Disney, Pixar in Dispute Over Pact

Like the creatures emerging from the closet in the upcoming movie “Monsters, Inc.,” demons are creeping into the open in the longtime business relationship between Walt Disney Co. and Pixar Animation Studios.

As “Monsters” is expected to become one of the holiday season’s biggest films when it opens Nov. 2, the two companies are wrestling over an issue critical to the future of their partnership.

An impasse over how Pixar would make a third installment in the lucrative “Toy Story” franchise is straining the alliance, raising questions of whether the Pixar computer animation wizards might eventually go their own way.

For now, Pixar officials say “Toy Story 3” won’t happen for years, if at all.

Adding to tensions is a shift in the balance of power between the two companies, owing not only to Pixar’s stellar track record and the growing popularity of its cutting-edge 3-D animation but also to struggles at Disney’s own venerable animation unit.

Disney’s last two major animated releases, “Atlantis: The Lost Empire” and “The Emperor’s New Groove,” failed to meet box office expectations. And spiraling production and labor costs have forced the studio to slash about 500 jobs at its animation division, mostly from its Burbank headquarters.

The standoff over “Toy Story 3” is one of the few public cracks in a partnership that is one of the movie industry’s most successful. The two companies formed a filmmaking partnership in 1991, under which Pixar makes the movies and Disney markets and distributes them. The duo splits production costs and profits.

In an industry in which failure is routine, Pixar and Disney together have had a perfect batting average with “Toy Story,” “Toy Story 2” and “A Bug’s Life”--which amassed a combined $1.2 billion in worldwide box office and still more in profit from home videos, DVDs, computer games and merchandise.

“It’s a mutually beneficial relationship,” Merrill Lynch media analyst Jessica Reif Cohen said. “The blowout success has obviously been Pixar, but Disney brings a lot to the table in marketing power, cross-promotional traffic in its theme parks and stores and the perfect target reach of the Disney Channel audience.”

Contract Decrees That

Sequels Don’t Count

“Monsters,” a comedy featuring the voices of Billy Crystal and John Goodman as friendly monsters who invade the bedrooms of children at night, is expected by some media analysts to gross as much as $200 million in the U.S. alone. Disney and Pixar spent more than $100 million to produce “Monsters” and will spend $50 million more on domestic marketing.

After the release of “Monsters,” Disney and Pixar are bound together for three more films that already have been identified.

“Toy Story 3” isn’t one of them.

The dispute stems from a clause in the Disney-Pixar contract that says sequels don’t count toward films Pixar must deliver. Nonetheless, Pixar Chairman Steve Jobs and Disney Chairman Michael Eisner are at odds, with Jobs arguing that if Disney wants another “Toy Story,” Eisner should be flexible enough to let it count.

In an interview last week, Jobs declared that because Eisner won’t budge, Pixar has no plans to make Disney another “Toy Story.”

“The train has left the station,” he said. “The next three films are spoken for.... We wanted to make ‘Toy Story 3,’ but in the current deal it’s not going to happen.”

Jobs said another “Toy Story” would further tie up Pixar’s animators. That would postpone the day when Pixar would have the option to unshackle itself from Disney, becoming a free agent that could negotiate a potentially lucrative deal with a host of eager suitors.

Jobs said Pixar already gave Disney “a freebie” when it made the sequel “Toy Story 2.”

“‘Toy Story 2’ was a big success, and we never complained it didn’t count [as a contracted film], but we can’t do it again,” Jobs said.

Eisner, who declined to comment, has cited the contract previously in making it clear he believes any more “Toy Story” films shouldn’t count. Disney can legally make “Toy Story 3” without Pixar, since the studio bankrolled the original and controls the franchise. But that is unlikely, unless Pixar lets the contract expire.

Asked about “Toy Story 3,” Disney animation chief Tom Schumacher said, “That’s a question we all have. The reality is everyone would like to make ‘Toy Story 3.’ Pixar has one set of business issues they want to fulfill and we have another.”

But Schumacher said the dispute hasn’t soured things. Though Disney and Pixar have “a lot of business issues, there’s not a lot of creative tension between the two companies.” He said he and Pixar creative guru John Lasseter “are always talking about the future and continuing the relationship.”

The Disney-Pixar deal expires with the delivery of the last picture, which Pixar said will be “no earlier than 2005.” At that point, Pixar potentially could declare its independence from Disney in much the same way George Lucas did from Hollywood’s studios after his early “Star Wars” successes. Using his clout and financial wherewithal, Lucas now controls every aspect of “Star Wars” and pays 20th Century Fox Film Corp. a distribution fee of about 5% to release the movies.

Or Pixar could use its leverage to cut a better deal with Disney than its current 50-50 split.

“We don’t have to think about it now, but we have all the options in the world, including continuing to work with Disney,” said Jobs, who controls Pixar with a 62% stake worth more than $1 billion.

Pixar and Disney started doing business in 1986 after Jobs, who founded and still heads Apple Computer Inc., bought Pixar for $10 million from Lucas. Pixar supplied technology to help modernize Disney’s animation division. In 1991, they agreed to make computer-animated features.

Wall Street analysts are confident that “Monsters” will continue their winning streak, despite competition from Warner Bros.’ “Harry Potter and the Sorcerer’s Stone,” which bows Nov. 16. In addition, “Monsters” is the first Pixar movie not directed by Lasseter, whose involvement early on was limited because he was tied up with “Toy Story 2.” Lasseter did serve as an executive producer, with protege Pete Docter directing.

