<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 27, 1998.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number: 0-26976
PIXAR
(Exact name of registrant as specified in its charter)
California 68-0086179
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 West Cutting Boulevard, Richmond, California 94804
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (510) 236-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the registrant's Common Stock as of August
5, 1998 was 44,441,342.
<PAGE> 2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
JUNE 27, DECEMBER 31,
1998 1997
--------- ---------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 41,170 $ 101,847
Short-term investments 119,819 74,198
Trade and other accounts receivable, net 5,009 3,988
Prepaid expenses and other current assets 1,199 783
--------- ---------
Total current assets 167,197 180,816
Property and equipment, net 24,867 21,462
Capitalized film production costs, long-term 43,709 28,589
Other assets 3,104 201
--------- ---------
Total assets $ 238,877 $ 231,068
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,154 $ 1,694
Income taxes payable 1,734 1,776
Payable to Disney 1,562 2,162
Accrued liabilities 6,099 7,276
Unearned revenue 835 860
--------- ---------
Total current liabilities 11,384 13,768
--------- ---------
Commitments and contingencies
Shareholders' equity:
Preferred stock; no par value; 5,000,000 shares authorized
and no shares issued and outstanding -- --
Common stock; no par value; 100,000,000 shares authorized;
44,350,910 and 42,410,707 shares issued and outstanding
as of June 27, 1998 and December 31, 1997, respectively 215,083 210,902
Unrealized gain (loss) on investments (19) 29
Deferred compensation (229) (414)
Retained earnings 12,658 6,783
--------- ---------
Total shareholders' equity 227,493 217,300
--------- ---------
Total liabilities and shareholders' equity $ 238,877 $ 231,068
========= =========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
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<PAGE> 3
PIXAR
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
-------------------- --------------------
JUNE 27, JUNE 30, JUNE 27, JUNE 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Software $ 854 $ 1,060 $ 1,527 $ 2,478
Animation services -- 269 171 269
Film 2,912 11,596 6,948 17,897
Patent licensing 3 1,451 120 1,599
-------- -------- -------- --------
Total revenues 3,769 14,376 8,766 22,243
-------- -------- -------- --------
Cost of revenues:
Software 100 14 136 22
Animation services -- 174 38 174
Film -- 769 -- 1,327
-------- -------- -------- --------
Total cost of revenues 100 957 174 1,523
-------- -------- -------- --------
Gross profit 3,669 13,419 8,592 20,720
-------- -------- -------- --------
Operating expenses:
Research and development 946 1,427 1,812 2,508
Sales and marketing 434 353 652 605
General and administrative 1,780 1,026 3,546 2,253
-------- -------- -------- --------
Total operating expenses 3,160 2,806 6,010 5,366
-------- -------- -------- --------
Income from continuing operations 509 10,613 2,582 15,354
Other income, net 2,162 1,912 4,562 4,046
-------- -------- -------- --------
Income from continuing operations before income taxes 2,671 12,525 7,144 19,400
Income tax expense 614 3,596 1,643 5,246
-------- -------- -------- --------
Net income from continuing operations 2,057 8,929 5,501 14,154
-------- -------- -------- --------
Income (loss) from discontinued operations, net of taxes
(See Note 5) -- -- 374 (77)
-------- -------- -------- --------
Net income $ 2,057 $ 8,929 $ 5,875 $ 14,077
======== ======== ======== ========
Basic net income per share from continuing operations $ 0.05 $ 0.22 $ 0.13 $ 0.35
Basic net income (loss) per share from discontinued operations -- -- 0.01 (0.00)
-------- -------- -------- --------
Basic net income per share $ 0.05 $ 0.22 $ 0.14 $ 0.35
======== ======== ======== ========
Shares used in computing basic net income per share 43,839 41,261 43,497 40,503
======== ======== ======== ========
Diluted net income per share from continuing operations $ 0.04 $ 0.19 $ 0.11 $ 0.30
Diluted net income (loss) per share from discontinued operations -- -- 0.01 (0.00)
-------- -------- -------- --------
Diluted net income per share $ 0.04 $ 0.19 $ 0.12 $ 0.30
======== ======== ======== ========
Shares used in computing diluted net income per share 51,432 48,020 50,948 47,553
======== ======== ======== ========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS
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<PAGE> 4
PIXAR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
----------------------------
JUNE 27, JUNE 30,
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,875 $ 14,077
Adjustments to reconcile net income to net cash
provided by continuing operating activities:
Discontinued operations (374) 77
Amortization of deferred compensation 185 365
Depreciation and amortization 2,567 887
Loss on disposition of property and equipment -- 423
Amortization of capitalized film production costs -- 1,327
Credits from patent licensing, net of expense items (114) (1,491)
Changes in operating assets and liabilities:
Trade and other accounts receivable (1,021) 1,312
Prepaid expenses and other current assets (302) 450
Accounts payable (540) 657
Income taxes payable (42) 4,826
Payable to Disney (600) 7,500
Accrued liabilities (1,277) 407
Unearned revenue (325) 259
--------- ---------
Net cash provided by continuing operations 4,032 31,076
Net cash provided by discontinued operations 374 1,095
--------- ---------
Net cash provided by operating activities 4,406 32,171
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (5,882) (11,690)
Proceeds from sale of short-term securities 79,943 56,422
Investments in short-term securities (125,612) (56,276)
Capitalized film production costs (15,120) (17,997)
Other assets 7 (74)
--------- ---------
Net cash used in investing activities (66,664) (29,615)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock and warrants, net -- 14,885
Proceeds from exercised stock options 1,581 506
--------- ---------
Net cash provided by financing activities 1,581 15,391
--------- ---------
Net increase (decrease) in cash and cash equivalents (60,677) 17,947
Cash and cash equivalents at beginning of period 101,847 44,648
--------- ---------
Cash and cash equivalents at end of period $ 41,170 $ 62,595
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 1,796 $ 280
========= =========
Supplemental disclosure of non-cash investing and financing activities:
Value of common stock issued and liabilities assumed for purchase
of PEI $ 3,000 $ --
========= =========
Credits from patent licensing $ 120 $ 1,599
========= =========
Non-cash film production costs capitalized $ -- $ 7,514
========= =========
Unrealized loss on investments $ (48) $ (9)
========= =========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
-4-
<PAGE> 5
PIXAR
NOTES TO FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission. In the
opinion of management, the accompanying unaudited financial statements reflect
all adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation of Pixar's financial condition, results of
operations and cash flows for the periods presented. These financial statements
should be read in conjunction with the audited financial statements as of
December 31, 1997 and 1996, and for each of the years in the three year period
ended December 31, 1997, including notes thereto, incorporated by reference into
Pixar's Annual Report on Form 10-K for the year ended December 31, 1997.
The results of operations for the three- and the six-month periods ended
June 27, 1998 are not necessarily indicative of the results expected for the
current year or any other period.
Certain amounts reported in previous periods have been reclassified to
conform to the 1998 financial statement presentation.
(2) FISCAL YEAR
Effective for fiscal year 1998, the Company adjusted its fiscal year end
from December 31 to the 52 or 53-week period that ends on the Saturday nearest
December 31. As a result, the second quarter of 1998 represents the
thirteen-week period ended June 27, 1998. The 1998 fiscal year will end on
January 2, 1999 and will consist of 53 weeks.
(3) EARNINGS PER SHARE CALCULATION
Basic net income per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted net income per share is
computed using the weighted-average number of common and dilutive common
equivalent shares outstanding during the period, using the treasury stock method
for options and warrants.
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<PAGE> 6
Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------
JUNE 27, 1998 JUNE 30, 1997
------------------------------------ -----------------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------- ------ ------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic net income per share $ 2,057 43,839 $ 0.05 $ 8,929 41,261 $ 0.22
Effect of dilutive shares:
Warrants/options -- 7,593 -- 6,759
------- ------ ------- ------
Diluted net income per share $ 2,057 51,432 $ 0.04 $ 8,929 48,020 $ 0.19
======= ====== ======= ======
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-------------------------------------------------------------------------------
JUNE 27, 1998 JUNE 30, 1997
------------------------------------ -----------------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------- ------ ------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Basic net income per share $ 5,875 43,497 $ 0.14 $14,077 40,503 $ 0.35
Effect of dilutive shares:
Warrants/options -- 7,451 -- 7,050
------- ------ ------- ------
Diluted net income per share $ 5,875 50,948 $ 0.12 $14,077 47,553 $ 0.30
======= ====== ======= ======
</TABLE>
(4) FEATURE FILM AND CO-PRODUCTION AGREEMENTS
FEATURE FILM AGREEMENT
In 1991, Pixar entered into a feature film agreement with Walt Disney
Pictures, a wholly owned subsidiary of The Walt Disney Company (together with
its subsidiaries and affiliates collectively referred to herein as "Disney") to
develop and produce up to three computer animated feature films (the "Feature
Film Agreement"). Under the Feature Film Agreement, Pixar is entitled to receive
compensation based on the revenue from the distribution of these films and
related products. In 1995, Pixar released its first feature film under the terms
of the Feature Film Agreement, Toy Story, and recognized related revenues of
$6.9 million and $17.9 million for the six months ended June 27, 1998 and June
30, 1997, respectively, for a total of $52.6 million since the film's release.
All production costs incurred by Pixar through 1995 were reimbursed by Disney on
a current basis and recorded by Pixar as cost reimbursements. Accordingly, these
reimbursements were not recorded as revenue.
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<PAGE> 7
CO-PRODUCTION AGREEMENT
In February 1997, Pixar and Disney entered into a new co-production
agreement (the "Co-Production Agreement") which now governs all films made by
Pixar since Toy Story. Films in development or production by Pixar as of June
27, 1998 include A Bug's Life, Toy Story 2, and Pixar's fourth film ("Film
Four"). Under the Co-Production Agreement, Pixar, on an exclusive basis, will
produce five original computer animated theatrical motion pictures (the
"Pictures") for distribution by Disney. A Bug's Life and Film Four count toward
the five Pictures, whereas Toy Story 2 is a derivative work that will not count
towards the five Pictures. However, Pixar and Disney have agreed that all
provisions of the Co-Production Agreement applicable to the Pictures will also
apply to Toy Story 2. Pixar and Disney will co-own, co-brand and co-finance the
production costs of the Pictures and will share equally in the profits of each
Picture and any related merchandise and other ancillary products, after recovery
of all Disney marketing, distribution and other predefined fees and costs. The
Co-Production Agreement generally provides that Pixar will produce each Picture
and Disney will control decisions relating to film and distribution.
