U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

x	Quarterly report under Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2003

¨	Transition report under Section 13 or 15 (d) of the Exchange Act

For the transition period from to

Commission File No. 0-28604

TDK MEDIACTIVE, INC.

(Exact Name of Issuer as Specified in Its Charter)

Delaware

33-0557833

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

4373 Park Terrace Drive, Westlake Village, California 91361

(Address of Principal Executive Offices)

(818) 707-7063

(Issuer’s Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

Check whether the issuer: (1) filed all reports required to be file by Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such shorter period that the Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ¨ YES x NO

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) ¨ YES x NO

The number of shares outstanding of the issuer’s common stock as of November 18, 2003 was 23,005,885.

TDK MEDIACTIVE, INC. AND SUBSIDIARY

Form 10-Q

INDEX

		Page

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Balance Sheets - September 30, 2003 (unaudited) and March 31, 2003		3

Condensed Consolidated Statements of Operations (unaudited) -
Three month periods ended September 30, 2003 and 2002		4
Six month periods ended September 30, 2003 and 2002		5

Condensed Consolidated Statements of Cash Flows (unaudited) -
Six month periods ended September 30, 2003 and 2002		6

Notes to Condensed Consolidated Financial Statements		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		12

Item 3. Quantitative and Qualitative Disclosure About Market Risks		19

Item 4. Controls and Procedures		19

PART II - OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K		20

Signatures		20

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

TDK MEDIACTIVE, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

	September 30, 2003			March 31, 2003
	(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents	$	1,500		$	421
Accounts receivable - net		182			3,075
Inventory - net		955			2,548
Prepaid royalties		7,561			9,475
Software development costs		7,594			12,592
Prepaid expenses and other		7,271			905

Total current assets		25,063			29,016

Property and equipment - net		785			954
Software development costs – long term		1,426			175
Other assets		49			69

TOTAL	$	27,323		$	30,214


LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current Liabilities:
Note payable to TDK USA	$	36,989		$	23,785
Accounts payable and accrued expenses		3,305			3,064
Accrued royalties		4,043			6,465
Deferred revenue		7,272			—
Deferred revenue – related entity		399			781

Total current liabilities		52,008			34,095

Deferred revenue – related entity, net of current portion		—			150
Deferred revenue		7,000			5,000

Stockholders’ Deficit:
Common stock - $.001 par value, 50,000,000 shares authorized, 22,894,582 and 22,884,582 shares issued and outstanding		23			23
Additional paid-in capital		19,954			19,954
Accumulated deficit		(51,662	)		(29,008	)

Total stockholders’ deficit		(31,685	)		(9,031	)

TOTAL	$	27,323		$	30,214

See notes to condensed consolidated financial statements.

TDK MEDIACTIVE, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months Ended September 30, 2003 and 2002 (unaudited)

(In thousands, except per share data)

	2003			2002
Net Revenues
Net sales	$	3,018		$	16,892
Revenues from related entity		194			69

Total revenues		3,212			16,961

Costs and expenses:
Cost of sales		14,034			11,722
Product development		202			198
Sales and marketing		1,560			1,938
General and administrative		1,874			1,333

Total costs and expenses		17,670			15,191

Operating income (loss)		(14,458	)		1,770
Interest expense, net		(464	)		(286	)

Income (loss) before provision for income taxes		(14,922	)		1,484
Provision for income taxes		0			0

Net income (loss)	$	(14,922	)	$	1,484

Basic and diluted net income (loss) per share	$	(0.65	)	$	0.06

See notes to condensed consolidated financial statements.

TDK MEDIACTIVE, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Six Months Ended September 30, 2003 and 2002 (unaudited)

(In thousands, except per share data)

	2003			2002
Net Revenues
Net sales	$	5,779		$	20,400
Revenues from related entity		532			156

Total revenues		6,311			20,556

Costs and expenses:
Cost of sales		21,221			15,454
Product development		397			486
Sales and marketing		3,687			3,229
General and administrative		2,790			2,302

Total costs and expenses		28,095			21,471

Operating loss		(21,784	)		(915	)
Interest expense, net		(868	)		(533	)

Loss before provision for income taxes		(22,652	)		(1,448	)
Provision for income taxes		2			2

Net loss	$	(22,654	)	$	(1,450	)

Basic and diluted net loss per share	$	(0.98	)	$	(0.06	)

See notes to condensed consolidated financial statements.

