<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 March 28, 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
May 5, 1998 was 43,843,686.
<PAGE> 2
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
March 28, December 31,
1998 1997
--------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,576 $ 101,847
Short-term investments 162,875 74,198
Trade and other accounts receivable, net 6,378 3,988
Prepaid expenses and other current assets 761 783
--------- ---------
Total current assets 175,590 180,816
Property and equipment, net 21,250 21,462
Capitalized film production costs, long-term 36,085 28,589
Other assets 229 201
--------- ---------
Total assets $ 233,154 $ 231,068
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 691 $ 1,694
Income taxes payable 1,596 1,776
Payable to Disney 2,249 2,162
Accrued liabilities 6,148 7,276
Unearned revenue 654 860
--------- ---------
Total current liabilities 11,338 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;
43,521,476 and 42,410,707 shares issued and outstanding
as of March 28, 1998 and December 31, 1997, respectively 211,594 210,902
Unrealized gain (loss) on investments (63) 29
Deferred compensation (316) (414)
Retained earnings 10,601 6,783
--------- ---------
Total shareholders' equity 221,816 217,300
--------- ---------
Total liabilities and shareholders' equity $ 233,154 $ 231,068
========= =========
</TABLE>
See accompanying notes to financial statements.
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PIXAR
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended
-----------------------
March 28, March 31,
1998 1997
--------- ---------
<S> <C> <C>
Revenues:
Software $ 673 $ 1,418
Animation services 171 --
Film 4,036 6,301
Patent licensing 117 148
-------- --------
Total revenues 4,997 7,867
-------- --------
Cost of revenues:
Software 36 9
Animation services 38 --
Film -- 558
-------- --------
Total cost of revenues 74 567
-------- --------
Gross profit 4,923 7,300
-------- --------
Operating expenses:
Research and development 866 1,081
Sales and marketing 218 252
General and administrative 1,766 1,227
-------- --------
Total operating expenses 2,850 2,560
-------- --------
Income from continuing operations 2,073 4,740
-------- --------
Other income, net 2,400 2,135
-------- --------
Income from continuing operations before income taxes 4,473 6,875
Income tax expense 1,029 1,650
-------- --------
Net income from continuing operations 3,444 5,225
Income (loss) from discontinued operations (net of income tax
expense of $112 in 1998 and income tax benefit of $24 in 1997) 374 (77)
-------- --------
Net income $ 3,818 $ 5,148
======== ========
Shares used in computing basic net income (loss) per share 43,119 39,570
======== ========
Basic net income per share from continuing operations $ 0.08 $ 0.13
Basic net income (loss) per share from discontinued operations 0.01 (0.00)
-------- --------
Basic net income per share $ 0.09 $ 0.13
======== ========
Shares used in computing diluted net income (loss) per share 50,316 46,906
======== ========
Diluted net income per share from continuing operations $ 0.07 $ 0.11
Diluted net income (loss) per share from discontinued operations 0.01 (0.00)
-------- --------
Diluted net income per share $ 0.08 $ 0.11
======== ========
</TABLE>
See accompanying notes to financial statements.
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<PAGE> 4
PIXAR
STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Quarter Ended
-------------------------
March 28, March 31,
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,818 $ 5,148
Adjustments to reconcile net income to net cash
provided by (used in) continuing operating activities:
Discontinued operations (374) 77
Amortization of deferred compensation 98 192
Depreciation and amortization 1,151 338
Amortization of capitalized film production costs -- 558
Credits from patent licensing, net of expense items (114) (117)
Changes in operating assets and liabilities:
Trade and other accounts receivable (2,390) 1,193
Prepaid expenses and other current assets 136 256
Accounts payable (1,003) (71)
Income taxes payable (180) 1,510
Payable to Disney 87 --
Accrued liabilities (1,128) 1,634
Unearned revenue (206) 172
--------- ---------
Net cash provided by (used in) continuing operations (105) 10,890
Net cash provided by discontinued operations 374 112
--------- ---------
Net cash provided by operating activities 269 11,002
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (939) (1,831)
Proceeds from sale of short-term securities 13,417 29,585
Investments in short-term securities (102,186) (24,021)
Capitalized film production costs (7,496) (4,440)
Other assets (28) (399)
--------- ---------
Net cash used in investing activities (97,232) (1,106)
--------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock and warrants, net -- 14,896
Proceeds from exercised stock options 692 389
--------- ---------
Net cash provided by financing activities 692 15,285
--------- ---------
Net increase (decrease) in cash and cash equivalents (96,271) 25,181
Cash and cash equivalents at beginning of period 101,847 44,648
--------- ---------
Cash and cash equivalents at end of period $ 5,576 $ 69,829
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 1,320 $ --
========= =========
Supplemental disclosure of non-cash investing and financing activities:
Credits from patent licensing $ 117 $ 148
========= =========
Non-cash film production costs capitalized $ -- $ 8,235
========= =========
Unrealized gain (loss) on investments $ (92) $ 212
========= =========
</TABLE>
See accompanying notes to financial statements.
