- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
<Table>
(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 29, 2001.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
</Table>
COMMISSION FILE NUMBER: 0-26976
PIXAR
(Exact name of registrant as specified in its charter)
<Table>
CALIFORNIA 68-0086179
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
1200 PARK AVENUE, EMERYVILLE, CALIFORNIA 94608
(Address of principal executive offices) (Zip code)
</Table>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 752-3000
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 2, 2001 was 48,646,821.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PIXAR
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<Table>
<Caption>
SEPTEMBER 29, DECEMBER 30,
2001 2000
------------- ------------
ASSETS
Cash and cash equivalents................................... $ 40,027 $ 63,241
Short-term investments...................................... 250,029 139,514
Trade receivables, net...................................... 682 1,136
Receivable from Disney...................................... 2,712 73,850
Other receivables........................................... 5,826 3,121
Prepaid expenses and other assets........................... 3,234 4,903
Deferred income taxes....................................... 24,805 25,915
Property and equipment, net................................. 112,421 110,891
Capitalized film production costs........................... 82,472 57,032
-------- --------
Total assets...................................... $522,208 $479,603
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable............................................ $ 360 $ 1,622
Income taxes payable........................................ 4,130 9,650
Accrued liabilities......................................... 14,374 17,229
Unearned revenue............................................ 21,946 15,382
-------- --------
Total liabilities................................. 40,810 43,883
-------- --------
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;
48,406,796 and 47,633,372 shares issued and outstanding
as of September 29, 2001 and December 30, 2000,
respectively........................................... 313,825 293,209
Accumulated other comprehensive income.................... 2,127 249
Retained earnings......................................... 165,446 142,262
-------- --------
Total shareholders' equity........................ 481,398 435,720
-------- --------
Total liabilities and shareholders' equity........ $522,208 $479,603
======== ========
</Table>
See accompanying notes to financial statements.
1
PIXAR
STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
QUARTER ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
SEPTEMBER 29, SEPTEMBER 30, SEPTEMBER 29, SEPTEMBER 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
Revenue:
Film and animation services............. $ 9,836 $15,511 $38,643 $90,290
Software................................ 1,481 1,785 5,490 6,317
------- ------- ------- -------
Total revenue................... 11,317 17,296 44,133 96,607
------- ------- ------- -------
Cost of revenue:
Film and animation services............. 1,989 2,061 6,520 20,662
Software................................ 131 129 422 408
------- ------- ------- -------
Total cost of revenue........... 2,120 2,190 6,942 21,070
------- ------- ------- -------
Gross profit.................... 9,197 15,106 37,191 75,537
------- ------- ------- -------
Operating expenses:
Research and development................ 1,840 1,404 4,948 4,579
Sales and marketing..................... 541 390 1,350 1,117
General and administrative.............. 2,101 1,873 6,039 5,694
------- ------- ------- -------
Total operating expenses........ 4,482 3,667 12,337 11,390
------- ------- ------- -------
Income from continuing
operations.................... 4,715 11,439 24,854 64,147
Other income, net......................... 5,093 3,579 11,760 9,474
------- ------- ------- -------
Income from continuing
operations before income
taxes......................... 9,808 15,018 36,614 73,621
Income tax expense........................ 3,643 6,232 13,602 30,553
------- ------- ------- -------
Net income from continuing
operations.................... 6,165 8,786 23,012 43,068
Income from discontinued operations, net
of taxes................................ -- 35 172 161
------- ------- ------- -------
Net income...................... $ 6,165 $ 8,821 $23,184 $43,229
======= ======= ======= =======
Basic net income per share from continuing
operations.............................. $ 0.13 $ 0.19 $ 0.48 $ 0.91
Basic net income per share from
discontinued operations................. -- -- -- 0.01
------- ------- ------- -------
Basic net income per share................ $ 0.13 $ 0.19 $ 0.48 $ 0.92
======= ======= ======= =======
Shares used in computing basic net income
per share............................... 48,328 47,376 48,002 47,187
======= ======= ======= =======
Diluted net income per share from
continuing operations................... $ 0.12 $ 0.18 $ 0.45 $ 0.86
Diluted net income per share from
discontinued operations................. -- -- -- 0.01
------- ------- ------- -------
Diluted net income per share.............. $ 0.12 $ 0.18 $ 0.45 $ 0.87
======= ======= ======= =======
Shares used in computing diluted net
income per share........................ 52,090 49,837 51,400 49,918
======= ======= ======= =======
</Table>
See accompanying notes to financial statements.
2
PIXAR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Cash flows from operating activities:
Net income................................................ $ 23,184 $ 43,229
Adjustments to reconcile net income to net cash provided
by continuing operating activities:
Discontinued operations................................ (172) (161)
Depreciation and amortization.......................... 5,988 3,545
Amortization of capitalized film production costs...... 6,347 20,178
Tax benefit from option exercises...................... 5,835 5,537
Deferred income tax.................................... 1,110 218
Changes in operating assets and liabilities:
Receivables, net..................................... (2,251) 12,356
Due from Disney...................................... 71,138 (2,555)
Prepaid expenses and other assets.................... 1,309 (863)
Accounts payable..................................... (1,262) 2,397
Income taxes payable................................. (5,520) (16,757)
Accrued liabilities.................................. (2,855) (4,304)
Unearned revenue..................................... 6,564 15,157
--------- ---------
Net cash provided by continuing operations........ 109,415 77,977
Net cash provided by discontinued operations...... 172 161
--------- ---------
Net cash provided by operating activities......... 109,587 78,138
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment........................ (7,179) (41,100)
Proceeds from sale of equipment........................... -- 399
Proceeds from sale of short-term securities............... 156,595 281,789
Investments in short-term securities...................... (265,232) (276,928)
Capitalized film production costs......................... (31,766) (19,044)
--------- ---------
Net cash used in investing activities............. (147,582) (54,884)
--------- ---------
Cash flows from financing activities:
Proceeds from exercised stock options..................... 14,781 5,267
--------- ---------
Net cash provided by financing activities......... 14,781 5,267
--------- ---------
Net increase (decrease) in cash and cash equivalents........ (23,214) 28,521
Cash and cash equivalents at beginning of period............ 63,241 31,170
--------- ---------
Cash and cash equivalents at end of period.................. $ 40,027 $ 59,691
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes.............. $ 13,800 $ 41,886
========= =========
Supplemental disclosure of non-cash investing and financing
activities:
Loss on equipment disposals capitalized as film production
costs.................................................. $ 21 $ 396
========= =========
Unrealized gain on investments............................ $ 1,878 $ 308
========= =========
</Table>
See accompanying notes to financial statements.
