-----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, UCzVrMZM0t8hpN6RFvzIchfe4zK0TWoXux4W8K/pFd6ioSdsrSpb1v8dvavU7mVZ Z2UpN/1YFRNKm3pBK088lw== 0000891618-98-003750.txt : 19980812 0000891618-98-003750.hdr.sgml : 19980812 ACCESSION NUMBER: 0000891618-98-003750 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980627 FILED AS OF DATE: 19980811 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: 0102 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26976 FILM NUMBER: 98682252 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-Q 1 FORM 10-Q FOR THE PERIOD ENDING JUNE 27, 1998 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 27, 1998. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ Commission File Number: 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 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 [ ] The number of shares outstanding of the registrant's Common Stock as of August 5, 1998 was 44,441,342. 2 PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PIXAR BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 27, DECEMBER 31, 1998 1997 --------- --------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 41,170 $ 101,847 Short-term investments 119,819 74,198 Trade and other accounts receivable, net 5,009 3,988 Prepaid expenses and other current assets 1,199 783 --------- --------- Total current assets 167,197 180,816 Property and equipment, net 24,867 21,462 Capitalized film production costs, long-term 43,709 28,589 Other assets 3,104 201 --------- --------- Total assets $ 238,877 $ 231,068 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 1,154 $ 1,694 Income taxes payable 1,734 1,776 Payable to Disney 1,562 2,162 Accrued liabilities 6,099 7,276 Unearned revenue 835 860 --------- --------- Total current liabilities 11,384 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; 44,350,910 and 42,410,707 shares issued and outstanding as of June 27, 1998 and December 31, 1997, respectively 215,083 210,902 Unrealized gain (loss) on investments (19) 29 Deferred compensation (229) (414) Retained earnings 12,658 6,783 --------- --------- Total shareholders' equity 227,493 217,300 --------- --------- Total liabilities and shareholders' equity $ 238,877 $ 231,068 ========= =========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. -2- 3 PIXAR STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
QUARTER ENDED SIX MONTHS ENDED -------------------- -------------------- JUNE 27, JUNE 30, JUNE 27, JUNE 30, 1998 1997 1998 1997 -------- -------- -------- -------- Revenues: Software $ 854 $ 1,060 $ 1,527 $ 2,478 Animation services -- 269 171 269 Film 2,912 11,596 6,948 17,897 Patent licensing 3 1,451 120 1,599 -------- -------- -------- -------- Total revenues 3,769 14,376 8,766 22,243 -------- -------- -------- -------- Cost of revenues: Software 100 14 136 22 Animation services -- 174 38 174 Film -- 769 -- 1,327 -------- -------- -------- -------- Total cost of revenues 100 957 174 1,523 -------- -------- -------- -------- Gross profit 3,669 13,419 8,592 20,720 -------- -------- -------- -------- Operating expenses: Research and development 946 1,427 1,812 2,508 Sales and marketing 434 353 652 605 General and administrative 1,780 1,026 3,546 2,253 -------- -------- -------- -------- Total operating expenses 3,160 2,806 6,010 5,366 -------- -------- -------- -------- Income from continuing operations 509 10,613 2,582 15,354 Other income, net 2,162 1,912 4,562 4,046 -------- -------- -------- -------- Income from continuing operations before income taxes 2,671 12,525 7,144 19,400 Income tax expense 614 3,596 1,643 5,246 -------- -------- -------- -------- Net income from continuing operations 2,057 8,929 5,501 14,154 -------- -------- -------- -------- Income (loss) from discontinued operations, net of taxes (See Note 5) -- -- 374 (77) -------- -------- -------- -------- Net income $ 2,057 $ 8,929 $ 5,875 $ 14,077 ======== ======== ======== ======== Basic net income per share from continuing operations $ 0.05 $ 0.22 $ 0.13 $ 0.35 Basic net income (loss) per share from discontinued operations -- -- 0.01 (0.00) -------- -------- -------- -------- Basic net income per share $ 0.05 $ 0.22 $ 0.14 $ 0.35 ======== ======== ======== ======== Shares used in computing basic net income per share 43,839 41,261 43,497 40,503 ======== ======== ======== ======== Diluted net income per share from continuing operations $ 0.04 $ 0.19 $ 0.11 $ 0.30 Diluted net income (loss) per share from discontinued operations -- -- 0.01 (0.00) -------- -------- -------- -------- Diluted net income per share $ 0.04 $ 0.19 $ 0.12 $ 0.30 ======== ======== ======== ======== Shares used in computing diluted net income per share 51,432 48,020 50,948 47,553 ======== ======== ======== ========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS -3- 4 PIXAR STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED ---------------------------- JUNE 27, JUNE 30, 1998 1997 --------- --------- Cash flows from operating activities: Net income $ 5,875 $ 14,077 Adjustments to reconcile net income to net cash provided by continuing operating activities: Discontinued operations (374) 77 Amortization of deferred compensation 185 365 Depreciation and amortization 2,567 887 Loss on disposition of property and equipment -- 423 Amortization of capitalized film production costs -- 1,327 Credits from patent licensing, net of expense items (114) (1,491) Changes in operating assets and liabilities: Trade and other accounts receivable (1,021) 1,312 Prepaid expenses and other current assets (302) 450 Accounts payable (540) 657 Income taxes payable (42) 4,826 Payable to Disney (600) 7,500 Accrued liabilities (1,277) 407 Unearned revenue (325) 259 --------- --------- Net cash provided by continuing operations 4,032 31,076 Net cash provided by discontinued operations 374 1,095 --------- --------- Net cash provided by operating activities 4,406 32,171 --------- --------- Cash flows from investing activities: Purchase of property and equipment (5,882) (11,690) Proceeds from sale of short-term securities 79,943 56,422 Investments in short-term securities (125,612) (56,276) Capitalized film production costs (15,120) (17,997) Other assets 7 (74) --------- --------- Net cash used in investing activities (66,664) (29,615) --------- --------- Cash flows from financing activities: Net proceeds from issuance of common stock and warrants, net -- 14,885 Proceeds from exercised stock options 1,581 506 --------- --------- Net cash provided by financing activities 1,581 15,391 --------- --------- Net increase (decrease) in cash and cash equivalents (60,677) 17,947 Cash and cash equivalents at beginning of period 101,847 44,648 --------- --------- Cash and cash equivalents at end of period $ 41,170 $ 62,595 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $ 1,796 $ 280 ========= ========= Supplemental disclosure of non-cash investing and financing activities: Value of common stock issued and liabilities assumed for purchase of PEI $ 3,000 $ -- ========= ========= Credits from patent licensing $ 120 $ 1,599 ========= ========= Non-cash film production costs capitalized $ -- $ 7,514 ========= ========= Unrealized loss on investments $ (48) $ (9) ========= =========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. -4- 5 PIXAR NOTES TO FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION The accompanying unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of Pixar's financial condition, results of operations and cash flows for the periods presented. These financial statements should be read in conjunction with the audited financial statements as of December 31, 1997 and 1996, and for each of the years in the three year period ended December 31, 1997, including notes thereto, incorporated by reference into Pixar's Annual Report on Form 10-K for the year ended December 31, 1997. The results of operations for the three- and the six-month periods ended June 27, 1998 are not necessarily indicative of the results expected for the current year or any other period. Certain amounts reported in previous periods have been reclassified to conform to the 1998 financial statement presentation. (2) FISCAL YEAR Effective for fiscal year 1998, the Company adjusted its fiscal year end from December 31 to the 52 or 53-week period that ends on the Saturday nearest December 31. As a result, the second quarter of 1998 represents the thirteen-week period ended June 27, 1998. The 1998 fiscal year will end on January 2, 1999 and will consist of 53 weeks. (3) EARNINGS PER SHARE CALCULATION 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, using the treasury stock method for options and warrants. -5- 6 Reconciliation of basic and diluted net income per share (in thousands, except per share amounts):
QUARTER ENDED ------------------------------------------------------------------------------- JUNE 27, 1998 JUNE 30, 1997 ------------------------------------ ----------------------------------- NET NET INCOME SHARES EPS INCOME SHARES EPS ------- ------ ------- ------- ------ ------ Basic net income per share $ 2,057 43,839 $ 0.05 $ 8,929 41,261 $ 0.22 Effect of dilutive shares: Warrants/options -- 7,593 -- 6,759 ------- ------ ------- ------ Diluted net income per share $ 2,057 51,432 $ 0.04 $ 8,929 48,020 $ 0.19 ======= ====== ======= ======
