10-Q 1 dwa6301410q.htm FORM 10-Q DWA 6.30.14 10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
___________________________
FORM 10-Q
___________________________
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
Commission File Number 001-32337
DREAMWORKS ANIMATION SKG, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
68-0589190
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
1000 Flower Street
Glendale, California 91201
(Address of principal executive offices) (Zip code)
(818) 695-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No   o.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
T
Accelerated filer
o
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o   No  x.
Indicate the number of shares outstanding of each of the registrant's classes of common stock: As of July 17, 2014, there were 76,831,503 shares of Class A common stock and 7,838,731 shares of Class B common stock of the registrant outstanding.

 





TABLE OF CONTENTS
 

Unless the context otherwise requires, the terms "DreamWorks Animation," the "Company," "we," "us" and "our" refer to DreamWorks Animation SKG, Inc., its consolidated subsidiaries, predecessors in interest and the subsidiaries and assets and liabilities contributed to it by the entity then known as DreamWorks L.L.C. ("Old DreamWorks Studios") on October 27, 2004 (the "Separation Date") in connection with our separation from Old DreamWorks Studios (the "Separation").



1


PART I—FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS

DREAMWORKS ANIMATION SKG, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
June 30,
2014
 
December 31,
2013
 
(in thousands, except par value and share amounts)
Assets
 
 
 
Cash and cash equivalents
$
32,196

 
$
95,467

Trade accounts receivable, net of allowance for doubtful accounts (see Note 7 for related party amounts)
146,991

 
130,744

Receivables from distributors, net of allowance for doubtful accounts (see Note 7 for related party amounts)
212,669

 
283,226

Film and other inventory costs, net
979,919

 
943,486

Prepaid expenses
22,133

 
20,555

Other assets
31,940

 
23,385

Investments in unconsolidated entities
49,300

 
38,542

Property, plant and equipment, net of accumulated depreciation and amortization
184,200

 
186,670

Deferred taxes, net
250,265

 
221,920

Intangible assets, net of accumulated amortization
197,438

 
150,511

Goodwill
189,667

 
179,722

Total assets
$
2,296,718

 
$
2,274,228

Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Accounts payable
$
4,899

 
$
5,807

Accrued liabilities
232,317

 
263,668

Payable to former stockholder
261,694

 
262,309

Deferred revenue and other advances
35,082

 
36,425

Revolving credit facility
100,000

 

Senior unsecured notes
300,000

 
300,000

Total liabilities
933,992

 
868,209

Commitments and contingencies (Note 17)


 


Equity:
 
 
 
DreamWorks Animation SKG, Inc. Stockholders' Equity:
 
 
 
Class A common stock, par value $0.01 per share, 350,000,000 shares authorized, 104,334,982 and 104,155,993 shares issued, as of June 30, 2014 and December 31, 2013, respectively
1,043

 
1,042

Class B common stock, par value $0.01 per share, 150,000,000 shares authorized, 7,838,731 shares issued and outstanding, as of June 30, 2014 and December 31, 2013
78

 
78

Additional paid-in capital
1,116,412

 
1,100,101

Accumulated other comprehensive income (loss)
95

 
(600
)
Retained earnings
1,014,075

 
1,072,398

Less: Class A Treasury common stock, at cost, 27,503,479 and 27,439,119 shares, as of June 30, 2014 and December 31, 2013, respectively
(770,037
)
 
(768,224
)
Total DreamWorks Animation SKG, Inc. stockholders' equity
1,361,666

 
1,404,795

Non-controlling interests
1,060

 
1,224

Total equity
1,362,726

 
1,406,019

Total liabilities and equity
$
2,296,718

 
$
2,274,228


See accompanying notes.

2



DREAMWORKS ANIMATION SKG, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
(in thousands, except per share amounts)
Revenues (see Note 7 for related party amounts)
$
122,277

 
$
213,436

 
$
269,518

 
$
348,084

Costs of revenues
87,532

 
133,276

 
248,221

 
218,797

Gross profit
34,745

 
80,160

 
21,297

 
129,287

Product development
611

 
1,069

 
1,151

 
2,032

Selling, general and administrative expenses
54,595

 
49,711

 
101,774

 
92,500

Change in fair value of contingent consideration
(7,220
)
 

 
(4,720
)
 

Other operating income (see Note 7 for related party amounts)
(2,317
)
 
(2,859
)
 
(3,989
)
 
(2,859
)
Operating (loss) income
(10,924
)
 
32,239

 
(72,919
)
 
37,614

 
 
 
 
 
 
 
 
Non-operating income (expense):
 
 
 
 
 
 
 
Interest (expense) income, net
(2,484
)
 
777

 
(4,257
)
 
1,640

Other income, net
1,853

 
1,050

 
3,071

 
2,042

Decrease (increase) in income tax benefit payable to former stockholder
1,695

 
(371
)
 
2,622

 
(1,069
)
(Loss) income before loss from equity method investees and income taxes
(9,860
)
 
33,695

 
(71,483
)
 
40,227

 
 
 
 
 
 
 
 
Loss from equity method investees
3,467

 
1,329

 
6,727

 
1,329

(Loss) income before income taxes
(13,327
)
 
32,366

 
(78,210
)
 
38,898

Provision (benefit) for income taxes
2,601

 
10,118

 
(19,866
)
 
10,536

Net (loss) income
(15,928
)
 
22,248

 
(58,344
)
 
28,362

Less: Net (loss) income attributable to non-controlling interests
(541
)
 
(5
)
 
(21
)
 
532

Net (loss) income attributable to DreamWorks Animation SKG, Inc.
$
(15,387
)
 
$
22,253

 
$
(58,323
)
 
$
27,830

 
 
 
 
 
 
 
 
Net (loss) income per share of common stock attributable to DreamWorks Animation SKG, Inc.
 
 
 
 
 
 
 
Basic net (loss) income per share
$
(0.18
)
 
$
0.27

 
$
(0.69
)
 
$
0.33

Diluted net (loss) income per share
$
(0.18
)
 
$
0.26

 
$
(0.69
)
 
$
0.33

Shares used in computing net (loss) income per share
 
 
 
 
 
 
 
Basic
84,554

 
83,524

 
84,520

 
84,094

Diluted
84,554

 
84,533

 
84,520

 
84,898










See accompanying notes.

3



DREAMWORKS ANIMATION SKG, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited)

 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Net (loss) income
 
$
(15,928
)
 
$
22,248

 
$
(58,344
)
 
$
28,362

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
 
Foreign currency translation gains (losses)
 
563

 
(104
)
 
695

 
(2,596
)
Comprehensive (loss) income
 
(15,365
)
 
22,144

 
(57,649
)
 
25,766

Less: Comprehensive (loss) income attributable to non-controlling interests
 
(541
)
 
(5
)
 
(21
)
 
532

Comprehensive (loss) income attributable to DreamWorks Animation SKG, Inc.
 
$
(14,824
)
 
$
22,149

 
$
(57,628
)
 
$
25,234






See accompanying notes.


4


DREAMWORKS ANIMATION SKG, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) 
 
Six Months Ended
 
June 30,
 
2014
 
2013
 
(in thousands)
Operating activities
 
 
 
Net (loss) income
$
(58,344
)
 
$
28,362

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
 
 
 
Amortization and write-off of film and other inventory costs(1)
206,493

 
178,023

Amortization of intangible assets
6,436

 
4,408

Stock-based compensation expense
8,421

 
9,837

Amortization of deferred financing costs
550

 

Depreciation and amortization
2,249

 
2,351

Change in fair value of contingent consideration
(4,720
)
 

Revenue earned against deferred revenue and other advances
(32,584
)
 
(39,061
)
Income related to investment contributions
(3,989
)
 
(10,700
)
Loss from equity method investees
6,727

 
1,329

Deferred taxes, net
(26,590
)
 
9,576

Changes in operating assets and liabilities, net of the effects of acquisitions:
 
 
 
Trade accounts receivable
(15,691
)
 
7,208

Receivables from distributors
70,315

 
(18,933
)
Film and other inventory costs
(236,376
)
 
(210,984
)
Intangible assets

 
1,015

Prepaid expenses and other assets
(14,312
)
 
(8,537
)
Accounts payable and accrued liabilities
(38,113
)
 
3,694

Payable to former stockholder
(615
)
 
(14,929
)
Income taxes payable/receivable, net
7,353

 
2,212

Deferred revenue and other advances
56,355

 
74,825

Net cash (used in) provided by operating activities
(66,435
)
 
19,696

Investing activities
 
 
 
Investments in unconsolidated entities
(13,365
)
 
(14,720
)
Purchases of property, plant and equipment
(17,653
)
 
(14,858
)
Acquisitions of character and distribution rights
(51,000
)
 

Acquisitions, net of cash acquired
(12,605
)
 
(30,093
)
Net cash used in investing activities
(94,623
)
 
(59,671
)
Financing activities
 
 
 
Proceeds from stock option exercises
261

 

Purchase of treasury stock
(1,956
)
 
(25,854
)
Borrowings from revolving credit facility
110,000

 
45,000

Repayments of borrowings from revolving credit facility
(10,000
)
 
(10,000
)
Net cash provided by financing activities
98,305

 
9,146

Effect of exchange rate changes on cash and cash equivalents
(518
)
 
428

Decrease in cash and cash equivalents
(63,271
)
 
(30,401
)
Cash and cash equivalents at beginning of period
95,467

 
59,246

Cash and cash equivalents at end of period
$
32,196

 
$
28,845

Non-cash investing activities:
 
 
 
Contingent consideration portion of business acquisition purchase price
$

 
$
95,000

Intellectual property and technology licenses granted in exchange for equity interest
3,395

 
10,129

Services provided in exchange for equity interest
600

 
571

Total non-cash investing activities
$
3,995

 
$
105,700

Supplemental disclosure of cash flow information:
 
 
 
Cash refunded during the period for income taxes, net
$
608

 
$
1,529

Cash paid during the period for interest, net of amounts capitalized
$
5,273

 
$
690

(1) Included within this amount is depreciation and amortization, interest expense and stock-based compensation previously capitalized to "Film and other inventory costs" (see Note 1). During the six months ended June 30, 2014 and 2013, these amounts totaled $14,066 and $17,378, respectively.
See accompanying notes.

