Document/Exhibit Description Pages Size
1: 10KSB Egames, Inc. 10Ksb, Fiscal Year 2005 52 259K
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, 2005
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-27102
eGames, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2694937
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
2000 Cabot Boulevard, Suite 110, Langhorne, PA 19047-1811
(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 None
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 )
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act): Yes ( ) No ( X )
State issuer's revenues for its most recent fiscal year: $5,344,000
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: $3,425,000 as of September 21, 2005.
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: 10,906,754 shares of Common Stock, no
par value per share, as of September 21, 2005.
Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X )
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the issuer's definitive proxy statement for its 2005 Annual Meeting
of Shareholders are incorporated by reference into Part III and Part IV of this
report. With the exception of those portions, which are expressly incorporated
by reference, the proxy statement is not deemed to be filed as a part of this
report.
eGames, Inc.
Form 10-KSB
For the Fiscal Year Ended June 30, 2005
INDEX
Page
----
PART I
Item 1. Business......................................................... 3
Item 2. Properties....................................................... 13
Item 3. Legal Proceedings................................................ 13
Item 4. Submission of Matters to a Vote of Security Holders ............. 13
PART II
Item 5. Market for the Registrant's Common Stock, Related Stockholder
Matters and Small Business Issuer Purchases of Equity
Securities....................................................... 14
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations ........................................... 15
Item 7. Financial Statements ............................................ 28
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ........................................... 43
Item 8A. Controls and Procedures ........................................ 43
Item 8B. Other Information .............................................. 43
PART III
Item 9. Directors and Executive Officers of the Registrant, Promoters
and Control Persons, Compliance with Section 16(a) of the
Exchange Act..................................................... 43
Item 10. Executive Compensation.......................................... 44
Item 11. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters................................. 44
Item 12. Certain Relationships and Related Transactions ................. 44
PART IV
Item 13. Exhibits ....................................................... 45
Item 14. Principal Accountant Fees and Services.......................... 45
Signatures................................................................ 46
PART I
This annual report on Form 10-KSB contains forward-looking statements about
future events and our future financial performance that involve risks and
uncertainties. Actual events and our actual future financial results may differ
substantially from the events and results discussed in the forward-looking
statements due to various factors, including, but not limited to, those
discussed in "Factors Affecting Future Performance" beginning on page 9.
Item 1. Business
GENERAL
eGames, Inc. ("eGames", "our", "us" or "we") is a Pennsylvania corporation
incorporated in July 1992 that publishes, markets and sells affordable PC
software games. Historically, we have focused on publishing software games for
the PC platform only. We are currently evaluating various opportunities to
publish quality content for other gaming platforms, such as console devices,
hand held game devices and mobile phones. We sell products to consumers who are
seeking a broad range of high-quality, affordable PC gaming software, which are
sold on CDs through retail distribution or online via the Internet. In North
America, our PC games are distributed primarily through third-party software
distributors who service mass-merchant and major retailers. In territories
outside North America, we license our PC games to third-party software
distributors who are responsible for the manufacture and distribution of our PC
games within specific geographic territories.
All eGames titles are family friendly, easy-to-use, and are typically rated E
for Everyone by the Entertainment Software Ratings Board, which means they are
non-violent and appropriate for all ages. The majority of our software titles
are sold in jewel case packaging, but we also sell a small number of higher
priced box titles retail priced at $19.99. We promote the eGames(TM) brand in
order to generate customer loyalty, encourage repeat purchases and differentiate
eGames software products to retailers and consumers.
Acquisition of Assets of Cinemaware, Inc.
-----------------------------------------
eGames expects to enter into an Asset Purchase Agreement (the "Agreement") with
Cinemaware, Inc. ("Cinemaware") during or prior to the first week of October to
purchase substantially all of the assets of Cinemaware. The assets to be
acquired upon closing of the transaction, anticipated to occur in October, 2005,
principally consist of intellectual property, contract rights and goodwill. As
part of the transaction, at closing Cinemaware and its principal shareholder,
Lars Fuhrken-Batista, will enter into non-competition agreements, and Mr.
Batista will become Vice President of Development for eGames. We currently
intend to use the Cinemaware assets for the purposes of developing new
higher-priced PC game titles and console game titles.
In consideration for the Cinemaware assets, at closing eGames will issue shares
of its common stock equal to $300,000 divided by the average closing price of a
share of eGames common stock for the five trading days prior to the date of the
Agreement, and the five trading days ending one trading day prior to the
closing, but in no event less than 600,000 shares or more than 855,000 shares.
Also at closing, eGames will issue to Cinemaware a warrant to purchase 150,000
shares of eGames common stock at an exercise price of $.50 per share, and a
warrant to purchase 150,000 shares of eGames common stock at an exercise price
of $.75 per share. The warrants will have a term of five years. One-third of the
shares of eGames common stock to be issued at closing will be held in an escrow
account for one year for eGames' indemnification claims. eGames is not assuming
any of Cinemaware's liabilities, except for certain obligations relating to
assumed contracts.
Additionally, as part of Mr. Batista's employment, upon his start date he will
receive stock options to purchase 150,000 shares of eGames common stock with an
exercise price equal to the closing price of eGames common stock on that date.
These options will not be part of any stock option plan and will vest and become
exercisable over five years in equal annual installments. The options will have
terms of six years.
INDUSTRY BACKGROUND
The worldwide consumer entertainment software market is very competitive. We
compete with other companies having operations that vary from small companies
with limited resources to large companies with much greater resources than we
have.
The changing characteristics of the worldwide consumer entertainment software
market in recent years has been impacted by many factors, such as: an increasing
number of technologically advanced PCs with more powerful operating systems,
enhanced graphics and video cards, and expanded memory chips, as well as higher
capacities and faster speeds for CD, DVD and hard drives in the home and office;
greater access by consumers to the Internet through high-speed access modes
(such as cable modems and DSL connections); increased interest in online game
play; the increasing number of game console devices in the home; and the
development of increasingly advanced technologies supporting game play (such as
hand held game devices, mobile phones and personal digital assistants). As a
result of the increased competition in the overall consumer entertainment market
that has been driven by this growing array of alternative game-playing
technologies, market data suggests that the retail market for PC game software
has decreased in recent years.
Additionally, the continued growth in the installed base of technologically
advanced yet affordably priced PCs has made PC software games a mass-market
commodity. The development of this mass market for consumer entertainment PC
software games has contributed to the importance of mass merchant PC software
sales as a distribution channel, and has increased the pricing pressure for
these types of games and the competition for high quality, competitively-priced
gaming software content. 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 for PC games are pursuing relationships with publishing companies
with stronger distribution capabilities than ours, including better access to
mass market retailers and greater merchandising, marketing and promotional
resources than we have. At the same time, retailers with limited shelf space in
their stores are faced with the challenge of managing an increasing number of
software titles to select from. This factor has increased the competition for
maintaining and/or growing our share of the declining amount of retail shelf
space allocated to value-priced PC software games. A significant result of these
market pressures is an industry trend toward the consolidation of consumer
entertainment PC software publishers and distributors, in addition to the
diversification of products offered by these companies. The trends toward
industry consolidation and increased competition for game content and retailer
shelf space are expected to continue for the foreseeable future.
BUSINESS STRATEGY
The goal of our business strategy is to be a leading publisher of high quality,
affordably priced PC software games. We continue to work towards executing our
business plan that focuses on:
o Gaining brand name recognition of our PC game software titles;
o Developing new top-selling titles within existing brands and
previously successful core game genres;
o Developing top-selling titles within new brands and software
categories;
o Strengthening existing and developing new distribution and retail
relationships;
o Expanding our online presence through more attractive and
value-adding websites; and
o Seeking opportunities to acquire intellectual property, brands or
assets that will enable us to broaden our product offering in the
consumer entertainment software market.
The eGames Business Model. The dominant element of our strategy is to bring
familiar, fun, family friendly games to PC gamers of all ages and capabilities
at affordable prices, while maintaining a lean and focused business
organization. Our business model focuses primarily on the under-$20 retail
priced segment of the PC game software market because that is where we have an
established track record of quality titles at an affordable price.
We Rely On Marketplace Sales Data. We evaluate marketplace sales data to
determine which types of products are achieving successful consumer acceptance
as indicated by strong retail sell-through results of various consumer
entertainment software categories. We then focus on developing successful titles
that can have sustainable lifecycles and be attractive to a wide range of PC
gaming consumers. We seek to obtain the rights to PC gaming content that we
anticipate will meet these criteria while complementing our branding strategy.
Deliver Products To Market Quickly To Maximize Sales Opportunities. We believe
that the best method of bringing products to market successfully is to identify
games that consumers are currently enjoying and will likely continue buying. We
then focus on quickly developing or obtaining product content that we believe
the consumer will buy when it is combined with our exciting and distinctive
packaging designed to drive impulse sales in retail stores. Our product
development efforts focus on product design, a user-friendly unique interface,
ease-of-use, product quality and consistency. Our internal product development
team collaborates with third-party software developers in developing PC software
games that we believe consumers will want to play. Although we do not develop
our titles internally, we influence the creative aspects of our products by
working closely with an experienced group of third-party software developers in
order to minimize product development costs and to increase the potential
consumer acceptance of new titles at retail locations.
Develop PC Games That Are Easy To Play. We design PC games so they are easy to
install and easy to play, requiring little or no technical experience or
subsequent support. We provide very basic product support to consumers who have
purchased our products, and based on consumer feedback we may incorporate
different or upgraded features within future titles.
Gaining Distribution. Gaining more North American retail distribution is a very
important element of our business strategy. Our flexible distribution model
enables retailers to buy eGames software titles either directly from us or from
a distributor that they prefer to manage their software requirements. Due to the
additional costs associated with servicing certain retailers directly, we
attempt to adjust our pricing structure with these retailers to help cover the
additional costs associated with direct-to-store product shipments. Our aim is
to make eGames software titles easily available to consumers at the retail
stores in which they shop frequently.
Market Brand Names That Deliver Consistent Quality. We focus our marketing
resources on developing or acquiring brands that represent value, quality and
consistency to the gaming consumer. We believe that recognizable brands offer a
safer choice to the consumer in an otherwise confusing, rapidly changing and
often intimidating software marketplace for games. Once a consumer becomes
highly satisfied with a brand in any given product category, we believe they
will typically tend to actively search for that brand versus competing ones. We
believe that recognizable brands can help drive consistent product demand by
consumers at retail stores, which is our objective.
INTERNET STRATEGY
Our website, www.egames.com, is a comprehensive website where visitors can try
game demos, play fun games for free, buy our products (both physical and
downloadable versions), register software purchases, get product support, or
review investor relations information such as regulatory filings, press releases
and corporate governance documents. We seek to maintain a leading edge website
that provides value added services and information to new and repeat visitors.
Our goal is to continually improve the quality of our website so that our
Internet presentation clearly communicates our commitment to providing fun and
easy-to-use games that are affordably priced.
In October 2004, we launched an online games website, www.egamesonline.com,
intended to complement our existing e-commerce website by channeling additional
consumer traffic to our online store and increasing our Internet sales. This new
online games website is designed to cross-promote eGames downloadable
demonstration software and drive retail sales through the main eGames website.
Since launch the online games website has attracted an increasing number of
visitors, but to date it has been only marginally successful at increasing
online sales of games on our e-commerce site.
MARKETING
Our marketing efforts focus on:
o Coordinating in-store marketing programs with retailers;
o Participating in retail trade shows;
o Improving our websites, (www.egames.com and www.egamesonline.com);
o Issuing press releases and establishing media contacts; and
o Distributing demonstration software through the Internet or on CDs.
Our marketing department is responsible for designing programs intended to
increase retailer and consumer demand for our software products resulting in
incremental retailer and distributor purchase orders, and to then achieve
positive consumer acceptance as indicated by stronger product sell-through
results to consumers. Our marketing personnel create attractive product
catalogs, sales brochures, advertisements, related promotional materials and
various retail displays. Our marketing personnel and distribution vendors work
together to coordinate retail and promotional programs so that they are in place
when products are received by retailers. Accordingly, in-store advertising,
public relations, and advertisements are designed and implemented in parallel
with product availability at retail stores.
SALES AND DISTRIBUTION
North American Sales and Distribution. We primarily sell our products through
national software distributors servicing North American mass-merchant and major
retailers. Additionally, we have direct sales relationships with certain
software retailers. We often utilize electronic data interchange hardware and
software systems in order to fulfill orders to retailers that require us to have
direct-to-store distribution and replenishment capability.
During the year ended June 30, 2005, we had one major distributor, Atari that
represented 45% of our net sales compared to the year ended June 30, 2004, when
Atari accounted for approximately 69% of our net sales. During fiscal 2005, one
retailer accounted for about half of our business through Atari, while two other
national retailers accounted for most of our remaining sales to Atari.
International Revenues. Our international distribution efforts are managed
through a series of licensing agreements covering various territories outside of
North America, with the majority of our international revenues originating from
the United Kingdom, Germany, Australia and Brazil. Our international net
revenues for the years ended June 30, 2005 and 2004, were $468,000 and $341,000,
respectively, and represented 9% and 4% of net sales, respectively.
Distribution Procedures. Our sales organization works with distributors' and
retailers' sales and purchasing personnel in order to maximize our sales at
specific retailers. They work with retail buyers and their distributors to
ensure an appropriate level of our products are available at each retail store,
warehouse stock levels are sufficient, promotions and advertising are
coordinated with product availability, and in-store merchandising plans are
properly maintained.
The distribution of our products is governed by purchase orders, distribution
agreements or direct sale agreements, most of which allow for product returns
and price markdowns. Our sales are made primarily to software distributors and
retailers and are typically made on credit, with terms that vary depending upon
the customer and the nature of the product. We establish and maintain allowances
for product returns and price markdowns by distributor and retailer at levels we
believe are adequate based upon many factors, including: our analysis of
historical product return and price markdown results; current product
sell-through results at retail store locations; current field inventory
quantities at distributors' warehouses and at retail store locations; the length
of time that products have been released at retail along with their estimated
remaining retail life; the introduction of new and/or competing software
products that could negatively impact the sales of one or more of our current
products; outstanding return material and price markdown authorizations; and the
extent to which units of new products with higher price points or unproven
genres remain in the retail channel.
We also have relationships with certain software distributors for product
distribution to various retailers, which are based on consignment sales
agreements. Accordingly, revenues from product shipments pursuant to these
arrangements are only recognized to the extent that the distributor has reported
to us that our products have actually sold through to consumers.
COMPETITION
The consumer entertainment PC game software industry is intensely competitive
and is continuing to consolidate. The market for affordable consumer
entertainment PC software games is especially competitive. We believe that the
principal competitive factors include content quality, which is a combination of
compelling game play, appealing graphics and sounds, technical compatibility and
trouble-free operation, brand name recognition, price, product packaging,
merchandising, ease-of-use, reliability, on-line capabilities, and distribution
strength.
