This letter was originally our “Read of the Day” for today’s (November 30th) This Day in Stock Market History, but it was too good not to post here as well.
I did not know just how fast of growth Pixar had under Jobs. Just look at this timeline:
1986 – Jobs purchased Pixar from Lucas Films for $10 million.
1996 – Pixar has its IPO, jumping from $22 per share to $39, giving it a market cap of about $1.5 billion.
2006 – Pixar is sold to Disney for $7.4 billion.
In 20 years Jobs turned $10 million into $7.4 billion! Pixar had an average annual compounded return of 39.15% under Jobs – amazing!
This is a different type of shareholder letter than what is normally posted and discussed here. Steve Jobs’ letter is much different than Buffett’s or other classic “businessman”. But that does not mean it does not offer a lot to learn. Jobs goes into Pixar’s competitive advantages, structure of their deals with Disney, discusses earnings irregularity and more. With that said and knowing just how successful the company was under Jobs and his team, this letter is certainly worth a read:
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Letter from Steve Jobs
June 1997
Dear Shareholders,
1996 was Pixar’s first full year as a public company, and for annual report I’ve decided to write you a long letter, fully aware of Pascal’s dictum that people write long letters when they don’t have time to write short ones. I’ve got the time (Pixar is the focus of all my attention these days), but there also happens to be a great deal I want to tell you about our company: the great year we had in 1996, the landmark deal we were secretly negotiating with Disney throughout last year, the exciting productions now underway at Pixar, and the progress we’re making in building a world-class animation studio. We have also embarked on a new strategic course for Pixar which will carry us through our next decade. There are only a few limits in the lives of most companies when events converge to create such enormous promise. This is such a time for Pixar, and I’m thrilled to be able to tell you all about it.
The past year
Observing annual report tradition, let’s start with the year we’ve just completed. We accomplished a lot in 1996 was a terrific year. Here are some of the most notable achievements:
- we earn $23.5 million, compared to $1.6 million in 1995, with earnings per share of $0.54 compared to $0.04 a year earlier. I think this is a strong performance for the first year following an initial public offering. Perhaps the most important thing about her 1996 financial performance is that it validated Pixar’s business model. We have shown that we are capable of generating substantial revenues and real earnings.
- We started 1996 with a strong balance sheet, largely as a result of the IPO, And it became even stronger by year end. We are carefully managing the money you have invested in Pixar. We have no debt, and our cash investments climbed from $144 million-$161 million during 1996. The strong cash position gives us staying power, as well as the opportunity to co-finance our productions and thereby keep a tighter share of the profits (more on this later).
- The success of toys story, starting with its release in late 1995 and continuing throughout 1996, made Pixar only the second studio in history to produce a blockbuster feature animated film (Disney was the first, and they’ve produced a number of them). In 1996 toys story became the third highest grossing animated film of all time (behind Disney’s ‘the lion King’ and ‘Aladdin’) with gross box office receipts of $192 million in the United States and $360 million worldwide. The toy story home video was released in late 1996 and a record-breaking 21 million videocassettes were sold into US consumer channels for the holiday season, with expected sales of over 30 million worldwide.
- We of course are thrilled by toy stories box office success, but we are just as proud of the artistic recognition it has brought Pixar: a special Oscar for director John Lasseter and an Oscar nomination for best screenplay (for all films, both live action and animated) that went to the Pixar’s storied team of Andrew Stanton, Pete Docter, Joe Ranft and John Lasseter. It was the first time in animated film has received this honor.
- Pixar created two interactive CD-ROMs based on toy story which were released in 1996 through Disney interactive. Both did extremely well, with combined sales of almost 1,000,000 units to date. Many reviewers cited our CD-ROMs as bringing a new level of animation and high quality computer graphics to this medium. Unfortunately, the open market for CD-ROMs has not grown as rapidly as many it hoped and predicted and so in early 1997 we made the decision to take our wings off the table and exit this market, allowing us to redirect talented staff to work on our mainstream productions.
- One of our major achievements in 1996 was the addition of 125 new people. Our studio grew 70% last year, and is now more than 300 strong. Success in our business depends not just on having good people, but on having a group of people with special talents, or gifts that are almost unique. There is intense competition for these people in our industry and we have worked very hard this past year to search out and hire the very best people to help build our studio.
- On a personal note, Apple’s acquisition of the next software in late 1996 now allows me to devote all of my energy (and hopes and dreams) to the future of Pixar. I am spending all of my work life with Pixar and loving it.
The Disney partnership
There was a tremendous sense of accomplishment at Pixar as we close the books on 1996. Throughout the year our focus was not just on the work at hand, but on the difficult long-term task of building a world-class studio. This future goal came dramatically closer just two months later, on February 24, 1997, when we announced a momentous new 10 year partnership with the Walt Disney Studios.
