<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JULY 3, 1999.
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
Commission File Number: 0-26976
PIXAR
(Exact name of registrant as specified in its charter)
California 68-0086179
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 West Cutting Boulevard, Richmond, California 94804
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (510) 236-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes (X) No ( )
The number of shares outstanding of the registrant's Common Stock as of August
13, 1999 was 46,367,246.
<PAGE> 2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
July 3, January 2,
1999 1999
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 16,991 $ 29,557
Short-term investments 119,147 119,491
Receivables, net 3,559 3,885
Prepaid expenses and other assets 4,846 4,884
Deferred income taxes 13,117 988
Capitalized film production costs 73,146 60,841
Property and equipment, net 42,945 31,160
------------ ------------
Total assets $ 273,751 $ 250,806
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 1,107 $ 2,615
Income taxes payable 1,372 97
Payable to Disney -- 3,363
Accrued liabilities 8,652 8,396
Unearned revenue 3,754 1,188
------------ ------------
Total liabilities 14,885 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;
46,254,291 and 45,335,770 shares issued and outstanding
as of July 3, 1999 and January 2, 1999, respectively 237,395 220,397
Accumulated other comprehensive income (loss) (447) 249
Deferred compensation (29) (104)
Retained earnings 21,947 14,605
------------ ------------
Total shareholders' equity 258,866 235,147
------------ ------------
Total liabilities and shareholders' equity $ 273,751 $ 250,806
============ ============
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
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<PAGE> 3
PIXAR
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
QUARTER ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
JULY 3, 1999 JUNE 27, 1998 JULY 3, 1999 JUNE 27, 1998
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C>
Revenue:
Software $ 1,240 $ 854 $ 2,814 $ 1,527
Animation services -- -- 222 171
Film 12,239 2,912 13,884 6,948
Patent licensing -- 3 -- 120
---------- ---------- ---------- ----------
Total revenue 13,479 3,769 16,920 8,766
---------- ---------- ---------- ----------
Cost of revenue:
Software 133 100 431 136
Animation services -- -- 154 38
Film 3,574 -- 3,846 --
---------- ---------- ---------- ----------
Total cost of revenue 3,707 100 4,431 174
---------- ---------- ---------- ----------
Gross profit 9,772 3,669 12,489 8,592
---------- ---------- ---------- ----------
Operating expenses:
Research and development 1,320 946 2,666 1,812
Sales and marketing 304 434 652 652
General and administrative 1,554 1,780 2,941 3,546
---------- ---------- ---------- ----------
Total operating expenses 3,178 3,160 6,259 6,010
---------- ---------- ---------- ----------
Income from continuing operations 6,594 509 6,230 2,582
Other income, net 1,793 2,162 3,658 4,562
---------- ---------- ---------- ----------
Income from continuing operations before income taxes 8,387 2,671 9,888 7,144
Income tax expense 2,012 614 2,613 1,643
---------- ---------- ---------- ----------
Net income from continuing operations 6,375 2,057 7,275 5,501
Income from discontinued operations, net of taxes 67 -- 67 374
---------- ---------- ---------- ----------
Net income $ 6,442 $ 2,057 $ 7,342 $ 5,875
========== ========== ========== ==========
Basic net income per share from continuing operations $ 0.14 $ 0.05 $ 0.16 $ 0.13
Basic net income per share from discontinued operations -- -- -- 0.01
---------- ---------- ---------- ----------
Basic net income per share $ 0.14 $ 0.05 $ 0.16 $ 0.14
========== ========== ========== ==========
Shares used in computing basic net income per share 46,023 43,839 45,785 43,497
========== ========== ========== ==========
Diluted net income per share from continuing operations $ 0.13 $ 0.04 $ 0.14 $ 0.11
Diluted net income per share from discontinued operations -- -- -- 0.01
---------- ---------- ---------- ----------
Diluted net income per share $ 0.13 $ 0.04 $ 0.14 $ 0.12
========== ========== ========== ==========
Shares used in computing diluted net income per share 51,334 51,432 51,260 50,948
========== ========== ========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
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<PAGE> 4
PIXAR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended
-----------------------------
July 3, June 27,
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 7,342 $ 5,875
Adjustments to reconcile net income to net cash
provided by (used in) continuing operating activities:
Discontinued operations (67) (374)
Amortization of deferred compensation 75 185
Depreciation and amortization 3,297 2,567
Amortization of capitalized film production costs 3,846 --
Tax benefit from disqualifying dispositions 14,163 --
Credits from patent licensing, net of expense items -- (114)
Deferred income tax (12,129) --
Changes in operating assets and liabilities:
Receivables 326 (1,021)
Prepaid expenses and other assets (351) (295)
Accounts payable (1,508) (540)
Income taxes payable 1,275 (42)
Payable to Disney (3,363) (600)
Accrued liabilities 256 (1,277)
Unearned revenue 2,566 (325)
----------- -----------
Net cash provided by continuing operations 15,728 4,039
Net cash provided by discontinued operations 67 374
----------- -----------
Net cash provided by operating activities 15,795 4,413
----------- -----------
Cash flows from investing activities:
Purchase of property and equipment (16,259) (5,882)
