##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended December 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File No. 0-27338
 ATARI, INC.
  DELAWARE
    
    13-3689915(State or Other Jurisdiction of 
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)
 417 FIFTH AVENUE, NEW YORK, NY 10016
 (212) 726-6500
 þ o
  Large accelerated filer o
    
    Accelerated filer o
    
    Non-accelerated filer o
    
    Smaller reporting company þ(Do not check if a smaller reporting company)
  o þ




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##### 



ATARI, INC. AND SUBSIDIARIES
DECEMBER 31, 2007 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
 PagePART I  FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited):Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2007
    
    
    3Condensed Consolidated Statements of Operations for the Three Months and Nine
Months Ended December 31, 2006 and 2007
    
    
    4Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
December 31, 2006 and 2007
    
    
    5Condensed Consolidated Statement of Stockholders Equity and Comprehensive Loss
for the Nine Months Ended December 31, 2007
    
    
    7Notes to the Condensed Consolidated Financial Statements
    
    
    8Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    30Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    47Item 4T.
    
    Controls and Procedures
    
    
    48PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    48Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    49Item 5.
    
    Other Matters
    
    
    50Item 6.
    
    Exhibits
    
    
    51Signatures
    
    
    52EX-3.1: AMENDMENT NO. 3 TO AMENDED AND RESTATED BY-LAWSEX-10.59: PARTIAL SURRENDER AGREEMENTEX-10.60: AMENDMENT #1 TO PARTIAL SURRENDER AGREEMENTEX-10.61: RIGHTS AND REPRESENTATIONEX-31.1: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32.1: CERTIFICATIONEX-32.2: CERTIFICATION




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 ATARI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
 March 31,
    
    
    December 31,2007
    
    
    2007ASSETSCurrent assets:Cash
    
    $
    7,603
    
    
    $
    5,428Receivables, net of allowances of $14,148 and $15,052 at March 31, 2007
and December 31, 2007, respectively
    
    
    6,473
    
    
    
    16,156Inventories, net (Note 4)
    
    
    8,843
    
    
    
    7,367Due from related parties (Note 6)
    
    
    1,799
    
    
    
    425Prepaid expenses and other current assets (Note 4)
    
    
    10,229
    
    
    
    5,559Assets of discontinued operations (Note 9)
    
    
    645
    
    
    
    Total current assets
    
    
    35,592
    
    
    
    34,935Property and equipment, net of accumulated depreciation of $30,945 and
$32,143 at
March 31, 2007 and December 31, 2007, respectively
    
    
    4,217
    
    
    
    6,344Security deposits
    
    
    1,940
    
    
    
    1,094Other assets
    
    
    1,070
    
    
    
    1,150Total assets
    
    $
    42,819
    
    
    $
    43,523LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY)Current liabilities:Accounts payable
    
    $
    11,013
    
    
    $
    10,648Accrued liabilities (Note 4)
    
    
    13,381
    
    
    
    11,458Royalties payable
    
    
    4,282
    
    
    
    3,808Credit facility (Note 8)
    
    
    
    
    
    
    14,000Due to related parties (Note 6)
    
    
    5,703
    
    
    
    5,333Total current liabilities
    
    
    34,379
    
    
    
    45,247Due to related parties  long-term (Note 6)
    
    
    1,912
    
    
    
    3,021Long-term deferred rent and related rental obligations
    
    
    3,093
    
    
    
    6,690Related party license advance (Note 1, 6 and 10)
    
    
    
    
    
    
    5,108Other long-term liabilities
    
    
    341
    
    
    
    268Total liabilities
    
    
    39,725
    
    
    
    60,334Commitments and contingencies (Note 7)Stockholders equity (deficiency):Preferred stock, $0.01 par value, 5,000,000 shares authorized, none
issued or
outstanding
    
    
    
    
    
    
    Common stock, $0.10 par value, 30,000,000 shares authorized, 13,477,920
shares issued and outstanding at March 31, 2007 and December 31, 2007
    
    
    1,348
    
    
    
    1,348Additional paid-in capital
    
    
    760,527
    
    
    
    760,634Accumulated deficit
    
    
    (761,299
    )
    
    
    (781,279
    )Accumulated other comprehensive income
    
    
    2,518
    
    
    
    2,486Total stockholders equity (deficiency)
    
    
    3,094
    
    
    
    (16,811
    )Total liabilities and stockholders equity (deficiency)
    
    $
    42,819
    
    
    $
    43,523
  Page 3




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##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
 Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2006
    
    
    2007
    
    
    2006
    
    
    2007Net revenues
    
    $
    47,277
    
    
    $
    41,115
    
    
    $
    95,338
    
    
    $
    64,845Costs, expenses, and income:Cost of goods sold
    
    
    27,117
    
    
    
    21,145
    
    
    
    56,296
    
    
    
    34,186Research and product development
    
    
    5,522
    
    
    
    4,423
    
    
    
    19,988
    
    
    
    12,425Selling and distribution expenses
    
    
    6,377
    
    
    
    7,123
    
    
    
    20,795
    
    
    
    15,882General and administrative expenses
    
    
    5,206
    
    
    
    3,341
    
    
    
    16,321
    
    
    
    13,894Restructuring expenses
    
    
    224
    
    
    
    3,730
    
    
    
    558
    
    
    
    4,722Gain on sale of intellectual property
    
    
    
    
    
    
    
    
    
    
    (9,000
    )
    
    
    Gain on sale of development studio assets
    
    
    
    
    
    
    
    
    
    
    (885
    )
    
    
    Depreciation and amortization
    
    
    565
    
    
    
    323
    
    
    
    2,227
    
    
    
    1,198Atari trademark license expense
    
    
    554
    
    
    
    554
    
    
    
    1,663
    
    
    
    1,663Total costs, expenses, and income
    
    
    45,565
    
    
    
    40,639
    
    
    
    107,963
    
    
    
    83,970Operating income (loss)
    
    
    1,712
    
    
    
    476
    
    
    
    (12,625
    )
    
    
    (19,125
    )Interest (expense) income, net
    
    
    (45
    )
    
    
    (810
    )
    
    
    187
    
    
    
    (855
    )Other income
    
    
    23
    
    
    
    19
    
    
    
    58
    
    
    
    33Income (loss) before income taxes
    
    
    1,690
    
    
    
    (315
    )
    
    
    (12,380
    )
    
    
    (19,947
    )Provision for (benefit from) income taxes
    
    
    607
    
    
    
    
    
    
    
    (4,226
    )
    
    
    Income (loss) from continuing operations
    
    
    1,083
    
    
    
    (315
    )
    
    
    (8,154
    )
    
    
    (19,947
    )(Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    
    (1,727
    )
    
    
    (33
    )
    
    
    146
    
    
    
    (33
    )Net loss
    
    $
    (644
    )
    
    $
    (348
    )
    
    $
    (8,008
    )
    
    $
    (19,980
    )Basic and diluted net loss income per share:Income (loss) from continuing operations
    
    $
    0.08
    
    
    $
    (0.02
    )
    
    $
    (0.60
    )
    
    $
    (1.47
    )(Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    
    (0.13
    )
    
    
    (0.01
    )
    
    
    0.01
    
    
    
    (0.01
    )Net loss
    
    $
    (0.05
    )
    
    $
    (0.03
    )
    
    $
    (0.59
    )
    
    $
    (1.48
    )Basic weighted average shares outstanding
    
    
    13,477
    
    
    
    13,478
    
    
    
    13,477
    
    
    
    13,478Diluted weighted average shares outstanding
    
    
    13,477
    
    
    
    13,478
    
    
    
    13,477
    
    
    
    13,478
   Page 4




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ATARI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 Nine MonthsEndedDecember 31,2006
    
    
    2007CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (8,008
    )
    
    $
    (19,980
    )Adjustments to reconcile net loss to net cash used in operating activities:Loss from discontinued operations of Reflections Interactive Ltd., net of tax
    
    
    11,326
    
    
    
    33Gain on sale of Reflections Interactive Ltd.
    
    
    (11,472
    )
    
    
    Non-cash tax
benefit included in continuing operations associated with tax
provisions of discontinued operations of Reflections Interactive Ltd.
    
    
    (4,716
    )
    
    
    Adjustment for non-cash gain on sale of Reflections Interactive Ltd.
    