3
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 December 30, 2000 and for each of the years
in the three-year period ended December 30, 2000, including notes thereto.
The results of operations for the three and nine months ended September 29,
2001 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 2001 financial statement presentation.
(2) FISCAL YEAR
Effective for fiscal year 1998, Pixar (the "Company") adopted a 52- or
53-week fiscal year, changing the year end dates from December 31 to the
Saturday nearest December 31. Fiscal year 2001 will end on December 29, 2001 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 potential
common shares outstanding during the period, using the treasury stock method for
options and warrants. Of the outstanding options to purchase shares of common
stock, for the three and nine month periods ended September 29, 2001, options to
purchase approximately 345,000 shares and 545,000 shares of common stock 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 29, SEPTEMBER 30,
2001 2000
----------------------- -----------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------ ------ ----- ------ ------ -----
Basic net income per share.................. $6,165 48,328 $0.13 $8,821 47,376 $0.19
Effect of dilutive shares:
Warrants/options.......................... -- 3,762 -- 2,461
------ ------ ------ ------
Diluted net income per share................ $6,165 52,090 $0.12 $8,821 49,837 $0.18
====== ====== ====== ======
</Table>
4
PIXAR
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
NINE MONTHS ENDED
---------------------------------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------------------ ------------------------
NET NET
INCOME SHARES EPS INCOME SHARES EPS
------- ------ ----- ------- ------ -----
Basic net income per share................ $23,184 48,002 $0.48 $43,229 47,187 $0.92
Effect of dilutive shares:
Warrants/options........................ -- 3,398 -- 2,731
------- ------ ------- ------
Diluted net income per share.............. $23,184 51,400 $0.45 $43,229 49,918 $0.87
======= ====== ======= ======
</Table>
(4) COMPREHENSIVE INCOME
Other comprehensive income consists of unrealized holding gains or losses
on the Company's short-term investments. The following table sets forth the
calculation of comprehensive income, net of income taxes (in thousands):
<Table>
<Caption>
QUARTER ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Net income................................................. $6,165 $8,821
Unrealized holding gains on short-term investments......... 1,629 222
------ ------
Comprehensive income....................................... $7,794 $9,043
====== ======
</Table>
<Table>
<Caption>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Net income................................................. $23,184 $43,229
Unrealized holding gains on short-term investments......... 1,878 308
------- -------
Comprehensive income....................................... $25,062 $43,537
======= =======
</Table>
(5) FEATURE FILM AND CO-PRODUCTION AGREEMENTS
FEATURE FILM AGREEMENT
In 1991, the Company entered into a feature film agreement with Walt Disney
Pictures, a wholly owned subsidiary of Walt Disney Pictures and Television
(together with its subsidiaries and affiliates collectively referred to herein
as "Disney"), to develop and produce up to three computer-animated feature films
(the "Feature Film Agreement"). The Company is entitled to receive compensation
based on revenue from the distribution of these films and related products. In
1995, the Company released its first feature film under the terms of the Feature
Film Agreement, Toy Story.
CO-PRODUCTION AGREEMENT
In February 1997, Pixar and Disney entered into a new co-production
agreement (the "Co-Production Agreement") which now governs all films made by
the Company since Toy Story. Under the Co-Production Agreement, Pixar, on an
exclusive basis, agreed to produce five original computer-animated theatrical
motion pictures (the "Pictures") for distribution by Disney. 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 is responsible for the production of each Picture and Disney
is responsible for the marketing, promotion, publicity, advertising and
distribution of
5
PIXAR
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
each Picture. The first original film produced under the Co-Production Agreement
was A Bug's Life. Films in development or production at Pixar governed by this
agreement include Monsters, Inc., Finding Nemo, the Company's sixth film "Film
Six" and the Company's seventh film "Film Seven." A Bug's Life, Monsters, Inc.,
Finding Nemo, Film Six and Film Seven count toward the five original Pictures,
whereas Toy Story 2, as a sequel, is a derivative work that will not count
toward the Pictures. However, under the Co-Production Agreement, all provisions
applicable to the Pictures also apply to derivative works such as Toy Story 2.
All payments to Pixar from Disney for development and production of Toy
Story under the Feature Film Agreement, and A Bug's Life, Toy Story 2, Monsters,
Inc., Finding Nemo, Film Six, and Film Seven under the Co-Production Agreement
have been recorded as cost reimbursements. Accordingly, no revenue has been
recognized for such reimbursements; rather, the Company has netted the
reimbursements against the related costs.
CREATIVE DEVELOPMENT GROUP
In addition to the films produced and in process under the Co-Production
Agreement, Pixar's creative development group is working on concept development
for several new projects that are not governed by the Co-Production Agreement.
