##### 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 June 30, 2004 OR  o
    
    TRANSITIONAL 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
(Address of principal executive offices) REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 726-6500 Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes þ No o As of August 5, 2004, there were 121,275,614 of the registrants Common
Stock outstanding.




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
JUNE 30, 2004 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS PART I  FINANCIAL INFORMATION PageItem 1.
    
    Financial Statements:Consolidated Balance Sheets as of March 31, 2004 and June 30, 2004 (unaudited)
    
    
    3Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended June 30, 2003 and 2004 (unaudited)
    
    
    4Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2003 and 2004 (unaudited)
    
    
    5Consolidated Statements of Stockholders' Equity (Deficiency) for the Year Ended March 31, 2004 and Three Months Ended June 30, 2004 (unaudited)
    
    
    6Notes to the Consolidated Financial Statements
    
    
    7Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    26Item 4.
    
    Controls and Procedures
    
    
    26PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    27Item 2.
    
    Change in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    28Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    29Signature
    
    
    
    
    30EMPLOYMENT AGREEMENTCONSENT TO CREDIT AGREEMENTCERTIFICATIONCERTIFICATION




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements 
 ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands) March 31,
    
    June 30,2004
    
    2004(unaudited)ASSETSCurrent assets:Cash
    
    $
    9,621
    
    
    $
    1,256Receivables, net
    
    
    37,707
    
    
    
    67,710Inventories, net
    
    
    27,520
    
    
    
    24,539Income taxes receivable
    
    
    2,320
    
    
    
    1,745Due from related parties
    
    
    4,175
    
    
    
    19,048Prepaid expenses and other current assets
    
    
    12,465
    
    
    
    12,210Related party notes receivable
    
    
    8,571
    
    
    
    8,571Total current assets
    
    
    102,379
    
    
    
    135,079Property and equipment, net
    
    
    13,267
    
    
    
    11,851Goodwill, net of accumulated amortization of $26,116 in both periods
    
    
    70,224
    
    
    
    70,224Other intangible assets, net of accumulated amortization of $1,294 and
$1,462, at March 31, 2004 and June 30, 2004, respectively
    
    
    1,406
    
    
    
    1,238Other assets
    
    
    6,680
    
    
    
    5,699Total assets
    
    $
    193,956
    
    
    $
    224,091LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    37,837
    
    
    $
    44,765Accrued liabilities
    
    
    15,886
    
    
    
    19,917Revolving credit facility
    
    
    
    
    
    
    9,654Royalties payable
    
    
    14,481
    
    
    
    13,272Income taxes payable
    
    
    450
    
    
    
    881Short-term deferred income
    
    
    2,107
    
    
    
    77Due to related parties
    
    
    6,704
    
    
    
    7,941Total current liabilities
    
    
    77,465
    
    
    
    96,507Deferred income
    
    
    555
    
    
    
    536Other long-term liabilities
    
    
    873
    
    
    
    784Total liabilities
    
    
    78,893
    
    
    
    97,827Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 5,000 shares authorized, none
issued or outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 300,000 shares authorized, 121,231 and
121,275 shares issued and outstanding at March 31, 2004 and June 30,
2004, respectively
    
    
    1,212
    
    
    
    1,213Additional paid-in capital
    
    
    735,964
    
    
    
    735,963Accumulated deficit
    
    
    (625,436
    )
    
    
    (613,380
    )Accumulated other comprehensive income
    
    
    3,323
    
    
    
    2,468Total stockholders equity
    
    
    115,063
    
    
    
    126,264Total liabilities and stockholders equity
    
    $
    193,956
    
    
    $
    224,091
 The accompanying notes are an integral part of these consolidated financial statements. Page 3




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited) Three Months
    
    Three MonthsEnded
    
    EndedJune 30,
    
    June 30,2003
    
    2004Net revenues
    
    $
    151,357
    
    
    $
    110,296Cost of goods sold
    
    
    70,846
    
    
    
    51,868Gross profit
    
    
    80,511
    
    
    
    58,428Selling and distribution expenses
    
    
    20,127
    
    
    
    17,652General and administrative expenses
    
    
    8,548
    
    
    
    8,058Research and development
    
    
    22,229
    
    
    
    17,132Depreciation and amortization
    
    
    1,950
    
    
    
    2,766Operating income
    
    
    27,657
    
    
    
    12,820Interest expense, net
    
    
    3,046
    
    
    
    174Other income
    
    
    118
    
    
    
    19Income before provision for income taxes
    
    
    24,729
    
    
    
    12,665Provision for income taxes
    
    
    937
    
    
    
    609Net income
    
    $
    23,792
    
    
    $
    12,056Basic net income per share
    
    $
    0.34
    
    
    $
    0.10Diluted net income per share
    
    $
    0.32
    
    
    $
    0.10Basic weighted average shares outstanding
    
    
    69,974
    
    
    
    121,249Diluted weighted average shares outstanding
    
    
    80,499
    
    
    
    121,334Net income
    
    $
    23,792
    
    
    $
    12,056Other comprehensive income:Foreign currency translation adjustments
    
    
    44
    
    
    
    4Recognition of cumulative translation adjustment
from liquidation of a foreign subsidiary
    
    
    
    
    
    
    (859
    )Comprehensive income
    
    $
    23,836
    
    
    $
    11,201
 The accompanying notes are an integral part of these consolidated financial statements. Page 4




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited) Three Months
    
    Three MonthsEnded
    
    EndedJune 30,
    
    June 30,2003
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    23,792
    
    
    $
    12,056Adjustments to reconcile net income to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    1,950
    
    
    
    2,766Recognition of deferred income
    
    
    (19
    )
    
    
    (2,049
    )Recognition of cumulative translation adjustment from liquidation of a
foreign subsidiary
    
    
    
    
    
    
    (859
    )Amortization of discount on related party debt
    
    
    717
    
    
    
    Accrued interest
    
    
    1,930
    
    
    
    56Amortization of deferred financing fees
    
    
    419
    
    
    
    205Write-off of property and equipment
    
    
    10
    
    
    
    193Changes in operating assets and liabilities:Receivables, net
    
    
    (15,283
    )
    
    
    (30,003
    )Inventories, net
    
    
    (517
    )
    
    
    2,980Due from related parties
    
    
    (17,678
    )
    
    
    (14,873
    )Due to related parties
    
    
    (1,470
    )
    
    
    1,265Prepaid expenses and other current assets
    
    
    2,724
    
    
    
    141Accounts payable
    
    
    11,624
    
    
    
    6,939Accrued liabilities
    
    
    (212
    )
    
    
    3,988Royalties payable
    
    
    13,003
    
    
    
    (1,209
    )Income taxes payable
    
    
    465
    
    
    
    431Income taxes receivable
    
    
    
    
    
    
    576Other long-term liabilities
    
    
    (97
    )
    
    
    (89
    )Other assets
    
    
    25
    
    
    
    22Net cash provided by (used in) operating activities
    
    
    21,383
    
    
    
    (17,464
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (1,657
    )
    
    
    (562
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    21Advances to related parties
    
    
    (8,530
    )
    
    
    Net cash used in investing activities
    
    
    (10,187
    )
    
    
    (541
    )CASH FLOWS FROM FINANCING ACTIVITIES:(Payments) borrowings under General Electric Capital Corporation Senior
Credit Facility, net
    
    
    (3,019
    )
    
    
    9,654Proceeds from exercise of stock options
    
    
    23
    
    
    
    Proceeds from employee stock purchase plan
    
    
    104
    
    
    
    Net cash (used in) provided by financing activities
    
    
    (2,892
    )
    
    
    9,654Effect of exchange rates on cash
    
    
    35
    
    
    
    (14
    )Net increase (decrease) in cash
    
    
    8,339
    
    
    
    (8,365
    )Cash  beginning of fiscal period
    
    
    815
    
    
    
    9,621Cash  end of fiscal period
    
    $
    9,154
    
    
    $
    1,256SUPPLEMENTAL CASH FLOW INFORMATIONSUPPLEMENTAL DISCLOSURE OF NON-CASH
OPERATING ACTIVITIES:Cash paid for interest
    
    
    1,622
    
    
    
    88Cash paid for taxes
    
    
    490
    
    
    
    Income tax refunds
    
    
    18
    
    
    
    397
 The accompanying notes are an integral part of these consolidated financial statements. Page 5




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIENCY)
(in thousands) AccumulatedCommon
    
    
    
    
    
    Additional
    
    
    
    
    
    OtherStock
    
    Common
    
    Paid-In
    
    Accumulated
    
    ComprehensiveShares
    
    Stock
    
    Capital
    
    Deficit
    
    Income
    
    TotalBalance, March 31, 2003
    
    
    69,920
    
    
    $
    699
    
    
    $
    486,053
    
    
    $
    (586,851
    )
    
    $
    3,181
    
    
    $
    (96,918
    )Issuance of common stock pursuant to
employee stock purchase plan
    
    
    47
    
    
    
    1
    
    
    
    103
    
    
    
    
    
    
    
    
    
    
    
    104Exercise of stock options
    
    
    120
    
    
    
    1
    
    
    
    517
    
    
    
    
    
    
    
    
    
    
    
    518Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    766
    
    
    
    
    
    
    
    766Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142
    
    
    
    142Cashless exercise of warrants
    
    
    13
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock in lieu of partial
royalty payment
    
    
    280
    
    
    
    3
    
    
    
    1,196
    
    
    
    
    
    
    
    
    
    
    
