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Executives

Rich Sullivan - Investor Relations

Jeffrey Katzenberg - Chief Executive Officer, Director

Lewis W. Coleman - President, Chief Financial Officer, Director

Analysts

Ingrid Chung - Goldman Sachs

Barton Crockett - J.P. Morgan

Richard Greenfield - Pali Research

Drew Crum - Stifel Nicolaus

David Miller - Sanders Morris Harris

Tuna Amobi - Standard & Poor’s

Michael Morris - UBS

Doug Creutz - Cowen & Company

DreamWorks Animation SKG, Inc. (DWA) Q1 2008 Earnings Call April 29, 2008 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the DreamWorks Animation earnings conference call. (Operator Instructions) Now I would like to turn the conference over to Mr. Rich Sullivan from investor relations. Please go ahead.

Rich Sullivan

Thank you. Good afternoon, everyone and welcome to DreamWorks Animation’s first quarter 2008 earnings conference call. With me today is our Chief Executive Officer, Jeffrey Katzenberg, and our President and Chief Financial Officer, Lew Coleman. This call will begin with a brief discussion of the quarterly results disclosed in today’s press release followed by an opportunity for you to ask questions. I would like to remind everyone that today’s press release is available on our website, www.dreamworksanimation.com.

Before we begin, we need to remind you that certain statements made on this call may constitute forward-looking statements. Forward-looking statements can vary materially from actual results and are subject to a number of risks and uncertainties, including those contained in the company’s annual and quarterly reports, as well as in other filings with the SEC. I would encourage all of you to review the risk factors listed in these documents. The company undertakes no obligation to update any of its forward-looking statements.

And with that, I would like to now turn the call over to DreamWorks Animation Chief Executive Officer, Jeffrey Katzenberg. Jeffrey.

Jeffrey Katzenberg

Thank you, Rich. Hello, everyone and thanks for joining us today. During the first quarter, Bee Movie completed its theatrical run after opening in its last remaining international territories, including South Korea and Japan. Its international box office receipts totaled approximately $160 million, bringing its worldwide box office to $287 million.

The film was also released into the domestic home video market on March 11th, where it has sold an estimate 4.8 million net units. It will be released on home video into the majority of its international territories by the end of the second quarter. Additionally, the title will be released on Blu-Ray disc by the end of the second quarter.

In addition to Bee Movie, Shrek The Third was release onto home video during the first quarter and its remaining international territories, including Italy and France. To date, the title has sold nearly 20 million net units on a worldwide basis.

As we have seen with similar titles, we now expect Shrek The Third to move into a catalog like performance pattern. However, as we saw with the first two chapters of Shrek, we believe that we’ll have several opportunities to sell additional home video units through events specific to the Shrek franchise, including programs around Shrek The Musical on Broadway, Shrek The Halls on DVD, and Shrek Goes Fourth in theaters in 2010.

Next up for DreamWorks Animation is Kung Fu Panda which opens in theaters domestically on June 6th. Creatively, we are pleased with the film. I think it strikes the right balance of comedy and emotion, a formula that makes family animation memorable and special.

While it certainly is aimed at our core audience, the film’s action sequences combined with the talent of Jack Black as the lovable, funny, and charismatic Po the Panda, provides something for everyone. Once again this summer’s theatrical schedule is packed with many blockbuster franchise films, so Kung Fu Panda will compete not only with other family product but also a number of other significant event films that will be released in the same time frame. But we think we have something unique to offer family audiences in Kung Fu Panda and are excited to see how it performs on June 6th.

Aside from that, we have a number of other projects to look forward to in the remainder of 2008. Shrek The Musical makes its world premiere in Seattle this August and its Broadway debut on December 14th for the holiday season. With a strong creative team and a first-rate cast, we continue to be pleased with the project’s progress and look forward to seeing it on stage this summer.

