BUSINESS ACQUISITIONS

12 Months Ended

Dec. 31, 2011

BUSINESS ACQUISITIONS

BUSINESS ACQUISITIONS

2. BUSINESS ACQUISITIONS

Acquisition of Predecessor

        During 2009, the Company acquired the Predecessor through two transactions: (a) on September 30, 2009, the Company purchased, from the Company's Chairman and Chief Executive Officer and the Company's Board of Director's Member and Chief Financial Officer, a total of 1,741,667 shares of Digital Domain's Common Stock which represented 13.2% of Digital Domain's outstanding Common Stock on that date (see Note 22). The Company recorded this initial investment at cost and carried the investment using the cost method for the 15-day period until the Acquisition occurred; and (b) on October 1, 2009 and on October 15, 2009 (the "Closing" or "Acquisition Date"), the Company acquired 666,667 shares and 1,666,667 shares, respectively, for an aggregate total of 2,333,334 shares of Series C 8% Cumulative Convertible Preferred Stock ("Series C Preferred Stock") from the Predecessor. The purchase price for the 2,333,334 shares of Series C Preferred Stock was $7.0 million ("2009 Series C Preferred Stock"). Simultaneously with the purchase of the 2009 Series C Preferred Stock, the Company purchased the Predecessor's ongoing rights to participate in the profits of the movie Titanic for an additional $1.0 million, bringing the aggregate purchase price to $8.0 million (see Note 22). As the two transactions occurred simultaneously, they have been accounted for as a single transaction.

        The holders of 2009 Series C Preferred Stock had the right to vote on any matter submitted to a vote of the holders of common stock or Series C Preferred Stock. The number of votes in which holders of Series C Preferred Stock was entitled equaled the number of shares of Common Stock into which such shares of Series C Preferred Stock was then convertible. The Series C Preferred Stock was convertible, in aggregate, into such number of shares of Common Stock as was equal to 51% of the fully diluted shares of Digital Domain's common stock assuming conversion of all warrants, preferred stock and options to purchase shares of the Predecessor's Common Stock into common stock as of October 15, 2009.

        On May 24, 2010, the Company elected to convert all 2,333,334 shares of its 2009 Series C Preferred Stock into approximately 22 million shares of Digital Domain's Common Stock. See Note 18 for further details of the rights of conversion.

        In connection with the proceeds from the sale of Series C Preferred Stock, Falcon Mezzanine Partners II, LP ("Falcon") irrevocably waived all prior financial covenant breaches by the Predecessor, and the Predecessor was required to pay down the Falcon debt by $3.0 million, including accrued interest and prepayment penalties. In addition, the financial covenants under the cumulative outstanding debt with Falcon were significantly altered to include only closing cash covenants, and an accelerated debt repayment schedule was entered into. See Note 16 for further details.

        In accordance with guidance provided in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 805, Business Combinations, this transaction was accounted for under the acquisition method of accounting. Accordingly, the Company was required to record the fair value of the assets acquired and liabilities assumed in the acquisition. The Company used techniques such as discounted cash flow models and multiples of revenue models in valuing the various elements of Digital Domain.

        The following table summarizes the fair value of assets acquired, liabilities assumed, the purchase price and the fair value of the non-controlling interests in the Predecessor as of the Acquisition Date (in thousands):

Net assets acquired:
Cash and cash equivalents	$	6,863
Prepaid expenses and other assets		1,695
Property and equipment		13,578
Trade name		14,800
Unpatented technology		25,700
Other intangible assets		6,600
Goodwill		15,282
Fair value of assets		84,518
Accounts payable and accrued liabilities		12,375
Acquired contract obligations		7,050
Notes payable		8,971
Capital lease obligations		1,549
Warrant and debt-related liabilities		9,500
Deferred income tax liability		6,183
Fair value of liabilities		45,628
Net assets acquired	$	38,890
Purchase price:
Cash	$	8,000
Fair value of non-controlling interests		36,772
Fair value of previously held equity interest		3,618
Total purchase price		48,390
Less: non-controlling interests classified as equity		(9,500	)
Net assets acquired	$	38,890

        The weighted-average amortizable life for all identifiable intangible assets, excluding the Trade name, at the time of acquisition was 11.7 years. The Trade name has an indefinite life and will be evaluated on an annual basis in accordance with the Company's established policies described in Note 4 and further disclosed in Note 10.

        The acquisition of the Predecessor resulted in Goodwill of $15.3 million, none of which is deductible for tax purposes. Such Goodwill resulting from the acquisition of the Predecessor reflects the $8.0 million paid by the Company, the $27.3 million fair value of the non-controlling interests, and the $3.6 million fair value of the previously held equity interests in the Predecessor, over the $38.9 million fair value of the net assets acquired including Goodwill. Goodwill was allocated to the reporting units as follows: $12.3 million to Feature Films and $3.0 million to Commercials.

