-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VNHE556sysR9uiTpuvDwQzp1sf+a5HyLc7f4jSPGsqN6vVzod9/y+FVDJpS1ngZA iq53aLOdd6xNtIwxL0BONg== 0000891618-98-001447.txt : 19980401 0000891618-98-001447.hdr.sgml : 19980401 ACCESSION NUMBER: 0000891618-98-001447 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PIXAR \CA\ CENTRAL INDEX KEY: 0001002114 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 680086179 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-26976 FILM NUMBER: 98581210 BUSINESS ADDRESS: STREET 1: 1001 WEST CUTTING BLVD CITY: RICHMOND STATE: CA ZIP: 94808 BUSINESS PHONE: 5102364000 MAIL ADDRESS: STREET 1: 1001 WEST CUTTING BLVD CITY: RICHMOND STATE: VA ZIP: 94804 10-K405 1 FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1997 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER DECEMBER 31, 1997 0-26976
PIXAR (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 68-0086179 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1001 WEST CUTTING BOULEVARD, RICHMOND, CALIFORNIA 94804 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 236-4000 ------------------------ SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, NO PAR VALUE PER SHARE (TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 18, 1998, there were 43,515,276 shares of the Registrant's Common Stock outstanding and the aggregate market value of such shares held by non-affiliates of the Registrant (based upon the closing sale price of such shares on the Nasdaq National Market on March 18, 1998) was approximately $403,074,076. Shares of Common Stock held by each executive officer and director have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. DOCUMENTS INCORPORATED BY REFERENCE Certain sections of Pixar's Annual Report to Shareholders for the year ended December 31, 1997 (the "1997 Annual Report") are incorporated by reference in Parts II and IV of this Form 10-K to the extent stated herein. Also, certain sections of Pixar's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders to be held on June 17, 1998 are incorporated by reference in Part III of this Form 10-K to the extent stated herein. ================================================================================ 2 This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates and projections about Pixar's industry, management's beliefs, and assumptions made by management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under "Certain Factors Affecting Business, Operating Results and Financial Condition" on pages 13 through 27 as well as those noted in the documents incorporated herein by reference. Particular attention should be paid to the cautionary language in Certain Factors Affecting Business, Operating Results and Financial Condition "-- Dependence on Toy Story, A Bug's Life and Toy Story Sequel," "-- Liquidity Risks," "-- Scheduled Successive Release of Films; Management of Growth" and "-- Risks Associated with Co-Production Agreement." Unless required by law, Pixar undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. PART I ITEM 1. BUSINESS GENERAL Pixar is a digital animation studio with the technical, creative and production capabilities to create a new generation of animated feature films and related products. Pixar's objective is to develop computer animated feature films with a new three-dimensional appearance, memorable characters and heartwarming stories that will appeal to audiences of all ages. The first such film, Toy Story, was created and produced by Pixar and was distributed by The Walt Disney Company (along with its subsidiaries hereinafter referred to as "Disney"). Pixar believes that consumer marketing campaigns surrounding the theatrical release of such films can generate broad consumer awareness of the films, which in turn can drive box office demand as well as sales of film-related products, such as theatrical sequels, soundtracks, toys and other merchandise. RECENT DEVELOPMENTS In February 1998, pursuant to the Co-Production Agreement, Pixar and Disney agreed to co-finance and Pixar agreed to produce a theatrical motion picture sequel to Toy Story (with the working title, Toy Story Sequel), in lieu of the Toy Story made-for-home video sequel. Because Toy Story Sequel is a derivative work of the original Toy Story, it will not be counted toward the five Pictures to be produced under the Co-Production Agreement. However, for all other purposes, Toy Story Sequel will be treated as a "Picture" under the Co-Production Agreement. Accordingly, Toy Story Sequel has been added to the definition of Pictures produced and financed under the Co-Production Agreement and all the provisions applicable to the other five Pictures apply. Specifically, Pixar and Disney will co-own and co-brand Toy Story Sequel (with Disney having exclusive distribution and exploitation rights) and will share equally in the profits of Toy Story Sequel and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which will be financed by Disney), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. See "-- Relationship with Disney -- Co-Production Agreement." Since 1996, Pixar has been in the process of producing Toy Story Sequel for the less expensive made-for-home video format. Therefore, Pixar will necessarily spend substantially more production time and incur substantially higher production costs to convert Toy Story Sequel into a feature-length and feature-quality motion picture. As a result, Toy Story Sequel will not be released until late in 1999 at the earliest. Pixar does not expect to recognize any revenue from Toy Story Sequel until six to twelve months after the theatrical 1 3 release (i.e. until the second half of 2000 at the earliest). The budget for Toy Story Sequel will also be much greater than the original Toy Story film because, among other things, compensation rates for personnel have escalated and, unlike Toy Story, significant upfront and participation costs for key voice talent will be incurred. BUSINESS MODEL AND PRODUCTS Pixar's strategy is to develop and produce animated feature films and related products, such as theatrical sequels, and to work jointly with Disney in the development and production of certain other related products such as soundtracks, toys and other merchandise. Pixar is currently implementing this strategy through the Co-Production Agreement with Disney. Animated Feature Films. Pixar's first computer-animated feature film, Toy Story, was released on November 22, 1995, and Pixar intends to continue to develop computer animated feature films for the family entertainment market. In 1997, Pixar began the production phase on a second computer-animated feature film for Disney, called A Bug's Life, which will be the first of five such films developed and distributed under the new Co-Production Agreement with Disney. This film is not expected to be released until the end of 1998. In 1997, Pixar continued development and began production on Toy Story Sequel, a derivative work now subject to the same terms as the other theatrical motion pictures developed under the Co-Production Agreement, except Toy Story Sequel will not be counted toward the five Pictures to be produced under that agreement. See "Recent Developments." Toy Story Sequel is not expected to be released until the end of 1999 at the earliest. Also in 1997, Pixar continued story development on its fourth theatrical film (the "Fourth Film"). This film will be developed and distributed under the Co-Production Agreement and will count as the second of the five original films to be produced under the Co-Production Agreement. Production of the Fourth Film has not yet begun, and Disney and Pixar have not yet approved the story treatment and budget as required under the Co-Production Agreement. The Fourth Film is not expected to be released until the end of 2000 at the earliest. See "Certain Factors Affecting Business, Operating Results and Financial Condition -- Scheduled Successive Release of Films; Management of Growth." Home Videos. Toy Story was released by Disney as a home video in October 1996, and Pixar believes that its future animated feature films will lend themselves to home video distribution in both domestic and international markets. Distribution of home video versions of the animated feature films developed and produced under the Co-Production Agreement will also be pursuant to the Co-Production Agreement. Merchandise and Soundtracks. Pixar believes that the characters and music created in animated feature films lend themselves to opportunities for selling merchandise and soundtracks. For example, merchandise such as children's toys based on stories and characters in Toy Story were designed using three-dimensional data from Pixar's digital models. Disney has the rights to distribute merchandise and soundtracks from Toy Story and the feature films to be made pursuant to the Co-Production Agreement, and Pixar shares in the profits, if any, generated from such sales. Short Animation Products. Pixar has also in the past produced animated or partially animated television commercials, including for products such as Coca-Cola, Listerine and Gummi-Savers (a LifeSavers product). However, in 1996, Pixar largely discontinued its business of producing commercials in favor of other opportunities. Pixar does still produce short animation projects, such as projects related to Disney theme parks. Moreover, Pixar believes that there may continue to be other opportunities to produce short animation projects for Disney in connection with work performed under the Co-Production Agreement. Short Films. Pixar has developed a number of short films since its inception and continues to invest in developing new short films. In 1997, Pixar created and produced a new short film, Geri's Game. Although the short films have few commercial opportunities, Pixar believes it is an important investment for the development of creative talent and Pixar's computer animation technology. For example, Geri's Game enabled Pixar to further its technology in computer generated skin and cloth. Other Products. Pixar has been selling its RenderMan software for over eight years. RenderMan has helped visual effects studios create visual effects such as certain dinosaurs in Jurassic Park, the metal cyborg in Terminator 2 and the ghosts in Casper. RenderMan runs on Unix-based workstations from Silicon 2 4 Graphics, Sun Microsystems, Inc. ("Sun"), The Hewlett-Packard Company ("Hewlett-Packard"), International Business Machines Corporation ("IBM") and Digital Equipment Corp. ("Digital Equipment") as well as the Windows platform. Examples of RenderMan customers include movie studios such as Disney, Digital Domain, Twentieth Century Fox Film Corporation, Industrial Light and Magic ("ILM"), Columbia/Tri-Star Pictures Inc. and Warner Bros. Inc. Customers also include government agencies and universities. RenderMan is sold in several formats, including a Toolkit at a list price of $5,000 per license. Discounts are available for site or multi-use licenses. As a result of Pixar's reduced emphasis on the commercialization of software in favor of products sold for their content, Pixar continues to expect to dedicate less time and resources to distributing and marketing RenderMan than it has in the past and expects that sales of these products may decline. See "Technology -- RenderMan." See also "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1997 Annual Report to Shareholders. Discontinuation of Interactive Products Division. In 1995, Pixar established a division that focused on the development of interactive CD-ROM stories and games for PCs. Under a separate prior agreement with Disney, this division of Pixar developed two CD-ROM titles based on Toy Story -- Toy Story Interactive Storybook and Toy Story Activity Center. The products developed under that agreement with Disney were financed and distributed by Disney. Pixar determined in March 1997 to discontinue its business of producing CD-ROM and other interactive products and successfully redirected the approximately 60 employees in this division to film and related projects within Pixar. PIXAR COMPUTER ANIMATION PROCESS AND DIGITAL BACK LOT Pixar Computer Animation Process The production of an animated feature film is extremely complex and time consuming due to the very large number of frames and intricate detail of each frame. At 24 frames per second, a 77-minute animated feature film such as Toy Story requires approximately 110,000 individual frames. Animation for a feature film has traditionally been created through hand-drawn cels, requiring hundreds of people working for two to three years. Although computers have been used to assist in some elements of painting cels for more recent releases, almost every frame is still hand-drawn. Pixar believes that its proprietary technology, which allows animators to manipulate hundreds of motion control points within a single character, allows for more intricacy and subtlety of character and personality than traditional two-dimensional cel-based animation. This technology also facilitates the manipulation, editing and re-use of animated images. Pixar makes its computer animated films and other projects in three stages: creative development, production and post-production. ----------- ----------- ----------- ----------- ----------- CREATIVE Story Treatment/ Screen- Story Story DEVELOPMENT Concept 5 Outline 5 Play 5 Board 5 Reels 5 ----------- ----------- ----------- ----------- -----------
----------- CREATIVE Voice DEVELOPMENT Recording -----------
Creative Development. Creative development is an iterative process in which the story and its characters are created and developed. The first step in creative development involves the development of a story concept, which often takes the form of a story summary or outline known as a treatment. After numerous iterations and research into the story and characters, a first draft of a screenplay is written. The screenplay is then turned into story boards, which are panels filled with thousands of sketches that represent the story to be animated. The story boards are then transferred to film or video so that they can be electronically edited into a photo play of the film called story reels, a process which enables editing of the film before the production phase begins. 3 5 Voices are then selected, recorded and added to the story reels. Throughout the creative development process, plans are developed for the style, colors and look of the film. ----------- ----------- ----------- ----------- ----------- Shading PRODUCTION Modeling 5 Layout 5 Animation 5 and 5 Rendering 5 Lighting ----------- ----------- ----------- ----------- -----------
----------- PRODUCTION Film Recording -----------
Production. Pixar's production stage consists of six phases: modeling, layout, animation, shading and lighting, rendering and film recording. In the modeling phase, digitized models of each set and character are created by defining their shapes in three dimensions (height, width and depth) and by adding animation control points that allow the model to be moved or animated. In some cases, a model has hundreds of animation controls. In the layout stage, artists place the digital models into a scene and position the digital cameras at the angles from which the three-dimensional shot is to be seen. The assembled shot is then given to the animator together with the prerecorded voice. In the animation stage, the digitized models are animated, or "brought to life," in three dimensions to create a motion sequence. Animation is performed by defining "key frames," which are the frames containing the extremes of motion that will occur in a scene. The computer then interpolates frames in between the two most extreme positions in a particular segment of movement to create smooth motion. The animators can then adjust the interpolation and key frames repeatedly until they achieve the desired result. The next step in completing a scene requires attaching to each object and model a description of its surface characteristics. These "shaders" describe the pattern, texture, finish and color for every object in the scene. Next, lighting is added by placing digital lights into the scene. In the rendering phase, the renderer takes the modeling, layout, animation, shading and lighting data and, for each frame in the sequence, computes a three-dimensional image of what the scene looks like at that point in time from the point of view of the camera. The final rendering of a single frame can take between one and twenty hours. The final rendered data is then sent to one of Pixar's film recorders for imaging onto film. ----------- ----------- ----------- ----------- ----------- Sound Print POST-PRODUCTION Effects 5 Musical 5 Sound 5 Color 5 Delivery Design Score Mixing Correction of Print ----------- ----------- ----------- ----------- -----------
Post-Production. The post-production stage consists of two parallel processes: the picture process and the sound process. In the picture process, images are put on film, the film is sent to a laboratory for color correction and final prints are made. In the sound process, the sound effects and musical score are added and the final sound is mixed. Pixar's post-production is simpler than post-production in a live-action film, which requires more significant editing. In most live-action films, many hours of film are shot, and the film is then significantly edited and re-edited in the post-production stage to create a feature film. Pixar, like other animation studios, edits the film throughout the entire creative development and production process. Thus post-production involves only final editing. Digital Back Lot The digital models that Pixar develops to create its animated products may be used again in future films, CD-ROM titles, television commercials and other animation products. The Pixar technical team has developed a proprietary database of thousands of digital models, sets, textures and surface appearances from its short films and commercials. Much like the traditional movie studio's back lot, this digital database allows Pixar animators to retrieve and re-use thousands of different elements that make up the characters and scenes of a film. Unlike a traditional movie studio's back lot however, digital animation sequences can be easily re-used. For example, a sequence of a character walking could be re-used with little or no rework in another portion of the film. These models may also be used in other films or in videos, CD-ROM titles or to create merchandise. For example, the models that were used to animate Toy Story were "re-used" or rendered in a different resolution for use in Pixar's two Toy Story CD-ROM titles and are being re-used in Toy Story Sequel. 4 6 TECHNOLOGY Pixar has three core proprietary technologies: (i) Marionette, an animation software system for modeling, animating and lighting, (ii) Ringmaster, a production management software system for scheduling, coordinating and tracking of a computer animation project and (iii) RenderMan, a rendering software system for high quality photo-realistic image synthesis that Pixar uses internally and licenses to third parties. Each of these systems is critical to the production of Pixar's animated feature films and other animation products. Marionette. Marionette is Pixar's software system for modeling, animation and lighting for computer animation. Marionette is the primary software tool of every animator and technical director at Pixar. In contrast to many commercially available animation systems which are designed to address product design, corporate logo graphics or cinematic special effects, Marionette has been designed and optimized for character modeling and animation. Marionette is portable across many of the standard Unix workstations, including those from Silicon Graphics and Sun. Pixar has also ported Marionette to IBM and Hewlett-Packard workstations for hardware evaluation purposes. Ringmaster. Ringmaster is a production management software system for scheduling, coordinating and tracking a computer animation project. Due to the enormous amount of data required in three-dimensional animation, accurate production information is essential for producing high quality animation. Pixar's production coordination staff uses Ringmaster to plan and track projects ranging from short animation projects to feature films. A key component of Ringmaster is a distributed rendering system for managing the huge quantity of images and data that must be rendered to create Pixar's products. Pixar does its rendering on an array of powerful Unix processors which are dedicated to rendering 24 hours a day. These machines, which Pixar calls the RenderFarm, are connected via a local area network. To achieve the desired quality level, the average time to render a single frame at film resolution is between one and four hours; for video resolution the average time to render a single frame is between 30 and 90 minutes. Since an animated feature film contains well over 100,000 frames, each of which may be rendered several times in the production process, Pixar typically has a large number of frames to render at any given time. To manage this process, Ringmaster coordinates and schedules all the processors in the RenderFarm. Ringmaster includes a compositing system and also maintains an array of disk drives as a central data repository for the digital image files generated by the rendering and compositing steps of the production process. Finally, Ringmaster controls the filming phase of production and is responsible for backing up shots for archival purposes. RenderMan. RenderMan is a rendering software system for high quality photo-realistic image synthesis that Pixar uses internally and also licenses to third parties. Today, RenderMan is used by many major film studios and special effects firms. Examples of projects which have used RenderMan include Terminator 2, Jurassic Park, Aladdin and Apollo 13. By licensing RenderMan to film studios, visual effects houses, commercial production facilities and other computer animation companies, Pixar believes that RenderMan has been established as a de facto industry standard for high quality rendering. Pixar has used RenderMan for animation production since 1988, when it was first used in the making of the short animated film Tin Toy. Since that time, Pixar has used RenderMan for its films and short projects. Pixar also used RenderMan to render approximately 110,000 frames for the animated feature film, Toy Story, and to render all frames for the two Toy Story CD-ROM titles. RenderMan was designed to be easily portable. It runs on a wide variety of Unix workstations, including those from Silicon Graphics, Sun, Hewlett-Packard and Digital Equipment. Pixar has also ported RenderMan to the Windows and Macintosh platforms. CREATIVE DEVELOPMENT GROUP Pixar's creative and technical personnel have collaborated for over ten years to produce three-dimensional computer animated films. The principal objective of Pixar's creative group is to use the medium of computer animation to create heartwarming stories with memorable characters that are targeted for family entertainment. The members of Pixar's creative and technical teams have been nominated for and received a number 5 7 of awards. In 1986, the short animated film Luxo Jr. earned an Academy Award nomination for Best Short Film (Animated). In 1988, another of Pixar's short films, Tin Toy, became the first computer animated film to win the Academy Award for Best Short Film (Animated). In 1998, Pixar's most recent animated short film, Geri's Game, also won an Academy Award for Best Short Film (Animated). The creative team at Pixar is under the direction of John Lasseter, an Academy Award-winning director and animator and the director of Toy Story. In March 1996, Mr. Lasseter received a Special Achievement Oscar from the Academy of Motion Picture Arts and Sciences for the development and application of techniques that made possible the first feature-length computer animated film, Toy Story. Pixar has built an entire creative team consisting of highly skilled animators, story artists and other artists highly skilled in the art of animation, especially computer animation. Pixar strives to hire animators who have superior acting ability, those able to make characters and inanimate objects come to life and appear as though they have their own thought processes. Pixar's proprietary software tools enable artists unfamiliar with computers to quickly become skilled in the art of three-dimensional animation. Along with animators, the creative team at Pixar includes a story department and an art department. The story department is responsible for a project's concept, treatment, outline, script, story boards and story reels. The art department is responsible for the visual development of a project, including the design of characters and sets and the color, textures, shading and lighting. It is also quite common for creative contributions to come from the technical group. All groups work closely together in an iterative process. To encourage collaboration, Pixar has strived to create a cooperative working environment and a non-hierarchical culture whereby each member of the creative team, regardless of position or department, considers the ideas of any other member of the team. The success of each animated feature film developed by Pixar will depend in large part upon the Pixar creative team's ability to predict the type of content that will appeal to a broad audience and to develop stories and characters that achieve broad market acceptance. Traditionally, this has been extremely difficult. Disney provided creative assistance throughout the production of Toy Story, including creative reviews and approvals, and the Co-Production Agreement contemplates that Disney will continue to provide creative assistance to Pixar on feature films and other products made pursuant to that agreement, but there can be no assurance that Disney will continue to provide assistance to Pixar in the development of creative content for its feature films or related products. In addition, there can be no assurance that voices and other intellectual property rights used in an animated feature film will be available for use in any sequel or other product related to such feature film. For example, Pixar was unable to obtain the rights to use certain voices from Toy Story in the two CD-ROM products based on Toy Story. See "Certain Factors Affecting Business, Operating Results and Financial Condition -- Dependence on Successful Development of Appealing Creative Content For Animated Feature Films and Related Products." RELATIONSHIP WITH DISNEY Prior Agreements Pixar's relationship with Disney dates to 1986, when Pixar and Disney entered into a joint technical development effort that resulted in the Computer Animated Production System ("CAPS"), a production system owned and used by Disney in certain of its two-dimensional cel-based animated feature films. Disney first used CAPS for The Rescuers Down Under and has continued to use it for other animated feature films, including Aladdin, The Lion King, The Hunchback of Notre Dame and Hercules. In 1992, certain employees of Pixar and Disney were jointly awarded an Academy Award for Scientific and Engineering Achievement for CAPS. In May 1991, Pixar entered into a Feature Film Agreement with Walt Disney Pictures, a wholly-owned subsidiary of Disney, which provided for the development, production and distribution of up to three feature-length motion pictures (the "Feature Film Agreement"). It is pursuant to that Feature Film Agreement that Toy Story and the Toy Story home video were developed, produced and distributed. In August 1995, Pixar entered into a non-exclusive CD-ROM development and publishing agreement with Disney Interactive, Inc. ("Disney Interactive"), a wholly-owned subsidiary of Disney, for the development, production and distribution of CD-ROM titles based on Toy Story (the "CD-ROM Agreement"). It is pursuant to the CD-ROM 6 8 Agreement that the two Toy Story CD-ROM products were developed, produced and distributed. Both the Feature Film Agreement and the CD-ROM Agreement were superseded by the Co-Production Agreement, except as discussed below. Co-Production Agreement The following is a summary of the Co-Production Agreement, which was filed as an exhibit to Pixar's Annual Report on Form 10-K for the year ended December 31, 1996 (the "1996 Form 10-K"). The foregoing summary is not complete, and reference is made to the Co-Production Agreement filed as an exhibit to the 1996 Form 10-K. This summary is qualified in all respects by such reference. Shareholders and prospective investors in Pixar's Common Stock are encouraged to read the Co-Production Agreement. Overview. On February 24, 1997 Pixar and Walt Disney Pictures and Television entered into the Co-Production Agreement pursuant to which Pixar, on an exclusive basis, will produce five computer animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney over approximately the next ten years. Pixar and Disney will co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which will be financed by Disney), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. The Co-Production Agreement generally provides that Pixar will produce each Picture and that Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Disney and Pixar have agreed that the first Picture under the Co-Production Agreement is A Bug's Life. The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, Pixar will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. Pixar will not share in any theme park revenues generated as a result of the Pictures. Production. The Co-Production Agreement provides a mechanism for Pixar's submission and the mutual selection of treatments that will be developed and produced as Pictures. After the selection of a treatment, Pixar generally controls the production of each Picture. Disney is entitled to designate a representative at Pixar to monitor the production and production costs of the Pictures. Financing of Development and Production. Pixar and Disney are to equally share all production costs. Production costs are defined in the Co-Production Agreement to mean all costs and expenses incurred by Pixar directly related to or fairly allocable to the creation, development, pre-production, production, post-production and delivery to Disney of the Pictures. Production costs include, among other things, all carrying