On November 7th, our fall theatrical release, Madagascar: Escape to Africa, opens domestically in theaters. The film reunites us with a complete cast from the from the story’s first chapter and introduces us to a host of exciting new characters.

After the sequel, we look forward to building on our franchise with our Penguins TV series on Nickelodeon in early 2009. So it’s a busy time, both with our core business and our new initiatives. We are hopeful that this is the start of a successful year for DreamWorks Animation.

Before we take your questions, I will turn things over to Lew for a few comments. Lew.

Lewis W. Coleman

Thank you, Jeffrey. Good afternoon, everyone. I would like to briefly highlight a few items before we take your questions. In the first quarter, the company reported total revenue of $157 million, resulting in net income of $26 million, or $0.28 per share on a fully diluted basis. Revenue was mainly driven by the company’s 2007 releases, Bee Movie and Shrek The Third.

Bee Movie contributed $149 million of revenue from both continued international box office and its release into the domestic home video market on March 11th. The majority of the home video revenue from international territories will impact the second quarter due to the international release schedule.

Based on our current expectations, including its upcoming performance in the international home video markets, we expect that Bee Movie will be a profitable film for the company. However, at its anticipated revenue level, we do not believe that the title will have a material impact on the company’s earnings going forward due to its high expense amortization rate.

The other major revenue driver in the quarter was Shrek The Third, which contributed $48 million, primarily from international home video. Through the first quarter, the film recorded 19.8 million units shipped worldwide net of actual returns and estimated future returns.

Library and other titles contributed $19 million of revenue in the quarter, primarily driven by continued catalog home video.

Earnings for the remainder of the year will be largely determined by the performance of Kung Fu Panda, which as Jeffrey mentioned opens in the U.S. on June the 6th. As you know, because we do not recognize revenue for a title from our distributor until after they have recouped their up-front marketing and distribution costs, it is possible that we will not receive significant revenue from Paramount until the film is released in home video in the fourth quarter.

Our fall film, the sequel to Madagascar, is scheduled for release on November 7th. Again, because our distributor takes sufficient revenues to recover its costs up-front, we do not expect to see significant revenue from this film until 2009.

Finally, I would like to update everyone on our share repurchase program. Year-to-date, the company has repurchased approximately $88 million, or 3.7 million shares at an average price of approximately $24 per share, and we have approximately $62 million remaining under our current authorization.

With that, we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question today comes from the line of Ingrid Chung with Goldman Sachs. Please go ahead.

Ingrid Chung - Goldman Sachs

Thank you. Good afternoon. So my first question is around home video. It seems to us that the first quarter of a release for Shrek The Third and Bee Movie seemed to be better than what we are originally expecting. I was just wondering if there is a trend toward selling more of the ultimate in the first quarter of release.

And then my second question is could you talk about some of the marketing and partnership initiatives around the Kung Fu Panda release? What kind of things are you doing differently with this movie that you haven’t done in the past?

Jeffrey Katzenberg

On the first question on home video, I don’t think that we’ve seen anything that we’d be ready to sort of say is a new paradigm or trend in all of this. At the same time, I do think there is some indication that more of our -- and it’s not just for us but in general in the industry, you are seeing sort of a stronger performance in the initial period of release, that initial four to eight week period of time.

And as to the marketing on Kung Fu Panda, I think that we have a very strong campaign behind it. We once again have a great partnership working with McDonald’s, Hewlett-Packard, and a number of other companies. The movie will be premiering in the Cannes Film Festival in two weeks and we have very, very strong support from the cast who are going to be traveling internationally supporting the rollout of the film. So we will come out with all the bells and whistles. I can’t tell you that we’ve reinvented the wheel for this but I think we’ve tailored our game plan that’s been very successful for us in this release window in the past to the unique things about Kung Fu Panda.

Ingrid Chung - Goldman Sachs

Okay, great. And just one last question -- it sounded like from your comments on Bee Movie that Kung Fu Panda is probably going to be coming out in Blu-Ray in November also.