    
    2,400
    
    
    
    Gain on sale of intellectual property
    
    
    (9,000
    )
    
    
    Gain on sale of development studio assets
    
    
    (885
    )
    
    
    Adjustment for non-cash gain on sale of development studio assets
    
    
    200
    
    
    
    Stock-based compensation expense
    
    
    1,135
    
    
    
    107Non-cash expense/income on cash collateralized security deposit
    
    
    
    
    
    
    (1
    )Atari name license expense
    
    
    1,663
    
    
    
    1,663Depreciation and amortization
    
    
    2,227
    
    
    
    1,198Amortization of deferred financing fees
    
    
    149
    
    
    
    610Accrued interest
    
    
    
    
    
    
    108Gain on sale of property and equipment
    
    
    (74
    )
    
    
    Other miscellaneous adjustments to net loss
    
    
    (332
    )
    
    
    (57
    )Changes in operating assets and liabilities:Receivables, net
    
    
    (11,091
    )
    
    
    (9,686
    )Inventories, net
    
    
    7,382
    
    
    
    1,475Due from related parties
    
    
    2,975
    
    
    
    (925
    )Due to related parties
    
    
    (357
    )
    
    
    1,374Prepaid expenses and other current assets
    
    
    (1,981
    )
    
    
    4,655Accounts payable
    
    
    (10,756
    )
    
    
    (371
    )Accrued liabilities
    
    
    (4,274
    )
    
    
    (1,970
    )Royalties payable
    
    
    (10,219
    )
    
    
    (474
    )Long-term liabilities
    
    
    1,468
    
    
    
    807Other assets
    
    
    2,793
    
    
    
    (609
    )Net cash used in continuing operating activities
    
    
    (39,447
    )
    
    
    (22,043
    )Net cash (used in) provided by discontinued operations
    
    
    (7,163
    )
    
    
    612Net cash used in operating activities
    
    
    (46,610
    )
    
    
    (21,431
    )CASH FLOWS FROM INVESTING ACTIVITIES:Proceeds from sale of intellectual property
    
    
    9,000
    
    
    
    (Increase)
decrease in restricted cash collateralizing letter of credit
    
    
    (1,764
    )
    
    
    845Proceeds from sale of property and equipment
    
    
    179
    
    
    
    Proceeds from sale of development studio assets
    
    
    1,550
    
    
    
    Purchases of acquired intangible assets
    
    
    (1,212
    )
    
    
    Purchases of property and equipment
    
    
    (897
    )
    
    
    (533
    )Net cash provided by (used in) continuing investing activities
    
    
    6,856
    
    
    
    312Net cash provided by discontinued operations
    
    
    21,593
    
    
    
    Net cash provided by (used in) investing activities
    
    
    28,449
    
    
    
    312CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings under credit facility
    
    
    15,000
    
    
    
    14,000Payments under credit facility
    
    
    (8,000
    )
    
    
    Proceeds from related party license advance
    
    
    
    
    
    
    5,000Proceeds from exercise of stock options
    
    
    4
    
    
    
    Payments under capitalized lease obligation
    
    
    (173
    )
    
    
    (63
    )Net cash provided by continuing financing activities
    
    
    6,831
    
    
    
    18,937Effect of foreign exchange rates on cash
    
    
    13
    
    
    
    7Net decrease in cash
    
    
    (11,317
    )
    
    
    (2,175
    )Cash  beginning of fiscal period
    
    
    14,948
    
    
    
    7,603Cash  end of fiscal period
    
    $
    3,631
    
    
    $
    5,428
 Page 5




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ATARI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)
(unaudited)
 SUPPLEMENTAL CASH FLOW INFORMATIONCash paid for interest
    
    $
    120
    
    
    $
    342Income tax refunds
    
    $
    
    
    
    $
    Income tax payments
    
    $
    
    
    
    $
    SUPPLEMENTAL DISCLOSURE OF NON-CASH OPERATING,
INVESTING, AND FINANCING ACTIVITIESEscrow receivable in connection with sale of Reflections Interactive Ltd.
    
    $
    2,400
    
    
    $
    Escrow receivable in connection with sale of development studio assets
    
    $
    200
    
    
    $
    Consideration accrued for purchase of capitalized licenses
    
    $
    970
    
    
    $
    0Capitalization of leasehold improvements funded by landlord
    
    $
    
    
    
    $
    2,792
  Page 6




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ATARI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
(DEFICIENCY)AND COMPREHENSIVE LOSS
(in thousands)
(unaudited)
 AccumulatedCommon
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    OtherStock
    
    
    Common
    
    
    Paid-In
    
    
    Accumulated
    
    
    ComprehensiveShares
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    Income
    
    
    TotalBalance, March 31, 2007
    
    
    13,478
    
    
    $
    1,348
    
    
    $
    760,527
    
    
    $
    (761,299
    )
    
    $
    2,518
    
    
    $
    3,094Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,980
    )
    
    
    
    
    
    
    (19,980
    )Foreign currency translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (32
    )
    
    
    (32
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,012
    )Stock-based compensation expense
    
    
    
    
    
    
    
    
    
    
    107
    
    
    
    
    
    
    
    
    
    
    
    107Balance, December 31, 2007
    
    
    13,478
    
    
    $
    1,348
    
    
    $
    760,634
    
    
    $
    (781,279
    )
    
    $
    2,486
    
    
    $
    (16,811
    )
  Page 7




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ATARI, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
 Nature of Business
   Going Concern
  Driver
    Page 8




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Guggenheim Corporate Funding LLC Covenant Default
  Removal of the Atari, Inc. Board of Directors
  Transfer of the Guggenheim credit facility to BlueBay High Yield Investments (Luxembourg)
S.A.R.L.
   Test Drive Intellectual Property License
   Overhead Reduction
  Page 9




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Global Memorandum of Understanding
    Short Form Distribution Agreement
      Page 10




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##### Table of Contents



Termination and Transfer of Assets Agreement
    QA Services Agreement
   Intercompany Services Agreement
       Page 11




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##### Table of Contents



NASDAQ Delisting Notice
    Basis of Presentation
  Principles of Consolidation
  Reclassifications
  Revenue recognition, sales returns, price protection, other customer related allowances and
allowance for doubtful accounts
   Page 12




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Concentration of Credit Risk
  Use of Estimates
  Fair Values of Financial Instruments
  Long-Lived Assets
  Research and Product Development Expenses
   Licenses
  Page 13




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Atari Trademark License
  Net Loss Per Share
  Recent Accounting Pronouncements
   NOTE 2  STOCK-BASED COMPENSATION
    Page 14




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Three Months Ended
    
    Nine Months EndedDecember 31,
    
    December 31,2006
    
    2007
    
    2006
    
    2007Research and product development
    
    $
    433
    
    
    $
    (13
    )
    
    $
    542
    
    
    $
    2Selling and distribution expenses
    
    $
    26
    
    
    $
    (4
    )
    
    $
    55
    
    
    $
    (30
    )General and administrative expenses
    
    $
    (22
    )
    
    $
    (2
    )
    
    $
    538
    
    
    $
    135
   Three Months Ended
    
    Nine Months EndedDecember 31,
    
    December 31,2006
    
    2007
    
    2006
    
    2007Expected volatility
    
    
    79
    %
    
    
    71
    %
    
    
    79
    %
    
    
    71
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected term
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    4
   Page 15




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Weighted AverageShares
    
    
    Exercise Price(in thousands)Options outstanding at March 31, 2007
    
    
    1,112
    
    
    $
    33.45Granted
    
    
    50
    
    
    
    2.92Forfeited
    
    
    (453
    )
    
    
    10.19Expired
    
    
    (378
    )
    
    
    54.51Options outstanding at December 31, 2007
    
    
    331
    
    
    $
    36.62Options exercisable at December 31, 2007
    
    
    197
    
    
    $
    57.41
  Page 16




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NOTE 3  CONCENTRATION OF CREDIT RISK
  For the year endedMarch 31,
    
    March 31,2007
    
    2007% of Accounts Receivable
    
    % of Net Revenues (1)Customer 1
    
    
    34
    %
    
    
    19
    %Customer 2
    
    
    20
    %
    
    
    9
    %54
    %
    
    
    28
    %
  For the nine months endedDecember 31,
    
    December 31,2007
    
    2007% of Accounts Receivable
    
    % of Net Revenues (1)Customer 1
    
    
    37
    %
    
    
    28
    %Customer 2
    
    
    15
    %
    
    
    12
    %Customer 3
    
    
    13
    %
    
    
    9
    %Customer 4
    
    
    11
    %
    
    
    7
    %76
    %
    
    
    56
    %
 
 (1)
    
    Excluding international royalty, licensing, and other income.  NOTE 4  BALANCE SHEET DETAILS
 Inventories
  March 31,
    
