10-Q 1 e10-q.txt FORM 10-Q 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 JULY 1, 2000. 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 8, 2000 was 47,366,143. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 PART I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PIXAR BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
JULY 1, JANUARY 1, 2000 2000 -------- ---------- ASSETS Cash and cash equivalents................................... $ 55,219 $ 31,170 Short-term investments...................................... 159,335 163,779 Receivables, net............................................ 14,091 16,740 Prepaid expenses and other assets........................... 4,623 3,888 Deferred income taxes....................................... 34,533 34,533 Property and equipment, net................................. 86,200 60,266 Capitalized film production costs........................... 58,626 64,529 -------- -------- Total assets...................................... $412,627 $374,905 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable............................................ $ 3,403 $ 458 Income taxes payable........................................ 14,114 12,230 Payable to Disney........................................... 811 -- Accrued liabilities......................................... 10,314 16,475 Unearned revenue............................................ 1,353 1,299 -------- -------- Total liabilities................................. 29,995 30,462 -------- -------- 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; 47,300,823 and 46,959,093 shares issued and outstanding as of July 1, 2000 and January 1, 2000, respectively......... 284,909 281,274 Accumulated other comprehensive loss........................ (514) (660) Retained earnings........................................... 98,237 63,829 -------- -------- Total shareholders' equity........................ 382,632 344,443 -------- -------- Total liabilities and shareholders' equity........ $412,627 $374,905 ======== ========
See accompanying notes to financial statements. 2 3 PIXAR STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED SIX MONTHS ENDED --------------------------- --------------------------- JULY 1, 2000 JULY 3, 1999 JULY 1, 2000 JULY 3, 1999 ------------ ------------ ------------ ------------ Revenue: Film.......................................... $16,059 $12,239 $73,965 $13,884 Software...................................... 1,793 1,240 4,532 2,814 Animation services............................ 481 -- 814 222 ------- ------- ------- ------- Total revenue......................... 18,333 13,479 79,311 16,920 ------- ------- ------- ------- Cost of revenue: Film.......................................... 3,314 3,574 18,159 3,846 Software...................................... 138 133 279 431 Animation services............................ 253 -- 442 154 ------- ------- ------- ------- Total cost of revenue................. 3,705 3,707 18,880 4,431 ------- ------- ------- ------- Gross profit.......................... 14,628 9,772 60,431 12,489 ------- ------- ------- ------- Operating expenses: Research and development...................... 1,763 1,320 3,176 2,666 Sales and marketing........................... 337 304 727 652 General and administrative.................... 2,004 1,554 3,820 2,941 ------- ------- ------- ------- Total operating expenses.............. 4,104 3,178 7,723 6,259 ------- ------- ------- ------- Income from continuing operations..... 10,524 6,594 52,708 6,230 Other income, net............................... 3,058 1,793 5,895 3,658 ------- ------- ------- ------- Income from continuing operations before income taxes................. 13,582 8,387 58,603 9,888 Income tax expense.............................. 5,637 2,012 24,320 2,613 ------- ------- ------- ------- Net income from continuing operations.......................... 7,945 6,375 34,283 7,275 Income from discontinued operations, net of taxes......................................... 75 67 125 67 ------- ------- ------- ------- Net income............................ $ 8,020 $ 6,442 $34,408 $ 7,342 ======= ======= ======= ======= Basic net income per share from continuing operations.................................... $ 0.17 $ 0.14 $ 0.73 $ 0.16 Basic net income per share from discontinued operations.................................... -- -- -- -- ------- ------- ------- ------- Basic net income per share...................... $ 0.17 $ 0.14 $ 0.73 $ 0.16 ======= ======= ======= ======= Shares used in computing basic net income per share......................................... 47,179 46,023 47,092 45,785 ======= ======= ======= ======= Diluted net income per share from continuing operations.................................... $ 0.16 $ 0.13 $ 0.69 $ 0.14 Diluted net income per share from discontinued operations.................................... -- -- -- -- ------- ------- ------- ------- Diluted net income per share.................... $ 0.16 $ 0.13 $ 0.69 $ 0.14 ======= ======= ======= ======= Shares used in computing diluted net income per share..................................... 49,977 51,334 49,953 51,260 ======= ======= ======= =======
See accompanying notes to financial statements. 3 4 PIXAR STATEMENTS OF CASH FLOWS (IN THOUSANDS)
SIX MONTHS ENDED --------------------- JULY 1, JULY 3, 2000 1999 --------- -------- Cash flows from operating activities: Net income................................................ $ 34,408 $ 7,342 Adjustments to reconcile net income to net cash provided by continuing operating activities: Discontinued operations................................ (125) (67) Amortization of deferred compensation.................. -- 75 Depreciation and amortization.......................... 2,608 3,297 Amortization of capitalized film production costs...... 18,159 3,846 Tax benefit from disqualifying dispositions............ -- 14,163 Deferred income tax.................................... -- (12,129) Changes in operating assets and liabilities: Receivables.......................................... 2,649 326 Prepaid expenses and other assets.................... (975) (351) Accounts payable..................................... 2,945 (1,508) Income taxes payable................................. 1,884 1,275 Payable to Disney.................................... 811 (3,363) Accrued liabilities.................................. (6,161) 256 Unearned revenue..................................... 54 2,566 --------- -------- Net cash provided by continuing operations........ 56,257 15,728 Net cash provided by discontinued operations...... 125 67 --------- -------- Net cash provided by operating activities......... 56,382 15,795 --------- -------- Cash flows from investing activities: Purchase of property and equipment........................ (28,701) (16,259) Proceeds from sale of property and equipment.............. 399 994 Proceeds from sale of short-term securities............... 