    1,199Issuance of 39,030 common shares as part of the
Companys recapitalization in exchange for cancellation
of related party debt, related party credit facility and
related party medium-term loan
    
    
    39,030
    
    
    
    390
    
    
    
    165,487
    
    
    
    
    
    
    
    
    
    
    
    165,877Dividend to parent as part of the
recapitalization of related party debt to
common shares
    
    
    
    
    
    
    
    
    
    
    39,351
    
    
    
    (39,351
    )
    
    
    
    
    
    
    Issuance of 2,000 common shares for license of
the Atari name
    
    
    2,000
    
    
    
    20
    
    
    
    8,480
    
    
    
    
    
    
    
    
    
    
    
    8,500Issuance of 9,821 common shares in secondary
offering, net of expenses
    
    
    9,821
    
    
    
    98
    
    
    
    34,777
    
    
    
    
    
    
    
    
    
    
    
    34,875Balance, March 31, 2004
    
    
    121,231
    
    
    
    1,212
    
    
    
    735,964
    
    
    
    (625,436
    )
    
    
    3,323
    
    
    
    115,063Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,056
    
    
    
    
    
    
    
    12,056Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    4Cashless exercise of warrants
    
    
    44
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    Recognition of cumulative translation adjustment from
liquidation of a foreign subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (859
    )
    
    
    (859
    )Balance, June 30, 2004 (unaudited)
    
    
    121,275
    
    
    $
    1,213
    
    
    $
    735,963
    
    
    $
    (613,380
    )
    
    $
    2,468
    
    
    $
    126,264
 The accompanying notes are an integral part of these consolidated financial statements. Page 6




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) NOTE 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS Nature of Business We are a leading global publisher and developer of video game software for
both gaming enthusiasts and the mass-market audience, as well as a leading
distributor of video game software in North America. We publish and distribute
games for all platforms, including Sony PlayStation and PlayStation 2; Nintendo
Game Boy, Game Boy Advance and GameCube; Microsoft Xbox; and personal
computers, referred to as PCs. We also publish and sub-license games for the
wireless, internet, and other evolving platforms. Our diverse portfolio of
products extends across every major video game genre, including: action,
adventure, strategy, children, family, driving and sports games. Through our relationship with our majority stockholder, Infogrames
Entertainment S.A., a French corporation (IESA), listed on Euronext, our
products are distributed exclusively by IESA throughout Europe, Asia and other
regions. Similarly, we exclusively distribute IESAs products in the United
States, Canada and their territories and possessions. IESA owns approximately
59% of us directly and through its wholly-owned subsidiary California U.S.
Holdings, Inc. (CUSH) and its majority-owned subsidiary Atari Interactive,
Inc. (Atari Interactive). During September 2003, we entered into a series of transactions to
restructure our debt and equity through a recapitalization of debt and an
underwritten secondary public offering of common stock (Offering). In
conjunction with the recapitalization of debt, we secured long-term rights to
the Atari name (Atari License). (See Recapitalization, Atari License,and
Offeringbelow.) Recapitalization In September 2003, we, IESA, and CUSH entered into an agreement
(Recapitalization Agreement) resulting in the exchange of all of our net
related party debt with IESA and certain of its wholly-owned subsidiaries
totaling $165.9 million into 39,029,877 shares of our common stock immediately
prior to the Offering. The conversion price was consistent with the Offering
price of $4.25 per share. The converted debt consisted of the following
outstanding amounts at September 18, 2003: $48.3 million of a medium-term loan,
$44.8 million of a revolving credit agreement with IESA, $46.3 million of
non-interest bearing subordinated convertible notes and $73.1 million of 5%
subordinated convertible notes. The Recapitalization Agreement provided for an
offset of previously provided advances to Atari Interactive and Atari Australia
Pty. Ltd. (Atari Australia) of $44.7 million and $1.9 million, respectively.
Accordingly, at March 31, 2004 and June 30, 2004, no previously outstanding
amounts remain outstanding in Advances to Related Parties, Current Portion of
Related Party Medium-Term Loan, Related Party Credit Facility and Related Party
Debt. However, we have $8.6 million in related party notes receivable
outstanding at March 31, 2004 and June 30, 2004, which arose after the
Recapitalization and are related to certain other transactions. Such notes are
permitted by the GECC senior credit facility (see Note 7). In connection with the Recapitalization Agreement, we issued stock at a
more favorable rate than was available, at the holders option, under the
original terms of the 5% subordinated convertible notes. The incremental value
of the additional stock issued was reported as a dividend to IESA for $39.4
million during the September 2003 quarter, which had no impact on total
stockholders equity. Atari License In connection with the Recapitalization Agreement, Atari Interactive
extended the term of the license under which we use the Atari name to ten years
expiring on December 31, 2013. We issued 2,000,000 shares of our common stock
to Atari Interactive for the extended license and will pay a royalty equal to
1% of our net revenues during years six through ten of the extended license.
We recorded a deferred charge of $8.5 million, which is being amortized at the
rate of approximately $0.3 million per month. The monthly amortization is
based on the total estimated cost to be incurred by us over the ten-year
license period. At June 30, 2004, $3.4 million of this deferred charge is
included in Page 7




---



##### Table of Contents



Prepaid Expenses and Other Current Assets with the remaining $2.5
million, net of $2.6 million of amortization, included in Other Assets. Offering On September 24, 2003, we offered to the public 9,820,588 new shares of
our common stock at an offering price of $4.25 per share. The net proceeds to
us after all costs were $34.9 million.We used $3.9 million of the net
proceeds to repay indebtedness outstanding under our credit facility with GECC.
The remaining proceeds were used to pay costs of developing video game
software and to meet general working capital needs. Additionally, on September 24, 2003, IESA sold 17,179,412 shares of our
common stock as part of the Offering. We did not receive any proceeds from the
sale by IESA of our common stock. Finally, on October 21, 2003, the
underwriters exercised their over-allotment option, purchasing 3,855,400 shares
from IESA at a purchase price of $4.25 per share. We did not receive any of
the proceeds from the exercise of the over-allotment option. Basis of Presentation Our accompanying interim consolidated financial statements are unaudited,
but in the opinion of management, reflect all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of the results for the
interim period in accordance with instructions for Form 10-Q. Accordingly, they
do not include all information and notes required by generally accepted
accounting principles for complete financial statements. These interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K for the year ended March 31, 2004. Principles of Consolidation The consolidated financial statements include our accounts and our
wholly-owned subsidiaries. All material intercompany transactions and balances
have been eliminated. Revenue Recognition Revenue is recognized when title and risk of loss transfer to the
customer, provided that collection of the resulting receivable is deemed
probable by management. We are not contractually obligated to accept returns except for defective
product. However, we may permit our customers to return or exchange product
and we provide allowances for estimated returns, price concessions, or other
allowances on a negotiated basis. We estimate such returns and allowances based
upon managements evaluation of historical experience, market acceptance of
products produced, retailer inventory levels, budgeted customer allowances, the
nature of the title and existing commitments to customers. Such estimates are
deducted from gross sales and provided for at the time revenue is recognized. Use of Estimates The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could materially
differ from those estimates. Goodwill and Other Intangible Assets Statement of Financial Accounting
Standards (SFAS) No. 142, Goodwill and
Other Intangible Assets, eliminates goodwill amortization over its estimated
useful life. Goodwill is subject to at least an annual assessment for
impairment by applying a fair-value based test. Additionally, acquired
intangible assets are separately recognized if the benefit of the intangible
asset is obtained through contractual or other legal rights, or if the
intangible asset can be sold, transferred, licensed, rented or exchanged,
regardless of our intent to do so. Intangible assets with finite lives are
amortized over their useful lives. As of March 31, 2004, we performed our
annual fair-value based assessment which did not result in any impairment of
goodwill or intangibles. As of June 30, 2004, we do not believe that there are
any indications of impairment of goodwill or intangibles. However, future
changes in the facts and circumstances relating to our goodwill and other
intangible assets could result in an impairment of intangible assets in
subsequent periods. Page 8




---



##### Table of Contents



Other intangible assets approximate $1.4 million and $1.2 million, net of
accumulated amortization of $1.3 million and $1.5 million at March 31, 2004 and
June 30, 2004, respectively. Fair Values of Financial Instruments SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
requires certain disclosures regarding the fair value of financial instruments.
Cash, accounts receivable, accounts payable, accrued liabilities, royalties
payable, revolving credit facility, related party notes receivable, and amounts
due to and from related parties are reflected in the consolidated financial
statements at fair value due to the short-term maturity and the denomination in
US dollars of these instruments. Long-Lived Assets We review long-lived assets, such as fixed assets to be held, for
impairment annually or whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be fully recoverable. If the
estimated fair market value of the asset is less than the carrying amount of
the asset plus the cost to dispose, an impairment loss is recognized as the
amount by which the carrying amount of the asset plus the cost to dispose
exceeds its fair value, as defined in SFAS No. 144, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. Research and Development Costs Research and development costs related to the design, development and
testing of new software products, whether internally or externally developed,
are charged to expense as incurred. Research and development costs also
include payments for royalty advances (milestone payments) to third-party
developers for products that are currently in development. Rapid technological innovation, shelf-space competition, shorter product
life cycles and buyer selectivity have made it extremely difficult to determine
the likelihood of individual product acceptance and success. As a result, we
follow the policy of expensing milestone payments as incurred, treating such
costs as research and development expenses. Licenses Payments made to third parties for licensing intellectual property are
capitalized and amortized over projected unit sales. Management evaluates the
carrying value of these capitalized licenses and records an impairment in
value, if any, as research and development expense. Income Taxes We account for income taxes using the asset and liability method of
accounting for income taxes. Under this method, deferred tax assets and
liabilities are determined based on differences between financial reporting and
tax bases of assets and liabilities and are measured using the enacted tax
rates in effect for the years in which the differences are expected to reverse.
We record an allowance to reduce tax assets to a realizable amount. We monitor
our tax liability on a quarterly basis and record the estimated tax obligation
based on our current year-to-date taxable income and expectations of the full
year results. Net Income Per Share Basic net income per share is computed by dividing net income by the
weighted average number of shares of common stock outstanding for the period.
Diluted net income per share reflects the potential dilution that could occur
from shares of common stock issuable through stock-based compensation plans
including stock options, restricted stock awards, warrants using the treasury
stock method and other convertible securities. The following is an analysis of
the difference between the shares used in basic and diluted net income per
share (in thousands, except per share data): Page 9




