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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2005



Commission file number 001-32337



DREAMWORKS ANIMATION SKG, INC.

(Exact name of Registrants as specified in their charters)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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

(Registrants telephone number, including area code)



Indicate by check mark whether the Registrants (1) have 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) have been subject to such filing requirements for the past
90 days.    Yes  x    No ̈.



Indicate by check mark whether the
Registrants are accelerated filers (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x.



Indicate the number of shares outstanding of each of the Registrants classes of common stock: As of March 31, 2005, there were 52,189,992 shares of Class A common stock, 50,842,414 shares of Class B common stock and 1 share
of Class C common stock of the registrant outstanding.



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##### Table of Contents

TABLE OF CONTENTS



|              |  |                                                                                       |  |     
|------------- |  | ------------------------------------------------------------------------------------- |  | ----
|              |  |                                                                                       |  | Page
|PART I.       |  | FINANCIAL INFORMATION                                                                 |  |     
|              |  |                                                                                      
|Item 1.       |  | Financial StatementsDreamWorks Animation SKG, Inc. (unaudited)                       |  | 3   
|              |  |                                                                                      
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 17  
|              |  |                                                                                      
|Item 3.       |  | Quantitative and Qualitative Disclosure About Market Risk                             |  | 44  
|              |  |                                                                                      
|Item 4.       |  | Controls and Procedures                                                               |  | 45  
|              |  |                                                                                      
|PART II.      |  | OTHER INFORMATION                                                                     |  |     
|              |  |                                                                                      
|Item 1.       |  | Legal Proceedings                                                                     |  | 46  
|              |  |                                                                                      
|Item 6.       |  | Exhibits                                                                              |  | 46  
|              | 
|SIGNATURES    |  | 47                                                                                   
|              | 
|EXHIBIT INDEX |  | 48                                                                                   



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##### Table of Contents

PART IFINANCIAL INFORMATION



|Item l. | Financial Statements
|------- | --------------------



DREAMWORKS ANIMATION SKG, INC.



CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)



|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | --------- | - | ------------- | - | --------- | -
|                                                                                                                                                                                      |  | December 31,2004 |           |   | March 31,2005 |  
|Assets                                                                                                                                                                                |  |                  |           |   |               |   |           |  
|Cash and cash equivalents                                                                                                                                                             |  | $                | 63,134    |   |               | $ | 445,003   |  
|Trade accounts receivable, net of allowance for doubtful accounts                                                                                                                     |  |                  | 14,015    |   |               |   | 5,578     |  
|Receivable from affiliate                                                                                                                                                             |  |                  | 385,449   |   |               |   | 77,143    |  
|Receivables from employees                                                                                                                                                            |  |                  | 1,634     |   |               |   | 1,449     |  
|Film inventories, net                                                                                                                                                                 |  |                  | 519,926   |   |               |   | 532,760   |  
|Property, plant, and equipment, net of accumulated depreciation and amortization                                                                                                      |  |                  | 85,997    |   |               |   | 86,397    |  
|Deferred costs, net of amortization of $1,438, and $1,744, respectively                                                                                                               |  |                  | 3,741     |   |               |   | 3,435     |  
|Income taxes receivable                                                                                                                                                               |  |                  | 6,569     |   |               |   |          |  
|Deferred taxes, net                                                                                                                                                                   |  |                  | 93,343    |   |               |   | 93,343    |  
|Goodwill                                                                                                                                                                              |  |                  | 34,216    |   |               |   | 34,216    |  
|Other assets                                                                                                                                                                          |  |                  | 11,881    |   |               |   | 27,008    |  
|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  
|Total assets                                                                                                                                                                          |  | $                | 1,219,905 |   |               | $ | 1,306,332 |  
|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  
|                                                                                                                                                                                      |  |                 
|Liabilities and Stockholders Equity                                                                                                                                                  |  |                  |           |   |               |   |           |  
|Liabilities                                                                                                                                                                           |  |                  |           |   |               |   |           |  
|Accounts payable                                                                                                                                                                      |  | $                | 4,414     |   |               | $ | 8,083     |  
|Payable to stockholder                                                                                                                                                                |  |                  | 70,643    |   |               |   | 70,643    |  
|Accrued liabilities                                                                                                                                                                   |  |                  | 65,537    |   |               |   | 56,132    |  
|Income taxes payable                                                                                                                                                                  |  |                  |          |   |               |   | 16,413    |  
|Other advances and unearned revenue                                                                                                                                                   |  |                  | 32,225    |   |               |   | 51,009    |  
|Obligations under capital leases                                                                                                                                                      |  |                  | 2,993     |   |               |   | 2,798     |  
|Universal Studios advance                                                                                                                                                             |  |                  | 75,000    |   |               |   | 75,000    |  
|Bank borrowings and other debt                                                                                                                                                        |  |                  | 139,207   |   |               |   | 144,348   |  
|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  
|Total liabilities                                                                                                                                                                     |  |                  | 390,019   |   |               |   | 424,426   |  
|Commitments and contingencies                                                                                                                                                         |  |                  |           |   |               |   |           |  
|Non-controlling minority interest                                                                                                                                                     |  |                  | 2,941     |   |               |   | 2,941     |  
|Stockholders equity                                                                                                                                                                  |  |                  |           |   |               |   |           |  
|Class A common stock, par value $.01 per share, 350,000,000 shares authorized, 52,107,616 and 52,189,992 shares outstanding, as of December
31, 2004 and March 31, 2005, respectively |  |                  | 521       |   |               |   | 522       |  
|Class B common stock, par value $.01 per share, 150,000,000 shares authorized, 50,842,414 shares outstanding                                                                          |  |                  | 508       |   |               |   | 508       |  
|Class C common stock, par value $.01 per share, one share authorized and outstanding                                                                                                  |  |                  |          |   |               |   |          |  
|Additional paid-in capital                                                                                                                                                            |  |                  | 693,198   |   |               |   | 667,416   |  
|Less: Deferred compensation                                                                                                                                                           |  |                  | (32,171   | ) |               |   |          |  
|Retained earnings                                                                                                                                                                     |  |                  | 165,320   |   |               |   | 210,993   |  
|Less: Treasury stock, at cost                                                                                                                                                         |  |                  | (431      | ) |               |   | (473      | )
|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  
|Total stockholders equity                                                                                                                                                            |  |                  | 826,945   |   |               |   | 878,965   |  
|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  
|Total liabilities and stockholders equity                                                                                                                                            |  | $                | 1,219,905 |   |               | $ | 1,306,332 |  
|                                                                                                                                                                                      |  |                  |           |   |               |   |           |  



See accompanying notes.



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DREAMWORKS ANIMATION SKG, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)



|                                                     |  |                             |         |   |      |   |         |  
|---------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                     |  | Three Months EndedMarch 31, |        
|                                                     |  | 2004                        |         |   | 2005 |  
|Operating revenue                                    |  | $                           | 40,814  |   |      | $ | 166,959 |  
|Costs of revenue                                     |  |                             | 45,426  |   |      |   | 80,419  |  
|                                                     |  |                             |         |   |      |   |         |  
|Gross profit (loss)                                  |  |                             | (4,612  | ) |      |   | 86,540  |  
|Selling, general and administrative expenses         |  |                             | 7,767   |   |      |   | 18,071  |  
|                                                     |  |                             |         |   |      |   |         |  
|Operating income (loss)                              |  |                             | (12,379 | ) |      |   | 68,469  |  
|Interest income (expense), net                       |  |                             | (3,541  | ) |      |   | 669     |  
|Other expense, net of other income                   |  |                             | (9,232  | ) |      |   | (287    | )
|                                                     |  |                             |         |   |      |   |         |  
|Income (loss) before income taxes                    |  |                             | (25,152 | ) |      |   | 68,851  |  
|Provision for income taxes                           |  |                             | 303     |   |      |   | 23,178  |  
|                                                     |  |                             |         |   |      |   |         |  
|Net income (loss)                                    |  | $                           | (25,455 | ) |      | $ | 45,673  |  
|                                                     |  |                             |         |   |      |   |         |  
|Basic net income (loss) per share                    |  | $                           | (0.33   | ) |      | $ | 0.44    |  
|Diluted net income (loss) per share                  |  | $                           | (0.33   | ) |      | $ | 0.44    |  
|                                                     |  |                            
|Shares used in computing net income (loss) per share |  |                             |         |   |      |   |         |  
|Basic                                                |  |                             | 76,636  |   |      |   | 102,985 |  
|Diluted                                              |  |                             | 76,636  |   |      |   | 104,616 |  



See accompanying notes.



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DREAMWORKS ANIMATION SKG, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



|                                                                                         |  |           |         |   |      |   |         |  
|---------------------------------------------------------------------------------------- |  | --------- | ------- | - | ---- | - | ------- | -
|                                                                                         |  | March 31, |        
|                                                                                         |  | 2004      |         |   | 2005 |  
|Operating activities                                                                     |  |           |         |   |      |   |         |  
|Net income (loss)                                                                        |  | $         | (25,455 | ) |      | $ | 45,673  |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |           |         |   |      |   |         |  
|Amortization and write off of film inventories                                           |  |           | 20,065  |   |      |   | 77,269  |  
|Stock compensation expense (benefit)                                                     |  |           | (1,149  | ) |      |   | 4,556   |  
|Depreciation and amortization                                                            |  |           | 1,387   |   |      |   | 1,947   |  
|Change in operating assets and liabilities:                                              |  |           |         |   |      |   |         |  
|Trade accounts receivable                                                                |  |           | 86,139  |   |      |   | 8,437   |  
|Receivables from employees                                                               |  |           | 220     |   |      |   | 185     |  
|Receivable from affiliate                                                                |  |           |        |   |      |   | 308,306 |  
|Film inventories                                                                         |  |           | (72,890 | ) |      |   | (90,103 | )
|Other assets                                                                             |  |           | (550    | ) |      |   | (15,154 | )
|Accounts payable and accrued expenses                                                    |  |           | (7,589  | ) |      |   | (5,645  | )
|Income taxes, net                                                                        |  |           |        |   |      |   | 22,982  |  
|Advances and unearned revenue                                                            |  |           | 5,650   |   |      |   | 18,784  |  
|                                                                                         |  |           |         |   |      |   |         |  
|Net cash provided by operating activities                                                |  |           | 5,828   |   |      |   | 377,273 |  
|                                                                                         |  |           |         |   |      |   |         |  
|Investing activities                                                                     |  |           |         |   |      |   |         |  
|Purchases of property, plant, and equipment                                              |  |           | (179    | ) |      |   | (1,737  | )
|                                                                                         |  |           |         |   |      |   |         |  
|Net cash used in investing activities                                                    |  |           | (179    | ) |      |   | (1,737  | )
|                                                                                         |  |           |         |   |      |   |         |  
|Financing activities                                                                     |  |           |         |   |      |   |         |  
|Net transfers to DreamWorks Studios                                                      |  |           | (21,073 | ) |      |   |        |  
|Bank borrowings and other debt                                                           |  |           | 5,072   |   |      |   | 4,837   |  
|Increase in debt allocated from DreamWorks Studios                                       |  |           | (38,317 | ) |      |   |        |  
|Payments on capital leases                                                               |  |           | (180    | ) |      |   | (195    | )
|Receipts from exercises of stock options                                                 |  |           |        |   |      |   | 1,769   |  
|Purchases of treasury stock                                                              |  |           |        |   |      |   | (42     | )
|Universal Studios and other advances                                                     |  |           | 48,849  |   |      |   |        |  
|                                                                                         |  |           |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                                      |  |           | (5,649  | ) |      |   | 6,369   |  
|                                                                                         |  |           |         |   |      |   |         |  
|Increase in cash and cash equivalents                                                    |  |           |        |   |      |   | 381,869 |  
|Cash and cash equivalents at beginning of period                                         |  |           | 41      |   |      |   | 63,134  |  
|                                                                                         |  |           |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                               |  | $         | 41      |   |      | $ | 445,003 |  
|                                                                                         |  |           |         |   |      |   |         |  



See accompanying notes.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS



1. Organization and Basis of Presentation



Business



DreamWorks Animation (the Company) has been developing and producing animated films as a division of DreamWorks L.L.C. (DreamWorks
Studios) since its formation in 1994. On October 27, 2004 (Separation Date), the Company was spun off from DreamWorks Studios. As a result of the separation from DreamWorks Studios (the Separation), the assets and
liabilities that comprised the animation business of DreamWorks Studios were transferred to DreamWorks Animation SKG, Inc., the entity through which the Company now conducts it business. Immediately thereafter, the Company sold shares to the public
as a part of an initial public offering that closed November 2, 2004. The consolidated financial statements of DreamWorks Animation SKG, Inc. present the stand-alone financial position, results of operations, and cash flows of the animation
businesses and activities of DreamWorks Studios and its consolidated subsidiaries on a combined basis up through the Separation Date, and the consolidated financial position, results of operations and cash flows of DreamWorks Animation SKG, Inc.
thereafter. In the accompanying consolidated financial statements and footnotes, DreamWorks Animation or the Company are terms used interchangeably to refer to DreamWorks Animation SKG, Inc. as well as its predecessor. The
businesses and activities of DreamWorks Studios animation business included the development, production and exploitation of animated films in the domestic and international theatrical, home video, television and other markets, as well the
activities of its consumer products division. DreamWorks Studios is a limited liability company that prior to the Separation Date engaged primarily in the businesses of development, production and distribution of live action and animated feature
films. The consolidated financial statements of the Company prior to the Separation Date reflect all adjustments, including allocations of costs incurred by DreamWorks Studios, necessary for a fair presentation of the operations of the Company.
After the Separation Date, the consolidated financial statements of the Company include the accounts of DreamWorks Animation SKG, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.



Upon the Separation, the Company authorized three classes of
common stock which are identical and generally vote together on all matters, except that the Class A common stock and the Class C common stock each carry one vote per share, whereas the Class B common stock carries 15 votes per share. In addition,
the Class C common stock, voting separately as a class, has the right to elect one director. The Class A, Class B and Class C common stock each have a par value of $.01 per share and authorized shares of 350 million, 150 million and one,
respectively.



As of the Separation, DreamWorks Studios and
DreamWorks Animation are effectively under common ownership and control.



In connection with the Separation, the Company assumed $325 million of debt that DreamWorks Studios had borrowed under its revolving credit facility and $80 million of subordinated debt DreamWorks Studios owed to HBO.
In addition, the Company borrowed $101.4 million under a new revolving credit facility to repay an equivalent amount of debt of DreamWorks Studios.



In connection with the Separation, DreamWorks Studios contributed to the Company its interests in Pacific Data Images, Inc. (PDI) and its
subsidiary, Pacific Data Images LLC (PDI LLC). Prior to the contribution, PDI was an approximately 90% owned subsidiary of DreamWorks Studios. PDIs sole asset was its 60% ownership interest in PDI LLC. The remaining 40% interest in
PDI LLC was owned directly by DreamWorks Studios. As part of the contribution, DreamWorks Studios contributed its 40% interest in PDI LLC to the Company in exchange for shares of Class A Common stock of the Company. Both DreamWorks Studios and the
minority stockholders of PDI received shares of the Companys Class A common stock pursuant to the merger.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



As a result of these transactions, PDI became a wholly owned subsidiary of the Company and PDI LLC became a wholly owned subsidiary of PDI.



The acquisition of the approximately 10% minority interest in PDI has been
accounted for as a purchase of minority interest and, accordingly, the Company recorded goodwill for the purchase price over the fair value of the assets acquired of $7.8 million.



Effective October 2004, the Company entered into the Distribution Agreement (the Distribution Agreement) with
DreamWorks Studios. Pursuant to the Distribution Agreement, the Company has granted DreamWorks Studios the exclusive right to distribute, throughout the world, all of it animated feature films that it delivers to DreamWorks Studios through the later
of (i) delivery of 12 animated feature films, beginning with Shark Tale, and (ii) December 31, 2010. DreamWorks Studios is responsible for (1) the domestic and international theatrical exhibition of the Companys films, (2) the domestic
and international home video exhibition of the Companys films and direct-to-video pictures, (3) the domestic and international television licensing of the Companys films, including pay-per-view, pay television, network, basic cable and
syndication, and (4) non-theatrical exhibition of the Companys films, such as on airlines, in schools and in armed forces institutions. DreamWorks Studios was also granted Internet, radio (for promotional purposes only) and new media rights
with respect to the Companys films. The Company has retained all other rights to exploit the films, including the right to make sequels, commercial tie-in and promotional rights with respect to each film, as well as merchandising, interactive,
literary publishing, music publishing, soundtrack, radio, legitimate stage and theme park rights.



