<PAGE> 1
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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 SEPTEMBER 26, 1998.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER: 0-26976
PIXAR
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
CALIFORNIA 68-0086179
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
1001 WEST CUTTING BOULEVARD, RICHMOND, CALIFORNIA 94804
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 236-4000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares outstanding of the registrant's Common Stock as of
November 3, 1998 was 44,975,302.
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 26, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 16,974 $101,847
Short-term investments.................................... 136,221 74,198
Trade and other accounts receivable, net.................. 4,294 3,988
Prepaid expenses and other current assets................. 829 783
-------- --------
Total current assets.............................. 158,318 180,816
Property and equipment, net................................. 25,785 21,462
Capitalized film production costs, long-term................ 52,435 28,589
Other assets................................................ 3,295 201
-------- --------
Total assets...................................... $239,833 $231,068
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,240 $ 1,694
Income taxes payable...................................... 1,993 1,776
Payable to Disney......................................... 10 2,162
Accrued liabilities....................................... 5,436 7,276
Unearned revenue.......................................... 710 860
-------- --------
Total current liabilities......................... 10,389 13,768
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock; no par value; 5,000,000 shares authorized
and no shares issued and outstanding................... -- --
Common stock; no par value; 100,000,000 shares authorized;
44,776,004 and 42,410,707 shares issued and outstanding
as of September 26, 1998 and December 31, 1997,
respectively........................................... 215,652 210,902
Other cumulative comprehensive income..................... 425 29
Deferred compensation..................................... (158) (414)
Retained earnings......................................... 13,525 6,783
-------- --------
Total shareholders' equity........................ 229,444 217,300
-------- --------
Total liabilities and shareholders' equity........ $239,833 $231,068
======== ========
</TABLE>
See accompanying notes to financial statements.
2
<PAGE> 3
PIXAR
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 26, SEPTEMBER 30, SEPTEMBER 26, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Software................................... $ 1,214 $ 908 $ 2,740 $ 3,386
Animation services......................... -- 896 171 1,165
Film....................................... 1,260 3,509 8,208 21,406
Patent licensing........................... -- 28 120 1,627
------- ------- ------- -------
Total revenues..................... 2,474 5,341 11,239 27,584
------- ------- ------- -------
Cost of revenues:
Software................................... 302 24 438 46
Animation services......................... -- 534 38 708
Film....................................... -- 85 -- 1,412
------- ------- ------- -------
Total cost of revenues............. 302 643 476 2,166
------- ------- ------- -------
Gross profit............................ 2,172 4,698 10,763 25,418
------- ------- ------- -------
Operating expenses:
Research and development................... 928 1,202 2,740 3,710
Sales and marketing........................ 311 422 963 1,027
General and administrative................. 1,731 1,218 5,276 3,471
Operating expense reimbursement............ -- (2,184) -- (2,184)
------- ------- ------- -------
Total operating expenses........... 2,970 658 8,979 6,024
------- ------- ------- -------
Income (loss) from continuing
operations............................ (798) 4,040 1,784 19,394
Other income, net............................ 1,924 2,432 6,487 6,478
------- ------- ------- -------
Income from continuing operations before
income taxes.......................... 1,126 6,472 8,271 25,872
Income tax expense........................... 259 2,913 1,903 8,159
------- ------- ------- -------
Net income from continuing operations... 867 3,559 6,368 17,713
------- ------- ------- -------
Income from discontinued operations, net of
taxes...................................... -- 113 374 36
------- ------- ------- -------
Net income.............................. $ 867 $ 3,672 $ 6,742 $17,749
======= ======= ======= =======
Basic net income per share from continuing
operations................................. $ 0.02 $ 0.09 $ 0.14 $ 0.43
Basic net income (loss) per share from
discontinued operations.................... -- 0.00 0.01 0.00
------- ------- ------- -------
Basic net income per share................... $ 0.02 $ 0.09 $ 0.15 $ 0.43
======= ======= ======= =======
Shares used in computing basic net income per
share...................................... 44,519 41,717 43,836 40,913
======= ======= ======= =======
Diluted net income per share from continuing
operations................................. $ 0.02 $ 0.07 $ 0.12 $ 0.37
Diluted net income per share from
discontinued operations.................... -- 0.01 0.01 0.00
------- ------- ------- -------
Diluted net income per share................. $ 0.02 $ 0.08 $ 0.13 $ 0.37
======= ======= ======= =======
Shares used in computing diluted net income
per share.................................. 51,733 48,428 51,227 47,857
======= ======= ======= =======
</TABLE>
See accompanying notes to financial statements.
3
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PIXAR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------
SEPTEMBER 26, SEPTEMBER 30,
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 6,742 $ 17,749
Adjustments to reconcile net income to net cash provided
by continuing operating activities:
Discontinued operations................................ (374) (36)
Amortization of deferred compensation.................. 256 504
Depreciation and amortization.......................... 4,321 2,037
Loss on disposition of property and equipment.......... 258 425
Amortization of capitalized film production costs...... -- 1,412
Credits from patent licensing, net of expense items.... (114) (1,519)
Changes in operating assets and liabilities:
Trade and other accounts receivable.................. (306) 1,474
Prepaid expenses and other current assets............ 68 644
Accounts payable..................................... 546 (755)
Income taxes payable................................. 217 7,647
Payable to Disney.................................... (2,152) 104
Accrued liabilities.................................. (1,940) 1,619
Unearned revenue..................................... (450) 108
--------- --------
Net cash provided by continuing operations........ 7,072 31,413
Net cash provided by discontinued operations...... 374 1,468
--------- --------
Net cash provided by operating activities......... 7,446 32,881
--------- --------
Cash flows from investing activities:
Purchase of property and equipment........................ (8,751) (15,483)
Proceeds from sale of short-term securities............... 103,066 105,579
Investments in short-term securities...................... (164,693) (112,051)
Capitalized film production costs......................... (23,846) (21,682)
Proceeds from sale of equipment........................... 247 --
Other assets.............................................. (492) (52)
--------- --------
Net cash used in investing activities.................. (94,469) (43,689)
--------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock and warrants,
net.................................................... -- 14,885
Proceeds from exercised stock options..................... 2,150 737
--------- --------
Net cash provided by financing activities.............. 2,150 15,622
--------- --------
Net increase (decrease) in cash and cash equivalents........ (84,873) 4,814
Cash and cash equivalents at beginning of period............ 101,847 44,648
--------- --------
Cash and cash equivalents at end of period.................. $ 16,974 $ 49,462
========= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes.............. $ 1,796 $ 390
========= ========
Supplemental disclosure of non-cash investing and financing
activities:
Value of common stock issued and liabilities assumed for
purchase of PEI........................................ $ 3,000 $ --
========= ========
Tax benefit from disqualifying dispositions............... $ -- $ 5,500
========= ========
Credits from patent licensing............................. $ 120 $ 1,627
========= ========
Non-cash film production costs capitalized................ $ -- $ 124
========= ========
Unrealized gain on investments............................ $ 396 $ 118
========= ========
</TABLE>
See accompanying notes to financial statements.
