-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VxG+6djEmxdXXwbsxYFbFo+ATMnn6k682VOjeb10uBWREWLG5QUH4X9X+tpW9or+ HDu2Qw0LyYYdPDSYdc8sLw== 0000891618-97-001519.txt : 19970401 0000891618-97-001519.hdr.sgml : 19970401 ACCESSION NUMBER: 0000891618-97-001519 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PIXAR \CA\ CENTRAL INDEX KEY: 0001002114 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 680086179 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-26976 FILM NUMBER: 97569947 BUSINESS ADDRESS: STREET 1: 1001 WEST CUTTING BLVD CITY: RICHMOND STATE: CA ZIP: 94808 BUSINESS PHONE: 5102364000 MAIL ADDRESS: STREET 1: 1001 WEST CUTTING BLVD CITY: RICHMOND STATE: VA ZIP: 94804 10-K405 1 FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1996 1 - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER DECEMBER 31, 1996 0-26976 PIXAR (Exact name of registrant as specified in its charter) CALIFORNIA 68-0086179 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1001 WEST CUTTING BOULEVARD, RICHMOND, CALIFORNIA 94804 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (510) 236-4000 --------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, NO PAR VALUE PER SHARE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 20, 1997, there were 40,141,461 shares of the Registrant's Common Stock outstanding and the aggregate market value of such shares held by non-affiliates of the Registrant (based upon the closing sale price of such shares on the Nasdaq National Market on March 20, 1997) was approximately $167,113,835. Shares of Common Stock held by each executive officer and director and by each entity that owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. DOCUMENTS INCORPORATED BY REFERENCE Certain sections of Pixar's Annual Report to Shareholders for the year ended December 31, 1996 (the "1996 Annual Report") are incorporated by reference in Parts II and IV of this Form 10-K to the extent stated herein. Also, certain sections of Pixar's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders to be held on June 11, 1997 are incorporated by reference in Part III of this Form 10-K to the extent stated herein. - -------------------------------------------------------------------------------- 2 This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates and projections about Pixar's industry, management's beliefs, and assumptions made by management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under " Certain Factors Affecting Business, Operating Results and Financial Condition" on pages 15 through 26, as well as those noted in the documents incorporated herein by reference. Particular attention should be paid to the cautionary language in "Certain Factors Affecting Business, Operating Results and Financial Condition--Anticipated Decline in Operating Results in 1997 and Net Losses in 1998," "--Dependence on Toy Story, Bugs and Toy Story Video Sequel," "--Liquidity Risks, "--Scheduled Concurrent Release of Films; Management of Growth" and "--Risks Associated With Co-Production Agreement." Unless required by law, Pixar undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. PART I ITEM 1. BUSINESS GENERAL Pixar is a digital animation studio with the technical, creative and production capabilities to create a new generation of animated feature films and related products. Pixar's objective is to develop computer animated feature films with a new three-dimensional appearance, memorable characters and heartwarming stories that will appeal to audiences of all ages. The first such film, Toy Story, was created and produced by Pixar and was distributed by The Walt Disney Company (along with its subsidiaries hereinafter referred to as "Disney"). Pixar believes that consumer marketing campaigns surrounding the theatrical release of such films can generate broad consumer awareness of the films, which in turn can drive box office demand as well as sales of film-related products, such as theatrical sequels, made-for-home video sequels, soundtracks, toys and other merchandise. RECENT DEVELOPMENTS On February 24, 1997 Pixar and Walt Disney Pictures and Television, a wholly-owned subsidiary of Disney, entered into the Co-Production Agreement ("Co-Production Agreement") pursuant to which Pixar, on an exclusive basis, will produce five computer animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney over approximately the next ten years. Pixar and Disney will co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which will be financed by Disney), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. The Co-Production Agreement generally provides that Pixar will produce each Picture and that Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Disney and Pixar have agreed that the first Picture under the Co-Production Agreement is the Picture with the working title "Bugs." The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, Pixar will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. Disney and Pixar have announced their intention to produce a made-for-home video sequel to Toy Story (the "Toy Story Video Sequel"), and Pixar has already begun work on the production under the terms of the Co-Production Agreement. Pixar will not share in any theme park revenues generated as a result of the Pictures. -2- 3 In addition to entering into the Co-Production Agreement, Pixar agreed to sell, and Disney agreed to purchase for cash, 1,000,000 shares of Pixar Common Stock which Disney has agreed to hold for at least three years. Pixar also granted two warrants, each exercisable for five years, to Disney: one warrant to purchase 750,000 shares of Common Stock at an exercise price of $20.00 per share and another warrant to purchase 750,000 shares of Common Stock at an exercise price of $25.00 per share. Pixar granted certain registration rights for the shares issuable upon exercise of the warrants. This transaction was consummated in late March 1997 and Pixar received gross proceeds of $15.0 million. Also in connection with the Co-Production Agreement, Pixar entered into a new Employment Agreement with John Lasseter, the Academy Award -- winning director of Toy Story, which contemplates that Mr. Lasseter's services will continue to be available to Pixar until February 2004. Mr. Lasseter's Employment Agreement is described in detail in the Pixar's Proxy Statement for the 1997 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of Pixar's fiscal year ended December 31, 1996. In late March 1997, Pixar determined to discontinue its business of producing CD-ROM and other interactive products in favor of other opportunities made available through the Co-Production Agreement. See "Business Model and Products -- Discontinuation of Interactive Products Division." BUSINESS MODEL AND PRODUCTS Pixar's strategy is to develop and produce animated feature films and related products, such as theatrical sequels, made-for-home video sequels, soundtracks, toys and other merchandise. Pixar is currently implementing this strategy through the Co-Production Agreement with Disney. Animated Feature Films. Pixar's first computer-animated feature film, Toy Story, was released on November 22, 1995, and Pixar intends to continue to develop computer animated feature films for the family entertainment market. In 1995, Pixar began development on a second computer-animated feature film for Disney, with the working title of Bugs, which shall be the first such film developed and distributed under the new Co-Production Agreement with Disney. The screenplay for this film, which is also targeted to the family entertainment market, is currently under development, but the film is not expected to be released until the end of 1998 at the earliest. Pixar has established parallel creative teams so that it can develop more than one film at a time. Home Videos. Toy Story was released by Disney as a home video in October 1996, and Pixar believes that its future animated feature films will lend themselves to home video distribution in both domestic and international markets. Distribution of home video versions of the animated feature films developed and produced under the Co-Production Agreement will also be pursuant to the Co-Production Agreement. Made-For-Home Video Sequels. Disney and Pixar have announced their intention to produce a made-for- home video sequel to Toy Story, such as Disney's made-for-home video sequel to Aladdin entitled The Return of Jafar, and Pixar has begun work on the Toy Story Video Sequel under the terms of the Co-Production Agreement. Pixar intends in the future to continue to produce made-for-home video sequels generally based on the same characters as the original feature film. The Toy Story Video Sequel will also be distributed pursuant to the Co-Production Agreement. Pixar expects that the Toy Story Video Sequel and other made-for-home video sequels will be shorter in length and lower in cost and quality than the theatrical films then under development. Merchandise and Soundtracks. Pixar believes that the characters and songs created in animated feature films lend themselves to opportunities for selling merchandise and soundtracks. For example, merchandise such as children's toys based on stories and characters in Toy Story were designed using three-dimensional data from Pixar's digital models. Disney has the rights to distribute merchandise and soundtracks from Toy Story and the feature films to be made pursuant to the Co-Production Agreement, and Pixar shares in the profits, if any, generated from such sales. Short Animation Products. Pixar has also in the past produced animated or partially animated television commercials, including for products such as Coca-Cola, Listerine, Levi's Jeans, Gummi-Savers (a LifeSavers product) and Fresca. However, in 1996, Pixar largely discontinued its business of producing commercials in favor of other -3- 4 opportunities. Pixar does still produce short animation projects, such as 30-second Toy Story vignettes for television programming targeted at children. Moreover, Pixar believes that there may be other opportunities to produce short animation projects for Disney in connection with work performed under the Co-Production Agreement. In particular, Pixar believes that there may be opportunities for short animation projects related to theme parks and children's television programming. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1996 Annual Report. Other Products. Pixar has been selling its RenderMan software for over seven years. RenderMan has helped visual effects studios create visual effects such as certain dinosaurs in Jurassic Park, the metal cyborg in Terminator 2 and the ghosts in Casper. RenderMan runs on Unix-based workstations from Silicon Graphics, Sun Microsystems, Inc. ("Sun"), The Hewlett-Packard Company ("Hewlett-Packard"), International Business Machines Corporation ("IBM") and Digital Equipment Corp. ("Digital Equipment") as well as the Windows platform. Examples of RenderMan customers include movie studios such as Disney, Boss Film Studios, Inc., Digital Domain, Twentieth Century Fox Film Corporation, Industrial Light and Magic ("ILM"), Columbia/Tri-Star Pictures Inc. and Warner Bros. Inc. Customers also include government agencies and universities. RenderMan is sold in several formats, including a Toolkit at a list price of $5,000 per license. Discounts are available for site or multi-use licenses. As a result of Pixar's reduced emphasis on the commercialization of software in favor of products sold for their content, Pixar expects to dedicate less time and resources to distributing and marketing RenderMan than it has in the past, particularly shrink-wrapped versions of RenderMan, and expects that sales of these products may decline. See "-- Technology -- RenderMan." See also "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1996 Annual Report. Discontinuation of Interactive Products Division. In 1995, Pixar established a division that focused on the development of interactive CD-ROM stories and games for PCs. Under a separate prior agreement with Disney, this division of Pixar developed two CD-ROM titles based on Toy Story -- Toy Story Interactive Storybook and Toy Story Activity Center. The products developed under that agreement with Disney were financed and distributed by Disney. All future CD-ROM products and other interactive products based on feature films made pursuant to the Co-Production Agreement, if any, will be produced and distributed pursuant to the terms of the Co-Production Agreement, which provides Pixar with the option to produce and co-finance such products and to share equally in the profits, after recovery of marketing and distribution costs. After the Co-Production Agreement was executed on February 24, 1997, Pixar began evaluating the merits of staying in the business of producing CD-ROM products and comparing those opportunities with opportunities in film and other potential projects under the Co-Production Agreement. Management determined that, despite the fact that Pixar's first CD-ROM titles were successful on relative terms, the resources currently devoted to its interactive products division would be better allocated to other projects arising from the Co-Production Agreement, which Pixar believes have greater potential than CD-ROM titles, such as theatrical films, home video sequels and short animation projects. Moreover, the CD-ROM and interactive product market is not growing as fast as expected, the production costs of such products are increasing and one project under negotiation with a third party was canceled. For these reasons, Pixar determined in the last week of March 1997 to discontinue its business of producing CD-ROM and other interactive products and redirect the approximately 60 employees in this division to film and related projects within Pixar. This decision is expected to have a material adverse impact on Pixar's results of operations in 1997. PIXAR COMPUTER ANIMATION PROCESS AND DIGITAL BACK LOT Pixar Computer Animation Process The production of an animated feature film is extremely complex and time consuming due to the very large number of frames and intricate detail of each frame. At 24 frames per second, a 77-minute animated feature film such as Toy Story requires approximately 110,000 individual frames. Animation for a feature film has traditionally been created through hand-drawn cels, requiring hundreds of people working for two to three years. Although computers have been used to assist in some elements of painting cels for more recent releases, almost every frame is still hand-drawn. -4- 5 Pixar believes that its proprietary technology, which allows animators to manipulate hundreds of motion control points within a single character, allows for more intricacy and subtlety of character and personality than traditional two-dimensional cel-based animation. This technology also facilitates the manipulation, editing and re-use of animated images. Pixar makes its computer animated films and other projects in three stages: creative development, production and post-production. CREATIVE Story -- Treatment/ -- Screen- -- Story -- Story -- Voice DEVELOPMENT Concept Outline Play Board Reels Recording Creative Development. Creative development is an iterative process in which the story and its characters are created and developed. The first step in creative development involves the development of a story concept, which often takes the form of a story summary or outline known as a treatment. After numerous iterations and research into the story and characters, a first draft of a screenplay is written. The screenplay is then turned into story boards, which are panels filled with thousands of sketches that represent the story to be animated. The story boards are then transferred to film or video so that they can be electronically edited into a photo play of the film called story reels, a process which enables editing of the film before the production phase begins. Voices are then selected, recorded and added to the story reels. Throughout the creative development process, plans are developed for the style, colors and look of the film. PRODUCTION Modeling -- Layout -- Animation -- Shading -- Rendering -- Film and Recording Lighting Production. Pixar's production stage consists of six phases: modeling, layout, animation, shading and lighting, rendering and film recording. In the modeling phase, digitized models of each set and character are created by defining their shapes in three dimensions (height, width and depth) and by adding animation control points that allow the model to be moved or animated. In some cases, a model has hundreds of animation controls. In the layout stage, artists place the digital models into a scene and position the digital cameras at the angles from which the three-dimensional shot is to be seen. The assembled shot is then given to the animator together with the prerecorded voice. In the animation stage, the digitized models are animated, or "brought to life," in three dimensions to create a motion sequence. Animation is performed by defining "key frames," which are the frames containing the extremes of motion that will occur in a scene. The computer then interpolates frames in between the two most extreme positions in a particular segment of movement to create smooth motion. The animators can then adjust the interpolation and key frames repeatedly until they achieve the desired result. The next step in completing a scene requires attaching to each object and model a description of its surface characteristics. These "shaders" describe the pattern, texture, finish and color for every object in the scene. Next, lighting is added by placing digital lights into the scene. In the rendering phase, the renderer takes the modeling, layout, animation, shading and lighting data and, for each frame in the sequence, computes a three-dimensional image of what the scene looks like at that point in time from the point of view of the camera. The final rendering of a single frame can take between one and twenty hours. The final rendered data is then sent to one of Pixar's film recorders for imaging onto film. POST- Sound -- Print -- Sound -- Color -- Delivery PRODUCTION Effects Musical Mixing Correction of Print Design Score Post-Production. The post-production stage consists of two parallel processes: the picture process and the sound process. In the picture process, images are put on film, the film is sent to a laboratory for color correction and final prints are made. In the sound process, the sound effects and musical score are added and the final sound is mixed. Pixar's post-production is simpler than post-production in a live-action film, which requires more significant editing. In -5- 6 most live-action films, many hours of film are shot, and the film is then significantly edited and re-edited in the post-production stage to create a feature film. Pixar, like other animation studios, edits the film throughout the entire creative development and production process. Thus post-production involves only final editing. Digital Back Lot The digital models that Pixar develops to create its animated products may be used again in future films, CD-ROM titles, television commercials and other animation products. The Pixar technical team has developed a proprietary database of thousands of digital models, sets, textures and surface appearances from its short films and commercials. Much like the traditional movie studio's back lot, this digital database allows Pixar animators to retrieve and re-use thousands of different elements that make up the characters and scenes of a film. Unlike a traditional movie studio's back lot however, digital animation sequences can be easily re-used. For example, a sequence of a character walking could be re-used with little or no rework in another portion of the film. These models may also be used in other films or in videos, CD-ROM titles or to create merchandise. For example, the models that were used to animate Toy Story were "re-used" or rendered in a different resolution for use in Pixar's two Toy Story CD-ROM titles and are being re-used in the Toy Story Video Sequel. TECHNOLOGY Pixar has three core proprietary technologies: (i) Marionette, an animation software system for modeling, animating and lighting, (ii) Ringmaster, a production management software system for scheduling, coordinating and tracking of a computer animation project and (iii) RenderMan, a rendering software system for high quality photo-realistic image synthesis that Pixar uses internally and licenses to third parties. Each of these systems is critical to the production of Pixar's animated feature films and other animation products. Marionette. Marionette is Pixar's software system for modeling, animation and lighting for computer animation. Marionette is the primary software tool of every animator and technical director at Pixar. In contrast to many commercially available animation systems which are designed to address product design, corporate logo graphics or cinematic special effects, Marionette has been designed and optimized for character modeling and animation. Marionette is portable across many of the standard Unix workstations, including those from Silicon Graphics and Sun. Pixar has also ported Marionette to IBM and Hewlett-Packard workstations for hardware evaluation purposes. Ringmaster. Ringmaster is a production management software system for scheduling, coordinating and tracking a computer animation project. Due to the enormous