"Shrek" Is a Dream for DreamWorks

Shrek the Third turned DreamWorks Animation's (NYSE: DWA  ) latest earnings report into nothing short of a fairy tale. Revenues nearly tripled to $222.5 million. Earnings per diluted share also delighted, powering up to $0.60 compared to $0.13 per share last year. The current results include an $0.11-per-share benefit related to the reduction of reserves and marketing costs involving a transition to new distributor Paramount, as well as a $0.04-per-share tax benefit. Even so, I'm impressed.

Talk about magic. Shrek the Third opened to an awesome $122 million box office take, and has grossed about $320 million to date at the domestic box office, according to Taking into account international revenues, the sequel is closing in on $720 million. Poor Disney (NYSE: DIS  ) . DreamWorks Animation's archcompetitor is being overshadowed this summer, even though it has a Pixar title in the marketplace, Ratatouille. DreamWorks Animation is proving, in fact, that its top franchise can hold its own against the major guns from studios like Time Warner (NYSE: TWX  ) , Sony (NYSE: SNE  ) , Viacom (NYSE: VIA  ) , and News Corp. (NYSE: NWS  ) .

To be certain, this isn't much of a surprise. I think most observers realized that Shrek would be a formidable hit. What many Wall Street analysts didn't count on was the profit potential for the company's second quarter. The belief circulating around the hallowed halls of the institutions that set market expectations was that DreamWorks Animation would yield about $0.31 in earnings per share after special items. Quite off the mark, wouldn't you say?

DreamWorks Animation, while primarily being driven by Shrek this time around, nevertheless saw tangible benefit from its growing product library. Over the Hedge supplied almost $27 million in net sales because of its domestic pay television and home video performance. In addition, Flushed Away and Wallace and Gromit: Curse of the Were-Rabbit helped out. Oh, and so did Shark Tale, Madagascar, and the previous Shrek installments. You've gotta love the value of a film library over time.  

One sore spot from the report has to do with cash flow. Net cash from operating activities for the six-month period dropped precipitously, from $124 million last year to $22 million this year. Changes in working capital related to film and distribution costs were partly to blame. Even so, since DreamWorks Animation doesn't have much in the way of capital requirements, it was able to generate more than $20 million of free cash flow.

I know, that's still a huge decline, but it's not causing me to become bearish on DreamWorks Animation. Now is the time for shareholders to look forward to the November release of Shrek the Third on DVD, the Bee Movie project from Jerry Seinfeld, and next year's sequel to Madagascar. And don't forget, there will be a fourth Shrek film in a few years. Holding DreamWorks Animation for the long term should be a prosperous endeavor, making the current drop in free cash flow seem like a nothing event. All hail Shrek!  

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Fool contributor Steven Mallas owns shares of Disney. As of this writing, he was ranked 7,951 out of more than 60,000 investors in the CAPS system. Don't know what CAPS is? Check it out. The Fool's disclosure policy is big, green, and lovable.

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