Entertainment Games, Inc. – ‘10KSB’ for 6/30/99

On:  Tuesday, 9/28/99   ·   For:  6/30/99   ·   Accession #:  948703-99-9   ·   File #:  0-27102

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Annual Report — Small Business   —   Form 10-KSB
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10KSB       10 Ksb Fiscal Year 1999                               49    287K 
 2: EX-10.19    Employee Incentive Compensation Plan                   1      8K 
 3: EX-21.1     Subsidiaries                                           1      3K 
 4: EX-23.1     Consent of Independent Auditors                        1      6K 
 5: EX-27     ƒ Art. 5 FDS for 10-Ksb                                  1      7K 

10KSB   —   10 Ksb Fiscal Year 1999
Document Table of Contents

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 FORM 10-KSB

(Mark one)                                                              
|X|          ANNUAL  REPORT  PURSUANT TO SECTION 13 OR 15(d)            
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended June 30, 1999

|_|          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 Identification Number)  
incorporation or organization)                                              

2000 Cabot Boulevard, Suite 110, Langhorne, PA               19047-1833   
(Address of principal executive offices)                  (Zip code)

 Registrant's telephone number, including area code 215-750-6606

Securities registered pursuant to Section 12(b) of the Act:  None               
Securities registered pursuant to Section 12(g) of the Act:                     

  Title of each class            Name of each exchange on which registered
  -------------------            -----------------------------------------
Common Stock, No Par Value                         NASDAQ                   

Indicate by check mark 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 ( )                               

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure  will be contained,  to
the  best  of  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB. (X)                                              

State issuer's revenues for its most recent fiscal year:  $10,022,000           

State the aggregate market value of the voting and non-voting common equity held
by non-affiliates  computed by reference to the price at which the common equity
was sold,  or the average bid and asked  price of such  common  equity,  as of a
specified date within the past 60 days: $20,250,000 as of September 14, 1999.   

ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:

Check  whether the issuer has filed all  documents  and  reports  required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the  distribution  of
securities under a plan confirmed by a court. Yes ( ) No ( )                    

APPLICABLE ONLY TO CORPORATE REGISTRANTS

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:  9,661,490 shares of Common Stock, no
par  value per  share,  as of  August  31,  1999.  Transitional  Small  Business
Disclosure  Format  (check  one):  Yes ( ) No ( X )  DOCUMENTS  INCORPORATED  BY
REFERENCE  Portions of  Registrant's  definitive  proxy  statement  for its 1999
Annual Meeting of  Stockholders  are  incorporated by reference into Part III as
set forth  herein.  With the  exception of those  portions,  which are expressly
incorporated  by reference,  said proxy  statement is not deemed filed as a part
hereof.                                                                         

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eGames, Inc.

 Form 10-KSB
 For the Fiscal Year Ended June 30, 1999

 INDEX

                                                                            Page
                                                                            ----
PART I

Item  1. Business........................................................     3 

Item  2. Properties......................................................    16 

Item  3. Legal Proceedings...............................................    16 

Item  4. Submission of Matters to a Vote of Security Holders.............    16 

 PART II

Item  5. Market for the Registrant's Common Stock and Related                   
        Stockholder Matters.............................................    17

Item  6. Management's Discussion and Analysis of Results of Operations          
        and Financial Condition.........................................    17

Item  7. Financial Statements ...........................................    23 

Item  8. Changes in and Disagreements with Accountants on Accounting            
        and Financial Disclosure........................................    42

PART III

Item  9. Directors and Executive Officers of the Registrant..............    43 

Item 10. Executive Compensation..........................................    43 

Item 11. Security Ownership of Certain Beneficial Owners and Management..    43 

Item 12. Certain Relationships and Related Transactions..................    43 

 PART IV

Item 13. Exhibits, List and Reports on Form 8-K..........................    44 

Index of Exhibits........................................................    44 
Signatures...............................................................    47 

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PART I

This annual report on Form 10-KSB contains forward-looking  statements regarding
future events or the future  financial  performance  of the Company that involve
certain risks and  uncertainties.  Actual events or the actual future results of
the  Company  may  differ   materially   from  the  results   discussed  in  the
forward-looking  statements due to various factors,  including,  but not limited
to, those discussed in "Factors Affecting Future  Performance" below at pages 10
to 16.                                                                          

Item 1.     Business                                                            

GENERAL                                                                         

eGames,   Inc.,  formerly  RomTech,   Inc.,  (the  "Company"),   a  Pennsylvania
corporation   incorporated  in  July  1992,  publishes,   markets  and  sells  a
diversified  line  of  personal   computer   software   primarily  for  consumer
entertainment.  The Company also offers personal productivity products for sale,
but the Company  anticipates  minimal future  investment in that category of the
market  and  expects  sales  from  these  products  to be less  than  15% of the
Company's net sales in the  foreseeable  future.  In October  1995,  the Company
completed its initial public offering coincident with its acquisition of Applied
Optical Media  Corporation  ("AOMC"),  a developer of educational  and reference
software   titles.   In  April  1996,  the  Company   acquired  Virtual  Reality
Laboratories, Inc. ("VRLI"), a software developer of landscape generation, space
exploration,  and business  forms  manipulation  programs.  In August 1998,  the
Company acquired Software Partners  Publishing and Distribution Ltd.  ("Software
Partners"), a United Kingdom-based distributor of personal computer software for
consumer  entertainment and small office/home office applications.  On March 31,
1999 Software Partners changed its name to eGames Europe Ltd. ("eGames Europe").
As a result of these  acquisitions,  together  with the  Company's  own internal
development  efforts,  the  Company  offers  primarily  consumer   entertainment
software titles and to a lesser extent certain personal productivity titles. The
Company's  product  line  enables it to serve  customers  who are  seeking  high
quality, familiar, easy-to-play value-priced entertainment software.            

The  Company  believes  that  today's  consumers  base their  software  purchase
decisions on the same criteria as other consumer product  purchases,  relying on
recognized  brands for  consistent  quality,  value and ease of use. The Company
promotes  its  proprietary  brand  names,  including  eGames(TM),   Game  Master
Series(TM),  Multi-Pack and Galaxy of Home Office Help(TM) (the "eGames Series")
in  order  to  generate  customer   loyalty,   encourage  repeat  purchases  and
differentiate the eGames Series products to retailers and consumers. The Company
targets the growing  market of home  personal  computer  ("PC")  users who value
fully-featured,  value-priced and easy-to-use entertainment software. All eGames
Series  titles  are  "Family  Friendly",   which  means  they  are  easy-to-use,
non-violent, and appeal to all ages. The Company's software packaging is labeled
with the distinctive Family  Friendly(TM) logo to help attract consumers towards
its software.  The Company's  eGames Series,  Game Master Series,  and Galaxy of
Home Office Help products  generally sell at retail for under $15, a price point
which  is  intended  to  generate  impulse  purchases  in mass  market  shopping
environments.  The  Company's  Game  Master  Series  titles  are boxed  software
products that  generally  sell at retail for $14.99,  yet feature  packaging and
content  usually found in software  titles  selling for more than $20 at retail.
The  balance of the eGames  software  titles,  including  its Galaxy of Games(R)
collections,  are typically  sold in jewel case packaging and sell at retail for
$9.99 or are occasionally sold in special value boxes at $12.99.  The Company is
in the process of launching its Multi-Pack  software titles,  which are intended
to be sold in special retail point-of-sale packages at $4.99.                   

Industry Background                                                             

According to a recent Arbitron  NewMedia  Pathfinder  Study,  the number of U.S.
households  with PCs  nearly  doubled  to 54  percent in 1999 from 29 percent in
1995.  The  worldwide  consumer  entertainment  software  market is estimated to
exceed $6 billion in revenues  in 1999 versus $5.5 and $4.1  billion in 1998 and
1997, respectively.  This dramatic growth in recent years has been driven by the
increasing  number of  multimedia  PCs in the home and  office,  the  increasing
number of game  console  devices  in the home,  the  proliferation  of  software
titles,  and  the  development  of  new  and  expanding  distribution  channels.
Declining  prices of  microprocessors  and  CD-ROM  drives  have  made  high-end
interactive  computer  entertainment  more affordable,  resulting in low-end PCs
targeted to the mass consumer market costing under $500.                        

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The  worldwide  consumer  entertainment  software  industry  has  also  recently
undergone a number of profound  changes  with the  introduction  of new hardware
platforms and new technologies,  such as on-line networks and the Internet.  The
proliferation of on-line networks and the Internet has created new opportunities
for the consumer entertainment software industry, including on-line game playing
by  users in  different  locations  and  direct  on-line  marketing,  sales  and
distribution to end users.                                                      

Growth in the  installed  base of  multimedia  PCs has created a mass market for
consumer  entertainment  software products. The development of a mass market for
consumer  entertainment  software products has been characterized by the growing
importance of mass merchant software sales as a distribution channel, increasing
price  pressure  and  competition   for  retail  shelf  space.   This  increased
competition has emphasized the importance of marketing,  merchandising and brand
name recognition. Faced with the challenges of marketing and distribution,  many
independent software developers and content providers are pursuing relationships
with  publishing  companies with broader  distribution  capabilities,  including
better access to mass market retailers and greater merchandising,  marketing and
promotional  support.  At the same time,  retailers with limited shelf space are
faced with the  challenge  of managing  an  increasing  number of new titles.  A
significant  result of these market  pressures is a trend in the industry toward
the consolidation of entertainment software companies and the diversification of
products offered by such companies.                                             

BUSINESS STRATEGY                                                               

The  Company  believes  that its  success in the  industry  will be  achieved by
executing a business plan that focuses on: gaining brand name recognition of its
Family  Friendly  brand  products;  developing  new  top-selling  titles  within
existing brands;  developing new brands;  establishing  strong  distribution and
retail  relationships;   consistently   offering  a  diversified   high-quality,
high-value software portfolio of products that provide significant  sell-through
and   return-on-investment   opportunities  for  all  types  of  retailers;  and
implementing a sound Internet  strategy and comprehensive web site. The intended
result  of the  Company's  business  strategy  is to be a leading  publisher  of
high-quality,  value-priced  consumer  entertainment  software  in the  consumer
entertainment  category of the market. To implement its business  strategy,  the
Company intends to utilize the following tactics.                               

Rely On Consumer  Research and Marketplace  Data. The Company utilizes  consumer
research and  marketplace  sales data to determine  which products are achieving
favorable sales results in the consumer  entertainment  software categories that
the Company serves. The Company then focuses on developing  top-selling products
that have a  sustainable  product life and also appeal to the broadest age group
of consumers  regardless of gender. This involves either developing or obtaining
rights to  products  that the Company  expects  will meet these  criteria  while
complementing and supporting the Company's branding strategy.                   

Deliver Products To Market Quickly To Maximize Sales Opportunities.  The Company
believes  that one of its  significant  competitive  strengths,  primarily  as a
result of market  research,  is its ability to identify  products that consumers
are buying and which they will  continue  to buy.  The  Company  leverages  this
competitive strength by quickly developing or procuring product content that the
Company  believes will achieve  favorable sales results in its category when the
product is combined with the Company's  attractive,  distinctive and informative
packaging that is designed to encourage impulse purchases in retail stores.  The
Company's development efforts focus primarily on product design,  consistent and
user friendly  interfaces,  ease of use,  product quality and  consistency.  The
Company's internal product development  activities are supplemented by utilizing
existing  technologies  and externally  developed  programming and content.  The
Company maintains control over the creative and market-driven aspects of product
development while utilizing  outside  resources to reduce  development costs and
minimize risks.                                                                 

Develop  Products That Are Easy To Use.  Based on  information  from  registered
users  of the  Company's  products,  most  of the  Company's  customers  are new
computer owners. Therefore, the Company's products are designed to be simple and
easy to install and use, requiring little or no technical expertise. The Company
provides  technical  support  for all of its  products  and  revises or upgrades
products in response to consumer feedback gained from customer's registration of
products they have purchased.                                                   

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Develop  Efficient  Distribution  Channels and Expand Internet  Strategies.  The
Company  has  historically  used large and  well-established  merchandising  and
distribution   organizations  to  distribute  its  products  to  North  American
retailers.  The Company is in the  process of  implementing  a new  distribution
strategy,  which  focuses on  increasing  domestic  and  international  sales to
retailers  on both a direct  basis as well as through a network  of  independent
distributors,  and increasing  sales through the Internet,  cable television and
alternative  retail markets such as  supermarkets,  drug stores and  convenience
stores.  The Company believes the Internet has created new opportunities for the
consumer   entertainment   software  industry  to  better  serve  its  customers
including:  strengthening  existing  customer  relationships;  effecting  direct
marketing,  promotion  and  distribution  activities to broaden its reach to new
customers;  adding value to existing  products;  and developing new products and
markets.  The  Company  has taken  steps to  capitalize  on these  opportunities
including:  the  continuous  improvement  and expansion of its site on the World
Wide Web; the  development  of its  Internet  infrastructure  and  capabilities,
including  electronic  distribution   capabilities,   incorporation  of  on-line
functionality   into   existing   products,   continued   development   of   new
Internet-based  partnerships and products;  and infusing  web-based  advertising
opportunities into the Company's  entertainment  software products.  In order to
reduce the  resources  required  for  effective  distribution,  the  Company has
incorporated Internet capabilities into its products,  which permit customers or
prospective  customers to review or  demonstrate  the Company's  products at its
website, (www.egames.com), before purchasing them.                              

Market  Brand Names That Deliver  Consistent  Quality.  The Company  focuses its
marketing resources on developing brands that represent consistency, quality and
value to the consumer. The Company believes that to the consumer, brands offer a
safe and  secure  choice  in an  otherwise  confusing,  fast-changing  and often
intimidating  software  marketplace.  Consumers view  successful  brand logos as
friendly marks of quality  assurance.  Once a consumer  becomes highly satisfied
with a brand in any  given  product  category,  the  Company  believes  that the
consumer will  typically  tend to actively seek out that brand versus  competing
brands.  The Company  believes that  successful  brands can lead to consistently
successful sell-through results, which is one of the Company's long-term goals. 

Maintain Profitable Operations.  During its first two years as a public company,
the Company did not achieve profitability. During the second half of fiscal 1997
the Company  undertook  changes in its operations and business strategy to focus
on the value-priced  segment of the consumer  software market while  structuring
the Company to be  profitable in fiscal 1998.  During  fiscal 1999,  the Company
further focused its business  strategy to concentrate on consumer  entertainment
software  products  (specifically  PC games).  The  value-priced  segment of the
consumer  entertainment  software  market  continues  to be the largest and most
rapidly  growing  category of the consumer  entertainment  software  market,  as
reflected in the monthly  reports by the reporting  firm PC Data.  This trend is
expected to continue for the foreseeable future as consumers demand lower prices
for  software.  In order to achieve  and  maintain  profitable  operations,  the
Company has created a business  model that  focuses on:  delivering  top selling
branded  titles  with  predictable,  controllable  development  costs and risks;
outsourcing production and warehousing while achieving high quality products and
packaging,  low costs, timely and efficient  deliveries and predictable overhead
costs  during  periods of  rapidly  increasing  sales  volume;  and  controlling
operating expenses.                                                             

MARKETING                                                                       

The Company's  marketing  efforts  include:  developing its World Wide Web site,
(www.egames.com), promoting specific Company titles; engaging a public relations
firm for announcements and disclosures;  advertising in trade journals and other
publications;   coordinating   in-store   and  industry   promotions   including
merchandising  and point of  purchase  displays;  participating  in  cooperative
advertising  programs  with  specific  retailers;  and  utilizing  demonstration
software distributed through the Internet or on compact discs. In addition,  the
Company's  products  contain  software that enables  customers to register their
purchases via  electronic  mail,  while at the same time  providing a variety of
additional market research data.                                                

The  Company's  marketing  department  is  responsible  for  creating  marketing
programs to generate  product  sell-in  (sales to  retailers)  and  sell-through
(sales to end user customers). These programs generally are based on established
consumer  product  marketing  techniques that the Company  believes are becoming
more important as software becomes more of a consumer product.  The Company uses
consumer product graphic  designers and copywriters to create effective  package
designs,  catalogs,   brochures,   advertisements  and  related  materials.  The
Company's marketing and sales personnel and outside contractors work together to
coordinate  retail and  publicity  programs so that those  programs are in place
when products are initially shipped to retailers and consumers.  Public relation
campaigns,  in-store  advertising,   catalog  mailings  and  advertisements  are
designed in advance of product availability.                                    