5


DREAMWORKS ANIMATION SKG, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1.
Business and Basis of Presentation

Business

The businesses of DreamWorks Animation SKG, Inc. ("DreamWorks Animation" or the "Company") is primarily devoted to the development, production and exploitation of animated films and their associated characters in the worldwide theatrical, home entertainment, digital, television, merchandising and licensing and other markets. The Company continues to build upon the value of its intellectual property created from its animated films by creating high-quality entertainment through the development and production of non-theatrical content such as television series and specials and live performances based on characters from its feature films. In addition, the Company has an extensive library of other intellectual property rights through its acquisition of Classic Media, which can be exploited in various markets. The Company's activities also include technology initiatives as it explores opportunities to exploit its internally developed software.

Distribution and Servicing Arrangements
 
The Company derives revenue from Twentieth Century Fox Film Corporation's worldwide (excluding China and South Korea) exploitation of its films in the theatrical and 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 (collectively, "Fox"), the Company has agreed to license Fox certain exclusive distribution rights and exclusively engage Fox to render fulfillment services with respect to certain of the Company's 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.

Also beginning in 2013, the Company's films are distributed in China and South Korea territories by distinct distributors. The key terms of the Company's distribution arrangements with its Chinese and South Korean distributors are largely similar to those with Fox and Paramount such that the Company also recognizes revenues earned under these arrangements on a net basis. The Company's distribution partner in China is Oriental DreamWorks Holding Limited ("ODW"), which is a related party.

Lastly, the Company has continued to derive revenues from the distribution in worldwide theatrical, home entertainment, digital and television markets by Paramount Pictures Corporation, a subsidiary of Viacom Inc., and its affiliates (collectively, "Paramount"), for films that were released on or before December 31, 2012, 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 had the right to continue rendering such services for 16 years from such film's initial general theatrical release. On June 30, 2014, the Company reacquired certain distribution rights from Paramount and, as a result, Paramount only retains television distribution rights (which includes subscription and free video-on-demand formats) for titles covered by the Paramount Agreements. The reacquired rights are now subject to the Fox Distribution Agreement. The amount paid to reacquire these rights was recorded as a definite-lived intangible asset (see Note 6).

The Company generally retains all other rights to exploit its films, including commercial tie-in and promotional rights with respect to each film, as well as merchandising, interactive, literary publishing, music publishing and soundtrack rights. The Company's activities associated with its Classic Media properties and AwesomenessTV, Inc. ("ATV") business are not subject to the Company's distribution agreements with its theatrical distributors.

Basis of Presentation

The accompanying unaudited financial data as of June 30, 2014 and for the three and six months ended June 30, 2014 and 2013 has been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") and in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") for interim financial information. Accordingly, certain information and footnote disclosures normally included in comprehensive financial statements have been condensed or omitted pursuant to such rules and regulations. The consolidated balance sheet as of December 31, 2013 was derived from the audited financial statements at that date, but does not include all the information and footnotes required by U.S. GAAP. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013

6

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


(the "2013 Form 10-K"). Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the Company's 2014 presentation.
 
The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of only normal recurring items, which in the opinion of management, are necessary for a fair statement for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full year, or for any future period, as fluctuations can occur based upon the timing of the Company's films' theatrical and home entertainment releases, and television series and specials broadcasts.

Consolidation

The consolidated financial statements of the Company present the financial position, results of operations and cash flows of DreamWorks Animation and its wholly-owned subsidiaries. The Company also consolidates less-than-wholly owned entities if the Company has a controlling financial interest in that entity. The Company uses the equity method of accounting for investments in companies in which it has a 50% or less ownership interest and has the ability to exercise significant influence. Such investments are presented as investments in unconsolidated entities on the Company's consolidated balance sheets (refer to Note 7 for further information of such investments). Prior to recording its share of net income or losses from equity method investees, investee financial statements are converted to U.S. GAAP. All significant intercompany accounts and transactions have been eliminated. Intra-entity profit related to transactions with equity method investees is eliminated until the amounts are ultimately realized.

In addition, the Company reviews its relationships with other entities to identify whether they are variable interest entities ("VIE") as defined by the Financial Accounting Standards Board ("FASB"), and to assess whether the Company is the primary beneficiary of such entity. If the determination is made that the Company is the primary beneficiary, then the entity is consolidated. As of June 30, 2014, the Company determined that it continued to have a variable interest in ODW as ODW does not have sufficient equity at risk (i.e., cash on hand to fund its operations) as a result of the timing of capital contributions to the entity in accordance with the Transaction and Contribution Agreement (see Note 7). However, the Company concluded that it is not the primary beneficiary of ODW as it does not have the ability to control ODW. As a result, it does not consolidate ODW into its financial statements. Refer to Note 7 for further discussion of how the Company accounts for its investment in ODW, including the Company's remaining contributions (which represent the maximum exposure to the Company).

The Company also determined that, as of June 30, 2014, it continued to have a variable interest in an entity that was created to operate and tour its live arena show that is based on its feature film How to Train Your Dragon, and that the Company is the primary beneficiary of this entity as a result of the Company's obligation to fund all losses. Accordingly, the Company's consolidated financial statements included the activities of the VIE. The consolidation of the VIE had an immaterial impact as of and for the three and six months ended June 30, 2014 and 2013.

Film and Other Inventory Costs Amortization

Amortization and write-off of film and other inventory costs in any period includes depreciation and amortization, interest expense and stock-based compensation expense that were capitalized as part of film and other inventory costs in the period that those charges were incurred. The total amount of such expenses reflected as a component of amortization and write-off of film and other inventory costs for the six months ended June 30, 2014 and 2013 is presented in the statements of cash flows.

Goodwill

The Company performs a goodwill impairment test on an annual basis, or sooner if indicators of impairment are identified. As of June 30, 2014, $118.2 million of total goodwill was attributable to the ATV reporting unit (“ATV Goodwill”). ATV Goodwill represented the excess of the purchase price over the identifiable acquired net assets as of the time of the acquisition of ATV. A large portion of ATV’s purchase price was derived from the fair value of the contingent consideration arrangement entered into in connection with the acquisition (see Note 3). As a result, the cash flow assumptions used for purposes of the goodwill impairment assessment are closely aligned with those used to determine the fair value of the contingent consideration. In connection with the fair value assessment of the contingent consideration as of June 30, 2014, the Company evaluated the revised forecasts for the acquired business, noting a decline in the forecasted earnings for the period applicable to the determination of the contingent consideration payment. Based on this information, the Company determined

7

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


that an interim goodwill impairment test was necessary and, accordingly, performed a qualitative assessment (commonly referred to as Step 0) to determine whether it was more likely than not that the fair value of the reporting unit was below its carrying value. This assessment included a review of the forecast for periods extending beyond the contingent consideration performance period, which reflected a significant decline in forecasted earnings for certain of the reporting unit's revenue streams when compared to the forecasted amounts at the time of the initial valuation of ATV, as well as delays in the timing of revenue growth. Based on this evaluation, the Company concluded that it was more likely than not that the fair value of the ATV reporting unit was less than the reporting unit's carrying amount and, accordingly, the Company proceeded with determining whether the reporting unit's fair value was greater than its carrying value (referred to as Step 1). The Company used the income approach to determine fair value and applied a blended discount rate of 35%. Because a key driver of fair value when applying the income approach is the forecast of future cash flows, the Company's determination of fair value was highly dependent on the level and timing of forecasted earnings and the resulting cash flows. Due to ATV’s limited operating history, there is significant uncertainty in the underlying estimates of ATV’s forecasted earnings. Changes in one or more of the key assumptions could lead to a different fair value of the reporting unit. For further discussion, see "Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates—Goodwill."

Upon completion of this analysis, the Company concluded that the fair value of the ATV reporting unit was greater than its carrying value by approximately 12% as of June 30, 2014 and, thus, ATV Goodwill was not impaired as of June 30, 2014.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The most significant estimates made by management in the preparation of the financial statements relate to the following:

ultimate revenues and ultimate costs of film, television product and live performance productions;
relative selling price of the Company's products for purposes of revenue allocation in multi-property licenses and other multiple deliverable arrangements;
determination of fair value of assets and liabilities for the allocation of the purchase price in an acquisition;
determination of the fair value of reporting units for purposes of testing goodwill for impairment;
determination of fair value of non-cash contributions to investments in unconsolidated entities;
useful lives of intangible assets;
product sales that will be returned and the amount of receivables that ultimately will be collected;
the potential outcome of future tax consequences of events that have been recognized in the Company's financial statements;
loss contingencies and contingent consideration arrangements; and
assumptions used in the determination of the fair value of equity-based awards for stock-based compensation or their probability of vesting.

Actual results could differ from those estimates. To the extent that there are material differences between these estimates and actual results, the Company's financial condition or results of operations will be affected. Estimates are based on past experience and other assumptions that management believes are reasonable under the circumstances, and management evaluates these estimates on an ongoing basis.

2.
Recent Accounting Pronouncements

In June 2014, the FASB issued an accounting standards update relating to the accounting for certain share-based awards. The accounting update states that, when the terms of an award provide that a performance target could be achieved after the requisite service period, the performance target should be treated as a performance condition that affects vesting and should not be reflected in the grant-date fair value. Companies are permitted to apply the guidance either prospectively to all awards granted or modified after the effective date or retrospectively to awards outstanding as of the beginning of the earliest annual period presented. The guidance is effective for the Company's fiscal year beginning January 1, 2016, with early adoption permitted. The Company adopted the new guidance upon issuance of the accounting standards update, which did not have an impact on its consolidated financial statements as the Company's existing accounting policy was already consistent with this guidance.