amount of data required in three-dimensional animation, accurate production information is essential for producing high quality animation. Pixar's production coordination staff uses Ringmaster to plan and track projects ranging from short commercials to feature films. A key component of Ringmaster is a distributed rendering system for managing the huge quantity of images and data that must be rendered to create Pixar's products. Pixar does its rendering on an array of powerful Unix processors which are dedicated to rendering 24 hours a day. These machines, which Pixar calls the RenderFarm, are connected via a local area network. To achieve the desired quality level, the average time to render a single frame at film resolution is between one and four hours; for video resolution the average time to render a single frame is between 30 and 90 minutes. Since an animated feature film contains well over 100,000 frames, each of which may be rendered several times in the production process, Pixar typically has a large number of frames to render at any give time. To manage this process, Ringmaster coordinates and schedules all the processors in the RenderFarm. Ringmaster includes a compositing system and also maintains an array of disk drives as a central data repository for the digital image files generated by the rendering and compositing steps of the production process. Finally, Ringmaster controls the filming phase of production and is responsible for backing up shots for archival purposes. RenderMan. RenderMan is a rendering software system for high quality photo realistic image synthesis that Pixar uses internally and also licenses to third parties. Today, RenderMan is used by many major film studios and special effects firms. Examples of projects which have used RenderMan include Terminator 2, Jurassic Park, True Lies, Aladdin, Casper and Apollo 13. By licensing RenderMan to film studios, visual effects houses, commercial production -6- 7 facilities and other computer animation companies, Pixar believes that RenderMan has been established as a de facto industry standard for high quality rendering. Pixar has used RenderMan for animation production since 1988, when it was first used in the making of the short animated film Tin Toy. Since that time, Pixar has used RenderMan for its films and for more than 40 television commercials. Pixar also used RenderMan to render approximately 110,000 frames for the animated feature film, Toy Story, and to render all frames for the two Toy Story CD-ROM titles. RenderMan was designed to be easily portable. It runs on a wide variety of Unix workstations, including those from Silicon Graphics, Sun, Hewlett-Packard and Digital Equipment. Pixar has also ported RenderMan to the Windows and Macintosh platforms. CREATIVE DEVELOPMENT GROUP Pixar's creative and technical personnel have collaborated for over ten years to produce three-dimensional computer animated films. The principal objective of Pixar's creative group is to use the medium of computer animation to create heartwarming stories with memorable characters that are targeted for family entertainment. The members of Pixar's creative and technical teams have been nominated for and received a number of awards. In 1986, the short animated film Luxo Jr. earned an Academy Award nomination for Best Short Film (Animated). In 1988, another of Pixar's short films, Tin Toy, became the first computer animated film to win the Academy Award for Best Short Film (Animated). The creative team at Pixar is under the direction of John Lasseter, an Academy Award-winning director and animator and the director of Toy Story. In March 1996, Mr. Lasseter received a Special Achievement Oscar from the Academy of Motion Picture Arts and Sciences for the development and application of techniques that made possible the first feature-length computer animated film -- Toy Story. Pixar has built an entire creative team consisting of highly skilled animators, story artists and other artists highly skilled in the art of animation, especially computer animation. Pixar strives to hire animators who have superior acting ability -- those able to make characters and inanimate objects come to life and appear as though they have their own thought processes. Pixar's proprietary software tools enable artists unfamiliar with computers to quickly become skilled in the art of three-dimensional animation. Along with animators, the creative team at Pixar includes a story department and an art department. The story department is responsible for a project's concept, treatment, outline, script, story boards and story reels. The art department is responsible for the visual development of a project, including the design of characters and sets and the color, textures, shading and lighting. It is also quite common for creative contributions to come from the technical group. All groups work closely together in an iterative process. To encourage collaboration, Pixar has strived to create a cooperative working environment and a non-hierarchical culture whereby each member of the creative team, regardless of position or department, considers the ideas of any other member of the team. The success of each animated feature film developed by Pixar will depend in large part upon the Pixar creative team's ability to predict the type of content that will appeal to a broad audience and to develop stories and characters that achieve broad market acceptance. Traditionally, this has been extremely difficult. Disney provided creative assistance throughout the production of Toy Story, including creative reviews and approvals, and the Co-Production Agreement contemplates that Disney will continue to provide creative assistance to Pixar on feature films and other products made pursuant to that agreement, but there can be no assurance that Disney will continue to provide assistance to Pixar in the development of creative content for its feature films or related products. In addition, there can be no assurance that voices and other intellectual property rights used in an animated feature film will be available for use in any sequel or other product related to such feature film. For example, Pixar was unable to obtain the rights to use certain voices from Toy Story in the two CD-ROM products based on Toy Story. See "Certain Factors Affecting Business, Operating Results and Financial Condition -- Dependence on Successful Development of Appealing Creative Content For Animated Feature Films and Related Products." -7- 8 RELATIONSHIP WITH DISNEY Prior Agreements Pixar's relationship with Disney dates to 1986, when Pixar and Disney entered into a joint technical development effort that resulted in the Computer Animated Production System ("CAPS"), a production system owned and used by Disney in certain of its two-dimensional cel-based animated feature films. Disney first used CAPS for The Rescuers Down Under and subsequently used it for other animated feature films, including Beauty and the Beast, Aladdin, The Lion King and Pocahontas. In 1992, certain employees of Pixar and Disney were jointly awarded an Academy Award for Scientific and Engineering Achievement for CAPS. In May 1991, Pixar entered into a Feature Film Agreement with Walt Disney Pictures, a wholly-owned subsidiary of Disney, which provided for the development, production and distribution of up to three feature-length motion pictures (the "Feature Film Agreement"). It is pursuant to that Feature Film Agreement that Toy Story and the Toy Story home video were developed, produced and distributed. In August 1995, Pixar entered into a non-exclusive CD-ROM development and publishing agreement with Disney Interactive, Inc. ("Disney Interactive"), a wholly-owned subsidiary of Disney, for the development, production and distribution of CD-ROM titles based on Toy Story (the "CD-ROM Agreement"). It is pursuant to the CD-ROM Agreement that the two Toy Story CD-ROM products were developed, produced and distributed. Both the Feature Film Agreement and the CD-ROM Agreement were superseded by the Co-Production Agreement, except as discussed below. Co-Production Agreement The following is a summary of the Co-Production Agreement, which has been filed as an exhibit to this Annual Report on Form 10-K. The foregoing summary is not complete, and reference is made to the Co-Production Agreement filed as an exhibit to this Annual Report on Form 10-K. This summary is qualified in all respects by such reference. Shareholders and prospective investors in Pixar's Common Stock are encouraged to read the Co-Production Agreement. Overview. On February 24, 1997 Pixar and Walt Disney Pictures and Television entered into the Co-Production Agreement pursuant to which Pixar, on an exclusive basis, will produce five computer animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney over approximately the next ten years. Pixar and Disney will co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which will be financed by Disney), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. The Co-Production Agreement generally provides that Pixar will produce each Picture and that Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Disney and Pixar have agreed that the first Picture under the Co-Production Agreement is the Picture with the working title "Bugs." The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, Pixar will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. Disney and Pixar have announced their intention to produce a made-for-home video sequel to Toy Story, and Pixar has already begun work on the production under the terms of the Co-Production Agreement. Pixar will not share in any theme park revenues generated as a result of the Pictures. Production. The Co-Production Agreement provides a mechanism for Pixar's submission and the mutual selection of treatments that will be developed and produced as Pictures. After the selection of a treatment, Pixar generally controls the production of each Picture. Disney is entitled to designate a representative at Pixar to monitor the production and production costs of the Pictures. Financing of Development and Production. Pixar and Disney are to equally share all production costs. Production costs are defined in the Co-Production Agreement to mean all costs and expenses incurred by Pixar directly related to or fairly allocable to the creation, development, pre-production, production, post-production and delivery to -8- 9 Disney of the Pictures. Production costs include, among other things, all carrying costs incurred by Pixar for retaining of employees for production purposes and the overhead attendant thereto, the costs of all treatments prepared by Pixar for submission to Disney, all costs of computer hardware and software used to develop the Pictures, and fair allocations of all costs and expenses of Pixar associated with or benefiting the Picture, including research and development, general and administrative and overhead expenses and facilities. The Co-Production Agreement provides mechanisms for Disney and Pixar to agree upon the budgets for treatments, development and production of each Picture. Pixar may not exceed production budgets (which may be revised with mutual approval) without Disney's written approval, subject to certain limited exceptions. Distribution. Disney has control over all decisions relating to, and is solely responsible for financing the costs and expenses of, the marketing, promotion, publicity, advertising and distribution of each Picture, subject to certain requirements. Provided, in general, that Disney has agreed on the treatment to be developed into each Picture, Disney has committed to initially release each Picture within certain windows and not to release other Disney family films during certain windows, and each Picture is to be distributed and marketed under the Walt Disney Pictures brand (or the then current Disney brand for premiere Disney movies) and is to be distributed and marketed by Disney in all markets and media and on a worldwide basis in a manner similar to that in which Disney then currently distributes and markets its premiere animated movies. Disney is to consult with Pixar relating to all such major marketing and distribution decisions, and Pixar is entitled to designate a representative to monitor marketing and distribution of the Pictures. Division of Gross Receipts. Pixar and Disney are entitled to share equally in all gross receipts remaining after deduction of: (i) a distribution fee to Disney, (ii) mutually agreed participations (payments to third parties such as actors, composers and other artists contingent upon the success of the Pictures), if any, on a pro rata basis, paid by either Disney or Pixar, and (iii) Disney's distribution costs. Gross receipts includes all revenues or other consideration received by Disney from the exploitation of the Pictures and any related merchandise, books, soundtracks and other tangible personal property based upon the Pictures, as more specifically provided in the Co-Production Agreement (collectively, "Merchandise"), subject to certain exceptions relating primarily to receipts from Disney's affiliates. The distribution fee payable to Disney is substantially lower than under the prior Feature Film Agreement and reflects Pixar's commitment to finance half of the production costs of the Pictures. Distribution costs are broadly defined in the Co-Production Agreement to include out-of-pocket costs paid (or in certain instances, accrued for payment) to a third party (or in certain instances, to Disney's affiliates) by Disney or certain of its affiliates, provided that such out-of-pocket costs are directly related or fairly allocable to the distribution of the Picture and Merchandise. Pursuant to the Co-Production Agreement, Pixar will receive statements and payments of its share of gross receipts monthly within 45 days after the end of each calendar month, and Pixar has the right to audit Disney's and its affiliates' books and records relating to the Pictures and Merchandise. Derivative Works. Subject to certain exceptions, Disney and Pixar have mutual control of the decision to develop, produce or otherwise exploit any derivative works (or to transfer or license any rights to exploit any derivative works) during the term of the Co-Production Agreement or thereafter. Derivative works include theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works as more specifically provided in the Co-Production Agreement (collectively, "Derivative Works"). Except in certain very limited circumstances, in the event of a disagreement over whether to proceed with a Derivative Work, Disney's decision governs. Pixar is to be given the option to co-finance and produce, or to participate on a passive financial basis with respect to, a Derivative Work that is (i) a theatrical motion picture, a (ii) a made-for-home video production, (iii) a television production, (iv) location-based entertainment which uses unique characters or other elements from any of the Pictures or Toy Story as its primary theme, or (v) an interactive product such as CD-ROMs, DVDs, video games and arcade games (collectively, "Interactive Products"). -9- 10 If Pixar elects to co-finance and produce a Derivative Work, the Co-Production Agreement provides for the following: (i) with respect to theatrical motion pictures and made-for-home video productions, the terms and conditions of the Co-Production Agreement are to be extended to cover such Derivative Works, subject to certain exceptions; (ii) with respect to (A) location-based entertainment using characters or other elements from a Picture or Toy Story as its primary theme and (B) television productions , Pixar and Disney are to mutually agree upon the terms and the conditions under which such work shall be financed, produced and distributed, subject to certain specified requirements in the case of television productions; and (iii) with respect to Interactive Products, Disney and Pixar are to mutually agree upon the terms and conditions under which such Interactive Product shall be financed, produced and distributed, subject to certain commitments by Disney with respect to marketing and distribution and provided that there shall be no distribution fee payable to Disney. For live entertainment such as stage plays or ice shows, Pixar is entitled to participate on a passive financial basis as is specified in the Co-Production Agreement. For all other Derivative Works except theme parks, Pixar is entitled to participate on a passive financial basis in such work and to receive a reasonable royalty to be mutually agreed upon if the work is a revenue-producing work. Disney has the sole and exclusive right in perpetuity to use, without compensation to Pixar, each Picture, the characters therefrom and any story elements thereof in theme parks, location- based entertainment for which Picture or Toy Story characters or elements are not the primary theme and cruise ships. A Derivative Work that is a theatrical motion picture would not count towards the five Pictures to be produced under the Co-Production Agreement. The Toy Story Video Sequel is the first such Derivative Work that Pixar has elected to co-finance and produce. Creative Controls. Creative controls and decisions with respect to developing and producing Pictures are generally subject to the mutual approval of Pixar and Disney. The Co-Production Agreement provides for certain dispute resolution procedures in the event of disagreement. Brand/Credit. The Co-Production Agreement sets forth Disney's and Pixar's intent that the Pixar brand be established as a co-equal brand to the Disney brand in connection with the Pictures, Merchandise and Derivative Works. The Co-Production Agreement provides that the Pixar logo, animated logo and credit shall be used in a manner which is perceptually equal to the Disney logo, animated logo and credit, subject to certain specific requirements as set forth in the Co-Production Agreement. Exclusivity. Pixar has agreed not to release or authorize the release of any feature length animated theatrical motion picture produced by Pixar, other than the Pictures and Derivative Works produced by Pixar under the Co-Production Agreement, until twelve months from delivery of the fifth Picture under the Co-Production Agreement. Pixar has further agreed that it will not enter into any agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture until after Pixar has delivered the third Picture to Disney under the Co-Production Agreement. Pixar has also agreed that it will not develop or produce any rides or attractions for major theme parks not owned or operated by Disney, and to give Disney a right to negotiate with respect to animated television productions or animated made-for-home video productions that Pixar proposes to produce during the term of the Co-Production Agreement. Proprietary Rights. The copyrights, trademarks and other intellectual property rights in and to the Pictures, all new and unique characters and story elements thereof and the audio-visual images thereof, and Merchandise relating thereto, shall be jointly owned by Disney and Pixar on an undivided 50/50 basis, subject to Pixar's ownership rights in the technology and excluding any intellectual property rights previously owned by Pixar or Disney. Notwithstanding the foregoing, Disney has the exclusive distribution and exploitation rights with respect to the Pictures, Derivative Works -10- 11 and Merchandise relating thereto. Pixar shall own the copyright and all other intellectual property rights in and to all computer programs and other technology developed or discovered by Pixar before, during or after the term of the Co-Production Agreement. Term and Termination. The Co-Production Agreement continues until delivery to Disney of the fifth Picture produced and financed under the Co-Production Agreement, unless earlier terminated. Disney is entitled to terminate the Co-Production Agreement in the event that Disney and Pixar fail to agree on a treatment for a Picture within one year after the initial theatrical release of the last Picture for which a treatment has been approved or selected, subject to certain exceptions. Disney is also entitled to terminate the Co-Production Agreement in the event that certain types of competitors directly or indirectly acquire or control a 50% or greater ownership interest in Pixar or Pixar merges or consolidates into such a competitor. Upon termination by Disney pursuant to either of the last two sentences, Disney has certain rights to compel Pixar to complete works in production. In the event of termination, the Co-Production Agreement provides that its terms and conditions continue to apply with respect to Pictures, Merchandise and Derivative Works which have been delivered by Pixar to Disney or which Disney elects to have completed, as well as all future Merchandise and future Derivative Works relating thereto, but otherwise terminates. Effect on Prior Agreements. All Derivative Works based on Toy Story, including the Toy Story Video Sequel currently being produced, are to be governed by the Co-Production Agreement and not the original Feature Film Agreement or the CD-ROM Agreement. The original Feature Film Agreement now applies only to the rights and obligations of Disney and Pixar relating to the financial participation in, and the production and distribution of, the theatrical motion picture Toy Story and the financial participation in Merchandise related to Toy Story (unless gross