SIX MONTHS ENDED ------------------------------------------------------------------------------- JUNE 27, 1998 JUNE 30, 1997 ------------------------------------ ----------------------------------- NET NET INCOME SHARES EPS INCOME SHARES EPS ------- ------ ------- ------- ------ ------ Basic net income per share $ 5,875 43,497 $ 0.14 $14,077 40,503 $ 0.35 Effect of dilutive shares: Warrants/options -- 7,451 -- 7,050 ------- ------ ------- ------ Diluted net income per share $ 5,875 50,948 $ 0.12 $14,077 47,553 $ 0.30 ======= ====== ======= ======
(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 The Walt Disney Company (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"). Under the Feature Film Agreement, Pixar is entitled to receive compensation based on the 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, and recognized related revenues of $6.9 million and $17.9 million for the six months ended June 27, 1998 and June 30, 1997, respectively, for a total of $52.6 million since the film's release. All production costs incurred by Pixar through 1995 were reimbursed by Disney on a current basis and recorded by Pixar as cost reimbursements. Accordingly, these reimbursements were not recorded as revenue. -6- 7 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 by Pixar as of June 27, 1998 include A Bug's Life, Toy Story 2, and Pixar's fourth film ("Film Four"). Under the Co-Production Agreement, Pixar, on an exclusive basis, will produce five original computer animated theatrical motion pictures (the "Pictures") for distribution by Disney. A Bug's Life and Film Four count toward the five Pictures, whereas Toy Story 2 is a derivative work that will not count towards 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 2. 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 Disney 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 and distribution. (5) DISCONTINUED OPERATIONS In 1996, Pixar entered into an agreement with Disney to develop and produce interactive CD-ROM titles based on Toy Story. Pixar determined in March 1997 to discontinue its business of producing CD-ROM and other interactive products and reassigned all of the employees in this division to feature film productions and other departments within Pixar. The CD-ROM division incurred a loss of $77,000, net of income tax benefits, for the six months ended June 30, 1997. Pixar recorded income from discontinued operations of $374,000, net of income taxes, for the six months ended June 27, 1998, due to royalty income received from the Toy Story CD-ROM products. Pixar anticipates that future royalty income, if any, will not be significant. (6) COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 130, Reporting of Comprehensive Income. SFAS No. 130 establishes standards for the display of comprehensive income and its components in a full set of financial statements. Comprehensive income includes all changes in equity during a period except those resulting from the issuance of shares of stock and distributions to shareholders. There were no material differences between net income and comprehensive income for the three and six months ended June 27, 1998 and June 30, 1997. (7) BUSINESS COMBINATION On June 16, 1998, Pixar issued 60,468 shares of its common stock in exchange for all of the outstanding common stock of Physical Effects, Inc. ("PEI"). Pixar assumed $300,000 of liabilities as part of this merger. The merger was accounted for under the purchase method of accounting with the operating results of PEI being included in the Company's results of operations from the date of acquisition. The majority of the purchase price was assigned to purchased technology associated with certain technology developed by PEI. The purchased technology will be amortized over a period not to exceed three years. -7- 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains 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," and "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 "Declining Revenues and Anticipated Net Losses in the Second Half of 1998 and the First Half of 1999," "Dependence on Toy Story, A Bug's Life and Toy Story 2," "Scheduled Successive Release of Films; Management of Growth," and "Competition From Movie Studios" 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 sections 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 2," "--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 any forward-looking statements, whether as a result of new information, future events or otherwise. Pixar's operating performance each quarter is subject to various risks and uncertainties as discussed in the Company's Form 10-K. The following discussion should be read in conjunction with the sections entitled "Certain Factors Affecting Business, Operating Results and Financial Condition" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10-K. In particular, the factors set forth below in "Factors Affecting Operating Results and Financial Condition" could affect the Company's operating results and financial condition. CO-PRODUCTION AGREEMENT In February 1997, Pixar and Walt Disney Pictures and Television, a wholly owned subsidiary of The Walt Disney Company (together with its subsidiaries and affiliates collectively referred to herein as "Disney"), entered into a co-production agreement (the "Co-Production Agreement") pursuant to which Pixar, on an exclusive basis, will produce five original computer animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney. 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 certain other fees and costs, including 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 will be A Bug's Life, which is targeted for release on November 20, 1998. The Co-Production Agreement also contemplates that with respect to sequels, interactive media products and other derivative works related to the Pictures, Pixar will have the opportunity to choose between co-financing and producing such products or earning 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. In February 1998, Pixar and Disney agreed to produce a theatrical motion picture sequel to Toy Story (with the working title, Toy Story 2), in lieu of the Toy Story made-for-home video sequel. Toy Story 2 will be Pixar's third feature film and will not be released until late 1999 at the earliest. Because Toy Story 2 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 2 will be treated as a Picture under the Co-Production Agreement. Accordingly, Toy Story 2 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. From 1996 until the first quarter of 1998, Pixar was producing -8- 9 Toy Story 2 for the less expensive made-for-home video format. Therefore, Pixar has begun and will necessarily continue to spend substantially more production time and incur substantially higher production costs to convert Toy Story 2 into a feature-length and feature-quality motion picture. At the present time, Pixar is continuing story development on its fourth theatrical film ("Film Four"). Production of Film Four has not yet begun, and Disney and Pixar have not yet approved the story treatment and budget as required under the Co-Production Agreement. If the story treatment and budget are approved, this film will be developed and distributed under the Co-Production Agreement and will count as the second of the five Pictures. Film Four is not expected to be released until the end of 2000 at the earliest. In May 1991, Pixar entered into a feature film agreement (the "Feature Film Agreement") with Disney, pursuant to which Toy Story and the Toy Story home video were developed, produced and distributed. The Feature Film Agreement was largely superseded by the Co-Production Agreement above. However, the Feature Film Agreement remains in effect with respect to Pixar's financial participation in Toy Story and related products. RESULTS OF OPERATIONS REVENUES Total revenues for the three and six months ended June 27, 1998 were $3.8 million and $8.8 million, respectively, compared to $14.4 million and $22.2 million in the corresponding periods of the prior year. The decreases were primarily due to the decline in Toy Story-related revenue, although each of the other categories of revenues also declined. Software revenues consist mainly of software license revenues, principally from RenderMan. Software revenues decreased by 19% to $854,000 for the quarter ended June 27, 1998 from $1.1 million in the corresponding prior year period and decreased 38% to $1.5 million in the six months ended June 27, 1998 from $2.5 million in the corresponding prior year period. The decreases in software revenues resulted from decreases in the number of RenderMan software licenses. Pixar expects ongoing variability in revenues derived from software licenses and that such revenue may continue to decline. All historical and future royalty income associated with Pixar's discontinued CD-ROM division has been and will continue to be excluded from software revenues and presented in results of discontinued operations. See "Results of Discontinued Operations." Animation services revenues of $171,000 for the six months ended June 27, 1998 represented revenue recognized in the first quarter of 1998 from a short project related to Toy Story. As was the case in the quarter ended June 27, 1998, it is likely that in the remaining quarters in 1998, Pixar will generate little or no animation services revenues since Pixar has transferred substantially all of its animation services employees to assist in the completion of