    
    December 31,2007
    
    
    2007Finished goods, net
    
    $
    8,226
    
    
    $
    6,803Return inventory, net
    
    
    615
    
    
    
    553Raw materials, net
    
    
    2
    
    
    
    11$
    8,843
    
    
    $
    7,367
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Prepaid Expenses and Other Current Assets
  March 31,
    
    
    December 31,2007
    
    
    2007Licenses short-term
    
    $
    7,054
    
    
    $
    1,976Royalties receivable
    
    
    495
    
    
    
    140Prepayments to manufacturers and other deposits
    
    
    127
    
    
    
    955Reflections escrow receivable
    
    
    626
    
    
    
    28Deferred financing fees
    
    
    209
    
    
    
    380Taxes receivable
    
    
    90
    
    
    
    68Prepaid insurance
    
    
    802
    
    
    
    1,196Other prepaid expenses and current assets
    
    
    826
    
    
    
    816$
    10,229
    
    
    $
    5,559
 Accrued Liabilities
  March 31,
    
    
    December 31,2007
    
    
    2007Accrued advertising
    
    $
    1,222
    
    
    $
    2,326Accounts
receivable credit balances (See Note 3)
    
    
    828
    
    
    
    Accrued distribution services
    
    
    2,061
    
    
    
    1,571Accrued salary and related costs
    
    
    1,581
    
    
    
    561Accrued professional fees and other services
    
    
    2,578
    
    
    
    1,038Accrued third party development expenses
    
    
    2,660
    
    
    
    979Restructuring reserve (Note 10)
    
    
    54
    
    
    
    1,604Taxes payable
    
    
    299
    
    
    
    282Accrued freight and handling fees
    
    
    193
    
    
    
    257Deferred income
    
    
    231
    
    
    
    277Other
    
    
    1,674
    
    
    
    2,563$
    13,381
    
    
    $
    11,458
 NOTE 5  INCOME TAXES
    Page 18




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NOTE 6  RELATED PARTY TRANSACTIONS
 Relationship with IESA
    Page 19




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##### Table of Contents



Summary of Related Party Transactions
  Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,Income (expense)
    
    2006
    
    
    2007
    
    
    2006
    
    
    2007Net revenues
    
    $
    47,277
    
    
    $
    41,115
    
    
    $
    95,338
    
    
    $
    64,845Related party activity:Royalty income (1)
    
    
    909
    
    
    
    506
    
    
    
    1,886
    
    
    
    1,322License income (1)
    
    
    285
    
    
    
    709
    
    
    
    1,394
    
    
    
    5,697Sale of goods
    
    
    287
    
    
    
    271
    
    
    
    677
    
    
    
    505Production and quality and assurance testing
services
    
    
    1,472
    
    
    
    598
    
    
    
    3,762
    
    
    
    2,034Total related party net revenues
    
    
    2,953
    
    
    
    2,084
    
    
    
    7,719
    
    
    
    9,558Cost of goods sold
    
    
    (27,117
    )
    
    
    (21,145
    )
    
    
    (56,296
    )
    
    
    (34,186
    )Related party activity:Distribution fee for Humongous, Inc. product
    
    
    (694
    )
    
    
    (4,368
    )
    
    
    (3,939
    )
    
    
    (5,820
    )Royalty expense (2)
    
    
    (7,394
    )
    
    
    (2,058
    )
    
    
    (9,106
    )
    
    
    (3,403
    )Total related party cost of goods sold
    
    
    (8,088
    )
    
    
    (6,426
    )
    
    
    (13,045
    )
    
    
    (9,223
    )Research and product development
    
    
    (5,522
    )
    
    
    (4,423
    )
    
    
    (19,988
    )
    
    
    (12,425
    )Related party activity:Development expenses (3)
    
    
    (1,190
    )
    
    
    (82
    )
    
    
    (6,517
    )
    
    
    (247
    )Other miscellaneous development services
    
    
    5
    
    
    
    
    
    
    
    14
    
    
    
    Total related party research and product
development
    
    
    (1,185
    )
    
    
    (82
    )
    
    
    (6,503
    )
    
    
    (247
    )Selling and distribution expenses
    
    
    (6,377
    )
    
    
    (7,123
    )
    
    
    (20,795
    )
    
    
    (15,882
    )Related party activity:Miscellaneous purchase of services
    
    
    (3
    )
    
    
    
    
    
    
    (82
    )
    
    
    (41
    )Total related party selling and distribution
expenses
    
    
    (3
    )
    
    
    
    
    
    
    (82
    )
    
    
    (41
    )General and administrative expenses
    
    
    (5,206
    )
    
    
    (3,341
    )
    
    
    (16,321
    )
    
    
    (13,894
    )Related party activity:Management fee revenue
    
    
    750
    
    
    
    719
    
    
    
    2,270
    
    
    
    2,219Management fee expense
    
    
    (750
    )
    
    
    (529
    )
    
    
    (2,250
    )
    
    
    (2,030
    )Office rental and other services (4)
    
    
    46
    
    
    
    46
    
    
    
    138
    
    
    
    138Total related party general and
administrative
expenses
    
    
    46
    
    
    
    236
    
    
    
    158
    
    
    
    327Restructuring expenses
    
    
    (224
    )
    
    
    (3,730
    )
    
    
    (558
    )
    
    
    (4,722
    )Related party activity:Related party rent expense (4)
    
    
    (116
    )
    
    
    
    
    
    
    (349
    )
    
    
    Total related party restructuring expenses
    
    
    (116
    )
    
    
    
    
    
    
    (349
    )
    
    
    Interest expense (income), net
    
    
    (45
    )
    
    
    (810
    )
    
    
    187
    
    
    
    (855
    )Related party activity:Related party interest on license advance (5)
    
    
    
    
    
    
    (108
    )
    
    
    
    
    
    
    (108
    )Total related party interest expense
    
    
    
    
    
    
    (108
    )
    
    
    
    
    
    
    (108
    )(Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    
    (1,727
    )
    
    
    (33
    )
    
    
    146
    
    
    
    (33
    )Related party activity:Royalty income (1)
    
    
    (864
    )
    
    
    
    
    
    
    (1,570
    )
    
    
    License income (1)
    
    
    134
    
    
    
    
    
    
    
    525
    
    
    
    Total related party loss from discontinued
operations
    
    
    (730
    )
    
    
    
    
    
    
    (1,045
    )
    
    
    
 Page 20




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##### Table of Contents



(1)
    
    We have entered into a distribution agreement with IESA and Atari Europe which provides for
IESAs and Atari Europes distribution of our products across Europe, Asia, and certain other
regions pursuant to which IESA, Atari Europe, or any of their subsidiaries, as applicable, will
pay us 30.0% of the gross margin on such products or 130.0% of the royalty rate due to the
developer, whichever is greater. We recognize this amount as royalty income as part of net
revenues, net of returns. Additionally, we earn license income from related parties iFone and
Glu Mobile (see below).(2)
    
    We have also entered into a distribution agreement with IESA and Atari Europe, which
provides for our distribution of IESAs (or any of its subsidiaries) products in the United
States, Canada and Mexico, pursuant to which we will pay IESA either 30.0% of the gross margin
on such products or 130.0% of the royalty rate due to the developer, whichever is greater. We
recognize this amount as royalty expense as part of cost of goods sold, net of returns.(3)
    
    We engage certain related party development studios to provide services such as product
development, design, and testing.(4)
    
    In July 2002, we negotiated a sale-leaseback transaction between Atari Interactive and an
unrelated party. As part of this transaction, we guaranteed the lease obligation of Atari
Interactive. The lease provides for minimum monthly rental payments of approximately $0.1
million escalating nominally over the ten-year term of the lease. During fiscal 2006, when the
Beverly studio (which held the office space for Atari Interactive) was closed, rental payments
were recorded to restructuring expense. We also received indemnification from IESA from costs,
if any, that may be incurred by us as a result of the full guarantee.We received a $1.3 million payment for our efforts in connection with the sale-leaseback
transaction. Approximately $0.6 million, an amount equivalent to a third party brokers
commission, was recognized during fiscal 2003 as other income, while the remaining balance of
$0.7 million was deferred and is being recognized over the life of the sub-lease. Accordingly,
during the nine months ended December 31, 2006 and 2007, a nominal amount of income was
recognized in each period. As of December 31, 2007, the remaining balance of approximately $0.3
million is deferred and is being recognized over the life of the sub-lease. Although the
Beverly studio was closed in fiscal 2006 as part of a restructuring plan (Note 10), the space
was not sublet; the lease expired June 30, 2007.Additionally, we provide management information systems services to Atari Australia for which we
are reimbursed. The charge is calculated as a percentage of our costs, based on usage, which is
agreed upon by the parties.(5)
    