---



##### Table of Contents



Three MonthsEndedJune 30,2003
    
    2004Basic earnings per share calculation:Net income
    
    $
    23,792
    
    
    $
    12,056Weighted average shares outstanding
    
    
    69,974
    
    
    
    121,249Basic net income per share
    
    $
    0.34
    
    
    $
    0.10Diluted earnings per share calculation:Net income
    
    $
    23,792
    
    
    $
    12,056Interest expense:IESA 0% subordinated convertible
note
    
    
    718
    
    
    
    5% subordinated convertible notes
    
    
    889
    
    
    
    Adjusted net income
    
    $
    25,399
    
    
    $
    12,056Weighted average shares outstanding
    
    
    69,974
    
    
    
    121,249Dilutive potential common shares:Employee stock options and warrants
    
    
    215
    
    
    
    85IESA 0% subordinated convertible
note
    
    
    2,500
    
    
    
    5% subordinated convertible notes
    
    
    7,810
    
    
    
    Diluted weighted average shares
outstanding
    
    
    80,499
    
    
    
    121,334Diluted net income per share
    
    $
    0.32
    
    
    $
    0.10
 The number of antidilutive shares that were excluded from the diluted
earnings per share calculation for the three months ended June 30, 2003 and
2004 were 6,142,000 and 6,755,000, respectively, from stock options and
warrants in which the exercise price is greater than the average market price
of the common shares during the respective periods. Stock-Based Compensation We account for employee
stock option plans under the intrinsic value
method prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees and related interpretations. Any
equity instruments issued other than to employees for acquiring goods and
services are accounted for using fair value at the date of grant. We have also
adopted the disclosure provisions of Financial Accounting Standards Board
(FASB) Statement No. 123, Accounting for Stock-Based Compensation, as amended
by FASB Statement No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure  an Amendment to FASB Statement No. 123. At June 30, 2004, we had three stock option plans. No compensation cost
is reflected in net income, as all options granted under those plans
have an exercise price equal to the market value of the underlying common stock
on the date of grant. The following table illustrates the effect on the net
income and income per share if we had applied the fair value recognition
provisions of the FASB Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation (in thousands, except per
share data): Page 10




---



##### Table of Contents



Three MonthsEndedJune 30,2003
    
    2004Net income:Basic  as reported
    
    $
    23,792
    
    
    $
    12,056Less: Fair value of
stock-based employee
compensation expense, net of
related tax effects
    
    
    1,423
    
    
    
    1,259Basic  pro forma net income
    
    $
    22,369
    
    
    $
    10,797Diluted  as reported
    
    $
    25,399
    
    
    $
    12,056Less: Fair value of
stock-based employee
compensation expense, net of
related tax effects
    
    
    1,423
    
    
    
    1,259Diluted  pro forma net income
    
    $
    23,976
    
    
    $
    10,797Net income per share:Basic  as reported
    
    $
    0.34
    
    
    $
    0.10Basic  proforma
    
    $
    0.32
    
    
    $
    0.09Diluted  as reported
    
    $
    0.32
    
    
    $
    0.10Diluted  proforma
    
    $
    0.30
    
    
    $
    0.09
 The fair market value of options granted under stock option plans during
the three months ended June 30, 2003 and 2004 was determined using the
Black-Scholes option pricing model utilizing the following assumptions: Three MonthsEndedJune 30,2003
    
    2004Dividend yield
    
    
    0
    %
    
    
    0
    %Anticipated volatility
    
    
    116
    %
    
    
    120
    %Weighted average risk-free
interest rate
    
    
    2.60
    %
    
    
    2.44
    %Expected lives
    
    4 years
    
    4 years
 Page 11




---



##### Table of Contents



NOTE 2  RECEIVABLES, NET Receivables consist of the following (in thousands): March 31,
    
    June 30,2004
    
    2004Trade accounts receivable
    
    $
    73,986
    
    
    $
    103,653Less: Allowances for bad debts,
returns, price protection and
other
customer promotional programs
    
    
    (36,279
    )
    
    
    (35,943
    )$
    37,707
    
    
    $
    67,710
 NOTE 3  INVENTORIES, NET Inventories consist of the following (in thousands): March 31,
    
    June 30,2004
    
    2004Finished goods
    
    $
    26,790
    
    
    $
    24,102Return inventory
    
    
    1,964
    
    
    
    1,945Raw materials
    
    
    911
    
    
    
    41329,665
    
    
    
    26,460Less: Obsolescence reserve
    
    
    (2,145
    )
    
    
    (1,921
    )$
    27,520
    
    
    $
    24,539
 NOTE 4  ACCRUED LIABILITIES Accrued liabilities consist of the following (in thousands): March 31,
    
    June 30,2004
    
    2004Accrued advertising
    
    $
    3,036
    
    
    $
    6,462Accrued salary and related costs
    
    
    4,579
    
    
    
    5,703Accrued
third-party license and development expenses
    
    
    1,491
    
    
    
    2,177Accrued distribution services
    
    
    1,848
    
    
    
    1,682Accrued freight and processing fees
    
    
    989
    
    
    
    1,134Accrued professional fees and other services
    
    
    1,295
    
    
    
    941Other
    
    
    2,648
    
    
    
    1,818$
    15,886
    
    
    $
    19,917
 Page 12




---



##### Table of Contents



NOTE 5  RELATED PARTY TRANSACTIONS Related party notes receivable Related party notes receivable consist of the following amounts (in
thousands): March 31,
    
    June 30,2004
    
    2004Related party note receivable  Atari Interactive (1)
    
    $
    5,122
    
    
    $
    5,122Related party note receivable  Atari Interactive (2)
    
    
    2,620
    
    
    
    2,620Related party note receivable  Paradigm (2)
    
    
    829
    
    
    
    829Total related party notes receivable (3)
    
    $
    8,571
    
    
    $
    8,571
 (1) This note is payable at the earlier of the release of certain development
projects to the public or December 31, 2004. The note bears interest at a
rate of prime plus 1.25%. (2) The
Atari Interactive note and the Paradigm note are payable on September 30,
2004 and bear interest at a rate of prime plus 1.25%. (3) As security for the related party notes receivable, Atari Interactive
has agreed to not transfer, assign, sell, pledge or otherwise dispose of or
encumber 2,000,000 shares of our common stock given to Atari Interactive as
part of the Atari License. (See Note 1, Atari License.) We have the right to
receive the 2,000,000 shares or the proceeds of sales of such shares in the
event Atari Interactive or Paradigm default on the related party notes
receivable or payment is not made timely at maturity. Additionally, such
notes have been provided to GECC as additional security. For the three months ended June 30, 2004, $0.1 million interest income has
been earned on the Atari Interactive notes and remains outstanding at June 30,
2004. A nominal amount of interest income was earned on the Paradigm note
during the three months ended June 30, 2004. Royalty agreement Royalties transactions are as follows (in thousands): Three MonthsEndedJune 30,2003
    
    2004Income (expense)Royalty income (1)
    
    $
    17,236
    
    
    $
    14,800Royalty expense (2)
    
    
    (287
    )
    
    
    (121
    )Net royalty income
    
    $
    16,949
    
    
    $
    14,679
 (1) We have a distribution agreement with IESA which provides for IESAs
distribution of our products across Europe, Asia, and certain other regions
pursuant to which IESA pays us 30.0% of the gross profit on such products or
130.0% of the royalty rate due to the developer, whichever is greater. We
recognize this amount as royalty income which is included in net revenues. (2) The distribution agreement with IESA also provides for our distribution
of IESAs (or any of its subsidiaries) products in the United States, Canada
and their territories and possessions, pursuant to which we pay IESA either
30.0% of the gross profit on such products or 130.0% of the royalty rate due
to the developer, whichever is greater. We recognize this amount as royalty
expense which is included in cost of goods sold. As of March 31, 2004 and June 30, 2004, the following amounts are
outstanding with regard to related party royalty transactions and are included
in due from related parties (in thousands): Page 13




---



##### Table of Contents



March 31,
    
    June 30,2004
    
    2004Receivable (payable)Royalties due from IESA
    
    $
    3,564
    
    
    $
    18,795Royalties due to IESA
    
    
    
    
    
