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.
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.
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