4
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PIXAR
NOTES TO FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission. In the
opinion of management, the accompanying unaudited financial statements reflect
all adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation of Pixar's financial condition, results of
operations and cash flows for the periods presented. These financial statements
should be read in conjunction with the audited financial statements as of
December 31, 1997 and 1996, and for each of the years in the three year period
ended December 31, 1997, including notes thereto, incorporated by reference into
Pixar's Annual Report on Form 10-K for the year ended December 31, 1997.
The results of operations for the three- and the nine-month periods ended
September 26, 1998 are not necessarily indicative of the results expected for
the current year or any other period.
Certain amounts reported in previous periods have been reclassified to
conform to the 1998 financial statement presentation.
(2) FISCAL YEAR
Effective for fiscal year 1998, the Company adjusted its fiscal year end
from December 31 to the 52 or 53-week period that ends on the Saturday nearest
December 31. As a result, the first three quarters of 1998 represented
thirteen-week periods and the fourth quarter will represent a fourteen-week
period. The 1998 fiscal year will end on January 2, 1999 and will consist of 53
weeks.
(3) EARNINGS PER SHARE CALCULATION
Basic net income per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted net income per share is
computed using the weighted-average number of common and dilutive common
equivalent shares outstanding during the period, using the treasury stock method
for outstanding options and warrants.
Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------
SEPTEMBER 26, 1998 SEPTEMBER 30, 1997
------------------------- -------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Basic net income per share............ $ 867 44,519 $0.02 $3,672 41,717 $0.09
Effect of dilutive shares:
Warrants/options.................... -- 7,214 -- 6,711
------ ------ ------ ------
Diluted net income per share.......... $ 867 51,733 $0.02 $3,672 48,428 $0.08
====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------------------------------------------
SEPTEMBER 26, 1998 SEPTEMBER 30, 1997
------------------------- --------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------ ------ ----- ------- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Basic net income per share............ $6,742 43,836 $0.15 $17,749 40,913 $0.43
Effect of dilutive shares:
Warrants/options.................... -- 7,391 -- 6,944
------ ------ ------- ------
Diluted net income per share.......... $6,742 51,227 $0.13 $17,749 47,857 $0.37
====== ====== ======= ======
</TABLE>
5
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PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(4) FEATURE FILM AND CO-PRODUCTION AGREEMENTS
Feature Film Agreement
In 1991, Pixar entered into a feature film agreement with Walt Disney
Pictures, a wholly owned subsidiary of The Walt Disney Company (together with
its subsidiaries and affiliates collectively referred to herein as "Disney") to
develop and produce up to three computer animated feature films (the "Feature
Film Agreement"). Under the Feature Film Agreement, Pixar is entitled to receive
compensation based on the revenue from the distribution of these films and
related products. In 1995, Pixar released its first feature film under the terms
of the Feature Film Agreement, Toy Story, and recognized related revenues of
$8.2 million and $21.4 million for the nine months ended September 26, 1998 and
September 30, 1997, respectively, for a total of $53.8 million since the film's
release. All production costs incurred by Pixar through 1995 were reimbursed by
Disney on a current basis and recorded by Pixar as cost reimbursements.
Accordingly, these reimbursements were not recorded as revenue.
Co-Production Agreement
In February 1997, Pixar and Disney entered into a new co-production
agreement (the "Co-Production Agreement") which now governs all films made by
Pixar since Toy Story. Films in development or production by Pixar as of
September 26, 1998 include A Bug's Life, Toy Story 2, and Pixar's fourth film
("Film Four"). Under the Co-Production Agreement, Pixar, on an exclusive basis,
will produce five original computer animated theatrical motion pictures (the
"Pictures") for distribution by Disney. A Bug's Life and Film Four count toward
the five Pictures, whereas Toy Story 2 is a derivative work that will not count
towards the five Pictures. However, Pixar and Disney have agreed that all
provisions of the Co-Production Agreement applicable to the Pictures will also
apply to Toy Story 2. Pixar and Disney will co-own, co-brand and co-finance the
production costs of the Pictures and will share equally in the profits of each
Picture and any related merchandise and other ancillary products, after recovery
of all Disney marketing, distribution and other predefined fees and costs. The
Co-Production Agreement generally provides that Pixar will produce each Picture
and Disney will control decisions relating to film marketing and distribution.
(5) DISCONTINUED OPERATIONS
In 1996, Pixar entered into an agreement with Disney to develop and produce
interactive CD-ROM titles based on Toy Story. Pixar determined in March 1997 to
discontinue its business of producing CD-ROM and other interactive products and
reassigned all of the employees in this division to feature film productions and
other departments within Pixar. The CD-ROM division reported income of $36,000,
net of income taxes, for the nine months ended September 30, 1997. Pixar
recorded income from discontinued operations of $374,000, net of income taxes,
for the nine months ended September 26, 1998, due to royalty income received
from the Toy Story CD-ROM products. Pixar anticipates future royalty income, if
any, will not be significant.
(6) COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards (SFAS) No. 130, Reporting of Comprehensive
Income. SFAS No. 130 establishes standards for the display of comprehensive
income and its components in a full set of financial statements. Comprehensive
income includes all changes in equity during a period except those resulting
from the issuance of shares of stock and distributions to shareholders. The
Company's total comprehensive income for the three and nine months ended
September 26, 1998, was $444,000 and $396,000, respectively. The Company's total
comprehensive income for the three and nine months ended September 30, 1997, was
$109,000 and $118,000, respectively. In all periods, total comprehensive income
consists entirely of changes in the Company's unrealized gain on short-term
investments.
6
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PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(7) BUSINESS COMBINATION
On June 16, 1998, Pixar issued 60,468 shares of its common stock in
exchange for all of the outstanding common stock of Physical Effects, Inc.
("PEI"). Pixar assumed $300,000 of liabilities as part of this merger. The
merger was accounted for under the purchase method of accounting with the
operating results of PEI being included in the Company's results of operations
from the date of acquisition. The majority of the purchase price was assigned to
purchased technology associated with certain technology developed by PEI. The
purchased technology is being amortized over a period not to exceed three years.
7
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements that have been made
pursuant to the provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based on current expectations,
estimates and projections about Pixar's industry, management's beliefs, and
assumptions made by management. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," and "estimates," variations of such
words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict; therefore, actual results and outcomes may differ materially from what
is expressed or forecasted in any such forward-looking statements. Such risks
and uncertainties include those set forth herein under "Declining Revenues and
Anticipated Net Losses in the Second Half of 1998 and the First Half of 1999,"
"Dependence on Toy Story, A Bug's Life and Toy Story 2," "Scheduled Successive
Release of Films; Management of Growth," and "Competition From Movie Studios" as
well as those noted in the section entitled "Certain Factors Affecting Business,
Operating Results and Financial Condition" in Pixar's Annual Report on Form 10-K
for the year ended December 31, 1997 (the "Form 10-K"). Particular attention
should be paid to the cautionary language in the sections in the Form 10-K
entitled "Certain Factors Affecting Business, Operating Results and Financial
Condition -- Anticipated Net Losses in 1998 and The First Half of 1999,"
"-- Dependence on Toy Story, A Bug's Life and Toy Story 2," "-- Liquidity
Risks," "-- Scheduled Successive Release of Films; Management of Growth" and
"-- Risks Associated With Co-Production Agreement." Unless required by law,
Pixar undertakes no obligation to update any forward-looking statements, whether
as a result of new information, future events or otherwise.
