. As a result of these factors, we may not be able to
maintain positive cash flow. Additional 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 stockholder 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 No. 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
adopted the disclosure provisions of this statement effective January 1, 2003
(see Note 10).
In March 2003, the Emerging Issues Task Force published Issue No. 00-21
"Accounting for Revenue Arrangements with Multiple Deliverables" (EITF 00-21).
EITF 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it performs multiple revenue generating activities and
how to determine whether such an arrangement involving multiple deliverables
contains more than one unit of accounting for purposes of revenue recognition.
The guidance in this Issue is effective for revenue arrangements entered in
fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 on July
1, 2003 did not have any impact on our financial statements.
Listing of Our Common Stock
Our common stock trades on the OTC Bulletin Board under the symbol EGAM. We
periodically review our alternatives with respect to listing on an exchange or
dealer quotation system, such as the American Stock Exchange or the Nasdaq
SmallCap Market. At this time we do not meet all of the criteria for listing on
these markets. We will, therefore, from time to time continue to evaluate our
available alternatives to the OTC Bulletin Board.
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 our future performance.
During our recent history, we have experienced significant volatility in our
financial results, making it difficult to evaluate our future financial
prospects. Although during fiscal 2003 and 2002, we were able to earn net income
of $1,592,000 and $2,181,000, respectively, those results were preceded with our
$5,933,000 loss in fiscal 2001. Prior to those periods, our earnings had
continued to decline for three years in a row when we earned $1,253,000,
$463,000 and $253,000 in fiscal 1998, 1999 and 2000 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 have access only to a $500,000 credit facility with
Hudson United Bank ("HUB") that is subject to borrowing restrictions based on
the value of our accounts receivable.
Our accumulated deficit at June 30, 2003 was $8,176,000. Even though we achieved
profitability in fiscal 2002 and 2003, given current economic conditions in the
United States in general, we cannot predict whether we will continue to be
profitable in fiscal 2004 and beyond. Our operations today continue to be
subject to all of the risks inherent in the operation of a small business, which
has suffered liquidity problems in a highly competitive industry dominated by
larger and financially stronger competitors. These risks include difficulties
obtaining quality content for our products, distributing and marketing our
products on terms that are profitable and commercially reasonable to us,
competition from other products in the genres and at the price points that we
sell our products, and unanticipated costs and expenses associated with product
development, distribution, or marketing. 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. In July 2001, we were notified by
our commercial lender at that time, Fleet Bank ("Fleet"), that due to our
violation of the financial covenants under our credit facility and the material
adverse changes in our financial condition, Fleet would no longer continue to
fund its $2,000,000 credit facility with us. In November 2001, we entered into a
forbearance agreement with Fleet to pay off the credit facility's outstanding
balance of $1,400,000 over a twenty-two month period. In January 2003, we repaid
the remaining outstanding balance due to Fleet, in full satisfaction of all
obligations under the forbearance agreement and redeemed from Fleet the warrant
associated with the forbearance agreement.
While we currently have access to a $500,000 credit facility with our current
commercial lender, Hudson United Bank ("HUB"), it is subject to limitations
based on the value of our accounts receivable, and therefore working capital may
not be available to us when we need it. Our ability to continue operations
essentially 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 and our $500,000 credit facility with
HUB. 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, which
makes 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, to access
funds from our credit facility 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. Our products are currently sold at some of the
largest mass-market retailers in the United States - including Wal-Mart, Best
Buy and Target - and the success of our business depends on our continued
ability to sell our products at these and other major retail stores. While we
currently have distribution relationships with some of the major distributors
who sell our products to these retailers, such as Atari and Take-Two
Interactive, if these distributors were unwilling to distribute our products or
were only willing to distribute our products on terms that were commercially
unacceptable to us, our financial condition would be materially harmed. We also
may not be able to distribute our products directly to key retailers on terms
that we consider commercially acceptable. 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 serving these drug store retailers, 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
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 servicing the major mass-merchant retailers in North
America, such as Wal-Mart, Target, and Best Buy, among others. Our net sales to
Atari during the fiscal year ended June 30, 2003 were $4,370,000 and represented
61% of our total net sales. We anticipate that net sales to Atari may represent
greater than 65% of our total net sales during fiscal 2004. Accordingly, we
expect to continue depending upon a limited number of significant distributors
and retailers, and in particular Atari, for the foreseeable future.