    Represents interest charged to us from the license advance from the Test Drive license. See
Note 1 and Test Drive Intellectual Property License below.  March 31,
    
    
    December 31,2007
    
    
    2007Due from/(Due to)  currentIESA (1)
    
    $
    (1,494
    )
    
    $
    (1,279
    )Atari Europe (2)
    
    
    280
    
    
    
    (978
    )Eden Studios (3)
    
    
    (595
    )
    
    
    (223
    )Atari Studio Asia (3)
    
    
    (401
    )
    
    
    (6
    )Humongous, Inc. (4)
    
    
    (2,218
    )
    
    
    (2,279
    )Atari Interactive (5)
    
    
    (992
    )
    
    
    (169
    )Glu Mobile/iFone (6)
    
    
    1,265
    
    
    
    Other miscellaneous net receivables
    
    
    251
    
    
    
    26Net due to related parties  current
    
    
    (3,904
    )
    
    
    (4,908
    )Due from/(Due to)  long-termDeferred related party license advance
    
    
    
    
    
    
    (5,108
    )Atari Interactive (see Atari Licensebelow)
    
    
    (1,912
    )
    
    
    (3,021
    )Net due to related parties
    
    $
    (5,816
    )
    
    $
    (13,037
    )
  Page 21




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##### Table of Contents



March 31,
    
    
    December 31,2007
    
    
    2007Due from related parties
    
    $
    1,799
    
    
    $
    425Due to related parties
    
    
    (5,703
    )
    
    
    (5,333
    )Net (due to) due from related parties  current
    
    $
    (3,904
    )
    
    $
    (4,908
    )
 
 (1)
    
    Balances comprised primarily of the management fees charged to us by IESA and other
charges of cost incurred on our behalf.(2)
    
    Balances comprised of royalty income or expense from our distribution agreements with
IESA and Atari Europe relating to properties owned or licensed by Atari Europe.(3)
    
    Represents net payables for related party development activities. (Note: Atari
Melbourne House, a related party development studio, was sold to a third party by IESA in
the third quarter of fiscal 2007. Balances due to Atari Melbourne House as of March 31,
2007 were transferred to Atari Studio Asia.)(4)
    
    Represents primarily distribution fees owed to Humongous, Inc., a related party,
related to sale of their product.(5)
    
    Comprised primarily of royalties owed to Atari Interactive, offset by receivables
related to management fee revenue and production and quality and assurance testing services
revenue earned from Atari Interactive.(6)
    
    Balances comprised of license income from our licensing agreements with Glu Mobile,
Inc. (merged with Ifone in 2006) relating to properties in which we own or hold rights to
publish and/or sub-license. Atari Name License
  Sale of Hasbro Licensing Rights
  Test Drive Intellectual Property License
  Page 22




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##### Table of Contents



Related Party Transactions with Employees or Former Employees
 
    
    License Revenue from Glu Mobile
  NOTE 7  COMMITMENTS AND CONTINGENCIES
 Contractual Obligations
  Contractual ObligationsRoyalty and license
    
    
    Milestone payments
    
    
    Operating lease
    
    
    Capital leaseThrough
    
    advances (1)
    
    
    (2)
    
    
    obligations (3)
    
    
    obligations (4)
    
    
    TotalDecember 31, 2008
    
    $
    3,884
    
    
    $
    405
    
    
    $
    1,710
    
    
    $
    33
    
    
    $
    6,032December 31, 2009
    
    
    
    
    
    
    
    
    
    
    1,851
    
    
    
    
    
    
    
    1,851December 31, 2010
    
    
    
    
    
    
    
    
    
    
    1,768
    
    
    
    
    
    
    
    1,768December 31, 2011
    
    
    
    
    
    
    
    
    
    
    1,178
    
    
    
    
    
    
    
    1,178December 31, 2012
    
    
    
    
    
    
    
    
    
    
    1,329
    
    
    
    
    
    
    
    1,329Thereafter
    
    
    
    
    
    
    
    
    
    
    12,302
    
    
    
    
    
    
    
    12,302Total
    
    $
    3,884
    
    
    $
    405
    
    
    $
    20,138
    
    
    $
    33
    
    
    $
    24,460
 
 (1)
    
    We have committed to pay advance payments under certain royalty and
license agreements. The payments of these obligations are dependent on the delivery
of the contracted services by the developers.(2)
    
    Milestone payments represent royalty advances to developers for products
that are currently in development. Although milestone payments are not guaranteed,
we expect to make these payments if all deliverables and milestones are met timely
and accurately.(3)
    
    We account for our office leases as operating leases, with expiration
dates ranging from fiscal 2008 through fiscal 2022. These are future minimum annual
rental payments required under the leases net of $0.6 million of sublease income to
be received in fiscal 2008 and fiscal 2009. Rent expense and sublease income for
the three and nine months ended December 31, 2006 and 2007 is as follows (in
thousands): Three months ended
    
    Nine months endedDecember 31,
    
    December 31,2006
    
    2007
    
    2006
    
    2007Rent expense
    
    $
    1,052
    
    
    $
    928
    
    
    $
    2,682
    
    
    $
    3,456Sublease income
    
    $
    (225
    )
    
    
    (244
    )
    
    $
    (403
    )
    
    
    (745
    )
 
    
    Renewal of New York lease
 
 During June 2006, we entered into a new lease with our current landlord at our New
York headquarters for approximately 70,000 square feet of office space for our
principal offices. The term of this lease Page 23




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##### Table of Contents



commenced on July 1, 2006 and is to expire
on June 30, 2021. Upon entering into the new lease, our prior lease, which was set
to expire in December 2006, was terminated. The rent under the new lease for the
office space was approximately $2.4 million per year for the first five years,
increased to approximately $2.7 million per year for the next five years, and
increased to $2.9 million for the last five years of the term. In addition, we must
pay for electricity, increases in real estate taxes and increases in porter wage
rates over the term. The landlord is providing us with a one year rent credit of
$2.4 million and an allowance of $4.5 million to be used for building out and
furnishing the premises, of which $1.2 million has been recorded as a deferred credit
as of March 31, 2007; the remainder of the deferred credit will be recorded as the
improvements are completed, and will be amortized against rent expense over the life
of the lease. A nominal amount of amortization was recorded during the year ended
March 31, 2007. For the nine months ended December 31, 2007, we recorded an
additional deferred credit of $2.8 million and amortization against the total
deferred credits of approximately $0.2 million. Shortly after signing the new lease,
we provided the landlord with a security deposit under the new lease in the form of a
letter of credit in the initial amount of $1.7 million, which has been cash
collateralized and is included in security deposits on our condensed consolidated
balance sheet. On August 14, 2007, we and our new landlord, W2007 Fifth Realty, LLC,
amended the lease under which we occupy space in 417 Fifth Avenue, New York City, to
reduce the space we occupy by approximately one-half, effective December 31, 2007. As
a result, our rent under the amended lease will be reduced from its current
approximately $2.4 million per year to approximately $1.2 million per year from
January 1, 2008 through June 30, 2011, approximately $1.3 million per year for the
five years thereafter, and approximately $1.5 million per year for the last five
years of the term.(4)
    
    We maintain several capital leases for computer equipment. Per FASB
Statement No. 13, Accounting for Leases, we account for capital leases by
recording them at the present value of the total future lease payments. They are
amortized using the straight-line method over the minimum lease term. As of March
31, 2007, the net book value of the assets, included within property and equipment
on the balance sheet, was $0.1 million, net of accumulated depreciation of $0.5
million. As of December 31, 2007, the net book value of the assets was $0.1
million, net of accumulated depreciation of $0.5 million. Litigation
  Bouchat v. Champion Products, et al. (Accolade)
  Ernst & Young, Inc. v. Atari, Inc.
  Page 24




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##### Table of Contents



Research in Motion Limited v. Atari, Inc. and Atari Interactive, Inc.
  FUNimation License Agreement
  NOTE 8  DEBT
 Credit Facilities
 Guggenheim Credit Facility
    Page 25




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##### Table of Contents



NOTE 9  DISCONTINUED OPERATIONS
 Sale of Reflections
  Driver Driver Driver: Parallel Lines
 Balance Sheets
 Driver
 March 31, 2007Assets:Prepaid expenses and other current assets
    
    $
    310Other non-current assets
    
    
    335Total assets
    
    $
    645
  Page 26




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##### Table of Contents




    
    Results of Operations
  Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2006
    
    
    2007
    
    
    2006
    
    
    2007Net revenues
    
    $
    (563
    )
    
    $
    
    
    
    $
    (360
    )
    
    $
    (Loss) from operations of Reflections
Interactive
Ltd.
    
