##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period
ended December 31, 2004 OR o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to
Commission File No. 0-27338
 ATARI, INC.  DELAWARE
    
    13-3689915(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)
 417 FIFTH AVENUE, NEW YORK, NY 10016
(Address of principal executive offices)
(Zip code) (212) 726-6500
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12b-2). þ o
 As
of February 7, 2005, there were 121,294,592 of the registrants Common Stock outstanding.




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ATARI, INC. AND SUBSIDIARIES
DECEMBER 31, 2004 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS  
 PagePART I   FINANCIAL INFORMATIONItem 1. Financial Statements:Consolidated Balance Sheets as of March 31, 2004 and December 31, 2004 (unaudited)
    
    
    3Consolidated Statements of Operations and Comprehensive Income for the Three
Months and Nine Months Ended December 31, 2003 and 2004 (unaudited)
    
    
    4Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2003
and 2004 (unaudited)
    
    
    5Consolidated Statements of Stockholders Equity for the Year Ended March 31,
2004 and Nine Months Ended December 31, 2004 (unaudited)
    
    
    7Notes to the Consolidated Financial Statements
    
    
    8Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    22Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    36PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    37Item 6. Exhibits
    
    
    41Signature
    
    
    42OBLIGATION ASSIGNMENT AND SECURITY AGREEMENTSECURED PROMISSORY NOTETERMINATION AND GENERAL RELEASE AGREEMENTEMPLOYMENT AGREEMENTCERTIFICATIONCERTIFICATIONCERTIFICATIONCERTIFICATIONTENTH AMENDMENT TO CREDIT AGREEMENTELEVENTH AMENDMENT TO CREDIT AGREEMENTTERM EXTENSION TO XBOX PUBLISHER LICENSE AGREEMENTAMENDMENT SEVEN TO THE SUBLICENSE AGREEMENTCONSULTANT AGREEMENT WITH ANN KRONEN




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##### Table of Contents



PART I. FINANCIAL
INFORMATIONItem 1. Financial Statements 
 ATARI, INC. AND
SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
(in thousands)
 March 31,
    
    
    December 31,2004
    
    
    2004(unaudited)ASSETSCurrent assets:Cash
    
    $
    9,621
    
    
    $
    14,710Receivables, net
    
    
    37,707
    
    
    
    78,782Inventories, net
    
    
    27,520
    
    
    
    28,622Income taxes receivable
    
    
    2,320
    
    
    
    1,514Due from related parties
    
    
    4,175
    
    
    
    1,007Prepaid expenses and other current assets
    
    
    12,465
    
    
    
    14,965Related party notes receivable
    
    
    8,571
    
    
    
    20,830Total current assets
    
    
    102,379
    
    
    
    160,430Property and equipment, net
    
    
    13,267
    
    
    
    9,661Goodwill, net of accumulated amortization of $26,116 in both periods
    
    
    70,224
    
    
    
    70,224Other intangible assets, net of accumulated amortization of $1,294 and $1,800, at
March 31, 2004 and December 31, 2004, respectively
    
    
    1,406
    
    
    
    900Other assets
    
    
    6,680
    
    
    
    9,026Total assets
    
    $
    193,956
    
    
    $
    250,241LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    37,837
    
    
    $
    43,355Accrued liabilities
    
    
    15,886
    
    
    
    32,831Royalties payable
    
    
    14,481
    
    
    
    20,048Income taxes payable
    
    
    450
    
    
    
    1,089Short-term deferred income
    
    
    2,107
    
    
    
    77Due to related parties
    
    
    6,704
    
    
    
    22,368Total current liabilities
    
    
    77,465
    
    
    
    119,768Deferred income
    
    
    555
    
    
    
    497Other long-term liabilities
    
    
    873
    
    
    
    880Total liabilities
    
    
    78,893
    
    
    
    121,145Commitments 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 121,295
shares issued and outstanding at March 31, 2004 and December 31, 2004,
respectively
    
    
    1,212
    
    
    
    1,213Additional paid-in capital
    
    
    735,964
    
    
    
    736,190Accumulated deficit
    
    
    (625,436
    )
    
    
    (610,665
    )Accumulated other comprehensive income
    
    
    3,323
    
    
    
    2,358Total stockholders equity
    
    
    115,063
    
    
    
    129,096Total liabilities and stockholders equity
    
    $
    193,956
    
    
    $
    250,241
 The accompanying notes are an integral part of these consolidated financial statements. Page 3




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ATARI, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
 (in thousands, except per share data)
 (unaudited)
 Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004
    
    
    2003
    
    
    2004Net revenues
    
    $
    190,607
    
    
    $
    161,759
    
    
    $
    402,540
    
    
    $
    343,446Cost of goods sold
    
    
    93,916
    
    
    
    89,638
    
    
    
    202,712
    
    
    
    182,519Gross profit
    
    
    96,691
    
    
    
    72,121
    
    
    
    199,828
    
    
    
    160,927Selling and distribution expenses
    
    
    37,339
    
    
    
    20,553
    
    
    
    71,270
    
    
    
    53,560General and administrative expenses

    
    
    8,067
    
    
    
    10,155
    
    
    
    25,377
    
    
    
    28,311Research and development
    
    
    26,928
    
    
    
    18,462
    
    
    
    72,734
    
    
    
    54,508Gain on sale of development project to a
related party
    
    
    (3,744
    )
    
    
    
    
    
    
    (3,744
    )
    
    
    Depreciation and amortization
    
    
    2,811
    
    
    
    3,053
    
    
    
    6,757
    
    
    
    8,434Operating income
    
    
    25,290
    
    
    
    19,898
    
    
    
    27,434
    
    
    
    16,114Interest (expense) income, net
    
    
    (453
    )
    
    
    94
    
    
    
    (7,215
    )
    
    
    (608
    )Other (expense) income
    
    
    (1,737
    )
    
    
    (10
    )
    
    
    (2,077
    )
    
    
    23Income before provision for income
taxes
    
    
    23,100
    
    
    
    19,982
    
    
    
    18,142
    
    
    
    15,529Provision for income taxes
    
    
    81
    
    
    
    376
    
    
    
    63
    
    
    
    758Net income
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    18,079
    
    
    $
    14,771Dividend to parent
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    Income (loss) attributable to common
stockholders
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    (21,272
    )
    
    $
    14,771Basic and diluted income (loss)
attributable to common stockholders
per share
    
    $
    0.19
    
    
    $
    0.16
    
    
    $
    (0.24
    )
    
    $
    0.12Basic weighted average shares
outstanding
    
    
    121,170
    
    
    
    121,283
    
    
    
    88,981
    
    
    
    121,269Diluted weighted average shares
outstanding
    
    
    121,325
    
    
    
    121,376
    
    
    
    88,981
    
    
    
    121,412Net income
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    18,079
    
    
    $
    14,771Other comprehensive income:Foreign currency translation
adjustments
    
    
    (99
    )
    
    
    (100
    )
    
    
    (7
    )
    
    
    (106
    )Recognition of cumulative translation
adjustment from liquidation of a
foreign subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (859
    )Comprehensive income
    
    $
    22,920
    
    
    $
    19,506
    
    
    $
    18,072
    
    
    $
    13,806
 The accompanying notes are an integral part of these consolidated financial statements. Page 4




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ATARI, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 (unaudited)
 Nine Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    18,079
    
    
    $
    14,771Adjustments to reconcile net income to net cash (used in) provided by
operating activities:Depreciation and amortization
    
    
    6,757
    
    
    
    8,434Recognition of deferred income
    
    
    (3,557
    )
    
    
    (2,087
    )Modification of stock options previously granted
    
    
    
    
    
    
    139Loss on transfer of investment held at cost
    
    
    1,750
    
    
    
    Recognition of cumulative translation adjustment from liquidation of a
foreign subsidiary
    
    
    
    
    
    
    (859
    )Amortization of discount on related party debt
    
    
    1,339
    
    
    
    Accrued interest
    
    
    1,860
    
    
    
    26Amortization of deferred financing fees
    
    
    2,149
    
    
    
    616Write-off of property and equipment
    
    
    37
    
    
    
    204Changes in operating assets and liabilities:Receivables, net
    
    
    (53,325
    )
    
    
    (41,070
    )Inventories, net
    
    
    (5,048
    )
    
    
    (1,097
    )Due from related parties
    
    
    (7,783
    )
    
    
    3,181Due to related parties
    
    
    (5,325
    )
    
    
    15,565Prepaid expenses and other current assets
    
    
    5,596
    
    
    
    (2,924
    )Accounts payable
    
    
    23,979
    
    
    
    5,504Accrued liabilities
    
    
    2,813
    
    
    
    16,658Royalties payable
    
    
    7,114
    
    
    
    5,567Income taxes payable
    
    
    (711
    )
    
    
    628Income taxes receivable
    
    
    2
    
    
    
    806Other long-term liabilities
    
    
    (231
    )
    
    
    (181
    )Other assets
    
    
    (637
    )
    
    
    (4,988
    )Net cash (used in) provided by operating activities
    
    
    (5,142
    )
    
    
    18,893CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (4,040
    )
    
    
    (1,624
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    21Repayment of short-term notes receivable from related party
    
    
    
    
    
    
    1,317Transfer and assignment of short-term notes receivable from related party
    
    
    
    
    
    
    7,254Issuance of secured promissory note
    
    
    
    
    
    
    (23,059
    )Repayment of secured promissory note, net
    
    
    
    
    
    
    2,229Advances to related parties
    
    
    (14,368
    )
    
    
    Net cash (used in) investing activities
    
    
    (18,408
    )
    
    
    (13,862
    )CASH FLOWS FROM FINANCING ACTIVITIES:Payments under General Electric Capital Corporation Senior
Credit Facility, net
    
    
    (3,771
    )
    
    
    Proceeds from exercise of stock options
    
    
    448
    
    
    
    88Net proceeds from public stock offering
    
    
    34,894
    
    
    
    Payments under capitalized lease obligation
    
    
    
    
    
    
    (73
    )Proceeds from employee stock purchase plan
    
    
    103
    
    
    
    Net cash provided by financing activities
    
    
    31,674
    
    
    
    15Effect of exchange rates on cash
    
    
    101
    
    
    
    43Net increase in cash
    
    
    8,225
    
    
    
    5,089Cash  beginning of fiscal period
    
    
    815
    
    
    
    9,621Cash  end of fiscal period
    
    $
    9,040
    
    
    $
    14,710
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Nine Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004SUPPLEMENTAL CASH FLOW INFORMATIONSUPPLEMENTAL DISCLOSURE OF OPERATING ACTIVITIES:Cash paid for interest
    
    $
    5,738
    
    
    $
    379Cash paid for taxes
    
    $
    730
    
    
    $
    Income tax refunds
    
    $
    
    
    
    $
    731SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
ACTIVITIES:Acquisition of Atari license for 2,000 shares of common stock
    
    $
    8,500
    
    
    $
    Capital lease obligation for computer equipment
    
    $
    
    
    
    $
    391SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING
ACTIVITIES:Net debt exchanged for 39,030 shares of common stock:Related party debt, revolving credit facility and related party
medium-term loanprior to recapitalization of debt
    
    $
    212,429
    
    
    $
    Less: Offset of advances to related parties against related party debt
    
    
    46,552
    
    
    
    Net debt exchanged for common stock
    
    $
    165,877
    
    
    $
    Issuance of shares in lieu of partial royalty payment
    
    $
    1,199
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. Page 6




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ATARI, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 (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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,771
    
    
    
    
    
    
    
    14,771Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (106
    )
    
    
    (106
    )Cashless exercise of warrants
    
    
    44
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    Recognition of cumulative translation adjustment from
liquidation of a foreign subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (859
    )
    