Jeffrey Katzenberg

We haven’t made a decision yet beyond the release on Bee Movie, but stay tuned.

Ingrid Chung - Goldman Sachs

Okay, great. Thank you.

Rich Sullivan

Next question, please.

Operator

From the line of Barton Crockett, J.P. Morgan.

Barton Crockett - J.P. Morgan

Thanks for taking the question. I guess first I was wondering on the library and other line item, that $19 million number in the quarter, is that a reasonable number to take as kind of a quarterly run-rate as we look to the balance of the year?

Jeffrey Katzenberg

Lew.

Lewis W. Coleman

Barton, I think -- I’m just trying to -- the library has got Shrek 1 and 2 in it, which turned out to be strong performers because of the Shrek 3 release. And that would be the only thing I would be cautious about if I was to take out my ruler and project it going forward.

Barton Crockett - J.P. Morgan

Okay. All right, so maybe a little bit higher than what we see later -- and then the second thing is on the Bee Movie DVD. Can you give us -- I know you can’t quantify this but should we in general assume that there was a meaningful HD-DVD payment in that number in the quarter?

Lewis W. Coleman

I think we’ve said in the past that we would rather not comment on that, and I think we will probably stick with that comment, Barton.

Jeffrey Katzenberg

Other than to say that we’ve amortized -- I mean, it’s in the overall amortization.

Lewis W. Coleman

Yeah, it’s in the overall amortization, obviously, and we’ve amortized -- the Bee Movie, I’m not sure, we’re probably 60% amortized.

Barton Crockett - J.P. Morgan

Okay.

Lewis W. Coleman

Roughly, so it is sitting in there but beyond that, we probably would not give you an amount.

Barton Crockett - J.P. Morgan

Okay, and than a final question here and then I’ll step aside; can you give us a sense of how you feel currently about the pace of the negotiations between the studios and the theaters for digital projectors and your comfort now in having the number of screens you’d like to see for Monsters vs. Aliens in March for 3D?

Jeffrey Katzenberg

I think that probably in the last 30 days, things have not progressed as well as I had hoped, expected, and frankly been committed to by all the parties involved. You know, it’s ongoing as we speak, literally now. But in terms of getting the big three on board and actively moving forward, I feel as though things have dragged along and it’s been pretty disappointing.

That said, it’s not a tactical flaw or issue for us yet but I’m not very happy with how everybody has handled themselves in the last 30 days.

Barton Crockett - J.P. Morgan

Do you have any hope that this will turn around quickly or is it still --

Jeffrey Katzenberg

Well, the answer is yes and they have to, but it’s just the rate of the way this is getting done has been bureaucratic would be the nice way to put it.

Barton Crockett - J.P. Morgan

All right. Thanks a lot.

Rich Sullivan

Thanks, Barton. Next question, please.

Operator

From Richard Greenfield with Pali. Please go ahead.

Richard Greenfield - Pali Research

A couple of questions; one, Madagascar you cited as one of the strong, uniquely strong performers in the quarter. Could you give us a sense, with another film coming out later this year, what are the DVD sales now up to for Madagascar, and any sense of just how significant it actually was in DVD unit sales over the course of the last quarter, or even the last couple of quarters?

And then two, just in terms of Penguins, Jeffrey, you mentioned that it’s coming out on Nickelodeon the beginning of ’09. Is this something that is immediately revenue accretive or profit accretive or is this something that takes time until it gets into a later stage of life like DVD for you actually to participate in terms of profitability? Thanks.

Jeffrey Katzenberg

I’ll do the TV show first and then you guys can talk about the Madagascar units. I don’t think you will see any immediate impact, financial impact from it. As you said, it will come over a period of time. Probably the thing that it will have the greatest benefit to will be our overall licensing and merchandising campaign for the Madagascar franchise as a whole. So that will be the first place in which we will see in success some immediate value and impact, and then from the show itself, it will roll out over a longer period of time.