    
    (1,727
    )
    
    
    (33
    )
    
    
    (11,326
    )
    
    
    (33
    )Gain on sale of Reflections Interactive Ltd.
    
    
    
    
    
    
    
    
    
    
    11,472
    
    
    
    (Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax.
    
    $
    (1,727
    )
    
    $
    (33
    )
    
    $
    146
    
    
    $
    (33
    )
 NOTE 10  RESTRUCTURING
  Three Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2006
    
    
    2007
    
    
    2006
    
    
    2007May severance and retention expenses (1)
    
    $
    60
    
    
    $
    
    
    
    $
    101
    
    
    $
    787November severance and retention expenses
(2)
    
    
    
    
    
    
    812
    
    
    
    
    
    
    
    812Restructuring consultants and legal fees (2)
    
    
    
    
    
    
    2,874
    
    
    
    
    
    
    
    2,874Lease related costs (3) (2)
    
    
    161
    
    
    
    44
    
    
    
    434
    
    
    
    249Miscellaneous costs
    
    
    3
    
    
    
    
    
    
    
    23
    
    
    
    Total
    
    $
    224
    
    
    $
    3,730
    
    
    $
    558
    
    
    $
    4,722
 
 (1)
    
    In the first quarter of fiscal 2008, management announced a plan to reduce our total
workforce by 20%, primarily in general and administrative functions.(2)
    
    In the third quarter of fiscal 2008, as part of the removal of the Board of Directors
and the hiring of a restructuring firm, management announced an additional workforce
reduction of 30%, primarily in research and development and general and administrative
functions. This restructuring is anticipated to cost us approximately $5.0 to $6.0 million
dollars of which $1.0 to $1.5 million would relate to severance arrangements (See Note 1).(3)
    
    As part of a restructuring plan implemented in fiscal 2005, we recorded the present
value of all future lease payments, less the present value of expected sublease income to
be recorded, primarily for the Beverly and Santa Monica offices, in accordance with FASB
Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
Through the remainder of the related leases, FASB Statement No. 146 requires us to record
expense to adjust the present value recorded in 2005 to the actual expense and income
recorded for the month. For the three months ended June 30, 2006, we recorded $0.1 million
for the present value adjustments related to the Beverly and Santa Monica offices. The
Santa Monica lease ended during the second quarter of fiscal 2007; therefore the expense of
$0.2 million for the nine months ended December 31, 2006, relates to the Beverly lease,
which ended as of that date. Page 27




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##### Table of Contents



Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atMarch 31, 2007
    
    
    Accrued Amounts
    
    
    Reclasses
    
    
    Cash payments, net
    
    
    December 31, 2007Short termSeverance and
retention expenses
(1) and (2)
    
    $
    
    
    
    $
    1,599
    
    
    $
    
    
    
    $
    (803
    )
    
    $
    796Restructuring
consultants and
legal fees (2)
    
    
    
    
    
    
    2,874
    
    
    
    
    
    
    
    (2,074
    )
    
    
    800Lease related costs
    
    
    54
    
    
    
    249
    
    
    
    3
    
    
    
    (298
    )
    
    
    8Total
    
    
    54
    
    
    
    4,722
    
    
    
    3
    
    
    
    (3,175
    )
    
    
    1,604Long termLease related costs
    
    
    3
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    Total
    
    
    3
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    Total
    
    $
    57
    
    
    $
    4,722
    
    
    $
    
    
    
    $
    (3,175
    )
    
    $
    1,604
 NOTE 11  SALE OF INTELLECTUAL PROPERTY
 Stuntman
 NOTE 12  OPERATIONS BY REPORTABLE SEGMENTS
     Page 28




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##### Table of Contents



Publishing
    
    
    Distribution
    
    
    Corporate
    
    
    TotalThree months ended December 31, 2006:Net revenues
    
    $
    45,954
    
    
    $
    1,323
    
    
    $
    
    
    
    $
    47,277Operating income (loss) (1)
    
    
    8,984
    
    
    
    (979
    )
    
    
    (6,069
    )
    
    
    1,936Depreciation and amortization
    
    
    (73
    )
    
    
    
    
    
    
    (492
    )
    
    
    (565
    )Interest expense, net
    
    
    
    
    
    
    
    
    
    
    (45
    )
    
    
    (45
    )Nine months ended December 31, 2006:Net revenues
    
    $
    78,847
    
    
    $
    16,491
    
    
    $
    
    
    
    $
    95,338Operating income (loss) (1)
    
    
    5,536
    
    
    
    1,858
    
    
    
    (19,461
    )
    
    
    (12,067
    )Depreciation and amortization
    
    
    (446
    )
    
    
    
    
    
    
    (1,781
    )
    
    
    (2,227
    )Interest income, net
    
    
    
    
    
    
    
    
    
    
    187
    
    
    
    187Three months ended December 31, 2007:Net revenues
    
    $
    35,169
    
    
    $
    5,946
    
    
    $
    
    
    
    $
    41,115Operating income (loss) (1)
    
    
    7,441
    
    
    
    905
    
    
    
    (4,140
    )
    
    
    4,206Depreciation and amortization
    
    
    21
    
    
    
    
    
    
    
    (344
    )
    
    
    (323
    )Interest expense, net
    
    
    
    
    
    
    
    
    
    
    (810
    )
    
    
    (810
    )Nine months ended December 31, 2007:Net revenues
    
    $
    56,254
    
    
    $
    8,591
    
    
    $
    
    
    
    $
    64,845Operating income (loss) (1)
    
    
    1,076
    
    
    
    999
    
    
    
    (16,478
    )
    
    
    (14,403
    )Depreciation and amortization
    
    
    (126
    )
    
    
    
    
    
    
    (1,072
    )
    
    
    (1,198
    )Interest expense, net
    
    
    
    
    
    
    
    
    
    
    (855
    )
    
    
    (855
    )
 
 (1)
    
    Operating loss for the Corporate segment for the three months ended December 31, 2006
and 2007, excludes restructuring charges of $0.2 million and $3.8 million, respectively,
and for the nine months ended December 31, 2006 and 2007 excludes $0.6 million and $4.7
million, respectively. Including restructuring charges, total operating income for the
three months ended December 31, 2006 and 2007 is $1.7 million and $0.5 million,
respectively, and operating (loss) for the nine months ended December 31, 2006 and 2007 is
$(12.6) million and $(19.1) million, respectively. Page 29




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 This document includes statements that may constitute forward-looking statements made pursuant
to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution
readers regarding certain forward-looking statements in this document, press releases, securities
filings, and all other documents and communications. All statements, other than statements of
historical fact, including statements regarding industry prospects and expected future results of
operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking.
The words believe, expect, anticipate, intend and similar expressions generally identify
forward-looking statements. Forward-looking statements are necessarily based upon a number of
estimates and assumptions that, while considered reasonable by us, are inherently subject to
significant business, economic and competitive uncertainties and contingencies and known and
unknown risks. As a result of such risks, our actual results could differ materially from those
expressed in any forward-looking statements made by, or on behalf of, us. Some of the factors
which could cause our results to differ materially include the following: the loss of key
customers, such as Wal-Mart, Best Buy, Target, and GameStop; delays in product development and
related product release schedules; inability to secure capital; loss of our credit facility;
inability to adapt to the rapidly changing industry technology, including new console technology;
inability to maintain relationships with leading independent video game software developers;
inability to maintain or acquire licenses to intellectual property; fluctuations in our quarterly
net revenues or results of operations based on the seasonality of our industry; and the termination
or modification of our agreements with hardware manufacturers. Please see the Risk Factors in
our Annual Report on Form 10-K for the year ended March 31, 2007, or in our other filings with the
Securities and Exchange Commission (SEC) for a description of some, but not all, risks,
uncertainties and contingencies. Except as otherwise required by the applicable securities laws,
we disclaim any intention or obligation publicly to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
 Going Concern
  Driver
    
    
    Guggenheim Corporate Funding LLC Covenant Default
    
    Removal of the Atari, Inc. Board of Directors
    
    Transfer of the Guggenheim credit facility to BlueBay High Yield Investments
(Luxembourg) S.A.R.L.
    