Proceeds from sale of property and equipment 994 --
Proceeds from sale of short-term securities 86,692 79,943
Investments in short-term securities (87,044) (125,612)
Capitalized film production costs (15,579) (15,120)
----------- -----------
Net cash used in investing activities (31,196) (66,671)
----------- -----------
Cash flows from financing activities:
Proceeds from exercised stock options 2,835 1,581
----------- -----------
Net cash provided by financing activities 2,835 1,581
----------- -----------
Net decrease in cash and cash equivalents (12,566) (60,677)
Cash and cash equivalents at beginning of period 29,557 101,847
----------- -----------
Cash and cash equivalents at end of period $ 16,991 $ 41,170
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ -- $ 1,796
=========== ===========
Supplemental disclosure of non-cash investing and financing activities:
Value of common stock issued and liabilities assumed for purchase
of PEI $ -- $ 3,000
=========== ===========
Loss on equipment disposals capitalized as film production costs $ (572) $ --
=========== ===========
Credits from patent licensing $ -- $ 120
=========== ===========
Unrealized loss on investments $ (696) $ (48)
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
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<PAGE> 5
NOTES TO FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission.
In the opinion of management, the accompanying unaudited financial statements
reflect all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation of Pixar's financial condition,
results of operations, and cash flows for the periods presented. These financial
statements should be read in conjunction with the audited financial statements
as of January 2, 1999 and for each of the years in the three-year period ended
January 2, 1999, including notes thereto, incorporated by reference into Pixar's
Annual Report on Form 10-K for the year ended January 2, 1999.
The results of operations for the three and six months ended July 3,
1999 are not necessarily indicative of the results expected for the current year
or any other period.
Certain amounts reported in previous periods have been reclassified to
conform to the 1999 financial statement presentation.
(2) FISCAL YEAR
Effective in 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, fiscal year 1998 ended on January 2, 1999 and
consisted of 53 weeks. The second quarter of 1999 represents the thirteen-week
period ended July 3, 1999, and fiscal year 1999 will end on January 1, 2000 and
consist of 52 weeks.
(3) EARNINGS PER SHARE CALCULATION
Basic net income per share is computed using the weighted-average number
of common shares outstanding during the period. Diluted net income per share is
computed using the weighted-average number of common and dilutive common
equivalent shares outstanding during the period, using the treasury stock method
for options and warrants.
Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------------------------------
July 3, 1999 June 27, 1998
------------------------------------- -------------------------------------
Net Net
Income Shares EPS Income Shares EPS
----------------------- --------- ----------------------- ---------
<S> <C> <C> <C> <C> <C> <C>
BASIC NET INCOME PER SHARE $ 6,442 46,023 $ 0.14 $ 2,057 43,839 $ 0.05
EFFECT OF DILUTIVE SHARES:
Warrants/options -- 5,311 -- 7,593
----------------------- -----------------------
DILUTED NET INCOME PER SHARE $ 6,442 51,334 $ 0.13 $ 2,057 51,432 $ 0.04
======================= =======================
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
------------------------------------------------------------------------------
July 3, 1999 June 27, 1998
------------------------------------- -------------------------------------
Net Net
Income Shares EPS Income Shares EPS
----------------------- --------- ----------------------- ---------
<S> <C> <C> <C> <C> <C> <C>
BASIC NET INCOME PER SHARE $ 7,342 45,785 $ 0.16 $ 5,875 43,497 $ 0.14
EFFECT OF DILUTIVE SHARES:
Warrants/options -- 5,475 -- 7,451
----------------------- -----------------------
DILUTED NET INCOME PER SHARE $ 7,342 51,260 $ 0.14 $ 5,875 50,948 $ 0.12
======================= =======================
</TABLE>
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<PAGE> 6
(4) FEATURE FILM AND CO-PRODUCTION AGREEMENTS
FEATURE FILM AGREEMENT
In 1991, Pixar entered into a feature film agreement with Walt Disney
Pictures, a wholly owned subsidiary of The Walt Disney Company (together with
its subsidiaries and affiliates collectively referred to herein as "Disney") to
develop and produce up to three computer-animated feature films (the "Feature
Film Agreement"). Pixar is entitled to receive compensation based on the revenue
from the distribution of these films and related products. In 1995, Pixar
released its first feature film under the terms of the Feature Film Agreement,
Toy Story. 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 governs all films made by Pixar
after Toy Story. Under the Co-Production Agreement, Pixar, on an exclusive
basis, agreed to produce five computer-animated theatrical motion pictures (the
"Pictures") for distribution by Disney. Pixar's first film produced under this
agreement was A Bug's Life. Films in development or production at Pixar as of
July 3, 1999, which include Toy Story 2 and Pixar's fourth film (with the
working title "Monsters, Inc.") are also governed by this agreement. A Bug's
Life and Monsters, Inc. count toward the five Pictures, whereas Toy Story 2 is a
derivative work that will not count towards 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.