Lew, do you want to talk about the --

Lewis W. Coleman

Rich, on the DVD units on Madagascar, we stopped disclosing the actual DVD units at the end of last year but if you want to think of a total in terms of more or less about 25 million units, you are probably right.

Richard Greenfield - Pali Research

And Jeffrey, if you could just follow-up and comment on from the standpoint of the Penguin release on Nickelodeon, how is that going to be tied in thematically to what the actual feature release in November?

Jeffrey Katzenberg

Really I think you should look at them as two very separate events, sequential and probably adding value and building towards. So the way to look at it is that you will have the movie rollout in November with a pretty strong licensing campaign behind it. Then the TV show will probably come on the air in the sort of mid first quarter and lead into the DVD release in the spring.

So we’ve been really trying to do a good job of aligning these things in a really nice kind of sequential and complementary way to one another and think that they will add value to one another. Penguins have a prominent and a very funny role in the movie itself in the second chapter, so it seems like it is lined up in a pretty good way.

Richard Greenfield - Pali Research

Thanks.

Rich Sullivan

Thanks, Rich. Next question, please.

Operator

A question from the line of Drew Crum with Stifel Nicolaus. Please go ahead.

Drew Crum - Stifel Nicolaus

Thanks. Good afternoon, everyone. Maybe I can start with the free cash flow -- you generated about $100 million in the quarter. I know you are not giving guidance on that metric but can you just give us a sense as to how we should expect that metric to trend through the balance of the year?

Lewis W. Coleman

It’s a hard question. The easy answer is it is going to be somewhat lumpy. In the first quarter, we paid studio bonuses. It was a fairly large amount out of our cash flow. We also purchased the -- repurchased the shares I mentioned and paid taxes. Those items are probably from a cash standpoint, you won’t see those items again until next year.

Conversely, we have a couple of quarters now where we don’t have a lot of film activity that will generate revenue from our distributors, so most of the revenue -- most of the cash, excuse me, left will be coming in closer to the fourth quarter than in the third quarter or the second quarter.

So it is going to be a bit lumpy out there, fewer disbursements and fewer cash revenues from our distributor over the next couple of quarters, with sort of a reasonable make-up in the fourth quarter.

Drew Crum - Stifel Nicolaus

Okay, thanks. That’s helpful. And Jeffrey, maybe you can comment on 3D screens in foreign territories. Where are we now, what the current pace looks like, and what your expectations are for Monsters vs. Aliens?

Jeffrey Katzenberg

You know, the pace has picked up there. There are a couple of significant players in the international market have come on board and actually placed orders for a meaningful rollout this year. They are probably close to -- I think I discussed this last call. I think the U.K. is looking at like 500, 600 screens. France has now come in and there are a couple of meaningful orders places, or about to be placed. Canada looks pretty strong, and the rate of it is picking up.

It is interesting. Brazil had an opening on the Hannah Montana movie this last weekend and just had -- they had five screens there and the business was just absolutely blockbuster and I got e-mails from exhibitors there saying this is what we needed to -- you know, sort of proof of concept for them. So I think it is starting to happen but again, it will lag behind the U.S.

Drew Crum - Stifel Nicolaus

Okay, and one last question -- the Shrek Musical in 2008, should we expect any meaningful contributions from that initiative?

Jeffrey Katzenberg

No.

Drew Crum - Stifel Nicolaus

Okay. Thanks, guys.

Rich Sullivan

Thanks, Drew. Next question, please.

Operator

David Miller with SMH Capital, please go ahead.

David Miller - Sanders Morris Harris

Congratulations on the results. Just a general question about the pay TV frame -- when I look at the revenue composition of some of your films in the home video frame relative to domestic box office, that tail over the last couple of years seems to have shortened somewhat. Obviously that may have to do with the overall maturation of the marketplace but it seems like, and correct me if I’m wrong here, but it seems like that delta, if you will, has been easily made up for by the pay TV frame, which is pretty flush for you guys. And I’m wondering, does that have to do with the overall expansion of certain international markets in the pay TV frame that you guys are exploiting very nicely, or is there something about this genre of film that now plays better in the pay TV frame more than it used to? Thanks very much.

