As previously reported in our Annual Report on Form 10-K for the fiscal year ended March 31,
2006, management determined that, as of March 31, 2006, there were material weaknesses in our
internal control over financial reporting relating to (i) ineffective controls relating to the
financial closing and reporting process that failed to detect certain accounting errors, (ii)
controls related to computer-generated information were not designed appropriately to ensure data
integrity as it relates to the accuracy, calculation and recording of revenue, accounts receivable
and cost of sales, (iii) controls related to computer-generated information were not designed
appropriately to ensure data integrity as it relates to the accuracy, calculation and recording of
payments and disbursements to suppliers, (iv) ineffective controls over payroll records and related
reconciliations at one of our development studios, and (v) control failures over income tax
accounts and related disclosures. Management is currently assembling a dedicated team in the areas
of information and technology and finance to spearhead the remediation efforts. Management is also
finalizing negotiations with certain third party experts to assist in our remediation efforts.
Management believes our remediation efforts will be completed prior to the end of the third quarter
of our fiscal year 2007.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred
during the quarter ended June 30, 2006 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As of June 30, 2006, our management believes that the ultimate resolution of any of the
matters summarized below and/or any other claims which are not stated herein, if any, will not have
a material adverse effect on our liquidity, financial condition or results of operations. With
respect to matters in which we are the defendant, we believe that the underlying complaints are
without merit and intend to defend ourselves vigorously.
Atari, Inc., Atari Interactive, Inc., and Hasbro, Inc. v. Games, Inc., Roger W. Ach, II , and
Chicago West Pullman LLC
On May 17, 2004, we and Atari Interactive together with Hasbro filed a complaint against
Games, its CEO, Ach, and Chicago West Pullman in the United States District Court for the Southern
District of New York and sought a temporary restraining order and preliminary injunction to stop
Games and Achs use of certain trademarks and copyrights owned by Atari Interactive and Hasbro.
The plaintiffs alleged that an interim license that we granted to Games for the development and
publication of certain games in a specified online format expired by its terms when Games failed to
pay us certain fees by April 30, 2004, pursuant to an Asset Purchase, License and Assignment
Agreement between us and Games dated December 31, 2003, as amended. The plaintiffs also alleged
that Games failure to pay voided an expected transfer of the Games.com domain name and certain
web site assets from us to Games and constituted a breach of contract and that Chicago West
Pullmans failure to pay constituted a breach of guarantee. The plaintiffs further alleged that
upon the expiration of the interim license, all intellectual property rights granted under that
license reverted back to us, but that Games nevertheless continued to use plaintiffs intellectual
On May 4, 2005, the Court issued a memorandum order granting us damages in the following
amount: (1) immediate payment of $3,104,108, plus interest at an annual rate of nine percent from
April 30, 2004; (2) immediate redemption of 10,250 shares of Games, Inc. stock for $1.025 million,
plus interest at an annual rate of nine percent from April 30, 2004; (3) immediate redemption of
10,000 additional shares of Games, Inc. stock for $1 million; (4) redemption of the remaining
10,000 shares at any time after December 29, 2005. The order provided that the judgment runs
directly against Games but in the event Games fails to satisfy it, it runs secondarily against
Chicago West Pullman and Ach.
On June 30, 2005, defendants filed a Notice of Appeal to the United States Court of Appeals
for the Second Circuit. On July 6, 2005, defendants filed a motion for a stay of enforcement of
the amended judgment pending resolution of the appeal. On July 13, 2005, the Court of Appeals
granted a temporary stay of execution, but on August 3, 2005, the Court of Appeals denied
defendants motion for a stay, holding that defendants had not shown a substantial likelihood of
success on appeal or that they would suffer irreparable injury if a stay was not issued. On
February 2, 2006, the Court of Appeals issued an order affirming the judgment against Ach, Games,
and Chicago West Pullman.
On April 19, 2006, we, Atari Interactive, Hasbro, Games, Chicago West Pullman and Ach executed
a Settlement Agreement pursuant to which Games paid us (for the
benefit of ourselves and Atari Interactive) $1.2 million in full
settlement of the lawsuit. Our portion, $0.6 million, was recorded in the first
quarter of fiscal 2007.
Bouchat v. Champion Products, et al. (Accolade)
This suit involving Accolade, Inc. (a predecessor entity of Atari, Inc.) was filed in 1999 in
the District Court of Maryland. The plaintiff originally sued the NFL claiming copyright
infringement of a logo being used by the Baltimore Ravens that plaintiff allegedly designed. The
plaintiff then also sued nearly 500 other defendants, licensees of the NFL, on the same basis. The
NFL hired White & Case to represent all the defendants. Plaintiff filed an amended complaint in
2002. In 2003, the District Court held that plaintiff was precluded from recovering actual
damages, profits or statutory damages against the defendants, including Accolade. Plaintiff has
appealed the District Courts ruling to the Fourth Circuit Court of Appeals. White & Case
continues to represent Accolade and the NFL continues to bear the cost of the defense.