221,934 86,692 Investments in short-term securities...................... (217,344) (87,044) Capitalized film production costs......................... (12,256) (15,579) --------- -------- Net cash used in investing activities............. (35,968) (31,196) --------- -------- Cash flows from financing activities: Proceeds from exercised stock options..................... 3,635 2,835 --------- -------- Net cash provided by financing activities......... 3,635 2,835 --------- -------- Net increase (decrease) in cash and cash equivalents........ 24,049 (12,566) Cash and cash equivalents at beginning of period............ 31,170 29,557 --------- -------- Cash and cash equivalents at end of period.................. $ 55,219 $ 16,991 ========= ======== Supplemental disclosure of cash flow information: Cash paid during the period for income taxes.............. $ 22,525 $ -- ========= ======== Supplemental disclosure of non-cash investing and financing activities: Loss on equipment disposals capitalized as film production costs.................................................. $ -- $ (572) ========= ======== Credits from patent licensing............................. $ 24 $ -- ========= ======== Unrealized gain (loss) on investments..................... $ 146 $ (696) ========= ========
See accompanying notes to financial statements. 4 5 PIXAR NOTES TO FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION The accompanying unaudited condensed 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 condensed financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of our 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 January 1, 2000 and January 2, 1999, and for each of the years in the three-year period ended January 1, 2000, including notes thereto, incorporated by reference into our Annual Report on Form 10-K for the year ended January 1, 2000. The results of operations for the three and six months ended July 1, 2000 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 2000 financial statement presentation. (2) FISCAL YEAR Effective for fiscal year 1998, we adopted a 52 or 53-week fiscal year, changing the year end date from December 31 to the Saturday nearest December 31. Fiscal year 2000 will end on December 30, 2000 and will consist of 52 weeks. (3) NET INCOME PER SHARE 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. Reconciliation of basic and diluted net income per share (in thousands, except per share amounts):
QUARTER ENDED ------------------------------------------------- JULY 1, 2000 JULY 3, 1999 ----------------------- ----------------------- NET NET INCOME SHARES EPS INCOME SHARES EPS ------ ------ ----- ------ ------ ----- Basic net income per share............... $8,020 47,179 $0.17 $6,442 46,023 $0.14 Effect of dilutive shares: Warrants/options....................... -- 2,798 -- 5,311 ------ ------ ------ ------ Diluted net income per share............. $8,020 49,977 $0.16 $6,442 51,334 $0.13 ====== ====== ====== ======
SIX MONTHS ENDED -------------------------------------------------- JULY 1, 2000 JULY 3, 1999 ------------------------ ----------------------- NET NET INCOME SHARES EPS INCOME SHARES EPS ------- ------ ----- ------ ------ ----- Basic net income per share.............. $34,408 47,092 $0.73 $7,342 45,785 $0.16 Effect of dilutive shares: Warrants/options...................... -- 2,861 -- 5,475 ------- ------ ------ ------ Diluted net income per share............ $34,408 49,953 $0.69 $7,342 51,260 $0.14 ======= ====== ====== ======
5 6 PIXAR NOTES TO FINANCIAL STATEMENTS (CONTINUED) (4) FEATURE FILM AND CO-PRODUCTION AGREEMENTS Feature Film Agreement In 1991, we 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"). We were entitled to receive compensation based on the revenue from the distribution of these films and related products. In 1995, we released our first feature film under the terms of the Feature Film Agreement, Toy Story. Based on the individual film forecast method, all significant Toy Story film production costs were fully amortized by the year ended December 31, 1997. 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 us since Toy Story. Under the Co-Production Agreement, we agreed, on an exclusive basis, to produce five original computer-animated theatrical motion pictures (the "Pictures") for distribution by Disney. A Bug's Life, released in 1998, and Toy Story 2, released in November 1999, were the first films produced under this agreement. Films in development or production at Pixar as of July 1, 2000, all governed by this agreement, include our fourth film (with the working title "Monsters, Inc."), our fifth film (Film Five), our sixth film (Film Six) and our seventh film (Film Seven). A Bug's Life, Monsters, Inc., Film Five, Film Six and Film Seven will be counted toward the five original Pictures under this agreement, whereas Toy Story 2 is a derivative work that will not count towards the Pictures. However, under the Co-Production Agreement, all provisions applicable to the Pictures also apply to any derivative works that we elect to co-produce, such as Toy Story 2. Pixar and Disney co-own, co-brand and co-finance the production costs of the Pictures, and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all of Disney's marketing, distribution and other predefined fees and costs. The Co-Production Agreement generally provides that we will produce each Picture and Disney will control decisions relating to film marketing and distribution. (5) DISCONTINUED OPERATIONS In 1997, we determined to discontinue our business of producing CD-ROM and other interactive products. We immediately discontinued these operations and reassigned all employees of this division. Since the measurement date and the disposal date were virtually simultaneous, no income or loss was measured for the intervening period. We recorded income from discontinued operations of $125,000 and $67,000, net of income taxes, for the six months ended July 1, 2000 and July 3, 1999, respectively, due to royalty income received for the Toy Story CD-ROM products. We do not expect any significant future CD-ROM royalty income in future periods. (6) SEGMENT REPORTING We adopted the provisions of SFAS 131, Disclosures about Segments of an Enterprise and Related Information. Our chief operating decision-maker is considered to be our Chief Executive Officer ("CEO"). The CEO reviews financial information presented on a summary basis accompanied by disaggregated information about film revenue for purposes of making operating decisions and assessing financial performance. The summary financial information reviewed by the CEO is identical to the information presented in the accompanying statements of operations and we have no foreign operations. Therefore, we operate in a single operating segment. 