    
    (341
    )Net royalties receivable
    
    $
    3,564
    
    
    $
    18,454
 IESA liquidity IESA has incurred significant losses from operations and is highly
leveraged. Should IESA experience liquidity issues, among other things, this
may result in its inability to fund the development efforts of Atari
Interactive, and our results of operations may suffer because, as the North
American distributor of the games developed by Atari Interactive, our revenue
could significantly decrease. Such a reduction of our revenues, among other
things, could result in a breach of one or more of the covenants contained in
our GECC senior credit facility. In the event any of the above contingencies
occur, we are prepared to take various actions which may include, but not be
limited to, a reduction in our expenditures for internal and external new
product development and a reduction in overhead expenses. These actions, should
they become necessary, may result in a significant reduction in the size of our
operations. NOTE 6  COMMITMENTS AND CONTINGENCIES Litigation During the three months ended June 30, 2004, no significant claims were
asserted against or by us that, in managements opinion, the likely resolution
of which would have a material adverse affect on our liquidity, financial
condition or results of operations, although we are involved in various claims
and legal actions arising in the ordinary course of business. The following is
a summary of pending litigation matters. With respect to matters in which we
are the defendant, we believe that the underlying complaints are without merit
and intend to defend ourselves vigorously. Our management believes that the ultimate resolution of any of the matters
summarized below and/or any other claims which are not stated herein will not
have a material adverse effect on our liquidity, financial condition or results
of operations. Knight Bridging Korea v. Infogrames, Inc. (now known as Atari, Inc.) et al On September 16, 2002, Knight Bridging Korea Co., Ltd., (KBK), a
distributor of electronic games via the Internet and local area networks, filed
a lawsuit against Gamesonline.com, Inc. (Gamesonline), a subsidiary of
Interplay Entertainment Corp. (Interplay), and us in Superior Court of
California, Orange County. KBK alleges that on or about December 15, 2001, KBK
entered into a contract with Gamesonline to obtain the right to localize and
distribute electronically in Korea, Neverwinter Nights and certain back list
games. The complaint further alleges that Gamesonline and we conspired to
prevent KBK from entering the market with Neverwinter Nights or any back title
of Gamesonline. The complaint alleges the following causes of action against
us: misappropriation of trade secrets under the California Uniform Trade
Secrets Act; common law misappropriation; intentional interference with
contract; negligent interference
with contract; intentional interference with prospective economic advantage;
negligent interference with prospective economic advantage; and violation of
Business & Professions Code Section 17200 et seq. The complaint seeks $98.8
million for each of these causes of action. An amended complaint was filed on December 3, 2002, alleging all of the
foregoing against us, adding Atari Interactive (f/k/a Infogrames Interactive,
Inc.) as a named defendant, and alleging that we managed and directed Atari
Interactive to engage in the foregoing alleged acts. We and Atari Interactive
filed answers on January 9, 2003. On or about January 28, 2003, Gamesonline
answered the original complaint and served a cross-complaint against KBK. On
April 29, 2003, KBK named defendants Does 2, 3 and 4 as Infogrames Asia
Pacific, Infogrames Korea and Interplay,
Inc., respectively. On October 29, 2003, Interplay filed a cross-complaint against us, Atari Interactive,
Infogrames Korea and Roes 101 through 200. We and Atari Interactive filed an
answer on December 3, 2003. On March 25, 2004, KBK filed a Second Amended
Complaint for Damages adding new causes of action for fraud against Gamesonline
and Interplay; seeking rescission of the Electronic Distribution Agreement
between KBK and Gamesonline; for breach of third party beneficiary rights
against Atari Interactive; for unlawful restraint of trade against all
defendants; for RICO Act violations against all defendants; and for civil
conspiracy against all defendants; and adding allegations of alter ego status
between Gamesonline and Interplay and as between us, Atari Interactive, and
Atari Korea. Discovery is ongoing. Page 14




---



##### Table of Contents



On March 10, 2004, the Court entered a stipulation among the parties
referring the matter to a private judge. The private judge, retired Superior
Court Judge Harvey Schneider, will be presiding over all aspects of the case,
including the non-jury trial. The trial is currently set for November 1, 2004. On June 17, 2004, we and Atari Interactive prevailed on a Motion for Leave
to File a Cross-Complaint against Interplay and Gamesonline. On such date, we
and Atari Interactive also prevailed on a Motion for Summary Adjudication on
the RICO Act claim. On July 1, 2004, KBK filed a Third Amended Complaint whereby certain
previous allegations were either omitted or clarified as a result of the
Courts rulings at the June 17, 2004 hearings. KBK has purported to serve in Korea an entity it called Atari Korea with
a Summons and Complaint in this case. Atari Korea Ltd. is planning to file a
Motion to Quash Service based on failure to comply with the terms of the Hague
Convention and/or lack of personal jurisdiction over that entity. This motion
is pending. Atari, Inc., Atari Interactive, Inc., and Hasbro, Inc. v. Games, Inc., Roger W. Ach, II, and Chicago West Pullman LLC On May 17, 2004, we and Atari Interactive together with Hasbro, Inc.
(Hasbro) filed a complaint against Games, Inc. (Games), its CEO, Roger W.
Ach, II (Ach), and Chicago West Pullman LLC (Chicago West Pullman) in the
United States District Court for the Southern District of New York and sought a
temporary restraining order and preliminary injunction to stop Games and Achs
use of certain trademarks and copyrights owned by Atari Interactive and Hasbro.
The plaintiffs allege that an interim license that we granted to Games for the
development and publication of certain games in a specified online format
expired by its terms when Games failed to pay us certain fees by April 30,
2004, pursuant to an Asset Purchase, License and Assignment
Agreement between us and Games dated December 31, 2003, as amended. The
plaintiffs allege that Games failure to pay voided an expected transfer of the
Games.com domain name and certain web site assets from us to Games and
constituted a breach of contract and that Chicago West Pullmans failure to pay
constituted a breach of guarantee. On May 18, 2004, the Court granted a temporary restraining order against
Games and Ach and scheduled a preliminary injunction hearing prior to which,
Games agreed to the preliminary injunction. The Court signed an order granting
the preliminary injunction pending the outcome of the case. On June 16, 2004, Games served its Answer and Counterclaim to the
complaint. In its counterclaim, Games alleges that plaintiffs breached the
Agreement and a Settlement Agreement dated March 31, 2004 by, among other
things, licensing other web sites to use online play of certain Atari and
Hasbro games that Games claimed were part of its exclusive license under the
Agreement. The parties are now in the document production stage of discovery and
expect depositions to begin in August and September. Trial is scheduled for
November 2004. Atari, Inc., Electronic Arts, Inc., and Vivendi Universal Games, Inc. v. 321 Studios, LLC On June 14, 2004, we, Electronic Arts, Inc. and Vivendi Universal Games,
Inc. filed a lawsuit against 321 Studios, LLC (321 Studios) in U.S. District Court for the
Southern District of New York. The plaintiffs alleged that 321 Studios
violated the Digital Millennium Copyright Act because its Games X Copy software
circumvents copy protection technology embedded on video game CDs and DVDs.
The plaintiffs filed a Preliminary Injunction Motion on July 1, 2004. 321
Studios has not answered the Complaint. 321 Studios agreed to the preliminary
injunction and the Court signed an order granting the preliminary injunction
pending the outcome of the case. The litigation is being coordinated by the
ESA (the Entertainment Software Association) and the costs associated with the
litigation are being paid by the ESA. Page 15




---



##### Table of Contents



NOTE 7  DEBT Credit Facilities GECC Senior Credit Facility On November 12, 2002 (last amended May 20, 2004), we obtained a 30-month
$50.0 million senior credit facility with GECC to fund our working capital and
general corporate needs, as well as to fund advances to Atari Interactive and
Paradigm, each a related party. Loans under the senior credit
facility are based on a borrowing base comprised of the value of our accounts receivable and
short term marketable securities. The senior credit facility bears interest at
prime plus 1.25% for daily borrowings or LIBOR plus 3% for borrowings with a
maturity of 30 days or greater. A commitment fee of 0.5% on the average unused
portion of the facility is payable monthly and we paid $0.6 million as an
initial commitment fee at closing. The senior credit facility contains certain
financial covenants and originally named certain related entities, such as
Atari Interactive and Paradigm, as guarantors. In addition, amounts
outstanding under the senior credit facility are secured by our assets. As of
June 30, 2004, $9.7 million was outstanding under the senior credit facility
and an additional $0.4 million of letters of credit were outstanding. As of
June 30, 2004, accrued interest of approximately $0.1 million was included in
accrued liabilities and we were in compliance with all financial covenants. Under an amendment to the senior credit facility, dated December 23, 2003,
Atari Interactive and Paradigm have been removed as guarantors. Furthermore,
under the amendment, we are no longer permitted to fund advances to Atari
Interactive and Paradigm unless otherwise approved by GECC. All outstanding
related party notes receivable have been approved. NOTE 8  OPERATIONS BY REPORTABLE SEGMENTS We have three reportable segments: publishing, distribution and corporate.
Publishing is comprised of two studios located in Santa Monica, California and
Beverly, Massachusetts. Closed in March 2004, the Minnesota studio was
included in June 30, 2003, figures. Distribution consists of the sale of other
publishers titles to various mass merchants and other retailers. Corporate
includes the costs of senior executive management, legal, finance, and
administration. The majority of depreciation expense for fixed assets is
charged to the corporate segment and a portion is recorded to the publishing
and distribution segments. This amount consists of depreciation on computers
and office furniture at the publishing unit. Historically, we do not
separately track or maintain records, other than fixed asset records, which
identify assets by segment and, accordingly, such information is not available. The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. We evaluate performance based
on operating results of these segments. Our reportable segments are strategic business units with different
associated costs and profit margins. They are managed separately because each
business unit requires different planning, merchandising and marketing
strategies. The following unaudited summary represents the consolidated net revenues,
operating income (loss), depreciation and amortization and interest by
reportable segment for the three months ended June 30, 2003 and 2004 (in
thousands): Publishing
    
