UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

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TRANSITIONAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

ATARI, INC.

417 FIFTH AVENUE, NEW YORK, NY 10016
(Address of principal executive offices)

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 726-6500

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

     As of August 5, 2004, there were 121,275,614 of the registrant’s Common Stock outstanding.

ATARI, INC. AND SUBSIDIARIES
JUNE 30, 2004 QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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ATARI, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIENCY)
(in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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ATARI, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS

Nature of Business

     We are a leading global publisher and developer of video game software for both gaming enthusiasts and the mass-market audience, as well as a leading distributor of video game software in North America. We publish and distribute games for all platforms, including Sony PlayStation and PlayStation 2; Nintendo Game Boy, Game Boy Advance and GameCube; Microsoft Xbox; and personal computers, referred to as PCs. We also publish and sub-license games for the wireless, internet, and other evolving platforms. Our diverse portfolio of products extends across every major video game genre, including: action, adventure, strategy, children, family, driving and sports games.

     Through our relationship with our majority stockholder, Infogrames Entertainment S.A., a French corporation (“IESA”), listed on Euronext, our products are distributed exclusively by IESA throughout Europe, Asia and other regions. Similarly, we exclusively distribute IESA’s products in the United States, Canada and their territories and possessions. IESA owns approximately 59% of us directly and through its wholly-owned subsidiary California U.S. Holdings, Inc. (“CUSH”) and its majority-owned subsidiary Atari Interactive, Inc. (“Atari Interactive”).

     During September 2003, we entered into a series of transactions to restructure our debt and equity through a recapitalization of debt and an underwritten secondary public offering of common stock (“Offering”). In conjunction with the recapitalization of debt, we secured long-term rights to the Atari name (“Atari License”). (See Recapitalization, Atari License, and Offering below.)

Recapitalization

     In September 2003, we, IESA, and CUSH entered into an agreement (“Recapitalization Agreement”) resulting in the exchange of all of our net related party debt with IESA and certain of its wholly-owned subsidiaries totaling $165.9 million into 39,029,877 shares of our common stock immediately prior to the Offering. The conversion price was consistent with the Offering price of $4.25 per share. The converted debt consisted of the following outstanding amounts at September 18, 2003: $48.3 million of a medium-term loan, $44.8 million of a revolving credit agreement with IESA, $46.3 million of non-interest bearing subordinated convertible notes and $73.1 million of 5% subordinated convertible notes. The Recapitalization Agreement provided for an offset of previously provided advances to Atari Interactive and Atari Australia Pty. Ltd. (“Atari Australia”) of $44.7 million and $1.9 million, respectively. Accordingly, at March 31, 2004 and June 30, 2004, no previously outstanding amounts remain outstanding in Advances to Related Parties, Current Portion of Related Party Medium-Term Loan, Related Party Credit Facility and Related Party Debt. However, we have $8.6 million in related party notes receivable outstanding at March 31, 2004 and June 30, 2004, which arose after the Recapitalization and are related to certain other transactions. Such notes are permitted by the GECC senior credit facility (see Note 7).

     In connection with the Recapitalization Agreement, we issued stock at a more favorable rate than was available, at the holder’s option, under the original terms of the 5% subordinated convertible notes. The incremental value of the additional stock issued was reported as a dividend to IESA for $39.4 million during the September 2003 quarter, which had no impact on total stockholders’ equity.

Atari License

     In connection with the Recapitalization Agreement, Atari Interactive extended the term of the license under which we use the Atari name to ten years expiring on December 31, 2013. We issued 2,000,000 shares of our common stock to Atari Interactive for the extended license and will pay a royalty equal to 1% of our net revenues during years six through ten of the extended license. We recorded a deferred charge of $8.5 million, which is being amortized at the rate of approximately $0.3 million per month. The monthly amortization is based on the total estimated cost to be incurred by us over the ten-year license period. At June 30, 2004, $3.4 million of this deferred charge is included in

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Prepaid Expenses and Other Current Assets with the remaining $2.5 million, net of $2.6 million of amortization, included in Other Assets.

Offering

     On September 24, 2003, we offered to the public 9,820,588 new shares of our common stock at an offering price of $4.25 per share. The net proceeds to us after all costs were $34.9 million. We used $3.9 million of the net proceeds to repay indebtedness outstanding under our credit facility with GECC. The remaining proceeds were used to pay costs of developing video game software and to meet general working capital needs.

     Additionally, on September 24, 2003, IESA sold 17,179,412 shares of our common stock as part of the Offering. We did not receive any proceeds from the sale by IESA of our common stock. Finally, on October 21, 2003, the underwriters exercised their over-allotment option, purchasing 3,855,400 shares from IESA at a purchase price of $4.25 per share. We did not receive any of the proceeds from the exercise of the over-allotment option.

