U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 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 West, Suite 110
Langhorne, PA 19047-1811
(address of Principal executive offices)
Issuer's Telephone Number, Including Area Code: 215-750-6606
Not Applicable
(Former name, former address and former
fiscal year, if changed since last report.)
Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes (X) No ( )
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
Yes ( ) No (X)
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 11,724,193 shares of common stock, no
par value per share, as of February 13, 2006.
Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X )
INDEX
Page
----
Part I. Financial Information
Item 1. Unaudited Financial Statements:
Balance Sheet at December 31, 2005............................ 3
Statements of Operations for the three and six months
ended December 31, 2005 and 2004 ......................... 4
Statements of Cash Flows for the six months
ended December 31, 2005 and 2004.......................... 5
Notes to Financial Statements................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ...................... 12
Item 3. Controls and Procedures ...................................... 25
Part II Other Information
Item 4. Submission of Matters to a Vote of Security Holders .......... 25
Item 6. Exhibit Listing .............................................. 26
Exhibit Index .............................................................. 26
Signatures .............................................................. 27
Exhibits .............................................................. 28
Item 1. Unaudited Financial Statements
eGames, Inc.
Balance Sheet
(Unaudited)
December 31,
ASSETS 2005
- ------ -----------
Current assets:
Cash and cash equivalents $ 1,742,396
Accounts receivable, net 824,810
Inventory, net 848,417
Prepaid and other expenses 348,191
-----------
Total current assets 3,763,814
Furniture and equipment, net 36,804
Goodwill 420,000
Intangible assets 24,089
-----------
Total assets $ 4,244,707
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $ 384,419
Accrued expenses 293,909
-----------
Total current liabilities 678,328
-----------
Stockholders' equity:
Common stock, no par value (40,000,000 shares authorized;
11,956,093 issued and 11,724,193 outstanding) 9,179,827
Additional paid-in capital 2,093,378
Accumulated deficit (7,205,409)
Treasury stock, at cost - 231,900 shares (501,417)
-----------
Total stockholders' equity 3,566,379
-----------
Total liabilities and stockholders' equity $ 4,244,707
===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Operations
(Unaudited)
Three Months Ended Six Months Ended
December 31, December 31,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net sales $ 1,154,053 $ 1,912,630 $ 2,448,064 $ 3,090,459
Cost of sales 678,619 839,234 1,382,424 1,410,392
----------- ----------- ----------- -----------
Gross profit 475,434 1,073,396 1,065,640 1,680,067
Operating expenses:
Product development 127,492 103,878 211,520 342,993
Selling, general and
administrative 593,674 647,533 1,161,901 1,218,665
----------- ----------- ----------- -----------
Total operating expenses 721,166 751,411 1,373,421 1,561,658
----------- ----------- ----------- -----------
Operating income (loss) (245,732) 321,985 (307,781) 118,409
Interest income, net 12,331 1,597 20,408 2,827
----------- ----------- ------------ -----------
Income (loss) before income taxes (233,401) 323,582 (287,373) 121,236
Provision for income taxes - 0 - 28,324 - 0 - 10,301
----------- ------------ ----------- -----------
Net income (loss) ($ 233,401) $ 295,258 ($ 287,373) $ 110,935
=========== =========== =========== ===========
Net income (loss)
per common share:
- Basic ($ 0.02) $ 0.03 ($ 0.03) $ 0.01
====== ======= ====== =======
- Diluted ($ 0.02) $ 0.03 ($ 0.03) $ 0.01
====== ======= ====== =======
Weighted average common shares
outstanding - Basic 11,618,717 10,116,329 11,262,736 10,109,501
Dilutive effect of common share
equivalents - 0 - 502,459 - 0 - 869,972
----------- ----------- ----------- -----------
Weighted average common shares
outstanding - Diluted 11,618,717 10,618,788 11,262,736 10,979,473
=========== =========== =========== ===========
See accompanying notes to financial statements.
eGames, Inc.
Statements of Cash Flows
(Unaudited)
Six Months Ended
December 31,
--------------------------
2005 2004
----------- -----------
OPERATING ACTIVITIES:
- ---------------------
Net income (loss) ($ 287,373) $ 110,935
Adjustment to reconcile net income (loss) to
net cash used in operating activities:
Stock-based compensation 37,234 36,612
Depreciation 16,029 17,712
Changes in operating assets and liabilities:
Accounts receivable, net (555,642) 246,543
Inventory, net 45,349 (102,456)
Prepaid and other expenses (34,507) 3,812
Accounts payable 227,827 (65,401)
Accrued expenses (115,731) (307,031)
----------- -----------
Net cash used in operating activities (666,814) (59,274)
----------- -----------
INVESTING ACTIVITIES:
- ---------------------
Purchases of furniture and equipment (2,952) (10,291)
----------- -----------
Net cash used in investing activities (2,952) (10,291)
----------- -----------
FINANCING ACTIVITIES:
- ---------------------
Proceeds from exercise of stock options - 0 - 19,250
----------- -----------
Net cash provided by financing activities - 0 - 19,250
----------- -----------
Net decrease in cash and cash equivalents (669,766) (50,315)
Cash and cash equivalents:
Beginning of period 2,412,162 1,742,224
----------- -----------
End of period $ 1,742,396 $ 1,691,909
=========== ===========
Supplemental cash flow information:
Cash paid (refunds received) for income taxes ($ 34,000) $ 127,620
=========== ===========
See accompanying notes to financial statements.
eGames, Inc.
Notes to Financial Statements
(Unaudited)
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 PC software games.
Historically, we have focused on publishing affordable software games for the PC
platform only. Our current strategy is to begin offsetting the impact from the
decrease in retail shelf space being allocated to value-priced PC software by
publishing higher quality, higher-priced PC game titles, as well as seeking
opportunities to publish titles for other gaming platforms, such as console and
handheld game devices. We sell our software titles 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), Cinemaware(R) and Cinemaware Marquee(TM)
brands in order to generate customer loyalty, encourage repeat purchases and
differentiate our software products to retailers and consumers.
Basis of Presentation
The accompanying unaudited interim financial statements were prepared in
accordance with the instructions to Form 10-QSB and Item 310(b) of Regulation
S-B. Accordingly, these financial statements do not include all information and
disclosures required by generally accepted accounting principles in the United
States for complete financial statements. These financial statements include all
adjustments that management believes are necessary for a fair presentation of
the financial statements. These interim operating results are not necessarily
indicative of the results for a full year. The accompanying financial statements
should be read in conjunction with the audited financial statements and notes
thereto contained in our Form 10-KSB for the fiscal year ended June 30, 2005.
Amounts discussed within the "Notes to Financial Statements" have been rounded
to the nearest thousand ("000") dollars.
Fair Value of Financial Instruments
The recorded amounts of cash and net accounts receivable at December 31, 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 if any, 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 reductions to gross sales);
and customer bad debts (if any, 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.
Goodwill and Other Intangible Assets
Goodwill is the excess purchase price paid by an acquiring company for
identified intangible and tangible net assets. Intangible assets usually consist
of trademarks, intellectual property, non-compete agreements, customer lists and
acquired technology. SFAS No. 142, "Goodwill and Other Intangible Assets"
requires that purchased goodwill and intangibles with indefinite lives not be
amortized. Rather, goodwill and intangible assets with indefinite lives are
subject to at least an annual assessment for impairment by applying a
fair-value-based test. SFAS No. 142 requires a two-step approach to testing
goodwill for impairment for each reporting unit. The first step tests for
impairment by applying fair value-based tests at the reporting unit level. The
second step (if necessary), measures the amount of impairment by applying fair
value-based tests to individual assets and liabilities within each reporting
unit.
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
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. 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 six months from the period we
recognize revenue and these costs have historically averaged 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
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.
