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 2, 2005

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 Incorporation or organization)	(I.R.S. Employer Identification No.)
1200 Park Avenue, Emeryville, California	94608
(Address of principal executive offices)	(Zip code)

(510) 752-3000

(Registrant’s telephone number, including area code)

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 (the “Act”) during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨.

The number of shares outstanding of the Registrant’s Common Stock as of August 1, 2005 was 118,586,311.

Pixar

FORM 10-Q

Index

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Balance Sheets as of July 2, 2005 and January 1, 2005	Page 2
Statements of Income for the Quarter and Six Months Ended July 2, 2005 and July 3, 2004	Page 3
Statements of Cash Flows for the Six Months Ended July 2, 2005 and July 3, 2004	Page 4
Notes to Financial Statements	Page 5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	Page 14
Risk Factors	Page 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk	Page 38
Item 4. Controls and Procedures	Page 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	Page 39
Item 6. Exhibits	Page 39
SIGNATURE	Page 40
EXHIBIT INDEX	Page 41
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

1

PART I—FINANCIAL INFORMATION

Item 1.  Financial Statements

PIXAR

BALANCE SHEETS

(Unaudited, in thousands, except share data)

	July 2, 2005			January 1, 2005
ASSETS
Cash and cash equivalents	$	13,115		$	28,661
Investments		888,313			826,123
Trade accounts receivable, net of allowance for doutbtful accounts of $177 as of July 2, 2005 and January 1, 2005		2,546			5,581
Receivable from Disney, net of reserve for returns and allowance for doubtful accounts of $7,572 and $3,479 as of July 2, 2005 and January 1, 2005, respectively		140,531			68,074
Other receivables		6,612			8,307
Prepaid expenses and other assets		3,283			2,227
Deferred income taxes		75,061			70,424
Property and equipment, net		125,863			125,602
Capitalized film production costs, net		147,148			140,038
Total assets	$	1,402,472		$	1,275,037
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable	$	1,700		$	5,392
Income taxes payable		13,566			14,077
Other accrued liabilities		16,717			26,971
Unearned revenue		10,732			8,502
Total liabilities		42,715			54,942
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; 200,000,000 shares authorized; 118,568,761 and 116,852,504 shares issued and outstanding as of July 2, 2005 and January 1, 2005, respectively		732,995			687,387
Accumulated other comprehensive loss		(2,746	)		(2,211	)
Retained earnings		629,508			534,919
Total shareholders’ equity		1,359,757			1,220,095
Total liabilities and shareholders’ equity	$	1,402,472		$	1,275,037

See accompanying notes to financial statements.

2

PIXAR

STATEMENTS OF INCOME

(Unaudited, in thousands, except per share data)

	Quarter Ended				Six Months Ended
	July 2, 2005		July 3, 2004		July 2, 2005		July 3, 2004
Revenue:
Film	$	23,446	$	63,713	$	181,358	$	114,805
Software		2,991		2,576		6,323		5,308
Total revenue		26,437		66,289		187,681		120,113
Cost of revenue		4,274		6,437		31,731		12,341
Gross profit		22,163		59,852		155,950		107,772
Operating expenses:
Research and development		3,105		4,154		5,929		7,552
Sales and marketing		752		635		1,514		1,007
General and administrative		3,920		3,017		8,295		6,093
Total operating expenses		7,777		7,806		15,738		14,652
Income from operations		14,386		52,046		140,212		93,120
Interest income and other		5,783		2,489		10,559		5,385
Income before income taxes		20,169		54,535		150,771		98,505
Income tax expense		7,467		17,150		56,182		34,378
Net income	$	12,702	$	37,385	$	94,589	$	64,127
Basic net income per share	$	0.11	$	0.33	$	0.80	$	0.57
Shares used in computing basic net income per share		118,338		112,574		117,833		112,078
Diluted net income per share	$	0.10	$	0.32	$	0.77	$	0.55
Shares used in computing diluted net income per share		123,537		117,974		123,023		117,594

See accompanying notes to financial statements.

3

PIXAR

STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

	Six Months Ended
	July 2, 2005			July 3, 2004
Cash flows from operating activities:
Net income	$	94,589		$	64,127
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,904			3,572
Capitalized film production costs		(37,759	)		(27,323	)
Amortization of capitalized film production costs		30,960			12,157
Provision for return reserves and allowance for doubtful accounts, net		7,425			45,463
Income from warrant received in connection with license agreement		(843	)		—
Warrants adjustment to fair value		(135	)		—
Loss on dispositions of property and equipment		64			—
Loss (gain) on sales of investments		343			(656	)
Tax benefit from stock option exercises		18,787			16,258
Deferred income taxes		(4,246	)		—
Changes in operating assets and liabilities:
Trade accounts receivable		3,035			334
Receivable from Disney		(79,882	)		138,212
Other receivables		1,695			(2,886	)
Prepaid expenses and other assets		345			(318	)
Accounts payable		(3,692	)		(671	)
Other accrued liabilities		(10,254	)		272
Income taxes payable		(511	)		(34,028	)
Unearned revenue		1,807			(1,351	)
Net cash provided by operating activities		26,632			213,162
Cash flows from investing activities:
Purchases of property and equipment		(5,702	)		(5,573	)
Proceeds from sales of property and equipment		162			—
Proceeds from sales of investments		431,215			343,395
Purchases of investments		(494,674	)		(591,099	)
Net cash used in investing activities		(68,999	)		(253,277	)
Cash flows from financing activities:
Proceeds from exercised stock options		26,821			27,621
Net cash provided by financing activities		26,821			27,621
Net decrease in cash and cash equivalents		(15,546	)		(12,494	)
Cash and cash equivalents at beginning of period		28,661			48,320
Cash and cash equivalents at end of period	$	13,115		$	35,826
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes	$	41,281		$	53,735
Supplemental disclosure of non-cash investing and financing activities:
Warrant received in connection with license agreement	$	1,266		$	—
Loss on equipment disposals capitalized as film production costs	$	(311	)	$	—
Unrealized loss on investments, net of tax benefits	$	(535	)	$	(1,579	)

See accompanying notes to financial statements.

4

PIXAR

NOTES TO FINANCIAL STATEMENTS

(1) Organization and Basis of Presentation

The Company

Pixar was formed in 1986 when Steve Jobs purchased the computer division of Lucasfilm and incorporated it as a separate company. Pixar (or the “Company”) is a leading digital animation studio with the creative, technical and production capabilities to create animated feature films and related products. The Company’s objective is to create, develop and produce computer-animated feature films with heartwarming stories and memorable characters that appeal to audiences of all ages. Through the creation of entertaining, enduring and successful films, the Company seeks to maintain its position as a leading brand in animated feature films.

Basis of Presentation

The accompanying unaudited financial statements have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and 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 the financial condition, results of operations, and cash flows of Pixar for the periods presented. These financial statements should be read in conjunction with the audited financial statements as of January 1, 2005, and for each of the years in the three-year period ended January 1, 2005, including notes thereto. These audited financial statements are included in Pixar’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 17, 2005.

On March 23, 2005, Pixar announced that its Board of Directors had approved a two-for-one stock split of the Company’s common stock and a proportional increase in the number of Pixar common shares authorized from 100 million to 200 million. Shareholders of record at the close of trading on April 4, 2005, were entitled to receive one additional share of Pixar common stock for every outstanding share held on such date. The additional shares were distributed on April 18, 2005, and reporting of the Company’s share price on a split-adjusted basis commenced on April 19, 2005. All issued and outstanding share and per share amounts and stock prices related to Pixar’s common stock in the accompanying unaudited financial statements and notes thereto have been restated to reflect the stock split for all periods presented.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of ultimate revenues and ultimate costs and estimates of product sales that will be returned and the amount of receivables that ultimately will be collected. Actual results could differ from those estimates.

The results of operations for the quarter and six months ended July 2, 2005, 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 2005 financial statement presentation.

(2) Fiscal Year

Pixar operates on a 52 or 53-week fiscal year, whereby the year ends on the Saturday nearest December 31. Fiscal year 2005 will end on December 31, 2005, and will consist of 52 weeks.

(3) Stock Option Accounting

The Company has elected to continue using the intrinsic-value method of accounting for stock-based compensation plans in accordance with Accounting Principles Board Opinion (APB) No. 25, “Accounting for

5

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

Stock Issued to Employees,” and related interpretations. The Company has adopted those provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” as amended, which requires disclosure of the pro forma effects on net income and net income per share as if compensation cost had been recognized based upon the fair value-based method at the date of grant of options awarded.

The following table reflects pro forma net income and net income per share had the Company elected to adopt the fair value-based method (in thousands, except per share data):

	Quarter Ended						Six Months Ended
	July 2, 2005			July 3, 2004			July 2, 2005			July 3, 2004
Net income:
As reported	$	12,702		$	37,385		$	94,589		$	64,127
Fair value-based compensation cost, net of taxes		(4,405	)		(4,472	)		(13,975	)		(8,981	)
Pro forma net income	$	8,297		$	32,913		$	80,614		$	55,146
Basic net income per share:
As reported	$	0.11		$	0.33		$	0.80		$	0.57
Pro forma	$	0.07		$	0.29		$	0.68		$	0.49
Diluted net income per share:
As reported	$	0.10		$	0.32		$	0.77		$	0.55
Pro forma	$	0.07		$	0.29		$	0.66		$	0.48

These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years. The pro forma amounts assume that the Company had been following the fair value-based method since the beginning of 1996.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average fair value of options granted was $17.75 and $17.45 for the quarter and six months ended July 2, 2005, respectively, and $13.53 and $13.46 for the quarter and six months ended July 3, 2004, respectively. Values were estimated using zero dividend yield for all years; expected volatility of 35% for the quarter and six months ended July 2, 2005, respectively, and 39% for the corresponding prior year periods; risk-free interest rates of 3.90% and 3.96% for the quarter and six months ended July 2, 2005, respectively, and 3.77% and 3.59%, respectively, for the corresponding prior year periods; and weighted-average expected lives for all periods of 5.0 years.

(4) 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 potential common shares outstanding during the period, using the treasury stock method for options. Of the outstanding options to purchase shares of common stock, for the quarter and six months ended July 2, 2005, options to purchase approximately 26,000 shares and 50,000 shares, respectively, of common stock were not included in the computation of diluted net income per share because the options’ exercise price was greater than the average market price of the common shares. Options to purchase approximately 1,012,000 and 1,040,000 shares, respectively, of common stock were excluded for the quarter and six month periods ended July 3, 2004.

6

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

The reconciliation of basic and diluted net income per share is as follows (in thousands, except per share amounts):

	Quarter Ended
	July 2, 2005					July 3, 2004
	Net Income		Shares	Net Income per Share		Net Income		Shares	Net Income per Share
Basic net income per share	$	12,702	118,338	$	0.11	$	37,385	112,574	$	0.33
Effect of dilutive shares:
Options		—	5,199				—	5,400
Diluted net income per share	$	12,702	123,537	$	0.10	$	37,385	117,974	$	0.32
	Six Months Ended
	July 2, 2005					July 3, 2004
	Net Income		Shares	Net Income per Share		Net Income		Shares	Net Income per Share
Basic net income per share	$	94,589	117,833	$	0.80	$	64,127	112,078	$	0.57
Effect of dilutive shares:
Options		—	5,190				—	5,516
Diluted net income per share	$	94,589	123,023	$	0.77	$	64,127	117,594	$	0.55

(5) Comprehensive Income

Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” establishes standards for the reporting and display of comprehensive income and its components in the financial statements. Items of other comprehensive income (loss) currently consist of unrealized holding gains (losses) on the Company’s investments. The following table sets forth the components of comprehensive income, net of tax (in thousands):

	Quarter Ended					Six Months Ended
	July 2, 2005		July 3, 2004			July 2, 2005			July 3, 2004
Net income	$	12,702	$	37,385		$	94,589		$	64,127
Unrealized holding gains (losses) on investments, net of tax		767		(1,203	)		(535	)		(1,579	)
Comprehensive income	$	13,469	$	36,182		$	94,054		$	62,548

(6) Feature Film and Co-Production Agreements

Feature Film Agreement

In 1991, the Company entered into a feature film agreement with Walt Disney Pictures, a wholly owned subsidiary of Walt Disney Pictures and Television (together with its subsidiaries and affiliates collectively referred to herein as “Disney”), to develop and produce up to three computer-animated feature films (the “Feature Film Agreement”). In 1995, the Company released its first and only feature film under the terms of the

7

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

Feature Film Agreement, Toy Story. The Company continues to receive compensation based on revenue from the distribution of Toy Story and related products. Based on the individual-film-forecast-computation method, all Toy Story film production costs were fully amortized at December 31, 1997.

