(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
417 FIFTH AVENUE, NEW YORK, NY10016
(Address of principal executive offices) (Zip code)
(212) 726-6500
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (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 o No þ
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer o Accelerated
filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Preferred stock, $0.01 par value, 5,000 shares authorized, none issued or
outstanding
—
—
Common stock, $0.01 par value, 300,000 shares authorized, 121,296 and 134,749
shares issued and outstanding at March 31, 2005 and December 31, 2005,
respectively
1,213
1,347
Additional paid-in capital
736,790
758,156
Accumulated deficit
(619,744
)
(682,533
)
Accumulated other comprehensive income
2,408
2,493
Total stockholders’ equity
120,667
79,463
Total liabilities and stockholders’ equity
$
190,039
$
165,231
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
Nature of Business
We are a global publisher and developer of video game software for both gaming enthusiasts and
the mass-market audience, as well as a distributor of video game software in North America. We
publish and distribute games for all platforms, including Sony PlayStation and PlayStation 2;
Nintendo Game Boy, Game Boy Advance, GameCube, and DS; Microsoft Xbox and Xbox 360; and personal
computers, referred to as PCs. We also publish and sub-license games for the wireless, internet,
and other evolving platforms. Our diverse portfolio of products extends across every major video
game genre, including action, adventure, strategy, children, family, driving and sports games.
Through our relationship with our majority stockholder, Infogrames Entertainment S.A., a
French corporation (“IESA”), listed on Euronext, our products are distributed exclusively by IESA
throughout Europe, Asia and certain other regions. Similarly, we exclusively distribute IESA’s
products in the United States and Canada. Furthermore, we distribute product in Mexico through
various non-exclusive agreements. At December 31, 2005, IESA owns approximately 51% of us directly
and through its wholly-owned subsidiary California U.S. Holdings, Inc. (“CUSH”) and its
majority-owned subsidiary Atari Interactive, Inc. (“Atari Interactive”).
Going Concern
A weak holiday season for the industry combined with underperformance from new product launches and
product launch delays have contributed to third quarter results substantially below our
expectations. For the three months and nine months ended December 31, 2005, we generated net
losses of $4.8 million and $62.8 million, respectively, and are in default of certain financial
covenants for the quarter ended December 31, 2005 on our credit
facility with HSBC Business Credit (USA) Inc. (“HSBC”). We have been
advised by our lender that it will not currently extend further credit under our revolving credit
facility because of the default. HSBC also stated that it may agree to review revised business
plans or projections and make or not make future advances under the facility, however, it would not
do so on the basis of our current business plans. As of the date hereof, we had no balance or
letters of credit outstanding under the credit facility. IESA currently plans to provide some
financial support to us during our fiscal fourth quarter, however, as IESA continues to address its
own financial condition, its ability to fund its subsidiaries’ operations, including ours, remains
limited. Therefore, there can be no assurance we will ultimately receive any funding from them.
The uncertainties caused by these conditions raise substantial doubt about our ability to
continue as a going concern. The condensed consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
We are exploring various alternatives to improve our financial position and secure other
sources of financing. Such possibilities include a replacement of the credit facility, new
arrangements to license intellectual property, the sale of selected
intellectual property rights and
sale of development studios. To reduce working capital
requirements and further conserve cash we will need to take additional actions in the near-term,
which may include personnel reductions and suspension of certain development projects. These
actions may or may not prove to be consistent with our long-term strategic objectives. We cannot
guarantee the completion of these actions or that such actions will generate sufficient resources
to fully address the uncertainties of our financial position.
Goodwill and Other Intangible Assets
As of March 31, 2005, our annual fair-value based assessment, in accordance with Financial
Accounting Standards Board (“FASB”) Statement No. 142, “Goodwill and Other Intangible Assets”, did
not result in any impairment of goodwill or intangibles. Subsequently, a portion of goodwill
relating to our publishing business was allocated to Humongous, Inc., a related party, as part of the sale transaction,
which reduced the amount on the balance sheet by $3.8 million (Note 10).
At December 31, 2005, the video game industry’s transition from current to next generation
hardware was well underway. As consumers shift to next generation hardware, demand for games
played on current generation hardware and unit prices of those games are expected to decline. The
market uncertainties associated with this industry transition, coupled with our own weakened
financial condition and product portfolio, could affect the carrying value of our goodwill and
intangible assets and we are currently assessing the potential impact of these conditions. We
believe our analysis will be completed prior to the filing of our March 31, 2006 annual report on
Form 10-K.
Other intangible assets, included in other assets on the balance sheet, approximate $0.7
million and $0.2 million, net of accumulated amortization of $2.0 million and $2.5 million at March31, 2005 and December 31, 2005, respectively.
Basis of Presentation
Our accompanying interim condensed consolidated financial statements are unaudited, but in the opinion
of management, reflect all adjustments, consisting of normal recurring accruals, necessary for a
fair presentation of the results for the interim period in accordance
with the instructions for Form
10-Q. Accordingly, they do not include all information and notes required by generally accepted
accounting principles for complete financial statements. These interim condensed consolidated
financial statements should be read in conjunction with the consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K for the
year ended March 31, 2005, which we expect to amend for the
effects of the restatement discussed in Note 13 to the condensed
consolidated financial statements.
The
condensed consolidated financial statements include our accounts and those of our wholly-owned subsidiaries.
All significant intercompany transactions and balances have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting
principles in the United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could materially differ from those estimates.
Reclassifications
We have made certain reclassifications on our condensed consolidated statements of operations in order
to provide better insight into the results of operations and to align our presentation to
certain industry competitors. We have moved license amortization and license impairments related
to products released or previously sold from research and product development to cost of goods
sold. Additionally, we have eliminated the gross profit line item and added a subtotal of total
costs and expenses on our consolidated statements of operations.
Revenue Recognition
Revenue is recognized when title and risk of loss transfer to the customer, provided that
collection of the resulting receivable is deemed probable by management.
We are not contractually obligated to accept returns except for defective product. However,
we may permit our customers to return or exchange product and we provide allowances for estimated
returns, price concessions, or other allowances on a negotiated basis. We estimate such returns and
allowances based upon management’s evaluation of historical experience, market acceptance of
products produced, retailer inventory levels, budgeted customer allowances, the nature of the title
and existing commitments to customers. Such estimates are deducted from gross sales and provided
for at the time revenue is recognized.
Concentration of Credit Risk
We extend credit to various companies in the retail and mass merchandising industry for the
purchase of our merchandise which results in a concentration of credit risk. This concentration of
credit risk may be affected by changes in economic or other industry conditions and may,
accordingly, impact our overall credit risk. Although we generally do not require collateral, we
perform ongoing credit evaluations of our customers and reserves for potential losses are
maintained.
As of December 31, 2005, we had three customers which aggregated 48% of our accounts
receivable. These three customers accounted for approximately 32% of our net revenues for the nine
months ended December 31, 2005. These same three customers
accounted for approximately 30% of our net revenues for the nine
months ended December 31, 2004.
Research and Product Development Costs
Research and product development costs related to the design, development and testing of new
software products, whether internally or externally developed, are charged to expense as incurred.
Research and product development costs also include payments for royalty advances (milestone
payments) to third-party developers for products that are currently
in development. Once a product is sold, we may be obligated to make
additional payments in the form of backend royalties to developers
which are calculated based on contractual terms, typically a
percentage of sales. Such payments are expensed and included in cost
of goods sold in the period the sales are recorded.
Rapid technological innovation, shelf-space competition, shorter product life cycles and buyer
selectivity have made it difficult to determine the likelihood of individual product acceptance and
success. As a result, we follow the policy of expensing milestone payments as incurred, treating
such costs as research and product development expenses. Due to recently implemented enhancements
in our internal project planning and acceptance process and anticipated additional improvements in
our ability to assess post-release consumer acceptance, we are currently considering a change from
expensing such costs when incurred to a method of deferral and amortization, when appropriate, over
each product’s life cycle. Such change may be implemented prospectively as early as our next
fiscal year, beginning on April 1, 2006. Management believes that the ability to amortize such
costs over the product’s life cycle will result in a better matching of costs and revenues.
Licenses
Licenses for intellectual property are capitalized as assets upon the execution of the
contract when no significant obligation of performance remains with us or the third party. If
significant obligations remain, the asset is capitalized when payments are due or when performance
is completed as opposed to when the contract is executed. These licenses are
amortized at the licensor’s royalty rate over unit sales to cost
of goods sold. Management evaluates the carrying value of these capitalized licenses and records an
impairment charge in the period management determines
that such capitalized amounts are not expected to be realized. Such
impairments are charged to cost of goods sold if the product has
released or previously sold and if the product has never been
released these impairments are charged to research and development.
Fair Values of Financial Instruments
FASB
Statement No. 107, “Disclosures About Fair Value of Financial Instruments”, requires
certain disclosures regarding the fair value of financial instruments. Cash, accounts receivable,
accounts payable, accrued liabilities, restructuring reserve, royalties payable, assets and
liabilities of discontinued operations, and amounts due to and from related parties reflected
in the consolidated financial statements approximates fair value due to the short-term maturity and the
denomination in U.S. dollars of these instruments.
Long-Lived Assets
We review long-lived assets, such as fixed assets to be held, for impairment annually or
whenever events or changes in circumstances indicate that the carrying amount of an asset may not
be fully recoverable. If the estimated fair value of the asset is less than the carrying
amount of the asset plus the cost to dispose, an impairment loss is recognized as the amount by
which the carrying amount of the asset plus the cost to dispose exceeds its fair value, as defined
in FASB Statement No. 144, “Accounting for the Impairment
or Disposal of Long-Lived Assets.”
Income Taxes
We account for income taxes using the asset and liability method of accounting for income
taxes. Under this method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates in effect for the years in which the differences are expected to reverse. We
record an allowance to reduce tax assets to an estimated realizable amount. We monitor our tax
liability on a quarterly basis and record the estimated tax obligation based on our current
year-to-date results and expectations of the full year results.
In December 2004, the FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets”. This
Statement requires that exchanges of nonmonetary assets be measured based on the fair value of the
assets exchanged. Statement No. 153 is effective for nonmonetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. As of December 31, 2005, the adoption of this issue
has had no material impact on our consolidated financial statements.
In December 2004, the FASB issued Statement No. 123-R, “Share Based Payments”. Statement No.
123-R is a revision of Statement No. 123, “Accounting for Stock-Based Compensation” and supersedes
Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. Statement No. 123-R eliminates the
alternative to use the intrinsic value method of accounting that was provided in Statement No. 123,
which generally resulted in no compensation expense recorded in the financial statements related to
the issuance of equity awards to employees. Statement No. 123-R establishes fair value as the
measurement objective in accounting for share-based payment arrangements and requires all companies
to apply a fair value based measurement method in accounting for generally all share-based payment
transactions.
We plan to adopt Statement No. 123-R using a modified prospective application. Under this
application, companies are required to record compensation expense for all awards granted after the
required effective date and for the unvested portion of previously granted awards that remain
outstanding at the date of adoption. The provisions of Statement No. 123-R are effective as of the
beginning of the first annual reporting period that begins after June 15, 2005, but early adoption
is encouraged. As of December 31, 2005, management is currently reviewing the effect that the
adoption of Statement No. 123-R will have on our consolidated financial statements.
In June 2005, the Emerging Issues Task Force (“EITF”) issued EITF Issue No. 05-6, “Determining
the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a
Business Combination”. Issue No. 05-6 states that leasehold improvements that are placed in service
significantly after the beginning of the lease term should be amortized over the shorter of the
useful life of the assets or a term that includes required lease periods and renewals that are
deemed to be reasonably assured at the date the leasehold improvements are purchased. The
pronouncement is effective for leasehold improvements that are purchased or acquired in reporting
periods beginning after June 29, 2005. As of December 31, 2005, the adoption of this issue has had
no material impact on our consolidated financial statements.