A Bug's Life. More generally, Pixar expects that animation services revenues 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. There can be no assurance that Pixar will generate any animation services revenues during periods in which its animation services employees are devoted to feature films or other projects, such as will be the case for the remainder of 1998, and may be the case thereafter. Film revenues for the quarter ended June 27, 1998 were $2.9 million compared with $11.6 million in the corresponding prior year period. Film revenues for the six months ended June 27, 1998 were $6.9 million compared with $17.9 million in the corresponding prior year period. Such revenues for the six months ended June 27, 1998 represent Pixar's share of Toy Story-related merchandising royalties, the ABC and Disney Channel television airings of Toy Story, and Toy Story home video revenue. Since Pixar has already recognized the vast majority of the revenue it expects to receive from Toy Story and related products, and since Pixar's next feature film, A Bug's Life, is not targeted for release until November 20, 1998 and is not expected to generate revenues for Pixar until the second half of 1999 at the earliest, Pixar expects that revenue will continue to decline in the second half of 1998 as compared to the corresponding period in 1997. Therefore, Pixar expects to incur operating and net losses in the second half of 1998 and in the first half of 1999. -9- 10 Patent licensing revenues of $120,000 for the six months ended June 27, 1998 were attributable to a patent license with Silicon Graphics, Inc. ("SGI"), whereby Pixar granted to SGI 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, SGI agreed to pay Pixar total compensation of $11.0 million, of which $6.0 million was paid in cash in March 1996 and $5.0 million was to be paid in the form of purchase credits for SGI hardware and software. Recognition of the $5.0 million in credits depended upon purchases of the hardware and software to be obtained from SGI in lieu of payment. In the six months ended June 30, 1997 and June 27, 1998, revenue of $1.6 million and $120,000 was recognized, respectively, representing credits used during those periods. Pixar has used substantially all of the $5.0 million worth of credits and the small amount of remaining credits are expected to be used in the second half of 1998. Pixar does not expect that further patent licensing revenues will be generated on an ongoing basis. For the three and six months ended June 27, 1998, Disney accounted for 77% and 81%, respectively, of Pixar's total revenues. The revenues from Disney consisted primarily of film and animation services revenues. Substantially all of the revenue derived from Disney for the quarter ended June 27, 1998 was included in trade and other accounts receivable and represented 61% of the balance at June 27, 1998. For the three and six months ended June 30, 1997, Disney accounted for 83% and 82%, respectively, of Pixar's total revenues, primarily from film and software revenues. COST OF REVENUES Cost of software revenues consist of the direct costs and manufacturing overhead required to reproduce and package software products as well as amortization of purchased technology. Cost of software revenues include no amortization of internal software development expenses since no such expenses have been capitalized. Cost of software revenues as a percentage of the related revenues increased to 12% and 9% for the three and six months ended June 27, 1998, respectively, from 1% in both the three and six months corresponding prior year periods, due primarily to the amortization of purchased technology associated with its acquisition of Physical Effects, Inc. ("PEI"), on which no revenue will be recognized until the third quarter of 1998 at the earliest. Approximately $2.7 million of the PEI purchase price was assigned to purchased technology, which PEI has licensed to a third party. Over a period not to exceed three years, Pixar will amortize the purchased technology against related license revenues, thereby essentially eliminating any gross margins with respect to license revenues associated with this purchased technology until such amortization has been completed. As a result of the ongoing amortization of this purchased technology, it is likely that Pixar's total software gross margins will be substantially lower during the next several years. In addition, if Pixar determines that the license revenue generated by the purchased technology will be lower than expected and that all or part of the purchased technology asset may not be recoverable, Pixar would, at that point, be required to write off all or a significant portion of the unamortized purchased technology. Cost of animation services revenues consist of production costs, which include salaries, benefits, facility expenses and department overhead costs. Costs of animation services revenues as a percentage of the related revenues were 22% for the six months ended June 27, 1998 compared to 65% for the six months ended June 30, 1997, due to the lower negotiated profit margins on animation services projects completed in the six months ended June 30, 1997. Because there were no animation services revenues in the quarter ended June 27, 1998, there were no associated costs. Costs of film revenues represent amortization of film costs capitalized by Pixar. See "Capitalized Film Production Costs." Due to higher than expected Toy Story film revenues, which resulted in Pixar's amortizing all Toy Story related film costs by December 31, 1997, there were no costs of revenues associated with film revenues for the three and six months ended June 27, 1998. Any further Toy Story film-related revenues will have no associated costs of revenues. Costs of film revenues as a percentage of the related revenues were 7% for the six months ended June 30, 1997. 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. In addition, since Pixar's share of production costs under the terms of the Co-Production Agreement are capitalized, 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. -10- 11 OPERATING EXPENSES Total operating expenses for the three and six months ended June 27, 1998 were higher than in the same period in the prior year, and Pixar intends to continue to increase its spending levels in a number of areas. First, as a result of competition for technical and certain administrative personnel, Pixar has had to pay higher salaries to attract new technical and administrative personnel. Pixar expects compensation for such personnel to continue to increase. In the three and six months ended June 27, 1998, Pixar expanded its administrative staff, increased systems and facilities costs and expanded other operations. Pixar expects continued growth in operating expenses in 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 from Disney is treated as operating expense reimbursements. In addition, because Disney is responsible for paying all film marketing costs under the Co-Production Agreement, if Pixar incurs film marketing costs, Disney is responsible for reimbursing Pixar for such costs. To the extent that spending in any of these areas is not capitalized by Pixar nor paid for by Disney under the Co-Production Agreement, and precedes or is not subsequently followed by an increase in revenues, Pixar's business, operating results and financial condition will be materially adversely affected. Research and development expenses consist primarily of salaries and support for personnel conducting research and development for the RenderMan product, for Pixar's proprietary Marionette and Ringmaster software and for certain other unreimbursed projects. Research and development expenses decreased 34% to $946,000 in the three months ended June 27, 1998 from $1.4 million in the corresponding prior year period, and decreased 28% to $1.8 million in the six months ended June 27, 1998 from $2.5 million in the corresponding prior year period. The decreases were due to the completion of a significant research and development project in the last quarter of 1997, coupled with the reassignment in the current year of certain research and development employees to temporarily work on film productions. Pixar expects increased research and development spending in future quarters. To date, all software development costs not reimbursed by Disney have been expensed as incurred. Sales and marketing expenses consist primarily of salaries and related overhead, as well as advertising, technical support, public relations and trade show costs required to support the software segment and complement the film segment. Sales and marketing expenses increased 23% to $434,000 in the three months ended June 27, 1998 from $353,000 in the corresponding prior year period and increased 8% to $652,000 in the six months ended June 27, 1998 from $605,000 in the corresponding prior year period, due to increased corporate marketing and promotion of Pixar's short animated film Geri's Game, offset by the reimbursement by Disney of all film-specific marketing costs incurred. Pixar expects that sales and marketing spending will increase in future periods because corporate marketing and public relations expenses, net of reimbursements, may continue to increase in absolute dollars in future periods. General and administrative expenses consist primarily of salaries of management and administrative