    Distribution
    
    Corporate
    
    TotalThree months ended June 30, 2003:Net revenues
    
    $
    135,600
    
    
    $
    15,757
    
    
    $
    
    
    
    $
    151,357Operating income (loss)
    
    
    31,031
    
    
    
    2,973
    
    
    
    (6,347
    )
    
    
    27,657Depreciation and amortization
    
    
    (953
    )
    
    
    (176
    )
    
    
    (821
    )
    
    
    (1,950
    )Interest income (expense)
    
    
    
    
    
    
    16
    
    
    
    (3,062
    )
    
    
    (3,046
    )Three months ended June 30, 2004:Net revenues
    
    $
    99,663
    
    
    $
    10,633
    
    
    $
    
    
    
    $
    110,296Operating income (loss)
    
    
    18,025
    
    
    
    1,711
    
    
    
    (6,916
    )
    
    
    12,820Depreciation and amortization
    
    
    (947
    )
    
    
    
    
    
    
    (1,819
    )
    
    
    (2,766
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    (174
    )
    
    
    (174
    )
 Page 16




---



##### Table of Contents



NOTE 9  INCOME TAXES As of June 30, 2004, we have combined net operating loss carryforwards of
approximately $457.1 million for federal tax purposes. These loss
carryforwards are available to offset future taxable income, if any, and will
expire beginning in the years 2011 through 2024. We experienced an ownership
change in 1999 as a result of the acquisition by IESA. Under Section 382 of
the Internal Revenue Code, when there is an ownership change, the
pre-ownership-change loss carryforwards are subject to an annual limitation
which could reduce or defer the utilization of these losses. Pre-acquisition
losses of approximately $186.8 million are subject to an annual limitation
(approximately $7.2 million). A full valuation allowance has been recorded
against the net deferred tax asset based on our historical operating results
and the conclusion that such asset may not be realized. Management reassesses
its position with regard to the valuation allowance on a quarterly basis. During the three months ended June 30, 2004, we recorded federal and state
alternative minimum tax provisions of approximately $0.3 million and regular
provisions for state taxes of approximately $0.3 million. For the three months
ended June 30, 2003, we recorded federal and state alternative minimum tax
provisions of approximately $0.6 million and a regular provision for state
taxes of approximately $0.3 million. Page 17




---



##### 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 future results of operations or financial position, made in this
Quarterly Report onForm 10-Qare forward looking. The words believe,
expect, anticipate, intend and similar expressions generally identify
forward-looking statements. While we believe in the veracity of all statements
made herein, forward-looking statements are necessarily based upon a number of
estimates and assumptions that, while considered reasonable by us, are
inherently subject to significant business, economic and competitive
uncertainties and contingencies and known and unknown risks. As a result of
such risks, our actual results could differ materially from those expressed in
any forward-looking statements made by, or on behalf of, us. Some of the
factors that could cause actual results or future events to differ materially
or otherwise, include the following: the loss of key customers; delays in
product development and related product release schedules; maintaining
relationships with leading independent video game software developers; adapting
to the rapidly changing industry technology; maintaining or acquiring licenses
to intellectual property; the termination or modification of our agreements
with hardware manufacturers; an inability to maintain or find debt financing on
terms commercially reasonable to us; and pricing of and demand for distributed
products. Please see the Risk Factors in our Annual Report onForm 10-Kfor
the year ended March 31, 2004 on file with the Securities and Exchange
Commission for a description of some, but not all, risks, uncertainties and
contingencies. Except as otherwise required by the applicable securities laws,
we disclaim any intention or obligation publicly to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Overview Business and Operating Segments We are a leading global publisher and developer of video game software for
both gaming enthusiasts and the mass-market audience. Development, publishing and distribution of video game software are our
major activities. Development activities include development of games by both
internal and external development studios. Internal studios are studios owned
by us for the sole purpose of game development and external development studios
are independent studios with which we or IESA and its subsidiaries have
contracts for the development of specific titles. Our publishing activities
include overseeing development, sales, marketing and packaging of video game
software. Distribution activities primarily include the sale of games produced
by other publishers. The distribution channels for interactive software have expanded
significantly in recent years. Consumers have access to interactive software
through a variety of outlets, including mass-merchant retailers such as
Wal-Mart and Target; major retailers, such as Best Buy, CompUSA, and Toys R
Us; and specialty stores such as Electronics Boutique and GameStop.
Additionally, our games are made available through various Internet and online
networks. Our sales to key customers Wal-Mart, Target, Best Buy and GameStop
accounted for approximately 20.5%, 8.9%, 8.6% and 7.9%, respectively, of net
revenues for the three months ended June 30, 2004. Key Challenges The video game software industry has experienced an increased rate of
change and complexity in the technological innovations of video game hardware
and software. In addition to these technological innovations, there has been
greater competition for shelf space and creative talent as well as increased
buyer selectivity. As a result, the video game industry has become
increasingly hit-driven, which has led to higher per game production budgets,
longer and more complex development processes, and generally shorter product
life cycles. The importance of the timely release of hit titles, as well as
the increased scope and complexity of the product development process, have
increased the need for disciplined product development processes that limit
cost and overruns. This, in turn, has increased the importance of leveraging
the technologies, characters or storylines of existing hit titles into
additional video game software franchises in order to spread development costs
among multiple products. In this environment, we are determined to achieve
balances between internal and external development, and licensed and
proprietary products. Page 18




---



##### Table of Contents



Critical accounting policies Our discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to accounts and notes receivable, inventories, intangible assets,
investments, income taxes and contingencies. We base our estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results could differ
materially from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. Sales returns, price protection, other customer related allowances and allowance for doubtful accounts Sales are recorded net of estimated future returns, price protection and
other customer related allowances. We are not contractually obligated to
accept returns; however, based on facts and circumstances at the time a
customer may request approval for a return, we may permit the return or
exchange of products sold to certain customers. In addition, we may provide
price protection, co-operative advertising and other allowances to certain
customers in accordance with industry practice. These reserves are determined
based on historical experience, market acceptance of products produced,
retailer inventory levels, budgeted customer allowances, the nature of the
title and existing commitments to customers. Although management believes it
provides adequate reserves with respect to these items, actual activity could
vary from managements estimates and such variances could have a material
impact on reported results. We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers to make payments when due or
within a reasonable period of time thereafter. If the financial condition of
our customers were to deteriorate, resulting in an impairment of their ability
to make required payments, additional allowances may be required. For the three months ended June 30, 2003 and 2004, we recorded allowances
for bad debts, returns, price protection and other customer promotional
programs of approximately $31.5 million and $24.1 million, respectively. As of
March 31, 2004 and June 30, 2004, the aggregate reserves against accounts
receivables for bad debts, returns, price protection and other customer
promotional programs were approximately $36.3 million and $35.9 million,
respectively. Inventories We write down our inventories for estimated slow-moving or obsolete
inventories equal to the difference between the cost of inventories and
estimated market value based upon assumed market conditions. If actual market
conditions are less favorable than those assumed by management, additional
inventory write-downs may be required. For the three months ended June 30,
2003 and 2004, we recorded obsolescence expense of approximately $0.4 million
and $0.5 million, respectively. As of March 31, 2004 and June 30, 2004, the
aggregate reserve against inventories was approximately $2.1 million and $1.9
million, respectively. External developer royalty advances and milestone payments Rapid technological innovation, shelf-space competition, shorter product
life cycles and buyer selectivity have made it extremely difficult to determine
the likelihood of individual product acceptance and success. As a result, we follow the policy of expensing
external developer royalty advances (also known as developer advances) as
incurred, treating such costs as research and development expenses. Generally,
developers are paid an advance upon the signing of a contract with us.
Subsequent payments are due as the specific contractual milestones are met by
the developer and approved by us. The timing of when these contracts are
entered into and when milestone payments are made could vary significantly from
budgeted amounts and, because these payments are expensed as incurred, they
could have a material impact on reported results in a given period. Page 19




---



##### Table of Contents



Income taxes As part of the process of preparing our consolidated financial statements,
we are required to estimate our income taxes in each of the jurisdictions in
which we operate. This process involves estimating our current tax exposures
in each jurisdiction including the impact, if any, of additional taxes
resulting from tax examinations as well as making judgments regarding the
recoverability of deferred tax assets. To the extent recovery of deferred tax
assets is not likely based on our estimation of future taxable income in each
jurisdiction, a valuation allowance is established. The estimated effective
tax rate is adjusted for the tax related to significant unusual items. Changes
in the geographic mix or estimated level of annual pre-tax income can affect
the overall effective tax rate. As of June 30, 2004, we have combined net operating loss carryforwards of
approximately $457.1 million for federal tax purposes. These loss
carryforwards are available to offset future taxable income, if any, and will
expire beginning in the years 2011 through 2024. We experienced an ownership
change in 1999 as a result of the acquisition by IESA. Under Section 382 of
the Internal Revenue Code, when there is an ownership change, the
pre-ownership-change loss carryforwards are subject to an annual limitation
which could reduce or defer the utilization of these losses. Pre-acquisition
losses of approximately $186.8 million are subject to an annual limitation
(approximately $7.2 million). A full valuation allowance has been recorded
against the net deferred tax asset based on our historical operating results
and the conclusion that such asset may not be realized. Management reassesses
its position with regard to the valuation allowance on a quarterly basis. Related party transactions We are involved in numerous related party transactions with IESA and its
subsidiaries. These related party transactions include, but are not limited
to, the purchase and sale of product, game development, management and support
services and distribution agreements. See the Notes to the Consolidated
Financial Statements contained in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission for the year ended March 31, 2004 for
details. Page 20