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SALES AND DISTRIBUTION                                                          

North American Sales and Distribution. The Company has determined that there are
a number of  strategic  advantages  to selling its products on a direct basis to
major  computer and software  retailing  organizations,  mass market  retailers,
consumer  electronic  stores,  discount  warehouses  and mail  order  companies.
Management of the Company believes that direct sales  relationships  with retail
accounts would result in more effective inventory management,  merchandising and
communications  than are possible through indirect sales  relationships.  Direct
sales to  retailers  also  diminish  the  Company's  dependence  on  third-party
distributors  for sales of the  Company's  products and  increases the potential
gross  profit  margin  that  can be  realized  on  the  sale  of  its  products.
Accordingly, the Company has established direct sales relationships with several
traditional  national software retailers such as Electronics  Boutique,  CompUSA
and Toys-R-Us,  as well as  non-traditional  software retailers such as Rite Aid
Corporation.                                                                    

The  Company has  entered  into  relationships  with third  party  suppliers  of
electronic  data  interchange  ("EDI")  services to establish  linkages with its
direct sales  retailers,  which in turn  facilitates the placement,  control and
shipment of orders and the processing of payments and credits. The Company seeks
to continue to increase the number of retail outlets served directly through its
internal  sales  force.  However,  to a larger  extent,  the  Company  sells its
products  through  wholesale  distributors,  such as GT Value Products,  Navarre
Corporation,  Merisel  Americas,  Inc.,  SVG  Distribution,  Inc. and  Beamscope
Canada.  GT  Value  Products  accounted  for  approximately  65%  and 81% of the
Company's net sales during fiscal 1999 and 1998, respectively.  From May 1997 to
April 1999 GT Value  Products was the  exclusive  distributor  of the  Company's
products in North America.  In April 1999, the Company  terminated its exclusive
distribution   relationship   with  GT  Value   Products   and  entered  into  a
non-exclusive   distribution   relationship   with  them.  (See  "Dependence  on
Distributors  and Retailers",  page 10).  Internet sales  currently  account for
approximately 1% of the Company's sales.                                        

International  Sales and  Distribution.  The Company  currently  distributes its
products  in  Argentina,  Australia,  Belgium,  Brazil,  the  Caribbean,  Chile,
Colombia,  Denmark,  Finland,  France, Germany,  India, Ireland,  Israel, Italy,
Mexico, the Middle East, the Netherlands,  New Zealand, Panama, the Philippines,
Portugal, Saudi Arabia,  Singapore,  South Africa, Spain and the United Kingdom.
The Company seeks to maximize its worldwide sales and earnings by releasing high
quality  localized  foreign  language  titles,  whenever  practicable,   and  by
continuing to expand the number of direct selling and distribution relationships
it maintains  with key  retailers and  distributors  in major  territories.  The
Company  currently  publishes  localized  products in French,  German,  Italian,
Spanish and Portuguese,  and the Company offers localized  product packaging for
all of these languages as well as in Hebrew and Brazilian Portuguese.           

Distribution  Procedures.  The Company's product line focuses on branded content
for  the  value-priced  category  of  the  consumer   entertainment  market.  By
maintaining a branded  product  category  focus,  the Company  believes that its
advertising,  promotion,  merchandising  and packaging  expenditures  will build
long-term benefits for all the products in each category.                       

The Company's  internal sales staff calls on retail accounts  directly and works
with each distributor's sales personnel in order to maximize the sales potential
with retail  accounts.  The Company's  sales staff works closely with the retail
buyers and their  distributors to ensure that  appropriate  Company products are
inventoried for each retail outlet, stocking levels are adequate, promotions and
advertising are coordinated with product availability and in-store merchandising
plans are properly implemented.                                                 

The Company's  agreements with its distributors and retailers provide for rights
to return the Company's  products if the Company's  products do not sell through
at satisfactory  levels to the retailers.  The Company sells to its distributors
and  retailers  on  credit,  with  varying  discounts  and  credit  terms.  (See
"Dependence on Distributors and Retailers",  page 10). The Company also has some
limited exposure to returns by consumers.  Reserves for returns by distributors,
retailers and consumers are established at levels that the Company  believes are
adequate based on product  sell-through,  inventory  levels and historic  return
rates (See Note 1 to Financial  Statements,  "Summary of Significant  Accounting
Policies,  Revenue  Recognition").  However,  there can be no assurance that the
actual returns will not exceed the established  reserves.  The Company typically
accepts  returns  from  customers,  even when not legally  required to do so, in
order to maintain  good  customer  relations  to enhance  repeat  purchasing  by
consumers.                                                                      

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COMPETITION                                                                     

The consumer  entertainment software industry is intensely competitive and is in
the process of substantial  consolidation.  The market for value-priced consumer
entertainment  software  in the  category  in  which  the  Company  competes  is
especially  competitive.  The Company  believes that the  principal  competitive
factors generally include content quality, brand name recognition,  ease of use,
merchandising,  product  features,  quality,  reliability,  on-line  technology,
distribution  channels and price.  Based on its current and  anticipated  future
product  offerings,  the  Company  believes  that it  competes  or will  compete
effectively  in these  areas,  particularly  in price,  brand name  recognition,
quality, ease of use and product features.                                      

The Company competes primarily with other software publishers,  although certain
book  publishers,   magazine  publishers,   entertainment  companies  and  media
companies  may expand their  product  offerings  to compete  with the  Company's
products.  The Company's competitors vary in size from very small companies with
limited resources to very large corporations with greater financial,  marketing,
distribution, technical and other resources than the Company. Although there are
a variety of consumer and business software  publishers,  based on product lines
and price points, Hasbro Interactive,  Mattel Media, Activision, GT Interactive,
Electronic Arts, Humongous (a subsidiary of GT Interactive),  Cosmi,  Microsoft,
and Interplay are the Company's primary competitors. In addition, it is possible
that certain large software  companies,  hardware  companies and media companies
may  increasingly  target  the  value-priced  segment  of  the  software  market
resulting in additional competition.                                            

The Company believes that increasing  competition in the consumer  entertainment
software market may result in lower selling prices, which could adversely affect
the Company's business, operating results and financial condition. To the extent
that competitors achieve  performance,  price or other selling  advantages,  the
Company could be adversely affected.  In addition,  commercial acceptance of new
technologies  such as the Internet may reduce demand for the Company's  existing
products.  Intense price  competition,  reduced demand, or distribution  channel
changes may have a material adverse effect on the Company's business,  financial
condition, liquidity and operating results.                                     

The market is also extremely  competitive  with respect to access to third-party
developers and content providers. The Company may not be successful in competing
for  the  most  sought-after  content  for  its  products  to  the  extent  that
competitors  achieve  better  access  to  distribution  channels,  have  greater
financial resources to pay for development fees or royalties,  or have developed
a  widely-recognized  reputation.  (See "Factors  Affecting Future  Performance,
Rapid Technological Change; Product Development" beginning on page 12.)         

PRODUCT DEVELOPMENT                                                             

The Company seeks to develop a broad line of branded products in rapidly growing
and sustainable  market  categories.  The Company utilizes consumer research and
marketplace sales data (including  reported industry sales,  computer trade show
sales and retail sell-through results) to determine which products are achieving
top ranked sales results in the consumer  entertainment software categories that
the Company  serves.  New product ideas are evaluated based upon market research
in the subject area, the type and demographics of the target  consumer,  and the
existence and characteristics of competitive  products.  The Company then either
develops or procures  products that the Company expects will meet these criteria
while complementing and supporting the Company's branding strategy.  The Company
believes that its development process has certain material advantages over other
software  companies,  including  consistent  product quality,  reliable delivery
schedules and predictable cost estimates. The Company has also acquired products
through the  acquisition  of other  software  companies  or the  acquisition  or
licensing of software  products or technologies and will most likely continue to
acquire products this way in the future.                                        

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The Company's  Director of Product  Development  oversees the  development  of a
product from  conception  through  completion,  and controls the scope,  design,
content and management of the project. The Company seeks to publish new products
that  incorporate  all of the  important  functions  and features of the leading
competitive  products and to add  innovative,  helpful  concepts and upgrades to
achieve a "better than" positioning relative to directly  competitive  products.
Once a product is approved for  development,  a design  specification is created
that  includes the  product's  features,  estimated  development  time and cost,
projected  delivery date and projected  selling price.  Whenever  possible,  the
software is designed to  incorporate  technology  used in the Company's  current
products in an effort to shorten the  development  cycle and improve quality and
consistency.  The overall product,  including  packaging and  documentation,  is
designed  to  comply  with a  manufacturing  specification  that  will  meet the
Company's margin requirements at the intended consumer price points.            

The Director of Product Development executes the project with a development team
that  typically may include  programmers,  designers,  artists and testers.  The
development  team  members  are  usually  employees  of the  Company  but may be
independent  contractors  depending on the scheduling of and skills required for
each project.                                                                   

The Company's internal development efforts focus primarily on product design and
features,  consistent user interfaces, and product quality and consistency.  The
Company  supplements  its internal  product  development  resources by utilizing
existing technologies and externally developed programming and content when such
utilization  results in a more  efficient  method of  creating a higher  quality
product.  Using this method,  the Company  maintains  internal  control over the
creative and market-driven  aspects of product  development while using external
resources to shorten  development  time and lower  development  costs and risks.
Development costs associated with externally  licensed  technology are generally
paid through a nominal one-time  customization fee and royalties based on actual
sales of the  product,  thereby  reducing  the  Company's  investment  risk in a
product.                                                                        

Developed  products are tested for quality  assurance  before being released for
production.  Products are typically tested for bugs, compatibility with numerous
popular PC brands and configurations, typical installation issues, functionality
and  ease-of-use.   Marketing  or  development  employees,   under  a  manager's
supervision,  are  responsible  for  reviewing  customer  feedback,  competitive
products,  product  performance  and market  positioning  in order to  introduce
upgrades that keep abreast of consumer  tastes and trends while  satisfying  the
Company's business strategy.                                                    

DEPENDENCE ON KEY PERSONNEL                                                     

The continued  success of the Company  depends to a significant  extent upon the
continued  performance and contribution of its top management and its ability to
continue to attract, motivate and retain highly qualified employees. The loss of
the  services  of any of the  Company's  top  management  could  have a material
adverse  effect on the  Company's  business,  operating  results  and  financial
condition.  Competition for highly skilled employees with technical, management,
marketing, sales, product development and other specialized training is intense.
Specifically, the Company may experience increased costs in order to attract and
retain skilled employees.  The Company's failure to attract additional qualified
employees  or to retain the  services  of key  personnel  could  materially  and
adversely  affect  the  Company's  business,  operating  results  and  financial
condition.                                                                      

BACKLOG                                                                         

The Company  typically ships its products within one to two days after accepting
a  customer's  order,  which is common in the  consumer  entertainment  software
industry.  Consequently,  the  Company  does not  usually  generate a backlog of
orders that would be a significant or important  indicator of future revenues or
earnings.                                                                       

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CUSTOMER AND TECHNICAL SUPPORT                                                  

Customer  and  technical  support  standards  are  very  high  in  the  consumer
entertainment  software  market.  In order to remain  competitive,  the  Company
provides  telephone  and  Internet  technical  support  to its  customers  at no
additional  charge.  However,  costs  associated  with these  activities are not
significant.  The Company believes that  high-quality,  user-friendly  technical
support  provides  valuable  feedback to the  Company's  marketing  and software
development personnel for use in the product development process.               

OPERATIONS                                                                      

The Company's  accounting,  purchasing,  inventory  control,  scheduling,  order
processing and development activities are conducted at its headquarters location
in  Langhorne,  Pennsylvania.  The Company  maintains  a sales and  distribution
operation in St. Ives, England, which it obtained through its acquisition of its
United Kingdom distributor, Software Partners Distribution Ltd., in August 1998.
Most  product   shipments  to  major  customers  are  performed  by  independent
contractors at their  warehousing  and production  facilities  working under the
Company's direction.  The Company's information  management system handles order
entry,  order  processing,   picking,  billing,  accounts  receivable,  accounts
payable, general ledger, inventory control, and mailing list management. Subject
to credit terms and product availability,  orders are typically shipped from the
Company's  facilities within one to two days after accepting a customer's order.
Third party  contractors  replicate the software and assemble  manuals,  catalog
inserts and boxes in which the Company's  products are shipped.  The Company has
multiple sources for all components of its products, and has not experienced any
material delays in production or assembly.                                      

EMPLOYEES                                                                       

As of June 30, 1999,  the Company had 39 full-time  employees,  of which 12 were
employed in software development;  17 in sales,  marketing and customer support;
and 10 in  operations,  finance and  administration.  In  addition,  the Company
regularly utilizes  approximately 20 independent  contractors in connection with
its product  development  activities.  No  employees  are  represented  by labor
unions, and the Company has never experienced a work stoppage.                  

INTELLECTUAL PROPERTY RIGHTS                                                    

The Company  relies  primarily on a combination of trademark,  copyright,  trade
secret  and other  proprietary  rights  laws,  license  agreements,  third-party
nondisclosure  agreements and other methods to protect its  proprietary  rights.
United  States  copyright  law,  international   conventions  and  international
treaties,  however,  may not provide meaningful  protection against unauthorized
duplication or infringement  of the Company's  software.  The Company  generally
sells its published software under licenses from independent  developers and, in
such cases, does not acquire the copyrights for the underlying content.         

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 such
as South  America,  the Middle  East,  the  Pacific  Rim and the Far East.  If a
significant  amount of  unauthorized  copying of the Company's  products were to
occur, the Company's  business,  operating results and financial condition could
be adversely affected.                                                          

Software developers and publishers are subject to infringement claims, and there
has been substantial  litigation in the industry regarding copyright,  trademark
and other intellectual  property rights. If any such claims or litigation,  with
or without merit, were brought against the Company,  such claims could be costly
and result in a diversion of management's attention, which could have a material
adverse  effect on the  Company's  business,  operating  results  and  financial
condition.  Adverse  determinations  with  respect to such claims or  litigation
would  have a  material  adverse  effect on the  Company's  business,  operating
results and financial  condition.  As of the date of filing this  document,  the
Company is not subject to such a claim.                                         

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FACTORS AFFECTING FUTURE PERFORMANCE                                            

This report  contains  certain  forward-looking  statements  involving risks and
uncertainties  that could cause actual results to differ  materially  from those
anticipated,   including,  but  without  limitation:  economic  and  competitive
conditions  in the  software  business  affecting  the demand for the  Company's
products;  the  Company's  need for  additional  funds;  the ability to hire and
retain key management  personnel to manage anticipated  growth; the development,
market acceptance and timing of new products;  access to distribution  channels;
and the  renewal of licenses  for key  software  products.  Those  factors,  the
factors  discussed below, and the factors  identified on page 22 of Management's
Discussion  and Analysis  should be considered by investors in the Company.  All
forward-looking  statements are  necessarily  speculative and there are numerous
risks and  uncertainties  that could  cause  actual  events or results to differ
materially  from  those  referred  to in such  forward-looking  statements.  The
discussion  below  highlights  some of the more  important  risks  identified by
management,  but should not be assumed to be the only  factors that could affect
future performance.                                                             

Early Stage  Company;  Consumer  Entertainment  Software  Business;  Maintaining
Profitability.  The  Company  commenced  operations  in July 1992.  The  Company
experienced  significant  losses from inception  through the end of fiscal 1997.
Fiscal 1998 was the first year that the Company  earned a profit.  After earning
$463,000 and $1,253,000 in fiscal 1999 and 1998,  respectively,  the accumulated
deficit for the Company at June 30, 1999 was approximately $6,268,000.  Prior to
fiscal 1998, the Company's  operations were funded  primarily  through  proceeds
from the Company's  initial public  offering of Common Stock in October 1995 and
through  the sale in private  offerings  of  preferred  stock and  Common  Stock
warrants in  November  1996 and in January  and April  1997.  Subsequently,  the
Company has funded its activities through income from operations.  The Company's
operations  today  are  still  subject  to  all  of the  risks  inherent  in the
development  of  a  recently  profitable  business,  particularly  in  a  highly
competitive industry,  including, but not limited to, development,  distribution
and marketing  difficulties,  competition and unanticipated  costs and expenses.
The Company's  future success will depend upon its ability to increase  revenues
from the  development,  marketing  and  distribution  of its  current and future
software products.  The development of multimedia  software products,  which can
combine text, sound,  high quality graphics,  images and video, is difficult and
time consuming, requiring the coordinated participation of various technical and
marketing  personnel  and  outside  developers.   Other  factors  affecting  the
Company's  future  success  include,  but are not limited to, the ability of the
Company  to  overcome  problems  and  delays  in  product  development,   market
acceptance of products and successful  implementation of its sales, distribution
and marketing strategy. There can be no assurance the Company will be successful
in  maintaining  and expanding a  sustainable  consumer  entertainment  software
business.                                                                       

Dependence On Distributors  And Retailers;  Risk Of Customer  Business  Failure;
Product  Returns.  Many of the largest  mass-market  retailers have  established
exclusive  buying  relationships  under which such  retailers  will buy consumer
entertainment  software only from certain distributors.  In such instances,  the
Company will not be able to sell its products to such  mass-market  retailers if
these   distributors  are  unwilling  to  distribute  the  Company's   products.
Additionally,  even if the  distributors  are willing to purchase the  Company's
products, the distributor is frequently able to dictate the price or other terms
on which the Company  sells to such  retailers,  or the Company may be unable to
sell to such retailers on terms that the Company deems acceptable. The inability
of the Company to negotiate commercially viable distribution  relationships with
these and other distributors,  or the loss of, or significant reduction in sales
attributable to, any of the Company's principal  distributors or retailers could
materially  adversely  effect the  Company's  business,  operating  results  and
financial condition.                                                            

Distributors  and  retailers  in the  computer  industry  have from time to time
experienced  significant  fluctuations in their businesses and there have been a
number of business  failures  among these  entities.  The insolvency or business
failure of any  significant  retailer or distributor  of the Company's  products
could  have a  material  adverse  effect on the  Company's  business,  operating
results and financial condition.  Sales are typically made on credit, with terms
that vary depending upon the customer and the nature of the product. The Company
does not hold collateral to secure payment.                                     

