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DreamWorks Animation SKG (NASDAQ: DWA) is a digital animation film studio that that develops and produces computer-generated, or CG, animated feature films. The company has released a total of 18 animated feature films, 11 of which have been CG animated feature films, and one direct-to-video title. Shrek the Third, Shrek 2 and Madagascar were the highest-grossing animated films in the domestic box office in their respective years of release, and Shrek 2 remains the highest-grossing animated film, as well as the third-highest grossing film, of all time in the domestic box office. As of 2010, DreamWorks is focused on releasing three animated films, How to Train Your Dragon, Shrek Forever After and Megamind.

Due to the unpredictability of the box office, DWA seeks to manage its risk ensuring that one of its releases is a sequel. [1]. Sequels are inherently less risky because of their proven fan base. However, with only about a handful of movie releases per year, a box-office flop could still have a major negative impact on the studio's annual earnings and future revenue [2]. Dreamworks which derives 50% of its revenue from DVD sales could be significantly impacted by continuing declines in the DVD market.

Company Overview

The Company derives revenue from its distributors’ worldwide exploitation of the feature films in theaters, in home entertainment, and pay and free broadcast television. In addition, DreamWorks Animation earns revenue from the licensing and merchandising of the films and characters in markets around the world. DreamWorks films are distributed in theatrical, home entertainment and television markets on a worldwide basis by Paramount Pictures Corporation.[3]

In recent years approximately two-thirds of DWA's revenue has been from the domestic arena, with the remaining one-third coming from international markets. The studio's three primary sources of revenue are ticket sales (30%), home entertainment sales (50%), and television licensing (17%).

DWA remains highly dependent on its flagship Shrek franchise. The first two Shrek movies accounted for roughly half of the company's revenue since 2001. These factors combine to give DWA a volatile earnings stream. The company's revenue growth has ranged from 258% in 2004 (the year Shrek 2 was released) to negative 57% in 2005 (a non-Shrek release year) [4].

First Quarter 2010 Results[5]

DreamWorks reported total revenue of $162.1 million and net income of $21.7 million, or $0.24 per share on a fully diluted basis. During the quarter DreamWorks released How to Train Your Dragon, which - having grossed nearly $375 million to date in worldwide box office - has become DreamWorks Animation's next franchise. The company plans to release the sequel in 2013. How to Train Your Dragon, which was released on March 26, 2010, contributed $59.7 million of revenue to the quarter, driven primarily by merchandising and licensing activities.

The Company's 2009 release, Monsters vs. Aliens, contributed $24.6 million of revenue to the quarter, driven primarily by domestic pay television. The film reached an estimated 7.5 million home entertainment units sold, net of actual and estimated future returns, by the end of the first quarter.

The Company's 2008 releases, Madagascar: Escape 2 Africa and Kung Fu Panda, contributed $19.2 million and $5.7 million of revenue to the quarter, respectively, with the former driven by international pay television and home entertainment and the latter driven primarily by home entertainment. Through the end of the first quarter, Madagascar: Escape 2 Africa reached 13.7 million home entertainment units sold worldwide, net of actual and estimated future returns.

Library and other titles contributed approximately $52.9 million of revenue to the quarter.

The Company's second quarter results are expected to be driven primarily by the performance of Shrek Forever After. The Company expects its full year 2010 results, which will likely be heavily weighted toward the second half of the year, to be driven primarily by the continued performance of How to Train Your Dragon and the performance of Shrek Forever After, which is scheduled to be released on May 21, 2010.

Animated Filmmaking

Inspiration for DreamWorks films comes from many sources—from in-house staff, from freelance writers or from existing literary works. Successful ideas are written up as a story description and then proceed to a screenplay, followed by the storyboarding process and then finally into the production process. Excluding the script and early development phase, the production process, from storyboarding to filming out the final image, for a full-length feature film can take approximately three to four years.

DreamWorks employs small collaborative teams that are responsible for preparing storylines and ideas for the initial stages of development. The four general and overlapping phases that constitute the process and their components are:

  1. The development phase generally consists of story and visual development. The duration of the development phase can vary project by project—from a matter of months to a number of years.
  2. In the pre-production phase, the script and story are further developed and refined prior to the majority of the film crew commencing work on the project.
  3. The production phase which follows can last up to two years depending on the length of the project (television specials will generally be shorter) and involves the largest number of staff. The Company’s introduction of stereoscopic 3D for its films beginning in 2009 provides the filmmakers with additional variables to review and decide upon during this production phase.
  4. In the post-production phase, the core visuals and dialogue are in place and DreamWorks adds important elements such as sound effects and the music/score.
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DreamWorks Animated Film Production Process[6]
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Dreamworks animated films sales, 2007-2009[7]
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Release dates for future DreamWorks animated films[8]

bold text===Business Expansion===

Television Specials and Series

In December 2007, the DreamWorks half-hour television Christmas special, Shrek the Halls, premiered on network television. The special was one of the highest-rated television shows in its time slot during 2007. In 2009, two additional half-hour television sfdgfdkhfdfMonsters vs. Aliens: Mutant Pumpkins from Outer Space and Merry Madagascar, debuted on network television. DreamWorks has several additional television specials in development for initial broadcast in 2010 and beyond. In connection with these specials, the Company has or intends to enter into long-term network television distribution agreements, while retaining all other distribution rights (such as DVD, other home entertainment and consumer product distribution rights).

