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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE NUMBER: 0-26976
PIXAR
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
CALIFORNIA 68-0086179
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
1001 WEST CUTTING BOULEVARD, RICHMOND, CALIFORNIA 94804
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 236-4000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
The number of shares outstanding of the registrant's Common Stock as of
November 3, 2000 was 47,548,833.
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, JANUARY 1,
2000 2000
------------- ----------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 59,691 $ 31,170
Short-term investments...................................... 159,226 163,779
Receivables, net............................................ 6,939 16,740
Prepaid expenses and other assets........................... 4,391 3,888
Deferred income taxes....................................... 34,533 34,533
Property and equipment, net................................. 97,782 60,266
Capitalized film production costs........................... 63,395 64,529
-------- --------
Total assets...................................... $425,957 $374,905
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable............................................ $ 2,855 $ 458
Income taxes payable........................................ 1,010 12,230
Accrued liabilities......................................... 12,171 16,475
Unearned revenue............................................ 16,456 1,299
-------- --------
Total liabilities................................. 32,492 30,462
-------- --------
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;
47,483,898 and 46,959,093 shares issued and outstanding
as of September 30, 2000 and January 1, 2000,
respectively........................................... 286,541 281,274
Accumulated other comprehensive income (loss)............. (134) (660)
Retained earnings......................................... 107,058 63,829
-------- --------
Total shareholders' equity........................ 393,465 344,443
-------- --------
Total liabilities and shareholders' equity........ $425,957 $374,905
======== ========
</TABLE>
See accompanying notes to financial statements.
1
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PIXAR
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, OCTOBER 2, SEPTEMBER 30, OCTOBER 2,
2000 1999 2000 1999
------------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
Revenue:
Film and animation services............... $15,511 $77,497 $90,290 $91,603
Software.................................. 1,785 1,738 6,317 4,553
------- ------- ------- -------
Total revenue..................... 17,296 79,235 96,607 96,156
------- ------- ------- -------
Cost of revenue:
Film and animation services............... 2,061 21,672 20,662 25,673
Software.................................. 129 136 408 567
------- ------- ------- -------
Total cost of revenue............. 2,190 21,808 21,070 26,240
------- ------- ------- -------
Gross profit...................... 15,106 57,427 75,537 69,916
------- ------- ------- -------
Operating expenses:
Research and development.................. 1,404 1,597 4,579 4,263
Sales and marketing....................... 390 338 1,117 989
General and administrative................ 1,873 1,761 5,694 4,703
------- ------- ------- -------
Total operating expenses.......... 3,667 3,696 11,390 9,955
------- ------- ------- -------
Income from continuing
operations...................... 11,439 53,731 64,147 59,961
Other income................................ 3,579 1,913 9,474 5,571
------- ------- ------- -------
Income from continuing operations
before income taxes............. 15,018 55,644 73,621 65,532
Income tax expense.......................... 6,232 23,370 30,553 25,984
------- ------- ------- -------
Net income from continuing
operations...................... 8,786 32,274 43,068 39,548
Income from discontinued operations, net of
taxes..................................... 35 13 161 80
------- ------- ------- -------
Net income........................ $ 8,821 $32,287 $43,229 $39,628
======= ======= ======= =======
Basic net income per share from continuing
operations................................ $ 0.19 $ 0.70 $ 0.91 $ 0.86
Basic net income per share from discontinued
operations................................ 0.00 0.00 0.01 0.00
------- ------- ------- -------
Basic net income per share.................. $ 0.19 $ 0.70 $ 0.92 $ 0.86
======= ======= ======= =======
Shares used in computing basic net income
per share................................. 47,376 46,355 47,187 45,975
======= ======= ======= =======
Diluted net income per share from continuing
operations................................ $ 0.18 $ 0.63 $ 0.86 $ 0.77
Diluted net income per share from
discontinued operations................... 0.00 0.00 0.01 0.00
------- ------- ------- -------
Diluted net income per share................ $ 0.18 $ 0.63 $ 0.87 $ 0.77
======= ======= ======= =======
Shares used in computing diluted net income
per share................................. 49,837 51,223 49,918 51,253
======= ======= ======= =======
</TABLE>
See accompanying notes to financial statements.
2
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PIXAR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
---------------------------
SEPTEMBER 30, OCTOBER 2,
2000 1999
------------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 43,229 $ 39,628
Adjustments to reconcile net income to net cash provided
by continuing operating activities:
Discontinued operations................................ (161) (80)
Depreciation and amortization.......................... 3,547 5,128
Loss on disposition of property and equipment.......... (2) --
Amortization of capitalized film production costs...... 20,178 25,398
Deferred income tax.................................... -- 2,034
Changes in operating assets and liabilities:
Receivables, net..................................... 9,801 (6,664)
Prepaid expenses and other assets.................... (863) (105)
Accounts payable..................................... 2,397 (2,315)
Income taxes payable................................. (11,220) 24,655
Payable to Disney.................................... -- (3,161)
Accrued liabilities.................................. (4,304) 1,604
Unearned revenue..................................... 15,157 (359)
--------- ---------
Net cash provided by continuing operations........ 77,759 85,763
Net cash provided by discontinued operations...... 161 80
--------- ---------
Net cash provided by operating activities......... 77,920 85,843
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment........................ (41,100) (25,803)
Proceeds from sale of equipment........................... 399 994
Proceeds from sale of short-term securities............... 281,789 110,529
Investments in short-term securities...................... (276,710) (158,983)
Capitalized film production costs......................... (19,044) (24,507)
--------- ---------
Net cash used in investing activities............. (54,666) (97,770)
--------- ---------
Cash flows from financing activities:
Proceeds from exercised stock options..................... 5,267 3,668
--------- ---------
Net cash provided by financing activities......... 5,267 3,668
--------- ---------
Net increase (decrease) in cash and cash equivalents........ 28,521 (8,259)
Cash and cash equivalents at beginning of period............ 31,170 29,557
--------- ---------
Cash and cash equivalents at end of period.................. $ 59,691 $ 21,298
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes.............. $ 41,886 $ --
========= =========
Supplemental disclosure of non-cash investing and financing
activities:
Loss on equipment disposals capitalized as film production
costs.................................................. $ 396 $ 603
========= =========
Unrealized gain (loss) on investments..................... $ 526 $ (778)
========= =========
Tax benefit from disqualifying dispositions............... $ -- $ 14,163
========= =========
</TABLE>
See accompanying notes to financial statements.