TDK MEDIACTIVE, INC. AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended September 30, 2003 and 2002 (unaudited)

(In thousands)

	2003			2002
Cash flows from operating activities:
Net loss	$	(22,654	)	$	(1,450	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		259			165
Amortization of software development costs		12,526			4,994
Provision for doubtful accounts, discounts and returns		(8	)		255
Changes in operating assets and liabilities:
Accounts receivable		2,901			(8,246	)
Inventories		1,593			(2,196	)
Prepaid royalties		1,914			(6,128	)
Software development costs		(8,779	)		(6,234	)
Prepaid expenses and other		(6,366	)		373
Accounts payable and accrued expenses		598			4,845
Accrued royalties		(2,422	)		3,498
Deferred revenue		8,740			4,725

Net cash used by operating activities		(11,698	)		(5,401	)

Cash flows from investing activities:
Purchases of property and equipment		(90	)		(1,054	)
Other		20			(62	)

Net cash used by investing activities		(70	)		(1,116	)

Cash flows from financing activities:
Proceeds from issuance of common stock		—			3
Proceeds from notes payable		12,851			7,539
Repayment on notes payable		—			(1,300	)
Payments on capital lease obligations		(4	)		(3	)

Net cash provided by financing activities		12,847			6,239

Net change in cash and cash equivalents		1,079			(278	)
Cash and cash equivalents, beginning of period		421			1,063

Cash and cash equivalents, end of period	$	1,500		$	785

Supplemental disclosure of cash flow information
Cash paid during the period for interest	$	822		$	503

See notes to condensed consolidated financial statements.

TDK MEDIACTIVE, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. While we believe that the disclosures made are adequate to make the information presented not misleading, we recommend that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2003.

In our opinion, such unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to fairly present the information provided. The results for the three months and six months ended September 30, 2003 are not necessarily indicative of the results to be expected for the full year or for any other interim period. The condensed consolidated financial statements include the accounts of TDK Mediactive, Inc. and our wholly owned subsidiary. All material intercompany balances and transactions have been eliminated in consolidation.

Note 2 – Merger Agreement

On September 2, 2003, we signed an agreement in connection with a proposed acquisition of all the common stock of TDK Mediactive by Take-Two Interactive Software, Inc. Pursuant to the agreement, Take-Two will acquire TDK Mediactive for $0.55 in cash per share of outstanding TDK Mediactive common stock, through the merger of its wholly-owned subsidiary, Mediactive, Inc., with and into TDK Mediactive. All outstanding options and warrants to purchase shares of our common stock will be cancelled, and each holder will be entitled to receive a cash payment for each cancelled option or warrant in an amount equal to the product of the number of shares of our common stock subject to such option or warrant multiplied by the excess, if any, of $0.55 over the exercise price per share subject to such option or warrant. At the closing of the merger, TDK Mediactive will be a wholly-owned subsidiary of Take-Two, and Mediactive, Inc. will cease to exist as a separate entity. In addition, our common stock will be delisted from the OTC Bulletin Board electronic quotation system and will be deregistered under the Securities Exchange Act of 1934.

On September 30, 2003, we filed an Information Statement pursuant to Section 14(c) of the Securities Exchange Act of 1934 and provided the related Information Statement to our stockholders. The proposed merger requires approval by a majority of the voting power of all outstanding shares of TDK Mediactive common stock. TDK USA and Vincent J. Bitetti, who together own approximately 79.5% of our outstanding common stock, have acted by written consent to adopt the merger agreement and approve the merger. This action by written consent is sufficient to ensure that stockholders owning a majority of the outstanding TDK Mediactive common stock adopt the merger agreement and approve the merger without the vote of any other stockholder.

consent on acceptable terms, at all. The merger agreement is terminable by either us or Take-Two if the merger has not been consummated as of December 1, 2003. Accordingly, we may be unable to consummate our merger with Take-Two.

Note 3 – Distribution Agreement

Concurrently with the execution of the merger agreement described in Note 2 above, we and Take-Two entered into a distribution agreement, whereby we granted Take-Two the sole and exclusive right to sell certain of our game products for a number of platforms. The distribution agreement is for a term of nine months from the date of commercial release of the last such designated game on the last platform and only applies to sales in North America. Take-Two agreed to place initial orders for the games, with a guaranteed aggregate purchase price for all the games of up to $24,945,000.

Prior to September 30, 2003, approximately $547,000 of product has been shipped under the distribution agreement with the remainder expected to be shipped during the December 2003 quarter. In connection with the distribution agreement, we received a payment of approximately $7.9 million of which approximately $7.3 million is recorded as deferred revenue – current in the accompanying balance sheet. At September 30, 2003 the Company recorded an approximately $3.7 million write-down of prepaid development costs relating to reduced revenues of products included in the distribution agreement. In addition we recorded an additional $2.4 million write-down of prepaid development costs and prepaid royalties relating to certain products, which were cancelled.

As of November 18, 2003, The Company was due approximately $6.0 million under the distribution agreement.

Note 4 – Earnings Per Share Computation

The computations of the weighted-average common shares used in the computation of basic and diluted net income (loss) per share is based on 23,005,885 shares for the three months and six months ended September 30, 2003. The computations of the weighted-average common shares used in the computation of basic and diluted net loss per share is based on 23,620,748 and 22,889,942 shares for the three months and six months ended September 30, 2002. Stock options and warrants to purchase 2,755,230 and 974,342 shares of common stock outstanding at September 30, 2003 and 2002, were not included in the computation as their effect would be anti-dilutive.

