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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003

Commission File Number 1-12367

MIDWAY GAMES INC.
(Exact name of registrant as specified in its charter)

Registrant's telephone number, including area code: (773) 961-2222

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None.

        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, and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

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

        The aggregate market value of the 54,468,444 shares of Common Stock held by non-affiliates of the registrant on March 8, 2004 was $197,720,452. This calculation was made using a price per share of Common Stock of $3.63, the closing price of the Common Stock on the NYSE on June 30, 2003, the last business day of the registrant's most recently completed second fiscal quarter. Solely for purposes of this calculation, all shares held by directors and executive officers of the registrant have been excluded. This exclusion should not be deemed an admission that these individuals are affiliates of the registrant. On March 8, 2004, the number of shares of Common Stock outstanding, excluding 2,930,000 shares held as treasury shares, was 55,912,196 shares.

        As used in this Annual Report on Form 10-K, the term "common stock" means our common stock, $.01 par value, and the term "preferred stock" means our Series D Convertible Preferred Stock, $.01 par value, unless the context indicates a different meaning. References to "fiscal" years for 2002 or later refer to our fiscal year ending on December 31. References to "transition period" in this report are to the six-month transition period beginning on July 1, 2001 and ended on December 31, 2001. References to earlier "fiscal" years in this report are to fiscal years ended June 30 of each year prior to or ended on June 30, 2001.

        Midway® is our registered trademark. Our product names mentioned in this report are also our trademarks, except where we license them. Other product names mentioned in this report are the trademarks of their respective owners.

        This report contains "forward-looking statements," within the meaning of the federal securities laws. These statements may be found throughout this report, particularly in the materials set forth under "Item 1. Business" and in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations," among others. These statements describe our plans, strategies and goals and our beliefs concerning future business conditions and our business outlook based on currently available information. Where possible, we have identified these statements by the use of terms such as "may," "will," "should," "expect," "anticipate," "plan," "strategy," "believe," "seek," "estimate," "intend" and similar words, although some forward-looking statements are expressed differently. Our actual results could differ materially from those described in the forward-looking statements due to a number of risks and uncertainties. These risks and uncertainties include the financial strength of the interactive entertainment industry and the risks more fully described under "Item 1. Business—Risk Factors." We make no commitment to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

PART I

Item 1. Business.

Development of Our Business

        We develop and publish interactive entertainment software. We and our predecessors have been in the business of creating videogames for more than 20 years and have published over 400 titles in that time. Our games are available for play on all the major current generation home videogame consoles and handheld game platforms, including Sony's PlayStation 2 computer entertainment system, Microsoft's Xbox and Nintendo's GameCube and Game Boy Advance. Our titles include many of the most popular game genres such as action, adventure, driving, extreme sports, fighting, horror, role-playing, sports and strategy.

        Over the years, we have released many successful videogames, including Mortal Kombat, a line of games that has sold over 20 million copies, MLB SlugFest, SpyHunter, NHL Hitz, Ready 2 Rumble Boxing, Hydro Thunder, San Francisco Rush Extreme Racing, NFL Blitz, Area 51, Cruis'n USA, NBA Jam, Rampage, Gauntlet, Joust, Defender, Centipede, Asteroids and Pong.

        In fiscal 2003, we released 28 videogames (directly, or under licensing arrangements, including all platforms). In fiscal 2002, we released 42 videogames (directly, or under licensing arrangements, including all platforms). During the six-month transition period ended December 31, 2001, we released 12 videogames (directly, or under licensing arrangements, including all platforms). In fiscal 2001, we released 29 videogames (directly or under licensing arrangements, including all platforms). For information about our revenues, assets and results of operations, see our consolidated financial statements included near the end of this report, including Note 1 (Concentration of Risk), and "Item 6. Selected Financial Data."

        Late in 2002, we reviewed our year to date performance, our plan for 2003 and the corresponding proposed staffing levels. We determined that we would reduce costs and consolidate operations in order to generate improved results in future periods. In December 2002, we decided to reduce the amount of leased space used in our Milpitas, California facility and terminate a group of mostly product development employees in both our Milpitas and San Diego, California facilities. During the first

quarter of 2003, we decided to terminate additional employees. The reduction in personnel associated with the Milpitas studio required us to reduce the scope of our product development efforts. Accordingly, three games in development at that time were cancelled due to the reduction in product development resources and our judgment about their prospects. During the second quarter of 2003, we decided that rather than just reducing the size of the Milpitas operation, it was advisable to consolidate almost all of its operations into existing facilities in San Diego and Chicago, Illinois. The total number of employees expected to be terminated from these reductions is 157, of which 154 had been terminated as of December 31, 2003. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."

        Midway is a Delaware corporation formed in 1988. In connection with our 1998 spinoff from our former parent company, WMS Industries Inc., we entered into a number of agreements with WMS. Our remaining agreements and relationships with WMS are described elsewhere in "Item 13. Certain Relationships and Related Transactions—Relationship with WMS."

        Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports are available through our website as soon as reasonably practicable after we electronically file or furnish such materials to or with the SEC. Our Corporate Governance Principles, Code of Business Conduct and Ethics, Audit Committee Charter, Nominating and Corporate Governance Committee Charter, Compensation Committee Charter and Stock Option Committee Charter are available on our website at www.investor.midway.com. All of these corporate governance documents are also available in print to any of our stockholders requesting such information by contacting us at: Investor Relations, Midway Games Inc., 2704 West Roscoe Street, Chicago, Illinois 60618. Our website home page is located at www.midway.com. Information contained on our website is not a part of this report.

Industry Overview

        The interactive entertainment industry is comprised of game hardware manufacturers and videogame software publishers. Home videogame software is played on game hardware platforms, including home game consoles which connect to a television set, self-contained handheld platforms and personal computers.

        Historically, a new generation of more technologically advanced game consoles has reached the market every four to five years. At the beginning of each new generation, or cycle, during the period of rapid growth in the installed base of the new generation of consoles, the interactive entertainment software industry has historically experienced periods of rapid expansion, as buyers purchase videogames for the new consoles. At the end of each cycle, when the introduction of a new generation of home game consoles is announced, sales of the older generation of platforms and games generally diminish, as consumers defer purchases in anticipation of the new platforms and games.

        The current generation of game platforms includes the following home consoles: Sony's PlayStation 2, released in 2000, the Nintendo GameCube and Microsoft Xbox, released in 2001, and the Nintendo handheld platform, Game Boy Advance, introduced in 2001.

        Historically, there have been multiple console platforms available in the market and strong competition between console manufacturers. The success of a title on a given platform is, to an extent, dependent upon the market acceptance of that platform. While Sony has for the past several years been the market leader, Microsoft and Nintendo are large and viable competitors.

        Videogame software is created by the platform manufacturers and by many independent developers. Platform manufacturers license publishers to publish games for their platforms and retain a significant degree of control over the content, quality and manufacturing of these games. The developers, subject to the approval of the platform manufacturers, determine the types of games they

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will create. Software publishers either create their games in-house, through their own development teams, or outsource this function to independent developers, or both.

        Software for game platforms is sold generally by mass merchandise retailers, such as Wal-Mart and Best Buy, or by regional retailers, discount store chains, video rental retailers, software specialty retailers and entertainment software distributors. Software publishers either distribute their products directly to these retailers or sell them through national distributors.

        Over the past two years, the number of titles introduced has increased significantly. Given the increased number of titles introduced, we have witnessed a trend where retailers tend to limit their buying to the titles that show the greatest potential for success.

        In addition, the market for our products is characterized by vigorous competition. The experience of our industry is that software game prices decline once a generation of consoles has been in the market for a significant period of time, because of the increasing number of software titles competing for acceptance from consumers.

Our Business Strategy

        Our product strategy going forward is focused on making games in genres that we have a demonstrated competency in, and a passion for, including: (1) games targeted at gamers 17 years and older, (2) sports games that emphasize "over-the-top" or lifestyle elements, and (3) games that leverage our established franchises. Highlights of our business strategy include:

        Build Games for Mature Gamers.    The first of these strategic thrusts, making M-rated games for consumers age 17 and older, plays to one of our historic strengths. During the last console cycle, from 1995 to 1999, we were the leader in making M-rated videogames. We led not only in total M-rated dollar and unit sales during this period, but also in the sheer number of M-rated title releases. On the current consoles, we have slipped to number six among publishers of M-rated titles, as we developed and released fewer M-rated titles. Through 2003, we had only developed four M-rated titles for this generation of home consoles. For 2004, we expect to release five M-rated titles for the current generation of home consoles. With the majority of gamers on the current consoles now over 18 years of age and the average age of the gamer trending upward, we expect this to continue to be one of the fastest growing segments of the industry. Our latest M-rated title just released in March 2004, The Suffering, should demonstrate our renewed focus in this category.

        Concentrate on our Over-The-Top Sports Games.    We have enjoyed strong sales from our line of sports games. Our titles in this popular category, such as NFL Blitz, NHL Hitz, MLB SlugFest and Ready 2 Rumble Boxing, are characterized by extreme game play and the superhuman abilities of the characters in these games, which we refer to as "over-the-top" sports entertainment. We believe our "over-the-top" style makes these games popular among sports videogame fans. We are no longer planning to release new versions of these "over-the-top" sports games every year, but rather, we will release new versions when we can infuse enough novelty and innovation into the game to stimulate the "over-the-top" buyer to purchase the game.

        Leverage our proven franchises and library value.    Many of our games have been best-sellers and have attracted loyal fan bases. The popularity of many of our games has enabled us to successfully market sequels, including sequels for Mortal Kombat, Spy Hunter, Gauntlet, NFL Blitz, NHL Hitz, MLB SlugFest, Rampage and San Francisco Rush Extreme Racing. We continue to hold these properties as valuable assets that may be leveraged in the future.

        Our most successful and profitable videogame franchise has been Mortal Kombat, with over 20 million units sold. We have also licensed two television and two film adaptations of Mortal Kombat and granted merchandising licenses for toys, clothing, comic books, strategy guides and other product

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lines. We released a new sequel in the Mortal Kombat series, Mortal Kombat: Deadly Alliance, in the fourth quarter of 2002, and this was our top selling game of fiscal 2002 and fiscal 2003. We expect to release the next sequel in the Mortal Kombat series, Mortal Kombat: Deception in late 2004.

        We have also leveraged our large library of "hit" titles by releasing "arcade classics" collections and entering into syndication agreements. We have released 15 collections of arcade classic games for home consoles and nine arcade classic products for handheld platforms. We control the intellectual property rights to hundreds of classic videogame titles, including titles originally released under the Midway, Williams and Atari brands. A number of these classic titles have been licensed for play on a variety of gaming mediums, including websites, interactive television, cellular telephones and other handheld wireless devices. We believe that we can continue to leverage our library of classic titles to produce additional successful titles in the future.

        Expand international sales.    We believe that we can expand our presence in foreign markets. In fiscal 2000, we opened an office in the United Kingdom to conduct sales of our products in Europe and Australia. To further expand our international presence, we are developing titles that we believe will have a global appeal.

Products

        We sell games for all of the major videogame platforms, including the PlayStation 2, Xbox, GameCube and Game Boy Advance platforms. Our revenues are shown in "Item 6. Selected Financial Data." Most of our videogames for the home consoles have suggested retail prices ranging from $39.95 to $49.95. Suggested retail prices for Game Boy Advance games are usually between $19.95 and $29.95.

2003 Videogame Releases

        During fiscal 2003, we released the following videogames:

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2002 Videogame Releases

        During fiscal 2002, we released the following videogames:

Product Development

        We seek to develop videogames that are action-packed and exciting, and which provide sufficient challenge at various levels of proficiency to encourage repeated play. Our game development personnel are organized into teams. The producers manage the work of the other team members and are generally responsible for the overall design of the game. Each concept is reviewed initially for technical feasibility and evaluated relative to several factors, including whether the proposed product fits within our general strategy and profitability objectives. Our management team meets regularly to formally review and evaluate the progress and quality of each title in development.

        The game design teams operate in a studio environment that encourages creativity, productivity and cooperation among design teams. We believe that this environment, together with a compensation structure that rewards design teams for the success of their games, enables us to attract and retain game designers that are among the best in the industry.

        The designers are supported by state-of-the-art design technology that allows for the creation of cutting-edge, three-dimensional graphics and advanced audio effects. We have developed and acquired a substantial library of proprietary software and development tools. Use of these tools streamlines the development process, allowing members of the development teams to focus their efforts on the play and simulation aspects of the product under development. We have also developed software tools to expedite conversion of software from one hardware format to another and to provide sound and special visual effects. We continually create and acquire new software and development tools and refine and upgrade our existing tools.

        Development of a new videogame for a home console generally takes 12 to 36 months or longer and generally costs between $3.5 million and $11.5 million, depending on the specific software requirements. Because of the increasingly complex technology and software involved, both the time and cost to develop games have increased during the past few years. We believe that we can generate significant incremental revenue from our games by introducing them on additional platforms at a much lower cost than the development cost for introducing the game on the first platform. Converting an

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existing game from one platform to another generally takes three to 12 months, which period may overlap with the development period of the original version of the game, and costs at least $300,000.

        We use both our own personnel and independent third parties to develop and convert videogames. We select third parties to develop videogames based on their capabilities, suitability, availability and cost. Our contracts with these developers generally provide that we own the videogame developed and protect the confidentiality of the development process and work product. These contracts are structured to give these developers incentives to provide timely and satisfactory performance of the development by associating payment of development fees with performance of substantive development milestones, and by providing for the payment of royalties to the developer based on sales of the product developed (after we recoup the development cost). To address development risks, we retain the right to discontinue development both without cause or for cause, with cause generally including failure to timely and satisfactorily perform the development, a change in the control of the developer, or the departure of specified key personnel from the developer's employ. We believe that as a result of consolidation in our industry, there are now fewer highly skilled independent developers available to us. Competition for highly skilled developers is intense in our industry, and we may not be successful in attracting and retaining these developers.

        We are required to submit games to the platform manufacturers for approval prior to publishing a game for their platforms. Additionally, prior to release, each product undergoes careful quality assurance testing which involves technical review of each component of the final product and testing on the applicable platforms.

        We incurred research and development expenses of $22.8 million in fiscal 2003, compared to $26.3 million in fiscal 2002 and $63.1 million in fiscal 2001. During the transition period, we incurred research and development expenses of $13.3 million. See Note 2 to the consolidated financial statements in this report for information about capitalized development costs.

        From time to time, we have purchased distribution rights to games under development by third parties for various home videogame platforms. Some of these games are sequels to games which have previously been successfully released. From time to time we may also purchase the right to adapt and market games owned by third parties from one platform to another, where we believe that success on the original platform suggests a probability of success on the other platform.

        We endeavor to comply with the rules established by a domestic ratings board voluntarily established by the videogame industry and some foreign countries' ratings boards, and we label our products with these ratings. We believe that ratings labels as to the violence contained in videogames will not have an adverse effect upon us as long as ratings are consistently applied throughout the industry.