(5) DISCONTINUED OPERATIONS
In 1996, Pixar entered into an agreement with Disney to develop and produce
interactive CD-ROM titles based on Toy Story. Pixar determined in March 1997 to
discontinue its business of producing CD-ROM and other interactive products and
reassigned all of the employees in this division to feature film productions and
other departments within Pixar. The CD-ROM division incurred a loss of $77,000,
net of income tax benefits, for the six months ended June 30, 1997. Pixar
recorded income from discontinued operations of $374,000, net of income taxes,
for the six months ended June 27, 1998, due to royalty income received from the
Toy Story CD-ROM products. Pixar anticipates that future royalty income, if any,
will not be significant.
(6) COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards (SFAS) No. 130, Reporting of Comprehensive
Income. SFAS No. 130 establishes standards for the display of comprehensive
income and its components in a full set of financial statements. Comprehensive
income includes all changes in equity during a period except those resulting
from the issuance of shares of stock and distributions to shareholders. There
were no material differences between net income and comprehensive income for the
three and six months ended June 27, 1998 and June 30, 1997.
(7) BUSINESS COMBINATION
On June 16, 1998, Pixar issued 60,468 shares of its common stock in
exchange for all of the outstanding common stock of Physical Effects, Inc.
("PEI"). Pixar assumed $300,000 of liabilities as part of this merger. The
merger was accounted for under the purchase method of accounting with the
operating results of PEI being included in the Company's results of operations
from the date of acquisition. The majority of the purchase price was assigned to
purchased technology associated with certain technology developed by PEI. The
purchased technology will be amortized over a period not to exceed three years.
-7-
<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 20, 1998. The Co-Production Agreement also
contemplates that with respect to sequels, interactive media products and other
derivative works related to the Pictures, Pixar will have the opportunity to
choose between co-financing and producing such products or earning passive
royalties on such products. Pixar will not share in any theme park revenues
generated as a result of the Pictures. Pursuant to the Co-Production Agreement,
in addition to co-financing the production costs of the Pictures, Disney will
reimburse Pixar for its share of certain general and administrative costs and
certain research and development costs that benefit the productions.
In February 1998, Pixar and Disney agreed to produce a theatrical motion
picture sequel to Toy Story (with the working title, Toy Story 2), in lieu of
the Toy Story made-for-home video sequel. Toy Story 2 will be Pixar's third
feature film and will not be released until late 1999 at the earliest. Because
Toy Story 2 is a derivative work of the original Toy Story, it will not be
counted toward the five Pictures to be produced under the Co-Production
Agreement. However, for all other purposes, Toy Story 2 will be treated as a
Picture under the Co-Production Agreement. Accordingly, Toy Story 2 has been
added to the definition of Pictures produced and financed under the
Co-Production Agreement and all the provisions applicable to the other five
Pictures apply. From 1996 until the first quarter of 1998, Pixar was producing
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<PAGE> 9
Toy Story 2 for the less expensive made-for-home video format. Therefore, Pixar
has begun and will necessarily continue to spend substantially more production
time and incur substantially higher production costs to convert Toy Story 2 into
a feature-length and feature-quality motion picture.
At the present time, Pixar is continuing story development on its fourth
theatrical film ("Film Four"). Production of Film Four has not yet begun, and
Disney and Pixar have not yet approved the story treatment and budget as
required under the Co-Production Agreement. If the story treatment and budget
are approved, this film will be developed and distributed under the
Co-Production Agreement and will count as the second of the five Pictures. Film
Four is not expected to be released until the end of 2000 at the earliest.
In May 1991, Pixar entered into a feature film agreement (the "Feature Film
Agreement") with Disney, pursuant to which Toy Story and the Toy Story home
video were developed, produced and distributed. The Feature Film Agreement was
largely superseded by the Co-Production Agreement above. However, the Feature
Film Agreement remains in effect with respect to Pixar's financial participation
in Toy Story and related products.
RESULTS OF OPERATIONS
REVENUES
Total revenues for the three and six months ended June 27, 1998 were $3.8
million and $8.8 million, respectively, compared to $14.4 million and $22.2
million in the corresponding periods of the prior year. The decreases were
primarily due to the decline in Toy Story-related revenue, although each of the
other categories of revenues also declined.
Software revenues consist mainly of software license revenues, principally
from RenderMan. Software revenues decreased by 19% to $854,000 for the quarter
ended June 27, 1998 from $1.1 million in the corresponding prior year period and
decreased 38% to $1.5 million in the six months ended June 27, 1998 from $2.5
million in the corresponding prior year period. The decreases in software
revenues resulted from decreases in the number of RenderMan software licenses.
Pixar expects ongoing variability in revenues derived from software licenses and
that such revenue may continue to decline. All historical and future royalty
income associated with Pixar's discontinued CD-ROM division has been and will
continue to be excluded from software revenues and presented in results of
discontinued operations. See "Results of Discontinued Operations."
Animation services revenues of $171,000 for the six months ended June 27,
1998 represented revenue recognized in the first quarter of 1998 from a short
project related to Toy Story. As was the case in the quarter ended June 27,
1998, it is likely that in the remaining quarters in 1998, Pixar will generate
little or no animation services revenues since Pixar has transferred
substantially all of its animation services employees to assist in the
completion of A Bug's Life. More generally, Pixar expects that animation
services revenues will vary significantly from period to period due to the
sporadic nature of this business and the need to utilize animation services
employees on other productions. There can be no assurance that Pixar will
generate any animation services revenues during periods in which its animation
services employees are devoted to feature films or other projects, such as will
be the case for the remainder of 1998, and may be the case thereafter.
Film revenues for the quarter ended June 27, 1998 were $2.9 million
compared with $11.6 million in the corresponding prior year period. Film
revenues for the six months ended June 27, 1998 were $6.9 million compared with
$17.9 million in the corresponding prior year period. Such revenues for the six
months ended June 27, 1998 represent Pixar's share of Toy Story-related
merchandising royalties, the ABC and Disney Channel television airings of Toy
Story, and Toy Story home video revenue. Since Pixar has already recognized the
vast majority of the revenue it expects to receive from Toy Story and related
products, and since Pixar's next feature film, A Bug's Life, is not targeted for
release until November 20, 1998 and is not expected to generate revenues for
Pixar until the second half of 1999 at the earliest, Pixar expects that revenue
will continue to decline in the second half of 1998 as compared to the
corresponding period in 1997. Therefore, Pixar expects to incur operating and
net losses in the second half of 1998 and in the first half of 1999.
-9-
<PAGE> 10
Patent licensing revenues of $120,000 for the six months ended June 27,
1998 were attributable to a patent license with Silicon Graphics, Inc. ("SGI"),
whereby Pixar granted to SGI and its subsidiaries a non-exclusive license to use
certain of Pixar's patents covering techniques for creating computer-generated
photorealistic images. Under the agreement, SGI agreed to pay Pixar total
compensation of $11.0 million, of which $6.0 million was paid in cash in March
1996 and $5.0 million was to be paid in the form of purchase credits for SGI
hardware and software. Recognition of the $5.0 million in credits depended upon
purchases of the hardware and software to be obtained from SGI in lieu of
payment. In the six months ended June 30, 1997 and June 27, 1998, revenue of
$1.6 million and $120,000 was recognized, respectively, representing credits
used during those periods. Pixar has used substantially all of the $5.0 million
worth of credits and the small amount of remaining credits are expected to be
used in the second half of 1998. Pixar does not expect that further patent
licensing revenues will be generated on an ongoing basis.
For the three and six months ended June 27, 1998, Disney accounted for 77%
and 81%, respectively, of Pixar's total revenues. The revenues from Disney
consisted primarily of film and animation services revenues. Substantially all
of the revenue derived from Disney for the quarter ended June 27, 1998 was
included in trade and other accounts receivable and represented 61% of the
balance at June 27, 1998. For the three and six months ended June 30, 1997,
Disney accounted for 83% and 82%, respectively, of Pixar's total revenues,
primarily from film and software revenues.
COST OF REVENUES
Cost of software revenues consist of the direct costs and manufacturing
overhead required to reproduce and package software products as well as
amortization of purchased technology. Cost of software revenues include no
amortization of internal software development expenses since no such expenses
have been capitalized. Cost of software revenues as a percentage of the related
revenues increased to 12% and 9% for the three and six months ended June 27,
1998, respectively, from 1% in both the three and six months corresponding
prior year periods, due primarily to the amortization of purchased technology
associated with its acquisition of Physical Effects, Inc. ("PEI"), on which no
revenue will be recognized until the third quarter of 1998 at the earliest.
Approximately $2.7 million of the PEI purchase price was assigned to purchased
technology, which PEI has licensed to a third party. Over a period not to
exceed three years, Pixar will amortize the purchased technology against
related license revenues, thereby essentially eliminating any gross margins
with respect to license revenues associated with this purchased technology
until such amortization has been completed. As a result of the ongoing
amortization of this purchased technology, it is likely that Pixar's total
software gross margins will be substantially lower during the next several
years. In addition, if Pixar determines that the license revenue generated by
the purchased technology will be lower than expected and that all or part of the
purchased technology asset may not be recoverable, Pixar would, at that point,
be required to write off all or a significant portion of the unamortized
purchased technology.
Cost of animation services revenues consist of production costs, which
include salaries, benefits, facility expenses and department overhead costs.
Costs of animation services revenues as a percentage of the related revenues
were 22% for the six months ended June 27, 1998 compared to 65% for the six
months ended June 30, 1997, due to the lower negotiated profit margins on
animation services projects completed in the six months ended June 30, 1997.
Because there were no animation services revenues in the quarter ended June 27,
1998, there were no associated costs.