receipts in any given month exceed a certain amount, in which case they will be subject to the Co-Production Agreement), and otherwise has no further force or effect. The original CD-ROM Agreement remains in full force and effect with respect to the first and second CD-ROM products developed under that agreement, but otherwise has no force or effect. COMPETITION Pixar experiences intense competition with respect to both animated feature films and software. Movie Studios. Pixar's animated feature films compete and will continue to compete with feature films and other family oriented entertainment products produced by major movie studios, including Disney (as somewhat limited by the Co-Production Agreement), Warner Bros. Inc. (which has acquired Turner Broadcasting Systems Inc.), Twentieth Century Fox Film Corporation, Paramount Pictures, Columbia/Tri-Star Pictures Inc., Lucasfilm Ltd. ("Lucasfilm"), Universal City Studios, Inc. and MGM/UA, as well as numerous other independent motion picture production companies. Several of these studios have already developed and released animated feature films, and Pixar expects additional competition in the animated feature film market from these and other movie studios. Some of these other movie studios have announced their intention to enter the animated feature film market, including DreamWorks SKG ("DreamWorks"), a studio formed in 1994 which is expressly targeting the animated film market. In particular, DreamWorks owns a significant equity stake in Pacific Data Images ("PDI"), a computer graphics special effects firm, and has begun developing a computer animated movie with PDI that is expected to be completed by 1998. This computer animated movie, which has been referred to publicly as "Ants", may contain similar subject matter as Bugs. Pixar's films will compete with the feature films of these movie studios for audience acceptance and exhibition outlets. In addition, Pixar competes and will continue to compete with these movie studios for the acquisition of literary properties, production financing, the services of performing artists, and the services of other creative and technical personnel, particularly in the fields of animation and technical direction. Most of the other movie studios with which Pixar competes have significantly greater name recognition and significantly greater financial, technical, creative, marketing and other resources than does Pixar. At least two of these movie studios, Disney and Lucasfilm (through its affiliate Industrial Light and Magic ("ILM")), have developed their own internal computer animation capability and have created computer animation for special effects in animated films. In addition, Pixar believes that Disney is currently developing and producing a feature film making substantial use of computer animation. Other movie studios may internally develop, license or sub-contract -11- 12 three-dimensional animation capability. Further, Pixar believes that continuing enhancements in computer hardware and software technology will lower barriers to entry for studios or special effects companies which intend to produce computer animated feature films or other products. The Co-Production Agreement provides for the development and production by Pixar of five computer animated feature films. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the "Walt Disney Pictures" label and enjoys financial benefits in the event that such films achieve significant box office revenues, Pixar believes that Disney desires such films to be successful. Nonetheless, Disney has been by far the most successful producer of animated feature films, and family oriented motion pictures distributed by Disney or its affiliates are likely to be in the market concurrently with and competing with Pixar's animated feature films. Pixar's contractual arrangement with Disney also presents other risks. See "Certain Factors Affecting Business, Operating Results And Financial Condition -- Risks Associated With Co-Production Agreement." Pixar believes that the primary competitive factors in the market for animated feature films include creative content and talent, product quality, technology, access to distribution channels and marketing resources. Due in part to the Co-Production Agreement with Disney, pursuant to which Disney co-finances the production of the feature films, markets the feature films and provides creative assistance and access to significant distribution channels, Pixar believes that it presently competes favorably with respect to each of these factors. Computer Graphics Special Effects Firms. Pixar also expects to compete with computer graphics special effects firms, including ILM, Digital Domain, PDI, Rhythm & Hues, Boss Film Studios, Inc. and Blue Sky Productions. These computer graphics special effects firms may be capable of creating their own three-dimensional computer animated feature films or may produce three-dimensional computer animated feature films for movie studios that compete with Pixar. For example, ILM has already created and produced three-dimensional character animation which was used for the ghosts in the live action film Casper, and ILM has a royalty-free, paid-up license to use Pixar's RenderMan software and to obtain at no cost all enhancements and upgrades thereto. Other computer graphics special effects firms have licensed or may license RenderMan. Accordingly, Pixar's RenderMan software may not provide Pixar with a competitive advantage. Pixar believes that the primary competitive factors in the market for three-dimensional computer animation for feature films include creative content and talent, product quality, technology, access to distribution channels and marketing resources. Pixar believes that it presently competes favorably with respect to each of these factors. Software Publishers. Pixar also experiences intense competition with respect to its RenderMan software product. In particular, Pixar competes with makers of computer graphics imaging and animation software, principally Microsoft (which acquired SoftImage Inc.), MentalImage (which offers the same product offered by Microsoft), and Silicon Graphics (which acquired Wavefront Technologies, Inc. ("Wavefront") and Alias Research, Inc. ("Alias")). Microsoft, through SoftImage Inc., MentalImage and Silicon Graphics, through Wavefront and Alias, are each marketing competing rendering software products. Microsoft and Silicon Graphics have each licensed several of Pixar's patents that cover certain rendering techniques and may therefore be better able to market products that compete with Pixar's RenderMan software. In addition, as PCs become more powerful, software suppliers may also be able to introduce products for PCs that would be competitive with RenderMan in terms of price and performance for professional users. Under appropriate circumstances, Pixar might elect to license its rendering technology patents to other companies, some of which may compete with Pixar. Pixar believes that the primary competitive factors in the market for rendering software include product quality, price/performance, technology, functionality, breadth of features and customer service and support. Pixar believes that it presently competes favorably with respect to each of these factors. Pixar expects competition to persist, intensify and increase in each of its business areas in the future. Almost all of Pixar's current and potential competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical, marketing and other resources than Pixar. There can be no assurance that Pixar will be able to compete successfully against current or future competitors. Such competition could materially adversely affect Pixar's business, operating results or financial condition. -12- 13 PROPRIETARY RIGHTS Pixar's success and ability to compete is dependent in part upon its proprietary technology. While Pixar relies on a combination of patents, copyright and trade secret protection, nondisclosure agreements and cross- licensing arrangements to establish and protect its proprietary rights, Pixar believes that factors such as the technical and creative skills of its personnel are more essential to its success and ability to compete. Pixar currently is the owner of eight patents issued in the United States, one patent issued in the United Kingdom, one patent issued in France, one patent issued in Germany, one patent issued in Japan and two patents issued in Canada. In addition, Pixar has six patent applications pending in the United States, four pending in Japan, one pending before the European Patent Office and one pending before the Patent Cooperation Treaty Office. There can be no assurance that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed will be sufficiently broad to protect Pixar's technology. In addition, there can be no assurance that any patents that have been issued to Pixar, or that Pixar may license from third parties, will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to Pixar. The source code for Pixar's proprietary software is protected both as trade secrets and as a copyrighted work. Pixar generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use Pixar's proprietary information, products or technology without authorization, or to develop similar or superior technology independently. Policing unauthorized use of Pixar's products is difficult. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. To license its RenderMan software product, Pixar primarily relies on "shrink wrap" licenses that are not signed by the end-user and, therefore, may be unenforceable under the laws of certain jurisdictions. There can be no assurance that the steps taken by Pixar will prevent misappropriation of its technology or that its confidentiality or license agreements will be enforceable. In addition, litigation may be necessary in the future to enforce Pixar's intellectual property rights, to protect Pixar's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on Pixar's business, operating results or financial condition. From time to time Pixar has received, and is likely to receive in the future, notice of claims of infringement of other parties' proprietary rights. There can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against Pixar or that any assertions or prosecutions will not materially adversely affect Pixar's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, Pixar would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on Pixar's business, financial condition or results of operations. If any claims or actions are asserted against Pixar, Pixar may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances a license would be available on reasonable terms or at all. Pixar also relies on certain technology that it licenses from third parties, including software which is integrated and used with internally developed software. There can be no assurance that these third party technology licenses will continue to be available to Pixar on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays in feature film releases or product shipments until equivalent technology could be identified, licensed and integrated. Any such delays in feature film releases or product shipments could materially adversely affect Pixar's business, operating results and financial condition. In March 1996, Pixar entered into a license agreement with Silicon Graphics whereby Pixar granted to Silicon Graphics and its subsidiaries a non-exclusive license to use certain of Pixar's patents covering techniques for creating computer-generated photorealistic images. These same patents were licensed to Microsoft Corporation in June 1995. These patents relate to pseudo-random point sampling techniques in computer graphics which are incorporated into Pixar's RenderMan. The license agreements with Silicon Graphics and Microsoft will expire no later than the year 2010. -13- 14 Silicon Graphics and Microsoft may use the licensed technology in rendering products which compete with Pixar's RenderMan software, which could adversely impact sales of RenderMan. EMPLOYEES As of December 31, 1996, Pixar had a total of 286 employees. Although none of Pixar's employees is represented by a labor union, it is common for animators and actors at film production companies to belong to a union, and there can be no assurance that Pixar's employees will not join or form a labor union or that Pixar, for certain purposes, will not be required to become a union signatory. Pixar has not experienced any work stoppages and considers its relations with the employees to be good. Pixar's success depends to a significant extent on the performance of a number of senior management personnel and other key employees, especially its animators, creative personnel and technical directors. In particular, Pixar is dependent upon the services of Steve Jobs, John Lasseter, Edwin E. Catmull and Lawrence B. Levy. Pixar does not maintain "key man" life insurance for any of its employees. Pixar does have employment agreements with Messrs. Lasseter and Catmull, who are fundamental to its relationship with Disney. However, such employment agreements do not necessarily assure the services of these employees. Pixar believes that it may be particularly difficult to retain its key employees, especially its animators, creative personnel and technical directors, during periods in which it is not developing animated feature films. The loss of the services of any of Messrs. Jobs, Lasseter, Catmull or Levy or of other key employees, especially its animators, creative personnel and technical directors, could have a material adverse effect on Pixar's business, operating results or financial condition. -14- 15 CERTAIN FACTORS AFFECTING BUSINESS, OPERATING RESULTS AND FINANCIAL CONDITION The following is a discussion of certain factors which currently impact or may impact Pixar's business, operating results and/or financial condition. Anyone making an investment decision with respect to Pixar's capital stock or other securities is cautioned to carefully consider these factors. ANTICIPATED DECLINE IN OPERATING RESULTS IN 1997 AND NET LOSSES IN 1998 A number of factors are expected to lead to a substantial decline in Pixar's operating results in 1997 and net losses in 1998, as discussed more fully below. End of Toy Story Revenues Pixar has already recognized the vast majority of the revenue it expects to receive from the domestic and international theatrical releases of Toy Story and expects substantially all of the revenue from the home video of Toy Story to be recognized in the first two quarters of 1997. Under the terms of the Feature Film Agreement, which still governs the compensation payable to Pixar from the home video of Toy Story, Pixar is compensated for the home video to a lesser extent than it was with respect to the theatrical release of Toy Story. Pixar does not expect to recognize significant revenue from the Toy Story home video in the third or fourth quarters of 1997 or in any quarter in 1998. Pixar also expects limited revenue from the Toy Story CD-ROM products in 1997 and little or no revenue from such products in 1998. Reduced CD-ROM Revenue Pixar also expects to recognize less CD-ROM revenue in 1997 and 1998 than was previously anticipated. Although its first two CD-ROM products were successful on relative terms, Pixar determined in the last week of March 1997 to discontinue its business of producing CD-ROM and other interactive products in favor of other opportunities arising, in part, as a result of entering into the Co-Production Agreement. This decision is expected to have a material adverse impact on Pixar's operating results in 1997 and 1998. Pixar will not recognize any CD-ROM or other interactive product revenue in 1997 or 1998, other than revenue attributable to the two Toy Story CD-ROM products, and may incur carrying costs associated with the approximately 60 employees currently assigned to the interactive products division. Pixar does, however, expect to be able to reassign most of these employees to Picture productions and other departments within Pixar. Timing of Bugs and Toy Story Video Sequel Releases Bugs is not expected to be released until the end of 1998 at the earliest, and revenue attributable to Bugs is not expected to be recognized until after all costs have been recovered. Recovery of all costs depends on many factors and may not occur until six to twelve months after its release at the earliest, ensuring that Pixar will not recognize any revenue from Bugs until the second half of 1999 at the earliest. The Toy Story Video Sequel is currently targeted for release in the second half of 1998, but its release date could change for a number of reasons. First, Pixar may be unable, for technical or other reasons, to complete the production of the Toy Story Video Sequel in time for its scheduled release in the second half of 1998. Second, even if completed, Disney and Pixar may choose to delay release of the Toy Story Video Sequel until the 1998 holiday season or thereafter. Depending on the timing of receipt of revenues by Disney, Pixar may not recognize revenue from the Toy Story Video Sequel until three to six months after its release at the earliest, meaning that if the Toy Story Video Sequel were released in late 1998 or thereafter, Pixar would not recognize any revenue from the Toy Story Video Sequel until 1999 at the earliest. Third, it is possible that the Toy Story Video Sequel could be released to the theaters instead of as a made-for-home video. In such event, Pixar would not expect to recognize any revenue until six to twelve months after the theatrical release, with the result that Pixar would not recognize any revenue from such film until 1999, even if released to the theaters in the second half of 1998. -15- 16 Possible Decline in Sales of RenderMan Due to Shift in Focus As a result of Pixar's reduced emphasis on the commercialization of software in favor of products sold for their content, Pixar expects to dedicate less time and resources to distributing and marketing RenderMan than it has in the past, particularly shrink-wrapped versions of RenderMan, and further expects that sales of RenderMan may decline. Increase in Operating Expenses In 1996, Pixar significantly increased its operating expenses, and Pixar plans to continue to increase its operating expenses to fund greater levels of research and development and to expand operations. Specifically, Pixar expects operating expenses to increase significantly due to continued investment in proprietary software systems, increased compensation costs as a result of intense competition for animators, creative personnel and technical directors and increased costs associated with the expansion of its facilities. Accordingly, Pixar anticipates significant increases in operating expenses in each of 1997 and 1998. Finally, Pixar expects its tax rate to increase in 1997 and future years as the result of utilization of net operating losses in 1996. Impact on Operating Results As a result of the above factors, the only substantial revenue expected to be recognized in 1997 will be from the Toy Story home video, and substantially all of that will be recognized in the first and second quarters. Further, unless the Toy Story Video Sequel is released early in the second half of 1998 and is an extraordinary success on relative terms, Pixar will not recognize substantial revenue in 1998. At the same time, Pixar's operating expenses may increase in 1997 and 1998, even after giving effect to capitalization of film production costs and allocation of certain operating expenses to Disney under the Co-Production Agreement. Therefore, Pixar expects revenue and operating results in the third and fourth quarters of 1997 to decline substantially from the first and second quarters of 1997 and from the same quarters of 1996. It is possible that Pixar would even incur operating and net losses in each of the last two quarters of 1997. Pixar also expects to incur operating and net losses in each of the first three quarters of 1998 and, unless the Toy Story Video Sequel is released early in the second half of 1998, the fourth quarter of 1998 and for the year ending December 31, 1998. See "Managements' Discussion and Analysis of Financial Condition and Results of Operations" in the 1996 Annual Report. POTENTIAL FLUCTUATIONS IN OPERATING RESULTS In addition to the factors set forth above, Pixar expects to generally experience significant fluctuations in its future annual and quarterly operating results caused by a variety of factors. Pixar expects that its annual and quarterly operating results, particularly its revenue, will fluctuate due to factors such as the timing of the domestic and international releases of the animated feature films, the success of the animated feature films (which can fluctuate significantly from film to film), the timing of the release of related products into their respective markets, the demand for the related products (which is often a function of the success of the related animated feature film), film production costs, Disney's costs to distribute and promote the feature films and related products, Disney's success at marketing the films and related products, the timing of receipt of proceeds from the animated feature films and related products by Disney, the timing of revenue recognition under the Co-Production Agreement, the Feature Film Agreement or the CD-ROM Agreement, as the case may be, the introduction of new feature films or products by Pixar's competitors, and general economic conditions. In particular, since Pixar's revenue under the Co-Production Agreement is directly related to the success of a feature film, Pixar's operating results are likely to fluctuate depending on the level of success of its 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. See "Risks of Motion Picture Industry -- Commercial Success of a Motion Picture is Unpredictable." 