costs incurred by Pixar for retention of employees for production purposes and the overhead attendant thereto, the costs of all treatments prepared by Pixar for submission to Disney, all costs of computer hardware and software used to develop the Pictures, and fair allocations of all costs and expenses of Pixar associated with or benefiting the Picture, including research and development, general and administrative and overhead expenses and facilities. The Co-Production Agreement provides mechanisms for Disney and Pixar to agree upon the budgets for treatments, development and production of each Picture. Pixar may not exceed production budgets (which may be revised with mutual approval) without Disney's written approval, subject to certain limited exceptions. Distribution. Disney has control over all decisions relating to, and is solely responsible for financing the costs and expenses of, the marketing, promotion, publicity, advertising and distribution of each Picture, subject to certain requirements. Provided, in general, that Disney has agreed on the treatment to be developed into each Picture, Disney has committed to initially release each Picture within certain windows and not to release other Disney family films during certain windows, and each Picture is to be distributed and marketed under the Walt Disney Pictures brand (or the then current Disney brand for premiere Disney movies) and is to be distributed and marketed by Disney in all markets and media and on a worldwide basis in a manner similar to that in which Disney then currently distributes and markets its premiere animated movies. Disney is 7 9 to consult with Pixar relating to all such major marketing and distribution decisions, and Pixar is entitled to designate a representative to monitor marketing and distribution of the Pictures. Division of Gross Receipts. Pixar and Disney are entitled to share equally in all gross receipts remaining after deduction of: (i) a distribution fee to Disney, (ii) mutually agreed participations (payments to third parties such as actors, composers and other artists contingent upon the success of the Pictures), if any, on a pro rata basis, paid by either Disney or Pixar, and (iii) Disney's distribution costs. Gross receipts includes all revenues or other consideration received by Disney from the exploitation of the Pictures and any related merchandise, books, soundtracks and other tangible personal property based upon the Pictures, as more specifically provided in the Co-Production Agreement (collectively, "Merchandise"), subject to certain exceptions relating primarily to receipts from Disney's affiliates. The distribution fee payable to Disney is substantially lower than under the prior Feature Film Agreement and reflects Pixar's commitment to finance half of the production costs of the Pictures. Distribution costs are broadly defined in the Co-Production Agreement to include out-of-pocket costs paid (or in certain instances, accrued for payment) to a third party (or in certain instances, to Disney's affiliates) by Disney or certain of its affiliates, provided that such out-of-pocket costs are directly related or fairly allocable to the distribution of the Picture and Merchandise. Pursuant to the Co-Production Agreement, Pixar will receive statements and payments of its share of gross receipts monthly within 45 days after the end of each calendar month, and Pixar has the right to audit Disney's and its affiliates' books and records relating to the Pictures and Merchandise. Derivative Works. Subject to certain exceptions, Disney and Pixar have mutual control of the decision to develop, produce or otherwise exploit any derivative works (or to transfer or license any rights to exploit any derivative works) during the term of the Co-Production Agreement or thereafter. Derivative works include theatrical sequels such as Toy Story Sequel, made-for-home video sequels, television productions, interactive media products and other derivative works as more specifically provided in the Co-Production Agreement (collectively, "Derivative Works"). Except in certain very limited circumstances, in the event of a disagreement over whether to proceed with a Derivative Work, Disney's decision governs. Pixar is to be given the option to co-finance and produce, or to participate on a passive financial basis with respect to, a Derivative Work that is (i) a theatrical motion picture, (ii) a made-for-home video production, (iii) a television production, (iv) location-based entertainment which uses unique characters or other elements from any of the Pictures or Toy Story as its primary theme, or (v) an interactive product such as CD-ROMs, DVDs, video games and arcade games (collectively, "Interactive Products"). If Pixar elects to co-finance and produce a Derivative Work, such as it did recently with Toy Story Sequel, the Co-Production Agreement provides for the following: (i) with respect to theatrical motion pictures and made-for-home video productions, the terms and conditions of the Co-Production Agreement are to be extended to cover such Derivative Works, subject to certain exceptions; (ii) with respect to (A) location-based entertainment using characters or other elements from a Picture or Toy Story as its primary theme and (B) television productions, Pixar and Disney are to mutually agree upon the terms and the conditions under which such work shall be financed, produced and distributed, subject to certain specified requirements in the case of television productions; and (iii) with respect to Interactive Products, Disney and Pixar are to mutually agree upon the terms and conditions under which such Interactive Product shall be financed, produced and distributed, subject to certain commitments by Disney with respect to marketing and distribution and provided that there shall be no distribution fee payable to Disney. For live entertainment such as stage plays or ice shows, Pixar is entitled to participate on a passive financial basis as specified in the Co-Production Agreement. For all other Derivative Works except theme parks, Pixar is entitled to participate on a passive financial basis in such work and to receive a reasonable royalty to be mutually agreed upon if the work is a revenue-producing work. Disney has the sole and exclusive right in perpetuity to use, without compensation to Pixar, each Picture, the characters therefrom and any story 8 10 elements thereof in theme parks, location-based entertainment for which Picture or Toy Story characters or elements are not the primary theme and cruise ships. A Derivative Work that is a theatrical motion picture would not count towards the five Pictures to be produced under the Co-Production Agreement. Accordingly, Toy Story Sequel will not count as one of the five Pictures to be produced. However, for all other purposes, it has been added to the definition of the original five Pictures produced and financed under the agreement. Therefore, all provisions applicable to the original five Pictures apply to Toy Story Sequel as well. Creative Controls. Creative controls and decisions with respect to developing and producing Pictures are generally subject to the mutual approval of Pixar and Disney. The Co-Production Agreement provides for certain dispute resolution procedures in the event of disagreement. Brand/Credit. The Co-Production Agreement sets forth Disney's and Pixar's intent that the Pixar brand be established as a co-equal brand to the Disney brand in connection with the Pictures, Merchandise and Derivative Works. The Co-Production Agreement provides that the Pixar logo, animated logo and credit shall be used in a manner which is perceptually equal to the Disney logo, animated logo and credit, subject to certain specific requirements as set forth in the Co-Production Agreement. Exclusivity. Pixar has agreed not to release or authorize the release of any feature length animated theatrical motion picture produced by Pixar, other than the Pictures and Derivative Works produced by Pixar under the Co-Production Agreement, until twelve months from delivery of the fifth Picture under the Co- Production Agreement. Pixar has further agreed that it will not enter into any agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture until after Pixar has delivered the third Picture to Disney under the Co-Production Agreement. Pixar has also agreed that it will not develop or produce any rides or attractions for major theme parks not owned or operated by Disney, and to give Disney a right to negotiate with respect to animated television productions or animated made-for-home video productions that Pixar proposes to produce during the term of the Co-Production Agreement. Proprietary Rights. The copyrights, trademarks and other intellectual property rights in and to the Pictures, all new and unique characters and story elements thereof and the audio-visual images thereof, and Merchandise relating thereto, shall be jointly owned by Disney and Pixar on an undivided 50/50 basis, subject to Pixar's ownership rights in the technology and excluding any intellectual property rights previously owned by Pixar or Disney. Notwithstanding the foregoing, Disney has the exclusive distribution and exploitation rights with respect to the Pictures, Derivative Works and Merchandise relating thereto. Pixar shall own the copyright and all other intellectual property rights in and to all computer programs and other technology developed or discovered by Pixar before, during or after the term of the Co-Production Agreement. Term and Termination. The Co-Production Agreement continues until delivery to Disney of the fifth Picture produced and financed under the Co-Production Agreement, unless earlier terminated. Disney is entitled to terminate the Co-Production Agreement in the event that Disney and Pixar fail to agree on a treatment for a Picture within one year after the initial theatrical release of the last Picture for which a treatment has been approved or selected, subject to certain exceptions. Disney is also entitled to terminate the Co-Production Agreement in the event that certain types of competitors directly or indirectly acquire or control a 50% or greater ownership interest in Pixar or Pixar merges or consolidates into such a competitor. Upon termination by Disney pursuant to either of the last two sentences, Disney has certain rights to compel Pixar to complete works in production. In the event of termination, the Co-Production Agreement provides that its terms and conditions continue to apply with respect to Pictures, Merchandise and Derivative Works which have been delivered by Pixar to Disney or which Disney elects to have completed, as well as all future Merchandise and future Derivative Works relating thereto, but otherwise terminates. Effect on Prior Agreements. All Derivative Works based on Toy Story, including Toy Story Sequel, are to be governed by the Co-Production Agreement and not the original Feature Film Agreement or the CD-ROM Agreement. The original Feature Film Agreement now applies only to the rights and obligations of Disney and Pixar relating to the financial participation in, and the production and distribution of, the theatrical 9 11 motion picture Toy Story and the financial participation in Merchandise related to Toy Story (unless gross receipts in any given month exceed a certain amount, in which case they will be subject to the Co-Production Agreement), and otherwise has no further force or effect. The original CD-ROM Agreement remains in full force and effect with respect to the first and second CD-ROM products developed under that agreement, but otherwise has no force or effect. COMPETITION Pixar experiences intense competition with respect to animated feature films, animation products and software. Movie Studios. Pixar's animated feature films compete and will continue to compete with feature films and other family oriented entertainment products produced by major movie studios, including Disney (as somewhat limited by the Co-Production Agreement), Warner Bros. Inc., Twentieth Century Fox Film Corporation ("Twentieth Century Fox"), Paramount Pictures ("Paramount"), Columbia/Tri-Star Pictures Inc., Lucasfilm Ltd. ("Lucasfilm"), Universal City Studios, Inc. and MGM/UA, as well as numerous other independent motion picture production companies. Competition has greatly intensified in the animated feature film market from these and other movie studios. Animated feature films released in 1997 included Anastasia by Twentieth Century Fox and Beavis and Butt-head Do America by United International Pictures with Paramount, each achieving domestic box office receipts between $55 and $65 million. Other of these movie studios have announced their intention to enter the animated feature film market, including DreamWorks SKG ("DreamWorks"), a studio formed in 1994 which is expressly targeting the animated film market. DreamWorks owns a significant equity stake in Pacific Data Images ("PDI"), a computer graphics special effects firm, and is producing a computer animated movie with PDI. This computer animated film, which has been referred to publicly as Antz, may contain similar subject matter to A Bug's Life. As a result, Pixar expects a variety of new animated feature films to be released in the theaters in the next two years generating competition for A Bug's Life and Toy Story Sequel, which are targeted for release in late 1998 and late 1999, respectively. These films include Paramount's Rugrats, The Movie and DreamWorks' The Prince of Egypt. Pixar is also aware of several other animated feature films in production at various studios. Due to the large number of expected releases in the next two years, it is possible that the market for animated films will become saturated before Pixar can release A Bug's Life and other feature films, which could result in failure of such films to achieve commercial success. In addition, other non-animated family oriented feature films are expected to be released in late 1998 and will generate additional competition for A Bug's Life. They include Babe: Pig in the City, The Wizard of Oz , Air Bud 2: Golden Receiver and Star Trek 9, among many others. Pixar's films will compete with the feature films of other movie studios for optimal release dates, audience acceptance and exhibition outlets. In addition, Pixar competes and will continue to compete with other movie studios for the acquisition of literary properties, production financing, the services of performing artists, and the services of other creative and technical personnel, particularly in the fields of animation and technical direction. Most of the other movie studios with which Pixar competes have significantly greater name recognition and significantly greater financial, technical, creative, marketing and other resources than does Pixar. At least two of these movie studios, Disney and Lucasfilm (through its affiliate Industrial Light and Magic ("ILM")), have developed their own internal computer animation capability and have created computer animation for special effects in animated films. In addition, Pixar believes that Disney is currently developing and producing a feature film making substantial use of computer animation. Other movie studios may internally develop, license or sub-contract three-dimensional animation capability. Further, Pixar believes that continuing enhancements in commercially available computer hardware and software technology have lowered and will continue to lower barriers to entry for studios or special effects companies which intend to produce computer animated feature films or other products. For example, Silicon Graphics Inc.'s Alias/Wavefront subsidiary has recently launched "Maya," its next generation three-D software for creating high quality animation and visual effects. Maya incorporates many new features and could be used to make a computer animated feature film. 10 12 The Co-Production Agreement provides for the development and production by Pixar of five computer animated feature films. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the "Walt Disney Pictures" label and enjoys financial benefits in the event that such films achieve significant box office revenues, Pixar believes that Disney desires such films to be successful. Nonetheless, Disney has been by far the most successful producer of animated feature films, and family oriented motion pictures distributed by Disney or its affiliates are likely to be in the market concurrently with and competing with Pixar's animated feature films. Pixar's contractual arrangement with Disney also presents other risks. See "Certain Factors Affecting Business, Operating Results and Financial Condition Risks Associated with Co-Production Agreement." Pixar believes that the primary competitive factors in the market for animated feature films include creative content and talent, product quality, technology, access to distribution channels and marketing resources. Due in part to Pixar's creative and technical resources and to the Co-Production Agreement with Disney, pursuant to which Disney co-finances the production of the feature films, markets the feature films and provides creative assistance and access to significant distribution channels, Pixar believes that it presently competes favorably with respect to each of these factors. Computer Graphics Special Effects Firms. Pixar also expects to compete with computer graphics special effects firms, including ILM, Digital Domain, PDI, Rhythm & Hues, and Blue Sky/VIFX Productions. These computer graphics special effects firms may be capable of creating their own three-dimensional computer animated feature films or may produce three-dimensional computer animated feature films for movie studios that compete with Pixar. For example, ILM has already created and produced three-dimensional character animation which was used for the ghosts in the live action film Casper,and ILM has a royalty-free, paid-up license to use Pixar's RenderMan software and to obtain at no cost all enhancements and upgrades thereto. Other computer graphics special effects firms have licensed or may license RenderMan. Accordingly, Pixar's RenderMan software may not provide Pixar with a competitive advantage. Pixar also competes, or may in the future compete, with the above firms with respect to animation products other than feature films. Pixar believes that the primary competitive factors in the market for three-dimensional computer animation for feature films and other animation products include creative content and talent, product quality, technology, access to distribution channels and marketing resources. Pixar believes that it presently competes favorably with respect to each of these factors. Software Publishers. Pixar also experiences intense competition with respect to its RenderMan software product. In particular, Pixar competes with makers of computer graphics imaging and animation software, principally Microsoft (which acquired SoftImage Inc.), MentalImage (which offers the same product offered by Microsoft), and Silicon Graphics (which acquired Wavefront Technologies, Inc. ("Wavefront") and Alias Research, Inc. ("Alias")). Microsoft, through SoftImage Inc., MentalImage and Silicon Graphics, through Wavefront and Alias, are each marketing competing rendering software products, usually at lower prices than Pixar. Microsoft and Silicon Graphics have each licensed several of Pixar's patents that cover certain rendering techniques and may therefore be better able to market products that compete with Pixar's RenderMan software. Under appropriate circumstances, Pixar might elect to license its rendering technology patents to other companies, some of which may compete with Pixar. In addition, as PCs become more powerful, software suppliers may also be able to introduce products for PCs that would be competitive with RenderMan in terms of price and performance for professional users. Pixar believes that the primary competitive factors in the market for rendering software include product quality, price/performance, technology, functionality, breadth of features and customer service and support. Pixar believes that it presently competes favorably with respect to each of these factors. Pixar expects competition to persist, intensify and increase in each of its business areas in the future. Almost all of Pixar's current and potential competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical, marketing and other resources than Pixar. There can be no assurance that Pixar will be able to compete successfully against current or future competitors. Such competition could materially adversely affect Pixar's business, operating results or financial condition. 11 13 PROPRIETARY RIGHTS Pixar's success and ability to compete is dependent in part upon its proprietary technology. While Pixar relies on a combination of patents, copyright and trade secret protection, nondisclosure agreements and cross- licensing arrangements to establish and protect its proprietary rights, Pixar believes that factors such as the technical and creative skills of its personnel are more essential to its success and ability to compete. Pixar currently is the owner of eight patents issued in the United States, one patent issued in the United Kingdom, one patent issued in France, one patent issued in Germany, one patent issued in Japan, two patents issued in Canada and one patent issued by the European Patent Office. In addition, Pixar has a number of patent applications pending in the United States and in foreign countries. There can be no assurance that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed will be sufficiently broad to protect Pixar's technology. In addition, there can be no assurance that any patents that have been issued to Pixar, or that Pixar may license from third parties, will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to Pixar. The source code for Pixar's proprietary software is protected both as trade secrets and as a copyrighted work. Pixar generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use Pixar's proprietary information, products or technology without authorization, or to develop similar or superior technology independently. Policing unauthorized use of Pixar's products is difficult. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. To license its RenderMan software product, Pixar primarily relies on "shrink wrap" licenses that are not signed by the end-user and, therefore, may be unenforceable under the laws of certain jurisdictions. There can be no assurance that the steps taken by Pixar will prevent misappropriation of its technology or that its confidentiality or license agreements will be enforceable. In addition, litigation may be necessary in the future to enforce Pixar's intellectual property rights, to protect Pixar's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on Pixar's business, operating results or financial condition. One of the risks of the film production business is claims that Pixar's productions infringe the intellectual property rights of third parties with respect to previously developed films, stories, characters or other entertainment. In addition, Pixar's technology and software may be subject to patent, copyright or other intellectual property claims of third parties. Pixar has received, and is likely to receive in the future, notice of claims of infringement of other parties' proprietary rights. There can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against Pixar or that any assertions or prosecutions will not materially adversely affect Pixar's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, Pixar would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on Pixar's business, financial condition or results of operations. If any claims or actions are asserted against Pixar, Pixar may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances a license would be available on reasonable terms or at all. Pixar also relies on certain technology that it licenses from third parties, including software which is integrated and used with internally developed software. There can be no assurance that these third party technology licenses will continue to be available to Pixar on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays in feature film releases or product shipments until equivalent technology could be identified, licensed and integrated. Any such delays in feature film releases or product shipments could materially adversely affect Pixar's business, operating results or financial condition. In 1996, Pixar entered into a license agreement with Silicon Graphics whereby Pixar granted to Silicon Graphics and its subsidiaries a non-exclusive license to use certain of Pixar's patents covering techniques for 12 14 creating computer-generated photo-realistic images. These same patents were licensed to Microsoft Corporation in 1995. These patents relate to pseudo-random point sampling techniques in computer graphics which are incorporated into Pixar's RenderMan. The license agreements with Silicon Graphics and Microsoft will expire no later than the year 2010. Silicon Graphics and Microsoft may use the licensed technology in rendering products which compete with Pixar's RenderMan software, which could adversely impact sales of RenderMan. EMPLOYEES As of December 31, 1997, Pixar had a total of 391 employees. Although none of Pixar's employees is represented by a labor union, it is common for animators and actors at film production companies to belong to a union, and there can be no assurance that Pixar's employees will not join or form a labor union or that Pixar, for certain purposes, will not be required to become a union signatory. Further, Pixar may be directly or indirectly dependent upon union members, and work stoppages or strikes organized by such unions could materially adversely impact Pixar's business, financial condition or results of operations. For example, many of the actors who provide the voice talents for the Pictures and Derivative Works are members of the Screen Actors Guild, which is currently renegotiating its basic agreement that otherwise expires on June 30, 1998. Pixar has not experienced any work stoppages and considers its relations with its employees to be good. Pixar's success depends to a significant extent on the performance of a number of senior management personnel and other key employees, especially its animators, creative personnel and technical directors. In particular, Pixar is dependent upon the services of Steven P. Jobs, John Lasseter, Edwin E. Catmull, Lawrence B. Levy and Sarah McArthur. Pixar does not maintain "key person" life insurance for any of its employees. Pixar does have employment agreements with Messrs. Lasseter and Catmull, who are fundamental to its relationship with Disney. However, such employment agreements do not necessarily assure the services of these employees. Pixar believes that it may be particularly difficult to retain its key employees, especially its animators, creative personnel and technical directors, during periods in which it is not developing animated feature films. The loss of the services of any of Messrs. Jobs, Lasseter, Catmull, or Levy, Ms. McArthur, or of other key employees, especially its animators, creative personnel and technical directors, could have a material adverse effect on Pixar's business, operating results or financial condition. CERTAIN FACTORS AFFECTING BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION The following is a discussion of certain factors which currently impact or may impact Pixar's business, operating results and/or financial condition. Anyone making an investment decision with respect to Pixar's capital stock or other securities is cautioned to carefully consider these factors. ANTICIPATED NET LOSSES IN 1998 AND THE FIRST HALF OF 1999 A number of factors are expected to result in net losses in 1998 and in the first half of 1999, as discussed more fully below. End of Toy Story Revenues Pixar has already recognized the vast majority of the revenue it expects to receive from Toy Story. While relatively minor amounts of revenue may be received by Pixar in subsequent periods from sources such as Toy Story merchandise royalties, Toy Story television airings, and minor remaining international home video sales of Toy Story, Pixar does not expect to recognize any further significant revenue from Toy Story in the future. Timing of A Bug's Life and Toy Story Sequel Releases A Bug's Life is not expected to be released until the end of 1998 at the earliest, and revenue attributable to A Bug's Life is not expected to be recognized until after all marketing and distribution costs and fees have been recovered by Disney. Recovery of all costs depends on many factors and may not occur until six to twelve 13 15 months after its release at the earliest, making it likely that Pixar will not recognize any revenue from A Bug's Life until the second half of 1999 at the earliest. In addition, Toy Story Sequel is not expected to be released until the end of 1999 at the earliest. As with A Bug's Life, Pixar does not expect to recognize any revenue from Toy Story Sequel until six to twelve months after its release at the earliest. Therefore, Pixar is unlikely to recognize any revenue from Toy Story Sequel until the second half of 2000 at the earliest. Limited CD-ROM Income Although its first two CD-ROM products were successful on relative terms, Pixar determined in March 1997 to discontinue its business of producing CD-ROM and other interactive products in favor of other opportunities arising, in part, as a result of entering into the Co-Production Agreement. Pixar has not recognized and will not recognize any CD-ROM income from this discontinued operation in 1998 or thereafter, other than royalty income attributable to the two existing Toy Story CD-ROM products. Pixar has reassigned all of the approximately 60 employees previously employed in the CD-ROM division to feature film productions and other departments within Pixar. Possible Decline in Sales of RenderMan Due to Shift in Focus As a result of Pixar's reduced emphasis on the commercialization of software in favor of products sold for their content, Pixar continues to expect to dedicate less time and resources to distributing and marketing RenderMan than it has in the past and further expects that licensing of RenderMan may decline. Increase in Operating Expenses and Tax Rate In 1996 and 1997, Pixar significantly increased