8

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


In May 2014, the FASB issued an accounting standards update to provide companies with a single model for use in accounting for revenue from contracts with customers. Once it becomes effective, the new guidance will replace most existing revenue recognition guidance in U.S. GAAP, including industry-specific guidance. The core principle of the model is to recognize revenue when control of goods or services transfers to the customer and in an amount that reflects the consideration that the Company expects to be entitled to in exchange for those goods or services that have transferred. Under current U.S. GAAP, the Company recognizes revenue when the risks and rewards of ownership transfer to the customer. In addition, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing and uncertainty of revenue that is recognized and the related cash flows. The guidance is effective for the Company's fiscal year beginning January 1, 2017, including interim periods within that fiscal year. Early adoption is not permitted. Companies are permitted to either apply the guidance retrospectively to all prior periods presented or, alternatively, apply the guidance in the year of adoption with the cumulative effect recognized at the date of initial application (referred to as the modified retrospective approach). The Company is in the process of determining the method of adoption, as well as evaluating the impact that the new standard will have on its consolidated financial statements.

In July 2013, the FASB issued an accounting standards update relating to the presentation of unrecognized tax benefits. The accounting update requires companies to present a deferred tax asset net of related unrecognized tax benefits if there is a net operating loss or other tax carryforwards that would apply in settlement of the uncertain tax position. To the extent that an uncertain tax position would not be settled through a reduction of a net operating loss or other tax carryforwards, the unrecognized tax benefit will be presented as a liability. The guidance is effective for the Company's fiscal year beginning January 1, 2014, with early adoption permitted. The Company adopted the new guidance effective January 1, 2014. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.

3.
Acquisitions

Recent Acquisitions

The Company entered into an Agreement and Plan of Merger and Reorganization (the "Big Frame Merger Agreement”) pursuant to which, on April 7, 2014 (the “Big Frame Closing Date”), a wholly-owned subsidiary of the Company merged with and into Big Frame, Inc. (“Big Frame”). As a result of this transaction, Big Frame became a wholly-owned subsidiary of the Company. Big Frame is an online multi-channel network that connects advertisers with highly engaged audiences. The goodwill that resulted from the acquisition represents the potential synergies between Big Frame and the Company’s multi-channel network presence on the Internet and is not deductible for tax purposes.

Additionally, on May 20, 2014, the Company acquired certain rights, properties and other items pertaining to Felix the Cat and related characters pursuant to an Asset Purchase Agreement. The acquisition was accounted for as a business combination due to the Company assuming certain licensing arrangements related to the rights. The goodwill that resulted from the acquisition represents potential synergies between the rights acquired and consumer product opportunities. The goodwill is deductible for tax purposes.
 
The Company’s total cash consideration for these two transactions totaled approximately $33.6 million. As a result of these transactions and the preliminary purchase price allocations, the primary assets acquired were identifiable intangible assets of $22.1 million and resulting goodwill of $10.4 million. The results of operations for these two acquisitions have been included in the Company’s consolidated financial statements since their respective closing dates and had an immaterial impact for the three and six months ended June 30, 2014.

AwesomenessTV

On May 1, 2013, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") pursuant to which, on May 3, 2013 (the "ATV Closing Date"), a wholly-owned subsidiary of the Company ("the Merger Sub") merged with and into ATV. As a result of this transaction, ATV became a wholly-owned subsidiary of the Company. ATV is an online next-generation media production company that generates revenues primarily from online advertising sales and distribution of content through media channels such as theatrical, home entertainment and television. Through ATV's multi-channel network presence on the Internet, the Company will be able to gain access to new content distribution methods, as well as a broader audience. The goodwill that resulted from the acquisition represents the potential synergies between ATV's filmed content, character portfolio and the Company's cross-platform expansion plans. The goodwill is allocated to a reporting unit that is currently not part of a separately reportable segment.

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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



The Company's total consideration for this transaction totaled $128.5 million, including an accrual for estimated contingent consideration of $95.0 million. The following table outlines the components of consideration for the transaction (in thousands):
 
As of
 
May 3, 2013
Cash payment
$
33,460

Estimated contingent consideration
95,000

Total consideration
$
128,460


The following table summarizes the final allocation of the purchase price (in thousands):
 
 
As of
 
 
May 3, 2013(1)
Cash and cash equivalents
 
$
1,340

Trade receivables(2)
 
1,279

Prepaid and other assets
 
434

Production costs
 
612

Property, plant and equipment
 
183

Intangible assets
 
12,900

Total identified assets acquired
 
16,748

 
 
 
Accounts payable
 
655

Deferred revenue
 
2,057

Deferred tax liabilities, net
 
3,765

Total liabilities assumed
 
6,477

Net identified assets acquired
 
10,271

Goodwill(3)
 
118,189

Total consideration
 
$
128,460

____________________
(1)
Measurement period adjustments include a $0.9 million decrease in goodwill, which resulted from changes in the fair value of the estimated contingent consideration of $0.5 million, as well as a decrease to deferred tax liabilities of $0.4 million.
(2)
Gross contractual amounts due total $1.3 million and, of this amount, no amounts are deemed to be uncollectible.
(3) 
The goodwill resulting from the acquisition of ATV is not deductible for tax purposes.

Contingent Consideration

Pursuant to the Merger Agreement, the Company may be required to make future cash payments to ATV's former shareholders as part of the total purchase price to acquire ATV. The contingent consideration is based on whether ATV increases its adjusted earnings before interest expense, income taxes, depreciation and amortization ("EBITDA") over an adjusted EBITDA threshold, over a two-year period (which commenced on January 1, 2014). Adjustments to EBITDA for purposes of determining the contingent consideration earned include, but are not limited to: ATV's employee bonus plan, non-cash gains and losses (such as those related to foreign currency accounting and reversals of prior year accruals) and changes in the fair value of contingent payment liabilities resulting from the acquisition of ATV. The Company estimates the fair value of contingent consideration using significant unobservable inputs in a Monte-Carlo simulation model and bases the fair value on the estimated risk-adjusted cost of capital of ATV's adjusted EBITDA following integration into the Company (an income approach). The estimate of the liability may fluctuate if there are changes in the forecast of ATV's future earnings or as a result of actual earnings levels achieved. Any changes in estimate of the contingent consideration liability will be reflected in the Company's results of operations in the period that the change occurs.


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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


The estimated fair value of the contingent consideration arrangement at the acquisition date was $95.0 million. The key assumptions in applying the income approach were as follows: an 8.5% discount rate, volatility of 32.6% and a probability-adjusted earnings measure for ATV of $25.0 million for 2014 and $41.0 million for 2015. Changes in one or more of the key assumptions could lead to a different fair value estimate of the contingent consideration. For example, using a discount rate of 15.0% or a volatility rate of 20.0% would change the estimated fair value of the contingent consideration to $90.5 million and $103.5 million, respectively. Under the Merger Agreement, the maximum contingent consideration that may be earned is $117.0 million. The estimate of contingent consideration liability decreased from $96.5 million as of December 31, 2013 to $91.8 million as of June 30, 2014, primarily due to changes in the forecast of cash flows. The change in estimate was recorded as a gain in the consolidated statements of operations. As of June 30, 2014, the discount rate and volatility applied were 16.5% and 35.3%, respectively. Using a discount rate of 25% or a volatility of 20% would change the estimated fair value of the contingent consideration to $88.6 million and $99.3 million, respectively.

Pro Forma Financial Information

The following table presents (in thousands, except per share data) pro forma results of the Company as though ATV had been acquired as of January 1, 2012 (the beginning of the prior annual reporting period based on the period in which the acquisition occurred).
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30, 2013
 
June 30, 2013
Revenues
 
$
213,984

 
$
348,905

Net income attributable to DreamWorks Animation SKG, Inc.
 
$
22,443

 
$
26,340

Basic net income per share
 
$
0.27

 
$
0.31

Diluted net income per share
 
$
0.27

 
$
0.31


These pro forma results do not necessarily represent what would have occurred if the ATV transaction had taken place on January 1, 2012, nor do they represent the results that may occur in the future. The pro forma amounts include the historical operating results of the Company and ATV prior to the acquisition, with adjustments directly attributable to the acquisition. The pro forma results include a increase to tax expense in the amount of $1.4 million for the six months ended June 30, 2013. The pro forma results also include an increase to amortization expense related to the fair value of the intangible assets acquired of $1.0 million for the three months ended June 30, 2013 and $3.9 million for the six months ended June 30, 2013.

4.
Financial Instruments

The fair value of cash and cash equivalents, accounts payable, advances and amounts outstanding under the revolving credit facility approximates carrying value due to the short-term maturity of such instruments and floating interest rates. As of June 30, 2014, the fair value of trade accounts receivable approximated carrying value due to the similarities in the initial and current discount rates. In addition, as of June 30, 2014, the fair value of the senior unsecured notes approximated carrying value as the current borrowing rate approximated the debt instrument's actual interest rate. The fair value of trade accounts receivable and the senior unsecured notes was determined using significant unobservable inputs by performing a discounted cash flow analysis and using current discount rates as appropriate for each type of instrument.

The Company has short-term money market investments which are classified as cash and cash equivalents on the consolidated balance sheets. The fair value of these investments at June 30, 2014 and December 31, 2013 was measured based on quoted prices in active markets.


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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


5.
Film and Other Inventory Costs

Film, television, live performance and other inventory costs consist of the following (in thousands):
 
June 30,
2014
 
December 31,
2013
In release, net of amortization:
 
 


Feature films
$
443,929

 
$
285,238

Television series and specials
55,527

 
58,631

In production:
 
 


Feature films
305,295

 
474,609

Television series and specials
49,937

 
15,332

In development:
 
 


Feature films
108,443

 
75,498

Television series and specials
165

 
1,500

Product inventory and other(1)
16,623

 
32,678

Total film, television, live performance and other inventory costs, net
$
979,919

 
$
943,486

 ____________________
(1) 
This category includes $8.8 million and $24.8 million of capitalized live performance costs as of June 30, 2014 and December 31, 2013, respectively. In addition, as of June 30, 2014 and December 31, 2013, this category includes $7.7 million and $7.9 million, respectively, of physical inventory of certain DreamWorks Animation and Classic Media titles for distribution in the home entertainment market.

