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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
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                                   FORM 10-K
 
              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                      SECURITIES AND EXCHANGE ACT OF 1934
 
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           FOR THE FISCAL YEAR ENDED                       COMMISSION FILE NUMBER
               FEBRUARY 2, 1997                                    0-21085
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                                JTS CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
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                   DELAWARE                                      77-0364572
        (STATE OR OTHER JURISDICTION OF               (IRS EMPLOYER IDENTIFICATION NO.)
        INCORPORATION OR ORGANIZATION)
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                   166 BAYPOINTE PARKWAY, SAN JOSE, CA 95134
          (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
 
                                 (408) 468-1800
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
          Securities registered pursuant to Section 12(b) of the Act:
                    COMMON STOCK, $.001 PAR VALUE PER SHARE
          5.25% CONVERTIBLE SUBORDINATED DEBENTURES DUE APRIL 29, 2002
 
       Securities registered pursuant to Section 12(g) of the Act:  NONE
 
     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 and Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes  [X]     No  [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in any amendment to this Form 10-K.  [ ]
 
     The approximate aggregate market value of the Common Stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock reported on The American Stock Exchange, Inc. on April 21, 1997 was
$121,589,135.40.
 
     The number of shares of Common Stock outstanding as of April 21, 1997 was
104,079,609.
 
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                   SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
 
     This Annual Report on Form 10-K contains forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed here. Factors that could cause or contribute to
such differences include, but are not limited to, those factors identified below
under "Item 1 -- Business -- Risk Factors."
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Certain parts of the JTS Corporation Proxy Statement relating to the annual
meeting of stockholders to be held on July 9, 1997 (the "Proxy Statement") are
incorporated by reference into Part III of this Annual Report on Form 10-K. The
Proxy Statement shall be deemed to have been "filed" only to the extent portions
thereof are expressly incorporated by reference.
<PAGE>   3
 
                                     PART I
 
ITEM 1 -- BUSINESS.
 
INTRODUCTION
 
     Atari Corporation ("Atari") was formed to design and market interactive
multimedia entertainment systems and related software and peripheral products.
On July 30, 1996, Atari merged (the "Merger") into JTS Corporation ("JTS" or the
"Company"), a manufacturer of hard disk drives for notebook and desktop personal
computers. Due to a lack of market acceptance of its video game console, Jaguar,
Atari had significantly downsized its video game operations prior to the merger.
This downsizing resulted in significant reductions in Atari's workforce and
significant curtailment of research and development and sales and marketing
activities for Jaguar and related products. Despite the introduction of
additional game titles in the first quarter of 1996, sales of Jaguar and related
software remained disappointing such that by the end of fiscal 1997
approximately all of the remaining inventory had been written off. The prior
business of Atari is now conducted through the Company's Atari division;
however, the Atari division does not and is not expected to represent a
significant portion of the Company's business going forward.
 
     The most significant portion of the Company's business today is its disk
drive division acquired in the merger with JTS, which designs, manufactures and
markets hard disk drives for use in notebook computers and desktop personal
computers. JTS was incorporated in February 1994 and remained in the development
stage until October 1995, when it began shipping its 3.5-inch "Palladium" disk
drives to customers in the United States and Europe. The Company currently has
three disk drive product families in production, the 3-inch form factor "Nordic"
family for notebook computers and the 3.5-inch form factor "Champ" and
"Champion" families for desktop personal computers. The Company introduced into
production its higher performance "Champion" family for desktop personal
computers in the first quarter of fiscal 1998.
 
     Through fiscal 1997, the Company had shipped over 800,000 disk drives,
consisting primarily of 3.5-inch drives. JTS began shipment of Nordic disk
drives to Compaq Computer Corporation ("Compaq") in the second quarter of fiscal
1997; however, to date volume shipments of 3-inch drives have not occurred. The
Company markets its disk drives to computer companies and system integrators for
incorporation into their computer systems and subsystems and to original
equipment manufacturers ("OEMs"). The Company sells its products through a
direct sales force operating throughout the United States, Europe and Asia, as
well as through distributors in the United States, Europe, Latin America and
Canada.
 
     All of JTS' products are manufactured in Madras, India by its subsidiary,
JTS Technology Ltd. (formerly Moduler Electronics (India) Pvt. Ltd.) ("JTS
Technology"), which was acquired by JTS in April 1996. JTS Technology employed
approximately 6,270 individuals at February 2, 1997.
 
     Since its inception, JTS has incurred significant losses which have
resulted from the substantial costs associated with the design and development
of its products, the establishment of manufacturing operations, the development
of a supplier base, the marketing of its new products and the ramp up of
production volumes. JTS has yet to generate profits from its disk drive business
and cannot assure that it will achieve or maintain successful operations in the
future.
 
INDUSTRY BACKGROUND
 
     DISK DRIVE MARKET.  The hard disk drive industry is intensely competitive
and is dominated by a small number of large companies, including Maxtor
Corporation ("Maxtor"), Quantum Corporation ("Quantum"), Seagate Corporation
("Seagate") and Western Digital Corporation ("Western Digital"). In addition,
several computer companies, such as Toshiba Corporation ("Toshiba") and
International Business Machines Corp. ("IBM"), have in-house or "captive" disk
drive manufacturing operations that produce disk drives for incorporation into
their own computers as well as for sale to other OEMs.
 
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     In 1996, approximately 106 million hard disk drives were shipped,
representing a 18% increase over the prior year. Approximately 85 million, or
80%, of the hard disk drives shipped in 1996 were sold as part of desktop
personal computers, and approximately 14 million, or 13%, were sold as part of
notebook computers. In 1996, Seagate, Quantum and Western Digital controlled
approximately 74% of the desktop hard disk drive market and IBM and Toshiba
controlled approximately 73% of the notebook hard disk drive market.
 
     DISK DRIVE TECHNOLOGY.  All hard disk drives used in notebook and desktop
personal computers incorporate the same basic technology. One or more rigid
disks are attached to a spin motor assembly which rotates the disks at a
constant speed within a sealed, contamination-free enclosure. Typically, both
surfaces of each disk are coated with a thin layer of magnetic material.
Magnetic heads record and retrieve data from discrete magnetic domains located
on preformatted concentric tracks in the magnetic layers of the rotating disks.
An actuator positions the head over the proper track upon instructions from the
drive's electronic circuitry. Most disk drives are "intelligent" disk drives
which incorporate an embedded application specific integrated circuit ("ASIC")
controller to manage communications with the computer. The magnetic heads
employed in disk drives have traditionally been based on inductive-head
technology (referred to as metal-in-gap or "MIG" technology) which combines the
read and write function within a single head. Magneto-resistive ("MR") head
technology, which segregates the read and write function to different elements
of the head to optimize performance, has emerged recently as an alternative to
inductive-head technology.
 
     The size of a hard disk drive is referred to as the drive's "form factor"
or "footprint." At present, the vast majority of personal desktop and notebook
computers incorporate disk drives with 3.5-inch or 2.5-inch form factors,
respectively. The size of the form factor determines the size of the recording
disk and, hence, dictates the recording capacity of the disk drive. Disk drives
with smaller form factors must incorporate more disks and, therefore, more heads
to offer the same recording capacity as larger form factor drives. Because heads
and disks are the most expensive components in the hard disk drive, larger form
factor disk drives are relatively less expensive to manufacture than smaller
form factor drives with comparable recording capacities. As a result, 3.5-inch
drives are better suited for desktop personal computers, which are not subject
to the size constraints of notebook computers. In contrast, 2.5 inch drives,
because of their reduced size, power conservation features, shock resistance and
lightweight design, presently dominate the notebook computer market.
 
     EMERGING INDUSTRY TRENDS.  In recent years, the computer industry has
witnessed the emergence of several trends that JTS believes will continue to
drive demand for innovative disk drive products. First, new data and
image-intensive, multimedia applications are generating increased demand for
greater storage capacities and performance at a lower cost. Second, the demand
for portable computing devices, such as notebook computers, has kept pace with
the significant growth in sales of personal computers, with portables
representing approximately 14.1% of all personal computers sold in 1996. As the
gap in technology and pricing between desktop and portable computers continues
to narrow, consumers are demanding storage capacities in portable computers
comparable to those offered by desktops. Lastly, the notebook computer industry
is generally migrating towards lower profile computing devices. The pressure to
reduce the profiles, increase the capacities and lower the costs of personal
computers has presented manufacturers with a substantial ongoing technical
challenge.
 
JTS' STRATEGY
 
     JTS has undertaken several key initiatives to meet the challenges currently
facing hard disk drive manufacturers and to position the Company to become a
leading international supplier of hard disk drives to the notebook and desktop
computer markets. These key initiatives include the following:
 
     ESTABLISH 3-INCH FORM FACTOR TECHNOLOGY AS AN INDUSTRY STANDARD FOR
NOTEBOOK COMPUTERS.  To address demand in the portable computing market for
lower profiles, greater storage capacities and lower costs, JTS has developed
its Nordic family of 3-inch form factor disk drives. The disks used in the
3-inch format have 82% greater recording area than disks used in 2.5-inch
drives, the current industry standard for notebook computers, offering nearly
double the storage capacity at the same areal densities. Nordic drives also
offer cost
 
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advantages per megabyte of storage space over competing drives. The design of
the Nordic drives makes them the lowest profile disk drives currently in the
market.
 
     FORM STRATEGIC ALLIANCES WITH COMPAQ AND OTHER KEY PARTICIPANTS IN THE
COMPUTER INDUSTRY.  As part of the Company's effort to gain rapid market
acceptance of the 3-inch form factor Nordic drives, JTS has entered into
agreements with Compaq, as a leading end-user of the 3-inch disk drives, and
Western Digital, as an alternate source for disk drives incorporating Nordic
technology. JTS intends to continue to take advantage of its management's
considerable experience in the computer industry to obtain access to other key
computer industry participants.
 
     DEVELOP INNOVATIVE DISK DRIVE TECHNOLOGY FOR NOTEBOOK AND DESKTOP PERSONAL
COMPUTERS.  JTS expects to continue to develop and design into each of its
product families innovative and advanced hard disk drive technology which the
Company believes will enhance the performance characteristics and storage
capacities of its products. The Company intends to continue to work closely with
its customers and suppliers to design drives that satisfy the customers'
end-product requirements using efficient and low-cost manufacturing methods. JTS
is committed to the timely development of new products and the continuing
evaluation of new technologies. In this regard, JTS is presently designing into
its hard disk drive product families various high-performance features, such as
MR heads, new ASIC/channel technology, advanced dynamic head lifters, positive
latch mechanisms, and multi-insertion interface connectors.
 
     ACHIEVE LOW PRODUCT COST STRUCTURE.  By locating manufacturing facilities
in Madras, India, JTS intends to capitalize upon a low-cost and highly-skilled
labor force. JTS believes that labor costs in India are significantly lower than
labor costs in other countries where hard disk drives are commonly manufactured,
such as Singapore, Malaysia and Thailand. To leverage its low-cost labor force,
JTS manufactures a portion of certain labor-intensive components inhouse rather
than purchasing such components from outside suppliers. The Company also uses
many common components in its 3-inch and 3.5-inch form factor disk drives,
thereby reducing inventory requirements, creating significant assembling
efficiencies and providing cost advantages from volume purchases of materials
and toolings.
 
PRODUCTS
 
     JTS currently has three product families in production, the 3-inch form
factor "Nordic" family for notebook computers and the 3.5-inch form factor
"Champ" and "Champion" families for desktop personal computers. Shipments of
Nordic drives to Compaq began in the second quarter of fiscal 1997; however, to
date, volume shipments of Nordic drives have not yet occurred. JTS began volume
production of Palladium disk drives in October 1995, and replaced these drives
with Champ drives in the fourth quarter of fiscal 1997. The Company introduced
its high performance Champion drives into production in the first quarter of
fiscal 1998.
 
     JTS' disk drives are characterized by the following design features:
 
     LOW-PROFILE AND FULLY ENCAPSULATED DESIGN.  JTS' hard disk drives have a
lower profile than competing hard disk drives with comparable form factors and
recording capacities. The low-profile design is made possible by the drives'
high level of electronic integration that permits placement of the printed
circuit board assembly ("PCBA") in the same plane as the recording disks
(referred to as "board in the plane of the media" packaging). Most competing
drives place the PCBA under the drive mechanics which significantly increases
the height of the drive. JTS disk drives are fully-encapsulated with no exposed
PCBA and contain either a standard fixed drive connector or optional
multi-insertion connector. The encapsulated design eliminates the possibility of
damage to the PCBA due to electrostatic discharge and improves the
electromagnetic interference immunity of the drive.
 
     SIMPLIFIED AND HIGHLY-INTEGRATED PLATFORM APPROACH.  JTS' product families
share a simplified, highly-integrated platform approach characterized by a
reduced number of components. JTS believes that its PCBAs have the fewest
components in the industry due to JTS' use of highly-integrated ASIC
controllers. JTS believes this simplified platform approach combined with a
substantial percentage of common componentry among its product families
facilitates the introduction of new technology and utilizes research personnel
in a more efficient manner, thereby reducing development costs.
 
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     COMMON COMPONENTRY AND MICRO-CODE.  The Nordic, Champ and Champion product
families share a substantial percentage of common electronic componentry and
micro-code which facilitates the simultaneous development of products for the
notebook and desktop computer markets and reduces time to market for JTS
products. For example, JTS' product families share spindle motors, certain head
stack components and controller ASICs. Common componentry also reduces inventory
requirements, thereby creating significant assembling efficiencies and providing
cost advantages from volume purchases of materials. The commonality of
micro-code assists in production testing, diagnostics, failure analysis and
uniform product performance.
 
     NORDIC PRODUCT FAMILY
 
     JTS' Nordic product family is designed for notebook computers. Nordic
drives measure 90mm wide, the same width as a floppy diskette, and are
classified as 3-inch drives. The Nordic drives incorporate low-profile
architecture, measuring 10.5mm high for the two-disk version and 12.5mm for the
three-disk version. Nordic drive capacity presently ranges from 1.0 and 1.4
gigabytes for the two-disk version to 1.2 and 1.6 gigabytes for the three-disk
version. The two and three-disk Nordic drives are significantly thinner than the
two and three-disk 2.5-inch drives (10.5mm and 12.5mm compared to 17mm and
19mm), while the surface area of the recording disk in a Nordic drive is 82%
greater than a 2.5-inch disk. The greater surface area of the disk media used in
the Nordic drives provides greater recording capacity using the same areal
densities. Moreover, the Nordic drives consume approximately the same amount of
power as 2.5-inch drives, making them well suited for battery operated
applications. Nordic drives are currently offered at prices that are competitive
with the prices of 2.5-inch drives.
 
     The Nordic product family was developed in conjunction with Western
Digital, which has entered into a Technology Transfer and License Agreement with
JTS. Under the terms of this agreement, Western Digital is obligated to share
advancements in 3-inch technology and is licensed by JTS to serve as an
alternate source of Nordic products to Compaq. In addition, JTS has entered into
a Development Agreement with Compaq which obligates Compaq to purchase a minimum
number of disk drives prior to June 1998. Production and shipment to Compaq of
Nordic disk drives commenced in the second quarter of fiscal 1997. Volume
shipments of 3-inch drives have not yet occurred. See "-- Strategic Alliances."
 
     CHAMP PRODUCT FAMILY
 
     Champ disk drives are 3.5-inch form factor drives designed for desktop
personal computers. The Champ family replaced the Company's earlier "Palladium"
family of 3.5-inch disk drives. The Champ product family includes two and
three-disk versions with capacities presently ranging from 1.3 gigabytes to 2.0
gigabytes. The Champ drives incorporate low-profile architecture similar to
Nordic drives, measuring 1/2 inch in height compared to competing drives that
typically measure 1 inch in height. The low profile design allows two disk
drives to be configured into the same space required for one competing 3.5-inch
drive. JTS began volume production and shipments of 3.5-inch drives in October
1995.
 
     CHAMPION PRODUCT FAMILY
 
     JTS' recently-introduced Champion family of hard disk drives has been
developed for the desktop personal computer market. Like the Company's Champ
drives, the Champion family includes 3.5-inch form factor drives that are
offered in two and three-disk versions. The two-disk version presently offers
capacities of 1.7 and 2.0 gigabytes, and the three-disk version presently offers
capacities of 2.5 and 3.0 gigabytes. The Champion drives incorporate the same
low-profile architecture used in the Nordic and Champ drives. This family of
disk drives has been designed with MIG head technology, thereby reducing the
cost of the drives. The most important distinguishing factor of the Champion
family as compared to Champ drives is that Champion drives incorporate a
recently-introduced chipset from Adaptec, Inc. ("Adaptec"). The Adaptec chipset
enhances the performance and capacity of the drives. As a result, the increased
transfer rate of the Champion drives supports full-motion video, making them
ideal for multimedia applications. JTS began production of Champion drives and
initiated shipments to distributors in the first quarter of fiscal 1998.
Although JTS will continue to manufacture Champ drives in the short term, the
Company expects that its
 
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Champion family will entirely replace the Champ family of disk drives during the
second quarter of fiscal 1998.
 
STRATEGIC ALLIANCES
 
     As part of the Company's strategy to establish the Nordic family of disk
drives as the standard for notebook computers, the Company has entered into key
strategic alliances with Compaq and Western Digital.
 
     COMPAQ.  In June 1994, JTS and Compaq entered into a Development Agreement
pursuant to which Compaq agreed to design JTS' Nordic disk drives into at least
one of Compaq's products and to purchase a minimum number of hard disk drives
from JTS prior to June 1998. In addition, JTS granted to Compaq certain pricing
preferences and agreed to pay royalties to Compaq on sales of Nordic disk drives
to third parties during the term of the agreement. Compaq was granted a license
to use the Nordic designs to manufacture or to have manufactured Nordic drives
on a royalty-free basis in the event JTS fails to meet the agreed upon
production schedule or, if JTS is not in default under the agreement, to have
Nordic drives manufactured by third-parties upon payment of a royalty to JTS.
The Development Agreement also restricts JTS' ability to sublicense Nordic
technology. The Development Agreement has a five year term, which will
automatically be renewed under certain circumstances and may be terminated by
either party only with cause. The Company began shipments of Nordic disk drives
to Compaq in June 1996. Volume shipments of Nordic disk drives began in the
fourth quarter of fiscal 1997. See "Risk Factors -- Dependence on Compaq
Computer Relationship; Customer Concentration."
 
     WESTERN DIGITAL.  In February 1995, JTS and Western Digital entered into a
Technology Transfer and License Agreement pursuant to which Western Digital
obtained manufacturing and marketing rights to JTS' 3-inch hard disk drive
products and is licensed to act as an alternate source of Nordic drives to
Compaq. In return, Western Digital has made payments to JTS totalling $5.3
million upon the achievement of certain development milestones. In February
1995, Western Digital also made a $4.1 million equity investment in JTS as part
of the transaction. The parties have reciprocal, royalty-free, cross-license
agreements for future 3-inch drive developments, and Western Digital has granted
to JTS licenses on existing patents covering its 3-inch disk drive technology.
The Technology Transfer and License Agreement restricts JTS from sublicensing
Nordic technology, under certain circumstances, until 1998. See " -- Patents and
Licenses." JTS intends to establish similar arrangements with other major
computer OEMs and notebook computer manufacturers. See "Risk
Factors -- Dependence on Compaq Computer Relationship; Customer Concentration."
 
MANUFACTURING
 
     JTS' manufacturing strategy is to be a low-cost producer of hard disk
drives for the notebook and desktop personal computer markets by capitalizing on
low labor costs, common componentry and selective vertical integration. Due to
the common componentry of the Nordic, Champ and Champion disk drives, JTS
believes that it enjoys considerable flexibility in managing inventory levels
and meeting its customers' production requirements. In addition, JTS believes
that common componentry reduces the amount of scrap materials in the
manufacturing process and facilitates the training of operators in producing new
products, thus reducing production costs. JTS is evaluating continued selective
vertical integration as an alternative to outsourcing certain sub-assembly
manufacturing. At present, JTS is vertically integrated in certain labor
intensive components, such as head stacks.
 
     All of JTS' manufacturing operations are currently conducted at its Indian
subsidiary, JTS Technology, which JTS acquired in April 1996. JTS Technology was
founded in 1986 by members of the family of Sirjang L. Tandon, JTS' Chairman and
Corporate Technical Strategist, as a contract manufacturer of power supplies for
computers and hard disk drive subassemblies. In December 1994, JTS Technology
received Indian government approval to manufacture hard disk drives. At
approximately the same time, JTS Technology discontinued production of hard disk
drive subassemblies for customers other than JTS. In March 1995, JTS entered
into a verbal agreement to acquire the hard disk drive division of JTS
Technology. JTS subsequently assumed operational and management control of
certain portions of the hard disk drive business of JTS Technology. In April
1996, JTS purchased 90% of the outstanding capital stock of JTS Technology. JTS
has a
 
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right of first refusal to purchase the remaining equity interest in JTS
Technology at a proportionate percent of the net book value of JTS Technology at
the time of the purchase.
 
     JTS Technology's Madras facility presently occupies 85,000 square feet. At
this facility, JTS is adding production lines and expanding its clean room
environment. JTS believes that locating its manufacturing operations in India is
an important element of its low-cost manufacturing strategy due to the
availability of a high-quality, low-cost technical labor pool. JTS believes that
labor costs in India are significantly lower than labor costs in other countries
where hard disk drives are commonly manufactured, such as Singapore, Malaysia
and Thailand. As of February 2, 1997, 6,270 individuals were employed at JTS
Technology. In 1995, JTS Technology was granted a five year "tax holiday," which
is expected to expire in 2001, with respect to sales of JTS' products in and
outside of India. In addition, JTS Technology is located in the Madras Export
Processing Zone and, therefore, enjoys a tax exemption with respect to profits
generated from sales outside of India. Such exemption may be terminated or
additional taxes may be imposed at any time, for political or economic reasons,
in which event JTS would become subject to significantly greater taxes on sales
of disk drives outside of India. Furthermore, JTS does not have a long-term
lease agreement, but rather occupies the Madras facility pursuant to allotment
letters from the Development Commissioner of the Madras Export Processing Zone.
Such benefits associated with conducting business in India, which historically
has experienced considerable political instability, are subject to the vagaries
of the Indian government and may be withdrawn at any time.
 