Pixar's operating performance each quarter is subject to various risks and
uncertainties as discussed in the Company's Form 10-K. The following discussion
should be read in conjunction with the sections entitled "Certain Factors
Affecting Business, Operating Results and Financial Condition" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in the
Form 10-K. In particular, the factors set forth below in "Factors Affecting
Operating Results and Financial Condition" could affect the Company's operating
results and financial condition.
Co-Production Agreement
In February 1997, Pixar and Walt Disney Pictures and Television, a wholly
owned subsidiary of The Walt Disney Company (together with its subsidiaries and
affiliates collectively referred to herein as "Disney"), entered into a
co-production agreement (the "Co-Production Agreement") pursuant to which Pixar,
on an exclusive basis, will produce five original computer animated
feature-length theatrical motion pictures (the "Pictures") for distribution by
Disney. Pixar and Disney will co-finance the production costs of the Pictures,
co-own the Pictures (with Disney having exclusive distribution and exploitation
rights), co-brand the Pictures and share equally in the profits of each Picture
and any related merchandise and other ancillary products, after recovery of all
marketing and distribution costs (which will be financed by Disney), a
distribution fee paid to Disney and certain other fees and costs, including
participations provided to talent and the like. The Co-Production Agreement
generally provides that Pixar will produce each Picture and that Disney will
control all decisions relating to marketing, promotion, publicity, advertising
and distribution of each Picture. Disney and Pixar have agreed that the first
Picture under the Co-Production Agreement will be A Bug's Life, which is
targeted for release on November 25, 1998. The Co-Production Agreement also
contemplates that with respect to sequels, interactive media products and other
derivative works related to the Pictures, Pixar will have the opportunity to
choose between co-financing and producing such products or earning passive
royalties on such products. Pixar will not share in any theme park revenues
generated as a result of the Pictures. Pursuant to the Co-Production Agreement,
in addition to co-financing the production costs of the Pictures, Disney will
reimburse Pixar for its share of certain general and administrative costs and
certain research and development costs that benefit the productions.
In February 1998, Pixar and Disney agreed to produce a theatrical motion
picture sequel to Toy Story (with the title, "Toy Story 2"), in lieu of the Toy
Story made-for-home video sequel. Toy Story 2 will be Pixar's third feature film
and will not be released until late 1999 at the earliest. Because Toy Story 2 is
a
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derivative work of the original Toy Story, it will not be counted toward the
five Pictures to be produced under the Co-Production Agreement. However, for all
other purposes, Toy Story 2 will be treated as a Picture under the Co-Production
Agreement. Accordingly, Toy Story 2 has been added to the definition of Pictures
produced and financed under the Co-Production Agreement and all the provisions
applicable to the other five Pictures apply. From 1996 until the first quarter
of 1998, Pixar was producing Toy Story 2 for the less expensive made-for-home
video format. Therefore, Pixar has begun and will necessarily continue to spend
substantially more production time and incur substantially higher production
costs to convert Toy Story 2 into a feature-length and feature-quality motion
picture.
At the present time, Pixar is continuing story development on its fourth
theatrical film ("Film Four"). Production of Film Four has not yet begun. Disney
and Pixar have approved the story treatment as required under the Co-Production
Agreement but have not yet approved the budget as required under the
Co-Production Agreement. Once the budget is approved, this film will be
developed and distributed under the Co-Production Agreement and will count as
the second of the five Pictures. Film Four is not expected to be released until
the end of 2000 at the earliest; however, given the creative and production
uncertainties at this stage of the production of Film Four, there can be no
assurance that Film Four will be developed in time for release even by late
2000.
In May 1991, Pixar entered into a feature film agreement (the "Feature Film
Agreement") with Disney, pursuant to which Toy Story and the Toy Story home
video were developed, produced and distributed. The Feature Film Agreement was
largely superseded by the Co-Production Agreement above. However, the Feature
Film Agreement remains in effect with respect to Pixar's financial participation
in Toy Story and related products.
RESULTS OF OPERATIONS
Revenues
Total revenues for the three and nine months ended September 26, 1998 were
$2.5 million and $11.2 million, respectively, compared to $5.3 million and $27.6
million in the corresponding periods of the prior year. The decreases were
primarily due to the decline in Toy Story-related revenue, although each of the
other categories of year to date revenues also declined.
Software revenues consist mainly of software license revenues, principally
from RenderMan. Software revenues increased 34% to $1.2 million for the quarter
ended September 26, 1998 from $908,000 in the corresponding prior year period
and decreased 19% to $2.7 million in the nine months ended September 26, 1998
from $3.4 million in the corresponding prior year period. The decrease in
software revenues for the nine months ended September 26, 1998 resulted from
decreases in the number of RenderMan software licenses. Pixar expects ongoing
variability in revenues derived from software licenses and that such revenue may
continue to decline. All historical and future royalty income associated with
Pixar's discontinued CD-ROM division has been and will continue to be excluded
from software revenues and presented in results of discontinued operations. See
"Results of Discontinued Operations."
Animation services revenues of $171,000 for the nine months ended September
26, 1998 represented revenue recognized in the first quarter of 1998 from a
short project related to Toy Story. As was the case in the quarters ended June
27, 1998 and September 26, 1998, it is likely that in the fourth quarter of 1998
Pixar will generate little or no animation services revenues since Pixar had
transferred substantially all of its animation services employees to assist in
the completion of A Bug's Life. More generally, Pixar expects that animation
services revenues will vary significantly from period to period due to the
sporadic nature of this business and the need to utilize animation services
employees on other productions or projects. There can be no assurance that Pixar
will generate any animation services revenues during periods in which its
animation services employees are devoted to feature films or other projects,
such as was the case for the second and third quarters of 1998, and may be the
case thereafter.
Film revenues for the quarter ended September 26, 1998 were $1.3 million
compared with $3.5 million in the corresponding prior year period. Film revenues
for the nine months ended September 26, 1998 were
9
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$8.2 million compared with $21.4 million in the corresponding prior year period.
Film revenues for the nine months ended September 26, 1998 represent Pixar's
share of Toy Story-related merchandising royalties, the ABC and Disney Channel
television airings of Toy Story, and Toy Story home video revenue. Since Pixar
has already recognized the vast majority of the revenue it expects to receive
from Toy Story and related products, and since Pixar's next feature film, A
Bug's Life, while targeted for release on November 25, 1998, is not expected to
generate revenues for Pixar until the second half of 1999 at the earliest, Pixar
expects that revenue will continue to decline in the last quarter of 1998 as
compared to the corresponding period in 1997. Therefore, Pixar expects to incur
operating and net losses in the remainder of 1998 and in the first half of 1999.
Patent licensing revenues of $120,000 for the nine months ended September
26, 1998 were attributable to a patent license with Silicon Graphics, Inc.