Marketing and Distribution

        We market videogames for play on home and handheld platforms under the Midway trademark. We market through our internal sales staff and through independent sales representatives to over 20,000 stores, including:

•

mass merchandisers;



•

foreign, national and regional retailers;



•

discount store chains;



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video rental retailers; and



•

entertainment software distributors and re-sellers.

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        It is customary for the sales representatives and distributors of our videogames who are assigned specific customers to also distribute games produced by other manufacturers. Distribution channels are dominated by a select group of companies, and a publisher's access to retail shelf space is a significant competitive factor. In fiscal 2003 in particular, we experienced difficulty in obtaining shelf space for many of our products at various retailers. For example, three of our games, Freestyle MetalX, Freaky Flyers and Roadkill all failed to obtain shelf space at several key retailers.

        Our principal customers for home videogames are mass merchandisers such as Wal-Mart and Best Buy. Sales to our largest customer in fiscal 2003, Wal-Mart, represented 11.7% of our total revenues in fiscal 2003. In fiscal 2003, 47% of our revenues were attributable to our five largest customers. We warrant our home videogame discs to be free from defects for a period of 90 days. Defective product returns have historically not been material relative to our revenues.

        Our distribution efforts are supported by marketing programs, which emphasize product awareness, brand recognition, dealer merchandising opportunities and celebrity endorsements. Our marketing activities include television and print advertising, retail store promotions, direct mailings, user support programs and our website. We also utilize a store-oriented marketing approach which includes point-of-purchase promotions, use of display cards and other forms of merchandise displays. We provide technical support for our home products through a customer support department, which is staffed by personnel trained to respond to customer inquiries.

        Our office in the United Kingdom sells both through distributors and directly to retailers in Europe and Australia. See Note 1 to the consolidated financial statements in this report for additional information regarding our foreign revenues.

Competition

        The interactive entertainment software business is highly competitive. It is characterized by the continuous introduction of new titles and the development of new technologies. Our competitors vary in size from very small companies with limited resources to very large corporations with greater financial, marketing and product development resources than ours. The principal factors of competition in our industry are the ability to:

•

select and develop popular titles;



•

identify and obtain rights to commercially marketable intellectual properties; and



•

adapt products for use with new technologies.

        Successful competition in our market is also based on:

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price;



•

access to retail shelf space;



•

product quality;



•

product enhancements;



•

brand recognition;



•

marketing support; and



•

access to distribution channels.

        We compete with Nintendo, Microsoft and Sony, who publish software for their respective systems. We also compete with numerous companies licensed by the platform manufacturers to develop or publish software products for use with their respective systems. These competitors include Acclaim, Activision, Atari (f/k/a Infogrames), BAM!, Capcom, Eidos, Electronic Arts, Konami, Lucas Arts,

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Namco, Sega, Take-Two Interactive, THQ and Ubi Soft, among others. We face additional competition from the entry of new companies, including large diversified entertainment companies, into our market.

Manufacturing

        The manufacturers of the home and handheld game platforms manufacture our videogames for us, either themselves or through their designees, as required by the applicable platform license. Platform manufacturers retain the right to approve the games to be released under manufacturing and licensing arrangements. The platform manufacturers charge us a fixed amount for each software disc or cartridge that they manufacture or a royalty if third parties perform the manufacturing. This charge generally includes a manufacturing, printing and packaging fee, as well as a royalty for the use of the manufacturer's trademarks and proprietary information and technology. The platform manufacturer may change its fee without our consent. We are responsible in most cases for resolving, at our expense, any applicable warranty or repair claim. To date, we have not experienced any material costs from warranty or repair claims.

        Production is based upon estimated demand for each specific title. The level of the inventory of finished goods depends upon anticipated market demand during the life of a specific game title. At the time a product is approved for manufacturing, we must generally provide the platform manufacturer with a purchase order for that product and, in some cases, either an irrevocable letter of credit for 100% of the purchase price or cash in advance. Most of our products are manufactured for us on an "as is" and "where is" basis, and delivery is at our expense and risk. Initial orders generally require seven to 45 days to manufacture depending on the platform. Reorders of disc-based products generally require only seven to 14 days to manufacture, while reorders of cartridge-based products require approximately 30 to 40 days to manufacture. Shipping of orders requires an additional three to ten days, depending on the mode of transport and location of the manufacturer. Only the Nintendo Game Boy Advance uses cartridges, while the current generation home consoles are all disc-based.

        We lease a warehouse facility in Dallas, Texas, from which we distribute our videogames into North America. Some products are imported into the United States, cleared by customs and transferred to our warehouse facility, where they are unpacked and shipped to our customers. At times, some components of our products are assembled into finished products for us by third parties prior to their transfer to our warehouse facility. We participate in the electronic data interchange program maintained by most of our large customers for home videogames. The electronic data interchange program allows us to receive purchase orders from our customers, and to send invoices to our customers, in an agreed-upon standardized format via electronic transmission between computer systems. We generally fill re-orders from inventory within two days. As a result, our videogames traditionally have no backlog of orders. We ship products to a customer only upon receipt of a purchase order from that customer. Due to the relatively short time frame needed to reorder inventory, we are generally able to manage our inventory levels to closely approximate actual orders received or anticipated to be received. We will generally have received information from our largest customers on their intended order quantities prior to placing our orders with the manufacturers.

        Our standard payment terms with our customers are 30 days or 60 days from the date of shipment of the goods. In general, we do not permit extended payment terms with our customers. In some cases involving inventory closeouts, payment terms are further extended, typically not more than 90 days.

        We sometimes accept product returns and sometimes provide replacements, markdowns or other credits on varying terms to customers holding slow-moving inventory of our home videogames. At the time of product shipment, we establish reserves, including reserves under our practices for price protection and returns, which estimate the potential for future returns of products based on historical return rates, seasonality of sales, retailer inventories of our products and other factors. See "Business—

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Risk Factors—If product returns and price adjustments exceed our reserves we will incur additional charges which may have an adverse affect on our results of operations".

Licenses and Intellectual Property

        Platform Licenses.    The major platform manufacturers require that publishers obtain a license from them to publish games for play on their platforms. We have non-exclusive licenses from Nintendo, Sony and Microsoft under which we develop and market software products for their current major platforms. Each platform manufacturer requires that the software and a prototype of each title, together with all related artwork and documentation, be submitted for its pre-publication approval. This approval is generally discretionary.

        Upon expiration of a platform license, we usually have a limited period to sell off our inventory subject to that license, after which time any remaining inventory is generally required to be destroyed. Nintendo, Microsoft and Sony are among the largest publishers of software for use on their respective systems, and they compete directly with us. See "Risk Factors—If game platform manufacturers refuse to license their platforms to us or do not approve, or delay in approving, our games, our revenues would be adversely affected" below.

        Intellectual Property Licenses.    While we develop original proprietary games, some of our games are licensed from third party developers or based on trademarks and other rights and properties owned by third parties, such as the National Basketball Association, National Hockey League, Major League Baseball and the National Football League or various players' associations. Typically, we are obligated to make minimum guaranteed royalty payments over the term of these licenses and to advance payment against these guarantees. License agreements generally extend for a term of two to three years, are terminable in the event of a material breach by us, including failure to pay any amounts owing to the licensor in a timely manner, and other events. Some licenses are limited to specific territories or platforms. Each license typically provides that the licensor retains the right to leverage the licensed property for all other purposes, including the right to license the property for use with other products and, in some cases, software for other interactive hardware platforms.

        Patent, Trademark and Copyright Protection.    Each software title may embody a number of separately protected intellectual property rights, including:

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trademarks associated with elements of the game, such as team logos;



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trademarks under which the game is marketed;



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the copyrights for the game software, including the game's audiovisual elements; and



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the patents for inventions in the game software.

        We have hundreds of trademark registrations worldwide for our games, and we apply for trademark protection for all of our game titles, other than those licensed from third parties. Notwithstanding our patent, copyright and trademark protection, preventing and/or bringing infringement actions against unauthorized duplication of software products is difficult and costly.

        Each game also includes patents, copyrights and trademarks licensed from the platform manufacturer. Elements of some of our titles are owned by third parties and licensed to us. We rely on these third parties for protection of our licensed intellectual property rights. Their failure to adequately protect these rights could have a material adverse effect on us.

        The platform manufacturers incorporate security devices in the games that they manufacture for us, and also in their platforms, which seek to prevent unlicensed software products from being played on their platforms. We rely upon each platform manufacturer for protection of this intellectual property from infringement. We bear the risk of claims of infringement brought by third parties arising from the

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sale of software with respect to intellectual property supplied by third party developers and embodied in our software products. Our agreements with these outside developers generally require the developers to indemnify us for costs and damages incurred in connection with these claims. These software developers, however, may not have sufficient resources to indemnify us for any claims that may arise.

Coin-operated Products

        Until June 2001, we sold coin-operated videogames under the Midway trademark. Although coin-operated games were a traditional strength of ours, because of the contraction of the arcade game market, in June 2001 we decided to exit the coin-operated amusement games product line, and to stop developing and manufacturing coin-operated videogame products. Our revenues from coin-operated videogames since fiscal 1999 are shown in "Item 6. Selected Financial Data".

Seasonality

        The videogame business is highly seasonal and generally has experienced higher revenues in the quarters ended September 30 and December 31 due to customer purchases preceding the year-end retail holiday selling season. Significant working capital is required to finance high levels of inventories and accounts receivable during the quarters in which we release a significant number of games. Typically this has been the quarters ended September 30 and December 31.

Employees

        As of March 10, 2004, we had approximately 500 employees, approximately 310 of whom are members of our development staff. We believe that our relations with our employees are satisfactory.

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Risk Factors

        The most significant factors that make an investment in our common stock risky or speculative are discussed below. These factors may cause our operating results to vary from anticipated results or may materially and adversely affect our operating results or the value of our common stock.

We have experienced recent operating and net losses, and we may incur future losses.

        We have not reported a net or operating profit since the second quarter of the fiscal year ended June 30, 2000 ("fiscal 2000"). Since that time, we have reported the following operating losses:

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$116.0 million for fiscal 2003;



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$52.3 million for fiscal 2002;



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$6.9 million for the transition period;



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$78.4 million for fiscal 2001; and



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$20.9 million for fiscal 2000.

        We believe that our losses have been primarily attributable to:

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a tendency for retailers and consumers to only order and purchase top-tier videogames during late 2002 and during fiscal 2003;



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slower than expected sales of some of our games in fiscal 2002 and fiscal 2003;



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a weakness in the home videogame industry during the transition to the new generation of home videogame platforms;



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our transition strategy to discontinue games under development for older platforms and concentrate instead on the development of games for these new platforms; and



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a decline in the market for coin-operated videogames in fiscal 2000 and 2001.

        We cannot assure you that we will become profitable again.

If our new products fail to gain market acceptance, we may not have sufficient revenues to pay our expenses and to develop a continuous stream of new games.

        Our success depends on generating revenue from new products. Videogame products typically have market life spans of only three to 12 months. Our new products may not achieve and sustain market acceptance during the short life cycle sufficient to generate revenue to recover our investment in developing the products and to cover our other costs. The cost of developing new games for the current generation of platforms is generally between $3.5 million and $11.5 million. The cost of converting an existing game from one platform to another is at least $300,000. If our new products fail to gain market acceptance, we may not have sufficient revenues to pay our expenses and to develop a continuous stream of new games.

We may experience delays in introducing new products, which may adversely affect our revenues.

        From time to time, we have experienced delays in product introductions. The timing of a creative process is difficult to predict. Unanticipated delays could cause us to miss an important selling season. A delay in introducing products could also affect our development schedule for other products. In either case, we may not achieve anticipated revenues.

Our market is subject to rapid technological change, which may render our products obsolete or affect the timing of purchases of our products by consumers, which in turn may adversely affect our revenues.

        Technology changes rapidly in the interactive entertainment industry. We must continually anticipate and adapt our products to emerging technologies, including new hardware platforms,

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operating systems, online game play and media formats. When we choose to incorporate a new technology into our products or to publish or develop a product for a new platform, we may make a substantial development investment one to two years in advance of initial shipment of these products. We may not be able to identify accurately which emerging technologies will gain widespread acceptance. If we invest in the development of a videogame incorporating a new technology or for a new platform that does not achieve significant commercial success, our revenues from that product will be adversely affected. If, on the other hand, we do not choose to pursue the development of products incorporating new technology or for new platforms that achieve significant commercial success, our revenues may also be adversely affected.

        In addition, consumers may defer purchasing videogame software for use on existing platforms following the announcement of an introduction date for hardware platforms incorporating new technologies. Once new platform introduction dates have been announced, retail videogame prices may decrease as the market makes the transition to the new generation of hardware and software, resulting in lower revenues for us during that transition period. Accordingly, these announcements could adversely affect sales of our existing videogames.

Our operating results may fluctuate from quarter to quarter, making our results difficult to predict.

        We have experienced and expect to continue to experience significant quarterly fluctuations in net sales and other operating results due to a variety of factors, including:

•

variations in the level of market acceptance of our products;



•

delays and timing of product introductions;



•

fluctuations in our mix of products with varying profit margins;



•

introduction and market penetration of game platforms;



•

development and promotional expenses relating to the introduction of our products;



•

peak demand during the year-end retail holiday selling season;



•

changes in our pricing practices and those of our competitors;



•

the accuracy of the forecasts of consumer demand made by retailers and by us; and



•

the timing of orders from major customers, order cancellations and delays in shipment.

        Our purchasing and marketing levels are based, in part, on our expectations regarding future sales. As a result, operating results in any particular quarter may be adversely affected by a decrease in sales or a failure to meet our sales expectations in that quarter.

Restrictive debt covenants in our credit facility limit our operating flexibility, and all amounts outstanding under the credit facility, including our term loan, may become immediately payable if we default under the facility.

        In March 2004, we entered into a five-year loan and security agreement with Wells Fargo Foothill, Inc. for a credit facility of up to $30,000,000. The credit facility provides for a $15,000,000 term loan, all of which was outstanding at March 12, 2004, and a revolving line of credit of up to $15,000,000, none of which was outstanding at March 12, 2004. Availability under the revolver is limited to the lesser of (a) 85% of our eligible accounts receivable and (b) an amount equal to our collections of accounts receivable in the United States during a period which varies based upon seasonality, less the outstanding amount of the term loan; in each case reduced by reserves established by the lender. In addition, the credit facility allows for the issuance of up to $5,000,000 in aggregate letters of credit. Any letters of credit outstanding reduce availability under the revolving line of credit. Substantially all of our assets are pledged as collateral under the credit facility.