    Test Drive Intellectual Property License
 Page 30




---



##### Table of Contents




    
    Overhead Reduction
    
    Global Memorandum of Understanding
    
    Short Form Distribution Agreement
    
    Termination and Transfer of Assets Agreement
    
    QA Services Agreement
    
    Intercompany Services Agreement
 See Note 1 for detailed description of each transaction.
       Related party transactions
  Business and Operating Segments
  Page 31




---



##### Table of Contents



Key Challenges
    Critical Accounting Policies
  Page 32




---



##### Table of Contents



Revenue recognition, sales returns, price protection, other customer related allowances and
allowance for doubtful accounts
     Inventories
  Research and product development costs
   Licenses
 Page 33




---



##### Table of Contents



Atari Trademark License
  Goodwill
    Page 34




---



##### Table of Contents



Results of operations
 Three months ended December 31, 2006 versus the three months ended December 31, 2007
 Condensed Consolidated Statements of Operations (dollars in thousands):
 Three
    
    
    
    
    
    
    ThreeMonths
    
    
    % of
    
    
    Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)/December 31,
    
    
    Revenues
    
    
    December 31,
    
    
    Revenues
    
    
    Increase2006
    
    
    
    
    
    
    2007
    
    
    
    
    
    
    $
    
    
    %Net revenues
    
    $
    47,277
    
    
    
    100.0
    %
    
    $
    41,115
    
    
    
    100.0
    %
    
    $
    (6,162
    )
    
    
    (13.0
    )%Costs, expenses, and income:Cost of goods sold
    
    
    27,117
    
    
    
    57.4
    %
    
    
    21,145
    
    
    
    51.4
    %
    
    
    (5,972
    )
    
    
    (22.0
    )%Research and product development
    
    
    5,522
    
    
    
    11.7
    %
    
    
    4,423
    
    
    
    10.8
    %
    
    
    (1,099
    )
    
    
    (19.9
    )%Selling and distribution expenses
    
    
    6,377
    
    
    
    13.5
    %
    
    
    7,123
    
    
    
    17.3
    %
    
    
    746
    
    
    
    11.7
    %General and administrative expenses
    
    
    5,206
    
    
    
    11.0
    %
    
    
    3,341
    
    
    
    8.1
    %
    
    
    (1,865
    )
    
    
    (35.8
    )%Restructuring expenses
    
    
    224
    
    
    
    0.5
    %
    
    
    3,730
    
    
    
    9.1
    %
    
    
    3,506
    
    
    
    1565.2
    %Depreciation and amortization
    
    
    565
    
    
    
    1.2
    %
    
    
    323
    
    
    
    0.8
    %
    
    
    (242
    )
    
    
    (42.8
    )%Atari trademark license expense
    
    
    554
    
    
    
    1.2
    %
    
    
    554
    
    
    
    1.3
    %
    
    
    
    
    
    
    0.0
    %Total costs, expenses, and income
    
    
    45,565
    
    
    
    96.5
    %
    
    
    40,639
    
    
    
    98.8
    %
    
    
    (4,926
    )
    
    
    (10.8
    )%Operating income
    
    
    1,712
    
    
    
    3.5
    %
    
    
    476
    
    
    
    1.2
    %
    
    
    (1,236
    )
    
    
    (72.2
    )%Interest expense, net
    
    
    (45
    )
    
    
    (0.1
    )%
    
    
    (810
    )
    
    
    (2.0
    )%
    
    
    (765
    )
    
    
    1700.0
    %Other income
    
    
    23
    
    
    
    0.0
    %
    
    
    19
    
    
    
    0.0
    %
    
    
    (4
    )
    
    
    (17.4
    )%Income (loss) before provision for
income taxes
    
    
    1,690
    
    
    
    3.4
    %
    
    
    (315
    )
    
    
    (0.8
    )%
    
    
    (2,005
    )
    
    
    (118.6
    )%Provision for income taxes
    
    
    607
    
    
    
    1.1
    %
    
    
    
    
    
    
    0.0
    %
    
    
    (607
    )
    
    
    (100.0
    )%Income (loss) from continuing operations
    
    
    1,083
    
    
    
    2.3
    %
    
    
    (315
    )
    
    
    (0.8
    )%
    
    
    (1,398
    )
    
    
    (129.1
    )%(Loss) from discontinued operations of
Reflections Interactive Ltd., net of
tax
    
    
    (1,727
    )
    
    
    (3.7
    )%
    
    
    (33
    )
    
    
    (0.0
    )%
    
    
    1,694
    
    
    
    (98.1
    )%Net loss
    
    $
    (644
    )
    
    
    (1.4
    )%
    
    $
    (348
    )
    
    
    (0.8
    )%
    
    $
    296
    
    
    
    (46.0
    )%
 Net Revenues
 Net Revenues by Segment (in thousands):
 Three MonthsEndedDecember 31,
    
    
    (Decrease)/2006
    
    
    2007
    
    
    IncreasePublishing
    
    $
    45,954
    
    
    $
    35,169
    
    
    $
    (10,785
    )Distribution
    
    
    1,323
    
    
    
    5,946
    
    
    
    4,623Total
    
    $
    47,277
    
    
    $
    41,115
    
    
    $
    (6,162
    )
 Page 35




---



##### Table of Contents



Publishing Sales Platform Mix
 Three MonthsEndedDecember 31,2006
    
    2007PlayStation 2
    
    
    39.8
    %
    
    
    41.9
    %Wii
    
    
    15.0
    %
    
    
    25.3
    %PC
    
    
    31.5
    %
    
    
    23.9
    %Nintendo DS
    
    
    2.0
    %
    
    
    4.4
    %PSP
    
    
    1.8
    %
    
    
    3.9
    %Xbox
    
    
    0.1
    %
    
    
    0.4
    %Xbox 360
    
    
    3.6
    %
    
    
    0.2
    %Plug and Play
    
    
    3.6
    %
    
    
    0.0
    %Game Boy Advance
    
    
    2.6
    %
    
    
    0.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  
    
    Net publishing product sales during the three months ended December 31, 2007 were driven
by new releases of Dragon Ball Z Tenkaichi 3 (Wii and PS2), Godzilla Unleashed (Wii, PS2,
and DS), Jenga (Wii and DS)and The Witcher (PC). These titles comprised approximately
53.2% of our net publishing product sales. The three months ended December 31, 2006 sales
were driven by the new releases Neverwinter Nights 2 (PC) and DragonBall Z Tenkaichi 2 (PS2
and Wii).
    
    International royalty income decreased by $0.4 million as the prior period income
contained international sales of Test Drive Unlimited.
    
    The overall average unit sales price (ASP) of the publishing business has increased
slightly from $23.65 in the prior comparable quarter to $24.80 in the current period due to
a higher percentage of next generation product sales as compared to the prior years
comparable quarter..
  Cost of Goods Sold
  Page 36




---



##### Table of Contents




    
    savings in related party royalty expense (20% of net revenues in third quarter fiscal
2008 versus 28% in 2007) as our product mixed favored products licensed or owned by us
which carry a lower royalty rate as opposed to IESA product, offset by
    
    a higher mix of higher cost third-party distributed product sales as a percentage of net
revenues (14.5% in fiscal 2008 compared with 2.8% in fiscal 2007).
 Research and Product Development Expenses
  
    
    decreased spending of $1.2 million at our related party development studios due to the
completion of Test Drive Unlimited, which was released in the second quarter of fiscal
2007,
    
    decreased salaries and other overhead of $2.0 million due to the sale of our Shiny
studio in the second quarter of fiscal 2007, as well as additional executive and other
personnel reductions, offset by
    
    a write-off of licenses which will no longer be exploited of approximately $2.0 million.
 Selling and Distribution Expenses
  
    
    increased spending on advertising of $0.9 million to support the periods new releases ,
offset by
    
    savings in salaries and related overhead costs due to reduced headcount resulting from
studio closure and personnel reductions.
 General and Administrative Expenses
  
    
    a reduction in salaries and other overhead costs of $1.3 million due to studio closures
and other personnel reductions, and
    
    savings in legal and audit fees of approximately $0.4 million.
 Page 37




---



##### Table of Contents



Restructuring Expenses
  Depreciation and Amortization
  
    
    savings in depreciation relate to the closure of offices and reduction of staffing and
associated overhead.
 Provision for Income Taxes
   Loss from Discontinued Operations of Reflections Interactive Ltd., net of tax
  Page 38




