##### 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 September 30, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the transition period from ___ to ___


Commission File No. 0-27338 ATARI, INC.
  DELAWARE
    
    13-3689915(State or Other Jurisdiction of 
Incorporation or Organization)
    
    (I.R.S. Employer
Identification No.)
 417 FIFTH AVENUE, NEW YORK, NY 10016
 (212) 726-6500
 þ  o
  o o x
 o þ




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##### 



ATARI, INC. AND SUBSIDIARIES
SEPTEMBER 30, 2007 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
 PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited):Condensed
Consolidated Balance Sheets as of March 31, 2007 and September 30, 2007
    
    
    3Condensed Consolidated Statements of Operations for the Three Months and Six
Months Ended September 30, 2006 and 2007
    
    
    4Condensed Consolidated Statements of Cash Flows for the Six Months Ended
September 30, 2006 and 2007
    
    
    5Condensed Consolidated Statement of Stockholders Equity and Comprehensive Loss
for the Six Months Ended September 30, 2007
    
    
    7Notes to the Condensed Consolidated Financial Statements
    
    
    8Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations
    
    
    25Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    43Item 4T. Controls and Procedures
    
    
    44PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    45Item 4. Submission of Matters to a Vote of Security Holders
    
    
    46Item 5. Other Information
    
    
    47Item 6. Exhibits
    
    
    48Signature
    
    
    49EX-31.1: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32.1: CERTIFICATIONEX-32.2: CERTIFICATION




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 ATARI, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (in thousands, except share data)
 (unaudited)
 March 31,
    
    
    September 30,2007
    
    
    2007ASSETSCurrent assets:Cash
    
    $
    7,603
    
    
    $
    2,718Receivables, net of allowances of $14,148 and $490 at March 31, 2007
and September 30, 2007, respectively
    
    
    6,473
    
    
    
    513Inventories, net (Note 4)
    
    
    8,843
    
    
    
    6,211Due from related parties (Note 6)
    
    
    1,799
    
    
    
    610Prepaid expenses and other current assets (Note 4)
    
    
    10,229
    
    
    
    9,470Assets of discontinued operations (Note 9)
    
    
    645
    
    
    
    395Total current assets
    
    
    35,592
    
    
    
    19,917Property and equipment, net of accumulated depreciation of $30,945 and
$26,052 at
March 31, 2007 and September 30, 2007, respectively
    
    
    4,217
    
    
    
    6,483Security deposits
    
    
    1,940
    
    
    
    1,924Other assets
    
    
    1,070
    
    
    
    966Total assets
    
    $
    42,819
    
    
    $
    29,290LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY)Current liabilities:Accounts payable
    
    $
    11,013
    
    
    $
    10,606Accrued liabilities (Note 4)
    
    
    13,381
    
    
    
    13,916Royalties payable
    
    
    4,282
    
    
    
    6,591Due to related parties (Note 6)
    
    
    5,703
    
    
    
    4,641Total current liabilities
    
    
    34,379
    
    
    
    35,754Due to related parties  long-term (Note 6)
    
    
    1,912
    
    
    
    3,021Long-term deferred rent and related rental obligations
    
    
    3,093
    
    
    
    6,665Other long-term liabilities
    
    
    341
    
    
    
    286Total liabilities
    
    
    39,725
    
    
    
    45,726Commitments and contingencies (Note 7)Stockholders equity (deficiency):Preferred stock, $0.01 par value, 5,000,000 shares authorized, none
issued or
outstanding
    
    
    
    
    
    
    Common stock, $0.10 par value, 30,000,000 shares authorized, 13,477,920
shares issued and outstanding at March 31, 2007 and September 30, 2007
    
    
    1,348
    
    
    
    1,348Additional paid-in capital
    
    
    760,527
    
    
    
    760,653Accumulated deficit
    
    
    (761,299
    )
    
    
    (780,932
    )Accumulated other comprehensive income
    
    
    2,518
    
    
    
    2,495Total stockholders equity (deficiency)
    
    
    3,094
    
    
    
    (16,436
    )Total liabilities and stockholders equity (deficiency)
    
    $
    42,819
    
    
    $
    29,290
  Page 3




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##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (in thousands, except per share data)
 (unaudited)
 Three Months
    
    
    Six MonthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2006
    
    
    2007
    
    
    2006
    
    
    2007Net revenues
    
    $
    28,588
    
    
    $
    13,309
    
    
    $
    48,062
    
    
    $
    23,729Costs, expenses, and income:Cost of goods sold
    
    
    15,251
    
    
    
    6,276
    
    
    
    29,178
    
    
    
    13,042Research and product development
    
    
    7,321
    
    
    
    3,557
    
    
    
    14,467
    
    
    
    7,968Selling and distribution expenses
    
    
    9,317
    
    
    
    5,209
    
    
    
    14,418
    
    
    
    8,760General and administrative expenses
    
    
    5,680
    
    
    
    4,852
    
    
    
    11,115
    
    
    
    10,552Restructuring expenses
    
    
    204
    
    
    
    44
    
    
    
    334
    
    
    
    993Gain on sale of intellectual property
    
    
    
    
    
    
    
    
    
    
    (9,000
    )
    
    
    Gain on sale of development studio assets
    
    
    (885
    )
    
    
    
    
    
    
    (885
    )
    
    
    Atari trademark license expense
    
    
    555
    
    
    
    555
    
    
    
    1,109
    
    
    
    1,109Depreciation and amortization
    
    
    768
    
    
    
    460
    
    
    
    1,662
    
    
    
    875Total costs, expenses, and income
    
    
    38,211
    
    
    
    20,953
    
    
    
    62,398
    
    
    
    43,299Operating loss
    
    
    (9,623
    )
    
    
    (7,644
    )
    
    
    (14,336
    )
    
    
    (19,570
    )Interest (expense) income, net
    
    
    116
    
    
    
    (32
    )
    
    
    233
    
    
    
    (45
    )Other (expense) income
    
    
    15
    
    
    
    (4
    )
    
    
    34
    
    
    
    15(Loss) before (benefit from) income taxes
    
    
    (9,492
    )
    
    
    (7,680
    )
    
    
    (14,069
    )
    
    
    (19,600
    )(Benefit from) income taxes
    
    
    (5,015
    )
    
    
    
    
    
    
    (4,833
    )
    
    
    Loss from continuing operations
    
    
    (4,477
    )
    
    
    (7,680
    )
    
    
    (9,236
    )
    
    
    (19,600
    )(Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    
    4,409
    
    
    
    (11
    )
    
    
    1,873
    
    
    
    (33
    )Net loss
    
    $
    (68
    )
    
    $
    (7,691
    )
    
    $
    (7,363
    )
    
    $
    (19,633
    )Basic and diluted net loss income per share:Loss from continuing operations
    
    $
    (0.33
    )
    
    $
    (0.57
    )
    
    $
    (0.69
    )
    
    $
    (1.45
    )(Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    
    0.33
    
    
    
    0.00
    
    
    
    0.14
    
    
    
    (0.01
    )Net loss
    
    $
    0.00
    
    
    $
    (0.57
    )
    
    $
    (0.55
    )
    
    $
    (1.46
    )Basic weighted average shares outstanding
    
    
    13,477
    
    
    
    13,478
    
    
    
    13,476
    
    
    
    13,478Diluted weighted average shares outstanding
    
    
    13,477
    
    
    
    13,478
    
    
    
    13,476
    
    
    
    13,478
   Page 4




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ATARI, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 (unaudited)
 Six MonthsEndedSeptember 30,2006
    
    
    2007CASH FLOWS FROM OPERATING ACTIVITIES:Net loss
    
    $
    (7,363
    )
    
    $
    (19,633
    )Adjustments to reconcile net loss to net cash used in operating activities:Loss from discontinued operations of Reflections Interactive Ltd., net of tax
    
    
    9,599
    
    
    
    33Gain on sale of Reflections Interactive Ltd.
    
    
    (11,472
    )
    
    
    Adjustment for non-cash gain on sale of Reflections Interactive Ltd.
    
