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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 2, 1999
COMMISSION FILE NUMBER 0-26976
PIXAR
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 68-0086179
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
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1001 WEST CUTTING BOULEVARD, RICHMOND, CALIFORNIA 94804
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 236-4000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, NO PAR VALUE PER SHARE
(TITLE OF CLASS)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of March 19, 1999, there were 45,625,719 shares of the Registrant's
Common Stock outstanding and the aggregate market value of such shares held by
non-affiliates of the Registrant (based upon the closing sale price of such
shares on the Nasdaq National Market on March 19, 1999) was approximately
$584,134,562. Shares of Common Stock held by each executive officer and director
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
Certain sections of Pixar's Annual Report to Shareholders for the year
ended January 2, 1999 (the "1998 Annual Report") are incorporated by reference
in Parts II and IV of this Form 10-K to the extent stated herein.
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This Annual Report on Form 10-K and the documents incorporated herein by
reference contain 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 "Risk Factors" on pages 14 through 28 as
well as those noted in the documents incorporated herein by reference.
Particular attention should be paid to the cautionary language in Risk Factors,
"-- We Depend on Toy Story, A Bug's Life, Toy Story 2 and Film Four," "-- Risks
Associated with Adequacy of Cash Balances," "-- Risks Associated with Scheduled
Successive Release of Films" and "-- Risks Associated with Co-Production
Agreement." Unless required by law, Pixar undertakes no obligation to update
publicly any forward-looking statements, whether as a result of new information,
future events or otherwise.
PART I
ITEM 1. BUSINESS
GENERAL
Pixar is a leading digital animation studio with the creative, technical
and production capabilities to create a new generation of animated feature films
and related products. Pixar's objective is to create, develop and produce
computer animated feature films with a new three-dimensional appearance,
heartwarming stories and memorable characters that appeal to audiences of all
ages. Through the creation of entertaining, enduring and successful films, Pixar
seeks to become a leading brand in animated feature films. Pixar's first and
second such films, Toy Story and A Bug's Life, were created and produced by
Pixar and were marketed and distributed by The Walt Disney Company (along with
its subsidiaries hereinafter referred to as "Disney"). Toy Story was released in
November 1995 and generated over $191 million in domestic box office revenue,
and Pixar's second animated feature film, A Bug's Life, was released in November
1998. See "-- Recent Developments."
In February 1997, Pixar extended its existing relationship with Disney
(under which Toy Story was created and produced) by entering into the
Co-Production Agreement. Under the Co-Production Agreement, Pixar will produce,
on an exclusive basis, five original computer animated feature films (the
"Pictures") for distribution by Disney. Pixar and Disney will co-finance and
co-brand the films and share equally in the profits of each film and any related
merchandise and other ancillary products, after recovery of all marketing and
distribution costs and fees. The first of the films produced under the
Co-Production Agreement was A Bug's Life. See "-- Relationship with
Disney -- Co-Production Agreement."
RECENT DEVELOPMENTS
Release of A Bug's Life. In November 1998, A Bug's Life was released and,
as of March 28, 1999, it had generated over $160 million in domestic box office
revenue and $176 in foreign box office revenue.
Changes in Management. In March 1999, Pixar announced that, at the end of
March 1999, Lawrence B. Levy will be resigning from his position as Executive
Vice President, Chief Financial Officer and member of the Office of the
President. Pixar also announced that, effective in April 1999, Mr. Levy and
Edwin E. Catmull, Executive Vice President, Chief Technical Officer and member
of the Office of the President, will become members of Pixar's Board of
Directors. Effective in April 1999, Dr. Catmull will also become Secretary of
Pixar in lieu of Mr. Levy. In addition, in February 1999, Pixar announced the
promotion of five of its employees to senior executive positions. John Lasseter
was promoted to Executive Vice President of Creative, Sarah McArthur was
promoted to Executive Vice President of Production, Darwyn Peachey was
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promoted to Vice President of Research and Development, Greg Brandeau was
promoted to Vice President of Computer Operations and Sarah Flatley was promoted
to Vice President of Finance.
John Lasseter transitions to Toy Story 2. In January 1999, after completion
of A Bug's Life, John Lasseter, Pixar's Executive Vice President of Creative
Development and Director of Toy Story and A Bug's Life, transitioned to Director
of Toy Story 2. Lee Unkrich and Ashley Brannon will be Co-Directors of Toy Story
2.
BUSINESS MODEL AND PRODUCTS
Pixar's strategy is to become a leading brand in the development and
production of animated feature films and related products, such as soundtracks,
toys and other merchandise. Pixar is currently implementing this strategy
through the Co-Production Agreement with Disney.
Animated Feature Films. Pixar's first computer-animated feature film, Toy
Story, was released in November 1995. On November 25, 1998, Pixar successfully
released A Bug's Life, its second computer-animated feature film for
distribution by Disney. A Bug's Life was the first of five such films developed
and distributed under the Co-Production Agreement with Disney, and Pixar intends
to continue to develop computer animated feature films for the family
entertainment market. In 1998, Pixar continued development and production on Toy
Story 2, a derivative work now subject to the same terms as the other theatrical
motion pictures developed under the Co-Production Agreement, except Toy Story 2
will not be counted toward the five Pictures to be produced under that
agreement. Toy Story 2 is not expected to be released until late 1999 at the
earliest. Also in 1998, Pixar continued story development on its fourth
theatrical film ("Film Four") and other future films. Production of Film Four
has not yet begun, however Disney and Pixar have approved the related story
treatment and budget as required under the Co-Production Agreement. Film Four is
not expected to be released until mid 2001 at the earliest. See "Risk
Factors -- Risk Associated with Scheduled Successive Releases of Films."
Home Videos. Toy Story was released by Disney as a home video in October
1996 and A Bug's Life is scheduled for home video release on April 20, 1999.
Pixar believes that its future animated feature films will also lend themselves
to home video distribution in both domestic and international markets.
Distribution of home video versions of the animated feature films developed and
produced under the Co-Production Agreement will also be pursuant to the
Co-Production Agreement.
Merchandise and Soundtracks. Pixar believes that the characters and music
created in animated feature films lend themselves to opportunities for selling
merchandise and soundtracks. For example, merchandise such as children's toys
based on stories and characters in A Bug's Life were designed using
three-dimensional data from Pixar's digital models. Disney has the rights to
distribute merchandise and soundtracks from Toy Story, A Bug's Life and the
remaining feature films to be made pursuant to the Co-Production Agreement.
Pixar shares in the profits, if any, generated from such sales.
Short Films. Pixar has developed a number of short films since its
inception and continues to invest in developing new short films. In 1997, Pixar
created and produced a short film, Geri's Game. Although the short films have
few commercial opportunities, Pixar believes it is an important investment for
the development of creative talent and Pixar's computer animation technology.
For example, Geri's Game enabled Pixar to further its technology in computer
generated skin and cloth. In addition, such short films provide Pixar with
opportunities for valuable publicity and critical acclaim that further
establishes the Pixar brand. For example, in 1998, Geri's Game won an Academy
Award for Best Short Film (Animated). In addition, Geri's Game was released
theatrically nationwide as the preceding short film to A Bug's Life.
RenderMan. Pixar has been selling its RenderMan software for nearly ten
years. RenderMan has helped visual effects studios create visual effects such as
certain dinosaurs in Jurassic Park, new creatures appearing in the 1998
re-release of Star Wars, the metal cyborg in Terminator 2 and the hoard of
horsemen charging over the hill in Mulan. RenderMan runs on Unix-based
workstations from Silicon Graphics, Inc ("Silicon Graphics"), Sun Microsystems,
Inc. ("Sun") and Digital Equipment Corp. ("Digital Equipment"). Examples of
RenderMan customers include movie studios such as Disney, Twentieth Century Fox
Film Corpora-
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tion, Lucasfilm Ltd. through its affiliate Industrial Light and Magic ("ILM"),
Columbia/Tri-Star Pictures Inc. and Warner Bros., Inc. Customers also include
government agencies and universities. The RenderMan ToolKit is sold at a list
price of $5,000 per license. Discounts are available for site or multi-use
licenses. See "-- Technology -- RenderMan" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in the 1998 Annual
Report to Shareholders.
Short Animation Products. Pixar has also in the past produced animated or
partially animated television commercials, including commercials for products
such as Coca-Cola, Listerine and Gummi-Savers (a LifeSavers product). However,
in 1996, Pixar largely discontinued its business of producing commercials in
favor of other opportunities. Pixar still produces short animation projects,
primarily derived from Pixar's films, such as the "Tree of Life" which is
currently on display at the Animal Kingdom in Disney World, and animation for
the advertising of McDonald's Happy Meals which were tied into A Bug's Life.
Moreover, Pixar believes that there may continue to be other opportunities to
produce short animation projects for Disney in connection with work performed
under the Co-Production Agreement.
PIXAR COMPUTER ANIMATION PROCESS AND DIGITAL BACK LOT
Pixar Computer Animation Process
The development and production of animated feature films is extremely
complex and time consuming due to the very large number of frames and intricate
detail of each frame. At 24 frames per second, a 77-minute animated feature film
such as Toy Story requires approximately 110,000 individual frames. Animation
for feature films has traditionally been created through hand-drawn cels,
requiring hundreds of people working for two to three years. Although computers
have been used to assist in some elements of cel animation during the past
several years, most frames are still hand-drawn.
Pixar believes that its proprietary technology, which allows animators to
manipulate hundreds of motion control points within a single character, allows
for more intricacy and subtlety of character and personality than traditional
two-dimensional cel-based animation. This technology also facilitates the
manipulation, editing and re-use of animated images.
Pixar makes its computer animated films and other projects in four stages:
creative development, pre-production, production and post-production. Because
this process is iterative, there is continual reworking of the film. The basic
elements of this highly complex process are outlined below.
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CREATIVE
DEVELOPMENT Story Concept 5 Treatment/Outline 5 Screenplay
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Creative Development. Creative development is an iterative process in which
the story and its characters are created and developed. The first step in
creative development involves the development of a story concept, which often
takes the form of a story summary or outline known as a "treatment." After
numerous iterations and research into the story and characters, a first draft of
a screenplay is written.
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PRE-
PRODUCTION Story Board 5 Story Reel Editing 5 Voice Recording
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Pre-Production. The pre-production stage begins when the screenplay is
turned into story boards, which are panels filled with thousands of sketches
that represent the story to be animated. The story boards are then transferred
to film or video so that they can be electronically edited into a photo play of
the film called story reels, a process that enables editing of the film before
the production phase begins. Voices are then selected, recorded and added to the
story reels. Throughout the creative development and pre-production processes,
plans are developed for the style, colors and look of the film.
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Shading and
PRODUCTION Modeling 5 Layout 5 Animation 5 Lighting 5 Rendering 5
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Film
PRODUCTION Recording
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Production. Pixar's production stage consists of six phases: modeling,
layout, animation, shading and lighting, rendering and film recording. In the
modeling phase, digitized models of each set and character are created by
defining their shapes in three dimensions (height, width and depth) and by
adding animation control points that allow the model to be moved or animated. In
some cases, a model has hundreds of animation controls. In the layout stage,
artists place the digital models into a scene and position the digital cameras
at the angles from which the three-dimensional shot is to be seen. The assembled
shot is then given to the animator together with the prerecorded voice.
In the animation stage, the digitized models are animated, or "brought to
life," in three dimensions to create a motion sequence. The next step in
completing a scene requires attaching to each object and model a description of
its surface characteristics. These "shaders" describe the pattern, texture,
finish and color for every object in the scene. Next, lighting is added by
placing digital lights into the scene. In the rendering phase, the renderer
takes the modeling, layout, animation, shading and lighting data and, for each
frame in the sequence, computes a three-dimensional image of what the scene
looks like at that point in time from the point of view of the camera. The final
rendering of a single frame takes an average of one to four hours, but a small
percentage of more complex frames can take much longer, between 20 and 40 hours
each or more. The final rendered data is then sent to one of Pixar's film
recorders for imaging onto film.
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Sound Print
POST- Effects 5 Musical 5 Sound 5 Color 5 Delivery
PRODUCTION Design Score Mixing Correction of Print
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Post-Production. The post-production stage consists of two parallel
processes: the picture process and the sound process. In the picture process,
images are put on film, the film is sent to a laboratory for color correction
and final prints are made. In the sound process, the sound effects and musical
score are added and the final sound is mixed. Pixar's post-production is simpler
than post-production in a live-action film, which requires more significant
editing. In most live-action films, many hours of film are shot, and the film is
then significantly edited and re-edited in the post-production stage to create a
feature film. Pixar, like other animation studios, edits the film throughout the
entire creative development and production process. Thus post-production
involves only final editing.
Digital Back Lot
The digital models that Pixar develops to create its animated products may
be used again in future films, television commercials and other animation
products. The Pixar technical team has developed a proprietary database of
thousands of digital models, sets, textures and surface appearances from its
short films and commercials. Much like the traditional movie studio's back lot,
this digital database allows Pixar animators to retrieve and re-use thousands of
different elements that make up the characters and scenes of a film. However,
unlike a traditional movie studio's back lot, digital animation sequences can be
easily re-used. For example, a sequence of a character walking could be re-used
with little or no rework in another portion of the film. These models may also
be used in other films or in videos or to create merchandise. For example, the
models that were used to animate Toy Story were "re-used" or rendered in a
different resolution for use in Pixar's two Toy Story CD-ROM titles and are
being re-used in Toy Story 2.
CREATIVE DEVELOPMENT GROUP
Pixar's creative and technical personnel have collaborated for over ten
years to produce three-dimensional computer-animated films. The principal
objective of Pixar's creative group is to create heartwarming stories with
memorable characters that are targeted for family entertainment, utilizing the
medium of computer animation. The members of Pixar's creative and technical
teams have been nominated for and received a number of awards. In 1986, the
short animated film Luxo Jr. earned an Academy Award nomination for Best Short
Film (Animated). In 1988, another of Pixar's short films, Tin Toy, became the
first computer-animated film to win the Academy Award for Best Short Film
(Animated). In 1998, Pixar's most recent animated short film, Geri's Game, also
won an Academy Award for Best Short Film (Animated).
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The creative team at Pixar is under the direction of John Lasseter, an
Academy Award-winning director and animator and the Director of Toy Story and A
Bug's Life. In March 1996, Mr. Lasseter received a Special Achievement Oscar
from the Academy of Motion Picture Arts and Sciences for the development and
application of techniques that made possible the first feature-length
computer-animated film, Toy Story. Pixar has built an entire creative team
consisting of highly skilled story artists, animators and other artists highly
skilled in the art of animation, especially computer animation. Pixar's story
department is responsible for a project's concept, treatment, outline, script,
story boards and story reels. The art department is responsible for the visual
development of a project, including the design of characters and sets and the
color, textures, shading and lighting. It is also quite common for creative
contributions to come from the technical group. Along with the story department
and the art department, the creative team at Pixar includes animators. Pixar
strives to hire animators who have superior acting ability, those able to make
characters and inanimate objects come to life and appear as though they have
their own thought processes. Pixar's proprietary software tools enable artists
unfamiliar with computers to quickly become skilled in the art of
three-dimensional animation. All groups work closely together in an iterative
process. To encourage collaboration, Pixar has strived to create a cooperative
working environment and a non-hierarchical culture whereby each member of the
creative team, regardless of position or department, considers the ideas of any
other member of the team. See "Risk Factors -- We Depend on Certain Key
Employees."
The success of each animated feature film developed by Pixar will depend in
large part upon the Pixar creative team's ability to predict the type of content
that will appeal to a broad audience and to develop stories and characters that
achieve broad market acceptance. Traditionally, this has been extremely
difficult. Disney provided creative assistance throughout the production of Toy
Story and A Bug's Life, including creative reviews and approvals, and the
Co-Production Agreement contemplates that Disney will continue to provide
creative assistance to Pixar on feature films and other products made pursuant
to that agreement; however, there can be no assurance that Disney will continue
to provide assistance to Pixar in the development of creative content for its
feature films or related products. In addition, there can be no assurance that
voices and other intellectual property rights used in an animated feature film
will be available for use in any sequel or other product related to such feature
film. For example, Pixar was unable to obtain the rights to use certain voices
from Toy Story in the two CD-ROM products based on Toy Story. See "Risk
Factors -- We Depend on Successful Development of Appealing Creative Content For
Animated Feature Films and Related Products."
TECHNOLOGY
Pixar has three core proprietary technologies: (1) Marionette, an animation
software system for modeling, animating and lighting, (2) Ringmaster, a
production management software system for scheduling, coordinating and tracking
of a computer animation project and (3) RenderMan, a rendering software system
for high quality photo-realistic image synthesis that Pixar uses internally and
licenses to third parties. Each of these systems is critical to the production
of Pixar's animated feature films and other animation products.
Marionette. Marionette is Pixar's software system for modeling, animation
and lighting for computer animation. Marionette is the primary software tool of
every animator and technical director at Pixar. In contrast to many commercially
available animation systems which are designed to address product design,
corporate logo graphics or cinematic special effects, Marionette has been
designed and optimized for character modeling and animation. Marionette is
portable across many of the standard Unix workstations, including those from
Silicon Graphics and Sun. Pixar has also ported Marionette to IBM and
Hewlett-Packard workstations for hardware evaluation purposes.
Ringmaster. Ringmaster is a production management software system for
scheduling, coordinating and tracking a computer animation project. Due to the
enormous amount of data required in three-dimensional animation, accurate
production information is essential for producing high quality animation.
Pixar's production coordination staff uses Ringmaster to plan and track projects
ranging from short animation projects to feature films.
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A key component of Ringmaster is a distributed rendering system for
managing the huge quantity of images and data that must be rendered to create
Pixar's products. Pixar does its rendering on an array of powerful Unix
processors which are dedicated to rendering 24 hours a day. These machines,
which Pixar calls the RenderFarm, are connected via a local area network. To
achieve the desired quality level, the average time to render a single frame at
film resolution is between one and four hours. Since an animated feature film
contains well over 100,000 frames, each of which may be rendered several times
in the production process, Pixar typically has a large number of frames to
render at any given time. To manage this process, Ringmaster coordinates and
schedules all the processors in the RenderFarm. Ringmaster includes a
compositing system and also maintains an array of disk drives as a central data
repository for the digital image files generated by the rendering and
compositing steps of the production process. Finally, Ringmaster controls the
filming phase of production and is responsible for backing up shots for archival
purposes.
RenderMan. RenderMan is a rendering software system for high quality
photo-realistic image synthesis that Pixar uses internally and also licenses to
third parties. Today, RenderMan is used by many major film studios and special
effects firms. Examples of projects which have used RenderMan include Terminator
2, Jurassic Park, Apollo 13, the re-release of Star Wars and Mulan. By licensing
RenderMan to film studios, visual effects houses, commercial production
facilities and other computer animation companies, Pixar believes that RenderMan
has been established as a de facto industry standard for high quality rendering.
RenderMan was designed to be easily portable. It runs on a wide variety of
Unix workstations, including those from Silicon Graphics, Sun and Digital
Equipment. Pixar has also ported RenderMan to the Windows NT platform.
RELATIONSHIP WITH DISNEY
A critical component of Pixar's objective to become a leading brand in the
animated feature film market is to secure strong promotion, marketing and
distribution of its films and related products. Pixar believes that Disney is
the leader in marketing and distribution of animated feature films and related
products and one of the industry's most widely recognized brand names.
Consequently, in February 1997 Pixar extended its existing relationship with
Disney by entering into the Co-Production Agreement. This arrangement allows
Pixar to focus on the story and other creative and production elements of making
animated feature films while utilizing Disney's significant promotion, marketing
and distribution capabilities.
Prior Agreements
Pixar's relationship with Disney dates to 1986, when Pixar and Disney
entered into a joint technical development effort that resulted in the Computer
Animated Production System ("CAPS"), a production system owned and used by
Disney in certain of its two-dimensional cel-based animated feature films.
Disney first used CAPS for The Rescuers Down Under and has continued to use it
for other animated feature films, including Aladdin, The Lion King, The
Hunchback of Notre Dame, Hercules and Mulan. In 1992, certain employees of Pixar
and Disney were jointly awarded an Academy Award for Scientific and Engineering
Achievement for CAPS.
In May 1991, Pixar entered into the Feature Film Agreement with Disney
which provided for the development, production and distribution of up to three
feature-length motion pictures (the "Feature Film Agreement"). It is pursuant to
the Feature Film Agreement that Toy Story and the Toy Story home video were
developed, produced and distributed. In August 1995, Pixar entered into a
non-exclusive CD-ROM development and publishing agreement with Disney for the
development, production and distribution of CD-ROM titles based on Toy Story
(the "CD-ROM Agreement"). It is pursuant to the CD-ROM Agreement that the two
Toy Story CD-ROM products were developed, produced and distributed. Both the
Feature Film Agreement and the CD-ROM Agreement were superseded by the
Co-Production Agreement, except as discussed below.
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Co-Production Agreement
The following is a summary of the Co-Production Agreement, which was filed
as an exhibit to Pixar's Annual Report on Form 10-K for the year ended December
31, 1996 (the "1996 Form 10-K"). The foregoing summary is not complete, and
reference is made to the Co-Production Agreement filed as an exhibit to the 1996
Form 10-K. This summary is qualified in all respects by such reference.
Prospective investors in Pixar's Common Stock are encouraged to read the
Co-Production Agreement.
Overview. On February 24, 1997, Pixar and Disney entered into 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 over approximately 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 any other fees or costs, including any
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. The first Picture under the Co-Production
Agreement was A Bug's Life, which was released in November 1998. The
Co-Production Agreement also contemplates that with respect to theatrical
sequels, made-for-home video sequels, television productions, interactive media
products and other derivative works related to the Pictures, 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 generated as a
result of the Pictures.
Production. The Co-Production Agreement provides a mechanism for Pixar's
submission and the mutual selection of treatments that will be developed and
produced as Pictures. After the selection of a treatment, Pixar generally
controls the production of each Picture. Disney is entitled to designate a
representative at Pixar to monitor the production and production costs of the
Pictures.
Financing of Development and Production. Pixar and Disney are to equally
share all production costs. Production costs are defined in the Co-Production
Agreement to mean all costs and expenses incurred by Pixar directly related to
or fairly allocable to the creation, development, pre-production, production,
post-production and delivery to Disney of the Pictures. Production costs
include, among other things, all carrying costs incurred by Pixar for retention
of employees for production purposes and the overhead attendant thereto, the
costs of all treatments prepared by Pixar for submission to Disney, all costs of
computer hardware and software used to develop the Pictures, and fair
allocations of all costs and expenses of Pixar associated with or benefiting the
Picture, including research and development, general and administrative and
overhead expenses and facilities. The Co-Production Agreement provides
mechanisms for Disney and Pixar to agree upon the budgets for treatments,
development and production of each Picture. In order to be reimbursed for
production costs, Pixar may not exceed production budgets (which may be revised
with mutual approval) without Disney's written approval, subject to certain
limited exceptions.
Distribution. Disney has control over all decisions relating to, and is
solely responsible for financing the costs and expenses of, the marketing,
promotion, publicity, advertising and distribution of each Picture, subject to
certain requirements. Provided, in general, that Disney has agreed on the
treatment to be developed into each Picture, Disney has committed to initially
release each Picture within certain windows and not to release other Disney
family films during certain windows, and each Picture is to be distributed and
marketed under the Walt Disney Pictures brand (or the then current Disney brand
for premiere Disney movies) and is to be distributed and marketed by Disney in
all markets and media and on a worldwide basis in a manner similar to that in
which Disney then currently distributes and markets its premiere animated
movies. Disney is to consult with Pixar regarding all such major marketing and
distribution decisions, and Pixar is entitled to designate a representative to
monitor marketing and distribution of the Pictures. In addition, the costs for
marketing, distribution and promotion of the films and related products are
incurred well in advance of the release of such films and products, and Pixar
will experience a delay in the recognition of revenue from such films and
products until after Disney recovers such costs.
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Division of Gross Receipts. Pixar and Disney are entitled to share equally
in all gross receipts remaining after deduction of: (1) a distribution fee to
Disney, (2) mutually agreed participations (payments to third parties such as
actors, composers and other artists contingent upon the success of the
Pictures), if any, paid by either Disney or Pixar, and (3) Disney's distribution
costs. Gross receipts includes all revenues or other consideration received by
Disney from the exploitation of the Pictures and any related merchandise, books,
soundtracks and other tangible personal property based upon the Pictures, as
more specifically provided in the Co-Production Agreement (collectively,
"Merchandise"), subject to certain exceptions relating primarily to receipts
from Disney's affiliates. The distribution fee payable to Disney is
substantially lower than under the prior Feature Film Agreement and reflects
Pixar's commitment to finance half of the production costs of the Pictures.
Distribution costs are broadly defined in the Co-Production Agreement to include
out-of-pocket costs paid (or in certain instances, accrued for payment) to a
third party (or in certain instances, to Disney's affiliates) by Disney or
certain of its affiliates, provided that such out-of-pocket costs are directly
related or fairly allocable to the distribution of the Picture and Merchandise.
Pursuant to the Co-Production Agreement, Pixar will receive statements and
payments of its share of gross receipts monthly within 45 days after the end of
each calendar month, and Pixar has the right to audit Disney's and its
affiliates' books and records relating to the Pictures and Merchandise.
Derivative Works. Subject to certain exceptions, Disney and Pixar have
mutual control of the decision to develop, produce or otherwise exploit any
derivative works (or to transfer or license any rights to exploit any derivative
works) during the term of the Co-Production Agreement or thereafter. Derivative
works include theatrical sequels such as Toy Story 2, made-for-home video
sequels, television productions, interactive media products and other derivative
works as more specifically provided in the Co-Production Agreement
(collectively, "Derivative Works"). Except in certain very limited
circumstances, in the event of a disagreement over whether to proceed with a
Derivative Work, Disney's decision governs. Pixar is to be given the option to
co-finance and produce, or to participate on a passive financial basis with
respect to, a Derivative Work that is (1) a theatrical motion picture, (2) a
made-for-home video production, (3) a television production, (4) location-based
entertainment which uses unique characters or other elements from any of the
Pictures or Toy Story as its primary theme, or (5) an interactive product such
as CD-ROMs, DVDs, video games and arcade games (collectively, "Interactive
Products").
If Pixar elects to co-finance and produce a Derivative Work, such as it did
with Toy Story 2, the Co-Production Agreement provides for the following:
(1) with respect to theatrical motion pictures and made-for-home video
productions, the terms and conditions of the Co-Production Agreement are to
be extended to cover such Derivative Works, subject to certain exceptions;
(2) with respect to (A) location-based entertainment using characters
or other elements from a Picture or Toy Story as its primary theme and (B)
television productions, Pixar and Disney are to mutually agree upon the
terms and the conditions under which such work will be financed, produced
and distributed, subject to certain specified requirements in the case of
television productions; and
(3) with respect to Interactive Products, Disney and Pixar are to
mutually agree upon the terms and conditions under which such Interactive
Product shall be financed, produced and distributed, subject to certain
commitments by Disney with respect to marketing and distribution and
provided that there will be no distribution fee payable to Disney.
For live entertainment such as stage plays or ice shows, Pixar is entitled
to participate on a passive financial basis as specified in the Co-Production
Agreement. For all other Derivative Works except theme parks, Pixar is entitled
to participate on a passive financial basis in such work and to receive a
reasonable royalty to be mutually agreed upon if the work is a revenue-producing
work. Disney has the sole and exclusive right in perpetuity to use, without
compensation to Pixar, each Picture, the characters therefrom and any story
elements thereof in theme parks, location-based entertainment for which Picture
or Toy Story characters or elements are not the primary theme and cruise ships.
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A Derivative Work that is a theatrical motion picture would not count
towards the five Pictures to be produced under the Co-Production Agreement.
Accordingly, Toy Story 2 does not count as one of the five Pictures to be
produced. However, for all other purposes, it has been added to the definition
of the original five Pictures produced and financed under the agreement.
Therefore, all provisions applicable to the original five Pictures apply to Toy
Story 2 as well.
Creative Controls. Creative controls and decisions with respect to
developing and producing Pictures are generally subject to the mutual approval
of Pixar and Disney. The Co-Production Agreement provides for certain dispute
resolution procedures in the event of disagreement.
Brand/Credit. The Co-Production Agreement sets forth Disney's and Pixar's
intent that the Pixar brand be established as a co-equal brand to the Disney
brand in connection with the Pictures, Merchandise and Derivative Works. The
Co-Production Agreement provides that the Pixar logo, animated logo and credit
shall be used in a manner which is perceptually equal to the Disney logo,
animated logo and credit, subject to certain specific requirements as set forth
in the Co-Production Agreement.
Exclusivity. Pixar has agreed not to release or authorize the release of
any feature-length animated theatrical motion picture produced by Pixar, other
than the Pictures and Derivative Works produced by Pixar under the Co-Production
Agreement, until twelve months from delivery of the fifth Picture under the
Co-Production Agreement. Pixar has further agreed that it will not enter into
any agreement with any third party for the development, production or
distribution of any feature-length animated theatrical motion picture until
after Pixar has delivered the third Picture to Disney under the Co-Production
Agreement. Pixar has also agreed that it will not develop or produce any rides
or attractions for major theme parks not owned or operated by Disney, and to
give Disney a right to negotiate with respect to animated television productions
or animated made-for-home video productions that Pixar proposes to produce
during the term of the Co-Production Agreement. Disney, however, is not
similarly restricted by the exclusivity provisions that bind Pixar under the
Co-Production Agreement and, therefore, may develop, produce, or distribute
other feature length animated and computer-animated theatrical motion pictures
itself or enter into similar agreements with third parties. See
"-- Competition."
Proprietary Rights. The copyrights, trademarks and other intellectual
property rights in and to the Pictures, all new and unique characters and story
elements thereof and the audio-visual images thereof, and Merchandise relating
thereto, shall be jointly owned by Disney and Pixar on an undivided 50/50 basis,
subject to Pixar's ownership rights in the technology and excluding any
intellectual property rights previously owned by Pixar or Disney.
Notwithstanding the foregoing, Disney has the exclusive distribution and
exploitation rights with respect to the Pictures, Derivative Works and
Merchandise relating thereto. Pixar shall own the copyright and all other
intellectual property rights in and to all computer programs and other
technology developed or discovered by Pixar before, during or after the term of
the Co-Production Agreement.
Term and Termination. The Co-Production Agreement continues until delivery
to Disney of the fifth Picture produced and financed under the Co-Production
Agreement, unless earlier terminated. Disney is entitled to terminate the
Co-Production Agreement in the event that Disney and Pixar fail to agree on a
treatment for a Picture within one year after the initial theatrical release of
the last Picture for which a treatment has been approved or selected, subject to
certain exceptions. Disney is also entitled to terminate the Co-Production
Agreement in the event that certain types of competitors directly or indirectly
acquire or control a 50% or greater ownership interest in Pixar or Pixar merges
or consolidates into such a competitor. Upon termination by Disney pursuant to
either of the last two sentences, Disney has certain rights to compel Pixar to
complete works in production. In the event of termination, the Co-Production
Agreement provides that its terms and conditions continue to apply with respect
to Pictures, Merchandise and Derivative Works which have been delivered by Pixar
to Disney or which Disney elects to have completed, as well as all future
Merchandise and future Derivative Works relating thereto, but otherwise
terminates.
Effect on Prior Agreements. All Derivative Works based on Toy Story,
including Toy Story 2, are to be governed by the Co-Production Agreement and not
the original Feature Film Agreement or the CD-ROM Agreement. The original
Feature Film Agreement now applies only to the rights and obligations of Disney
and Pixar relating to the financial participation in, and the production and
distribution of, the theatrical motion
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picture Toy Story and the financial participation in Merchandise related to Toy
Story (unless gross receipts in any given month exceed a certain amount, in
which case they will be subject to the Co-Production Agreement), and otherwise
has no further force or effect. The original CD-ROM Agreement remains in full
force and effect with respect to the first and second CD-ROM products developed
under that agreement, but otherwise has no force or effect.
COMPETITION
Pixar experiences intense competition with respect to animated feature
films, animation products and software.
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 continues to
expressly target 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.
In 1998, competition significantly intensified in the animated feature film
market from these and other movie studios. Animated feature films released in
1998 included Quest for Camelot by Warner Bros., Inc., The Rugrats Movie by
Paramount, Prince of Egypt by DreamWorks and Antz, a fully computer-animated
movie by DreamWorks with its affiliate Pacific Data Images ("PDI"). While the
release of A Bug's Life was extremely successful, achieving domestic box office
revenues over $160 million as of March 28, 1999, Antz, The Rugrats Movie and
Prince of Egypt achieved domestic box office revenues of over $91 million, $100
million and $99 million, respectively. These three films were released during or
near the 1998 holiday season and directly competed with A Bug's Life. Each of
these films was more successful than any preceding animated feature film not
released by Disney or Disney and Pixar. In addition, other non-animated family
oriented feature films released during the 1998 holiday season, such as Disney's
Mighty Joe Young, also generated competition for A Bug's Life. Pixar expects
that a variety of animated feature films which may be released in the theaters
in the next several years will directly compete with Toy Story 2 and Film Four,
which are targeted for release in late 1999, and mid 2001, respectively. Due to
a potentially large number of releases in the next several years, it is possible
that the market for animated films will become further saturated before Pixar
can release Toy Story 2 and Film Four, which could result in the failure of such
films to achieve the extraordinary commercial success required for Pixar to
profit from such films.