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The Company maintains allowances for uncollected receivables that it believes to
be adequate,  but the actual allowance maintained may not be sufficient in every
circumstance.  The failure to pay an  outstanding  receivable  by a  significant
customer or  distributor  could have a material  adverse effect on the Company's
business,  operating results and financial  condition.  Although the Company has
established  allowances for returns that it believes are adequate,  there can be
no assurance  that actual returns will not exceed such  allowances.  The Company
may  also  accept   substantial   product  returns  in  order  to  maintain  its
relationships  with  retailers  and its access to  distribution  channels.  As a
result of the Company's termination of its exclusive  distribution  relationship
with GT Value Products,  and its new  non-exclusive  distribution  relationships
with  other  distributors,  including  GT Value  Products,  the  Company  is now
increasingly  exposed to the risk of product  returns from these  retailers  and
distributors.  Product returns that exceed the Company's allowances could have a
material  adverse  effect  on the  Company's  business,  operating  results  and
financial condition.                                                            

During the years ended June 30, 1999 and 1998,  sales of the Company's  products
to GT Value Products accounted for approximately 65% and 81%,  respectively,  of
the Company's net sales.  As of June 30, 1999 and 1998,  the Company's  accounts
receivable  with GT Value Products  accounted for 63% and 85 % of gross accounts
receivable,  respectively.  Since  either GT Value  Products  or the Company can
terminate the distribution  relationship between the parties at any time for any
reason,  there can be no  assurance  that GT Value  Products  will  continue  to
distribute  the  Company's  products.  The  loss  of  GT  Value  Products  as  a
distributor or an inability to collect receivables from GT Value Products or any
other adverse change in the Company's  relationship with GT Value Products would
have a material  adverse effect on the Company's  business,  operating  results,
liquidity and financial condition.                                              

Highly  Competitive  Market;   Pricing  Concerns;   Rapidly  Changing  Marketing
Environment;  Competition  for Retail  Shelf  Space.  The  market  for  consumer
entertainment  software is highly competitive,  particularly at the retail shelf
level where a rapidly increasing number of software titles are competing for the
same  amount of shelf  space.  Retailers  have a limited  amount of shelf  space
relative to the number of consumer entertainment software products competing for
that space. Therefore, there is intense competition among consumer entertainment
software  publishers for adequate levels of shelf space and promotional  support
from  retailers.  As the number of 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.  The Company's products represent a
relatively small percentage of any retailer's sales volume,  and there can be no
assurance  that  retailers  will continue to purchase the Company's  products or
promote  the  Company's  products  with  adequate  levels  of  shelf  space  and
promotional support.                                                            

Most of the Company's competitors have substantially  greater sales,  marketing,
development and financial  resources.  The Company believes that the competitive
factors  affecting  the  market  for  its  products  and  services  include  the
traditional attributes used in determining a product's value such as: vendor and
product   reputation;   product   quality,   performance   and  price;   product
functionality  and features;  product  ease-of-use;  and the quality of customer
support services and training.  The relative importance of each of these factors
depends upon the specific customer  involved,  and while the Company believes it
competes  favorably  in each of these areas,  there can be no assurance  that it
will continue to do so. Moreover,  the Company's  present or future  competitors
may be able to  develop  products  which are  comparable  or  superior  to those
offered by the Company,  offer lower priced  products or adapt more quickly than
the Company to new technologies or evolving customer requirements. The Company's
competitors  may also  have  more  money to spend on  marketing  promotions  and
advertising  efforts.  Competition  is  expected  to  intensify.  In order to be
successful  in the future,  the Company  must respond to  technological  change,
customer  requirements and competitors' current products and innovations.  There
can be no  assurance  that  the  Company  will be able to  continue  to  compete
effectively  in its market or that future  competition  will not have a material
adverse effect on its business operating results and financial condition.       

Need for Additional Funds. The Company's future capital requirements will depend
on many  factors,  but  particularly  on cash flow from  sales of the  Company's
products.  If the Company is not able to maintain cash flow from operations at a
level sufficient to support  continued  growth of its business,  the Company may
require  additional  funds  to  sustain  and  expand  its  product  development,
marketing and sales  activities.  Adequate  funds for these  purposes may not be
available  or may be available  only on terms that would  result in  significant
dilution or otherwise be unfavorable to existing stockholders. If the Company is
unable to  secure  additional  funding,  or if the  Company  is unable to obtain
adequate  funds from  operations or other external  sources when  required,  the
Company's  inability  to do so  would  have a  material  adverse  effect  on the
long-term viability of the Company.                                             

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On March 10,  1999,  the Company  entered  into a  $1,000,000  revolving  credit
facility with a commercial bank. Amounts  outstanding under this credit facility
are charged  interest at one-half of one percent above the bank's  current prime
rate and such interest is due monthly.  The credit facility is collateralized by
substantially  all of the Company's  assets.  The credit  facility  requires the
Company,  among other things, to maintain certain  financial ratios,  such as: a
minimum working capital balance of $1,500,000 and a maximum debt to net tangible
assets ratio of 1.50 to 1.00. As of June 30, 1999, the Company was in compliance
with each of those  covenants.  This credit facility was established to provide,
among  other  things,  additional  working  capital  to  support  the  Company's
anticipated  growth.  As of August 31, 1999,  the Company had not utilized  this
credit  facility,  which expires on October 31, 1999. On September 20, 1999, the
Company and its  commercial  bank  signed a  commitment  letter to increase  the
Company's  credit  facility from $1,000,000 to $1,500,000 and to extend its term
to October 31,  2000.  See  "Management's  Discussion  and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital  Resources" in Part
II, Item 6 of this document.                                                    

Uncertainty  of Market  Acceptance;  Short  Product Life Cycles.  The market for
consumer  entertainment  software has been  characterized  by shifts in consumer
preferences   and  short   product  life  cycles.   Consumer   preferences   for
entertainment  software  products  are  difficult  to predict  and few  products
achieve sustained market acceptance. There can be no assurance that new products
introduced  by the  Company  will  achieve  any  significant  degree  of  market
acceptance,  that such acceptance will be sustained for any significant  period,
or that product life cycles will be  sufficient to permit the Company to recover
development,  marketing  and other  associated  costs.  In  addition,  if market
acceptance  is not achieved,  the Company could be forced to accept  substantial
product returns to maintain its  relationships  with  distributors and retailers
and its access to distribution  channels.  Failure of new products to achieve or
sustain  market  acceptance  or  product  returns  in  excess  of the  Company's
expectations  would have a material  adverse  effect on the Company's  business,
operating results and financial condition.                                      

Rapid  Technological   Change;   Product   Development.   Frequent  new  product
introductions  and  enhancements,  rapid  technological  developments,  evolving
industry standards and swift changes in customer  requirements  characterize the
market for the Company's products.  The Company's continued success depends upon
its 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  the  Company's  competitors
introduce  products more quickly than the Company,  or if they introduce  better
products,  the Company's business could be adversely  affected.  There can be no
assurance  that the Company will be successful  in developing  and marketing new
products or enhancements to its existing  products on a timely basis or that any
new or enhanced  products  will  adequately  address the  changing  needs of the
marketplace.  From time to time, the Company or its competitors may announce new
products,  capabilities  or  technologies  that have the potential to replace or
shorten  the life cycles of the  Company's  existing  products.  There can be no
assurance  that  announcements  of  currently  planned or other new  products by
competitors  will not cause  customers  to delay their  purchasing  decisions in
anticipation of such products, which could have a material adverse effect on the
Company's business, liquidity and operating results.                            

Fluctuations  in Quarterly  Results;  Uncertainty of Future  Operating  Results;
Seasonality. The Company's 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 the  Company's  control.  Future
operating results will depend upon many factors including:  the size and rate of
growth  of the  consumer  entertainment  software  market;  the  demand  for the
Company's  products;  the level of product and price competition;  the length of
the Company's sales cycle;  seasonality of individual  customer buying patterns;
the timing of new product  introductions and product enhancements by the Company
and its  competitors;  the  timing of orders  from  major  customers;  delays in
shipment of products; access to distribution channels; product defects and other
quality problems; product life cycles; levels of international sales; changes in
foreign  currency  exchange  rates;  the  ability of the  Company to develop and
market new  products  and control  costs;  general  domestic  and  international
economic and political conditions;  and personnel changes.  Products are usually
shipped  as orders  are  received  so the  Company  operates  with  little or no
backlog.  Therefore,  net revenues in any quarter are dependent on orders booked
and shipped during that quarter.                                                

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The consumer  entertainment software industry is somewhat seasonal due primarily
to  holiday  shopping  and  back-to-school  buying  patterns.   Accordingly,  in
descending  order, the calendar  fourth,  first and third quarters are typically
the  strongest  quarters  for sales  results with the  calendar  second  quarter
typically the weakest.                                                          

Therefore,  revenues  and  operating  results  for any  future  quarter  are not
predictable with any significant degree of accuracy.  Consequently,  the Company
believes that  period-to-period  comparisons  of its  operating  results are not
necessarily  meaningful  and should not be relied upon as  indications of future
performance.                                                                    

Risk of Defects.  Products offered by the Company 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 the Company's 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,  which  could  have a  material  adverse  effect  on  the  Company's
business, operating results and financial condition.                            

Possible Inadequacy of Protection of Trade Names; Software Technology; and Other
Proprietary  Rights.  The Company holds  copyrights  on the  products,  manuals,
advertising  and other  materials  owned by it. The  Company  also  either  owns
trademark  rights  or is in the  process  of  applying  for such  rights  in the
Company's  name and logo, and the names of the products owned or licensed by the
Company.  The  Company's  success  depends in part on its ability to protect its
proprietary  rights  to the  trademarks,  trade  names and  content  used in its
principal  products.   The  Company  relies  on  a  combination  of  copyrights,
trademarks, trade secrets, confidentiality procedures and contractual provisions
to protect its proprietary rights.  There can be no assurance that the Company's
existing or future copyrights,  trademarks,  trade secrets or other intellectual
property  rights will be of sufficient  scope or strength to provide  meaningful
protection or commercial  advantage to the Company.  Also, in selling certain of
its products,  the Company  relies on "shrink wrap" 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
the Company's  proprietary rights as do the laws of the United States. There can
be no assurance  that such factors would not have a material  adverse  effect on
the Company's business or operating results.                                    

The Company may from time to time be notified  that it is  infringing on certain
patent or  intellectual  property  rights of others.  Combinations of technology
acquired through past or future  acquisitions and the Company's  technology will
create new products and technology that may give rise to claims of infringement.
While no actions are currently  pending against the Company for  infringement of
patent or other proprietary  rights of third parties,  there can be no assurance
that third parties will not initiate infringement actions against the Company in
the future. Any such action could result in substantial cost to and diversion of
resources of the Company.  If the Company was found to be infringing  the rights
of others,  no  assurance  can be given that  licenses  would be  obtainable  on
acceptable terms or at all, that significant damages for past infringement would
not be assessed,  or that further  litigation  relative to any such  licenses or
usage would not occur. The failure to obtain necessary licenses or other rights,
or the  advent  of  litigation  arising  out of any such  claims,  could  have a
material adverse effect on the Company's operating results.                     

Acquisition-Related  Risks.  Since its initial public offering,  the Company has
acquired Applied Optical Media Corporation,  Saturn Publishing,  Virtual Reality
Laboratories,  Inc. and  Software  Partners  Publishing  and  Distribution  Ltd.
Consistent with the Company's  strategy of enhancing its sales and  distribution
capabilities  and product  offerings,  the Company intends to continue to pursue
acquisitions  of companies,  intellectual  property rights and other assets that
can be purchased or licensed on acceptable  terms and which the Company believes
will contribute to profitability.  Some of these  transactions could be material
in size and  scope.  While the  Company  searches  for  appropriate  acquisition
opportunities,  the  Company  may  not be  successful  in  identifying  suitable
acquisitions. If potential acquisition opportunities are identified, the Company
may not be able to consummate such  acquisitions and if such an acquisition does
occur,  it may  not  enhance  the  Company's  business  or be  accretive  to the
Company's  earnings.  As  the  consumer   entertainment  industry  continues  to
consolidate,  the Company faces significant  competition in seeking acquisitions
and may in the future face increasing competition for acquisition opportunities.
This competition is likely to inhibit the Company's ability to complete suitable
transactions.                                                                   

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The Company  may,  in the future,  issue  additional  shares of Common  Stock in
connection an acquisition, which may dilute its existing stockholders.          

Future  acquisitions  could  divert  substantial   management  time  that  would
otherwise be available for the ongoing  development  of the Company's  business,
and could result in short term reductions in earnings or special  transaction or
other  charges.  An acquired  business may also be  difficult to integrate  with
existing  operations  or  assets.  If the  Company's  management  is not able to
respond to these  challenges  effectively,  the Company's  results of operations
could be  adversely  affected.  Moreover,  there  can be no  assurance  that the
anticipated  benefits of an acquisition  will be realized.  The Company believes
that its future  growth  will  depend,  in part,  on its  ability to continue to
identify,  acquire  and  integrate  companies  that have  software  development,
publishing  and/or   distribution   capabilities.   While  the  Company  reviews
acquisition  opportunities  in the ordinary course of its business,  the Company
presently  has no  commitments  or  undertakings  with  respect to any  material
acquisitions.  There can be no assurance  that the Company will be successful in
identifying and acquiring  suitable  acquisition  candidates or integrating such
acquired businesses into the Company's operations.                              

Dependence on Key  Management  and Technical  Personnel.  The Company's  success
depends to a  significant  degree upon the  continued  contributions  of its key
management, marketing, technical and operational personnel, including members of
senior  management.  The loss of the services of one or more key employees could
have a material adverse effect on the Company's  operating results.  The Company
also  believes its future  success will depend in large part upon its ability to
attract and retain additional highly skilled management,  technical,  marketing,
product development and operational personnel. Competition for such personnel is
intense,  and there can be no assurance  that the Company will be  successful in
attracting and retaining such personnel.                                        

International  Sales. In fiscal 1999, the Company derived  approximately  27% of
its total  revenues  from  international  sales  versus 8% in fiscal  1998.  The
Company  expects  international  sales to continue to comprise a significant and
increasing  percentage  of the  Company's  sales.  The  Company's  international
business is subject to certain risks including: varying regulatory requirements;
tariffs  and  trade  barriers;  political  and  economic  instability;   reduced
protection for intellectual  property rights in certain countries;  difficulties
in supporting foreign customers;  difficulties in managing foreign distributors;
potentially  adverse  tax  consequences;  the  burden of  complying  with a wide
variety of complex operations;  customs, foreign laws, regulations and treaties;
fluctuating  currency  valuations;   and  the  possibility  of  difficulties  in
collecting accounts receivable.                                                 

Year 2000 Issues:  the Company's  State of  Readiness;  Cost to Address the Year
2000 Issues;  Year 2000 Contingency  Plan. The Company has reviewed its critical
information  systems for Year 2000  compliance.  The compliance  review revealed
that all but one of the Company's  critical  information  systems were Year 2000
compliant  due to the fact  that  most of the  Company's  network  hardware  and
operating systems are "off-the-shelf" products from third parties with Year 2000
compliant versions. The one critical information system that required an upgrade
to become Year 2000 compliant was upgraded during December 1998. The Company has
determined  that there  should be no Year 2000  issues for the  products  it has
already   sold   since  the   Company's   products   predominantly   contain  no
date-sensitive  software.  As part of the Company's Year 2000 compliance review,
the Company is in the process of contacting  its primary  vendors,  distributors
and customers to determine the extent to which the Company is vulnerable to such
third  parties'  failures  to address  their Year 2000  compliance  issues.  The
Company will continue to work to obtain  sufficient  information  and assurances
from its  significant  vendors,  distributors  and customers as part of its Year
2000 compliance review. However, there can be no guarantee that third parties on
which the  Company's  business  relies will  adequately  address their Year 2000
compliance  issues  nor is there any  guarantee  that the  failure by such third
parties to  adequately  deal with such issues would not have a material  adverse
effect on the Company and its operations.                                       

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The  Company  has  completed  its Year 2000  compliance  review of its  critical
information  systems,  including the upgrading of one if its software systems at
an approximate cost of $15,000. The Company's Year 2000 compliance review of its
third party suppliers,  distributors  and vendors is an ongoing process,  but to
date has not  required any material  amount of Company  resources or funds.  The
Company does not expect the cost of its Year 2000  compliance  to be material to
the  Company's  financial  position,  cash flow or  results of  operations.  The
Company  believes that its primary risk  associated with Year 2000 compliance is
the failure of third parties upon whom the Company's  business  relies to timely
address their Year 2000 issues.  Failure by third parties to adequately  address
their Year 2000 issues in a timely  manner  could result in  disruptions  in the
Company's supply of products,  packaging and related  materials,  late or missed
payments,  temporary  disruptions in order processing and other general problems
related to the Company's daily  operations.  While the Company believes its Year
2000 compliance review procedures will adequately address the Company's internal
Year  2000  issues,  until  the  Company  receives  responses  from  all  of its
significant  vendors,  distributors and customers,  the overall risks associated
with the Year 2000 issue currently remain  difficult to accurately  describe and
quantify,  and there can be no guarantee that such  uncertainty  will not have a
material  adverse  effect  on the  Company's  business,  operating  results  and
financial position.                                                             

The Company has not, to date,  implemented  a Year 2000  contingency  plan.  The
Company  intends to  develop  and  implement  a  contingency  plan by the end of
October 1999.                                                                   

Stock Price  Volatility.  The Company  believes  that a variety of factors could
cause the price of its Common Stock to fluctuate, perhaps substantially,  over a
short  period of time  including:  quarter to quarter  variations  in  operating
results; announcements of developments related to its business;  fluctuations in
its order levels;  general  conditions in the technology sector or the worldwide
economy;  announcements  of technological  innovations,  new products or product
enhancements  by the Company or its  competitors;  key management  changes;  and
developments in the Company's relationships with its customers, distributors and
suppliers.  In addition,  in recent  years the stock market in general,  and the
market for shares of software,  high technology stocks,  micro-cap and small cap
stocks in particular,  has  experienced  extreme price  fluctuations  which have
often been unrelated to the operating  performance of affected  companies.  Such
fluctuations  could  adversely  affect the market price of the Company's  Common
Stock.                                                                          

Listing of Securities;  Risk of Low Priced Stocks. The Company's Common Stock is
listed on the Nasdaq SmallCap Market under the symbol EGAM. A listed company may
be de-listed if it fails to maintain  minimum  levels of  Stockholders'  equity,
shares publicly held, number of Stockholders or aggregate market value, or if it
violates other aspects of its listing  agreement.  At June 30, 1999, the Company
satisfied  the  minimum  level of  Stockholders'  equity  required  to be listed
($2,000,000) and all other aspects of its listing agreement.                    