Costs of film revenues represent amortization of film costs capitalized by
Pixar. See "Capitalized Film Production Costs." Due to higher than expected Toy
Story film revenues, which resulted in Pixar's amortizing all Toy Story related
film costs by December 31, 1997, there were no costs of revenues associated with
film revenues for the three and six months ended June 27, 1998. Any further Toy
Story film-related revenues will have no associated costs of revenues. Costs of
film revenues as a percentage of the related revenues were 7% for the six months
ended June 30, 1997.
Under the Feature Film Agreement all payments to Pixar from Disney for
Pixar's efforts in the development and production of feature films were recorded
as cost reimbursements and were netted against the related costs. In addition,
since Pixar's share of production costs under the terms of the Co-Production
Agreement are capitalized, amortized film production costs for future feature
films will be significantly higher, and gross profit margins on future film
projects, if any, will be substantially lower than those achieved on Toy Story.
There are no costs of revenues associated with patent licensing revenues.
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<PAGE> 11
OPERATING EXPENSES
Total operating expenses for the three and six months ended June 27, 1998
were higher than in the same period in the prior year, and Pixar intends to
continue to increase its spending levels in a number of areas. First, as a
result of competition for technical and certain administrative personnel, Pixar
has had to pay higher salaries to attract new technical and administrative
personnel. Pixar expects compensation for such personnel to continue to
increase. In the three and six months ended June 27, 1998, Pixar expanded its
administrative staff, increased systems and facilities costs and expanded other
operations. Pixar expects continued growth in operating expenses in these areas.
Under the Co-Production Agreement, Disney reimburses Pixar for its share of
certain general and administrative costs and certain research and development
costs that benefit the productions. The funding from Disney is treated as
operating expense reimbursements. In addition, because Disney is responsible for
paying all film marketing costs under the Co-Production Agreement, if Pixar
incurs film marketing costs, Disney is responsible for reimbursing Pixar for
such costs. To the extent that spending in any of these areas is not capitalized
by Pixar nor paid for by Disney under the Co-Production Agreement, and precedes
or is not subsequently followed by an increase in revenues, Pixar's business,
operating results and financial condition will be materially adversely affected.
Research and development expenses consist primarily of salaries and support
for personnel conducting research and development for the RenderMan product, for
Pixar's proprietary Marionette and Ringmaster software and for certain other
unreimbursed projects. Research and development expenses decreased 34% to
$946,000 in the three months ended June 27, 1998 from $1.4 million in the
corresponding prior year period, and decreased 28% to $1.8 million in the six
months ended June 27, 1998 from $2.5 million in the corresponding prior year
period. The decreases were due to the completion of a significant research and
development project in the last quarter of 1997, coupled with the reassignment
in the current year of certain research and development employees to temporarily
work on film productions. Pixar expects increased research and development
spending in future quarters. To date, all software development costs not
reimbursed by Disney have been expensed as incurred.
Sales and marketing expenses consist primarily of salaries and related
overhead, as well as advertising, technical support, public relations and trade
show costs required to support the software segment and complement the film
segment. Sales and marketing expenses increased 23% to $434,000 in the three
months ended June 27, 1998 from $353,000 in the corresponding prior year period
and increased 8% to $652,000 in the six months ended June 27, 1998 from $605,000
in the corresponding prior year period, due to increased corporate marketing and
promotion of Pixar's short animated film Geri's Game, offset by the
reimbursement by Disney of all film-specific marketing costs incurred. Pixar
expects that sales and marketing spending will increase in future periods
because corporate marketing and public relations expenses, net of
reimbursements, may continue to increase in absolute dollars in future periods.
General and administrative expenses consist primarily of salaries of
management and administrative personnel, insurance costs and professional fees.
General and administrative expenses increased 73% to $1.8 million in the three
months ended June 27, 1998 from $1.0 million in the corresponding prior year
period and increased 57% to $3.5 million in the six months ended June 27, 1998
from $2.3 million in the corresponding prior year period. The increases were
primarily due to a general increase in staffing and public company costs, such
as payroll taxes from the exercise of stock options. Growth in these costs is
partially offset by the recovery of certain general and administrative costs
reimbursed by Disney under the Co-Production Agreement. Pixar expects general
and administrative expenses to continue to increase in absolute dollars in
future periods as Pixar incurs additional costs to expand its administrative
staff and facilities.
OTHER INCOME, NET
Other income, net consists primarily of interest income on Pixar's
short-term investments. Other income, net was $2.2 million and $4.6 million in
the three and six months ended June 27, 1998, respectively, and $1.9 million and
$4.0 million in the three and six months ended June 30, 1997, respectively.
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INCOME TAXES
Income tax expense from continuing operations for the three and six months
ended June 27, 1998 reflects Pixar's federal and state income tax liability
after utilization of remaining net operating loss carryforwards and federal and
state tax credits. Income taxes decreased for the three and six months ended
June 27, 1998 as a result of the benefit of certain tax deductions occurring in
1998 coupled with Pixar's projected lower earnings for fiscal 1998.
RESULTS OF DISCONTINUED OPERATIONS
After the Co-Production Agreement was executed in February 1997, Pixar
determined that the resources devoted to its interactive products division would
be better allocated to other projects arising from the Co-Production Agreement.
Therefore, Pixar determined in March 1997 to discontinue its business of
producing CD-ROM and other interactive products and to redirect the employees
that were in that division to feature film productions and related projects
within Pixar.
The discontinued CD-ROM division incurred a loss of $77,000, net of income
tax benefits, for the six months ended June 30, 1997. For the six months ended
June 27, 1998, Pixar recorded income from discontinued operations of $374,000,
net of income taxes, due to royalty income received for the Toy Story CD-ROM
products. Pixar anticipates that future royalty income, if any, will exceed
costs to be incurred in all future periods, but that such amounts will not be
significant.
FACTORS AFFECTING OPERATING RESULTS AND FINANCIAL CONDITION
The following is a discussion of certain factors which currently impact or
may impact Pixar's business, operating results and/or financial condition.
Anyone making an investment decision with respect to Pixar's capital stock or
other securities is cautioned to carefully consider these factors, along with
the factors discussed in Pixar's Form 10-K under the section entitled "Certain
Factors Affecting Business, Operating Results and Financial Condition."
DECLINING REVENUES AND ANTICIPATED NET LOSSES IN THE SECOND HALF OF 1998
AND THE FIRST HALF OF 1999
A number of factors are expected to result in declining revenues and net
losses in the second half of 1998 and in the first half of 1999, as discussed
more fully below.
End of Toy Story Revenues. Pixar has already recognized the vast majority
of the revenue it expects to receive from Toy Story, Pixar's first
computer animated feature film. While relatively minor amounts of revenue may be
received by Pixar in subsequent periods, Pixar does not expect to recognize any
significant revenue from Toy Story in the future.
Timing of A Bug's Life and Toy Story 2 Releases. A Bug's Life, Pixar's
second computer animated feature film, is targeted for release on November 20,
1998, and revenue attributable to A Bug's Life is not expected to be recognized
until all marketing and distribution costs and fees have been recovered by
Disney. Recovery of all costs depends on many factors and may not occur until
six to twelve months after its release at the earliest, making it likely that
Pixar will not recognize any revenue from A Bug's Life until the second half of
1999 at the earliest. In addition, the theatrical motion picture sequel to Toy
Story (with the working title, Toy Story 2) is not expected to be released until
the end of 1999 at the earliest. As with A Bug's Life, Pixar does not expect to
recognize any revenue from Toy Story 2 until six to twelve months after its
release at the earliest. Therefore, Pixar is unlikely to recognize any revenue
from Toy Story 2 until the second half of 2000 at the earliest.
Limited CD-ROM Income. Pixar determined in March 1997 to discontinue its
business of producing CD-ROM and other interactive products in favor of other
opportunities arising, in part, as a result of entering into the Co-Production
Agreement (as defined herein). Pixar has not recognized and will not recognize
any CD-ROM income from this discontinued operation in 1998 or thereafter, other
than royalty income attributable to the two existing Toy Story CD-ROM products.
Pixar redirected all of the CD-ROM division employees to feature film
productions and other departments within Pixar.
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Increase in Operating Expenses and Effective Tax Rate. Since Pixar's
initial public offering, Pixar significantly increased its operating expenses,
and Pixar plans to continue to increase its operating expenses to fund greater
levels of research and development and to expand operations. Specifically, Pixar
expects its spending levels to increase significantly due to continued
investment in proprietary software systems, increased compensation costs as a
result of intense competition for animators, creative personnel, technical
directors and other personnel, and increased costs associated with the expansion
of its facilities. A portion of Pixar's operating expenses that are allocable to
film productions are capitalized by Pixar or reimbursed by Disney under the
Co-Production Agreement. To the extent that the increases in expenses are not
capitalized by Pixar nor paid for by Disney, Pixar's operating expenses will
significantly increase in the second half of 1998 and thereafter. In addition,
in 1998, if the story for Film Four is not approved, Pixar could be required to
write-off certain related film costs previously capitalized. Finally, Pixar's
effective tax rate increased in the year ended December 31, 1997, and although
it may decrease slightly in 1998, it is likely to increase in future years due
to utilization of remaining net operating loss carryforwards in 1997.
Impact on Operating Results. As a result of the above factors, Pixar
expects revenue to substantially decline in 1998 as compared to 1997. At the
same time, Pixar's operating expenses have increased and are expected to
continue to increase in 1998. Therefore, Pixar expects operating results in 1998
to decline substantially from operating results in 1997. Pixar expects to incur
operating and net losses in the second half of 1998 and in the first half of
1999. Operating results thereafter will depend upon the success of Pixar's next
films, starting with the planned release of A Bug's Life on November 20, 1998.
DEPENDENCE ON TOY STORY, A BUG'S LIFE AND TOY STORY 2
Dependence on Toy Story. For at least the remainder of 1998 and the first
half of 1999, Pixar's revenue and operating results will again be largely
dependent upon whatever remains to be received from Toy Story, such as possible
further merchandise royalties. Pixar recognized the vast majority of Toy Story
home video revenue in 1997 and expects little revenue from Toy Story or related
products in the second half of 1998 and thereafter. Pixar also expects little or
no royalty income from its Toy Story CD-ROM products in 1998 or thereafter.