personnel, insurance costs and professional fees. General and administrative expenses increased 73% to $1.8 million in the three months ended June 27, 1998 from $1.0 million in the corresponding prior year period and increased 57% to $3.5 million in the six months ended June 27, 1998 from $2.3 million in the corresponding prior year period. The increases were primarily due to a general increase in staffing and public company costs, such as payroll taxes from the exercise of stock options. Growth in these costs is partially offset by the recovery of certain general and administrative costs reimbursed by Disney under the Co-Production Agreement. Pixar expects general and administrative expenses to continue to increase in absolute dollars in future periods as Pixar incurs additional costs to expand its administrative staff and facilities. OTHER INCOME, NET Other income, net consists primarily of interest income on Pixar's short-term investments. Other income, net was $2.2 million and $4.6 million in the three and six months ended June 27, 1998, respectively, and $1.9 million and $4.0 million in the three and six months ended June 30, 1997, respectively. -11- 12 INCOME TAXES Income tax expense from continuing operations for the three and six months ended June 27, 1998 reflects Pixar's federal and state income tax liability after utilization of remaining net operating loss carryforwards and federal and state tax credits. Income taxes decreased for the three and six months ended June 27, 1998 as a result of the benefit of certain tax deductions occurring in 1998 coupled with Pixar's projected lower earnings for fiscal 1998. RESULTS OF DISCONTINUED OPERATIONS After the Co-Production Agreement was executed in February 1997, Pixar determined that the resources devoted to its interactive products division would be better allocated to other projects arising from the Co-Production Agreement. Therefore, Pixar determined in March 1997 to discontinue its business of producing CD-ROM and other interactive products and to redirect the employees that were in that division to feature film productions and related projects within Pixar. The discontinued CD-ROM division incurred a loss of $77,000, net of income tax benefits, for the six months ended June 30, 1997. For the six months ended June 27, 1998, Pixar recorded income from discontinued operations of $374,000, net of income taxes, due to royalty income received for the Toy Story CD-ROM products. Pixar anticipates that future royalty income, if any, will exceed costs to be incurred in all future periods, but that such amounts will not be significant. FACTORS AFFECTING 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, along with the factors discussed in Pixar's Form 10-K under the section entitled "Certain Factors Affecting Business, Operating Results and Financial Condition." DECLINING REVENUES AND ANTICIPATED NET LOSSES IN THE SECOND HALF OF 1998 AND THE FIRST HALF OF 1999 A number of factors are expected to result in declining revenues and net losses in the second half of 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, Pixar's first computer animated feature film. While relatively minor amounts of revenue may be received by Pixar in subsequent periods, Pixar does not expect to recognize any significant revenue from Toy Story in the future. Timing of A Bug's Life and Toy Story 2 Releases. A Bug's Life, Pixar's second computer animated feature film, is targeted for release on November 20, 1998, and revenue attributable to A Bug's Life is not expected to be recognized until 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, the theatrical motion picture sequel to Toy Story (with the working title, Toy Story 2) 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 2 until six to twelve months after its release at the earliest. Therefore, Pixar is unlikely to recognize any revenue from Toy Story 2 until the second half of 2000 at the earliest. Limited CD-ROM Income. 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 (as defined herein). 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 redirected all of the CD-ROM division employees to feature film productions and other departments within Pixar. -12- 13 Increase in Operating Expenses and Effective Tax Rate. Since Pixar's initial public offering, 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 the second half of 1998 and thereafter. In addition, in 1998, if the story for Film Four is not approved, Pixar could be required to write-off certain related film costs previously capitalized. Finally, Pixar's effective tax rate increased in the year ended December 31, 1997, and although it may decrease slightly in 1998, it is likely to increase in future years due to 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 1997. At the same time, Pixar's operating expenses have increased and are expected to continue to increase in 1998. Therefore, Pixar expects operating results in 1998 to decline substantially from operating results in 1997. Pixar expects to incur operating and net losses in the second half of 1998 and in the first half of 1999. Operating results thereafter will depend upon the success of Pixar's next films, starting with the planned release of A Bug's Life on November 20, 1998. DEPENDENCE ON TOY STORY, A BUG'S LIFE AND TOY STORY 2 Dependence on Toy Story. For at least the remainder of 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, such as possible further merchandise royalties. Pixar recognized the vast majority of Toy Story home video revenue in 1997 and expects little revenue from Toy Story or related products in the second half of 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 targeted for release on November 20, 1998, and Toy Story 2 is not expected to be released until the end of 1999 at the earliest, any other revenues in the second half of 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 2. Beyond 1998 and the first half of 1999, Pixar expects to be significantly dependent upon the success of A Bug's Life, Toy Story 2, and Film Four (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 Film Four 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 Film Four 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 2. Risks Associated with A Bug's Life. Under the Co-Production Agreement, Pixar equally shares the production costs of A Bug's Life with Disney which are expected to be more than twice the production costs of Toy Story. Most of these costs will initially be capitalized as film production costs under SFAS No. 53 and will then be amortized over the expected revenue stream when revenue is recognized. In addition, under the Co-Production Agreement, Disney determines and finances the costs and expenses of promoting, marketing and distributing A Bug's Life. Such costs are likely to be very significant and will be recovered by Disney before any revenues are recognized by Pixar. If A Bug's Life is not an extraordinary box office success, the amount of revenue recognized by Pixar will not be significant, and Pixar's 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 -13- 14 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. 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. Risks Associated with Toy Story 2. As a theatrical feature film release, Toy Story 2 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 2. 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. In many cases, sequels substantially under-perform the original film. Only a few sequels have 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. Furthermore, theatrical sequels to animated feature films are very rare, making it more difficult to predict their success. Accordingly, there can be no assurance that Toy Story 2 will perform as well as Toy Story at the box office. In addition, fees and participations paid to key talent on Toy Story 2 are substantially greater than for the original film, which together with other increases in production costs will have the effect of substantially increasing the cost of the film when compared to Toy Story. As a result of these factors and the same factors associated with A Bug's Life, Toy Story 2 and related products may not generate significant revenue and operating results for Pixar, even if Toy Story 2 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. For example, the production budget of A Bug's Life is more than twice the production costs of Toy Story. 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. 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 A Bug's Life, Toy Story 2 and Film Four, which are currently targeted for release on November 20, 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 may 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 2 or Film Four 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. For example, to meet the production schedule of A Bug's Life, substantially all employees from Pixar's animation services group and a significant number of employees from other projects, including Toy Story 2, have been assigned to A Bug's Life. Pixar may need to take similar actions for Toy Story 2 and subsequent films. 