("SGI"), whereby Pixar granted to SGI and its subsidiaries a non-exclusive
license to use certain of Pixar's patents covering techniques for creating
computer-generated photorealistic images. Under the agreement, SGI agreed to pay
Pixar total compensation of $11.0 million, of which $6.0 million was paid in
cash in March 1996 and $5.0 million was to be paid in the form of purchase
credits for SGI hardware and software. Recognition of the $5.0 million in
credits depended upon purchases of the hardware and software to be obtained from
SGI in lieu of payment. In the nine months ended September 30, 1997 and
September 26, 1998, revenue of $1.6 million and $120,000, respectively, was
recognized, representing credits used during those periods. Pixar has used
substantially all of the $5.0 million worth of credits and the small amount of
remaining credits are expected to be used in the remainder of 1998. Pixar does
not expect that further patent licensing revenues will be generated.
For the three and nine months ended September 26, 1998, Disney accounted
for 70% and 79%, respectively, of Pixar's total revenues. The revenues from
Disney consisted primarily of film, software and animation services revenues.
Substantially all of the revenue derived from Disney for the quarter ended
September 26, 1998 was included in trade and other accounts receivable and
combined with other receivables from Disney represented 48% of the balance at
September 26, 1998. For the three and nine months ended September 30, 1997,
Disney accounted for 80% and 82%, respectively, of Pixar's total revenues,
primarily from film and software revenues.
Cost of Revenues
Cost of software revenues consist of the direct costs and manufacturing
overhead required to reproduce and package software products as well as
amortization of purchased technology. Cost of software revenues include no
amortization of internal software development expenses since no such expenses
have been capitalized. Cost of software revenues as a percentage of the related
revenues increased to 25% and 16% for the three and nine months ended September
26, 1998, respectively, from 3% and 1%, respectively, in the three and nine
months corresponding prior year periods, due primarily to the amortization of
purchased technology associated with the acquisition of Physical Effects, Inc.
("PEI"). Approximately $2.7 million of the PEI purchase price was assigned to
purchased technology, which PEI has licensed to a third party. Over a period not
to exceed three years, Pixar will amortize the purchased technology against
related license revenues, thereby essentially eliminating any gross margins with
respect to license revenues associated with this purchased technology until such
amortization has been completed. As a result of the ongoing amortization of this
purchased technology, it is likely that Pixar's total software gross margins
will be substantially lower during the next several years. In addition, if Pixar
determines that the license revenue generated by the purchased technology will
be lower than expected and that all or part of the purchased technology asset
may not be recoverable, Pixar would, at that point, be required to write off all
or a significant portion of the unamortized purchased technology.
Costs of animation services revenues consist of production costs, which
include salaries, benefits, facility expenses and department overhead costs.
Costs of animation services revenues as a percentage of the related revenues
were 22% for the nine months ended September 26, 1998 compared to 61% for the
nine months ended September 30, 1997, due to the lower negotiated profit margins
on animation services projects completed in the nine months ended September 30,
1997. Because there were no animation services revenues in the quarter ended
September 26, 1998, there were no associated costs.
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Costs of film revenues represent amortization of film costs capitalized by
Pixar. See "Capitalized Film Production Costs." Due to higher than expected Toy
Story film revenues, which resulted in Pixar's amortizing all Toy Story related
film costs by December 31, 1997, there were no costs of revenues associated with
film revenues for the three and nine months ended September 26, 1998. Any
further Toy Story film-related revenues will have no associated costs of
revenues. Costs of film revenues as a percentage of the related revenues were 7%
for the nine months ended September 30, 1997.
Under the Feature Film Agreement all payments to Pixar from Disney for
Pixar's efforts in the development and production of feature films were recorded
as cost reimbursements and were netted against the related costs. In addition,
since Pixar's share of production costs under the terms of the Co-Production
Agreement are capitalized, amortized film production costs for future feature
films will be significantly higher, and gross profit margins on future film
projects, if any, will be substantially lower than those achieved on Toy Story.
There are no costs of revenues associated with patent licensing revenues.
Operating Expenses
Total operating expenses for the three and nine months ended September 26,
1998 were higher than in the same period in the prior year, and Pixar intends to
continue to increase its spending levels in a number of areas. First, as a
result of competition for technical and certain administrative personnel, Pixar
has had to pay higher salaries to attract new technical and administrative
personnel. Pixar expects compensation for such personnel to continue to
increase. In the three and nine months ended September 26, 1998, Pixar expanded
its administrative staff, increased systems and facilities costs and expanded
other operations. Pixar expects continued growth in operating expenses in these
areas. Included in the three and nine months ended September 30, 1997 was a $2.2
million one-time adjustment reducing Pixar's operating expenses. This reduction
was due to an additional reimbursement from Disney under the Co-Production
Agreement. Since the Co-Production Agreement began with A Bug's Life and Toy
Story 2, both in production in 1996, Pixar was entitled to reimbursement for
Disney's share of certain of Pixar's operating expenses incurred in 1996 and in
the first two months of 1997, prior to signing the agreement. The determination
of this one-time operating expense reimbursement was finalized in the quarter
ended September 30, 1997.
Under the Co-Production Agreement, Disney reimburses Pixar for its share of
certain general and administrative costs and certain research and development
costs that benefit the productions. The funding from Disney is treated as
operating expense reimbursements. In addition, because Disney is responsible for
paying all film marketing costs under the Co-Production Agreement, if Pixar
incurs film marketing costs, Disney is responsible for reimbursing Pixar for
such costs. To the extent that spending in any of these areas is not capitalized
by Pixar nor paid for by Disney under the Co-Production Agreement, and precedes
or is not subsequently followed by an increase in revenues, Pixar's business,
operating results and financial condition will be materially adversely affected.
Research and development expenses consist primarily of salaries and support
for personnel conducting research and development for the RenderMan product, for
Pixar's proprietary Marionette and Ringmaster software and for certain other
unreimbursed projects. Research and development expenses decreased 23% to
$928,000 in the three months ended September 26, 1998 from $1.2 million in the
corresponding prior year period, and decreased 26% to $2.7 million in the nine
months ended September 26, 1998 from $3.7 million in the corresponding prior
year period. The decreases were due to the completion of a significant research
and development project, a short film entitled Geri's Game, in the last quarter
of 1997, coupled with the reassignment in the current year of certain research
and development employees to temporarily work on film productions. Pixar expects
increased research and development spending in future quarters. To date, all
internal software development costs not reimbursed by Disney have been expensed
as incurred.
Sales and marketing expenses consist primarily of salaries and related
overhead, as well as advertising, technical support, public relations and trade
show costs required to support the software segment and complement the film
segment. Sales and marketing expenses decreased 26% to $311,000 in the three
months ended September 26, 1998 from $422,000 in the corresponding prior year
period and decreased 6% to
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$963,000 in the nine months ended September 26, 1998 from $1.0 million in the
corresponding prior year period. These decreases are the result of increased
spending for film-specific marketing expenses which are reimbursed by Disney
under the Co-Production Agreement, as more time and attention are devoted to the
release of A Bug's Life on November 25, 1998. Pixar expects that sales and
marketing spending will increase in future periods because corporate marketing
and public relations expenses, net of reimbursements, may continue to increase
in absolute dollars in future periods.
General and administrative expenses consist primarily of salaries of
management and administrative personnel, insurance costs and professional fees.
