This Day in Pixar History: Pixar Earnings Report, 2nd Quarter 1997

I noticed that The Walt Disney Company will be announcing their quarterly earnings in a couple of weeks. If you were a Pixar shareholder when the Pixar/Disney merger was completed, you would have become a Disney shareholder as I explained in my previous post on the merger.  For a large company, I think Disney stock has done well, more than doubling from the upper $20s to the mid $60s, and a tripling of the dividend. Of course, the question for those of us who were Pixar shareholders, would we have done better if Pixar had remained independent? We will never know the answer to that question. At some point I hope to write a post on the benefits and disadvantages of the merger.

But for today, I'd like to continue my series on previous Pixar earnings reports, this time going back to the second quarter of 1997. From all accounts, Pixar had a blowout quarter! Revenue increased over 100% to $14.4M from $6.9M in 1996. The majority of this revenue came from Toy Story home video and other related merchandise income, which more than doubled to $11.6M vs. $5.0M in the second quarter of 1996. In addition, their software division did well, bringing in $1.1M vs. $722,000, primarily due to more RenderMan licenses being sold. They also continued to benefit from their patent license agreement with SGI, which contributed $1.5M. Only the animation services group saw a year-over-year decrease, which was expected as Pixar had mostly exited that business in mid-1996. The $269,000 in animation services revenue was due to projects related to A Bug's Life.

As I've said in prior posts, Pixar's gross margins were very high, and this quarter was no exception. Gross margin increased from about $5.7M (or 82.5% of total revenue) in the second quarter of 1996 to $13.4M (over 93%) in 1997. A large part of the increase was due to the decrease in animation services, which had a higher cost of service. Also, film gross margins increased from 92% in 1996 to almost 93.5% in 1997. I have also mentioned that Pixar's operating expenses had been increasing as competition for animation and technical people was rising, and the company was bringing more staff on board. So it may surprise you to learn that their operating expenses decreased this quarter versus the year ago period! This was due to the new Co-Production agreement Disney and Pixar signed earlier in 1997, which required Disney to pay half of all film production costs plus certain R&D and other general/administrative expenses. R&D expenses did increase 18% to $1.4M, primarily for RenderMan research and support. General and administrative expenses stayed roughly even at $1.0M and sales and marketing expenses dropped over 40% to $353,000 due to Pixar exiting the television commercial business. Given the increase in revenue and good expense control, Pixar's net income increased over 86% from $4.8M in 1996 to $8.9M in 1997!

Pixar's balance sheet was also very strong, with cash and short-term investments of almost $179M vs. $161M at the beginning of the year. The majority of the cash increase was due to the 1 million shares of Pixar stock that Disney purchased as part of the new Co-Production agreement. Other items of interest on the balance sheet was the $7.5M Pixar had accrued in film costs, which represented Pixar's share of costs in the development of A Bug's Life. This amount would be paid to Disney by the end of the year. Pixar had also accumulated $19.6M in capitalized film production costs for A Bug's Life and Toy Story 2, which was still being developed as a direct-to-video sequel. These production costs would need to be offset by future revenue for Pixar to show a profit on these films.

Once again, Pixar was very cautious in their expectations for the rest of 1997 and 1998. They stated they did not expect any future revenue from Toy Story home video sales, and did not expect any revenue from A Bug's Life or Toy Story 2 until 1999, thereby causing a significant decline in operating results. Of course, they said similar things in the first quarter 1997 report, and look at how good the results were!

I found two other very interesting tidbits in this quarterly report. The first was that in May, 1997, Pixar paid $5.8M to purchase land in Emeryville for their new headquarters (I wrote about the land purchase in more detail in May, 2012). Pixar stated in the report they would spend over $10M in 1997 and over $12M in 1998 on the construction of the studio, which wouldn't be finished until the end of 2000. Fortunately, with $179M in cash, Pixar would probably be able to fund the construction plus ongoing operating expenses without having to resort to a secondary stock offering or taking on debt.

The other interesting note, from what I can tell, was the first mention that the second theatrical release was being developed. In the Co-Production agreement, Pixar agreed to develop 5 new theatrical films, with the first being A Bug's Life. Therefore, there would have to be four more films produced. But this was the first time I found information that the second film, which would become Monsters, Inc., was actually in development. I should mention that if you're interested in hearing more about Monsters, Inc. you need to listen to The Pixar Post's episode 15, where TJ, Julie and I discuss its development plus other interesting notes like the lawsuits that were brought against it. If you're curious as to why Toy Story 2 wasn't considered the second film, it's because it was a sequel to Toy Story, so it was developed under the original Feature Film agreement.

I will return in 3 months or so with a look at Pixar's 3rd quarter, 1997 earnings.