From CBSmarketwatch.com: Disney tries to get back the pixie dust Lull raises concerns at core animation, parks businesses By Russ Britt, CBS.MarketWatch.com Last Update: 9:24 AM ET March 18, 2003 BURBANK, Calif. (CBS.MW) -- It's been a while since the renowned animators here on Walt Disney Co.'s main lot, where their legendary founder first sketched Mickey Mouse more than 75 years ago, have produced a hit. The group's last three original films -- "Treasure Planet," "Atlantis: The Lost Empire" and "The Emperor's New Groove" -- all fizzled at the box office. The $140 million "Treasure Planet" forced Disney to take a charge against earnings last quarter, unprecedented for one of the company's animated features. Down in Anaheim, the company's California Adventure theme park next to its flagship Disneyland struggles amid concerns there aren't enough attractions to keep the facility afloat. These are tough times for the Mouse House's cornerstone divisions. For decades, Disney's animators have created characters on screen, while its "Imagineers" have taken those characters, invented others and built rides around them. This braintrust has spawned countless revenue streams through a massive array of consumer products and services. But as Disney (DIS: news, chart, profile) prepares for its annual meeting Wednesday in Denver (see MarketWatch's special "Measuring Disney's Magic" report) after a year in which its stock has dropped more than 30 percent, shareholders are craving a bit of that patented pixie dust. The groups that once served as virtual golden geese now seem to be in a creative funk. "I think it is a concern, that Disney may have lost some of its touch," said David Joyce, an analyst at Guzman & Co. who follows the entertainment companies. "For the past year or two, there's been some high-level talent drain." Former Disney employee Arthur Levitt disagrees. Levitt, now the president of online ticket service Fandango, left Disney in 2000 and was once a personal assistant to Disney Chairman and CEO Michael Eisner. "I don't think Disney has lost one drop of its creative juices," Levitt said. "My opinion is they don't compromise on creative product." He said heavy cost cutting might be having an effect on operations. "Any time you talk to anybody in the creative world and tell them it doesn't have to cost more, people get sensitive," Levitt said. Disney executives and spokespersons declined to answer specific questions for this story. Disney spokesman John Spelich said this in an e-mail message: "The premise of your story is factually incorrect and we will not participate in a factually incorrect, biased story." A tough decade to match While Disney's net income has hopscotched between the red and the black due to one-time events since 2000, operating income has dropped from $4.1 billion in 2000 to $2.8 billion last fiscal year. Along with the slumping economy, fears of war and terrorism have kept theme-park attendance down and hurt advertising on ABC. Overall Disney sales have been flat to down since 2000, but that stall comes after a decade of massive growth, when sales quadrupled. Some of that growth came from the 1996 purchase of ABC. But in the five years before that, Disney's sales doubled from $6 billion to $12 billion. They now stand at $25 billion. As films such as "Beauty And The Beast," "Aladdin" and Disney's biggest hit, "The Lion King," set box-office records, they also spawned countless products, direct-to-video sequels and even a couple of Broadway shows. "It just became poetry in motion throughout the company," said Chuck Champlin, who at the time was public relations director for Disney's consumer products division. Champlin resigned in 1999 after 12 years with the company and now is public relations director for a nearby college. The company has evolved since the 1996 ABC buy. That media unit, which includes ESPN and the ABC Family Channel, now accounts for 38.4 percent of the company's sales. Theme parks and studio entertainment make up roughly a quarter each, while consumer products comprise the remainder. Consumer products operates Disney Stores and sells various souvenirs, many spawned from movies. The division has been a sore spot for several years, as sales have tumbled 36.8 percent from $3.8 billion in 1997 to $2.4 billion in 2002. "I think there was such a relentless pursuit of growth, which was a good and noble try," Champlin said. "But it really began to exhaust the brand. There were some overexposure issues." Product difficulties are showing up in such areas as the exclusive pact Disney now has with McDonald's (MCD: news, chart, profile) for movie-related promotions. On a recent conference call, new McDonald's CEO Jim Cantalupo told analysts he was disappointed in the deal and put it under review. "Everything is on the table," Cantalupo said. The company later said in a statement that it "valued" its relationship with Disney, and Disney echoed the same sentiment in its own statement. New animation focus As the in-house animation efforts have slipped, partners such as Pixar (PIXR: news, chart, profile) have helped pick up the slack. Pixar has had nothing but hits with two "Toy Story" films, "A Bug's Life" and "Monsters Inc." The Disney-Pixar pact runs out in 2005, and Pixar is shopping around for possible new suitors. If the deal is renewed, Disney may have to yield more to its successful partner the next time around. Inside Disney, a group of in-house animators in Florida developed last year's hit "Lilo & Stitch," which helped prime the Disney product pump. The group's prior outing was 1998's "Mulan." And the company points out that three of its animated features were nominated this year for Academy Awards. Disney's core group of cartoonists in Burbank -- long considered the center of the animation universe -- is now churning out the kinds of sequels that used to go directly to video. Now those are starting out on the big screen, as evidenced by "Jungle Book 2" and "Return to Never Land." That process is quite profitable. The company says its 13 recent sequels cost a total of $200 million to make and will generate more than $1 billion in profit. But former animators say they shortchange Disney's reputation. "They're beginning to try and come up with new stuff out of the old