     The manufacture of high-capacity hard disk drives is a complex process,
requiring a clean room environment, the assembly of precision components within
narrow tolerances and extensive testing to ensure reliability. JTS'
manufacturing process is performed in three stages: subassembly, final assembly
and final test. The subassembly group builds mechanical subassemblies and flex
cables and modifies PCBAs. Printed circuit board assembly is performed by
outside vendors. The final assembly group assembles all subassemblies and
components into the mechanical head/disk assembly ("HDA"), writes servo
information, and performs preliminary testing. To avoid contamination by dust
and other particles which may impair the functioning of the disk drive, most
assembly takes place under controlled clean room conditions. The final test
group connects PCBAs to HDAs, burns-in completed drives and performs final
tests.
 
     The principal components used in JTS' manufacturing process are disks,
heads and PCBAs. JTS has three qualified sources each for PCBAs and disks and
four qualified sources for heads. JTS Technology imports approximately 85% of
the componentry used in the manufacture of disk drives from outside of India. In
the past, JTS has experienced delays in obtaining certain components, and there
can be no assurance that such delays, or difficulties in obtaining those or
other components, will not occur in the future. JTS' inability to obtain
essential components or to qualify additional sources as necessary, if
prolonged, could have a material adverse effect on JTS' business, operating
results and financial condition.
 
     JTS has developed a comprehensive quality assurance program. All
significant electrical and mechanical parts received from outside sources are
inspected or tested, normally on a sample basis, and testing and burn-in of
certain components and subassemblies occurs during assembly. In addition, JTS
performs several in-process quality checks and inspections both in the PCBA and
HDA processes, and a final drive-level quality check prior to packaging.
Additional performance and reliability testing is done on a sample basis from
each week's production units in order to monitor quality levels and provide
corrective action to the factory processes. JTS generally warrants its products
against defects in design, materials and workmanship for three years. See "Risk
Factors -- Availability of Components and Materials; Dependence on Suppliers,"
"-- Expansion of Manufacturing Capacity," "-- Dependence on Single Manufacturing
Capacity," "-- Risks of International Sales and Manufacturing," and
"-- Production Yields; Product Quality."
 
RESEARCH AND DEVELOPMENT
 
     The disk drive industry is characterized by rapid technological change and
short product life cycles. As a result, JTS' success will depend upon its
ability to develop new products, successfully introduce these products to the
market and ramp up production to meet customer demand. Accordingly, JTS is
committed to timely development of new products and the continuing evaluation of
new technologies. JTS' research and
 
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development efforts are presently concentrated on broadening its existing 3.5-
and 3-inch product lines and introducing new generations of products with
increased capacities and improved performance at a lower cost. In this regard,
JTS has designed various high performance features, such as new ASIC/channel
technology and advanced head lifters, into its recently-introduced Champion
family of hard disk drive. In addition, the Company is currently designing into
its disk drives MR head component technology, which allows data to be recorded
and read at much higher track densities than MIG or inductive thin-film head
technology. JTS expects to begin shipment of Champion drives with recording
capacities of up to 3.0 gigabytes and Nordic drives with recording capacities of
up to 2.1 gigabytes in the second quarter of fiscal 1998. As of February 2,
1997, JTS employed 129 individuals in engineering.
 
SALES AND MARKETING; CUSTOMERS
 
     JTS sells and markets its products through a direct sales force that
operates in the United States, Europe and Asia. In addition, JTS sells and
markets its products through an international network of distributors to OEMs,
VARs and systems integrators. The Company presently has sales offices throughout
the world that market JTS disk drives. International sales accounted for 56% of
revenues in fiscal 1997.
 
     A limited number of customers account for a significant percentage of JTS'
total revenue. In fiscal 1997, Karma International AG, FutureTech International,
Inc. ("FutureTech") and Synnex Information Technology accounted for
approximately 30%, 13% and 12%, respectively, of JTS' total revenue. JTS expects
that sales to a relatively small number of customers will account for a
substantial portion of its net revenues for the foreseeable future, although the
companies that comprise JTS' largest customers may change from period to period.
In particular, based on existing contracts with FutureTech and Compaq, JTS
expects that revenues from these companies will account for a substantial
percentage of JTS' revenues in the foreseeable future. The loss of, or decline
in orders from, one or more of JTS' key customers would have a material adverse
effect on JTS' business, operating results and financial condition.
 
BUSINESS OF ATARI DIVISION
 
     Atari was incorporated under the laws of Nevada in May 1984. From 1984 to
1992, Atari designed, manufactured and marketed proprietary personal computers
and video games and related software. Over the past several years, Atari has
undergone significant change. In 1992 and 1993, Atari significantly downsized
operations, decided to exit the computer business and focused on its video game
business. As a result, revenues from computer products as a percentage of total
revenues declined from 67% in 1993 to 16% in 1994 and 12% in 1995, while sales
of entertainment systems and related software and peripheral products and the
receipt of royalties represented the balance of revenues in each such year.
These actions resulted in significant restructuring charges for closed
operations and write-downs of computer and certain video game inventories in
1992 and 1993. (See Note 13 to Consolidated Financial Statements for discussion
of segment information.)
 
     While restructuring, Atari developed its 64-bit Jaguar interactive
multimedia entertainment system, which was introduced in selected markets in the
fourth quarter of 1993. For 1995 and 1994, total sales of Jaguar and related
products were $9.9 million and $29.3 million, respectively, and represented 68%
and 76% of Atari's net revenues, respectively. These Jaguar sales were
substantially below Atari's expectations, and Atari's business and financial
results were materially adversely affected in 1995. Atari presently has a
substantial unsold inventory of Jaguar and related products and there can be no
assurance that such inventory can be sold at current prices.
 
     By late 1995, Atari recognized that despite a significant commitment of
financial resources to the Jaguar and related products, it was unlikely that
Jaguar would ever become a broadly accepted video game console or that Jaguar
technology would be broadly adopted by software title developers. As a result,
Atari decided to significantly downsize its Jaguar operations. This downsizing
resulted in significant reductions in Atari's workforce, and significant
curtailment of research and development and sales and marketing activities for
Jaguar and related products. Accordingly, Atari decided to focus its efforts on
selling its inventory of Jaguar and related products and to emphasize its
existing licensing and development activities related to multimedia
entertainment software for various platforms. As a result of Atari's investment
in game design, and
 
                                        7
<PAGE>   10
 
programming for its Jaguar software, Atari has ported certain of its Jaguar
titles to the IBM PC compatible platform. In this regard, Atari commenced
shipment of the PC CD-ROM version of Tempest 2000 in Europe during the first
quarter of 1996. In 1997, Atari plans to continue its efforts to license titles
for its game library to third party publishers and to sell various properties
held for investment purposes.
 
PATENTS AND LICENSES
 
     JTS currently owns no patents (other than those acquired from Atari in the
Merger) and has licensed in a substantial portion of the technology used in its
hard disk drives pursuant to license agreements with Pont, TEAC and Western
Digital. If such license agreements were prematurely terminated or if JTS were
enjoined from relying upon such licenses due to JTS' alleged or actual breach of
such agreements, JTS would be prevented from manufacturing disk drives
incorporating technology subject to such licenses. As a result, JTS' business,
operating results and financial condition would be materially adversely
affected. JTS has filed three United States patents applications. Although JTS
believes that patent protection could offer significant value, the rapidly
changing technology of the computer industry makes JTS' future success dependent
primarily upon the technical competence and creative skills of its personnel
rather than on patent protection.
 
     A license with respect to certain key technology employed in JTS' Nordic
disk drives was granted to JTS by TEAC pursuant to a license agreement dated
February 4, 1994 (the "TEAC Agreement"). The TEAC Agreement also includes a
cross-license with respect to Nordic technology developed jointly by TEAC and
JTS, which will be owned jointly by the two companies, and granted certain
rights to TEAC with respect to Nordic technology developed independently by JTS,
which will be owned solely by JTS. Under the TEAC Agreement, JTS is obligated
under certain circumstances to make royalty payments to TEAC in connection with
the sale of future generation disk drives incorporating Nordic technology that
is jointly developed by JTS and TEAC or independently developed by TEAC. JTS is
not obligated to make royalty payments with respect to developments to Nordic
technology made independently by JTS, but JTS is obligated to license such
developments to TEAC on a royalty-free basis. The TEAC Agreement restricts JTS'
ability to sublicense certain technology licensed to JTS. Under the TEAC
Agreement, JTS has granted TEAC certain pricing preferences on purchases of
Nordic drives. TEAC originally acquired its rights in certain Nordic disk drive
technology pursuant to the Agreed Order Compromising Controversies dated
February 4, 1994 (the "Order") governing the distribution of the assets of Kalok
Corporation. The Order imposes certain restrictions on JTS' right to sublicense,
manufacture and sell certain disk drive technology of Kalok Corporation that was
transferred to both TEAC and Pont pursuant to the Order.
 
     In June 1994, JTS entered into a Development Agreement with Compaq which
imposes certain restrictions on JTS' ability to sublicense Nordic technology to
third parties. In addition, the Development Agreement imposes a royalty
obligation upon JTS with respect to the sale of Nordic disk drives to third
parties during the term of the agreement. Moreover, Compaq has a right of first
refusal with respect to all production of Nordic drives until June 1997 and a
right of first refusal to license and/or acquire future JTS technologies and
products during the term of the agreement. JTS has also granted certain
non-exclusive manufacturing and marketing rights with respect to certain Nordic
technology and developments thereto within the term of the Development
Agreement.
 
     In January 1995, JTS and Pont entered into a cross-licensing agreement (the
"Pont Agreement") pursuant to which JTS granted to Pont a royalty-free,
nonexclusive, perpetual license to use certain JTS and jointly-developed hard
disk drive technology, to make developments to such technology and to
manufacture and sell in certain territories hard disk drives incorporating such
technology. In return, Pont granted to JTS a royalty-free, nonexclusive,
perpetual license to use certain Pont and jointly-developed hard disk drive
technology, to make developments to such technology and to manufacture and sell
in certain territories hard disk drives incorporating such technology. In
addition, Pont was obligated to make certain royalty payments to JTS for a
limited period of time with respect to the sale of hard disk drives
incorporating certain JTS technology.
 
     In February 1995, the TEAC Agreement, the Order, the Pont Agreement and the
Compaq Development Agreement were each amended to permit the license and
sublicense by JTS to Western Digital of certain
 
                                        8
<PAGE>   11
 
rights in Nordic disk drive technology. In addition, the amendment to the TEAC
Agreement provides that JTS will pay certain royalties to TEAC, under certain
circumstances, upon the sale of Nordic drives for a limited period of time. The
Pont Agreement was also amended to expand the territories in which JTS may
manufacture and sell hard disk drives incorporating technology subject to the
agreement. JTS and Western Digital concurrently entered into a Technology
Transfer and License Agreement pursuant to which Western Digital obtained
certain manufacturing and marketing rights to Nordic disk drive technology. The
parties have reciprocal, royalty-free, cross-license agreements for future
Nordic technology developments, and Western Digital has granted to JTS licenses
on existing patents covering its 3-inch hard disk drive technology.
 
     The Company has exclusive use of the "Atari" name and "Fuji" logo in all
areas other than coin-operated arcade video game use. The Company also has a
portfolio of other intellectual properties including patents, trademarks, and
copyrights associated with the Atari video game and computer businesses. The
Company believes that such patents, trademarks and other intellectual property,
are important assets. As of February 2, 1997, the Company held approximately 150
patents in the United States and other jurisdictions relating to the business of
the Atari division which expire from 1997 to 2010 and had applications pending
for three additional patents. There can be no assurance that any of these patent
rights will be upheld in the future or that the Company will be able to preserve
any of the Atari division's other intellectual property rights. The occurrence
of litigation relating to patent infringement or other intellectual property,
matters, regardless of the outcome, could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
COMPETITION
 
     The hard disk drive industry is intensely competitive and dominated by a
small number of large companies, including Maxtor, Quantum, Seagate, and Western
Digital. In addition, a number of computer companies, such as Toshiba and IBM,
have in-house or "captive" disk drive manufacturing operations that produce disk
drives for incorporation into their own computers as well as for sale to other
OEMs. Many of JTS' competitors have broader product lines than JTS, and all have
significantly greater financial, technical and marketing resources. Furthermore,
JTS has licensed key 3-inch form factor technology to Western Digital, a
competitor in the personal computer disk drive market that could become a
significant supplier of 3-inch form factor disk drives to Compaq and other OEMs.
See "Initial Efforts to Achieve Market Acceptance of Hard Disk Drive Products."
There can be no assurance that JTS will develop and manufacture products on a
timely basis with the quality and features necessary to compete effectively.
Generally, OEM customers for hard disk drives rely on a limited number of
suppliers. As a result, it may be necessary for JTS to displace competitors to
increase its net sales. In addition, JTS faces competition from the
manufacturing operations of its current and potential OEM customers, which could
initiate or increase internal production of hard disk drives and reduce or cease
purchasing from independent hard disk drive suppliers such as JTS. Moreover, the
hard disk drive industry is characterized by price erosion and resulting
pressure on gross margins. JTS expects that hard disk drive prices will continue
to decline and that competitors will offer products which meet or exceed the
performance capabilities of JTS' current products. Due to such pricing
pressures, JTS' future gross margins will substantially depend upon its ability
to control manufacturing costs, improve manufacturing yields and introduce new
products on a timely basis. Any increase in price competition would have a
material adverse effect on JTS' business, operating results and financial
condition. JTS may also experience competition from other forms of data storage,
including optical storage, flash memory and holographic storage. If JTS' current
and prospective customers and end users were to adopt such data storage products
as an alternative to JTS' products, JTS' business, operating results and
financial condition would be materially adversely affected.
 
BACKLOG
 
     JTS' sales are generally made pursuant to purchase orders that are subject
to cancellation, modification, quantity reductions or rescheduling without
significant penalties. Changes in forecasts, cancellations, rescheduling and
quantity reductions may result in excess inventory costs, inventory losses and
under-utilization of production capacity and may have a material adverse effect
on JTS' business, operating results and financial condition. As a result of the
foregoing, JTS' backlog as of any particular date may not be
 
                                        9
<PAGE>   12
 
representative of actual sales for any succeeding period. As of February 2,
1997, JTS had a backlog of approximately $74 million. Backlog on any given date
is not necessarily indicative of total orders for a given period, which may be
more or less than expected.
 
EMPLOYEES
 
     As of February 2, 1997, JTS (excluding the Atari division) had 6,493
full-time employees, of whom 191 were located in San Jose, California, 6,270
were located in Madras, India, 25 were located in the Far East and 7 were
located in Europe. Of the full-time employees, 6,270 are engaged in
manufacturing, 28 in marketing, sales and service, 129 in engineering and 28 in
administration and finance and 38 others. Due to disappointing sales of Jaguar
and related products, Atari reduced its workforce from 101 persons at December
31, 1994 to 73 persons at December 31, 1995 and to 15 persons at December 31,
1996. JTS does not presently anticipate any further reductions in the Atari
division's workforce. As of February 2, 1997, the Atari division had
approximately six employees in the United States, including four in engineering
and product development and two in distribution. In addition, the Atari division
had one employee outside the United States at February 2, 1997.
 
     The market for well-trained employees with disk drive industry experience
is intensely competitive. JTS believes that its future success will depend on
its ability to continue to attract and retain a team of highly motivated and
skilled individuals. None of JTS' employees is represented by a labor
organization. JTS believes that its employee relations are good.
 
RISK FACTORS
 
     LIMITED OPERATING HISTORY; HISTORY OF OPERATING LOSSES.  JTS was
incorporated in February 1994 and did not commence production of hard disk
drives until October 1995. JTS experienced operating losses for its fiscal years
ended January 29, 1995, January 28, 1996 and February 2, 1997 of $5.2 million,
$32.5 million and $149.6 million, respectively, which resulted from the
substantial costs associated with the design, development and marketing of new
products, the establishment of manufacturing operations, the development of a
supplier base and, in fiscal 1997, the $110.0 million write off of in-process
research and development costs as a result of the merger with Atari. The Company
has yet to generate profits and cannot assure that it will achieve or maintain
successful operations in the future. Such factors have raised substantial doubt
about the ability of JTS to continue its operations without achieving successful
future operations or obtaining financing to meet its working capital needs,
neither of which can be assured.
 
     As of February 2, 1997, JTS had working capital of $1.8 million and a net
worth of $12.4 million. JTS had net revenues of only $90.5 million and an
operating loss of $149.6 million for the year ended February 2, 1997. These
results include Atari's six-month operations through July 28, 1996 and the
combined companies' operations from the closing of the merger (July 30, 1996) to
February 2, 1997.
 
     NEED FOR ADDITIONAL FINANCING; POSSIBLE BREACH OF LOAN COVENANTS.  The hard
disk drive business is extremely capital intensive, and JTS will need
significant additional financing resources in fiscal 1998 and over the next
several years for facilities expansion, capital expenditure, working capital,
research and development and vendor tooling. The issuance of equity or
convertible debt securities, upon conversion, would result in dilution of the
voting control of existing stockholders and could result in dilution to earnings
per share. There can be no assurance that additional funding will be available
on terms acceptable to JTS or at all. If JTS is unable to obtain sufficient
capital, it would be required to curtail its facilities expansion, capital
expenditures, working capital, research and development and vendor tooling
expenditures, which would materially adversely affect JTS' business, operating
results and financial condition. In this regard, due to delays in the receipt of
additional financing, the Company took action in September 1996 to conserve its
cash resources by reducing the production of disk drives planned for the third
and fourth quarters of fiscal 1997. Furthermore, certain equipment and
receivables financing as well as term loans made to JTS Technology are
contingent on JTS' ability to comply with stringent financial covenants. JTS'
failure to comply with such covenants could result in the loss of such financing
sources. In this regard, JTS Technology has failed to obtain certain debt and
equity required under one of its loan agreements. Management believes that the
lender is unlikely to require JTS to
 
                                       10
<PAGE>   13
 
immediately repay advances outstanding for non-compliance with debt covenants.
Although management believes it is in compliance with this provision due to the
open accounts receivable which they have from JTS Technology and intends to
convert a portion of its open accounts receivable from JTS Technology to
unsecured loans to satisfy this requirement, there can be no assurance that the
lender will not require JTS to immediately repay advances. The loss of any such
sources of funding could have a material adverse effect on JTS' business,
operating results and financial condition. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
 
     UNCERTAINTY OF MARKET ACCEPTANCE; LENGTHY SALES CYCLE.  Since its inception
in February 1994, JTS has primarily engaged in research and development of its
core technology for hard disk drives. JTS' marketing strategy depends
significantly on its ability to establish distribution, licensing, product
development and other strategic relationships with major computer OEMs and on
the willingness and ability of these companies to utilize and to promote JTS'
hard disk drive technology and products. JTS' first commercial product line, the
Palladium family of hard disk drives, was introduced in September 1995 and is
targeted at the desktop personal computer market. JTS' second product line, the
Nordic family of hard disk drives, has been designed for notebook computers. In
the second quarter of fiscal 1997, the Company introduced its newest family of
hard disk drives, the Champion product line. See "Business -- Products." There
can be no assurance that any significant market for any product family will
develop. In particular, the Nordic drives use a 3-inch form factor, which JTS
has only recently introduced to the industry. At present, only a limited number
of computer manufacturers are developing or have plans to develop computers that
may accommodate Nordic drives. If additional computer manufacturers do not
modify their existing products or develop new products to accommodate 3-inch
form factor disk drives, sales of Nordic disk drives and, therefore, JTS'
business, operating results and financial condition would be materially
adversely affected.
 
     Qualifying hard disk drives for incorporation into a new computer product
requires JTS to work extensively with the customer and the customer's other
suppliers to meet product specifications. Customers often require a significant
number of product presentations and demonstrations, as well as substantial
interaction with JTS' senior management, before making a purchasing decision.
Accordingly, JTS' products typically have a lengthy sales cycle during which JTS
may expend substantial financial resources and management time and effort with
no assurance that a sale will result.
 
     HIGHLY COMPETITIVE MARKET.  The hard disk drive industry is intensely
competitive and dominated by a small number of large companies, including
Maxtor, Quantum, Seagate and Western Digital. In addition, a number of computer
companies, such as IBM and Toshiba, have in-house or "captive" disk drive
manufacturing operations that produce disk drives for incorporation into their
own computers as well as for sale to other OEMs. Many of JTS' competitors have
broader product lines than JTS, and all have significantly greater financial,
technical and marketing resources. In this regard, JTS' lack of sufficient
working capital in the last two quarters has put JTS at a competitive
disadvantage relative to certain of its competitors which have had access to
greater financial resources. Furthermore, JTS has licensed key 3-inch form
factor technology to Western Digital, a competitor in the personal computer disk
drive market that could become a significant supplier of 3-inch form factor disk
drives to Compaq and other OEMs. See "Business -- Strategic Licenses." There can
be no assurance that JTS will develop and manufacture products on a timely basis
with the quality and features necessary to compete effectively. Generally, OEM
customers for hard disk drives rely on a limited number of suppliers. As a
result, it may be necessary for JTS to displace competitors to increase its net
sales. In addition, JTS faces competition from the manufacturing operations of
its current and potential OEM customers, which could initiate or increase
internal production of hard disk drives and reduce or cease purchasing from
independent hard disk drive suppliers such as JTS. Moreover, the hard disk drive
industry is characterized by price erosion and resulting pressure on gross
margins. JTS expects that hard disk drive prices will continue to decline and
that competitors will offer products which meet or exceed the performance
capabilities of JTS' current products. Due to such pricing pressures, JTS'
future gross margins will substantially depend upon its ability to control
manufacturing costs, improve manufacturing yields and introduce new products on
a timely basis. Any increase in price competition would have a material adverse
effect on JTS' business, operating results and financial condition. JTS may also
experience competition from other forms of data storage, including optical
storage, flash memory and holographic storage. If JTS' current
 
                                       11
<PAGE>   14
 
and prospective customers and end users were to adopt such data storage products
as an alternative to JTS' products, JTS' business, operating results and
financial condition would be materially adversely affected. See
"Business -- Competition."
 