If the Company fails to maintain the criteria for trading on the Nasdaq SmallCap
Market,  its  Common  Stock may be  de-listed.  Public  trading,  if any,  would
thereafter be conducted in the  over-the-counter  market in the so-called  "pink
sheets," or on the NASD's "Electronic  Bulletin Board." If the Common Stock were
de-listed,  it may be more difficult to dispose of, or even to obtain quotations
as to the price of, the  Common  Stock and the price,  if any,  offered  for the
Common Stock may be substantially reduced.                                      

In  addition,  if the  Common  Stock is  de-listed  from  trading  on the Nasdaq
SmallCap  Market,  and the trading  price of the Common Stock is less than $5.00
per share,  or the  Company  has less than $2 million  in net  tangible  assets,
trading in the Common Stock would be subject to the  requirements  of Rule 15g-9
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Under this rule,  broker/dealers who recommend such securities to persons
other  than   established   customers  and   accredited   investors   (generally
institutions with assets in excess of $5 million or individuals with a net worth
in excess of $1 million  or an annual  income  exceeding  $200,000  or  $300,000
jointly  with  their   spouses)   must  make  a  special   written   suitability
determination for the purchaser and receive the purchaser's written agreement to
a transaction prior to sale. The requirements of Rule 15g-9, if applicable,  may
affect the ability of  broker/dealers  to sell the Company's  securities and may
also  affect the ability of  purchasers  to sell their  shares in the  secondary
market. The Securities  Enforcement  Remedies and Penny Stock Reform Act of 1990
(the "Penny Stock Rule") also requires additional  disclosure in connection with
any trades  involving  a stock  defined as penny  stock (any  non-Nasdaq  equity
security that has a market price or exercise  price of less than $5.00 per share
and less than $2 million in net tangible assets, subject to certain exceptions).
Unless  exempt,  the  rules  require  the  delivery,  prior  to any  transaction
involving a penny stock, of a disclosure schedule prepared by the SEC explaining
important  concepts involving the penny stock market, the nature of such market,
terms  used in such  market,  the  broker/dealer's  duties  to the  customer,  a
toll-free telephone number for inquiries about the broker/dealer's  disciplinary
history and the customer's  rights and remedies in case of fraud or abuse in the
sale.  Disclosure  must  also be made  about  commissions  payable  to both  the
broker/dealer and the registered representative,  and current quotations for the
securities.  Finally,  monthly  statements must be sent disclosing  recent price
information  for the penny  stock held in the  account  and  information  on the
limited market in penny stocks.                                                 

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Item 2.     Properties                                                          

The Company leases 11,000 square feet of office, development and warehouse space
in Langhorne,  Pennsylvania  and 5,000 square feet of office and warehouse space
in St. Ives,  England.  The Company believes that its current facilities will be
adequate for the Company's  anticipated  needs through  fiscal 2000. The Company
leases its North  American and United  Kingdom  operating  facilities  under two
operating  leases,  expiring in September 2002 and in March 2007,  respectively.
Rent  expense was  $204,000  and  $157,000 for the years ended June 30, 1999 and
1998, respectively. The Company anticipates that it may require additional space
as its business  grows but  anticipates no difficulty in obtaining such space in
the vicinity of its current facilities on terms  substantially  similar to those
of the Company's current lease.                                                 

Item 3.     Legal Proceedings                                                   

None.                                                                           

Item 4.     Submission of Matters to a Vote of Security Holders                 

None.                                                                           

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 PART II

Item 5.     Market for the Registrant's Common Equity and Related Stockholder   
Matters                                                 

The  Company's  Common  Stock is traded on the  Nasdaq  SmallCap  Market  System
("Nasdaq")  under the symbol EGAM.  The  following are the range of high and low
bid prices for fiscal 1999 and 1998, as reported by Nasdaq:                     

                                                   High        Low
                                                   ----        ---
Fiscal 1998                                                           
-----------                                                           
     First quarter ...................              $2.000      $0.969
     Second quarter ..................              $3.000      $1.500
     Third quarter ...................              $2.813      $2.375
     Fourth quarter ..................              $2.719      $1.719
Fiscal 1999                                                           
-----------                                                           
     First quarter ...................              $2.125      $0.938
     Second quarter ..................              $1.935      $0.938
     Third quarter ...................              $6.156      $1.625
     Fourth quarter ..................              $4.500      $2.375

On August 31, 1999, the Company had  approximately  118  shareholders of record.
The  Company  has not  paid any  dividends  on its  Common  Stock.  The  Company
currently  intends to retain earnings,  if any, for use in its business and does
not anticipate paying cash dividends in the foreseeable future.                 

Item 6.     Management's  Discussion  and  Analysis  of Results of  Operations  
and Financial Condition                                 

Results of Operations                                                           

The following discussion should be read together with the Company's Consolidated
Financial Statements and Notes thereto beginning on page 23.                    

Year Ended June 30, 1999 Compared to the Year Ended June 30, 1998               

Net Sales and Cost of Sales                                                     

Net  sales  for the year  ended  June 30,  1999  were  $10,022,000  compared  to
$9,276,000  for the year  ended  June 30,  1998,  representing  an  increase  of
$746,000  or 8%.  As it  relates  to the mix of  products  sold,  this  increase
generally  resulted from increases in sales of the Company's  full-release  game
products,  while  sales  of the  Company's  shareware-based  products,  personal
productivity  and  non-eGames  products  decreased.  For the year ended June 30,
1999,  the  Company's  net sales were  comprised of  full-release  game products
(60%),  shareware-based products (25%), personal productivity products (10%) and
non-eGames  products (5%),  respectively.  For the year ended June 30, 1998, the
Company's  net  sales  were  comprised  of  full-release   game  products  (3%),
shareware-based   products  (59%),  personal  productivity  products  (24%)  and
non-eGames products (14%), respectively.  These changes in products sold reflect
the  Company's   transition   from   publishing   and   distributing   primarily
shareware-based  products to full-release,  proprietary products, which occurred
during  the 1999  fiscal  year.  Additionally,  due to issues  arising  from the
Company's   year-end   transition   towards  multiple   relationships   for  the
distribution  of its  products,  as described in the  following  paragraph,  the
Company's  domestic  sales for fiscal 1999  decreased by $1,251,000  from fiscal
1998  results.  This decrease in the  Company's  domestic  sales was offset by a
$1,997,000 increase in the Company's  international sales achieved during fiscal
1999 as compared to fiscal 1998 results,  which increase in international  sales
resulted   primarily  from  the  Company's   acquisition  of  Software  Partners
Publishing and Distribution Ltd., a United Kingdom-based  software  distributor,
that occurred in August 1998. The Company's  international sales represented 27%
and  8% of the  Company's  net  sales  for  the  1999  and  1998  fiscal  years,
respectively.                                                                   

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Until April 1999, the Company primarily  distributed its entertainment  software
products  in  North  America  through  a large  national  distributor,  GT Value
Products, a division of GT Interactive Software  Corporation.  At that time, the
Company terminated its exclusive  distribution  agreement with GT Value Products
and began  entering  into  non-exclusive  distribution  agreements  with various
national distributors, including GT Value Products. The Company has also entered
into  several  direct  sales  agreements  with  certain   retailers.   This  new
distribution  strategy is  intended  to  diversify  the  Company's  distribution
channels  to  retail,   provide  for  more   effective   inventory   management,
merchandising  and  communications   with  retailers,   diminish  the  Company's
dependence  on any  one  third-party  distributor  for  sales  of the  Company's
products, and increase the potential gross profit margin that can be realized on
the sale of its  products.  The Company  continues  to  distribute  its products
through GT Value  Products to certain mass  merchandise  retailers that purchase
value-priced  software  exclusively  through GT Value  Products.  The  Company's
product  sales to GT Value  Products  accounted for 65% and 81% of the Company's
net sales for the years ended June 30, 1999 and 1998, respectively.  The Company
believes  that for the year ending  June 30,  2000,  sales to GT Value  Products
could account for a  decreasing,  but  significant,  amount of the Company's net
sales.                                                                          

As a result of its  transition  to a new  distribution  strategy,  the Company's
sales for the fourth  quarter ended June 30, 1999 were adversely  affected.  The
Company's  sales were $1,383,000 for the quarter ended June 30, 1999 as compared
to $1,931,000 for the quarter ended June 30, 1998.                              

During  April  1999,  pursuant  to its new  distribution  strategy,  the Company
shipped its first order on a direct basis to over 2,600 individual Rite Aid drug
stores.  As competition  for shelf space in traditional  software  retail stores
continues   to   increase,   the   Company   intends  to   aggressively   target
non-traditional software retailers for opportunities to distribute the Company's
products.  These non-traditional  software retailers may include grocery stores,
drug stores, convenience stores, music stores and bookstores.                   

During  the  1999  fiscal  year,   the  Company  has  taken  steps  to  increase
distribution of its products via the Internet,  including: devoting resources to
the  improvement  and  expansion  of  its  web  site;   establishing  electronic
distribution  capabilities  by entering into an agreement  with Digital River, a
distributor of digital  software over the Internet;  and  incorporating  on-line
functionality  into existing  products.  Sales of the Company's products via the
Internet  were less than 1% of the  Company's net sales for the years ended June
30, 1999 and 1998, respectively.                                                

Product returns  experienced by the Company during the years ended June 30, 1999
and 1998 were $859,000 and $39,000,  respectively, or nine percent and less than
one percent of the Company's net sales,  respectively.  This increase in product
returns  was  caused  primarily  from the change in the  Company's  distribution
relationship  with GT Value Products,  which occurred during the year ended June
30, 1999,  as well as the Company's new  distribution  relationships  which also
allow for product returns.                                                      

Cost of sales for the year  ended  June 30,  1999 were  $3,597,000  compared  to
$3,442,000  for the year  ended  June 30,  1998,  representing  an  increase  of
$155,000 or 4%. This  increase  was caused  primarily  by  additional  inventory
obsolescence  costs of $207,000 and increased  royalty  costs of $345,000,  both
associated with the Company's transition from shareware to full-release software
products,  which was initiated during fiscal 1999. The increase in cost of sales
was partially  offset by a $569,000  decrease in replication  and assembly costs
resulting  from  negotiated  contract  manufacturing  pricing  with third  party
replicating and box assembly vendors. Product costs consist mainly of replicated
compact discs,  printed materials,  protective jewel cases and boxes for certain
products.  The  increase in gross  profit  margin to 64.1% from 62.9% was caused
primarily by increased sales of the Company's full-release products,  which have
a higher gross profit margin than the Company's discontinued shareware products,
combined with  replication  and assembly cost savings  achieved  during the year
ended June 30, 1999.                                                            

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Operating Expenses                                                              

Product  development  expenses  for the year ended June 30,  1999 were  $937,000
compared to $397,000 for the year ended June 30,  1998,  an increase of $540,000
or 136.0%.  This increase was caused primarily by a $248,000  increase in salary
and  related  costs  for  employees  hired  to focus  on the  Company's  product
development  efforts and a $277,000  increase in  independent  developer  costs,
which were both due to the Company's  significant increase in the development of
full-release products during the year ended June 30, 1999.                      

The  development  of  full-release   software  requires   substantially  greater
resources  than  producing   shareware-based   software,   because  it  involves
identifying  potential  sources  of  software  content,   negotiating  licensing
agreements with the developers of such content, and preparing a finished product
based  upon  the  acquired  content,   which  requires  additional  in-house  or
independent  contractor  development  efforts.  During the 1999 fiscal year, the
Company has also devoted  additional  resources to its quality assurance efforts
in order to determine  that each of the versions of products  that are developed
and marketed - including  demonstration,  full release and collection versions -
function properly. As competition for quality software content intensifies,  the
Company  anticipates  that it will require  additional  resources to continue to
develop  high-quality  products.  The  Company  has  also  utilized  independent
contractors  during the 1999 fiscal year to localize its software  products into
foreign languages. The Company currently publishes localized products in French,
German,  Italian,  Spanish and  Portuguese.  The Company  intends to continue to
increase the number of products that are available in foreign  languages,  which
would require the Company to incur additional product development expenses.     

The Company recorded sales from 38 full-release game products for the year ended
June 30, 1999 compared to recorded sales from 3  full-release  game products for
the year  ended  June  30,  1998.  The  Company  is  currently  working  towards
publishing between 35 and 40 new full-release game products during fiscal 2000. 

Selling,  general and  administrative  expenses for the year ended June 30, 1999
were  $4,814,000  compared to  $4,135,000  for the year ended June 30, 1998,  an
increase of $679,000 or 16.4%.  This increase was caused  primarily by operating
expenses  incurred by the  Company's  sales and  distribution  operation  in the
United  Kingdom,  acquired on August 14, 1998,  which were  partially  offset by
reductions in the Company's  marketing  promotional  costs incurred in the North
American marketplace.                                                           

Interest expense, net                                                           

Net  interest  expense for the year ended June 30, 1999 was $32,000  compared to
$46,000 for the year ended June 30,  1998,  a decrease of $14,000 or 30.4%.  The
reason for this decrease was the  reduction of long-term  debt and capital lease
obligations due to normal monthly principal  payments made during the year ended
June 30,  1999,  and the  increase  in interest  income  earned from higher cash
balances held by the Company during fiscal 1999.                                

Provision for income taxes                                                      

Provision  for  income  taxes  for the year  ended  June 30,  1999 was  $180,000
compared to $3,000 for the year ended June 30,  1998,  an increase of  $177,000.
The  increase in the  provision  for income taxes was  primarily  due to foreign
income taxes related to the Company's United Kingdom subsidiary  acquired during
fiscal 1999,  the expiration of net operating  losses  available to offset state
taxable income and federal taxable income not offset by net operating losses.   

Net income attributable to Common Stock                                         

Net income  attributable  to Common  Stock for the year ended June 30,  1999 was
$463,000  compared to $1,135,000 for the year ended June 30, 1998, a decrease of
$672,000 or 59.2%.  This decrease in  profitability  was primarily a result from
increases in operating expenses and provision for income taxes of $1,219,000 and
$177,000,  respectively,  which were partially offset by a $591,000  increase in
gross  profit  and a  $118,000  decrease  in the  accretion  of  the  beneficial
conversion feature on preferred stocks.                                         

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Weighted average common shares                                                  

The weighted  average common shares  outstanding on a diluted basis increased by
184,835  during the year  ended June 30,  1999.  During  the 1999  fiscal  year,
150,000 shares of Common Stock were issued in connection with the acquisition of
Software  Partners  Publishing and  Distribution  Ltd., now eGames Europe,  Ltd.
("eGames Europe") in August 1998, and 312,140 shares of Common Stock were issued
in  connection  with the exercise of 270,308  Common  Stock  warrants and 41,832
Common  Stock  options.  In  addition,  due to  the  $118,000  accretion  of the
beneficial  conversion  feature  of the Class Two and  Class  Three  Convertible
Preferred  Stock for the year ended June 30, 1998,  the Company's net income per
Common Share was negatively  impacted by $0.01 for the year ended June 30, 1998.
During the year ended June 30, 1999, the Company  acquired 231,900 shares of its
Common Stock for  approximately  $501,000 as part of a stock repurchase  program
approved by the Board of Directors in October 1998.                             

Liquidity and Capital Resources                                                 

As of June 30,  1999,  the  Company's  cash and working  capital  balances  were
$1,314,000 and $2,708,000,  respectively,  and the Company's total stockholders'
equity  balance at June 30, 1999 was  $3,224,000.  As of September 21, 1999, the
Company's  unaudited  cash balance was  approximately  $300,000,  primarily as a
result of lower than expected cash collections  from the Company's  distributors
since the end of the 1999 fiscal year.  On September  20, 1999,  the Company and
its commercial bank signed a commitment  letter to increase the Company's credit
facility from  $1,000,000  to  $1,500,000  and to extend its term to October 31,
2000.                                                                           

As indicated in the accompanying financial statements,  the Company's net income
for fiscal 1999 was  $463,000 and the  Company's  net income for fiscal 1998 was
$1,253,000.  In addition, cash provided by operating activities was $866,000 and
$707,000 for the years ended June 30, 1999 and 1998, respectively.  The $866,000
net cash  provided  by  operating  activities  for the year ended June 30,  1999
resulted   primarily  from  the  Company's  net  income  adjusted  for  non-cash
depreciation and amortization  expense for the period, in addition to a decrease
in accounts receivable, which was partially offset by an increase in inventory. 