---



##### Table of Contents



Results of operations Three months ended June 30, 2004 versus the three months ended June 30, 2003 Consolidated Statement of Operations (dollars in thousands): Three
    
    
    
    
    
    ThreeMonths
    
    % of
    
    Months
    
    % ofEnded
    
    Net
    
    Ended
    
    NetJune 30,
    
    Revenues
    
    June 30,
    
    Revenues
    
    Increase/2003
    
    2003
    
    2004
    
    2004
    
    (Decrease)Net revenues
    
    $
    151,357
    
    
    
    100.0
    %
    
    $
    110,296
    
    
    
    100.0
    %
    
    $
    (41,061
    )Cost of goods sold
    
    
    70,846
    
    
    
    46.8
    %
    
    
    51,868
    
    
    
    47.0
    %
    
    
    (18,978
    )Gross profit
    
    
    80,511
    
    
    
    53.2
    %
    
    
    58,428
    
    
    
    53.0
    %
    
    
    (22,083
    )Selling and distribution expenses
    
    
    20,127
    
    
    
    13.3
    %
    
    
    17,652
    
    
    
    16.0
    %
    
    
    (2,475
    )General and administrative expenses
    
    
    8,548
    
    
    
    5.6
    %
    
    
    8,058
    
    
    
    7.4
    %
    
    
    (490
    )Research and development
    
    
    22,229
    
    
    
    14.7
    %
    
    
    17,132
    
    
    
    15.5
    %
    
    
    (5,097
    )Depreciation and amortization
    
    
    1,950
    
    
    
    1.3
    %
    
    
    2,766
    
    
    
    2.5
    %
    
    
    816Operating income
    
    
    27,657
    
    
    
    18.3
    %
    
    
    12,820
    
    
    
    11.6
    %
    
    
    (14,837
    )Interest expense, net
    
    
    3,046
    
    
    
    2.0
    %
    
    
    174
    
    
    
    0.1
    %
    
    
    (2,872
    )Other income
    
    
    118
    
    
    
    0.0
    %
    
    
    19
    
    
    
    0.0
    %
    
    
    (99
    )Income before provision for
income
taxes
    
    
    24,729
    
    
    
    16.3
    %
    
    
    12,665
    
    
    
    11.5
    %
    
    
    (12,064
    )Provision for income taxes
    
    
    937
    
    
    
    0.6
    %
    
    
    609
    
    
    
    0.6
    %
    
    
    (328
    )Net income
    
    $
    23,792
    
    
    
    15.7
    %
    
    $
    12,056
    
    
    
    10.9
    %
    
    $
    (11,736
    )
 Net Revenues Net Revenues by Segment (in thousands): Three MonthsEndedJune 30,2003
    
    2004
    
    (Decrease)Publishing
    
    $
    135,600
    
    
    $
    99,663
    
    
    $
    (35,937
    )Distribution
    
    
    15,757
    
    
    
    10,633
    
    
    
    (5,124
    )Total
    
    $
    151,357
    
    
    $
    110,296
    
    
    $
    (41,061
    )
 Net revenues for the three months ended June 30, 2004 decreased approximately
$41.1 million or 27.1% from $151.4 million to $110.3 million.  
    
    Our publishing net revenues for the three months ended June 30, 2004
were driven by strong sales from new products and catalog titles. On
June 21, 2004, we launched the highly-anticipated DRIV3Rtitle, which
generated net U.S. revenues of $33.1 million on nearly 1.2 million units
shipped. Other new releases in the current quarter included
Transformers(PlayStation 2), Shadow Ops: Red Mercury(Xbox), Duel
Masters: Sempai Legends(Game Boy Advance), and Dragon Ball Z: Super
Sonic Warriors(Game Boy Advance), which produced net U.S. revenues
aggregating approximately $18.6 million. The current quarters
publishing sales decreased from the comparable period in the prior year
by $35.9 million or 26.5%, largely due to sales of Enter the Matrix,
which released on May 15, 2003 and generated net U.S. revenues of $75.5
million on approximately 2.6 million units shipped in the first quarter
of 2003.
    
    Publishing net revenue during the three months ended June 30, 2004
includes international royalties of $14.8 million earned on IESAs
international sales of our titles. These royalties include income of
$13.4 million from international sales of DRIV3R, released
internationally
on June 22, 2004 on approximately 1.5 million units shipped in the
quarter. The 2003 quarters international royalties of $17.3 million
were due largely to the success of Enter the Matrix. Page 21




---



##### Table of Contents




    
    Total distribution net revenues for the three months ended June 30,
2004 decreased approximately $5.1 million or 32.5% from the comparable
2003 period due to fewer new titles launched in the current period by
the third parties for whom we distribute and our decision during the
prior year to reduce our third party distribution operations in the
specific instances where margins are insufficient. Gross Profit Platform mix for the three months ended June 30, 2003 and 2004 is summarized
below: Publishing Platform Mix2003
    
    2004PlayStation 2
    
    
    36.6
    %
    
    
    46.9
    %Xbox
    
    
    19.6
    %
    
    
    22.4
    %PC
    
    
    22.3
    %
    
    
    16.1
    %Game Boy Advance
    
    
    7.4
    %
    
    
    11.4
    %Game Cube
    
    
    9.9
    %
    
    
    1.8
    %PlayStation
    
    
    3.8
    %
    
    
    1.3
    %Game Boy Color
    
    
    0.3
    %
    
    
    0.1
    %Other
    
    
    0.1
    %
    
    
    Total
    
    
    100.0
    %
    
    
    100.0
    %
 Gross profit decreased to $58.4 million for the three months ended June
30, 2004 from $80.5 million in the comparable 2003 period primarily from
decreased sales volume. Gross profit as a percentage of net revenues remained
relatively constant, decreasing slightly from 53.2% for the three months ended
June 30, 2003 to 53.0% in the comparable 2004 period. The impact of the sales
mix shift within the publishing business toward the more costly console product
and away from the less costly PC product are partially offset by lower royalty
costs. Approximately 83.9% of the publishing businesses shipments were console
sales during the three months ended June 30, 2004 versus 77.7% in the
comparable 2003 period. For the three months ended June 30, 2004, the
distribution business accounted for 9.6% of our net revenues as compared to
10.4% for the comparable 2003 period. Selling and Distribution Expenses Selling and distribution expenses primarily include shipping, personnel,
advertising, promotions and distribution expenses. During the three months
ended June 30, 2004, selling and distribution expenses decreased approximately
$2.4 million, or 11.9%, to $17.7 million from $20.1 million in the comparable
2003 period. Advertising expenses decreased $1.0 million, or 8.1%, in the
current period. Variable distribution costs, including freight, shipping and
handling, have decreased $1.1 million, or 29.8%, due to lower sales and have
remained constant with the comparable 2003 quarter as a percentage of net
revenues. Despite the reduction in advertising expense, the level of ad
spending increased the overall selling and distribution costs as a percentage
of net revenues from 13.3% for the three months ended June 30, 2003 to 16.0% in
the three months ended June 30, 2004. General and Administrative Expenses General and administrative expenses primarily include personnel expenses,
facilities costs, professional expenses and other overhead charges. During the
three months ended June 30, 2004, general and administrative expenses decreased
approximately $0.4 million, or 4.7%, to $8.1 million from $8.5 million in the
comparable 2003 period. Included in the current quarters expense is a $0.9
million translation gain from the liquidation of a dormant foreign subsidiary.
This positive variance is offset by a reversal of a $0.3 million reserve from a
foreign subsidiary occurring in the prior years comparable quarter. General
and administrative expenses as a percentage of net revenues increased primarily
due to a lower sales base to 7.4% for the three months ended June 30, 2004 from
5.6% in the comparable 2003 period. Research and Development Expenses Research and development expenses primarily include the payment of royalty
advances to third-party developers on products that are currently in
development and the direct costs of internally developing and producing a
title. These expenses for the three months ended June 30, 2004 decreased
approximately $5.1 million, or 23.0%, to $17.1 million from $22.2 million in
the comparable 2003 period, reflecting a lower number of titles in development
and the timing of the milestone completions upon which this expense is based.
A decrease of $0.8 million in license amortization expense of capitalized
licenses and a $1.5 million completion bonus paid in the first quarter of the prior Page 22