Pursuant to the Distribution Agreement, DreamWorks Animation is responsible for all of the costs of developing and producing its animated feature films,
and for contingent compensation and residual payments. DreamWorks Studios is generally responsible for all out-of-pocket costs, charges and expenses incurred in the distribution (including prints and the manufacture of home video units),
advertising, marketing, publicizing and promotion of the films, and has agreed to make distribution expenditures consistent with historical levels with respect to its films. The Distribution Agreement also provides that DreamWorks Studios will be
entitled to (1) retain a fee of 8.0% of revenue (without deduction of any distribution or marketing costs, and third-party distribution and fulfillment services fees) and (2) recoup all of its distribution and marketing costs prior to the Company
recognizing any revenue.



Upon the Separation, the Company
entered into a services agreement with DreamWorks Studios (the Services Agreement) that provides for certain services to be provided to the Company by DreamWorks Studios, including risk management, information systems management,
payroll, legal and certain business affairs advisory, human resources administration, procurement, and other general support services. The Services Agreement also provides that the Company will provide certain services for DreamWorks Studios
including information technology procurement and office space and facilities management services. The Services Agreement requires both parties to reimburse the other party for its actual costs incurred, plus 5%.



In November 2004, the Company issued shares of Class A common stock and
received approximately $635.5 million in net proceeds from the closing of its initial public offering after deducting underwriting discounts, and commissions and offering expenses. From those net proceeds the Company repaid the $325 million of debt
assumed with respect to DreamWorks Studios revolving credit facility and $30 million of the $80 million assumed with respect to DreamWorks Studios subordinated debt owed to HBO. Later in the fourth quarter of 2004, the Company also repaid the $101.4
million of debt borrowed under its revolving credit facility to fund the acquisition of its library of films from DreamWorks Studios.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Basis of 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 of the results of operations 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.



The preparation of consolidated
financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and
related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to provisions for future returns on home video product, uncollectible receivables, the useful lives of
long-lived assets including property and equipment, goodwill, income taxes and contingencies. In addition, the Company uses assumptions when employing the Black-Scholes option valuation model to estimate the fair value of stock options granted. The
Company bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily
available from other sources. Actual results may differ from these estimates.



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, 2004.



Certain amounts in prior years balance sheet and
statement of cash flows have been reclassified to conform to the current year presentation.



Stock-Based Compensation



In December 2004, the Financial Accounting Standards Board issued FAS No. 123 (revised 2004), Share-Based Payment (FAS 123R), which establishes standards for transactions in which an entity exchanges its equity
instruments for goods or services. This standard requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. This eliminates the exception
to account for such awards using the intrinsic method previously allowable under Accounting Principles Board Opinion No. 25, Accounting for Stock issued to Employees (APB 25). In March 2005, the Securities and Exchange
Commission (SEC) released Staff Accounting Bulletin (SAB) 107, Share-Based Payment, which expresses views of the SEC Staff about the application of FAS 123R. FAS 123R was to be effective for interim or annual reporting
periods beginning on or after June 15, 2005, but in April 2005 the SEC issued a rule that FAS 123R will be effective for annual reporting periods beginning on or after June 15, 2005.



The Company elected to adopt FAS 123R as of January 1, 2005. FAS 123R offers alternative adoption methods. The Company has
elected to use the modified prospective transition method and has not restated prior periods. Under this method the Company has recognized compensation costs for equity awards to employees based on their grant-date fair value from January 1, 2005.
Measurement and attribution of compensation cost for equity awards that were granted to employees prior to, but not vested as of January 1, 2005, were based on the same estimate of the grant-date fair value and the same attribution method that we
used previously for financial statement pro forma disclosure purposes under the provisions of FAS No. 123, Accounting for Stock-Based Compensation (FAS 123). For those equity awards to employees granted or settled after January 1,
2005, compensation cost will be measured and recognized in the financial statements in accordance with the provisions of FAS 123R.



In connection with the Separation the Company issued various equity awards to its employees. As of December 31, 2004, the Company had recorded deferred
compensation costs, net of amortization, of $32.2



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



million (determined based on grant-date fair value) related to unvested restricted stock awards to its employees. Prior to January 1, 2005, the Company
followed the provisions of FAS 123 and, as allowed under FAS 123, had been following the intrinsic value method set forth in APB 25 for stock option awards granted to employees at the Separation and the Companys initial public offering.



Upon adoption of FAS 123R, as of January 1, 2005, the Company
reversed the deferred compensation costs, net of amortization of $32.2 million, with a corresponding reduction to the Companys Additional paid-in capital. Compensation cost related to unvested restricted stock awards granted to employees
continues to be recognized on a straight-line basis over a four to seven year period with a corresponding increase to the Companys Additional paid in capital.



The Company granted approximately 1.0 million shares of restricted stock awards to employees in the three months ended March
31, 2005, substantially all related to the grant of restricted stock with performance criteria for certain named executive officers. Compensation costs were recorded for these awards in the period as management determined it was probable that the
objective performance goals over a four-year performance period set by the Compensation Committee of the Companys Board of Directors (the Committee) will be achieved.



Upon adoption of FAS 123R, beginning January 1, 2005, the Company is no longer using the intrinsic value method of
accounting for stock option awards granted to Company employees. The Company is now recognizing compensation costs for stock option awards to employees based on their grant-date fair value from January 1, 2005. The fair value of each stock option
grant is estimated on the date of grant using the Black-Scholes option-pricing model. For stock options granted to employees at the Separation and the initial public offering, which were the only such awards granted prior to January 1, 2005, the
weighted average fair value was $13.40. Values were estimated using a zero dividend yield, expected volatility of 50%, risk free interest rate range of 2.23% to 3.78% and a weighted average expected lives of 5.5 years. The weighted average fair
value of stock options granted to employees for the three months ended March 31, 2005 was $20.88. Values were estimated using a zero dividend yield, expected volatility of 40.5%, and a risk free interest rate range of 3.70% to 4.10%. As permitted by
SAB 107, the Company determined the weighted average expected lives as being equal to the average of the vesting term and contractual term of each stock option granted. The Company granted approximately 0.7 million shares underlying stock option
awards to employees during the three months ended March 31, 2005, substantially all related to the grant of stock options with performance criteria for certain named executive officers. Compensation costs were recorded for these awards in the period
as management determined it was probable that the objective performance goals over a four-year performance period set by the Committee will be achieved.



In January, 2005, performance compensation awards with respect to approximately 1.0 million shares of Common Stock were granted to certain named executive
officers. No compensation costs were recorded for these awards in the period as management determined that it was not probable that the objective performance goals over a four- year performance period set by the Committee will be achieved.



As required by FAS 123R, management made an estimate of
expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest. The impact on previously reported pro forma disclosures under FAS No. 123 where forfeitures were recognized as incurred is not material and
therefore the Company did not record an adjustment for a cumulative effect of an accounting change. As of March 31, 2005, the total compensation cost related to unvested equity awards granted to employees but not yet recognized was approximately
$90.8 million. This cost will be amortized on a straight-line basis over a weighted average of 4.9 years.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company recorded compensation expense of $4.6 million for the three months ended March 31, 2005,
compared to a stock compensation credit of $1.2 million for the three months ended March 31, 2004, which reflected a reduction in the redemption value of the underlying awards which were subject to the variable accounting of APB 25. Changes to the
Companys underlying stock price or satisfaction of performance criteria for performance-based awards granted to employees could significantly impact compensation expense to be recognized in 2005 and future periods. In addition, future grants
of equity awards will result in additional compensation expense in 2005 and future periods.



2. Earnings Per Share Data



Basic per share amounts exclude dilution and is the weighted average number of common shares outstanding for the period. Unless the effects are anti-dilutive, diluted per share amounts reflect the potential reduction in earnings per share
that could occur if equity based awards were exercised or converted into common stock. For the three months ended March 31, 2004, basic per share amounts are calculated using the number of shares of common stock outstanding immediately following the
Separation, but not including the shares issued in our initial public offering, as if such shares were outstanding for the entire period. For the three months ended March 31, 2005, basic per share amounts are calculated using the weighted average
number of common shares outstanding during the period.



For the
three months ended March 31, 2004, diluted per share amounts are calculated using the number of shares of common stock outstanding immediately following the Separation, but not including the shares issued in the Companys initial public
offering, as if such shares were outstanding for the entire period, excluding, because their effect would be anti-dilutive, the impact of 487,000 shares of Class A common stock which underlie equity based compensation awards converted at the
Separation. For the three months ended March 31, 2005, diluted per share amounts are calculated using the weighted average number of common shares outstanding during the period and, if dilutive, potential common shares outstanding during the period.
Potential common shares include unvested restricted stock and common shares issuable upon exercise of stock options using the treasury stock method. For the three months ended March 31, 2005, options to purchase 2.3 million shares were not included
in the calculation of diluted per share amounts because these options were anti-dilutive. Options to purchase 0.7 million shares of common stock, 1.0 million shares of unvested restricted stock, and 1.0 million performance stock awards granted to
certain named executive officers were not included in the calculation of diluted per share amounts because the number of shares ultimately issued is contingent upon the Companys performance against measures established for the performance
period.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table sets forth the computation of basic and diluted net income (loss) per share (in
thousands except per share amounts)



|                                                                      |  |                              |         |   |      |   |        
|--------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---- | - | -------
|                                                                      |  | Three Months Ended March 31,
|                                                                      |  | 2004                         |         |   | 2005
|Numerator:                                                            |  |                              |         |   |      |   |        
|Net income (loss)                                                     |  | $                            | (25,455 | ) |      | $ | 45,673 
|Denominator:                                                          |  |                              |         |   |      |   |        
|Weighted average common shares and denominator for basic calculation  |  |                              | 76,636  |   |      |   | 102,985
|                                                                      |  |                              |         |   |      |   |        
|Weighted average effects of dilutive equity-based compensation awards |  |                              |         |   |      |   |        
|Employee stock options                                                |  |                              |        |   |      |   | 514    
|Unvested restricted shares                                            |  |                              |        |   |      |   | 1,117  
|                                                                      |  |                              |         |   |      |   |        
|Denominator for diluted calculation                                   |  |                              | 76,636  |   |      |   | 104,616
|                                                                      |  |                              |         |   |      |   |        
|Net income (loss) per sharebasic                                     |  | $                            | (0.33   | ) |      | $ | 0.44   
|Net income (loss) per sharediluted                                   |  | $                            | (0.33   | ) |      | $ | 0.44   
|                                                                      |  |                              |         |   |      |   |        



3. Advances



DreamWorks Studios has received advances from Home Box Office, Inc.
(HBO) against license fees payable for future film product under an exclusive 10-year domestic pay television license agreement between HBO and DreamWorks Studios. Since the advances are identified for each film, the Company has been
allocated the portion of the advances related to its animated features. During the three months ended March 31, 2005, the Company recognized as revenue $0.3 million of such advances, representing a portion of the license fee due from HBO upon
availability of the underlying films. No such revenues were recognized in the three months ended March 31, 2004. As of December 31, 2004 and March 31, 2005, there were $16.9 million and $29.9 million respectively, in unrecognized advances from HBO.
DreamWorks Studios and the Company are obligated to refund the advances if the advances exceed the license fees earned by the films in accordance with the HBO agreement.



In the normal course of business, the Company received advances for licensing of the Companys animated characters from
various customers on a worldwide basis. As of December 31, 2004 and March 31, 2005, the Company had unearned licensing advances of $10.6 million and $13.3 million, respectively.



4. Film Inventories



The following is an analysis of film inventories (in thousands):



|                                   |  |                   |         |                |   |        
|---------------------------------- |  | ----------------- | ------- | -------------- | - | -------
|                                   |  | December 31, 2004 |         | March 31, 2005
|In development:                    |  |                   |         |                |   |        
|Animated feature films             |  | $                 | 42,531  |                | $ | 68,298 
|In production:                     |  |                   |         |                |   |        
|Animated feature films             |  |                   | 254,940 |                |   | 307,097
|In release, (net of amortization): |  |                   |         |                |   |        
|Animated feature films             |  |                   | 221,048 |                |   | 156,811
|Television series                  |  |                   | 1,407   |                |   | 554    
|                                   |  |                   |         |                |   |        
|Total film inventories             |  | $                 | 519,926 |                | $ | 532,760
|                                   |  |                   |         |                |   |        



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The Company anticipates that 87% of in release inventory as of March 31, 2005 will be
amortized over the next three years. The Company further anticipates that 33% of in release inventory will be amortized over the next twelve months.



Interest capitalized to film inventories during the three months ended March 31, 2004 and 2005 totaled $2.2 million and $3.2 million, respectively.



5. Financing Arrangements



(a) Animation Campus Financing.    In May 1996,
DreamWorks Animation entered into an agreement with a financial institution for the construction of an animation campus in Glendale, California, and the subsequent lease of the facility upon its completion in early 1998. The lease on the property,
which was acquired and financed by the financial institution for $76.5 million, qualified as an operating lease for the Company. In March 2002, the Company renegotiated the lease through the creation of a special-purpose entity that acquired the
property from the financial institution for $73.0 million and the special-purpose entity leased the facility to the Company for a five-year term. This transaction was structured to qualify as an operating lease and obligated the Company to provide a
residual value guarantee of approximately $61 million. The entire amount of the obligation, $70.1 million at March 31, 2005, is due and is payable in March 2007. In connection with the adoption of Interpretation 46, the special-purpose entity has
been consolidated by the Company as of December 31, 2003.



(b) Production Financing.    In October 2003, the Company entered into an agreement to acquire an animated film currently in production. Pursuant to the acquisition agreement, the Company will pay approximately
$45.0 million to acquire substantially all distribution rights to the film. Of this amount, $34.9 million and $42.4 million had been paid as of December 31, 2004, and March 31, 2005, respectively. In connection with the acquisition, DreamWorks
Studios entered into loan agreements for the financing of the production costs of up to approximately $27.8 million. Of this amount, $21.6 million and $27.4 million had been incurred as of December 31, 2004, and March 31, 2005, respectively. This
obligation is included in Other Debt and Film Inventories in the accompanying consolidated balance sheets and will be repaid when the film is completed in 2005. The loan agreement is secured by a perfected first security interest in all rights and
title to the film and is cross-defaulted with the Companys revolving credit facility. The Company has entered into certain foreign exchange transactions intended to hedge the fluctuations of foreign currency payments related to the acquisition
of this film. Pursuant to these transactions, the Company is obligated to purchase up to 16.7 million British pounds at an exchange rate specified in the transaction documents. These transactions do not quality for special hedge accounting and,
accordingly, changes in the fair value of these agreements are recorded as Other Income/Expense in the accompanying consolidated statements of operations. At December 31, 2004, and March 31, 2005, the banks would be required to pay the Company
approximately $2.7 million and $1.9 million, respectively, to terminate the foreign currency agreements. These amounts have been recorded in Other Assets in the accompanying consolidated financial statements.



(d) Universal Studios Advance.    In prior years,
DreamWorks Studios entered into several agreements with Vivendi Universal Entertainment LLLP (Universal) and its affiliates to provide international theatrical distribution and international and domestic home video fulfillment services.
In 2001, DreamWorks Studios amended and extended its agreements with Universal (the 2001 Universal Agreement). In accordance with the Universal Agreement, DreamWorks Studios received an advance against amounts due to DreamWorks Studios
based on the projected net receipts, as defined, of pictures in release and certain pictures in production or pre-production (the 2001 Advance). DreamWorks Studios is required to provide to Universal quarterly estimates of projected cash
receipts, net of projected expenses, distribution and service fees, due to DreamWorks Studios from Universal in the markets where Universal provides distribution and fulfillment services (the Pipeline Estimate).



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In October 2003, DreamWorks Studios entered into a new amended and restated agreement with Universal
(the 2003 Universal Agreement). The 2003 Universal Agreement extends the terms of the international theatrical distribution and international and domestic home video fulfillment services agreements until December 31, 2010, with an option
for Universal to extend the term for an additional one or two years if certain performance thresholds are not met. Pursuant to the 2003 Universal Agreement, DreamWorks Studios retains responsibility for all direct distribution costs and Universal
receives a fee for distribution and fulfillment services.



Pursuant to the 2003 Universal Agreement, Universal agreed to pay to DreamWorks Studios an additional advance of $75 million (the 2003 Advance), of which $37.5 million was received in December 2003 and $37.5 million was received
in March 2004. The entire 2003 Advance is based on projected net receipts, as defined, of the Companys animated features released subsequent to December 31, 2002 and of certain animated pictures in production or pre-production. As a result,
100% of the 2003 Advance has been allocated to the Company and is included in Universal Studios advance in the accompanying consolidated balance sheets. The 2003 Advance bears interest at a rate of 8.75% per annum.



If future Pipeline Estimates fall below the levels required to maintain the
maximum advance (which, as of March 31, 2005, would be $86.2 million), the excess advance must be repaid within five business days. The advances are otherwise not recoupable or refundable until the earlier of a payment default or termination of the
Universal Agreements. Management does not expect any amounts to be payable in 2005.