The Company anticipates that approximately 51% and 83% of the above "in release" film and other inventory costs as of June 30, 2014 will be amortized over the next 12 months and three years, respectively.

As a result of the weaker-than-expected worldwide theatrical performance of Mr. Peabody and Sherman (released into the domestic theatrical market during March 2014), the Company performed an analysis as of March 31, 2014 to determine whether the unamortized film inventory costs exceeded fair value and was thus impaired. Key assumptions used in the fair value measurement were a discount rate of 7% and estimated remaining cash flows over a period of approximately 15 years. As a result of the analysis, the six-month period ended June 30, 2014 includes an impairment charge of $57.1 million.

No impairment charges were recorded on film and other inventory costs during the six months ended June 30, 2013.


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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


6.
Intangible Assets

As of June 30, 2014 and December 31, 2013, intangible assets included $69.2 million and $49.5 million, respectively, of indefinite-lived intangible assets. In addition, intangible assets were comprised of definite-lived intangible assets as follows (in thousands, unless otherwise noted):
 
Weighted Average Estimated Useful Life (in years)
 
Gross
 
Accumulated Amortization
 
Impact of Foreign Currency Translation
 
Net
As of June 30, 2014:
 
 
 
 
 
 
 
 
 
Character rights
13.9
 
$
99,000

 
$
(11,994
)
 
$
3,003

 
$
90,009

Distribution rights
11.2
 
30,000

 

 

 
30,000

Programming content
2.0
 
11,200

 
(6,533
)
 

 
4,667

Trademarks and trade names
10.0
 
1,410

 
(145
)
 

 
1,265

Other intangibles
4.4
 
2,700

 
(403
)
 

 
2,297

Total
 
 
$
144,310

 
$
(19,075
)
 
$
3,003

 
$
128,238

 
 
 
 
 
 
 
 
 
 
As of December 31, 2013:
 
 
 
 
 
 
 
 
 
Character rights
13.9
 
$
99,000

 
$
(8,663
)
 
$
1,754

 
$
92,091

Programming content
2.0
 
11,200

 
(3,733
)
 

 
7,467

Trademarks and trade names
10.0
 
1,200

 
(80
)
 

 
1,120

Other intangibles
2.0
 
500

 
(167
)
 

 
333

Total
 
 
$
111,900

 
$
(12,643
)
 
$
1,754

 
$
101,011


The Company expects to record amortization over the next five fiscal years as follows (in thousands):

2015
$
12,260

2016
11,168

2017
11,588

2018
11,515

2019
11,130

Total
$
57,661


7.
Investments in Unconsolidated Entities

The Company has made investments in entities which are accounted for under either the cost or equity method of accounting. These investments are classified as investments in unconsolidated entities in the consolidated balance sheets and consist of the following (in thousands, unless otherwise indicated):
 
Ownership
 
 
 
 
 
Percentage at
 
June 30,
 
December 31,
 
June 30, 2014
 
2014
 
2013
Oriental DreamWorks Holding Limited
45.45%
 
$
16,645

 
$
16,389

All Other
17.5%-50.0%
 
3,642

 
3,140

Total equity method investments
 
 
20,287

 
19,529

 
 
 
 
 
 
Total cost method investments
 
 
29,013

 
19,013

Total investments in unconsolidated entities
 
 
$
49,300

 
$
38,542


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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


Under the equity method of accounting, the carrying value of an investment is adjusted for the Company's proportionate share of the investees' earnings and losses (adjusted for the amortization of any differences in the Company's basis, with respect to the Company's investment in ODW, compared to the Company's share of venture-level equity), as well as contributions to and distributions from the investee. The Company classifies its share of income or loss from investments accounted for under the equity method as income/loss from equity method investees in its consolidated statements of operations.

(Loss) income from equity method investees consist of the following (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Oriental DreamWorks Holding Limited(1)
$
(2,394
)
 
$
(957
)
 
$
(4,604
)
 
$
(957
)
All Other
(1,073
)
 
(372
)
 
(2,123
)
 
(372
)
(Loss) income from equity method investees
$
(3,467
)
 
$
(1,329
)
 
$
(6,727
)
 
$
(1,329
)
 
____________________
(1)  
The Company currently records its share of ODW results on a one-month lag. Accordingly, the Company's consolidated financial statements include its share of losses incurred by ODW from December 1, 2013 to May 31, 2014.

Oriental DreamWorks Holding Limited

On April 3, 2013 ("ODW Closing Date"), the Company formed a Chinese Joint Venture, ODW (or the "Chinese Joint Venture"), through the execution of a Transaction and Contribution Agreement, as amended, with its Chinese partners, China Media Capital (Shanghai) Center L.P. ("CMC"), Shanghai Media Group ("SMG") and Shanghai Alliance Investment Co., Ltd. ("SAIL", and together with CMC and SMG, the "CPE Holders"). In exchange for 45.45% of the equity of ODW, the Company has committed to making a total cash capital contribution to ODW of $50.0 million (of which $6.6 million had been funded as of June 30, 2014, with the balance to be funded over time) and non-cash contributions valued at approximately $100.0 million (of which approximately $28.7 million had been satisfied as of June 30, 2014). Such non-cash contributions include licenses of technology and certain other intellectual property of the Company, rights in certain trademarks of the Company, two in-development feature film projects developed by the Company and consulting and training services. During the three and six months ended June 30, 2013, the Company's consolidated statements of operations included $7.8 million of revenues recognized in connection with non-cash contributions made to ODW. The Company's consolidated statements of operations included other operating income recognized in connection with non-cash contributions made to ODW of $2.3 million and $2.9 million during the three months ended June 30, 2014 and 2013, respectively, and $4.0 million and $2.9 million during the six months ended June 30, 2014 and 2013, respectively.

As of June 30, 2014, the Company's remaining contributions consisted of the following: (i) $43.4 million in cash (which is expected to be funded over the next three years), (ii) two of the Company's in-development film projects, (iii) remaining delivery requirements under the licenses of technology and certain other intellectual property of the Company and (iv) approximately $7.0 million in consulting and training services. Some of these remaining contribution commitments will require future cash outflows for which the Company is not currently able to estimate the timing of contributions as this will depend on, among other things, ODW's operations.

Basis Differences. The Company's investment in ODW does not equal the venture-level equity (the amount recorded on the balance sheet of ODW) due to various basis differences. Basis differences related to definite-lived assets are being amortized based on the useful lives of the related assets. Basis differences related to indefinite-lived assets are not being amortized. The following are the differences between the Company's venture-level equity and the balance of its investment in ODW (in thousands):
 
June 30, 2014
Company's venture-level equity
$
40,997

Technology and intellectual property licenses(1)
(17,042
)
Other(2)
(7,310
)
Total ODW investment recorded
$
16,645



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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


____________________
(1)
Represents differences between the Company's historical cost basis and the equity basis reflected at the venture-level (the amount recorded on the balance sheet of ODW) related to the Company's contributions of technology and intellectual property licenses. These basis differences arise because the contributed assets are recorded at fair value by ODW.
(2) 
Represents the Company's net contribution commitment due to ODW.

Other Transactions with ODW. The Company has various other transactions with ODW, a related party. The Company has entered into a distribution agreement with ODW for the distribution of the Company's feature films in China (beginning with The Croods). In addition, from time to time, the Company may provide consulting and training services to ODW, the charges of which are based on the Company's actual cost of providing such services. The Company's consolidated statements of operations included revenues earned through ODW's distribution of its feature films of $1.3 million and $2.0 million during the three- and six-month periods ended June 30, 2014, respectively, and $13.0 million during each of the three- and six-month periods ended June 30, 2013. As of June 30, 2014 and December 31, 2013, the Company's consolidated balance sheets included receivables from ODW of $7.1 million and $3.8 million, respectively, which were classified as a component of trade accounts receivable, and $3.6 million and $16.7 million, respectively, which were classified as a component of receivables from distributors.

8.
Accrued Liabilities

Accrued liabilities consist of the following (in thousands):
 
June 30,
2014
 
December 31,
2013
Employee compensation
$
28,571

 
$
65,625

Participations and residuals
46,495

 
50,690

Contingent consideration(1)
92,691

 
97,545

Interest payable
7,958

 
7,849

Income taxes payable
7,494

 
118

Deferred rent
10,793

 
8,114

Other accrued liabilities
38,315

 
33,727

Total accrued liabilities
$
232,317

 
$
263,668

  ____________________
(1) 
Primarily represents the Company's estimate of the amount of contingent consideration payable in connection with the acquisition of ATV (refer to Note 3 for further information).

As of June 30, 2014, the Company estimates that over the next 12 months it will pay approximately $23.9 million of its accrued participation and residual costs.

9.
Deferred Revenue and Other Advances

The following is a summary of deferred revenue and other advances included in the consolidated balance sheets as of June 30, 2014 and December 31, 2013 and the related amounts earned and recorded either as revenue in the consolidated statements of operations or recorded as an offset to other costs (as described below) for the three- and six-month periods ended June 30, 2014 and 2013 (in thousands):  
 
 
 
 
 
Amounts Earned
 
 
 
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
December 31,
June 30,
 
June 30,
 
2014
 
2013
2014
 
2013
 
2014
 
2013
Deferred Revenue
$
8,673

 
$
14,578

 
$
8,628

 
$
5,741

 
$
16,265

 
$
13,473

Strategic Alliance/Development Advances(1)
4,167

 
1,667

 
8,229

 
6,816

 
15,367

 
15,890

Other(2)
22,242

 
20,180

 
6,228

 
23,865

 
26,125

 
28,617

Total deferred revenue and other advances
$
35,082

 
$
36,425

 
 
 
 
 
 
 
 
 

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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



 ____________________
(1) 
Of the total amounts earned against the "Strategic Alliance/Development Advances," for the three months ended June 30, 2014 and 2013, $3.5 million and $2.7 million, respectively, and $5.9 million and $7.9 million for the six months ended June 30, 2014 and 2013, respectively, were capitalized as an offset to property, plant and equipment. Additionally, during the three months ended June 30, 2014 and 2013, of the total amounts earned, $2.5 million and $0.7 million, respectively, and for the six months ended June 30, 2014 and 2013, $3.5 million and $1.2 million, respectively, were recorded as a reduction to other assets. During the six months ended June 30, 2014 and 2013, $0.5 million and $1.3 million, respectively, were recorded as a reduction to prepaid expenses. During the three months ended June 30, 2014 and 2013, of the total amounts earned, $0.5 million and $0.6 million, respectively, and for the six months ended June 30, 2014 and 2013, $1.6 million and $1.0 million, respectively, were recorded as a reduction to operating expenses.
(2) 
Of the total amounts earned, for the six months ended June 30, 2014, $14.0 million was recorded as a reduction to film and other inventory costs.