Note 5 – Inventories

As of September 30, 2003 and March 31, 2003, inventories consist of (in thousands):

	September 30, 2003		March 31, 2003
Finished goods	$	829	$	2,296
Raw materials (components)		126		252

	$	955	$	2,548

Note 6 – Deferred Revenue – Long Term

On May 23, 2002, we announced a strategic co-publishing / co-development agreement with Activision Publishing, Inc. The companies have agreed that their initial collaboration will be based on TDK Mediactive’s existing license to the sequel to DreamWorks’ feature film “Shrek.” The first “Shrek” title to be released under this agreement is expected to launch on multiple platforms simultaneously with the theatrical debut of the “Shrek” sequel. Additionally, TDK Mediactive and Activision have agreed to co-develop and co-publish a title originating from Activision’s portfolio of video game brands. Throughout

the co-publishing relationship, TDK Mediactive and Activision will maintain control over development and marketing of their respective properties and licenses, while pooling their substantial collective industry expertise, resources and global brands.

In connection with this agreement, we will receive minimum guaranteed royalty payments plus additional royalties once the minimum guaranteed royalty has been earned. Deferred (unearned) revenue in the accompanying balance sheet includes $5.0 million at March 31, 2003 and $7.0 million at September 30, 2003 representing cash advanced from Activision in connection with this agreement. The deferred revenue that will be recognized as income beginning at the time the sequel to the film “Shrek” is released, currently scheduled for May 2004. See Note 8.

Note 7 – Loan from Related Entity

On March 29, 2001, we entered into an $8.0 million Loan and Security Agreement with TDK USA. The agreement provided for a combination of cash advances and letters of credit relating to the purchase of product not to exceed an aggregate amount of $8.0 million and matured March 31, 2002. In connection with the agreement, we granted TDK USA a security interest in substantially all of our assets. The agreement provided for interest to be paid monthly at the annual rate of the higher of (i) the rate designated as “London Interbank Offered Rate (LIBOR)” for a one month period as published from time to time in The Wall Street Journal, Money Rates Section plus two percent (2%) or (ii) the rate designated as the “Prime Rate” as published from time to time in The Wall Street Journal, Money Rates Section plus one percent (1%).

On April 30, 2003, we entered an amended and restated loan agreement that expires on March 31, 2004 that provides for a combination of cash advances and letters of credit relating to the purchase of product, not to exceed aggregate borrowings of up to $37 million, $12 million of which is at the discretion of TDK USA. TDK USA holds a security interest in substantially all of our assets. This agreement provides for interest to be paid monthly at the annual rate of the higher of (i) LIBOR plus two and one-half percent (2.50%) or (ii) the Prime Rate plus one and one-half percent (1.50%). As to any borrowings on the uncommitted portion of the facility (that is, amounts exceeding $25 million), the respective interest rate margins are increased, from 2.50% to 2.75% for LIBOR borrowings and from 1.50% to 1.75% for prime rate borrowings.

The loan agreement as amended requires us to maintain: (i) a current ratio of 0.7 to 1.00 at June 30, 2003 and September 30, 2003, .6 to 1.00 at December 31, 2003 and .53 to 1.00 at March 31, 2004,; (ii) maintain a net sales to net assets (as defined) ratio of not less than 1.40 to 1.00 at June 30, 2003, 1.20 to 1.00 at September 30, 2003, 2.10 to 1.00 at December 31, 2003, and 3.00 to 1.00 at March 31, 2004. At September 30, 2003, we had a current ratio of 0.48 to 1.00 and therefore were not in compliance with the related the current ratio. On November 6, 2003, TDK USA issued a waiver for this requirement. At September 30, 2003, we have an outstanding balance of approximately $37.0 million (which includes accrued interest payable to TDK USA of approximately $467,000) under the loan agreement at an interest rate of 5.54%.

Note 8 – Related Party Transactions

The majority of our international business is conducted via a republishing and distribution agreement dated February 28, 2000 with TDK Recording Media Europe, S.A., a wholly owned subsidiary of TDK Corporation, an affiliated company pursuant to which TDK Europe distributes our software titles throughout Europe and certain other territories. Under the terms of the TDK Europe agreement, we are paid a republishing fee on each product sold. All costs of localization of the product, product boxes and collateral materials, as well as all costs of replication, marketing, warehousing and fulfillment, are borne by TDK Europe. Effective November 1, 2002, we signed a new agreement with TDK Europe whereby TDK Europe will have an non-exclusive right to distribute selected software titles offered by us and accepted by TDK Europe. The new agreement with TDK Europe supersedes the previous agreement and extends through July 31, 2004. At September 30, 2003, we have deferred (unearned) revenue amounting to $399,000 related to these agreements.

Note 9 – Stock Based Compensation

We account for our employee stock option plans under the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. We account for equity instruments issued to other than employees for acquiring goods and services, typically rights to intellectual property, using the fair value at the date of grant in accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation.”

