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DWA > SEC Filings for DWA > Form 10-Q on 2-May-2013All Recent SEC Filings

Show all filings for DREAMWORKS ANIMATION SKG, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for DREAMWORKS ANIMATION SKG, INC.


2-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section and other parts of this Quarterly Report on Form 10-Q (the "Quarterly Report") contain forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. You should read the following discussion and analysis in conjunction with our unaudited consolidated financial statements and the related notes thereto contained elsewhere in this Quarterly Report, and our audited consolidated financial statements and related notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the "Risk Factors" section included in our Annual Report on Form 10-K for the year ended December 31, 2012 (the "2012 Form 10-K"). We urge you to carefully review and consider the various disclosures made by us in this Quarterly Report and in our other reports filed with the Securities and Exchange Commission (the "SEC"), including our 2012 Form 10-K and Current Reports on Form 8-K, before deciding to purchase, hold or sell our common stock.

Management Overview

The following is a summary of the significant items that impacted our financial results for the three months ended March 31, 2013:

During the three months ended March 31, 2013, we earned net income (which excludes net income attributable to non-controlling interests) of $5.6 million, or $0.07 per diluted share. A detailed discussion of our financial results is provided in the section entitled "-Overview of Financial Results."

During the three months ended March 31, 2013, The Croods (released March 22, 2013) generated revenues of $4.0 million earned in the ancillary markets. This was the first feature film released under our distribution arrangement with Fox. As is somewhat typical for many of our new theatrical releases, our distributor did not report any theatrical revenue to us during the three months ended March 31, 2013 as our distributor is entitled to recover its marketing and distribution costs before it is required to report to us any revenue generated from the exploitation of this film. Further discussion of the revenues generated from this film is provided in the section entitled "-Overview of Financial Results -Revenues-Current year theatrical releases."

During the three months ended March 31, 2013, we released our feature film Rise of the Guardians (our November 2012 theatrical release) into the home entertainment market and generated revenues totaling $9.6 million (as the film recouped its distribution and marketing costs during the three months ended March 31, 2013). A discussion of the revenues generated from this film is provided in the section entitled "-Overview of Financial Results-Revenues-Prior year theatrical releases."

During the three months ended March 31, 2013, our operating results included $27.9 million of revenues and $16.7 million of gross profit attributable to Classic Media. Further discussion of revenues attributable to Classic Media is provided in the section entitled "-Overview of Financial Results-Revenues-Non-theatrical releases-Classic Media."

During the three months ended March 31, 2013, our selling, general and administrative expenses increased $15.3 million in comparison to the same period of the prior year, which was primarily driven by the addition of selling, general and administrative expenses related to Classic Media (our subsidiary that we acquired in August 2012), as well as higher salaries and benefits, including annual incentive compensation. Further discussion is provided in the section entitled "-Overview of Financial Results-Selling, General and Administrative Expenses."

Our Business and Distribution and Servicing Arrangements

Our business is primarily devoted to developing, producing and exploiting animated feature films and their associated characters, as well as creating television specials/series and live performances based on such characters. Beginning with our first feature film theatrically released in 2013 (which was The Croods released on March 22, 2013), we derive revenue from Twentieth Century Fox Film Corporation's worldwide exploitation of our films in the theatrical and various post-theatrical markets. Pursuant to a binding term sheet (the "Fox Distribution Agreement") entered into with Twentieth Century Fox and Twentieth Century Fox Home Entertainment, LLC (together with Twentieth Century Fox, "Fox"), we have agreed to license Fox certain exclusive distribution rights and exclusively engage Fox to render fulfillment services with respect to certain of our animated feature films and other audiovisual programs during the five-year period beginning on January 1, 2013. The rights licensed to, and serviced by, Fox will terminate on the date that is one year after the initial home video release date in the United States ("U.S.") of the last film theatrically released by Fox during such five-year period.