The animated television series, The Penguins of Madagascar, debuted on the Nickelodeon network in March 2009. Under the Company’s agreement with Paramount, an affiliate of Nickelodeon, DreamWorks is entitled to receive one-half of the revenues, as well as certain service fees, associated with home entertainment and consumer products sales related to the television series.

Live Productions

In December 2008, DreamWorks' Shrek The Musical debuted on Broadway. The play is based on the Company’s 2001 theatrical release, Shrek. Although the Broadway production closed in January 2010, the Company currently expects that a national touring production of the play will begin public performances in Chicago in the second half of 2010. The Company is also developing live shows based on its theatrical film properties, Madagascar, How to Train Your Dragon and Kung Fu Panda.

Online Virtual Worlds

DreamWorks currently expects that its online virtual world based on Kung Fu Panda will become available to the public in the first half of 2010. The virtual world, Kung Fu Panda World, will be aimed at children ages seven through 12. The Company currently expects that it will realize revenue from the virtual world through user subscription fees and advertising. The Company has also begun development of an online virtual world based on How to Train Your Dragon.

Trends and Forces

Unpredictability of Box Office Performance

The success of film releases is very difficult to project. Since DWA releases only a handful of films per year, a single box office failure could have a major negative impact on annual earnings and future cash flows. Notable successes include Shrek 2, which grossed $436.7 million at the domestic box office, and Madagascar, which pulled in $193.2 million [9]. Flops include Wallace & Gromit: The Curse of the Were-Rabbit, which grossed a mere $56.1 million in ticket sales, and Flushed Away, managing slightly better at $61.7 million [10]. In order to achieve revenue diversification and a more stable earnings stream, DWA will need to find another franchise hit besides Shrek.

Declining Box Office and DVD Sales

Domestic movie attendance in recent years has grown sluggishly, if at all, as more and more people turn to alternatives like DVDs, television, and online video. If this trend continues, it could have a dramatic impact on DWA's business since they make more than 50% of their revenue off of DVD sales.

Crowding of the Animation Market

Because of its relatively new introduction into the market, CG animation is currently one of the most popular and profitable movie genres [11]. This in turn has attracted more and more entrants into the field and increased the level of competition. Additionally, advances in CG animation technology are lowering the barriers to entry for independent studios [12]. These factors mean diluted box office returns for individual releases and higher production costs as studios compete for talent and increase advertising before the launch of a movie [13]. The intensification of product release has also diluted the sale of home entertainment units.

Technological Advance

Increased competition in the CG animation genre has diluted home entertainment sales largely due to the increased competition for shelf space [14]. However, new technology such as digital and video-on-demand platforms provide the potential for endless shelf space, and eliminate manufacturing and distribution costs. Additionally, the DVD market has reached maturation in the past two years and sales have slowed [15]. However, the next generation of DVD formatting, Blu-Ray, provides studios with new opportunities for growth.

Digital Piracy

The rising incidence of online piracy poses a growing worry for the movie industry. As more consumers switch to broadband and compression technology continues to shorten movie downloading time, the rate of film piracy looks set to increase [16]. The negative impact on studios is two-fold, as pirated films hurt DVD sales and drive down movie attendance.

Competition

DWA competes with studios who produce CG animated films, traditional animated films, and live-action films [17]. One key difference between DWA and its competitors is that it is the only pure animated play in the entertainment space, and (along with Lions Gate Entertainment) one of two pure plays on the entertainment segment. While many of the other major studios are part of large conglomerates with varied sources of income, DWA derives substantially all of its revenue from one source - CG animated feature films [18]. Some main competitors include:

A brief comparison of DWA and Pixar, chief rivals in the CG animation market:

Market Share

Given DWA's volatile earnings stream, its market share can vary widely from year to year. On average DWA captures about 5% of the studio market [19]. The top twelve studios by domestic market share are listed below:

Studio Market Share[20]
Rank Company Market Share
1 Warner Bros 15.6%
2 Fox 15.3%
3 Universal 11.4%
4 Buena Vista 10.4%
5 Sony/Columbia 10.4%
6 Paramount 9.4%
7 DreamWorks Animation SKG 5.7%
8 New Line 4.8%
9 Lions Gate Entertainment (LGF) 3.2%
10 Dimension Films 2.1%
11 Miramax 2.1%
12 MGM/UA 2.1%

Notes

  1. DWA 2006 10K, Item 1A, pg.20
  2. DWA 2006 10K, Item 1A, pg.20
  3. Reuters: DreamWorks Profile
  4. DWA 2006 10K, Item 7, pg.48
  5. DreamWorks Animation Reports First Quarter 2010 Financial Results
  6. DreamWorks Animation 10-k 2009
  7. DreamWorks Animation 10-k 2009
  8. DreamWorks Animation 10-k 2009
  9. DWA 2006 10K, Item 1, pg.2
  10. DWA 2006 10K, Item 1, pg.2
  11. DWA 2006 10K, Item 1A, pg.23
  12. DWA 2006 10K, Item 1, pg.18
  13. DWA 2006 10K, Item 1, pg.19
  14. DWA 2006 10K, Item 1, pg.18
  15. USA TODAY, "Video Slips as DVD Market Matures", January 3, 2006
  16. BBC News, "Online Film Piracy 'Set to Rise'", July 9, 2004
  17. DWA 2006 10K, Item 1, pg.18
  18. DWA 2006 10K, Item 1A, pg.21
  19. Box Office Mojo
  20. Box Office Mojo, "2005 Market Share and Box Office Results by Movie Studio"
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