Costs related to these projects are therefore not shared or reimbursed by
Disney. Such costs are capitalized as film costs and will be amortized under the
film forecast method assuming the concept development leads to a successful
concept and realization of a film project when it is expected that the film will
be set for production. In the event a film is not set for production within
three years from the time of the first capitalized transaction, such costs will
be expensed.
The total film production costs and related amounts capitalized are as
follows (in thousands):
<Table>
<Caption>
SEPTEMBER 29,
2001
-------------
RELEASED FILMS.............................................. $ 87,776
Cumulative amortization of film production costs............ (75,826)
--------
Total film production costs capitalized for
released films.................................. 11,950
FILMS IN PRODUCTION......................................... 58,476
FILMS IN DEVELOPMENT OR PREPRODUCTION....................... 12,046
--------
Total film production costs capitalized........... $ 82,472
========
</Table>
Under the Co-Production Agreement, certain operating expenses benefiting
the productions, such as certain research and development and certain general
and administrative expenses, are paid half by Pixar and half by Disney. From the
beginning of each respective fiscal year, the Company recorded the following
amounts reimbursed by Disney as offsets to the following expense categories (in
thousands):
<Table>
<Caption>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Research and development................................... $3,700 $3,660
General and administrative................................. 2,560 2,109
------ ------
Total............................................ $6,260 $5,769
====== ======
</Table>
At September 29, 2001 and December 30, 2000, the receivable from Disney
aggregated $2.7 million and $73.9 million, respectively, which consists of a
receivable from Disney for film revenue, advances net of Disney's actual share
of expenditures for all films, amounts due for animation services and
miscellaneous reimbursements.
6
PIXAR
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
For released films, the Company expects to amortize, based on current
estimates, approximately $3 million to $5 million in capitalized film production
costs over the succeeding twelve-month period. This forecast does not include
Monsters, Inc., which was released domestically on November 2, 2001. In
addition, the Company has amortized more than 80% of each released film's
original production costs as of September 29, 2001.
(6) SEGMENT REPORTING
The Company adopted the provisions of SFAS 131, "Disclosures about Segments
of an Enterprise and Related Information." The chief operating decision-maker is
considered to be the Company's 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 performance. The summary financial information reviewed by
the CEO is identical to the information presented in the accompanying statement
of income and the Company has no foreign operations. Therefore, the Company
operates in a single operating segment.
The Company's revenue segment information by film category follows (in
thousands):
<Table>
<Caption>
QUARTER ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Toy Story 2................................................ $7,287 $ 6,380
Library titles(1).......................................... 2,352 9,073
Animation services......................................... 197 58
------ -------
$9,836 $15,511
====== =======
</Table>
<Table>
<Caption>
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 29, SEPTEMBER 30,
2001 2000
------------- -------------
Toy Story 2................................................ $17,717 $73,621
Library titles(1).......................................... 20,716 15,797
Animation services......................................... 210 872
------- -------
$38,643 $90,290
======= =======
</Table>
- ---------------
(1) Library titles include A Bug's Life and Toy Story.
(7) EMPLOYMENT AGREEMENT
In March 2001, the Company entered into an employment agreement with John
Lasseter, (the "Employment Agreement"), which has a term of 10 years. Mr.
Lasseter is a two-time Academy Award(R)-winning director and animator. In
addition to serving as head of all of the Company's creative projects, he
directed Toy Story, the first feature-length computer animated film (for which
he won a Special Achievement Academy Award(R)), A Bug's Life and Toy Story 2. He
is currently in development on his fourth feature film for the Company. This
Employment Agreement supercedes the Company's prior employment agreement with
Mr. Lasseter, which was entered into in February 1997. Pursuant to the
Employment Agreement, Mr. Lasseter received a signing bonus of $4,940,000. The
Employment Agreement also provides for a current annual salary of $2,500,000
with 5% annual increases. In connection with the Employment Agreement, Mr.
Lasseter was previously granted an option to purchase 1,000,000 shares of our
common stock at the fair market value on the date of such grant. The option
vests on an equal monthly basis over the ten-year term of
7
PIXAR
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the agreement, except for options that vest on the last month will vest on the
penultimate month of this ten-year period.
(8) NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible
Assets", which supersedes APB 17, "Intangible Assets". SFAS 142 addresses the
accounting treatment for goodwill and other intangible assets acquired
individually or with a group of other assets upon their acquisition, but not
acquired in a business combination. This statement also addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. With the adoption of SFAS 142,
goodwill is no longer subject to amortization over its estimated useful life;
rather, goodwill will be subject to at least an annual assessment for impairment
by applying a fair-value-based test. Also, if the benefit of an intangible asset
is obtained through contractual or other legal rights, or if the intangible
asset can be sold, transferred, licensed, rented or exchanged, an acquired
intangible asset should be separately recognized. The terms of SFAS 142 are
effective as of the beginning of the first quarter of the fiscal year beginning
after December 15, 2001. Certain provisions of SFAS 142 shall be applied to
goodwill and other acquired intangible assets for which the acquisition date is
after June 30, 2001. The Company does not expect the adoption of SFAS 142 to
have a material impact on its financial position or results of operations.
On October 3, 2001, the Financial Accounting Standards Board issued FASB
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, ("SFAS 144") which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS 144 supersedes FASB Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and also supersedes the accounting and reporting
provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions, for the disposal of a
segment of a business. SFAS 144 is effective for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. The Company is
in the process of determining the impact of this new accounting standard.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This
Statement addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. This Statement applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development or normal use of the asset. As used in this Statement,
a legal obligation results from existing law, statute, ordinance, written or
oral contract, or by legal construction of a contract under the doctrine of
promissory estoppel. SFAS 143 is effective for fiscal years beginning after June
15, 2002. The Company does not expect the adoption of SFAS 143 to have a
material impact on its financial position or results of operations.
