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.

This Day in Pixar History: Pixar's 1998 Annual Report

As I am fond of doing, let's step back about 17 years to early 1999, when Pixar released their 1998 annual report. 1998 was an exciting year for Pixar. Early in the year it won an Academy Award for its short film Geri's Game, and in November they had released their second feature length film, A Bug's Life. The film was an immediate success, opening at #1 in late November with over $33 million and going on to be the 4th highest grossing film of 1998 with over $363 million worldwide. But looking at the annual report you might not believe it - revenues declined almost 59% to $14.3 million from $34.7 million in 1997, and net income dropped over 64% from $22.2 million to $7.8 million. This was because Pixar hadn't received any revenue yet from A Bug's Life, and according to the Co-Production Agreement with Disney, Disney was allowed to recover all marketing and distribution costs before any remaining revenue was shared equally between the two. Pixar didn't expect to start receiving money from A Bug's Life until the second half of 1999.

Annual reports are full of lots of interesting details. Here are a just a few in Pixar's 1998 report:

•  As of January 2, 1999 Pixar had a total of 427 employees.
•  As of March 19, 1999, Steve Jobs owned 30,000,001 shares, or 65.8% of all outstanding shares of Pixar. John Lasseter, the Executive Vice President of Creative Development owned a little over 1 million shares (2.3% of shares outstanding) and Chief Technical Officer Ed Catmull almost 613,000 shares, or 1.3%.
• Pixar was busy working on its new Emeryville headquarters. The company had spent $21.2 million through 1998 on the new studio and expected to spend another $38 million in 1999 and $19 million in 2000.

The annual report also gave a nice summary of Pixar's filmmaking process, stating the process was very iterative and required continued re-working of each film. The report stated the process was divided in 4 stages: Creative Development, Pre-Production, Production and Post-Production. It also discussed their digital backlot, which they equated to a traditional movie studio backlot. For Pixar, it encompassed a database of their digital models that Pixar stated could be used multiple times in future films and other animated products. They also went into their core technology components, consisting of:

• Marionette - The in-house developed system used for modeling, animating and lighting. Also known as Menv, Marionette was replaced by Presto, which was first used on Brave.
• Ringmaster - A complex, distributed system used for scheduling and tracking their animation projects. A key piece of functionality in Ringmaster was its ability to coordinate and schedule the processors in Pixar's render farm.
• RenderMan - The company's award-winning rendering system. Not only does Pixar continue using RenderMan, Pixar licenses it to other studios and third parties, and it has become the de facto industry standard for rendering. RenderMan licensing generated revenues of approximately $3.8 million in 1998.

If you've never read an annual report, companies always include a section on the risks involved with their business. Pixar was no exception, and the report detailed how difficult it was to be successful in creating animated films:

It is rare for animated feature films to achieve extraordinary box office success. We believe, based on available information, that there is a reasonable basis to conclude that of the more than 40 animated feature films introduced since 1990, only two films generated domestic box office revenues greater than A Bug's Life and Toy Story, and both of those films were produced and distributed solely by Disney.

I actually found 3 Disney films that had been released in the 1990s and had done better than A Bug's Life and Toy Story - Aladdin ($217 million), Beauty and the Beast ($219 million) and The Lion King ($423 million).

While also demonstrating the risks involved, this next quote shows just how powerful the Disney and Pixar films were in regards to their competition:

During at least the last five years, we believe The Rugrats Movie is the only fully-animated feature film (other than Toy Story and A Bug's Life) produced or developed by a studio other than Disney that has achieved more than $100 million in domestic box office revenues.

The Prince of Egypt also was released in 1998 and went over the $100 million threshold, making a little over $101 million. The report pointed out though that the animated world was changing and competition was intensifying:

While the release of A Bug's Life was extremely successful, achieving domestic box office revenues over $160 million as of March 28, 1999, Antz, The Rugrats Movie and Prince of Egypt achieved domestic box office revenues of over $91 million, $100 million and $99 million, respectively. These three films were released during or near the 1998 holiday season and directly competed with A Bug's Life. Each of these films was more successful than any preceding animated feature film not released by Disney or Disney and Pixar.

Another section of risks covered availability of key personnel and the possible impact to the schedule of upcoming films:

In addition, John Lasseter, who, while directing A Bug's Life, was providing creative oversight for Toy Story 2 in his role as Executive Vice President, Creative, has now transitioned to the role of Director of Toy Story 2. Using the personnel of future films to meet the immediate deadlines of films nearing release, as we have for both A Bug's Life and Toy Story 2, may have the long term impact of pushing out the targeted release dates of future films, increasing film budgets, and adversely impacting our ability to generate creative concepts for subsequent films on a timely basis. [. . . ] Although we cannot provide any assurances that Toy Story 2 or Film Four will be released on schedule, the targeted release timing of mid 2001 for Film Four is particularly uncertain.

Film Four referred to Monsters, Inc., whose name had not yet been officially announced, and it in fact did end up getting delayed until November 2, 2001.