In June 2005, the FASB issued FASB Staff Position (“FSP”) No. FAS 150-5. This FSP clarifies
that freestanding warrants and other similar instruments on shares that are redeemable (either
puttable or mandatorily redeemable) should be accounted for as liabilities under FASB Statement No.
150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and
Equity”, regardless of the timing of the redemption feature or price, even though the
underlying shares may be classified as equity. This FSP is effective for the first reporting period beginning
after June 30, 2005. As of December 31, 2005, the adoption of this issue has had no material
impact on our consolidated financial statements.
In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “Transition Election
Related to Accounting for the Tax Effects of Share-Based Award Payments” (“FSP 123(R)-3”). FSP
123(R)-3 provides an alternative method of calculating the excess tax benefits available to absorb
tax deficiencies recognized subsequent to the adoption of FASB Statement No. 123(R). We are
currently evaluating our available alternatives for the adoption of
FSP 123(R)-3 and have until the earlier of November 2006 or one year from adoption to make our one-time
election.
NOTE 2 – EQUITY
Sale of common stock to third party investors
On September 15, 2005, we entered into a Securities Purchase Agreement, with each of Sark
Master Fund Ltd (“SARK Fund”) and CCM Master Qualified Fund, Ltd., a current shareholder (“CCM
Fund”), to issue them an aggregate of 5,702,590 shares of our common stock in private placement
transactions. The shares were sold for cash at $1.30 per share for an aggregate offering price of
$7.4 million. In connection with the sale, we paid a placement agent fee of approximately $0.1
million.
Sale of Humongous Entertainment
On August 22, 2005, we sold the Humongous Business (“Humongous”) to IESA in exchange for
4,720,771 of their shares valued at $8.3 million. See Note 10 for further details.
Issuance of common stock as settlement of certain net related party balances
In September 2005, we entered into two transactions with our majority stockholder, IESA, to
settle certain outstanding net related party balances totaling $8.0 million through the issuance of
an aggregate of 6,145,051 shares of our common stock. See Note 7 for further details.
NOTE 3 – STOCK BASED COMPENSATION
We account for employee stock option plans under the intrinsic value method prescribed by
APB Opinion No. 25, “Accounting for Stock Issued to Employees” and
related interpretations. Any equity instruments issued, other than to employees, for acquiring
goods and services are accounted for using fair value at the date of grant. We have also adopted
the disclosure provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, as
amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and
Disclosure – an Amendment of FASB Statement No. 123”.
At December 31, 2005, we had four stock option plans. All options granted under those plans
generally have an exercise price equal to the market value of the underlying common stock on the
date of grant; therefore, no compensation cost is recognized. The following table illustrates the
effect on income (loss) from continuing operations per share and net income (loss) if we had
applied the fair value recognition provisions of the FASB Statement No. 123, “Accounting for
Stock-Based Compensation”, to stock-based employee compensation (in thousands, except per share
data):
Income (loss) from continuing operations per
share:
Basic and diluted – as reported
$
0.16
$
(0.03
)
$
0.14
$
(0.46
)
Basic and diluted – pro forma
$
0.15
$
(0.04
)
$
0.11
$
(0.47
)
Net income (loss):
As reported
$
19,606
$
(4,761
)
$
14,771
$
(62,789
)
Add:
Stock-based employee compensation expense, included in reported net
income (loss), net of related tax
effects
139
—
139
404
Less: Fair value of stock-based employee
compensation expense, net of related tax effects
(1,479
)
(400
)
(3,892
)
(1,588
)
Pro forma net income (loss)
$
18,266
$
(5,161
)
$
11,018
$
(63,973
)
Net income (loss) per share:
Basic and diluted – as reported
$
0.16
$
(0.04
)
$
0.12
$
(0.50
)
Basic and diluted – pro forma
$
0.15
$
(0.04
)
$
0.09
$
(0.51
)
The
fair market value of options granted under stock option plans during
the three months ended December 31, 2004 and 2005 was $1.35 and
$1.36, respectively, and during the nine months ended December 31,2004 and 2005 was $1.50 and $1.78, respectively. Amounts were
determined using the Black-Scholes option pricing model using the
following assumptions:
The weighted average risk-free interest rate for the three months ended December 31, 2004 and 2005 was 3.40% and 4.30%, respectively, and for the nine months ended December 31, 2004 and 2005 was 3.40% and 4.30%, respectively.
NOTE 4 – NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income (loss) by the weighted
average number of shares of common stock outstanding for the period. Diluted net income (loss) per
share reflects the potential dilution that could occur from shares of common stock issuable through
stock-based compensation plans, including stock options and warrants, using the treasury stock
method. The following is a reconciliation of basic and diluted net income (loss) per share (in
thousands, except per share data):
Basic and diluted income (loss) from continuing
operations per share
$
0.16
$
(0.03
)
$
0.14
$
(0.46
)
Basic and diluted income (loss) from discontinued
operations of Humongous Entertainment per share
0.00
(0.01
)
(0.02
)
(0.04
)
Basic and diluted net income (loss) per share
$
0.16
$
(0.04
)
$
0.12
$
(0.50
)
The number of antidilutive shares that was excluded from the diluted earnings per share
calculation for the three months and nine months ended December 31, 2004 was 8,889,000 and
6,766,000, respectively, due to stock options and warrants in which the exercise price is greater
than the average market price of the common shares during the period. For three months and nine
months ended December 31, 2005, the number of antidilutive shares that were excluded from the
diluted earnings per share calculation were 9,629,000 and 9,412,000, respectively, due to the net
loss for each period presented.
NOTE 5 – BALANCE SHEET DETAILS
Inventories
Inventories consist of the following (in thousands):
As of December 31, 2005, we have combined net operating loss carryforwards of approximately
$524.7 million for federal and state tax purposes. These loss carryforwards are available to
offset future taxable income, if any, and will expire beginning in the years 2009 through 2025. We
experienced an ownership change in 1999 as a result of the acquisition by IESA. Under Section 382
of the Internal Revenue Code, when there is an ownership change, the pre-ownership-change loss
carryforwards are subject to an annual limitation which could reduce or defer the utilization of
these losses. Pre-acquisition losses of approximately $186.8 million are subject to an annual
limitation (approximately $7.2 million). A full valuation allowance has been recorded against the
net deferred tax asset based on our historical operating results and the conclusion that it is more
likely than not that such asset will not be realized. Management reassesses its position with
regard to the valuation allowance on a quarterly basis.
During the three months ended December 31, 2005, we recorded a tax provision of $0.1 million
pursuant to a state tax audit, which was offset in the current period by the reversal of a $0.2
million tax reserve at our UK subsidiary, pursuant to discussions with UK tax inspectors. During
the nine months ended December 31, 2005, we also recorded an additional $0.3 million tax expense
reduction with respect to the reversal of an income tax reserve pursuant to a successful IRS
examination of the tax year ended June 30, 2003 completed in the current period. During the three
months ended December 31, 2004, we recorded provisions for state and federal alternative minimum
taxes of $0.4 million. For the nine months ended December 31, 2004, we also recorded a provision
of $0.2 million for a potential tax expense at our UK subsidiary as well as additional provisions
for state and federal alternative minimum taxes.
NOTE 7 – RELATED PARTY TRANSACTIONS
Relationship with IESA
As of December 31, 2005, IESA, our majority stockholder, beneficially owns, directly and
indirectly, approximately 51% of our stock. IESA distributes our products in Europe, Asia, and
certain other regions, and pays us royalties in this respect. IESA also develops products which we
distribute in the U.S., Canada, and Mexico, and for which we pay royalties to IESA. Both IESA and
Atari Interactive, through the ownership of intellectual property or through the development of
products, are material sources of products which we market in the United States and Canada. During
fiscal 2005, Atari Interactive was the source of approximately 38% of our publishing net revenues
and we generated approximately 5% of our net revenues from royalties on IESA’s distribution of our
products in Europe, Asia, and certain other regions. For the nine months ended December 31, 2005,
Atari Interactive was the source of approximately 29% of our publishing net revenues and we
generated approximately 8% of our net revenues from royalties on IESA’s distribution of our
products in Europe, Asia, and certain other regions.
Historically, IESA has incurred significant continuing operating losses and has been highly
leveraged. Although IESA has improved its financial stability, it has not yet completed all of the
actions it plans to take in order to improve its operations and reduce its debt. As a result,
IESA’s current ability to fund, among other things, its subsidiaries’ operations is limited. As of
the date of this report, we believe IESA has limited ability to fund us. If IESA is unable to
address its liquidity problems, fund its working capital needs and provide financial support to
us, the results of our operations and our financial position could be materially impaired and our
operations could be significantly reduced.
Additionally, although Atari is a separate and independent legal entity and we are not a party
to, or a guarantor of, and have no obligations or liability in respect of IESA’s indebtedness
(except that we have guaranteed a lease obligation of Atari Interactive), because
IESA owns a majority of our stock, potential investors and current and potential business/trade
partners may view IESA’s financial situation with its creditors as relevant to an assessment of
Atari. Therefore, if IESA is unable to address its financial issues with its creditors, it may
taint our relationship with our suppliers and distributors, damage our business reputation, affect
our ability to generate business and enter into agreements on financially favorable terms, and
otherwise impair our ability to raise and generate capital.
Summary of Related Party Transactions
The following table provides a detailed break out of related party amounts within each line of
our Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (in thousands):
Distribution fee for Humongous, Inc.
products (Note 10)
—
(3,830
)
—
(5,057
)
Royalty expense (2)
(18,488
)
(4,611
)
(28,803
)
(6,784
)
Total related party cost of goods sold
(18,488
)
(8,441
)
(28,803
)
(11,841
)
Research and product development
(15,397
)
(12,965
)
(46,109
)
(46,807
)
Related party activity:
Development expenses (3)
(3,651
)
(4,368
)
(9,365
)
(12,650
)
Other miscellaneous development expenses
(34
)
(12
)
(61
)
(83
)
Total related party research and product
development
(3,685
)
(4,380
)
(9,426
)
(12,733
)
Selling and distribution expenses
(19,177
)
(19,629
)
(50,929
)
(34,486
)
Related party activity:
Miscellaneous purchase of services
(17
)
—
(45
)
(8
)
Total related party selling and distribution
expenses
(17
)
—
(45
)
(8
)
General and administrative expenses
(9,765
)
(8,689
)
(26,989
)
(24,852
)
Related party activity:
Management fee revenue
750
480
2,250
1,693
Management fee expense
(750
)
(750
)
(2,250
)
(2,250
)
Office rental and other services
(97
)
65
(270
)
34
Total related party general and administrative
expenses
(97
)
(205
)
(270
)
(523
)
Interest income (expense), net
94
(244
)
(608
)
(589
)
Related party activity:
Interest income
368
—
595
—
Total related party interest expense, net
368
—
595
—
Income (loss) from discontinued operations, net of tax
365
(270
)
(2,541
)
(4,004
)
Related party activity:
Royalty income from discontinued operations
49
—
84
10
Total related party income from discontinued
operations
49
—
84
10
(1)
We have entered into a distribution agreement with IESA and Atari Europe which
provides for IESA’s and Atari Europe’s distribution of our products across Europe, Asia, and
certain other regions pursuant to which IESA, Atari Europe, or any of their subsidiaries, as
applicable, will pay us 30.0% of the gross margin on such products or 130.0% of the royalty rate
due to the developer, whichever is greater. We recognize this amount as royalty income as part
of net revenues, net of returns.
(2)
We have also entered into a distribution agreement with IESA and Atari Europe, which
provides for our distribution of IESA’s (or any of its subsidiaries’) products in the United
States, Canada and Mexico, pursuant to which we will pay IESA either 30.0% of the gross margin
on such products or 130.0% of the royalty rate due to the
Balances comprised primarily from the management fees charged to us by IESA and other
recharges of cost incurred on our behalf.