Pixar's films will continue to 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, 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 and ILM have
developed their own internal computer animation capability which may be used for
special effects in animated films and live action films. For example, DreamWorks
(with PDI) successfully produced Antz. In addition, Disney is currently
developing and producing a feature film making substantial use of computer
animation. Other movie studios may internally develop, license or sub-contract
three-dimensional animation capability. Further, Pixar believes that continuing
enhancements in commercially available computer hardware and software technology
have lowered and will continue to lower barriers to entry for studios or special
effects companies which intend to produce computer animated feature films or
other products. For example, Silicon Graphics Inc.'s Alias/ Wavefront subsidiary
licenses "Maya," its next generation three-dimensional 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.
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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. 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, such as was the case with the release of Mighty
Joe Young during the 1998 holiday season which then competed against A Bug's
Life. Pixar's contractual arrangement with Disney also presents other risks. See
"Risk Factors -- Risks Associated with Co-Production Agreement."
Pixar believes that the primary competitive factors in the market for
animated feature films include creative content and talent, product quality,
technology, access to distribution channels and marketing resources. Due in part
to Pixar's creative and technical resources and to the Co-Production Agreement
with Disney, pursuant to which Disney co-finances the production of the feature
films, markets the feature films and provides creative assistance and access to
significant distribution channels, Pixar believes that it presently competes
favorably with respect to each of these factors.
Computer Graphics Special Effects Firms. Pixar also expects to compete with
computer graphics special effects firms, including ILM, PDI, Rhythm & Hues,
Digital Domain and Blue Sky/VIFX Productions. These computer graphics special
effects firms may be capable of creating their own three-dimensional computer-
animated feature films or may produce three-dimensional computer-animated
feature films for movie studios that compete with Pixar. For example, ILM has
already created and produced three-dimensional character animation which was
used for the ghosts in the live action film Casper, and ILM has a royalty-free,
paid-up license to use Pixar's RenderMan software and to obtain at no cost all
enhancements and upgrades thereto. Other computer graphics special effects firms
have licensed or may license RenderMan. Accordingly, Pixar's RenderMan software
may not provide Pixar with a competitive advantage. Pixar also competes, or may
in the future compete, with the above firms with respect to animation products
other than feature films. Pixar believes that the primary competitive factors in
the market for three-dimensional computer animation for feature films and other
animation products include creative content and talent, product quality,
technology, access to distribution channels and marketing resources. Pixar
believes that it presently competes favorably with respect to each of these
factors.
Software Publishers. Pixar also experiences intense competition with
respect to its RenderMan software product. In particular, Pixar competes with
makers of computer graphics imaging and animation software, principally
Microsoft (which acquired SoftImage Inc.), MentalImage (which offers the same
product offered by Microsoft), and Silicon Graphics (which acquired Wavefront
Technologies, Inc. ("Wavefront") and Alias Research, Inc. ("Alias")). Microsoft,
through SoftImage Inc., MentalImage and Silicon Graphics, through Wavefront and
Alias, are each marketing competing rendering software products, usually at
lower prices than Pixar. Microsoft and Silicon Graphics have each licensed
several of Pixar's patents that cover certain rendering techniques and may
therefore be better able to market products that compete with Pixar's RenderMan
software. Under appropriate circumstances, Pixar might elect to license its
rendering technology patents to other companies, some of which may compete with
Pixar. In addition, as PCs become more powerful, software suppliers may also be
able to introduce products for PCs that would be competitive with RenderMan in
terms of price and performance for professional users. Pixar believes that the
primary competitive factors in the market for rendering software include product
quality, price/performance, technology, functionality, breadth of features and
customer service and support. Pixar believes that it presently competes
favorably with respect to each of these factors.
Pixar expects competition to persist, intensify and increase in each of its
business areas in the future. Almost all of Pixar's current and potential
competitors have longer operating histories, greater name recognition, larger
installed customer bases and significantly greater financial, technical,
marketing and other resources than Pixar. There can be no assurance that Pixar
will be able to compete successfully against current or future competitors. Such
competition could materially adversely affect Pixar's business, operating
results or financial condition.
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PROPRIETARY RIGHTS
Pixar's success and ability to compete is dependent in part upon its
proprietary technology. While Pixar relies on a combination of patents,
copyright and trade secret protection, nondisclosure agreements and cross-
licensing arrangements to establish and protect its proprietary rights, Pixar
believes that factors such as the technical and creative skills of its personnel
are more essential to its success and ability to compete. Pixar currently is the
owner of thirteen patents issued in the United States and seven issued in
foreign countries. In addition, Pixar has a number of patent applications
pending in the United States and in foreign countries. There can be no assurance
that patents will issue from any of these pending applications or that, if
patents do issue, any claims allowed will be sufficiently broad to protect
Pixar's technology. In addition, there can be no assurance that any patents that
have been issued to Pixar, or that Pixar may license from third parties, will
not be challenged, invalidated or circumvented, or that any rights granted
thereunder would provide proprietary protection to Pixar.
The source code for Pixar's proprietary software is protected both as trade
secrets and as a copyrighted work. Pixar generally enters into confidentiality
or license agreements with its employees, consultants and vendors, and generally
controls access to and distribution of its software, documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use Pixar's proprietary information,
products or technology without authorization, or to develop similar or superior
technology independently. Policing unauthorized use of Pixar's products is
difficult. In addition, effective copyright and trade secret protection may be
unavailable or limited in certain foreign countries. To license its RenderMan
software product, Pixar primarily relies on "shrink wrap" licenses that are not
signed by the end-user and, therefore, may be unenforceable under the laws of
certain jurisdictions. There can be no assurance that the steps taken by Pixar
will prevent misappropriation of its technology or that its confidentiality or
license agreements will be enforceable. In addition, litigation may be necessary
in the future to enforce Pixar's intellectual property rights, to protect
Pixar's trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity. Any
such litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on Pixar's business, operating results or
financial condition.
One of the risks of the film production business is claims that Pixar's
productions infringe the intellectual property rights of third parties with
respect to previously developed films, stories, characters or other
entertainment. In addition, Pixar's technology and software may be subject to
patent, copyright or other intellectual property claims of third parties. Pixar
has received, and is likely to receive in the future, notice of claims of
infringement of other parties' proprietary rights. There can be no assurance
that infringement or invalidity claims (or claims for indemnification resulting
from infringement claims) will not be asserted or prosecuted against Pixar or
that any assertions or prosecutions will not materially adversely affect Pixar's
business, financial condition or results of operations. Irrespective of the
validity or the successful assertion of such claims, Pixar would incur
significant costs and diversion of resources with respect to the defense thereof
which could have a material adverse effect on Pixar's business, financial
condition or results of operations. If any claims or actions are asserted
against Pixar, Pixar may seek to obtain a license under a third party's
intellectual property rights. There can be no assurance, however, that under
such circumstances a license would be available on reasonable terms or at all.
Pixar also relies on certain technology that it licenses from third
parties, including software that is integrated and used with internally
developed software. There can be no assurance that these third party technology
licenses will continue to be available to Pixar on commercially reasonable
terms. The loss of or inability to maintain any of these technology licenses
could result in delays in feature film releases or product shipments until
equivalent technology could be identified, licensed and integrated. Any such
delays in feature film releases or product shipments could materially adversely
affect Pixar's business, operating results or financial condition.
In 1996, Pixar entered into a license agreement with Silicon Graphics
whereby Pixar granted to Silicon Graphics and its subsidiaries a non-exclusive
license to use certain of Pixar's patents covering techniques for creating
computer-generated photo-realistic images. These same patents were licensed to
Microsoft Corpora-
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tion in 1995. These patents relate to pseudo-random point sampling techniques in
computer graphics which are incorporated into Pixar's RenderMan. The license
agreements with Silicon Graphics and Microsoft will expire no later than the
year 2010. Silicon Graphics and Microsoft may use the licensed technology in
rendering products which compete with Pixar's RenderMan software, which could
adversely impact sales of RenderMan.
EMPLOYEES
As of January 2, 1999 Pixar had a total of 427 employees. Although none of
Pixar's employees are represented by a labor union, it is common for animators
and actors at film production companies to belong to a union. There can be no
assurance that Pixar's employees will not join or form a labor union or that
Pixar, for certain purposes, will not be required to become a union signatory.
Further, Pixar may be directly or indirectly dependent upon union members, and
work stoppages or strikes organized by such unions could materially adversely
impact Pixar's business, financial condition or results of operations. For
example, many of the actors who provide the voice talents for the Pictures and
Derivative Works are members of the Screen Actors Guild. Pixar has not
experienced any work stoppages and considers its relations with its employees to
be good.
Pixar's success depends to a significant extent on the performance of a
number of senior management personnel and other key employees, especially its
animators, creative personnel and technical directors. In particular, Pixar is
dependent upon the services of Steve Jobs, John Lasseter, Edwin E. Catmull and
Sarah McArthur. Pixar does not maintain "key person" life insurance for any of
its employees. Pixar does have an employment agreement with Mr. Lasseter who is
fundamental to its relationship with Disney. However, this employment agreement
does not necessarily assure his services. Pixar believes that it may be
particularly difficult to retain its key employees, especially its animators,
creative personnel and technical directors, during periods in which it is not
developing animated feature films. The loss of the services of any of Messrs.
Jobs, Lasseter, or Catmull, Ms. McArthur, or of other key employees, especially
its animators, creative personnel and technical directors, could have a material
adverse effect on Pixar's business, operating results or financial condition.
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RISK FACTORS
The following is a discussion of certain factors that currently impact or
may impact our business, operating results and/or financial condition. You
should carefully consider these factors before making an investment decision
with respect to our Common Stock.
WE MAY EXPERIENCE NET LOSSES IN THE FIRST AND SECOND QUARTERS OF 1999
We may experience net losses in the first and second quarters of 1999
because of the factors discussed below.
End of Toy Story Revenue
We have already recognized the vast majority of the revenue we expect to
receive from Toy Story. While we may receive minor amounts of revenue in
subsequent periods, we do not expect to recognize any further significant
revenue from Toy Story.
Timing of A Bug's Life Revenue
A Bug's Life was released on November 25, 1998, but we do not expect to
recognize a significant amount of revenue from A Bug's Life until after Disney
recovers all marketing and distribution costs and fees. It is difficult to
predict when Disney will recover these costs because of the many variables
involved, some of which are unpredictable, such as the timing and amount of
revenue generated from (1) foreign box office, (2) sales of the home video of A
Bug's Life, which is scheduled for release April 20, 1999, and (3) sales of film
related merchandise. The level of success achieved by A Bug's Life in foreign
box office, home video sales, merchandise sales and the level of marketing and
distribution costs incurred by Disney will determine whether Pixar first
receives significant revenues from A Bug's Life in the second or third quarter
of 1999. We expect that even if the film is an extraordinary success in foreign
theaters and in the home video and merchandising markets, we will not recognize
significant revenue from A Bug's Life until the second quarter of 1999 at the
earliest and possibly not until the third quarter of 1999. Moreover, we may not
receive sufficient revenue from A Bug's Life in the first or second quarter of
1999 to generate earnings.
Timing of Toy Story 2 Release
In addition, we expect that Toy Story 2 will be released in late 1999 at
the earliest. As with A Bug's Life, we do not expect to recognize any revenue
from Toy Story 2 until six to twelve months after its release. Therefore, we are
unlikely to recognize any revenue from Toy Story 2 until the second half of 2000
at the earliest.
Limited CD-ROM Revenue
In March 1997, we discontinued our business of producing CD-ROM products in
favor of other opportunities arising, in part, as a result of entering into the
Co-Production Agreement. We have not received royalty income from our two
existing CD ROM products, both based on Toy Story, since the first quarter of
1998. It is unlikely that we will recognize any further royalty income from
these products or from this discontinued operation in 1999 or thereafter.
Possible Decline in Sales of RenderMan Due to Our Shift in Focus
As a result of our shift in focus to products sold for their content, we
have reduced emphasis on the commercialization of software products. We are not
increasing the time and resources necessary to generate higher RenderMan sales;
therefore, we continue to expect that revenue from the licensing of RenderMan
will remain flat and possibly decline.
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Increase in Our Operating Expenses and Effective Tax Rate
Since our initial public offering in November 1995, we significantly
increased our operating expenses, and we plan to continue to increase our
operating expenses to fund greater levels of research and development and to
expand operations. Specifically, we expect our spending levels to increase
significantly due to (1) continued investment in proprietary software systems,
(2) increased compensation costs as a result of intense competition for
animators, creative personnel, technical directors and other personnel, and (3)
increased costs associated with the expansion of our facilities. A portion of
our operating expenses that are allocable to film productions is either
capitalized by us or reimbursed by Disney under the Co-Production Agreement. To
the extent that we do not capitalize (or Disney does not pay for) the increases
in expenses, our operating expenses will significantly increase in 1999.
Finally, our tax rate increased in 1998 and is likely to increase in future
years because we have utilized our remaining net operating loss carryforwards
except those which originated from the exercise of non-qualified employee stock
options. The realization of tax benefits from the exercise of non-qualified
employee stock options will reduce the amount of our tax payments and
liabilities, but will not reduce our effective tax rate.
Impact on Our Operating Results
As a result of the factors discussed above, revenue may decline in the
first half of 1999 as compared to prior periods. At the same time, our operating
expenses are expected to increase in 1999. Therefore, revenue and operating
results in the first half of 1999 may decline from revenue and operating results
in 1998, and operating and net losses in the first half of 1999 are possible.
Our operating results thereafter will depend upon the success of A Bug's Life,
Toy Story 2 and our subsequent films.
WE EXPECT OUR OPERATING RESULTS TO CONTINUE TO FLUCTUATE
In addition to the factors set forth above, we continue to expect
significant fluctuations in our future annual and quarterly operating results
because of a variety of factors, including the following:
- the timing of the domestic and international releases of our animated
feature films,
- the success of our animated feature films (which can fluctuate
significantly from film to film),
- the timing of the release of related products into their respective
markets (such as home videos and merchandising),
- the demand for such related products (which is often a function of the
success of the related animated feature film),
- film production costs,
- Disney's costs to distribute and promote the feature films and related
products,
- Disney's success at marketing the films and related products,
- the timing of receipt of proceeds from our animated feature films and
related products by Disney,
- the timing of revenue recognition under the Co-Production Agreement and
the Feature Film Agreement, as the case may be,
- the introduction of new feature films or products by Pixar's competitors,
and
- general economic conditions.
In particular, since our revenue under the Co-Production Agreement is
directly related to the success of a feature film, our operating results are
likely to fluctuate depending on the level of success of our animated feature
films and related products. The revenues derived from the production and
distribution of an animated feature film depend primarily on the film's
acceptance by the public, which cannot be predicted and does not necessarily
bear a direct correlation to the production or distribution costs incurred. The
commercial success of a motion picture also depends upon promotion and
marketing, production costs and other factors. Further,
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the theatrical success of a feature film can be a significant factor in
determining the amount of revenues generated from the sale of the related
products.
Moreover, our operating expenses will continue to be extremely difficult to
forecast. We budget the direct costs of film productions with Disney, and we
share such costs equally. We capitalize our share of these direct costs of film
production in accordance with Statement of Financial Accounting Standards
("SFAS") No. 53, Financial Reporting by Producers and Distributors of Motion
Picture Films. A substantial portion of all of our other costs are incurred for
the benefit of feature films ("Overhead"), including research and development
expenses and general and administrative expenses. Portions of our Overhead are
included in the budgets for the Pictures, and we will share such costs equally
with Disney under the Co-Production Agreement. With respect to the portion of
our Overhead that is not reimbursed by Disney, we either (1) capitalize such
portion as film production costs, if required under SFAS No. 53, or (2) charge
it to operating expense in the period incurred. Since a substantial portion of
our Overhead is related to the Pictures and is, therefore, reimbursed by Disney,
and since we capitalize other amounts in accordance with SFAS No. 53, our
reported operating expenses for 1998 have not reflected, and future reported
operating expenses will not reflect, our true level of spending on the
production of animated feature films, related products and overhead.
We may not be able to recognize the tax benefits of all of our net
operating loss carryforwards. Although we have been profitable for financial
statement purposes, we have not been profitable for federal income tax purposes
for each of fiscal 1996, 1997 and 1998 due to additional tax deductible items
and the utilization of federal net operating loss carryforwards. We were
profitable for state income tax purposes for each of 1996 and 1997, but at
levels significantly lower than those reported for financial statement purposes.
We maintain a valuation allowance which substantially offsets our deferred tax
asset, due to our dependence on the success of A Bug's Life and future films,
which continues to be uncertain.
As a result of the factors discussed above, we believe that
period-to-period comparisons of our results of operations are not necessarily
meaningful, and you should not rely on our annual and quarterly results of
operations as any indication of future performance. Due to the factors discussed
above, it is likely that in some future period our operating results will be
below the expectations of public market analysts and investors. In such event,
the price of our Common Stock would likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in the 1998 Annual Report to Shareholders.
WE DEPEND ON TOY STORY, A BUG'S LIFE, TOY STORY 2 AND FILM FOUR
Our Dependence on Toy Story
For at least the first quarter of 1999 and possibly the second quarter of
1999, our revenue and operating results will again be largely dependent upon (1)
whatever revenue remains to be received from Toy Story merchandise and (2) our
other businesses, software and animation services, from which we expect limited
revenue. We recognized the vast majority of Toy Story revenue from all sources
by the end of 1998, and we expect little revenue from Toy Story or related
products in 1999 and thereafter. We also expect no further royalty income from
our Toy Story CD-ROM products in 1999 or thereafter.
Our Dependence on A Bug's Life
In 1999, we expect to be significantly dependent upon the success of A
Bug's Life. Although A Bug's Life was released in November 1998 and has
experienced relative domestic box office success, we will not recognize
significant revenue from the film until Disney recovers its marketing and
distribution fees and costs. We believe that domestic box office proceeds alone
will be inadequate to recover all of these costs. Foreign box office proceeds
and sales of related products, such as A Bug's Life home videos and merchandise,
must also be substantial in order for the film to generate profits. We cannot
provide any assurances that A Bug's Life will be successful in these other key
markets. Therefore, it is possible that we will not recognize sufficient revenue
from A Bug's Life to generate earnings on a consistent basis.
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Risks Associated with A Bug's Life
Under the Co-Production Agreement, we share with Disney the production
costs of A Bug's Life. These costs were initially capitalized as film production
costs under SFAS No. 53, and we will amortize these costs over the expected
revenue stream when we recognize revenue from the film and related products.
Although A Bug's Life has achieved substantial domestic box office success, we
believe that the amount spent by Disney for marketing and distribution has been
and will continue to be significant. Unless the amount of revenue generated by A
Bug's Life from box office proceeds, home video sales and merchandise sales is
substantial even after Disney recovers the marketing and distribution costs, our
revenues could be relatively low, and we would have to amortize the capitalized
production costs 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. It is possible that total
revenue generated in all markets by A Bug's Life may not generate significant
revenue and operating results for us, even though A Bug's Life is critically
acclaimed and has achieved domestic box office success. See "-- Risks Associated
with Co-Production Agreement -- Dependence on Disney for Distribution and
Promotion of Feature Films and Related Products," "Risks Associated with the
Motion Picture Industry," and "Business -- Relationship with Disney." See also
Note 4 of Notes to Financial Statements in the 1998 Annual Report to
Shareholders.
Our Dependence on Toy Story 2 and Film Four
We expect to receive the majority of proceeds from A Bug's Life by the end
of 2000. Beyond 2000, we expect to be largely dependent upon the success of Toy
Story 2 and Film Four (together referred to as the "Current Projects"). Although
development and/or production of the Current Projects is underway, we cannot
provide any assurances that they will be successfully produced and released when
scheduled. For example, while we are currently targeting Film Four for release
in mid 2001, we have not formally agreed with Disney on the timing of its
release, and we cannot provide any assurances that Disney will agree to release
Film Four in mid 2001. We cannot provide any assurances that we 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 we are 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, our business, operating results
and financial condition will be materially adversely affected.
Risks Associated with Toy Story 2
It is rare for animated feature films to achieve extraordinary box office
success. We believe, 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 films generated domestic box office revenues greater than A
Bug's Life and Toy Story, and both of those films were produced and distributed
solely by Disney. During at least the last five years, we believe The Rugrats
Movie is the only fully-animated feature film (other than Toy Story and A Bug's
Life) produced or developed by a studio other than Disney that has achieved more
than $100 million in domestic box office revenues. Unless Toy Story 2 achieves
extraordinary box office success and also achieves success in home video and
merchandise sales, Toy Story 2 may not generate significant revenue and
operating results for us. See "-- Risks Associated with Co-Production
Agreement -- Dependence on Disney for Distribution and Promotion of Feature
Films and Related Products," "Risks Associated with the Motion Picture
Industry," and "Business -- Relationship with Disney." See also Note 4 of Notes
to Financial Statements in the 1998 Annual Report to Shareholders.
As 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 these cases,
the original feature films and related sequels were action-adventure films, such
as Lethal Weapon
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and Die Hard. Accordingly, we cannot provide any assurances 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 together with other increases in
production costs will have the effect of increasing the cost of the film when
compared to Toy Story.
As a result of these factors Toy Story 2 and related products may not
generate significant revenue and operating results for us, even if Toy Story 2
is critically acclaimed and achieves substantial, but not extraordinary, box
office success.
Risks Associated with Production Budgets
Given the (1) escalation in compensation rates of people required to work
on the Current Projects, (2) number of people required to work on the Current
Projects, and (3) 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 A Bug's Life. We will continue to
finance these budgets equally with Disney under the Co-Production Agreement. In
addition, due to production exigencies which are often difficult to predict, we
believe that it is not uncommon for film production spending to exceed film
production budgets, and we cannot provide any assurances that any of the Current
Projects can be completed within the budgeted amounts. For example, in order to
meet the production schedule for Toy Story 2, we expect to reassign many
employees from our animation services group and from Film Four to Toy Story 2
for the completion of its production, which will result in a larger production
staff than originally anticipated and which will generate additional production
costs. In addition, when production of each film is completed, if completed, we
may incur significant carrying costs associated with transitioning personnel on
creative and development teams from one project to another which, although
shared with Disney, are treated as film costs which increase overall production
budgets and could have a material adverse effect on our results of operations
and financial condition.
RISKS ASSOCIATED WITH ADEQUACY OF CASH BALANCES
Pursuant to the Co-Production Agreement, we co-financed A Bug's Life and
will co-finance the next four original animated feature films which we produce,
including Film Four. We are also co-financing Toy Story 2 on the same basis as
the other theatrical films. In the future, we may co-finance other derivative
works such as sequels, interactive products and television productions. In
addition, we are constructing a new headquarters and studio facility in
Emeryville, California, which is being financed by the use of our cash and may
continue to be financed by the use of our cash. Since we do not expect to
generate substantial, if any, cash from operations in the first quarter and
possibly the second quarter of 1999, the development and production costs of Toy
Story 2, Film Four and costs of the new Emeryville facility will have a material
adverse impact on our cash and short-term investment balances. As of January 2,
1999, we had approximately $149 million in cash and short-term investments. We
believe that these funds will be sufficient to meet our anticipated cash needs
for working capital and capital expenditures, including the development and
production costs of Toy Story 2 and Film Four, until we begin receiving cash
from the release of A Bug's Life (which we do not expect to occur until the
second quarter of 1999). However, even if these films generate cash, unless each
is a success such that we recover on a timely basis our share of the production
costs, as well as other operating expenses and capital expenditures, we will be
required to seek financing for our ongoing commitments under the Co-Production
Agreement and any other requirements of its operations. We may also seek
additional financing in connection with the construction of our new facility.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" in the 1998 Annual Report to
Shareholders. The sale of additional equity or convertible debt securities would
result in additional dilution to our shareholders. Moreover, we cannot provide
any assurances that we will be successful in obtaining future financing, or even
if such financing is available, that we will obtain it on favorable terms or on
terms providing us with sufficient funds to meet our obligations and objectives.
If we fail to obtain such financing, it would have a material adverse effect on
our business, operating results and financial condition.
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RISKS ASSOCIATED WITH SCHEDULED SUCCESSIVE RELEASES OF FILMS
In order to meet our obligations pursuant to the Co-Production Agreement,
we have established parallel creative teams so that we can develop more than one
film at a time. These teams are currently working on Toy Story 2, which is
currently targeted for release in late 1999, and Film Four, which is currently
targeted for release in mid 2001. We have only produced two prior feature films
to date and have limited experience with respect to producing animated feature
films in parallel. We have been required, and will continue to be required, to
expand our employee base, increase capital expenditures and procure additional
resources and facilities in order to produce animated feature films in parallel.
This growth has placed, and continues to place, a significant strain on our
resources. We cannot provide any assurances that Toy Story 2 or Film Four will
be released as targeted or that this strain on resources will not have a
material adverse effect on our business, financial condition or results of
operations. For example, to meet the production schedule of A Bug's Life, we
reassigned employees from other projects, including Toy Story 2, to A Bug's
Life. Similarly, to meet the production schedule of Toy Story 2, we expect to
reassign employees from other projects, including Film Four, to Toy Story 2. In
addition, John Lasseter, who, while directing A Bug's Life, was providing
creative oversight for Toy Story 2 in his role as Executive Vice President,
Creative, has now transitioned to the role of Director of Toy Story 2. Using the
personnel of future films to meet the immediate deadlines of films nearing
release, as we have for both A Bug's Life and Toy Story 2, may have the long
term impact of pushing out the targeted release dates of future films,
increasing film budgets, and adversely impacting our ability to generate
creative concepts for subsequent films on a timely basis.
Although we cannot provide any assurances that Toy Story 2 or Film Four
will be released on schedule, the targeted release timing of mid 2001 for Film
Four is particularly uncertain. While the story treatment and production budget
for Film Four have been approved pursuant to the Co-Production Agreement, we
have not formally agreed with Disney on the timing of its release and we cannot
provide any assurances that Disney will agree to release Film Four in mid 2001
as it is currently targeted. In addition, as Director of Toy Story 2, John
Lasseter will be focused on Toy Story 2 until its completion in late 1999, and
will be less available to assist on Film Four or future films during their
development phases. This may adversely impact Pixar's ability to release Film
Four in mid 2001 and the timing of release of future films thereafter.
If we are able to release films in late 1999 and mid 2001, we cannot
provide any assurances that we will release our next film in 2002. Due to the
strain on our personnel from the effort required for the release of Toy Story 2
and Film Four and the time required for creative development of a new film, it
is possible that we would be unable to release a successive new film in 2002. It
is too early to determine the rate at which any future films are to be released,
and we cannot provide any assurances that we will release a film in each
successive year or in any particular year.
To continue to accommodate growth, we will be required to implement a
variety of new and upgraded operational and financial systems, procedures and
controls, including improvement and maintenance of our accounting system, other
internal management systems and backup systems. In addition, this growth and
these diversification activities, along with the corresponding increase in the
number of our employees and rapidly increasing costs, have resulted in increased
responsibility for our management team. We will need to continue to improve our
operational, financial and management information systems and to hire, train,
motivate and manage our employees, to integrate them into Pixar and to provide
adequate facilities and other resources for them. We cannot provide any
assurances that we will be successful in accomplishing all of these activities
on a timely and cost-effective basis, and any failure to accomplish one or more
of these activities on a timely and cost-effective basis would have a material
adverse effect on our business, financial condition and results of operations.
RISKS ASSOCIATED WITH CO-PRODUCTION AGREEMENT
Dependence on Disney for Distribution and Promotion of Feature Films and
Related Products
The decisions regarding the timing of release of motion pictures and
related products and which of Disney's motion pictures and related products will
receive extensive promotional support from the studio are important in
determining the success of the motion picture and related products. Under the
terms of the
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Co-Production Agreement, we have some general protections with respect to the
marketing and distribution of the feature films in the form of commitments by
Disney as to release windows, the timing of release of other Disney family films
and marketing obligations. However, we ultimately do not control (1) the manner
in which Disney distributes our animated feature films and related products, (2)
the number of theaters to which Disney distributes our feature films, (3) the
specific timing of release of the feature films and related products or (4) the
specific amount or quality of promotional support of the feature films and
related products and the associated promotional and marketing budgets. Because
Disney Co-finances the films developed and produced under the Co-Production
Agreement, distributes the films under the "Walt Disney Pictures" label and may
enjoy financial benefits in the event that such films achieve significant box
office revenues, we believe that Disney desires such films to be successful.
Nonetheless, Disney could make certain decisions as to marketing, distribution
or promotion of the animated feature films or related products or the marketing
and promotion of its own animated or other family films that could have a
material adverse effect on our business, operating results or financial
condition. In addition, the costs for marketing, distribution and promotion of
the films and related products are incurred well in advance of the release of
such films and products, and we will experience a delay in the recognition of
revenue from such films and products until after Disney recovers such costs.
Exclusivity
We have agreed not to release or authorize the release of any of our
feature length animated theatrical motion pictures, other than the feature films
that we produced under the Co-Production Agreement, until twelve months from our
delivery of the fifth original feature film under the Co-Production Agreement.
We currently anticipate that we will not deliver the fifth Picture until 2004 or
2005 at the earliest. We have further agreed that we will not enter into any
agreement with any third party for the development, production or distribution
of any feature length animated theatrical motion picture until after we have
delivered the third original feature film to Disney under the Co-Production
Agreement. We have also agreed that we will not develop or produce any rides or
attractions for major theme parks not owned or operated by Disney, and to give
Disney a right to negotiate with respect to animated television productions or
animated made-for-home video productions that we propose to produce during the
term of the Co-Production Agreement. Disney, however, is not similarly
restricted by the exclusivity provisions that bind us under the Co-Production
Agreement and, therefore, may develop, produce, or distribute other feature
length animated and computer animated theatrical motion pictures itself or enter
into similar agreements with third parties. For example, we believe that Disney
is developing Expedition, a science fiction adventure, with Phil Tippett
Studios. See "Business -- Competition."
Financing of Production Costs
Under the Co-Production Agreement, unlike the prior Feature Film Agreement
which is applicable to Toy Story, we will continue to co-finance each of the
four remaining original animated feature films and may co-finance other related
products to be developed and produced pursuant to the Co-Production Agreement.
We co-financed A Bug's Life and are currently co-financing Toy Story 2 and Film
Four under the Co-Production Agreement. Accordingly, unlike the Feature Film
Agreement, we will incur significant production costs which must be offset by
revenue generated by the animated feature films and related products. If the
feature films and related products do not generate revenue sufficient to more
than offset our share of their production costs, our business, operating results
and financial condition will be materially adversely effected.
Rights to Characters and Elements Retained by Disney
Disney retains the exclusive distribution and exploitation right to all
feature films, all characters and story elements of the feature films and all
related products we develop under the Co-Production Agreement. Accordingly,
except in certain specified circumstances unlikely to generate revenue, we are
not able to exploit or distribute any of the feature films or characters or
elements of any of the feature films or related products developed under the
Co-Production Agreement without a license from Disney. We cannot provide any
assurances that such a license would be available to us on commercially
reasonable terms or at all.
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Termination
Under the terms of the Co-Production Agreement, Disney may terminate the
agreement under certain circumstances. For example, Disney is entitled to
terminate the Co-Production Agreement in the event that we fail to agree with
Disney on a treatment for a Picture within one year after the initial theatrical
release of the last Picture for which a treatment has been approved or selected,
subject to certain exceptions. Disney is also entitled to terminate the
Co-Production Agreement in the event that certain types of competitors directly
or indirectly acquire or control a 50% or greater ownership interest in Pixar or
Pixar merges or consolidates into such a competitor. We cannot provide any
assurances that Disney would not terminate the Co-Production Agreement under
these circumstances. Disney would not lose any of its rights to distribute and
exploit all feature films and all characters and elements of the feature films
and other products we develop under the Co-Production Agreement, except for a
feature film or related product then in production as to which Disney does not
elect to proceed, as to which we would regain the rights subject to a lien in
favor of Disney for the costs advanced to date. Further, in the event that
Disney terminated the Co-Production Agreement, we would be required to seek
alternative channels for distribution of our animated feature films and related
products. We cannot provide any assurances that we would be able to find a third
party to finance, distribute and promote our animated feature films and related
products on terms acceptable to us, if at all. See "Business -- Relationship
with Disney."
RISKS ASSOCIATED WITH THE MOTION PICTURE INDUSTRY
Commercial Success of a Motion Picture is Unpredictable
The motion picture industry involves a substantial degree of risk. Each
motion picture is an individual artistic work, and its commercial success is
primarily determined by audience reaction, which is unpredictable. The
commercial success of a motion picture also depends upon other factors, such as:
- the quality and acceptance of other competing films released into the
marketplace at or near the same time,
- critical reviews,
- the availability of alternative forms of entertainment and leisure time
activities,
- general economic conditions,
- weather conditions, and
- other tangible and intangible factors.