In all, Pixar spent 14 of their 71 page report discussing all sorts of risk factors in investing in the company. And this is for a company I consider fairly straight-forward to understand and analyze! I love a company with a simple-to-understand balance sheet that actually has a significant amount of cash, not one with millions of dollars of goodwill or intangibles. A company with a straight-forward cash flow statement where cash from operations exceeds net income. Granted, there were risks in investing in Pixar, but to me, the largest of those risks was easy to understand - Pixar revenue was driven by film releases, and since they weren't releasing films on a consistent basis it led to very lumpy earnings. I could look at the income statement and immediately understand why revenues in 1998 dropped 59% from 1997 - the majority of film, video and merchandise revenue from Toy Story has been collected, and revenues for A Bug's Life hadn't started flowing in. So while this "lumpy" behavior might scare off analysts and people looking for consistency, to me it made sense. With their sizable stockpile of cash, there was little risk of going bankrupt. It was just as unlikely that people would all of a sudden stop wanting to see family friendly films. To me, the only question was, would their future films continue to be successful? From what I had experienced, read and heard, that question was easy to answer. I had confidence Pixar would continue to generate excellent films, I just had to be patient. And in the periods between films, if the stock price began rising too much, like it did in the summer prior to the release of A Bug's Life, I could take some profit. Or, if the price dropped like Pixar would never create another film again, like it did immediately before the release of A Bug's Life, I could buy more shares. Pixar was not a company for investors looking for consistency but one for the patient investor. It was one of my most enjoyable investments, and actually still is as I continue to own the Disney stock I received when Pixar was bought out by them.

One of the best parts of being a Pixar investor in the early years was the cool merchandise the company sent with the annual report. As I mentioned in my post for the 1997 annual report, I received a VHS copy of the short Geri's Game. For 1998, I received 2 posters, one celebrating the release of A Bug's Life with Flik floating on a dandelion (shown at the top of this article), and the second teasing their next film, Toy Story 2 (shown below). These posters were large and beautiful, I think 16" x 40". Even after only 2 films, I had become accustom to the extras Pixar put in their works, such as the bloopers at the end of A Bug's Life. So as I analyzed the poster trying to figure out the roles of the new characters (remember, back in the late 90s, in-depth coverage and fan sites weren't as common as they are now!), I noticed tiny Flik waving from the grill of RC!

Pixar News Articles for May 17, 2015

I know I've said it before, but this is such an exciting year for Pixar fans! Yes, the excitement always builds as we approach a new theatrical release. But this year we have not one but two releases, and both are looking to be amazing. Plus, not only are we looking to the future with these new films, but we can look back to the studio's first feature length film, as this year marks the 20th anniversary of Toy Story. Here are a couple news stories surrounding Toy Story. The first is a story that KTLA aired, going into how dependent Pixar was on the success of their first film. I love hearing from some of the long-time employees like Bill Reeves and Tom Porter, and hopefully with more attention being paid to Toy Story we'll be seeing and hearing from more of these artists who really created the computer animation industry.

Twitter user e_pixar retweeted a Variety article which recapped a recent speech John Lasseter gave at the Academy of Motion Picture Arts and Sciences. He began by talking about technology and the part technology plays in film grammar. Then he went on to talk about the importance of learning the fundamentals and continuous learning, the importance of showing your work often, and surrounding yourself with people you trust, who will give you honest and candid feedback. I love these themes of learning and trusted mentors, and how they permeate the Pixar culture. I mentioned this in a post earlier this year where I highlighted some of my favorite Pixar interviews from 2014, and how often these topics came up in those interviews. I strongly recommend listening to the speech; if you want to hear it, head over to the Pixar Post and grab episode 38 of their podcast where they have a recording of it.

As I started writing this article, I noticed I had started another article a few weeks ago that I never finished. That post contained links regarding Brent Schlender and Rick Tetzeli's new book Becoming Steve Jobs: The Evolution of a Reckless Upstart Into a Visionary Leader. The first link was to a great BusinessWeek cover story written back on November 23, 1998, just days before A Bug's Life was released. Titled Steve Jobs, Movie Mogul, the in-depth article covered the beginnings of Pixar back at the New York Institute of Technology, through Job's purchase of the company from Lucasfilm, their film agreements with Disney and even hinted at a future where Disney might buy out Pixar. One quote I enjoyed was from Ed Catmull, who stated "We're not jumping on the bandwagon, we're making it." In addition to the cover story, the BusinessWeek site has links to other related information such as how the company brings a character like Flik to life and some estimates of how much profit Pixar could make from A Bug's Life. I will have to dig deeper into that last one and see how it compares to reality.

Another article related to Becoming Steve Jobs came from Business Insider and talks about how Jobs split his time between Pixar and Apple, and how he was more hands off, and therefore more relaxed, when he was at Pixar. The article states that Apple employees would try to meet with Jobs on Fridays when he was at Pixar as he was less likely to get upset.

A fun factoid, I found these last 2 articles through tweets from long-time Pixar employee AJ Riebli. If you read the BusinessWeek story, you'll recognize that it was Riebli who won the 1998 Halloween contest mentioned in the first paragraph of the article!

This Day in Pixar History: Toy Story Revenue and Profits

If you've followed my blog for a while, you probably know I have an ongoing series of posts looking at Pixar's earnings from when they were a standalone public company. I started with their first quarter after their IPO (January - March, 1996), and am now up to the last quarter of 1998 (which I hope to post in a few weeks). Pixar's earnings during this period of time was primarily driven by Toy Story - its theatrical release in November, 1995, the home video release in late 1996 and related merchandise sales.

By the end of 1998, Disney and Pixar had received the majority of revenue that would be generated by Toy Story. Sure, there would be continuing revenue from merchandise sales and television syndication fees. But this would be minimal, especially compared to the imminent release of A Bug's Life. So I thought it would be fun to take a look at the revenue and profit Pixar made from Toy Story's original theatrical debut, home video release and merchandise.

