Thursday, April 18, 2013

This Day in Pixar History: Pixar 1996 Annual Report

Once again, I'm back looking at the financial earnings reports from Pixar when they were an independent public company. In my previous posts, I covered their quarterly earnings for the first, second and third quarters of 1996. In this post I'm going to cover their 1996 annual report.

1996 Annual Report cover

For their first year as a public company, Pixar did quite well. The studio ended the year with over $38.2 million in revenues, more than 200% higher than the $12.1 million made in 1995. Almost half of the revenue, $18.8 million, came from their first feature film, Toy Story, released November 22, 1995. $9.1 million came from patent licensing, primarily from Silicon Graphics. Another $6.3 million came from software, such as RenderMan licenses and their 2 Toy Story-based CD-ROM products, The Toy Story Animated Storybook and The Toy Story Activity Center. Finally, they made another $3.9 million from television commercials and other animation services.

Toy Story 2 art

Gross margins for the year were amazing - over 87%, higher than the 80% margins in 1995. As I mentioned in my post for the 3rd quarter of 1996, Pixar had very low cost of revenue. According to the Feature Film Agreement signed with Disney in 1991 (and the subsequent CD-ROM agreement), Disney reimbursed Pixar for almost all costs related to the development and production of Toy Story and the CD-ROM titles. In addition, there were no costs of revenues associated with their licensing revenue. Their total cost of revenue was only $4.7 million, of which $3 million was attributed to their television commercials and animation services. Pixar had announced in 1996 they would be getting out of the commercial business and moving those employees to their feature film development teams. As this segment had the lowest margins (23% vs 95% for the other business segments), it is not surprising that Pixar made the decision to exit it.

Research & Development expenses increased from $4.1 million in 1995 to $7.0 million in 1996, primarily in support of their software tools like RenderMan, Marionette (their animation system), and Ringmaster (a production management software system). General & Administrative expenses increased 87% from $3.0 million to $5.6 million. Pixar stated in the annual report that they expected G&A expenses to continue to increase, partly due to intense competition (and the corresponding higher salaries) for animators and other creative personnel. Pixar also experienced an increase in Sales & Marketing expenses in 1996 compared to 1995 (from $1.6 million to $1.8 million) due to the release of Toy Story and becoming a public company.

Net Income for the year was over $25.3 million, or $0.54/share, compared to only $1.6 million ($0.04/share) in 1995. This is a net profit margin of over 66%! Pixar's balance sheet was also very strong, courtesy of their IPO in late 1995 and the good results in 1996. Cash and short-term investments grew from $144.3 million in December, 1995 to $161.0 million in December, 1996, and liabilities were only $6.7 million with not a dollar of debt on the balance sheet!

Even with all this good news, Pixar raised concerns regarding their future financial situation. They stated they expected a substantial decline in their operating results in 1997. The primary cause of this was the expected drop-off in revenue from Toy Story. They only expected revenue from the Toy Story home video release, and the majority of that would occur in the first half of the year. And according to their agreement with Disney, they received a lessor amount of home video revenue than theatrical revenue.

In addition, Pixar had decided in early 1997 to discontinue its CD-ROM production business. The business had been successful, but Pixar wanted to reassign most of the 60 employees in that department to other groups such as feature film production. This meant Pixar would experience a "material adverse impact" (accounting lingo for "we're going to make less money than we expected") on its operating results in both 1997 and 1998.

Pixar also warned of a decline in RenderMan revenue, as the company focused more on their film business, plus they expected increases in operating expenses from continued growth in their operations and research and development efforts.

Finally, they had no new films due for almost 1 1/2 years. A Bug's Life was to be released in late 1998, and Pixar didn't expect to recognize any revenue until later half of 1999. Also, at this point, Toy Story 2 was still scheduled to be a direct-to-video release, also in late 1998, which meant no revenue from that would be received until 1999. I did find it interesting though that they mention the possibility of releasing Toy Story 2 to theaters rather than direct-to-video. I had always thought that decision had been made late in its production.

It should not be much of a surprise then, given all the cautionary talk on decreasing revenues and increasing expenses, that Pixar stock was stuck in the low to mid teens. I made my first purchase of Pixar stock in April, 1997 for $15/share. Obviously, I was in it for the long term!

I am probably one of those rare (some may say weird) people who enjoy reading annual reports, especially the ones from Pixar! They always started out with an entertaining and informative letter from Chairman and CEO Steve Jobs. His letter in this report was 15 pages long, and include some beautiful drawings, pre-production artwork and storyboards from Toy Story 2, Geri's Game and The Adventures of André and Wally B. In addition to discussing the previous year's results, Jobs provided a good summary of the what's and why's on the newly signed co-production agreement with Disney (I will discuss this agreement in detail in a future post). He also discussed Pixar's 3 core capabilities that would enable them to become a world-class animation studio: Creative, Technical and Production. The annual report also discussed their purchase of land in Emeryville to build a new studio facility. Pixar had put down a $300,000 non-refundable deposit for the land, and while they had not made the final decision to move ahead with building the new studio, the report stated that was their intention.

The next post in this series will cover results from the first quarter of 1997.

Back cover

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