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. -16- 17 Moreover, Pixar's operating expenses will be extremely difficult to forecast. The direct costs of film production are budgeted in agreement with Disney and shared equally. Pixar's share of these direct costs of film production are capitalized by Pixar in accordance with Statement of Financial Accounting Standards ("SFAS") No. 53, "Financial Reporting by Producers and Distributors of Motion Picture Films." A substantial portion of all of Pixar's other costs are incurred for the benefit of feature films ("Pixar's Overhead"), including research and development expenses and general and administrative expenses. Portions of Pixar's Overhead are included in the budgets for the Pictures and will be shared equally with Disney under the Co-Production Agreement. The remaining portion of Pixar's Overhead is either capitalized as film production costs, if required under SFAS No. 53, or charged to operating expense in the period incurred. Because a substantial portion of Pixar's Overhead is allocated to the Pictures and reimbursed by Disney and other amounts are capitalized by Pixar in accordance with SFAS No. 53, Pixar's future reported operating expenses will not reflect the true level of spending on the production of animated feature films, related products and overhead. Pixar has a valuation allowance as of December 31, 1996 which fully offsets its gross deferred tax assets due to Pixar's historical losses and the fact that there is no guarantee Pixar will generate sufficient taxable income in the future to be able to realize any or all of its deferred tax assets. As a result, Pixar may not be able to realize a benefit in the future from its net operating loss carryforwards, nor may it be able to recognize the tax benefits of net operating losses to be generated in the future. As a result of all of the foregoing, Pixar believes that period-to-period comparisons of its results of operations are not necessarily meaningful, and its annual and quarterly results of operations should not be relied upon as any indication of future performance. Due to all of the foregoing factors, it is likely that in some future period Pixar's operating results will be below the expectations of public market analysts and investors. In such event, the price of Pixar's Common Stock would likely be materially adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1996 Annual Report. DEPENDENCE ON TOY STORY, BUGS AND TOY STORY VIDEO SEQUEL Dependence on Toy Story For at least 1997, Pixar's revenue and operating results will be almost entirely dependent upon the success of Toy Story home video and the CD-ROM products related to Toy Story. Under the Feature Film Agreement, even though Toy Story grossed more than $350 million worldwide in box office receipts, Pixar's compensation from these receipts (approximately $18.8 million) was relatively small compared to that of Disney. Pixar expects to recognize substantially all of the Toy Story home video revenue in the first two quarters of 1997 and little or no revenue thereafter. The amount of compensation payable to Pixar from the Toy Story home video is governed by the prior Feature Film Agreement, pursuant to which Pixar's compensation rate for home videos is less than it was for theatrical exhibitions of Toy Story. Pixar also expects limited revenue from its Toy Story CD-ROM products in 1997 and little or no revenue from such products in 1998. Otherwise, Pixar expects little or no revenue in 1997 and 1998 from Toy Story or related products. Because Bugs and the Toy Story Video Sequel are not expected to be released until the end of 1998, all other revenues in the last half of 1997 and 1998 will be primarily dependent upon Pixar's other businesses, from which Pixar expects limited revenue. See "Business -- Relationship With Disney -- Co-Production Agreement." Dependence on Bugs and Toy Story Video Sequel Beyond 1998, Pixar expects to be significantly dependent upon the success of Bugs and the Toy Story Video Sequel (the "Current Projects") and related products. Although creative development on each of the Current Projects has begun, the Toy Story Video Sequel is not expected to be released any earlier than the last half of 1998, and Bugs is not expected to be released any earlier than the end of 1998. There can be no assurance that either of the Current Projects will be successfully created, developed and released when scheduled or thereafter. In addition, given the escalation in compensation rates of people required to work on the Current Projects, the number of people required to work on the Current Projects, and the equipment needs, the budget for the Current Projects and subsequent films and related products will be substantially greater than the budget for Toy Story and will be financed equally by Pixar and Disney under the Co-Production Agreement. There can be no assurance that Pixar will not experience difficulties that could delay or prevent the successful development or production of either of the Current Projects or subsequent animated -17- 18 feature films or related products. If Pixar is unable to produce and develop on a timely basis the Current Projects and subsequent animated feature films and related products that meet with broad market acceptance, Pixar's business, operating results and financial condition will be materially adversely affected. Risks Associated With Bugs. Under the Co-Production Agreement, Pixar shares the production costs of Bugs as well as a portion of the receipts. These costs will initially be capitalized as film production costs under SFAS No. 53 and then be amortized over Bugs's expected revenue stream when revenue is recognized. If Bugs is not an extraordinary box office success similar to Toy Story, the amount of revenue recognized will not be significant, and the capitalized production costs will have to be amortized in large amounts over a limited number of quarters, resulting in significant costs of film revenue in those quarters and, potentially, significant quarterly operating and net losses. Animated feature films that become extraordinary box office successes are rare. Pixar believes, based on available information, that there is a reasonable basis to conclude that of the more than 40 animated feature films introduced since 1990, only two movies generated domestic box office revenues greater than Toy Story, and both of those films were produced and distributed solely by Disney. During at least the last five years, Pixar believes that there has been no fully animated feature film (other than Toy Story) produced or developed by a studio other than Disney that has achieved more than $25 million in domestic box office revenues. While Bugs will be co-financed, promoted and marketed by Disney, it will have a different look, theme and musical style than Disney's other recent animated films (except for Toy Story), and there can be no assurance that it will have the same audience appeal as Disney's other animated films. For example, The Nightmare Before Christmas, released in 1993, was an animated feature film with a different appearance than traditional, hand drawn cel animated feature films such as Beauty and the Beast, The Lion King, Aladdin, Pocahontas and The Hunchback of Notre Dame and did not experience the same box office returns as those films. As a result, even if released, Bugs and related products may not generate significant revenue and operating results for Pixar, even if Bugs is critically acclaimed and achieves substantial, but not extraordinary, box office success. See "-- Risks Associated with Co-Production Agreement -- Dependence on Disney for Distribution and Promotion of Feature Films and Related Products," "-- Risks of Motion Picture Industry," and "Business -- Relationship with Disney. " See also Note 4 of Notes to Financial Statements in the 1996 Annual Report. Risks Associated with Toy Story Video Sequel. There are several additional risks unique to the Toy Story Video Sequel. First, Pixar has no experience developing sequels, either theatrical or made- for-home video. Moreover, the made-for-home video market has only recently begun to develop. As is typical in the case of an undeveloped market, demand and market acceptance are uncertain. Competition in this market is expected to increase dramatically. Disney alone has announced its intention to distribute several made-for-home video sequels in the next year, as have other studios. Pixar is at a disadvantage in the made-for-home video sequel market as compared to other animation studios in that Pixar cannot produce low cost animation, which typically characterizes sequels to animated feature films. Finally, the Toy Story Video Sequel will need to be an extraordinary success on relative terms in order to generate profits for Pixar. If the Toy Story Video Sequel is not an extraordinary success on relative terms, Pixar will incur substantial costs of film revenue in those quarters in which revenue is recognized, which will have a material adverse effect on its results of operations. There can be no assurance that the Toy Story Video Sequel will be an extraordinary success on relative terms, particularly given the recent emergence and uncertainty of the made-for-home video market. LIQUIDITY RISKS Pursuant to the Co-Production Agreement, Pixar will co-finance the next five animated feature films which it produces, including Bugs and the second theatrical film being developed under the Co-Production Agreement (the "Second Theatrical Film"), and will also co-finance the Toy Story Video Sequel. In the future, Pixar may co-finance other derivative works such as theatrical sequels, interactive products and television productions. As Pixar does not expect to generate substantial, if any, cash from operations in 1997 and 1998, the production costs of Bugs, the Second Theatrical Film and the Toy Story Video Sequel are expected to have a material adverse impact on Pixar's cash and short-term investment balances. As of December 31, 1996, Pixar had approximately $161 million in cash and short-term investments. Pixar believes that these funds will be sufficient to meet its anticipated cash needs for working capital and capital expenditures, including the production costs of Bugs, the Second Theatrical Film and the Toy Story Video Sequel, until Pixar begins receiving cash from the release of these films (which is generally not expected to occur until -18- 19 1999). However, even if these films generate cash, unless each is a success such that Pixar recovers on a timely basis its share of the production costs, as well as other operating expenses and capital expenditures, Pixar will be required to seek financing for its ongoing commitments under the Co-Production Agreement and any other requirements of its operations. Pixar may also seek additional financing in connection with the expansion of its facilities. See "Properties." The sale of additional equity or convertible debt securities would result in additional dilution to Pixar's shareholders. Moreover, there can be no assurance that Pixar will be successful in obtaining future financing, or even if such financing is available, that it will be obtained on terms favorable to Pixar or on terms providing Pixar with sufficient funds to meet its obligations and objectives. The failure to obtain such financing would have a material adverse effect on Pixar's business, operating results and financial condition. SCHEDULED CONCURRENT RELEASE OF FILMS; MANAGEMENT OF GROWTH In order to meet its obligations pursuant to the Co-Production Agreement, Pixar has established parallel creative teams so that it can develop more than one film at a time. These teams are currently working on Bugs, the Second Theatrical Film and the Toy Story Video Sequel. Bugs and the Toy Story Video Sequel are currently targeted for release at or about the same time in late 1998. Pixar believes that the concurrent release of two major animated feature films by one company is rare if not unique. Moreover, Pixar has only produced one prior feature film to date and has no experience with respect to producing two animated feature films in parallel. Pixar has been required, and will continue to be required, to expand its employee base, increase capital expenditures and procure additional resources and facilities in order to accomplish the scheduled concurrent release of these two feature films. This period of rapid growth and expansion has placed, and continues to place, a significant strain on Pixar's resources. There can be no assurance that either Bugs or the Toy Story Video Sequel will be released as scheduled in late 1998 or that this strain on resources will not have a material adverse effect on Pixar's business, financial condition or results of operations. In addition, when the production of either film is completed, if completed, Pixar may incur significant carrying costs associated with transitioning personnel on creative and development teams from one project to another which, although shared with Disney, could have a material adverse effect on Pixar's results of operations and financial condition. To continue to accommodate this growth, Pixar will be required to implement a variety of new and upgraded operational and financial systems, procedures and controls, including improvement of its accounting and other internal management systems. In addition, this growth and these diversification activities, along with the corresponding increase in the number of Pixar's employees and rapidly increasing costs, have resulted in increased responsibility for Pixar's management. Pixar will need to continue to implement and improve its operational, financial and management information systems and to hire, train, motivate and manage its employees, to integrate them into Pixar and to provide adequate facilities and other resources for them. There can be no assurance that Pixar will be successful in accomplishing all of these activities on a timely and cost-effective basis, and any failure to accomplish one or more of these activities on a timely and cost-effective basis would have a material adverse effect on Pixar's business, financial condition and results of operations. RISKS ASSOCIATED WITH CO-PRODUCTION AGREEMENT Dependence on Disney for Distribution and Promotion of Feature Films and Related Products The decisions regarding the timing of release of motion pictures and related products and which of Disney's motion pictures and related products will receive extensive promotional support from the studio are important in determining the success of the motion picture and related products. Under the terms of the Co-Production Agreement, Pixar has some general protections with respect to the marketing and distribution of the feature films in the form of commitments by Disney as to release windows, the timing of release of other Disney family films and marketing obligations. However, Pixar ultimately does not control the manner in which Disney distributes Pixar's animated feature films and related products, the number of theaters to which Disney distributes Pixar's feature films, the specific timing of release of the feature films and related products or the specific amount or quality of promotional support of the feature films and related products. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the "Walt Disney Pictures" label and may enjoy financial benefits in the event that such films achieve significant box office revenues, Pixar believes that Disney desires such films to be successful. -19- 20 Nonetheless, Disney could make certain decisions as to distribution or promotion of the animated feature films or related products that could have a material adverse effect on Pixar's business, operating results or financial condition. See "Business -- Relationship with Disney." Exclusivity Pixar has agreed not to release or authorize the release of any feature length animated theatrical motion picture produced by Pixar, other than the feature films produced by Pixar under the Co-Production Agreement, until twelve months from delivery of the fifth feature film under the Co-Production Agreement. Pixar currently anticipates that the delivery of the fifth Picture would not occur until at least ten years from the date of the Co-Production Agreement. Pixar has further agreed that it will not enter into any agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture until after Pixar has delivered the third feature film to Disney under the Co-Production Agreement. Pixar has also agreed that it will not develop or produce any rides or attractions for major theme parks not owned or operated by Disney, and to give Disney a right to negotiate with respect to animated television productions or animated made-for-home video productions that Pixar proposes to produce during the term of the Co-Production Agreement. Financing of Production Costs Under the Co-Production Agreement, unlike the prior Feature Film Agreement and the prior CD-ROM Agreement, Pixar will co-finance each of the five animated feature films and may co-finance other related products to be developed and produced pursuant to the Co-Production Agreement. Pixar is currently co-financing Bugs, the Second Theatrical Film and the Toy Story Video Sequel under the Co-Production Agreement. Accordingly, unlike the Feature Film Agreement and the prior CD-ROM Agreement, Pixar will incur significant production costs which must be offset by revenue generated by the animated feature films and related products. If the feature films and related products do not generate revenue sufficient to more than offset Pixar's share of their production costs, Pixar's business, operating results and financial condition will be materially adversely effected. Rights to Characters and Elements Retained by Disney Disney retains the exclusive distribution and exploitation right to all feature films, all characters and story elements of the feature films and all related products developed by Pixar under the Co-Production Agreement. Accordingly, except in certain specified circumstances unlikely to generate revenue, Pixar is not able to exploit or distribute any of the feature films or characters or elements of any of the feature films or related products developed under the Co-Production Agreement without a license from Disney. There can be no assurances that such a license would be available to Pixar on commercially reasonable terms or at all. See "Business -- Relationship with Disney." Termination Under the terms of the Co-Production Agreement, Disney may terminate the agreement under certain circumstances. There can be no assurance that Disney would not terminate the Co-Production Agreement under these circumstances. Disney would not lose any of its rights to distribute and exploit all feature films and all characters and elements of the feature films and other products developed by Pixar under the Co-Production Agreement, except for a feature film or related product then in production as to which Disney does not elect to proceed, as to which Pixar would regain the rights subject to a lien in favor Disney for the costs advanced to date. Further, in the event that Disney terminated the Co-Production Agreement, Pixar would be required to seek alternative channels for distribution of its animated feature films and related products. There can be no assurance that Pixar would be able to find a third party to finance, distribute and promote its animated feature films and related products on terms acceptable to Pixar, if at all. -20- 21 RISKS OF MOTION PICTURE INDUSTRY Commercial Success of a Motion Picture is Unpredictable The motion picture industry involves a substantial degree of risk. Each motion picture is an individual artistic work, and its commercial success is primarily determined by audience reaction, which is unpredictable. The commercial success of a motion picture also depends upon the quality and acceptance of other competing films released into the marketplace at or near the same time, critical reviews, the availability of alternative forms of entertainment and leisure time activities, general economic conditions and other tangible and intangible factors, all of which can change and cannot be predicted with certainty. In addition, motion picture attendance is seasonal, with the greatest attendance typically occurring during the summer and holidays. The release of a film during a period of relatively low theater attendance is likely to affect the film's box office receipts adversely. Further, due to the expected release of a large number of animated films by Disney and other movie studios in the next several years, it is possible that the market for animated films will become saturated. Therefore, there is a substantial risk that some or all of Pixar's motion pictures will not be commercially successful, which would have a material adverse effect on Pixar's business, financial condition and results of operations. Completion of a Motion Picture Subject to Uncertainties and Financial Risks The production, completion