In the event that the Distribution Agreement with DreamWorks Studios is terminated, the Company remains subject to the terms of the DreamWorks Studios 2003 Universal Agreement, including the obligation to pay
distribution fees and to pay distribution expenses as they are incurred. The Company will not have the right to terminate the 2003 Universal Agreement unless and until (i) DreamWorks Studios has repaid all amounts it owes to Universal Studios,
including in respect of investments and advances which aggregate $175 million as of December 31, 2004, (ii) the Company has repaid all amounts owed to Universal Studios, and (iii) Universal Studios has received an aggregate of $75 million of net
proceeds from the sale of shares of the Companys common stock.



(d) Revolving Credit Facility.    In connection with the Separation, the Company entered into a five-year $200 million revolving credit facility with a number of banks. The credit facility is secured by
substantially all of the Companys assets. Interest on borrowed amounts is determined either at a floating rate of LIBOR plus 1.75% or the alternate base rate (which is generally the prime rate) plus 0.75% per annum. In addition, the Company is
required to pay a commitment fee on undrawn amounts at an annual rate of 0.50% on any date when more then $100 million is outstanding under the credit facility and 0.75% on any other date. The credit agreement requires the Company to maintain
certain financial ratios.



The Company borrowed $101.4 million
on the credit facility in October 2004 to repay an equivalent amount of debt of DreamWorks Studios assumed in connection with the Separation. In November 2004, the Company repaid the entire outstanding balance. As of March 31, 2005 there were no
borrowings on the credit facility.



(e) HBO Subordinated
Notes.    In connection with the Separation, the Company assumed $80 million of subordinated notes issued by DreamWorks Studios in December 2000 pursuant to a subordinated loan agreement, $30 million of which was repaid with
the proceeds from the Companys initial public offering. The subordinated notes bear interest in amount equal to the Eurodollar rate plus 0.50% per annum and are due in November 2007. The subordinated notes are secured by a lien in favor of HBO
that is junior to the security interest in certain exhibition rights related to DreamWorks Studios films. The subordinated notes are recorded net of a discount of $3.7 million, which is to be amortized to interest expense over the remaining term of
the subordinated loan



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



agreement. In the event that DreamWorks Studios ceases to be the Companys distributor, the Company remains obligated to continue to license its films
to HBO under the terms of DreamWorks Studios license agreement with HBO. The terms of the notes require the Company to maintain certain financial ratios.



As of March 31, 2005 the Company was in compliance with all applicable debt covenants.



6. Related Party Transactions



Pursuant to the Distribution Agreement, the Company incurred distribution fees payable to DreamWorks Studios of $21.8 million during the three months
ended March 31, 2005.



Pursuant to the Services Agreement, the
Company reimbursed DreamWorks Studios $2.3 million and DreamWorks Studios reimbursed the Company $1.3 million during the three months ended March 31, 2005.



For the three months ended March 31, 2005, the distribution and marketing expenses (including its distribution fee) incurred by DreamWorks Studios
exceeded the revenues recorded for Shrek 2, primarily related to its worldwide home video distribution, including returns of domestic home video units in excess of amounts previously estimated by DreamWorks Studios. Pursuant to the
Distribution Agreement, DreamWorks Studios is responsible for all costs incurred in the distribution of the Companys films and is entitled to recoup these distribution and marketing expenses incurred for Shrek 2 before the Company can
record any additional revenue from the exploitation of this film. As a result, DreamWorks Studios must recoup approximately $24.7 million of distribution and marketing costs in future periods before the Company recognizes any additional revenues
from the exploitation of Shrek 2.



As of December 31,
2004 and March 31, 2005, the Company had a receivable from DreamWorks Studios of approximately $385.4 million and $77.1 million, respectively. The Company has made loans to certain of its employees pursuant to various notes receivable arrangements.
These arrangements require interest to be paid at rates ranging from 0% to 5.88%. Payments are due under terms ranging from 1 to 10 years. Amounts due at December 31, 2004, and March 31, 2005, are reflected in Receivables from Employees in the
accompanying consolidated balance sheets. Interest income associated with these notes receivable for the three months ended March 31, 2004 and 2005 respectively was not material. As of March 31, 2005, the Company had no loans outstanding to named
executive officers.



The Company provides services to
DreamWorks Studios related to the licensing of products based on DreamWorks Studios films and characters in such films. In the three months ended March 31, 2004, revenues earned from licensing activities on behalf of DreamWorks Studios totaled
$0.2 million, and was not material for the three months ended March 31, 2005.



The Company has an arrangement with an affiliate of a stockholder to share tax benefits generated by the stockholder. See Note 9.



7. Significant Customer, Segment and Geographic Information



For the three months ended March 31, 2004, Universal Studios represented 75% of total revenue. If the Distribution Agreement
had not been in effect, Universal Studios would have represented 94% of revenues for the three months ended March 31, 2005.



The Company operates in a single segment: the production and distribution of animated films. Revenues attributable to foreign countries were approximately
$32.5 million and $55.4 million, respectively, for the three months ended March 31, 2004 and 2005. Long-lived assets located in foreign countries were not material.



Pursuant to the terms of the distribution agreements in place at DreamWorks Studios, whereby DreamWorks Studios has not been
responsible for collecting foreign currency, there is a relatively short period between revenue recognition and cash payment. DreamWorks Studios generally has not used foreign currency swap transactions to hedge foreign currency exchange risks
associated with these distribution agreements.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following is an analysis of the Companys revenue by film (in thousands):



|                                 |  |                             |        |      |   |        
|-------------------------------- |  | --------------------------- | ------ | ---- | - | -------
|                                 |  | Three Months EndedMarch 31,
|                                 |  | 2004                        |        | 2005
|Spirit: Stallion of the Cimmaron |  | $                           | 7,280  |      | $ | 3,430  
|Sinbad: Legend of the Seven Seas |  |                             | 12,980 |      |   | 2,697  
|Shrek 2                          |  |                             |       |      |   | 8,571  
|Shark Tale                       |  |                             |       |      |   | 142,436
|Film Library / Other(1)          |  |                             | 20,554 |      |   | 8,361  
|Television Series                |  |                             |       |      |   | 1,464  
|                                 |  |                             |        |      |   |        
|                                 |  | $                           | 40,814 |      | $ | 166,959
|                                 |  |                             |        |      |   |        

---

|(1) | Primarily includes film library revenue from Antz, Prince of Egypt, The Road to El Dorado, Chicken Run,Joseph: King of Dreams and Shrek.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------



8. Accrued Liabilities



Accrued liabilities consists of the following (in thousands):



|                             |  |                  |        |                |   |       
|---------------------------- |  | ---------------- | ------ | -------------- | - | ------
|                             |  | December 31,2004 |        | March 31, 2005
|Salaries and benefits        |  | $                | 7,022  |                | $ | 5,090 
|Participations and residuals |  |                  | 32,692 |                |   | 29,744
|Production costs             |  |                  | 6,443  |                |   | 5,853 
|Occupancy                    |  |                  | 9,844  |                |   | 9,615 
|Other accrued liabilities    |  |                  | 9,536  |                |   | 5,830 
|                             |  |                  |        |                |   |       
|                             |  | $                | 65,537 |                | $ | 56,132
|                             |  |                  |        |                |   |       



9. Income Taxes



Effective as of the Separation, the Company is taxed at regular corporate
rates. Deferred tax assets and liabilities are recognized for the tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets
and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. A deferred tax asset valuation allowance will be recorded if it
is more likely than not that all or a portion of the recorded deferred tax assets will not be realized.



For the three months ended March 31, 2005, the Company recorded income tax expense of $23.2 million, or an effective tax rate of 34%. The Companys
effective tax rate was lower than the statutory tax rate primarily as a result of the recognition of federal tax benefits for income earned outside the U.S. and qualifying manufacturing activities under the Jobs Creation Act of 2004. For the three
months ended March 31, 2004, the Company was not subject to federal income taxes but recorded tax expense of $0.3 million for foreign withholding and state franchise taxes.



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DREAMWORKS ANIMATION SKG, INC.



NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



At the time of the Separation, affiliates controlled by a stockholder entered into a series of
transactions that resulted in a partial increase in the tax basis of the Companys tangible and intangible assets. This partial increase in tax basis is expected to reduce the amount of tax that the Company may pay in the future, to the extent
that the Company generates taxable income in sufficient amounts in the future. The Company is obligated to remit to the stockholders affiliate 85% of any such cash savings in U.S. Federal income tax and California franchise tax and certain
other related tax benefits, subject to repayment if it is determined that these savings should not have been available to the Company. At the time of the Separation, the increase in the tax basis of the assets was approximately $1.64 billion,
resulting in a deferred tax asset of approximately $620 million. A substantial portion of these potential tax benefits may be realized over approximately 15 years. As a result of the taxable income generated by the Company from the Separation Date
through December 31, 2004, the Company expects to realize $6.5 million in tax benefits as a result of the increased basis in the assets for the period from October 28, 2004 through December 31, 2004. The Company also expects to receive a tax benefit
of $76.6 million in future years as management has determined that the benefits can be realized through a refund of taxes paid in 2004. Accordingly, the Company has recorded a liability to the stockholders affiliate of approximately $70.6
million representing 85% of these recognized benefits as of December 31, 2004 and March 31, 2005. All of the tax benefits to the Company and related obligation to an affiliate of a stockholder described in this section have been recognized as a
component of stockholders equity and have not impacted the Companys operating results.



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|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------



This Managements Discussion and Analysis of Financial Condition and Results of Operations contains
forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995, particularly statements referencing the targeted release dates of our feature films, our anticipated operating
expenses and capital expenditures, and our expectations regarding any future distribution agreement into which we may enter. In some cases, forward-looking statements can be identified by the use of words such as may, could,
would, might, will, should, expect, forecast, predict, potential, continue, anticipates, expects,
intends, plans, believes, seeks, estimates, is scheduled for, targeted, and variations of such words and similar expressions. Such forward-looking statements are
based on current expectations, estimates, and projections about our industry, managements beliefs, and assumptions made by management. These statements are not guarantees of future performance and are subject to certain risks, uncertainties
and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein
under Risk Factors on pages 28 through 43. Particular attention should be paid to the cautionary language in Risk Factors Our success is primarily dependent on audience acceptance of our films, which is extremely difficult to
predict and therefore inherently risky, Our business is dependent upon the success of a limited number of releases each year and the commercial failure of any one of them could have a material adverse effect on our business,
Our operating results fluctuate significantly, The production and marketing of CG animated films is capital intensive and our capacity to generate cash from our films may be insufficient to meet our anticipated cash
requirements, and Our scheduled releases of CG animated feature films will place a significant strain on our resources. Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether
as a result of new information, future events or otherwise. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those listed under Risk
Factors and discussed elsewhere in this Form 10-Q, in our other filings with the SEC or in materials incorporated therein by reference.



The information discussed below should be read in conjunction with the Managements Discussion and Analysis of Financial Condition and Results
of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC, which contains additional information concerning our financial statements.



Overview



We have been developing and producing animated films as a division of DreamWorks Studios since its formation in 1994. Our
business (the Animation Business) includes the development, production and exploitation of animated films in the domestic and international theatrical, home video, television and other markets, as well as consumer products activities.
Prior to October 27, 2004 (the Separation Date), we were a division of DreamWorks Studios and our operations were conducted through DreamWorks Studios. DreamWorks Studios is a limited liability company formed in 1994 that, prior to the
Separation Date, engaged primarily in the businesses of developing, producing and distributing live action and animated feature films. As a result of our separation from DreamWorks Studios (the Separation), the assets and liabilities
that comprised the Animation Business were transferred to DreamWorks Animation SKG, Inc., the entity through which we now conduct our business. Prior to the Separation, our assets, liabilities and operating results were included in DreamWorks
Studios financial statements.



We have theatrically
released a total of nine animated feature films, including Antz, Shrek, Shrek 2and Shark Tale. We have a substantial number of projects in development that are expected to fill our release schedule through 2007 and beyond. The table
below lists our next six films and their anticipated release schedule.



| |  |  | Madagascar (release on May 27, 2005)
| | - |  | ------------------------------------



| |  |  | Wallace and Gromit: Curse of the Were Rabbit (release on October 7, 2005)
| | - |  | -------------------------------------------------------------------------



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| |  |  | Over the Hedge (release on May 19, 2006)
| | - |  | ----------------------------------------



| |  |  | Flushed Away (release on November 4, 2006)
| | - |  | ------------------------------------------



| |  |  | Shrek 3 (release on May 18, 2007)
| | - |  | ---------------------------------



| |  |  | Bee Movie (release on November 2, 2007)
| | - |  | ---------------------------------------



Release dates are tentative. Due to the uncertainties involved in the development and production of animated feature films, the date of their completion
can be significantly delayed.



Distribution Agreement with DreamWorks
Studios



We entered into several agreements with
DreamWorks Studios in connection with the Separation, including the Distribution Agreement. Under the Distribution Agreement, which is described below, DreamWorks Studios uses film receipts to recover the distribution and marketing expenses it
incurs for a film and to cover its distribution fee. Accordingly, we only record revenue from film receipts to the extent it exceeds these costs. As a result, we expect that our revenue will be principally derived from the home video and television
markets and other ancillary sources, and we expect that domestic and international theatrical receipts will principally be used by DreamWorks Studios to recover its distribution and marketing expenses. Because DreamWorks Studios recoups distribution
and marketing costs and its distribution fee before we recognize any revenue, our revenue will be significantly lower than it would have been had we not entered into the Distribution Agreement. For example, while we expect to release
Madagascar on May 27, 2005, we estimate that we will not recognize any meaningful revenue from Madagascaruntil the fourth quarter of 2005.



Pursuant to the Distribution Agreement, we granted to DreamWorks Studios the exclusive right to distribute all of our completed animated feature films,
including our previously released films, throughout the world that are available for delivery through the later of (i) delivery of 12 animated feature films, beginning with Shark Tale,and (ii) December 31, 2010. However, in general, the term
of the Distribution Agreement will be extended to the extent of the term, if longer, of any of DreamWorks Studios sub-distribution, servicing and licensing agreements that we pre-approve (such as DreamWorks Studios existing arrangements
with Universal Studios, CJ Entertainment and Kadokawa Entertainment). In addition, even if we terminate our distribution relationship with DreamWorks Studios, our existing and future films generally will still be subject to the terms of pre-approved
agreements. DreamWorks Studios is responsible for (1) the domestic and international theatrical exhibition of our films, (2) the domestic and international home video exhibition of our films and direct-to-video pictures, (3) the domestic and
international television licensing of our films, including pay-per-view, pay television, network, basic cable and syndication, (4) non-theatrical exhibition of our films, such as on airlines, in schools and in armed forces institutions. DreamWorks
Studios has also been granted Internet, radio (for promotional purposes only) and new media rights with respect to our films. We retain all other rights to exploit our films, including the right to make sequels and commercial tie-in and promotional
rights with respect to each film, as well as merchandising, interactive, literary publishing, music publishing, soundtrack, radio, legitimate stage and theme park rights. However, to the extent we wish to exploit theme park rights, we will only do
so through Universal Studios for so long as Steven Spielberg has certain contractual relationships with us or if he, his wife, his or her issue (or trusts for the primary benefit of any of them) or a private charitable foundation organized by him
and/or his wife directly or indirectly owns or controls our Class A common stock.



DreamWorks Studios is directly responsible for the initial U.S. theatrical release of all of our animated films, but may engage one or more sub-distributors and service providers for all other markets, subject to our
prior written approval with respect to entities not currently so engaged by DreamWorks Studios. Pursuant to the Distribution Agreement, we are solely responsible for all of the costs of developing and producing our animated feature films and for
contingent compensation and residual costs. DreamWorks Studios is responsible for all out-of-pocket costs, charges and expenses incurred in the distribution (including prints and the manufacture of home video units and distribution and fulfillment
services fees payable to third-parties), advertising, marketing,



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publicizing and promotion of the films, and has agreed to make expenditures consistent with historical levels with respect to our films. If we make a good
faith determination that the expenditure of additional distribution and marketing amounts will enhance a films gross receipts, we may cause DreamWorks Studios to spend additional amounts. In such a case, we will be solely responsible for
advancing such additional amounts to DreamWorks Studios for those additional expenditures and we will expense such additional costs in the period in which they are incurred. The Distribution Agreement also provides that DreamWorks Studios is
entitled to (i) retain a fee of 8.0% of revenue (without deduction for any distribution and marketing costs or third-party distribution and fulfillment services fees) and (ii) recoup all of its distribution and marketing costs prior to our
recognizing any revenue. Once DreamWorks Studios acquires the license to distribute one of our animated films or direct-to-video pictures, it has the right to exploit the animated film or direct-to-video film in the manner described above for 16
years from initial general theatrical release or 10 years from initial direct-to-video release.