At December 31, 2005, the allowance for product returns and price markdowns
amounted to 45% of our gross accounts receivable. Historically, the allowance
for product returns and price markdowns has represented a large percentage of
our gross accounts receivable because we continue to have product return and
price markdown exposure for the physical software units related to paid
receivables while these units remain in the retailers' stores or in the
retailers' or distributors' warehouses. Until physical software units sell
through to consumers, or are returned to us, we continue to evaluate our product
return or price markdown exposure for these previously sold units while these
units remain in the retail channel. During reporting periods, through retailer
and distributor provided reports, we have regular and timely visibility of
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, retail market
reporting 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. Advance licensing and royalty payments are usually
expensed as cost of sales at the higher of the contractual or effective rate
(see Notes 4 and 7). Income tax payments 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 (Loss) per Common Share
Net income (loss) per common share is computed in accordance with SFAS No. 128,
"Earnings per Share". Basic earnings per share is computed by dividing net
income (loss) 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 at 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 $ 1,499,000
Allowance for product returns and price markdowns (674,000)
-----------
Accounts receivable, net $ 825,000
===========
3. Inventory, net
Inventory, net consists of the following:
Raw materials - warehouse $ 237,000
Finished goods - warehouse 531,000
Finished goods - consignment 129,000
Product returns - retailer and distributor locations 120,000
-----------
Inventory, gross 1,017,000
Allowance for obsolescence (169,000)
-----------
Inventory, net $ 848,000
===========
4. Prepaid and Other Expenses
Prepaid and other expenses consist of the following:
Royalties $ 150,000
Insurances 74,000
Federal tax 58,000
Retail market reporting 36,000
Retailer slotting fees 15,000
Other expenses 15,000
-----------
Prepaid and other expenses $ 348,000
===========
5. Furniture and Equipment, net
Furniture and equipment consists of the following:
Furniture and equipment, gross $ 361,000
Accumulated depreciation (324,000)
-----------
Furniture and equipment, net $ 37,000
===========
6. Accrued Expenses
Accrued expenses consist of the following:
Vacation accrual $ 104,000
Professional fees 37,000
Marketing promotions 30,000
Other 30,000
Customer credit balances 23,000
Relocation 20,000
Charities 18,000
Royalties 16,000
State taxes 16,000
-----------
Accrued expenses $ 294,000
===========
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 quarters ended December 31, 2005 and 2004, total rent
expense amounted to $22,000 and $21,000, respectively. During the six months
ended December 31, 2005 and 2004, total rent expense amounted to $44,000 and
$43,000, respectively. At December 31, 2005, we had future operating lease
commitments of $125,000 scheduled to be paid as follows: $64,000 in less than
one year; and $61,000 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 December 31, 2005, we had
future commitments to pay $101,000 in advance licensing and royalty payments in
less than one year to various third-party licensors and software developers.
As part of a public relations campaign intended to support and promote our
brands and the retail releases of our new higher priced PC game titles, we have
entered into a professional services agreement with a public relations firm for
services from January 2006 through June 2006 with a future cost of $41,000
payable in monthly installments during that period.
8. Credit Facility
In December 2005, we renewed our credit facility agreement with Hudson United
Bank ("HUB"), which matures on December 1, 2006. This credit facility was
established to provide working capital for our operations. 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 December 31, 2005, we had not utilized any of this credit facility,
and we had access to approximately $600,000 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 certain
financial covenants that are tested quarterly.
9. Concentration of Customers
We continue to have a concentration of customers consisting of a few large
software distributors and retailers. Historically, Atari, Inc. ("Atari") has
represented our primary software distributor servicing the North American
mass-merchants and other major retailers. In December 2005, we began to
transition a portion of our mass-merchant retail distribution to Take-Two
Interactive Software ("Take Two"), which has distributed our titles into the
office superstore and discount warehouse retail channels for several years. As a
result of this transition, Take Two has become the distributor of record with
the largest mass-merchant retailer selling our software titles, and for this
reason we anticipate that Take Two will represent a larger percentage of our net
sales and net accounts receivable in future periods.
During the three months ended December 31, 2005, Atari accounted for $360,000 of
net sales, or 31% of net sales, compared to the three months ended December 31,
2004, when Atari accounted for $963,000 of net sales, or 50% of net sales.
During the six months ended December 31, 2005, Atari accounted for $923,000 of
net sales, or 38% of net sales, compared to the six months ended December 31,
2004, when Atari accounted for $1,477,000 of net sales, or 48% of net sales. At
December 31, 2005, Atari's net receivable balance amounted to $409,000, or 50%
of our total net accounts receivable.
During the three months ended December 31, 2005, Take Two accounted for $77,000
of net sales, or 7% of net sales, compared to the three months ended December
31, 2004, when Take Two accounted for $66,000 of net sales, or 3% of net sales.
During the six months ended December 31, 2005, Take Two accounted for $124,000
of net sales, or 5% of net sales, compared to the six months ended December 31,
2004, when Take Two accounted for $117,000 of net sales, or 4% of net sales. At
December 31, 2005, Take Two's net accounts receivable amounted to $55,000, or
7%, of our total net accounts receivable.
10. Accounting for Stock-Based Compensation
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. On January 1, 2003, we adopted the provisions of SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure". During
the three months ended December 31, 2005 and 2004, we recognized stock-based
compensation expense within our financial statements of $20,000 and $18,000,
respectively, and during the six months ended December 31, 2005 and 2004, we
recognized stock-based compensation expense within our financial statements of
$37,000 during both periods.
11. 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 gaming software titles.
12. Goodwill and Other Intangible Assets
At December 31, 2005, we had goodwill of $420,000, which related to the
acquisition of substantially all of the assets of Cinemaware, Inc. in October
2005. The acquired assets consisted principally of goodwill, intellectual
property and contract rights. We intend to use the acquired Cinemaware assets
for developing, publishing and branding higher-priced game titles for the PC and
eventually for other gaming platforms. In consideration for the Cinemaware
assets, eGames issued to Cinemaware 817,439 shares of its common stock valued at
$300,000 based on the average closing stock price of the eGames' common stock
for the ten trading days that ended on October 12, 2005 and warrants (valued at
$120,000 using the Black-Scholes valuation model) to purchase 300,000 shares of
eGames common stock.
At December 31, 2005, we had other intangible assets of approximately $24,000
relating to the Company's trademark registration activities with the United
States Patent and Trademark Office. As of December 31, 2005, we had not recorded
any expense relating to these other intangible assets based upon our evaluation
that no impairment has occurred.
13. Advertising Costs
We generally expense advertising costs (such as in-store circulars and point of
sale materials) as incurred, except for production costs associated with media
campaigns (such as print ads, online banner ads and video loops) which would be
recognized as prepaid assets (to the extent these items were paid in advance)
and expensed during the period in which the ad or video loop is first released.
During the three months ended December 31, 2005 and 2004, advertising expenses
totaled $4,000 and $13,000, respectively. During the six months ended December
31, 2005 and 2004, advertising expenses amounted to $6,000 and $16,000,
respectively.
14. 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 SFAS 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 became effective during the first interim period beginning after
June 15, 2005. The adoption of SFAS No. 123 (revised 2004) did not 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 became effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS
No. 151 did not have a material impact on our financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This Quarterly Report on Form 10-QSB contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. All statements made in this Quarterly Report on
Form 10-QSB, other than statements of historical fact, including statements
regarding industry prospects and future results of operations or financial
position, are forward looking. We use the words "believe", "expect",
"anticipate", "intend", "will", "should", "may" and similar expressions to
identify forward-looking statements. These forward-looking statements are
subject to business volatility, economic risk, and world events, which are
inherently uncertain and difficult to predict. Our actual results could differ
materially from management's expectations due to such risks. We will not
necessarily update information if any forward-looking statement later turns out
to be inaccurate. In particular, these forward-looking statements include, among
others, statements about:
- The impact on our financial results of decreasing retail shelf space
for value-priced PC games and increased competition in this category;
- Our anticipated release of three higher-priced PC titles during our
third fiscal quarter;
- Our attempts to seek incremental revenues through licensing,
alternative retail channels and in-statement advertisers;
- Our efforts to license or develop higher-priced, unique casual game
content to compete more effectively in the value-priced, casual game
category;
- Our expectation that Take Two Interactive will account for a larger
percentage of our net sales, accounts receivable and related cash
receipts in future periods as a result of our recent transition of a
portion of our mass-merchant retail business to them;
- Our expectation that we will continue to receive product returns from
retailers that are then sold to inventory liquidators at discounted
prices;
- Our provision for product returns and price markdowns, as a
percentage of related gross sales, trending higher for the
foreseeable future;
- Our expectation that we will incur sales incentives and promotional
costs from software distributors and retailers at an increasing rate
for the foreseeable future;
- Our expectation regarding upfront payments to gaming platform
manufactures;
- Our expectation that product development expenses and advance
royalty payments will increase and we will incur higher costs for
promotional efforts in future periods as we publish higher-priced
PC game titles, and seek to publish titles for other platforms;
- the impact on our liquidity if Atari or Take Two were unable or
unwilling to make receivable payments to us in a timely manner; and
- our plan to continue to market promotional programs to reduce excess
inventory, increase collectible accounts receivable and be a source
of funds to support operations.