    
    (859
    )Exercise of stock options
    
    
    20
    
    
    
    
    
    
    
    40
    
    
    
    
    
    
    
    
    
    
    
    40Issuance of stock options to related party
    
    
    
    
    
    
    
    
    
    
    48
    
    
    
    
    
    
    
    
    
    
    
    48Modification of stock options previously granted
    
    
    
    
    
    
    
    
    
    
    139
    
    
    
    
    
    
    
    
    
    
    
    139Balance, December 31, 2004 (unaudited)
    
    
    121,295
    
    
    $
    1,213
    
    
    $
    736,190
    
    
    $
    (610,665
    )
    
    $
    2,358
    
    
    $
    129,096
 The accompanying notes are an integral part of these consolidated financial statements. Page 7




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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 wireless devices, the
internet, and other evolving platforms. Our diverse portfolio of products extends across every
major video game genre, including: action, adventure, strategy, children, family, driving and
sports games. Through our relationship with our majority stockholder, Infogrames Entertainment S.A., a
French corporation (IESA), listed on Euronext, our products are distributed exclusively by IESA
throughout Europe, Asia and certain other regions. Similarly, we exclusively distribute IESAs
products in the United States, Canada and their territories and possessions. At December 31, 2004,
IESA owns approximately 61% 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). As of the date of this filing, IESAs ownership has been reduced to approximately
52% (see Note 7). 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. Goodwill and Other Intangible Assets Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible
Assets, eliminated 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 Page 8




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not result in any impairment of goodwill or intangibles. As of December 31, 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. Other intangible assets approximate $1.4 million and $0.9 million, net of accumulated
amortization of $1.3 million and $1.8 million at March 31, 2004 and December 31, 2004,
respectively. 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. 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, 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 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 Licenses for intellectual property are capitalized as assets upon the execution of the
contract when no significant obligation of performance remains with the third party. If significant
obligations remain, the asset is capitalized when payments are due as opposed to when the contract
is executed. These licenses are amortized at the licensors royalty rate over unit sales.
Management evaluates the carrying value of these capitalized licenses and records an impairment
charge (as research and development expense) in the period management determines that such
capitalized amounts are not expected to be realized. Income Taxes We account for income taxes using the asset and liability method of accounting for income
taxes. Under this method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates in effect for the years in which the differences are expected to reverse. We
record an allowance to reduce tax assets to an estimated realizable amount. We
monitor our tax liability on an estimated Page 9




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quarterly basis and record the estimated tax obligation based on our current year-to-date
taxable income and expectations of the full year results. Income (Loss) Attributable to Common Stockholders Per Share Basic income (loss) attributable to common stockholders per share is computed by dividing
income (loss) attributable to common stockholders by the weighted average number of shares of
common stock outstanding for the period. Diluted income (loss) attributable to common stockholders
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 a
reconciliation of basic and diluted income (loss) attributable to common stockholders per share (in
thousands, except per share data): Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004
    
    
    2003
    
    
    2004Basic and diluted earnings per share calculation:Net income
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    18,079
    
    
    $
    14,771Dividend to parent
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    Income (loss) attributable to common
stockholders
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    (21,272
    )
    
    $
    14,771Basic weighted average shares outstanding
    
    
    121,170
    
    
    
    121,283
    
    
    
    88,981
    
    
    
    121,269Basic income (loss) attributable to common
stockholders per share
    
    $
    0.19
    
    
    $
    0.16
    
    
    $
    (0.24
    )
    
    $
    0.12Diluted earnings per share calculation:Net income
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    18,079
    
    
    $
    14,771Dividend to parent
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    Income (loss) attributable to common
stockholders
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    (21,272
    )
    
    $
    14,771Weighted average shares outstanding
    
    
    121,170
    
    
    
    121,283
    
    
    
    88,981
    
    
    
    121,269Dilutive potential common shares:Employee stock options and warrants
    
    
    155
    
    
    
    93
    
    
    
    
    
    
    
    143Diluted weighted average shares outstanding
    
    
    121,325
    
    
    
    121,376
    
    
    
    88,981
    
    
    
    121,412Diluted income (loss) attributable to common
stockholders per share
    
    $
    0.19
    
    
    $
    0.16
    
    
    $
    (0.24
    )
    
    $
    0.12
 The
number of antidilutive shares that was excluded from the diluted earnings per share
calculation for the three months and nine months ended December 31, 2003 was 7,034,000 and
13,019,000, respectively. The number of antidilutive shares that was excluded from the diluted
earnings per share calculation for the three months and nine months
ended December 31, 2004 was
8,889,000 and 6,766,000, respectively. For the three months ended December 31, 2003 and the three
months and nine months ended December 31, 2004, the antidilutive shares result from stock options
and warrants in which the exercise price is greater than the average market price of the common
shares during the period. For the nine months ended December 31, 2003, the shares were
antidilutive due to the loss attributable to common stockholders for the period. 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 Page 10




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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 December 31, 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 income (loss) attributable to common stockholders and income (loss) attributable to
common stockholders 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): Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004
    
    
    2003
    
    
    2004Net income:Basic and diluted  as reported
    
    $
    23,019
    
    
    $
    19,606
    
    
    $
    18,079
    
    
    $
    14,771Plus: Fair value of stock-based employee
compensation expense, net of related tax effects
    
    
    (1,668
    )
    
    
    (1,340
    )
    
    
    (4,523
    )
    
    
    (3,753
    )Basic and diluted  pro forma net income
    
    
    21,351
    
    
    
    18,266
    
    
    
    13,556
    
    
    
    11,018Dividend to parent
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    Basic and diluted  pro forma income (loss)
attributable to common stockholders
    
    $
    21,351
    
    
    $
    18,266
    
    
    $
    (25,795
    )
    
    $
    11,018Income (loss) attributable to common stockholders per
share:Basic and diluted attributable to common
stockholders  as reported
    
    $
    0.19
    
    
    $
    0.16
    
    
    $
    (0.24
    )
    
    $
    0.12Basic and diluted attributable to common
stockholders  pro forma
    
    $
    0.18
    
    
    $
    0.15
    
    
    $
    (0.29
    )
    
    $
    0.09
 The fair market value of options granted under stock option plans during the three months and
nine months ended December 31, 2003 and 2004 was determined using the Black-Scholes option pricing
model utilizing the following assumptions: Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004
    
    
    2003
    
    
    2004Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Anticipated volatility
    
    
    123
    %
    
    
    255
    %
    
    
    122
    %
    
    
    255
    %Weighted average risk-free interest rate
    
    
    3.00
    %
    
    
    3.40
    %
    
    
    2.78
    %
    
    
    3.40
    %Expected lives
    
    4 years
    
    4 years
    
    4 years
    
    4 years
 Recent Accounting Pronouncements In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-based Payment,
which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation.
Statement 123(R) supersedes APB No. 25, Accounting for Stock Issued to Employees, and amends
FASB Statement No. 95, Statement of Cash Flows. Generally, the
approach to accounting in Statement 123 (R)
requires all share-based payments to employees, including grants of employee stock options, to be
recognized in the financial statements as based on their fair values. Currently we account for
these payments under the intrinsic value provisions of APB No. 25 with no expense recognition in
the financial statements. Statement 123(R) is effective for quarters beginning after June 15,
2005. The Statement offers several alternatives for implementation. At this time, management has
not made a decision as to the alternative it may select. In November 2004, the FASB issued Statement No. 151, Inventory Costs, an amendment of APB
No. 43, Chapter 4. The amendments made by Statement No. 151 will improve financial reporting by
requiring that abnormal amounts of idle facility expense, freight, handling costs, and wasted
materials (spoilage) be recognized as current-period charges and by requiring the allocation of
fixed production overheads to inventory based on the normal capacity of Page 11




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production facilities. Statement No. 151 is effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs
incurred during fiscal years beginning after November 24, 2004. We have determined that adoption of
SFAS No. 151 will have no material effect on our financial position and results of operations. NOTE 2  RECAPITALIZATION AND OTHER CORPORATE MATTERS During September 2003, we entered into a series of transactions to restructure our debt and
equity through a recapitalization of debt (Recapitalization) and a 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). 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. Accordingly, at March 31, 2004 and December 31, 2004, no
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 had $8.6
million in related party notes receivable outstanding at March 31, 2004, which arose after the
Recapitalization and are related to certain other transactions. In November 2004, we converted the
remaining outstanding portion of these notes in addition to $15.7 million of related party royalty
receivables into a secured promissory note, which, as of December 31, 2004, was approximately $20.8
million (see Note 6). These notes are permitted by the GECC senior credit facility (see Note 9). In connection with the Recapitalization Agreement, we issued stock to IESA at the same price
as in the Offering (see Offeringbelow), which was 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, representing the fair market value of the shares
issued, 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 December 31, 2004, $3.4 million of this deferred charge is included in Prepaid Expenses
and Other Current Assets with the remaining $0.8 million, net of $4.3 million of amortization,
included in Other Assets. As part of the secured promissory note due from Atari Interactive
entered into in November 2004 (see Note 6), the 2,000,000 shares have been pledged as collateral
should Atari Interactive default on payment of the secured promissory note. 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. Page 12




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NOTE 3  RECEIVABLES, NET Receivables consist of the following (in thousands): March 31,
    
    
    December 31,2004
    
    
    2004Trade accounts receivable
    
    $
    73,986
    
    
    $
    116,609Less: Allowances for bad debts, returns, price protection and other
customer promotional programs
    
    
    (36,279
    )
    
    
    (37,827
    )$
    37,707
    
    
    $
    78,782
 NOTE 4  INVENTORIES, NET Inventories consist of the following (in thousands): March 31,
    
    
    December 31,2004
    
    
    2004Finished goods
    
    $
    26,790
    
    
    $
    27,031Return inventory
    
    
    1,964
    
    
    
    3,416Raw materials
    
    
    911
    
    
    
    30229,665
    
    
    
    30,749Less: Obsolescence reserve
    
    
    (2,145
    )
    
    
    (2,127
    )$
    27,520
    
    
    $
    28,622
 NOTE 5  ACCRUED LIABILITIES Accrued liabilities consist of the following (in thousands): March 31,
    
    
    December 31,2004
    
    
    2004Accrued third-party license and development expenses
    
    $
    1,491
    
    
    $
    12,221Accrued advertising
    
    
    3,036
    
    
    
    6,078Accrued distribution services
    
    
    1,848
    
    
    
    4,465Accrued salary and related costs
    
    
    4,579
    
    
    
    4,192Accrued freight and processing fees
    
    
    989
    
    
    
    1,469Accrued professional fees and other services
    
    
    1,295
    
    
    
    1,428Customer deposits
    
    
    
    
    
    
    463Other
    
    
    2,648
    
    
    
    2,515$
    15,886
    
    
    $
    32,831
 NOTE 6  RELATED PARTY TRANSACTIONS Related Party Notes Receivable On March 31, 2004, Atari Interactive and Paradigm, respectively, issued to us related party
notes receivable (as described in (1) and (2) below) which bore interest, prior to default, at
prime plus 1.25%. As of September 30, 2004, Atari Interactive and Paradigm had amounts past due related to these
notes of approximately $5.6 million. We renegotiated the payments of and security for these
related party notes receivable as of November 3, 2004. For a description of the renegotiated
terms, see below. Page 13




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Related party notes receivable consist of the following amounts (in thousands): March 31,
    
    
    December 31,2004
    
    
    2004Related party note receivable  Atari Interactive (1)
    
    $
    5,122
    
    
    $
    Related party note receivable  Atari Interactive (2)
    
    
    2,620
    
    
    