We compete primarily with other PC game publishers. Our primary competitors are
very large companies with much greater financial, marketing, distribution and
technical resources than we have. Although there are a variety of consumer PC
software game publishers, based on our product lines and retail price points,
Microsoft, Electronic Arts, Atari, Activision, Vivendi, THQ, Cosmi, Take-Two
Interactive, and Interplay are our primary competitors. In addition, it is
probable that an increasing number of large software companies will continue to
intensify their focus on the value-priced segment of the PC software market and,
as a result, could increasingly compete with us directly in our gaming genres
and value-oriented retail price points. We are facing greater competition as a
result of an increase in the number of competitors' previously higher-priced
titles transitioning down to the $9.99 retail price point more quickly than in
the past, combined with more competitor titles within the core gaming genres in
which we compete. We also face additional competition for the consumer's
entertainment purchases from other evolving gaming platforms, such as game
consoles, online game websites, handheld game devices and mobile phones.
The market for product content from third-party PC software game developers is
also extremely competitive. We may not be successful in obtaining high-quality
content to be included in our products if our competitors achieve better access
to distribution channels, have greater financial resources, or have developed or
acquired a widely recognized brand more attractive to a potential licensor.
PRODUCT DEVELOPMENT
Our product development expenses for the years ended June 30, 2005 and 2004 were
$538,000 and $510,000, respectively. Product development expenses consist
primarily of personnel costs related to product management, quality assurance
testing, packaging design and website administration, along with outside
services for product ratings, website infrastructure maintenance and
non-recoverable costs related to products not achieving distribution into their
intended retail channels.
Our product development team meets regularly throughout each reporting period to
review new product opportunities, discuss new competitive products and recent
market data, develop strategies for new products and to review the status and
performance of current titles. This product development process, which is
managed by the product development team by continually evaluating updated
product review data, gives management valuable visibility into:
o Products currently being sold at the major retailers;
o Genres represented by upcoming titles;
o New product availability for presenting and subsequent delivery to
the major retailers during upcoming quarters based on retailer shelf
reset dates; and
o Timing and scope of financial commitments relating to the content
within future titles.
We strive 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 improvements to achieve "better than"
characteristics compared to directly competitive products.
All products are thoroughly tested by our quality assurance personnel before
they are released for mass production to our third-party CD replication vendor.
Products are typically tested for performance, compatibility with numerous
popular PC brands and configurations, typical installation issues,
functionality, and ease-of-use. Marketing and development employees are
responsible for reviewing customer feedback, competitive products, product
performance, and market positioning in order to help introduce additional titles
that reflect current consumer trends while remaining consistent with our
business strategy.
In addition to the development of our products' content, considerable effort is
also spent on seeking ways to continually improve the presentation quality of
our jewel case and box packaging. Our products are considered consumer "impulse
buys". Therefore, our main opportunity to capture the consumer's attention is
through attractive packaging that effectively describes the title's best
features and key attributes relative to competitors' products. We have continued
to enhance our packaging features through use of flap-fronts on our jewel case
and box products, affording us additional print space upon which to communicate
our products' features to consumers. We have also utilized unique cutouts in the
packaging and special embossing and foils, which further helps differentiate our
products from those of our competitors.
BACKLOG
We typically ship our products within several days after accepting a retailer or
distributor purchase order, which is common in the PC software game industry.
Consequently, we do not usually generate a backlog of distributor or retailer
purchase orders that would be a significant indicator of our future sales or
earnings.
PRODUCT SUPPORT
We provide telephone and Internet product support to consumers who purchase our
products either at a retailer's store or through the Internet at no additional
charge to them. The cost to provide this service is included in the price we
charge to our distributors and retailers. We believe that high-quality,
user-friendly product support can provide valuable feedback to our marketing and
software development personnel for use in the product development process.
Accordingly, the support we provide to consumers is typically simple and
low-level in nature and usually occurs (if at all) shortly after consumers
purchase our products. These services are rendered by our customer support staff
and through the frequently asked questions section of our website, and the costs
to provide these services have historically been minimal (about 1% of net
sales).
OPERATIONS - INTERNAL
Our accounting, purchasing, inventory control, scheduling, order processing, and
development activities are conducted at our only physical location, which is
situated in Langhorne, Pennsylvania. Our information management system supports
order entry, order processing, picking, billing, accounts receivable, accounts
payable, general ledger, financial reporting, inventory control, and mailing
list management. We coordinate with our major suppliers through a comprehensive
material planning system, which provides us with timely, accurate inventory
information, on a daily basis. This same system also incorporates a synchronized
material requirements forecasting module that projects product availability, and
has helped to minimize our product delivery lead times.
OPERATIONS - EXTERNAL
Subject to credit terms and product availability, distributor and retailer
purchase orders are typically shipped from one of our third-party vendors'
facilities shortly after we receive them. Based upon specific instructions from
our internal operations department, third-party vendors:
o Replicate our PC software game titles onto CDs;
o Print our jewel case and box packaging;
o Assemble our completed jewel case and box products;
o Ship our products directly to retailers and distributors; and
o Process products returned by retailers and distributors.
We have multiple sources for all components of our products, and have not
experienced any material delays in production, assembly or delivery.
SEASONALITY
Our business and the PC game industry in general are highly seasonal primarily
because there is more store traffic during the period commencing with
back-to-school shopping beginning in mid to late August and continuing through
the holiday selling season before culminating in January. We typically
experience our highest sales and best operating results during our second fiscal
quarter, which ends in December, compared to the quarter ending in June when we
usually experience our seasonal lows in sales and operating results. Our
financial results can also vary based on other factors, such as: the timing of
retailer decisions to reset their software department offerings; changes in
consumer demand for our products; and the success or failure of our existing
titles based on the retailers' evaluation of product sell-through results to
consumers, which would then impact their decisions on replenishment orders for
those titles and their willingness to place additional orders for our new titles
in the future.
EMPLOYEES AND THIRD-PARTY PC SOFTWARE DEVELOPERS
As of June 30, 2005, we had 15 full-time and 2 part-time employees, of which 4
were employed in product development, 4 in sales, marketing and customer
support, and 9 in operations, finance and administration. In addition, we
regularly utilize approximately 20 third-party PC software developers in
connection with our product development activities. Of these third-party PC
software developers, we are substantially dependent on less than five of them to
develop the PC software titles that have become and continue to be our
best-selling products. No employees are represented by labor unions, and we have
never experienced a work stoppage.
INTELLECTUAL PROPERTY RIGHTS
We rely 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 our proprietary rights. United States
copyright law, international conventions and international treaties, however,
may not provide meaningful protection against unauthorized duplication or
infringement of our software. Policing unauthorized use of an easily duplicated
and broadly disseminated product such as PC software is very difficult. Software
piracy is expected to be a persistent problem for the software industry for the
foreseeable future. If a significant amount of unauthorized copying of our
products were to occur, our operating results and financial condition would be
adversely affected.
We generally sell our published software titles under license agreements with
third-party PC software game developers, and in such case we do not acquire the
copyrights for the underlying content. These licenses are typically limited to
use of the licensed rights in products for specific time periods. While we may
have renewal rights for most of our licenses, the development of many of our
products is dependent on our ability to continue to obtain the intellectual
property rights from these third parties on mutually agreeable terms and at
satisfactory contractual rates.
PC game 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. When claims or litigation, with or
without merit, are brought against us, such claims can and have been costly and
result in a diversion of management's attention and our financial resources,
which could have a material adverse effect on our business, operating results
and financial condition. We can and have incurred substantial expenses in
evaluating and defending such claims, regardless of the merit of the claims. In
the event that there is a determination that we have infringed on a third
party's intellectual property rights, we could incur significant monetary
liability and be prevented from using these rights in the future.
FACTORS AFFECTING FUTURE PERFORMANCE
Our business is subject to many risks and uncertainties that could affect our
future financial performance. The following discussion highlights some of the
more important risks we have identified, but they may not be the only factors
that could affect our future performance.
A significant part of our sales come from a limited number of customers because
of consolidation in the retail marketplace. The majority of our current sales
are to software distributors that service the mass-market and major retailers in
North America, and therefore our business relies on a concentrated group of
these large customers. Atari is currently our primary North American distributor
servicing the major mass-merchant retailers in North America. Our net sales to
Atari during the fiscal year ended June 30, 2005 were $2.4 million and
represented 45% of our total net sales. Our financial condition, financial
results and ability to continue as a going concern could be significantly
affected if: we lost our distribution capability through Atari; the amount of
net sales to Atari were to substantially decrease; we chose to transition all or
part of our business with Atari to one or more alternative software
distributors; or Atari would not be able or willing to make timely receivable
payments to us in the normal course of business.
If we cannot continue viable business relationships with key distributors and
retailers, this would materially harm our business. The terms of our business
relationships with the primary distributors of our products do not require them
to purchase our products. If these distributors were to stop distributing our
products, our sales would decline substantially and in a brief period of time.
In addition, if distributors of our products were only willing to distribute our
products on terms that were commercially unacceptable to us, our financial
condition would be materially harmed. We also might not be successful in
distributing our products directly to key retailers. Even if we were successful
in selling our products directly to these retailers, it might be on terms that
are not commercially acceptable. Our inability to negotiate commercially viable
distribution relationships with major software retailers and distributors, or
the loss of, or significant reduction in sales to, any of our key distributors
or retailers, would adversely affect our business, operating results and
financial condition.
The shelf space retailers are allocating to value-priced PC software is
shrinking, which has already negatively impacted our business and will continue
to negatively effect our future business prospects in this market segment. The
reduced amount of shelf space being allocated to our category of products in
retail stores during this fiscal year has impacted our net sales during this
period. We continue to see indications that the amount of retail shelf space
being allocated to PC software games at the $9.99 retail price point is
decreasing, and we expect this trend to continue negatively impacting our
results for the foreseeable future unless we are able to capitalize on our other
strategies, including our attempt to offset the reduction in the basic PC
department with high value promotional packs which most likely will be displayed
in a secondary location within or outside of the PC software department,
entering into incremental licensing opportunities, obtaining alternative retail
channels such as dollar stores and in-statement advertising providers and using
our online game website to increase sales. We cannot predict whether these new
opportunities and strategies will be effective in increasing net sales.
We depend on the market acceptance of our products, and these products typically
have relatively short product life cycles. Our profitability depends on our
ability to publish new PC software titles that get into retail stores and
successfully sell through to consumers. During fiscal 2005, we experienced a
decrease in consumer demand for our titles as indicated by reduced product
sell-through rates of our titles to consumers at retail. We believe this decline
in consumer demand for our titles was due in part to an increase in competitors'
previously higher-priced titles transitioning down to the $9.99 retail price
point more quickly than in the past, combined with more competitor titles within
the core gaming genres in which we compete. Although in fiscal 2006, we will
continue to evaluate various product and marketing strategies to increase
consumer demand for our products, there is no assurance that any of these
initiatives will increase consumer demand for our products, particularly because
consumer preferences for entertainment PC software products are difficult to
predict and only a few products achieve sustained market acceptance. Typical
product lifecycles are no more than six to fifteen months, and have recently
been trending towards shorter retail lifecycles. New products we introduce may
not achieve any significant degree of market acceptance, or the product
lifecycles may not be long enough for us to recover advance royalty, inventory,
development, marketing and promotional costs. If a product does not sell through
to consumers at a rate satisfactory to our retailers or distributors, we could
be forced to accept substantial product returns or be required to issue
significant price markdowns to maintain our relationships with these
distributors and retailers. We may also lose retail shelf space if our products
do not sell through to consumers at rates that satisfy retailers. The failure of
new products to achieve or sustain market acceptance can materially and
adversely impact our business, operating results and financial condition.
The consumer entertainment PC software market is highly competitive and changes
rapidly. The market for consumer entertainment PC software is highly
competitive. A constantly increasing number of software titles are competing for
a limited amount of shelf space, which has diminished over time. Retailer
changes to shelf space allocations, such as the reductions in retail shelf space
that occurred during fiscal 2005, can negatively affect our future sales and
operating results. The competition for retail shelf space continues to
intensify. We are seeing shifts in the retail market for PC software games that
are likely to continue to affect our operating results. Competition for retail
shelf space also results in greater leverage for retailers and distributors in
negotiating terms of sale, including price markdowns and product return
policies, and our larger competitors may have more leverage than we do to
negotiate more and better-positioned shelf space than we do. Our retail and
distribution customers have no long-term obligations to purchase our products,
and may discontinue purchasing our products at any time. If our competitors
develop more successful products, offer competitive products at lower price
points, or if we do not continue to develop consistently high-quality and
well-received products, our revenue, margins, and profitability will decline.
If our major distributors or retailers are not able to or are unwilling to pay
us at all or within the normal course of business, this would materially harm
our financial condition. Distributors and retailers in the consumer
entertainment PC software industry and in mass-market retail channels can and
have experienced significant fluctuations in their businesses and some of these
companies have failed. If any significant retailer or distributor of our
products experienced financial difficulties, became insolvent, or went out of
business, this would significantly harm our business, operating results and
financial condition. Our sales are typically made on credit, with terms that
vary depending upon the customer and the nature of the product. We do not hold
collateral to secure payment. We maintain an allowance for bad debts for
anticipated uncollectible accounts receivable which we believe to be adequate.
The actual allowance required for any one customer's account or on all of the
accounts receivable in total, may ultimately be greater than our allowance for
bad debts at any point in time. If any of our major distribution or retail
customers failed to pay an outstanding receivable, particularly Atari, our
business, operating results and financial condition would be significantly
harmed.
We may need additional funds, and we may not be able to obtain such funding if
we need it. In November 2004, we renewed our $750,000 credit facility agreement
with Hudson United Bank ("HUB"), which matures on December 1, 2005. Our capital
requirements are currently funded from the cash flow generated from product
sales and our $750,000 credit facility with HUB. This credit facility is subject
to limitations based on the value of our accounts receivable, and therefore
working capital may not be available to us when we need it. At June 30, 2005 we
had access to approximately $200,000 under this credit facility, based on the
prescribed calculation of seventy-five percent of qualified accounts receivable
as of that date. Our ability to continue operations essentially requires us to
generate sufficient cash flow from operations to fund our business activities.
In the past we have experienced dramatic fluctuations in cash flows, so we
cannot be sure we will be able to continue achieving sufficient cash flows to
fund our operations in the future. If we had to seek financing, we may only be
able to obtain such financing on terms that would result in significant dilution
or otherwise be unfavorable to existing shareholders. Our inability to secure
additional funding when needed, to access funds from our credit facility when
needed, or generate adequate funds from operations, would adversely impact our
long-term viability.
Price markdowns and product returns could materially reduce our net sales and
results of operations. Most of our customer relationships allow for product
returns and price markdowns. We generally establish allowances for future
product returns and price markdowns at the time revenues associated with product
shipments are recognized. These allowances are based on many factors, including
historical product returns and price markdowns, product sell-through results at
retail store locations, field inventory at distributors' warehouses and at
retail stores, the length of time that products have been released at retail
along with their estimated remaining retail life, outstanding return material
and price markdown authorizations, the introduction of new and/or competing
software products that could negatively impact the sales of our products, and
the extent to which our newer products with higher retail prices or unproven
genres remain in the retail channel. Our sales to these customers are reported
net of product return and price markdown provisions. Since the allowances we
establish for product returns and price markdowns are only estimates, actual
product returns and price markdowns could exceed our established allowances for
these anticipated amounts, and would negatively impact our results of
operations.
Our operating results fluctuate from quarter to quarter, which makes our future
operating results uncertain and difficult to predict. Our quarterly operating
results have varied significantly in the past and will likely vary significantly
in the future depending on numerous factors, many of which are not under our
control. Comparative sequential and year-to-year quarterly operating results may
provide little meaningful information or guidance because of our relatively
small size and the impact on our net sales resulting from the timing of purchase
orders from retailers and distributors and other changes in market forces.