No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on the net income (loss) and related earnings per share if we had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

	Three months ended September 30,					Six months ended September 30,
	2003			2002		2003			2002
	(in thousands)
Net income (loss) as reported	$	(14,922	)	$	1,484	$	(22,654	)	$	(1,450	)
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		114			114		228			228

Net income (loss) pro forma	$	(15,036	)	$	1,370	$	(22,882	)	$	(1,678	)

Net income (loss) per share:
Basic and diluted as reported	$	(0.65	)	$	0.06	$	(0.98	)	$	(0.06	)

Basic and diluted pro forma	$	(0.65	)	$	0.06	$	(0.99	)	$	(0.06	)

The fair value of each option granted was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions for the three months ended September 30, 2003 and September 30, 2002: dividend yield of zero; anticipated volatility of 113 % and 113%; risk-free interest rate of 2.2% and 3.5%; and expected option lives of four years.

Note 10 – Commitments and Contingencies

We have indemnification agreements with each of our executive officers whereby we have agreed to indemnify our executive officers and directors for certain events or occurrences arising as a result of there serving in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. We maintain a directors and officers liability insurance policy that limits our exposure and enables us to recover a portion of any amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal and has no liabilities recorded for these agreements as of September 30, 2003.

We also enter into indemnification provisions under agreements with other companies in its ordinary course of business, typically with our business partners, licensors, developers, contractors, customers, and our landlord. Under these provisions we generally indemnify and hold harmless the indemnified party for losses suffered or

incurred as a result of our acts or omissions. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments that we could be required to make under these indemnification provisions is not possible to quantify although we have not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. As a result, we believe the estimated fair value of these agreements is minimal and we have no liabilities recorded for these agreements as of September 30, 2003.

We have entered into contractual arrangements with third parties for the rights to intellectual property and for the development of products. Under these agreements, we commit to provide specified payments to an intellectual property holder or developer, based upon contractual arrangements. Assuming all contractual provisions are met, the total future minimum contract commitment for contracts in place as of September 30, 2003 is approximately $10.6 million. We also have various operating lease commitments of $821,000 expiring at various times through 2006. We also have various employee agreements with three employees that expire on various dates through November 2004. An agreement with one corporate officer provides for, (i) annual adjustments based on the Consumer Price Index; (ii) annual performance bonuses; (iii) options to purchase 500,000 shares of common stock that vest over a four year period and (iv) other normal employee benefits.

The following table summarizes our minimum contractual obligations and commercial commitments as of September 30, 2003 (in thousands):

	Contractual Obligations and Commercial Commitments
Years Ended September 30,	License Guarantees		Software Development Agreements		Employee Agreements		Leases		Total
2004	$	3,117	$	6,756	$	618	$	302		10,793
2005		290		225		54		324		893
2006		30		0		0		195		225
2007		150		0		0		0		150

	$	3,587	$	6,981	$	672	$	821	$	12,061

Excluded from the table above are normal recurring accounts payable, accrued expenses and accrued royalties.

ITEM 2 –

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The statements contained in this quarterly report that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include, without limitation, statements regarding future actions, prospective performance or results of current and anticipated products, sales, efforts, expenses, the outcome of contingencies such as legal proceedings, and financial results.

All of the forward-looking statements contained in this Quarterly Report on Form 10-Q or in our other publications may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining actual or future results. Consequently, no forward-looking statement can be guaranteed. Our actual results may vary materially and there are no guarantees about the performance of our publicly traded securities. We undertake no obligation to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise. Future disclosures on related subjects in our reports to the Securities and Exchange Commission may update some of our disclosures (including Forms 10-K, 10-Q and 8-K filed in the future) contained herein.

Some of the facts that could cause uncertainties are:

•

Our ability to complete our pending merger with Take-Two Interactive Software, Inc;

•

Our ability to collect amounts due to us from Take-Two Interactive Software, Inc., under the terms of our distribution agreement;

•

New competitors and intensification of price competition from other manufacturers of consumer software products and/or toy companies and the studio licensors themselves;

•

New products that make our products and services obsolete;

•

Inability to obtain additional capital as needed;

•

Loss of customers;

•

Technical problems with our products and services;

•

Departure of key employees, and inability to attract new employees;

•

Litigation and administrative proceedings;

•

Departure or retirement of key executives; and

•

Contracts tied to key executives and/or change in control.