Jeffrey Katzenberg

I am genuinely for the life of me not sure I know how to answer your question, but I think what I would say is that in terms of the television -- you know, pay and free TV television, these are in almost every instance are long-term output deals and are consistent. And so there really hasn’t been any meaningful change in that, so I’m not sure that all answers come back to the video market itself as opposed to somehow or another being tied to the television release.

Lewis W. Coleman

David, I think you may be seeing some foreign exchange effects.

Jeffrey Katzenberg

Well, there you go. That would answer it.

David Miller - Sanders Morris Harris

Okay, Lew, if I could just talk to you offline about that, that would be great. Thanks.

Rich Sullivan

Next question, please.

Operator

From the line of Tuna Amobi with Standard & Poor’s Equity Group. Please go ahead.

Tuna Amobi - Standard & Poor’s

Thank you very much. If I can stay on that 3D theme for a moment here, I’m just trying to understand -- is it fair to assume that all of your upcoming 3D releases, starting with Monsters, is going to be day-and-date with 2D as well?

Jeffrey Katzenberg

Yes, that is the case.

Tuna Amobi - Standard & Poor’s

Okay, so on that note then, how do you track the incremental opportunity here, given the -- I’m trying to understand how the incremental $10 million to $15 million cost that you had referenced in negative cost, how that ultimately can be justified by the economics of the 3D in that theatrical window. What are the main drivers, the parameters that is going to make you ultimately convinced that it was money that was well spent?

Jeffrey Katzenberg

Well, we have taken a pretty careful look at the ticket pricing and the number of screens that we are certain will be in the marketplace by the time we are out a year from now and think that we will see a good return on that investment. Whether or not it achieves the fullest potential and sort of the outside goals that I’ve set for ourselves and challenged exhibition with is the thing that is up for grabs right now.

So when you hear me talk about my disappointment, it is in the context of really trying to achieve the 5,000-plus screens installed by the time of our release. That is an optimum, optimum goal and that’s the thing you hear in me a level of disappointment in, which is if these guys don’t get their act together very quickly in the next 30 days, they are not going to be able to achieve that goal and it will start to deteriorate quickly. Every week that goes by, it will be several hundred less screens that will manage to be rolled out in the timeframe.

But what we are confident about being installed in that timeframe will we feel pay for our investment.

Tuna Amobi - Standard & Poor’s

Is there any way that this investment can be monetized beyond the theatrical window, or that’s --

Jeffrey Katzenberg

Well, that will -- the first thing is that you will see I think a meaningful premium for the ticket price itself. There will be a time in which this will migrate on to other platforms and have I think again premium value but that’s down the road a bit.

Tuna Amobi - Standard & Poor’s

Okay, just one follow-up question for Lew then, a separate question, actually on the tax benefit of this amortization. I was just trying to see if you can remind us where we are in terms of the original 15 years that was contemplated and off the I think it was $600 million potential savings that was originally anticipated, how much of that has been realized and how do you assess the potential realization of whatever amount might be outstanding on that?

(Multiple Speakers)

Lewis W. Coleman

I think I can cover three-quarters of your question. As you’ll recall in 2004, which I think is sort of the first part of your question, we essentially wrote up the assets of the company as a part of the going public transaction with Vulcan and we wrote it up about $1.5 billion.

The $1.5 billion translates through our books in two places. One is in tax savings and the other is in a payable to our shareholder, Vulcan, Paul Allen. And the difference between those two is actually our real taxes and the benefit to us net of those two things is about $0.02. If we maintain our current earnings rate, you can anticipate that that $0.02 will be available more or less every year between now and 15 years from 2004. So we have another 10, 11 years worth of pretty constant benefits.