(5) INCOME TAXES
Pixar's tax rate for the three months ended July 3, 1999 reflects
Pixar's expected tax rate for fiscal year 1999 (of approximately 40%) net of a
non-recurring tax benefit recorded in the second quarter, which lowered Pixar's
effective tax rate for the three and six months ended July 3, 1999 to 24% and
26%, respectively. The tax benefit recorded in the second quarter related to the
reversal of certain deferred tax asset reserves. Prior to the second quarter,
Pixar believed that there was sufficient uncertainty regarding the realizability
of its deferred tax assets to warrant the reserves. As of July 3, 1999, Pixar
believes that it has sufficient confidence in the amount and timing of its
anticipated participation revenues from A Bug's Life and the amount and timing
of certain offsetting tax-related expenses in the foreseeable future to project
that a portion of these deferred tax assets will be realized, and thus a
favorable adjustment for such has been recognized on Pixar's balance sheet and
in its tax rate in the second quarter.
(6) 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 the disposal date were virtually simultaneous, no income or loss was
measured for the intervening period. Pixar recorded income from discontinued
operations of $374,000 and $67,000, net of income taxes, for the six months
ended June 27, 1998, and July 3, 1999, respectively, due to royalty income
received for the Toy Story CD-ROM products. Pixar does not expect to receive
significant Toy Story CD-ROM royalty income in future periods.
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<PAGE> 7
(7) SEGMENT REPORTING
Pixar adopted the provisions of SFAS 131, Disclosures about Segments of
an Enterprise and Related Information. Pixar's chief operating decision-maker is
considered to be Pixar's Chief Executive Officer ("CEO"). The CEO reviews
financial information accompanied by disaggregated information about film
revenue for purposes of making operating decisions and assessing financial
performance. The financial information reviewed by the CEO is identical to the
information presented in the accompanying statements of operations and Pixar has
no foreign operations. Therefore, the Company operates in a single operating
segment.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements that have been made
pursuant to the provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based on current expectations,
estimates and projections about Pixar's industry, management's beliefs, and
assumptions made by management. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict; therefore, actual results and outcomes may differ materially from what
is expressed or forecasted in any such forward-looking statements. Such risks
and uncertainties include those set forth herein under "Dependence on Toy Story,
A Bug's Life, Toy Story 2 and Monsters, Inc.," 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--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," "--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.
Pixar's operating performance each quarter is subject to various risks
and uncertainties as discussed in the Company's Form 10-K. The following
discussion should be read in conjunction with the sections entitled "Risk
Factors" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in the Form 10-K. In particular, the factors set forth
below in "Risk Factors" could affect the Company's operating results and
financial condition.
CO-PRODUCTION AGREEMENT
In February 1997, Pixar and Walt Disney Pictures, a wholly owned
subsidiary of The Walt Disney Company (together with its subsidiaries and
affiliates collectively referred to herein as "Disney"), entered into a
co-production agreement (the "Co-Production Agreement") pursuant to which Pixar,
on an exclusive basis, 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 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,
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<PAGE> 8
interactive media products and other derivative works related to the Pictures,
Pixar has 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.
In February 1998, Pixar and Disney agreed to produce a theatrical motion
picture sequel to Toy Story, entitled "Toy Story 2". Toy Story 2 will be Pixar's
third feature film and is scheduled for release in November 1999. 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.
