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

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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.

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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.

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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.

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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.

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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.

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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.

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© Pixar