3
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PIXAR
NOTES TO FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying unaudited condensed 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 condensed
financial statements reflect all adjustments (consisting only of normal
recurring adjustments) considered necessary for a fair presentation of our
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 1, 2000 and January 2, 1999, and for
each of the years in the three-year period ended January 1, 2000, including
notes thereto, incorporated by reference into our Annual Report on Form 10-K for
the year ended January 1, 2000.
The results of operations for the three and nine months ended September 30,
2000 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 2000 financial statement presentation.
(2) FISCAL YEAR
Effective for fiscal year 1998, we adopted a 52- or 53-week fiscal year,
changing the year end date from December 31 to the Saturday nearest December 31.
Fiscal year 2000 will end on December 30, 2000 and will consist of 52 weeks.
(3) NET INCOME 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, using the treasury stock method
for options and warrants. Options to purchase approximately 2.6 million shares
of common stock , and 661,000 shares of common stock, respectively, were
outstanding during the three and nine month periods ending September 30, 2000,
but were not included in the computation of diluted earnings per share because
the options' exercise price was greater than the average market price of the
common shares.
Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
SEPTEMBER 30, 2000 OCTOBER 2, 1999
------------------------- -------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------ ------ ----- ------- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Basic net income per share............ $8,821 47,376 $0.19 $32,287 46,355 $0.70
Effect of dilutive shares:
Warrants/options.................... -- 2,461 -- 4,868
------ ------ ------- ------
Diluted net income per share.......... $8,821 49,837 $0.18 $32,287 51,223 $0.63
====== ====== ======= ======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
-------------------------------------------------------
SEPTEMBER 30, 2000 OCTOBER 2, 1999
-------------------------- -------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------- ------ ----- ------- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Basic net income per share........... $43,229 47,187 $0.92 $39,628 45,975 $0.86
Effect of dilutive shares:
Warrants/options................... -- 2,731 -- 5,278
------- ------ ------- ------
Diluted net income per share......... $43,229 49,918 $0.87 $39,628 51,253 $0.77
======= ====== ======= ======
</TABLE>
4
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PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(4) OTHER COMPREHENSIVE INCOME (LOSS)
For the three and nine months ended September 30, 2000, other comprehensive
income was $380,000 and $526,000, respectively. Other comprehensive loss was
$82,000 and $778,000, respectively, for the same periods of the prior year.
(5) FEATURE FILM AND CO-PRODUCTION AGREEMENTS
Feature Film Agreement
In 1991, we 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"). We were entitled to receive compensation based on the revenue
from the distribution of these films and related products. In 1995, we released
our 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 we have
made since Toy Story. Under the Co-Production Agreement, we agreed, on an
exclusive basis, to produce five original computer-animated theatrical motion
pictures (the "Pictures") for distribution by Disney. A Bug's Life, released in
1998, and Toy Story 2, released in November 1999, were the first films produced
under this agreement. Films in development or production at Pixar as of
September 30, 2000, all governed by this agreement, include our fourth film,
"Monsters, Inc.", our fifth film (with the working title "Finding Nemo"), our
sixth film (Film Six) and our seventh film (Film Seven). A Bug's Life, Monsters,
Inc., Finding Nemo, Film Six and Film Seven will be counted toward the five
original Pictures under this agreement, whereas Toy Story 2 is a derivative work
that will not count towards the Pictures. However, under the Co-Production
Agreement, all provisions applicable to the Pictures also apply to any
derivative works that we elect to produce, such as 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 we will produce each Picture and Disney will control decisions
relating to film marketing and distribution.
(6) DISCONTINUED OPERATIONS
In 1997, we determined to discontinue our business of producing CD-ROM and
other interactive products. We 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. We recorded income from discontinued operations of
$161,000 and $80,000, net of income taxes, for the nine months ended September
30, 2000 and October 2, 1999, respectively, due to royalty income received for
the Toy Story CD-ROM products. We do not expect any significant CD-ROM royalty
income in future periods.
(7) SEGMENT REPORTING
We adopted the provisions of SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information." Our chief operating decision-maker is
considered to be our Chief Executive Officer ("CEO"). The CEO reviews financial
information presented on a summary basis accompanied by disaggregated
information about film revenue for purposes of making operating decisions and
assessing financial perform-
5
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PIXAR
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
ance. The summary financial information reviewed by the CEO is identical to the
information presented in the accompanying statements of operations and we have
no foreign operations. Therefore, we operate in a single operating segment.
