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No. of Recommendations: 8
The share price has firmed up since the Q2 results, but it seems the only substantive change has been some resolution of uncertainty in terms of what's affecting home video sales. That resolution is that the changing marketplace dynamics took DWA and competitors by surprise, but that there are no changes to the core strengths of the company. These changing dynamics weren't spelled out thoroughly, but included the glut of TV-related DVDs and "management at the retail level" (I think that means shelf space and/or pricing). Their strategy is to be more on top of these changing dynamics. (Vague, but probably effective)

One thing to note is that the accounting for DWA is not altogether intuitive and affects earnings. It's critical to read their revenue recognition policies in the annual report regarding how they amortize film costs in relation to revenues. In short, they make a prediction about expected ultimate DVD sales, and they will amortize a proportionate amount of the film costs relative to how much of those ultimate sales are reflected in the revenues earned in that period. This accounting treatment affected earnings materially this past quarter because of revised ultimate figures for Shark Tale. As a result, the Shark Tale revenues booked in Q1 didn't get matched to high enough film costs, and the difference in costs was recognized in Q2 (but should have been recognized in Q1, had management known)

One reason DWA is hard to value is because the reporting periods don't match up very well with the operating cycle. Their business strategy is to release two successful CG-animated feature films per year. A better way to look at DWA's performance is to consider their revenues and expenses on a "film cycle", using a half-by-half versus quarter-by-quarter reporting basis, and considering P/E ratios for 2-film rather than 1-year periods. As a result of the way things are set up, FY '05 results will reflect the performance of 1 film (Madagascar) even though two releases are expected (the other is Wallace & Gromit). Madagascar results won't be reflected in earnings until Q4, even though the film has already earned $430m worldwide, and nothing will really happen in Q3.


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