In May 1999, Pixar began production of its fourth theatrical film (with
the working title "Monsters, Inc."). This film will be produced and distributed
under the Co-Production Agreement and will count as the second of the five
original films to be produced under the Co-Production Agreement. Pixar is
currently scheduled to complete production of Monsters, Inc. in the spring of
2001 at the earliest.
RESULTS OF OPERATIONS
REVENUE
Total revenue for the three and six months ended July 3, 1999 were $13.5
million and $16.9 million, respectively, compared to $3.8 million and $8.8
million in the corresponding periods of the prior year. The increases were
primarily due to revenue from the domestic and foreign theatrical releases of A
Bug's Life and related merchandise.
Software revenue includes software license revenue, principally from
RenderMan. Software revenue increased 45% to $1.2 million for the quarter ended
July 3, 1999 from $854,000 in the corresponding prior year period and increased
84% to $2.8 million in the six months ended July 3, 1999 from $1.5 million in
the corresponding prior year period. The increase in software revenue resulted
from a general increase in RenderMan software licensing. Due to Pixar's focus on
content creation for animated feature films and related products, Pixar has not
increased the time and resources necessary to generate significantly higher
RenderMan sales. Therefore, Pixar expects ongoing variability in revenues
derived from software licenses and that such revenue will remain flat or
possibly decline. All historical and future royalty income associated with
Pixar's discontinued CD-ROM division is now and will continue to be excluded
from software revenue and will be 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. Animation services revenue increased slightly
to $222,000 for the six months ended July 3, 1999 from $171,000 in the
corresponding prior year period. Pixar expects that revenue in this area will
continue to vary significantly from quarter to quarter due to the sporadic
nature of this business and the need to utilize animation services employees on
other productions. For example, as occurred with A Bug's Life, Pixar has
transferred substantially all of its animation services employees to assist in
the completion of Toy Story 2. There can be no assurance that Pixar will
generate any animation services revenues during periods in which its animation
services employees are devoted to feature films or other projects.
Film revenue for the quarter ended July 3, 1999 was $12.2 million
compared with $2.9 million in the corresponding prior year period. Film revenue
for the six months ended July 3, 1999 was $13.9 million compared with $6.9
million in the corresponding period. Under the Co-Production Agreement, Pixar
and Disney share equally in the profits of A Bug's Life after Disney recovers
its distribution costs and its distribution fee. Therefore, Pixar's film revenue
for the three and six months ended July 3, 1999 resulted primarily from
theatrical revenues from A Bug's Life (most of which have already been reported
by Disney) and related merchandise, offset by Disney's distribution costs and
its distribution fee. Distribution costs reported to date include theatrical
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<PAGE> 9
distribution costs as well as the majority of Disney's costs to market A Bug's
Life home video, released in April 1999. Also included in film revenue for the
six months ended July 3, 1999 were residual Toy Story merchandise and home video
revenue of $559,000. Film revenue for the six months ended June 27, 1998
represented proceeds from Toy Story merchandise and home video sales and Toy
Story television airings.
Patent licensing revenue of $120,000 for the six months ended June 27,
1998 was attributable to a patent license with Silicon Graphics, Inc. ("SGI"),
whereby Pixar granted to SGI and its subsidiaries a non-exclusive license to use
certain of Pixar's patents covering techniques for creating computer-generated
photorealistic images. Under the agreement, SGI agreed to pay Pixar total
compensation of $11.0 million, of which $6.0 million was paid in cash in March
1996 and $5.0 million was to be paid in the form of purchase credits for SGI
hardware and software. As of the end of 1998, Pixar had used substantially all
of the remaining credits and does not expect that patent licensing revenue will
be generated on an on-going basis.
For the three and six months ended July 3, 1999, Disney accounted for
91% and 83% respectively, of Pixar's total revenue. The revenue from Disney
consisted of film and animation services revenue. Due to the Co-Production
Agreement, Disney is expected to continue to represent significantly in excess
of 10% of Pixar's revenue in 1999 and for the foreseeable future. A portion of
the Disney revenue for the quarter was included in receivables and represented
17% of the balance at July 3, 1999. For the three and six months ended June 27,
1998, Disney accounted for 77% and 81%, respectively, of Pixar's total revenue,
primarily from film and animation services revenue.