6 7 PIXAR NOTES TO FINANCIAL STATEMENTS (CONTINUED) (7) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 2000, the AICPA issued Statement of Position (SOP) 00-2, Accounting by Producers or Distributors of Films. The guidance in this SOP applies to all types of films, and is applicable to all producers or distributors that own or hold rights to distribute or exploit films. For purposes of this SOP, films are defined as feature films, television specials, television series, or similar products including animated films and television programming that are sold, licensed or exhibited, whether produced on film, videotape, digital, or other video recording format. SOP 00-2 is effective for financial statements for fiscal years beginning after December 15, 2000. We are in the process of determining the impact of SOP 00-2 on our financial statements. 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 the industry in which we operate, management's beliefs, and assumptions made by management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under "-- Dependence on Toy Story 2 and A Bug's Life in 2000," and "Risks Associated with Adequacy of Cash Balances, " as well as those noted in the section entitled "Risk Factors" in our Annual Report on Form 10-K for the year ended January 1, 2000 (the "Form 10-K"). Particular attention should be paid to the cautionary language in the section in the Form 10-K entitled "-- Dependence on Toy Story 2, A Bug's Life and Toy Story in 2000," "-- Risks Associated with Adequacy of Cash Balances," "-- Risks Associated with Scheduled Successive Release of Films" and "-- Risks Associated with Co-Production Agreement." Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Our operating performance each quarter is subject to various risks and uncertainties as discussed in our Form 10-K. The following discussion should be read in conjunction with the sections entitled "Risk Factors" 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 "Risk Factors" could affect our operating results and financial condition. OVERVIEW In February 1997, we entered into the Co-Production Agreement ("Co-Production 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"), pursuant to which we agreed, on an exclusive basis, to produce five original computer-animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney. Pixar and Disney agreed to 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 Disney finances), a distribution fee paid to Disney and any other fees or costs, including participations provided to talent and the like. The Co-Production Agreement generally provides that we will produce each Picture and that Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Our second feature film, A Bug's Life, was released in November 1998 and counts as the first original Picture under the Co-Production Agreement. The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, we will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. We 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 us for our share of certain general and administrative costs and certain research and development costs that benefit the productions. In November 1999, Toy Story 2, our third animated feature film, was released. As a sequel, Toy Story 2 is a derivative work of the original Toy Story; therefore, it is not counted toward the five original Pictures to be produced under the Co-Production Agreement. However, as a derivative work, Toy Story 2 will be treated as a Picture under the Co-Production Agreement and all the provisions applicable to the five original Pictures apply. 8 9 In May 1999, we began production on our fourth theatrical film with the working title "Monsters, Inc." Also in 1999, we began story development on our fifth animated feature film, "Film Five," and concept development on our sixth animated feature film, "Film Six." In 2000 we began concept development on our seventh animated feature film, "Film Seven." These films will be produced and distributed under the Co-Production Agreement and will count as the second, third, fourth and fifth films of the five original films to be produced under the Co-Production Agreement. We do not expect to release Monsters, Inc. until November 2001, at the earliest, and Film Five until holiday 2002, at the earliest. Films Six and Seven are currently targeted for release no earlier than the holiday seasons in 2003 and 2004, respectively. Target Earnings per Share for Fiscal Year 2000 We are targeting diluted earnings per share of at least $1.30 for fiscal year 2000, which represents an increase from the $1.25 we had targeted during the first quarter of fiscal year 2000. This is forward-looking information and actual results may differ materially. Factors that could cause actual results to differ include but are not limited to: (1) the timing of the release of the Toy Story 2 home video in domestic and foreign markets and the timing and amount of related revenues; (2) the timing and amount of Toy Story 2 and A Bug's Life merchandise sales; (3) the timing and amount of revenue from the Buzz Lightyear television series and related home video release; (4) the amount of our revenues from the home video release of A Bug's Life as part of Disney's Gold Collection; (5) the timing and amount of A Bug's Life television revenue; (6) the timing and amount of distribution costs incurred in all markets for Toy Story 2, Toy Story and A Bug's Life; and (7) the timing, accuracy and sufficiency of the information we receive from Disney to determine revenues and associated gross profits. See "Risk Factors" set forth below for important factors that could cause actual results to differ. RESULTS OF OPERATIONS Revenue Total revenue for the three and six months ended July 1, 2000 were $18.3 million and $79.3 million, respectively, compared to $13.5 million and $16.9 million in the corresponding periods of the prior year. The increase for both periods was primarily due to an increase in film revenue, and, to a lesser extent, increases in software revenue and animation services revenue. Film revenue for the quarter ended July 1, 2000 was $16.1 million compared with $12.2 million in the corresponding prior year period. Film revenue for the six months ended July 1, 2000 was $74.0 million compared with $13.9 million in the corresponding prior year period. Under the Co-Production Agreement, we share equally with Disney in the profits of Toy Story 2 and A Bug's Life after Disney recovers its distribution costs and fees. Beginning with the first quarter of 2000, we have had an improved ability, through information available to us from Disney and other sources, to estimate and record our share of film revenues and gross profits. For the three and six months ended July 1, 2000, film revenues from Toy Story 2 of $13.3 million and $67.2 million, respectively, were primarily due to our share of worldwide theatrical revenues and related merchandise, offset by Disney's distribution costs and fees. There were no amounts from Toy Story 2 for comparable periods in the prior year as Toy Story 2 was released in November 1999. For the three month period ended July 1, 2000, film revenues from our library titles, which include A Bug's Life and Toy Story, netted to $2.8 million as compared to $12.2 million for the prior year period. For the six month period ending July 1, 2000, the revenue for our library titles was a net $6.8 million as compared to $13.9 million for the corresponding prior year period. The decrease in library titles from both prior year periods resulted from a decrease in A Bug's Life worldwide theatrical revenue and certain distribution cost estimate revisions from Disney occurring in the second quarter of 2000. This decrease was offset by an increase in Toy Story revenue which included revenues from its home video Gold Collection release. See "Risk Factors -- Dependence on Toy Story 2 and A Bug's Life in 2000." 