    Related party note receivable  Paradigm (2)
    
    
    829
    
    
    
    Secured promissory note  Atari Interactive (3)
    
    
    
    
    
    
    20,830Total related party notes receivable
    
    $
    8,571
    
    
    $
    20,830
 (1) This note was payable at the earlier of the release of certain development projects to
the public or December 31, 2004. One project was released to the public on September 14, 2004.
On September 30, 2004, we offset royalties due to Atari Interactive of approximately $1.3
million against the portion of the principal that was past due. The outstanding balance of this
note as of September 30, 2004 was $3.8 million, of which $2.2 million was past due. The
outstanding balance was converted to a secured promissory note from Atari Interactive on
November 3, 2004 (see (3) below). (2) The Atari Interactive note and the Paradigm note were payable on September 30, 2004. The
balance of the Atari Interactive note was converted to a secured promissory note. The balance
of the Paradigm note was assigned to Atari Interactive and subsequently transferred to a secured
promissory note from Atari Interactive on November 3, 2004 (see (3) below). (3) As at September 30, 2004, royalty payments past due to us by IESA under our existing
distribution agreement (see Royalty Agreementbelow) for the period then ended amounted to
approximately $15.7 million. In addition, as at that same date, amounts past due to us by Atari
Interactive and Paradigm, respectively (see above), amounted to approximately $4.8 million and
to $0.8 million, in respect of related party notes receivable (see (1) and (2) above). On November 3, 2004, we entered into an agreement with IESA and several of its subsidiaries
under which, in lieu of receiving payment on the past due amounts, we transferred the amounts
due to us from IESA and Paradigm to Atari Interactive in exchange for a secured promissory note
(the Secured Note) from Atari Interactive that also includes in the initial principal amount
the sums past due to us from Atari Interactive and a $1.6 million note payment that would have
been due from Atari Interactive on December 31, 2004, and interest on those amounts of
approximately $0.1 million. Specifically, the Secured Note has a principal amount of
approximately $23.1 million, will mature on March 31, 2005, bears annual interest at the prime
rate plus 3.25%, and is secured by 2,000,000 shares of our common stock owned and pledged by
Atari Interactive and by the rights, as owner, to the
Atari trademark and the Fuji logo in
North America for specific uses (collectively, the Collateral). The Atari trademark and Fuji logo currently
are owned by Atari Interactive and licensed to us through 2013 under the terms of the Trademark
License Agreement, dated September 4, 2003 (see Note 2). The Secured Note allows for the
netting of sums currently due to us with IESA and several of its subsidiaries. As of December
31, 2004, a net related party payable balance of $2.6 million was netted against the Secured
Note, offset by interest income of $0.3 million added to the
Secured Note. As of December 31, 2004, we have approximately
$22.4 million due to IESA and certain of its subsidiaries, which
we may offset against amounts outstanding under the Secured Note.
Based on our projections of amounts payable to Atari Interactive,
IESA, and certain of its other subsidiaries, we anticipate that on
March 31, 2005, the Secured Note will be repaid through
the offset of those amounts. For the three months and nine months ended December 31, 2004, $0.1 million and $0.3 million,
respectively, of interest income has been earned on the related party notes receivable with Atari
Interactive and Paradigm. This interest was outstanding as of November 3, 2004 and was
consolidated into the Secured Note. Subsequent to November 3, 2004, $0.3 million of interest
income was earned on the Secured Note and was added to the outstanding Secured Note balance. Page 14




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Royalty Agreement Royalties transactions are as follows (in thousands): Three Months
    
    
    Nine MonthsEnded
    
    
    EndedDecember 31,
    
    
    December 31,2003
    
    
    2004
    
    
    2003
    
    
    2004Income (expense)Royalty income (1)
    
    $
    9,984
    
    
    $
    721
    
    
    $
    27,237
    
    
    $
    17,011Royalty expense (2)
    
    
    (747
    )
    
    
    (4,152
    )
    
    
    (1,070
    )
    
    
    (4,025
    )Net royalty income (expense)
    
    $
    9,237
    
    
    $
    (3,431
    )
    
    $
    26,167
    
    
    $
    12,986
 (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 December 31, 2004, the following amounts are outstanding with regard
to related party royalty transactions and are included in due from and due to related parties (in
thousands): March 31,
    
    
    December 31,2004
    
    
    2004Royalties due from IESA
    
    $
    3,564
    
    
    $
    355Royalties due to IESA
    
    
    
    
    
    
    (4,508
    )Net royalties receivable (payable)
    
    $
    3,564
    
    
    $
    (4,153
    )
 Options Issued to Paradigm on behalf of IESA On July 30, 2004, 27,500 options to purchase our common stock were issued to two officers of
Paradigm on behalf of IESA. The options were valued at a nominal amount using the Black-Scholes
model. As of September 30, 2004, Paradigm reimbursed us for the expense incurred related to the
issuance of these options. Gain on sale of development project to a related party During the third quarter of the prior year, we sold a development project to Atari Interactive
for $3.7 million resulting in a gain of an equal amount. The project involved a license owned by
Atari Interactive for which development rights were transferred to us in the fourth quarter of
fiscal 2003 at no cost to us. Management believes that the value of the development rights was
minimal at the time of transfer. The sales price to Atari Interactive was equal to the development
costs incurred by us, which were expensed during the period of development, principally in the
first six months of fiscal 2004. The sale was initiated as a result of concerns expressed by the
original third party licensor relating to our development efforts. Page 15




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NOTE 7  PARENT LIQUIDITY As of the date of this report,
IESA beneficially owns, directly and indirectly, approximately 52% of our stock. IESA has incurred
significant continuing operating losses and is highly leveraged. IESA has taken steps to improve
its financial situation, including, (i) restructuring its outstanding debt obligations such that the
debt amount is reduced and the debt maturity schedule is more favorable, (ii) reducing operating
expenses, (iii) raising capital by selling (through CUSH) 11,000,000 of its shares in Atari, pursuant
to a registration statement, (iv) entering into banking arrangements to fund operations and position
itself for the new hardware cycle, (v) selling assets, such as its rights in the Civilization
franchise, and (vi) entering into production fund agreements to finance certain game development projects.
However, IESA has not yet completed all of the actions it plans to take in order to improve its
operations and reduce its debt. As a result, IESA's current ability to, among other things, fund its
subsidiaries' operations is diminished.  There can be no assurance that IESA will complete such actions
to assure its future financial stability. If IESA is unable to complete its
action plan and address its liquidity problems and fund its working capital needs, IESA would likely be
unable to fund its and its subsidiaries' video game development operations, including that of Atari
Interactive. Pursuant to our GECC senior credit facility, we are prohibited from making advances to
Atari Interactive. Therefore, our results of operations could be materially impaired if IESA fails to
fund Atari Interactive, as any delay or cessation in product development could materially decrease our
revenue from the distribution of Atari Interactive and IESA products. Such a reduction of our revenues,
among other things, could result in a breach of one or more of the covenants contained
in our senior credit facility with GECC. If the above contingencies occurred, we probably would be
forced to take actions that, could include, but would not necessarily be limited to, a
significant reduction in our expenditures for internal and external new product development
and the implementation of a comprehensive cost reduction program to reduce our overhead expenses.
These actions, should they become necessary, could result in a significant reduction in the size of
our operations and could have a material adverse effect on our revenue and cash flows. At present
there can be no assurance regarding any of the foregoing contingencies and management will
continue to monitor these developments closely. IESA distributes our products in Europe,
Asia, and certain other regions, and pays us royalties in this respect. IESA also develops products which
we distribute in the U.S., Canada, and their territories and possessions, and for which we pay
royalties to IESA. Both IESA and Atari Interactive are material sources of products which we
market in the United States and Canada. Atari Interactive is the source of approximately 31%
of our net revenue and we generate approximately 5% of our net
revenue from royalties on IESAs distribution of our products in Europe, Asia, and certain
other regions.  Also, pursuant to the Secured Note payable as of March 31, 2005, as detailed
in Note 6 above, at December 31, 2004, Atari Interactive owes us approximately
$20.8 million (subject to further interest accrual and nettings). As of December 31, 2004,
we have approximately $22.4 million due to IESA and certain of its subsidiaries, which
we may offset against amounts outstanding under the Secured Note. Based on our projections of
amounts payable to Atari Interactive, IESA, and certain of its other subsidiaries,
we anticipate that on March 31, 2005, the Secured Note will be repaid through the offset
of those amounts. Additionally,
though Atari is a separate and independent legal entity and we are not a party to,
or a guarantor of, and have no obligations or liability in respect of, IESAs indebtedness, because
IESA owns the majority of our stock, potential investors and current and potential
business/trade partners may view IESAs financial situation as relevant to an assessment of Atari.
Therefore, if IESA is unable to address its financial issues, it may taint our relationship
with our suppliers and distributors, damage our business reputation, and otherwise
impair our ability to raise and generate capital. IESA continues to focus on ways to
address and improve its financial situation. NOTE 8  COMMITMENTS AND CONTINGENCIES Litigation During the nine months ended December 31, 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. 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 Page 16




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Entertainment Corp. (Interplay), and us in Superior Court of California, Orange County (the
Court). 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 adds
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. We and Atari Interactive prevailed on a Motion for Leave to File a Cross-Complaint against
Interplay and Gamesonline. 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. filed 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 was granted. On or about October 1, 2004, KBKs litigation counsel resigned. On October 8, 2004, we and
Atari Interactive filed an ex parte application to strike KBKs pleadings or, in the alternative,
for an order shortening the time to hear such application as noticed motions. The ex parte
application was heard and denied on October 11, 2004 but the Court did grant the application for a
shortened period of time to hear such application as noticed motions. On October 19, 2004, the
Court granted our Motion to Strike KBKs Pleadings due to the fact that KBK has no counsel to
represent it in the litigation and did not file any opposition to the motion. The Court dismissed
KBKs complaint without prejudice. The cross-claims have not been dismissed by the other parties to
the litigation. We and Atari Interactive are in discussions with the other parties with respect to
same. 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. We, 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 Page 17