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<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 quarter ended March 28, 1998 are not
necessarily indicative of the results expected for the current year or any
other period.
Certain amounts reported in previous periods have been reclassified to
conform to the 1998 financial statement presentation.
(2) FISCAL YEAR
Effective for fiscal year 1998, the Company adjusted its fiscal year end
from December 31 to the 52 or 53-week period that ends on the Saturday nearest
December 31. As a result, the first quarter of 1998 represents the thirteen-week
period ended March 28, 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.
Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------------------------------------------------
March 28, 1998 March 31, 1997
----------------------------------------- -----------------------------------------
Net Net
Income Shares EPS Income Shares EPS
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
BASIC NET INCOME PER SHARE $ 3,818 43,119 $ 0.09 $ 5,148 39,570 $ 0.13
EFFECT OF DILUTIVE SHARES:
WARRANTS/OPTIONS -- 7,197 -- 7,336
------------------------- -------------------------
DILUTED NET INCOME PER SHARE $ 3,818 50,316 $ 0.08 $ 5,148 46,906 $ 0.11
========================= =========================
</TABLE>
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(4) FEATURE FILM PRODUCTION AND CO-PRODUCTION AGREEMENT
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
$6.3 million and $4.0 million for the quarters ended March 31, 1997 and March
28, 1998, respectively, for a total of $49.8 million since the film's release.
All production costs incurred by Pixar through 1995 were reimbursed by Disney on
a current basis and recorded by Pixar as cost reimbursements. Accordingly, these
reimbursements were not recorded as revenue.
CO-PRODUCTION AGREEMENT
In February 1997, Pixar and Disney entered into a new co-production
agreement (the "Co-Production Agreement") which now governs all films made by
Pixar since Toy Story. Films in development or production by Pixar as of March
28, 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 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 approximately 60 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 quarter ended
March 31, 1997. Pixar recorded income from discontinued operations of $374,000,
net of income taxes, for the quarter ended March 28, 1998, due to royalty income
received for the Toy Story CD-ROM products. Pixar anticipates future royalty
income will exceed costs to be incurred in all future periods, but that such
amounts 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
quarters ended March 28, 1998 and March 31, 1997.
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<PAGE> 7
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," "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 "Anticipated Net Losses
in 1998 and The First Half of 1999", "Dependence on Toy Story, A Bug's Life and
Toy Story 2", and "Liquidity Risks" 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 section 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 Growth" and "--Risks Associated With Co-Production Agreement." Unless
required by law, Pixar undertakes no obligation to update publicly 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, 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 computer animated feature-length
theatrical motion pictures (the "Pictures") for distribution by Disney over
approximately the next ten years. 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 or 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 is
the Picture with the working title "A Bug's Life." The Co-Production Agreement
also contemplates that with respect to interactive media products and other
derivative works related to the Pictures, Pixar will have the opportunity to
co-finance and produce such products or to earn passive royalties on such
products. Pixar will not share in any theme park revenues 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
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<PAGE> 8
Co-Production Agreement and all the provisions applicable to the other five
Pictures apply. Since 1996, Pixar has been producing Toy Story 2 for the less
expensive made-for-home video format. Therefore, Pixar will necessarily 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 continues story development on its fourth
theatrical film ("Film Four"). This film will be developed and distributed under
the Co-Production Agreement and will count as the second of the five original
films to be produced under the Co-Production Agreement. 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. 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 quarter ended March 28, 1998 were $5.0 million
compared to $7.9 million in the same period of the prior year. The decrease was
primarily due to declines in Toy Story-related revenue and in software license
revenue.