9 10 Software revenue includes software license revenue, principally from RenderMan, and royalty revenue from licensing Physical Effects, Inc. (PEI) technology to a third party. Software revenue increased to $1.8 million for the three months ended July 1, 2000 from $1.2 million in the corresponding prior year period and increased to $4.5 million for the six months ended July 1, 2000 from $2.8 million in the corresponding prior year period. The increase in software revenue resulted primarily from a general increase in RenderMan software licensing, and to a lesser extent, from an increase in the royalty revenue from licensing PEI technology to a third party. PEI, a company we acquired in 1998, licensed certain of its technology to a third party, from which we now receive associated royalty revenue on a quarterly basis. Due to our focus on content creation for animated feature films and related products, we have not increased the time and resources necessary to generate significantly higher RenderMan sales. Therefore, we expect ongoing variability in revenues derived from software licenses and that such revenue will remain flat or possibly decline. All historical and future royalty income associated with our discontinued CD-ROM division is now and will continue to be excluded from software revenue and presented in results of discontinued operations. See "Results of Discontinued Operations." Animation services revenue includes revenue generated from short projects related to our feature films. Animation services revenue was $481,000 for the three months ended July 1, 2000, and increased to $814,000 for the six months ended July 1, 2000 from $222,000 in the corresponding prior year period. There was no animation services revenue for the three months ended July 3, 1999. We expect that revenue in this area will continue to vary significantly from quarter to quarter due to the sporadic nature of this business and the need to utilize animation services employees on other productions. For example, we transferred substantially all of our animation services employees to assist in the completion of both A Bug's Life and Toy Story 2 during peak production periods. There can be no assurance that we will generate any animation services revenues during periods in which animation services employees are devoted to feature films or other projects. For the three and six months ended July 1, 2000, Disney accounted for 91% and 94% respectively, of our total revenue. The revenue from Disney consisted of film and animation services revenue. Due to the Co-Production Agreement, Disney is expected to continue to represent significantly greater than 10% of our revenue in 2000 and for the foreseeable future. A significant portion of the Disney revenue for the quarter was included in receivables and represented 80% of the balance at July 1, 2000. For the three and six months ended July 3, 1999, Disney accounted for 91% and 83%, respectively, of our total revenue, primarily from film and animation services revenue. Cost of Revenue Cost of film revenue represents amortization of capitalized film costs. See "Capitalized Film Production Costs." For the three months ended July 1, 2000, cost of film revenue represents amortization of film costs associated with Toy Story 2, and represents 21% of total film revenue. For the six months ended July 1, 2000, cost of film revenue represents amortization of capitalized film costs associated with Toy Story 2 and to a lesser extent, our library titles, and represents 25% of total film revenue. For the three and six months ended July 3, 1999, cost of film revenue represented amortized costs from A Bug's Life, and was 29% and 28%, respectively, of total film revenue. Cost of software revenue consists of the direct costs and manufacturing overhead required to reproduce and package our software products, as well as amortization of purchased technology. Cost of software revenue includes no amortization of capitalized software development expenses. Cost of software revenue as a percentage of the related revenue was 8% and 6% for the three and six months ended July 1, 2000, compared to 11% and 15% for the three and six month corresponding prior year periods. The percentage decreases for the three and six months ended July 1, 2000 are due to increases in software and license sales that have low associated costs. Included in cost of software revenue is $120,000 of amortization of $2.7 million of purchased technology associated with the acquisition of PEI. Over a period not to exceed four years, we are amortizing this purchased technology against related license revenue. As a result of the ongoing amortization of purchased technology, our total software gross profit may be lower during the next few years as compared to software gross profit prior to the 1998 acquisition. In addition, if we determine that the license revenue generated by the purchased technology will be lower than expected and that all or part of the purchased 10 11 technology asset may not be recoverable, we would, at that point, be required to write off all or a significant portion of the unamortized purchased technology. Cost of animation services revenue consists of production costs, which include salaries, benefits, facility expenses and department overhead costs. Cost of animation services revenue as a percentage of related revenue was 53% for the three months ended July 1, 2000. There was no animation services revenue for the three months ended July 3, 1999 and therefore, no cost of animation services for the same period. Cost of animation services revenue as a percentage of related revenue was 54% and 69% for the six months ended July 1, 2000 and July 3, 1999, respectively. Animation services projects are negotiated individually and depending on the complexity of the project, profit margins vary significantly from project to project. Operating Expenses Total operating expenses for the three and six months ended July 1, 2000 were higher than in the prior periods, and we intend to continue to increase our spending levels in a number of areas. With respect to general expense growth, as a result of intense competition for animators, creative personnel, technical directors and certain administrative personnel, we have had to pay higher salaries to attract new creative, technical and other personnel. We expect compensation for such personnel to continue to increase. In 2000, we will continue to expand our creative development