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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. The plaintiffs further allege that upon the expiration of the interim license,
all intellectual property rights granted under that license reverted back to us, but that Games
nevertheless continued to use the plaintiffs intellectual property. On May 18, 2004, the Court
granted a temporary restraining order against Games and Ach and scheduled a preliminary injunction
hearing for May 28, 2004, which was postponed until June 11, 2004. Prior to that hearing, Games
agreed to the preliminary injunction and 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 the plaintiffs breached the Agreement and a Settlement Agreement
dated March 31, 2004 by, inter alia, licensing other web sites to use on-line play of certain Atari
and Hasbro games that Games claimed were part of its exclusive license under the Agreement. On June 23, 2004, the Court ordered that the parties attend a case management conference
scheduled for June 29, 2004. At the June 29, 2004, case management conference, Games counsel
raised issues relating to the plaintiffs failure to respond to its discovery requests. The Court
directed that the plaintiffs submit a letter brief setting forth its generic objections to Games
discovery requests. The Court ordered that the plaintiffs letter brief be submitted by July 6,
2004 and that Games submit its reply by July 13, 2004. The Court also scheduled a teleconference
for July 14, 2004. On July 6, 2004, the plaintiffs submitted their letter brief to the Court and
also served Games with its Rule 26(a)(1) initial disclosures and answer to the counterclaim. Games counsel failed to appear for the July 14, 2004, teleconference and it was adjourned to
July 15, 2004. At that teleconference, the Court granted the majority of the plaintiffs motion to
quash Games discovery requests. As a result of the Courts ruling, the plaintiffs do not have to
produce any documents that were created on or before March 31, 2004, any documents relating to
derivative games, or any documents relating to any license agreements with third parties concerning
derivative games, downloads, or streaming. On July 16, 2004, it came to the plaintiffs attention that, in flagrant violation of the
preliminary injunction, Games had issued a press release on July 13, 2004, that erroneously stated
that Games owned the games.com web site and that it had an exclusive license to certain Atari and
Hasbro games. The plaintiffs immediately brought the erroneous press release to the attention of
Games counsel. On that same day, Games replaced the erroneous press release with a corrected press
release, but refused to issue a corrective press release explaining that it in fact did not own
either the web site or have any license to Atari and Hasbro games. On July 19, 2004, the plaintiffs
brought this to the attention of the Court, who ordered that a corrective press release be issued,
but approved language submitted by Games counsel. On September 3, 2004, in a teleconference with the Court, Games requested from the Court that
the plaintiffs be ordered to produce agreements with third parties from the first quarter of 2004
concerning online play of certain Atari and Hasbro games. During that same teleconference, the
plaintiffs sought permission to move to dismiss the counterclaims against Atari Interactive and
Hasbro. On September 8, 2004, the Court broadened the scope of discovery to include documents
regarding contracts and negotiations between us and Hasbro and third parties between January 1,
2004 and March 31, 2004 regarding online play of the original classic versions of the games. The
Court also set a schedule for the plaintiffs motion to dismiss the Counterclaims, which has been
fully submitted and is under judicial deliberation. On October 4, 2004, it came to the plaintiffs attention that, once again, Games was in
flagrant violation of the preliminary injunction because it represented in its Form 10-KSB filing
dated October 1, 2004, that Games owned the domain name games.com and that it had an exclusive
license to certain Hasbro and Atari games. The plaintiffs immediately brought this to the attention
of Games counsel, who represented that certain, but not all, statements would be amended. But
Games did not amend its Form 10-KSB. Accordingly, the plaintiffs sought permission to move for
contempt for violation of the preliminary injunction. On October 14, 2004, in a teleconference with the Court, the Court granted the plaintiffs
request to move for contempt, and ordered that the parties brief that motion on the same schedule
as the briefing schedule for motions for summary judgment. The Court also reset the schedule for
this case. The Court ordered that all discovery be completed by November 12, 2004, that opening
briefs on summary judgment be filed by November 29, 2004, that answering papers be filed on
December 13, 2004, and that reply papers be filed on December 20, 2004. The parties completed
discovery, and the plaintiffs filed their motion for summary judgement and motion for contempt
sanctions, on November 29, 2004. The Court held oral argument on these motions on January 12, 2005
and we await the Courts decision. Page 18




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Atari, Inc., Electronic Arts, Inc. and Vivendi Universal Games, Inc. v. 321 Studios, LLC On June 14, 2004, we, Electronic Arts, Inc. (Electronic Arts), and Vivendi Universal Games,
Inc. (Vivendi) filed a lawsuit against 321 Studios, LLC (321 Studios), in U.S. District Court
for the Southern District of New York. We, Electronic Arts, and Vivendi 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. We, Electronic Arts, and Vivendi filed a
Preliminary Injunction Motion on July 1, 2004. 321 Studios did not answer the Complaint and did not
respond to the Preliminary Injunction Motion. On December 14, 2004 the case was settled, with the
parties executing a Settlement Agreement and the court entering a Final Judgment and Permanent
Injunction. Pursuant to the settlement, 321 Studios agreed to permanently cease manufacturing,
distributing and selling Games X Copy software. The litigation and settlement was coordinated by
the ESA (the Entertainment Software Association) and the costs associated therewith were paid by
the ESA. American Video Graphics, L.P., v. Electronic Arts, Inc. et al. On August 23, 2004, American Video Graphics, L.P. filed a lawsuit against us, Electronic Arts,
Take-Two Interactive Software, Inc., Ubi Soft, Activision Inc., THQ, Inc., Vivendi, Sega of
America, Inc., Square Enix, Inc., Tecmo, Inc., Lucasarts, a division of Lucas Films Entertainment
Co., Ltd., and Namco Hometek, Inc. in the United States District Court for the Eastern District of
Texas, Tyler Division (Case No. 6:04 CV-398-LED). We were served with the Summons and Complaint on
September 7, 2004. The complaint alleges infringement of US Patent No. 4,734,690 (method and
apparatus for spherical panning) and seeks unspecified damages. We were served with a First Amended
Complaint on or about October 7, 2004, which amended the original complaint to properly name
certain of the other defendants in the suit. We filed our answer to such complaint on November 8,
2004. Discovery is ongoing. iEntertainment Network,
Inc. v. Epic Games, Inc., Atari, Inc., Valve Corporation, Sierra

Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of America, Sony Computer
Entertainment America, Inc. and Sony Online Entertainment, Inc. On December 22, 2004, we were served with a complaint by iEntertainment, Inc. The complaint
has been filed in the United States District Court of the Eastern District of North Carolina
Western Division (5:04-CV-647-BD(1)) and names the following defendants: us, Epic Games, Inc.,
Valve Corporation, Sierra Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of
America, Sony Computer Entertainment America, Inc. and Sony Online Entertainment, Inc. The
complaint alleges infringement of US Patent No. 6,042,477 (method of and system for minimizing the
effects of time latency in multiplayer electronic games played on interconnected computers) and
seeks unspecified damages. We intend to answer the complaint. Codemasters, Inc. v. Atari, Inc. On January 13, 2005, we were served with a Complaint by Codemasters, Inc. (Codemasters).
The complaint has been filed in New York Supreme Court, County of New York. The causes of action
arise out of contractual disputes regarding payments owed by each party to the other. Codemasters
causes of action include breach of contract, failure to respond to submitted statements of account
and unjust enrichment. Codemasters is seeking relief in the amount of $931,050.09 and such other
relief as may be just and proper, including interests, costs associated with the suit. We intend
to answer the complaint. NOTE 9  DEBT Credit Facilities GECC Senior Credit Facility On November 12, 2002 (last amended January 12, 2005), 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 Page 19




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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 December 31,
2004, no borrowings or letters of credit are outstanding under the senior credit facility. As of
December 31, 2004, a nominal amount of accrued interest is included in accrued liabilities and we
were in compliance with all financial covenants, as amended. 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, as well as the renegotiated debt

arrangement with Atari Interactive and Paradigm (see Note 6). As currently projected, we will be in breach of our fourth quarter financial covenants under
the senior credit facility. We plan to secure all necessary waivers or amendments prior to the
filing of our March 31, 2005 annual report. However, no assurance can be given that all necessary
waivers or amendments will be secured in a timely manner, if at all. The
senior credit facility expires on May 12, 2005 (if not otherwise
extended). We plan to secure an equivalent credit
arrangement with either GECC or another lender. However, no assurance can be given that another
facility will be secured in a timely manner, if at all, or on terms acceptable to us. NOTE 10  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 December 31, 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 and
nine months ended December 31, 2003 and 2004 (in thousands): Publishing
    
    
    Distribution
    
    
    Corporate

    
    
    TotalThree months ended December 31, 2003:Net revenues
    
    $
    174,368
    
    
    $
    16,239
    
    
    $
    
    
    
    $
    190,607Operating income (loss)
    
    
    28,729
    
    
    
    2,905
    
    
    
    (6,344
    )
    
    
    25,290Depreciation and amortization
    
    
    (1,001
    )
    
    
    (2
    )
    
    
    (1,808
    )
    
    
    (2,811
    )Interest (expense)
    
    
    
    
    
    
    
    
    
    
    (453
    )
    
    
    (453
    )Three months ended December 31, 2004:Net revenues
    
    $
    143,254
    
    
    $
    18,505
    
    
    $
    
    
    
    $
    161,759Operating income (loss)
    
    
    26,961
    
    
    
    2,601
    
    
    
    (9,664
    )
    
    
    19,898Depreciation and amortization
    
    
    (704
    )
    
    
    
    
    
    
    (2,349
    )
    
    
    (3,053
    )Interest income
    
    
    
    
    
    
    
    
    
    
    94
    
    
    
    94Nine months ended December 31, 2003:Net revenues
    
    $
    354,976
    
    
    $
    47,564
    
    
    $
    
    
    
    $
    402,540Operating income (loss)
    
    
    38,841
    
    
    
    8,699
    
    
    
    (20,106
    )
    
    
    27,434Depreciation and amortization
    
    
    (2,916
    )
    
    
    (185
    )
    
    
    (3,656
    )
    
    
    (6,757
    )Interest income (expense)
    
    
    
    
    
    
    22
    
    
    
    (7,237
    )
    
    
    (7,215
    )Nine months ended December 31, 2004:Net revenues
    
    $
    300,953
    
    
    $
    42,493
    
    
    $
    
    
    
    $
    343,446Operating income (loss)
    
    
    35,641
    
    
    
    10,587
    
    
    
    (30,114
    )
    
    
    16,114
 Page 20




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Publishing
    
    
    Distribution
    
    
    Corporate
    
    
    TotalDepreciation and amortization
    
    
    (2,557
    )
    
    
    
    
    
    
    (5,877
    )
    
    
    (8,434
    )Interest (expense)
    
    
    
    
    
    
    
    
    
    
    (608
    )
    
    
    (608
    )
 NOTE 11  INCOME TAXES As of December 31, 2004, we have combined net operating loss carryforwards of approximately
$452.3 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 it is more
likely than not that such asset will not be realized. Management reassesses its position with
regard to the valuation allowance on a quarterly basis. During the nine months ended December 31, 2004, we recorded a provision of approximately $0.2
million for a potential tax expense related to our UK subsidiary, and the remaining balance
consists principally of provisions for state and federal alternative minimum taxes. For the nine
months ended December 31, 2003, a provision for income taxes of $0.1 million was recorded. NOTE 12  ODDWORLD TRANSACTION On December 19, 2003, we and Oddworld Inhabitants, Inc. (Oddworld), a developer, entered
into a Settlement and Release Agreement (Oddworld Agreement), which provided for, among other
things, the exchange of our licensed publishing rights and preferred stock investment (carried at
$3.5 million) in the developer in return for a release of Oddworlds interest in $1.8 million in
publishing royalties previously advanced to us by Microsoft Corporation (Microsoft). As part of the transaction, we amended our existing Microsoft/Oddworld License Agreement,
which, among other things, provided that we retain, without any ongoing obligations, $3.5 million
of non-refundable publishing royalties previously advanced by Microsoft. The foregoing
transactions resulted in the recognition of $3.5 million of royalties which were previously
deferred and an impairment charge on the disposition of our preferred stock investment in Oddworld
of $1.7 million. The charge was included in Other (Expense) Income and the royalty was included in
net revenues in the accompanying Consolidated Statement of Operations for the three months and nine
months ended December 31, 2003. NOTE 13  SUBSEQUENT EVENTS On February 9, 2005, we
announced the closure of our publishing studios located in Santa Monica,
California and Beverly, Massachusetts, and the relocation of the functions handled by
those studios to our corporate headquarters in New York. We anticipate recording a
restructuring reserve during our fiscal 2005 fourth quarter to reflect severance packages,
lease obligations and other related items. Page 21