Before getting into this new deal, let me answer one obvious question: if things were going so well for Pixar, why did even need a new deal? We Artie had a three picture deal with Disney that would take us through the year 2000. And toy story had proven that Pixar had many unique assets that would drive our long-term success: a creative team second to none, the top technical team in our field, state-of-the-art proprietary technology that is at least five years of anything outside Pixar’s walls, one of only a handful of production teams in the world experienced in producing a feature-length animated film, and the best marketing and distribution partner in the world in Disney. But even with this unique set of assets, two other ingredients essential to building a truly world-class studio were missing. What were they?
First, better economics. To realize our vision of building the second great animation studio, we needed a much larger share the profits from her work in order to increase investment in our future and provide greater returns for shareholders. While the original Disney deals one of the best things that ever happened Pixar, with financial terms our outstanding for a newcomer breaking into the big leagues, Disney did keep over 85% of all profits. It is hard to build a world-class anything on just 10 to 15% of the profits.
Second, branding. We believe there are only two significant brands in the film industry—“ Disney” and “Steven Spielberg”. We would like to establish Pixar as the third. Successful brands are reflection of consumer trust, which is earned over time by consumers positive experiences with the brand’s products. For example, parents trust Disney branded animated films to provide satisfying and appropriate family entertainment, based on Disney’s undisputed track record of making wonderful animated films. This trust benefits both parents and Disney: it makes the selection of family entertainment that much easier for parents, and it allows Disney to more easily and assuredly draw audiences to see their new films. Over time we want Pixar to grow into a brand that embodies the same level of trust as the Disney brand but in order for Pixar to earn this trust, consumers must first know that Pixar is creating the films. Hence, our need to dramatically expand the Pixar branding of all of our products.
The new partnership with Disney provides both missing ingredients. Pixar and Disney will jointly produce five feature-length animated films over the next 10 years under the following key items:
- Pixar and Disney will split 50-50 all of the profits from the films and related products, including home videos, merchandise, interactive products, sequels, and made for home video sequels. This gives Pixar dramatically higher share of the profits then we had under the old deal.
- All products from the partnership will be equally co-branded, from the films to the toothbrushes. This Will Place Pixar’s brand prominently on all of our products – right beside the Disney brand, one of the most respected and trusted brands in the world.
- Pixar and Disney will equally co-finance the productions, and Disney will solely finance the marketing and distribution, taking a much lower distribution fee than the original deal. While financing half of each production increases our risk compared to the old deal, where Disney solely finance production cost, it buys us a much larger share of the potential profits. It’s the kind of risk we want to take will be betting ourselves because we are the ones creating the films.
- The remaining two pictures from the original deal become the first two pictures of the new partnership. Pixar will reap the benefits of this new partnership, including its higher share of profits and cobranding, at least four years sooner than we would have under the old deal.
- Finally, Disney becomes an investor in Pixar with the purchase of 1 million shares of Pixar stock, which they’ve agreed to hold for a minimum of three years. Disney may eventually own up to 5% of Pixar if they fully exercise their warrants. We warmly welcome them to the family of Pixar shareholders, and believe their investment reflects a strong commitment to a successful Pixar Disney partnership.
A strategic fork in the road
To better understand the long-term significance of this deal for Pixar, let me take you behind the scenes, back to early 1996. With the release of immediate success of toy story, we begin to broaden our horizons beyond just making one film. We wanted to grow an entire studio that could produce a succession of successful films, and after a great deal of thought we realize that we faced a strategic fork in the road. We could wait for our original three picture deal with Disney to conclude with the delivery of our third film in the year 2000, and then “go it alone” by financing the entire production and marketing costs ourselves, thereby keeping the lines share of the profits. Or, we could try to negotiate a new partnership with Disney that had much more favorable terms.
Going alone was certainly tempting, especially in the heady atmosphere surrounding toy stories success. But it would’ve been in exercise in hubris. Under our original deal, Disney financed all of the marketing and distribution, which for high profile feature animated films can be more expensive than the production. Going it alone would have exposed Pixar to a much higher financial risk betting twice as much on each picture with no assurance that every picture would be a success.
We also took stock of our uniqueness. There are at least six studios capable of marketing and distributing major motion pictures (Disney, Warner, Paramount, Fox, Sony and Universal). And there is only one studio that has created a fully computer animated feature film (Pixar). Diverging our management attention away from doing what only Pixar can do in order to become beginners at marketing and distribution seem like a bad idea to us. Nor did we want our culture to change. Pixar is in unique blend of animators, visual artists, story artists, scientists, engineers and production managers. Distribution involves different skills, and we were concerned that adding them to our cultural mix at this time would be disruptive. Creating is different than selling.