(9) SUBSEQUENT EVENT
In conjunction with the signing of the Co-Production Agreement, Pixar
issued to Disney two warrants, each exercisable for five years: one warrant to
purchase 750,000 shares of Common Stock at an exercise price of $20.00 per share
and another warrant to purchase 750,000 shares of Common Stock at an exercise
price of $25.00 per share. On October 25, 2001, pursuant to the terms of the
Common Stock Purchase Warrant Agreement, Disney fully exercised both warrants.
In lieu of exercising the warrants for cash, Disney surrendered the warrants in
exchange for 640,651 shares of Common Stock.
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 our industry, management's beliefs, and
assumptions made by management. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict; therefore, actual results and outcomes may differ materially from what
is expressed or forecasted in any such forward-looking statements. Such risks
and uncertainties include those set forth herein under Risk Factors on pages 14
to 18. Particular attention should be paid to the cautionary language in Risk
Factors "-- To meet our fiscal 2001 diluted earning per share target, we must
receive sufficient revenues primarily from our feature films and, to a lesser
extent, our non-film related sources," "-- Our operating results have fluctuated
in the past and we expect such fluctuations to continue," and "-- Our scheduled
successive releases of feature films will continue to place a significant strain
on our resources," as well as those noted in the section entitled "Risk Factors"
in our Annual Report on Form 10-K for the year ended December 30, 2000, as
amended (the "Form 10-K"). 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.
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.
OVERVIEW
In February 1997, we entered into the Co-Production Agreement with Disney
pursuant to which we, on an exclusive basis, agreed 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 as well as other
ancillary products, after recovery of all marketing and distribution costs
(which Disney finances), a distribution fee paid to Disney and any other fees or
costs, including any participations provided to talent and the like. The
Co-Production Agreement generally provides that we will be responsible for the
production of each Picture, while Disney will be responsible for the 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 and therefore it does not count toward the five original Pictures to be
produced under the Co-Production Agreement. However, as a derivative work, Toy
Story 2 is treated as a Picture under the Co-Production Agreement, and all the
provisions applicable to the five original Pictures apply.
On November 2, 2001, we released Monsters, Inc., our fourth animated
feature film, which counts as the second original Picture under the
Co-Production Agreement. In 2000, we began production on our fifth animated
feature film, Finding Nemo. We began concept development on our sixth animated
feature film
9
"Film Six" and seventh animated feature film, "Film Seven," in 1999 and 2000,
respectively. These films will be produced and distributed under the
Co-Production Agreement and will count as the third, fourth, and fifth films of
the five original films to be produced under the Co-Production Agreement. We
expect to release Finding Nemo in summer 2003 at the earliest. Film Six and Film
Seven are currently targeted for release no earlier than 2004 and 2005,
respectively.
TARGET EARNINGS PER SHARE FOR FISCAL YEAR 2001
We are targeting diluted earnings per share of about $.60 for fiscal year
2001. This estimate is primarily based on the results from the first nine months
of the fiscal year and our current expectations regarding the following: (1)
initial theatrical and merchandise revenues from Monsters, Inc., released
domestically on November 2, 2001; and (2) licensing of international television
rights, continuing home video and merchandise revenue from Toy Story, A Bug's
Life and Toy Story 2.
These statements regarding our targeted earnings are forward-looking, and
actual results may differ materially. Factors that could cause actual fiscal
year 2001 results to differ include but are not limited to: (1) the timing and
amount of revenues from the worldwide theatrical release of Monsters, Inc.; (2)
the timing and amount of related revenues from all home video releases of our
films and the Buzz Lightyear of Star Command direct-to-video; (3) the timing and
amount of Monsters, Inc., Toy Story franchise, and A Bug's Life merchandise
sales and ancillary royalties; (4) the timing and amount of worldwide television
revenues from our films; (5) the timing and amount of distribution costs
incurred in all markets for our films; (6) the timing, accuracy, and sufficiency
of the information we receive from Disney to determine revenues and associated
gross profits; (7) the timing and amount of non-film related revenues and
expenses, such as software licensing, interest income and effective income tax
rate; (8) the market price of our common stock and related volatility; (9)
political and economic events beyond our control; and (10) the competitive
environment entering the holiday season. See "Risk Factors" set forth below for
a more detailed discussion of factors that could cause actual results to differ.
RESULTS OF OPERATIONS
REVENUE
Total revenue for the three and nine months ended September 29, 2001 were
$11.3 million and $44.1 million, respectively, compared to $17.3 million and
$96.6 million in the corresponding periods of the prior year.
Film and animation services revenue for the three months ended September
29, 2001 were $9.8 million compared with $15.5 million in the corresponding
prior year period. Film revenue for the three months ended September 29, 2001
included domestic network television licensing of Toy Story and Toy Story 2,
merchandise sales, derivative works and ancillary royalties. These revenues were
partially offset by additional expenses associated with home video sales. Film
revenue for the three months ended September 30, 2000 were comprised of
continued merchandise sales, home video sales, derivative works and
international television licensing of A Bug's Life and the Toy Story franchise,
as well as royalties from the direct to video release of Buzz Lightyear of Star
Command.
Film and animation services revenue for the nine months ended September 29,
2001 were $38.6 million compared to $90.3 million in the corresponding prior
year period. The decrease in the current nine-month period from the
corresponding prior year period was largely due to the timing and success of Toy
Story 2's theatrical performance in the first quarter of 2000.