     RAPID TECHNOLOGICAL CHANGE; SHORT PRODUCT LIFE CYCLES.  The hard disk drive
industry is characterized by rapid technological change and short product life
cycles. As a result, JTS must continually anticipate change and adapt its
products to meet demand for increased storage capacities. Although JTS intends
to continuously develop new products and production techniques, there can be no
assurance that JTS will anticipate advances in hard disk drive technology and
develop products incorporating such advances in a timely manner to compete
effectively against its competitors' new products. Due to the rapid
technological change and frequent development of new hard disk drive products,
it is common in the industry for the relative mix of customers and products to
change rapidly, even from quarter to quarter. For example, in the first half of
calendar 1996, the demand for 1 gigabyte 3.5-inch form factor hard disk drives
decreased dramatically due to increased availability of and demand for larger
capacity disk drives. As a result, pricing pressure on such disk drives,
including those marketed by JTS, increased and gross margins decreased.
Generally, new products have higher selling prices than more mature products.
Therefore, JTS' ability to introduce new products on a timely basis is an
important factor in achieving growth and profitability. In addition, JTS
anticipates continued changes in the requirements of its customers in the
computer industry. There can be no assurance that JTS will be able to develop,
manufacture and sell products that respond adequately to such changes or that
future technological innovations will not reduce demand for hard disk drives.
JTS' business, operating results and financial condition will be materially
adversely affected if its development efforts are unsuccessful, if the
technologies that JTS has chosen not to develop prove to be competitive
alternatives or if its current and prospective customers and end users were to
adopt alternative data storage products, such as optical storage, flash memory
and holographic storage. As JTS increases its production and shipment of hard
disk drives and expands its product line, JTS' inventory levels will increase.
Due to the rapid rate of technological change in the computer industry, a large
inventory poses the risk of inventory obsolescence which could have a material
adverse effect on JTS' business, operating results and financial condition. In
this regard, JTS anticipates incurring future inventory allowances, the level of
which will depend upon a number of factors, including manufacturing yields, new
product introductions, maturity or obsolescence of product designs, inventory
levels and competitive pressures.
 
     AVAILABILITY OF COMPONENTS AND MATERIALS; DEPENDENCE ON SUPPLIERS.  JTS
relies on a limited number of suppliers for many components and materials used
in its manufacturing processes, including recording disks, head stack components
and integrated circuits. At present, JTS does not have multiple suppliers to all
of its materials and component requirements, and there can be no assurance that
JTS will secure more than one source for all of its requirements in the future
or that its suppliers will be able to meet its requirements on a timely basis or
on acceptable terms. Furthermore, JTS does not have contractual arrangements
with any of its sole source suppliers. In particular, JTS presently relies on
sole source suppliers for controller ASICs, read channels, digital signals wP
and spindle motor drivers, and certain head stack components. Delays in the
receipt of certain components and materials have occurred in the past, and there
can be no assurance that delays will not occur in the future or that suppliers
will not extend lead times. Moreover, changing suppliers for certain materials,
such as spindle motors, could require requalification of JTS' products with some
or all of its customers. Requalification could prevent early design-in wins or
could prevent or delay continued participation in hard disk drive programs for
which JTS' products have been qualified. In addition, long lead times are
required to obtain many materials, such as integrated circuits utilized in JTS'
PCBAs. Regardless of whether these materials are available from established or
new sources of supply, long lead times could impede JTS' ability to quickly
respond to changes in demand and product requirements. Any limitations on, or
delays in, the supply of materials could disrupt JTS' production volume and
could have a material adverse effect on JTS' business, operating results and
financial condition. In this regard, in the fourth quarter of fiscal 1996, JTS
experienced delays in obtaining sufficient quantities of certain components
provided by one supplier, which resulted in a significant reduction in JTS'
production volume during such period. The Company subsequently added three new
suppliers of this component, but there can be no assurance that production
problems of this type or otherwise will not occur again in the future.
Furthermore, a significant increase in the price of one or more of these
components or materials could adversely affect JTS' business, operating results
and financial
 
                                       12
<PAGE>   15
 
condition. In addition, there are only a limited number of providers of hard
disk drive manufacturing equipment, such as servo-writers, burn-in equipment and
final test equipment, and ordering additional equipment for replacement or
expansion involves long lead times, which limit the rate and flexibility of
capacity expansion. Failure to obtain such manufacturing equipment on a timely
basis could limit JTS' production of hard disk drives and adversely affect JTS'
business, operating results and financial condition. See
"Business -- Manufacturing."
 
     CYCLICAL NATURE OF HARD DISK DRIVE AND COMPUTER INDUSTRIES.  JTS' operating
results are dependent on the demand for hard disk drives, which in turn depends
on the demand for notebook and desktop personal computers. The hard disk drive
industry is cyclical and has experienced periods of oversupply, resulting in
significantly reduced demand for hard disk drives, as well as pricing pressures
and reduced production levels. The effect of these cycles has been magnified by
computer manufacturers' practice of ordering components, including hard disk
drives, in excess of their needs during periods of rapid growth. In recent
years, the disk drive industry has experienced significant growth, and JTS
intends to expand its capacity based on current and anticipated demand. There
can be no assurance that such growth will continue or that the level of demand
will not decline. In this regard, certain personal computer manufacturers have
announced reductions in anticipated revenue growth. A decline in demand for hard
disk drives would have a material adverse effect on JTS' business, operating
results and financial condition. Additionally, in the past some computer
manufacturers have experienced substantial financial difficulties due to the
cyclical nature of the computer industry and other factors. Any increased price
pressure in the personal computer industry could be passed through to personal
computer component suppliers, including manufacturers of hard disk drives. To
date, JTS has not incurred significant bad debt expense. However, there can be
no assurance that JTS will not face difficulty in collecting receivables or be
required to offer more liberal payment terms in the future, particularly in a
period of reduced demand. Any failure to collect or delay in collecting
receivables could have a material adverse effect on JTS' business, operating
results and financial condition.
 
     DEPENDENCE ON COMPAQ COMPUTER RELATIONSHIP; CUSTOMER CONCENTRATION.  JTS'
strategy to commercialize its products and achieve market acceptance has focused
on the development of distribution, licensing, product development and other
strategic relationships with leading computer companies, other manufacturers of
computer peripherals and recognized distribution organizations. In this regard,
JTS entered into a Development Agreement with Compaq in 1994 pursuant to which
Compaq agreed to design JTS' Nordic disk drives into at least one of Compaq's
products and to purchase a minimum number of Nordic disk drives from JTS within
two years following Compaq's acceptance of the first of such products. In
return, JTS granted Compaq certain pricing preferences and agreed to pay
royalties to Compaq on sales of Nordic disk drives to third parties during the
term of the agreement. Compaq was also granted a License to use the Nordic
designs to manufacture or to have manufactured Nordic drives on a royalty-free
basis in the event JTS fails to meet the agreed upon production schedule or, if
JTS is not in default under the agreement, to have Nordic drives manufactured by
third-parties upon payment of a royalty to JTS. The Development Agreement also
restricts JTS' ability to sublicense Nordic technology. The Development
Agreement has a five year term, which will automatically be renewed under
certain circumstances and may be terminated by either party only with cause. In
order to provide an alternate source of Nordic products, JTS entered into a
Technology Transfer and License Agreement with Western Digital pursuant to which
Western Digital has the right to manufacture and sell Nordic disk drives to
Compaq and others. If either of these agreements were to terminate prematurely,
JTS' efforts to establish market acceptance of its products and, consequently,
its business, operating results and financial condition would be adversely
affected. In the first half of calendar 1996, Compaq delayed introduction of a
notebook product line that incorporates the Company's hard disk drives, which
resulted in shipment delays by the Company to Compaq and others. The Company may
experience similar delays in the future. In fiscal 1997, Karma International AG,
FutureTech International, Inc. and Synnex Information Technology accounted for
approximately 30%, 13% and 12%, respectively, of JTS' total revenues. JTS
expects that sales to a relatively small number of OEMs will account for a
substantial portion of its net revenues for the foreseeable future, although the
companies that comprise JTS' largest customers may change from period to period.
The loss of, or decline in orders from, one or more of JTS' key customers would
have a material adverse effect on JTS' business, operating results and financial
condition. See "Business -- Initial Efforts to Achieve Market Acceptance of Hard
Disk Drive Products."
 
                                       13
<PAGE>   16
 
     RELIANCE ON LICENSED TECHNOLOGY.  JTS currently owns no patents (other than
those acquired from Atari in the Merger) and has obtained licenses to a
substantial portion of the technology used in its hard disk drives pursuant to
license agreements with TEAC Corporation ("TEAC"), Pont Peripherals Corporation
("Pont") (formerly DZU Corporation), and Western Digital. If such license
agreements were prematurely terminated or if JTS were enjoined from relying upon
such licenses due to JTS' alleged or actual breach of such agreements, JTS would
be prevented from manufacturing hard disk drives incorporating technology
subject to such licenses. As a result, JTS' business, operating results and
financial condition would be materially adversely affected. See
"Business -- Patents and Licenses."
 
     INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS.  Although JTS attempts to
protect its intellectual property rights through patents, copyrights, trade
secrets and other measures, there can be no assurance that JTS will be able to
protect its technology adequately or that competitors will not be able to
develop similar technology independently. There can be no assurance that patents
will be issued with respect to JTS' pending patent applications or that any
future patents will be sufficiently broad to protect JTS' technology. There can
be no assurance that any future patent issued to JTS will not be challenged,
invalidated or circumvented or that the rights granted thereunder will provide
adequate protection to JTS' products. Furthermore, there can be no assurance
that others will not independently develop similar products, duplicate JTS'
products or design around any possible patents issued to JTS in the future. In
addition, the laws of certain foreign countries may not protect JTS'
intellectual property rights to the same extent as do the laws of the United
States.
 
     In recent years, the hard disk drive industry has experienced an increase
in litigation to enforce intellectual property rights. Litigation may be
necessary to enforce any future JTS patents, patents acquired in the Merger,
copyrights or other intellectual property rights, to protect JTS' trade secrets,
to determine the validity and scope of the proprietary rights of others or to
defend against claims of infringement or claims for indemnification resulting
from infringement claims. Such litigation, even if successful, could result in
substantial costs and diversion of resources and could have a material adverse
effect on JTS' business, operating results and financial condition.
Alternatively, if any claims are asserted against JTS, JTS may seek to obtain a
license under the third party's intellectual property rights or to seek to
design around such claims. There can be no assurance, however, that a license
will be available on reasonable terms or at all, and it could be expensive and
time consuming or prove impossible for JTS to design around such claims. Any of
such alternatives could materially and adversely affect JTS' business, results
of operations and financial condition.
 
     Pursuant to the Merger, JTS has exclusive use of the "Atari" name and
"Fuji" logo in all areas other than coin-operated arcade video game use. JTS
also has a portfolio of other intellectual properties of Atari, including
patents, trademarks, and copyrights associated with its video game and computer
businesses. JTS believes these patents, trademarks and other intellectual
property are important assets. As of February 2, 1997, Atari approximately 150
patents in the United States and other jurisdictions which expire from 1997 to
2010 and had applications pending for three additional patents. There can be no
assurance that any of these patent rights will be upheld in the future or that
JTS will be able to preserve any of these intellectual property rights. Atari
has in the past received communications from third parties asserting title to
certain of its intellectual property. Atari has also been involved in several
major lawsuits regarding its intellectual property, including a suit with
Nintendo of America, Inc. and its affiliates ("Nintendo") which was settled in
March 1994 and a suit with Sega which was settled in September 1994. In the
event any third party were to make a valid claim with respect to the Atari
division's intellectual property and a license were not available on
commercially reasonable terms, JTS' business, financial condition and results of
operations could be materially and adversely affected. Litigation, which has in
the past resulted and could in the future result in substantial costs and
diversion of resources, may also be necessary to enforce the Atari patents at
other intellectual property rights or to defend against third party infringement
claims. The occurrence of litigation relating to patent enforcement, patent
infringement or other intellectual property matters, regardless of the outcome,
could have a material adverse effect on JTS' business, financial condition and
results of operations.
 
     EXPANSION OF MANUFACTURING CAPACITY.  JTS' competitive position will depend
substantially on its ability to expand its manufacturing capacity. Accordingly,
JTS is continuing to make significant investments to expand such capacity,
particularly through the acquisition of capital equipment, facilities expansion
and the hiring and training of new personnel. JTS currently plans to complete
the fit out of its existing manufacturing
 
                                       14
<PAGE>   17
 
facility in Madras, India during fiscal year 1998, after which time JTS will
occupy 125,000 square feet of floor space at this facility. There can be no
assurance that JTS will be able to expand such capacity in a timely manner, that
the cost of such expansion will not exceed management's current estimates, that
such capacity will not exceed the demand for JTS products or that such
additional capacity will achieve satisfactory levels of manufacturing efficiency
in a timely manner or at all. For example, the Company's failure to obtain a
term loan when expected in 1995 resulted in the postponement of planned
facilities improvements at JTS Technology and, consequently, the curtailment of
manufacturing capacity expansion. In addition, the expansion of manufacturing
capacity will significantly increase JTS' fixed costs. JTS' profitability will
depend on its ability to utilize its manufacturing capacity in an effective
manner, and JTS' inability to fully utilize its capacity would have a material
adverse effect on JTS' business, operating results and financial condition. See
"Business -- Manufacturing."
 
     DEPENDENCE ON SINGLE MANUFACTURING FACILITY.  Substantially all of JTS'
manufacturing operations take place at JTS Technology in Madras, India. Because
JTS does not currently operate multiple facilities in different geographic
areas, a disruption of JTS' manufacturing operations resulting from various
factors, including sustained process abnormalities, human error, government
interventions or a natural disaster such as fire or flood, could cause JTS to
cease or limit its manufacturing operations and consequently would have a
material adverse effect on JTS' business, operating results and financial
condition. See "Business -- Manufacturing."
 
     RISKS OF INTERNATIONAL SALES AND MANUFACTURING.  In fiscal 1997, 65% of
JTS' net sales consisted of products sold to customers in Europe, Asia and Latin
America, and JTS anticipates that a substantial percentage of its products will
be sold to customers outside of the United States for the foreseeable future. In
the near term, JTS expects to conduct substantially all of its manufacturing
operations in India, although JTS will evaluate alternative or additional
locations from time to time. Accordingly, JTS' operating results are subject to
the risks of doing business in a foreign country, including compliance with, or
changes in, the law and regulatory requirements of a foreign country, political
instability, local content rules, taxes, tariffs or other barriers, and
transportation delays and other interruptions. For example, the Indian
government has granted JTS' subsidiary, JTS Technology, a five year reduced tax
rate which is expected to expire in 2001. In addition, JTS Technology is located
in the Madras Export Processing Zone, where it currently enjoys an exemption
from Indian taxes on export profits. To date, JTS has obtained only minimal
benefits from such tax exemptions. Such exemptions may be terminated or
additional taxes may be imposed at any time, for political or economic reasons,
in which event JTS may become subject to significantly greater taxes on sales of
disk drives outside of India at rates currently up to 46%. Furthermore, JTS
Technology does not have a long-term lease agreement, but rather occupies the
Madras facility pursuant to allotment letters from the Development Commissioner
of the Madras Export Processing Zone. Such benefits associated with conducting
business in India, which historically has experienced considerable political
instability, are subject to the vagaries of the Indian government and may be
withdrawn at any time. Although all of JTS' sales presently are made in U.S.
dollars, there can be no assurance that future international sales will not be
denominated in foreign currencies. Regardless of whether JTS' sales are
denominated in foreign currencies, JTS is, and will continue to be, subject to
risks related to foreign currency fluctuations. See "Business -- Manufacturing."
 
     PRODUCTION YIELDS; PRODUCT QUALITY.  The hard disk drive manufacturing
process is complex, and low production yields may result from a variety of
factors, including the introduction of new products, increased complexity in
product specifications, human error, the introduction of contaminants in the
manufacturing environment, equipment malfunction, use of defective materials and
components and inadequate testing. From time to time, JTS has experienced lower
than anticipated production yields as a result of such factors. Furthermore,
while JTS has implemented procedures to monitor the quality of the materials
received from its suppliers, there can be no assurance that materials will meet
JTS' specifications or that substandard materials will not adversely impact
production yields or cause other production problems. JTS' failure to maintain
high quality production standards or acceptable production yields would result
in loss of customers, delays in shipments, increased costs, cancellation of
orders and product returns for rework, any of which could have a material
adverse effect on JTS' business, operating results and financial condition. For
example, JTS' cost of sales for fiscal 1996 and fiscal 1997 included a $4.3
million and $2.8 million, respectively, provision for
 
                                       15
<PAGE>   18
 
inventory allowances principally due to the costs for return of defective
products, scrapped material associated with unrepairable damage caused during
the assembly process and estimates of physical loss of inventory associated with
high volume manufacturing activities. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
 
     VARIABILITY OF OPERATING RESULTS.  JTS' operating results are expected to
be subject to significant quarterly and annual fluctuations based upon a variety
of factors including market acceptance of JTS' products, timing of significant
orders, changes in pricing by JTS or its competitors, the timing of product
announcements by JTS, its customers or its competitors, changes in product mix,
manufacturing yields, order cancellations, modifications and quantity
adjustments and shipment reschedulings, the level of utilization of JTS'
production capacity, increases in production and engineering costs associated
with initial manufacture of new products, changes in the cost of or limitations
on availability of components and materials and customer returns. The impact of
these and other factors on JTS' revenues and operating results in any future
period cannot be predicted with certainty. JTS' expense levels are based, in
large part, on its expectations as to future revenues. Substantial advance
planning and commitment of financial and other resources is necessary for
expansion of manufacturing capacity, while JTS' sales are generally made
pursuant to purchase orders that are subject to cancellation, modification,
quantity reductions or rescheduling without significant penalties. Furthermore,
because the hard disk drive industry is capital intensive and requires a high
level of fixed costs, operating results are extremely sensitive to changes in
volume. Accordingly, if revenue levels do not meet expectations, operating
results and net income, if any, are likely to be adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
 
     MANAGEMENT OF GROWTH.  JTS has recently experienced and may continue to
experience substantial growth in the number of its employees and the scope of
its operations. Such growth would further strain JTS' managerial, financial,
manufacturing and other resources. In addition, to manage its growth
effectively, JTS must implement additional operating, financial and management
information systems and hire and train additional personnel. In particular, JTS
must hire and train a significant number of additional personnel to operate the
highly complex capital equipment required by its manufacturing operations. There
can be no assurance that JTS will successfully implement additional systems in a
timely or efficient manner, hire and properly train a sufficient number of
qualified personnel or effectively manage such growth, and JTS' failure to do so
could have a material adverse effect on its business, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business -- Employees."
 
     DEPENDENCE ON KEY MANAGEMENT PERSONNEL.  JTS' operating results will depend
in significant part upon the continued contributions of its key management and
technical personnel, who are difficult to replace. See "Management." JTS does
not have an employment agreement with any of its key executives, other than with
Kenneth D. Wing, its Executive Vice President, Engineering and Chief Operating
Officer. The loss of any of these key personnel could have a material adverse
effect on the business, operating results and financial condition of JTS. In
addition, JTS' future operating results will depend in part upon its ability to
attract, train, retain and motivate other qualified management, technical,
manufacturing, sales and support personnel for its operations. Competition for
such personnel is intense, and there can be no assurance that JTS will be
successful in attracting or retaining such personnel. The loss of the services
of existing personnel as well as the failure to recruit additional personnel
could materially adversely affect JTS' business, operating results and financial
condition. See "Business -- Employees."
 
     PURCHASE ORDERS SUBJECT TO CANCELLATION, MODIFICATION AND
RESCHEDULING.  JTS' sales are generally made pursuant to purchase orders that
are subject to cancellation, modification, quantity reductions or rescheduling
without significant penalties. Changes in forecasts, cancellations, rescheduling
and quantity reductions may result in excess inventory costs, inventory losses
and under-utilization of production capacity and could have a material adverse
effect on JTS' business, operating results and financial condition. As a result
of the foregoing, JTS' backlog as of any particular date may not be
representative of actual sales for any succeeding period.
 
                                       16
<PAGE>   19
 
     RISK OF POTENTIAL LIABILITIES RELATED TO ATARI'S BUSINESS.  In connection
with the restructuring of Atari's business in 1992 and 1993 and Atari's decision
in late 1995 to significantly downsize its Jaguar operations, Atari has
terminated and JTS plans to terminate numerous contracts and business
relationships, including several related to software development activities.
Although JTS does not regard such contracts or business relationships, either
individually or in the aggregate, as material, the termination of contracts and
relationships has, from time to time, resulted in litigation, diverting
management attention and financial resources. There can be no assurance that the
parties to such contracts will not commence or threaten to commence litigation
related to such contracts. Any such litigation or threatened litigation would
divert management attention and financial resources and could have a material
adverse effect on JTS' business, operating results and financial condition.
 
     CONTROL BY AFFILIATES; ANTI-TAKEOVER EFFECTS.  Directors and executive
officers of the Company own approximately 29.5% of the outstanding shares of
Common Stock (assuming no exercise of options or warrants after December 31,
1996). As a result, these affiliates of JTS, acting together, have the ability
to exert significant influence over the election of directors and other
corporate actions affecting JTS. Certain provisions of the Certificate of
Incorporation and Bylaws of JTS and certain provisions of the Delaware General
Corporation Law, including Section 203 thereof, may also discourage certain
transactions involving a change in control of JTS. In addition to the foregoing,
the ability of the Board of Directors of JTS to issue additional "blank check"
preferred stock without further stockholder approval could have the effect of
delaying, deferring or preventing a change in control of JTS. See "Principal and
Selling Stockholders" and "Description of Capital Stock."
 
     SHARES ELIGIBLE FOR FUTURE SALE; POTENTIAL DILUTION.  Sales of substantial
amounts of Common Stock in the public market could adversely affect prevailing
market prices. A substantial number of shares of Common Stock are issuable by
the Company upon the conversion of the Company's Series B Preferred Stock and
Series C Preferred Stock and the exercise of outstanding warrants, which would
result in substantial dilution to a stockholder's percentage ownership interest
in the Company and could adversely affect the market price of the Common Stock.
Under the applicable conversion formulas of the Series B Preferred Stock and the
Series C Preferred Stock, (i) the number of shares of Common Stock issuable upon
conversion is generally inversely proportional to the market price of the Common
Stock at the time of conversion (i.e., the number of shares issuable increases
as the market price of the Common Stock decreases); and (ii) a minimum of
4,567,474 shares and 6,920,415 shares are issuable upon conversion of the Series
B Preferred Stock and Series C Preferred Stock, respectively (based on a
conversion price, subject to adjustment, of $3.6125). In addition, the number of
shares issuable upon conversion of the Series B Preferred Stock and the Series C
Preferred Stock and the exercise of certain outstanding warrants is subject to
adjustment upon the occurrence of certain dilutive events. As of February 2,
1997, the Company had approximately 104,764,673 shares of Common Stock
outstanding. In March 1997, the Company's Registration Statement on Form S-1
(No. 333-21881) was declared effective, registering for public resale 56,392,046
shares of Common Stock (consisting of 10,037,500 newly-issued shares of Common
Stock issuable upon the conversion of outstanding Series B Preferred Stock and
Common Stock purchase warrants, 17,000,000 newly-issued shares of Common Stock
issuable upon conversion of the Series C Preferred Stock, and 29,354,546
previously outstanding shares of Common Stock). The Company may be obligated to
register additional shares of Common Stock for resale upon conversion of the
Series B Preferred Stock and Series C Preferred Stock depending on, among other
factors, the future market price of the Common Stock. In addition, JTS has
registered for sale on a Form S-8 Registration Statement under the Securities
Act an aggregate of 8,985,000 shares of Common Stock issued or issuable upon the
exercise of options granted under JTS' Amended and Restated 1995 Stock Option
Plan, 500,000 shares of Common Stock issued or issuable upon the exercise of
options granted under JTS' 1996 Non-Employee Directors' Stock Option Plan, and
225,800 shares of Common Stock issued or issuable upon the exercise of options
granted under Atari's 1986 Stock Option Plan which were assumed by JTS in the
merger with Atari.
 