staff and facilities and expand other operations. Under the Co-Production Agreement, Disney reimburses us for half of certain general and administrative costs and certain research and development costs that benefit the productions. The funding received from Disney is treated as operating expense reimbursements. To the extent that personnel, facilities and other expenditures are not capitalized by us nor allocated to and paid for by Disney, and precede or are not subsequently followed by an increase in revenue, our 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 and for our proprietary Marionette and Ringmaster animation and production management software and for creative development of concepts for future films. Research and development expenses increased to $1.8 million in the three months ended July 1, 2000 from $1.3 million in the corresponding prior year period and increased to $3.2 million in the six months ended July 1, 2000 from $2.7 million in the corresponding prior year period. In the first quarter of fiscal year 2000 we recorded a one-time $523,000 adjustment, which reduced our research and development expenses for the six months ended July 1, 2000, from $3.7 million to $3.2 million. This adjustment was due to an additional reimbursement from Disney under the Co-Production Agreement for certain research and development expenses incurred prior to fiscal year 2000. After allowing for this adjustment, the increases are due to our continued investment in proprietary technology, short films and creative development. We expect research and development expenses to increase in future periods. To date, all research and 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. Sales and marketing expenses increased to $337,000 for the three months ended July 1, 2000 from $304,000 in the corresponding prior year period and increased to $727,000 for the six months ended July 1, 2000 from $652,000 in the corresponding prior year period. Increases in both periods from 1999 are attributable to increases in corporate marketing and public relations. We believe that sales and marketing expenses will increase in absolute dollars in future periods, particularly in the areas of public relations and corporate marketing. General and administrative expenses consist primarily of salaries of management and administrative personnel, insurance costs and professional fees. General and administrative expenses increased to $2.0 million for the three months ended July 1, 2000 from $1.6 million in the corresponding prior year period and increased to $3.8 million for the six months ended July 1, 2000 from $2.9 million in the corresponding prior year period. The increase was due to general and administrative staffing and public company costs. We expect general and administrative expenses to further increase in absolute dollars in future periods. 11 12 Other Income, Net Other income, net was $3.1 million and $5.9 million for the three and six months ended July 1, 2000, respectively, and $1.8 million and $3.7 million for the three and six months ended July 3, 1999, respectively, consisting primarily of interest income on short-term investments. The increase for both periods is primarily due to an increase in interest rates, and an increase in our average cash and short-term investment balances during the second half of 1999 and continuing through July 1, 2000. Income Taxes Income tax expense from continuing operations for the three and six months ended July 1, 2000 reflects our federal and state income tax liability of 41.5%, consistent with statutory rates. Income tax expense as a percentage of pre-tax income for the three and six months ended July 3, 1999, was 24% and 26%, respectively. The income tax rate increased for both periods because in 1999, we utilized our remaining net operating loss carryforwards, except those originating from the exercise of non-qualified employee stock options. The realization of tax benefits from the exercise of non-qualified employee stock options will reduce the amount of our tax payments and liabilities, but will not reduce our effective tax rate. We expect our tax rate in the future to be at or near statutory levels. Results of Discontinued Operations After the Co-Production Agreement was executed, we determined that the resources devoted to our interactive products division would be better allocated to other projects arising from the Co-Production Agreement. We determined in March 1997 to discontinue our business of producing CD-ROM and other interactive products and redirected employees in that division to film and related projects. For the six months ended July 1, 2000, we recorded income from discontinued operations of $125,000, net of income taxes, due to royalty income received. We do not expect to receive any significant CD-ROM royalty income in future periods. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 2000, the AICPA issued Statement of Position (SOP) 00-2, Accounting by Producers or Distributors of Films. The guidance in this SOP applies to all types of films, and is applicable to all producers or distributors that own or hold rights to distribute or exploit films. For purposes of this SOP, films are defined as feature films, television specials, television series, or similar products including animated films and television programming that are sold, licensed or exhibited, whether produced on film, videotape, digital, or other video recording format. SOP 00-2 is effective for financial statements for fiscal years beginning after December 15, 2000. We are in the process of determining the impact of SOP 00-2 on our financial statements. RISK FACTORS The following is a discussion of certain factors which currently impact or may impact our business, operating results and/or financial condition. Anyone making an investment decision with respect to our capital stock or other securities is cautioned to carefully consider these factors, along with the factors discussed in our Form 10-K under the section entitled "Risk Factors." DEPENDENCE ON TOY STORY 2 AND A BUG'S LIFE IN 2000 In the remaining quarters of 2000, our revenue and operating results will be largely dependent upon (1) the timing of the release of the Toy Story 2 home video in domestic and foreign markets and the timing and amount of related revenues; (2) the timing and amount of Toy Story 2 and A Bug's Life merchandise sales; (3) the timing and amount of revenue from the Buzz Lightyear television series and related home video release; (4) the amount of our revenues from the home video release of A Bug's Life as part of Disney's Gold Collection; (5) the timing and amount of A Bug's Life television revenue; (6) the timing and amount of distribution costs incurred in all markets for Toy Story 2 and A Bug's Life; and (7) the timing, accuracy and sufficiency of the information we receive from Disney to determine revenues and associated gross profits. 