    
    2,400
    
    
    
    Gain on sale of intellectual property
    
    
    (9,000
    )
    
    
    Gain on sale of development studio assets
    
    
    (885
    )
    
    
    Adjustment for non-cash gain on sale of development studio assets
    
    
    200
    
    
    
    Stock-based compensation expense
    
    
    698
    
    
    
    126Non-cash expense/income on cash collateralized security deposit
    
    
    
    
    
    
    14Atari name license expense
    
    
    1,109
    
    
    
    1,109Depreciation and amortization
    
    
    1,662
    
    
    
    875Amortization of deferred financing fees
    
    
    115
    
    
    
    104Accrued interest
    
    
    
    
    
    
    1Gain on sale of property and equipment
    
    
    (74
    )
    
    
    Other miscellaneous adjustments to net loss
    
    
    (38
    )
    
    
    (38
    )Changes in operating assets and liabilities:Receivables, net
    
    
    4,826
    
    
    
    5,958Inventories, net
    
    
    4,024
    
    
    
    2,631Due from related parties
    
    
    2,112
    
    
    
    1,188Due to related parties
    
    
    (5,088
    )
    
    
    (1,061
    )Prepaid expenses and other current assets
    
    
    (634
    )
    
    
    743Accounts payable
    
    
    (7,781
    )
    
    
    (415
    )Accrued liabilities
    
    
    983
    
    
    
    549Royalties payable
    
    
    (10,030
    )
    
    
    2,309Long-term liabilities
    
    
    1,003
    
    
    
    781Other assets
    
    
    386
    
    
    
    15Net cash used in continuing operating activities
    
    
    (23,248
    )
    
    
    (4,711
    )Net cash (used in) provided by discontinued operations
    
    
    (10,907
    )
    
    
    217Net cash used in operating activities
    
    
    (34,155
    )
    
    
    (4,494
    )CASH FLOWS FROM INVESTING ACTIVITIES:Proceeds from sale of intellectual property
    
    
    9,000
    
    
    
    Increase in restricted cash collateralizing letter of credit
    
    
    (1,764
    )
    
    
    Proceeds from sale of development studio assets
    
    
    1,550
    
    
    
    Purchases of acquired intangible assets
    
    
    (350
    )
    
    
    Purchases of property and equipment
    
    
    (455
    )
    
    
    (349
    )Net cash provided by (used in) continuing investing activities
    
    
    7,981
    
    
    
    (349
    )Net cash provided by discontinued operations
    
    
    21,593
    
    
    
    Net cash provided by (used in) investing activities
    
    
    29,574
    
    
    
    (349
    )CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from exercise of stock options
    
    
    8
    
    
    
    Payments under capitalized lease obligation
    
    
    (160
    )
    
    
    (51
    )Net cash used in continuing financing activities
    
    
    (152
    )
    
    
    (51
    )Effect of foreign exchange rates on cash
    
    
    9
    
    
    
    9Net decrease in cash
    
    
    (4,724
    )
    
    
    (4,885
    )Cash  beginning of fiscal period
    
    
    14,948
    
    
    
    7,603Cash  end of fiscal period
    
    $
    10,224
    
    
    $
    2,718
 Page 5




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ATARI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, except share data)
(unaudited)
 Six MonthsEndedSeptember 30,2006
    
    
    2007SUPPLEMENTAL CASH FLOW INFORMATIONCash paid for interest
    
    $
    43
    
    
    $
    55Income tax refunds
    
    $
    
    
    
    $
    Income tax payments
    
    $
    
    
    
    $
    SUPPLEMENTAL DISCLOSURE OF NON-CASH OPERATING, INVESTING, AND FINANCING ACTIVITIESEscrow receivable in connection with sale of Reflections Interactive Ltd.
    
    $
    2,400
    
    
    $
    Escrow receivable in connection with sale of development studio assets
    
    $
    200
    
    
    $
    Additional consideration accrued for purchase of acquired intangible assets
    
    $
    345
    
    
    $
    Consideration accrued for purchase of capitalized licenses
    
    $
    1,887
    
    
    $
    551Receivable from third party for sale of property and equipment
    
    $
    179
    
    
    $
    Capitalization
of leasehold improvements funded by landlord
    
    $
    
    
    
    $
    3,014
  Page 6




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ATARI, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE LOSS
 (in thousands)
 (unaudited)
 AccumulatedCommon
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    OtherStock
    
    
    Common
    
    
    Paid-In
    
    
    Accumulated
    
    
    ComprehensiveShares
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    Income
    
    
    TotalBalance, March 31, 2007
    
    
    13,478
    
    
    $
    1,348
    
    
    $
    760,527
    
    
    $
    (761,299
    )
    
    $
    2,518
    
    
    $
    3,094Comprehensive loss:Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,633
    )
    
    
    
    
    
    
    (19,633
    )Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23
    )
    
    
    (23
    )Total comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (19,656
    )Stock-based compensation expense
    
    
    
    
    
    
    
    
    
    
    126
    
    
    
    
    
    
    
    
    
    
    
    126Balance, September 30, 2007
    
    
    13,478
    
    
    $
    1,348
    
    
    $
    760,653
    
    
    $
    (780,932
    )
    
    $
    2,495
    
    
    $
    (16,436
    )
  Page 7




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




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Basis of Presentation
  Principles of Consolidation
  Reclassifications
  Page 9




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Revenue recognition, sales returns, price protection, other customer related allowances and
allowance for doubtful accounts
    Concentration of Credit Risk
  Use of Estimates
  Fair Values of Financial Instruments
  Long-Lived Assets
  Research and Product Development Expenses
  Page 10




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Licenses
  Atari Trademark License
  Net Loss Per Share
  Recent Accounting Pronouncements
   Page 11




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NOTE 2  STOCK-BASED COMPENSATION
      Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2006
    
    2007
    
    2006
    
    2007Research and product development
    
    $
    70
    
    
    $
    (70
    )
    
    $
    109
    
    
    $
    15Selling and distribution expenses
    
    
    (11
    )
    
    
    (55
    )
    
    
    29
    
    
    
    (26
    )General and administrative expenses
    
    
    298
    
    
    
    46
    
    
    
    560
    
    
    
    137
  Three Months Ended
    
    Six Months EndedSeptember 30,
    
    September 30,2006
    
    2007
    
    2006
    
    2007Expected volatility
    
    
    85
    %
    
    
    68
    %
    
    
    85
    %
    
    
    68
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Expected term
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    4
   Page 12




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WeightedAverageShares
    
    
    Exercise Price(in thousands)Options outstanding at March 31, 2007
    
    
    1,112
    
    
    $
    33.45Granted
    
    
    40
    
    
    
    3.03Forfeited
    
    
    (301
    )
    
    
    11.61Expired
    
    
    (365
    )
    
    
    56.21Options outstanding at September 30,2007
    
    
    486
    
    
    $
    27.43Options exercisable at September 30,2007
    
    
    201
    
    
    $
    56.59
  NOTE 3  CONCENTRATION OF CREDIT RISK
  For the year endedMarch 31,
    
    March 31,2007
    
    2007% of Accounts Receivable
    
    % of Net Revenues (1)Customer 1
    
    
    34
    %
    
    
    19
    %Customer 2
    
    
    20
    %
    
    
    9
    %54
    %
    
    
    28
    %
  For the nine months endedSeptember 30,
    
    September 30,2007
    
    2007% of Accounts Receivable
    
    % of Net Revenues (1)Customer 1
    
    
    29
    %
    
    
    23
    %Customer 2
    
    
    19
    %
    
    
    9
    %Customer 3
    
    
    12
    %
    
    
    6
    %Customer 4
    
    
    11
    %
    
    
    12
    %71
    %
    
    
    50
    %
 
 (1)
    
    Excluding international royalty, licensing, and other income.  Page 13




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NOTE 4  BALANCE SHEET DETAILS
 Inventories
  March 31,
    
    
    September 30,2007
    
    
    2007Finished goods, net
    
    $
    8,226
    
    
    $
    5,699Return inventory, net
    
    
    615
    
    
    
    177Raw materials, net
    
    
    2
    
    
    