and distribution of motion pictures is subject to numerous uncertainties, including financing requirements, personnel availability and the release schedule of competitive films. Pixar is concurrently developing three motion pictures, Bugs, the Second Theatrical Film and the Toy Story Video Sequel, which compounds these uncertainties and jeopardizes the successful, timely and cost-effective production and completion of each film. Under the Co-Production Agreement, Pixar has increased its financial involvement in the production costs of motion pictures, subjecting Pixar to substantial financial risks relating to the production, completion and release of the motion pictures. In addition, a significant amount of time will elapse between the expenditure of funds by Pixar and the receipt of revenues from the animated feature films. COMPETITION Pixar experiences intense competition with respect to both animated feature films and software. Competition From Movie Studios Pixar's animated feature films compete and will continue to compete with feature films and other family oriented entertainment products produced by major movie studios, including Disney (as somewhat limited by the Co-Production Agreement), Turner Broadcasting Systems Inc., Warner Bros. Inc. (which has acquired Turner Broadcasting Systems Inc.), Twentieth Century Fox Film Corporation, Paramount Pictures, Columbia/Tri-Star Pictures Inc., Lucasfilm, Universal City Studios, Inc. and MGM/UA, as well as numerous other independent motion picture production companies. Several of these studios have already developed and released animated feature films, and Pixar expects additional competition in the animated feature film market from these and other movie studios. Some of these other movie studios have announced their intention to enter the animated feature film market, including DreamWorks, a studio formed in 1994 which is expressly targeting the animated film market. In particular, DreamWorks owns a significant equity stake in PDI, a computer graphics special effects firm, and has begun developing a computer animated movie with PDI that is expected be completed by 1998. This computer animated movie, which has been referred to publicly as "Ants", may contain similar subject matter as Bugs. Pixar's films will compete with the feature films of these movie studios for audience acceptance and exhibition outlets. In addition, Pixar competes and will continue to compete with these movie studios for the acquisition of literary properties, production financing, the services of performing artists, and the services of other creative and technical personnel, particularly in the fields of animation and technical direction. Most of the other movie studios with which Pixar competes have significantly greater name recognition and significantly greater financial, technical, creative, marketing and other resources than does Pixar. At least two of these movie studios, Disney and Lucasfilm (through its affiliate ILM), have developed their own internal computer animation capability and have created computer animation for special effects in animated films. In -21- 22 addition, Pixar believes that Disney is currently developing and producing a feature film making substantial use of computer animation. Other movie studios may internally develop, license or sub-contract three-dimensional animation capability. Further, Pixar believes that continuing enhancements in computer hardware and software technology will lower barriers to entry for studios or special effects companies which intend to produce computer animated feature films or other products. The Co-Production Agreement provides for the development and production by Pixar of five computer animated feature films. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the "Walt Disney Pictures" label and enjoys financial benefits in the event that such films achieve significant box office revenues, Pixar believes that Disney desires such films to be successful. Nonetheless, Disney has been by far the most successful producer of animated feature films, and family oriented motion pictures distributed by Disney or its affiliates are likely to be in the market concurrently with and competing with Pixar's animated feature films. Pixar's contractual arrangement with Disney also presents other risks. See "-- Risks Associated With Co-Production Agreement" and "Business -- Competition." Competition From Computer Graphics Special Effects Firms Pixar also expects to compete with computer graphics special effects firms, including ILM, Digital Domain, PDI, Rhythm & Hues, Boss Film Studios, Inc. and Blue Sky Productions. These computer graphics special effects firms may be capable of creating their own three-dimensional computer animated feature films or may produce three-dimensional computer animated feature films for movie studios that compete with Pixar. For example, ILM has already created and produced three-dimensional character animation which was used for the ghosts in the live action film Casper, and ILM has a royalty-free, paid-up license to use Pixar's RenderMan software and to obtain at no cost all enhancements and upgrades thereto. Other computer graphics special effects firms have licensed or may license RenderMan. Accordingly, Pixar's RenderMan software may not provide Pixar with a competitive advantage. See "Business -- Competition." Competition From Software Publishers Pixar also experiences intense competition with respect to its RenderMan software product. In particular, Pixar competes with makers of computer graphics imaging and animation software, principally Microsoft (which acquired SoftImage, Inc.), MentalImage (which offers the same product offered by Microsoft), and Silicon Graphics (which acquired Wavefront and Alias). Microsoft, through SoftImage, Inc., MentalImage and Silicon Graphics, through Wavefront and Alias, are each marketing competing rendering software products. Microsoft and Silicon Graphics have each licensed several of Pixar's patents that cover certain rendering techniques and may therefore be better able to market products that compete with Pixar's RenderMan software. In addition, as PCs become more powerful, software suppliers may also be able to introduce products for PCs that would be competitive with RenderMan in terms of price and performance for professional users. Under appropriate circumstances, Pixar might elect to license its rendering technology patents to other companies, some of which may compete with Pixar. See "Business -- Competition." Competition Could Adversely Impact Pixar Pixar expects competition to persist, intensify and increase in each of its business areas in the future. Almost all of Pixar's current and potential competitors have longer operating histories, greater name recognition, larger installed customer bases and significantly greater financial, technical, marketing and other resources than Pixar. There can be no assurance that Pixar will be able to compete successfully against current or future competitors. Such competition could materially adversely affect Pixar's business, operating results or financial condition. See "Business -- Competition." -22- 23 LIMITED OPERATING HISTORY Until 1996, Pixar had generated recurring revenue primarily from the license of its RenderMan software, amounts received under software development contracts and fees for animated television commercial development. However, Pixar intends to generate a substantial majority of its future revenue from the development and production of animated feature films and related products, such as it did in 1996. Pixar has, to date, developed and produced only one animated feature film, Toy Story, and only two related products (both CD-ROM titles, which Pixar no longer intends to produce). Accordingly, Pixar has only a limited operating history in implementing its new business model upon which an evaluation of Pixar and its prospects can be based. Pixar's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of a new business enterprise, particularly companies in highly competitive markets. To address these risks, Pixar, among other things, must respond to competitive developments, continue to attract, retain and motivate qualified persons, and continue to upgrade its technologies. There can be no assurance that Pixar will be successful in addressing such risks. Risk of Made-For-Home Video Sequels Market In addition to feature films, Pixar intends to generate revenue from made-for-home video sequels, such as the Toy Story Video Sequel. There are several risks associated with this market. Pixar has no experience developing made-for-home video sequels. In addition, Pixar expects competition for sequels to increase and intensify. Further, there can be no assurance that voices and other intellectual property rights used in the original animated feature film will be available for use in any made-for-home video sequel, or if available, that such voices or other intellectual property rights can be obtained at a reasonable cost. For example, certain of the voices used in Toy Story were significantly more expensive to obtain for the Toy Story Video Sequel than they were to obtain for the original feature film. Moreover, Pixar is at a disadvantage in this market as compared to other animation studios in that Pixar cannot produce low-cost animation which typically characterizes made-for-home video sequels to animated feature films. DEPENDENCE ON KEY PERSONNEL Pixar's success depends to a significant extent on the performance of a number of senior management personnel and other key employees, especially its animators, creative personnel and technical directors. In particular, Pixar is dependent upon the services of Steve Jobs, John Lasseter, Edwin E. Catmull and Lawrence B. Levy. Pixar does not maintain "key man" life insurance for any of its employees. Pixar does have employment agreements with Messrs. Lasseter and Catmull, who are fundamental to Pixar's relationship with Disney. However, such employment agreements do not necessarily assure the services of these employees. Pixar believes that it may be particularly difficult to retain its key employees, especially its animators, creative personnel and technical directors, during periods in which it is not developing animated feature films. The loss of the services of any of Messrs. Jobs, Lasseter, Catmull or Levy or of other key employees, especially its animators, creative personnel and technical directors, could have a material adverse effect on Pixar's business, operating results or financial condition. Although none of Pixar's employees are represented by a labor union, it is common for animators and actors at film production companies to belong to a union. There can be no assurance that Pixar's employees will not join or form a labor union or that Pixar, for certain purposes, will not be required to become a union signatory. See "Business -- Employees" and "Executive Officers of the Company." NEED TO ATTRACT AND RETAIN QUALIFIED PERSONNEL TO BE SUCCESSFUL Pixar's success depends to a significant extent on its ability to identify, attract, hire, train and retain qualified professional, creative, technical and managerial personnel. Competition for such personnel is intense, and there can be no assurance that Pixar will be successful in identifying, attracting, hiring, training and retaining such personnel in the -23- 24 future. The competition for quality animators, creative personnel and technical directors is especially intense because the entertainment market has significantly expanded over the past several years. If Pixar is unable to hire, assimilate and retain qualified personnel in the future, particularly animators, creative personnel and technical directors, such inability would have a material adverse effect on Pixar's business, operating results and financial condition. See "Business -- Employees" and "Executive Officers of the Company." DEPENDENCE ON SUCCESSFUL DEVELOPMENT OF APPEALING CREATIVE CONTENT FOR ANIMATED FEATURE FILMS AND RELATED PRODUCTS The success of each animated feature film created and produced by Pixar will depend in large part upon the Pixar creative team's ability to predict the type of content that will appeal to a broad audience and to develop stories and characters that achieve broad market acceptance. Traditionally, this has been extremely difficult. Disney provided creative assistance throughout the production of Toy Story, including creative reviews and approvals, and the Co-Production Agreement contemplates that Disney will continue to provide creative assistance to Pixar on feature films and other products made pursuant to that agreement, but there can be no assurance that Disney will continue to provide assistance to Pixar in the development of creative content for its feature films or related products. There also can be no assurance that voices and other intellectual property rights used in an animated feature film will be available for use in any CD-ROM or other product related to such feature film. For example, Pixar was unable to obtain the rights to use certain voices from Toy Story in the two CD-ROM products based on Toy Story. See "Business -- Creative Development Group." DISTRIBUTION RISKS Disney is required to distribute the five animated feature films to be produced pursuant to the Co-Production Agreement. Distribution of a motion picture generally involves domestic and foreign licensing for (i) theatrical exhibition, (ii) home video, (iii) presentation on television, including pay, basic cable and syndication, (iv) non-theatrical exhibition, which includes airlines, hotels and armed forces facilities and (v) marketing of other rights of the picture, which may include merchandising, such as CD-ROM titles, toys and soundtrack recordings. Although the Co-Production Agreement provides Pixar with some protection, there can be no assurance that the feature films made under the Co-Production Agreement will be distributed through all of these outlets. For example, Disney has traditionally not made its animated feature films available on pay television other than the Disney Channel or on network television other than ABC, an affiliate of Disney. See "Business -- Business Model and Products." DEPENDENCE ON PROPRIETARY TECHNOLOGY FOR TIMELY AND SUCCESSFUL DEVELOPMENT OF FEATURE FILMS AND RELATED PRODUCTS There can be no assurance that Pixar will not experience difficulties that could delay or prevent the successful development or production of future animated feature films or other related products. Among other things, because Pixar is dependent upon a large base of software and a large number of computers for the development and production of its animated feature films and related products, an error or defect in the software or a failure in the hardware could result in a significant delay in production. A significant delay in production could have a material adverse effect on Pixar's business, operating results or financial condition. Further, because Pixar relies mostly on internally developed software, Pixar would not be able to rely upon assistance from third parties in the event that the software fails. See "Business -- Technology." CONCENTRATION OF STOCK OWNERSHIP Pixar's Chief Executive Officer, Steve Jobs, beneficially owns approximately 74.7% of the outstanding Common Stock as of March 20, 1997. As a result, Mr. Jobs, acting alone, is able to exercise sole discretion over all matters requiring shareholder approval, including the election of the entire board of directors and approval of significant corporate transactions, including an acquisition of Pixar. Such concentration of ownership may also have the effect of delaying or preventing a change in control of Pixar. -24- 25 RISK OF SUBSTANTIAL ADDITIONAL COSTS RELATED TO FACILITIES EXPANSION Pixar leased significant additional space during 1996, but continues to seek additional space. Pixar is evaluating such alternatives as building a new studio facility and leasing additional buildings. Pixar currently expects to exercise an option to purchase property (which option Pixar purchased in 1996) and to build a new studio facility on the property. If Pixar purchases the property and builds a new studio facility, Pixar currently expects to incur capital expenditures of more than $10 million in 1997 and more than $12 million in 1998. Pixar may choose to use its existing cash resources for such expenditures or to finance such capital expenditures through the issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. If Pixar does not choose to purchase the property and build a new facility, Pixar would need to write-off more than $900,000 of capitalized expenses associated with site development and engineering and architectural plans related to the new building, and would incur an additional $300,000 charge related to Pixar's share of the site preparation. See "Properties" and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" in the 1996 Annual Report. NEED FOR TECHNOLOGICAL ADVANCEMENT TO BE SUCCESSFUL Substantially all of Pixar's revenues have been derived, and substantially all of Pixar's future revenues are expected to be derived, from the use and license of Pixar's proprietary technologies. Pixar expects that it will be required to enhance these technologies and to develop new technologies in order to be successful in its industry and in the licensing of its RenderMan software. There can be no assurance that Pixar will be successful in enhancing its existing technologies or in developing and utilizing new technologies, or that competitors will not develop technology that is equivalent or superior to Pixar's technologies or that makes Pixar's technologies obsolete. If Pixar is unable to develop enhancements to its existing technologies or new technologies as required, Pixar's business, operating results or financial condition could be materially adversely affected. See "Business -- Technology." DEPENDENCE ON PROPRIETARY RIGHTS No Assurance That Patents Will Issue From Applications or Sufficiently Protect Pixar's Technology Pixar's success and ability to compete is dependent in part upon its proprietary technology. While Pixar relies on a combination of patents, copyright and trade secret protection, nondisclosure agreements and cross-licensing arrangements to establish and protect its proprietary rights, Pixar believes that factors such as the technical and creative skills of its personnel are more essential to its success and ability to compete. Pixar currently is the owner of eight patents issued in the United States, one patent issued in the United Kingdom, one patent issued in France, one patent issued in Germany, one patent issued in Japan and two patents issued in Canada. In addition, Pixar has six patent applications pending in the United States, four pending in Japan, one pending before the European Patent Office and one pending before the Patent Cooperation Treaty Office. There can be no assurance that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed will be sufficiently broad to protect Pixar's technology. In addition, there can be no assurance that any patents that have been issued to Pixar, or that Pixar may license from third parties, will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to Pixar. Failure of the patents to provide protection of Pixar's technology may make it easier for Pixar's competitors to offer technology equivalent to or superior to Pixar's technology. See "Business - -- Proprietary Rights." No Assurance That Efforts to Protect Proprietary Technologies Will Succeed The source code for Pixar's proprietary software is protected both as trade secrets and as a copyrighted work. Pixar generally enters into confidentiality or license agreements with its employees, consultants and vendors, and generally controls access to and distribution of its software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use Pixar's proprietary information, products or technology without authorization, or to develop similar or superior technology independently. Policing unauthorized use of Pixar's products is difficult. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. To license its RenderMan software product, Pixar primarily relies -25- 26 on "shrink wrap" licenses that are not signed by the end-user and, therefore, may be unenforceable under the laws of certain jurisdictions. There can be no assurance that the steps taken by Pixar will prevent misappropriation of its technology or that its confidentiality or license agreements will be enforceable. See "Business -- Proprietary Rights." Risk That Litigation Will Be Required to Enforce Proprietary Rights Litigation may be necessary in the future to enforce Pixar's intellectual property rights, to protect Pixar's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on Pixar's business, operating results or financial condition. See "Business -- Proprietary Rights." Risks of Infringement Claims From time to time Pixar has received, and is likely to receive in the future, notice of claims of infringement of other parties' proprietary rights. There can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against Pixar or that any assertions or prosecutions will not materially adversely affect Pixar's business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, Pixar would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on Pixar's business, financial condition or results of operations. If any claims or actions are asserted against Pixar, Pixar may seek to obtain a license under a third party's intellectual property rights. There can be no assurance, however, that under such circumstances a license would be available on reasonable terms or at all. See "Business -- Proprietary Rights." No Assurance That Third Party Technology Licenses Will Continue to be Available Pixar also relies on certain technology that it licenses from third parties, including software that is integrated and used with internally developed software. There can be no assurance that these third party technology licenses will continue to be available to Pixar on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays in feature film releases or product shipments until equivalent technology could be identified, licensed and integrated. Any such delays in feature film releases or product shipments could materially adversely affect Pixar's business, operating results and financial condition. See "Business -- Proprietary Rights." POSSIBLE VOLATILITY OF SHARE PRICE AND RISK OF LITIGATION Pixar believes that factors such as the publication of box office results for Pixar's or its competitors' feature films, fluctuations in quarterly or annual results of operations, changes in financial estimates by securities analysts, announcements by Pixar or by its competitors, budget increases, delays in or cancellation of feature film or other product release dates, or other events or factors may cause the market price of Pixar's Common Stock to fluctuate. Moreover, in recent years, the stock market in general, and the shares of technology companies in particular, have experienced extreme price and volume fluctuations, some of which have been unrelated or disproportionate to the operating performances of such companies. These broad market and industry fluctuations may adversely affect the market price of Pixar's Common Stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of management's attention and resources, which would have a material adverse effect on Pixar's business, operating results and financial condition. -26- 27 ITEM 2. PROPERTIES Pixar leases approximately 72,000 square feet of office space in Richmond, California. Pixar has signed a lease for an additional 46,000 square feet of office space at the same location which is scheduled to begin in the second quarter of 1997. The leases expire on various dates ranging from July 1999 to February 2001. Pixar will need to seek additional space in the near future and is evaluating such alternatives as building a new studio facility and leasing additional buildings. Pixar currently intends to build a new studio facility and has paid deposits on the purchase of land which are nonrefundable and will be applied to the purchase price of the property should Pixar elect to purchase the property. If Pixar purchases the property and builds a new studio facility, Pixar would incur substantial capital expenditures in 1997 and 1998. If Pixar does not choose to purchase the property and build a new facility, Pixar would need to write-off significant capitalized expenses associated with the new building. See "Business -- Certain Factors Affecting Business, Operating Results and Financial Condition -- Risk of Substantial Additional Costs Related to Facilities Expansion". See also "Managements' Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" in the 1996 Annual Report. ITEM 3. LEGAL PROCEEDINGS Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. -27- 28 EXECUTIVE OFFICERS OF THE COMPANY The executive officers of Pixar and their ages as of March 20, 1997 are as follows:
NAME AGE POSITION ---- --- -------- Steve Jobs.......................... 42 Chairman, Chief Executive Officer and Office of the President Edwin E. Catmull.................... 51 Executive Vice President, Chief Technical Officer and Office of the President Lawrence B. Levy.................... 37 Executive Vice President, Chief Financial Officer, Office of the President and Secretary John Lasseter....................... 40 Vice President, Creative Development Ralph J. Guggenheim................. 45 Vice President, Feature Film Production Pamela J. Kerwin.................... 48 Vice President, Interactive Products William T. Reeves................... 45 Technical Director, Feature Films
Pixar's executive officers are appointed by, and serve at the discretion of, the Board of Directors. Each executive officer is a full time employee of Pixar. There is no family relationship between any executive officer or director of Pixar. Mr. Jobs is a co-founder of Pixar and has served as its Chairman since March 1991, as its Chief Executive Officer since February 1986 and in the Office of the President since February 1995. He has been a director of Pixar since February 1986 and served as Chairman from February 1986 to November 1988. Mr. Jobs was also a co-founder of NeXT Software, Inc. ("NeXT"), which developed and marketed object-oriented software for client/server business applications and the Internet, and served as the Chairman and Chief Executive Officer of NeXT from October 1985 until February 1997, when NeXT was acquired by Apple Computer, Inc. ("Apple"). Mr. Jobs currently serves as an advisor to Apple on a limited basis. Mr. Jobs was a co-founder of Apple, where he co-designed the Apple II and led the development, manufacturing and marketing of the Macintosh and LaserWriter printer. Mr. Jobs was awarded the National Technology Medal in 1985, the Jefferson Award for Public Service in 1987 and was named Entrepreneur of the Decade by Inc. magazine. Mr. Jobs attended Reed College in Portland, Oregon. Dr. Catmull is a co-founder of Pixar and has served as Executive Vice President and Chief Technical Officer since June 1995 and in the Office of the President since February 1995. From March 1991 to February 1995, he served as President, from November 1988 to March 1991 he served as Chairman and from February 1986 to November 1988 he served as President. Prior to joining Pixar, he was Vice President of the Computer Division of Lucasfilm. Dr. Catmull received the Scientific and Engineering Award from The Academy of Motion Picture Arts and Sciences in 1992 and also received the SIGGRAPH Coons Award for lifetime contributions in 1993. Dr. Catmull is a member of the Scientific and Technical Awards Committee of The Academy of Motion Picture Arts and Sciences. Dr. Catmull received B.S. degrees in computer science and physics and a Ph.D. in computer science from the University of Utah. Mr. Levy has served as Executive Vice President, Chief Financial Officer and in the Office of the President since February 1995. Mr. Levy has served as Secretary of Pixar since October 1995. Prior to joining Pixar, he was Vice Chairman and Chief Financial Officer of Electronics for Imaging, Inc., a provider of hardware and software products for the digital color imaging market, where he held various executive positions from April 1991 until January 1995. From December 1987 to April 1991, he was head of the Technology Licensing and Distribution Department at the law firm of Wilson Sonsini Goodrich & Rosati, where he became a partner in February 1990. Mr. Levy received a B.S. in business and accounting from Indiana University and a J.D. from Harvard Law School. Mr. Levy is also a certified public accountant. Mr. Lasseter has served as Vice President, Creative Development since August 1991. Mr. Lasseter joined Pixar in February 1986 as Animator/Director. From 1984 to 1986, he was an animator at Lucasfilm and from 1979 to 1984 he worked as an animator at The Walt Disney Company. For his work in directing Toy Story, Mr. Lasseter -28- 29 received an Academy Award in 1996 for Special Achievement, and for his work in directing Tin Toy, Mr. Lasseter received an Academy Award in 1988 for Best Short Film (Animated). Mr. Lasseter received a B.F.A. degree in film from the California Institute of the Arts. Mr. Guggenheim has served as Vice President, Feature Film Production since April 1995. From May 1992 to April 1995, he served as Vice President and General Manager, Animation Division. From July 1989 to May 1992, he served as Executive Producer and from February 1986 to July 1989 he served as Director, Animation Services. Since 1992, Mr. Guggenheim has also served as Vice President of the production company set up to produce Toy Story. From 1980 to 1986, he was Director of Editing Research at Lucasfilm's Computer Research Group and from 1978 to 1980 he was Producer of Computer Animated Commercials at the Computer Graphics Lab of New York Institute of Technology. Mr. Guggenheim received a B.A. in communications and an M.S. in computer graphics and motion picture production from Carnegie Mellon University. Ms. Kerwin has served as Vice President, Interactive Products since April 1995. From May 1992 to April 1995, she served as Vice President and General Manager, Technology Division. From May 1990 to May 1992, she served as Vice President of Marketing and Sales and from June 1989 to May 1990 she served as Director of Marketing. From July 1986 to June 1989, she was the Vice President of Marketing and Sales at Media Cybernetics, which develops and markets image processing software. From February 1985 to July 1986, Ms. Kerwin served as Vice President of Marketing for Levine and Rudd, Inc., a marketing consulting and graphic arts firm. From December 1978 to February 1985, Ms. Kerwin held various marketing positions at Control Data. Ms. Kerwin received a B.S. degree in English from Towson State University. Dr. Reeves has served as Technical Director, Feature Films Production since February 1991. Dr. Reeves joined Pixar in February 1986 as Director of Animation Research and Development. From July 1982 to February 1986, he was Project Leader of the Modeling and Animation Group at the Computer Division of Lucasfilm. From September 1980 to July 1982, he was the Project Leader of the Systems Group and a member of the Computer Graphics Group at Lucasfilm where he invented a new image synthesis technique called particle systems that enables the generation of very complex and detailed images. For his work as Technical Director on Tin Toy, Dr. Reeves received an Academy Award in 1988 for Best Short Film (Animated). Dr. Reeves received a B.S. in math from the University of Waterloo in Canada and M.S. and Ph.D. degrees in computer science from the University of Toronto. -29- 30 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS Pixar's Common Stock has been traded on the Nasdaq National Market under the trading symbol "PIXR" since Pixar's initial public offering on November 29, 1995. The following table sets forth the high and low sale prices per share of Pixar's Common Stock for the periods indicated.
HIGH LOW ------- ------- 1995 Fourth Quarter (from November 29, 1995).................. $49 1/2 $22 1996 First Quarter............................................ $29 $18 1/2 Second Quarter........................................... $25 1/2 $16 3/4 Third Quarter............................................ $19 1/4 $12 1/4 Fourth Quarter........................................... $20 1/2 $12 3/4 1997 First Quarter (through March 20, 1997)................... $22 3/4 $12 5/8
As of March 20, 1997, Pixar had approximately 2,103 shareholders of record. The price for the Common Stock as of the close of business on March 20, 1997 was $19.75 per share. Pixar has never paid any cash dividends on its Common Stock. Pixar intends to retain any earnings for use in its business and does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated by reference to the section entitled "Selected Financial Data" in the 1996 Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the 1996 Annual Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is incorporated by reference to the section entitled "Financial Statements and Selected Financial Data" in the 1996 Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. -30- 31 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The information required by this item concerning Pixar's directors is incorporated by reference to the information set forth in the section entitled "Election of Directors" in Pixar's Proxy Statement for the 1997 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of the Pixar's fiscal year ended December 31, 1996, except that the information required by this item concerning the executive officers of Pixar is incorporated by reference to the information set forth in the section entitled "Executive Officers of the Company" at the end of Part I of this Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information required by this item regarding executive compensation is incorporated by reference to the information set forth in the sections entitled "Election of Directors -- Director Compensation" and "Executive Officer Compensation" in Pixar's Proxy Statement for the 1997 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of the Pixar's fiscal year ended December 31, 1996. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to the information set forth in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in Pixar's Proxy Statement for the 1997 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of Pixar's fiscal year ended December 31, 1996. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item regarding certain relationships and related transactions is incorporated by reference to the information set forth in the section entitled "Certain Transactions" in Pixar's Proxy Statement for the 1997 Annual Meeting of Shareholders to be filed with the Commission within 120 days after the end of Pixar's fiscal year ended December 31, 1996. -31- 32 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Form 10-K: 1. Financial Statements. The following financial statements of Pixar and the Independent Auditors' Report therein are incorporated by reference to the portions of Pixar's 1996 Annual Report filed as Exhibit 13.1 to this Form 10-K: Independent Auditors' Report ........................ Balance Sheets as of December 31, 1995 and 1996 ..... Statements of Operations for the years ended December 31, 1994, 1995 and 1996 .................. Statements of Shareholders' Equity (Deficit) for the years ended December 31, 1994, 1995 and 1996 ...... Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996 .................. Notes to Financial Statements .......................
2. Financial Statement Schedule. The following financial statement schedule of Pixar for the years ended December 31, 1994, 1995, and 1996 is filed as part of this Form 10-K and should be read in conjunction with the Financial Statements, and related notes thereto, of Pixar. Independent Auditors' Report on Financial Statement Schedule......................................... S-1 Schedule II--Valuation and Qualifying Accounts and Reserves............................ S-2 Schedules not listed above have been omitted since they are either not required, not applicable, or the information is otherwise included. 3. Exhibits: See Item 14(c) below. (b) Reports on Form 8-K. No Reports on Form 8-K were filed during the fourth quarter ended December 31, 1996. (c) Exhibits. The exhibits listed on the accompanying index to exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Form 10-K. (d) Financial Statement Schedules. See Item 14(a) above. -32- 33 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, on this 31st day of March 1997. PIXAR By: /s/ Lawrence B. Levy ---------------------------------- Lawrence B. Levy Executive Vice President and Chief Financial Officer POWER OF ATTORNEY KNOW ALL THESE PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven P. Jobs, Lawrence B. Levy, Edwin E. Catmull and Pamela J. Kerwin and each of them, jointly and severally, his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorneys-in-fact or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE ----------- ------ ------ /s/ Steven P. Jobs Chairman of the Board and Chief Executive Officer March 31, 1997 - -------------------------------------- (Principal Executive Officer) Steven P. Jobs /s/ Lawrence B. Levy Executive Vice President and Chief Financial Officer March 31, 1997 - -------------------------------------- (Principal Financial and Accounting Officer) Lawrence B. Levy /s/ Skip M. Brittenham Director March 31, 1997 - -------------------------------------- Skip M. Brittenham /s/ Joseph A. Graziano Director March 31, 1997 - -------------------------------------- Joseph A. Graziano /s/ Larry W. Sonsini Director March 31, 1997 - -------------------------------------- Larry W. Sonsini
-33- 34 INDEPENDENT AUDITORS' REPORT ON SCHEDULE The Board of Directors and Shareholders Pixar: Under date of January 31, 1997, except as to Note 11, which is as of March 25, 1997, we reported on the balance sheets of Pixar as of December 31, 1995 and 1996, and the related statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1996, which are included in the annual report on Form 10-K. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedule included herein. This financial statement schedule is the responsibility of Pixar's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Palo Alto, California January 31, 1997 S-1 35 PIXAR SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
BALANCE AT DEDUCTIONS: BEGINNING WRITE OFFS OF BALANCE AT CLASSIFICATION OF YEAR ADDITIONS ACCOUNTS END OF YEAR --------------- ------------- ------------- ------------- ----------- Allowance for returns and doubtful accounts Year ended December 31, 1994............. $ 36 $191 $ -- $227 ==== ==== ==== ==== Year ended December 31, 1995............. $227 $ 61 $(32) $256 ==== ==== ==== ==== Year ended December 31, 1996............. $256 $ 3 $ -- $259 ==== ==== ==== ====
S-2 36 INDEX TO EXHIBITS
EXHIBIT NUMBER EXHIBITS --------- -------- 3.1 Amended and Restated Articles of Incorporation(1)............................................. 3.4 Amended and Restated Bylaws, as amended(1).................................................... 4.1 See Exhibit 3.1............................................................................... 4.2 See Exhibit 3.2............................................................................... 4.5 Specimen Common Stock Certificate(1).......................................................... 4.6 Common Stock and Warrant Purchase Agreement between the Registrant and Disney Enterprises, Inc. dated as of February 23, 1997............................................... 4.7 Form of Common Stock Purchase Warrant to be issued to Disney Enterprises, Inc................. 4.8 Form of Registration Rights Agreement by and between the Registrant and Disney Enterprises, Inc.............................................................................. 10.1* 1995 Stock Plan, as amended, and forms of agreements thereto(1)............................... 10.2* 1995 Director Option Plan(1).................................................................. 10.3* Form of Indemnification Agreement entered into between the Registrant and each of the executive officers and directors(1)........................................................... 10.4 Agreement between the Registrant and Walt Disney Pictures dated May 3, 1991, as amended(1)(5)................................................................................. 10.5 Net Office Lease between the Registrant and Point Richmond R&D Associates dated February 15, 1990, as amended(1)............................................. 10.6 Secured Promissory Note between the Registrant and Edwin E. Catmull dated May 10, 1995(1)....................................................................................... 10.7 Patent License Agreement between the Registrant and Microsoft Corporation dated June 21, 1995(1)(5)......................................................... 10.8 Recapitalization Agreement between the Registrant and the sole shareholder and key employees of the Registrant dated April 28, 1995 and related agreement thereto(1)............. 10.9* Employment Agreement between the Registrant and Edwin E. Catmull dated August 1, 1991(1)....................................................................................... 10.10* Employment Agreement between the Registrant and John Lasseter dated February 24, 1997(4)....................................................................................... 10.11* Employment Agreement between the Registrant and Ralph J. Guggenheim dated August 1,1991(1).............................................................................. 10.12* Employment Agreement between the Registrant and William T. Reeves dated August 1, 1991(1)....................................................................................... 10.13 Promissory Note between the Registrant and Steven P. Jobs dated January 13, 1995(1)........... 10.14 Patent License Agreement between the Registrant and Silicon Graphics, Inc. dated March 12, 1996(2)............................................................................. 10.15 Net Office Lease between the Registrant and Point Richmond R&D Associates dated November 7, 1995(2)........................................................................... 10.16 Co-Production Agreement between the Registrant and Walt Disney Pictures and Television dated February 24, 1997(4).................................................................... 10.17 Net Office Lease between the Registrant and Point Richmond R&D Associates dated April 1, 1996(3)..............................................................................
