I'm back with another post reviewing Pixar's quarterly earnings reports from when they were a public company. I started about a year ago with the first quarter of 1996, their first quarterly report as a public company. In this post I'm covering the first quarter of 1997, another positive if uneventful quarter except for the big, new film agreement with Disney that was announced after the end of the quarter (discussed at the end of this post).
Total revenue for the quarter was almost $7.9 million. As Pixar warned in their annual report earlier in the year, revenues decreased from $8.3 million in the first quarter of 1996 due to a number of reasons. In the first quarter of 1996 Pixar received a large ($6.5 million) patent royalty payment from Silicon Graphics. In addition, Pixar had significantly reduced their commercial animation services business during 1996 to focus on developing feature films, which had a negative impact on the 1997 earnings. On the positive side, Pixar did receive $6.3 million from home video sales of Toy Story, compared to only $76,000 in film revenue in the year ago period. They also increased software sales (mostly from RenderMan licenses) from $911,000 to $1.4 million. But the increases in film and software revenue were not enough to make up for the losses in the other segments.
Cost of revenue as a percentage of revenue continued to be very low. For software sales, cost of revenue was 1% in 1997 compared to 6% in 1996 due to the higher margins received for RenderMan. Cost of film revenue also decreased (as a percentage of revenue) from 12% in 1996 to 9% in 1997. There were no costs for the patent licensing revenue. Therefore, gross margins for the 1997 quarter were $7.3 million, and on a percentage of revenue basis, were 92.7% vs. 90.5% in 1996.
Operating expenses stayed fairly constant, increasing 2% to $2.6 million. Expenses were held in check partially due to the new Co-Production agreement with Disney, who was now paying half of all expenses associated with film production.
Net Income for the first quarter of 1997 was $5.1 million versus $6.3 million in 1996, primarily due to the decrease in revenues from Toy Story. Diluted earnings per share were $0.11 versus $0.13.
In usual Pixar style, management gave a plethora of reasons why future revenues and earnings would be decreasing and why losses should be expected, especially in the 1998 fiscal year. They pointed out that since 1990, about 40 animated films had been released and only 2 of those films had generated more revenue than Toy Story, and both of those films were produced solely by Disney. And in the 5 year period prior to early 1997, no animated feature film produced by any studio other than Disney had generated domestic revenue of more than $25 million, other than Toy Story. The point Pixar was trying to make was that even if their next film, A Bug's Life, was a critical and box-office success, generating results similar to Toy Story would be very unlikely. But as we know, A Bug's Life was a hit, generating almost $163 million in domestic revenue and over $363 million worldwide. As an investor I appreciated Pixar's conservative outlooks - it helped keep the stock price stable and avoided large price drops. It also helped keep analyst estimates in check, and as became a regular occurrence, Pixar would exceed these estimates which would help drive the price up.
The biggest news of the quarter was the announcement on February 24 by Pixar and Disney of a new film agreement between the 2 companies. The new agreement, which was expected to run 10 years, expanded the original 3 film agreement to 5 films. With the new agreement, both Pixar and Disney would have equal billing on the films, home videos and other merchandise. It also greatly increased the risk and reward for Pixar, as they would now evenly split all costs and revenue with Disney from the films and merchandise (in the original agreement, Disney paid for almost all film development costs and Pixar only received a small percentage of the profits). A Bug's Life was to be the first film developed under the new agreement, and it would run through 2006 and the release of Cars.
In addition, as part of the new agreement Disney bought 1,000,000 shares of Pixar stock at $15/share and committed to hold the stock for at least 3 years. This was a strong signal to the market of the confidence Disney had in Pixar, and Pixar's stock price reacted positively, jumping almost $7 to $21. The higher stock price did not last long though, as investors realized the new agreement wouldn't do anything to increase revenue or profits, at least until A Bug's Life was released about 20 months later. But for patient investors, the future was set and looked extremely promising. We'll find out how the 1997 fiscal year proceeded when I look at second quarter earnings in a couple of months.