General and administrative expenses increased 42% to $1.7 million in the three
months ended September 26, 1998 from $1.2 million in the corresponding prior
year period and increased 52% to $5.3 million in the nine months ended September
26, 1998 from $3.5 million in the corresponding prior year period. The increases
were primarily due to a general increase in staffing and public company costs,
such as payroll taxes from the exercise of stock options. Growth in these costs
is partially offset by the recovery of certain general and administrative costs
reimbursed by Disney under the Co-Production Agreement. Pixar expects general
and administrative expenses to continue to increase in absolute dollars in
future periods as Pixar incurs additional costs to expand its administrative
staff and facilities.
Other Income, Net
Other income, net consists primarily of interest income on Pixar's
short-term investments. Other income, net was $1.9 million and $6.5 million in
the three and nine months ended September 26, 1998, respectively, and $2.4
million and $6.5 million in the three and nine months ended September 30, 1997,
respectively.
Income Taxes
Income tax expense from continuing operations for the three and nine months
ended September 26, 1998 reflects Pixar's federal and state income tax liability
after utilization of remaining net operating loss carryforwards and federal and
state tax credits. Income taxes decreased for the three and nine months ended
September 26, 1998 as a result of the benefit of certain tax deductions
occurring in 1998 coupled with Pixar's projected lower earnings for fiscal 1998.
Results of Discontinued Operations
After the Co-Production Agreement was executed in February 1997, Pixar
determined that the resources devoted to its interactive products division would
be better allocated to other projects arising from the Co-Production Agreement.
Therefore, Pixar determined in March 1997 to discontinue its business of
producing CD-ROM and other interactive products and to redirect the employees
that were in that division to feature film productions and related projects
within Pixar.
The discontinued CD-ROM division recorded a gain of $36,000, net of income
taxes, for the nine months ended September 30, 1997. For the nine months ended
September 26, 1998, Pixar recorded income from discontinued operations of
$374,000, net of income taxes, due to royalty income received for the Toy Story
CD-ROM products. Pixar anticipates that future royalty income, if any, will
exceed costs to be incurred in all future periods, but that such amounts, if
any, will not be significant.
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FACTORS AFFECTING OPERATING RESULTS AND FINANCIAL CONDITION
The following is a discussion of certain factors which currently impact or
may impact Pixar's business, operating results and/or financial condition.
Anyone making an investment decision with respect to Pixar's capital stock or
other securities is cautioned to carefully consider these factors, along with
the factors discussed in Pixar's Form 10-K under the section entitled "Certain
Factors Affecting Business, Operating Results and Financial Condition."
Declining Revenues and Anticipated Net Losses in the Remainder of 1998 and the
First Half of 1999
A number of factors are expected to result in declining revenues and net
losses in the remainder of 1998 and in the first half of 1999, as discussed more
fully below.
End of Toy Story Revenues. Pixar has already recognized the vast majority
of the revenue it expects to receive from Toy Story, Pixar's first computer
animated feature film. While relatively minor amounts of revenue may be received
by Pixar in subsequent periods, Pixar does not expect to recognize any
significant revenue from Toy Story in the future.
Timing of A Bug's Life and Toy Story 2 Releases. A Bug's Life, Pixar's
second computer animated feature film, is targeted for release on November 25,
1998, and revenue attributable to A Bug's Life is not expected to be recognized
until marketing and distribution costs and fees have been recovered by Disney.
Recovery of such costs depends on many factors and may not occur until six to
twelve months after its release at the earliest, making it likely that Pixar
will not recognize any revenue from A Bug's Life until the second half of 1999
at the earliest. In addition, the theatrical motion picture sequel to Toy Story,
Toy Story 2, is not expected to be released until the end of 1999 at the
earliest. As with A Bug's Life, Pixar does not expect to recognize any revenue
from Toy Story 2 until six to twelve months after its release at the earliest.
Therefore, Pixar is unlikely to recognize any revenue from Toy Story 2 until the
second half of 2000 at the earliest.
Limited CD-ROM Income. Pixar determined in March 1997 to discontinue its
business of producing CD-ROM and other interactive products in favor of other
opportunities arising, in part, as a result of entering into the Co-Production
Agreement. Pixar has not recognized and will not recognize any CD-ROM income
from this discontinued operation in 1998 or thereafter, other than royalty
income attributable to the two existing Toy Story CD-ROM products. Pixar
redirected all of the CD-ROM division employees to feature film productions and
other departments within Pixar.
Increase in Operating Expenses and Effective Tax Rate. Since Pixar's
initial public offering, Pixar significantly increased its operating expenses,
and Pixar plans to continue to increase its operating expenses to fund greater
levels of research and development and to expand operations. Specifically, Pixar
expects its spending levels to increase significantly due to continued
investment in proprietary software systems, increased compensation costs as a
result of competition for animators, creative personnel, technical directors and
other personnel, and increased costs associated with the expansion of its
facilities. A portion of Pixar's operating expenses that are allocable to film
productions are capitalized by Pixar or reimbursed by Disney under the Co-
Production Agreement. To the extent that the increases in expenses are not
capitalized by Pixar nor paid for by Disney, Pixar's operating expenses will
significantly increase in the remainder of 1998 and thereafter. Finally, Pixar's
effective tax rate increased in the year ended December 31, 1997, and although
it may decrease slightly in 1998, it is likely to increase in future years due
to previous utilization of remaining net operating loss carryforwards in 1997.
Impact on Operating Results. As a result of the above factors, Pixar
expects revenue to continue to substantially decline in 1998 as compared to
1997. At the same time, Pixar's operating expenses have increased and are
expected to continue to increase in 1998. Therefore, Pixar expects operating
results in 1998 to continue to decline substantially from operating results in
1997. Pixar expects to incur operating and net losses in the remainder of 1998
and in the first half of 1999. Operating results thereafter will depend upon the
success of Pixar's next films, starting with the planned release of A Bug's Life
on November 25, 1998.
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Dependence on Toy Story, A Bug's Life and Toy Story 2
Dependence on Toy Story. For at least the remainder of 1998 and the first
half of 1999, Pixar's revenue and operating results will again be largely
dependent upon whatever remains to be received from Toy Story, such as possible
further merchandise royalties. Pixar recognized the vast majority of Toy Story
home video revenue in 1997 and expects little revenue from Toy Story or related
products in the remainder of 1998 and thereafter. Pixar also expects little or
no royalty income from its Toy Story CD-ROM products for the remainder of 1998
or thereafter. Because A Bug's Life is targeted for release on November 25,
1998, and Toy Story 2 is not expected to be released until the end of 1999 at
the earliest, any other revenues in the remainder of 1998 and in the first half
of 1999 will be primarily dependent upon Pixar's other businesses, from which
Pixar expects limited revenue.
Dependence on A Bug's Life and Toy Story 2. Beyond 1998 and the first half
of 1999, Pixar expects to be significantly dependent upon the success of A Bug's
Life, Toy Story 2, Film Four (Toy Story 2 and Film Four are the "Current
Projects") and related products. A Bug's Life has been completed and is
currently scheduled for release on November 25, 1998. Although development
and/or production on each of the Current Projects is underway, there can be no
assurance that any of the Current Projects will be successfully produced and
released when scheduled or thereafter. There can be no assurance that Pixar will
not experience difficulties that could delay or prevent the successful
development or production of any of the Current Projects or subsequent animated
feature films or related products. If Pixar is unable to produce and develop on
a timely basis the Current Projects and subsequent animated feature films and
related products that meet with broad market acceptance, Pixar's business,
operating results and financial condition will be materially adversely affected.