---



##### Table of Contents



Nine months ended December 31, 2006 versus the nine months ended December 31, 2007
 Condensed Consolidated Statements of Operations (dollars in thousands):
 Nine
    
    
    
    
    
    
    NineMonths
    
    
    % of
    
    
    Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)/December 31,
    
    
    Revenues
    
    
    December 31,
    
    
    Revenues
    
    
    Increase2006
    
    
    
    
    
    
    2007
    
    
    
    
    
    
    $
    
    
    %Net revenues
    
    $
    95,338
    
    
    
    100.0
    %
    
    $
    64,845
    
    
    
    100.0
    %
    
    $
    (30,493
    )
    
    
    (32.0
    )%Costs, expenses, and income:Cost of goods sold
    
    
    56,296
    
    
    
    59.0
    %
    
    
    34,186
    
    
    
    52.7
    %
    
    
    (22,110
    )
    
    
    (39.3
    )%Research and product development
    
    
    19,988
    
    
    
    21.0
    %
    
    
    12,425
    
    
    
    19.2
    %
    
    
    (7,563
    )
    
    
    (37.8
    )%Selling and distribution expenses
    
    
    20,795
    
    
    
    21.8
    %
    
    
    15,882
    
    
    
    24.5
    %
    
    
    (4,913
    )
    
    
    (23.6
    )%General and administrative expenses
    
    
    16,321
    
    
    
    17.1
    %
    
    
    13,894
    
    
    
    21.4
    %
    
    
    (2,427
    )
    
    
    (14.9
    )%Restructuring expenses
    
    
    558
    
    
    
    0.6
    %
    
    
    4,722
    
    
    
    7.3
    %
    
    
    4,164
    
    
    
    746.2
    %Gain on sale of intellectual property
    
    
    (9,000
    )
    
    
    (9.4
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    9,000
    
    
    
    100.0
    %Gain on sale of development studio
assets
    
    
    (885
    )
    
    
    (0.9
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    885
    
    
    
    100.0
    %Depreciation and amortization
    
    
    2,227
    
    
    
    2.3
    %
    
    
    1,198
    
    
    
    1.8
    %
    
    
    (1,029
    )
    
    
    (46.2
    )%Atari trademark license expense
    
    
    1,663
    
    
    
    1.7
    %
    
    
    1,663
    
    
    
    2.6
    %
    
    
    
    
    
    
    0.0
    %Total costs, expenses, and income
    
    
    107,963
    
    
    
    113.2
    %
    
    
    83,970
    
    
    
    129.5
    %
    
    
    (23,993
    )
    
    
    (22.2
    )%Operating loss
    
    
    (12,625
    )
    
    
    (13.2
    )%
    
    
    (19,125
    )
    
    
    (29.5
    )%
    
    
    (6,500
    )
    
    
    (51.5
    )%Interest (expense) income, net
    
    
    187
    
    
    
    0.2
    %
    
    
    (855
    )
    
    
    (1.3
    )%
    
    
    (1,042
    )
    
    
    (557.2
    )%Other (expense) income
    
    
    58
    
    
    
    0.1
    %
    
    
    33
    
    
    
    0.0
    %
    
    
    (25
    )
    
    
    (43.1
    )%Loss before (benefit from) income
taxes
    
    
    (12,380
    )
    
    
    (12.9
    )%
    
    
    (19,947
    )
    
    
    (30.8
    )%
    
    
    (7,567
    )
    
    
    61.1
    %(Benefit from) income taxes
    
    
    (4,226
    )
    
    
    (4.4
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    4,226
    
    
    
    (100.0
    )%Loss from continuing operations
    
    
    (8,154
    )
    
    
    (8.5
    )%
    
    
    (19,947
    )
    
    
    (30.8
    )%
    
    
    (11,793
    )
    
    
    144.6
    %Income (loss) from discontinued
operations of Reflections Interactive
Ltd., net of tax
    
    
    146
    
    
    
    0.1
    %
    
    
    (33
    )
    
    
    0.0
    %
    
    
    (179
    )
    
    
    (122.6
    )%Net loss
    
    $
    (8,008
    )
    
    
    (8.4
    )%
    
    $
    (19,980
    )
    
    
    (30.8
    )%
    
    $
    (11,972
    )
    
    
    (149.5
    )%
 Net Revenues
 Net Revenues by Segment (in thousands):
 Nine MonthsEndedDecember 31,2006
    
    
    2007
    
    
    (Decrease)Publishing
    
    $
    78,847
    
    
    $
    56,254
    
    
    $
    (22,593
    )Distribution
    
    
    16,491
    
    
    
    8,591
    
    
    
    (7,900
    )Total
    
    $
    95,338
    
    
    $
    64,845
    
    
    $
    (30,493
    )
 Page 39




---



##### Table of Contents



Publishing Sales Platform Mix
 Nine MonthsEndedDecember 31,2006
    
    2007PlayStation 2
    
    
    36.9
    %
    
    
    33.9
    %PC
    
    
    28.5
    %
    
    
    28.2
    %Wii
    
    
    9.0
    %
    
    
    18.2
    %PSP
    
    
    5.4
    %
    
    
    12.1
    %Nintendo DS
    
    
    1.8
    %
    
    
    6.2
    %Xbox 360
    
    
    10.6
    %
    
    
    0.9
    %Xbox
    
    
    0.2
    %
    
    
    0.5
    %Game Boy Advance
    
    
    3.8
    %
    
    
    0.0
    %Plug and Play
    
    
    3.6
    %
    
    
    0.0
    %GameCube
    
    
    0.2
    %
    
    
    0.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  
    
    Net publishing product sales during the nine months ended December 31, 2007 were driven
by new releases of Dragon Ball Z Tenkaichi 3 (Wii and PS2), Godzilla Unleashed (Wii, PS2,
and DS), Jenga (Wii and DS)and The Witcher (PC). These titles comprised approximately
50.7% of our net publishing product sales. The nine months ended December 31, 2006 sales
were driven by the new releases of Test Drive Unlimited (Xbox 360), Neverwinter Nights 2
(PC) and DragonBall Z Tenkaichi 2 (PS2 and Wii).
    
    International royalty income decreased by $0.5 million as the prior period contained
income from the international release of Test Drive Unlimitedoffset by reductions due
to returns on international sales of Matrix: Path of Neoand Getting Up: Contents Under
Pressure, released in the third quarter and fourth quarter, respectively, of fiscal 2006.
    
    The nine months ended December 31, 2007 contains a one-time license payment of $4.0
million related to the sale of Hasbro, Inc. publishing and licensing rights which IESA sold
back to Hasbro in July 2007. We anticipate the sale of these rights will reduce the amount
of immediate license opportunities we have.
  Cost of Goods Sold
 Page 40




---



##### Table of Contents




    
    a lower mix of higher cost third-party distributed product sales as a percentage of net
revenues (13.2% in fiscal 2008 compared with 17.3% in fiscal 2007), and
    
    a higher average sales price on our publishing products in the current period driven by
new release sales on next generation hardware, offset by
    
    an additional $1.2 million royalty reserve related to the FUNimation dispute.
 Research and Product Development Expenses
  
    
    decreased spending of $6.3 million at our related party development studios due to the
completion of Test Drive Unlimited, which was released in the second quarter of fiscal
2007, and
    
    decreased salaries and other overhead of $5.3 million due to the sale of our Shiny
studio in the second quarter of fiscal 2007, as well as additional executive and other
personnel reductions, offset by
    
    a write-off of licenses which will no longer be exploited of approximately $2.0 million,
and
    
    increased spending of $1.5 million for projects with external developers, as we completed
certain development projects.
 Selling and Distribution Expenses
  
    
    decreased spending on advertising of $4.1 million, and
    
    savings in salaries and related overhead costs due to reduced headcount resulting from
studio closure and personnel reductions, offset by
    
    an additional $1.6 million expense related to minimum advertising commitment shortfalls
to be paid to FUNimation.
 General and Administrative Expenses
  
    
    a reduction in salaries and other overhead costs of $2.4 million due to studio closures
and other personnel reductions.
 Restructuring Expenses
  Page 41




---



##### Table of Contents



Gain on Sale of Intellectual Property
 Stuntman
 Gain on Sale of Development Studio Assets
  Depreciation and Amortization
  
    
    savings in depreciation relate to the closure of offices and reduction of staffing and
associated overhead
 (Benefit from) Income Taxes
   Income
(loss) from Discontinued Operations of Reflections Interactive Ltd., net of tax
 Benefit from Income Taxes
 Page 42