Below is a table of revenue, gross profit and gross profit margins Pixar had for the years 1996 through the first quarter of 1999:

Quarter	Film Revenue (Thousands)	Film Gross Profit (Thousands)	Film Gross Profit Margin
1st Quarter, 1996	$76	$67	88.2%
2nd Quarter, 1996	$5,000	$4,586	91.7%
3rd Quarter, 1996	$11,146	$10,224	91.7%
4th Quarter, 1996	$2,625	$2,419	92.2%
1st Quarter, 1997	$6,301	$5,743	91.1%
2nd Quarter, 1997	$11,596	$10,827	93.4%
3rd Quarter, 1997	$3,509	$3,424	97.6%
4th Quarter, 1997	$5,508	$5,436	98.7%
1st Quarter, 1998	$4,036	$4,036	100%
2nd Quarter, 1998	$2,912	$2,912	100%
3rd Quarter, 1998	$1,260	$1,260	100%
4th Quarter, 1998	$1,551	$1,551	100%
1st Quarter, 1999	$559	$559	100%
Total	$56,079	$53,044	94.6%

There are a few significant points I'd like to point out regarding this table:

• Gross profit margin - Wow! The reason it is so high is because of how the Feature Film Agreement was written. Disney reimbursed all production costs that Pixar incurred except for any budget overages. These payments were not treated as revenue but as cost reimbursements, which lowered cost of revenue to almost nothing.
• Notice how the profit margin started increasing in mid 1997 until it reached 100%. This was due to how much better Toy Story performed than expected, causing all production costs to be fully reimbursed sooner than Disney had expected. Once all the costs had been reimbursed, all revenue received by Pixar was pure profit.
• While Pixar had huge profit margins, the actual amount they made from Toy Story isn't very much. To put it into perspective, let's look at the revenues through 1996 which came from the theatrical release of the film. Toy Story made over $361 million worldwide but Pixar's revenues were not even $19 million, equating to only 5%. This was a big reason for Steve Jobs pushing for the Co-Production Agreement, which became effective with A Bug's Life and would give Pixar 50% of all revenue.

Looking ahead to A Bug's Life, the new agreement would mean Pixar receiving half of all film and merchandise revenue, and in exchange would be responsible for half of all film production costs. Without spoiling future earnings report posts, it's easy to expect that while revenues will be significantly higher, we won't see profit margins of 90%! But I think it's safe to say the new Co-Production Agreement works out well for Pixar. Just as a tease, if we look at only a single quarter, the 3rd quarter of 1999, Pixar reported $77 million in film revenue and $55.8 million in profits. Those numbers for that single quarter are higher than the total that Pixar made from Toy Story!

Pixarian Birth and Start Dates, December, 2014 Edition

Wow, it's been almost a year since I last posted a birth and start dates article! Where did the time go? Well, let's jump right in with some Pixar employees who started with the company in the month of December:

• Mark Andrews (2000) -
  
  Before Mark came to Pixar, he had been a storyboard artist for a number of animated films, including The Iron Giant, for which he won an Annie Award. Andrews also worked on animated television shows such as The New Adventures of Jonny Quest and Star Wars: The Clone Wars (which he won an Emmy award). Mark has also worked on live action films including Spider-Man, and was second-unit director and co-writer on Andrew Stanton's John Carter. Andrews came to Pixar with Brad Bird and others in 2000, first working as story supervisor on The Incredibles. He also serve as a storyboard artist on Cars, then again as story supervisor on Ratatouille. His latest effort was as co-writer and co-director of Brave. According to an interview the A113Animation blog did with Brave Story Supervisor Brian Larsen, Andrews is working with Larsen in the early stages of development of an idea for a new film.

• Jay Ward (1998) - Jay started in the art department as a production assistant on Monsters, Inc. Then in 2001, he began working on Cars.
  
  With his deep knowledge of cars, he quickly became a key contributor on the film's development, acting as consultant to co-directors John Lasseter and Joe Ranft, plus as the character team manager. Ward's passion for automobiles has led to him being named the Guardian of the Cars franchise, and he has worked on Cars 2 plus other Cars-related efforts. Ward also organizes the annual Motorama car show at Pixar. Prior to coming to Pixar, Ward received a Bachelor of Fine Arts in Illustration from the California College of the Arts.

And now for some birth dates:

• Jordy Ranft (December 24, 1991) - Jordy is the son of late Pixar story artist Joe Ranft. He is an actor and poet, and voiced Tad in Finding Nemo, and one of the ants in A Bug's Life. Jordy has a sister, Sophia, who has also done voice work for Pixar, voicing one of the monster children in Monsters, Inc. 

• Scott Morse (December 4th) - Morse studied character animation at CalArts in the early 1990s, then went to work at Chuck Jones' Film Productions. At Pixar, Scott has been a story artist on Ratatouille, Cars 2 and Brave. He has also been active with a number of the Cars Toons episodes, with writing credit on episodes such as Time Travel Mater, Unidentified Flying Mater and Monster Truck Mater. He is now serving as director for the next episode, To Protect and Serve. Morse is also a well-known author of a number of graphic novels and other books, including the Magic Pickle series and the rare The Ancient Book of Myth and War, which he did with other Pixarians like Lou Romano, Nate Wragg and Don Shank.

• Andrew Stanton (December 3, 1965) -
  
  Many of you may know that when Pixar started creating animated television commercials in the late 1980s, the first animator John Lasseter hired was Stanton. Since then, Stanton has written and directed a number of Pixar films, having writing credits on Pixar's first 5 films, co-directing A Bug's Life and having directed Finding Nemo and WALL•E. Stanton has also done a number of character voices including Zurg in Toy Story 2 and Crush in Finding Nemo. Stanton is busy directing Finding Dory, coming out June 17, 2016. 