(8) IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 2000, the AICPA issued Statement of Position (SOP) 00-2,
"Accounting by Producers or Distributors of Films." The guidance in this SOP
applies to all types of films, and is applicable to all producers or
distributors that own or hold rights to distribute or exploit films. For
purposes of this SOP, films are defined as feature films, television specials,
television series, or similar products including animated films and television
programming that are sold, licensed or exhibited, whether produced on film,
videotape, digital, or other video recording format. SOP 00-2 is effective for
financial statements for fiscal years beginning after December 15, 2000. We have
evaluated the pro forma effects of SOP 00-2, and based on that evaluation, we do
not believe SOP 00-2 will have a material effect on our financial statements,
liquidity, or results of operations.
In March 2000, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation, an interpretation of ABP Opinion No. 25." This interpretation
clarifies the application of Opinion 25 for certain issues: (a) the definition
of an employee for purposes of applying Opinion 25; (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan; (c) the
accounting consequences of various modifications to the terms of a previously
fixed stock option or award; and (d) the accounting for an exchange of stock
compensation awards in a business combination. Generally, this interpretation is
effective July 1, 2000. The adoption of Interpretation No. 44 did not have a
material effect on our financial statements, liquidity, or results of
operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities"
(SFAS 133), which as amended by SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities, Deferral of the Effective Date of FASB
Statement No. 133, and Amendment of FASB Statement No. 133" and SFAS No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an amendment of FASB No. 133", issued in June 2000, will be effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. SFAS 133 generally provides for matching the
timing of gain or loss recognition of (a) the changes in the fair value of the
hedged asset or liability that are attributed to the hedged risk or (b) the
earnings effect of hedged forecasted transactions. Earlier application of all
provisions of this statement is encouraged but it is permitted only as of the
beginning of any fiscal quarter that begins after issuance of this statement. We
do not believe that adoption of this statement will have a material effect on
our financial statements.
6
<PAGE> 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" contains forward-looking statements that have been made
pursuant to the provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based on current expectations,
estimates and projections about the industry in which we operate, 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 Feature
Films, and Difficulty and Risks in Forecasting the Toy Story Franchise,
Monsters, Inc. and A Bug's Life Revenues" as well as those noted in the section
entitled "Risk Factors" in our Annual Report on Form 10-K for the year ended
January 1, 2000 (the "Form 10-K"). Particular attention should be paid to the
cautionary language in the section in the Form 10-K entitled "--Dependence on
Toy Story 2, A Bug's Life and Toy Story in 2000," "-- 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, we undertake no obligation to update publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Our operating performance each quarter is subject to various risks and
uncertainties as discussed in our 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 our operating results and financial condition.
OVERVIEW
In February 1997, we entered into the Co-Production Agreement
("Co-Production 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"), pursuant to which we agreed, on an
exclusive basis, to produce five original computer-animated feature-length
theatrical motion pictures (the "Pictures") for distribution by Disney. 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 we will
produce each Picture and that Disney will control all decisions relating to
marketing, promotion, publicity, advertising and distribution of each Picture.
Our second feature film, A Bug's Life, was released in November 1998 and counts
as the first original 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, we will have the
opportunity to co-finance and produce such products or to earn passive royalties
on such products. We 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 us for
our share of certain general and administrative costs and certain research and
development costs that benefit the productions.
In November 1999, Toy Story 2, our third animated feature film, was
released. As a sequel, Toy Story 2 is a derivative work of the original Toy
Story; therefore, it is not counted toward the five original Pictures to be
produced under the Co-Production Agreement. However, as a derivative work, Toy
Story 2 will be treated as a Picture under the Co-Production Agreement and all
the provisions applicable to the five original Pictures apply.
7
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In May 1999, we began production on our fourth theatrical film, Monsters,
Inc. In 2000, we began production on our fifth animated feature film, "Finding
Nemo." In 1999 we began concept development on our sixth animated feature film,
"Film Six" and in 2000 we began concept development on our seventh animated
feature film, "Film Seven." These films will be produced and distributed under
the Co-Production Agreement and will count as the second, third, fourth and
fifth films of the five original films to be produced under the Co-Production
Agreement. We do not expect to release Monsters, Inc. until Thanksgiving 2001,
at the earliest, and Finding Nemo until the summer of 2003, at the earliest.
Film Six and Seven are currently targeted for release no earlier than 2004 and
2005, respectively.
Target Earnings per Share for Fiscal Year 2000 and 2001
We are targeting diluted earnings per share of $1.45 for fiscal year 2000,
which represents an increase to the guidance of at least $1.30 we had targeted
during the second quarter of fiscal year 2000. This increase can be attributed
to higher than anticipated merchandise and television revenues from Toy Story
and A Bug's Life and to higher than anticipated software revenue in the third
quarter of 2000, as well as from sales of A Bug's Life to international pay
television, now projected for the fourth quarter.
In addition, we expect our fiscal year 2001 diluted earnings per share to
be somewhere in the range of $0.20 to $0.45. This estimate is primarily based on
our current expectations regarding the following: (1) merchandise revenue
relating to the sale of products from the Toy Story franchise and A Bug's Life;
(2) residual home video sales from all three titles; (3) revenues from potential
worldwide television exhibition of A Bug's Life, Toy Story and Toy Story 2; and
(4) our assumptions, including the timing and amount, for box office receipts
from our upcoming film, Monsters, Inc., targeted for release Thanksgiving 2001.