S-3 37
EXHIBIT NUMBER EXHIBITS --------- -------- 10.18 Net Office Lease between the Registrant and Point Richmond R&D Associates dated September 12, 1996(3)......................................................................... 11.1 Computation of Net Income (Loss) Per Share................................................... 13.1 Portions of the Annual Report to Shareholders for the fiscal year ended December 31, 1996, expressly incorporated by reference herein.................................................... 23.1 Consent of Independent Auditors............................................................... 27.1 Financial Data Schedule.......................................................................
- ---------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (File No. 33-97918) declared effective on November 28, 1995. (2) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996. (4) Documents for which confidential treatment has been requested for certain portions of these exhibits. (5) Documents for which confidential treatment has been granted for certain portions of these exhibits. * Indicates management compensatory plan, contract or arrangement. S-4 EX-4.6 2 COMMON STOCK AND WARRANT PURCHASE AGREEMENT 1 Exhibit 4.6 COMMON STOCK AND WARRANT PURCHASE AGREEMENT DATED AS OF FEBRUARY 23, 1997 BY AND BETWEEN PIXAR AND DISNEY ENTERPRISES, INC. 2 TABLE OF CONTENTS
PAGE ---- SECTION 1 SALE OF COMMON STOCK AND WARRANTS.................................... 1 1.1 Sale of Common Stock and Warrants................................... 1 1.2 Closing Date........................................................ 1 1.3 Delivery............................................................ 1 1.4 Legend.............................................................. 1 SECTION 2 REPRESENTATIONS AND WARRANTIES OF THE COMPANY........................ 2 2.1 Organization........................................................ 2 2.2 Capitalization...................................................... 2 2.3 Authorization....................................................... 3 2.4 No Conflict......................................................... 3 2.5 Accuracy of Reports................................................. 3 2.6 Financial Statements and Changes.................................... 4 2.7 Governmental Consent, etc........................................... 4 SECTION 3 REPRESENTATIONS AND WARRANTIES OF THE PURCHASER...................... 4 3.1 Investment.......................................................... 4 3.2 Organization........................................................ 5 3.3 Authority........................................................... 5 3.4 Government Consents, etc............................................ 5 3.5 Investigation....................................................... 5 3.6 Financing........................................................... 5 SECTION 4 CONDITIONS TO OBLIGATIONS OF THE PURCHASER........................... 6 4.1 Representations and Warranties Correct.............................. 6 4.2 Covenants........................................................... 6 4.3 Opinion of Company's Counsel........................................ 6 4.4 No Order Pending.................................................... 6 4.5 HSR Act............................................................. 6 4.6 No Law Prohibiting or Restricting Such Sale......................... 6 4.7 Compliance Certificate.............................................. 6 SECTION 5 CONDITIONS TO OBLIGATIONS OF COMPANY................................. 7 5.1 Representations and Warranties Correct.............................. 7 5.2 Covenants........................................................... 7 5.3 No Order Pending.................................................... 7 5.4 HSR Act............................................................. 7 5.5 No Law Prohibiting or Restricting Such Sale......................... 7 5.6 Compliance Certificate.............................................. 7
-i- 3 TABLE OF CONTENTS (CONTINUED)
PAGE ---- SECTION 6 COVENANTS OF THE COMPANY AND THE PURCHASER........................... 8 6.1 Market Standoff..................................................... 8 6.2 Registration Rights Agreement....................................... 8 SECTION 7 MISCELLANEOUS........................................................ 9 7.1 Termination of Agreement............................................ 9 7.2 Effect of Termination............................................... 9 7.3 Best Efforts........................................................ 9 7.4 Governing Law....................................................... 9 7.5 Survival............................................................ 9 7.6 Successors and Assigns.............................................. 9 7.7 Entire Agreement; Amendment......................................... 9 7.8 Notices............................................................ 10 7.9 Brokers............................................................ 11 7.10 Severability....................................................... 11 7.11 Injunctive Relief.................................................. 11 7.12 Costs and Expenses................................................. 11 7.13 No Third Party Rights.............................................. 11 7.14 Publicity.......................................................... 11 7.15 Captions and Headings.............................................. 12 7.16 Counterparts....................................................... 12
-ii- 4 COMMON STOCK AND WARRANT PURCHASE AGREEMENT THIS COMMON STOCK AND WARRANT PURCHASE AGREEMENT (the "Agreement") is dated as of February 23, 1997, by and between PIXAR, a California corporation (the "Company") and Disney Enterprises, Inc., a Delaware corporation and wholly owned subsidiary of The Walt Disney Company (the "Purchaser"). SECTION 1 SALE OF COMMON STOCK AND WARRANTS 1.1 Sale of Common Stock and Warrants. Subject to the terms and conditions hereof, the Company will issue and sell to the Purchaser, and the Purchaser will purchase from the Company, at the Closing (as defined below), (i) 1,000,000 shares (the "Shares") of the Company's common stock (the "Common Stock"), at a purchase price of $15.00 per share, for an aggregate purchase price of $15,000,000, and (ii) two warrants (for other good and valuable consideration hereby acknowledged): one warrant ("Warrant A") to purchase up to 750,000 shares of the Company's Common Stock (the "Warrant A Shares") at an exercise price of $20.00 per share; and one warrant ("Warrant B") to purchase up to 750,000 shares of the Company's Common Stock (the "Warrant B Shares") at an exercise price of $25.00 per share (together, Warrant A and Warrant B shall hereinafter be referred to as the "Warrants," and the Warrant A Shares and the Warrant B Shares together shall hereinafter be referred to as the "Warrant Shares"), and on such other terms and conditions as are specified in the form of Common Stock Purchase Warrant attached as Exhibit A hereto. 1.2 Closing Date. The closing of the purchase and sale of the Shares and the Warrants (the "Closing") shall be held at the law offices of Wilson Sonsini Goodrich & Rosati, 650 Page Mill Road, Palo Alto, California at 10:00 a.m. not later than the third business day following expiration or early termination of all waiting periods imposed by the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and satisfaction of all closing conditions set forth in Sections 4 and 5 hereof or at such other time and place upon which the Company and the Purchaser shall mutually agree (the date of the Closing is hereinafter referred to as the "Closing Date"). 1.3 Delivery. At the Closing, the Company will deliver to the Purchaser (i) a certificate registered in the name of the Purchaser representing the Shares, against payment of the purchase price therefor by check payable to the order of the Company or by wire transfer in same day funds to the Company's account, and (ii) the duly executed Warrants. 1.4 Legend. The certificate for the Shares shall be subject to a legend restricting transfer under the Securities Act of 1933, as amended (the "Securities Act"), and referring to restrictions on transfer herein, such legends to be substantially as follows: -1- 5 "The securities represented by this certificate have been acquired for investment and have not been registered under the Securities Act of 1933. Such securities may not be sold or transferred in the absence of such registration or an opinion of counsel satisfactory to the Company as to the availability of an exemption from such registration." "The securities represented by this certificate are subject to restrictions on transfer, including any sale, pledge or other hypothecation, as set forth in a certain Common Stock and Warrant Purchase Agreement dated as of February 23, 1997, a copy of which may be obtained at no cost by written request made by the holder of record of this certificate to the corporate secretary of the Company at the Company's principal executive offices." SECTION 2 REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to the Purchaser as follows: 2.1 Organization. The Company is a corporation duly organized and validly existing under the laws of the State of California and is in good standing under such laws. The Company has all requisite corporate power and authority to own, lease and operate its properties and assets, and to carry on its business as presently conducted. The Company is qualified to do business as a foreign corporation in each jurisdiction in which the ownership of its property or the nature of its business requires such qualification, except where failure to so qualify would not have a material adverse effect on the Company. The Company has furnished to the Purchaser true and correct copies of its Articles of Incorporation and Bylaws, each as amended to date, and will furnish upon request to the Purchaser true and correct copies of any amendments thereto through the term of this Agreement. 2.2 Capitalization. The authorized capital stock of the Company consists of 100,000,000 shares of Common Stock, of which at December 31, 1996, 39,413,102 shares were issued and outstanding and 5,000,000 shares of Preferred Stock, of which at December 31, 1996, no shares were issued and outstanding. All such issued and outstanding shares have been duly authorized and validly issued and are fully paid and nonassessable. As of December 31, 1996, the Company has reserved a total of 13,000,000 shares of its Common Stock for issuance under its 1995 Stock Plan, of which 10,486,898 shares are reserved for issuance upon exercise of outstanding options; and a total of 200,000 shares of its Common Stock for issuance under its 1995 Director Option Plan, of which no shares are reserved for issuance upon exercise of outstanding options. In addition, effective upon the Closing, the Company has reserved such number of shares of Common Stock as shall be necessary to provide for the exercise of the Warrants. Except as provided or described in this Agreement, there are no other options, warrants, conversion privileges or other contractual rights presently outstanding to purchase or otherwise acquire any authorized but unissued shares of the Company's capital stock or other securities. -2- 6 2.3 Authorization. The Company has all corporate right, power and authority to enter into this Agreement, the Registration Rights Agreement in substantially the form attached hereto as Exhibit B (the "Registration Rights Agreement") and the Warrants and to consummate the transactions contemplated hereby and thereby. All corporate action on the part of the Company, its directors and shareholders necessary for the authorization, execution, delivery and performance of this Agreement, the Registration Rights Agreement and the Warrants by the Company, the authorization, sale, issuance and delivery of the Shares and the Warrant Shares upon exercise of the Warrants pursuant to the terms thereof and the performance of the Company's obligations hereunder and under the Registration Rights Agreement and the Warrants have been taken. This Agreement, the Registration Rights Agreement and the Warrants have been duly executed and delivered by the Company and constitute legal, valid and binding obligations of the Company enforceable in accordance with their respective terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies, and to limitations of public policy as they may apply to Section 7 of the Registration Rights Agreement. Upon their issuance and delivery pursuant to this Agreement, the Shares will be validly issued, fully paid and nonassessable. Upon exercise of the Warrants in accordance with the terms thereof, the Warrant Shares will be validly issued, fully paid and nonassessable. The issuance and sale of the Shares and the Warrant Shares upon exercise of the Warrants will not give rise to any preemptive rights or rights of first refusal on behalf of any person in existence either on the date hereof or immediately prior to the Closing. 2.4 No Conflict. Subject to compliance with the HSR Act, the execution and delivery of this Agreement, the Registration Rights Agreement and the Warrants do not, and the consummation of the transactions contemplated hereby and thereby will not, conflict with, or result in any violation of, or default (with or without notice or lapse of time, or both), or give rise to a right of termination, cancellation or acceleration of any obligation or to a loss of a material benefit, under, any provision of the Articles of Incorporation or Bylaws of the Company, as amended, or any mortgage, indenture, lease or other agreement or instrument, permit, concession, franchise, license, judgment, order, decree, statute, law, ordinance, rule or regulation applicable to the Company, its properties or assets, the effect of which would have a material adverse effect on the Company or materially impair or restrict its power to perform its obligations as contemplated hereby or thereby. 2.5 Accuracy of Reports. The Company has, since November 29, 1995, filed with the Securities and Exchange Commission ("SEC") all forms, reports and documents (collectively, the "SEC Reports") which it has been required to file under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations promulgated thereunder. Each of the SEC Reports complied as of its filing date in all material respects with all applicable requirements of the Exchange Act. Except as subsequently disclosed or corrected in an SEC Report filed prior to the date of this Agreement, none of such SEC Reports, including without limitation, any financial statement or schedule included therein, contained at the time filed any untrue statement of a material fact or omitted to state a material fact required to be stated therein, or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. -3- 7 2.6 Financial Statements and Changes. The Company's (a) unaudited balance sheet as of September 30, 1996 and the related statements of income, cash flows and stockholders' equity for the interim periods then ended contained in the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 and (b) audited balance sheet as of December 31, 1995 and the related audited statements of income, cash flows and stockholders' equity for the fiscal year then ended contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1995 comply as to form in all material respects with applicable accounting requirements and with the published rules and regulations of the SEC with respect thereto, have been prepared in accordance with generally accepted accounting principles (except to the extent that certain footnote disclosures regarding any period may have been omitted in accordance with the applicable rules of the SEC under the Exchange Act), consistently applied except as noted therein and except, in the case of unaudited interim financial statements, for normal year-end adjustments, and fairly present the financial position of the Company as of the respective dates set forth therein and the results of operations and cash flows for the Company for the respective fiscal periods set forth therein. Except as otherwise disclosed herein or in the SEC Reports, since September 30, 1996, there has been no material adverse change in the business, financial condition or results of operations of the Company, taken as a whole (other than on account of matters which generally affect the economy or the industry in which the Company is engaged). 2.7 Governmental Consent, etc. No consent, approval or authorization of or designation, declaration or filing with any governmental authority on the part of the Company is required in connection with the valid execution and delivery of this Agreement, or the offer, sale or issuance of the Shares or the Warrant Shares upon exercise of the Warrants, or the consummation of any other transaction contemplated hereby, except the filing of such forms with the United States Department of Justice and the Federal Trade Commission as shall be required by the HSR Act and the expiration of any waiting periods thereunder and such filings as may be required to be made with the SEC and the National Association of Securities Dealers, Inc. ("NASD") and filings, if any, to be made in compliance with applicable blue sky requirements. SECTION 3 REPRESENTATIONS AND WARRANTIES OF THE PURCHASER The Purchaser hereby represents and warrants to the Company as follows: 3.1 Investment. The Purchaser will acquire the Shares, the Warrants and the Warrant Shares for investment for its own account, not as a nominee or agent, and not with a view to, or for resale in connection with, any distribution thereof. The Purchaser understands that the Shares, the Warrants and the Warrant Shares have not been, and will not be, registered (unless pursuant to the Registration Rights Agreement) under the Securities Act by reason of a specific exemption from the registration provisions of the Securities Act which depends upon, among other things, the bona fide nature of the Purchaser's investment intent and the accuracy of the Purchaser's representations as expressed herein. -4- 8 3.2 Organization. The Purchaser is a corporation duly organized and validly existing and in good standing under the laws of the state of its incorporation, with all requisite corporate power and authority to own, lease and operate its properties and assets and to carry on its business as presently conducted. 3.3 Authority. The Purchaser has all corporate right, power and authority to enter into this Agreement and the Registration Rights Agreement and to consummate the transactions contemplated hereby and thereby. The execution and delivery of this Agreement and the Registration Rights Agreement by the Purchaser and the consummation by the Purchaser of the transactions contemplated hereby and thereby have been duly authorized by all necessary corporate action on behalf of the Purchaser. This Agreement and the Registration Rights Agreement have been duly executed and delivered by the Purchaser and constitute legal, valid and binding obligations of the Purchaser, enforceable in accordance with their respective terms, subject to laws of general application relating to bankruptcy, insolvency and the relief of debtors and rules of law governing specific performance, injunctive relief or other equitable remedies, and to limitations of public policy as they may apply to Section 7 of the Registration Rights Agreement. Subject to compliance with the HSR Act and such filings as may be required to be made with the SEC and any exchange or quotation system on which the Purchaser's securities are listed or designated, the execution and delivery of this Agreement and the Registration Rights Agreement do not, and the consummation of the transactions contemplated hereby and thereby will not, conflict with or result in any violation of any obligation under any provision of the Restated Certificate of Incorporation or Bylaws of the Purchaser or any judgment, order, decree, statute, law, ordinance, rule or regulation applicable to the Purchaser. 