10.
Financing Arrangements

Senior Unsecured Notes. On August 14, 2013, the Company issued $300.0 million in aggregate principal amount of 6.875% Senior Notes due 2020 (the "Notes"). In connection with the issuance of the Notes, the Company entered into an indenture (the “Indenture”) with The Bank of New York Mellon Trust Company, N.A., as trustee, specifying the terms of the Notes. The Notes were sold at a price to investors of 100% of their principal amount and were issued in a private placement pursuant to the exemptions under Rule 144A and Regulation S under the Securities Act of 1933, as amended. The net proceeds from the Notes amounted to $294.0 million and a portion was used to repay the outstanding borrowings under the Company's revolving credit facility. The Notes are effectively subordinated to indebtedness under the revolving credit facility. Beginning on February 15, 2014, the Company is required to pay interest on the Notes semi-annually in arrears on February 15 and August 15 of each year. The principal amount is due upon maturity. The Notes are guaranteed by all of the Company's domestic subsidiaries that also guarantee its revolving credit facility.

The Indenture contains certain restrictions and covenants that, subject to certain exceptions, limit the Company's ability to incur additional indebtedness, pay dividends or repurchase the Company's common shares, make certain loans or investments, and sell or otherwise dispose of certain assets, among other limitations. The Indenture also contains customary events of default, which, if triggered, may accelerate payment of principal, premium, if any, and accrued but unpaid interest on the Notes. Such events of default include non-payment of principal and interest, non-performance of covenants and obligations, default on other material debt, failure to satisfy material judgments and bankruptcy or insolvency. If a change of control as described in the Indenture occurs, the Company may be required to offer to purchase the Notes from the holders thereof at a repurchase price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to, but not including, the date of repurchase.

At any time prior to August 15, 2016, the Company may redeem all or part of the Notes at a redemption price equal to the sum of (i) 100% of the principal amount thereof, plus (ii) a specified premium as of the date of redemption, plus (iii) accrued and unpaid interest to, but not including, the date of redemption, subject to the rights of holders of Notes on the relevant record date to receive interest due on the relevant interest payment date. On or after August 15, 2016, the Company may redeem all or a part of the Notes, at specified redemption prices plus accrued and unpaid interest thereon, to, but not including, the applicable redemption date, subject to the rights of holders of Notes on the relevant record date to receive interest due on the relevant interest payment date. In addition, at any time prior to August 15, 2016, the Company may redeem up to 35% of the Notes with the net proceeds of certain equity offerings at a redemption price equal to 106.875% of the principal amount thereof, in each case plus accrued and unpaid interest and additional interest, if any, thereon to, but not including, the redemption date.

Revolving Credit Facility. The Company has a revolving credit facility with a number of banks. On August 10, 2012, the Company and the facility banks terminated the then-existing credit agreement and entered into a new Credit Agreement ("New Credit Agreement"). The New Credit Agreement allows the Company to have outstanding borrowings up to $400.0 million at any one time, on a revolving basis. The Company may from time to time, so long as no default or event of default has occurred under the New Credit Agreement, increase the commitments under the New Credit Agreement by up to $50.0 million. Borrowings are secured by substantially all of the Company's assets. The New Credit Agreement requires the Company to maintain a specified ratio of total debt to total capitalization and a specified ratio of net remaining ultimates to facility exposure. In addition, subject to specified exceptions, the New Credit Agreement also restricts the Company and its subsidiaries from

16

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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


taking certain actions, such as granting liens, entering into any merger or other significant transactions, making distributions, entering into transactions with affiliates, agreeing to negative pledge clauses and restrictions on subsidiary distributions, and modifying organizational documents. The revolving credit facility also prohibits the Company from paying dividends on its capital stock if, after giving pro forma effect to such dividend, an event of default would occur or exist under the revolving credit facility. The Company is required to pay a commitment fee on undrawn amounts at an annual rate of 0.375%. Interest on borrowed amounts (per draw) is determined by reference to either i) the lending banks' base rate plus 1.50% per annum or ii) the London Interbank Offered Rate ("LIBOR") plus 2.50% per annum.

The following table summarizes information associated with the Company's financing arrangements (in thousands, except percentages):
 
 
 
 
 
 
 
 
 
Interest Expense
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Six Months Ended
 
Balance Outstanding at
 
Maturity Date
 
 
 
June 30,
 
June 30,
 
June 30,
2014
 
December 31, 2013
 
 
Interest Rate at
June 30, 2014
 
2014
 
2013
 
2014
 
2013
Senior Unsecured Notes
$
300,000

 
$
300,000

 
August 2020
 
6.875%
 
$
2,849

 
N/A
 
$
5,083

 
N/A
Revolving Credit Facility
$
100,000

 
$

 
August 2017
 
2.70%
 
$
466

 
$
215

 
$
841

 
$
435

____________________
N/A: Not applicable

Additional Financing Information
 
Interest Capitalized to Film Costs.    Interest on borrowed funds that are invested in major projects with substantial development or construction phases is capitalized as part of the asset cost until the projects are released or construction projects are put into service. Thus, capitalized interest is amortized over future periods on a basis consistent with that of the asset to which it relates. During the three months ended June 30, 2014 and 2013, the Company incurred interest costs totaling $6.2 million and $1.7 million, respectively, of which $2.6 million and $1.5 million, respectively, were capitalized to film costs. During the six months ended June 30, 2014 and 2013, the Company incurred interest costs totaling $12.3 million and $3.3 million, respectively, of which $5.8 million and $2.9 million, respectively, were capitalized to film costs.

As of June 30, 2014, the Company was in compliance with all applicable financial debt covenants.


17

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DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


11.
Income Taxes

Set forth below is a reconciliation of the components that caused the Company's provision/benefit for income taxes (including the income statement line item "Decrease (increase) in income tax benefit payable to former stockholder") to differ from amounts computed by applying the U.S. Federal statutory rate of 35% for the three and six months ended June 30, 2014 and 2013.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013(4)
 
2014
 
2013(4)
Provision for income taxes (combined with decrease/increase in income tax benefit payable to former stockholder)(1)
 
 
 
 
 
 
 
U.S. Federal statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
 
35.0
 %
U.S. state taxes, net of Federal benefit
0.5

 
(1.7
)
 
1.4

 
(1.9
)
Export sales exclusion/manufacturer's deduction(2)
15.4

 
(0.7
)
 
3.9

 
0.8

Research and development credit(2)

 
(1.8
)
 

 
(6.1
)
Federal energy tax credit(3)

 
(2.0
)
 

 
(2.1
)
Executive compensation
(39.4
)
 
3.2

 
(7.6
)
 
3.2

Non-controlling interests
5.8

 

 
1.1

 

Change in fair value of contingent consideration
(2.5
)
 

 
(1.5
)
 

Losses from an equity method investee
(19.0
)
 

 
(3.5
)
 

Other
(1.8
)
 

 
(1.0
)
 
0.1

Effective tax rate (combined with decrease/increase in income tax benefit payable to former stockholder)(1)
(6.0
)%
 
32.0
 %
 
27.8
 %
 
29.0
 %
Less: change in income tax benefit payable to former stockholder(1):

 

 
 
 
 
U.S. state taxes, net of Federal benefit
0.5

 

 
0.1

 

Export sales exclusion/manufacturer's deduction(2)
(15.9
)
 
0.4

 
(3.9
)
 
(1.0
)
Imputed interest on payable to former stockholder
3.1

 
(1.5
)
 
0.6

 
(1.6
)
Other
1.0

 

 

 

Total change in income tax benefit payable to former stockholder(1)
(11.3
)%
 
(1.1
)%
 
(3.2
)%
 
(2.6
)%
Effective tax rate
(17.3
)%
 
30.9
 %
 
24.6
 %
 
26.4
 %
  
____________________
(1) 
As a result of a partial increase in the tax basis of the Company's tangible and intangible assets attributable to transactions entered into by affiliates controlled by a former stockholder at the time of the Company's 2004 initial public offering, the Company may pay reduced tax amounts to the extent it generates sufficient taxable income in the future. The Company is obligated to remit to an affiliate of the former stockholder 85% of any realized cash savings in U.S. Federal income tax, California franchise tax and certain other related tax benefits. Refer to the Company's 2013 Form 10-K for a more detailed description.
(2) 
The American Taxpayer Relief Act of 2012 (the "Act"), enacted on January 2, 2013, included extensions to many expiring corporate income tax provisions. The Act included a two-year extension of research and development credits and other federal tax incentives, which were to be retroactively applied beginning with January 1, 2012 and ending on December 31, 2013. The Company recognized the effects of the retroactive changes in its results for the three months ended March 31, 2013 (the period of enactment).
(3) 
The Company's policy for accounting for investment tax credits is to recognize the income tax benefit in the year that the credit is generated.
(4) 
Certain reclassifications have been made to the prior period presentation to conform to current period presentation.

Although the Company recognized a pre-tax loss for the three months ended June 30, 2014, the Company's effective tax rate and combined effective tax rate were negative due to limitations on its ability to recognize a portion of its state tax benefit during the quarter.


18

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


The Company's federal income tax returns for the tax years ended December 31, 2007 through 2009 are currently under examination by the Internal Revenue Service, and all subsequent tax years remain open to audit. The Company's California state tax returns for all years subsequent to 2007 remain open to audit. The Company's India subsidiary's income tax returns are currently under examination for the tax years ended March 31, 2011 through 2012.