Because A Bug's Life is targeted for release on November 20, 1998, and Toy Story
2 is not expected to be released until the end of 1999 at the earliest, any
other revenues in the second half of 1998 and in the first half of 1999 will be
primarily dependent upon Pixar's other businesses, from which Pixar expects
limited revenue.
Dependence on A Bug's Life and Toy Story 2. Beyond 1998 and the first half
of 1999, Pixar expects to be significantly dependent upon the success of A Bug's
Life, Toy Story 2, and Film Four (the "Current Projects") and related products.
Although development and/or production on each of the Current Projects is
underway, there can be no assurance that any of the Current Projects will be
successfully produced and released when scheduled or thereafter. There can be no
assurance that Pixar will not experience difficulties that could delay or
prevent the successful development or production of any of the Current Projects
or subsequent animated feature films or related products. If Pixar is unable to
produce and develop on a timely basis the Current Projects and subsequent
animated feature films and related products that meet with broad market
acceptance, Pixar's business, operating results and financial condition will be
materially adversely affected.
The development of Film Four began in late 1996. Although it is currently
targeted for release in 2000, to date there has been no final approval under the
Co-Production Agreement of the story treatment or the budget for Film Four and
there can be no assurance that it will be released as targeted in 2000. As a
result, for the next two or three years, Pixar expects to be significantly
dependent upon A Bug's Life and Toy Story 2.
Risks Associated with A Bug's Life. Under the Co-Production Agreement,
Pixar equally shares the production costs of A Bug's Life with Disney which are
expected to be more than twice the production costs of Toy Story. Most of these
costs will initially be capitalized as film production costs under SFAS No. 53
and will then be amortized over the expected revenue stream when revenue is
recognized. In addition, under the Co-Production Agreement, Disney determines
and finances the costs and expenses of promoting, marketing and distributing A
Bug's Life. Such costs are likely to be very significant and will be recovered
by Disney before any revenues are recognized by Pixar. If A Bug's Life is not an
extraordinary box office success, the amount of revenue recognized by Pixar will
not be significant, and Pixar's capitalized production costs will have to be
amortized in large amounts over a limited number of quarters, resulting in
significant costs of film revenue in those quarters and, potentially,
significant quarterly operating
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and net losses. Animated feature films that become extraordinary box office
successes are rare. Pixar believes, based on available information, that there
is a reasonable basis to conclude that of the more than 40 animated feature
films introduced since 1990, only two movies generated domestic box office
revenues greater than Toy Story, and both of those films were produced and
distributed solely by Disney. During at least the last five years, Pixar
believes that there has been no fully-animated feature film (other than Toy
Story) produced or developed by a studio other than Disney that has achieved
more than $65 million in domestic box office revenues. While A Bug's Life will
be co-financed, promoted and marketed by Disney, it will have a different look,
theme and musical style than Disney's other recent animated films (except for
Toy Story), and there can be no assurance that it will have the same audience
appeal as Disney's other animated films. As a result, A Bug's Life and related
products may not generate significant revenue and operating results for Pixar,
even if A Bug's Life is critically acclaimed and achieves substantial, but not
extraordinary, box office success.
Risks Associated with Toy Story 2. As a theatrical feature film release,
Toy Story 2 is subject to the same risks associated with A Bug's Life specified
above. In addition, because it is a sequel, there are also risks unique to Toy
Story 2. In the vast majority of cases in which a film that achieved domestic
box office receipts of greater than $100 million was followed by the release of
a sequel, the sequel did not perform as well at the box office as the original.
In many cases, sequels substantially under-perform the original film. Only a few
sequels have performed as well or better than the original blockbuster feature
film, and in almost all of these cases, the original feature films and related
sequels were action-adventure films, such as Lethal Weapon and Die Hard.
Furthermore, theatrical sequels to animated feature films are very rare, making
it more difficult to predict their success. Accordingly, there can be no
assurance that Toy Story 2 will perform as well as Toy Story at the box office.
In addition, fees and participations paid to key talent on Toy Story 2 are
substantially greater than for the original film, which together with other
increases in production costs will have the effect of substantially increasing
the cost of the film when compared to Toy Story.
As a result of these factors and the same factors associated with A Bug's
Life, Toy Story 2 and related products may not generate significant revenue and
operating results for Pixar, even if Toy Story 2 is critically acclaimed and
achieves substantial, but not extraordinary, box office success.
Production Budgets. Given the escalation in compensation rates of people
required to work on the Current Projects, the number of people required to work
on the Current Projects, and the equipment needs, the budget for the Current
Projects and subsequent films and related products are and will continue to be
substantially greater than the budget for Toy Story and will be financed equally
by Pixar and Disney under the Co-Production Agreement. For example, the
production budget of A Bug's Life is more than twice the production costs of Toy
Story. In addition, due to production exigencies which are often difficult to
predict, Pixar believes that it is not uncommon for film production spending to
exceed film production budgets and there can be no assurance that any of the
Current Projects can be completed within the budgeted amounts.
SCHEDULED SUCCESSIVE RELEASE OF FILMS; MANAGEMENT OF GROWTH
In order to meet its obligations pursuant to the Co-Production Agreement,
Pixar has established parallel creative teams so that it can develop more than
one film at a time. These teams are currently working on A Bug's Life, Toy Story
2 and Film Four, which are currently targeted for release on November 20, 1998,
late 1999, and late 2000, respectively. Pixar has only produced one prior
feature film to date and has no experience with respect to producing three
animated feature films in parallel. Pixar has been required, and may continue to
be required, to expand its employee base, increase capital expenditures and
procure additional resources and facilities in order to accomplish the scheduled
release of these three feature films. This period of rapid growth and expansion
has placed, and continues to place, a significant strain on Pixar's resources.
There can be no assurance that A Bug's Life, Toy Story 2 or Film Four will be
released as scheduled or that this strain on resources will not have a material
adverse effect on Pixar's business, financial condition or results of
operations. For example, to meet the production schedule of A Bug's Life,
substantially all employees from Pixar's animation services group and a
significant number of employees from other projects, including Toy Story 2, have
been assigned to A Bug's Life. Pixar may need to take similar actions for Toy
Story 2 and subsequent films. In addition, when production of each of these
films is completed, if completed, Pixar may incur significant carrying costs
associated with transitioning personnel on creative and development teams from
one project to another which, although shared with Disney, could have a material
adverse effect on film production budgets and Pixar's results of operations and
financial condition.
Although there can be no assurance that any of A Bug's Life, Toy Story 2,
or Film Four will be released on schedule, the targeted release date of late
2000 for Film Four is particularly uncertain. Pursuant to the Co-Production
Agreement, Disney and Pixar are required to agree on a number of elements for
each film, including the treatment, which summarizes the story on which the film
is based, and the budget for the film. Although Film Four has been in
development at Pixar since late 1996, there has been no final agreement between
Pixar and Disney on the story or budget for Film Four, and there can be no
assurance that either the story or the budget will be approved in time to
release the film by late 2000 or at all. If Disney and Pixar do not reach final
agreement on a treatment and budget for Film Four currently under development at
Pixar, Pixar would be unable to develop an alternative film in time for release
in 2000, and it may be 2001 or later before a film which follows Toy Story 2 is
ready to be released. In addition, if the story currently under development for
Film Four is canceled because Pixar and Disney are unable to reach final
agreement on a treatment or budget, Pixar could be required to write-off certain
related story development costs previously capitalized. If such event occurs in
1998, then all or a portion of these costs would be written off in 1998.
Furthermore, even if Pixar and Disney reach final agreement and use the story
currently under development for Film Four, there can be no assurance that Film
Four will be developed in time for release in 2000.
If Pixar is able to release films in each of 1998, 1999 and 2000, due to
the strain on Pixar's personnel from the effort required for such successive
releases and the time required for creative development of a new film, it is
extremely unlikely that Pixar would be able or would even attempt to release a
new film in 2001. Instead, Pixar's creative and production personnel would
develop films targeted for release in 2002 and for subsequent years, although it
is too early to determine the release schedule or whether it would be possible
to release one film in each successive year after 2001. As a result,
notwithstanding the targeted successive release of films in 1998, 1999 and 2000,
it is too early to determine the rate at which any future films are to be
released, and there can be no assurance that Pixar will release a film in each
successive year or in any particular year.
COMPETITION FROM MOVIE STUDIOS
Pixar's animated feature films compete and will continue to compete with
feature films and other family oriented entertainment products produced by major
movie studios, including Disney (as somewhat limited by the Co-Production
Agreement), DreamWorks SKG ("DreamWorks") (which is expressly targeting the
animated film market), Warner Bros. Inc., Twentieth Century Fox Film Corporation
("Twentieth Century Fox"), Paramount Pictures ("Paramount"), Columbia/ Tri-Star
Pictures Inc., Lucasfilm Ltd. ("Lucasfilm"), Universal City Studios, Inc. and
MGM/UA, as well as numerous other independent motion picture production
companies. Competition has greatly intensified in the animated feature film
market from these and other movie studios. Animated feature films released in
1997 included Anastasia by Twentieth Century Fox and Beavis and Butt-head Do
America by United International Pictures with Paramount, each achieving domestic
box office receipts between $55 million and $65 million. DreamWorks owns a
significant equity stake in Pacific Data Images ("PDI"), a computer animation
firm, and is producing with PDI Antz, a computer animated movie which, like A
Bug's Life, features ants as characters. Antz is scheduled for release on
October 2, 1998 (approximately seven weeks before A Bug's Life). Pixar expects a
variety of additional animated feature films to be released in the theaters in
the next two years generating competition for A Bug's Life and Toy Story 2,
which are targeted for release on November 20, 1998 and late 1999, respectively.