Under the terms of the Distribution Agreement, all amounts received by DreamWorks Studios from sub-distributors are payable by DreamWorks Studios to us
within three business days from the date received by DreamWorks Studios. (In general, sub-distributors remit 30% of applicable home video net receipts to DreamWorks Studios within 60 days from the end of the month in which applicable home video
shipments were billed and the remaining 70% within 90 days from the end of the month in which applicable home video shipments were billed). All other applicable net receipts received by DreamWorks Studios are due to us 30 days after the end of the
month in which such receipts were received by DreamWorks Studios.



Services Agreement with DreamWorks Studios



As an operating division of DreamWorks Studios prior to October 27, 2004, we have historically been allocated a portion of DreamWorks Studios total overhead expenses incurred prior to the Separation for the marketing and distribution
of all DreamWorks Studios films (including our films), and for corporate functions, such as executive management, finance, accounting, legal, human resources, facilities management, insurance and information technology. In general, these
allocations were calculated based on the percentage that our films, headcount, revenue or other criteria constituted of the total films, headcount, revenue or other criteria of DreamWorks Studios (which amounts include our films, headcount, revenue
or other criteria).



In connection with the Separation, we
entered into a services agreement (the Services Agreement) with DreamWorks Studios in connection with certain services DreamWorks Studios provides to us. These include (i) risk management; (ii) information systems management; (iii)
payroll services; (iv) legal and business affairs advisory and consulting services; (v) human resources administration; (vii) certain procurement services and (viii) other general support services. We provide DreamWorks Studios with certain services
under the Services Agreement, including information technology procurement, office space and facilities management services. The Services Agreement requires both parties to reimburse the other party for its actual costs incurred, plus 5%.



Critical Accounting Policies



Revenue Recognition



Both historically and under the Distribution Agreement, we have recognized
and will recognize revenue from the distribution of our animated feature films when earned, as reasonably determinable in accordance with the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants
Statement of Position 00-2, Accounting by Producers or Distributors of Films (the SOP). The following are the conditions that must be met in order to recognize revenue in accordance with the SOP: (i) persuasive evidence of a
sale or licensing arrangement with a customer exists; (ii) the film is complete and has been delivered or is available for immediate and unconditional delivery; (iii) the license period of the arrangement has begun and the customer can begin its
exploitation, exhibition or sale; (iv) the arrangement fee is fixed or determinable and (v) collection of the arrangement fee is reasonably assured. Revenue from the theatrical distribution of films is recognized at the later of (i) when films are
exhibited in theaters or (ii) when theatrical revenues are reported to us by third parties, such as third party distributors.



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Revenue from the sale of home video units is recognized at the later of (i) when product is made
available for retail sale or (ii) when video sales to customers are reported to us by third parties, such as fulfillment service providers or distributors. We follow the practice of providing for future returns of home video product at the time the
products are sold. We calculate an estimate of future returns of product by analyzing a combination of historical returns, current economic trends, projections of consumer demand for our product and point-of-sale data available from certain
retailers. Based on this information, a percentage of each sale is reserved, provided that the customer has the right of return. Customers are currently given varying rights of return, from 15% up to 100%. However, although we and DreamWorks Studios
allow various rights of return for our customers, we do not believe that these rights are critical in establishing return estimates, as other factors, such as our historical experience with similar types of sales, information we receive from
retailers, and our assessment of the products appeal based on domestic box office success and other research, are more important in estimating returns. Generally, payment terms are within 90 days from the end of the month in which the product was
shipped. Actual returns are charged against the reserve. Revenue associated with the licensing of home video product under revenue-sharing agreements is recorded as earned under the terms of the underlying agreements.



Revenue from both free and pay television licensing agreements are recognized
at the time the production is made available for exhibition in those markets.



Revenue from licensing and merchandising is recognized when the associated films have been released and the criteria for revenue recognition have been met. In most instances, this generally results in the recognition
of revenue in periods when royalties are reported by licenses or cash is received.



For periods prior to October 1, 2004 (the effective date of the Distribution Agreement), we recognized revenue from our films net of reserves for returns, rebates and other incentives. Under the Distribution
Agreement, we are entitled to recognize revenue net of reserves for returns, rebates and other incentives after DreamWorks Studios (i) retains a distribution fee of 8.0% of revenue (without deduction for any distribution and marketing costs or
third-party distribution and fulfillment services fees) and (ii) recovers all of its distribution and marketing costs with respect to our films. As of October 1, 2004, DreamWorks Studios began retaining its 8.0% fee for all revenue recognized by it
subsequent to the effective date, regardless of whether the revenue relates to a film released prior to the effective date of the Distribution Agreement and regardless of whether it has recouped the distribution and marketing expenses related to
that film that it has incurred.



Because DreamWorks Studios is
the principal distributor of our films, in accordance with the SOP, the amount of revenue that we recognize from our films in any given period following the effective date of the Distribution Agreement depends on the timing, accuracy and sufficiency
of the information we receive from DreamWorks Studios. Although DreamWorks Studios has agreed to provide us with the most current information available to it to enable us to recognize our share of revenue, we may make adjustments to that information
based on our estimates and judgments. For example, we may make adjustments to our revenue derived from home video units for estimates on return reserves, rebates and other incentives that may differ from those that DreamWorks Studios recommends. The
estimates on reserves may be adjusted periodically based on actual rates of returns, inventory levels in the distribution channel, as well as other business and industry information. We also review expense estimates and may make adjustments to these
estimates in order to ensure that our revenue and gross margin are accurately reflected in our financial statements. In addition, as is typical in the movie industry, our distributor and its sub-distributors may also make subsequent adjustments to
the information that they provide and these adjustments could have a material impact on our operating results in later periods.



Costs of Revenue



Film Production Costs.    We capitalize film production costs to film inventories in production in accordance with the
provisions of the SOP. Direct film production costs include costs to develop and produce CG animated films, which primarily consists of salaries and fringe benefits for animators and voice talent, equipment and other direct operating costs.
Production overhead, a component of film inventory, includes allocable costs of



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individuals or departments with exclusive or significant responsibility for the production of our films. In addition to the films being produced, we are also
working on the development of several new projects. Costs of these projects are capitalized as film inventories in development in accordance with the provisions of the SOP and are transferred to film inventories in production when a film is set for
production. We evaluate each project in development and production on a quarterly basis to determine whether capitalized costs are in excess of our estimate of fair value. If they are in excess, then we write-off the excess cost and reflect these in
costs of revenue. In addition, after three years, if the project is still in development and has not been set for production, it is written off and reflected in costs of revenue.



Amortization.    Once a film is released, the amount of film inventory relating to that film,
including film production costs and contingent compensation and residual costs, is amortized and included in costs of revenue in the proportion that the revenue during the period for each film (Current Revenue) bears to the estimated
total revenue to be received from all sources for each film (Ultimate Revenue) under the individual-film-forecast-computation method in accordance with the provision of the SOP. The amount of film costs that are amortized each quarter
will therefore depend on the ratio of Current Revenue to Ultimate Revenue for each film. We make certain estimates and judgments of Ultimate Revenue to be received for each film based on information received from DreamWorks Studios, and our
knowledge of the industry. Estimates of Ultimate Revenue and anticipated contingent compensation and residual costs are reviewed periodically and are revised if necessary. A change to the Ultimate Revenue for an individual film will result in an
increase or decrease to the percentage of amortization of capitalized film costs relative to a previous period. Unamortized film production costs are evaluated for impairment each reporting period on a film-by-film basis in accordance with the
requirements of the SOP. If estimated remaining revenue is not sufficient to recover the unamortized film inventory for that film, the unamortized film inventory will be written down to fair value determined using a net present value calculation.



Contingent Compensation and
Residuals.    We are responsible for certain compensation paid to creative participants, such as writers, producers, directors, voice talent, animators and other persons associated with the production of a film, which is
dependent on the performance of the film and is based on factors such as domestic box office and total revenue recognized by the distributor related to the film, with the vast majority of these costs dependent on domestic box office performance. In
some cases, particularly with respect to sequels (such as Shrek 2), these contingent compensation costs can be significant. We are also responsible for residuals, which are payments based on similar factors and generally made to third-parties
pursuant to collective bargaining, union or guild agreements or for providing certain services such as recording or synchronization services. Accordingly, residual payments generally increase as total revenue for a film increases. These forms of
contingent compensation and residual costs are accrued in accordance with the SOP, using the individual-film-forecast computation method, which accrues and amortizes such costs in the same ratio that current period actual revenue (numerator) bears
to estimated remaining unrecognized revenue as of the beginning of the current fiscal year (denominator), as described above.



We expect that, in periods following the effectiveness of the Distribution Agreement, the amount of revenue that we recognize in the periods immediately
following a films release will be substantially less than the amounts that we have historically recognized in similar periods, due to the fact that, under the Distribution Agreement, we recognize revenue net of DreamWorks Studios 8.0%
distribution fee and the distribution and marketing costs that it incurs. Consequently, although the total amount of production costs that are amortized for any particular film will be the same over the life of the film, the timing of the
amortization will change, since amortization is calculated based on the ratio of Current Revenue to Ultimate Revenue.



Stock-Based Compensation



In December 2004, the Financial Accounting Standards Board issued FAS No. 123 (revised 2004), Share-Based Payment (FAS 123R),
which establishes standards for transactions in which an entity exchanges its equity instruments for goods and services. This standard requires a public entity to measure the cost of employee



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services received in exchange for an award of equity instruments based on the grant-date fair value of the award. This eliminates the exception to account
for such awards using the intrinsic method previously allowable under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. In March 2005, the Securities and Exchange Commission (the SEC)
released Staff Accounting Bulletin (SAB) 107, Share-Based Payment, which expresses views of the SEC Staff about the application of FAS 123R. FAS 123R was to be effective for interim or annual reporting periods beginning on or
after June 15, 2005, but in April 2005 the SEC issued a rule that FAS 123R will be effective for annual reporting periods beginning on or after June 15, 2005.



We voluntarily elected to adopt FAS 123R as of January 1, 2005. FAS 123R offers alternative adoption methods. We have elected to use the modified
prospective transition method and have not restated prior periods. Under this method we have recognized compensation costs for equity awards to our employees based on their grant-date fair value from January 1, 2005. Measurement and attribution of
compensation costs for equity awards that were granted to our employees prior to, but not vested as of January 1, 2005, were based on the same estimate of the grant-date fair value and the same attribution method that we used previously for
financial statement pro forma disclosure purposes under FAS 123, Accounting for Stock-Based Compensation. For those equity awards to employees granted or settled after January 1, 2005, compensation cost will be measured and recognized in
the financial statements in accordance with the provisions of FAS 123R.



As required by FAS 123R, we made an estimate of expected forfeitures and are recognizing compensation costs only for those equity awards expected to vest. The impact on our previously reported pro forma disclosures under FAS 123 where we
accounted for forfeitures as incurred is not material and therefore we will not record an adjustment for a cumulative effect of an accounting change. As of March 31, 2005, the total compensation cost related to unvested equity awards granted to
employees but not yet recognized was approximately $90.8 million. This cost will be amortized on a straight-line basis over a weighted average of 4.9 years. Changes to our underlying stock price or satisfaction of performance criteria for
performance-based awards granted to employees could significantly impact compensation expense to be recognized in 2005 and future periods. In addition, future grants of equity awards will result in additional compensation expense in 2005 and future
periods.



Provision for Income Taxes



Prior to the Separation, DreamWorks Studios paid no federal income taxes as
an entity as the operations of DreamWorks Studios were included in the taxable income of its individual members. The tax expense in our consolidated statements of operations, through the Separation Date, principally represents foreign withholding
taxes and state franchise taxes. Effective as of the Separation, we are subject to federal taxation as a corporation and will be filing separate tax returns. We account for income taxes pursuant to SFAS No. 109, Accounting for Income
Taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates and a change in tax status is recognized in income in the period that includes the enactment date.



At the time of the Separation, entities controlled by Paul
Allen entered into a series of transactions that resulted in a partial increase in the tax basis of our tangible and intangible assets. This partial increase in tax basis is expected to reduce the amount of tax that we may pay in the future, to the
extent we generate taxable income in sufficient amounts in the future. We are obligated to remit to an entity controlled by Paul Allen 85% of any such cash savings in U.S. Federal income tax and California franchise tax and certain other related tax
benefits, subject to repayment if it is determined that these savings should not have been available to us. At the time of the Separation, the increase in the tax basis of the assets was approximately $1.64 billion, resulting in a deferred tax asset
of approximately $620 million. A substantial portion of these potential tax benefits may be realized over approximately 15 years. As a result of taxable income generated by us from the Separation Date through



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December 31, 2004, we expect to realize $6.5 million in tax benefits as a result of the increased basis in the assets for the period from October 28, 2004
through December 31, 2004. We also currently expect to receive a tax benefit of $76.6 million in future years, as management has determined that the benefits can be realized through a refund of taxes paid in 2004. Accordingly, we recorded a
liability to an entity controlled by Paul Allen of approximately $70.6 million as of December 31, 2004 and March 31, 2005 representing 85% of these recognized benefits. All transactions described in this section with an entity controlled by Paul
Allen have been recognized as a component of stockholders equity and have not impacted our operating results.



Results of Operations



Three Months Ended March 31, 2005, compared to Three Months Ended March 31, 2004



For the three months ended March 31, 2005, our results were primarily driven by worldwide home video contribution from Shark Tale and from
continuing merchandising and licensing revenue from Shrek 2, and our library of films.



For the three months ended March 31, 2005, the distribution and marketing expenses incurred by DreamWorks Studios (including its distribution fee) exceeded the revenues recorded by DreamWorks Studios for Shrek
2, primarily related to its worldwide home video distribution, including returns of domestic home video units in excess of amounts previously estimated by DreamWorks Studios. Pursuant to the Distribution Agreement, DreamWorks Studios is
responsible for all costs incurred in the distribution of our films and is entitled to recoup its distribution and marketing expenses incurred for Shrek 2 before we can record any additional revenue from the exploitation of this film. As a
result, DreamWorks Studios must recoup approximately $24.7 million of distribution and marketing costs in future periods before we will recognize additional revenues from the exploitation of Shrek 2.



Revenue.    For the three months ended March 31,
2005, revenue increased by $126.2 million from $40.8 million to $167.0 million, as compared to the three months ended March 31, 2004. Film revenue for the three months ended March 31, 2005 was primarily driven by the success ofShark Tale in
the worldwide home video market. During the three months ended March 31, 2005, Shark Tale generated total revenue of $142.4 million, including revenue earned through merchandising and licensing. Shrek 2 contributed $8.6 million of
revenues earned through merchandising and licensing. Our other films contributed $16.0 million of revenues, including $5.7 million of revenues from Shrek in the worldwide home video market.



Since the revenues we recognized during the three months ended March 31, 2005
followed the effectiveness of the Distribution Agreement, the amount of revenue that we recognized during the three months ended March 31, 2005 was substantially less than the amounts that we would have recognized if the Distribution Agreement had
not been in effect, due to the fact that, under the Distribution Agreement, we recognize revenue net of DreamWorks Studios 8.0% distribution fee and the distribution and marketing costs that it incurs.



Film revenue for the three months ended March 31, 2004 was primarily driven
by the continuing success of Shrek in the worldwide home video and television markets, which contributed $14.0 million in revenues. The international theatrical and home video release of Sinbad: Legend of the Seven Seas also
contributed $13.0 million in revenues in the first quarter of 2004. Other films contributed revenue of approximately $13.8 million for the three months ended March 31, 2004, primarily from worldwide home video sales.



Costs of Revenue.    Costs of film revenue were
$80.4 million in the three months ended March 31, 2005, as compared to $45.4 million in the three months ended March 31, 2004. Costs of revenues primarily represent the amortization of capitalized film costs, contingent compensation and residuals.
Amortization for released films as a percentage of film revenue in the three months ended March 31, 2005 was 47%, compared to 30% for the three months ended March 31, 2004. Amortization as a percentage of film revenue may vary from period to period
due to several factors, including: (i) changes in the mix of films earning revenue, (ii) changes in any films Ultimate Revenue and capitalized costs and (iii) write offs of film inventory due to changes in the estimated fair value of
unamortized film inventory, as required by the SOP. In addition, following the effectiveness of the Distribution



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Agreement in the fourth quarter of 2004, the amount of revenue that we recognize in the periods immediately following a films release will be
substantially less than the amounts that we have historically recognized in similar periods, due to the fact that, under the Distribution Agreement, we recognize revenue net of DreamWorks Studios 8.0% distribution fee and the distribution and
marketing costs that it incurs. Consequently, although the total amount of production costs that are amortized for any particular film will be the same over the life of the film, the timing of the amortization will change, since amortization is
calculated based on the ratio of Current Revenue for a film to Ultimate Revenue for the film.