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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 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 25.6%, 12.3%, 10.2% and 7.2%,
respectively, of net revenues for the nine months ended December 31, 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 costs and overruns. This, in turn, has increased the importance of leveraging the
technologies, characters or storylines of existing hit titles into additional video game software
franchises in order to spread development costs among multiple products. In this environment, we
are determined to achieve balances between internal and external development, and licensed and
proprietary products. Company Reorganization On February 9, 2005, we
announced the decision to redefine our cost structure with a stronger emphasis on product
development and marketing. As a result, we are closing our publishing studios located
in Santa Monica, California and Beverly, Massachusetts, and will relocate the functions
handled by those studios to our corporate headquarters in New York. We are also assessing our
asset portfolio and anticipate divestitures of certain non-core assets. We anticipate
that the closures, recent senior management changes and potential divestitures will result
in a reduction in annualized general and administrative expenses. We also expect to record
a restructuring reserve during our fiscal 2005 fourth quarter to reflect severance packages,
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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 December 31, 2003 and 2004, we recorded allowances for bad debts,
returns, price protection and other customer promotional programs of approximately $36.3 million
and $31.6 million, respectively. For the nine months ended December 31, 2003 and 2004, we recorded
allowances for bad debts, returns, price protection and other customer promotional programs of
approximately $87.2 million and $72.7 million, respectively. As of March 31, 2004 and December 31,
2004, the aggregate reserves against accounts receivables for bad debts, returns, price protection
and other customer promotional programs were approximately $36.3 million and $37.8 million,
respectively. Inventories We write down our inventories for estimated slow-moving or obsolete inventories equal to the
difference between the cost of inventories and estimated market value based upon assumed market
conditions. If actual market conditions are less favorable than those assumed by management,
additional inventory write-downs may be required. For the three months ended December 31, 2003 and
2004, we recorded obsolescence expense of approximately $0.3 million and $0.6 million,
respectively. For the nine months ended December 31, 2003 and 2004, we recorded obsolescence
expense of approximately $0.9 million and $1.7 million, respectively. As of March 31, 2004 and
December 31, 2004, the aggregate reserve against inventories was approximately $2.1 million in each
period. External developer royalty advances and milestone payments Rapid technological innovation, shelf-space competition, shorter product life cycles and buyer
selectivity have made it difficult to determine the likelihood of individual product
acceptance and success. As a result, we follow the policy of expensing external developer royalty
advances (milestone payments) 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 23




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Licenses Licenses for intellectual property are capitalized as assets upon the execution of the
contract when no significant obligation for performance remains with the third party. If
significant obligations remain, the asset is capitalized when due as opposed to when the contract
is executed. These licenses are amortized at the licensors royalty rate over unit sales.
Management evaluates the carrying value of these capitalized licenses and records an impairment
charge (as research and development expense) in the period management determines that such
capitalized amounts are not expected to be realized. Income taxes As part of the process of preparing our consolidated financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate. This process involves
estimating our current tax exposures in each jurisdiction including the impact, if any, of
additional taxes resulting from tax examinations as well as making judgments regarding the
recoverability of deferred tax assets. To the extent recovery of deferred tax assets is not likely
based on our estimation of future taxable income in each jurisdiction, a valuation allowance is
established. The estimated effective tax rate is adjusted for the tax related to significant
unusual items. Changes in the geographic mix or estimated level of annual pre-tax income can
affect the overall effective tax rate. As of December 31, 2004, we have combined net operating loss carryforwards of approximately
$452.3 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 it is more
likely than not that such asset will not be realized. Management reassesses its position with
regard to the valuation allowance on a quarterly basis. Related party transactions We are involved in numerous related party transactions with IESA and its subsidiaries. These
related party transactions include, but are not limited to, the purchase and sale of product, game
development, 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, as well as the
notes to the financial statements included in this quarterly report. Page 24




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Results of operations Three months ended December 31, 2004 versus the three months ended December 31, 2003 Consolidated Statement of Operations (dollars in thousands): Three
    
    
    
    
    
    
    ThreeMonths
    
    
    % of
    
    
    Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    NetDecember 31,

    
    Revenues

    
    December 31,

    
    Revenues

    
    Increase/2003

    
    2003

    
    2004

    
    2004

    
    (Decrease)Net revenues
    
    $
    190,607
    
    
    
    100.0
    %
    
    $
    161,759
    
    
    
    100.0
    %
    
    $
    (28,848
    )Cost of goods sold
    
    
    93,916
    
    
    
    49.3
    %
    
    
    89,638
    
    
    
    55.4
    %
    
    
    (4,278
    )Gross profit
    
    
    96,691
    
    
    
    50.7
    %
    
    
    72,121
    
    
    
    44.6
    %
    
    
    (24,570
    )Selling and distribution expenses
    
    
    37,339
    
    
    
    19.6
    %
    
    
    20,553
    
    
    
    12.7
    %
    
    
    (16,786
    )General and administrative expenses
    
    
    8,067
    
    
    
    4.2
    %
    
    
    10,155
    
    
    
    6.3
    %
    
    
    2,088Research and development
    
    
    26,928
    
    
    
    14.1
    %
    
    
    18,462
    
    
    
    11.4
    %
    
    
    (8,466
    )Gain on sale of development
project to
a related party
    
    
    (3,744
    )
    
    
    (2.0
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    (3,744
    )Depreciation and amortization
    
    
    2,811
    
    
    
    1.5
    %
    
    
    3,053
    
    
    
    1.9
    %
    
    
    242Operating income
    
    
    25,290
    
    
    
    13.3
    %
    
    
    19,898
    
    
    
    12.3
    %
    
    
    (5,392
    )Interest (expense) income, net
    
    
    (453
    )
    
    
    (0.2
    )%
    
    
    94
    
    
    
    0.1
    %
    
    
    547Other (expense) income
    
    
    (1,737
    )
    
    
    (1.0
    )%
    
    
    (10
    )
    
    
    0.0
    %
    
    
    1,727Income before provision for
income
Taxes
    
    
    23,100
    
    
    
    12.1
    %
    
    
    19,982
    
    
    
    12.4
    %
    
    
    (3,118
    )Provision for income taxes
    
    
    81
    
    
    
    0.0
    %
    
    
    376
    
    
    
    0.3
    %
    
    
    295Net income
    
    $
    23,019
    
    
    
    12.1
    %
    
    $
    19,606
    
    
    
    12.1
    %
    
    $
    (3,413
    )
 Net Revenues Net Revenues by Segment (in thousands): Three MonthsEndedDecember 31,
    
    
    Increase/2003
    
    
    2004
    
    
    (Decrease)Publishing
    
    $
    174,368
    
    
    $
    143,254
    
    
    $
    (31,114
    )Distribution
    
    
    16,239
    
    
    
    18,505
    
    
    
    2,266Total
    
    $
    190,607
    
    
    $
    161,759
    
    
    $
    (28,848
    )
 Net revenues for the three months ended December 31, 2004 decreased approximately $28.8
million or 15.1% from $190.6 million to $161.8 million.  
    The current quarters net revenues were influenced by several events in the marketplace
including the release of premium priced titles by competitors, a shortage of console
hardware in the marketplace, and continued contraction of the childrens segment. New
releases in the current quarter generated net U.S. revenues aggregating approximately $90.8
million and included Dragonball Z: Budokai 3(PlayStation 2), Roller Coaster Tycoon 3(PC),
Godzilla: Save the Earth(PlayStation 2 and Xbox), Atari Anthology(PlayStation 2 and
Xbox), Sid Meiers Pirates!(PC), and Atari Flashback, a plug and play classic game
console.
    Publishing net revenue during the three months ended December 31, 2004 includes
international royalty income of $0.7 million earned on IESAs international sales of our
titles. The 2003 quarters international royalty income of $10.0 million included
royalties earned on Terminator 3and Mission Impossible, while fewer Atari, Inc. titles
were released during the current quarter.
    The overall average unit sales price (ASP) of the publishing business is up 5.6% from
$18.63 to $19.68 due to:  °
    the inclusion of Atari Flashbackunits, which have an average sales price
of approximately $30.00 per unit, Page 25




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##### Table of Contents



°
    an improvement in the ASP of PC titles from $12.41 to $16.49, offset by°
    a decrease in console ASP from $23.09 to $21.54, and°
    a mix shift within the publishing business toward lower priced PC
product. This quarters mix consisted of 59.5% console product, 30.9% PC product,
and 9.6% Atari Flashback product. The prior years comparable quarters mix
consisted of 72.1% console product and 27.9% PC product.  
    Total distribution net revenues for the three months ended December 31, 2004, increased
approximately $2.3 million or 14.0% from the comparable 2003 period on strong sales of
productivity software. Gross Profit Platform mix for the three months ended December 31, 2003 and 2004 is summarized below: Publishing Platform Mix2003
    
    
    2004PlayStation 2
    
    
    40.5
    %
    
    
    38.3
    %PC
    
    
    27.9
    %
    
    
    30.9
    %Game Boy Advance
    
    
    16.5
    %
    
    
    12.2
    %Plug and Play
    
    
    0.0
    %
    
    
    9.6
    %Xbox
    
    
    8.7
    %
    
    
    4.6
    %Game Cube
    
    
    5.1
    %
    
    
    3.7
    %PlayStation
    
    
    1.3
    %
    
    
    0.7
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 Gross profit decreased to $72.1 million for the three months ended December 31, 2004 from
$96.7 million in the comparable 2003 period primarily from decreased sales volume. Gross profit as
a percentage of net revenues decreased from 50.7% for the three months ended December 31, 2003 to
44.6% in the comparable 2004 period. This decrease in margin is due to:  
    a lower mix of international royalty income on which we incur no costs,
    an increased mix of lower margin third party business (11.4% in the current quarter as
compared to 8.5% in the prior years comparable quarter), and
    a higher mix of royalty bearing product in the current period. Royalty expense is 17.9%
of net U.S. revenues in the current quarter compared with 16.0% in the prior years
comparable quarter. Selling and Distribution Expenses Selling and distribution expenses primarily include shipping, personnel, advertising,
promotions and distribution expenses. During the three months ended December 31, 2004, selling and
distribution expenses decreased approximately $16.7 million, or 44.8%, to $20.6 million (12.7% of
net revenues) from $37.3 million (19.6% of net revenues) in the comparable 2003 period due to:  
    significantly decreased advertising spending ($13.5 million in the current period
compared with $28.6 million in the prior years comparable period) due to stricter
rationalization of advertising funds and fewer new titles released, and
    reduced variable distribution costs, including freight, shipping and handling, due to
lower sales. General and Administrative Expenses General and administrative expenses primarily include personnel expenses, facilities costs,
professional expenses and other overhead charges. During the three months ended December 31, 2004,
general and administrative expenses increased approximately $2.1 million, or 25.9%, to $10.2
million from $8.1 million in the comparable 2003 period due to: Page 26




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
    higher professional fees,
    a lower bonus reversal in the current period as compared with the prior period, and
    general salary increases and the inclusion of a fully salaried chief creative officer
and chief executive officer costs. General and administrative expenses increased as a percentage of net revenues from 4.2% in the 2003
quarter to 6.3% in the current quarter. 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, the direct costs of
internally developing and producing a title, and billings from related party developers. These
expenses for the three months ended December 31, 2004 decreased approximately $8.4 million, or
31.2%, to $18.5 million from $26.9 million in the comparable 2003 period due to:  
    a planned reduction in the number of titles in development with external developers, and
    savings over the 2003 quarter due to the closure of the Legend and Minnesota studios
during fiscal 2004, offset partially by
    increased spending for certain projects currently in development at our internal
studios. Internal research and development expenses represent 45.9% of the total R&D expenses for the three
months ended December 31, 2004 and 32.4% of the total R&D expenses for the three months ended
December 31, 2003. As a percentage of net revenues, expenses decreased to 11.4% for the three
months ended December 31, 2004 from 14.1% in the comparable 2003 period. Gain on Sale of Development Project During the third quarter of the prior year, we sold a development project to Atari Interactive
for $3.7 million resulting in a gain of an equal amount. The sales price to Atari Interactive was
equal to the development costs incurred by us, which were expensed during the period of
development. The sale was initiated as a result of concerns expressed by the original third party
licensor relating to our development efforts. No such gain was recorded in the current period. Depreciation and Amortization Depreciation and amortization for three months ended December 31, 2004 increased by $0.3
million, or 10.7%, to $3.1 million from $2.8 million in the comparable 2003 period. This increase
is due to new assets being put into service since the prior years comparable period. Interest (Expense) Income, net Net interest expense decreased by $0.6 million from $0.5 million in the prior years
comparable period to income of $0.1 million for the three months ended December 31, 2004 due to:  
    reduced interest expense on the GECC senior credit facility on lower borrowings for the
current quarter, and
    the inclusion of $0.4 million of interest income on the related party notes receivable
and the Secured Note (see Note 6). Other (Expense) Income In
the prior years comparable period, we recorded a $1.8 million write down of an investment
to reflect the termination of an arrangement to publish certain titles. No significant items have
been recorded in the current period. Page 27