These statements are forward-looking, and actual results may differ
materially. Factors that could cause actual fiscal year 2000 and 2001 results to
differ include but are not limited to: (1) the timing of the release of the Toy
Story 2 home video in foreign markets and the timing and amount of related
revenues from domestic and foreign home video; (2) the timing and amount of
Monsters, Inc., Toy Story franchise and A Bug's Life merchandise sales; (3) the
timing and amount of revenue from the Buzz Lightyear of Star Command television
series and related home video release; (4) the timing and amount of our
remaining revenues from the home video release of A Bug's Life and Toy Story as
part of Disney's Gold Collection; (5) the timing and amount of worldwide
television revenues for A Bug's Life, Toy Story and Toy Story 2; (6) the timing
of the theatrical release of Monsters, Inc. and the amount of related revenue;
(7) the timing and amount of distribution costs incurred in all markets for
Monsters, Inc., Toy Story 2, Toy Story and A Bug's Life; (8) the timing,
accuracy and sufficiency of the information we receive from Disney to determine
revenues and associated gross profits; and (9) the timing and amount of non-film
related revenues, such as software sales and interest income. See "Risk Factors"
set forth below for important factors that could cause actual results to differ.
RESULTS OF OPERATIONS
REVENUE
Total revenue for the three and nine months ended September 30, 2000 was
$17.3 million and $96.6 million, respectively, compared to $79.2 million and
$96.2 million in the corresponding periods of the prior year. The decrease in
revenues for the three month period as compared to the prior year period can be
attributed to a decrease in film revenue.
Film and animation services revenue for the quarter ended September 30,
2000 was $15.5 million compared with $77.5 million in the corresponding prior
year period. The decrease in revenue from the prior year period was due to the
earlier home video release of A Bug's Life in April 1999, versus the October
2000 home video release of Toy Story 2.
Film revenue for the third quarter of 2000 consisted primarily of $11.8
million of continued merchandise sales, derivative works, and international
television licensing of the Toy Story franchise, as well as recognized royalties
from the direct-to-video release of Buzz Lightyear of Star Command.
Additionally, A Bug's Life contributed $3.7 million to revenue through home
video sales and international premium pay television licensing. Included in film
revenue was approximately $4.0 million of earlier than expected international
television sales from both Toy Story and A Bug's Life, as well as one-time
8
<PAGE> 10
revenues associated with Toy Story interactive games. Film revenue for the nine
months ended September 30, 2000 and October 2, 1999 was $89.4 million and $91.2
million, respectively. Although the amounts were relatively consistent for the
nine month periods, the components varied in each fiscal year. In 1999, A Bug's
Life home video, which was released in April 1999, contributed to revenue for
the nine months ended October 2, 1999. In fiscal year 2000, we had higher
worldwide theatrical revenue for Toy Story 2, which offset the effect of a later
home video release for Toy Story 2 as compared to A Bug's Life in the same prior
year period. Additionally, beginning with the first quarter of 2000, we have had
an improved ability, through information available to us from Disney and other
sources, to estimate and record our share of film revenues and gross profits.
Under the Co-Production Agreement, we share equally with Disney in the profits
of Toy Story 2 and A Bug's Life after Disney recovers its distribution costs and
fees See "Risk Factors -- Dependence on Feature Films."
Animation services revenue includes revenue generated from short projects
related to our feature films. Animation services revenue decreased to $58,000
for the three months ended September 30, 2000 from $185,000 in the corresponding
prior year period and increased to $872,000 for the nine months ended September
30, 2000 from $408,000 in the corresponding prior year period. We expect 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, we transferred
substantially all of our animation services employees to assist in the
completion of both A Bug's Life and Toy Story 2 during peak production periods.
There can be no assurance that we will generate any animation services revenues
during periods in which animation services employees are devoted to feature
films or other projects.
Software revenue includes software license revenue, principally from
RenderMan, and royalty revenue from licensing Physical Effects, Inc. (PEI)
technology to a third party. Software revenue remained relatively constant at
$1.8 million for the three months ended September 30, 2000 versus $1.7 million
in the corresponding prior year period and increased to $6.3 million for the
nine months ended September 30, 2000 from $4.6 million in the corresponding
prior year period. The increase in software revenue resulted primarily from a
general increase in RenderMan software licensing, and to a lesser extent, from
an increase in the royalty revenue from licensing PEI technology to a third
party. PEI, a company we acquired in 1998, licensed certain of its technology to
a third party, from which we now receive associated royalty revenue on a
quarterly basis. Due to our focus on content creation for animated feature films
and related products, we have not increased the time and resources necessary to
generate significantly higher RenderMan sales. Therefore, we expect 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 our 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."
For the three and nine months ended September 30, 2000, Disney accounted
for 92% and 94% respectively, of our total revenue. The revenue from Disney
consisted of film and animation services revenue, and software revenue. Due to
the Co-Production Agreement, Disney is expected to continue to represent
significantly greater than 10% of our revenue in 2000 and for the foreseeable
future. As of September 30, 2000, amounts related to Disney include receivables
which represent 49% of the receivables balance and unearned revenue from Disney,
which represented 91% of unearned revenue on the balance sheet. For the three
and nine months ended October 2, 1999, Disney accounted for 98% and 95%,
respectively, of our total revenue, primarily from film and animation services
revenue.