    335$
    8,843
    
    
    $
    6,211
 Prepaid Expenses and Other Current Assets
  March 31,
    
    
    September 30,2007
    
    
    2007Licenses short-term
    
    $
    7,054
    
    
    $
    6,478Royalties receivable
    
    
    495
    
    
    
    169Prepayments to manufacturers and other deposits
    
    
    127
    
    
    
    1,389Reflections escrow receivable
    
    
    626
    
    
    
    28Deferred financing fees
    
    
    209
    
    
    
    209Taxes receivable
    
    
    90
    
    
    
    68Prepaid insurance
    
    
    802
    
    
    
    319Other prepaid expenses and current assets
    
    
    826
    
    
    
    810$
    10,229
    
    
    $
    9,470
 Accrued Liabilities
  March 31,
    
    
    September 30,2007
    
    
    2007Accounts receivable credit balances (Note 3)
    
    $
    828
    
    
    $
    4,071Accrued distribution services
    
    
    2,061
    
    
    
    1,905Accrued salary and related costs
    
    
    1,581
    
    
    
    817Accrued professional fees and other services
    
    
    2,578
    
    
    
    1,311Accrued third party development expenses
    
    
    2,660
    
    
    
    1,630Restructuring reserve (Note 10)
    
    
    54
    
    
    
    292Accrued advertising
    
    
    1,222
    
    
    
    736Taxes payable
    
    
    299
    
    
    
    283Accrued freight and handling fees
    
    
    193
    
    
    
    92Deferred income
    
    
    231
    
    
    
    367Other
    
    
    1,674
    
    
    
    2,412$
    13,381
    
    
    $
    13,916
 NOTE 5  INCOME TAXES
  Page 14




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NOTE 6  RELATED PARTY TRANSACTIONS
 Relationship with IESA
   Page 15




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Summary of Related Party Transactions
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedSeptember 30,
    
    

September 30,2006
    
    
    2007
    
    
    2006
    
    
    2007Income (expense)Net revenues
    
    $
    28,588
    
    
    $
    13,309
    
    
    $
    48,062
    
    
    $
    23,729Related party activity:Royalty income (1)
    
    
    1,868
    
    
    
    351
    
    
    
    977
    
    
    
    816License income (1)
    
    
    485
    
    
    
    5,236
    
    
    
    1,499
    
    
    
    6,407Sale of goods
    
    
    188
    
    
    
    89
    
    
    
    390
    
    
    
    233Production and quality and assurance testing
services
    
    
    1,458
    
    
    
    669
    
    
    
    2,290
    
    
    
    1,435Total related party net revenues
    
    
    3,999
    
    
    
    6,345
    
    
    
    5,156
    
    
    
    8,891Cost of goods sold
    
    
    (15,251
    )
    
    
    (6,276
    )
    
    
    (29,178
    )
    
    
    (13,042
    )Related party activity:Distribution fee for Humongous, Inc. product
    
    
    (2,033
    )
    
    
    (1,287
    )
    
    
    (3,245
    )
    
    
    (1,452
    )Royalty expense (2)
    
    
    (335
    )
    
    
    (479
    )
    
    
    (1,712
    )
    
    
    (1,345
    )Total related party cost of goods sold
    
    
    (2,368
    )
    
    
    (1,766
    )
    
    
    (4,957
    )
    
    
    (2,797
    )Research and product development
    
    
    (7,321
    )
    
    
    (3,557
    )
    
    
    (14,467
    )
    
    
    (7,968
    )Related party activity:Development expenses (3)
    
    
    (2,031
    )
    
    
    (216
    )
    
    
    (5,327
    )
    
    
    (216
    )Other miscellaneous development services
    
    
    4
    
    
    
    
    
    
    
    9
    
    
    
    Total related party research and product
development
    
    
    (2,027
    )
    
    
    (216
    )
    
    
    (5,318
    )
    
    
    (216
    )Selling and distribution expenses
    
    
    (9,317
    )
    
    
    (5,209
    )
    
    
    (14,418
    )
    
    
    (8,760
    )Related party activity:Miscellaneous purchase of services
    
    
    (79
    )
    
    
    
    
    
    
    (79
    )
    
    
    Total related party selling and distribution
expenses
    
    
    (79
    )
    
    
    
    
    
    
    (79
    )
    
    
    General and administrative expenses
    
    
    (5,680
    )
    
    
    (4,852
    )
    
    
    (11,115
    )
    
    
    (10,552
    )Related party activity:Management fee revenue
    
    
    740
    
    
    
    750
    
    
    
    1,520
    
    
    
    1,500Management fee expense
    
    
    (750
    )
    
    
    (750
    )
    
    
    (1,500
    )
    
    
    (1,500
    )Office rental and other services (4)
    
    
    46
    
    
    
    51
    
    
    
    92
    
    
    
    101Total related party general and
administrative
expenses
    
    
    36
    
    
    
    51
    
    
    
    112
    
    
    
    101Restructuring expenses
    
    
    (204
    )
    
    
    (44
    )
    
    
    (334
    )
    
    
    (993
    )
 Page 16




---



##### Table of Contents



Three Months
    
    
    Six MonthsEnded
    
    
    EndedSeptember 30,
    
    

September 30,2006
    
    
    2007
    
    
    2006
    
    
    2007Related party activity:Related party rent expense (4)
    
    
    (116
    )
    
    
    
    
    
    
    (233
    )
    
    
    Total related party restructuring expenses
    
    
    (116
    )
    
    
    
    
    
    
    (233
    )
    
    
    (Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    
    4,409
    
    
    
    (11
    )
    
    
    1,873
    
    
    
    (33
    )Related party activity:Royalty income (1)
    
    
    (314
    )
    
    
    
    
    
    
    (706
    )
    
    
    Total related party loss from discontinued
operations
    
    
    (314
    )
    
    
    
    
    
    
    (706
    )
    
    
    
 
 (1)
    
    We have entered into a distribution agreement with IESA and Atari Europe which provides for
IESAs and Atari Europes distribution of our products across Europe, Asia, and certain other
regions pursuant to which IESA, Atari Europe, or any of their subsidiaries, as applicable, will
pay us 30.0% of the gross margin on such products or 130.0% of the royalty rate due to the
developer, whichever is greater. We recognize this amount as royalty income as part of net
revenues, net of returns. Additionally, we earn license income from related parties iFone and
Glu Mobile (see below).(2)
    
    We have also entered into a distribution agreement with IESA and Atari Europe, which
provides for our distribution of IESAs (or any of its subsidiaries) products in the United
States, Canada and Mexico, pursuant to which we will pay IESA either 30.0% of the gross margin
on such products or 130.0% of the royalty rate due to the developer, whichever is greater. We
recognize this amount as royalty expense as part of cost of goods sold, net of returns.(3)
    
    We engage certain related party development studios to provide services such as product
development, design, and testing.(4)
    
    In July 2002, we negotiated a sale-leaseback transaction between Atari Interactive and an
unrelated party.   As part of this transaction, we guaranteed the lease obligation of Atari
Interactive. The lease provides for minimum monthly rental payments of approximately $0.1
million escalating nominally over the ten year term of the lease. During fiscal 2006, when the
Beverly studio (which held the office space for Atari Interactive) was closed, rental payments
were recorded to restructuring expense. We also received indemnification from IESA from costs,
if any, that may be incurred by us as a result of the full guarantee.We received a $1.3 million payment for our efforts in connection with the sale-leaseback
transaction. Approximately $0.6 million, an amount equivalent to a third party brokers
commission, was recognized during fiscal 2003 as other income, while the remaining balance of
$0.7 million was deferred and is being recognized over the life of the sub-lease. Accordingly,
during the six months ended September 30, 2006 and 2007, a nominal amount of income was
recognized in each period. As of September 30, 2007, the remaining balance of approximately
$0.4 million is deferred and is being recognized over the life of the sub-lease. Although the
Beverly studio was closed in fiscal 2006 as part of a restructuring plan (Note 10), the space
was not sublet; the lease expired June 30, 2007.Additionally, we provide management information systems services to Atari Australia for which we
are reimbursed. The charge is calculated as a percentage of our costs, based on usage, which is
agreed upon by the parties.  March 31,
    
