From Shrek to Kung Fu Panda, DreamWorks Animation has crafted some of the most indelible characters in recent animation history. But a bruising earnings report and deep staff cuts have exposed flaws in the company's business model.
The failure of DreamWorks Animation's most recent film, "The Rise of the Guardians," is the most immediate cause of an $83 million loss in the fourth quarter of fiscal year 2012, and not the fact that the Glendale campus still serves free lunch to all its employees (it does). Though the film grossed $302 million at the worldwide box office, that was not enough to offset its production and marketing costs, forcing the company to announce on Tuesday that it will take an $87 million write-down and lay off 350 of its 2,200 employees.
If one film can result in all that carnage, how can DreamWorks Animation maintain its status as the primary challenger to Disney and Pixar's children's entertainment empire?
"They spend as if every movie they produce is a new 'Shrek,' but it's unreasonable to spend as if you are making big, big tentpoles when you really aren't," Vasily Karasyov, an analyst for Susquehanna Financial Group, which is a market maker in the securities of DreamWorks Animation, told TheWrap. "They need to cut production and releasing costs to make it less risky."
Indeed, DreamWorks Animation's track record show high costs that leave little room for error. Its last 13 films all have had reported production budgets of at least $130 million.
DreamWorks Animation CEO Jeffrey Katzenberg acknowledged corporate excess while speaking to analysts on Tuesday, describing the layoffs as a painful necessity.
"We have actually taken this as an opportunity to significantly right-size the whole enterprise here and to put it on what we believe is a much more profitable, better margin and what will be a long-term successful path going forward," Katzenberg said.
He later added, "We've done a reset, and we've done it across the board, top to bottom, including our development and everything else here. So I feel like we have, going forward, a leaner and much more profitable business."
In the aftermath of that frank admission, some analysts praised Katzenberg and company for recognizing the necessity of doing more with less.
"They’re going to go through a lot pain, but they need to rip off the Band-Aid so they can operate as a lower cost business," Tony Wible, an analyst with Janney Montgomery Scott, told TheWrap. "It doesn’t happen overnight. But in terms of a leaner cost structure, it’s similar to what the airlines did when they went through a process of reorganization to emerge as a more effective business."
It will take some time before DreamWorks Animation's costs drop. "Rise of the Guardians" was made for a reported $145 million. The company is still working on developing technology that will lower production budgets to $120 million by 2015 — less than past movies but more than its non-Pixar competitors. After all, competitors Blue Sky Studios and Illumination Entertainment are producing hits that rival "How to Train Your Dragon" and "Kung Fu Panda," but they are doing so more economically.
Production budgets will rise because of what Katzenberg attributed to changes in the company's release schedule. After signing a new distribution agreement with Fox, the studio pushed DreamWorks Animation to delay its release of "Mr. Peabody and Sherman" from November to March 2014. It also took a $54 million charge for putting "Me and My Shadow," a film about the world's most boring person and his shadow, back into development instead of moving into production.
DreamWorks Animation has been criticized in the past for being overly reliant on every film turning a profit, leaving no room for flops.
"It puts an awful lot of pressure on them to get it right every time they release a film," Marla Backer, an analyst with Hudson Square Research, told TheWrap. "To the extent that they might have been climbing back a little bit with investors in recent months, this has put them a few steps back."
DreamWorks Animation is positioning itself to reduce its dependence on films. In December, the studio hired former J.C. Penney President Michael Francis for its newly created position of global brand officer. It is relying on him to leverage the recently purchased Classic Media, which owns shows like "Casper" and "Lassie." He also will try to build up the company's consumer products offerings and create more TV shows, such as the upcoming "Turbo," a Netflix series tied to one of the studio's next movies. But that's a long-term play.
A lot still rides on DreamWorks Animations' 2013 slate.
The studio is in franchise-launching mode with two original films on the docket: "The Croods," a prehistoric adventure will hit theaters on March 22, and "Turbo," a sports comedy about a snail that dreams of winning a race, opens on July 11.
After four installments of "Shrek" and three editions of "Madagascar," it makes sense that the studio is trying to develop new characters to take the place of its most iconic figures, but there's a reason that Hollywood has a well-documented aversion to new ideas.
"Some of DreamWorks' recent efforts haven't lived up to their past ones," Jeff Bock, a box office analyst at Exhibitor Relations, told TheWrap. "They get credit for trying to set up new tentpole films, but it's been the sequels that are keeping them afloat."
"Croods" doesn't open for another month, but it will likely benefit from a lack of competition for the family dollar. Aside from Disney's "Oz: The Great and Powerful," there is a dearth of movies geared toward children that will hit theaters this spring. Bock said the film is on pace to open to at a very respectable $40 million domestically, which should help enliven the studio's balance sheet, but will not ensure the kind of four-quadrant hit that will instantly mop up all the red ink.
The company hasn't made an original film that topped $500 million at the box office since "Kung Fu Panda" in 2008 — though "How to Train Your Dragon" pulled in $495 million. That film inspired a traveling "arena spectacular" and the studio will release a sequel in 2014.
The company must set lofty standards just to make up for its own expenditures.
"The way their accounting works, the production costs will take years to go down," Karasyov said. "It's a matter of right-sizing it. I hate that word because it comes from Wall Street and layoffs, but costs make it very risky for them."
Meanwhile, several competitors have entered the field and are making movies at a lower price.
Fox's animation division and its Blue Sky Studios created the "Ice Age" and 'Rio" franchises, and will release the highly anticipated "Epic" this summer. Beyonce Knowles, who has a passionate following and has been nearly ubiquitous lately, will lend her voice to that one.
Illumination Entertainment, formed by former Fox Animation chief Chris Meledandri, struck gold with "Despicable Me" and is at work on both a sequel and a spin-off. Of its three movies to date, one of them, "Hop," came up short, but lower costs reduced the risk.
There are several other new players as well, such as Dallas-based Reel FX. Reel FX is at work on three different features, "Turkeys" for Relativity, "Book of Life" for Fox and "Beasts of Burden," which doesn't yet have a distributor.
All of those are budgeted for less than $100 million.