     LIQUIDITY; STOCK PRICE VOLATILITY.  The trading price of the Common Stock
may be subject to wide fluctuations in response to quarter-to-quarter variations
in operating results, announcements of technological innovations or new products
by JTS or its competitors, general conditions in the hard disk drive, computer
or
 
                                       17
<PAGE>   20
 
video game industries, changes in earnings estimates or recommendations by
analysts, or other events or factors. In addition, the public stock markets have
occasionally experienced extreme price and trading volume volatility. This
volatility has significantly affected the market prices of securities of many
technology companies for reasons frequently unrelated to the operating
performance of the specific companies. These broad market fluctuations may
adversely affect the market price of the Common Stock.
 
ITEM 2 -- PROPERTIES.
 
     JTS presently leases facilities in San Jose, Sunnyvale and Santa Clara,
California; Madras, India; Singapore; Slough, England; and Taipei, Taiwan. JTS'
executive and administrative headquarters are located in a 52,000 square foot
building in San Jose. The lease on this facility expires in July 2000, and JTS
has an option to renew for four years, subject to certain restrictions.
 
     The Madras facility comprises approximately 85,000 square feet and is used
for all of JTS' manufacturing operations. The Madras facility is owned by the
Indian Government, and JTS currently pays $14,000 per month for its use. JTS
does not have a long-term lease agreement, but rather occupies the Madras
facility pursuant to allotment letters from the Development Commissioner of the
Madras Export Processing Zone. Such allotment letters authorize JTS to occupy
the premises so long as the space is used in the reasonable conduct of JTS'
business and rents are paid in a timely fashion. The allotment letters and other
benefits associated with conducting business in India, which historically has
experienced considerable political instability, are subject to the vagaries of
the Indian government and may be withdrawn at any time. JTS currently intends to
increase the size of the Madras facility by 40,000 square feet by the end of
fiscal 1998.
 
     The Singapore office comprises approximately 1,500 square feet and is used
for JTS' purchasing operations in Southeast Asia. The lease for this facility
expires in October 1997. The Taiwan sales office has approximately 1,144 square
feet and is used for JTS' marketing and sales operations in Taiwan. The lease
for this facility expires in July 1997.
 
     In addition, JTS leases a 7,200 square feet facility in Sunnyvale,
California under a lease which expires in 2001, which is presently being
subleased. JTS also leases a 20,200 square feet warehouse facility in Santa
Clara, California and a 33,600 square feet international sales facility in
Slough, England. Each of these leases was assumed by JTS when it merged with
Atari, and each facility is presently used primarily for the Atari division's
operations.
 
     The following table summarizes the principal properties occupied by the
Company:
 
<TABLE>
<CAPTION>
                                                                        EXPIRATION DATE
        LOCATION                                       SQUARE FOOTAGE      OF LEASE
        ---------------------------------------------  --------------   ---------------
        <S>                                            <C>              <C>
        Administrative and Sales Offices:
          San Jose, California.......................      52,000       July 2000
          Slough, England............................      33,600       September 1997
          Singapore..................................       1,500       July 1997
          Taiwan.....................................       1,144       July 1997
        Manufacturing Facility:
          Madras, India..............................      85,000       *
        Warehouse Facility:
          Santa Clara, California....................      20,200       July 1999
</TABLE>
 
---------------
* Occupied pursuant to allotment letters provided certain conditions are
  satisfied.
 
ITEM 3 -- LEGAL PROCEEDINGS.
 
     The Company is a defendant in a civil action brought in the Superior Court
of the State of California in and for the County of Santa Clara by Citizen
America Corporation, a former supplier, in February 1994
 
                                       18
<PAGE>   21
 
seeking damages of approximately $900,000 for alleged breach of contract and
related claims. The Company has filed a countersuit alleging damages of
approximately $8.3 million.
 
     The Company is a defendant and counter claimant in a civil action for
alleged breach of contract brought in U.S. District Court for the Southern
District of New York, case number 95 Civ. 1935, by Tradewell, Inc., a New York
corporation, seeking specific performance for release of goods having a value of
$1.6 million. The Company has counterclaimed seeking specific performance for
the purchase of media or, alternatively, damages in the amount of $3.3 million.
As a result of a partial resolution, the Company now seeks damages of
approximately $2.5 million.
 
     The Company is a defendant in a civil action brought in England titled
Bullfrog Production, Ltd., v. Atari Corporation, Case No. 1996 B No. 584, for
which Bullfrog obtained judgment against the Company in the amount of $250,000
plus interest and costs.
 
     The Company is a plaintiff in a civil action brought in the Superior Court
of the State of California in and for the county of Santa Clara brought against
Philips Laser Magnetic Storage ("Philips") for breach of contract and breach of
implied covenant of good faith and fair dealing arising out of Philips' failure
to deliver goods to Atari. Philips has filed a counterclaim to the action for
goods sold and delivered and work in process for approximately $3 million.
 
     The Company is a plaintiff in a civil action brought in the Superior Court
of the State of California in and for the County of Santa Clara, and removed to
the United States District Court, Northern District of California, against Probe
Entertainment Limited ("Probe") for breach of contract and related claims. A
counterclaim has been filed by Probe against the Company for alleged breach of
contract. In connection with this matter, Acclaim Entertainment, an affiliate of
Probe, joined in the claim against the Company seeking damages in excess of
$1.25 million.
 
     On January 23, 1992, certain debenture holders filed an involuntary
bankruptcy petition against The Federated Group, Inc., a subsidiary of the
Company and formerly a subsidiary of Atari. The case was appealed by the Company
to the Ninth Circuit Court of Appeals, and a hearing for oral arguments was held
on December 12, 1996. The case was reversed and remanded to the District Court
for further proceedings.
 
     The Company is a defendant in a claim brought by Extron Contract
Manufacturing Co. in the Superior court of the State of California in and for
the County of Santa Clara for work in material overages in excess of
$215,826.33.
 
     On January 3, 1997, Dusseldorf Securities, Limited ("DSL") and Greystone
Capital, Ltd. ("GCL"), through counsel, made a letter demand of the Company for
payment of $1,250,000 allegedly due under a letter agreement between DSL and the
Company dated December 21, 1996 (the "Agreement"). DSL and GCL claim that the
Company owes $1,250,000 as fees for a January 1997 private placement of the
Company's stock which was not completed through DSL and/or GCL. On February 26,
1997, DSL and GCL filed suit against the Company in Los Angeles County Superior
Court, No. BC166450, entitled Dusseldorf Securities, Limited v. JTS Corporation.
The lawsuit asserts claims for breach of contract, breach of warranty, and
misrepresentation against the Company and asserts those and other tort claims
against Michael Arnous, an individual not affiliated with the Company, through
whom the Company recently completed a private placement of its securities. A
writ of attachment has been filed and is scheduled to be argued on May 9, 1997.
If granted, the motion will require the segregation of some or all of $5.2
million of JTS' cash or assets.
 
     The Company is a defendant in a claim brought by Zion Technology, Corp. in
the Superior Court of the State of California in and for the County of Santa
Clara for goods ordered. The claim is in excess of $66,000.
 
     The Company is presently, and may become in the future, a defendant in
certain other actions relating to the downsizing of Atari's operations. The
above actions may include claims for attorneys fees and interest. The Company
believes that none of these claims will have a material adverse effect on its
business, financial condition or results of operations.
 
                                       19
<PAGE>   22
 
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
     No matters were submitted to a vote of the Company's security holders
during the fourth quarter of fiscal 1997.
 
                                    PART II
 
ITEM 5 -- MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The Company's Common Stock is traded on The American Stock Exchange, Inc.
under the symbol "JTS." The table below sets forth the high and low sales prices
for the Company's Common Stock (as reported on The American Stock Exchange,
Inc.) during the periods indicated. The reported last sale price of the Common
Stock on The American Stock Exchange, Inc. on April 28, 1997 was $1 9/16.
 
<TABLE>
<CAPTION>
                                                                       PRICE RANGE OF
                                                                        COMMON STOCK
                                                                       ---------------
                                                                       HIGH       LOW
                                                                       -----      ----
        <S>                                                            <C>        <C>
        YEAR ENDED FEBRUARY 2, 1997:
          3rd Quarter................................................  5 13/16    3 1/8
          4th Quarter................................................  4 1/2      2 15/16
        YEAR ENDING FEBRUARY 1, 1998:
          1st Quarter (through April 28, 1997).......................  3 7/16     1 1/2
</TABLE>
 
     As of April 21, 1997, there were approximately 2,700 holders of record of
the Company's Common Stock.
 
     DIVIDENDS
 
     Pursuant to the Series B Preferred Stock Subscription Agreements entered
into between the Company and each of GFL Advantage Fund Limited and Genesee Fund
Limited -- Portfolio B (the "Subscription Agreements"), the Company is obligated
to pay 5% annual dividends on the Company's outstanding shares of Series B
Preferred Stock, payable in cash or Common Stock (the "Series B Dividends"). In
addition, the Company is obligated to pay 5% annual dividends on the Company's
outstanding shares of Series C Preferred Stock, payable in cash or Common Stock
(the "Series C Dividends"). Other than the Series B Dividends and the Series C
Dividends, the Company has not declared or paid cash dividends on its capital
stock since inception and presently intends to retain earnings, if any, for use
in its business, and does not anticipate paying cash dividends in the
foreseeable future. However, the Company may issue additional shares of
preferred stock in the future which require the payment of cash or stock
dividends. The Company's Amended and Restated Certificate of Incorporation (the
"Certificate of Incorporation"), restricts the Company's ability to issue
dividends with respect to capital stock that is junior in preference to the
Series B Preferred Stock. Furthermore, the Company's Certificate of
Incorporation prohibits the issuance of cash dividends on its Common Stock
without the consent of the outstanding shares of Series C Preferred Stock.
 
     RECENT SALES OF UNREGISTERED SECURITIES.
 
     During the Company's fiscal year ended February 2, 1997, the Company has
sold and issued the following unregistered securities:
 
          (1) On November 5, 1996, the Company issued an aggregate of 15,000
     shares of Series B Preferred Stock at a purchase price of $1,000 per share
     to Genesee Fund Limited-Portfolio B and GFL Advantage Fund Limited for an
     aggregate offering price of $15,000,000. Upon conversion of the Series B
     Preferred Stock, the purchaser is entitled to receive warrants to purchase
     shares of the Company's Common Stock; and
 
          (2) On January 22, 1997, the Company issued an aggregate of 25,000
     shares of Series C Preferred Stock at a purchase price of $1,000 per share
     to Nelson Partners, Olympus Securities, LTD, RGC International Investors,
     LDC and Capital Ventures International for an aggregate purchase price of
     $25,000,000.
 
                                       20
<PAGE>   23
 
     The sale and issuance of securities in the transactions described in
paragraphs (1) and (2) above were deemed to be exempt from registration under
the Securities Act by virtue of Section 4(2) and/or Regulation D promulgated
under the Securities Act. Appropriate legends are affixed to the stock
certificates and/or warrants issued in such transactions.
 
     SERIES B PREFERRED STOCK.  The holders of Series B Preferred Stock have the
right to convert all or a portion of the Series B Preferred Stock into units
consisting of Common Stock and Investor Warrants. The Series B Preferred Stock,
together with any accrued and unpaid dividends, may be converted into Common
Stock at a conversion price (the "Series B Initial Conversion Price") equal to
the lower of (i) 85% (subject to adjustment) of the average lowest trading price
for the five days immediately preceding the conversion notice date; or (ii)
$3.6125 (subject to adjustment). In addition, for every 10 shares of Common
Stock issued upon conversion of the Series B Preferred Stock, the holder thereof
shall be entitled to receive an Investor Warrant to purchase one share of Common
Stock. The Series B Preferred Stock is convertible at the option of the Company
at any time after November 5, 1999. The Series B Initial Conversion Price is
subject to proportional adjustment for stock splits, stock dividends,
recapitalizations and the like. The Series B Initial Conversion Price is subject
to further adjustment in the event that (i) the Registration Statement covering
the Common Stock issuable upon conversion of the Series B Preferred Stock and
Investor Warrants ceases to remain effective for a specified period, or (ii) the
conversion rights of the holders of the Series B Preferred Stock are suspended
for any reason.
 
     SERIES C PREFERRED STOCK.  The holders of Series C Preferred Stock have the
right to convert all or a portion of the Series C Preferred Stock into shares of
Common Stock. The Series C Preferred Stock may be converted into Common Stock at
a conversion price (the "Series C Initial Conversion Price") equal to the lower
of (i) 85% (subject to adjustment) of the average lowest sale price for the five
days immediately preceding the conversion date, or (ii) $2.8875 (subject to
adjustment). In addition, upon conversion of the Series C Preferred Stock, the
Company is obligated to pay an additional amount, in cash or Common Stock, to
the holder thereof equal to 5% of the converted principal amount per annum. The
Series C Initial Conversion Price is subject to proportional adjustment for
stock splits, stock combinations, reclassifications and the like. The Series C
Initial Conversion Price is subject to further adjustment in the event that
sales cannot be made pursuant to the Registration Statement covering the Common
Stock issuable upon conversion of the Series C Preferred Stock for any reason.
 
     INVESTOR WARRANTS.  The holders of Series B Preferred Stock have the right
to convert all or a portion of the Series B Preferred Stock into units
consisting of Common Stock and Investor Warrants. For every 10 shares of Common
Stock issued upon conversion of the Series B Preferred Stock, the holder thereof
shall be entitled to receive an Investor Warrant to purchase one share of Common
Stock. Each Investor Warrant is exercisable for one share of Common Stock at
110% of the lower of the average closing bid price of the Company's Common Stock
for the five days immediately preceding (i) the conversion notice date or (ii)
November 5, 1996 (the closing date of the Series B Preferred Stock financing).
The Investor Warrants are exercisable in full or in part at any time or from
time to time for up to three years after the issuance date of the Investor
Warrants. The exercise price of the Investor Warrants is subject to adjustment
under certain circumstances, including dividends, stock splits, reorganizations,
reclassifications, and consolidations. The holders may elect to exercise the
Investor Warrants, in whole or in part, by receiving shares of Common Stock
equal to the net issuance value upon surrender of the Investor Warrants.
 
     FINDER'S WARRANTS.  In connection with the issuance of Series B Preferred
Stock to GFL Advantage Fund Limited and Genesee Fund Limited -- Portfolio B in a
November 1996 private placement, the Company issued 37,500 Finder's Warrants to
Wharton Capital Corporation in consideration for financial consulting services
furnished to the Company. Each Finder's Warrant is exercisable for one share of
Common Stock at $4.2625 per share, which price is equal to 110% of the closing
price of the Company's Common Stock on the issuance date of the Finder's
Warrants. The Finder's Warrants are exercisable in full or in part at any time
or from time to time through November 5, 1999. The exercise price of the
Finder's Warrants is subject to adjustment under certain circumstances,
including dividends, stock splits, reorganizations, reclassifications and
consolidations. The holders of the Finder's Warrants may elect to exercise the
Finder's Warrants in whole or in part by receiving shares of Common stock equal
to the net issuance value upon surrender of the Finder's Warrants.
 
                                       21
<PAGE>   24
 
ITEM 6 -- SELECTED CONSOLIDATED FINANCIAL DATA.
 
     The following historical selected consolidated financial data have been
derived from the historical consolidated financial statements of Atari prior to
its merger with JTS and the combined operations of Atari and JTS post merger and
should be read in conjunction with such consolidated financial statements and
notes thereto and with Management's Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere in this Annual Report on
Form 10-K with the exception of the Consolidated Statement of Operations Data
prior to fiscal 1994 and the Consolidated Balance Sheet Data prior to December
31, 1995, which were derived from historical consolidated financial statement
not included herein. These historical results are not necessarily indicative of
results to be expected in the future.
 
<TABLE>
<CAPTION>
                                                                                          FISCAL
                                                                                           YEAR
                                                                                           ENDED
                                                                                         FEBRUARY
                                                FISCAL YEARS ENDED DECEMBER 31,             2,
                                           -----------------------------------------     ---------
                                             1992       1993       1994       1995        1997(1)
                                           --------   --------   --------   --------     ---------
                                             (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                        <C>        <C>        <C>        <C>          <C>
CONSOLIDATED STATEMENT OF OPERATIONS
  DATA:
Net revenues.............................  $127,340   $ 29,108   $ 38,748   $ 14,626     $  90,530
Cost of revenues.........................   132,455     42,768     35,200     44,234       100,328
Acquired in-process research and
  development............................        --         --         --         --       110,012
Selling, general and administrative
  expenses...............................    47,669     16,538     21,820     18,647        13,067
Amortization of acquired technology......        --         --         --         --         3,923
Research and development expenses........     9,171      4,876      5,775      5,410        12,849
Restructuring charges....................    17,053     12,425         --         --            --
Operating loss...........................   (79,008)   (47,499)   (24,047)   (53,665)     (149,649)
Other income (expense), net(2)...........    (4,145)    (1,631)    33,441      3,507        (2,846)
Income (loss) from continuing
  operations.............................   (82,719)   (48,866)     9,394    (50,158)     (152,495)
Discontinued operations..................     9,000         --         --         --            --
Income (loss) before extraordinary
  income.................................   (73,719)   (48,866)     9,394    (50,158)     (152,495)
Extraordinary credit.....................       104         --         --        582            --
Net income (loss)........................   (73,615)   (48,866)     9,394    (49,576)     (152,495)
EARNINGS (LOSS) PER COMMON SHARES:
Income (loss) from continuing
  operations.............................     (1.44)     (0.85)      0.16      (0.79)        (1.81)
Income (loss) before extraordinary
  credit.................................     (1.29)     (0.85)      0.16      (0.79)        (1.81)
Net income (loss)........................     (1.28)     (0.85)      0.16      (0.78)        (1.81)
</TABLE>
 
<TABLE>
<CAPTION>
                                                             DECEMBER 31,
                                                ---------------------------------------   FEBRUARY 2,
                                                  1992      1993       1994      1995       1997(1)
                                                --------   -------   --------   -------   -----------
                                                       (IN THOUSANDS)
<S>                                             <C>        <C>       <C>        <C>       <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets................................  $109,551   $51,538   $113,188   $65,126    $  66,302
Working capital...............................    75,563    33,896     92,670    55,084        1,072
Total assets..................................   138,508    74,833    131,042    77,569      130,717
Current liabilities...........................    33,988    17,492     20,518    10,042       65,230
Long-term debt................................    53,937    52,987     43,454    42,354       53,081
Shareholders' equity..........................    50,583     4,354     67,070    25,173       12,406
</TABLE>
 
---------------
(1) The Merger was consummated on July 30, 1996, and was accounted for as a
    purchase of JTS by Atari. Subsequent to the Merger, the fiscal year of the
    Company was changed from a 52/53 week fiscal year ending on the Saturday
    closest to December 31 to a 52/53 week fiscal year ending on the Sunday
    closest to January 31. Accordingly, the Company's current fiscal year begins
    on January 29, 1996 and the twelve-month period for fiscal 1997 includes the
    results of Atari's options from January 29, 1996 through February 2, 1997
    and JTS' operations from July 30, 1996 through February 2, 1997.
 
(2) Includes a gain from the sale of marketing securities of $3.9 million and a
    loss from disposal of obsolete equipment of $2.7 million in 1997 and a gain
    from the settlement of patent litigation of $32.1 million in 1994.
 
                                       22
<PAGE>   25
 
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
 
     This document includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. All statements other than statements of historical fact
included in this Prospectus, including without limitation, statements regarding
the Company's financial position, business strategy, budgets and the plans and
objectives of management for future operations, including plans and objectives
relating to the Company's products, are forward-looking statements. Although the
Company believes that assumptions underlying such forward-looking statements are
reasonable, it can give no assurance that such assumptions will prove to have
been correct. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Important cautionary
factors that could cause actual results to differ materially from the Company's
expectations include, but are not limited to, those disclosed under "Risk
Factors", "Business", and elsewhere in this 10-K. All written and oral
forward-looking statements attributable to the Company, or persons acting on its
behalf, are expressly qualified in their entirety by these cautionary
statements. Prospective investors should consider carefully the information
discussed under "Risk Factors", "Business", and elsewhere in this 10-K.
 
JTS AND ATARI BACKGROUND
 
     On July 30, 1996, Atari was merged into JTS (the "Merger") and the separate
existence of Atari ceased. Although the business combination resulted in Atari
merging into the JTS legal entity, the substance of the transaction was that
Atari, as a public company with substantially greater operating history and net
worth, owned approximately 62% of the equity of the merged company. The
acquisition was accounted for as a purchase of JTS by Atari and, accordingly,
the operating results of JTS from July 30, 1996 forward were combined with
Atari's operating results and reported as JTS' operating results. The aggregate
purchase price of $112.3 million was allocated to the acquired assets and
liabilities of JTS.
 
     Subsequent to the Merger the Company changed its fiscal year from a 52/53
week fiscal year ending on the Saturday closest to December 31 to a 52/53 week
fiscal year ending on the Sunday closest to January 31. The Merger was accounted
for as a purchase of JTS by Atari, and, as such, the historical balance sheets
and the statements of operations for the prior years include Atari only. In
addition, due to the change in year end, Atari's balance sheet for the end of
transition period as of January 28, 1996 is included herein, as are Atari's
operating results for the one month period then ended.
 