Net cash used in investing  activities for the year ended June 30, 1999 and 1998
were  $313,000 and  $403,000,  respectively.  Purchases  of software  rights and
furniture and equipment  totaled  $108,000 and $193,000,  respectively,  for the
year ended June 30, 1999.  On August 14, 1998,  the Company  acquired all of the
outstanding  shares of Software  Partners  Publishing and Distribution  Ltd., in
exchange  for  150,000  shares  of  the  Company's   Common  Stock,   valued  at
approximately $213,000. On March 31, 1999, Software Partners changed its name to
eGames Europe Ltd.  Acquisition costs, net of cash received,  were approximately
$13,000.                                                                        

Net cash used in financing  activities  was $193,000 for the year ended June 30,
1999 and net cash  provided by  financing  activities  was $205,000 for the year
ended June 30,  1998.  On October 26,  1998,  the  Company's  Board of Directors
authorized  the  Company to purchase  up to  $1,000,000  of its shares of Common
Stock in the Nasdaq  SmallCap  Market.  As of June 30,  1999,  the  Company  had
purchased 231,900 shares of its Common Stock at an approximate cost of $501,000,
pursuant to its stock repurchase  program.  During the year ended June 30, 1999,
the Company received net proceeds from the exercise of Common Stock warrants and
options totaling  approximately  $485,000.  During the year ended June 30, 1999,
the Company made  $124,000 in notes  payable  repayments  and $53,000 in capital
lease repayments.                                                               

The Company's  ability to achieve and maintain positive cash flow depends upon a
variety of factors,  including the  timeliness  and success of the collection of
outstanding   accounts   receivable,   the   creditworthiness   of  the  primary
distributors of the Company's products,  the development and sell-through of the
Company's  products,  the costs of  developing,  producing  and  marketing  such
products,  and various  other  factors,  some of which are beyond the  Company's
control.  In the  future,  the  Company  expects  its cash and  working  capital
requirements to be affected by each of these factors.  The Company believes cash
and working capital balances will be sufficient to fund the Company's operations
for the foreseeable future. However, there can be no assurances that the Company
will be able to achieve  and  maintain a positive  cash flow or that  additional
financing  will be available if and when required or, if  available,  will be on
terms satisfactory to the Company.                                              

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On March 10,  1999,  the Company  entered  into a  $1,000,000  revolving  credit
facility with a commercial bank. Amounts  outstanding under this credit facility
are charged  interest at one-half of one percent above the bank's  current prime
rate and such interest is due monthly.  The credit facility is collateralized by
substantially  all of the Company's  assets.  The credit  facility  requires the
Company,  among other things, to maintain certain  financial ratios,  such as: a
minimum working capital balance of $1,500,000 and a maximum debt to net tangible
assets ratio of 1.50 to 1.00. As of June 30, 1999, the Company was in compliance
with each of those  covenants.  This credit facility was established to provide,
among  other  things,  additional  working  capital  to  support  the  Company's
anticipated  growth.  As of August 31, 1999,  the Company had not utilized  this
credit  facility,  which expires on October 31, 1999. On September 20, 1999, the
Company and its  commercial  bank  signed a  commitment  letter to increase  the
Company's  credit  facility from $1,000,000 to $1,500,000 and to extend its term
to October 31, 2000.                                                            

At June 30,  1999,  the  Company  continued  to  satisfy  the  minimum  level of
stockholders' equity required and all other aspects of its listing agreement for
the Nasdaq SmallCap Market.  At June 30, 1999, the Company had $2,967,000 in net
tangible assets.                                                                

Year 2000                                                                       

The Company's State of Readiness                                                
--------------------------------                                                

The  Company  has  reviewed  its  critical  information  systems  for Year  2000
compliance.  The  compliance  review  revealed that all but one of the Company's
critical  information systems were Year 2000 compliant due to the fact that most
of the  Company's  network  hardware and operating  systems are  "off-the-shelf"
products from third parties with Year 2000 compliant versions.  The one critical
information  system that  required an upgrade to become Year 2000  compliant was
upgraded in December 1998.                                                      

The  Company  has  determined  that there  should be no Year 2000 issues for the
products it has already sold since the Company's products  predominantly contain
no date-sensitive software.                                                     

As part of the Company's Year 2000 compliance  review, the Company has contacted
its primary vendors, distributors and customers to determine the extent to which
the Company is vulnerable to such third parties'  failures to address their Year
2000 compliance issues. The Company has received responses from several, but not
all,  of the  Company's  primary  vendors,  including  the  primary  third-party
manufacturers of the Company's products and packaging.  Responses have also been
received  from  several,  but not all, of the  significant  distributors  of the
Company's  products.  The Company  will  continue  to work to obtain  sufficient
information  and  assurances  from its  significant  vendors,  distributors  and
customers as it completes its Year 2000 compliance review. However, there can be
no guarantee  that third  parties on which the  Company's  business  relies will
adequately  address their Year 2000 compliance issues nor is there any guarantee
that the failure by such third parties to adequately deal with such issues would
not have a material adverse effect on the Company and its operations.           

The Cost to Address the Company's Year 2000 Issues                              
--------------------------------------------------                              

The  Company  has  completed  its Year 2000  compliance  review of its  critical
information  systems,  including the upgrading of one of its software systems at
an approximate cost of $15,000. The Company's Year 2000 compliance review of its
third party suppliers,  distributors  and vendors is an ongoing process,  but to
date has not  required any material  amount of Company  resources or funds.  The
Company's  costs to review and address any Year 2000  compliance  issues are not
expected  to be  material  to the  Company's  financial  position,  cash flow or
results of operations.                                                          

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The Risks Associated with the Company's Year 2000 Compliance                    
------------------------------------------------------------                    

The Company  believes that its primary risk associated with Year 2000 compliance
is the  failure of third  parties  upon whom the  Company's  business  relies to
timely  address  their Year 2000 issues.  Failure by third parties to adequately
address their Year 2000 issues in a timely manner could result in disruptions in
the Company's supply of products,  packaging and related materials, late, missed
or unapplied  payments,  temporary  disruptions  in order  processing  and other
general  problems related to the Company's daily  operations.  While the Company
believes its Year 2000 compliance review procedures will adequately  address the
Company's  internal Year 2000 issues,  until the Company receives responses from
all of its significant  vendors,  distributors and customers,  the overall risks
associated  with the Year 2000 issue  currently  remain  difficult to accurately
describe and quantify,  and there can be no guarantee that such uncertainty will
not have a material adverse effect on the Company's business,  operating results
and financial position.                                                         

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The Company's Contingency Plan                                                  

The Company has not, to date,  implemented  a Year 2000  contingency  plan.  The
Company intends to develop and implement a contingency plan by October 31, 1999.
It is the  Company's  intention to devote  whatever  resources  are necessary to
assure that all of its Year 2000 compliance issues are resolved.                

Forward-Looking Statements                                                      

This  report  contains  statements  that are  forward-looking,  as that  term is
defined  by the  Private  Securities  Litigation  Reform  Act of 1995 and by the
Securities and Exchange  Commission in rules,  regulations  and releases.  These
statements include, but are not limited to, statements regarding:  the Company's
efforts to diversify the distribution  channels used to distribute its products,
including direct sales to traditional and alternative software retailers, use of
the Internet and  expansion  into  international  markets  through the Company's
wholly-owned  subsidiary,  eGames Europe;  the projected  amount of sales of the
Company's products to GT Value Products Corporation during the 2000 fiscal year;
the costs  associated  with the  development  and  localization of the Company's
products;  the number of new full-release products that the Company will develop
during the 2000 fiscal year;  the  sufficiency of the Company's cash and working
capital balances to fund the Company's  operations in the future;  the affect of
adopting new accounting pronouncements on the Company's financial statements and
practices; the Company's expectations and cost estimates regarding its Year 2000
compliance efforts;  and the Company's expansion of its product offerings in the
United Kingdom and distribution of its products into the European  markets.  All
forward-looking   statements  are  based  on  current   expectations   regarding
significant  risk  factors,  and such  statements  should not be  regarded  as a
representation  by the Company or any other person that the results expressed in
this report will be achieved.                                                   

The  following  important  factors,  among  others  discussed  elsewhere in this
report, could cause the Company's actual results to differ materially from those
indicated  by the  forward-looking  statements  contained  in this  report:  the
success of the Company's  new  distribution  strategy,  including its ability to
enter into new  distribution  and direct  sales  relationships  on  commercially
acceptable  terms;  the market  acceptance  and successful  sell-through  of the
Company's  existing  and new  products  in the United  States and  international
markets;  the allocation of adequate  shelf space for the Company's  products in
major retail chain stores; the Company's ability to collect outstanding accounts
receivable and establish  adequate reserves for uncollectible  receivables;  the
amount of returns of the Company's  products from distributors and retailers and
the Company's ability to establish  adequate  reserves for product returns;  the
continued  increase in the number of computers in homes in North America and the
world;  the  ability  to  deliver  products  in  response  to  orders  within  a
commercially acceptable time frame; downward pricing pressure; fluctuating costs
of  developing,  producing and marketing the Company's  products;  the Company's
ability to license or develop  quality  content for its products;  the Company's
ability  to access  alternative  distribution  channels  and the  success of the
Company's efforts to develop its Internet sales; consumers' continued demand for
value-priced  software;  increased  competition  in  the  value-priced  software
category;  the  ability of the  Company  and its key  distributors,  vendors and
suppliers to effectively  address Year 2000 compliance issues; and various other
factors,  many of which are beyond the Company's  control.  The Company does not
undertake to update any  forward-looking  statement  made in this report or that
may be made from time to time by or on behalf of the Company.                   

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Item 7.     Financial Statements                                                

eGames, Inc.
Index to Consolidated Financial Statements

                                                                      Page
                                                                      ----

Independent Auditors' Report......................................     24 

Consolidated Balance Sheet June 30, 1999..........................     25 

Consolidated Statements of Operations for the years                       
ended June 30, 1999 and 1998......................................     26 

Consolidated Statements of Stockholders' Equity for the years             
ended June 30, 1999 and 1998......................................     27 

Consolidated Statements of Cash Flows for the years                       
ended June 30, 1999 and 1998......................................     28 

Notes to Consolidated Financial                                           
Statements........................................................     30 

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Independent Auditors' Report

The Board of Directors and Stockholders                                         
eGames, Inc.:                                                                   

We have audited the accompanying  consolidated balance sheet of eGames, Inc. and
subsidiary  as of June 30,  1999,  and the related  consolidated  statements  of
operations,  stockholders'  equity,  and cash flows for the years ended June 30,
1999 and 1998. These consolidated financial statements are the responsibility of
the Company's  management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.                          

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting  principles used and the significant  estimates made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.          

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of eGames,  Inc. and
subsidiary  as of June 30,  1999 and the results of their  operations  and their
cash  flows for the years  ended  June 30,  1999 and 1998,  in  conformity  with
generally accepted accounting principles.                                       

/s/ KPMG LLP                                                                    

Philadelphia, Pennsylvania                                                      
August 19, 1999                                                                 

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eGames, Inc.
Consolidated Balance Sheet
 June 30, 1999

                                                                [Download Table]


                                                                        1999    
                                                                        ----    
ASSETS                                                                          
                                                                                
Current assets:                                                                 
   Cash and cash equivalents                                        $ 1,313,853 
   Restricted cash                                                       17,560 
   Accounts receivable, net of allowances totaling $417,732           1,934,503 
   Inventory                                                          1,153,198 
   Prepaid expenses                                                     108,702 
                                                                    ----------- 
          Total current assets                                        4,527,816 

Furniture and equipment, net                                            375,717 
Intangibles and other assets, net                                       487,233 
                                                                    ----------- 
          Total assets                                              $ 5,390,766 
                                                                    =========== 

LIABILITIES AND STOCKHOLDERS' EQUITY                                            
Current liabilities:                                                            
   Accounts payable                                                 $ 1,040,438 
   Accrued expenses                                                     627,264 
   Notes payable                                                        129,210 
   Capital lease obligations                                             22,986 
                                                                    ----------- 
          Total current liabilities                                   1,819,898 

Capital lease obligations, net of current portion                        22,459 
Notes payable-long term portion                                         174,471 
Convertible subordinated debt                                           150,000 
                                                                    ----------- 
          Total liabilities                                           2,166,828 

Commitments and contingencies - Notes 6, 7, 8 and 14                            

Stockholders' equity:                                                           
   Common Stock, no par value (40,000,000 shares authorized;                    
     9,833,340 issued and 9,601,440 outstanding)                      8,874,889 
   Additional paid in capital                                         1,148,550 
   Accumulated deficit                                               (6,268,169)
   Treasury Stock at cost - 231,900 shares                             (501,417)
   Accumulated other comprehensive loss                                 (29,915)
                                                                    ----------- 
          Total stockholders' equity                                  3,223,938 
                                                                    ----------- 
          Total liabilities and stockholders' equity                $ 5,390,766 
                                                                    =========== 

See accompanying notes to consolidated financial statements.                    

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eGames, Inc.
 Consolidated Statements of Operations
Years ended June 30, 1999 and 1998

                                                                [Download Table]


                                                         1999          1998    
                                                         ----          ----    
                                                                               
Net sales                                             $10,022,305  $ 9,275,889 

Cost of sales                                           3,596,982    3,441,793 
                                                      -----------  ----------- 
Gross profit                                            6,425,323    5,834,096 

Operating expenses:                                                            
     Product development                                  936,938      397,272 
     Selling, general and administrative                4,814,345    4,135,266 
                                                      -----------  ----------- 
        Total operating expenses                        5,751,283    4,532,538 
                                                      -----------  ----------- 

Operating income                                          674,040    1,301,558 

Interest expense, net                                      31,761       45,859 
                                                      -----------  ----------- 

Income before income taxes                                642,279    1,255,699 

Provision for income taxes                                179,724        3,069 
                                                      -----------  ----------- 

Net income                                                462,555    1,252,630 

Accretion of beneficial conversion feature on                                  
     preferred stocks, including dividend                                      
     payable in the form of Common Stock                    - 0 -     (117,991)
                                                      -----------  ----------- 

Net income attributable to Common Stock               $   462,555  $ 1,134,639 
                                                      ===========  =========== 

Net income per common share - basic                   $      0.05  $      0.13 
                                                      ===========  =========== 
Net income per common share - diluted                 $      0.05  $      0.12 
                                                      ===========  =========== 

Weighted average common shares outstanding - basic      9,494,988    8,716,756 

Dilutive effect of Common Stock equivalents               344,453      937,850 
                                                      -----------  ----------- 

Weighted average common shares outstanding - diluted    9,839,441    9,654,606 
                                                      ===========  =========== 


See accompanying notes to consolidated financial statements.                    

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eGames, Inc.
Consolidated Statements of Stockholders' Equity 
Years ended June 30, 1999 and 1998

                                                        [Enlarge/Download Table]


                                                                                             Additional              
                                           Preferred Stock             Common Stock           Paid-in     Accumulated
                                         Shares       Amount        Shares       Amount       Capital      Deficit   
                                        ----------   ----------    ---------   -----------  -----------  ----------- 
                                                                                                                     
Balance as of June 30, 1997              3,521,340   $3,415,899    6,535,614   $ 4,368,736  $ 1,148,550  ($7,865,363)

Net income                                                                                                 1,252,630 

Shares issued in connection with                                                                                     
   exercise of warrants and options                                  137,100       274,200                           

Shares issued in connection with the                                                                                 
   conversion of Class One Preferred    (1,000,000)  (1,000,000)     303,030     1,000,000                           

Shares issued in connection with the                                                                                 
   conversion of Class Two Preferred    (1,271,340)  (1,271,340)     907,948     1,271,340                           

Shares issued in connection with the                                                                                 
   conversion of Class Three Preferred  (1,250,000)  (1,250,000)   1,487,508     1,250,000                           

Effects from the beneficial conversion                                                                               
    feature of Class Two Preferred                        3,716                                               (3,716)

Effects from the beneficial conversion                                                                               
   feature of Class Three Preferred                     101,725                                             (101,725)

Stock dividend accrued                                                                                               
   on Class Three Preferred                                                         12,550                   (12,550)
                                        ----------   ----------  -----------   -----------  -----------  ----------- 
Balance as of June 30, 1998                  - 0 -   $    - 0 -    9,371,200   $ 8,176,826  $ 1,148,550  ($6,730,724)

Net income                                                                                                   462,555 

Shares issued in connection with                                                                                     
   exercise of warrants and options                                  312,140       485,063                           

Purchase of Treasury Stock                                                                                           

Foreign currency translation                                                                                         
   adjustment                                                                                                        

Shares issued in connection with                                                                                     
   acquisition                                                       150,000       213,000                           
                                        ----------   ----------    ---------   -----------  -----------  ----------- 
Balance as of June 30, 1999                  - 0 -   $    - 0 -    9,833,340   $ 8,874,889  $ 1,148,550  ($6,268,169)
                                        ==========   ==========    =========   ===========  ===========  =========== 


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                                                        [Enlarge/Download Table]


                                                                Accumulated                
                                                                  Other                    
                                           Treasury Stock      Comprehensive  Stockholders'
                                          Shares      Amount       Loss          Equity    
                                        ---------   ---------   ---------     ------------ 
                                                                                           
Balance as of June 30, 1997                 - 0 -   $   - 0 -   $   - 0 -       $1,067,822 

Net income                                                                       1,252,630 

Shares issued in connection with                                                           
   exercise of warrants and options                                                274,200 

Shares issued in connection with the                                                       
   conversion of Class One Preferred                                                 - 0 - 

Shares issued in connection with the                                                       
   conversion of Class Two Preferred                                                 - 0 - 

Shares issued in connection with the                                                       
   conversion of Class Three Preferred                                               - 0 - 

Effects from the beneficial conversion                                                     
    feature of Class Two Preferred                                                   - 0 - 

Effects from the beneficial conversion                                                     
   feature of Class Three Preferred                                                  - 0 - 

Stock dividend accrued                                                                     
   on Class Three Preferred                                                          - 0 - 
                                        ----------  ---------   ---------     ------------ 
Balance as of June 30, 1998                  - 0 -  $   - 0 -   $   - 0 -       $2,594,652 

Net income                                                                         462,555 

Shares issued in connection with                                                           
   exercise of warrants and options                                                485,063 

Purchase of Treasury Stock                 231,900   (501,417)                    (501,417)

Foreign currency translation                                                               
   adjustment                                                     (29,915)         (29,915)

Shares issued in connection with                                                           
   acquisition                                                                     213,000 
                                        ----------  ---------   ---------     ------------ 
Balance as of June 30, 1999                231,900  ($501,417)   ($29,915)      $3,223,938 
                                        ==========  =========   =========     ============ 


See accompanying notes to consolidated financial statements.                    