12

        Our new credit facility contains significant operating and financial restrictions on us, including restrictions on our ability to:

•

make payments, including dividends or other distributions, on our capital stock except in shares of common stock and the scheduled quarterly dividends on our Series D Preferred Stock;



•

incur additional indebtedness;



•

sell, lease, license or dispose of any of our assets;



•

make loans or investments;



•

make acquisitions, except two acquisitions not exceeding $5,000,000 each, provided no portion of the purchase price is payable in cash;



•

cause or permit a change of control;



•

amend, alter or modify any documents relating to our Series D Preferred Stock;



•

repurchase or redeem any shares of our capital stock, except that we may redeem our Series D Preferred Stock at maturity with shares of our common stock or, if after the redemption we would have cash and borrowing availability under our revolver of at least $25,000,000, in cash;



•

issue or sell securities of our subsidiaries; and



•

make capital expenditures.

        Our credit facility also requires us to maintain minimum levels of cash and borrowing availability under the revolver and to deliver periodic financial projections acceptable to the lender.

        We cannot assure you that we will be able to meet these requirements. Our failure to do so would constitute a default under the facility. If we default under the credit facility, the lender could terminate the facility and declare all amounts borrowed, together with interest, to be due and payable. We might not be able to pay these debts under those circumstances. If not, the lender could sell our assets.

        These restrictions and requirements limit our ability to finance operations, service debt, make acquisitions or engage in other business activities that may be in our interest.

If we need to seek additional capital due to continuing operating losses, we may incur additional expenses in the form of periodic interest or other debt service payments, or our current stockholders may suffer dilution in their percentage ownership of common stock.

        If we continue to generate operating losses, our working capital and cash resources may not be adequate. This may cause us to seek additional capital, including through the issuance of debt or equity, or through other financing. If we borrow additional funds, we likely will be obligated to make additional periodic dividend, interest or other debt service payments. If we seek financing through the sale of equity securities, our current stockholders may suffer dilution in their percentage ownership of common stock. Additionally, we are not certain as to our ability to raise additional capital in the future or under what terms capital would be available.

Our market is highly competitive, and we may not be able to continue to compete. If we are unable to compete, our revenues will be adversely affected.

        The interactive entertainment software business is highly competitive. Our ability to compete successfully in this market is based, in large part, upon our ability to:

•

select and develop popular titles;



•

identify and obtain rights to commercially marketable intellectual properties; and



•

adapt products for use with new technologies.

        Successful competition in our market is also based on:

•

price;

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•

access to retail shelf space;



•

product quality;



•

product enhancements;



•

brand recognition;



•

marketing support; and



•

access to distribution channels.

        Our competitors vary in size from very small companies with limited resources to large corporations with greater financial, marketing and product and technology development resources than ours. We compete with the platform manufacturers, including Nintendo, Sony and Microsoft. We also compete with companies that we depend upon for foreign distribution or other services. These companies may have an incentive to promote their own products in preference to ours. In addition, due to their dominant positions in the industry, the manufacturers of platform hardware have a competitive advantage with respect to retail pricing, acquiring intellectual property licenses and securing shelf space.

        We believe that large diversified entertainment, cable and telecommunications companies, in addition to large software companies, are increasing their focus on the interactive entertainment software market, which will result in greater competition for us. Many of our competitors are developing on-line interactive games and interactive networks. We may not be able to compete successfully against current or future competitors.

If product returns and price adjustments exceed our reserves we will incur additional charges which may have an adverse affect on our results of operations.

        We sometimes accept product returns and sometimes provide replacements, markdowns or other credits on varying terms to customers that hold slow-moving inventory of our home videogames. At the time of product shipment, we establish reserves, including reserves under our practices for price protection and returns. These reserves are established according to estimates of the potential for future returns of products based on historical return rates, expected sales, retailer inventories of our products and other factors. If product returns, markdowns and credits exceed our reserves, our operating results and financial condition could be adversely affected.

If game platform manufacturers refuse to license their platforms to us or do not approve, or delay in approving, our games, our revenues would be adversely affected.

        We sell our products for use on proprietary game platforms manufactured by other companies. We depend upon these companies for the following reasons:

•

we may only publish our games for play on their game platforms if we receive a platform license from them, which is renewable at their discretion;



•

platform manufacturers set the prices for their platform licenses, which may be economically prohibitive;



•

we must obtain their prior review and approval to publish games on their platforms;



•

if the popularity of a game platform declines, or the manufacturer stops manufacturing, or does not meet the demand for a platform, or delays the introduction of a platform in a region important to us, the games that we have published and that we are developing for that platform would likely produce lower sales than we anticipate;



•

these manufacturers control the manufacture of, or approval to manufacture, our game discs and cartridges; and



•

these manufacturers have the exclusive right to protect the intellectual property rights to their respective hardware platforms and technology and to discourage others from producing unauthorized software for their platforms that compete with our games.

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        Because these manufacturers compete against us in the videogame publishing markets, they could be motivated to give preference to their own products over ours in product approval and manufacturing, in promotion and in granting licenses to us for products that might compete with their products.

In fiscal 2003, 47.0% of our total revenues were attributable to our five largest customers. Our revenues could be adversely affected if any of them decrease or terminate their purchases from us.

        Sales to our five largest customers collectively accounted for approximately 47.0% of our total revenues for fiscal 2003. Our largest customer was Wal-Mart, which, during fiscal 2003, accounted for 11.7% of our total revenues.

        We have no agreements with any of our customers that guarantee future purchases. As a result, purchases by any of our customers could be reduced or terminated at any time. A substantial reduction or a termination of purchases by one or more of our largest customers may substantially reduce our revenues.

A business failure by any of our major customers could have an adverse effect on our revenues and our ability to collect receivables.

        We typically make sales on credit, with terms that vary depending upon the customer and other factors. Normally we do not hold any collateral to secure payment by our customers. Additionally, we do not factor any of our receivables.

        While we attempt to carefully monitor the creditworthiness of our customers, we bear the risk of their inability to pay us as well as any delay in payment. A business failure by any of our major customers could have a material adverse effect on our revenues and our ability to collect receivables.

Our products are manufactured by third parties who set the manufacturing prices for our products. Therefore, we depend on these manufacturers to fill our orders on a timely basis, and our margins and operating profit could be affected if the price changes.

        We depend on third parties, including the platform manufacturers, to manufacture our products. Manufacturing delays or interruptions could cause delays or interruptions in product delivery. If any significant delays occur, we may not achieve anticipated revenues. This is particularly true if any of our products miss an important selling season. Unanticipated price changes from these manufacturers also could adversely affect our margins and our operating profits.

We cannot control the personnel, scheduling and priority of use of resources by third parties who develop many of our game titles, and our revenues may be adversely affected by delays caused by these developers.

        More than fifty percent of our games are currently being developed by third parties. The number of titles developed for us by third parties varies from quarter to quarter. We have less control of a game being developed by a third party because we cannot control the developer's personnel, schedule or resources. This may lead to a game not being completed on time, or not being completed at all, if the third party's business fails or is acquired by one of our competitors or experiences some other disruption. If this happens with a game under development, we would lose revenues from the game and could lose our investment in the game.

If we are not able to maintain or acquire licenses for intellectual property necessary to the success of some of our games, our revenues would be adversely affected.

        Some of our games are based on properties or trademarks owned by third parties, such as Major League Baseball, the National Basketball Association, National Hockey League and National Football League or various players' associations. Our future success may depend upon our ability to maintain existing licenses and to acquire additional licenses for popular intellectual properties. There is

15

competition for these licenses, and we may not be successful in maintaining or acquiring intellectual property rights with significant commercial value.

        Our intellectual property licenses generally require that we submit new products developed under licenses to the licensor for approval prior to release. This approval is generally discretionary. Rejection or delay in approval of a product by a licensor could prevent us from selling the product. As a result, we might not recover our investment in the product. The owners of intellectual property licensed by us generally reserve the right to protect the intellectual property against infringement. If any of these owners fails to protect its own, or infringes someone else's, intellectual property, it could have a material adverse effect on us.

We may experience increased costs to continue to attract and maintain senior management and highly qualified software developers.

        Our success depends to a significant extent upon the performance of senior management and on our ability to continue to attract, motivate and retain highly qualified software developers. The loss of the services of a number of senior management personnel or highly qualified software developers could have a material adverse effect on us. We believe that as a result of consolidation in our industry, there are now fewer highly skilled independent developers available to us. Competition for highly skilled software developers is intense in our industry, and we may not be successful in attracting and retaining these developers. Specifically, we may experience increased costs in order to attract and retain skilled developers.

Sumner Redstone and Phyllis Redstone together control 47.7% of our common stock. If they were to dispose of a large number of their shares in a short period of time, the market price of our common stock would likely decline. If their shares were sold to a single purchaser, that purchaser might seek to influence our business strategies.

        Based on his report filed on March 9, 2004, Sumner Redstone owns directly and indirectly through his wife Paula Redstone and an affiliate, a total of 23,028,053 shares, or 41.2% of our currently outstanding common stock or, if all of our outstanding stock options and warrants were exercised, and all of our outstanding preferred stock were converted into common stock, 28.9% of our common stock. Mr. Redstone's former wife, Phyllis Redstone, owns a total of 3,659,783 shares, or 6.5% of our currently outstanding common stock, based on her most recent public report filed on August 8, 2002. Mr. Redstone or Phyllis Redstone could sell some or all of these shares at any time on the open market or otherwise. The sale either by Mr. Redstone or Phyllis Redstone of a large number of shares would likely have an adverse effect on the market price of our common stock. Although Mr. Redstone and Phyllis Redstone have each stated that they have no plans to acquire control of Midway, they could change their positions or could sell their stock to a person who wishes to acquire control of Midway. Such a person may not agree with our business strategies and goals. These substantial interests in Midway could discourage a third party from making an acquisition of Midway favorable to our other stockholders.

Shares available for issuance in the future could have an adverse effect on the market price of our common stock.

        As of March 8, 2004, we have 200,000,000 authorized shares of common stock, of which 55.9 million shares are issued and outstanding, 2.9 million are treasury shares, 16.3 million shares are reserved for issuance under our stock options and compensation plans, 3.4 million shares are reserved for issuance under outstanding warrants, 16.5 million shares are reserved for issuance upon conversion of preferred stock, and 0.3 million shares are reserved for payment of dividends on our preferred stock. We also have 5,000,000 authorized shares of preferred stock, of which 3,500 shares were issued and outstanding, and another 1,250 were reserved for issuance, as of March 8, 2004.

        Our Board of Directors has broad discretion with respect to the issuance of the remaining 104.7 million authorized but unissued common shares, the 2.9 million treasury shares and 4,995,250 authorized but unissued preferred shares, including discretion to issue shares in compensatory and acquisition transactions.

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        On October 14, 2003, we issued 9.3 million shares in a private placement at a discount from the market price on that date. On February 25, 2004, we filed a shelf registration statement on Form S-3 with the SEC in connection with the possible offer and sale, from time to time on a delayed basis, of up to $100,000,000 aggregate amount of our common stock, preferred stock, warrants, rights, units and/or stock purchase contracts. If we seek further financing through the sale of our securities, our then-current stockholders may suffer additional dilution in their percentage ownership of common stock. If we issue securities at a discount from the market price, our then-current stockholders would suffer immediate dilution. The future issuance, or even the potential issuance, of shares at a price below the then-current market price may depress the future market price of our common stock.

Conversion of our preferred stock, exercise of warrants and payment of dividends using stock will dilute our common stock, and the sale of the underlying shares may depress the market price of our common stock.

        On October 14, 2003, we issued 3,500 shares of our Series D Convertible Preferred Stock and 1,141,000 three year common stock purchase warrants to three institutional investors in exchange for the 3,500 shares of Series C Convertible Preferred Stock and 1,141,000 warrants that we had issued in May 2003 in a private placement to the same investors for a total purchase price of $35 million. The 3,500 shares of Series D preferred stock are convertible into common stock until March 15, 2006 at a conversion price of $3.65 per common share, for a total of 9,589,042 shares, subject to adjustment. The exercise price of the warrants is $3.75 per share.

        The same three investors also have the right to purchase an additional 1,250 shares of our Series D preferred stock, at any time until May 15, 2004, for a total purchase price of $12,500,000. If issued, the 1,250 additional shares of preferred stock will be convertible until March 15, 2006 subject to adjustment and limited redemption rights, into a total of 3,125,000 shares of common stock at a conversion price of $4.00 per share, subject to adjustment.

        We have the right to pay dividends on the Series D preferred stock using shares of common stock at a 2.5% discount from the weighted average market price over the five trading days prior to the dividend date.

        In addition, in May 2001 we issued warrants to purchase an aggregate of 1,605,564 shares of our common stock, exercisable at $9.33 per share, and in August 2001, we issued warrants to purchase an aggregate of 123,821 shares of our common stock, exercisable at $10.60.

        Because the conversion, exercise or issuance of these securities would result in more shares of our common stock outstanding, such conversion, exercise or issuance would dilute our earnings per share and the percentage ownership of our stockholders. We are required to redeem, on March 15, 2006, the shares of Series D preferred stock that have not been previously converted. We have the right, subject to some exceptions, to redeem the preferred stock in shares of our common stock. If we redeem the preferred stock in shares of common stock, this would result in more shares of common stock outstanding.

        The conversion or exercise of our preferred stock and warrants and the sale of the underlying stock would likely occur at a time when the conversion or exercise price is below the market price of our common stock. If the holders of the preferred stock and warrants were to sell a large number of their shares over a short period of time, those sales would likely have an adverse effect on the market price of our common stock. Even the potential sale of a large number of shares may depress the future market price of our common stock.

If we fail to fulfill covenants made to the holders of our preferred stock, we may be required to pay cash penalties or redeem the preferred stock for cash.

        If we breach our agreements with the holders of the preferred stock, or upon a change of control of Midway, the holders of the preferred stock may require us to repurchase the preferred stock at a premium. If we were required to repurchase the preferred stock at a premium, we might suffer serious

17

adverse financial consequences. The premium is 25% above the stated value in the case of a change of control. The premium is 20% above the stated value upon the occurrence of default events including:

•

our failure to maintain an effective registration statement for the underlying common stock beyond permitted grace periods;



•

suspension from trading or failure of our common stock to be listed on the NYSE or the Nasdaq National Market for five consecutive trading days or for more than ten trading days in any 365-day period; and



•

our statement of an intention not to comply with the conversion requirements of the preferred stock or our failure to deliver common stock upon conversion within the allowable time periods.

        The premium is 10% above the stated value upon our breach of any other agreement with, or representation or warranty made to, the selling stockholders, except if the breach would not have a material adverse effect on our business.

The exercise of outstanding stock options may dilute our common stock and depress its market price.

        As of March 8, 2004, we had outstanding options to purchase an aggregate of 11.1 million shares of common stock. Our stock options are generally exercisable for a period of nine years, beginning one year after the date of grant. Stock options are exercised, and the underlying common stock is generally sold, at a time when the exercise price of the options is below the market price of the common stock. Therefore, the exercise of these options generally has a dilutive effect on our common stock outstanding at the time of sale. Such exercises may have an adverse effect on the market price of our common stock. Even the potential for the exercise of a large number of options with an exercise price significantly below the market price may depress the future market price of common stock.