“There’s no reason to believe ‘Monsters’ won’t be as successful as the other films,” said Jeffrey Logsdon, an analyst at Gerard Klauer Mattison.

Both Logsdon and Reif Cohen said that if the film grosses $200million domestically, as they expect, it will be highly profitable.

Reif Cohen said Pixar eventually could net as much as $200 million. Because Disney receives a 13% distribution fee, its cut of the profit is higher.

“I think Disney is reaping enormous benefits from the relationship,” Logsdon said. “And Pixar is clearly the controller of its own destiny after their agreement is up.” He noted that “Shrek,” last summer’s hugely successful animated movie from Pixar rival Pacific Data Images and DreamWorks SKG, “proved that even a non-Disney-distributed animated film can generate top-level grosses if the content is right.”

The Godfather of 3-D Animation

There’s no question Pixar and Disney have benefited from each other’s strengths. Pixar is considered the godfather of 3-D computer animation, both for its technological know-how and its deft touch for appealing stories.

Pixar now is flush with about $275 million in cash, and its market value hovers around $2 billion. For 2000, Pixar reported record profit of $78.4 million on revenue of $172.3 million. With a staff that now numbers 600, Jobs hopes Pixar can attain its goal of making one movie a year, up from one every 18 months.

As for Disney, the company remains the most valuable family brand name and, despite its recent troubles in animation, continues to dominate the genre as it has since the 1937 release of “Snow White and the Seven Dwarfs.”

Schumacher acknowledged that the studio’s last two big animation releases, “Atlantis,” which grossed $83 million in the U.S., and “The Emperor’s New Groove,” which took in $89 million, both were disappointing, especially for a division used to seeing its animated films routinely gross much more. “The Lion King” was Disney’s high-water mark, generating $1 billion in profit.

Schumacher said he has “great confidence” in “Monsters” as well as Disney’s lineup of future animated releases, which include “Lilo & Stitch” (June 2002), “Treasure Planet” (fall 2002), Pixar’s “Finding Nemo” (summer 2003), “Sweating Bullets” (fall 2003) and two Pixar movies, details of which have yet to be announced.

Jobs is coy when it comes to Pixar’s future and whether he will try to replicate the Lucas model.

“There are a lot of companies that can distribute, but only two companies that can make blockbuster animated films,” Jobs said, describing his dealings with Disney as “a good relationship.”

By the time their contract expires, the partners will have collaborated on seven movies. “Tell me another relationship in Hollywood between two studios that [will last] for seven pictures,” Jobs said. Asked to characterize his relationship with Eisner, Jobs said, “Some people will look at any relationship and try to pick it apart, but to be honest, it’s kind of like a marriage. The thing I want people to judge our relationship by is how has it endured and what it has produced.”

Though Jobs may have business disagreements with Disney, he wants to emulate how the company has built its brand name. “We really admire and respect Disney and their brand, but we also want to build our brand,” he said.

When Jobs renegotiated the deal with Disney in 1997, Pixar gained the right to have its name appear alongside Disney’s on the credits of all their movies.

“They are together for better or for worse for three more movies,” Reif Cohen said. “There’s no way Disney should let Pixar go given their unbelievable track record.’

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Strained Alliance

A standoff between Disney chief Michael Eisner and Pixar Chairman Steve Jobs over “Toy Story 3” is undermining what has otherwise been one of Hollywood’s most successful partnerships. At the center of the dispute is whether the sequel to the lucrative “Toy Story” franchise should count as one of the three movies Pixar still owes Disney under their current deal. Eisner says it shouldn’t count. Jobs says it should and insists that he will not make the movie under the existing terms of their agreement.

The original “Toy Story,” released in 1995 as the first picture under Pixar and Disney’s joint venture, grossed $361.5 million worldwide and put Pixar and director John Lasseter on the ap as trend- setting pioneers of computer-animated movies. The film also established Woody (Tom Hanks) and Buzz Lightyear (Tim Allen) as instant classic screen heroes.

“Toy Story 2,” originally intended as a direct-to-video sequel, instead went out theatrically in 1999 only after Pixar fought vigorously for it to be seen on the big screen. The picture grossed even more than the original, taking in $485 million worldwide.

“Toy Story 3” is not even in development and is in jeopardy of not being made despite how potentially lucrative it would be to both companies.

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Monster Profit

“Monsters Inc.” is expected to be a major hit for Disney and Pixar. The companies split the profit after Disney recoups advertising costs and is paid a 13% distribution fee. Here’s an estimated breakdown of what the movie could make (in millions of dollars):

Revenue

Domestic theatrical rentals ($175-million box office)*: $96.3

International theatrical rentals ($200-million box office) : $90.0

Domestic home video and DVD: $180.0

International home video and DVD: $72.0

Merchandise licensing and royalties: $28.0

All television, pay-per-view, cable, music, games: $125.0

Total revenue: $591.3

Costs

Production: $115.0

Global marketing: $100.0

Distribution fee: $76.9

Total costs: $291.9

Accounting adjustment (added to profit): $25.0

Estimated net profit: $324.4

Pixar estimated share of profit: $162.2

* Theatrical rentals are the portion of the box office retained by the studio, which is roughly 50%.

Source: Jeffrey B. Logsdon of Gerard Klauer Mattison