The development of Film Four began in late 1996. Although it is currently
targeted for release in late 2000, and there has been approval of the story
treatment, there has been no final approval under the Co-Production Agreement of
the budget for Film Four and there can be no assurance that it will be released
as targeted in late 2000. Film Four is not expected to be released until the end
of 2000 at the earliest; however, given the creative and production
uncertainties at this stage of the production of Film Four, there can be no
assurance that Film Four will be developed in time for release even by late
2000. As a result, for the next two or three years, Pixar will be significantly
dependent upon A Bug's Life and Toy Story 2.
Risks Associated with A Bug's Life. Under the Co-Production Agreement,
Pixar equally shares the production costs of A Bug's Life with Disney, which are
expected to be more than twice the production costs of Toy Story. Most of these
costs have been capitalized as film production costs under SFAS No. 53 and will
be amortized over the expected revenue stream beginning when revenue is
recognized. In addition, under the Co-Production Agreement, Disney determines
and finances the costs and expenses of promoting, marketing and distributing A
Bug's Life. Such costs are likely to be very significant and will be recovered
by Disney before any revenues are recognized by Pixar. If A Bug's Life is not an
extraordinary box office success, the amount of revenue recognized by Pixar will
not be significant, and Pixar's capitalized production costs will have to be
amortized in large amounts over a limited number of quarters, resulting in
significant costs of film revenue in those quarters and, potentially,
significant quarterly operating and net losses. Animated feature films that
become extraordinary box office successes are rare. Pixar believes, based on
available information, that there is a reasonable basis to conclude that of the
more than 40 animated feature films introduced since 1990, only two movies
generated domestic box office revenues greater than Toy Story, and both of those
films were produced and distributed solely by Disney. During at least the last
five years, Pixar believes that there has been no fully-animated feature film
(other than Toy Story) produced or developed by a studio other than Disney that
has achieved more than $80 million in domestic box office revenues. While A
Bug's Life will be co-financed, promoted and marketed by Disney, it will have a
different look, theme and musical style than Disney's other recent animated
films (except for Toy Story), and there can be no assurance that it will have
the same audience appeal as Disney's other animated films. In addition, A Bug's
Life will face significant competition when it is released. DreamWorks SKG
("DreamWorks") (which is expressly targeting the animated film market) recently
released Antz, a co-production with Pacific Data Images ("PDI"), a computer
animation firm in which DreamWorks owns a significant equity stake. Antz is a
computer animated feature film which, like A Bug's Life, features ants as
characters. Through November 1, 1998, Antz had
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achieved approximately $68 million in domestic box office revenues and is still
showing in theaters. Paramount Pictures' ("Paramount") Rugrats, The Movie and
DreamWorks' Prince of Egypt are animated feature films which will be released
around the same time as A Bug's Life as will other family films such as
Universal City Studios' ("Universal") Babe -- Pig in the City, which is also
scheduled for release on November 25, 1998. As a result of these and other
factors, A Bug's Life and related products may not generate significant revenue
and operating results for Pixar, even if A Bug's Life is critically acclaimed
and achieves substantial, but not extraordinary, box office success.
Risks Associated with Toy Story 2. As a theatrical feature film release,
Toy Story 2 is subject to the same risks associated with A Bug's Life specified
above. In addition, because it is a sequel, there are also risks unique to Toy
Story 2. In the vast majority of cases in which a film that achieved domestic
box office receipts of greater than $100 million was followed by the release of
a sequel, the sequel did not perform as well at the box office as the original.
In many cases, sequels substantially under-perform the original film. Only a few
sequels have performed as well or better than the original blockbuster feature
film, and in almost all of these cases, the original feature films and related
sequels were action-adventure films, such as Lethal Weapon and Die Hard.
Furthermore, theatrical sequels to animated feature films are very rare, making
it more difficult to predict their success. Accordingly, there can be no
assurance that Toy Story 2 will perform as well as Toy Story at the box office.
In addition, fees and participations paid to key talent on Toy Story 2 are
substantially greater than for the original film, which together with other
increases in production costs will have the effect of substantially increasing
the cost of the film when compared to Toy Story.
As a result of these factors and the same factors associated with A Bug's
Life, Toy Story 2 and related products may not generate significant revenue and
operating results for Pixar, even if Toy Story 2 is critically acclaimed and
achieves substantial, but not extraordinary, box office success.
Production Budgets. Given the escalation in compensation rates of people
required to work on the Current Projects, the number of people required to work
on the Current Projects, and the equipment needs, the budget for the Current
Projects and subsequent films and related products are and will continue to be
substantially greater than the budget for Toy Story and will be financed equally
by Pixar and Disney under the Co-Production Agreement. For example, the
production budget of A Bug's Life is more than twice the production costs of Toy
Story. In addition, due to production exigencies which are often difficult to
predict, Pixar believes that it is common for film production spending to exceed
film production budgets, and there can be no assurance that any of the Current
Projects can be completed within the budgeted amounts.
Scheduled Successive Release of Films; Management of Growth
In order to meet its obligations pursuant to the Co-Production Agreement,
Pixar has established parallel creative teams so that it can develop more than
one film at a time. These teams were working on A Bug's Life, Toy Story 2 and
Film Four, which are currently targeted for release on November 25, 1998, late
1999, and late 2000 at the earliest, respectively. Pixar has only produced one
prior feature film to date and has no previous experience with respect to
producing three animated feature films in parallel. Pixar has been required, and
may continue to be required, to expand its employee base, increase capital
expenditures and procure additional resources and facilities in order to
accomplish the scheduled release of these three feature films. This period of
rapid growth and expansion has placed, and continues to place, a significant
strain on Pixar's resources. There can be no assurance that Toy Story 2 or Film
Four will be released as scheduled or that this strain on resources will not
have a material adverse effect on Pixar's business, financial condition or
results of operations. For example, to meet the production schedule and the
targeted completion date of A Bug's Life, substantially all employees from
Pixar's animation services group and a significant number of employees from
other projects, including Toy Story 2, were assigned to A Bug's Life. Pixar may
need to take similar actions for Toy Story 2 and subsequent films. In addition,
when production of each of these films is completed, if completed, Pixar may
incur significant carrying costs associated with transitioning personnel on
creative and development teams from one project to another which, although
shared with Disney, could have a material adverse effect on film production
budgets and Pixar's results of operations and financial condition.