        While there was only nominal income statement activity for the Successor from the Inception Date through September 30, 2009 other than Grant revenues for government agencies, the amounts of revenue and earnings of the Predecessor since the Acquisition Date included in the consolidated statement of operations for the Period from January 7 (the Inception Date) through December 31, 2009 are as follows (in thousands):

Revenues	$	15,582
Net loss before non-controlling interests	$	(3,115	)
Net income attributable to non-controlling interests		2,703
Net loss attributable to common stockholders	$	(412	)

        At various times during 2009 and 2010, the Company purchased an additional 1.7 million and 4.9 million shares, respectively, for a cumulative total of 6.6 million shares, of Digital Domain's Common Stock from various investors, some of which were from related parties (see Note 22). The shares of Digital Domain's common stock the Company purchased during 2009 were remeasured to fair value as of the Acquisition Date, resulting in a gain of $3.5 million, which is reflected as Adjustment of held interest in business combination in the accompanying consolidated statement of operations for the period from January 7, 2009 (the Inception Date) through December 31, 2009, inclusive of the operations of Digital Domain from the Acquisition Date through December 31, 2009.

        During 2010, the Company purchased an additional 666,667 shares of Series C Preferred Stock from Digital Domain for $2.0 million, with terms similar to the previous purchases. See Note 18 for further discussion.

        During the year ended December 31, 2011, five shareholders of Digital Domain's Common Stock exchanged 4,600,001 shares of Digital Domain's Common Stock, for 2,866,045 shares of the Company's Common Stock. These exchanges increased the Company's controlling interest in Digital Domain. See Notes 4, 18, 19, 22 and 24 for further discussion.

        Supplemental Pro Forma Information (unaudited)—Supplemental information on an unaudited pro forma basis, as if the acquisition had been consummated at the Inception Date and for the period from January 7, 2009 (the Inception Date) through December 31, 2009 are as follows (in thousands, except share and per share data):

	For the Period from January 7, 2009 (the inception date) through December 31, 2009
Total revenues	$	66,800
Operating income	$	(12,669	)
Loss from continuing operations	$	(24,777	)
Loss from discontinued operations—net of tax		(2,429	)
Gain from sale of discontinued operations—net of tax		9,241
Net loss before non-controlling interests		(17,965	)
Net loss attributable to non-controlling interests		21,206
Net income attributable to Digital Domain Media Group, Inc.		3,241
Preferred stockholders accretion, deemed dividends and income participation		(889	)
Net income attributable to Common Stockholders	$	2,352
Weighted average number of common shares outstanding
Basic		12,226,107
Diluted		14,383,656
Basic earnings (loss) per share:
Loss from continuing operations	$	(2.03	)
Discontinued operations		0.56
Net loss attributable to non-controlling interests		1.73
Preferred stockholders accretion, deemed dividends and income participation		(0.07	)
Basic income per share attributable to Common Stockholders	$	0.19
Diluted earnings (loss) per share:
Loss from continuing operations	$	(1.72	)
Discontinued operations		0.47
Net loss attributable to non-controlling interests		1.47
Preferred stockholders accretion, deemed dividends and income participation		(0.06	)
Diluted income per share attributable to Common Shareholders	$	0.16

        The unaudited pro forma supplemental information is based on estimates and assumptions which the Company believes are reasonable and reflect amortization of intangible assets as a result of the acquisition. The pro forma results are not necessarily indicative of the results that have been realized had the acquisition been consolidated beginning with the Inception Date.

Acquisition of In-Three

        On November 22, 2010, the Company acquired substantially all of the interests of In-Three, Inc., a Nevada corporation. The results of operations have been included in the consolidated financial statements since that date. In-Three is a provider of proprietary Dimensionalization® solutions for the conversion of 2D content into high-quality 3D stereo imagery, including a software product, known as Intrigue, that converts entertainment media from 2D to 3D. In-Three's product offerings enable the Company to offer a digital production and stereo conversion solution to studios and filmmakers. By integrating In-Three's technology and team, the Company plans to use, and offer its clients the use of, an expanded set of creative and development capabilities.

        In-Three was purchased for 423,287 shares of the Company's Common Stock, plus contingent consideration in the form of royalty payments as follows: payment of the contingent consideration will continue until the earlier to occur of the fifth anniversary of the closing date or the date on which the sum of the contingent consideration and the value of the Common Stock exceeds $22.0 million. If on the fifth anniversary of the closing date the sum of the contingent consideration and the value of the Common Stock do not exceed $22.0 million, then the contingent consideration will continue until such time as the sum equals $12.0 million in royalties. In addition, the Company paid $0.9 million for certain assets of In-Three.

        In accordance with the acquisition method of accounting as specified in FASB ASC Topic 805, the total acquisition consideration is allocated to the assets acquired, net of liabilities assumed, based on their estimated fair values as of the date of the transaction. The Company obtained an independent third-party appraisal of the estimated fair value of the acquired net assets as of the acquisition date. The remaining portion of the purchase price, or $2.8 million, was allocated to Goodwill representing the amount of the purchase price in excess of the fair value of the assets, net of liabilities acquired, subject to possible adjustment during the allocation period, which will not exceed one year. The Company used techniques such as discounted cash flow models and multiples of revenue models in valuing the various elements of the acquired business.