its operating expenses, and Pixar plans to continue to increase its operating expenses to fund greater levels of research and development and to expand operations. Specifically, Pixar expects its spending levels to increase significantly due to continued investment in proprietary software systems, increased compensation costs as a result of intense competition for animators, creative personnel, technical directors and other personnel, and increased costs associated with the expansion of its facilities. A portion of Pixar's operating expenses that are allocable to film productions are capitalized by Pixar or reimbursed by Disney under the Co-Production Agreement. To the extent that the increases in expenses are not capitalized by Pixar nor paid for by Disney, Pixar's operating expenses will significantly increase in 1998. In addition, in 1998, if the story for the Fourth Film is not approved, Pixar could be required to write-off certain related film costs previously capitalized. Finally, Pixar's tax rate increased in the year ended December 31, 1997 and is likely to increase in future years due to near complete utilization of remaining net operating loss carryforwards in 1997. Impact on Operating Results As a result of the above factors, Pixar expects revenue to substantially decline in 1998 as compared to the year ended December 31, 1997. At the same time, Pixar's operating expenses are expected to increase in 1998. Therefore, Pixar expects revenue and operating results in 1998 to decline substantially from revenue and operating results in 1997. Pixar expects operating and net losses in 1998 and in the first half of 1999. Operating results thereafter will depend upon the success of Pixar's next films, starting with A Bug's Life. POTENTIAL FLUCTUATIONS IN OPERATING RESULTS In addition to the factors set forth above, Pixar continues to expect to generally experience significant fluctuations in its future annual and quarterly operating results caused by a variety of factors. Pixar expects that its annual and quarterly operating results, particularly its revenue, will fluctuate due to factors such as the timing of the domestic and international releases of the animated feature films, the success of the animated feature films (which can fluctuate significantly from film to film), the timing of the release of related products into their respective markets, the demand for the related products (which is often a function of the success of the related animated feature film), film production costs, Disney's costs to distribute and promote the feature films and related products, Disney's success at marketing the films and related products, the timing of receipt 14 16 of proceeds from the animated feature films and related products by Disney, the timing of revenue recognition under the Co-Production Agreement and the Feature Film Agreement, as the case may be, the introduction of new feature films or products by Pixar's competitors, and general economic conditions. In particular, since Pixar's revenue under the Co-Production Agreement is directly related to the success of a feature film, Pixar's operating results are likely to fluctuate depending on the level of success of its animated feature films and related products. The revenues derived from the production and distribution of an animated feature film depend primarily on the film's acceptance by the public, which cannot be predicted and does not necessarily bear a direct correlation to the production or distribution costs incurred. The commercial success of a motion picture also depends upon promotion and marketing, production costs and other factors. Further, the theatrical success of a feature film can be a significant factor in determining the amount of revenues generated from the sale of the related products. Moreover, Pixar's operating expenses will continue to be extremely difficult to forecast. The direct costs of film production are budgeted in agreement with Disney and shared equally. Pixar's share of these direct costs of film production are capitalized by Pixar in accordance with Statement of Financial Accounting Standards ("SFAS") No. 53, Financial Reporting by Producers and Distributors of Motion Picture Films. A substantial portion of all of Pixar's other costs are incurred for the benefit of feature films ("Pixar's Overhead"), including research and development expenses and general and administrative expenses. Portions of Pixar's Overhead are included in the budgets for the Pictures and will be shared equally with Disney under the Co-Production Agreement. The portion of Pixar's Overhead that is not reimbursed by Disney is either capitalized as film production costs, if required under SFAS No. 53, or charged to operating expense in the period incurred. Because a substantial portion of Pixar's Overhead is related to the Pictures and is, therefore, reimbursed by Disney, and other amounts are capitalized by Pixar in accordance with SFAS No. 53, Pixar's reported operating expenses for the year ended December 31, 1997 have not reflected, and future reported operating expenses will not reflect, the true level of spending on the production of animated feature films, related products and overhead. Pixar may not be able to recognize the tax benefits of net operating loss carryforwards to be generated in the future. Pixar had a valuation allowance as of December 31, 1997 which fully offset its gross deferred tax assets due to the fact that there is no guarantee Pixar would generate sufficient taxable income in the future to be able to realize all of its deferred tax assets. As a result of all of the foregoing, Pixar believes that period-to-period comparisons of its results of operations are not necessarily meaningful, and its annual and quarterly results of operations should not be relied upon as any indication of future performance. Due to all of the foregoing factors, it is likely that in some future period Pixar's operating results will be below the expectations of public market analysts and investors. In such event, the price of Pixar's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1997 Annual Report to Shareholders. DEPENDENCE ON TOY STORY, A BUG'S LIFE AND TOY STORY SEQUEL Dependence on Toy Story For at least 1998 and the first half of 1999, Pixar's revenue and operating results will again be largely dependent upon whatever remains to be received from Toy Story merchandise royalties, any remaining Toy Story home video revenues and revenue from television airings of Toy Story. Pixar recognized the vast majority of Toy Story home video revenue in 1997 and expects little revenue from Toy Story or related products in 1998 and thereafter. Pixar also expects little or no royalty income from its Toy Story CD-ROM products in 1998 or thereafter. Because A Bug's Life is not expected to be released until the end of 1998 at the earliest, and Toy Story Sequel is not expected to be released until the end of 1999 at the earliest, any other revenues in 1998 and in the first half of 1999 will be primarily dependent upon Pixar's other businesses, from which Pixar expects limited revenue. 15 17 Dependence on A Bug's Life and Toy Story Sequel Beyond 1998 and the first half of 1999, Pixar expects to be significantly dependent upon the success of A Bug's Life, Toy Story Sequel, and the Fourth Film (the "Current Projects") and related products. Although development and/or production on each of the Current Projects is underway, there can be no assurance that any of the Current Projects will be successfully produced and released when scheduled or thereafter. There can be no assurance that Pixar will not experience difficulties that could delay or prevent the successful development or production of any of the Current Projects or subsequent animated feature films or related products. If Pixar is unable to produce and develop on a timely basis the Current Projects and subsequent animated feature films and related products that meet with broad market acceptance, Pixar's business, operating results and financial condition will be materially adversely affected. The development of the Fourth Film only began in late 1996. Although it is currently targeted for release in 2000, to date there has been no final approval under the Co-Production Agreement of the story treatment or the budget for the Fourth Film and there can be no assurance that it will be released as targeted in 2000. As a result, for the next two or three years, Pixar expects to be significantly dependent upon A Bug's Life and Toy Story Sequel. Risks Associated with A Bug's Life Under the Co-Production Agreement, Pixar shares the production costs of A Bug's Life. These costs will initially be capitalized as film production costs under SFAS No. 53 and then be amortized over the expected revenue stream when revenue is recognized. If A Bug's Life is not an extraordinary box office success similar to Toy Story, the amount of revenue recognized will not be significant, and the capitalized production costs will have to be amortized in large amounts over a limited number of quarters, resulting in significant costs of film revenue in those quarters and, potentially, significant quarterly operating and net losses. Animated feature films that become extraordinary box office successes are rare. Pixar believes, based on available information, that there is a reasonable basis to conclude that of the more than 40 animated feature films introduced since 1990, only two movies generated domestic box office revenues greater than Toy Story, and both of those films were produced and distributed solely by Disney. During at least the last five years, Pixar believes that there has been no fully-animated feature film (other than Toy Story) produced or developed by a studio other than Disney that has achieved more than $65 million in domestic box office revenues. While A Bug's Life will be co-financed, promoted and marketed by Disney, it will have a different look, theme and musical style than Disney's other recent animated films (except for Toy Story), and there can be no assurance that it will have the same audience appeal as Disney's other animated films. For example, The Nightmare Before Christmas, released in 1993, was an animated feature film with a different appearance than traditional, hand-drawn cel animated feature films such as Beauty and the Beast, The Lion King, Aladdin, Pocahontas, The Hunchback of Notre Dame and Hercules and did not experience the same box office returns as those films. As a result, A Bug's Life and related products may not generate significant revenue and operating results for Pixar, even if A Bug's Life is critically acclaimed and achieves substantial, but not extraordinary, box office success. See "-- Risks Associated with Co-Production Agreement -- Dependence on Disney for Distribution and Promotion of Feature Films and Related Products," "Risks of Motion Picture Industry," and "Business -- Relationship with Disney." See also Note 4 of Notes to Financial Statements in the 1997 Annual Report to Shareholders. Risks Associated with Toy Story Sequel As a theatrical feature film release, Toy Story Sequel is subject to the same risks associated with A Bug's Life specified above. In addition, because it is a sequel, there are also risks unique to Toy Story Sequel. With a theatrical sequel, the story concept and characters are not as novel as the original film. In the vast majority of cases in which a film that achieved domestic box office receipts of greater than $100 million was followed by the release of a sequel, the sequel did not perform as well at the box office as the original. This was the case for sequels to such films as Star Wars, Jurassic Park, Home Alone, Jaws, Batman, Raiders of the Lost Ark, Beverly Hills Cop, Ghostbusters and Back to the Future, among others. In many cases, sequels substantially under-perform the original film. In far fewer cases have sequels performed as well or better than the original 16 18 blockbuster feature film, and in almost all of these cases, the original feature films and related sequels were action-adventure films, such as Lethal Weapon and Die Hard. Accordingly, there can be no assurance that Toy Story Sequel will perform as well as Toy Story at the box office. It is possible that Toy Story Sequel will substantially under-perform the original feature film. In addition, fees and participations paid to key talent on Toy Story Sequel are substantially greater than for the original film, which will have the effect of increasing the cost of the film. As a result of these factors and the same factors associated with A Bug's Life, Toy Story Sequel and related products may not generate significant revenue and operating results for Pixar, even if Toy Story Sequel is critically acclaimed and achieves substantial, but not extraordinary, box office success. Production Budgets Given the escalation in compensation rates of people required to work on the Current Projects, the number of people required to work on the Current Projects, and the equipment needs, the budget for the Current Projects and subsequent films and related products are and will continue to be substantially greater than the budget for Toy Story and will be financed equally by Pixar and Disney under the Co-Production Agreement. In addition, due to production exigencies which are often difficult to predict, Pixar believes that it is not uncommon for film production spending to exceed film production budgets and there can be no assurance that any of the Current Projects can be completed within the budgeted amounts. For example, in order to meet the production schedule, substantially all employees from Pixar's animation services group are expected to be assigned to A Bug's Life for the duration of its production, which will result in a larger production staff than originally anticipated and which will generate additional production costs. LIQUIDITY RISKS Pursuant to the Co-Production Agreement, Pixar will co-finance the next five animated feature films which it produces, including A Bug's Life and the Fourth Film. Pixar will also co-finance Toy Story Sequel on the same basis as the other theatrical films. In the future, Pixar may co-finance other derivative works such as sequels, interactive products and television productions. In addition, Pixar is planning construction of a new headquarters and studio facility in Emeryville, California, construction of which will begin in the first half of 1998 and which may be financed by the use of Pixar's cash. As Pixar does not expect to generate substantial, if any, cash from operations in 1998, the production costs of A Bug's Life, the Fourth Film, Toy Story Sequel and possibly costs of the new Emeryville facility will have a material adverse impact on Pixar's cash and short-term investment balances. As of December 31, 1997, Pixar had approximately $176 million in cash and short-term investments. Pixar believes that these funds will be sufficient to meet its anticipated cash needs for working capital and capital expenditures, including the development and production costs of A Bug's Life, the Fourth Film and Toy Story Sequel, until Pixar begins receiving cash from the release of these films (which is not expected to occur until the second half of 1999 at the earliest). However, even if these films generate cash, unless each is a success such that Pixar recovers on a timely basis its share of the production costs, as well as other operating expenses and capital expenditures, Pixar will be required to seek financing for its ongoing commitments under the Co-Production Agreement and any other requirements of its operations. Pixar may also seek additional financing in connection with the expansion of its facilities. See also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" in the 1997 Annual Report to Shareholders. The sale of additional equity or convertible debt securities would result in additional dilution to Pixar's shareholders. Moreover, there can be no assurance that Pixar will be successful in obtaining future financing, or even if such financing is available, that it will be obtained on terms favorable to Pixar or on terms providing Pixar with sufficient funds to meet its obligations and objectives. The failure to obtain such financing would have a material adverse effect on Pixar's business, operating results and financial condition. SCHEDULED SUCCESSIVE RELEASE OF FILMS; MANAGEMENT OF GROWTH In order to meet its obligations pursuant to the Co-Production Agreement, Pixar has established parallel creative teams so that it can develop more than one film at a time. These teams are currently working on 17 19 A Bug's Life, Toy Story Sequel, and the Fourth Film which are currently targeted for release in late 1998, late 1999, and late 2000, respectively. Pixar has only produced one prior feature film to date and has no experience with respect to producing three animated feature films in parallel. Pixar has been required, and will continue to be required, to expand its employee base, increase capital expenditures and procure additional resources and facilities in order to accomplish the scheduled release of these three feature films. This period of rapid growth and expansion has placed, and continues to place, a significant strain on Pixar's resources. There can be no assurance that A Bug's Life, Toy Story Sequel or the Fourth Film will be released as scheduled or that this strain on resources will not have a material adverse effect on Pixar's business, financial condition or results of operations. In addition, when production of each of these films is completed, if completed, Pixar may incur significant carrying costs associated with transitioning personnel on creative and development teams from one project to another which, although shared with Disney, could have a material adverse effect on Pixar's results of operations and financial condition. Although there can be no assurance that any of A Bug's Life, Toy Story Sequel, or the Fourth Film will be released on schedule, the targeted release date of late 2000 for the Fourth Film is particularly uncertain. Pursuant to the Co-Production Agreement, Disney and Pixar are required to agree on a number of elements for each film, including the treatment, which summarizes the story on which the film is based, and the budget for the film. Although the Fourth Film has been in development at Pixar since late 1996, there has been no final agreement between Pixar and Disney on the story or budget for the Fourth Film, and there can be no assurance that either the story or the budget will be approved in time to release the film by late 2000 or at all. If Disney and Pixar do not reach final agreement on a treatment and budget for the Fourth Film currently under development at Pixar, Pixar would be unable to develop an alternative film in time for release in 2000, and it may be 2001 or later before a film which follows Toy Story Sequel is ready to be released. If Pixar is able to release films in each of 1998, 1999 and 2000, due to the strain on Pixar's personnel from the effort required for such successive releases and the time required for creative development of a new film, it is extremely unlikely that Pixar would be able or would even attempt to release a new film in 2001. Instead, Pixar's creative and production personnel would develop films targeted for release in 2002 and for subsequent years, although it is too early to determine the release schedule or whether it would be possible to release one film in each successive year after 2001. As a result, notwithstanding the targeted successive release of films in 1998, 1999 and 2000, it is too early to determine the rate at which any future films are to be released, and there can be no assurance that Pixar will release a film in each successive year or in any particular year. To continue to accommodate this growth, Pixar will be required to implement a variety of new and upgraded operational and financial systems, procedures and controls, including improvement and maintenance of its accounting system, other internal management systems and backup systems. In addition, this growth and these diversification activities, along with the corresponding increase in the number of Pixar's employees and rapidly increasing costs, have resulted in increased responsibility for Pixar's management. Pixar will need to continue to improve its operational, financial and management information systems and to hire, train, motivate and manage its employees, to integrate them into Pixar and to provide adequate facilities and other resources for them. There can be no assurance that Pixar will be successful in accomplishing all of these activities on a timely and cost-effective basis, and any failure to accomplish one or more of these activities on a timely and cost-effective basis would have a material adverse effect on Pixar's business, financial condition and results of operations. RISKS ASSOCIATED WITH CO-PRODUCTION AGREEMENT Dependence on Disney for Distribution and Promotion of Feature Films and Related Products The decisions regarding the timing of release of motion pictures and related products and which of Disney's motion pictures and related products will receive extensive promotional support from the studio are important in determining the success of the motion picture and related products. Under the terms of the Co-Production Agreement, Pixar has some general protections with respect to the marketing and distribution of the feature films in the form of commitments by Disney as to release windows, the timing of release of other Disney family films and marketing obligations. However, Pixar ultimately does not control the manner in 18 20 which Disney distributes Pixar's animated feature films and related products, the number of theaters to which Disney distributes Pixar's feature films, the specific timing of release of the feature films and related products or the specific amount or quality of promotional support of the feature films and related products. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the "Walt Disney Pictures" label and may enjoy financial benefits in the event that such films achieve significant box office revenues, Pixar believes that Disney desires such films to be successful. Nonetheless, Disney could make certain decisions as to marketing, distribution or promotion of the animated feature films or related products that could have a material adverse effect on Pixar's business, operating results or financial condition. Exclusivity Pixar has agreed not to release or authorize the release of any feature length animated theatrical motion picture produced by Pixar, other than the feature films produced by Pixar under the Co-Production Agreement, until twelve months from delivery of the fifth feature film under the Co-Production Agreement. Pixar currently anticipates that the delivery of the fifth Picture would not occur until at least ten years from the date of the Co-Production Agreement. Pixar has further agreed that it will not enter into any agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture until after Pixar has delivered the third feature film to Disney under the Co-Production Agreement. Pixar has also agreed that it will not develop or produce any rides or attractions for major theme parks not owned or operated by Disney, and to give Disney a right to negotiate with respect to animated television productions or animated made-for-home video productions that Pixar proposes to produce during the term of the Co-Production Agreement. Financing of Production Costs Under the Co-Production Agreement, unlike the prior Feature Film Agreement and the prior CD-ROM Agreement, Pixar will co-finance each of the five animated feature films and may co-finance other related products to be developed and produced pursuant to the Co-Production Agreement. Pixar is currently co-financing A Bug's Life, the Fourth Film and Toy Story Sequel under the Co-Production Agreement. Accordingly, unlike the Feature Film Agreement and the prior CD-ROM Agreement, Pixar will incur significant production costs which must be offset by revenue generated by the animated feature films and related products. If the feature films and related products do not generate revenue sufficient to more than offset Pixar's share of their production costs, Pixar's business, operating results and financial condition will be materially adversely effected. Rights to Characters and Elements Retained by Disney Disney retains the exclusive distribution and exploitation right to all feature films, all characters and story elements of the feature films and all related products developed by Pixar under the Co-Production Agreement. Accordingly, except in certain specified circumstances unlikely to generate revenue, Pixar is not able to exploit or distribute any of the feature films or characters or elements of any of the feature films or related products developed under the Co-Production Agreement without a license from Disney. There can be no assurances that such a license would be available to Pixar on commercially reasonable terms or at all. Termination Under the terms of the Co-Production Agreement, Disney may terminate the agreement under certain circumstances. There can be no assurance that Disney would not terminate the Co-Production Agreement under these circumstances. Disney would not lose any of its rights to distribute and exploit all feature films and all characters and elements of the feature films and other products developed by Pixar under the Co-Production Agreement, except for a feature film or related product then in production as to which Disney does not elect to proceed, as to which Pixar would regain the rights subject to a lien in favor of Disney for the costs advanced to date. Further, in the event that Disney terminated the Co-Production Agreement, Pixar would be required to seek alternative channels for distribution of its animated feature films and related 19 21 products. There can be no assurance that Pixar would be able to find a third party to finance, distribute and promote its animated feature films and related products on terms acceptable to Pixar, if at all. See "Business -- Relationship with Disney." RISKS OF MOTION PICTURE INDUSTRY Commercial Success of a Motion Picture is Unpredictable The motion picture industry involves a substantial degree of risk. Each motion picture is an individual artistic work, and its commercial success is primarily determined by audience reaction, which is unpredictable. The commercial success of a motion picture also depends upon the quality and acceptance of other competing films released into the marketplace at or near the same time, critical reviews, the availability of alternative forms of entertainment and leisure time activities, general economic conditions, weather conditions and other tangible and intangible factors, all of which can change and cannot be predicted with certainty. In addition, motion picture attendance is seasonal, with the greatest attendance typically occurring during the summer and holidays. The release of a film during a period of relatively low theater attendance is likely to affect the film's box office receipts adversely. Further, due to the expected release of a large number of animated films by Disney and other movie studios in the next several years, it is possible that the market for animated films will become saturated. Therefore, there is a substantial risk that some or all of Pixar's motion pictures will not be commercially successful, which would have a material adverse effect on Pixar's business, financial condition and results of operations. See "Business -- Competition." Completion of a Motion Picture Subject to Uncertainties and Financial Risks The production, completion and distribution of motion pictures is subject to numerous uncertainties, including financing requirements, personnel availability and the release schedule of competitive films. Pixar is concurrently developing three motion pictures, A Bug's Life, the Fourth Film and Toy Story Sequel, which compounds these uncertainties and jeopardizes the successful, timely and cost-effective production and completion of each film. Under the Co-Production Agreement, Pixar has increased its financial involvement in the production costs of motion pictures, subjecting Pixar to substantial financial risks relating to the production, completion and release of the motion pictures. In addition, a significant amount of time will elapse between the expenditure of funds by Pixar and the receipt of revenues from the animated feature films. COMPETITION Pixar experiences intense competition with respect to animated feature films, animation products and software. Competition From Movie Studios Pixar's animated feature films compete and will continue to compete with feature films and other family oriented entertainment products produced by major movie studios, including Disney (as somewhat limited by the Co-Production Agreement), Warner Bros. Inc., Twentieth Century Fox, Paramount, Columbia/Tri-Star Pictures Inc., Lucasfilm, Universal City Studios, Inc. and MGM/UA, as well as numerous other independent motion picture production companies. Competition has greatly intensified in the animated feature film market from these and other movie studios. Animated feature films released in 1997 included Anastasia by Twentieth Century Fox and Beavis and Butt-head Do America by United International Pictures with Paramount, each achieving domestic box office receipts between $55 and $65 million. Other of these movie studios have announced their intention to enter the animated feature film market, including DreamWorks, a studio formed in 1994 which is expressly targeting the animated film market. DreamWorks owns a significant equity stake in PDI, a computer graphics special effects firm, and is producing a computer animated movie with PDI. This computer animated film, which has been referred to publicly as Antz, may contain similar subject matter to A Bug's Life. As a result, Pixar expects a variety of new animated feature films to be released in the theaters in the next two years generating competition for A Bug's Life and Toy Story Sequel, which are targeted for release in late 1998 and late 1999, respectively. These films include Paramount's Rugrats, The Movie and 20 22 DreamWorks' The Prince of Egypt. Pixar is also aware of several other animated feature films in production at various studios. Due to the large number of expected releases in the next two years, it is possible that the market for animated films will become saturated before Pixar can release A Bug's Life and other feature films, which could result in failure of such films to achieve commercial success. In addition, other non-animated family oriented feature films are expected to be released in late 1998 and will generate additional competition for A Bug's Life. They include Babe: Pig in the City, The Wizard of Oz , Air Bud 2: Golden Receiver and Star Trek 9, among many others. Pixar's films will compete with the feature films of other movie studios for optimal release dates, audience acceptance and exhibition outlets. In addition, Pixar competes and will continue to compete with other movie studios for the acquisition of literary properties, production financing, the services of performing artists, and the services of other creative and technical personnel, particularly in the fields of animation and technical direction. Most of the other movie studios with which Pixar competes have significantly greater name recognition and significantly greater financial, technical, creative, marketing and other resources than does Pixar. At least two of these movie studios, Disney and Lucasfilm (through its affiliate ILM), have developed their own internal computer animation capability and have created computer animation for special effects in animated films. In addition, Pixar believes that Disney is currently developing and producing a feature film making substantial use of computer animation. Other movie studios may internally develop, license or sub-contract three-dimensional animation capability. Further, Pixar believes that continuing enhancements in commercially available computer hardware and software technology have lowered and will continue to lower barriers to entry for studios or special effects companies which intend to produce computer animated feature films or other products. For example, Silicon Graphics Inc.'s Alias/Wavefront subsidiary has recently launched "Maya," its next generation three-D software for creating high quality animation and visual effects. Maya incorporates many new features and could be used to make a computer animated feature film. The Co-Production Agreement provides for the development and production by Pixar of five computer animated feature films. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the "Walt Disney Pictures" label and enjoys financial benefits in the event that such films achieve significant box office revenues, Pixar believes that Disney desires such films to be successful. Nonetheless, Disney has been by far the most successful producer of animated feature films, and family oriented motion pictures distributed by Disney or its affiliates are likely to be in the market concurrently with and competing with Pixar's animated feature films. Pixar's contractual arrangement with Disney also presents other risks. See "-- Risks Associated With Co-Production Agreement" and "Business -- Competition." Competition From Computer Graphics Special Effects Firms Pixar also expects to compete with computer graphics special effects firms, including ILM, Digital Domain, PDI, Rhythm & Hues and Blue Sky/VIFX Productions. These computer graphics special effects firms may be capable of creating their own three-dimensional computer animated feature films or may produce three-dimensional computer animated feature films for movie studios that compete with Pixar. For example, ILM has already created and produced three-dimensional character animation which was used for the ghosts in the live action film Casper, and ILM has a royalty-free, paid-up license to use Pixar's RenderMan software and to obtain at no cost all enhancements and upgrades thereto. Other computer graphics special effects firms have licensed or may license RenderMan. Pixar also competes, or may in the future compete, with the above firms with respect to animation products other than feature films. Accordingly, Pixar's RenderMan software may not provide Pixar with a competitive advantage. See "Business -- Competition." Competition From Software Publishers Pixar also experiences intense competition with respect to its RenderMan software product. In particular, Pixar competes with makers of computer graphics imaging and animation software, principally Microsoft (which acquired SoftImage, Inc.), MentalImage (which offers the same product offered by Microsoft), and 21 23 Silicon Graphics (which acquired Alias/Wavefront). Microsoft, through SoftImage, Inc., MentalImage and Silicon Graphics, through Alias/Wavefront, are each marketing competing rendering software products, usually at lower prices than Pixar. Microsoft and Silicon Graphics have each licensed several of Pixar's patents that cover certain rendering techniques and may therefore be better able to market products that compete with Pixar's RenderMan software. Under appropriate circumstances, Pixar might elect to license its rendering technology patents to other companies, some of which may compete with Pixar. In addition, as PCs become more powerful, software suppliers may also be able to introduce products for PCs that would be competitive with RenderMan in terms of price and performance for professional users. See "Business -- Competition." Competition Could Adversely Impact Pixar Pixar expects competition to persist, intensify and increase in each of its business areas in the future. Almost all of Pixar's current and potential competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical, marketing and other resources than Pixar. There can be no assurance that Pixar will be able to compete successfully against current or future competitors. Such competition could materially adversely affect Pixar's business, operating results or financial condition. See "Business -- Competition." LIMITED OPERATING HISTORY Until 1996, Pixar had generated recurring revenue primarily from the license of its RenderMan software, amounts received under software development contracts and fees for animated television commercial development. However, Pixar intends to generate a substantial majority of its future revenue from the development and production of animated feature films and related products, such as it did in 1996 and 1997. Pixar has, to date, developed and produced only one animated feature film, Toy Story, and only two related products (both CD-ROM titles, which Pixar no longer intends to produce). Accordingly, Pixar has only a limited operating history in implementing its new business model upon which an evaluation of Pixar and its prospects can be based. Pixar's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of a new business enterprise, particularly companies in highly competitive markets. To address these risks, Pixar, among other things, must respond to competitive developments, continue to attract, retain and motivate qualified persons, and continue to upgrade its technologies. There can be no assurance that Pixar will be successful in addressing such risks. DEPENDENCE ON KEY PERSONNEL Pixar's success depends to a significant extent on the performance of a number of senior management personnel and other key employees, especially its animators, creative personnel and technical directors. In particular, Pixar is dependent upon the services of Steven P. Jobs, John Lasseter, Edwin E. Catmull, Lawrence B. Levy and Sarah McArthur. Pixar does not maintain "key person" life insurance for any of its employees. Pixar does have employment agreements with Messrs. Lasseter and Catmull, who are fundamental to Pixar's relationship with Disney. However, such employment agreements do not necessarily assure the services of these employees. Pixar believes that it may be particularly difficult to retain its key employees, especially its animators, creative personnel and technical directors, during periods in which it is not developing animated feature films. The loss of the services of any of Messrs. Jobs, Lasseter, Catmull or Levy, Ms. McArthur or of other key employees, especially its animators, creative personnel and technical directors, could have a material adverse effect on Pixar's business, operating results or financial condition. Although none of Pixar's employees are represented by a labor union, it is common for animators and actors at film production companies to belong to a union. Further, Pixar may be directly or indirectly dependent upon union members, and work stoppages or strikes organized by such unions could materially adversely impact Pixar's business, financial condition or results of operations. For example, many of the actors who provide their voice talents for the Pictures and Derivative Works are members of the Screen Actors Guild, which is currently renegotiating its basic agreement that otherwise expires on June 30, 1998. There can be no assurance that Pixar's employees will not join or form a labor union, or that Pixar will not be directly or indirectly impacted 22 24 by industry related work stoppages or that Pixar, for certain purposes, will not be required to become a union signatory. See "Business -- Employees" and "Executive Officers of the Company." DIVIDED RESPONSIBILITIES OF CHIEF EXECUTIVE OFFICER Pixar's Chief Executive Officer and Chairman, Steven P. Jobs, is also acting as interim Chief Executive Officer at Apple Computer, Inc. ("Apple") until such time as a new Chief Executive Officer is identified and named at Apple. Although Mr. Jobs spends time at Pixar and is active in Pixar's management, he does not devote his full time and resources to Pixar. For day to day operations, since 1995, Pixar has established an Office of the President which is comprised of Mr. Jobs as Chief Executive Officer, Edwin E. Catmull as Executive Vice President and Chief Technical Officer and Lawrence B. Levy, Executive Vice President and Chief Financial Officer. NEED TO ATTRACT AND RETAIN QUALIFIED PERSONNEL TO BE SUCCESSFUL Pixar's success continues to depend to a significant extent on its ability to identify, attract, hire, train and retain qualified professional, creative, technical and managerial personnel. Competition for such personnel is intense, and there can be no assurance that Pixar will be successful in identifying, attracting, hiring, training and retaining such personnel in the future. The competition for quality animators, creative personnel and technical directors is especially intense because the entertainment market has significantly expanded over the past several years. If Pixar is unable to hire, assimilate and retain qualified personnel in the future, particularly animators, creative personnel and technical directors, such inability would have a material adverse effect on Pixar's business, operating results and financial condition. See "Business -- Employees" and "Executive Officers of the Company." DEPENDENCE ON SUCCESSFUL DEVELOPMENT OF APPEALING CREATIVE CONTENT FOR ANIMATED FEATURE FILMS AND RELATED PRODUCTS The success of each animated feature film created and produced by Pixar will depend in large part upon the Pixar creative team's ability to predict the type of content that will appeal to a broad audience and to develop stories and characters that achieve broad market acceptance. Traditionally, this has been extremely difficult. Disney provided creative assistance throughout the production of Toy Story, including creative reviews and approvals, and the Co-Production Agreement contemplates that Disney will continue to provide creative assistance to Pixar on feature films and other products made pursuant to that agreement, but there can be no assurance that Disney will continue to provide assistance to Pixar in the development of creative content for its feature films or related products. There also can be no assurance that voices and other intellectual property rights used in an animated feature film will be available for use in any derivative product related to such feature film. For example, Pixar was unable to obtain the rights to use certain voices from Toy Story in the two CD-ROM products based on Toy Story. See "Business -- Creative Development Group." DISTRIBUTION RISKS Disney is required to distribute the five animated feature films to be produced pursuant to the Co-Production Agreement and has agreed to distribute Toy Story Sequel pursuant to the Co-Production Agreement. Distribution of a motion picture generally involves domestic and foreign licensing for (i) theatrical exhibition, (ii) home video, (iii) presentation on television, including pay, basic cable and syndication, (iv) non-theatrical exhibition, which includes airlines, hotels and armed forces facilities and (v) marketing of other rights of the picture, which may include merchandising, such as CD-ROM titles, toys and soundtrack recordings. Although the Co-Production Agreement provides Pixar with some protection, there can be no assurance that the feature films made under the Co-Production Agreement will be distributed through all of these outlets. For example, Disney has traditionally not made its animated feature films available on pay television other than the Disney Channel or on network television other than ABC, an affiliate of Disney. See "Business -- Business Model and Products." 23 25 DEPENDENCE ON PROPRIETARY TECHNOLOGY AND COMPUTER SYSTEMS FOR TIMELY AND SUCCESSFUL DEVELOPMENT OF FEATURE FILMS AND RELATED PRODUCTS There can be no assurance that Pixar will not experience difficulties that could delay or prevent the successful development or production of future animated feature films or other related products. Among other things, because Pixar is dependent upon a large base of software and a large number of computers for the development and production of its animated feature films and related products, an error or defect in the software, a failure in the hardware or a failure of the backup facilities could result in a significant delay in one or more productions in process which, in turn, could result in potentially significant delays in the release dates of Pixar's feature films or other products. For example, early in 1998 Pixar experienced a failure of its backup systems for Toy Story Sequel which resulted in substantial effort to restore data and a loss of certain data, but which is not expected to have a material impact on the schedule for production or release of Toy Story Sequel. However, significant delays in production and significant delays in release dates could have a material adverse effect on Pixar's business, operating results or financial condition. Further, because Pixar relies mostly on internally developed software, Pixar would not be able to rely upon assistance from third parties in the event that the software fails. See "Business -- Technology." CONCENTRATION OF STOCK OWNERSHIP Pixar's Chief Executive Officer, Steven P. Jobs, beneficially owns approximately 68.9% of the outstanding Common Stock as of March 18, 1998. As a result, Mr. Jobs, acting alone, is able to exercise sole discretion over all matters requiring shareholder approval, including the election of the entire board of directors and approval of significant corporate transactions, including an acquisition of Pixar. Such concentration of ownership may also have the effect of delaying or preventing a change in control of Pixar. RISK OF SUBSTANTIAL ADDITIONAL COSTS RELATED TO FACILITIES EXPANSION In May 1997, Pixar exercised its option (which option Pixar purchased in 1996) and paid $5.8 million to purchase approximately 15 acres of land in Emeryville, California to build a new headquarters and studio facility. To construct the facility, Pixar currently expects to incur total capital expenditures of more than $17 million in 1998 and more than $31 million in 1999. To date, Pixar has chosen to use its existing cash resources to fund facility-related costs. Pixar may continue to use its cash resources for such expenditures, or may choose to finance such capital expenditures through the issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. If Pixar chooses to seek financing for such expenditures, there can be no assurance that such financing will be available on terms reasonably acceptable to Pixar or at all. See "Liquidity Risks" and "Properties" herein and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" in the 1997 Annual Report to Shareholders. NEED FOR TECHNOLOGICAL ADVANCEMENT TO BE SUCCESSFUL Substantially all of Pixar's revenues have been derived, and substantially all of Pixar's future revenues are expected to be derived, from the use and license of Pixar's proprietary technologies. Pixar expects that it will be required to enhance these technologies and to develop new technologies in order to be successful in its industry and in the licensing of its RenderMan software. There can be no assurance that Pixar will be successful in enhancing its existing technologies or in developing and utilizing new technologies, or that competitors will not develop technology that is equivalent or superior to Pixar's technologies or that makes Pixar's technologies obsolete. If Pixar is unable to develop enhancements to its existing technologies or new technologies as required, Pixar's business, operating results or financial condition could be materially adversely affected. See "Business -- Technology" and "Competition -- Movie Studios." 24 26 DEPENDENCE ON PROPRIETARY RIGHTS No Assurance That Patents Will Issue From Applications or Sufficiently Protect Pixar's Technology Pixar's success and ability to compete is dependent in part upon its proprietary technology. While Pixar relies on a combination of patents, copyright and trade secret protection, nondisclosure agreements and cross- licensing arrangements to establish and protect its proprietary rights, Pixar believes that factors such as the technical and creative skills of its personnel are more essential to its success and ability to compete. Pixar currently is the owner of eight patents issued in the United States, one patent issued in the United Kingdom, one patent issued in France, one patent issued in Germany, one patent issued in Japan, two patents issued in Canada and one patent issued by the European Patent Office. In addition, Pixar has a number of patent applications pending in the United States and in foreign countries. There can be no assurance that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed will be sufficiently broad to protect Pixar's technology. In addition, there can be no assurance that any patents that have been issued to Pixar, or that Pixar may license from third parties, will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to Pixar. Failure of the patents to provide protection of Pixar's technology may make it easier for Pixar's competitors to offer technology equivalent to or superior to Pixar's technology. See "Business -- Proprietary Rights." No Assurance That Efforts to Protect Proprietary Technologies Will Succeed The source code for Pixar's proprietary software is protected both as trade secrets and as a copyrighted work. Pixar generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use Pixar's proprietary information, products or technology without authorization, or to develop similar or superior technology independently. Policing unauthorized use of Pixar's products is difficult. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. To license its RenderMan software product, Pixar primarily relies on "shrink wrap" licenses that are not signed by the end-user and, therefore, may be unenforceable under the laws of certain jurisdictions. There can be no assurance that the steps taken by Pixar will prevent misappropriation of its technology or that its confidentiality or license agreements will be enforceable. See "Business -- Proprietary Rights." Risk That Litigation Will Be Required to Enforce Proprietary Rights Litigation may be necessary in the future to enforce Pixar's intellectual property rights, to protect Pixar's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on Pixar's business, operating results or financial condition. See "Business -- Proprietary Rights." Risks of Infringement Claims One of the risks of the film production business is claims that Pixar's productions infringe the intellectual property rights of third parties with respect to previously developed films, stories, characters or other entertainment. In addition, Pixar's technology and software may be subject to patent, copyright or other intellectual property claims of third parties. Pixar has received, and is likely to receive in the future, notice of claims of infringement of other parties' proprietary rights. There can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against Pixar or that any assertions or prosecutions will not materially adversely affect Pixar's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, Pixar would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on Pixar's business, financial condition or results of operations. If any claims or actions are asserted against Pixar, Pixar may seek to obtain a license under a third party's 25 27 intellectual property rights. There can be no assurance, however, that under such circumstances a license would be available on reasonable terms or at all. See "Business -- Proprietary Rights." No Assurance That Third Party Technology Licenses Will Continue to be Available Pixar also relies on certain technology that it licenses from third parties, including software that is integrated and used with internally developed software. There can be no assurance that these third party technology licenses will continue to be available to Pixar on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays in feature film releases or product shipments until equivalent technology could be identified, licensed and integrated. Any such delays in feature film releases or product shipments could materially adversely affect Pixar's business, operating results and financial condition. See "Business -- Proprietary Rights." LITIGATION AND THREATENED LITIGATION On January 21, 1998, an e-mail message was sent to all Pixar employees containing salary data of certain employees as of early 1997. The e-mail was falsely alleged to have been sent from Pixar's Chief Executive Officer, Steven Jobs. Pixar has filed a lawsuit against an unnamed defendant seeking damages and an injunction. In addition, a former employee of Pixar who was named by press reports as a suspect in this matter has threatened Pixar with legal action relating to being named as a suspect. Pixar does not believe these matters will have any material adverse effect on its business, operations or financial condition. However, due to the inherent uncertainties of litigation, there can be no assurance that such litigation will not distract management's time and attention and other resources from the business and will not have a material adverse effect on Pixar's business, operating results or financial condition. POSSIBLE VOLATILITY OF SHARE PRICE AND RISK OF LITIGATION Pixar believes that factors such as the publication of box office results for Pixar's or its competitors' feature films, fluctuations in quarterly or annual results of operations, changes in financial estimates by securities analysts, announcements by Pixar or by its competitors, budget increases, delays in or cancellation of feature film or other product release dates, or other events or factors may cause the market price of Pixar's Common Stock to fluctuate. Moreover, in recent years, the stock market in general, and the shares of technology companies in particular, have experienced extreme price and volume fluctuations, some of which have been unrelated or disproportionate to the operating performances of such companies. These broad market and industry fluctuations may adversely affect the market price of Pixar's Common Stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which could have a material adverse effect on Pixar's business, operating results or financial condition. ITEM 2. PROPERTIES Pixar leases approximately 118,000 square feet of office space in Richmond, California. The related leases expire on various dates ranging from July 1999 to May 2001. In May 1997, Pixar exercised its option (which option Pixar purchased in 1996) and paid $5.8 million to purchase approximately 15 acres of land in Emeryville, California to build a new headquarters and studio facility. To construct the facility, Pixar will incur substantial capital expenditures in 1998 and 1999. To date, Pixar has chosen to use its existing cash resources to fund facility-related costs. Pixar may continue to use its cash resources for such expenditures, or may choose to finance such capital expenditures through the issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. See "Business -- Certain Factors Affecting Business, Operating Results and Financial Condition -- Risk of Substantial Additional Costs Related to Facilities Expansion." See also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" in the 1997 Annual Report to Shareholders. 26 28 ITEM 3. LEGAL PROCEEDINGS Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 27 29 EXECUTIVE OFFICERS OF THE COMPANY The executive officers of Pixar and their ages as of March 18, 1998 are as follows:
NAME AGE POSITION - ------------------- --- --------------------------------------------------------- Steven P. Jobs 43 Chairman, Chief Executive Officer and Office of the President Edwin E. Catmull 52 Executive Vice President, Chief Technical Officer and Office of the President Lawrence B. Levy 38 Executive Vice President, Chief Financial Officer, Office of the President and Secretary John Lasseter 41 Vice President, Creative Development Sarah McArthur 41 Vice President, Production
Pixar's executive officers are appointed by, and serve at the discretion of, the Board of Directors. Each executive officer is an employee of Pixar. There is no family relationship between any executive officer or director of Pixar. Mr. Jobs is a co-founder of Pixar and has served as its Chairman since March 1991, as its Chief Executive Officer since 1986 and in the Office of the President since 1995. He has been a director of Pixar since 1986. In addition, Mr. Jobs currently serves as interim Chief Executive Officer and as a member of the Board of Directors of Apple Computer, Inc. ("Apple"). Mr. Jobs was also a co-founder of NeXT Software, Inc. ("NeXT"), which developed and marketed object-oriented software for client/server business applications and the Internet, and served as the Chairman and Chief Executive Officer of NeXT from October 1985 until February 1997, when NeXT was acquired by Apple. Mr. Jobs then served as an advisor to Apple on a limited basis until assuming his current role as interim Chief Executive Officer at Apple. Dr. Catmull is a co-founder of Pixar and has served as Executive Vice President and Chief Technical Officer since June 1995 and in the Office of the President since February 1995. From March 1991 to February 1995, he served as President, from November 1988 to March 1991 he served as Chairman and from February 1986 to November 1988 he served as President. Prior to joining Pixar, he was Vice President of the Computer Division of Lucasfilm. Dr. Catmull received the Scientific and Engineering Award from The Academy of Motion Picture Arts and Sciences in 1992 and also received the SIGGRAPH Coons Award for lifetime contributions in 1993. Dr. Catmull is a member of the Scientific and Technical Awards Committee of The Academy of Motion Picture Arts and Sciences. Dr. Catmull received B.S. degrees in computer science and physics and a Ph.D. in computer science from the University of Utah. Mr. Levy has served as Executive Vice President, Chief Financial Officer and in the Office of the President since February 1995. Mr. Levy has served as Secretary of Pixar since October 1995. Prior to joining Pixar, he was Vice Chairman and Chief Financial Officer of Electronics for Imaging, Inc., a provider of hardware and software products for the digital color imaging market, where he held various executive positions from April 1991 until January 1995. From December 1987 to April 1991, he was head of the Technology Licensing and Distribution Department at the law firm of Wilson Sonsini Goodrich & Rosati, where he became a partner in February 1990. Mr. Levy received a B.S. in business and accounting from Indiana University and a J.D. from Harvard Law School. Mr. Levy is also a certified public accountant. Mr. Lasseter has served as Vice President, Creative Development since August 1991 and is currently Director of A Bug's Life in addition to serving as creative head of Pixar's other films and projects. Mr. Lasseter joined Pixar in February 1986 as Animator/Director. From 1984 to 1986, he was an animator at Lucasfilm and from 1979 to 1984 he worked as an animator at The Walt Disney Company. For his work in directing Toy Story, Mr. Lasseter received an Academy Award in 1996 for Special Achievement, and for his work in directing Tin Toy, Mr. Lasseter received an Academy Award in 1988 for Best Short Film (Animated). Mr. Lasseter received a B.F.A. degree in film from the California Institute of the Arts. Ms. McArthur has served as Vice President, Production since May 1997, overseeing all Pixar production teams and managing all aspects of making the films. From 1989 to April 1997, Ms. McArthur worked at The Walt Disney Company, where she was most recently Vice President of Production for Disney Feature 28 30 Animation, overseeing the production of feature animation films in Disney's Burbank, Florida and Paris studios. During Ms. McArthur's eight years at Disney, she was the Production Manager on The Rescuers Down Under, went on to be the Associate Producer on Beauty and the Beast and an Executive Producer on The Lion King. She was appointed Director of Production in late 1991 and promoted to Vice President of Production in 1994. Prior to working at Disney, Ms. McArthur worked at the Mark Taper Forum as their Production Manager of special projects. Ms. McArthur earned her B.A. degree in Theatre from the University of California, Santa Barbara, and she attended Carnegie-Mellon University's M.F.A. program in Theater Arts. 29 31 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS Pixar's Common Stock has traded on The Nasdaq Stock Market under the trading symbol "PIXR" since Pixar's initial public offering on November 29, 1995. The following table sets forth the high and low sale prices per share of Pixar's Common Stock for the periods indicated.