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Our films that were released on or before December 31, 2012 continue to be distributed in the worldwide theatrical, home entertainment, digital and television markets by Paramount Pictures Corporation, a subsidiary of Viacom Inc., and its affiliates (collectively, "Paramount") pursuant to a distribution agreement and a fulfillment services agreement (collectively, the "Paramount Agreements"). With respect to each film for which Paramount has rendered fulfillment services, Paramount generally has the right to continue rendering such services for 16 years from such film's initial general theatrical release.

For a description of the terms of the Paramount Agreements and the Fox Distribution Agreement, please see "Part I-Item 1-Business-Distribution and Servicing Arrangements" of our 2012 Form 10-K.

Our Revenues and Costs

Our Revenues

Our feature films are currently the source of a significant percentage of our revenues. The following description of our revenues from feature films does not include a description of revenues generated by our subsidiary, Classic Media. For a description of Classic Media's revenues, refer to "-Our Revenues and Costs-Our Revenues-Classic Media."

We derive revenue from our distributors' worldwide exploitation of our feature films in theaters and in post-theatrical markets such as home entertainment, digital, pay and free broadcast television, as well as other ancillary markets. Pursuant to the Fox Distribution Agreement, prior to reporting any revenue for one of our feature films to us, Fox is entitled to (i) retain a fee of 8.0% of all gross receipts and home video gross receipts, except in connection with certain pay television and video-on-demand rights and other digital distribution rights, for which the fee will be 6.0%, and (ii) recoup all of its permissible distribution and marketing costs with respect to the exploitation of our films on a film-by-film basis. Pursuant to the Paramount Agreements, prior to reporting to us any revenue for one of our feature films as to which it provides distribution or fulfillment services, Paramount is entitled to (i) retain a fee of 8.0% of gross revenue (without deduction for distribution and marketing costs and third-party distribution fees and sales agent fees), and (ii) recoup all of its permissible distribution and marketing costs with respect to the exploitation of our films on a film-by-film basis.

As such, under the distributor agreements, each film's total expenses and fees are offset against that film's revenues on a worldwide basis across all markets, and our distributor reports no revenue to the Company until the first period in which an individual film's cumulative worldwide gross revenues exceed its cumulative worldwide gross distribution fee and costs, which may be several quarters after a film's initial theatrical release. Additionally, as the cumulative revenues and cumulative costs for each individual film are commingled between all markets and geographical territories and our distributors only report additional revenue to us for a film in those reporting periods in which that film's cumulative worldwide gross revenues continue to exceed its cumulative worldwide gross costs, our reported revenues in any period are often a result of gross revenues with respect to an individual film generated in one or several territories being offset by the gross costs of both related and unrelated territories, as well as markets, for such film.

In addition, we generate royalty-based revenues from the licensing of our character and film elements to consumer product companies, home entertainment companies, theme parks, cruise ships and hotels worldwide. We have also entered into business activities beyond our core feature film business, including the development, production and licensing of animated television specials/series and live performances. Certain revenue and cost activities related to our live performances and our television specials/series are not subject to our distribution agreements and, accordingly, we receive payment and record revenues directly from third parties. Historically, the revenue activities related to our live performances have been minor relative to the size of our animated feature film business. We launched a live arena touring show based on our feature film How to Train Your Dragon on June 27, 2012, following a limited international launch in March 2012. The live arena touring show was operated through a third-party entity that we consolidate because we have determined that the entity qualifies as a variable interest entity due to our commitment to fund all losses. During the three months ended March 31, 2013, we recorded $3.5 million of revenues and operating expenses of $3.6 million related to this show. The initial public performances during the three months ended March 31, 2012 were considered to be incidental to the primary operations of the tour. Under our accounting policy, we record revenues generated during this period, in excess of expenses attributable to the incidental operations, as a reduction to capitalized inventory costs. Such amounts recorded during the three months ended March 31, 2012 were not material. The final performance of this arena touring show was in January 2013. We have entered into an arrangement to license the show directly to a third party, as well as to sell the majority of the physical assets of the production, for exploitation in China. We are actively pursuing other opportunities to license the show to other third parties.


