DreamWorks’ DVD Sales Could Be Wake-Up Call

DreamWorks Animation SKG Inc.’s troubles continued Monday as the studio warned that it would lose money in the second quarter because of softer-than-expected DVD sales, the second time in two months it has projected a shortfall in its home video business.

DreamWorks also disclosed that the Securities and Exchange Commission had launched an informal probe into stock trading around the time the company surprised Wall Street in May with earnings that fell short of expectations. DreamWorks said it was cooperating with the inquiry.

The disclosure that sales of “Shrek 2” and “Shark Tale” were off sent the Glendale computer animator’s stock plunging 13%, or $3.54, to $23.27 a share.

It also raised fresh questions about whether DreamWorks and other studios were simply being overly optimistic about DVD sales, or failing to adapt to long-term changes in the home video market. DreamWorks’ chief competitor, Pixar Animation Studios, recently revised its second-quarter earnings estimate downward, citing slower DVD sales for its hit film “The Incredibles.”

Although “Shrek 2” sold briskly when it was released on DVD late last year, purchases slowed quickly. Retailers are increasingly sweeping older titles from their shelves and returning them to make room for the freshest DVDs available. Many consumers also have filled their shelves with movies purchased after they bought their first DVD players.

“The market is fast approaching maturity,” said Thomas K. Arnold, group editor and associate publisher of trade publication Home Media Retailing. “People who’ve bought DVD players have got a pretty big library and maybe they’re being more selective.”

“Shrek 2” is one of the top-selling DVDs ever, with more than 35 million copies sold. But DreamWorks and its investors expected solid sales well into this year, mirroring the way the original “Shrek” continued to sell on home video.

DreamWorks Chief Executive Jeffrey Katzenberg told analysts in a conference call that it was too early to draw permanent conclusions.

“There is a tremendous amount of product in the marketplace,” he said. “It’s obviously much more crowded than it has been before. We don’t know if this is a short-term issue or if some larger shift is going on.”

DreamWorks executives said in a conference call with analysts that an eight-week survey of domestic and international markets with distribution partner Universal Pictures International found “lower inventory levels and higher-than-expected returns” for “Shrek 2” and “Shark Tale.”

As a result, the studio opted to increase its reserves -- money it reimburses retailers for unsold DVD titles -- from its 2004 releases.

Wall Street has been unforgiving since DreamWorks first disclosed the shortfalls in May. Its stock is off nearly 45% from its peak of $41.98 in December.

With its stock sagging, the company confirmed that it had scrapped for now a $500-million secondary stock offering by billionaire investor Paul Allen, Katzenberg and company principal David Geffen. The offering has been considered a long shot since the company’s stock began its slide.

DreamWorks is projecting a quarterly loss of 7 cents to 9 cents a share, down from a previous forecast of break-even, and lowered its full-year projection to a profit of 80 cents to 90 cents a share, down from $1 to $1.25.

“One time is understandable,” Anthony Valencia, an analyst at TCW Group Inc. in Los Angeles, said of the earnings revisions. “The fact that they’re doing it again is something that investors just don’t like. It goes to the issue of credibility.”

Richard Greenfield, an analyst at Fulcrum Global Partners in New York, responded to Monday’s news by lowering his rating on the company’s stock to “neutral” from “buy.”

“They don’t seem to have a good handle on where their numbers are,” Greenfield said.

DreamWorks did not elaborate on the SEC matter. It said the agency, as it usually does when it launches an informal inquiry, told the company that the review “should not be construed as an indication that any violations of law have occurred.”

DreamWorks also said six class-action lawsuits had been filed related to its earnings shortfalls. The company said that the suits were without merit and that it planned to vigorously defend itself.