COST OF REVENUE
Cost of software revenue consists of the direct costs and manufacturing
overhead required to reproduce and package Pixar's software products, as well as
amortization of purchased technology. Cost of software revenue includes no
amortization of capitalized software development expenses. Cost of software
revenue as a percentage of the related revenue was 11% and 15% for the three and
six months ended July 3, 1999, compared to 12% and 9% for the three and six
month corresponding prior year periods. The percentage increase for the six
months ended July 3, 1999 was due to amortization of purchased technology
associated with the June 1998 acquisition of Physical Effects, Inc. ("PEI").
Approximately $2.7 million of the PEI purchase price was assigned to purchased
technology, which PEI licensed to a third party. Over a period not to exceed
four years, Pixar will amortize the purchased technology against related license
revenue, thereby essentially eliminating any gross profit with respect to
license revenue associated with this purchased technology until such
amortization has been completed. As a result of the ongoing amortization of this
purchased technology, it is likely that Pixar's total software gross profit 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 related revenue increased
to 69% for the six months ended July 3, 1999 from 22% in the prior year period.
Animation services projects are negotiated individually and depending on the
complexity of the project, profit margins vary significantly from project to
project.
Cost of film revenue represents amortization of film costs capitalized
by Pixar. See "Capitalized Film Production Costs." Due to higher than expected
Toy Story film revenue, which resulted in Pixar's amortizing all Toy Story
related film costs by December 31, 1997, there was no cost of revenue associated
with the Toy Story revenue for the six months ended July 3, 1999 or June 27,
1998. Cost of film revenue from A Bug's Life was 29% and 28% of total film
revenue for the three and six months ended July 3, 1999, respectively.
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. Since Pixar's
share of production costs under the terms of the Co-Production Agreement are
capitalized, amortized
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<PAGE> 10
film production costs for A Bug's Life and future feature films will be
significantly higher, and the related gross profit margins will be substantially
lower than those achieved on Toy Story.
There is no cost of revenue associated with patent licensing revenue.
OPERATING EXPENSES
Total operating expenses for the three and six months ended July 3, 1999
were slightly higher than in the prior year, and Pixar intends to continue to
increase its spending levels in a number of areas. As a result of 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, and compensation for such personnel may
continue to increase. In addition, Pixar expects increases in systems and
facilities costs and to expand other operations.
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. Further, a portion of Pixar's general and
administrative overhead costs which benefit the productions are capitalized by
Pixar. In addition, because Disney is responsible for paying all film marketing
costs under the Co-Production Agreement, to the extent that Pixar incurs film
marketing costs, Disney is responsible for reimbursing Pixar for such costs. To
the extent that 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.
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
software, for production management for short film projects and for certain
other unreimbursed projects. Research and development expenses increased 40% to
$1.3 million in the three months ended July 3, 1999 from $946,000 in the
corresponding prior year period and increased 47% to $2.7 million in the six
months ended July 3, 1999 from $1.8 million in the corresponding prior year
period. The increases are due to Pixar's continued investment in proprietary
technology and short film development projects. 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.
Sales and marketing expenses consist primarily of salaries and related
overhead, as well as advertising, technical support, public relations and trade
show costs required to support software sales and complement film activities.
Sales and marketing expenses decreased by 30% to $304,000 for the three months
ended July 3, 1999 from $434,000 in the corresponding prior year period and
remained flat at $652,000 for the six months ended July 3, 1999 and June 27,
1998. The decrease for the quarter ended July 3, 1999 resulted from increased
corporate marketing and promotion in the corresponding prior year period related
to Pixar's short animated film, Geri's Game. Pixar expects these and other
marketing expenses may increase in future periods.
General and administrative expenses consist primarily of salaries of
management and administrative personnel, insurance costs and professional fees.
General and administrative expenses decreased 13% to $1.6 million for the three
months ended July 3, 1999 from $1.8 million in the corresponding prior year
period and decreased 17% to $2.9 million for the six months ended July 3, 1999
from $3.5 million in the corresponding prior year period. The decrease was
primarily due to the favorable timing of certain payroll-related and outside
services costs. Pixar expects general and administrative expenses to increase in
future periods as Pixar incurs additional costs to expand its administrative
staff and facilities.
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<PAGE> 11
OTHER INCOME, NET
Other income, net consists primarily of interest income on Pixar's
short-term investments. Other income, net was $1.8 million and $3.7 million for
the three and six months ended July 3, 1999, respectively, and $2.2 million and
$4.6 million for the three and six months ended June 27, 1998, respectively. The
decreases are primarily due to a decline in Pixar's cash and short-term
investment balances.