Fluctuations in quarterly operating results will depend upon many factors
including:
- Seasonality of consumer demand for PC software games;
- Shelf space allocations for value-priced PC software games by major
retailers;
- Amount of competitors' previously higher-priced titles transitioning
down to the $9.99 retail price point;
- Number of competitor titles being offered within the core gaming
genres in which we compete;
- Timing of receiving and fulfillment of major distributor and
retailer purchase orders;
- Amount and timing of retailer and distributor product returns and
price markdown requests; and
- Timing of our new product introductions, product enhancements and
those of our competitors.
The seasonal nature of the PC software market can result in harm to our
financial results if our product releases, shipments and orders do not optimize
sales during key selling periods. The PC game software industry is highly
seasonal, with sales tending to be higher during the quarter ending December
31st. This is due to increased demand for PC software games during the
back-to-school and holiday selling seasons. Delays in product development or
manufacturing can affect the timing of the release of our products, causing us
to miss out on key selling periods, such as the year-end holiday buying season.
If retailers decide not to sell our products, or substantially reduce the number
of our titles that they sell, during this key selling season, our net sales
would decline substantially and our operating results would be adversely
affected. If we miss product deliveries during these key selling periods, or if
our products are not ready for shipment to meet these critical selling periods,
our net sales and operating results would be adversely affected. Additionally,
if our products do not adequately sell-in to our customers' retail locations or
sell-through to consumers at these retail locations during these key selling
periods, our financial results for the entire fiscal year would be adversely
affected.
Our business is dependent on commercially viable licensing arrangements with
third party software developers. Independent software developers develop all of
the content for our software titles. Our success in introducing new high quality
PC software titles depends on our ability to maintain relationships and obtain
licensing agreements on favorable terms with skilled independent software
developers. Increased competition for the licensing rights to quality consumer
entertainment PC software content has compelled us to agree to increasingly
higher contractual royalty rates and advance royalty payments and, in some
cases, to guarantee minimum royalty payments to content licensors. If the
products subject to these advance and minimum payments do not generate
sufficient sales volumes to recover these costs, this would have a negative
impact on our financial results. Additionally, if we are not able to obtain
quality content on commercially viable terms from independent software
developers, this would also adversely affect our business.
Our present or future competitors may develop products that are comparable or
superior to ours. Our competitors may offer higher quality products, lower
priced products or adapt more quickly than we do to new technologies or evolving
customer requirements. Our competitors typically have more financial resources
to spend on marketing promotions, sales incentives, licensing recognizable
brands, and advertising efforts. Competition has continued to intensify as our
industry has consolidated, since we have remained a small software publisher and
some of our competitors have grown larger. In order to be successful in the
future, we must be able to respond to technological changes, customer
requirements and competitors' current products and innovations. We may not be
able to compete effectively in this market, which would adversely affect our
operating results and financial condition.
Our common stock has experienced low trading volumes and unpredictable
volatility on the OTC Bulletin Board. Our shares of Common Stock are currently
traded on the OTC Bulletin Board under the symbol EGAM, and we currently do not
qualify for listing on any of the major exchanges, such as Nasdaq or the
American Stock Exchange. Many stocks traded on the OTC Bulletin Board -
including our stock - have experienced significant price and trading volume
fluctuations. These fluctuations are often unrelated or disproportionate to the
operating performance of individual companies. Our stock price may be adversely
affected by such fluctuations, regardless of our operating results.
Additionally, many common stocks traded on the OTC Bulletin Board are thinly
traded, such as our common stock, which can make it difficult to sell our stock.
If our stock is not eligible to be traded on the OTC Bulletin Board, our stock
will then be traded on the Pink Sheets, which may have even less trading volume
potential and more price fluctuations than the OTC Bulletin Board.
We may have difficulty protecting our intellectual property rights. We either
own or have licensed the rights to copyrights for our product content,
trademarks and our corporate name and logo. We may not have sufficient resources
to adequately protect our intellectual property rights, and our existing or
future copyrights, trademarks, trade secrets or other intellectual property
rights may not be of sufficient scope or strength to provide meaningful
protection or commercial advantage to us. If we are not able to sufficiently
protect our intellectual property rights, this would have an adverse effect on
our business and operating results and on the overall value of our company.
We may incur substantial expenses and be required to use our internal resources
to defend infringement claims, and settlements may not be favorable or
attainable. We may from time to time be notified that we are infringing the
intellectual property rights of others. Combinations of content acquired through
past or future acquisitions and content licensed from third-party software
developers may give rise to claims of infringement. In past years, we have
incurred significant defense costs and utilized internal resources in defending
trademark and copyright claims and lawsuits. Other third parties may initiate
infringement actions against us in the future. Any future claims could result in
substantial costs to us, and diversion of our limited resources. If we are found
to be infringing the rights of others, we may not be able to obtain licenses on
acceptable terms or at all, and significant damages for past infringement may be
assessed, or further litigation relating to any such licenses or usage may
occur. Our failure to obtain necessary licenses or other rights, or the
initiation of litigation arising from any such claims, could materially and
adversely affect our operating results.
We are exposed to the risk of product defects. Products we offer can contain
errors or defects. The PC hardware environment is characterized by a wide
variety of non-standard peripherals, such as sound and graphics cards, and
configurations that make pre-release testing for programming or compatibility
errors difficult and time-consuming. Despite the extensive testing performed by
our quality assurance personnel, new products or releases may contain errors
discovered after shipments have commenced, resulting in a loss of or delay in
market acceptance or product recalls, which would adversely affect our business,
operating results and financial condition.
We depend on key management and technical personnel. We rely on our management
and other key personnel for the successful operation of our business. We are
dependent upon the expertise and skills of several key sales, marketing and
product development employees, and there can be no assurance that we will be
able to continue to retain these personnel at current compensation levels, or at
all. Failure to continue to attract and retain qualified personnel could
materially adversely affect our business and prospects.
We may experience unique risks with our international revenues and distribution
efforts. International net revenues, primarily consisting of licensing revenues,
represented 9% of our net sales for the fiscal year ended June 30, 2005. We
anticipate that in fiscal 2006 our international business will continue to be
transacted primarily through third-party licensees, which is subject to some
risks that our domestic business is not, including: varying regulatory
requirements; difficulties in managing foreign distributors; potentially adverse
tax consequences; and difficulties in collecting delinquent accounts receivable.
Additionally, because our international business is concentrated among a small
number of third-party licensees, the business failure of any one of these
licensees, and the resulting inability for us to collect the related outstanding
licensing receivable, could have a material adverse effect on our financial
condition.
Item 2. Properties
As of June 30, 2005, we leased 5,000 square feet of office space in Langhorne,
Pennsylvania under an operating lease scheduled to expire on September 30, 2007.
We believe that our current operating facility will be adequate for our
anticipated needs through at least June 30, 2006. Rent expense for our operating
facility was $58,000 for each of the fiscal years ended June 30, 2005 and 2004.
Item 3. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5. Market for the Registrant's Common Stock, Related Stockholder
Matters and Small Business Issuer Purchases of Equity Securities
Our common stock began trading on the Over the Counter Bulletin Board ("OTCBB")
under the symbol "EGAM" on April 2, 2001. Prior to that date, our common stock
traded on the Nasdaq SmallCap Market under the same symbol. These quotations
reflect inter-dealer prices, without retail mark-up, mark-down or commission and
may not necessarily represent actual transactions.
The following table sets forth the quarterly high and low price per share of our
common stock for the fiscal years ended June 30, 2005 and 2004, as reported by
the OTCBB:
High Low
------ ------
Fiscal Year Ended June 30, 2005
-------------------------------
First Quarter $ 1.62 $ 0.85
Second Quarter $ 0.81 $ 0.38
Third Quarter $ 0.91 $ 0.56
Fourth Quarter $ 0.84 $ 0.53
Fiscal Year Ended June 30, 2004
-------------------------------
First Quarter $ 0.75 $ 0.29
Second Quarter $ 0.94 $ 0.59
Third Quarter $ 1.47 $ 1.04
Fourth Quarter $ 1.70 $ 1.29
As of June 30, 2005, we had approximately 157 shareholders of record. In
addition, a large number of shareholders of our common stock hold their shares
in street name, and as such are collectively counted as one shareholder of
record.
During fiscal 2005, we paid two quarterly cash dividends to shareholders of the
Company's stock as of February 15, 2005 and May 17, 2005. Our Board of Directors
has decided to suspend paying future quarterly cash dividends, and instead to
have the Company retain future earnings, if any, for use in funding its
business. It is our intention to continue evaluating the feasibility of paying a
quarterly cash dividend to shareholders of our common stock in future periods.
However, the payment of any future cash dividend depends entirely upon the
discretion of the Company's Board of Directors.
Equity Compensation Plan Information:
The following table summarizes, as of June 30, 2005, outstanding options to
acquire shares of the Company's Common Stock that may be issued under the
Company's 1995 Amended and Restated Stock Option Plan.
[Enlarge/Download Table]
Number of securities
remaining available for
future issuance under
Number of securities to Weighted-average equity compensation
be issued upon exercise exercise price of plans (excluding
of outstanding options, outstanding options, securities reflected in
warrants and rights warrants and rights column (a))
Plan category (a) (b) (c)
--------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by
security holders 1,479,666 $0.69 - 0 -
Equity compensation
plans not approved by
security holders - 0 - n/a - 0 -
--------------------------------------------------------------------------------------------------------------
Total 1,479,666 $0.69 - 0 -
===== ========= ===== =====
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
This Annual Report on Form 10-KSB contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. All statements made in this report, other than
statements of historical fact, including statements regarding industry prospects
and future results of operations or financial position, are forward looking. We
use the words "believe", "expect", "anticipate", "intend", "will", "should",
"may" and similar expressions to identify forward-looking statements. These
forward-looking statements are subject to business volatility, economic risk,
and world events, which are inherently uncertain and difficult to predict. Our
actual results could differ materially from management's expectations due to
such risks. We will not necessarily update information if any forward-looking
statement later turns out to be inaccurate. In particular, these forward-looking
statements include, among others, statements about:
- The consummation of our acquisition of substantially all the assets
of Cinemaware, Inc.;
- The employment of Cinemaware's principal shareholder by eGames;
- Our evaluation of opportunities to publish quality content for other
gaming platforms in the future, such as console devices, hand held
game devices and mobile phones;
- Our expectation that reductions in retail shelf space allocated to
affordable PC game software will continue to negatively impact our
financial results and inventory levels in the future, and the
strategies we are pursuing to offset the decreases in our net
sales caused by this market shift;
- The strategies and new opportunities that we are exploring in order
to increase consumer demand for our products;
- Our plan to continue to seek distribution on the Internet through
larger affiliate partners during fiscal 2006;
- Our expectation that our provision for product returns and price
markdowns, as a percentage of related gross sales, will continue
trending higher for the foreseeable future;
- Our expectation that reductions in retail shelf space for
value-priced PC software games and weaker consumer demand for our
titles could continue to negatively impact our inventory levels
during fiscal 2006;
- Our expectation that, during the remainder of fiscal 2005, we will
continue to sell our products to the retailers and distributors
that charge sales incentive and promotional fees, which will
continue having a negative impact on our net sales, gross profit
and gross profit margin;
- Our expectation that our gross profit margin will continue to be
impacted by higher royalty expense and freight costs in fiscal 2006;
- Additional quantities of discontinued titles will be returned to
us from retailers and distributors that need to be sold to
inventory liquidators at discounted prices, which can cause
inventory liquidation sales to vary from quarter to quarter;
- Our belief that our ability to collect, in a timely manner, the
net account receivable owed by Atari during most periods will
remain critical for us to be able to meet our financial
obligations and to fund normal operations;
- Our expectation that the adoption of recent accounting pronouncements
will not have a material impact on our financial statements;
- Our expectation that future advance royalty commitments will be
funded by cash flows from operations; and
- Our current intention not to seek listing on a stock exchange even
if we meet the standards for listing.
The following important factors, as well as those factors discussed under
"Factors Affecting Future Performance" beginning on page 9 in this report, could
cause our actual results to differ materially from those indicated by the
forward-looking statements contained in this report:
- our ability to retain Mr. Batista as an executive officer;
- the market acceptance and successful sell-through results for our
products at retail stores, particularly at North American
mass-merchant retailers where consumer entertainment PC software
has traditionally been sold;
- the continued successful business relationship between us and Atari,
as our largest customer and our distributor to the major mass-market
retailers;
- the amount of shelf space the major mass-market retailers allocate to
affordable, jewel case PC game software;
- the amount of unsold product that is returned to us by retail stores
and distributors;
- the amount of price markdowns granted to retailers and distributors;
- our ability to accurately estimate the amount of product returns and
price markdowns that will occur and the adequacy of the allowances
established for such product returns and price markdowns;
- the continued success of our current business model of selling,
primarily through third-party distributors, to a concentrated
number of select mass-merchant and major retailers;
- our ability to control the manufacturing and distribution costs of
our software titles;
- the success of our distribution strategy, including the ability to
continue to increase the distribution of our products into key
North American mass-merchant retailers and to enter into new
distribution and direct sales relationships on commercially
acceptable terms;
- the allocation of shelf space (retail facings) for our products in
major retail chain stores;
- the ability of our international product distribution through
licensing agreements to earn a royalty and the ability of our
licensees to pay us such royalties within agreed upon terms;
- our ability to collect outstanding accounts receivable and establish
an adequate allowance for bad debts;
- the ability to deliver products in response to customer orders
within a commercially acceptable time frame;
- downward pricing pressure;
- fluctuating costs of developing, producing and marketing our
products;
- our ability to license or develop quality content for our products;
- the success of our efforts to increase website traffic and product
sales over the Internet;
- consumers' continued demand for affordable consumer entertainment
PC software;
- increased competition in the affordable software category;
and various other factors, many of which are beyond our control.
Overview
The following overview is a summary of our operating results as well as some
recent trends and events in our business. We believe that an understanding of
these trends and events is important in order to understand our results for
fiscal 2005, as well as our future results. This summary is not intended to be
exhaustive, nor is it intended to be a substitute for the detailed discussion
and analysis provided elsewhere in this Form 10-KSB, including Item 1
"Business", the remainder of "Management's Discussion and Analysis of Financial
Condition and Results of Operations", "Factors Affecting Future Performance"
under "Business" or the financial statements and the related notes.
About eGames
eGames, Inc. ("eGames", "our", "us" or "we") is a Pennsylvania corporation
incorporated in July 1992 that publishes, markets and sells affordable PC
software games. Historically, we have focused on publishing software games for
the PC platform only. We are currently evaluating various opportunities to
publish quality content for other gaming platforms, such as console devices,
hand held game devices and mobile phones. We sell products to consumers who are
seeking a broad range of high-quality, affordable PC gaming software, which are
sold on CDs through retail distribution or online via the Internet. In North
America, our PC games are distributed primarily through third-party software
distributors who service mass-merchant and major retailers. In territories
outside North America, we license our PC games to third-party software
distributors who are responsible for the manufacture and distribution of our PC
games within specific geographic territories. We promote the eGames(TM) brand in
order to generate customer loyalty, encourage repeat purchases and differentiate
eGames software products to retailers and consumers.