Co-Production Agreement

In 1997, the Company extended its original relationship with Disney (under which Toy Story was created and produced) by entering into the Co-Production Agreement. Under the Co-Production Agreement, the Company agreed to produce, on an exclusive basis, five original computer-animated feature films (the “Pictures”) for distribution by Disney. Pixar and Disney agreed to co-finance, co-own and co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after Disney recovers all marketing and distribution costs and fees. The first four original Pictures produced under the Co-Production Agreement were A Bug’s Life, Monsters, Inc., Finding Nemo, and The Incredibles. The Company is currently in production on Cars, the final Picture under this agreement. As a sequel, Toy Story 2 did not count toward the Pictures; however, it was produced under the Co-Production Agreement and is afforded the same financial terms as the Pictures.

The term of the Co-Production Agreement continues until delivery to Disney of the fifth Picture, Cars, which is currently scheduled for a June 9, 2006 release. Since the April 2003 delivery of Finding Nemo, the Company has had the ability to negotiate and enter into another distribution agreement with any other third party. The Company has produced six highly successful films to date, and believes that this success combined with the strength of its financial resources, position Pixar to negotiate a distribution arrangement with more favorable economic terms and full ownership of its films beyond the Co-Production Agreement.

All payments to Pixar from Disney for development and production of films under the Feature Film Agreement and the Co-Production Agreement have been recorded as cost reimbursements. Accordingly, no revenue has been recognized for such reimbursements; rather, the Company has netted the reimbursements against the related costs.

Creative Development Group

In addition to the films produced and in process under the Co-Production Agreement, Pixar’s creative development group is working on concept development, pre-production and production for several new projects that are not governed by the Co-Production Agreement. Costs related to these projects are therefore neither shared nor reimbursed by Disney. Such costs are capitalized as film costs and will be amortized under the individual-film-forecast-computation method assuming the concept development leads to a successful concept and realization of a film project, when it is expected that the film will be set for production. In the event a film is not set for production within three years from the time of the first capitalized transaction, such costs will be expensed.

Components of Capitalized Film Production Costs

The components of capitalized film production costs are as follows:

	July 2, 2005		January 1, 2005
	(in thousands)
In release, (net of amortization)	$	23,565	$	53,881
In production		117,875		81,741
In development		5,708		4,416
Capitalized film production costs, net	$	147,148	$	140,038

8

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

Pixar and Disney jointly finance all production costs relating to the Pictures on an equal basis. Film production costs include costs to develop and produce the Pictures, which primarily consist of salaries, equipment and overhead. Additionally, certain operating expenses benefiting the productions, such as certain research and development and certain general and administrative expenses are paid half by Pixar and half by Disney. Pursuant to the terms of the Co-Production Agreement, the parties established a mutually acceptable funding mechanism to ensure that sums would be available in a timely manner to fund production costs. In practice, Pixar prepares funding requests for forecasted film production costs and Disney funds its share on a monthly basis at approximately the beginning of the month. All payments to Pixar from Disney for development and production of films under the Feature Film Agreement and the Co-Production Agreement have been recorded as cost reimbursements. Accordingly, no revenue has been recognized for such reimbursements; rather, the Company has netted the reimbursements against the related costs.

The table below sets forth the amounts reimbursed by Disney:

	Six Months Ended
	July 2, 2005		July 3, 2004
	(in thousands)
Production related	$	14,518	$	18,687
Research and development		1,184		3,834
General and administrative		1,618		1,795
Expense related		2,802		5,629
Total reimbursements by Disney	$	17,320	$	24,316

For films in release, the Company expects to amortize, based on current estimates, approximately $15 million to $19 million in capitalized film production costs over the succeeding twelve-month period. The Company has amortized more than 80% of each released film’s original production costs as of July 2, 2005, with the exception of The Incredibles. The Company projects The Incredibles to be approximately 80% amortized by the end of fiscal year 2005.

At July 2, 2005 and January 1, 2005, net receivables from Disney aggregated $140.5 million and $68.1 million, respectively, which consists of receivables for film revenue, advances net of Disney’s actual share of production expenditures for all films under the Co-Production Agreement and amounts due for miscellaneous reimbursements.

(7) Significant Customer and Segment Reporting

Significant Customer

For the quarter and six months ended July 2, 2005, Disney represented 81% and 94% of total revenue, respectively, compared to 93% and 92%, respectively, for the corresponding prior year periods. As of July 2, 2005 and January 1, 2005, Disney represented 94% and 83% of total accounts receivable, respectively.

Segment Reporting

The chief operating decision-maker is the Company’s 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 income, and the Company has no foreign operations. Therefore, the Company operates in a single operating segment.

9

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

The Company’s revenue segment information by film is as follows (in thousands):

	Quarter Ended				Six Months Ended
	July 2, 2005		July 3, 2004		July 2, 2005		July 3, 2004
The Incredibles (1)	$	2,184	$	—	$	129,723	$	—
Finding Nemo		7,657		49,412		22,052		89,595
Library titles (2)		13,457		14,169		28,279		24,944
Animation services		148		132		1,304		266
	$	23,446	$	63,713	$	181,358	$	114,805

(1) During the quarter ended July 2, 2005, The Incredibles generated net revenues of $2.2 million, which consisted of revenues of $16.3 million reduced by an adjustment of $14.1 million resulting from updated information provided by Disney reflecting higher home video returns than had originally been anticipated.

(2) Library titles include Monsters, Inc., Toy Story 2, A Bug’s Life and Toy Story. For the quarter and six months ended July 3, 2004, Monsters, Inc. revenues of $4.2 million and $6.7 million, respectively, have been reclassified to “Library titles” to conform to the current year presentation. During the quarter and six months ended July 2, 2005, the Company increased its net revenues relating to Toy Story by approximately $4.1 million, which primarily reflected a reduction in television expenses based on recent information obtained from Disney.

(8) Valuation and Qualifying Accounts and Reserves

A summary of the valuation and qualifying accounts and reserves included in the balance sheets are as follows (in thousands):

Classification	Balance at Beginning of Period		Changes to Reserves Impacting Operations			Reductions to Reserves (Actual Returns and Bad Debt Write-offs)			Balance at End of Period
Six months ended July 2, 2005
Reserve for returns, Disney	$	2,473	$	8,349		$	(3,332	)	$	7,490
Allowance for doubtful accounts, Disney		1,006		(924	)		—			82
Allowance for doubtful accounts, trade		177		—			—			177
Fiscal year ended January 1, 2005
Reserve for returns, Disney		27,753		12,271			(37,551	)		2,473
Allowance for doubtful accounts, Disney		2,167		(1,161	)		—			1,006
Allowance for doubtful accounts, trade		186		—			(9	)		177

Reserve for Returns, Disney

The Company recognizes revenue from its films under the Co-Production Agreement and Feature Film Agreements net of distribution fees, actual returns, estimated reserve for returns, and marketing and distribution expenses in accordance with FASB Concepts Statement No. 6 and EITF 99-19. The Company makes adjustments to home video revenues for estimates on return reserves (as a percentage of sales) that may differ from those reported by Disney. To the extent that the Company’s reserve for returns percentage differs from that reported by Disney, such differences are recorded as a reserve against the receivable from Disney. These reserves are reflected above and amounted to $7.5 million and $2.5 million at July 2, 2005 and January 1, 2005, respectively. Furthermore, these reserves can change for a variety of reasons:

• Changes to reserves that increase the dollar amount of return reserves (with a corresponding decrease in film revenue) occur when (a) the Company establishes and maintains a return reserve percentage that is

10

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

higher than Disney’s: as revenues are earned, the difference between the Company’s higher estimated return reserve percentage results in an increase to the returns reserve, and (b) Disney lowers its return reserve percentage from a previous period and the Company maintains its higher reserve percentage: as revenues are incurred, the difference between Disney’s return reserves percentage and the Company’s higher estimated return reserves percentage results in an increase to the returns reserve.

• Changes to reserves that decrease return reserves (with a corresponding increase in film revenue) occur when the Company is carrying a higher reserve percentage than Disney and the Company reduces its return reserve percentage. This results in a reduction of the reserve and an increase in revenue in the period that the Company reduces the percentage.

• Reductions to return reserve balances occur when the Company establishes a higher return reserve percentage than Disney and Disney subsequently increases its return reserve percentage to reflect actual return experience. As revenues are incurred and Disney increases its return reserve percentage, the return reserves are reduced.

In determining Pixar’s home video return reserves for a particular title, the Company reviews information such as Disney’s current return reserves, the historical returns for its previous titles, actual rates of returns, inventory levels in the distribution channel and other business and industry trend information that is available. Disney has provided and may continue to provide the Company with reserve information that may differ substantially from Pixar’s historical experience with its previous titles. Unless Disney provides the Company with what the Company believes is a sufficient rationale as to why the market and sales performance are substantially different for a particular title, the Company has and may continue to record reserves more consistent with its historical experience.

During the six months ended July 2, 2005, the Company increased its return reserves by approximately $8.3 million for differences in reserve percentage estimates with Disney for The Incredibles and Finding Nemo’s home video revenues. During the second quarter of the current year, Disney increased its international home video return reserves for The Incredibles, which reduced the Company’s difference in reserves from Disney by approximately $3.3 million.

During fiscal year 2004, the Company increased its return reserves by approximately $46.2 million primarily for differences in reserve percentage estimates with Disney for Finding Nemo’s home video revenues, as well as some increases to Monsters, Inc. home video reserves. The Company’s reserves were reduced during the year due to subsequent revisions to its estimates for both Finding Nemo and Monsters, Inc. These revisions reduced the Company’s reserves by $33.9 million, of which approximately $8.1 million and $15.6 million increased the Company’s revenues for reversals of reserves which were established in prior years for Monsters, Inc. international home video reserves and Finding Nemo domestic home video reserves, respectively. During 2004, Disney increased its return reserves primarily for Finding Nemo’s international home video revenues, which resulted in a reduction of approximately $37.6 million in the Company’s reserves.

Further, the Company may not always maintain differences in reserves from those reported by Disney. In such instances when the Company relies on Disney’s estimates, it is possible that Disney may make subsequent revisions to those estimates which could result in a change to the Company’s estimate of revenue for a given period. Such reserves and related changes as reported by Disney are not reflected in the above table. For example, during the second quarter of 2005, Pixar reduced its worldwide home video revenue from The Incredibles after receiving updated information from Disney which reflected higher home video returns than had originally been anticipated. This adjustment reduced Pixar’s home video revenue by $14.1 million in the second quarter of 2005 for revenues that had been recorded in the previous quarter.

11

PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

Allowance for Doubtful Accounts, Disney

The Company maintains reserves against potential uncollectible receivables from theatrical exhibitors. Estimates are established based on a review of the industry, discussions with Disney, and historical experience. To date the Company has not experienced significant losses, and therefore it has not had significant reserves for uncollectible receivables.

Allowance for Doubtful Accounts, Trade

The Company maintains an allowance for doubtful accounts for the estimated losses on trade receivables. Pixar assesses collectability of the receivable by determining whether the creditworthiness of the customer has deteriorated and could result in an inability to collect payment. To date the Company has not experienced significant losses, and therefore it has not had a significant allowance against trade receivables.