The following important factors, as well as those factors discussed under
"Factors Affecting Future Performance" in our Form 10-KSB for the fiscal year
ended June 30, 2005, could cause our actual results to differ materially from
those indicated by the forward-looking statements contained in this report:
- the market acceptance and successful sell-through results for our
products at retail stores;
- the continued successful business relationship between us and our
primary distributors to major mass-market retailers;
- the amount of shelf space major mass-market retailers allocate to
our products;
- the amount of unsold product that is returned to us by retailers
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;
- our ability to collect net outstanding accounts receivable and
establish an adequate allowance for customer 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, distributing and
marketing our products;
- our ability to license or develop quality content for our products
on commercially-viable terms;
- our ability to develop new higher-priced products and successfully
enter the new market segment for higher-priced products;
- our ability to control our costs and expenses in connection with
implementing our new strategy;
- our ability to fund our strategy of publishing higher quality and
higher-priced game titles for the PC and, potentially, other
platforms; and
- increased competition in the affordable software category.
Overview
The following overview identifies certain 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 the three and six months ended
December 31, 2005, as well as our future results. This overview 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-QSB, including the
remainder of "Management's Discussion and Analysis of Financial Condition and
Results of Operations," or the financial statements and the related notes.
Amounts, other than percentages, discussed within the "Management's Discussion
and Analysis of Financial Condition and Results of Operations" have been rounded
to the nearest thousand ("000") dollars.
About eGames
eGames, Inc. ("eGames", "our", "us", or "we") is a Pennsylvania corporation
incorporated in July 1992 that publishes, markets and sells PC software games.
Historically, we have focused on publishing affordable software games for the PC
platform only. Our current strategy is to begin offsetting the impact from the
decrease in retail shelf space being allocated to value-priced PC software by
publishing higher quality, higher-priced PC game titles, as well as seeking
opportunities to publish titles for other gaming platforms, such as console and
handheld game devices. We sell our software titles 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), Cinemaware(R) and Cinemaware Marquee(TM)
brands in order to generate customer loyalty, encourage repeat purchases and
differentiate our software products to retailers and consumers.
Significant Trends and Events in our Business
Publishing of Higher Quality and Higher-Priced Games
for PC and Other Gaming Devices
-------------------------------
Our current strategy is to begin offsetting the impact from the decrease in
retail shelf space being allocated to value-priced PC software by publishing
higher quality, higher-priced PC game titles, as well as seeking opportunities
to publish titles for other gaming platforms, such as console and handheld game
devices. During our third fiscal quarter, we expect to release three
higher-priced PC titles, Space Rangers 2: Rise of the Dominators, Buccaneers
Bounty, and Neighbors From Hell: On Vacation, under our newly introduced
Cinemaware Marquee brand. Due to the increased complexity of game play and
additional quality control and other procedures that we anticipate will be
required to bring to market these more technically sophisticated games, we
expect our future product development costs to increase compared to prior
periods. Additionally, higher quality software content for these gaming
platforms generally require higher licensing fees and advance royalty payments,
and we therefore expect our future licensing and advanced royalty payments to
significantly increase over prior periods and represent a greater use of
available cash as we bring such products to market. As we begin to publish
higher priced titles for the PC or other gaming platforms, we expect to incur
greater costs and cash expenditures for promotional efforts, such as print ads,
online banner ads, in-store circulars, video loops, public relations and
slotting fees, to support the retail and online releases of these higher quality
titles competing at higher price points. Also, to the extent that we begin to
publish games for console and handheld game devices, we would be required to
make upfront payments to gaming platform manufacturers to preorder production
units prior to retail product releases, which could further consume available
cash in future periods.
Decrease in Retail Shelf Space for Value-Priced PC Software Combined
with Increased Competition in this Market Segment Has Impacted Our Sales
------------------------------------------------------------------------
The reduced amount of shelf space allocated to our category of products in
retail stores has continued to impact our net sales. 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.
Additionally, competition in the core value-priced casual game genres has
increased in recent periods, which has also had an impact on our net sales as it
becomes more competitive to secure retail shelf positions for these titles at
retail. We continue to seek incremental licensing opportunities and pursue
increased sales at alternative retail channels such as discount retailers and
in-statement advertising providers. We are also seeking to license or develop
higher-priced, unique casual game content in order to compete more effectively
in these markets. We cannot predict whether these initiatives will be effective
in increasing net sales.
Concentration of Customers
--------------------------
We continue to have a concentration of customers consisting of a few large
software distributors and retailers. Historically, Atari, Inc. ("Atari") has
represented our primary software distributor servicing the North American
mass-merchants and other major retailers. In December 2005, we began to
transition a portion of our mass-merchant retail distribution to Take-Two
Interactive Software ("Take Two"), which has distributed our titles into the
office superstore and discount warehouse retail channels for several years. As a
result of this transition, Take Two has become the distributor of record with
the largest mass-merchant retailer selling our software titles, and for this
reason we anticipate that Take Two will represent a larger percentage of our net
sales and net accounts receivable in future periods.
Although our sales through Atari have declined, Atari has continued to represent
the largest percentage of our business activity. During the three months ended
December 31, 2005, Atari accounted for $360,000 of net sales, or 31% of net
sales, compared to the three months ended December 31, 2004, when Atari
accounted for $963,000 of net sales, or 50% of net sales. Additionally, during
the six months ended December 31, 2005, Atari accounted for $923,000 of net
sales, or 38% of net sales, compared to the six months ended December 31, 2004,
when Atari accounted for $1,477,000 of net sales, or 48% of net sales. At
December 31, 2005, Atari's net accounts receivable amounted to $409,000, or 50%
of our total net accounts receivable.
During the three months ended December 31, 2005, Take Two accounted for $77,000
of net sales, or 7% of net sales, compared to the three months ended December
31, 2004, when Take Two accounted for $66,000 of net sales, or 3% of net sales.
During the six months ended December 31, 2005, Take Two accounted for $124,000
of net sales, or 5% of net sales, compared to the six months ended December 31,
2004, when Take Two accounted for $117,000 of net sales, or 4% of net sales. At
December 31, 2005, Take Two's net accounts receivable amounted to $55,000, or
7%, of our total net accounts receivable.
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 titles. 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 and have shipping terms of
FOB destination. 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 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
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 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 warehouse units and estimated product return units), 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 sales of similar products to inventory liquidators and discount
retailers.
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 as "Prepaid and other
expenses", and are then usually expensed within the "Cost of sales" category of
our Statements of Operations at the greater of the contractual or effective
royalty rate.
Key Assumptions
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 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 a title and similar titles, if any, 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 3.
Three and Six Months Ended December 31, 2005 and 2004
Net Sales
For the three months ended December 31, 2005, net sales decreased by $759,000,
or 40%, to $1,154,000, compared to $1,913,000 for the same quarter a year
earlier. This decrease in net sales resulted from a $752,000 decrease in net
sales to North American software distributors, primarily related to a decrease
in the distribution of our software titles to mass-merchant retailers.
Contributing to the decline in product distribution, and the related reduction
in net sales, has been the increasing number of competitors' titles vying for a
reduced number of retail shelf positions (facings) offering PC software games at
the $9.99 retail price point. Additionally, our net sales have been negatively
impacted by a slowing in consumer demand for our titles, due in part to an
increasing number of competitors' last generation versions of higher priced
titles (with more recognizable brands) defaulting down to the $9.99 jewel case
market more quickly than in the past.