Once we had decided that our best long-term strategy was to have a partner, our first choice was by far Disney. They are, quite simply, the best. Disney invented the feature animated film art form with snow white in 1937 and has produced more than 30 animated features since then. They are the number one studio in the world, with in over 20% box office market share in 1996, and they dominate the home video market as well. It is also important that we have a relationship with Disney that goes back 10 years. They were there at our sides as the invaluable mentor would be made toy story. We like working with these guys.
A final question might be,” why did Disney strike this new deal with Pixar?” We believe it is because Disney, far more than most, appreciates how difficult it is to create blockbuster animated feature films. They know what it took to make toy story, and they’ve seen the progress we’ve made on our next feature film and other feature productions in development. When we announced the new partnership Michael Eisner, Disney’s CEO, said that feature animated films are the essence of what Disney does providing the stories, characters, and settings that are merchandise throughout their theme parks, stores and other marketing channels. The new partnership with Pixar gives Disney five more feature animated films over the next 10 years, and more characters like Woody and Buzz to populate Disney’s magical kingdoms.
What’s happening now
Which brings us to today. Strategy, business models, production agreements are one thing, but what are we doing? One of the people of Pixar working on when they come in each morning (and many evenings)? We are hard at work on three very exciting major new productions, each one stretching us in a new direction. I like to tell you a little bit about each of them.
The first is a bug’s life, the working title of Pixar’s second feature-length animated film and the first picture under our new Disney partnership. A bug’s life is loosely based on Aesop’s fable ‘ants and the grasshoppers’. Our film tells the story of an ant colony that works hard to collect for food for the winter, and every year a band of grasshoppers comes to wreak havoc, still of food, and leave. The answer had enough of this, so they decide to go out and hire some really tough warrior bugs to help them defend themselves when the grasshoppers returned. They send our lead character, whose named flick, out into the world to recruit these warrior bugs. Flick means well, but by accident he hires an out of work flea circus who believe it been hired to do a circus gig. Only when they get to the ant colony do they realize the circus bugs realize that they are supposed to fight the grasshoppers. A bug’s life has a compelling story, memorable characters, and lots of humor the same recipe that worked so well for Toy story. And a bug’s life will have a new appearance we are using almost 10 times the computing power that we used to make toy story, so expect a level of detail never before seen in an animated film. We’ve been working on a bug’s life for over two years and we are on scheduled to release it for the 1998 holiday season.
Our second work in progress is toy story two, a made for home video sequel to toy story, with Tom Hanks and Tim Allen reprising their roles as Woody and Buzz. In creating toy story two, we have the enormous had started being able to draw from our “digital back lot” the rich library of computer models, sets, textures, surface appearances and motion sequences that we created for the original toy story production. We only recently announced toy story two, but we’ve been working on it since last summer. We are really excited about bringing new adventures of Woody and Buzz to audiences in our studio’s first made for home video sequel, scheduled for release in the fall of 1998.
The third is our next feature animated release following a bug’s life. We’ve been in development on this project for over a year, and it looks very promising. The need to protect our story ideas prevents me from telling you more about it at this time. We hope to release this film for the holiday season of the year 2002 years after the release of a bug’s life.
With all of this work now in progress at Pixar, we will clearly have to keep expanding our staff. We grew from 175 to 300 people during 1996, and plan have a studio 400 people by the end of this year. We take great care in hiring only the best people to work at Pixar, and once they’re hired, we take equal care and helping them become productive members of our studio. Every animator and technical director who joins us immediately matriculates at Pixar University, taking a three-month course designed and taught by our experienced Pixar staff. We established Pixar University last year and its third class will graduate this month.
We also emphasize continuing education, which is one of the reasons Pixar has carried on its tradition of producing animated short subjects. This year’s short subject is Geri’s Game, which is about an old man (Geri) playing chess in the park. We regard the short subjects as an investment into the development of our creative and technical capabilities part of our studios R&D. For example, technical development for Geri’s Game has advance the state of the art computer animation of skin and cloth, two areas of great importance to Pixar. We are already incorporating some of these advances into a bug’s life and toy story two. And, just as John Lasseter honed his directing skills making five short subjects at Pixar on the weight toy story, we are investing in our future by continuing to produce at least once short subject each year.
Core capabilities
Looking at individual productions, and we’ve just done, is one way to chart Pixar’s progress. Another way is to look at the capabilities that enable us to create these pictures. We believe there are three core capabilities that are needed to build a world-class animation studio: creative, technical and production. We have been building a depth of talent in these areas for 10 years now. Let me review each of them.