(2)
Balances comprised of royalty income or expense from our distribution agreements with
IESA and Atari Europe relating to properties owned or licensed by Atari Europe.
(3)
Balance at March 31, 2005 represents a loan owed by our dormant UK subsidiary to
another IESA subsidiary. This note was settled through the issuance of stock in September
2005 (see below).
(4)
Represents net payables related to related party development activities.
(5)
Represents distribution fees owed to Humongous, Inc., a related party. As of
March 31, 2005, Humongous existed as a development studio within Atari, Inc. (see Note 9).
(6)
Comprised primarily of payables related to royalty expense from our distribution
agreement with IESA relating to properties owned or licensed by Atari Interactive, offset
by receivables related to management fee revenue earned from Atari Interactive.
Issuance of Common Stock to Related Parties
In the quarter ended September 30, 2005, we entered into two transactions with our majority
stockholder, IESA, to settle certain outstanding related party balances through the issuance of an
aggregate of 6,145,051 shares of our common stock.
•
Related Party Payables
On September 15, 2005, we and IESA entered into an Agreement Regarding Issuance of Shares
(“Related Party Share Issuance”) for 4,881,533 shares of our common stock. These shares represent
payment for development costs
incurred and other net trade payables that have been incurred in the ordinary course of
business due to IESA and several of its subsidiaries. The common stock issued to IESA was valued
at $1.30 (market price at the date of the agreement) per share and paid $6.4 million of related
party invoices.
•
Settlement of Indebtedness
On September 15, 2005, we, IESA (and all of its subsidiaries) and Atari UK entered into the GT
Interactive UK Settlement of Indebtedness Agreement (“Settlement of Indebtedness”) whereby we
issued 1,263,518 shares of our common stock in payment of a $1.6 million loan owed by a dormant
Atari subsidiary to an IESA subsidiary. The common stock issued to IESA was valued at $1.30 per
share.
Related Party Transactions with Employees or Former Employees
On August 31, 2005, pursuant to a Compromise Agreement executed on August 12, 2005 between us,
Reflections Interactive Limited (“Reflections”), our wholly-owned subsidiary, and Martin Lee
Edmondson, a former employee of Reflections, we issued 1,557,668 shares to Mr. Edmondson as part of
the full and final settlement of a dismissal claim and any and all other claims that Mr. Edmondson
had or may have had against us and Reflections, except for personal injury claims, accrued pension
rights, non-waivable claims, claims to enforce rights under the Compromise Agreement, and claims
for financial compensation for services rendered (if any) in connection with our game Driver:
Parallel Lines. The share issuance was valued at $2.1 million and the issuance was recorded as a
reduction of royalties payable. The Compromise Agreement also included a cash payment of $2.2
million paid in twelve equal installments beginning on September 1, 2005, as well as a one time
payment of $0.4 million payable on September 1, 2005.
NOTE 8 – COMMITMENTS AND CONTINGENCIES
Litigation
During the nine months ended December 31, 2005, no significant claims were asserted against or
by us that, in management’s opinion, the likely resolution would have a material adverse
affect on our liquidity, financial condition or results of operations, although we are involved in
various claims and legal actions arising in the ordinary course of business. The following is a
summary of pending litigation matters.
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.
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.
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, Inc. (“Hasbro”) filed a
complaint against Games, Inc. (“Games”), its CEO, Roger W. Ach, II (“Ach”), and Chicago West
Pullman LLC (“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
Ach’s use of certain trademarks and copyrights owned by Atari Interactive and Hasbro. The
plaintiffs allege that an interim license that Atari 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 Atari certain fees by April 30, 2004, pursuant to an Asset Purchase, License and Assignment
Agreement between Atari and Games dated December 31, 2003, as amended (the “Agreement”). The
plaintiffs allege that Games’ failure to pay voided an expected transfer of the “Games.com” domain
name and certain web site assets from Atari to Games and constituted a breach of contract and that
Chicago West Pullman’s failure to pay constituted a breach of guarantee. The plaintiffs further
allege that upon the expiration of the interim license, all intellectual property rights granted
under that license reverted back to Atari, but that Games nevertheless continued to use plaintiffs’
intellectual property.
On June 29, 2005, the Clerk of the District Court entered an amendment judgment stating that
we were entitled to the following damages: (1) immediate payment of $3,104,108, plus interest at
the annual rate of 9% from April 30, 2004, (2) immediate redemption of the initial 10,250 shares
for $1.025 million, plus interest at the annual rate of 9% from April 30, 2004, (3) immediate
redemption of 10,000 additional shares for $1 million, (4) the $50,000 bond that plaintiffs posted
on May 19, 2004 to secure a temporary restraining order in this case is exonerated, (5) redemption
of the remaining 10,000 shares at any time after December 29, 2005 at a price of $100 per share,
for a total of $1 million, (6) plaintiffs collectively
are entitled to recoup their $150 filing fee, (7) this judgment runs directly against Games, but in
the event Games fails to
satisfy it, it runs secondarily against Chicago West Pullman and Ach, (8)
the preliminary injunction is lifted, and (9) defendant Games, Inc. is enjoined from selling or
distributing any product that contains the intellectual property it licensed in its contract with
us.
On February 2, 2006, the Court of Appeals issued an order affirming the District Court’s
judgment against Ach, Games, Inc., and Chicago West Pullman.
Atari has made efforts to collect on the
judgment it obtained in the District Court.
On August 26, 2005, we filed a garnishment proceeding in Hamilton County Court of Common Pleas
in Cincinnati, Ohio seeking to restrain assets of Games, Chicago West
Pullman and Ach held at Fifth Third
Bank. On September 21, 2005, Games, Chicago West Pullman and Ach filed a
complaint and motion for temporary restraining order in the Court of Common Pleas, Hamilton County,
Ohio against us, Atari Interactive, and Hasbro seeking to restrain them from executing upon the
judgment in Ohio. On December 12, 2005, a hearing was held on the motion for a temporary
restraining order. On December 16, 2005, the Court denied the temporary restraining order and
dismissed Hasbro and Atari Interactive from the action. Atari filed an answer to the complaint
filed by Games, Chicago West Pullman and Ach on January 23,2006. Games, Chicago West Pullman and Ach filed an amended
complaint on January 24, 2006. On February 7, 2006, Games Chicago
West Pullman, and Ach voluntarily dismissed their claims against us,
without prejudice.
We are currently investigating further options with respect to our collection
efforts. As of December 31, 2005, we have not recorded any amounts
related to this matter.
American Video Graphics, L.P., v. Electronic Arts, Inc. et al.
On August 23, 2004, American Video Graphics, L.P. filed a lawsuit against us, Electronic Arts,
Inc., Take-Two Interactive Software, Inc., Ubi Soft, Activision Inc., THQ, Inc., Vivendi Universal
Games, Inc., Sega of America, Inc., Square Enix, Inc., Tecmo, Inc., Lucasarts, a division of Lucas
Films Entertainment Co., Ltd., and Namco Hometek, Inc. in the United States District Court for the
Eastern District of Texas, Tyler Division (Case No. 6:04
CV-398-LED), alleging infringement of US
Patent No. 4,734,690 (method and apparatus for spherical panning) and seeking unspecified damages.
On October 19, 2005, we and AVG executed a Patent License and Settlement Agreement pursuant to
which we will pay $0.3 million in full settlement of the lawsuit,
which has been accrued as of December 31, 2005, and
will receive an irrevocable,
nonexclusive, worldwide license to use, publish, sell, etc. products covered by the AVG patents.
iEntertainment
Network, Inc. v. Epic Games, Inc., Atari, Inc., Valve Corporation, Sierra
Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of America, Sony Computer
Entertainment America, Inc. and Sony Online Entertainment, Inc.
On December 22, 2004, we were served with a Complaint by iEntertainment, Inc. The Complaint
has been filed in the United States District Court of the Eastern District of North Carolina
Western Division (5:04-CV-647-BD(1)) and names the following defendants: us, Epic Games, Inc.,
Valve Corporation, Sierra Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of
America, Sony Computer Entertainment America, Inc. and Sony Online Entertainment, Inc. The
Complaint alleges infringement of US Patent No. 6,042,477 (method of and system for minimizing the
effects of time latency in multiplayer electronic games played on interconnected computers) and
seeks unspecified damages. On December 15, 2005, the parties entered into a settlement agreement
pursuant to which in exchange for $175,000, iEntertainment released all parties (and their
affiliates) from claims and granted Atari an irrevocable, fully paid-up, nonexclusive right and
license under US Patent No. 6,042,477 and all other patents and patent applications currently owned
by or enforceable by iEntertainment, with the right to sublicense to others, to make, have made,
import, use, practice, offer for sale, sell or otherwise dispose of
our products worldwide. Our portion of the settlement amount,
$25,000, was paid in full as of December 31, 2005. A Stipulation of Dismissal was entered with the
Court on December 22, 2005.
Mr. M.L. Edmondson v. Reflections Interactive Limited
On March 4, 2005, Martin Lee Edmondson, the former Managing Director of Reflections
Interactive Limited, our wholly-owned UK subsidiary, filed a Notice of Claim with the Newcastle
upon Tyne Employment Tribunal claiming constructive unfair dismissal as a result of Reflections
alleged repudiatory breach of a contract of employment that necessitated Mr. Edmondson’s
resignation. Mr. Edmondson was seeking a declaration that he was unfairly dismissed and
compensation in an unspecified amount for such dismissal. Compensation in the Employment Tribunal
is limited to £55,000 in respect of the maximum compensatory award. Mr. Edmondson could be awarded
for unfair dismissal, together with a maximum basic award of (depending on age and length of
service) £1,350 to £2,025. On April 1, 2005, Reflections filed a Response denying that there was a
fundamental breach of contract that entitled Mr. Edmondson to resign and claim constructive
dismissal. The parties have concluded a negotiation process with Mr. Edmondson whereby Mr.
Edmondson agreed to withdraw his claims against us in return for a settlement payment. Mr.
Edmondson signed the Compromise Agreement on August 9, 2005 and the Agreement was executed by us
and Reflections on August 12, 2005. Mr. Edmondson has now withdrawn his claim and the Employment
Tribunal dismissed the claim on September 15, 2005.
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 counsel 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 Court’s ruling to the Fourth Circuit Court of Appeals.
Indigo Moon Productions, LLC v. Hasbro, Inc., et al.
On August 12, 2005, Indigo Moon Productions, LLC, or Indigo Moon, filed a lawsuit against us,
Hasbro, Hasbro Interactive, Atari Interactive and Infogrames, Inc. (n/k/a Atari, 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.
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 Moon’s work. Indigo
Moon’s 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 Atari’s Santa Monica studio
as of December 1, 2001. His assignment in the US was on a three
year renewable basis. As of August 31, 2004, in connection with
the closing of the Santa Monica studio, Mr. Curulla’s assignment in
the US was terminated. Mr. Curulla’s Complaint was lodged before the
Industrial Tribunal of Lyon, France (Conseil de Prud’hommes). A
hearing took place on October 6, 2005 and a discovery period was
established. 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. As of February 22, 2006, the
February 16, 2006 hearing date has been postponed and a new date for
the hearing has not yet been set. Atari Europe is representing Atari,
Inc.
NOTE 9 – DEBT
Credit Facilities
HSBC Loan and Security Agreement
On May 13, 2005 (amended August 9, 2005), we obtained a one year $50.0 million revolving
credit facility with HSBC, pursuant to a Loan and Security Agreement, to fund our working capital
and general corporate needs. Loans under the revolving credit facility are determined based on
percentages of our eligible receivables and eligible inventory for certain seasonal peak periods.