All of these factors can change and cannot be predicted with certainty. In
addition, motion picture attendance is seasonal, with the greatest attendance
typically occurring during the summer and holidays. The release of a film during
a period of relatively low theater attendance is likely to affect the film's box
office receipts adversely. Further, due to the expected release of a large
number of animated films by Disney and other movie studios in the next several
years, it is possible that the market for animated films will become saturated.
Therefore, there is a substantial risk that some or all of our motion pictures
will not be commercially successful, which would have a material adverse effect
on our business, financial condition and results of operations. See
"Business -- Competition."
Completion of a Motion Picture Subject to Uncertainties and Financial Risks
The production, completion and distribution of motion pictures is subject
to numerous uncertainties, including financing requirements, personnel
availability and the release schedules of competitive films. We are concurrently
developing and producing two motion pictures, Toy Story 2 and Film Four, which
compounds these uncertainties and jeopardizes the successful, timely and
cost-effective production and completion of each film. Under the Co-Production
Agreement, we have increased our financial involvement in the production costs
of motion pictures, which subjects us to substantial financial risks relating to
the production,
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completion and release of the motion pictures. In addition, a significant amount
of time will elapse between our expenditure of funds and our receipt of revenues
from the animated feature films.
WE DEPEND ON SUCCESSFUL DEVELOPMENT OF APPEALING CREATIVE CONTENT FOR ANIMATED
FEATURE FILMS AND RELATED PRODUCTS
The success of each of our animated feature films will depend in large part
upon our creative team's ability to predict the type of content that will appeal
to a broad audience and to develop stories and characters that achieve broad
market acceptance. Traditionally, this has been extremely difficult. Disney
provided creative assistance throughout the production of Toy Story and A Bug's
Life, including creative reviews and approvals. Although the Co-Production
Agreement contemplates that Disney will continue to provide creative assistance
on feature films and other products made pursuant to that agreement, we cannot
provide any assurances that Disney will continue to provide us with assistance
in the development of creative content for our feature films or related
products. We cannot provide any assurances that voices and other intellectual
property rights used in an animated feature film will be available for use in
any derivative product related to such feature film. For example, we were unable
to obtain the rights to use certain voices from Toy Story in the two CD-ROM
products based on Toy Story. See "Business -- Creative Development Group."
OUR MARKETS ARE HIGHLY COMPETITIVE
We experience intense competition with respect to animated feature films,
animation products and software.
Movie Studios. Our animated feature films compete and will continue to
compete with feature films and other family oriented entertainment products
produced by major movie studios, including Disney (as somewhat limited by the
Co-Production Agreement), DreamWorks (which continues to expressly target the
animated film market), Warner Bros. Inc., Twentieth Century Fox, Paramount,
Columbia/Tri-Star Pictures Inc., Lucasfilm, Universal City Studios, Inc. and
MGM/UA, as well as numerous other independent motion picture production
companies.
In 1998, competition significantly intensified in the animated feature film
market. Animated feature films released in 1998 included the following:
- Quest for Camelot by Warner Bros., Inc.
- The Rugrats Movie by Paramount,
- Prince of Egypt by DreamWorks, and
- Antz, a fully computer-animated movie by DreamWorks with its affiliate
Pacific Data Images ("PDI").
While the release of A Bug's Life was extremely successful, achieving
domestic box office revenues of $160 million as of March 28, 1999, Antz, The
Rugrats Movie and Prince of Egypt achieved domestic box office revenues of over
$91 million, $100 million and $99 million, respectively. These three films were
released during or near the 1998 holiday season and directly competed with A
Bug's Life. Each of these films was more successful than any preceding animated
feature film not released by Disney or the combination of Disney and Pixar. In
addition, other non-animated family oriented feature films released during the
1998 holiday season, such as Disney's Mighty Joe Young, also generated
competition for A Bug's Life. We expect that a variety of animated feature films
may be released in the theaters in the next several years that will directly
compete with Toy Story 2 and Film Four, which are targeted for release in late
1999, and mid 2001, respectively. Due to a potentially large number of releases
in the next several years, it is possible that the market for animated films
will become further saturated before we can release Toy Story 2 and Film Four,
which could result in failure of such films to achieve the extraordinary
commercial success required for us to profit from such films.
Our films will continue to compete with the feature films of other movie
studios for optimal release dates, audience acceptance and exhibition outlets.
In addition, we compete and will continue to compete with other movie studios
for the acquisition of literary properties, the services of performing artists,
and the services of
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other creative and technical personnel, particularly in the fields of animation
and technical direction. Most of the other movie studios with which we compete
have significantly greater name recognition and significantly greater financial,
technical, creative, marketing and other resources.
At least three of these movie studios, Disney, DreamWorks and ILM have
developed their own internal computer animation capability which may be used for
special effects in animated films and live action films. For example, DreamWorks
(with PDI) successfully produced Antz. In addition, Disney is currently
developing and producing a feature film making substantial use of computer
animation. Other movie studios may internally develop, license or sub-contract
three-dimensional animation capability. Further, we believe 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
licenses "Maya," its next generation three-dimensional 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 that we will develop and produce five
original computer-animated feature films. Because Disney co-finances the films
developed and produced under the Co-Production Agreement, distributes the films
under the "Walt Disney Pictures" label and enjoys financial benefits in the
event that such films achieve significant box office revenues, we believe that
Disney desires such films to be successful. Nonetheless, Disney has been by far
the most successful producer of animated feature films. Family oriented motion
pictures distributed by Disney or its affiliates are likely to be in the market
concurrently with and competing with our animated feature films, such as was the
case with the release of Mighty Joe Young during the 1998 holiday season which
competed against A Bug's Life. Our contractual arrangement with Disney also
presents other risks. See "-- Risks Associated with Co-Production Agreement."
We believe that the primary competitive factors in the market for animated
feature films include creative content and talent, product quality, technology,
access to distribution channels and marketing resources. Due in part to our
creative and technical resources and to the Co-Production Agreement with Disney,
pursuant to which Disney co-finances the production of the feature films,
markets the feature films and provides creative assistance and access to
significant distribution channels, we believe that we presently compete
favorably with respect to each of these factors.
Computer Graphics Special Effects Firms. We also expect to compete with
computer graphics special effects firms, including ILM, PDI, Rhythm & Hues,
Digital Domain and Blue Sky/VIFX Productions. These computer graphics special
effects firms may be capable of creating their own three-dimensional
computer-animated feature films or may produce three-dimensional
computer-animated feature films for movie studios that we compete with. For
example, ILM has already created and produced three-dimensional character
animation which was used for the ghosts in the live action film Casper, and ILM
has a royalty-free, paid-up license to use our RenderMan software and to obtain
at no cost all enhancements and upgrades thereto. Other computer graphics
special effects firms have licensed or may license RenderMan. Accordingly, our
RenderMan software may not provide us with a competitive advantage. We also
compete, or may in the future compete, with the above firms with respect to
animation products other than feature films. We believe that the primary
competitive factors in the market for three-dimensional computer-animation for
feature films and other animation products include creative content and talent,
product quality, technology, access to distribution channels and marketing
resources. We believe that we presently compete favorably with respect to each
of these factors.
Software Publishers. We also experience intense competition with respect to
our RenderMan software product. In particular, we compete with makers of
computer graphics imaging and animation software, principally Microsoft (which
acquired SoftImage Inc.), MentalImage (which offers the same product offered by
Microsoft), and Silicon Graphics (which acquired Wavefront and Alias).
Microsoft, through SoftImage Inc., MentalImage and Silicon Graphics, through
Wavefront and Alias, are each marketing competing rendering software products,
usually at prices that are lower than ours. Microsoft and Silicon Graphics have
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each licensed several of our patents that cover certain rendering techniques and
may therefore be better able to market products that compete with our RenderMan
software. Under appropriate circumstances, we might elect to license our
rendering technology patents to other companies, some of which may compete with
us. In addition, as PCs become more powerful, software suppliers may also be
able to introduce products for PCs that would be competitive with RenderMan in
terms of price and performance for professional users. We believe that the
primary competitive factors in the market for rendering software include product
quality, price/performance, technology, functionality, breadth of features and
customer service and support. We believe that we presently compete favorably
with respect to each of these factors.
We expect competition to persist, intensify and increase in each of our
business areas in the future. Almost all of our current and potential
competitors have longer operating histories, greater name recognition, larger
installed customer bases and significantly greater financial, technical,
marketing and other resources. We cannot provide any assurances that we will be
able to compete successfully against current or future competitors. Such
competition could materially adversely affect our business, operating results or
financial condition.
WE HAVE A LIMITED OPERATING HISTORY
Until 1996, we had generated recurring revenue primarily from the license
of our RenderMan software, amounts we received under software development
contracts and fees for animated television commercial development. However, we
continue to expect to generate a substantial majority of our future revenue from
the development and production of animated feature films and related products,
such as we did in 1996, 1997 and 1998. We have, to date, developed and produced
only two animated feature films Toy Story and A Bug's Life, and only two related
products (both CD-ROM titles, which we no longer produce). Accordingly, we have
only a limited operating history in implementing our new business model upon
which an evaluation of Pixar and our prospects can be based. Our prospects must
be considered in light of the risks, expenses and difficulties frequently
encountered by companies in the early stages of a new business enterprise,
particularly companies in highly competitive markets. To address these risks, we
must, among other things, respond to competitive developments, continue to
attract, retain and motivate qualified persons, and continue to upgrade our
technologies. We cannot provide any assurances that we will be successful in
addressing such risks.
WE DEPEND ON CERTAIN KEY EMPLOYEES
Our success depends to a significant extent on the performance of a number
of senior management personnel and other key employees, especially our
animators, creative personnel and technical directors. In particular, we are
dependent upon the services of Steve Jobs, John Lasseter, Edwin E. Catmull and
Sarah McArthur. We do not maintain "key person" life insurance for any of our
employees. We do have an employment agreement with Mr. Lasseter, who is
fundamental to Pixar's relationship with Disney. However, such employment
agreement does not necessarily assure the services of Mr. Lasseter. Moreover,
although it is standard in the motion picture industry to rely on employment
agreements as a method of retaining the services of key employees, we have not
required our employees, other than Mr. Lasseter, to enter into employment
agreements. We believe that it may be particularly difficult to retain our key
employees, especially our animators, creative personnel and technical directors,
during periods in which we are not developing animated feature films. The loss
of the services of any of Messrs. Jobs, Lasseter, or Catmull, Ms. McArthur or of
other key employees, especially our animators, creative personnel and technical
directors, could have a material adverse effect on our business, operating
results or financial condition. Although none of our employees is represented by
a labor union, it is common for animators and actors at film production
companies to belong to a union. Further, we may be directly or indirectly
dependent upon union members, and work stoppages or strikes organized by such
unions could materially adversely impact our business, financial condition or
results of operations. There can be no assurance that our employees will not
join or form a labor union, or that we will not be directly or indirectly
impacted by industry related work stoppages or that we, for certain purposes,
will not be required to become a union signatory.
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<PAGE> 26
OUR CHIEF EXECUTIVE OFFICER HAS DIVIDED RESPONSIBILITIES
Pixar's Chief Executive Officer and Chairman, Steve Jobs, is also acting as
interim Chief Executive Officer at Apple Computer, Inc. ("Apple"). Although Mr.
Jobs spends time at Pixar and is active in our management, he does not devote
his full time and resources to Pixar.
WE NEED TO ATTRACT AND RETAIN QUALIFIED PERSONNEL TO BE SUCCESSFUL
Our success continues to depend to a significant extent on our ability to
identify, attract, hire, train and retain qualified professional, creative,
technical and managerial personnel. Competition for such personnel is intense,
and there can be no assurance that we will be successful in identifying,
attracting, hiring, training and retaining such personnel in the future. The
competition for quality animators, creative personnel and technical directors is
especially intense because the entertainment market has significantly expanded
over the past several years. If we are unable to hire, assimilate and retain
qualified personnel in the future, particularly animators, creative personnel
and technical directors, such inability would have a material adverse effect on
our business, operating results and financial condition.
WE FACE DISTRIBUTION RISKS
Disney is required to distribute the five animated feature films to be
produced pursuant to the Co-Production Agreement and has agreed to distribute
Toy Story 2 pursuant to the Co-Production Agreement. Distribution of a motion
picture generally involves domestic and foreign licensing for (1) theatrical
exhibition, (2) home video, (3) presentation on television, including pay, basic
cable and syndication, (4) non-theatrical exhibition, which includes airlines,
hotels and armed forces facilities and (5) marketing of other rights of the
picture, which may include merchandising, such as CD-ROM titles, toys and
soundtrack recordings. Although the Co-Production Agreement provides us with
some protection, we cannot provide any assurances that the feature films made
under the Co-Production Agreement will be distributed through all of these
outlets. For example, Disney has traditionally not made its animated feature
films available on pay television other than the Disney Channel or on network
television other than ABC, an affiliate of Disney. See "Business -- Business
Model and Products."
WE DEPEND ON PROPRIETARY TECHNOLOGY AND COMPUTER SYSTEMS FOR TIMELY AND
SUCCESSFUL DEVELOPMENT OF FEATURE FILMS AND RELATED PRODUCTS
We cannot provide any assurances that we will not experience difficulties
that could delay or prevent the successful development or production of future
animated feature films or other related products. Among other things, because we
are dependent upon a large base of software and a large number of computers for
the development and production of our animated feature films and related
products, an error or defect in the software, a failure in the hardware or a
failure of the backup facilities could result in a significant delay in one or
more productions in process which, in turn, could result in potentially
significant delays in the release dates of our feature films or other products.
For example, early in 1998 we experienced a failure of our backup systems for
Toy Story 2 which resulted in substantial effort to restore data and a loss of
certain data, but which is not expected to have a material impact on the
schedule for production or release of Toy Story 2. However, significant delays
in production and significant delays in release dates could have a material
adverse effect on our business, operating results or financial condition.
Further, because we rely mostly on internally developed software, we would not
be able to rely upon assistance from third parties in the event that the
software fails. See "Business -- Technology."
ONE SHAREHOLDER OWNS A LARGE PERCENTAGE OF OUR STOCK
Pixar's Chief Executive Officer, Steve Jobs, beneficially owns
approximately 65.8% of the outstanding Common Stock as of March 19, 1999. As a
result, Mr. Jobs, acting alone, is able to exercise sole discretion over all
matters requiring shareholder approval, including the election of the entire
board of directors and approval of significant corporate transactions, including
an acquisition of Pixar. Such concentration of ownership may also have the
effect of delaying or preventing a change in control of Pixar, impeding a
merger,
25
<PAGE> 27
consolidation, takeover or other business combination involving Pixar, or
discouraging a potential acquirer from making a tender offer or otherwise
attempting to obtain control of Pixar.
WE MAY INCUR SUBSTANTIAL ADDITIONAL COSTS RELATED TO FACILITIES EXPANSION
As of January 2, 1999, we had incurred capital expenditures of
approximately $21.2 million to purchase and begin construction of approximately
15 acres of land in Emeryville, California to build a new headquarters and
studio facility. To construct the facility, we currently expect to incur capital
expenditures of approximately $38.0 million in 1999 and $19.0 million in 2000.
In addition, we expect to spend approximately $6.5 million total over the years
1999 and 2000 on related furniture, fixtures and equipment for the new facility.
Due to changes in construction, design and/or other specifications which may or
may not be at the discretion of management and are often difficult to predict,
we cannot provide any assurances that construction of the new studio facility
can be completed within these specified amounts. To date, we have chosen to use
our existing cash resources to fund facility-related costs. We may continue to
use our cash resources for such expenditures, or may choose to finance such
capital expenditures through the issuance of additional equity or debt
securities, by obtaining a credit facility or by some other financing mechanism.
If we choose to seek financing for such expenditures, we cannot provide any
assurances that such financing will be available on terms reasonably acceptable
to us or at all. See "-- Risks Associated with Adequacy of Cash Balances" and
"Properties" herein and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" in the
1998 Annual Report to Shareholders.
WE DEPEND ON TECHNOLOGICAL ADVANCEMENT TO BE SUCCESSFUL
Substantially all of our revenues have been derived, and substantially all
of our future revenues are expected to be derived, from the use and license of
our proprietary technologies. We expect that it will be required to enhance
these technologies and to develop new technologies in order to be successful in
our industry and in the licensing of our RenderMan software. We cannot provide
any assurances that we will be successful in enhancing our existing technologies
or in developing and utilizing new technologies, or that competitors will not
develop technology that is equivalent or superior to our technologies or that
makes our technologies obsolete. If we are unable to develop enhancements to our
existing technologies or new technologies as required, our business, operating
results or financial condition could be materially adversely affected. See
"Business -- Technology" and "Competition -- Movie Studios."
WE DEPEND ON PROPRIETARY RIGHTS
No Assurance That Efforts to Protect Proprietary Technologies Will Succeed
Our success and ability to compete is dependent in part upon our
proprietary technology. While we rely on a combination of patents, copyright and
trade secret protection, nondisclosure agreements and cross-licensing
arrangements to establish and protect our proprietary rights, we believe that
factors such as the technical and creative skills of our personnel are more
essential to our success and ability to compete. We currently own thirteen
patents issued in the United States and seven issued in foreign countries. In
addition, we have a number of patent applications pending in the United States
and in foreign countries. We cannot provide any assurances that patents will
issue from any of these pending applications or that, if patents do issue, any
claims allowed will be sufficiently broad to protect our technology. In
addition, we cannot provide any assurances that any patents that have been
issued to us, or that we may license from third parties, will not be challenged,
invalidated or circumvented, or that any rights granted thereunder would provide
us with any proprietary protection. Failure of the patents to provide protection
of our technology may make it easier for our competitors to offer technology
equivalent to or superior to our technology. See "Business -- Proprietary
Rights."
The source code for our proprietary software is protected both as trade
secrets and as a copyrighted work. We generally enter into confidentiality or
license agreements with our employees, consultants and vendors, and generally
control access to and distribution of our software, documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use our
26
<PAGE> 28
proprietary information, products or technology without authorization, or to
develop similar or superior technology independently. Policing unauthorized use
of our products is difficult. In addition, effective copyright and trade secret
protection may be unavailable or limited in certain foreign countries. To
license our RenderMan software product, we primarily rely on "shrink wrap"
licenses that are not signed by the end-user and, therefore, may be
unenforceable under the laws of certain jurisdictions. We cannot provide any
assurances that the steps we take will prevent misappropriation of our
technology or that our confidentiality or license agreements will be
enforceable. See "Business -- Proprietary Rights."
Risk That Litigation Will Be Required to Enforce Proprietary Rights
Litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets, to determine the validity and
scope of the proprietary rights of others, or to defend against claims of
infringement or invalidity. Any such litigation could result in substantial
costs and diversion of resources and could have a material adverse effect on our
business, operating results or financial condition. See "Business -- Proprietary
Rights."
Risks of Infringement Claims
One of the risks of the film production business is claims that our
productions infringe the intellectual property rights of third parties with
respect to previously developed films, stories, characters or other
entertainment. In addition, our technology and software may be subject to
patent, copyright or other intellectual property claims of third parties. We
have received, and are likely to receive in the future, notice of claims of
infringement of other parties' proprietary rights. There can be no assurance
that infringement or invalidity claims (or claims for indemnification resulting
from infringement claims) will not be asserted or prosecuted against us or that
any assertions or prosecutions will not materially adversely affect our
business, financial condition or results of operations. Irrespective of the
validity or the successful assertion of such claims, we would incur significant
costs and diversion of resources with respect to the defense thereof which could
have a material adverse effect on our business, financial condition or results
of operations. If any claims or actions are asserted against us, we may seek to
obtain a license under a third party's intellectual property rights. We cannot
provide any assurances, however, that under such circumstances a license would
be available on reasonable terms or at all. See "Business -- Proprietary
Rights."
No Assurance That Third Party Technology Licenses Will Continue to be
Available
We also rely on certain technology that we license from third parties,
including software that we integrate and use with our internally developed
software. We cannot provide any assurances that these third party technology
licenses will continue to be available to us on commercially reasonable terms.
The loss of or inability to maintain any of these technology licenses could
result in delays in feature film releases or product shipments until equivalent
technology could be identified, licensed and integrated. Any such delays in
feature film releases or product shipments could materially adversely affect our
business, operating results and financial condition. See
"Business -- Proprietary Rights."
POSSIBLE VOLATILITY OF SHARE PRICE AND RISK OF LITIGATION
The market price of our Common Stock is highly volatile and is subject to
wide fluctuations in response to a wide variety of factors including the
publication of box office results for our feature films and those of our
competitors, fluctuations in our quarterly or annual results of operations,
changes in financial estimates by securities analysts, announcements made by us
or our competitors, budget increases, delays in or cancellation of feature film
or other product release dates, or other events or factors. For example, since
December 31, 1997, our Common Stock has closed as low as $21 and as high as $64
per share. Moreover, in recent years, the stock market in general, and the
shares of technology companies in particular, have experienced extreme price and
volume fluctuations, some of which have been unrelated or disproportionate to
the operating performances of such companies. These broad market and industry
fluctuations may adversely affect the market price of our Common Stock. In the
past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been instituted against
such a company. If brought against Pixar,
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<PAGE> 29
such litigation could result in substantial costs and a diversion of
management's attention and resources, which could have a material adverse effect
on our business, operating results or financial condition. See "Market for
Registrant's Common Stock and Related Shareholder Matters."
WE FACE YEAR 2000 RISKS
The Year 2000 problem is the result of computer programs 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. We are currently reviewing our products, our internal computer
systems and the systems of third parties on which we rely for handling the Year
2000. We are also seeking confirmation from third parties that their systems are
Year 2000 compliant or plans are being developed to address the Year 2000
problem. Based on information available to date, we believe that we will be able
to complete our Year 2000 compliance review and make any necessary modifications
to our internal systems prior to the end of 1999. We further believe that such
review and modification will not require us to incur any material charge to
operating expenses, although we cannot provide any assurance that such expenses
will not be material.
Our most significant Year 2000 risk results from our relationship with
Disney, a public company. We rely on Disney for the distribution and marketing
of our films and Toy Story 2 is expected to be released in late 1999. The
disruption of Disney's distribution activities as a result of Year 2000 problems
could result in lost revenues for Toy Story 2 and related merchandise. In
addition, if the accounting and financial systems of Disney are adversely
affected by Year 2000 issues and Disney is unable to issue revenue reports to
us, our recognition of our share of the revenue generated pursuant to the
Co-Production Agreement could be delayed. There can be no assurance that
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
our financial position or results of operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- The Year 2000"
in the 1998 Annual Report to Shareholders.
ITEM 2. PROPERTIES
Pixar leases approximately 120,000 square feet of office space in Richmond,
California. The related leases expire on various dates ranging from July 1999 to
January 2002.
As of January 2, 1999, Pixar had incurred total capital expenditures of
approximately $21.2 million to purchase and begin construction on approximately
15 acres of land in Emeryville, California for a new headquarters and studio
facility. Pixar expects to incur capital expenditures of approximately $38.0
million in 1999 and $19.0 million in 2000. To date, Pixar has chosen to use its
existing cash resources to fund facility-related costs. Pixar may continue to
use its cash resources for such expenditures, or may choose to finance such
capital expenditures through the issuance of additional equity or debt
securities, by obtaining a credit facility or by some other financing mechanism.
See "Risk Factors -- We May Incur Substantial Additional Costs Related to
Facilities Expansion" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" in the
1998 Annual Report to Shareholders.
ITEM 3. LEGAL PROCEEDINGS
Pixar is not party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 1998.
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<PAGE> 30
EXECUTIVE OFFICERS OF PIXAR
The executive officers of Pixar and their ages as of March 31, 1999 are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH PIXAR
---- --- -------------------
<S> <C> <C>
Steve Jobs 44 Chairman, Chief Executive Officer and Office of the
President
Edwin E. Catmull 54 Executive Vice President, Chief Technical Officer and
Office of the President
Lawrence B. Levy(1) 40 Executive Vice President, Chief Financial Officer,
Office of the President and Secretary
John Lasseter 42 Executive Vice President, Creative Development
Sarah McArthur 42 Executive Vice President, Production
</TABLE>
- ---------------
(1) Effective March 31, 1999, Mr. Levy will resign as Executive Vice President,
Chief Financial Officer, and Office of the President and effective in April
1999, Mr. Levy will join Pixar's Board of Directors.
Pixar's executive officers are appointed by, and serve at the discretion
of, the Board of Directors. Each executive officer is an employee of Pixar.
There is no family relationship between any executive officer or director of
Pixar.
Mr. Jobs is a co-founder of Pixar and has served as its Chairman since
March 1991, as its Chief Executive Officer since 1986 and in the Office of the
President since 1995. He has been a director of Pixar since 1986. In addition,
Mr. Jobs currently serves as interim Chief Executive Officer and as a member of
the Board of Directors of Apple Computer, Inc. ("Apple"). Mr. Jobs was also a
co-founder of NeXT Software, Inc. ("NeXT"), which developed and marketed
object-oriented software for client/server business applications and the
Internet, and served as the Chairman and Chief Executive Officer of NeXT from
October 1985 until February 1997, when NeXT was acquired by Apple. Mr. Jobs then
served as an advisor to Apple on a limited basis until assuming his current role
as interim Chief Executive Officer at Apple.
Dr. Catmull is a co-founder of Pixar and has served as Executive Vice
President and Chief Technical Officer since June 1995 and in the Office of the
President since February 1995. From March 1991 to February 1995, he served as
President, from November 1988 to March 1991 he served as Chairman and from
February 1986 to November 1988 he served as President. Prior to joining Pixar,
he was Vice President of the Computer Division of Lucasfilm. Dr. Catmull
received the Scientific and Engineering Award from The Academy of Motion Picture
Arts and Sciences in 1992 and also received the SIGGRAPH Coons Award for
lifetime contributions in 1993. Dr. Catmull is a member of the Scientific and
Technical Awards Committee of The Academy of Motion Picture Arts and Sciences.
Dr. Catmull received B.S. degrees in computer science and physics and a Ph.D. in
computer science from the University of Utah.
Mr. Levy has served as Executive Vice President, Chief Financial Officer
and in the Office of the President since February 1995. Mr. Levy has served as
Secretary of Pixar since October 1995. Prior to joining Pixar, he was Vice
Chairman and Chief Financial Officer of Electronics for Imaging, Inc., a
provider of hardware and software products for the digital color imaging market,
where he held various executive positions from April 1991 until January 1995.
From December 1987 to April 1991, he was head of the Technology Licensing and
Distribution Department at the law firm of Wilson Sonsini Goodrich & Rosati,
where he became a partner in February 1990. Mr. Levy also serves as a director
of IDG Books Worldwide, Inc. Mr. Levy received a B.S. in business and accounting
from Indiana University and a J.D. from Harvard Law School. Mr. Levy is also a
certified public accountant.
Mr. Lasseter has served as Vice President, Creative Development since
August 1991 and was promoted to Executive Vice President, Creative Development
in February 1999. Mr. Lasseter was Director of Toy Story and A Bug's Life and
currently is Director of Toy Story 2. In addition, he serves as creative head of
Pixar's other films and projects. Mr. Lasseter joined Pixar in February 1986 as
Animator/Director. From 1984 to 1986, he was an animator at Lucasfilm and from
1979 to 1984 he worked as an animator at Disney. For his work in directing Toy
Story, Mr. Lasseter received an Academy Award in 1996 for Special Achievement,
and
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for his work in directing Tin Toy, Mr. Lasseter received an Academy Award in
1988 for Best Short Film (Animated). Mr. Lasseter received a B.F.A. degree in
film from the California Institute of the Arts.
Ms. McArthur has served as Vice President, Production since May 1997 and
was promoted to Executive Vice President, Production in February 1999. Ms.
McArthur oversees all Pixar production teams and manages all aspects of making
the films. From 1989 to April 1997, Ms. McArthur worked at Disney, where she was
most recently Vice President of Production for Disney Feature Animation,
overseeing the production of feature animation films in Disney's Burbank,
Florida and Paris studios. During Ms. McArthur's eight years at Disney, she was
the Production Manager on The Rescuers Down Under, went on to be the Associate
Producer on Beauty and the Beast and an Executive Producer on The Lion King. She
was appointed Director of Production in late 1991 and promoted to Vice President
of Production in 1994. Prior to working at Disney, Ms. McArthur worked at the
Mark Taper Forum as their Production Manager of special projects. Ms. McArthur
earned her B.A. degree in Theatre from the University of California, Santa
Barbara, and she attended Carnegie-Mellon University's M.F.A. program in Theater
Arts.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Pixar's Common Stock has traded on The Nasdaq Stock Market under the
trading symbol "PIXR" since Pixar's initial public offering on November 29,
1995. The following table sets forth the high and low sale prices per share of
Pixar's Common Stock for the periods indicated.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1997
First Quarter............................................. $22 3/4 $12 5/8
Second Quarter............................................ $18 1/2 $14 1/8
Third Quarter............................................. $24 3/4 $14 1/2
Fourth Quarter............................................ $27 1/4 $19 1/2
1998
First Quarter............................................. $38 $20 1/4
Second Quarter............................................ $65 5/8 $33 3/4
Third Quarter............................................. $66 $27 1/2
Fourth Quarter............................................ $53 3/4 $31
1999
First Quarter (through March 19, 1999).................... $45 1/4 $35
</TABLE>
As of March 19, 1999, Pixar had approximately 2,672 shareholders of record.
The price for the Common Stock as of the close of business on March 19, 1999 was
$41.75 per share. Pixar has never paid any cash dividends on its Common Stock.
Pixar intends to retain any earnings for use in its business and does not
anticipate paying any cash dividends on its Common Stock in the foreseeable
future.
USE OF PROCEEDS
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 January 2, 1999, the Company had used the net proceeds from the
offering as follows: $24,167,034 for construction of plant, building and
facilities, $12,650,029 for the purchase and installation of machinery and
equipment, $2,374,000 for the repayment of indebtedness, $79,784,138 for the
development of films and other animated products, $16,196,615 for working
capital and $4,489,470 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.
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<PAGE> 33
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated by reference to the
section entitled "Selected Financial Data" in the 1998 Annual Report to
Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is incorporated by reference to the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in the 1998 Annual Report to Shareholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated by reference to the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in the 1998 Annual Report to Shareholders.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is incorporated by reference to the
section entitled "Financial Statements and Selected Financial Data" in the 1998
Annual Report to Shareholders.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
DIRECTORS
The members of Pixar's Board of Directors as of March 31, 1999 are as
follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH PIXAR
---- --- -------------------
<S> <C> <C>
Steve Jobs 44 Chairman, Chief Executive Officer and Office of
the President
Larry W. Sonsini 58 Director
Skip M. Brittenham 57 Director
Joseph A. Graziano 55 Director
Jill E. Barad 47 Director
</TABLE>
Mr. Jobs is a co-founder of Pixar and has served as its Chairman since
March 1991, as its Chief Executive Officer since February 1986 and in the Office
of the President since February 1995. He has been a director of Pixar since
February 1986. In addition, Mr. Jobs currently serves as interim Chief Executive
Officer and as a member of the Board of Directors of Apple Computer, Inc.
("Apple"). Mr. Jobs was also a co-founder of NeXT Software, Inc. ("NeXT"), which
developed and marketed object-oriented software for client/server business
applications and the Internet, and served as the Chairman and Chief Executive
Officer of NeXT from October 1985 until February 1997, when NeXT was acquired by
Apple. Mr. Jobs then served as an advisor to Apple on a limited basis until
assuming his current role as interim Chief Executive Officer at Apple.
Mr. Sonsini has served as a director of Pixar since April 1995 and served
as Secretary from April 1995 to October 1995. He has been an attorney with the
law firm of Wilson Sonsini Goodrich & Rosati since 1966 and currently serves as
the Chairman of the firm's Executive Committee. Mr. Sonsini also serves as a
director of Lattice Semiconductor Corporation and Novell, Inc. Mr. Sonsini
received A.B. and L.L.B. degrees from the University of California, Berkeley.
Mr. Brittenham has served as a director of Pixar since August 1995. He has
been an attorney with the law firm of Ziffren, Brittenham, Branca & Fischer, an
entertainment law firm, since 1978. Mr. Brittenham currently serves on the board
of, or is a trustee of, numerous charitable organizations, including
Conservation International, the American Oceans Campaign, the Environmental
Media Association and the Alternative Medical AIDS Foundation. Mr. Brittenham
received a B.S. from the United States Air Force Academy and a J.D. from the
University of California at Los Angeles.
Mr. Graziano has served as a director of Pixar since August 1995. From June
1989 to December 1995, he was the Executive Vice President and Chief Financial
Officer of Apple and was a member of the Board of Directors of Apple from June
1993 until October 1995. From May 1987 to June 1989, Mr. Graziano served as
Chief Financial Officer of Sun Microsystems, Inc. and from October 1981 to May
1985 as Chief Financial Officer of Apple. In addition, he has held accounting
positions with various technology companies in the Silicon Valley. Mr. Graziano
also serves as a director of IntelliCorp, Inc., Carrier Access Corporation and
CIDCO Incorporated. Mr. Graziano received a B.S. in accounting from Merrimack
College and is a certified public accountant.