    
    September 30,2007
    
    
    2007Due from/(Due to)  currentIESA (1)
    
    $
    (1,494
    )
    
    $
    (749
    )Atari Europe (2)
    
    
    280
    
    
    
    (1,123
    )Eden Studios (3)
    
    
    (595
    )
    
    
    (140
    )Atari Studio Asia (3)
    
    
    (401
    )
    
    
    83Humongous, Inc. (4)
    
    
    (2,218
    )
    
    
    (2,562
    )Atari Interactive (5)
    
    
    (992
    )
    
    
    417Glu Mobile/iFone (6)
    
    
    1,265
    
    
    
    Other miscellaneous net receivables
    
    
    251
    
    
    
    43Net due to related parties  current
    
    
    (3,904
    )
    
    
    (4,031
    )Due from/(Due to)  long-termAtari Interactive (see Atari Licensebelow)
    
    
    (1,912
    )
    
    
    (3,021
    )Net due to related parties
    
    $
    (5,816
    )
    
    $
    (7,052
    )
 Page 17




---



##### Table of Contents



March 31,
    
    
    September 30,2007
    
    
    2007Due from related parties
    
    $
    1,799
    
    
    $
    610Due to related parties
    
    
    (5,703
    )
    
    
    (4,641
    )Net (due to) due from related parties  current
    
    $
    (3,904
    )
    
    $
    (4,031
    )
 
 (1)
    
    Balances comprised primarily of the management fees charged to us by IESA and other
charges of cost incurred on our behalf.(2)
    
    Balances comprised of royalty income or expense from our distribution agreements with
IESA and Atari Europe relating to properties owned or licensed by Atari Europe.(3)
    
    Represents net payables for related party development activities. (Note: Atari
Melbourne House, a related party development studio, was sold to a third party by IESA in
the third quarter of fiscal 2007. Balances due to Atari Melbourne House as of March 31,
2007 were transferred to Atari Studio Asia.)(4)
    
    Represents primarily distribution fees owed to Humongous, Inc., a related party,
related to sale of their product.(5)
    
    Comprised primarily of royalties owed to Atari Interactive, offset by receivables
related to management fee revenue and production and quality and assurance testing services
revenue earned from Atari Interactive.(6)
    
    Balances comprised of license income from our licensing agreements with Glu Mobile,
Inc. (merged with Ifone in 2006) relating to properties in which we own or hold rights to
publish and/or sub-license. Atari Name License
  Sale of Hasbro Licensing Rights
  Related Party Transactions with Employees or Former Employees
 
    
    License Revenue from Glu Mobile
  NOTE 7  COMMITMENTS AND CONTINGENCIES
 Contractual Obligations
 Page 18




---



##### Table of Contents



Contractual ObligationsRoyalty andlicense
    
    
    Milestone
    
    
    Operating lease
    
    
    Capital leaseThrough
    
    advances (1)
    
    
    payments (2)
    
    
    obligations (3)
    
    
    obligations (4)
    
    
    TotalSeptember 30, 2008
    
    $
    5,900
    
    
    $
    1,704
    
    
    $
    2,045
    
    
    $
    33
    
    
    $
    9,682September 30, 2009
    
    
    8
    
    
    
    
    
    
    
    1,851
    
    
    
    
    
    
    
    1,859September 30, 2010
    
    
    2
    
    
    
    
    
    
    
    1,806
    
    
    
    
    
    
    
    1,808September 30, 2011
    
    
    
    
    
    
    
    
    
    
    1,720
    
    
    
    
    
    
    
    1,720September 30, 2012
    
    
    
    
    
    
    
    
    
    
    1,329
    
    
    
    
    
    
    
    1,329Thereafter
    
    
    
    
    
    
    
    
    
    
    12,301
    
    
    
    
    
    
    
    12,301Total
    
    $
    5,910
    
    
    $
    1,704
    
    
    $
    21,052
    
    
    $
    33
    
    
    $
    28,699
 
 (1)
    
    We have committed to pay advance payments under certain royalty and
license agreements. The payments of these obligations are dependent on the delivery
of the contracted services by the developers.(2)
    
    Milestone payments represent royalty advances to developers for products
that are currently in development. Although milestone payments are not guaranteed,
we expect to make these payments if all deliverables and milestones are met timely
and accurately.(3)
    
    We account for our office leases as operating leases, with expiration
dates ranging from fiscal 2008 through fiscal 2022. These are future minimum annual
rental payments required under the leases, including a related party sublease with
Atari Interactive, net of $1.1 million of sublease income to be received in fiscal
2008 and fiscal 2009. Rent expense and sublease income for the three and six months
ended September 30, 2006 and 2007 is as follows (in thousands): Three months ended
    
    Six months endedSeptember 30,
    
    September 30,2006
    
    2007
    
    2006
    
    2007Rent expense
    
    $
    880
    
    
    $
    1,421
    
    
    $
    1,630
    
    
    $
    2,528Sublease income
    
    
    (62
    )
    
    
    (220
    )
    
    
    (178
    )
    
    
    (501
    )
 
    
    Renewal of New York lease
 During June 2006, we entered into a new lease with our current landlord at our New
York headquarters for approximately 70,000 square feet of office space for our
principal offices. The term of this lease commenced on July 1, 2006 and is to expire
on June 30, 2021. Upon entering into the new lease, our prior lease, which was set
to expire in December 2006, was terminated. The rent under the new lease for the
office space was approximately $2.4 million per year for the first five years,
increased to approximately $2.7 million per year for the next five years, and
increased to $2.9 million for the last five years of the term.
In addition, we must pay for electricity, increases in real estate taxes and
increases in porter wage rates over the term. The landlord is providing us with a
one year rent credit of $2.4 million and an allowance of $4.5 million to be used for
building out and furnishing the premises, of which $1.2 million has been recorded as
a deferred credit as of March 31, 2007; the remainder of the deferred credit will be
recorded as the improvements are completed, and will be amortized against rent
expense over the life of the lease. A nominal amount of amortization was recorded
during the year ended March 31, 2007. For the six months ended September 30, 2007,
we recorded an additional  deferred credit of $3.0 million and
amortization against the total deferred credits of
approximately $0.1 million. Shortly after signing the new lease, we provided the
landlord with a security deposit under the new lease in the form of a letter of
credit in the initial amount of $1.7 million, which has been cash collateralized and
is included in security deposits on our condensed consolidated
balance sheet. On August 14, 2007, we and our new landlord, W2007 Fifth Realty, LLC, amended
the lease under which we occupy space in 417 Fifth Avenue, New York City, to
reduce the space we occupy by approximately one-half, effective December 31,
2007. As a result, our rent under the amended lease will be reduced from its
current approximately $2.4 million per year to approximately $1.2 million per
year from January 1, 2008 through June 30, 2011, approximately $1.3 million per
year for the five years thereafter, and approximately $1.5 million per year for
the last five years of the term.(4)
    
    We maintain several capital leases for computer equipment. Per FASB
Statement No. 13, Accounting for Leases, we account for capital leases by
recording them at the present value of the total future lease
 Page 19




---



##### Table of Contents



payments. They are
amortized using the straight-line method over the minimum lease term. As of March
31, 2007, the net book value of the assets, included within property and equipment
on the balance sheet, was $0.1 million, net of accumulated depreciation of $0.5
million. As of September 30, 2007, the net book value of the assets was $0.1
million, net of accumulated depreciation of $0.5 million.
 Litigation
  Bouchat v. Champion Products, et al. (Accolade)
  Ernst & Young, Inc. v. Atari, Inc.
  Research in Motion Limited v. Atari, Inc. and Atari Interactive, Inc.
  NOTE 8  DEBT
 Credit Facilities
 Guggenheim Credit Facility
  Page 20




---



##### Table of Contents



NOTE 9  DISCONTINUED OPERATIONS
 Sale of Reflections
  Driver Driver Driver: Parallel Lines
 Balance Sheets
 Driver
 March 31, 2007
    
    
    September 30, 2007Assets:Prepaid
expenses and other current assets
    
    $
    310
    
    
    $
    47Other non-current assets
    
    
    335
    
    
    
    348Total assets
    
    $
    645
    
    
    $
    395
 Page 21




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##### Table of Contents




    
    Results of Operations
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedSeptember 30,
    
    
    September 30,2006
    
    
    2007
    
    
    2006
    
    
    2007Net revenues
    
    $
    (105
    )
    
    $
    
    
    
    $
    203
    
    
    $
    (Loss) from operations of Reflections
Interactive
Ltd.
    