---



##### Table of Contents



year have also contributed to the year-over-year variance. Internal
research and development expenses represent 53% of the total R&D expenses for
the three months ended June 30, 2004 and 48% of the total R&D expenses for the
three months ended June 30, 2003. Research and development expenses, as a
percentage of net revenues, increased slightly to 15.5% for the three months
ended June 30, 2004 from 14.7% in the comparable 2003 period. Depreciation and Amortization Depreciation and amortization for three months ended June 30, 2004
increased by $0.8 million, or 40.0%, to $2.8 million from $2.0 million in the
comparable 2003 period due primarily to our license with Atari Interactive for
the rights to the Atari name. Interest Expense, net Interest expense, net, decreased by $2.8 million to $0.2 million for the
three months ended June 30, 2004 from $3.0 million in the comparable 2003
period. The decrease is a result of our September 2003 recapitalization whereby
all outstanding related party debt was converted to equity. Since the
recapitalization, interest and financing fees have consisted solely of expenses
incurred under our credit facility arrangement with GECC. Additionally,
interest expense has been further reduced by interest income received from
related party notes receivable of approximately $0.1 million during the 2004
period. Provision for Income Taxes Provision for income taxes decreased approximately $0.3 million or 33.3%
to $0.6 million from $0.9 million due to the decrease in taxable income in 2004
compared to the 2003 period. During the three months ended June 30, 2004, we
recorded federal and state alternative minimum tax provisions of approximately
$0.3 million and regular provisions for state taxes of approximately $0.3
million. For the three months ended June 30, 2003, we recorded federal and
state alternative minimum tax provisions of approximately $0.6 million and a
regular provision for state taxes of approximately $0.3 million. Liquidity and Capital Resources Overview As of June 30, 2004, management believes that we have sufficient capital
resources to finance our operational requirements for the next twelve months,
including the funding of the development, production, marketing and sale of new
products, the purchases of equipment, and the acquisition of intellectual
property rights for future products. On November 12, 2002 (last amended May 20, 2004), we obtained a 30-month
$50.0 million senior credit facility with GECC which was used to fund our
working capital and general corporate needs and to provide funding to certain
related parties which are wholly-owned by IESA. As part of the most recent
amendments under the GECC senior credit facility, we no longer provide funding
to related parties beyond amounts previously advanced without GECCs consent.
We also utilize the GECC senior credit facility to open letters of credit with
overseas manufacturers for the production of console games. Cash Flows (in thousands) March 31,
    
    June 30,2004
    
    2004Cash
    
    $
    9,621
    
    
    $
    1,256Working Capital
    
    $
    24,914
    
    
    $
    38,572
 Page 23




---



##### Table of Contents



Three Months Ended
    
    Three Months EndedJune 30,
    
    June 30,2003
    
    2004Cash provided by (used in) operating
activities
    
    $
    21,383
    
    
    $
    (17,464
    )Cash (used in) investing activities
    
    
    (10,187
    )
    
    
    (541
    )Cash (used in) provided by financing activities
    
    
    (2,892
    )
    
    
    9,654Effect of exchange rates on cash
    
    
    35
    
    
    
    (14
    )Net increase (decrease) in cash
    
    $
    8,339
    
    
    $
    (8,365
    )
 During the three months ended June 30, 2004, cash of $17.5 million was
used in operating activities to increase trade and international royalties
receivable from the late June 2004 quarters DRIV3Rsales. The growth in our
receivables was partially offset by the decrease of our inventories and
increased payments for accounts payable and accrued liabilities from tight
working capital management. Prior years operating activities benefited from
the mid-quarter release of Enter the Matrix. We saw a decrease in cash used in investing activities of approximately
$9.7 million to a usage of $0.5 million in the three months ended June 30, 2004
as compared to $10.2 million of usage in the comparable 2003 period. The
primary reason for this decrease is due to the advances to Atari Interactive of
$8.5 million under the terms of the GECC senior credit facility during the 2003
period. No such advances were made in the 2004 period. During the three months ended June 30, 2004, our financing activities
provided cash of approximately $9.7 million, an increase of $12.5 million as
compared to the 2003 period. This increase in cash is attributable to the $9.7
million borrowings against the GECC senior credit facility principally to
finance trade receivables related to the release of DRIV3Rlate in the June
2004 quarter. The net use of cash in the June 2004 period was financed by the
borrowings and $8.4 million of cash on hand at March 31, 2004. We expect continued volatility in the use of cash due to seasonality of
the business, receivable payment cycles and quarterly working capital needs to
finance our publishing businesses and growth objectives. Our outstanding accounts receivable balance varies significantly on a
quarterly basis due to the seasonality of our business and the timing of new
product releases, such as the late June 2004 quarter release of DRIV3R. There
were no significant changes in the credit terms with customers during the three
month period. We do not currently have any material commitments with respect to any
capital expenditures. However, we do have commitments to pay royalty and
license advances, milestone payments, and operating lease obligations. We are also party to various litigations arising in the course of our
business. Management believes that the ultimate resolution of these matters
will not have a material adverse effect on our liquidity, financial condition
or results of operations. Our ability to maintain sufficient levels of cash could be affected by
various risks and uncertainties including, but not limited to, customer demand
and acceptance of our new versions of our titles on existing platforms and our
titles on new platforms, our ability to collect our receivables as they become
due, risks of product returns, successfully achieving our product release
schedules and attaining our forecasted sales goals, seasonality in operating
results, fluctuations in market conditions and the other risks described in the
Risk Factors as noted in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission for the year ended March 31, 2004. IESA has incurred significant losses from operations and is highly
leveraged. Should IESA experience liquidity issues, among other things, this
may result in its inability to fund the development efforts of Atari
Interactive, and our results of operations may suffer because, as the North
American distributor of the games developed by Atari Interactive, our revenue
could significantly decrease. Such a reduction of our revenue, among other
things, could result in a breach of one or more of the covenants contained in
our GECC senior credit facility. In the event any of the above contingencies
occur, management is prepared to take various actions which may include, but
not be limited to, a reduction in our expenditures for internal and external
new product development and a reduction in overhead expenses. These actions,
should they become necessary, may result in a significant reduction in the size
of our operations. Page 24




---



##### Table of Contents



GECC Senior Credit Facility On November 12, 2002 (last amended May 20, 2004), we obtained a 30-month
$50.0 million senior credit facility with GECC to fund our working capital and
general corporate needs, as well as to fund advances to Atari Interactive and
Paradigm, each a related party. Loans under the senior credit
facility are
based on a borrowing base comprised of the value of our accounts receivable and
short term marketable securities. The senior credit facility bears interest at
prime plus 1.25% for daily borrowings or LIBOR plus 3% for borrowings with a
maturity of 30 days or greater. A commitment fee of 0.5% on the average unused
portion of the facility is payable monthly and we paid $0.6 million as an
initial commitment fee at closing. The senior credit facility contains certain
financial covenants and originally named certain related entities, such as
Atari Interactive and Paradigm, as guarantors. In addition, amounts
outstanding under the senior credit facility are secured by our assets. As of
June 30, 2004, $9.7 million was outstanding under the senior credit facility
and an additional $0.4 million of letters of credit were outstanding. As of
June 30, 2004, accrued interest of approximately $0.1 million was included in
accrued liabilities and we were in compliance with all financial covenants. Under an amendment to the senior credit facility, dated December 23, 2003,
Atari Interactive and Paradigm have been removed as guarantors. Furthermore,
under the amendment, we are no longer permitted to fund advances to Atari
Interactive and Paradigm unless otherwise approved by GECC. All outstanding
related party notes receivable have been approved. Contractual Obligations As of June 30, 2004, royalty and license advance obligations, milestone
payments, and future minimum lease obligations under non-cancelable operating
leases are summarized as follows (in thousands): Contractual Obligations
Payments Due by Period Within 1 Year
    
    1-3 Years
    
    4-5 Years
    
    After 5 Years
    
    TotalRoyalty and license
advances (1)
    
    $
    4,970
    
    
    $
    88
    
    
    $
    
    
    
    $
    
    
    
    $
    5,058Milestone payments
(2)
    
    
    26,041
    
    
    
    4,609
    
    
    
    
    
    
    
    
    
    
    
    30,650Operating lease
obligations (3)
    
    
    5,462
    
    
    
    10,753
    
    
    
    1,400
    
    
    
    817
    
    
    
    18,432Total
    
    $
    36,473
    
    
    $
    15,450
    
    
    $
    1,400
    
    
    $
    817
    
    
    $
    54,140
  (1)
    
    We have committed to pay advance payments under certain royalty
and license agreements. Most of the payments of these obligations are not
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 leases as operating leases, with expiration
dates ranging from 2005 through 2012. These are future minimum annual
rental payments required under the leases, including a related party
sub-lease with Atari Interactive. Page 25




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures about Market Risk Our carrying value of cash, trade accounts receivable, accounts payable,
accrued liabilities, royalties payable, revolving credit facility, related
party notes receivable, amounts due to and from related parties and our
existing lines of credit are a reasonable approximation of their fair value. Foreign Currency Exchange Rates As of June 30, 2004, foreign operations represented 0.0% and 1.1% of
consolidated net revenues and total assets, respectively. We also recorded
approximately $2.9 million in operating expenses attributed to foreign
operations related primarily to a development studio located outside the United
States. Currently, substantially all of our business is conducted in the
United States where revenues and expenses are transacted in U.S. dollars. As a
result, the majority of our results of operations are not subject to foreign
exchange rate fluctuations. We earn royalties on sales of our product sold
internationally. These revenues, which are based on various foreign currencies
and are billed and paid in U.S. dollars, represented $14.8 million of our
revenue for the three months ended June 30, 2004. We do not hedge against
foreign exchange rate fluctuations due to the limited financial exposure we
face with respect to such risk. We purchase certain of our inventories from
foreign developers. We also pay royalties primarily denominated in euros to
IESA from the sale of IESA products in North America. Our business in this
regard is subject to certain risks, including, but not limited to, differing
economic conditions, changes in political climate, differing tax structures,
other regulations and restrictions and foreign exchange rate volatility. Our
future results could be materially and adversely impacted by changes in these
or other factors. 
 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures. As of June 30, 2004, with the
participation of our management, our Chief Executive Officer and Acting Chief
Financial Officer evaluated our disclosure controls and procedures (as defined
in the Securities Exchange Act of 1934 (the Exchange Act) Rules 13a-15(e) and
15d-15(e)). In designing and evaluating our disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives. Based on this evaluation, our Chief Executive
Officer and Acting Chief Financial Officer concluded that as of June 30, 2004, our disclosure controls and procedures were (1)
designed to ensure that material information relating to us, including our
consolidated subsidiaries, is made known to our Chief Executive Officer and
Acting Chief Financial Officer by others within those entities, particularly
during the period in which this report was being prepared and (2) effective, in
that they provide reasonable assurance that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the SECs rules and forms. In connection with the rules, we are continuing
the process of reviewing and documenting our disclosure controls and
procedures, including our internal controls and procedures for financial
reporting, and may from time to time make changes aimed at enhancing their
effectiveness and to ensure that our systems evolve with our business. Changes in Internal Control over Financial Reporting. No change in our internal
control over financial reporting (as defined in the Exchange Act Rules
13a-15(f) and 15d-15(f)) occurred during the fiscal quarter ended June 30,
2004, that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting. Page 26