(9) New Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 Revised 2004 (“SFAS 123R”), “Share-Based Payment.” The statement replaces SFAS 123, supersedes APB 25, and amends SFAS No. 95, “Statement of Cash Flows.” The accounting provisions of SFAS 123R are effective for annual reporting periods beginning after June 15, 2005. The Company intends to adopt SFAS 123R for its fiscal year beginning January 1, 2006. SFAS 123R requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in our statements of income. SFAS 123R eliminates the ability to account for share-based compensation transactions using APB 25, and generally would require instead that such transactions be accounted for using a fair-value based method. Companies are required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. While the fair value method under SFAS 123R is very similar to the fair value method under SFAS 123 with regards to measurement and recognition of stock-based compensation, management is currently evaluating the impact of several of the key differences between the two standards on the Company’s financial statements. For example, SFAS 123 permits the Company to recognize forfeitures as they occur while SFAS 123R will require the Company to estimate future forfeitures and adjust its estimate on a quarterly basis. SFAS 123R will also require a classification change in the statement of cash flows; whereby, a portion of the tax benefit from stock options will move from operating cash flows to financing cash flows (total cash flows will remain unchanged). The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Although the Company has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, it is currently evaluating the requirements under SFAS 123R. Current estimates of option values using the Black-Scholes method may not be indicative of results from valuation methodologies ultimately adopted by the Company. The cumulative effect of adoption, if any, applied on a modified prospective basis, would be measured and recognized on January 1, 2006.

In March 2004, the Emerging Issues Task Force (EITF) reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 requires that when the fair value of an investment security is less than its carrying value, an impairment exists for which the determination must be made as to whether the impairment is other-than-temporary. The EITF 03-1 impairment model applies to all investment securities accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and to investment securities accounted for under the cost method to the extent an impairment indicator exists. Under the guidance, the determination of whether an impairment is other than temporary and therefore would result in a recognized loss depends on market conditions and management’s intent and ability to hold the securities with unrealized losses. In September 2004, the FASB

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PIXAR

NOTES TO FINANCIAL STATEMENTS—(Continued)

approved FASB Staff Position (“FSP”) EITF 03-1 which defers the effective date for recognition and measurement guidance contained in EITF 03-1 until certain issues are resolved; however the disclosure requirements remain effective for annual periods ending after June 15, 2004. The Company will adopt the recognition and measurement guidance at the time of final issuance.

On December 16, 2004, the FASB issued Statement No. 153 (“SFAS 153”), “Exchanges of Non-monetary Assets,” an amendment of APB Opinion No. 29. SFAS 153 addresses the measurement of exchanges of non-monetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS 153 is effective for non-monetary asset exchanges beginning in our third quarter of fiscal year 2005. The Company believes that the adoption of SFAS 153 will not have a material effect on its results of operations, financial position or cash flows.

In May 2005, the FASB issued Statement No. 154 (“SFAS 154”), “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS 154. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will adopt this pronouncement beginning in fiscal year 2006 and believes that the adoption of SFAS 154 will not have a material effect on its results of operations, financial position or cash flows.

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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 within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements identify prospective information, particularly statements referencing the scheduled release dates of our feature films, our anticipated revenues and operating expenses, our expectations on DVD penetration and the resulting effect on our home video sales and our expectations regarding any future distribution agreement into which we may enter. In some cases, forward-looking statements can be identified by the use of words such as “may,” “could,” “would,” “might,” “will,” “should,” “expect,” “forecast,” “predict,” “potential,” “continue,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “is scheduled for,” “targeted,” and variations of such words and similar expressions. Such forward-looking statements are based on current expectations, estimates, and projections about our industry, management’s beliefs, and assumptions made by management. 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 “Risk Factors” on pages 23 through 38. 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.

The following discussion should be read in conjunction with the section entitled “Risk Factors” on pages 23 through 38 below and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended January 1, 2005, in addition to our interim financial statements and notes included elsewhere in this report.

Overview

Pixar was formed in 1986 when Steve Jobs purchased the computer division of Lucasfilm and incorporated it as a separate company. In 1991, we entered into a feature film agreement (the “Feature Film Agreement”) with Walt Disney Pictures, a wholly owned subsidiary of the Walt Disney Company (together with its subsidiaries and affiliates collectively referred to herein as “Disney”), for the development and production of up to three animated feature films to be marketed and distributed by Disney. It was pursuant to the Feature Film Agreement that Toy Story was developed, produced, and distributed in 1995. Our share of revenues and expenses from Toy Story is governed by the terms of the Feature Film Agreement.

In February 1997, we entered into the Co-Production Agreement (which, except for certain economic provisions applicable to Toy Story, superseded the Feature Film Agreement) with Disney pursuant to which we, on an exclusive basis, agreed 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 as well as other ancillary products, after recovery of all marketing and distribution costs (which Disney finances), a distribution fee paid to Disney and any other predefined fees or costs, including any participations provided to talent. The Co-Production Agreement generally provides that we will be responsible for the production of each Picture, while Disney will be responsible for the marketing, promotion, publicity, advertising and distribution of each Picture.

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 of the Pictures.

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Our second feature film, A Bug’s Life, was released in November 1998 and counted as the first original Picture under the Co-Production Agreement. In November 1999, Toy Story 2, our third animated feature film was released. As a theatrical sequel, Toy Story 2 is a derivative work of the original Toy Story and therefore it does not count toward the five original Pictures to be produced under the Co-Production Agreement. As a derivative work, Toy Story 2 is treated as a Picture under the Co-Production Agreement, and all the provisions applicable to the five original Pictures apply.

In November 2001, we released Monsters, Inc., our fourth animated feature film, which counts as the second original Picture under the Co-Production Agreement. In May 2003, we released Finding Nemo, our fifth animated feature film, which counts as the third original Picture under the Co-Production Agreement. In November 2004, we released The Incredibles, our sixth animated feature film, which counts as the fourth original Picture under the Co-Production Agreement. We are currently in production on Cars, which is scheduled for theatrical release on June 9, 2006. Cars will be produced and distributed under the Co-Production Agreement and will count as the fifth and final film of the Pictures to be produced under the Co-Production Agreement. We are also in various stages of development and production on our slate of feature films outside of our current Disney relationship and have other projects in various stages of development.

The term of the Co-Production Agreement continues until we deliver our fifth and final Picture, Cars, to Disney. However, since our April 2003 delivery of Finding Nemo to Disney, we have had the right to negotiate and enter into another distribution agreement with any third party. We have produced six highly successful films to date, and we believe that this success, combined with our strong financial resources, position us to negotiate a new distribution arrangement with a major studio that will provide us with, among other things, (1) better economic terms than we currently have under the Co-Production Agreement and (2) full ownership of our films. With respect to the distribution of our films after Cars, we currently are not pursuing alternatives, other than entering into such an agreement with a major studio. We continue to explore our options with respect to a future distribution agreement.

Although we look forward to a more favorable distribution agreement for films released after Cars, we also understand that distributing our films through another studio may increase some of the risks we face in the motion picture industry. See “Risk Factors—We experience intense competition with respect to our animated feature films, animation products, and software” and “Risk Factors—We face various distribution risks with respect to our feature films.”

Pixar and Disney jointly finance all production costs relating to the Pictures on an equal basis. Pursuant to the terms of the Co-Production Agreement the parties established a mutually acceptable funding mechanism to ensure that sums would be available in a timely manner to fund production costs. In practice, Pixar prepares funding requests for forecasted film production costs and Disney funds its share on a monthly basis at approximately the beginning of the month. All payments to Pixar from Disney for development and production of Toy Story under the Feature Film Agreement, and the Pictures under the Co-Production Agreement have been recorded as cost reimbursements. Accordingly, no revenue has been recognized for such reimbursements; rather, we have netted the reimbursements against the related costs. These reimbursed costs through the end of July 2, 2005 are set forth in Note 6 of Notes to Financial Statements in Item 1 of this report.

Stock Split

On March 23, 2005, we announced that our Board of Directors had approved a two-for-one stock split of our common stock and a proportional increase in the number of authorized shares of our common stock from 100 million to 200 million. Shareholders of record at the close of trading on April 4, 2005 were entitled to receive one additional share of Pixar common stock for every outstanding share held on such date. The additional shares were distributed on April 18, 2005, and reporting of our share price on a post-split basis commenced on April 19, 2005. All issued and outstanding shares and per share amounts and stock prices related to Pixar’s common stock in this report have been restated to reflect the stock split for all periods presented.

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Critical Accounting Policies

Revenue Recognition

We recognize film revenue from the distribution of our animated feature films and related products when earned and reasonably estimable in accordance with Statement of Position 00-2—“Accounting by Producers or Distributors of Films” (“SOP 00-2”). The following are the conditions that must be met in order to recognize revenue in accordance with SOP 00-2:

• persuasive evidence of a sale or licensing arrangement with a customer exists;

• the film is complete and, in accordance with the terms of the arrangement, has been delivered or is available for immediate and unconditional delivery;

• the license period of the arrangement has begun and the customer can begin its exploitation, exhibition or sale;

• the arrangement fee is fixed or determinable; and

• collection of the arrangement fee is reasonably assured.

Under the Co-Production Agreement, we share equally with Disney in the profits of The Incredibles, Finding Nemo, Monsters, Inc., Toy Story 2 and A Bug’s Life after Disney recovers its marketing, distribution and other predefined costs and fees. Our revenues for Toy Story are governed by the terms of the Feature Film Agreement under which Disney fully financed the production costs and shares a specified percentage of Toy Story profits with Pixar after certain agreed upon costs and fees are deducted. We recognize revenue from our films net of distribution fees, reserves for returns, and marketing and distribution expenses. Disney provides us with gross receipt information, return reserve information, marketing and distribution costs and any other fees and expenses. We utilize this information to determine our portion of the revenue by applying the contractual provisions included in our arrangements with Disney. We may also adjust certain of Disney’s estimates, such as home video returns and distribution expenses, based on Pixar’s historical experience and other industry information. The amount of revenue recognized in any given quarter or quarters from all of our films depends on the timing, accuracy, and sufficiency of information we receive from Disney to determine revenues and associated gross profits. Although Disney provides us with the most current information available to enable us to recognize our share of revenue and determine our film gross profit, in the past we have made revisions, and we may make revisions in the future, to that information based on our estimates and judgments. Such information includes theatrical bad debt reserves and expenses, home video return reserves and expenses, merchandise expenses, and estimates for both revenues and related expenses resulting from differences between Disney’s fiscal reporting period and ours.

For example, in the past, our theatrical revenues have been adjusted for our estimated reserves on potential uncollectible amounts to be received from theatrical exhibitors. Estimated reserves for uncollectible amounts are established based on a review of the industry, discussions with Disney, and our historical experience. To date we have not experienced significant losses, and therefore we have not had significant reserves for uncollectible receivables. See Note 8 of Notes to Financial Statements in Item 1 of this report for further discussion of reserves for uncollectible amounts.

We have also made adjustments to our home video revenues for estimates on return reserves that may differ from those reported by Disney. In determining our home video reserves for a particular title, we review information such as Disney’s current return reserves, the historical returns for our previous titles, actual rates of returns, inventory levels in the distribution channel and other business and industry trend information that are available. Disney has provided and may continue to provide us with reserve information that may differ substantially from our historical experience with our previous titles. Unless Disney provides a sufficient rationale as to why the market and sales performance are substantially different for a particular title, we have and may continue to record reserves more consistent with our historical experience. Our home video return reserves exceeded Disney’s estimates by $7.5 million and $2.5 million at July 2, 2005 and January 1, 2005, respectively. The estimate for return reserves, whether based on historical information or more current information from

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Disney, is inherently subjective and may differ significantly from actual results. Our original estimates on reserves may be revised in future periods as new and additional information becomes available. See Note 8 of Notes to Financial Statements in Item 1 of this report for further discussion of reserves for returns.

We have utilized margin normalization, such as with merchandise or home video expenses, in accordance with the provisions of SOP 00-2. This may result in the utilization of budgeted or forecasted information to calculate an ultimate lifetime expense margin, rather than actual costs incurred if it is deemed to be a more accurate reflection of our participation. Similar to return reserves, these expense estimates are reviewed and may be adjusted periodically to ensure that the most accurate depiction of our participation is reflected.