Since the expenses we recorded during the three months ended March 31, 2005 followed the effectiveness of the Distribution Agreement, the amount of expenses that we recorded during the three months ended March 31,
2005 was substantially less than the amounts that we would have recorded if the Distribution Agreement had not been in effect due to the fact that, under the Distribution Agreement, DreamWorks Studios is responsible for paying the distribution and
marketing costs relating to each film.



The increase in
amortization as a percentage of film revenue for the three months ended March 31, 2005 was primarily due to the change in the mix of films earning revenue. Shark Tale earned substantially more revenue for the three months ended March 31, 2005
than any other film during that period and any other film during the comparable 2004 period. Shark Tale has a higher amortization percentage due to the size of its Ultimate Revenue in comparison to capitalized costs than either Shrek
or Shrek 2. In addition, Sinbad: Legend of the Seven Seas had a pre-release write down in 2003 which significantly lowers its amortization percentage in subsequent periods.



Selling, General and Administrative Expenses.    Total selling, general and administrative
expenses were $18.1 million (including $4.6 million of stock compensation expense) for the three months ended March 31, 2005 as compared to $7.8 million (including a stock compensation credit of $1.2 million) for the three months ended March 31,
2004. Net of the stock compensation costs for 2005 and 2004 which is described in more detail below, this $4.5 million increase was primarily due to an increase in personnel and professional services fees in our legal, finance, investor relations
and information technology functions in order to accommodate the increased demands of a public company and Sarbanes-Oxley compliance.



Stock Compensation Expense



Stock compensation expense was $4.6 million for the three months ended March 31, 2005, as compared to a stock compensation credit of $1.2 million for the
three months ended March 31, 2004, which reflected a reduction in the redemption value of the underlying awards which were subject to the variable accounting of APB 25. The increase in stock compensation expense resulted from our grants of
restricted stock awards to our employees since the Separation and our initial public offering, which have been recorded as compensation expense based on their grant-date fair value and our decision to voluntarily adopt FAS 123R as of January 1,
2005. As a result of adopting FAS 123R, we are now recording compensation expense based on the grant-date fair value for all stock option awards that we have granted to our employees.



Interest and Other Income (Expense).    Total interest income net of other expense was $0.4
million for the three months ended March 31, 2005 as compared to total interest expense and other expense of $12.8 million for the three months ended March 31, 2004. This $13.2 million net decrease in expense was primarily due to a decrease in
expense from interest rate swap agreements and debt related interest expense that are no longer allocated from DreamWorks Studios. Additionally, we recorded interest income of $1.1 million in the first quarter of 2005 from our cash and cash
equivalents.



Provision for Income Taxes



For the three months ended March 31, 2005 we recorded income tax expense of
$23.2 million, and for the three months ended March 31, 2004 we recorded tax expense of $0.3 million for state franchise and foreign taxes. For the three months ended March 31, 2005 our effective tax rate of 34% was lower than the statutory tax



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rate primarily from the recognition of Federal tax benefits for income earned outside the U.S. and qualifying manufacturing activities under the American
Jobs Creation Act of 2004. For the three months ended March 31, 2004, we were not subject to federal income taxes.



Operating Results



The three months ended March 31, 2005 resulted in operating income of $68.5 million and net income of $45.7 million, as compared to operating losses of
$12.4 million and a net loss of $25.5 million for the three months ended March 31, 2004. This was primarily due to substantial profits generated from the success of Shark Tale in the worldwide home video market.



Revolving Credit Facility



In connection with the Separation, we entered into a five-year $200 million
revolving credit facility with a number of banks, including JPMorgan Chase Bank, an affiliate of J.P. Morgan Securities Inc., and affiliates of certain of the other underwriters for our initial public offering. We intend to use the credit facility,
which is secured by substantially all of our assets, to fund our working capital needs. As of May 16, 2005, we had no outstanding borrowings on our revolving credit facility. The maximum amount of borrowings available to us under the credit facility
is the lesser of $200 million and an available amount generally determined by applying an advance rate of 67% against estimated receipts from all sources (net of estimated cash expenses directly associated with such receipts) for all of our released
films and an advance rate of 100% against our cash on hand to the extent the lenders have a perfected security interest in such cash and by reducing such available amount by the amount of our outstanding debt (other than subordinated debt owing to
HBO and up to $50 million of other subordinated debt). Interest on borrowed amounts is determined at either a floating rate of LIBOR plus 1.75% or the alternate base rate (which is generally the prime rate) plus 0.75% per annum. In addition, we pay
a commitment fee on undrawn amounts at an annual rate of 0.50% on any date when more than $100 million is outstanding under the credit facility and 0.75% on any other date. The credit agreement requires us to maintain certain financial ratios and
has customary terms that restrict our ability to make fundamental changes to our business, sell assets, incur secured debt, declare dividends and make other distributions. As of March 31, 2005, we were in compliance with all financial ratios with
which we are required to comply under the credit agreement.



Universal
Studios Advance



As part of their distribution and home
video fulfillment services relationship, DreamWorks Studios and Universal Studios have entered into agreements pursuant to which Universal Studios advances amounts to DreamWorks Studios based on projected cash receipts, net of projected expenses,
due to DreamWorks Studios for pictures that DreamWorks Studios intends to license to Universal Studios for distribution in the international theatrical and worldwide home video markets. These advances are generally based on quarterly estimates of
projected cash receipts, net of projected expenses, distribution and service fees, that will become due to DreamWorks Studios from Universal Studios in the markets where Universal Studios provides distribution and fulfillment services. In October
2003, Universal Studios agreed to advance to DreamWorks Studios a maximum of $75 million, which was based on the projected net receipts of our animated feature films released subsequent to December 2002 (the 2003 advance). The 2003
advance carries an effective annualized interest rate of 8.75% and matures, subject to certain conditions, upon the expiration or termination of the Universal Distribution Agreement and the Universal Home Video Agreement.



HBO Subordinated Debt



In connection with the Separation, we assumed $80 million of subordinated notes issued by DreamWorks Studios to HBO in
December 2000 pursuant to a subordinated loan agreement, $30 million of which we repaid with proceeds of our initial public offering. The subordinated notes bear interest in an amount equal to the Eurodollar rate plus 0.50% per annum and are due in
November 2007. Subject to the consent of the lenders under our revolving credit facility (or any replacement senior credit facility), we are able to prepay all or a portion of the principal amount of the subordinated notes. The notes are not subject
to any sinking fund obligations.



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The subordinated notes were secured by a lien granted by DreamWorks Studios in favor of HBO in certain
exhibition rights related to DreamWorks Studios films that is junior to the security interest granted to HBO in connection with a 1995 licensing agreement between DreamWorks Studios and HBO. We granted substantially the same security interests
in rights to exploit our films to HBO when we assumed the subordinated indebtedness.



The terms of the subordinated notes require us to maintain certain financial ratios and they have customary terms that restrict us from making fundamental changes to our business, selling assets, incurring secured
debt, declaring dividends and making other distributions. Additionally, we are restricted from entering non-arms length transactions with our affiliates.



Liquidity and Capital Resources



The Companys operating activities for the three months ended March 31, 2005 generated adequate cash to meet our operating needs. As of March 31,
2005 we had cash and cash equivalents totaling $445.0 million, a $381.9 million increase compared to $63.1 million at December 31, 2004. The principal components of the increase in cash and cash equivalents were cash generated from operating
activities of $377.3 million, additional loan proceeds of $4.8 million for the financing of a film production, and proceeds of $1.8 million from the exercise of employee stock options, slightly offset by $1.7 million invested in equipment. Although
we expect that, for the next twelve months, cash on hand and cash from operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures, in the event that these cash flows are insufficient, we expect
to be able to draw funds from the revolving credit facility to meet these needs.



|                                                    |  |                    |         |   |               |   |        |  
|--------------------------------------------------- |  | ------------------ | ------- | - | ------------- | - | ------ | -
|                                                    |  | Three months ended |        
|                                                    |  | March 31,2005      |         |   | March 31,2004 |  
|                                                    |  | (in thousands)     |        
|Net cash provided by operating activities           |  | $                  | 377,273 |   |               | $ | 5,828  |  
|Net cash (used in) investing activities             |  |                    | (1,737  | ) |               |   | (179   | )
|Net cash provided by (used in) financing activities |  |                    | 6,369   |   |               |   | (5,649 | )



Cash provided by
operating activities for the first three months of 2005 was $377.3 million and was primarily attributable to collection of revenue earned in 2004 for the theatrical release of Shark Tale and worldwide home video revenue from Shrek 2,
partially offset by film production spending and contingent compensation. Cash provided by operating activities for the first three months of 2004 was $5.8 million and was primarily attributable to collection of worldwide home video revenue earned
in 2003 for Shrekand Sinbad: Legend of the Seven Seas offset by film production spending and other operating uses. Cash used in investing activities for the first three months of 2005 and 2004 were $1.7 million and $0.2 million,
respectively, stemming mainly from investment in equipment. Cash provided by (used in) financing activities for the three months ended March 31, 2005 and 2004, were $6.4 million and ($5.7) million, respectively. During the first three months of
2005, this primarily was from loan proceeds for the financing of one of our films and proceeds from the exercise of stock options. During the first three months of 2004, this was primarily related to cash funding and the difference in the amount of
debt allocated to us by DreamWorks Studios.



For the remainder
of 2005, we expect our commitments to fund production costs (excluding capitalized interest and overhead expense), to make contingent compensation and residual payments (on films released to date) and to fund technology capital expenditures will be
approximately $239.0 million, which includes the obligation to acquire certain distribution rights to Wallace & Gromit: Curse of the Were Rabbitand additional production spending related to an increase in our direct-to-video business.



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Contractual Obligations.    As of March 31, 2005, we had contractual
commitments to make the following payments (in thousands):



|                                                        |  |                        |        |           |   |           |  |                    |        |       |   |        |  |   |        
|------------------------------------------------------- |  | ---------------------- | ------ | --------- | - | --------- |  | ------------------ | ------ | ----- | - | ------ |  | - | -------
|                                                        |  | Payments Due by Period
|Contractual Cash Obligations                            |  | Remainderof 2005       |        | 2006-2007 |   | 2008-2009 |  | 2010 andThereafter |        | Total
|Operating leases, net of sublease income                |  | $                      | 7,212  |           | $ | 11,880    |  | $                  | 7,223  |       | $ | 9,971  |  | $ | 36,286 
|Executive officers employment agreements(1)            |  |                        | 1,625  |           |   | 4,375     |  |                    | 4,400  |       |   |       |  |   | 10,400 
|Wallace & Gromit: Curse of the Were Rabbitobligation(2) |  |                        | 29,974 |           |   |          |  |                    |       |       |   |       |  |   | 29,974 
|Glendale animation campus note payable(3)               |  |                        |       |           |   | 70,059    |  |                    |       |       |   |       |  |   | 70,059 
|Universal advance(4)                                    |  |                        |       |           |   |          |  |                    |       |       |   | 75,000 |  |   | 75,000 
|HBO subordinated debt(5)                                |  |                        |       |           |   | 50,000    |  |                    |       |       |   |       |  |   | 50,000 
|Capital leases(6)                                       |  |                        | 747    |           |   | 1,992     |  |                    | 332    |       |   |       |  |   | 3,071  
|                                                        |  |                        |        |           |   |           |  |                    |        |       |   |        |  |   |        
|Total contractual cash obligations                      |  | $                      | 39,558 |           | $ | 138,306   |  | $                  | 11,955 |       | $ | 84,971 |  | $ | 274,790
|                                                        |  |                        |        |           |   |           |  |                    |        |       |   |        |  |   |        

---

|(1) | In connection with the Separation, we entered into employment agreements with contractual cash salaries totaling $10.9 million over the next five years.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | In October 2003, we entered into an agreement to acquire certain distribution rights to Wallace & Gromit: Curse of the Were Rabbit, an animated film
currently in production. Pursuant to the acquisition agreement, we are obligated to pay approximately $45.0 million to acquire substantially all rights to the film (of which $42.4 million had been paid as of March 31, 2005). In connection with the
acquisition, DreamWorks Studios entered into loan agreements for the financing of the production costs of up to approximately $29.0 million. Of this amount, $27.8 million had been borrowed at March 31, 2005. Because we are obligated to acquire this
film upon its completion in 2005, the $27.8 million borrowed as of March 31, 2005 plus the amount the Company is still obligated to fund are included in this table.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | We operate an animation campus in Glendale, California. The lease on the property, which was originally acquired for $76.5 million, qualified as an operating lease.
In March 2002, we renegotiated the lease through the creation of a special-purpose entity that acquired the property for $73.0 million and leased the facility to us for a five-year term. In accordance with the provisions of FIN 46, we have included
the asset, debt and non-controlling interest on our combined balance sheet as of December 31, 2004. We expect to refinance this obligation prior to its maturity.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | In connection with the Separation, we assumed approximately $75 million of indebtedness related to advances that Universal Studios made to DreamWorks Studios to fund
animated motion pictures. Universal Studios advanced DreamWorks Studios amounts based on anticipated future receipts from films that DreamWorks Studios is expected to release, and DreamWorks Studios allocated to us $87.2 million of this advance on a
historical basis. Of this allocation, $12.2 million relates to a 2001 animated film advance that was initially allocated to us but, as part of the Separation, was not assumed by us.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | In connection with the Separation, we assumed $80 million of subordinated debt that DreamWorks Studios incurred from HBO in December 2000, $30 million of which we
repaid with proceeds from our initial public offering.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Includes $0.4 million of imputed interest.
|--- | ------------------------------------------



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RISK FACTORS



You should carefully consider the following risk factors before deciding to invest in shares of our Class A common stock.
The following risks and uncertainties could materially adversely affect our business, financial condition or operating results.



Our success is primarily dependent on audience acceptance of our films, which is extremely difficult to predict and therefore inherently risky.



We cannot predict the economic success of any of our motion pictures because
the revenue derived from the distribution of a motion picture (which does not necessarily bear any correlation to the production or distribution costs incurred) depends primarily upon its acceptance by the public, which cannot be accurately
predicted. The economic success of a motion picture also depends upon the publics acceptance of competing films, the availability of alternative forms of entertainment and leisure time activities, general economic conditions and other tangible
and intangible factors, all of which can change and cannot be predicted with certainty. Furthermore, part of the appeal of CG animated films may be due to their relatively recent introduction to the market. We cannot assure you that the introduction
of new animated filmmaking techniques, an increase in the number of CG animated films or the resurgence in popularity of older animated filmmaking techniques will not adversely impact the popularity of CG animated films.



In general, the economic success of a motion picture is dependent on its
domestic theatrical performance, which is a key factor in predicting revenue from other distribution channels and is largely determined by our ability to produce content and develop stories and characters that appeal to a broad audience and the
effective marketing of the motion picture. If we are unable to accurately judge audience acceptance of our film content or to have the film effectively marketed, the commercial success of the film will be in doubt, which could result in costs not
being recouped or anticipated profits not being realized. Moreover, we cannot assure you that any particular feature film will generate enough revenue to offset its distribution and marketing costs, in which case we would not receive any gross
receipts for such film from DreamWorks Studios. In the past, some of our films have not recovered, after recoupment of marketing and distribution costs, their production costs in an acceptable timeframe or at all. For example, in 2003 we released
our final primarily hand-drawn animated feature film, Sinbad: Legend of the Seven Seas,which we estimate will not generate sufficient revenue over its first 10 years in distribution to fully recover, after recoupment of marketing and
distribution costs, its production costs.



Our business is dependent upon
the success of a limited number of releases each year and the commercial failure of any one of them could have a material adverse effect on our business.



We expect to theatrically release a limited number of animated feature films per year for the foreseeable future. The commercial failure of just one of
these films can have a significant adverse impact on our results of operations in both the year of release and in the future. For example, for the remainder of 2005, we will be dependent on the continuing success of Shrek 2 and Shark Talehome video sales. Historically, there has been a close correlation between domestic box office success and international box office, home video and television success, such that feature films that are successful in the domestic theatrical market
are generally also successful in the international theatrical, home video and television markets. Because of this close correlation, we believe that Shrek 2 and Shark Tale, both of which performed successfully in the domestic and
international theatrical markets, will continue to strongly perform in the home video and television markets, although there is no way to guarantee such results. Our success in 2005 also significantly depends on audience acceptance of Madagascar,which is scheduled for release in the domestic theatrical market on May 27, 2005, and Wallace & Gromit: Curse of the Were Rabbit, which is scheduled for domestic theatrical release on October 7, 2005. If our films fail to achieve
domestic box office success, because of the close correlation mentioned above, their international box office and home video success and our business, results of operations and financial condition could be adversely affected in the remainder of 2005
and beyond. Further, we can make no assurances that the historical correlation between domestic box office results and international box office and home video results will continue in the future. In addition, we can make no assurances that home
video wholesale prices can be maintained at current



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levels due to aggressive retail pricing or other factors. Finally, the limited number of films that we release in a year magnifies fluctuations in our
earnings. Therefore, our reported results at quarter and year end may be skewed based on the release dates of our films, which could result in volatility in the price of our Class A common stock.