Software revenues consist mainly of software license revenue,
principally from RenderMan. Software revenues decreased by 53% to $673,000 for
the quarter ended March 28, 1998 from $1.4 million in the corresponding prior
year period. The decrease in software revenues resulted from a general decrease
in the number of RenderMan software licenses due to Pixar's focus on content
creation for animated feature films and related products. 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 revenue and presented in results of discontinued operations. See
"Results of Discontinued Operations."
Animation services revenues of $171,000 for the quarter ended March 28,
1998 primarily represents revenue from a short project related to Pixar's films.
Pixar expects that revenue in this area will vary significantly from quarter to
quarter. It is likely that in some or all of the remaining quarters in 1998,
Pixar will generate no animation services revenues due to the fact that Pixar
has transferred substantially all of its animation services employees to assist
in the completion of A Bug's Life. 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 throughout most of 1998, and may be the case thereafter.
Film revenues decreased to $4.0 million for the quarter ended March 28,
1998 from $6.3 million in the corresponding prior year period. First quarter
1997 film revenues primarily represent Pixar's initial share of Toy Story home
video revenues as determined under the original Feature Film Agreement. First
quarter 1998 film revenues represent Pixar's share of Toy Story-related
merchandising royalties, the 1997 ABC television airing of Toy Story and Toy
Story-related home video revenue. Since Pixar has already recognized the vast
majority of the revenue it expects to receive from Toy Story, and since Pixar's
next feature film, A Bug's Life, is not targeted for release until the end of
1998 at the earliest, Pixar expects that revenue and earnings will continue to
decline in subsequent periods as compared to 1997.
Patent licensing revenues of $117,000 for the quarter ended March 28,
1998 and $148,000 in the same period of the prior year 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
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<PAGE> 9
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 through the year 2000. 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 quarter ended March 31, 1997, revenue of $148,000
was recognized representing credits used during that period. For the quarter
ended March 28, 1998, revenue of $117,000 was recognized representing credits
used during that period. Since March 1996, Pixar has used substantially all of
the $5.0 million worth of credits, with the remaining credits of $27,000
expected to be used during 1998. Pixar does not expect that patent licensing
revenues will be generated on an on-going basis.
For the quarter ended March 28, 1998, Disney accounted for 84% of
Pixar's total revenues. The revenues from Disney consisted primarily of film and
animation services revenues. Pixar expects to continue to be dependent upon
Disney for a majority of its revenue. Substantially all of the Disney revenue
for the quarter was included in trade and other accounts receivable and
represented 62% of the balance at March 28, 1998. For the quarter ended March
31, 1997, Disney accounted for 88% of Pixar's total revenues, primarily from
film and software revenues.
COST OF REVENUES
Cost of software revenues consists of the direct costs and manufacturing
overhead required to reproduce and package software products. Cost of software
revenues as a percentage of the related revenues increased to 5% for the quarter
ended March 28, 1998 from 1% in the prior year period due to an increase in the
cost of related manuals. Cost of software revenues includes no amortization of
capitalized software development expenses.
Cost of animation services revenues consists of production costs, which
include salaries, benefits, facility expenses and department overhead costs.
Costs of animation services revenues as a percentage of related revenues was 22%
for the quarter ended March 28, 1998. During the quarter ended March 31, 1997,
there were no animation services revenues nor related costs.
Cost 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 was no cost of revenues
associated with film revenues for the quarter ended March 28, 1998. Any further
Toy Story film-related revenues will have no associated cost of revenues. Cost
of film revenues as a percentage of the related revenues was 9% for the quarter
ended March 31, 1997.
There is no cost of revenues associated with patent licensing revenues.
