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Company Profile. Click for Overview, Financials, Ownership, News and more. ATARI INC
 Form:10-K/A  Filing Date:3/7/2006
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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 Tycoon and Alone in the Dark, Atari classics such as Asteroids, PONG, Missile Commandand Centipede and a limited number of Hasbro properties including Dungeons & Dragons.

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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 Z titles, 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.

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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.

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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 March 31, 2005, 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 Civilization franchise 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

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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 Date DRIV3R PS2; Xbox; PC June 2004 Dragon Ball Z: Budokai 3 PS2 November 2004 Dragon Ball Z: Sagas PS2; Xbox; GC March 2005 RollerCoaster Tycoon 3 PC October 2004 Atari Flashback Retro October 2004 Dragon Ball Z: Budokai 2 PS2; GC December 2003
TRANSFORMERS PS2 May 2004
Duel Masters: Sempai Legends! GBA; PS2 June 2004 Unreal Tournament 2004 PC March 2004 Dragon Ball Z: Buu's Fury GBA September 2004 Sid Meier's Pirates! PC November 2004 Dragon Ball Z: Super Sonic Warriors GBA June 2004 Atari Anthology PS2; Xbox; PC November 2003 Godzilla: Save the Earth PS2; Xbox November 2004 Yu Yu Hakusho: Dark Tournament PS2; GBA September 2004 Test Drive: Eve of Destruction PS2; Xbox August 2004 Enter the Matrix PS2; Xbox; GC; PC May 2003 Demon Stone PS2; Xbox; PC September 2004 Shadow Ops: Red Mercury Xbox; PC June 2004 Act of War: Direct Action PC March 2005 Neverwinter Nights Platinum PC September 2004 Backyard Baseball 2005 PS2; PC March 2004 Duel Master 2: Kaijudo Showdown GBA November 2004 Terminator 3: The Redemption PS2; Xbox; GC September 2004 Axis & 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.

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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 Z titles, 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 Z and Backyard Sports franchises, 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 Driver franchise, 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 Driver franchise, 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 Matrix film trilogy. Shiny developed Enter the Matrix, which was released simultaneously with The Matrix Reloaded, the second film in The Matrix trilogy, 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 Matrix franchise, 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 Fishand Putt Putt franchises have to date sold in excess of 2.6 million units and 2.4 million units, respectively, in the United States, and its Backyard Sports franchise, 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.

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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 Wings game. Most recently, Paradigm developed Mission Impossible: Operation Surma and Terminator 3: The Redemption.

• Eden Studios SAS-Lyon, France-Eden Studios SAS, or Eden, developed the successful V-Rally series, 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 Unlimited for 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 Tycoon series);

• 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

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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.

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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 Date Microsoft Xbox Publisher Determined on a November 15, 2007 License title-by-title basis Agreement, dated
April 18, 2000

Nintendo Game Boy Advance License Western Hemisphere September 23, 2007 Agreement, dated
September 24, 2001

Nintendo GameCube License Western Hemisphere March 28, 2005** Agreement dated
March 29, 2002

Sony PlayStation Licensed US, Canada, Mexico, January 18, 2007 Publisher Latin America Agreement, dated
January 19, 2003

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Manufacturer Platform Agreement Territory* Expiration Date Sony PlayStation Licensed US and Canada March 31, 2006,
2 Publisher with automatic Agreement, 1 year renewals dated June 6, 2000

Sony PlayStation Licensed US and Canada March 31, 2007, Portable Publisher with automatic Agreement, 1 year renewals dated March 23, 2005



* 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 for the year ended March 31, 2005. 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.

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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.

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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 Drive and RollerCoaster Tycoon, along with the catalog of classic Atari Games, as well as attractive licenses, such as The Matrix, Dragon Ball Z and 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.

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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.

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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

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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;

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• 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.

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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.

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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 Civilization franchise 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

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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:

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• 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.