12.
Stockholders’ Equity and Non-controlling Interests

Class A Common Stock

Stock Repurchase Program.  In July 2010, the Company's Board of Directors terminated the then-existing stock repurchase program and authorized a new stock repurchase program pursuant to which the Company may repurchase up to an aggregate of $150.0 million of its outstanding stock. During the three and six months ended June 30, 2014, the Company did not repurchase any shares of its Class A Common Stock. During the three and six months ended June 30, 2013, the Company repurchased 0.5 million and 1.3 million shares, respectively, of its outstanding Class A Common Stock for $8.8 million and $25.0 million, respectively, under the July 2010 authorization. As of June 30, 2014, the Company's remaining authorization under the current stock repurchase program was $100.0 million.

Non-controlling Interests

The Company's consolidated balance sheets include non-controlling interests, which are presented as a separate component of equity. A non-controlling interest represents the other equity holder's interest in a joint venture that the Company consolidates. The net income or loss attributable to the non-controlling interests is presented in the Company’s consolidated statements of operations. There is no other comprehensive income or loss attributable to the non-controlling interests.
 
The following table presents the changes in equity for the six-month periods ended June 30, 2014 and 2013 (in thousands):
 
DreamWorks Animation SKG, Inc. Stockholders' Equity
 
Non-controlling Interests
 
Total Equity
Balance as of December 31, 2013
$
1,404,795

 
$
1,224

 
$
1,406,019

Proceeds from stock option exercises
261

 

 
261

Stock-based compensation
15,989

 

 
15,989

Purchase of treasury shares
(1,751
)
 

 
(1,751
)
Foreign currency translation adjustments
695

 

 
695

Distributions to non-controlling interest holder

 
(143
)
 
(143
)
Net loss
(58,323
)
 
(21
)
 
(58,344
)
Balance as of June 30, 2014
$
1,361,666

 
$
1,060

 
$
1,362,726

 
 
 
 
 
 
Balance as of December 31, 2012
$
1,345,616

 
$
630

 
$
1,346,246

Stock-based compensation
18,224

 

 
18,224

Purchase of treasury shares
(25,685
)
 

 
(25,685
)
Foreign currency translation adjustments
(2,596
)
 

 
(2,596
)
Distributions to non-controlling interest holder

 
(45
)
 
(45
)
Net income
27,830

 
532

 
28,362

Balance as of June 30, 2013
$
1,363,389

 
$
1,117

 
$
1,364,506



19

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


13.
Stock-Based Compensation

The Company recognizes compensation costs for equity awards granted to its employees based on each award's grant-date fair value. Most of the Company's equity awards contain vesting conditions dependent upon the completion of specified service periods or achievement of established sets of performance criteria. Compensation cost for service-based equity awards is recognized ratably over the requisite service period. Compensation cost for certain performance-based awards is recognized using a graded expense-attribution method. The Company has granted performance-based awards where the value of the award upon vesting will vary depending on the level of performance ultimately achieved (for example, during the year ended December 31, 2013, the Company granted awards that vest only if the Company achieves positive earnings before interest and taxes for the year ending December 31, 2014). The Company recognizes compensation cost for these awards based on the level of performance expected to be achieved. The Company will recognize the impact of any change in estimate in the period of the change.

Generally, equity awards are forfeited by employees who terminate prior to vesting. However, certain employment contracts for certain executive officers provide for the acceleration of vesting in the event of a change in control or specified termination events. The Company currently satisfies exercises of stock options and stock appreciation rights, the vesting of restricted stock and the delivery of shares upon the vesting of restricted stock units with the issuance of new shares.

The impact of stock options (including stock appreciation rights) and restricted stock awards on net income (excluding amounts capitalized) for the three- and six-month periods ended June 30, 2014 and 2013, respectively, were as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Total stock-based compensation
$
3,112

 
$
5,762

 
$
8,421

 
$
9,837

Tax impact(1)
187

 
(1,844
)
 
(2,341
)
 
(2,853
)
Reduction in net income, net of tax
$
3,299

 
$
3,918

 
$
6,080

 
$
6,984

 ____________________
(1) 
Tax impact is determined at the Company's combined effective tax rate, which includes the income statement line item "Decrease/increase in income tax benefit payable to former stockholder" (see Note 11).

Stock-based compensation cost capitalized as a part of film costs was $3.7 million and $4.0 million for the three-month periods ended June 30, 2014 and 2013, respectively, and $7.3 million and $8.3 million for the six-month periods ended June 30, 2014 and 2013, respectively.

The following table sets forth the number and weighted average grant-date fair value of equity awards granted during the three- and six-month periods ended June 30, 2014 and 2013:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
Number
Granted
 
Weighted
Average
Grant-Date
Fair Value
 
Number
Granted
 
Weighted
Average
Grant-Date
Fair Value
 
(in thousands)
2014
 
 
 
 
 
 
 
Restricted stock and restricted stock units
235

 
$
25.21

 
459

 
$
27.50

2013
 
 
 
 
 
 
 
Restricted stock and restricted stock units
166

 
$
21.49

 
427

 
$
18.67


As of June 30, 2014, the total compensation cost related to unvested equity awards granted to employees (excluding equity awards with performance objectives not probable of achievement) but not yet recognized was approximately $71.9 million and will be amortized on a straight-line basis over a weighted average period of 1.8 years.


20

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


14.
Reportable Segments

During the three months ended September 30, 2013, the Company reorganized its internal management structure to align with changes in how it operates the business and evaluates financial performance of individual business units. As a result, there were changes to its operating segments and the Company has revised its segment information for prior periods to conform to the current presentation. The Company's current reportable segments are the following: Feature Films, Television Series and Specials and Consumer Products. Feature Films consists of the development, production and exploitation of feature films in the theatrical, television, home entertainment and digital markets. Television Series and Specials consists of the development, production and exploitation of television, direct-to-video and other non-theatrical content in the television, home entertainment and digital markets. Consumer Products consists of the Company's merchandising and licensing activities related to the exploitation of its intellectual property rights. Operating segments that are not separately reportable are categorized in "All Other" and include ATV and live performances.

Segment performance is evaluated based on revenues and gross profit. The Company does not allocate assets to each of its operating segments, nor does the Company's chief operating decision maker evaluate operating segments using discrete asset information. Information on the reportable segments and a reconciliation of total segment revenues and gross profit to consolidated financial statements are presented below (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Revenues
 
 
 
 
 
 
 
 
Feature Films
$
69,686

 
$
172,921

 
$
179,722

 
$
251,446

 
Television Series and Specials
19,950

 
21,131

 
37,919

 
40,499

 
Consumer Products
18,533

 
15,609

 
30,661

 
43,113

 
All Other
14,108

 
3,775

 
21,216

 
13,026

Total revenues
$
122,277

 
$
213,436

 
$
269,518

 
$
348,084

 
 
 
 
 
 
 
 
 
Gross profit(1)
 
 
 
 
 
 
 
 
Feature Films
$
23,902

 
$
68,052

 
$
(1,526
)
 
$
93,983

 
Television Series and Specials
1,220

 
6,762

 
6,979

 
11,679

 
Consumer Products
7,308

 
5,046

 
13,351

 
23,494

 
All Other
2,315

 
300

 
2,493

 
131

Total gross profit
$
34,745

 
$
80,160

 
$
21,297

 
$
129,287

____________________
(1) 
The Company defines segment profit as segment revenues less segment costs of revenues ("segment gross profit"). The Company's segment gross profit is equivalent to total gross profit (or loss) as presented on the consolidated statements of operations, which includes a reconciliation to consolidated (loss) income before income taxes.

The following table presents goodwill for each of the Company's reportable segments (in thousands):
 
Feature Films
 
Television Series and Specials
 
Consumer Products
 
All Other
 
Total
Balance as of December 31, 2013
$
43,995

 
$
6,111

 
$
10,999

 
$
118,617

 
$
179,722

Measurement period adjustments related to the acquisition of ATV

 

 

 
(428
)
 
(428
)
Acquisitions

 

 
1,300

 
9,073

 
10,373

Balance as of June 30, 2014
$
43,995

 
$
6,111

 
$
12,299

 
$
127,262

 
$
189,667



21

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


15.
Related Party Transactions

Transactions with ODW

During the six months ended June 30, 2014, the Company had various transactions with a related party, ODW. See Note 7 for further discussion related to these transactions.

Transactions with Universal Music Group

One of the Company's directors, Lucian Grainge, is the chief executive officer of Universal Music Group ("UMG"). From time to time, the Company and UMG (including its subsidiaries) make payments to each other in connection with the licensing of music that is owned by the other company. In addition, UMG serves as the Company's music publisher. Finally, UMG and ATV (which the Company acquired in May 2013) have formed joint ventures related to the music business. As it relates to these arrangements, for the three and six months ended June 30, 2014 and 2013, revenues recognized and expenses incurred (which were recorded as film inventory costs) were not material. As of June 30, 2014, the Company's deferred revenue and other advances (see Note 9) included a cash advance received in the amount of $5.0 million related to music licensing revenues.

Fuhu, Inc.

The Company holds an equity investment in Fuhu, Inc. (“Fuhu”) representing approximately 3% of Fuhu’s outstanding equity securities. The Company's chief financial officer’s son currently serves as the chief financial officer of Fuhu. The Company has entered into various agreements with Fuhu, involving, among other things, the licensing of certain of the Company’s characters and other intellectual property for use by Fuhu in connection with Fuhu’s tablet computers and the provision of marketing and other services to Fuhu. During the six months ended June 30, 2014, revenues earned from Fuhu were immaterial.

16.
Concentrations of Credit Risk

A substantial portion of the Company's revenue is derived directly from the Company's third-party distributors, Paramount and Fox. Paramount represented approximately 27% and 47% of total revenue for the three-month periods ended June 30, 2014 and 2013, respectively, and 27% and 51% for the six-month periods ended June 30, 2014 and 2013, respectively. Fox represented approximately 30% and 28% of total revenue for the three-month periods ended June 30, 2014 and 2013, respectively, and 21% and 18% for the six-month periods ended June 30, 2014 and 2013, respectively .