Ms. Barad has served as a director of Pixar since July 1997. She has been
Chairman and Chief Executive Officer of Mattel, Inc. since October 1997. From
January 1997 to October 1997, she was President and Chief Executive Officer of
Mattel, Inc., and from July 1992 until December 1996, she was President and
Chief Operating Officer. Ms. Barad serves as a director of Mattel, Inc. and
Microsoft Corporation.
In addition, Lawrence B. Levy and Edwin E. Catmull will become members of
Pixar's Board of Directors effective in April 1999. See the section entitled
"Executive Officers of Pixar" at the end of Part I of this Form 10-K.
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EXECUTIVE OFFICERS
The information required by this item concerning the executive officers of
Pixar is incorporated by reference to the information set forth in the section
entitled "Executive Officers of Pixar" at the end of Part I of this Form 10-K.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act ("Section 16(a)") requires Pixar's
executive officers, directors and persons who own more than ten percent of
Pixar's Common Stock, to file initial reports of ownership on Form 3 and changes
in ownership on Form 4 or Form 5 with the SEC and the National Association of
Securities Dealers, Inc. Such executive officers, directors and ten-percent
shareholders are also required by SEC rules to furnish Pixar with copies of all
such forms that they file.
Based solely on its review of the copies of such forms received by Pixar
and written representations from certain reporting persons that no Forms 5 were
required for such persons, Pixar believes that during fiscal 1998 all Section
16(a) filing requirements applicable to its executive officers, directors and
ten-percent shareholders were complied with.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table shows, as to the Chief Executive Officer and each of
the four most highly compensated executive officers whose salary plus bonus
exceeded $100,000 during the last fiscal year (the "Named Officers"),
information concerning compensation paid for services to Pixar in all capacities
during the last three fiscal years.
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
------------------------------- UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#)
--------------------------- ---- --------- ---------- ------------
<S> <C> <C> <C> <C>
Steve Jobs 1998 $ 50 $ -- --
Chairman, Chief Executive Officer 1997 -- -- --
and Office of the President 1996 -- -- --
Edwin E. Catmull 1998 295,846 -- --
Executive Vice President, Chief 1997 208,539 -- --
Technical Officer and Office of the
President 1996 198,512 -- --
Lawrence B. Levy 1998 295,846 -- --
Executive Vice President, Chief Financial 1997 208,539 -- --
Officer and Office of the President 1996 197,789 -- --
John Lasseter 1998 769,315 250,000 --
Executive Vice President, 1997 625,903 1,250,000 125,000
Creative Development 1996 256,203 -- --
Sarah McArthur(1) 1998 300,000 -- 200,000
Executive Vice President, Production 1997 196,148 -- 200,000
1996 N/A N/A N/A
</TABLE>
- ---------------
(1) Ms. McArthur joined Pixar in 1997.
34
<PAGE> 36
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows, as to each of the Named Officers, information
concerning stock options granted during the fiscal year ended January 2, 1999.
OPTION GRANTS IN FISCAL 1998
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE VALUE
-------------------------------------- AT ASSUMED ANNUAL RATES
% OF TOTAL OF STOCK PRICE APPRECIATION
NUMBER OF SECURITIES OPTIONS GRANTED FOR OPTION TERM(4)
UNDERLYING TO EMPLOYEES IN EXERCISE EXPIRATION ---------------------------
NAME OPTIONS GRANTED(1) FISCAL YEAR(2) PRICE ($/SH) DATE(3) 5% 10%
---- -------------------- --------------- ------------ ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Steve Jobs -- --% $ -- -- $ -- $ --
Edwin E. Catmull -- -- -- -- -- --
Lawrence B. Levy -- -- -- -- -- --
John Lasseter -- -- -- -- -- --
Sarah McArthur 200,000(5) 6.2 21.38 1/9/08 2,688,525 6,813,249
</TABLE>
- ---------------
(1) All options in this table were granted under the 1995 Stock Plan and have
exercise prices equal to the fair market value on the date of grant.
(2) Pixar granted options for 3,205,922 shares of Common Stock to employees in
fiscal 1998.
(3) Options may terminate before their expiration upon the termination of
optionee's status as an employee or consultant, the optionee's death or an
acquisition of Pixar.
(4) The 5% and 10% assumed rates of appreciation are provided in accordance with
rules of the SEC and do not represent Pixar's estimate or projection of the
future Common Stock price. This table does not take into account any
appreciation in the price of the Common Stock from the date of grant to
date.
(5) These options are nonstatutory stock options which vest over a four-year
period at the rate of one-fourth at the end of each year from the vesting
start date.
OPTION EXERCISES AND HOLDINGS
The following table sets forth, for each of the Named Officers, certain
information concerning stock options exercised during fiscal 1998, and the
number of shares subject to both exercisable and unexercisable stock options as
of January 2, 1999. Also reported are values for "in-the-money" options that
represent the positive spread between the respective exercise prices of
outstanding stock options and the fair market value of Pixar's Common Stock as
of January 2, 1999.
AGGREGATED OPTION EXERCISES IN FISCAL 1998 AND FISCAL 1998 YEAR END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END($)(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Steve Jobs -- $ -- -- -- $ -- $ --
Edwin E. Catmull 340,000 9,508,250 66,667 83,333 2,320,012 2,899,988
Lawrence B. Levy 946,210 33,036,202 136,124 66,666 4,737,115 2,319,977
John Lasseter 405,000 15,272,813 498,959 151,041 16,565,982 4,313,393
Sarah McArthur 15,000 572,500 64,167 320,833 1,427,716 5,413,534
</TABLE>
- ---------------
(1) Market value of underlying securities based on the closing price of Pixar's
Common Stock on December 31, 1998 (the last trading day of fiscal 1998) on
the Nasdaq National Market of $35.00 minus the exercise price.
35
<PAGE> 37
EMPLOYMENT AGREEMENTS
In February 1997, Pixar entered into a new employment agreement with John
Lasseter that extends until February 23, 2004. Pursuant to the agreement, Mr.
Lasseter received a signing bonus of $1,250,000 and was granted additional stock
options to purchase 125,000 shares of Pixar's Common Stock which vest over four
years. The agreement provides for a current annual salary of $816,480 with 8%
annual increases. The agreement also provides for the payment of a bonus (the
"Motion Picture Bonus") based upon domestic theatrical box office gross receipts
from feature-length animated motion pictures ("Feature Films") directed by Mr.
Lasseter. Under the agreement, Mr. Lasseter will direct three Feature Films and
has the option to direct certain sequels to Feature Films he directed if Pixar
elects to produce such sequels within twelve years after the initial release of
the applicable picture. A Bug's Life counted as the first of the three feature
films Mr. Lasseter has agreed to produce. During the term of the agreement, Mr.
Lasseter is prohibited from accepting other employment and from becoming
financially interested or associated with any entity engaged in a related or
competitive business. Pixar can terminate the agreement at any time for any
reason. However, if Pixar terminates Mr. Lasseter's employment without cause,
Pixar must pay Mr. Lasseter (i) an amount equal to 75% of the balance of the
salary Mr. Lasseter would have earned through the remainder of the term of the
agreement and (ii) any portion of the Motion Picture Bonus as and if due. In
addition, the vesting of Mr. Lasseter's stock options would accelerate so that
they would be exercisable in full and Mr. Lasseter could accept employment with
any third party.
DIRECTOR COMPENSATION
Directors who are not employees of Pixar receive a fee of $1,000 for each
meeting attended of the Board of Directors and a fee of $1,000 for each meeting
attended of a committee of the Board of Directors if such committee meeting is
not held in conjunction with a meeting of the Board of Directors. All directors
are reimbursed for expenses incurred in attending such meetings.
Non-employee directors are eligible to receive option grants pursuant to
Pixar's 1995 Director Option Plan (the "Director Plan") which was adopted by the
Board of Directors in October 1995, approved by the shareholders in November
1995 and took effect in November 1995. A total of 200,000 shares of Common Stock
has been reserved for issuance under the Director Plan. As of March 19, 1999,
there were 60,000 options outstanding under the Director Plan. The Director Plan
provides for an automatic grant of an option to purchase 30,000 shares of Common
Stock (the "First Option") to each non-employee director who first becomes a
non-employee director (other than an employee director who ceases to be an
employee but remains a director) after the effective date of the Director Plan
on the date on which such person first becomes a non-employee director.
Beginning on the third anniversary of the date he or she became an outside
director, each nonemployee director will automatically be granted an option to
purchase 10,000 shares of Common Stock (a "Subsequent Option") each year on the
date of such anniversary, provided he or she is then a non-employee director.
Each nonemployee director will be eligible to receive a Subsequent Option,
regardless of whether such non-employee director was eligible to receive a First
Option. First Options and each Subsequent Option will have a term of ten years.
One-third of the shares subject to a First Option will vest one year after its
date of grant and an additional one-third will vest at the end of each year
thereafter, provided that the optionee continues to serve as a director on such
dates. All of the shares subject to a Subsequent Option will vest one year after
the date of the option grant, provided that the optionee continues to serve as a
director on such date. The exercise prices of the First Option and each
Subsequent Option will be 100% of the fair market value per share of Pixar's
Common Stock on the date of the grant of the option. Ms. Barad was granted a
First Option in July 1997 at an exercise price of $15.125 per share. Mr. Sonsini
was granted a Subsequent Option in April 1998 at an exercise price of $43.50 per
share. Messrs. Brittenham and Graziano were each granted a Subsequent Option in
August 1998 at an exercise price of $30.75 per share. Ms. Barad will be eligible
for a Subsequent Option under the Director Plan on the third anniversary of the
date she became a director and Messrs. Sonsini, Brittenham and Graziano are
eligible for Subsequent Options each year on the anniversary of the dates they
became directors.
36
<PAGE> 38
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Pixar's Compensation Committee is currently composed of Ms. Barad and Mr.
Graziano. No interlocking relationship exists between any member of Pixar's
Board of Directors or Compensation Committee and any member of the Board of
Directors or compensation committee of any other company, nor has any such
interlocking relationship existed in the past. No member of the Compensation
Committee is or was formerly an officer or an employee of Pixar.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the beneficial ownership of Common Stock of
Pixar as of March 19, 1999 for the following: (i) each person who is known by
Pixar to own beneficially more than 5% of the outstanding shares of Pixar's
Common Stock; (ii) each of Pixar's directors; (iii) each of the Named Officers;
and (iv) all directors and executive officers of Pixar as a group.
<TABLE>
<CAPTION>
NUMBER OF PERCENT
NAME OF BENEFICIAL OWNER SHARES(1) OF TOTAL(1)
------------------------ ---------- -----------
<S> <C> <C>
Steve Jobs 30,000,001 65.8%
c/o Pixar
1001 West Cutting Boulevard
Richmond, CA 94804
Transamerica Corporation(2) 3,432,900 7.5
600 Montgomery Street
San Francisco, CA 94111
Disney Enterprises, Inc.(3) 2,500,100 5.3
500 South Buena Vista Street
Burbank, CA 91521
John Lasseter(4) 1,084,708 2.3
Edwin E. Catmull(5) 612,800 1.3
Lawrence B. Levy(6) 733,800 1.6
Sarah McArthur(7) 85,000 *
Larry W. Sonsini(8) 14,528 *
Skip M. Brittenham(9) 30,000 *
Joseph A. Graziano(10) 30,000 *
Jill E. Barad(11) 10,800 *
All directors and executive officers as a group (9
persons)(12) 32,601,637 70.0
</TABLE>
- ---------------
* Represents less than 1% of the total.
(1) Based on shares outstanding on March 19, 1999. The number and percentage of
shares beneficially owned is determined under rules of the Securities and
Exchange Commission ("SEC"), and the information is not necessarily
indicative of beneficial ownership for any other purpose. Under such rules,
beneficial ownership includes any shares as to which the individual has
sole or shared voting power or investment power and also any shares which
the individual has the right to acquire within sixty days of March 19, 1999
through the exercise of any stock option or other right. Unless otherwise
indicated in the footnotes, each person has sole voting and investment
power (or shares such powers with his or her spouse) with respect to the
shares shown as beneficially owned.
(2) As indicated in the Schedule 13G/A filed by Transamerica Corporation
pursuant to the Exchange Act on February 16, 1999. Includes 3,091,900
shares owned by direct and indirect subsidiaries of Transamerica
Corporation.
(3) As indicated in the Schedule 13D filed by Disney Enterprises, Inc. pursuant
to the Exchange Act on April 18, 1997. Includes 1,500,000 shares issuable
upon exercise of warrants.
(4) Includes 532,708 shares subject to options that are exercisable within 60
days of March 19, 1999.
(5) Includes 66,667 shares subject to options that are exercisable within 60
days of March 19, 1999.
37
<PAGE> 39
(6) Includes 202,790 shares subject to options that are exercisable within 60
days of March 19, 1999.
(7) Includes 85,000 shares subject to options that are exercisable within 60
days of March 19, 1999.
(8) Includes 10,000 shares subject to options that are exercisable within 60
days of March 19, 1999.
(9) Includes 30,000 shares subject to options that are exercisable within 60
days of March 19, 1999.
(10) Includes 30,000 shares subject to options that are exercisable within 60
days of March 19, 1999.
(11) Includes 10,000 shares subject to options that are exercisable within 60
days of March 19, 1999.
(12) Includes 967,165 shares subject to options that are exercisable within 60
days of March 19, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pixar has engaged the law firm of Ziffren, Brittenham, Branca & Fischer
("ZBB&F") to handle certain matters. Skip M. Brittenham, a director of Pixar, is
a senior partner of the firm. Pixar has also engaged the law firm of Wilson
Sonsini Goodrich & Rosati ("WSGR") to handle certain legal matters. Larry W.
Sonsini, a director of Pixar, is a member of the firm. Payments by Pixar to each
of ZBB&F and WSGR did not exceed five percent of either law firm's respective
gross revenues in the last fiscal year of either such firm.
Pixar believes that all of the transactions set forth above were made on
terms no less favorable to Pixar than could have been obtained from unaffiliated
third parties. All future transactions, including loans, between Pixar and its
officers, directors and principal shareholders and their affiliates will be
approved by a majority of the Board of Directors, including a majority of the
independent and disinterested directors of the Board of Directors, and will be
on terms no less favorable to Pixar than could be obtained from unaffiliated
third parties.
38
<PAGE> 40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form 10-K:
<TABLE>
<S> <C> <C>
1. Financial Statements. The following financial statements of
Pixar and the Independent Auditors' Report therein are
incorporated by reference to the portions of Pixar's 1998
Annual Report to Shareholders filed as Exhibit 13.1 to this
Form 10-K:
Independent Auditors' Report................................
Balance Sheets as of December 31, 1997 and January 2,
1999........................................................
Statements of Operations for the years ended December 31,
1996, December 31, 1997 and January 2, 1999.................
Statements of Shareholders' Equity for the years December
31, 1996, December 31, 1997 and January 2, 1999.............
Statements of Cash Flows for the years December 31, 1996,
December 31, 1997 and January 2, 1999.......................
Notes to Financial Statements...............................
2. Financial Statement Schedule. The following financial
statement schedule of Pixar for the years ended December 31,
1996, December 31, 1997 and January 2, 1999 is filed as part
of this Form 10-K and should be read in conjunction with the
Financial Statements, and related notes thereto, of Pixar.
Independent Auditors' Report on Financial Statement
Schedule.................................................... S-1
Schedule II -- Valuation and Qualifying Accounts............ S-2
Schedules not listed above have been omitted since they are
either not required, not applicable, or the information is
otherwise included.
3. Exhibits: See Item 14(c) below.
</TABLE>
(b) Reports on Form 8-K. No Reports on Form 8-K were filed during the fourth
quarter ended January 2, 1999.
(c) Exhibits. The exhibits listed on the accompanying index to exhibits
immediately following the financial statement schedule are filed as part of,
or incorporated by reference into, this Form 10-K.
(d) Financial Statement Schedules. See Item 14(a) above.
39
<PAGE> 41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized, on this 31st day of
March, 1999.
PIXAR
By: /s/ LAWRENCE B. LEVY
------------------------------------
Lawrence B. Levy
Executive Vice President and Chief
Financial Officer
POWER OF ATTORNEY
KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Steve Jobs, Lawrence B. Levy and Edwin E.
Catmull and each of them, jointly and severally, his or her attorneys-in-fact,
each with full power of substitution, for him or her in any and all capacities,
to sign any and all amendments to this Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each said attorneys-in-fact or his substitute or substitutes, may do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Form 10-K has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- --------------
<S> <C> <C>
/s/ STEVE JOBS Chairman of the Board and Chief March 31, 1999
- ----------------------------------------------------- Executive Officer
Steve Jobs (Principal Executive Officer)
/s/ LAWRENCE B. LEVY Executive Vice President and March 31, 1999
- ----------------------------------------------------- Chief Financial Officer
Lawrence B. Levy (Principal Financial and
Accounting Officer)
/s/ JILL E. BARAD Director March 31, 1999
- -----------------------------------------------------
Jill E. Barad
/s/ SKIP M. BRITTENHAM Director March 31, 1999
- -----------------------------------------------------
Skip M. Brittenham
/s/ JOSEPH A. GRAZIANO Director March 31, 1999
- -----------------------------------------------------
Joseph A. Graziano
/s/ LARRY W. SONSINI Director March 31, 1999
- -----------------------------------------------------
Larry W. Sonsini
</TABLE>
40
<PAGE> 42
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Shareholders
Pixar:
Under date of January 29, 1999, we reported on the balance sheets of Pixar
as of December 31, 1997 and January 2, 1999, and the related statements of
operations, shareholders' equity, and cash flows for each of the years in the
three-year period ended January 2, 1999, which are incorporated by reference in
the 1998 annual report on Form 10-K. In connection with our audits of the
aforementioned financial statements, we also audited the related financial
statement schedule included herein. This financial statement schedule is the
responsibility of Pixar's management. Our responsibility is to express an
opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
/s/ KPMG LLP
San Francisco, California
January 29, 1999
S-1
<PAGE> 43
PIXAR
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT DEDUCTIONS:
BEGINNING WRITE OFFS BALANCE AT
CLASSIFICATION OF YEAR ADDITIONS OF ACCOUNTS END OF YEAR
-------------- ---------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Allowance for returns and doubtful accounts
Year ended December 31, 1996................. $256 $ 3 $ -- $259
==== ==== ===== ====
Year ended December 31, 1997................. $259 $100 $(102) $257
==== ==== ===== ====
Year ended January 2, 1999................... $257 $ -- $ (28) $229
==== ==== ===== ====
</TABLE>
S-2
<PAGE> 44
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
- ------- --------
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation (which is
incorporated herein by reference to Exhibit 3.3 to the
Registrant's Form S-1 Registration Statement No.
33-97918)...................................................
3.4 Amended and Restated Bylaws, as amended (which is
incorporated herein by reference to Exhibit 3.4 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1997.........................................
4.1 See Exhibit 3.1.............................................
4.2 See Exhibit 3.4.............................................
4.5 Specimen Common Stock Certificate (which is incorporated
herein by reference to Exhibit 4.5 to the Registrant's Form
S-1 Registration Statement No. 33-97918)....................
4.6 Common Stock and Warrant Purchase Agreement between the
Registrant and Disney Enterprises, Inc. dated as of February
23, 1997 (which is incorporated herein by reference to
Exhibit 4.6 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996).......................
4.7 Form of Common Stock Purchase Warrant to be issued to Disney
Enterprises, Inc. (which is incorporated herein by reference
to Exhibit 4.7 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1996)..................
4.8 Form of Registration Rights Agreement by and between the
Registrant and Disney Enterprises, Inc. (which is
incorporated herein by reference to Exhibit 4.8 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1996)..........................................
10.1* 1995 Stock Plan, as amended (which is incorporated herein by
reference to Exhibit 10.1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 27, 1998)....
10.2* 1995 Director Option Plan (which is incorporated herein by
reference to Exhibit 10.2 to the Registrant's Form S-1
Registration Statement No. 33-97918)........................
10.3* Form of Indemnification Agreement entered into between the
Registrant and each of the executive officers and directors
(which is incorporated herein by reference to Exhibit 10.3
to the Registrant's Form S-1 Registration Statement No.
33-97918)...................................................
10.4 Agreement between the Registrant and Walt Disney Pictures
dated May 3, 1991, as amended (which is incorporated herein
by reference to Exhibit 10.4 to the Registrant's Form S-1
Registration Statement No. 33-97918)(1).....................
10.5 Net Office Lease between the Registrant and Point Richmond
R&D Associates dated February 15, 1990, as amended (which is
incorporated herein by reference to Exhibit 10.5 to the
Registrant's Form S-1 Registration Statement No.
33-97918)...................................................
10.6 Patent License Agreement between the Registrant and
Microsoft Corporation dated June 21, 1995 (which is
incorporated herein by reference to Exhibit 10.7 to the
Registrant's Form S-1 Registration Statement No.
33-97918.(1)................................................
10.7* Employment Agreement between the Registrant and John
Lasseter dated February 24, 1997 (which is incorporated
herein by reference to Exhibit 10.10 to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1996).(1)...................................................
10.8 Patent License Agreement between the Registrant and Silicon
Graphics, Inc. dated March 12, 1996 (which is incorporated
herein by reference to Exhibit 10.14 to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1995).......................................................
10.9 Net Office Lease between the Registrant and Point Richmond
R&D Associates dated November 7, 1995 (which is incorporated
herein by reference to Exhibit 10.15 to the Registrant's
Annual Report on Form 10-K for the year ended December 31,
1995).......................................................
</TABLE>
<PAGE> 45
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBITS
- ------- --------
<S> <C> <C>
10.10 Co-Production Agreement between the Registrant and Walt
Disney Pictures and Television dated February 24, 1997
(which is incorporated herein by reference to Exhibit 10.16
to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1996).(1)................................
10.11 Net Office Lease between the Registrant and Point Richmond
R&D Associates dated April 1, 1996 (which is incorporated
herein by reference to Exhibit 10.16 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1996).........................................
10.12 Net Office Lease between the Registrant and Point Richmond
R&D Associates dated September 12, 1996 (which is
incorporated herein by reference to Exhibit 10.17 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1996)...................................
10.13 Agreement of Purchase and Sale between the Registrant and
Del Monte Corporation dated as of September 6, 1996, as
amended (which is incorporated herein by reference to
Exhibit 10.19 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997)...................
10.14 Amendment to the September 12, 1996 Net Office Lease between
the Registrant and Point Richmond R&D Associates dated as of
May 8, 1997 (which is incorporated herein by reference to
Exhibit 10.17 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997).......................
10.15 Net Office Lease between the Registrant and Point Richmond
R&D Associates dated January 11, 1999.......................
13.1 Portions of the Annual Report to Shareholders for the fiscal
year ended January 2, 1999, expressly incorporated by
reference herein............................................
23.1 Consent of Independent Auditors.............................
27.1 Financial Data Schedule.....................................
</TABLE>
- ---------------
(1) Documents for which confidential treatment has been granted for certain
portions of these exhibits.
* Indicates management compensatory plan, contract or arrangement.
<PAGE> 1
EXHIBIT 10.15
PREMISES LEASE
This Lease is made and entered into as of January 11, 1998, between Point
Richmond R&D Associates II, LLC, a California Limited Liability Company
("Landlord") and Pixar Animation Studios, a California Corporation ("Tenant").
1. DEFINITIONS. Words not defined in this Section or elsewhere in this
Lease have their customary meanings. (1) "Term" is the total of the Initial
Term and any validly exercised Option Terms allowed by this Lease; the "Initial
Term" is three years; (2) "Commencement Date" is January 15, 1999, which is
also the first day of the Initial Term; (3) "Base Monthly Rent" means, subject
to adjustment as provided in the Lease, $2.00 per month per Rentable Square
Foot, payable in advance, without deduction, offset, prior notice or demand, on
the first day of each Month of the Term; (4) "Premises" means the part of the
Building leased to Tenant for Tenant's exclusive use, consisting of the
portions of the Building shown on Exhibit A to this Lease as Space A; (5)
"Building" means the structure in which the Premises are located; (6)
"Property" includes the Building and land on which it stands, commonly known as
1003 West Cutting Boulevard, Richmond, California; (7) "Agents" includes
employees, agents, guests, invitees and, when applied to tenant, subtenants and
assignees; (8) "Day", "Month" and "Year" mean, respectively, calendar
day/month/year; (9) "Lease Year" means consecutive 12-month periods starting on
the Commencement Date; (10) "Common Area" means parts of the Building not for
exclusive use by Tenants including halls, lobby, elevators, rest rooms, roof,
exterior walls and structural components; (11) "Tax" means any form of
assessment, license, fee, rent, tax, levy, penalty or tax imposed by any
authority having direct or indirect taxing powers (including Improvement
Districts) against Landlord's interest in the Property or personal property
used in the operation of the Property and/or Landlord's business of renting the
Property; (12) "Alteration" includes additions, deletions, modifications and
changes to the Premises (including utility installations such as ducting,
power panels, fluorescent fixtures, base heaters, conduit and wiring); (13)
"Operating Expenses" are all expenses for maintenance, servicing, management
and repair of the Property and the Premises inclusive of Taxes and insurance
premiums; (14) "Base Year" means calendar year 1999; (15) Tenant's "Pro Rata
Share" is the total cost of an item multiplied by 14% [Landlord may adjust
Tenant's Pro Rata Share of specific Operating Expenses if Landlord reasonably
determines that Tenant's usage warrants an adjustment]; (16) "Floor Area of the
Premises" is measured from the exterior surface of exterior walls and from the
center of walls separating the Premises from adjacent premises or common areas;
(17) "Floor Area of the Building" is measured from the exterior surface of
exterior walls including common and core areas; (18) "consent" and "approval"
require reasonable conduct by the acting party; (19) "Regulation" includes all
laws, ordinances statutes, regulations and requirements adopted by duly
constituted public authorities now in force or hereafter adopted; (20)
"Litigation" includes judicial actions, arbitrations and administrative
proceedings; (21) "Condemnation" includes taking by exercise of governmental
power or the transfer to any condemnor under threat of or
1
<PAGE> 2
during the pendency of condemnation proceedings; (22) "Usable Square Foot"
refers to space within the total Floor Area of the Building consisting of the
square footage of the Premises less the amount of square footage of the Common
Areas. The Premises contain about 5,470 Usable Square Feet; (23) "Load Factor"
means that portion of the Common Area attributable to the Premises which shall
be calculated as 12.5% of the usable square footage or about 684 square feet
(24) "Rentable Square Foot" refers to each square foot of the Floor Area of the
Premises adjusted to include a prorata portion of the Common Area (halls,
entryways, lobbies, rest rooms, etc.). The Premises contain about 6154 Rentable
Square Feet; (25) "Rent" means the total of the Base Monthly Rent plus all
Additional Rent required to be paid under the provisions of this Lease; (26)
"Normal Working Hours" means 7:00 am through 7:00 pm, Monday through Friday,
excluding bank holidays (days on which consumer branches of the Bank of America
(or any successor to the Bank of America) are not open).
2. PREMISES. Landlord hereby leases to Tenant and Tenant shall have
exclusive use of the Premises for the Term, including any extension of the
Term. Tenant shall also have a non-exclusive right to use the Common Area in
conjunction with all other tenants of the Building.
3. DELAY IN POSSESSION. If Landlord cannot deliver possession of the
Premises to Tenant on the scheduled Commencement Date, the failure shall not
affect this Lease's validity, or render Landlord liable for resulting damages;
but Tenant shall not be obligated to pay rent until Landlord tenders
possession. If Landlord cannot deliver possession within 90 days of the
scheduled Commencement Date, Tenant may terminate this Lease on written notice
to Landlord. In such event, Tenant shall have no further recourse against
Landlord respecting the Lease. If this lease is not terminated for delayed
possession and possession is not delivered to Tenant on the scheduled
Commencement Date, the Commencement Date shall be deemed the date on which
Landlord tenders possession of the Premises to Tenant and the Term will run
from the new Commencement Date.
4. RENT. Tenant shall pay all Rent due Landlord in United States dollars
at the address for notice set forth below, or such other place as Landlord
designates in writing. If Alterations increase the Rentable Square Feet of the
Premises, Base Monthly Rent will increase proportionately. If the obligation to
pay rent commences other than on the first day of a Month, the first payment
shall include rent from the date the obligation commences to the first day of
the following month calculated per diem on the basis of a 30 Day Month.
4.1. BASE MONTHLY RENT. The Base Monthly Rent shall be $12,308 (6,154
Rentable Square Feet at $2.00 per Rentable Square Foot per month).
4.2. BASE MONTHLY RENT ADJUSTMENT. The Base Monthly Rent shall not be
adjusted during the Term.
4.3. ADDITIONAL RENT. For each year during the Term that Operating
Expenses for the Property exceed the Base Year's Operating Expenses, Tenant
shall pay to Landlord, in addition to the Base Monthly Rent and all other
payments due under this Lease, an amount equal to Tenant's Pro Rata Share of
the amount by which the actual Operating Expenses for that year exceed the Base
Year Operating Expenses (the "Excess Operating Expenses"). It is the intent of
the parties that Tenant shall pay to Landlord Tenant's Pro Rata Share of
increases in Operating
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Expenses for the Property over the amount of the Base Year Operating Expenses.
Payment obligations created by to this paragraph are elements of "Additional
Rent". In the event that Tenant questions any amount demanded by Landlord as
Additional Rent, Landlord shall provide Tenant with verification of the amounts
required from Tenant and Tenant shall have the right to review such
documentation. In the event of any error discovered in such review process, the
amount will be appropriately adjusted.
4.4. CALCULATION OF BASE YEAR OPERATING EXPENSES. Base Year Operating
Expenses shall be determined as the actual Operating Expenses incurred for the
Property during the Base Year. Within three months following the first
anniversary of the Commencement Date, or as soon thereafter as may be practical,
Landlord shall prepare and deliver to Tenant a schedule of Base Year Operating
Expenses. The said schedule will fix the amount of the Base Year Operating
Expenses for all purposes under the provisions of this Lease. Should Tenant
question the said schedule, Landlord shall provide Tenant with verification of
the amounts set forth in the schedule. In the event Landlord, for any reason,
neglects or fails to timely provide the required schedule of Base Year Operating
Expenses to Tenant, such failure shall not be deemed a default under or breach
of this Lease by Landlord for any purpose, neither shall it be deemed a waiver
of any rights of Landlord to collect Tenant's Pro Rata Share of excess Operating
Expenses, neither shall such failure by Landlord excuse Tenant from performance
of any of Tenant's obligations under the provisions of this Lease. Landlord
shall be required to deliver the required schedule of actual Base Year Operating
Expenses to Tenant no less than 60 days prior to the date on which Tenant's
payment is due to Landlord for Tenant's Pro Rata Share of Excess Operating
Expenses.
4.5. SECURITY DEPOSIT. Tenant shall give Landlord as a security
deposit the sum of $12,308 (the "Deposit"). Landlord shall hold the Deposit as
security for Tenant's faithful performance of all its obligations under this
Lease and may, at its option, apply the Deposit to remedy defaults in the
payment of any charge hereunder, to repair damages to the Property caused by
Tenant, or to clean the Premises at the end of this Lease. If any portion of the
Deposit is so applied, Tenant shall, within 10 Days after written demand
therefor, deliver to Landlord funds sufficient to restore the Deposit to its
original amount. Landlord shall not be required to keep the Deposit separate
from its general funds. Tenant shall earn no interest on the Deposit.
4.6. LATE CHARGES. Late payment of any sums due hereunder will cause
Landlord to incur costs not contemplated by this Lease, including, without
limit, accounting charges and late charges that may be imposed on Landlord by
the terms of loans secured by the Property. If Tenant fails to deliver to
Landlord any moneys due hereunder within 10 Days of the due date, Tenant shall
pay to Landlord a late charge of 10% of the overdue amount which is agreed to be
a reasonable estimate of the costs Landlord will incur by reason of the late
payment, the exact amount of which will be difficult to determine. Acceptance of
a late charge shall not constitute a waiver of the default or preclude
Landlord's exercise of other rights and remedies.
5. TAXES. Landlord shall pay (subject to Tenant's obligation to
contribute to Excess Operating Expenses) all Taxes assessed against Landlord's
interest in the Property and personal property used in its operation. Tenant
shall pay all Taxes assessed on Tenant's fixtures, improvements, furnishings,
merchandise, equipment and personal property in and on the Premises. If Tenant
fails to timely pay Taxes, Landlord may (but is not obligated to) pay the same
at any time thereafter. On demand, Tenant shall repay Landlord amounts so paid
with
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interest at the highest rate allowable by law. If Tenant desires to contest the
validity or amount of any Tax applicable to the Premises, Tenant shall be
entitled to do so and to defer payment of such Tax until final determination of
such contest upon giving Landlord written notice thereof prior to commencing
such contest and protecting Landlord on demand by obtaining a surety bond in the
amount of 150% of the total amount of Taxes in dispute. The surety bond shall
hold Landlord harmless from any damages or costs incurred in connection with the
contest. Landlord shall, at Tenant's request, cooperate in all reasonable ways
requested by Tenant in connection with the contest of Taxes, provided that
Tenant pays all reasonable costs incurred by Landlord resulting from such
cooperation.