Disney may also make subsequent adjustments to the information that it has provided, and these adjustments could have a significant impact on our operating results in later periods. As updated information becomes available from Disney, it may result in a change of estimation for revenue recognition. For example, during the second quarter of 2005, we recognized an adjustment that reduced our worldwide home video revenues from The Incredibles after we received updated information from Disney, which reflected higher home video returns than had been originally anticipated. This adjustment reduced our home video revenues by $14.1 million in the second quarter of 2005 for revenues that had been recorded in the previous quarter.

Any revisions to our estimated reserves, margin normalization or updated information from Disney, as noted above, as well as findings from audit rights offered in accordance with the terms of the Co-Production Agreement, could have a material effect on our financial statements in any given quarter or quarters.

A film is classified as a library title after three years from the film’s initial release. Currently, Toy Story, A Bug’s Life, Toy Story 2 and Monsters, Inc. are classified as library titles. The term “library title” is used solely for the purpose of classification and for identifying previously released films. Revenue recognition for such titles is in accordance with our revenue recognition policy for film revenue.

Software Revenue

Revenue for software licenses is recognized in compliance with SOP 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, With Respect to Certain Transactions.” Under SOP 97-2, as amended, we recognize revenues when all of the following conditions are met:

• persuasive evidence of an agreement exists;

• delivery of the product has occurred;

• the fee is fixed or determinable; and

• collection of these fees is probable.

SOP 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of the elements. Revenue recognized from multiple-element arrangements is allocated to undelivered elements of the arrangement, such as support services, based on the residual value of the elements. Under the residual method, we allocate and defer revenue for the undelivered elements based on vendor-specific objective evidence of fair value, and recognize the difference between the total arrangement fee and the amount deferred for the undelivered elements as revenue. The determination of fair value of each undelivered element in multiple element arrangements is based on the price charged when the same element is sold separately.

Software maintenance is recorded as deferred revenue and is recognized ratably over the term of the agreement, which is generally twelve months.

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Film Production Costs

We capitalize our share of direct film production costs in accordance with SOP 00-2. Film production costs include costs to develop and produce computer-animated motion pictures, which primarily consist of salaries, equipment and overhead. With regard to the Pictures, we capitalize film production costs in excess of reimbursable amounts from Disney. For film projects outside of our existing Disney relationship, we capitalize all film production costs. Production overhead, a component of film costs, includes allocable costs of individuals or departments with exclusive or significant responsibility for the production of our films. Capitalized production overhead does not include administrative, general and research and development expenses.

Once a film is released, capitalized film production costs will be amortized in the proportion that the revenue during the period for each film bears to the estimated revenue to be received from all sources under the individual-film-forecast-computation method. The amount of film costs that will be amortized each quarter will depend on how much future revenue we expect to receive from each film. With respect to the Pictures, we make certain estimates and judgments of our future gross revenues to be received for each film based on information received from Disney and on our knowledge of the industry. Estimates of anticipated total gross revenues are reviewed periodically and may be revised if necessary. A change to the estimate of gross revenues for an individual film may result in an increase or decrease to the percentage of amortization of capitalized film costs relative to a previous period. Unamortized film production costs are reviewed for indicators of impairment each reporting period on a film-by-film basis. If estimated remaining gross revenues are not sufficient to recover the unamortized film production costs, the unamortized film production costs will be written down to fair value. In the event a film is not set for production within three years from the time of the first capitalized transaction, all such costs will be expensed.

Results of Operations

Our results for the quarter and six months ended July 2, 2005 were driven primarily by worldwide home video revenue, continuing international theatrical revenue, merchandising, and ancillary royalties from The Incredibles, as well as continued worldwide home video revenue and merchandising from Finding Nemo and our library titles.

Revenue

Total revenue, which consists of film revenue and software revenue, was $26.4 million and $187.7 million for the quarter and six months ended July 2, 2005, respectively, compared to $66.3 million and $120.1 million in the corresponding prior year periods. The significant drivers of revenues for the first half of 2005 were the continuing foreign theatrical release and the worldwide home video release of The Incredibles, which was initially released in theaters in the holiday season of 2004. The significant drivers of revenues for the first half of 2004 were the continuing worldwide home video release of Finding Nemo, which was initially released in theaters in the summer of 2003.

Film revenue for the quarter ended July 2, 2005 was $23.4 million compared with $63.7 million in the corresponding prior year period. In the current quarter, The Incredibles generated net revenues of $2.2 million, which consisted of revenues of $16.3 million reduced by an adjustment of $14.1 million resulting from updated information provided by Disney reflecting higher home video returns than had originally been anticipated. Finding Nemo generated revenues of $7.7 million and our library titles and animation services generated revenues of $13.5 million. The majority of these revenues resulted from home video sales, merchandise licensing, ancillary royalties, and television and other licensing related to our films. During the quarter, we also increased our net revenues relating to Toy Story by approximately $4.1 million, which primarily reflected a reduction in television expenses based on recent information obtained from Disney.

Film revenue for the quarter ended July 3, 2004 was primarily driven by the success of Finding Nemo in the worldwide home video and domestic pay television markets, as well as merchandising and ancillary royalties, which contributed $49.4 million in revenues. Additionally, we generated $14.2 million from the continuing success of our library titles.

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Film revenue for the six months ended July 2, 2005 was $181.4 million compared to $114.8 million in the corresponding prior year period and consisted of $129.7 million from The Incredibles related primarily to worldwide home video revenue, international theatrical revenue, domestic pay-per-view television revenue, derivative products, merchandise licensing, and ancillary royalties. Finding Nemo contributed $22.1 million of film revenue during the six months ended July 2, 2005, primarily from worldwide home video sales as well as merchandise licensing and ancillary royalties. Our library titles contributed $28.3 million to film revenue for the six months ended July 2, 2005, which consisted primarily of television licensing, worldwide home video sales, merchandise licensing and ancillary royalties. During the six months ended July 2, 2005, we increased our net revenues relating to Toy Story by approximately $4.1 million, which primarily reflected a reduction in television expenses based on recent information obtained from Disney. Additionally, animation services contributed $1.3 million of revenue during the six months ended July 2, 2005.

Film revenue for the six months ended July 3, 2004 of $114.8 million consisted of $89.6 million from Finding Nemo, relating primarily to worldwide home video revenue, worldwide theatrical revenue, merchandise sales and ancillary royalties, and worldwide television licensing. Also included in film revenues for the six months ended July 3, 2004 was $24.9 million from our library titles, which consisted of worldwide home video and television revenue as well as merchandise and ancillary royalties.

Software revenue includes license revenue, principally from RenderMan^®, and royalty revenue from licensing Physical Effects, Inc. (“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 receive associated royalty revenue on a quarterly basis. Software revenue for the quarter and six months ended July 2, 2005 was $3.0 million and $6.3 million, respectively, compared to $2.6 million and $5.3 million in the corresponding prior year periods. Although this increase demonstrates the continuing demand for our software revenue, our primary focus is on content creation for animated feature films and related products, and as a result, we continue to expect ongoing variability in revenues derived from our software product. Software maintenance contracts are recorded as unearned revenue and recognized ratably over the term of the agreement, which is generally twelve months.

For the quarter and six months ended July 2, 2005, Disney accounted for 81% and 94%, respectively, of our total revenue compared to 93% and 92% for the corresponding prior year periods. The revenue from Disney consisted primarily of film related revenue. Because of our relationship with Disney under the Co-Production Agreement, Disney is expected to continue to represent significantly greater than 10% of our revenue in 2005 and for the near future.

Cost of Revenue

Cost of revenue for the quarter and six months ended July 2, 2005 was $4.3 million and $31.7 million, respectively, compared to $6.4 million and $12.3 million in the corresponding prior year periods. Cost of revenue represents primarily amortization of capitalized film costs. Cost of revenue as a percentage of total revenue for the quarter and six months ended July 2, 2005 was 16% and 17%, respectively, as compared to 10% for the corresponding prior year periods. Our cost of revenue as a percentage of revenue may vary for any given period due to changes in the mix of film revenue as the gross profit varies by film, as well as for revisions to estimates on revenue to be received under the individual-film-forecast-computation method. A change to an individual film’s estimate of revenue to be received may result in an increase or decrease to the amortization of the capitalized film costs relative to a previous period. Toy Story revenue has no related cost, as film costs have been fully amortized. The increase in cost of film revenue as a percentage of total revenue for the quarter and six months ended July 2, 2005 compared to the corresponding prior periods is attributable to a higher cost of sales percentage for The Incredibles as compared to Finding Nemo. The increase in cost of revenue is partially offset by the decline in the cost amortization percentages from Finding Nemo in the first half of 2005 relative to the corresponding prior year period due to increases in ultimate revenues for the title.

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Operating Expenses

Total operating expenses were $7.8 million and $15.7 million, respectively, for the quarter and six months ended July 2, 2005 compared to $7.8 million and $14.7 million in the corresponding prior year periods. 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 of the Pictures. The funding received from Disney is treated as operating expense reimbursements. Since February 2003 when we approved our first feature film to be produced outside of the existing relationship with Disney, we have begun to expense as incurred, certain costs that were previously reimbursed by Disney. To the extent that personnel, facilities and other expenditures are neither 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. Research and development expenses consist primarily of salaries and support for personnel conducting research and development for our RenderMan^® software and for our proprietary Marionette^™ and Ringmaster^™ animation and production management software and for creative development for future films and our short film projects. Research and development expenses decreased to $3.1 million and $5.9 million, respectively, for the quarter and six months ended July 2, 2005 from $4.2 million and $7.6 million for the corresponding prior year periods due to a decrease in employee related costs resulting from a shift in employee resources from research and development to film production, offset by a larger share of operating expenses previously shared with Disney and an increase in expenses related to short film projects. We believe that research and development expenses may increase in future periods. To date, all research and development costs not reimbursed by Disney have been expensed as incurred.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related overhead, as well as public relations, advertising, technical support and trade show costs required to support our software sales. Sales and marketing expenses increased to $0.8 million and $1.5 million, respectively, for the quarter and six months ended July 2, 2005, from $0.6 million and $1.0 million in the corresponding prior year periods primarily due to increased marketing and publicity initiatives and higher employee related costs. We believe that sales and marketing expenses may increase in future periods, particularly in the areas of public relations, corporate marketing, and consumer products.

General and Administrative. General and administrative expenses consist primarily of salaries of management and administrative personnel, insurance costs and professional fees. General and administrative expenses increased to $3.9 million and $8.3 million, respectively, for the quarter and six months ended July 2, 2005 from $3.0 million and $6.1 million in the corresponding prior year periods primarily due to increased professional services fees, employee related costs, and an increased proportion of operating expenses previously shared with Disney. General and administrative expenses may continue to increase in future periods.

Interest Income and Other

Interest income and other was $5.8 million and $10.6 million, respectively, for the quarter and six months ended July 2, 2005, compared to $2.5 million and $5.4 million in the corresponding prior year periods and consists primarily of interest income on investments. For the quarter and six months ended July 2, 2005, our interest income and other increased over the corresponding prior year period primarily due to higher average cash, cash equivalent, and investment balances earning interest at higher rates.

Income Tax Expense

The income tax rate for the quarter and six months ended July 2, 2005 was 37.0% and 37.3%, respectively, compared to 31.4% and 34.9% in each of the corresponding prior year periods. The lower rate in the corresponding prior periods is primarily attributable to the recognition of a federal tax benefit associated with certain income earned outside the U.S. for fiscal years 2000 through 2003, which was recorded in the second

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quarter of 2004 since the identification, analysis and conclusions with respect to this benefit were conducted during that period. Our current tax rate is lower than the statutory rate due to a number of factors including a federal tax benefit associated with certain income outside the U.S and a tax deduction related to income attributable to domestic production activities, which became available in the current year.

Capitalized Film Production Costs

We had $147.1 million in capitalized film production costs as of July 2, 2005, consisting primarily of costs relating to Toy Story 2, A Bug’s Life, Monsters, Inc., Finding Nemo, The Incredibles, and Cars, all of which are being co-financed by Disney under the Co-Production Agreement. Capitalized film production costs also include costs related to our Pixar-only financed films currently in various stages of production and development. All Toy Story capitalized film costs were fully amortized as of December 31, 1997.