     Throughout this discussion, "fiscal 1997" refers to the fiscal year ended
February 2, 1997.
 
     Prior to the merger with JTS, Atari significantly downsized its video game
operations due primarily to lack of market acceptance of its video game console,
Jaguar. This downsizing resulted in significant reductions in Atari's workforce
and significant curtailment of research and development and sales and marketing
activities for Jaguar and related products. Despite the introduction of four
additional game titles in the first quarter of 1996, sales of Jaguar and related
software remained disappointing. As a result, management revised estimates and
wrote-down inventory by $5.0 million in the first quarter of 1996 and by an
additional $3.3 million during July 1996. The prior business of Atari is now
conducted through the Company's Atari division; however, the Atari division is
not expected to represent a significant portion of the Company's business going
forward.
 
     The major portion of the Company's business today is its disk drive
division acquired in the merger with JTS, which designs, manufactures and
markets hard disk drives for use in notebook computers and desktop personal
computers. JTS was incorporated in February 1994 and remained in the development
stage until October 1995, when it began shipping its 3.5-inch "Palladium" disk
drives to customers in the United States and Europe. The Company currently has
three disk drive product families in production, the 3-inch form factor "Nordic"
family for notebook computers and the 3.5-inch form factor "Champ" and
"Champion" families for desktop personal computers. During the first quarter of
fiscal 1998, the Company introduced into production its higher performance
"Champion" family for desktop personal computers. During the second quarter of
fiscal 1998, the Champion drives are expected to entirely replace the Champ
drives.
 
                                       23
<PAGE>   26
 
     Through fiscal 1997, the Company had shipped over 800,000 disk drives,
consisting primarily of 3.5-inch drives. JTS began shipment of Nordic disk
drives to Compaq in the second quarter of fiscal 1997; however, to date volume
shipments of 3.0-inch drives have not occurred. The Company markets its disk
drives to computer companies and systems integrators for incorporation into
their computer systems and subsystems and to OEMs. The Company sells its
products through a direct sales force operating throughout the United States,
Europe and Asia, as well as through distributors in the United States, Europe,
Latin America and Canada.
 
     All of JTS' products are manufactured in Madras, India by its subsidiary,
JTS Technology (formerly Moduler Electronics (India) Pvt. Ltd.), which was
acquired in April 1996 and employed approximately 6,270 individuals at February
2, 1997.
 
     Since its inception, JTS has incurred significant losses which have
resulted from the substantial costs associated with the design and development
of its products, the establishment of manufacturing operations, the development
of a supplier base, and the marketing of its new products and the ramp up of
production volumes. JTS has yet to generate profits from its disk drive business
and cannot assure that it will achieve or maintain successful operations in the
future.
 
YEAR ENDED FEBRUARY 2, 1997 COMPARED TO THE ATARI YEAR ENDED DECEMBER 31, 1995
 
     The year ended February 2, 1997 operating results include only Atari for
the two quarters prior to the merger date, and for the two quarters after the
merger date the operations of both companies are included. For fiscal 1997, the
Company incurred a net loss of $152.5 million, including a one time charge of
$110 million, compared to a net loss for Atari for 1995 of $49.6 million.
 
     Total revenues for the Company for fiscal 1997 were $90.5 million compared
to $14.6 million for Atari for 1995. Included in the $90.5 million are $86.0
million in revenues derived from the sales of disk drive products during the
second half of fiscal 1997 on shipments of approximately 600,000 units. For the
entire fiscal year including the two quarters prior to the merger with Atari,
approximately 820,000 disk drives were shipped which generated revenues of
$119.1 million.
 
     The prior year's revenues of $14.6 million are entirely attributed to the
sale of Atari games, and sales of the Jaguar video game console represented 68%
of the total revenue for 1995.
 
     The gross margin deficit for fiscal 1997 was $9.8 million compared to $29.6
million for 1995. The fiscal 1997 gross margin deficit includes $3.7 million
attributed to the disk drive division for the six-month period after the merger
and $1.1 million is attributed to the Atari operations for the entire year. The
fiscal 1997 gross margin deficit includes approximately $3.3 million of
inventory write-offs related to Atari games, and a provision of approximately
$2.8 million for inventory allowances related to the disk drive operation. The
principal reasons for these allowances are obsolete and unsalable inventory and
costs associated with the repair of defective product. JTS anticipates recording
future inventory allowances, the level of which will depend upon a number of
factors including manufacturing yields, new product introductions, maturity or
obsolescence of product designs, inventory levels and competitive pressures. The
portion of the gross margin deficit attributed to the disk drive division also
included amounts provided for potential product returns and distributor price
protection of $2.8 million.
 
     The hard disk drive industry has been characterized by ongoing rapid price
erosion and resulting pressure on gross margins. JTS expects that hard disk
drive prices will continue to decline in the future and that competitors will
offer products which meet or exceed the performance capabilities of JTS
products. Due to such pricing pressures, JTS future gross margins will be
substantially dependent upon its ability to control manufacturing costs, improve
manufacturing yields and introduce new products on a timely basis.
 
     The $110 million one time charge represented that portion of the purchase
price which was attributed to in-process research and development and was
expensed in Atari's July operations as the technology had not yet reached
technological feasibility and did not have alternative future uses.
 
     Research and development expenses for JTS for 1997 were $12.8 million
compared to $5.4 million for Atari for 1995. The prior year's research and
development expenses reflect that of the video game business
 
                                       24
<PAGE>   27
 
only, which had begun to downsize. In the fourth quarter of 1995, Atari entirely
eliminated its internal Jaguar development teams and other development staff as
titles for Jaguar were completed. The fiscal 1997 research and development
expenses include six months of research and development expenses of the disk
drive division. The 1997 research and development expenses reflect amounts
significantly greater than the expenses incurred in the prior year due primarily
to salaries and benefits for staffing required for the design of disk drives and
the development of manufacturing processes as well as $1.9 million of expense
for amortization of purchased technology acquired at the time of the Merger.
Going forward, the company expects that research and development expenses will
continue to increase in the next fiscal year in absolute dollars but will
decline as a percent of revenues.
 
     Selling, general and administrative expenses for 1997 were $13.7 million
compared to $18.6 million for 1995. The decrease in such expenses was primarily
a result of the Atari division's staff reductions, reduced rent, reduced legal
fees and other operating costs. The Company expects selling, general and
administrative expenses will increase in the next fiscal year in absolute
dollars primarily to support the expansion of the disk drive marketing and sales
efforts, but will decline as a percent of revenues.
 
     Other income and expense for 1997 was a net expense of $2.8 million and
consisted primarily of $2.7 million of losses from disposal of obsolete
equipment, approximately $3.5 million of interest expense and approximately $3.9
million of realized gain from the sale of marketable securities. For 1995, other
income of $3.5 million was primarily due to realized gains of approximately $6.0
million from the sale of Dixon PLC holdings, which was offset by approximately
$2.0 million of interest expense on the $42 million of the Company's 5 1/4%
convertible debentures.
 
YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994
 
     Total revenues for Atari for 1995 were $14.6 million compared to $38.7
million for 1994. Sales of Jaguar and related products represented 68% and 76%
of total revenues for 1995 and 1994, respectively, and sales of other products
and royalties represented the balance of revenues in each such year. The
reduction in revenues was primarily the result of lower unit volumes of Jaguar
products and lower average selling prices of Jaguar and certain of its software
titles. In the first quarter of 1995, Atari reduced the suggested retail price
of Jaguar from its original price of $249.99 to $149.99. As a result of the
Jaguar price reductions, the substantial curtailment of sales and marketing
activities for Jaguar and the substantial curtailment of efforts by Atari and
independent software developers to develop additional software titles for
Jaguar, Atari expected sales of Jaguar and related products to decline
substantially in 1996 and thereafter.
 
     Cost of revenues for 1995 was $44.2 million compared to $35.2 million for
1994. Included in cost of revenues for 1995 were accelerated amortization and
write-offs of capitalized game software development costs of $16.6 million and
inventory write-downs of $12.6 million primarily relating to Jaguar products. As
a result of these charges and lower selling prices for Jaguar products and
provisions for returns and allowances and price protection, gross margin for the
year was a loss of $29.6 million. For 1994, gross margin was $3.5 million, or
9.2% of revenues. Included in cost of revenues for 1994 were write-downs of
inventory of $3.6 million and amortization and the write-off of capitalized game
software development costs of $1.5 million. As of December 31, 1995, Atari had
approximately 100,000 units of the Jaguar console in inventory which was
subsequently written off in 1996.
 
     Research and development expenses for 1995 were $5.4 million compared to
$5.8 million for 1994. During 1995 and 1994, a significant number of Atari
employees and consultants were devoted to developing hardware and software for
the Jaguar, and Atari contracted with third-party software developers to develop
Jaguar software titles. As a result of Jaguar's poor sales performance, in the
third and fourth quarters of 1995, Atari accelerated its amortization of
contracted software development which resulted in charges in those quarters of
$6.0 million and $10.6 million, respectively. At December 31, 1995 and 1994,
Atari had capitalized software development costs of $758,000 and $5.1 million,
respectively. In the fourth quarter of 1995, Atari eliminated its internal
Jaguar development teams and other development staff as titles for Jaguar were
completed.
 
                                       25
<PAGE>   28
 
     Marketing and distribution expenses for 1995 were $12.7 million compared to
$14.7 million for 1994. Such costs included television and print media,
promotions and other activities to promote Jaguar.
 
     General and administrative expenses for 1995 were $5.9 million compared to
$7.2 million for 1994. The decrease in such expenses was primarily a result of
staff reductions, reduced legal fees and other operating costs.
 
     Atari experienced a gain on foreign currency exchange of $13,000 for 1995
compared to a gain of $1.2 million for 1994. These changes were a result of
lower foreign asset exposure and a greater percentage of sales made in U.S.
dollars which further reduced exposure to foreign currency transaction
fluctuations.
 
     In 1994, Atari received $2.2 million in connection with the settlement of
litigation between Atari, Atari Games Corporation and Nintendo. In 1994, Atari
also reached an agreement with Sega, which resulted in a gain of $29.8 million,
after contingent legal fees, and the sale of 4,705,883 shares of Atari Common
Stock to Sega at $8.50 per share for an aggregate of $40.0 million.
 
     During 1995, Atari sold a portion of its holdings in Dixon PLC, a retailer
in England, and realized a gain of $2.4 million, of which $1.8 million was
realized in the fourth quarter of 1995. In the first quarter of 1996, Atari sold
the remaining portion of its holdings and realized a gain of $6.1 million. The
1995 gain of $2.4 million together with other income items resulted in a total
other income of $2.7 million compared to $484,000 for 1994.
 
     For each of 1995 and 1994, interest expense was approximately $2.3 million
on the Atari Debentures. In 1995, Atari repurchased a portion of the Atari
Debentures and realized a gain of $582,000. As of December 31, 1995, the
outstanding balance of these debentures was $42.4 million.
 
     Interest income for 1995 and 1994 was $3.1 million and $2.0 million,
respectively. The increase in interest income was primarily attributable to
higher average cash balances in 1995.
 
     As a result of Atari's operating losses, there was no provision for income
taxes in 1995.
 
     As a result of the factors discussed above, Atari reported a net loss for
1995 of $49.6 million compared to net income of $9.4 million in 1994.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     As of February 2, 1997, the Company had cash and cash equivalents of $24.8
million, working capital of $1.8 million and a net worth of $12.4 million.
 
     At February 2, 1997, total debt, including bank credit lines and notes
payable, was $64.4 million. The Company had a $5.0 million revolving line of
credit with Silicon Valley Bank which bore interest at the bank's prime rate
plus .75%. As of February 2, 1997, all amounts available under this line were
drawn. The principal amount was replaced by a factoring arrangement of the same
amount which the Company entered into with Silicon Valley Bank in April 1997.
During 1997 the Company also entered into an agreement with a European bank to
finance certain of the Company's European accounts receivable. At February 2,
1997, $3.0 million was outstanding under this agreement. The Company also had
equipment lease financing of $4.2 million at February 2, 1997. There were $5.5
million of working capital loans outstanding between JTS Technology and two
Indian banks at interest rates ranging from 13% to 15% as of February 2, 1997,
as well as borrowing under term loan facilities with the Industrial Credit and
Investment Corporation of India Limited (ICICI) and the Shipping Credit and
Investment Corporation of India Limited (SICI) in the amount of $11.0 million at
interest rates of LIBOR plus 2.75% and LIBOR plus 4%, respectively. The term
loans are due in 2000 through 2002. Amounts borrowed under these loan agreements
have been used for working capital purposes, tooling, facilities expansion and
purchases of capital equipment.
 
     Certain sources of financing in India require the Company to comply with
stringent financial covenants. In this regard, certain unsecured debt and equity
required under one loan agreement has not been obtained. However, management
believes that the lender is unlikely to require JTS to immediately repay
advances outstanding for non-compliance with debt covenants. JTS believes that
such matter will not have a material
 
                                       26
<PAGE>   29
 
adverse effect on JTS' business, operating results or financial condition.
However, JTS may not be able to renew or maintain its current Indian financing
facilities and its failure to do so would have a material adverse effect on JTS'
business, operating results and financial condition.
 
     At February 2, 1997, the Company had $42.3 million of 5 1/4% convertible
subordinated debentures due April 29, 2002, which had originally been issued by
Atari in 1987.
 
     JTS has yet to generate profits and cannot assure that profits will be
attained or that JTS will achieve or maintain successful operations in the
future. The Company's accounts receivable are heavily concentrated with a small
number of customers. If any large customer of the Company became unable to pay
its debts to the Company, liquidity would be adversely affected. In the event
the Company is unable to increase sales or maintain production yields at
acceptable levels there would be a significant adverse impact on liquidity. This
would require the Company to either obtain additional capital from external
sources or to curtail its capital, research and development and working capital
expenditures. Such curtailment could adversely affect the Company's operations
and competitive position. Due to delays in the receipt of additional financing,
the Company took action in September 1996 to conserve its cash resources by
reducing the production of drives planned for the third and fourth quarters of
fiscal 1997.
 
     In September 1996, the Company sold certain of its real estate acquired
from Atari in the Merger to one of its board members for $10 million. The
property was sold at fair value, and the Company has an option to repurchase the
property one year from the date of sale for $10 million. Also, in early November
1996, the Company completed a $15 million private financing involving the sale
of its Series B Preferred Stock. In January 1996, the Company completed a $25
million private financing involving the sale of its Series C Preferred Stock.
 
     The Company will need significant additional financing resources over the
next several years for working capital, facilities expansion and capital
equipment. In fiscal year 1998, the Company plans approximately $17 million in
capital expenditures related primarily to equipment and facilities required to
increase drive production volumes in its Madras, India facility. In addition,
significant cash resources will be required to fund purchases of inventory
needed to achieve anticipated sales levels. Failure to obtain such cash
resources will negatively impact the Company's ability to manufacture its
products at required levels. The Company is currently pursuing working capital
and equipment financing options and, in April 1997, received commitments for a
$30 million revolving line of credit, a $25 million accounts receivable line and
a $5 million equipment lease line from three financial institutions.
 
     The precise amount and timing of the Company's funding needs beyond these
amounts cannot be determined at this time and will depend upon a number of
factors, including the market demand for its products, the progress of the
Company's product development efforts and the Company's inventory and accounts
receivable management. The Company currently expects that it would seek to
obtain such funds from additional borrowing arrangements and/or public offering
of debt and equity securities. There can be no assurance that funds required by
the Company in the future will be available on terms satisfactory to the Company
or at all.
 
     As of February 2, 1997, the Company had Federal net operating losses
("NOLs") and tax credit carryforwards in the amount of approximately $245
million and $2 million, respectively. Under the Internal Revenue Code of 1986,
as amended (the "Code"), certain changes in the ownership or business of a
corporation that has NOLs or tax credit carryforwards will result in the
inability to use or the imposition of significant restrictions on the use of
such NOLs or tax credit carryforwards to offset future income and tax
liabilities of the Company. The merger between Atari and JTS constituted a
change in ownership with respect to JTS and, accordingly, restricts the use of
JTS' pre-merger NOLs against post-merger income of the Company to the maximum of
$12.5 million per year, unless previously expired. In addition, subsequent
events may result in the imposition of restrictions on the ability of the
Company to utilize its NOLs and tax credit carryforwards. There can be no
assurance that the Company will be able to utilize all or any of its NOLs or tax
credit carryforwards.
 
                                       27
<PAGE>   30
 
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
<TABLE>
<S>                                                                                   <C>
Independent Auditors' Reports.......................................................  29, 30
Consolidated Balance Sheets
  February 2, 1997; January 28, 1996 and December 31, 1995..........................    31
Consolidated Statements of Operations for the year ended February 2, 1997; the
  one-month period ended January 28, 1996; and the years ended December 31, 1995 and
  1994..............................................................................    32
Consolidated Statements of Shareholders' Equity for the year ended February 2, 1997;
  the one-month period ended January 28, 1996; and the years ended December 31, 1995
  and 1994..........................................................................    33
Consolidated Statements of Cash Flows for the year ended February 2, 1997; the
  one-month period ended January 28, 1996; and the years ended December 31, 1995 and
  1994..............................................................................    34
Notes to Consolidated Financial Statements..........................................    35
II  Valuations and Qualifying Accounts..............................................    50
</TABLE>
 
                                       28
<PAGE>   31
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Shareholders and Board of Directors
  of JTS Corporation:
 
     We have audited the accompanying consolidated balance sheets of JTS
Corporation (formerly Atari Corporation) and subsidiaries as of February 2, 1997
and January 28, 1996, and the related consolidated statements of operations,
shareholders' equity, and cash flows for the year ended February 2, 1997 and the
one month ended January 28, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of JTS Corporation and
subsidiaries as of February 2, 1997 and January 28, 1996 and the results of
their operations and their cash flows for the year ended February 2, 1997 and
the one month period ended January 28, 1996 in conformity with generally
accepted accounting principles.
 
                                          ARTHUR ANDERSEN LLP
 
San Jose, California
April 21, 1997
 
                                       29
<PAGE>   32
 
                        REPORT OF DELOITTE & TOUCHE LLP
 
To the Shareholders and Board of Directors
  of Atari Corporation:
 
     We have audited the accompanying consolidated balance sheet of Atari
Corporation and subsidiaries as of December 31, 1995, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
the two years in the period ended December 31, 1995. Our audits also included
the financial statement schedule for the two years in the period ended December
31, 1995 listed in the Index at Item 14. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Atari Corporation and
subsidiaries at December 31, 1995 and the results of their operations and their
cash flows for each of the two years in the period ended December 31, 1995 in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
 
DELOITTE & TOUCHE LLP
 
San Jose, California
March 1, 1996
 
                                       30
<PAGE>   33
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
                          CONSOLIDATED BALANCE SHEETS
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                  FEBRUARY 2,     JANUARY 28,     DECEMBER 31,
                                                                     1997            1996             1995
                                                                  -----------     -----------     ------------
<S>                                                               <C>             <C>             <C>
                                                    ASSETS
CURRENT ASSETS:
  Cash and cash equivalents (including $1,800, $700 and $700
    held as restricted balances in 1997, 1996, and 1995,
    respectively)...............................................   $  24,766       $  31,790       $   28,941
  Marketable securities.........................................          --          16,460           21,649
  Accounts receivable, less allowances for returns and doubtful
    accounts of $1,615, $4,271 and $4,221 in 1997, 1996 and
    1995, respectively..........................................      21,445           2,784            2,468
  Inventories...................................................      17,750           5,666           10,934
  Other current assets..........................................       2,341           1,895            1,134
                                                                   ---------       ---------        ---------
         Total current assets...................................      66,302          58,595           65,126
PROPERTY AND EQUIPMENT, net.....................................      27,674             599              671
REAL ESTATE HELD FOR SALE.......................................          --          10,443           10,468
ACQUIRED TECHNOLOGY, net........................................      19,618              --               --
GOODWILL, net...................................................      16,673              --               --
OTHER ASSETS....................................................         450             538            1,304
                                                                   ---------       ---------        ---------
         TOTAL..................................................   $ 130,717       $  70,175       $   77,569
                                                                   =========       =========        =========
</TABLE>
 
                      LIABILITIES AND SHAREHOLDERS' EQUITY
 
<TABLE>
<S>                                                               <C>             <C>             <C>
CURRENT LIABILITIES:
  Bank line of credits..........................................   $  10,540       $      --       $       --
  Borrowings under factoring arrangement........................       2,981              --               --
  Accounts payable..............................................      33,327           4,316            4,954
  Accrued liabilities...........................................      16,415           5,847            5,088
  Current portion of long-term obligations......................       1,967              --               --
                                                                   ---------       ---------        ---------
         Total current liabilities..............................      65,230          10,163           10,042
                                                                   ---------       ---------        ---------
LONG-TERM OBLIGATIONS...........................................      53,081          42,354           42,354
                                                                   ---------       ---------        ---------
COMMITMENTS AND CONTINGENT LIABILITIES (Note 11)
 