6. INSURANCE.
6.1. LANDLORD'S INSURANCE. Landlord shall insure the Property for up
to 100% of its replacement value against loss or damage by those risks normally
included by the insurance industry in the term "All Risk"; any recovery from
such insurance shall belong to Landlord. Landlord shall maintain comprehensive
general liability insurance insuring Landlord (and others named by Landlord, but
not Tenant) against liability for bodily injury, death and property damage on or
about the Property, with combined single limit coverage of at least $2 million.
6.2. TENANT'S INSURANCE. Tenant, at its sole expense, shall maintain:
a) All Risk coverage insurance on all fixtures, improvements, furnishings,
merchandise, equipment and personal property in the Premises; and b) for the
benefit of Tenant and Landlord, commercial general liability and property damage
insurance against claims for bodily injury, death or property damage occurring
in or about, and/or arising from Tenant's use of, the Premises, with combined
single limit coverage of at least $2,000,000 (such insurance shall include,
without limitation, products liability, coverage for liability arising from
consumption of any food or beverages sold from the Premises (including coverage
for liability from consumption or sale of alcoholic beverages). Such insurance
coverage shall not limit Tenant's liability. Tenant shall furnish to Landlord
prior to the Commencement Date, and at least 30 Days prior to the expiration
date of any policy, certificates indicating that the insurance required of
Tenant is in full force and effect, that Landlord has been named as an
additional insured on the liability policy, and that no such policy will be
canceled unless 30 Days' prior written notice has been given to Landlord. Each
liability policy shall include a broad form liability endorsement and provide
that Landlord as an additional insured may recover for any loss it suffers by
reason of acts/omissions of Tenant and its Agents. Except as Landlord may
approve in writing before issuance of such policy, all policies which Tenant
shall obtain hereunder shall be issued by companies with "AAA" rating by either
Moody's Rating Service or Standard & Poor's Rating Service and general policy
rating of at least A in Best Insurance Guide's then most current issue. Policies
obtained by Tenant pursuant to this Lease shall be subject to Landlord's
reasonable approval.
6.3. WAIVER OF SUBROGATION. Notwithstanding anything to the contrary
in this Lease, the parties release each other and their respective officers,
agents, employees and servants, from all claims for damages, loss, expense or
injury to the Premises, and/or to the furnishings and fixtures and equipment or
inventory or other property of either Landlord or Tenant in, about or upon the
Premises, which is caused by or results from perils, events or happenings which
are covered by insurance in force at the time of any such loss or by insurance
required to be carried hereunder; provided, however, that such waiver shall be
effective only to
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the extent permitted by the applicable insurance and only to the extent such
insurance coverage is not prejudiced thereby. Each party shall cause every
insurance policy obtained by it to provide that the insurance company waives
all right of recovery by way of subrogation in connection with any damage
covered by such policy.
6.4. LANDLORD INDEMNIFICATION. Tenant will indemnify and save Landlord
harmless from and against any and all claims, actions, damages, liability and
expense relating to loss of life, personal injury and/or property damage
arising from or out of any occurrence in, upon or at the Premises, or the
Tenant's occupancy and/or use of the Property, occasioned wholly or in part by
any acts or omissions of Tenant and its Agents. If Landlord becomes a party to
such Litigation commenced by or against Tenant, Tenant shall defend and hold
Landlord harmless from all claims, liabilities, costs and expenses, and shall
pay all costs, expenses and reasonable legal fees incurred by Landlord in
connection with such Litigation. If Tenant is made a party to Litigation
commenced by or against Landlord solely as a result of Landlord's acts or
omissions, Landlord shall defend Tenant and indemnify Tenant against the costs
of such Litigation. The provisions of this Paragraph shall be deemed to apply
only to those circumstances where a portion of a loss or claim is not covered
by existing insurance covering the indemnified party and then only to the
extent that such loss or claim is not covered by insurance. This Paragraph
shall not preclude application of comparative negligence if the parties or
their agents are both at fault.
6.5. TENANT INDEMNIFICATION. Landlord will indemnify and save Tenant
harmless from and against any and all claims, actions, damages, liability and
expense relating to loss of life, personal injury and/or property damage
arising from or out of any occurrence in, upon or at the Premises, or the
occupancy or Landlord's use of the Property, occasioned wholly or in part by
any acts or omissions of Landlord and its Agents or arising from or out of any
occurrence in, upon, or at the Property (other than the Premises), except to
the extent that such occurrence or event was caused by the acts or omissions of
Tenant and its Agents. If Tenant becomes a party to such Litigation commenced
by or against Landlord, Landlord shall defend and hold Tenant harmless from all
claims, liabilities, costs and expenses, and shall pay all costs, expenses and
reasonable legal fees incurred by Tenant in connection with such Litigation.
The provisions of this Paragraph shall apply only to those circumstances where
a portion of a loss or claim is not covered by existing insurance covering the
indemnified party and then only to the extent that such loss or claim is not
covered by insurance. This Paragraph shall not preclude application of
comparative negligence if the parties or their agents are both at fault.
6.6. WORKER'S INSURANCE. Tenant shall keep in force for the Term and pay
for worker's compensation and other insurance to comply with all applicable
Regulations.
7. MAINTENANCE.
7.1. PREMISES. During the Term, Landlord shall maintain the Premises
(including all interior walls, doors, doorways, lighting fixtures, plumbing
fixtures, and all windows) in good order, condition and repair, subject to
Tenant's obligation to pay for damages caused by the acts of Tenant and its
Agents. Tenant waives the provisions of any law permitting Tenant to make
repairs at Landlord's expense, including, without limitation, California Civil
Code Sections 1941-1946. Landlord will supply janitorial services for the
Premises as Landlord deems appropriate, but to a standard comparable to such
services provided to similar use buildings in the city where the
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Property is located.
7.2. COMMON AREAS. Landlord shall maintain the Common Area in
reasonably good order and condition; however, damage caused by the acts or
omissions of Tenant and/or its Agents shall be repaired at Tenant's expense.
Landlord shall maintain all improvements and appurtenances upon the Property in
good order, condition and repair. Tenant shall notify Landlord in writing of
required repairs to the Property. Landlord shall make necessary repairs in a
reasonable time. Maintenance and repairs shall be completed in a good and
workmanlike manner using such methods as Landlord deems appropriate in its sole
discretion. Landlord shall make commercially reasonable efforts to perform
maintenance and repairs with minimum interference with Tenant's business
operations.
7.3. ALTERATIONS. Tenant shall make no Alteration to the Property
costing in excess of $2,500 without Landlord's prior written consent, which
Landlord will not unreasonably withhold. Landlord may impose such conditions
upon approval of an Alteration as Landlord may deem appropriate. Every
Alteration shall be done under supervision of a licensed contractor and in
accordance with plans and specifications furnished to and approved by Landlord
prior to commencement of work. If an Alteration increases the Floor Area of the
Premises, the Base Monthly Rent and Tenant's Pro Rata Share shall be increased
in proportion to the resulting increase in the Floor Area of the Premises.
Tenant shall give Landlord 7 Days' advance written notice prior to starting
construction of each Alteration. Each Alteration shall remain in place and
become the property of Landlord, unless, at the time of consent, Landlord
required removal of the Alteration on Termination, in which case, Tenant shall
remove such Alteration(s) and restore the Premises to their pre-Alteration
condition at Termination.
7.4. SYSTEMS. The heating/air-conditioning ("HVAC"), plumbing and
electrical systems (collectively "Systems") shall not be used for any purpose
other than that for which they were constructed. Tenant shall pay for repairs
resulting from the willful misconduct of Tenant and its Agents and for any
violation of the provisions of this paragraph.
7.5. LIENS. Tenant shall keep the Property free of liens arising out
of obligations incurred, work performed or materials furnished for or to Tenant.
Tenant shall indemnify Landlord against all costs, liens and encumbrances from
work performed or materials furnished by or at Tenant's direction. If Tenant
fails to obtain removal of such lien within 20 Days following its imposition,
Landlord shall have the right, but not the obligation, to obtain such release by
such means as it deems proper, including payment of the underlying claim. On
demand, Tenant shall reimburse Landlord for all such sums paid and expenses
incurred by Landlord in connection therewith (including attorneys' fees and
costs) together with interest at the highest rate allowable by law from the date
Landlord makes such payment until the date of reimbursement.
8. MANAGEMENT. The Wareham Property Group, Inc., an affiliate of
Landlord, or another affiliated, or unaffiliated, third party, will manage the
Property for a reasonable fee, which fee shall be set and, from time to time,
adjusted by Landlord in line with fees for such services for similar use
buildings in the San Francisco-Oakland Bay Area.
9. UTILITIES AND SERVICES.
9.1. PREMISES. Landlord will make HVAC and utilities for heating and
lighting use
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available to the Premises during Normal Working Hours. The cost of such
utilities and services, shall be considered a portion of the Operating
Expenses, subject to a maximum utilities charge of $.13 per month per Usable
Square Foot per month. Any utility and service costs in excess of $.13 per
Usable Square Foot per month shall be paid by Tenant to Landlord upon demand.
Should Tenant desire to use the Premises other than during Normal Working
Hours, Tenant shall pay Landlord as Additional Rent, and within 21 days of
receipt of Landlord's bill therefor, the cost of providing additional utilities
and services for the extra time and use. Landlord shall estimate the actual
cost of such services and expenses in the best exercise of its reasonable
business judgment and bill in accordance with that estimate. Tenant shall
provide its own janitorial services for the Premises at Tenant's own expense.
9.2. COMMON AREAS. Landlord shall provide Common Area utilities,
landscaping, janitorial and, if Landlord deems it appropriate, security
services, all of which shall be considered Operating Expenses, to a standard
comparable to other similar use buildings in the general vicinity of the
Property.
9.3. LIMITATION OF LIABILITY. Landlord shall not be in default under
the provisions of this Lease or be liable for any damages directly or
indirectly resulting from the following conditions: (1) the interruption of use
of any equipment in connection with the furnishing of any of the services
described in Paragraphs 9.1 and 9.2 of this lease; (2) failure to furnish or
delay in furnishing any services referred to in Paragraphs 9.1 and 9.2 of this
lease where failure or delay is caused by accident or any condition or event
beyond Landlord's reasonable control; (3) the limitation, curtailment or
rationing of, or restrictions on, use of water, electricity, gas or any other
form of energy serving the Premises. Landlord shall not be liable under any
circumstances for a loss of or injury to property or business, however
occurring, through or in connection with or incidental to failure to furnish
any such services. Notwithstanding the foregoing provisions of this Paragraph,
in the event that utility service to the Premises is unavailable for a period
exceeding 15 consecutive days, then from and after the 16th consecutive day
without utility service and until utility service is restarted, Tenant shall be
entitled to an abatement of rent unless the disruption of the utility service
results in whole, or in part, from the acts and/or omissions of Tenant
(inclusive of Tenant's agents, servants, employees, guests, invitees,
operatives and/or contractors) in which case there shall be no abatement of
rent.
10. USE OF PREMISES. This Lease is subject to all Regulations governing
use of the Property. Tenant has not entered into this Lease relying on any
representation by Landlord or its Agents as to suitability of the Premises for
the conduct of Tenant's Business. Tenant has made its own analysis of
suitability of the Premises for its intended use. Tenant shall: 1) use the
Premises for only general office, administrative and storage and other, legal,
related uses in connection with the development of computer software (including
testing of the software and training in its use); 2) pay Landlord the full
amount of any increased insurance premium resulting from Tenant's use of the
Premises; 3) at its sole expense, promptly comply with all Regulations and the
requirements of any board of fire underwriters or other similar body now or
hereafter constituted relating to or affecting Tenant's particular use of the
Premises. Tenant shall not: 1) sell or permit to be kept, used or sold in or
about the Premises any articles prohibited by a standard form policy of fire
insurance; 2) do or permit anything to be done in or about the Property which
will obstruct or interfere with rights of other occupants of the Property or
injure
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or annoy them; 3) maintain or permit any nuisance in or about the Property; 4)
commit or suffer to be committed any waste in or upon the Property; 5) conduct
or allow any auction or similar sale upon the Property; 6) do or permit
anything to be done in or about the Property which will violate any Regulation
[the judgment of any court of competent jurisdiction, a binding arbitration
award, a decision after an administrative hearing or Tenant's admission in any
Litigation (whether or not Landlord is a party) that Tenant has violated a
Regulation shall be conclusive of that fact between Landlord and Tenant]; 7)
place a sign upon the Property; 8) do or permit anything to be done which will
increase existing insurance premiums for the Property or cause cancellation of
any policy covering any of the Property. However, Tenant shall not be required
to comply with or cause the Premises to comply with any Regulations requiring
the construction of improvements in the Premises unless the compliance with any
of the foregoing is necessitated by Tenant's particular use of the Premises.
11. DEFAULTS AND REMEDIES.
11.1. TENANT'S DEFAULT. The occurrence of any one or more of the
following events shall constitute a default and breach of this Lease by Tenant:
(a) Tenant's failure to pay any Rent or charges required to be paid by Tenant
under this Lease within 5 days of Landlord's delivery of written notice to
Tenant that said amounts are past due; (b) Tenant's abandonment or vacation of
the Premises; (c) Tenant's failure to promptly and fully perform any other
covenant, condition or agreement contained in this Lease where such failure
continues for 30 days after written notice from Landlord to Tenant of such
default; (d) the levy of a writ of attachment or execution on this Lease or on
any of the property of Tenant located in the Premises; (e) the making by Tenant
of a general assignment for the benefit of its creditors or of an arrangement,
composition, extension or adjustment with its creditors; (f) the filing by or
against Tenant of a petition for relief or other proceeding under federal
bankruptcy laws or state or other insolvency laws, which petition is not
removed or which action is not dismissed within 90 days of its filing, or the
assumption by any court or administrative agency, or by a receiver, trustee or
custodian appointed by either, of jurisdiction, custody or control of the
Premises or of Tenant or any substantial part of its assets or property; or (g)
if the interest of Tenant under this Lease is held by a partnership or by more
than one person or entity, the occurrence of any act or event described in
parts (e) or (f) above in respect of any partner or principal in the Tenant
entity. Except as otherwise specified by this Paragraph, in the event a
nonmonetary default occurs which cannot reasonably be cured within the time
period specified above and Tenant commences corrective action within said time
period, Tenant shall not be subject to penalty under this Lease so long as
Tenant prosecutes such corrective action diligently and continuously to
completion.
11.2. LANDLORD'S REMEDIES. In the event of Tenant's default
hereunder, then in addition to any other rights or remedies Landlord may have
under this Lease or under law, Landlord may elect either of the remedies set
forth in Paragraphs 11.2(a) or 11.2(b) Notwithstanding any other provision of
this Lease, the Lessor has the remedy described in California Civil Code
Section 1951.5 (Lessor (Landlord) may continue lease in effect after Lessee's
(Tenant's) breach and abandonment and recover rent as it becomes due, if Lessee
(Tenant) has the right to sublet or assign, subject only to reasonable
limitations):
(a) To immediately terminate this Lease and Tenant's right
to possession of the Premises by giving written notice to Tenant and
to recover from Tenant an award of
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damages equal to the sum of (i) the worth at the time of award of the
unpaid rental which had been earned at the time of termination, (ii) the
worth at the time of award of the amount by which the unpaid rental
which would have been earned after termination until the time of award
exceeds the amount of such rental loss that Tenant affirmatively proves
could have been reasonably avoided, (iii) the worth at the time of award
of the amount by which the unpaid rental for the balance of the term
after the time of award exceeds the amount of such rental loss that
Tenant affirmatively proves could be reasonable avoided, (iv) any other
amount necessary to compensate Landlord for all the detriment either
proximately caused by Tenant's failure to perform Tenant's obligations
under this Lease or which in the ordinary course of things would be
likely to result therefrom, and (v) all such other amounts in addition
to or in lieu of the foregoing as may be permitted from time to time
under applicable law; or
(b) To have this Lease continue in effect for so long as Landlord
does not terminate this Lease and Tenant's right to possession of the
Premises, in which event Landlord shall have the right to enforce all of
the rights and remedies provided by this Lease and by law, including the
right to recover the rental and other charges payable by Tenant under
this Lease as they become due.
For purposes of this Section 11, the worth at the time of award of the amounts
referred to in Paragraph 11.2(a)(i) and 11.2(a)(ii) shall be computed by
allowing interest at the highest rate allowable by law, and the worth at time of
award of the amount referred to in part 11.2(a)(iii) shall be computed by
discounting such amount at the rate specified in California Civil Code Section
1951.2(b) or any successor statute. In such computations, the rent due shall
include Base Monthly Rent plus the aggregate amount of all Additional Rents and
other charges and amounts payable by Tenant pursuant to the provisions of this
Lease.
11.3. LANDLORD'S DEFAULT. Landlord will be in default if Landlord fails
to perform any obligation required of Landlord (other than a delay in delivery
of possession as provided for in Section 3 of this Lease) with 30 days after
written notice by Tenant, specifying wherein Landlord has failed to perform such
obligation; provided that if the nature of Landlord's obligation is such that
more than 30 days are required for performance, then Landlord shall not be in
default if Landlord commences performance within 30 days of Tenant's written
notice to Landlord of the problem and thereafter diligently prosecutes the same
to completion. Except as expressly set forth in this Lease, Tenant shall not
have any right whatsoever to terminate this Lease or to withhold, reduce or
offset any amount against any payments of rents or charges due and payable under
this Lease.
12. TERMINATION. Upon expiration of the Term or the early termination
of this Lease (collectively "Termination"), Tenant shall deliver up and
surrender to Landlord possession of the Premises in as good order and condition
as when Tenant took possession excepting only ordinary wear and tear. Tenant's
obligation with respect to the surrender of the Premises shall be fulfilled if
Tenant surrenders possession of the Premises in the condition existing at the
Commencement Date, except for ordinary wear and tear, casualties, condemnation,
Hazardous Materials (other than those released or emitted by Tenant in or about
the Premises) and
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alterations or other interior improvements which Landlord states in writing may
be surrendered at the termination of the Lease. Upon Termination, Landlord may
reenter the Premises and remove all persons and property therefrom. If Tenant
fails to remove anything that Tenant is required or entitled to remove from the
Premises on Termination, Landlord may remove the same and store or dispose of
such item(s) in accordance with Civil Code Sections 1980-91. Tenant shall pay
to Landlord on demand all expenses incurred in such removal and storage and in
cleaning the Premises. If the Premises are not surrendered at the end of the
Term, Tenant shall indemnify Landlord against all losses resulting from
Tenant's delay in surrendering the Premises. If Tenant remains in possession of
the Premises after expiration of the Term and if Landlord and Tenant have not
executed an express written agreement as to such holding over, then such
occupancy shall be a tenancy from month to month at a Base Monthly Rent fixed
at 125% of the Base Monthly Rent in effect immediately prior to such
expiration, such payments to be made as herein provided. In the event of such
holding over, all terms of this Lease including the obligation for payment of
all charges owing hereunder shall remain in force and effect on said month to
month basis. The voluntary or other surrender of this Lease by Tenant, if
accepted by Landlord, or a mutual cancellation thereof, shall not work a
merger, but shall, at the Landlord's option, terminate or operate as an
assignment to Landlord of any or all subleases or subtenancies.
13. CONDEMNATION OF PREMISES.
13.1. TOTAL CONDEMNATION. If the entire Premises are taken by
Condemnation during the Term, this Lease shall terminate on the date of
transfer of possession and Tenant shall have no claim against Landlord for the
value of the unexpired Term.
13.2. PARTIAL CONDEMNATION. If any portion of the Premises is taken
by Condemnation during the Term, this Lease shall remain in full force and
effect; except that if a partial taking leaves the Premises unsuitable for
occupancy, Tenant may terminate this Lease effective on the date transfer of
possession is required unless Landlord makes other comparable arrangements for
Tenant's space. Landlord and Tenant shall each have the right to terminate this
Lease effective on the date transfer of possession is required in the event of
Condemnation of more than 25% of the Floor Area of the Premises. Either party
may exercise its right to terminate this Lease by serving 30 Days written notice
to the other within 30 Days of their receipt of notice of condemnation, except
that Tenant's notice shall be ineffective if Landlord serves written notice upon
Tenant of Landlord's election to provide alternate space equivalent to that
condemned within 10 Days of Tenant's deliver of notice to Landlord pursuant to
this Paragraph. Tenant shall have the right of reasonable approval of
replacement space. Landlord shall be required to deliver the alternate space to
Tenant within 60 Days of Landlord's notice to Tenant of its election to provide
alternate space. All rent and other obligations of Tenant under this Lease shall
be paid to the date of Termination; Tenant shall have no claim against Landlord
for any unexpired portion of the Term if the Lease is terminated under the
provisions of this Paragraph. If this Lease is not canceled after a partial
taking, Base Monthly Rent and Tenant's Pro Rata Share shall be adjusted to
reflect the net change in the Floor Area of the Premises. TENANT WAIVES
CALIFORNIA CODE OF CIVIL PROCEDURE SECTION 1265.130.
13.3. AWARD TO TENANT. In the event of Condemnation, Tenant may
claim from the condemnor such compensation as Tenant may separately recover for
moving costs, loss of business, fixtures or equipment belonging to Tenant.
Tenant shall have no other right to recover
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from Landlord or the condemnor for any additional claims arising out of such
taking.
14. LANDLORD'S ENTRY. Landlord and its Agents may enter the Premises at
all reasonable times to: inspect; make repairs or Alterations; post "For Lease"
signs during the last 120 Days of the Term; show the Premises during the last
120 days of the Term; and/or to post notices of nonresponsibility. Landlord
shall have such right of entry without any rebate of rent to Tenant for any
loss of occupancy or quiet enjoyment of the Premises. Landlord shall provide 24
hours' notice of intended entry except under circumstances Landlord deems an
emergency. Landlord shall make commercially reasonable efforts to minimize any
interference with Tenant's operations in connection with any entry by Landlord
upon the Premises pursuant to this Paragraph.
15. LIMITATION OF LIABILITY AND INDEMNITY: This Section 15, inclusive of
all paragraphs and subparagraphs, supersedes each and every other provision of
this Lease.
15.1. LIMITATION OF LANDLORD'S LIABILITY. LANDLORD SHALL NOT BE
LIABLE FOR AMOUNTS EXCEEDING INSURANCE COVERAGE MAINTAINED BY LANDLORD UNDER
THIS LEASE ("EXISTING COVERAGE") RESPECTING ANY INJURY OR DAMAGE, PROXIMATE OR
REMOTE, OCCURRING THROUGH OR CAUSED BY REPAIRS OR ALTERATIONS TO THE PROPERTY,
UNLESS THE INJURY OR DAMAGE ARISES FROM LANDLORD'S NEGLIGENCE, WILLFUL
MISCONDUCT, OR BREACH OF THIS LEASE ("LANDLORD'S ACTS"). EXCEPT FOR LOSSES
ARISING FROM LANDLORD'S ACTS, LANDLORD SHALL HAVE NO LIABILITY IN EXCESS OF
EXISTING COVERAGE FOR ANY INJURY OR DAMAGE OCCASIONED BY DEFECTIVE ELECTRIC
WIRING, OR THE BREAKING, BURSTING, STOPPAGE OR LEAKING OF THE PLUMBING,
AIR-CONDITIONING, HEATING, FIRE CONTROL SPRINKLER SYSTEMS OR GAS, SEWER OR
STEAM PIPES.
15.2. LIMITATION ON ENFORCEMENT OF REMEDIES. NOTWITHSTANDING ANY
OTHER PROVISION OF THIS LEASE, TENANT AND ITS AGENTS SHALL, UNDER ALL
CIRCUMSTANCES, BE ABSOLUTELY LIMITED TO LANDLORD'S INTEREST IN THE PROPERTY FOR
SATISFACTION OF ANY AND ALL JUDGMENTS, AWARDS AND/OR ORDERS AGAINST LANDLORD
RELATING TO OR ARISING OUT OF TENANT AND ITS AGENTS' OCCUPANCY AND USE OF THE
PROPERTY AND/OR IN THE EVENT OF ANY DEFAULT BY LANDLORD UNDER THIS LEASE; AND
NO OTHER PROPERTY OF LANDLORD OR ITS PARTNERS OR PRINCIPALS, DISCLOSED OR
UNDISCLOSED, SHALL BE SUBJECT TO LEVY, EXECUTION OR OTHER ENFORCEMENT PROCEDURE
FOR THE SATISFACTION OF TENANT AND ITS AGENTS' REMEDIES WITH RESPECT TO THIS
LEASE, THE RELATIONSHIP OF LANDLORD AND TENANT HEREUNDER, OR THE USE AND
OCCUPANCY OF THE PROPERTY AND THE PREMISES BY TENANT AND ITS AGENTS. TENANT, ON
BEHALF OF TENANT AND ITS AGENTS, WAIVES ALL RIGHTS TO COLLECT OR ENFORCE ANY
AND ALL ORDERS, AWARDS AND/OR JUDGMENTS AGAINST LANDLORD IN EXCESS OF
LIMITATIONS IMPOSED BY THIS SECTION 15. TENANT SHALL REQUIRE EVERY SUBTENANT
AND ASSIGNEE OF TENANT AGREE TO BE BOUND BY THE WAIVER SET FORTH IN THIS
SECTION. LANDLORD'S EXPOSURE AS SET FORTH IN THIS SECTION IS CUMULATIVE AND IN
THE AGGREGATE (AS TO ALL JUDGMENTS, AWARDS AND ORDERS AGAINST LANDLORD ARISING
IN CONNECTION WITH THIS LEASE, THE RELATIONSHIP OF LANDLORD AND TENANT, OR THE
USE AND OCCUPANCY OF THE PROPERTY BY TENANT AND ITS AGENTS). LIMITS IMPOSED BY
THIS SECTION INCLUDE DUTIES OF EXPRESS AND/OR IMPLIED INDEMNITY. "LANDLORD"
INCLUDES ALL PERSONS AND ENTITIES WHO NOW OR HEREAFTER OWN AN INTEREST IN
LANDLORD.
Initial Initial
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16. ASSIGNMENT AND SUBLETTING. Tenant shall not directly or indirectly:
(1) assign this Lease in whole or in part; (2) sublet any part or all of the
Premises; (3) license the use of all or any part of the Premises or a business
conducted thereon; or (4) encumber or hypothecate this Lease (collectively
"Transfer"), without first obtaining Landlord's written consent, which consent
shall not be unreasonably withheld or delayed. The transfer of shares of stock,
partnership interests or other ownership interests in Tenant resulting in a
change in the effective control of Tenant, or any merger, consolidation or
other reorganization of Tenant is a Transfer of this Lease. Tenant's request
for consent to any assignment, sublease or other transfer shall be in writing
and shall include the following: (a) the name and legal composition of the
proposed transferee; (b) the nature of the proposed transferee's business to be
carried on in the Premises; (c) the terms and provisions of the proposed
assignment or sublease; and (d) such financial and other information as
Landlord may reasonably request concerning the proposed transferee or
concerning the proposed assignment or sublease. Any Transfer of this Lease, in
whole or in part, without Landlord's prior written consent shall constitute a
default under this Lease. Landlord's consent to any Transfer shall not
constitute a waiver of the need for such consent to any subsequent Transfer.
Tenant may, without Landlord's prior written consent sublet the Premises or
assign the Lease to (i) a subsidiary, affiliate, division or corporation,
controlling, controlled by or under common control with Tenant. Landlord's
failure to respond in writing to Tenant's request for consent to a Transfer
within 30 Days of the delivery of the request to Landlord shall constitute
Landlord's consent to the Transfer.
Notwithstanding the preceding Paragraph of this Section, provided that Tenant
remains a publicly traded company and merges with or is purchased by another
publicly traded company of equal or greater financial strength than Tenant, the
transaction shall not be considered a Transfer of the Tenant's interest in this
Lease.
Notwithstanding any Transfer with or without Landlord's consent, Tenant shall
remain fully liable on this Lease unless expressly released by Landlord in
writing. Without limiting other reasons or circumstances, Landlord and Tenant
agree that it is reasonable for Landlord to withhold consent if, in Landlord's
judgment: (i) in the case of an assignment of the Tenant's interest in this
Lease, the financial strength of the proposed assignee is not commensurate with
the obligations of the Lease; (ii) the proposed use would be incompatible with
the use of the rest of the Property; or (iii) the proposed use would generate
traffic and/or wear and tear materially in excess of Tenant's use. If Landlord
consents to a Transfer, Tenant shall pay Landlord's reasonable attorneys' fees
incurred in connection with such consent. Tenant shall pay to Landlord 50% of
all Excess Rent received by Tenant directly or indirectly in respect of Transfer
of all or any part of this Lease or of the Premises. "Excess Rent" means, in the
case of an assignment, all consideration attributable to this Lease and, in the
case of a sublease, all consideration in excess of the rents and charges
reserved under this Lease. Tenant, however, shall not be required to pay
Landlord any Excess Rent until Tenant has deducted therefrom the costs to Tenant
to effectuate the assignment or sublease, including attorneys' fees, leasing
commissions and remodeling costs.
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17. DAMAGE OR DESTRUCTION. Each party may terminate this Lease if the
Premises or the Building are damaged to an extent exceeding 50% of the then
replacement cost of the Premises (in the event of damage limited to the
Premises) or 33% of the Building (in the event of damage not limited to the
Premises). Landlord may also terminate this Lease if the Premises or the
Building are damaged by an uninsured peril to an extent exceeding 33% of the
then replacement cost of the Premises (in the event of damage limited to the
Premises) or 25% of the Building (in the event of damages not limited to the
Premises). If a party elects Termination under this section, the terminating
party shall deliver written notice to the non-terminating party within 30 Days
of the occurrence of the damage. Tenant shall have 30 Days to vacate the
Premises unless they are unsafe for occupancy, in which case, Tenant shall
immediately vacate. TENANT WAIVES SECTION 1932(2), AND SECTION 1933(4) OF THE
CALIFORNIA CIVIL CODE. If this Lease is not terminated pursuant to this
Section, Landlord shall, within 90 Days of the occurrence of the damage,
proceed to repair the Building, on substantially the same plan as existed
immediately before the occurrence of damage. Tenant shall be liable for repair
and replacement of all fixtures, leasehold improvements, furnishings,
merchandise, equipment and Tenant's personal property not covered by insurance.
If Tenant is able to continue to conduct its business during the making of
repairs, the Base Monthly Rent will be reduced during the repair period in the
proportion that the unusable part of the Premises bears to the whole.
Notwithstanding any other provision of this Lease, if the discounted present
value of the Base Monthly Rent due for the remaining Term, using as the
discount rate the prime commercial lending rate in effect at the Bank of
America, NT&SA, as of the date of the damage is less than the cost of repairing
the damage to the Premises, Landlord may terminate this Lease on 10 Days'
written notice to Tenant.
18. HAZARDOUS MATERIALS.
18.1. TENANT'S WARRANTIES. Tenant's obligations are:
18.1.1. RESTRICTIONS ON HAZARDOUS MATERIALS. Hazardous
Material (as defined below) shall not be brought upon, manufactured, generated,
disposed of, handled, used, kept or stored (collectively "Handled" or
"Handling") in, on, about or under the Property by Tenant and its Agents
without Landlord's prior written consent.
18.1.2. APPLICABLE REGULATIONS. If any Hazardous Material is
Handled, in, on, about or under the Property by Tenant and its Agents, Tenant
shall bear all responsibility for ensuring that such material shall be handled
in compliance with all Environmental, Health and Safety Requirements regulating
such Hazardous Material. Tenant shall procure, maintain in effect and comply
with all conditions and requirements of any and all permits, licenses and other
governmental and regulatory approvals or authorizations required by
Environmental, Health or Safety Requirements relating to the Handling of
Hazardous Material. Tenant shall give Landlord copies of all such permits,
licenses, or other regulatory approvals within 5 Days of receipt.
18.1.3. RESTORATION. If, as a result of actions caused or
permitted by Tenant and its Agents, Hazardous Material in, on, about or under
the Property or any adjoining property results in contamination of the Property
or other property, Tenant, at its sole expense, shall promptly take all actions
as are necessary to return the Property and/or the other affected property to
the condition existing prior to such contamination ("Restoration"). Tenant
shall not, however, undertake Restoration without first providing Landlord with
written notice and
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obtaining Landlord's approval of the restoration procedures, work and
contractor. Tenant shall effect Restoration in compliance with all
Environmental, Health and Safety Requirements. Tenant shall not enter into any
settlement agreement, consent decree or compromise respecting any claims
relating to Hazardous Material connected with the Property without first
notifying Landlord of its intention to do so and affording Landlord ample
opportunity to appear, intervene or appropriately assert and protect Landlord's
interests.
18.1.4. REMOVAL. On Termination, Tenant shall remove from the Property
all Hazardous Materials in, on, about or under the Property Handled by Tenant
and its Agents and all receptacles and containers therefor, and shall cause such
Hazardous Materials, receptacles and containers to be Handled, transported and
disposed of pursuant to all applicable Environmental, Health and Safety
Requirements. Hazardous Materials, receptacles and containers shall be removed
by duly licensed haulers, transported to and disposed of at duly licensed
facilities for the disposal of such Hazardous Materials, receptacles or
containers. Tenant shall deliver to Landlord copies of all documentation
relating to Handling of Hazardous Materials, receptacles or containers therefor,
reflecting legal and proper Handling. Tenant shall, at its sole expense, repair
all damage to the Property resulting from its removal of Hazardous Materials,
receptacles and containers. Tenant shall continue to pay rent until completion
of such removal and repairs.