For the six months ended December 31, 2005, net sales decreased by $642,000, or
21%, to $2,448,000, compared to $3,090,000 for the similar year ago period. This
decrease in net sales resulted from a $796,000 decrease in net sales to North
American software distributors (due to similar factors impacting the three month
results), which was partially offset by an $88,000 increase in licensing
revenues within the United States and a $50,000 increase in net sales made
directly to various North American discount retailers.
The following table represents the Company's net sales by distribution channel
for the three and six months ended December 31, 2005 and 2004, respectively:
Net Sales by Distribution Channel
(rounded to the nearest thousand)
---------------------------------
Three Months Ended
December 31,
-----------------------------------------
Increase %
Distribution Channel 2005 % 2004 % (Decrease) Change
- ------------------------------------------------------------------------------------------
Software Distributors $ 691,000 60% $ 1,443,000 76% ($ 752,000) (52%)
Software Retailers 167,000 14% 138,000 7% 29,000 21%
Licensing 179,000 16% 156,000 8% 23,000 15%
Internet 70,000 6% 72,000 4% (2,000) (3%)
Inventory Liquidators 47,000 4% 104,000 5% (57,000) (55%)
- ------------------------------------------------------------------------------------------
Totals $ 1,154,000 100% $ 1,913,000 100% ($ 759,000) (40%)
=========== ==== =========== ==== ========= ===
Six Months Ended
December 31,
-----------------------------------------
Increase %
Distribution Channel 2005 % 2004 % (Decrease) Change
- ------------------------------------------------------------------------------------------
Software Distributors $ 1,461,000 60% $ 2,257,000 73% ($ 796,000) (35%)
Software Retailers 348,000 14% 298,000 10% 50,000 17%
Licensing 337,000 14% 249,000 8% 88,000 35%
Internet 144,000 6% 144,000 5% - 0 - 0%
Inventory Liquidators 158,000 6% 142,000 4% 16,000 11%
- ------------------------------------------------------------------------------------------
Totals $ 2,448,000 100% $ 3,090,000 100% ($ 642,000) (21%)
=========== ==== =========== ==== ========= ===
Software Distributors
---------------------
For the three months ended December 31, 2005, net sales to software distributors
that serve North American mass-merchants and other major retailers amounted to
$691,000, which represented a decrease of $752,000 or 52% compared to the three
months ended December 31, 2004. This decline in net sales to software
distributors was caused primarily by a $603,000 decrease in net sales to Atari,
largely as a result of a 50% reduction in retail shelf positions (facings)
displaying our titles at the largest mass-merchant retailer selling our software
titles compared to the year ago period. Additionally, we experienced a $151,000
decrease in net sales to Canadian software distributors, due to the reduction in
retail distribution we experienced through a major Canadian software distributor
that ceased operations during the second half of fiscal 2005.
For the six months ended December 31, 2005, net sales to software distributors
that serve North American mass-merchants and other major retailers amounted to
$1,461,000, which represented a decrease of $796,000 or 35% compared to the six
months ended December 31, 2004. This decline in net sales to software
distributors resulted from a $554,000 decrease in net sales to Atari, and a
$225,000 decrease in net sales to Canadian software distributors, due to the
same factors that caused declines in the three month results.
Software Retailers
------------------
For the three months ended December 31, 2005, net sales made directly to
software retailers totaled $167,000, representing a $29,000 increase compared to
the three months ended December 31, 2004. This increase resulted primarily from
sales to various discount retailers of last generation titles at the end of
their product lifecycles, which was partially offset by net sales decreases to
various traditional software retailers.
For the six months ended December 31, 2005, net sales made directly to software
retailers totaled $348,000, representing a $50,000 increase compared to the six
months ended December 31, 2004, and was a result of similar factors that
impacted the three month results.
Licensing
---------
For the three months ended December 31, 2005 and 2004, we realized licensing
revenues of $179,000 and $156,000, respectively, which represented 16% and 8%,
respectively, of net sales. This $23,000 increase in licensing revenues was
generated by revenue increases in the United States traceable to software units
sold at a national electronics specialty retailer, which was partially offset by
a decrease in licensing revenues generated primarily from our German licensee.
For the six months ended December 31, 2005 and 2004, we realized licensing
revenues of $337,000 and $249,000, respectively, which represented 14% and 8%,
respectively, of net sales. This $88,000 increase in licensing revenues was due
to the same contributing factors as were highlighted for the three month
results.
Internet
--------
For the three months ended December 31, 2005 and 2004, Internet sales were
$70,000 and $72,000, respectively, and totaled $144,000 for both the six-month
periods ended December 31, 2005 and 2004. Our Internet sales strategy remains
focused on distributing our game titles via affiliate programs and on popular
Internet game websites and other online portals.
Inventory Liquidators
---------------------
Net sales to inventory liquidators consist of sales of residual inventory units
of titles that have been discontinued (in part or entirely) at traditional
software retail stores. As retailers continue to routinely change the mix of
software titles displayed on their store shelves - usually on a quarterly basis
- - we expect to continue receiving 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. The amount of inventory
liquidation sales vary, period to period, and are usually made at discounted
prices with no right of product return or price markdown.
For the three months ended December 31, 2005 and 2004, net sales to inventory
liquidators were $47,000 and $104,000, respectively, and represented 4% and 5%,
respectively, of net sales, compared to the six months ended December 31, 2005
and 2004, when net sales to inventory liquidators amounted to $158,000 and
$142,000, respectively, or 6% and 4%, respectively, of net sales.
Product Returns and Price Markdowns
-----------------------------------
Until physical units of our products are returned to us from software
distributors or retailers, or until these units sell through to consumers, we
continue to evaluate our product return and price markdown exposure for the
software units we previously sold to software distributors and retailers. Based
on various assumptions, including shorter product lifecycles, more competitive
titles in our core game genres, continued reduction of retail shelf space
allocated to $9.99 retail priced PC software games and our intention to publish
a larger number of higher priced PC game titles in upcoming periods, we
anticipate our provision for product returns and price markdowns, as a
percentage of related gross sales, to trend higher for the foreseeable future.
During the three months ended December 31, 2005 and 2004, our provision for
product returns and price markdowns relating to gross product sales with
software distributors and retailers amounted to $232,000 and $412,000,
respectively, or 17.9% and 18.3%, respectively, of related gross sales.
During the six months ended December 31, 2005 and 2004, our provision for
product returns and price markdowns relating to gross product sales with
software distributors and retailers amounted to $476,000 and $640,000,
respectively, or 17.7% and 18.0%, respectively, of related gross sales.
Sales Incentives and Promotional Costs
--------------------------------------
In order to maintain retail shelf space for our titles, we incur sales
incentives and promotional costs from software distributors and retailers, such
as distributor pricing rebates and retailer slotting fees, which are recognized
as reductions to gross sales. We anticipate increasing our sales to software
retailers and distributors that charge such fees, and so we expect to incur
these types of reductions to gross sales at an increasing rate for the
foreseeable future.
For the three months ended December 31, 2005 and 2004, our sales incentives and
promotional costs were $160,000 and $152,000, respectively, or 12.3% and 6.8%,
respectively, of related gross sales.
For the six months ended December 31, 2005 and 2004, our sales incentives and
promotional costs were $240,000 for both periods, which represented 8.9% and
6.7%, respectively, of related gross sales.
Cost of Sales
Cost of sales consists of the following costs that are associated with
publishing 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, and other costs such as
tooling, labeling and reclamation.