OPERATING EXPENSES
Total operating expenses for the quarter ended March 28, 1998 were
higher than in the prior year, and Pixar intends to continue to increase its
spending levels in a number of areas. First, as a result of intense competition
for animators, creative personnel, technical directors and certain
administrative personnel, Pixar has had to pay higher salaries to attract new
creative, technical and other personnel. Pixar expects compensation for such
personnel to continue to increase. In the quarter ended March 28, 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. Further, a portion of Pixar's general and
administrative overhead costs which benefit the productions are capitalized by
Pixar. In addition, because Disney is responsible for paying all film marketing
costs under the Co-Production Agreement, to the extent that 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 precede or are not
subsequently followed by an increase in revenues, Pixar's business, operating
results and financial condition will be materially adversely affected.
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<PAGE> 10
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 totaled
$866,000 and $1.1 million for the quarters ended March 28, 1998 and March
31,1997, respectively. The decrease was due to the completion of a significant
research and development project in the quarter ended December 31, 1997, coupled
with the reassignment of certain research and development employees to work on
film productions. Pixar expects increased research and development spending in
future quarters. To date, all software development costs have been expensed as
incurred.
Sales and marketing expenses consist primarily of salaries and related
overhead, as well as advertising, technical support, public relations and trade
show costs required to support the software segment and complement the film
segment. Sales and marketing expenses decreased 13% to $218,000 for the quarter
ended March 28, 1998 from $252,000, due to the reimbursement by Disney of all
film-specific marketing costs incurred. Pixar expects that marketing expenses
may increase in absolute dollars in future periods, particularly in the areas of
corporate marketing and public relations.
General and administrative expenses consist primarily of salaries of
management and administrative personnel, insurance costs and professional fees.
General and administrative expenses increased 44% to $1.8 million for the
quarter ended March 28, 1998 from $1.2 million in the same period of the prior
year. The increase was primarily due to increased staffing and increased systems
and facilities costs. 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 continues to expect general and administrative
expenses to increase in absolute dollars in future periods as Pixar incurs
additional costs to expand its administrative staff and facilities.
OTHER INCOME (EXPENSE), NET
Other income, net was $2.4 million and $2.1 million for the quarters
ended March 28, 1998 and March 31, 1997, respectively, consisting primarily of
interest income on investments of the net proceeds from Pixar's initial public
offering of common stock.
INCOME TAXES
Income tax expense from continuing operations for the quarter ended
March 28, 1998 reflects Pixar's federal and state income tax liability after
near complete utilization of remaining net operating loss carryforwards and
federal and state tax credits. Income taxes decreased for the quarter ended
March 28, 1998 as a result of the Company's projected lower results for fiscal
year 1998 and the benefit of certain tax deductions occurring in 1998.
RESULTS OF DISCONTINUED OPERATIONS
After the Co-Production Agreement was executed, Pixar determined that,
despite the fact that Pixar's first CD-ROM titles were successful on relative
terms, the resources devoted to its interactive products division would be
better allocated to other projects arising from the Co-Production Agreement.
Pixar determined in March 1997 to discontinue its business of producing CD-ROM
and other interactive products and has redirected the approximately 60 employees
that were in this 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 quarter ended March 31, 1997. Pixar recorded income
from discontinued operations of $374,000, net of income taxes, for the quarter
ended March 28, 1998, due to royalty income received for the Toy Story CD-ROM
products. Pixar anticipates future royalty income, if any, will exceed costs to
be incurred in all future periods, but that such amounts will not be
significant.
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FACTORS AFFECTING OPERATING RESULTS AND FINANCIAL CONDITION
The following is a discussion of certain factors which currently impact
or may impact Pixar's business, operating results and/or financial condition.
Anyone making an investment decision with respect to Pixar's capital stock or
other securities is cautioned to carefully consider these factors, along with
the factors discussed in Pixar's Form 10-K under the section entitled "Certain
Factors Affecting Business, Operating Results and Financial Condition."