        The following table summarizes the components of the total consideration paid to acquire In-Three (in thousands):

	Amount
Cash paid on closing date	$	870
Contingent consideration(a)		3,120
Equity		1,943
Total consideration	$	5,933

(a)

Payment of the contingent consideration will continue until the earlier to occur of the fifth anniversary of the closing date or the date on which the sum of the contingent consideration and the value of the Common Stock exceeds $22.0 million. If on the fifth anniversary of the Closing Date, the sum of the contingent consideration and the value of the Common Stock do not exceed $22.0 million, then the contingent consideration will continue until such time as the sum equals $12.0 million in royalties.

        The following table summarizes the purchase price allocation of the total consideration paid to acquire In-Three (in thousands):

	Amount
Property and equipment	$	494
Intellectual properties		2,030
Trade name		610
Goodwill(b)		2,799
Total net assets	$	5,933

(b)

The Company has assigned $2.8 million toGoodwill, consisting of the excess of the purchase price over the estimated fair values of net assets acquired. This goodwill arises primarily from the avoidance of the time and costs which would be required (and the associated risks that would be encountered) to develop a business with a service offering and customer base comparable to In-Three and the expected cost synergies that will be realized through the consolidation of the acquired business into our digital productions studio business unit. This goodwill is nondeductible for tax purposes.

        In-Three recognized revenue on a completed contracts basis in which contract revenues and related cost of revenues are deferred until the completion of all deliverables agreed to in the contract have occurred and the customer has accepted delivery of the final product. During the interim period ended September 30, 2010 and 2009, In-Three had three contracts with customers. Two of these contracts were separate independent contracts for two unrelated 3D films with a single customer that accounts for a majority of the Company's historical revenue. The Company expects to continue its business relationship with this customer for future services. The third contract was with a different customer and accounts for the balance of deferred revenue as of September 30, 2010 and a refund demand that occurred in August 2010. As the Company did not assume the obligation for this customer, the Company did not recognize a liability for any deferred revenue related to In-Three.

        In-Three recognized a decline in revenues during the interim period ended September 30, 2010 which was due to the substantially smaller dollar value of the contract that was completed during the interim period ended September 30, 2010 as compared to the contract completed during the interim period ended September 30, 2009. In-Three did not have any other completed contracts during these interim periods that were of significant dollar value. The deferral of revenue recognition relating to the refund demand that occurred in August 2010 is not directly related to the decline in revenue during the interim period ended September 30, 2010.

        The weighted-average amortizable life for all identifiable intangible assets, excluding the Trade name, was 6.2 years. The Trade name has an indefinite life and will be evaluated on an annual basis in accordance with the Company's established policies described in Note 4 and further disclosed in Note 10. The Company did not assume any liabilities of In-Three, and therefore did not recognize a liability for any deferred revenue of In-Three. Furthermore, no deferred revenue was included in the above purchase price allocation.

        As of December 31, 2011, the accounting for this business acquisition is subject to final adjustment primarily for the useful lives of intangible assets, amounts allocated to intangible assets and goodwill, and for settlement of post-closing purchase price adjustments.

        The amounts expensed for transaction costs and the costs of integrating the acquired business into the Company were not material.

        Supplemental Pro Forma Information (unaudited)—Supplemental information on an unaudited pro forma basis (i) as if the acquisition had been consummated at January 1, 2010, for the period from January 1, 2010 through December 31, 2010 and (ii) as if the acquisition had been consummated at the Inception Date and for the period from January 7, 2009 (the Inception Date) through December 31, 2009:

	Pro Forma
	For the Year Ended December 31, 2010 (unaudited)			January 7 (the Inception Date) through December 31, 2009 (unaudited)
Total revenues	$	106,075		$	25,141
Operating loss	$	(20,328	)	$	(3,114	)
Net loss before non-controlling interests	$	(52,640	)	$	(2,267	)
Net loss attributable to non-controlling interests		2,747			2,703
Net (loss) income attributable to Common Stockholders	$	(49,893	)	$	436
Weighted average number of common shares outstanding
Basic		12,750,237			12,649,394
Diluted		12,750,237			13,193,215
Basic loss per share:
Loss from continuing operations	$	(4.13	)	$	(0.18	)
Net loss attributable to non-controlling interests		0.22			0.21
Basic loss per share	$	(3.91	)	$	0.03
Diluted loss per share:
Income from continuing operations	$	(4.13	)	$	(0.18	)
Net loss attributable to non-controlling interests		0.22			0.21
Diluted loss per share	$	(3.91	)	$	0.03

        The unaudited pro forma supplemental information is based on estimates and assumptions which the Company believes are reasonable and reflect amortization of intangible assets as a result of the acquisition. The pro forma results are not necessarily indicative of the results that have been realized had the acquisition been consolidated as of the beginning of the respective periods indicated.

        Common share equivalents have been excluded from the computation of diluted earnings per share for the year ended December 31, 2010, as the inclusion of dilutive common share equivalents in the calculation of diluted earnings per share would be anti-dilutive.