COST OF REVENUE
Cost of film and animation services revenue for the three months ended
September 30, 2000, decreased to $2.1 million from $21.7 million in the
corresponding prior year period and for the nine months ended September 30,
2000, decreased to $20.7 million from $25.7 million in the corresponding prior
year period. Cost of film revenue represents amortization of capitalized film
costs. See "Capitalized Film Production Costs." For the three months ended
September 30, 2000, cost of film revenue represents amortization of film costs
associated with Toy Story 2 and A Bug's Life, and represents 13% of total film
revenue. For the nine months ended September 30, 2000, cost of film revenue
represents amortization of capitalized film costs
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<PAGE> 11
associated with Toy Story 2 and to a lesser extent, our library titles, and
represents 23% of total film revenue. For the three and nine months ended
October 2, 1999, cost of film revenue represented amortized costs from A Bug's
Life, and was 28% of total film revenue for both periods. The decrease in cost
of revenue as a percent of revenue for the current period as compared to the
prior year periods, can be attributed to revenue relating to Toy Story for which
there was no related cost. Higher than expected Toy Story film revenue resulted
in amortizing all Toy Story related film costs by December 31, 1997.
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 72% for the three months ended September 30, 2000 from 65% in the
corresponding prior year period. Cost of animation services revenue as a
percentage of related revenue was 55% and 67% for the nine months ended
September 30, 2000 and October 2, 1999, respectively. Animation services
projects are negotiated individually and depending on the complexity of the
project, profit margins vary significantly from project to project.
Cost of software revenue consists of the direct costs and manufacturing
overhead required to reproduce and package our 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 7% and 6% for the three and
nine months ended September 30, 2000, compared to 8% and 12% for the three and
nine month corresponding prior year periods. The percentage decreases for the
three and nine months ended September 30, 2000 are due to increases in software
and license sales that have low associated costs. Included in cost of software
revenue for the three and nine months ended September 30, 2000 is $120,000 and
$360,000, respectively, of amortization of $2.7 million of purchased technology
associated with the acquisition of PEI. Over a period not to exceed four years,
we are amortizing this purchased technology against related license revenue. As
a result of the ongoing amortization of purchased technology, our total software
gross profit may be lower during the next few years as compared to software
gross profit prior to the 1998 acquisition. In addition, if we determine 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, we would, at that point, be required to write off all or a
significant portion of the unamortized purchased technology.
OPERATING EXPENSES
Although total operating expenses remained relatively consistent for the
current quarter as compared to the previous quarter, total operating expenses
for the nine months ended September 30, 2000 were higher than in the prior year
corresponding period. We intend to continue to increase our spending levels 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, we have had to pay higher salaries to attract new
creative, technical and other personnel. We expect compensation for such
personnel to continue to increase. In addition, the increase in operating
expenses from the previous period reflects costs associated with the growth of
the studio as we ramp up toward our goal of producing one feature film per year.
Under the Co-Production Agreement, Disney reimburses us for half 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. To the extent that personnel, facilities and
other expenditures are not capitalized by us nor allocated to and paid for by
Disney, and precede or are not subsequently followed by an increase in revenue,
our 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 our RenderMan product and
for our proprietary Marionette and Ringmaster animation and production
management software and for creative development of concepts for future films.
Research and development expenses decreased to $1.4 million in the three months
ended September 30, 2000 from $1.6 million in the corresponding prior year
period, due to a short project in progress in 1999, which was completed in the
second quarter of 2000. For the nine months ended September 30, 2000 research
and development expenses increased to $4.6 million from $4.3 million in the
corresponding prior year period. In
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<PAGE> 12
the first quarter of fiscal year 2000 we recorded a one-time $523,000
adjustment, which reduced our research and development expenses for the nine
months ended September 30, 2000, from $5.1 million to $4.6 million. This
adjustment was due to an additional reimbursement from Disney under the
Co-Production Agreement for certain research and development expenses incurred
prior to fiscal year 2000. After allowing for this adjustment, the increase is
due to our continued investment in proprietary technology, short film projects
and creative development. We expect 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 our software segment. Sales and marketing
expenses increased to $390,000 for the three months ended September 30, 2000
from $338,000 in the corresponding prior year period and increased to $1.1
million for the nine months ended September 30, 2000 from $989,000 in the
corresponding prior year period. Increases in both periods from 1999 are
attributable to increases in corporate marketing and public relations. We
believe that sales and marketing expenses will increase in absolute dollars in
future periods.
General and administrative expenses consist primarily of salaries of
management and administrative personnel, insurance costs and professional fees.
General and administrative expenses increased to $1.9 million for the three
months ended September 30, 2000 from $1.8 million in the corresponding prior
year period and increased to $5.7 million for the nine months ended September
30, 2000 from $4.7 million in the corresponding prior year period. The increase
was due to general and administrative staffing and public company costs. We
expect general and administrative expenses to further increase in absolute
dollars in future periods.
OTHER INCOME
Other income was $3.6 million and $9.5 million for the three and nine
months ended September 30, 2000, respectively, and $1.9 million and $5.6 million
for the three and nine months ended October 2, 1999, respectively, consisting
primarily of interest income on short-term investments. The increase for both
periods is primarily due to an increase in interest rates and an increase in our
average cash, cash equivalents and short-term investment balances through
September 30, 2000.
INCOME TAXES
Income tax expense from continuing operations for the three and nine months
ended September 30, 2000 reflects our federal and state income tax liability of
41.5%, consistent with statutory rates. Income tax expense as a percentage of
pre-tax income for the three and nine months ended October 2, 1999, was 42.0%
and 39.7%, respectively. The income tax rate remained constant for fiscal year
2000 because in 1999, we utilized our remaining net operating loss
carryforwards, except those originating 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. We expect our tax
rate in the future to be at or near statutory levels.