The revolving credit facility bears interest at prime for daily borrowings or LIBOR plus 1.75% for
borrowings with a maturity of 30 days or greater. We are required to pay a commitment fee of 0.25%
on the average unused portion of the facility quarterly in arrears and closing costs of
approximately $0.1 million. The revolving credit facility contains certain financial covenants
that require us to maintain enumerated EBITDA, tangible net worth, and working capital minimums.
In addition, amounts outstanding under the revolving credit facility are secured by liens on
substantially all of our present and future assets, including accounts receivable, inventory,
general intangibles, fixtures, and equipment and excluding certain non-U.S. assets. As of December31, 2005, a balance of $4.4 million was outstanding under the revolving credit facility; a nominal
amount of letters of credit were outstanding. Additionally, accrued interest of $0.1 million was
included in accrued liabilities as of December 31, 2005.
On January 18, 2006, HSBC notified us that as a result of our default of certain financial
covenants for the quarter ended December 31, 2005, they will not extend further credit under our
revolving credit facility. HSBC stated that, without waiving any rights, it may in its sole
discretion agree to review revised business plans or projections and make or not make future
advances under the facility, however, it would not do so on the basis of our current business
plans. As of the date hereof, we had no balance or letters of credit outstanding under the credit
facility.
NOTE 10 – DISCONTINUED OPERATIONS
In the fourth quarter of fiscal 2005, following the guidance established under FASB Statement
No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”, management committed to a
plan to divest of Humongous. During the period ended December 31, 2005 selected Humongous assets
were sold to our majority stockholder, IESA.
On August 22, 2005, we sold Humongous to IESA in exchange for 4,720,771 of their shares valued
at $8.3 million. Humongous’ book value approximated $4.8 million and consisted primarily of
intellectual property, existing inventory, license rights, and an allocation of goodwill of $3.8
million. The difference of approximately $3.5 million between the sale price and the Humongous’
book value was recorded to additional paid-in capital, as no gain can be recorded on sales of
businesses with entities under common control.
Immediately following the sale, we entered into a Distribution Agreement, dated as of August22, 2005, (the “Humongous Distribution Agreement”), with Humongous, Inc. (formerly Humongous), a
newly formed wholly-owned subsidiary of IESA, under which we will be the sole distributor in the
US, Canada, and Mexico of products developed by Humongous, Inc.
As we have entered into a short-term distribution agreement (ending March 31, 2006) with
Humongous, Inc., we expect to generate continuing cash flows from the distribution of their
product, although at significantly lower margins. Furthermore, we have no rights to any licensing
income derived from these games, we will incur no future development costs, and Humongous, Inc. is
managed and operated by an independent management group. Therefore, we have concluded that these
continuing cash flows are now part of our distribution business and are recorded within continuing
operations.
Additionally, IESA advanced approximately $2.0 million, totaling 1,119,390 of their shares,
for certain future costs related to platform royalty advances, manufacturing costs and milestone
payments that we have subsequently paid on behalf of Humongous, Inc. In the aggregate, we received
5,840,161 shares of IESA (“IESA Shares”).
In connection with the above transactions, on August 22, 2005, we and IESA entered into an
agreement, pursuant to which we agreed to cooperate with regard to the sale of some or all of the
IESA Shares received. Therefore, in September 2005, the IESA Shares were sold for $10.1 million and
we realized a loss of $0.2 million included in other income (expense) as part of net loss. We did
not incur any additional expenses in conjunction with this transaction.
Balance Sheets
At March 31, 2005 and December 31, 2005, the assets and liabilities of Humongous are presented
separately on our Condensed Consolidated Balance Sheets. The components of the assets and liabilities of
discontinued operations are as follows (in thousands):
As a result of management’s plan to divest of Humongous, during the first three quarters of
fiscal 2006, following the guidance established under FASB Statement No. 146, “Accounting for Costs
Associated with Exit or Disposal Activities”, we recorded severance and restructuring charges of
approximately $1.5 million for the termination of Humongous employees and other miscellaneous
items, included in the loss from discontinued operations for the nine
months ended December 31, 2005, respectively, and the associated remaining liability for this charge of $0.3 million is
included in liabilities of discontinued operations.
Results of Operations
As Humongous represented a component of our business and its results of operations and cash
flows can be separated from the rest of our operations, the results for the periods presented are
disclosed as discontinued operations on the face of the Condensed Consolidated Statements of Operations and
Comprehensive Income (Loss). Net revenues and income (loss) from discontinued operations, net of
tax, for the three months and nine months ended December 31, 2004 and 2005, respectively, are as
follows (in thousands):
Income (loss) from discontinued operations,
net of tax
$
365
$
(270
)
$
(2,541
)
$
(4,004
)
Prior to its identification as a discontinued operation, Humongous’ results were reported
as part of our publishing segment. Since the sale of Humongous and under the distribution
agreement, Humongous, Inc. sales are now reported in our distribution segment (Note 12).
Results of Continuing Involvement with Humongous, Inc.
The following table shows the results of continuing involvement with Humongous, Inc. for the
three months and nine months ended December 31, 2004 and 2005 (in thousands):
During the fourth quarter of fiscal 2005, following the guidance established under FASB
Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, management
announced a restructuring plan to strengthen our competitive position in the marketplace as well as
enhance shareholder value. During the three months and nine months ended December 31, 2005, we
recorded restructuring expenses of $1.1 million and $4.8 million, respectively, which include the
termination of several key executives as well as severance and other charges related to the closing
of the Beverly, MA, and Santa Monica, CA, publishing studios and the transfer of all publishing
operations to the New York office. Also included in this charge, in accordance with FASB Statement
No. 146, is the present value of all future lease payments, less the present value of expected
sublease income to be recorded, primarily for the Beverly and Santa Monica offices. The charge for
restructuring is comprised of the following (in thousands):
We expect to incur an additional $1.0 million to $2.0 million in order to complete
management’s restructuring plan. We will incur these costs through early fiscal 2007.
The following is a reconciliation of our restructuring reserve from inception through December31, 2005 (in thousands):
The charge of $0.4 million for the modification of stock options was recorded as part of
the termination agreement with certain employees as an increase to additional paid-in capital, and
the charge of $0.3 million for fixed asset write offs was recorded as a decrease to property and
equipment, net.
NOTE 12 – OPERATIONS BY REPORTABLE SEGMENTS
We have three reportable segments: publishing, distribution and corporate. Publishing was
comprised of two studios located in Santa Monica, California and Beverly, Massachusetts. As part
of our restructuring plan, the Beverly studio was closed in the first quarter of fiscal 2006 and
the Santa Monica studio was closed in the second quarter of fiscal 2006; all publishing operations
have been transferred to the New York office. Distribution constitutes the sale of other
publishers’ titles to various mass merchants and other retailers. Corporate includes the costs of
senior executive management, legal, finance, and administration. The majority of depreciation
expense for fixed assets is charged to the corporate segment and a portion is recorded in the
publishing segment. This amount consists of depreciation on computers and office furniture in the
publishing unit. Historically, we do not separately track or maintain records, other than those
for goodwill (publishing) and a nominal amount of fixed assets, which identify assets by segment
and, accordingly, such information is not available.
The accounting policies of the segments are the same as those described in the summary of
significant accounting policies. We evaluate performance based on operating results of these
segments.
The results of operations for Humongous through August 2005 are not included in our segment
reporting below as they are classified as discontinued operations in our Consolidated Financial
Statements. After August 2005, all sales of Humongous, Inc. products are included as part of the
distribution segment (Note 10).
Our reportable segments are strategic business units with different associated costs and
profit margins. They are managed separately because each business unit requires different
planning, and where appropriate, merchandising and marketing strategies.
The following summary represents the consolidated net revenues, operating income (loss),
depreciation and amortization, and interest income (expense) by reportable segment for the three
months and nine months ended December 31, 2004 and 2005 (in thousands):
Operating income (loss) for the Corporate segment for the three months and nine months
ended December 31, 2005, excludes restructuring charges of $1.1 million and $4.8 million,
respectively. Including restructuring charges, total operating loss for the three months
and nine months ended December 31, 2005 is $4.4 million and $58.4 million, respectively.
NOTE 13 – RESTATEMENT OF CASH FLOWS
Subsequent to the
issuance of our condensed consolidated financial statements for the three
and nine months ended December 31, 2004, management determined
that secured promissory notes received by us
from IESA and its subsidiaries in satisfaction of royalties due from
IESA and its subsidiaries to us and in exchange for short-term notes
receivable and other receivables due from related parties represented
non-cash activities
that should not have been included as cash transactions in our statements of cash flows. In our
previously issued financial statements, the amounts associated with these transactions had been
reported as cash provided by operating activities and cash used in investing activities. As a
result, the accompanying condensed consolidated statement of cash flows for the nine months ended
December 31, 2004 has been restated from the amounts previously reported.
A summary of the significant effects of the restatement are as follows (in thousands):
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This document includes statements that may constitute forward-looking statements made pursuant
to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution
readers regarding certain forward-looking statements in this document, press releases, securities
filings, and all other documents and communications. All statements, other than statements of
historical fact, including statements regarding industry prospects and future results of operations
or financial position, made in this Quarterly Report on Form 10-Q are forward looking. The words
“believe”, “expect”, “anticipate”, “intend” and similar expressions generally identify
forward-looking statements. While we believe in the veracity of all statements made herein,
forward-looking statements are necessarily based upon a number of estimates and assumptions that,
while considered reasonable by us, are inherently subject to significant business, economic and
competitive uncertainties and contingencies and known and unknown risks. As a result of such
risks, our actual results could differ materially from those expressed in any forward-looking
statements made by, or on behalf of, us. Some of the factors which could cause our results to
differ materially include the following: the loss of key customers, such as Wal-Mart, Best Buy,
Target, GameStop and Electronics Boutique; delays in product development and related product
release schedules; inability to secure capital; loss of our credit facility; adapting to the
rapidly changing industry technology, including new console technology; maintaining relationships
with leading independent video game software developers; maintaining or acquiring licenses to
intellectual property; fluctuations in the Company’s quarterly net revenues and results of
operations based on the seasonality of our industry; and the termination or modification of our
agreements with hardware manufacturers. Please see the “Risk Factors” in our Annual Report on Form
10-K for the year ended March 31, 2005, which we expect to amend
for the effects of the restatement discussed in Note 13 to the
condensed consolidated financial statements included in Item 1, or in our other filings with the Securities and Exchange
Commission for a description of some, but not all, risks, uncertainties and contingencies. Except
as otherwise required by the applicable securities laws, we disclaim any intention or obligation
publicly to update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
Overview
Restatement of Cash Flows
As discussed in Note 13 to the condensed consolidated financial statements included in Item 1,
our condensed consolidated statement of cash flows for the nine months ended December 31, 2004 has
been restated to eliminate the amounts associated with secured promissory notes received by us from IESA and its subsidiaries in
satisfaction of royalties due from IESA and its subsidiaries to us and in exchange for short-term notes receivable and
other receivables due from related parties, which represented non-cash activities that
should not have been included as cash transactions in our statements of cash flows. We have also determined that
short-term notes receivable previously received from IESA and its subsidiaries during the year ended March 31, 2004 in satisfaction
of amounts set off by one of our customers against amounts due to the customer by IESA and its subsidiaries, and receivables associated with certain intellectual property of IESA and its subsidiaries represented
non-cash transactions that should not have been
included as cash transactions in our statements of cash flows for the years ended March 31, 2004 and
2005. As a result, we have determined that our previously issued statements of cash flows for the
years ended March 31, 2004 and 2005, the six months ended September 30, 2004 and the nine months
ended December 31, 2004 should be restated.