HIGH LOW -------- ------- 1996 First Quarter.......................................... $29 $18 1/2 Second Quarter......................................... $25 1/2 $16 3/4 Third Quarter.......................................... $19 1/4 $12 1/4 Fourth Quarter......................................... $20 1/2 $12 3/4 1997 First Quarter.......................................... $22 3/4 $12 5/8 Second Quarter......................................... $18 1/2 $14 1/8 Third Quarter.......................................... $24 3/4 $14 1/2 Fourth Quarter......................................... $27 1/4 $19 1/2 1998 First Quarter (through March 18, 1998)................. $38 $20 1/4
As of March 18, 1998, Pixar had approximately 2,487 shareholders of record. The price for the Common Stock as of the close of business on March 18, 1998 was $33.13 per share. Pixar has never paid any cash dividends on its Common Stock. Pixar intends to retain any earnings for use in its business and does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. USE OF PROCEEDS The effective date of the Company's first registration statement, filed on Form S-1 under the Securities Act of 1933 (No. 33-97918), was November 28, 1995 (the "Registration Statement"). The class of securities registered was Common Stock. The offering commenced on November 29, 1995 and all securities were sold in the offering. The managing underwriters for the offering were Robertson, Stephens & Company, L.P., Hambrecht & Quist LLC and Cowen & Company. A total of 6,900,000 shares were registered pursuant to the Registration Statement, all of which the Company sold for its own account, for an aggregate offering price of $151,800,000. The Company incurred expenses of approximately $12,138,714, of which $10,246,500 represented underwriting discounts and commissions and $1,892,214 represented other expenses. All such expenses were direct or indirect payments to others. The net offering proceeds to the Company after total expenses was $139,661,286. As of December 31, 1997, the Company had used the net proceeds from the offering as follows: $11,227,043 for construction of plant, building and facilities, $9,017,312 for the purchase and installation of machinery and equipment, $2,374,000 for the repayment of indebtedness, $42,512,172 for the development of future films and other animated products, $6,229,973 for working capital and $68,300,786 remaining in temporary investments. Of these amounts, $2,374,000 represented direct or indirect payments to directors, officers, general partners of the Company or their associates; to persons owning ten (10) percent or more of any class of equity securities of the Company; or to affiliates of the Company. The use of the proceeds from the offering does not represent a material change in the use of proceeds described in the prospectus. 30 32 ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated by reference to the section entitled "Selected Financial Data" in the 1997 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1997 Annual Report to Shareholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is incorporated by reference to the section entitled "Financial Statements and Selected Financial Data" in the 1997 Annual Report to Shareholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 31 33 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information required by this item concerning Pixar's directors is incorporated by reference to the information set forth in the section entitled "Election of Directors" in Pixar's Proxy Statement for the 1998 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of the Pixar's fiscal year ended December 31, 1997, except that the information required by this item concerning the executive officers of Pixar is incorporated by reference to the information set forth in the section entitled "Executive Officers of the Company" at the end of Part I of this Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information required by this item regarding executive compensation is incorporated by reference to the information set forth in the sections entitled "Election of Directors -- Director Compensation" and "Executive Officer Compensation" in Pixar's Proxy Statement for the 1998 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of the Pixar's fiscal year ended December 31, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to the information set forth in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in Pixar's Proxy Statement for the 1998 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of Pixar's fiscal year ended December 31, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item regarding certain relationships and related transactions is incorporated by reference to the information set forth in the section entitled "Certain Transactions" in Pixar's Proxy Statement for the 1998 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of Pixar's fiscal year ended December 31, 1997. 32 34 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Form 10-K: 1. Financial Statements. The following financial statements of Pixar and the Independent Auditors' Report therein are incorporated by reference to the portions of Pixar's 1997 Annual Report to Shareholders filed as Exhibit 13.1 to this Form 10-K: Independent Auditors' Report................................ Balance Sheets as of December 31, 1996 and 1997............. Statements of Operations for the years ended December 31, 1995, 1996 and 1997....................................... Statements of Shareholders' Equity (Deficit) for the years ended December 31, 1995, 1996 and 1997.................... Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997....................................... Notes to Financial Statements...............................
2. Financial Statement Schedule. The following financial statement schedule of Pixar for the years ended December 31, 1995, 1996 and 1997 is filed as part of this Form 10-K and should be read in conjunction with the Financial Statements, and related notes thereto, of Pixar. Independent Auditors' Report on Financial Statement Schedule.................................................. S-1 Schedule II -- Valuation and Qualifying Accounts and Reserves.................................................. S-2 Schedules not listed above have been omitted since they are either not required, not applicable, or the information is otherwise included.
3. Exhibits: See Item 14(c) below. (b) Reports on Form 8-K. No Reports on Form 8-K were filed during the fourth quarter ended December 31, 1997. (c) Exhibits. The exhibits listed on the accompanying index to exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Form 10-K. (d) Financial Statement Schedules. See Item 14(a) above. 33 35 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on this 31st day of March 1998. PIXAR By: /s/ LAWRENCE B. LEVY --------------------------------------- Lawrence B. Levy Executive Vice President and Chief Financial Officer POWER OF ATTORNEY KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven P. Jobs, Lawrence B. Levy and Edwin E. Catmull and each of them, jointly and severally, his or her attorneys-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorneys-in-fact or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE --------- ----- ---- /s/ STEVEN P. JOBS Chairman of the Board and March 31, 1998 - -------------------------------------------------------- Chief Executive Officer Steven P. Jobs (Principal Executive Officer) /s/ LAWRENCE B. LEVY Executive Vice President March 31, 1998 - -------------------------------------------------------- and Chief Financial Officer Lawrence B. Levy (Principal Financial and Accounting Officer) /s/ JILL E. BARAD Director March 31, 1998 - -------------------------------------------------------- Jill E. Barad /s/ SKIP M. BRITTENHAM Director March 31, 1998 - -------------------------------------------------------- Skip M. Brittenham /s/ JOSEPH A. GRAZIANO Director March 31, 1998 - -------------------------------------------------------- Joseph A. Graziano /s/ LARRY W. SONSINI Director March 31, 1998 - -------------------------------------------------------- Larry W. Sonsini
34 36 INDEPENDENT AUDITORS' REPORT ON SCHEDULE The Board of Directors and Shareholders Pixar: Under date of January 30, 1998, we reported on the balance sheets of Pixar as of December 31, 1996 and 1997, and the related statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1997, which are incorporated by reference in the annual report on Form 10-K. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedule included herein. This financial statement schedule is the responsibility of Pixar's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP San Francisco, California January 30, 1998 S-1 37 PIXAR SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
BALANCE AT DEDUCTIONS: BEGINNING WRITE OFFS OF BALANCE AT CLASSIFICATION OF YEAR ADDITIONS ACCOUNTS END OF YEAR -------------- ---------- --------- ------------- ----------- Allowance for returns and doubtful accounts Year ended December 31, 1995 $227 $ 61 $ (32) $256 ==== ==== ===== ==== Year ended December 31, 1996................. $256 $ 3 $ -- $259 ==== ==== ===== ==== Year ended December 31, 1997................. $259 $100 $(102) $257 ==== ==== ===== ====
S-2 38 INDEX TO EXHIBITS
EXHIBIT NUMBER EXHIBITS ------- -------- 3.1 Amended and Restated Articles of Incorporation(1)........... 3.4 Amended and Restated Bylaws, as amended(5).................. 4.1 See Exhibit 3.1............................................. 4.2 See Exhibit 3.2............................................. 4.5 Specimen Common Stock Certificate(1)........................ 4.6 Common Stock and Warrant Purchase Agreement between the Registrant and Disney Enterprises, Inc. dated as of February 23, 1997(4)................................................. 4.7 Form of Common Stock Purchase Warrant to be issued to Disney Enterprises, Inc.(4)........................................ 4.8 Form of Registration Rights Agreement by and between the Registrant and Disney Enterprises, Inc.(4).................. 10.1* 1995 Stock Plan, as amended, and forms of agreements thereto(5).................................................. 10.2* 1995 Director Option Plan(1)................................ 10.3* Form of Indemnification Agreement entered into between the Registrant and each of the executive officers and directors(1)................................................ 10.4 Agreement between the Registrant and Walt Disney Pictures dated May 3, 1991, as amended(1)(6)......................... 10.5 Net Office Lease between the Registrant and Point Richmond R&D Associates dated February 15, 1990, as amended(1)....... 10.6 Patent License Agreement between the Registrant and Microsoft Corporation dated June 21, 1995(1)(6)............. 10.7* Employment Agreement between the Registrant and Edwin E. Catmull dated August 1, 1991(1)............................. 10.8* Employment Agreement between the Registrant and John Lasseter dated February 24, 1997(4)(6)...................... 10.11 Patent License Agreement between the Registrant and Silicon Graphics, Inc. dated March 12, 1996(2)...................... 10.12 Net Office Lease between the Registrant and Point Richmond R&D Associates dated November 7, 1995(2).................... 10.13 Co-Production Agreement between the Registrant and Walt Disney Pictures and Television dated February 24, 1997(4)(6) 10.14 Net Office Lease between the Registrant and Point Richmond R&D Associates dated April 1, 1996(3)....................... 10.15 Net Office Lease between the Registrant and Point Richmond R&D Associates dated September 12, 1996(3).................. 10.16 Agreement of Purchase and Sale between the Registrant and Del Monte Corporation dated as of September 6, 1996, as amended(5).................................................. 10.17 Amendment to the September 12, 1996 Net Office Lease between the Registrant and Point Richmond R&D Associates dated as of May 8, 1997................................................. 13.1 Portions of the Annual Report to Shareholders for the fiscal year ended December 31, 1997, expressly incorporated by reference herein............................................ 23.1 Consent of Independent Auditors.............................
39
EXHIBIT NUMBER EXHIBITS ------- -------- 27.1 Financial Data Schedule..................................... 27.2 Restated 1996 Financial Data Schedule.......................
- --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (File No. 33-97918) declared effective on November 28, 1995. (2) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. (4) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996. (5) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (6) Documents for which confidential treatment has been granted for certain portions of these exhibits. * Indicates management compensatory plan, contract or arrangement. EX-10.17 2 AMENDMENT TO THE NET OFFICE LEASE DATED MAY 8,1997 1 EXHIBIT 10.17 FIRST AMENDMENT TO PIXAR/POINT RICHMOND TECH CENTER II BUILDING B LEASE THIS FIRST AMENDMENT ("Amendment") dated May 8, 1997, is made with reference to that certain Industrial Gross Lease between POINT RICHMOND R&D ASSOCIATES, a California general partnership ("Landlord"), and PIXAR ANIMATION STUDIOS, a California corporation ("Tenant"), dated September 12, 1996 (the "Lease") for certain space located in the Building, commonly known as Point Richmond Tech Center II Building B (the "Premises"). A. In the process of developing its space plan for the Premises, Tenant planned for the use of more space than the 30,000 square feet originally specified in the Lease. B. In addition, Tenant has delivered to Landlord notice of its desire to convert the Shell Carry Space to Warm Shell Condition pursuant to Section 3.01 of the Lease. C. It is now in the best interests of both parties to amend the Lease respecting the actual square footage of the Premises as related to the scheduled buildout of tenant improvements in the Build Out Space. 1. Section I, DEFINITIONS. Terms defined in the Lease shall have the same meaning when used in this Amendment, except as amended by this Paragraph 1 of this Amendment. The Build Out Space square footage is changed to 31,500 square feet. The Shell Carry Space is changed to 13,987 square feet. The Base Monthly Rent is changed to $55,119.15, subject to adjustment as specified in this Amendment. The Commencement Date will be May 16, 1997, subject to adjustment as specified in this Amendment. 2. Section 4.1. BASE MONTHLY RENT ADJUSTMENT, is amended in its entirety to read as follows: "The Base Monthly Rent for the first six months from the Commencement Date shall be $50,153.76. From the beginning of the seventh month from the Commencement Date until the end of the Initial Term, or unless modified pursuant to paragraph 4.2, the Base Monthly Rent shall be $55,119.15." 3. Section 4.2. CONVERSION OF SPACE BASE RENT ADJUSTMENTS, is amended to delete the language of Section 4.2 in its entirety and replace it with the following sentence: "Upon the substantial completion of the additional tenant improvements to the Shell Carry Space pursuant to paragraph 3.1 and 19.12, the monthly Base Rent shall be increased to $70,504.85." 4. Section 19.12. TENANT IMPROVEMENTS, is amended as follows: (a) The following sentence is added to the end of Section 19.12: "Working Drawings for the construction of tenant improvements in the Built Out Space have been approved 1 2 by the parties. Landlord has executed a contract with Dome Construction dated March 4, 1997 (attached as Exhibit A to this Amendment) for construction of tenant improvements in the Built Out Space and delivery of the Shell Carry Space in the Warm Shell Condition. Landlord and Tenant agree to co-pay Dome Construction as follows: Landlord will pay 80.15% of each bill to a maximum of $810,000 (this number includes the amount necessary to convert the existing shell into its Warm Shell Condition minus $8,286 for upgrades to the base building HVAC and electrical systems). Tenant will pay the remaining 19.85%." (b) On page 16, in the first sentence of the paragraph beginning: "It is the intent . . .," the words "this space" are replaced by "the Premises;" in addition, the fifth and sixth sentences of that paragraph are deleted in their entirety. Finally, the words prior to "Landlord" in the last sentence of that paragraph are deleted in their entirety. 5. The Commencement Date stipulated in Paragraph 1 of this Amendment is predicated upon the currently proposed construction schedule for delivery of the Shell Carry Space in the Warm Shell Condition and for completion of tenant improvements in the Built Out Space being met. Exhibit B to this Amendment shows the critical schedule/key milestones which must be met to allow the Tenant Improvement Work to stay on schedule. If Landlord is not able to deliver possession of the Shell Carry Space in the Warm Shell Condition on the Commencement Date, then the Commencement Date shall be increased on a day-for-day basis until Landlord is able to deliver possession of the Shell Carry Space in the Warm Shell Condition and Tenant shall be entitled to offset the amount of $833.00 per day of delay in delivery past the Commencement Date against the rent due to Landlord (as currently specified in Section 3 of the Lease), but the Initial Term shall not thereby be extended. Except for the amendments, additions and deletions described in this Amendment, all other terms and conditions of the Lease remain in full force and effect. LANDLORD: TENANT: RICHMOND R&D ASSOCIATES, PIXAR ANIMATION STUDIOS, a California general partnership a California corporation By: [SIG] By: [SIG] ------------------------------- ------------------------------- Its: Its: Facility Director ------------------------------ ----------------------------- Dated: , 1997 Dated: 5-7, 1997 ---------------- --------------- EXHIBITS: A - Construction Contract B - Construction Milestones 2 EX-13.1 3 PORTIONS OF THE ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13.1 SELECTED FINANCIAL DATA The following selected financial data is derived from the Company's financial statements. This data should be read in conjunction with the Financial Statements and Notes thereto, and with Management's Discussion and Analysis of Financial Condition and Results of Operations.
Year Ended December 31, 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- (In thousands, except per share data) Revenue $ 6,829 $ 5,590 $ 12,113 $ 35,218 $ 34,699 Net income (loss) from continuing operations (1,173) (2,372) 3,331 26,342 21,956 Net income (1,173) (2,372) 1,627 25,319 22,190 Basic net income (loss) per share from continuing operations(1) (0.24) 0.26 0.68 0.53 Basic net income (loss) per share(1) (0.24) 0.13 0.66 0.54 Diluted net income (loss) per share from continuing operations(1) (0.24) 0.10 0.56 0.46 Diluted net income (loss) per share(1) (0.24) 0.05 0.54 0.46 Working capital (deficit) (638) (1,199) 138,687 162,983 167,048 Total assets 1,987 1,896 152,815 176,941 231,068 Long - term obligations 1,460 1,573 -- -- -- Total shareholders' equity (deficit) (1,216) (1,675) 142,907 170,804 217,300
(1) Basic and diluted net income per share have been restated in accordance with SFAS No. 128 and SAB No. 98. 1 2 The foregoing discussion, the Letter to Shareholders, and other sections of this Annual Report to Shareholders contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward looking statements are based on current expectations, estimates and projections about Pixar's industry, management's beliefs, and assumptions made by management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under "Overview," "Anticipated Net Losses in 1998 and The First Half of 1999", "Dependence on Toy Story, A Bug's Life and Toy Story Sequel," and "Liquidity Risks" as well as those noted in the section entitled "Certain Factors Affecting Business, Operating Results and Financial Condition" in Pixar's Annual Report on Form 10-K for the year ended December 31, 1997 (the "Form 10-K"). Particular attention should be paid to the cautionary language in the section in the Form 10-K entitled "Certain Factors Affecting Business, Operating Results and Financial Condition--Anticipated Net Losses in 1998 and the First Half of 1999, " "--Dependence on Toy Story, A Bug's Life and Toy Story Sequel," "--Liquidity Risks," "--Scheduled Successive Release of Films; Management of Growth" and "--Risks Associated with Co-Production Agreement." Unless required by law, Pixar undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Pixar was formed in 1986 when Steve Jobs purchased the computer division of LucasFilm and incorporated it as a separate company. Until 1996, Pixar generated its recurring revenue primarily from the license of RenderMan software, software development contracts and fees for animated television commercials. Financial information relating to business segments is set forth in Note 10 of Notes to Financial Statements. In 1991, Pixar entered into a feature film agreement (the "Feature Film Agreement") with Walt Disney Pictures, a wholly owned subsidiary of The Walt Disney Company (together with its subsidiaries and affiliates collectively referred to herein as "Disney"), for the development and production of up to three animated feature films to be marketed and distributed by Disney. As a result, in 1992, Pixar began to place more emphasis on products sold for their content, especially feature films, and the continued development of its proprietary software. At the same time, Pixar reduced emphasis on the commercialization of software and contract development work. Pixar has implemented this shift in focus over the last five years. In accordance with this shift in focus, Pixar adopted a new business model pursuant to which it will develop and produce new animated feature films and related products such as theatrical sequels, and will produce jointly with Disney related products such as merchandise and soundtracks. Adoption of this new business model did not materially impact Pixar's results of operations and financial condition until 1996, when Pixar first recognized film revenue and cost of film revenue attributable to Pixar's first animated feature film, Toy Story, which was released in November 1995. Pixar's share of revenues and expenses from Toy Story was governed by the terms of the Feature Film Agreement. This agreement has been superseded by the Co-Production Agreement entered into in February 1997, as described below, except with respect to treatment of Toy Story and products developed pursuant to the Feature Film Agreement, such as the Toy Story home video. Accordingly, Pixar believes that the results of its operations for 1995 and prior years, during which time Pixar recognized no revenue from animated feature films or related products, are not meaningful indicators of future performance. Further, Pixar believes that its results of operations for 1996 and 1997, during which time revenue and costs attributable to feature films were governed by the terms of the Feature Film Agreement, are also not meaningful indicators of future performance, although they are more meaningful than results of operations for 1995 and prior years. See "Anticipated Net Losses in 1998 and the First Half of 1999." In February 1997, Pixar and Walt Disney Pictures and Television, a wholly-owned subsidiary of Disney, entered into the Co-Production Agreement ("Co-Production Agreement") pursuant to which Pixar, on an exclusive 2 3 basis, will produce five computer animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney over approximately the next ten years. Pixar and Disney will co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which will be financed by Disney), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. The Co-Production Agreement generally provides that Pixar will produce each Picture and that Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Disney and Pixar have agreed that Pixar's second feature film, called "A Bug's Life", will be the first Picture under the Co-Production Agreement. The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, Pixar will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. Pixar will not share in any theme park revenues generated as a result of the Pictures. Pursuant to the Co-Production Agreement, in addition to co-financing the production costs of the Pictures, Disney will reimburse Pixar for its share of certain general and administrative costs and certain research and development costs that benefit the productions. See Note 4 of Notes to Financial Statements. In February 1998, Pixar and Disney agreed to produce a theatrical motion picture sequel to Toy Story (with the working title, "Toy Story Sequel"), in lieu of the Toy Story made-for-home video sequel. Toy Story Sequel will be Pixar's third feature film and will not be released until late in 1999 at the earliest. Because Toy Story Sequel is a derivative work of the original Toy Story, it will not be counted toward the five Pictures to be produced under the Co-Production Agreement. However, for all other purposes, Toy Story Sequel will be treated as a "Picture" under the Co-Production Agreement. Accordingly, Toy Story Sequel has been added to the definition of Pictures produced and financed under the Co-Production Agreement and all the provisions applicable to the other five Pictures apply. Since 1996, Pixar has been producing Toy Story Sequel for the less expensive made-for-home video format. Therefore, Pixar will necessarily spend substantially more production time and incur substantially higher production costs to convert Toy Story Sequel into a feature-length and feature-quality motion picture. In 1997, Pixar continued story development on its fourth theatrical film (the "Fourth Film"). This film will be developed and distributed under the Co-Production Agreement and will count as the second of the five original films to be produced under the Co-Production Agreement. Production of the Fourth Film has not yet begun, and Disney and Pixar have not yet approved the story treatment and budget as required under the Co-Production Agreement. The Fourth Film is not expected to be released until the end of 2000 at the earliest. RESULTS OF OPERATIONS A number of factors are expected to result in net losses in 1998 and the first half of 1999. See "Anticipated Net Losses in 1998 and the First Half of 1999." Revenues In the year ended December 31, 1997, Pixar derived revenue from its first animated feature film, Toy Story, from software licenses, from the license of certain patents and from fees for other animation services. Revenue from feature films is recognized upon receipt of compensation from Disney. All payments to Pixar from Disney for development and production of Toy Story under the Feature Film Agreement and A Bug's Life, Toy Story Sequel and the Fourth Film under the Co-Production Agreement have been recorded as cost reimbursements. Accordingly, no revenues have been recognized for such reimbursements; rather, Pixar has netted the reimbursements against the related costs. These reimbursed costs through the year ended December 31, 1997 are set forth in Note 4 of Notes to Financial Statements. Software license revenue is recognized upon shipment if there are no significant vendor obligations. Revenue from patent licensing is recognized upon release of the rights to the technology. Animation services revenues is recognized on the percentage-of-completion method of accounting. Prior to 1996, Pixar also derived revenue from software development contracts for which revenues were recognized on the percentage-of-completion method of accounting. See Note 1 of Notes to Financial Statements. 