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eGames, Inc.
Consolidated Statements of Cash Flows 
Years ended June 30, 1999 and 1998

                                                        [Enlarge/Download Table]


                                                                 1999          1998     
                                                                 ----          ----     
                                                                                        
Cash flows from operating activities:                                                   
    Net income                                                $   462,555   $ 1,252,630 
    Adjustments to reconcile net income to net cash                                     
        provided by operating activities:                                               
    Depreciation and amortization                                 413,605       262,276 
    Changes in items affecting operations:                                              

             Restricted cash                                       (1,029)        8,257 
             Accounts receivable                                  173,007      (944,766)
             Prepaid expenses                                         891       146,154 
             Inventory                                           (206,127)     (431,160)
             Accounts payable                                     (95,956)      216,312 
             Accrued expenses                                     118,749       196,793 
                                                              -----------   ----------- 
Net cash provided by operating activities                         865,695       706,496 

Cash flows from investing activities:                                                   
    Purchase of furniture and equipment                          (192,685)     (187,416)
    Acquisition, net of cash acquired                             (12,929)        - 0 - 
    Purchase of software rights and other assets                 (107,498)     (217,615)
    Repayments of loan from related party                           - 0 -         2,000 
                                                              -----------   ----------- 
Net cash used in investing activities                            (313,112)     (403,031)

Cash flows from financing activities:                                                   
     Purchase of Treasury Stock                                  (501,417)        - 0 - 
     Repayments of notes payable                                 (123,851)      (39,594)
     Proceeds from exercise of warrants and stock options         485,063       274,200 
     Repayments of capital lease obligations                      (52,674)      (29,897)
                                                              -----------   ----------- 

Net cash provided by (used in) financing activities              (192,879)      204,709 

Effect of exchange rate changes on cash and cash equivalents          501         - 0 - 
                                                              -----------   ----------- 

Net increase in cash and cash equivalents                         360,205       508,174 

Cash and cash equivalents:                                                              
   Beginning of period                                            953,648       445,474 
                                                              -----------   ----------- 
   End of period                                              $ 1,313,853   $   953,648 
                                                              ===========   =========== 


See accompanying notes to consolidated financial statements.                    

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eGames, Inc.
 Consolidated Statements of Cash Flows
Years ended June 30, 1999 and 1998

                                                        [Enlarge/Download Table]


                                                                       1999      1998  
                                                                       ----      ----  
                                                                                       
Supplemental cash flow information:                                                    

Cash paid for interest                                               $ 58,409  $ 56,229
                                                                     ========  ========

Cash paid for income taxes                                           $128,051  $  - 0 -
                                                                     ========  ========

Non-cash investing and financing activities:                                           

           Capital lease additions                                   $ 26,147  $  - 0 -
                                                                     ========  ========

           150,000 shares of Common Stock issued in connection with                    
             acquisition                                             $213,000  $  - 0 -
                                                                     ========  ========


See accompanying notes to consolidated financial statements.                    

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eGames, Inc.
Notes to Consolidated Financial Statements

1.  Summary of Significant Accounting Policies                                  

Description of Business                                                         

eGames, Inc. (the "Company"),  a Pennsylvania  corporation  incorporated in July
1992,  develops,  publishes,  markets and sells a  diversified  line of personal
computer software  primarily for consumer  entertainment.  The Company's product
line  enables  it  to  serve   customers  who  are  seeking  a  broad  range  of
high-quality,  value-priced  software.  The  Company's  sales  are made  through
various  national  distributors on a  non-exclusive  basis in addition to direct
relationships with certain national retailers.                                  

Consolidation                                                                   

The consolidated  financial  statements  include the accounts of the Company and
its wholly-owned  subsidiary.  All inter-company  balances and transactions have
been eliminated.                                                                

Fair Value of Financial Instruments                                             

The recorded amounts of cash and short term  investments,  accounts  receivable,
and  accounts  payable  at June  30,  1999  approximate  fair  value  due to the
relatively short period of time between origination of the instruments and their
expected realization.  The Company's debt is carried at cost, which approximates
fair value,  as the debt bears  interest at rates  approximating  current market
rates for similar instruments.                                                  

Cash and Cash Equivalents                                                       

For purposes of the statements of cash flows,  the Company  considers all highly
liquid  instruments  purchased with an original maturity of three months or less
to be cash equivalents.                                                         

Inventory                                                                       

Inventory is valued at the lower of cost or market.  Cost is  determined  by the
first-in, first-out method (FIFO).                                              

Furniture and Equipment                                                         

Furniture and equipment  are stated at cost.  Depreciation  is calculated on the
straight-line  method over the estimated useful lives of the assets ranging from
three to five years.                                                            

Leasehold  improvements  are  amortized  on the  straight-line  method  over the
shorter of the lease term or  estimated  useful life of the assets.  Maintenance
and repair costs are expensed as incurred.                                      

Long-Lived Assets                                                               

In accordance with Statement of Financial  Standards Board No. 121,  "Accounting
for  Impairment of Long-Lived  Assets and for  Long-Lived  Assets to be Disposed
Of", the Company  records  impairment  losses on  long-lived  assets,  including
intangible assets,  used in operations when indicators of impairment are present
and the  undiscounted  cash flows  estimated to be generated by those assets are
less than the assets' carrying amount.                                          

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Intangible Assets                                                               

The Company has intangible assets resulting  primarily from goodwill  associated
with the eGames Europe, Ltd.  acquisition on August 14, 1998 and the purchase of
software rights and clip art images.  Accumulated  amortization at June 30, 1999
was $535,000.  The Company  amortizes its goodwill  totaling  $308,000 using the
straight-line  method  over five  years and other  intangible  assets  using the
straight-line method over three years. The Company recorded amortization expense
of  $249,000  and  $141,000  for  the  years  ended  June  30,  1999  and  1998,
respectively.                                                                   

Revenue Recognition                                                             

Product sales:                                                                  
--------------                                                                  

Revenue  from the sale of  products  is  recognized  when the  product  has been
shipped.  The  Company  offers  rights  of return  to  substantially  all of its
customers.  The Company recognizes product sales to its customers, in accordance
with  the  criteria  of FASB  No.  48,  at the  time of the  sale  based  on the
following:  the  selling  price  is fixed  at the  date of  sale,  the  buyer is
obligated to pay the Company,  title of the product  transfers to the buyer, the
buyer has economic  substance apart from the Company,  the Company does not have
further  obligations  to assist the buyer in the resale of the  product  and the
returns can be reasonably  estimated at the time of sale.  While the Company has
no other  obligations to perform  future  services  subsequent to shipment,  the
Company provides telephone customer support as an accommodation to purchasers of
its products and as a means of fostering customer loyalty. Costs associated with
this effort are insignificant and, accordingly, are expensed as incurred.       

Allowance for product returns:                                                  
------------------------------                                                  

The Company  distributes the majority of its products  through various  national
and regional  distributors and directly to national retailers.  The distribution
of these products is governed by distribution agreements, direct sale agreements
or purchase orders, all of which allow for product returns.  The Company records
an  allowance  for returns as a reduction  of gross sales at the time of product
shipment. This allowance, which is included in accounts receivable, is estimated
based primarily upon historical experience, analysis of distributor and retailer
inventories of the Company's products and analysis of retail sell-through of the
Company's products. Actual product returns experienced by the Company during the
years ended June 30, 1999 and 1998 were $859,000 and $39,000,  respectively,  or
nine percent and less than one percent of the Company's net sales, respectively.

Software Development Costs                                                      

Software   development  costs  are  expensed  as  incurred  until  technological
feasibility  has been  established.  After  technological  feasibility  has been
established,  any additional  costs are capitalized in accordance with Statement
of Financial Accounting Standards (SFAS) No. 86. To date, amounts qualifying for
capitalization, net of valuation allowances, have not been material.            

Marketing Promotions and Advertising Costs                                      

Marketing  promotions and  advertising  costs are charged to expense as incurred
and were  approximately  $534,000 and $520,000 for the years ended June 30, 1999
and 1998, respectively.                                                         

Income Taxes                                                                    

The Company uses 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.  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.                  

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Computation of Earnings Per Share                                               

Net  earnings  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
year.  Diluted  earnings  per share is computed by dividing  net earnings by the
weighted  average  number of common and  common  share  equivalents  outstanding
during each year.  Common share  equivalents  include stock options and warrants
using the treasury stock method.                                                

Accounting for Stock-based Compensation                                         

Stock-based  compensation  is  recognized  using the  intrinsic  value method in
accordance  with  Accounting  Principles  Board Opinion No. 25,  "Accounting for
Stock Issued to  Employees"  (APB 25). For  disclosure  purposes,  pro forma net
income/(loss)  and  income/(loss) per share data are provided in accordance with
SFAS 123, "Accounting for Stock-Based  Compensation" as if the fair value method
had been applied.                                                               

Management's Estimates                                                          

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the reported amounts of revenues and expenses during the reporting period.      
Actual results could differ from those estimates.                               

New Accounting Pronouncements                                                   

In March  1999,  the FASB  issued an  exposure  draft,  "Accounting  for Certain
Transactions  involving Stock  Compensation".  This exposure draft addresses the
application of Accounting  Standards  Board No. 25 to  stock-based  compensation
granted to independent  contractors and independent members of an entity's Board
of Directors,  as well as the accounting for option  re-pricing and modification
to the terms of a stock  option or award.  The  Company  intends to review  this
exposure draft to determine its impact on the Company's  financial  position and
results of operations.                                                          

In April 1998, the AICPA issued  Statement of Position  98-5,  "Reporting on the
Costs of Start-Up Activities"                                                   
(SOP 98-5).  SOP 98-5,  which is  effective  for fiscal  years  beginning  after
December  15, 1998,  provides  guidance on the  financial  reporting of start-up
costs and  organization  costs.  It requires  costs of start up  activities  and
organization  costs to be expensed as incurred.  As the Company has historically
expensed  these costs,  the adoption of this standard will not have an impact on
the Company's results of operations, financial position or cash flows.          

2.  Inventory                                                                   

Inventory consists of the following:                                            

Finished goods                                              $  879,028
Raw materials                                                  274,170
                                                            ----------
                                                            $1,153,198
                                                            ==========

3.  Furniture and Equipment                                                     

Furniture and equipment consists of the following:                              

Equipment                                                    $ 436,710
Furniture                                                      266,173
Equipment under capital leases                                 232,279
                                                             ---------
                                                               935,162
 Accumulated depreciation                                      (559,445)
                                                             ---------
Furniture and equipment, net                                 $ 375,717
                                                             =========

4.  Accrued Expenses                                                            

Accrued expenses consist of the following:                                      

Accrued payroll                                               $203,264
Accrued professional fees                                      123,321
Accrued taxes                                                   76,643
Accrued marketing promotions                                    68,504
Other accrued expenses                                         155,532
                                                              --------
                                                              $627,264
                                                              ========

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5.  Notes Payable                                                               

Notes payable consists of the following:                                        

Note payable, bearing interest of 9%.  Scheduled                      
principal payments of $39,500 each are due on July 1, 1999            
     and October 1, 1999.                                               $ 79,000

Note payable to bank, bearing interest at the prime rate plus         
2.75% (10.50% at June 30, 1999).  Matures on March 24, 2003,          
principal and interest of $5,953 payable monthly.  The note is        
guaranteed by a former officer of the Company and the Small           
     Business Administration.                                            224,681
                                                                        --------

                                                                         303,681

     Less current portion                                                129,210
                                                                        --------

     Long term portion                                                  $174,471
                                                                        ========

6.  Lease Obligations                                                           

The Company leases its North American and United  Kingdom  operating  facilities
under  two  operating  leases,  expiring  in  September  2002  and  March  2007,
respectively.  Rent  expense was  $204,000 and $157,000 for the years ended June
30, 1999 and 1998, respectively.                                                

The Company has financed the purchase of office  equipment and vehicles  through
capital lease  agreements.  The  obligations are  collaterallized  by the leased
assets, which had a net book value of approximately  $63,000 and $36,000 at June
30, 1999 and 1998, respectively and are recorded in Furniture and Equipment.    

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Future payments of leases are as follows:                                       

                                 Operating     Capital
                                             Leases      Leases      Total
                                              --------     -------    --------
  2000                                        $156,546     $27,560    $184,106
  2001                                         143,223      22,724     165,947
  2002                                         142,196       3,425     145,621
  2003                                          79,147       - 0 -      79,147
  2004                                          56,709       - 0 -      56,709
  2005 and thereafter                          135,828       - 0 -     135,828
                                              --------     -------    --------
                                              $713,649      53,709    $767,358
                                              ========     -------    ========
Less interest                                             (8,264)         
                                               -------
Present value of future lease payments                    45,445          
Less current portion                                     (22,986)         
                                               -------
Long term portion                                        $22,459          
                                               =======

7.  Convertible Subordinated Debt                                               

In  connection   with  the  merger  of  its  subsidiary   with  Virtual  Reality
Laboratories, Inc. ("VRLI") on April 5, 1996 the Company assumed $150,000 of 10%
convertible   subordinated  debt,   maturing  in  November  2000.  The  note  is
convertible  at any time into 46,685 shares of Common Stock at a price of $3.213
per  share,  (the  conversion  price  established  at the  time of the  merger).
Interest is payable quarterly.  The convertible debt is subordinated to the note
payable   ($224,681  at  June  30,  1999)   guaranteed  by  the  Small  Business
Administration.                                                                 

8.    Revolving Lines of Credit                                                 

On March 10,  1999,  the Company  entered  into a  $1,000,000  revolving  credit
facility with a commercial bank. Amounts  outstanding under this credit facility
are charged  interest at one-half of one percent above the bank's  current prime
rate and such interest is due monthly.  The credit facility is collateralized by
substantially  all of the Company's  assets.  The credit  facility  requires the
Company,  among other things, to maintain certain  financial ratios,  such as: a
minimum working capital balance of $1,500,000 and a maximum debt to net tangible
assets ratio of 1.50 to 1.00. As of June 30, 1999, the Company was in compliance
with each of those  covenants.  This credit facility was established to provide,
among  other  things,  additional  working  capital  to  support  the  Company's
anticipated  growth.  As of August 31, 1999,  the Company had not utilized  this
credit  facility,  which expires on October 31, 1999. On September 20, 1999, the
Company and its  commercial  bank  signed a  commitment  letter to increase  the
Company's  credit  facility from $1,000,000 to $1,500,000 and to extend its term
to October 31, 2000.                                                            

The Company's United Kingdom  operation has an $80,000 revolving credit facility
with a  commercial  bank.  Amounts  outstanding  under this credit  facility are
charged  interest at two and one-half percent above the bank's current base rate
and such  interest is due monthly.  As of August 31,  1999,  the Company had not
utilized this credit facility,  which expires on September 30, 1999. The Company
is currently in discussion  with the bank to extend the facility's  term through
September 30, 2000.                                                             

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9.    Acquisition                                                               

On August 14,  1998,  the  Company  acquired  all of the  outstanding  shares of
Software  Partners  Publishing and Distribution  Ltd.  ("Software  Partners") in
exchange  for  150,000  shares  of  the  Company's   Common  Stock,   valued  at
approximately  $213,000,  which was the  estimated  fair value of the  Company's
Common Stock on the acquisition  date.  This  acquisition was accounted for as a
purchase and the  corresponding  goodwill in the approximate  amount of $308,000
will be amortized over five years. On March 31, 1999,  Software Partners changed
its name to eGames Europe Ltd.  ("eGames  Europe").  For the year ended June 30,
1999,  eGames  Europe  contributed  $2,252,000  in net sales and $181,000 in net
income.  At June 30,  1998,  the  Company  had a trade  accounts  receivable  of
$122,000 with Software Partners and for the year ended June 30, 1998 the Company
had recorded $457,000 in sales through Software  Partners.  The Company believes
that this acquisition will allow the Company to expand its product  offerings in
the United  Kingdom,  while  providing a base for the Company to distribute  its
products into the European markets.                                             

The following summary of unaudited pro-forma financial  information gives effect
to the eGames  Europe  acquisition  as though it had  occurred  on July 1, 1997,
after  giving  effect to  certain  adjustments,  primarily  the  elimination  of
inter-company  sales and  amortization  of  goodwill.  The  unaudited  pro-forma
financial  information,  which is for informational purposes only, is based upon
certain  assumptions and estimates and does not necessarily  reflect the results
that would have occurred had the acquisition taken place at the beginning of the
period  presented,  nor are they necessarily  indicative of future  consolidated
results.                                                                        

 Unaudited Pro-Forma Financial Information

                                                     Years Ended
                                                    June 30,
                                                     ---------------------------
                                                      1999            1998
                                                      ----            ----
Net sales                                            $10,080,000     $10,453,000
Net income attributable to Common Stock              $   354,000     $   758,000
Net income per diluted share                         $      0.04     $      0.08

10.  Income Taxes                                                               

The  provision  (benefit)  for  income  taxes  is  comprised  of  the  following
components for the year ended June 30, 1999:                                    

                                                  Income Tax
                                                   Provision
                                                   -----------
Current                                                         
-------                                                         
   Federal                                         $    60,800
   State                                                85,151
   Foreign                                              33,773
                                                   -----------
                                                       179,724

Deferred                                                        
--------                                                        
    Federal                                          (1,623,400)
    State                                               (97,299)
                                                   -----------
                                                     (1,720,699)

Valuation allowance                                   1,720,699 
                                                   -----------
Provision for income taxes                          $   179,724 
                                                   ===========

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The  reconciliation  between  the  statutory  federal  income  tax  rate and the
Company's effective rate for income tax expense for the year ended June 30, 1999
is as follows:                                                                  
                                                                        Rate
                                                                        ----
Statutory  federal  income tax rate                                        34%  
Increase  (decrease) in taxes  resulting                                        
from:                                                                           
 Non-deductible goodwill amortization and other permanent items          3
  Foreign taxes                                                          (7)
  Utilization of net operating loss carryforwards and other              (2)
                                                                         ---
Effective rate for income tax expense                                      28%  
                                                                         ===