Basis of Presentation

     Our accompanying interim consolidated financial statements are unaudited, but in the opinion of management, reflect all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results for the interim period in accordance with instructions for Form 10-Q. Accordingly, they do not include all information and notes required by generally accepted accounting principles for complete financial statements. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2004.

Principles of Consolidation

     The consolidated financial statements include our accounts and our wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated.

Revenue Recognition

     Revenue is recognized when title and risk of loss transfer to the customer, provided that collection of the resulting receivable is deemed probable by management.

     We are not contractually obligated to accept returns except for defective product. However, we may permit our customers to return or exchange product and we provide allowances for estimated returns, price concessions, or other allowances on a negotiated basis. We estimate such returns and allowances based upon management’s evaluation of historical experience, market acceptance of products produced, retailer inventory levels, budgeted customer allowances, the nature of the title and existing commitments to customers. Such estimates are deducted from gross sales and provided for at the time revenue is recognized.

Use of Estimates

     The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

Goodwill and Other Intangible Assets

     Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, eliminates goodwill amortization over its estimated useful life. Goodwill is subject to at least an annual assessment for impairment by applying a fair-value based test. Additionally, acquired intangible assets are separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented or exchanged, regardless of our intent to do so. Intangible assets with finite lives are amortized over their useful lives. As of March 31, 2004, we performed our annual fair-value based assessment which did not result in any impairment of goodwill or intangibles. As of June 30, 2004, we do not believe that there are any indications of impairment of goodwill or intangibles. However, future changes in the facts and circumstances relating to our goodwill and other intangible assets could result in an impairment of intangible assets in subsequent periods.

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     Other intangible assets approximate $1.4 million and $1.2 million, net of accumulated amortization of $1.3 million and $1.5 million at March 31, 2004 and June 30, 2004, respectively.

Fair Values of Financial Instruments

     SFAS No. 107, “Disclosure About Fair Value of Financial Instruments”, requires certain disclosures regarding the fair value of financial instruments. Cash, accounts receivable, accounts payable, accrued liabilities, royalties payable, revolving credit facility, related party notes receivable, and amounts due to and from related parties are reflected in the consolidated financial statements at fair value due to the short-term maturity and the denomination in US dollars of these instruments.

Long-Lived Assets

     We review long-lived assets, such as fixed assets to be held, for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. If the estimated fair market value of the asset is less than the carrying amount of the asset plus the cost to dispose, an impairment loss is recognized as the amount by which the carrying amount of the asset plus the cost to dispose exceeds its fair value, as defined in SFAS No. 144, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”.

Research and Development Costs

     Research and development costs related to the design, development and testing of new software products, whether internally or externally developed, are charged to expense as incurred. Research and development costs also include payments for royalty advances (milestone payments) to third-party developers for products that are currently in development.

     Rapid technological innovation, shelf-space competition, shorter product life cycles and buyer selectivity have made it extremely difficult to determine the likelihood of individual product acceptance and success. As a result, we follow the policy of expensing milestone payments as incurred, treating such costs as research and development expenses.

Licenses

     Payments made to third parties for licensing intellectual property are capitalized and amortized over projected unit sales. Management evaluates the carrying value of these capitalized licenses and records an impairment in value, if any, as research and development expense.

Income Taxes

     We account for income taxes using the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates in effect for the years in which the differences are expected to reverse. We record an allowance to reduce tax assets to a realizable amount. We monitor our tax liability on a quarterly basis and record the estimated tax obligation based on our current year-to-date taxable income and expectations of the full year results.

Net Income Per Share

     Basic net income per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the period. Diluted net income per share reflects the potential dilution that could occur from shares of common stock issuable through stock-based compensation plans including stock options, restricted stock awards, warrants using the treasury stock method and other convertible securities. The following is an analysis of the difference between the shares used in basic and diluted net income per share (in thousands, except per share data):

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     The number of antidilutive shares that were excluded from the diluted earnings per share calculation for the three months ended June 30, 2003 and 2004 were 6,142,000 and 6,755,000, respectively, from stock options and warrants in which the exercise price is greater than the average market price of the common shares during the respective periods.

Stock-Based Compensation

     We account for employee stock option plans under the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Any equity instruments issued other than to employees for acquiring goods and services are accounted for using fair value at the date of grant. We have also adopted the disclosure provisions of Financial Accounting Standards Board (“FASB”) Statement No. 123, “Accounting for Stock-Based Compensation”, as amended by FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an Amendment to FASB Statement No. 123”.

     At June 30, 2004, we had three stock option plans. No compensation cost is reflected in net income, as all options granted under those plans have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on the net income and income per share if we had applied the fair value recognition provisions of the FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation (in thousands, except per share data):

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     The fair market value of options granted under stock option plans during the three months ended June 30, 2003 and 2004 was determined using the Black-Scholes option pricing model utilizing the following assumptions:

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NOTE 2 – RECEIVABLES, NET

     Receivables consist of the following (in thousands):

NOTE 3 – INVENTORIES, NET

     Inventories consist of the following (in thousands):