A summary of the
significant effects of the restatement on our consolidated statements of cash
flows for the years ended March 31, 2004 and 2005, and the six months ended
September 30, 2004 are as follows (in thousands):
Net cash (used in) provided by continuing operations
(2,280
)
8,571
6,291
Net cash (used in) discontinued operations
(3,364
)
—
(3,364
)
Net cash (used in) provided by operating activities
$
(5,644
)
$
8,571
$
2,927
Cash Flows From Investing Activities:
Repayment of related party notes receivable
$
1,317
$
(1,317
)
$
—
Transfer and
assignment of related party notes receivable
7,254
(7,254
)
—
Issuance of secured promissory note
(23,059
)
23,059
—
Repayment of secured promissory note, net
23,059
(23,059
)
—
Net cash provided by (used in) continuing operations
6,549
(8,571
)
(2,022
)
Net cash (used in) discontinued operations
(90
)
—
(90
)
Net cash provided by (used in) investing activities
$
6,459
$
(8,571
)
$
(2,112
)
SUPPLEMENTAL DISCLOSURE OF
NON-CASH OPERATING ACTIVITIES:
As Restated
Transfer of certain related party trade payables against
short-term notes receivable from related parties
1,317
Transfer and assignment of short-term notes receivable from
related parties into a secured promissory note
7,254
Issuance of a secured promissory note in exchange for certain
short-term notes receivable and certain related party trade receivables
(23,059
)
Transfer of certain related party trade payables against a secured promissory note
23,059
We intend to amend our
Annual Report on Form 10-K for the year ended March 31, 2005 and Form 10-Q for the three months ended September 30, 2005 to
include restated statements of cash flows as soon as practicable.
The following Management’s Discussion and Analysis gives effect to the restatement discussed in Note 13.
Going Concern
A weak holiday season for the industry combined with underperformance from new product launches and
product launch delays have contributed to third quarter results substantially below our
expectations. For the three months and nine months ended December 31, 2005, we generated net
losses of $4.8 million and $62.8 million, respectively, and are in default of certain financial
covenants for the quarter ended December 31, 2005 on our credit facility with HSBC. We have been
advised by our lender that it will not currently extend further credit under our revolving credit
facility because of the default. HSBC also stated that it may agree to review revised business
plans or projections and make or not make future advances under the facility, however, it would not
do so on the basis of our current business plans. As of the date hereof, we had no balance or
letters of credit outstanding under the credit facility. IESA currently plans to provide some
financial support to us during our fiscal fourth quarter, however, as IESA continues to address its
own financial condition, its ability to fund its subsidiaries’ operations, including ours, remains
limited. Therefore, there can be no assurance we will ultimately receive any funding from them.
The uncertainties caused by these conditions raise substantial doubt about our ability to
continue as a going concern. The consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
We are exploring various alternatives to improve our financial position and secure other
sources of financing. Such possibilities include a replacement of the credit facility, new
arrangements to license intellectual property, the sale of selected intellectual property rights,
sale of development studios and equity capital from external sources. To reduce working capital
requirements and further conserve cash we will need to take additional actions in the near-term,
which may include personnel reductions and suspension of certain development projects. These
actions may or may not prove to be consistent with our long-term strategic objectives. We cannot
guarantee the completion of these actions or that such actions will generate sufficient resources
to fully address the uncertainties of our financial position.
Goodwill and Other Intangible Assets
As of March 31, 2005, our annual
fair-value based assessment, in accordance with FASB Statement No. 142,
“Goodwill and Other Intangible Assets”, did not result in any impairment of goodwill or
intangibles. Subsequently, a portion of goodwill relating to our publishing business
was allocated to Humongous as part of the sale transaction, which reduced the amount on
the balance sheet by $3.8 million (Note 10).
At December 31, 2005, the
video game industry’s transition from current to next generation hardware was well
underway. As consumers shift to next generation hardware,
demand for games played on current generation hardware and unit prices
of those games are expected to decline. The market uncertainties associated
with this industry transition, coupled with our own weakened financial condition
and product portfolio, could affect the carrying value of our goodwill
and intangible assets and we are currently assessing the potential impact
of these conditions. We believe our analysis will be completed prior to the filing of
our March 31, 2006 annual report on Form 10-K.
Business and Operating Segments
We are a global publisher and developer of video game software for gaming enthusiasts and the
mass-market audience, and a distributor of video game software in North America. We publish and
distribute games for all platforms, including Sony PlayStation and PlayStation 2; Nintendo Game
Boy, Game Boy Advance, GameCube and DS; Microsoft Xbox and Xbox 360; and personal computers,
referred to as PCs. We also publish and sublicense games for the
wireless, internet, and other evolving platforms. Our diverse portfolio of products extends across
most major video game
genres, including action, adventure, strategy, role-playing, and driving.
Our products are based on intellectual properties that we have either created internally and own or
which have been licensed from third parties. We leverage both internal and external resources in
the development of our games, assessing each project independently to determine which development
team is best suited to handle the product based on technical expertise and historical development
experience, among other factors. Additionally, through our relationship with IESA, our products
are distributed exclusively by IESA throughout Europe, Asia and other regions. Through our
distribution agreement with IESA, we have the rights to publish and sublicense certain intellectual
properties either owned or licensed by IESA or its subsidiaries, including Atari Interactive. We
also manage the development of product at studios owned by IESA that focus solely on game
development.
In addition to our publishing and development activities, we also distribute video game
software in North America for titles developed by certain third-party publishers with whom we have
contracts (“Distribution Business”). As a distributor of video game software throughout the U.S.,
we maintain what we believe to be state-of-the-art distribution operations and systems, reaching
well in excess of 30,000 retail outlets nationwide. The distribution channels for interactive
software have expanded significantly in recent years. Consumers have access to interactive
software through a variety of outlets, including mass-merchant retailers such as Wal-Mart and
Target; major retailers, such as Best Buy and Toys ‘R’ Us; and specialty stores such as Electronics
Boutique and GameStop. Additionally, our games are made available through various Internet and
online networks. Our sales to key customers Wal-Mart, Target, Best Buy, and GameStop accounted for
approximately 31.6%, 13.9%, 9.4%, and 8.5%, respectively, of net revenues for the nine months ended
December 31, 2005.
Industry
Generally, the video game software industry has experienced an
increased rate of change and complexity in the technological innovations
of video game hardware and software. As technological innovations
become viable, next generation hardware is introduced to the market
place (approximately every five years). As consumers shift to next
generation hardware, demand for games played on current generation
hardware and unit prices of those games are expected to decline.
Currently, delivery of next generation hardware from Sony and Nintendo, expected this fall, is uncertain
with respect to available quantities just as quantities of
Microsoft’s newly launched Xbox 360 remain tight. The industry
generally had a disappointing holiday season and we anticipate that
such reduced sales trend will continue through the transition period.
In
addition to these technological innovations, there has been greater
competition for shelf space and creative talent as well as increased
buyer selectivity. As a result, the video game industry has become
increasingly hit-driven, which has led to higher per game production
budgets, longer and more complex development processes, and generally
shorter product life cycles. The importance of the timely release of
hit titles, as well as the increased scope and complexity of the
product development process, have increased the need for disciplined
product development processes that limit costs and overruns. This, in
turn, has increased the importance of leveraging the technologies,
characters or storylines of existing hit titles into additional video
game software franchises in order to spread development costs among
multiple products.
We
expect these trends to continue and our operating results will be
impacted by our ability to keep pace with technological developments
and to timely produce high quality products.
Critical accounting policies
Our discussion and analysis of financial condition and results of operations are based upon
our consolidated 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 estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.
On an on-going basis, we evaluate our estimates, including those related to accounts and notes
receivable, inventories, intangible assets, investments, income taxes and contingencies. We base
our estimates on historical experience and on various other
assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results could differ materially from these estimates under different assumptions or
conditions.
We believe the following critical accounting policies affect our more significant judgments
and estimates used in the preparation of our consolidated financial statements.
Revenue
recognition, sales returns, price protection, other customer related allowances and allowance for doubtful accounts
Revenue
is recognized when title and risk of loss transfer to the customer,
provided that collection of the resulting receivable is deemed
probable by management.
Sales are recorded net of estimated future returns, price protection and other customer
related allowances. We are not contractually obligated to accept returns; however, based on facts
and circumstances at the time a customer may request approval for a return, we may permit the
return or exchange of products sold to certain customers. In addition, we may provide price
protection, co-operative advertising and other allowances to certain customers in accordance with
industry practice. These reserves are determined based on historical experience, market acceptance
of products produced, retailer inventory levels, budgeted customer allowances, the nature of the
title and existing commitments to customers.
Although management believes it provides adequate reserves with respect to these items, actual
activity could vary from management’s estimates and such variances could have a material impact on
reported results.
We maintain allowances for doubtful accounts for estimated losses resulting from the inability
of our customers to make payments when due or within a reasonable period of time thereafter. If
the financial condition of our customers were to deteriorate, resulting in an impairment of their
ability to make required payments, additional allowances may be required.
For the three months ended December 31, 2004 and 2005, we recorded allowances for bad debts,
returns, price protection and other customer promotional programs of approximately $31.2 million
and $20.2 million, respectively. For the nine months ended December 31, 2004 and 2005, we
recorded allowances for bad debts, returns, price protection and other customer promotional
programs of approximately $70.4 million and $41.6 million, respectively. As of March 31, 2005 and
December 31, 2005, the aggregate reserves against accounts receivable for bad debts, returns, price
protection and other customer promotional programs were approximately $24.3 million and $24.4
million, respectively.
Inventories
We write down our inventories for estimated slow-moving or obsolete inventories equal to the
difference between the cost of inventories and estimated market value based upon assumed market
conditions. If actual market conditions are less favorable than those assumed by management,
additional inventory write-downs may be required. For the three months ended December 31, 2004 and
2005, we recorded obsolescence expense of approximately $0.6 million and $1.6 million,
respectively. For the nine months ended December 31, 2004 and 2005, we recorded obsolescence
expense of approximately $1.7 million and $2.9 million, respectively. As of March 31, 2005 and
December 31, 2005, the aggregate reserve against inventories was approximately $2.4 million and
$3.3 million, respectively.
Research and Product Development Costs
Research and product development costs relate to the design, development, and testing of new
software products, whether internally or externally developed. Rapid technological innovation,
shelf-space competition, shorter product life cycles and buyer selectivity have made it difficult
to determine the likelihood of individual product acceptance and success. As a result, we follow
the policy of expensing our research and product development costs including external developer
royalty advances (milestone payments) as incurred. Generally, developers are paid an advance upon
the signing of a contract with us. Subsequent payments are due as the specific contractual
milestones are met by the developer and approved by us. The timing of when these contracts are
entered into and when milestone payments are made could vary significantly from budgeted amounts
and, because these payments are expensed as incurred, they could have a material impact on reported
results in a given period. Once a product is sold, we may be obligated to make
additional payments in the form of backend royalties to developers
which are calculated based on contractual terms, typically a
percentage of sales. Such payments are expensed and included in cost
of goods sold in the period the sales are recorded.
Due to recently implemented enhancements in our internal project
planning and acceptance process and anticipated additional improvements in our ability to assess
post-release consumer acceptance, we are currently considering a change from expensing such costs
when incurred to a method of deferral and amortization over each product’s life cycle. Such change
may be implemented prospectively as early as our next fiscal year, beginning April 1, 2006.
Management believes that the ability to amortize such costs over the product’s life cycle will
result in a better matching of costs and revenues.
Licenses
Licenses for intellectual property are capitalized as assets upon the execution of the
contract when no significant obligation of performance remains with us or the third party. If
significant obligations remain, the asset is capitalized when payments are due or when performance
is completed as opposed to when the contract is executed. These licenses are amortized at the
licensor’s royalty rate over unit sales to cost of goods sold. Management
evaluates the carrying value of these capitalized licenses and records an impairment charge in the period management determines that such capitalized
amounts are not expected to be realized. Such
impairments are charged to cost of goods sold if the product has
released or previously sold and if the product has never been
released these impairments are charged to research and development.