stuff," said David Pruiksma, a 20-year Disney animation veteran who left voluntarily in 2001. "A company that does that is being very shortsighted." Bob Smithouser, who reviews movies for an online publication produced by psychologist Dr. James Dobson's Focus On The Family group, praises a number of Disney projects, including "Treasure Planet." His latest review of "Jungle Book 2" takes issue, though, with Disney's decision to put animated sequels in theaters. "You almost feel like you're watching the first one," he said. "It makes you think these were more inspired by marketing instead of creativity." A look at Disney-Burbank animation releases since 1994's "Lion King" shows steadily declining returns in U.S. ticket sales in relation to budgets. U.S. ticket sales are not the final say on profitability, but they are the first indicator of how well a film will do. "Pocahontas" returned $141 million in U.S. ticket sales in 1995 on a $55 million budget. In 1997, "Hercules" took in $99 million on a $70 million budget. Then 1999's "Tarzan" brought back $171 million on a budget of $150 million. "Dinosaur" in 2000 was a $128 million undertaking, much of it an investment in a computer animation studio. It returned $138 million in U.S. receipts. The tide turned negative later that year with "Emperor's New Groove." Made for $100 million, the film garnered $89.3 million in U.S. sales. "Atlantis," with a $90 million budget, had $84 million in U.S. sales. Animation evolution Former animators say a confluence of events has worked against their department since the mid-1990s: the departure of studio chief Jeffrey Katzenberg to DreamWorks in 1994, a huge influx of managers and, most importantly, increased competition that boosted artist salaries as high as $500,000. "They just didn't want to lose anybody, and salaries went through the roof," said Doug Krohn, a 20-year Disney veteran who left last year after his contract ran out and wasn't renewed. He joined Klasky-Csupo, which makes animated films and television shows for Viacom. (VIA: news, chart, profile) (VIA.B: news, chart, profile) (Editor's note: Viacom is an investor in MarketWatch.com, publisher of this report.) Krohn said one of the biggest changes came in oversight of animation. The tremendous success of "Lion King," which made $781 million worldwide, turned the spotlight on the division. Katzenberg's departure shortly after that made the department fair game, and managers seeking a piece of the action poured in. Prior to "Lion King," the department would put three or four supervisors and 50 animators on one film. After "Lion King," there were 300 artists on one film, with several dozen supervisors. Disney replaced animation chief Thomas Schumacher with David Stainton in January. It's also separating its television animation group from the features operation. Both moves are said to have pleased key shareholders. Disney has said it wants to avoid $140 million films like "Treasure Planet" in coming years, and so it is cutting costs. The animation staff has been cut by nearly half in the last few years. It now stands at 1,200. The group's next release is "Brother Bear," due in November. Disney plans to keep budget at a more moderate, $80 million level. "I would say creative people are still there," said Pruiksma. "You can have the greatest athletes in the world, but if you don't let them run, what is the point?" Theme park troubles The same refrains are heard when the subject turns to Disney's Imagineering department. "I don't think Disney's lost its creativity," said Jim Cora, a 43-year Disney veteran who retired as chairman of Disney's international theme park business in 2001. "I think the problem is having enough money to be as creative as we can be." Cora said it's much more costly now to develop and build imaginative new rides at Disney's parks. Imagineers consider the popular "Pirates Of The Caribbean" a quintessential Disney ride. Not only does it thrill riders, it tells them a story of pillaging rapscallions. "Pirates" was built in the 1970s for $32 million. It would cost up to $145 million now, Cora estimates. "It's amazing how much it costs to build a good attraction," he said. Disney is constructing a ride called "Mission: Space" at Walt Disney World in Orlando, Fla., geared to simulate the weightlessness of space. At California Adventure, Disney hopes a new "Tower Of Terror" ride -- a replica of one at Disney World -- will boost interest in what critics say is a park too heavily weighted with shops and restaurants instead of rides and attractions. "I didn't think it measured up to guest expectations for a Disney theme park," Cora said. Disney has said it takes time for a theme park to gain momentum and promises to continue to improve California Adventure. One way it's doing that without heavy costs is with an "Aladdin" stage show, which is winning good reviews. Disney also has said it will keep a lid on capital spending at its parks for a while, which means a facility such as Disneyland may not get a significant new attraction for some time. Disneyland's last debut was the Indiana Jones ride that appeared in the early 1990s. An experiment with a "Rocket Rods" ride in 1998 failed. And now is not the time to expand, analysts say. Disney just revealed that its current quarter theme park business is lower than expected due to war fears, prompting some on Wall Street to lower forecasted earnings. Disney officials have said the theme parks already have undergone significant expansion with the addition of California Adventure, the building of additional facilities in Paris and the opening of Tokyo DisneySea, built by Imagineers and owned by Oriental Land Co., which pays Disney a license fee. DisneySea is winning rave reviews, partly because Oriental Land spent $4 billion to build the park. By comparison, Disney shelled out $700 million for California Adventure, plus another $700 million for an adjacent hotel. Cora's brother John, a former Disney vice president in charge of resort development, says the company's tight fiscal constraints have stifled creativity. "Disney has lost the good storytellers of the past, like Walt, who could tell stories in a good, passionate way," he said. Russ Britt is the Los Angeles Bureau Chief for CBS.MarketWatch.com.