---



##### Table of Contents



PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings During the three months ended June 30, 2004, no significant claims were
asserted against or by us that, in managements opinion, the likely resolution
of which would have a material adverse affect on our liquidity, financial
condition or results of operations, although we are involved in various claims
and legal actions arising in the ordinary course of business. The following is
a summary of pending litigation matters. With respect to matters in which we
are the defendant, we believe that the underlying complaints are without merit
and intend to defend ourselves vigorously. Our management believes that the ultimate resolution of any of the matters
summarized below and/or any other claims which are not stated herein will not
have a material adverse effect on our liquidity, financial condition or results
of operations. Knight Bridging Korea
v. Infogrames, Inc. (now known as Atari, Inc.) et al On September 16, 2002, Knight Bridging Korea Co., Ltd., (KBK), a
distributor of electronic games via the Internet and local area networks, filed
a lawsuit against Gamesonline.com, Inc. (Gamesonline), a subsidiary of
Interplay Entertainment Corp. (Interplay), and us in Superior Court of
California, Orange County. KBK alleges that on or about December 15, 2001, KBK
entered into a contract with Gamesonline to obtain the right to localize and
distribute electronically in Korea, Neverwinter Nights and certain back list
games. The complaint further alleges that Gamesonline and we conspired to
prevent KBK from entering the market with Neverwinter Nights or any back title
of Gamesonline. The complaint alleges the following causes of action against
us: misappropriation of trade secrets under the California Uniform Trade
Secrets Act; common law misappropriation; intentional interference with
contract; negligent interference with contract; intentional interference with
prospective economic advantage; negligent interference with prospective
economic advantage; and violation of Business & Professions Code Section 17200
et seq. The complaint seeks $98.8 million for each of these causes of action. An amended complaint was filed on December 3, 2002, alleging all of the
foregoing against us, adding Atari Interactive (f/k/a Infogrames Interactive,
Inc.) as a named defendant, and alleging that we managed and directed Atari
Interactive to engage in the foregoing alleged acts. We and Atari Interactive
filed answers on January 9, 2003. On or about January 28, 2003, Gamesonline
answered the original complaint and served a cross-complaint against KBK. On
April 29, 2003, KBK named defendants Does 2, 3 and 4 as Infogrames Asia
Pacific, Infogrames Korea and Interplay, Inc., respectively. On October
29, 2003, Interplay filed a cross-complaint against us, Atari Interactive,
Infogrames Korea and Roes 101 through 200. We and Atari Interactive filed an
answer on December 3, 2003. On March 25, 2004, KBK filed a Second Amended
Complaint for Damages adding new causes of action for fraud against Gamesonline
and Interplay; seeking rescission of the Electronic Distribution Agreement
between KBK and Gamesonline; for breach of third party beneficiary rights
against Atari Interactive; for unlawful restraint of trade against all
defendants; for RICO Act violations against all defendants; and for civil
conspiracy against all defendants; and adding allegations of alter ego status
between Gamesonline and Interplay and as between us, Atari Interactive, and
Atari Korea. Discovery is ongoing. On March 10, 2004, the Court entered a stipulation among the parties
referring the matter to a private judge. The private judge, retired Superior
Court Judge Harvey Schneider, will be presiding over all aspects of the case,
including the non-jury trial. The trial is currently set for November 1, 2004. On
June 17, 2004, we and Atari Interactive prevailed on a Motion for Leave
to File a Cross-Complaint against Interplay and Gamesonline. On such date, we
and Atari Interactive also prevailed on a Motion for Summary Adjudication on
the RICO Act claim. On July 1, 2004, KBK filed a Third Amended Complaint whereby certain
previous allegations were either omitted or clarified as a result of the
Courts rulings at the June 17, 2004 hearings. KBK has purported to serve in Korea an entity it called Atari Korea with
a Summons and Complaint in this case. Atari Korea Ltd. is planning to file a
Motion to Quash Service based on failure to comply with the terms of the Hague
Convention and/or lack of personal jurisdiction over that entity. This motion
is pending. Page 27




---



##### Table of Contents



Atari, Inc., Atari
Interactive, Inc., and Hasbro, Inc. v. Games, Inc., Roger W. Ach, II,
and Chicago West Pullman LLC On May 17, 2004, we and Atari Interactive together with Hasbro, Inc.
(Hasbro) filed a complaint against Games, Inc. (Games), its CEO, Roger W.
Ach, II (Ach), and Chicago West Pullman LLC (Chicago West Pullman) in the
United States District Court for the Southern District of New York and sought a
temporary restraining order and preliminary injunction to stop Games and Achs
use of certain trademarks and copyrights owned by Atari Interactive and Hasbro.
The plaintiffs allege that an interim license that we granted to Games for the
development and publication of certain games in a specified online format
expired by its terms when Games failed to pay us certain fees by April 30,
2004, pursuant to an Asset Purchase, License and Assignment Agreement between
us and Games dated December 31, 2003, as amended (the Agreement). The
plaintiffs allege that Games failure to pay voided an expected transfer of the
Games.com domain name and certain web site assets from us to Games and
constituted a breach of contract and that Chicago West Pullmans failure to pay
constituted a breach of guarantee. On May 18, 2004, the Court granted a temporary restraining order against
Games and Ach and scheduled a preliminary injunction hearing prior to which,
Games agreed to the preliminary injunction. The Court signed an order granting
the preliminary injunction pending the outcome of the case. On June 16, 2004, Games served its Answer and Counterclaim to the
complaint. In its counterclaim, Games alleges that plaintiffs breached the
Agreement and a Settlement Agreement dated March 31, 2004 by, among other
things, licensing other web sites to use online play of certain Atari and
Hasbro games that Games claimed were part of its exclusive license under the
Agreement. The parties are
now in the document production stage of discovery and
expect depositions to begin in August and September. Trial is scheduled for
November 2004. Atari, Inc., Electronic
Arts, Inc., and Vivendi Universal Games, Inc. v. 321 Studios, LLC On June 14, 2004, we, Electronic Arts, Inc. and Vivendi Universal Games,
Inc. filed a lawsuit against 321 Studios, LLC (321
Studios) in U.S. District Court for the
Southern District of New York. The plaintiffs alleged that 321 Studios
violated the Digital Millennium Copyright Act because its Games X Copy software
circumvents copy protection technology embedded on video game CDs and DVDs.
The plaintiffs filed a Preliminary Injunction Motion on July 1, 2004. 321
Studios has not answered the Complaint. 321 Studios agreed to the preliminary
injunction and the Court signed an order granting the preliminary injunction
pending the outcome of the case. The litigation is being coordinated by the
ESA (the Entertainment Software Association) and the costs associated with the
litigation are being paid by the ESA. 
 Item 2. Change in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. On May 24, 2004, we issued 44,418 shares of our common stock to Wachovia
Bank, National Association (f/k/a First Union National Bank) pursuant to the
cashless exercise of warrants to purchase an aggregate of 45,200 shares of our
common stock at an exercise price of $0.05 per share (after giving effect to
the one-for-five reverse stock split effected in June 2000). The warrants were
issued on June 29, 1999 in connection with the amendment of our then effective
Credit Agreement, dated September 30, 1998, with First Union National Bank, as agent
for a syndicate of banks. Page 28




---



##### Table of Contents



Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.1*
    
    Employment Agreement with Bruno Bonnell, dated as of July 1, 2004 and
effective as of April 1, 2004.10.2
    
    Consent to Credit Agreement, dated as of July 15, 2004, among the
Company, as Borrower, the other credit parties signatory thereto, the
lenders signatory thereto from time to time, and General Electric Capital
Corporation, as Administrative Agent, Agent and Lender.31.1
    
    Chief Executive Officer and Acting Chief Financial Officer Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer and Acting Chief Financial Officer Certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  *
    
    Exhibit indicated with an * symbol is a management or compensatory plan
arrangement filed pursuant to Item 6(a) of Form 10-Q. (b) Reports on Form 8-K On May 6, 2004, we furnished a Current Report on Form 8-K pursuant to Item
12 (Results of Operations and Financial Condition), containing a copy of our
earnings release for the fourth quarter and year ended March 31, 2004
(including financial information). Page 29




---



##### Table of Contents



SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. ATARI, INC.By:
    
    /s/  Bruno BonnellBruno BonnellChairman of the Board, Chief Executive Officer and
Acting Chief Financial OfficerDate: August 9, 2004
 Page 30