Overview of the Company’s Operations

We are engaged primarily in developing, publishing, distributing and marketing interactive entertainment software primarily based on well-recognized intellectual content. This includes the development, distribution, marketing and publishing of video games for console and handheld electronic entertainment platforms. We also publish titles for Personal Computers on a case by case basis. We currently publish – or intend to publish – titles for Sony PlayStation, Sony PlayStation 2, Microsoft Xbox, Nintendo GameCube, Nintendo Game Boy Advance and Nintendo Game Boy Color. We intend to support most interactive software categories, including children’s, action, adventure, driving, fighting, puzzle, role-playing, simulation, sports and strategy. Our major retail customers include Toys “R” Us, Wal-Mart, Electronics Boutique, Target, Kmart Stores, GameStop, Best Buy, Kay Bee Toys, other national and regional retailers, discount store chains, specialty retailers and distributors.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The policies discussed below are considered by management to be critical because they are both important to the portrayal of our financial condition and results of operations and their application places the most significant demands on management’s judgment, with financial reporting results relying on estimates about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described in the following paragraphs. For all of these policies, management cautions that actual results may differ materially from these estimates under different assumptions or conditions.

Licenses – We have entered into various license agreements that require payment of up-front minimum guarantees against future royalties. Such license agreements generally require that we pay a percentage of sales of the products but no less than a specified minimum guaranteed royalty. We record the minimum guaranteed royalty as a liability together with a related prepaid asset at the time the agreement is consummated. The liability is extinguished as payments are made to the license holders and the asset is expensed at the contractual royalty rate based on actual sales of the related product. Additional royalty liabilities, in excess of minimum guaranteed amounts, are recorded when such amounts are earned by the licensor.

Prepaid royalties are expensed at the contractual royalty rate based on actual net product sales. When, in management’s estimate, future revenues will not be sufficient to recover previously capitalized costs, we expense such costs to royalty expense that is included in cost of sales. If actual revenues or revised forecasted units fall below initial forecasted units, the charge to royalty expense may be larger than anticipated in any given quarter. As of September 30, 2003, the net carrying value of our prepaid royalties and related licenses was $ 3.5 million. If we were required to write off licenses, due to changes in market condition or product quality, our results of operations could be materially adversely affected.

Software development costs – Software development costs include payments made to independent software developers under agreements for the development of products for the company. We account for such software development in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Cost of Capitalized Software to Be Sold, Leased or Otherwise Marketed.” We capitalize software development costs once technological feasibility is established and such costs are determined to be recoverable against future revenues. All other internal development costs are expensed as incurred.

Capitalized software development costs are expensed on the ratio of current units sold to total projected units. When, in management’s estimate, future revenues will not be sufficient to recover previously capitalized advances or software development costs, we expense these items as additional software development amortization in the period the impairment is identified. Such losses are solely attributable to changes in market conditions or product quality considerations. If actual or revised forecasted units fall below initial forecasted units, the charge to software development amortization may be larger than anticipated in any given quarter. As of September 30, 2003, the net carrying value of our software development costs was $ 9.0 million. If we were required to write off software development costs, due to changes in market condition or product quality, our results of operations could be materially adversely affected.

Revenue recognition – Our revenue recognition policies are in compliance with American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, “Software Revenue Recognition”, as amended and Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB

101”) which outlines the basic criteria that must be met to recognize revenue and provides guidance for presentation of revenue and for disclosure related to revenue recognition policies in financial statements filed with the SEC.

Product Sales: Direct-to-customer sales are recognized when title and risk of loss passes to the customers and are recorded net of discounts, allowances, and estimated merchandise returns. Although we sell our products on a no-return basis, in certain circumstances we may allow returns, price concessions, or allowances on a negotiated basis. While we have no obligation to perform future services subsequent to shipment, we provide telephone customer support as an accommodation to purchasers of products for a limited time. Costs associated with this effort are charged to cost of sales as incurred in our consolidated statements of operations.

Allowances for price protection, returns, and doubtful accounts: Product sales are recognized net of allowances for price protection and returns, and various anticipated customer discounts. Although we sell our products on a no-return basis, in certain circumstances we may allow returns, price concessions or allowances on a negotiated basis. We may decide to provide price protection or allow returns for our products after we analyze:

•

Inventory remaining in the retail channel;

•

The rate of inventory sell-through in the retail channel; and

•

Our remaining inventory on hand.

We establish sales allowances based on estimates of future price protection and returns with respect to current period product revenue. In addition, management monitors the volume of our sales to retailers and distributors and their inventories because substantial overstocking in the distribution channel can result in the requirement for substantial price protection or high returns in subsequent periods. Price protection and returns in future periods are inherently uncertain as unsold products in the distribution channels are exposed to rapid changes in consumer preferences, market conditions or technological obsolescence due to new platforms, product updates or competing products. While management believes it can make reliable estimates for these matters, if we changed our assumptions and estimates, our price protection and returns reserves would change and impact the net revenue we report. In addition, if actual price protection and returns were significantly greater than the reserves we have established, the actual results would decrease our reported revenue. Conversely, if actual price protection and returns were significantly less than our reserves, this would increase our reported revenue.

Similarly, management must use significant judgment and make estimates in connection with establishing allowances for doubtful accounts in any accounting period. Management analyzes customer concentrations, customer credit-worthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Material differences may result in the amount and timing of our bad debt expense for any period if management made different judgments or utilized different estimates. If our customers experience financial difficulties and are not able to meet their ongoing financial obligations to us, our results of operations could be adversely impacted.