These films include for example Paramount's Rugrats, The Movie and DreamWorks'
The Prince of Egypt, which are each scheduled to be released in late 1998. Pixar
is also aware of several other animated feature films in production at various
studios. Due to the large number of expected releases in the next two years, it
is possible that the market for animated films will become saturated before
Pixar can release A Bug's Life and other feature films, which could result in
failure of such films to achieve commercial success. In addition, other
non-animated family oriented feature films are expected to be released in late
1998 and will generate additional competition for A Bug's Life. Such feature
films include Babe: Pig in the City, The Wizard of Oz, Air Bud 2: Golden
Receiver, Star Trek 9, and Disney's Mighty Joe Young, among others.
Pixar's films will compete with the feature films of other movie studios
for optimal release dates, audience acceptance and exhibition outlets. In
addition, Pixar competes and will continue to compete with other movie studios
for the acquisition of literary properties, production financing, the services
of performing artists, and the services of other creative and technical
personnel, particularly in the fields of animation and technical direction. Most
of the other movie studios with which Pixar competes have significantly greater
name recognition and significantly greater financial, technical, creative,
marketing and other resources than does Pixar.
At least three of these movie studios, Disney, DreamWorks (with PDI) and
Lucasfilm (through its affiliate Industrial Light and Magic ("ILM")), have
developed their own internal computer animation capability which may be used for
special effects in computer animated feature films. For example, DreamWorks
(with PDI) is producing Antz. In addition, Pixar believes that Disney is
currently developing and producing a feature film making substantial use of
computer animation. Other movie studios may internally develop, license or
sub-contract three-dimensional animation capability. Further, Pixar believes
that continuing enhancements in commercially available computer hardware and
software technology have lowered and will continue to lower barriers to entry
for studios or special effects companies which intend to produce computer
animated feature films or other products. For example, Silicon Graphics Inc.'s
Alias/Wavefront subsidiary has recently launched "Maya," its next generation
three-D software for creating high quality animation and visual effects. Maya
incorporates many new features and could be used to make a computer animated
feature film.
The Co-Production Agreement provides for the development and production by
Pixar of five original computer animated feature films. Because Disney
co-finances the films developed and produced under the Co-Production Agreement,
distributes the films under the "Walt Disney Pictures" label and enjoys
financial benefits in the event that such films achieve significant box office
revenues, Pixar believes that Disney desires such films to be successful.
Nonetheless, Disney has been by far the most successful producer of animated
feature films, and family oriented motion pictures distributed by Disney or its
affiliates are likely to be in the market concurrently with and competing with
Pixar's animated feature films.
DIVIDED RESPONSIBILITIES OF CHIEF EXECUTIVE OFFICER
Pixar's Chief Executive Officer and Chairman, Steven P. Jobs, is also
acting as interim Chief Executive Officer at Apple Computer, Inc. ("Apple")
until such time as a new Chief Executive Officer is identified and named at
Apple. Although Mr. Jobs spends time at Pixar and is active in Pixar's
management, he does not devote his full time and resources to Pixar. For day to
day operations, since 1995, Pixar has established an Office of the President
which is comprised of Mr. Jobs as Chief Executive Officer, Edwin E. Catmull as
Executive Vice President and Chief Technical Officer and Lawrence B. Levy,
Executive Vice President and Chief Financial Officer.
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LIQUIDITY RISKS
Pursuant to the Co-Production Agreement, Pixar will co-finance the next
five animated feature films which it produces, including A Bug's Life and Film
Four. Pixar will also co-finance Toy Story 2 on the same basis as the other
theatrical films. In the future, Pixar may co-finance other derivative works
such as sequels, interactive products and television productions. In addition,
Pixar is planning construction of a new headquarters and studio facility in
Emeryville, California, construction of which will begin in the second half of
1998 and which may be financed by the use of Pixar's cash. As Pixar does not
expect to generate substantial, if any, cash from operations in 1998, the
production costs of A Bug's Life, Film Four and Toy Story 2 and the costs of the
new Emeryville facility will have a material adverse impact on Pixar's cash and
short-term investment balances. As of June 27, 1998, Pixar had approximately
$161.0 million in cash and short-term investments. Pixar believes that these
funds will be sufficient to meet its anticipated cash needs for working capital
and capital expenditures, including the development and production costs of A
Bug's Life, Film Four and Toy Story 2, until Pixar begins receiving cash from
the release of these films (which is generally not expected to occur until the
second half of 1999 at the earliest). However, even if these films generate
cash, unless each is a success such that Pixar recovers on a timely basis its
share of the production costs, as well as other operating expenses and capital
expenditures, Pixar will be required to seek financing for its ongoing
commitments under the Co-Production Agreement and any other requirements of its
operations. Pixar may also seek additional financing in connection with the
expansion of its facilities. See also "--Liquidity and Capital Resources". The
sale of additional equity or convertible debt securities would result in
additional dilution to Pixar's shareholders. Moreover, there can be no assurance
that Pixar will be successful in obtaining future financing, or even if such
financing is available, that it will be obtained on terms favorable to Pixar or
on terms providing Pixar with sufficient funds to meet its obligations and
objectives. The failure to obtain such financing would have a material adverse
effect on Pixar's business, operating results and financial condition.
CAPITALIZED FILM PRODUCTION COSTS
As of December 31, 1997, all capitalized film costs related to Toy Story
had been amortized. Pixar had $43.7 million in capitalized film production costs
as of June 27, 1998, consisting primarily of costs related to A Bug's Life, Toy
Story 2 and Film Four, all of which are being co-financed by Disney under the
Co-Production Agreement.
YEAR 2000 COMPLIANCE
The year 2000 problem is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a major system
failure or miscalculations. Pixar is currently reviewing its products, its
internal computer systems and systems of third parties on which Pixar relies for
handling the year 2000. Based on information available to date, Pixar believes
that it will be able to complete its year 2000 compliance review and make any
necessary modifications to its products and internal systems prior to the end of
1999. Pixar further believes that such review and modification, if any, will not
require Pixar to incur any material charge to operating expenses over the next
several years. Pixar is also seeking confirmation from third parties that their
systems are year 2000 compliant or plans are being developed to address the year
2000 problem. However, there can be no assurance that such third-party systems
will be year 2000 compliant or that the failure of such systems to be year 2000
compliant would not have a material adverse effect on Pixar's financial position
or results of operations.
LIQUIDITY AND CAPITAL RESOURCES
Cash and short-term investments decreased $15.0 million to $161.0 million
at June 27, 1998 from $176.0 million at December 31, 1997. Working capital
decreased $11.2 million to $155.8 million at June 27, 1998 from $167.0 million
at December 31, 1997.
Net cash provided by continuing operations for the six months ended June
27, 1998 was primarily attributable to net income of $5.9 million and the
non-cash impact of depreciation expense of $2.6 million offset by increases in
accounts receivable and other assets of $1.3 million and decreases in accrued
and other liabilities of $2.8 million. Cash flows used in investing activities
were due primarily to net investments in short-term securities of $45.7 million,
the purchase of property and equipment of $5.9 million and funding of film
production costs of $15.1 million. Cash flows
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provided by financing activities were due to proceeds from the exercise of stock
options.
As of June 27, 1998, Pixar's principal source of liquidity was
approximately $161.0 million in cash and short-term investments. Pixar believes
that these funds will be sufficient to meet the Company's operating requirements
through the next twelve months. Thereafter, if cash generated by operations is
insufficient to satisfy Pixar's liquidity requirements, Pixar may be required to
sell additional equity or debt securities or obtain credit facilities. The sale
of additional equity or convertible debt securities would result in additional
dilution to Pixar's shareholders. There can be no assurance that financing will
be available to Pixar in an amount and on terms acceptable to Pixar.
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PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) In connection with Pixar's acquisition of Physical Effects, Inc.
("PEI") on June 16, 1998, Pixar issued an aggregate of 60,468 shares of Pixar's
Common Stock (the "Merger Shares") to the existing stockholders of PEI in
exchange for all of the outstanding shares of capital stock of PEI. The Merger
Shares were issued pursuant to the exemption for the registration requirements
of the Securities Act of 1933, as amended (the "1933 Act"), afforded by
Regulation D under Section 4(2) of the 1933 Act. The stockholders of PEI were
either accredited or sophisticated investors with access to all relevant
information regarding Pixar necessary to evaluate the investment and
represented to Pixar that the shares were being acquired for investment intent.
(d) The effective date of the Company's first registration statement, filed
on Form S-1 under the 1933 Act (No. 33-97918), was November 28,
1995 (the "Registration Statement"). The class of securities registered was
Common Stock. The offering commenced on November 29, 1995 and all securities
were sold in the offering. The managing underwriters for the offering were
Robertson, Stephens & Company, L.P., Hambrecht & Quist LLC and Cowen & Company.
A total of 6,900,000 shares were registered pursuant to the Registration
Statement, all of which the Company sold for its own account, for an aggregate
offering price of $151,800,000.
The Company incurred expenses of approximately $12,138,714, of which
$10,246,500 represented underwriting discounts and commissions and $1,892,214
represented other expenses. All such expenses were direct or indirect payments
to others. The net offering proceeds to the Company after total expenses were
$139,661,286.
As of June 27, 1998, the Company had used the net proceeds from the
offering as follows: $14,197,105 for construction of plant, building and
facilities, $11,926,328 for the purchase and installation of machinery and
equipment, $2,374,000 for the repayment of indebtedness, $60,038,467 for the
development of future films and other animated products, $3,185,571 for working
capital and $47,939,815 remaining in temporary investments. Of these amounts,
$2,374,000 represented direct or indirect payments to directors, officers,
general partners of the Company or their associates; to persons owning ten (10)
percent or more of any class of equity securities of the Company; or to
affiliates of the Company. The use of the proceeds from the offering does not
represent a material change in the use of proceeds described in the prospectus.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to the shareholders at Pixar's Annual
Meeting of Shareholders held June 17, 1998. Each of these matters was approved
by a majority of the shares present at the meeting.