As of June 30, 2014 and December 31, 2013, approximately 58% and 49%, respectively, of the Company's trade accounts receivable balance consisted of long-term receivables related to licensing arrangements with Netflix, Inc.

17.Commitments and Contingencies

Legal Proceedings. From time to time, the Company is involved in legal proceedings arising in the ordinary course of its business, typically intellectual property litigation and infringement claims related to the Company's feature films and other commercial activities, which could cause the Company to incur significant expenses or prevent the Company from releasing a film or other properties. The Company also has been the subject of patent and copyright claims relating to technology and ideas that it may use or feature in connection with the production, marketing or exploitation of the Company's feature films and other properties, which may affect the Company's ability to continue to do so. Furthermore, from time to time the Company may introduce new products or services, including in areas where it currently does not operate, which could increase its exposure to litigation and claims by competitors, consumers or other intellectual property owners. Defending intellectual property litigation is costly and can impose a significant burden on management and employees, and there can be no assurances that favorable final outcomes will be obtained in all cases. While the resolution of these matters cannot be predicted with certainty, the Company does not believe, based on current knowledge, that any existing legal proceedings or claims are likely to have a material effect on its financial position, results of operations or cash flows.

Contributions to ODW. The Company has committed to making certain contributions in connection with the formation of ODW. Refer to Note 7 for further discussion related to these commitments.


22

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


Contingent Consideration. As a result of the Company's acquisition of ATV, the Company may be obligated to make additional contingent cash payments as part of the purchase price. Refer to Note 3 for further discussion.

18.
Earnings Per Share Data

The following table sets forth the computation of basic and diluted net (loss) income per share (in thousands, except per share amounts): 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net (loss) income attributable to DreamWorks Animation SKG, Inc.
$
(15,387
)
 
$
22,253

 
$
(58,323
)
 
$
27,830

Denominator:
 
 
 
 
 
 
 
Weighted average common shares and denominator for basic calculation:
 
 
 
 
 
 
 
Weighted average common shares outstanding
84,658

 
83,634

 
84,624

 
84,204

Less: Unvested restricted stock
(104
)
 
(110
)
 
(104
)
 
(110
)
Denominator for basic calculation
84,554

 
83,524

 
84,520

 
84,094

Weighted average effects of dilutive stock-based compensation awards:
 
 
 
 
 
 
 
Restricted stock awards

 
1,009

 

 
804

Denominator for diluted calculation
84,554

 
84,533

 
84,520

 
84,898

Net (loss) income per share—basic
$
(0.18
)
 
$
0.27

 
$
(0.69
)
 
$
0.33

Net (loss) income per share—diluted
$
(0.18
)
 
$
0.26

 
$
(0.69
)
 
$
0.33


The following table sets forth (in thousands) the weighted average number of options to purchase shares of common stock, stock appreciation rights, restricted stock awards and equity awards subject to performance conditions which were not included in the calculation of diluted per share amounts (for periods where the Company had net income) because the effects would be anti-dilutive:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2013
 
June 30, 2013
Options to purchase shares of common stock and restricted stock awards
1,714

 
3,180

Stock appreciation rights
5,112

 
5,172

Total
6,826

 
8,352


The following table sets forth (in thousands) the number of equity awards that are contingently issuable which were not included in the calculation of diluted shares (for periods where the Company had net income) as the required performance conditions had not been met as of June 30, 2013:
 
Three Months Ended
 
Six Months Ended
 
June 30, 2013
 
June 30, 2013
Options to purchase shares of common stock and restricted stock awards
716

 
716



23

Table of Contents

DREAMWORKS ANIMATION SKG, INC.
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)


19.
Restructuring Charges

During the three months ended December 31, 2012, the Company made a strategic business decision to change the production and release slates for some of its animated feature films. In connection with this decision, the Company committed to a restructuring plan to align its production and operating infrastructure. During the three months ended March 31, 2013, the Company implemented a restructuring plan to lower the cost structure, which resulted in a commitment to further reduce its workforce. As a result, the Company incurred restructuring charges attributable to employee-related costs (primarily related to severance and benefits) totaling $0.4 million for 12 employees, and $2.9 million for 59 employees for the three- and six-month periods ended June 30, 2013, respectively. Restructuring charges were not material for the six months ended June 30, 2014. These charges were recorded in costs of revenues and selling, general and administrative expenses in the Company's consolidated statements of operations. Payments made during the three months ended June 30, 2014 and 2013 totaled $0.7 million and $2.5 million, respectively, and during the six months ended June 30, 2014 and 2013 totaled $1.7 million and $4.5 million, respectively, related to these restructuring plans. As of June 30, 2014 and December 31, 2013, $0.2 million and $1.7 million, respectively, remained accrued as a liability. As of June 30, 2014, the Company's restructuring plans were substantially complete. The Company's restructuring plans are primarily attributable to its Feature Films reportable segment.


24


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, 2013 (the "2013 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 2013 Form 10-K and Current Reports on Form 8-K, before deciding to purchase, hold or sell our common stock.

Management Overview

The discussion of our revenues and costs of revenues for the three and six months ended June 30, 2014 and 2013 reflects our new segment categories. Refer to Note 14 of our unaudited consolidated financial statements contained elsewhere in this Quarterly Report for further information, including a description of each of our segments.

The following is a summary of the significant items that affected our financial results for the three and six months ended June 30, 2014:

During the three and six months ended June 30, 2014, we incurred a net loss (excluding net loss/income attributable to non-controlling interests) of $15.4 million, or a loss of $0.18 per share, and $58.3 million, or a loss of $0.69 per share, respectively. A detailed discussion of our financial results is provided in the section entitled "—Overview of Financial Results."

During the three months ended June 30, 2014, we released our feature film How to Train Your Dragon 2. A discussion of the revenues generated from this film is provided in the section entitled "—Overview of Financial Results —Revenues—Feature Films— Current year theatrical releases."

In May 2013, we completed the acquisition of AwesomenessTV ("ATV"). During the three and six months ended June 30, 2014, our operating results included $9.2 million and $13.3 million, respectively, of revenues and, for each of the three- and six-month periods ended June 30, 2014, $2.3 million of gross profit attributable to ATV. Further discussion is provided in the section entitled "—Overview of Financial Results."

As of June 30, 2014, we updated our estimate of the fair value of the contingent consideration liability related to the acquisition of ATV. As a result, during the three and six months ended June 30, 2014, we recorded a gain of $7.2 million and $4.7 million, respectively, to reflect the change in fair value of the liability. Further discussion is provided in the section entitled "—Overview of Financial Results."

Our Business

Our business is primarily devoted to developing, producing and exploiting animated feature films and their associated characters in the worldwide theatrical, home entertainment, digital, television, merchandising and licensing and other markets. In addition, we continue to build upon the value of our intellectual property by creating high-quality entertainment through the development and production of non-theatrical content such as television series and specials and live performances based on characters from our feature films.

For further information on our business, refer to Note 1 of our unaudited consolidated financial statements in "Part I—Item 1." For further details of our primary distribution and servicing arrangements, see "Part I—Item 1—Business—Distribution and Servicing Arrangements" of our 2013 Form 10-K. In addition, on June 30, 2014, we reacquired certain distribution rights from Paramount and, as a result, Paramount only retains television distribution rights (which includes subscription and free video-on-demand formats) for titles covered by the Paramount Agreements. The reacquired rights are now subject to the Fox Distribution Agreement.

25


Our Revenues and Costs

Our Revenues

Feature Films

Our feature films are currently the source of a significant portion of our revenues. 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 distribution arrangements with each of our theatrical distributors, prior to reporting any revenue for one of our feature films to us, each of our distributors is entitled to (i) retain a distribution fee, which is based on a percentage of gross revenues (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 various distributor agreements, each film’s total exploitation expenses and distribution fees are offset against that film’s revenues on a worldwide basis across all markets, and our distributors report 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 exploitation 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.

Our films are distributed in foreign countries and, in recent years, we have derived on average 71% of our worldwide box office receipts and 59% 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 is 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—Market and Exchange Rate Risk—Foreign Currency Risk" of our 2013 Form 10-K.

Television Series and Specials

Our business activities also include the development, production and exploitation of television, direct-to-video and other non-theatrical content. We have certain rights in our distribution and servicing arrangements (described above) to engage our distributors to distribute non-feature film product for us. However, our revenue and cost activities related to our television series/specials and direct-to-video product are generally not subject to our distribution agreements and, accordingly, we receive payment and record revenues directly from third parties. In June 2013, we announced that we had entered into separate, long-term agreements with Netflix and the German television network SuperRTL regarding the production and distribution of existing and future episodic series. The agreement with Netflix provides for the Company to deliver over 300 hours of newly created series based on DreamWorks Animation and Classic Media properties. Under both agreements, we will receive a per-episode license fee. We will also be entitled to retain all revenues from the exploitation of the series in other countries and derived from all media not expressly licensed to Netflix or SuperRTL.

Direct-to-video sales are conducted through distribution agreements with various third parties. Revenues from direct-to-video sales are primarily generated in the U.S., Canada and the United Kingdom. Although the majority of direct-to-video sales are conducted through third parties, we bear the inventory risk and cash collection risk, have discretion in supplier selection and are significantly involved in the marketing of the products. Consequently, we are considered the principal in the transactions and recognize direct-to-video revenue and the related distribution, marketing and placement fees on a gross basis.

Consumer Products

Our Consumer Products segment includes all merchandising and licensing activities related to our intellectual properties. We generate royalty-based revenues from the licensing of our characters, film elements and other intellectual property rights to consumer product companies, retailers, live entertainment companies, music publishers, theme parks, cruise ships and hotels worldwide.

Due to the significant expansion of our merchandising and licensing activities, we have made a strategic shift in our business such that some of our consumer product programs are becoming perennial rather than focused on specific events, such as film or DVD releases. Consumer product revenues derived from our franchise properties (e.g., Shrek and Madagascar) are

26


allocated to individual titles based on the time period surrounding a title's initial release. Consumer product revenues earned in periods significantly after initial release are attributed to the franchise's brand and not an individual title.