Income Taxes
As part of the process of preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This process involves
estimating our current tax exposures in each jurisdiction including the impact, if any, of
additional taxes resulting from tax examinations as well as making judgments regarding the
recoverability of deferred tax assets. To the extent recovery of deferred tax assets is not likely
based on our estimation of future taxable income in each jurisdiction, a valuation allowance is
established. The estimated effective tax
rate is adjusted for the tax related to significant unusual items. Changes in the geographic
mix or estimated level of annual pre-tax income can affect the overall effective tax rate.
As of December 31, 2005, we have combined net operating loss carryforwards of approximately
$524.7 million for federal and state tax purposes. These loss carryforwards are available to
offset future taxable income, if any, and will
expire beginning in the years 2009 through 2025. We
experienced an ownership change in 1999 as a result of the acquisition by IESA. Under Section 382
of the Internal Revenue Code, when there is an ownership change, the pre-ownership-change loss
carryforwards are subject to an annual limitation which could reduce or defer the utilization of
these losses. Pre-acquisition losses of approximately $186.8 million are subject to an annual
limitation (approximately $7.2 million). A full valuation allowance has been recorded against the
net deferred tax asset based on our historical operating results and the conclusion that it is more
likely than not that such asset will not be realized. Management reassesses its position with
regard to the valuation allowance on a quarterly basis.
Related Party Transactions
We are involved in numerous related party transactions with IESA and its subsidiaries. These
related party transactions include, but are not limited to, the purchase and sale of product, game
development, administrative and support services and distribution agreements. See Note 7 and the
Notes to the Consolidated Financial Statements contained in our Annual Report on Form 10-K filed
with the Securities and Exchange Commission for the year ended March 31, 2005 for details.
Publishing net revenues decreased 40.2% due to lower sales from less successful new releases
and fewer back catalogue reorders, offset by greater international royalty income in the current
period.
•
Net product sales of new releases during the current quarter were approximately $51.1
million. This includes Dragon Ball Z: Budokai Tenkaichi (Playstation 2), Matrix: Path of
Neo (Playstation 2, Xbox, and PC), Roller Coaster Tycoon 3: Gold (PC), and Dragon Ball Z:
Super Sonic Warriors 2 (Nintendo DS).
Net product sales of new releases in the prior year’s comparable quarter were approximately
$94.5 million and included Dragonball Z: Budokai 3 (PlayStation 2), Roller Coaster Tycoon 3
(PC), Godzilla: Save the Earth (PlayStation 2 and Xbox), Atari Anthology (PlayStation 2 and
Xbox), Sid Meier’s Pirates! (PC), and Atari Flashback (plug and play).
•
Back catalogue reorder sales decreased by approximately 41.9% from the prior year. Net
product sales of $6.1 million of Atari Flashback 2 (plug and play), released in the prior
quarter, contributed to the current period total. The prior comparable period’s sales
included strong reorders of DRIV3R, released in the first quarter of fiscal 2005.
•
Publishing net revenue during the current quarter includes $9.0 million of international
royalties earned on IESA’s international sales of our titles, primarily for sales of
Matrix: Path of Neo, shipped in October 2005. The three months ended December 31, 2004
includes international royalties of $0.7 million, earned on various catalog titles.
•
The overall average unit sales price (“ASP”) of the publishing business has increased from
$20.18 in the prior comparable quarter to $23.61 in the current period. The increase ASP
is due to the shift in the mix towards a greater percent of console product which carries a
greater average sales price. This is offset by a decrease in the ASP for the plug and play
product from $29.87 in the prior period to $21.29 in the current period.
Total distribution net revenues for the three months ended December 31, 2005 are in line with the
comparable 2004 period. Current period distribution net revenues include product sales from a new
related party distribution partner, Humongous, Inc., offset by decreased product sales of other
third party publishers.
Cost of Goods Sold
Cost of goods sold as a percentage of net revenues can vary primarily due to segment mix,
platform mix within the publishing business, average unit sales prices, mix of royalty bearing
products and the mix of licensed product. These expenses for the
three months ended December 31, 2005 decreased by $28.8 million; however as a percentage of net revenues, cost
of goods sold increased slightly from 57.3% to 60.2% due to the following:
•
higher mix of international royalty income in the current period, with a lower
associated expense,
•
a greater mix of higher cost console product sales in the publishing business,
•
increased license amortization due to sales of Dragon Ball
Z titles, and
•
higher distribution net revenues (on which we incur higher costs) as a percentage of
total net revenues, which increased from 11.8% for the three months ended December 31,2004 to 18.2% for the three months ended December 31, 2005, offset by
•
higher average sales price for the current period as compared to the prior period (see
above).
Research and product development expenses consist of development costs relating to the design,
development, and testing of new software products whether internally or externally developed,
including the payment of royalty advances to third-party developers and billings from related party
developers on products that are currently in development. These
expenses for the three months ended December 31, 2005 decreased
approximately $2.4 million, or
15.8%, due primarily to:
•
decreased spending for projects in development with external developers due to timing of
milestone completions, offfset by
•
increased spending for certain projects currently in
development at our related party development studios.
For the three months ended December 31, 2004 and 2005, internal research and product development
costs incurred to run our development studios represented 42.2% and 43.3%, respectively, of total
research and product development costs.
Selling and Distribution Expenses
Selling and distribution expenses primarily include shipping, personnel, advertising,
promotions and distribution expenses. During the three months ended December 31, 2005, selling and
distribution expenses increased approximately $0.5 million, or 2.4%, due to:
•
increased spend on advertising ($14.7 million in the current period as compared to $12.1
million in the prior period) driven by a television media campaign for Matrix: Path of Neo,
offset by
•
savings in salaries and related overhead costs due to reduced headcount resulting from
management’s restructuring plan, and
•
lower variable distribution costs, including freight, shipping and handling, on lower
sales.
General and Administrative Expenses
General and administrative expenses primarily include personnel expenses, facilities costs,
professional expenses and other overhead charges. During the three months ended December 31, 2005,
general and administrative expenses decreased approximately $1.1 million, or 11.0%, due to:
•
a reduction in salary, rent, and other overhead costs due to reduced headcount and the
closure of the Beverly and Santa Monica offices (expenses included in restructuring expense
in the current period),
•
reduced bad debt expense due to lower sales, offset by
•
an increase of $0.5 million in professional and consulting fees, primarily due to outsourced legal services.
Restructuring Expenses
In the fourth quarter of fiscal 2005, management announced the planned closure of the Beverly,
Massachusetts, and Santa Monica, California, publishing studios and the relocation of the functions
previously provided by the studios to our corporate headquarters in New York. The costs associated
with these closures incurred in the three months ended December 31, 2005 were $1.1 million. The
costs are comprised of $0.4 million of consultant expenses, $0.3 million of lease related costs,
$0.2 million of relocation expenses, $0.1 million of severance and retention costs, and $0.1
million of miscellaneous expenses related to the transition. No such expenses were incurred in the
comparable prior period.
Depreciation and amortization for three months ended December 31, 2005 decreased 30.2% due to
prior year inclusion of depreciation expense for assets from the Beverly and Santa Monica studios
which were written off in the current period as well as assets becoming fully depreciated during
the year, partially offset by the commencement of depreciation for new assets placed into service.
Interest Income (Expense), net
Interest income (expense), net, decreased by $0.3 million, due to interest income recorded in
the prior period on related party notes receivable from Atari Interactive and Paradigm. No such
interest income was recorded in the current period.
Provision for (Benefit from) Income Taxes
The benefit of $0.1 million recorded in the three months ended December 31, 2005 resulted from
the reversal of the prior period UK tax reserve of $0.2 million, pursuant to discussions with UK
tax inspectors, offset by an additional state tax provision of $0.1 million recorded arising from a
current New York State tax audit. The provision recorded in the quarter ended December 31, 2004 of
$0.4 million included a potential tax expense of $0.2 million at our UK subsidiary as well as
federal and state alternative minimum taxes.
Income (Loss) from Discontinued Operations of Humongous Entertainment, net of tax
Income (loss) from discontinued operations of Humongous Entertainment, net of tax, decreased
by $0.6 million. The decrease is due to the fact that we no longer generate revenues from this
business; however we continue to incur lease and other miscellaneous costs for the Humongous
Entertainment offices.
Publishing net revenues decreased 59.4% due to fewer and less successful new releases and
fewer back catalogue reorders, compounded by the highly successful release of DRIV3R in the prior
comparable period.
•
Net product sales for all new releases during the current period were $73.0 million and
include Dragon Ball Z: Budokai Tenkaichi (Playstation 2), Matrix: Path of Neo (Playstation
2 and Xbox), Atari Flashback 2 (Plug and Play), Indigo Prophecy (PC, PlayStation 2, and
Xbox), and Dragon Ball Z: Transformations (Game Boy Advance).
Prior period publishing net product sales for new releases were $197.0 million led by DRIV3R
which contributed approximately $38.6 million of publishing net product sales. Other new
releases in the prior year included Dragonball Z: Budokai 3 (PlayStation 2), Roller Coaster
Tycoon 3 (PC), Transformers (PlayStation 2), Duel Masters: Sempai Legends (PlayStation 2 and
Game Boy Advance), Dragonball Z: Buu’s Fury (Game Boy Advance), Dragon Ball Z: Super Sonic
Warriors (Game Boy Advance), Atari Anthology (PlayStation 2 and Xbox), and Atari Flashback,
a plug and play classic game console.
•
Back catalogue reorder sales decreased by approximately 47.8% from the prior year. The
prior comparable period’s sales included strong reorders of Unreal Tournament 2004, Dragon
Ball Z: Budokai 2, and Enter the Matrix.
•
Publishing net revenues during the current period include $12.6 million of international
royalties earned on IESA’s international sales of our titles, primarily for sales of
Matrix: Path of Neo, which shipped in October 2005, and Indigo Prophecy, released in
September 2005. Publishing net revenues during the nine months ended December 31, 2004
included international royalties of $16.9 million, which
included $14.9 million from
international sales of DRIV3R.
•
Publishing net revenues also decreased from the prior period due to lower license income
as well as the recognition in the prior period of deferred revenue of approximately $4.0
million related to the release of DRIV3R on Xbox paid by Microsoft. No such revenues were
recorded in the current period.
The overall ASP of the publishing business has remained consistent with the prior period
at approximately $20.00. Trends include a mix shift toward lower priced PC product and
plug and play console, offset by an increase in price for PlayStation 2 and Xbox product.
Total distribution net revenues for the nine months ended December 31, 2005 increased approximately
$3.1 million or 7.3% due to the inclusion of sales from Humongous, Inc., a new related party
distribution partner.
Cost of Goods Sold
Cost of goods sold decreased by $77.5 million, primarily from decreased sales volume. Cost of
goods sold as a percentage of net revenues increased from 54.6% for the nine months ended December31, 2004 to 63.7% in the comparable 2005 period. The increase is due primarily to the following:
•
lower international royalty, license, and other income in the current period, which
have a higher associated royalty expense as a percentage of income than in the prior
period,
•
increased license amortization due to sales of Dragon Ball Z titles, and
•
higher distribution net revenues (on which we incur higher costs) as a percentage of
total net revenues, which increased from 12.8% to 27.9% for the three months ended
December 31, 2004 and 2005, respectively, offset by
•
higher mix of international royalty income in the current period, with a lower
associated expense.
Research and Product Development Expenses
Research
and product development expenses increased approximately
$0.7 million, or 15.1%, due
to:
•
increased spending for certain projects currently in
development at our related party development studios, offset by
•
decreased spending for current titles in development with external developers due to
fewer titles in development and timing of milestone completions.
For the nine months ended December 31, 2004 and 2005, internal research and product development
costs incurred to run our development studios represented 45.0% and 43.1%, respectively, of total
research and product development costs.
