##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K  þ
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2005 OR  o
    TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _________________ Commission File No.: 0-27338 ATARI, INC. (Exact name of registrant as specified in its charter)
 Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
    
    13-3689915
(I.R.S. Employer
Identification No.)
 417 Fifth Avenue, New York, NY 10016
(Address of principal executive offices) Registrants telephone number, including area code: (212) 726-6500 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value 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. Yes
þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of the registrants knowledge,
in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange
Act Rule 12b-2). Yes
þ No o The aggregate market value of the registrants Common Stock held by non-affiliates of the
registrant, based on the $1.57 closing sale price of the Common Stock on September 30, 2004 as
reported on the NASDAQ National Market, was approximately $78.1 million. As of
June 10, 2005, there were 121,297,967 shares of the registrants Common Stock
outstanding. Documents Incorporated by Reference Portions of Registrants definitive proxy statement for its 2005 Annual Meeting of
Stockholders are incorporated by reference into Part III hereof.




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES
MARCH 31, 2005 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS PagePART IITEM 1.
    
    Business
    
    
    2ITEM 2.
    
    Properties
    
    
    21ITEM 3.
    
    Legal Proceedings
    
    
    22ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    25PART IIITEM 5.
    
    Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
    
    
    26ITEM 6.
    
    Selected Financial Data
    
    
    27ITEM 7.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    28ITEM 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    45ITEM 8.
    
    Financial Statements and Supplementary Data
    
    
    46ITEM 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
    
    
    46ITEM 9A.
    
    Controls and Procedures
    
    
    46ITEM 9B.
    
    Other Information
    
    
    48PART IIIITEM 10.
    
    Directors and Executive Officers
    
    
    48ITEM 11.
    
    Executive Compensation
    
    
    48ITEM 12.
    
    Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
    
    
    48ITEM 13.
    
    Certain Relationships and Related Transactions
    
    
    48ITEM 14.
    
    Principal Accountant Fees and Services
    
    
    48PART IVITEM 15.
    
    Exhibits and Financial Statement Schedules
    
    
    49SIGNATURES
    
    
    57CONSOLIDATED FINANCIAL STATEMENTS
    
    
    F-1EXHIBIT INDEXEX-10.20: LOAN AND SECURITY AGREEMENTEX-10.29: DESCRIPTION OF REGISTRANT'S ANNUAL INCENTIVE PLANEX-10.34: LETTER AGREEMENTEX-10.37: FIRST AMENDMENT OF LEASEEX-10.45: LICENSED PUBLISHER AGREEMENTEX-21.1: LIST OF SUBSIDIARIESEX-23.1: CONSENT OF DELOITTE & TOUCHE LLPEX-31.1: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32.1: CERTIFICATIONEX-32.2: CERTIFICATIONEX-99.1: LICENSED PUBLISHER AGREEMENTEX-99.2: AMENDMENT TO THE XBOX PUBLISHER LICENSE AGREEMENTEX-99.3: LICENSE AGREEMENTEX-99.4: LICENSE AGREEMENT




---



##### Table of Contents



This Annual Report contains 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 Report, 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 Annual Report on Form 10-K are forward looking. The words
believe, expect, anticipate, intend and similar expressions generally identify
forward-looking statements. These forward-looking statements are necessarily based upon 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 anticipated by any
forward-looking statements made by, or on behalf of, us. We will not necessarily update
information if any forward-looking statement later turns out to be inaccurate. For a discussion of
factors that could cause our operating results or other matters not to be as anticipated by
forward-looking statements in this document, please see the section entitled Risk Factors on
pages 13 to 21.




---



##### Table of Contents



PART I 
 ITEM 1. BUSINESS OVERVIEW We are a global publisher and developer of video game software for gaming enthusiasts and the
mass-market audience, and a 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, GameCube and DS; Microsoft Xbox; and personal computers, referred to as PCs.
We also publish and sublicense games for the wireless, internet, and other evolving platforms.
Our diverse portfolio of products extends across most major video game genres, including action,
adventure, strategy, role-playing, and driving. Our publishing activities include the management
of business development, strategic alliances, product development, marketing, packaging, and sales
of video game software. Additionally, we distribute the products of third party publishers throughout North America. In order to improve our sales performance, profitability, and competitive position, we have begun to make certain structural, financial and
creative changes. Leading our structural changes has been an almost complete transformation of our
senior management team in order to bring greater focus and establish stricter procedures and
practices throughout all of our operations. We have added senior executives in finance, marketing,
product development, business and legal affairs and corporate communications. Creatively, we have initiated a redirection of the focus of our product portfolio, applying our
resources primarily to those intellectual properties that  based on market trends, consumer base growth, and
emerging technologies  management believes have the greatest potential to deliver the most substantial returns on
investment. We have also implemented more rigorous financial and design controls that better
enable us to deliver quality products to the market on time, on budget, and supported by appropriate
marketing initiatives. Our products are based on intellectual properties that we have either created internally and
own or which have been licensed from third parties. Our portfolio of wholly-owned franchises is
designed for all popular platforms. Examples of our wholly-owned franchises include Driver(more
than 15.0 million units sold in the U.S., including all installments), Stuntman(more than 1.5
million units sold in the U.S., including all installments), and Test Drive(more than 6.0 million
units sold in the U.S., including all installments). Our extensive library of licensed properties, which constitutes an important component of our
product strategy, includes some of the most recognizable names in popular entertainment, a factor which we
believe reduces product risk. A significant number of our licensed properties have come from the
television and motion picture industries, including the following:  
    Warner Bros. Entertainment (The Matrix);
    FUNimation (Dragon Ball Z);
    Viacom / Nickelodeon (Blues Clues); and
    Sony Pictures (Godzilla). In addition to our publishing and development activities, we also distribute video game
software in the United States, Canada and Mexico, handling both our own products and
titles developed by third-party publishers with whom we have contracts. As a distributor
of video game software throughout North America, we maintain what we believe to be state-of-the-art
distribution operations and systems, reaching well in excess of 30,000 retail outlets nationwide.
Additionally, through our relationship with our majority stockholder, Infogrames Entertainment
S.A., or IESA, a French corporation, listed on Euronext, our products are distributed exclusively
by IESA throughout Europe, Asia and other regions. See our risk factor regarding our dependence
upon IESA. Similarly, we exclusively distribute IESAs products in the United States and Canada. Furthermore, we
distribute product in Mexico through various non-exclusive agreements. Through our distribution agreement with IESA, we have the rights to publish and sublicense
certain intellectual properties either owned or licensed by IESA or its subsidiaries, including
Atari Interactive, Inc., or Atari Interactive. Those properties include key franchises such as
RollerCoaster Tycoonand Alone in the Dark, Atari classics such as Asteroids, PONG, Missile Command
and Centipedeand a limited number of Hasbro properties including Dungeons & Dragons. 2




---



##### Table of Contents



For the year ended March 31, 2005, we reported net revenues of $395.2 million and net income
of $5.7 million. During this twelve month period, on the strength of several of our key releases,
particularly DRIV3R,several Dragon Ball Ztitles, and Atari Flashback, we ranked fourth among PC
game publishers and seventh among third-party video game publishers in market share based on video
game software dollar sales, according to data provided by NPD Group, Inc. (NPD), an independent
market research company. Atari, Inc. (formerly known as Infogrames, Inc. and GT Interactive Software Corp.) was
organized as a corporation in Delaware in 1992. In May 2003, we changed our name to Atari, Inc. and changed our
trading symbol on the NASDAQ National Market to ATAR. Our corporate office and U.S. headquarters
is located at 417 Fifth Avenue, New York, New York 10016 (main telephone: (212) 726-6500). We
maintain a worldwide website at www.atari.com. Information
contained on the website is not part of this Annual Report. RECENT DEVELOPMENTS On June 6, 2005, James Caparro resigned his position as our President and Chief Executive
Officer, effective immediately. Our Board of Directors has appointed Bruno Bonnell, our Chairman
and Chief Creative Officer, to act as Chief Executive Officer on an interim basis. Our Board has
instituted an immediate search for a permanent President and Chief
Executive Officer. Our compensation committee is reviewing our and
Mr. Caparros rights, if any, relating to
Mr. Caparros resignation. Effective June 3, 2005, IESA sold back to Hasbro, Inc. certain of its rights under its then existing
license agreement with Hasbro. Specifically, Hasbro reacquired the digital gaming rights for its
properties for $65.0 million. We did not receive any of the
$65.0 million in proceeds. As part of the transaction, IESA and Hasbro have entered into a new
licensing agreement that provides IESA with the rights for ten Hasbro franchises, including
Dungeons and Dragons and Monopoly, at a slightly higher royalty rate and for a shorter period of
time. Our rights under our distribution agreement with IESA to
exploit the Hasbro properties that IESA licenses are not diminished. Recently, we announced transactions which we believe better position us in the interactive
entertainment marketplace. These transactions include an agreement with FUNimation extending the
Dragon Ball Z license on an exclusive basis over a multi-year
period and an exclusive long-term
agreement with Spark Unlimited to develop new intellectual
properties. In addition, we have entered into a
new secured revolving credit facility with HSBC Business Credit (USA) Inc., or HSBC, the
asset-based lending unit of HSBC Bank USA, N.A., which provides up to $50.0 million of credit
availability. INDUSTRY OVERVIEW The video game software industry primarily comprises software for dedicated game consoles or
platforms (such as PlayStation 2, Xbox and GameCube), handhelds (such as Game Boy Advance,
Nintendo DS and Sony PlayStation Portable, or PSP) and PCs. Publishers of video game software
include the console manufacturers, or first-party publishers, and third-party publishers such as
ourselves whose sole role is the development, publishing and distribution of video game software.
Additionally, the use of wireless devices (such as mobile phones and personal digital assistants)
as a gaming platform, known as mobile gaming, is growing rapidly. According to International
Data Group (IDG), an independent technology, media, research, and event company, the combined U.S.
and European video game software and hardware market is expected to be $20.5 billion in 2005.
Additionally, we believe growth in the video game industry will be accelerated by strong expansion
in new geographic regions, as well as the continued adoption and further penetration of the
current generation of gaming consoles into new demographics. The latest PricewaterhouseCoopers
report (Global Entertainment and Media Outlook: 2004-2008) on the video game industry predicts
that the worlds fastest and largest video game growth will come from the Asia/Pacific region, and
that female gamers are becoming an increasingly large demographic. Finally, access to the
expanding geographic regions and a larger demographic is aided by digital distribution channels,
which are being used with increasing frequency within the industry. The Console and Handheld Market Console platforms as they exist today have made significant technological advances since
the introduction of the first generation of modern consoles by Nintendo in 1985. Hardware
manufacturers have historically introduced a new and more technologically advanced gaming console
platform every four to five years. Handhelds have also made advances since their introduction.
However, handhelds have typically experienced longer product cycles. With each new cycle, the
customer base for video game software has expanded as gaming enthusiasts mature and advances in
video game hardware and software technology engage new participants, generating greater numbers of
console units purchased than the prior cycle. The beginning of each cycle is largely dominated by
console sales as consumers upgrade to the next-generation
technology. As the cycle matures, consumers focus shifts to software, resulting in a period of rapid growth for
the video game software industry. 3




---



##### Table of Contents



Sony was the first manufacturer to introduce the current generation of console hardware with
the introduction of the PlayStation 2 platform in 2000. Nintendo introduced its current generation
platforms a year later, launching the GameCube and Game Boy Advance in 2001. This generation also
saw the entrance of Microsoft into the industry with the introduction of the Xbox console.
PlayStation 2s early introduction helped establish it as the leading hardware platform, with a
projected installed base in North America of 33.1 million households in 2005, compared to 11.4
million and 15.4 million households for GameCube and Xbox, respectively, according to IDG. This cycle, in particular, has been defined by an increased rate of change and complexity in
the technological innovations of video game hardware and software. In addition to these
technological innovations, there has been greater competition for shelf space and creative talent
as well as increased buyer selectivity. As a result, the video game industry has become
increasingly hit-driven, which has led to higher per game production budgets, longer and more
complex development processes, and generally shorter product life cycles. The importance of the
timely release of hit titles, as well as the increased scope and complexity of the product
development process, have increased the need for disciplined product development processes that
limit cost and overruns. This in turn has increased the importance of leveraging the technologies,
characters or storylines of existing hit titles into additional video game software franchises in
order to spread development costs among multiple products. The existing first-party publishers have announced their plans to launch the next generation of console game
systems within the next two years. Specifically, Microsoft is expected to launch Xbox 360 for the
2005 holiday season and Sony is expected to launch PlayStation 3 in 2006. Recently, Nintendo
announced that its next generation system, Revolution, will launch in the near future. These
systems will represent a significant advance in gaming technology, with the potential eventually
to reach broader audiences after a console transition period. Innovation also continues in the handheld market with manufacturers offering more
sophisticated units, such as Sonys PSP, that offer multiple features and capabilities in addition
to game play functionality. Personal Computers Advances in personal computer technology outpace advances in console and
handheld technology. Advances in microprocessors, graphics chips, hard-drive capacity, operating
systems and memory capacity have greatly enhanced the ability of the PC to serve as a video game
platform. These technological advances have enabled developers to introduce video games for PCs
with enhanced game play technology and superior graphics. The PC market has typically not been
subject to video game industry cycles and, coupled with the fact that publishers are not required to
pay hardware royalties and high manufacturing costs for PC products, this is an attractive market for video game
publishers. Though retailers have been allocating diminished shelf space to PC products, this
trend may be offset by demand for Massively Multiplayer Online Games, or MMOG. Consolidation We and other publishers have used acquisitions to obtain creative talent as well as
independently developed intellectual properties. We believe economies of scale will be increasingly
important as the complexity and costs associated with video game development continue to increase.
In addition, the acquisition of proven intellectual properties has become increasingly important as
publishers seek to diversify and expand their product portfolio, while limiting exposure to
unsuccessful product development efforts. Acquisitions have also been used as a means of vertically
integrating functions that are key to the business process. Given these facts, coupled with the
fact that financial performance within the industry indicates that the more successful companies
are those that are the most vertically integrated, we expect consolidation within the video game
software industry to continue. CORPORATE RESTRUCTURING Historically, our sales growth and profitability have not been at the same level as our more
successful competitors. During the fourth quarter of fiscal 2005, we announced that, as part of an
overall strategic plan, we would implement financial and restructuring
initiatives with the goal of improving our profitability and competitive position. 4




---



##### Table of Contents



Specifically, we and our
majority stockholder are considering ways to simplify our corporate
structure. Financially, we have begun taking steps to streamline our U.S. operations, including the
closing of our studios in Santa Monica, California and Beverly, Massachusetts. The functions
handled by those studios are being primarily relocated to our New York headquarters. Additionally, we have
assessed our assets and resources and have determined that certain operations are not consistent
with our strategic vision or creative direction. We plan to dispose of those non-core assets. One
such divestiture will be our Humongous Entertainment studio assets and operations, which we
anticipate will occur prior to the end of fiscal 2006. The potential
sale of Humongous Entertainment is also evidence of our creative restructuring
and re-focus of our product portfolio on, among other things, the
action and adventure genre (including driving games) and
products which are best suited to cross-media exploitation and diverse revenue streams.
Creatively, we have also taken steps to expand our development relationships in order to facilitate
the introduction of new franchises and to maximize catalogue properties. RELATIONSHIP WITH IESA As of the date of this report, IESA beneficially owns, directly and indirectly, approximately
52% of our stock. IESA renders management services to us (systems and
administrative support) and through June 30, 2005, we rendered
management services to Atari Interactive, a subsidiary of IESA. Atari Interactive develops
video games, and owns the name Atari and the Atari logo, which we use under a license. IESA
distributes our products in Europe, Asia, and certain other regions, and pays us royalties in this
respect. IESA also develops (through its subsidiaries) products which we distribute in the U.S.,
Canada, and Mexico and for which we pay royalties to IESA. Both IESA and Atari Interactive are
material sources of products which we bring to market in the United States, Canada and Mexico. Atari
Interactive is the source of approximately 38% 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. 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 California U.S.
Holdings, Inc., or 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 Civilizationfranchise and certain of its
rights under its previous license with Hasbro, 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 fund, among other things, its subsidiaries operations is diminished. There can
be no assurance that IESA will complete sufficient 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. 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 revolving credit facility with HSBC. 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. 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 (except that we have guaranteed
the Beverly, MA lease obligation of Atari Interactive)
because IESA owns the majority of our stock, potential 5




---



##### Table of Contents



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,
affect our ability to generate business and enter into agreements on financially favorable terms,
and otherwise impair our ability to raise and generate capital. We
understand that IESA continues to focus on ways to
address and improve its financial situation. PRODUCTS Our core strength has typically been in titles for the action, adventure, strategy, and
driving genres. We have developed a number of successful game franchises based on proven
television and movie franchises, and have created and fostered new internally owned and developed
intellectual properties. We continually seek to expand our product portfolio with proven
intellectual properties and through the creation of sequels and expansions of successful titles. The following table lists our 25 top selling titles (based on dollar sales) during the year
ended March 31, 2005. Title
    
    Platform
    
    Release DateDRIV3R
    
    PS2; Xbox; PC
    
    June 2004Dragon Ball Z: Budokai 3
    
    PS2
    
    November 2004Dragon Ball Z: Sagas
    
    PS2; Xbox; GC
    
    March 2005RollerCoaster Tycoon 3
    
    PC
    
    October 2004Atari Flashback
    
    Retro
    
    October 2004Dragon Ball Z: Budokai 2
    
    PS2; GC
    
    December 2003TRANSFORMERS
    
    PS2
    
    May 2004Duel Masters: Sempai Legends!
    
    GBA; PS2
    
    June 2004Unreal Tournament 2004
    
    PC
    
    March 2004Dragon Ball Z: Buus Fury
    
    GBA
    
    September 2004Sid Meiers Pirates!
    
    PC
    
    November 2004Dragon Ball Z: Super Sonic Warriors
    
    GBA
    
    June 2004Atari Anthology
    
    PS2; Xbox; PC
    
    November 2003Godzilla: Save the Earth
    
    PS2; Xbox
    
    November 2004Yu Yu Hakusho: Dark Tournament
    
    PS2; GBA
    
    September 2004Test Drive: Eve of Destruction
    
    PS2; Xbox
    
    August 2004Enter the Matrix
    
    PS2; Xbox; GC; PC
    
    May 2003Demon Stone
    
    PS2; Xbox; PC
    
    September 2004Shadow Ops: Red Mercury
    
    Xbox; PC
    
    June 2004Act of War: Direct Action
    
    PC
    
    March 2005Neverwinter Nights Platinum
    
    PC
    
    September 2004Backyard Baseball 2005
    
    PS2; PC
    
    March 2004Duel Master 2: Kaijudo Showdown
    
    GBA
    
    November 2004Terminator 3: The Redemption
    
    PS2; Xbox; GC
    
    September 2004Axis & Allies
    
    PC
    
    November 2004
 GBA = Game Boy Advance
GC = GameCube
PS2 = PlayStation 2 For fiscal 2005, we had one title, DRIV3R, published on three different platforms, which
represented approximately 10.6% of our publishing net revenues. 6




---



##### Table of Contents



PUBLISHING Our publishing activities include the management of business development, strategic alliances,
product development, marketing, packaging and sales of video game software for all platforms,
including PlayStation, PlayStation 2, PSP, Nintendo DS, Game Boy, Game Boy
Advance, GameCube, Xbox, PC and the next generation of consoles scheduled to be released by Sony,
Microsoft and Nintendo. During the year ended March 31, 2005, on the strength of several of our
key releases, particularly DRIV3R,several Dragon Ball Ztitles, RollerCoaster Tycoon 3, Unreal
Tournament 2004, and Sid Meiers Pirates!, we ranked fourth among PC game publishers and seventh
among third-party video game publishers in market share based on video game software dollar sales,
according to data provided by NPD. During the year ended March 31, 2005, our publishing operations were located in Santa Monica,
CA and Beverly, MA. Our Santa Monica studio focused on action, adventure, and driving titles, and
published titles that were developed both internally and externally. Key titles published by the
Santa Monica studio during fiscal 2005 included DRIV3R, Demon Stone,and Terminator 3: The
Redemption, among others.Our Beverly studio focused on developing and publishing a range of
products, from interactive entertainment for children and the mass market to strategy and adventure
games for more seasoned gamers. The Beverly studios publishing lineup included those titles
previously published under the Hasbro Interactive label, which was acquired by IESA in 2001 and is
now named Atari Interactive. Key titles published by the Beverly studio during fiscal 2005
included all titles within the Dragon Ball Zand Backyard Sportsfranchises, RollerCoaster Tycoon
3, Sid Meiers Pirates!,and TRANSFORMERS, among others. Recently, we elected to centralize our
publishing operations in our New York headquarters and closed our publishing studios in Santa
Monica, CA and Beverly, MA in order to capitalize on managerial and cost efficiencies. With a lineup that spans from hardcore games through mass market titles, we publish games at
various price points, ranging from value-priced titles to premium-priced products. Pricing is
determined by a variety of factors, including but not limited to: licensed or franchise property;
internal or external development; single or multiple platform development; production costs and
volumes; target audience; and distribution territory. DEVELOPMENT Internal and Related-Party Development We leverage both internal and external resources in the development of our games,
assessing each project independently to determine which development team is best suited to handle
the product based on technical expertise and historical development experience, among other
factors. In addition to our publishing operations described above, we own studios and manage the
development of product at studios owned by IESA that focus solely on game development. Titles from
these locations range in genre and are published for various audiences on the full array of gaming
platforms. Development studios owned by Atari include:  
    ReflectionsNewcastle, EnglandReflections is responsible for the
creation and development of our hit Driverfranchise, which has
sold more than 15 million units worldwide to date, as well as
Stuntman, which was released in June 2002. Reflections is
currently working on the next installment of the Driverfranchise,
scheduled for release in early calendar year 2006.
    Shiny EntertainmentNewport Beach, CaliforniaWe acquired
Shiny in April 2002, along with the rights to develop console and
PC games based on The Matrixfilm trilogy. Shiny developed Enter
the Matrix, which was released simultaneously with The Matrix
Reloaded,the second film in The Matrixtrilogy, in May 2003 and
has sold in excess of 6 million units worldwide to date, and it is
currently working on the next installment of The Matrixfranchise,
The Matrix: Path of Neo,scheduled for release in November 2005.
    Humongous EntertainmentSeattle, WashingtonThe Humongous studio
focuses solely on the development of childrens titles, and the
studio has developed some of the most successful childrens
interactive franchises in the industry. Among its critically and
commercially successful character series of games, its Freddi Fish
and Putt Puttfranchises have to date sold in excess of 2.6 million
units and 2.4 million units, respectively, in the United States,
and its Backyard Sportsfranchise, the leading interactive sports
series for children, has sold more than 7 million units in the
United States to date. As noted above, in fiscal 2006, we plan to
divest of the Humongous Entertainment studio. 7




---



##### Table of Contents



In
addition to the studios we own, we also manage or will manage development of product at several studios
owned by IESA:  
    Paradigm Entertainment, Inc.Dallas,
TexasParadigm Entertainment, Inc., or Paradigm, is the studio
behind the successful Pilot Wingsgame. Most recently, Paradigm
developed Mission Impossible: Operation Surmaand Terminator 3: The
Redemption.
    Eden Studios SASLyon, FranceEden Studios
SAS, or Eden, developed the successful
V-Rallyseries, which, to date, has sold more than 3.8 million
units worldwide. Most recently, Eden developed Kya, which was
released for the holiday 2003 season and is currently developing
Test Drive Unlimitedfor Xbox 360.
    Atari Melbourne House Pty LtdMelbourne, AustraliaAtari Melbourne
House Pty Ltd is the studio behind TRANSFORMERS,released in May 2004.
Previously, the studio had developed Grand Prix Challenge. External Development In addition to developing products ourselves or through IESA wholly-owned subsidiaries,
we publish or have contracts to publish video game software developed by some of the industrys most highly regarded independent
external developers. These developers include, among others:  
    Deep Red (Monopoly Tycoon);  
    Frontier Development  Chris Sawyer (RollerCoaster Tycoonseries);  
    Monster Games (Test Drive: Eve of Destruction);  
    Obsidian (Neverwinter Nights);  
    Quantic Dream (Indigo Prophecy);  
    Spark Unlimited (next generation new intellectual property);  
    Stormfront Studios (Forgotten Realms: Demon Stone);  
    The Collective (Marc Eckos Getting Up: Contents Under Pressure);  
    Webfoot Technologies (Dragon Ball Z: The Legacy of Goku);  
    Zombie Studios (Shadow Ops: Red Mercury); and  
    Eugen Systems (Act of War). Products which are acquired from these external developers are marketed under the Atari name,
as well as the name of the external developer. The agreements with external developers typically
provide us with exclusive publishing and distribution rights for a specific period of time for
specified platforms and territories. The agreements may grant us the right to publish sequels,
enhancements and add-ons to the products originally developed and produced by the external
developer. We pay the external developer a royalty based on sales of its products. A portion of
this royalty may be in the form of advances against future royalties payable at the time of
execution of the development agreement, with additional payments tied to the completion of detailed
performance and development milestones by the developer. We manage external development projects by appointing a producer to oversee each products
development and to work with the external developer to design, develop and test the product. The
producer also helps ensure that development milestones are met in a timely manner. We generally
have the right to suspend or terminate making payments to an external 8




---



##### Table of Contents



developer if the developer
fails to meet its development milestones in a timely fashion. Also, we generally have the option to
terminate these agreements at relatively low costs. SALES AND MARKETING Our sales and marketing programs emphasize a number of key areas:  
    launching new products;  
    increasing demand for our existing franchises;  
    leveraging and strengthening the Atari brand;  
    extending the life of existing products and properties to the greatest degree possible; and  
    exploiting the marketability of our intellectual property and products through licensing
arrangements that expand application into other gaming platforms and consumer product
categories and bring in new revenue streams such as advertising and product placement. To achieve maximum benefit from our sales and marketing programs, we employ a wide range of
marketing techniques, including:  
    product publicity via enthusiast and mass market outlets, including major consumer newspapers and magazines;  
    advertising in video gaming and computer publications;  
    advertising on television and radio;  
    retail marketing and in-store promotions and displays;  
    on-line marketing on the Internet and direct mailings;  
    guerilla or underground marketing techniques, in which marketing materials are placed in locations which are
frequented by the targeted groups of consumers;  
    viral marketing techniques in which consumers pass along our messages to other targeted groups of consumers; and  
    strategic partnerships and cross-promotions with other consumer product companies and third-parties. Our marketing approach uses a brand management system to evaluate and improve our brands based
on analyses of market trends, consumers, competition, core competencies, retail and first-party
partner support, and other key factors. This brand management system is combined with
entertainment marketing approaches and techniques to create consumer and trade anticipation and
demand for our products. We monitor and measure the effectiveness of our marketing strategies throughout the life cycle
of each product. To maximize our marketing efforts, we may begin to deploy an integrated marketing
program for a product more than a year in advance of its release. Historically, we have devoted a
substantial portion of our marketing resources to support our key products and intend to do so in
the future. We believe that integrated marketing strategies for our key products are essential for
other product successes and brand-name loyalty. We believe the Internet is an integral element of our marketing efforts. We use it, in part,
to generate awareness of and buzz about titles months prior to their market debut. We incorporate
the Internet into our marketing programs by creating product-dedicated mini-sites and on-line
promotions. In addition, in the months leading up to the release of a new product, we provide
extensive editorial material to on-line publications that reach the core gaming audience. 9




---



##### Table of Contents



In addition, central to supporting all marketing, promotions and sales efforts for each title
are customized public relations programs designed to create awareness of our products with all
relevant audiences, including core gamers and mass entertainment consumers. These public relations
efforts have resulted in our coverage in key computer and video gaming publications, as well as
major consumer newspapers, magazines and broadcast outlets. In
order to improve efficiency, our sales efforts are handled by a
single internal sales
organization. We currently have two sales regions, one
which encompasses our North American retail sales business, and the
other which encompasses the licensing of our intellectual property and
products. The two regions are comprised of 14 sales/licensing directors who serve as the primary contacts with
our approximately 35 largest retail and licensing customers. INTELLECTUAL PROPERTY Licenses Licensed properties Our strategy includes the creation of games based on licensed properties that have
attained a high level of consumer recognition or acceptance. We have entered into licensing
agreements with a number of licensors, including Warner Bros., Viacom/Nickelodeon, Sony Pictures,
and FUNimation. We pay royalties at variable rates based on our net sales of the corresponding title. We
frequently make advance payments against minimum guaranteed royalties over the license term.
License fees tend to be higher for properties with proven popularity and less perceived risk of
commercial failure. Licenses are of variable duration and may in some instances be renewable upon
payment of minimum royalties or the attainment of specified sales levels. Other licenses are not
renewable upon expiration, and we cannot be sure that we will reach agreement with the licensor to
extend the term of any particular license. Our property licenses usually grant us exclusive use of
the property for the specified titles, on specified platforms, worldwide or within a defined
territory, during the license term. Licensors typically retain the right to exploit the property
for all other purposes and to license other developers with regard to other properties. Hardware licenses We currently develop software for use with PlayStation and PlayStation 2, GameCube, Game
Boy and Game Boy Advance, Xbox and other video game consoles pursuant to licensing agreements with
each of the respective hardware developers. Each license allows us to create one or more products
for the applicable system, subject to certain approval rights, which are reserved by each hardware
licensor. Each license also requires us to pay the hardware licensor a per-unit license fee for the
product produced. The following table sets forth information with respect to our platform licenses: Manufacturer
    
    Platform
    
    Agreement
    
    Territory*
    
    Expiration DateMicrosoft
    
    Xbox
    
    Publisher License
Agreement, dated
April 18, 2000
    
    Determined on a
title-by-title
basis
    
    November 15, 2007Nintendo
    
    Game Boy Advance
    
    License Agreement,
dated September 24,
2001
    
    Western Hemisphere
    
    September 23, 2007Nintendo
    
    GameCube
    
    License Agreement
dated March 29,
2002
    
    Western Hemisphere
    
    March 28, 2005**Sony
    
    PlayStation
    
    Licensed Publisher
Agreement, dated
January 19, 2003
    
    US, Canada, Mexico,
Latin America
    
    January 18, 2007
 10




---



##### Table of Contents



Manufacturer
    
    Platform
    
    Agreement
    
    Territory*
    
    Expiration DateSony
    
    PlayStation 2
    
    Licensed Publisher
Agreement, dated
June 6, 2000
    
    US and Canada
    
    March 31, 2006,
with automatic 1
year renewalsSony
    
    PlayStation Portable
    
    Licensed Publisher
Agreement, dated
March 23, 2005
    
    US and Canada
    
    March 31, 2007,
with automatic 1
year renewals
   *   IESA, our
majority stockholder and the distributor of our products in Europe, has entered into similar
agreements with each of the manufactures for applicable European territories. **   The renewal of this contract is currently being negotiated. In the interim, we are operating in
accordance with the historical terms of the License Agreement. We currently are not required to obtain any license for the publishing of video game software
for PCs. Accordingly, our per-unit manufacturing cost for such software products is less than the
per-unit manufacturing cost for console products. Protection We develop proprietary software titles and have obtained the rights to publish and distribute
software titles developed by third parties. Our products are susceptible to unauthorized copying.
Unauthorized third parties may be able to copy or to reverse engineer our titles to obtain and use
programming or production techniques that we regard as proprietary. In addition, our competitors
could independently develop technologies substantially equivalent or superior to our technologies.
We attempt to protect our software and production techniques under copyright, trademark and trade
secret laws as well as through contractual restrictions on disclosure, copying and distribution.
Although we generally do not hold any patents, we seek to obtain trademark and copyright
registrations for our products. In addition, each manufacturer incorporates security devices in
its platform to prevent unlicensed use. DISTRIBUTION United States, Canada and Mexico Throughout the United States, Canada and Mexico, we distribute our own products, as well
as the products of other publishers, utilizing our distribution operations and systems. We are the
exclusive distributor for the products of IESA (and its subsidiaries, including Atari Interactive)
in the United States and Canada. Furthermore, we distribute product in Mexico through various non-exclusive agreements. Utilizing our point-of-sale replenishment systems and
electronic data interchange links with our largest customers, we are able to efficiently handle
high sales volume and manage and replenish inventory on a store-by-store basis. We also utilize
what we believe to be state-of-the-art systems for our entire supply chain management, including
manufacturing, EDI/order processing, inventory management, purchasing, and tracking of shipments.
We believe these systems accomplish:  
    Efficient and accurate processing of orders and payments;  
    expedited order turnaround time; and  
    prompt delivery. We are one of the largest distributors of video game software to mass merchants in the United
States. Our strength in distribution ensures access to favorable shelf space for our products. We
distribute our products to a variety of outlets, including mass-merchant retailers such as Wal-Mart
and Target; major retailers, such as Best Buy, Circuit City, and Toys R
Us; specialty stores such as Electronics Boutique and GameStop; rental chains such as Blockbuster
and Hollywood Video; and warehouse clubs such as Sams Club and
Costco. Wal-Mart and Target accounted for 25.7% and 12.3%,
respectively, of our net revenues. Additionally, our games are
made available through various on-line retail and e-tail companies (e.g. Amazon.com), and through
the emerging digital distribution/electronic software download marketplace. 11




---



##### Table of Contents



Based on the strength of our distribution operations, we have successfully attracted other
publishers to utilize our distribution capabilities. Other publishers products are generally
acquired by us and distributed under the name of the publisher of such products. Our agreements
with these publishers typically provide for retail distribution rights in designated territories
for a specific period of time, which are typically renewable. Under such agreements, the third
party publisher is typically responsible for the publishing, packaging, marketing and customer
support of such products. Our sales and distribution programs for other publishers products are an
integral part of our overall approach to the marketplace, providing value-added services to both
publishers and retailers alike and an additional source of revenue for us. We outsource our warehouse operations in the United States to Arnold Logistics, which is
located in Lancaster, Pennsylvania. The warehouse operations include the receipt and storage of
inventory as well as the distribution of inventory to mass market and other retailing customers. Europe, Asia and Other Regions IESA distributes our products
 in these regions pursuant to a distribution agreement we entered into
with IESA. We believe that IESAs strong presence in Europe, Asia and certain other regions
provides effective distribution in these regions of our titles while allowing us to focus our
efforts in the United States, Canada and Mexico. IESA distributes our products to several major
retailers in Europe, Asia and certain other regions; these retailers include Auchan, Carrefour,
Mediamarket and Tesco. IESA has extensive access to retail outlets in these regions. See our risk
factor regarding our dependence upon IESA. Under our distribution agreement with IESA, we are
entitled to receive 30.0% of the gross margin of the products distributed by IESA, or 130.0% of the
royalty rate due to the developer or licensor, whichever is greater. Backlog We typically ship products within three days of receipt of orders. As a result, backlog is
not material to our business. MANUFACTURING Disk duplication and the printing of user manuals and packaging materials are performed to our
specifications by outside sources. To date, we have not experienced any material difficulties or
delays in the manufacture and assembly of our products, or material returns due to product defects.
There is some concentration for the supply of our publishing needs, but a number of other outside
vendors are also available as sources for these manufacturing and replication services. Sony, Nintendo and Microsoft control the manufacture of our products that are compatible with
their respective video game consoles, as well as the manuals and packaging for these products, and
ship the finished products to us, either directly or through third party vendors, for distribution.
Sony PlayStation and PlayStation 2, Nintendo GameCube and Microsoft Xbox products consist of
proprietary format CD-ROMs and are typically delivered to us within a relatively short lead time
(approximately 3-4 weeks). Manufacturers of other Nintendo products, which use a cartridge format,
typically deliver these products to us within 45 to 60 days after receipt of a purchase order. To
date, we have not experienced any material difficulties or delays in the manufacture and assembly
of our products. However, manufacturers difficulties, which are beyond our control, could impair
our ability to bring products to the marketplace in a timely manner. EMPLOYEES As of the end of fiscal 2005, we had 400 employees domestically, with 195 in product
development, 82 in administration (i.e., senior management, human resources, legal, IT and
facilities), 52 in finance, 48 in sales and 23 in marketing. During the fiscal year, we had
operations in New York, New York; Beverly, Massachusetts; Seattle, Washington;
Sunnyvale, California; Santa Monica, California; and Newport Beach, California. We also have
operations internationally at our Reflections studio located in Newcastle, England, which has 92
employees. In February 2005, we announced the closing of our operations in Beverly, Massachusetts and
Santa Monica, California. As a result, by August 2005 most of the employees located in those
offices will cease employment with us and we will be re-staffing most
of the functions handled by such departing employees in our New
York headquarters. 12