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##### Table of Contents



Provision for Income Taxes Provision for income taxes increased by approximately $0.3 million in the current period to
$0.4 million from $0.1 million in the comparable 2003 period. The current quarters tax provision
consists of provisions for federal and state alternative minimum taxes; no alternative minimum
taxes were recorded in the prior years comparable period since we had expected to be in a
break-even position for the full fiscal 2004 year. Page 28




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Nine months ended December 31, 2004 versus the nine months ended December 31, 2003 Consolidated Statement of Operations (dollars in thousands): Nine
    
    
    
    
    
    
    NineMonths
    
    
    % of
    
    
    Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    NetDecember 31,
    
    
    Revenues

    
    December 31,
    
    
    Revenues

    
    Increase/2003
    
    
    2003

    
    2004
    
    
    2004

    
    (Decrease)Net revenues
    
    $
    402,540
    
    
    
    100.0
    %
    
    $
    343,446
    
    
    
    100.0
    %
    
    $
    (59,094
    )Cost of goods sold
    
    
    202,712
    
    
    
    50.4
    %
    
    
    182,519
    
    
    
    53.1
    %
    
    
    (20,193
    )Gross profit
    
    
    199,828
    
    
    
    49.6
    %
    
    
    160,927
    
    
    
    46.9
    %
    
    
    (38,901
    )Selling and distribution expenses
    
    
    71,270
    
    
    
    17.7
    %
    
    
    53,560
    
    
    
    15.6
    %
    
    
    (17,710
    )General and administrative expenses
    
    
    25,377
    
    
    
    6.2
    %
    
    
    28,311
    
    
    
    8.2
    %
    
    
    2,934Research and development
    
    
    72,734
    
    
    
    18.1
    %
    
    
    54,508
    
    
    
    15.9
    %
    
    
    (18,226
    )Gain on sale of development
project to
a related party
    
    
    (3,744
    )
    
    
    (0.9
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    (3,744
    )Depreciation and amortization
    
    
    6,757
    
    
    
    1.7
    %
    
    
    8,434
    
    
    
    2.5
    %
    
    
    1,677Operating income
    
    
    27,434
    
    
    
    6.8
    %
    
    
    16,114
    
    
    
    4.7
    %
    
    
    (11,320
    )Interest expense, net
    
    
    (7,215
    )
    
    
    (1.8
    )%
    
    
    (608
    )
    
    
    (0.2
    )%
    
    
    (6,607
    )Other (expense) income
    
    
    (2,077
    )
    
    
    (0.5
    )%
    
    
    23
    
    
    
    0.0
    %
    
    
    2,100Income before provision for
income
taxes
    
    
    18,142
    
    
    
    4.5
    %
    
    
    15,529
    
    
    
    4.5
    %
    
    
    (2,613
    )Provision for income taxes
    
    
    63
    
    
    
    0.0
    %
    
    
    758
    
    
    
    0.2
    %
    
    
    695Net income
    
    $
    18,079
    
    
    
    4.5
    %
    
    $
    14,771
    
    
    
    4.3
    %
    
    $
    (3,308
    )Dividend to parent
    
    
    (39,351
    )
    
    
    (9.8
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    (39,351
    )(Loss) income attributable to
common stockholders
    
    $
    (21,272
    )
    
    
    (5.3
    )%
    
    $
    14,771
    
    
    
    4.3
    %
    
    $
    36,043
 Net Revenues Net Revenues by Segment (in thousands): Nine MonthsEndedDecember 31,2003
    
    
    2004
    
    
    (Decrease)Publishing
    
    $
    354,976
    
    
    $
    300,953
    
    
    $
    (54,023
    )Distribution
    
    
    47,564
    
    
    
    42,493
    
    
    
    (5,071
    )Total
    
    $
    402,540
    
    
    $
    343,446
    
    
    $
    (59,094
    )
 Net revenues for the nine months ended December 31, 2004 decreased approximately $59.1
million or 14.7% from $402.5 million to $343.4 million.  
    Our decrease in net sales is largely a function of the current years highly competitive
holiday season and the recent hardware shortage during the industrys key period compounded
by Ataris hugely successful launch in the first quarter of the prior year of Enter the
Matrix.
    New releases in the current quarter as well as the successful launch of DRIV3Rin June
2004 have generated net publishing revenues of $301.0 million for the nine months ended
December 31, 2004. Year-to-date domestic net revenues on DRIV3Rare approximately $38.6
million compared with year-to-date domestic net revenues of Enter the Matrixin the same
period last year of approximately $84.1 million. Other new releases in the current year
included Dragonball Z: Budokai 3(PlayStation 2), Roller Coaster Tycoon 3(PC),
Transformers(PlayStation 2), Duel Masters: Sempai Legends(PlayStation 2 and Game Boy
Advance), Dragonball Z: Buus Fury(Game Boy Advance), Dragon Ball Z: Super Sonic Warriors
(Game Boy Advance), Atari Anthology(PlayStation 2 and Xbox), and Atari Flashback, a plug
and play classic game console.
    Publishing net revenue during the nine months ended December 31, 2004 includes
international royalty income of $17.0 million earned on IESAs international sales of our
titles. These royalties include income of $14.9 million Page 29




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from international sales of DRIV3Ras well as a $0.6 million favorable exchange rate impact
from the weakening US dollar against the euro. The comparable 2003 periods international
royalty income of $27.3 million included $17.6 million earned on international sales of
Enter the Matrix.  
    The overall ASP of the publishing business has increased by a modest 3.1% over the prior
year from $18.99 to $19.58 due to:  °
    the inclusion of Atari Flashbackunits, which have an average sales price
of approximately $30.00 per unit, and°
    an improvement in the ASP of PC titles from $12.43 to $14.23, amid°
    a relatively flat console ASP (approximately $23.00), and°
    a relatively consistent platform mix. The current year to date mix
consisted of 69.6% console product, 25.7% PC product, and 4.7% Atari Flashback
product. The prior years mix consisted of 72.9% console product and 27.1% PC
product.  
    Total distribution net revenues for the nine months ended December 31, 2004 decreased
approximately $5.1 million or 10.7% from $47.6 million the comparable 2003 period to $42.5
million in the current period due to our decision to reduce our third party distribution
operations in the specific instances where margins were insufficient. Gross Profit Platform mix for the nine months ended December 31, 2003 and 2004 is summarized below: Publishing Platform Mix2003
    
    
    2004PlayStation 2
    
    
    36.3
    %
    
    
    40.6
    %PC
    
    
    27.1
    %
    
    
    25.7
    %Game Boy Advance
    
    
    12.7
    %
    
    
    13.3
    %Xbox
    
    
    13.3
    %
    
    
    11.4
    %Plug and Play
    
    
    0.0
    %
    
    
    4.7
    %Game Cube
    
    
    7.5
    %
    
    
    3.2
    %PlayStation
    
    
    2.9
    %
    
    
    1.1
    %Game Boy Color
    
    
    0.2
    %
    
    
    0.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 Gross profit decreased to $160.9 million for the nine months ended December 31, 2004 from
$199.8 million in the comparable 2003 period primarily from decreased sales volume. Gross profit
as a percentage of net revenues decreased from 49.6% in the 2003 period to 46.9% in the current
period, reflecting:  
    higher average unit costs as a percentage of ASPs on the Xbox, Game Boy Advance, and PC
platforms within the publishing business and
    a lower mix of international royalty income on which we incur no costs. Selling and Distribution Expenses Selling and distribution expenses primarily include shipping, personnel, advertising,
promotions and distribution expenses. During the nine months ended December 31, 2004, selling and
distribution expenses decreased approximately $17.7 million, or 24.8%, to $53.6 million (15.6% of
net revenues) from $71.3 million (17.7% of net revenues) in the comparable 2003 period due to:  
    significant savings in the current period on advertising ($33.2 million in the current
period as compared to $47.4 million in the prior period) due to stricter rationalization of
advertising funds and fewer new titles released,
    reduction of bonus expense in the current period versus prior years expense as we do
not expect to meet our financial targets, Page 30




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##### Table of Contents




    lower variable distribution costs, including freight, shipping and handling, on lower sales, and
    savings in salaries and related overhead costs from the closure of the Minnesota studio in fiscal 2004. General and Administrative Expenses General and administrative expenses primarily include personnel expenses, facilities costs,
professional expenses and other overhead charges. During the nine months ended December 31, 2004,
general and administrative expenses increased approximately $2.9 million, or 11.4%, to $28.3
million (8.2% of net revenues) from $25.4 million (6.2% of net revenues) in the comparable 2003
period due to:  
    general salary increases and the inclusion of a fully salaried chief creative officer
and chief executive officer, and
    higher professional fees, offset by
    a reduction of bonus expense in the current period versus prior years expense as we do
not expect to meet our financial targets, and
    the recognition of a $0.9 million translation gain from the liquidation of the dormant
Australian subsidiary in the first quarter of the current year. 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, the direct costs of
internally developing and producing a title, and billings from related party developers. These
expenses for the nine months ended December 31, 2004 decreased approximately $18.2 million, or
25.0%, to $54.5 million from $72.7 million in the comparable 2003 period due to:  
    the planned reduction in the number of titles in development with external developers,
    a reduction of bonus expense in the current period versus prior years expense as we do
not expect to meet our financial targets, and
    savings over the prior years comparable period from the closure of the Legend and
Minnesota studios in fiscal 2004, partially offset by
    increased spending for certain projects currently in development at our internal
studios. Internal research and development expenses represent 49.4% of the total R&D expenses for the nine
months ended December 31, 2004 and 38.5% of the total R&D expenses for the nine months ended
December 31, 2003. Research and development expenses, as a percentage of net revenues, decreased
to 15.9% for the nine months ended December 31, 2004 from 18.1% in the comparable 2003 period. Gain on Sale of Development Project During the third quarter of the prior year, we sold a development project to Atari Interactive
for $3.7 million resulting in a gain of an equal amount. The sales price to Atari Interactive was
equal to the development costs incurred by us, which were expensed during the period of
development. The sale was initiated as a result of concerns expressed by the original third party
licensor relating to our development efforts. No such gain was recorded in the current period. Depreciation and Amortization Depreciation and amortization for nine months ended December 31, 2004 increased by $1.6
million, or 23.5%, to $8.4 million from $6.8 million in the comparable 2003 period due to $1.6
million in amortization expense on our amended license with Atari Interactive for the rights to the
Atari name. The license was amended late in September 2003. Page 31




