Sunday, May 21, 2017

This Day in Pixar History: Pixar's 1999 Annual Report

I've written a number of posts on the earning reports Pixar released when they were a public company. I began with their first report as a public company, the 1996 annual report, and now am reviewing the 1999 annual report. But I thought it would be fun to look at their earnings as someone considering buying Pixar stock.

To be clear, nothing in this post should be construed as stock advice or a recommendation to buy or sell any stock. One of the first rules of investing is to do your own due diligence. The point of this post is to highlight some of the numbers and factors one might look at when analyzing a company, using Pixar's 1999 annual report as a concrete example.

A Thinking Machines CM-5 Supercomputer
In addition to doing due diligence, an important investing rule (at least for me) is to be interested in the company. I know from my own experience, when I'm interested in the company I'll spend the time to research it, keep up with their press releases, read their quarterly and annual reports, etc. Fortunately, I was very interested in the company. I was an early investor in Pixar, with my first stock purchase in 1997. I wish I had kept a diary so I could better remember my thought process in why I bought the stock. Obviously I loved Toy Story and saw the potential in computer generated animation. Even prior to the release of Toy Story I was aware of the company. In the early 1990s I was working at the Minnesota Supercomputer Center, doing system administration and system programming for their Thinking Machine supercomputers. A number of folks on our team were involved with computer graphics and were aware of the work Pixar was doing in the field. Plus, during a conversation with Pixar's Bill Reeves, I learned Pixar had used one of our Cray supercomputers to render one of their early short films.

While at the Supercomputer Center, I also had the opportunity to hear Pete Docter speak at a conference I was attending. I believe it was his talk that introduced me to Pixar.

Getting back to Pixar's 1999 annual report, what can we learn? A couple of questions investors usually ask about a company is, is the revenue or sales of the company growing, and is that sales growth sustainable? Sales growth is what propels a company's stock price higher. From those sales we hope it covers all the expenses of the company and ends up on the "bottom line", which is more commonly referred to as net income. Sales, expenses and net income can be found on the income statement. For Pixar, their revenue is pretty straight forward, primarily coming from making their films - theater ticket sales, home videos and merchandise. If you've read my article on the film production agreements Pixar had with Disney, you may recall that Pixar and Disney split all profits 50/50 as well as the expenses to develop the films. In 1999, Pixar's revenue was $121 million. Even though Toy Story 2 had just been released in November of 1999, Pixar made no money from it during 1999 - that money would be earned in 2000 and later. In 1999, over $110M of their revenue came from A Bug's Life, which was released in November of 1998. This amount included theatrical, home video and merchandise sales. They also made $4.1M from Toy Story merchandise, television royalties and home video sales. The rest of their sales came from $5.7M of RenderMan sales and less than $1M of animation services.

From the $121M in revenue, Pixar deducted $46.5M in film development costs and other expenses such as research and development, sales and marketing, and general administrative costs. In addition, they paid almost $33M in income taxes and made about $7.5M in interest on their cash and investments. In the end, this gave Pixar a little over $49M in net income.

How did these results compare to previous years? Well, since Pixar hadn't released a film since Toy Story in 1995, they compared extremely well! For 1998, Pixar only had $14.3M in revenue and almost $8M in net income, while in 1997 the did a little better with $34.7M in revenue and $22.2M in net income.

Not only did revenue and profits jump dramatically in 1999, but their balance sheet was strong. The balance sheet shows how much assets (cash, bonds, property, equipment, etc) and liabilities (salaries to be paid, debt, upcoming income taxes, money owed to Disney, etc) the company has. At the end of 1999, Pixar had about $195M in cash and investments, plus other assets of $180M for total assets of almost $375M, while they had no debt and only owed $30.5M, giving them a net worth of over $344M. And the balance sheet was getting stronger - from the $121M in total revenue for the year, over $109M of that ended up as cash the company could use for buying more computers, developing films and putting in the bank. I think it's clear that A Bug's Life was very profitable for the studio!

So going back to the questions I asked earlier, in regards to sales growth, I think it's clear that Pixar had this covered! As for the second question, whether the growth was sustainable, I think this is where it helps to really understand the company. What I mean is that while 1999 was a banner year compared to 1998, revenue and income in 1998 dropped from 1997, when Pixar was receiving more income from the international and home video releases of Toy Story. Up to this point one could say Pixar's profits were lumpy and not consistent, rising when a new film was released and falling just as dramatically the year after. This "lumpiness" might scare off investors who didn't look deeper at the company and the film production agreement Pixar had with Disney.

But I think there were strong signs as to why Pixar could continue growing their revenue and net income.

First was the new Co-Production Agreement with Disney. As I mentioned earlier, Pixar received half of all the profits from A Bug's Life and any of their other future films. The impact the new agreement would have was already clear. I wrote a post about how much money Pixar made from Toy Story. That film was produced under Pixar's original agreement with Disney, where they received a much smaller percentage (closer to 10% - 15%) of the film's profits. While I don't have the exact numbers, in the 3 year period after Toy Story was released, I estimate Pixar received about $56M. Compare that to just one year of revenue from A Bug's Life where they made $110M, or almost double all their revenue from Toy Story!

Second, Pixar had a set a goal of delivering a new film every year. They weren't there yet - Toy Story came out at the end of 1995, and it was 3 years before A Bug's Life was released. But Toy Story 2 came out 1 year later, and Monsters, Inc. would be released 2 years later (with Finding Nemo about 18 months after that). One could see that Pixar received significant revenue from Toy Story for over 3 years. So even if their next films weren't as successful as Toy Story, I think it was clear their earnings "lumpiness" would smooth out as they approached delivering a film every year.

I also think it was clear their growing film library would continue delivering results long after the films had left the theater. I wish I could say I had the foresight to see all the ways Pixar could have a positive impact on the Disney corporation. I'm not sure I envisioned theme park lands being devoted to one of their films, or that sections of resorts would be named after other films, or that Disney theme parks would dedicate entire weekends exploring the development of their films or celebrating the studio's 30th anniversary. But I do think it was obvious Disney was making good use of their partner. Pixar characters were showing up in parades at the Disney theme parks, and Buzz Lightyear had his own attraction at Disney World's Magic Kingdom (which opened in late 1998), all of which would help keep the films and its iconic characters in people's minds, helping drive additional merchandise sales beyond the ebb and flow of their film releases.

All of these factors pointed to the strong possibility of continued growth for the company.  Were these factors reflected in Pixar's stock price? Well, the price stayed between $15 and $25 from 1999 through 2001 (note, all prices are adjusted for the 2-for-1 stock split the company declared in early 2005). Even into the beginning of 2002 one could buy their stock for around $15. But then in 2002 it began a steady climb for the next few years, going over $50 before the company announced its merger with Disney at a price of almost $60 in early 2006. For that period, from early 2002 to early 2006, Pixar's stock price returned over 30%/year, compared to the average annual return of 8% - 10% for the overall market! We will never know, but I think Pixar would have continued to be an exciting company for shareholders if they hadn't merged with Disney.

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