Liquidity and Capital Resources

	Six Months Ended
	July 2, 2005			July 3, 2004
	(in thousands)
Net cash provided by operating activities	$	26,632		$	213,162
Net cash used in investing activities		(68,999	)		(253,277	)
Net cash provided by financing activities		26,821			27,621
Net decrease in cash and cash equivalents	$	(15,546	)	$	(12,494	)

During the first half of 2005, we generated $26.6 million of cash from operating activities as compared to $213.2 million during the first half of 2004. The decrease in cash generated from operating activities during the first six months of 2005 resulted primarily from increased spending on production costs and differences in the timing of our receivables from Disney, partially offset by an overall increase in net income. The decrease in cash used in investing activities for the first half of 2005 compared to the same period in 2004 was mainly attributable to the timing of purchases and sales of investments, while cash provided by financing activities for the first half of 2005 and 2004, were both attributable to the proceeds received from the exercise of stock options by employees.

As of July 2, 2005, our principal source of liquidity was approximately $901.4 million in cash, cash equivalents and investments. Our future capital commitments primarily consist of obligations to fund production costs of films and derivative products under the Co-Production Agreement and beyond. Pursuant to the Co-Production Agreement, we will co-finance the last original animated feature films we have in production, Cars. In the future, we may co-finance other derivative works such as theatrical sequels, direct to home video sequels, interactive products and television productions. Additionally, we have already approved for production other films beyond the Co-Production Agreement and have other projects in various stages of development, which we will finance entirely on our own. We also have obligations to pay portions of any revenue derived from each feature film produced under the Co-Production Agreement to our entertainment law firm in consideration for services rendered.

Film Production Costs. For the remainder of 2005, we expect to spend approximately $36 million to $42 million, net of Disney’s film cost reimbursements, on direct film costs and other costs to fund our ongoing film projects under the Co-Production Agreement and beyond, which will directly impact working capital.

Capital Expenditures. For the remainder of 2005, we expect to spend approximately $8 million to $10 million related to capital expenditures for our Emeryville headquarters and studio and other facility related projects.

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We believe that our current available funds and forecasted cash from operations for the remainder of 2005 will be sufficient to satisfy our currently anticipated operating needs for the next twelve months, including working capital, capital expenditures, the film production costs of Cars, as well as the production and development costs associated with films not covered under the Co-Production Agreement. There can be no assurance that current and forecasted cash from operations will be sufficient to fund future operations. To date, we have chosen to use our existing cash resources to fund both capital expenditures and film production costs. We may continue to use our cash resources for such expenditures, or may choose at any time to finance such capital expenditures through issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism.

Contractual Obligations. At July 2, 2005, we had contractual commitments to make payments under operating leases. Payments due under these long-term obligations are as follows (in thousands):

			Payments Due by Period
	Total		Less Than 1 Year		1-3 Years		3-5 Years		More Than 5 Years
Operating lease obligations	$	1,291	$	414	$	623	$	217	$	37

Off-Balance Sheet Arrangements

As of July 2, 2005, we did not have any off-balance sheet arrangements.

Recent Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123—Revised 2004 (“SFAS 123R”), “Share-Based Payment.” The statement replaces SFAS 123, supersedes APB 25, and amends SFAS No. 95, “Statement of Cash Flows.” The accounting provisions of SFAS 123R are effective for annual reporting periods beginning after June 15, 2005. We intend to adopt SFA 123R for our fiscal year beginning January 1, 2006. SFAS 123R requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in our statements of income. SFAS 123R eliminates the ability to account for share-based compensation transactions using APB 25, and generally would require instead that such transactions be accounted for using a fair-value based method. Companies are required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. While the fair value method under SFAS 123R is very similar to the fair value method under SFAS 123 with regards to measurement and recognition of stock-based compensation, management is currently evaluating the impact of several of the key differences between the two standards on our financial statements. For example, SFAS 123 permits us to recognize forfeitures as they occur while SFAS 123R will require us to estimate future forfeitures and adjust our estimate on a quarterly basis. SFAS 123R will also require a classification change in the statement of cash flows; whereby, a portion of the tax benefit from stock options will move from operating cash flows to financing cash flows (total cash flows will remain unchanged). The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are currently evaluating the requirements under SFAS 123R. Current estimates of option values using the Black-Scholes method may not be indicative of results from valuation methodologies ultimately adopted by us. The cumulative effect of adoption, if any, applied on a modified prospective basis, would be measured and recognized on January 1, 2006.

In March 2004, the Emerging Issues Task Force (EITF) reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 requires that when the fair value of an investment security is less than its carrying value, an impairment exists for which the determination must be made as to whether the impairment is other-than-temporary. The EITF 03-1 impairment model applies to all investment securities accounted for under SFAS No. 115, “Accounting for

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Certain Investments in Debt and Equity Securities,” and to investment securities accounted for under the cost method to the extent an impairment indicator exists. Under the guidance, the determination of whether an impairment is other-than-temporary and therefore would result in a recognized loss depends on market conditions and management’s intent and ability to hold the securities with unrealized losses. In September 2004, the FASB approved FASB Staff Position (“FSP”) EITF 03-1 which defers the effective date for recognition and measurement guidance contained in EITF 03-1 until certain issues are resolved; however the disclosure requirements remain effective for annual periods ending after June 15, 2004. We will adopt the recognition and measurement guidance at the time of final issuance.

On December 16, 2004, the FASB issued Statement No. 153 (“SFAS 153”), “Exchanges of Non-monetary Assets,” an amendment of APB Opinion No. 29. SFAS 153 addresses the measurement of exchanges of non-monetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS 153 is effective for non-monetary asset exchanges beginning in our third quarter of fiscal year 2005. We believe that the adoption of SFAS 153 will not have a material effect on our results of operations, financial position or cash flows.

In May 2005, the FASB issued Statement No. 154 (“SFAS 154”), “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS 154. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We will adopt this pronouncement beginning in fiscal year 2006 and believe that the adoption of SFAS 154 will not have a material effect on our results of operations, financial position or cash flows.

Risk Factors

The following is a discussion of certain factors that currently impact or may impact our business, operating results and/or financial condition. You should carefully consider these factors before making an investment decision with respect to our Common Stock.

Our operating results are primarily dependent on the success of our feature films, and forecasting is extremely difficult.

For the remainder of fiscal year 2005, our revenue, operating results, and diluted earnings per share will be largely dependent upon (1) the timing and amount of worldwide revenues and distribution costs for The Incredibles, Finding Nemo, and the titles in our film library, (2) the timing, accuracy, and sufficiency of information we receive from Disney to determine revenues and associated gross profits, (3) the timing and amount of non-film related revenues and expenses, (4) the accuracy of our assumptions and judgments used to estimate certain revenues and associated gross profits, (5) the market price of our Common Stock and related volatility, (6) the terms of our next distribution agreement and (7) domestic and international socioeconomic and political events that are beyond our control.

Dependence on revenue from our feature films.

Under the current Co-Production Agreement, which governs our relationship with Disney regarding the Pictures, Pixar and Disney share equally in the profits of our animated feature films after Disney recovers its distribution fee and its marketing and distribution costs. Distribution costs include worldwide theatrical release costs, costs related to merchandise, Disney’s costs to market and distribute home videos in the United States and international markets, Disney’s distribution fee, and other distribution costs including talent participation and residuals. We remain dependent on the timing, accuracy, and sufficiency of information provided by Disney.

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For our business to be successful, our films must achieve box office success. While we have been successful in the release of all six of our feature films, this level of success is highly unusual in the motion picture industry, and our future releases may not achieve similar results. For the remainder of fiscal year 2005, we will be dependent primarily on the television licensing and merchandising revenue of The Incredibles and Finding Nemo and the home video re-release of Toy Story and Toy Story 2, as well as the ongoing performance of our other library titles.

Forecasting film revenue and associated gross profits from our feature films is extremely difficult.

Although we have experienced a successful track record with the releases of our feature films, it is difficult to predict their worldwide box office success prior to their release. While the popularity of the film is initially measured by box office success, the film’s success within each follow-on product category, such as home video, merchandise 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 into which a product is released, among many other factors. We have experienced a very successful worldwide box office release and domestic home video release of The Incredibles, and the international home video release of The Incredibles has been expanded to all key international territories. However, it is difficult to predict the ultimate revenues from the worldwide home video release, television licensing, merchandise licensing, and ancillary stream of The Incredibles. While box office success is often a good indicator of general customer acceptance, the relative success of follow-on products is not always directly correlated, and the degree of correlation is difficult to predict.

It is also difficult to forecast the amount of revenues from Finding Nemo and the titles in our film library. The revenues generated from continued home video and merchandise sales can fluctuate due to various market factors. Because the revenues from films nearing the end of their life cycle tend to be relatively small, minor fluctuations can result in notable variances from our forecast. Both Toy Story and Toy Story 2 domestic home videos are currently subject to a domestic sales moratorium, which began on May 1, 2003. Internationally, these two titles were placed on moratorium at various dates beginning in the Spring of 2004. This strategy is designed to increase potential sales over the lifetime of a title, to prevent a declining sales price and to support a potentially higher sales price upon re-release. We have announced the U.S. re-release of Toy Story on DVD, scheduled for September 6, 2005, in celebration of the film’s 10^th Anniversary and the U.S. re-release of Toy Story 2 on DVD, scheduled for December 26, 2005. This will be the first time our titles are removed from a sales moratorium, and it is difficult to predict the actual effect of the sales moratorium strategy on home video sales and it may not generate the results we expect.

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. Although we are moving towards a strategy to release our films theatrically worldwide within a narrower timeframe relative to our earlier films, the specific dates of the international releases for these films will depend on territory-specific factors, such as the local competitive environment and school holidays. Therefore, the timing of international revenues could span over several months, and the forecasting of such revenues is inherently more difficult.

In addition, the amount of revenue recognized in any given quarter or quarters from all of our films depends on the timing, accuracy, and amount of 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 revisions to the information that it has provided, which could have a significant impact on us in later periods. For instance, towards the end of the life cycle for a revenue stream, Disney may inform us, and has in the past informed us, of additional distribution costs to those previously forecasted. Such revisions have impacted and may continue to impact our revenue share and our film gross profit. In addition, through information we obtain from other sources, we may make certain judgments and/or assumptions and adjust the information we receive from Disney. For example, we make adjustments to our home video revenues for estimates on return reserves that may differ from those reported by Disney. In determining our home video reserves, we review information which includes Disney’s current return reserves, the historical returns for our previous titles, actual rates of returns, inventory

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levels in the distribution channel and other business and industry trend information that is available. Disney has provided and may continue to provide us with reserve information that may differ substantially from our historical experience with our previous titles. Unless Disney provides a sufficient rationale as to why the market and sales performance are substantially different for a particular title, we have and may continue to record reserves more consistent with our historical experience. The estimate for return reserves, whether based on historical information or more current information from Disney, is inherently subjective and may differ significantly from actual results. Our original estimates on reserves may be revised in future periods as new and additional information becomes available. For example, during the second quarter of 2005, we recognized an adjustment that reduced our worldwide home video revenues from The Incredibles after we received updated information from Disney, which reflected higher home video returns than had been originally anticipated. This adjustment reduced our home video revenues by $14.1 million in the second quarter of 2005 for revenues that had been recorded in the previous quarter.

We have utilized margin normalization, such as with merchandise or home video expenses, in accordance with the provisions of SOP 00-2. This may result in the utilization of budgeted or forecasted information to calculate an ultimate lifetime expense margin, rather than actual costs incurred if it is deemed to be a more accurate reflection of our participation. Similar to return reserves, these expense estimates are reviewed and may be adjusted periodically to ensure the most accurate depiction of our participation is reflected.

Any revisions to our estimated reserves, margin normalization or updated information from Disney, as noted above, as well as findings from audit rights offered in accordance with the terms of the Co-Production Agreement, could have a material effect on our financial statements in any given quarter or quarters.

With respect to capitalized film production costs, 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 depends on how much future revenue we expect to receive from each film. Unamortized film production costs are reviewed for indicators of impairment each reporting period on a film-by-film basis. If estimated remaining gross revenues are not sufficient to recover the unamortized film production costs, the unamortized film production costs will be written down to net realizable value. In any given quarter, if we lower our previous forecast with respect to total anticipated revenue from any individual feature film, 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.