• Ronnie del Carmen (December 31, 1959) - Ronnie was born in the Philippines and received a fine arts degree from the University of Santo Tomas. He worked at both Warner Brothers and Dreamworks before coming to Pixar in 2000. His first Pixar effort was story supervisor for Finding Nemo.
  
  He also did storyboard work on Ratatouille and was story supervisor on Up. del Carmen directed the wonderfully cute short film Dug's Special Mission, and is now co-director of next year's Inside Out. Ronnie has also published a number of books such as My Name is Dug, Three Trees Make a Forest (along with Tadahiro Uesugi and fellow Pixarian Enrico Casarosa), plus And There You Are, featuring beautiful drawings of Nina (from del Carmen's Paper Biscuit series) plus a look into his story and character creation process. I love both this book and Three Trees Make a Forest, and find myself often going back and flipping through the pages admiring his illustrations.

• Eugene Levy (December 17, 1946) - Levy is a well-known Canadian actor and comedian, having been in films such as Night at the Museum: Battle of the Smithsonian, Cheaper by the Dozen 2 and both Father of the Bride films. He has also done voice acting in Curious George and Over the Hedge. His first Pixar effort will be for Charlie, Dory's father in Finding Dory. 

Sadly, December has also held some Pixar-related losses. Japeth Pieper, an artist on Cars, Ratatouille and WALL•E, passed away on December 7, 2010. Pixar dedicated Cars 2 to him. And exactly 1 year ago today on December 14th, 2013, the amazing Peter O'Toole, the voice of Anton Ego in Ratatouille, passed away.

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.

This Day in Pixar History: Pixar Earnings Report, 2nd Quarter 1998

I'm back with another look at one of Pixar's quarterly earnings reports from when they were an independent public company. In this post we'll look at their second quarter (April - June) of 1998.

© Disney/Pixar

The middle of 1998 was a quiet period for Pixar, at least in terms of revenues and earnings. Revenues from the home video release of Toy Story continued to drop, and there wouldn't be an increase in revenue until the first quarter of 1999 when money from A Bug's Life began to come in. Revenue for the quarter was only $3.8 million compared to over $14 million in the second quarter of 1997. Of the $3.8 million, $2.9 million was from Toy Story film revenues and $850,000 from RenderMan sales.

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.

David Baraff
© Disney/Pixar

One item I noticed in the quarterly report was that on June 16, 1998, Pixar had purchased Physical Effects, Inc. ("PEI") for $3 million in Pixar stock (over 60,000 shares) and the assumption of $300,000 in liabilities. PEI was co-founded by David Baraff and had been working on simulation technology, which they had licensed to a third party. I'm guessing Pixar bought the company primarily in preparation for the fur and cloth simulations they would need in Monsters, Inc. In fact, Baraff is credited with creating Boo's shirt in the film, and he continued to enhance the simulation tools Pixar would use for later films like Brave and Monsters University. Baraff is now a Senior Animation Scientist at Pixar and received a Scientific and Technical Academy Award for his work on cloth simulation in 2006.

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.

This Day in Pixar History: Pixar Earnings Report, 1st Quarter 1998

© Pixar

I'm back with another look at Pixar's earnings from when they were a standalone company. In my continuing series, this post will look at their first quarter 1998 earnings report, which was announced after the market closed on Thursday, April 23, 1998. At this time, little money was flowing in but the company was busier than ever. 3 films were in different stages of development - A Bug's Life, which would be released later in the year, Toy Story 2, which in February, 1998, had been upgraded to a theatrical release (from a direct-to-video sequel), and Monsters, Inc. (officially referred to as "Film 4") was in early development.

© Pixar

Film revenue from Toy Story home video and merchandise was $4.0 million vs. $6.3 million in the same quarter of 1997. Through the end of March, 1998, Pixar had received just shy of $50 million from Toy Story. Given that the film made $362 million worldwide plus the hundreds of millions more in home video and merchandise sales, it's obvious why Pixar pushed for the Co-Production Agreement, where Pixar and Disney would share equally in all costs and revenues (versus the approximately 10% - 15% it was receiving in accordance with the original Feature Film agreement).

Even though the Animation Services department was shut down in 1997 to reassign its artists to A Bug's Life and Toy Story 2, the segment generated $171,000 in revenue due to royalties from their Toy Story CD-ROM interactive games. Software sales of RenderMan generated another $673,000 and patent licensing brought in $117,000, to bring total quarterly revenues to just shy of $5 million versus $7.9 million in 1997. While revenue in 1998 was lower, gross margins actually improved from 92.8% in 1997 to 98.5%! This was due to the lack of any film-related expenses - all costs from the production of Toy Story had already been accounted for. In addition, Pixar was capitalizing almost all development costs for its upcoming films, so while it was showing up on the cash flow statement (in the sum of $7.5 million), it wouldn't actually impact the income statement until it could be offset against the revenue of the upcoming film releases.

Although earnings per share dropped from $0.11 in 1997 to $0.08, the stock reacted very favorably to the earnings report as analysts had expected the company to only breakeven. The stock jumped over 8.7% the day after the earnings report to $44 5/16. This was on top of the almost 6% gain the previous day when Disney announced better than expected earnings and a 3-for-1 stock split. Pixar's stock had a great run in early 1998, more than doubling since the beginning of the year.