Effects of anti-takeover provisions could inhibit the acquisition of Midway, and could adversely affect the market price of our common stock.

        Our Board of Directors or management could use several charter or statutory provisions and agreements as anti-takeover devices to discourage, delay or prevent a change in control of Midway. The use of these provisions and agreements could adversely affect the market price of our common stock:

        Blank Check Preferred Stock.    Our certificate of incorporation authorizes the issuance of 5,000,000 shares of preferred stock with designations, rights and preferences that may be determined from time to time by the Board of Directors. Accordingly, our Board has broad power, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights which could adversely affect the voting power or other rights of the holders of our common stock. Other than the 3,500 shares of our Series D preferred stock owned by the preferred stockholders, and the additional 1,250 additional shares of our Series D preferred stock that the selling stockholders have the right to purchase, our Board has no current plans, agreements or commitments to issue any shares of preferred stock.

        Rights Plan.    Under a rights agreement with The Bank of New York, each share of our common stock has an accompanying right to purchase, if a person acquires beneficial ownership of 15% or more of our common stock without the prior approval of our Board, convertible preferred stock that permits each holder, other than the acquiror, to purchase a number of shares of common stock at half the market price. The effect of our rights plan is to discourage a hostile takeover by diluting the acquiror's percentage interest in our common stock. We can redeem the rights at $0.01 per right, subject to limited conditions, at any time. The rights expire on December 31, 2006.

        Other Charter Provisions.    Our certificate of incorporation and bylaws provide that:

•

directors may be removed by a vote of the stockholders, only for cause;



•

any vacancy on the Board may be filled only by a vote of a majority of the remaining directors then in office;



•

there may be no stockholder action by written consent;

18

•

only the President, the Chairman of the Board or the entire Board may call special meetings of stockholders, and the only business permitted to be conducted at stockholder meetings is business brought before the meeting by or at the direction of the Board;



•

stockholders must follow an advance notice procedure for the submission of director nominations and other business to be considered at an annual meeting of stockholders;



•

either a majority vote of the Board or an affirmative vote of at least 80% of outstanding common stock is needed in order to adopt, amend or repeal our bylaws; and



•

an affirmative vote of 80% of outstanding common stock is needed in order to amend or repeal the above provisions.

        Section 203 of the Delaware General Corporation Law.    In general, this statute prohibits a publicly-held Delaware corporation from engaging in a business combination with anyone who owns at least 15% of its common stock. This prohibition lasts for a period of three years after that person has acquired the 15% ownership. The corporation may, however, engage in a business combination if it is approved by the Board before the person acquires the 15% ownership or later by the Board and two-thirds of the stockholders of the public corporation.

Item 2. Properties.

        Our principal corporate office is located at 2704 West Roscoe Street, Chicago, Illinois. Our design and development studios are located in facilities in San Diego, California, and in Chicago, Illinois. We principally conduct our marketing operations out of our offices in Chicago, Illinois and London, England. We principally conduct our sales operations out of an office which we lease in Corsicana, Texas, and out of our offices in San Diego, California, and London, England. We also lease a warehouse and distribution facility in Dallas, Texas. With the exception of our principal corporate office and some surrounding parking lots, all of our properties are leased. See Note 10 to the consolidated financial statements in this report for additional information regarding our lease commitments.

        We believe that our facilities and equipment are suitable for the purposes for which they are employed, are adequately maintained and will be adequate for current requirements and projected growth.

Item 3. Legal Proceedings.

        Three putative securities class actions were filed against us in the United States District Court, Northern District of Illinois in 2003: (1) Allen Ehrlich, Individually and On Behalf of All Others Similarly Situated, Plaintiff, v. Midway Games, Inc., Neil D. Nicastro, Thomas E. Powell, and Kenneth J. Fedesna, Defendants, Case No. 03 C 6821, filed September 29, 2003; (2) Denise R. McVey, Individually and On Behalf of All Others Similarly Situated, Plaintiff, v. Midway Games, Inc., Neil D. Nicastro, Thomas E. Powell, and Kenneth J. Fedesna, Defendants, Case No. 03 C 7008, filed October 6, 2003; and (3) Ezra Birnbaum, Individually and On Behalf of All Others Similarly Situated, Plaintiff, v. Midway Games, Inc., Neil D. Nicastro, Thomas E. Powell, Kenneth J. Fedesna, UBS Warburg LLC, Gerard Klauer Mattison & Co., Inc., and Jefferies & Company, Inc., Defendants, Case No. 03 C 7095, filed October 7, 2003.

        The complaints seek damages for a class consisting of persons who purchased our securities between December 11, 2001 and July 30, 2003. Plaintiffs allege that during this time, the defendants concealed facts concerning expected release dates for our major new game titles, our ability to develop new game titles in a timely manner, and a decrease in consumer demand for our released products. Plaintiffs claim that, as a result, defendants lacked a reasonable basis for our earnings projections, which plaintiffs allege were materially false and misleading. Plaintiffs Ehrlich and McVey allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Plaintiff Birnbaum alleges the same, as well as violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933.

        On October 23, 2003, Judge Lefkow entered a finding of relatedness for the three cases that had been filed as of that date and, in accordance with the district court's local rules, recommended to the

19

court's Executive Committee that all the cases should be assigned to her. Following assignment of these cases to Judge Lefkow, in January 2004, the court ordered all plaintiffs to file a Consolidated Complaint by March 8, 2004 and also ordered us to answer the Consolidated Complaint or serve our motion to dismiss and accompanying memorandum in support by April 22, 2004. Discovery has not yet commenced, and no trial date has been set.

        On January 6, 2004, a shareholders' derivative lawsuit was filed against the directors and some officers of Midway and nominally against Midway in the Circuit Court of Cook County, Illinois: Dhillon v. Neil D. Nicastro, Thomas E. Powell, Kenneth J. Fedesna, Harold H. Bach, Jr., William C. Bartholomay, William C. McKenna, Norman J. Menell, Louis J. Nicastro, Harvey Reich, Ira S. Sheinfeld, Richard D. White and Midway Games, Inc,. Case No. 04 CH 00174. The complaint alleges that, during the period between December 2001 and July 2003, the individual defendants made misrepresentations to the investing public through their involvement in drafting, producing, reviewing, approving, disseminating, and or controlling the dissemination of false and misleading statements that plaintiff claims violated the securities laws. Plaintiff alleges that defendants breached their fiduciary duties to Midway and its shareholders by failing in their oversight responsibility and by making or permitting to be made material false and misleading statements concerning Midway's business prospects and financial conditions. Plaintiff also asserts that Midway is entitled to contribution and indemnification from each individual in connection with all such present and future claims resulting from the individuals' alleged misconduct.

        We believe all of the above cases lack merit and intend to contest them vigorously.

        We currently and from time to time are involved in other litigation incidental to the conduct of our business, none of which, in our opinion, is likely to have a material adverse effect on us.

Item 4. Submission of Matters to a Vote of Security Holders.

        We held a Special Meeting of Stockholders on December 12, 2003. The matters submitted to a stockholder vote were:

1)

to approve a resolution authorizing the issuance of common stock upon conversion of our Series D Convertible Preferred Stock, exercise of related warrants and payment of dividends on the preferred stock; and

2)

to approve a resolution authorizing an amendment to our certificate of incorporation to increase the number of shares of authorized common stock from 100,000,000 to 200,000,000.

        The voting results were as follows:

1)

The stockholders approved the resolution authorizing the issuance of common stock upon conversion of our Series D Convertible Preferred Stock, exercise of related warrants and payment of dividends on the preferred stock, as follows:

2)

The stockholders approved the resolution authorizing an amendment to our certificate of incorporation to increase the number of shares of authorized common stock from 100,000,000 to 200,000,000, as follows:

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PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.

        Our common stock trades publicly on the NYSE under the symbol "MWY". The following table shows the high and low sale closing prices of our common stock for the periods indicated as reported on the NYSE:

         On March 8, 2004, there were approximately 1,050 holders of record of our common stock.

        No cash dividends with respect to our common stock were declared or paid during fiscal 2003 or fiscal 2002. In addition, under our agreements with our lender and with our preferred stockholders, we are prohibited from paying cash dividends on our common stock. We plan to retain any earnings to fund the operation of our business.

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Item 6. Selected Financial Data.

        The following table sets forth our selected operating data and balance sheet data as of the dates and for the periods indicated. Effective December 31, 2001, we changed our fiscal year from June 30 to December 31. The selected financial data as of and for the years ended December 31, 2003 and 2002 ("fiscal 2003" and "fiscal 2002," respectively), the six-months ended December 31, 2001, and the years ended June 30, 2001, 2000 and 1999 ("fiscal 2001," "fiscal 2000" and "fiscal 1999," respectively), listed below have been derived from our audited consolidated financial statements included in this report and in our previous Annual Reports on Form 10-K. The selected financial data as of and for the six-months ended December 31, 2000 is unaudited.

(In thousands, except per share amounts)

(1)

Certain amounts have been reclassified to reflect current period presentation.

(2)

We exited our coin-operated videogame product line in the quarter ended June 30, 2001. See Note 9 to the consolidated financial statements included in this report.

(3)

Beginning on July 1, 2001, in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), we no longer recognize amortization expense on goodwill but conduct an ongoing impairment review of the asset. Accordingly, administrative expense includes amortization of goodwill for the six-months ended December 31, 2000 and fiscal 2001, 2000 and 1999, but not for fiscal 2003, 2002 and the six-months ended December 31, 2001. See Note 1 to the consolidated financial statements included in this report.

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(4)

After December 31, 2000, we have not provided an income tax benefit due to the establishment of a valuation reserve on our deferred tax assets.

(5)

During fiscal 2003, we incurred $33.2 million of charges related to the writedown of capitalized product development costs. Such charges are included in cost of sales.

(6)

During fiscal 2003, Neil D. Nicastro ceased to serve as our chief executive officer, president and chief operating officer. As a result, fiscal 2003 administrative expense includes $9.5 million of charges incurred under the terms of our employment agreement and severance agreement with Mr. Nicastro. See Note 12 to the consolidated financial statements included in this report. In addition, we incurred $9.7 million of restructuring and other charges relating to the consolidation of California product development and marketing operations, net of reductions recorded in prior year restructuring activities. See Note 9 to the consolidated financial statements included in this report.

(7)

During fiscal 2002, we incurred selling and marketing expense and administrative expense totaling $0.9 million relating to the closing of administrative facilities located in Corsicana, Texas. In addition, we incurred restructuring and other charges totaling $10.6 million relating primarily to the consolidation of product development operations in California and the closing of the Corsicana facility, net of reductions recorded in prior year restructuring activities. See Note 9 to the consolidated financial statements included in this report.

(8)

During fiscal 2002, provision for income taxes includes $5.4 million of deferred income tax expense resulting from the revaluation of net deferred tax assets. We also incurred $0.1 million of current foreign income tax expense during fiscal 2002. See Note 6 to the consolidated financial statements included in this report.

(9)

Fiscal 2002 includes the accelerated recognition of imputed (non-cash) preferred stock dividends related to the conversion of $42.0 million shares of Series B redeemable convertible preferred stock into shares of common stock. See Note 7 to the consolidated financial statements included in this report.

(10)

The six-months ended December 31, 2001 contains a restructuring charge of $0.2 million and a net adjustment to other charges of $0.9 million related to the coin-operated videogame product line. See Note 9 to the consolidated financial statements included in this report.

(11)

Fiscal 2001 contains restructuring and other charges totaling $12.5 million relating to exiting our coin-operated videogame product line in the quarter ended June 30, 2001. See Note 9 to the consolidated financial statements included in this report.

(12)

Fiscal 2000 loss before income taxes includes charges related to market conditions and asset realization of $26.0 million or $16.2 million on an after-tax basis.

(13)

Fiscal 1999 operating income includes charges for settlement of litigation, restructuring and other unusual items of $13.0 million that reduced net income on an after-tax basis by $8.1 million.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

        We develop and publish interactive entertainment software. Videogames for play on home consoles or handheld devices are sold to mass merchants, video rental retailers and entertainment software distributors. We sell games primarily in North America, Europe and Australia for the major videogame platforms, including Sony's PlayStation 2 computer entertainment system, Microsoft's Xbox and Nintendo's GameCube and Game Boy Advance. Most of our videogames have suggested retail prices on the initial release date ranging from $39.95 to $49.95 for console games and from $19.95 to $29.95 for handheld games.

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        We have experienced operating losses since our fiscal year ended June 30, 2000. In order to address this issue, we have implemented several restructuring plans, the most recent of which is described below. During the second half of 2003, we refocused our product strategy to: (i) build games for mature gamers; (ii) build over-the-top sports games and (iii) build games that leverage our proven intellectual properties and franchises. We are focusing our product development and marketing resources to build fewer, higher quality games with more marketing support than in the past. We are structuring our product release schedules and product launch timing to best position our products against their competition. We also plan to increase pre-launch awareness and visibility of our games with consumers through increased spending on media advertising and retail marketing. In addition, during 2003, we completed several financing transactions and hired a new chief executive officer to support and execute our refocused strategy. All of these efforts are designed to reverse the trend of large losses that we experienced in recent fiscal periods by reducing losses significantly in 2004 and eventually returning us to profitability.

Restructuring

        Late in 2002, we reviewed our year to date performance, our plan for 2003 and the corresponding proposed staffing levels. We determined that we would reduce costs and consolidate operations in order to generate improved results in future periods. In December 2002, we decided to reduce the amount of leased space used in our Milpitas, California facility and terminate a group of mostly product development employees in both our Milpitas and San Diego, California facilities. During the first quarter of 2003, we decided to terminate additional employees. The reduction in personnel associated with the Milpitas studio required us to reduce the scope of our product development efforts. Accordingly, three games in development at that time were cancelled due to the reduction in product development resources and our judgment about their prospects resulting in a charge of $4,998,000 during fiscal 2003. During the second quarter of 2003, we decided that rather than just reducing the size of the Milpitas operation, it was advisable to consolidate almost all of its operations into existing facilities in San Diego and Chicago, Illinois. We recorded charges related to lease commitments for which we will receive no future economic benefit, fixed asset impairments and other costs of $2,090,000 during fiscal 2003 related to this decision. The total number of employees expected to be terminated from these reductions is 157, of which 154 had been terminated as of December 31, 2003, resulting in restructuring charges of $3,311,000 for fiscal 2003. We experienced lower research and development costs in fiscal 2003 resulting from this decision. See "Results of Operations" following. The fiscal 2003 restructuring amounts were partially offset by reversals to previously accrued restructuring charges of $746,000 related to changes in estimates of severance costs and sublease income.