Software revenue includes software license revenue, principally from
RenderMan(R), and royalty revenue from licensing Physical Effects, Inc. (PEI)
technology to a third party. Software revenue decreased to $1.5 million for the
three months ended September 29, 2001 compared to $1.8 million in the
corresponding period of the prior year and decreased to $5.5 million for the
nine months ended September 29, 2001 from $6.3 million in the corresponding
prior year period. The overall decrease in revenue for the nine month period
ended September 29, 2001 resulted primarily from decreases in RenderMan(R)
software licensing during the
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period and to a lesser extent, from a decrease in 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(R) sales.
Therefore, we expect ongoing variability in revenues derived from software
licenses and that such revenue will remain flat or possibly decline, as seen for
the nine month period ended September 29, 2001.
For the three and nine months ended September 29, 2001, Disney accounted
for 87% and 88%, respectively, of our total revenue compared to 92% and 94%,
respectively, for the corresponding periods of the prior year. The revenue from
Disney consisted primarily of film related revenue and to a lesser extent some
animation services revenue. Because of our relationship with Disney under the
Co-Production Agreement, Disney is expected to continue to represent
significantly greater than 10% of our revenue in 2001 and for the foreseeable
future. As of September 29, 2001, amounts related to Disney include unearned
revenue from Disney, which represents 95% of unearned revenue on the balance
sheet.
COST OF REVENUE
Cost of film and animation services revenue for the three and nine months
ended September 29, 2001 was $2.0 million and $6.5 million, respectively,
compared to $2.1 million and $20.7 million, respectively, in the corresponding
prior year periods. Cost of film revenue represents amortization of capitalized
film production costs. See "Capitalized Film Production Costs." For the three
and nine months ended September 29, 2001, cost of film and animation services
revenue represents amortization of capitalized film production costs associated
with Toy Story 2 and A Bug's Life, and represents 20% and 17%, respectively, of
total film revenue as compared to 13% and 23%, respectively, for the
corresponding prior year periods. The increase in cost of revenue as a percent
of revenue for the three month period ended September 29, 2001 as compared to
the prior year period, is primarily attributable to the mix of film revenue from
quarter to quarter as the gross profit margin varies by film. For example, Toy
Story and A Bug's Life have lower amortized costs as a percentage of revenue
relative to Toy Story 2. Toy Story revenue has no related cost, as film costs
were fully amortized by December 31, 1997. Since the majority of revenues for
the quarter ended September 29, 2001 related to Toy Story 2, the cost of revenue
percentage was higher. Cost of revenue as a percent of revenue decreased for the
nine months ended September 29, 2001 as compared to the prior year period, as
the prior year period experienced a higher mix of Toy Story 2 revenue resulting
in an increase in cost of film revenue.
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 as a percentage
of the related revenue was 9% and 8% for the three and nine months ended
September 29, 2001, respectively, compared to 7% and 6%, respectively, for the
three and nine month corresponding prior year periods. Cost of software revenue
for the three and nine months ended September 29, 2001 and September 30, 2000,
relates primarily to amortization of purchased technology associated with the
acquisition of PEI of $120,000 and $360,000, respectively, in both years. We are
amortizing this purchased technology against related license revenue over a
period not to exceed four years.
OPERATING EXPENSES
Total operating expenses were $4.5 million and $12.3 million for the three
and nine months ended September 29, 2001, respectively, compared to $3.7 million
and $11.4 million in the corresponding prior year periods. We anticipate an
increase in operating expenses in future periods impacting a number of areas. We
expect future operating expenses to reflect 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.
11
Research and Development. Research and development expenses consist
primarily of salaries and support for personnel conducting research and
development for our RenderMan(R) software and for our proprietary Marionette and
Ringmaster animation and production management software and for creative
development for future films. Research and development expenses increased to
$1.8 million and $4.9 million, respectively, for the three and nine months ended
September 29, 2001 from $1.4 million and $4.6 million, respectively, in the
corresponding prior year periods. During the first quarter of fiscal year 2000
we recorded a one-time adjustment of $523,000, 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 terms of the Co-Production Agreement for certain research
and development expenses incurred prior to fiscal year 2000. After allowing for
this adjustment, the decrease in research and development expenses for the nine
months ended September 29, 2001 from the same period in 2000, was due to reduced
short film project costs in the current period. The increase for the three
months ended September 29, 2001 from the same period in the prior year, was
primarily due to increases in employee related expenses associated with
additional staffing. 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. Sales and marketing expenses consist primarily of
salaries and related overhead, as well as public relations, advertising,
technical support and trade show costs required to support our software segment.
Sales and marketing expenses increased to $541,000 and $1.3 million,
respectively, for the three and nine months ended September 29, 2001, from
$390,000 and $1.1 million, respectively, in the corresponding prior year
periods. The increase is primarily due to additional expenses associated with
the corporate marketing and creative resources departments in preparation for
the release of our new film, Monsters, Inc. We believe that sales and marketing
expenses will increase in future periods, particularly in the areas of public
relations and corporate marketing.
General and Administrative. General and administrative expenses consist
primarily of salaries of management and administrative personnel, insurance
costs and professional fees. General and administrative expenses increased to
$2.1 million and $6.0 million, respectively, for the three and nine months ended
September 29, 2001 from $1.9 million and $5.7 million, respectively, in the
corresponding prior year periods. The increase is a result of employee related
costs and insurance, which was offset by reductions in public company costs.
General and administrative expenses may increase in future periods.
OTHER INCOME, NET
Other income, net was $5.1 million and $11.8 million, respectively, for the
three and nine months ended September 29, 2001 and $3.6 million and $9.5
million, respectively, in the corresponding prior year periods. Other income for
the quarter ended September 29, 2001 includes interest income and a one time,
non-recurring settlement of approximately $2 million not derived from our
ordinary course of business. The increase relates primarily to this settlement,
but was partially offset by decreases in interest income due to falling interest
rates during 2001.