All Other

The primary revenue streams generated by our other segments are related to ATV (which we acquired in May 2013) and live performances. ATV generates revenues primarily from online advertising sales and distribution of content through media channels such as theatrical, home entertainment and television. Historically, the revenue activities related to our live performances have been minor relative to the size of our animated feature film business. We receive payment and record revenues directly from third parties. Subsequent to final performances of our live shows during the initial engagement, we generally continue to earn revenues through license arrangements of these productions that we enter into directly with third parties.
 
Our Costs

Costs of Revenues

Feature Films. Costs of revenues related to our Feature Films segment primarily include the amortization of capitalized costs, participation and residual costs and write-offs of amounts previously capitalized for titles not expected to be released or released titles not expected to recoup their capitalized costs. While the amortization of capitalized costs is based on the amount of revenues earned from all markets (including consumer products revenue), the amount of amortization reflected in the Feature Films segment is only that attributable to revenues reported in this segment.

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 mutually agreed amounts.

Television Series and Specials. Similar to our Feature Films segment, costs of revenues related to our Television Series and Specials segment primarily include the amortization of capitalized costs, participation and residual costs and write-offs of amounts previously capitalized. In addition, costs of revenues include amortization of intangible assets (which consists of certain character rights). Our television series and specials are typically not subject to the same distribution agreements as our feature films, and accordingly, costs of revenues includes distribution and marketing costs directly incurred by us. We also use a third-party, ANConnect (formerly, Anderson Merchandisors) ("Anderson"), to distribute certain home entertainment product in the U.S. and Canada, and as a result of our arrangement with Anderson, costs of revenues also include costs related to physical inventory sales and associated distribution fees.

Consumer Products. Costs of revenues associated with our Consumer Products segment are primarily related to the portion of amortization of capitalized costs of our film, television series/specials and live performances, as well as amortization of certain intangible assets, associated with consumer product and licensing revenues. Costs of revenues also include participation costs, direct costs for sales commissions to outside third parties for the licensing and merchandising of our characters and certain marketing and promotion costs.

All Other. All Other costs of revenues primarily include those attributable to ATV and our live performance business. Costs of revenues associated with our live performance business include the amortization of capitalized costs (excluding the portion attributable to consumer products revenue), marketing and other operating costs.

Capitalized Production Costs
 
Capitalized production costs represent the costs incurred to develop and produce our animated films and television series/specials, which primarily consist of compensation (including salaries, bonuses, stock-based compensation and fringe benefits) for animators, creative talent and voice talent (which, in the case of sequels, can be significant), equipment and other direct operating costs relating to the production (including production overhead). In addition, capitalized production costs may include interest expense to the extent that amounts were qualified to be capitalized.

Capitalized production costs and participations and residual costs are amortized and included in costs of revenues in the proportion that the revenue for each film or television series/special ("Current Revenue") during the period bears to its respective estimated remaining total revenue to be received from all sources ("Ultimate Revenue"). The amount of capitalized production costs that are amortized each period will therefore depend on the ratio of Current Revenue to Ultimate Revenue for

27


each film or television series/special for such period. Because the profitability for each title varies depending upon its individual projection of Ultimate Revenues and its amount of capitalized costs incurred, total amortization may vary from period to period due to several factors, including: (i) changes in the mix of titles earning revenue, (ii) changes in any title’s Ultimate Revenue and capitalized costs and (iii) write-downs of capitalized production costs due to changes in the estimated fair value of unamortized capitalized production costs.

Unamortized capitalized production costs are evaluated for impairment each reporting period on a title-by-title basis. If estimated remaining revenue is not sufficient to recover the unamortized capitalized production costs for that title, the unamortized capitalized production costs will be written down to fair value determined using a net present value calculation. For our feature films (which comprise the largest part of our business), the degree of uncertainty around the estimates of net cash flows is substantially reduced after a film’s initial theatrical release, and thus, to the extent that we record a material impairment charge, it generally occurs in the quarter of a film's initial theatrical release. For example, in the quarter ended December 31, 2012, we recorded an impairment charge of $86.9 million with respect to our film Rise of the Guardians, which was initially released in November 2012. In the quarter ended March 31, 2014, we recorded an impairment charge of $57.1 million with respect to our film Mr. Peabody and Sherman, which was released in March 2014. We may also from time to time observe indicators of impairment subsequent to a film’s initial worldwide theatrical release, such as lower-than-expected performance in home entertainment and other post-theatrical markets, which result in a reduction in our estimate of a film’s Ultimate Revenues and may result in an impairment of the film in periods following its initial theatrical release. For example, Turbo was initially released in July 2013 in the domestic theatrical market and we recorded an impairment charge on the film during the quarter ended December 31, 2013.

As it relates to titles that have been impaired, additional impairments may be recorded subsequently if the uncertain components of our future revenues do not materialize as expected. For example, we may experience a further impairment of Turbo's remaining carrying costs if the uncertain components of our future revenues (e.g., those related to home entertainment sales and some consumer products licensing activity) do not materialize as currently expected. A reduction of 10% in our estimated future revenues attributable to Turbo would result in an additional impairment charge of approximately $4 million to $8 million. We may also experience a further impairment of Mr. Peabody and Sherman's remaining carrying costs if the uncertain components of our future revenues (e.g., those related to home entertainment sales) do not materialize as currently expected. A reduction of 10% in our estimated future revenues attributable to Mr. Peabody and Sherman would result in an additional impairment charge of approximately $5 million to $10 million.

For a discussion of write-downs of capitalized production costs recorded during the six months ended June 30, 2014, see "—Overview of Financial Results—Costs of Revenues."

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 series/specials or live performances. In addition, as a result of our restructuring plans (as described in Note 19 of the unaudited consolidated financial statements contained in Item 1 of this Quarterly Report), our selling, general and administrative expenses also include restructuring charges.

Other Operating Income

Operating-related income or gains that are not considered revenues are classified as other operating income in our consolidated statements of operations. Other operating income largely consists of income recognized in connection with our contributions to ODW in the form of consulting and training services and the license of technology. Refer to the section entitled "—Overview of Financial Results—Other Operating Income" for further details of amounts recognized as other operating income during the three and six months ended June 30, 2014.

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 2013 Form 10-K.

Seasonality

The timing of revenue reporting and receipt of cash remittances to us, related to our feature films, from our distributors fluctuates based upon the timing of our films’ theatrical and home entertainment releases and, with respect to certain of our distributors, the recoupment position of our distributors on a film-by-film basis, which varies depending upon a film’s overall

28


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 fluctuates depending on when each title is made available. Furthermore, the timing of revenues related to our television specials may fluctuate if the title is holiday-themed. 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 series/specials broadcasts. We expect that revenues generated from our Classic Media properties 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 operations. 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 June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014(1)
 
2013
 
$ Change
 
% Change
 
(in millions, except percentages and per share data)
Revenues
$
122.3

 
$
213.4

 
$
(91.1
)
 
(42.7
)%
 
$
269.5

 
$
348.0

 
$
(78.5
)
 
(22.6
)%
Costs of revenues
87.5

 
133.3

 
(45.8
)
 
(34.4
)%
 
248.2

 
218.8

 
29.4

 
13.4
 %
Gross profit
34.8

 
80.1

 
(45.3
)
 
(56.6
)%
 
21.3

 
129.2

 
(107.9
)
 
(83.5
)%
Product development
0.6

 
1.1

 
(0.5
)
 
(45.5
)%
 
1.2

 
2.0

 
(0.8
)
 
(40.0
)%
Selling, general and administrative expenses
54.6

 
49.7

 
4.9

 
9.9
 %
 
101.8

 
92.5

 
9.3

 
10.1
 %
Change in fair value of contingent consideration
(7.2
)
 

 
(7.2
)
 
(100.0
)%
 
(4.7
)
 

 
(4.7
)
 
(100.0
)%
Other operating income
(2.3
)
 
(2.9
)
 
(0.6
)
 
(20.7
)%
 
(4.0
)
 
(2.9
)
 
1.1

 
37.9
 %
Operating (loss) income
(10.9
)
 
32.2

 
(43.1
)
 
NM

 
(73.0
)
 
37.6

 
(110.6
)
 
NM

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-operating income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest (expense) income, net
(2.5
)
 
0.8

 
(3.3
)
 
NM

 
(4.2
)
 
1.6

 
(5.8
)
 
NM

Other income, net
1.8

 
1.0

 
0.8

 
80.0
 %
 
3.1

 
2.0

 
1.1

 
55.0
 %
Decrease (increase) in income tax benefit payable to former stockholder
1.7

 
(0.4
)
 
2.1

 
NM

 
2.6

 
(1.1
)
 
3.7

 
NM

(Loss) income before loss from equity method investees and income taxes
(9.9
)
 
33.6

 
(43.5
)
 
NM

 
(71.5
)
 
40.1

 
(111.6
)
 
NM

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loss from equity method investees
3.4

 
1.3

 
2.1

 
161.5
 %
 
6.7

 
1.3

 
5.4

 
415.4
 %
(Loss) income before income taxes
(13.3
)
 
32.3

 
(45.6
)
 
NM

 
(78.2
)
 
38.8

 
(117.0
)
 
NM

Provision (benefit) for income taxes
2.6

 
10.1

 
(7.5
)
 
(74.3
)%
 
(19.9
)
 
10.5

 
(30.4
)
 
NM

Net (loss) income
(15.9
)
 
22.2

 
(38.1
)
 
NM

 
(58.3
)
 
28.3

 
(86.6
)
 
NM

Less: Net (loss) income attributable to non-controlling interests
(0.5
)
 

 
(0.5
)
 
100.0
 %
 

 
0.5

 
(0.5
)
 
(100.0
)%
Net (loss) income attributable to DreamWorks Animation SKG, Inc.
$
(15.4
)
 
$
22.2

 
$
(37.6
)
 
NM

 
$
(58.3
)
 
$
27.8

 
$
(86.1
)
 
NM