---



##### Table of Contents



COMPETITION The video game software publishing industry is intensely competitive, and relatively few
products achieve market acceptance. The availability of significant financial resources has become
a major competitive factor in the industry primarily as a result of the increasing development,
acquisition, production and marketing, as well as potential licensing costs, required to publish
quality titles. We compete with other third-party publishers of video game software, including
Electronic Arts, Inc., THQ, Inc., Activision, Inc., Take Two Interactive, Inc., and Midway Games,
Inc., among others. In addition, we compete with first-party publishers such as Sony, Nintendo, and
Microsoft, which in some instances publish their own products in competition with third-party
publishers. Atari
Interactive has granted us a license to use the name
Atari until 2013 for software video games in the United
States, Canada, and Mexico. We believe that the Atari brand, which has a
heritage deeply rooted in innovation and is largely credited with
launching the video game industry, continues to carry a level of
recognition that can provide a
competitive advantage. Unlike many of Ataris competitors, the Atari brand can be seen as three
separate entitiesa pop icon, a classic gaming original and a modern interactive entertainment
company. We believe that no other interactive entertainment company can match this signature of authenticity or
unique ability to sell both lifestyle and product. Ataris opportunities to attract partnerships,
talent and other vehicles which uphold its legendary status are unbounded, providing a distinct
advantage among its competitors. We believe that a number of additional factors provide us with competitive opportunities in
the industry, including our extensive catalogue of multi-platform products, strength in the
mass-market, and strong sales forces in the United States, Canada and Mexico and, through IESA, in
Europe, Asia and other regions. We believe that popular franchises such as Driver, Test Driveand
RollerCoaster Tycoon,along with the catalog of classic Atari
Games, as well as attractive licenses,
such as The Matrix, Dragon Ball Zand Dungeons &
Dragons, provide us with a competitive advantage in the marketing
of our products. SEASONALITY Our business is highly seasonal with sales typically significantly higher during the calendar
year-end holiday season. SEGMENT REPORTING AND GEOGRAPHIC INFORMATION We operate in three reportable segments: publishing, distribution and corporate. Please see
the discussion regarding segment reporting in Note 22 of the Notes to Consolidated Financial
Statements, included in Items 7 and 8 of this Report. Please see Note 22 of the Notes to Consolidated Financial Statements, included in Items 7 and
8 of this Report, for information related to geographic information with respect to our revenues
from external customers and our long-lived assets. RISK FACTORS RISKS RELATED TO OUR BUSINESS Our revenues will decline and our competitive position will be adversely affected if we are unable
to introduce successful new products on a timely basis. Our performance in the video game software publishing business depends on the timely
introduction of successful new products, sequels or enhancements of existing products to replace
declining revenues from older products. Our inability to introduce compelling new products,
sequels or enhancements, or significant delays in their release, could materially and adversely
affect the ultimate success of our products and, in turn, our business, results of operations and
financial condition. Our product development activities over the last fiscal year and in the coming
fiscal year have been and will be less robust than
our historical product development, resulting in fewer product releases. The process of
introducing new products, sequels or product enhancements is extremely complex, time consuming and
expensive, and will become more complex as new platforms and technologies emerge. Competitive
factors in our industry demand that we create increasingly sophisticated products, which in turn
makes it difficult to produce and release compelling products on a predictable schedule. If we
introduce a relatively limited number of products in any period, the failure of such products to
achieve market acceptance could adversely affect our results of operations. 13




---



##### Table of Contents



The loss of Wal-Mart, Target, Best Buy, GameStop, or Electronics Boutique as key customers could
negatively affect our business. Our sales to Wal-Mart, Target, Best Buy, GameStop, and Electronics Boutique accounted for
approximately 25.7%, 12.3%, 9.8%, 7.4%, and 6.5% respectively, of net revenues for the year ended
March 31, 2005. Our gross accounts receivable from these retailers were approximately $15.7
million, $6.9 million, $4.8 million, $6.4 million, and $8.1 million, respectively, as of March 31,
2005. Our business, results of operations and financial condition would be adversely affected if:  
    we lost any of these retailers as a customer;
    any of these retailers purchased significantly fewer products supplied by us;
    we were unable to collect receivables from any of these retailers on a timely basis or at all; or
    we experienced any other adverse change in our relationship with any of these retailers. We cannot assure you that Wal-Mart, Target, Best Buy, GameStop, and Electronics Boutique will
continue to use us as a major supplier of video game software, or at
all. We have
experienced difficulties in collecting on certain accounts. We cannot guarantee that we will not
continue to have such difficulties and while we maintain a reserve
for uncollectible receivables, the reserve may not be sufficient. Our results of operations and competitive position may be adversely affected if we are unable to
anticipate and adapt to rapidly changing technology, including new console technology. The video game software industry is characterized by rapidly changing technology. The
introduction of new technologies, including new console technology, software media formats, and
delivery channels could render our previously released products obsolete or unmarketable. We are
continuing to devote significant development resources to products for PlayStation 2 and Xbox. If
consumer demand for those platforms declines as a result of the next generation of console games
systems, or generally, we may experience lower than expected sales from products designed for those
platforms. We must continually anticipate the emergence of, and adapt our products to, new technologies
and systems. In addition, the development cycle for products designed to operate on new systems has
been defined by an increased rate of change and complexity in the technological innovations of
video game hardware and software. When we choose to publish or develop a product for a new system,
we may need to make a substantial development investment one or two years in advance of when we
actually ship products for that system. If we develop products for a new system that is ultimately
unpopular, our net revenues from that product may be less than expected and we may not be able to
recoup our investment as quickly as anticipated, if at all. Conversely, if we choose not to
publish products for a new system that is ultimately popular, our revenue growth and competitive
position may be adversely affected. We will need to secure
additional capital. We
have in the past generated significant financial losses. In recent
years, our profits have been minimal compared to the profits reported
by our industry competitors. If we generate significant financial
losses in the future, our cash resources and revolving credit
facility may not be adequate to fund our operations. Based on
current assessments, we will need to raise capital in order to
support our product development efforts and other operational needs.
In order to complete the redirection of our product portfolio and to
increase our slate of titles in fiscal 2006 and 2007, we will need to
make a significant investment in product development. This investment
is critical in order to maintain and grow our business, keep current
with changing technology (including new hardware platforms), attract
premier development partners, and secure profitable intellectual
properties. We may raise additional capital in any number of ways,
including through the issuance of debt or equity, or through other
financing. If we borrow funds, we likely will be obligated to make
periodic interest or other debt service payments, and the terms of
this debt may impose burdensome restrictions on our ability to
operate our business. If we seek financing through the sale of equity
securities, our current stockholders may suffer dilution in their
percentage ownership of common stock. Additionally, due to the
relative size of Atari, our majority ownership by a financially
challenged foreign entity and our history of significant losses, we
are not certain as to our ability to raise additional capital in the
future or under what terms capital would be available. If we are
unable to raise capital on terms that are favorable to us, our
business will be negatively affected, which could cause our stock
price to decline. Specifically, if we are not successful in raising
capital, we will have to take various actions that may include, but
not be limited to, a reduction in our expenditures for internal and
external new product development and further reduction in overhead
expenses. These actions, should they become necessary, will probably
result in a significant reduction in our size of operations. Such
capital raising needs are discussed with our majority stockholder
with respect to appropriate timing and structure of such funding. We may be unable to develop and publish new products if we are unable to secure or maintain
relationships with leading independent video game software developers. Although we have substantially increased our internal video game software development
capabilities over the last five years, we are still dependent, to a meaningful degree, upon leading
independent software developers. Consequently, our success depends in part on our continued ability
to obtain or renew product development agreements with leading independent video game software
developers. However, we cannot assure you that we will be able to obtain or renew these product
development agreements on favorable terms, or at all, nor can we assure you that we will be able to
obtain the rights to sequels of successful products which were originally developed for us by
leading independent video game software developers. Many of our competitors have greater financial
resources and access to capital than we do, which puts us at a competitive disadvantage when
bidding to attract leading independent video game software developers to enter into publishing
agreements with us. We may be unable to secure or maintain relationships with leading independent
video game software developers if our competitors can offer them better shelf access, better
marketing support, more development funding, higher royalty rates, or other advantages. Usually,
our agreements with independent software developers are easily terminable, often without notice, if
either party declares bankruptcy, becomes insolvent, ceases operations or materially
breaches its agreement and fails to cure that breach within a designated time frame. In addition,
many leading independent video game software developers have limited financial resources. Many are
small companies with a few key individuals without whom a project may be difficult or impossible to
complete. Consequently, we are exposed to the risk that these developers will go out of business
before completing a project, or simply cease work on a project for which we have hired them. 14




---



##### Table of Contents



Fluctuations in our quarterly net revenues and results of operations may lead to reduced prices for
our stock. Our quarterly net revenues and results of operations have varied in the past and can be
expected to vary in the future. Our business experiences substantial seasonality, and typically,
our net revenue is significantly higher during our third fiscal quarter (which ends on December 31)
than during our other quarters because of increased consumer demand during the calendar year-end
holiday season. Other factors that cause fluctuations include:  
    the number of new titles released;
    the timing of our release of new titles;
    the popularity of new titles and titles released in prior periods;
    changes in the mix of titles with varying profit margins;
    the timing of customer orders; and
    fluctuations in the size and rate of growth of consumer demand for titles for different platforms. In
other particular fiscal quarters, our net revenues may be lower and
may vary significantly. As
a result, we cannot assure you that our results of operations will be consistent on a quarterly or
annual basis. If our results of operations in a quarter fall below
our expectations and/or fall below the
expectations of market analysts or investors, the price of our common stock will likely decrease. If we are unable to maintain or acquire licenses to intellectual property, our operating results
will be adversely impacted. Many of our products are based on or incorporate intellectual property owned by others.
For example, some of our titles are based on key film licenses. We expect that many of the
products we publish in the future will also be based on intellectual property owned by others. The
rights we enjoy to licensed intellectual property may vary based on the agreement we have with the
licensor. Competition for these licenses is intense and many of our competitors have greater
resources to take advantage of opportunities for such licenses. If we are unable to maintain our current
licenses and obtain additional licenses with significant commercial value, we believe our sales
will decline. In addition, obtaining licenses for popular franchises owned by others could require
us to expend significant resources and the licenses may require us to pay relatively high royalty
rates. If these titles are ultimately unpopular, we may not recoup our investment made to obtain
such licenses. Furthermore, in many instances we do not have exclusive licenses for intellectual
property owned by others. In these cases, we may face direct competition from other publishers
holding a similar license. Additionally, many of the products we
distribute are products that are published by IESA or its
subsidiaries, such as certain Hasbro games. Recently, IESA has sold
off properties that we historically distributed, such as
Civilization and Sid Meiers Pirates! If IESA continues to dispose
of properties, we will lose revenue. Termination or modification of our agreements with hardware manufacturers will adversely affect our
business. We are required to obtain a license to develop and distribute software for each of the
video game consoles. We currently have licenses from Sony to develop products for PlayStation,
PlayStation 2, and PSP, from Nintendo to develop products for Game Boy Advance and GameCube, and
from Microsoft to develop products for Xbox. These licenses are non-exclusive, and as a result,
many of our competitors also have licenses to develop and distribute video game software for these
systems. These licenses must be periodically renewed, and if they are not, or if any of our
licenses are terminated or 15




---



##### Table of Contents



adversely modified, we may not be able to publish games for such platforms or we may be required to
do so on less attractive terms. In addition, our contracts with these manufacturers often grant
them approval rights over new products and control over the manufacturing of our products. In some
circumstances, this could adversely affect our business, results of operations or financial
condition by:  
    terminating a project for which we have expended significant resources;  
    leaving us unable to have our products manufactured and shipped to customers;  
    increasing manufacturing lead times and expense to us over the lead times and costs we could
achieve if we were able to manufacture our products independently;  
    delaying the manufacture and, in turn, the shipment of products; and  
    requiring us to take significant risks in prepaying for and holding an inventory of products. The loss of our senior management and skilled personnel could negatively affect our business. Our future success will depend to a significant degree upon the performance and
contribution of our senior management team and upon our ability to attract, motivate and retain
highly qualified employees with technical, management, marketing, sales, product development,
creative and other skills. In the video game software industry, competition for highly skilled and
creative employees is intense and costly. We expect this competition to continue for the
foreseeable future, and we may experience increased costs in order to attract and retain skilled
employees. We cannot assure you that we will be successful in attracting and retaining skilled
personnel. Our business, operating results and financial condition could be materially and
adversely affected if we lost the services of senior management or key technical or creative
employees or if we failed to attract additional highly qualified employees. James
Caparro, who had been our President and Chief Executive Officer since November 2004,
had assembled our new senior management team, and had initialized our
strategic restructuring, resigned on June 6, 2005, and will take
a position with a company in another industry. Bruno Bonnell, who is
the Chief Executive Officer of IESA and is our Chairman of the Board
and Chief Creative Officer, has assumed the functions of Chief
Executive Officer until we hire a replacement for Mr. Caparro.
We could be significantly affected by the length of time it takes to
hire a new chief executive officer and by changes a new chief executive officer
might make after he or she is hired and takes office. If returns and other concessions given to our customers exceed our reserves, our business may be
negatively affected. To cover returns and other concessions, we establish reserves at the time we ship our
products. We estimate the potential for future returns and other concessions based on, among other
factors, 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. While we are able to recover the majority of our costs when third-party
products we distribute are returned, we bear the full financial risk when our own products are
returned. In addition, the license fees we pay Sony, Microsoft and Nintendo are non-refundable and
we cannot recover these fees when our products are returned. Although we believe we maintain
adequate reserves with respect to product returns and other
concessions, we cannot assure you that actual returns and other
concessions will
not exceed our reserves, which could adversely affect our business, results of operations and
financial condition. Significant competition in our industry could adversely affect our business. The video game software market is highly competitive and relatively few products achieve
significant market acceptance. Currently, we compete primarily with other publishers of video game
software for both video game consoles and PCs. Our competitors include Activision, Inc., Electronic
Arts, Inc., Midway Games, Inc., Take Two Interactive, Inc., and THQ, Inc., among others. In
addition, console manufacturers including Microsoft, Nintendo, and Sony publish products for their
respective platforms. Media companies and film studios, such as Warner Bros., are increasing their
focus on the video game software market and may become significant
competitors and/or may increase the price of their outbound licenses
to competitors. These current and
future competitors may also gain access to wider distribution channels than we do. As a result,
these current and future competitors may be able to:  
    respond more quickly to new or emerging technologies or changes in customer preferences;  
    carry larger inventories;  
    undertake more extensive marketing campaigns; 16




---



##### Table of Contents




    adopt more aggressive pricing policies; and  
    make higher offers or guarantees to software developers and licensors. We may not have the resources required for us to respond effectively to market or
technological changes or to compete successfully with current and future competitors. Increased
competition may also result in price reductions, reduced gross margins and loss of market share,
any of which could have a material adverse effect on our business, results of operations or
financial condition. We cannot assure you that we will be able to
compete successfully against our
current or future competitors or that competitive pressures will not have a material adverse effect
on our business, results of operations and financial condition. Retailers of our products typically have a limited amount of shelf space and promotional
resources, and there is intense competition among consumer interactive entertainment software
products for high quality retail shelf space and promotional support from retailers. To the extent
that the number of products and platforms increases, competition for shelf space may intensify and
may require us to increase our marketing expenditures. Due to increased competition for limited
shelf space, retailers and distributors are in an increasingly better position to negotiate
favorable terms of sale, including price discounts, price protection, marketing and display fees
and product return policies. We cannot be certain that retailers will continue to purchase our
products or to provide our products with adequate levels of shelf space and promotional support on
acceptable terms. A prolonged failure in this regard may significantly harm our business and
financial results. We may face limitations on our ability to integrate additional acquired businesses or to find
suitable acquisition opportunities. We intend to pursue additional acquisitions of companies, properties and other assets
which we believe can be operated profitably, which may include companies, properties, and assets held by
IESA and its subsidiaries. Some of these transactions could be material in size and scope. Although we continue to
search for additional acquisition opportunities, we may not be successful in identifying suitable
acquisition opportunities. As the video game software industry continues to consolidate, we face
significant competition in seeking and consummating acquisition opportunities. We may not be able
to consummate potential acquisitions or an acquisition that is consummated may not enhance our
profitability. In the future, we may issue additional shares of our common stock in connection with
one or more acquisitions, which may dilute our existing stockholders. Future acquisitions could
also divert substantial management time and result in short-term reductions in earnings or special
transaction or other charges. In addition, we cannot guarantee that we will be able to successfully
integrate the businesses that we may acquire into our existing business. Our stockholders may also
not have the opportunity to review, vote on or evaluate future acquisitions. Revenues from our distribution business may decline as competition increases and Internet
technology improves. During the years ended March 31, 2004 and March 31, 2005, net revenues from our
distribution business were approximately 14.1% and 13.7%, respectively, of our total net revenues.
This decrease as a percentage of net revenues is primarily a result of increased competition. New
video game systems and electronic delivery systems may also be introduced into the software market
and potential new competitors may enter the software development and distribution market, resulting
in greater competition. Revenues from our distribution business may be adversely affected as
Internet technology is improved to enable consumers to purchase and download full-version software
products or order products directly from publishers or from unauthorized or illegal sources over
the Internet. Revenues from our distribution business may decline if the products which we distribute for
third-party developers become unavailable to us. As part of our distribution business, we earn revenues by distributing to retailers our
own products and products of others, including products published by our competitors. We cannot
assure you that these competitors will continue to provide us with their products for distribution
to our mass merchant customers. Our inability to obtain software titles developed or published by
our competitors, coupled with our inability to obtain these titles from other distributors, could
have a material adverse effect on our relationships with retailers and our ability to obtain shelf
space for our own products, as well as our own revenues that we earn from our distribution
activities. This, in turn, could have a material adverse effect on our business, results of
operations and financial condition. 17




---



##### Table of Contents



If our distribution arrangements with IESA are adversely modified or terminated, we may lose
revenue or incur disruption in the distribution of our products. Pursuant to agreements we have in place with IESA, we distribute products on their behalf
in the United States, Canada and Mexico, and IESA distributes products on our behalf in Europe,
Asia and certain other regions throughout the world. If these
agreements, or product licenses to which IESA is a party, are terminated or amended
in a manner adverse to us, we may, as applicable:  
    obtain new distribution arrangements for our products which may be on less favorable terms;  
    lose revenue from the distribution of IESAs products;  
    experience difficulties or other delays in the distribution of our products outside the United States, Canada and Mexico;  
    incur an increase in the cost of distributing our products outside the United States, Canada and Mexico; or  
    incur problems with retailers to whom we distribute IESAs products or to whom IESA distributes our products. We may face increased competition and downward price pressure if we are unable to protect our
intellectual property rights. Our business is heavily dependent upon our confidential and proprietary intellectual
property. We sell a significant portion of our published software under licenses from independent
software developers and, in these cases, we do not acquire the copyrights for the underlying work.
We rely primarily on a combination of confidentiality and non-disclosure agreements, patent,
copyright, trademark and trade secret laws, as well as other proprietary rights laws and legal
methods, to protect our proprietary rights and the intellectual property rights of our developers.
However, current U.S. and international laws afford us only limited
protection and amendments to such laws or newly enacted laws may
weaken existing protections. Despite our efforts
to protect our proprietary rights, unauthorized parties may attempt to copy our products or
franchises, or obtain and use information that we regard as proprietary. Software piracy is also a
persistent problem in the video game software industry. Policing unauthorized use of our products
is extremely difficult because video game software can be easily duplicated and disseminated.
Furthermore, the laws of some foreign countries may not protect our proprietary rights to as great
an extent as U.S. law. Our business, results of operations and financial condition could be
adversely affected if a significant amount of unauthorized copying of our products were to occur or
if other parties develop products substantially similar to our products. We cannot assure you that
our attempts to protect our proprietary rights will be adequate or that our competitors will not
independently develop similar or competitive products. We may face intellectual property infringement claims which would be costly to resolve. As the number of available video game software products increases, and their
functionality overlaps, software developers and publishers may increasingly become subject to
infringement claims. We are not aware that any of our products infringe on the proprietary rights
of third parties. However, we cannot assure you that third parties will not assert infringement
claims against us in the future with respect to past, current or future products. There has been
substantial litigation in the industry regarding copyright, trademark and other intellectual
property rights. We have also initiated litigation to assert our intellectual property rights.
Whether brought by or against us, these claims can be time consuming, result in costly litigation
and divert managements attention from our day-to-day operations, which can have a material adverse
effect on our business, operating results and financial condition. We may be burdened with payment defaults and uncollectible accounts if our customers do not or
cannot satisfy their payment obligations. Distributors and retailers in the video game software industry have, from time to time,
experienced significant fluctuations in their businesses, and a number of them have become
insolvent. The insolvency or business failure of any significant retailer or distributor of our
products could materially harm our business, results of operations and financial condition. We
typically make sales to most of our retailers and some distributors on unsecured credit, with terms
that vary depending upon the customers credit history, solvency, credit limits and sales history.
In addition, while we maintain a reserve for uncollectible receivables, the reserve may not be
sufficient in every circumstance. As a result, a payment default by a significant customer could
significantly harm our business and results of operations. 18




---



##### Table of Contents



Our software is subject to governmental restrictions or rating systems. Legislation is periodically introduced at the local, state and federal levels in the
United States and in foreign countries to establish systems for providing consumers with
information about graphic violence and sexually explicit material contained in video game software.
In addition, many foreign countries have laws that permit governmental entities to censor the
content and advertising of video game software. We believe that mandatory government-run rating
systems may eventually be adopted in many countries that are potential markets for our products. We
may be required to modify our products or alter our marketing strategies to comply with new
regulations, which could increase development costs and delay the release of our products in those
countries. Due to the uncertainties regarding such rating systems, confusion in the marketplace may
occur, and we are unable to predict what effect, if any, such rating systems would have on our
business. In addition to such regulations, certain retailers have in the past declined to stock some of
our competitors video game products because they believed that the content of the packaging
artwork or the products would be offensive to the retailers customer base. Although to date these
actions have not impacted our business, we cannot assure you that similar actions by our
distributors or retailers in the future would not cause material harm to our business. We may become subject to litigation which could be expensive or disruptive. Similar to our competitors in the video game software industry, we have been and will
likely become subject to litigation. Such litigation may be costly and time consuming and may
divert managements attention from our day-to-day operations. In addition, we cannot assure you
that such litigation will be ultimately resolved in our favor or that an adverse outcome will not
have a material adverse effect on our business, results of operations and financial condition. RISKS RELATED TO OUR CORPORATE STRUCTURE AND FINANCING ARRANGEMENTS Our performance may be
affected by IESAs performance and financial stability. 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 Civilizationfranchise and certain of its rights under its previous
license with Hasbro, 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 fund, among
other things, its subsidiaries operations is diminished. There can be no assurance that IESA
will complete sufficient 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. 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 revolving credit facility with HSBC. 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 (through its subsidiaries) also develops products which we
distribute in the U.S., Canada, and Mexico 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, Canada and
Mexico. Atari Interactive is the source of approximately 38% 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. Additionally, though we are 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 (except that we have guaranteed the Beverly,
MA lease obligation of Atari Interactive), because
IESA owns the majority of our stock, potential 19




---



##### Table of Contents



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,
affect our ability to generate business and enter into agreements on financially favorable terms
and otherwise impair our ability to raise and generate capital. IESA controls us and could prevent a transaction favorable to our other stockholders. IESA beneficially owns approximately 52% of our common stock, which gives it sufficient
voting power to prevent any transaction that it finds unfavorable, including an acquisition,
consolidation or sale of assets that might be desirable to our other stockholders. Additionally, despite efforts to implement all necessary corporate
governance safeguards, for example, review by an independent special committee of the Board, IESA
may unilaterally approve certain transactions as a result of their majority position. IESA also has sufficient voting
power to elect a majority of our Board of Directors; four of the nine members of our Board of
Directors are directors, employees or former employees (within three years) of IESA or its
affiliates. Two of the remaining five directors are currently affiliated with us (or were
affiliated with us within the past three years). Therefore, only three of the total nine directors
are considered independent. This concentration of control could be disadvantageous to other
stockholders whose interests differ from those of IESA. By October
2005, we must appoint/elect a new independent director to serve on
our Audit Committee in order to remain compliant with the NASDAQ
corporate governance requirements. Our affiliates retain considerable control over the Atari trademarks, and their oversight or
exploitation of such trademarks could affect our business. Atari Interactive, a wholly owned subsidiary of IESA, has granted us the right to use the
Atari name for software video games in the United States, Canada and Mexico. In connection with
a 2003 recapitalization, Atari Interactive extended the term of the license under which we use the Atari
name to ten years expiring December 31, 2013, for which we issued 2,000,000 shares of our
common stock to Atari Interactive. In addition, we will pay a royalty equal to 1% of our net
revenues during years six through ten of the extended license. We are subject to quality control
oversight for our use of the Atari name. Any disputes over our performance under the trademark
license agreement could materially affect our business. Furthermore, Atari Interactives use of the
Atari mark (either through itself, its affiliates or third parties) to exploit products could affect the reputation or value associated with the
Atari mark, and therefore materially affect our business. Therefore, we are dependent upon the
cooperation and business actions of IESA and its affiliates with regard to the Atari trademark. Our restructuring efforts will create short term costs that may not be offset by increased
efficiencies. We
are incurring substantial costs in connection with our restructuring efforts, including
severance obligations, relocation expenses, advisor fees, and lease obligations for unused
property. Though we anticipate that the restructuring will ultimately result in reduced general
and administrative expenses and more efficient corporate operations, we can give no assurance that
we will be successful in redefining our cost and operational structures in the near term. If we
are not successful, we may not recoup our investment, which may negatively impact our results of
operations. Our revolving credit facility could be terminated. As of May 13, 2005, we utilize the proceeds of our revolving credit facility with HSBC to
fund our working capital needs, including the manufacturing and development of products. The credit
documents which we entered into with HSBC to obtain this revolving credit facility contain numerous covenants
and conditions which may cause a default upon breach thereof by us. Although we are currently in
full compliance under the credit documents and no event of default has occurred, there can be no assurance that we will continue to remain in compliance. If an event of
default occurs under any credit document and HSBC opts not to waive such default, the revolving
credit facility may be terminated and all debt outstanding accelerated, in which case we will need
to raise additional capital or seek other alternatives, many of which may adversely affect our
stock price. RISKS RELATED TO OUR COMMON STOCK Our stock price is highly volatile. The trading price of our common stock has been and could continue to be subject to wide
fluctuations in response to certain factors, including, but not limited to, the following: 20




---



##### Table of Contents




    quarter to quarter variations in results of operations;  
    our announcements of new products;  
    our announcements of changes in senior management;  
    actions by our majority stockholder;  
    our competitors announcements of new products;  
    our product development or release schedule;  
    general conditions in the video game software, entertainment, media or electronics industries;  
    our ability to successfully negotiate licenses with third parties;  
    timing of the introduction of new platforms and delays in the actual release of new platforms;  
    changes in earnings estimates; or  
    investor perceptions and expectations regarding our products, plans and strategic position
and those of our competitors and customers. Additionally, the public stock markets experience price and trading volume volatility,
particularly in high technology sectors of the market. This volatility has significantly affected
the market prices of securities of many technology companies for reasons often unrelated to the
operating performance of the specific companies. These broad market fluctuations may adversely
affect the market price of our common stock. As of March 31, 2005, of the 121,296,092 million
shares of our outstanding common stock, only 57.9 million shares (approximately 47.7%) were not
held by our affiliates. This stock ownership structure and general lack of liquidity may also be a
cause of volatility in the market price of our stock. The large number of shares eligible for public sale could cause our stock price to decline. IESA holds a substantial number of shares of our common stock that it is able to sell in
the public market. We generally cannot control the timing of any sale made by IESA. During fiscal
2005, IESA sold approximately 18.5 million shares of our stock. Large sales by IESA could
significantly reduce the market price of our common stock. These potential sales also could impede
our ability to raise future capital. AVAILABLE INFORMATION We file annual, quarterly and current reports, proxy statements and other information with the
SEC. Our SEC filings, including our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to
Section 13(a) of the Exchange Act, are available to the public free of charge over the Internet at
our website at http://www.atari.com or at the SECs web site at http://www.sec.gov. Our SEC
filings will be available on our website as soon as reasonably practicable after we have
electronically filed or furnished them to the SEC. You may also read and copy any document we file
at the SECs Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may
obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. 
 ITEM 2. PROPERTIES New York.Our principal administrative and sales facilities are located in
approximately 90,000 square feet of space at 417 Fifth Avenue in New York City under a lease which
commenced in December 1996 and is to expire in December 2006. We subleased 10,000 square feet of
this space beginning in May 2003 through December 2006. We also lease three 21




---



##### Table of Contents



corporate apartments
in New York City for use by our executive officers, directors, consultants and relocating
executives. Those leases expire in August 2005, December 2005, and July 2006, respectively. California. We have a lease for approximately 17,400 square feet of office space in
Santa Monica, California, which expires in May 2006. We have announced that we are ceasing
operations at this location and we are looking to sublease this space. We also lease approximately
16,460 square feet of office space in Newport Beach, California for long-term use by Shiny, an
internal development studio. This lease expires in August 2007. We have a lease for approximately 15,000
square feet of office space in Sunnyvale, California, which expires in December 2006. Washington. We lease approximately 65,500 square feet of office space in Bothell,
Washington, under a lease which expires in May 2008. This office space is occupied by our Humongous
studio. Under this lease, Humongous subleases parking lot space and an approximate total of 16,600
square feet of office space under four subleases, one of which expires in April 2008 and three of
which expire in May 2008. Minnesota. We lease 14,291 square feet of office space in Plymouth, Minnesota, under
a lease which expires in March 2006. This office space was occupied by the Minneapolis studio
which ceased operations in fiscal 2004. Our intention is to sublet the space. Massachusetts.In Beverly, Massachusetts, we occupy a portion of the 53,184 square feet of
the office space leased by Atari Interactive. Our lease expires in June 2007. We have announced
that we are ceasing operations at this location and we are looking to sublease this space. Other States in the U.S.In Scottsdale, Arizona, we lease 25,000 square feet of
office space under a lease which expires in March 2006. We have subleased these premises for the
remainder of the lease term. Europe.For our internal Reflections studio, we maintain a lease for approximately
23,285 square feet of office space in Newcastle upon Tyne, United Kingdom. This lease expires in
August 2011. Reflections also maintained a lease for office space in Gateshead Tyne and Wear,
which we had sublet until September 2004. Reflections exercised its right to terminate the lease
early so that Reflections lease expired in September 2004, the same time as the sublease for this
space. 
 ITEM 3. LEGAL PROCEEDINGS The following litigation matters are still pending during the fourth quarter of fiscal 2005.
With respect to matters in which we are a defendant, we continue to believe that the underlying
complaints are without merit and we intend to defend ourselves vigorously against these actions.
No matter was terminated during the fourth quarter of fiscal 2005. Our management believes that the ultimate resolution 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., or KBK, a distributor of electronic
games via the Internet and local area networks, filed a lawsuit against Gamesonline.com, Inc., or
Gamesonline, a subsidiary of Interplay Entertainment Corp., or Interplay, and us in Superior Court
of California, Orange County. KBK alleges that on or about December 15, 2001, KBK entered into a
contract with Gamesonline to obtain the right to localize and distribute electronically in Korea,
Neverwinter Nights and certain back list games. The Complaint further alleges that Gamesonline and
we conspired to prevent KBK from entering the market with Neverwinter Nights or any back title of
Gamesonline. The Complaint alleges the following causes of action against us: misappropriation of
trade secrets under the California Uniform Trade Secrets Act; common law misappropriation;
intentional interference with contract; negligent interference with contract; intentional
interference with prospective economic advantage; negligent interference with prospective economic
advantage; and violation of Business & Professions Code Section 17200 et seq. The Complaint seeks
$98.8 million for each of these causes of action. An Amended Complaint was filed on December 3, 2002, alleging all of the foregoing against us,
adding Atari Interactive 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, 22




---



##### Table of Contents



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. 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, Inc. 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., or Hasbro, filed a
complaint against Games, Inc., its CEO, Roger W. Ach, II, or Ach, and Chicago West Pullman LLC 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, Inc.s 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, Inc. for the development and publication of certain games
in a specified online format expired by its terms when Games, Inc. failed to pay us certain fees by
April 30, 2004, pursuant to an Asset Purchase, License and Assignment Agreement between us and
Games, Inc. dated December 31, 2003, as amended. The plaintiffs allege that Games, Inc.s failure
to pay voided an expected transfer of the Games.com domain name and certain web site assets from
us to Games, Inc. and constituted a breach of contract and that Chicago West Pullman LLC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, Inc. nevertheless continued to use plaintiffs intellectual property. On
May 18, 2004, the Court granted a temporary restraining order against Games, Inc. and Ach and
scheduled a preliminary injunction hearing for May 28, 2004, which was postponed until June 11,
2004. Prior to that hearing, Games, Inc. 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, Inc. served its Answer and Counterclaim to the Complaint. In its
counterclaim, Games, Inc. alleges that plaintiffs breached the Asst Purchase, License and
Assignment 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 , Inc. 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, Inc.s
counsel raised issues relating to plaintiffs failure to respond to its discovery requests. The
Court directed that plaintiffs submit a letter brief setting forth its generic objections to Games,
Inc.s discovery requests. The Court ordered that plaintiffs letter brief be submitted by July 6,
2004 and that Games, Inc. submit its reply by July 13, 2004. The Court also scheduled a
teleconference for July 14, 2004. On July 6, 2004, 23