INCOME TAXES
Income tax expense from continuing operations for the three and nine months
ended September 29, 2001 reflects our federal and state income tax expense of
37.1% versus 41.5% in the same period of the prior year. Our income tax rate is
lower in 2001 due to the utilization of research and experimentation credits for
federal and state tax purposes, as well as the utilization of certain other
state credits and exemptions.
CAPITALIZED FILM PRODUCTION COSTS
We had $82.5 million in capitalized film production costs as of September
29, 2001, consisting primarily of costs relating to Toy Story 2, A Bug's Life,
Monsters, Inc., Finding Nemo, Film Six, and Film Seven, 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.
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LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments increased $87.3 million
to $290.1 million at September 29, 2001 from $202.8 million at December 30, 2000
due primarily to cash received from Disney for our share of film revenue, as
well as proceeds from stock option exercises, software revenue and interest
income, which was offset by film production spending and capital expenditures.
Net cash provided by continuing operations for the nine months ended
September 29, 2001 was primarily attributable to net income of $23.2 million,
the non-cash impact of depreciation and amortization expense and amortization of
capitalized film production costs totaling $12.3 million, the tax benefit from
option exercises of $5.8 million, a decrease in receivables from Disney of $71.1
million and an increase in unearned revenue of $6.6 million, which were offset
by decreases in income taxes payable and accrued liabilities totaling $8.4
million. Net cash used in investing activities primarily consisted of
investments in short-term securities of $265.2 million, the purchase of property
and equipment of $7.2 million and funding of film production costs of $31.8
million, which were offset by net proceeds from sales of short-term investments
of $156.6 million. Net cash provided by financing activities consisted of
proceeds from exercised stock options.
As of September 29, 2001, our principal source of liquidity was $290.1
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.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS 142, "Goodwill and Other Intangible
Assets", which supersedes APB 17, "Intangible Assets". SFAS 142 addresses the
accounting treatment for goodwill and other intangible assets acquired
individually or with a group of other assets upon their acquisition, but not
acquired in a business combination. This statement also addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. With the adoption of SFAS 142,
goodwill is no longer subject to amortization over its estimated useful life;
rather, goodwill will be subject to at least an annual assessment for impairment
by applying a fair-value-based test. Also, if the benefit of an intangible asset
is obtained through contractual or other legal rights, or if the intangible
asset can be sold, transferred, licensed, rented or exchanged, an acquired
intangible asset should be separately recognized. The terms of SFAS 142 are
effective as of the beginning of the first quarter of the fiscal year beginning
after December 15, 2001. Certain provisions of SFAS 142 shall be applied to
goodwill and other acquired intangible assets for which the acquisition date is
after June 30, 2001. We do not expect the adoption of SFAS 142 to have a
material impact on our financial position or results of operations
On October 3, 2001, the Financial Accounting Standards Board issued FASB
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, ("SFAS 144") which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. SFAS 144 supersedes FASB Statement
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of, and also supersedes the accounting and reporting
provisions of APB Opinion No. 30, Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions, for the disposal of a
segment of a business. SFAS 144 is effective for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. The Company is
in the process of determining the impact of this new accounting standard.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"). This
Statement addresses financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. This Statement applies to legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development or normal use of the asset. As used in this Statement,
a legal obligation results from existing law, statute, ordinance, written or
oral contract, or by legal construction of a contract under the doctrine of
promissory estoppel. SFAS 143 is effective for fiscal years beginning after June
15, 2002. We do not expect the adoption of SFAS 143 to have a material impact on
our financial position or results of operations.
13
RISK FACTORS
The following is a discussion of certain factors that currently impact or
may impact our business, operating results and/or financial condition. In
addition, please refer to the section entitled "Risk Factors" in our Form 10-K,
as amended, for additional factors that may impact our business, operating
results and/or financial condition in the future. You should carefully consider
these factors before making an investment decision with respect to our Common
Stock.
TO MEET OUR FISCAL 2001 DILUTED EARNINGS PER SHARE TARGET, WE MUST RECEIVE
SUFFICIENT REVENUES PRIMARILY FROM OUR FEATURE FILMS AND, TO A LESSER EXTENT,
OUR NON-FILM RELATED SOURCES.
In 2001, our revenue and operating results will be largely dependent upon
(1) the timing and amount of revenues from the worldwide theatrical release of
Monsters, Inc.; (2) the timing and amount of related revenues from all home
video releases of our films and the Buzz Lightyear of Star Command
direct-to-video; (3) the timing and amount of Monsters, Inc., Toy Story
franchise, and A Bug's Life merchandise sales and ancillary royalties; (4) the
timing and amount of worldwide television revenues from our films; (5) the
timing and amount of distribution costs incurred in all markets for our films;
(6) the timing, accuracy, and sufficiency of the information we receive from
Disney to determine revenues and associated gross profits; (7) the timing and
amount of non-film related revenues and expenses, such as software licensing,
interest income and effective income tax rate; (8) the market price of our
common stock and related volatility; (9) political and economic events beyond
our control; and (10) the competitive environment entering the holiday season.
See "Risk Factors" set forth below for a more detailed discussion of factors
that could cause actual results to differ.
Dependence on revenue from our feature films.
Under the Co-Production Agreement, Pixar and Disney share equally in the
profits of 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 including
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.