RESULTS OF DISCONTINUED OPERATIONS
After the Co-Production Agreement was executed, we determined that the
resources devoted to our interactive products division would be better allocated
to other projects arising from the Co-Production Agreement. We determined in
1997 to discontinue our business of producing CD-ROM and other interactive
products and redirected employees in that division to film and related projects.
For the nine months ended September 30, 2000 and October 2, 1999, we recorded
income from discontinued operations of $161,000 and $80,000, respectively, net
of income taxes, due to royalty income received. We do not expect to receive any
significant CD-ROM royalty income in future periods.
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<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments increased $24.0 million
to $218.9 million at September 30, 2000 from $194.9 million at January 1, 2000
due primarily to cash received from Disney for our share of film revenue, as
well as software revenue and interest income. This increase was offset by film
production spending and construction spending of $31 million on our new studio
and headquarter facilities in Emeryville, California. On March 16, 2000, we
purchased an existing building on 1.76 acres in Emeryville for $7.7 million.
While it was purchased for potential future expansion, the building presently
serves as rental property, is currently occupied by commercial tenants and has
generated net rental income of $180,000 for the period ended September 30, 2000.
Net cash provided by continuing operations for the nine months ended
September 30, 2000 was primarily attributable to net income of $43.2 million,
the non-cash impact of depreciation and amortization expense and amortization of
capitalized film production costs, totaling $23.7 million, and increases in
unearned revenue and accounts payable totaling $17.6 million, and a decrease in
receivables of $9.8 million, offset by decreases in income taxes payable and
accrued liabilities totaling $15.5 million. Cash flows used in investing
activities were due primarily to investments in short-term securities of $276.7
million, the purchase of property and equipment of $41.1 million and funding of
film production costs of $19.0 million, offset by net proceeds from maturities
of short-term securities of $281.8 million. Cash flows provided by financing
activities were due to proceeds from the exercise of stock options.
As of September 30, 2000, our principal source of liquidity was $218.9
million in cash, cash equivalents and short-term investments. We believe that
these funds will be sufficient to meet our operating requirements through the
next twelve months.
CAPITALIZED FILM PRODUCTION COSTS
We had $63.4 million in capitalized film production costs as of September
30, 2000, consisting primarily of costs relating to Toy Story 2, A Bug's Life,
Monsters, Inc., and Finding Nemo, 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.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 2000, the AICPA issued Statement of Position (SOP) 00-2,
"Accounting by Producers or Distributors of Films." The guidance in this SOP
applies to all types of films, and is applicable to all producers or
distributors that own or hold rights to distribute or exploit films. For
purposes of this SOP, films are defined as feature films, television specials,
television series, or similar products including animated films and television
programming that are sold, licensed or exhibited, whether produced on film,
videotape, digital, or other video recording format. SOP 00-2, which we plan to
adopt in the first quarter of fiscal year 2001, is effective for financial
statements for fiscal years beginning after December 15, 2000. We have evaluated
the pro forma effects of SOP 00-2, and based on that evaluation, we do not
believe SOP 00-2 will have a material effect on our financial statements,
liquidity, or results of operations.
In March 2000, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44, "Accounting for Certain Transactions involving Stock
Compensation, an interpretation of ABP Opinion No. 25." This interpretation
clarifies the application of Opinion 25 for certain issues: (a) the definition
of an employee for purposes of applying Opinion 25; (b) the criteria for
determining whether a plan qualifies as a noncompensatory plan; (c) the
accounting consequences of various modifications to the terms of a previously
fixed stock option or award; and (d) the accounting for an exchange of stock
compensation awards in a business combination. Generally, this interpretation is
effective July 1, 2000. The adoption of Interpretation No. 44 did not have a
material effect on our financial statements, liquidity, or results of
operations.
In June 1998, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities"
(SFAS 133), which as amended by SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities, Deferral of the Effective Date of
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<PAGE> 14
FASB Statement No. 133, and Amendment of FASB Statement No. 133" and SFAS No.
138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities, an amendment of FASB No. 133," issued in June 2000, will be
effective for all fiscal quarters of fiscal years beginning after June 15, 2000.
SFAS 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS 133 generally
provides for matching the timing of gain or loss recognition of (a) the changes
in the fair value of the hedged asset or liability that are attributed to the
hedged risk or (b) the earnings effect of hedged forecasted transactions.
Earlier application of all provisions of this statement is encouraged but it is
permitted only as of the beginning of any fiscal quarter that begins after
issuance of this statement. We do not believe that adoption of this statement
will have a material effect on our financial statements.
RISK FACTORS
For the balance of fiscal year 2000, and for fiscal year 2001, our revenue
and operating results will be largely dependent upon: (1) the timing of the
release of the Toy Story 2 home video in foreign markets and the timing and
amount of related revenues from domestic and foreign home video; (2) the timing
and amount of Monsters, Inc., the Toy Story franchise and A Bug's Life
merchandise sales; (3) the timing and amount of revenue from the Buzz Lightyear
of Star Command television series and related home video release; (4) the timing
and amount of our remaining revenues from the home video release of A Bug's Life
and Toy Story as part of Disney's Gold Collection; (5) the timing and amount of
worldwide television revenues for A Bug's Life, Toy Story and Toy Story 2; (6)
the timing of the theatrical release of Monsters, Inc. and the amount of related
revenue; (7) the timing and amount of distribution costs incurred in all markets
for Monsters, Inc., Toy Story 2, Toy Story and A Bug's Life; (8) the timing,
accuracy and sufficiency of the information we receive from Disney to determine
revenues and associated gross profits; and (9) the timing and amount of non-film
related revenue, such as software sales and interest income.