12 13 Toy Story 2 Revenue We will continue to be significantly dependent upon the success of Toy Story 2 for the remaining quarters of fiscal year 2000. Toy Story 2, released in November 1999, has achieved significant box office success, with worldwide box office receipts of more than $486 million as of August 8, 2000. Beginning with the first quarter of 2000, we have had an improved ability, through information available to us from Disney and other sources, to estimate and record our share of film revenues and gross profits. As a result, we recognized revenues from Toy Story 2 of $67.2 million for the six months ended July 1, 2000, which represents our related revenue recorded to date. While we anticipate this improved ability will continue to allow us to recognize our share of film revenues and gross profits on a more timely basis, we will remain dependent on the timing and accuracy of the information provided by Disney, as well as on the continuing commercial success of Toy Story 2 throughout the balance of fiscal year 2000. We have already recognized in the first six months of 2000 essentially all of Toy Story 2 worldwide theatrical revenues, as well as a significant portion of related merchandise revenue. As a result, we do not expect to recognize further significant revenue from Toy Story 2, other than any remaining revenues from related merchandise sales, until the release of Toy Story 2 on home video in October 2000, when we expect to recognize a portion of domestic and foreign home video revenues. These future revenues from Toy Story 2 will be offset by distribution and marketing costs from its domestic and foreign home video releases, video cost of goods, Disney's distribution fee, and other distribution costs such as talent participation and residuals. Fees and participations paid to key talent on Toy Story 2 are substantially greater than for Toy Story or A Bug's Life, which together with other increases in production costs will have the effect of increasing the cost of the film when compared to our first two films. A Bug's Life Revenue A Bug's Life was released in November 1998, and to date, we have recognized related revenues of $109 million. Under the Co-Production Agreement, Pixar and Disney share equally in the profits of A Bug's Life after Disney recovers its distribution fee and its marketing and distribution costs. Correspondingly, our film revenue to date has resulted primarily from the domestic and foreign theatrical revenues from A Bug's Life, related domestic and foreign home video revenue, and related merchandise licensing, offset by Disney's distribution costs and its distribution fee. Distribution costs include worldwide theatrical release costs, and Disney's costs to distribute A Bug's Life on home video in the United States and foreign markets. The majority of revenues we expect to receive from A Bug's Life were reported in 1999 and through the six months ended July 1, 2000. In line with Disney's new home video strategy, by which more titles will be available on a year-round basis, A Bug's Life VHS and DVD were repackaged and released as part of Disney's Gold Collection on August 1, 2000. We expect sources of revenue for the balance of 2000 to include these home video sales, possibly some television revenues, and any future merchandise royalties, all of which must be substantial in order for the film to generate significant revenues in 2000. Moreover, potential future revenues will be offset by associated distribution costs, which include home video distribution costs, any television distribution costs, any remaining theatrical distribution costs, Disney's distribution fee based on film-related revenues, and other distribution costs such as residuals. DIFFICULTY AND RISKS IN FORECASTING TOY STORY 2 AND A BUG'S LIFE REVENUES It is difficult to forecast the amount and timing of our future revenues from Toy Story 2 and A Bug's Life in the remaining quarters of 2000. The amount of future revenues depends not only on customer acceptance of a film in its worldwide theatrical release, but also on customer acceptance of related products in each separate release category -- home video, merchandise and television being the most significant. While customer acceptance is initially measured by box office success, customer acceptance within each follow-on product category, such as home video, toys or television, depends on factors unique to each type of product, such as pricing, competitive products, and the time of year or state of the economy in which a product is released, among many other factors. In addition, we have found that the degree of customer acceptance varies widely among foreign countries. While box office success is often a good indicator of general customer acceptance, 13 14 the relative success of follow-on products is not always directly correlated, and the degree of correlation is difficult to predict. Disney's strategic distribution decisions also impact the amount of our future revenues. For example, in the first half of 1999, Disney reported general softness in its domestic home video sales and worldwide merchandise licensing as compared to levels associated with many of its previous blockbuster animated feature films. As a result, Disney implemented a new strategy of releasing animated films on home video year round, and in special editions in both VHS and DVD formats. However, the relative success of that new strategy is not yet known. For this reason and all of the above reasons, in spite of Toy Story 2's remarkable box office success, it is difficult to predict how successful its home video release will be, or how successful sales of other follow-on products will be in the remaining quarters of 2000. Similarly, it is difficult to predict remaining video sales or television revenue from A Bug's Life in 2000. With respect to the difficulty of forecasting the timing of revenues, Disney distributes our films and film-related products and therefore determines the timing of product releases. While the timing of theatrical releases is typically known well in advance of release, the timing of release of follow-on products is often decided just in advance of release, is subject to change, and is therefore less predictable. For example, it was not until the first quarter of fiscal year 2000 that it was determined that the Toy Story 2 home video will be released on October 17, 2000. In all product categories, timing of revenues is particularly uncertain with respect to releases in foreign markets as a foreign product release is often marked by a rollout across many countries over the course of many months. Therefore, the timing of international revenues is inherently more difficult to predict than the timing of domestic revenues. In addition, the amount of revenue recognized in any given quarter or quarters from all of our films depends on the timing, accuracy, and sufficiency of the information we receive from Disney to determine revenues and associated gross profits. Although we obtain from Disney the most current information available to recognize our share of revenue and to determine our film gross profit, Disney