SHAREHOLDERS' EQUITY:
  Convertible preferred stock, $.001 par value -- authorized,
    10,000,000 shares; 40,000 shares outstanding in 1997;
    liquidation value of $40,227................................          --              --               --
  Common Stock, $.001 par value in 1997 and $.01 par value in
    1996 and 1995 -- authorized, 150,000,000 shares;
    outstanding: 104,744,765, 63,690,418, and 63,687,118 in
    1997, 1996 and 1995, respectively...........................         105             637              637
  Additional paid-in capital....................................     349,961         196,213          196,209
  Notes receivable from shareholders............................      (2,510)             --               --
  Unrealized gain on marketable securities......................          --           3,930            7,088
  Cumulative translation adjustments............................          --            (694)            (663)
  Accumulated deficit...........................................    (335,150)       (182,428)        (178,098)
                                                                   ---------       ---------        ---------
         Total shareholders' equity.............................      12,406          17,658           25,173
                                                                   ---------       ---------        ---------
         TOTAL..................................................   $ 130,717       $  70,175       $   77,569
                                                                   =========       =========        =========
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       31
<PAGE>   34
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                ONE MONTH
                                                                  PERIOD
                                                                  ENDED        YEARS ENDED DECEMBER
                                                YEAR ENDED       JANUARY                31,
                                               FEBRUARY 2,         28,         ---------------------
                                                   1997            1996          1995         1994
                                               ------------     ----------     --------     --------
<S>                                            <C>              <C>            <C>          <C>
REVENUES......................................  $   90,530       $    735      $ 14,626     $ 38,748
                                                  --------       --------      --------     --------
COST AND EXPENSES:
  Cost of revenues............................     100,328          6,156        44,234       35,200
  Acquired in-process research and
     development..............................     110,012             --            --           --
  Amortization of acquired technology.........       3,923             --            --           --
  Research and development....................      12,849            161         5,410        5,775
  Selling, general and administrative.........      13,067          1,089        18,647       21,820
                                                  --------       --------      --------     --------
          Total operating expenses............     240,179          7,406        68,291       62,795
                                                  --------       --------      --------     --------
OPERATING LOSS................................    (149,649)        (6,671)      (53,665)     (24,047)
Settlements of patent litigation..............          --             --            --       32,062
Exchange gain (loss)..........................        (590)          (115)           13        1,184
Other income, net.............................         394          2,533         2,670          484
Interest income...............................         895            112         3,133        2,015
Interest expense..............................      (3,545)          (189)       (2,309)      (2,304)
                                                  --------       --------      --------     --------
INCOME (LOSS) BEFORE EXTRAORDINARY CREDIT.....    (152,495)        (4,330)      (50,158)       9,394
Extraordinary credit -- gain on extinguishment
  of 5 1/4% convertible subordinated
  debentures..................................          --             --           582           --
                                                  --------       --------      --------     --------
NET INCOME (LOSS).............................  $ (152,495)      $ (4,330)     $(49,576)    $  9,394
                                                  ========       ========      ========     ========
EARNINGS (LOSS) PER COMMON SHARE:
  Income (loss) before extraordinary credit...  $    (1.81)      $  (0.07)     $  (0.79)    $   0.16
  Net income (loss)...........................  $    (1.81)      $  (0.07)     $  (0.78)    $   0.16
  Weighted average shares used in
     computations.............................      84,322         63,687        63,697       58,962
                                                  ========       ========      ========     ========
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       32
<PAGE>   35
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                    NOTES
                                                                  RECEIVABLE
                 CONVERTIBLE                                         FROM      UNREALIZED
               PREFERRED STOCK      COMMON STOCK     ADDITIONAL    SALE OF      GAIN ON     CUMULATIVE
               ----------------   ----------------    PAID-IN       COMMON     MARKETABLE   TRANSLATION   ACCUMULATED
               SHARES   AMOUNT    SHARES    AMOUNT    CAPITAL       STOCK      SECURITIES   ADJUSTMENTS     DEFICIT       TOTAL
               ------   -------   -------   ------   ----------   ----------   ----------   -----------   -----------   ---------
<S>            <C>      <C>       <C>       <C>      <C>          <C>          <C>          <C>           <C>           <C>
 
BALANCES,
 DECEMBER 31,
   1993.......    --    $   --    57,215    $ 572     $142,497     $     (3)    $     --      $  (796)     $(137,916)   $   4,354
Sale of common
 stock........                     6,277       63       53,270                                                             53,333
Stock options
 exercised....                       157        1          371                                                                372
Collection of
 notes
 receivable...                                                            3                                                     3
Translation
adjustments...                                                                                   (928)                       (928)
Unrealized
 gain on
 marketable
 securities...                                                                       542                                      542
Net income....                                                                                                 9,394        9,394
               ------   ------    ------     ----     --------         ----      -------       ------         ------    ---------
 
BALANCES,
 DECEMBER 31,
   1994.......    --        --    63,649      636      196,138           --          542       (1,724)      (128,522)      67,070
Stock options
 exercised....                        82        1          109                                                                110
Stock
repurchased...                       (44)                  (38)                                                               (38)
Translation
adjustments...                                                                                  1,061                       1,061
Unrealized
 gain on
 marketable
 securities...                                                                     6,546                                    6,546
Net loss......                                                                                               (49,576)     (49,576)
               ------   ------    ------     ----     --------         ----      -------       ------         ------    ---------
 
BALANCES,
 DECEMBER 31,
   1995.......    --        --    63,687      637      196,209           --        7,088         (663)      (178,098)      25,173
Stock options
 exercised....                         4                     4                                                                  4
Translation
 adjustment...                                                                                    (31)                        (31)
Change in
 unrealized
 gain on
 marketable
 securities...                                                                    (3,158)                                  (3,158)
Net loss......                                                                                                (4,330)      (4,330)
               ------   ------    ------     ----     --------         ----      -------       ------         ------    ---------
 
BALANCES,
 JANUARY 28,
   1996.......    --        --    63,691      637      196,213           --        3,930         (694)      (182,428)      17,658
Change in
 unrealized
 gain on
 marketable
 securities...                                                                    (3,930)                                  (3,930)
Common stock
 issued in
 connection
 with JTS
acquisition...                    39,907       40      113,562       (2,510)                                              111,092
Reduction of
 par value
 from $.01
 per share to
 $.001 per
 share........                               (573)         573
Issuance of
 convertible
 Series B and
 C preferred
 stock, net of
 $2,027
 issuance
 costs........    40        --                          37,973                                                             37,973
Stock options
 exercised....                     1,147        1        1,640                                                              1,641
Translation
 adjustment...                                                                                    694                         694
Preferred
 stock
 dividends....                                                                                                  (227)        (227)
Net loss......                                                                                              (152,495)    (152,495)
               ------   ------    ------     ----     --------         ----      -------       ------         ------    ---------
 
BALANCES,
 FEBRUARY 2,
   1997.......    40    $   --    104,745   $ 105     $349,961     $ (2,510)    $     --      $    --      $(335,150)   $  12,406
               ======   ======    ======     ====     ========         ====      =======       ======         ======    =========
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       33
<PAGE>   36
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                                                  ONE MONTH
                                                                  YEAR ENDED       PERIOD            YEARS ENDED
                                                                   FEBRUARY         ENDED            DECEMBER 31,
                                                                      2,         JANUARY 28,     --------------------
                                                                     1997           1996           1995        1994
                                                                  ----------     -----------     --------     -------
<S>                                                               <C>            <C>             <C>          <C>
OPERATING ACTIVITIES:
  Net income (loss).............................................  $(152,495)       $(4,330)      $(49,576)    $ 9,394
  Adjustments to reconcile net income (loss) to net cash
    provided (used) by operating activities:
    Depreciation................................................      7,505            363          2,270       2,619
    Acquired in-process research and development................    110,012             --             --          --
    Amortization of goodwill and acquired technology............      5,207             --             --          --
    Loss from disposal of equipment and real estate.............      2,700             31             --          --
    Gain on sale of marketable securities.......................     (3,930)        (2,436)        (2,377)         --
    Gain from extinguishment of debentures......................         --             --           (582)         --
    Change in operating assets/liabilities
    Accounts receivable.........................................    (10,056)          (316)         6,715      (3,626)
    Inventories.................................................        676          5,268          7,251      (8,815)
    Other current assets........................................        797             (4)        16,973         468
    Other assets................................................         89              8             --          --
    Accounts payable............................................      5,625           (637)        (7,193)      3,763
    Accrued liabilities.........................................      1,931            759            (42)       (660)
                                                                   --------       --------       --------     -------
  Net cash provided (used) by operating activities..............    (31,939)        (1,294)       (26,561)      3,143
INVESTING ACTIVITIES:
    Cash acquired in connection with the Merger.................        684             --             --          --
    Loan to JTS Corporation prior to the Merger.................    (30,000)            --             --          --
    Proceeds from sale of marketable securities.................     16,460          4,467         55,703          --
    Purchase of marketable securities...........................         --             --         (9,997)    (50,000)
    Purchase of property and equipment..........................    (16,239)          (297)          (782)     (1,207)
    Proceeds from sale of property and equipment................     10,000             --             29       7,543
    Game software development costs.............................         --             --        (12,791)     (5,810)
    Other assets................................................         --             --            107         482
                                                                   --------       --------       --------     -------
  Net cash provided (used) by investing activities..............    (19,095)         4,170         32,269     (48,992)
FINANCING ACTIVITIES:
    Extinguishment of debentures................................         --             --           (518)         --
    Borrowing under line of credit and bank borrowings..........      7,084             --             --          --
    Repayments of borrowings....................................         --             --             --      (7,642)
    Repayments of capital leases................................     (3,382)            --             --          --
    Issuance of common stock....................................      1,641              4             72      53,708
    Issuance of preferred stock.................................     40,000             --             --          --
    Issuance costs of preferred stock...........................     (2,027)            --             --          --
                                                                   --------       --------       --------     -------
  Net cash provided (used) by financing activities..............     43,316              4           (446)     46,066
  EFFECT OF EXCHANGE RATE CHANGES...............................        694            (31)         1,087        (684)
                                                                   --------       --------       --------     -------
  NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..........     (7,024)         2,849          6,349        (467)
  CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD..............     31,790         28,941         22,592      23,059
                                                                   --------       --------       --------     -------
  CASH AND CASH EQUIVALENTS AT END OF PERIOD....................  $  24,766        $31,790       $ 28,941     $22,592
                                                                   ========       ========       ========     =======
NONCASH INVESTING AND FINANCING ACTIVITIES:
  Issuance of common stock and assumptions of warrants and
    employee stock options in connection with the Merger........  $ 111,093        $    --       $     --     $    --
  Liabilities of $84,308 assumed net of related assets of
    $45,297 acquired from the Merger............................     39,011             --             --          --
  Notes receivable from shareholders acquired from the Merger...      2,510             --             --          --
  Extinguishment of note receivable from the Merger.............     30,000             --             --          --
  Exchange of inventory for advertising services................         --             --             --       3,179
  Exchange of property for retirement of debt...................         --             --             --       1,891
</TABLE>
 
                See notes to consolidated financial statements.
 
                                       34
<PAGE>   37
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. ORGANIZATION AND OPERATIONS:
 
     Atari Corporation ("Atari" or the "Company") was formed to design and
market interactive multimedia entertainment systems and related software and
peripheral products. On July 30, 1996, Atari merged into JTS Corporation
("JTS"), a manufacturer of hard disk drives for notebook and desktop personal
computers. Due to a lack of market acceptance of its video game console, Jaguar,
Atari had significantly downsized its video game operations prior to the merger,
described below. This downsizing resulted in significant reductions in Atari's
workforce and significant curtailment of research and development and sales and
marketing activities for Jaguar and related products. Despite the introduction
of additional game titles in the first quarter of 1996, sales of Jaguar and
related software remained disappointing such that by the end of fiscal 1997
approximately all of the remaining inventory had been written off. The prior
business of Atari is now conducted through the Company's Atari division;
however, the Atari division does not and is not expected to represent a
significant portion of the Company's business going forward.
 
     The most significant portion of the Company's business today is its disk
drive division acquired in the merger with JTS, which designs, manufactures and
markets hard disk drives for use in notebook computers and desktop personal
computers. JTS was incorporated in February 1994 and remained in the development
stage until October 1995, when it began shipping its 3.5-inch "Palladium" disk
drives to customers in the United States and Europe. The Company currently has
three disk drive product families in production, the 3-inch form factor "Nordic"
family for notebook computers and the 3.5-inch form factor "Champ" and
"Champion" families for desktop personal computers. The Company introduced into
production its higher performance "Champion" family for desktop personal
computers in the first quarter of fiscal 1998. All of JTS' products are
manufactured in Madras, India by its subsidiary, JTS Technology Ltd. (formerly
Moduler Electronics (India) Pvt. Ltd.).
 
     On July 30, 1996, Atari was merged with JTS (the "Merger") and the separate
existence of Atari ceased. Although the business combination resulted in Atari
merging into the JTS legal entity, the substance of the transaction was that
Atari, as a public company with substantially greater operating history and net
worth owned approximately 62% of the equity of the merged company. Therefore,
for accounting purposes the merger was accounted for as a purchase of JTS by
Atari. (See Note 3.)
 
     The hard disk drive business is extremely capital intensive, and the
Company will need significant additional financing resources in 1998 and over
the next several years for facilities expansion, capital expenditure, working
capital, research and development and vendor tooling. There can be no assurance
that additional funding will be available on terms acceptable to the Company or
at all. If the Company is unable to obtain sufficient capital, it would be
required to curtail its facilities expansion, capital expenditures, working
capital, research and development and vendor tooling expenditures, which would
materially adversely affect, the Company's business, operating results and
financial condition.
 
2. SIGNIFICANT ACCOUNTING POLICIES
 
     Principles of Consolidation -- The consolidated financial statements
include the Company and its subsidiaries. All intercompany transactions and
balances have been eliminated in consolidation.
 
     Pervasiveness of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
 
     Cash and Cash Equivalents -- For purposes of the statements of cash flows,
the Company considers all highly liquid debt instruments purchased with original
maturities of less than three months to be cash equivalents.
 
                                       35
<PAGE>   38
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Restricted Cash -- As of February 2, 1997, January 28, 1996 and December
31, 1995, cash balances of $1,800,000, $700,000 and $700,000 were collateral for
outstanding commercial letters of credit associated with inventory components,
software development agreements and for bank borrowings.
 
     Marketable Securities -- Marketable securities are carried as
available-for-sale securities and reported at the fair market value. Unrealized
gains and losses are reported as a separate component of shareholders' equity
until realized. The cost of securities sold is based on average cost.
 
     Factored Receivables with Recourses -- Certain accounts receivable have
been factored with recourse with a European bank. The net cash proceeds from the
bank amounted to $2,981,000 as of February 2, 1997 and are reflected as a
current liability in the accompanying balance sheet.
 
     Concentration of Credit Risk -- The Company sells its products to original
equipment manufacturers and distributors throughout the world. The Company
performs ongoing credit evaluations of its customers' financial condition and,
generally, requires no collateral from its customers. The Company maintains an
allowance for uncollectible accounts receivable based upon the expected
collectibility of all accounts receivable.
 
     Inventories -- Inventories are stated at the lower of cost (first-in,
first-out basis) or market and consist of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                       FEBRUARY 2,     JANUARY 28,     DECEMBER 31,
                                                          1997            1996             1995
                                                       -----------     -----------     ------------
    <S>                                                <C>             <C>             <C>
    Finished goods...................................    $   489         $ 5,666         $  9,927
    Raw materials and work-in-process................     17,261              --            1,007
                                                         -------         -------          -------
         Total.......................................    $17,750         $ 5,666         $ 10,934
                                                         =======         =======          =======
</TABLE>
 
     Property and Equipment -- Property and equipment are stated at cost and are
depreciated using the straight-line method over estimated useful lives of two to
seven years. Repairs and maintenance costs are expensed as incurred. Major
renewals and betterments which substantially extend the useful life of the asset
are capitalized.
 
     Real Estate Held for Sale -- Real property associated with closed
operations of former Atari Corporation in the United States is stated at
estimated market value as of December 31, 1995 and January 28, 1996 as
determined by valuations, appraisals or pending sales offers. The real property
was sold at fair value to one of the Company's directors in September 1996 for
cash of $10 million. The Company has an option to repurchase the property from
the director before September 1997 for $10 million.
 
     Research and Development -- Research and development costs are expensed as
incurred and consist primarily of salaries, materials and supplies.
 
     Revenue Recognition and Product Warranty -- Revenue from product sales is
generally recognized upon shipment to customers. The Company warrants its
products against defects in design, materials and workmanship generally for
three years. A provision for estimated future costs relating to warranty expense
is recorded when products are shipped.
 
     Foreign Currency Translation -- For the one month ended January 28, 1996
and the years ended December 31, 1995 and 1994, assets and liabilities of
operations outside the United States were translated into United States dollars
using current exchange rates, and the effects of foreign currency translation
adjustments were deferred and included as a component of shareholders' equity.
During the year ended February 2, 1997, the functional currency of the
operations outside the United States was deemed to be the U.S. dollar due to the
change of the operations discussed in Note 1. As a result, the effects of
foreign currency translation adjustments are now charged to the statement of
operations.
 
                                       36
<PAGE>   39
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Accounting for Stock Based Compensation -- The Company accounts for
stock-based compensation under the provisions of Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25). The Company
has adopted the disclosure provisions of Statement of Financial Accounting
Standards No. 123 "Accounting for Stock-Based Compensation," effective January
29, 1996. (See Note 10.)
 
     Income (Loss) per Common Share -- Net income per common share is computed
using the weighted average number of common and dilutive common equivalent
shares outstanding during the period. Net loss per share is based on the
weighted average number of common shares outstanding during the period. Common
equivalent shares have not been included in the calculation of loss per share as
their inclusion would be antidilutive. The effect of the assumed conversion of
the 5 1/4% convertible subordinated debentures was antidilutive for all periods
presented and excluded from the computation.
 
     Fiscal Year -- The fiscal year of the Company was a 52- or 53-week period
ending the Saturday closest to December 31 for 1994 and 1995. Subsequent to the
Merger, the Company changed its fiscal year to a 52/53 week fiscal year ending
on the Sunday closest to January 31. Accordingly, the Company's current fiscal
year commenced on January 29, 1996, ended on February 2, 1997 and included 53
weeks. The financial statements for the transition period from January 1, 1996
to January 28, 1996 are also included herein.
 
     Reclassifications -- Certain reclassifications have been made to prior
period financial statements to conform to the current presentation.
 
3. MERGER WITH JTS CORPORATION
 
     Prior to the Merger, the Company had made a $30 million loan to JTS and
upon consummation of the merger the loan was cancelled. The merger was accounted
for as a purchase of JTS by Atari and, accordingly, the operating results of JTS
from July 30, 1996, the date of the merger, have been included in the
accompanying financial statements. The allocation resulted in $133.6 million
allocated to purchased technology, $110 million of which represented in-process
research and development. The $110 million has been expensed in the accompanying
statement of operations for the year ended February 2, 1997, as the technology
had not yet reached technological feasibility and does not have alternative
future uses.
 
     The purchase price has been allocated as follows (in thousands):
 
<TABLE>
        <S>                                                                 <C>
        Inventories, trade accounts receivable and other current assets...  $ 24,697
        Equipment and tooling.............................................    20,600
        In-process research and development...............................   110,012
        Acquired technology...............................................    23,542
        Goodwill..........................................................    17,956
        Liabilities assumed...............................................   (84,308)
                                                                            ---------
             Net assets acquired..........................................  $112,499
                                                                            =========
</TABLE>
 
     Acquired technology and goodwill are amortized using the straight-line
method over seven and ten years, respectively and the accumulated amortization
as of February 2, 1997 was $3,924,000 and $1,283,000 for existing technology and
goodwill, respectively.
 
     In April 1996, JTS acquired 90% of the outstanding shares of Moduler
Electronics, a contract disk drive component manufacturer, the owner of which is
a significant shareholder of JTS. JTS acquired the stock in consideration for
1,911,673 shares of JTS' Series A preferred stock and a warrant to purchase
750,000 shares of JTS' common stock at an exercise price of $0.25 per share. The
acquisition was accounted for as a purchase.
 
                                       37
<PAGE>   40
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In connection with the acquisition, net assets acquired were as follows:
 
<TABLE>
        <S>                                                                 <C>
        Inventories and other current assets..............................  $  9,542
        Equipment and leasehold improvements..............................     7,754
        Current liabilities assumed.......................................   (12,681)
        Long-term liabilities assumed.....................................    (2,768)
                                                                            --------
                  Net assets acquired.....................................  $  1,847
                                                                            ========
</TABLE>
 
     The following unaudited proforma financial information shows the results of
operations for the fiscal years ended February 2, 1997 and December 31, 1995 as
if the JTS acquisition and JTS' acquisition of Moduler Electronics had occurred
at the beginning of each period presented. The results are not necessarily
indicative of what would have occurred had the acquisitions actually been made
at the beginning of each of the respective periods presented or of future
operations of the combined companies. The proforma results for 1997 combine
Atari's, JTS' and Moduler Electronics' results for the fiscal year ended
February 2, 1997. The proforma results for 1995 combine Atari's results for the
fiscal year ended December 31, 1995 with JTS' and Moduler Electronics' fiscal
year ended January 28, 1996.
 
<TABLE>
<CAPTION>
                                                                     FISCAL YEARS ENDED
                                                           --------------------------------------
                                                           FEBRUARY 2, 1997     DECEMBER 31, 1995
                                                           ----------------     -----------------
    <S>                                                    <C>                  <C>
    Revenue..............................................     $  124,294            $  33,403
    Net loss.............................................       (182,794)             (96,997)
    Net loss per share...................................     $    (1.75)           $   (0.94)
    Weighted average common shares outstanding...........        104,356              103,697
</TABLE>
 
4. FINANCIAL INSTRUMENTS
 
     Marketable Securities -- Marketable securities available-for-sale consist
of the following (in thousands):
 
<TABLE>
<CAPTION>
                                                JANUARY 28, 1996                  DECEMBER 31, 1995
                                        --------------------------------   --------------------------------
                                                                GROSS                              GROSS
                                        AMORTIZED   MARKET    UNREALIZED   AMORTIZED   MARKET    UNREALIZED
                                          COST       VALUE      GAINS        COST       VALUE      GAINS
                                        ---------   -------   ----------   ---------   -------   ----------
<S>                                     <C>         <C>       <C>          <C>         <C>       <C>
Equity securities --
  Dixon common stock..................   $ 2,534    $ 6,418     $3,884      $ 4,565    $11,606     $7,041
Government securities --
  Federal Home Loan Bank..............     4,993      5,009         16        4,993      5,026         33
  Federal Home Loan Mortgage Corp.....     5,003      5,033         30        5,003      5,017         14
                                         -------    -------    -------      -------    -------
     Total marketable securities......   $12,530    $16,460     $3,930      $14,561    $21,649     $7,088
                                         =======    =======    =======      =======    =======
</TABLE>
 
     The contractual maturities of the government securities range from two to
four years. All marketable securities were sold by February 2, 1997. Realized
gains were $3.9 million and $2.4 million for the years ended February 2, 1997
and December 31, 1995 and $2.4 million for the one month period ended January
28, 1996, which are included in "Other Income" in the accompanying statements of
operations.
 
     Fair Value of Financial Instruments -- The estimated fair value of the
5 1/4% convertible subordinated debentures issued by the Company and reflected
as long-term debt in the accompanying balance sheet at February 2, 1997 was
approximately $26 million based primarily on quoted market prices at that date.
The carrying amounts of the remainder of the Company's financial instruments at
February 2, 1997, consisting of cash and equivalents, approximate fair values
due to their short term maturities.
 
