Activision Blizzard (ATVI)

Product Development (in thousands)

Product development expenses for the three months ended June 30, 2007 increased 28% compared to the three months ended June 30, 2006, from $25.6 million to $32.9 million.  As a percentage of publishing net revenues, product development expense decreased from 19% to 8% as compared to the three months ended June 30, 2006 due to the higher level of revenues in the three months ended June 30, 2007. The increase in absolute dollars primarily resulted from higher development, quality assurance, and outside developer costs incurred during the first quarter of fiscal 2008 to support the development of more technologically advanced titles across more platforms. 

We expect product development costs for fiscal 2008 to be higher in absolute dollars than fiscal 2007, although lower as a percentage of publishing net revenues, due to the increased costs related to developing more technologically advanced titles for the next-generation console systems.  Over time, we intend to decrease the development costs of the next-generation console systems by leveraging technologies and tools across multiple platforms, increasing our development schedules to facilitate a longer pre-production phase and more predictable workflow times, and increasing the amount of game development that is being outsourced to lower cost off-shore service providers.

Product Development (in thousands)

Product development expenses for the year ended March 31, 2006 increased as a percentage of publishing net revenues from the prior fiscal year, from 8% to 11%. In absolute dollars, product development expenses for the year ended March 31, 2006 also increased from the prior fiscal year, from $87.8 million to $132.7 million. The increase in product development expenses both in absolute dollars and as a percentage of publishing net revenues was due to:

•                  Increased development, quality assurance, and outside developer costs as a result of the development of more technologically advanced titles across more platforms.

•                  Product cancellation charges of $11.4 million, including termination fees, incurred during fiscal 2006. Given the market conditions, the lower than expected performance of some of our third quarter fiscal 2006 releases, and risks associated with console transition, we performed a thorough review of our upcoming product slate. To better align opportunities associated with the next-generation console platforms with income potential and risks associated with certain titles in development, we canceled development of certain titles and permanently removed them from our future title slate.

•                  Increased costs in fiscal 2006 related to the full year operation of three recently acquired studios, Vicarious Visions, Inc., Toys for Bob, Inc., and Beenox, Inc., as well as costs incurred to fund more product development capacity at certain studios.

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Product Development (in thousands)

Product development expenses for the year ended March 31, 2005 decreased as a percentage of publishing net revenues from the prior fiscal year, from 15% to 8%. In absolute dollars, product development expenses for the year ended March 31, 2005 also decreased from the prior fiscal year, from $97.9 million to $86.5 million. The decrease in product development as a percentage of publishing net revenues and in absolute dollars primarily resulted from a pre-tax charge of approximately $21 million taken in the third quarter of fiscal 2004 related to the cancellation of products which were believed to be unlikely to produce an acceptable level of return on our investment. Excluding the impact of the pre-tax charge, product development expenses for the year ended March 31, 2005 increased by approximately $9.7 million. This increase was attributable to higher game development costs as development time and team sizes as well as quality assurance time increased due to enhanced production values and to support more complex and robust gaming experiences.

Product Development (in thousands)

Product development expenses for the three months ended June 30, 2005 decreased as a percentage of publishing net revenues as compared to the three months ended June 30, 2004, from 13% to 9%. In absolute dollars, product development expenses for the three months ended June 30, 2005 also decreased compared to the three months ended June 30, 2004, from $21.1 million to $17.8 million.  The decrease in product development as a percentage of publishing net revenues and in absolute dollars resulted from:

•                  Higher internal studio bonuses in the first quarter of fiscal 2005 due to the strong performance of the Shrek 2 and

Product Development (in thousands)

Product development expenses for the year ended March 31, 2004 increased as a percentage of publishing net revenues from the prior fiscal year, from 9% to 15%. In absolute dollars, product development expenses for the year ended March 31, 2004 also increased from the prior fiscal year, from $57.0 million to $97.9 million.  The increase in product development as a percentage of publishing net revenues and in absolute dollars resulted from:

•                  A $21 million game cancellation charge recorded in the fiscal 2004 third quarter.  We executed a realignment of our product portfolio driven by the evolution of the video game market, which is increasingly dominated by high quality products that are based on recognizable franchises and supported with big marketing programs.  We completed a comprehensive review of our product portfolio in which we evaluated each product based on a number of criteria, including:  the strength of the franchise, the projected product quality, the potential responsiveness of the product to aggressive marketing support and the financial risk in the event of product failure.  As a result of this review, we believed that we had an extensive slate of high-potential properties in development.  However, we found that certain projects had a lower likelihood of achieving acceptable levels of operating performance and that continued pursuit of these projects would create a substantial opportunity cost as it related to our slate of high-potential projects. Accordingly, in the three months ended December 31, 2003, we cancelled the development of ten products that we believed were unlikely to produce an acceptable level of return on our investment.  In connection with the cancellation of these products, we recorded a pre-tax charge of approximately $21 million.

•                  Our increased emphasis on product quality and the lengthening of product development schedules.  To maintain the competitiveness of our products and to take advantage of increasingly sophisticated technology associated with new hardware platforms, we have increased the amount of time spent play-testing new products, conducted more extensive product quality evaluations and lengthened product development schedules to allow time to make the improvements indicated by our testing and evaluations.  We are focused on improved game quality, and in many cases, this has resulted in an increase in product development costs.

•                  The increase in absolute dollars is also due to an increase in studio employee incentive compensation as a result of the strong performances of key fiscal 2004 title releases.