The  deferred tax asset is offset by a full  valuation  allowance as of June 30,
1999, as management  believes that it is more likely than not, that the deferred
tax asset will not be realized.                                                 

The tax effect of temporary  differences that give rise to significant  portions
of the deferred tax assets and  deferred  tax  liabilities  at June 30, 1999 and
1998 is as follows:                                                             

                                             1999           1998
                                             ----           ----
Deferred tax assets:                                                          
Accrued expenses and other                       $112,707       $108,900  
Reserves                                          204,442         39,668  
Depreciation                                        6,821          - 0 -  
Tax credits                                        10,003          - 0 -  
Net operating losses                           1,386,726      1,742,696   
                                             ----------     ----------
  Gross deferred tax assets                   1,720,699      1,891,264
Less: Valuation allowance                      (1,720,699)    (1,891,264) 
                                             ----------     ----------
Net deferred tax assets                             - 0 -          - 0 -  

Deferred tax liabilities:                             - 0 -          - 0 -    
                                             ----------     ----------

Net deferred tax assets/(liabilities)             - $ 0 -        - $ 0 -  
                                             ==========     ==========

As of June 30, 1999, the Company had  approximately  $4,000,000 of net operating
loss carry-forwards ("NOL's") for federal income tax purposes (expiring in years
2005 through  2012),  which may be available to offset  future  federal  taxable
income. The Company's NOL's may be subject to the provisions of Internal Revenue
Code Section 382 ("Section  382"), as established by the Tax Reform Act of 1986,
related to changes in stock  ownership.  As of June 30, 1999, the Company was in
the process of having an independent  study performed to make a determination on
what effect,  if any, the application of Section 382 may have on the utilization
of the NOL's.  Should these regulations  apply, the amount of the NOL's that can
be  utilized  to offset  taxable  income in future  periods may be subject to an
annual  limitation.  As a result of the Company's previous  acquisitions,  it is
possible  that some  portion  of the NOL's  may  never be  utilized  due to this
Section 382 limitation.                                                         

11.  Preferred Stock                                                            

During the year ended June 30, 1998, 1,000,000 shares of the Company's Class One
Convertible  Preferred Stock were converted into 303,030 shares of Common Stock;
1,271,340  shares of the Company's  Class Two  Convertible  Preferred Stock were
converted  into 907,948  shares of Common  Stock;  and  1,250,000  shares of the
Company's Class Three Convertible  Preferred Stock were converted into 1,487,508
shares of Common Stock.  As of June 30, 1999,  there were no shares of preferred
stock outstanding.                                                              

During  the year ended June 30,  1998,  the  Company  amortized  to  accumulated
deficit  $118,000 in the accretion of the beneficial  conversion  feature of the
Class Two and Class  Three  Convertible  Preferred  Stock,  including a dividend
payable in the form of Common Stock,  which  negatively  impacted the net income
per share during that period.  There was no such accretion during the year ended
June 30, 1999.                                                                  

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12.  Common Stock                                                               

On June 30, 1995, the Company amended its articles of incorporation to authorize
the  issuance of  40,000,000  shares of Common  Stock,  without  par value,  and
10,000,000 shares of preferred stock, without par value.                        

On June 1, 1999, the Board of Directors adopted a Stockholders  Rights Plan (the
"Plan"). The Plan is intended to protect the interests of the Company's existing
stockholders'  in the event that the  Company is  confronted  with  coercive  or
unfair  takeover  tactics.  The Plan contains  provisions to safeguard  existing
stockholders'  in the event of an  unsolicited  offer to  acquire  the  Company,
whether through a gradual  accumulation of shares in the open market,  a partial
or  two-tiered  tender offer that does not treat all  stockholders  equally,  or
other abusive takeover tactics,  which the Company's Board of Directors believes
are not in the best interests of the Company's  stockholders.  These tactics can
unfairly  pressure  stockholders  and  deprive  them of the full  value of their
shares.                                                                         

The Plan is not intended to prevent a takeover of the Company and will not do so
if the terms are favorable and fair to all stockholders.  The declaration of the
rights dividend (the "Rights") should not affect any prospective offer at a fair
price  to all  stockholders,  and  will not  interfere  with a  merger  or other
business combination transaction approved by the Company's Board of Directors.  

The  issuance  of the Rights will not change the way in which  stockholders  can
currently trade the Company's shares.  The Rights were issued to stockholders of
record on June 21, 1999, and will expire on June 1, 2009. Initially,  the Rights
will not be exercisable,  certificates will not be sent to any stockholders, and
the Rights will automatically trade with the Common Stock.                      

The  Rights  will not be  exercisable  until ten days  after any person or group
becomes the beneficial owner of 15% or more of the Company's Common Stock, or if
any  person or group  commences  a tender or  exchange  offer  which  would,  if
consummated,  result in such person becoming the beneficial owner of 15% or more
of the Company's Common Stock. At that time, separate certificates  representing
the  Rights  will be  distributed,  and the  Rights  could  then  begin to trade
independently  from the  Company's  shares.  At no time will the Rights have any
voting power.                                                                   

The Rights may be  redeemed  by the  Company at $.01 per Right prior to the time
any person or group has acquired 15% or more of the  Company's  shares or voting
power.  After  any  person or group has  acquired  15% or more of the  Company's
shares or voting  power,  the Rights may be redeemed only with the approval of a
majority of the Continuing Directors.  "Continuing Director" means any member of
the  Board of  Directors  who was a member  of the  Board on June 1, 1999 or any
person who is subsequently elected to the Board if such person is recommended or
approved by a majority of the Continuing Directors.                             

If the Rights  become  exercisable,  a holder  will be  entitled to buy from the
Company one  one-hundredth  (1/100) of a share of a new Series A Preferred Stock
of the Company at a purchase  price of $35. If a person  acquires 15% or more of
the  Company's  Common  Stock,  each Right not owned by such person would become
exercisable for Common Stock of the Company (or, in certain circumstances, cash,
property or other  securities of the Company) having a market value equal to two
times the exercise price of the Right.                                          

13.  Stock Options and Warrants                                                 

Stock Option Plans:                                                             

On August 31,  1994 the Company  adopted  its 1994 Stock  Option Plan (the "1994
Plan") under which  options to purchase an  aggregate  of 132,000  shares of the
Company's  Common Stock were  granted to officers,  directors or employees at an
exercise  price of $2.00 and with an  expiration  date of August 31, 1999. As of
June 30, 1999, 44,000 of the options under the 1994 Plan had been exercised.  As
of August 31, 1999,  an additional  55,000  options under the 1994 Plan had been
exercised and the remaining 33,000 options under the 1994 Plan expired. The 1994
Plan has been terminated and no additional options will be granted thereunder.  

During  1995,  the Company  adopted,  amended and  restated its 1995 Amended and
Restated  Stock  Option Plan (the "1995  Plan").  At the  Company's  1997 Annual
Meeting of  Stockholders,  the shareholders of the Company approved an amendment
to increase the number of shares available for issuance under the 1995 Plan from
the 950,000  shares of Common Stock  approved  during the 1996 Annual Meeting of
Stockholders  to a total of 1,950,000  shares.  The 1995 Plan is administered by
the Board of Directors and provides for the grant of incentive stock options and
non-qualified stock options to employees and eligible  independent  contractors;
and  non-qualified  stock options to  non-employee  directors at prices not less
than the fair market value of a share of Common Stock on the date of grant.  The
1995  Plan  also  provides  for  automatic  grants of  options  to  non-employee
directors of the Company.  Each  non-employee  director will receive options for
10,000 shares of Common Stock upon  appointment or election to the board and, in
addition,  each  director  receives  options for 5,000 shares of Common Stock on
January 1 of each year in which they are a director.  On December 14, 1998,  the
Company granted  options for 25,000 shares of Common Stock to each  non-employee
director in lieu of the automatic  annual option grants for 5,000 shares to each
non-employee director pursuant to the 1995 Plan, which would have been issued in
January 1999.                                                                   

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The  expiration  of an option and the vesting  period will be  determined by the
Board of Directors  at the time of the grant,  but in no event will an option be
exercisable  after  10  years  from  the  date  of  grant,  or in  the  case  of
non-employee  directors,  after 5 years from the date of grant.  In most  cases,
upon termination of employment, vested options must be exercised by the optionee
within 3 months after the  termination  of the  optionee's  employment  with the
Company.                                                                        

Information regarding the stock option plans is as follows:                     

                                              Number of     Weighted Average
                                              Options       Exercise Price
                                             ----------       --------------
Balances, June 30, 1997                        729,972         $ 3.10     
Granted                                    1,045,000           2.06   
Canceled                                    (528,821)          3.44   
Exercised                                    (20,000)          2.00   
                                       ----------         ------
Balances, June 30, 1998                      1,226,151         $ 2.08     
Granted                                      549,400           2.00   
Canceled                                     (63,819)          1.95   
Exercised                                    (41,832)          1.99   
                                       ----------         ------
Balances, June 30, 1999                      1,669,900         $ 2.06     
                                       ==========         ======

At June 30, 1999, 835,750 options outstanding under its 1994 and 1995 Plans were
vested and 420,268  options were available for issuance  under these plans.  The
following  summarizes  information about the Company's stock options outstanding
at June 30, 1999:                                                               

                                                        [Enlarge/Download Table]


                              Options Outstanding                    Options Exercisable    
                  ----------------------------------------------  --------------------------

                                     Weighted Avg.      Weighted                    Weighted
                      Number           Remaining          Avg.        Number          Avg.  
    Range of      Outstanding at    Contractual Life    Exercise  Exercisable at    Exercise
Exercises Prices   June 30, 1999       (in years)         Price    June 30, 1999      Price 
----------------   -------------       ----------         -----    -------------      ----- 
                                                                                            
 $1.35 - $2.00       1,258,000            3.08            $1.80       682,750         $1.93 
 $2.03 - $4.09         411,900            3.81            $2.86       153,000         $2.69 
                     ---------            ----            -----       -------         ----- 
 $1.35 - $4.09       1,669,900            3.26            $2.06       835,750         $2.07 
                     =========            ====            =====       =======         ===== 

The Company  applies APB 25 and related  interpretations  in accounting  for its
stock option plans. Had compensation costs for the Company's 1994 and 1995 Plans
been determined under Statement No. 123, the Company's net income/(loss) and net
income/(loss)  per share  would have been  negatively  impacted by the pro forma
amounts indicated below:                                                        

                                                        [Enlarge/Download Table]

                                                                Years ended June 30,  

                                                                1999           1998   
                                                                ----           ----   

                                                                                      
Net income/(loss) attributable to Common Stock  As reported   $462,555      $1,134,639
                                                Pro forma    ($280,761)       $563,254

Net income/(loss) per share - basic             As reported     $0.05          $0.13  
                                                Pro forma      ($0.03)         $0.06  

Net income/(loss) per share - diluted           As reported     $0.05          $0.12  
                                                Pro forma      ($0.03)         $0.06  


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The per share  weighted-average  fair values of stock options granted during the
years  ended June 30, 1999 and 1998 were $1.47 and $1.52,  respectively,  on the
date of grant using the  Black-Scholes  option-pricing  model with the following
assumptions:                                                                    

                                            Years ended June 30,

                                            1999                1998
                                            ----                ----
Dividend yield                                 0%                  0% 
Volatility factor                         119.85%             119.43% 
Risk-free interest rate             4.41% - 5.35%       5.51% - 6.13% 
Average expected option life           3.19 Years          4.74 Years 

On May 22, 1997, the Company  cancelled the options  outstanding  under the 1995
Plan that had  exercise  prices in excess of the market  price of the  Company's
Common  Stock on May 22,  1997,  and  reissued all such options with an exercise
price of $3.50.  On July 1, 1997 the Company  cancelled the options  outstanding
under the 1995 Plan that had  exercise  prices in excess of the market  price of
the Company's  Common Stock on July 1, 1997,  and reissued all such options with
an exercise price of $2.00.                                                     

On March 24, 1998,  20,000 stock options were exercised and the Company received
net proceeds of $40,000.                                                        

On  December  14,  1998,  the Company  granted a total of 75,000  options to its
non-employee Board members.  Each non-employee  director received 25,000 options
at an exercise price of $1.656,  the fair value of the Company's Common Stock on
the date of grant.  These options vest over a three-year period and expire after
a period of five years.  These options were not issued  pursuant to any plan and
were issued in lieu of the  automatic  annual  option grants for 5,000 shares to
each  non-employee  director  pursuant  to the 1995 Plan,  which would have been
issued in January 1999.                                                         

During the year ended June 30, 1999, the Company received  approximately $83,000
in net proceeds from the exercise of 41,832 stock  options with exercise  prices
ranging from $1.83 to $2.00.                                                    

Common Stock Warrants:                                                          

In April 1995, the Company received $100,000 in connection with the private sale
of a warrant to acquire 220,662 shares of the Company's Common Stock at any time
on or before April 27, 2002 at an exercise price of $.45 per share.  The warrant
holder  was also  granted  certain  registration  rights  for the  Common  Stock
issuable upon exercise of the warrants, which shares have been registered by the
Company.  Also in April 1995, the Company  issued 15,000  warrants to a group of
private  investors.  These warrants are exercisable at any time on or before May
1, 2000 at an exercise  price equal to the greater of $3.00 per share or 120% of
the  offering  price  of the  Company's  Common  Stock  pursuant  to  the  first
registration  statement  filed by the Company  pursuant to the Securities Act of
1933.  No value  was  assigned  to these  warrants.  On  October  18,  1995,  in
connection  with the Company's  initial  public  offering of Common  Stock,  the
underwriter  was granted  155,000  warrants.  These warrants are  exercisable at
anytime on or before  October 13, 2000 at an exercise  price of $3.60 per share,
which exercise price was adjusted as described below.  Registration  rights were
granted  for the  Common  Stock  issuable  upon  exercise  of the  underwriter's
warrants, and such Common Stock has been registered by the Company. In addition,
425,000  warrants  were  issued to the former  owners of Applied  Optical  Media
Corporation,  of which 1,200  warrants were  exercised on March 1, 1996,  45,200
warrants were exercised on January 24, 1997 and 198,687  warrants were exercised
on January 30, 1997. The remaining  warrants from this group are  exercisable at
any time on or before October 16, 2002 at an exercise price of $.50 per share.  

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Information regarding the warrants is as follows:                             

                                     Number of Warrants       Exercise Price
                                     ------------------       --------------
   Balances, June 30, 1997                 955,887             $0.50 - $6.00
     Warrants granted                        - 0 -                     - 0 -
     Warrants canceled                       - 0 -                     - 0 -
     Warrants exercised                   (117,100)                     2.00
                                          ---------           --------------
   Balances, June 30, 1998                 838,787             $0.50 - $6.00
     Warrants granted                        - 0 -                     - 0 -
     Warrants canceled                       - 0 -                     - 0 -
     Warrants exercised                   (270,308)              0.50 - 2.81
                                          ---------           --------------
   Balances, June 30, 1999                 568,479             $0.50 - $6.00
                                          =========           ==============

The exercise price of 355,975 warrants was automatically  adjusted from $6.25 to
$2.81 per share in June 1997 as a result of an  anti-dilution  provision  in the
warrant agreements.                                                             

On October 1, 1997, the Company  adjusted the exercise price of 332,988 warrants
to acquire the Company's  Common Stock to $2.00 per share, the fair market value
of the Company's  Common Stock on October 1, 1997,  until  December 12, 1997. Of
the 332,988  warrants,  155,000  were  originally  issued at $3.60 per share and
177,988  were  issued at $6.00 per share.  During  the  quarter  ended  December
31,1997,  117,100 of such warrants were  exercised and the Company  received net
proceeds of $234,200.  The warrants that were not exercised  during the exercise
price reduction  period were  subsequently  returned to their original  exercise
prices.                                                                         

During the year ended June 30,  1999,  the  Company  received  net  proceeds  of
$402,000 from the exercise of 270,308 warrants with exercise prices ranging from
$0.50 to $2.81.                                                                 

14.  Commitments and Contingencies                                              

Under various licensing agreements,  the Company is required to pay royalties on
the sales of certain products that incorporate licensed content. Royalty expense
under such  agreements,  which is recorded in cost of sales,  was  approximately
$507,000 and $162,000 for the years ended June 30, 1999 and 1998, respectively. 

The Company has a retirement  plan  covering  substantially  all of its eligible
employees. The retirement plan is qualified in accordance with Section 401(k) of
the Internal  Revenue  Code.  Under the plan,  employees  may defer up to 15% of
their  pre-tax  salary,   but  not  more  than  statutory  limits.  The  Company
contributes  50% of each dollar  contributed  by a  participant.  The  Company's
matching  contributions  to the plan were  $76,000 and $42,000  during the years
ended June 30, 1999 and 1998, respectively. The Company's matching contributions
vest in fifty percent increments over a two-year period.                        