Forecasting our operating expenses is extremely difficult.

Our operating expenses will continue to be extremely difficult to forecast. We budget the direct costs of the Pictures with Disney, and we share such costs equally. We capitalize our share of direct costs of film production in accordance with SOP 00-2. A substantial portion of all of our other costs is 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 under the Co-Production Agreement, 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 SOP 00-2 or (2) charge it to operating expense in the period incurred. A substantial portion of our Overhead is related to the Pictures produced pursuant to the Co-Production Agreement, and is therefore reimbursed by Disney. Since we capitalize other amounts in accordance with SOP 00-2, our reported operating expenses for the first half of fiscal year 2005 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. Further, as we continue production of our films beyond the Co-Production Agreement, we expect our operating expenses to continue to increase to the extent that they are not capitalized or shared with Disney.

Film production budgets may increase, and film production spending may exceed such budgets.

Our future film budgets may continue to increase due to factors including, but not limited to, (1) escalation in compensation rates of people required to work on our current projects, (2) number of personnel required to

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work on our current projects, (3) equipment needs, (4) the enhancement of existing, or the development of new, proprietary technology and (5) the expansion of our facilities to accommodate the growth of the studio. The budgets for Cars and subsequent films and related products are expected to be greater than the budgets for our previous films. Under the Co-Production Agreement, we will continue to finance the budget for Cars equally with Disney. Due to production exigencies, which are often difficult to predict, it is not uncommon for film production spending to exceed film production budgets, and our current projects may not be completed within the budgeted amounts. In addition, when production of each film is completed, we may incur significant carrying costs associated with transitioning personnel on creative and development teams from one project to another. These carrying costs increase overall production budgets and could have a material adverse effect on our results of operations and financial condition.

Software revenue.

Our fiscal year 2005 earnings are expected to include revenues attributable to non-film related sources including software revenue; however, there can be no assurance as to the timing and amount of such revenues.

Other items affecting forecasting.

Our fiscal year 2005 earnings are expected to include other income and expenses such as interest income and tax expense. Interest income is difficult to predict and can fluctuate depending on our cash, cash equivalents and investment balances as well as external factors beyond our control, such as economic conditions and interest rates available to us during the year. Our income tax rate for the second quarter of fiscal year 2005 was different from the U.S. statutory rate primarily due to state taxes, a federal tax benefit associated with certain income outside the U.S. and a tax deduction related to income attributable to domestic production activities. Our effective tax rate may fluctuate in future periods.

Changes in accounting regulations may also have a significant effect on our results of operations. For example, in December 2004, the Financial Accounting Standards Board (“FASB”) enacted Statement of Financial Accounting Standards 123—Revised 2004 (“SFAS 123R”), “Share-Based Payment,” which replaces Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees.” SFAS 123R requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such compensation expense in our statements of income. We intend to adopt SFAS 123R in the first quarter of fiscal year 2006. The pro forma disclosures, previously permitted under SFAS 123 and adopted by Pixar, no longer will be an alternative to financial statement recognition. Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we expect the adoption to increase our cost of revenues and operating expenses, and the adoption of SFAS 123R could make our net income less predictable in any given reporting period, could change the way we compensate our employees, or may cause other changes in the way we conduct our business.

Our operating results have fluctuated in the past, and we expect such fluctuations to continue.

Our revenues fluctuate significantly.

We continue to expect significant fluctuations in our future quarterly and annual revenues because of a variety of factors, including the following:

• the timing of the domestic and international theatrical and home video releases of our animated feature films,

• the success of our animated feature films,

• the timing of the release of related products into their respective markets, such as home videos, television, and merchandising,

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• 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 our feature films and related products under the Co-Production Agreement,

• Disney’s success at marketing our feature films and related products under the Co-Production Agreement,

• 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,

• the timing and amount of non-film related revenues, such as the licensing of our software,

• the competitive environment,

• the final terms of our next distribution arrangement, and

• external socioeconomic and political events that are beyond our control.

In particular, since our revenue under the Co-Production Agreement is directly related to the success of our animated feature films, 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.

Our operating expenses fluctuate.

We expect continuing increases to our operating expenses to fund greater levels of research and development, to meet the demands of multiple films in production and to expand operations. In addition, we expect our spending levels may increase significantly due to the following:

• continued investment in proprietary software systems,

• continued and potentially increasing competition costs for creative, technical and administrative talent,

• increased costs associated with the expansion of our facilities,

• increased number of personnel required to support studio growth as we have multiple films in parallel production,

• increased investment in creative development and our Pixar-only financed films,

• increased proportion of operating expenses previously shared with Disney, and

• increased investment in administrative functions to support our expanding operations.

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 reimburse) the increases in expenses, our operating expenses will increase in the remainder of fiscal year 2005. In addition, as we increase the resources allocated to our productions beyond our feature film Cars, which is the last film to be co-financed with Disney under the current Co-Production Agreement, we expect our operating expenses to increase significantly.

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Our scheduled successive releases of feature films will continue to place a significant strain on our resources.

We have only produced and released six feature films to date and have limited experience with respect to producing more than one animated feature film at a time. Due to the strain on our personnel from the effort required for the release of an upcoming film and the time required for creative development of future films, it is possible that we would be unable to release a new film in successive years. In the past, we have been required, and may continue to be required, to expand our employee base, increase capital expenditures and procure additional resources and facilities in order to accomplish the scheduled releases of our animated feature films. This growth and expansion has placed, and continues to place, a significant strain on our resources. We cannot provide any assurances that any future animated film will be released as scheduled or that this strain on resources will not have a material adverse effect on our business, financial condition or results of operations. In addition, John Lasseter’s availability has been a key ingredient in the successful completion of our prior films. As we move towards releasing one film a year, there has been and will continue to be additional demands placed on his availability. In addition to Mr. Lasseter’s role as our Executive Vice President—Creative, he is also directing Cars, our next feature film. A lack of his availability may adversely impact the success and timing of our future films.

We continuously implement a variety of new and upgraded operational and financial systems, procedures and controls, including improvement and maintenance of our accounting system, other internal management systems and backup systems. Our growth and these diversification activities, along with the corresponding increase in the number of our employees and our rapidly increasing costs, have resulted in increased responsibility for our management team. We will need to continue to improve our operational, financial and management information systems, to hire, train, motivate and manage our employees, to integrate them into Pixar and to provide adequate facilities and other resources for them. We cannot provide any assurance we will be successful in accomplishing all of these activities on a timely and cost-effective basis. Any failure to accomplish one or more of these activities on a timely and cost-effective basis would have a material adverse effect on our business, financial condition and results of operations.

The Co-Production Agreement imposes several risks and restrictions on us.

We are dependent on Disney for the distribution and promotion of our feature films and related products.

The decisions regarding the timing of the theatrical release and related products, the marketing and distribution strategy, and the extent of promotional support are important factors in determining the success of our motion pictures and related products. Under the terms of the Co-Production Agreement, Disney is required to market and distribute the Pictures in the same manner as their premier animated films, and Disney is required to consult with us with respect to all major marketing and distribution decisions. While Disney is prohibited from distributing potential competing films within certain release collars, we ultimately do not control (1) the manner in which Disney distributes our animated feature films and related products, (2) the number of theaters to which Disney distributes our feature films, (3) the specific timing of release of our feature films and related products or (4) the specific amount or quality of marketing and promotional support of the feature films and related products as well as the associated promotional and marketing budgets. 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 substantial financial benefits in the event that such films achieve significant box office revenues, we believe that Disney desires such films to be successful. Nonetheless, Disney could make certain decisions as to marketing, distribution or promotion of the animated feature films or related products or the marketing and promotion of its own animated or other family films that could have a material adverse effect on our business, operating results or financial condition. In addition, the costs for marketing, distribution and promotion of the films and related products are incurred well in advance of the release of such films and products, and we experience a delay in the receipt of proceeds from such films and products until after Disney recovers such costs. We are also dependent on Disney for receiving accurate information on a timely basis on which we base estimates to recognize revenue and associated gross profit from the animated feature films and related products. If we fail to receive accurate information from Disney, or fail to receive it on a timely basis, it could have a significant adverse effect on our business, operating results or financial condition.

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Disney has an exclusive arrangement with us.

We have agreed not to release or authorize the release of any of our feature length animated theatrical motion pictures, other than the Pictures, until twelve months from our delivery of the fifth Picture under the Co-Production Agreement. However, since our April 2003 delivery of Finding Nemo, we have been free to enter into any agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture (other than the Pictures).

We also agreed that we will not develop or produce any rides or attractions for major theme parks not owned or operated by Disney, and to give Disney a right to negotiate with respect to animated television productions or animated made-for-home video productions that we propose to produce during the term of the Co-Production Agreement. Disney, however, is not similarly restricted by the exclusivity provisions that bind us under the Co-Production Agreement and, therefore, may develop, produce or distribute other feature length animated and computer animated theatrical motion pictures itself or enter into similar agreements with third parties. However, if Disney produces any derivative works without Pixar, we are entitled to receive passive royalties pursuant to the terms of the Co-Production Agreement. See “Risk Factors—We experience intense competition with respect to our animated feature films, animation products, and software.”

We have an obligation to co-finance production costs.

We co-financed the first four films under the Co-Production Agreement, as well as Toy Story 2, and we will continue to co-finance Cars and may co-finance other related products to be developed and produced pursuant to the Co-Production Agreement. For example, we have, in the past, elected to actively participate in various interactive games with Disney where we fund half of the development costs of the games. We also have approved for production and have begun financing other Pixar-only financed films. If our feature films and related products do not generate proceeds sufficient to more than offset our share of their production costs, our business, operating results and financial condition will be materially adversely affected.

Disney retains the exclusive distribution and exploitation rights.

We share equally with Disney in the profits of each Picture and any related merchandise after Disney recovers certain costs; however, Disney retains the exclusive distribution and exploitation rights of each Picture, all characters and story elements of each Picture and all related products we develop under the Co-Production Agreement. Accordingly, except in certain specified circumstances, we are not able to exploit or distribute any of our feature films or characters or elements of any of our feature films or related products developed under the Co-Production Agreement without a license from Disney. We cannot provide any assurances that such a license would be available to us on commercially reasonable terms or at all.

Disney can terminate the agreement under various circumstances.

Under the terms of the Co-Production Agreement, Disney may terminate the agreement under certain circumstances. For example, Disney is entitled to terminate the Co-Production Agreement in the event that certain types of competitors directly or indirectly acquire or control a 50% or greater ownership interest in Pixar or Pixar merges or consolidates into such a competitor. Disney would not lose any of its rights to distribute and exploit all feature films and all characters and elements of our feature films and other products we develop under the Co-Production Agreement, except for feature films or related products then in development or production as to which Disney does not elect to proceed, as to which we would regain the rights subject to a lien in favor of Disney for the costs advanced to date. Further, in the event that Disney terminates the Co-Production Agreement, we would be required to seek alternative channels for distribution of our animated feature films and related products.

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There are significant risks associated with the motion picture industry.

The completion and commercial success of a motion picture is extremely unpredictable, and the motion picture industry involves a substantial degree of risk. Each motion picture is an individual artistic work, and its commercial success is primarily determined by audience reaction, which is unpredictable. The completion and commercial success of a motion picture also depends upon other factors, such as:

• talent and crew availability,

• financing requirements,

• distribution strategy, including the time of the year and the number of screens on which it is shown,

• the number, quality and acceptance of other competing films released into the marketplace at or near the same time,

• critical reviews,

• the availability of alternative forms of entertainment and leisure time activities,

• piracy and unauthorized recording, transmission and distribution of motion pictures,

• general socioeconomic conditions and political events,

• weather conditions, and

• other tangible and intangible factors.

