Stingy shoppers keep TDK from reaching next level. (Investments & Finance).

THE market for video games disappointed many in the industry over the holiday season, but perhaps none more so than TDK Mediactive Inc.

The Westlake Village-based company revised its sales guidance for the full fiscal year downward in mid-December, and while TDK still expects a 37 percent revenue increase over last year, it has moved from an expectation of profitability in its fiscal 2003 to projections that it would land in the red.

The problem is one shared by nearly all the software makers in the industry: The demand for video game software along with the new generation of hardware introduced over the past year and a half, it turns out, has been far softer than first thought. Rather than embracing the newest versions of game consoles and the software made to accompany them, all but the most hard core game players stuck to their older machines and to the older versions of games, which could be had at far cheaper prices.

"Last year was difficult to a degree just because of Sept. 11, but in the entertainment industry that was offset by the introduction of Microsoft Xbox and Nintendo GameCube," said Paul D. Kaump, vice president and senior equity analyst at Dougherty & Co. LLC in Minneapolis. "This year you had an even worse consumer environment by the fact that consumers were curbing their spending activity."

With shoppers in a scrooge-like spending mood this holiday season, there was little enthusiasm for $200 video game consoles and the accompanying software, which sells for about $50 for a game. Worse yet, unlike the past when upgraded consoles required upgraded software, some of the newest game machines are also compatible with older software. So even those who sprung for, say, a Sony PlayStation 2, did not have to go out and buy a new library of games.

"People can go to Costco and buy PlayStation games for $10," said Vincent Bitetti, CEO of TDK. "You can imagine the impact it has on front line titles."

TDK holds licenses for games based on the movie "Shrek," a popular title among children. But parents buying holiday gifts were not shelling Out $50 for video games this year. Most of the consumers buying pricey games were adult males in their twenties and thirties, and they were more apt to buy titles like "Grand Theft Auto."

"You don't get a lot of kids or casual garners spending $50 on games when the installed base is made up of early adopters," Bitetti said. "That doesn't mean there's not a market for kid's stuff. But it's a smaller market, and it's much more price sensitive."

For most of the year, TDK had been on plan. In the most recent quarter ended Sept. 30, TDK reported net income of $1.5 million or $0.06 per share on revenues of $17 million. That compared with a net loss of $100,000 or $0.00 per share on revenues of $4.6 million in the comparable period last year.

But the tide turned as the holiday season approached, and by mid-December, TDK officials announced that its fiscal year ended Mar. 31, 2003 would not be as successful as first thought.

TDK revised its full year guidance for fiscal 2003 down to $43 million to $46 million from the $50 million it had previously projected. TDK said it expected to report a net loss of anywhere from $1.2 million to $2.4 million or $0.05 to $0.10 per share in fiscal '03, down from earlier guidance that the company would earn $0.05 per share.

A small company like TDK needs a critical mass of sales to recoup the cost of its software. At the new revenue levels, the company was hard pressed to amortize its development costs.

"With our particular mix of products and our particular unique situation, at somewhere around $48 million or $50 million, that switch flips and it goes from minus one penny to plus one penny," Bitetti said.

The announcement revising its full year projections sent TDK's stock spiraling downward. The stock opened at $0.60 per share on the first trading day after the announcement, down from the $1.30 range previously. As of Friday, Jan. 17, TDK was trading at $0.68.

Competitors took similar blows to their stock prices as news of a tempered growth rate for the industry spread. But unlike some of its larger competitors, TDK has a limited number of shares outstanding, limiting the chances that its stock price will recover.

TDK USA Corp. owns 73 percent of the company, which would make it difficult to interest an institutional investor in the shares, even at a bargain price, and drive the price back up.

"The biggest risk for an institutional investor is getting out," said Kaump. "They have to get out incrementally, because there's not enough liquidity."

[GRAPH OMITTED]

TDK Mediactive Inc.

Stock Prices

YEAR (March 31)                   2002  2001 (1)

Revenue (millions)               $31.5      $6.2
Operating Expenses (millions)     30.7       7.2
Operating Income (millions)       0.78     (1.1)
Net Income (millions)             0.17    (0.87)
Earnings Per Share             ($0.01)   ($0.06)

(1) For nine months due to change in fiscal year end from June 30

Jan. 17, 2002  $1.86
Jan. 17, 2003  $0.68

Note: Table made from line graph

SUMMARY

Business: Video game software maker

Headquarters: Calabasas

CEO: Vincent Bitetti

Market Cap: $115.6 million

Dividend Yield: N/A *

Total Liabilities: $15.6 million

P/E: N/A

Long-Term Debt: none

* TDK does not pay dividends