1. The uncontested election of five directors to serve a one-year term
until their successors are duly elected and qualified. The following
is a summary of the nominees and voting results:
<TABLE>
<CAPTION>
Votes For Votes Withheld
--------- --------------
<S> <C> <C>
Steven P. Jobs 38,745,290 17,309
Larry W. Sonsini 38,473,119 289,480
Skip M. Brittenham 38,744,433 18,166
Joseph A. Graziano 38,745,906 16,693
Jill E. Barad 38,741,411 21,188
</TABLE>
2. The adoption of an amendment to the 1995 Stock Plan to increase the
number of shares reserved for issuance by an additional 500,000 shares
of Common Stock, for an aggregate of 15,772,321 shares reserved for
issuance thereunder. Results of the voting included 37,639,910 shares
for, 1,067,126 shares against and 55,563 shares abstained.
3. The ratification of the appointment of KPMG Peat Marwick LLP as the
independent auditors for the Company for the 1998 fiscal year ending
January 2, 1999. Results of the voting included 38,717,032 shares for,
20,812 shares against and 24,755 shares abstained.
-17-
<PAGE> 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.1 1995 Stock Plan (as amended through April 8, 1998)
27.1 Financial Data Schedule
(B) REPORTS ON FORM 8-K
On May 8, 1998, Pixar filed a Current Report on Form 8-K to report the
change in fiscal year from December 31 to the 52 or 53-week period that
ends on the Saturday nearest December 31, effective for fiscal year 1998.
ITEMS 1, 3 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
-18-
<PAGE> 19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PIXAR
Date: August 11, 1998 By: /s/ Lawrence B. Levy
---------------------- -------------------------------------
Lawrence B. Levy, Executive Vice
President and Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized Officer)
-19-
<PAGE> 20
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- --------------------------------------------------
<S> <C>
10.1 1995 Stock Plan (as amended through April 8, 1998)
27.1 Financial Data Schedule
</TABLE>
-20-
<PAGE> 1
EXHIBIT 10.1
PIXAR 1995 STOCK PLAN
(as amended April 8, 1998)
1. Purposes of the Plan. The purposes of this Stock Plan are to attract and
retain the best available personnel for positions of substantial responsibility,
to provide additional incentive to Employees and Consultants of the Company and
its Subsidiaries and to promote the success of the Company's business. Options
granted under the Plan may be Incentive Stock Options or Nonstatutory Stock
Options, as determined by the Administrator at the time of grant of an Option
and subject to the applicable provisions of Section 422 of the Code and the
regulations promulgated thereunder. Stock Purchase Rights may also be granted
under the Plan.
2. Definitions. As used herein, the following definitions shall apply:
(a) "Administrator" means the Board or any of its Committees appointed
pursuant to Section 4 of the Plan.
(b) "Board" means the Board of Directors of the Company.
(c) "Code" means the Internal Revenue Code of 1986, as amended.
(d) "Committee" means a Committee appointed by the Board of Directors
in accordance with Section 4 of the Plan.
(e) "Common Stock" means the Common Stock of the Company.
(f) "Company" means PIXAR, a California corporation.
(g) "Consultant" means any person who is engaged by the Company or any
Parent or Subsidiary to render consulting or advisory services and is
compensated for such services. The term Consultant shall not include Directors
who are not compensated for their services or are paid only a Director's fee by
the Company.
(h) "Continuous Status as an Employee or Consultant" means that the
employment or consulting relationship with the Company, any Parent or Subsidiary
is not interrupted or terminated. Continuous Status as an Employee or Consultant
shall not be considered interrupted in the case of (i) any leave of absence
approved by the Company or (ii) transfers between locations of the Company or
between the Company, its Parent, any Subsidiary, or any successor. A leave of
absence approved by the Company shall include sick leave, military leave, or any
other personal leave approved by an authorized representative of the Company.
For purposes of Incentive Stock Options, no such leave may exceed 90 days,
unless reemployment upon expiration of such leave is guaranteed by statute or
contract,
<PAGE> 2
including Company policies. If reemployment upon expiration of a leave of
absence approved by the Company is not so guaranteed, on the 91st day of such
leave any Incentive Stock Option held by the Optionee shall cease to be treated
as an Incentive Stock Option and shall be treated for tax purposes as a
Nonstatutory Stock Option.
(i) "Director" means a member of the Board of Directors of the
Company.
(j) "Employee" means any person, including Officers and Directors,
employed by the Company or any Parent or Subsidiary of the Company. The payment
of a Director's fee by the Company shall not be sufficient to constitute
"employment" by the Company.
(k) "Exchange Act" means the Securities Exchange Act of 1934, as
amended.
(l) "Fair Market Value" means, as of any date, the value of Common
Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system, including without limitation the Nasdaq
National Market of the National Association of Securities Dealers, Inc.
Automated Quotation ("NASDAQ") System, its Fair Market Value shall be the
closing sales price for such stock (or the closing bid, if no sales were
reported) as quoted on such exchange or system for the last market trading day
prior to the time of determination and reported in The Wall Street Journal or
such other source as the Administrator deems reliable;
(ii) If the Common Stock is quoted on the NASDAQ System (but not
on the Nasdaq National Market thereof) or regularly quoted by a recognized
securities dealer but selling prices are not reported, its Fair Market Value
shall be the mean between the high bid and low asked prices for the Common Stock
on the last market trading day prior to the day of determination; or
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Administrator.
(m) "Incentive Stock Option" means an Option intended to qualify as an
incentive stock option within the meaning of Section 422 of the Code.
(n) "Nonstatutory Stock Option" means an Option not intended to
qualify as an Incentive Stock Option.
(o) "Officer" means a person who is an officer of the Company within
the meaning of Section 16 of the Exchange Act and the rules and regulations
promulgated thereunder.
-2-
<PAGE> 3
(p) "Option" means a stock option granted pursuant to the Plan.
(q) "Optioned Stock" means the Common Stock subject to an Option or a
Stock Purchase Right.
(r) "Optionee" means an Employee or Consultant who receives an Option
or Stock Purchase Right.
(s) "Parent" means a "parent corporation," whether now or hereafter
existing, as defined in Section 424(e) of the Code.
(t) "Plan" means this 1995 Stock Plan.
(u) "Restricted Stock" means shares of Common Stock acquired pursuant
to a grant of a Stock Purchase Right under Section 11 below.
(v) "Share" means a share of the Common Stock, as adjusted in
accordance with Section 12 below.
(w) "Stock Purchase Right" means a right to purchase Common Stock
pursuant to Section 11 below.
(x) "Subsidiary" means a "subsidiary corporation," whether now or
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to Section 12, the maximum aggregate
number of Shares which may be subject to option and sold under the Plan is
15,772,321(1) Shares provided, however, that beginning January 1, 1998, the
number of Shares shall be increased each January 1 by three percent (3%) of the
total issued and outstanding Shares on such date. In no event, except as subject
to Section 12, shall more than 14,500,000 Shares be issued upon the exercise of
Incentive Stock Options under the Plan.
If an Option or Stock Purchase Right expires or becomes unexercisable
without having been exercised in full, or is surrendered pursuant to an Option
Exchange Program, the unpurchased Shares which were subject thereto shall become
available for future grant or sale under the Plan (unless the Plan has
terminated). However, Shares that have actually been issued under the Plan, upon
exercise of either an Option or Stock Purchase Right, shall not be returned to
the Plan and shall not become available for future distribution under the Plan,
except that if Shares of Restricted Stock are repurchased by the Company at
their original purchase price, and the original purchaser of such Shares did not
receive any benefits of ownership of such Shares, such Shares shall become
available for future grant under the Plan.
- --------
(1) Such number reflects the automatic increase of 1,272,321 shares on January
1, 1998.
-3-
<PAGE> 4
For purposes of the preceding sentence, voting rights shall not be considered a
benefit of Share ownership.
4. Administration of the Plan.
(a) Procedure.
(i) Multiple Administrative Bodies. If permitted by Rule 16b-3,
the Plan may be administered by different bodies with respect to Directors and
Officers, and Employees and Consultants who are neither Directors nor Officers.
(ii) Administration With Respect to Directors and Officers. With
respect to grants of Options and Stock Purchase Rights to Employees who are also
Officers or Directors of the Company, the Plan shall be administered by (A) the
Board if the Board may administer the Plan in compliance with Rule 16b-3
promulgated under the Exchange Act or any successor thereto ("Rule 16b-3") with
respect to a plan intended to qualify thereunder as a discretionary plan, or (B)
a Committee designated by the Board to administer the Plan, which Committee
shall be constituted in such a manner as to permit the Plan to comply with Rule
16b-3 with respect to a plan intended to qualify thereunder as a discretionary
plan. Once appointed, such Committee shall continue to serve in its designated
capacity until otherwise directed by the Board. From time to time the Board may
increase the size of the Committee and appoint additional members thereof,
remove members (with or without cause) and appoint new members in substitution
therefor, fill vacancies, however caused, and remove all members of the
Committee and thereafter directly administer the Plan, all to the extent
permitted by Rule 16b-3 with respect to a plan intended to qualify thereunder as
a discretionary plan.
(iii) Administration With Respect to Other Employees and
Consultants . With respect to grants of Options and Stock Purchase Rights to
Employees or Consultants who are neither Directors nor Officers of the Company,
the Plan shall be administered by (A) the Board or (B) a Committee designated by
the Board, which committee shall be constituted in such a manner as to satisfy
the legal requirements relating to the administration of incentive stock option
plans, if any, of California corporate and securities laws, of the Code, and of
any applicable stock exchange (the "Applicable Laws"). Once appointed, such
Committee shall continue to serve in its designated capacity until otherwise
directed by the Board. From time to time the Board may increase the size of the
Committee and appoint additional members thereof, remove members (with or
without cause) and appoint new members in substitution therefor, fill vacancies,
however caused, and remove all members of the Committee and thereafter directly
administer the Plan, all to the extent permitted by the Applicable Laws.