---



##### Table of Contents



plaintiffs submitted its letter brief to the
Court and also served Games, Inc. with its Rule 26(a)(1) initial disclosures and Answer to the
Counterclaim. Games, Inc.s 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 plaintiffs
motion to quash Games, Inc.s discovery requests. On July 16, 2004, it came to plaintiffs attention that, in flagrant violation of the
preliminary injunction, Games, Inc. had issued a press release on July 13, 2004, that erroneously
stated that Games, Inc. owned the games.com web site and that it had an exclusive license to
certain Atari and Hasbro games. Plaintiffs immediately brought the erroneous press release to the
attention of Games, Inc.s counsel. On that same day, Games, Inc. 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, plaintiffs brought this to the attention of the Court, who ordered that a corrective
press release be issued, but approved language submitted by Games, Inc.s counsel. On September 3, 2004, in a teleconference with the Court, Games, Inc. requested from the Court
that 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,
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 Atari 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 plaintiffs motion to dismiss the Counterclaims, which has been fully
submitted and is under judicial deliberation. On October 4, 2004, it came to plaintiffs attention that, once again, Games, Inc. was in
flagrant violation of the preliminary injunction because it represented in its Form 10-KSB filing
dated October 1, 2004, that Games, Inc. owned the domain name games.com and that it had an
exclusive license to certain Hasbro and Atari games. Plaintiffs immediately brought this to the
attention of Games, Inc.s counsel, who represented that certain, but not all, statements would be
amended. But Games, Inc. did not amend its Form 10-KSB. Accordingly, 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 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 by December 20, 2004. The parties completed discovery, and
plaintiffs filed their motion for summary judgment, and motion for contempt sanctions, on November
29, 2004. The Court heard oral argument on these motions on January 12, 2005. On February 23, 2005, the Court issued an order granting plaintiffs motion to dismiss certain
of Games, Inc.s counterclaims, and on March 11, 2005, the court granted our motion for summary
judgment on its breach of contract claim and dismissed Games, Inc.s remaining counterclaims. The
Court denied Games, Inc.s motion for reconsideration on April 4, 2005. On May 4, 2005, the Court
issued a memorandum order granting us and Atari Interactive damages in the following amount: (1)
immediate payment of approximately $3.1 million, plus interest at an annual rate of nine percent
from April 30, 2004; (2) immediate redemption of 10,250 shares of Games, Inc. stock for $1.025
million, plus interest at an annual rate of nine percent from April 30, 2004; (3) immediate
redemption of 10,000 additional shares of Games, Inc. stock for $1 million; (4) redemption of the
remaining 10,000 share at any time after December 29, 2005. The order provides that the judgment
runs directly against Games, Inc. but in the event Games fails to satisfy it, it runs secondarily
against Chicago West Pullman LLC and Ach. The Courts order also lifts the preliminary injunction
imposed at the outset of the case. Ach filed a motion for reconsideration concerning the Courts ruling that the judgment would
run directly against Ach, and we requested that the Court issue a permanent injunction and clarify
certain aspects of the judgment. On May 27, 2005, the Court issued an order denying Achs motion
for reconsideration and confirming its earlier ruling that the judgment would run against Ach
personally. The Court also clarified that after December 29, 2005, we are entitled to an additional
$1.0 million, representing the cash redemption of the last 10,000 shares of Games Inc.s stock.
The Court also issued a permanent injunction barring Games Inc. from selling or distributing any
product that contains the intellectual property that is the subject of the asset purchase
agreement. The remaining elements of the original judgment remain. 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 24




---



##### Table of Contents



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 an Answer on
November 8, 2004. On February 7, 2005, a Second Amended Complaint was filed against all of the above defendants,
plus Sony Online Entertainment, Inc., Sony Computer Entertainment America, Inc., Microsoft Corp.,
and Nintendo of America, Inc. We answered the Second Amended Complaint on February 24, 2005.
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 answered the Complaint on or about March 28, 2005. Codemasters, Inc. v. Atari, Inc. On January 13, 2005, we were served with a Complaint filed by Codemasters, Inc., or
Codemasters, against us 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 approximately $0.9 million
and such other relief as may be just and proper, including interests, costs associated with the
suit. In February 2005, we answered the Complaint and also served Counterclaims. The parties
settled the matter on May 5, 2005. Pursuant to the settlement Agreement, we paid Codemasters
approximately $0.3 million. Mr. M.L. Edmondson v. Reflections Interactive Limited On March 4, 2005, Martin Lee Edmondson, the former Managing Director of Reflections
Interactive Limited, our wholly-owned UK subsidiary, filed a Notice of Claim with the Newcastle
upon Tyne Employment Tribunal claiming constructive unfair dismissal as a result of Reflections
alleged repudiatory breach of a contract of employment that necessitated Mr. Edmondsons
resignation. Mr. Edmondson is seeking a declaration that he was unfairly dismissed and
compensation in an unspecified amount for such dismissal. Compensation in the Employment Tribunal
is limited to £55,000 in respect of the maximum compensatory award. Mr. Edmondson could be awarded
for unfair dismissal, together with a maximum basic award of (depending on age and length of
service) £1,350 to £2,025. On April 1, 2005, Reflections filed a Response denying that there was a
fundamental breach of contract that entitled Mr. Edmondson to resign and claim constructive
dismissal. A case management discussion was scheduled for April 29, 2005 but has been postponed
pending the parties ongoing without prejudice discussions regarding settlement. The Employment
Tribunal has granted a stay of the proceedings until July 8, 2005, by which date the parties must
report to the Employment Tribunal on the progress of the without prejudice discussions. 
 ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the quarter ended March 31, 2005. 25




---



##### Table of Contents



PART II 
 ITEM 5.
MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER
MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES Our Common Stock is quoted on the NASDAQ National Market. The high and low sale prices for
the Common Stock as reported by the NASDAQ National Market for the fiscal years ended March 31,
2004 and March 31, 2005 are summarized below. These over-the-counter market quotations reflect
inter-dealer prices, without retail mark-ups, mark-downs, or commissions and may not necessarily
represent actual transactions. High
    
    
    LowFiscal 2004First Quarter
    
    $
    7.02
    
    
    $
    1.75Second Quarter
    
    $
    5.55
    
    
    $
    3.53Third Quarter
    
    $
    4.76
    
    
    $
    3.15Fourth Quarter
    
    $
    5.00
    
    
    $
    2.61Fiscal 2005First Quarter
    
    $
    3.66
    
    
    $
    2.10Second Quarter
    
    $
    2.51
    
    
    $
    1.35Third Quarter
    
    $
    2.94
    
    
    $
    1.10Fourth Quarter
    
    $
    3.40
    
    
    $
    2.10
 On
June 10, 2005, the last reported sale price of the Common Stock on the NASDAQ National
Market was $2.81. As of June 10, 2005, there were approximately
267 record owners
of our Common Stock. We currently anticipate that we will retain all of our future earnings for use in the
expansion and operation of our business. We have not paid any cash dividends nor do we anticipate
paying any cash dividends on our Common Stock in the foreseeable future. In addition, the payment
of cash dividends may be limited by financing agreements entered into by us. Recent Sales of Unregistered Securities None. Securities Authorized for Issuance under Equity Compensation Plans The table setting forth this information is included in Part III  Item 12. Security Ownership
of Certain Beneficial Owners and Management. 26




---



##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The following tables set forth selected consolidated financial information which, for the
years ended June 30, 2001 and 2002, the nine months ended March 31, 2003, and the years ended March
31, 2004 and 2005, is derived from our audited consolidated financial statements. The consolidated
financial information for the nine months ended March 31, 2002 and the year ended March 31, 2003,
is derived from unaudited financial statements. The unaudited consolidated financial statements
have been prepared on the same basis as the audited consolidated financial statements. Effective April 1, 2000, we changed our fiscal year-end from March 31 to June 30. Effective
March 28, 2003, we changed our fiscal year-end from June 30 to March 31. These tables should be read in conjunction with our Consolidated Financial Statements,
including the notes thereto, appearing elsewhere in this Form 10-K. See Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations. Years
    
    
    Nine Months
    
    
    YearsEnded
    
    
    Ended
    
    
    EndedJune 30,
    
    
    March 31,
    
    
    March 31,2001
    
    
    2002
    
    
    2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)(in thousands, except per share data)Statement of Operations Data:Net revenues
    
    $
    266,928
    
    
    $
    388,258
    
    
    $
    263,824
    
    
    $
    376,887
    
    
    $
    501,321
    
    
    $
    447,451
    
    
    $
    395,165Cost of goods sold
    
    
    120,589
    
    
    
    204,116
    
    
    
    146,392
    
    
    
    195,743
    
    
    
    253,468
    
    
    
    240,238
    
    
    
    205,503Gross profit
    
    
    146,339
    
    
    
    184,142
    
    
    
    117,432
    
    
    
    181,144
    
    
    
    247,853
    
    
    
    207,213
    
    
    
    189,662Selling and distribution expenses
    
    
    66,915
    
    
    
    79,590
    
    
    
    58,778
    
    
    
    66,959
    
    
    
    87,771
    
    
    
    80,442
    
    
    
    60,763General and administrative expenses
    
    
    65,148
    
    
    
    37,469
    
    
    
    28,925
    
    
    
    32,256
    
    
    
    40,800
    
    
    
    33,031
    
    
    
    36,887In process research and development
    
    
    
    
    
    
    7,400
    
    
    
    
    
    
    
    
    
    
    
    7,400
    
    
    
    
    
    
    
    Research and product development
    
    
    46,086
    
    
    
    60,974
    
    
    
    42,189
    
    
    
    55,829
    
    
    
    74,614
    
    
    
    79,495
    
    
    
    65,944Gain on sale of development project
to a related party
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,744
    )
    
    
    Restructuring and other charges
    
    
    3,539
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,932Infogrames North America merger
costs
    
    
    1,700
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Gain on sale of line of business
    
    
    (5,501
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Depreciation and amortization(1)
    
    
    19,296
    
    
    
    5,044
    
    
    
    3,227
    
    
    
    5,580
    
    
    
    7,397
    
    
    
    8,804
    
    
    
    10,602Operating (loss) income
    
    
    (50,844
    )
    
    
    (6,335
    )
    
    
    (15,687
    )
    
    
    20,520
    
    
    
    29,871
    
    
    
    9,185
    
    
    
    10,534Interest expense, net
    
    
    (13,399
    )
    
    
    (11,956
    )
    
    
    (7,887
    )
    
    
    (9,598
    )
    
    
    (13,667
    )
    
    
    (7,658
    )
    
    
    (459
    )Other income (expense)
    
    
    1,358
    
    
    
    (3,226
    )
    
    
    287
    
    
    
    644
    
    
    
    (2,868
    )
    
    
    (2,068
    )
    
    
    42(Loss) income from continuing
operations before (benefit from)
provision for income taxes
    
    
    (62,885
    )
    
    
    (21,517
    )
    
    
    (23,287
    )
    
    
    11,566
    
    
    
    13,336
    
    
    
    (541
    )
    
    
    10,117(Benefit
from) provision for income taxes
    
    
    (2,368
    )
    
    
    (3,336
    )
    
    
    (5,014
    )
    
    
    405
    
    
    
    2,083
    
    
    
    (2,919
    )
    
    
    184(Loss) income from continuing
operations
    
    
    (60,517
    )
    
    
    (18,181
    )
    
    
    (18,273
    )
    
    
    11,161
    
    
    
    11,253
    
    
    
    2,378
    
    
    
    9,933(Loss) income from discontinued
operations of Humongous
Entertainment
    
    
    (151
    )
    
    
    7,251
    
    
    
    8,052
    
    
    
    6,909
    
    
    
    6,107
    
    
    
    (1,612
    )
    
    
    (4,241
    )Net (loss) income
    
    
    (60,668
    )
    
    
    (10,930
    )
    
    
    (10,221
    )
    
    
    18,070
    
    
    
    17,360
    
    
    
    766
    
    
    
    5,692Dividend to parent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    (Loss) income attributable to
common stockholders
    
    $
    (60,668
    )
    
    $
    (10,930
    )
    
    $
    (10,221
    )
    
    $
    18,070
    
    
    $
    17,360
    
    
    $
    (38,585
    )
    
    $
    5,692Basic and diluted (loss) income
per share from continuing
operations
    
    $
    (1.07
    )
    
    $
    (0.26
    )
    
    $
    (0.26
    )
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.02
    
    
    $
    0.08Basic and
diluted income (loss) per
share from discontinued operations
of Humongous Entertainment
    
    
    0.00
    
    
    
    0.10
    
    
    
    0.11
    
    
    
    0.10
    
    
    
    0.09
    
    
    
    (0.01
    )
    
    
    (0.03
    )Basic and diluted (loss) per
share related to dividend to
parent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.41
    )
    
    
    Basic and diluted (loss) income
per share attributable to common
stockholders
    
    $
    (1.07
    )
    
    $
    (0.16
    )
    
    $
    (0.15
    )
    
    $
    0.26
    
    
    $
    0.25
    
    
    $
    (0.40
    )
    
    $
    0.05Basic weighted average shares
outstanding
    
    
    56,839
    
    
    
    69,722
    
    
    
    69,686
    
    
    
    69,878
    
    
    
    69,864
    
    
    
    96,990
    
    
    
    121,276Diluted weighted average shares
outstanding
    
    
    56,839
    
    
    
    69,722
    
    
    
    69,686
    
    
    
    70,055
    
    
    
    70,058
    
    
    
    96,990
    
    
    
    121,587
   (1)
    
    We adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets effective July 1, 2001. The adoption has eliminated the goodwill
amortization prospectively from the effective date. 27




---



##### Table of Contents



June 30,
    
    
    March 31,2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005Balance Sheet Data:Cash and cash equivalents
    
    $
    4,724
    
    
    $
    5,392
    
    
    $
    810
    
    
    $
    9,607
    
    
    $
    10,433Working (deficit) capital
    
    
    (56,636
    )
    
    
    (90,958
    )
    
    
    (90,910
    )
    
    
    25,228
    
    
    
    35,651Total assets
    
    
    145,084
    
    
    
    241,863
    
    
    
    232,082
    
    
    
    193,956
    
    
    
    190,039Total debt
    
    
    149,308
    
    
    
    236,211
    
    
    
    220,061
    
    
    
    
    
    
    
    Stockholders (deficit) equity
    
    
    (106,536
    )
    
    
    (115,329
    )
    
    
    (96,918
    )
    
    
    115,063
    
    
    
    120,667
 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Business and Operating Segments We are a global publisher and developer of video game software for gaming enthusiasts and the
mass-market audience, and as a 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, GameCube and DS; Microsoft Xbox; and personal computers, referred to as PCs.
We also publish and sublicense games for the wireless, internet, and other evolving platforms.
Our diverse portfolio of products extends across most major video game genres, including action,
adventure, strategy, role-playing, and driving. Our products are based on intellectual properties
that we have either created internally and own or which have been licensed from third parties. We
leverage both internal and external resources in the development of our games, assessing each
project independently to determine which development team is best suited to handle the product
based on technical expertise and historical development experience, among other factors.
Additionally, through our relationship with IESA, our products are distributed exclusively by IESA
throughout Europe, Asia and other regions. Through our distribution agreement with IESA, we have
the rights to publish and sublicense certain intellectual properties either owned or licensed by
IESA or its subsidiaries, including Atari Interactive. We also manage the development of product
at studios owned by IESA that focus solely on game development. In addition to our publishing and development activities, we also distribute video game
software in North America for titles developed by certain third-party publishers with whom we have
contracts (Distribution Business). As a distributor of video game software throughout the U.S.,
we maintain what we believe to be state-of-the-art distribution operations and systems, reaching
well in excess of 30,000 retail outlets nationwide. 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, GameStop, and Electronics
Boutique accounted for approximately 25.7%, 12.3%, 9.8%, 7.4%, and 6.5% respectively, of net
revenues for the year ended March 31, 2005. 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. 28




---



##### Table of Contents



Company Reorganization Historically, our sales growth and profitability have not been at the same level as our more
successful competitors. During the fourth quarter of fiscal 2005, we announced that as part of an
overall strategic plan, we would implement structural, financial, and creative restructuring
initiatives with the goal of improving profitability and competitive position. Specifically, we and our
majority stockholder are considering ways to simplify our corporate structure. The following are
key steps that management has taken as of March 31, 2005:  
    Restructuring During the fourth quarter of fiscal 2005, following the guidance established under
Financial Accounting Standards Board (FASB) Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, we recorded restructuring expenses of $4.9
million, which include the termination of several key executives as well as severance and other
charges related to the closing of the Beverly, MA, and Santa Monica, CA, publishing studios and
the transfer of all publishing operations to the New York office. The costs include severance
and retention expenses, expenses associated with the modification of stock option agreements for
terminated executives, and other miscellaneous transition costs. We expect to incur an
additional $5.0 million to $8.0 million over the next twelve month period in order to complete
managements plan.  
    Discontinued Operations In the fourth quarter of fiscal 2005, following the guidance established under FASB
Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, management
committed to a plan to divest of our Humongous Entertainment development studio and its operations.
The sale is expected to occur in the twelve months following the end of fiscal 2005. It is
unknown at March 31, 2005 the amount of the gain or loss that will be recorded on the sale, once
completed. The assets and liabilities of Humongous are presented separately on our Consolidated
Balance Sheets; additionally, its results for the periods presented are disclosed as
discontinued operations on the face of the Consolidated Statement of Operations and
Comprehensive Income (Loss). A summary of the net revenues and (loss) income from discontinued
operations of Humongous Entertainment for the years presented in our Selected Financial Data is
as follows (in thousands): Nine MonthsYears Ended
    
    
    Ended
    
    
    Years EndedJune 30,
    
    
    March 31,
    
    
    March 31,2001
    
    

    2002
    
    
    2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Net revenues
    
    $
    24,460
    
    
    $
    30,786
    
    
    $
    25,617
    
    
    $
    27,758
    
    
    $
    32,927
    
    
    $
    21,494
    
    
    $
    12,649(Loss) income from discontinued operations
    
    $
    (151
    )
    
    $
    7,251
    
    
    $
    8,052
    
    
    $
    6,909
    
    
    $
    6,107
    
    
    $
    (1,612
    )
    
    $
    (4,241
    )
 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 29




---



##### Table of Contents



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 nine months ended March 31, 2002 (unaudited) and 2003, and the years ended March 31,
2003 (unaudited), 2004, and 2005, we recorded allowances for bad debts, returns, price protection
and other customer promotional programs of approximately $77.7 million, $76.4 million, $103.4
million, $102.7 million, and $85.7 million, respectively. As of March 31, 2004 and March 31,
2005, the aggregate reserves against accounts receivable for bad debts, returns, price protection
and other customer promotional programs were approximately $36.3 million and $24.3 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 nine months ended March 31, 2002
(unaudited) and 2003, and the years ended March 31, 2003 (unaudited), 2004, and 2005, we recorded
obsolescence expense of approximately $(0.8) million, $3.4 million, $5.0 million, $1.7 million, and
$2.6 million, respectively. As of March 31, 2004 and March 31, 2005, the aggregate reserve against
inventories was approximately $2.0 million and $2.4 million, respectively. Research and Product Development Costs Research and product development costs relate to the design, development, and testing of new
software products, whether internally or externally developed. 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 our research and product development costs including external developer
royalty advances (milestone payments) as incurred. 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. Due to recently implemented enhancements in our internal project
planning and acceptance process and anticipated additional improvements in our ability to assess
post-release consumer acceptance, we are currently considering a change from expensing such costs
when incurred to a method of deferral and amortization over each
products life cycle. Should
management change its method of accounting for product development costs, such change will be
implemented prospectively. Management believes that the ability to amortize such costs over the
products life cycle will result in a better matching of costs and revenues. 30




---



##### Table of Contents



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 product 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 March 31, 2005, we have combined net operating loss carryforwards of approximately
$486.0 million for federal tax purposes. These loss carryforwards are available to offset future
taxable income, if any, and will expire beginning in the years 2009 through 2025. 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. In December 2004, the FASB issued Staff Position (FSP) 109-2, Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of
2004 (AJCA). The AJCA introduces a limited time 85% dividends received deduction
on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision),
provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the
repatriation provision. As we have no earnings to repatriate from our foreign subsidiaries, we
have determined that the issuance of FSP 109-2 has no effect on our financial position and results
of operations. 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, administrative and support services and distribution agreements. (See Note 13 to the
Consolidated Financial Statements for information on related party transactions.) Results of Operations Year ended March 31, 2005 versus year ended March 31, 2004 Consolidated Statement of Operations (dollars in thousands): Year
    
    
    % of
    
    
    Year
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)March 31,
    
    
    Revenues
    
    
    March 31,
    
    
    Revenues
    
    

Increase2004
    
    
    
    
    
    
    2005Net revenues
    
    $
    447,451
    
    
    
    100.0
    %
    
    $
    395,165
    
    
    
    100.0
    %
    
    $
    (52,286
    )Cost of goods sold
    
    
    240,238
    
    
    
    53.7
    %
    
    
    205,503
    
    
    
    52.0
    %
    
    
    (34,735
    )Gross profit
    
    
    207,213
    
    
    
    46.3
    %
    
    
    189,662
    
    
    
    48.0
    %
    
    
    (17,551
    )Selling and distribution expenses
    
    
    80,442
    
    
    
    18.0
    %
    
    
    60,763
    
    
    
    15.4
    %
    
    
    (19,679
    )General and administrative expenses
    
    
    33,031
    
    
    
    7.2
    %
    
    
    36,887
    
    
    
    9.3
    %
    
    
    3,856
 31




---



##### Table of Contents



Year
    
    
    % of
    
    
    Year
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)/March 31,
    
    
    Revenues
    
    
    March 31,
    
    
    Revenues
    
    
    Increase2004
    
    
    
    
    
    
    2005Restructuring expenses
    
    
    
    
    
    
    0.0
    %
    
    
    4,932
    
    
    
    1.2
    %
    
    
    4,932Research and product development
    
    
    79,495
    
    
    
    17.8
    %
    
    
    65,944
    
    
    
    16.7
    %
    
    
    (13,551
    )Gain on sale of development project
to a related party
    
    
    (3,744
    )
    
    
    (0.8
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    (3,744
    )Depreciation and amortization
    
    
    8,804
    
    
    
    2.0
    %
    
    
    10,602
    
    
    
    2.7
    %
    
    
    1,798Operating income
    
    
    9,185
    
    
    
    2.1
    %
    
    
    10,534
    
    
    
    2.7
    %
    
    
    1,349Interest expense, net
    
    
    (7,658
    )
    
    
    (1.7
    )%
    
    
    (459
    )
    
    
    (0.1
    )%
    
    
    (7,199
    )Other (expense) income
    
    
    (2,068
    )
    
    
    (0.5
    )%
    
    
    42
    
    
    
    0.0
    %
    
    
    2,110(Loss) income from continuing
operations before provision for
(benefit from) income taxes
    
    
    (541
    )
    
    
    (0.1
    )%
    
    
    10,117
    
    
    
    2.6
    %
    
    
    10,658(Benefit from) provision for income
taxes
    
    
    (2,919
    )
    
    
    (0.6
    )%
    
    
    184
    
    
    
    0.1
    %
    
    
    3,103Income from continuing operations
    
    
    2,378
    
    
    
    0.5
    %
    
    
    9,933
    
    
    
    2.5
    %
    
    
    7,555(Loss) from discontinued operations of
Humongous Entertainment
    
    
    (1,612
    )
    
    
    (0.3
    )%
    
    
    (4,241
    )
    
    
    (1.1
    )%
    
    
    2,629Net income
    
    $
    766
    
    
    
    0.2
    %
    
    $
    5,692
    
    
    
    1.4
    %
    
    $
    4,926Dividend to parent
    
    
    (39,351
    )
    
    
    (8.8
    )%
    
    
    
    
    
    
    0.0
    %
    
    
    (39,351
    )(Loss) income attributable to
common stockholders
    
    $
    (38,585
    )
    
    
    (8.6
    )%
    
    $
    5,692
    
    
    
    1.4
    %
    
    $
    44,277
 Net Revenues Net Revenues by Segment (dollars in thousands): YearsEndedMarch 31,
    
    
    (Decrease)2004
    
    
    2005Publishing
    
    $
    384,490
    
    
    $
    340,964
    
    
    $
    (43,526
    )Distribution
    
    
    62,961
    
    
    
    54,201
    
    
    
    (8,760
    )Total
    
    $
    447,451
    
    
    $
    395,165
    
    
    $
    (52,286
    )
 Net revenues for the year ended March 31, 2005 decreased approximately $52.3 million or 11.7%
from $447.5 million to $395.2 million. Our decrease in net revenues is largely a function of the
current years highly competitive holiday season, compounded by our hugely successful launch in the
first quarter of the prior year of Enter the Matrixversus this years best seller of DRIV3R.  
    The successful launch of DRIV3Rin June 2004 and
the continued success of our Dragon Ball
Z franchise have contributed to the generation of $341.0 million of net publishing revenues
for the year ended March 31, 2005. Year-to-date domestic net revenues on DRIV3Rare
approximately $41.8 million compared with year-to-date domestic net revenues of Enter the
Matrixin the same period last year of approximately
$87.4 million. The Dragon Ball Z
franchise which generated year-to-date net revenues of $85.9 million was led by Budokai 3
(PlayStation 2), Sagas(PlayStation 2, Xbox and GameCube), Buus Fury(Game Boy Advance),
and Super Sonic Warriors(Game Boy Advance). The Dragon Ball Z franchise generated $85.0
million in the comparable prior year primarily from sales of Budokai 2(PlayStation 2).
Other new releases in the current year included RollerCoaster Tycoon 3(PC), TRANSFORMERS
(PlayStation 2), Duel Masters: Sempai Legends(PlayStation 2 and Game Boy Advance), Atari
Anthology(PlayStation 2 and Xbox), and Atari Flashback, a plug and play classic game
console.
    Publishing net revenues include international royalty income earned on IESAs
international sales of our titles. International royalty income has decreased by $10.1
million from $28.7 million in the year ended March 31, 2004 to $18.6 million in the
comparable 2005 period, due to higher international royalty income from Enter the Matrix,
Unreal Tournament 2004, Mission Impossible 2,and Terminator 3: Rise of the Machines,
totaling $26.7 million in the prior period compared with income from DRIV3Rof $16.0
million in the current period. The decrease includes a favorable exchange rate impact in
the current fiscal year of approximately $1.8 million from the
weakening U.S. dollar against
the euro. 32




---



##### Table of Contents




    Domestic licensing and other income, included in publishing net revenues, increased
approximately $9.0 million or 54.9% to $25.4 million from $16.4 million in the prior
period. We recognized $17.2 million in domestic licensing income, an increase of $3.2
million or 22.9%, primarily from the recognition of the Duke Nukem Royalty Advance
Promissory Note of $4.3 million. Additionally, we recognized $4.0 million in fees paid by
Microsoft to develop DRIV3Rfor the Xbox platform; $1.2 million in advertising revenue; and
$2.4 million in sales of quality and assurance services to Atari Interactive. In the
comparable 2004 period, we recognized $3.5 million of previously deferred revenue in
sublicensing income as a result of the termination of our sublicensing arrangement with
Microsoft and the retention of the previously collected nonrefundable advance.
    The overall average sales price (ASP) of the publishing business has increased by 9.7%
over the prior year from $18.43 to $20.21 due to:  o
    sales of Atari Flashback, which have an average sales price of approximately $30.00 per unit, ando
    an improvement in the ASP of PC titles from $12.20 to $14.58, amido
    a relatively flat console ASP (approximately $23.00), ando
    a relatively consistent platform mix. The current year to date mix
consisted of 70.1% console product, 24.9% PC product, and 5.0% Atari Flashback
product. The prior years mix consisted of 72.2% console product and 27.8% PC
product.  
    Total distribution net revenues decreased $8.8 million due to increased competition. Gross Profit Platform mix for the year ended March 31, 2004 and 2005 is summarized below: Publishing Platform Mix2004
    
    
    2005PlayStation 2
    
    
    36.2
    %
    
    
    40.3
    %PC
    
    
    27.8
    %
    
    
    24.9
    %Xbox
    
    
    14.3
    %
    
    
    12.4
    %Game Boy Advance
    
    
    11.7
    %
    
    
    11.2
    %Plug and Play
    
    
    0.0
    %
    
    
    5.0
    %Game Cube
    
    
    7.0
    %
    
    
    4.5
    %PlayStation
    
    
    2.8
    %
    
    
    1.0
    %Nintendo DS
    
    
    0.0
    %
    
    
    0.7
    %Gameboy Color
    
    
    0.2
    %
    
    
    0.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 Gross profit decreased to $189.7 million for the year ended March 31, 2005 from $207.2
million in the comparable 2004 period primarily from decreased sales volume. Gross profit as a
percentage of net revenues increased from 46.3% in the 2004 period to 48.0% in the current period,
reflecting:  
    lower average unit costs as a percentage of ASPs on the console products within the
publishing business and
    a higher mix of international royalty income on which we incur lower costs, as well as
higher licensing and other revenue with lower associated royalty costs. Selling and Distribution Expenses Selling and distribution expenses primarily include shipping, personnel, advertising,
promotions and distribution expenses. During the year ended March 31, 2005, selling and
distribution expenses decreased approximately $19.6 million, or 24.4%, to $60.8 million (15.4% of
net revenues) from $80.4 million (18.0% of net revenues) in the comparable 2004 period due to: 33




---



##### Table of Contents




    significant savings in the current period on advertising ($34.1 million in the current
period as compared to $49.2 million in the prior period) due to stricter rationalization of
advertising funds and fewer new titles released,
    lower variable distribution costs, including freight, shipping and handling, on lower
sales,
    reduced inventory warehousing costs due to increased inventory turn (5.4 in 2004 versus
6.7 in 2005) and a reduced number of active titles,
    bonus expense of $0.2 million in the current period versus $1.2 million in the prior period, 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 year ended March 31, 2005, general and
administrative expenses increased approximately $3.9 million, or 11.8%, to $36.9 million (9.3% of
net revenues) from $33.0 million (7.2% of net revenues) in the comparable 2004 period due to:  
    bonus expense of $0.3 million in the current period compared with a reversal of $1.6 million in the prior period,
    increased external spending of approximately $1.1 million for Sarbanes-Oxley compliance work,
    increased professional and legal fees of approximately $0.7 million,
    general salary increases and the addition of fully salaried senior executives, offset by
    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. Restructuring Expenses In February 2005, management announced the planned closure of the Beverly, Massachussetts, and
Santa Monica, California, publishing studios and the relocation of the functions previously
provided by the studios to our corporate headquarters in New York. The costs associated with these
closures incurred in the year ended March 31, 2005 were $4.9 million. The costs are comprised of
$4.2 million of severance and retention costs, $0.6 million of costs related to the modification of
stock options for terminated executives, and $0.1 million of miscellaneous expenses related to the
transition. We expect to incur an additional $5.0 million to $8.0 million over the next twelve
month period in order to complete managements plan. Research and Product Development Expenses Research and product development expenses consist of development costs relating to the design,
development, and testing of new software products whether internally or externally developed,
including the payment of royalty advances to third-party developers on products that are currently
in development and billings from related party developers. These expenses for the year ended March
31, 2005 decreased approximately $13.6 million, or 17.1%, to $65.9 million from $79.5 million in
the comparable 2004 period due to:  
    the planned reduction in the number of titles in development with external developers,
    bonus expense of $0.6 million in the current period versus prior years expense of $3.0
million (includes a $1.5 million completion bonus related to Enter the Matrix), and
    savings over the prior years comparable period from the closure of the Legend and
Minnesota studios in fiscal 2004, partially offset by 34




---



##### Table of Contents




    increased spending for certain projects currently in development at our internal
studios. Internal research and product development expenses represent 43.6% of the total research and
product development expenses for the year ended March 31, 2005 and 38.2% of the total research and
product development expenses for the year ended March 31, 2004. Research and product development
expenses, as a percentage of net revenues, decreased to 16.7% for the year ended March 31, 2005
from 17.8% in the comparable 2004 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 gain was recorded in the current period. Depreciation and Amortization Depreciation and amortization for year ended March 31, 2005 increased by $1.8 million, or
20.5%, to $10.6 million from $8.8 million in the comparable 2004 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. Interest Expense, net Interest expense, net, decreased by $7.2 million to $0.5 million for the year ended March 31,
2005 from $7.7 million in the comparable 2004 period. The decrease is a result of:  
    our September 2003 recapitalization whereby all outstanding related party debt was
converted to equity (savings of $6.8 million in interest expense over the prior year), and
    interest income of $0.9 million earned on the various related party notes receivable
outstanding during the period. Since the recapitalization, interest and financing fees have consisted of expenses incurred
under our credit facility arrangement with GECC, which expired in the first quarter of fiscal 2006. Other (Expense) Income In
the prior year, we recorded a $1.7 million write down of an investment in an independent
developer as part of the termination of a publishing agreement with Microsoft. No significant
items have been recorded in the current period. (Benefit from) Provision for Income Taxes During the year ended March 31, 2005, we recorded approximately $0.2 million for foreign tax
liabilities at our dormant UK subsidiary. For the year ended March 31, 2004, we recorded a tax
benefit of approximately $2.9 million, which resulted primarily from a June 30, 2001 amended
federal tax return to recover taxes paid in 1996 and refunds of estimated state tax payments made
during the tax year ended June 30, 2003. (Loss) from Discontinued Operations of Humongous Entertainment Loss from discontinued operations of Humongous Entertainment increased by $2.6 million from
$1.6 million for the year ended March 31, 2004 to $4.2 million for the year ended March 31, 2005.
The increase is attributable to a drop off in net revenues of approximately $8.8 million, offset by
savings of approximately $3.1 million in costs of goods sold due to reduced sales volume, and
decreased spending on advertising, research and product development, and distribution costs of
approximately $3.1 million. Dividend to Parent In connection with the Recapitalization Agreement entered into in the prior year, we issued
stock at a more favorable rate than was available, at the holders option, under the original terms
of the 5.0% subordinated convertible notes it held. The incremental value of the additional stock
issued was reported as a dividend to IESA for $39.4 million, which had 35




---



##### Table of Contents



no impact on total stockholders equity and has been reported as a charge in computing (loss)
income attributable to common stockholders. Year ended March 31, 2004 versus year ended March 31, 2003 (unaudited) Consolidated Statement of Operations (dollars in thousands): Year
    
    
    % of
    
    
    Year
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    (Decrease)/March 31,
    
    
    Revenues
    
    
    March 31,
    
    
    Revenues
    
    
    Increase2003
    
    
    
    
    
    
    2004Net revenues
    
    $
    501,321
    
    
    
    100.0
    %
    
    $
    447,451
    
    
    
    100.0
    %
    
    $
    (53,870
    )Cost of goods sold
    
    
    253,468
    
    
    
    50.6
    %
    
    
    240,238
    
    
    
    53.7
    %
    
    
    (13,230
    )Gross profit
    
    
    247,853
    
    
    
    49.4
    %
    
    
    207,213
    
    
    
    46.3
    %
    
    
    (40,640
    )Selling and distribution expenses
    
    
    87,771
    
    
    
    17.5
    %
    
    
    80,442
    
    
    
    18.0
    %
    
    
    (7,329
    )General and administrative expenses
    
    
    40,800
    
    
    
    8.1
    %
    
    
    33,031
    
    
    
    7.2
    %
    
    
    (7,769
    )In-process research and development
    
    
    7,400
    
    
    
    1.5
    %
    
    
    
    
    
    
    0.0
    %
    
    
    (7,400
    )Research and product development
    
    
    74,614
    
    
    
    14.9
    %
    
    
    79,495
    
    
    
    17.8
    %
    
    
    4,881Gain on sale of development project to
a related party
    
    
    
    
    
    
    0.0
    %
    
    
    (3,744
    )
    
    
    (0.8
    )%
    
    
    3,744Depreciation and amortization
    
    
    7,397
    
    
    
    1.4
    %
    
    
    8,804
    
    
    
    2.0
    %
    
    
    1,407Operating income
    
    
    29,871
    
    
    
    6.0
    %
    
    
    9,185
    
    
    
    2.1
    %
    
    
    (20,686
    )Interest expense, net
    
    
    (13,667
    )
    
    
    (2.7
    )%
    
    
    (7,658
    )
    
    
    (1.7
    )%
    
    
    (6,009
    )Other expense
    
    
    (2,868
    )
    
    
    (0.6
    )%
    
    
    (2,068
    )
    
    
    (0.5
    )%
    
    
    (800
    )Income (loss) from continuing
operations before provision for
(benefit from) income taxes
    
    
    13,336
    
    
    
    2.7
    %
    
    
    (541
    )
    
    
    (0.1
    )%
    
    
    13,877Provision for (benefit from) income
taxes
    
    
    2,083
    
    
    
    0.5
    %
    
    
    (2,919
    )
    
    
    (0.6
    )%
    
    
    (5,002
    )Income from continuing operations
    
    
    11,253
    
    
    