The following table represents our cost of sales for the three and six months
ended December 31, 2005 and 2004:
December 31, % of December 31, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
- -----------------------------------------------------------------------------------------------------------
Three months ended $ 679,000 58.8% $ 840,000 43.9% ($ 161,000) (19.2%)
Six months ended $ 1,382,000 56.5% $ 1,410,000 45.6% ($ 28,000) ( 2.0%)
During the three months ended December 31, 2005, cost of sales decreased by
$161,000 compared to the prior year's three month period and resulted from lower
costs related to the 40% decrease in net sales, which was partially offset by a
14.9% increase in the cost of sales, as a percentage of net sales. The 14.9%
increase in cost of sales, as a percentage of net sales, was due to a 9.2%
increase in product costs, as a percentage of net sales, traceable to increased
sales of:
o Promotional titles consisting of higher costing components such as
multiple CD's and jewel cases, more expensive box packaging and
greater assembly costs;
o Titles with substantial price discounts required by certain
retailers to secure shelf positions in their retail stores; and
o Last generation titles to discount retailers and distributors at
prices below traditional wholesale and distributor prices.
Additionally, we experienced other cost of sales increases, as a percentage of
net sales, of:
o 2.1% in the provision for inventory obsolescence due to an
increase in titles being revalued down to liquidation market
values;
o 1.6% in other costs such as increased labeling and tooling costs
associated with certain titles;
o 1.4% in royalty expense traceable to higher effective royalty rates
resulting from shorter lifecycles of various titles; and
o 0.6% in freight expense related to increased consignment product
shipments with delivery costs being expensed before revenues are
recognized.
During the six months ended December 31, 2005, cost of sales decreased by
$28,000 compared to the prior year's six month period and resulted from
decreased costs associated with the 21% reduction in net sales. This decrease in
cost of sales was partially offset by a 9.9% increase in product costs, as a
percentage of net sales, which was related to similar factors impacting the
three month period, along with an increase in inventory liquidation sales with
higher product costs, as a percentage of net sales.
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,
language localization and website infrastructure maintenance and non-recoverable
costs related to products that did not achieve distribution into their intended
retail channels.
The following table represents our product development expenses for the three
and six months ended December 31, 2005 and 2004:
December 31, % of December 31, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
- -----------------------------------------------------------------------------------------------------------
Three months ended $ 127,000 11.0% $ 104,000 5.4% $ 23,000 22.1%
Six months ended $ 212,000 8.6% $ 343,000 11.1% ($ 131,000) (38.2%)
The $23,000 increase in product development expenses for the three months ended
December 31, 2005 resulted from relocation expenses incurred with hiring an
employee.
The $131,000 decrease in product development expenses for the six months ended
December 31, 2005 related to the non-recurrence of the prior year's $122,000
write-off of capitalized costs related to the RealAge Games & Skills title.
Additionally, salary and related costs decreased by $29,000 due to reductions
traceable to employee turnover, partially offset by relocation costs incurred
during the current year's six month period.
As we begin to implement our strategy of publishing higher quality, and
higher-priced PC game titles, as well as seek to publish titles for other gaming
platforms, we expect our product development expenses to increase due to the
increased complexity of game play, additional quality control and language
localization required, and other procedures required to bring these more
technically sophisticated games to market.
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, advertising costs, as
well as occupancy costs including rent, utilities and phones, and other
administrative expenses.
The following table represents our selling, general and administrative expenses
for the three and six months ended December 31, 2005 and 2004:
December 31, % of December 31, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
- -----------------------------------------------------------------------------------------------------------
Three months ended $ 594,000 51.4% $ 648,000 33.9% ($ 54,000) (8.3%)
Six months ended $ 1,162,000 47.5% $ 1,219,000 39.4% ($ 57,000) (4.7%)
The $54,000 decrease in selling, general and administrative expenses for the
three months ended December 31, 2005 was primarily attributable to $32,000 in
lower legal expenses traceable to intellectual property matters in the year ago
three month period, and $21,000 in lower commission expense incurred with
independent sales representatives as a result of decreased product sales to
certain retailers.
The $57,000 decrease in selling, general and administrative expenses for the six
months ended December 31, 2005 was attributable to the same factors that
impacted the three month results.
As we begin to publish higher priced titles for the PC, we expect to incur
greater costs for promotional efforts, such as print ads, online banner ads,
in-store circulars, video loops, and public relations, to support the retail and
online releases of these higher quality titles competing at higher price points.
Interest Income, net
The following table represents our net interest income for the three and six
months ended December 31, 2005 and 2004:
December 31, % of December 31, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
- -----------------------------------------------------------------------------------------------------------
Three months ended $ 12,000 1.1% $ 2,000 0.1% $ 10,000 n/m
Six months ended $ 20,000 0.8% $ 3,000 0.1% $ 17,000 n/m
Provision for Income Taxes
The following table represents our provision for income taxes for the three and
six months ended December 31, 2005 and 2004:
December 31, % of December 31, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
- -----------------------------------------------------------------------------------------------------------
Three months ended $ - 0 - - 0 - % $ 28,000 1.5% ($ 28,000) n/m
Six months ended $ - 0 - - 0 - % $ 10,000 0.3% ($ 10,000) n/m
Net income (loss)
The following table represents our net income (loss) for the three and six
months ended December 31, 2005 and 2004:
December 31, % of December 31, % of Increase %
2005 net sales 2004 net sales (Decrease) Change
- -----------------------------------------------------------------------------------------------------------
Three months ended ($ 233,000) (20.2%) $ 295,000 15.4% ($ 528,000) n/m
Six months ended ($ 287,000) (11.7%) $ 111,000 3.6% ($ 398,000) n/m
Weighted Average Common Shares
For the three months ended December 31, 2005, the weighted average common shares
outstanding on the diluted basis increased to 11,618,717, compared to 10,618,788
for the three months ended December 31, 2004. This 999,929 increase in the
diluted basis calculations of weighted average common shares resulted from the
issuance of the Company's shares of common stock related to the exercise of
common stock options, combined with the weighted average of the common shares
issued in October 2005 to the shareholders of Cinemaware Inc., partially offset
by the common stock equivalents included in the prior year period's calculation
due to that period's reported net income.
For the six months ended December 31, 2005, the weighted average common shares
outstanding on the diluted basis increased to 11,262,736, compared to 10,979,473
for the three months ended December 31, 2004. This 283,263 increase in the
diluted basis calculations of weighted average common shares resulted from the
same issuances that affected the three-month calculations.
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 SFAS 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
became effective during the first interim period beginning after June 15, 2005.
The adoption of SFAS No. 123 (revised 2004) did not 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 became effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS
No. 151 did not have a material impact on our financial statements.
Liquidity and Capital Resources
At December 31,
-------------------------
2005 2004 Change
-----------------------------------
Cash and cash equivalents $ 1,742,000 $ 1,692,000 $50,000
=========== =========== =======
Percent of total assets 41.0% 38.2%
===== =====
Six Months Ended
December 31,
-----------------------
2005 2004 Change
------------------------------------
Cash used in operating activities ($ 667,000) ($ 59,000) ($ 608,000)
Cash used in investing activities (3,000) (10,000) 7,000
Cash provided by financing activities - 0 - 19,000 (19,000)
------------------------------------
Net decrease in cash and cash equivalents ($ 670,000) ($ 50,000) ($ 620,000)
========== ======== =========
Changes in Cash Flow, Operating Activities
During the six months ended December 31, 2005, we had $667,000 in cash used in
operating activities compared to $59,000 in cash used in operating activities
for the six months ended December 31, 2004. The $667,000 in cash used in
operating activities for the six months ended December 31, 2005 resulted
primarily from increases in net accounts receivable, along with the $287,000 net
loss realized during this period, which cash uses were partially offset by cash
sources from an increase in accounts payable and a decrease in net inventory.
Accounts Receivable, net
------------------------
At December 31, 2005, net accounts receivable totaled $825,000, compared to
$269,000 at June 30, 2005. This $556,000 increase in net accounts receivable
resulted from a $724,000 increase in gross accounts receivable that was
partially offset by a $168,000 increase in the allowance for product returns and
price markdowns. The increase in gross accounts receivable resulted primarily
from a higher level of gross sales invoiced during the three months ended
December 31, 2005 compared to the three months ended June 30, 2005, combined
with lower receivable collections during the three months ended December 31,
2005 compared to the three months ended June 30, 2005. The increase in the
allowance for product returns and price markdowns resulted from the additional
provision associated with the increase in comparative three month gross sales
discussed above, in addition to higher allowance percentages applied to holiday
promotional titles remaining in the retail channel at December 31, 2005.