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Classic Media

Since the close of our acquisition of Classic Media on August 29, 2012, our operating results include those of Classic Media. Classic Media has two primary revenue streams: (1) licensing activities ("Classic Licensing") and (2) physical product sales (e.g., DVD, Blu-Ray and audio products) ("Classic Product Sales"). Classic Media licenses intellectual property rights for a variety of uses, including television, video and digital distribution, consumer products, live events and music publishing. The majority of Classic Product Sales are conducted through distribution agreements with various third parties. Revenues from Classics Product Sales are primarily generated in the U.S., the United Kingdom and Canada.

Our Costs

Our primary operating expenses include:

            Costs of Revenues-Our costs of revenues primarily include the
             amortization of capitalized costs related to feature films,
             television specials/series and live performances (which consist of
             production, overhead and interest costs), participation and residual
             costs for our feature films and television specials/series and
             write-offs of amounts previously capitalized for titles not expected
             to be released or released titles not expected to recoup their
             capitalized costs. Generally, given the structure of our
             distribution arrangements, our costs of revenues do not include
             distribution and marketing costs or third-party distribution and
             fulfillment services fees associated with our feature films.
             Distribution and marketing costs associated with the exploitation of
             our feature films would be included in our costs of revenues to the
             extent that we caused our distributors to make additional
             expenditures in excess of agreed amounts.

Our television specials/series are typically not subject to the same distribution agreements as our feature films, and accordingly, we may directly incur distribution and marketing costs, which are classified as costs of revenues. In addition, costs of revenues also include direct costs for sales commissions to outside third parties for the licensing and merchandising of our characters and marketing and promotion costs. Our costs of revenues also include marketing and other operating costs related to our live performance business.

As a result of our acquisition of Classic Media, costs of revenues also includes manufacturing costs related to physical inventory product sales, distribution fees for Classic Media product, amortization of intangible assets (which consists of certain character rights), marketing costs directly associated with the release of a product and participation and residual costs.

            Selling, General and Administrative Expenses-Our selling, general
             and administrative expenses consist primarily of employee
             compensation (including salaries, bonuses, stock-based compensation
             and employee benefits), rent, insurance and fees for professional
             services. In addition, selling, general and administrative expenses
             include advertising and marketing costs that are not directly
             attributable to our feature films, television specials/series or
             live performances.

Our films are distributed in foreign countries and, in recent years, we have derived on average 67% of our worldwide box office receipts and 57% of our feature film revenue from foreign countries (sequel films generally have higher percentages than our original films). A significant amount of our transactions in foreign countries are conducted in the local currencies and, as a result, fluctuations in foreign currency exchange rates can affect our business, results of operations and cash flow. For a detailed discussion of our foreign currency risk, please see "Part II-Item 7A-Quantitative and Qualitative Disclosures About Market Risk" of our 2012 Form 10-K.

For a detailed description of our revenues and operating expenses, please see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Our Revenues and Costs" of our 2012 Form 10-K.

Seasonality

The timing of revenue reporting and receipt of cash remittances to us from our distributors fluctuate based upon the timing of our films' theatrical and home entertainment releases and the recoupment position of our distributors on a film-by-film basis, which varies depending upon a film's overall performance. From time-to-time, we may enter into license arrangements directly with third-parties to distribute our titles through digital media formats. The timing of revenues earned under these license arrangements fluctuate depending on when each title is made available. Furthermore, revenues related to our television specials/series fluctuate based upon the timing of their broadcast and the licensing of our character and film elements are influenced by seasonal consumer purchasing behavior and the timing of our animated feature film theatrical releases and television special/series broadcasts. We expect that revenues generated by our newly acquired subsidiary, Classic


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Media, will tend to be higher during the fourth quarter of each calendar year due to the holiday-themed content offered through television distribution rights as well as home entertainment products geared towards the holiday season. As a result, our annual or quarterly operating results, as well as our cash on hand, for any period are not necessarily indicative of results to be expected for future periods.