may make subsequent adjustments to the information that it has provided which could have a material impact on us in later periods. For instance, towards the end of the life cycle for a revenue stream, Disney may inform us of additional distribution costs to those previously forecasted, as occurred in the second quarter of fiscal year 2000. Such adjustments have and may continue to impact our revenue share and our film gross profit. Due to these factors, the amount and timing of our future revenues from Toy Story 2 and A Bug's Life are difficult to forecast, and it is possible, in any given quarter or quarters remaining in 2000 that we will not recognize sufficient film revenue to generate significant earnings. Under the Co-Production Agreement, Pixar and Disney share the production costs of Toy Story 2 and A Bug's Life. We initially capitalized our share of these costs as film production costs, under Statement of Financial Accounting Standards ("SFAS") No. 53, Financial Reporting by Producers and Distributors of Motion Picture Films. Our policy is to amortize these costs over the expected revenue streams as we recognize revenues from the associated films. The amount of film costs that will be amortized each quarter will depend on how much future revenue we expect to receive from Toy Story 2 and A Bug's Life. Although Toy Story 2 has achieved substantial worldwide box office success, and we have recognized significant theatrical revenues, we believe that the amount spent by Disney for marketing and distribution has been and will continue to be significant. It is possible that total revenue generated in all markets by Toy Story 2 may not generate significant revenue and operating results for us in any remaining given quarter in 2000, even though Toy Story 2 is critically acclaimed and has achieved worldwide box office success. With respect to A Bug's Life, it is difficult to predict how much additional revenue will be derived from home video and merchandise sales, and from television airings. In any given quarter, if our forecast changes with respect to total anticipated revenue from Toy Story 2 or A Bug's Life, and becomes lower than was previously forecasted, we would be required to accelerate amortization of related film costs, resulting in lower gross margins. Such lower gross margins would adversely impact our business, operating results, and financial condition. SOFTWARE REVENUE We continue to reduce our emphasis on the commercialization of software products. We are not increasing the time and resources necessary to generate higher RenderMan licensing revenues; therefore, we expect that revenue from the licensing of RenderMan will remain flat or possibly decline. In addition, from the acquisition date of Physical Effects, Inc. ("PEI") in June 1998 through July 1, 2000, we have received lower 14 15 license revenue than expected related to the purchased technology associated with the acquisition. If future license revenue continues to be lower than originally estimated, we may be required to write-off all or a significant portion of the unamortized purchased technology. WE EXPECT OUR OPERATING RESULTS TO CONTINUE TO FLUCTUATE Fluctuations in Revenue We continue to expect significant fluctuations in our future annual and quarterly revenues because of a variety of factors, including the following: - the timing of the domestic and international releases of our animated feature films, - the success of our animated feature films (which could fluctuate significantly from film to film), - the timing of the release of related products into their respective markets (such as home videos, television, and merchandising), - the demand for such related products (which is often a function of the success of the related animated feature film), - Disney's costs to distribute and promote the feature films and related products, - Disney's success at marketing the feature films and related products, - the timing and accuracy of information received from Disney and other sources on which we base estimates of revenue to be recognized from our animated feature films and related products by Disney, - the introduction of new feature films or products by our competitors, and - general economic conditions. In particular, since our revenue under the Co-Production Agreement is directly related to the success of a feature film, our operating results are likely to fluctuate depending on the level of success of our animated feature films and related products. The revenues derived from the production and distribution of an animated feature film depend primarily on the film's acceptance by the public, which cannot be predicted and does not necessarily bear a direct correlation to the production or distribution costs incurred. The commercial success of a motion picture also depends upon promotion and marketing, production costs and other factors. Further, the theatrical success of a feature film can be a significant factor in determining the amount of revenues generated from the sale of the related products. Fluctuations in Operating Expenses Increase in Our Operating Expenses and Effective Tax Rate Over the last few years, we significantly increased our operating expenses, and we plan to continue to increase our operating expenses to fund greater levels of research and development and to expand operations. Specifically, we expect our spending levels to increase significantly due to (1) continued investment in proprietary software systems, (2) increased compensation costs as a result of intense competition for animators, creative personnel, technical directors and other personnel, (3) increased costs associated with the expansion of our facilities, and (4) increased investment in creative development. A portion of our operating expenses that are allocable to film productions is either capitalized by us or reimbursed by Disney under the Co-Production Agreement. To the extent that we do not capitalize (or Disney does not pay for) the increases in expenses, our operating expenses will significantly increase in 2000. Finally, our tax rate in the first half of fiscal year 2000 approximates statutory levels and is expected to remain at that level in future periods because we have utilized our remaining net operating loss carryforwards, except those which originated as non-qualified employee stock option costs. The realization of tax benefits from non-qualified employee stock option costs will not reduce our effective tax rate in the future. 