For our business to be successful, our films must achieve box office
success. While we have been successful in the release of our first three feature
films, this level of success is unusual in the motion picture industry. Although
the domestic opening box office results for Monsters, Inc. are very positive,
continued uncertainty regarding such factors as the competitive environment
entering the holidays as well as general political and economic conditions could
impact the ultimate success of the film. In addition, our future releases may
not achieve similar results. Beyond 2001, we will be dependent on the future
success of Monsters, Inc., Finding Nemo, Film Six, and Film Seven (Film Six and
Film Seven are together referred to as the "Current Projects"). Unless Monsters,
Inc., Finding Nemo, and our Current Projects achieve box office success and also
achieve success in home video and merchandise sales, they may not generate
significant revenue and operating results for us in future years.
A portion of our anticipated revenues for fiscal year 2001 is based on the
assumption that Monsters, Inc. will be a box office success. Therefore, if
Monsters, Inc. does not generate sufficient box office receipts or merchandise
sales to be deemed successful, it could adversely impact our targeted 2001
operating results. To date, we have recognized a significant amount of the
revenues we expect to recognize over the lifetime of the Toy Story franchise and
A Bug's Life resulting primarily from domestic and foreign theatrical revenues,
related domestic and foreign home video revenue, merchandise licensing, and
television revenue, offset by Disney's marketing and distribution costs and its
distribution fee. Although our forecast assumes some
14
continued revenues from these titles, there can be no assurance these revenues
will be achieved, and this may adversely impact our targeted earnings.
Forecasting revenue from our feature films is extremely difficult.
It is difficult to forecast the amount and timing of our future revenues
from Toy Story, A Bug's Life, Toy Story 2 and Monsters, Inc. for the remainder
of 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 collectively, 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,
merchandise 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. It
is also difficult to predict theatrical revenue and related merchandise revenue
from the release of Monsters, Inc. on November 2, 2001. While Monsters, Inc.
experienced a very successful opening weekend at the domestic box office, it is
difficult to predict the ultimate domestic and foreign theatrical revenues to be
realized as well as related home video, merchandising and ancillary revenue
streams. In particular, it is difficult to predict how the potential audience
for Monsters, Inc. may be affected by the terrorist attacks against the United
States on September 11, 2001, the heightened security measures and military
action in response to such attacks, and the possibility of further acts of
terrorism in the United States and elsewhere.
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. In addition,
through information we obtain from other sources, we may make certain judgments
and/or assumptions and adjust the information we receive from Disney. Due to
these factors, the amount and timing of our future revenues from Toy Story, Toy
Story 2, A Bug's Life and Monsters, Inc. 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 capitalize 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.
15
Software revenue.
Software revenue declined in the first nine months of fiscal year 2001 as
compared to the first nine months of 2000. This decline may be indicative of
future trends as we continue to reduce our emphasis on the commercialization of
software products. We are not increasing the time and resources necessary to
generate higher RenderMan(R) licensing revenues; therefore, we expect that
revenue from the licensing of RenderMan(R) will remain flat or possibly decline.
However, to meet our fiscal 2001 diluted earnings per share target, our revenue
estimates include revenues attributable to non-film related sources including
software revenue. There can be no assurance that the timing and amount of such
revenues will be sufficient to meet our targeted earnings.
OUR OPERATING RESULTS HAVE FLUCTUATED IN THE PAST, AND WE EXPECT SUCH
FLUCTUATIONS TO CONTINUE.
Our revenues fluctuate significantly.
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 can 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 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,
- general political and economic conditions, and
- timing and amount of non-film related revenues such as licensing of our
software.
In particular, since our revenue under the Co-Production Agreement is
directly related to the success of a feature film, our operating results are
likely to fluctuate depending on the level of success of our animated feature
films and related products. The revenues derived from the production and
distribution of an animated feature film depend primarily on the film's
acceptance by the public, which cannot be predicted and does not necessarily
bear a direct correlation to the production or distribution costs incurred. The
commercial success of a motion picture also depends upon promotion and
marketing, production costs and other factors. Further, 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.
Our operating expenses fluctuate.
Our operating expenses and effective tax rate continue to
fluctuate. Operating expenses for the nine months ended September 29, 2001
increased in comparison to the first nine months of fiscal year 2000 and we
expect to continue to increase our operating expenses to fund greater levels of
research and development, to build to our goal of producing one feature film per
year and to expand operations. Although we have experienced some recent leveling
off on the competition of personnel, our spending levels may still increase
significantly due to (1) continued investment in proprietary software systems,
(2) potential increased compensation costs as a result of possible competition
for creative, technical and administrative talent, (3) increased costs
associated with the expansion of our facilities, (4) number of personnel
required to
16
support studio growth and (5) 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
2001. Finally, we expect our tax rate in 2001 to be lower than statutory rates
due to the utilization of certain federal and state tax credits, as well as the
realization of certain tax benefits. We realize tax benefits from the exercise
of non-qualified employee stock options that reduce the amount of our tax
payments and liabilities, but will not reduce our future effective tax rates. We
expect our tax rate in the future to be at or near statutory levels.
Forecasting our operating expenses is extremely difficult. Moreover, our
operating expenses will continue to be extremely difficult to forecast. We
budget the direct costs of film productions with Disney, and we share such costs
equally. We capitalize our share of these direct costs of film production in
accordance with SOP 00-2, which we adopted in the first quarter of fiscal year
2001. A substantial portion of all of our other costs are incurred for the
benefit of feature films ("Overhead"), including research and development
expenses and general and administrative expenses. Portions of our Overhead are
included in the budgets for the Pictures, and we will share such costs equally
with Disney under the Co-Production Agreement. With respect to the portion of
our Overhead that is not reimbursed by Disney, we either (1) capitalize such
portion as film production costs, if required under SOP 00-2, or (2) charge it
to operating expense in the period incurred. Since a substantial portion of our
Overhead is related to the Pictures, and is therefore reimbursed by Disney, and
since we capitalize other amounts in accordance with SOP 00-2, our reported
operating expenses for the first nine months of fiscal year 2001 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.