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Although there can be no assurance that Toy Story 2 or Film Four will be
released on schedule, the targeted release date of late 2000 for Film Four is
particularly uncertain. Pursuant to the Co-Production Agreement, Disney and
Pixar are required to agree on a number of elements for each film, including the
treatment, which summarizes the story on which the film is based, and the budget
for the film. Film Four has been in development at Pixar since late 1996, and
although there has recently been agreement between Pixar and Disney on the story
treatment, there has not been final approval on the budget for Film Four, and
there can be no assurance that the budget will be approved in time to release
the film by late 2000 or at all. If Disney and Pixar do not reach final
agreement on the budget for Film Four currently under development at Pixar,
Pixar would be unable to develop an alternative film in time for release in
2000, and it may be 2001 or later before a film which follows Toy Story 2 is
ready to be released. In addition, if the story currently under development for
Film Four is canceled because Pixar and Disney are unable to reach final
agreement on the budget, Pixar could be required to write-off certain related
story development costs previously capitalized. If such event occurs in 1998,
then all or a portion of these costs would be written off in 1998. Furthermore,
even if Pixar and Disney reach final agreement on the budget for Film Four,
given creative and production uncertainties at this stage of the production of
Film Four, there can be no assurance that Film Four will be developed in time
for release in late 2000.
If Pixar is able to release films in each of 1998, 1999 and 2000, due to
the strain on Pixar's personnel from the effort required for such successive
releases and the time required for creative development of a new film, Pixar
almost certainly would be unable to release a new film in 2001 and would most
likely not attempt to do so. Instead, Pixar's creative and production personnel
would develop films targeted for release in 2002 and for subsequent years,
although it is too early to determine the release schedule or whether it would
be possible to release one film in successive years after 2001. As a result,
notwithstanding the targeted successive release of films in 1998, 1999 and 2000,
it is too early to determine the rate at which any future films may be released,
and there can be no assurance that Pixar will release a film in successive years
or in any particular year.
Competition From Movie Studios
Pixar's animated feature films compete and will continue to compete with
feature films and other family oriented entertainment products produced by major
movie studios, including Disney (as somewhat limited by the Co-Production
Agreement), DreamWorks (which is expressly targeting the animated film market),
Warner Bros. Inc., Twentieth Century Fox Film Corporation ("Twentieth Century
Fox"), Paramount, Columbia/Tri-Star Pictures Inc., Lucasfilm Ltd. ("Lucasfilm"),
Universal and MGM/UA, as well as numerous other independent motion picture
production companies. Competition has greatly intensified in the animated
feature film market from these and other movie studios. Animated feature films
released in 1997 included Anastasia by Twentieth Century Fox and Beavis and
Butt-head Do America by United International Pictures with Paramount, each
achieving domestic box office receipts between $55 million and $65 million.
DreamWorks owns a significant equity stake in PDI, a computer animation firm,
and in conjunction with PDI produced Antz, a computer animated feature film
which, like A Bug's Life, features ants as characters. Antz was released in
October 1998 (approximately eight weeks before the scheduled release of A Bug's
Life) and through November 1, 1998, had achieved approximately $68 million in
domestic box office revenues and is still showing in theaters. Pixar expects a
variety of additional animated feature films to be released in the theaters in
the next two years generating competition for A Bug's Life and Toy Story 2,
which are targeted for release on November 25, 1998 and late 1999, respectively.
These films include Paramount's Rugrats, The Movie and DreamWorks' The Prince of
Egypt, which are each scheduled to be released in late 1998 and will compete
with A Bug's Life. Pixar is also aware of several other animated feature films
in production at various studios. Due to the large number of expected releases
in late 1998 and over the next two years, it is possible that the market for
animated films will become saturated before Pixar can release A Bug's Life and
other feature films, which could result in failure of such films to achieve
commercial success. In addition, other non-animated family oriented feature
films are expected to be released in late 1998 and will generate additional
competition for A Bug's Life. Such feature films include Babe: Pig in the City,
The Wizard of Oz, Air Bud 2: Golden Receiver, Star Trek 9, and Disney's Mighty
Joe Young, among others.
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Pixar's films will compete with the feature films of other movie studios
for optimal release dates, audience acceptance and exhibition outlets. In
addition, Pixar competes and will continue to compete with other movie studios
for the acquisition of literary properties, production financing, the services
of performing artists, and the services of other creative and technical
personnel, particularly in the fields of animation and technical direction. Most
of the other movie studios with which Pixar competes have significantly greater
name recognition and significantly greater financial, technical, creative,
marketing and other resources than Pixar.
At least three of these movie studios, Disney, DreamWorks (with PDI) and
Lucasfilm (through its affiliate Industrial Light and Magic ("ILM")), have
developed their own internal computer animation capability which may be used for
computer animated feature films. For example, DreamWorks (with PDI) produced
Antz, and Pixar believes they are working on a second computer animated feature
film. In addition, Disney is currently developing and producing a feature film
making substantial use of computer animation. Other movie studios may internally
develop, license or sub-contract three-dimensional animation capability.
Further, Pixar believes that continuing enhancements in commercially available
computer hardware and software technology have lowered and will continue to
lower barriers to entry for studios or special effects companies which intend to
produce computer animated feature films or other products. For example, Silicon
Graphics Inc.'s Alias/Wavefront subsidiary has recently launched "Maya," its
next generation three-D software for creating high quality animation and visual
effects. Maya incorporates many new features and could be used to make a
computer animated feature film.
The Co-Production Agreement provides for the development and production by
Pixar of five original computer animated feature films. Because Disney
co-finances the films developed and produced under the Co-Production Agreement,
distributes the films under the "Walt Disney Pictures" label and enjoys
financial benefits in the event that such films achieve significant box office
revenues, Pixar believes that Disney desires such films to be successful.
Nonetheless, Disney has been by far the most successful producer of animated
feature films, and family oriented motion pictures distributed by Disney or its
affiliates are likely to be in the market concurrently with and competing with
Pixar's animated feature films.
Divided Responsibilities of Chief Executive Officer
Pixar's Chief Executive Officer and Chairman, Steven P. Jobs, is also
acting as interim Chief Executive Officer at Apple Computer, Inc. ("Apple")
until such time as a new Chief Executive Officer is identified and named at
Apple. Although Mr. Jobs spends time at Pixar and is active in Pixar's
management, he does not devote his full time and resources to Pixar. For day to
day operations, since 1995, Pixar has established an Office of the President
which is comprised of Mr. Jobs as Chief Executive Officer, Edwin E. Catmull as
Executive Vice President and Chief Technical Officer and Lawrence B. Levy as
Executive Vice President and Chief Financial Officer.
Liquidity Risks
Pursuant to the Co-Production Agreement, Pixar will co-finance the next
five animated feature films which it produces, including A Bug's Life and Film
Four. Pixar will also co-finance Toy Story 2 on the same basis as the other
theatrical films. In the future, Pixar may co-finance other derivative works
such as sequels, interactive products and television productions. In addition,
Pixar began construction of a new headquarters and studio facility in
Emeryville, California on July 29, 1998 which may be financed by the use of
Pixar's cash. As Pixar does not expect to generate substantial, if any, cash
from operations in 1998, the production costs of A Bug's Life, Film Four and Toy
Story 2 and the costs of the new Emeryville facility have had and will continue
to have a material adverse impact on Pixar's cash and short-term investment
balances. As of September 26, 1998, Pixar had approximately $153.2 million in
cash and short-term investments. Pixar believes that these funds will be
sufficient to meet its anticipated cash needs for working capital and capital
expenditures, including the development and production costs of A Bug's Life,
Film Four and Toy Story 2, until Pixar begins receiving cash from the release of
these films (which is generally not expected to occur until the second half of
1999 at the earliest). However, even if these films generate cash, unless each
is a success such that Pixar recovers on a timely basis its share of the
production costs, as well as other operating expenses and capital expenditures,
Pixar will be required to seek financing for its ongoing commitments under the
Co-
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Production Agreement and any other requirements of its operations. Pixar may
also seek additional financing in connection with the expansion of its
facilities. See also "-- Liquidity and Capital Resources." The sale of
additional equity or convertible debt securities would result in additional
dilution to Pixar's shareholders. Moreover, there can be no assurance that Pixar
will be successful in obtaining future financing, or even if such financing is
available, that it will be obtained on terms favorable to Pixar or on terms
providing Pixar with sufficient funds to meet its obligations and objectives.