Indigo Moon Productions, LLC v. Hasbro, Inc., et al.
On August 12, 2005, Indigo Moon filed a lawsuit against
Hasbro, Inc., Hasbro Interactive, Atari Interactive, us and Infogrames, Inc. in the United States
District Court in the Western District of Kentucky. Indigo Moon alleges that on or about June 28,
2000, Indigo Moon and Hasbro Interactive, Inc. (n/k/a Atari Interactive) entered into a
Confidential Information Agreement for sharing information regarding the possibility of cooperating
on the production or exploitation of interactive games. Indigo Moon alleges that it provided Atari
Interactive with designs and concepts for a computerized version of Clue and that Atari Interactive
represented that it would compensate Indigo Moon for its work, but did not. Indigo Moon further
alleges that in October 2003 Hasbro, Atari Interactive and/or Infogrames, Inc. (n/k/a Atari)
released a Clue FX Game and that in the spring of 2005 Hasbro, Atari Interactive and/or Infogrames,
Inc. released Clue Mysteries, each of which allegedly incorporates Indigo Moons work. Indigo
Moons complaint alleges the following specific causes of action: breach of express contract,
breach of implied contract, promissory estoppel, quasi-contract and unjust enrichment, breach of a
confidential relationship and misappropriation of trade secret; and seeks unspecified damages.
Rafael Curulla v. SAS Atari Europe and Atari, Inc.
On April 1, 2005, Mr. Curulla, a former employee of Atari Europe filed a Complaint against
Atari Europe and Atari, Inc. Mr. Curulla was an employee of Atari Europe who had been assigned to
work at Ataris Santa Monica studio as of December 1, 2001.
His assignment in the U.S. was on a
three year renewable basis. As of August 31, 2004,
Mr. Curullas assignment in the U.S. was
terminated. Mr. Curullas Complaint was lodged before the Industrial Tribunal of Lyon, France
(Conseil de Prudhommes). A hearing took place on October 6, 2005 and a discovery period was
established. Mr. Curulla is claiming that he is owed damages for dismissal without serious cause in
the amount of 88,674 Euros, a bonus in the amount of 5,494 Euros, compensation for dismissal in the
amount of 4,261 Euros, damages under Article 700 of the New Code of Civil Procedure in the amount
of 2,000 Euros plus expenses. Discovery closed on January 5, 2006. The next hearing was scheduled
to take place on February 16, 2006 at which time all parties were to have an opportunity to make
their case. The parties were not prepared to move forward as of February 16, 2006 and the matter
has been adjourned until November 2006. Atari Europe has secured representation on behalf of
itself and us.
Thomas Licensing, LLC v. Atari Interactive, Inc. and Atari, Inc.
On May 15, 2006, we were served with a lawsuit by Thomas Licensing. The complaint was filed
in Supreme Court in the County of New York. Under a licensing agreement between Thomas Licensing
and Atari Interactive, Atari Interactive was granted a license to design, develop, manufacture,
distribute, promote and sell interactive computer games on CD-ROM and 3D key-top playsets. In
return, Atari Interactive was obligated to make certain payments to Thomas Licensing. Pursuant to
intercompany services agreements, we provided services to Atari Interactive in connection with
Atari Interactives performance under the License Agreement. These services included administering
royalty calculations and payments, subject to the review and approval of Atari Interactive. Thomas
Licensing alleges that we controlled Atari Interactive and caused Atari Interactive to not make
required payments under the License Agreement. Therefore, Thomas Licensing claims that we are
equally liable along with Atari Interactive for liabilities to Thomas Licensing. These liabilities
include failures to: (i) make certain guaranteed payments, (ii) rectify inconsistencies and
mistakes in royalty statements, and (iii) make full payments from the sale and distribution of the
licensed products. In total, Thomas Licensing demands a judgment of just over $2 million dollars.
Pursuant to the intercompany services agreement, Atari Interactive is fully indemnifying us
for all damages (including legal fees) that are incurred in this matter. An answer to the
complaint was due by June 5, 2006. However,
Atari Interactive sought an extension of time to
answer for itself and on behalf of us. Atari, Inc.s motion to dismiss was filed on July 6, 2006.
Ernst & Young, Inc. v. Atari, Inc.
On July 21, 2006 we were served with a complaint filed by Ernst & Young as Interim Receiver
for HIP Interactive, Inc. This suit was filed in New York State Supreme Court, New York County.
HIP is a Canadian company that has gone into bankruptcy. HIP contracted with us to have us act as
its distributor for various software products in the U.S. HIP is alleging breach of contract
claims; to wit, that we failed to pay HIP for product in the amount of $0.7 million. We will
investigate filing counter claims against HIP, as HIP owes us, via our Canadian Agent, Hyperactive,
for our product distributed in Canada.
Item 6. Exhibits
Chief Executive Officer and Acting Chief Financial Officer Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Chief Executive Officer and Acting Chief Financial Officer Certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.