    2.2
    %
    
    
    2,378
    
    
    
    0.5
    %
    
    $
    (8,875
    )Income (loss) from discontinued
operations of Humongous Entertainment
    
    
    6,107
    
    
    
    1.3
    %
    
    
    (1,612
    )
    
    
    (0.3
    )%
    
    
    7,719Net income
    
    $
    17,360
    
    
    
    3.5
    %
    
    $
    766
    
    
    
    0.2
    %
    
    $
    (16,594
    )Dividend to parent
    
    
    
    
    
    
    0.0
    %
    
    
    (39,351
    )
    
    
    (8.8
    )%
    
    
    39,351Income (loss) attributable to
common stockholders
    
    $
    17,360
    
    
    
    3.5
    %
    
    $
    (38,585
    )
    
    
    (8.6
    )%
    
    $
    (55,945
    )
 Net Revenues Net Revenues by Segment (dollars in thousands): YearsEndedMarch 31,
    
    
    (Decrease)2003
    
    
    2004Publishing
    
    $
    405,188
    
    
    $
    384,490
    
    
    $
    (20,698
    )Distribution
    
    
    96,133
    
    
    
    62,961
    
    
    
    (33,172
    )Total
    
    $
    501,321
    
    
    $
    447,451
    
    
    $
    (53,870
    )
 Net revenues for the year ended March 31, 2004 decreased approximately $53.8 million or 10.7% from
$501.3 million to $447.5 million.  
    Our publishing net revenues were driven this period by strong sales from new products
and existing franchises. Led by Enter the Matrix(PlayStation 2, Xbox, PC and GameCube),
with approximately 3.2 million units shipped in the United States, our new title releases
generated approximately 63.2% of publishing net revenues. Other major new releases in the
year ended March 31, 2004 include three Dragon Ball Ztitles Budokai 2(PlayStation 2),
Legacy of Goku II(Game Boy Advance) and Taiketsu(Game Boy Advance) for a total of over
2.4 million units shipped. Although we had many successful product releases during the
year, our publishing net revenues decreased approximately $20.7 million or 5.1%. This
decrease is attributable to the delayed launch of DRIV3Rinto the first 36




---



##### Table of Contents



quarter of fiscal 2005, our decision to release a lighter slate of new titles in the second
and fourth quarters and reduced replenishment orders during our holiday season.
    Publishing net revenue includes international royalty income earned on IESAs
international sales of our titles, which are up by $8.3 million from $20.4 million in the
year ended March 31, 2003 to $28.7 million in the comparable 2004 period. The increase
includes a favorable exchange rate impact in the current fiscal year of approximately $4.3
million from the weakening US dollar against the euro and strong 2004 period international
sales of Enter the Matrix.
    Additionally, we recognized $3.5 million of previously deferred revenue in sublicensing
income as a result of the termination of our sublicensing arrangement with Microsoft and
the retention of the previously collected nonrefundable advance. See Note 6 of the Notes
of these Consolidated Financial Statements for additional information related to this
transaction.
    Total distribution net revenues decreased $33.2 million from continued general industry
softness in productivity software and managements decision to reduce our third party
distribution operations in the specific instances where margins are considered
insufficient. Gross Profit Platform mix for the year ended March 31, 2003 and 2004 is summarized below: Publishing Platform Mix2003
    
    
    2004PlayStation 2
    
    
    32.9
    %
    
    
    36.2
    %PC
    
    
    36.5
    %
    
    
    27.8
    %Xbox
    
    
    10.9
    %
    
    
    14.3
    %Game Boy Advance
    
    
    10.3
    %
    
    
    11.7
    %Game Cube
    
    
    3.7
    %
    
    
    7.0
    %PlayStation
    
    
    4.3
    %
    
    
    2.8
    %Game Boy Color
    
    
    1.3
    %
    
    
    0.2
    %Dreamcast
    
    
    0.1
    %
    
    
    0.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 Gross profit decreased to $207.2 million for the year ended March 31, 2004 from $247.9
million in the comparable 2003 period primarily from decreased sales volume while, as a percentage
of net revenues, gross profit decreased from 49.4% to 46.3%. The benefit of a sales mix shift out
of the higher cost distribution business and into the lower cost publishing business is largely
being offset by a continuing sales mix shift within the publishing business toward the more costly
console product and away from the less costly PC product, which is consistent with current industry
trends. Approximately 72.2% of the publishing business shipments consisted of console sales
during the year ended March 31, 2004 versus 63.5% in the comparable 2003 period. For the year
ended March 31, 2004, the distribution business accounted for 14.1% of our net revenues as compared
to 19.2% for the comparable 2003 period. Finally, a higher mix of royalty-bearing products sold in
the current period also contributed to lower margins. In the year ended March 31, 2004, royalty
expense included in cost of goods sold was 16.3% of net revenues, while in the 2003 period royalty
expense was 12.6% of net revenues. Selling and Distribution Expenses During the year ended March 31, 2004, selling and distribution expenses decreased
approximately $7.4 million, or 8.4%, to $80.4 million from $87.8 million in the comparable 2003
period due to lower advertising expense from fewer new product releases as well as lower variable
costs (mainly freight and handling) from decreased net revenues. Advertising expenses decreased
$1.8 million or 3.5% and variable freight and distribution expenses decreased $2.6 million from the
comparable 2003 period. The selling and distribution expenses remained relatively unchanged as a
percentage of net revenues, increasing slightly to 18.0% for the year ended March 31, 2004 from
17.5% in the comparable 2003 period. 37




---



##### Table of Contents



General and Administrative Expenses The general and administrative expenses of $33.0 million are significantly below the March
2003 periods expenses of $40.8 million. This decrease is primarily from a $2.1 million one-time
bonus tied to the closing of the GECC senior credit facility and a $3.8 million bonus charge from
increased performance incentives which were achieved and incurred in the year ended March 31, 2003.
Without the one-time incentive compensation in the 2003 period, general and administrative expense
as a percentage of net revenues of 8.1% would have been reduced to 7.0% in the 2003 period. In-Process Research and Development Expense In-process research and development costs of $7.4 million were incurred during the year ended
March 31, 2003 and represents a portion of the purchase price paid for Shiny during that period.
The allocation of the purchase price to in-process research and development was based on an
independent third-party valuation and all such costs were expensed at the date of the acquisition.
There were no comparable costs incurred during the year ended March 31, 2004. Research and Product Development Expenses Research and product development expenses for the year ended March 31, 2004 increased
approximately $4.9 million, or 6.6%, to $79.5 million from $74.6 million in the comparable 2003
period, primarily from the increase of approximately $7.0 million in amortization and write-off of
capitalized licenses and the timing of milestone completions upon which this expense is based.
This increase in research and product development has been offset by reductions in internal studio
development costs due to the completion of certain titles early in the 2004 period. Internal costs
represented 38.2% of the total research and product development costs for the year ended March 31,
2004, while internal costs were 44.8% of total research and product development costs for the
comparable 2003 period. Gain on Sale of a Development Project to a Related Party During the third quarter of the year ended March 31, 2004, 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 the year ended March 31, 2003 at no cost to us. Management believes that the
value of the development rights was minimal at the time of the 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 the year ended March 31, 2004. The sale was
initiated as a result of concerns expressed by the original third party licensor relating to our
development efforts. Depreciation and Amortization Depreciation and amortization for the year ended March 31, 2004, increased by $1.4 million, or
18.9%, to $8.8 million from $7.4 million in the comparable 2003 period due primarily to
amortization expense from our license with Atari Interactive for the rights to the Atari name
offset by lower depreciation expense from assets which were fully depreciated during the period. Interest Expense, net Interest expense, net, decreased approximately $6.0 million to $7.7 million for the year ended
March 31, 2004 from $13.7 million in the comparable 2003 period. The decrease is a result of our
September 2003 recapitalization whereby all outstanding related party debt was converted to equity.
Since the recapitalization, interest and financing fees have consisted solely of expenses incurred
under our credit facility arrangement with GECC. Furthermore, interest expense has been further
reduced by interest income received from advances to related parties of approximately $1.1 million
earned through the date of the Recapitalization Agreement. Offsetting this decrease in interest
expense, we expensed the full $1.3 million remaining deferred financing fees outstanding with IESA
as a result of the conversion of all outstanding related party debt to equity in the September 2003
quarter. 38




---



##### Table of Contents



Other Expense Other expense in the year ended March 31, 2004 included a net $1.7 million write-down related
to the Oddworld Inhabitants, Inc. (Oddworld) transaction (see Note 7 of the Notes of these
Consolidated Financial Statements for additional information related to this transaction). Other
expense in the comparable 2003 period included an initial write-down of the Oddworld investment of
approximately $3.6 million. As of March 31, 2004, we no longer own an investment in Oddworld. The
2003 period also included $0.6 million of commission income recorded by us as compensation for
negotiating a sale-lease back transaction for a related-party. Provision for (Benefit from) Income Taxes During the year ended March 31, 2004, we recorded a tax benefit of approximately $2.9 million,
which resulted primarily from a June 30, 2001 amended federal tax return to recover taxes paid in
1996 and refunds of estimated state tax payments made during the tax year ended June 30, 2003.
During the year ended March 31, 2003, we recorded a provision for taxes of $2.1 million, primarily
from foreign tax liabilities from our foreign operations. Dividend to Parent In connection with the Recapitalization Agreement, we issued stock at a more favorable rate
than was available, at the holders option, under the original terms of the 5% subordinated
convertible notes. The incremental value of the additional stock issued was reported as a dividend
to IESA for $39.4 million, which had no impact on total stockholders equity and has been reported
as a charge in computing income (loss) attributable to common stockholders. Nine months ended March 31, 2003 versus nine months ended March 31, 2002 (unaudited) Consolidated Statement of Operations (dollars in thousands): Nine Months
    
    
    % of
    
    
    Nine Months
    
    
    % ofEnded
    
    
    Net
    
    
    Ended
    
    
    Net
    
    
    Increase/March 31,
    
    
    Revenues
    
    
    March 31,
    
    
    Revenues
    
    
    (Decrease)2002
    
    
    
    
    
    
    2003Net revenues
    
    $
    263,824
    
    
    
    100.0
    %
    
    $
    376,887
    
    
    
    100.0
    %
    
    $
    113,063Cost of goods sold
    
    
    146,392
    
    
    
    55.5
    %
    
    
    195,743
    
    
    
    51.9
    %
    
    
    49,351Gross profit
    
    
    117,432
    
    
    
    44.5
    %
    
    
    181,144
    
    
    
    48.1
    %
    
    
    63,712Selling and distribution expenses
    
    
    58,778
    
    
    
    22.3
    %
    
    
    66,959
    
    
    
    17.8
    %
    
    
    8,181General and administrative expenses
    
    
    28,925
    
    
    
    10.9
    %
    
    
    32,256
    
    
    
    8.6
    %
    
    
    3,331Research and product development
    
    
    42,189
    
    
    
    16.0
    %
    
    
    55,829
    
    
    
    14.8
    %
    
    
    13,640Depreciation and amortization
    
    
    3,227
    
    
    
    1.2
    %
    
    
    5,580
    
    
    
    1.5
    %
    
    
    2,353Operating (loss) income
    
    
    (15,687
    )
    
    
    (5.9
    )%
    
    
    20,520
    
    
    
    5.4
    %
    
    
    36,207Interest expense, net
    
    
    (7,887
    )
    
    
    (3.0
    )%
    
    
    (9,598
    )
    
    
    (2.5
    )%
    
    
    1,711Other income
    
    
    287
    
    
    
    0.1
    %
    
    
    644
    
    
    
    0.2
    %
    
    
    357(Loss) income from continuing
operations before (benefit from) provision for income taxes
    
    
    (23,287
    )
    
    
    (8.8
    )%
    
    
    11,566
    
    
    
    3.1
    %
    
    
    34,853(Benefit from) provision for income taxes
    
    
    (5,014
    )
    
    
    (1.9
    )%
    
    
    405
    
    
    
    0.1
    %
    
    
    5,419(Loss) income from continuing operations
    
    
    (18,273
    )
    
    
    (6.9
    )%
    
    
    11,161
    
    
    
    3.0
    %
    
    
    29,434Income from discontinued operations of
Humongous Entertainment
    
    
    8,052
    
    
    
    3.0
    %
    
    
    6,909
    
    
    
    1.8
    %
    
    
    (1,143
    )Net (loss) income
    
    $
    (10,221
    )
    
    
    (3.9
    )%
    
    $
    18,070
    
    
    
    4.8
    %
    
    $
    28,291
 Net Revenues Net revenues for the nine months ended March 31, 2003 increased approximately $113.1 million
or 42.9% from $263.8 million to $376.9 million. This increase is attributable to our growth in our
publishing business, offset by a slight decrease in our third-party distribution business. Total publishing net revenues for the nine months ended March 31, 2003 increased approximately
$115.8 million or 62.2% to $302.1 million from $186.3 million in the comparable 2002 period. This
increase is due to the success of both new 39




---



##### Table of Contents



releases and catalogue titles, as well as an increase in royalty income earned from sales of
our product sold internationally. Our top ten selling published products for the nine months ended
March 31, 2003 generated revenues of approximately $132.1 million, an increase of $53.0 million or
67.0%, from $79.1 million in the comparative 2002 period. The top new releases during the nine
months ended March 31, 2003 were expansions from some of our most successful franchises and include
Dragon Ball Z: Budokaifor PlayStation 2, Unreal Championshipfor Xbox, Unreal Tournament 2for the
PC and RollerCoaster Tycoon 2for the PC. Additionally, we increased our royalty income generated
from international sales of our products. International royalties were $18.8 million for the nine
months ended March 31, 2003, an increase from $2.9 million in the comparable 2002 period. Total
third-party distribution net revenues for the nine months ended March 31, 2003 decreased slightly
by approximately $2.7 million or 3.5% to $74.8 million from $77.5 million in the comparable 2002
period due primarily to a reduction in the Australian operations distribution business. Gross Profit Gross profit increased to $181.1 million for the nine months ended March 31, 2003 from $117.4
million in the comparable 2002 period due mainly to increased sales volume. Gross profit as a
percentage of net revenues increased to 48.1% for the nine months ended March 31, 2003 from 44.5%
in the comparable 2002 period. This increase was the result of our product mix shift out of the
lower margin distribution business and into the publishing business and a stronger publishing
product offering, offset partially by a shift within the publishing business from higher margin PC
product to console product. For the nine months ended March 31, 2003, the distribution business
accounted for 19.8% of our net revenues as compared to 29.4% for the comparable period in 2002.
Approximately 61.0% of the publishing businesss shipments were console sales during the nine
months ended March 31, 2003 versus 33.4% in the comparable 2002 period. However, the overall margin
of the publishing business as a percentage of net revenues for the nine months ended March 31, 2003
remained consistent with the 2002 percentage of 53.5%. Selling and Distribution Expenses During the nine months ended March 31, 2003, selling and distribution expenses increased
approximately $8.2 million, or 13.9%, to $67.0 million from $58.8 million in the comparable 2002
period. The increase in selling and distribution expenses was primarily the result of an increase
in advertising expenses and variable selling expenses related to the increase in sales from the
nine months ended March 31, 2003 over the comparable 2002 period, partially offset by a decrease in
certain fixed expenses. Advertising expenditures increased $13.5 million, or 49.8%, to
approximately $40.6 million during the nine months ended March 31, 2003 as compared to $27.1
million in the comparable 2002 period as a result of increased advertising to support new product
releases in the 2003 period. Fixed costs, including salaries and consulting expenses, decreased by
$3.7 million, to $11.3 million during the nine months ended
March 31, 2003 as compared to $15.0 million in the 2002 period. This decrease was primarily attributed to our centralization and
streamlining of marketing and publishing functions. Additionally, efficiencies in selling and
distribution expenses due to increased volume created a decrease in these expenses as a percentage
of net revenues to 17.8% for the nine months ended March 31, 2003 from 22.3% in the comparable 2002
period. Distribution expenses decreased 16.7% to approximately $12.0 million during the nine months
ended March 31, 2003 as compared to $14.4 million in the comparable 2002 period. This decrease is
due to lower costs associated with our distribution business stemming from increased shipments to
customer distribution centers as opposed to individual customers stores and our product mix shift
from PC to console product, which cost less to handle and ship. General and Administrative Expenses General and administrative expenses for the nine months ended March 31, 2003 increased
approximately $3.4 million, or 11.8%, to $32.3 million from $28.9 million in the comparable 2002
period. The increase resulted primarily from the payment of bonuses which were offset partially by
decreased bad debt expense. We paid a one-time bonus of $2.1 million in the quarter ended December
31, 2002 tied to the closing of the GECC senior credit facility. Furthermore, we met increased
performance incentives and incurred additional bonus expense of $3.8 million in the current period
versus the prior period. This increase was partially offset by a decrease in bad debt expense of
$3.1 million to $3.8 million from $6.9 million for the nine months ended March 31, 2003 and 2002,
respectively. The nine months ended March 31, 2002 included a $4.2 million bad debt charge related
to the Kmart bankruptcy, compared to a $0.3 million charge in the comparable 2003 period relating
to the bankruptcy of one of our customers, FAO Inc. General and administrative expenses as a
percentage of net revenues decreased to 8.6% for the months ended March 31, 2003 from 10.9% in the
comparable 2002 period. 40




---



##### Table of Contents



Research and Product Development Expenses Research and product development expenses for the nine months ended March 31, 2003 increased
approximately $13.6 million, or 32.2%, to $55.8 million from $42.2 million in the comparable 2002
period. The primary reason for the increase in research and product development expense was from
increased spending by our internal development studios, which include Legend, Reflections and
Shiny. Much of the increase related to the costs associated with the development of the Enter the
Matrixvideo game on all platforms incurred by Shiny, which we acquired in April 2002. During the
nine months ended March 31, 2003, our internal development studios incurred expenses of $26.3
million, an increase of $10.1 million or 62.3% from $16.2 million in the comparable 2002 period. In
relation to total research and product development expenses, the internal costs represented 47.1%
of the total research and product development costs for the nine months ended March 31, 2003, while
internal costs were 38.4% of total research and product development costs for the comparable 2002
period. Research and product development expenses, as a percentage of net revenues, decreased to
14.8% for the nine months ended March 31, 2003 from 16.0% in the comparable 2002 period. Depreciation and Amortization Depreciation and amortization for the nine months ended March 31, 2003 increased approximately
$2.4 million, or 75.0%, to $5.6 million from $3.2 million in the comparable 2002 period. The
increase is due to the depreciation on capital expenditures and projects completed since the prior
period. Additionally, the 2003 period includes the amortization of intangibles related to the April
2002 acquisition of Shiny in the amount of $0.6 million. Interest Expense, net Interest expense, net, increased approximately $1.7 million to $9.6 million for the nine
months ended March 31, 2003 from $7.9 million in the comparable 2002 period. This increase in the
nine months ended March 31, 2003 is due from a higher level of average borrowings in 2003 as
compared to the 2002 period attributable to the new medium-term loan with IESA and the senior
credit facility with GECC, offset partially by a repayment of amounts outstanding under the
revolving credit facility with BNP Paribas and interest income earned on advances to related
parties. (Benefit from) Provision for Income Taxes During the nine months ended March 31, 2003, we recorded a provision for income taxes of
approximately $0.4 million as compared to a $5.0 million benefit from income taxes in the prior
comparable period. The charge in the 2003 period relates to estimated federal and state alternative
minimum tax provisions of $1.0 million to be paid by us based on our current taxable income. This
provision is offset by $0.5 million in federal income tax benefits resulting from loss carryback
refund claims filed in the current period with respect to our fiscal 2002 federal income tax return
and an amended 2001 federal income tax return. For the nine months ended March 31, 2002, we
received a tax benefit of $5.0 million based on federal tax law changes enabling us to carryback
our June 30, 2001 loss and recover taxes paid in 1996. Liquidity and Capital Resources Overview As of March 31, 2005, 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
certain intellectual property rights for future products. However, in order to complete the redirection of the focus of our product portfolio, we will
need to make significant investment in the expansion of our product development efforts. This
investment is critical in order to maintain and grow our business, keep up to date with changing
technology (including new hardware platforms scheduled to be introduced in late 2005 and in 2006),
attract premier development partners, and secure profitable
intellectual properties. Our capital raising needs are discussed with
our majority stockholder with respect to appropriate timing and
structure. However, we cannot guarantee that this capital
will be raised or that we will be successful in our strategic initiatives. If we are not
successful, management is prepared to take various actions which may include, but not be limited
to, a reduction in our expenditures for internal and external new product development and further
reduction in overhead expenses. These actions, should they become necessary, may result in a
significant reduction in the size of our operations. 41




---



##### Table of Contents



Cash Flows (in thousands) March 31,
    
    
    March 31,2004
    
    
    2005Cash
    
    $
    9,607
    
    
    $
    10,433Working capital
    
    $
    25,228
    
    
    $
    35,651
 Year
    
    
    YearEnded
    
    
    EndedMarch 31,
    
    
    March 31,2004
    
    
    2005Cash provided by (used in) operating activities
    
    $
    11,868
    
    
    $
    (5,644
    )Cash (used in) provided by investing activities
    
    
    (28,067
    )
    
    
    6,459Cash provided by (used in) financing activities
    
    
    24,846
    
    
    
    (17
    )Effect of exchange rates on cash
    
    
    150
    
    
    
    28Net increase in cash
    
    $
    8,797
    
    
    $
    826
 During
the year ended March 31, 2005, cash usage of $5.6 million
was caused by operating activities reflecting increased payments of
trade payables and royalties payable, and increased trade receivables
due to the planned late March release of Dragon Ball Z:
Sagas. This usage is further compounded by $2.5 million in
payments made in the fourth quarter due to managements
restructuring plan and $3.4 million cash usage from funding our
discontinued operations. Investing activities for the year ended March 31, 2005 created a cash inflow of approximately
$6.5 million as compared to cash usage of $28.1 million in the comparable prior period. This
increase in cash inflow is attributable to our decision to no longer make advances to related
parties and payments received in the current period for related party notes receivable issued in
the comparable prior period. The comparable 2004 period had cash usage of approximately $14.4
million from related party advances. In the year ended March 31, 2005, we received payments on
certain related party notes receivable, which were issued in 2004, for approximately $7.2 million.
Furthermore, during the year ended March 31, 2005, we issued and received payment on a secured
promissory note totaling $23.1 million. During the year ended March 31, 2005, our financing activities resulted in a nominal usage of
cash, while financing activities during the 2004 period provided cash of approximately $24.8
million. This decrease in cash is primarily attributable to the $34.9 million of proceeds received
from our equity offering in the 2004 period. There were no material financing activities in the
year ended March 31, 2005. 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 twelve 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. 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 (See Risk
Factors on page 13). We are also party to various 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. 42




---



##### Table of Contents



Credit Facilities HSBC Loan and Security Agreement On May 13, 2005, we obtained a one year $50.0 million revolving credit facility (Revolving
Credit Facility) with HSBC Business Credit (USA) Inc. (HSBC), pursuant to a Loan and Security
Agreement, to fund our working capital and general corporate needs. Loans under the Revolving
Credit Facility are determined based on percentages of our eligible receivables and eligible
inventory for certain seasonal peak periods. The Revolving Credit Facility bears interest at prime
for daily borrowings or LIBOR plus 1.75% for borrowings with a maturity of 30 days or greater. We
are required to pay a commitment fee of 0.25% on the average unused portion of the facility
quarterly in arrears and closing costs of approximately $0.1 million. The Revolving Credit
Facility contains certain financial covenants that require us to maintain enumerated EBITDA,
tangible net worth, and working capital minimums. In addition, amounts outstanding under the
Revolving Credit Facility are secured by liens on substantially all of our present and future
assets, including accounts receivable, inventory, general intangibles, fixtures, and equipment and
excluding certain non-U.S. assets. GECC Senior Credit Facility On November 12, 2002, 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 were based
on a borrowing base comprised of the value of our accounts receivable and short-term marketable
securities. The senior credit facility bore interest at prime plus 1.25% for daily borrowings or
LIBOR plus 3% for borrowings with a maturity of 30 days or greater. This senior credit facility
expired on May 12, 2005 and was replaced by the HSBC Revolving Credit Facility. Contractual Obligations As of March 31, 2005, royalty and license advance obligations, milestone payments and future
minimum lease obligations under non-cancelable operating and capital leases are summarized as
follows (in thousands): Payments Due by PeriodFiscal Years Ended March 31,2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    Thereafter
    
    
    TotalRoyalty and license advances (1)
    
    $
    1,685
    
    
    $
    908
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    2,593Milestone payments (2)
    
    
    11,858
    
    
    
    7,423
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,281Operating lease obligations (3)
    
    
    5,845
    
    
    
    4,456
    
    
    
    2,101
    
    
    
    870
    
    
    
    1,692
    
    
    
    14,964Capital lease obligations (4)
    
    
    175
    
    
    
    164
    
    
    
    28
    
    
    
    1
    
    
    
    
    
    
    
    368Total
    
    $
    19,563
    
    
    $
    12,951
    
    
    $
    2,129
    
    
    $
    871
    
    
    $
    1,692
    
    
    $
    37,206
   (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
fiscal 2006 through fiscal 2013. 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. 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. 43




---



##### Table of Contents



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 Civilizationfranchise and certain of its
rights under its previous license with Hasbro, 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 fund, among other things, its subsidiaries operations is diminished. There can
be no assurance that IESA will complete sufficient 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. 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 revolving 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 Mexico, 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 38% 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. 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 (except that we have guaranteed
the Beverly, MA lease obligation of Atari Interactive),
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, affect our ability to generate
business and enter into agreements on financially favorable terms, and otherwise impair our
ability to raise and generate capital. IESA continues to focus on ways to address and improve its
financial situation. Recent Accounting Pronouncements In December 2004, the FASB issued Statement No. 123-R, Share Based Payments. Statement No.
123-R is a revision of Statement No. 123, Accounting for Stock-Based Compensation and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement No. 123-R eliminates the
alternative to use the intrinsic value method of accounting that was provided in Statement No. 123,
which generally resulted in no compensation expense recorded in the financial statements related to
the issuance of equity awards to employees. Statement No. 123-R establishes fair value as the
measurement objective in accounting for share-based payment arrangements and requires all companies
to apply a fair value based measurement method in accounting for generally all share-based payment
transactions with employees. We plan to adopt Statement No. 123-R using a modified prospective application. Under this
application, companies are required to record compensation expense for all awards granted after the
required effective date and for the unvested portion of previously granted awards that remain
outstanding at the date of adoption. The provisions of Statement No. 123-R are effective as of the
beginning of the first annual reporting period that begins after June 15, 2005, but early adoption
is encouraged. 44




---



##### Table of Contents



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 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 Statement No. 151 will have
no material effect on our financial position and results of operations. In December 2004, the FASB issued Staff Position (FSP) 109-2, Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of
2004 (AJCA). The AJCA introduces a limited time 85% dividends received deduction
on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision),
provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the
repatriation provision. As we have no earnings to repatriate from our foreign subsidiaries, we
have determined that the issuance of FSP 109-2 has no effect on our financial position and results
of operations. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our carrying value of cash, accounts receivable, related party notes
receivable, accounts payable, accrued liabilities,
royalties payable, assets and liabilities of discontinued operations,
and amounts due to and from related parties are a
reasonable approximation of their fair value. 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 $18.6
million of our revenue for the year ended March 31, 2005. 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 March 31, 2005,
foreign subsidiaries represented 0.0% and 1.4% of consolidated net revenues and total assets,
respectively. We also recorded approximately $10.4 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. 45




---



##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Our Consolidated Financial Statements, and notes thereto, and our Financial Statement
Schedule, are presented on pages F-1 through F-35 hereof as set forth below: PAGEATARI, INC. AND SUBSIDIARIESReport of Independent Registered Public Accounting Firm
    
    
    F-1Consolidated Balance Sheets as of March 31, 2004 and March 31, 2005
    
    
    F-2Consolidated Statements of Operations and Comprehensive Income (Loss) for the
Nine Months Ended March 31, 2002 (unaudited) and 2003, and the Years Ended
March 31, 2003 (unaudited), 2004, and 2005
    
    
    F-3Consolidated Statements of Cash Flows for the Nine Months Ended
March 31, 2002 (unaudited) and 2003, and the Years Ended
March 31, 2003 (unaudited), 2004, and 2005
    
    
    F-5Consolidated Statements of Stockholders Equity (Deficiency) for the Nine Months
Ended March 31, 2003, and the Years Ended March 31, 2004 and 2005
    
    
    F-8Notes to the Consolidated Financial Statements
    
    F-10 to F-43FINANCIAL STATEMENT SCHEDULENine Months Ended March 31, 2003, and Years Ended March 31, 2004 and 2005Schedule IIValuation and Qualifying Accounts
    
    
    F-44
 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 
 ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures As of March 31, 2005, with the participation of our management, our Interim Chief Executive
Officer and our 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 recognized 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 Interim Chief
Executive Officer and our Chief Financial Officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information relating to Atari
(including its consolidated subsidiaries) required to be included in our periodic SEC filings. Managements Annual Report on Internal Control Over Financial Reporting Management of Atari is responsible for establishing and maintaining adequate internal control
over financial reporting, as such term is defined in the Exchange Act Rule 13a-15(f). Under the
supervision and with the participation of our management, including our Interim Chief Executive
Officer and our Chief Financial Officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting as of March 31, 2005 as required by the Exchange Act Rule
13a-15(c). In making this assessment, we used the criteria set forth in the framework in Internal
Control  Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in Internal Control  Integrated Framework,
our management concluded that our internal control over financial reporting was effective as of
March 31, 2005. Our managements assessment of the effectiveness of our internal control over financial
reporting as of March 31, 2005 has been audited by Deloitte & Touche LLP, an independent registered
public accounting firm, as stated in their report which appears below. Atari, Inc.
June 14, 2005 46




---



##### Table of Contents



Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of
Atari, Inc.
New York, New York We have audited managements assessment, included in the accompanying Managements Report on
Internal Control Over Financial Reporting, that Atari, Inc. and subsidiaries (the Company)
maintained effective internal control over financial reporting as of March 31, 2005, based on
criteria established in Internal Control  Integrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Companys management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility is to express an
opinion on managements assessment and an opinion on the effectiveness of the Companys internal
control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that the Company maintained effective internal control over
financial reporting as of March 31, 2005, is fairly stated, in all material respects, based on the
criteria established in Internal Control  Integrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also, in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of March 31, 2005,
based on the criteria established in Internal Control  Integrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements and consolidated financial statement
schedule as of and for the year ended March 31, 2005 of the Company and our report dated June 13,
2005 expressed an unqualified opinion on those financial statements and financial statement
schedule. DELOITTE & TOUCHE LLP New York, New York
June 13, 2005 47




---



##### Table of Contents



Changes in Internal Controls 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 March 31, 2005, that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting. 
 ITEM 9B. OTHER INFORMATION None. 
 PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The information required by this Item is incorporated by reference to the sections of our
definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, entitled Election of
Directors and Executive Officers, to be filed with the Securities and Exchange Commission within
120 days after the end of the fiscal year covered by this Form 10-K. 
 ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the sections of our
definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, entitled Executive
Compensation, to be filed with the Securities and Exchange Commission within 120 days after the
end of the fiscal year covered by this Form 10-K. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. The information required by this Item is incorporated by reference to the sections of our
definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, entitled Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, to be filed
with the Securities and Exchange Commission within 120 days after the end of the fiscal year
covered by this Form 10-K. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference to the sections of our
definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, entitled Certain
Relationships and Related Transactions, to be filed with the Securities and Exchange Commission
within 120 days after the end of the fiscal year covered by this Form 10-K. 
 ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this Item is incorporated by reference to the sections of our
definitive Proxy Statement for our 2005 Annual Meeting of Stockholders, entitled Principal
Accountant Fees and Services, to be filed with the Securities and Exchange Commission within 120
days after the end of the fiscal year covered by this Form 10-K. 48




---



##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) and (2) Financial Statements and Financial Statement Schedules See Item 8 above. (a)(3) Exhibits  3.1
    Amended and Restated Certificate of Incorporation is incorporated herein by reference to
Exhibit 3.1 to the Companys Annual Report on Form 10-K for the fiscal year ended March 31,
2000.3.2
    Amended and Restated By-laws are incorporated herein by reference to Exhibit 3.2 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.3.3
    Amendment No. 1 to Amended and Restated By-laws is incorporated by reference to Exhibit 3.2
to the Companys Quarterly Report on Form 10-Q for the quarter ended December 31, 2003.4.1
    Specimen form of stock certificate of Common Stock is incorporated herein by reference to the
Companys Registration Statement on Form S-1 (File No. 333-14441) initially filed with the SEC
on October 20, 1995, and all amendments thereto.4.2
    Registration Rights Agreement by and among Joseph J. Cayre, Kenneth Cayre, Stanley Cayre,
Jack J. Cayre, the Trusts listed on Schedule I attached thereto and the Company is
incorporated herein by reference to an exhibit filed as a part of the Companys Registration
Statement on Form S-1 filed October 20, 1995.4.3
    Second Amended and Restated Registration Rights Agreement, dated as of October 2, 2000,
between California U.S. Holdings, Inc. and the Company is incorporated herein by reference to
Exhibit 4.6 of the Companys Registration Statement on Form S-2 (File No. 333-107819)
initially filed with the SEC on August 8, 2003, and all amendments thereto.10.1
    Distribution Agreement between Infogrames Entertainment SA, Infogrames Multimedia SA and the
Company, dated as of December 16, 1999, is incorporated herein by reference to Exhibit 7 to
the Schedule 13D filed by Infogrames Entertainment SA and California U.S. Holdings, Inc. on
January 10, 2000. 49




---



##### Table of Contents



10.2
    Addendum to Distribution Agreement between Infogrames Entertainment SA and the Company,
dated as of December 16, 1999, is incorporated herein by reference to Exhibit 10.26a to the
Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2001.10.3
    Amendment to Distribution Agreement between Infogrames Entertainment SA and the Company dated as of
 July 1, 2000, is incorporated by reference to Exhibit 10.24a to the
Companys Transitional Report on Form 10-K for the transition
period March 31, 2000 to June 30, 2000.10.4
    Distribution Agreement between Infogrames Entertainment SA and the Company, dated October 2,
2000, as supplemented on November 12, 2002 is incorporated
herein by reference to Exhibit 10.3 to the Companys Annual
Report on Form 10-K for the fiscal year ended March 31, 2004.10.5
    Services Agreement, dated as of January 1, 2000, between Infogrames Entertainment SA and the
Company is incorporated herein by reference to Exhibit 10.41 to the Companys Transitional Report on
Form 10-K for the transition period March 31, 2000 to June 30, 2000.10.6
    Services Agreement, dated as of January 26, 2001, between the Company and Infogrames
Interactive, Inc. (now known as Atari Interactive, Inc.), is incorporated herein by reference
to Exhibit 10.46 to the Companys Annual Report on Form 10-K for the fiscal year ended June
30, 2001.10.7
    Warehouse Services Contract, dated March 2, 1999, by and between the Company and Arnold
Transportation Services, Inc. t/d/b/a Arnold Logistics is incorporated herein by reference to
Exhibit 10.50 to the Companys Annual Report on Form 10-K for the fiscal year ended March 31,
1999. 50