Significant Trends and Events in our Business
Decrease in Retail Shelf Space for Value-Priced PC Software
Has Impacted Our Sales
-----------------------------------------------------------
The reduced amount of shelf space being allocated to our category of products in
retail stores throughout this fiscal year has impacted our net sales during this
period. We continue to see indications that the amount of retail shelf space
being allocated to PC software games at the $9.99 retail price point is
decreasing, and we expect this trend to continue negatively impacting our
results for the foreseeable future. We are attempting to offset the reduction in
the basic PC department with high value promotional packs which most likely will
be displayed in a secondary location within or outside of the PC software
department. Additionally, we are exploring incremental licensing opportunities,
pursuing alternative retail channels such as dollar stores and in-statement
advertising providers and promoting our online game website. We are also
evaluating alternative marketing strategies, such as innovative packaging,
creative display options and variations of our titles at different retail price
points that may help develop previously untapped markets for value-priced PC
software. We cannot predict whether these new opportunities and strategies will
be effective in increasing net sales.
Decline in Consumer Demand for Titles Has Reduced Our Sales
-----------------------------------------------------------
During fiscal 2005, we experienced a decrease in consumer demand for our titles
as indicated by reduced product sell-through rates of our titles to consumers at
retail. We believe this decline in consumer demand for our titles was due in
part to an increase in competitors' previously higher-priced titles
transitioning down to the $9.99 retail price point more quickly than in the
past, combined with more competitor titles within the core gaming genres in
which we compete. In fiscal 2006, we will continue to evaluate various product
and marketing strategies to increase consumer demand for our products, such as
offering more content per title to the consumer, creating unique and compelling
packaging, exploring different gaming genres and price points, acquiring higher
quality gaming content and licensing higher-profile brands, and investigating
different gaming platform opportunities that could offer us incremental business
growth.
Dependence on One Large Software Distributor - Atari
----------------------------------------------------
We continue to have a concentrated customer base of a few large software
distributors and retailers. Atari is our primary software distributor serving
the mass-merchant and major retailers in North America. Although our business
activity through Atari declined during fiscal 2005 compared to the prior year,
Atari continued to represent the largest percentage of our net sales and
customer cash receipts during this fiscal year. In particular, during the year
ended June 30, 2005, Atari accounted for $2,412,000 of net sales, or 45% of net
sales, compared to the year ended June 30, 2004, when Atari accounted for
$5,508,000 of net sales, or 69% of net sales. Additionally during fiscal years
2005 and 2004, we collected receivable payments from Atari of $3,679,000 and
$5,090,000, respectively, which represented approximately 55% and 68%,
respectively, of total customer receipts during those periods.
Our financial condition, financial results and ability to continue as a going
concern could be significantly affected if: we lost our distribution capability
through Atari; the amount of net sales to Atari were to substantially decrease;
we chose to transition all or part of our business with Atari to one or more
alternative software distributors; or Atari would not be able or willing to make
timely receivable payments to us in the normal course of business.
Inventory Costs
---------------
During the year ended June 30, 2005, our net inventory increased by $79,000, or
10%, while our net sales decreased by 34%. This increase resulted from many of
our newer titles that were manufactured during the current year not reaching our
anticipated level of retail distribution and consumer demand for these titles.
We believe this was due in part to the reduction in retail shelf space being
allotted to PC software titles at the $9.99 retail price point, as well as a
decrease in product sell-through rates of the Company's titles to consumers at
retail stores that impacted retailer and distributor replenishment orders for
our titles. We anticipate the reduction of retail shelf space for $9.99 retail
priced PC software games and weaker consumer demand for our titles could
continue to negatively impact our inventory levels, particularly during the
first half of fiscal 2006.
Acquisition of Assets of Cinemaware, Inc.
-----------------------------------------
eGames expects to enter into an Asset Purchase Agreement with Cinemaware during
or prior to the first week of October to purchase substantially all of the
assets of Cinemaware. The assets to be acquired upon closing of the transaction,
anticipated to occur in October, 2005, principally consist of intellectual
property, contract rights and goodwill. As part of the transaction, at closing
Cinemaware and its principal shareholder, Lars Fuhrken-Batista, will enter into
non-competition agreements, and Mr. Batista will become Vice President of
Development for eGames. We currently intend to use the Cinemaware assets for
the purposes of developing new higher-priced PC game titles and console game
titles.
In consideration for the Cinemaware assets, at closing eGames will issue shares
of its common stock equal to $300,000 divided by the average closing price of a
share of eGames common stock for the five trading days prior to the date of the
Agreement, and the five trading days ending one trading day prior to the
closing, but in no event less than 600,000 shares or more than 855,000 shares.
Also at closing, eGames will issue to Cinemaware a warrant to purchase 150,000
shares of eGames common stock at an exercise price of $.50 per share, and a
warrant to purchase 150,000 shares of eGames common stock at an exercise price
of $.75 per share. The warrants will have a term of five years. One-third of the
shares of eGames common stock to be issued at closing will be held in an escrow
account for one year for eGames' indemnification claims. eGames is not assuming
any of Cinemaware's liabilities, except for certain obligations relating to
assumed contracts.
Additionally, as part of Mr. Batista's employment, upon his start date he will
receive stock options to purchase 150,000 shares of eGames common stock with an
exercise price equal to the closing price of eGames common stock on that date.
These options will not be part of any stock option plan and will vest and become
exercisable over five years in equal annual installments. The options will have
terms of six years.
Critical Accounting Policies and Estimates
Our significant accounting policies and methods used in the preparation of the
Financial Statements are discussed in Note 1 of the Notes to Financial
Statements. We believe our policies for revenue recognition, inventory valuation
and recoverability of advanced licensing and royalty payments require us to make
significant judgments and estimates that could materially affect the amount of
revenue we recognize, the cost of sales we expense, and the reported net values
for inventory, accounts receivable, prepaid and other expenses. Our discussion
and analysis of our financial condition and results of operations are based upon
our financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires us to make judgments and estimates that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an ongoing basis, we
evaluate our estimates for product returns, price markdowns, customer bad debts,
inventory obsolescence, recoverable values of advanced licensing and royalty
payments, income tax expense, contingencies and litigation risks. We base our
estimates on historical experience and on various other factors and assumptions
that we believe are appropriate. Actual results may differ from these estimates
under different assumptions or conditions.
Revenue Recognition (Net Sales, Product Returns and Price Markdowns)
--------------------------------------------------------------------
We distribute the majority of our products through third-party software
distributors to North American mass-merchant and major retailers and directly to
certain PC software retailers, most of which have traditionally sold consumer
entertainment PC software products. The distribution of our products is governed
by purchase orders, distribution agreements or direct sale agreements, most of
which allow for product returns and price markdowns. For product shipments to
these software distributors or retailers, we record a provision for product
returns and price markdowns as a reduction to gross sales at the time the title
of our product transfers to the distributor or retailer.
We also have relationships with certain software distributors for product
distribution to various retailers on a consignment basis. Accordingly, revenues
from product shipments pursuant to these arrangements are only recognized to the
extent that the distributor has reported to us that our product has actually
sold through to consumers.
Key Assumptions
Our provision for anticipated product returns and price markdowns is based on
the assumptions we make after evaluating various factors, including: our
analysis of historical product return and price markdown results; current
product sell-through activity at retail store locations; current field inventory
quantities at distributors' warehouses and at retail store locations; the length
of time that products have been released at retail along with their estimated
remaining retail life; the introduction of new and/or competing software
products that could negatively impact the sales of our current products;
outstanding return material and price markdown authorizations; and the extent to
which units of new products with higher price points or unproven genres remain
in the retail channel.
The adequacy of our allowance for product returns and price markdowns is
reviewed throughout each reporting period and any necessary adjustment to this
allowance is reflected within the current period's provision. Significant
management judgments and estimates must be made and used in order to determine
how much revenue can be recognized in any reporting period. Material differences
may result in the amount and timing of our revenue for any period if
management's judgments or estimates for product returns or price markdowns prove
to be insufficient or excessive compared to actual results.
Inventory Valuation
-------------------
Our inventory valuation policy requires management to make estimates and
assumptions about the recoverability of the carrying value of inventory at the
end of each reporting period and cost of sales expensed during each reporting
period. Our inventory could be valued differently at the close of any reporting
period and the amount of expense recorded as cost of sales during any reporting
period could differ, if management's judgments or estimates of provisions for
the potential impairment of inventory value are insufficient or excessive when
compared to actual results.
Key Assumptions
Our provision for inventory obsolescence is based on the assumptions we make
after evaluating the remaining value of existing inventory units (consisting of
unsold titles and estimated product returns), which involves: assessing the
remaining product life of existing titles based on how long the titles have been
released at retail; analyzing the trend of current product sell-through activity
to consumers for existing titles; identification of competitors' new products
with greater capabilities or more recognizable brands that could replace or
shorten the lifecycles of our existing titles; assessing the potential for
litigation that may affect our ability to sell existing titles containing
certain product content; monitoring expiration dates of licensing agreements
with software developers for content within existing titles; and tracking the
current market value for remaining units of discontinued titles based on recent
liquidation or alternative channel sales of similar products.
Although we attempt to accurately match production requirements of our products
to forecasted consumer demand, at the end of a product's lifecycle we usually
have some level of excess inventory units that need to be disposed of through
liquidation sales. If we cannot liquidate such inventory, or if we are unable to
sell any remaining units due to legal or other reasons, we would then write down
the remaining inventory value to zero. The adequacy of our allowance for
inventory obsolescence is reviewed throughout each reporting period, and any
adjustments are reflected in the current period's provision for inventory
obsolescence.
Advance Licensing and Royalty Payments
--------------------------------------
We make advance licensing and royalty payments to third party software
developers and other licensors for the licensing of software content and
intellectual properties for use within our PC software titles. These advance
payments are initially classified on our balance sheet under the caption
"Prepaid and other expenses", and are then usually expensed within the "Cost of
sales" category of our Statements of Operations based upon the greater of the
contractual or effective royalty rate based on net sales.
Key Assumptions
We continually evaluate the recoverability of our advanced licensing and royalty
payments by reviewing the information available about each title and the
underlying licensed content in existing titles. In particular, we evaluate the
potential future sales of a title or subsequent titles containing the same
licensed content based on current and potential sales programs, along with
historical sell-through results of similar titles to consumers. For titles that
have achieved distribution into their intended retail channels, we charge to
cost of sales the remaining costs we determine to be non-recoverable in future
periods. In the rare circumstance that a title does not achieve distribution
into its intended retail channels, we charge to product development expense the
remaining costs we determine to be non-recoverable in future periods.
Non-recoverable costs are expensed in the reporting period in which management
determines that it is not likely that we will be able to recover these costs in
future periods.
Results of Operations
The following discussion should be read together with our Financial Statements
and Notes beginning on page 28.
Year Ended June 30, 2005 Compared to the Year Ended June 30, 2004
Net Sales
Net sales decreased by $2,694,000, or 34%, to $5,344,000 for the year ended June
30, 2005, compared to $8,038,000 for the year ended June 30, 2004. This
$2,694,000 decrease in net sales for the year ended June 30, 2005 was driven by
a $2,995,000 decrease in net sales to software distributors. This decrease in
net sales to software distributors was partially offset by increases of $188,000
in licensing revenues, $62,000 in direct net sales to retailers, and $39,000 in
Internet related sales.
The following table represents our net sales by distribution channel for the
years ended June 30, 2005 and 2004:
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Net Sales by Distribution Channel
---------------------------------
Years Ended
June 30,
------------------------------------------
Increase %
Distribution Channel 2005 % 2004 % (Decrease) Change
------------------------------------------------------------------------------------------------
Software Distributors $ 3,527,000 66% $ 6,522,000 81% ($ 2,995,000) (46%)
Software Retailers 722,000 13% 660,000 8% 62,000 9%
Licensing 575,000 11% 387,000 5% 188,000 49%
Internet 323,000 6% 284,000 4% 39,000 14%
Inventory Liquidators 197,000 4% 166,000 2% 31,000 19%
Other - 0 - 0% 19,000 0% (19,000) N/M
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Totals $ 5,344,000 100% $ 8,038,000 100% ($ 2,694,000) (34%)
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Software Distributors
---------------------
For the year ended June 30, 2005, net sales to software distributors that serve
North American mass-merchants and other major retailers amounted to $3,527,000,
which represented a decrease of $2,995,000 or 46% compared to the year ended
June 30, 2004. This $2,995,000 decline in net sales to software distributors was
caused by a $3,096,000 decrease in net sales to Atari. Additionally, we
experienced a $76,000 net sales decrease to Take Two Interactive serving certain
North American office supply stores and warehouse clubs, and a $150,000 increase
in net sales to Canadian software distributors.
Factors contributing to the $3,096,000 decrease in net sales to Atari included:
the reduction in the overall retail shelf space allotted to PC software games at
the $9.99 retail price point; a decrease in product sell-through rates of eGames
titles to consumers at retail stores; and a major electronics retailer's
transition away from Atari as its provider of $9.99 retail priced PC software
games offered in jewel case packaging. We believe the current year's decline in
consumer demand for our titles was largely due to an increased amount of
competitors' previously higher-priced titles transitioning down to the $9.99
retail price category at faster rates than in the past, in addition to more
competitor titles within our core gaming genres.
Software Retailers
------------------
For the year ended June 30, 2005, direct net sales to software retailers totaled
$722,000, which represented a $62,000 increase compared to the year ended June
30, 2004. This increase resulted primarily from initial product shipments to
Dollar Tree Stores, Scholastic Inc. and Discovery Stores that generated $224,000
in net sales. Partially offsetting this net sales increase was a $137,000 net
sales decrease to CompUSA traceable to declining sell-through rates of our
software titles, especially for our box titles retail priced at $19.99.
Licensing
---------
For the years ended June 30, 2005 and 2004, we earned licensing revenues of
$575,000 and $387,000, respectively, which represented 11% and 5%, respectively,
of net sales. Licensing revenues continued to be primarily generated from
increased sales made by our international software distributors under a series
of licensing agreements covering specific territories outside of North America,
with the majority of our licensing revenue growth originating from the United
Kingdom and Germany, in addition to some licensing revenue growth generated from
certain newly established licensing relationships in the United States.
Internet
--------
For the years ended June 30, 2005 and 2004, Internet sales were $323,000 and
$284,000, respectively, and represented 6% and 4%, respectively, of net sales
during those years. During fiscal 2005, our Internet sales strategy focused on
distributing our game titles more broadly via affiliate programs and on popular
Internet game websites and other portals. We expect to continue to seek
distribution on the Internet through larger affiliate partners during fiscal
2006.
Inventory Liquidators
---------------------
For the years ended June 30, 2005 and 2004, net sales to inventory liquidators
were $197,000 and $166,000, respectively, and represented 4% and 2%,
respectively, of net sales. Net sales to inventory liquidators consist of sales
of residual inventory titles that have been discontinued (in part or entirely)
at traditional software retail stores because these titles had reached the end
of their product lifecycles. As retailers continue to routinely change the mix
of software titles displayed on their store shelves - usually on a quarterly
basis - we expect to receive additional quantities of discontinued titles back
from the retail channel that will then need to be liquidated, along with any
quantities of those titles remaining in our warehouse. Accordingly, the amount
of inventory liquidation sales can vary greatly, period to period, and are
usually made at discounted prices with no right of return or price markdown.