The following is a discussion of certain factors which currently impact or
may impact our business, operating results and/or financial condition. Anyone
making an investment decision with respect to our capital stock or other
securities is cautioned to carefully consider these factors, along with the
factors discussed in our Form 10-K under the section entitled "Risk Factors."
DEPENDENCE ON FEATURE FILMS
Under the Co-Production Agreement, Pixar and Disney share equally in the
profits of a A Bug's Life, Toy Story 2, and Monsters, Inc. after Disney recovers
its distribution fee and its marketing and distribution costs. Distribution
costs include worldwide theatrical release costs, costs related to merchandise,
Disney's costs to distribute home videos in the United States and foreign
markets, Disney's distribution fee, and other distribution costs such as talent
participation and residuals.
Beginning with the first quarter of 2000, we have had an improved ability,
through information available to us from Disney and other sources, to estimate
and record our share of film revenues and gross profits. While we anticipate
this improved ability will continue to allow us to recognize our share of film
revenues and gross profits on a more timely basis, we will remain dependent on
the timing, accuracy, and sufficiency of the information provided by Disney.
Revenues from Toy Story 2 and A Bugs's Life
We will continue to be significantly dependent upon the success of Toy
Story 2 for the balance of fiscal year 2000 and in fiscal year 2001. We have
already recognized in the first nine months of 2000 essentially all of Toy Story
2 worldwide theatrical revenues, as well as a substantial amount of anticipated
related merchandise revenue. Toy Story 2 was released on home video domestically
on October 17, 2000, and was released in various major international markets,
including the U.K. and Japan, in November 2000. Consequently, we anticipate a
significant amount of expected lifetime worldwide home video revenues from Toy
Story 2 will be recognized in the fourth quarter of 2000. We also expect some
revenues from the Buzz Lightyear of Star
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<PAGE> 15
Command television series and related home video release. However, there is no
guarantee revenues from either of these sources will be sufficient to meet our
targeted earnings for fiscal year 2000. In fiscal year 2001, we anticipate
revenues from continuing worldwide home video sales, merchandising and some
television revenues, however there can be no assurance that such revenues will
be sufficient to meet our targeted earnings.
A Bug's Life was released in November 1998, and we have recognized film
revenues to date of $113 million resulting primarily from the domestic and
foreign theatrical revenues from A Bug's Life, related domestic and foreign home
video revenue, related merchandise licensing, and some television revenue,
offset by Disney's distribution costs and its distribution fee. In line with
Disney's new home video strategy, by which more titles will be available on a
year-round basis, A Bug's Life VHS and DVD were repackaged and released as part
of Disney's Gold Collection on August 1, 2000. We expect sources of revenue for
the balance of 2000 and in fiscal year 2001 to include any remaining revenues
from these home video sales, possibly some television revenues, and any
remaining merchandise royalties; however, there can be no assurance that such
revenues will be sufficient to meet our targeted earnings for the remainder of
2000 and 2001.
Revenue from Monsters, Inc.
While we anticipate Monsters, Inc. will be released as targeted in
Thanksgiving 2001, we cannot guarantee Monsters, Inc. will be released at the
scheduled time, and if it is released as scheduled, whether it will be a box
office success. A significant portion of our anticipated revenues for fiscal
year 2001, are based on the assumption that Monsters, Inc. will be released as
scheduled, and that it will be a relative box office success. If Monsters, Inc.
is not released as scheduled, and is not a relative box office success, it would
adversely affect our 2001 operating results.
Revenue from Toy Story
We have already recognized the majority of the revenue we expect to receive
from Toy Story. Disney re-released the original Toy Story home video, in VHS
format, in January 2000 as part of Disney's Gold Collection, and released the
DVD version of Toy Story for the first time along with the Toy Story 2 home
video release in October 2000. Other than potential revenue from these home
video releases, any additional worldwide television revenues, and any additional
merchandise sales, we do not expect to recognize further significant revenue
from Toy Story.
DIFFICULTY AND RISKS IN FORECASTING THE TOY STORY FRANCHISE, MONSTERS, INC., AND
A BUG'S LIFE REVENUES
It is difficult to forecast the amount and timing of our future revenues
from the Toy Story franchise, Monsters, Inc., and A Bug's Life for the balance
of 2000 and for fiscal year 2001. The amount of future revenues depends not only
on customer acceptance of a film in its worldwide theatrical release, but also
on customer acceptance of related products in each separate release
category -- home video, merchandise and television being the most significant.
While customer acceptance is initially measured by box office success, customer
acceptance within each follow-on product category, such as home video, toys or
television, depends on factors unique to each type of product, such as pricing,
competitive products, and the time of year or state of the economy in which a
product is released, among many other factors. In addition, we have found that
the degree of customer acceptance varies widely among foreign countries. While
box office success is often a good indicator of general customer acceptance, the
relative success of follow-on products is not always directly correlated, and
the degree of correlation is difficult to predict. Disney's strategic
distribution decisions also impact the amount of our future revenues. For
example, in the first half of 1999, Disney 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.
As a result, Disney implemented a new strategy of releasing animated films on
home video year round, and in special editions in both VHS and DVD formats.