18.1.5. TENANT'S WRITTEN CONFIRMATION. Tenant shall execute such
documents as Landlord may request as to Tenant's knowledge of the presence of
Hazardous Materials in, on, about or under the Property. On each anniversary of
the Commencement Date, Tenant shall give Landlord a letter stating the during
the preceding year Tenant complied with this Section 18 or, if Tenant has not so
complied, stating the details of noncompliance.
18.1.6. TENANT'S DUTY TO NOTIFY LANDLORD. Tenant shall notify Landlord
in writing immediately upon learning of: (1) enforcement, cleanup, remediation
or other action threatened, instituted or completed by any governmental or
regulatory agency or private person with respect to the Property or any
adjoining property relating to Hazardous Materials; (2) any claim threatened or
made by any person against Tenant, Landlord, the Property or any adjoining
landowner, Tenant or property for personal injury, compensation or any other
matter relating to Hazardous Materials; and (3) any reports made by or to any
governmental or regulatory agency with respect to the Property or any adjoining
property relating to Hazardous Materials, including without limitation, any
complaints, notices or asserted violations in connection therewith. Tenant shall
supply to Landlord as promptly as possible, and in any event within 5 Days after
Tenant first receives or sends the same, copies of all claims, reports,
complaints, notices, warnings, asserted violations or other documents relating
in any way to the foregoing.
18.2. LANDLORD'S RIGHTS. Landlord and its Agents shall have the right
to communicate, verbally or in writing, with any regulatory agency or any
environmental consultant on any matter respecting the Property relating to
Hazardous Materials. Landlord shall be entitled to copies of all notices,
reports or other documents issued by or to any such regulatory agency or
consultant respecting the Property relating to Hazardous Materials.
18.3. TENANT'S DUTY TO INDEMNIFY. If the Handling by Tenant and its
Agents of Hazardous Materials results in contamination of the Property, or if
any lender or governmental agency requires an investigation to determine whether
there is contamination of the Property or any adjoining property as a result of
the Handling of Hazardous Materials by Tenant and its Agents, then Tenant shall
indemnify, defend and hold Landlord and its Agents and all of
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Landlord's partners or other affiliates, together with all their directors,
officers, shareholders, employees, agents, contractors and attorneys, harmless
from and defend them against any and all claims, damages, penalties, fines,
costs, liabilities and losses (including, without limitation, diminution in
value of the Property, damages for the loss or restriction on use of rental or
usable space or of any other amenity of the Property, damages arising from any
adverse impact on marketing of space in the Property, other consequential
damages and sums paid in settlement of claims, attorneys' fees, consultants'
fees and experts' fees) which arise during or after the Term as a result of
such contamination. This indemnification includes, without limitation, costs
incurred in connection with removal or restoration work required by any
regulatory agency and/or private persons because of the presence of Hazardous
Materials in the soil or groundwater in, on, about or under the Property or any
adjoining property as a result of the acts of Tenant and its Agents and legal
fees and expenses incurred by Landlord relating to such claims, demands,
investigations and responses.
18.4. RIGHT OF ENTRY. If contamination of the Property by Hazardous
Materials occurs or if any lender or regulatory agency requires an
investigation to determine if there is contamination of the Property or any
adjoining property, then Landlord and its Agents shall have the right, at any
reasonable time and from time to time, to enter the Premises to perform
monitoring, testing or other analyses, and to review applicable documents,
notices, or other materials. If such contamination resulted from the conduct of
Tenant and its Agents, Tenant shall pay, on delivery of Landlord's invoice, all
costs and expenses reasonably incurred by Landlord in connection with such
investigation, monitoring, and testing.
18.5. DEFINITIONS. The following terms shall have the following meanings:
18.5.1. "HAZARDOUS MATERIAL": means (a) any petroleum or chemical
products, whether in liquid, solid, or gaseous form, or any fraction or
by-product thereof, (b) asbestos or asbestos-containing materials, (c)
polychlorinated biphenyls (PCBs), (d) radon gas, (e) underground storage
tanks, (f) any explosive or radioactive substances, (g) lead or lead-based
paint, or (h) any other substance, material, waste or mixture now or hereafter
during the term of this lease listed, defined or otherwise determined by any
governmental authority to be hazardous, toxic, dangerous or otherwise
regulated, controlled or giving rise to liability under any Environmental
Health and Safety Requirements.
18.5.2. "ENVIRONMENTAL HEALTH AND SAFETY REQUIREMENTS" means any
federal, state or local law or rule (whether imposed by statute, administrative
or judicial order, or common law), now in force or hereafter enacted, governing
health, safety, industrial hygiene, the environment, natural resources, or
Hazardous Materials, including, without limitation, such laws governing or
regulating the use, generation, storage, removal, recovery treatment, handling,
transport, disposal, control, discharge of, or exposure to Hazardous Materials.
All Environmental Health and Safety Requirements are Regulations under the
terms of this Lease.
18.6. ALLOCATION OF RESPONSIBILITIES. ALL LIABILITY ARISING FROM THE
TRANSPORTATION OR HANDLING OF HAZARDOUS MATERIALS IN, ON, UNDER, AND/OR ABOUT
THE PROPERTY OR ADJOINING PROPERTY BY TENANT AND ITS AGENTS SHALL, AT ALL
TIMES, REMAIN TENANT'S SOLE RESPONSIBILITY, EVEN IF THE HAZARDOUS MATERIALS
ORIGINATE FROM THE PROPERTY. NO ACT BY LANDLORD OR ITS AGENTS SHALL CONSTITUTE
ASSUMPTION BY LANDLORD OF ANY OBLIGATIONS, DUTIES, LIABILITIES OR
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RESPONSIBILITIES PERTAINING TO TENANT'S COMPLIANCE WITH ANY ENVIRONMENTAL,
HEALTH OR SAFETY REQUIREMENTS. NOTWITHSTANDING TERMINATION OF THIS LEASE,
TENANT SHALL RETAIN ALL LIABILITY AND RESPONSIBILITY FOR COMPLIANCE WITH
REGULATIONS AND ENVIRONMENTAL, HEALTH OR SAFETY REQUIREMENTS CONCERNING TENANT
AND ITS AGENTS' HANDLING OF HAZARDOUS MATERIALS. TENANT SHALL INDEMNIFY AND
HOLD LANDLORD AND ITS AGENTS HARMLESS FROM ALL COSTS AND EXPENSES ASSOCIATED
WITH SUCH COMPLIANCE.
18.7. INSPECTIONS. Tenant will cooperate with the completion of
inspections of the Property as required by applicable law and regulation.
Tenant shall provide to Landlord a copy of the reports for each such inspection
within 15 days of Tenant's receipt of such reports.
18.8. COOPERATION. Tenant will not interfere with Landlord's acts pursuant
to the above-referenced Regulations. Tenant will comply with reasonable
procedures promulgated by Landlord pursuant to such laws and regulations.
Landlord shall have no duty to establish any procedures or to supervise in any
way Tenant's activities on the Property.
18.9. SURVIVAL. The covenants, agreements and indemnities set forth in
this Section 18 shall survive Termination and shall not be affected by any
investigation, or information obtained as a result of any investigation, by or
on behalf of Landlord or any prospective Tenant.
18.10. SPECIAL MATTERS.
18.10.1. STORAGE TANKS: TENANT SHALL NOT INSTALL ANY STORAGE TANKS
ON THE PROPERTY WITHOUT LANDLORD'S PRIOR WRITTEN CONSENT.
18.10.2. FLAMMABLE CHEMICALS: Tenant shall store all flammable
chemicals in a metal storage cabinet. Flammable Chemicals includes, without
limitation, turpentine, thinner, brush cleaner, solvents and other combustible
products.
18.10.3. NFPA WARNINGS: If Tenant uses any chemicals on the
Premises Tenant shall post an NFPA diamond on the exterior side of the door to
the Premises.
18.11. LANDLORD'S OBLIGATIONS. Landlord's obligations are:
18.11.1. COMPLIANCE WITH REGULATIONS. If Landlord and its Agents
Handle Hazardous Material in, on, about or under the Property, such material
shall be Handled in compliance with all Environmental, Health and Safety
Requirements.
18.11.2. RESTORATION. If, as a result of Landlord's bringing
Hazardous Material upon the Property, any contamination of the Property or the
surrounding environment occurs, Landlord shall promptly take all necessary
actions to return the Property and/or the surrounding environment to the
condition existing prior to such contamination.
18.11.3. DUTY TO NOTIFY TENANT. Landlord shall notify Tenant in
writing upon learning of: (1) enforcement, cleanup, remediation or other action
threatened, instituted or completed by any regulatory agency or private person
with respect to the Property relating to Hazardous Materials; (2) any claim
threatened or made against Landlord respecting the Tenant or the Property for
personal injury, compensation or any other matter relating to Hazardous
Materials; and (3) reports made by or to any regulatory agency respecting the
Property, complaints, notices or asserted violations in connection therewith.
Landlord shall supply to Tenant copies of claims, notices, warnings, or other
documents relating to the foregoing.
18.11.4. INDEMNITY OF TENANT. If Hazardous Materials, resulting from
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Landlord's acts, contaminate the Property, or if the Property is contaminated
on the Commencement Date, Landlord shall indemnify, defend, protect and hold
Tenant and its Agents harmless from and against any and all claims, damages,
penalties, costs, liabilities and losses resulting from such contamination.
19. MISCELLANEOUS PROVISIONS.
19.1. WAIVER. No waiver of any breach of this Lease shall be
construed as a waiver of any other breach. Landlord's acceptance of rent after
tenant's breach shall not be a waiver of any preceding breach of this Lease by
Tenant, even if known by Landlord at the time.
19.2. NOTICES. Notices, requests, demands and other communications
shall be in writing personally delivered or sent by certified mail, return
receipt requested, postage prepaid, properly addressed to the other party at
the address set forth by its signature below, or at such other address as may
be designated in writing by one party to the other. Notice shall be effective
on personal delivery or on the date indicated on the post office's certified
mail receipt of delivery.
19.3. CONSTRUCTION. This Lease shall be construed pursuant to
California law. The invalidity of any provision of this Lease shall not affect
the remainder. All terms of this Lease shall be construed to mean either the
singular or the plural, masculine, feminine or neuter, as the situation may
demand. Headings are descriptive only and not determinative of meaning. Time is
of the essence in performance of all obligations. This Lease constitutes the
entire agreement between the parties respecting the subject matters that it
addresses. This Lease supersedes all prior oral and written agreements
respecting the hiring of the Premises. Provisions of this Lease may be waived,
amended or repealed only by all parties' written consent. This Lease binds and
inures to the benefit of the parties and their heirs, personal representatives,
successors and assigns. Should any provision of this Lease require judicial
interpretation, it is agreed that the court interpreting or construing the same
shall not apply a presumption that the terms shall be more strictly construed
against one party by reason of the rule that a document is to be construed more
strictly against the party responsible for its preparation; the parties agree
that all parties have participated in the preparation of this Lease.
19.4. MEMORANDUM. If Landlord requests a Memorandum of Lease, the
parties shall execute, acknowledge and record a document identifying: the
parties, Premises, Term and Commencement Date. No other memorandum of this
Lease shall be recorded.
19.5. AUTHORITY. Each individual executing this Lease for a
corporation warrants that he is duly authorized to execute and deliver the
Lease for the corporation and that the Lease binds the corporation in
accordance with its terms. Each individual executing this Lease on behalf of a
partnership warrants that he is duly authorized to execute and deliver this
Lease for the partnership and that this Lease binds the partnership in
accordance with its terms.
19.6. LITIGATION. All Litigation arising out of or in connection with
this Lease shall be venued in Contra Costa County, California. The prevailing
party shall recover costs of suit and attorneys' fees, whether or not the matter
proceeds to judgment or award.
19.7. SUBORDINATION OF LEASEHOLD. This Lease shall, at all times, be
subordinate to the lien of any loan which Landlord may secure with the Property.
Tenant shall execute written instruments to effect such subordination
conditioned upon the lienholder executing a nondisturbance agreement providing
that absent Tenant's default, the lienholder will allow
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Tenant to remain in possession of the Premises, subject to the provisions of
this Lease, for the duration of the Term.
19.8. ESTOPPEL. Within 15 Days of Landlord's request, Tenant shall
complete, execute and deliver to Landlord a certification: (a) that this Lease
is unmodified and in full force and effect (or if modified, stating the nature
of such modification and certifying that this Lease as so modified is in full
force and effect); (b) of the date to which the rent and other charges are
paid; (c) that Tenant knows of no uncured defaults on the part of Landlord
hereunder, or specifying such defaults, if any are claimed; and (d) of the date
of commencement and expiration of the Term. Tenant's failure to timely deliver
the document constitutes a certification that Landlord is not in default under
the Lease and the terms of the Lease are in force without modification.
Prospective purchasers, lenders or lender's assignees may rely upon such
certification.
19.9. ATTORNMENT. In the event of a sale of the Property or the completion
of foreclosure against the Property, Tenant shall attorn to the Landlord's
successor in interest.
19.10. LENDER'S REQUESTS. Tenant shall consent to Lease amendments
requested by any lender against the Property, provided that such amendments do
not materially affect Tenant's obligations. Tenant shall timely supply
financial information requested by such lender.
19.11. REASONABLE EXPENDITURES. Any expenditure by a party permitted or
required under the Lease, for which such party is entitled to demand and does
demand reimbursement from the other party, shall be limited to the fair market
value of the goods and services involved, shall be reasonably incurred, and
shall be substantiated by documentary evidence available for inspection and
review by the other party or its representative during normal business hours.
19.12. TENANT IMPROVEMENTS. Landlord shall have no obligation to modify or
improve the Premises or the Property in connection with this Lease. Landlord
shall, however, reimburse Tenant in an amount not to exceed $13,675 for the
cost of replacement of the flooring in the Premises; reimbursement shall be
made within 15 Days of Tenant's delivery to Landlord of appropriate evidence of
payment of the requested amount for the replacement flooring or a billing from
a licensed contractor for the completion of the said work, without regard to
whether it has been paid. Tenant shall comply with all provisions of this Lease
regarding Alterations in performing the modifications and other improvements to
the Premises contemplated by Tenant.
19.13. SUBMISSION. Submission of this document to Tenant does not create a
reservation for a lease or any rights respecting the Premises prior to
Landlord's execution.
19.14. ARBITRATION OF DISPUTES. NOTWITHSTANDING ANY OTHER PROVISION OF
THIS LEASE, THE PROVISIONS OF THIS SECTION APPLY TO ALL DISPUTES ARISING OUT OF
THE LEASE SAVE AND EXCEPT UNLAWFUL DETAINER PROCEEDINGS; NOTHING IN THIS
AGREEMENT SHALL BE INTERPRETED TO REQUIRE LANDLORD TO SUBMIT UNLAWFUL DETAINER
PROCEEDINGS TO ARBITRATION. IF A CONTROVERSY, CLAIM OR DISPUTE EXCLUDING
UNLAWFUL DETAINER PROCEEDINGS AND ISSUES RAISED IN CONNECTION THEREWITH
(COLLECTIVELY "DISPUTE"). THE TERM "DISPUTE" SHALL NOT BE CONSTRUED TO INCLUDE
UNLAWFUL DETAINER PROCEEDINGS. IN THE EVENT THAT A
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DISPUTE BETWEEN THE PARTIES ARISES OUT OF THIS LEASE, THE DISPUTE SHALL BE
SUBMITTED TO BINDING ARBITRATION TO BE CONDUCTED UNDER THE COMMERCIAL
ARBITRATION RULES OF THE AMERICAN ARBITRATION ASSOCIATION, JUDGMENT ON THE
ARBITRATOR'S AWARD MAY BE ENTERED IN ANY COURT OF COMPETENT JURISDICTION.
CALIFORNIA CODE OF CIVIL PROCEDURE SECTION 1283.05 SHALL APPLY TO SUCH
ARBITRATION.
NOTICE: BY INITIALING IN THE SPACE BELOW YOU ARE AGREEING TO HAVE ANY DISPUTE
ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISIONS
DECIDED BY NEUTRAL ARBITRATION AS PROVIDED BY CALIFORNIA LAW AND YOU ARE GIVING
UP ANY RIGHTS YOU MIGHT POSSESS TO HAVE THE DISPUTE LITIGATED IN A COURT OR
JURY TRIAL. BY INITIALING IN THE SPACE BELOW YOU ARE GIVING UP YOUR JUDICIAL
RIGHTS TO DISCOVERY AND APPEAL UNLESS THOSE RIGHTS ARE SPECIFICALLY INCLUDED IN
THE "ARBITRATION OF DISPUTES" PROVISION. IF YOU REFUSE TO SUBMIT TO ARBITRATION
AFTER AGREEING TO THIS PROVISION YOU MAY BE COMPELLED TO ARBITRATE UNDER THE
AUTHORITY OF THE CALIFORNIA CODE OF CIVIL PROCEDURE. YOUR AGREEMENT TO THIS
ARBITRATION PROVISION IS VOLUNTARY.
WE HAVE READ AND UNDERSTAND THE FOREGOING AND AGREE TO SUBMIT DISPUTES ARISING
OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION TO
NEUTRAL ARBITRATION.
/s/ [SIG] /s/ [SIG]
---------- ----------
Initial Initial
19.15. BROKERAGE. This transaction has been negotiated by the parties
without the assistance or participation of real estate licensees. Tenant
represents to Landlord that Tenant has been assisted by any real estate
licensee in connection with this transaction.
19.16. COOPERATION. Tenant will not interfere with Landlord's actions
pursuant to any Regulation affecting the Property. Tenant will comply with all
reasonable procedures promulgated by Landlord relating to the matters covered
by such Regulations. Landlord has no duty to establish procedures or
regulations or to supervise Tenant's activities for any purpose including,
without limitation, the Handling of Hazardous Materials.
19
<PAGE> 20
19.17. PARKING. Tenant shall have the non-exclusive right to the use of
16 off-street parking places.
19.18. MEASUREMENTS. All measurements respecting Usable Square Feet,
Rentable Square Feet and Floor Areas are approximate. Landlord reserves the
right to re-measure the Premises and the Building at any time. In the event that
such re-measurement indicates sizes different than those used in this lease, the
lease will be appropriately amended to reflect any required corrections
prospectively.
19.19. PREPARATION. This Lease was prepared by the Law Offices of Graves
& Allen ("G&A") acting solely as counsel for Landlord. Tenant has had the
opportunity to review this Lease and have it reviewed by such legal counsel and
other advisors as Tenant deems necessary or appropriate. Tenant acknowledges
that G&A has not acted as counsel for Tenant or provided Tenant any advice in
connection with this transaction. Tenant understands that this document affects
significant legal rights.
Approved and executed:
LANDLORD: TENANT:
POINT RICHMOND R&D ASSOCIATES, PIXAR ANIMATION STUDIOS,
A California Limited Partnership a California Corporation
By /s/ [SIG] By /s/ [SIG]
-------------------------------- ------------------------------
Authorized Signature Authorized Signature
--------------------------------
Please print name and title
Date: 1/13/99 Date:
---------------
ADDRESS FOR NOTICES: ADDRESS FOR NOTICES:
1120 Nye Street, Suite 400
San Rafael, CA 94901
20
<PAGE> 1
EXHIBIT 13.1
SELECTED FINANCIAL DATA
The following selected financial data is derived from the Company's
financial statements. This data should be read in conjunction with the Financial
Statements and Notes thereto, and with Management's Discussion and Analysis of
Financial Condition and Results of Operations.
<TABLE>
<CAPTION>
FISCAL YEAR
---------------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenue...................................... $ 5,590 $ 12,113 $ 35,218 $ 34,699 $ 14,307
Net income (loss) from continuing
operations................................. (2,372) 3,331 26,342 21,956 7,464
Net income (loss)............................ (2,372) 1,627 25,319 22,190 7,822
Basic net income (loss) per share from
continuing operations(1)................... (0.24) 0.26 0.68 0.53 0.17
Basic net income (loss) per share............ (0.24) 0.13 0.66 0.54 0.18
Diluted net income (loss) per share from
continuing operations...................... (0.24) 0.10 0.56 0.46 0.14
Diluted net income (loss) per share.......... (0.24) 0.05 0.54 0.46 0.15
Total assets............................. 1,896 152,815 176,941 231,068 250,806
Long-term obligations.................... 1,573 -- -- -- --
Total shareholders' equity (deficit)..... (1,675) 142,907 170,804 217,300 235,147
</TABLE>
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The foregoing discussion, the preceding Letter to Shareholders and other
sections of this Annual Report to Shareholders contain 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
"Overview," "Pixar May Experience Net Losses in the First and Second Quarters of
1999", "Dependence on Toy Story, A Bug's Life, Toy Story 2 and Film Four," and
"Risks Associated with Adequacy of Cash Balances" as well as those noted in the
section entitled "Risk Factors " in Pixar's Annual Report on Form 10-K for the
year ended January 2, 1999 (the "Form 10-K"). Particular attention should be
paid to the cautionary language in the section in the Form 10-K entitled " Risk
Factors -- We May Experience Net Losses in the First and Second Quarters of
1999," "-- Our Dependence on Toy Story, Our Dependence on A Bug's Life and Our
Dependence on Toy Story 2 and Film Four," " -- Risks Associated with Adequacy of
Cash Balances," "Risk Associated with Scheduled Successive Release of Films" 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.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Pixar was formed in 1986 when Steve Jobs purchased the computer division of
LucasFilm and incorporated it as a separate company. Until 1996, Pixar generated
its recurring revenue primarily from the license of RenderMan software, software
development contracts and fees for animated television commercials. In 1991,
Pixar entered into a feature film agreement (the "Feature Film Agreement") with
Walt Disney Pictures, a wholly owned subsidiary of The Walt Disney Company
(together with its subsidiaries and affiliates collectively referred to herein
as "Disney"), for the development and production of up to three animated feature
films to be marketed and distributed by Disney. As a result, in 1992, Pixar
began to place more emphasis on products sold for their content, especially
feature films, and the continued development of its proprietary software. Pixar
therefore reduced emphasis on the commercialization of software and contract
development work and later moved away from producing computer-animated
commercials. Pixar has implemented this shift in focus toward feature films over
the last six years. In accordance with this shift in focus, Pixar adopted a new
business model pursuant to which it will continue to develop and produce new
animated feature films and related products and will produce jointly with Disney
other related products such as merchandise and soundtracks.
Adoption of this new business model did not materially impact Pixar's
results of operations and financial condition until 1996, when Pixar first
recognized film revenue and cost of film revenue attributable to Pixar's first
animated feature film, Toy Story, which was released in November 1995. Pixar's
share of revenues and expenses from Toy Story have been governed by the terms of
the Feature Film Agreement. This agreement was superseded in February 1997 by
the Co-Production Agreement, described below, except with respect to treatment
of Toy Story and Toy Story-related products developed pursuant to the Feature
Film Agreement, such as the Toy Story home video. Accordingly, Pixar believes
that the results of its operations for 1995 and prior years, during which time
Pixar recognized no revenue from animated feature films or related products, are
not meaningful indicators of future performance. Further, Pixar believes that
its results of operations for 1996, 1997 and 1998, during which time revenue and
costs attributable to feature films were governed by the terms of the Feature
Film Agreement, are also not meaningful indicators of future performance,
although they are more meaningful than results of operations for 1995 and prior
years. See "Risk Factors: Pixar May Experience Net Losses in the First and
Second Quarters of 1999."
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<PAGE> 3
In February 1997, Pixar and Disney entered into the Co-Production Agreement
("Co-Production Agreement") pursuant to which Pixar, on an exclusive basis,
agreed to produce five computer-animated feature-length theatrical motion
pictures (the "Pictures") for distribution by Disney over approximately ten
years. Pixar and Disney agreed to co-finance the production costs of the
Pictures, co-own the Pictures (with Disney having exclusive distribution and
exploitation rights), co-brand the Pictures and share equally in the profits of
each Picture and any related merchandise and other ancillary products, after
recovery of all marketing and distribution costs (which Disney finances), a
distribution fee paid to Disney and any other fees or costs, including any
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. Pixar's second feature film, A Bug's Life, was
released on November 25, 1998 and is the first Picture under the Co-Production
Agreement. The Co-Production Agreement also contemplates that with respect to
theatrical sequels, made-for-home video sequels, television productions,
interactive media products and other derivative works related to the Pictures,
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 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.
See Note 4 of Notes to Financial Statements.
In February 1998, Pixar and Disney agreed to produce a theatrical motion
picture sequel to Toy Story, entitled 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 in 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 February 1998,
Pixar was developing and producing Toy Story 2 for the less expensive
made-for-home video format. Therefore, Pixar is spending substantially more
production time and incurring substantially higher production costs to convert
Toy Story 2 into a feature-length and feature-quality motion picture.
In 1998, Pixar continued story development on its fourth theatrical film
("Film Four"). This film is being developed and will be distributed under the
Co-Production Agreement and counts as the second of the five original films to
be produced under the Co-Production Agreement. Pixar does not expect to release
Film Four until mid 2001, at the earliest.
Effective for fiscal year 1998, Pixar adjusted its fiscal year end from
December 31 to a 52- or 53-week period that ends on the Saturday nearest
December 31. As a result, the first three quarters of 1998 represented
thirteen-week periods and the fourth quarter represented a fourteen-week period.
The 1998 fiscal year ended on January 2, 1999 and consisted of 53 weeks.
RESULTS OF OPERATIONS
A number of factors may result in net losses in the first and second
quarters of 1999. See "Risk Factors: Pixar May Experience Net Losses in the
First and Second Quarters of 1999."
Revenue
In 1998, Pixar derived revenue from its first animated feature film, Toy
Story, from software licenses, from the license of certain patents and from fees
for other animation services. Revenue from feature films is recognized as earned
and reasonably estimable. All payments to Pixar from Disney for development and
production of Toy Story under the Feature Film Agreement and A Bug's Life, Toy
Story 2 and Film Four under the Co-Production Agreement have been recorded as
cost reimbursements. Accordingly, no revenue has been recognized for such
reimbursements; rather, Pixar has netted the reimbursements against the related
costs. These reimbursed costs through the end of 1998 are set forth in Note 4 of
Notes to Financial
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<PAGE> 4
Statements. Software license revenue is recognized upon shipment. Revenue from
patent licensing is recognized upon release of the rights to the technology.
Animation services revenue is recognized on the percentage-of-completion method
of accounting. See Note 1 of Notes to Financial Statements.
Total revenue declined from $35.2 million in 1996 to $34.7 million in 1997
and to $14.3 in 1998. The decrease in total revenue from 1996 to 1997 was
primarily attributable to a decrease in patent licensing revenue, largely offset
by higher film revenue derived from Toy Story home video and merchandise sales.
The decrease in revenue from 1997 to 1998 was primarily attributable to a
decrease in Toy Story related revenue because Toy Story had been released in all
its primary and secondary markets in 1996 and 1997. Each of the other revenue
categories also declined.
Software revenue includes software license revenue, principally from
RenderMan. Software revenue increased from $3.3 million in 1996 to $4.5 million
in 1997 and declined to $3.8 million in 1998. Software revenue increased in 1997
and decreased in 1998 due primarily to general corresponding increases and
decreases in RenderMan software license revenue. Due to Pixar's focus on content
creation for animated feature films and related products, Pixar has not been
increasing the time and resources necessary to generate higher RenderMan sales.
Therefore, Pixar continues to expect that revenue derived from software licenses
will remain flat and possibly decline. All historical royalty income and future
royalty income, if any, associated with Pixar's discontinued CD-ROM division is
now and will continue to be excluded from software revenue and presented in
results of discontinued operations. See "Results of Discontinued Operations."
Animation services revenue includes revenue generated from short projects
related to Pixar's films, other short animated productions and television
commercials. Fees for animation services, which are fixed in advance, depend on
the relative complexity and length of each production and may also depend on the
market and other competitive conditions. Animation services revenue decreased
from $3.9 million in 1996 to $1.6 million in 1997 and to $630,000 in 1998. The
decreases in animation services revenue from 1996 to 1998 were primarily
attributable to decreased television commercials revenue, which resulted from
Pixar's decision to substantially discontinue its production of animated
television commercials for third parties. In addition, with respect to the
decline in revenue in 1998, for a portion of 1998, Pixar transferred
substantially all of its animation services employees to assist in the
completion of A Bug's Life. Pixar expects that revenue in the animation services
area 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.
Under the Feature Film Agreement, film revenue of $18.8 million was
recognized in 1996, representing Pixar's share of both the domestic and
international theatrical releases of Toy Story and related products. In 1997,
film revenue of $26.9 million was recognized, primarily representing Pixar's
share of Toy Story worldwide home video sales and Toy Story merchandise sales.
Toy Story revenue increased in 1997 primarily because, under the Feature Film
Agreement, Pixar's percentage of Toy Story revenue increased once Disney
recovered related production, marketing and distribution costs for the film. The
Toy Story home video, which was released in 1997, was the last major release
window for Toy Story. Consequently, film revenue declined significantly in 1998
to $9.8 million, which primarily represented residual amounts of Toy Story
merchandise revenue. Pixar's second feature film, A Bug's Life, was released in
November 1998. Pixar will not receive significant revenue from A Bug's Life
until Disney recovers its distribution and marketing costs. While it is too
early to tell when Disney will recover these costs, it is unlikely that Pixar
will recognize significant revenue from A Bug's Life until the second quarter of
1999 at the earliest and possibly not until the third quarter of 1999.
Patent licensing revenue of $9.1 million in the year ended December 31,
1996 was attributable to a patent license with Silicon Graphics whereby Pixar
granted to Silicon Graphics and its subsidiaries a non-exclusive license to use
certain of Pixar's patents covering techniques for creating computer-generated
photo-realistic images. Under the agreement, Silicon Graphics agreed to pay
Pixar total compensation of $11.0 million, of which $6.0 million in cash was
paid in March 1996 and $5.0 million was to be paid in the form of credits to
purchase hardware and software from Silicon Graphics. In 1996 and 1997, Pixar
recognized revenue of $9.1 million and $1.7 million, respectively, in accordance
with this license. Pixar utilized $120,000 of the
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<PAGE> 5
remaining credits in 1998. Pixar does not expect that patent licensing revenue
will be generated on an on-going basis. See Note 5 of Notes to Financial
Statements.
In the year ended December 31, 1996, Disney accounted for 62% of Pixar's
revenue from continuing operations, attributable to revenue generated from Toy
Story and short animated television productions based on Toy Story, and, to a
lesser degree, software license sales. Also in 1996, Silicon Graphics accounted
for 26% of total revenues, attributable to a one-time patent license. In 1997
and 1998, Disney accounted for 83% and 76% of Pixar's revenue from continuing
operations, attributable to revenue generated from Toy Story home video,
television airings and merchandise sales, animation services and software
revenues. Due to the Co-Production Agreement, Disney is expected to continue to
represent greater than 10% of Pixar's revenue in 1999 and for the foreseeable
future.
Cost of Revenue
Cost of software revenue consists of the direct cost and manufacturing
overhead required to reproduce and to package Pixar's software products, as well
as amortization of purchased technology. Cost of software revenue includes no
amortization of internal software development expenses since no such expenses
have been capitalized. Cost of software revenue as a percentage of the related
revenue decreased from 3% in 1996 to 2% in 1997 and increased to 19% in 1998.
The decrease from 1996 to 1997 was primarily due to a reduction in revenue from
low margin software development contracts and to an increase in sales of the
RenderMan ToolKit, which carry a higher gross margin than other software
products. The increase in cost of software revenue in 1998 was due primarily to
the amortization of purchased technology associated with the acquisition of
Physical Effects, Inc ("PEI"). Approximately $2.7 million of the PEI purchase
price was assigned to purchased technology, which PEI has licensed to a third
party. Over a period not to exceed three years, Pixar will amortize the
purchased technology against related revenue, thereby essentially eliminating
any gross margins with respect to license revenue associated with this purchased
technology until such amortization is complete. 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 few 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 revenue consists of production costs, which
include salaries, benefits, facility expenses, and department overhead costs.
Cost of animation services revenue as a percentage of the related revenue
decreased from 77% in 1996 to 63% in 1997 and to 22% in 1998. The decrease from
1996 to 1998 reflects Pixar's decision in 1996 to largely discontinue its
business of producing animated television commercials, which had higher
associated costs relative to revenue, in favor of working on animated services
related to feature films, which have had lower associated costs relative to
revenue. The decreased cost of animation services in 1998 also reflects the
redeployment of all of the animation services personnel to assist in the
completion of A Bug's Life. Pixar continues to expect that cost of revenue, and
therefore gross profits, in this area will vary significantly from period to
period and could even be zero, as was the case in both the second and third
quarters of 1998.
In 1996, 1997 and 1998, cost of film revenue consisted of the amortized
portion of Pixar's share of unreimbursed amounts incurred to produce Toy Story.
