Business and Basis of Presentation

Business

The businesses and activities of DreamWorks Animation SKG, Inc. ("DreamWorks Animation" or the "Company") primarily include 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.

Beginning with the domestic theatrical release of The Croods on March 22, 2013, the Company began to derive revenue from Twentieth Century Fox Film Corporation's worldwide (excluding China and South Korea, which are distributed by Oriental DreamWorks Holding Limited ("ODW") and C.J. E&M Corporation ("C.J."), respectively) exploitation of its films in the theatrical and various post-theatrical markets. Pursuant to a binding term sheet (the "Fox Distribution Agreement") entered into with Twentieth Century Fox and Twentieth Century Fox Home Entertainment, LLC (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.

In addition, beginning with The Croods (released on April 19, 2013 in China), the Company also derives revenue from ODW's exploitation of the Company's feature films in the Chinese theatrical and post-theatrical markets. Pursuant to the master distribution agreement entered into with ODW, the Company has agreed to license certain exclusive distribution rights to ODW and exclusively engage them to render fulfillment services with respect to certain of the Company's animated feature films and other audiovisual programs in China. Pursuant to the master distribution agreement, prior to reporting any revenue for one of the Company's feature films, ODW is entitled to (i) retain a fee of 8.0% of all gross receipts, 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. The rights licensed to, and serviced by, ODW will terminate on the date that is the earlier of 15 months after the initial release of the film in China, or 24 months after delivery of the film to ODW of the last film released in China during such period. The Company holds a 45.45% equity interest in ODW. See Note 7 for further information related to the Company's accounting for its investment in ODW.

The Company continues 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 the right to continue rendering such services for 16 years from such film's initial general theatrical release. Similar to how the Company accounts for revenues earned under the Paramount Agreements, the Company recognizes revenues derived from titles distributed by Fox, ODW and C.J., net of reserves for returns and rebates, and after each distributor has (i) retained its distribution fee and (ii) recovered all of its permissible distribution and marketing costs with respect to the Company’s films on a title-by-title basis.

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. In addition, the Company continues to build upon the value of its intellectual property by seeking opportunities beyond its core animated feature film business and creating high-quality entertainment through the development and production of non-theatrical content such as television specials, television series and live performances based on characters from its feature films. The Company's activities include technology initiatives as it explores opportunities to exploit its internally developed software.

Since August 2012, the Company's financial results also include those of Classic Media (see Note 3). Classic Media is primarily engaged in the acquisition and exploitation of character-based family entertainment properties across television, home entertainment, merchandising, music and other media channels worldwide. Classic Media has acquired, licensed or created intellectual property rights in relation to a number of characters including Veggie Tales, Casper, Lassie, Barbie, Postman Pat, Tinga Tinga Tales, Frosty and Rudolph the Red-Nosed Reindeer. Classic Media now operates under the brand name "DreamWorks Classics" and generates revenues from home entertainment products and licensing of intellectual property for sale or use (including consumer products, merchandise and live performances) and music publishing.

Recent Events

Business Acquisition. On May 1, 2013, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") pursuant to which, on May 3, 2013, a wholly-owned subsidiary of the Company ("the Merger Sub") merged with and into AwesomenessTV, Inc. (“ATV”), an online media production company. As a result of this transaction, ATV became a wholly-owned subsidiary of the Company. ATV generates revenues primarily from online advertising sales and distribution of content through media channels such as theatrical, home entertainment and television. Refer to Note 3 for further discussion of this acquisition.

Chinese Joint Venture. On April 3, 2013 ("ODW Closing Date"), the Company closed its previously announced transaction to form 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"). Refer to Note 7 for further discussion of this investment.

Basis of Presentation

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 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. generally accepted accounting principles ("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.

The accompanying unaudited financial data as of June 30, 2013 and for the three and six months ended June 30, 2013 and 2012 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. 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, 2012 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, 2012 (the "2012 Form 10-K"). Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the Company's 2013 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 special broadcasts. In connection with the preparation of the Company's financial statements for the period ended June 30, 2013, the Company identified an error in the calculation of amortization expense related to its live performance business for the three months ended March 31, 2013, which it corrected during the three months ended June 30, 2013. The impact of the adjustments to the consolidated statement of income for the three months ended March 31, 2013 would have been to increase costs of revenues by $1.8 million, decrease income before income taxes in the amount of $1.8 million, decrease net income in the amount of $1.4 million and decrease diluted earnings per share by $0.02. In the opinion of management, the impact of the adjustments is not material to the financial position, results of operations or cash flows as previously reported for the three months ended March 31, 2013, nor to the three-month period ended June 30, 2013 in which the error was corrected.

Contingent Consideration

Pursuant to the Merger Agreement that the Company entered into in connection with the acquisition of ATV, the Company may be required to make future cash payments as part of the total purchase price to acquire ATV. The estimated liability recorded as of June 30, 2013 was based on a fair value analysis performed in conjunction with determining the purchase price allocation related to the ATV acquisition. The fair value measurement was determined using significant unobservable inputs (see Note 3 for a description of this contingent consideration arrangement and the key assumptions used to derive the estimated value). 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.

Other Operating Income Related to Oriental DreamWorks Contributions

Other operating income related to Oriental DreamWorks contributions consists of income recognized in connection with the Company's contributions to ODW in the form of consulting and training services and the license of technology. Costs incurred to fulfill the Company's obligations related to these contributions are included in selling, general and administrative expenses in its consolidated statements of income. Income related to the Company's contributions in the form of intellectual property licenses are included in revenues. The Company only recognizes the proportion of gains on contributions to equity method investees that is attributable to other investors' equity ownership interest in the investee.

As part of the Company's contribution commitments to ODW, it has committed to licensing certain of its internally developed animation technology to ODW, including preparing the software in a format that can be delivered to ODW and providing ongoing maintenance. The Company determined, due to the level of preparation involved, that this constitutes significant modification and customization of the existing software, and accordingly, it uses the percentage-of-completion method for recognition of the income associated with this contribution. Under the percentage-of-completion method, the Company uses costs incurred to measure progress towards completion. In addition, the Company makes certain estimates of the overall gross profit of the license granted and any changes in such estimates will be recorded in the period in which the change occurs. As the Company's investment in ODW is accounted for under the equity method of accounting, it only recognizes gross profit margin to the extent that control has transferred through the equity ownership interests (i.e. only 54.55% of the gross margin is recognized, which represents the portion of ODW that the Company does not own). This amount is classified as other operating income in the consolidated statements of income.

Variable Interest Entities

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, 2013, the Company determined that 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 its obligation to fund all losses. As of June 30, 2013, the Company's consolidated financial statements included the activities of the VIE, including approximately $5.8 million of assets and approximately $3.5 million of revenues generated during the six months ended June 30, 2013. Additionally, during the six months ended June 30, 2013 and 2012, the Company's consolidated financial statements also included operating expenses incurred by the VIE of approximately $4.2 million and $3.0 million, respectively, which are classified in costs of revenues. The consolidation of the VIE had an immaterial impact on the Company's consolidated financial statements the three months ended June 30, 2013 and 2012.

In addition, the Company also determined that as of June 30, 2013, it had a variable interest in ODW as ODW does not have sufficient equity to fund its operations as a result of the timing of capital contributions to the entity in accordance with the Transaction and Contribution Agreement. However, the Company concluded that it is not the primary beneficiary of ODW as it does not have the ability to control ODW, and 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 remaining contributions (which represent the maximum exposure to the Company).

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 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, third-party valuations (as deemed necessary) and other assumptions that management believes are reasonable under the circumstances, and management evaluates these estimates on an ongoing basis.