15.  Related Party Transactions                                                 

During the years  ended June 30, 1999 and 1998,  the Company  engaged in certain
related  party  transactions  with a company owned and operated by an individual
who also  performed the buyer  function for the Company as a part- time employee
during the year ended June 30, 1998. As of June 30, 1998, this individual was no
longer an employee and was  continuing  to perform the function of a distributor
of the Company's  line of products.  The Company  recorded  $56,000 in sales and
$16,000 in commission expense with this related party during the year ended June
30, 1999.  The Company  recorded  $773,000 in sales and  $220,000 in  commission
expense with this related party during the year ended June 30, 1998. At June 30,
1999, the Company had a trade accounts receivable of approximately  $22,000 with
this related party.                                                             

On June 22, 1998,  the Company  accepted the  resignation of Joseph A. Falsetti,
the  Company's  Chairman  and  Chief  Executive  Officer.  As the  result of the
separation agreement and general release dated June 22, 1998 between the Company
and Mr. Falsetti, the Company expensed approximately $225,000 in severance costs
in the year ended June 30, 1998,  which was paid out over the next twelve months
during the year ended June 30, 1999.                                            

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16.  Major Customers and Export Sales                                           

During the years  ended June 30,  1999 and June 30,  1998,  the  Company had two
customers,  which accounted for  approximately  65% and 5% and 81% and 8% of net
sales, respectively. As of June 30, 1999 these customers represented 63% and 5%,
respectively,  of gross  accounts  receivable.  During  April 1999,  the Company
transitioned  its  previously  exclusive  distribution  agreement  with GT Value
Products  Corporation  ("GT Value  Products"),  (a  division  of GT  Interactive
Software  Corp.  "GTIS")  covering  distribution  of the  Company's  products to
retailers in North America, to a non-exclusive distribution  relationship.  GTIS
is currently one of the largest distributors of consumer  entertainment software
to mass merchants in the United States. During the years ended June 30, 1999 and
1998, GT Value Products  accounted for approximately 65% and 81%,  respectively,
of the Company's net sales. The Company is continuing to distribute its products
through GT Value  Products as well as through  various other  distributors  on a
non-exclusive  basis.  The  Company  believes  that for the year ending June 30,
2000,  sales  to  GT  Value  Products  could  account  for  a  decreasing,   but
significant,  amount of the  Company's  net sales.  The  amount of export  sales
included in net sales was approximately $2,691,000 and $694,000 or 27% and 8% of
the   Company's  net  sales  for  the  years  ended  June  30,  1999  and  1998,
respectively.                                                                   

17.  Liquidity                                                                  

As indicated in the accompanying financial statements,  the Company's net income
for fiscal 1999 was  $463,000 and the  Company's  net income for fiscal 1998 was
$1,253,000.  In addition, cash provided by operating activities was $866,000 and
$707,000 for the years ended June 30, 1999 and 1998, respectively.              

On September 20, 1999, the Company and its  commercial  bank signed a commitment
letter to increase the Company's  credit  facility from $1,000,000 to $1,500,000
and to extend its term to October 31, 2000.                                     

The  Company's  ability to achieve  positive cash flow depends upon a variety of
factors,  including the  timeliness  and success of  developing  and selling its
products,  the costs of  developing,  producing and marketing  such products and
various other factors, some of which may be beyond the Company's control. In the
future,  the Company's  capital  requirements  will be affected by each of these
factors.  The  Company  believes  cash  and  working  capital  balances  will be
sufficient to fund the Company's operations for the foreseeable future. However,
there can be no assurances  that the Company will be able to maintain a positive
cash flow or that  additional  financing  will be available if and when required
or, if available, will be on terms satisfactory to the Company.                 

At June  30,  1999  the  Company  continued  to  satisfy  the  minimum  level of
Stockholders' equity required and all other aspects of its listing agreement for
the Nasdaq SmallCap Market.  At June 30, 1999, the Company had $2,967,000 in net
tangible assets.                                                                

18. Operations by Reportable Segments and Geographic Area                       

The Company  adopted SFAS No. 131,  "Disclosure  about Segments of an Enterprise
and Related Information", as of July 1, 1998. SFAS No. 131 establishes standards
for reporting  information about an enterprise's  operating segments and related
disclosures about its products, geographic areas and major customers.           

The Company publishes interactive  entertainment  software for PCs. Based on its
organizational  structure,  the  Company  operates  in only one  non-geographic,
reportable segment, which is publishing.                                        

The President and Chief  Executive  Officer  allocates  resources to each of the
geographical  areas in which the Company  operates  using  information  on their
respective  revenues  and  operating  profits  before  interest  and taxes.  The
President and Chief Executive Officer has been identified as the Chief Operating
Decision Maker as defined by SFAS No. 131.                                      

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The accounting policies of these segments are the same as those described in the
Summary of Significant  Accounting Policies.  Revenue derived from sales between
segments is eliminated in consolidation.                                        

Geographic  information  for the two years ended June 30, 1999 and 1998 is based
on  the  location  of  the  selling  entity.  Information  about  the  Company's
operations by segmented  geographic  locations for the years ended June 30, 1999
and June 30, 1998 is presented below.                                           

                                                                [Download Table]


                  United States  United Kingdom  Eliminations  Consolidated
                  -------------  --------------  ------------  ------------
1999:                                                                      
                                                                           
Sales                $8,490,642      $2,251,628    ($719,965)   $10,022,305
Operating Income        444,794         229,246         - 0 -       674,040
Assets               $5,010,286      $  862,219    ($481,739)   $ 5,390,766

1998:                                                                      
Sales                $9,275,889      $    - 0 -     $   - 0 -   $ 9,275,889
Operating Income      1,301,558           - 0 -         - 0 -     1,301,558
Assets               $4,403,422      $    - 0 -     $   - 0 -   $ 4,403,422


19.  Comprehensive Income                                                       

On July 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income".
This Statement  requires that all items that are required to be recognized under
accounting  standards as  components  of  comprehensive  income be reported in a
financial  statement  that is  displayed  with  the  same  prominence  as  other
financial statements. Comprehensive income is computed as follows:              

                                             Years Ended
                                              June 30,
                                               ---------------------------
                                              1999              1998
                                              ----              ----
Net income attributable to Common Stock           $462,555         $1,134,639   
Other comprehensive income:                                                     
Foreign currency translation adjustment         (29,915)             - 0 -
                                               --------         ----------
Comprehensive income                              $432,640         $1,134,639   
                                               ========         ==========

Item  8.     Changes  in and  Disagreements  with  Accountants  on  Accounting  
and Financial Disclosure                              

None.                                                                           

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PART III

Item 9.      Directors and Executive Officers of the Registrant                 

There is hereby incorporated herein by reference the information appearing under
the caption "Election of Directors",  under the caption  "Executive  Officers of
the Company",  and under the caption  "Compliance  with Securities  Laws" of the
Registrant's   definitive  Proxy  Statement  for  its  1999  Annual  Meeting  of
Stockholders to be filed with the Securities and Exchange Commission.           

Item 10.     Executive Compensation                                             

There is hereby incorporated herein by reference the information appearing under
the  caption  "Executive  Compensation"  and  under  the  caption  "Election  of
Directors" of the  Registrant's  definitive  Proxy Statement for its 1999 Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission.

Item 11.     Security Ownership of Certain Beneficial Owners and Management     

There is hereby incorporated herein by reference the information appearing under
the  caption  "Voting   Securities  and  Principal   Holders   Thereof"  of  the
Registrant's   definitive  Proxy  Statement  for  its  1999  Annual  Meeting  of
Stockholders to be filed with the Securities and Exchange Commission.           

Item 12.     Certain Relationships and Related Transactions                     

There is hereby incorporated by reference herein the information appearing under
the  caption  "Certain  Transactions"  of  the  Registrant's   definitive  Proxy
Statement  for its 1999  Annual  Meeting  of  Stockholders  to be filed with the
Securities and Exchange Commission.                                             

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Item 13.     Exhibits, List and Reports on Form 8-K                             

               The following is a list of exhibits  filed as part of this annual
               report on Form 10-KSB.  Where so indicated,  exhibits  which were
previously filed are incorporated by reference.   

Exhibit No.                Description of Exhibit                         
-----------                ----------------------                         

(1)   2.1 Form of Amended and Restated  Agreement  and Plan of Merger 
             between and among  Applied  Optical Media  Corporation  and the
Registrant ("AOMC Merger Agreement").             

(2)   2.2 Agreement and Plan of Reorganization dated April 4, 1996 by 
             and  among  the  Registrant,   the  Registrant's   wholly-owned
subsidiary and Virtual Reality Laboratories, Inc. 

(2)   2.3 Agreement  and Plan of Merger  dated  April 4, 1996 by and  
             among the Registrant,  the Registrant's wholly-owned subsidiary
and Virtual Reality Laboratories, Inc.            

(3)   2.4 Sale and Purchase  Agreement between the Registrant and the 
             stockholders of Software  Partners  Publishing and Distribution
Ltd. dated August 14, 1998.                       

     (5)   3.1 Amended and Restated Articles of Incorporation of the Registrant.

(6) 3.2.1 By-Laws of the Registrant.                                  

(7)   4.1 Promissory  Note in the amount of $350,000  from Virtual    
               Reality  Laboratories,  Inc. to Heller First Capital  Corporation
               dated March 25, 1996;  Commercial  Security Agreement dated March
               25, 1996 between  Virtual Reality  Laboratories,  Inc. and Heller
               First Capital Corporation; and U.S. Small Business Administration
Guaranty dated March 25, 1996.                    

(4)   4.2 Rights Agreement,  dated as of June 1, 1999,  between the   
Registrant and StockTrans, Inc.                   

(5)  10.1 Form of  Redeemable  Warrant  for the  Purchase  of the     
              Registrant's Common Shares (Exhibit A to AOMC Merger Agreement).

(5)  10.2 Form of Underwriter's Warrant Agreement.                    

(5)  10.3 1994 Stock Option Plan.                                     

(3)  10.4 Amended and Restated 1995 Stock Option Plan.                

(8)  10.5 Form of Purchase Agreement for the Class Two Convertible    
               Preferred Stock (the "Class Two Preferred")  dated as of November
15, 1996.                                         

(8)  10.6 Form  of  Warrant  Agreement  for  the  Warrants  (the      
"Warrants") issued to the holders of the          
Class Two Preferred dated as of November 15, 1996.

(8)  10.7 Form of Registration Rights Agreement for the Common Stock  
             underlying the Class Two Preferred and the Warrants dated as of
November 15, 1996.                                

(8)  10.8 Form of Agreement  amending certain terms of the Class Two  
             Preferred Certificate of Designation, Warrants and Registration
Rights Agreement dated as of November 15, 1996.   

(9)  10.9 Purchase  Agreement  dated January 30, 1997 between the     
Registrant and Odyssey Capital Group, L.P.        

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Exhibit No.                Description of Exhibit                         
-----------                ----------------------                         

(9) 10.10 Agreement dated January 30, 1997 between the Registrant     
and Odyssey Capital Group, L.P.                   

(9) 10.11 Registration  Rights  Agreement dated January 30, 1997      
    between the Registrant and Odyssey Capital Group, L.P.

(10) 10.12 Form of  Securities  Purchase  Agreement for the Class       
              Three Convertible Preferred Stock (the "Class Three Preferred").

(10) 10.13 Form of Warrant Agreement for the Warrants (the "Class       
               Three  Warrants")  issued  to  the  holders  of the  Class  Three
Preferred.                                        

(10) 10.14 Form of Registration  Rights  Agreement for the Common       
               Stock  underlying  the Class Three  Preferred and the Class Three
Warrants.                                         

(11) 10.15 Warrant Agreement dated January 30, 1997 by and between      
Registrant and PJM Trading Company, Inc.          

(3) 10.16 Separation  Agreement and General Release dated June 22,    
 1998 between the Registrant and Joseph A. Falsetti.

(12) 10.17 Line of Credit Note dated March 10, 1999 by and between      
the Registrant and Sovereign Bank.                

   (12) 10.18 Line of Credit Loan and Security  Agreement dated March 10, 1999
by and between the Registrant and Sovereign Bank. 

         10.19 Description of Registrant's 1998 Employee Incentive  Compensation
Plan                                              

21.1 Subsidiaries.                                          

23.1 Consent of KPMG LLP.                                   

(13)  24.1 Power of Attorney.                                           

27.1 Financial Data Schedule.                               

--------------------------------------------------------------------------------

     (1)   Incorporated  by  reference  herein  from  Amendment  No.  3  of  the
           Registrant's  Form SB-2 as filed  with the  Securities  and  Exchange
Commission on October 4, 1995.                            
   (2)   Incorporated by reference herein from the Registrant's  Form 8-K as
          filed with the Securities and Exchange Commission on April 19, 1996.
     (3)   Incorporated  herein by reference from the  Registrant's  Form 10-KSB
        for the year  ended  June  30, 1998 as  filed  with the Securities
and Exchange Commission on September 10, 1998.            
     (4)   Incorporated by reference  herein from the  Registrant's  Form 8-K as
         filed with the Securities and Exchange Commission on June 10, 1999.
     (5)   Incorporated by reference herein from the  Registrant's  Form SB-2 as
         filed with the Securities and Exchange Commission on July 28, 1995.
     (6)   Incorporated by reference  herein from the  Registrant's  Form 10-QSB
           for the quarter ended September 30, 1998 as filed with the Securities
and Exchange Commission on November 16, 1998.             
     (7)   Incorporated by reference  herein from the  Registrant's  Form 10-QSB
           for the quarter ended March 31, 1996 as filed with the Securities and
Exchange Commission on May 14, 1996.                      
     (8)   Incorporated by reference  herein from the  Registrant's  Form 8-K as
           filed with the  Securities  and Exchange  Commission  on November 27,
1996.                                                     
     (9)   Incorporated by reference  herein from the  Registrant's  Form 8-K as
           filed with the  Securities  and  Exchange  Commission  on February 4,
1997.                                                     

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    (10)   Incorporated by reference  herein from the  Registrant's  Form 8-K as
         filed with the Securities and Exchange Commission on April 9, 1997.
    (11)   Incorporated  herein by reference from the  Registrant's  Form 10-KSB
           for the year ended June 30,  1997 as filed  with the  Securities  and
Exchange Commission on September 29, 1997.                
    (12)   Incorporated by reference  herein from the  Registrant's  Form 8-K as
          filed with the Securities and Exchange Commission on March 22, 1999.
(13)   See signature page.                                              

Reports on Form 8-K                                                             

On June 10, the Company  filed a report on Form 8-K  regarding  a press  release
announcing  that the  Company's  Board of  Directors  had adopted a  Shareholder
Rights Plan.                                                                    

On July 23, the Company  filed a report on Form 8-K  regarding  a press  release
announcing the Company's sales and earnings for the year ended June 30, 1999.   

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SIGNATURES

         In  accordance  with  Section  13 or 15(d)  of the  Exchange  Act,  the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereunto duly authorized.                                                      

eGames, Inc.                                                                    

By: /s/ Gerald W. Klein                                                         
------------------------------------------------------                  
Gerald W. Klein, President and Chief Executive Officer                  

Date: September 28, 1999                                                        
------------------                                                  

         In accordance  with the Exchange Act, this report has been signed below
by the following  persons on behalf of the  registrant and in the capacities and
on the dates indicated.                                                         

Date: September 28, 1999               /s/ Gerald W. Klein                      
------------------               -------------------                
                                  Gerald W. Klein, President and Chief
               Executive Officer

Date: September 28, 1999               /s/ Thomas W. Murphy                     
------------------               --------------------               
                                       Thomas W. Murphy, Chief Financial Officer
                          and Chief Accounting Officer

         Each person in so signing also makes,  constitutes  and appoints Thomas
D. Parente,  Chairman of the Board of Directors,  and Gerald W. Klein, President
and Chief Executive  Officer,  and each of them  severally,  his true and lawful
attorney-in-fact,  in his name, place and stead to execute and cause to be filed
with the  Securities  and  Exchange  Commission  any or all  amendments  to this
report.                                                                         

Date: September 28, 1999               /s/ Thomas D. Parente                    
------------------               ---------------------              
               Thomas D. Parente
                                Chairman of the Board of Directors

Date: September 28, 1999               /s/ Robert M. Aiken, Jr.                 
------------------               ------------------------           
                  Robert M. Aiken, Jr.
      Director

Date: September 28, 1999               /s/ Lambert C. Thom                      
------------------               -------------------                
             Lambert C. Thom
      Director

Dates Referenced Herein   and   Documents Incorporated by Reference

				Referenced-On Page
This ‘10KSB’ Filing		Date		First		Last			Other Filings
		6/1/09		39
		3/24/03		35
		10/16/02		41
		4/27/02		41
		10/31/00		12		43
		10/13/00		41
		9/30/00		36					10QSB,  10QSB/A
		6/30/00		18		43			10KSB
		5/1/00		41					8-K
		10/31/99		12		36
		10/1/99		35
		9/30/99		36					10QSB
Filed on:		9/28/99		49					8-K
		9/21/99		20
		9/20/99		12		43
		9/14/99		1
		8/31/99		1		39
		8/19/99		25
		7/1/99		35
For Period End:		6/30/99		1		48
		6/21/99		39
		6/10/99		47					8-K
		6/1/99		39		46			8-K
		3/31/99		3		37			10QSB,  8-K
		3/22/99		48					8-K
		3/10/99		12		47			8-K
		12/15/98		34
		12/14/98		39		41
		11/16/98		47					10QSB
		10/26/98		20					8-K
		9/30/98		47					10QSB
		9/10/98		47					10KSB
		8/14/98		19		46			8-K
		7/1/98		43		44
		6/30/98		11		47			10KSB
		6/22/98		42		47
		3/24/98		41
		12/12/97		42
		10/1/97		42
		9/29/97		48					10KSB
		7/1/97		37		41
		6/30/97		29		48			10KSB
		5/22/97		41
		4/9/97		48					8-K
		2/4/97		47					8-K
		1/30/97		41		47			8-K
		1/24/97		41
		11/27/96		47					8-K
		11/15/96		46					8-K
		5/14/96		47					10QSB
		4/19/96		47
		4/5/96		36
		4/4/96		46
		3/31/96		47					10QSB
		3/25/96		46
		3/1/96		41
		10/18/95		41
		10/4/95		47
		7/28/95		47
		6/30/95		39
		8/31/94		39
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