There wasn't much else of note in the quarterly report, besides the upgrade of Toy Story 2 from direct-to-video to full theatrical release. Some other minor items included that construction of the new Emeryville headquarters would start in the second half of 1998, and the earliest discussion I recall seeing regarding the studio's Y2K planning and preparation.

I'll be back in a few weeks to discuss Pixar's 1998 second quarter results.

This Day in Pixar History: WALL•E Theatrical Release

6 years ago today on June 27, 2008, Pixar released their 9th feature film, WALL•E. A totally original film, WALL•E was a huge hit. It made over $223M domestically, making it the 5th highest grossing film of 2008 and the highest grossing animated film of the year, ahead of Kung Fu Panda, Madagascar: Escape 2 Africa and Dr. Seuss' Horton Hears a Who!. WALL•E is Pixar's 10th (out of 14) highest grossing film. It was also a critical success, garnering a 96% Rotten Tomatoes rating.

WALL•E was released with the short film Presto. Doug Sweetland made his directorial debut with the short film and to me is one of Pixar's most funny shorts.

WALL•E is one of those rare science-fiction films that is more than just amazing visuals. It has wonderful music (composed by Thomas Newman), characters we care about and an engaging story. From the 40 minute dialog-free opening to memorable scenes such as WALL•E looking over a hibernating EVE, the Define Dancing scene, and the emotional ending, it is easy to forget these characters are robots, and ranks as one of Pixar's finest films.

Some of you may not know that the origins of WALL•E began back in 1994, during a meeting at the Hidden City Cafe in Pt. Richmond, CA. WALL•E was the last film produced from the ideas that came out of that meeting, the others including A Bug's Life, Monsters, Inc. and Finding Nemo. Andrew Stanton talks about this meeting in the teaser trailer for WALL•E. Many Pixar fans, myself included, have made a trip to the Hidden City Cafe and had one of their great breakfast items like the Hidden City Scramble, or visited with owner Shellie Bourgault. Sadly the cafe closed in 2012 - I wrote about the closing which I discovered when I tried bringing my wife there while celebrating our 25th anniversary in the San Francisco area! Needless to say, my wife does not have the same, fond memories of the cafe as I do, especially when she discovered the reasons for the closing.

This Day in Pixar History: Pixar's 1997 Annual Report

© Pixar

I've written a number of articles on Pixar's financial reports when it was a public company. Today, let's turn time back about 26 years to look at their 1997 annual report, which came out in early 1998. As with many of Pixar's early annual reports, it started with an informative and entertaining letter from CEO Steve Jobs. They also often included a nice little gift - the 1997 annual report came with a VHS copy of the Academy Award winning short film Geri's Game. So I will try and minimize the financial information (much of it has already been covered in the individual quarterly posts I've done) and focus on the other content.

In their 1996 annual report, Pixar warned of a significant decrease in revenue for the upcoming year due to a decrease in revenue from Toy Story. This was logical; Toy Story was released more than 2 years earlier in late 1995, and Pixar's revenue in 1996 were over $35 million, primarily from the film. But in usual Pixar fashion, they were conservative in their guidance for 1997 and the company's revenue were almost as much as in 1996, $34.7 million. In fact, film revenue was higher in 1997 than 1996: $26.9 million versus $18.8 million, or an increase of 43%!! Not too bad given the expectations of a significant decline! The increase in film revenue was due to the Feature Film agreement between Pixar and Disney: as Toy Story revenue began to accrue, Disney was allowed to capture the majority of it to offset their marketing and distribution costs. As Disney's outstanding costs declined, Pixar received a larger percentage of the revenue. By the middle of 1997 Disney had recovered all their costs, allowing Pixar to capture a proportionally higher percentage of the Toy Story home video and merchandise sales.

© Pixar

You might then ask why were overall revenues down in 1997? This was due to 2 areas. First was in patent revenues - in 1996 Pixar received patent revenue of over $9 million from Silicon Graphics (SGI), which dropped to only $1.7 million in 1997. The second area of decreased revenue was in animation services, such as television commercials. Pixar decided to get out of doing animation services for external customers in 1996 to focus on its feature films which caused this revenue drop.

Pixar's gross margins continued to increase, which is amazing since they already were quite high. Overall gross margins increased from 86.6% in 1996 to 92.7% in 1997. Much of the increase came from Pixar getting out of animation services, which had the lowest gross margins of all their segments. Patent licensing revenue had no associated costs and the software segment (which derived revenues from sales of their RenderMan application) had very low costs (1.8% in 1997 versus 3.4% in 1996). Cost of film revenue also dropped to 5.5% versus 8.2%, mostly due to Disney recovering all their costs in mid-1997 which allowed Pixar to receive a proportionally higher amount of the revenue.

Overall, 1997 turned out to be a better year financially than 1996, except for the bottom line. Pixar ended up paying quite a higher amount of taxes ($9.9 million) in 1997 than 1996 ($2.0 million), due to the utilization of net operating loss carryforwards during 1996. In the end, Pixar reported net income of $22.2 million ($0.46/share) in 1997 versus $25.3 million ($0.54/share) in 1996. Still, I'd consider those pretty good results given the guidance Pixar gave at the beginning of the year!

Pixar's cash position also improved in 1997, growing from $161 million in 1996 to $176 million, even with the much larger outflow of cash Pixar experienced. Pixar spent $10 million on computers and other property to run the studio and $7.7 million on the new Emeryville studio. In addition, with the new Co-Production agreement Disney and Pixar signed in early 1997, Pixar was responsible for half of all film development costs, which totaled a little over $27 million. These costs were more than offset by the higher revenues and the $15 million Disney invested in Pixar on the signing of the Co-Production agreement.