---



##### Table of Contents



10.8
    Credit Agreement, dated as of November 12, 2002, among the Company, as Borrower, the other
credit parties signatory thereto, the lenders signatory thereto from time to time, General
Electric Capital Corporation, as Administrative Agent, Agent and Lender, and GECC Capital
Markets Group, Inc., as Lead Arranger, is incorporated herein by reference to Exhibit 10.1 to
the Companys Current Report on Form 8-K filed on November 19, 2002.***10.9
    First Amendment and Consent to the Credit Agreement, dated as of March 28, 2003, among the
Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.57a to the Companys
Transition Report on Form 10-K for the fiscal year ended March 31, 2003.10.10
    Second Amendment and Consent to the Credit Agreement, dated as of April 15, 2003, among the
Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.57b to the Companys
Transition Report on Form 10-K for the fiscal year ended March 31, 2003.10.11
    Third Amendment and Waiver to the Credit Agreement, dated as of July 11, 2003, among the
Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.57c to the Companys
Transition Report on Form 10-K for the fiscal year ended March 31, 2003.10.12
    Fourth Amendment and Consent to the Credit Agreement, dated as of September 12, 2003, among
the Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003.10.13
    Fifth Amendment to the Credit Agreement, dated as of October 15, 2003, among the Company, as
Borrower, the other credit parties signatory thereto, the lenders signatory thereto from time
to time, General Electric Capital Corporation, as Administrative Agent, Agent and Lender is
incorporated herein by reference to Exhibit 10.2 to the Companys Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 2003.10.14
    Sixth Amendment to the Credit Agreement, dated as of December 23, 2003, among the Company,
as Borrower, the other credit parties signatory thereto, the lenders signatory thereto from
time to time, General Electric Capital Corporation, as Administrative Agent, Agent and Lender
is incorporated herein by reference to Exhibit 10.1 to the Companys Quarterly Report on Form
10-Q for the fiscal quarter ended December 31, 2003. 51




---



##### Table of Contents



10.15
    Seventh Amendment to the Credit Agreement, dated as of March 31, 2004, among the Company, as
Borrower, the other credit parties signatory thereto, the lenders signatory thereto from time
to time, General Electric Capital Corporation, as Administrative
Agent, Agent and Lender, is incorporated herein by reference to
Exhibit 10.28 to the Companys Annual Report on
Form 10-K for the year ended March 31, 2004.10.16
    Eighth Amendment to the Credit Agreement, dated as of May 20, 2004, among the Company, as
Borrower, the other credit parties signatory thereto, the lenders signatory thereto from time
to time, General Electric Capital Corporation, as Administrative
Agent, Agent and Lender, is incorporated herein by reference to
Exhibit 10.29 to the Companys Annual Report on
Form 10-K for the year ended March 31, 2004.10.17
    Consent to Credit Agreement, dated as of July 15, 2004,
among the Company, as Borrower, the other credit parties signatory
thereto, the lenders signatory thereto from time to time, and General
Electric Capital Corporation, as Administrative Agreement, Agent and
Lender, is incorporated herein by reference to Exhibit 10.2 to
the Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2004.10.18
    Intercreditor and Subordination Agreement, dated as of November 12, 2002, among Infogrames
Entertainment S.A, California U.S. Holdings, Inc., General Electric Capital Corporation and
the Credit Parties signatory thereto, is incorporated herein by reference to Exhibit 10.2 to
the Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended December 31, 2002.10.19
    First Amendment to Intercreditor and Subordination Agreement, dated as of December 23, 2003,
among Infogrames Entertainment S.A, California U.S. Holdings, Inc., Atari Interactive, Inc.,
General Electric Capital Corporation and the Credit Parties signatory thereto is incorporated
herein by reference to Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q for the
fiscal quarter ended December 31, 2003.10.20
    Loan and Security Agreement, dated as of May 13, 2005,
among the Company, as Borrower, and HSBC Business Credit (USA) Inc.,
as Lender.**10.21*
    Letter of Employment, dated as of April 23, 2002, between David Perry and the Company is
incorporated herein by reference to Exhibit 10.53 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2002.10.22*
    The 1995 Stock Incentive Plan (as amended on October 31, 1996) is incorporated herein by
reference to Exhibit 10.1 to Amendment No. 2 to the Companys Registration Statement on Form
S-1, filed December 6, 1996.10.23*
    The 1997 Stock Incentive Plan is incorporated herein by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.10.24*
    The 1997 Stock Incentive Plan (as amended on June 17, 1998) is incorporated herein by
reference to Exhibit 10.5 to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998. 52




---



##### Table of Contents



10.25*
    The 2000 Stock Incentive Plan is incorporated herein by reference to Appendix B to the
Companys proxy statement dated June 29, 2000.10.26*
    Amendment No. 1 to 2000 Stock Incentive Plan is
incorporated herein by reference to Exhibit A to the
Companys
Information Statement dated November 27, 2000.10.27*
    Third Amendment to the Atari, Inc. 2000 Stock Incentive Plan
is incorporated herein by reference to Exhibit 10.1 to the
Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2004.10.28*
    The 1998 Employee Stock Purchase Plan is incorporated herein by reference to Exhibit 10.6 to
the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.10.29*
    Description of Registrants Annual Incentive Plan for
fiscal 2005.**10.30*
    Employment Agreement, dated June 1, 2002, between the Company and Harry M. Rubin is
incorporated herein by reference to Exhibit 6.1 to the Companys Annual Report on Form 10-K
for the quarter ended June 30, 2002.10.31*
    Employment Agreement with Bruno Bonnell, dated as of
July 1, 2004 and effective as of April 1, 2004, is
incorporated herein by reference  to Exhibit 10.1 to the
Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2004.10.32*
    Termination and General Release Agreement, dated
October 15, 2004, by and between the Company and Denis Guyennot is incorporated herein by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended
December 31, 2004.10.33*
    Employment Agreement, dated November 26, 2004, by and
between the Company and James Caparro is incorporated herein by
reference to Exhibit 10.4 to the Companys Quarterly Report on
Form 10-Q for the quarter ended December 31, 2004.10.34*
    Letter Agreement by and between the Company and Diane Price
Baker, dated January 24, 2005.**10.35*
    Consultant Agreement between the Company and Ann Kronen,
dated as of July 8, 2003 is incorporated herein by reference to
Exhibit 10.63 to the Companys Annual Report on Form 10-K for the
year ended March 31, 2004.***10.36
    Agreement of Lease, dated as of December 12, 1996, by and between the Company and F.S.
Realty Corp is incorporated herein by reference to Exhibit 10.29 to the Companys Annual
Report on Form 10-K for the year ended December 31, 1996.10.37
    First Amendment of Lease dated July 1, 1997 by and
between the Company and F.S. Realty Corporation.**10.38
    Lease Agreement between the Company and Netbreeders Realty LLC, dated November 1, 1999, is
incorporated herein by reference to Exhibit 10.11 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.10.39
    Sublease Agreement between the Company and SAVI Technology, Inc., dated May 30, 2001, is
incorporated herein by reference to Exhibit 10.14 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.10.40
    Lease Agreement between the Company and Edward Silver, Co-Trustee of the Silver Trust and
Paul Weinstein, Co-Trustee of the Weinstein Trust (dba PTL Realty), dated May 7, 2001, is
incorporated herein by reference to Exhibit 10.15 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.10.41
    Lease Agreement between the Company and MV 1997, L.L.C., dated November 24, 1997, is
incorporated herein by reference to Exhibit 10.16 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001. 53




---



##### Table of Contents



10.42
    Lease Agreement between Parabola Estates Limited and Reflections Interactive Limited dated
September 10, 2001 is incorporated herein by reference to Exhibit 10.56 to the
Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2002.10.43
    Lease Agreement between Prima Development Corp. and the Company dated May 17, 2002 is
incorporated herein by reference to Exhibit 10.55 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2002.10.44
    Licensed Publisher Agreement between the Company and Sony Computer Entertainment America,
Inc., dated January 19, 2003, is incorporated herein by reference to Exhibit 10.62 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.45
    PlayStation®2 Licensed Publisher Agreement between the Company and Sony
Computer Entertainment America, Inc., dated April 1, 2000, as amended.**10.46
    Xbox® Publisher License Agreement between the Company and Microsoft Corporation, dated April
18, 2000, is incorporated herein by reference to Exhibit 10.63 to the Companys Registration
Statement on Form S-2 (File No. 333-107819) initially filed with the SEC on August 8, 2003,
and all amendments thereto.***10.47
    Sublicense Agreement between the Company and Funimation Productions, Ltd., dated October 27,
1999, is incorporated herein by reference to Exhibit 10.64 to the Companys Registration
Statement on Form S-2 (File No. 333-107819) initially filed with the SEC on August 8, 2003,
and all amendments thereto.***10.48
    Amendment One to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated April 20, 2002, is incorporated herein by reference to Exhibit 10.65 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.49
    Amendment Two to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated June 15, 2002, is incorporated herein by reference to Exhibit 10.66 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.50
    Amendment Three to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated October 15, 2002, is incorporated herein by reference to Exhibit 10.67 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.51
    Amendment Four to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated November 13, 2002, is incorporated herein by reference to Exhibit 10.68 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.52
    Amendment Five to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated February 21, 2003, is incorporated herein by reference to Exhibit 10.69 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.53
    Amendment Six to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated August 11, 2003 as incorporated herein by reference
to Exhibit 10.83 to the Companys Annual Report on Form 10-K for
the year ended March 31, 2004.10.54
    Agreement Regarding Satisfaction of Debt and License Amendment among the Company, Infogrames
Entertainment S.A. and California U.S. Holdings, Inc., dated September 4, 2003, is
incorporated herein by reference to Exhibit 10.70 to the Companys Registration Statement on
Form S-2 (File No. 333-107819) initially filed with the SEC on August 8, 2003, and all
amendments thereto.10.55
    Amended Trademark License Agreement between the Company and Infogrames Entertainment S.A.,
dated September 4, 2003, is incorporated herein by reference to Exhibit 10.71 to the Companys
Registration Statement on Form S-2 (File No. 333-107819) initially filed with the SEC on
August 8, 2003, and all amendments thereto.10.56
    Obligation Assignment and Securing Agreement, dated as of
November 3, 2004, by and among the Company, Infogrames
Entertainment SA, Atari Interactive, Inc., Atari Europe SAS, and
Paradigm Entertainment, Inc, is incorporated herein by reference to
Exhibit 10.1 of the Companys Quarterly Report on Form 10-Q
for the quarter ended December 31, 2004.10.57
    Secured Promissory Note of Atari Interactive, Inc. in the
aggregate amount of $23,058,997.19 payable to the Company is
incorporated herein by reference to Exhibit 10.2 of the Companys
Quarterly Report on Form 10-Q for the quarter ended December 31, 2004.10.58
    Promissory Note of Atari Interactive, Inc., in the aggregate amount of $5,122,625 payable to
the Company as incorporated herein by reference to Exhibit 10.86 to
the Companys Annual Report on Form 10-K for the year ended
March 31, 2004.10.59
    Promissory Note of Atari Interactive, Inc., in the aggregate amount of $2,620,280 payable to
the Company as incorporated herein by reference to Exhibit 10.87 to
the Companys Annual Report on Form 10-K for the year ended
March 31, 2004.10.60
    Promissory Note of Paradigm Entertainment, Inc., in the aggregate amount of $828,870 payable
to the Company as incorporated herein by reference to Exhibit 10.88 to
the Companys Annual Report on Form 10-K for the year ended
March 31, 2004. 54




---



##### Table of Contents



21.1
    List of Subsidiaries.**23.1
    Consent of Deloitte & Touche LLP.**31.1
    Interim 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
    Certification by the Interim Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**32.2
    Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**99.1
    Licensed PSP Publisher Agreement by and between the Company and
Sony Computer Entertainment America, Inc. dated March 23, 2005, for PlayStation® Portable.**99.2
    Amendment to the Xbox® Publisher Licensing Agreement, dated
March 1, 2005.**99.3
    Confidential License Agreement for Nintendo GameCube, by and between
Nintendo of America, Inc. and the Company effective March 29, 2002.**99.4
    License Agreement between the Company and FUNimation
Productions, Ltd., dated December 31, 2004.** Exhibit indicated with an * symbol is a management contract or compensatory plan or arrangement
filed pursuant to Item 15(c) of Form 10-K. Exhibit indicated with an ** symbol is filed herewith. *** All immaterial
amendments/extensions to this agreement were filed as an exhibit 99
in the Companys Quarterly Report for the respective period.  Portions of this exhibit have been redacted pursuant to a confidential treatment request filed
with the SEC. A copy of any of the exhibits included in this Annual Report on Form 10-K may be obtained by
written request to Atari, Inc. upon payment of a fee of $0.10 per page to cover costs. Requests
should be sent to Atari, Inc. at the address set forth on the front cover, attention Director,
Investor Relations. 55




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized. ATARI, INC.By:
    /s/     Bruno BonnellName:
    Bruno BonnellTitle:  Date:
    Interim Chief Executive Officer
            June 14, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant in the capacities and on the
dates indicated. Signature
    
    Title(s)
    
    Date/s/ Bruno Bonnell
    
    Interim Chief Executive Officer
(principal executive officer) and Director
    
    June 14, 2005Bruno Bonnell/s/ Diane Price Baker
    
    Executive Vice President and Chief Financial Officer
(principal financial officer)
    
    June 14, 2005Diane Price Baker/s/ Jodi Scheurenbrand
    
    Senior Vice President and Controller (principal
accounting officer)
    
    June 14, 2005Jodi Scheurenbrand/s/ James Ackerly
    
    Director
    
    June 14, 2005James Ackerly/s/ James Caparro
    
    Director
    
    June 14, 2005James Caparro/s/ Denis Guyennot
    
    Director
    
    June 14, 2005Denis Guyennot/s/ Thomas A. Heymann
    
    Director
    
    June 14, 2005Thomas A. Heymann/s/ Ann E. Kronen
    
    Director
    
    June 14, 2005Ann E. Kronen/s/ Thomas J. Mitchell
    
    Director
    
    June 14, 2005Thomas J. Mitchell/s/ Thomas Schmider
    
    Director
    
    June 14, 2005Thomas Schmider
 56




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES 
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of
Atari, Inc.
New York, New York We have audited the accompanying consolidated balance sheets of Atari, Inc. and
subsidiaries (the Company) as of March 31, 2005 and 2004, and the related
consolidated statements of operations and comprehensive income (loss), stockholders
equity (deficiency) and cash flows for the years ended March 31, 2005 and 2004, and
for the nine months ended March 31, 2003. Our audits also included the consolidated
financial statement schedule listed at Item 15. These consolidated financial
statements and the consolidated financial statement schedule are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements and the consolidated financial statement schedule
based on our audits. We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company at March 31,
2005 and 2004, and the consolidated results of their operations and their cash flows
for the years ended March 31, 2005 and 2004, and for the nine months ended March 31,
2003 in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth therein. We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Companys
internal control over financial reporting as of March 31, 2005, based on the criteria
established in Internal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission and our report
dated June 13, 2005
expressed an unqualified opinion on managements assessment of the effectiveness of
the Companys internal control over financial reporting and an unqualified opinion on
the effectiveness of the Companys internal control over financial reporting.  DELOITTE & TOUCHE
LLP
New York, New York
June 13, 2005 F-1




---



##### Table of Contents



ATARI, INC. AND
SUBSIDIARIES 
 CONSOLIDATED BALANCE
SHEETS
 (in thousands)
 March 31,
    
    
    March 31,2004
    
    
    2005ASSETSCurrent assets:Cash
    
    $
    9,607
    
    
    $
    10,433Receivables, net
    
    
    37,707
    
    
    
    42,179Inventories, net
    
    
    25,643
    
    
    
    25,209Income taxes receivable
    
    
    2,320
    
    
    
    1,533Due from related parties
    
    
    4,175
    
    
    
    248Prepaid expenses and other current assets
    
    
    12,449
    
    
    
    20,996Related party notes receivable
    
    
    8,571
    
    
    
    Assets of discontinued operations (Note 20)
    
    
    2,677
    
    
    
    3,555Total current assets
    
    
    103,149
    
    
    
    104,153Property and equipment, net
    
    
    12,581
    
    
    
    8,289Goodwill, net of accumulated amortization of $26,116 in both periods
    
    
    70,224
    
    
    
    70,224Other intangible assets, net of accumulated amortization of $1,294 and $1,969, at
March 31, 2004 and March 31, 2005, respectively
    
    
    1,406
    
    
    
    731Other assets
    
    
    6,596
    
    
    
    6,642Total assets
    
    $
    193,956
    
    
    $
    190,039LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    37,780
    
    
    $
    27,756Accrued liabilities
    
    
    15,665
    
    
    
    16,537Restructuring reserve
    
    
    
    
    
    
    1,885Royalties payable
    
    
    14,195
    
    
    
    13,641Income taxes payable
    
    
    450
    
    
    
    500Short-term deferred income
    
    
    2,107
    
    
    
    77Due to related parties
    
    
    6,704
    
    
    
    5,421Liabilities of discontinued operations (Note 20)
    
    
    1,020
    
    
    
    2,685Total current liabilities
    
    
    77,921
    
    
    
    68,502Deferred income
    
    
    555
    
    
    
    478Other long-term liabilities
    
    
    417
    
    
    
    392Total liabilities
    
    
    78,893
    
    
    
    69,372Commitments and contingencies
    
    
    
    
    
    
    Stockholders 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 121,296
shares issued and outstanding at March 31, 2004 and March 31, 2005,
respectively
    
    
    1,212
    
    
    
    1,213Additional paid-in capital
    
    
    735,964
    
    
    
    736,790Accumulated deficit
    
    
    (625,436
    )
    
    
    (619,744
    )Accumulated other comprehensive income
    
    
    3,323
    
    
    
    2,408Total stockholders equity
    
    
    115,063
    
    
    
    120,667Total liabilities and stockholders equity
    
    $
    193,956
    
    
    $
    190,039
 The accompanying notes are an integral part of these consolidated financial statements. F-2




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
 (in thousands, except per share data)
 Nine Months
    
    
    YearsEnded March 31,
    
    
    Ended March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Net revenues
    
    $
    263,824
    
    
    $
    376,887
    
    
    $
    501,321
    
    
    $
    447,451
    
    
    $
    395,165Cost of goods sold
    
    
    146,392
    
    
    
    195,743
    
    
    
    253,468
    
    
    
    240,238
    
    
    
    205,503Gross profit
    
    
    117,432
    
    
    
    181,144
    
    
    
    247,853
    
    
    
    207,213
    
    
    
    189,662Selling and distribution expenses
    
    
    58,778
    
    
    
    66,959
    
    
    
    87,771
    
    
    
    80,442
    
    
    
    60,763General and administrative expenses
    
    
    28,925
    
    
    
    32,256
    
    
    
    40,800
    
    
    
    33,031
    
    
    
    36,887Restructuring expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,932In-process research and development
    
    
    
    
    
    
    
    
    
    
    7,400
    
    
    
    
    
    
    
    Research and product development
    
    
    42,189
    
    
    
    55,829
    
    
    
    74,614
    
    
    
    79,495
    
    
    
    65,944Gain on sale of development project
to a related party
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,744
    )
    
    
    Depreciation and amortization
    
    
    3,227
    
    
    
    5,580
    
    
    
    7,397
    
    
    
    8,804
    
    
    
    10,602Operating (loss) income
    
    
    (15,687
    )
    
    
    20,520
    
    
    
    29,871
    
    
    
    9,185
    
    
    
    10,534Interest expense, net
    
    
    (7,887
    )
    
    
    (9,598
    )
    
    
    (13,667
    )
    
    
    (7,658
    )
    
    
    (459
    )Other income (expense)
    
    
    287
    
    
    
    644
    
    
    
    (2,868
    )
    
    
    (2,068
    )
    
    
    42(Loss) income from continuing
operations before (benefit from)
provision for income taxes
    
    
    (23,287
    )
    
    
    11,566
    
    
    
    13,336
    
    
    
    (541
    )
    
    
    10,117(Benefit from) provision for income
taxes
    
    
    (5,014
    )
    
    
    405
    
    
    
    2,083
    
    
    
    (2,919
    )
    
    
    184(Loss) income from continuing operations
    
    
    (18,273
    )
    
    
    11,161
    
    
    
    11,253
    
    
    
    2,378
    
    
    
    9,933Income (loss) from discontinued
operations of Humongous
Entertainment (Note 20)
    
    
    8,052
    
    
    
    6,909
    
    
    
    6,107
    
    
    
    (1,612
    )
    
    
    (4,241
    )Net (loss) income

    
    
    (10,221
    )
    
    
    18,070
    
    
    
    17,360
    
    
    
    766
    
    
    
    5,692Dividend to parent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    (Loss) income attributable to
common stockholders
    
    $
    (10,221
    )
    
    $
    18,070
    
    
    $
    17,360
    
    
    $
    (38,585
    )
    
    $
    5,692Basic and diluted (loss) income per share:(Loss) income from continuing
operations
    
    $
    (0.26
    )
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.02
    
    
    $
    0.08Income (loss) from discontinued
operations of Humongous
Entertainment
    
    
    0.11
    
    
    
    0.10
    
    
    
    0.09
    
    
    
    (0.01
    )
    
    
    (0.03
    )Dividend to parent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.41
    )
    
    
    (Loss) income per share attributable to
common stockholders
    
    $
    (0.15
    )
    
    $
    0.26
    
    
    $
    0.25
    
    
    $
    (0.40
    )
    
    $
    0.05Basic weighted average shares
outstanding
    
    
    69,686
    
    
    
    69,878
    
    
    
    69,864
    
    
    
    96,990
    
    
    
    121,276
 F-3




---



##### Table of Contents



Nine Months
    
    
    YearsEnded March 31,
    
    
    Ended March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Diluted weighted average shares
outstanding
    
    
    69,686
    
    
    
    70,055
    
    
    
    70,058
    
    
    
    96,990
    
    
    
    121,587Net (loss) income
    
    $
    (10,221
    )
    
    $
    18,070
    
    
    $
    17,360
    
    
    $
    766
    
    
    $
    5,692Other comprehensive (loss) income:Recognition of cumulative translation
adjustment from liquidation of a
foreign subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (859
    )Foreign currency translation
adjustments
    
    
    489
    
    
    
    46
    
    
    
    334
    
    
    
    142
    
    
    
    (56
    )Unrealized (loss) on securities
    
    
    (57
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Reclassification adjustment for
realized gains included in net loss
    
    
    (388
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Comprehensive (loss) income
    
    $
    (10,177
    )
    
    $
    18,116
    
    
    $
    17,694
    
    
    $
    908
    
    
    $
    4,777
 The accompanying notes are an integral part of these consolidated financial statements. F-4




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (in thousands)
 Nine Months
    
    
    YearsEnded
    
    
    EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)CASH FLOWS FROM OPERATING ACTIVITIES:Net (loss) income
    
    $
    (10,221
    )
    
    $
    18,070
    
    
    $
    17,360
    
    
    $
    766
    
    
    $
    5,692Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    3,227
    
    
    
    5,580
    
    
    
    7,397
    
    
    
    8,804
    
    
    
    10,602(Income) loss from discontinued operations
    
    
    (8,052
    )
    
    
    (6,909
    )
    
    
    (6,107
    )
    
    
    1,612
    
    
    
    4,241Modification of stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    139Non-cash restructuring charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    596Recognition of cumulative translation adjustment from
foreign subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (859
    )Loss on sale of investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,750
    
    
    
    Write-down of investment
    
    
    
    
    
    
    
    
    
    
    3,622
    
    
    
    
    
    
    
    Amortization of discount on related party debt
    
    
    2,153
    
    
    
    2,153
    
    
    
    2,870
    
    
    
    1,339
    
    
    
    Accrued interest
    
    
    2,911
    
    
    
    5,295
    
    
    
    6,141
    
    
    
    1,903
    
    
    
    23Amortization of deferred financing fees
    
    
    819
    
    
    
    1,035
    
    
    
    1,061
    
    
    
    2,466
    
    
    
    822Recognition of deferred income
    
    
    (1,750
    )
    
    
    631
    
    
    
    2,438
    
    
    
    (3,577
    )
    
    
    (2,107
    )Write-off of property and equipment
    
    
    52
    
    
    
    358
    
    
    
    832
    
    
    
    38
    
    
    
    198In-process research and development related to
acquisition of Shiny Entertainment, Inc.
    
    
    
    
    
    
    
    
    
    
    7,400
    
    
    
    
    
    
    
    Gain on sale of marketable securities
    
    
    (388
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Changes in operating assets and liabilities:Receivables, net
    
    
    (3,067
    )
    
    
    34,162
    
    
    
    (6,479
    )
    
    
    9,346
    
    
    
    (4,472
    )Inventories, net
    
    
    (11,535
    )
    
    
    7,446
    
    
    
    4,551
    
    
    
    9,893
    
    
    
    434Due from related parties
    
    
    (1,691
    )
    
    
    1,532
    
    
    
    3,689
    
    
    
    (793
    )
    
    
    3,934Due to related parties
    
    
    (10,476
    )
    
    
    2,830
    
    
    
    4,652
    
    
    
    (6,774
    )
    
    
    (1,333
    )Prepaid expenses and other current assets
    
    
    (3,774
    )
    
    
    (8,604
    )
    
    
    (7,399
    )
    
    
    6,207
    
    
    
    (9,165
    )Accounts payable
    
    
    2,889
    
    
    
    (19,492
    )
    
    
    (1,234
    )
    
    
    (1,606
    )
    
    
    (10,046
    )Accrued liabilities
    
    
    (819
    )
    
    
    (3,446
    )
    
    
    4,321
    
    
    
    (15,726
    )
    
    
    631Royalties payable
    
    
    (5,661
    )
    
    
    4,650
    
    
    
    6,944
    
    
    
    2,261
    
    
    
    (554
    )Restructuring reserve
    
    
    (1,946
    )
    
    
    (470
    )
    
    
    (630
    )
    
    
    (71
    )
    
    
    1,938Deferred income
    
    
    2,121
    
    
    
    
    
    
    
    
    
    
    
    30
    
    
    
    Income taxes payable
    
    
    
    
    
    
    507
    
    
    
    1,503
    
    
    
    (1,543
    )
    
    
    45Income taxes receivable
    
    
    (3,973
    )
    
    
    689
    
    
    
    5,985
    
    
    
    (1,909
    )
    
    
    789Other long-term liabilities
    
    
    1,441
    
    
    
    (269
    )
    
    
    (259
    )
    
    
    (461
    )
    
    
    (264
    )Other assets
    
    
    3,094
    
    
    
    (564
    )
    
    
    2,174
    
    
    
    (288
    )
    
    
    (3,564
    )Net cash (used in) provided by continuing operations
    
    
    (44,646
    )
    
    
    45,184
    
    
    
    60,832
    
    
    
    13,667
    
    
    
    (2,280
    )Net cash provided by (used in) discontinued
operations
    
    
    6,335
    
    
    
    7,124
    
    
    
    7,605
    
    
    
    (1,799
    )
    
    
    (3,364
    )Net cash (used in) provided by operating activities
    
    
    (38,311
    )
    
    
    52,308
    
    
    
    68,437
    
    
    
    11,868
    
    
    
    (5,644
    )
 F-5




---



##### Table of Contents



Nine Months
    
    
    YearsEnded
    
    
    EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of property and equipment
    
    
    (6,304
    )
    
    
    (3,940
    )
    
    
    (5,883
    )
    
    
    (5,038
    )
    
    
    (2,039
    )Proceeds from sale of property and equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Proceeds from sale of marketable securities
    
    
    497
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of related party notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,571
    )
    
    
    Issuance of secured promissory note
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (23,059
    )Repayment of secured promissory note, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,059Transfer and assignment of related party notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,254Repayment of related party notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,317Advances to related parties
    
    
    
    
    
    
    (32,184
    )
    
    
    (32,184
    )
    
    
    (14,368
    )
    
    
    Acquisition of Shiny Entertainment, Inc., net of nominal
cash acquired
    
    
    
    
    
    
    
    
    
    
    (34,010
    )
    
    
    
    
    
    
    Net cash (used in) provided by continuing
operations
    
    
    (5,807
    )
    
    
    (36,124
    )
    
    
    (72,077
    )
    
    
    (27,977
    )
    
    
    6,549Net cash (used in) discontinued operations
    
    
    (185
    )
    
    
    (128
    )
    
    
    (201
    )
    
    
    (90
    )
    
    
    (90
    )Net cash (used in) provided by investing activities
    
    
    (5,992
    )
    
    
    (36,252
    )
    
    
    (72,278
    )
    
    
    (28,067
    )
    
    
    6,459CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings (payments) under related party credit
facility, net
    
    
    54,000
    
    
    
    (16,632
    )
    
    
    (18,258
    )
    
    
    
    
    
    
    Borrowings from related party medium-term loan
    
    
    
    
    
    
    8,896
    
    
    
    48,277
    
    
    
    
    
    
    
    Payments of BNP Paribus revolving credit facility
    
    
    (10,000
    )
    
    
    (15,000
    )
    
    
    (25,000
    )
    
    
    
    
    
    
    Borrowings (payments) under General Electric Capital
Corporation Senior Credit Facility, net
    
    
    
    
    
    
    10,651
    
    
    
    10,651
    
    
    
    (10,651
    )
    
    
    Payments under short-term promissory notes
    
    
    
    
    
    
    (8,833
    )
    
    
    (16,058
    )
    
    
    
    
    
    
    Proceeds from exercise of stock options
    
    
    32
    
    
    
    116
    
    
    
    116
    
    
    
    518
    
    
    
    92Payments under capitalized lease obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (109
    )Net proceeds from public stock offering
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    34,875
    
    
    
    Proceeds from employee stock purchase plan
    
    
    127
    
    
    
    125
    
    
    
    199
    
    
    
    104
    
    
    
    Net cash provided by (used in) financing activities
    
    
    44,159
    
    
    
    (20,677
    )
    
    
    (73
    )
    
    
    24,846
    
    
    
    (17
    )Effect of exchange rates on cash
    
    
    75
    
    
    
    39
    
    
    
    69
    
    
    
    150
    
    
    
    28Net (decrease) increase in cash
    
    
    (69
    )
    
    
    (4,582
    )
    
    
    (3,845
    )
    
    
    8,797
    
    
    
    826Cash  beginning of fiscal year
    
    
    4,724
    
    
    
    5,392
    
    
    
    4,655
    
    
    
    810
    
    
    
    9,607Cash  end of fiscal year
    
    $
    4,655
    
    
    $
    810
    
    
    $
    810
    
    
    $
    9,607
    
    
    $
    10,433
 F-6




---



##### Table of Contents



Nine Months
    
    
    YearsEnded
    
    
    EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)SUPPLEMENTAL CASH FLOW INFORMATIONSUPPLEMENTAL DISCLOSURE OF
OPERATING ACTIVITIES:Cash paid for interest
    
    
    2,344
    
    
    
    3,599
    
    
    
    4,114
    
    
    
    5,984
    
    
    
    450Cash paid for taxes
    
    
    
    
    
    
    450
    
    
    
    450
    
    
    
    739
    
    
    
    Income tax refunds
    
    
    1,066
    
    
    
    1,157
    
    
    
    6,952
    
    
    
    18
    
    
    
    764SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING ACTIVITIES:Acquisition of Shiny Entertainment, Inc.:Fair value of assets acquired
    
    $
    
    
    
    $
    
    
    
    $
    50,776
    
    
    $
    
    
    
    $
    Less: Short-term promissory notes issued to seller and others
    
    
    
    
    
    
    
    
    
    
    (16,059
    )
    
    
    
    
    
    
    Assumption of stock options
    
    
    
    
    
    
    
    
    
    
    (672
    )
    
    
    
    
    
    
    Other payments due seller
    
    
    
    
    
    
    
    
    
    
    (31
    )
    
    
    
    
    
    
    Cash acquired
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    
    
    
    
    Acquisition, net of cash acquired
    
    $
    
    
    
    $
    
    
    
    $
    34,010
    
    
    $
    
    
    
    $
    Acquisition of Atari license for 2,000 shares of common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,500
    
    
    
    SUPPLEMENTAL DISCLOSURE OF NON-CASH
FINANCING ACTIVITIES:Sale of treasury stock in lieu of partial royalty payment
    
    
    855
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Assumption of Shiny Entertainment, Inc. employee stock
purchase plan
    
    
    
    
    
    
    
    
    
    
    672
    
    
    
    
    
    
    
    Issuance of warrants to external developer
    
    
    
    
    
    
    54
    
    
    
    54
    
    
    
    
    
    
    
    Issuance of shares in lieu of partial royalty payment
    
    
    41
    
    
    
    
    
    
    
    
    
    
    
    1,199
    
    
    
    Net debt exchanged for 39,030 shares of common stock:Related party debt, revolving credit facility and related party
medium-term loan prior 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
    
    
    $
    
 The accompanying notes are an integral part of these consolidated financial statements. F-7




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIENCY)
 (in thousands)
 AccumulatedCommon
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    OtherStock
    
    
    Common
    
    
    Paid-In
    
    
    Accumulated
    
    
    ComprehensiveShares
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    Income
    
    
    TotalBalance, June 30, 2002
    
    
    69,826
    
    
    
    698
    
    
    
    485,759
    
    
    
    (604,921
    )
    
    
    3,135
    
    
    
    (115,329
    )Issuance of common stock pursuant to
employee stock
purchase plan
    
    
    46
    
    
    
    
    
    
    
    125
    
    
    
    
    
    
    
    
    
    
    
    125Exercise of stock options
    
    
    48
    
    
    
    1
    
    
    
    115
    
    
    
    
    
    
    
    
    
    
    
    116Issuance of warrants to external developer
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    
    
    
    
    
    
    
    
    54Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,070
    
    
    
    
    
    
    
    18,070Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    46
    
    
    
    46Balance, 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
    
    
    
    
    
    
    
    
    
    
    
    34,875
 F-8




---



##### Table of Contents



AccumulatedCommon
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    OtherStock
    
    
    Common
    
    
    Paid-In
    
    
    Accumulated
    
    
    ComprehensiveShares
    
    
    Stock
    
    
    Capital
    
    
    Deficit
    
    
    Income
    
    
    TotalBalance, March 31, 2004
    
    
    121,231
    
    
    $
    1,212
    
    
    $
    735,964
    
    
    $
    (625,436
    )
    
    $
    3,323
    
    
    $
    115,063Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,692
    
    
    
    
    
    
    
    5,692Foreign currency translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (56
    )
    
    
    (56
    )Cashless exercise of warrants
    
    
    44
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    Recognition of cumulative translation
adjustment from
liquidation of a foreign subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (859
    )
    
    
    (859
    )Exercise of stock options
    
    
    21
    
    
    
    
    
    
    
    44
    
    
    
    
    
    
    
    
    
    
    
    44Issuance of stock options to related party
    
    
    
    
    
    
    
    
    
    
    48
    
    
    
    
    
    
    
    
    
    
    
    48Modification of stock options
    
    
    
    
    
    
    
    
    
    
    735
    
    
    
    
    
    
    
    
    
    
    
    735Balance, March 31, 2005
    
    
    121,296
    
    
    $
    1,213
    
    
    $
    736,790
    
    
    $
    (619,744
    )
    
    $
    2,408
    
    
    $
    120,667
 The accompanying notes are
an integral part of these consolidated financial
statements. F-9