INCOME TAXES
Income tax expense from continuing operations for the three and six
months ended July 3, 1999 reflects Pixar's federal and state income tax
liability after recognition of a non-recurring tax benefit recorded in the
second quarter of 1999. This one-time adjustment reflects Pixar's sufficient
confidence in anticipated revenue from A Bug's Life such that Pixar will realize
the benefit of certain tax assets. Pixar's tax rate for the three months ended
July 3, 1999 was 24%. In future quarters, Pixar expects that quarterly tax rates
will return to statutory levels.
RESULTS OF DISCONTINUED OPERATIONS
Pixar determined in March 1997 to discontinue its business of producing
CD-ROM and other interactive products and redirected all employees in that
division to film and related projects within Pixar. Pixar recorded income from
discontinued operations of $67,000 and $374,000, net of income taxes, for the
six months ended July 3, 1999 and June 27,1998, respectively. This income is due
to royalty income received for the Toy Story CD-ROM products. Pixar does not
expect to receive significant CD-ROM royalty income in future periods.
RISK FACTORS
The following is a discussion of certain factors that currently impact
or may impact Pixar's business, operating results and/or financial condition.
Anyone making an investment decision with respect to Pixar's capital stock or
other securities is cautioned to carefully consider these factors, along with
the factors discussed in Pixar's Form 10-K under the section entitled "Risk
Factors."
DEPENDENCE ON TOY STORY, A BUG'S LIFE, TOY STORY 2 AND MONSTERS, INC.
DEPENDENCE ON A BUG'S LIFE FOR THE BALANCE OF 1999 AND THE FIRST HALF OF
2000
For the balance of 1999 and the first half of 2000, Pixar's revenue and
operating results will be largely dependent upon (1) Pixar's share of revenue
from the theatrical and video releases of A Bug's Life and related merchandise,
(2) whatever revenues remain from Toy Story, if any, and (3) Pixar's software
and animation services revenue, from which Pixar expects limited revenue.
A BUG'S LIFE REVENUE
A Bug's Life was released in November 1998, and in the three months
ended July 3, 1999, Pixar received its first significant share of film revenues.
Under the Co-Production Agreement, Pixar and Disney share equally in the profits
of A Bug's Life after Disney recovers its distribution costs and its
distribution fee. Correspondingly, Pixar's film revenue for the six months ended
July 3, 1999 resulted primarily from the domestic and foreign theatrical
revenues from A Bug's Life (most of which have already been reported by Disney)
and related merchandise licensing, offset by Disney's distribution costs and its
distribution fee. Distribution costs reported to date include the majority of
worldwide theatrical marketing and distribution costs, and the majority of
Disney's costs to market A Bug's Life home video, which was released in April
1999. While A Bug's Life has done extremely well in its theatrical release,
Disney recently reported general softness in its domestic home video sales and
worldwide merchandise licensing as compared to levels associated with many of
its previous blockbuster animated feature films. In addition, Pixar believes
that A Bug's Life faced an unusually high number of competing films released
during the 1998 holiday season such as Antz, The Rugrats Movie and Prince of
Egypt, and that the related home video and/or merchandise sales from these films
have adversely impacted sales of A Bug's Life products. As a result, Pixar
expects that revenues associated with A Bug's Life home video sales and
merchandise licensing will be lower than previously anticipated.
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<PAGE> 12
For the remainder of 1999 and the first half of 2000, Pixar expects to
be significantly dependent upon the success of A Bug's Life. Because most
revenues from the worldwide theatrical release of A Bug's Life have been
reported by Disney, sources of future revenues primarily include domestic and
foreign home video sales and any future merchandise royalties, both of which
must be substantial in order for Pixar to generate significant revenues. Revenue
from any future television airings of A Bug's Life are not expected until a few
years after release of the film, at the earliest. Moreover, potential future
revenues will be offset by future distribution costs, which primarily include
remaining marketing costs for the domestic release of A Bug's Life home video,
marketing costs for the foreign video release, video cost of goods, remaining
distribution costs for the international theatrical release of A Bug's Life,
Disney's distribution fee based on film-related revenues, and other distribution
costs such as residuals. Therefore, it is difficult to predict the timing of
Pixar's future revenues from A Bug's Life, particularly in the second half of
1999 and the first half of 2000, because of the many variables involved. Such
variables include the amount and timing of distribution cost outlays, and the
amount and timing of revenue and cash flows generated from (1) worldwide home
video sales, (2) sales of film related merchandise, and (3) remaining foreign
box office. For example, the timing of the release of A Bug's Life video in
foreign countries is particularly uncertain since the video will be released in
various countries over the course of six months or more. All decisions regarding
its international release are made by Disney and such decisions are subject to
change. It is possible, in any given quarter or quarters for the remainder of
1999 and in 2000 that Pixar will not recognize sufficient revenue from A Bug's
Life to generate significant earnings.