© Pixar

OK, enough of the financial information. As I mentioned at the beginning of the post, Steve Jobs started the annual report with the shareholder letter, which he wrote after watching the 1997 Academy Awards. Pixar won their third Oscar that year, this time a Best Animated Short Film award for Geri's Game. Jobs congratulated director Jan Pinkava,  producer Karen Dufilho and the entire Geri's Game team. Besides the Oscar, Tom Duff, Eben Ostby and Bill Reeves each won an Academy Scientific and Technical Achievement award for their work on Pixar's Marionette 3-D Animation System. In addition, Tom Porter won a Scientific Academy Award for his work on digital painting. The addition of these awards brought Pixar's total count of Academy Science awards to 18.

A few other pieces of information Jobs shared:

• Hiring 97 employees during 1997 for a total of 391.
• Expecting to break ground on the new Emeryville studio that summer with a move-in date of early 2000.
• Investing over $8 million annually on research.
• Growing the size of their RenderFarm to 1000 Sun processors and having storage capacity of over 5 terabytes.
• Highlighting that Toy Story 2 had been upgraded to a full theatrical release, and that their still secret 4th film (Monsters, Inc.) was in development and was hoped to go into production by the end of the year.

Jobs was very clear on his goal for Pixar - to make it the second greatest feature animation studio in the world, only behind Disney Animation. As part of reaching this goal, Jobs stated they were trying to release one animated film per year for the next 3 years (A Bug's Life in 1998, Toy Story 2 in 1999 and Monsters, Inc. in 2000). But Monsters, Inc. would end up not being released until 2001 and Pixar did not accomplish the goal of 3 films in 3 years until 10 years later.

© Pixar

Jobs went into great detail on the making of A Bug's Life.  He highlighted how there were over a dozen major characters, and that each one was more complex than any characters in Toy Story. He talked about how a new subdivision surface technology developed for Geri's Game was used to bring more subtlety and lifelike expressions to the characters. He also explained how they were using simulation software for moving crowds of hundreds of ants or creating lifelike movement in blades of grass (Simulation would reach a new level of complexity and use in Monsters, Inc.). Finally, he discussed how the lighting team was challenged to create more sophisticated lighting to support the outdoors environment the film takes place in. He said the results were "breathtaking". Jobs was also excited about the wide-screen nature of the film, stating that it would look "epic".  A Bug's Life was the first film entirely transferred to film via lasers, and Pixar had to develop their own laser film recorder to perform the transfer. And with all the complexity and larger cast of characters, Jobs stated they were using 10 times more processing power to create the film as they did on Toy Story just three years earlier.

© Pixar

Jobs also explained how it was decided to upgrade Toy Story 2 to a full theatrical release. They originally felt that, with most of their key people from the original Toy Story working on A Bug's Life, they would not be able to find and recruit enough talent to meet the higher standard demanded of a theatrical release. But since the success of Toy Story, Jobs stated Pixar had "become one of the hottest places to work in our industry," and had pulled together a team capable of delivering the necessary quality, at that time being led by Ash Brannon and Colin Brady. The decision to expand Toy Story 2 to a full theatrical release occurred after a November, 1997 meeting in which teams from Disney and Pixar watched the completed story reels and felt the story was strong enough to receive a full theatrical treatment.

Readers of this blog are probably familiar with the story that, less than a year after Jobs wrote this letter, Pixar would realize the story wasn't as strong as originally thought, and in late 1998 production was stopped and the story underwent a major overhaul, with John Lasseter, Lee Unkrich and others coming on board to make sure the film was delivered on time.

© Pixar

To finish this post, many of you have probably seen the image above of Ed Catmull, Steve Jobs and John Lasseter. Interestingly, the image's origination was in this annual report but in a slightly different fashion. You can see the original image below, which is of Pixar's executive team at the end of 1997, including CFO Lawrence Levy and Vice President of Production Sarah McArthur.

© Pixar

© Pixar

This Day In Pixar History: Tia Kratter Quits (and Quits Again)!

It's April Fools Day, so what better way to celebrate it than with a story of April Fools pranks! Tia Kratter is a long time Pixar employee, starting her career as a digital painter on Toy Story in 1993.  Since then she has been the shading art director on a number of films including A Bug's Life, Monsters, Inc., Cars and most recently Brave.

Growing up in a family of practical jokers, she decided to play an April Fools joke on her co-workers. So on April 1, 1998 she sent a company-wide email saying she was quitting. She fooled quite a few people (she even got a "Goodbye Tia" cake!), and has quit every year since (at least through 2009). She even fooled CEO Steve Jobs on 3 separate occasions! You can tell Tia is a true Pixarian, as her reasons for quitting are always original, such as becoming the art director for Tron 2, going to work in a wax museum and (my favorite) air brushing monster trucks!

Not to be outdone, her co-workers did get her back one year. I won't say how - if you want to find out go to the Disney/Pixar official YouTube channel and watch the "Tia Quits" Studio Story, which is narrated by Tia Kratter and Pixar producer Jonas Rivera.

I would love to hear if Tia has kept this tradition going and if so, what new ways she has come up with for quitting!

This Day in Pixar History: Pixar Earnings Report, 3rd Quarter 1997

I am back with another look at Pixar's earning reports back before it was purchased by The Walt Disney Company. In this post we'll be reviewing the 3rd quarter of 1997.