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 Note 1  Operations and Summary of Significant Accounting Policies Nature of Business We are a global publisher and developer of video game software for both gaming enthusiasts and
the mass-market audience, as well as a 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, GameCube, and DS; Microsoft Xbox; and personal computers,
referred to as PCs. We also publish and sub-license games for the
wireless, internet, and
other evolving platforms. Our diverse portfolio of products extends across every major video game
genre, including action, adventure, strategy, children, family, driving and sports games. Through our relationship with our majority stockholder, Infogrames Entertainment S.A., a
French corporation (IESA), listed on Euronext, our products are distributed exclusively by IESA
throughout Europe, Asia and certain other regions. Similarly, we exclusively distribute IESAs
products in the United States and Canada. Furthermore, we distribute product in Mexico through various non-exclusive agreements. At March 31, 2005, IESA owns approximately 52%
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). Principles of Consolidation The consolidated financial statements include our accounts and our wholly-owned subsidiaries.
All material intercompany transactions and balances have been eliminated. Change in Fiscal Year-end Effective March 28, 2003, we changed our fiscal year-end from June 30 to March 31.
Accordingly, the audited fiscal period ended March 31, 2003, represents nine months of operations
and the audited fiscal periods ended March 31, 2004 and March 31, 2005 represent twelve months of
operations. Unaudited Consolidated Financial Statements The unaudited consolidated financial statements and related notes for the nine months ended
March 31, 2002 and the year ended March 31, 2003 have been prepared on the same basis as the
audited consolidated financial statements. In the opinion of management, such unaudited financial
statements include all adjustments (consisting only of normal recurring accruals) necessary for a
fair presentation of this information. These financial statements are presented for comparative
purposes. Revenue Recognition Revenue is recognized when title and risk of loss transfer to the customer, provided that
collection of the resulting receivable is deemed probable by management. We are not contractually obligated to accept returns except for defective product. However,
we may permit our customers to return or exchange product and we provide allowances for estimated
returns, price concessions, or other allowances on a negotiated basis. We estimate such returns and
allowances based upon managements evaluation of historical experience, market acceptance of
products produced, retailer inventory levels, budgeted customer allowances, the nature of the title
and existing commitments to customers. Such estimates are deducted from gross sales and provided
for at the time revenue is recognized. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting
principles in the United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and F-10




---



##### Table of Contents



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. Cash Cash consists of cash in banks and highly liquid short-term investments with original
maturities of three months or less at the date acquired. Inventories Inventories are stated at the lower of cost (average cost method) or market. Allowances are
established to reduce the recorded cost of obsolete inventory and slow moving inventory to its net
realizable value. Property and Equipment Property and equipment is recorded at cost. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets, which range from three to seven years.
Leasehold improvements are amortized using the straight-line method over the shorter of the lease
term or the estimated useful lives of the related assets. Goodwill and Other Intangible Assets Financial Accounting Standards Board (FASB) Statement 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, 2005, our annual
fair-value based assessment did not result in any 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 $0.7 million, net of accumulated
amortization of $1.3 million and $2.0 million at March 31, 2004 and March 31, 2005, respectively. Fair Values of Financial Instruments FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, requires
certain disclosures regarding the fair value of financial instruments. Cash, accounts receivable,
related party notes receivable, accounts payable, accrued liabilities, royalties payable, assets
and liabilities of discontinued operations, 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 U.S. 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 FASB Statement No. 144, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of. Research and Product Development Costs Research and product 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 product development costs also include payments for royalty advances (milestone
payments) to third-party developers for products that are currently in development. F-11




---



##### Table of Contents



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 product development expenses. Due to recently implemented enhancements
in our internal project planning and acceptance process and anticipated additional improvements in
our ability to assess post-release consumer acceptance, we are currently considering a change from
expensing such costs when incurred to a method of deferral and amortization over each products
life cycle. Should management change its method of accounting for product development costs, such
change will be implemented prospectively. Management believes that the ability to amortize such
costs over the products life cycle will result in a better matching of costs and revenues. 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 product development expense) in the period management determines that such
capitalized amounts are not expected to be realized. Advertising Expenses Advertising costs are expensed as incurred. Advertising expenses for the the nine months
ended March 31, 2002 (unaudited) and 2003, and the years ended March 31, 2003 (unaudited), 2004,
and 2005 amounted to approximately $27.1 million, $40.6 million, $51.0 million, $49.2 million, and
$34.1 million, respectively. 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 a quarterly basis and record the estimated tax obligation based on our current
year-to-date taxable income and expectations of the full year results. Foreign Currency Assets and liabilities of foreign subsidiaries have been translated at year-end exchange
rates, while revenues and expenses have been translated at average exchange rates in effect during
the year. Cumulative translation adjustments have been reported as a component of accumulated
other comprehensive income. Foreign Exchange Gains (Losses) Foreign exchange gains or losses arise from exchange rate fluctuations on transactions
denominated in currencies other than the functional currency. For the nine months ended March 31,
2002 (unaudited) and 2003, foreign exchange gains (losses) were nominal. For the years ended March
31, 2003 (unaudited), 2004, and 2005, foreign exchange losses were $0.1 million, $0.3 million, and
$0.3 million, respectively. Shipping, Handling and Warehousing Costs Shipping, handling and warehousing costs incurred to move product to the customer are charged
to selling and distribution expense. For the nine months ended March 31, 2002 (unaudited) and
2003, and the years ended March 31, 2003 (unaudited), 2004, and 2005, these charges were
approximately $14.4 million, $12.0 million, $16.2 million, $13.2 million, and $11.0 million,
respectively. F-12




---



##### Table of Contents



(Loss) Income Per Share Attributable to Common Stockholders Basic (loss) income per share attributable to common stockholders is computed by dividing
(loss) income attributable to common stockholders by the weighted average number of shares of
common stock outstanding for the period. Diluted (loss) income per share attributable to common
stockholders reflects the potential dilution that could occur from shares of common stock issuable
through stock-based compensation plans including stock options, warrants using the treasury stock
method and other convertible securities. The following is a reconciliation of basic and diluted
(loss) income per share attributable to common stockholders (in thousands, except per share data): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Basic and diluted earnings per share calculation:(Loss) income from continuing operations
    
    $
    (18,273
    )
    
    $
    11,161
    
    
    $
    11,253
    
    
    $
    2,378
    
    
    $
    9,933Income (loss) from discontinued operations
    
    
    8,052
    
    
    
    6,909
    
    
    
    6,107
    
    
    
    (1,612
    )
    
    
    (4,241
    )Net (loss) income
    
    
    (10,221
    )
    
    
    18,070
    
    
    
    17,360
    
    
    
    766
    
    
    
    5,692Dividend to parent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (39,351
    )
    
    
    (Loss) income attributable to common
stockholders
    
    $
    (10,221
    )
    
    $
    18,070
    
    
    $
    17,360
    
    
    $
    (38,585
    )
    
    $
    5,692Basic weighted average shares outstanding
    
    
    69,686
    
    
    
    69,878
    
    
    
    69,864
    
    
    
    96,990
    
    
    
    121,276Dilutive effect of stock options and warrants
    
    
    
    
    
    
    177
    
    
    
    194
    
    
    
    
    
    
    
    311Diluted weighted average shares outstanding
    
    
    69,686
    
    
    
    70,055
    
    
    
    70,058
    
    
    
    96,990
    
    
    
    121,587Basic and diluted (loss) income per share from
continuing operations
    
    $
    (0.26
    )
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.02
    
    
    $
    0.08Basic and diluted income (loss) per share from
discontinued operations
    
    
    0.11
    
    
    
    0.10
    
    
    
    0.09
    
    
    
    (0.01
    )
    
    
    (0.03
    )Basic and diluted (loss) per share  dividend to
parent
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.41
    )
    
    
    Basic and diluted (loss) income per share
attributable to common stockholders
    
    $
    (0.15
    )
    
    $
    0.26
    
    
    $
    0.25
    
    
    $
    (0.40
    )
    
    $
    0.05
 The number of anti-dilutive shares that was excluded from the diluted
earnings per share calculation for the nine months ended March 31, 2002 (unaudited) and 2003, and
the years ended March 31, 2003 (unaudited), 2004, and 2005 was approximately 16,000,000,
16,000,000, 15,800,000, 11,200,000, and 6,500,000, respectively. For the nine months ended March
31, 2003 and the year ended March 31, 2003 (unaudited), the shares are antidilutive due to
convertible debt and stock options and warrants in which the exercise price is greater than the
average market price of the common shares during the respective periods. For the year ended March
31, 2005, the antidilutive shares are due to 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 March 31, 2002 (unaudited) and the year ended March 31, 2004, 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 FASB Statement No. 123, Accounting for Stock-Based Compensation, as
amended by FASB Statement No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure  an Amendment to FASB Statement No. 123. At March 31, 2005, we had three stock option plans, which are described more fully in Note 12.
All options granted under those plans generally have an exercise price equal to the market value
of the underlying common stock on the date of grant; therefore, no compensation cost is recognized.
The following table illustrates the effect on the (loss) income
from continuing operations per share and
(loss) income per share attributable to common stockholders if we had applied the fair value F-13




---



##### Table of Contents



recognition provisions of the FASB Statement No. 123, Accounting for Stock-Based
Compensation, to stock-based employee compensation (in thousands, except per share data): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)(Loss) income from continuing operations:(Loss) income from continuing operations as
reported
    
    $
    (18,273
    )
    
    $
    11,161
    
    
    $
    11,253
    
    
    $
    2,378
    
    
    $
    9,933Plus: Fair value of stock-based
employee compensation expense, net of
related tax effects
    
    
    (4,460
    )
    
    
    (4,198
    )
    
    
    (5,737
    )
    
    
    (5,962
    )
    
    
    (4,559
    )Pro forma (loss) income from continuing
operations
    
    
    (22,733
    )
    
    
    6,963
    
    
    
    5,516
    
    
    
    (3,584
    )
    
    
    5,374Basic and
diluted (loss) income from continuing operations per
share as reported
    
    $
    (0.26
    )
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.02
    
    
    $
    0.08Pro forma
basic and diluted (loss) income from continuing
operations per share
    
    $
    (0.33
    )
    
    $
    0.10
    
    
    $
    0.08
    
    
    $
    (0.04
    )
    
    $
    0.04(Loss) income attributable to common
stockholders:(Loss) income attributable to common
stockholders as reported
    
    $
    (10,221
    )
    
    $
    18,070
    
    
    $
    17,360
    
    
    $
    (38,585
    )
    
    $
    5,692Pro forma (loss) income attributable to
common stockholders
    
    $
    (14,681
    )
    
    $
    13,872
    
    
    $
    11,623
    
    
    $
    (44,547
    )
    
    $
    1,133Basic and diluted (loss) income per share
attributable to common stockholders as
reported
    
    $
    (0.15
    )
    
    $
    0.26
    
    
    $
    0.25
    
    
    $
    (0.40
    )
    
    $
    0.05Pro forma basic and diluted (loss) income
per share attributable to common
stockholders
    
    $
    (0.21
    )
    
    $
    0.20
    
    
    $
    0.17
    
    
    $
    (0.46
    )
    
    $
    0.01
 The fair market value of options granted under the stock option plans during the nine
months ended March 31, 2002 (unaudited) and 2003, and the years ended March 31, 2003 (unaudited),
2004, and 2005 was determined using the Black-Scholes option pricing model utilizing the following
assumptions: Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Anticipated volatility
    
    
    95
    %
    
    
    116
    %
    
    
    116
    %
    
    
    120
    %
    
    
    254
    %Weighted average risk-free interest rate
    
    
    4.51
    %
    
    
    2.60
    %
    
    
    2.60
    %
    
    
    2.44
    %
    
    
    3.69
    %Expected lives
    
    4 years
    
    4 years
    
    4 years
    
    4 years
    
    3 years
 Recent Accounting Pronouncements In December 2004, the FASB issued Statement No. 123-R, Share Based Payments. Statement No.
123-R is a revision of Statement No. 123, Accounting for Stock-Based Compensation and supersedes
APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement No. 123-R eliminates the
alternative to use the intrinsic value method of accounting that was provided in Statement No. 123,
which generally resulted in no compensation expense recorded in the financial statements related to
the issuance of equity awards to employees. Statement No. 123-R establishes fair value as the
measurement objective in accounting for share-based payment arrangements and requires all companies
to apply a fair value based measurement method in accounting for generally all share-based payment
transactions with employees. F-14




---



##### Table of Contents



We plan to adopt Statement No. 123-R using a modified prospective application. Under this
application, companies are required to record compensation expense for all awards granted after the
required effective date and for the unvested portion of previously granted awards that remain
outstanding at the date of adoption. The provisions of Statement No. 123-R are effective as of the
beginning of the first annual reporting period that begins after June 15, 2005, but early adoption
is encouraged. 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 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 Statement No. 151 will have
no material effect on our financial position and results of operations. In December 2004, the FASB issued Staff Position (FSP) 109-2, Accounting and Disclosure
Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of
2004 (AJCA). The AJCA introduces a limited time 85% dividends received deduction on the
repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided
certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the
repatriation provision. As we have no earnings to repatriate from our foreign subsidiaries, we
have determined that the issuance of FSP 109-2 has no 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. As of March 31, 2004, we had $8.6 million in related party
notes receivable outstanding, 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. As of March 31, 2005, the note was paid in full through nettings of outstanding balances due
to IESA and certain other related parties (Note 13, Related Party Notes Receivable). These notes
were permitted by the GECC senior credit facility, which expired on May 12, 2005 (Note 15, Credit
Facilities). 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. 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. F-15




---



##### Table of Contents



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 March 31, 2005, $3.4 million of this deferred charge remains outstanding and is
included in Prepaid Expenses and Other Current Assets. As part of the secured promissory note due
from Atari Interactive entered into in November 2004 (Note 13, Related Party Notes Receivable), the
2,000,000 shares were pledged as collateral should Atari Interactive default on payment of the
secured promissory note. As of March 31, 2005, the secured promissory note was paid in full (Note
13, Related Party Notes Receivable). Note 3  Acquisition of Shiny Entertainment, Inc. On April 30, 2002, we acquired all of the outstanding shares of common stock of Shiny
Entertainment, Inc. (Shiny), a video game development studio (the Shiny Acquisition). Total
consideration, including acquisition costs and assumption of employee stock options to purchase
shares of common stock of Shiny was approximately $50.8 million. The Shiny Acquisition was
accounted for as a purchase. The purchase price was allocated to net assets acquired, in-process
research and product development, other intangible assets and goodwill. Accordingly, $7.4 million
of in process research and development was expensed in the year ended June 30, 2002. Furthermore,
$2.7 million of the purchase price was allocated to other intangible assets and the balance was
allocated to net liabilities and goodwill. Other intangible assets are being amortized over four
years. The purchase price paid for the shares of Shiny consisted of (i) $31.0 million in cash at
closing, (ii) the issuance of short-term promissory notes for an aggregate principal face amount of
$16.2 million payable by us in installments through July 31, 2002, (iii) $2.0 million paid to
third-party licensors, (iv) assumption of employee stock options granted to purchase shares of
Shiny valued at $0.7 million and (v) approximately $0.9 million in professional and legal costs.
We financed the purchase with borrowings from IESA, under a medium-term loan, which guaranteed
repayments of the short-term promissory notes. As of March 31, 2004, no amount remained outstanding
under the medium-term loan which was converted as part of the Recapitalization Agreement (Note 2). UNAUDITED PRO FORMA RESULTS OF OPERATIONS The following unaudited consolidated pro forma results of our operations for the nine months ended March 31, 2002 give effect to the Shiny acquisition as if
it had occurred on July 1, 2000. (in thousands, except per share data): Nine MonthsEndedMarch 31,2002Net revenues
    
    $
    264,144Loss before provision for income taxes
    
    
    (30,214
    )Loss from continuing operations
    
    
    (25,200
    )Income from
discontinued operations of Humongous Entertainment
    
    
    8,052Net loss
    
    
    (17,148
    )Loss attributable to common stockholders
    
    
    (17,148
    )Basic and diluted loss per share attributable to common stockholders
    
    $
    (0.25
    )
 In December 2002, Shiny was merged into our operations and now is operated as a division. F-16




---



##### Table of Contents



Note 4  Receivables, net Receivables consist of the following (in thousands): March 31,
    
    
    March 31,2004
    
    
    2005Trade accounts receivable
    
    $
    73,986
    
    
    $
    66,464Less: Allowances for bad debts, returns, price protection and other
customer promotional programs
    
    
    (36,279
    )
    
    
    (24,285
    )$
    37,707
    
    
    $
    42,179
 Note 5  Inventories, net Inventories consist of the following (in thousands): March 31,
    
    
    March 31,2004
    
    
    2005Finished
goods
    
    $
    24,741
    
    
    $
    23,991Return
inventory
    
    
    1,964
    
    
    
    3,379Raw materials
    
    
    911
    
    
    
    28127,616
    
    
    
    27,651Less: Obsolescence reserve
    
    
    (1,973
    )
    
    
    (2,442
    )$
    25,643
    
    
    $
    25,209
 Note 6  Prepaid Expenses and Other Current Assets Prepaid expenses and other current assets consist of the following (in thousands): March 31,
    
    
    March 31,2004
    
    
    2005Licenses short-term
    
    $
    3,146
    
    
    $
    6,795Royalties receivable
    
    
    1,208
    
    
    
    6,551Atari name license
    
    
    3,350
    
    
    
    3,350Prepaid insurance
    
    
    1,094
    
    
    
    1,130Deferred financing fees
    
    
    694
    
    
    
    131Other prepaid expenses and current assets
    
    
    2,957
    
    
    
    3,039$
    12,449
    
    
    $
    20,996
 On December 1, 2000, we entered into a contract to sell all of our property in and rights
to the Duke Nukem line of business to an outside party. We received consideration in the form of
common stock of the purchaser valued at $5.5 million, which was recognized during fiscal 2001, and
subsequently sold the stock for approximately $6.2 million. Additionally, we received $6.0 million
in future royalty advances in the form of a promissory note, which was payable upon completion of
certain requirements by an independent developer. On March 31, 2005, we entered into a settlement
agreement with the outside party receiving a $4.3 million promissory note (included in royalties
receivable above), payable in May 2005, in lieu of the original promissory note. The $4.3 million
settlement has been recognized as royalty income as of March 31, 2005 and the note was subsequently
paid in full in May 2005. As part of this settlement, we also received an additional $0.5 million
secondary promissory note, which will be recognized if certain milestones are achieved by the
outside party by December 2005. If these milestones are not met by December 2005, the secondary
promissory note will expire. Note 7  Oddworld Inhabitants, Inc. 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 F-17




---



##### Table of Contents



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 8  Property and Equipment, net Property and equipment consists of the following (in thousands): March 31,
    
    
    March 31,2004
    
    
    2005Computer equipment
    
    $
    20,002
    
    
    $
    19,992Capitalized computer software
    
    
    14,788
    
    
    
    16,098Leasehold improvements
    
    
    6,935
    
    
    
    6,694Furniture and fixtures
    
    
    4,295
    
    
    
    3,335Machinery and equipment
    
    
    305
    
    
    
    30946,325
    
    
    
    46,428Less: accumulated depreciation
    
    
    (33,744
    )
    
    
    (38,139
    )$
    12,581
    
    
    $
    8,289
 Depreciation expense for the nine months ended March 31, 2002 (unaudited) and 2003, and
the years ended March 31, 2003 (unaudited), 2004, and 2005 amounted to approximately $3.2 million,
$5.0 million, $6.8 million, $6.4 million, and $6.6 million, respectively. Note 9  Accrued Liabilities Accrued liabilities consist of the following (in thousands): March 31,
    
    
    March 31,2004
    
    
    2005Accrued distribution services
    
    $
    1,848
    
    
    $
    3,332Accrued salary and related costs
    
    
    4,271
    
    
    
    3,296Accrued third-party development expenses
    
    
    1,419
    
    
    
    2,551Accrued advertising
    
    
    3,036
    
    
    
    1,810Accrued professional fees and other services
    
    
    1,295
    
    
    
    1,418Accrued freight and handling fees
    
    
    989
    
    
    
    1,141Other
    
    
    2,807
    
    
    
    2,989$
    15,665
    
    
    $
    16,537
 Note 10  Income Taxes The components of the (benefit from) provision for income taxes are as follows (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Federal:Current
    
    $
    (4,998
    )
    
    $
    43
    
    
    $
    27
    
    
    $
    (2,074
    )
    
    $
    100(4,998
    )
    
    
    43
    
    
    
    27
    
    
    
    (2,074
    )
    
    
    100
 F-18




---



##### Table of Contents



Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)State and local:Current
    
    
    
    
    
    
    463
    
    
    
    453
    
    
    
    (422
    )
    
    
    (134
    )
    
    
    
    463
    
    
    
    453
    
    
    
    (422
    )
    
    
    (134
    )Foreign:Current
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (423
    )
    
    
    218Deferred
    
    
    (16
    )
    
    
    (101
    )
    
    
    1,603
    
    
    
    
    
    
    
    (16
    )
    
    
    (101
    )
    
    
    1,603
    
    
    
    (423
    )
    
    
    218(Benefit from)
provision for
income taxes
    
    $
    (5,014
    )
    
    $
    405
    
    
    $
    2,083
    
    
    $
    (2,919
    )
    
    $
    184
 For the nine months ended March 31, 2002 (unaudited), we received a tax benefit of $5.0
million based on federal tax law changes enabling us to carryback our June 30, 2001 loss and
recover taxes paid in 1996. During the nine months ended March 31, 2003, we recorded federal and state alternative minimum
tax provisions of approximately $1.0 million. This provision is offset by $0.5 million in federal
income tax benefits resulting from loss carryback refund claims filed in the current period with
respect to our fiscal 2002 federal income tax return and an amended 2001 federal income tax return. During the year ended March 31, 2003 (unaudited), we recorded a provision for taxes of $2.1
million, primarily from foreign tax liabilities from our foreign operations. During the year ended March 31, 2004, we recorded a tax benefit of approximately $2.9 million,
which resulted primarily from a June 30, 2001 amended federal tax return to recover taxes paid in
1996 and refunds of estimated state tax payments made during the tax year ended June 30, 2003. During the year ended March 31, 2005, we recorded a tax provision of approximately $0.2
million, which results primarily from certain tax exposures related to our UK subsidiary. A reconciliation of the (benefit from) provision for income taxes from continuing operations
computed at the Federal statutory rate to the reported (benefit from) provision for income taxes is
as follows (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)(Benefit from) provision for income taxes
computed at federal statutory rate
    
    $
    (3,724
    )
    
    $
    4,048
    
    
    $
    4,387
    
    
    $
    (189
    )
    
    $
    3,541(Benefit) expense from income
taxes resulting from:State and local taxes, net of
federal tax effect
    
    
    (433
    )
    
    
    499
    
    
    
    686
    
    
    
    195
    
    
    
    (134
    )Difference between U.S. and foreign
income tax rates
    
    
    (3,068
    )
    
    
    2,496
    
    
    
    4,638
    
    
    
    514
    
    
    
    1,962Other, net
    
    
    492
    
    

    
    233
    
    
    
    286
    
    
    
    (55
    )
    
    
    99Increase (decrease) to deferred tax asset
valuation allowance
    
    
    1,719
    
    
    
    (6,871
    )
    
    
    (7,914
    )
    
    
    (3,384
    )
    
    
    (5,284
    )(Benefit from) provision for
Income taxes
    
    $
    (5,014
    )
    
    $
    405
    
    
    $
    2,083
    
    
    $
    (2,919
    )
    
    $
    184
 Deferred income taxes reflect the net tax effects of temporary differences between the
carrying amount of assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. The components of our net deferred tax asset are as follows (in thousands): F-19




---



##### Table of Contents



March 31,
    
    
    March 31,2004
    
    
    2005Deferred tax asset:Inventory valuation
    
    $
    879
    
    
    $
    1,094Deferred income
    
    
    874
    
    
    
    54Tax loss carryforwards
    
    
    175,825
    
    
    
    179,098Restructuring reserve
    
    
    
    
    
    
    774Alternative minimum tax carryforward credit
    
    
    330
    
    
    
    263Allowances for bad debts, returns, price protection
and other customer promotional programs
    
    
    7,244
    
    
    
    1,520In process research and development
    
    
    2,630
    
    
    
    2,428Research and development credit carryforwards
    
    
    
    
    
    
    6,056Other
    
    
    1,294
    
    
    
    1,285189,076
    
    
    
    192,572Deferred tax liability:Depreciation
    
    
    (1,174
    )
    
    
    (1,583
    )Duke Nukem promissory note
    
    
    
    
    
    
    (1,742
    )(1,174
    )
    
    
    (3,325
    )Subtotal
    
    
    187,902
    
    
    
    189,247Less: valuation allowance
    
    
    (187,902
    )
    
    
    (189,247
    )Net deferred tax asset
    
    $
    
    
    
    $
    
 As of March 31, 2005, we have combined net operating loss carryforwards of approximately
$486.0 million for federal and state tax purposes. These loss carryforwards are available to
offset future taxable income, if any, and will expire beginning in the years 2009 through 2025. 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). As
of March 31, 2005, we have combined research and development
credits of approximately $6.0 million for federal and state tax purposes. These credits will expire beginning in 2011. We have
$0.3 million in alternative minimum tax credits that will carry forward indefinitely. A full valuation allowance has been recorded against the net deferred tax asset based on
historical information that such an asset will not be realized; however management reviews the
asset quarterly to ensure the valuation allowance is proper. As of March 31, 2005, there were no
undistributed earnings for our 100% owned foreign subsidiaries. Note 11  Stockholders Equity As of March 31, 2004, and March 31, 2005, we had warrants, excluding warrants related to our
purchase by IESA, outstanding to purchase an aggregate of approximately 271,889 and 200,499 shares,
respectively, of our common stock. On April 30, 2002, in connection with the acquisition of the shares of Shiny, we assumed all
of the options granted to purchase shares of common stock of Shiny under Shinys 1995 Stock
Incentive Plan. Such options were converted into options to purchase an aggregate of approximately
240,000 shares of our common stock. Such options were valued at approximately $0.7 million at the
acquisition date. In September 2003, we entered into a Recapitalization Agreement resulting in the exchange of
all of our net related party debt with IESA and certain of its subsidiaries, totaling $165.9
million into 39,029,887 shares of our common stock. Additionally, 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 after all costs were $34.9 million. In connection with the
Recapitalization, we issued 2,000,000 shares of its common stock to Atari Interactive in order to
extend the term of the license under which we use the Atari name to ten years expiring on December
31, 2013 (Note 2, Recapitalizationand Offering). F-20




---



##### Table of Contents



On October 15, 2003, approximately 280,000 shares of common stock were issued to a developer
in lieu of cash payments for royalties due. Such amount approximated $1.2 million. On May 26, 2004, 44,418 shares of our common stock were issued to Wachovia Bank, National
Association (Wachovia) as a result of the cashless exercise of certain warrants owned by
Wachovia. These warrants were issued to Wachovia in accordance with the Warrant Agreement dated as
of June 29, 1999. During fiscal 2005, we recorded $0.7 million of expense related to the modification of stock
option agreements for certain executives terminated during the year and in connection with
managements restructuring plan (Note 21). Note 12  Stock Options and Employee Stock Purchase Plan We have three stock option plans which began in 1995, 1997 and 2000 (the Plans). We account
for these Plans under the provisions of Accounting Principles Board Opinion No. 25, under which no
compensation cost has been recognized. Generally, under the Plans, options are granted to employees and directors to purchase shares
of our common stock at no less than the fair market value at the date of the grant, vest over a
period of four or five years and are exercisable for a period of ten years from the grant date. An aggregate summary of the status of our Plans and changes during the periods at March 31,
2003, March 31, 2004, and March 31, 2005 are as follows: March 31, 2003Weighted AverageShares
    
    
    Exercise Price(in thousands)Outstanding at beginning of
the nine months ended
    
    
    6,855
    
    
    $
    12.23Granted
    
    
    63
    
    
    
    2.58Exercised
    
    
    (48
    )
    
    
    0.34Cancelled
    
    
    (520
    )
    
    
    16.42Outstanding at end of nine months ended
    
    
    6,350
    
    
    $
    11.88
 March 31, 2004Weighted AverageShares
    
    
    Exercise Price(in thousands)Outstanding at beginning of
the fiscal year
    
    
    6,350
    
    
    $
    11.88Granted
    
    
    1,332
    
    
    
    4.22Exercised
    
    
    (120
    )
    
    
    0.61Cancelled
    
    
    (684
    )
    
    
    11.54Outstanding at end of fiscal year
    
    
    6,878
    
    
    $
    10.62
 March 31, 2005Weighted AverageShares
    
    
    Exercise Price(in thousands)Outstanding at beginning of
the fiscal year
    
    
    6,878
    
    
    $
    10.62Granted
    
    
    4,925
    
    
    
    2.11Exercised
    
    
    (21
    )
    
    
    0.46Cancelled
    
    

    (469
    )
    
    
    10.07Outstanding at end of fiscal year
    
    
    11,313
    
    
    $
    6.94
 F-21




---



##### Table of Contents



The following table summarizes information concerning currently outstanding and exercisable
options (shares in thousands): Weighted
    
    
    Weighted
    
    
    
    
    
    
    WeightedRange of
    
    
    
    
    
    
    Average
    
    
    Average
    
    
    Number
    
    
    AverageExercise Price
    
    
    Number Outstanding
    
    
    Remaining Life
    
    
    Exercise Price
    
    
    Exercisable
    
    
    Exercise Price$
    0.34-1.91
    
    
    
    2,246
    
    
    
    9.5
    
    
    $
    1.85
    
    
    
    198
    
    
    $
    1.33$
    2.24-5.19
    
    
    
    5,172
    
    
    
    8.2
    
    
    $
    3.41
    
    
    
    2,364
    
    
    $
    4.24$
    5.44-9.38
    
    
    
    2,453
    
    
    
    5.9
    
    
    $
    6.92
    
    
    
    2,327
    
    
    $
    6.90$
    10.00-97.50
    
    
    
    1,442
    
    
    
    3.6
    
    
    $
    27.58
    
    
    
    1,442
    
    
    $
    27.5811,313
    
    
    
    
    
    
    
    
    
    
    
    6,331
 Employee Stock Purchase Plan We had an employee stock purchase plan (ESPP) which provided employees an opportunity to
purchase common stock every six months through payroll deductions. The purchase price of each
share was 85% of the lower of the fair market value on the first or last day of each six-month
period. Employees were allowed to purchase shares having a value not exceeding 10% of their gross
compensation during a six-month period. Effective April 1, 2003, all shares of common stock
reserved for issuance under the ESPP were issued and, as a result, we terminated the ESPP. Note 13  Related Party Transactions Transactions with IESA As of March 31, 2004 we had a net payable due to IESA of $0.9 million, and as of March 31,
2005, we had no outstanding balances due to or from IESA. These balances resulted from the
following transactions (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Management fees (1)
    
    $
    (2,304
    )
    
    $
    (2,346
    )
    
    $
    (2,344
    )
    
    $
    (3,000
    )
    
    $
    (3,000
    )Interest expense and facility fees (2)
    
    
    (1,502
    )
    
    
    (3,945
    )
    
    
    (5,985
    )
    
    
    (2,143
    )
    
    
    Interest expense on 5% subordinated
convertible note (3)
    
    
    (2,487
    )
    
    
    (2,614
    )
    
    
    (3,460
    )
    
    
    (1,680
    )
    
    
    Interest expense on non-interest bearing
subordinated convertible notes (4)
    
    
    (718
    )
    
    
    (2,153
    )
    
    
    (2,870
    )
    
    
    (1,339
    )
    
    
    Net expense
    
    $
    (7,011
    )
    
    $
    (11,058
    )
    
    $
    (14,659
    )
    
    $
    (8,162
    )
    
    $
    (3,000
    )
   (1)
    
    IESA charges us monthly management fees for systems and administrative support.(2)
    
    IESA charged us monthly interest and fees for the amount outstanding on the related party
credit facilities and the medium-term loan. The interest rate was LIBOR plus 2.5% for the
related party credit facility and LIBOR plus 2.75% for the medium-term loan (Note 2,
Recapitalizationand Note 15, IESA Credit Facilities and Debt).(3)
    
    IESA charged us monthly interest for the amount outstanding on its long term related party
5.0% subordinated convertible note. The 5.0% subordinated convertible note was terminated as
part of our September 2003 Recapitalization (Note 2, Recapitalization).(4)
    
    On December 28, 2001, IESA assumed from General Atlantic Partners, LLC (GAP) the $50.0
million principal amount of non-interest bearing subordinated convertible notes (the GAP 0%
Notes) in exchange for IESA shares of common stock. IESA did not change any of the terms of
the former GAP 0% Notes as they relate to us. Interest on these notes was being accreted at the
rate of 7% and had a redemption value of $50.0 million at maturity. The GAP 0% notes were
terminated as part of our September 2003 Recapitalization (Note 2, Recapitalization). F-22




---



##### Table of Contents




    IESA stock options granted On November 7, 2002, IESA granted stock options of approximately 510,000 shares to our senior
management. All options granted were at fair market value at the date of the grant and have a
vesting period of four years. IESA does not expense stock options granted to employees, therefore,
no charge was recorded in our statement of operations for the nine
months ended March 31, 2003 and the year ended
March 31, 2003 (unaudited).  
    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 Civilizationfranchise and certain of its
rights under its previous license with Hasbro, 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. 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 revolving credit facility with HSBC
Business Credit (USA) Inc. 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 Mexico, 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 38% 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. 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, affect our ability to generate
business and enter into agreements on financially favorable terms, and otherwise impair our
ability to raise and generate capital. IESA continues to focus on ways to address and improve its
financial situation. Transactions with Atari Europe SAS (formerly know as Infogrames Multimedia, S.A. and Infogrames
Europe SAS), a wholly-owned subsidiary of IESA As of March 31, 2004 we had a net receivable due from Atari Europe SAS (Atari Europe) of
$3.6 million, and as of March 31, 2005, we had a net payable due to Atari Europe of $1.4 million.
These balances resulted from the following transactions (in thousands): F-23




---



##### Table of Contents



Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)(Expense) incomePurchase of product and
other various services
    
    $
    (144
    )
    
    $
    (113
    )
    
    $
    (46
    )
    
    $
    (54
    )
    
    $
    (73
    )Sale of product and services
    
    
    
    
    
    
    4
    
    
    
    4
    
    
    
    59
    
    
    
    15Royalty expense (1)
    
    
    (3,532
    )
    
    
    (4,067
    )
    
    
    (5,147
    )
    
    
    (552
    )
    
    
    (4,204
    )Royalty income (2)
    
    
    2,886
    
    
    
    18,777
    
    
    
    20,383
    
    
    
    28,725
    
    
    
    18,579Net (expense) income
    
    $
    (790
    )
    
    $
    14,601
    
    
    $
    15,194
    
    
    $
    28,178
    
    
    $
    14,317
   (1) We 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.(2) We have also 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.  
    Worldwide licensing rights As of March 31, 2005, we entered into a settlement agreement with IESA and Atari Europe
related to royalty income received by us related to worldwide licensing rights of intellectual
property. We agreed to pay IESA and Atari Europe approximately $2.7 million for royalties received
by us as a reduction of net revenues. Additionally, IESA and Atari Europe agreed to pay back $0.2
million related to back end royalties paid for the income received by us. As of March 31, 2005, we
had a net amount of approximately $2.5 million due to IESA and Atari Europe related to this
settlement, of which all amounts outstanding have been paid in the first quarter of fiscal 2006. Transactions with Atari Interactive (formerly known as Infogrames Interactive, Inc. and Hasbro
Interactive, Inc.), a wholly-owned subsidiary of IESA As of March 31, 2004 and March 31, 2005, we had a net payable due to Atari Interactive of $3.2
million and $2.1 million, respectively. These balances resulted primarily from the following
transactions (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Income (expense)Management fees and other support (1)
    
    $
    2,250
    
    
    $
    2,250
    
    
    $
    3,000
    
    
    $
    3,000
    
    
    $
    3,000Interest income on related party
advances (2)
    
    
    
    
    
    
    398
    
    
    
    398
    
    
    
    1,065
    
    
    
    Interest income on secured note (3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    859Rent expense (4)
    
    
    
    
    
    
    (405
    )
    
    
    (405
    )
    
    
    (612
    )
    
    
    (612
    )(Purchase) sale of goods and services (5)
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    1,234
    
    
    
    2,439Royalty expense (6)
    
    
    (32,682
    )
    
    
    (24,263
    )
    
    
    (29,945
    )
    