(b) Powers of the Administrator. Subject to the provisions of the Plan
and, in the case of a Committee, the specific duties delegated by the Board to
such Committee, and subject to the approval of any relevant authorities,
including the approval, if required, of any stock exchange upon which the Common
Stock is listed, the Administrator shall have the authority in its discretion:
-4-
<PAGE> 5
(i) to determine the Fair Market Value of the Common Stock, in
accordance with Section 2(l) of the Plan;
(ii) to select the Consultants and Employees to whom Options and
Stock Purchase Rights may be granted hereunder;
(iii) to determine whether and to what extent Options and Stock
Purchase Rights or any combination thereof, are granted hereunder;
(iv) to determine the number of shares of Common Stock to be
covered by each Option and Stock Purchase Right granted hereunder;
(v) to approve forms of agreement for use under the Plan;
(vi) to determine the terms and conditions, not inconsistent with
the terms of the Plan, of any award granted hereunder. Such terms and conditions
include, but are not limited to, the exercise price, the time or times when
Options or Stock Purchase Rights may be exercised (which may be based on
performance criteria), any vesting acceleration or waiver of forfeiture
restrictions, and any restriction or limitation regarding any Option or Stock
Purchase Right or the shares of Common Stock relating thereto, based in each
case on such factors as the Administrator, in its sole discretion, shall
determine;
(vii) to reduce the exercise price of any Option or Stock
Purchase Right to the then current Fair Market Value if the Fair Market Value of
the Common Stock covered by such Option or Stock Purchase Right shall have
declined since the date the Option or Stock Purchase Right was granted;
(viii) to construe and interpret the terms of the Plan and awards
granted pursuant to the Plan;
(ix) to prescribe, amend and rescind rules and regulations
relating to the Plan, including rules and regulations relating to sub-plans
established for the purpose of qualifying for preferred tax treatment under
foreign tax laws;
(x) to modify or amend each Option or Stock Purchase Right
(subject to Section 14 of the Plan), including the discretionary authority to
extend the post-termination exercisability period of Options longer than is
otherwise provided for in the Plan;
(xi) to authorize any person to execute on behalf of the Company
any instrument required to effect the grant of an Option or Stock Purchase Right
previously granted by the Administrator;
(xii) to determine the terms and restrictions applicable to
Options and Stock Purchase Rights and any Restricted Stock; and
-5-
<PAGE> 6
(xiii) to make all other determinations deemed necessary or
advisable for administering the Plan.
(c) Effect of Administrator's Decision. All decisions, determinations
and interpretations of the Administrator shall be final and binding on all
Optionees and any other holders of any Options or Stock Purchase Rights.
5. Eligibility.
(a) Nonstatutory Stock Options and Stock Purchase Rights may be
granted to Employees and Consultants. Incentive Stock Options may be granted
only to Employees. An Employee or Consultant who has been granted an Option or
Stock Purchase Right may, if otherwise eligible, be granted additional Options
or Stock Purchase Rights.
(b) Each Option shall be designated in the written option agreement as
either an Incentive Stock Option or a Nonstatutory Stock Option. However,
notwithstanding such designations, to the extent that the aggregate Fair Market
Value of Shares subject to an Optionee's Incentive Stock Options granted by the
Company, any Parent or Subsidiary, which become exercisable for the first time
during any calendar year (under all plans of the Company or any Parent or
Subsidiary) exceeds the limit imposed by Section 422(d) of the Code or any
successor thereto, such excess Options shall be treated as Nonstatutory Stock
Options. For purposes of this Section 5(b), Incentive Stock Options shall be
taken into account in the order in which they were granted. The Fair Market
Value of the Shares shall be determined as of the time the Option with respect
to such Shares is granted.
(c) Neither the Plan nor any Option or Stock Purchase Right shall
confer upon any Optionee any right with respect to continuation of his or her
employment or consulting relationship with the Company, nor shall it interfere
in any way with his or her right or the Company's right to terminate his or her
employment or consulting relationship at any time, with or without cause.
(d) Upon the Company or a successor corporation issuing any class of
common equity securities required to be registered under Section 12 of the
Exchange Act or upon the Plan being assumed by a corporation having a class of
common equity securities required to be registered under Section 12 of the
Exchange Act, the following limitations shall apply to grants of Options and
Stock Purchase Rights to Employees:
(i) No Employee shall be granted, in any fiscal year of the
Company, Options and Stock Purchase Rights to purchase more than 3,000,000
Shares.
(ii) The foregoing limitation shall be adjusted proportionately
in connection with any change in the Company's capitalization as described in
Section 12.
-6-
<PAGE> 7
(iii) If an Option or Stock Purchase Right is canceled in the
same fiscal year of the Company in which it was granted (other than in
connection with a transaction described in Section 12), the canceled Option
shall be counted against the limit set forth in Section 5(d)(i). For this
purpose, if the exercise price of an Option is reduced, such reduction will be
treated as a cancellation of the Option and the grant of a new Option.
6. Term of Plan. The Plan shall become effective upon the earlier to occur
of its adoption by the Board of Directors or its approval by the shareholders of
the Company, as described in Section 18 of the Plan. It shall continue in effect
for a term of ten (10) years unless sooner terminated under Section 14 of the
Plan.
7. Term of Option. The term of each Option shall be the term stated in the
Option Agreement; provided, however, that the term shall be no more than ten
(10) years from the date of grant thereof. In the case of an Incentive Stock
Option granted to an Optionee who, at the time the Option is granted, owns stock
representing more than ten percent (10%) of the voting power of all classes of
stock of the Company or any Parent or Subsidiary, the term of the Option shall
be five (5) years from the date of grant thereof or such shorter term as may be
provided in the Option Agreement.
8. Option Exercise Price and Consideration.
(a) The per Share exercise price for the Shares to be issued upon
exercise of an Option shall be such price as is determined by the Administrator,
but shall be subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time of grant of such
Option, owns stock representing more than ten percent (10%) of the voting power
of all classes of stock of the Company or any Parent or Subsidiary, the per
Share exercise price shall be no less than 110% of the Fair Market Value per
Share on the date of grant.
(B) granted to any other Employee, the per Share exercise
price shall be no less than 100% of the Fair Market Value per Share on the date
of grant.
(ii) In the case of a Nonstatutory Stock Option, the per Share
exercise price shall be determined by the Administrator.
(b) The consideration to be paid for the Shares to be issued upon
exercise of an Option, including the method of payment, shall be determined by
the administrator (and, in the case of an Incentive Stock Option, shall be
determined at the time of grant). Such consideration may consist of (1) cash,
(2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares
acquired upon exercise of an Option, have been owned by the Optionee for more
than six months on the date of surrender, and (y) have a Fair Market Value
-7-
<PAGE> 8
on the date of surrender equal to the aggregate exercise price of the Shares as
to which such Option shall be exercised, (5) delivery of a proprerly executed
exercise notice together with such other documentation as the Administreator and
a broker, if applicable, shall require to effect an exercise of the Option and
delivery to the Company of the sale or loan proceeds required to pay the
exercixe price, (6) a reduction in the amount of any Company liability to the
Optionee, including any liability attributable to the Optionee's participation
in any Company-sponsored deferred compensation program or arrangement, or (7)
any combination of the foregoing methods of payment. In making its determination
as to the type of consideration to accept, the Administrator shall consider if
acceptance of such consideration may be reasonably expected to benefit the
Company.
9. Exercise of Option.
(a) Procedure for Exercise; Rights as a Shareholder. Any Option
granted hereunder shall be exercisable at such times and under such conditions
as determined by the Administrator, including performance criteria with respect
to the Company and/or the Optionee, and as shall be permissible under the terms
of the Plan.
An Option may not be exercised for a fraction of a Share.
An Option shall be deemed to be exercised when written notice of such
exercise has been given to the Company in accordance with the terms of the
Option by the person entitled to exercise the Option and full payment for the
Shares with respect to which the Option is exercised has been received by the
Company. Full payment may, as authorized by the Administrator, consist of any
consideration and method of payment allowable under Section 8(b) hereof. Until
the issuance (as evidenced by the appropriate entry on the books of the Company
or of a duly authorized transfer agent of the Company) of the stock certificate
evidencing such Shares, no right to vote, receive dividends or any other rights
as a shareholder shall exist with respect to the Optioned Stock, notwithstanding
the exercise of the Option. The Company shall issue (or cause to be issued) such
stock certificate promptly upon exercise of the Option. No adjustment shall be
made for a dividend or other right for which the record date is prior to the
date the stock certificate is issued, except as provided in Section 12 hereof.
Exercise of an Option in any manner shall result in a decrease in the
number of Shares which thereafter may be available, both for purposes of the
Plan and for sale under the Option, by the number of Shares as to which the
Option is exercised.
(b) Termination of Employment or Consulting Relationship. In the event
of termination of an Optionee's Continuous Status as an Employee or Consultant
(but not in the event of an Optionee's change of status from Employee to
Consultant (in which case an Employee's Incentive Stock Option shall
automatically convert to a Nonstatutory Stock Option on the ninety-first (91st)
day following such change of status) or from Consultant to Employee), such
Optionee may, but only within such period of time as is determined by the
Administrator, with such determination in the case of an Incentive Stock Option
not exceeding
-8-
<PAGE> 9
three (3) months after the date of such termination (but in no event later than
the expiration date of the term of such Option as set forth in the Option
Agreement), exercise his or her Option to the extent that the Optionee was
entitled to exercise it at the date of such termination. To the extent that the
Optionee was not entitled to exercise the Option at the date of such
termination, or if the Optionee does not exercise such Option to the extent so
entitled within the time specified herein, the Option shall terminate.
(c) Disability of Optionee. In the event of termination of an
Optionee's Continuous Status as an Employee or Consultant as a result of his or
her "Disability," as such term is defined in Section 22(c)(3) of the Code, the
Optionee may, but only within twelve (12) months from the date of such
termination (and in no event later than the expiration date of the term of such
Option as set forth in the Option Agreement), exercise the Option to the extent
otherwise entitled to exercise it at the date of such termination. To the extent
that the Optionee was not entitled to exercise the Option at the date of
termination, or if the Optionee does not exercise such Option to the extent so
entitled within the time specified herein, the Option shall terminate, and the
Shares covered by such Option shall revert to the Plan.