Let's freshen our memories of the situation in late 1997. Toy Story was released in late 1995, and Pixar's next film, A Bug's Life, would not be coming out until the end of 1998. At this time, Toy Story 2 was still being planned as a straight-to-video sequel set for a late 1998 release (in the quarterly report it was referred to as the Toy Story Video Sequel as they had still not given it an official name). Pixar's revenues had been doing quite well through 1996 and the first half of 1997 due to first theatrical revenue from Toy Story, and then the home video release and other merchandising of the film. But if you've read any of my previous posts on the earnings reports, Pixar had been warning of decreasing revenues, and in the 3rd quarter we are able to see this quite clearly.

Revenues totaled $5.3M for the quarter, compared to $13.5M in the 3rd quarter of 1996. Animation service revenue was almost $900,000 from projects related to A Bug's Life.  Software revenue for the quarter was almost $910,000, primarily from RenderMan licenses. Revenue from their patent licensing deal with Silicon Graphics (SGI) was only $28,000. As a reminder, in 1996 Pixar and SGI signed a licensing deal allowing SGI to use Pixar's patents for creating photo-realistic CGI images. The agreement called for SGI to pay Pixar a total of $11M, of which was broken into $6M in cash paid in March, 1996, and the other $5M as a credit for Pixar to purchase SGI hardware and software. As of the end of the 3rd quarter of 1997, Pixar had used over $4.7M of the $5M credit.

Film revenue for the quarter was $3.5M, primarily from Toy Story home video sales. This was a significant drop from the second quarter of 1997, where Pixar had $11.6M in film revenue. It should be pointed out the drop was even larger, as $1.8M of the $3.5M was from a one-time payment from Disney due to a recalculation of the marketing and distribution costs incurred by Disney. According to the Feature Film agreement, Disney received a larger percentage of film revenues until they had been reimbursed for their costs to market and distribute the film. During the quarter, Disney determined they had recovered all their costs earlier than previously thought, therefore Pixar should have received a larger percentage of the revenue earlier than they had. This extra revenue amounted to $1.8M and was paid in the third quarter.

As was usual for Pixar, their gross margins were amazing (I wish all the companies I invest in had margins like these). For the quarter they were over 88%, compared to over 86% in the comparable quarter from 1996. High margins were delivered by all segments. Costs of software revenue was 3%, consistent with the previous year. Since Pixar capitalized most of the costs for developing the software, these costs are basically what it took to package the software. As for patent licensing revenue, there were no related costs.

Costs of animation services revenue was much higher than the other segments at 60%, but this was down significantly from the same quarter in 1996 which was 84%. In 1996 Pixar had decided to get out of the animated TV commercial business to focus on development of feature films and related short-term projects. Pixar needed to focus on A Bug's Life and Toy Story 2, so closing the TV commercial business and refocusing those animators made a lot of sense, and I'm sure with those (relatively) low margins that made the decision even easier.

Finally, cost of film revenues for the quarter was low - only $85,000! This equates to a cost of 2%, compared to 7% in the previous quarter. These costs are small, as Disney reimbursed Pixar for almost all development costs of Toy Story, but Pixar was responsible if they went over budget. To account for these overages, Pixar would capitalize the costs as they occurred, and then amortize the costs as revenue from Toy Story came in. As for A Bug's Life and Toy Story 2, they were developed under the new co-production agreement which required Pixar to pay half of all development costs (but they would get half of all revenue). As of the 3rd quarter of 1997, Pixar had accrued over $23M in film development costs.

As for expenses, Pixar only incurred $658,000, or 12% of revenue, in the 3rd quarter of 1997 compared to $2.8M or 21% of revenue. But this is somewhat an aberration as expenses were reduced by a $2.2M one-time payment from Disney. The co-production agreement was signed in February, 1997, which as mentioned above requires Disney to pay for half of all development costs. Since A Bug's Life and Toy Story 2 had both been in production since 1996, Pixar had already incurred costs for these films, so Disney was obligated to pay for half of those costs. Without this one-time payment, Pixar's expenses would have been $2.8M or over 53% of revenue!

For the bottom line, Pixar had net income of $3.6M (69% profit margin), compared to $10.2M (76% profit margin). It's interesting to note that Pixar made $2.4M just on interest from their cash and investments (Pixar had over $172M in cash and short-term investments).

Given these mixed results, what did the stock market think? I mean, their margins were still stellar but if you take out one-time items like the $1.8M in extra revenue and the $2.2M reduction in expenses, plus non-operating results like $2.4M in interest, it was obvious revenue and earnings were on a downswing that would likely show no improvement for over a year when revenue from A Bug's Life started coming in. But as is often the case in the stock market, investors seem to ignore these results in anticipation of the future and the next film release. Pixar's stock price had slowly increased through the summer, from around $15 to close to $25 by the time Pixar released 3rd quarter results. The stock price only dropped slightly through the end of the year and was still in the low $20s. As we will see in future posts, the stock price took some wild swings throughout 1998 as we approach the release of A Bug's Life and the announcement of Toy Story 2 getting a full theatrical release.

This Day in Pixar History: Pixar and Disney Film Agreements

In this look at Pixar history, I wanted to dig into the two film agreements between Pixar and The Walt Disney Company. These agreements launched Pixar from being a money-losing software and animated commercial company into creating Toy Story and all its other animated feature films.

Discussions surrounding the first agreement began in late 1990 when Peter Schneider, head of Disney Feature Animation, met with Pixar management to discuss the possibility of creating a feature film. As an aside, this was not the first interaction between Disney and Pixar. Back in the late 1980s, when Pixar was primarily a hardware company, Disney purchased a large number of the Pixar Image Computers for their Computer Animated Production System (CAPS). Disney was extremely happy with the system and this success likely helped pave the way for the feature film deal (If you'd like to hear more about this early Pixar history and the Pixar Image Computer, you should listen to The Pixar Post's episode 14 podcast where TJ, Julie and I discuss these and many other topics).

