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A year ago at this time, David Wu and his colleagues at Toronto-based Pseudo Interactive were burning the midnight oil to get ready for E3, a hugely influential annual showcase for the video game industry.

The 29-year-old president of Pseudo Interactive has still been putting in the hours, in advance of this week's opening of the 2004 version of E3 in Los Angeles.

But just about everything else has changed.

Last year, Pseudo Interactive used E3 to showcase a first look of Vectorman, a game backed by industry giant Sega.

"We were really stoked about it, and we actually received some good press on it," said Wu.

But following E3, Sega Japan went through a reorganization and Vectorman was cancelled.

Pseudo Interactive is a small developer, with 22 employees at the moment. That means when it works on a game, all its eggs are in one basket. Pulling the plug on Vectorman almost crippled the company.

"It was an enormous roller-coaster," Mr. Wu said of 2003. "It was insane. There were points when I was sure we weren't going to make it and things started picking up bit by bit."

Credit Microsoft for a big helping hand.

The computer giant is the parent company of Xbox and its gaming tentacles also extend to the PC. And Microsoft was looking for developers to try out its new XNA software development system.

"Luckily Microsoft heard that we were available," Mr. Wu said.

Mr. Wu explains XNA as Microsoft's attempt to do for video game development what Windows did for the PC - by making development of applications much easier and to provide the tools needed to make games more easily.

Xbox chief Robbie Bach has estimated that developers spend 80 per cent of their time working on a game's mechanics, with the other 20 per cent on more creative elements.

"Right now there's an enormous time and effort that goes into making games and a lot of it is not necessary," Mr. Wu said.

Previously game designers either had to build or buy the tools they needed.

"Usually you build it and it can take a lot of time," Mr. Wu said.

Also money. Buying the necessary tools can cost $500,000 on a game with a budget of $1.5-million, Mr. Wu estimated. And often the result is the same as other game developers are independently working on themselves.

Microsoft wants to make such tools available to game developers, most free of charge in a bid to increase its market share against Sony (PlayStation) and Nintendo (GameCube).

So Microsoft went to 10 developers to see what they can do with its XNA system.

It was interested in Pseudo Interactive, because Mr. Wu and the Toronto-based company are known for their expertise in in-game physics - which covers everything from making a car crash look real to allowing a gamer to truly interact with his environment.

Pseudo Interactive's demo - showing a sleek car and a series of crashes - turned heads at the Game Developers Conference in San Diego in late March. That has resulted in publishers approaching Mr. Wu's company to inquire about creating a game for them. A project is already under way.

The Pseudo Interactive demo will see more action at Microsoft's booth in E3.

The positive exposure the demo has already earned is key to a developer like Pseudo Interactive.

"Because in this industry reputation is everything," Mr. Wu explained. "And for a developer like us, if people see you do very impressive stuff, they want to work with you and they're willing to pay for something. And it could be licensing the technology or it could be making a game. But either way, they're willing to invest, because they want to invest in your company."

Mr. Wu's company is already in pre-production. He expects Pseudo Interactive will grow to 36 employers from 22 once production is in full swing.

The tentative title is Full Auto.

"I don't know if I can tell you too much about it, but we're looking at . .. basically the most destructive racing game ever."

Its release date is Christmas 2005, when the second-generation Xbox is expected to ship.

The future looks bright for Pseudo Interactive. Mr. Wu saw reaction to his demo at the Game Developers' Conference as a sign that physics are coming to the forefront in game design.

And that's right up Pseudo Interactive's alley.

Previously graphics ruled as designers worked to improve the look of a game. Physics improves the feel, sense of reality and opens up game play.

Instead of following a script by a game designer, the gamer can forge his own path.

Mr. Wu's company has its own game engine, which allows designers to torque up reality and do some damage.

There have been some discussions with Microsoft about licensing that game engine.

"We're talking about that but we're not there yet," Mr. Wu said. "Because there are a number of other companies licensing physics and they're much larger than us, they have teams of several hundred people."

Mr. Wu got into the business because of his interest in physics.

An engineering student with an interest in programming at the University of Toronto in the mid-'90s, he was doing some work for Imax Corp. on mechanical simulation, when he thought: "It would be really cool if we had this kind of physics in a game."

So he created a demo that, when posted on the Internet, attracted attention from Origin Systems in Austin, Texas, a game developer whose titles included Wing Commander.

They offered him a job in '96 and he accepted, returning the next year to Toronto to start up his own shop. His first base of operations was his mother's laundry room.

Now his company is based in downtown Toronto, a stone's throw from trendy Yorkville, and moving to a bigger space.