While revenues were decreasing, expenses were increasing, growing from $2.8 million in 1997 to $3.2 million in 1998. Much of this was due to general and administrative expenses, which grew over 73%. Pixar had both A Bug's Life and Toy Story 2 in production, and were in the early stages of developing Film Four (Monsters, Inc.). In the report, Pixar pointed out production hadn't started yet on Monsters, Inc. as the story treatment hadn't been approved. They also stated if the story treatment and budget were approved, it was not expected to be released until late 2000 at the earliest. As we all know, it would be a year later before it hit theaters.
Net income was a little over $2 million ($0.05/share) compared to almost $9 million ($0.22/share) in the year before quarter. You might ask, if revenue was $3.8 million and $3.2 million went into expenses, how did Pixar end up with over $2 million in net income? The answer comes in the category of Other Income which totaled close to $2.2 million. This income was basically interest Pixar earned on their short-term investments - the large cash hoard Pixar still had from their IPO in 1995.
The impact of lower earnings was more apparent by looking at their cash flow statement. For the first 6 months of 1998, Pixar generated $4.4 million of cash from their operations, but they spent $5.9 million on new equipment and $15.1 million on the production of A Bug's Life, Toy Story 2 and Monsters, Inc., for a cash outflow of $16.6 million. Remember, with the Co-Production Agreement with Disney, Pixar was now responsible for financing half of their film costs. With those higher costs and no expected revenue from A Bug's Life coming until early 1999, Pixar would be burning through a significant amount of cash for the next couple of quarters. Fortunately, they had over $160 million in the bank so they were well prepared to handle these expenditures.
Pixar's stock had had a good run-up through the first half of 1998, going over $63/share early in July. But after these results were announced their price began to drop, going down to around $50 by months end and getting as low as $28 near the end of August, 1998. Pixar was always known to be conservative in their earnings estimates and often beat expectations, as I discussed in my post for their first quarter of 1998 earnings report. I think analysts were somehow expecting revenues and earnings would continue to grow even in the absence of a recent film release. As a long term investor I wasn't concerned with the quarterly gyrations of revenues and earnings, but most analysts are only concerned with short term results. I think this quarterly report woke those analysts up and they realized it would be months before revenues would start to grow again.