Obviously if we earn a lot more money, we can use it up a little faster and if we don’t earn money, we aren’t going to use it up as fast. But if you think of it as a steady state, there is a net $0.02 there that is pretty permanent, at least another 10 years.

Tuna Amobi - Standard & Poor’s

In terms of the seasonality of that $0.02, do you see most of that occurring in a certain half or quarter? Is there any trend there that can --

Lewis W. Coleman

No, there is no real trend within a year, because essentially our tax provision sort of estimates that anyway for the year. And I think for the purposes of the next three or four or five years, I would assume pretty high degree of confidence that the $0.02 net is there. Obviously if our earnings fluctuate a lot it will change and at the end of the five-year period, it is quite likely we will have another five years of approximately the same benefit.

Tuna Amobi - Standard & Poor’s

That’s helpful. Thank you very much.

Rich Sullivan

Next question, please.

Operator

Michael Morris with UBS, please go ahead.

Michael Morris - UBS

Thank you. On your balance sheet, it seems like you have enough cash receivables to meet both the cushion that you want, cover the remainder on the share repurchase plan and have some left over. Given that you’ve had an incremental disclosure in your last K that acquisitions could impact the operating results, is there any reason to believe that you are not looking at potential acquisitions? And also, are there any particular businesses that you feel you can excel in with your content base and expertise? Thanks.

Lewis W. Coleman

Obviously we don’t comment on acquisitions or on our acquisition posture. It’s a difficult thing to comment on because we would have to update it too often, and this is fairly volatile kind of activity.

I will say broadly that we are always on the lookout to do something to extend our basic IP in new markets and at times, we may decide to do that internally and at times we may decide to partner it and at times we may decide to do it externally.

So if you were to anticipate something down the road, I would be inclined to think very hard about things that extend our existing IP. It depends obviously on the circumstances at the time.

We don’t have a tendency to build a war chest, nor do we have a tendency to let this cash burn a hole in our pocket. We are fairly happy with our liquidity position but we are obviously careful, given the nature of the credit markets and given the nature of liquidity today.

Michael Morris - UBS

Would you consider something like a special dividend then say if Kung Fu Panda or the Madagascar sequel were to outperform your expectations?

Lewis W. Coleman

That’s a matter that has to be taken up by the board.

Michael Morris - UBS

Okay. Thank you.

Rich Sullivan

Thanks, Mike. Next question, please.

Operator

The next question is from the line of Doug Creutz with Cowen & Company.

Doug Creutz - Cowen & Company

Could you talk about given that sequels have a little bit higher cost base due to [inaudible], what’s the box office level at which you start to think that a sequel looks attractive versus producing another original movie? Thanks.

Jeffrey Katzenberg

You know, this is an art, not a science. I think there are a lot of things that we look at in terms of the potential of a sequel. A lot of it depends on starting with the creative side of it, which is the story that sort of has natural continuing chapters and stories to it. Some of our movies have had them, some of them have now. And Madagascar clearly -- you know, the New York Zoo animals were not meant to stay on the island of Madagascar and that was really -- we knew that from the outset making that movie and it is following its natural progression.

There is no magic number here in terms of if it hits X, then that’s the answer we need to move forward. But there is no question that we see a lot of value for the two franchises we have and we would love to find a third.

Doug Creutz - Cowen & Company

All right, thank you.

Rich Sullivan

Thanks, Doug. Next question, please.

Operator

(Operator Instructions) At this point, there are no further questions in queue.

Rich Sullivan

Great. Well, that concludes today’s first quarter earnings conference call. I’d like to remind everyone that a replay of this call will be available shortly and accessible on the DreamWorks Animation website -- that address again, www.dreamworksanimation.com, and please feel free to contact DreamWorks Investor Relations if you have any further questions. Thanks again for participating and have a great evening.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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