Results of Operations

Overview of Financial Results

The following table sets forth, for the periods presented, certain data from our
unaudited consolidated statements of income. This information should be read in
conjunction with our unaudited consolidated financial statements and the notes
thereto included elsewhere in this Quarterly Report.
                                                              Three Months Ended March 31,
                                                   2013               2012         $ Change      % Change
                                                  (in millions, except percentages and per share data)
Revenues                                      $      134.6       $      136.1     $    (1.5 )      (1.1 )%
Costs of revenues                                     85.5               96.5         (11.0 )     (11.4 )%
Product development                                    1.0                1.1          (0.1 )      (9.1 )%
Selling, general and administrative expenses          42.8               27.5          15.3        55.6  %
Operating income                                       5.3               11.0          (5.7 )     (51.8 )%
Interest income, net                                   0.9                0.6           0.3        50.0  %
Other income, net                                      1.0                2.5          (1.5 )     (60.0 )%
(Increase) decrease in income tax benefit
payable to former stockholder                         (0.7 )              0.1          (0.8 )        NM
Income before income taxes                             6.5               14.2          (7.7 )     (54.2 )%
Provision for income taxes                             0.4                5.1          (4.7 )     (92.2 )%
Net income                                             6.1                9.1          (3.0 )     (33.0 )%
Less: Net income attributable to
non-controlling interests                              0.5                  -           0.5       100.0  %
Net income attributable to DreamWorks
Animation SKG, Inc.                           $        5.6       $        9.1     $    (3.5 )     (38.5 )%
Diluted net income per share attributable to
DreamWorks Animation SKG, Inc.                $       0.07       $       0.11     $   (0.04 )     (36.4 )%
Diluted shares used in computing diluted net
income per share                                      85.3               84.8                       0.6  %


 ____________________
NM: Not meaningful


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Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012 The following table sets forth (in millions), for the periods presented, our revenues by category. This information should be read in conjunction with our unaudited consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report.

[[Image Removed]]

(1) For each period shown, "Current year theatrical releases" consists of revenues attributable to films released during the current year, "Prior year theatrical releases" consists of revenues attributable to films released during the immediately prior year, and "Preceding year theatrical releases" consists of revenues attributable to films released during all previous periods that are not yet part of our library. Titles are added to the "Library" category starting with the quarter of a title's second anniversary of the initial domestic theatrical release.

(2) On August 29, 2012, we completed our acquisition of Classic Media.

(3) For each period shown, "All other" consists of revenues not attributable to a specific feature film title. Examples of sources of revenue included in "All other" are those generated from multi-property licenses of our characters (such as for use at theme parks, hotels or cruise ships), television specials/series and live performances, as well as revenues generated from sources that are non-film related.


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Revenues. For the three months ended March 31, 2013, our revenues were $134.6 million, a decrease of $1.5 million, or 1.1%, as compared to $136.1 million for the three months ended March 31, 2012.

Theatrical Releases

The following chart sets forth the components of our theatrical release revenues, by category, for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 (in millions):

[[Image Removed]]

Current year theatrical releases. Revenues generated by our "Current year theatrical release" category increased $4.0 million during the three months ended March 31, 2013 when compared to the three months ended March 31, 2012. During the three months ended March 31, 2013, The Croods (released on March 22, 2013) contributed $4.0 million, or 3.0%, of revenues, earned in the ancillary markets. During the three months ended March 31, 2012, we did not release a feature film, and as a result did not have any titles in the "Current year theatrical releases" category. As is somewhat typical for many of our new theatrical releases, our distributor (in this case, Fox) did not report any theatrical revenue to us during the three months ended March 31, 2013 for The Croods as they are entitled to recover its marketing and distribution costs before they are required to report to us any revenue generated from the exploitation of this film. We anticipate that Fox will begin reporting revenue to us during the three months ended June 30, 2013 as a result of the film's performance in the worldwide theatrical markets.