We can start with creative, which is at the heart of everything we do. Even though Pixar is rightly regarded as the pioneer of computer animation, the essence of our businesses to create compelling stories and memorable characters. It is chiseled in stone at our studio that no amount of technology can ever turn a bad story into a good one nor can technology, no matter how dazzling, hold an audience for longer than five minutes without a captivating story. Pixar’s directors and story teams create these original stories – the stories for Toy story, a bug’s life, toy story two, and our new features and development all come from Pixar. This capability is rare, and it’s a hallmark of our studio. Once we have a compelling story, is then the creative challenge of our animators and visual, layout, lighting and editorial artist to bring the story to life. Many of them are the best in the industry. Our creative staff has grown to over 100 people, which gives us real depth of talent. For example, one of our staff working on a bug’s life has a PhD in computer generated plants! It’s not easy to find these creative talents, and I’m very happy to report that increasingly we are growing many of our own inside Pixar. For example, Andrew Stanton, one of toy stories writers and key story artist, is now the codirector of a bug’s life, working beside director John Lasseter. And Ash Brannon, one of toy stories directing animators, is now the director of toy story two. We believe Pixar is one of the best, and most sought after, creative training grounds in the country.
Our second core asset is technology or more precisely, our technical team and the technology they have pioneered. The computer animation technology that helped bring such a claim to toy story is proprietary to Pixar and we invented it and it’s not for sale. And our R&D and technical directors continued to develop new technology focused directly on advancing the art of our filmmaking. For example, based on what we’d learned making toy story, we compiled a list of over 1500 improvements that would make her computer animation systems even better. These improvements have been incorporated into the software being used to create a bug’s life. In the new world of computer animation opportunities for innovation armbands. And we have the most talented staff in the world working to keep Pixar in the lead.
Our advanced computer animation technology gives Pixar a number of other advantages some perhaps unexpected. It saves us time, helps us stay the lowest-cost producer of premier quality feature-length animated films, and helps make our animators better at what they do (as any good technology should). Traditional cell animators must spend a great deal of time drawing, because every one of the over 100,000 frames in a typical feature-length animated film (24 frames per second X 75 minutes) must be drawn by hand. In Pixar’s computer animation, all the drawing is done by computers hundreds and hundreds of very fast computers. This process results in two important differences from traditional cell animation. First, it frees our animators from drawing so that they can concentrate on acting – breathing life into their characters as they move. This allows Pixar to hire animators who may or may not excel at drawing.. but are brilliant actors. Our animators even take acting lessons. And second, our computers spend an average of three hours drawing each frame of the film, and they can draw a lot of detail in three hours. This incredible detail is what gives Pixar’s films their unique three-dimensional appearance and subtle textures, which are impossible to achieve in traditional hand-drawn animation.
The third capability is production management expertise, which encompasses the entire process of making a feature length animated film, from original story concept through delivery of the print. You can divide the process into about 17 different stages. It is a task of enormous complexity, requiring detailed coordination of over 150 people, managing budgets of $50-$100 million, and melding the Director’s artistic vision with the commercial necessity of getting the film done on time and within budget. Our production challenge became more complex as we expanded from one to three simultaneous productions. Fortunately, we’ve been able to build a strong production management team. To lead this team, we recently were able to hire Sarah McArthur, formerly Vice President of Production for Disney Feature Animation, to be Pixar’s Vice President of Production. Sarah is perhaps the most senior production leader in the animation industry.
Looking Forward
Even so, there will undoubtedly be a few bumps along the way as we build our studio. Though we will be keeping a much larger share of the profits from each picture, there’s no assurance that every one of them will be a box office blockbuster. And our revenue stream is uneven to begin with, coming in bursts following the release of each new successful feature film and its home video. We expect Toy Story’s revenue burst to taper off in 1997, with the next revenue burst coming in 1999, following the releases of Toy Story 2 and A Bug’s Life in late 1998. This will result in a substantial revenue decline and earnings loss for 1998, followed by record earnings in 1999 if Toy Story 2 and A Bug’s Life are successful as we hope they will be. I know the lack of traditional incremental growth from quarter to quarter, or even year to year, must drive some of our investors crazy. But our life is measured in pictures, not quarters, and we firmly believe we are creating long term shareholder value as we build out studio into a unique and valuable entertainment asset.
A few year ago Disney re-released ‘Snow White’, the original animated feature film that started it all 60 years ago. My family owns a copy, and our children love it. In fact, I don’t know anyone who doesn’t know and love the story of ‘Snow White’. The best animated films have become our modern day myths. At Pixar, we want to create some of these myths, which capture the hearts of each new generation, so that our films will still be watched and loved 60 years from now, just as ‘Snow White’ is today.
As we look to the future, there is a sense of great purpose and creative excitement at our studio. Our vision is clear: to build the second great animation studio by leveraging our unique position in the new medium of computer animation. Our challenge is well defined: to create and produce five great films over the next ten years. We have all the ingredients in place to do this. If we can, the artistic and financial rewards will be ample, because there is no asset or legacy more valuable than one which renews itself with each generation.
Steve Jobs
Chairman and CEO
The last page of Steve Jobs’ 1997 letter to Pixar shareholders