---



##### Table of Contents



Liquidity and Capital Resources
 Overview
    Cash Flows
 (in thousands)
 March 31,
    
    December 31,2007
    
    2007Cash
    
    $
    7,603
    
    
    $
    5,428Working capital
    
    $
    1,213
    
    
    $
    (10,312
    )
 Nine Months EndedDecember 31,2006
    
    
    2007Cash used in operating activities
    
    $
    (46,610
    )
    
    $
    (21,431
    )Cash provided by (used in) investing activities
    
    
    28,449
    
    
    
    312Cash provided by financing activities
    
    
    6,831
    
    
    
    18,937Effect of exchange rates on cash
    
    
    13
    
    
    
    7Net decrease in cash
    
    $
    (11,317
    )
    
    $
    (2,175
    )
  Page 43




---



##### Table of Contents




    
    proceeds of $21.6 million received in connection with the sale of our Reflections
studio,
    
    proceeds of $9.0 million from the sale of the Stuntmanintellectual property,
    
    and proceeds of $1.6 million from the sale of our Shiny studio in the current
period
          Selected Balance Sheet Accounts
 Receivables, net
  Page 44




---



##### Table of Contents



Due from Related Parties/Due to Related Parties
  Prepaid and other current assets
  Long-term liabilities and Property and Equipment
 th
 NASDAQ Delisting Notice
    Credit Facilities
 Guggenheim Credit Facility
  Page 45




---



##### Table of Contents



Contractual Obligations
  Contractual ObligationsRoyalty andlicense
    
    
    Milestone
    
    
    Operating lease
    
    
    Capital leaseThrough
    
    advances (1)
    
    
    payments (2)
    
    
    obligations (3)
    
    
    obligations (4)
    
    
    TotalDecember 31, 2008
    
    $
    3,884
    
    
    $
    405
    
    
    $
    1,710
    
    
    $
    33
    
    
    $
    6,032December 31, 2009
    
    
    
    
    
    
    
    
    
    
    1,851
    
    
    
    
    
    
    
    1,851December 31, 2010
    
    
    
    
    
    
    
    
    
    
    1,768
    
    
    
    
    
    
    
    1,768December 31, 2011
    
    
    
    
    
    
    
    
    
    
    1,178
    
    
    
    
    
    
    
    1,178December 31, 2012
    
    
    
    
    
    
    
    
    
    
    1,329
    
    
    
    
    
    
    
    1,329Thereafter
    
    
    
    
    
    
    
    
    
    
    12,302
    
    
    
    
    
    
    
    12,302Total
    
    $
    3,884
    
    
    $
    405
    
    
    $
    20,138
    
    
    $
    33
    
    
    $
    24,460
 
 (1)
    
    We have committed to pay advance payments under certain royalty and
license agreements. The payments of these obligations are dependent on the delivery
of the contracted services by the developers.(2)
    
    Milestone payments represent royalty advances to developers for products
that are currently in development. Although milestone payments are not guaranteed,
we expect to make these payments if all deliverables and milestones are met timely
and accurately.(3)
    
    We account for our office leases as operating leases, with expiration
dates ranging from fiscal 2008 through fiscal 2022. These are future minimum annual
rental payments required under the leases net of $0.6 million of sublease income to
be received in fiscal 2008 and fiscal 2009. Rent expense and sublease income for
the three and nine months ended December 31, 2006 and 2007 is as follows (in
thousands):     Renewal of New York leaseDuring June 2006, we entered into a new lease with our current landlord at our New
York headquarters for approximately 70,000 square feet of office space for our
principal offices. The term of this lease Page 46




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##### Table of Contents



commenced on July 1, 2006 and is to expire on June 30, 2021. Upon entering into the
new lease, our prior lease, which was set to expire in December 2006, was terminated.
The rent under the new lease for the office space was approximately $2.4 million
per year for the first five years, increased to approximately $2.7 million per year
for the next five years, and increased to $2.9 million for the last five years of the
term. In addition, we must pay for electricity, increases in real estate taxes and
increases in porter wage rates over the term. The landlord is providing us with a
one year rent credit of $2.4 million and an allowance of $4.5 million to be used for
building out and furnishing the premises, of which $1.2 million has been recorded as
a deferred credit as of March 31, 2007; the remainder of the deferred credit will be
recorded as the improvements are completed, and will be amortized against rent
expense over the life of the lease. A nominal amount of amortization was recorded
during the year ended March 31, 2007. For the nine months ended December 31, 2007,
we recorded an additional deferred credit of $2.8 million and amortization against
the total deferred credits of approximately $0.2 million. Shortly after signing the
new lease, we provided the landlord with a security deposit under the new lease in
the form of a letter of credit in the initial amount of $1.7 million, which has been
cash collateralized and is included in security deposits on our condensed
consolidated balance sheet. On August 14, 2007, we and our new landlord, W2007 Fifth
Realty, LLC, amended the lease under which we occupy space in 417 Fifth Avenue, New
York City, to reduce the space we occupy by approximately one-half, effective
December 31, 2007. As a result, our rent under the amended lease will be reduced from
its current approximately $2.4 million per year to approximately $1.2 million per
year from January 1, 2008 through June 30, 2011, approximately $1.3 million per year
for the five years thereafter, and approximately $1.5 million per year for the last
five years of the term.(4)
    
    We maintain several capital leases for computer equipment. Per FASB Statement
No. 13, Accounting for Leases, we account for capital leases by recording them at the
present value of the total future lease payments. They are amortized using the
straight-line method over the minimum lease term. As of March 31, 2007, the net book
value of the assets, included within property and equipment on the balance sheet, was
$0.1 million, net of accumulated depreciation of $0.5 million. As of December 31,
2007, the net book value of the assets was $0.1 million, net of accumulated
depreciation of $0.5 million. Effect of Relationship with IESA on Liquidity
  Recent Accounting Pronouncements
  
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
  Foreign Currency Exchange Rates
  Page 47




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##### Table of Contents



Item 4T. Controls and Procedures
 Evaluation of disclosure controls and procedures
   Managements Remediation Initiatives
  Changes in Internal Control over Financial Reporting
   
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 Litigation
  Page 48




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##### Table of Contents



Bouchat v. Champion Products, et al. (Accolade)
  Ernst & Young, Inc. v. Atari, Inc.
  Research in Motion Limited v. Atari, Inc. and Atari Interactive, Inc.
  
 Item 4. Submission of Matters to a Vote of Security Holders
 Action by Written Consent
  Annual Meeting of Stockholders
  Proposal 1
 For
    
    WithheldCLASS IIIEvence-Charles Coppee
    
    
    10,228,079
    
    
    
    751,403Jean-Michel Perbet
    
    
    10,185,990
    
    
    
    793,492
 Page 49




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##### Table of Contents



Item 5. Other
Matters
   Page 50




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##### Table of Contents



Item 6. Exhibits
 (a)
    
    Exhibits3.1
    
    Amendment No. 3 to Amended and Restated By-laws dated July 24, 200710.59
    
    Partial Surrender Agreement dated August 14, 2007 between W2007 417 Fifth Realty, LLC and Atari, Inc.10.60
    
    Amendment No. 1 to Partial Surrender Agreement dated August 14, 2007 between W2007 417 Fifth  Realty, LLC and Atari, Inc.10.61
    
    Rights and Representation related to the Hasbro License between Infogrames Entertainment, S.A, and Atari, Inc.31.1
    
    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Acting Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Acting Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 Page 51




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##### Table of Contents



SIGNATURE
  ATARI, INC.By:
    /s/     Curtis G. SolsvigName:
    Curtis G. Solsvig IIITitle:
    Chief Restructuring Officer (duly authorized
officer)Date:
    February 12, 2008By:
    /s/     Arturo RodriguezName:
    Arturo RodriguezTitle:
    Acting Chief Financial OfficerDate:
    February 12, 2008 Page 52




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##### Table of Contents



INDEX TO EXHIBITS
 Exhibit No.
    
    Description3.1
    
    Amendment No. 3 to Amended and Restated By-laws dated July 24, 200710.59
    
    Partial Surrender Agreement dated August 14, 2007 between W2007 417 Fifth Realty, LLC and Atari, Inc.10.60
    
    Amendment No. 1 to Partial Surrender Agreement dated August 14, 2007 between W2007 417 Fifth Realty,
LLC and Atari, Inc.10.61
    
    Rights and Representation related to the Hasbro License between Infogrames Entertainment, S.A, and
Atari, Inc31.1
    
    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Acting Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Acting Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 Page 53