Product Returns and Price Markdowns
-----------------------------------
Until physical units of our products are returned to us from software
distributors or retailers, or until they sell through to consumers, we continue
to evaluate our product return or price markdown exposure for any remaining
physical software units we had previously sold to software distributors and
retailers.
During the years ended June 30, 2005 and 2004, our provisions for product
returns and price markdowns related to gross sales with software distributors
and retailers amounted to $1,254,000 and $1,727,000, respectively, or 20.5% and
18.0%, respectively, of related gross sales. Although the amount of the current
year's provision for product returns and price markdowns decreased due to
comparatively lower gross sales, the current year's provision, as a percentage
of related gross sales, increased year over year. The current year's percentage
increase was due to our overall evaluation of the retail channel inventory level
in relation to our reduced product distribution of existing titles, combined
with declining consumer sell-through rates of those titles remaining in retail
distribution. Based on various assumptions, including shorter product
lifecycles, more competitor titles in our core game genres, and the continued
reduction of retail shelf space allocated to $9.99 PC games, we anticipate our
provision for product returns and price markdowns, as a percentage of related
gross sales, to continue trending higher for the foreseeable future.
Sales Incentives and Promotional Costs
--------------------------------------
For the years ended June 30, 2005 and 2004, our sales incentives and promotional
costs were $419,000 and $518,000, respectively, or 6.9% and 5.4%, respectively,
of related gross sales. In order to maintain retail shelf space for our titles,
we incur sales incentives and promotional costs from software distributors and
retailers, such as pricing rebates and slotting fees, which are recognized as
reductions to gross sales. We intend to continue selling our products to
software retailers and distributors that charge such fees, and accordingly we
expect these types of costs to continue impacting our net sales, gross profit
and gross profit margin.
Cost of Sales
Cost of sales consists of the following costs that are associated with
publishing our PC games: product costs; royalty costs incurred with
third-parties for licensing product content or other intellectual properties;
freight and handling costs; inventory obsolescence provision, reclamation fees
and other costs.
The following table represents our cost of sales for the years ended June 30,
2005 and 2004:
June 30, % of June 30, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
-----------------------------------------------------------------------------
$ 2,483,000 46.5% $ 3,312,000 41.2% ($ 829,000) (25.0%)
During the year ended June 30, 2005, cost of sales decreased by $829,000, or
25.0%, compared to the prior year. This $829,000 cost of sales decrease resulted
from a $2.7 million decrease in net sales, which was mitigated by a 5.3% higher
cost of sales percentage on those reduced sales. The 5.3% increase in cost of
sales, as a percentage of net sales, was primarily due to cost increases, as a
percentage of net sales of:
o 3.0% in royalty expense due to accelerated expensing of royalty
payments above contractual rates due to shorter life-cycles for
titles that did not achieve anticipated consumer demand and product
distribution, combined with the impact from product mix changes;
o 1.6% in freight expense traceable to a greater proportion of product
shipments of smaller deliveries that incurred fixed minimum delivery
fees allocated to fewer units per order, combined with a decreased
proportion of product deliveries to Atari that are more cost
effective per unit due to shorter shipping distances and larger
quantities per shipment; and
o 0.7% in other cost of sales due mainly to higher reclamation fees
associated with increased processing of product returns.
In fiscal 2006, we expect our gross profit margin to continue to be impacted by
a higher effective royalty rate and an increased freight percentage due to the
reasons discussed above.
Product Development
Product development expenses consist of personnel costs related to product
management, content acquisition, quality assurance testing, packaging design and
website administration, along with outside services for product ratings, website
infrastructure maintenance and non-recoverable costs related to products not
achieving distribution into their intended retail channels.
The following table represents our product development expenses for the years
ended June 30, 2005 and 2004:
June 30, % of June 30, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
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$ 538,000 10.1% $ 510,000 6.3% $ 28,000 5.5%
The $28,000 increase in product development expenses for the year ended June 30,
2005 resulted from the write-off of $122,000 in capitalized licensing and
inventory costs related to the RealAge Games & Skills title. We determined
earlier this fiscal year that the recovery of these costs in future periods was
unlikely, based upon our consideration of all available information at that
time, and in particular on the expected amount of any future sales related to
this title and brand. This expense increase was partially offset by the non
recurrence of the year ago period's costs related to the redesign of our website
of $45,000 and the fiscal 2004 employee incentive compensation plan of $53,000.
The write-off of the costs related to the RealAge Games & Skills title were
charged to product development expense, rather than to cost of sales, because
these costs related to a new title that had not achieved distribution into its
intended retail channels. This title was not designed for traditional retail
distribution through our normal business operations, but rather through
alternative retail distribution channels such as direct response TV. The RealAge
Games & Skills title and brand was developed, in an attempt to attract new
consumers to the PC game category by providing consumers with a compelling
reason to play PC games in order to help maintain mental sharpness.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of personnel
related costs, insurance costs, stock-based compensation expense, professional
service fees for legal, accounting and public relations, along with occupancy
costs including rent, utilities and phones, in addition to other administrative
expenses.
The following table represents our selling, general and administrative expenses
for the years ended June 30, 2005 and 2004:
June 30, % of June 30, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
-----------------------------------------------------------------------------
$ 2,492,000 46.6% $ 2,394,000 29.8% $ 98,000 4.1%
The $98,000 increase in selling, general and administrative expenses for the
year ended June 30, 2005 was driven by increases primarily in legal expenses
incurred in enforcing our intellectual property rights, and to a lesser extent
in litigation costs and charitable contributions. These cost increases were
partially offset by the non-recurrence in public relations costs associated with
the RealAge Games & Skills title and a decrease in salary related costs due to
no fiscal 2005 expense related to the current year's employee incentive
compensation plan.
Interest Income, net
The following table represents our net interest income for the years ended June
30, 2005 and 2004:
June 30, % of June 30, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
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$ 7,000 0.1% $ - 0 - 0.0% $ 7,000 N/M
Provision (Benefit) for Income Taxes
The following table represents our provision (benefit) for income taxes for the
years ended June 30, 2005 and 2004:
June 30, % of June 30, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
-----------------------------------------------------------------------------
($ 7,000) 0.0% $ 83,000 1.0% ($ 90,000) (108.4%)
For the year ended June 30, 2005, our provision for income taxes decreased by
$90,000, compared to the year ended June 30, 2004, and was due to the reduction
in the current year's estimated taxable income for state income tax purposes. As
of June 30, 2005, we had approximately $3,321,000 of net operating loss
carry-forwards for federal income tax purposes, (expiring through fiscal year
ending June 30, 2020), which are available to offset future federal taxable
income, and $617,000 in net operating loss carry-forwards for state purposes,
(expiring through fiscal year ending June 30, 2008), which are available to
offset future state taxable income.
Net Income (Loss)
The following table represents our net income (loss) for the years ended June
30, 2005 and 2004:
June 30, % of June 30, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
-----------------------------------------------------------------------------
($ 155,000) (2.9%) $ 1,740,000 21.6% ($ 1,895,000) (108.9%)
Weighted Average Common Shares
The weighted average common shares outstanding on a diluted basis decreased by
620,275 for the year ended June 30, 2005 to 10,445,216 from 11,065,491 for the
year ended June 30, 2004. This 620,275 decrease in the diluted basis calculation
of weighted average common shares resulted from the current year's exclusion of
common share equivalents based on their potential anti-dilutive impact on the
current year's loss, which was partially offset by an increase in outstanding
shares that resulted from the exercise of common stock options.
Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" which revised Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation". This statement supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees". The revised
statement addresses the accounting for share-based payment transactions with
employees and other third parties, eliminates the ability to account for
share-based compensation transactions using APB 25 and requires that the
compensation expense relating to such transactions be recognized in the
statement of operations. The revised statement is effective as of the first
interim period beginning after June 15, 2005. Since we had adopted within our
financial statements the provisions of SFAS No. 123 as of July 1, 2002, we do
not expect the adoption of SFAS No. 123 (revised 2004) to have a material impact
on our financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment
of ARB No. 43, Chapter 4". SFAS No. 151 amends the guidance in Accounting
Research Bulletin ("ARB") No. 43, "Restatement and Revision of Accounting
Research Bulletins", Chapter 4, "Inventory Pricing", to clarify the accounting
for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) and requires that those items be recognized as
current-period charges. SFAS No. 151 also requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. We do not believe
the adoption of SFAS No. 151 will have a material impact on our financial
statements.
Liquidity and Capital Resources
[Download Table]
As of
June 30,
---------------------------
2005 2004 Change
-----------------------------------------
Cash and cash equivalents $ 2,412,000 $ 1,742,000 $ 670,000
=========== =========== =========
Percent of total assets 60.9% 37.6%
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Years Ended
June 30,
---------------------------
2005 2004 Change
-----------------------------------------
Cash provided by operating activities $ 779,000 $ 805,000 ($ 26,000)
Cash used in investing activities (12,000) (104,000) 92,000
Cash (used in) provided by financing activities (97,000) 17,000 (114,000)
-----------------------------------------
Net increase in cash and cash equivalents $ 670,000 $ 718,000 ($ 48,000)
========= ========= =========
Changes in Cash Flow, Operating Activities
During the year ended June 30, 2005, we had $779,000 in cash provided by
operating activities compared to $805,000 in cash provided by operating
activities for the year ended June 30, 2004. The $779,000 in cash provided by
operating activities for the year ended June 30, 2005 resulted primarily from
collections of accounts receivable from our larger software distributors,
retailers, licensees and Internet customers.
Partially offsetting this source of cash were cash uses traceable to:
o Employee bonus payments related to the fiscal 2004 employee incentive
compensation plan that were accrued as of June 30, 2004, and paid
during fiscal 2005;
o Accelerated accounts payable vendor payments made in exchange for
obtaining cash discounts; and
o Payments related to estimated federal alternative minimum tax.
Accounts Receivable, net
------------------------
Gross accounts receivable totaled $0.8 million and $2.7 million at June 30, 2005
and June 30, 2004, respectively. This $1.9 million decrease in gross accounts
receivable resulted from accounts receivable collections exceeding the declining
rate of sales during fiscal 2005. At June 30, 2005, the allowances for product
returns, price markdowns and bad debts had declined to $0.5 million, compared to
$1.2 million at June 30, 2004. Although the allowances for product returns,
price markdowns and bad debts had decreased in dollar terms compared the year
ago period, these allowances had increased to 65% of gross accounts receivable
at June 30, 2005, compared to 43% of gross accounts receivable at June 30, 2004.
Generally, we have been able to collect our net accounts receivable in the
ordinary course of business, but have from time to time experienced periods of
slowness in distributor and retailer payments. We continually monitor our
receivable balances and communicate with our distributors and retailers in order
to expedite their payments of past due amounts or to process authorized
receivable credits for product returns and price markdowns. Since we do not hold
any collateral to secure payment from any of our customers and because most of
our customers have the right to return products and receive price markdowns that
can be used to reduce their payments to us, the valuation of our accounts
receivable is continually reviewed in order to help anticipate liquidity issues
that could result from our inability to collect a receivable balance in the
normal course of business.
We continue to have a very concentrated customer base consisting of a few large
software distributors and retailers. Although throughout fiscal 2005 Atari had
represented the majority of our net accounts receivable, as of June 30, 2005,
Atari only represented 8% of our net accounts receivable, due to their gross
receivable being mostly offset by allowances for product returns and price
markdowns for physical units of our titles (previously sold to Atari) that
remained in the retail channel. Additionally, during the year ended June 30,
2005, we collected receivable payments of $3.7 million from Atari, which
represented 55% of our total customer receipts during fiscal 2005. We believe
that our ability to collect, in a timely manner, the net account receivable owed
by Atari during most periods will remain critical for us to be able to meet our
financial obligations and to fund normal operations. If at any time Atari would
become unable or unwilling to make receivable payments to us in a timely manner,
our ability to continue ongoing operations would be significantly impaired.
In fiscal 2006, we plan to implement product and marketing strategies intended
to increase consumer demand for our products, which is critical to our ability
to support our operations from cash collections of accounts receivable. These
strategies include offering more content per title to the consumer, creating
unique and compelling packaging, exploring different game genres and price
points, acquiring higher quality game content and licensing higher-profile
brands, and investigating different game platform opportunities.
Inventory, net
--------------
During the year ended June 30, 2005, our net inventory increased by $79,000, or
10%, and related to an increase in our gross inventory due to many of our titles
that were manufactured during the current year not reaching the anticipated
level of retail distribution, due in part to the reduction in retail shelf space
being allotted to PC software titles at the $9.99 retail price point, as well as
a decrease in product sell-through rates of the Company's titles to consumers at
retail stores that impacted retailer and distributor replenishment orders for
our titles. We anticipate that the reduction of retail shelf space for $9.99
retail priced PC software games and weaker consumer demand for our titles could
continue to negatively impact our inventory levels during fiscal 2006. During
the first half of fiscal 2006 we plan to aggressively market various promotional
programs designed to convert excess inventory into cash. These programs are
intended to reduce inventory levels, increase collectible accounts receivable,
and be a source of funds to help support our operations.
Prepaid and other expenses
--------------------------
During the year ended June 30, 2005, our prepaid and other expenses decreased by
$126,000, which related to a decrease in capitalized advanced royalties that was
partially offset by an increase in federal alternative minimum tax payments.
Accounts Payable
----------------
During the year ended June 30, 2005, accounts payable decreased by $284,000,
which resulted from our continued acceleration of payments to our major trade
vendors in exchange for receiving cash discounts.
Accrued Expenses
----------------
During the year ended June 30, 2005, accrued expenses decreased by $207,000 as a
result of employee bonus payments made during fiscal 2005 pursuant to the fiscal
2004 employee incentive compensation plan. There was no such accrual recorded
during the year ended June 30, 2005 due to our financial results not reaching
the operating income threshold required to make bonus payments pursuant to the
fiscal 2005 employee incentive compensation plan.
Changes in Cash Flow, Non-Operating Activities
During the year ended June 30, 2005, we had net cash used in investing
activities of $12,000 for equipment upgrades to our computer network, compared
to $104,000 in net cash used in investing activities during the prior year for
similar network upgrades and certain trademark related expenditures.
During the year ended June 30, 2005, we had $97,000 in net cash used in
financing activities that resulted from two quarterly cash dividend payments to
shareholders of our common stock totaling $327,000, which expenditures were
partially offset by $230,000 in cash proceeds we received from the exercise of
options to purchase shares of our common stock.
Credit Facility
In November 2004, we renewed our credit facility agreement with Hudson United
Bank ("HUB"), which matures on December 1, 2005. Amounts outstanding under this
credit facility are charged interest at one-half of one percent above HUB's
current prime rate and such interest is due monthly. Our access to these funds
is limited to the lesser of $750,000 or seventy-five percent of qualified
accounts receivable, which are defined as invoices less than ninety days old and
net of any allowances for product returns, price markdowns and customer bad
debts. At June 30, 2005 we had access to approximately $200,000 under this
credit facility, based on the prescribed calculation of seventy-five percent of
qualified accounts receivable as of that date.