3 4 Total revenues increased from $12.1 million in 1995 to $35.2 million in 1996 and declined slightly to $34.7 million in 1997. Total revenues increased from 1995 to 1996 primarily as a result of revenues attributable to the domestic and international theatrical release of Toy Story. The decrease in total revenues from 1996 to 1997 was primarily attributable to a decrease in patent licensing revenue, largely offset by higher film revenue derived from Toy Story home video and merchandise sales. Software revenues include software license revenue, principally from RenderMan and in 1995, software development contract revenues. Software revenue increased from $3.1 million in 1995 to $3.3 million in 1996 and to $4.5 million in 1997. Software revenues increased in each of 1996 and 1997 due primarily to a general increase in RenderMan software license revenue. Due to Pixar's focus on content creation for animated feature films and related products, Pixar continues to expect that revenue derived from software licenses may decline. All historical and future royalty income associated with Pixar's discontinued CD-ROM division is now and will continue to be excluded from software revenue and presented in results of discontinued operations. See "Results From Discontinued Operations." Animation services revenues include revenue generated from short projects related to Pixar's films, other short animated productions and, in 1996 and prior years, television commercials. Fees for animation services, which are fixed in advance, depend on the relative complexity and length of each production and may also depend on the market and other competitive conditions. Animation services revenues increased from $2.5 million in 1995 to $3.9 million in 1996 and decreased to $1.6 million in 1997. The increase in revenue from 1995 to 1996 was due to $2.4 million in fees from Disney for a series of televised animation short productions related to Toy Story. The decrease in animation services revenue from 1996 to 1997 was primarily attributable to decreased television commercials revenue in 1997, which resulted from Pixar's decision to substantially discontinue its production of animated television commercials for third parties. More generally, Pixar expects that revenue in the animation services area will vary significantly from period to period due to the sporadic nature of this business and the need to utilize animation services employees on other productions. For example, Pixar has transferred substantially all of its animation services employees to assist in the completion of A Bug's Life. There can be no assurance that Pixar will generate any animation services revenue during periods in which its animation services employees are devoted to feature films or other projects. Toy Story was not released until November 1995, and accordingly, there were no film revenues in 1995. Under the Feature Film Agreement, film revenues of $18.8 million were recognized in 1996, representing Pixar's share of both the domestic and international theatrical releases of Toy Story and related products. In 1997, film revenues of $26.9 million were recognized, primarily representing Pixar's share of Toy Story worldwide home video sales and Toy Story merchandise sales. Toy Story revenues increased in 1997 primarily because, under the Feature Film Agreement, Pixar's percentage of Toy Story revenues is calculated on a sliding scale with lower percentages earned by Pixar at the outset while Disney recovered related production, marketing and distribution costs for the film, and higher percentages earned once Disney has recovered these costs. Disney's costs were recovered in the quarter ended June 30, 1997, which increased Pixar's proportionate share of revenue received from all film-related sources thereafter. In addition to the general increase in Pixar's proportionate share, Pixar received $4.1 million additional film revenue from Disney for two reasons. First, in the quarter ended June 30, 1997, when Disney recovered its costs, Pixar was entitled under the Feature Film Agreement to recoup from Disney $2.3 million of overbudget production costs originally paid by Pixar when Toy Story was in production (see "Capitalized Film Production Costs"). Also, in the quarter ended September 30, 1997, Pixar and Disney determined that the date on which Disney's costs were recovered occurred earlier than previously thought, resulting in agreement on an additional payment to Pixar of $1.8 million. Since the Toy Story home video is the last major release for Toy Story, and since Pixar's next feature film is not targeted for release until the fourth quarter of 1998 at the earliest, Pixar's revenues and earnings will decline in 1998 as compared to 1997, and Pixar expects to incur a net loss in 1998 and in the first half of 1999. Patent license revenues of $6.5 million in the year ended December 31, 1995 were attributable to a patent license with Microsoft. Patent license revenues of $9.1 million in the year ended December 31, 1996 were 4 5 attributable to a patent license with Silicon Graphics whereby Pixar granted to Silicon Graphics and its subsidiaries a non-exclusive license to use certain of Pixar's patents covering techniques for creating computer-generated photorealistic images. Under the agreement, Silicon Graphics agreed to pay Pixar total compensation of $11 million, $6 million in cash and $5 million in the form of credits to purchase hardware and software from Silicon Graphics. In 1996, Pixar recognized revenue of $9.1 million in accordance with this license. In 1997, Pixar recognized $1.7 million of the remaining $1.9 million of credits. Pixar expects to use the remaining credits in 1998. Pixar does not expect that patent license revenues will be generated on an on-going basis. See Note 5 of Notes to Financial Statements. In the year ended December 31, 1995, Microsoft accounted for 54% of Pixar's total revenues, attributable to a one-time patent license. In the year ended December 31, 1996, Disney accounted for 62% of Pixar's revenues from continuing operations, attributable to revenue generated from Toy Story and short animated television productions based on Toy Story, and, to a lesser degree, software license sales. Also in 1996, Silicon Graphics accounted for 26% of total revenues, attributable to a one-time patent license. In the year ended December 31, 1997, Disney accounted for 83% of Pixar's revenues from continuing operations, attributable to revenue generated from Toy Story home video, animation services and software revenues. Due to the Co-Production Agreement, Disney is expected to continue to represent greater than 10% of Pixar's revenues in 1998 and for the forseeable future. Cost of Revenues Cost of software revenues consists of the direct cost and manufacturing overhead required to reproduce and package Pixar's software products. Cost of software revenues as a percentage of the related revenues decreased from 16% in 1995 to 3% in 1996 and to 2% in 1997. The decrease from 1995 to 1996 and from 1996 to 1997 was primarily due to a reduction in revenue from low margin software development contracts and to increased sales of the RenderMan ToolKit, which carries a higher gross margin than other software products. Cost of software revenues includes no amortization of capitalized software development expenses. Cost of animation services revenues consists of production costs, which include salaries, benefits, facility expenses, and department overhead costs. Cost of animation services revenues as a percentage of the related revenues increased slightly from 76% in 1995 to 77% in 1996 and decreased to 63% in 1997. The increase from 1995 to 1996 was due to higher costs associated with increased complexity and reduced prices for television commercials attributable to competitive pressures, largely offset by the higher margins earned on a series of animated short projects related to Toy Story. The decrease from 1996 to 1997 reflects Pixar's decision in 1996 to largely discontinue its business of producing animated television commercials, which had higher associated costs relative to revenues, in favor of working on animated services related to feature films, which have had lower associated costs relative to revenues. Pixar expects that costs of revenue, and therefore gross profits, in this area will vary significantly period to period. Toy Story was released in November 1995, and accordingly, there was neither film revenue nor cost of film revenues in 1995. In 1996 and 1997 cost of film revenue consisted of the amortized portion of Pixar's share of unreimbursed amounts incurred to produce Toy Story. See "Capitalized Film Production Costs." Cost of film revenues decreased from $1.6 million, or 8% of film revenues in 1996, to $1.5 million, or 6% of film revenue in 1997, due to higher than expected film revenue which resulted in Pixar's amortizing the majority of related film costs in 1996. As of December 31, 1997, all significant Toy Story film costs have been fully amortized. Under the Feature Film Agreement all payments to Pixar from Disney for Pixar's efforts in the development and production of feature films were recorded as cost reimbursements and were netted against the related costs. However, under the terms of the Co-Production Agreement, in which Pixar co-finances each film production, amortized film production costs for future feature films will be significantly higher, and gross profit margins on future film projects, if any, will be substantially lower than those achieved on Toy Story. There are no costs of revenues associated with patent licensing revenues. 5 6 Operating Expenses Pixar intends to continue to increase operating expenses in a number of areas. With respect to general expense growth, as a result of intense competition for animators, creative personnel, technical directors and certain administrative personnel, Pixar has had to pay higher salaries to attract new creative, technical and other personnel. Pixar expects compensation for such personnel to continue to increase. In the year ended December 31, 1997, Pixar funded greater levels of research and development, expanded its administrative staff and facilities and expanded other operations. Pixar expects continued growth in operating expenses in each of these areas. Under the Co-Production Agreement, Disney reimburses Pixar for its share of certain general and administrative costs and certain research and development costs that benefit the productions. The funding received from Disney is treated as operating expense reimbursements. See Note 4 of Notes to Financial Statements. To the extent that personnel, facilities and other expenditures are not capitalized by Pixar nor allocated to and paid for by Disney, and precede or are not subsequently followed by an increase in revenues, Pixar's business, operating results and financial condition will be materially adversely affected. Included in the period ended December 31, 1997 was a one time $2.2 million adjustment reducing Pixar's operating expenses. This reduction was due to an additional reimbursement from Disney under the Co-Production Agreement which was signed in February 1997. Under this agreement, certain operating expenses benefiting the productions, such as certain research and development and certain general and administrative expenses, are paid half by Pixar and half by Disney. Since the Co-Production Agreement applies to A Bug's Life and Toy Story Sequel, both of which were in development and production in 1996, Pixar was entitled to reimbursement for Disney's share of certain of Pixar's operating expenses incurred in 1996 and in the first two months of 1997, prior to signing the agreement. Without this adjustment, Pixar's total operating expenses increased from $6.9 million in 1995 to $10.2 million in 1996 and to $11.3 million in 1997. In 1995, Pixar recorded deferred compensation of $3.7 million for the difference between the grant price and the deemed fair value of Pixar's Common Stock for 9,823,900 shares subject to options granted during 1995. Amortization of deferred compensation of $1.4 million, $1.2 million and $635,000 was recorded in the years ended December 31, 1995, 1996 and 1997 respectively; $292,000, $44,000 and $24,000 was capitalized to film production costs in 1995, 1996 and 1997, respectively, and the balances were charged to expense in the respective years. See "Capitalized Film Production Costs." The remaining deferred compensation expense of $414,000 will be amortized primarily to operating expense over the related vesting period of the options and will therefore continue to have an adverse effect on Pixar's results of operations. See Note 8 of Notes to Financial Statements. Research and Development. Research and development expenses consist primarily of salaries and support for personnel conducting research and development for the RenderMan product and for Pixar's proprietary Marionette and Ringmaster animation and production management software. Research and development expenses increased from $3.0 million in 1995 to $4.5 million in 1996 and to $4.7 million in 1997. Research and development expenses increased in each of 1996 and 1997 as compared to the prior year due to an increase in personnel. To date, all research and development costs not reimbursed by Disney have been expensed as incurred. Pixar expects research and development expenses to further increase. See Note 4 of Notes to Financial Statements. Sales and Marketing. Sales and marketing expenses consist primarily of salaries and overhead, as well as public relations, advertising, technical support and trade show costs required to support the software segment. Sales and marketing expenses increased slightly from $1.4 million in 1995 to $1.5 million in each of 1996 and 1997 due to increases in public relations and corporate marketing costs. Pixar believes that sales and marketing expenses will increase in absolute dollars in future periods, particularly in the areas of public relations and corporate marketing. Pixar has not received substantive amounts of reimbursements from Disney for sales and marketing expenses pursuant to the Co-Production Agreement. General and Administrative. General and administrative expenses consist primarily of salaries of management and administrative personnel, insurance costs and professional fees. General and administrative 6 7 expenses increased from $2.5 million in 1995 to $4.2 million in 1996 and to $5.1 million in 1997. The increase in general and administrative expenses from 1995 through 1997 was primarily due to increased general and administrative staffing, increased systems costs and increased facilities costs. Pixar expects general and administrative expenses to further increase in absolute dollars in future periods as Pixar incurs additional costs to expand its administrative staff and facilities. See Note 4 of Notes to Financial Statements. Other Income, Net Other income, net was $715,000 in 1995, $8.0 million in 1996 and $8.8 million in 1997. In 1995, net other income consisted primarily of interest income from investments, amounts received pursuant to settlement of an intellectual property rights dispute and additional gain on the sale of equity securities, offset by net interest expense attributable to interest accrued on a promissory note issued to Pixar's majority shareholder. Other income, net in 1996 and 1997 consisted primarily of interest income from investments made with the net proceeds from Pixar's initial public offering of common stock. Income Taxes Income tax expense from continuing operations of $246,000 for the year ended December 31, 1995 represented federal and state alternative minimum taxes (after utilization of net operating loss carryforwards) on the earnings of Pixar following termination of its S corporation status. Income tax expense from continuing operations of $2.0 million and $9.9 million for the years ended December 31, 1996 and 1997, respectively, consisted primarily of state income taxes and federal alternative minimum tax. Income taxes increased from 1995 to 1997 due to increased earnings and to full utilization of state net operating loss carryforwards during 1996. Pixar had net operating loss carryforwards for federal income tax purposes from pre-S corporation years of approximately $3.4 million as of December 31, 1997. See Notes 1 and 7 of Notes to Financial Statements. Results of Discontinued Operations After the Co-Production Agreement was executed, Pixar determined that, despite the fact that Pixar's first CD-ROM titles were successful on relative terms, the resources devoted to its interactive products division would be better allocated to other projects arising from the Co-Production Agreement. Pixar determined in March 1997 to discontinue its business of producing CD-ROM and other interactive products and has redirected the approximately 60 employees in this division to film and related projects within Pixar. Discontinued operations, net of income taxes, resulted in losses of $1.7 million and $1.0 million in 1995 and 1996, respectively. Pixar recorded income from discontinued operations, net of taxes, of $234,000 in 1997 primarily due to royalty income received. Pixar anticipates that future royalty income will exceed costs to be incurred in all future periods. See Note 12 of Notes to Financial Statements. ANTICIPATED NET LOSSES IN 1998 AND THE FIRST HALF OF 1999 A number of factors are expected to result in net losses in 1998 and in the first half of 1999, as discussed more fully below. End of Toy Story Revenues Pixar has already recognized the vast majority of the revenue it expects to receive from Toy Story. While relatively minor amounts of revenue may be received by Pixar in subsequent periods from sources such as Toy Story merchandise royalties, Toy Story television airings, and minor remaining international home video sales of Toy Story, Pixar does not expect to recognize any further significant revenue from Toy Story in the future. 7 8 Timing of A Bug's Life and Toy Story Sequel Releases A Bug's Life is not expected to be released until the end of 1998 at the earliest, and revenue attributable to A Bug's Life is not expected to be recognized until after all marketing and distribution costs and fees have been recovered by Disney. Recovery of all costs depends on many factors and may not occur until six to twelve months after its release at the earliest, making it likely that Pixar will not recognize any revenue from A Bug's Life until the second half of 1999 at the earliest. In addition, Toy Story Sequel is not expected to be released until the end of 1999 at the earliest. As with A Bug's Life, Pixar does not expect to recognize any revenue from Toy Story Sequel until six to twelve months after its release at the earliest. Therefore Pixar is unlikely to recognize any revenue from Toy Story Sequel until the second half of 2000 at the earliest. Limited CD-ROM Income Although its first two CD-ROM products were successful on relative terms, Pixar determined in March 1997 to discontinue its business of producing CD-ROM and other interactive products in favor of other opportunities arising, in part, as a result of entering into the Co-Production Agreement. Pixar has not recognized and will not recognize any CD-ROM income from this discontinued operation in 1998 or thereafter, other than royalty income attributable to the two existing Toy Story CD-ROM products. Pixar has reassigned all of the approximately 60 employees previously employed in the CD-ROM division to feature film productions and other departments within Pixar. Possible Decline in Sales of RenderMan Due to Shift in Focus As a result of Pixar's reduced emphasis on the commercialization of software in favor of products sold for their content, Pixar continues to expect to dedicate less time and resources to distributing and marketing RenderMan than it has in the past and further expects that licensing of RenderMan may decline. Increase in Operating Expenses and Tax Rate In 1996 and 1997, Pixar significantly increased its operating expenses, and Pixar plans to continue to increase its operating expenses to fund greater levels of research and development and to expand operations. Specifically, Pixar expects its spending levels to increase significantly due to continued investment in proprietary software systems, increased compensation costs as a result of intense competition for animators, creative personnel, technical directors and other personnel, and increased costs associated with the expansion of its facilities. A portion of Pixar's operating expenses that are allocable to film productions are capitalized by Pixar or reimbursed by Disney under the Co-Production Agreement. To the extent that the increases in expenses are not capitalized by Pixar nor paid for by Disney, Pixar's operating expenses will significantly increase in 1998. In addition, in 1998, if the story for the Fourth Film is not approved, Pixar could be required to write-off certain related film costs previously capitalized. Finally, Pixar's tax rate increased in the year ended December 31, 1997 and is likely to increase in future years due to near complete utilization of remaining net operating losses in 1997. Impact on Operating Results As a result of the above factors, Pixar expects revenue to substantially decline in 1998 as compared to the year ended December 31, 1997. At the same time, Pixar's operating expenses are expected to increase in 1998. Therefore, Pixar expects revenue and operating results in 1998 to decline substantially from revenue and operating results in 1997. Pixar expects operating and net losses in 1998 and in the first half of 1999. Operating results thereafter will depend upon the success of Pixar's next films, starting with A Bug's Life. 8 9 DEPENDENCE ON TOY STORY, A BUG'S LIFE AND TOY STORY SEQUEL Dependence on Toy Story For at least 1998 and the first half of 1999, Pixar's revenue and operating results will again be largely dependent upon whatever remains to be received from Toy Story merchandise royalties, any remaining Toy Story home video revenues and revenue from television airings of Toy Story. Pixar recognized the vast majority of Toy Story home video revenue in 1997 and expects little revenue from Toy Story or related products in 1998 and thereafter. Pixar also expects little or no royalty income from its Toy Story CD-ROM products in 1998 or thereafter. Because A Bug's Life is not expected to be released until the end of 1998 at the earliest, and Toy Story Sequel is not expected to be released until the end of 1999 at the earliest, any other revenues in 1998 and in the first half of 1999 will be primarily dependent upon Pixar's other businesses, from which Pixar expects limited revenue. Dependence on A Bug's Life and Toy Story Sequel Beyond 1998 and the first half of 1999, Pixar expects to be significantly dependent upon the success of A Bug's Life, Toy Story Sequel, and the Fourth Film (the "Current Projects") and related products. Although development and/or production on each of the Current Projects is underway, there can be no assurance that any of the Current Projects will be successfully produced and released when scheduled or thereafter. There can be no assurance that Pixar will not experience difficulties that could delay or prevent the successful development or production of any of the Current Projects or subsequent animated feature films or related products. If Pixar is unable to produce and develop on a timely basis the Current Projects and subsequent animated feature films and related products that meet with broad market acceptance, Pixar's business, operating results and financial condition will be materially adversely affected. The development of the Fourth Film only began in late 1996. Although it is currently targeted for release in 2000, to date there has been no final approval under the Co-Production Agreement of the story treatment or the budget for the Fourth Film and there can be no assurance that it will be released as targeted in 2000. As a result, for the next two or three years, Pixar expects to be significantly dependent upon A Bug's Life and Toy Story Sequel. Risks Associated with A Bug's Life Under the Co-Production Agreement, Pixar shares the production costs of A Bug's Life. These costs will initially be capitalized as film production costs under SFAS No. 53, Financial Reporting by Producers and Distributors of Motion Picture Films, and then be amortized over the expected revenue stream when revenue is recognized. If A Bug's Life is not an extraordinary box office success similar to Toy Story, the amount of revenue recognized will not be significant, and the capitalized production costs will have to be amortized in large amounts over a limited number of quarters, resulting in significant costs of film revenue in those quarters and, potentially, significant quarterly operating and net losses. Animated feature films that become extraordinary box office successes are rare. Pixar believes, based on available information, that there is a reasonable basis to conclude that of the more than 40 animated feature films introduced since 1990, only two movies generated domestic box office revenues greater than Toy Story, and both of those films were produced and distributed solely by Disney. During at least the last five years, Pixar believes that there has been no fully-animated feature film (other than Toy Story) produced or developed by a studio other than Disney that has achieved more than $65 million in domestic box office revenues. While A Bug's Life will be co-financed, promoted and marketed by Disney, it will have a different look, theme and musical style than Disney's other recent animated films (except for Toy Story), and there can be no assurance that it will have the same audience appeal as Disney's other animated films. For example, The Nightmare Before Christmas, released in 1993, was an animated feature film with a different appearance than traditional, hand drawn cel animated feature films such as Beauty and the Beast, The Lion King, Aladdin, Pocahontas, The Hunchback of Notre Dame and Hercules and did not experience the same box office returns as those films. As a result, A Bug's Life and related products may not generate significant revenue and operating results for Pixar, even 9 10 if A Bug's Life is critically acclaimed and achieves substantial, but not extraordinary, box office success. See "--Risks Associated with Co-Production Agreement--Dependence on Disney for Distribution and Promotion of Feature Films and Related Products," "Risks of Motion Picture Industry," and "Business--Relationship with Disney. " See also Note 4 of Notes to Financial Statements. Risks Associated with Toy Story Sequel. As a theatrical feature film release, Toy Story Sequel is subject to the same risks associated with A Bug's Life specified above. In addition, because it is a sequel, there are also risks unique to Toy Story Sequel. With a theatrical sequel, the story concept and characters are not as novel as the original film. In the vast majority of cases in which a film that achieved domestic box office receipts of greater than $100 million was followed by the release of a sequel, the sequel did not perform as well at the box office as the