Selling and Distribution Expenses
Selling and distribution expenses during the nine months ended December 31, 2005 decreased
approximately $16.4 million, or 32.3%, due to:
•
a significant savings in the current period on advertising ($20.9 million in the current
period as compared to $30.5 million in the prior period) due to fewer new titles released,
•
savings in salaries and related overhead costs due to reduced headcount resulting from
management’s restructuring plan, and
•
lower variable distribution costs, including freight, shipping and handling, on lower
sales.
General and Administrative Expenses
General and administrative expenses during the nine months ended December 31, 2005 decreased
approximately $2.1 million, or 7.9%, due to:
•
a reduction in salary, rent, and other overhead costs due to reduced headcount and the
closure of the Beverly and Santa Monica offices,
•
decreased bad debt expense on lower sales, offset by
an increase of $1.6 million in professional fees, including $0.2 million for a
settlement with AVG as well as a general increase in legal expense due to outsourcing, and
•
the recognition of a $0.9 million translation gain from the liquidation of the dormant
Australian subsidiary in the first quarter of the prior year.
Restructuring Expenses
The costs associated with the closures of the Beverly and Santa Monica publishing studios
incurred in the nine months ended December 31, 2005 were $4.8 million. The costs are comprised of
$1.7 million of severance and retention costs, $1.0 million of lease related costs, $0.4 million
of costs related to the modification of stock options for terminated executives, $0.4 million of
consultant expenses, $0.4 million of relocation costs,
$0.3 million of fixed asset write-offs, and
$0.6 million of miscellaneous expenses related to the transition. No such expenses were incurred
in the comparable prior period.
Depreciation and Amortization
Depreciation and amortization for nine months ended December 31, 2005 decreased by $1.5
million, or 18.7%, due primarily to asset write-offs associated with the restructuring, compounded
by assets becoming fully depreciated during the quarter, partially offset by the commencement of
depreciation for new assets placed into service.
Interest Expense, net
Interest expense, net, remained consistent with the prior year at $0.6 million. Trends
include a decrease in credit facility interest expense due to decreased borrowings as well as lower
negotiated interest rates under the HSBC revolving credit facility, offset by the prior year’s
inclusion of interest income earned on related party notes receivable from Atari Interactive and
Paradigm. No such income was recorded in the current period.
Other Income (Expense)
Other income (expense) for the current period is due to a loss of $0.2 million realized on the
sale of the IESA shares received in connection with the sale of Humongous. The previous period
included a nominal amount of income from miscellaneous transactions with third parties.
Provision for (Benefit from) Income Taxes
The benefit recorded in the nine months ended December 31, 2005 resulted from the reversal of
a prior period tax reserve resulting from a successful IRS examination of the tax year ended June30, 2003 completed in the current period, as well as the reversal of the $0.2 million UK tax
reserve, pursuant to discussions with UK tax inspectors, offset by an additional state tax
provision of $0.1 million recorded arising from a current New York State tax audit. During the
period ended December 31, 2004, we recorded a provision of approximately $0.2 million for a
potential tax expense at our UK subsidiary as well as federal and
state alternative minimum taxes.
(Loss) from Discontinued Operations of Humongous Entertainment, net of tax
Loss from discontinued operations of Humongous Entertainment, net of tax, increased by $1.5
million. The increase is due to the fact that we no longer generate revenues from this business;
however we continue to incur lease and other miscellaneous costs for the Humongous Entertainment
offices.
Liquidity and Capital Resources
Overview
As consumers shift to next generation hardware, demand for games played on current generation
hardware and unit prices of those games are expected to decline. Meanwhile, delivery of next
generation hardware from Sony and Nintendo, expected this fall, is uncertain with respect to
available quantities just as quantities of Microsoft’s newly launched Xbox 360 remain tight. Due
to the risks and uncertainties associated with these and other significant changes in the
marketplace, coupled with our fiscal quarter and year-to-date losses and default of certain
financial covenants under our
credit facility with HSBC, management is uncertain as to whether we will have sufficient
capital resources to finance our operational requirements for the fourth quarter and through fiscal
2007.
We are exploring various alternatives to improve our financial position and secure other
sources of financing. Such possibilities include a replacement of the credit facility, new
arrangements to license intellectual property, the sale of selected intellectual property rights,
sale of development studios and equity capital from external sources. To reduce working capital
requirements and further conserve cash we will need to take additional actions in the near-term,
which may include personnel reductions and suspension of certain development projects. These
actions may or may not prove to be consistent with our long-term strategic objectives. We cannot
guarantee the completion of these actions or that such actions will generate sufficient resources
to fully address the uncertainties of our financial position. In
February 2006, we completed the sale of certain intellectual property
for approximately $2.2 million. A gain of $2.2 million will be recorded in the fourth quarter
of fiscal 2006.
During the nine months ended December 31, 2005, our operations used cash of approximately
$26.5 million due to the net loss of $62.8 million for the period, offset by collections of
outstanding trade receivables, increased royalties payable accruals, and decreased prepaid expenses
and other assets from the amortization of licenses due to sales of Dragon Ball Z titles.
During the nine months ended December 31, 2005, investing activities provided cash of $8.0
million, primarily from the sale of IESA common stock that was acquired in the sale of Humongous
Entertainment to Humongous Inc., a subsidiary of IESA. This cash was offset by $2.1 million in
purchases of fixed assets. During the nine months ended December 31, 2004, cash used in investing
activities was comprised primarily of purchases of property and
equipment of approximately $1.5 million.
During the nine months ended December 31, 2005, cash provided by financing activities of $11.7
million was driven by proceeds of $7.3 million from the issuance of shares of our common stock to
third party investors in a private placement, compounded by current period borrowings of $4.4
million from the HSBC revolving credit facility. During the nine months ended December 31, 2004,
our financing activities provided for a nominal amount of cash.
We expect continued volatility in the use of cash due to seasonality of the business,
receivable payment cycles and quarterly working capital needs to finance our publishing businesses
and growth objectives.
Our outstanding accounts receivable balance varies significantly on a quarterly basis due to
the seasonality of our business and the timing of new product releases. There were no significant
changes in the credit terms with customers during the twelve month period.
We do not currently have any material commitments with respect to any capital expenditures.
However, we do have commitments to pay royalty and license advances, milestone payments, operating
lease obligations and capital lease obligations.
Our ability to maintain sufficient levels of cash could be affected by various risks and
uncertainties including, but not limited to, customer demand and acceptance of our new versions of
our titles on existing platforms and our titles on new platforms, our ability to collect our
receivables as they become due, risks of product returns, successfully achieving our product
release schedules and attaining our forecasted sales goals, seasonality in operating results,
fluctuations in market conditions and the other risks described in the “Risk Factors” as noted in
our Annual Report on Form 10-K for the year ended March 31, 2005, which we expect to amend for the effects of the restatement discussed
in Note 13 to the condensed consolidated financial statements.
We are also party to various litigation arising in the course of our business. Management
believes that the ultimate resolution of these matters will not have a material adverse effect on
our liquidity, financial condition or results of operations.
Credit Facilities
HSBC Loan and Security Agreement
On May 13, 2005 (amended August 9, 2005), we obtained a one year $50.0 million revolving credit
facility with HSBC, pursuant to a Loan and Security Agreement, to fund our working capital and
general corporate needs. On January 18, 2006, HSBC notified us that as a result of our default of
certain financial covenants for the quarter ended December 31, 2005, they will not extend further
credit under our revolving credit facility. HSBC stated that, without waiving any rights, it may
in its sole discretion agree to review revised business plans or projections and make or not make
future advances under the facility but would not do so on the basis of our current business plans.
Loans under the revolving credit facility were determined based on percentages of our eligible
receivables and eligible inventory for certain seasonal peak periods. The revolving credit
facility bore interest at prime for daily borrowings or LIBOR plus 1.75% for borrowings with a
maturity of 30 days or greater. We were required to pay a commitment fee of 0.25% on the average
unused portion of the facility quarterly in arrears and closing costs of approximately $0.1
million. The revolving credit facility contains certain financial covenants that require us to
maintain enumerated EBITDA, tangible net worth, and working capital minimums. In addition, amounts
outstanding under the revolving credit facility were secured by liens on substantially all of our
present and future assets, including accounts receivable, inventory, general intangibles, fixtures,
and equipment and excluding certain non-U.S. assets. As of December 31, 2005, a balance of $4.4
million was outstanding under the revolving credit facility; a nominal amount of letters of credit
were outstanding. Additionally, accrued interest of $0.1 million was included in accrued
liabilities as of December 31, 2005. As of February 9, 2006, we had no balance or letters of credit
outstanding under the credit facility.
We are currently looking for other borrowing alternatives as we currently anticipate our cash
from operations will be insufficient to fund our cash requirements.
Contractual Obligations
As of December 31, 2005, royalty and license advance obligations, milestone payments, and
future minimum lease obligations under non-cancelable operating and capital leases are summarized
as follows (in thousands):
Contractual Obligations
Payments Due by Period
Within 1 Year
1-3 Years
4-5 Years
After 5 Years
Total
Royalty and license advances (1)
$
2,264
$
175
$
—
$
—
$
2,439
Milestone payments (2)
10,107
15,771
—
—
25,878
Operating lease obligations (3)
4,618
3,223
1,167
—
9,008
Capital lease obligations (4)
212
126
—
—
338
Total
$
17,201
$
19,295
$
1,167
$
—
$
37,663
(1)
We have committed to pay advance payments under certain royalty and license
agreements. These payments are tied to significant obligations of performance and we
accrue for these commitments once those performance obligations are met.
Milestone payments represent royalty advances to developers for products that are
currently in development. Although milestone payments are not guaranteed, we expect to
make these payments if all deliverables and milestones are met timely and accurately.
(3)
We account for our leases as operating leases, with expiration dates ranging from
fiscal 2006 through fiscal 2012. These are future minimum annual rental payments
required under the leases, including a related party sub-lease with Atari Interactive.
(4)
We entered into several capital leases for computer equipment beginning in the
third quarter of fiscal 2005. Per FASB Statement No. 13, “Accounting for Leases,” we
account for capital leases by recording them at the present value of the total future
lease payments. They are amortized using the straight-line method over the minimum lease
term.
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets”. This
Statement requires that exchanges of nonmonetary assets be measured based on the fair value of the
assets exchanged. Statement No. 153 is effective for nonmonetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005. As of December 31, 2005, the adoption of this issue
has had no material impact on our consolidated financial statements.
In December 2004, the FASB issued Statement No. 123-R, “Share Based Payments”. Statement No.
123-R is a revision of Statement No. 123, “Accounting for Stock-Based Compensation” and supersedes
APB Opinion No. 25, “Accounting for Stock Issued to Employees”. Statement No. 123-R eliminates the
alternative to use the intrinsic value method of accounting that was provided in Statement No. 123,
which generally resulted in no compensation expense recorded in the financial statements related to
the issuance of equity awards to employees. Statement No. 123-R establishes fair value as the
measurement objective in accounting for share-based payment arrangements and requires all companies
to apply a fair value based measurement method in accounting for generally all share-based payment
transactions.
We plan to adopt Statement No. 123-R using a modified prospective application. Under this
application, companies are required to record compensation expense for all awards granted after the
required effective date and for the unvested portion of previously granted awards that remain
outstanding at the date of adoption. The provisions of Statement No. 123-R are effective as of the
beginning of the first annual reporting period that begins after June 15, 2005, but early adoption
is encouraged. As of December 31, 2005, management is currently reviewing the effect that the
adoption of Statement No. 123-R will have on our consolidated financial statements.
In June 2005, the EITF Issue No. 05-6, “Determining the Amortization Period for Leasehold
Improvements Purchased after Lease Inception or Acquired in a Business Combination”. Issue No. 05-6
states that leasehold improvements that are placed in service significantly after the beginning of
the lease term should be amortized over the shorter of the useful life of the assets or a term that
includes required lease periods and renewals that are deemed to be reasonably assured at the date
the leasehold improvements are purchased. The pronouncement is effective for leasehold improvements
that are purchased or acquired in reporting periods beginning after June 29, 2005. As of December31, 2005, the adoption of this issue has had no material impact on our consolidated financial
statements.