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 film production budgets and Pixar's results of operations and financial condition. Although there can be no assurance that any of A Bug's Life, Toy Story 2, or Film Four will be released on schedule, the targeted release date of late 2000 for Film Four 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 Film Four 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 Film Four, 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 Film Four 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 2 is ready to be released. In addition, if the story currently under development for Film Four is canceled because Pixar and Disney are unable to reach final agreement on a treatment or budget, Pixar could be required to write-off certain related story development costs previously capitalized. If such event occurs in 1998, then all or a portion of these costs would be written off in 1998. Furthermore, even if Pixar and Disney reach final agreement and use the story currently under development for Film Four, there can be no assurance that Film Four will be developed in time for release in 2000. 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. 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), DreamWorks SKG ("DreamWorks") (which is expressly targeting the animated film market), 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 million and $65 million. DreamWorks owns a significant equity stake in Pacific Data Images ("PDI"), a computer animation firm, and is producing with PDI Antz, a computer animated movie which, like A Bug's Life, features ants as characters. Antz is scheduled for release on October 2, 1998 (approximately seven weeks before A Bug's Life). Pixar expects a variety of additional animated feature films to be released in the theaters in the next two years generating competition for A Bug's Life and Toy Story 2, which are targeted for release on November 20, 1998 and late 1999, respectively. These films include for example Paramount's Rugrats, The Movie and DreamWorks' The Prince of Egypt, which are each scheduled to be released in late 1998. 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. Such feature films include Babe: Pig in the City, The Wizard of Oz, Air Bud 2: Golden Receiver, Star Trek 9, and Disney's Mighty Joe Young, among 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 three of these movie studios, Disney, DreamWorks (with PDI) and Lucasfilm (through its affiliate Industrial Light and Magic ("ILM")), have developed their own internal computer animation capability which may be used for special effects in computer animated feature films. For example, DreamWorks (with PDI) is producing Antz. 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 original 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. 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. -14- 15 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 Film Four. Pixar will also co-finance Toy Story 2 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 second 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, Film Four and Toy Story 2 and the costs of the new Emeryville facility will have a material adverse impact on Pixar's cash and short-term investment balances. As of June 27, 1998, Pixar had approximately $161.0 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, Film Four and Toy Story 2, 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 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 As of December 31, 1997, all capitalized film costs related to Toy Story had been amortized. Pixar had $43.7 million in capitalized film production costs as of June 27, 1998, consisting primarily of costs related to A Bug's Life, Toy Story 2 and Film Four, all of which are being co-financed by Disney under the Co-Production Agreement. YEAR 2000 COMPLIANCE The year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. Pixar is currently reviewing its products, its internal computer systems and systems of third parties on which Pixar relies for handling the year 2000. Based on information available to date, Pixar believes that it will be able to complete its year 2000 compliance review and make any necessary modifications to its products and internal systems prior to the end of 1999. Pixar further believes that such review and modification, if any, will not require Pixar to incur any material charge to operating expenses over the next several years. Pixar is also seeking confirmation from third parties that their systems are year 2000 compliant or plans are being developed to address the year 2000 problem. However, there can be no assurance that such third-party systems will be year 2000 compliant or that the failure of such systems to be year 2000 compliant would not have a material adverse effect on Pixar's financial position or results of operations. LIQUIDITY AND CAPITAL RESOURCES Cash and short-term investments decreased $15.0 million to $161.0 million at June 27, 1998 from $176.0 million at December 31, 1997. Working capital decreased $11.2 million to $155.8 million at June 27, 1998 from $167.0 million at December 31, 1997. Net cash provided by continuing operations for the six months ended June 27, 1998 was primarily attributable to net income of $5.9 million and the non-cash impact of depreciation expense of $2.6 million offset by increases in accounts receivable and other assets of $1.3 million and decreases in accrued and other liabilities of $2.8 million. Cash flows used in investing activities were due primarily to net investments in short-term securities of $45.7 million, the purchase of property and equipment of $5.9 million and funding of film production costs of $15.1 million. Cash flows -15- 16 provided by financing activities were due to proceeds from the exercise of stock options. As of June 27, 1998, Pixar's principal source of liquidity was approximately $161.0 million in cash and short-term investments. Pixar believes that these funds will be sufficient to meet the Company's operating requirements through the next twelve months. Thereafter, if cash generated by operations is insufficient to satisfy Pixar's liquidity requirements, Pixar may be required to sell additional equity or debt securities or obtain credit facilities. The sale of additional equity or convertible debt securities would result in additional dilution to Pixar's shareholders. There can be no assurance that financing will be available to Pixar in an amount and on terms acceptable to Pixar. -16- 17 PART II -- OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (c) In connection with Pixar's acquisition of Physical Effects, Inc. ("PEI") on June 16, 1998, Pixar issued an aggregate of 60,468 shares of Pixar's Common Stock (the "Merger Shares") to the existing stockholders of PEI in exchange for all of the outstanding shares of capital stock of PEI. The Merger Shares were issued pursuant to the exemption for the registration requirements of the Securities Act of 1933, as amended (the "1933 Act"), afforded by Regulation D under Section 4(2) of the 1933 Act. The stockholders of PEI were either accredited or sophisticated investors with access to all relevant information regarding Pixar necessary to evaluate the investment and represented to Pixar that the shares were being acquired for investment intent. (d) The effective date of the Company's first registration statement, filed on Form S-1 under the 1933 Act (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 were $139,661,286. As of June 27, 1998, the Company had used the net proceeds from the offering as follows: $14,197,105 for construction of plant, building and facilities, $11,926,328 for the purchase and installation of machinery and equipment, $2,374,000 for the repayment of indebtedness, $60,038,467 for the development of future films and other animated products, $3,185,571 for working capital and $47,939,815 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The following matters were submitted to the shareholders at Pixar's Annual Meeting of Shareholders held June 17, 1998. Each of these matters was approved by a majority of the shares present at the meeting. 1. The uncontested election of five directors to serve a one-year term until their successors are duly elected and qualified. The following is a summary of the nominees and voting results:
Votes For Votes Withheld --------- -------------- Steven P. Jobs 38,745,290 17,309 Larry W. Sonsini 38,473,119 289,480 Skip M. Brittenham 38,744,433 18,166 Joseph A. Graziano 38,745,906 16,693 Jill E. Barad 38,741,411 21,188
2. The adoption of an amendment to the 1995 Stock Plan to increase the number of shares reserved for issuance by an additional 500,000 shares of Common Stock, for an aggregate of 15,772,321 shares reserved for issuance thereunder. Results of the voting included 37,639,910 shares for, 1,067,126 shares against and 55,563 shares abstained. 3. The ratification of the appointment of KPMG Peat Marwick LLP as the independent auditors for the Company for the 1998 fiscal year ending January 2, 1999. Results of the voting included 38,717,032 shares for, 20,812 shares against and 24,755 shares abstained. -17- 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS 10.1 1995 Stock Plan (as amended through April 8, 1998) 27.1 Financial Data Schedule (B) REPORTS ON FORM 8-K On May 8, 1998, Pixar filed a Current Report on Form 8-K to report the change in fiscal year from December 31 to the 52 or 53-week period that ends on the Saturday nearest December 31, effective for fiscal year 1998. ITEMS 1, 3 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED. -18- 19 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PIXAR Date: August 11, 1998 By: /s/ Lawrence B. Levy ---------------------- ------------------------------------- Lawrence B. Levy, Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer) -19- 20 EXHIBIT INDEX