Our operating results fluctuate significantly.



We continue to expect significant fluctuations in our future quarterly and
annual operating results because of a variety of factors, including the following:



| |  |  | the success of our feature films;
| | - |  | ---------------------------------



| |  |  | the timing of the domestic and international theatrical releases and home video release of our feature films; and
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | DreamWorks Studios costs to distribute and market our feature films under the Distribution Agreement.
| | - |  | ------------------------------------------------------------------------------------------------------



We also expect that our operating results will continue to be affected by the
terms of the Distribution Agreement. Under the Distribution Agreement, DreamWorks Studios uses film revenue (i) to recover the distribution and marketing expenses it incurs for the film and (ii) to cover its distribution fee relating to these
markets before we recognize any revenue for that film. Accordingly, we recognize significantly less revenue from a film in the period of that films theatrical release than we would absent the Distribution Agreement. Furthermore, in the event
that the Distribution Agreement were terminated, depending on the arrangement that we negotiate with a replacement distributor, we could be required to directly incur distribution and marketing expenses related to our films, which under the
Distribution Agreement are incurred by DreamWorks Studios. Because we would expense those costs as incurred, further significant fluctuations in our operating results could result.



In response to these fluctuations, the market price of our Class A common stock could decrease significantly in spite of our
operating performance.



We principally operate in one business, the
production of CG animated feature films, and our lack of a diversified business could adversely affect us.



Unlike most of the major studios, which are part of large diversified corporate groups with a variety of other operations, we depend primarily on the
success of our feature films. For example, unlike us, many of the major studios are part of corporate groups that include television networks and cable channels that can provide stable sources of earnings and cash flows that offset fluctuations in
the financial performance of their feature films. Substantially all of our revenue is derived from a single sourceour CG animated feature filmsand our lack of a diversified business model could adversely affect us if our films fail to
perform to our expectations.



Animated films are expensive to produce and
the uncertainties inherent in their production could result in the expenditure of significant amounts on films that are canceled or significantly delayed.



The production, completion and distribution of animated feature films is subject to a number of uncertainties, including delays and increased
expenditures due to creative problems, technical difficulties, talent availability, accidents, natural disasters or other events beyond our control. Because of these uncertainties, the projected costs of an animated feature film at the time it is
set for production may increase, the date of completion may be substantially delayed or the film may be abandoned due to the exigencies of production. Delays in production may also result in a film not being ready for release at the intended time
and postponement to a potentially less favorable time, which could result in lower gross receipts for that film. In extreme cases, a film in production may be abandoned or significantly modified (including as a result of creative changes) after
substantial amounts have been spent, causing the write-off of expenses incurred with respect to the film. This



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was the case in 2003 when we wrote-off a significant amount of expenses that we had incurred for two of our animated films.



Animated films typically take longer to produce than live-action films, which increases
the uncertainties inherent in their production and distribution.



Animated feature films typically take three to four years to produce after the initial development stage, as opposed to an average of twelve to eighteen months for live-action films. The additional time that it takes to produce and release
an animated feature film increases the risk that our films in production will fall out of favor with target audiences and that competing films will be released in advance of or concurrently with ours, either of which risks could reduce the demand
for, or popular appeal of, our films.



The production and marketing of CG
animated feature films is capital intensive and our capacity to generate cash from our films may be insufficient to meet our anticipated cash requirements.



The costs to develop, produce and market a film are substantial and some of our competitors have more capital and greater resources than we and
DreamWorks Studios have. In 2004, for example, we spent approximately $315 million to fund production costs (excluding capitalized interest and overhead expense) of our feature films, to make contingent compensation and residual payments and to fund
technology capital expenditures. For the remainder of 2005, we expect that these costs will be approximately $239.0 million, which includes a one-time payment to Aardman Animations related to Wallace & Gromit: Curse of the Were Rabbitand
additional production spending related to an increase in our direct-to-video business. In addition, historically, we made substantial expenditures on distribution and marketing costs that are now generally incurred by DreamWorks Studios under the
Distribution Agreement. Although we retain the right to exploit each of the ten films that we have previously released, the size of our film collection is insubstantial compared to the film libraries of the major U.S. movie studios, which typically
have the ability to exploit hundreds of library titles. Library titles can provide a stable source of earnings and cash flows that offset fluctuations in the financial performance of newly released films. Many of the major studios use these cash
flows, as well as cash flows from their other businesses, to finance the production and marketing of new feature films. We are not able to rely on such cash flows and are required to fund our films in development and production and other commitments
with cash retained from operations and the proceeds of films that are generating revenue from theatrical, home video and ancillary markets. If our films fail to perform, we may be forced to seek substantial sources of outside financing. Such
financing may not be available in sufficient amounts for us to continue to make substantial investments in the production of new CG animated feature films or may be available only on terms that are disadvantageous to us, either of which could have a
material adverse effect on our growth or our business.



The costs of
producing and marketing feature films have steadily increased and may increase in the future, which may make it more difficult for a film to generate a profit or compete against other films.



The production and marketing of theatrical feature films requires
substantial capital and the costs of producing and marketing feature films have generally increased in recent years. According to the MPAA, the average negative cost of a motion picture produced by a major U.S. studio, which includes all costs
associated with creating a feature film, including production costs, allocated studio overhead and capitalized interest, but excludes abandoned project costs, has grown at a compound annual growth rate of 6.4% from 1994 to 2004 and the average
domestic marketing cost (which includes prints and advertising costs) per picture has grown at a compound annual growth rate of 7.9% over the same period. Although these growth rates include the costs of both live-action and animated films, they are
indicative of the cost trend for motion pictures generally. These costs may continue to increase in the future, which may make it more difficult for our films to generate a profit or compete against other films. Historically, production costs and
marketing costs have risen at a rate faster than increases in either domestic admissions to movie theaters or admission ticket prices. A continuation of this trend would leave us more dependent on other media, such as home video, television,
international markets and new media for revenue.



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We compete for audiences based on a number of factors, many of which are beyond our control.



Despite a general increase in movie theater attendance, the number of
animated and live-action feature films released by competitors, particularly the major U.S. motion picture studios, may create an oversupply of product in the market, and may make it more difficult for our films to succeed. In particular, we compete
directly against other animated films and family oriented live-action films. Oversupply of such products may become most pronounced during peak release times, such as school holidays, national holidays and the summer release season, when theater
attendance has traditionally been highest. Although we seek to release our films during peak release times, we cannot guarantee that we will be able to release all of our films during those times and, therefore, may miss potentially higher gross
box-office receipts. In addition, a substantial majority of the motion picture screens in the U.S. typically are committed at any one time to only 10 to 15 films distributed nationally by major studio distributors. If our competitors were to
increase the number of films available for distribution and the number of exhibition screens remained static, it could be more difficult for us to release our films during optimal release periods.



The market for CG animated films is relatively new, and the entrance of additional film
studios into the CG animated film market could adversely affect our business in several ways.



CG animation is a relatively new form of animation that has been successfully exploited by a limited number of movie studios since the first CG animated
feature film, Toy Story,was released by Pixar in 1995. Because there are currently only a few studios capable of producing CG animated feature films, there are a limited number of CG animated feature films in the market each year, a fact
that may enhance their popular appeal. If additional studios were to enter the CG animated film market and increase the number of CG animated films released per year, the popularity of the CG animation technique could suffer. Although we have
developed proprietary technology, experience and know-how in the CG animation field that we believe provide us with significant advantages over new entrants in the CG animated film market, there are no substantial technological barriers to entry
that would prevent other film studios from entering the field, and in 2004 both Sony and Lucasfilm Ltd. announced plans to do so. Furthermore, advances in technology may substantially decrease the time that it takes to produce a CG animated feature
film, which could result in a significant number of new CG animated films or products. The entrance of additional animation companies into the CG animated feature film market could adversely impact us by eroding our market share, increasing the
competition for CG animated film audiences and increasing the competition for, and cost of, hiring and retaining talented employees, particularly CG animators and technical staff.



Our success depends on certain key employees.



Our success greatly depends on our employees. In particular, we are dependent upon the services of Jeffrey Katzenberg. We do
not maintain key person life insurance for any of our employees. We have entered into employment agreements with Mr. Katzenberg and with all of our top executive officers and production executives. However, although it is standard in the motion
picture industry to rely on employment agreements as a method of retaining the services of key employees, these agreements cannot assure us of the continued services of such employees. The loss of the services of Mr. Katzenberg or a substantial
group of key employees could have a material adverse effect on our business, operating results or financial condition.



Our scheduled releases of CG animated feature films will place a significant strain on our resources.



We have established multiple creative and production teams so that we can
simultaneously produce more than one CG animated feature film. As of April 2005, we have theatrically released four CG animated feature films and five non-CG animated feature films and have limited experience sustaining the ability to produce and
release more than one CG animated feature film at the same time. Due to the strain on our personnel from the effort required to produce a film and the time required for creative development of future films, it is possible that we will be unable to
consistently release two CG animated feature films per year. In the past, we have been required, and may continue to be required, to expand our employee base, increase capital expenditures and procure additional resources and facilities in order to
accomplish the scheduled releases of our animated feature films. This growth and expansion has



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placed, and continues to place, a significant strain on our resources. We cannot provide any assurances that any of our animated feature films will be
released as targeted or that this strain on resources will not have a material adverse effect on our business, financial condition or results of operations.



We are dependent on DreamWorks Studios and others for the distribution and promotion of our feature films and related products.



In connection with the Separation, we entered into the Distribution
Agreement with DreamWorks Studios, pursuant to which DreamWorks Studios is responsible, with some exceptions, for the worldwide distribution of all of our films in all media. Although the Distribution Agreement obligates DreamWorks Studios to
distribute our films, DreamWorks Studios is able to terminate the agreement upon the occurrence of certain events of default, including a failure by us to deliver to DreamWorks Studios a minimum number of films over specified time periods. If
DreamWorks Studios fails to perform under the Distribution Agreement or the agreement is terminated by DreamWorks Studios or otherwise (including as a result of DreamWorks Studios ceasing to be engaged in the motion picture distribution business),
we may have difficulty finding a replacement distributor, in part because our films would become directly subject to the terms and conditions of the Universal Distribution Agreement and the Universal Home Video Agreement and would continue to be
subject to the terms of the existing sub-distribution, servicing and licensing agreements that DreamWorks Studios has entered into with CJ Entertainment, Kadokawa Entertainment and our other third-party service providers. We cannot assure you that
we will be able to find a replacement distributor on terms as favorable as those in the Distribution Agreement. In addition, in general, the term of the Distribution Agreement will be extended to the extent of the term, if longer, of any of
DreamWorks Studios sub-distribution, servicing and licensing agreements that we pre-approve (such as the Universal Agreements and DreamWorks Studios existing arrangements with CJ Entertainment and Kadokawa Entertainment). As a result,
our ability to terminate the Distribution Agreement is effectively limited. Moreover, under the Universal Agreements, we would be required to pay Universal Studios distribution fees and reimburse them for distribution expenses as they are incurred,
regardless of the performance of our films. As a result, we would have to record such expenses as they were incurred and we would recognize revenue consistent with the method we recognized revenue prior to the effectiveness of the Distribution
Agreement.



DreamWorks Studios currently distributes, and we
expect will continue to distribute, our motion pictures in international theatrical markets through the Universal Agreements and distribution agreements with CJ Entertainment (in Korea and the Peoples Republic of China) and Kadokawa
Entertainment (in Japan). In addition, DreamWorks Studios has engaged Universal Studios to be our worldwide principal fulfillment services provider for our home videos, excluding only Japan and Korea. We are therefore dependent on the ability of
each of these companies to exploit our feature films in the territories in which they distribute them and any termination of these agreements could adversely affect DreamWorks Studios ability to distribute our films. In addition, if Universal
Studios, CJ Entertainment or Kadokawa Entertainment were to experience financial difficulty or file for bankruptcy, our revenue could be substantially reduced with respect to the films in distribution.



DreamWorks Studios provides a number of services to us pursuant to the Services Agreement.
If the Services Agreement were terminated, we would be required to replace those services on terms that may be less favorable to us.



Under the terms of a Services Agreement that we entered into with DreamWorks Studios, DreamWorks Studios provides us with certain accounting, insurance
administration, risk management, information systems management, tax, payroll, legal and business affairs, human resources administration, procurement and other general support services. In addition, pursuant to the Services Agreement, we provide
DreamWorks Studios office space at our Glendale facility, facilities management, information technology purchasing services and limited legal services. DreamWorks Studios and we charge the receiving party so that it or we generally recovers the
actual costs of providing these services, including allocable employee salaries, fringe benefits and office costs



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and all out-of-pocket costs and expenses, plus 5% of the actual costs. While our historical financial statements reflect our allocated costs of these
services, neither the historical financial statements nor our pro forma statement of operations necessarily reflect what the costs of these services will be in the future. Both DreamWorks Studios and we have the right, upon notice, to terminate any
or all of the services either party is providing under the Services Agreement. As a receiving party, both we and DreamWorks Studios may exercise our termination rights generally upon 45 days notice. As a providing party, both we and DreamWorks
Studios may exercise our termination rights generally upon 45 days notice, provided that the party exercising termination rights is not providing such service for itself. If the Services Agreement is terminated, DreamWorks Studios will no
longer be obligated to provide these services to us or pay us for the services we are providing it, and we will be required to either enter a new agreement with DreamWorks Studios or another services provider or assume the responsibility for these
functions ourselves and, in the case of office space, seek to find a new tenant. If we were to enter a new agreement with DreamWorks Studios, hire a new services provider, assume these services ourselves or find a new tenant, the economic terms of
the new arrangement may be less favorable than our current arrangement with DreamWorks Studios, which may adversely affect our business, financial condition or results of operations.



If DreamWorks Studios were to experience financial difficulty or file for bankruptcy, our business, results of operations and financial
conditions could be materially adversely affected.



Under
the terms of the Distribution Agreement, DreamWorks Studios is entitled to collect all amounts relating to our films from the various distribution channelsincluding from domestic theatrical exhibitors, international sub-distributors, domestic
and international home video services providers and television licensees. DreamWorks Studios is obligated to remit the amounts that it collects to us after it has deducted its distribution fee and distribution and marketing costs. If DreamWorks
Studios were to default in its obligations to pay us these amounts, our revenue with respect to films in distribution at that time could be substantially reduced. Moreover, because we rely on DreamWorks Studios relationships and agreements
with its sub-distributors, home video fulfillment services providers and licensees, if DreamWorks Studios were to experience financial difficulty or file for bankruptcy, we could lose the benefit of some of those relationships and agreements. In
addition, DreamWorks Studios is responsible for the costs of marketing our films in substantially all media and markets. If DreamWorks Studios were to experience financial difficulty or file for bankruptcy, DreamWorks Studios may not have sufficient
resources to market our films as effectively as the major studios market their films, which could adversely affect our revenue. In addition, pursuant to the terms of the Services Agreement, we rely on DreamWorks Studios for specified services, share
expenses relating to some of these services and receive payments from DreamWorks Studios for certain services we provide, including office space. If DreamWorks Studios were not able to pay its share of these expenses, or ceased to provide these
services, we may be required to absorb a greater portion of these expenses or obtain them from other sources or seek a new tenant, which could be more costly. Accordingly, if DreamWorks Studios were to experience financial difficulty or file for
bankruptcy, our business, results of operations and financial conditions could be materially adversely affected.



We face risks relating to the international distribution of our films and related products.



Because we have historically derived approximately one-third of our revenue from the exploitation of our films in
territories outside of the United States, our business is subject to risks inherent in international trade, many of which are beyond our control. These risks include:



| |  |  | laws and policies affecting trade, investment and taxes, including laws and policies relating to the repatriation of funds and withholding taxes, and changes in these laws;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | differing cultural tastes and attitudes, including varied censorship laws;
| | - |  | --------------------------------------------------------------------------



| |  |  | differing degrees of protection for intellectual property;
| | - |  | ----------------------------------------------------------



| |  |  | financial instability and increased market concentration of buyers in foreign television markets, including in European pay television markets;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | the instability of foreign economies and governments;
| | - |  | -----------------------------------------------------



| |  |  | fluctuating foreign exchange rates; and
| | - |  | ---------------------------------------



| |  |  | war and acts of terrorism.
| | - |  | --------------------------



Piracy of motion pictures, including digital and Internet piracy, may decrease revenue received from the exploitation of our films.