    
    (7,063
    )
    
    
    (11
    )
    
    
    (9,599
    )
    
    
    (33
    )Gain on sale of Reflections Interactive Ltd.
    
    
    11,472
    
    
    
    
    
    
    
    11,472
    
    
    
    (Loss) income from discontinued operations of
Reflections Interactive Ltd., net of tax
    
    $
    4,409
    
    
    $
    (11
    )
    
    $
    1,873
    
    
    $
    (33
    )
 NOTE 10  RESTRUCTURING
  Three Months Ended
    
    
    Six Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2007
    
    
    2006
    
    
    2007Severance and retention expenses (1)
    
    $
    41
    
    
    $
    19
    
    
    $
    41
    
    
    $
    787Lease related costs (2)
    
    
    160
    
    
    
    25
    
    
    
    273
    
    
    
    206Miscellaneous costs
    
    
    3
    
    
    
    
    
    
    
    20
    
    
    
    Total
    
    $
    204
    
    
    $
    44
    
    
    $
    334
    
    
    $
    993
 
 (1)
    
    In the first quarter of fiscal 2008, management announced a plan to reduce our total
workforce by 20%, primarily in general and administrative functions.(2)
    
    As part of a restructuring plan implemented in fiscal 2005, we recorded the present
value of all future lease payments, less the present value of expected sublease income to
be recorded, primarily for the Beverly and Santa Monica offices, in accordance with FASB
Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities.
Through the remainder of the related leases, FASB Statement No. 146 requires us to record
expense to adjust the present value recorded in 2005 to the actual expense and income
recorded for the month. For the three months ended June 30, 2006, we recorded $0.1 million
for the present value adjustments related to the Beverly and Santa Monica offices. The
Santa Monica lease ended during the second quarter of fiscal 2007; therefore
the expense of $0.2 million for the six months ended September 30, 2006. relates to the
Beverly lease, which ended as of that date.  Balance at
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance atMarch 31, 2007
    
    
    Accrued Amounts
    
    
    Reclasses
    
    
    Cash payments, net
    
    
    September 30, 2007Short termSeverance and retention
    
    $
    
    
    
    $
    787
    
    
    $
    
    
    
    $
    (507
    )
    
    $
    280Lease related costs
    
    
    54
    
    
    
    206
    
    
    
    3
    
    
    
    (251
    )
    
    
    12Total
    
    
    54
    
    
    
    993
    
    
    
    3
    
    
    
    (758
    )
    
    
    292Long termLease related costs
    
    
    3
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    Total
    
    
    3
    
    
    
    
    
    
    
    (3
    )
    
    
    
    
    
    
    Total
    
    $
    57
    
    
    $
    993
    
    
    $
    
    
    
    $
    (758
    )
    
    $
    292
 Page 22




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##### Table of Contents



NOTE 11  SALE OF INTELLECTUAL PROPERTY
 Stuntman
 NOTE 12  OPERATIONS BY REPORTABLE SEGMENTS
      Publishing
    
    Distribution
    
    Corporate
    
    TotalThree months ended September 30, 2006:Net revenues
    
    $
    23,130
    
    
    $
    5,458
    
    
    $
    
    
    
    $
    28,588Operating (loss) income (1)
    
    
    (3,994
    )
    
    
    1,466
    
    
    
    (6,891
    )
    
    
    (9,419
    )Depreciation and amortization
    
    
    (171
    )
    
    
    
    
    
    
    (598
    )
    
    
    (769
    )Interest income, net
    
    
    
    
    
    
    
    
    
    
    116
    
    
    
    116Six months ended September 30, 2006:Net revenues
    
    $
    32,894
    
    
    $
    15,168
    
    
    $
    
    
    
    $
    48,062Operating (loss) income (1)
    
    
    (3,057
    )
    
    
    2,446
    
    
    
    (13,391
    )
    
    
    (14,002
    )Depreciation and amortization
    
    
    (373
    )
    
    
    
    
    
    
    (1,289
    )
    
    
    (1,662
    )Interest income, net
    
    
    
    
    
    
    
    
    
    
    233
    
    
    
    233Three months ended September 30, 2007:Net revenues
    
    $
    11,352
    
    
    $
    1,957
    
    
    $
    
    
    
    $
    13,309Operating (loss) income (1)
    
    
    (1,886
    )
    
    
    49
    
    
    
    (5,763
    )
    
    
    (7,600
    )Depreciation and amortization
    
    
    (77
    )
    
    
    
    
    
    
    (383
    )
    
    
    (460
    )Interest expense, net
    
    
    
    
    
    
    
    
    
    
    (32
    )
    
    
    (32
    )Six months ended September 30, 2007:Net revenues
    
    $
    21,085
    
    
    $
    2,644
    
    
    $
    
    
    
    $
    23,729Operating (loss) income (1)
    
    
    (6,365
    )
    
    
    126
    
    
    
    (12,338
    )
    
    
    (18,577
    )Depreciation and amortization
    
    
    (147
    )
    
    
    
    
    
    
    (728
    )
    
    
    (875
    )Interest expense, net
    
    
    
    
    
    
    
    
    
    
    (45
    )
    
    
    (45
    )
 Page 23




---



##### Table of Contents



(1)
    
    Operating loss for the Corporate segment for the three months ended September 30, 2006
and 2007, excludes restructuring charges of $0.2 million and $0.1 million, respectively,
and for the six months ended September 30, 2006 and 2007 excludes $0.3 million and $1.0
million, respectively. Including restructuring charges, total operating loss for the three
months ended September 30, 2006 and 2007 is $9.6 million
and $7.6 million, respectively,
and for the six months ended September 30, 2006 and 2007 is
$14.3 million and $19.6
million, respectively. NOTE 13  SUBSEQUENT EVENTS
 FUNimation License Agreement
  Restructuring and the License of Intellectual Property
 Test Drive
   Overhead Reduction
   Page 24




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 This document includes statements that may constitute forward-looking statements made pursuant
to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution
readers regarding certain forward-looking statements in this document, press releases, securities
filings, and all other documents and communications. All statements, other than statements of
historical fact, including statements regarding industry prospects and expected future results of
operations or financial position, made in this Quarterly Report on Form 10-Q are forward looking. 
The words believe, expect, anticipate, intend and similar expressions generally identify
forward-looking statements. Forward-looking statements are necessarily based upon a number of
estimates and assumptions that, while considered reasonable by us, are inherently subject to
significant business, economic and competitive uncertainties and contingencies and known and
unknown risks. As a result of such risks, our actual results could differ materially from those
expressed in any forward-looking statements made by, or on behalf of, us.  Some of the factors
which could cause our results to differ materially include the following: the loss of key
customers, such as Wal-Mart, Best Buy, Target, and GameStop; delays in product development and
related product release schedules; inability to secure capital; loss of our credit facility;
inability to adapt to the rapidly changing industry technology, including new console technology;
inability to maintain relationships with leading independent video game software developers;
inability to maintain or acquire licenses to intellectual property; fluctuations in our quarterly
net revenues or results of operations based on the seasonality of our industry; and the termination
or modification of our agreements with hardware manufacturers. Please see the Risk Factors in
our Annual Report on Form 10-K for the year ended March 31, 2007, or in our other filings with the
Securities and Exchange Commission (SEC) for a description of some, but not all, risks,
uncertainties and contingencies. Except as otherwise required by the applicable securities laws,
we disclaim any intention or obligation publicly to update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
 Going Concern
  Driver
     Page 25




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Related party transactions
  Business and Operating Segments
  Page 26