All of these factors can change and cannot be predicted with certainty. In addition, motion picture attendance is seasonal, with the greatest attendance typically occurring during the summer and holidays. The release of a film during a period of relatively low theater attendance is likely to affect the film’s box office receipts adversely. Under the terms of the Co-Production Agreement, Pixar is guaranteed theatrical release either during the summer or holiday period. In addition, due to the expected release of a large number of family films by Disney and other movie studios in the next several years, it is possible that further saturation of the family film market, particularly computer graphics imagery (“CGI”) animated films, may adversely impact the commercial success of our films, and therefore have a material adverse effect on our business, financial condition and results of operations.

Motion picture piracy, which may intensify, could decrease the revenue we receive from the exploitation of our films.

Piracy and the unauthorized recording, transmission and distribution of our content are increasing challenges. Motion picture piracy is already prevalent outside of the United States, Canada and Western Europe and in countries where we may have difficulty enforcing our intellectual property rights. Technological advances, such as the digital distribution of motion pictures, could increase the prevalence of piracy, including in the United States, because such advances simplify the creation, transmission and sharing of high quality unauthorized copies of motion pictures in theatrical release, on videotapes and DVDs, from pay-per-view through set top boxes and other devices and through unlicensed broadcasts on free TV and the Internet. The proliferation of unauthorized copies of our products could have an adverse effect on our business, financial condition and results of operations and decrease the revenue we receive from our legitimate products.

Motion picture trade associations such as the Motion Picture Association of America monitor the progress and efforts made by various countries to limit or prevent piracy. Some of these trade associations have initiated voluntary embargoes on motion picture exports to certain countries in the past to exert pressure on the governments of those countries to become more aggressive in preventing motion picture piracy. In addition, the U.S. government has publicly considered implementing trade sanctions against specific countries that, in its opinion, do not make appropriate efforts to prevent copyright infringements of U.S. produced motion pictures. There can be no assurance, however, that voluntary industry embargoes or U.S. government trade sanctions will

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be enacted or, if enacted, effective. If enacted, such actions could impact the amount of revenue that we realize from the international exploitation of motion pictures depending upon the countries subject to such action and the duration and effectiveness of such action. If embargoes or sanctions are not enacted or if other measures are not taken, we may lose an indeterminate amount of additional revenue as a result of motion picture piracy.

In order for our feature films and related products to be successful, we must develop appealing creative content.

The success of each animated feature film developed and produced by us depends in large part upon our ability to develop and produce compelling stories and characters that will appeal to a broad audience. Traditionally, this process has been extremely difficult. While we have enjoyed worldwide box office success with all of our feature films, there can be no assurance that similar levels of success will be achieved by our subsequent films, including Cars and projects beyond the Co-Production Agreement.

We experience intense competition with respect to our animated feature films, animation products, and software.

Animated Feature Films.

Our animated feature films compete and will continue to compete with family-oriented, animated and live action feature films and other family-oriented entertainment products produced by major movie studios, including Disney (as somewhat limited by the Co-Production Agreement), DreamWorks Animation SKG, Inc. (“DreamWorks”), Warner Bros. Entertainment (“Warner Bros.”), Sony Pictures Entertainment, Fox Entertainment Group Inc. (“Fox”), Paramount Pictures, Lucasfilm Ltd., Universal Studios, Inc., MGM/UA, and Studio Ghibli as well as numerous other independent motion picture production companies.

In 2005, competition is expected to continue to intensify in the family-oriented, animated and live action feature film market. In addition, there appears to be increasing widespread acceptance for CGI-animated films. In 2004, there was a significant increase in the number of CGI-animated films released, a trend that is likely to carry through 2005 and beyond. Primarily CGI-animated feature films currently in production for major studios include, A Day With Wilbur Robinson, American Dog, Bee Movie, Chicken Little, Flushed Away, Ice Age 2, Open Season, Over the Hedge, Rapunzel Unbraided, Shrek 3, The Barnyard, and The Wild, among others. Some studios have also announced publicly that they intend to release multiple CGI films per year. In addition to box office and home video competition, other family-oriented films may continue to compete with Finding Nemo and The Incredibles, as well as our film library, with respect to related television, merchandise, and other future revenue sources.

Furthermore, due to the recent success of CGI-animated films, several movie studios have developed their own internal computer animation capability, which may be used for special effects in animated films and live action films. For example, DreamWorks has successfully produced and released Antz in 1998, Shrek in 2001, Shrek 2 and Shark Tale in 2004, and Madagascar in May 2005. In addition, Fox successfully produced, through its subsidiary Blue Sky, Ice Age, which was released in March 2002 and Robots, which was released in March 2005; Warner Bros. released The Polar Express in November 2004; and Disney will distribute Valiant, a film co-produced with Vanguard, in the U.S. in August 2005. Other movie studios may internally develop, license or sub-contract three-dimensional animation capability, or enter into co-production agreements with other studios capable of developing and producing three-dimensional CGI-animated films. Further, we believe that continuing enhancements to 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.

Therefore, we believe competition from animated feature films and family-oriented feature films will likely continue to intensify over the next several years. Due to a potentially large number of family-oriented films scheduled for release over the next few years, it is possible that the market for these films, whether animated or live action, will become further saturated.

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Our films will continue to compete with the feature films of other movie studios for optimal release dates, audience acceptance, and exhibition outlets. In addition, we compete and will continue to compete with other movie studios for the services of performing artists, and the services of other creative and technical personnel, particularly in the fields of animation and technical direction. Some of the other movie studios with which we compete have significantly greater financial, marketing and other resources than we do.

The Co-Production Agreement provides that we will develop and produce 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, we believe that Disney desires such films to be successful. Nonetheless, during its long history, Disney has been a very successful producer and distributor of its own animated feature films. While the Co-Production Agreement imposes restrictions prohibiting Disney and its affiliates from releasing animated films or live action family films within certain release windows from our films, it is likely that other family-oriented motion pictures distributed by Disney or its affiliates will overlap in the market and compete with our animated feature films. For example, Pirates of the Caribbean: The Curse of the Black Pearl, Spy Kids 3D: Game Over, and Freaky Friday, competed directly with Finding Nemo for domestic theatrical market share during summer 2003. The home video releases of Pirates of the Caribbean: The Curse of the Black Pearl and Freaky Friday have also competed with Finding Nemo in the worldwide home video market. The theatrical releases of Disney’s National Treasure and Miramax’s Finding Neverland on November 19, 2004 competed with the worldwide theatrical release of The Incredibles, and the home video release of these films competed with The Incredibles in the worldwide home video market. After Cars, Disney may begin to release its movies during our release windows. This could have an adverse impact on the commercial success required for us to profit from future films. Our contractual arrangement with Disney also presents other risks. See “Risk Factors—The Co-Production Agreement imposes several risks and restrictions on us.”

Computer Graphics Special Effects Firms.

We also expect to compete with computer graphics special effects firms, including Industrial, Light & Magic (“ILM”), Rhythm & Hues/VIFX, Tippett Studios, WETA Digital, Digital Domain, and Sony Pictures Imageworks. These computer graphics special effects firms may be capable of creating their own three-dimensional computer animated feature films or may produce three-dimensional computer-animated feature films for movie studios that compete with us. For example, ILM has already created and produced three-dimensional character animation which was used for several central characters in the live action film Star Wars Episode III: Revenge of the Sith, and ILM has a royalty-free, paid-up license to use our RenderMan^® software and to obtain at no cost all enhancements and upgrades thereto. Other computer graphics special effects firms have licensed or may license RenderMan^®. Accordingly, our RenderMan^® software may not provide us with a competitive advantage. We also compete, or may in the future compete, with the above firms with respect to animation products other than feature films.

Software Publishers.

We also experience competition with respect to our RenderMan^® software product. In particular, we compete with makers of computer graphics imaging and animation software, principally Alias, Discreet (a division of Autodesk), Mental Images GmbH and Avid Technologies. Mental Images and Avid are each marketing competing rendering software products, usually at lower prices than the price at which we offer RenderMan^®. Under appropriate circumstances, we have in the past elected and might in the future elect to license our rendering technology patents to other companies, some of which may compete with us. In addition, as PC’s become more powerful, software suppliers may also be able to introduce products for PC’s that would be competitive with RenderMan^® in terms of price and performance for professional users. In addition, there have been advances in graphics processing unit technology that may impinge on the market for software rendering solutions. Faster and lower cost graphic cards provide capability for users to produce pictures of higher complexity than previously available.

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We expect competition to persist, intensify and increase in each of our business areas in the future. Some of our current and potential competitors have longer operating histories, larger installed customer bases and significantly greater financial, technical, marketing and other resources than we do. There can be no assurance that we will be able to compete successfully against current or future competitors. Such competition could have a material adverse effect on our business, operating results or financial condition.

Our success depends on certain key employees.

Our success depends to a significant extent on the performance of a number of senior management personnel and other key employees, especially our film directors, producers, animators, creative personnel and technical directors. In particular, we are dependent upon the services of Steve Jobs, John Lasseter, Edwin E. Catmull, Simon Bax, Sarah McArthur and Lois Scali. We do not currently have “key person” life insurance for any of our employees. We do have an employment agreement with Mr. Lasseter, however, such employment agreement does not necessarily assure the services of Mr. Lasseter. Moreover, although it is standard in the motion picture industry to rely on employment agreements as a method of retaining the services of key employees, we have not required our employees, other than Mr. Lasseter, to enter into employment agreements. The loss of the services of any of Messrs. Jobs, Lasseter, Bax, Dr. Catmull, Ms. McArthur, Ms. Scali or of other key employees, especially our film directors, producers, animators, creative personnel and technical directors, could have a material adverse effect on our business, operating results or financial condition.

Our Chief Executive Officer has divided responsibilities.

Pixar’s Chief Executive Officer and Chairman, Steve Jobs, is also Chief Executive Officer at Apple Computer, Inc. Although Mr. Jobs spends time at Pixar and is active in our management, he does not devote his full time and resources to Pixar.

To be successful, we need to attract and retain qualified personnel.

Our success continues to depend to a significant extent on our ability to identify, attract, hire, train and retain qualified professional, creative, technical and managerial personnel. Competition for the caliber of talent required to make our films, particularly our film directors, producers, animators, creative personnel and technical directors, will continue to intensify as more studios build their in-house CGI-animation or special effects capabilities. There can be no assurance that we will be successful in identifying, attracting, hiring, training and retaining such personnel in the future. If we were unable to hire, assimilate and retain qualified personnel in the future, particularly film directors, producers, animators, creative personnel and technical directors, such inability would have a material adverse effect on our business, operating results and financial condition.

We face various distribution risks with respect to our feature films.

Under the Co-Production Agreement, Disney is required to distribute the Pictures in a manner consistent with that of Disney’s premier animated films. Currently, distribution of our films generally includes (1) worldwide theatrical exhibition, (2) worldwide home video sales, (3) worldwide television licensing, including Pay-Per-View, pay television, network, basic cable and syndication and some video-on-demand (VOD), (4) non-theatrical exhibition, such as airlines, schools and armed forces facilities and (5) marketing of other rights of the picture, which may include licensing of merchandise, such as toys, interactive games and soundtrack recordings. Although the Co-Production Agreement provides us with some protection, we cannot provide any assurances that our feature films made under the Co-Production Agreement will be distributed through all of these outlets.

Although we have enjoyed a tremendously successful track record with all six of our feature films, we cannot provide any assurances that our future films will enjoy the same level of success. Currently, Disney shares the financial risks associated with the production of our films under the Co-Production Agreement by financing 50% of the production costs. In addition, under the Co-Production Agreement, Disney is responsible for financing 100% of the costs related to the marketing and distribution of the films. In the event that a film does

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not generate sufficient revenues to offset such costs, Pixar is not responsible for any losses Disney incurs. However, because we anticipate financing 100% of the production costs of our films under any future distribution agreement, we expect to bear all of the financial risks associated with a future film’s production costs. In addition, we cannot provide any assurances that future distribution agreements will provide us with our current level of risk minimization related to the financing of marketing and distribution expenses. In addition, as additional entrants emerge in the animation marketplace, there may be increased competition for distribution partners.

We have a limited operating history.