Financing Transactions

        During May 2003, we sold 3,500 shares of Series C redeemable convertible preferred stock and warrants to purchase 1,141,000 shares of our common stock for $35,000,000 in a private placement resulting in proceeds of $34,050,000, net of issuance costs. In conjunction with the sale of the Series C preferred stock, we redeemed the remaining 1,312.5 shares of outstanding Series B redeemable convertible preferred stock at the stated value of $13,125,000. See Note 7 to the consolidated financial statements included in this report.

        During October 2003, we completed a private placement of 9,317,886 shares of common stock, resulting in net proceeds of $23,457,000. Additionally, in October 2003, all of the Series C preferred stock and related warrants and purchase rights were exchanged for Series D redeemable convertible preferred stock and related warrants and purchase rights. See Notes 7 and 8 to the consolidated financial statements included in this report.

Chief Executive Officer

        During May 2003, David F. Zucker succeeded Neil D. Nicastro as our chief executive officer and president. Mr. Nicastro continues to serve as the chairman of our board of directors. As a result of this

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event, severance provisions of Mr. Nicastro's employment agreement were triggered, and Mr. Nicastro entered into a severance agreement with us. Administrative expense includes $9,459,000 of charges incurred in fiscal 2003 related to the employment agreement and severance agreement with Mr. Nicastro. See Note 12 to the consolidated financial statements included in this report.

Critical Accounting Policies and Estimates

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The policies discussed below are considered by management to be critical to our business operations. The interpretation of these policies requires management judgments and estimates of matters which ultimately may differ from actual results. For a discussion of our other significant accounting policies, refer to Note 1 to the consolidated financial statements included in this report.

Revenue recognition

        We recognize revenue in accordance with the provisions of Statement of Position 97-2, Software Revenue Recognition. Accordingly, revenue is recognized when there is persuasive evidence that an arrangement exists, the software is delivered, the selling price is fixed and determinable and collectibility of the customer receivable is probable. We do not provide any significant customization of software or post contract support. If consumer demand for a product falls below expectations, we may grant price protection to spur further sales or accept product returns. Therefore, revenue is recorded net of an allowance for price protection, returns and discounts.

Price protection, returns and discounts

        We may grant price protection or discounts to, or allow product returns from, our customers under certain conditions. Therefore, we record an allowance for price protection, returns and discounts at each balance sheet date. Price protection means credits relating to retail price markdowns on our products previously sold by us to customers. We base these allowances on expected trends and estimates of potential future price protection, product returns and discounts related to current period product revenue. Several factors are used in developing these estimates, including: (a) prior experience with price protection, returns and discounts; (b) historical and expected sell-through rates for particular games; (c) historical and expected rates of requests for such credits; (d) specific identification of problem accounts; (e) existing field inventories; (f) shipments by geography as price protection, returns and discounts experience differs by geography; (g) terms of sale; (h) sales rates or trends for similar products; (i) consideration of price points that would encourage future sell-through at the retail level and corresponding price protection credits that would be granted to appropriate customers; (j) the net price paid by our customers for products on which previous price protection has been granted and (k) other relevant factors. Sell-through refers to consumer purchases of our product at retail from our customers. Actual price protection, product returns and discounts may materially differ from our estimates as our products are subject to changes in consumer preferences, technological obsolescence due to new platforms, or competing products. Changes in these factors could change our judgments and estimates and result in variances in the amount of allowance required. This may impact the amount and timing of our revenue for any period. For example, if customers request price protection in amounts exceeding the rate expected and if management agrees to grant it, then we may incur additional charges.

        During fiscal 2003, 2002, the six-months ended December 31, 2001 and fiscal 2001, we recorded provisions for price protection, returns and discounts of $15,802,000, $27,824,000, $4,526,000 and $9,680,000, respectively. Such amounts are reflected in revenues. Our accounts receivable balance is reported net of an allowance for future price protection and discounts to be issued and future product returns to be accepted from sales made prior to the balance sheet date. At December 31, 2003 and

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2002, our allowances for price protection, returns and discounts were $7,002,000 and $10,319,000, respectively. We believe these reserves are adequate based on historical experience and our current estimate of potential price protection, returns and discounts.

Doubtful accounts

        We evaluate the collectibility of our trade receivables and establish an allowance for doubtful accounts based on a combination of factors. We analyze significant customer accounts and current economic trends when evaluating the adequacy of our allowance for doubtful accounts. Additionally, we may record allowances for doubtful accounts related to customers based on length of time the receivable balance is outstanding, financial health of the customer and historical experience. This analysis requires management to make estimates of collectibility which may materially differ from actual collections. If circumstances related to our customers change, the amount and timing of bad debt expense for any period may be impacted.

        During fiscal 2003, 2002, the six-months ended December 31, 2001 and fiscal 2001, we recorded provisions for doubtful accounts of $312,000, $889,000, $1,003,000 and $2,494,000, respectively. Such amounts are included in administrative expense. Our accounts receivable balance is reported in the consolidated balance sheets net of an allowance for doubtful accounts from sales made prior to the balance sheet date. At December 31, 2003 and 2002, our allowances for doubtful accounts were $2,410,000 and $2,590,000. There were no significant unreserved amounts of doubtful accounts receivable with any major customers or classes of customers at December 31, 2003. We believe this allowance is adequate based on historical experience and our current estimate of doubtful accounts.

Capitalized software development

        Our capitalized product development costs principally consist of software development costs for videogames that will be sold to consumers through retailers. We account for software development in accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. Software development costs incurred prior to the establishment of technological feasibility are expensed by us when incurred and are included in research and development expense. Once a software product has reached technological feasibility, all subsequent software development costs for that product are capitalized until that product is released for sale. Technological feasibility is evaluated on a product-by-product basis and can occur early in the development cycle or later depending on required technology to complete the product and the availability of such technology to us. After a product is released, the capitalized product development costs are amortized to expense based on the ratio of current sales to the total of current plus projected future sales for each game. This expense is recorded as a component of cost of sales.

        We evaluate the recoverability of capitalized software development costs on a product-by-product basis. Capitalized costs for products that are cancelled are expensed in the period of cancellation. In addition, a charge to cost of sales is recorded when our forecast for a particular game indicates that unamortized capitalized costs exceed the net realizable value of that asset. The net realizable value is the estimated future revenues from that game reduced by the estimated future cost of completing and selling the game. If a revised game sales forecast is less than management's current game sales forecast, or if actual game sales are less than management's forecast, it is possible we could accelerate the amortization of software development costs previously capitalized. As a result, the forecasted sales for a given game are a sensitive factor in this calculation. Critical factors evaluated in estimating forecasted sales include, among other things: historical sales of similar titles, pre-launch awareness, game ratings from publications and websites, current demand and sell-through rates. Management judgments and estimates are used in the assessment of when technological feasibility is established and in the ongoing assessment of the recoverability of capitalized costs. Different estimates or assumptions could result in materially different reported amounts of capitalized product development costs, research and development expense or cost of sales.

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        During fiscal 2003, 2002, the six-months ended December 31, 2001 and fiscal 2001, we recorded capitalized product development cost impairment charges in cost of sales and, where appropriate, restructuring and other charges of $36,919,000, $13,362,000, $1,288,000 and $39,000, respectively. Our capitalized product development costs balances at December 31, 2003 and 2002 were $11,292,000 and $28,761,000, respectively. We believe our capitalized product development costs balance at December 31, 2003 is recoverable from future revenue activity.

Valuation of long-lived assets

        Long-lived assets, primarily property and equipment, are reviewed for other-than-temporary impairment as events or changes in circumstances occur indicating that the amount of the asset reflected in our balance sheet may not be recoverable. When certain events or changes in circumstances occur, an estimate of undiscounted cash flows produced by the asset, or the appropriate group of assets, is compared to the carrying value to determine whether impairment exists. Historically, long-lived asset impairment charges, other than those incurred as a result of restructuring activities, have not been significant. The net book value of property and equipment at December 31, 2003 and 2002 was $13,272,000 and $19,345,000, respectively. The estimates of future cash flows involve considerable management judgment and are based upon assumptions about expected future operating performance. Future operating performance is affected by sales of our products and ability to meet product release schedules. The actual cash flows could materially differ from management's estimates due to changes in business conditions, operating performance and economic conditions. This may preclude us from realizing the future cash flows necessary to recover our long-lived assets resulting in an impairment charge recorded in the future.

Goodwill

        In accordance with SFAS 142, we evaluate whether any event has occurred which might indicate that the carrying value of goodwill is impaired. In addition, SFAS 142 requires that goodwill be subject to at least an annual assessment of impairment by applying a fair value-based test. We use October 1 as our annual measurement date and use market capitalization as an initial indicator of the fair value for the Company. We completed our current annual impairment test on October 1, 2003 and found no indicators of impairment of goodwill. As a result, we did not recognize an impairment loss. The net book value of goodwill at December 31, 2003 and 2002 was $33,464,000. Future goodwill impairment tests may result in a material charge to earnings if, for example, our enterprise fair value falls below our net book value.

Valuation of deferred tax assets

        We record a valuation allowance for the realization of deferred tax assets, resulting primarily from tax loss carryforwards. The amount of tax loss carryforward expected to be used within the carryforward period is limited to sources of future taxable income that are more likely than not to be generated within the carryforward period. The valuation allowance recorded is a reduction to the deferred tax asset, with a corresponding charge to the statement of operations. In the event we determine that we will realize our deferred tax asset in the future in excess of our net recorded amount, an increase to the net deferred tax asset would be recorded in the period such determination was made. Generating taxable income in subsequent periods and changes in estimates of future taxable income could affect the amounts of the net deferred tax assets and valuation allowances. At December 31, 2003 and 2002, we had valuation allowances of $88,856,000 and $45,384,000, respectively. Stockholder ownership change(s), as defined under Section 382 of the Internal Revenue Code, may limit the annual amount of net operating loss carryforward we may use to offset future taxable income. See Note 6 to the consolidated financial statements included in this report.

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Results of Operations

        The following table sets forth our operating results in dollars and expressed as a percentage of total revenues for the years ended December 31, 2003, 2002 and 2001. Amounts for the years ended December 31, 2003 and 2002 have been derived from our audited consolidated financial statements included in this report. Amounts for the comparable year ended December 31, 2001 are unaudited.

(Dollars in thousands)

        We exited the coin-operated videogame product line in the quarter ended June 30, 2001. Accordingly, activity relating to the coin-operated videogame product line for fiscal 2003 and 2002 was not significant.

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Fiscal 2003 Compared with Fiscal 2002

        The following table sets forth our total revenues by platform and territory for the periods indicated (dollars in thousands):

        North American revenues decreased 60.3% from $173,983,000 for fiscal 2002 to $69,154,000 for fiscal 2003. We released 28 videogames in North America during fiscal 2003 which represented $41,055,000 of revenue versus 42 videogames released in North America during fiscal 2002 which represented $155,165,000 of revenue. The decrease in revenues was due to releasing the latest version of our highly successful Mortal Kombat franchise in North America during 2002 and a decrease in the number of new releases from the prior year. During the second quarter of 2003, we made a decision to add more time and effort to the development of several games and to cancel one game that was in production. As a result of this decision, the release dates for several games were moved out of the third quarter of 2003 and into subsequent quarters, including quarters in 2004. While these operational decisions had an impact on 2003 revenues, we believe that lengthening product development schedules will give us the opportunity to enhance the product quality of future games to be released, which we believe is crucial to generating revenues given the highly competitive nature of our industry and the continuous introduction of new titles to the marketplace. Because of these factors, we expect North American revenues for fiscal 2004 to be higher than North American revenues for fiscal 2003. Our top selling videogames for fiscal 2003 in North America included: MLB SlugFest 20-04, SpyHunter 2 and NFL Blitz Pro all for the PS2 console released in 2003, as well as continued sales from our 2002 release of Mortal Kombat: Deadly Alliance for the PS2 and XBX consoles.

        International revenues increased 30.7% from $17,874,000 for fiscal 2002 to $23,370,000 for fiscal 2003. The increase in revenues is due to the international release of Mortal Kombat: Deadly Alliance for the PS2, XBX and NGC consoles, as well as for GBA handheld devices, during the first quarter of 2003. Our top selling videogames for fiscal 2003 outside of North America included: Mortal Kombat: Deadly Alliance for the PS2, XBX and NGC consoles, as well as for GBA handheld devices, and Freestyle Metal X for the PS2 console.

        Cost of sales includes product costs, distribution costs, royalties, and amortization and writedowns of capitalized product development costs. Gross profit decreased $69,939,000 from a profit of $49,158,000 for fiscal 2002 to a loss of $20,781,000 for fiscal 2003. This decrease is due to decreases in

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sales volume of approximately 30.0% and in average per unit selling prices of approximately 30.5%. The lower average selling price is the result of a greater portion of fiscal 2003 revenues being derived from games released in prior years, which typically have lower price points in the current year than new releases. In addition, there were several new releases in fiscal 2003, including new intellectual properties as well as a budget title, that were introduced at lower selling points to attract consumer interest. Amortization and writedowns of capitalized product development costs, the largest portion of costs of sales, was $56,883,000 and $52,826,000 for fiscal 2003 and 2002, respectively. Included in these amounts are writedowns of capitalized product development costs, contributing to the decrease in gross margins. Aggregate writedowns of capitalized product development costs excluding amounts included in restructuring and other charges totaled $33,244,000 in fiscal 2003. We lowered our sales forecasts for several games in development resulting in a $31,101,000 writedown of capitalized product development costs, $18,187,000 of which relates to costs capitalized on games to be released in 2004. In addition, we cancelled development on games during 2003 resulting in a $2,143,000 writedown of capitalized development costs. This compares to aggregate writedowns in the prior year of $4,404,000, resulting from changes in sales forecasts for certain games resulting in charges of $4,155,000 and cancellation of one game resulting in a charge of $249,000.

        Research and development expense decreased $3,501,000 from $26,310,000 for fiscal 2002 to $22,809,000 for fiscal 2003. The decrease reflects reduced overhead costs after the restructuring efforts described in the "Overview" above. We are focusing on producing fewer titles per year yet increasing our product development spending per title to produce better quality games. The net impact of these factors resulted in lower research and development expense from fiscal 2002. For console titles introduced during fiscal 2003, the cost of development averaged approximately $6.0 million per title, consistent with console titles introduced during fiscal 2002.

        Selling and marketing expense decreased $12,237,000 from $47,281,000 for fiscal 2002 to $35,044,000 for fiscal 2003. The decrease is due to 28 new releases in fiscal 2003 compared to 42 new releases in the prior year. As described in the "Overview" above, although we anticipate releasing fewer titles in future years, we plan to increase pre-launch awareness of our games and increase advertising support of our games, including television, print and on-line advertising.