(d) Death of Optionee. In the event of the death of an Optionee, the
Option may be exercised at any time within twelve (12) months following the date
of death (but in no event later than the expiration of the term of such Option
as set forth in the Notice of Grant) by the Optionee's estate or by a person who
acquired the right to exercise the Option by bequest or inheritance, but only to
the extent that the Optionee was entitled to exercise the Option on the date of
death. If, at the time of death, the Optionee was not entitled to exercise his
or her entire Option, the Shares covered by the unexercisable portion of the
Option shall immediately revert to the Plan. If, after the Optionee's death, the
Optionee's estate or a person who acquires the right to exercise the Option by
bequest or inheritance does not exercise the Option within the time specified
herein, the Option shall terminate, and the Shares covered by such Option shall
revert to the Plan.
(e) Rule 16b-3. Options granted to persons subject to Section 16(b) of
the Exchange Act must comply with Rule 16b-3 and shall contain such additional
conditions or restrictions as may be required thereunder to qualify for the
maximum exemption from Section 16 of the Exchange Act with respect to Plan
transactions.
(f) Buyout Provisions. The Administrator may at any time offer to buy
out for a payment in cash or Shares, an Option previously granted, based on such
terms and conditions as the Administrator shall establish and communicate to the
Optionee at the time that such offer is made.
10. Non-Transferability of Options and Stock Purchase Rights. Options and
Stock Purchase Rights may not be sold, pledged, assigned, hypothecated,
transferred, or disposed of in any manner other than by will or by the laws of
descent or distribution and may be exercised, during the lifetime of the
Optionee, only by the Optionee.
-9-
<PAGE> 10
11. Stock Purchase Rights.
(a) Rights to Purchase. Stock Purchase Rights may be issued either
alone, in addition to, or in tandem with other awards granted under the Plan
and/or cash awards made outside of the Plan. After the Administrator determines
that it will offer Stock Purchase Rights under the Plan, it shall advise the
offeree in writing of the terms, conditions and restrictions related to the
offer, including the number of Shares that such person shall be entitled to
purchase, the price to be paid, and the time within which such person must
accept such offer, which shall in no event exceed thirty (30) days from the date
upon which the Administrator makes the determination to grant the Stock Purchase
Right. The offer shall be accepted by execution of a Restricted Stock purchase
agreement in the form determined by the Administrator. Shares purchased pursuant
to the grant of a Stock Purchase Right shall be referred to herein as
"Restricted Stock."
(b) Repurchase Option. Unless the Administrator determines otherwise,
the Restricted Stock purchase agreement shall grant the Company a repurchase
option exercisable upon the voluntary or involuntary termination of the
purchaser's employment with the Company for any reason (including death or
Disability). The purchase price for Shares repurchased pursuant to the
Restricted Stock purchase agreement shall be the original price paid by the
purchaser and may be paid by cancellation of any indebtedness of the purchaser
to the Company. The repurchase option shall lapse at such rate as the
Administrator may determine.
(c) Rule 16b-3. Stock Purchase Rights granted to Insiders, and Shares
purchased by Insiders in connection with Stock Purchase Rights, shall be subject
to any restrictions applicable thereto in compliance with Rule 16b-3. An Insider
may only purchase Shares pursuant to the grant of a Stock Purchase Right, and
may only sell Shares purchased pursuant to the grant of a Stock Purchase Right,
during such time or times as are permitted by Rule 16b-3.
(d) Other Provisions. The Restricted Stock purchase agreement shall
contain such other terms, provisions and conditions not inconsistent with the
Plan as may be determined by the Administrator in its sole discretion. In
addition, the provisions of Restricted Stock purchase agreements need not be the
same with respect to each purchaser.
(e) Rights as a Shareholder. Once the Stock Purchase Right is
exercised, the purchaser shall have rights equivalent to those of a shareholder
and shall be a shareholder when his or her purchase is entered upon the records
of the duly authorized transfer agent of the Company. No adjustment shall be
made for a dividend or other right for which the record date is prior to the
date the Stock Purchase Right is exercised, except as provided in Section 12 of
the Plan.
-10-
<PAGE> 11
12. Adjustments Upon Changes in Capitalization or Merger.
(a) Changes in Capitalization. Subject to any required action by the
shareholders of the Company, the number of shares of Common Stock covered by
each outstanding Option or Stock Purchase Right, and the number of shares of
Common Stock which have been authorized for issuance under the Plan but as to
which no Options or Stock Purchase Rights have yet been granted or which have
been returned to the Plan upon cancellation or expiration of an Option or Stock
Purchase Right, as well as the price per share of Common Stock covered by each
such outstanding Option or Stock Purchase Right, shall be proportionately
adjusted for any increase or decrease in the number of issued shares of Common
Stock resulting from a stock split, reverse stock split, stock dividend,
combination or reclassification of the Common Stock, or any other increase or
decrease in the number of issued shares of Common Stock effected without receipt
of consideration by the Company. The conversion of any convertible securities of
the Company shall not be deemed to have been "effected without receipt of
consideration." Such adjustment shall be made by the Board, whose determination
in that respect shall be final, binding and conclusive. Except as expressly
provided herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or price
of shares of Common Stock subject to an Option or Stock Purchase Right.
(b) Dissolution or Liquidation. In the event of the proposed
dissolution or liquidation of the Company, the Administrator shall notify the
Optionee at least fifteen (15) days prior to such proposed action. To the extent
it has not been previously exercised, the Option or Stock Purchase Right shall
terminate immediately prior to the consummation of such proposed action.
(c) Merger or Asset Sale. In the event of a merger of the Company with
or into another corporation, or the sale of substantially all of the assets of
the Company, each outstanding Option and Stock Purchase Right shall be assumed
or an equivalent option or right substituted by the successor corporation or a
Parent or Subsidiary of the successor corporation. In the event that the
successor corporation refuses to assume or substitute for the Option or Stock
Purchase Right, the Optionee shall have the right to exercise the Option or
Stock Purchase Right as to all of the Optioned Stock, including Shares as to
which it would not otherwise be exercisable. If an Option or Stock Purchase
Right is exercisable in lieu of assumption or substitution in the event of a
merger or sale of assets, the Administrator shall notify the Optionee that the
Option or Stock Purchase Right shall be fully exercisable for a period of
fifteen (15) days from the date of such notice, and the Option or Stock Purchase
Right shall terminate upon the expiration of such period. For the purposes of
this paragraph, the Option or Stock Purchase Right shall be considered assumed
if, following the merger or sale of assets, the option or right confers the
right to purchase or receive, for each Share of Optioned Stock subject to the
Option or Stock Purchase Right immediately prior to the merger or sale of
assets, the consideration (whether stock, cash, or other securities or property)
received in the merger or sale of assets by holders of Common Stock for each
Share held on
-11-
<PAGE> 12
the effective date of the transaction (and if holders were offered a choice of
consideration, the type of consideration chosen by the holders of a majority of
the outstanding Shares); provided, however, that if such consideration received
in the merger or sale of assets was not solely common stock of the successor
corporation or its Parent, the Administrator may, with the consent of the
successor corporation, provide for the consideration to be received upon the
exercise of the Option or Stock Purchase Right, for each Share of Optioned Stock
subject to the Option or Stock Purchase Right, to be solely common stock of the
successor corporation or its Parent equal in fair market value to the per share
consideration received by holders of Common Stock in the merger or sale of
assets.
13. Time of Granting Options and Stock Purchase Rights. The date of grant
of an Option or Stock Purchase Right shall, for all purposes, be the date on
which the Administrator makes the determination granting such Option or Stock
Purchase Right, or such other date as is determined by the Administrator. Notice
of the determination shall be given to each Employee or Consultant to whom an
Option or Stock Purchase Right is so granted within a reasonable time after the
date of such grant.
14. Amendment and Termination of the Plan.
(a) Amendment and Termination. The Board may at any time amend, alter,
suspend or discontinue the Plan, but no amendment, alteration, suspension or
discontinuation shall be made which would impair the rights of any Optionee
under any grant theretofore made, without his or her consent. In addition, to
the extent necessary and desirable to comply with Rule 16b-3 under the Exchange
Act or with Section 422 of the Code (or any other applicable law or regulation,
including the requirements of the NASD or an established stock exchange), the
Company shall obtain shareholder approval of any Plan amendment in such a manner
and to such a degree as required.
(b) Effect of Amendment or Termination. Any such amendment or
termination of the Plan shall not affect Options or Stock Purchase Rights
already granted, and such Options and Stock Purchase Rights shall remain in full
force and effect as if this Plan had not been amended or terminated, unless
mutually agreed otherwise between the Optionee and the Administrator, which
agreement must be in writing and signed by the Optionee and the Company.
15. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant
to the exercise of an Option or Stock Purchase Right unless the exercise of such
Option or Stock Purchase Right and the issuance and delivery of such Shares
pursuant thereto shall comply with all relevant provisions of law, including,
without limitation, the Securities Act of 1933, as amended, the Exchange Act,
the rules and regulations promulgated thereunder, and the requirements of any
stock exchange upon which the Shares may then be listed, and shall be further
subject to the approval of counsel for the Company with respect to such
compliance.
-12-
<PAGE> 13
As a condition to the exercise of an Option or Stock Purchase Right, the
Company may require the person exercising such Option or Stock Purchase Right to
represent and warrant at the time of any such exercise that the Shares are being
purchased only for investment and without any present intention to sell or
distribute such Shares if, in the opinion of counsel for the Company, such a
representation is required by any of the aforementioned relevant provisions of
law.
16. Reservation of Shares. The Company, during the term of this Plan, shall
at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan.
The inability of the Company to obtain authority from any regulatory body
having jurisdiction, which authority is deemed by the Company's counsel to be
necessary to the lawful issuance and sale of any Shares hereunder, shall relieve
the Company of any liability in respect of the failure to issue or sell such
Shares as to which such requisite authority shall not have been obtained.
17. Agreements. Options and Stock Purchase Rights shall be evidenced by
written agreements in such form as the Administrator shall approve from time to
time.
18. Shareholder Approval. Continuance of the Plan shall be subject to
approval by the shareholders of the Company within twelve (12) months before or
after the date the Plan is adopted. Such shareholder approval shall be obtained
in the degree and manner required under applicable state and federal law and the
rules of any stock exchange upon which the Common Stock is listed.
-13-
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