Prior year theatrical releases. Revenues generated by our "Prior year theatrical releases" category decreased $55.3 million, or 63.1%, to $32.4 million during the three months ended March 31, 2013 when compared to $87.7 million the three months ended March 31, 2012, primarily due to the weak worldwide theatrical performance of Rise of the Guardians (our November 2012 release) as compared to Puss in Boots (our October 2011 release). During the three months ended March 31, 2013, Rise of the Guardians recouped its distribution and marketing costs (driven by stronger than expected


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home entertainment sales) and contributed $9.6 million, or 7.1%, of revenues, primarily earned in the domestic home entertainment market. The first quarter of 2012 benefited from the stronger performance of Puss in Boots, which recouped its distribution and marketing costs during the fourth quarter of 2011. As a result, during the three months ended March 31, 2012, Puss in Boots contributed $73.6 million, or 54.1% of revenues, primarily earned in the international theatrical and domestic home entertainment markets.

This decrease in revenues between the periods was somewhat offset by the overall stronger performance of Madagascar 3 (released in the second quarter of 2012) during the three months ended March 31, 2013 when compared to the performance of Kung Fu Panda 2 (released in the second quarter of 2011) during the same period of the prior year. During the three months ended March 31, 2013, Madagascar 3 contributed $22.8 million, or 16.9%, of revenues, primarily earned in the international home entertainment market. During the three months ended March 31, 2012, Kung Fu Panda 2 contributed $14.1 million, or 10.4%, of revenues, primarily earned in international home entertainment, worldwide television and ancillary markets.

Preceding year theatrical releases. Revenues generated by our "Preceding year theatrical releases" category consist of revenues attributable to films released during all previous periods that are not yet part of our library. Titles are added to the "Library" category starting with the quarter of a title's second anniversary of the initial domestic theatrical release. Revenues generated by our "Preceding year theatrical releases" category increased $0.5 million, or 6.7%, to $8.0 million during the three months ended March 31, 2013 when compared to $7.5 million of revenues the three months ended March 31, 2012.

Preceding year theatrical release revenues for the three months ended March 31, 2013 consisted of:

            Puss in Boots, which contributed $7.5 million, or 5.6% of revenues,
             primarily earned in the worldwide home entertainment market; and


            Kung Fu Panda 2, which contributed $0.5 million, or 0.4%, of
             revenues, primarily earned in the worldwide home entertainment
             market.

Preceding year theatrical release revenues for the three months ended March 31, 2012 consisted of:

            Megamind, which contributed $5.0 million, or 3.7% of revenues,
             primarily earned in the worldwide home entertainment and
             international television markets; and


            Shrek Forever After, which contributed $2.5 million, or 1.8%, of
             revenues, primarily earned in the international home entertainment
             markets.

Library. Revenue from our "Library" category increased $14.0 million, or 51.1%, to $41.4 million during the three months ended March 31, 2013 when compared to $27.4 million during the three months ended March 31, 2012, primarily due to Megamind, which contributed $14.6 million of revenues, primarily earned in the worldwide free television markets. Our feature film titles are generally released into the domestic and international free television markets two and a half years after the title's initial domestic theatrical release. Our "Library" category during the three months ended March 31, 2013 benefited from worldwide free television market revenues from our fourth quarter 2010 release, Megamind. During the three months ended March 31, 2012, revenues generated by our "Library" category were attributable to a variety of titles earned across several markets.


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Non-theatrical Releases

The following table sets forth the components of our non-theatrical release
revenues, by category, for the three months ended March 31, 2013 as compared to
the three months ended March 31, 2012 (in millions, except percentages):
                           Three Months Ended March 31,         Increase (Decrease)
     Category                  2013                2012             $            %
Classic Media          $             27.9         N/A(1)          N/A(1)      N/A(1)
All other:
Television
specials/series                       5.8              3.3            2.5      75.8 %
Live performances                     9.9              6.1            3.8      62.3 %
Other(2)                              5.2              4.1            1.1      26.8 %
. . .
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