See "Capitalized Film Production Costs." Cost of film revenues decreased from
$1.6 million, or 8% of film revenues in 1996, to $1.5 million, or 6% of film
revenue in 1997 and 0% in 1998, due to higher than expected film revenue in 1996
and 1997 which resulted in Pixar's amortizing all related film costs by December
31, 1997. Therefore, any further Toy Story related film revenue will have no
associated cost of revenue.
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. Under the
terms of the Co-Production Agreement, in which Pixar co-finances each film
production, 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.
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There is no cost of revenue associated with patent licensing revenue.
Operating Expenses
Pixar intends to continue to increase operating expenses in a number of
areas. With respect to general expense growth, as a result of intense
competition for animators, creative personnel, technical directors and certain
administrative personnel, 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 1998, Pixar expanded its administrative
staff and facilities 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 received from Disney is treated as operating expense reimbursements.
See Note 4 of Notes to Financial Statements. To the extent that personnel,
facilities and other expenditures are not capitalized by Pixar nor allocated to
and paid for by Disney, and precede or are not subsequently followed by an
increase in revenue, Pixar's business, operating results and financial condition
will be materially adversely affected.
Included in 1997 was a one-time $2.2 million adjustment, reducing Pixar's
operating expenses. This reduction was due to an additional reimbursement from
Disney under the Co-Production Agreement, which was signed in February 1997.
Under this agreement, certain operating expenses benefiting the productions,
such as certain research and development and certain general and administrative
expenses, are paid half by Pixar and half by Disney. Since the Co-Production
Agreement applies to A Bug's Life and Toy Story 2, both of which were in
development and production in 1996, Pixar was entitled to reimbursement for
Disney's share of certain of Pixar's operating expenses incurred prior to
signing the agreement. Without this adjustment, Pixar's total operating expenses
for 1997 were $11.3 million. Operating expenses increased in 1998 to $12.1
million.
Pixar recorded amortization of deferred compensation for the difference
between the grant price and the deemed fair value of Pixar's common stock for
options granted during 1995. Amortization of deferred compensation of $1.2
million, $635,000 and $310,000 was recorded in 1996, 1997 and 1998 respectively;
$44,000 and $24,000 were capitalized to film production costs in 1996 and 1997,
respectively, and the balances were charged to expense in the respective years.
In 1998 the entire amount was charged to expense. See "Capitalized Film
Production Costs" and Note 8 of Notes to Financial Statements.
Research and Development. Research and development expenses consist
primarily of salaries and support for personnel conducting research and
development for the RenderMan product and for Pixar's proprietary Marionette and
Ringmaster animation and production management software. Research and
development expenses increased from $4.5 million in 1996 to $4.7 million in 1997
due to an increase in personnel. Research and development expenses decreased to
$3.9 million in 1998 due to the completion of a significant research and
development project, the short film entitled Geri's Game, in 1997, coupled with
the reassignment in 1998 of certain research and development employees to assist
in the completion of A Bug's Life. Pixar expects research and development
expenses to increase in future periods. To date, all research and development
costs not reimbursed by Disney have been expensed as incurred. See Note 4 of
Notes to Financial Statements.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and overhead, as well as public relations, advertising, technical
support and trade show costs required to support the software segment. Sales and
marketing expenses decreased slightly from $1.5 million in each of 1996 and 1997
to $1.3 million in 1998, due to increased spending for film-specific marketing
expenses which are reimbursed by Disney under the Co-Production Agreement. Pixar
believes that sales and marketing expenses will increase in absolute dollars in
future periods, particularly in the areas of public relations and corporate
marketing.
General and Administrative. General and administrative expenses consist
primarily of salaries of management and administrative personnel, insurance
costs and professional fees. General and administrative expenses increased from
$4.2 million in 1996 to $5.1 million in 1997 and to $7.0 million in 1998. The
increase in general and administrative expenses from 1996 through 1998 was
primarily due to increased general and
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<PAGE> 7
administrative staffing and public company costs such as payroll taxes generated
from the exercise of stock options. Pixar expects general and administrative
expenses to further increase in absolute dollars in future periods.
Other Income, Net
Other income, net was $8.0 million in 1996, $8.8 million in 1997 and $8.8
million in 1998. Other income, net consisted primarily of interest income from
investments made with the net proceeds from Pixar's initial public offering of
common stock in 1995. Pixar expects other income to decrease as cash balances
are used for film production and the construction of the Emeryville facilities.
Income Taxes
Income tax expense from continuing operations of $2.0 million, $9.9 million
and $2.6 million for 1996, 1997 and 1998, respectively, consisted primarily of
state and federal income taxes. Income taxes increased from 1996 to 1997 due to
increased earnings and to full utilization of state net operating loss
carryforwards during 1996. Income taxes decreased in 1998 due to the benefit of
certain tax deductions occurring in 1998 coupled with decreased earnings.
Pixar's tax rate is likely to increase in future years because Pixar has
utilized the remaining net operating loss carryforwards except those which
originated from the exercise of non-qualified employee stock options. The
realization of tax benefits from the exercise of non-qualified employee stock
options will reduce the amount of Pixar's tax payments and liabilities, but will
not reduce Pixar's effective tax rate. See Notes 1 and 7 of Notes to Financial
Statements.
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 redirected the approximately 60 employees in
that division to film and related projects within Pixar.
Discontinued operations, net of income taxes, resulted in losses of $1.0
million in 1996. Pixar recorded income from discontinued operations, net of
taxes, of $234,000 in 1997 and $358,000 in 1998 primarily due to royalty income
received. Pixar does not expect any future CD-ROM royalty income or costs in
future periods. See Note 12 of Notes to Financial Statements.
RISK FACTORS
PIXAR MAY EXPERIENCE NET LOSSES IN THE FIRST AND SECOND QUARTERS OF 1999
Pixar may experience net losses in the first and second quarters of 1999
because of the factors discussed below.
End of Toy Story Revenue
Pixar has already recognized the vast majority of the revenue it expects to
receive from Toy Story. While Pixar may receive minor amounts of revenue in
subsequent periods, Pixar does not expect to recognize any further significant
revenue from Toy Story.
Timing of A Bug's Life Revenue
A Bug's Life was released on November 25, 1998, but Pixar does not expect
to recognize significant revenue from A Bug's Life until after Disney recovers
all marketing and distribution costs and fees. It is difficult to predict when
Disney will recover these costs because of the many variables involved, some of
which are unpredictable, such as the timing and amount of revenue generated from
(1) foreign box office, (2) sales of the home video of A Bug's Life, which is
scheduled for release April 20, 1999, and (3) sales of film related merchandise.
The level of success achieved by A Bug's Life in foreign box office, home video
sales,
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merchandise sales and the level of marketing and distribution costs incurred by
Disney will determine whether Pixar first receives significant revenue from A
Bug's Life in the second or third quarter of 1999. Pixar expects that even if
the film is an extraordinary success in foreign theaters and in the home video
and merchandising markets, Pixar will not recognize significant revenue from A
Bug's Life until the second quarter of 1999 at the earliest and possibly not
until the third quarter of 1999. Moreover, Pixar may not receive sufficient
proceeds from A Bug's Life in the first or second quarter of 1999 to generate
earnings.
Timing of Toy Story 2 Release
In addition, Pixar expects that Toy Story 2 will be released at 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.
Therefore, Pixar is unlikely to recognize any revenue from Toy Story 2 until the
second half of 2000 at the earliest.
Limited CD-ROM Revenue
In March 1997 Pixar discontinued its business of producing CD-ROM products
in favor of other opportunities arising, in part, as a result of entering into
the Co-Production Agreement. Pixar has not received royalty income from Pixar's
only two existing CD ROM products, both based on Toy Story, since the first
quarter of 1998. It is unlikely that Pixar will recognize any further royalty
income from these products or from this discontinued operation in 1999 or
thereafter.
Possible Decline in Sales of RenderMan Due to Shift in Focus
As a result of Pixar's shift in focus to products sold for their content,
Pixar has reduced emphasis on the commercialization of software products. Pixar
is not increasing the time and resources necessary to generate higher RenderMan
sales; therefore, Pixar continues to expect that revenue from the licensing of
RenderMan will remain flat and possibly decline.
Increase in Operating Expenses and Effective Tax Rate
Since Pixar's initial public offering in November 1995, Pixar has
significantly increased its operating expenses, and plans to continue to
increase operating expenses to fund greater levels of research and development
and to expand operations. Specifically, Pixar expects spending levels to
increase significantly due to (1) continued investment in proprietary software
systems, (2) increased compensation costs as a result of intense competition for
animators, creative personnel, technical directors and other personnel, and (3)
increased costs associated with the expansion of facilities. A portion of
operating expenses that are allocable to film productions is either capitalized
or reimbursed by Disney under the Co-Production Agreement. To the extent that
Pixar does not capitalize (or Disney does not pay for) the increases in
expenses, Pixar's operating expenses will significantly increase in 1999.
Finally, Pixar's tax rate increased in 1998 and is likely to increase in future
years because Pixar has utilized the remaining net operating loss carryforwards
except those which originated from the exercise of non-qualified employee stock
options. The realization of tax benefits from the exercise of non-qualified
employee stock options will reduce the amount of Pixar's tax payments and
liabilities, but will not reduce Pixar's effective tax rate.
Impact on Pixar's Operating Results
As a result of the factors discussed above, revenue may decline in the
first half of 1999 as compared to prior periods. At the same time, Pixar's
operating expenses are expected to increase in 1999. Therefore, revenue and
operating results in the first half of 1999 may decline from revenue and
operating results in 1998, and operating and net losses in the first half of
1999 are possible. Pixar's operating results thereafter will depend upon the
success of A Bug's Life, Toy Story 2 and subsequent films.
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<PAGE> 9
PIXAR EXPECTS OPERATING RESULTS TO CONTINUE TO FLUCTUATE
In addition to the factors set forth above, Pixar continues to expect
significant fluctuations in future annual and quarterly operating results
because of a variety of factors, including the following:
- the timing of the domestic and international releases of animated feature
films,
- the success of animated feature films (which can fluctuate significantly
from film to film),
- the timing of the release of related products into their respective
markets (such as home videos and merchandising),
- the demand for such related products (which is often a function of the
success of the related animated feature film),
- film production costs,
- Disney's costs to distribute and promote the feature films and related
products,
- Disney's success at marketing the films and related products,
- the timing of receipt of proceeds from animated feature films and related
products by Disney,
- the timing of revenue recognition under the Co-Production Agreement and
the Feature Film Agreement, as the case may be,
- the introduction of new feature films or products by Pixar's competitors,
and
- general economic conditions.
In particular, since Pixar's revenue under the Co-Production Agreement is
directly related to the success of a feature film, operating results are likely
to fluctuate depending on the level of success of Pixar's animated feature films
and related products. The revenue derived from the production and distribution
of an animated feature film depends primarily on the film's acceptance by the
public, which cannot be predicted and does not necessarily bear a direct
correlation to the production or distribution costs incurred. The commercial
success of a motion picture also depends upon promotion and marketing,
production costs and other factors. Further, the theatrical success of a feature
film can be a significant factor in determining the amount of revenues generated
from the sale of the related products.
Moreover, Pixar's operating expenses will continue to be extremely
difficult to forecast. Pixar budgets the direct costs of film productions with
Disney, and shares such costs equally. Pixar capitalizes its share of these
direct costs of film production in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 53, Financial Reporting by Producers and
Distributors of Motion Picture Films. A substantial portion of all of Pixar's
other costs are incurred for the benefit of feature films ("Overhead"),
including research and development expenses and general and administrative
expenses. Portions of overhead are included in the budgets for the Pictures, and
Pixar will share such costs equally with Disney under the Co-Production
Agreement. With respect to the portion of overhead that is not reimbursed by
Disney, Pixar either (1) capitalizes such portion as film production costs, if
required under SFAS No. 53, or (2) charges it to operating expense in the period
incurred. Since a substantial portion of overhead is related to the Pictures and
is, therefore, reimbursed by Disney, and since Pixar capitalizes other amounts
in accordance with SFAS No. 53, reported operating expenses for 1998 have not
reflected, and future reported operating expenses will not reflect, the true
level of spending on the production of animated feature films, related products
and overhead.
Pixar may not be able to recognize the tax benefits of all of its net
operating loss carryforwards. Although Pixar was profitable for financial
statement purposes, Pixar has not been profitable for federal income tax
purposes for each of fiscal 1996, 1997 and 1998 due to additional tax deductible
items and the utilization of federal net operating loss carryforwards. Pixar was
profitable for state income tax purposes for each of 1996 and 1997, but at
levels significantly lower than those reported for financial statement purposes.
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<PAGE> 10
Pixar maintains a valuation allowance which substantially offsets their
deferred tax asset, given the dependence on the success of A Bug's Life and
future films, which continues to be uncertain.
As a result of the factors discussed above, Pixar believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful, and one should not rely on Pixar's annual and quarterly results of
operations as any indication of future performance. Due to the factors discussed
above, it is likely that in some future period Pixar's operating results will be
below the expectations of public market analysts and investors. In such event,
the price of Pixar's Common Stock would likely be materially adversely affected.
DEPENDENCE ON TOY STORY, A BUG'S LIFE, TOY STORY 2 AND FILM FOUR
Dependence on Toy Story
For at least the first quarter of 1999 and possibly the second quarter of
1999, Pixar's revenue and operating results will again be largely dependent upon
(1) whatever remains to be received from Toy Story merchandise, if any, and (2)
Pixar's other businesses, software and animation services, from which Pixar
expects limited revenue. Pixar recognized the vast majority of Toy Story revenue
from all sources by the end of 1998, and expects little revenue, if any, from
Toy Story or related products in 1999 and thereafter. Pixar also expect no
further royalty income from Toy Story CD-ROM products in 1999 or thereafter.
Dependence on A Bug's Life
In 1999, Pixar expects to be significantly dependent upon the success of A
Bug's Life. Although A Bug's Life was released in November 1998 and has
experienced relative domestic box office success, Pixar will not recognize any
significant revenue from the film until Disney recovers its marketing and
distribution fees and costs. Pixar believes that domestic box office proceeds
alone will be inadequate to recover all of these costs. Foreign box office
proceeds and sales of related products, such as A Bug's Life home videos and
merchandise, must also be substantial in order for the film to generate profits.
Pixar cannot provide any assurances that A Bug's Life will be successful in
these other key markets. Therefore, it is possible that Pixar will not recognize
sufficient revenue from A Bug's Life to generate earnings on a quarter to
quarter basis.
Risks Associated with A Bug's Life
Under the Co-Production Agreement, Pixar shares with Disney the production
costs of A Bug's Life. These costs were initially capitalized as film production
costs under SFAS No. 53, and Pixar will amortize these costs over the expected
revenue stream when Pixar recognizes revenue under the film. Although A Bug's
Life has achieved substantial domestic box office success, Pixar believes that
the amount spent by Disney for marketing and distribution has been and will
continue to be significant. Unless the amount of revenue generated by A Bug's
Life from box office proceeds, home video sales and merchandise sales is
substantial even after Disney recovers the marketing and distribution costs,
Pixar's revenue could be relatively low, and Pixar would have to amortize the
capitalized production costs 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. It is possible that
total revenue generated in all markets by A Bug's Life may not generate
significant revenue and operating results for us, even though A Bug's Life is
critically acclaimed and has achieved domestic box office success. See also Note
4 of Notes to Financial Statements.
Dependence on Toy Story 2 and Film Four
Pixar expects to receive the majority of proceeds from A Bug's Life by the
end of 2000. Beyond 2000, Pixar expects to be largely dependent upon the success
of Toy Story 2 and Film Four (together referred to as the "Current Projects").
Although development and/or production of the Current Projects is underway,
Pixar cannot provide any assurances that the Current Projects will be
successfully produced and released when scheduled. For example, while Film Four
is currently targeted for release in mid 2001, Pixar has not formally agreed
with Disney on the timing of its release, and Pixar cannot provide any
assurances that Disney will agree to release Film Four in mid 2001 as it is
currently targeted. Pixar cannot provide any assurances that it will not
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<PAGE> 11
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, its business, operating results
and financial condition will be materially adversely affected.
Risks Associated with Toy Story 2
It is rare for animated feature films to achieve extraordinary box office
success. 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 films generated domestic box office revenues
greater than A Bug's Life and Toy Story, and both of those films were produced
and distributed solely by Disney. During at least the last five years, Pixar
believes that The Rugrats Movie is the only fully-animated feature film (other
than Toy Story and A Bug's Life) produced or developed by a studio other than
Disney that has achieved more than $100 million in domestic box office revenues.
Unless Toy Story 2 achieves extraordinary box office success and also achieves
success in home video and merchandise sales, Toy Story 2 may not generate
significant revenue and operating results. See Note 4 of Notes to Financial
Statements.
As 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 these cases,
the original feature films and related sequels were action-adventure films, such
as Lethal Weapon and Die Hard. Accordingly, Pixar cannot provide any assurances
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 together with other
increases in production costs will have the effect of increasing the cost of the
film when compared to Toy Story.
As a result of these factors, 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.
Risks Associated with Production Budgets
Given the (1) escalation in compensation rates of people required to work
on the Current Projects, (2) number of people required to work on the Current
Projects, and (3) equipment needs, the budget for the Current Projects and
subsequent films and related products are and will continue to be substantially
greater than the budgets for Toy Story and A Bug's Life. Pixar will continue to
finance these budgets equally with 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 Pixar cannot provide any assurances that any of the
Current Projects can be completed within the budgeted amounts. For example, in
order to meet the production schedule for Toy Story 2, Pixar expects to reassign
many employees from its animation services group and from Film Four to Toy Story
2 for the completion of its production, which will result in a larger production
staff than originally anticipated and which will generate additional production
costs. In addition, when production of each film 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, are treated as film costs which increase overall
production budgets and could have a material adverse effect on results of
operations and financial condition.
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<PAGE> 12
RISKS ASSOCIATED WITH ADEQUACY OF CASH BALANCES
Pursuant to the Co-Production Agreement, Pixar will co-finance the next
four animated feature films that it produces, including 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 and
television productions. In addition, Pixar is building a new headquarters and
studio facility in Emeryville, California, which is being financed by the use of
cash and may continue to be financed by the use of cash. Since Pixar does not
expect to generate substantial, if any, cash from operations in the first
quarter and possibly the second quarter of 1999, the development and production
costs of the Current Projects and costs of the new Emeryville facility will have
a material adverse impact on Pixar's cash and short-term investment balances. As
of January 2, 1999, Pixar had approximately $149.0 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 the Current Projects, until
Pixar begins receiving cash from the release of A Bug's Life and these films
(which Pixar does not expect to be significant until the second or third quarter
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 construction of its new
facility. 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
Although Disney funded the entire production of Toy Story, Pixar
contractually guaranteed certain of the film budget overages and was liable to
Disney for those amounts under the original Feature Film Agreement. Because
these are "production costs" under SFAS No. 53, the costs were capitalized and
amortized against film revenue. In 1996 and 1997, film production costs of $1.6
million and $1.5 million were amortized against film revenue, respectively.
Since substantially all Toy Story revenue has been recognized, all related
capitalized film costs were amortized in 1996 and 1997.
Pixar had $60.8 million in capitalized film production costs as of January
2, 1999, consisting of costs relating 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. See Notes 1 and 4 of Notes to Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash and short-term investments decreased from $176.0 million at December
31, 1997 to $149.0 million at January 2, 1999 due primarily to cash used for
film production and construction of the Emeryville studio discussed below.
Pixar's cash provided by operating activities in 1996 primarily consisted
of net income resulting from film revenue related to Toy Story and from the cash
portion of patent licensing revenue totaling $6.0 million. In 1997, Pixar's cash
provided by operating activities largely consisted of net income of $22.2
million primarily resulting from film revenue related to Toy Story as well as
growth in accounts payable and accrued liabilities and a tax benefit from stock
option exercises. In 1998, Pixar's cash provided by operating activities largely
consisted of net income of $7.8 million primarily resulting from film revenue
related to Toy Story. In 1996, Pixar's cash used in investing activities
primarily consisted of investments in short-term securities. In 1997 and 1998,
Pixar's cash used in investing activities primarily consisted of investments in
short-term securities, capitalized film production costs and purchase of
property and equipment, as described below, offset by net proceeds from
maturities of short-term investments. In 1996, Pixar's cash used in financing
activities was primarily for the repayment of the note payable to the majority
shareholder. In 1997, Pixar's cash flows
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<PAGE> 13
provided by financing activities primarily consisted of the net proceeds of
approximately $14.9 million from sale of stock to Disney in conjunction with the
signing of the Co-Production Agreement. See Note 4 and Note 6 of Notes to
Financial Statements. In 1998, cash provided by financing activities primarily
consisted of proceeds from exercised stock options.
At January 2, 1999, Pixar's capital commitments primarily consisted of
obligations to fund production costs of films and derivative products under the
Co-Production Agreement and costs related to a new studio facility, both
discussed below. Pixar also has obligations to pay portions of any revenue
derived from each feature film produced under the Co-Production Agreement to its
entertainment law firm in consideration for services rendered and obligations
under operating leases. See Note 9 of Notes to Financial Statements. Pixar
expects 1999 cash expenditures for capital equipment to be approximately $6.0
million, excluding costs related to the new studio facility discussed below.
Film Production Costs Under Co-Production Agreement. In 1999, Pixar's
expects to spend approximately $40.0 million, net of Disney's film cost
reimbursements, on direct film costs and other costs to fund its ongoing film
projects under the Co-Production Agreement, which will directly impact working
capital.
New Studio Facility. As of January 2, 1999, Pixar had incurred capital
expenditures of approximately $21.2 million to purchase and begin construction
of approximately 15 acres of land in Emeryville, California to build a new
headquarters and studio facility. To construct the facility, Pixar currently
expects to incur capital expenditures of approximately $38.0 million in 1999 and
$19.0 million in 2000. In addition, Pixar expects to spend approximately $6.5
million total over the years 1999 and 2000 on related furniture, fixtures and
equipment for the new facility. Due to changes in construction, design and/or
other specifications, which may or may not be at the discretion of management
and are often difficult to predict, Pixar cannot provide any assurances that
construction of the new studio facility can be completed within these specified
amounts. To date, Pixar has chosen to use its existing cash resources to fund
construction costs. Pixar may continue to use its cash resources for such
expenditures, or may choose to finance such capital expenditures through
issuance of additional equity or debt securities, by obtaining a credit facility
or by some other financing mechanism.
As of January 2, 1999, Pixar's principal source of liquidity was
approximately $149.0 million in cash and short-term investments. Pursuant to the
Co-Production Agreement, Pixar will co-finance the next four original animated
feature films, which it produces, including 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 theatrical sequels,
direct to home video sequels, interactive products and television productions.
As Pixar may not generate substantial, if any, cash from operations in the first
half of 1999, the production costs of Toy Story 2 and Film Four are expected to
have a material adverse impact on Pixar's cash and short-term investment
balances. Pixar believes that available funds will be sufficient to meet its
anticipated cash needs for working capital and capital expenditures, including
the production costs of Toy Story 2 and Film Four, until Pixar begins receiving
cash from the release of A Bug's Life and these films. 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. 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.
THE YEAR 2000
The Year 2000 problem is the result of computer programming 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.
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<PAGE> 14
Pixar has formed a committee to address Year 2000 issues and the committee
is currently reviewing Pixar's products, Pixar's internal computer systems and
the systems of third parties on which Pixar relies for handling the Year 2000.
This committee is composed of senior management and personnel from the systems
department and the finance and administration staff. The committee's strategy
for identifying and addressing Year 2000 issues involves five phases:
Phase 1 -- Inventory: Prepare an inventory of software, hardware, third
party services and building systems used by Pixar and determine Year 2000
compliance. For third party software, hardware and services, vendors are
contacted and written certification is obtained to verify that such items
are Year 2000 compliant. To date, most items in the inventory are either
Year 2000 compliant or will be with minor modifications and most of the
Year 2000 issues identified by Pixar relate to the financial software that
Pixar uses. This phase is approximately 95% complete and is anticipated to
be complete by April 1999.
Phase 2 -- Assessment: Determine which of the inventory items identified in
Phase 1 are critical or important as they relate to Pixar's business. For
third party software, hardware and services which are deemed to be critical
or important, Pixar is reviewing the written certification provided by
vendors and performing internal testing where possible. To date, Pixar has
identified a few third party systems which are not Year 2000 compliant.
This phase is approximately 95% complete, and completion is anticipated
shortly after completion of Phase 1 in April 1999.
Phase 3 -- Strategy: Prepare strategies to modify or replace systems that
are not Year 2000 compliant. To date, the few items in the inventory that
have been identified as not being Year 2000 compliant are software items
that can be made compliant by upgrading to the most recent versions of the
software. This phase also includes monitoring the Year 2000 compliance
programs of third parties whose services have been deemed to be critical to
Pixar's business. This phase is approximately 50% complete, and is
anticipated to be complete in July 1999.
Phase 4 -- Remediation: Initiate remediation strategies. Pixar is planning
to upgrade certain of its systems to the most recent versions of the
software and most required fixes are underway. This phase is approximately
50% complete, and is anticipated to be complete in November 1999.
Phase 5 -- Testing: Test and certify all critical and certain important
systems where appropriate. Testing schedules have been set for Pixar's
financial systems and studio tools. This phase is approximately 25%
complete, and is anticipated to be complete in November 1999.
Based on information available to date, Pixar believes that it will be able
to complete it's Year 2000 compliance review and make any necessary
modifications to its internal systems prior to the end of 1999. Pixar expects
that the total costs associated with resolving its Year 2000 issues will not be
material and does not expect such costs to exceed $500,000. The majority of
these costs will result from purchasing an updated version of the financial
software that Pixar uses.
Pixar's most significant Year 2000 risk results from Pixar's relationship
with Disney, a public company. Pixar relies on Disney for the distribution and
marketing of its films and Toy Story 2 is expected to be released at the end of
1999. The disruption of Disney's distribution activities as a result of Year
2000 problems could result in lost revenues for Toy Story 2 and related
merchandise. In addition, if the accounting and financial systems of Disney are
adversely affected by Year 2000 issues and Disney is unable to issue revenue
reports to Pixar, Pixar's recognition of its share of the revenue generated
pursuant to the Co-Production Agreement and the Feature Film Agreement could be
delayed. There can be no assurance that the failure of any third parties to have
systems that are Year 2000 compliant would not have a material adverse effect on
Pixar's financial position or results of operations.
RECENT PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 133 in June 1988, Accounting for Derivatives
and Hedging Activities, effective for fiscal years beginning after June 15,
1999. The standard requires that an entity recognizes all derivatives as either
assets or
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<PAGE> 15
liabilities in the balance sheet and measures those instruments at fair value.
Pixar believes the adoption of SFAS No. 133 will not have a material effect on
the consolidated results of operations, financial position or cash flows.
In March 1998, the American Institute of Certified Public Accountants
issued SOP 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. SOP 98-1 requires that certain costs related to the
development or purchase of internal-use software be capitalized and amortized
over the estimated useful life of the software, SOP 98-1 is effective for
financial statements issued for fiscal years beginning after December 15, 1998.
The Company does not expect the adoption of SOP 98-1 will have a material impact
on its results of operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pixar invests in a variety of investment grade, interest-bearing
securities, including fixed rate obligations of corporations, municipalities,
and national governmental entities and agencies. This diversification of risk is
consistent with Pixar's policy to ensure safety of its principal and maintain
liquidity. Pixar only invests in securities with a maturity of 24 months or
less, with only government obligations exceeding 12 months. Pixar's investments
are fixed rate obligations and carry a certain degree of interest rate risk. A
rise in interest rates could adversely impact the fair market value of these
securities.
All of Pixar's financial instruments are held for purposes other than
trading and are considered "available for sale" per SFAS 115. The table below
provides information regarding Pixar's investment portfolio at January 2, 1999.
The table presents principal cash flows and related weighted average fixed
interest rates presented by expected maturity date (dollars in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR
-------------------------------
1999 2000 TOTAL
-------- ------- --------
<S> <C> <C> <C>
Available-for-sale securities............... $119,190 $21,758 $140,948
Weighted-average interest rate.............. 5.48% 6.34% 5.61%
</TABLE>
Pixar has no debt or foreign operations, therefore Pixar has no further
market rate risk or foreign currency rate fluctuation risk.
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INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Pixar:
We have audited the accompanying balance sheets of Pixar as of December 31,
1997 and January 2, 1999 and the related statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period ended
January 2, 1999. These financial statements are the responsibility of Pixar's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Pixar as of December 31,
1997 and January 2, 1999, and the results of its operation and its cash flows
for each of the years in the three-year period ended January 2, 1999, in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
KMPG LLP
San Francisco, California
January 29, 1999
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<PAGE> 17
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, JANUARY 2,
1997 1999
------------ ----------
<S> <C> <C>
Cash and cash equivalents................................... $101,847 $ 29,557
Short-term investments...................................... 74,198 119,491
Trade accounts receivable, net of allowance for returns and
doubtful accounts of $257 and $229 in 1997 and 1998,
respectively.............................................. 1,321 595
Other receivables........................................... 2,667 3,290
Prepaid expenses and other assets........................... 984 5,872
Property and equipment, net................................. 21,462 31,160
Capitalized film production costs........................... 28,589 60,841
-------- --------
Total assets...................................... $231,068 $250,806
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable............................................ $ 1,694 $ 2,615
Income taxes payable........................................ 1,776 97
Payable to Disney........................................... 2,162 3,363
Accrued liabilities......................................... 7,276 8,396
Unearned revenue............................................ 860 1,188
-------- --------
Total liabilities................................. 13,768 15,659
-------- --------
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;
42,410,707 and 45,335,770 shares issued and outstanding as
of December 31, 1997 and January 2, 1999, respectively.... 210,902 220,397
Accumulated other comprehensive income...................... 29 249
Deferred compensation....................................... (414) (104)
Retained earnings........................................... 6,783 14,605
-------- --------
Total shareholders' equity........................ 217,300 235,147
-------- --------
Total liabilities and shareholders' equity........ $231,068 $250,806
======== ========
</TABLE>
See accompanying notes to financial statements.
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PIXAR
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED
------------------------------------------
DECEMBER 31, DECEMBER 31, JANUARY 2,
1996 1997 1999
------------ ------------ ----------
<S> <C> <C> <C>
Revenue:
Software.............................................. $ 3,297 $ 4,499 $ 3,798
Animation services.................................... 3,947 1,556 630
Film.................................................. 18,847 26,914 9,759
Patent licensing...................................... 9,127 1,730 120
------- ------- -------
Total revenue................................. 35,218 34,699 14,307
------- ------- -------
Cost of revenue:
Software.............................................. 113 81 723
Animation services.................................... 3,041 973 141
Film.................................................. 1,551 1,484 --
------- ------- -------
Total cost of revenue......................... 4,705 2,538 864
------- ------- -------
Gross profit.................................. 30,513 32,161 13,443
------- ------- -------
Operating expenses:
Research and development.............................. 4,501 4,712 3,862
Sales and marketing................................... 1,471 1,450 1,301
General and administrative............................ 4,249 5,129 6,956
Operating expense reimbursement....................... -- (2,184) --
------- ------- -------
Total operating expenses...................... 10,221 9,107 12,119
------- ------- -------
Income from continuing operations............. 20,292 23,054 1,324
Other income, net....................................... 8,033 8,766 8,777
------- ------- -------
Income from continuing operations before
taxes....................................... 28,325 31,820 10,101
Income tax expense...................................... 1,983 9,864 2,637
------- ------- -------
Net income from continuing operations......... 26,342 21,956 7,464
Income (loss) from discontinued operations (includes
income tax benefit of $77 in 1996 and income tax
expense of $105 and $127 in 1997 and 1998,
respectively)......................................... (1,023) 234 358
------- ------- -------
Net income.................................... $25,319 $22,190 $ 7,822
======= ======= =======
Basic net income per share from continuing operations... $ 0.68 $ 0.53 $ 0.17
Basic net income (loss) per share from discontinued
operations............................................ (0.02) 0.01 0.01
------- ------- -------
Basic net income per share.............................. $ 0.66 $ 0.54 $ 0.18
======= ======= =======
Shares used in computing basic net income (loss) per
share................................................. 38,632 41,224 44,185
======= ======= =======
Diluted net income per share from continuing
operations............................................ $ 0.56 $ 0.46 $ 0.14
Diluted net income (loss) per share from discontinued
operations............................................ (0.02) 0.00 0.01
------- ------- -------
Diluted net income per share............................ $ 0.54 $ 0.46 $ 0.15
======= ======= =======
Shares used in computing diluted net income (loss) per
share................................................. 46,989 48,144 51,338
======= ======= =======
</TABLE>
See accompanying notes to financial statements.