original. This was the case for sequels to such films as Star Wars, Jurassic Park, Home Alone, Jaws, Batman, Raiders of the Lost Ark, Beverly Hills Cop, Ghostbusters and Back to the Future, among others. In many cases, sequels substantially under-perform the original film. In far fewer cases have sequels performed as well or better than the original blockbuster feature film, and in almost all of these cases, the original feature films and related sequels were action-adventure films, such as Lethal Weapon and Die Hard. Accordingly, there can be no assurance that Toy Story Sequel will perform as well as Toy Story at the box office. It is possible that Toy Story Sequel will substantially under-perform the original feature film. In addition, fees and participations paid to key talent on Toy Story Sequel are substantially greater than for the original film, which will have the effect of increasing the cost of the film. As a result of these factors and the same factors associated with A Bug's Life, Toy Story Sequel and related products may not generate significant revenue and operating results for Pixar, even if Toy Story Sequel is critically acclaimed and achieves substantial, but not extraordinary, box office success. Production Budgets Given the escalation in compensation rates of people required to work on the Current Projects, the number of people required to work on the Current Projects, and the equipment needs, the budget for the Current Projects and subsequent films and related products are and will continue to be substantially greater than the budget for Toy Story and will be financed equally by Pixar and Disney under the Co-Production Agreement. In addition, due to production exigencies which are often difficult to predict, Pixar believes that it is not uncommon for film production spending to exceed film production budgets and there can be no assurance that any of the Current Projects can be completed within the budgeted amounts. For example, in order to meet the production schedule, substantially all employees from Pixar's animation services group are expected to be assigned to A Bug's Life for the duration of its production, which will result in a larger production staff than originally anticipated and which will generate additional production costs. LIQUIDITY RISKS Pursuant to the Co-Production Agreement, Pixar will co-finance the next five animated feature films which it produces, including A Bug's Life and the Fourth Film. Pixar will also co-finance Toy Story Sequel on the same basis as the other theatrical films. In the future, Pixar may co-finance other derivative works such as sequels, interactive products and television productions. In addition, Pixar is planning construction of a new headquarters and studio facility in Emeryville, California, construction of which will begin in the first half of 1998 and which may be financed by the use of Pixar's cash. As Pixar does not expect to generate substantial, if any, cash from operations in 1998, the production costs of A Bug's Life, the Fourth Film, Toy Story Sequel and possibly costs of the new Emeryville facility will have a material adverse impact on Pixar's cash and short-term investment balances. As of December 31, 1997, Pixar had approximately $176 million in cash and short-term investments. Pixar believes that these funds will be sufficient to meet its anticipated cash needs for working capital and capital expenditures, including the development and production costs of A Bug's Life, the Fourth Film and Toy Story Sequel, until Pixar begins receiving cash from the release of these films (which is generally not expected to occur until the second half of 1999 at the earliest). However, even if these films generate cash, unless each is a success such that Pixar 10 11 recovers on a timely basis its share of the production costs, as well as other operating expenses and capital expenditures, Pixar will be required to seek financing for its ongoing commitments under the Co-Production Agreement and any other requirements of its operations. Pixar may also seek additional financing in connection with the expansion of its facilities. See also"--Liquidity and Capital Resources." The sale of additional equity or convertible debt securities would result in additional dilution to Pixar's shareholders. Moreover, there can be no assurance that Pixar will be successful in obtaining future financing, or even if such financing is available, that it will be obtained on terms favorable to Pixar or on terms providing Pixar with sufficient funds to meet its obligations and objectives. The failure to obtain such financing would have a material adverse effect on Pixar's business, operating results and financial condition. CAPITALIZED FILM PRODUCTION COSTS Although Disney funded the entire production of Toy Story, Pixar contractually guaranteed certain of the film budget overages and was liable to Disney for those amounts under the original Feature Film Agreement. Because these are "production costs" under SFAS No. 53, the costs were capitalized and amortized against film revenue. During 1996, Pixar's budget overage liability of $2.3 million owed to Disney was satisfied through Disney's deduction of that amount from Pixar's share of Toy Story revenues. In 1997, Pixar recovered these overages from Disney when Toy Story reached certain predefined criteria in the Feature Film Agreement (see "Results of Operations--Revenues"). Film production costs of $1.6 million and $1.5 million were amortized against film revenue in 1996 and 1997, respectively. Since substantially all Toy Story revenue has been recognized, all significant related capitalized film costs have been amortized as of December 31, 1997. Pixar had $28.6 million in capitalized film production costs as of December 31, 1997, consisting primarily of costs relating to A Bug's Life, Toy Story Sequel and the Fourth Film, all of which are being co-financed by Disney under the Co-Production Agreement. See Notes 1 and 4 of Notes to Financial Statements. LIQUIDITY AND CAPITAL RESOURCES Cash and short-term investments increased from $161.0 million at December 31, 1996 to $176.0 million at December 31, 1997 due primarily to net proceeds of $14.9 million from Disney in connection with the sale of 1,000,000 shares of Pixar Common Stock and the issuance of two warrants to purchase an aggregate of 1,500,000 shares of Common Stock. See Note 6 of Notes to Financial Statements. Cash provided by operating activities in 1995 primarily consisted of net income resulting from patent licensing revenue of $6.5 million and an increase in accrued liabilities, somewhat offset by growth in other receivables. Cash provided by operating activities in 1996 primarily consisted of net income resulting from film revenues related to Toy Story and from the cash portion of patent licensing revenue totaling $6.0 million. In 1997, cash provided by operating activities largely consisted of net income of $22.2 million primarily resulting from film revenues related to Toy Story as well as growth in accounts payable and accrued liabilities and a tax benefit from disqualifying dispositions. Cash used in investing activities in 1995 and 1996 primarily consisted of investments in short-term securities. In 1997, cash used in investing activities primarily consisted of investments in short term securities, capitalized film production costs and purchase of property and equipment, as described below, offset by net proceeds from maturities of short term investments. Cash flows provided by financing activities in 1995 primarily consisted of the net proceeds of approximately $139.7 million from Pixar's initial public offering of Common Stock. Cash used in financing activities in 1996 primarily consisted of the repayment of the note payable to the majority shareholder. In 1997, cash flows provided by financing activities primarily consisted of the net proceeds of approximately $14.9 million from sale of stock to Disney in conjunction with the signing of the Co-Production Agreement. See Note 4 and Note 6 of Notes to Financial Statements. At December 31, 1997, Pixar's capital commitments primarily consisted of obligations to fund production costs of films and derivative products under the Co-Production Agreement and costs related to a new studio facility, both discussed below. Pixar also has obligations to pay portions of any revenue derived from each feature film 11 12 produced under the Co-Production Agreement to its entertainment law firm in consideration for services rendered and obligations under operating leases. See Note 9 of Notes to Financial Statements. Pixar expects 1998 cash expenditures for capital equipment to be approximately $6.0 million, excluding costs related to the new studio facility discussed below. Film Production Costs Under Co-Production Agreement. Under the Co-Production Agreement, in order to fund several films in various stages of development and production, Pixar's share of direct film costs and other costs benefiting the productions is expected to total approximately $42 million in 1998, which will directly impact working capital. New Studio Facility. In May 1997, Pixar exercised its option (which option Pixar purchased in 1996) and paid $5.8 million to purchase approximately 15 acres of land in Emeryville, California to build a new headquarters and studio facility. For the new facility, Pixar incurred total capital expenditures of $7.7 million in 1997, inclusive of the property costs, and expects to spend approximately $17 million in 1998. To date, Pixar has chosen to use its existing cash resources to fund construction costs. Pixar may continue to use its cash resources for such expenditures, or may choose to finance such capital expenditures through issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. As of December 31, 1997, Pixar's principal source of liquidity was approximately $176.0 million in cash and short-term investments. Pursuant to the Co-Production Agreement, Pixar will co-finance the next five animated feature films which it produces, including A Bug's Life and the Fourth Film. Pixar will also co-finance Toy Story Sequel on the same basis as the other theatrical films. In the future, Pixar may co-finance other derivative works such as theatrical sequels, direct to home video sequels, interactive products and television productions. As Pixar does not expect to generate substantial, if any, cash from operations in 1998, the production costs of A Bug's Life, the Fourth Film and Toy Story Sequel are expected to have a material adverse impact on Pixar's cash and short-term investment balances. Pixar believes that available funds will be sufficient to meet its anticipated cash needs for working capital and capital expenditures, including the production costs of A Bug's Life, the Fourth Film and Toy Story Sequel, until Pixar begins receiving cash from the release of these films (which is generally not expected to occur until the second half of 1999). However, even if these films generate cash, unless each is a success such that Pixar recovers on a timely basis its share of the production costs, as well as other operating expenses and capital expenditures, Pixar will be required to seek financing for its ongoing commitments under the Co-Production Agreement and any other requirements of its operations. Pixar may also seek additional financing in connection with the expansion of its facilities. The sale of additional equity or convertible debt securities would result in additional dilution to Pixar's shareholders. Moreover, there can be no assurance that Pixar will be successful in obtaining future financing, or even if such financing is available, that it will be obtained on terms favorable to Pixar or on terms providing Pixar with sufficient funds to meet its obligations and objectives. The failure to obtain such financing would have a material adverse effect on Pixar's business, operating results and financial condition. 12 13 Independent Auditors' Report The Board of Directors and Shareholders Pixar: We have audited the accompanying balance sheets of Pixar as of December 31, 1996 and 1997 and the related statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1997. These financial statements are the responsibility of Pixar's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pixar as of December 31, 1996 and 1997, and the results of its operation and its cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP San Francisco, California January 30, 1998 13 14 PIXAR BALANCE SHEETS (In thousands, except share data)
DECEMBER 31, 1996 1997 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 44,648 $ 101,847 Short-term investments 116,321 74,198 Trade accounts receivable, net of allowance for returns and doubtful accounts of $259 and $257 in 1996 and 1997, respectively 929 1,321 Other receivables 3,399 2,667 Prepaid expenses and other current assets 982 781 Net assets - discontinued operations 1,469 2 Capitalized film production costs, current portion 1,372 -- --------- --------- Total current assets 169,120 180,816 Property and equipment, net 4,655 21,462 Capitalized film production costs, net of current portion 1,578 28,589 Other assets 1,588 201 --------- --------- Total assets $ 176,941 $ 231,068 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,060 $ 1,694 Income taxes payable -- 1,776 Payable to Disney -- 2,162 Accrued liabilities 4,740 7,276 Unearned revenue 337 860 --------- --------- Total current liabilities 6,137 13,768 --------- --------- Commitments and contingencies Shareholders' equity: Preferred stock, no par value; 5,000,000 shares authorized and no shares issued and outstanding -- -- Common stock, no par value; 100,000,000 shares authorized; 39,413,102 and 42,410,707 shares issued and outstanding as of December 31, 1996 and 1997, respectively 187,308 210,902 Unrealized gain (loss) on investments (48) 29 Deferred compensation (1,049) (414) Retained earnings (accumulated deficit) (15,407) 6,783 --------- --------- Total shareholders' equity 170,804 217,300 --------- --------- Total liabilities and shareholders' equity $ 176,941 $ 231,068 ========= =========
See accompanying notes to financial statements. 14 15 PIXAR STATEMENTS OF OPERATIONS (In thousands, except per share data)
Year Ended December 31, 1995 1996 1997 -------- -------- -------- Revenues: Software $ 3,144 $ 3,297 $ 4,499 Animation services 2,469 3,947 1,556 Film -- 18,847 26,914 Patent licensing 6,500 9,127 1,730 -------- -------- -------- Total revenues 12,113 35,218 34,699 -------- -------- -------- Cost of revenues: Software 513 113 81 Animation services 1,873 3,041 973 Film -- 1,551 1,484 -------- -------- -------- Total cost of revenues 2,386 4,705 2,538 -------- -------- -------- Gross profit 9,727 30,513 32,161 -------- -------- -------- Operating expenses: Research and development 2,994 4,501 4,712 Sales and marketing 1,392 1,471 1,450 General and administrative 2,479 4,249 5,129 Operating expense reimbursement -- -- (2,184) -------- -------- -------- Total operating expenses 6,865 10,221 9,107 -------- -------- -------- Income from continuing operations 2,862 20,292 23,054 Other income, net 715 8,033 8,766 -------- -------- -------- Income from continuing operations before taxes 3,577 28,325 31,820 Income tax expense 246 1,983 9,864 -------- -------- -------- Income from continuing operations 3,331 26,342 21,956 Income (loss) from discontinued operations (includes income tax benefit of $126 and $77 in 1995 and 1996, respectively, and income tax expense of $105 in 1997) (1,704) (1,023) 234 -------- -------- -------- Net income $ 1,627 $ 25,319 $ 22,190 ======== ======== ======== Basic net income per share from continuing operations $ 0.26 $ 0.68 $ 0.53 Basic net income (loss) per share from discontinued operations (0.13) (0.02) 0.01 -------- -------- -------- Basic net income per share $ 0.13 $ 0.66 $ 0.54 ======== ======== ======== Shares used in computing basic net income (loss) per share 12,955 38,632 41,224 ======== ======== ======== Diluted net income per share from continuing operations $ 0.10 $ 0.56 $ 0.46 Diluted net income (loss) per share from discontinued operations (0.05) (0.02) 0.00 -------- -------- -------- Diluted net income per share $ 0.05 $ 0.54 $ 0.46 ======== ======== ======== Shares used in computing diluted net income (loss) per share 33,216 46,989 48,144 ======== ======== ========
See accompanying notes to financial statements. 15 16 PIXAR STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (In thousands)
Unrealized Retained Total Gain Earnings Share- Preferred Stock Common Stock (Loss) on Deferred (Accum- holders' --------------------- -------------------- Invest- Compen- ulated Equity Shares Amount Shares Amount ments sation Deficit) (Deficit) --------- --------- --------- --------- --------- --------- --------- --------- Balances, December 31, 1994 -- -- 20 $ 48,255 $ 63 -- $ (49,993) $ (1,675) Recapitalization (conversion of note payable to the majority shareholder and existing common stock into Series A preferred stock and common stock) 10,000 $ 47,900 9,980 (46,288) -- -- -- 1,612 Recapitalization of S corporation net operating losses -- -- -- (7,640) -- -- 7,640 -- Exercise of stock options -- -- 1,386 277 -- -- -- 277 Deferred compensation related to grant of stock options -- -- -- 3,680 -- $ (3,680) -- -- Amortization of deferred compensation -- -- -- -- -- 1,419 -- 1,419 Conversion of existing preferred stock into common stock (10,000) (47,900) 20,000 47,900 -- -- -- -- Initial public offering, net of expenses of $1,892 -- -- 6,900 139,661 -- -- -- 139,661 Unrealized gain on investments -- -- -- -- 76 -- -- 76 Realized gain on investment -- -- -- -- (90) -- -- (90) Net income -- -- -- -- -- -- 1,627 1,627 --------- --------- --------- --------- --------- --------- --------- --------- Balances, December 31, 1995 -- -- 38,286 185,845 49 (2,261) (40,726) 142,907 Exercise of stock options, including tax benefit from disqualifying dispositions -- -- 1,127 1,463 -- -- -- 1,463 Amortization of deferred compensation -- -- -- -- -- 1,212 -- 1,212 Unrealized loss on investments -- -- -- -- (97) -- -- (97) Net income -- -- -- -- -- -- 25,319 25,319 --------- --------- --------- --------- --------- --------- --------- --------- Balances, December 31, 1996 -- -- 39,413 187,308 (48) (1,049) (15,407) 170,804 Exercise of stock options, including tax benefit from disqualifying dispositions -- -- 1,998 8,709 -- -- -- 8,709 Issuance of common stock and warrants, net of expenses of $115 -- -- 1,000 14,885 -- -- -- 14,885 Amortization of deferred compensation -- -- -- -- -- 635 -- 635 Unrealized gain on investments -- -- -- -- 77 -- -- 77 Net income -- -- -- -- -- -- 22,190 22,190 --------- --------- --------- --------- --------- --------- --------- --------- Balances, December 31, 1997 -- -- 42,411 $ 210,902 $ 29 $ (414) $ 6,783 $ 217,300 ========= ========= ========= ========= ========= ========= ========= =========
See accompanying notes to financial statements. 16 17 PIXAR STATEMENTS OF CASH FLOWS (In thousands)
Year Ended December 31, 1995 1996 1997 --------- --------- --------- Cash flows from operating activities: Net income $ 1,627 $ 25,319 $ 22,190 Adjustments to reconcile net income to net cash provided by operating activities: Discontinued operations 1,704 1,023 (234) Amortization of deferred compensation, net of capitalization 1,127 1,168 611 Non-cash revenue attributable to film overbudget -- (2,324) -- Depreciation and amortization 467 732 3,182 Amortization of capitalized film production costs -- 1,551 1,484 Tax benefit from disqualifying dispositions -- 1,236 7,688 Licenses exchanged for equipment -- (1,465) (1,594) Loss on disposition of property and equipment 13 -- 718 Gain on sale of equity securities (90) -- -- Changes in operating assets and liabilities: Trade accounts receivable (473) (144) (392) Other receivables (1,625) (1,614) 732 Prepaid expenses and other current assets (85) (673) 288 Accounts payable 86 318 634 Other liabilities 2,456 1,539 4,698 Income taxes payable -- -- 1,776 Unearned revenue (142) 68 584 --------- --------- --------- Net cash provided by continuing operations 5,065 26,734 42,365 Net cash provided by (used in) discontinued operations (1,688) (2,508) 1,701 --------- --------- --------- Net cash provided by operating activities 3,377 24,226 44,066 --------- --------- --------- Cash flows from investing activities: Purchase of property and equipment (968) (2,371) (17,761) Proceeds from sale of property and equipment 33 -- 31 Proceeds from sale of short term securities 90 175,360 169,210 Investments in short term securities (46,953) (244,776) (127,010) Capitalized film production costs -- (1,840) (27,098) Other assets (497) (1,091) (145) --------- --------- --------- Net cash used in investing activities (48,295) (74,718) (2,773) --------- --------- --------- Cash flows from financing activities: Net proceeds from initial public offering 139,661 -- -- Net proceeds from issuance of common stock and warrants -- -- 14,885 Proceeds from exercised stock options 277 227 1,021 Proceeds from (repayment of) note payable to shareholder 2,225 (2,373) -- --------- --------- --------- Net cash provided by (used in) financing activities 142,163 (2,146) 15,906 --------- --------- --------- Net increase (decrease) in cash and cash equivalents 97,245 (52,638) 57,199 Cash and cash equivalents at beginning of period 41 97,286 44,648 --------- --------- --------- Cash and cash equivalents at end of period $ 97,286 $ 44,648 $ 101,847 ========= ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $ 172 $ 523 $ 390 ========= ========= ========= Supplemental disclosure of non-cash investing and financing activities: Credits used to purchase equipment $ -- $ 3,127 $ 1,730 ========= ========= ========= Film overbudget reductions $ -- $ 3,324 $ -- ========= ========= ========= Non-cash film production costs capitalized $ 3,616 $ 44 $ 24 ========= ========= ========= Conversion of note payable to shareholder, and accrued interest, to equity $ 1,612 $ -- $ -- ========= ========= ========= Accrual of stock option deferred compensation $ 3,680 $ -- $ -- ========= ========= ========= Unrealized gain (loss) on investments $ (14) $ (97) $ 77 ========= ========= =========
See accompanying notes to financial statements. 17 18 PIXAR NOTES TO FINANCIAL STATEMENTS (1) SUMMARY OF PIXAR AND SIGNIFICANT ACCOUNTING POLICIES The Company Pixar was incorporated in the state of California on December 9, 1985. The Company is a digital animation studio with the technical, creative and production capabilities to create a new generation of animated feature films and related products. Cash and Cash Equivalents Pixar considers all highly liquid instruments with an original maturity of 90 days or less to be cash equivalents. Cash equivalents as of December 31, 1997 consisted primarily of U.S. Treasury Bills, demand notes, commercial paper and government agency bonds. Short-Term Investments Pixar has classified its investments as "available-for-sale." Such investments are recorded at fair value, and unrealized gains and losses, if material, are reported as a separate component of equity until realized. Interest income is recorded using an effective interest rate with the associated premium or discount amortized to interest income. The cost of securities sold is based upon the specific identification method. Property and Equipment Property and equipment are stated at cost. Depreciation of property and equipment is calculated using the straight-line method over estimated useful lives ranging from three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the life of the improvement. Film Production Costs Film production costs include costs to develop and produce computer animated motion pictures, mainly salaries, equipment and overhead. Film production costs in excess of reimbursable amounts are capitalized. Once a film is released, any film production costs capitalized will be amortized in the proportion that the revenue during the year for each film bears to the estimated revenue to be received from all sources under the individual film forecast method. Estimates of anticipated total gross revenues will be reviewed periodically and revised when necessary. Unamortized film production costs will be compared with net realizable value each reporting period on a film-by-film basis. If estimated gross revenues are not sufficient to recover the unamortized film production costs, the unamortized film production costs will be written down to net realizable value. The costs of released feature films are classified as current assets to the extent such costs are expected to be recovered from primary markets. Costs of released feature films recoverable from secondary markets and unreleased films are classified as noncurrent assets. Research and Development Costs Research and development costs are charged to operations as incurred. In accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, development costs related to software products are expensed as incurred until the technological feasibility of the product has been established. After technological feasibility is established, additional costs would be capitalized. To date, Pixar has not capitalized any software development costs after technological feasibility has been established on its software products since Pixar believes its process for developing 18 19 software is essentially completed concurrently with the establishment of technological feasibility and costs incurred thereafter have not been material. Revenue Recognition Compensation based on the revenues from the distribution of animated feature films and related products is recognized as earned and reasonably estimable. The related revenue cycle is generally five to seven years, with the substantial majority expected to be recognized in the first two years. Software licensing revenue is recognized upon shipment if there are no significant vendor obligations and if collection is probable. Animation service revenues are recognized on the percentage-of-completion method of accounting. Patent licensing revenue is recognized upon release of the rights to the technology. Financial Instruments and Concentration of Credit Risk The carrying value of financial instruments, including marketable securities and accounts receivable, approximate fair value. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments and trade accounts receivable. The Company invests its excess cash in a variety of investment grade, interest-bearing securities with a major bank. This diversification of risk is consistent with the Company's policy to ensure safety of principal and maintain liquidity. Excluding its software business, the Company's revenue is concentrated in a few large customers, as outlined in Note 10. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Income Taxes Pixar utilizes SFAS No. 109, Accounting for Income Taxes, which requires the use of the asset and liability method of accounting for income taxes. Net Income per Share On October 1, 1997, Pixar adopted SFAS No. 128, Earnings per Share. In accordance with SFAS No. 128, basic net income per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period and using the treasury stock method for options and warrants (see Note 11). On February 3, 1998, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 98 which supersedes the previous method used, SAB No. 83, for the calculation of earnings per share in periods including or prior to initial public offerings. The Company has restated net income per share in accordance with SAB No. 98 and SFAS No. 128. Reclassifications Certain amounts reported in previous years have been reclassified to conform to the 1997 financial statement presentation. 19 20 Stock Option Plans The Company uses the intrinsic value-based method to account for all of its employee stock-based compensation plans. Recently Issued Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and displaying comprehensive income and its components in the financial statements. The Company is in the process of determining its preferred format. This Statement is effective for fiscal years beginning after December 15, 1997. Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Statement establishes standards for companies to report information about operating segments in annual and interim financial statements. The Company is in the process of determining its preferred format. This Statement is effective for financial statements for periods beginning after December 15, 1997. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, Software Revenue Recognition. The Company will be required to adopt SOP 97-2 for software transactions entered into beginning January 1, 1998, and retroactive application to years prior to adoption is prohibited. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements (i.e., software products, upgrades/enhancements, postcontract customer support, etc.) to be allocated to each element based on the relative values of the elements and revenue of each element to be recognized individually using the most appropriate accounting method. The Company believes that adoption of SOP 97-2 will not have a material impact on the Company's results of operations. (2) SHORT-TERM INVESTMENTS All investments were considered available-for-sale securities and consisted of the following (in thousands):
UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE ---------------------------------------------- DECEMBER 31, 1996: U.S. Treasury Bills $ 39,186 -- $ (33) $ 39,153 Demand notes 22,106 -- -- 22,106 Commercial paper 20,000 -- -- 20,000 Federal Agency obligations 69,495 $ 6 (21) 69,480 Banker's Acceptances 4,886 -- -- 4,886 ---------------------------------------------- $ 155,673 $ 6 $ (54) $ 155,625 ============================================== DECEMBER 31, 1997: U.S. Treasury Bills $ 41,993 $ 27 -- $ 42,020 Demand notes 77,817 -- -- 77,817 Commercial paper 16,474 -- -- 16,474 Federal Agency obligations 32,175 2 -- 32,177 Time Deposits 5,000 -- -- 5,000 ---------------------------------------------- $ 173,459 $ 29 -- $ 173,488 ==============================================
20 21 The contractual maturities of available-for-sale debt securities as of December 31, 1997, regardless of their balance sheet classification, are as follows (in thousands):
COST FAIR VALUE ------------------------ Due within one year $158,501 $158,523 Due after one year through five years 14,958 14,965 ------------------------ $173,459 $173,488 ========================
(3) BALANCE SHEET COMPONENTS Selected balance sheet components are as follows (in thousands):
DECEMBER 31, 1996 1997 ------- ------- Property and equipment: Land -- $ 7,669 Equipment $ 6,238 14,751 Leasehold improvements 1,007 2,867 Construction in proces -- 1,571 ------- ------- 7,245 26,858 Less accumulated depreciation and amortization 2,590 5,396 ------- ------- $ 4,655 $21,462 ======= ======= Accrued liabilities: Employee-related expenses $ 2,249 $ 4,213 Professional services 1,544 1,375 Other 947 1,688 ------- ------- $ 4,740 $ 7,276 ======= =======
(4) FEATURE FILM AND CO-PRODUCTION AGREEMENTS Feature Film Agreement In 1991, Pixar entered into a feature film agreement with Walt Disney Pictures, a wholly owned subsidiary of Walt Disney Pictures and Television (together with its subsidiaries and affiliates collectively referred to herein as "Disney"), to develop and produce up to three computer animated feature films (the "Feature Film Agreement"). Pixar is entitled to receive compensation based on revenue from the distribution of these films and related products. In 1995, Pixar released its first feature film under the terms of the Feature Film Agreement, Toy Story. Under that agreement, Disney fully funded Toy Story production costs. All production costs incurred by Pixar were reimbursed by Disney on a current basis, and recorded by Pixar as cost reimbursements. Accordingly, no revenues were recorded. The Feature Film Agreement provided that, if production costs for Toy Story exceeded the agreed-upon budget, Pixar was obligated to fund certain of the cost overages, but was entitled to recover those cost overages if Toy Story met certain criteria with respect to profitability. Pixar's share of the film cost overage was approximately $3,300,000 as of December 31, 1995, which was reduced by $1,000,000 during the year ended December 31, 1996. Additional costs capitalized as Toy Story film production costs in the three year period ended December 31, 1997 included amortization of deferred compensation expense and certain participation fees. Based on the individual film forecast method, Toy Story film production costs were fully amortized by the year ended December 31, 1997. 21 22 Co-Production Agreement In February 1997, Pixar and Disney entered into a new co-production agreement (the Co-Production Agreement) which now governs all films made by Pixar since Toy Story. Films in development or production at Pixar as of December 31, 1997 include A Bug's Life, Toy Story Sequel, and Pixar's fourth film (the "Fourth Film"). Under the Co-Production Agreement, Pixar, on an exclusive basis, will produce five computer animated theatrical motion pictures (the Pictures) for distribution by Disney. A Bug's Life and the Fourth Film count toward the five Pictures, whereas Toy Story Sequel is a derivative work that will not count toward the five Pictures. However, Pixar and Disney have agreed that all provisions of the Co-Production Agreement applicable to the Pictures will also apply to Toy Story Sequel. Pixar and Disney will co-own, co-brand and co-finance the production costs of the Pictures, and will share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing, distribution and other predefined fees and costs. The Co-Production Agreement generally provides that Pixar will produce each Picture and Disney will control decisions relating to film marketing and distribution. The total film production costs and related amounts capitalized are as follows (in thousands):
TOTAL AS OF 1995 AND DECEMBER 31, DECEMBER 31, PRIOR 1996 1997 1997 -------- -------- -------- -------- RELEASED FILM: Disney production costs (unaudited) $ 18,845 $ 754 -- $ 19,599 Pixar reimbursed film production costs 8,069 53 -- 8,122 --------------------------------------- Total film production costs (unaudited) $ 26,914 $ 807 -- 27,721 =========================== Disney reimbursements of budgeted costs and approved overages (unaudited) (25,396) Amortization of deferred compensation 360 Participation fees 350 Amortization of film production costs (3,035) -------- Total film production costs capitalized for released films -- -------- FILMS IN PROCESS: Pixar production costs -- -- $ 28,339 28,339 Disney production funding (unaudited) $ 2,807 $ 17,782 7,750 28,339 --------------------------------------- Total film production costs (unaudited) $ 2,807 $ 17,782 $ 36,089 56,678 ============================= Disney reimbursements of production costs (unaudited) (28,339) Participation fees 250 -------- Total film production costs capitalized for films in process 28,589 -------- Total film production costs capitalized $ 28,589 ========
Under the Co-Production Agreement, certain operating expenses benefiting the productions, such as certain research and development and certain general and administrative expenses, are paid half by Pixar and half by Disney. From the date of the Co-Production Agreement, the Company recorded the following amounts reimbursed by Disney as offsets to the following expense categories (in thousands): 22 23 February 24 to December 31, 1997 -------------- Research and development $2,012 General and administrative 1,277 ------ Total $3,289 ====== Since the Co-Production Agreement begins with Pixar's next films, A Bug's Life and Toy Story Sequel, both in various stages of production in 1996 and 1997, Pixar was entitled to reimbursement for Disney's share of certain of Pixar's operating expenses incurred in 1996 and the first two months of 1997, prior to signing the Co-Production Agreement. The determination of this $2,184,000 one-time operating expense reimbursement was finalized in the quarter ended September 30, 1997. The amount recorded represented reimbursements of the following expense categories (in thousands):
Year Ended January 1 to December 31, 1996 February 24, 1997 Total ----------------- ----------------- ----- Research and development $ 936 $ 179 $1,115 General and administrative 620 449 1,069 ----------------- ----------------- ----- Total $1,556 $ 628 $2,184 ================= ================= ======
There were no reimbursements receivable from Disney for Toy Story as of December 31, 1996 and December 31, 1997. The reimbursements receivable from Disney for A Bug's Life was $1,313,000 as of December 31, 1996. The reimbursements receivable from Disney for Toy Story Sequel was $617,000 as of December 31, 1996. All of these items are included in other receivables on the accompanying balance sheet. At December 31, 1997 the Disney payable of $2,162,000 consisted of advances in excess of Disney's actual share of expenditures for all films. (5) PATENT LICENSING ARRANGEMENTS As of December 31, 1995, fees of $6,500,000 were recognized on the licensing of certain patents. For the year ended December 31, 1996, fees of $9,127,000 were recognized on the licensing of certain patents. The Company delivered all rights to utilize the technology underlying the license to the licensee, and received a non-refundable fixed-fee payment of $6,000,000 in cash and $5,000,000 of credits for products to be purchased from the licensee by Pixar over the next four years. Following the release of the rights to utilize the patents to the licensee, Pixar maintained no significant vendor obligations to the licensee, so the Company recognized as revenue the fixed and determinable amounts of the $6,000,000 cash payment received, plus $3,127,000 that represented the portion of the credits Pixar used during the year ended December 31, 1996. Patent licensing revenue of $1,730,000 recognized in 1997 represents additional credits used. The remaining $143,000 of credits are expected to be utilized in 1998. (6) RELATED PARTY TRANSACTIONS Notes Payable to Shareholder As of December 31, 1995, Pixar had a $2,225,000 note payable to the majority shareholder, plus accrued interest of $148,000, which bore simple variable interest equal to prime rate revised quarterly (8.75% as of December 31, 1995). The note plus accrued interest was repaid in January 1996. Disney In conjunction with signing the Co-Production Agreement, Disney purchased for cash 1,000,000 shares of Pixar Common Stock, which Disney has agreed to hold for at least three years, and two warrants each exercisable for five years: one warrant to purchase 750,000 shares of Common Stock at an exercise price of $20.00 per share 23 24 and another warrant to purchase 750,000 shares of Common Stock at an exercise price of $25.00 per share. Pixar granted certain registration rights for the shares issuable upon exercise of the warrants. Upon consummation of this agreement in March 1997, Pixar received net proceeds of $14,885,000. (7) INCOME TAXES Pixar elected to be treated as an S corporation for federal income tax purposes as of January 1, 1992. The S corporation status was terminated as a result of the recapitalization described in Note 8. Accordingly, Pixar was taxed as a C corporation following the recapitalization. The components of income taxes from continuing operations are as follows (in thousands):
YEAR ENDED DECEMBER 31, 1995 1996 1997 ------------------------------------------ Income taxes: Current: Federal $ 203 $ 340 $ 944 State 43 136 1,288 Foreign -- -- 26 ------------------------------------------ Total current taxes 246 476 2,258 ------------------------------------------ Charge in lieu of taxes attributable to employer stock option plans -- 1,507 7,606 ------------------------------------------ Total tax provision $ 246 $1,983 $9,864 ==========================================
The following tabulation reconciles the statutory corporate federal income tax expense (benefit) (computed by multiplying Pixar's income from continuing operations, before income taxes by 34% for the years ended December 31, 1995 and 1996 and 35% for the year ended December 31, 1997) to Pixar's income tax expense (in thousands):
YEAR ENDED DECEMBER 31, 1995 1996 1997 ------------------------------------------ Expected income tax expense $ 1,216 $ 9,631 $11,137 State income taxes, net of federal tax effect 15 882 1,742 Change in beginning of year valuation allowance (1,028) (9,179) (3,370) Alternative minimum tax -- 611 -- Other, net 43 38 355 ------------------------------------------ Income taxes $ 246 $ 1,983 $ 9,864 ==========================================
The tax effects of temporary differences attributable to continuing operations that give rise to significant portions of the deferred tax assets are presented below (in thousands):
DECEMBER 31, 1996 1997 -------- -------- Deferred tax assets: Deferred compensation $ 1,016 $ 733 Capitalized film costs 539 5,981 Capitalized research expenses 210 134 Credit carryforwards 748 1,490 Net operating loss carryforwards 7,749 1,207 Reserves and accruals 348 1,536 -------- -------- Total gross deferred tax assets 10,610 11,081 Valuation allowance (10,610) (11,081) -------- -------- Net deferred tax assets $ -- $ -- ======== ========
24 25 Pixar has a valuation allowance as of December 31, 1997 which fully offsets its gross deferred tax assets due to the fact that there is no guarantee the Company will generate sufficient taxable income in the future to be able to realize any or all of the deferred tax assets. The increase in the valuation allowance for the year ended December 31, 1997 was $471,000. Included in the deferred tax assets above is approximately $7,600,000 related to stock option compensation for which the benefit when realized will be an adjustment to equity. As of December 31, 1997, Pixar had net operating loss carryforwards from pre-S corporation years of approximately $3,400,000 for federal income tax purposes. Pixar has research credit carryforwards of approximately $700,000 for federal income tax purposes. In addition, Pixar has alternative minimum tax credit carryforwards for federal income tax purposes of approximately $400,000. If not utilized, the federal operating loss and research credit carryforwards will expire in years 2004 through 2012. (8) SHAREHOLDERS' EQUITY Recapitalization and Stock Split As of December 31, 1994, Pixar had 100,000 shares of common stock authorized, 20,000 shares of common stock issued and outstanding, and no preferred stock authorized, issued and outstanding. In April 1995, the sole shareholder approved the recapitalization of Pixar, whereby the 20,000 shares of common stock then outstanding and a note payable to the sole shareholder were converted into 9,999,999 shares of Series A preferred stock and 10,000,002 shares of common stock. In October 1995, the Board of Directors approved a two-for-one stock split of the common stock. The 1995 financial statements have been retroactively restated to reflect the effect of the stock split on the common stock. Initial Public Offering In November 1995, Pixar completed an IPO of 6,900,000 shares of common stock for $22 per share, which resulted in proceeds to the Company of approximately $139,700,000, net of issuance costs of approximately $1,900,000. Deferred Compensation Pixar recorded deferred compensation of $3,680,000 for the difference between the grant price and the deemed fair value of the common stock underlying certain options granted in 1995. This amount is being amortized over the vesting period of the individual options, generally four years. Amortization of deferred compensation was approximately $1,419,000, $1,212,000 and $635,000 for the years ended December 31, 1995, 1996 and 1997, respectively. Of these amounts $292,000, $44,000 and $24,000 were capitalized as film production costs in 1995, 1996 and 1997, respectively. The remaining amounts of $1,127,000, $1,168,000 and $611,000 were expensed in 1995, 1996 and 1997, respectively. Stock Option Plans Pixar has stock option plans for employees, consultants and nonemployee directors which provide incentive and nonstatutory stock options. The option exercise price for incentive stock options is not less than the fair market value at the grant date. Nonstatutory options are granted at prices and terms determined by the Board of Directors, or a committee of the Board of Directors. Employee and consultant options generally vest 25% per year over four years. Initial grants to non-employee directors vest one-third annually for three years; subsequent grants vest after one year. All options have a term not greater than 10 years from the date of grant. As of December 31, 1997, Pixar had 15,472,321 shares reserved for issuance under the plans. 25 26 A summary of stock options outstanding as of December 31, 1995, 1996 and 1997 were as follows:
Weighted-average Shares exercise price ------ -------------- Outstanding at January 1, 1995 -- $ -- Granted 10,641,400 0.89 Exercised (1,386,500) 0.20 Forfeited (114,000) 0.20 ---------- Outstanding at December 31,1995 9,140,900 1.00 Granted 1,297,000 15.18 Exercised (1,126,602) 0.20 Forfeited (447,458) 15.79 ---------- Outstanding at December 31,1996 8,863,840 2.41 Granted 1,671,700 15.52 Exercised (1,997,605) 0.52 Forfeited (163,317) 12.53 ---------- Outstanding at December 31,1997 8,374,618 5.28 ==========
For various price ranges, weighted average characteristics of outstanding stock options at December 31, 1997 were as follows:
OPTIONS OUTSTANDING OPTIONS VESTED ------------------------------------------------- ----------------------------- Remaining Weighted-average Weighted-average Exercise prices Shares life (years) exercise price Shares exercise price - --------------- ------ ------------ -------------- ------ -------------- $ 0.20 5,049,980 7.35 $ 0.20 3,055,802 $ 0.20 $1.25 to $ 9.60 819,227 7.79 7.44 504,286 7.54 $10.80 to $15.00 1,707,503 8.97 13.29 225,653 12.57 $15.13 to $19.00 519,408 9.13 16.25 46,565 16.60 $19.13 to $25.88 278,500 9.61 21.50 -- --------- --------- -- 8,374,618 5.28 3,832,306 2.09 ========= =========
The Company uses the intrinsic value-based method to account for all of its employee stock-based compensation plans. Had compensation cost for the Company's two stock option plans been determined consistent with SFAS No. 123, the Company's net income and net income per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data):
YEAR ENDED DECEMBER 31, ----------------------------------------- 1995 1996 1997 -------- -------- -------- Pro forma net income $ 880 $24,017 $18,710 Pro forma basic net income per share $ 0.07 $ 0.62 $ 0.45 Pro forma diluted net income per share $ 0.03 $ 0.51 $ 0.39
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted average fair value of options granted was $0.31, $6.51 and $6.27 for the years ended December 31, 1995, 1996 and 1997, respectively. Values were estimated using zero dividend yield for all years, expected volatility of 50 percent for all years; risk-free interest rates of 5.90%, 6.06%, and 6.17%, for 1995, 1996 and 1997, respectively; and weighted-average expected lives of 2.42 years, 3.52 years and 3.15 years, for 1995, 1996, and 1997, respectively for both plans. 26 27 EMPLOYEE BENEFIT PLANS In 1992, Pixar adopted a 401(k) Profit Sharing Plan (the 401(k) Plan) that is intended to qualify under Section 401(k) of the Internal Revenue Code of 1986, as amended. The 401(k) Plan covers substantially all of Pixar's employees. Participants may elect to contribute a percentage of their compensation to this plan, up to the statutory maximum amount, Pixar may make discretionary contributions to the 401(k) Plan; none have been made to the 401(k) Plan to date. (9) COMMITMENTS AND CONTINGENCIES Lease Commitments Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 1997 were as follows (in thousands):
YEAR ENDING DECEMBER 31, ------------ 1998 $ 2,496 1999 2,279 2000 1,595 2001 356 ------- Total minimum lease payments $ 6,726 =======
Rental expense from operating leases amounted to approximately $925,000, $1,236,000 and $2,095,000 for the years ended December 31, 1995, 1996 and 1997, respectively. Participation Commitment Pixar is obligated to pay 5% of its revenue from the distribution of each of the Pictures under the Co-Production Agreement to a third party in consideration for services rendered. The compensation is subject to a cap of $500,000 for each theatrical motion picture and a cap of $200,000 for each sequel or remake, with a total aggregate cap of $3,000,000. Legal Matters Pixar is involved in claims arising in the ordinary course of business. Pixar believes these matters will be resolved without material adverse effect on the Company's financial position, results of operations or cash flows. (10) SIGNIFICANT CUSTOMERS AND SEGMENT REPORTING The following table summarizes the annual percentage contribution to revenues by customers when revenues from such customers exceeded 10% of total revenues in 1995, 1996 and 1997 and the amounts due from these customers as a percentage of total accounts receivable at the corresponding year-end:
PERCENTAGE OF TOTAL PERCENTAGE OF TOTAL REVENUES ACCOUNTS RECEIVABLE AS OF YEAR ENDED DECEMBER 31, DECEMBER 31, 1995 1996 1997 1995 1996 1997 ------------------------ ------------------------ Microsoft Corporation 54% -- -- -- -- -- Disney -- 62% 83% -- 34% 23% Silicon Graphics, Inc. -- 26% -- -- -- --
27 28 Pixar operates principally in three business segments: software, animation services, and film. Financial information relating to business segments follows (in thousands):
YEAR ENDED DECEMBER 31, 1995 1996 1997 --------- --------- --------- Revenues: Software $ 3,144 $ 3,297 $ 4,499 Animation services 2,469 3,947 1,556 Film -- 18,847 26,914 Corporate and other 6,500 9,127 1,730 -------------------------------- $ 12,113 $ 35,218 $ 34,699 ================================ Income (loss) from continuing operations: Software $ 1,336 $ 2,685 $ 3,885 Animation services (55) 302 16 Film (3,826) 9,308 18,016 Corporate and other 5,407 7,997 1,137 -------------------------------- $ 2,862 $ 20,292 $ 23,054 ================================ Depreciation expense: Software $ 125 $ 176 $ 24 Animation services 158 95 148 Film 104 251 1,666 Corporate and other 80 210 1,344 -------------------------------- $ 467 $ 732 $ 3,182 ================================ Capital expenditures: Software $ 317 $ 942 $ 32 Animation services 133 51 392 Film 340 1,694 6,565 Corporate and other 178 1,149 12,366 -------------------------------- $ 968 $ 3,836 $ 19,355 ================================ Identifiable assets (continuing operations): Software $ 920 $ 1,841 $ 1,308 Animation services 769 627 840 Film 5,534 6,882 34,854 Corporate and other 145,608 166,122 194,064 -------------------------------- $ 152,831 $ 175,472 $ 231,066 ================================
(11) EARNINGS PER SHARE CALCULATION Reconciliation of basic and diluted net income per share (in thousands, except per share amounts):
Year Ended December 31, 1995 1996 1997 --------------------------------- ------------------------------ --------------------------------- Net Net Net Income Shares EPS Income Shares EPS Income Shares EPS ------- ------ --------- ------ ------ ---------- ------- ------ ------------ Basic net income per share $ 1,627 12,955 $ 0.13 $25,319 38,632 $ 0.66 $22,190 41,224 $ 0.54 Effect of dilutive shares: Convertible preferred stock -- 20,000 -- -- -- -- Warrants/options -- 261 -- 8,357 -- 6,920 ------------------- ------- ------ ------- ------ Diluted net income per share $ 1,627 33,216 $ 0.05 $25,319 46,989 $ 0.54 $22,190 48,144 $ 0.46 =================== ======= ====== ======= ======
28 29 A warrant to purchase 750,000 shares of common stock issued in 1997 at an exercise price of $20.00 per share and another warrant to purchase 750,000 shares of common stock issued in 1997 at an exercise price of $25.00 per share were excluded from the calculation of diluted net income per share because their effect was antidilutive for the year ended December 31, 1997. (See Note 6). (12) DISCONTINUED OPERATIONS Pixar determined in March of 1997 to discontinue its business of producing CD-ROM and other interactive products. Pixar had no CD-ROM revenue in 1995 and revenue of $3,009,000 and $1,212,000 in 1996 and 1997, respectively. Pixar recorded losses from discontinued operations, net of income taxes, of $1,704,000 and $1,023,000 in 1995 and 1996, respectively. In 1997, Pixar recorded income from discontinued operations of $234,000, net of income taxes, primarily due to royalty income received for the Toy Story CD-ROM products. Pixar anticipates future royalty income will exceed costs to be incurred in all future periods. Net assets of the discontinued operations of $1,469,000 and $2,000 at December 31, 1996 and 1997, respectively, primarily consist of reimbursements and royalties receivable from Disney. 29 30 QUARTERLY FINANCIAL INFORMATION (unaudited) The unaudited financial statements have been prepared on substantially the same basis as the audited financial statements and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of operations for such periods. (in thousands, except per share data)
Three Months Ended March 31 June 30 September 30 December 31 ------- ------- ------- ------- 1996 Revenue $ 8,267 $ 6,917 $13,486 $ 6,548 Gross profit 7,488 5,711 11,688 5,626 Net income 6,279 4,790 9,600 4,650 Basic net income per share (1) 0.16 0.12 0.25 0.12 Diluted net income per share (1) 0.13 0.10 0.21 0.10 1997 Revenue $ 7,867 $14,376 $ 5,341 $ 7,115 Gross profit 7,300 13,419 4,698 6,744 Net income 5,148 8,929 3,672 4,441 Basic net income per share (1) 0.13 0.22 0.09 0.11 Diluted net income per share (1) 0.11 0.19 0.08 0.09
(1) Basic and diluted net income per share amounts have been restated in accordance with SFAS No. 128. 30 EX-23.1 4 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Pixar: We consent to the incorporation by reference in the registration statement (No. 33-99838) on Form S-8 of Pixar of our reports dated January 30, 1998, relating to the balance sheets of Pixar as of December 31, 1996 and 1997, and the related statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1997, and the related schedule, which reports appear or are incorporated by reference in the December 31, 1997, annual report on Form 10-K of Pixar. KPMG PEAT MARWICK LLP San Francisco, California March 30, 1998 EX-27.1 5 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 101,847 74,198 4,293 305 0 180,816 26,858 5,396 231,068 13,768 0 0 0 210,902 6,398 231,068 0 34,699 0 2,538 9,107 0 0 31,820 9,864 21,956 234 0 0 22,190 0.54 0.46
EX-27.2 6 RESTATED 1996 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 44,648 116,321 4,651 323 0 169,120 7,245 2,590 176,941 6,137 0 0 0 187,308 (16,504) 176,941 0 35,218 0 4,705 10,221 0 0 28,325 1,983 26,342 (1,023) 0 0 25,319 0.66 0.54
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