---



##### Table of Contents



Key Challenges
    Page 27




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##### Table of Contents



Critical Accounting Policies
   Revenue recognition, sales returns, price protection, other customer related allowances and
allowance for doubtful accounts
     Inventories
  Research and product development costs
  Page 28




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##### Table of Contents



Licenses
  Atari Trademark License
  Goodwill
    Page 29




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##### Table of Contents



Results of operations
 Three months ended September 30, 2006 versus the three months ended September 30, 2007
 Condensed Consolidated Statements of Operations (dollars in thousands):
 Three
    
    
    
    
    
    
    ThreeMonths
    
    
    % of
    
    
    Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)/September 30,
    
    
    Revenues
    
    
    September 30,
    
    
    Revenues
    
    
    Increase2006
    
    
    
    
    
    
    2007
    
    
    
    
    
    
    $
    
    
    %Net revenues
    
    $
    28,588
    
    
    
    100.0
    %
    
    $
    13,309
    
    
    
    100.0
    %
    
    $
    (15,279
    )
    
    
    (53.4
    )%Costs, expenses, and income:Cost of goods sold
    
    
    15,251
    
    
    
    53.3
    %
    
    
    6,276
    
    
    
    47.2
    %
    
    
    (8,975
    )
    
    
    (58.8
    )%Research and product development
    
    
    7,321
    
    
    
    25.6
    %
    
    
    3,557
    
    
    
    26.7
    %
    
    
    (3,764
    )
    
    
    (51.4
    )%Selling and distribution expenses
    
    
    9,317
    
    
    
    32.7
    %
    
    
    5,209
    
    
    
    39.2
    %
    
    
    (4,108
    )
    
    
    (44.1
    )%General and administrative expenses
    
    
    5,680
    
    
    
    19.9
    %
    
    
    4,852
    
    
    
    36.5
    %
    
    
    (828
    )
    
    
    (14.6
    )%Restructuring expenses
    
    
    204
    
    
    
    0.7
    %
    
    
    44
    
    
    
    0.3
    %
    
    
    (160
    )
    
    
    (78.4
    )%Gain on sale of development studio assets
    
    
    (885
    )
    
    
    (3.1
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    885
    
    
    
    100.0
    %Atari trademark license expense
    
    
    555
    
    
    
    1.9
    %
    
    
    555
    
    
    
    4.2
    %
    
    
    
    
    
    
    0.0
    %Depreciation and amortization
    
    
    768
    
    
    
    2.7
    %
    
    
    460
    
    
    
    3.5
    %
    
    
    (308
    )
    
    
    (40.1
    )%Total costs, expenses, and income
    
    
    38,211
    
    
    
    133.7
    %
    
    
    20,953
    
    
    
    157.5
    %
    
    
    (17,258
    )
    
    
    (45.2
    )%Operating loss
    
    
    (9,623
    )
    
    
    (33.7
    )%
    
    
    (7,644
    )
    
    
    (57.5
    )%
    
    
    1,979
    
    
    
    20.6
    %Interest (expense) income, net
    
    
    116
    
    
    
    0.4
    %
    
    
    (32
    )
    
    
    (0.2
    )%
    
    
    (148
    )
    
    
    (127.6
    )%Other (expense) income
    
    
    15
    
    
    
    0.1
    %
    
    
    (4
    )
    
    
    0.0
    %
    
    
    (19
    )
    
    
    (126.7
    )%Loss before (benefit from) income taxes
    
    
    (9,492
    )
    
    
    (33.2
    )%
    
    
    (7,680
    )
    
    
    (57.7
    )%
    
    
    1,812
    
    
    
    19.1
    %(Benefit from) income taxes
    
    
    (5,015
    )
    
    
    (17.5
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    5,015
    
    
    
    100.0
    %Loss from continuing operations
    
    
    (4,477
    )
    
    
    (15.7
    )%
    
    
    (7,680
    )
    
    
    (57.7
    )%
    
    
    (3,203
    )
    
    
    (71.5
    )%(Loss) income from discontinued operations
of Reflections Interactive Ltd., net of
tax
    
    
    4,409
    
    
    
    15.4
    %
    
    
    (11
    )
    
    
    (0.1
    )%
    
    
    (4,420
    )
    
    
    (100.2
    )%0.0
    %Net loss
    
    $
    (68
    )
    
    
    (0.3
    )%
    
    $
    (7,691
    )
    
    
    (57.8
    )%
    
    $
    (7,623
    )
    
    
    (11210.3
    )%
 Net Revenues
 Net Revenues by Segment (in thousands):
 Three MonthsEndedSeptember 30,2006
    
    
    2007
    
    
    (Decrease)Publishing
    
    $
    23,130
    
    
    $
    11,352
    
    
    $
    (11,778
    )Distribution
    
    
    5,458
    
    
    
    1,957
    
    
    
    (3,501
    )Total
    
    $
    28,588
    
    
    $
    13,309
    
    
    $
    (15,279
    )
 Publishing Sales Platform Mix
 Three MonthsEndedSeptember 30,2006
    
    2007PlayStation 2
    
    
    39.4
    %
    
    
    20.6
    %Xbox 360
    
    
    32.6
    %
    
    
    1.1
    %PC
    
    
    15.6
    %
    
    
    38.2
    %PSP
    
    
    6.3
    %
    
    
    33.6
    %Plug and Play
    
    
    2.5
    %
    
    
    0.0
    %Game Boy Advance
    
    
    2.0
    %
    
    
    0.4
    %Nintendo DS
    
    
    1.4
    %
    
    
    0.9
    %Xbox
    
    
    0.1
    %
    
    
    1.6
    %GameCube
    
    
    0.1
    %
    
    
    0.0
    %Wii
    
    
    0.0
    %
    
    
    3.6
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  Page 30




---



##### Table of Contents




    
    Net publishing product sales during the current quarter were driven
by reorders of catalogue titles, which made up 75.3% of sales. The 2006
three months ended sales were driven by the new release of Test Drive
Unlimited.
    
    International royalty income decreased by $1.5 million as the prior period income
contained international sales of Test Drive Unlimited.
    
    The three months ended September 30, 2007 contains a one-time license payment of $4.0
million related to the sale of Hasbro, Inc. publishing and licensing rights which IESA sold
back to Hasbro in July 2007. We anticipate the sale of these rights will reduce the amount
of immediate license opportunities we have.
    
    The overall average unit sales price (ASP) of the publishing
business has decreased from $19.59 in the prior comparable quarter to
$17.58 in the current period as the current quarters sales consisted
primarily of back catalogue sales.
  Cost of Goods Sold
  
    
    a lower mix of higher cost third-party distributed product sales as a percentage of net
revenues (14.7% in fiscal 2008 compared with 19.0% in fiscal 2007),
offset by
    
    a lower average sales price on our publishing products in the current period driven by
catalogue sales and budget releases versus the inclusion of new release sales for the
newest generation of console platforms in prior period, and
    
    an additional $1.2 million royalty reserve related to the FUNimation dispute.
 Research and Product Development Expenses
  
    
    decreased spending of $2.0 million at our related party development studios due to the
completion of Test Drive Unlimited, which was released in the second quarter of fiscal
2007,
    
    decreased salaries and other overhead of $1.0 million due to the sale of our Shiny
studio in the second quarter of fiscal 2007, as well as additional executive and other
personnel reductions, and
    
    decreased spending of $0.8 million for projects in development with external developers,
as our development efforts have been limited due to cash constraints.
 