                                       38
<PAGE>   41
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
5. GAME SOFTWARE DEVELOPMENT COSTS
 
     Internal game software development costs are expensed as incurred as these
costs relate primarily to development tools. External development costs are
capitalized once technological feasibility has been determined. During 1995 and
1994, the Company capitalized $12.8 million and $5.8 million, respectively, of
amounts paid to third parties, primarily as prepaid licenses, in connection with
game development for the Jaguar. The Company amortized such costs over the
shorter of 12 months from game introduction or the estimated unit sales of the
game title. The Company assesses the recoverability of capitalized games
software development costs in light of many factors, including, but not limited
to, anticipated future revenues, estimated economic useful lives and changes in
software and hardware technologies. Amortization expense and adjustments for
management's assessment of recoverability were $17.1 million (including a
write-off of $16.6 million) and $1.5 million (including a write-off of $804,000)
for the years ended December 31, 1995 and 1994, respectively. The capitalized
development costs, net of amortization, as of December 31, 1995 amounting to
$758,000 was included in "Other Assets" in the accompanying balance sheet and
were written off during the year ended February 2, 1997.
 
6. PROPERTY AND EQUIPMENT
 
     Property and equipment consists of the following (in thousands):
 
<TABLE>
<CAPTION>
                                            ESTIMATED
                                           USEFUL LIFE     FEBRUARY 2,    JANUARY 28,    DECEMBER 31,
                                             (YEARS)          1997           1996            1995
                                           ------------    -----------    -----------    ------------
    <S>                                    <C>             <C>            <C>            <C>
    Equipment and tooling................    2-7             $25,945        $ 1,424        $  1,526
    Furniture and fixtures...............    2-7               3,495            131             198
    Leasehold improvements...............     4                  410             --              --
                                                              ------         ------          ------
    Total................................                     29,850          1,555           1,724
    Accumulated depreciation and
      amortization.......................                     (2,176)          (956)           (753)
    Reserve for production tooling.......                         --             --            (300)
                                                              ------         ------          ------
    Property and equipment, net..........                    $27,674        $   599        $    671
                                                              ======         ======          ======
</TABLE>
 
     In March 1995, the Financial Accounting Standards Board ("FASB") issued
FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). SFAS 121 requires that
long-lived assets be reviewed for impairment and, if necessary, an impairment
loss be recorded whenever events or changes in circumstances indicate that the
carrying amount of the asset may not be recoverable. SFAS 121 became effective
for the year ended February 2, 1997. The adoption of SFAS 121 did not have a
material effect on the financial position or results of operations of the
Company. In fiscal 1997, the Company wrote off equipment with a book value of
approximately $2.7 million and the loss is included in "Other income" in the
accompanying statement of operations.
 
7.  LONG-TERM DEBT OBLIGATIONS AND BANK ARRANGEMENT
 
     New Revolving Line of Credit Arrangement -- On April 16, 1997, the Company
obtained a commitment from a finance company for a revolving line of credit to
refinance present debt and to obtain working capital credit facilities of up to
$30 million. The revolving line of credit will have an initial term of three
years with automatic annual renewals thereafter unless terminated by the finance
company. The Company will grant the finance company a first and exclusive lien
on all of the Company's present and future accounts receivable, inventory,
equipment and intangible assets to secure the obligations. The agreement will
also contain certain financial covenants.
 
                                       39
<PAGE>   42
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Bank Line of Credits -- The Company has a line of credit arrangement with a
bank for $5 million, of which all was outstanding as of February 2, 1997. The
line of credit is collateralized by certain assets, bore interest at Prime plus
0.75% (9% as of February 2, 1997) and the principal was replaced by the
factoring arrangement with the same amount in April 1997.
 
     The Company's Indian subsidiary, JTS Technology Ltd. ("Technology"), has
entered into an agreement with a consortium of three Indian Government owned
commercial banks to obtain working capital credit facilities. While the three
banks have agreed to a total extension of credit and an allocation of
participation, each bank independently sanctions its portion of the
participation. The credit agreement with the consortium has four separate
facilities, namely, export sales accounts receivable bill discounting, exports
sales order based inventory packing credit, foreign letters of credit and
letters of guarantee. Technology can borrow up to $10,375,000 and, as of
February 2, 1997, $5,540,000 was outstanding. The line of credit is
collateralized by certain assets, is guaranteed by a relative of the Chairman of
the Company and bears interest from 6.5% to 15%.
 
     According to the terms stipulated in the credit facility sanction letter of
one of the banks, the Company is required to contribute unsecured loans of
approximately $1.8 million to Technology. No unsecured loans have been
contributed as of February 2, 1997. However, management believes it is in
compliance with this provision due to the open accounts receivable which they
have from Technology and intends to convert a portion of its open accounts
receivable from Technology to unsecured loans to satisfy this requirement.
 
     Convertible Subordinated Debentures -- The Company has $42.4 million of
5 1/4% convertible subordinated debentures due April 29, 2002. The debentures
may be redeemed at the Company's option, upon payment of a premium. The
debentures, at the option of the holders, are convertible into common stock at
$16.3125 per share. As of February 2, 1997, 2,596,414 shares of common stock
were reserved for issuance upon conversion. Default with respect to other
indebtedness of the Company in an aggregate amount exceeding $5 million would
result in an event of default whereby the outstanding debentures would be due
and payable immediately.
 
     In 1995, the Company reacquired in the open market and extinguished $1.1
million face value of these debentures for $500,000, resulting in an
extraordinary gain of $582,000.
 
     Secured Long Term Loans -- Technology has entered into term loan agreements
with the Industrial Credit and Investment Corporation of India Limited
("ICICI"), a term lending institution in India under which $2,625,000 was
outstanding as of February 2, 1997. The loan is repayable in US dollars in 13
equal quarterly installments of $202,000 each commencing from April 1997.
Interest on outstanding amounts is payable quarterly at the rate of US dollar
LIBOR plus 2.75% per annum (8.5% at February 2, 1997). As of February 2, 1997,
Technology also has a second loan outstanding from ICICI for $7,000,000,
repayable in US dollars in twelve equal quarterly installments of $583,000 each
commencing on May 20, 1998. Interest on these loans is payable at US dollar
LIBOR plus 4% (9.94% at February 2, 1997).
 
     On June 13, 1996, Technology entered into a loan agreement with the
Shipping Credit and Investment Corporation of India Limited. As at February 2,
1997, the Company has borrowed $2.12 million and the loan is repayable in US
dollars in 12 equal quarterly installments of $177,000 each commencing from the
first quarter of 1998. Interest on these loans is payable at US dollar LIBOR
plus 4% (9.94% at February 2, 1997).
 
     The loans are collateralized by all of the Technology's property and
equipment and are guaranteed by a relative of the Chairman of the Company.
 
     The loan covenants require Technology to increase its paid in capital by
approximately $5.6 million and the Company is required to make unsecured loans
of $3.7 million to Technology. With respect to the equity requirement, the
Company has obtained the approval of the Reserve Bank of India ("RBI") to
contribute funds aggregating to $5 million. Subsequent to February 2, 1997,
Technology received $2.5 million towards
 
                                       40
<PAGE>   43
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
capital contribution from the Company. These funds, along with amounts invested,
would result in Technology's paid in capital to increase to $5.88 million.
 
     No unsecured loans have been contributed up to the date of the financial
statements. Management believes that the lender is unlikely to require the
Company to immediately repay advances outstanding for non-compliance with debt
covenants. Management believes it is in compliance with this provision due to
the open accounts receivable which they have from Technology and intends to
convert a portion of its open accounts receivable from Technology to unsecured
loans to satisfy this requirement.
 
     Capitalized Lease Obligations -- As of February 2, 1997, the Company has
equipment lease agreements of which payments are due in equal monthly
installments over a 36 month period. As of February 2, 1997, the cost of the
leased assets was $925,000 and the related accumulated depreciation was
$220,000. The leases bear interest between 11.5% and 18.2%.
 
     The following is a schedule of future payments under subordinated
debentures, secured long term loans and capital lease obligations together with
the present value of the net minimum lease payments at February 2, 1997.
 
<TABLE>
<CAPTION>
                                                        SECURED
                                       CAPITAL LEASE   LONG TERM   SUBORDINATED
                      YEAR              OBLIGATIONS      LOANS      DEBENTURES        AMOUNT
            -------------------------  -------------   ---------   ------------   --------------
                                                                                  (IN THOUSANDS)
            <S>                        <C>             <C>         <C>            <C>
            1998.....................      $ 560        $ 1,516      $     --        $  2,076
            1999.....................        521          3,848            --           4,369
            2000.....................         27          3,848            --           3,875
            2001.....................         --          2,534            --           2,534
            2002.....................         --             --            --              --
            2003.....................         --             --        42,354          42,354
                                                                                  --------------
            Total....................                                                  55,208
            Less: Amount representing
              interest...............                                                    (160)
                                                                                  --------------
            Present value............                                                  55,048
            Less: Current portion....                                                  (1,967)
                                                                                  --------------
            Long term portion........                                                $ 53,081
                                                                                  ===========
</TABLE>
 
8. INCOME TAXES
 
     The effective income tax rate for the periods shown below was 0% and
differs from the Federal statutory rate of 35% as follows (in thousands):
 
<TABLE>
<CAPTION>
                                                                                YEARS ENDED
                                            YEAR ENDED     PERIOD ENDED         DECEMBER 31,
                                            FEBRUARY 2,    JANUARY 28,      --------------------
                                               1997            1996           1995        1994
                                            ----------     ------------     --------     -------
    <S>                                     <C>            <C>              <C>          <C>
    Computed at federal statutory rates...   $(53,373)        (1,515)       $(17,402)    $ 3,288
    Nondeductible acquired in-process
      research and development............     38,504             --              --          --
    Nondeductible amortization expense....      2,042             --              --          --
    Other.................................     (5,511)        (1,053)         (1,202)         --
    Valuation allowance...................     18,338          2,569          18,604      (3,288)
                                             --------        -------
    Income tax............................   $     --         $   --        $     --     $    --
                                             ========        =======
</TABLE>
 
                                       41
<PAGE>   44
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The components of the net deferred tax asset consist of (in thousands):
 
<TABLE>
<CAPTION>
                                                       FEBRUARY 2,     JANUARY 28,     DECEMBER 31,
                                                          1997            1996             1995
                                                       -----------     -----------     ------------
    <S>                                                <C>             <C>             <C>
    Deferred tax assets:
      Federal operating loss carryforwards...........   $  85,760       $  57,238        $ 57,706
      State operating loss carryforwards.............       8,764           4,999           3,820
      Capital loss carryforwards.....................       1,008           1,008           1,035
      Research and development tax credit
         carryforwards...............................       3,100           1,496           1,813
      Inventory reserves.............................       7,268           5,287           3,237
      Capitalized software development costs.........       3,022           3,022           3,022
      Other..........................................       8,045           4,613           4,461
                                                         --------        --------
    Subtotal.........................................     116,967          77,663          75,094
    Valuation allowance..............................    (116,967)        (77,663)        (75,094)
                                                         --------        --------
    Net deferred tax asset...........................   $      --       $      --        $     --
                                                         ========        ========
</TABLE>
 
     Management believes that, based on a number of factors, the available
objective evidence creates sufficient uncertainty regarding the realizability of
the net deferred tax assets such that a valuation allowance has been recorded to
completely offset the net deferred tax assets. Such factors include recurring
operating losses from inception, recent increases in expense levels to support
the Company's growth, and the fact that the market in which the Company competes
is intensely competitive and is characterized by rapidly changing technology.
 
     For income tax purposes, the Company has Federal and State net operating
loss ("NOL") carryforwards of approximately $245 million and $94 million,
respectively, and Federal and State research and development tax credit
carryforwards of approximately $2.1 million and $1.0 million, respectively, all
of which will expire on various dates through 2012.
 
     Under the Internal Revenue Code of 1986, as amended, certain changes in the
ownership or business of a corporation that has Federal NOLs or tax credit
carryforwards will result in the inability to use or the imposition of
significant restrictions on the use of such NOLs or tax credit carryforwards to
offset future income and tax liabilities of the Company. The merger between
Atari and JTS constituted a change in ownership with respect to JTS and
accordingly, restricts the use of JTS' pre-merger NOLs against post-merger
income of the Company to the maximum of $12.5 million per year, unless
previously expired. In addition, subsequent events may result in the imposition
of restrictions on the ability of the Company to utilize its NOLs and tax credit
carryforwards. There can be no assurance that the Company will be able to
utilize all or any of its NOL's or tax credit carryforwards.
 
     Under the Indian Income Tax Act 1961, Technology is exempted from payment
of certain corporate income taxes for a period of five years during the first
eight years of operations, subject to fulfillment of certain conditions.
Technology continues to be exempt from certain income tax to the extent of
income attributable to the export sales of Technology. As Technology did not
have any taxable income for the period from July 30, 1996 to February 2, 1997,
no provision for income tax has been made.
 
                                       42
<PAGE>   45
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
9. CONVERTIBLE PREFERRED STOCK
 
     Convertible preferred stock outstanding as of February 2, 1997 consisted of
the following (dollars in thousands, except share amounts):
 
<TABLE>
        <S>                                                                  <C>
        Series B:
          Authorized -- 15,000 shares
          Outstanding -- 15,000 shares; liquidation preference of
             $15,193.......................................................  $ 15,000
        Series C:
          Authorized -- 25,000 shares
          Outstanding -- 25,000 shares; liquidation preference of
             $25,034.......................................................  $ 25,000
                                                                             --------
                                                                             $ 40,000
                                                                              =======
</TABLE>
 
     The rights, restrictions and preferences of Series B convertible preferred
stock are as follows:
 
     - Each stockholder is entitled to receive annual dividends at a rate of
       $50.00 per share when, and if, declared by the Board of Directors, prior
       to payment of dividends on common stock. Dividends are cumulative and
       payable in cash or in common stock quarterly. As of February 2, 1997,
       dividends accrued totaled $193,000.
 
     - Each stockholder may convert any or all of his shares into common stock
       at the lower of (i) $3.6125 or (ii) 85% of the average trading price of
       the common stock on the five consecutive trading days immediately
       preceding the conversion date times the conversion rate (defined in the
       agreement). In addition, for every ten shares of common stock issued upon
       conversion, the holder is entitled to receive a warrant to purchase one
       share of common stock. Each warrant is exercisable at 110% of the lower
       of the average closing price of common stock for the five days
       immediately preceding (i) the conversion notice date or (ii) the closing
       date of the stock purchase agreement.
 
     - In the event of any voluntary liquidation, dissolution or winding up of
       the Company, the holders are entitled to receive an amount per share
       equal to the total amount of (i) $1,000 and (ii) all dividends accrued
       and unpaid.
 
     The rights, restrictions and preferences of Series C convertible preferred
stock are as follows:
 
     - Each stockholder is entitled to receive dividends at a rate of 5% per
       annum which are cumulative and payable in cash or in common stock. As of
       February 2, 1997, dividends accrued totaled $34,000.
 
     - Each stockholder may convert any or all of his shares and unpaid
       dividends into common stock at the lower of (i) $2.94 or (ii) 85% of the
       average market price for the common stock for the five consecutive
       trading days immediately preceding the conversion date.
 
     - The holders have the right, at the option of the holders of at least two
       thirds of the Series C convertible preferred stock then outstanding, to
       require the Company to redeem all of the Series C Preferred upon the
       occurrence of certain events, all of which are within the control of the
       Company and therefore, Series C is included in shareholders' equity in
       the accompanying balance sheet.
 
     - In the event of any voluntary or involuntary liquidation, dissolution or
       winding up of the Company, the holders are entitled to receive an amount
       per share equal to the total amount of (i) $1,000 and (ii) an additional
       amount defined in the agreement.
 
     - Holders do not have any voting right.
 
10. COMMON STOCK AND STOCK OPTION PLANS
 
     Reduction in Par Value -- Upon the Merger, a new Certificate of
Incorporation was approved and the par value of the common stock was reduced
from $.01 per share to $.001. As a result, the common stock account was reduced
by $573,000 and the additional paid-in capital account was increased by the same
amount.
 
                                       43
<PAGE>   46
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Warrants -- In connection with the acquisition of Moduler Electronics, the
Company issued warrants to purchase 750,000 shares of the Company's common stock
at an exercise price of $0.25 per share to an entity owned by a relative of the
Chairman of the Company, of which 500,000 warrants have been exercised. The
remaining 250,000 shares become exercisable when there becomes available to
Technology certain borrowings and credit facilities in the amount of at least
$29 million. Subject to the foregoing, the warrant may be exercised at any time
until February 25, 2001.
 
     The Company issued a warrant to purchase 37,500 shares of the Company's
common stock at an exercise price of $4.26 per share to a placement agent upon
the issuance of Series B convertible preferred stock. (See Note 9.) The warrant
is exercisable at any time until November 5, 1999. Such warrants were deemed to
have nominal value at the issuance date and, accordingly, are carried at no
value in the accompanying financial statement.
 
     The Company has issued warrants to purchase 50,000 shares of common stock
at $3.00 to the bank with which it has a line of credit. The warrants may be
exercised at any time before various dates through 2001. Such warrants were
deemed to have nominal value at the issuance date and, accordingly, are carried
at no value in the accompanying financial statements.
 
     Restricted Stock Purchase Agreement -- Prior to the Merger, JTS issued
5,000,000 shares of its common stock to certain officers in exchange for notes
receivable amounting to $2,750,000, of which $240,000 has been subsequently
collected. The notes bear interest at annual rates ranging from 5.45% to 5.91%
and the principal and interest is payable on various dates within four years.
The notes are with full recourse and are collateralized by the stock purchased.
The Company has the right to repurchase such shares upon termination of
employment at the original purchase price; however, the Company's right to
repurchase lapses ratably over four years. As of February 2, 1997, 3,162,494
shares were subject to repurchase.
 
     Stock Option Plans -- The Company has reserved 9,000,000 shares of common
stock for issuance under its 1995 Stock Option Plan. Under the plan, either
incentive or nonstatutory stock options may be granted to purchase shares of
common stock. Nonstatutory stock options may be granted to employees,
nonemployee members of the Board of Directors and consultants at prices not less
than 85% of the fair value of the stock at the date of the grant, as determined
by the Board. Incentive stock options may be granted only to employees at prices
not lower than the fair value of the stock at the date of grant, as determined
by the Board. Options granted under the plan are generally exercisable over four
years, and expire no later than ten years from the date of grant. Options
granted vest at a rate of 25% per annum.
 
     The Company has also reserved 500,000 shares of common stock for issuance
under its 1996 Non-Employee Directors' Stock Option Plan. Under the plan, each
Non-Employee Director has options to purchase shares of common stock at the
market value at the date of grant. Options vest in two equal annual installments
from the date of grant and will expire no later than ten years from the date of
grant.
 
                                       44
<PAGE>   47
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table presents the option activity through February 2, 1997:
 
<TABLE>
<CAPTION>
                                                              NUMBER OF      WEIGHTED AVERAGE
                                                               OPTIONS        EXERCISE PRICE
                                                              ----------     ----------------
    <S>                                                       <C>            <C>
    Balance, December 31, 1994..............................   1,308,458          $ 3.94
    Granted.................................................   1,487,000          $ 2.66
    Exercised...............................................     (82,333)         $ 1.44
    Cancelled...............................................    (615,600)         $ 5.47
                                                               ---------
    Balance, December 31, 1995..............................   2,097,525          $ 2.68
                                                               ---------
    Granted.................................................     195,000          $ 1.60
    Exercised...............................................      (4,000)         $ 1.19
    Cancelled...............................................          --              --
    Balance, January 28, 1996...............................   2,292,525          $ 2.59
                                                               ---------
    Granted.................................................   4,201,203          $ 1.83
    Assumed upon JTS merger.................................   3,885,747          $ 2.31
    Exercised...............................................  (1,047,000)         $ 1.04
    Cancelled...............................................  (2,130,933)         $ 2.21
    Balance, February 2, 1997...............................   7,197,542          $ 2.34
                                                               =========
</TABLE>
 
     The following table summarizes information concerning stock options
outstanding and exercisable as of February 2, 1997:
 
<TABLE>
<CAPTION>
                                           OPTIONS OUTSTANDING                 OPTIONS EXERCISABLE
                                    ---------------------------------     ------------------------------
                                       WEIGHTED           WEIGHTED                           WEIGHTED
   RANGE OF           SHARES           AVERAGE            AVERAGE           SHARES           AVERAGE
EXERCISE PRICES     OUTSTANDING     REMAINING LIFE     EXERCISE PRICE     EXERCISABLE     EXERCISE PRICE
---------------     -----------     --------------     --------------     -----------     --------------
<S>                 <C>             <C>                <C>                <C>             <C>
     $0.25           2,430,229           8.59              $ 0.25             749,065         $ 0.25
 $2.50 - $4.20       4,637,313           9.66              $ 3.41             375,609         $ 3.77
     $6.00             130,000           7.49              $ 6.00              55,000         $ 6.00
                     ---------           ----               -----           ---------          -----
                     7,197,542           9.22              $ 2.34           1,179,674         $ 1.53
                     =========           ====               =====           =========          =====
</TABLE>
 
     Stock-Based Compensation -- In January 1996, the Company adopted FASB
Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS
123 defines a fair value method of accounting for stock-based compensation
plans. Under the fair value method, compensation cost is measured at the grant
date on the value of the award and is recognized over the service period. As
permitted under SFAS 123, the Company continues to apply the provisions of APB
25 and related interpretations in accounting for its stock-based compensation
plans and, accordingly, does not recognize compensation cost. If the Company had
elected to recognize compensation cost based on the fair value of the stock
options at the grant date as prescribed by SFAS 123, net loss and loss per share
would have been as follows (in thousands, except per share amounts):
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED      PERIOD ENDED      YEAR ENDED
                                                     FEBRUARY 2,     JANUARY 28,      DECEMBER 31,
                                                        1997             1996             1995
                                                     -----------     ------------     ------------
    <S>                                              <C>             <C>              <C>
    Net loss -- As reported........................   $ (152,495)      $ (4,330)        $(49,576)
    Net loss -- Pro forma..........................   $ (161,496)      $ (4,335)        $(49,778)
    Loss per share -- As reported..................   $    (1.81)      $  (0.07)        $  (0.78)
    Loss per share -- Pro forma....................   $    (1.92)      $  (0.07)        $  (0.78)
</TABLE>
 
                                       45
<PAGE>   48
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Because SFAS 123 has not been applied to options granted prior to January
1, 1995, the resulting pro-forma compensation cost may not be representative of
that to be expected in future years.
 