However, the relative success of that new strategy is not yet known. For this
reason and all of the above reasons, in spite of Toy Story 2's remarkable box
office success, it is difficult to predict how successful its home video release
will be, or how successful sales of other follow-on products will be for the
balance of 2000 and fiscal year 2001. Similarly, it is difficult to predict
remaining video sales or television
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<PAGE> 16
revenue from A Bug's Life in 2000 and 2001. It is also difficult to predict
theatrical revenue and related merchandise revenue from the anticipated release
of Monsters, Inc. in the fourth quarter of 2001.
With respect to the difficulty of forecasting the timing of revenues,
Disney distributes our films and film-related products and therefore determines
the timing of product releases. While the timing of theatrical releases is
typically known well in advance of release, the timing of release of follow-on
products is often decided just in advance of release, is subject to change, and
is therefore less predictable. For example, it was not until the first quarter
of fiscal year 2000 that it was determined that the Toy Story 2 home video would
be released domestically on October 17, 2000. In all product categories, timing
of revenues is particularly uncertain with respect to releases in foreign
markets as a foreign product release is often marked by a rollout across many
countries over the course of many months. Therefore, the timing of international
revenues is inherently more difficult to predict than the timing of domestic
revenues. In addition, the amount of revenue recognized in any given quarter or
quarters from all of our films depends on the timing, accuracy, and sufficiency
of the information we receive from Disney to determine revenues and associated
gross profits. Although we obtain from Disney the most current information
available to recognize our share of revenue and to determine our film gross
profit, Disney may make subsequent adjustments to the information that it has
provided which could have a material impact on us in later periods. For
instance, towards the end of the life cycle for a revenue stream, Disney may
inform us of additional distribution costs to those previously forecasted, as
occurred in the second quarter of fiscal year 2000. Such adjustments have and
may continue to impact our revenue share and our film gross profit. Due to these
factors, the amount and timing of our future revenues from Toy Story 2 and A
Bug's Life are difficult to forecast, and it is possible, in any given quarter,
that we will not recognize sufficient film revenue to generate significant
earnings.
Under the Co-Production Agreement, Pixar and Disney share the production
costs of our feature films. We initially capitalized our share of these costs as
film production costs. Our policy is to amortize these costs over the expected
revenue streams as we recognize revenues from the associated films. The amount
of film costs that will be amortized each quarter will depend on how much future
revenue we expect to receive from each film. In any given quarter, if our
forecast changes with respect to total anticipated revenue from any individual
feature film and becomes lower than was previously forecasted, we would be
required to accelerate amortization of related film costs, resulting in lower
gross margins. Such lower gross margins would adversely impact our business,
operating results, and financial condition.
WE EXPECT OUR OPERATING RESULTS TO CONTINUE TO FLUCTUATE
Fluctuations in Revenue
We continue to expect significant fluctuations in our future annual and
quarterly revenues 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 could fluctuate
significantly from film to film),
- the timing of the release of related products into their respective
markets (such as home videos, television, and merchandising),
- the demand for such related products (which is often a function of the
success of the related animated feature film),
- Disney's costs to distribute and promote the feature films and related
products,
- Disney's success at marketing the feature films and related products,
- the timing and accuracy of information received from Disney and other
sources on which we base estimates of revenue to be recognized from our
animated feature films and related products by Disney,
- the introduction of new feature films or products by our 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
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<PAGE> 17
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, 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.
Fluctuations in Operating Expenses
Increase in Our Operating Expenses and Effective Tax Rate. Over the last
few years, 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, (3) increased costs associated with the expansion of our facilities,
and (4) increased investment in creative development. 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 2000. Finally, our tax rate in
the first nine months of fiscal year 2000 approximates statutory levels and is
expected to remain at that level in future periods because we have utilized our
remaining net operating loss carryforwards, except those which originated as
non-qualified employee stock option costs. The realization of tax benefits from
non-qualified employee stock option costs will not reduce our effective tax rate
in the future.
Difficulty in Predicting Operating Expenses. 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. 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 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, 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 , our reported
operating expenses for the first nine months of fiscal year 2000 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We invest 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 our policy to ensure safety of our principal and maintain liquidity. We
only invest in securities with a maturity of 24 months or less, with only
government obligations exceeding 12 months. Our 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 our financial instruments are held for purposes other than trading
and are considered "available for sale" per SFAS 115, "Accounting for Certain
Investments in Debt and Equity Securities." The table below
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<PAGE> 18
provides information regarding our investment portfolio at September 30, 2000.
The table presents principal cash flows and related weighted-average fixed
interest rates presented by expected maturity date (dollars in thousands):
<TABLE>
<CAPTION>
LESS THAN OVER
1 YEAR 1 YEAR TOTAL
--------- ------- --------
<S> <C> <C> <C>
Available-for-sale securities....................... $178,645 $32,060 $210,705
Weighted-average interest rate...................... 6.12% 6.63% 6.20%
</TABLE>
While our products are distributed in foreign markets by Disney and its
affiliates, we derive no direct revenues from foreign markets. However, our
revenue share estimate is affected by foreign currency fluctuations as managed
by Disney.
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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
September 30, 2000.
ITEMS 1, 2, 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PIXAR
By: /s/ ANN MATHER
------------------------------------
Ann Mather,
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting
Officer and Duly Authorized
Officer)
Date: November 14, 2000
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EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBITS DESCRIPTION
-------- -----------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
20