        Administrative expense increased $10,477,000 from $17,211,000 for fiscal 2002 to $27,688,000 for fiscal 2003. The increase in administrative expense was due to severance expense related to Neil D. Nicastro and increased charges related to legal proceedings of approximately $2,277,000 compared to the prior year. During May 2003, David F. Zucker succeeded Neil D. Nicastro as our chief executive officer and president. As a result of this event, severance provisions of Mr. Nicastro's employment agreement were triggered and Mr. Nicastro entered into a severance agreement with us. Under the terms of an employment agreement and severance agreement with Mr. Nicastro, administrative expense includes $9,459,000 of charges incurred in fiscal 2003. See Note 12 to the consolidated financial statements included in this report. These increases were partially offset by prior year charges of approximately $684,000 related to the consolidation of administrative operations located in Corsicana with existing operations in Chicago.

        On a consolidated basis, restructuring and other charges for fiscal 2002 totaled $10,621,000 compared to $9,653,000 for fiscal 2003.

        Restructuring and other charges of $9,653,000 were recognized during fiscal 2003. For discussion of restructuring activities see "Overview" above and Note 9 to the consolidated financial statements included in this report. The fiscal 2003 charges related to severance of $3,311,000 for terminated employees and $2,090,000 of charges for operating lease commitments for which we will receive no future economic benefit, fixed asset impairments and other charges. Included in the fiscal 2003 restructuring and other charges was the impairment of capitalized product development costs of $4,998,000 related to abandonment of titles associated with the consolidation of product development

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operations. Fiscal 2003 amounts were partially offset by reversals to previously accrued restructuring activities in the amount of $746,000 related to changes in estimates of severance costs and sublease income. See Note 9 to the consolidated financial statements included in this report.

        Restructuring and other charges of $10,621,000 were recognized during fiscal 2002. These charges related to severance of $1,207,000 for terminated employees and $562,000 of charges for operating lease commitments for which we will receive no future economic benefit, fixed asset impairments and other charges. Also included in the 2002 other charges was impairment of capitalized product development costs of $8,958,000 related to abandonment of titles associated with the consolidation of product development operations. Prior year amounts were partially offset by reversals to previously accrued restructuring activities in the amount of $106,000 related to changes in estimates of sublease income. See Note 9 to the consolidated financial statements included in this report.

        Operating loss increased $63,710,000 from $52,265,000 for fiscal 2002 to $115,975,000 for fiscal 2003. This increase was due to the $69,939,000 decrease in gross profit and the $9,459,000 employment agreement and severance agreement expense related to Neil D. Nicastro included in administrative expense. These increased costs were partially offset by a $3,501,000 decrease in research and development expenses, a $12,237,000 decrease in selling and marketing expenses and a reduction in restructuring and other charges of $968,000 from the prior year.

        We provided $1,264,000 and $5,477,000 for income taxes for fiscal 2003 and 2002, respectively. These amounts primarily consisted of deferred tax expense related to goodwill of $1,313,000 and $4,147,000 for fiscal 2003 and 2002, respectively. We are required to record a valuation allowance on net deferred tax assets if it is more likely than not that we will not realize these deferred tax assets. Given our recent history of book and tax losses, a full valuation allowance has been recorded on the net deferred tax asset, excluding the deferred tax liability specifically related to goodwill, at December 31, 2003 and 2002. See Note 6 to the consolidated financial statements included in this report.

        Loss applicable to common stock was $73,618,000, or $1.61 per share, for fiscal 2002 compared with a loss of $117,934,000, or $2.43 per share for fiscal 2003. Loss applicable to common stock for fiscal 2003 included a $1,263,000 distributed dividend and a $698,000 imputed dividend on our Series C and Series D convertible preferred stock or $0.04 per share and a $192,000 distributed dividend and a $554,000 imputed dividend on our Series B convertible preferred stock or $0.02 per share. Loss applicable to common stock fiscal 2002 included a $1,159,000 distributed dividend and an $18,636,000 imputed dividend on our Series B convertible preferred stock or $0.43 per share.

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Fiscal 2002 Compared with Twelve-Months Ended December 31, 2001

        The following table sets forth our total revenues by platform and territory for the periods indicated (dollars in thousands):

        Home videogame revenues increased 98.3% from $96,001,000 for the comparable twelve-months ended December 31, 2001 to $190,412,000 for fiscal 2002. The increase was due to our releasing 42 products in North America during fiscal 2002 which represented $155,165,000 of revenue versus releasing 19 products in North America during the comparable twelve-months ended December 31, 2001 which represented $72,149,000 of revenue. The increase in new products was due to our strategy for the platform transition from 32 and 64-bit home videogame consoles to the new generation consoles including Sony's PlayStation 2, Microsoft's Xbox, and Nintendo's GameCube and Nintendo's 32-bit handheld Game Boy Advance, which required significant development efforts before we could release an increased number of games for these new consoles. Our top selling videogames for fiscal 2002 included: Mortal Kombat: Deadly Alliance, MLB SlugFest 20-03, NFL Blitz 20-03, SpyHunter and Gauntlet Dark Legacy.

        Home videogame gross margin decreased 14.4 percentage points from 39.8% for the comparable twelve-months ended December 31, 2001 to 25.4% for fiscal 2002. The decrease was due to the underperformance of titles released in the fourth quarter of 2002, including Defender, Haven: Call of the King and Dr. Muto. During that quarter, consumer demand was focused on more mature themes while these titles were youth oriented. As a result, additional reserves were established to provide anticipated price protection in order to stimulate consumer demand and clear the retail channel of inventories. Asset write-downs for inventory and capitalized product development costs in fiscal 2002 related to these titles totaled $12,100,000. Amortization of capitalized product development costs increased to 27.7% of revenues in fiscal 2002, compared to 11.7% in the comparable twelve-months ended December 31, 2001, due to higher capitalized product development costs associated with game development for the new generation platforms and lower revenues due to the underperformance of titles released in 2002.

        Research and development expense decreased $18,252,000 from $44,562,000 for the comparable twelve-months ended December 31, 2001 to $26,310,000 for fiscal 2002. The decrease was due to increased product development costs capitalized on new generation games and our exit from the

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coin-operated videogame product line. Gross research and development spending increased by $26,253,000 between the two periods; however, the portion of spending we capitalized increased by $44,505,000 during the same two periods. The development activity and expenditures for home videogames are much greater for new generation platforms than previous platforms. The newer generation of platforms provides many more capabilities than previous platforms which results in an increased number of people working to develop a more elaborate game and much longer development timelines to finalize a game. For console titles introduced during fiscal 2001 and fiscal 2000, the cost of development averaged approximately $2.0 million per title, as compared to an average cost per title of approximately $6.0 million for the new generation titles introduced during fiscal 2002. The increase in capitalized software development costs is due to an increase in software development costs being incurred after the point of technological feasibility and attaining technological feasibility earlier in the development process. All development costs subsequent to the establishment of technological feasibility are capitalized until that product is released for sale. The new generation platforms are more widely supported by vendors who supply tools which facilitate the attainment of technological feasibility earlier in the development process. Accordingly, with the use of these tools to attain technological feasibility earlier in the development process and the substantial increase in costs required to develop the newer generation games, the amounts capitalized as product development costs have increased.

        Selling and marketing expense increased $14,067,000 from $33,214,000 (28.6% of revenues) for the comparable twelve-months ended December 31, 2001 to $47,281,000 (24.6% of revenues) for fiscal 2002. The increase in spending was due to $8,829,000 of additional television and print advertising to promote the higher number of new products released during 2002. In addition, we shifted our strategy toward a larger, more expensive promotional campaign, including television and expanded print campaigns, for our 2002 Mortal Kombat: Deadly Alliance release. Sales commissions also increased $1,201,000 from $620,000 (0.5% of revenues) for the comparable twelve-months ended December 31, 2001 to $1,821,000 (1.0% of revenues) for fiscal 2002 due to a change in our mix of customers. We increased our Internet related marketing efforts during fiscal 2002, resulting in an increase of $907,000 related to such expenditures. The decrease in selling and marketing expense as a percentage of revenues from 28.6% of related revenues in 2001 to 24.6% of related revenues in 2002 is due to these costs being spread over significantly increased revenues.

        Administrative expense decreased $2,188,000 from $19,399,000 for the comparable twelve-months ended December 31, 2001 to $17,211,000 for fiscal 2002. The comparable twelve-months ended December 31, 2001 included $1,961,000 of goodwill amortization of which none was recorded for fiscal 2002 pursuant to the adoption of SFAS 142. See Note 1 to the financial statements included in this report. The comparable twelve-months ended December 31, 2001 also included $965,000 of bad debt expense and $200,000 of administrative expense related to the exit of the coin-operated videogame product line. See Note 9 to the consolidated financial statements included in this report. Administrative expense in fiscal 2002 increased for a number of items, including a $1,483,000 increase in legal expenses related to lawsuits and claims arising in the normal course of business and a $684,000 charge related to the consolidation of administrative operations located in Corsicana with existing operations in Chicago (see Note 9 to the consolidated financial statements included in this report).

        On a consolidated basis, restructuring and other charges for the comparable twelve-months ended December 31, 2001 was $7,026,000 compared to $10,621,000 for fiscal 2002.

        During 2002, we consolidated both product development and administrative departments. This consolidation was aimed at strategically focusing our efforts on a narrower core group of products. We believe that several benefits will accrue from the consolidation including: (1) lower overhead costs producing more cost-efficient operations; (2) greater focus on our key intellectual properties and (3) more flexible staffing of projects due to a concentration of our talent base in fewer locations. Restructuring costs incurred included severance for terminated employees, charges for operating lease space for which we will receive no future economic benefit, fixed asset disposals and various other

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charges. The total number of employees expected to be terminated was 55, of whom 51 had been terminated as of December 31, 2002. These charges totaled $1,769,000. In addition, three games being developed by terminated product development employees were cancelled due to the reduction in resources and our judgment about their prospects. Accordingly, all capitalized product development costs related to these games totaling $8,958,000 were written-off in 2002. In addition, we recorded a reversal of $106,000 of previously accrued restructuring charges related to changes in estimates of sublease income. See Note 9 to the consolidated financial statements included in this report.

        We exited our coin-operated videogame product line in the quarter ended June 30, 2001. Although coin-operated games were a traditional strength of ours, because of the contraction of the arcade game market we decided to focus on the home videogame market. The results of this decision included the termination of 109 employees during the twelve-months ended December 31, 2001 and resulted in a severance charge of $2,059,000. In addition, fixed assets related to the coin-operated videogame product line were written-off resulting in a charge of $3,070,000. The restructuring charges also included $1,037,000 of lease commitment costs, for which we will receive no future economic benefit, and administrative costs of $860,000. Cost savings from exiting the coin-operated videogame product line have been used to support the home videogame product line.

        Operating loss for fiscal 2002 was $52,265,000 compared with an operating loss of $63,486,000 for the comparable twelve-months ended December 31, 2001. The decrease in the operating loss is due to increased revenues from the release of products on new generation platforms and decreased research and development expense partially offset by increased selling and marketing expenses.

        We provided $5,477,000 and $0 for income taxes in fiscal 2002 and for the comparable twelve-months ended December 31, 2001, respectively. In fiscal 2002, the income tax expense was the result of a deferred tax expense relating to goodwill.

        During fiscal 2002, we received tax refunds totaling $13,626,000 based on net operating loss carryback claims filed with the Internal Revenue Service ("IRS") and state taxing authorities. The $12,900,000 IRS tax refunds were the result of tax legislation enacted in March 2002 that allowed companies to carryback 2001 net operating losses five years where previously they could be carried back two years. The $726,000 state tax refunds were also the result of net operating loss carryback claims.

        Loss applicable to common stock was $73,618,000, or $1.61 per share, for fiscal 2002 compared with $66,778,000, or $1.75 per share, for the comparable twelve-months ended December 31, 2001. Loss applicable to common stock for fiscal 2002 reflected a $1,159,000 distributed dividend and an $18,636,000 imputed dividend on our Series B convertible preferred stock or $0.43 per share. The majority of the $18,636,000 imputed dividend was the result of investors converting $42,000,000 of preferred stock into common stock, accelerating the recognition of imputed preferred stock dividends (i.e. non-cash dividends) that otherwise would have been recognized in subsequent periods. Loss applicable to common stock for the comparable twelve-months ended December 31, 2001 reflected a $1,227,000 distributed dividend and a $4,187,000 imputed dividend on our Series B convertible preferred stock or $0.14 per share.

Liquidity and Capital Resources

        Our principal source of cash is from distribution and sale of our videogames. Our principal uses of cash are for payments associated with both internal and third-party developers of our software, third-party manufacturers of our videogame inventory and costs incurred to sell and market our videogames. As of December 31, 2003 our primary source of liquidity was $41,682,000 of cash and cash equivalents, compared with $48,983,000 at December 31, 2002. Our working capital at December 31, 2003 totaled $50,669,000, compared with $100,637,000 at December 31, 2002. Our cash requirements in recent fiscal periods have been funded through approximately $182,047,000 of net proceeds from financing activities,

34

of which $57,344,000, $85,303,000 and $39,400,000 were received in fiscal 2003, the six-months ended December 31, 2001 and fiscal 2001, respectively.

        Our strategy depends on generating revenue from new products. If our new products fail to gain market acceptance, we may not have sufficient revenues to pay our expenses and to develop a continuous stream of new games. In March 2004, we entered into a new credit facility of up to $30,000,000 to provide additional liquidity to reach our goals. Under the new credit facility we have a $15,000,000 five-year term loan, a revolving line of credit up to $15,000,000 and up to $5,000,000 in letters of credit, which if outstanding, reduce availability under the revolving line of credit. Availability under the line of credit is limited by the borrowing base, which is a function of eligible accounts receivable and collections as defined by the new credit facility. See Note 13 to the consolidated financial statements included in this report. Management has the ability, if necessary, to implement further restructuring activities that would: substantially reduce personnel and personnel-related costs, reduce capital expenditures, reduce research and development expenditures and/or reduce selling and marketing expenditures.

        We actively manage our capital structure and balance sheet as a component of our overall business strategy. We have historically been successful raising capital in the equity markets and may seek to do so in the future if we deem such activity beneficial. In February 2004, we filed a shelf registration statement on Form S-3 with the SEC in connection with the possible offer and sale, from time to time on a delayed basis, of up to $100,000,000 aggregate amount of our common stock, preferred stock, warrants, rights, units and/or stock purchase contracts. We may issue shares of common stock in the future to settle outstanding obligations such as our redeemable convertible preferred stock, if terms and conditions allow, alleviating cash use requirements.

        In addition, under the terms of our agreements with WMS, approximately $6.5 million, which is presently reflected in other non-current liabilities on our balance sheet, will become immediately due and payable to WMS if we experience a change of control, which includes, among other things, any person or group becoming the beneficial owner, directly or indirectly, of more than 50% of our outstanding voting stock.

        We had a letter of credit facility with a bank providing for the availability of up to $10,000,000 of letters of credit, which was terminated upon our entering into a new credit facility with a different bank in March 2004. See Note 13 to the consolidated financial statements included in this report. There were no letters of credit outstanding at December 31, 2003 and $541,000 of letters of credit outstanding at December 31, 2002.