Generally, we have been able to collect net accounts receivable in the ordinary
course of business, but periodically we have experienced slowness in distributor
and retailer receivable collections. Throughout each reporting period, we
communicate with distributors and retailers in order to expedite their payments
of past due amounts or to process receivable credits for authorized 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 receivable payments to us, the realizable value of our net accounts
receivable is continually reviewed in order to help anticipate future liquidity
issues that could result from our inability to collect a net receivable balance
in the normal course of business.
Concentration of Customers
--------------------------
Historically, Atari has represented the majority of our net accounts receivable
and related cash receipts. In December 2005, we began to transition a portion of
our mass-merchant retail distribution to Take Two. As this transition continues,
we anticipate the proportion of Take Two's net sales, accounts receivable and
related cash receipts to increase along with our reliance on Take Two's
distribution activity to impact our financial results. We believe that our
ability to collect, in a timely manner, the net account receivable owed by Atari
and Take Two will be significant for us to be able to meet our financial
obligations and to fund our operations for the foreseeable future.
At December 31, 2005, Atari's net accounts receivable totaled $409,000, or 50%,
of our total net accounts receivable and Take Two's net accounts receivable
amounted to $55,000, or 7%, of our total net accounts receivable. During the six
months ended December 31, 2005, we collected $513,000 in receivable payments
from Atari and $72,000 in receivable payments from Take Two, which represented
29% and 7%, respectively, of our total accounts receivable collections during
that period.
Inventory, net
--------------
At December 31, 2005, our net inventory value remained high relative to our net
accounts receivable balance. We plan to continue to market various promotional
sales programs which are designed to reduce excess inventory stock levels,
increase collectible net accounts receivable, and be a source of funds to help
support our operations. During the six months ended December 31, 2005, our net
inventory value decreased by $45,000, or 5%, and was a result of incremental
sales of last generation titles to inventory liquidators and discount retailers,
promotional sales of holiday packs to traditional software retailers, combined
with reduced warehouse stock levels of finished goods.
Prepaid and other expenses
--------------------------
During the six months ended December 31, 2005, our prepaid and other expenses
increased by $35,000, which related to annual payments for corporate insurances
and retail market research, partially offset by a refund of prepaid federal
taxes.
Accounts Payable
----------------
During the six months ended December 31, 2005, our accounts payable increased by
$228,000, due to increased inventory purchases to support various sales
programs.
Accrued Expenses
----------------
During the six months ended December 31, 2005, our accrued expenses decreased by
$116,000, as a result of a decrease in the amount of customer accounts
receivable credit balances reclassified as liabilities.
Changes in Cash Flow, Non-Operating Activities
During the six months ended December 31, 2005, we had net cash used in investing
activities of $3,000 for equipment purchases for our computer network, compared
to $10,000 in net cash used in investing activities during the year ago period
for similar expenditures.
During the six months ended December 31, 2005, we had no financing activities
compared to the six months ended December 31, 2004, when we had $19,000 in cash
provided by financing activities related to cash proceeds received from the
exercise of options to purchase shares of the Company's common stock.
Credit Facility
In December 2005, we renewed our credit facility agreement with Hudson United
Bank ("HUB"), which matures on December 1, 2006. This credit facility was
established to provide working capital for our operations. 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 December 31, 2005, we had not utilized any of this credit facility,
and we had access to approximately $600,000 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 certain
financial covenants that are tested quarterly.
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 December 31, 2005, we had future
operating lease commitments of $125,000, 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 we begin to implement our
strategy of publishing higher quality, and higher-priced game titles for the PC,
and seek opportunities to publish titles for other gaming devices, we expect our
advance royalty payments to significantly increase and represent a greater use
of available cash. At December 31, 2005, we had future commitments to pay
$101,000 in advance licensing and royalty payments to third-party licensors and
software developers as reflected in the table below.
As part of a public relations campaign intended to support and promote our
brands and the retail releases of our new higher priced PC game titles, we have
entered into a professional services agreement with a public relations firm for
services from January 2006 through June 2006 with a future cost of $41,000
payable in monthly installments during that period.
The following table represents a summary of our off-balance sheet contractual
obligations and commitments at December 31, 2005, which are expected to be
funded by cash flows from operations.
Payments Due by Period
----------------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year years years 5 years
- ----------------------------------------------------------------------------------------
Operating leases $ 125,000 $ 64,000 $ 61,000 $ - 0 - $ - 0 -
Advanced royalties 101,000 101,000 - 0 - - 0 - - 0 -
Public relation services 41,000 41,000 - 0 - - 0 - - 0 -
- ----------------------------------------------------------------------------------------
Totals $ 267,000 $ 206,000 $ 61,000 $ - 0 - $ - 0 -
========= ========= ======== ======= ========
Liquidity Risk
Our ability to achieve positive cash flow remains essential to our survival as a
going concern because access to our existing credit facility is limited to the
lesser of $750,000 or 75% of our qualified accounts receivable, which at
December 31, 2005 amounted to approximately $600,000, based on the prescribed
calculation as of that date. In particular, our ability to achieve positive cash
flow depends upon a variety of factors, including the timing of the collection
of net accounts receivable, the creditworthiness of our software distributors
and retailers, sell-through of our products to consumers, and the costs of
developing, producing, distributing, marketing and promoting our software
titles.
There are significant challenges that we will need to continue 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
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
significantly impacted if Atari or Take Two, for any reason, did not make
receivable payments to us on a timely basis.
Additionally, there are market factors beyond our control that could
significantly affect our operating cash flow. The most significant of these
market factors are the shelf space allocated to our products at retail and the
market acceptance of our titles, as evidenced by actual sell-through results of
our titles to consumers. If major retailers where our products are sold further
reduce or eliminate entirely the shelf space allocated to $9.99 retail priced 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, we could then 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 distributor
replenishment orders for our products. If we experienced a negative trend in any
of these factors, we may not be able to achieve positive cash flow.
Also, as we implement our strategy of publishing higher quality, and
higher-priced game titles for the PC, and potentially console and handheld game
devices, we may need to seek additional funds to provide financing for:
- increased advanced royalty payments or substantial content
acquisition costs needed to obtain higher quality games on various
gaming platforms;
- upfront payments required by console platform manufacturers to order
production units;
- greater product development costs to finalize titles for
retail release; and
- larger marketing expenditures to more aggressively promote the
retail and online releases of key titles.
Additional outside financing to support our operations may not be available if
and when we need it. Even if such financing was available from a bank or other
financing source, such financing may cause significant stockholder dilution or
may have other significant costs associated with such financing.
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.
Item 3. Controls and Procedures
(a) Disclosure Controls and Procedures. Under the supervision and with the
participation of our Chief Executive Officer and Chief Financial Officer, we
carried out an evaluation of the effectiveness of our disclosure controls and
procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as of December 31, 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 are recorded, processed, summarized and reported, within the
periods specified in the SEC's rules and forms. We believe that a controls
system, no matter how well designed and operated, cannot provide absolute
assurance that the objectives of the controls system are met, and no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within a company have been detected.
(b) Changes in Internal Control over Financial Reporting. There have not been
any changes in our internal control over financial reporting during the quarter
ended December 31, 2005 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of the Company was held on December 1, 2005,
where the following actions were taken:
The shareholders voted to elect Gerald W. Klein, Eugene H. Mauro, Thomas D.
Parente and Lambert C. Thom to the Board of Directors. The votes cast for each
Director were as follows:
Number of Shares
----------------
For Withheld
--- --------
Gerald W. Klein 10,175,978 310,143
Eugene H. Mauro 10,163,178 322,943
Thomas D. Parente 10,174,978 311,143
Lambert C. Thom 10,175,178 310,943
The shareholders voted to ratify the selection of Stockton Bates, LLP as the
Company's independent registered public accounting firm for the fiscal year
ending June 30, 2006. The votes cast in this matter were as follows:
Number of Shares
----------------
For Against Abstain
--- ------- -------
10,217,806 262,762 5,553
Item 6. Exhibit Listing
The following exhibits are being filed or furnished as part of this Quarterly
Report on Form 10-QSB:
Exhibit Number Description of Exhibit
- -------------- ----------------------
2.1 (1) Asset Purchase Agreement between eGames, Inc., Cinemaware,
Inc. and Lars Fuhrken-Batista dated as of October 6, 2005.