    
    (24,064
    )
    
    
    (26,140
    )Gain on sale of development project (7)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,744
    
    
    
    Net expense
    
    $
    (30,432
    )
    
    $
    (22,020
    )
    
    $
    (26,958
    )
    
    $
    (15,633
    )
    
    $
    (20,454
    )
   (1) We charge management fees to Atari Interactive primarily for legal, financial,
information systems and human resource management. Effective June 30, 2005, Atari Interactive
cancelled these services (Note 24, Termination of Service Agreement). F-24




---



##### Table of Contents



(2) Advances made to Atari Interactive bore interest at prime plus 150 basis points and was to
be repaid from distribution royalties owed by us to Atari Interactive in the ordinary course of
operations (see Advances to Related Partiesbelow).(3) During the third quarter of fiscal 2005, we signed a secured promissory note with Atari
Interactive (see Related Party Notes Receivablebelow). We earned interest on this note at a
rate of prime plus 3.25%.(4) We entered into a sub-lease agreement with Atari Interactive through June 30, 2007 (see
Sale-Leasebackbelow). The rented space serves as the principal executive and administrative
offices of our Beverly Studio located in Beverly, Massachusetts, whose closing in fiscal 2006 is
part of managements restructuring plan (Note 21). We incur rent expense of approximately $0.1
million per month for this space.(5) We record income from the sale of services primarily for quality and assurance testing of
products in development.(6) Pursuant to our distribution agreement with IESA and Atari Europe, we distribute products
for Atari Interactive. We must pay a royalty of either 30.0% of our gross margin or 130.0% of
the royalty rate due to the developer, whichever is greater, for all Atari Interactive products
distributed by us. In the fourth quarter of 2002, we and Atari Interactive agreed to adjust the
base sales upon which the royalty is calculated. Accordingly, we reduced accrued and unpaid
royalties due to Atari Interactive by approximately $2.0 million.(7) During the third quarter of fiscal 2004, 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 the 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 (see Related Party Notes Receivablebelow).  
    Sale-Leaseback 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. We also received indemnification from
IESA from any costs, if any, that may be incurred by us as a result of the full guaranty. 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 the nine months ended March 31, 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 years ended March 31, 2004 and 2005, approximately $0.1 million
of income was recognized in each period. As of March 31, 2004 and March 31, 2005, the remaining
balances of approximately $0.6 million and $0.5 million, respectively, are deferred and are being
recognized over the life of the sub-lease. As the closure of the Beverly studio is included in
managements restructuring plan, we will review the remaining balance of the deferred income when
the studio is officially closed in early fiscal 2006 (Note 21). Additionally, since we are ceasing
operations at this location, we are looking to sublease this space.  
    Settlement of customer returns, price concessions and other allowances Customers of Atari Interactive, who are current customers of ours, reduced payments of
receivables on current invoices of ours for returns, price concessions and other allowances. These
deductions related to pre-acquisition sales of Atari Interactive. Accordingly, we, IESA and Atari
Interactive agreed to a settlement reimbursing us an aggregate of approximately $6.7 million for
these deductions for the nine months ended March 31, 2002 (unaudited). During fiscal 2004, a
customer made a deduction of $2.6 million which was transferred to a secured promissory note in
November 2004 (see Related Party Notes Receivablebelow). F-25




---



##### Table of Contents




    Milestone payments advanced Advances were as follows (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Advances for milestone payments
    
    $
    
    
    
    $
    534
    
    
    $
    1,888
    
    
    $
    1,379
    
    
    
    
 We have advanced, on behalf of Atari Interactive, funds to third-party developers for the
development of properties owned and managed by Atari Interactive. The amount outstanding for these
items at March 31, 2004 were payable in the form of an interest-bearing note, which was
subsequently transferred to a secured promissory note (see Related Party Notes Receivablebelow).  
    Warrants issued in relation to Atari Interactive On November 18, 2002, 24,999 warrants of our stock were issued to a third-party developer to
enhance a development agreement between the developer and Atari Interactive. The warrants were
valued using the Black-Scholes model for approximately $0.1 million. As of March 31, 2004 and
March 31, 2005, no balance remains outstanding. Atari Interactive reimbursed us for expenses

incurred related to the issuance of these warrants. Transactions with Atari Australia, a wholly-owned subsidiary of IESA As of March 31, 2004 and March 31, 2005, we had a net receivable due from Atari Australia of
$0.3 million and $0.1 million, respectively. These balances resulted from the following
transactions (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Income (expense)Management fees (1)
    
    $
    283
    
    
    $
    204
    
    
    $
    224
    
    
    $
    211
    
    
    $
    224Distribution income (2)
    
    
    4,164
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Distribution expense (2)
    
    
    (3,703
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Royalty income (3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36
    
    
    
    4Purchase of other support services
    
    
    
    
    
    
    (45
    )
    
    
    
    
    
    
    
    
    
    
    Sale of product and other support services
    
    
    
    
    
    
    640
    
    
    
    630
    
    
    
    874
    
    
    
    981Net income
    
    $
    744
    
    
    $
    799
    
    
    $
    854
    
    
    $
    1,121
    
    
    $
    1,209
   (1) Effective August 25, 2000, we began charging Atari Australia yearly management fees
primarily for the management and maintenance of information systems.(2) During the nine months ended March 31, 2002, our Australian operations used the distribution
facilities of Atari Australia who distributed product on behalf of us, recording distribution
revenue and related distribution expenses. During the nine months ended March 31, 2003, the
activity between our Australian operations and Atari Australia ceased. As part of the
Recapitalization Agreement, IESA and we agreed to offset the receivable balance owed by Atari
Australia against amounts due under the related party debt (Note 2, Recapitalization).(3) We, IESA, and Atari Europe entered into a distribution agreement, which provides for the
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, Atari Europe, or any of their subsidiaries as
applicable 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. We have also 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 F-26




---



##### Table of Contents



130.0% of the royalty rate due to the developer, whichever is greater. We recognize this as
royalty income as part of net revenues. Transactions with Paradigm Entertainment Inc. (Paradigm), a wholly-owned subsidiary of IESA As of March 31, 2004, our related party balances with Paradigm were netted, creating a short
term note receivable. On November 3, 2004, the short term note receivable was assigned to Atari
Interactive and subsequently transferred to a secured promissory note (see Related Party Notes
Receivablebelow). As of March 31, 2005, we have a net trade payable balance due to Paradigm of
$0.2 million and no outstanding notes receivable. The related party balances primarily resulted
from the transactions discussed below.  
    Purchase of services and advances to fund expenses Paradigm, a wholly-owned subsidiary of IESA, is a product developer located in the United
States. Paradigm performs such services as program development and design for us. Service fees
provided and charged to us are as follows (in thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Development expenses
    
    $
    5,405
    
    
    $
    7,133
    
    
    $
    9,135
    
    
    $
    10,099
    
    
    $
    9,003
 Additionally, since July 1, 2001, we have advanced funds in payment of
certain Paradigm expenses. As of March 31, 2004, we had a receivable due from Paradigm of $2.5
million for funds advanced to Paradigm and $1.7 million outstanding of development expenses charged
to us by Paradigm, which were netted and included in a short term note receivable and subsequently
transferred to a secured promissory note (see Related Party Notes Receivablebelow). A nominal
amount of interest income was earned on this note during fiscal 2005, and no such notes were
outstanding and no netting of receivables and payables occurred at March 31, 2005.  
    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. Transactions with other related parties wholly-owned by IESA The net related party balances with other IESA subsidiaries are as follows (in thousands): March 31, 2004
    
    
    March 31, 2005Receivable (payable)Atari Taiwan Ltd
    
    $
    23
    
    
    $
    70Atari Melbourne House Pty Ltd
    
    
    (42
    )
    
    
    Atari Studio Ltd
    
    
    (10
    )
    
    
    (10
    )Eden Studio SAS
    
    
    (606
    )
    
    
    Atari Asia Pacific Pty Ltd
    
    
    24
    
    
    
    3Atari United Kingdom Ltd
    
    
    (1,800
    )
    
    
    (1,696
    )Atari Japan KK
    
    
    (20
    )
    
    
    (12
    )Miscellaneous nominal balances, net (1)
    
    
    165
    
    
    
    44Net payable
    
    $
    (2,226
    )
    
    $
    (1,601
    )
 F-27




---



##### Table of Contents



(1) We have entered into various nominal transactions with certain other IESA
subsidiaries located in North America, Europe, Asia, and certain other regions. The following transactions occurred with us and other related parties wholly-owned by IESA (in
thousands): Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Income (expense)Development expense (1):Eden Studios SAS
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (611
    )
    
    $
    (3,576
    )Atari Melbourne House Pty Ltd
    
    
    (1
    )
    
    
    (81
    )
    
    
    (112
    )
    
    
    (307
    )
    
    
    Atari Studio Asia Pty Ltd
    
    
    
    
    
    
    (694
    )
    
    
    (694
    )
    
    
    (84
    )
    
    
    Atari Studio Ltd
    
    
    
    
    
    
    (756
    )
    
    
    (747
    )
    
    
    
    
    
    
    Sale of product:Atari Taiwan Ltd
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    252
    
    
    
    399Atari Asia Pacific Pty Ltd
    
    
    170
    
    
    
    141
    
    
    
    428
    
    
    
    163
    
    
    
    62Atari United Kingdom Ltd
    
    
    73
    
    
    
    55
    
    
    
    55
    
    
    
    
    
    
    
    Purchase of product/services:Atari United Kingdom Ltd
    
    
    (52
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Royalty expense (2):Atari Japan KK
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (373
    )
    
    
    6Miscellaneous sale of product
and services, net  other (3)
    
    
    (29
    )
    
    
    (398
    )
    
    
    (412
    )
    
    
    (62
    )
    
    
    262Net income (expense)
    
    $
    161
    
    
    $
    (1,733
    )
    
    $
    (1,482
    )
    
    $
    (1,022
    )
    
    $
    (2,847
    )
   (1) Eden Studios SAS, Atari Melbourne House Pty Ltd, Atari Studio Asia Pty Ltd, and Atari
Studio Ltd, wholly-owned subsidiaries of IESA, develop product for us. The subsidiaries provide
services such as product development, design, and testing.(2) As a part of our distribution agreement with IESA and Atari Europe, we must pay a royalty
of either 30.0% of our gross margin or 130.0% of the royalty rate due to the developer,
whichever is greater, for all Atari Japan products distributed by us.(3) We have entered into various nominal transactions with certain other IESA subsidiaries
located in North America, Europe, Asia, and certain other regions. Transactions with other Atari Europe Related Parties We have entered into a licensing transaction with iFone Limited (iFone), a
producer and publisher of entertainment content for current and future mobile devices, which is
wholly-owned by iFone Holdings Limited. Atari Europe is a shareholder of iFone Holdings Limited.
Pursuant to a three year license agreement with iFone, we granted to iFone a worldwide exclusive
license of the rights to certain games for development and exploitation on the mobile phone
platform. In consideration for such license, iFone paid us a
$0.1 million non-refundable advance
against royalties and will make royalty payments. Related Party Notes Receivable Related party notes receivable consist of the following amounts (in thousands): March 31, 2004
    
    
    March 31, 2005Development rights and advances  Atari Interactive (1)
    
    $
    5,122
    
    
    $
    
 F-28




---



##### Table of Contents



March 31, 2004
    
    
    March 31, 2005Customer deductions  Atari Interactive (2)
    
    
    2,620
    
    
    
    Loans  Paradigm (2)
    
    
    829
    
    
    
    Total related party notes receivable
    
    $
    8,571
    
    
    $
    
   (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.(2) The Atari Interactive note and the Paradigm note were payable on September 30, 2004. The
Atari Interactive note of $2.6 million was converted to a secured promissory note. The Paradigm
note of $0.8 million was assigned to Atari Interactive and transferred to a secured promissory
note from Atari Interactive on November 3, 2004. As at September 30, 2004, royalty payments past due to us by IESA under our existing
distribution agreement for the period then ended amounted to approximately $15.7 million, which was
converted to a secured promissory note. 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 included in the initial principal amount the sums
past due to us from Atari Interactive and a 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 had a principal amount of approximately $23.1 million, a maturity
date of March 31, 2005, bore annual interest at the prime rate plus 3.25%, and was 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 (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 a Trademark License Agreement, dated September 4,
2003 (Note 2). The Secured Note allowed for the netting of sums currently due to us with IESA and
several of its subsidiaries. Additionally, if a balance remained in the Secured Note as of March
31, 2005, the Secured Note allowed for any sums not yet due and payable to IESA and certain of its
subsidiaries to be applied to the balance of the Secured Note. As of March 31, 2005, we had
approximately $3.0 million outstanding of which we applied sums not yet due and payable from IESA
and certain other subsidiaries, satisfying all remaining Secured Note obligation. At that time,
all rights to the Collateral were released. Advances to Related Parties The GECC Senior Credit Facility originally allowed us to make advances to Atari Interactive
through related party loans. These loans bore interest at prime plus 150 basis points and, prior
to the Recapitalization Agreement, were payable from distribution royalties owed by us to Atari
Interactive in the ordinary course of operations. Additionally, normal trade activities with Atari
Interactive were netted against the loan balance outstanding when the invoices became due
(generally in 45 days). On July 3, 2003, we entered into an offset agreement with Atari Interactive and IESA. The
agreement provides that on the date of termination of the Senior Credit Facility with GECC, we may
offset any amount outstanding from Atari Interactive for advances, loans and current accounts
receivable against amounts due under the revolving credit agreement with IESA (Credit Agreement). On July 3, 2003, we, Atari Australia and IESA entered into an offset agreement, the effect of
which provides us with the ability to offset approximately $1.7 million, the amount owed to us as
of March 31, 2003, or any portion of that amount outstanding, if any, on July 3, 2005, against
amounts owed under the then existing Credit Agreement with IESA. As part of the Recapitalization Agreement, Atari Interactive, Atari Australia, IESA and we
agreed to offset the amount due from Atari Interactive for advances, loans and current accounts
receivable and the outstanding receivable balance owed from Atari Australia against amounts due
under the $50.0 million principal amount of non-interest bearing subordinated convertible notes and
the 5% subordinated convertible notes to IESA. During the first half of the year ended March 31,
2004, we advanced additional funds of $14.2 million to Atari Interactive and Atari Australia
through intercompany F-29




---



##### Table of Contents



loans. As of September 18, 2003, we had approximately $44.7 million due from Atari
Interactive and $1.9 million outstanding from Atari Australia that was offset against the
outstanding balance of the $50.0 million principal amount of non-interest bearing subordinated
convertible notes and the 5% subordinated convertible notes. Accordingly, at March 31, 2004, no
amounts remain outstanding in advances to related parties that are not evidenced by related party
notes receivable. For the year ended March 31, 2004, we recognized interest income on the advances
of approximately $1.1 million, of which no amount remained outstanding at March 31, 2004. No
advances or interest have been recorded as of March 31, 2005. Transactions with current and former Officers Employment Agreement with James Caparro We entered into an employment agreement with James Caparro (the Caparro Employment
Agreement) to serve as President and Chief Executive Officer, effective November 26, 2004. The
term of the Caparro Employment Agreement will continue through March 31, 2009, and may be extended
for up to two additional one year periods under terms that are identical to those contained in the
Caparro Employment Agreement. Under the Caparro Employment Agreement, Mr. Caparro receives an annual salary of $0.7 million,
to be reviewed annually for increase at the discretion of the Compensation Committee. Mr. Caparro
is also eligible to receive an annual bonus with a target amount of 100.0% of his based salary,
with a maximum of 150.0% based on significant above-target achievement. Additionally, Mr. Caparro
is eligible to receive an annual bonus of 100.0% of his base salary based upon the attainment of
strategic objectives determined by the Compensation Committee and Mr. Caparro on an annual basis.
Mr. Caparro received stock options to purchase 1,750,000 shares of our common stock, as well as a
life insurance policy with a face value of $1.0 million and a nominal allowance for tax and
financial planning services. If Mr. Caparro is terminated without cause or resigns for good reason prior to a change of
control event, then in exchange for a general release and conditional upon Mr. Caparros ongoing
compliance with the non-compete covenant, Mr. Caparro will receive (i) his then current base
salary, in 12 equal monthly installments, (ii) a bonus payment equal to the amount of the Caparro
Bonuses earned for the fiscal year prior to the fiscal year of termination, but no greater than the
target Caparro Bonuses for such year (or, if during the fiscal years ending March 31, 2005 or 2006,
based on the target Caparro Bonuses), paid when such bonuses would otherwise be paid, (iii) a bonus
payment equal to the pro-rata portion of the Caparro Bonuses for the year of termination and
payment of any accrued amounts for vacation, expenses, or bonuses, (iv) 100% vesting of options,
which remain exercisable for a period of six months thereafter, or, if less, the remainder of the
term of the grant, and (v) continued medical, health and life insurance for the earlier of 12
months or until such benefits are covered by a new employer. If Mr. Caparro is terminated without cause or resigns for good reason within 24 months of a
change of control event, then in exchange for a general release and conditional upon Mr. Caparros
ongoing compliance with the non-compete covenant, Mr. Caparro will receive (i) two times the sum of
(a) his then current base salary, and (b) the greater of (I) the amount of the target Caparro
Bonuses for the year of termination, or (II) the amount of the Caparro Bonuses earned for the
immediately preceding bonus year (or if higher, the bonus payment made to Mr. Caparro with respect
to the full fiscal year immediately preceding the change of control event), (ii) a bonus payment
equal to the pro-rata portion of the Caparro Bonuses for the year of termination and payment of any
accrued amounts for vacation, expenses, or bonuses, (iii) 100% vesting of options, which remain
exercisable for a period of 12 months thereafter or, if less, the remainder of the term. Mr. Caparro has resigned his employment with us effective June 6, 2005 (Note 24). Employment Agreement with Diane Price Baker We entered into an employment agreement with Diane Price Baker (the Baker Employment
Agreement) to serve as Executive Vice President and Chief Financial Officer, effective January 24,
2005. The term of the Baker Employment Agreement will continue through January 24, 2008; should an
agreement not be reached regarding the continuation of employment by this date, Ms. Baker may
remain in our employ under the current terms of employment for a period not to exceed one year. Under the Baker Employment Agreement, Ms. Baker receives an annual salary of $0.4 million, to
be reviewed annually for increase at the discretion of the Compensation Committee. Ms. Baker is
eligible to receive an annual bonus F-30




---



##### Table of Contents



(beginning in fiscal 2006) with a target amount of 50.0% of her base salary, based upon our
financial performance as well as Ms. Bakers attainment of individual objectives. Ms. Baker
received stock options to purchase 250,000 of our common stock. If Ms. Baker is terminated without cause prior to a change of control or within 24 months of a
change in control event, then in exchange for a general release, Ms. Baker will receive her then
current base salary and continued medical, health and life insurance for the period of one year.
Additionally, in the case where Ms. Baker is terminated without cause within 24 months of a change
of control event, 100% of her stock options shall vest and remain exercisable for a period of six
months thereafter. Employment Agreement with Harry M. Rubin We entered into an employment agreement with Harry M. Rubin (the Rubin Employment
Agreement), which was effective as of June 1, 2002. The Term of the Rubin Employment Agreement
was to continue through May 31, 2007, and may have been extended for five additional years under
terms that were identical to those contained in the Rubin Employment Agreement. Under the Rubin Employment Agreement, Mr. Rubin received an annual salary of $0.4 million
retroactive to January 1, 2002, and was eligible to receive an annual increase in the base salary
of five percent. Additionally, Mr. Rubin was eligible to receive an annual bonus of up to 50.0% of
his base salary and received a car allowance of $3,000 per month. During the fourth quarter of
fiscal 2005, Mr. Rubin resigned for good reason (as defined in the Rubin Employment Agreement).
Mr. Rubin received severance aggregating approximately $2.3 million in accordance with the terms of
his Employment Agreement. Termination Agreement with Denis Guyennot On October 15, 2004, we entered into an agreement with Denis Guyennot, pursuant to which Mr.
Guyennot ceased being the President and Chief Operating Officer as of that date. The agreement
provides that Mr. Guyennot will receive salary and benefits for services rendered through September
30, 2004. Mr. Guyennot has agreed to provide consulting services to us for a one-year period
following the termination of his employment for which he will receive a consulting fee of $450,000,
payable in six (6) equal monthly installments, commencing on October 20, 2004 and continuing until
March 20, 2005. Mr. Guyennot will continue to serve as a Director. Consultation Agreement with Ann Kronen On July 1, 2004, we entered into a consultation agreement with Ann Kronen (Kronen
Agreement). The Kronen Agreement engages Ms. Kronen to provide creative and editorial direction
for the projects and game development undertaken by us as reasonably requested. The term of the
Kronen Agreement began on July 1, 2004 and remained in effect until December 31, 2004. On January
1, 2005, the term of the Kronen agreement was extended through July 31, 2005. In connection with
the Kronen Agreement, Ms. Kronen was compensated $0.2 million for these services in fiscal 2005.
In addition, Ms. Kronen was given a nominal monthly expense allowance and was reimbursed for any
reasonable and pre-approved travel expenses incurred in connection with the rendering of her
services. Note 14  Leases Future minimum annual rental payments under our leases, including the related party sub-lease
with Atari Interactive, are as follows for the fiscal years then ended (in thousands):


Operating Leases2006
    
    $
    5,8452007
    
    
    4,4562008
    
    
    2,1012009
    
    
    8702010
    
    
    700Thereafter
    
    
    992Total minimum lease payments
    
    $
    14,964


F-31



---



##### Table of Contents





Capital Leases2006
    
    $
    1752007
    
    
    1642008
    
    
    282009
    
    
    12010
    
    
    Thereafter
    
    
    Total minimum lease payments
    
    $
    368Less: interest
    
    
    24Present value of net capital lease payments
    
    
    344Less: short-term portion of capital lease obligation
    
    
    158Long-term capital lease obligation
    
    $
    186


Total rent expense charged to operations for the nine months ended March 31, 2002 (unaudited)
and 2003, and the years ended March 31, 2003 (unaudited), 2004, and 2005 amounted to approximately
$2.9 million, $3.5 million, $4.5 million, $5.5 million, and $5.0 million respectively.

Note 15  Debt

Credit Facilities

HSBC Loan and Security Agreement

On May 13, 2005, we obtained a one year $50.0 million revolving credit facility (Revolving
Credit Facility) with HSBC Business Credit (USA) Inc. (HSBC), pursuant to a Loan and Security
Agreement, to fund our working capital and general corporate needs. Loans under the Revolving
Credit Facility are determined based on percentages of our eligible receivables and eligible
inventory for certain peak seasonal periods. The Revolving Credit Facility bears interest at prime
for daily borrowings or LIBOR plus 1.75% for borrowings with a maturity of 30 days or greater. We
are required to pay a commitment fee of 0.25% on the average unused portion of the facility
quarterly in arrears and closing costs of approximately $0.1 million. The Revolving Credit
Facility contains certain financial covenants that require us to maintain enumerated EBITDA,
tangible net worth, and working capital minimums. In addition, amounts outstanding under the
Revolving Credit Facility are secured by liens on substantially all of our present and future
assets, including accounts receivable, inventory, general intangibles, fixtures, and equipment and
excluding certain non-U.S. assets.

GECC Senior Credit Facility

On November 12, 2002, we obtained a 30-month $50.0 million secured revolving credit facility
(Senior Credit Facility) with General Electric Capital Corporation (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 were based on a borrowing base
comprised of the value of our accounts receivable and short-term marketable securities. The senior
credit facility bore 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 March 31,
2005, no borrowings are outstanding and $0.1 million of letters of credit are outstanding under the
senior credit facility. As of March 31, 2005, a nominal amount of accrued interest is included in
accrued liabilities.

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

F-32



---



##### Table of Contents



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. The senior credit facility expired on May 12, 2005. IESA credit facilities and debt Credit Agreement We maintained a Credit Agreement which provided for an aggregate commitment of $75.0 million
which bore interest at LIBOR plus 2.5%. Effective December 31, 2002, the maturity date of the
Credit Agreement was extended to April 1, 2004. This agreement required that we comply with
certain financial covenants and, among other items, restricted capital expenditures. As of
September 30, 2003, all outstanding borrowings were exchanged for 10,541,105 newly issued common
shares under the terms of the Recapitalization Agreement. Medium-Term Loan In connection with the Shiny Acquisition (Note 2), we obtained a $50.0 million medium-term
loan from IESA. Interest was based on the three month LIBOR rate plus 2.75% and payable on a
quarterly basis, in arrears. An unused commitment fee of 0.50% per annum was based on the
aggregate amount of the facility less outstanding loans. As of September 30, 2003, all outstanding
borrowings have been exchanged for 11,359,319 newly issued common shares under the terms of the
Recapitalization Agreement. Long-Term Related Party Debt 0% Notes In conjunction with the 1999 purchase of us by IESA, we issued to GAP the 0% Notes in exchange
for 600,000 shares of Series A Preferred Stock and $20.0 million of subordinated notes of us. The
0% Notes were to mature in December 2004 and had a redemption value of $50.0 million at maturity.
In lieu of payment at maturity, the 0% Notes were convertible at any time, at the holders option,
into shares of our common stock at $20.00 per share. On December 28, 2001, IESA assumed the 0%
Notes from GAP in exchange for shares of IESA common stock. IESA did not change any of the terms
of the 0% Notes (renamed the IESA 0% subordinate convertible note) as they relate to us.
Interest on the IESA 0% subordinate convertible note was accreted at the rate of 7% per annum. Under the terms of the September 4, 2003 Recapitalization Agreement, the IESA 0% subordinated
convertible note has been fully offset against the advances to related parties (Note 2,
Recapitalizationand Note 13, Advances to Related Parties). 5% Notes In conjunction with the 1999 purchase of us by IESA, we issued to CUSH, 5% subordinated
convertible notes (5% CUSH Notes) in exchange for $25.0 million in cash and $35.6 million in debt
and accrued interest. The 5% CUSH Notes were to mature in December 2004 and had a principal amount
of $60.6 million. In lieu of payment at maturity, the 5% CUSH Notes were convertible at any time,
at the holders option, into shares of our common stock at $9.25 per share. Under the terms of the September 4, 2003 Recapitalization Agreement, the 5% CUSH Notes, net of
the remaining advances to related parties, have been fully converted to 17,129,453 of our newly
issued common shares at a fair-market value of $4.25 per share. The common shares issued by us
were at a more favorable rate than that available under the original terms of the 5% CUSH Notes.
The resulting incremental value of the additional stock issued was recorded as a dividend to IESA
of $39.4 million (Note 2, Recapitalization). In September 2003, we expensed the full $1.3 million of remaining deferred financing fees
related to the IESA 0% subordinated convertible note and the 5% CUSH Notes as a result of the
Recapitalization Agreement. F-33




---



##### Table of Contents



Note 16  Legal Proceedings Litigation During the year ended March 31, 2005, 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 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, Inc.; 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. 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 Entertainment Corp. and Gamesonline.com, Inc. 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 F-34




---



##### Table of Contents



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. 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 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 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 plaintiffs failure to respond to its discovery requests. The Court
directed that plaintiffs submit a letter brief setting forth its generic objections to Games
discovery requests. The Court ordered that 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, plaintiffs submitted its 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 plaintiffs motion to
quash Games discovery requests. On July 16, 2004, it came to 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. 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,
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
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,
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 plaintiffs motion to dismiss the Counterclaims, which has been fully
submitted and is under judicial deliberation. On October 4, 2004, it came to 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 F-35




---



##### Table of Contents



domain name games.com and that it had an exclusive license to certain Hasbro and Atari games.
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, 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 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 by December 20, 2004. The parties completed discovery, and
plaintiffs filed their motion for summary judgment, and motion for contempt sanctions, on November
29, 2004. The Court heard oral argument on these motions on January 12, 2005. On February 23, 2005, the Court issued an order granting plaintiffs motion to dismiss certain
of Games counterclaims, and on March 11, 2005, the court granted Ataris motion for summary
judgment on its breach of contract claim and dismissed Games remaining counterclaims. The Court
denied Games motion for reconsideration on April 4, 2005. On May 4, 2005, the Court issued a
memorandum order granting us damages in the following amount: (1) immediate payment of $3,104,108,
plus interest at an annual rate of nine percent from April 30, 2004; (2) immediate redemption of
10,250 shares of Games, Inc. stock for $1.025 million, plus interest at an annual rate of nine
percent from April 30, 2004; (3) immediate redemption of 10,000 additional shares of Games, Inc.
stock for $1 million; (4) redemption of the remaining
10,000 shares at any time after December 29,
2005. The order provides that the judgment runs directly against Games but in the event Games
fails to satisfy it, it runs secondarily against Chicago West Pullman and Ach. The Courts order
also lifts the preliminary injunction imposed at the outset of the case. Ach filed a motion for reconsideration concerning the Courts ruling that the judgment would
run directly against Ach, and we requested that the Court issue a permanent injunction and clarify
certain aspects of the judgment. On May 27, 2005, the Court issued an order denying Achs motion
for reconsideration and confirming its earlier ruling that the judgment would run against Ach
personally. The Court also clarified that after December 29, 2005, we are entitled to an additional
$1.0 million, representing the cash redemption of the last 10,000 shares of Games Inc.s stock.
The Court also issued a permanent injunction barring Games Inc. from selling or distributing any
product that contains the intellectual property that is the subject of the asset purchase
agreement. The remaining elements of the original judgment remain. 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 an Answer on
November 8, 2004. On February 7, 2005, a Second Amended Complaint was filed against all of the above defendants,
plus Sony Online Entertainment, Inc., Sony Computer Entertainment America, Inc., Microsoft Corp.,
and Nintendo of America, Inc. We answered the Second Amended Complaint on February 24, 2005.
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: Atari, Inc., 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 F-36




---



##### Table of Contents



in multiplayer electronic games played on interconnected computers) and seeks unspecified
damages. We answered the Complaint on or about March 28, 2005. Codemasters, Inc. v. Atari, Inc. On January 13, 2005, we were served with a Complaint filed by Codemasters, Inc.
(Codemasters) against us 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. In February
2005, we answered the Complaint and also served Counterclaims. The parties settled the matter on
May 5, 2005. Pursuant to the settlement Agreement, we paid Codemasters $0.3 million, which has
been accrued as of March 31, 2005. Mr. M.L. Edmondson v. Reflections Interactive Limited On March 4, 2005, Martin Lee Edmondson, the former Managing Director of Reflections
Interactive Limited, our wholly-owned UK subsidiary, filed a Notice of Claim with the Newcastle
upon Tyne Employment Tribunal claiming constructive unfair dismissal as a result of Reflections
alleged repudiatory breach of a contract of employment that necessitated Mr. Edmondsons
resignation. Mr. Edmondson is seeking a declaration that he was unfairly dismissed and
compensation in an unspecified amount for such dismissal. Compensation in the Employment Tribunal
is limited to £55,000 in respect of the maximum compensatory award. Mr. Edmondson could be awarded
for unfair dismissal, together with a maximum basic award of (depending on age and length of
service) £1,350 to £2,025. On April 1, 2005, Reflections filed a Response denying that there was a
fundamental breach of contract that entitled Mr. Edmondson to resign and claim constructive
dismissal. A case management discussion was scheduled for April 29, 2005 but has been postponed
pending the parties ongoing without prejudice discussions regarding settlement. The Employment
Tribunal has granted a stay of the proceedings until July 8, 2005, by which date the parties must
report to the Employment Tribunal on the progress of the without prejudice discussions. Note 17  Employee Savings Plan We maintain an Employee Savings Plan (the Plan) which qualifies as a deferred salary
arrangement under Section 401(k) of the Internal Revenue Code. The Plan is available to all United
States employees who meet the eligibility requirements. Under the Plan, participating employees
may elect to defer a portion of their pretax earnings, up to the maximum allowed by the Internal
Revenue Service with matching of 100% of the first 3% and 50% of the next 6% of the employees
contribution provided by us. Generally, the Plans assets in a participants account will be
distributed to a participant or his or her beneficiaries upon termination of employment,
retirement, disability or death. All Plan administrative fees are paid by us. Generally, we do
not provide our employees any other post-retirement or post-employment benefits, except
discretionary severance payments upon termination of employment. Plan expense approximated $0.9
million, $1.0 million, $1.4 million, $1.4 million, and $1.1 million for the nine months ended March
31, 2002 (unaudited) and 2003, and the years ended March 31, 2003 (unaudited), 2004, and 2005,
respectively. Note 18  Royalty and License Advances We have committed to pay advance payments under certain royalty and license agreements. The
payments of these obligations are not dependent on the delivery of the contracted services by the
developers. Future advances due under these agreements are as follows for the fiscal years then
ended (in thousands): 2006
    
    $
    1,6852007
    
    
    9082008
    
    
    2009
    
    
    2010
    
    
    Thereafter
    
    
    $
    2,593
 F-37




---



##### Table of Contents



Note 19  Concentration of Credit Risk We extend credit to various companies in the retail and mass merchandising industry for the
purchase of its merchandise which results in a concentration of credit risk. This concentration of
credit risk may be affected by changes in economic or other industry conditions and may,
accordingly, impact our overall credit risk. Although we generally do not require collateral, we
perform ongoing credit evaluations of our customers and reserves for potential losses are
maintained. The percentage of net revenues earned from sales of its top two customers for the fiscal years
then ended are as follows: Nine MonthsEnded
    
    
    Years EndedMarch 31,
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    
    (unaudited)Top customer
    
    
    28
    %
    
    
    24
    %
    
    
    25
    %
    
    
    25
    %
    
    
    26
    %Second customer
    
    
    11
    %
    
    
    11
    %
    
    
    10
    %
    
    
    11
    %
    
    
    12
    %Third customer
    
    
    8
    %
    
    
    9
    %
    
    
    8
    %
    
    
    10
    %
    
    
    10
    %Top three customers
    
    
    47
    %
    
    
    44
    %
    
    
    43
    %
    
    
    46
    %
    
    
    48
    %
 Accounts receivable due from three of the most significant customers of each period
aggregated 35% and 41% of accounts receivable at March 31, 2004 and March 31, 2005, respectively. Note 20  Discontinued Operations In the fourth quarter of fiscal 2005, following the guidance established under FASB Statement
No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, management committed to a
plan to divest of our Humongous Entertainment development studio (Humongous). The sale is expected to
occur in the twelve months following the end of fiscal 2005. At March 31, 2005, the assets and
liabilities of Humongous are presented separately on our Consolidated Balance Sheets. The
components of the assets and liabilities of discontinued operations are as follows (in thousands): March 31, 2004
    
    
    March 31, 2005Assets:Cash
    
    $
    13
    
    
    $
    6Inventory, net
    
    
    1,877
    
    
    
    1,104Prepaid expenses and other
current assets
    
    
    17
    
    
    
    259Property and equipment, net
    
    
    686
    
    
    
    452Other non-current assets
    
    
    84
    
    
    
    1,734Total assets
    
    $
    2,677
    
    
    $
    3,555Liabilities:Accounts payable
    
    $
    57
    
    
    $
    31Accrued liabilities
    
    
    426
    
    
    
    2,078Royalty payable
    
    
    286
    
    
    
    386Other non-current liabilities
    
    
    251
    
    
    
    190Total liabilities
    
    $
    1,020
    
    
    $
    2,685
 As Humongous represents a component of our business and its results of operations and cash
flows can be separated from the rest of our operations, the results for the periods presented are
disclosed as discontinued operations on the face of the Consolidated Statement of Operations and
Comprehensive Income (Loss). Net revenues and (loss) income from discontinued operations are as
follows (in thousands): F-38




---



##### Table of Contents



Nine MonthsEnded
    
    
    
    
    
    
    Years EndedMarch 31,
    
    
    
    
    