        During fiscal 2003, cash used by operating, investing, financing activities and the effect of exchange rate changes was $7,301,000 compared with $37,899,000 during fiscal 2002.

        Net cash used in operating activities was $48,368,000 for fiscal 2003, compared to $59,942,000 for fiscal 2002. The fiscal 2003 net loss of $115,227,000 includes non-cash charges totaling $26,055,000, including $7,872,000 of depreciation and amortization and $16,114,000 of receivable provisions. In addition, amortization on capitalized product development costs totaled $60,558,000 for fiscal 2003. The amortization of capitalized product development costs includes aggregate writedowns of $36,919,000, $18,187,000 of which relates to costs capitalized on games to be released in 2004. The current year net loss was further offset by reductions from the prior year in both net receivables and inventories balances of $21,697,000 and $5,956,000, respectively. These balances were lower at December 31, 2003 than the beginning of the year due to the decreased sales volume experienced in 2003 compared to 2002. The decreased level of sales volume from 2002 to 2003 also resulted in an aggregate reduction of current liabilities during 2003 as lower levels of items such as trade and royalties payable were outstanding at December 31, 2003 than the beginning of the year, resulting in a net use of cash of $15,150,000. Additions to capitalized product development costs totaled $43,089,000 during 2003 compared to $70,572,000 during 2002. The decrease reflects restructuring efforts to reduce costs as

35

described in the "Overview" above and Note 9 to the consolidated financial statements included in this report. We are focusing on producing fewer titles per year but increasing our product development spending per title to produce better quality games, resulting in a decrease in overall spending from 2002. During 2003, our Chairman of the Board, Neil Nicastro, ceased to serve as our chief executive officer, president and chief operating officer. Other noncurrent liabilities increased $5,229,000 from the beginning of the year as a result of an employment agreement and severance agreement with Mr. Nicastro. See "Off Balance Sheet Arrangements and Contractual Obligations" below for further details of this liability. In addition, in August 2003, we received $4,000,000 from WMS, pursuant to a settlement agreement dated August 11, 2003, relating to tax sharing and separation agreements between the two companies. Under the tax sharing and separation agreements, we are required to reimburse WMS for the majority of this balance under certain circumstances related to our use of our net operating loss carryforwards or if there is a change in control of Midway prior to use or expiration of all net operating loss carryforwards, as defined by the agreements. Accordingly, we have recorded $3,686,000 of this amount as a liability, which is reflected in other noncurrent liabilities on our consolidated balance sheet.

        The fiscal 2002 net loss of $53,823,000 includes non-cash charges totaling $43,296,000, including $8,469,000 of depreciation and amortization, $28,713,000 of receivable provisions and $5,390,000 of deferred income taxes. In addition, amortization on capitalized product development costs totaled $61,784,000 for fiscal 2002. However, changes in net operating assets resulted in a net use of cash of $111,199,000. The increase in the net use of cash resulted from an approximate 83% increase in fourth quarter revenues for fiscal 2002 compared to fourth quarter revenues for the comparable twelve-months ended December 31, 2001, driven by the release of Mortal Kombat: Deadly Alliance in November 2002. We recognized an increased level of revenues for which we had not yet received cash. Since the game was released in the latter half of November 2002, a substantial amount of related receivables remained outstanding at December 31, 2002.

        Net cash used in investing activities of $2,068,000 for fiscal 2003 was for the purchase of property and equipment. Net cash provided by investing activities of $32,558,000 for fiscal 2002 resulted from a $41,000,000 net decrease in short-term investments offset by $8,442,000 for purchases of property and equipment.

        Net cash provided by financing activities for fiscal 2003 of $43,132,000 was the result of the net proceeds from the sale of the Series C convertible preferred stock and warrants of $34,050,000, less the redemption of the remaining Series B convertible preferred stock of $13,125,000, plus net proceeds from the private placement of common stock of $23,457,000 and less payment of preferred stock dividends of $1,087,000. See Notes 7 and 8 to the consolidated financial statements included in this report. Net cash used in financing activities of $10,752,000 for fiscal 2002 was the result of the purchase of treasury stock of $9,622,000 less the payment of preferred stock dividends of $1,363,000, plus the cash received from the exercise of stock options of $233,000.

        Management believes that our cash and cash equivalents on-hand at December 31, 2003 of $41,682,000, along with proceeds provided by and available under bank financing secured in March 2004, will be adequate to fund the anticipated levels of inventories, receivables and other working capital requirements for the operation of our business and our other presently anticipated needs, which includes items disclosed in "Off Balance Sheet Arrangements and Contractual Obligations" below, for at least the next twelve months.

Off Balance Sheet Arrangements and Contractual Obligations

        We lease various office facilities, a warehouse and equipment under non-cancelable operating leases. Additionally, we enter into license agreements for the use of intellectual property used in specific videogames or for a period of time. Some of these agreements provide for advance payments

36

or guarantee minimum payments of royalties. In accordance with GAAP, these obligations are not recognized as liabilities in our consolidated balance sheet.

        The following table summarizes the scheduled expiration of our contractual obligations as of December 31, 2003 (in thousands):

(1)

Excludes operating lease commitments expensed in conjunction with restructuring efforts for which we will receive no future economic benefit, which are reflected on our consolidated balance sheet at December 31, 2003. Amounts are net of related sublease income.

(2)

Includes minimum payments due under various licensing agreements and third party developer agreements. Purchase obligations assume transactions are carried to contractual term and do not reflect cancellations within our control; such cancellations could result in amounts owed being less than those reflected above.

(3)

These items are reflected on our consolidated balance sheet at December 31, 2003 in current and noncurrent liabilities, as appropriate.

(4)

Other long-term liabilities include a severance agreement with Mr. Nicastro to be settled in shares of common stock in the aggregate amount of $3,951,000: $768,000 (1-3 years), $2,634,000 (3-5 years) and $549,000 (after 5 years). An additional amount due Mr. Nicastro of $1,963,000 (1-3 years) is convertible into shares of common stock at the amount of $3.28 per share at the election of Mr. Nicastro. For a description of employment agreements with our named executives, which are not reflected in the table above, refer to "Item 11. Executive Compensation." Other long-term liabilities also include amounts owed WMS for tax-sharing arrangements totaling $6,487,000 (after 5 years) and are further described in Note 12 to the consolidated financial statements included in this report. The remaining $1,483,000 relates to other various contractual obligations.

(5)

Assumes Series D redeemable convertible preferred stock remains outstanding until the redemption date of March 15, 2006. We may elect to redeem all or part of the Series D preferred stock in cash or by converting all or a part of the shares of Series D preferred stock into common stock, under certain circumstances. In addition, the holders of the Series D preferred stock may convert their shares into shares of common stock at any time. See Note 7 to the consolidated financial statements included in this report.

(6)

Assumes Series D redeemable convertible preferred stock remains outstanding until the redemption date of March 15, 2006. Dividends may be paid in cash or at our option in registered shares of our common stock, under certain circumstances. See Note 7 to the consolidated financial statements included in this report.

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        In March 2004, we entered into a new credit facility of up to $30,000,000 to provide additional liquidity. Under the new credit facility we have a $15,000,000 five-year term loan, a revolving line of credit up to $15,000,000 and up to $5,000,000 in letters of credit, which if outstanding, reduce availability under the revolving line of credit. Availability under the line of credit is limited by the borrowing base, which is a function of eligible accounts receivable and collections, as defined by the new credit facility. See Note 13 to the consolidated financial statements included in this report.

Impact of Inflation

        In recent years, the level of inflation affecting us has been relatively low. Our ability to pass on future cost increases in the form of higher sales prices will continue to be dependent on the prevailing competitive environment and the acceptance of our products in the marketplace.

Seasonality

        The videogame business is highly seasonal and generally has experienced higher revenues in the quarters ended September 30 and December 31 due to customer purchases preceding the year-end retail holiday selling season. Significant working capital is required to finance high levels of inventories and accounts receivable during the quarters in which we release a significant number of games. Typically this has been the quarters ended September 30 and December 31.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

        We are exposed to market risks arising in the ordinary course of business, primarily associated with foreign currency fluctuations. We had no debt or letters of credit outstanding on December 31, 2003. We have not entered into any financial instruments either for trading or for other purposes.

Interest Rate Risk

        At December 31, 2003 and 2002, we had no short-term investments. At December 31, 2003, we had a letter of credit facility which was based on variable interest rates, under which there were no borrowings outstanding. At December 31, 2002, we had a letter of credit facility and revolving line of credit which were based on variable interest rates. At December 31, 2002, no borrowings were outstanding under the revolving line of credit and letters of credit were $541,000, representing 0.27% of total assets at December 31, 2002. We do not believe that interest rate risk was material to us at December 31, 2003 or 2002.

Foreign Currency Risk

        We transact business in different foreign currencies and may be exposed to financial market risk resulting from fluctuations in foreign currency exchange rates, particularly the British Pound ("GBP") and the Euro which may result in a loss or gain of earnings to us. We monitor the volatility of the GBP and the Euro (and all other applicable currencies) frequently throughout the year. While we have not engaged in foreign currency hedging, we may in the future use hedging programs, currency forward contracts, currency options and/or other derivative financial instruments commonly used to reduce financial market risks if we determine that such hedging activities are appropriate to reduce risk.

        We had a cumulative foreign currency translation loss of $919,000 and $436,000 reflected in stockholders' equity as of December 31, 2003 and 2002, respectively. We do not believe that foreign currency risk was material at December 31, 2003 or 2002.

Item 8. Financial Statements and Supplementary Data.

        Our Consolidated Financial Statements are included in this report immediately following Part IV.

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

        None.

Item 9A. Controls and Procedures.

        As of the end of the period covered by this report, our Chief Executive Officer and our Chief Financial Officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as required by Rule 13a-15 under the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring that information about us and our subsidiaries, including the information required to be disclosed in our filings under the Securities Exchange Act of 1934, is recorded, processed, summarized and communicated to them as appropriate to allow timely decisions regarding required disclosure.

        No change was identified in connection with the evaluation described above that occurred during the fourth quarter of fiscal 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART III

Item 10. Directors and Executive Officers of the Registrant.

        Identification of Directors and Executive Officers.    Below is information about our executive officers and directors. Neil D. Nicastro is the son of Louis J. Nicastro; and Jay N. Whipple III is the son-in-law of William C. Bartholomay. Otherwise, there is no family relationship between any of our directors or executive officers. Each director is elected until the next annual meeting, or until his earlier resignation or removal. Executive officers are elected annually by the Board of Directors.

(1)

Director until June 12, 2003.

(2)

Member of the Nominating and Corporate Governance Committee

(3)

Member of the Audit Committee

(4)

Member of the Compensation Committee

(5)

Member of the Stock Option Committee

(*)

Indicates chairman of committee whose number precedes the *.

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        David F. Zucker has been our President and Chief Executive Officer since May 6, 2003. Prior to that he was President and Chief Operating Officer of Playboy Enterprises, Inc., a men's lifestyle and adult entertainment company, from July 2002 to May 2003. From October 2000 to June 2002 he was President and Chief Executive Officer of Skillgames, LLC, and Managing Director of Walker Digital, LLC, online "pay for play" games companies. From February 1999 to September 2000 he was President and Chief Executive Officer of Diva Systems Corporation, an interactive television and information technology company. From 1988 to January 1999, Mr. Zucker served in a number of executive positions for The Walt Disney Company, a global entertainment company, including Executive Publisher of Travel Agent Magazine; Manager of Current Series for ABC Television; Vice President of Programming for ESPN; and Executive Vice President of ESPN, Inc. and the Managing Director of ESPN International, Inc.

        Kenneth J. Fedesna has been our Executive Vice President—Product Development since May 2000 and was our Executive Vice President—Coin-Op Video from 1996 until May 2000. Mr. Fedesna served as our Vice President and General Manager from 1988 to 1996. He also served as Vice President and General Manager of Williams Electronics Games, Inc., a subsidiary of WMS, for over five years until August 1999. Mr. Fedesna served on our Board of Directors from 1996 until June 12, 2003.

        Thomas E. Powell joined us as Executive Vice President—Finance and Treasurer in April 2001. In September 2001, he became our Executive Vice President—Finance, Treasurer and Chief Financial Officer. From 1997 to February 2001, Mr. Powell was employed by Dade Behring, Inc., a manufacturer of medical equipment, serving most recently as Vice President of Corporate Business Development, Strategic Planning. From 1991 to 1997, he was employed by Frito-Lay, a division of PepsiCo, Inc., ultimately serving as Director of Finance.

        Mark S. Beaumont has served as our Senior Vice President—Entertainment since October 17, 2003. Prior to that, since January 2002, he served as our Senior Vice President—Publishing. He has served as Senior Vice President—Business Development of our wholly-owned subsidiary, Midway Games West Inc., since January 2000. Mr. Beaumont provided marketing and business development consulting services to Midway from October 1999 to January 2000. Prior to joining Midway, from 1996 to 1999, Mr. Beaumont was Executive Vice President and General Manager of U.S. Operations for Psygnosis, a division of Sony Corporation of America.

        David W. Nichols has served as our Senior Vice President—Administration and Operations since January 30, 2002. He has served as Executive Vice President—Operations of our wholly-owned subsidiary, Midway Home Entertainment Inc., since February 2001. From May 2000 to February 2001, Mr. Nichols served as Vice President—Operations, of Midway Home Entertainment, after serving as that company's Vice President—Administration, from 1997 to May 2000. Mr. Nichols joined us in 1995 as Controller for Midway Home Entertainment.

        Steven M. Allison joined us as Senior Vice President—Marketing and Chief Marketing Officer on December 22, 2003. Prior to joining us, he was Vice President of Marketing and Business Development, Atari/Infogrames, from December 2001 to December 2003. Prior to that, he served as Infogrames' Vice President of New Business Development and Production Content, from May 2000 to December 2001, Vice President of Licensing and Product Planning from October 1999 to April 2000, and Director of Product Marketing from April 1999 to October 1999. Before joining Infogrames, Mr. Allison was Director of Product Marketing at Accolade, Inc. from 1998 to April 1999.

        Deborah K. Fulton has served as our Senior Vice President, Secretary and General Counsel since January 30, 2002. She served us as Vice President, Secretary and General Counsel from May 2000 to January 30, 2002. She was employed by us as Senior Counsel from March 1998 until May 2000 and by WMS as Senior Counsel from 1994 to 1998. Formerly, she was employed by the law firm of Gardner Carton & Douglas from 1988 until 1994.

