This Day in Pixar History: Pixar Earnings Report, 3rd Quarter 1998

Welcome back to another look at Pixar's earnings reports from when the studio was a standalone company. Today I am looking back at their 3rd quarter 1998 results.

©Disney/Pixar

As had been the case for a few quarters, revenues for Pixar had been dropping as Toy Story revenue was drying up, and their next film, A Bug's Life, wouldn't be released until later in 1998. Total revenues for the quarter were $2.5 million, down over 50% from $5.3 million in the 3rd quarter of 1997. This was due to a 63% drop in film revenue, from over $3.5 million to $1.3 million, but that's not the full story. As part of the Feature Film Agreement between Disney and Pixar, once Disney recovered all their marketing and production costs, Pixar was eligible to receive a higher percentage of the revenue. Disney ended up recovering all their costs earlier than expected, so in the 3rd quarter of 1997, Disney paid Pixar an additional $1.8 million to catch up for the higher percentage. Removing this one-time item, film revenue only dropped $400,000. There was also no animation service or patent licensing revenue in 1998, compared to almost $1 million in 1997. There was an uptick in software revenue, growing from $900,000 to $1.2 million, which I think can be mostly attributed to their purchase of PEI which had occurred in June of 1998.

Not surprisingly, gross profits for the quarter also dropped to $2.2 million from $4.7 million in the 3rd quarter of 1997. There was a large increase in software cost of revenues due to the PEI acquisition. As discussed in the quarterly report, Pixar was amortizing a large portion ($2.7 million) of the purchase price for PEI over the next 3 years. Basically, Pixar would match amortized expenses against any related revenue so there would be no gross profit until the $2.7 million had been accounted for.

Even though software cost of revenues increased dramatically, gross margins stayed the same at 88% year-over-year. This was due to the high cost of animation services that was recorded in 1997 - $534,000 in costs against $896,000 in revenue for a gross margin of only 40%. While 40% gross margins would be good in many businesses, that was less than half of what Pixar was generating with their film and software businesses, and I'm sure had a large influence on the company deciding to exit that business segment.

©Disney/Pixar

Expenses for the quarter were $3 million, up from only $658,000 in 1997. But I should point out that 1997 had an extraordinary event which I discussed in my post of that quarterly report: due to Disney and Pixar signing the new Co-Production Agreement in early 1997, Disney was responsible for paying half of all the costs Pixar incurred in developing films. At the time of signing the agreement, both A Bug's Life and Toy Story 2 had been in production since 1996, so Disney was responsible for paying half of those expenses, resulting in a $2.2 million reimbursement.

In the end, net income for the quarter was $867,000 (net profit margin of 35%)  or $0.02/share versus $3.6 million (68%) or $0.08/share in 1997, but given the 2 extraordinary revenue and expense reimbursements that occurred in 1997, it's not an apples-to-apples comparison.

Pixar also continued to burn through cash, although fortunately they still had a large amount of cash from their IPO. Cash and short-term investments were $153.2 million at the end of the 3rd quarter of 1998, down from $176.0 million at the beginning of the year. Much of the cash burn was due to development and production costs for A Bug's Life, Toy Story 2 and Film Four (the title for Monsters, Inc. before it was green-lit), which totaled almost $24 million for the first 3 quarters of 1998. Another $8.8 million had been spent for new computers and other equipment.

Pixar's stock had a wild ride during the quarter. Whereas the first half of the year was good for shareholders, with the stock tripling from around $20 to the mid-$60s by July, the stock dropped over 50% to below $28 by the end of August. It recovered somewhat and ended the quarter around $40. While I was a long-term buy-and-hold Pixar investor (making my first purchase in early 1997 and holding on through the merger with Disney), the stock's volatility made it possible to do some "stock trading". Pixar's stock seemed to often follow the "buy on rumor, sell on fact" axiom. In early July, 1998, with the price over $60, there was a lot of optimism about the company with A Bug's Life soon to be released and Toy Story 2 being upgraded to a full theatrical sequel. But it seemed premature for the stock price to be increasing so rapidly since it would be close to a year before any income from A Bug's Life would be recognized. I sold about half my holdings in early July, and would buy back all that and more in the spring of 1999 at a 30% discount.