 Page 31




---



##### Table of Contents



Selling and Distribution Expenses
  
    
    decreased spend on advertising of $4.3 million as the prior period contained advertising
expense related to release of Test Drive Unlimited, and
    
    savings in salaries and related overhead costs due to reduced headcount resulting from
studio closure and personnel reductions offset by
    
    an additional $1.6 million expense related to minimum
advertising commitment shortfalls to be paid to FUNimation.
 General and Administrative Expenses
  
    
    a reduction in salaries and other overhead costs of $0.5 million due to studio closures
and other personnel reductions.
 Restructuring Expenses
  Gain on Sale of Development Studio Assets
  Depreciation and Amortization
  
    
    savings in depreciation relate to the closure of offices and reduction of staffing and
associated overhead
 (Benefit from) Income Taxes
  Page 32




---



##### Table of Contents



Loss from Discontinued Operations of Reflections Interactive Ltd., net of tax
 Benefit from Income Taxes
 Six months ended September 30, 2006 versus the six months ended September 30, 2007
 Condensed Consolidated Statements of Operations (dollars in thousands):
 Six
    
    
    
    
    
    
    SixMonths
    
    
    % of
    
    
    Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)/September 30,
    
    
    Revenues
    
    
    September 30,
    
    
    Revenues
    
    
    Increase2006
    
    
    
    
    
    
    2007
    
    
    
    
    
    
    $
    
    
    %Net revenues
    
    $
    48,062
    
    
    
    100.0
    %
    
    $
    23,729
    
    
    
    100.0
    %
    
    $
    (24,333
    )
    
    
    (50.6
    )%Costs, expenses, and income:Cost of goods sold
    
    
    29,178
    
    
    
    60.7
    %
    
    
    13,042
    
    
    
    55.0
    %
    
    
    (16,136
    )
    
    
    (55.3
    )%Research and product development
    
    
    14,467
    
    
    
    30.1
    %
    
    
    7,968
    
    
    
    33.6
    %
    
    
    (6,499
    )
    
    
    (44.9
    )%Selling and distribution expenses
    
    
    14,418
    
    
    
    30.0
    %
    
    
    8,760
    
    
    
    36.8
    %
    
    
    (5,658
    )
    
    
    (39.2
    )%General and administrative expenses
    
    
    11,115
    
    
    
    23.1
    %
    
    
    10,552
    
    
    
    44.5
    %
    
    
    (563
    )
    
    
    (5.1
    )%Restructuring expenses
    
    
    334
    
    
    
    0.7
    %
    
    
    993
    
    
    
    4.2
    %
    
    
    659
    
    
    
    197.3
    %Gain on sale of intellectual property
    
    
    (9,000
    )
    
    
    (18.7
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    9,000
    
    
    
    100.0
    %Gain on sale of development studio
assets
    
    
    (885
    )
    
    
    (1.8
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    885
    
    
    
    100.0
    %Atari trademark license expense
    
    
    1,109
    
    
    
    2.3
    %
    
    
    1,109
    
    
    
    4.7
    %
    
    
    
    
    
    
    0.0
    %Depreciation and amortization
    
    
    1,662
    
    
    
    3.5
    %
    
    
    875
    
    
    
    3.7
    %
    
    
    (787
    )
    
    
    (47.4
    )%Total costs, expenses, and income
    
    
    62,398
    
    
    
    129.9
    %
    
    
    43,299
    
    
    
    (182.5
    )%
    
    
    (19,099
    )
    
    
    (30.6
    )%Operating loss
    
    
    (14,336
    )
    
    
    (29.9
    )%
    
    
    (19,570
    )
    
    
    (82.5
    )%
    
    
    (5,234
    )
    
    
    (36.5
    )%Interest (expense) income, net
    
    
    233
    
    
    
    0.5
    %
    
    
    (45
    )
    
    
    (0.2
    )%
    
    
    (278
    )
    
    
    (119.3
    )%Other (expense) income
    
    
    34
    
    
    
    0.1
    %
    
    
    15
    
    
    
    0.1
    %
    
    
    (19
    )
    
    
    (55.9
    )%Loss before (benefit from) income
taxes
    
    
    (14,069
    )
    
    
    (29.3
    )%
    
    
    (19,600
    )
    
    
    (82.6
    )%
    
    
    (5,531
    )
    
    
    (39.3
    )%(Benefit from) income taxes
    
    
    (4,833
    )
    
    
    (10.1
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    4,833
    
    
    
    (100.0
    )%Loss from continuing operations
    
    
    (9,236
    )
    
    
    (19.2
    )%
    
    
    (19,600
    )
    
    
    (82.6
    )%
    
    
    (10,364
    )
    
    
    (112.2
    )%(Loss) income from discontinued
operations of Reflections Interactive
Ltd., net of tax
    
    
    1,873
    
    
    
    3.9
    %
    
    
    (33
    )
    
    
    (0.1
    )%
    
    
    (1,906
    )
    
    
    (101.8
    )%Net loss
    
    $
    (7,363
    )
    
    
    (15.3
    )%
    
    $
    (19,633
    )
    
    
    (82.7
    )%
    
    $
    (12,270
    )
    
    
    (166.6
    )%
 Net Revenues
 Net Revenues by Segment (in thousands):
 Six MonthsEndedSeptember 30,2006
    
    
    2007
    
    
    (Decrease)Publishing
    
    $
    32,894
    
    
    $
    21,085
    
    
    $
    (11,809
    )Distribution
    
    
    15,168
    
    
    
    2,644
    
    
    
    (12,524
    )Total
    
    $
    48,062
    
    
    $
    23,729
    
    
    $
    (24,333
    )
 Publishing Sales Platform Mix
 Six MonthsEndedSeptember 30,2006
    
    2007PlayStation 2
    
    
    32.3
    %
    
    
    16.9
    %PC
    
    
    24.4
    %
    
    
    37.1
    %Xbox 360
    
    
    21.2
    %
    
    
    2.4
    %PSP
    
    
    10.6
    %
    
    
    29.6
    %Game Boy Advance
    
    
    5.7
    %
    
    
    0.3
    %
 Page 33




---



##### Table of Contents



Six MonthsEndedSeptember 30,2006
    
    2007Plug and Play
    
    
    3.5
    %
    
    
    0.0
    %Nintendo DS
    
    
    1.5
    %
    
    
    9.9
    %Xbox
    
    
    0.4
    %
    
    
    0.7
    %GameCube
    
    
    0.4
    %
    
    
    0.0
    %Wii
    
    
    0.0
    %
    
    
    3.1
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
  
    
    Net publishing product sales during the current quarter were driven
by reorders of catalogue titles, which made up 70.6% of sales. Sales
from new releases in the first six months were driven mainly by Dungeon
and Dragons: Tactics(Sony PSP) and Dragon Ball Z: HARUKANARU DENSETSU
(Nintendo DS). The six months ended September 30, 2007 sales are
comprised of the new release of Test Drive Unlimitedand back catalogue
sales.
    
    International royalty income decreased by $0.1 million as the prior period income from
the international release of Test Drive Unlimitedand reductions due to larger than
anticipated returns on international sales of Matrix: Path of Neoand Getting Up: Contents
Under Pressure, released in the third quarter and fourth quarter, respectively, of fiscal
2006.
    
    The six months ended September 30, 2007 contains a one-time license payment of $4.0
million related to the sale of Hasbro, Inc. publishing and licensing rights which IESA sold
back to Hasbro in July 2007. We anticipate the sale of these rights will reduce the amount
of immediate license opportunities we have.
    
    The overall average unit sales price (ASP) of the publishing
business remained consistent from $18.03 in the prior comparable
quarter versus $17.91 in the current period.
  Cost of Goods Sold
  
    
    a lower mix of higher cost third-party distributed product sales as a percentage of net
revenues (11.1% in fiscal 2008 compared with 31.6% in fiscal 2007),
offset by
    
    a lower average sales price on our publishing products in the current period driven by
catalogue sales and budget releases versus the inclusion of new release sales for the
newest generation of console platforms in prior period, and
    
    an additional $1.2 million royalty reserve related to the FUNimation dispute.
 Research and Product Development Expenses
  
    
    decreased spending of $5.2 million at our related party development studios due to the
completion of Test Drive Unlimited, which was released in the second quarter of fiscal
2007, and
 Page 34