Three Months Ended September 30, 2003 Compared to the Three Months Ended September 30, 2002

Net Revenues – Net revenues decreased 81% from $17.0 million for the three months ended September 30, 2002 to $3.2 million for the three months ended September 30, 2003. Product sales decreased by 82% from $ 16.3 million for the three months ended September 30, 2002 to $ 2.9 million for the three months ended September 30, 2003.

The decrease in product sales results primarily the timing of the release of product to the market. During the current quarter we experienced lower sales of new releases which included Shrek: Reekin’ Havoc for Nintendo’s GameBoy Advance, Aquaman and Dinotopia for Nintendo’s GameCube, plus Aquaman and

Dinotopia for Microsoft’s Xbox as compared to the new releases of prior year’s quarter which included Robotech for Sony’s Playstation2 and Microsoft’s Xbox, Shrek for Sony’s Playstation 1 and Casper for Nintendo’s GameCube. We have established reserves for price protection and returns and various anticipated customer discounts that we believe to be adequate based upon historical return data and our analysis of current customer inventory levels and sell-through rates

Republishing and distribution fees from our affiliate TDK Europe increased from $69,000 for the three months ended September 30, 2002 to $194,000 for the three months ended September 30, 2003. The increase is primarily attributed to additional sales of Robotech and Shrek consoles. At September 30, 2003, we have $399,000 in deferred revenue related to this agreement with TDK Europe that extends through July 31, 2004.

Co-publishing fees decreased from $523,000 for the three months ended September 30, 2002 to $102,000 for the three months ended September 30, 2003. This decrease is mainly attributed to lower sales of PC titles.

Cost of Sales – Cost of sales is composed of cost of purchased product, amortization of software development costs, royalty expense as well as freight and fulfillment costs. Cost of sales increased from $11.7 million for the three months ended September 30, 2002 to $14.0 million for the three months ended September 30, 2003, and increased from 69% to 437% of net revenues. Cost of purchased product and platform royalties increased from 34% to 72% of net revenues as a result of lower average selling price in the current year’s quarter than compared to prior year’s quarter. Amortization of software development cost increased from 24% to 286% of net revenues primarily due to write-downs in the aggregate amount of $8.1 million to net realizable value and included certain titles which we agreed to sell to Take-Two at reduced prices in connection with the Distribution Agreement explained in Note 2.

Internal Product Development – Internal product development expenses increased from $198,000 for the three months ended September 30, 2002 to $202,000 during the three months ended September 30, 2003. As a percentage of net revenues, product development expenses increased from 1% to 6% of net revenues. The increase as a percentage of sales is due to decreased salaries and benefits costs as there was a decrease in personnel in this department compared to prior year’s quarter plus the lower sales base for the current year quarter

Sales and Marketing – Sales and marketing expenses decreased from $1.9 million for the three months ended September 30, 2002 to $1.6 million for the three months ended September 30, 2003 and as a percentage of net revenues increased from 11% to 49%. The decrease relates primarily to lower sales commissions due to reduced sales in the current quarter than in prior year’s quarter plus a decrease in advertising and promotional cost.

General and Administrative – General and administrative expenses increased from $1.3 million for the three months ended September 30, 2002 to $1.9 million for the three months ended September 30, 2003. The increase is primarily attributable to the following major components (i) merger costs expensed during the quarter ($947,000); (ii) increased depreciation expense related to additional equipment ($27,000); (iii) higher insurance premiums ($14,000); offset by (iv) lower bad debt expense ($339,000); (v) moving costs incurred during the prior year quarter ($54,000); and (vi) various other expenses ($60,000).

Interest Expense – During the three months ended September 30, 2003 and 2002, we incurred interest expense in connection with borrowings under our loan agreement with TDK USA, a related entity. The average interest rate for the current quarter was 5.68% whereas the average interest rate for the previous year’s quarter was 6.25% on average borrowing of $33 million for the current quarter compared to $18 million for the prior year quarter.

Six Months Ended September 30, 2003 Compared to the Six Months Ended September 30, 2002

Net Revenues – Net revenues decreased 69% from $20.6 million for the six months ended September 30, 2002 to $6.3 million for the six months ended September 30, 2003. Product sales decreased by 71% from $ 19.3 million for the six months ended September 30, 2002 to $ 5.5 million for the six months ended September 30, 2003.

The decrease in product sales results primarily from the timing of the release of product to the market. During the six months ended September 30, 2003 we experienced lower sales of new releases which included Shrek Reekin’ Havoc for Nintendo’s GameBoy Advance; Aquaman and Dinotopia for Nintendo’s GameCube and for Microsoft’s Xbox; Shrek Party for Nintendo’s GameCube and Pirates of the Caribbean for Nintendo’s GameBoy Advance as compared to the new releases of prior year’s period which included Robotech for Sony’s Playstation2 and Microsoft’s Xbox, Shrek for Sony’s Playstation 1 and Casper for Nintendo’s GameCube and Dinotopia for Nintendo’s GameBoy Advance. We have established reserves for price protection and returns and various anticipated customer discounts that we believe to be adequate based upon historical return data and our analysis of current customer inventory levels and sell-through rates

Republishing and distribution fees from our affiliate TDK Europe increased from $156,000 for the six months ended September 30, 2002 to $532,000 for the six months ended September 30, 2003. The increase is primarily attributed to additional sales of Robotech and Shrek consoles.