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Interest Expense, net Interest expense, net, decreased by $6.6 million to $0.6 million for the nine months ended
December 31, 2004 from $7.2 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, and
    interest income of $0.6 million earned on the various related party notes receivable
outstanding during the nine months ended December 31, 2004. Since the recapitalization, interest and financing fees have consisted of expenses incurred under
our credit facility arrangement with GECC. Other (Expense) Income In
the prior years comparable period, we recorded a $1.8 million write down of an investment
to reflect the termination of an arrangement to publish certain titles. No significant items have
been recorded in the current period. Provision for Income Taxes During the nine months ended December 31, 2004, we recorded federal and state alternative
minimum tax provisions, as well as approximately $0.2 million for a potential tax expense at our
dormant UK subsidiary. For the nine months ended December 31, 2003, no alternative minimum taxes
were recorded since we had expected to be in a break-even position for the full fiscal year. Page 32




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Liquidity and Capital Resources The
senior credit facility expires on May 12, 2005 (if not otherwise
extended), and, as currently projected, we will be in breach of our
fourth quarter financial covenants under the senior credit facility.
We plan to secure an equivalent credit arrangement with either GECC
or another lender. We also plan to secure all necessary waivers or
amendments prior to filing of our March 31, 2005, annual report.
Therefore, as of December 31, 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. However, it is expected that
a new generation of video game equipment will be introduced in late 2005 and early 2006. We will
have to invest a substantial sum to make our products compatible with this new generation of
equipment and to generate an inventory of products for the new equipment. Potential sources of
capital to fund these investments, are cash from operations, proceeds from the sale of equity, debt
or assets, and/or new borrowings. Cash Flows (in thousands) March 31,
    
    
    December 31,2004
    
    
    2004Cash
    
    $
    9,621
    
    
    $
    14,710Working Capital
    
    $
    24,914
    
    
    $
    40,662Nine Months Ended
    
    
    Nine Months EndedDecember 31,
    
    
    December 31,2003
    
    
    2004Cash (used in) provided by operating
activities
    
    $
    (5,142
    )
    
    $
    18,893Cash (used in) investing activities
    
    
    (18,408
    )
    
    
    (13,862
    )Cash provided by financing activities
    
    
    31,674
    
    
    
    15Effect of exchange rates on cash
    
    
    101
    
    
    
    43Net increase (decrease) in cash
    
    $
    8,225
    
    
    $
    5,089
 During the nine months ended December 31, 2004, cash of $18.9 million was provided by
operating activities reflecting a seasonal increase in accounts receivable of $41.1 million, offset
by net income of $14.8 million, favorable timing of trade payables, and a reduction in net amounts
due from related parties of $18.8 million largely stemming from the conversion of these trade
receivables to notes. We saw a decrease in cash used for investing activities from $18.4 million in the 2003 period
to $13.9 million in the nine months ended December 31, 2004. The current periods activity
reflects a net increase in notes due from related parties of $12.3 million primarily from the
conversion of certain amounts owed by related parties to interest bearing, term notes. During the nine months ended December 31, 2004, our financing activities were minimal. No
borrowings or letters of credit are outstanding against the GECC senior credit facility at December
31, 2004. Prior years cash inflow is attributable to the $34.9 million proceeds from the
September 2003 secondary offering. We expect continued volatility in the use of cash due to seasonality of the business,
receivable payment cycles and quarterly working capital needs to finance our publishing businesses
and growth objectives. Our outstanding accounts receivable balance varies significantly on a quarterly basis due to
the seasonality of our business and the timing of new product releases. There were no significant
changes in the credit terms with customers during the 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. See Contractual Obligationsbelow for a summary of such commitments. We are also party to certain litigation arising in the course of our business. Management
believes that the ultimate resolution of these matters will not have a material adverse effect on
our liquidity, financial condition or results of operations. Page 33




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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 Liquidity As of the date of this report,
IESA beneficially owns, directly and indirectly, approximately 52% of our stock. IESA has incurred
significant continuing operating losses and is highly leveraged. IESA has taken steps to improve
its financial situation, including, (i) restructuring its outstanding debt obligations such that the
debt amount is reduced and the debt maturity schedule is more favorable, (ii) reducing operating
expenses, (iii) raising capital by selling (through CUSH) 11,000,000 of its shares in Atari, pursuant
to a registration statement, (iv) entering into banking arrangements to fund operations and position
itself for the new hardware cycle, (v) selling assets, such as its rights in the Civilization
franchise, and (vi) entering into production fund agreements to finance certain game development projects.
However, IESA has not yet completed all of the actions it plans to take in order to improve its
operations and reduce its debt. As a result, IESA's current ability to, among other things, fund its
subsidiaries' operations is diminished.  There can be no assurance that IESA will complete such actions
to assure its future financial stability. If IESA is unable to complete its
action plan and address its liquidity problems and fund its working capital needs, IESA would likely be
unable to fund its and its subsidiaries' video game development operations, including that of Atari
Interactive. Pursuant to our GECC senior credit facility, we are prohibited from making advances to
Atari Interactive. Therefore, our results of operations could be materially impaired if IESA fails to
fund Atari Interactive, as any delay or cessation in product development could materially decrease our
revenue from the distribution of Atari Interactive and IESA products. Such a reduction of our revenues,
among other things, could result in a breach of one or more of the covenants contained
in our senior credit facility with GECC. If the above contingencies occurred, we probably would be
forced to take actions that, could include, but would not necessarily be limited to, a
significant reduction in our expenditures for internal and external new product development
and the implementation of a comprehensive cost reduction program to reduce our overhead expenses.
These actions, should they become necessary, could result in a significant reduction in the size of
our operations and could have a material adverse effect on our revenue and cash flows. At present
there can be no assurance regarding any of the foregoing contingencies and management will
continue to monitor these developments closely. IESA distributes our products in Europe,
Asia, and certain other regions, and pays us royalties in this respect. IESA also develops products which
we distribute in the U.S., Canada, and their territories and possessions, and for which we pay
royalties to IESA. Both IESA and Atari Interactive are material sources of products which we
market in the United States and Canada. Atari Interactive is the source of approximately 31%
of our net revenue and we generate approximately 5% of our net
revenue from royalties on IESAs distribution of our products in Europe, Asia, and certain
other regions.  Also, pursuant to the Secured Note payable as of March 31, 2005, as detailed
in Note 6 above, at December 31, 2004, Atari Interactive owes us approximately
$20.8 million (subject to further interest accrual and nettings). As of December 31, 2004,
we have approximately $22.4 million due to IESA and certain of its subsidiaries, which
we may offset against amounts outstanding under the Secured Note. Based on our projections of
amounts payable to Atari Interactive, IESA, and certain of its other subsidiaries,
we anticipate that on March 31, 2005, the Secured Note will be repaid through
the offset of those amounts. Additionally,
though Atari is a separate and independent legal entity and we are not a party to,
or a guarantor of, and have no obligations or liability in respect of, IESAs indebtedness, because
IESA owns the majority of our stock, potential investors and current and potential
business/trade partners may view IESAs financial situation as relevant to an assessment of Atari.
Therefore, if IESA is unable to address its financial issues, it may taint our relationship
with our suppliers and distributors, damage our business reputation, and otherwise
impair our ability to raise and generate capital. IESA continues to focus on ways to
address and improve its financial situation. GECC Senior Credit Facility On November 12, 2002 (last amended January 12, 2005), 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 December 31, 2004, no borrowings or letters of credit
are outstanding Page 34




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under the senior credit facility. As of December 31, 2004, a nominal amount of accrued
interest is included in accrued liabilities and we were in compliance with all financial covenants,
as amended. 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, as well as the renegotiated debt
arrangement with Atari Interactive and Paradigm. As currently projected, we will be in breach of our fourth quarter financial covenants under
the senior credit facility. We plan to secure all necessary waivers or amendments prior to the
filing of our March 31, 2005 annual report. However, no assurance can be given that all necessary
waivers or amendments will be secured in a timely manner, if at all. The
senior credit facility expires on May 12, 2005 (if not otherwise
extended). We plan to secure an equivalent credit
arrangement with either GECC or another lender. However, no assurance can be given that another
facility will be secured in a timely manner, if at all, or on terms acceptable to us. Contractual Obligations As of December 31, 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 ObligationsPayments Due by PeriodWithin 1 Year
    
    
    1-3 Years
    
    
    4-5 Years
    
    
    After 5 Years
    
    
    TotalRoyalty and license advances (1)
    
    $
    3,215
    
    
    $
    88
    
    
    $
    
    
    
    $
    
    
    
    $
    3,303Milestone payments (2)
    
    
    23,256
    
    
    
    5,116
    
    
    
    
    
    
    
    
    
    
    
    28,372Operating lease obligations (3)
    
    
    5,821
    
    
    
    8,585
    
    
    
    1,400
    
    
    
    467
    
    
    
    16,273Capital lease obligations (4)
    
    
    146
    
    
    
    200
    
    
    
    
    
    
    
    
    
    
    
    346Total
    
    $
    32,438
    
    
    $
    13,989
    
    
    $
    1,400
    
    
    $
    467
    
    
    $
    48,294
  (1)
    We have committed to pay advance payments under certain royalty and license
agreements. The payments of these obligations are dependent on the delivery of the
contracted services by the developers.(2)
    Milestone payments represent royalty advances to developers for products that are
currently in development. Although milestone payments are not guaranteed, we expect to
make these payments if all deliverables and milestones are met timely and accurately.(3)
    We account for our 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.(4)
    We entered into several capital leases for computer equipment in the third quarter
of fiscal 2005. We account for capital leases by recording them at the present value of the
total future lease payments. They are amortized using the straight-line method over the
minimum lease term. Page 35




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Item 3. Quantitative and Qualitative Disclosures about Market Risk Our carrying value of cash, trade accounts receivable, accounts payable, accrued liabilities,
royalties payable, 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. We have interest rate risk related to our senior credit facility, which is based on variable interest rates. Foreign Currency Exchange Rates We earn royalties on sales of our product sold internationally. These revenues, which are
based on various foreign currencies and are billed and paid in U.S. dollars, represented $17.0
million of our revenue for the nine months ended December 31, 2004. We also purchase certain of
our inventories from foreign developers and pay royalties primarily denominated in euros to IESA
from the sale of IESA products in North America. While we do not hedge against foreign exchange
rate fluctuations, our business in this regard is subject to certain risks, including, but not
limited to, differing economic conditions, changes in political climate, differing tax structures,
other regulations and restrictions and foreign exchange rate volatility. Our future results could
be materially and adversely impacted by changes in these or other factors. As of December 31, 2004,
foreign subsidiaries represented 0.0% and 0.9% of consolidated net revenues and total assets,
respectively. We also recorded approximately $7.9 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. 
 Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures. As of December 31, 2004, with the participation
of our management, our Chief Executive Officer and 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 Chief Financial Officer concluded that as of December
31, 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 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. 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 December 31, 2004, that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting. However, as required by
Section 404 of the Sarbanes Oxley Act of 2002, we are in the process of evaluating, enhancing the
effectiveness of, and identifying and remediating deficiencies and weaknesses in, our internal
controls and procedures for financial reporting. Page 36




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings During the nine months ended December 31, 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. et al. On September 16, 2002, KBK, a distributor of electronic games via the Internet and local area
networks, filed a lawsuit against Gamesonline, a subsidiary of Interplay, and us in Superior Court
of California, Orange County (the Court). 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 adds
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. We and Atari Interactive prevailed on a Motion for Leave to File a Cross-Complaint against
Interplay and Gamesonline. 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. filed 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 was granted. On or about October 1, 2004, KBKs litigation counsel resigned. On October 8, 2004, we and
Atari Interactive filed an ex parte application to strike KBKs pleadings or, in the alternative,
for an order shortening the time to hear such Page 37