Exhibit No. Description - ------- -------------------------------------------------- 10.1 1995 Stock Plan (as amended through April 8, 1998) 27.1 Financial Data Schedule
-20- EX-10.1 2 PIXAR 1995 STOCK PLAN 1 EXHIBIT 10.1 PIXAR 1995 STOCK PLAN (as amended April 8, 1998) 1. Purposes of the Plan. The purposes of this Stock Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to Employees and Consultants of the Company and its Subsidiaries and to promote the success of the Company's business. Options granted under the Plan may be Incentive Stock Options or Nonstatutory Stock Options, as determined by the Administrator at the time of grant of an Option and subject to the applicable provisions of Section 422 of the Code and the regulations promulgated thereunder. Stock Purchase Rights may also be granted under the Plan. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" means the Board or any of its Committees appointed pursuant to Section 4 of the Plan. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means a Committee appointed by the Board of Directors in accordance with Section 4 of the Plan. (e) "Common Stock" means the Common Stock of the Company. (f) "Company" means PIXAR, a California corporation. (g) "Consultant" means any person who is engaged by the Company or any Parent or Subsidiary to render consulting or advisory services and is compensated for such services. The term Consultant shall not include Directors who are not compensated for their services or are paid only a Director's fee by the Company. (h) "Continuous Status as an Employee or Consultant" means that the employment or consulting relationship with the Company, any Parent or Subsidiary is not interrupted or terminated. Continuous Status as an Employee or Consultant shall not be considered interrupted in the case of (i) any leave of absence approved by the Company or (ii) transfers between locations of the Company or between the Company, its Parent, any Subsidiary, or any successor. A leave of absence approved by the Company shall include sick leave, military leave, or any other personal leave approved by an authorized representative of the Company. For purposes of Incentive Stock Options, no such leave may exceed 90 days, unless reemployment upon expiration of such leave is guaranteed by statute or contract, 2 including Company policies. If reemployment upon expiration of a leave of absence approved by the Company is not so guaranteed, on the 91st day of such leave any Incentive Stock Option held by the Optionee shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option. (i) "Director" means a member of the Board of Directors of the Company. (j) "Employee" means any person, including Officers and Directors, employed by the Company or any Parent or Subsidiary of the Company. The payment of a Director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (l) "Fair Market Value" means, as of any date, the value of Common Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the Nasdaq National Market of the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system for the last market trading day prior to the time of determination and reported in The Wall Street Journal or such other source as the Administrator deems reliable; (ii) If the Common Stock is quoted on the NASDAQ System (but not on the Nasdaq National Market thereof) or regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination; or (iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Administrator. (m) "Incentive Stock Option" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code. (n) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (o) "Officer" means a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. -2- 3 (p) "Option" means a stock option granted pursuant to the Plan. (q) "Optioned Stock" means the Common Stock subject to an Option or a Stock Purchase Right. (r) "Optionee" means an Employee or Consultant who receives an Option or Stock Purchase Right. (s) "Parent" means a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (t) "Plan" means this 1995 Stock Plan. (u) "Restricted Stock" means shares of Common Stock acquired pursuant to a grant of a Stock Purchase Right under Section 11 below. (v) "Share" means a share of the Common Stock, as adjusted in accordance with Section 12 below. (w) "Stock Purchase Right" means a right to purchase Common Stock pursuant to Section 11 below. (x) "Subsidiary" means a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. 3. Stock Subject to the Plan. Subject to Section 12, the maximum aggregate number of Shares which may be subject to option and sold under the Plan is 15,772,321(1) Shares provided, however, that beginning January 1, 1998, the number of Shares shall be increased each January 1 by three percent (3%) of the total issued and outstanding Shares on such date. In no event, except as subject to Section 12, shall more than 14,500,000 Shares be issued upon the exercise of Incentive Stock Options under the Plan. If an Option or Stock Purchase Right expires or becomes unexercisable without having been exercised in full, or is surrendered pursuant to an Option Exchange Program, the unpurchased Shares which were subject thereto shall become available for future grant or sale under the Plan (unless the Plan has terminated). However, Shares that have actually been issued under the Plan, upon exercise of either an Option or Stock Purchase Right, shall not be returned to the Plan and shall not become available for future distribution under the Plan, except that if Shares of Restricted Stock are repurchased by the Company at their original purchase price, and the original purchaser of such Shares did not receive any benefits of ownership of such Shares, such Shares shall become available for future grant under the Plan. - -------- (1) Such number reflects the automatic increase of 1,272,321 shares on January 1, 1998. -3- 4 For purposes of the preceding sentence, voting rights shall not be considered a benefit of Share ownership. 4. Administration of the Plan. (a) Procedure. (i) Multiple Administrative Bodies. If permitted by Rule 16b-3, the Plan may be administered by different bodies with respect to Directors and Officers, and Employees and Consultants who are neither Directors nor Officers. (ii) Administration With Respect to Directors and Officers. With respect to grants of Options and Stock Purchase Rights to Employees who are also Officers or Directors of the Company, the Plan shall be administered by (A) the Board if the Board may administer the Plan in compliance with Rule 16b-3 promulgated under the Exchange Act or any successor thereto ("Rule 16b-3") with respect to a plan intended to qualify thereunder as a discretionary plan, or (B) a Committee designated by the Board to administer the Plan, which Committee shall be constituted in such a manner as to permit the Plan to comply with Rule 16b-3 with respect to a plan intended to qualify thereunder as a discretionary plan. Once appointed, such Committee shall continue to serve in its designated capacity until otherwise directed by the Board. From time to time the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies, however caused, and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by Rule 16b-3 with respect to a plan intended to qualify thereunder as a discretionary plan. (iii) Administration With Respect to Other Employees and Consultants . With respect to grants of Options and Stock Purchase Rights to Employees or Consultants who are neither Directors nor Officers of the Company, the Plan shall be administered by (A) the Board or (B) a Committee designated by the Board, which committee shall be constituted in such a manner as to satisfy the legal requirements relating to the administration of incentive stock option plans, if any, of California corporate and securities laws, of the Code, and of any applicable stock exchange (the "Applicable Laws"). Once appointed, such Committee shall continue to serve in its designated capacity until otherwise directed by the Board. From time to time the Board may increase the size of the Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies, however caused, and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by the Applicable Laws. (b) Powers of the Administrator. Subject to the provisions of the Plan and, in the case of a Committee, the specific duties delegated by the Board to such Committee, and subject to the approval of any relevant authorities, including the approval, if required, of any stock exchange upon which the Common Stock is listed, the Administrator shall have the authority in its discretion: -4- 5 (i) to determine the Fair Market Value of the Common Stock, in accordance with Section 2(l) of the Plan; (ii) to select the Consultants and Employees to whom Options and Stock Purchase Rights may be granted hereunder; (iii) to determine whether and to what extent Options and Stock Purchase Rights or any combination thereof, are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each Option and Stock Purchase Right granted hereunder; (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder. Such terms and conditions include, but are not limited to, the exercise price, the time or times when