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        Miguel Iribarren has served as our Vice President, Corporate Communications and Strategic Planning, since February 2002. Prior to joining Midway, Mr. Iribarren was a Vice President, Research for Wedbush Morgan Securities. At Wedbush, where he worked from May 2000 to February 2002, Mr. Iribarren was responsible for research on the interactive entertainment industry. From 1993 to May 2000, Mr. Iribarren was employed by the Atlantic Richfield Corporation, an oil and gas company, in various finance and planning positions, ultimately serving as Manager, Corporate Finance.

        Neil D. Nicastro joined our Board in 1988 and was our President and Chief Operating Officer from 1991 until May 6, 2003. In 1996, Mr. Nicastro became Chairman of the Board and Chief Executive Officer, having served as Co-Chief Executive Officer since 1994. Mr. Nicastro also served in other executive positions for us in the past. Mr. Nicastro has served as a director of WMS Industries Inc., our former parent company, since 1986 and as consultant to WMS since 1998. Mr. Nicastro became sole Chief Executive Officer of WMS in 1996, Co-Chief Executive Officer in 1994, President in 1991 and Chief Operating Officer in 1991. Mr. Nicastro resigned from his offices with WMS in April 1998 to devote his full business time to Midway.

        Harold H. Bach, Jr. joined our Board in 1996 and served as our Chief Financial Officer and an Executive Vice President from 1996 to September 2001, when he retired. Mr. Bach served as our Senior Vice President—Finance and Chief Financial Officer from 1990 to 1996, and he served as our Treasurer from 1994 to April 2001. Mr. Bach also served as Vice President—Finance, Chief Financial and Chief Accounting Officer of WMS for over five years until September 1999. Mr. Bach was a partner in the accounting firms of Ernst & Young (1989-1990) and Arthur Young & Company (1967-1989). Mr. Bach is a director of WMS.

        William C. Bartholomay joined our Board in 1996. Mr. Bartholomay was appointed Group Vice Chairman of Willis Group Holdings, Inc. and Vice Chairman of its principal U.S. subsidiary, Willis North America, a global insurance brokerage, in August 2003. For more than five years previous to this appointment, Mr. Bartholomay served as President and a director of Near North National Group, insurance brokers in Chicago, Illinois. He has served as Vice Chairman of Turner Broadcasting System, Inc., a division of AOL-Time Warner, Inc. since 1994, having also held that office during the period 1976-1992. He is Chairman of the Board of the Atlanta Braves baseball team. Mr. Bartholomay is a director of WMS. He is also a director and audit committee member of International Steel Group Inc.

        William E. McKenna joined our Board in 1996. He has served as a General Partner of MCK Investment Company, Beverly Hills, California for over five years. He also is a director of WMS and Drexler Technology Corporation, a developer and manufacturer of optical data storage products.

        Norman J. Menell joined our Board in 1996. He has been Vice Chairman of the Board of WMS since 1990 and is a director of WMS. He previously held various executive offices at WMS from 1981 to 1990, including President.

        Louis J. Nicastro joined our Board in 1988. He was the Chief Executive Officer of WMS from 1998 until June 2001 and was also its President from 1998 to April 2000. He has served as Chairman of the Board of WMS since its incorporation in 1974. Mr. Nicastro also served WMS as Chief Executive Officer or Co-Chief Executive Officer from 1974 to 1996 and as President (1985-1988, 1990-1991), among other executive positions. Mr. Nicastro also served as Chairman of the Board and Chief Executive Officer of WHG Resorts & Casinos Inc. and its predecessors from 1983 until 1998. He also served as our Chairman of the Board and Chief Executive Officer or Co-Chief Executive Officer from 1988 to 1996 and our President from 1988 to 1991.

        Harvey Reich joined our Board in 1996. He was a member of the law firm of Robinson Brog Leinwand Greene Genovese & Gluck, P.C., New York, New York and its predecessor firms for over five years until his retirement from that firm in 1998. He is a director of WMS.

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        Ira S. Sheinfeld joined our Board in 1996. He has been a partner of the law firm of Hogan & Hartson L.L.P., and its predecessor law firm, Squadron, Ellenoff, Plesent & Sheinfeld LLP, New York, New York for over five years. He is a director of WMS.

        Robert N. Waxman, CPA, joined our Board on December 31, 2003. Mr. Waxman has been a Principal of Corporate Finance Advisory, a New York-based consulting firm, for over five years.

        Jay N. Whipple III joined our Board on December 31, 2003. Mr. Whipple is President of J. N. Whipple, Inc., a money management firm, and is Chairman of Osprey Partners, LLP, a provider of portfolio tracking software and has served in both of these positions for over five years. Mr. Whipple is a director of Corillian Corporation, and is chairman of their Audit Committee.

        Richard D. White joined our Board in 1996. Since May 2002, Mr. White has been a private investor and President of Aeolus Capital Group LLC, an investment management and financial advisory group. He was a Managing Director of CIBC Capital Partners, New York, New York, an affiliate of CIBC World Markets Corp. and its predecessor, Oppenheimer & Co., Inc., for over five years until May 2002. Mr. White is a director and audit committee member of G-III Apparel Group, Ltd., a manufacturer, designer and importer of leather and non-leather apparel. Mr. White is also a director and audit committee member of ActivCard, Inc., a developer and marketer of digital identity and authentication software and hardware systems.

        Section 16(a) Beneficial Ownership Reporting Compliance.    Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than ten percent of a registered class of our equity securities, to file reports of ownership and changes in ownership with the SEC. These persons are required by regulation to furnish us with copies of all Section 16(a) reports that they file. Based on our review of the copies of these reports received by us, or written representations from the reporting persons that no Form 5 was required for those persons, we believe that, during fiscal 2003, all filing requirements applicable to our officers, directors and greater than ten percent beneficial owners were complied with.

        Audit Committee Membership.    The Board has a standing Audit Committee, consisting of Messrs. Bartholomay, McKenna, Waxman and White.

        Audit Committee Financial Expert.    The Board has determined that each of William E. McKenna, Robert N. Waxman and Richard D. White is a "financial expert" serving on its Audit Committee, and that each of Messrs. McKenna, Waxman and White is independent, as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.

        Code of Business Conduct and Ethics.    We have adopted a code of business conduct and ethics that applies to our principal executive officer and our principal financial and accounting officer. The code has been filed as an exhibit to this annual report and can be found on our website at www.investor.midway.com. We will provide, without charge, a copy of our Code of Business Conduct and Ethics upon request to: Investor Relations, Midway Games Inc., 2704 West Roscoe Street, Chicago, Illinois 60618.

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Item 11. Executive Compensation.

        The summary compensation table below sets forth the compensation earned during fiscal 2003, fiscal 2002, the transition period and fiscal 2001 by our former Chief Executive Officer, our current Chief Executive Officer and our four next most highly compensated executive officers.

SUMMARY COMPENSATION TABLE

*

Six-month transition period ended December 31, 2001.

(1)

Represents payments made under our Exec-U-Care insurance program.

(2)

Mr. Nicastro was our Chief Executive Officer, President and Chief Operating Officer until May 6, 2003. He remains as Chairman of the Board.

(3)

Mr. Nicastro's former employment agreement with us permitted him to receive advances against estimated bonus payments. Advances were made in the first six months of fiscal 2000 for bonuses accrued that were reversed in the second six months of fiscal 2000 totaling $984,000. Mr. Nicastro applied salary of $102,000 during fiscal 2003, $580,000 during fiscal 2002 and $302,000 during the transition period to the repayment of these advances. See "Item 13. Certain Relationships and Related Transactions—Other Related Party Transactions." Fiscal 2003 amounts also represent a reduction in salary of $123,871 due to Mr. Nicastro's participation in our salary and director fee reduction/stock option program under the 2002 Non-Qualified Stock Option Plan.

(4)

On May 4, 2000, our Board granted to Mr. Nicastro an option to purchase 300,000 shares of our common stock in lieu of his salary for fiscal 2001, which he waived. The option expires on June 30, 2005. The exercise price is $7.00 per share.

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(5)

Includes life insurance premiums of $2,211, $4,000,000 of severance paid to Mr. Nicastro pursuant to the terms of his severance agreement, $1,963,460 of deferred severance payable to Mr. Nicastro pursuant to the terms of his severance agreement, $64,552 of interest due to Mr. Nicastro on the deferred severance, $110,311 paid to Mr. Nicastro, representing the cash surrender value of his life insurance policies and $175,895 equal to conversion value of Mr. Nicastro's deferred severance in the event that Mr. Nicastro elects to have his deferred severance paid to him in shares of common stock. The remaining $3,265,781 represents amounts accrued for Mr. Nicastro's retirement benefits, and not yet paid, under the terms of Mr. Nicastro's severance agreement. See "Employment Agreements" below.

(6)

Includes life insurance premiums of $2,677 for fiscal 2002, $1,027 for the transition period and $2,091 for fiscal 2001. The remaining amounts represent amounts accrued for Mr. Nicastro's retirement benefits, and not yet paid, under the terms of Mr. Nicastro's former employment agreement. Pursuant to a letter agreement amending Mr. Nicastro's former employment agreement on October 30, 2000, Mr. Nicastro received contractual retirement benefits in the form of 607,846 shares of our common stock to be delivered to him over time beginning upon the later to occur of (1) his 45th birthday (October 25, 2001), or (2) the date of his termination from our employ. On October 30, 2000, we valued these retirement shares at $3,950,999, determined by multiplying 607,846 shares by $6.50, the closing price of our common stock on the NYSE on that date. For accrual purposes, we also assumed that Mr. Nicastro's employment with us would terminate on his 65^th birthday, October 25, 2021, which was 260 months after October 2000. Immediately prior to entering into the October 30, 2000 letter agreement, we had recorded on our books an accrual in the amount of $322,362 which related to contractual retirement benefits afforded to Mr. Nicastro in earlier agreements. The retirement benefits of those earlier agreements were superceded by the October 30, 2000 letter agreement. Therefore, we applied the existing accrual balance to the $3,950,999 fair value of the Retirement Shares, leaving a remaining balance of $3,628,637. Dividing the $3,628,637 balance by the estimated 260 months, we calculated an accrual of $13,956 per month for Mr. Nicastro. These amounts accrued for each year are reflected in this column of the Summary Compensation Table. See "Employment Agreements" below.

(7)

Mr. Zucker joined Midway on May 6, 2003.

(8)

Represents a $150,000 signing bonus under Mr. Zucker's employment agreement, and an additional bonus of $150,000 received in December 2003.

(9)

Represents the fair value of the restricted stock award granted to Mr. Zucker on May 6, 2003 pursuant to his restricted stock agreement, calculated by multiplying the 125,000 restricted shares of common stock by $3.57, the closing price of our common stock on the NYSE on that date. See "Employment Agreements" below.

(10)

Mr. Fedesna reduced his fiscal 2003 salary by $46,451 in connection with his participation in the salary and director fee reduction/stock option program under the 2002 Non-Qualified Stock Option Plan.

(11)

Represents life insurance premiums.

(12)

Mr. Powell joined Midway on April 9, 2001.

(13)

Mr. Powell reduced his fiscal 2003 salary by $61,935 in connection with his participation in the salary and director fee reduction/stock option program under the 2002 Non-Qualified Stock Option Plan.

(14)

Mr. Beaumont served as our Senior Vice President—Publishing, from January 30, 2002 to October 17, 2003, and since that date, he has served as our Senior Vice President—Entertainment.

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(15)

Mr. Nichols has served as our Senior Vice President—Administration and Operations, since January 30, 2002.

(16)

Mr. Nichols reduced his fiscal 2003 salary by $3,784 in connection with his participation in the salary and director fee reduction/stock option program under the 2002 Non-Qualified Stock Option Plan.

Stock Options

        During fiscal 2003, the following options to purchase common stock were granted under our stock option plans to the persons named in the Summary Compensation Table:

OPTION GRANTS IN LAST FISCAL YEAR

(1)

The assumed appreciation rates are examples set by rules promulgated under the Securities Exchange Act of 1934 and are not related to or derived from the historical or projected prices of our common stock.

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        The following table sets forth information with respect to the number and year-end values of options to purchase common stock owned by the executive officers named in the Summary Compensation Table.

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

(1)

Based on the closing price of our common stock on the NYSE on December 31, 2003, which was $3.88 per share.

        We have adopted a 2002 Non-Qualified Stock Option Plan, a 2002 Stock Option Plan, a 2000 Non-Qualified Stock Option Plan, a 1999 Stock Option Plan, a 1998 Stock Incentive Plan, a 1998 Non-Qualified Stock Option Plan and a 1996 Stock Option Plan. The plans provide for the granting of stock options to our directors, officers, employees, consultants and advisors.

        During fiscal 2002, we adopted a salary and director fee reduction/stock option program under the 2002 Non-Qualified Stock Option Plan. Employees and Directors who elected to participate in the program voluntarily elected to reduce their base salary or director's fee for a one-year period beginning in January 2003. For each dollar of salary or fee reduction, employees and directors were granted options to purchase one and one-half shares of our common stock at an exercise price of $5.29. The options vested over fiscal 2003, and are exercisable until September 2, 2012. The following table shows the reduction in fees and corresponding number of options granted to the participating directors:

        The 1998 Stock Incentive Plan required that participants purchase shares of our common stock at the market price in order to be eligible to receive options.

        The plans are intended to encourage stock ownership by our directors, officers, employees, consultants and advisors and thereby enhance their proprietary interest in us. Subject to the provisions of the plans, the Stock Option Committee determines which of the eligible directors, officers, employees, consultants and advisors receive stock options, the terms, including applicable vesting periods, of the options, and the number of shares for which options are granted.

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        The option price per share with respect to each option is determined by the Stock Option Committee and generally is not less than 100% of the fair market value of our common stock on the date the option is granted. The Plans each have a term of ten years, unless terminated earlier.

        The following is a summary of additional information about securities authorized for issuance under our equity compensation plans as of December 31, 2003:

EQUITY COMPENSATION PLAN INFORMATION

        The average exercise price of outstanding options, at March 8, 2004, was approximately $8.31 per share. See "Item 12. Security Ownership of Certain Beneficial Owners and Management" for information about options held by officers and directors of Midway.

Midway Management Bonus Incentive Plan

        Our executive officers, as well as our other senior employees, are also eligible for participation under the Midway Management Bonus Incentive Plan. The plan offers participants the opportunity to receive bonuses based on a combination of the following factors: (1) base salary; (2) the achievement of targets set for Midway's financial performance; and (3) management's evaluation of the individual and the degree to which he or she meets individual performance goals.

Compensation of Directors

        We pay a fee of $32,500 per year to each director who is not also our employee. A director who serves as the chairman of the Compensation Committee or Stock Option Committee of the Board receives a further fee of $2,500 per year for his services in that capacity. A director who serves as the chairman of the Nominating and Corporation Governance Committee of the Board receives a further fee of $7,500 per year for his services in that capacity and each other member of that Committee receives an additional fee of $5,000 per year. A director who serves as the chairman of the Audit Committee of the Board receives a further fee of $20,000 per year for his services in that capacity and each other member of that committee receives an additional fee of $15,000 per year.