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application as noticed motions. The ex parte application was heard and denied on October 11, 2004
but the Court did grant the application for a shortened period of time to hear such application as
noticed motions. On October 19, 2004, the Court granted our Motion to Strike KBKs Pleadings due to
the fact that KBK has no counsel to represent it in the litigation and did not file any opposition
to the motion. The Court dismissed KBKs complaint without prejudice. The cross-claims have not
been dismissed by the other parties to the litigation. We and Atari Interactive are in discussions
with the other parties with respect to same. Atari, Inc., Atari Interactive, Inc., and Hasbro, Inc. v. Games, Inc., Roger W. Ach, II , and
Chicago West Pullman LLC On May 17, 2004, we and Atari Interactive together with Hasbro filed a complaint against
Games, its CEO, Ach, and Chicago West Pullman in the United States District Court for the Southern
District of New York and sought a temporary restraining order and preliminary injunction to stop
Games and Achs use of certain trademarks and copyrights owned by Atari Interactive and Hasbro.
The plaintiffs allege that an interim license that 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. The plaintiffs further
allege that upon the expiration of the interim license, all intellectual property rights granted
under that license reverted back to us, but that Games nevertheless continued to use the
plaintiffs intellectual property. On May 18, 2004, the Court granted a temporary restraining order
against Games and Ach and scheduled a preliminary injunction hearing for May 28, 2004, which was
postponed until June 11, 2004. Prior to that hearing, Games agreed to the preliminary injunction
and 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 the plaintiffs breached the Agreement and a Settlement Agreement
dated March 31, 2004 by, inter alia, licensing other web sites to use on-line play of certain Atari
and Hasbro games that Games claimed were part of its exclusive license under the Agreement. On June 23, 2004, the Court ordered that the parties attend a case management conference
scheduled for June 29, 2004. At the June 29, 2004, case management conference, Games counsel
raised issues relating to the plaintiffs failure to respond to its discovery requests. The Court
directed that the plaintiffs submit a letter brief setting forth its generic objections to Games
discovery requests. The Court ordered that the plaintiffs letter brief be submitted by July 6,
2004 and that Games submit its reply by July 13, 2004. The Court also scheduled a teleconference
for July 14, 2004. On July 6, 2004, the plaintiffs submitted their letter brief to the Court and
also served Games with its Rule 26(a)(1) initial disclosures and answer to the counterclaim. Games counsel failed to appear for the July 14, 2004, teleconference and it was adjourned to
July 15, 2004. At that teleconference, the Court granted the majority of the plaintiffs motion to
quash Games discovery requests. As a result of the Courts ruling, the plaintiffs do not have to
produce any documents that were created on or before March 31, 2004, any documents relating to
derivative games, or any documents relating to any license agreements with third parties concerning
derivative games, downloads, or streaming. On July 16, 2004, it came to the plaintiffs attention that, in flagrant violation of the
preliminary injunction, Games had issued a press release on July 13, 2004, that erroneously stated
that Games owned the games.com web site and that it had an exclusive license to certain Atari and
Hasbro games. The plaintiffs immediately brought the erroneous press release to the attention of
Games counsel. On that same day, Games replaced the erroneous press release with a corrected press
release, but refused to issue a corrective press release explaining that it in fact did not own
either the web site or have any license to Atari and Hasbro games. On July 19, 2004, the plaintiffs
brought this to the attention of the Court, who ordered that a corrective press release be issued,
but approved language submitted by Games counsel. On September 3, 2004, in a teleconference with the Court, Games requested from the Court that
the plaintiffs be ordered to produce agreements with third parties from the first quarter of 2004
concerning online play of certain Atari and Hasbro games. During that same teleconference, the
plaintiffs sought permission to move to dismiss the counterclaims against Atari Interactive and
Hasbro. On September 8, 2004, the Court broadened the scope of discovery to include documents
regarding contracts and negotiations between us and Hasbro and third parties between January 1,
2004 and Page 38




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March 31, 2004 regarding online play of the original classic versions of the games. The Court also
set a schedule for the plaintiffs motion to dismiss the Counterclaims, which has been fully
submitted and is under judicial deliberation. On October 4, 2004, it came to the plaintiffs attention that, once again, Games was in
flagrant violation of the preliminary injunction because it represented in its Form 10-KSB filing
dated October 1, 2004, that Games owned the domain name games.com and that it had an exclusive
license to certain Hasbro and Atari games. The plaintiffs immediately brought this to the attention
of Games counsel, who represented that certain, but not all, statements would be amended. But
Games did not amend its Form 10-KSB. Accordingly, the plaintiffs sought permission to move for
contempt for violation of the preliminary injunction. On October 14, 2004, in a teleconference with the Court, the Court granted the plaintiffs
request to move for contempt, and ordered that the parties brief that motion on the same schedule
as the briefing schedule for motions for summary judgment. The Court also reset the schedule for
this case. The Court ordered that all discovery be completed by November 12, 2004, that opening
briefs on summary judgment be filed by November 29, 2004, that answering papers be filed on
December 13, 2004, and that reply papers be filed on December 20, 2004. The parties completed
discovery, and the plaintiffs filed their motion for summary judgement and motion for contempt
sanctions, on November 29, 2004. The Court held oral argument on these motions on January 12, 2005
and we await the Courts decision. Atari, Inc., Electronic Arts, Inc. and Vivendi Universal Games, Inc. v. 321 Studios, LLC On June 14, 2004, we, Electronic Arts, and Vivendi filed a lawsuit against 321 Studios, in
U.S. District Court for the Southern District of New York. We, Electronic Arts, and Vivendi 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. We, Electronic Arts,
and Vivendi filed a Preliminary Injunction Motion on July 1, 2004. 321 Studios did not answer the
Complaint and did not respond to the Preliminary Injunction Motion. On December 14, 2004 the case
was settled, with the parties executing a Settlement Agreement and the court entering a Final
Judgment and Permanent Injunction. Pursuant to the settlement, 321 Studios agreed to permanently
cease manufacturing, distributing and selling Games X Copy software. The litigation and settlement
was coordinated by the ESA (the Entertainment Software Association) and the costs associated
therewith were paid by the ESA. American Video Graphics, L.P., v. Electronic Arts, Inc. et al. On August 23, 2004, American Video Graphics, L.P. filed a lawsuit against us, Electronic Arts,
Inc., Take-Two Interactive Software, Inc., Ubi Soft, Activision Inc., THQ, Inc., Vivendi Universal
Games, Inc., Sega of America, Inc., Square Enix, Inc., Tecmo, Inc., Lucasarts, a division of Lucas
Films Entertainment Co., Ltd., and Namco Hometek, Inc. in the United States District Court for the
Eastern District of Texas, Tyler Division (Case No. 6:04 CV-398-LED). We were served with the
Summons and Complaint on September 7, 2004. The complaint alleges infringement of US Patent No.
4,734,690 (method and apparatus for spherical panning) and seeks unspecified damages. We were
served with a First Amended Complaint on or about October 7, 2004, which amended the original
complaint to properly name certain of the other defendants in the suit. We filed our answer to such
complaint on November 8, 2004. Discovery is ongoing. iEntertainment Network,
Inc., v. Epic Games, Inc., Atari, Inc., Valve Corporation, Sierra
Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of America, Sony Computer
Entertainment America, Inc. and Sony Online Entertainment, Inc. On December 22, 2004, we were served with a complaint by iEntertainment, Inc. The complaint
has been filed in the United States District Court of the Eastern District of North Carolina
Western Division (5:04-CV-647-BD(1)) and names the following defendants: us, Epic Games, Inc.,
Valve Corporation, Sierra Entertainment, Inc., Sony Corporation of Japan, Sony Corporation of
America, Sony Computer Entertainment America, Inc. and Sony Online Entertainment, Inc. The
complaint alleges infringement of US Patent No. 6,042,477 (method of and system for minimizing the
effects of time latency in multiplayer electronic games played on interconnected computers) and
seeks unspecified damages. We intend to answer the complaint. Codemasters, Inc. v. Atari, Inc. On January 13, 2005, we were served with a Complaint by Codemasters, Inc. (Codemasters).
The complaint has been filed in New York Supreme Court, County of New York. The causes of action
arise out of contractual disputes regarding payments owed by each party to the other. Codemasters
causes of action include breach of contract, failure to Page 39




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respond to submitted statements of account and unjust enrichment. Codemasters is seeking
relief in the amount of $931,050.09 and such other relief as may be just and proper, including
interests, costs associated with the suit. We intend to answer the complaint. Page 40




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Item 6. Exhibits (a)
    
    Exhibits ++10.1
    
    Obligation Assignment and Security Agreement, dated as of November 3, 2004, by
and among the Company, Infogrames Entertainment, S.A., Atari Interactive, Inc., Atari
Europe S.A.S. and Paradigm Entertainment, Inc.10.2
    
    Secured Promissory Note of Atari Interactive, Inc. in the aggregate amount of
$23,058,997.19 payable to the Company.10.3*
    
    Termination and General Release Agreement, dated October 15, 2004 by and
between the Company and Denis Guyennot.10.4*
    
    Employment Agreement, dated November 26, 2004, by and between the Company and James Caparro.31.1
    
    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
    
    Tenth Amendment to Credit Agreement, dated as of November 3, 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.99.2
    
    Eleventh Amendment to Credit Agreement, dated as of January 12, 2005, 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.99.3
    
    Term Extension to Xbox® Publisher License Agreement, executed November 10,
2004.99.4
    
    Amendment Seven to the Sublicense Agreement between the Company and Funimation
Productions, Ltd., dated as of December 31, 2004.99.5
    
    Consultant Agreement with Ann Kronen, effective as of January 1, 2005
  *
    Exhibit indicated with an * symbol is a management or compensatory plan arrangement filed
pursuant to Item 6(a) of Form 10-Q.  ++
    Certain schedules and exhibits to the documents listed in this index are not being filed
herewith or have not been previously filed because we believe that the information contained
therein is not material. Upon request therefore, we agree to furnish supplementally a copy of
any schedule or exhibit to the Securities and Exchange Commission. Page 41




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##### 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/ Diane Price BakerDiane Price Baker
Executive Vice-President and Chief Financial Officer
(Principal Financial Officer and Duly Authorized Officer)
 Date: February 9, 2005 Page 42




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##### Table of Contents



INDEX TO EXHIBITS++ Exhibit No.
    
    Description10.1
    
    Obligation Assignment and Security Agreement, dated as of November 3, 2004, by and among the
Company, Infogrames Entertainment, S.A., Atari Interactive, Inc., Atari Europe S.A.S. and
Paradigm Entertainment, Inc.10.2
    
    Secured Promissory Note of Atari Interactive, Inc. in the aggregate amount of $23,058,997.19
payable to the Company.10.3*
    
    Termination and General Release Agreement, dated October 15, 2004 by and between the Company
and Denis Guyennot.10.4*
    
    Employment Agreement, dated November 26, 2004, by and between the Company and James Caparro.31.1
    
    Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.99.1
    
    Tenth Amendment to Credit Agreement, dated as of November 3, 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.99.2
    
    Eleventh Amendment to Credit Agreement, dated as of January 12, 2005, 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.99.3
    
    Term Extension to Xbox® Publisher License Agreement, executed November 10, 2004.99.4
    
    Amendment Seven to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated as of December 31, 2004.99.5
    
    Consultant Agreement with Ann Kronen, effective as of January 1, 2005
  *
    Exhibit indicated with an * symbol is a management or compensatory plan arrangement filed
pursuant to Item 6(a) of Form 10-Q.  ++
    Certain schedules and exhibits to the documents listed in this index are not being filed
herewith or have not been previously filed because we believe that the information contained
therein is not material. Upon request therefore, we agree to furnish supplementally a copy of
any schedule or exhibit to the Securities and Exchange Commission. Page 43