Options or Stock Purchase Rights may be exercised (which may be based on performance criteria), any vesting acceleration or waiver of forfeiture restrictions, and any restriction or limitation regarding any Option or Stock Purchase Right or the shares of Common Stock relating thereto, based in each case on such factors as the Administrator, in its sole discretion, shall determine; (vii) to reduce the exercise price of any Option or Stock Purchase Right to the then current Fair Market Value if the Fair Market Value of the Common Stock covered by such Option or Stock Purchase Right shall have declined since the date the Option or Stock Purchase Right was granted; (viii) to construe and interpret the terms of the Plan and awards granted pursuant to the Plan; (ix) to prescribe, amend and rescind rules and regulations relating to the Plan, including rules and regulations relating to sub-plans established for the purpose of qualifying for preferred tax treatment under foreign tax laws; (x) to modify or amend each Option or Stock Purchase Right (subject to Section 14 of the Plan), including the discretionary authority to extend the post-termination exercisability period of Options longer than is otherwise provided for in the Plan; (xi) to authorize any person to execute on behalf of the Company any instrument required to effect the grant of an Option or Stock Purchase Right previously granted by the Administrator; (xii) to determine the terms and restrictions applicable to Options and Stock Purchase Rights and any Restricted Stock; and -5- 6 (xiii) to make all other determinations deemed necessary or advisable for administering the Plan. (c) Effect of Administrator's Decision. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of any Options or Stock Purchase Rights. 5. Eligibility. (a) Nonstatutory Stock Options and Stock Purchase Rights may be granted to Employees and Consultants. Incentive Stock Options may be granted only to Employees. An Employee or Consultant who has been granted an Option or Stock Purchase Right may, if otherwise eligible, be granted additional Options or Stock Purchase Rights. (b) Each Option shall be designated in the written option agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designations, to the extent that the aggregate Fair Market Value of Shares subject to an Optionee's Incentive Stock Options granted by the Company, any Parent or Subsidiary, which become exercisable for the first time during any calendar year (under all plans of the Company or any Parent or Subsidiary) exceeds the limit imposed by Section 422(d) of the Code or any successor thereto, such excess Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 5(b), Incentive Stock Options shall be taken into account in the order in which they were granted. The Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted. (c) Neither the Plan nor any Option or Stock Purchase Right shall confer upon any Optionee any right with respect to continuation of his or her employment or consulting relationship with the Company, nor shall it interfere in any way with his or her right or the Company's right to terminate his or her employment or consulting relationship at any time, with or without cause. (d) Upon the Company or a successor corporation issuing any class of common equity securities required to be registered under Section 12 of the Exchange Act or upon the Plan being assumed by a corporation having a class of common equity securities required to be registered under Section 12 of the Exchange Act, the following limitations shall apply to grants of Options and Stock Purchase Rights to Employees: (i) No Employee shall be granted, in any fiscal year of the Company, Options and Stock Purchase Rights to purchase more than 3,000,000 Shares. (ii) The foregoing limitation shall be adjusted proportionately in connection with any change in the Company's capitalization as described in Section 12. -6- 7 (iii) If an Option or Stock Purchase Right is canceled in the same fiscal year of the Company in which it was granted (other than in connection with a transaction described in Section 12), the canceled Option shall be counted against the limit set forth in Section 5(d)(i). For this purpose, if the exercise price of an Option is reduced, such reduction will be treated as a cancellation of the Option and the grant of a new Option. 6. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the shareholders of the Company, as described in Section 18 of the Plan. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 14 of the Plan. 7. Term of Option. The term of each Option shall be the term stated in the Option Agreement; provided, however, that the term shall be no more than ten (10) years from the date of grant thereof. In the case of an Incentive Stock Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Option shall be five (5) years from the date of grant thereof or such shorter term as may be provided in the Option Agreement. 8. Option Exercise Price and Consideration. (a) The per Share exercise price for the Shares to be issued upon exercise of an Option shall be such price as is determined by the Administrator, but shall be subject to the following: (i) In the case of an Incentive Stock Option (A) granted to an Employee who, at the time of grant of such Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant. (B) granted to any other Employee, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant. (ii) In the case of a Nonstatutory Stock Option, the per Share exercise price shall be determined by the Administrator. (b) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the administrator (and, in the case of an Incentive Stock Option, shall be determined at the time of grant). Such consideration may consist of (1) cash, (2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares acquired upon exercise of an Option, have been owned by the Optionee for more than six months on the date of surrender, and (y) have a Fair Market Value -7- 8 on the date of surrender equal to the aggregate exercise price of the Shares as to which such Option shall be exercised, (5) delivery of a proprerly executed exercise notice together with such other documentation as the Administreator and a broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercixe price, (6) a reduction in the amount of any Company liability to the Optionee, including any liability attributable to the Optionee's participation in any Company-sponsored deferred compensation program or arrangement, or (7) any combination of the foregoing methods of payment. In making its determination as to the type of consideration to accept, the Administrator shall consider if acceptance of such consideration may be reasonably expected to benefit the Company. 9. Exercise of Option. (a) Procedure for Exercise; Rights as a Shareholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Administrator, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Administrator, consist of any consideration and method of payment allowable under Section 8(b) hereof. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote, receive dividends or any other rights as a shareholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such stock certificate promptly upon exercise of the Option. No adjustment shall be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 12 hereof. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) Termination of Employment or Consulting Relationship. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant (but not in the event of an Optionee's change of status from Employee to Consultant (in which case an Employee's Incentive Stock Option shall automatically convert to a Nonstatutory Stock Option on the ninety-first (91st) day following such change of status) or from Consultant to Employee), such Optionee may, but only within such period of time as is determined by the Administrator, with such determination in the case of an Incentive Stock Option not exceeding -8- 9 three (3) months after the date of such termination (but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), exercise his or her Option to the extent that the Optionee was entitled to exercise it at the date of such termination. To the extent that the Optionee was not entitled to exercise the Option at the date of such termination, or if the Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. (c) Disability of Optionee. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant as a result of his or her "Disability," as such term is defined in Section 22(c)(3) of the Code, the Optionee may, but only within twelve (12) months from the date of such termination (and in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), exercise the Option to the extent otherwise entitled to exercise it at the date of such termination. To the extent that the Optionee was not entitled to exercise the Option at the date of termination, or if the Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. (d) Death of Optionee. In the event of the death of an Optionee, the Option may be exercised at any time within twelve (12) months following the date of death (but in no event later than the expiration of the term of such Option as set forth in the Notice of Grant) by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent that the Optionee was entitled to exercise the Option on the date of death. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the Shares covered by the unexercisable portion of the Option shall immediately revert to the Plan. If, after the Optionee's death, the Optionee's estate or a person who acquires the right to exercise the Option by bequest or inheritance does not exercise the Option within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. (e) Rule 16b-3. Options granted to persons subject to Section 16(b) of the Exchange Act must comply with Rule 16b-3 and shall contain such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. (f) Buyout Provisions. The Administrator may at any time offer to buy out for a payment in cash or Shares, an Option previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Optionee at the time that such offer is made. 10. Non-Transferability of Options and Stock Purchase Rights. Options and Stock Purchase Rights may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Optionee, only by the Optionee. -9- 10 11. Stock Purchase Rights. (a) Rights to Purchase. Stock Purchase Rights may be issued either alone, in addition to, or in tandem with other awards granted under the Plan and/or cash awards made outside of the Plan. After the Administrator determines that it will offer Stock Purchase Rights under the Plan, it shall advise the offeree in writing of the terms, conditions and restrictions related to the offer, including the number of Shares that such person shall be entitled to purchase, the price to be paid, and the time within which such person must accept such offer, which shall in no event exceed thirty (30) days from the date upon which the Administrator makes the determination to grant the Stock Purchase Right. The offer shall be accepted by execution of a Restricted Stock purchase agreement in the form determined by the Administrator. Shares purchased pursuant to the grant of a Stock Purchase Right shall be referred to herein as "Restricted Stock." (b) Repurchase Option. Unless the Administrator determines otherwise, the Restricted Stock purchase agreement shall grant the Company a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser's employment with the Company for any reason (including death or Disability). The purchase price for Shares repurchased pursuant to the Restricted Stock purchase agreement shall be the original price paid by the purchaser and may be paid by cancellation of any indebtedness of the purchaser to the Company. The repurchase option shall lapse at such rate as the Administrator may determine. (c) Rule 16b-3. Stock Purchase Rights granted to Insiders, and Shares purchased by Insiders in connection with Stock Purchase Rights, shall be subject to any restrictions applicable thereto in compliance with Rule 16b-3. An Insider may only purchase Shares pursuant to the grant of a Stock Purchase Right, and may only sell Shares purchased pursuant to the grant of a Stock Purchase Right, during such time or times as are permitted by Rule 16b-3. (d) Other Provisions. The Restricted Stock purchase agreement shall contain such other terms, provisions and conditions not inconsistent with the Plan as may be determined by the Administrator in its sole discretion. In addition, the provisions of Restricted Stock purchase agreements need not be the same with respect to each purchaser. (e) Rights as a Shareholder. Once the Stock Purchase Right is exercised, the purchaser shall have rights equivalent to those of a shareholder and shall be a shareholder when his or her purchase is entered upon the records of the duly authorized transfer agent of the Company. No adjustment shall be made for a dividend or other right for which the record date is prior to the date the Stock Purchase Right is exercised, except as provided in Section 12 of the Plan. -10- 11 12. Adjustments Upon Changes in Capitalization or Merger. (a) Changes in Capitalization. Subject to any required action by the shareholders of the Company, the number of shares of Common Stock covered by each outstanding Option or Stock Purchase Right, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options or Stock Purchase Rights have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option or Stock Purchase Right, as well as the price per share of Common Stock covered by each such outstanding Option or Stock Purchase Right, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company. The conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option or Stock Purchase Right. (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Administrator shall notify the Optionee at least fifteen (15) days prior to such proposed action. To the extent it has not been previously exercised, the Option or Stock Purchase Right shall terminate immediately prior to the consummation of such proposed action. (c) Merger or Asset Sale. In the event of a merger of the Company with or into another corporation, or the sale of substantially all of the assets of the Company, each outstanding Option and Stock Purchase Right shall be assumed or an equivalent option or right substituted by the successor corporation or a Parent or Subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the Option or Stock Purchase Right, the Optionee shall have the right to exercise the Option or Stock Purchase Right as to all of the Optioned Stock, including Shares as to which it would not otherwise be exercisable. If an Option or Stock Purchase Right is exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Administrator shall notify the Optionee that the Option or Stock Purchase Right shall be fully exercisable for a period of fifteen (15) days from the date of such notice, and the Option or Stock Purchase Right shall terminate upon the expiration of such period. For the purposes of this paragraph, the Option or Stock Purchase Right shall be considered assumed if, following the merger or sale of assets, the option or right confers the right to purchase or receive, for each Share of Optioned Stock subject to the Option or Stock Purchase Right immediately prior to the merger or sale of assets, the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Common Stock for each Share held on -11- 12 the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or sale of assets was not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received upon the exercise of the Option or Stock Purchase Right, for each Share of Optioned Stock subject to the Option or Stock Purchase Right, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or sale of assets. 13. Time of Granting Options and Stock Purchase Rights. The date of grant of an Option or Stock Purchase Right shall, for all purposes, be the date on which the Administrator makes the determination granting such Option or Stock Purchase Right, or such other date as is determined by the Administrator. Notice of the determination shall be given to each Employee or Consultant to whom an Option or Stock Purchase Right is so granted within a reasonable time after the date of such grant. 14. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may at any time amend, alter, suspend or discontinue the Plan, but no amendment, alteration, suspension or discontinuation shall be made which would impair the rights of any Optionee under any grant theretofore made, without his or her consent. In addition, to the extent necessary and desirable to comply with Rule 16b-3 under the Exchange Act or with Section 422 of the Code (or any other applicable law or regulation, including the requirements of the NASD or an established stock exchange), the Company shall obtain shareholder approval of any Plan amendment in such a manner and to such a degree as required. (b) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options or Stock Purchase Rights already granted, and such Options and Stock Purchase Rights shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Administrator, which agreement must be in writing and signed by the Optionee and the Company. 15. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option or Stock Purchase Right unless the exercise of such Option or Stock Purchase Right and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the Shares may then be listed, and shall be further subject to the approval of counsel for the Company with respect to such compliance. -12- 13 As a condition to the exercise of an Option or Stock Purchase Right, the Company may require the person exercising such Option or Stock Purchase Right to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. 16. Reservation of Shares. The Company, during the term of this Plan, shall at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 17. Agreements. Options and Stock Purchase Rights shall be evidenced by written agreements in such form as the Administrator shall approve from time to time. 18. Shareholder Approval. Continuance of the Plan shall be subject to approval by the shareholders of the Company within twelve (12) months before or after the date the Plan is adopted. Such shareholder approval shall be obtained in the degree and manner required under applicable state and federal law and the rules of any stock exchange upon which the Common Stock is listed. -13- EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS JAN-02-1999 JAN-01-1998 JUN-27-1998 41,170 119,819 5,270 261 0 167,197 32,740 7,873 238,877 11,384 0 0 0 215,083 12,410 238,877 0 8,766 0 174 6,010 0 0 7,144 1,643 5,501 374 0 0 5,875 0.14 0.12
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