Co-publishing fees decreased from $1.1 million for the prior year six month period to $236,000 for the six months ended September 30, 2003. This decrease is attributed to lower sales of PC titles.

Cost of Sales – Cost of sales is composed of cost of purchased product, amortization of software development costs, royalty expense as well as freight and fulfillment costs. Cost of sales increased from $15.5 million for the six months ended September 30, 2002 to $21.2 million for the six months ended September 30, 2003, and increased from 75% to 336% of net revenues. Cost of purchased product and platform royalties increased from 39% to 83% of net revenues as a result of lower average selling price in the current year’s quarter than compared to prior year’s quarter. Amortization of software development cost increased from 24% to 198% of net revenues primarily due to the write-down to net realizable value in the aggregate amount of $8.1 million of certain titles and included certain titles which we agreed to sell to Take-Two at reduced prices in connection with the Distribution Agreement explained in Note 2.

Internal Product Development – Internal product development expenses decreased from $486,000 for the six months ended September 30, 2002 to $397,000 during the six months ended September 30, 2003. As a percentage of net revenues, product development expenses increased from 2% to 6% of net revenues. The decrease is due mainly to salary termination costs incurred in the prior year.

Sales and Marketing – Sales and marketing expenses increased from $3.2 million for the six months ended September 30, 2002 to $3.7 million for the six months ended September 30, 2003 and as a percentage of net revenues increased from 16% to 58%. The increase relates primarily to higher costs incurred in trade shows of approximately $780,000. This was offset by a decrease in sales commission of approximately $370,000 due to lower sales in the current period when compared to prior year.

General and Administrative – General and administrative expenses increased from $2.3 million for the six months ended September 30, 2002 to $2.8 million for the six months ended September 30, 2003 and increased as a percentage of net revenues from 11% to 44%. The $488,000 increase is primarily attributable to the following major components (i) merger costs expensed during the period ($947,000); (ii) increased salaries due to hiring more experienced personnel and annual raises ($305,000); (iii) increased depreciation expense related to additional equipment ($94,000); (iv) higher insurance premiums

($37,000); offset by (v) decreased bad debt expense ($263,000); (vi) decreased compensation ($220,000); (vii) decreased in warrant expense to consultant ($84,000); (viii) moving costs incurred during the prior year period ($76,000); and (ix) other costs ($81,000).

Interest Expense – During the six months ended September 30, 2003 and 2002, interest expense was incurred in connection with borrowings under our loan agreement with TDK USA, a related entity. We expect that such borrowings and the associated interest expense will continue to grow, within the limits of the borrowing agreement, as our business grows and we borrow additional funds to finance such growth. See Liquidity and Capital Resources below. The average interest rate for the current period was 5.83% whereas the average interest rate for the previous year’s period was 6.25% on average borrowing of $30 million for the current period compared to $18 million for the prior year period.

Quarterly Results of Operations

We have experienced and may continue to experience, fluctuations in operating results due to a variety of factors, including the size and rate of growth of the consumer software market, market acceptance of our products and the licenses upon which they are based and those of our competitors, development and promotional expenses relating to the introduction of new products or new versions of existing products, product returns, changes in pricing policies by us and our competitors, the accuracy of retailers’ forecasts of consumer demand, the timing of the receipt of orders from major customers, and account cancellations or delays in shipment. Our expense levels are based, in part, on our expectations as to future sales and, as a result, operating results could be disproportionately affected by a reduction in sales or a failure to meet our sales expectations.

Seasonality

The consumer software business traditionally has been seasonal. Typically, net sales are the highest during the fourth calendar quarter and decline sequentially in the first and second calendar quarters. The seasonal pattern is due primarily to the increased demand for consumer software during the year-end holiday buying season. We expect net sales and operating results to continue to reflect seasonality.

Liquidity and Capital Resources

Our principal uses of cash are product purchases, payments to licensors, payments to developers and operating costs. In order to purchase products from manufacturers, we either open a letter of credit in their favor; obtain credit from the manufacturer or prepay the cost of the product.

Our cash and cash equivalents amounted to $1.5 million at September 30, 2003. Cash utilized in operating activities for the six months ended September 30, 2002 amounted to $11.7 million, compared to $5.4 million used during the six months ended September 30, 2002. The significant difference between the two six month periods relates to the increased loss during the current six month period ($21.2 million), a decrease in accounts payable and accrued expenses ($4.2 million), and a decrease in prepaid software development costs, net of amortization ($5.0 million), offset by a decrease in receivables ($11.1 million) and a net decrease in prepaid royalties ($2.1 million). Historically, we have not generated sufficient cash flow to fund our operations, and have had to rely on debt and equity financings to fund our operations. At September 30, 2003 we had a working capital deficit in the amount of $26.7 million.