    
    March 31,2002
    
    
    2003
    
    
    2003
    
    
    2004
    
    
    2005(unaudited)
    
    
    
    
    
    (unaudited)Net revenues
    
    $
    25,617
    
    
    $
    27,758
    
    
    $
    32,927
    
    
    $
    21,494
    
    
    $
    12,649Income (loss) from discontinued operations
    
    $
    8,052
    
    
    $
    6,909
    
    
    $
    6,107
    
    
    $
    (1,612
    )
    
    $
    (4,241
    )
 Prior to the recording of discontinued operations, Humongous was reported as part of our
publishing segment (Note 22). Note 21  Restructuring During the fourth quarter of fiscal 2005, following the guidance established under FASB
Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, management
announced a restructuring plan to strengthen our competitive position in the marketplace as well as
enhance shareholder value. We recorded restructuring expenses of $4.9 million, which include the
termination of several key executives as well as severance and other charges related to the closing
of the Beverly, MA, and Santa Monica, CA, publishing studios and the transfer of all publishing
operations to the New York office. The charge of $4.9 million is comprised of the following (in
thousands): Year EndedMarch 31, 2005Severance and retention expenses
    
    $
    4,219Modification of stock options
    
    
    596Miscellaneous costs
    
    
    117Total
    
    $
    4,932
 We expect to incur an additional $5.0 million to $8.0 million over the next twelve month
period in order to complete managements restructuring plan. The following is a reconciliation of our restructuring reserve from inception through March
31, 2005 (in thousands): Balance at
    
    
    
    
    
    
    
    
    
    
    Balance atMarch 31, 2004
    
    
    Accrued Amounts
    
    
    Cash payments
    
    
    March 31, 2005Severance and retention
    
    $
    
    
    
    $
    4,219
    
    
    $
    (2,414
    )
    
    $
    1,805Miscellaneous costs
    
    
    
    
    
    
    117
    
    
    
    (37
    )
    
    
    80Total
    
    $
    
    
    
    $
    4,336
    
    
    $
    (2,451
    )
    
    $
    1,885
 Note 22  Operations by Reportable Segments and Geographic Areas We have three reportable segments: publishing, distribution and corporate. Publishing is
comprised of three studios located in Santa Monica, California; Beverly, Massachusetts; and
Minneapolis, Minnesota (closed in March 2004). As part of our restructuring plan, the Santa Monica
and Beverly studios will be closed in fiscal 2006 and all publishing operations will be transferred
to the New York office. Distribution constitutes 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 in the publishing segment. This amount
consists of depreciation on computers and office furniture in 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. F-39




---



##### Table of Contents



The results of operations for Humongous are not included in our segment reporting as they
are classified as discontinued operations in our Consolidated Financial Statements. 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, and where appropriate, merchandising and marketing strategies. The following summary represents the consolidated net revenues, operating income (loss),
depreciation and amortization, and interest income (expense) by reportable segment for the nine
months ended March 31, 2002 (unaudited) and 2003, and the years ended March 31, 2003 (unaudited),
2004, and 2005 (in thousands): Publishing
    
    
    Distribution
    
    
    Corporate
    
    
    TotalNine months ended March 31, 2002
(unaudited):Net revenues
    
    $
    186,285
    
    
    $
    77,539
    
    
    $
    
    
    
    $
    263,824Operating (loss) income
    
    
    (6,146
    )
    
    
    6,996
    
    
    
    (16,537
    )
    
    
    (15,687
    )Depreciation and amortization
    
    
    (911
    )
    
    
    (401
    )
    
    
    (1,915
    )
    
    
    (3,227
    )Interest income (expense)
    
    
    
    
    
    
    75
    
    
    
    (7,962
    )
    
    
    (7,887
    )Nine months ended March 31, 2003:Net revenues
    
    $
    302,055
    
    
    $
    74,832
    
    
    $
    
    
    
    $
    376,887Operating income (loss)
    
    
    31,371
    
    
    
    14,151
    
    
    
    (25,002
    )
    
    
    20,520Depreciation and amortization
    
    
    (2,730
    )
    
    
    (438
    )
    
    
    (2,412
    )
    
    
    (5,580
    )Interest income (expense)
    
    
    
    
    
    
    151
    
    
    
    (9,749
    )
    
    
    (9,598
    )Year ended March 31, 2003 (unaudited):Net revenues
    
    $
    405,188
    
    
    $
    96,133
    
    
    $
    
    
    
    $
    501,321Operating income (loss)
    
    
    44,389
    
    
    
    16,367
    
    
    
    (30,885
    )
    
    
    29,871Depreciation and amortization
    
    
    (3,523
    )
    
    
    (582
    )
    
    
    (3,292
    )
    
    
    (7,397
    )Interest (expense) income
    
    
    (58
    )
    
    
    179
    
    
    
    (13,788
    )
    
    
    (13,667
    )Year ended March 31, 2004:Net revenues
    
    $
    384,490
    
    
    $
    62,961
    
    
    $
    
    
    
    $
    447,451Operating income (loss)
    
    
    26,430
    
    
    
    10,708
    
    
    
    (27,953
    )
    
    
    9,185Depreciation and amortization
    
    
    (3,260
    )
    
    
    (191
    )
    
    
    (5,353
    )
    
    
    (8,804
    )Interest income (expense)
    
    
    
    
    
    
    22
    
    
    
    (7,680
    )
    
    
    (7,658
    )Year ended March 31, 2005:Net revenues
    
    $
    340,964
    
    
    $
    54,201
    
    
    
    
    
    
    $
    395,165Operating income (loss)
    
    
    41,095
    
    
    
    8,028
    
    
    
    (38,589
    )
    
    
    10,534Depreciation and amortization
    
    
    (2,940
    )
    
    
    
    
    
    
    (7,662
    )
    
    
    (10,602
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    (459
    )
    
    
    (459
    )
 Information about our operations in the United States and other geographic locations for the
nine months ended March 31, 2002 (unaudited) and 2003, and the years ended March 31, 2003
(unaudited), 2004, and 2005 are presented below (in thousands): OtherUnited
    
    
    
    
    
    
    GeographicStates
    
    
    Europe
    
    
    Locations
    
    
    TotalNine months ended March 31, 2002 (unaudited):Net revenues
    
    $
    259,960
    
    
    $
    
    
    
    $
    3,864
    
    
    $
    263,824Operating (loss)
    
    
    (10,117
    )
    
    
    (4,950
    )
    
    
    (620
    )
    
    
    (15,687
    )Capital expenditures
    
    
    5,299
    
    
    
    1,005
    
    
    
    
    
    
    
    6,304Total assets
    
    
    159,344
    
    
    
    3,100
    
    
    
    6,014
    
    
    
    168,458Nine months ended March 31, 2003:Net revenues
    
    $
    376,880
    
    
    $
    
    
    
    $
    7
    
    
    $
    376,887Operating income (loss)
    
    
    26,527
    
    
    
    (5,442
    )
    
    
    (565
    )
    
    
    20,520Capital expenditures
    
    
    3,480
    
    
    
    460
    
    
    
    
    
    
    
    3,940Total assets
    
    
    215,635
    
    
    
    2,953
    
    
    
    5,169
    
    
    
    223,757
 F-40




---



##### Table of Contents



OtherUnited
    
    
    
    
    
    
    GeographicStates
    
    
    Europe
    
    
    Locations
    
    
    TotalYear ended March 31, 2003 (unaudited):Net revenues
    
    $
    499,797
    
    
    $
    604
    
    
    $
    920
    
    
    $
    501,321Operating income (loss)
    
    
    38,198
    
    
    
    (6,760
    )
    
    
    (1,567
    )
    
    
    29,871Capital expenditures
    
    
    5,237
    
    
    
    646
    
    
    
    
    
    
    
    5,883Total assets
    
    
    215,635
    
    
    
    2,953
    
    
    
    5,169
    
    
    
    223,757Year ended March 31, 2004:Net revenues
    
    $
    447,451
    
    
    $
    
    
    
    $
    
    
    
    $
    447,451Operating income (loss)
    
    
    18,136
    
    
    
    (8,808
    )
    
    
    (143
    )
    
    
    9,185Capital expenditures
    
    
    4,686
    
    
    
    352
    
    
    
    
    
    
    
    5,038Total assets
    
    
    190,607
    
    
    
    3,318
    
    
    
    31
    
    
    
    193,956Year ended March 31, 2005:Net revenues
    
    $
    395,165
    
    
    $
    
    
    
    $
    
    
    
    $
    395,165Operating income (loss)
    
    
    20,931
    
    
    
    (10,397
    )
    
    
    
    
    
    
    10,534Capital expenditures
    
    
    1,771
    
    
    
    268
    
    
    
    
    
    
    
    2,039Total assets
    
    
    187,370
    
    
    
    2,669
    
    
    
    
    
    
    
    190,039
 United States net revenues include royalties on sales of our product sold internationally.
For the nine months ended March 31, 2002 (unaudited) and 2003, and the years ended March 31, 2003
(unaudited), 2004, and 2005 the royalties were $2.9 million, $18.8 million, $20.3 million, $28.7
million, and $18.6 million respectively. Note 23  Quarterly Financial Data (unaudited) Summarized quarterly financial data for the nine months ended March 31, 2003 is as follows (in
thousands, except per share amounts): September 30,
    
    
    December 31,
    
    
    March 31,Net revenues
    
    $
    102,440
    
    
    $
    188,737
    
    
    $
    85,710Gross profit
    
    
    50,927
    
    
    
    89,380
    
    
    
    40,837Operating income (loss)
    
    
    1,893
    
    
    
    20,739
    
    
    
    (2,112
    )(Loss) income from continuing operations
    
    
    (854
    )
    
    
    17,020
    
    
    
    (5,005
    )Income (loss) from discontinued operations
    
    
    1,465
    
    
    
    12,808
    
    
    
    (7,364
    )Income (loss) attributable to common stockholders
    
    
    611
    
    
    
    29,828
    
    
    
    (12,369
    )Basic and diluted (loss) income per share from
continuing operations
    
    $
    (0.01
    )
    
    $
    0.25
    
    
    $
    (0.07
    )Basic and diluted income (loss) per share from
discontinued operations
    
    
    0.02
    
    
    
    0.18
    
    
    
    (0.11
    )Basic and diluted income (loss) per share
attributable to common stockholders
    
    
    0.01
    
    
    
    0.43
    
    
    
    (0.18
    )Weighted average shares outstanding  basic
    
    
    69,826
    
    
    
    69,891
    
    
    
    69,918Weighted average shares outstanding  diluted
    
    
    69,952
    
    
    
    69,984
    
    
    
    69,918
 During the third quarter of the nine months ended March 31, 2003, we reduced our royalty
payable by approximately $2.0 million as returns, price protection and other customer promotional
allowances of certain royalty bearing products were greater than the amounts estimated during the
second quarter. Summarized quarterly financial data for the fiscal year ended March 31, 2004 is as follows (in
thousands, except per share amounts): June 30,
    
    
    September 30,
    
    
    December 31,
    
    
    March 31,Net revenues
    
    $
    148,792
    
    
    $
    56,369
    
    
    $
    177,489
    
    
    $
    64,801Gross profit
    
    
    79,412
    
    
    
    20,003
    
    
    
    88,132
    
    
    
    19,666
 F-41




---



##### Table of Contents



June 30,
    
    
    September 30,
    
    
    December 31,
    
    
    March 31,Operating income (loss)
    
    
    29,931
    
    
    
    (25,196
    )
    
    
    22,297
    
    
    
    (17,847
    )Income (loss) from continuing operations
    
    
    25,986
    
    
    
    (28,336
    )
    
    
    20,027
    
    
    
    (15,299
    )(Loss) income from discontinued operations
    
    
    (2,194
    )
    
    
    (395
    )
    
    
    2,991
    
    
    
    (2,014
    )Dividend to parent
    
    
    
    
    
    
    (39,351
    )
    
    
    
    
    
    
    Income (loss) attributable to common stockholders
    
    
    23,792
    
    
    
    (68,082
    )
    
    
    23,018
    
    
    
    (17,313
    )Basic income (loss) per share from continuing
operations
    
    $
    0.37
    
    
    $
    (0.38
    )
    
    $
    0.17
    
    
    $
    (0.12
    )Basic (loss) income per share from discontinued
operations
    
    
    (0.03
    )
    
    
    (0.00
    )
    
    
    0.02
    
    
    
    (0.02
    )Dividend to parent
    
    
    
    
    
    
    (0.52
    )
    
    
    
    
    
    
    Basic income (loss) per share attributable to
common stockholders
    
    
    0.34
    
    
    
    (0.90
    )
    
    
    0.19
    
    
    
    (0.14
    )Diluted income (loss) per share from continuing
operations
    
    $
    0.32
    
    
    $
    (0.38
    )
    
    $
    0.17
    
    
    $
    (0.12
    )Diluted (loss) income per share from discontinued
operations
    
    
    (0.02
    )
    
    
    (0.00
    )
    
    
    0.02
    
    
    
    (0.02
    )Dividend to parent
    
    
    
    
    
    
    (0.52
    )
    
    
    
    
    
    
    Diluted income (loss) per share attributable to
common stockholders
    
    
    0.30
    
    
    
    (0.90
    )
    
    
    0.19
    
    
    
    (0.14
    )Weighted average shares outstanding  basic
    
    
    69,974
    
    
    
    75,594
    
    
    
    121,170
    
    
    
    121,214Weighted average shares outstanding  diluted
    
    
    80,499
    
    
    
    75,594
    
    
    
    121,325
    
    
    
    121,214
 During the fourth quarter of the year ended March 31, 2004, we recorded
approximately $3.7 million of additional royalties due as part of a negotiation and settlement
regarding disputes with respect to a contract with a third party licensor. Additionally, we
recorded approximately $5.4 million of additional reserves for returns, price protection, and other
customer promotional allowances that management deemed necessary to accurately reflect market
conditions at that time. Summarized quarterly financial data for the fiscal year ended March 31, 2005 is as follows (in
thousands, except per share amounts): June 30,
    
    
    September 30,
    
    
    December 31,
    
    
    March 31,Net revenues
    
    $
    108,124
    
    
    $
    67,984
    
    
    $
    156,364
    
    
    $
    62,693Gross profit
    
    
    57,260
    
    
    
    28,560
    
    
    
    68,550
    
    
    
    35,292Operating income (loss)
    
    
    14,839
    
    
    
    (15,718
    )
    
    
    19,534
    
    
    
    (8,121
    )Income (loss) from continuing operations
    
    
    14,074
    
    
    
    (16,003
    )
    
    
    19,241
    
    
    
    (7,379
    )(Loss) income from discontinued operations
    
    
    (2,018
    )
    
    
    (888
    )
    
    
    365
    
    
    
    (1,700
    )Income (loss) attributable to common stockholders
    
    
    12,056
    
    
    
    (16,891
    )
    
    
    19,606
    
    
    
    (9,079
    )Basic and diluted income (loss) per share from
continuing operations
    
    $
    0.12
    
    
    $
    (0.13
    )
    
    $
    0.16
    
    
    $
    (0.06
    )Basic and diluted (loss) income per share from
discontinued operations
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    0.00
    
    
    
    (0.01
    )Basic and diluted income (loss) per share
attributable to common stockholders
    
    
    0.10
    
    
    
    (0.14
    )
    
    
    0.16
    
    
    
    (0.07
    )Weighted average shares outstanding  basic
    
    
    121,249
    
    
    
    121,277
    
    
    
    121,283
    
    
    
    121,295Weighted average shares outstanding  diluted
    
    
    121,334
    
    
    
    121,277
    
    
    
    121,376
    
    
    
    121,295
 During the fourth quarter of the year ended March 31, 2005, we reported the results of
Humongous as discontinued operations. Additionally, during the fourth quarter, we recorded $4.9
million of restructuring expenses. Furthermore, in the fourth quarter of fiscal 2005, we recorded
a reduction of revenue in the amount of $2.5 million for amounts owed to Atari Europe related to
worldwide licensing rights for royalty income received by us from third parties (Note 13,
Transactions with Atari Europe). The per share amounts are calculated independently for each of the quarters presented. The
sum of the quarters may not equal the full year per share amounts. F-42




---



##### Table of Contents



Note 24  Subsequent Events Termination of Atari Interactive Services Agreement In the first quarter of fiscal 2006, Atari Interactive sent a notice of termination of the
Services Agreement between us and Atari Interactive, effective June 30, 2005. Pursuant to the
Services Agreement, we provide Atari Interactive with legal, financial, information technology, and human
resources management services in exchange for payment of $0.3 million per month. Under the Services
Agreement, either party has the right to terminate the agreement upon 30 days written notice, and
as such, there are no applicable early termination penalties. Termination of the Services
Agreement will result in the loss of such revenue but will also eliminate costs incurred in
connection with providing the management services. Resignation of Chief Executive Officer On June 6, 2005, James Caparro resigned his position as our President and Chief Executive
Officer, effective immediately. Our Board of Directors has appointed Bruno Bonnell, our Chairman
and Chief Creative Officer, to act as Chief Executive Officer on an interim basis. Our Board has
instituted an immediate search for a permanent President and Chief
Executive Officer. Our Compensation Committee is reviewing our and
Mr. Caparro's rights, if any, relating to Mr. Caparro's resignation. F-43




---



##### Table of Contents



ATARI, INC. AND SUBSIDIARIES SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS (in thousands) Additions
    
    
    AdditionsBalance
    
    
    Charged to
    
    
    Charged to
    
    
    
    
    
    
    BalanceBeginning
    
    
    Net
    
    
    Operating
    
    
    
    
    
    
    EndDescription
    
    of Period
    
    
    Revenues
    
    
    Expenses
    
    
    Deductions
    
    
    of PeriodAllowance for bad debts, returns,
price protection and other customer promotional programs:Year ended March 31, 2005
    
    $
    36,279
    
    
    $
    82,098
    
    
    $
    3,622
    
    
    $
    (97,714
    )
    
    $
    24,285Year ended March 31, 2004
    
    $
    40,319
    
    
    $
    98,320
    
    
    $
    4,422
    
    
    $
    (106,782
    )
    
    $
    36,279Nine months ended March 31, 2003
    
    $
    50,451
    
    
    $
    72,556
    
    
    $
    3,814
    
    
    $
    (86,502
    )
    
    $
    40,319
 Additions
    
    
    AdditionsBalance
    
    
    Charged to
    
    
    Charged to
    
    
    
    
    
    
    BalanceBeginning
    
    
    Cost of
    
    
    Operating
    
    
    
    
    
    
    EndDescription
    
    of Period
    
    
    Goods Sold
    
    
    Expenses
    
    
    Deductions
    
    
    of PeriodReserve for obsolescence:Year ended March 31, 2005
    
    $
    1,973
    
    
    $
    2,645
    
    
    $
    
    
    
    $
    (2,196
    )
    
    $
    2,422Year ended March 31, 2004
    
    $
    4,756
    
    
    $
    1,713
    
    
    $
    
    
    
    $
    (4,496
    )
    
    $
    1,973Nine months ended March 31, 2003
    
    $
    7,695
    
    
    $
    3,416
    
    
    $
    
    
    
    $
    (6,182
    )
    
    $
    4,756
 F-44




---



##### Table of Contents



EXHIBIT INDEX Exhibits  3.1
    Amended and Restated Certificate of Incorporation is incorporated herein by reference to
Exhibit 3.1 to the Companys Annual Report on Form 10-K for the fiscal year ended March 31,
2000.3.2
    Amended and Restated By-laws are incorporated herein by reference to Exhibit 3.2 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.3.3
    Amendment No. 1 to Amended and Restated By-laws is incorporated by reference to Exhibit 3.2
to the Companys Quarterly Report on Form 10-Q for the quarter ended December 31, 2003.4.1
    Specimen form of stock certificate of Common Stock is incorporated herein by reference to the
Companys Registration Statement on Form S-1 (File No. 333-14441) initially filed with the SEC
on October 20, 1995, and all amendments thereto.4.2
    Registration Rights Agreement by and among Joseph J. Cayre, Kenneth Cayre, Stanley Cayre,
Jack J. Cayre, the Trusts listed on Schedule I attached thereto and the Company is
incorporated herein by reference to an exhibit filed as a part of the Companys Registration
Statement on Form S-1 filed October 20, 1995.4.3
    Second Amended and Restated Registration Rights Agreement, dated as of October 2, 2000,
between California U.S. Holdings, Inc. and the Company is incorporated herein by reference to
Exhibit 4.6 of the Companys Registration Statement on Form S-2 (File No. 333-107819)
initially filed with the SEC on August 8, 2003, and all amendments thereto.10.1
    Distribution Agreement between Infogrames Entertainment SA, Infogrames Multimedia SA and the
Company, dated as of December 16, 1999, is incorporated herein by reference to Exhibit 7 to
the Schedule 13D filed by Infogrames Entertainment SA and California U.S. Holdings, Inc. on
January 10, 2000.




---



##### Table of Contents



10.2
    Addendum to Distribution Agreement between Infogrames Entertainment SA and the Company,
dated as of December 16, 1999, is incorporated herein by reference to Exhibit 10.26a to the
Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2001.10.3
    Amendment to Distribution Agreement between Infogrames Entertainment SA and the Company dated as of
 July 1, 2000, is incorporated by reference to Exhibit 10.24a to the
Companys Transitional Report on Form 10-K for the transition
period March 31, 2000 to June 30, 2000.10.4
    Distribution Agreement between Infogrames Entertainment SA and the Company, dated October 2,
2000, as supplemented on November 12, 2002 is incorporated
herein by reference to Exhibit 10.3 to the Companys Annual
Report on Form 10-K for the fiscal year ended March 31, 2004.10.5
    Services Agreement, dated as of January 1, 2000, between Infogrames Entertainment SA and the
Company is incorporated herein by reference to Exhibit 10.41 to the Companys Transitional Report on
Form 10-K for the transition period March 31, 2000 to June 30, 2000.10.6
    Services Agreement, dated as of January 26, 2001, between the Company and Infogrames
Interactive, Inc. (now known as Atari Interactive, Inc.), is incorporated herein by reference
to Exhibit 10.46 to the Companys Annual Report on Form 10-K for the fiscal year ended June
30, 2001.10.7
    Warehouse Services Contract, dated March 2, 1999, by and between the Company and Arnold
Transportation Services, Inc. t/d/b/a Arnold Logistics is incorporated herein by reference to
Exhibit 10.50 to the Companys Annual Report on Form 10-K for the fiscal year ended March 31,
1999.




---



##### Table of Contents



10.8
    Credit Agreement, dated as of November 12, 2002, among the Company, as Borrower, the other
credit parties signatory thereto, the lenders signatory thereto from time to time, General
Electric Capital Corporation, as Administrative Agent, Agent and Lender, and GECC Capital
Markets Group, Inc., as Lead Arranger, is incorporated herein by reference to Exhibit 10.1 to
the Companys Current Report on Form 8-K filed on November 19, 2002.***10.9
    First Amendment and Consent to the Credit Agreement, dated as of March 28, 2003, among the
Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.57a to the Companys
Transition Report on Form 10-K for the fiscal year ended March 31, 2003.10.10
    Second Amendment and Consent to the Credit Agreement, dated as of April 15, 2003, among the
Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.57b to the Companys
Transition Report on Form 10-K for the fiscal year ended March 31, 2003.10.11
    Third Amendment and Waiver to the Credit Agreement, dated as of July 11, 2003, among the
Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.57c to the Companys
Transition Report on Form 10-K for the fiscal year ended March 31, 2003.10.12
    Fourth Amendment and Consent to the Credit Agreement, dated as of September 12, 2003, among
the Company, as Borrower, the other credit parties signatory thereto, the lenders signatory
thereto from time to time, General Electric Capital Corporation, as Administrative Agent,
Agent and Lender is incorporated herein by reference to Exhibit 10.1 to the Companys
Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003.10.13
    Fifth Amendment to the Credit Agreement, dated as of October 15, 2003, among the Company, as
Borrower, the other credit parties signatory thereto, the lenders signatory thereto from time
to time, General Electric Capital Corporation, as Administrative Agent, Agent and Lender is
incorporated herein by reference to Exhibit 10.2 to the Companys Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 2003.10.14
    Sixth Amendment to the Credit Agreement, dated as of December 23, 2003, among the Company,
as Borrower, the other credit parties signatory thereto, the lenders signatory thereto from
time to time, General Electric Capital Corporation, as Administrative Agent, Agent and Lender
is incorporated herein by reference to Exhibit 10.1 to the Companys Quarterly Report on Form
10-Q for the fiscal quarter ended December 31, 2003.




---



##### Table of Contents



10.15
    Seventh Amendment to the Credit Agreement, dated as of March 31, 2004, among the Company, as
Borrower, the other credit parties signatory thereto, the lenders signatory thereto from time
to time, General Electric Capital Corporation, as Administrative
Agent, Agent and Lender, is incorporated herein by reference to
Exhibit 10.28 to the Companys Annual Report on
Form 10-K for the year ended March 31, 2004.10.16
    Eighth Amendment to the Credit Agreement, dated as of May 20, 2004, among the Company, as
Borrower, the other credit parties signatory thereto, the lenders signatory thereto from time
to time, General Electric Capital Corporation, as Administrative
Agent, Agent and Lender, is incorporated herein by reference to
Exhibit 10.29 to the Companys Annual Report on
Form 10-K for the year ended March 31, 2004.10.17
    Consent to Credit Agreement, dated as of July 15, 2004,
among the Company, as Borrower, the other credit parties signatory
thereto, the lenders signatory thereto from time to time, and General
Electric Capital Corporation, as Administrative Agreement, Agent and
Lender, is incorporated herein by reference to Exhibit 10.2 to
the Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2004.10.18
    Intercreditor and Subordination Agreement, dated as of November 12, 2002, among Infogrames
Entertainment S.A, California U.S. Holdings, Inc., General Electric Capital Corporation and
the Credit Parties signatory thereto, is incorporated herein by reference to Exhibit 10.2 to
the Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended December 31, 2002.10.19
    First Amendment to Intercreditor and Subordination Agreement, dated as of December 23, 2003,
among Infogrames Entertainment S.A, California U.S. Holdings, Inc., Atari Interactive, Inc.,
General Electric Capital Corporation and the Credit Parties signatory thereto is incorporated
herein by reference to Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q for the
fiscal quarter ended December 31, 2003.10.20
    Loan and Security Agreement, dated as of May 13, 2005,
among the Company, as Borrower, and HSBC Business Credit (USA) Inc.,
as Lender.**10.21*
    Letter of Employment, dated as of April 23, 2002, between David Perry and the Company is
incorporated herein by reference to Exhibit 10.53 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2002.10.22*
    The 1995 Stock Incentive Plan (as amended on October 31, 1996) is incorporated herein by
reference to Exhibit 10.1 to Amendment No. 2 to the Companys Registration Statement on Form
S-1, filed December 6, 1996.10.23*
    The 1997 Stock Incentive Plan is incorporated herein by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.10.24*
    The 1997 Stock Incentive Plan (as amended on June 17, 1998) is incorporated herein by
reference to Exhibit 10.5 to the Companys Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998.




---



##### Table of Contents



10.25*
    The 2000 Stock Incentive Plan is incorporated herein by reference to Appendix B to the
Companys proxy statement dated June 29, 2000.10.26*
    Amendment No. 1 to 2000 Stock Incentive Plan is
incorporated herein by reference to Exhibit A to the
Companys
Information Statement dated November 27, 2000.10.27*
    Third Amendment to the Atari, Inc. 2000 Stock Incentive Plan
is incorporated herein by reference to Exhibit 10.1 to the
Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended September 30, 2004.10.28*
    The 1998 Employee Stock Purchase Plan is incorporated herein by reference to Exhibit 10.6 to
the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.10.29*
    Description of Registrants Annual Incentive Plan for
fiscal 2005.**10.30*
    Employment Agreement, dated June 1, 2002, between the Company and Harry M. Rubin is
incorporated herein by reference to Exhibit 6.1 to the Companys Annual Report on Form 10-K
for the quarter ended June 30, 2002.10.31*
    Employment Agreement with Bruno Bonnell, dated as of
July 1, 2004 and effective as of April 1, 2004, is
incorporated herein by reference  to Exhibit 10.1 to the
Companys Quarterly Report on Form 10-Q for the fiscal
quarter ended June 30, 2004.10.32*
    Termination and General Release Agreement, dated
October 15, 2004, by and between the Company and Denis Guyennot is incorporated herein by reference to Exhibit 10.3 to the
Companys Quarterly Report on Form 10-Q for the quarter ended
December 31, 2004.10.33*
    Employment Agreement, dated November 26, 2004, by and
between the Company and James Caparro is incorporated herein by
reference to Exhibit 10.4 to the Companys Quarterly Report on
Form 10-Q for the quarter ended December 31, 2004.10.34*
    Letter Agreement by and between the Company and Diane Price
Baker, dated January 24, 2005.**10.35*
    Consultant Agreement between the Company and Ann Kronen,
dated as of July 8, 2003 is incorporated herein by reference to
Exhibit 10.63 to the Companys Annual Report on Form 10-K for the
year ended March 31, 2004.***10.36
    Agreement of Lease, dated as of December 12, 1996, by and between the Company and F.S.
Realty Corp is incorporated herein by reference to Exhibit 10.29 to the Companys Annual
Report on Form 10-K for the year ended December 31, 1996.10.37
    First Amendment of Lease dated July 1, 1997 by and
between the Company and F.S. Realty Corporation.**10.38
    Lease Agreement between the Company and Netbreeders Realty LLC, dated November 1, 1999, is
incorporated herein by reference to Exhibit 10.11 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.10.39
    Sublease Agreement between the Company and SAVI Technology, Inc., dated May 30, 2001, is
incorporated herein by reference to Exhibit 10.14 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.10.40
    Lease Agreement between the Company and Edward Silver, Co-Trustee of the Silver Trust and
Paul Weinstein, Co-Trustee of the Weinstein Trust (dba PTL Realty), dated May 7, 2001, is
incorporated herein by reference to Exhibit 10.15 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.10.41
    Lease Agreement between the Company and MV 1997, L.L.C., dated November 24, 1997, is
incorporated herein by reference to Exhibit 10.16 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2001.




---



##### Table of Contents



10.42
    Lease Agreement between Parabola Estates Limited and Reflections Interactive Limited dated
September 10, 2001 is incorporated herein by reference to Exhibit 10.56 to the
Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2002.10.43
    Lease Agreement between Prima Development Corp. and the Company dated May 17, 2002 is
incorporated herein by reference to Exhibit 10.55 to the Companys Annual Report on Form 10-K
for the fiscal year ended June 30, 2002.10.44
    Licensed Publisher Agreement between the Company and Sony Computer Entertainment America,
Inc., dated January 19, 2003, is incorporated herein by reference to Exhibit 10.62 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.45
    PlayStation®2 Licensed Publisher Agreement between the Company and Sony
Computer Entertainment America, Inc., dated April 1, 2000, as amended.**10.46
    Xbox® Publisher License Agreement between the Company and Microsoft Corporation, dated April
18, 2000, is incorporated herein by reference to Exhibit 10.63 to the Companys Registration
Statement on Form S-2 (File No. 333-107819) initially filed with the SEC on August 8, 2003,
and all amendments thereto.***10.47
    Sublicense Agreement between the Company and Funimation Productions, Ltd., dated October 27,
1999, is incorporated herein by reference to Exhibit 10.64 to the Companys Registration
Statement on Form S-2 (File No. 333-107819) initially filed with the SEC on August 8, 2003,
and all amendments thereto.***10.48
    Amendment One to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated April 20, 2002, is incorporated herein by reference to Exhibit 10.65 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.49
    Amendment Two to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated June 15, 2002, is incorporated herein by reference to Exhibit 10.66 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.50
    Amendment Three to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated October 15, 2002, is incorporated herein by reference to Exhibit 10.67 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.51
    Amendment Four to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated November 13, 2002, is incorporated herein by reference to Exhibit 10.68 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.52
    Amendment Five to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated February 21, 2003, is incorporated herein by reference to Exhibit 10.69 to the
Companys Registration Statement on Form S-2 (File No. 333-107819) initially filed with the
SEC on August 8, 2003, and all amendments thereto.10.53
    Amendment Six to the Sublicense Agreement between the Company and Funimation Productions,
Ltd., dated August 11, 2003 as incorporated herein by reference
to Exhibit 10.83 to the Companys Annual Report on Form 10-K for
the year ended March 31, 2004.10.54
    Agreement Regarding Satisfaction of Debt and License Amendment among the Company, Infogrames
Entertainment S.A. and California U.S. Holdings, Inc., dated September 4, 2003, is
incorporated herein by reference to Exhibit 10.70 to the Companys Registration Statement on
Form S-2 (File No. 333-107819) initially filed with the SEC on August 8, 2003, and all
amendments thereto.10.55
    Amended Trademark License Agreement between the Company and Infogrames Entertainment S.A.,
dated September 4, 2003, is incorporated herein by reference to Exhibit 10.71 to the Companys
Registration Statement on Form S-2 (File No. 333-107819) initially filed with the SEC on
August 8, 2003, and all amendments thereto.10.56
    Obligation Assignment and Securing Agreement, dated as of
November 3, 2004, by and among the Company, Infogrames
Entertainment SA, Atari Interactive, Inc., Atari Europe SAS, and
Paradigm Entertainment, Inc, is incorporated herein by reference to
Exhibit 10.1 of the Companys Quarterly Report on Form 10-Q
for the quarter ended December 31, 2004.10.57
    Secured Promissory Note of Atari Interactive, Inc. in the
aggregate amount of $23,058,997.19 payable to the Company is
incorporated herein by reference to Exhibit 10.2 of the Companys
Quarterly Report on Form 10-Q for the quarter ended December 31, 2004.10.58
    Promissory Note of Atari Interactive, Inc., in the aggregate amount of $5,122,625 payable to
the Company as incorporated herein by reference to Exhibit 10.86 to
the Companys Annual Report on Form 10-K for the year ended
March 31, 2004.10.59
    Promissory Note of Atari Interactive, Inc., in the aggregate amount of $2,620,280 payable to
the Company as incorporated herein by reference to Exhibit 10.87 to
the Companys Annual Report on Form 10-K for the year ended
March 31, 2004.10.60
    Promissory Note of Paradigm Entertainment, Inc., in the aggregate amount of $828,870 payable
to the Company as incorporated herein by reference to Exhibit 10.88 to
the Companys Annual Report on Form 10-K for the year ended
March 31, 2004.




---



##### Table of Contents



21.1
    List of Subsidiaries.**23.1
    Consent of Deloitte & Touche LLP.**31.1
    Interim 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
    Certification by the Interim Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**32.2
    Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.**99.1
    Licensed PSP Publisher Agreement by and between the Company and
Sony Computer Entertainment America, Inc. dated March 23, 2005, for PlayStation® Portable.**99.2
    Amendment to the Xbox® Publisher Licensing Agreement, dated
March 1, 2005.**99.3
    Confidential License Agreement for Nintendo GameCube, by and between
Nintendo of America, Inc. and the Company effective March 29, 2002.**99.4
    License Agreement between the Company and FUNimation
Productions, Ltd., dated December 31, 2004.** Exhibit indicated with an * symbol is a management contract or compensatory plan or arrangement
filed pursuant to Item 15(c) of Form 10-K. Exhibit indicated with an ** symbol is filed herewith. *** All immaterial
amendments/extensions to this agreement were filed as an exhibit 99
in the Companys Quarterly Report for the respective period.  Portions of this exhibit have been redacted pursuant to a confidential treatment request filed
with the SEC. A copy of any of the exhibits included in this Annual Report on Form 10-K may be obtained by
written request to Atari, Inc. upon payment of a fee of $0.10 per page to cover costs. Requests
should be sent to Atari, Inc. at the address set forth on the front cover, attention Director,
Investor Relations.