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. Based on the terms of the Feature Film Agreement, future
film revenue from Toy Story, if any, will be received from Disney on a
semi-annual basis going forward.
SOFTWARE REVENUE
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 licensing revenues; therefore, Pixar expects that revenue from
the licensing of RenderMan will remain flat or possibly decline. In addition,
from the acquisition date of PEI on June 16, 1998, through July 3, 1999, Pixar
has received significantly less license revenue than expected related to the
purchased technology associated with the acquisition. If future license revenue
continues to be substantially lower than originally estimated, Pixar may be
required to write off all or a significant portion of the unamortized purchased
technology.
RISK 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 is amortizing these costs over the
expected revenue stream as Pixar recognizes revenue from the film. The amount of
film costs that will be amortized each quarter will depend on how much future
revenue Pixar expects to receive from A Bug's Life. Although A Bug's Life has
achieved substantial domestic and foreign box office success and has done well
in its domestic home video release, the home video has not been substantially
released in foreign markets, nor have any significant domestic or home video
proceeds been received by Pixar. It is difficult to predict how much additional
revenue will be derived from merchandise sales and from television airings of A
Bug's Life. In addition, Pixar believes that the amount spent by Disney for
marketing and distribution, particularly for distribution of the home video,
will continue to be significant. In any given quarter, if Pixar's forecast
changes with respect to total revenue from A Bug's Life, and becomes lower than
was previously forecasted, Pixar would be required to accelerate amortization of
related film costs, resulting in lower gross margins. Such lower gross margins
from A Bug's Life would adversely impact Pixar's business, operating results,
and financial condition.
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<PAGE> 13
DEPENDENCE ON TOY STORY 2 AND MONSTERS, INC.
Pixar expects to receive the majority of the proceeds from A Bug's Life
by the end of 2000. In addition, while Toy Story 2 is scheduled for release in
November 1999, 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. Beyond 2000, Pixar expects to be largely dependent upon the success of
Toy Story 2 and Monsters, Inc. (together referred to as the "Current Projects").
Although production of the Current Projects is underway, Pixar cannot provide
any assurances that the Current Projects will be successfully produced and
released when targeted. Pixar is currently scheduled to complete production of
Monsters, Inc. in the spring of 2001. Disney has not formally scheduled the
theatrical release of Monsters, Inc., and Pixar cannot provide any assurances as
to when the film will be released. Pixar cannot provide any assurances that it
will not experience difficulties that could delay or prevent the successful
development or production of any of the Current Projects or subsequent animated
feature films or related products. If Pixar is unable to produce and develop on
a timely basis the Current Projects and subsequent animated feature films and
related products that meet with broad market acceptance, 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 and The Prince of Egypt are the only
fully-animated feature films (other than Toy Story and A Bug's Life) produced or
developed by a studio other than Disney that have 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.
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 (1) the escalation in compensation rates of people required to
work on the Current Projects, (2) the number of people required to work on the
Current Projects, and (3) the equipment needs, the budget for the Current
Projects and subsequent films and related products are and will continue to be
substantially greater than the 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
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<PAGE> 14
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 has reassigned employees from its animation services group and from
Monsters, Inc. 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 generally treated
as film costs which increase overall production budgets and could have a
material adverse effect on results of operations and financial condition.
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 Monsters, Inc. 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 cash from operations until
the third or fourth quarter of 1999 at the earliest, the development and
production costs of the Current Projects and the costs of the new Emeryville
facility will have a material adverse impact on Pixar's cash and short-term
investment balances. As of July 3, 1999, Pixar had approximately $136.1 million
in cash and short-term investments. Pixar believes that these funds, along with
any further cash received from the release of A Bug's Life, 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
cash is received from the future release of additional films. However, even if A
Bug's Life and these films generate cash in future quarters, unless each film 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 may
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.