The Company agrees to furnish supplementally a copy of
any of the exhibits and schedules to the Asset Purchase
Agreement identified therein upon request of the Securities
and Exchange Commission.
4.1 (2) Warrant for the Purchase of 150,000 shares of Common Stock
of eGames, Inc. exercisable at $0.75 per share.
4.2 (2) Warrant for the Purchase of 150,000 shares of Common Stock
of eGames, Inc. exercisable at $0.50 per share.
10.1 (2) Escrow Agreement dated October 13, 2005 between and among
eGames, Inc., Cinemaware, Inc. and Hudson United Bank.
10.2* (2) Non-Competition and Confidentiality Agreement dated
October 13, 2005 between Lars Fuhrken-Batista and eGames,
Inc.
10.3 (2) Non-Competition and Confidentiality Agreement dated
October 13, 2005 between Cinemaware, Inc. and eGames, Inc.
10.4* Employment Offer Letter to Lars Fuhrken-Batista from eGames,
Inc. dated October 13, 2005.
10.5 (3) Note and Loan Modification Agreement between eGames, Inc.
and Hudson United Bank dated December 5, 2005.
10.6* Form of Director Non-Qualified Stock Option Agreement.
31.1 Certification of Gerald W. Klein as President and Chief
Executive Officer of eGames, Inc. pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Thomas W. Murphy as Vice President and
Chief Financial Officer of eGames, Inc. pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Gerald W. Klein as President and Chief
Executive Officer of eGames, Inc. pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Thomas W. Murphy as Vice President and
Chief Financial Officer of eGames, Inc. pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
* Management contract
(1) Incorporated herein by reference from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on October 11, 2005.
(2) Incorporated herein by reference from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on October 19, 2005.
(3) Incorporated herein by reference from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on December 7, 2005.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
eGames, Inc.
(Registrant)
Date: February 14, 2006 /s/ Gerald W. Klein
----------------- --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: February 14, 2006 /s/ Thomas W. Murphy
----------------- --------------------
Thomas W. Murphy, Chief Financial
Officer and Chief Accounting Officer
Exhibit 10.4
October 13, 2005
Lars Fuhrken-Batista
Princeton, NJ 08542
Dear Lars:
I am pleased to offer you the position of Vice President of Product Development
at eGames, Inc. in accordance with the following terms:
Position Title: V.P. of Product Development
Supervisor: V.P. of Operations
Duties and
Responsibilities: Plans and directs all aspects of the organization's product
development policies, objectives, and initiatives. Researches new products,
products enhancements, and product redesign that align the product development
function with the goals of the organization. Evaluates the potential and
practicality of products in development, and responsible for all technical
requirements and specifications of such products. Maintains the organization's
competitive position and profitability by formulating product development
programs consistent with the Company's growth and financial objectives.
Researches new technologies that align and support the development function with
the objectives of the organization. Performs any such other duties as directed
by the V.P. of Operations.
Work Location: eGames' offices in Langhorne, Pennsylvania
Starting Date: October 13, 2005
Compensation: $100,000 per year
Bonus Opportunity: Subject to the approval of the Compensation Committee and the
Board of Directors of the Company, as an employee of the Company you are
eligible to participate in the eGames Employee Incentive Compensation Plan, if
adopted for Fiscal 2006, whereby you will be eligible to earn a bonus equal to
20% of your salary (prorated to your length of employment in the 2006 Fiscal
Year).
Reimbursement of Relocation and other Expenses:
First three months housing allowance Up to $5,700
Final moving & travel costs to Pennsylvania: Up to $9,000
Storage costs: Up to $3,000
Transportation (car rental): Up to $2,000
TOTAL: Up to $19,700
Stock Options: Subject to the approval of the Compensation Committee and the
Board of Directors of the Company, you will be granted 150,000 stock options
with an exercise price equal to the closing price of the company's common stock
on your start date and vesting over a five year period in equal installments of
30,000 options each.
Vacation: One year of service earns three weeks of paid vacation and after three
years of service Officers earn four weeks vacation thereafter.
Benefits: Group health, dental, AD&D, long term disability and life insurance
coverage in accordance with the company's group insurance plans. You will also
be eligible for enrollment in the eGames 401(K) savings plan during the first
quarterly open enrollment period after one month of employment.
Severance: Your employment will be at-will, meaning that you can leave at any
time for any reason, and eGames can terminate your employment at any time with
or without cause. In the event that eGames terminates your employment during the
first 12 months of your employment, you will be entitled to three months
severance pay, upon execution of a release of claims.
If you agree with the above terms, please sign and return the original copy. I
look forward to working with you at eGames in this new opportunity. Please
call if you have any questions.
Best Regards,
/s/ Gerald W. Klein /s/ Lars Fuhrken-Batista 10/13/05
- ------------------- -------------------------------------
Gerald W. Klein Accepted Date
President and CEO Lars Fuhrken-Batista
Exhibit 10.6
EGAMES. INC.
NON-QUALIFIED STOCK OPTION AGREEMENT
EGAMES, INC. (the "Company") hereby grants _____________ (the
"Optionee") this option to purchase shares of the Company's
Common Stock at a price and under the terms and conditions detailed below.
1. Grant. Effective as of ______________ (the "Date of Grant"), the
Company granted to the Optionee an option (the "Option") to purchase _______
shares of the Common Stock of the Company (the "Option Shares") at a price of
$_____ per share (the "Option Price").
2. Type of Option. This Option is intended to be a non-qualified stock
option, and is not intended to be an incentive stock option within the meaning
of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code").
3. Term. The Option granted hereunder shall expire at 5:00 p.m. (local
time at the principal executive offices of the Company) on ___________ (the
"Expiration Date"), unless sooner terminated as provided herein.
4. Exercise of Option. The Option shall vest and be exercisable in
accordance with the following schedule, subject to the limitations set forth in
Section 8.
5. Method of Exercise and Payment.
5.1 This Option shall be exercisable by written notice to the
Company, pursuant to Paragraph 10, specifying the number of Option Shares to be
purchased. The notice shall also be accompanied by payment of the aggregate
Option Price of the Option Shares being purchased.
5.2 Unless the Option Shares are covered by a then current
registration statement under the Securities Act of 1933 (the "Act") and current
registrations under all applicable state securities laws, the Optionee agrees
that he (i) is purchasing such Option Shares for investment and not for
distribution or resale (other than a distribution or resale which, in the
opinion of counsel satisfactory to the Company, may be made without violating
the registration provisions of the Act), (ii) has been advised and understands
that (A) the Option Shares have not been registered under the Act and are
"restricted securities" within the meaning of Rule 144 under the Act and are
subject to restrictions on transfer and (B) neither the Company nor any other
person is under any obligation to register the Option Shares under the Act or to
take any action which would make available to the Optionee any exemption from
such registration, and (iii) has been advised and understands that such Option
Shares may not be transferred or disposed of unless the Option Shares are
registered under the Act and any applicable state securities laws or the
Optionee obtains an opinion of counsel which is satisfactory to the Company that
such registration is not required.
If the listing, registration, or qualification of the Option
Shares upon any securities exchange or under any federal or state law, or the
consent or approval of any governmental regulatory body is necessary as a
condition of or in connection with the purchase of such Option Shares, the
Company shall not be obligated to issue or deliver the certificates representing
the Option Shares as to which the Option has been exercised unless and until
such listing, registration, qualification, consent, or approval shall have been
effected or obtained. If registration is considered unnecessary by the Company
or its counsel, a legend may be placed on the Option Shares being issued
reflecting the fact that they have been acquired for investment and have not
been registered.