Film production budgets may increase, and film production spending may
exceed such budgets. In spite of recent economic events which have reduced
competition for certain personnel, future film budgets may still increase due to
(1) escalation in compensation rates of people required to work on the Current
Projects, (2) number of personnel required to work on the Current Projects, and
(3) equipment needs. Therefore, the budget for the Current Projects and
subsequent films and related products may continue to be greater than the
budgets for Toy Story, A Bug's Life, and Toy Story 2. We will continue to
finance these budgets equally with Disney under the Co-Production Agreement. In
addition, due to production exigencies which are often difficult to predict, we
believe that it is not uncommon for film production spending to exceed film
production budgets, and the Current Projects may not be completed within the
budgeted amounts. In addition, when production of each film is completed, we may
incur significant carrying costs associated with transitioning personnel on
creative and development teams from one project to another. These carrying costs
are shared with Disney and treated as film costs, which increases overall
production budgets and could have a material adverse effect on our results of
operations and financial condition.
OUR SCHEDULED SUCCESSIVE RELEASES OF FEATURE FILMS WILL CONTINUE TO PLACE A
SIGNIFICANT STRAIN ON OUR RESOURCES.
In order to meet our obligations pursuant to the Co-Production Agreement,
we have established parallel creative teams so that we can develop more than one
film at a time. These teams are currently working on Finding Nemo, which is
currently targeted for release in summer 2003, Film Six and Film Seven as well
as future projects as we move towards producing one feature film per year. We
have only produced four prior feature films to date and have limited experience
with respect to producing animated feature films in parallel. We have been
required, and may continue to be required, to expand our employee base, increase
capital expenditures and procure additional resources and facilities in order to
accomplish the scheduled release of our feature films. This growth and expansion
has placed, and continues to place, a significant strain on our resources. We
cannot provide any assurances that Finding Nemo will be released as targeted or
that this strain on resources will not have a material adverse effect on our
business, financial condition or results of operations.
In addition, John Lasseter's availability has been a key ingredient in the
successful completion of our prior films. As the Company moves towards achieving
one film a year, there will be additional demands placed on his availability. A
lack of his availability may adversely impact the success of our films.
17
If we are able to release Finding Nemo in 2003, we cannot provide any
assurances that we will release our next film in 2004. Due to the strain on our
personnel from the effort required for the release of Finding Nemo and the time
required for creative development of a new film, it is possible that we would be
unable to release a successive new film in 2004. It is too early to determine
the rate at which any future films are to be released, and we cannot provide any
assurances that we will release a film in each successive year or in any
particular year.
To continue to accommodate growth, we will be required to implement a
variety of new and upgraded operational and financial systems, procedures and
controls, including improvement and maintenance of our accounting system, other
internal management systems and backup systems. In addition, this growth and
these diversification activities, along with the corresponding increase in the
number of our employees and rapidly increasing costs, have resulted in increased
responsibility for our management team. We will need to continue to improve our
operational, financial and management information systems and to hire, train,
motivate and manage our employees, to integrate them into Pixar and to provide
adequate facilities and other resources for them. We cannot provide any
assurance we will be successful in accomplishing all of these activities on a
timely and cost-effective basis. Any failure to accomplish one or more of these
activities on a timely and cost-effective basis would have a material adverse
effect on our business, financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Investment Portfolio. We invest in a variety of investment grade,
interest-bearing securities, including fixed rate obligations of corporations
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
primarily 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 provides information
regarding our investment portfolio at September 29, 2001. 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
--------- -------- --------
Available-for-sale securities......................... $98,649 $151,380 $250,029
Weighted-average interest rate........................ 4.92% 4.08% 4.41%
</Table>
Impact of Foreign Currency Rate Changes. While Disney and its affiliates
distribute our products in foreign markets, we are not directly exposed to
foreign currency rate fluctuations. However, we recognize revenues from foreign
territories based on an average foreign currency exchange rate used by Disney
for revenue reporting. This rate may differ from the actual exchange rate at the
time cash is remitted to Disney and subsequently to us. Therefore, there may be
some indirect foreign currency exchange rate exposure as managed by Disney.
PART II -- OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following proposals were submitted to shareholders at our Annual
Meeting of Shareholders held September 14, 2001. Each of these proposals was
approved by a majority of the shares present at the meeting.
1. To re-elect eight directors to serve for the ensuing year or until
their successors are duly elected and qualified.
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<Table>
<Caption>
SHARES FOR SHARES WITHHELD
---------- ---------------
Steve Jobs................................................ 44,107,170 802,109
Edwin E. Catmull.......................................... 44,092,526 816,753
Jill E. Barad............................................. 44,663,068 246,211
Skip M. Brittenham........................................ 44,089,093 820,186
Joseph A. Graziano........................................ 44,710,692 198,587
Lawrence B. Levy.......................................... 44,711,344 197,935
Joe Roth.................................................. 44,698,424 210,855
Larry W. Sonsini.......................................... 43,440,477 1,468,802
</Table>
2. To approve an amendment to our 1995 Stock Plan to increase the
number of shares reserved for issuance thereunder by 750,000 shares.
Results of the voting included 42,286,868 shares for, 2,594,579 shares
against and 27,832 shares abstained.
3. To ratify the appointment of KPMG LLP as our independent auditors
for the fiscal year ending December 29, 2001. Results of the voting
included 44,866,352 shares for, 27,357 shares against and 15,570 shares
abstained.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
No reports on Form 8-K were filed by Pixar during the quarter ended
September 29, 2001.
ITEMS 1, 2, 3 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 13, 2001
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