Our current retailers and distributors, including Atari, may terminate their
relationship with us at any time. If we lose our distribution capability through
Atari or any of our other large distributors or retailers, this 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. If any significant retailer or distributor of our
products became insolvent or went out of business, this 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. If any of our major
distributors or retail customers failed to pay an outstanding receivable, this
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 revenue is
recognized for sales to 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 products that have higher price points
than our typical $9.99 jewel case products, which would negatively impact our
future results of operations.
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 product
life cycles of six to twelve months. 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 retailers or distributors, we could be forced to accept
substantial product returns or be required to issue 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 would
adversely impact our business, operating results and financial condition.
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 the seasonality of computer entertainment PC software purchases;
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 tending to be
higher during the third and fourth calendar quarters (our first and second
fiscal quarters). This is due to increased demand for PC software games during
the back-to-school and holiday selling seasons. 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. Our
ability to maintain adequate liquidity to satisfy critical software developers
with required advance royalty payments and paying our manufacturing vendors
within acceptable timeframes are critical to avoiding any delays in having
product available for sale throughout the year, but especially during seasonal
peaks in demand. If we miss product deliveries during these key selling periods,
or if our products are not ready for shipment to meet these critical selling
periods, 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
back-to-school or holiday selling seasons, our financial results for the entire
fiscal year would be adversely affected.
The consumer entertainment PC 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 finite 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 we do to negotiate more and
better-positioned shelf space than we do. 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 operating
results and financial condition would be negatively impacted.
Increased competition for 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, this would have a negative impact on our financial
results.
Our present or future competitors may develop products that are comparable or
superior to ours. Our competitors may offer higher quality products, lower
priced products or adapt more quickly than we do 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 has continued to intensify as our industry has
consolidated, since we have remained a small software publisher and some of our
competitors have grown larger. 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 adversely affect our operating results
and financial condition.
We are vulnerable to periodic technological changes that could make our products
less marketable over time. Periodic introductions of new products and
enhancements, technological developments, evolving industry standards and
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 we do, or if they introduce
better products than ours, then our business could be adversely affected. 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. Additionally, over time 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 allowance, and the related 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
resumed trading on the OTC Bulletin Board, when we became current with our 1934
Act filings.
If we do not remain current with our 1934 Act filings, we would not be able to
maintain the trading of our stock on the OTC Bulletin Board. Even if we are
successful in maintaining trading of our stock on the OTC Bulletin Board, 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 can make it difficult
to sell our stock. If our stock is not eligible to be traded on the OTC Bulletin
Board, 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.
Regulation of our product content and features could affect the marketability of
our products. 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 for our product content,
trademarks and trade names and other marketing 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 top-selling 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 and on the overall value of our company.
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. A
significant amount of unauthorized copying of our products would adversely
affect our business, operating results and financial condition.
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 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
initiation 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 can be 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 years ended
June 30, 2003 and 2002. We anticipate that in fiscal 2004 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 licensees, the business failure
of any one of these licensees, and the resulting inability for us to collect
outstanding licensing receivables, could have a material adverse effect on our
financial condition.
Item 3. Controls and Procedures
(a) Disclosure Controls and Procedures. Under the supervision and with the
participation of our Chief Executive Officer and Chief Financial Officer, we
carried out an evaluation of the effectiveness of our disclosure controls and
procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as of December 31, 2003 (the "Evaluation
Date"). Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer have concluded that as of the Evaluation Date, our disclosure
controls and procedures were effective to provide reasonable assurance that the
information required to be disclosed in our reports filed or furnished under the
Exchange Act are recorded, processed, summarized and reported, within the
periods specified in the SEC's rules and forms. We believe that a controls
system, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the controls system are met, and no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within a company have been detected.