Until 1996, we had generated recurring revenue primarily from the license of our RenderMan^® software, amounts we received under software development contracts and fees for animated television commercial development. We expect to generate a substantial majority of our future revenue from the development and production of animated feature films and related products, as we have since 1996. We have, to date, developed, produced and released only six animated feature films. Accordingly, we have a limited operating history in implementing our business model upon which an evaluation of our prospects can be based. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of a business enterprise, particularly companies in highly competitive markets. To address these risks, we must, among other things, respond to changes in the competitive environment, continue to attract, retain and motivate qualified persons, and continue to upgrade our technologies. We cannot provide any assurances that we will be successful in addressing such risks.

Our current and future commitments may have an adverse impact on our cash balances.

We are currently co-financing our remaining unreleased Picture, Cars, pursuant to the Co-Production Agreement and solely financing our feature films beyond the Co-Production Agreement. The future production costs of Cars, and subsequent films, and any future expansion of our studio and headquarters in Emeryville, California, may have an adverse impact on our cash and investment balances. As of July 2, 2005, we had $901.4 million in cash, cash equivalents and investments. We believe that these funds, along with future cash provided by operating activities, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures, production costs for Cars, as well as production and development costs for future films and development projects. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” To date, we have chosen to use our existing cash resources to fund film production costs and construction 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.

We depend on our proprietary technology and computer systems for the timely and successful development of our feature films and related products.

We cannot provide any assurances that we will not experience difficulties that could delay or prevent the successful development or production of future animated feature films or other related products. Among other things, because we are dependent upon a large base of software and a large number of computers for the development and production of our animated feature films and related products, an error or defect in the software, a failure in the hardware or a failure of the backup processes could result in a significant delay in one or more productions in process which, in turn, could result in potentially significant delays in the release dates of our feature films or other products. In the past we have experienced minor delays as a result of such matters. Significant delays in production and significant delays in release dates could have a material adverse effect on our business, operating results or financial condition. Further, because we rely mostly on internally developed software, we would not be able to rely upon assistance from third parties in the event that the software fails.

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A single shareholder owns a large percentage of our outstanding stock.

Our Chief Executive Officer and Chairman, Steve Jobs, beneficially owned approximately 50.6% of our outstanding Common Stock as of August 1, 2005. As a result, Mr. Jobs, acting alone, is able to exercise sole discretion over all matters requiring shareholder approval, including the election of the entire board of directors and approval of significant corporate transactions, including an acquisition of Pixar. Such concentration of ownership may also have the effect of delaying or preventing a change in control of Pixar, impeding a merger, consolidation, takeover or other business combination involving Pixar, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of Pixar.

Business interruptions could adversely affect our operations.

Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. Although we have developed certain plans to respond in the event of a disaster, there can be no assurance that they will be effective in the event of a specific disaster. Our facilities in the State of California have in the past and may in the future be subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event of a short-term power outage, we have installed UPS (uninterrupted power source) equipment to protect our RenderFarm and other sensitive equipment, along with two 1.5 Megawatt backup generators; however, a long-term power outage could disrupt our operations. Prices for electricity have in the past risen dramatically and may increase in the future. An increase in prices would increase our operating costs, which could in turn adversely affect our profitability. We do not carry earthquake insurance for earthquake related losses and although we carry business interruption insurance for other potential losses, there can be no assurance that such insurance will be sufficient to compensate us for losses that may occur. Any losses or damages incurred by us could have a material adverse effect on our business and results of operations.

Terrorist activities and resulting military and other actions could adversely affect our business.

The continued threat of terrorism within the United States and abroad, military action and heightened security measures in response to such threats, as well as other socioeconomic and political events, may cause significant disruption to commerce, including the entertainment industry, throughout the world. For example, the terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the United States and Europe. Such disruption in the future could have a material adverse effect on our business and results of operations.

Work stoppages could adversely impact our operations.

Although none of our employees are represented by a labor union, it is common for film directors, producers, animators and actors at film production companies to belong to a union. There can be no assurance that our employees will not join or form a labor union or that we, for certain purposes, will not be required to become a union signatory. We may be directly or indirectly dependent upon certain union members, and work stoppages or strikes organized by such unions could have a material adverse impact on our business, financial condition or results of operations. If a work stoppage occurs, it could delay the completion of our films and have a material adverse effect on our business operating results or financial condition.

To be successful, we will need to continuously enhance our existing proprietary technology and develop new technology.

Substantially all of our revenues have been derived, and substantially all of our future revenues are expected to be derived, from the use and license of our proprietary technologies. We expect that we will be required to enhance these technologies and to develop new technologies in order to be successful in our industry and in the licensing of our RenderMan^® software. We cannot provide any assurances that we will be successful in enhancing our existing technologies or in developing and utilizing new technologies, or that competitors will not develop technology that is equivalent or superior to our technologies or that makes our technologies obsolete. If

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we are unable to develop enhancements to our existing technologies or new technologies as required, or if the costs associated with developing those technologies continue to increase, our business, operating results or financial condition could be materially adversely affected.

There are various risks associated with our proprietary rights.

Our efforts to protect our proprietary technologies may not succeed.

Our success and ability to compete is dependent in part upon our proprietary technology. While we rely on a combination of patents, copyright and trade secret protection, nondisclosure agreements and cross-licensing arrangements to establish and protect our proprietary rights, we believe that factors such as the technical and creative skills of our personnel are more essential to our success and ability to compete. We currently have thirty-two patents in force in the United States and eighteen patents in force in foreign countries. In addition, we have a number of patent applications pending in the United States and in foreign countries. We cannot provide any assurances that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed will be sufficiently broad to protect our technology. In addition, we cannot provide any assurances that any patents that have been issued to us, or that we may license from third parties, will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide us with any proprietary protection. Failure of the patents to provide protection of our technology may make it easier for our competitors to offer technology equivalent to or superior to our technology. We generally enter into confidentiality or license agreements with our employees, consultants and vendors, and generally control access to and distribution of our software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our proprietary information, products or technology without authorization, or to develop similar or superior technology independently. Policing unauthorized use of our products is difficult and expensive. In addition, effective copyright, patent and trade secret protection may be unavailable or limited in certain foreign countries. We generally rely on “electronically delivered” software licenses that include an electronic acceptance by the purchaser, which may be unenforceable under the laws of certain jurisdictions. We cannot provide any assurances that the steps we take will prevent misappropriation of our technology or that our confidentiality or license agreements will be enforceable.

Enforcing our proprietary rights may require litigation.

Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to protect our patents, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results or financial condition.

Others may assert infringement claims against us.

One of the risks of the film production business is the possibility of claims that our productions infringe on the intellectual property rights of third parties with respect to previously developed films, stories, characters or other entertainment. In addition, our technology and software may be subject to patent, copyright or other intellectual property claims of third parties. We have received, and are likely to receive in the future, claims of infringement of other parties’ proprietary rights. There can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against us, or that any assertions or prosecutions will not have a material adverse effect on our business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, we would incur significant costs and diversion of resources with respect to the defense thereof, which could have a material adverse effect on our business, financial condition or results of operations. If any claims or actions are asserted against us, we may seek to obtain a license under a third party’s intellectual property rights. We cannot provide any assurances, however, that under such circumstances a license would be available on reasonable terms or at all.

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Third-party technology licenses may not continue to be available to us in the future.

We also rely on certain technology that we license from third parties, including software that we integrate and use with our internally developed software. We cannot provide any assurances that these third-party technology licenses will continue to be available to us on commercially reasonable terms. The loss of, or inability to maintain any of these technology licenses could result in delays in feature film releases or product releases until equivalent technology could be identified, licensed and integrated. Any such delays in feature film releases or product releases could have a material adverse effect on our business, operating results and financial condition.

The market price of our Common Stock has been highly volatile in the past, and we expect such volatility to continue.

The market price of our Common Stock is highly volatile and is subject to wide fluctuations in response to a wide variety of factors, including the publication of box office results for our feature films and those of our competitors, fluctuations in our quarterly or annual results of operations, changes in financial estimates by securities analysts, announcements made by us, Disney, or our competitors, budget increases, delays in or cancellation of feature film or other product release dates, speculation about the negotiation of terms or conditions of our next distribution arrangement, or socioeconomic, political or other factors. For example, since the beginning of fiscal year 2004, our Common Stock closed as low as $31.21 and as high as $53.97 per share. Moreover, in recent years, the stock market has experienced extreme price and volume fluctuations, some of which have been unrelated or disproportionate to the operating performances of the companies affected. These broad market and industry fluctuations may adversely affect the market price of our Common Stock. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against such a company. If brought against Pixar, such litigation could result in substantial costs and a diversion of management’s attention and resources, which could have a material adverse effect on our business, operating results or financial condition.

As described in “Risk Factors—Our operating results have fluctuated in the past, and we expect such fluctuations to continue,” we believe that period-to-period comparisons of our results of operations may not be necessarily meaningful. Accordingly, you should not rely on our annual and quarterly results of operations as any indication of future performance. In addition, it is possible that in some future period our operating results will be below the expectations of public market analysts and investors or the guidance we have provided. In such event, the price of our Common Stock may be materially adversely affected. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

While we believe we currently have adequate internal control over financial reporting, we are required to assess our internal control over financial reporting on an annual basis and any future adverse results from such assessment could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, (“Section 404”) and the rules and regulations promulgated by the SEC to implement Section 404, we are required to include in our Form 10-K an annual report by our management regarding the effectiveness of our internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management.

Management’s assessment of internal controls over financial reporting requires management to make subjective judgments and, because this requirement to provide a management report is relatively new, some of our judgments will be in areas that may be open to interpretation. Therefore our management report may be uniquely difficult to prepare and our auditors, who are required to issue an audit report along with our management’s report, may not agree with management’s assessments. While we currently believe our internal control over financial reporting is effective, the effectiveness of our internal controls to future periods is subject

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to the risk that our controls may become inadequate because of changes in conditions, and, as a result, the degree of compliance of our internal control over financial reporting with the policies or procedures may deteriorate.

If we are unable to assert that our internal control over financial reporting is effective in any future period (or if our auditors are unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which may have an adverse effect on our stock price.

We are subject to risks caused by the availability and cost of insurance.

Changing conditions in the insurance industry have affected most areas of corporate insurance. These changes have in the past and may in the future result in higher premium costs, higher deductibles and lower insurance coverage limits. Due to these factors, we have elected to self-insure certain risks. For example, we do not carry earthquake insurance due to its high cost.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Investment Portfolio. We invest in a variety of investment grade, interest-bearing, fixed income securities, including obligations of corporations, states and municipalities, and national governmental entities and their 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 an effective maturity of 24 months or less. Our investments are primarily 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, “Accounting for Certain Investments in Debt and Equity Securities.” The table below provides information regarding our investment portfolio at July 2, 2005. The table presents principal cash flows and related weighted-average fixed interest rates presented by expected maturity date (dollars in thousands):

	Less than 1 Year			Over 1 Year			Total
Available-for-sale securities	$	425,689		$	462,624		$	888,313
Weighted-average interest rate		2.90	%		3.32	%		3.12	%

Impact of Foreign Currency Rate Changes. Disney and its affiliates distribute our products in foreign markets; therefore, we are not directly exposed to foreign currency rate fluctuations. We recognize revenues from foreign territories based on an average foreign currency exchange rate used by Disney for revenue reporting. This rate may differ from the actual exchange rate at the time cash is remitted to Disney and subsequently to us. Therefore, there may be some indirect foreign currency exchange rate exposure as managed by Disney.

Item 4.  Controls and Procedures

Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1.  Legal Proceedings

Pixar is regularly subject to certain legal proceedings and claims that arise in the ordinary course of business. Many of these have not yet been fully adjudicated. In the opinion of management, Pixar does not have a potential liability related to any current legal proceedings and claims that would have a material adverse effect on its financial condition, liquidity or results of operations. However, the results of legal proceedings cannot be predicted with certainty. Should Pixar fail to prevail in any of these legal matters or should several of these legal matters be resolved against Pixar in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.

Item 6.  Exhibits

(a) Exhibits

Exhibit 31.1	Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2	Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1	Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Items 2, 3, 4 and 5 are not applicable and have been omitted.

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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
By:	/s/    SIMON T. BAX
	Simon T. Bax Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer)

Date: August 11, 2005

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EXHIBIT INDEX

Exhibit Number	Description
31.1	Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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