On April 30, 2003, we signed an amended and restated loan agreement with TDK USA, a related party, to extend and expand our existing loan and security agreement. The agreement now matures on March 31, 2004 and provides for a combination of cash advances and letters of credit relating to the purchase of product, not to exceed aggregate borrowings of up to $37 million, $12 million of which is at the discretion of TDK USA. The loan agreement as amended required us to maintain a current ratio of 0.7 to 1.00 at September 30, 2003. At September 30, 2003, we had a current ratio of 0.48 to 1.00 and therefore were not in compliance with the related the current ratio. On November 6, 2003, TDK USA issued a waiver for this requirement. As of November 18, 2003, we have an outstanding balance of approximately $37.0 million (which includes accrued interest payable to TDK USA of approximately $467,000) under the loan agreement at an interest rate of 5.54%.

Our business plan indicates that we will continue to expand our operations during the next 12 to 18 months, and involves the production of fewer titles which are scheduled for launch during fiscal 2004. We have reached the maximum amount available under our amended and restated loan agreement. Our business plan indicates that funding the remaining titles in development will require approximately $10.0 million which TDK USA has indicated that they will fund only up to the allowable amount available under the loan agreement.

Merger with Take-Two

On September 2, 2003, we signed an agreement in connection with a proposed acquisition of all the common stock of TDK Mediactive by Take-Two Interactive Software, Inc. Pursuant to the merger agreement, Take-Two will acquire TDK Mediactive for $0.55 in cash per share of outstanding TDK Mediactive common stock, through the merger of its wholly-owned subsidiary, Mediactive, Inc., with and into TDK Mediactive. All outstanding options and warrants to purchase shares of our common stock will be cancelled, and each holder will be entitled to receive a cash payment for each cancelled option or warrant in an amount equal to the product of the number of shares of our common stock subject to such option or warrant multiplied by the excess, if any, of $0.55 over the exercise price per share subject to such option or warrant. At the closing of the merger, TDK Mediactive will be a wholly-owned subsidiary of Take-Two, and Mediactive, Inc. will cease to exist as a separate entity. In addition, our common stock will be delisted from the OTC Bulletin Board electronic quotation system and will be deregistered under the Securities Exchange Act of 1934.

As of November 18, 2003 not all the conditions to complete the merger have been satisfied. Specifically, we had not then obtained the consent of Dream Works L.L.C. to the assignment of our license agreement governing our rights to interactive software products based on the motion picture “Shrek”. There can be no assurance that we can obtain this consent on acceptable terms, at all. The merger agreement is terminable by either us or Take-Two if the merger has not been consummated as of December 1, 2003. Accordingly, we may be unable to consummate our merger with Take-Two.

Take-Two Distribution Agreement

Concurrently with the execution of the merger agreement described above, we and Take-Two entered into a distribution agreement, whereby we granted Take-Two the sole and exclusive right to sell certain of our game products for a number of platforms. The distribution agreement is for a term of nine months from the date of commercial release of the last such designated game on the last platform and only applies to sales in North America. Take-Two agreed to place initial orders for the games, with a guaranteed aggregate purchase price for all the games of up to $24,945,000.

As of November 18, 2003, approximately $18.0 million of product covered by the distribution agreement has been shipped with the remainder expected to be shipped during the December 2003 quarter. As of November 18, 2003, the Company was due approximately $6.0 million under the distribution agreement.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain market risks arising from transactions in the normal course of business, principally risk associated with interest rate fluctuations relating to our credit line. The interest rate is tied to the LIBOR and Prime rates and as such interest rates increase, we may incur higher interest expense. We have no foreign currency or commodity risk.

ITEM 4.

CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports filed with the Securities and Exchange Commission. In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those internal controls subsequent to the date we carried out our last evaluation.

PART II - OTHER INFORMATION

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

Exhibit Number		Title

31.1		Certification of Vincent J. Bitetti, Chief Executive Officer, Pursuant to Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934 as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Martin G. Paravato, Chief Financial Officer, Pursuant to Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934 as adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b)	Reports on Form 8-K

Current Report on Form 8-K dated July 23, 2003, reporting under Item 5.

Current Report on Form 8-K dated September 4, 2003 reporting under Item 5.

SIGNATURES

In accordance with the requirements of the Securities Exchange Act, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

TDK MEDIACTIVE, INC.

By:	/s/ VINCENT J. BITETTI	Date November 18, 2003

	Vincent J. Bitetti Chief Executive Officer (Principal Executive Officer)



By:	/s/ MARTIN G. PARAVATO	Date: November 18, 2003

	Martin G. Paravato Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

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TDK MEDIACTIVE INC 10-Q