Motion picture piracy is extensive in many parts of the world and is made easier by technological advances and the
conversion of motion pictures into digital formats, which facilitates the creation, transmission and sharing of high quality unauthorized copies of motion pictures in theatrical release, on videotapes and DVDs, from pay-per-view through set top
boxes and other devices and through unlicensed broadcasts on free TV and the Internet. The proliferation of unauthorized copies and piracy of these products has an adverse affect on our business because these products reduce the revenue we receive
from our legitimate products. Under the Distribution Agreement, DreamWorks Studios is primarily responsible for enforcing our intellectual property rights with respect to all of our films subject to the Distribution Agreement and is required to
maintain security and anti-piracy measures consistent with the highest levels it maintains for its own motion pictures. Other than the remedies we have in the Distribution Agreement, we have no way of requiring DreamWorks Studios to take any
anti-piracy actions, and DreamWorks Studios failure to take such actions may result in our having to undertake such measures ourselves, which could result in significant expenses and losses of indeterminate amounts of revenue. Even if applied,
there can be no assurance that the highest levels of security and anti-piracy measures will prevent piracy.



Unauthorized copying and piracy are prevalent in territories outside of the U.S., Canada and Western Europe and in countries where we may have difficulty
enforcing our intellectual property rights. The MPAA, the American Motion Picture Marketing Association and American Motion Picture Export Association monitor the progress and efforts made by various countries to limit or prevent piracy. In the
past, some of these trade associations have enacted voluntary embargoes on motion picture exports to certain countries in order to pressure the governments of those countries to become more aggressive in preventing motion picture piracy. In
addition, the U.S. government has publicly considered implementing trade sanctions against specific countries that, in its opinion, do not make appropriate efforts to prevent copyright infringements of U.S. produced motion pictures. There can be no
assurance, however, that voluntary industry embargoes or U.S. government trade sanctions will be enacted or, if enacted, effective. If enacted, such actions could impact the amount of revenue that we realize from the international exploitation of
motion pictures depending upon the countries subject to such action and the duration and effectiveness of such action. If embargoes or sanctions are not enacted or if other measures are not taken, we may lose an indeterminate amount of additional
revenue as a result of motion picture piracy.



We cannot predict the effect
that rapid technological change or alternative forms of entertainment may have on us or the motion picture industry.



The entertainment industry in general, and the motion picture industry in particular, continue to undergo significant changes, primarily due to
technological developments. Due to rapid growth of technology and shifting consumer tastes, we cannot accurately predict the overall effect that technological growth or the availability of alternative forms of entertainment may have on the potential
revenue from and profitability of our animated feature films. In addition, certain outlets for the distribution of motion pictures may not obtain the public acceptance that is or was previously predicted. For example, while we have benefited from
the rapid growth in the DVD market, we cannot assure that such growth will continue, or that other developing distribution channels, such as video-on-demand, will be accepted by the public or that, if they are accepted by the public, we will be
successful in exploiting such channels. Moreover, to the extent that other distribution channels gain popular acceptance, it is possible that demand for existing delivery channels, such as DVDs, will decrease. If we are unable to exploit new
delivery channels to the same extent that we have exploited existing channels, our business, results of operations or financial condition could be materially adversely affected.



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We have only recently operated as an independent company, and we do business in a relatively new industry, each of
which makes it more difficult to predict whether our business model is sound.



Prior to the Separation, which occurred on October 27, 2004, we were a business division of DreamWorks Studios. Accordingly, we have limited experience operating as an independent company implementing our own business
model and an evaluation of our prospects is difficult to make, particularly in light of the fact that CG animation constitutes a relatively new form of animated filmmaking and has been successfully exploited since only 1995. Our prospects must be
considered in light of the risks, expenses and difficulties encountered by companies in the early stages of independent business operations, particularly companies in highly competitive markets. To address these risks, we must, among other things,
respond to changes in the competitive environment, continue to attract, retain and motivate qualified persons and continue to upgrade our technologies. We cannot provide any assurances that we will be successful in addressing such risks.



We are required to evaluate our internal control over financial reporting under Section
404 of the Sarbanes Oxley Act of 2002, and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.



Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with
our Annual Report on Form 10-K for the fiscal year ending December 31, 2005, we will be required to furnish a report by our management on our internal control over financial reporting. Such a report will contain, among other matters, an assessment
of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of
any material weaknesses in our internal control over financial reporting identified by management. Our independent auditor will also be required to attest to and report on managements assessment at that time.



The Committee of Sponsoring Organizations of the Treadway Commission (COSO)
provides a framework for companies to assess and improve their internal control systems. The Public Company Accounting Oversight Standard No. 2 (Standard No. 2) provides the professional standards and related performance guidance for
auditors to attest to, and report on, managements assessment of the effectiveness of internal control over financial reporting under Section 404. Managements assessment of internal controls over financial reporting requires management to
make subjective judgments and, particularly because Standard No. 2 is newly effective, some of the judgments will be in areas that may be open to interpretation and therefore the report may be uniquely difficult to prepare, and our independent
auditors may not agree with managements assessments. We are still performing the system and process documentation and evaluation needed to comply with Section 404, which is both costly and challenging.



During this process, if our management identifies one or more material
weaknesses in our internal control over financial reporting that cannot be remediated in a timely manner, we will be unable to assert such internal control is effective. If we are unable to assert that our internal control over financial reporting
is effective as of December 31, 2005 (or if our independent auditors are unable to attest that our managements report is fairly stated or they are unable to express an opinion on the effectiveness of our internal controls), we could lose
investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.



We have discovered areas of our internal controls that need improvement and we may discover additional areas in the future. For example, management has
identified a need to increase the depth and capabilities of our internal accounting staff and improve the coordination and communication across business functions regarding contractual arrangements. In addition, management identified a need to
improve the timeliness and accuracy of financial data and other information received from one of our third party service providers.



Management believes, and our independent auditors concur, that these issues are significant deficiencies, which means that there is more than
a remote possibility that these deficiencies will result in a misstatement in



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our annual or interim reports that is more than inconsequential. In 2004 and year-to-date in 2005, we devoted significant resources to remediate and improve
our internal controls. Management has discussed with our Audit Committee and independent auditors the areas identified for improvement and the remediation efforts that we are undertaking. Although we believe that these efforts have strengthened our
internal controls, we are continuing to work to improve our internal controls.



We cannot be certain as to the timing of completion of our evaluation, testing and any required remediation. If we are not able to complete our assessment under Section 404 in a timely manner, we and our independent
auditors would be unable to conclude that our internal control over financial reporting is effective as of December 31, 2005.



Our historical financial information may not be indicative of our results as a separate company.



Our historical financial information presented in this document does not reflect what our results of operations, financial
condition and cash flows would have been had we been a separate, stand-alone entity pursuing independent strategies during all periods presented. For example, our historical consolidated financial statements do not reflect what our results of
operations, financial condition or cash flows would have been had the Distribution Agreement been in place for all periods presented or had we shifted to our current business model of primarily producing CG animated films at an earlier date. As a
result, our historical financial information is not necessarily indicative of our future results of operations, financial condition or cash flows.



We could be adversely affected by strikes and other union activity.



Along with the major U.S. film studios, we employ members of the International Alliance of Theatrical and Stage Employees, or IATSE, on many of our
productions. We are subject to a collective bargaining agreement with the IATSE that expires in August 2006. We are also subject to a collective bargaining agreement with Local 839 of IATSE. In addition, we employ members of the Screen Actors Guild,
or SAG, and we have signed an industry-wide collective bargaining agreement with SAG that expires on June 30, 2008. We may also become subject to additional collective bargaining agreements. A strike by one or more of the unions that provide
personnel essential to the production of our feature films could delay or halt our ongoing production activities. Such a halt or delay, depending on the length of time involved, could cause the delay of the release date of our feature films and
thereby could adversely affect the revenue that the film generates.



To be
successful, we must continue to attract and retain qualified personnel and our inability to do so would adversely affect the quality of our films.



Our success continues to depend to a significant extent on our ability to identify, attract, hire, train and retain qualified creative, technical and
managerial personnel. Competition for the caliber of talent required to make our films, particularly for our film directors, producers, animators, creative and technology personnel, will continue to intensify as other studios build their in-house CG
animation or special effects capabilities. For example, Lucasfilm Ltd. has announced its intent to make CG animated feature films, Sony has announced that it is producing its first CG animated feature film, and we believe Disney has begun to focus
more heavily on CG animated feature films. The entrance of additional film studios into the CG animated film industry or the increased production capacity of existing film studios will increase the demand for the limited number of talented CG
animators and programmers. There can be no assurance that we will be successful in identifying, attracting, hiring, training and retaining such qualified personnel in the future. If we are unable to hire and retain qualified personnel in the future,
particularly film directors, producers, animators, creative personnel and technical directors, there could be a material adverse effect on our business, operating results or financial condition.



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We depend on technology and computer systems for the timely and successful development of our animated feature films
and related products.



Because we are dependent upon a
large number of software applications and computers for the development and production of our animated feature films, an error or defect in the software, a failure in the hardware, a failure of our backup facilities or a delay in delivery of
products and services could result in significantly increased production costs for a feature film. Moreover, if a software or hardware problem is significant enough, it could result in delays in one or more productions, which in turn could result in
potentially significant delays in the release dates of our feature films or affect our ability to complete the production of a feature film. Significant delays in production and significant delays in release dates, as well as the failure to complete
a production, could have a material adverse effect on our results of operations. In addition, because we seek to make cutting edge CG animated films, we must ensure that our production environment integrates the latest CG animation tools and
techniques developed in the industry. To accomplish this, we can either develop these capabilities by upgrading our proprietary software, which can result in substantial research and development costs, or we can seek to purchase third-party
licenses, which can also result in significant expenditures. In the event we seek to obtain third-party licenses, we cannot guarantee that they will be available or, once obtained, will continue to be available on commercially reasonable terms, or
at all.



Our revenue may be adversely affected if we fail to protect our
proprietary technology or enhance or develop new technology.



We depend on our proprietary technology to develop and produce our CG animated feature films. We rely on a combination of patents, copyright and trade secret protection and nondisclosure agreements to establish and protect our proprietary
rights. We currently have five patents in force and 16 patent applications pending in the United States. We cannot provide any assurances that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed
will be sufficiently broad to protect our technology or that they will not be challenged, invalidated or circumvented. In addition, we also rely on third-party software to produce our films, which is readily available to others. Failure of our
patents, copyrights and trade secret protection, non-disclosure agreements and other measures to provide protection of our technology and the availability of third-party software may make it easier for our competitors to obtain technology equivalent
to or superior to our technology. If our competitors develop or license technology that is superior to ours or that makes our technology obsolete, our films could become uneconomical to make. In such a case, we may be required to incur significant
costs to enhance or acquire new technology so that our feature films remain competitive. We cannot assure you that such costs would not have a material adverse affect on our business, financial condition or results of operations.



In addition, we may be required to litigate in the future to enforce our
intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and
diversion of resources and could have a material adverse effect on our business, financial condition or results of operations.



Third-party technology licenses may not continue to be available to us in the future.



In addition to our proprietary technology, we also rely on certain technology that we license from third-parties, including
software that we use with our proprietary software. We cannot provide any assurances that these third-party technology licenses will continue to be available to us on commercially reasonable terms or at all. The loss of or inability to maintain any
of these technology licenses, or our inability to complete a given feature film, could result in delays in feature film releases until equivalent technology could be identified, licensed and integrated. Any such delays or failures in feature film
releases could materially adversely affect our business, financial condition or results of operations.



Others may assert intellectual property infringement claims against us.



One of the risks of the CG animated film production business is the possibility of claims that our productions and production techniques misappropriate or
infringe the intellectual property rights of third-parties



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with respect to their technology and software, previously developed films, stories, characters, other entertainment or intellectual property. We have
received, and are likely to receive in the future, claims of infringement of other parties proprietary rights. There can be no assurance that infringement or misappropriation claims (or claims for indemnification resulting from such claims)
will not be asserted or prosecuted against us, or that any assertions or prosecutions will not materially adversely affect our business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such
claims, we would incur significant costs and diversion of resources with respect to the defense thereof, which could have a material adverse effect on our business, financial condition or results of operations. If any claims or actions are asserted
against us, we may seek to obtain a license of a third-partys intellectual property rights. We cannot provide any assurances, however, that under such circumstances a license would be available on reasonable terms or at all.



Forecasting film revenue and associated gross profits from our feature films prior to
release is extremely difficult and may result in significant write-offs.



We are required to amortize capitalized film production costs over the expected revenue streams as we recognize revenue from the associated films. The amount of film production costs that will be amortized each
quarter depends on how much future revenue we expect to receive from each film. Unamortized film production costs are evaluated for impairment each reporting period on a film-by-film basis. If estimated remaining revenue is not sufficient to recover
the unamortized film production costs, the unamortized film production costs will be written down to fair value. In any given quarter, if we lower our previous forecast with respect to total anticipated revenue from any individual feature film, we
would be required to accelerate amortization of related film costs. Such accelerated amortization would adversely impact our business, operating results and financial condition. In addition, we base our estimates of revenue on information supplied
to us from DreamWorks Studios and other sources. If the information is not provided in a timely manner or is incorrect, the amount of revenue and related expenses that we recognize from our animated feature films and related products could be wrong,
which could result in fluctuations in our earnings.



If our stock price
fluctuates, you could lose a significant part of your investment.



The market price of our Class A common stock may be influenced by many factors, some of which are beyond our control, including those described above and the following:



| |  |  | changes in financial estimates by analysts;
| | - |  | -------------------------------------------



| |  |  | announcements by us or our competitors of significant contracts, productions, acquisitions, or capital commitments;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | variations in quarterly operating results;
| | - |  | ------------------------------------------



| |  |  | general economic conditions;
| | - |  | ----------------------------



| |  |  | terrorist acts;
| | - |  | ---------------



| |  |  | future sales of our common stock; and
| | - |  | -------------------------------------



| |  |  | investor perception of us and the filmmaking industry.
| | - |  | ------------------------------------------------------



In addition, the stock market in general has experienced extreme price and volume fluctuations that have often been unrelated to and disproportionate to
the operating performance of movie studios. These broad market and industry factors may materially reduce the market price of our Class A common stock, regardless of our operating performance.



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We have agreed to effect up to two follow-on secondary offerings of our Class A common stock in respect of the Holdco
arrangements described below. Sales of our Class A common stock in such follow-on offering or offerings may cause the market price of our Class A common stock to drop significantly, even if our business is doing well.



On March 28, 2005, we filed a registration statement on Form S-1 with the
SEC to register the sale of approximately $500 million of Class A common stock (assuming no exercise of an over-allotment option) by certain of our stockholders. This registration statement was filed in anticipation of a follow-on offering expected
to be completed sometime after May 27, 2005. The timing and amount of the offering is subject to market conditions and other factors. As described below, certain members of DreamWorks Studios who received shares of our common stock in connection
with the Separation entered into an arrangement among themselves with respect to the allocation of such shares among such members. Entities controlled by Paul Allen, Steven Spielberg, Jeffrey Katzenberg and David Geffen, together with Lee
Entertainment L.L.C. (Lee Entertainment) and Universal Studios, contributed the shares of our common stock received by them in the Separation to DWA Escrow LLLP, a limited liability limited partnership referred to in this report as
Holdco (other than (1) in the case of entities controlled by Steven Spielberg, Jeffrey Katzenberg and David Geffen, 577,040 shares of Class A common stock and 1,154,079 shares of Class B common stock, (2) in the case of an entity
controlled by Paul Allen, 12,627,933 shares of Class A common stock (4,901,858 shares of which were sold in our initial public offering) and one share of Class C common stock, (3) in the case of Lee Entertainment, 1,997,067 shares of Class A common
stock (775,213 shares of which were sold in our initial public offering) and (4) in the case of Universal Studios, 1,039,756 shares of Class A common stock (all of which were sold in our initial public offering). In connection with the establishment
of Holdco, we have agreed that Jeffrey Katzenberg and David Geffen (or entities controlled by them), acting together, or Paul Allen (or entities controlled by him) may select the timing of one follow-on secondary offering of Class A common stock,
which must occur during the period beginning six months after our initial public offering and ending on May 31, 2006. Such follow-on offering must be of a sufficient size to permit the Holdco partners to receive a minimum of approximately $533
million of aggregate net cash proceeds from a combination of sales of secondary shares in our initial public offering and such follow-on secondary offering (assuming participation by all Holdco partners in such offerings, subject in the case of
entities controlled by Steven Spielberg, Jeffrey Katzenberg and David Geffen, to the 365-day lock-up described in the following risk factor). Shares to be sold in such follow-on offering will consist of shares of common stock retained by Holdco
partners and certain of the common stock contributed to Holdco. Under no circumstances will we be obligated to issue additional shares of our common stock for sale in the follow-on offering, regardless of the size of such offering. Upon consummation
of a follow-on offering that satisfies this requirement, each Holdco partner will have the right to receive a portion of the remaining shares of common stock held by Holdco and allocated to such partner and, in the case of certain Holdco partners, a
portion of any net proceeds received by Holdco in connection with such offering, in each case in accordance with the Holdco partnership agreement.