This credit facility is secured by all of the Company's assets and requires us,
among other things, to maintain the following financial covenants to be tested
quarterly: total-liabilities to tangible net worth ratio of 1.25 to 1.00 and a
tangible net worth requirement of $2.0 million. As of June 30, 2005 and
September 26, 2005, we were in compliance with each of those covenants. This
credit facility was established to provide working capital for our operations.
As of September 26, 2005, we had not utilized any of this credit facility.
Contractual Obligations and Commitments
We occupy our 5,000 square foot office facility located in Langhorne,
Pennsylvania under an operating lease that is scheduled to expire on September
30, 2007. Additionally, we currently rent certain office equipment through
various operating lease agreements. At June 30, 2005, we had future operating
lease commitments of $158,000, as reflected in the table below.
Under various licensing agreements with third-party software developers, we are
required to pay royalties for the use of licensed content in our products. Most
of these licensing agreements require us to make advance royalty payments to
these software developers prior to the time we recognize any net sales of
software titles containing this licensed content. As of June 30, 2005, we had
future commitments to pay $110,000 in advance licensing and royalty payments to
various third-party licensors and software developers as reflected in the table
below. These commitments are expected to be funded by cash flows generated
through anticipated income from operations.
The following table represents a summary of our off-balance sheet contractual
obligations and commitments.
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Payments Due by Period
-----------------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year years years 5 years
---------------------------------------------------------------------------------------
Operating leases $ 158,000 $ 65,000 $ 93,000 $ - 0 - $ - 0 -
Advanced royalties 110,000 97,000 13,000 - 0 - - 0 -
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Totals $ 268,000 $ 162,000 $ 106,000 $ - 0 - $ - 0 -
========= ========= ========= ======= ========
Liquidity Risk
Our ability to maintain positive cash flow remains essential to our survival as
a going concern because our access to our existing credit facility is limited to
the lesser of $750,000 or 75% of our qualified accounts receivable, which at
June 30, 2005 amounted to approximately $200,000, based on the prescribed
calculation as of that date. In particular, our ability to maintain positive
cash flow depends upon a variety of factors, including the timing of the
collection of outstanding accounts receivable, the creditworthiness of our
primary software distributors and retailers, sell-through of our products to
consumers, and the costs of developing, producing, marketing and promoting our
PC software titles.
There are significant challenges that we will need to successfully manage in
order to fund our operations in the future. These challenges include, but are
not limited to, maintaining commercially viable relationships with our principal
distributors and retailers, collecting timely receivable payments from our
concentrated group of distributors and retailers, and maintaining acceptable
payment terms with our trade vendors. For example, our liquidity would be
severely impacted if Atari did not make receivable payments to us on a timely
basis, or if other business conditions caused Atari to fail to pay us at all.
Additionally, there are market factors beyond our control that could also
significantly affect our operating cash flow. The most significant market
factors are the shelf space allocated to our products at retail and the market
acceptance and sell-through rates of our products to consumers. If major
retailers where our products are sold further reduce or eliminate entirely the
shelf space allocated to $9.99 PC software games, our cash flow and future
financial prospects could be significantly impacted. Also, if any of our
software titles do not sell through to consumers at a rate acceptable to
retailers, then we could be exposed to unanticipated product return and price
markdown credit requests that could then be used by distributors and retailers
to reduce their future receivable payments to us. This could also cause a
reduction in retailer and/or distributor replenishment orders for these
products. If we experienced a negative trend in any of these factors, we may not
be able to maintain positive cash flow. Additional outside financing to
supplement our cash flow from operations may not be available if and when we
need it. Even if such financing were available from a bank or other financing
source, such financing may cause significant stockholder dilution or may have
other costs associated with such financing that would not be commercially
acceptable to us.
Listing of Our Common Stock
Our common stock trades on the OTC Bulletin Board under the symbol EGAM. We have
considered applying for listing on an exchange, such as the American Stock
Exchange, but at this time we do not meet the standards for listing. Even if we
did meet these standards, however, we do not believe at this time that the
benefits of listing are substantial enough to justify the fees, costs and
additional regulatory requirements imposed by such listing.
Item 7. Financial Statements
eGames, Inc.
Index to Financial Statements
Page
----
Report of Independent Registered Public Accounting Firm............ 29
Balance Sheet as of June 30, 2005.................................. 30
Statements of Operations for the years
ended June 30, 2005 and 2004....................................... 31
Statements of Stockholders' Equity for the years
ended June 30, 2005 and 2004....................................... 32
Statements of Cash Flows for the years
ended June 30, 2005 and 2004....................................... 33
Notes to Financial Statements...................................... 34
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
eGames, Inc.
We have audited the accompanying balance sheet of eGames, Inc. as of June 30,
2005, and the related statements of operations, stockholders' equity, and cash
flows for the years ended June 30, 2005 and 2004. These financial statements are
the responsibility of eGames' management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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 financial statements referred to above present fairly, in
all material respects, the financial position of eGames, Inc. as of June 30,
2005 and the results of its operations and its cash flows for the years ended
June 30, 2005 and 2004, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Stockton Bates, LLP
Philadelphia, Pennsylvania
August 2nd, 2005
eGames, Inc.
Balance Sheet
June 30,
ASSETS 2005
------ -----------
Current assets:
Cash and cash equivalents $ 2,412,162
Accounts receivable, net of allowances of $505,655 269,168
Inventory, net 893,766
Prepaid and other expenses 313,684
-----------
Total current assets 3,888,780
Furniture and equipment, net 49,881
Intangible assets 24,089
-----------
Total assets $ 3,962,750
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable $ 156,592
Accrued expenses 409,640
-----------
Total current liabilities 566,232
-----------
Stockholders' equity:
Common stock, no par value (40,000,000 shares authorized;
11,138,654 issued and 10,906,754 outstanding) 9,179,827
Additional paid-in capital 1,636,144
Accumulated deficit (6,918,036)
Treasury stock (501,417)
-----------
Total stockholders' equity 3,396,518
-----------
Total liabilities and stockholders' equity $ 3,962,750
===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Operations
[Download Table]
Years Ended June 30,
----------------------------
2005 2004
------------- ------------
Net sales $ 5,343,981 $ 8,038,169
Cost of sales 2,483,220 3,312,120
------------ ------------
Gross profit 2,860,761 4,726,049
Operating expenses:
Product development 538,002 510,282
Selling, general and administrative 2,492,357 2,393,571
------------ ------------
Total operating expenses 3,030,359 2,903,853
------------ ------------
Operating income (loss) (169,598) 1,822,196
Interest income, net 7,130 296
------------- ------------
Income (loss) before income taxes (162,468) 1,822,492
Provision (benefit) for income taxes (7,571) 82,692
------------- ------------
Net income (loss) ($ 154,897) $ 1,739,800
============ ============
Net income (loss) per common share:
- Basic ($ 0.01) $ 0.17
====== =======
- Diluted ($ 0.01) $ 0.16
====== =======
Weighted average common shares outstanding - Basic 10,445,216 9,996,607
Dilutive effect of common share equivalents - 0 - 1,068,884
------------- ------------
Weighted average common shares outstanding - Diluted 10,445,216 11,065,491
============= ============
See accompanying notes to financial statements.
[Enlarge/Download Table]
eGames, Inc.
Statements of Stockholders' Equity
Common Stock Additional Treasury Stock Stockholders'
------------------------ Paid-in Accumulated ---------------------- Equity
Shares Amount Capital Deficit Shares Amount (Deficit)
---------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2003 10,221,237 $ 9,179,827 $ 1,243,137 ($ 8,175,736) (231,900) ($ 501,417) $ 1,745,811
Net income 1,739,800 1,739,800
Common stock options issued to
employees and directors 68,952 68,952
Shares issued in connection with
stock option exercises 69,250 17,075 17,075
---------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2004 10,290,487 $ 9,179,827 $ 1,329,164 ($ 6,435,936) (231,900) ($ 501,417) $ 3,571,638
========== =========== =========== =========== ======= ========= ===========
Net (loss) (154,897) (154,897)
Cash dividends paid to common
stock shareholders (327,203) (327,203)
Common stock options issued to
employees and directors 77,338 77,338
Shares issued in connection with
stock option exercises 848,167 229,642 229,642
---------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2005 11,138,654 $ 9,179,827 $ 1,636,144 ($ 6,918,036) (231,900) ($ 501,417) $ 3,396,518
========== =========== =========== =========== ======= ========= ===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Cash Flows
[Enlarge/Download Table]
Years Ended June 30,
--------------------------
2005 2004
----------- -----------
OPERATING ACTIVITIES:
---------------------
Net income (loss) ($ 154,897) $ 1,739,800
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Stock-based compensation 77,338 68,952
Depreciation and amortization 36,667 24,570
Changes in operating assets and liabilities:
Accounts receivable, net 1,264,691 (385,324)
Inventory, net (79,480) (314,771)
Prepaid and other expenses 126,447 (202,896)
Accounts payable (284,424) (132,081)
Accrued expenses (207,154) 6,925
----------- -----------
Net cash provided by operating activities 779,188 805,175
INVESTING ACTIVITIES:
---------------------
Purchase of furniture and equipment (11,689) (80,174)
Purchase of software rights and other assets - 0 - (24,089)
----------- -----------
Net cash used in investing activities (11,689) (104,263)
FINANCING ACTIVITIES:
---------------------
Proceeds from exercise of stock options 229,642 17,075
Dividend payments to common stockholders (327,203) - 0 -
----------- -----------
Net cash (used in) provided by financing activities (97,561) 17,075
----------- -----------
Net increase in cash and cash equivalents 669,938 717,987
Cash and cash equivalents:
Beginning of period 1,742,224 1,024,237
----------- -----------
End of period $ 2,412,162 $ 1,742,224
=========== ===========
Supplemental cash flow information: 2005 2004
----------------------------------- ----------- -----------
Cash paid for interest $ - 0 - $ 5,475
=========== ===========
Cash paid for income taxes $ 146,430 $ 55,326
=========== ===========
See accompanying notes to financial statements.
eGames, Inc.
Notes to Financial Statements
1. Summary of Significant Accounting Policies
Description of Business
eGames, Inc. ("eGames", "our", "us" or "we") is a Pennsylvania corporation
incorporated in July 1992 that publishes, markets and sells affordable PC
software games. Historically, we have focused on publishing software games for
the PC platform only. We are currently evaluating various opportunities to
publish quality content for other gaming platforms, such as console devices,
hand held game devices and mobile phones. We sell products to consumers who are
seeking a broad range of high-quality, affordable PC gaming software, which are
sold on CDs through retail distribution or online via the Internet. In North
America, our PC games are distributed primarily through third-party software
distributors who service mass-merchant and major retailers. In territories
outside North America, we license our PC games to third-party software
distributors who are responsible for the manufacture and distribution of our PC
games within specific geographic territories. We promote the eGames(TM) brand in
order to generate customer loyalty, encourage repeat purchases and differentiate
eGames software products to retailers and consumers.
Basis of Presentation
The accompanying audited annual financial statements were prepared in accordance
with generally accepted accounting principles for financial information as
promulgated in the United States of America. These statements include all
adjustments that management believes are necessary for a fair presentation of
the statements. Certain dollar amounts discussed within the "Notes to Financial
Statements" have been rounded to the nearest thousand ("000").
Fair Value of Financial Instruments
The recorded amounts of cash and net accounts receivable at June 30, 2005
approximate fair value due to the relatively short period of time between
origination of the instruments and their expected realization. All liabilities
are carried at cost, which approximate fair value for similar instruments.
Cash and Cash Equivalents
For purposes of the statements of cash flows, we consider all highly liquid
instruments purchased with an original maturity of three months or less to be
cash equivalents.
Accounts Receivable, net
Accounts receivable is reflected net of the allowances for product returns,
price markdowns and customer bad debts. The adequacy of these allowances is
reviewed throughout each reporting period and any necessary adjustments to these
allowances are reflected within the current period's provisions for product
returns and price markdowns (reflected as a reduction to gross sales); and
customer bad debts (reflected as an operating expense). Actual product returns,
price markdowns and customer bad debts are recorded as reductions to these
allowances as well as reductions to the customers' individual accounts
receivable balances (see Note 2).
Inventory, net
Inventory, net consists primarily of finished goods and is valued at the lower
of cost or market. Cost is determined by the first-in, first-out method (FIFO).
Furniture and Equipment, net
Furniture and equipment, net is stated at cost and net of accumulated
depreciation. Depreciation is calculated on the straight-line method over the
estimated useful lives of the assets ranging from three to five years (see Note
5).
Long-Lived Assets, net
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," we record
impairment losses on long-lived assets, including intangible assets, used in
operations when the fair value of those assets, less the cost to sell, is lower
than our carrying value for those assets.
Intangible assets
At June 30, 2005, we had intangible assets of approximately $24,000, which
related to the Company's trademark registration activities with the United
States Patent and Trademark Office. As of June 30, 2005, we had not recorded any
expense relating to these assets based upon our evaluation that no impairment
has occurred.
Revenue Recognition
Product Sales
-------------
We distribute the majority of our products through third-party software
distributors to North American mass-merchant and major retailers and directly to
certain PC software retailers. The distribution of our products is governed by
customer purchase orders, distribution agreements, or direct sales agreements,
most of which allow for product returns and price markdowns. We recognize
revenues from product shipments to software distributors and retailers at the
time title to our inventory transfers to the distributor or retailer, less a
provision for anticipated product returns and price markdowns. Title to our
products usually transfers to software distributors and retailers upon their
receipt of our products, because retailer and distributor purchase orders
typically reflect shipping terms of FOB destination. In order to recognize
revenues associated with customer purchase orders having terms of FOB
destination, we perform sales cut-off tests, in which we obtain proof of
deliveries for product shipments made during the last two weeks of a reporting
period, from the freight companies that deliver our products to our retail and
distribution customers. All revenues and costs associated with product shipments
received by our customers after the end of a reporting period and having FOB
destination terms are excluded from the current period's operating results and
are deferred until the subsequent reporting period.
We recognize revenues in accordance with the criteria of SFAS No. 48 at the time
title to our inventory passes to software distributors or retailers, based on
the following: the selling price is fixed at the date of sale; the buyer is
obligated to pay us; title of the product transfers to the buyer; the buyer has
economic substance apart from us; we do not have further obligations to assist
the buyer in the resale of the product; and product returns and price markdowns
can be reasonably estimated at the time of sale. After product deliveries to our
distribution and retail customers are made, we do not provide any further
services or materials that are essential to our products' functionality.
However, we do provide basic telephone and web-based support as a means of
improving consumer satisfaction and brand loyalty. Costs associated with our
customer support efforts usually occur within one year from the period we
recognize revenue and these costs have historically been minimal (averaging
about 1% of net sales).
We also have relationships with certain software distributors for product
distribution to various retailers, which are based on consignment sales
agreements. Accordingly, revenues from product shipments pursuant to these
arrangements are only recognized to the extent that the distributor has reported
to us that our products have actually sold through to consumers.
Provision for Product Returns and Price Markdowns
-------------------------------------------------
Our provision for anticipated product returns and price markdowns (reflected as
a reduction to gross sales) is primarily based on our analysis of: historical
product return and price markdown results; current product sell-through activity
at retail store locations; current field inventory quantities at distributors'
warehouses and at retail store locations; the length of time that products have
been released at retail along with their estimated remaining retail life;
outstanding return material and price markdown authorizations; the introduction
of new and/or competing software products that could negatively impact the sales
of one or more of our current products; and the extent to which quantities of
new products with higher retail price points or unproven genres remain in the
retail channel.