5.3 Payment of the Option Price may be made: (i) in cash or
check; (ii) by exchange of shares of Common Stock valued at its fair market
value on the date of exercise; (iii) by means of a brokers' cash-less exercise
procedure by the delivery to the Company of an exercise notice together with
irrevocable instructions to a broker to sell a sufficient number of shares of
Common Stock to pay the purchase price of Common Stock as to which such exercise
relates: and to deliver promptly such amount to the Company; or (iv) by any
combination of the foregoing. Where payment of the Option Price is to be made
with shares of Common Stock acquired under any compensation plan of the Company,
such shares will not be accepted as payment unless the Optionee has held such
shares for a period of more than one year on the date of exercise, and further
provided that the Optionee shall not have tendered Stock in payment of the
exercise price of any other option under any stock option plan of the Company
within six calendar months of the date of exercise.
6. Rights of Shareholders. Neither an Optionee nor his legal
representatives or beneficiaries shall have any of the rights of a shareholder
with respect to any shares subject to any Option until such shares shall have
been issued upon the proper exercise of such Option.
7. Non-transferability of Options. No Option may be sold, transferred,
pledged, assigned, or otherwise alienated or hypothecated otherwise than by will
or by the laws of descent and distribution or, with respect to nonqualified
stock options, pursuant to a qualified domestic relations order as defined by
the Code, or Title I of the Employee Retirement Income Security Act, or the
rules thereunder. Except as otherwise specifically provided herein, these
Options granted to an Optionee shall be exercised during the lifetime of such
Optionee only by such Optionee.
8. Termination of Service. Subject to the condition that no Option
shall be exercisable after the Expiration date:
8.1 Upon the Optionee's cessation of service as a director of
the Company (for reasons other than retirement or death), including cessation of
service due to physical or mental disability that prevents the Optionee from
rendering further services as a director, only those options exercisable at the
date of cessation of service shall be exercisable by the Optionee. This Option
shall be exercisable until the first to occur of (v) the expiration of the
remaining term of the Option or (vi) three months after the Optionee's cessation
of service.
8.2 Upon the Optionee's retirement or death, this Option
shall be exercisable as follows:
(a) Retirement. Upon the Optionee's retirement as a
director of the Company after the Optionee has served for at least six
consecutive years as a director, this Option shall continue to be exercisable
during its term as if the Optionee had remained a director of the Company.
(b) Death. In the event of the Optionee's death while
a director of the Company or within the period after termination of service
during which the Option is exercisable by the Optionee in accordance with this
Paragraph 8, the Option shall be exercisable, to the extent then exercisable,
until the first to occur of (i) the expiration of the remaining term of the
Option or (ii) one year after the date of the Optionee's death.
9. Adjustments. In the event of any change in the outstanding Common
Stock of the Company without receiving new consideration therefor, such as
merger, consolidation, reorganization, stock split, stock dividend, combination
of shares or exchange of shares, the Board shall adjust appropriately the
maximum number and class of shares subject to the option and/or the Option
Price, except that any fractional shares resulting from such adjustments shall
be eliminated by rounding any portion of a share equal to .500 or greater up,
and any portion of a share equal to less than .500 down, in each case to the
nearest whole number.
10. Notice. Any notice to be given to the Company shall be addressed to
the Company at 2000 Cabot Boulevard West, Suite 110, Langhorne, Pennsylvania
19047, and any notice given to the Optionee shall be addressed to the Optionee
at the address then appearing on the records of the Company, or at such other
address as either party hereafter may designate in writing to the other. Any
such notice shall be deemed to have been duly given when deposited in the United
States mail, addressed as aforesaid, registered, or certified mail, and with
proper postage, registration, and certification fees prepaid, or transmitted by
hand delivery or overnight express.
11. Change in Control.
A "Change in Control" for purposes of this Agreement shall
mean any one of the events described below:
11.1 at any time during a period of two (2) consecutive years,
at least a majority of the Board shall not consist of Continuing Directors.
"Continuing Directors" shall mean directors of the Company at the beginning of
such two-year period and directors who subsequently became such and whose
selection or nomination for election by the Company's shareholders was approved
by a majority of the then Continuing Directors; or
11.2 any person or "group" (as determined for purposes of
Regulation 13D-G promulgated by the Commission under the Exchange Act or under
any successor regulation), but excluding any majority-owned subsidiary or any
employee benefit plan sponsored by the Company or any subsidiary or any trust or
investment manager for the account of such a plan, shall have acquired
"beneficial ownership" (as determined for purposes of such regulation) of the
Company's securities representing fifty percent (50%) or more of the combined
voting power of the Company's then outstanding securities unless such
acquisition is approved in advance by a majority of the directors of the Company
who were in office immediately preceding such acquisition and any individual
selected to fill any vacancy created by reason of the death or disability of any
such director; or
11.3 the Company becomes a party to a merger, consolidation or
share exchange in which either (i) the Company will not be the surviving
corporation or (ii) the Company will be the surviving corporation and any
outstanding shares of Common Stock will be converted into shares of any other
company (other than a re-incorporation or the establishment of a holding company
involving no change in ownership of the Company or other securities or cash or
other property (excluding payments made solely for fractional shares); or
11.4 the Company's shareholders (i) approve any plan or
proposal for the disposition or other transfer of all, or substantially all, of
the assets of the Company, whether by means of a merger, reorganization,
liquidation or dissolution or otherwise or (ii) dispose of, or become obligated
to dispose of, 50% or more of the outstanding capital stock of the Company by
tender offer or otherwise.
If a Change in Control has occurred, this Option shall be
immediately exercisable by the Optionee for the total remaining number of Option
Shares covered by this Option and shall survive any such event.
12. Governing Law.
The laws of the Commonwealth of Pennsylvania shall govern the
operation of, and the rights of the Optionee, under this agreement and the
Option granted hereunder.
13. Substitution of Options in a Merger, Consolidation or Share
Exchange.
In the event that the Company becomes a party to a merger,
consolidation or share exchange (a "Business Combination") and in connection
therewith substitutes this Option for options of another party to such Business
Combination, notwithstanding the provisions of this Option, the terms of such
substituted options may have the same terms and conditions (provided that the
number of shares issuable and the exercise prices are adjusted in accordance
with the terms of the Business Combination) as the former options of such other
party to the Business Combination, provided, however, that the exercise price of
the Options shall be lawful consideration as determined by the Company's Board
of Directors.
IN WITNESS WHEREOF, the Company has granted this Option as of
the ____ day of _____________, 200_.
EGAMES, INC.
By:________________________________
Gerald W. Klein, President,
President and Chief Executive Officer
ACKNOWLEDGMENT and AGREEMENT:
Optionee acknowledges receipt of this Agreement and agrees to all of
the terms and conditions contained herein.
OPTIONEE:
- ----------------------------------------
(Signature)
- ----------------------------------------
(Address)
- ----------------------------------------
(City)
- ----------------------------------------
(State) (Zip Code)
Exhibit 31.1
Certification
-------------
I, Gerald W. Klein, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eGames, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: February 14, 2006
- -----------------------
/s/ Gerald W. Klein
-------------------
Gerald W. Klein
President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 31.2
Certification
-------------
I, Thomas W. Murphy, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of eGames, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: February 14, 2006
- -----------------------
/s/ Thomas W. Murphy
--------------------
Thomas W. Murphy
Chief Financial Officer
(Principal Financial Officer)
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of eGames, Inc. (the "Company") on Form
10-QSB for the quarter ended December 31, 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, based on my knowledge, that:
1. The Report fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Gerald W. Klein
- -------------------
Gerald W. Klein
President and Chief Executive Officer
Date: February 14, 2006
-----------------
The foregoing certification is being furnished to the Securities and Exchange
Commission pursuant to 18 U.S.C. Section 1350 as an exhibit to the Report and is
not being filed as part of the Report or as a separate disclosure document.
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of eGames, Inc. (the "Company") on Form
10-QSB for the quarter ended December 31, 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, based on my knowledge, that:
1. The Report fully complies with the requirements of section 13(a) or 15(d) of
the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Thomas W. Murphy
- --------------------
Thomas W. Murphy
Chief Financial Officer
Date: February 14, 2006
-----------------
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.