If such follow-on offering has not occurred by May 31, 2006, then Paul Allen (or entities controlled by him) will have the ability to initiate a follow-on
offering during the 18-month period (or 24-month period if Universal Studios triggers a follow-on offering as described below) beginning June 1, 2006. If such follow-on offering has not occurred by December 1, 2007 (or June 1, 2008 if Universal
Studios triggers a follow-on offering as described below), then Jeffrey Katzenberg and David Geffen (or entities controlled by them) will have the right to initiate a follow-on offering on or prior to December 31, 2007 (or June 30, 2008 if Universal
Studios triggers a follow-on offering as described below). In addition, if a follow-on offering has not been consummated prior to December 1, 2006, then during the period from December 1, 2006 through February 28, 2007, Universal Studios will have
the right to initiate a follow-on offering of a portion of the stock contributed to Holdco of a sufficient size to generate aggregate net proceeds of $75 million for Universal Studios, when combined with the net proceeds received by Universal
Studios in our initial public offering.



The follow-on offering
or offerings may cause the market price of our Class A common stock to drop significantly, even if our business is doing well and even though we will not issue any additional shares to be sold in such offering or offerings.



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Shares eligible for future sale may cause the market price of our Class A common stock to drop significantly, even if
our business is doing well.



The market price of our Class
A common stock could decline as a result of sales of a large number of shares of our Class A common stock in the market or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it
more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.



As of March 31, 2005, there were 52,189,992 shares of our Class A common stock, 50,842,414 shares of our Class B common stock and one share of our Class C
common stock outstanding. The shares of Class B common stock and Class C common stock are convertible into Class A common stock on a one-for-one basis. The 33,350,000 shares of Class A common stock sold in our initial public offering, the 2,146,505
shares of our Class A common stock delivered to DreamWorks Studios and our employees (in connection with the conversion of equity-based compensation awards of DreamWorks Studios that are vested or will vest within 60 days and the grant of
shares to our and DreamWorks Studios employees and advisors in connection with our initial public offering) and the 276,924 shares of Class A common stock issued to current and former employees of PDI in connection with the merger of PDI and a
wholly owned subsidiary of ours are freely tradeable without restriction or further registration under the Securities Act of 1933, as amended, by persons other than our affiliates within the meaning of Rule 144 under the Securities Act.



In addition to the follow-on secondary offerings described in the previous
risk factor (which will occur no earlier than May 27, 2005), following the final allocation of shares by Holdco to the Holdco partners, each of Steven Spielberg, Jeffrey Katzenberg, David Geffen and Paul Allen or entities controlled by them or their
permitted transferees, subject to the lock-up described below, will be able to sell their shares in the public market from time to time without registering them, subject to certain limitations on the timing, amount and method of those sales imposed
by regulations promulgated by the Securities and Exchange Commission (the SEC). Entities controlled by each of Paul Allen, Steven Spielberg, Jeffrey Katzenberg and David Geffen (and certain of their permitted transferees), as well as
Universal Studios in limited circumstances, will also have the right to cause us to register the sale of shares of Class A common stock beneficially owned by them. In addition, certain of our stockholders that are members of DreamWorks Studios on
the closing date will have the right to include shares of Class A common stock beneficially owned by them (including the Class A common stock into which our Class B and Class C common stock is convertible) in certain future registration statements
relating to our securities. If any of Paul Allen, Steven Spielberg, Jeffrey Katzenberg, David Geffen, Holdco, Universal Studios, entities controlled by them or their respective permitted transferees were to sell a large number of their shares,
including in the follow-on secondary offerings described above, the market price of our Class A common stock could decline significantly. In addition, the perception in the public markets that sales by them might occur could also adversely affect
the market price of our Class A common stock.



In connection
with our initial public offering, entities controlled by Steven Spielberg, Jeffrey Katzenberg and David Geffen agreed to a lock-up period, meaning that they and their permitted transferees may not sell any of their shares without the prior consent
of the underwriters of our initial public offering until October 28, 2005. Although there is no present intention to do so, the underwriters may, in their sole discretion and without notice, release all or any portion of the shares from the
restrictions in any of the lock-up agreements described above. In addition to the lock-up agreements described above, we and entities controlled by Paul Allen, Steven Spielberg, Jeffrey Katzenberg and David Geffen and the other Holdco partners (and
their parent entities) have agreed to certain trading and hedging limitations until the final allocation of shares by Holdco to the Holdco partners.



In addition, Holdco and members of DreamWorks Studios not participating in Holdco (other than Thomson) have pledged approximately 10,714,286 shares of our
common stock as security for DreamWorks Studios obligations under its revolving credit agreement. Under certain circumstances, including an event of default by DreamWorks Studios under that revolving credit agreement, the lenders will be
entitled to take possession of the pledged shares of common stock (after converting any pledged Class B common stock into Class A common



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stock) and sell them in the open market, subject to applicable bankruptcy, securities and other laws, as well as any applicable lock-up agreements.



In October 2004, we filed a registration statement on Form S-8
under the Securities Act to register an aggregate of 16,521,358 shares of our Class A common stock reserved for issuance under our 2004 Omnibus Incentive Compensation Plan, including shares of our common stock underlying equity-based awards made at
the time of our initial public offering. Subject to the lock-ups described above and any limitations on sales of our common stock by our affiliates, shares registered under the registration statement on Form S-8 are available for sale into the
public market.



Also, in the future, we may issue our
securities in connection with investments and acquisitions. The amount of our common stock issued in connection with an investment or acquisition could constitute a material portion of our then outstanding common stock.



A few significant stockholders control the direction of our business. The concentrated
ownership of our common stock and certain corporate governance arrangements will prevent you and other stockholders from influencing significant corporate decisions.



Holdco, which is controlled by Jeffrey Katzenberg and David Geffen or entities controlled by them (subject to certain
approval rights of Holdcos limited partners) prior to the final allocation of shares contributed to Holdco, currently owns 97.8% of the outstanding shares of our Class B common stock (which represents 48.2% of our common equity and 91.5% of
the total voting power of our common stock). In addition, Jeffrey Katzenberg and David Geffen each own 577,040 shares of our Class B common stock outside of Holdco, which represents the remaining outstanding shares of Class B common stock and in the
aggregate 1.1% of our common equity and 2.1% of the total voting power of our common stock. Accordingly, Jeffrey Katzenberg and David Geffen or entities controlled by them generally have the collective ability to control all matters requiring
stockholder approval, including the nomination and election of directors (other than the director elected by an entity controlled by Paul Allen as the holder of Class C common stock), the determination of our corporate and management policies and
the determination, without the consent of our other stockholders, of the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including potential mergers or acquisitions, asset sales and other significant
corporate transactions. In addition, the disproportionate voting rights of the Class B common stock relative to the Class A common stock and the Class C common stock may make us a less attractive takeover target.



The interests of our controlling and significant stockholders may conflict with the
interests of our other stockholders.



We cannot assure you
that the interests of Jeffrey Katzenberg, David Geffen, Steven Spielberg and Paul Allen, or entities controlled by them, will coincide with the interests of the holders of our Class A common stock. For example, Jeffrey Katzenberg and David Geffen,
or entities controlled by them, could cause us to make acquisitions that increase the amount of our indebtedness or outstanding shares of common stock or sell revenue-generating assets. Additionally, DreamWorks Studios (which is controlled by
Jeffrey Katzenberg, David Geffen and Steven Spielberg) is in the business of making movies and derivative products and may, from time to time, compete directly or indirectly with us or prevent us from taking advantage of corporate opportunities.
Jeffrey Katzenberg, David Geffen, Steven Spielberg and DreamWorks Studios may also pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. Our restated
certificate of incorporation provides for the allocation of corporate opportunities between us, on the one hand, and certain of our founding stockholders, on the other hand, which could prevent us from taking advantage of certain corporate
opportunities. So long as Jeffrey Katzenberg, David Geffen or entities controlled by them continue to collectively own shares of our Class B common stock with significant voting power, Jeffrey Katzenberg and David Geffen, or entities controlled by
them, will continue to collectively be able to strongly influence or effectively control our decisions.



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Additionally, in connection with the Separation we entered into a tax receivable agreement with an entity
controlled by Paul Allen. As a result of certain transactions that entities controlled by Paul Allen engaged in, the tax basis of our assets was partially increased and the amount of tax we may pay in the future is expected to be reduced. Under the
tax receivable agreement, we are required to pay to an entity controlled by Paul Allen 85% of the amount of any cash savings in certain taxes resulting from the partial increase in tax basis and certain other related tax benefits, subject to
repayment if it is determined that these savings should not have been available to us. As a result, the interests of Paul Allen and entities controlled by him and the holders of our Class A common stock could differ. The actual amount and timing of
any payments under this tax receivable agreement will vary depending upon a number of factors. As a result of the increased tax basis, we expect to be entitled to a tax benefit of $83.1 million as management has determined that such benefit can be
realized through a reduction or refund of taxes paid in 2004. The tax receivable agreement requires us to pay an entity controlled by Paul Allen 85% of such benefit. As a result of the size of the increase in the tax basis of our tangible and
intangible assets, during the approximately 15-year average amortization period for such increased tax basis, the payments that may be made to an entity controlled by Paul Allen could be substantial. See Note 9 to our unaudited Consolidated
Financial Statements included in this Form 10-Q for further discussion of the tax receivable agreement.



Anti-takeover provisions of our charter and by-laws, as well as Delaware law may reduce the likelihood of any potential change of control or unsolicited acquisition proposal that you might consider favorable.



The anti-takeover provisions of Delaware law impose
various impediments to the ability of a third-party to acquire control of us, even if a change in control would be beneficial to our existing stockholders. Additionally, provisions of our charter and by-laws could deter, delay or prevent a
third-party from acquiring us, even if doing so would benefit our stockholders. These provisions include:



| |  |  | the division of our capital stock into Class A common stock and Class C common stock, each entitled to one vote per share, and Class B common stock, entitled to 15 votes per share,
all of which Class B common stock will initially be owned or controlled by Jeffrey Katzenberg and David Geffen;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the right of the holder of Class C common stock (voting as a separate class) to elect one director;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | the authority of the board to issue preferred stock with terms as the board may determine;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | the absence of cumulative voting in the election of directors;
| | - |  | --------------------------------------------------------------



| |  |  | following such time as the outstanding shares of Class B common stock cease to represent a majority of the combined voting power of the voting stock, prohibition on stockholder
action by written consent;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | limitations on who may call special meetings of stockholders;
| | - |  | -------------------------------------------------------------



| |  |  | advance notice requirements for stockholder proposals;
| | - |  | ------------------------------------------------------



| |  |  | following such time as the outstanding shares of Class B common stock cease to represent a majority of the combined voting power of the voting stock, super-majority voting
requirements for stockholders to amend the by-laws; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | stockholder super-majority voting requirements to amend certain provisions of the charter.
| | - |  | ------------------------------------------------------------------------------------------



It is possible that we may be treated as a personal holding company for Federal tax purposes now or in the future.



The Internal Revenue Code currently imposes an additional tax at a rate of
15% on the undistributed personal holding company income (as defined in the Internal Revenue Code) of a corporation that is a personal holding company and such rate of tax is scheduled to increase for taxable years beginning
after December 31, 2008. A corporation is treated as a personal holding company for a taxable year if both (i) five or fewer individuals directly or indirectly own (or are deemed under attribution rules to own) more than 50% of the value of the
corporations stock at any time during the last half of that taxable year and (ii) 60% or more of the



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corporations gross income for that taxable year is personal holding company income (which includes, among other things, dividends,
interest, annuities and, under certain circumstances, royalties and rents). We believe that, under applicable attribution rules, five or fewer individuals may be deemed to own more than 50% of the value of our stock and the stock of our
subsidiaries. We also believe, however, that less than 60% of our and our subsidiaries gross income consists of personal holding company income and, as a result, we believe that neither we nor any of our subsidiaries is a personal holding
company. There can be no assurance, however, that we or any of our subsidiaries are not, or will not become, a personal holding company and thus be subject, or become subject to, the tax imposed on our or our subsidiaries undistributed
personal holding company income.



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|Item 3. | Quantitative and Qualitative Disclosure About Market Risk
|------- | ---------------------------------------------------------



Market and Exchange Rate Risk



Interest Rate Risk.    We are exposed to the impact of interest rate changes as a result of our variable rate long-term debt
and debt allocated to us by DreamWorks Studios. DreamWorks Studios uses derivative instruments from time to time to manage the related risk. Because DreamWorks Studios allocates to us the income and expense associated with these derivative
instruments, this has resulted in short term gains or losses. As a result of the Separation, we are no longer allocated interest expense or other income and expense associated with derivative instruments, although we did assume the interest rate
swap and cap agreements associated with our production funding indebtedness. We continue to actively monitor fluctuations in interest rates. A hypothetical 1% change in the interest rates applicable to the debt associated with our Glendale animation
campus would approximately result in a $0.7 million increase or decrease in annual interest expense. We are not subject to significant interest rate risk on our other financing arrangements.



Foreign Currency Risk.    We are subject to market
risks resulting from fluctuations in foreign currency exchange rates through our non-U.S. revenue sources and we incur certain distribution and production costs in foreign currencies. However, there is a natural hedge against foreign currency
changes due to the fact that, while significant receipts for international territories may be foreign currency denominated, significant distribution expenses are similarly denominated, mitigating fluctuations to some extent depending on their
relative magnitude. Wallace & Gromit: Curse of the Were RabbitandFlushed Awayare currently being produced or partially produced in the United Kingdom and are our only productions being produced abroad. We have entered into a
hedge agreement for Wallace & Gromit intended to reduce our exposure to changes in the British pound. Flushed Away is only partially produced in the United Kingdom and a hypothetical currency fluctuation of 20% would approximately
result in $1.2 million increase or decrease in exchange gain or loss.



Credit Risk.    We are exposed to credit risk from DreamWorks Studios and third parties, including customers, counter parties and distribution partners. These parties may default on their obligations to us, due to
bankruptcy, lack of liquidity, operational failure or other reasons.



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|Item 4. | Controls and Procedures
|------- | -----------------------



(a) Evaluation of disclosure controls and procedures.



Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls
and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as of the end of the period covered by this report. The evaluation included certain internal control areas in which we have made and are continuing to make changes to
improve and enhance controls. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving
the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.



Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and
procedures were effective as of the end of the first quarter to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is accurately recorded, processed, summarized and
reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required disclosure.



(b)
Changes in internal controls over financial reporting.



There were no changes in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.



Since 2004 we have invested
significant resources to comprehensively document and analyze our system of internal controls. We have identified areas of our internal controls requiring improvement, and are in the process of designing enhanced processes and controls to address
issues identified through this review. For a further discussion, see Item 2Risk FactorsWe are required to evaluate our internal control over financial reporting under Section 404 of the Sarbanes Oxley Act of 2002, and any
adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price. Management will consider these matters when assessing the effectiveness of our
internal control over financial reporting at year end and we expect that we will make additional changes to enhance our internal control over financial reporting.



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PART IIOTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------



From time to time we are involved in legal proceedings arising in the ordinary course of our business, typically intellectual property litigation and
infringement claims related to our feature films, which could cause us to incur significant expenses or prevent us from releasing a film. We also have been the subject of patent and copyright claims relating to technology and ideas that we may use
or feature in connection with the production, marketing or exploitation of our feature films, which may affect our ability to continue to do so.



We believe that there is no litigation pending against us, including the matters described above, that should have, individually or in the aggregate, a
material adverse effect on our financial position or results of operations.



Items 2, 3, 4 and 5 are not applicable and have been omitted.



|Item 6. | Exhibits
|------- | --------



|             |  |                                                                                                                                                                                
|------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.           
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.           
|             | 
|Exhibit 32.1 |  | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.



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##### Table of Contents

SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                   |  |                                |  |                                           
|------------------ |  | ------------------------------ |  | ------------------------------------------
|                   |  | DREAMWORKS ANIMATION SKG, INC.
|                   |  |                               
|Date: May 16, 2005 |  | By:                            |  | /s/    KRISTINA M.
LESLIE                 
|                   |  | Name: Title:                   |  | Kristina M. Leslie Chief Financial Officer



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EXHIBIT INDEX



|              |  |                                                                                                                                                                                
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                    
|Exhibit 31.1  |  | Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.           
|              | 
|Exhibit 31.2  |  | Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.           
|              | 
|Exhibit 32.1  |  | Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.



48