In June 2005, the FASB issued FSP No. FAS 150-5. This FSP clarifies that freestanding
warrants and other similar instruments on shares that are redeemable (either puttable or
mandatorily redeemable) should be accounted for as liabilities under FASB Statement No. 150,
“Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”,
regardless of the timing of the redemption feature or price, even though the underlying shares may
be classified as equity. This FSP is effective for the first reporting period beginning after June30, 2005. As of December 31, 2005, the adoption of this issue has had no material impact on our
consolidated financial statements.
In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “Transition Election
Related to Accounting for the Tax Effects of Share-Based Award Payments” (“FSP 123(R)-3”). FSP
123(R)-3 provides an alternative method of calculating the excess tax benefits available to absorb
tax deficiencies recognized subsequent to the adoption of FASB Statement No. 123(R). We are
currently evaluating our available alternatives for the adoption of FSP 123(R)-3 and have until the
earlier of November 2006 or one year from adoption to make our one-time election.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our carrying value of cash, trade accounts receivable, accounts payable, accrued liabilities,
royalties payable, assets and liabilities of discontinued operations, and
amounts due to and from related parties are a reasonable approximation of their fair value.
Foreign Currency Exchange Rates
We earn royalties on sales of our product sold internationally. These revenues, which are
based on various foreign currencies and are billed and paid in U.S. dollars, represented $12.6
million of our revenue for the nine months ended December 31, 2005. We also pay royalties
primarily denominated in euros to IESA from the sale of IESA products in North America. While we do
not hedge against foreign exchange rate fluctuations, our business in this regard is subject to
certain risks, including, but not limited to, differing economic conditions, changes in political
climate, differing tax structures, other regulations and restrictions and foreign exchange rate
volatility. Our future results could be materially and adversely impacted by changes in these or
other factors. As of December 31, 2005, foreign subsidiaries represented 0.0% and 1.3% of
consolidated net revenues and total assets, respectively. We also recorded approximately $7.8
million in operating expenses attributed to foreign operations related primarily to a development
studio located outside the United States. Currently, substantially all of our business is
conducted in the United States where revenues and expenses are transacted in U.S. dollars. As a
result, the majority of our results of operations are not subject to foreign exchange rate
fluctuations.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures — Our management, with the participation of
our Chief Executive Officer and Acting Chief Financial Officer, evaluated the effectiveness of our
disclosure controls and procedures as of December 31, 2005 contemplated by Rule 13a-15(b) under the
Securities Exchange Act. Disclosure controls and procedures are designed to ensure that material
information required to be disclosed by us in the reports that we file or submit under the
Securities Exchange Act is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms and ensure that such material information is accumulated and
communicated to our management, including our Chief Executive Officer and Acting Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure. Based on their evaluation,
our Chief Executive Officer and Acting Chief Financial Officer concluded that as of December 31, 2005, our
disclosure controls and procedures were not effective solely because
of the material weakness described below.
Changes in Internal Control Over Financial Reporting — Our management, with the participation
of our Chief Executive Officer and Acting Chief Financial Officer, has evaluated whether any change in our
internal control over financial reporting occurred during the fiscal quarter ended December 31,2005. Based on that evaluation, management concluded that there has been no change in our internal
control over financial reporting during the fiscal quarter ended December 31, 2005 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
As
described in Note 13, we have determined that the restatement of our consolidated
statements of cash flows for the nine months ended December 31, 2004 was a result of a material
weakness in internal controls over financial reporting. Specifically,
there was an inadequate review process in place as it relates to the
reporting of certain non-cash transactions in the statements
of cash flows. We
are currently implementing additional formal procedures in order to remediate this material
weakness by March 31, 2006.
During the nine months ended December 31, 2005, no significant claims were asserted against or
by us that, in management’s opinion, the likely resolution would have a material adverse
affect on our liquidity, financial condition or results of operations, although we are involved in
various claims and legal actions arising in the ordinary course of business. The following is a
summary of pending litigation matters.
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.
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.
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 Ach’s use of certain trademarks and copyrights owned by Atari Interactive and Hasbro.
The plaintiffs allege that an interim license that Atari 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 Atari certain fees by April 30, 2004, pursuant to an Asset Purchase, License and Assignment
Agreement between Atari and Games dated December 31, 2003, as amended. The plaintiffs allege that
Games’ failure to pay voided an expected transfer of the “Games.com” domain name and certain web
site assets from Atari to Games and constituted a breach of contract and that Chicago West
Pullman’s failure to pay constituted a breach of guarantee. The plaintiffs further allege that
upon the expiration of the interim license, all intellectual property rights granted under that
license reverted back to Atari, but that Games nevertheless continued to use plaintiffs’
intellectual property.
On June 29, 2005, the Clerk of the District Court entered an amendment judgment stating that
we were entitled to the following damages: (1) immediate payment of $3,104,108, plus interest at
the annual rate of 9% from April 30, 2004, (2) immediate redemption of the initial 10,250 shares
for $1.025 million, plus interest at the annual rate of 9% from April 30, 2004, (3) immediate
redemption of 10,000 additional shares for $1 million, (4) the $50,000 bond that plaintiffs posted
on May 19, 2004 to secure a temporary restraining order in this case is exonerated, (5) redemption
of the remaining 10,000 shares at any time after December 29, 2005 at a price of $100 per share,
for a total of $1 million, (6) plaintiffs collectively are entitled to recoup their $150 filing
fee, (7) this judgment runs directly against Games, but in the event Games fails to satisfy it, it
runs secondarily against Chicago West Pullman and Ach, (8) the preliminary injunction is lifted,
and (9) defendant Games, Inc. is enjoined from selling or distributing any product that contains
the intellectual property it licensed in its contract with us.
On February 2, 2006, the Court of Appeals issued an order affirming the District Court’s
judgment against Ach, Games, Inc., and Chicago West Pullman.
Atari has made efforts to collect on the judgment it obtained in the District Court.
On August 26, 2005, we filed a garnishment proceeding in Hamilton County Court of Common Pleas
in Cincinnati, Ohio seeking to restrain assets of Games, Chicago West
Pullman and Ach held at Fifth Third
Bank. On September 21, 2005, Games, Chicago West Pullman and Ach filed a
complaint and motion for temporary restraining order in the Court of Common Pleas, Hamilton County,
Ohio against us, Atari Interactive, and Hasbro seeking to restrain them from executing upon the
judgment in Ohio. On December 12, 2005, a hearing was held on the motion for a temporary
restraining order. On December 16, 2005, the Court denied the temporary restraining order and
dismissed Hasbro and Atari Interactive from the action. Atari filed an answer to the complaint
filed by Games, Chicago West Pullman and Ach on January 23, 2006. Games,
Chicago West Pullman and Ach filed an amended
complaint on January 24, 2006. On February 7, 2006, Games,
Chicago West Pullman, and Ach voluntarily dismissed their claims
against us, without prejudice.
We
are currently investigating further options with respect to our
collection efforts. As of December 31, 2005, we have not
recorded any amounts related to this matter.
American Video Graphics, L.P., v. Electronic Arts, Inc. et al.
On August 23, 2004, American Video Graphics, L.P. filed a lawsuit against us, Electronic Arts,
Inc., Take-Two Interactive Software, Inc., Ubi Soft, Activision Inc., THQ, Inc., Vivendi Universal
Games, Inc., Sega of America, Inc.,
Square Enix, Inc., Tecmo, Inc., Lucasarts, a division of Lucas
Films Entertainment Co., Ltd., and Namco Hometek, Inc. in the United States District Court for the
Eastern District of Texas, Tyler Division (Case No. 6:04
CV-398-LED), alleging infringement of US
Patent No. 4,734,690 (method and apparatus for spherical panning) and seeking unspecified damages.
On October 19, 2005, we and AVG executed a Patent License and Settlement Agreement pursuant to
which we will pay $0.3 million in full settlement of the lawsuit and receive an irrevocable,
nonexclusive, worldwide license to use, publish, sell, etc. products covered by the AVG patents.
iEntertainment
Network, Inc. v. Epic Games, Inc., Atari, Inc., Valve Corporation, Sierra
Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of America, Sony Computer
Entertainment America, Inc. and Sony Online Entertainment, Inc.
On December 22, 2004, we were served with a Complaint by iEntertainment, Inc. The Complaint
has been filed in the United States District Court of the Eastern District of North Carolina
Western Division (5:04-CV-647-BD(1)) and names the following defendants: us, Epic Games, Inc.,
Valve Corporation, Sierra Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of
America, Sony Computer Entertainment America, Inc. and Sony Online Entertainment, Inc. The
Complaint alleges infringement of US Patent No. 6,042,477 (method of and system for minimizing the
effects of time latency in multiplayer electronic games played on interconnected computers) and
seeks unspecified damages. On December 15, 2005, the parties entered into a settlement agreement
pursuant to which in exchange for $175,000, iEntertainment released all parties (and their
affiliates) from claims and granted Atari an irrevocable, fully paid-up, nonexclusive right and
license under US Patent No. 6,042,477 and all other patents and patent applications currently owned
by or enforceable by iEntertainment, with the right to sublicense to others, to make, have made,
import, use, practice, offer for sale, sell or otherwise dispose of
our products worldwide. Our portion of the settlement amount
$25,000, was paid in full as of December 31, 2005. A Stipulation of Dismissal was entered with the
Court on December 22, 2005.
Mr. M.L. Edmondson v. Reflections Interactive Limited
On March 4, 2005, Martin Lee Edmondson, the former Managing Director of Reflections
Interactive Limited, our wholly-owned UK subsidiary, filed a Notice of Claim with the Newcastle
upon Tyne Employment Tribunal claiming constructive unfair dismissal as a result of Reflections
alleged repudiatory breach of a contract of employment that necessitated Mr. Edmondson’s
resignation. Mr. Edmondson was seeking a declaration that he was unfairly dismissed and
compensation in an unspecified amount for such dismissal. Compensation in the Employment Tribunal
is limited to £55,000 in respect of the maximum compensatory award. Mr. Edmondson could be awarded
for unfair dismissal, together with a maximum basic award of (depending on age and length of
service) £1,350 to £2,025. On April 1, 2005, Reflections filed a Response denying that there was a
fundamental breach of contract that entitled Mr. Edmondson to resign and claim constructive
dismissal. The parties have concluded a negotiation process with Mr. Edmondson whereby Mr.
Edmondson agreed to withdraw his claims against us in return for a settlement payment. Mr.
Edmondson signed the Compromise Agreement on August 9, 2005 and the Agreement was executed by us
and Reflections on August 12, 2005. Mr. Edmondson has now withdrawn his claim and the Employment
Tribunal dismissed the claim on September 15, 2005.
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 counsel 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 Court’s ruling to the Fourth Circuit Court of Appeals.
Indigo Moon Productions, LLC v. Hasbro, Inc., et al.
On August 12, 2005, Indigo Moon Productions, LLC, or Indigo Moon, filed a lawsuit against us,
Hasbro, Hasbro Interactive, Atari Interactive and Infogrames, Inc. (n/k/a Atari, 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.
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 Moon’s work. Indigo
Moon’s 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 Atari’s Santa Monica studio
as of December 1, 2001. His assignment in the US was on a three
year renewable basis. As of August 31, 2004, in connection with
the closing of the Santa Monica studio, Mr. Curulla’s assignment in
the US was terminated. Mr. Curulla’s Complaint was lodged before the
Industrial Tribunal of Lyon, France (Conseil de Prud’hommes). A
hearing took place on October 6, 2005 and a discovery period was
established. 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. As of February 22, 2006, the
February 16, 2006 hearing date has been postponed and a new date for
the hearing has not yet been set. Atari Europe is representing Atari,
Inc.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.