The adequacy of our allowance for product returns and price markdowns is
reviewed throughout each reporting period and any necessary adjustment to this
allowance is reflected within the current period's provision. At the end of each
reporting period, the allowance for product returns and price markdowns is
reflected as a reduction to our gross accounts receivable balance.
At June 30, 2005, the allowance for product returns and price markdowns amounted
to 62% of our gross accounts receivable. Historically, the allowance for product
returns and price markdowns has represented a substantial percentage of our
gross accounts receivable because we continue to have product return and price
markdown exposure relating to paid receivables while the physical software units
relating to paid receivables remain in the retailers' stores or in the
retailers' or distributors' warehouses. Until the physical software units are
actually returned to us, or sell through to consumers, we continue to evaluate
our product return or price markdown exposure for these previously sold units
that are still remaining in the retail channel. During reporting periods,
through retailer and distributor provided reports, we have regular and timely
visibility of the product sell-through activity and remaining quantities of our
titles in the retail channel that help us assess our exposure for future product
returns and price markdowns.
Prepaid and Other Expenses
Prepaid and other expenses represent advance payments made to third parties for
items such as licensing of software and intellectual properties used in our
products, estimated tax payments, certain insurance coverage and various service
contracts. Prepaid and other expenses are usually expensed as operating expenses
on a straight-line basis over the period of time covered by a contract, except
for advance licensing and royalty payments, which are usually expensed as cost
of sales at the higher of contractual or effective rates based on the net sales
of the related software titles (see Notes 4 and 7), and income tax payments that
are reflected as income tax expense when appropriate.
We continually evaluate the recoverability of our advance licensing and royalty
payments by reviewing the information available about each title and the
underlying licensed content. In particular, we evaluate the expected future
sales of a title or potential subsequent titles containing the same licensed
content based on current and potential sales programs, along with historical
sell-through results of similar titles to consumers. For titles that have
achieved distribution into their intended retail channels, we charge to cost of
sales the remaining costs we determine to be non-recoverable in future periods.
In the rare circumstance that a title does not achieve distribution into its
intended retail channels, we charge to product development expense the remaining
costs we determine to be non-recoverable in future periods. Costs determined to
be non-recoverable are expensed in the reporting period in which the decision is
reached by management that recoverability of these costs in future periods is
unlikely.
Income Taxes
We use the asset and liability method of accounting for income taxes. Under the
asset and liability method, deferred tax assets and liabilities are recognized
for the estimated future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and for net operating loss and credit carry-forwards.
Deferred tax assets and liabilities are measured using enacted tax rates in
effect for the year in which those temporary differences are expected to be
recovered or settled.
Computation of Net Income per Common Share
Net income per common share is computed in accordance with SFAS No. 128,
"Earnings per Share". Basic earnings per share is computed by dividing net
earnings by the weighted average number of common shares outstanding during each
period. Diluted earnings per share is computed by dividing net earnings by the
weighted average number of common shares and common share equivalents ("CSE's")
outstanding during each period that we report net income. CSE's may include
stock options and warrants using the treasury stock method.
Management's Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities. Estimates and assumptions are made in determining allowances for
inventory obsolescence, product returns, price markdowns and customer bad debts,
disclosure of contingent assets and liabilities, and the recoverable value of
advance licensing and royalty payments as of the end of the reporting period,
and the reported amounts of revenues and expenses during the reporting period.
We recognize the critical nature and potential impact from making these and any
other estimates and attempt to make reliable estimates, based upon the
information available to us as of any reporting period. However, we also
recognize that actual results could differ from any of our estimates and that
such differences could have either a negative or positive impact on future
financial results.
2. Accounts Receivable, net
Accounts receivable, net consists of the following:
Accounts receivable, gross $ 775,000
Allowance for product returns and price markdowns (484,000)
Allowance for bad debts (22,000)
----------
Accounts receivable, net $ 269,000
==========
3. Inventory, net
Inventory, net consists of the following:
Raw materials - warehouse $ 185,000
Finished goods - warehouse 685,000
Finished goods - consignment 87,000
Product returns - retailer and distributor locations 90,000
----------
Inventory, gross 1,047,000
Allowance for obsolescence (153,000)
----------
Inventory, net $ 894,000
==========
4. Prepaid and Other Expenses
Prepaid and other expenses consists of the following:
Royalties $ 140,000
Federal tax 89,000
Insurances 28,000
Other expenses 26,000
Retailer slotting fees 25,000
Marketing analysis 6,000
----------
Prepaid and other expenses $ 314,000
==========
5. Furniture and Equipment, net
Furniture and equipment consists of the following:
Furniture and equipment, gross $ 358,000
Accumulated depreciation (308,000)
----------
Furniture and equipment, net $ 50,000
==========
6. Accrued Expenses
Accrued expenses consists of the following:
Customers with credit balances $ 157,000
Vacation accrual 104,000
Professional fees 71,000
Other accruals 27,000
Marketing promotins 23,000
Charities 15,000
Annual report 13,000
----------
Accrued expenses $ 410,000
==========
7. Commitments and Contingencies
Our 5,000 square foot office facility located in Langhorne, Pennsylvania is
occupied under an operating lease through September 30, 2007. Additionally, we
currently rent certain office equipment through various operating lease
agreements. For the years ended June 30, 2005 and 2004, total rent expense
amounted to $87,000 and $82,000, respectively. At June 30, 2005, we had future
operating lease commitments of $158,000 that are scheduled to be paid as
follows: $65,000 in less than one year; and $93,000 in one to three years.
Under various licensing agreements with third-party software developers, we are
required to pay royalties for the use of licensed content in our products. Most
of these licensing agreements require us to make advance royalty payments to
these developers prior to the time we recognize any net sales of software titles
containing this licensed software content. As of June 30, 2005, we had future
commitments to pay $110,000 in advance licensing and royalty payments to various
third-party licensors and software developers, which are scheduled to be paid as
follows: $97,000 in less than one year; and $13,000 in one to three years.
8. Credit Facility
In November 2004, we renewed our credit facility agreement with Hudson United
Bank ("HUB"), which matures on December 1, 2005. Amounts outstanding under this
credit facility are charged interest at one-half of one percent above HUB's
current prime rate and such interest is due monthly. Our access to these funds
is limited to the lesser of $750,000 or seventy-five percent of qualified
accounts receivable, which are defined as invoices less than ninety days old and
net of any allowances for product returns, price markdowns and customer bad
debts. As of June 30, 2005, we had not utilized any of this credit facility, and
we had access to approximately $200,000 under this credit facility, based on the
prescribed calculation of seventy-five percent of qualified accounts receivable
as of that date.
The credit facility is secured by all of the Company's assets and requires us,
among other things, to maintain the following financial covenants to be tested
quarterly: total liabilities to tangible net worth ratio of 1.25 to 1.00 and a
tangible net worth requirement of $2.0 million. At June 30, 2005, we were in
compliance with each of those covenants. This credit facility was established to
provide working capital for our operations.
9. Dependence on One Large Software Distributor - Atari
Atari is our primary software distributor servicing the North American
mass-merchants and other major retailers. During the year ended June 30, 2005,
Atari accounted for $2,412,000 of net sales, or 45% of net sales, compared to
the year ended June 30, 2004, when Atari accounted for $5,508,000 of net sales,
or 69% of net sales.
Throughout fiscal 2005 Atari represented the majority of our net accounts
receivable, however as of June 30, 2005 Atari represented only 8% of our net
accounts receivable, due to their gross receivable being substantially offset by
allowances for product returns and price markdowns for physical units of our
titles (previously sold to Atari) that remained in the retail channel. Also
during the year ended June 30, 2005, we collected receivable payments of $3.7
million from Atari, which represented 55% of our total customer receipts during
fiscal 2005.
If we were to lose our product distribution through Atari, or if they were not
able or willing to make timely receivable payments to us in the normal course of
business, our financial condition would be significantly impacted. Since the
retail distribution of PC software is a competitive business, there may be
alternative distributors that could distribute our products to retailers if, for
example, Atari chose to discontinue distributing our titles, we chose to
transition all or part of our business with Atari to one or more alternative
software distributors, or if any retailers decided to discontinue their
relationship with Atari.
10. Income Taxes
The provision (benefit) for income taxes is comprised of the following
components for the years ended June 30, 2005 and 2004, respectively:
2005 2004
--------- --------
Current
Federal $ - 0 - $ - 0 -
State (7,000) 83,000
--------- --------
(7,000) 83,000
Deferred
Federal (5,000) 665,000
State (139,000) 109,000
---------- -------
(144,000) 774,000
Valuation allowance 144,000 (774,000)
--------- -------
Provision (benefit) for income taxes ($ 7,000) $ 83,000
========= ========
The reconciliation between the statutory federal income tax rate and our
effective federal rate for income tax provision for the years ended June 30,
2005 and 2004, respectively, is as follows:
2005 2004
--------- --------
Statutory federal income tax rate 34% 34%
Increase (decrease) in taxes resulting from:
Change in valuation allowance and other (34%) (34%)
----------------------
Effective federal rate for income tax provision - 0 -% - 0 -%
====== ======
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at June 30, 2005 and
2004 is as follows:
2005 2004
--------- --------
Net deferred tax assets:
Alternative minimum tax credit $ 52,000 $ 21,000
Accrued expenses and other 51,000 32,000
Allowances for accounts receivable and inventory 303,000 516,000
Depreciation 12,000 38,000
Net operating losses and capital losses 1,142,000 778,000
--------- ---------
Gross deferred tax assets 1,560,000 1,385,000
Less: Valuation allowance (1,508,000) (1,364,000)
--------- ---------
Net deferred tax assets $ 52,000 $ 21,000
========= ========
The deferred tax asset is offset by a full valuation allowance against timing
differences as of June 30, 2005, as management currently believes that it is
more likely than not that the deferred tax asset will not be realized. During
fiscal 2005, the valuation allowance for net deferred tax assets increased by
approximately $144,000. The increase was a result of net changes in the
temporary differences in the accounts reflected in the table above.
As of June 30, 2005, we had approximately $3,321,000 of net operating loss
carry-forwards for federal income tax purposes, (expiring through fiscal year
ending June 30, 2020), which are available to offset future federal taxable
income, and $617,000 in net operating loss carry-forwards for state purposes,
(expiring through fiscal year ending June 30, 2008), which are available to
offset future state taxable income.
11. Common Stock
On June 30, 1995, we amended our 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 was intended to protect the interests of our existing
stockholders' in the event that we were confronted with coercive or unfair
takeover tactics. The Plan contained provisions to safeguard existing
stockholders in the event of an unsolicited offer to acquire our company,
whether through a gradual accumulation of shares in the open market, a partial
or two-tiered tender offer that did not treat all stockholders equally, or other
abusive takeover tactics, which our Board of Directors believed was not in the
best interests of our stockholders.
On March 4, 2005, our Board of Directors approved an amendment to the
Stockholders Rights Plan to accelerate the expiration date from June 1, 2009 to
March 7, 2005. With this action, the Plan was terminated on March 7, 2005.
The Board's decision to terminate the Plan was not made in connection with
any business transaction pending at that time.
12. Quarterly Cash Dividends
On February 22, 2005 and on May 25, 2005, we made quarterly cash dividend
payments of $0.015 per common share to shareholders of record on February 15,
2005 and May 17, 2005. On August 18, 2005, our Board of Directors decided that
the Company will suspend future quarterly cash dividend payments to shareholders
of our common stock, and retain future earnings, if any, for use in funding our
business and we do not anticipate paying any cash dividends in the foreseeable
future. It is the Board of Director's intention to continue evaluating the
feasibility of paying quarterly cash dividends to shareholders of our common
stock in future periods. However, the payment of any future cash dividend
depends entirely upon the discretion of the Company's Board of Directors.
13. Stock Options
During 1995, we adopted, amended and restated our 1995 Amended and Restated
Stock Option Plan (the "1995 Plan"), which expired on June 30, 2005. The 1995
Plan allowed for the granting of options to purchase shares of our common stock
through June 30, 2005, after which date any previously granted option remains in
effect through its contractual term. At our 1997 Annual Meeting of Shareholders,
the shareholders of our 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. At our 2000 Annual Meeting of Shareholders, the
shareholders of our company approved an amendment to increase the number of
shares available for issuance under the 1995 Plan from the 1,950,000 shares of
common stock previously approved to a total of 2,950,000 shares. The 1995 Plan
is administered by the Board of Directors and provided 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 provided for automatic grants of
options to non-employee directors of our company. Each non-employee director
received options for 10,000 shares of common stock upon appointment or election
to the board and, in addition, each director would receive options for 5,000
shares of common stock on the first trading day in January of each year.
Except with respect to automatic grants of options to non-employee directors,
the expiration of a stock option and its vesting period are 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. Stock option grants under the
1995 Plan vest over periods ranging from six months to ten years. In most cases,
upon termination of employment, vested options must be exercised by the optionee
within three months after the termination of the optionee's employment with our
company.
Information regarding our stock options is as follows:
Number
of Weighted Average
Options Exercise Price
-----------------------------------
Balance, June 30, 2003 2,345,500 $ 0.91
========= ======
Granted 702,500 0.79
Canceled (388,750) 1.61
Exercised (69,250) 0.25
-----------------------------------
Balance, June 30, 2004 2,590,000 $ 0.79
========= ======
Granted 48,333 1.21
Canceled (310,500) 2.78
Exercised (848,167) 0.27
-----------------------------------
Balance, June 30, 2005 1,479,666 $ 0.69
========= ======
At June 30, 2005, 487,917 of outstanding stock options were vested and no stock
options were available for issuance under the 1995 Plan, since the 1995 Plan
expired on June 30, 2005. The following summarizes information about the stock
options outstanding at June 30, 2005:
[Enlarge/Download Table]
Options Outstanding Options Exercisable
--------------------------------------------------------------------------------
Weighted Avg. Weighted Weighted
Number Remaining Avg. Number Avg.
Range of Exercise Outstanding at Contractual Life Exercise Exercisable at Exercise
Prices June 30, 2005 (in years) Price June 30, 2005 Price
-----------------------------------------------------------------------------------------------------
$0.21 - $0.75 753,833 2.07 $0.55 413,167 $0.40
$0.79 - $1.50 725,833 8.31 $0.82 74,750 $0.80
------------- --------- ---- ----- ------- -----
$0.21 - $1.50 1,479,666 5.13 $0.69 487,917 $0.46
========= =======
The per share weighted-average fair values of stock options granted during the
years ended June 30, 2005 and 2004 were $1.21 and $0.79, respectively, as
determined on the date of grant using the Black-Scholes option-pricing model
with the following assumptions:
Years Ended
June 30,
--------------------------------
2005 2004
--------------------------------
Dividend Yield 0% 0%
Volatility Factor 227% to 300% 300%
Risk-Free Interest Rate 2.68% 2.25% to 3.81%
Average Expected Option Life 3 Years 3 to 7 Years
14. Accounting for Stock-Based Compensation
Prior to July 1, 2002, we accounted for all stock option grants under the
recognition and measurement provisions of APB Opinion No. 25, "Accounting for
Stock Issued to Employees", and related Interpretations. Accordingly, no
stock-based employee compensation cost is reflected in net income before fiscal
2003, as all stock option grants had an exercise price equal or greater than the
market value of the underlying common stock on the date of grant.