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:
o the timing of the domestic and international releases of animated
feature films,
o the success of animated feature films (which can fluctuate significantly
from film to film),
o the timing of the release of related products into their respective
markets (such as home videos and merchandising),
o the demand for such related products (which is often a function of the
success of the related animated feature film),
o film production costs,
o Disney's costs to distribute and promote the feature films and related
products,
o Disney's success at marketing the films and related products,
o the timing of receipt of proceeds from animated feature films and
related products by Disney,
o the timing of revenue recognition under the Co-Production Agreement and
the Feature Film Agreement, as the case may be,
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<PAGE> 15
o the introduction of new feature films or products by Pixar's
competitors, and
o 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 the first six
months of 1999 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.
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. Pixar maintains a valuation
allowance that offsets a portion of its deferred tax asset, given the dependence
on the success of A Bug's Life and future films, which continues to be
uncertain. In addition, Pixar's effective tax rate increased for 1998 and is
likely to return to statutory rates in the 40% range in the second half of 1999.
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.
CAPITALIZED FILM PRODUCTION COSTS
Pixar had $73.1 million in capitalized film production costs as of July
3, 1999, consisting primarily of costs relating to A Bug's Life, Toy Story 2 and
Monsters, Inc., all of which are being co-financed by Disney under the
Co-Production Agreement. All Toy Story capitalized film costs were fully
amortized as of December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash and short-term investments decreased $12.9 million to $136.1
million at July 3, 1999 from $149.0 million at January 2, 1999 due primarily to
cash used for film development and production costs and for construction of the
Emeryville facility.
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<PAGE> 16
Net cash provided by continuing operations for the six months ended July
3, 1999 was primarily attributable to net income of $7.3 million, and the
non-cash impacts of depreciation and amortization expense, and amortization of
capitalized film production costs totaling $7.2 million. Cash used in investing
activities was due primarily to funding of film production costs of $15.6
million and the purchase of property and equipment of $16.2 million. Cash
provided by financing activities was due to proceeds from the exercise of stock
options.
As of July 3, 1999, Pixar's principal source of liquidity was approximately
$136.1 million in cash and short-term investments. Pixar believes that these
funds will be sufficient to meet the Company's operating requirements through
the next twelve months.
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
miscalculation.
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. This phase was completed in
April 1999. 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.
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 that are deemed to be
critical or important, Pixar is reviewing the written certification
provided by vendors and performing internal testing where possible. This
phase was completed in May 1999. To date, Pixar has identified a few
third party systems that are not Year 2000 compliant.
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
80% complete, and is anticipated to be complete in August 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 80% 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 50%
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 its 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
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<PAGE> 17
such costs to exceed $500,000. The majority of these costs will result from
consultants, software upgrades and dedicated program equipment.
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. 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.
ITEM 3. 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 July 3, 1999. The
table presents principal amounts and related weighted average fixed interest
rates presented by expected maturity date (dollars in thousands):
<TABLE>
<CAPTION>
< 1 YEAR > 1 YEAR TOTAL
----------- ----------- -----------
<S> <C> <C> <C>
Available-for-sale securities $ 79,525 $ 54,895 $ 134,420
Weighted-average interest rate 5.12% 5.13% 5.13%
</TABLE>
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<PAGE> 18
PART II -- OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed by Pixar during the quarter
ended July 3, 1999.
Items 1, 2, 3, 4 and 5 are not applicable and have been omitted.
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<PAGE> 19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PIXAR
Date: August 17, 1999 By: /s/ Sarah S. Flatley
------------------- -----------------------------
Sarah S. Flatley,
Vice President, Finance
(Principal Accounting Officer
And Duly Authorized Officer)
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<PAGE> 20
EXHIBIT INDEX
EXHIBIT DOCUMENT DESCRIPTION
- ------- --------------------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-01-2000
<PERIOD-START> JAN-03-1999
<PERIOD-END> JUL-03-1999
<CASH> 16,991
<SECURITIES> 119,147
<RECEIVABLES> 3,851
<ALLOWANCES> 292
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 53,160
<DEPRECIATION> 10,215
<TOTAL-ASSETS> 273,751
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 237,395
<OTHER-SE> 21,471
<TOTAL-LIABILITY-AND-EQUITY> 273,751
<SALES> 0
<TOTAL-REVENUES> 16,920
<CGS> 0
<TOTAL-COSTS> 4,431
<OTHER-EXPENSES> 6,259
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 9,888
<INCOME-TAX> 2,613
<INCOME-CONTINUING> 7,275
<DISCONTINUED> 67
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,342
<EPS-BASIC> 0.16
<EPS-DILUTED> 0.14
</TABLE>