(b) Changes in Internal Control Over Financial Reporting. There have not been
any changes in our internal control over financial reporting during the fiscal
quarter ended December 31, 2003 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on December 4, 2003. At that
meeting, the following matters were acted upon, together with the number of
votes cast for, against or withheld as to such matter:
(i) The election of the following directors:
Votes Cast
----------
For Against Abstain
------------------------------------------------------------
Robert M. Aiken, Jr. 9,334,154 - 0 - 109,550
Gerald W. Klein 9,333,254 - 0 - 110,350
Thomas D. Parente 9,333,754 - 0 - 109,850
Lambert C. Thom 9,333,854 - 0 - 14,495
(ii) Ratification of the appointment of Stockton Bates, LLP as the Company's
auditors for the fiscal year ending June 30, 2004:
Votes Cast
----------
For Against Abstain
------------------------------------------------------------
9,393,459 35,650 14,495
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
- ----------- ----------------------
(1) 10.1 Business Loan Agreement dated September 18, 2003 between
eGames, Inc. and Hudson United Bank
(1) 10.2 Promissory Note dated September 18, 2003
(1) 10.3 Commercial Security Agreement dated September 18, 2003 between
eGames, Inc. and Hudson United Bank
31.1 Certification of Gerald W. Klein as President and Chief Executive
Officer of eGames, Inc. pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Thomas W. Murphy as Vice President and Chief
Financial Officer of eGames, Inc. pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Gerald W. Klein as President and Chief Executive
Officer of eGames, Inc. pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Thomas W. Murphy as Vice President and Chief
Financial Officer of eGames, Inc. pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(1) Incorporated herein by reference from the Registrant's Form 8-K as filed
with the Securities and Exchange Commission on September 19, 2003.
(b) Reports on Form 8-K
On October 30, 2003, the Company furnished a report on Form 8-K under Item 12
regarding a press release announcing the Company's financial results for the
three months ended September 30, 2003.
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: February 13, 2004 /s/ Gerald W. Klein
----------------- --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: February 13, 2004 /s/ Thomas W. Murphy
----------------- --------------------
Thomas W. Murphy, Chief Financial
Officer and Chief Accounting Officer
Exhibit 31.1
Certification
-------------
I, Gerald W. Klein, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eGames, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: February 13, 2004
-----------------
/s/ Gerald W. Klein
------------------------------------
Gerald W. Klein
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
Certification
-------------
I, Thomas W. Murphy, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eGames, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: February 13, 2004
-----------------
/s/ Thomas W. Murphy
-----------------------------
Thomas W. Murphy
Chief Financial Officer
(Principal Financial Officer)
Exhibit 32.1
CERTIFICATION PURSUANT TO
-------------------------
18 U.S.C. SECTION 1350,
-----------------------
AS ADOPTED PURSUANT TO
----------------------
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------
In connection with the Quarterly Report of eGames, Inc. (the "Company") on Form
10-QSB for the fiscal quarter ended December 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, based on my knowledge, that:
1. The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Gerald W. Klein
- -------------------------------------
Gerald W. Klein
President and Chief Executive Officer
February 13, 2004
The foregoing certification is being furnished to the Securities and Exchange
Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is
not being filed as part of the Report or as a separate disclosure document.
Exhibit 32.2
CERTIFICATION PURSUANT TO
-------------------------
18 U.S.C. SECTION 1350,
-----------------------
AS ADOPTED PURSUANT TO
----------------------
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------
In connection with the Quarterly Report of eGames, Inc. (the "Company") on Form
10-QSB for the fiscal quarter ended December 31, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), I, Thomas
W. Murphy, Vice President and Chief Financial Officer of the Company, certify,
pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002, based on my knowledge, that:
1. The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Thomas W. Murphy
- -----------------------
Thomas W. Murphy
Chief Financial Officer
February 13, 2004
The foregoing certification is being furnished to the Securities and Exchange
Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is
not being filed as part of the Report or as a separate disclosure document.