F-18
<PAGE> 19
PIXAR
STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED RETAINED
COMMON STOCK OTHER EARNINGS TOTAL
----------------- COMPREHENSIVE DEFERRED (ACCUMULATED SHAREHOLDERS' COMPREHENSIVE
SHARES AMOUNT INCOME COMPENSATION DEFICIT) EQUITY INCOME
------ -------- ------------- ------------ ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1995..... 38,286 $185,845 $ 49 $(2,261) $(40,726) $142,907
Exercise of stock options,
including tax benefit......... 1,127 1,463 -- -- -- 1,463
Amortization of deferred
compensation.................. -- -- -- 1,212 -- 1,212
Other comprehensive income:
Holding loss on securities
arising during the period... -- -- (163) -- -- (163)
Less: reclassification
adjustment for gains
included in income.......... -- -- 71 -- -- 71
Tax expense................. -- -- (5) -- -- (5)
------ -------- ----- ------- -------- --------
Unrealized loss on
investments................... -- -- (97) -- -- (97) $ (97)
Net income...................... -- -- -- -- 25,319 25,319 25,319
------ -------- ----- ------- -------- -------- -------
Balances, December 31, 1996..... 39,413 187,308 (48) (1,049) (15,407) 170,804 $25,222
=======
Exercise of stock options,
including tax benefit......... 1,998 8,709 -- -- -- 8,709
Issuance of common stock and
warrants, net of expenses of
$115.......................... 1,000 14,885 -- -- -- 14,885
Amortization of deferred
compensation.................. -- -- -- 635 -- 635
Other comprehensive income:
Holding gains on securities
arising during the period... -- -- 236 -- -- 236
Less: reclassification
adjustment for gains
included in income.......... -- -- (230) -- -- (230)
Tax expense................. -- -- 71 -- -- 71
------ -------- ----- ------- -------- --------
Unrealized gain on
investments................... -- -- 77 -- -- 77 $ 77
Net income...................... -- -- -- -- 22,190 22,190 22,190
------ -------- ----- ------- -------- -------- -------
Balances, December 31, 1997..... 42,411 210,902 29 (414) 6,783 217,300 $22,267
=======
Exercise of stock options,
including tax benefit......... 2,865 6,895 -- -- -- -- 6,895
Amortization of deferred
compensation.................. -- -- -- 310 -- 310
Acquisition of PEI.............. 60 2,600 -- -- -- 2,600
Other comprehensive income:
Holding gains on securities
arising during the period... -- -- 222 -- -- 222
Less: reclassification
adjustment for gains
included in income.......... -- -- (3) -- -- (3)
Tax expense................. -- -- 1 -- -- 1
------ -------- ----- ------- -------- --------
Unrealized gain on
investments................... -- -- 220 -- -- 220 $ 220
Net income...................... -- -- -- -- 7,822 7,822 7,822
------ -------- ----- ------- -------- -------- -------
Balances, January 2, 1999....... 45,336 $220,397 $ 249 $ (104) $ 14,605 $235,147 $ 8,042
====== ======== ===== ======= ======== ======== =======
</TABLE>
See accompanying notes to financial statements.
F-19
<PAGE> 20
PIXAR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED
------------------------------------------
DECEMBER 31, DECEMBER 31, JANUARY 2,
1996 1997 1999
------------ ------------ ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 25,319 $ 22,190 $ 7,822
Adjustments to reconcile net income to net cash provided
by operating activities:
Discontinued operations................................. 1,023 (234) (358)
Amortization of deferred compensation, net of
capitalization........................................ 1,168 611 310
Amortization of purchased technology.................... -- -- 630
Non-cash revenue attributable to film overbudget........ (2,324) -- --
Depreciation and amortization........................... 732 3,182 5,826
Amortization of capitalized film production costs....... 1,551 1,484 --
Tax benefit from option exercises....................... 1,236 7,688 3,636
Licenses exchanged for equipment........................ (1,465) (1,594) (114)
Loss on disposition of property and equipment........... -- 718 311
Deferred income taxes................................... -- -- (988)
Changes in operating assets and liabilities:
Trade accounts receivable............................. (144) (392) 726
Other receivables..................................... (1,614) 732 (623)
Prepaid expenses and other assets..................... (1,764) 143 (1,491)
Accounts payable...................................... 318 634 921
Other liabilities..................................... 1,539 4,698 2,221
Income taxes payable.................................. -- 1,776 (1,679)
Unearned revenue...................................... 68 584 103
--------- --------- ---------
Net cash provided by continuing operations......... 25,643 42,220 17,253
Net cash provided by (used in) discontinued
operations....................................... (2,508) 1,701 358
--------- --------- ---------
Net cash provided by operating activities.......... 23,135 43,921 17,611
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment........................ (2,371) (17,761) (16,576)
Proceeds from sale of property and equipment.............. -- 31 741
Proceeds from sale of short-term securities............... 175,360 169,210 150,381
Investments in short-term securities...................... (244,776) (127,010) (195,454)
Capitalized film production costs......................... (1,840) (27,098) (32,252)
--------- --------- ---------
Net cash used in investing activities.............. (73,627) (2,628) (93,160)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of common stock and warrants... -- 14,885 --
Proceeds from exercised stock options..................... 227 1,021 3,259
Repayment of note payable to shareholder.................. (2,373) -- --
--------- --------- ---------
Net cash provided by (used in) financing
activities....................................... (2,146) 15,906 3,259
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents........ (52,638) 57,199 (72,290)
Cash and cash equivalents at beginning of period............ 97,286 44,648 101,847
--------- --------- ---------
Cash and cash equivalents at end of period.................. $ 44,648 $ 101,847 $ 29,557
========= ========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes....... $ 523 $ 390 $ 1,796
========= ========= =========
Supplemental disclosure of non-cash investing and
financing activities:
Credits used to purchase equipment................. $ 3,127 $ 1,730 $ 120
========= ========= =========
Film overbudget reductions......................... $ 3,324 $ -- $ --
========= ========= =========
Value of common stock and liabilities assumed for
purchase of PEI.................................. $ -- $ -- $ 3,000
========= ========= =========
Non-cash film production costs capitalized......... $ 44 $ 24 $ --
========= ========= =========
Unrealized gain (loss) on investments.............. $ (97) $ 77 $ 220
========= ========= =========
</TABLE>
See accompanying notes to financial statements.
F-20
<PAGE> 21
PIXAR
NOTES TO FINANCIAL STATEMENTS
(1) SUMMARY OF PIXAR AND SIGNIFICANT ACCOUNTING POLICIES
The Company
Pixar was incorporated in the state of California on December 9, 1985.
Pixar is a digital animation studio with the technical, creative and production
capabilities to create a new generation of animated feature films and related
products.
Cash and Cash Equivalents
Pixar considers all highly liquid instruments with an original maturity of
90 days or less to be cash equivalents. Cash equivalents as of January 2, 1999
consisted primarily of U.S. Treasury Bills, demand notes, commercial paper and
government agency bonds.
Short-Term Investments
Pixar has classified its investments as "available-for-sale." Such
investments are recorded at fair value, and unrealized gains and losses, if
material, are reported as a separate component of equity until realized.
Interest income is recorded using an effective interest rate with the associated
premium or discount amortized to interest income. The cost of securities sold is
based upon the specific identification method.
Property and Equipment
Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over estimated useful
lives ranging from three to seven years. Leasehold improvements are amortized
over the lesser of the related lease term or the life of the improvement. Pixar
evaluates these assets for impairment whenever changes in circumstances indicate
that the carrying amount of the asset may not be recoverable. Impaired assets
and assets to be disposed of are reported at the lower of carrying values or
fair values, less costs of disposal.
Film Production Costs
Film production costs include costs to develop and produce computer
animated motion pictures, mainly salaries, equipment and overhead. Film
production costs in excess of reimbursable amounts are capitalized. Once a film
is released, any film production costs capitalized will be amortized in the
proportion that the revenue during the year for each film bears to the estimated
revenue to be received from all sources under the individual film forecast
method. Estimates of anticipated total gross revenues will be reviewed
periodically and revised when necessary. Unamortized film production costs will
be compared with net realizable value each reporting period on a film-by-film
basis. If estimated gross revenues are not sufficient to recover the unamortized
film production costs, the unamortized film production costs will be written
down to net realizable value.
Research and Development Costs
Research and development costs are charged to operations as incurred. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed, development costs related to software products are expensed as
incurred until the technological feasibility of the product has been
established. After technological feasibility is established, additional costs
would be capitalized. To date, Pixar has not capitalized any software
development costs after technological feasibility has been established on its
software products since Pixar believes its process for developing software is
essentially completed concurrently with the establishment of technological
feasibility and costs incurred thereafter have not been material.
F-21
<PAGE> 22
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Revenue Recognition
Revenue from the distribution of animated feature films and related
products is recognized as earned and reasonably estimable. The related revenue
cycle is generally five to seven years, with the substantial majority expected
to be recognized in the first two years. In accordance with SOP 97-2, software
licensing revenue is recognized upon shipment. Animation services revenue is
recognized on the percentage-of-completion method of accounting. Patent
licensing revenue is recognized upon release of the rights to the technology.
Financial Instruments and Concentration of Credit Risk
The carrying value of financial instruments, including marketable
securities and accounts receivable, approximate fair value. Financial
instruments that potentially subject Pixar to concentrations of credit risk
consist primarily of cash equivalents, short-term investments and trade accounts
receivable. Pixar invests its excess cash in a variety of investment grade,
interest-bearing securities with major banks. This diversification of risk is
consistent with Pixar's policy to ensure safety of principal and maintain
liquidity.
Excluding its software business, Pixar's revenue is concentrated in a few
large customers, as outlined in Note 10. Pixar maintains reserves for potential
credit losses and such losses have been within management's expectations.
Fiscal Year
Effective for the fiscal year 1998, Pixar adopted a 52 or 53-week fiscal
year, changing the year end date from December 31 to the Saturday nearest
December 31. As a result, the first three quarters of 1998 represented
thirteen-week periods and the fourth quarter represented a fourteen-week period.
The fiscal year ended January 2, 1999 had 53 weeks.
Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Income Taxes
Pixar utilizes SFAS No. 109, Accounting for Income Taxes, which requires
the use of the asset and liability method of accounting for income taxes.
Net Income per Share
In accordance with SFAS No. 128, Earnings per Share, basic net income per
share is computed using the weighted-average number of common shares outstanding
during the period. Diluted net income per share is computed using the weighted
average number of common and dilutive common equivalent shares outstanding
during the period and using the treasury stock method for options and warrants
(see Note 11).
Segment Reporting
During the fourth quarter of 1998, Pixar adopted SFAS 131, Disclosures
about Segments of an Enterprise and Related Information. SFAS 131 establishes
annual and interim reporting standards for operating segments of a company (see
Note 10).
F-22
<PAGE> 23
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Comprehensive Income
On January 1, 1998, Pixar adopted SFAS 130, Reporting Comprehensive Income,
which requires classification of other comprehensive income by nature in a
financial statement and a breakout of the accumulated balance of other
comprehensive income separately in the equity section of the balance sheet.
Reclassifications
Certain amounts reported in previous years have been reclassified to
conform to the 1998 financial statement presentation.
Stock Option Plans
Pixar uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans.
(2) SHORT-TERM INVESTMENTS
All investments were considered available-for-sale securities and consisted
of the following (in thousands):
<TABLE>
<CAPTION>
UNREALIZED ESTIMATED
COST GAINS (LOSSES) FAIR VALUE
-------- -------------- ----------
<S> <C> <C> <C>
DECEMBER 31, 1997:
U. S. Treasury Bills............................ $ 41,993 $ 27 $ 42,020
Demand notes.................................... 77,817 -- 77,817
Commercial paper................................ 16,474 -- 16,474
Federal agency obligations...................... 32,175 2 32,177
Time deposits................................... 5,000 -- 5,000
-------- ---- --------
$173,459 $ 29 $173,488
======== ==== ========
JANUARY 2, 1999:
U. S. Treasury Bills............................ $ 9,233 $ 45 $ 9,278
U. S. Treasury Notes............................ 59,917 122 60,039
Demand notes.................................... 2,585 -- 2,585
Commercial paper................................ 28,385 (1) 28,384
Federal agency obligations...................... 40,579 83 40,662
-------- ---- --------
$140,699 $249 $140,948
======== ==== ========
</TABLE>
The contractual maturities of available-for-sale debt securities as of
January 2, 1999 regardless of their balance sheet classification, are as follows
(in thousands):
<TABLE>
<CAPTION>
ESTIMATED
COST FAIR VALUE
-------- ----------
<S> <C> <C>
Due within one year.................................... $119,005 $119,190
Due after one year through two years................... 21,694 21,758
-------- --------
$140,699 $140,948
======== ========
</TABLE>
F-23
<PAGE> 24
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(3) BALANCE SHEET COMPONENTS
Selected balance sheet components are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, JANUARY 2,
1997 1999
------------ ----------
<S> <C> <C>
Property and equipment:
Land............................................... $ 7,355 $ 7,355
Equipment.......................................... 14,751 14,890
Leasehold improvements............................. 2,867 3,108
Construction in process............................ 1,885 15,070
------- -------
26,858 40,423
Less accumulated depreciation and amortization....... 5,396 9,263
------- -------
$21,462 $31,160
======= =======
Accrued liabilities:
Employee-related expenses.......................... $ 4,213 $ 3,720
Professional services.............................. 1,375 1,431
Facilities construction in process................. -- 2,232
Other.............................................. 1,688 1,013
------- -------
$ 7,276 $ 8,396
======= =======
</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 Walt Disney Pictures and Television
(together with its subsidiaries and affiliates collectively referred to herein
as "Disney"), to develop and produce up to three computer animated feature films
(the "Feature Film Agreement"). Pixar is entitled to receive compensation based
on 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. Based on the individual film forecast method, all
significant Toy Story film production costs were fully amortized by the year
ended December 31, 1997.
Co-Production Agreement
In February 1997, Pixar and Disney entered into a new co-production
agreement (the "Co-Production Agreement") which now governs all films made by
Pixar since Toy Story. Pixar's recently released film, A Bug's Life, was the
first film produced under this agreement. Films in development or production at
Pixar as of January 2, 1999, Toy Story 2 and Pixar's fourth film ("Film Four"),
are also governed by this agreement. 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 toward the 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 co-own, co-brand and co-finance the
production costs of the Pictures, and share equally in the profits of each
Picture and any related merchandise and other ancillary products, after recovery
of all of Disney's marketing, distribution and other predefined fees and costs.
The Co-Production Agreement generally provides that Pixar will produce each
Picture and Disney will control decisions relating to film marketing and
distribution.
F-24
<PAGE> 25
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The total film production costs and related amounts capitalized are as
follows (in thousands):
<TABLE>
<CAPTION>
1996 AND TOTAL THROUGH
PRIOR 1997 1998 1998
-------- ------- ------- -------------
<S> <C> <C> <C> <C>
RELEASED FILMS:
Pixar production costs................... $ -- $19,429 $16,819 $ 36,248
Disney production funding and
reimbursement (unaudited).............. 44,324 2,827 16,819 63,970
------- ------- ------- --------
Total film production costs
(unaudited)....................... $44,324 $22,256 $33,638 100,218
======= ======= =======
Disney reimbursements of production costs
(unaudited)............................ (61,646)
Amortization of deferred compensation.... 360
Participation fees....................... 600
Amortization of film production costs.... (3,035)
--------
Total film production costs
capitalized for released films.... 36,497
--------
FILMS IN PROCESS:
Pixar production costs................... $ -- $ 8,909 $15,435 24,344
Disney production funding and
reimbursement (unaudited).............. 3,986 4,923 15,435 24,344
------- ------- ------- --------
Total film production costs
(unaudited)....................... $ 3,986 $13,832 $30,870 48,688
======= ======= =======
Disney reimbursements of production costs
(unaudited)............................ (24,344)
--------
Total film production costs
capitalized for films in
process........................... 24,344
--------
Total film production costs
capitalized....................... $ 60,841
========
</TABLE>
Under the Co-Production Agreement, certain operating expenses benefiting
the productions, such as certain research and development and certain general
and administrative expenses, are paid half by Pixar and half by Disney. From the
date of the Co-Production Agreement, Pixar recorded the following amounts
reimbursed by Disney as offsets to the following expense categories (in
thousands):
<TABLE>
<CAPTION>
FEBRUARY 24 TO FISCAL YEAR
DECEMBER 31, 1997 1998
----------------- -----------
<S> <C> <C>
Research and development......................... $2,012 $2,818
General and administrative....................... 1,277 2,199
------ ------
Total.................................. $3,289 $5,017
====== ======
</TABLE>
Since the Co-Production Agreement began with A Bug's Life and Toy Story 2,
both in various stages of production in 1996 and 1997, Pixar was entitled to
reimbursement for Disney's share of certain of Pixar's operating expenses
incurred in 1996 and the first two months of 1997, prior to signing the
Co-Production Agreement. The determination of this $2,184,000 one-time operating
expense reimbursement was finalized in the quarter ended September 30, 1997. The
amount recorded represented reimbursements of the following expense categories
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED JANUARY 1 TO
DECEMBER 31, 1996 FEBRUARY 24, 1997 TOTAL
----------------- ----------------- ------
<S> <C> <C> <C>
Research and development........... $ 936 $179 $1,115
General and administrative......... 620 449 1,069
------ ---- ------
$1,556 $628 $2,184
====== ==== ======
</TABLE>
F-25
<PAGE> 26
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1997 and January 2, 1999 the Disney payable of $2,162,000
and $3,363,000, respectively, consisted of advances in excess of Disney's actual
share of expenditures for all films.
(5) PATENT LICENSING ARRANGEMENTS
For the year ended December 31, 1996, fees of $9,127,000 were recognized on
the licensing of certain patents. Pixar delivered all rights to utilize the
technology underlying the license to the licensee, and received a non-refundable
fixed-fee payment of $6,000,000 in cash and $5,000,000 of credits for products
to be purchased from the licensee by Pixar over the next four years. Following
the release of the rights to utilize the patents to the licensee, Pixar
maintained no significant vendor obligations to the licensee, so Pixar
recognized as revenue the fixed and determinable amounts of the $6,000,000 cash
payment received, plus $3,127,000 that represented the portion of the credits
Pixar used during the year ended December 31, 1996. Patent licensing revenue of
$1,730,000 recognized in 1997 represents additional credits used. Of the
remaining credits, $120,000 were utilized in 1998.
(6) RELATED PARTY TRANSACTIONS
In conjunction with signing the Co-Production Agreement, Disney purchased
for cash 1,000,000 shares of Pixar common stock, which Disney has agreed to hold
for at least three years, and two warrants each exercisable for five years: one
warrant to purchase 750,000 shares of common stock at an exercise price of
$20.00 per share and another warrant to purchase 750,000 shares of common stock
at an exercise price of $25.00 per share. Pixar granted certain registration
rights for the shares issuable upon exercise of the warrants. Upon consummation
of this agreement in March 1997, Pixar received net proceeds of $14,885,000.
(7) INCOME TAXES
The components of income taxes from continuing operations are as follows
(in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR
--------------------------
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
Income taxes:
Current:
Federal..................................... $ 340 $ 944 $ --
State....................................... 136 1,288 2
Foreign..................................... -- 26 79
------ ------ ------
Total current taxes.................... 476 2,258 81
------ ------ ------
Deferred:
Federal..................................... -- -- (786)
State....................................... -- -- (202)
------ ------ ------
Total deferred taxes................... -- -- (988)
------ ------ ------
Charge in lieu of taxes attributable to
employer stock option plans................. 1,507 7,606 3,544
------ ------ ------
Total tax provision.................... $1,983 $9,864 $2,637
====== ====== ======
</TABLE>
F-26
<PAGE> 27
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The following tabulation reconciles the statutory corporate federal income
tax expense (benefit) (computed by multiplying Pixar's income from continuing
operations before income taxes by 34% for the year ended December 31, 1996 and
35% for the years ended December 31, 1997 and January 2, 1999) to Pixar's income
tax expense (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR
-----------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Expected income tax expense................... $ 9,631 $11,137 $ 3,535
State income taxes, net of federal tax
effect...................................... 882 1,742 421
Change in beginning of year valuation
allowance................................... (9,179) (3,370) (1,688)
Alternative minimum tax....................... 611 -- --
Other, net.................................... 38 355 369
------- ------- -------
Income taxes.................................. $ 1,983 $ 9,864 $ 2,637
======= ======= =======
</TABLE>
The tax effects of temporary differences attributable to continuing
operations that give rise to significant portions of the deferred tax assets are
presented below (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR
--------------------
1997 1998
-------- --------
<S> <C> <C>
Deferred tax assets:
Deferred compensation................................ $ 733 $ 607
Capitalized film costs............................... 5,981 21,879
Capitalized research expenses........................ 134 69
Credit carryforwards................................. 1,490 2,466
Net operating loss carryforwards..................... 1,207 10,698
Reserves and accruals................................ 1,536 1,289
-------- --------
Total gross deferred tax assets.............. 11,081 37,008
Valuation allowance.................................... (11,081) (36,020)
-------- --------
Net deferred tax assets...................... $ -- $ 988
======== ========
</TABLE>
Pixar has a valuation allowance as of January 2, 1999 which partially
offsets its gross deferred tax assets due to the fact that there is no guarantee
Pixar will generate sufficient taxable income in the future to be able to
realize all of the deferred tax assets. The increase in the valuation allowance
for the year ended January 2, 1999 was $24,939,000.
Included in the deferred tax assets above is approximately $34,000,000
related to stock option compensation for which the benefit when realized will be
an adjustment to equity. As of January 2, 1999, Pixar had federal and state net
operating loss carryforwards of approximately $28,500,000 and $12,200,000,
respectively. The net operating loss carryforwards, if not utilized, will expire
in various years from 2003 through 2018. As of January 2, 1999, Pixar also has
federal and state research credit carryforwards of approximately $1,300,000 and
$260,000 (net of federal tax impact), respectively. The federal research credits
expire from 2004 to 2018. There is no expiration provision for the California
research credits carryforwards. In addition, Pixar has foreign tax credit and
alternative minimum tax credit carryforwards for federal income tax purposes of
approximately $105,000 and $784,000, respectively.
(8) SHAREHOLDERS' EQUITY
Deferred Compensation
Pixar recorded deferred compensation for the difference between the grant
price and the deemed fair value of the common stock underlying certain options
granted in 1995. This amount is being amortized over the vesting period of the
individual options, generally four years. Amortization of deferred compensation
was approximately $1,212,000, $635,000 and $310,000 for the years ended December
31, 1996, December 31,
F-27
<PAGE> 28
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1997 and January 2, 1999, respectively. Of these amounts $44,000, and $24,000
were capitalized as film production costs in 1996 and 1997, respectively. The
remaining amounts of $1,168,000 and $611,000 were expensed in 1996 and 1997,
respectively. In 1998, the entire amount of $310,000 was charged to expense.
Stock Option Plans
Pixar has stock option plans for employees, consultants and non-employee
directors which provide incentive and nonstatutory stock options. The option
exercise price for incentive stock options is not less than the fair market
value at the grant date. Nonstatutory options are granted at prices and terms
determined by the Board of Directors, or a committee of the Board of Directors.
Employee and consultant options generally vest 25% per year over four years.
Initial grants to non-employee directors vest one-third annually for three
years; subsequent grants vest after one year. All options have a term not
greater than 10 years from the date of grant. As of January 2, 1999, Pixar had
1,500,073 shares reserved for issuance under the plans.
A summary of activity under the option plans during 1996, 1997 and 1998 are
as follows:
<TABLE>
<CAPTION>
WEIGHTED-AVERAGE
SHARES EXERCISE PRICE
---------- ----------------
<S> <C> <C>
Outstanding at January 1, 1996.................. 9,140,900 $1.00
Granted....................................... 1,297,000 15.18
Exercised..................................... (1,126,602) 0.20
Forfeited..................................... (447,458) 15.79
----------
Outstanding at December 31, 1996................ 8,863,840 2.41
Granted....................................... 1,671,700 15.52
Exercised..................................... (1,997,605) 0.52
Forfeited..................................... (163,317) 12.53
----------
Outstanding at December 31, 1997................ 8,374,618 5.28
Granted....................................... 3,235,922 26.08
Exercised..................................... (2,864,595) 1.14
Forfeited..................................... (288,926) 13.11
----------
Outstanding at January 2, 1999.................. 8,457,019 14.38
========== =====
</TABLE>
For various price ranges, weighted-average characteristics of outstanding
stock options at January 2, 1999 were as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS VESTED
------------------------------------------- ----------------------------
REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE
EXERCISE PRICES SHARES LIFE (YEARS) EXERCISE PRICE SHARES EXERCISE PRICE
- --------------- --------- ------------ ---------------- --------- ----------------
<S> <C> <C> <C> <C> <C>
$0.20 2,314,476 6.35 $0.20 1,835,964 $0.20
$1.25 to $9.60 774,994 6.79 7.48 647,282 7.37
$10.80 to $15.00 1,522,972 7.99 13.33 570,426 13.04
$15.13 to $19.00 466,084 8.13 16.22 141,498 16.44
$19.13 to $25.88 2,254,373 8.99 21.43 68,864 21.50
$27.75 to $39.13 948,320 9.55 32.73 125 34.44
$41.00 to $61.50 175,800 9.45 46.07 -- --
--------- ---------
8,457,019 7.91 14.38 3,264,159 5.02
========= =========
</TABLE>
F-28
<PAGE> 29
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Pixar uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans. Had compensation cost for Pixar's stock
option plans been determined consistent with SFAS No. 123, Pixar's net income
and net income per share would have been reduced to the pro forma amounts
indicated below (in thousands, except per share data):
<TABLE>
<CAPTION>
FISCAL YEAR
-----------------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Pro forma net income (loss)................... $24,017 $18,710 $(2,635)
Pro forma basic net income (loss) per share... $ 0.62 $ 0.45 $ (0.06)
Pro forma diluted net income (loss) per
share....................................... $ 0.51 $ 0.39 $ (0.05)
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model. The weighted-average fair value of
options granted was $6.51, $6.27 and $11.75 for fiscal years 1996, 1997 and
1998, respectively. Values were estimated using zero dividend yield for all
years; expected volatility of 50 percent for all years; risk-free interest rates
of 6.06%, 6.17% and 4.96%, for 1996, 1997 and 1998, respectively; and
weighted-average expected lives of 3.52 years, 3.15 years and 4.29 years, for
1996, 1997 and 1998, respectively for both plans.
Employee Benefit Plans
In 1992, Pixar adopted a 401(k) Profit Sharing Plan (the 401(k) Plan) that
is intended to qualify under Section 401(k) of the Internal Revenue Code of
1986, as amended. The 401(k) Plan covers substantially all of Pixar's employees.
Participants may elect to contribute a percentage of their compensation to this
plan, up to the statutory maximum amount. Pixar may make discretionary
contributions to the 401(k) Plan; none have been made to date.
(9) COMMITMENTS AND CONTINGENCIES
Lease Commitments
Future minimum lease payments under noncancelable operating leases (with
initial or remaining lease terms in excess of one year) as of January 2, 1999
were as follows (in thousands):
<TABLE>
<CAPTION>
FISCAL YEAR
-----------
<S> <C>
1999.............................................. $2,722
2000.............................................. 2,193
2001.............................................. 504
2002.............................................. 6
------
Total minimum lease payments.............. $5,425
======
</TABLE>
Rental expense from operating leases amounted to approximately $1,236,000,
$2,095,000 and $2,697,000 for the years ended December 31, 1996, 1997 and
January 2, 1999, respectively.
Participation Commitment
Pixar is obligated to pay 5% of its revenue from the distribution of each
of the Pictures under the Co-Production Agreement to a third party in
consideration for services rendered. The compensation is subject to a cap of
$500,000 for each theatrical motion picture and a cap of $200,000 for each
sequel or remake, with a total aggregate cap of $3,000,000. Pixar paid
participation fees of $250,000 in 1997 under this obligation. No payments were
made in 1998.
Legal Matters
Pixar is involved in claims arising in the ordinary course of business.
Pixar believes these matters will be resolved without material adverse effect on
Pixar's financial position, results of operations or cash flows.
F-29
<PAGE> 30
PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(10) SIGNIFICANT CUSTOMERS AND SEGMENT REPORTING
The following table summarizes the annual percentage contribution to
revenue by customers when revenue from such customers exceeded 10% of total
revenue in 1996, 1997 or 1998 and the amounts due from these customers as a
percentage of total accounts receivable at the corresponding year end:
<TABLE>
<CAPTION>
PERCENTAGE OF PERCENTAGE OF TOTAL
TOTAL REVENUES ACCOUNTS RECEIVABLE AS OF
---------------------- -------------------------
1996 1997 1998 1996 1997 1998
---- ---- ---- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Disney.................................. 62% 83% 76% 34% 23% 12%
Silicon Graphics, Inc................... 26% -- -- -- -- --
</TABLE>
Pixar adopted the provisions of SFAS 131, Disclosures about Segments of an
Enterprise and Related Information (see Note 1). Pixar's chief operating
decision maker is considered to be Pixar's Chief Executive Officer ("CEO"). The
CEO reviews financial information presented on a consolidated basis accompanied
by disaggregated information about film revenue for purposes of making operating
decisions and assessing financial performance. The consolidated financial
information reviewed by the CEO is identical to the information presented in the
accompanying consolidated statement of operations and Pixar has no foreign
operations. Therefore, the Company operates in a single operating segment.
(11) EARNINGS PER SHARE CALCULATION
Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
FISCAL YEAR
-----------------------------------------------------------------------------
1996 1997 1998
------------------------ ------------------------ -----------------------
NET NET NET
INCOME SHARES EPS INCOME SHARES EPS INCOME SHARES EPS
------- ------ ----- ------- ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic net income per share...................... $25,319 38,632 $0.66 $22,190 41,224 $0.54 $7,822 44,185 $0.18
Effect of dilutive shares:
Warrants/options................................ -- 8,357 -- 6,920 -- 7,153
------- ------ ------- ------ ------ ------
Diluted net income per share.................... $25,319 46,989 $0.54 $22,190 48,144 $0.46 $7,822 51,338 $0.15
======= ====== ======= ====== ====== ======
</TABLE>
(12) DISCONTINUED OPERATIONS
In March 1997, Pixar determined to discontinue its business of producing
CD-ROM and other interactive products. Pixar immediately discontinued these
operations and reassigned all employees of this division. Since the measurement
date and disposal date were virtually simultaneous, no income or loss was
measured for the intervening period. Pixar had revenue of $3,009,000, $1,212,000
and $485,000 in 1996, 1997 and 1998, respectively. Pixar recorded losses from
discontinued operations, net of income tax benefit, of $1,023,000 in 1996. Pixar
recorded income from discontinued operations of $234,000 and $358,000 in 1997
and 1998, respectively, net of income taxes, primarily due to royalty income
received for the Toy Story CD-ROM products. Pixar does not expect any future
CD-ROM royalty income or costs in future periods.
(13) 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 Pixar's results of operations from
the date of acquisition. The majority of the purchase price was assigned to
purchased technology associated with certain technology developed by PEI. The
purchased technology is being amortized over a period not to exceed three years.
PEI's results of operations prior to the acquisition were immaterial and
therefore proforma financial statements were not materially different from
Pixar's financial statements.
F-30
<PAGE> 31
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The unaudited financial statements have been prepared on substantially the
same basis as the audited financial statements and, in the opinion of
management, include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the results of operations for
such periods (in thousands, except per share data).
<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
1997
Revenue....................................... $7,867 $14,376 $5,341 $7,115
Gross profit.................................. 7,300 13,419 4,698 6,744
Net income.................................... 5,148 8,929 3,672 4,441
Basic net income per share.................... .13 .22 .09 .11
Diluted net income per share.................. .11 .19 .08 .09
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------
MARCH 28 JUNE 27 SEPTEMBER 26 JANUARY 2
-------- ------- ------------ ---------
<S> <C> <C> <C> <C>
1998
Revenue.......................................... $4,997 $3,769 $2,474 $3,067
Gross profit..................................... 4,923 3,669 2,172 2,679
Net income....................................... 3,818 2,057 867 1,080
Basic net income per share....................... .09 .05 .02 .02
Diluted net income per share..................... .08 .04 .02 .02
</TABLE>
F-31
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Pixar:
We consent to the incorporation by reference in the registration statements
(No. 33-99838 and No. 333-62047) on Form S-8 of Pixar of our reports dated
January 29, 1999, relating to the balance sheets of Pixar as of December 31,
1997 and January 2, 1999, and the related statements of operations,
shareholders' equity, and cash flows for each of the years in the three-year
period ended January 2, 1999, and the related schedule, which reports appear or
are incorporated by reference in the 1998 annual report on Form 10-K of Pixar.
/s/ KPMG LLP
San Francisco, California
March 31, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> JAN-02-1999
<CASH> 29,557
<SECURITIES> 119,491
<RECEIVABLES> 4,183
<ALLOWANCES> 298
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 40,423
<DEPRECIATION> 9,263
<TOTAL-ASSETS> 250,806
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 220,397
<OTHER-SE> 14,750
<TOTAL-LIABILITY-AND-EQUITY> 250,806
<SALES> 0
<TOTAL-REVENUES> 14,307
<CGS> 0
<TOTAL-COSTS> 864
<OTHER-EXPENSES> 12,119
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 10,101
<INCOME-TAX> 2,637
<INCOME-CONTINUING> 7,464
<DISCONTINUED> 358
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,822
<EPS-PRIMARY> 0.18
<EPS-DILUTED> 0.15
</TABLE>