ANTICIPATED NET LOSSES IN 1998 AND THE FIRST HALF OF 1999
A number of factors are expected to result in net losses for fiscal year
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. While relatively minor amounts of revenue may be
received by Pixar in subsequent periods from sources such as Toy Story
merchandise royalties, Toy Story television airings, and minor remaining
international home video sales of Toy Story, Pixar does not expect to recognize
any further significant revenue from Toy Story in the future.
TIMING OF A BUG'S LIFE AND TOY STORY 2 RELEASES
A Bug's Life is not expected to be released until the end of 1998 at the
earliest, and revenue attributable to A Bug's Life is not expected to be
recognized until after all marketing and distribution costs and fees have been
recovered by Disney. Recovery of all marketing and distribution costs and fees
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, 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
Although its first two CD-ROM products were successful on relative
terms, 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 the Co-Production Agreement. Pixar has not
recognized and will not recognize any CD-ROM income from this discontinued
operation in 1998 or thereafter, other than royalty income attributable to the
two existing Toy Story CD-ROM products. Pixar has redirected all of the
approximately 60 employees that were in this division to feature film
productions and other departments within Pixar.
POSSIBLE DECLINE IN REVENUES FROM RENDERMAN LICENSING DUE TO SHIFT IN FOCUS
As a result of Pixar's reduced emphasis on the commercialization of
software in favor of products sold for their content, Pixar expects to dedicate
less time and resources to distributing and marketing RenderMan than it has in
the past and further expects that licensing of RenderMan may decline, as was the
case in the quarter ended March 28, 1998.
INCREASE IN OPERATING EXPENSES
In 1997 and the first quarter of 1998, 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.
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<PAGE> 12
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 such expenses are not capitalized by Pixar nor
paid for by Disney, Pixar's operating expenses will significantly increase in
1998. 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 and 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.
IMPACT ON OPERATING RESULTS
As a result of the above factors, Pixar expects revenue to substantially
decline for fiscal year 1998 as compared to the year ended December 31, 1997. At
the same time, Pixar's operating expenses are expected to increase in 1998, even
after giving effect to capitalization of film production costs and allocation of
certain operating expenses to Disney under the Co-Production Agreement.
Therefore, Pixar expects revenue and operating results in the second, third and
fourth quarters of 1998 to decline substantially from the first quarter of 1998
and from the same quarters of 1997. Pixar expects operating and net losses in
each of the next three quarters of 1998 and in the first half of 1999. Operating
results thereafter will depend upon the success of Pixar's next films, starting
with A Bug's Life.
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 merchandise royalties, any remaining Toy
Story home video revenues and revenues from television airings of Toy Story.
Pixar recognized the vast majority of Toy Story home video revenue in 1997 and
through the quarter ended March 28, 1998, and expects little revenue from Toy
Story or related products for the balance of fiscal year 1998 and thereafter.
Pixar also expects little or no royalty income from its Toy Story CD-ROM
products for the balance of fiscal year 1998 and thereafter. Because A Bug's
Life is not expected to be released until the end of 1998 at the earliest, and
Toy Story 2 is not expected to be released until the end of 1999 at the
earliest, any other revenues in the balance 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 shares the production costs of
A Bug's Life. These costs will initially be capitalized as film production costs
under SFAS No. 53, Financial Reporting by Producers and Distributors of Motion
Picture Films, and then be amortized over the expected revenue stream when
revenue is recognized. If A Bug's Life is not an extraordinary box office
success similar to Toy Story, the amount of revenue
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<PAGE> 13
recognized will not be significant, and the capitalized production costs will
have to be amortized in large amounts over a limited number of quarters,
resulting in significant costs of film revenue in those quarters and,
potentially, significant quarterly operating and net losses. Animated feature
films that become extraordinary box office successes are rare. Pixar believes,
based on available information, that there is a reasonable basis to conclude
that of the more than 40 animated feature films introduced since 1990, only two
movies generated domestic box office revenues greater than Toy Story, and both
of those films were produced and distributed solely by Disney. During at least
the last five years, Pixar believes that there has been no fully animated
feature film (other than Toy Story) produced or developed by a studio other than
Disney that has achieved more than $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. For
example, The Nightmare Before Christmas, released in 1993, was an animated
feature film with a different appearance than traditional, hand drawn cel
animated feature films such as Beauty and the Beast, The Lion King, Aladdin,
Pocahontas, The Hunchback of Notre Dame and Hercules and did not experience the
same box office returns as those 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. With a theatrical sequel,
the story concept and characters are not as novel as the original film. 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. This was
the case for sequels to such films as Star Wars, Jurassic Park, Home Alone,
Jaws, Batman, Raiders of the Lost Ark, Beverly Hills Cop, Ghostbusters and Back
to the Future, among others. In many cases, sequels substantially under-perform
the original film. In far fewer cases have sequels performed as well or better
than the original blockbuster feature film, and in almost all of the cases, the
original feature films and related sequels were action-adventure films, such as
Lethal Weapon and Die Hard. Accordingly, there can be no assurance that Toy
Story 2 will perform as well as Toy Story at the box office. It is possible that
Toy Story 2 will substantially under-perform the original feature film. In
addition, fees and participations paid to key talent on Toy Story 2 are
substantially greater than for the original film, which will have the effect of
increasing the cost of the film.