     The weighted average fair value of stock options granted during the year
ended December 31, 1995, the one month ended January 28, 1996 and the year ended
February 2, 1997 was $0.57, $0.18 and $4.38 per share, respectively. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model assuming a risk free interest rate of 6%, dividend yield of
0%, volatility factor of the expected market price of the Company's Common Stock
of 1.10 and a weighted average expected option life of 4 and 6 years from the
vest date.
 
     Common Stock Reserved for Future Issuance -- As of February 2, 1997, the
Company has reserved the following shares of common stock for issuance in
connection with:
 
<TABLE>
        <S>                                                                <C>
        Conversion of preferred stock....................................   27,037,500
        Conversion of subordinated debentures............................    2,596,414
        Stock option plans...............................................    9,429,416
        Warrants to purchase common stock................................      337,500
                                                                           -----------
                                                                            39,400,830
                                                                             =========
</TABLE>
 
11. COMMITMENTS AND CONTINGENT LIABILITIES
 
     License Agreements and Royalty Obligations -- The Company licenses certain
"Nordic" disk drive technology from TEAC Corporation ("TEAC"). In the event the
Company sells certain products incorporating certain technology jointly
developed by TEAC and the Company or independently developed by TEAC, it will
incur a royalty obligation. There was no sale of a product incorporating such
technology and accordingly, no royalties were due as of February 2, 1997. In
addition, the Company is obligated to license certain technology independently
developed by the Company on a royalty-free basis to TEAC.
 
     The Company also has a cross-license agreement with Pont Peripherals
Corporation ("Pont") pursuant to which the Company granted to Pont a
royalty-free, nonexclusive perpetual license to use certain technology
independently developed by the Company and jointly developed. In return, Pont
granted to the Company a royalty-free, nonexclusive, perpetual license to use
certain technology independently developed by Pont and jointly developed.
 
     The Company has entered into a Development Agreement with Compaq
Corporation which imposes certain restrictions on the Company's ability to
sublicense "Nordic" technology to third parties. In addition, the Development
Agreement imposes a royalty of $2 per unit with respect to the sale of "Nordic"
disk drives to third parties during the term of the agreement. No royalties were
due as of February 2, 1997.
 
     The Company has also entered into a Technology and License Agreement with
Western Digital Corporation ("WDC") pursuant to which WDC obtained certain
manufacturing and marketing rights to "Nordic" disk drive technology. The
Company and WDC have reciprocal, royalty-free, cross-license agreement for
future Nordic technology developments, and WDC has granted to the Company
licenses on existing patents covering certain technology on a royalty-free
basis.
 
     Lease Commitments -- The Company leases various facilities and equipment
under noncancellable operating lease arrangements. These leases generally
provide renewal options of five additional years.
 
                                       46
<PAGE>   49
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Minimum future lease payments under noncancellable operating leases as of
February 2, 1997 are as follows (in thousands):
 
<TABLE>
                <S>                                                   <C>
                1998................................................  $  781
                1999................................................     553
                2000................................................     571
                2001................................................     243
                                                                      ------
                          Total minimum lease payments..............  $2,148
                                                                      ======
</TABLE>
 
     Rent expense for operating leases was $1,015,000, $1,193,000 and $1,218,000
for the years 1997, 1995 and 1994, respectively, and $61,000 for the period
ended January 28, 1996.
 
     Claims and Suits -- On January 3, 1997, Dusseldorf Securities, Limited
("DSL") and Greystone Capital, Ltd. ("GCL"), through counsel, made a letter
demand of the Company for payment of $1,250,000 allegedly due under a letter
agreement between DSL and the Company dated December 21, 1996 (the "Agreement").
DSL and GCL claim that the Company owes $1,250,000 as fees for a January 1997
private placement of the Company's stock which was not completed through DSL
and/or GCL. On February 26, 1997, DSL and GCL filed suit against the Company in
Los Angeles County Superior Court, No. BC166450, entitled Dusseldorf Securities,
Limited v. JTS Corporation. The lawsuit asserts claims for breach of contract,
breach of warranty, and misrepresentation against the Company and asserts those
and other tort claims against an individual not affiliated with the Company,
through whom the Company recently completed a private placement of its
securities. A writ of attachment has been filed and is scheduled to be argued on
May 9, 1997. The Company denies the allegations of the complaint and intends to
vigorously defend itself in the action.
 
     Certain claims and suits arising in the ordinary course of business have
been filed or are pending against the Company. The number of such claims has
increased as the Company significantly downsized its development operations. In
the opinion of management, all such matters have been adequately provided for,
are without merit, or are such that if settled unfavorably would not have a
material adverse effect on the Company's consolidated financial position and
results of operations.
 
12. SETTLEMENTS OF PATENT LITIGATION
 
     During the first quarter of 1994, the Company received $2.2 million with
respect to the settlement of litigation between the Company, Atari Games
Corporation and Nintendo. Although not part of the litigation, the Company sold
1,500,000 shares of its common stock to Time Warner (parent company of Atari
Games Corporation), Inc. for $12.8 million.
 
     During the fourth quarter of 1994, the Company completed a comprehensive
agreement ("Agreement") with Sega Enterprises, Ltd. ("Sega") concerning
resolution of disputes, equity investment and patent and product licensing
agreements. The results of the Agreement were as follows: (i) Sega acquired
4,705,883 shares of the Company's common stock for $40.0 million; (ii) the
Company received a payment of $29.8 million ($50.0 million from Sega, net of
$20.2 million of legal fees and associated costs) in exchange for a license from
Atari covering the use of a library of Atari patents issued between 1977 through
1984 (excluding patents which exclusively claim elements of the Company's JAGUAR
and LYNX products) through the year 2001; and (iii) the Company and Sega agreed
to cross-license up to five software game titles each year through the year
2001.
 
                                       47
<PAGE>   50
 
                  JTS CORPORATION (FORMERLY ATARI CORPORATION)
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
13. SEGMENT INFORMATION
 
     The Company operates in two industry segments -- the design and sale of
consumer electronic products and the manufacture and distribution of hard disk
drives. The Company's foreign operations at February 2, 1997 consist of sales
and distribution facilities in Europe and a manufacturing plant in India.
Corporate assets are primarily cash and equivalents, marketable securities, real
estate held for sale and intangible assets.
 
     The following tables present a summary of operations by geographic region
(in thousands):
 
<TABLE>
<CAPTION>
                                                             ONE MONTH           YEARS ENDED
                                            YEAR ENDED         ENDED            DECEMBER 31,
                                            FEBRUARY 2,     JANUARY 28,     ---------------------
                                               1997            1996           1995         1994
                                            -----------     -----------     --------     --------
    <S>                                     <C>             <C>             <C>          <C>
    Revenues from unaffiliated customers:
      North America.......................   $   30,840      $     510      $  8,163     $ 23,158
      Export sales from North America.....       45,934             --         1,868        8,538
      Europe..............................       13,756            225         4,595        7,052
                                                -------        -------       -------
              Total.......................   $   90,530      $     735      $ 14,626     $ 38,748
                                                =======        =======       =======
    Operating income (loss):
      North America.......................   $ (153,234)     $  (6,632)     $(51,036)    $(21,600)
      Europe..............................          445            (39)       (2,629)      (2,447)
      India...............................        3,140             --            --           --
                                                -------        -------       -------
              Total.......................   $ (149,649)     $  (6,671)     $(53,665)    $(24,047)
                                                =======        =======       =======
    Identifiable assets at period end:
      North America.......................   $   26,871      $   9,135      $ 14,588     $ 37,627
      Europe..............................        8,285          1,810         1,856        1,650
      India...............................       35,855             --            --           --
      Corporate assets....................       59,706         59,230        61,125       91,765
                                                -------        -------       -------
              Total.......................   $  130,717      $  70,175      $ 77,569     $131,042
                                                =======        =======       =======
</TABLE>
 
     The following table presents a summary of the revenues by industry segment
(in thousands):
 
<TABLE>
<CAPTION>
                                                                                YEAR ENDED
                                                                                FEBRUARY 2,
                                                                                   1997
                                                                                -----------
    <S>                                                                         <C>
    Hard disk drives........................................................      $85,751
    Multimedia entertainment system.........................................        4,779
                                                                                -----------
                                                                                  $90,530
                                                                                 ========
</TABLE>
 
     All revenues for the years ended December 31, 1995 and 1994 and for the one
month period ended January 28, 1996 are from the multimedia entertainment system
segment.
 
     No single customer accounted for more than 10% of total revenues for the
years ended December 31, 1995 or 1994 or for the one month period ended January
28, 1996. Sales to major customers in 1997 in excess of 10% of total revenues
are as follows:
 
<TABLE>
<S>                             <C>
Karma International             30%
Future Technology               13%
Synnex Information Technology   12%
</TABLE>
 
                                       48
<PAGE>   51
 
              REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE
 
     We have audited in accordance with generally accepted auditing standards,
the financial statements of JTS Corporation and subsidiaries as of February 2,
1997 and January 28, 1996 and the periods then ended, included in this report,
and have issued our report thereon dated April 21, 1997. Our audit was made for
the purpose of forming an opinion on those statements taken as a whole. The
schedule listed in the index below is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
 
                                          ARTHUR ANDERSEN LLP
San Jose, California
April 21, 1997
 
                                       49
<PAGE>   52
 
                                                                     SCHEDULE II
                       VALUATIONS AND QUALIFYING ACCOUNTS
                             (AMOUNTS IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                       BALANCE AT     CHARGED TO      ACQUIRED                     BALANCE AT
                                       BEGINNING       COSTS AND      WITH THE                       END OF
                                       OF PERIOD       EXPENSES        MERGER       DEDUCTIONS       PERIOD
                                       ----------     -----------     ---------     ----------     -----------
<S>                                    <C>            <C>             <C>           <C>            <C>
December 31, 1994:
  Allowance for doubtful accounts....    $  472         $   194                       $   72         $   594
  Accrued sales returns and
     allowances......................       576           1,563                          776           1,363
December 31, 1995:
  Allowance for doubtful accounts....       594              50                          317             327
  Accrued sales returns and
     allowances......................     1,363           5,028                        2,497           3,894
January 28, 1996:
  Allowance for doubtful accounts....       327                                           52             275
  Accrued sales returns and
     allowances......................     3,894             137                           35           3,996
February 2, 1997:
  Allowance for doubtful accounts....       275             866          814             340           1,615
  Accrued sales returns and
     allowances......................     3,996           5,529          655           6,859           3,321
  Accrued warranty...................                     1,735          700               5           2,430
</TABLE>
 
                                       50
<PAGE>   53
 
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
     The information required by this item is incorporated by reference from the
Company's Current Report on Form 8-K filed with the Securities and Exchange
Commission on December 3, 1996.
 
                                    PART III
 
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS.
 
     The information required by this item regarding the Company's directors and
executive officers is incorporated herein by reference from the Proxy Statement,
to be filed with the Securities and Exchange Commission within 120 days of the
Company's fiscal year end (February 2, 1997).
 
ITEM 11 -- EXECUTIVE COMPENSATION
 
     The information required by this item regarding executive compensation is
incorporated herein by reference from the Proxy Statement.
 
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     The information required by this item regarding security ownership of
certain beneficial owners and management is incorporated herein by reference
from the Proxy Statement.
 
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     The information required by this item regarding certain relationships and
related transactions is incorporated herein by reference from the Proxy
Statement.
 
                                    PART IV
 
ITEM 14 -- EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
     (a) The following documents are filed as part of this Annual Report on Form
10-K:
 
          (1) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.  The following
     Consolidated Financial Statements of JTS Corporation and its subsidiaries
     are filed as part of this Annual Report on Form 10-K:
 
<TABLE>
<CAPTION>
                                                                                    FORM 10-K
                                                                                    PAGE NO.
                                                                                    ---------
<S>                                                                                 <C>
Independent Auditors' Reports.....................................................   29, 30
Consolidated Balance Sheets
  February 2, 1997, January 28, 1996 and December 31, 1995........................     31
Consolidated Statements of Operations for the year ended February 2, 1997; the
  one-month period ended January 28, 1996; and the years ended December 31, 1995
  and 1994........................................................................     32
Consolidated Statements of Shareholders' Equity for the year ended February 2,
  1997; the one-month period ended January 28, 1996; and the years ended December
  31, 1995 and 1994...............................................................     33
Consolidated Statements of Cash Flows for the year ended February 2, 1997; the
  one-month period ended January 28, 1996; and the years ended December 31, 1995
  and 1994........................................................................     34
Notes to Consolidated Financial Statements........................................     35
</TABLE>
 
          (2) INDEX TO FINANCIAL STATEMENT SCHEDULES.  The following
     Consolidated Financial Statement Schedules of JTS Corporation and its
     subsidiaries for each of the year ended February 2, 1997; the one-month
     period ended January 28, 1996; and the years ended December 31, 1995 and
     1994 are filed as part of this Annual Report on Form 10-K:
 
<TABLE>
<CAPTION>
                                                                                FORM 10-K
                                                                                PAGE NO.
                                                                                ---------
    <S>                                                                         <C>
    II  Valuations and Qualifying Accounts....................................    50
</TABLE>
 
     Schedules not listed above have been omitted because they are not
applicable or required or the information required to set forth therein is
included in the Consolidated Financial Statements or notes thereto.
 
                                       51
<PAGE>   54
 
<TABLE>
<CAPTION>
EXHIBIT    EXHIBIT
FOOTNOTE   NUMBER                                      EXHIBIT
--------   ------     --------------------------------------------------------------------------
<C>        <C>        <S>
 (a)         3.1      Amended and Restated Certificate of Incorporation, as amended
 (a)         3.2      Amended and Restated Bylaws of JTS Corporation
 (a)         4.1      Form of Specimen Common Stock Certificate of JTS Corporation
 (a)         4.2      Registration Rights Agreement, dated February 3, 1995, by and between the
                      holders of Series A Preferred Stock and the Company, as amended
 (b)         4.3      Certificate of Designations of Series B Preferred Stock, dated November 5,
                      1996
 (b)         4.4      Registration Rights Amendment, dated November 5, 1996 by and between the
                      holders of Series B Preferred Stock and the Company
 (c)         4.5      Certificate of Designations of Series C Preferred Stock, dated January
                      1997
 (c)         4.6      Registration Rights Agreement, dated January 22, 1997, by and among
                      holders of Series C Preferred Stock and the Company
 (a)        10.1*     Amended and Restated 1995 Stock Option Plan and forms of stock option
                      agreement
 (a)        10.2*     1996 Non-Employee Directors' Plan and form of stock option agreement
 (a)        10.3      401(k) Plan, adopted March 15, 1996
 (a)        10.4      Form of Indemnity Agreement
 (a)        10.5*     Employment Contract of Kenneth D. Wing, dated June 15, 1995
 (a)        10.6*     Consulting Agreement of Roger W. Johnson, dated April 1, 1996
 (a)        10.7      Restricted Stock Purchase Agreement, dated January 2, 1996, between JTS
                      and David T. Mitchell and related Promissory Note
 (a)        10.8      Restricted Stock Purchase Agreement, dated March 6, 1996, between JTS and
                      David T. Mitchell and related Promissory Note
 (a)        10.9      Restricted Stock Purchase Agreement, dated March 6, 1996, between JTS and
                      Sirjang Lal Tandon and related Promissory Note
 (a)        10.10     Restricted Stock Purchase Agreement, dated January 2, 1996, between JTS
                      and Kenneth D. Wing and related Promissory Note
 (a)        10.11     Restricted Stock Purchase Agreement, dated January 5, 1996, between JTS
                      and W. Virginia Walker and related Promissory Note
 (a)        10.12     Restricted Stock Purchase Agreement dated January 2, 1996, between JTS and
                      David Pearce and related Promissory Note
 (a)        10.13     Form of convertible promissory note between JTS and certain principal
                      stockholders of JTS
 (a)        10.14     Form of promissory note between JTS and certain principal stockholders of
                      JTS
 (a)        10.15     Subordinated Secured Convertible Promissory Note, dated February 13, 1996,
                      and related Security Agreement dated February 13, 1996, between JTS and
                      Atari
 (a)        10.16     Stock Purchase Agreement, dated April 4, 1996, between JTS and Lunenburg
                      S.A.
 (a)        10.17     Technical Know-How License Agreement, dated June 14, 1996, between JTS and
                      Moduler
 (a)        10.18     Lease, dated June 15, 1995, between JTS and Cilker Revocable Trust
 (a)        10.19     Loan Agreement between Moduler Electronics (India) Pvt. Ltd. as Borrower
                      and The Industrial Credit and Investment Corporation of India Limited as
                      Lenders, dated September 15, 1992
 (a)        10.20+    Loan Agreement between Moduler Electronics (India) Pvt. Ltd. as Borrower
                      and The Industrial Credit and Investment Corporation of India Limited as
                      Lenders, dated October 11, 1994
 (a)        10.21+    Loan Agreement between Moduler Electronics (India) Pvt. Ltd. as Borrower
                      and The Industrial Credit and Investment Corporation of India Limited as
                      Lenders, dated March 18, 1996
 (a)        10.22     Agreed Order Compromising Controversies, dated February 4, 1994, as
                      amended January 26, 1995
 (a)        10.23     TEAC Master Agreement, dated February 4, 1994
 (a)        10.24+    TEAC License Agreement, dated February 4, 1994, as amended on February 3,
                      1995
</TABLE>
 
                                       52
<PAGE>   55
 
<TABLE>
<CAPTION>
EXHIBIT    EXHIBIT
FOOTNOTE   NUMBER                                      EXHIBIT
--------   ------     --------------------------------------------------------------------------
<C>        <C>        <S>
 (a)        10.25+    Development Agreement, dated June 16, 1994, between JTS and Compaq, as
                      amended on February 3, 1995 and December 5, 1995
 (a)        10.26+    Purchase Manufacturing Agreement, dated June 16, 1994, between JTS and
                      Compaq Technology
 (a)        10.27+    Transfer and License Agreement, dated February 3, 1995, between JTS and
                      Western Digital
 (a)        10.28+    Agreement between JTS and Pont Peripherals Corporation, dated January 31,
                      1995, between JTS and Pont
 (a)        10.29+    Business Loan Agreement, Promissory Note and Collateral, Assignment,
                      Patent Mortgage and Security Agreement, dated December 18, 1995, between
                      JTS and Silicon Valley Bank
 (a)        10.30     Atari and Security Pacific National Bank Indenture, dated April 29, 1987
 (a)        10.31     Federated Group/Security Pacific National Bank Indenture, dated April 15,
                      1985
 (a)        10.32     First Supplemental Federated Group/Security Pacific National Bank
                      Indenture, dated September 24, 1987
 (a)        10.33     Warrant to Purchase 50,000 shares of JTS Common Stock, dated December 18,
                      1995, issued to Silicon Valley Bank
 (a)        10.34     Warrant to Purchase up to 750,000 shares of JTS Common Stock, dated April
                      4, 1996, issued to Lunenburg S.A.
 (a)        10.35     Agreement for Purchase and Sale of Real Property with Repurchase Option
                      dated September 10, 1996, between JTS and Jack Tramiel
 (b)        10.36     Series B Preferred Stock Subscription Agreement dated as of November 5,
                      1996 by and between the holder of Series B Preferred Stock and the Company
 (c)        10.37     Securities Purchase Agreement, dated as of January 22, 1997, by and
                      between the holders of Series C Preferred Stock and the Company
 (a)        21.1      List of Subsidiaries
            23.1      Consent of Arthur Andersen LLP
            23.2      Consent of Deloitte & Touche LLP
            24.1      Powers of Attorney. Reference is made to the signature page.
            27.1      Financial Data Schedule
</TABLE>
 
---------------
(a) Incorporated by reference to exhibits filed with the Registrant's
    Registration Statement on Form S-4 (No. 333-06643), as amended, which became
    effective on July 12, 1996.
 
(b) Incorporated by reference to exhibits filed with the Registrant's
    Registration Statement on From S-1 (No. 333-17093), as amended, which became
    effective on January 23, 1997.
 
(c) Incorporated by reference to exhibits filed with the Registrant's
    Registration Statement on Form S-1 (No. 333-21881), as amended, which became
    effective on March 5, 1997.
 
 +  Confidential treatment has previously been granted for portions of this
    Exhibit.
 
 *  Management contract or compensation plan or arrangement.
 
     (b) REPORTS ON FORM 8-K.
 
     On December 3, 1996, the Company filed a Current Report on Form 8-K
reporting a change in the Company's certifying accountant pursuant to Item 4 of
Form 8-K.
 
                                       53
<PAGE>   56
 
                                   SIGNATURES
 
     In accordance with the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this Annual
Report on Form 10-K to be signed on its behalf by the undersigned, thereunto
duly authorized, on the 30th day of April, 1997.
 
                                          JTS CORPORATION
 
                                          By:     /s/ W. VIRGINIA WALKER
                                            ------------------------------------
                                                     W. Virginia Walker
                                             Executive Vice President, Finance
                                            and Administration, Chief Financial
                                                   Officer and Secretary
 
                               POWER OF ATTORNEY
 
     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints David T. Mitchell and W. Virginia Walker
or either of them, his or her attorney-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this Report, and to file the same, with exhibits thereto and other documents
in connections therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his or her
substitute or substitutes, may do or cause to be done by virtue hereof.
 
     In accordance with the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates stated.
 
<TABLE>
<CAPTION>
              SIGNATURE                                   TITLE                      DATE
-------------------------------------      -----------------------------------  ---------------
 
<C>                                        <S>                                  <C>
 
            By: /s/ DAVID T. MITCHELL      President, Chief Executive Officer    April 30, 1997
-------------------------------------      and Director (Principal Executive
                    David T. Mitchell      Officer)
           By: /s/ W. VIRGINIA WALKER      Executive Vice President, Finance     April 30, 1997
-------------------------------------      and Administration, Chief Financial
                   W. Virginia Walker      Officer and Secretary (Principal
                                           Financial and Accounting Officer)
 
           By: /s/ SIRJANG LAL TANDON      Chairman of the Board and Corporate   April 30, 1997
-------------------------------------      Technical Strategist
                   Sirjang Lal Tandon
 
                                  By:      Director
-------------------------------------
                           Lip-Bu Tan
 
                 By: /s/ JACK TRAMIEL      Director                              April 30, 1997
-------------------------------------
                         Jack Tramiel
 
             By: /s/ ROGER W. JOHNSON      Director                              April 30, 1997
-------------------------------------
                     Roger W. Johnson
 
              By: /s/ JEAN D. DELEAGE      Director                              April 30, 1997
-------------------------------------
                      Jean D. Deleage
</TABLE>