The failure to obtain such financing would have a material adverse effect on
Pixar's business, operating results and financial condition.
Capitalized Film Production Costs
As of December 31, 1997, all capitalized film costs related to Toy Story
had been amortized. Pixar had $52.4 million in capitalized film production costs
as of September 26, 1998, consisting primarily of costs related to A Bug's Life,
Toy Story 2 and Film Four, all of which are being co-financed by Disney under
the Co-Production Agreement.
Year 2000 Compliance
The year 2000 problem is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs that have time-sensitive software may, for example, recognize a date
using "00" as the year 1900 rather than the year 2000. This could result in a
major system failure or miscalculations. Pixar is currently reviewing its
products, its internal computer systems and systems of third parties on which
Pixar relies for handling the year 2000. Based on information available to date,
Pixar believes that it will be able to complete its year 2000 compliance review
and make any necessary modifications to its products and internal systems prior
to the end of 1999. Pixar further believes that such review and modification
will not require Pixar to incur any material charge to operating expenses over
the next several years. Pixar is also seeking confirmation from third parties
that their systems are year 2000 compliant or plans are being developed to
address the year 2000 problem. However, there can be no assurance that such
third-party systems will be year 2000 compliant or that the failure of such
systems to be year 2000 compliant would not have a material adverse effect on
Pixar's financial position or results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash and short-term investments decreased $22.8 million to $153.2 million
at September 26, 1998 from $176.0 million at December 31, 1997. Working capital
decreased $19.1 million to $147.9 million at September 26, 1998 from $167.0
million at December 31, 1997.
Net cash provided by continuing operations for the nine months ended
September 26, 1998 was primarily attributable to net income of $6.7 million and
the non-cash impact of depreciation and amortization expense of $4.3 million
offset by net decreases in accrued and other liabilities of $3.8 million. Cash
flows used in investing activities were due primarily to net investments in
short-term securities of $61.6 million, the purchase of property and equipment
of $8.8 million and funding of film production costs of $23.8 million. Cash
flows provided by financing activities were due to proceeds from the exercise of
stock options.
As of September 26, 1998, Pixar's principal source of liquidity was
approximately $153.2 million in cash and short-term investments. Pixar believes
that these funds will be sufficient to meet the Company's operating requirements
through the next twelve months. Thereafter, if cash generated by operations is
insufficient to satisfy Pixar's liquidity requirements, Pixar may be required to
sell additional equity or debt securities or obtain credit facilities. The sale
of additional equity or convertible debt securities would result in additional
dilution to Pixar's shareholders. There can be no assurance that financing will
be available to Pixar in an amount and on terms acceptable to Pixar. See
"Factors Affecting Operating Results and Financial Condition -- Liquidity
Risks."
18
<PAGE> 19
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) The effective date of the Company's first registration statement, filed
on Form S-1 under the 1933 Act (No. 33-97918), was November 28, 1995 (the
"Registration Statement"). The class of securities registered was Common Stock.
The offering commenced on November 29, 1995 and all securities were sold in the
offering. The managing underwriters for the offering were Robertson, Stephens &
Company, L.P., Hambrecht & Quist LLC and Cowen & Company.
A total of 6,900,000 shares were registered pursuant to the Registration
Statement, all of which the Company sold for its own account, for an aggregate
offering price of $151,800,000.
The Company incurred expenses of approximately $12,138,714, of which
$10,246,500 represented underwriting discounts and commissions and $1,892,214
represented other expenses. All such expenses were direct or indirect payments
to others. The net offering proceeds to the Company after total expenses were
$139,661,286.
As of September 26, 1998, the Company had used the net proceeds from the
offering as follows: $16,869,491 for construction of plant, building and
facilities, $12,122,717 for the purchase and installation of machinery and
equipment, $2,374,000 for the repayment of indebtedness, $69,786,014 for the
development of future films and other animated products, $11,845,925 for working
capital and $26,663,139 remaining in temporary investments. Of these amounts,
$2,374,000 represented direct or indirect payments to directors, officers,
general partners of the Company or their associates; to persons owning ten (10)
percent or more of any class of equity securities of the Company; or to
affiliates of the Company. The use of the proceeds from the offering does not
represent a material change in the use of proceeds described in the prospectus.
ITEM 5. OTHER INFORMATION
The Securities and Exchange Commission recently amended Rule 14a-4(c)(1)
promulgated under the Securities Exchange Act of 1934, as amended. As amended,
Rule 14a-4(c)(1) provides that a proxy may confer discretionary authority to
vote on a matter for an annual meeting of shareholders if the Company did not
have notice of such matter at least 45 days prior to the month and day of
mailing of the prior year's proxy statement. The proxy statement for the
Company's 1998 Annual Meeting of Shareholders was mailed to shareholders on May
15, 1998. Accordingly, if a proponent does not notify the Company on or before
March 31, 1999 of a proposal for the 1999 Annual Meeting of Shareholders,
management may use its discretionary voting authority to vote on a proposal,
even if the matter is not discussed in the proxy statement for the 1999 Annual
Meeting of Shareholders.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)EXHIBITS
27.1 Financial Data Schedule
(b)REPORTS ON FORM 8-K
No reports on Form 8-K were filed by Pixar during the quarter ended
September 26, 1998.
ITEMS 1, 3, AND 4 ARE NOT APPLICABLE AND HAVE BEEN OMITTED
19
<PAGE> 20
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/ LAWRENCE B. LEVY
------------------------------------
Lawrence B. Levy, Executive Vice
President
and Chief Financial Officer
(Principal Financial and Accounting
Officer
and Duly Authorized Officer)
Date: November 9, 1998
20
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
21
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-26-1998
<CASH> 16,974
<SECURITIES> 136,221
<RECEIVABLES> 4,555
<ALLOWANCES> 261
<INVENTORY> 0
<CURRENT-ASSETS> 158,318
<PP&E> 33,833
<DEPRECIATION> 8,048
<TOTAL-ASSETS> 239,833
<CURRENT-LIABILITIES> 10,389
<BONDS> 0
0
0
<COMMON> 215,652
<OTHER-SE> 13,792
<TOTAL-LIABILITY-AND-EQUITY> 239,833
<SALES> 0
<TOTAL-REVENUES> 11,239
<CGS> 0
<TOTAL-COSTS> 476
<OTHER-EXPENSES> 8,979
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 8,271
<INCOME-TAX> 1,903
<INCOME-CONTINUING> 6,368
<DISCONTINUED> 374
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,742
<EPS-PRIMARY> 0.15
<EPS-DILUTED> 0.13
</TABLE>