Effective July 1, 2002, we adopted within our financial statements the
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" by
applying the fair value method prospectively for stock options grants made on or
after that date. As of January 1, 2003, we adopted the provisions of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure".
During the fiscal years ended June 30, 2005 and 2004, we recognized stock-based
compensation expense within our financial statements of $77,000 and $69,000,
respectively. All stock options that vested during these years had been
previously valued under the fair value method, and accordingly no reconciliation
of stock-based compensation expense between the valuation methods for APB
Opinion No. 25 and SFAS No. 123 is presented.
15. Operations by Reportable Segment and Geographic Area
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," establishes standards for reporting information about an
enterprise's operating segments and related disclosures about products,
geographic areas and major customers.
Based on our organizational structure, we operate in only one geographic area,
which is North America, and only one reportable segment, which is publishing
consumer entertainment software for PCs.
16. Subsequent Event - Acquisition of Assets of Cinemaware, Inc.
eGames expects to enter into an Asset Purchase Agreement with Cinemaware during
or prior to the first week of October to purchase substantially all of the
assets of Cinemaware. The assets to be acquired upon closing of the transaction,
anticipated to occur in October, 2005, principally consist of intellectual
property, contract rights and goodwill. As part of the transaction, at closing
Cinemaware and its principal shareholder, Lars Fuhrken-Batista, will enter into
non-competition agreements, and Mr. Batista will become Vice President of
Development for eGames. We currently intend to use the Cinemaware assets
for the purposes of developing new higher-priced PC game titles and console game
titles.
In consideration for the Cinemaware assets, at closing eGames will issue shares
of its common stock equal to $300,000 divided by the average closing price of a
share of eGames common stock for the five trading days prior to the date of the
Agreement, and the five trading days ending one trading day prior to the
closing, but in no event less than 600,000 shares or more than 855,000 shares.
Also at closing, eGames will issue to Cinemaware a warrant to purchase 150,000
shares of eGames common stock at an exercise price of $.50 per share, and a
warrant to purchase 150,000 shares of eGames common stock at an exercise price
of $.75 per share. The warrants will have a term of five years. One-third of the
shares of eGames common stock to be issued at closing will be held in an escrow
account for one year for eGames' indemnification claims. eGames is not assuming
any of Cinemaware's liabilities, except for certain obligations relating to
assumed contracts. We will assign the fair value of the acquired assets to our
balance sheet. This transaction is expected to be classified as an "asset
purchase."
Additionally, as part of Mr. Batista's employment, upon his start date he will
receive stock options to purchase 150,000 shares of eGames common stock with an
exercise price equal to the closing price of eGames common stock on that date.
These options will not be part of any stock option plan and will vest and become
exercisable over five years in equal annual installments. The options will have
terms of six years.
17. Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004),
"Share-Based Payment" which revised Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation". This statement supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees". The revised
statement addresses the accounting for share-based payment transactions with
employees and other third parties, eliminates the ability to account for
share-based compensation transactions using APB 25 and requires that the
compensation expense relating to such transactions be recognized in the
statement of operations. The revised statement is effective as of the first
interim period beginning after June 15, 2005. Since we had adopted within our
financial statements the provisions of SFAS No. 123 as of July 1, 2002, we do
not expect the adoption of SFAS No. 123 (revised 2004) to have a material impact
on our financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - an amendment
of ARB No. 43, Chapter 4". SFAS No. 151 amends the guidance in Accounting
Research Bulletin ("ARB") No. 43, "Restatement and Revision of Accounting
Research Bulletins", Chapter 4, "Inventory Pricing", to clarify the accounting
for abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) and requires that those items be recognized as
current-period charges. SFAS No. 151 also requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. We do not believe
the adoption of SFAS No. 151 will have a material impact on our financial
statements.
Item 8. Changes In and Disagreements with Accountants on Accounting
and Financial Disclosure
None
Item 8A. Controls and Procedures
(a) Disclosure Controls and Procedures. Under the supervision and with the
participation of our Chief Executive Officer and Chief Financial Officer, we
carried out an evaluation of the effectiveness of our disclosure controls and
procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as of June 30, 2005 (the "Evaluation Date").
Based on that evaluation, our Chief Executive Officer and Chief Financial
Officer have concluded that as of the Evaluation Date, our disclosure controls
and procedures were effective to provide reasonable assurance that the
information required to be disclosed in our reports filed or furnished under the
Exchange Act was recorded, processed, summarized and reported, within the
periods specified in the SEC's rules and forms. We believe that a controls
system, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the controls system are met, and no evaluation
of controls can provide absolute assurance that all the control issues and
instances of fraud, if any, within a company have been detected.
(b) Changes in Internal Control over Financial Reporting. There have not been
any changes in our internal control over financial reporting during the fiscal
quarter ended June 30, 2005 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Item 8B. Other Information
None
PART III
Item 9. Directors and Executive Officers of the Registrant, Promoters and
Control Persons, Compliance with Section 16(a) of the Exchange Act
The information required by this Item with respect to directors is incorporated
herein by reference from the information provided under the caption "Election of
Directors" of our definitive Proxy Statement for our 2005 Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission.
The information required by this Item with respect to executive officers is
incorporated herein by reference from the information provided under the caption
"Executive Officers of the Company" of our Proxy Statement.
The information required by this Item with respect to compliance with Section
16(a) of the Securities and Exchange Act is incorporated herein by reference
from the information provided under the caption "Compliance with Securities
Laws" of our Proxy Statement.
The information required by this Item with respect to our audit committee and
our audit committee financial expert is incorporated herein by reference from
the information provided under the heading "Election of Directors - Meetings and
Committees of the Board of Directors - Audit Committee" of our Proxy Statement.
The information required by this Item with respect to our Code of Ethics is
incorporated herein by reference from the information provided under the heading
"Election of Directors - Code of Ethics" of our Proxy Statement.
Item 10. Executive Compensation
The information appearing under the captions "Executive Compensation" and
"Election of Directors" of our definitive Proxy Statement for our 2005 Annual
Meeting of Shareholders to be filed with the Securities and Exchange Commission
is incorporated by reference into this report on Form 10-KSB.
Item 11. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters
The information appearing under the captions "Voting Securities and Principal
Holders Thereof" and "Equity Compensation Plan Information" of our definitive
Proxy Statement for our 2005 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission is incorporated by reference into this report
on Form 10-KSB.
Item 12. Certain Relationships and Related Transactions
The information appearing under the caption "Certain Transactions" of our
definitive Proxy Statement for our 2005 Annual Meeting of Shareholders to be
filed with the Securities and Exchange Commission is incorporated by reference
into this report on Form 10-KSB.
PART IV
Item 13.
Exhibits
The following is a list of exhibits filed as part of this annual report on Form
10-KSB. Where indicated, exhibits that were previously filed are incorporated by
reference.
Exhibit No. Description of Exhibit
----------- ----------------------
(1) 3.1 Amended and Restated Articles of Incorporation of the Registrant.
(2) 3.2 By-Laws of the Registrant.
(3) 10.1* Amended and Restated 1995 Stock Option Plan.
(4) 10.2* Form of Incentive Stock Option Agreement.
(4) 10.3* Form of Non-Employee Director Stock Option Agreement.
(5) 10.4 Business Loan Agreement by and between Hudson United Bank and
the Registrant dated November 23, 2004.
(5) 10.5 Promissory Note dated November 23, 2004.
(5) 10.6 Commercial Security Agreement dated November 23, 2004.
(6) 10.7* Change of Control Severance Plan for Level One Employees.
(6) 10.8* Change of Control Severance Plan for Level Two Employees.
14.1 Code of Ethics for Employees and Board Members
23.1 Consent of Stockton Bates, LLP.
31.1 Certification of Gerald W. Klein as President and Chief Executive
Officer of eGames, Inc. pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Thomas W. Murphy as Chief Financial Officer of
eGames, Inc. pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification of Gerald W. Klein as President and Chief Executive
Officer of eGames, Inc. pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Thomas W. Murphy as Chief Financial Officer of
eGames, Inc. pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Management contracts.
(1) Incorporated herein by reference from the Registrant's Form SB-2
as filed with the Securities and Exchange Commission on
July 28, 1995.
(2) Incorporated herein by reference 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.
(3) Incorporated by reference herein 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 10-KSB
for the year ended June 30, 2004 as filed with the Securities and
Exchange Commission on September 27, 2004
(5) Incorporated herein by reference from the Registrant's Form 8-K
as filed with the Securities and Exchange Commission on
November 24, 2004.
(6) Incorporated herein by reference from Registrant's Form 8-K as
filed with the Securities and Exchange Commission on
June 28, 2004.
Item 14. Principal Accountant Fees and Services
The information appearing under the caption "Audit Fees" under "Ratification of
the Appointment of Auditors" of our definitive Proxy Statement for our 2005
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission is incorporated by reference into this report on Form 10-KSB.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on our behalf by the undersigned, thereunto duly
authorized.
eGames, Inc.
By: /s/ Gerald W. Klein
------------------------------
Gerald W. Klein, President and
Chief Executive Officer
Date: September 27, 2005
------------------------
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 27, 2005 /s/ Gerald W. Klein
------------------ --------------------
Gerald W. Klein, President and
Chief Executive Officer
Date: September 27, 2005 /s/ Thomas W. Murphy
------------------ --------------------
Thomas W. Murphy, Chief Financial
Officer and Chief Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons, on behalf of the Registrant in
the capacities indicated and on the 27th of September 2005.
Name Title
--------------------------------------------------------------------------------
/s/ Gerald W. Klein President and Chief Executive Officer and Director
----------------------
Gerald W. Klein
/s/ Robert M. Aiken, Jr. Chairman of the Board of Directors
------------------------
Robert M. Aiken, Jr.
/s/ Thomas D. Parente Director
---------------------
Thomas D. Parente
/s/ Lambert C. Thom Director
-------------------
Lambert C. Thom
Exhibit 14.1
EGAMES, INC.
CODE OF ETHICS
FOR EMPLOYEES AND BOARD MEMBERS
At eGames, our mission is to seek, obtain, and serve customers. We firmly
believe in conducting our business in an honest and ethical manner. We expect
all of our employees and directors to comply with all applicable laws, and to
avoid conflicts of interest that could harm eGames' business or reputation. This
Code of Ethics is designed to summarize, in a simple and straightforward manner,
our policies and procedures that promote our core values of honesty, fairness,
respect and integrity.
What to do if you suspect a violation of this Code of Ethics
The Board of Directors of eGames has adopted this Code of Ethics for its
employees and Directors. Each employee and Director is responsible for complying
with this Code. Employees must also comply with the eGames Employee Handbook.
Any violations of this Code must be promptly reported to the Chairman of the
Board and the General Counsel of eGames. The Board will review and investigate
any reported violations. If the Board determines that a violation of this Code
has occurred, then appropriate remedial or disciplinary action will be taken.
eGames will disclose violations of this Code and the remedial or disciplinary
action taken, to the extent required by the Federal securities or other
applicable laws. If the Board determines that a violation of this Code has
occurred, but does not believe that any remedial or disciplinary action is
necessary or desirable (or if the Board agrees to waive compliance with a
provision of the Code on behalf of any Director or officer), then eGames will
promptly disclose the violation or waiver and the Board's rationale for its
decision as required by law.
All employees and Directors are expected to provide full assistance and
disclosure to the Board, eGames and its external auditors in connection with any
review of compliance with this Code.
Conduct of Business and Fair Dealing
No employee or Director of eGames shall:
o compete with eGames by providing service to a competitor as an
employee, officer or director or in a similar capacity;
o individually profit or assist others in profiting from confidential
information or business opportunities that are available because of
service to eGames;
o improperly influence or attempt to influence any business transaction
between eGames and another entity in which an employee or Director has
a direct or indirect financial interest or acts as an employee, officer
or director or in a similar capacity; or
o take unfair advantage of any customer or supplier through
manipulation, concealment, misrepresentation of material facts or other
unfair practice.
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
The Board of Directors
eGames, Inc.
We consent to the incorporation by reference in the registration statement (No.
333-42661) on Form S-8 of eGames, Inc. of our report dated August 2nd, 2005,
with respect to the balance sheet as of June 30, 2005 and the statements of
operations, stockholders' equity, and cash flows of eGames, Inc. for the years
ended June 30, 2005 and 2004, which report appears in the June 30, 2005 annual
report on Form 10-KSB of eGames, Inc.
/s/ Stockton Bates, LLP
Philadelphia, Pennsylvania
September 27, 2005
Exhibit 31.1
Certification
I, Gerald W. Klein, certify that:
1. I have reviewed this annual report on Form 10-KSB of eGames, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The small business issuer's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and
have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the small
business issuer, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the period
in which this report is being prepared;
b) Evaluated the effectiveness of the small business issuer's
disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on
such evaluation; and
c) Disclosed in this report any change in the small business issuer's
internal control over financial reporting that occurred during the
small business issuer's most recent fiscal quarter (the small business
issuer's fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect,
the small business issuer's internal control over financial reporting;
5. The small business issuer's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the small business issuer's auditors and the audit committee of
the small business issuer's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the small business issuer's
ability to record, process, summarize and report financial information;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the small business
issuer's internal control over financial reporting.
Date: September 27, 2005
/s/ Gerald W. Klein
Gerald W. Klein
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
Certification
I, Thomas W. Murphy, certify that:
1. I have reviewed this annual report on Form 10-KSB of eGames, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the small business
issuer as of, and for, the periods presented in this report;
4. The small business issuer's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and
have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the small
business issuer, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the period
in which this report is being prepared;
b) Evaluated the effectiveness of the small business issuer's
disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on
such evaluation; and
c) Disclosed in this report any change in the small business issuer's
internal control over financial reporting that occurred during the
small business issuer's most recent fiscal quarter (the small business
issuer's fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect,
the small business issuer's internal control over financial reporting;
5. The small business issuer's other certifying officer and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the small business issuer's auditors and the audit committee of
the small business issuer's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the small business issuer's
ability to record, process, summarize and report financial information;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the small business
issuer's internal control over financial reporting.
Date: September 27, 2005
/s/ Thomas W. Murphy
Thomas W. Murphy
Chief Financial Officer
(Principal Financial Officer)
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------
In connection with the Annual Report of eGames, Inc. (the "Company") on Form
10-KSB for the fiscal year ended June 30, 2005 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Gerald W. Klein,
President and Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
1. The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Gerald W. Klein
-------------------
Gerald W. Klein
President and Chief Executive Officer
September 27, 2005
The foregoing certification is being furnished to the Securities and Exchange
Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is
not being filed as part of the Report or as a separate disclosure document.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
---------------------------------------------
In connection with the Annual Report of eGames, Inc. (the "Company") on Form
10-KSB for the fiscal year ended June 30, 2005 as filed with the Securities and
Exchange Commission on the date hereof (the "Report"), I, Thomas W. Murphy, Vice
President and Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, that:
1. The Report fully complies with the requirements of section 13(a)
or 15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Thomas W. Murphy
--------------------
Thomas W. Murphy
Chief Financial Officer
September 27, 2005
The foregoing certification is being furnished to the Securities and Exchange
Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is
not being filed as part of the Report or as a separate disclosure document.
Dates Referenced Herein and Documents Incorporated by Reference
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