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 financed equally by Pixar and
Disney under the Co-Production Agreement. 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. For example, in order to meet the production
schedule, substantially all employees from Pixar's animation services group were
transferred to A Bug's Life for the duration of its production, which will
result in a larger production staff than originally anticipated and which will
generate additional production costs.
DIVIDED RESPONSIBILITIES OF CHIEF EXECUTIVE OFFICER
Pixar's Chief Executive Officer and Chairman, Steven P. Jobs, is also
acting 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 full time and resources to Pixar. For day to day operations,
since 1995, Pixar has established an Office of the President which is
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<PAGE> 14
comprised of Mr. Jobs as Chief Executive Officer, Edwin E. Catmull as Executive
Vice President and Chief Technical Officer, and Lawrence B. Levy, as Executive
Vice President and Chief Financial Officer.
LIQUIDITY RISKS
Pursuant to the Co-Production Agreement, Pixar will co-finance the next five
animated feature films which it produces, including A Bug's Life and Film Four.
Pixar will also co-finance Toy Story 2 on the same basis as the other theatrical
films. In the future, Pixar may co-finance other derivative works such as
sequels, interactive products and television productions. In addition, Pixar 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 March 28, 1998, Pixar had approximately $168.5
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 $36.1 million in capitalized film production costs as
of March 28, 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 the 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 $7.5 million to $168.5 million at
March 28, 1998 from $176.0 million at December 31, 1997. Working capital
decreased $2.7 million to $164.3 million at March 28, 1998 from $167.0 million
at December 31, 1997.
Net cash used in continuing operations for the quarter ended March 28, 1998
was primarily attributable to an increase in trade and other receivables of $2.4
million and a decrease in accounts payable and other accrued liabilities of $2.1
million offset by net income of $3.8 million and the non-cash impact of
depreciation expense of $1.2 million. Cash flows used in investing activities
were due primarily to investments in short-term securities of $102.2 million,
the purchase of property and equipment of $939,000 and funding of film
production costs of $7.5 million, offset by net proceeds from maturities of
short-term securities of $13.4 million. Cash flows provided by financing
activities were due to proceeds from the exercise of stock options.
As of March 28, 1998, Pixar's principal source of liquidity was
approximately $168.5 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 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.
-14-
<PAGE> 15
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) The effective date of the Company's first registration statement, filed
on Form S-1 under the Securities Act of 1933 (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 was
$139,661,286.
As of March 28, 1998, the Company had used the net proceeds from the
offering as follows: $12,073,466 for construction of plant, building and
facilities, $9,106,731 for the purchase and installation of machinery and
equipment, $2,374,000 for the repayment of indebtedness, $51,248,678 for the
development of future films and other animated products, $14,159,830 for working
capital and $50,698,581 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 6. EXHIBIT AND REPORTS ON FORM 8-K
(a) EXHIBITS
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by Pixar during the quarter ended
March 28, 1998.
ITEMS 1, 3, 4, AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
-15-
<PAGE> 16
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: May 12, 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)
-16-
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