15 16 Difficulty in Predicting Operating Expenses Moreover, our operating expenses will continue to be extremely difficult to forecast. We budget the direct costs of film productions with Disney, and we share such costs equally. We capitalize our share of these direct costs of film production in accordance with SFAS No. 53. A substantial portion of all of our other costs are incurred for the benefit of feature films ("Overhead"), including research and development expenses and general and administrative expenses. Portions of our Overhead are included in the budgets for the Pictures, and we share such costs equally with Disney under the Co-Production Agreement. With respect to the portion of our Overhead that is not reimbursed by Disney, we either (1) capitalize such portion as film production costs, if required under SFAS No. 53, or (2) charge it to operating expense in the period incurred. Since a substantial portion of our Overhead is related to the Pictures, and is therefore reimbursed by Disney, and since we capitalize other amounts in accordance with SFAS No. 53, our reported operating expenses for the first half of fiscal year 2000 have not reflected, and future reported operating expenses will not reflect, our true level of spending on the production of animated feature films, related products and overhead. RISKS ASSOCIATED WITH ADEQUACY OF CASH BALANCES Pursuant to the Co-Production Agreement, we co-financed A Bug's Life and Toy Story 2 and will co-finance the next four original animated feature films which we produce, including Monsters, Inc., Film Five, Film Six, and Film Seven. In the future, we may co-finance other derivative works such as sequels, interactive products and television productions. In addition, we are constructing new studio and headquarter facilities in Emeryville, California, which are being financed by the use of our cash and may continue to be financed by the use of our cash. The development and production costs of Monsters, Inc., Film Five, Film Six, and Film Seven, and costs of the new Emeryville facility may have an adverse impact on our cash and short-term investment balances. As of July 1, 2000, we had approximately $214.6 million in cash and short-term investments. We believe that these funds will be sufficient to meet our anticipated cash needs for working capital and capital expenditures, including the development and production costs of Monsters, Inc., Film Five, Film Six, and Film Seven, until we receive any remaining proceeds from the release of Toy Story 2 and A Bug's Life. See "-- Liquidity and Capital Resources." To date, we have chosen to use our existing cash resources to fund construction costs and film production costs. We may continue to use our cash resources for such expenditures, or may choose to finance such capital expenditures through issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. The sale of additional equity or convertible debt securities would result in additional dilution to our shareholders. Moreover, we cannot provide any assurances that we will be successful in obtaining future financing, or even if such financing is available, that we will obtain it on favorable terms or on terms providing us with sufficient funds to meet our obligations and objectives. If we fail to obtain such financing, it would have a material adverse effect on our business, operating results and financial condition. CAPITALIZED FILM PRODUCTION COSTS We had $58.6 million in capitalized film production costs as of July 1, 2000, consisting primarily of costs relating to Toy Story 2, A Bug's Life, and Monsters, Inc., all of which are being co-financed by Disney under the Co-Production Agreement. All Toy Story capitalized film costs were fully amortized as of December 31, 1997. LIQUIDITY AND CAPITAL RESOURCES Cash and short-term investments increased $19.7 million to $214.6 million at July 1, 2000 from $194.9 million at January 1, 2000 due primarily to our share of proceeds from Toy Story 2 and A Bug's Life, offset by film production spending and construction spending on our new studio and headquarter facilities in Emeryville, California. On March 16, 2000, we purchased an existing building on 1.76 acres in Emeryville for $7.7 million. While it was purchased for potential future expansion, the building presently serves as rental property, is currently occupied by commercial tenants and is generating rental income. 16 17 Net cash provided by continuing operations for the six months ended July 1, 2000 was primarily attributable to net income of $34.4 million, the non-cash impact of depreciation and amortization expense and amortization of capitalized film production costs, totaling $20.8 million and increases in accounts payable and income taxes payable of $4.8 million, offset by a decrease in accrued liabilities of $6.2 million. Cash flows used in investing activities were due primarily to investments in short-term securities of $217.3 million, the purchase of property and equipment of $28.7 million and funding of film production costs of $12.3 million, offset by net proceeds from maturities of short-term securities of $221.9 million. Cash flows provided by financing activities were due to proceeds from the exercise of stock options. As of July 1, 2000, our principal source of liquidity was approximately $214.6 million in cash and short-term investments. We believe that these funds will be sufficient to meet our operating requirements through the next twelve months. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We invest in a variety of investment grade, interest-bearing securities, including fixed rate obligations of corporations, municipalities, and national governmental entities and agencies. This diversification of risk is consistent with our policy to ensure safety of our principal and maintain liquidity. We only invest in securities with a maturity of 24 months or less, with only government obligations exceeding 12 months. Our investments are fixed rate obligations and carry a certain degree of interest rate risk. A rise in interest rates could adversely impact the fair market value of these securities. All of our financial instruments are held for purposes other than trading and are considered "available for sale" per SFAS 115. The table below provides information regarding our investment portfolio at July 1, 2000. The table presents principal cash flows and related weighted-average fixed interest rates presented by expected maturity date (dollars in thousands):
LESS THAN OVER 1 YEAR 1 YEAR TOTAL --------- ------- -------- Available-for-sale securities............... $202,061 $11,335 $213,396 Weighted-average interest rate.............. 6.13% 6.01% 6.13%
While our products are distributed in foreign markets by Disney and its affiliates, we derive no direct revenues from foreign markets. However, our revenue share estimate is affected by foreign currency fluctuations as managed by Disney. We also have no debt and therefore, no related market risk. PART II -- OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) EXHIBITS 27.1 Financial Data Schedule (B) REPORTS ON FORM 8-K No reports on Form 8-K were filed by Pixar during the quarter ended July 1, 2000. ITEMS 1, 2, 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED. 17 18 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 15, 2000 By: /s/ ANN MATHER ------------------------------------ Ann Mather, Executive Vice President and Chief Financial Officer (Principal Accounting Officer And Duly Authorized Officer) 18 19 EXHIBIT INDEX
EXHIBIT ------- 27.1 Financial Data Schedule