Discussions continued throughout the rest of 1990 and into 1991, when John Lasseter made his buddy movie pitch to Disney Studios chairman Jeffrey Katzenberg. Katzenberg loved the idea, and the Feature Film Agreement was finalized and announced in the spring of 1991. This agreement was for the development of 3 full-length computer animated feature films and would last through the end of the decade. Pixar would develop and produce the films while Disney was responsible for marketing and distributing them. The agreement called for Disney to reimburse Pixar for almost all production and development costs of the film. In return, when the film was released, Disney would initially receive the majority of all revenue to recover the amounts paid to Pixar, plus its marketing and distribution costs. Once production and marketing costs had been reimbursed, Disney would continue to receive the bulk of any additional revenue from the distribution of the film and associated merchandise such as toys and home videos, while Pixar would be eligible to receive approximately 10% - 15% of the remaining profits. Finally, Disney owned the rights to the characters developed under the agreement, plus controlled the development of any sequels.

Cover of Pixar's first annual report,
which covered the Co-Production
agreement in detail

This agreement was in place until February 24, 1997, when Disney and Pixar announced a new 10 year, 5 film Co-Production Agreement, starting with A Bug's Life. This new agreement split all costs and profits equally between Disney and Pixar, after Disney received a small distribution fee. The agreement covered revenue from the theatrical and international releases plus home video and merchandise sales. In addition, the films would be equally branded as Disney-Pixar and co-owned by both Disney and Pixar, while Disney would have exclusive rights to market and distribute the films. Disney would become an investor in Pixar, purchasing 1 million shares with the option of buying up to 5% of Pixar. As for ownership of the films and characters, the Co-Production Agreement called for Disney and Pixar to mutually agree to any derivative works, but if an agreement couldn't be reached, Disney had the final say. Pixar had no rights to use or distribute any characters or elements from any of the films without first receiving a license from Disney. The 5 films that were produced under this agreement were A Bug's Life, Monsters, Inc., Finding Nemo, The Incredibles and Cars (Toy Story 2 was also produced under the Co-Production Agreement, but since it was a derivative of Toy Story, it was not counted as one of the 5 Co-Production films).

To see how much Pixar gained from the new agreement, let's look at revenue and costs for their first two films, Toy Story and A Bug's Life. From numbers in Pixar's annual reports, the studio made approximately $55M from Toy Story through 1998, while the film earned $362M worldwide, not including home video and other merchandise sales. This film was developed under the original Feature Film Agreement, and Disney was responsible for paying almost all development costs. So we can estimate almost all of the $55M was profit. In comparison, A Bug's Life, which had $363M in worldwide revenue and was  accounted for using the Co-Production Agreement, had brought in almost $115M by the end of 2000. While Pixar was responsible for half of all production costs for A Bug's Life, that amounted to less than 30% of film revenue, meaning Pixar's net income from A Bug's Life was over $80M. So while the original agreement was a breakthrough for Pixar, given it was an unknown and untested studio teaming up with the leader in the animated film industry, it is obvious the new Co-Production Agreement was a much better arrangement in terms of economics.

The Co-Production Agreement was announced just weeks before Pixar's 1996 annual report (their first as a public company) was released, and in the report CEO Steve Jobs did an excellent job explaining why Pixar made the new agreement. The first reason for the new agreement was better economics, which from the previous paragraph we can see worked out perfectly.

The second reason was even more important to the long-term strategy of Pixar. As Jobs explained in the annual report, their goal was to build a world-class studio. In the eyes of Steve Jobs, there were only 2 significant brands in the film industry at the time - Disney and Steven Spielberg. Jobs wanted Pixar to become the third. To accomplish this goal, the new agreement gave Pixar more brand recognition than the first agreement. All products would be equally branded Disney and Pixar, including feature films, home videos, derivative works (sequels), toys and merchandise.

Storyboards of how the new co-branding in films will occur, © Disney/Pixar

I was fascinated to also read that Pixar had contemplated going it alone once the original 3 film agreement expired in 2000, but in the end decided against this direction. As Jobs writes in the annual report,

Going it alone was certainly tempting, especially in the heady atmosphere surrounding Toy Story's success. But it would have been an exercise in hubris.

He goes on to explain the costs and risks of taking on the marketing and distribution functions, noting that marketing can be as expensive as, if not more than, the development of a film. He also points out that Pixar had little experience in marketing, and it was far from their core capabilities of creating memorable animated films. Jobs realized that they would have to grow the company and bring on people with completely different skill sets than the current environment of artists, engineers and production experts. Doing so would have diverted management attention, possibly causing a loss of focus and destroying the unique culture they had built (I have a whole series of posts regarding Pixar's culture stuck in my head, I hope to get it written down someday). Steve Jobs is often referred to as egotistical and arrogant, but I think this gives a much different picture, someone who is savvy, humble and understands the importance of business focus and company culture.

The Co-Production Agreement was in place until 2006, when Pixar was bought out by Disney, just months before the last film of the agreement, Cars, was released. By then, the relationship between Disney and Pixar had soured dramatically to the point where Pixar was looking for a new distribution partner and Disney had plans to move ahead with development of Toy Story 3 without the support of Pixar. That was not a happy time, and is good material for a future blog post!