---



##### Table of Contents




    
    decreased salaries and other overhead of $2.2 million due to the sale of our Shiny
studio in the second quarter of fiscal 2007, as well as additional executive and other
personnel reductions, offset by
    
    increased spending of $0.9 million for projects in development with external developers,
as we increase our focus on external development.
 Selling and Distribution Expenses
  
    
    decreased spending on advertising of $4.6 million, and
    
    savings in salaries and related overhead costs due to reduced headcount resulting from
studio closure and personnel reductions, offset by
    
    an additional $1.6 million expense related to minimum
advertising commitment shortfalls to be paid to FUNimation.
 General and Administrative Expenses
  
    
    a reduction in salaries and other overhead costs of $0.6 million due to studio closures
and other personnel reductions.
 Restructuring Expenses
  Gain on Sale of Intellectual Property
 Stuntman
 Gain on Sale of Development Studio Assets
  Depreciation and Amortization
  
    
       savings in depreciation relate to the closure of offices and reduction of staffing and
associated overhead
 (Benefit from) Income Taxes




---



##### Table of Contents



Loss from Discontinued Operations of Reflections Interactive Ltd., net of tax
 Benefit from Income Taxes
 Liquidity and Capital Resources
 Overview
    Cash Flows
 (in thousands)
 March 31,
    
    September 30,2007
    
    2007Cash
    
    $
    7,603
    
    
    $
    2,718Working capital
    
    $
    1,213
    
    
    $
    (15,837
    )




---



##### Table of Contents



Six Months EndedSeptember 30,2006
    
    
    2007Cash used in operating activities
    
    $
    (34,155
    )
    
    $
    (4,494
    )Cash provided by (used in) investing activities
    
    
    29,574
    
    
    
    (349
    )Cash used in financing activities
    
    
    (152
    )
    
    
    (51
    )Effect of exchange rates on cash
    
    
    9
    
    
    
    9Net decrease in cash
    
    $
    (4,724
    )
    
    $
    (4,885
    )
   
    
    proceeds of $21.6 million received in connection with the sale of our Reflections
studio,
    
    proceeds of $9.0 million from the sale of the Stuntmanintellectual property,
    
    and proceeds of $1.6 million from the sale of our Shiny studio in the current
period




---



##### Table of Contents



Selected Balance Sheet Accounts
 Receivables, net
  Due from Related Parties/Due to Related Parties
  Long-term liabilities and Property Plant and Equipment
 th
 Credit Facilities
 Guggenheim Credit Facility




---



##### Table of Contents



Contractual Obligations
  Contractual ObligationsRoyalty andlicense
    
    
    Milestone
    
    
    Operating lease
    
    
    Capital leaseThrough
    
    advances (1)
    
    
    payments (2)
    
    
    obligations (3)
    
    
    obligations (4)
    
    
    TotalSeptember 30, 2008
    
    $
    5,900
    
    
    $
    1,704
    
    
    $
    2,045
    
    
    $
    33
    
    
    $
    9,682September 30, 2009
    
    
    8
    
    
    
    
    
    
    
    1,851
    
    
    
    
    
    
    
    1,859September 30, 2010
    
    
    2
    
    
    
    
    
    
    
    1,806
    
    
    
    
    
    
    
    1,808September 30, 2011
    
    
    
    
    
    
    
    
    
    
    1,720
    
    
    
    
    
    
    
    1,720September 30, 2012
    
    
    
    
    
    
    
    
    
    
    1,329
    
    
    
    
    
    
    
    1,329Thereafter
    
    
    
    
    
    
    
    
    
    
    12,301
    
    
    
    
    
    
    
    12,301Total
    
    $
    5,910
    
    
    $
    1,704
    
    
    $
    21,052
    
    
    $
    33
    
    
    $
    28,699
 
 (1)
    
    We have committed to pay advance payments under certain royalty and license
agreements. The payments of these obligations are dependent on the delivery of the
contracted services by the developers.(2)
    
    Milestone payments represent royalty advances to developers for products that
are currently in development. Although milestone payments are not guaranteed, we
expect to make these payments if all deliverables and milestones are met timely and
accurately.(3)
    
    We account for our office leases as operating leases, with expiration dates
ranging from fiscal 2008 through fiscal 2022. There are future minimum annual rental
payments required under the leases, including a related party sublease with Atari
Interactive, net of $1.1 million of sublease income to be received in fiscal 2008 and
fiscal 2009. Leasehold improvements made at the beginning of or during a lease are
amortized over the shorter of the remaining lease term or the estimated useful lives of
the assets.During June 2006, we entered into a new lease with our current landlord at our New York
headquarters for approximately 70,000 square feet of office space for our principal
offices. The term of this lease commenced on July 1, 2006 and is to expire on June 30,
2021. Upon entering into the new lease, our prior lease, which was set to expire in
December 2006, was terminated. The rent under the new lease for
the office space was
approximately $2.4 million per year for the first five years,
increased to approximately
$2.7 million per year for the next five years, and increased to $2.9 million for the last
five years of the term. In addition, we must pay for electricity, increases in real
estate taxes and increases in porter wage rates over the term. The landlord is providing
us with a one year rent credit of $2.4 million and an allowance of $4.5 million to be
used for building out and furnishing the premises, of which $1.2 million has been
recorded as a deferred credit as of March 31, 2007; the remainder of the deferred credit
will be recorded as the improvements are completed, and will be amortized against rent
expense over the life of the lease. A nominal amount of amortization was recorded during
the year ended March 31, 2007. For the six months ended September 30, 2007, we recorded
an additional deferred credit of $3.0 million and amortization
against the total deferred credits of approximately $0.1 million.
Shortly after signing the new




---



##### Table of Contents



lease, we provided the landlord with a security deposit
under the new lease in the form of a letter of credit in the initial amount of $1.7
million, which has been cash collateralized and is included in security deposits on our
condensed consolidated balance sheet at September 30, 2007. On August 14, 2007, we and our new landlord, W2007 Fifth Realty, LLC, amended
the lease under which we occupy space in 417 Fifth Avenue, New York City, to
reduce the space we occupy by approximately one-half, effective December 31,
2007. As a result, our rent under the amended lease will be reduced from its
current approximately $2.4 million per year to approximately $1.2 million per
year from January 1, 2008 through June 30, 2011, approximately $1.3 million per
year for the five years thereafter, and approximately $1.5 million per year for
the last five years of the term.(4)
    
    We maintain several capital leases for computer equipment. Per FASB Statement
No. 13, Accounting for Leases, we account for capital leases by recording them at the
present value of the total future lease payments. They are amortized using the
straight-line method over the minimum lease term. As of March 31, 2007, the net book
value of the assets, included within property and equipment on the balance sheet, was
$0.1 million, net of accumulated depreciation of $0.5 million. As of September 30,
2007, the net book value of the assets was $0.1 million, net of accumulated
depreciation of $0.5 million. Effect of Relationship with IESA on Liquidity
  Recent Accounting Pronouncements
  
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
  Foreign Currency Exchange Rates
  
 Item 4T. Controls and Procedures
 Evaluation of disclosure controls and procedures




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##### Table of Contents



Managements Remediation Initiatives
  Changes in Internal Control over Financial Reporting
  
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 Litigation
  Bouchat v. Champion Products, et al. (Accolade)
  Ernst & Young, Inc. v. Atari, Inc.
  Research in Motion Limited v. Atari, Inc. and Atari Interactive, Inc.




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##### Table of Contents



Item 4. Submission of Matters to a Vote of Security Holders
  Proposal 1.
 CLASS III
    
    For
    
    WithheldEvence-Charles Coppee
    
    
    10,228,120
    
    
    
    751,362Jean-Michel Perbet
    
    
    10,186,036
    
    
    
    793,446
 
 *
    
    With respect to the election of directors, there were no abstentions or broker non-votes
because, pursuant to the terms of the Notice of Annual Meeting and Proxy Statement, proxies
received were voted, unless authority was withheld, in favor of the election of the nominees named.




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##### Table of Contents



Item 6. Exhibits
  31.1
    
    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Acting Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Acting Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




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##### Table of Contents



SIGNATURE
  ATARI, INC.By:
    
    /s/ Curtis G. SolsvigName: Curtis G. Solsvig IIITitle: Chief Restructuring Officer
(duly authorized officer)Date: November 19, 2007By:
    
    /s/ Arturo RodriquezName: Arturo RodriguezTitle: Acting Chief
Financial Officer
(principal financial officer)Date: November 19, 2007
 
 INDEX TO EXHIBITS
 Exhibit No.
    
    Description31.1
    
    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Acting Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Acting Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.