3.4 Government Consents, etc. No consent, approval or authorization of or designation, declaration or filing with any governmental authority on the part of the Purchaser is required in connection with the valid execution and delivery of this Agreement, or the offer, sale or issuance of the Shares or the Warrants, the issuance of the Warrant Shares upon exercise of the Warrants or the consummation of any other transaction contemplated hereby, except the filing of such forms with the United States Department of Justice and the Federal Trade Commission as shall be required by the HSR Act and the expiration of any waiting periods thereunder and such filings as may be required to be made with the SEC and any exchange or quotation system on which the Purchaser's securities are listed or principally traded. 3.5 Investigation. The Purchaser has had a reasonable opportunity to discuss the Company's business, management and financial affairs with the Company's management and the Purchaser has received satisfactory responses from management of the Company to the Purchaser's inquiries. 3.6 Financing. The Purchaser has the funds, or has written commitments from responsible financial institutions, to provide the Company with the funds necessary to consummate the transactions to occur at the Closing. -5- 9 SECTION 4 CONDITIONS TO OBLIGATIONS OF THE PURCHASER The obligation of the Purchaser to purchase the Shares and the Warrants at the Closing is subject to the fulfillment on or prior to the Closing Date of the following conditions, any or all of which may be waived at the option of the Purchaser: 4.1 Representations and Warranties Correct. The representations and warranties made by the Company in Section 2 hereof shall be true and correct in all material respects when made, and shall be true and correct in all material respects on the Closing Date with the same force and effect as if they had been made on and as of said date. 4.2 Covenants. All covenants, agreements and conditions contained in this Agreement to be performed by the Company on or prior to the Closing Date shall have been performed or complied with in all material respects. 4.3 Opinion of Company's Counsel. The Purchaser shall have received from Wilson Sonsini Goodrich & Rosati, counsel to the Company, an opinion addressed to it, dated the Closing Date, in substantially the form attached hereto as Exhibit C. 4.4 No Order Pending. There shall not then be in effect any order enjoining or restraining the transactions contemplated by this Agreement. 4.5 HSR Act. The Purchaser and the Company shall have filed such forms with the United States Department of Justice and the Federal Trade Commission as shall be required by the HSR Act and the applicable waiting periods under such HSR Act shall have expired without notice from such governmental agencies that additional inquiries are being made. 4.6 No Law Prohibiting or Restricting Such Sale. There shall not be in effect any law, rule or regulation prohibiting or restricting such sale, or requiring any consent or approval of any person which shall not have been obtained to issue the Shares, the Warrants or the Warrant Shares. 4.7 Compliance Certificate. The Company shall have delivered to the Purchaser a certificate, executed on behalf of the Company by the Chief Executive Officer or Chief Financial Officer of the Company, dated the Closing Date, and certifying to the fulfillment of the conditions specified in Sections 4.1 and 4.2. -6- 10 SECTION 5 CONDITIONS TO OBLIGATIONS OF COMPANY The Company's obligation to sell and issue the Shares and the Warrants at the Closing is subject to the fulfillment on or prior to the Closing Date of the following conditions, any or all of which may be waived at the option of the Company: 5.1 Representations and Warranties Correct. The representations and warranties made by the Purchaser in Section 3 hereof shall be true and correct in all material respects when made, and shall be true and correct in all material respects on the Closing Date with the same force and effect as if they had been made on and as of said date. 5.2 Covenants. All covenants, agreements and conditions contained in this Agreement to be performed by the Purchaser on or prior to the Closing Date shall have been performed or complied with in all material respects. 5.3 No Order Pending. There shall not then be in effect any order enjoining or restraining the transactions contemplated by this Agreement. 5.4 HSR Act. The Purchaser and the Company shall have filed such forms with the United States Department of Justice and the Federal Trade Commission as shall be required by the HSR Act and the applicable waiting periods under such HSR Act shall have expired without notice from such governmental agencies that additional inquiries are being made. 5.5 No Law Prohibiting or Restricting Such Sale. There shall not be in effect any law, rule or regulation prohibiting or restricting such sale, or requiring any consent or approval of any person which shall not have been obtained to issue the Shares, the Warrants or the Warrant Shares. 5.6 Compliance Certificate. The Purchaser shall have delivered to the Company a certificate, executed on behalf of the Purchaser by an executive officer of the Purchaser, dated the Closing Date, and certifying to the fulfillment of the conditions specified in Section 5.1 and 5.2 of this Agreement. -7- 11 SECTION 6 COVENANTS OF THE COMPANY AND THE PURCHASER 6.1 Market Standoff. (a) Until the termination of this Agreement in accordance with Section 7.1 hereof, the Purchaser shall not, without the prior written consent of the Company, during the period commencing on the Closing Date and ending three years after the Closing Date, offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any of the Shares, whether or not any such transaction is to be settled by delivery of such Shares, in cash or otherwise. (b) The Purchaser agrees in connection with any registration of the Company's securities, upon request of the Company or the underwriters managing any underwritten offering of the Company's securities, during the period commencing on the effective date of the registration statement and ending not more than 180 days after the effective date of the registration statement, not to (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of the Company's Common Stock (other than those shares included in the registration pursuant to the exercise of rights pursuant to the Registration Rights Agreement) or (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Company's Common Stock, whether or not any such transaction described in clause (i) or (ii) above is to be settled by delivery of such Common Stock, in cash or otherwise, without the prior written consent of the Company or such underwriters, as the case may be, for such period of time (not to exceed 180 days) from the effective date of such registration as may be requested by the Company or such managing underwriters; provided, however, that the Purchaser shall not be subject to this Section 6.1(b) unless all executive officers and directors of the Company enter into similar agreements. Notwithstanding the foregoing, the obligations of the Purchaser contained in the preceding sentence shall not apply to up to 1,000,000 shares of the Company's Common Stock during the period beginning 91 days from the effective date of the registration statement. 6.2 Registration Rights Agreement. The Company shall enter into the Registration Rights Agreement at or prior to the Closing in order to provide registration rights to the Purchaser with respect to the Warrant Shares. -8- 12 SECTION 7 MISCELLANEOUS 7.1 Termination of Agreement. This Agreement may be terminated at any time: (a) by the mutual consent of the Company and the Purchaser; or (b) by the Purchaser or the Company prior to Closing if the United States Department of Justice or the Federal Trade Commission shall have objected in writing to the consummation of the transactions contemplated to occur at Closing. 7.2 Effect of Termination. From and after the termination of this Agreement, the covenants, obligations and agreements of the parties set forth herein shall be of no further force or effect and the parties shall be under no further obligation with respect thereto. 7.3 Best Efforts. The Company and Purchaser shall use their respective best efforts to take all actions required under the HSR Act and under any law, rule or regulation adopted subsequent to the date hereto in order that the Company may sell the Shares and the Warrants to the Purchaser and the Purchaser may purchase the Shares and the Warrants and to ensure that the conditions to the Closing set forth herein are satisfied on or before the scheduled date of such Closing. 7.4 Governing Law. This Agreement shall be governed in all respects by the laws of the State of California as applied to contracts entered into solely between residents of, and to be performed entirely within, such state. 7.5 Survival. The representations and warranties in Sections 2 and 3 of this Agreement shall survive any investigation made by the Purchaser or the Company. 7.6 Successors and Assigns. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Agreement may not be assigned by a party without the prior written consent of the other party; provided, however, that the Purchaser shall have the right, upon prior notice to the Company, to assign this Agreement to its parent or to any wholly owned subsidiary of the Purchaser. 7.7 Entire Agreement; Amendment. This Agreement and the other documents delivered pursuant hereto constitute the full and entire understanding and agreement between the parties with regard to the subject matter hereof and thereof and supersede all prior agreements and understandings among the parties relating to the subject matter hereof. Neither this Agreement nor any term hereof may be amended, waived, discharged or terminated other than by a written instrument signed by the party against whom enforcement of any such amendment, waiver, discharge or termination is sought. -9- 13 7.8 Notices and Dates. Any notice or other communication given under this Agreement shall be sufficient if in writing and sent by personal service, facsimile, courier service promising overnight delivery or registered or certified mail, return receipt requested, postage prepaid, to a party at its address set forth below (or at such other address as shall be designated for such purpose by such party in a written notice to the other party hereto): (a) if to the Company, to it at: PIXAR 1001 West Cutting Boulevard Richmond, California 94804 Facsimile: (510) 235-7772 Attn: Lawrence B. Levy, Esq. with a copy to: Wilson Sonsini Goodrich & Rosati 650 Page Mill Road Palo Alto, California 94304 Facsimile: (415) 493-6811 Attn: Larry W. Sonsini, Esq. (b) if to the Purchaser, to it at: Disney Enterprises, Inc. 500 S. Buena Vista Street Burbank, California 91521 Facsimile: (818) 842-5865 Attn: Robert Moore with a copy to: Disney Enterprises, Inc. 500 S. Buena Vista Street Burbank, California 91521 Facsimile: (818) 566-7308 Attn: Gloria S. Lepow, Esq. All such notices and communications shall be effective when received by the addressee. In the event that any date provided for in this Agreement falls on a Saturday, Sunday or legal holiday, such date shall be deemed extended to the next business day. -10- 14 7.9 Brokers. (a) The Company has not engaged, consented to or authorized any broker, finder or intermediary, to act on its behalf, directly or indirectly, as a broker, finder or intermediary in connection with the transactions contemplated by this Agreement. The Company hereby agrees to indemnify and hold harmless the Purchaser from and against all fees, commissions or other payments owing to any party acting on behalf of the Company hereunder. (b) The Purchaser has not engaged, consented to or authorized any broker, finder or intermediary to act on its behalf, directly or indirectly, as a broker, finder or intermediary in connection with the transactions contemplated by this Agreement. The Purchaser hereby agrees to indemnify and hold harmless the Company from and against all fees, commissions or other payments owing to any party acting on its behalf. 7.10 Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restriction of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 7.11 Injunctive Relief. The Purchaser, on the one hand, and the Company, on the other, acknowledge and agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached. It is accordingly agreed that the parties shall be entitled to an injunction or injunctions to prevent or cure breaches of the provisions of this Agreement and to enforce specific performance of the terms and provisions hereof in any court of the United States or any state thereof having jurisdiction, this being in addition to any other remedy to which they may be entitled at law or equity. 7.12 Costs and Expenses. Each party hereto shall pay its own costs and expenses incurred in connection herewith, including the fees of its counsel, auditors and other representatives, whether or not the transactions contemplated herein are consummated. 7.13 No Third Party Rights. Nothing in this Agreement shall create or be deemed to create any rights in any person or entity not a party to this Agreement. 7.14 Publicity. The Purchaser and the Company shall not, without the prior approval of each other party hereto, make or cause to be made any press release or other public statement concerning the transactions contemplated by this Agreement, except as and to the extent that any party hereto is so obligated by law or the regulations of any stock exchange or the NASD (but only after the Company or the Purchaser, as the case may be, shall have consulted with the other party in advance regarding the form and substance of such press release or public statement). -11- 15 7.15 Captions and Headings. The captions and headings used herein are for convenience and ease of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. 7.16 Counterparts. This Agreement may be executed in one or more counterparts. All of such counterparts together shall constitute one and the same agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective authorized officers as of the date aforesaid. "COMPANY" PIXAR By: /s/ STEVE JOBS ----------------------------------- Name: Steven P. Jobs Title: Chairman and Chief Executive Officer "PURCHASER" DISNEY ENTERPRISES, INC. By: /s/ RICHARD D. NANULA ---------------------------------- Name: Richard D. Nanula Title: Senior Executive Vice President and Chief Financial Officer -12- EX-4.7 3 FORM OF COMMON STOCK PURCHASE WARRANT 1 Exhibit 4.7 THIS WARRANT AND ANY SHARES OF COMMON STOCK ISSUED UPON EXERCISE HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISPOSITION MAY BE AFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL SATISFACTORY IN FORM AND SUBSTANCE TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THE WARRANT EVIDENCED HEREBY IS NON-TRANSFERABLE. NO. __ PIXAR __________, 1997 COMMON STOCK PURCHASE WARRANT This certifies that, in connection with that certain Common Stock and Warrant Purchase Agreement, dated February 23, 1997 (the "Purchase Agreement") by and between PIXAR, a California corporation (the "Company"), and Disney Enterprises, Inc., a Delaware corporation and wholly owned subsidiary of The Walt Disney Company ("Disney"), and for other value received, Disney, is entitled, upon the terms and subject to the conditions hereinafter set forth, at any time on or after the date hereof and at or prior to 11:59 pm., Pacific Time, on __________, 2002 (the "Expiration Time"), but not thereafter, to acquire from the Company, in whole or from time to time in part, up to 750,000 fully paid and nonassessable shares of Common Stock of the Company ("Common Stock") at a purchase price per share (the "Exercise Price") as set forth in Section 1 below. Such number of shares, type of security and Exercise Price are subject to adjustment as provided herein, and all references to "Common Stock" and "Exercise Price" herein shall be deemed to include any such adjustment or series of adjustments. 1. EXERCISE PRICE Subject to adjustments as provided herein, the Exercise Price per share of Common Stock subject to this Warrant shall be equal to $[20.00/25.00 per share]. 2. EXERCISE OF WARRANT (a) The purchase rights represented by this Warrant are exercisable by the registered holder hereof, in whole or in part, at any time from the date hereof and up to and including the Expiration Time by the surrender of this Warrant and the Notice of Exercise form attached hereto duly executed to the office of the Company at 1001 West Cutting Boulevard, Richmond, California 94804 (or such other office or agency of the Company as it may designate by notice in writing to the registered holder hereof at the address of such holder appearing on the books of the Company), and upon payment of the Exercise Price for the shares thereby purchased (by cash or by certified check or bank draft payable to the order of the Company in an amount equal to the purchase price of the shares thereby purchased or in accordance with the cashless exercise provision set forth in Section 2(b)); whereupon the holder of this Warrant shall be entitled to receive from the Company a stock certificate in proper form representing the number of shares of Common Stock so purchased, and a new Warrant in substantially identical form and dated as of such exercise for the purchase of that number of shares of Common Stock equal to the difference, if any, between the number of shares of Common Stock subject hereto and the number of shares of Common Stock as to which this Warrant is so exercised. -1- 2 (b) Notwithstanding any provisions herein to the contrary, if the fair market value (as defined in Section 3 hereof) of one share of the Company's Common Stock is greater than the Exercise Price (at the date of calculation as set forth below), in lieu of exercising this Warrant for cash, the holder may elect to receive shares equal to the value (as determined below) of this Warrant (or the portion thereof being canceled) by surrender of this Warrant at the principal office of the Company together with the properly endorsed Notice of Exercise in which event the Company shall issue to the holder a number of shares of Common Stock computed using the following formula: X=Y (A-B) -------- A Where X = the number of shares of Common Stock to be issued to the holder. Y = the number of shares of Common Stock purchasable under the Warrant or, if only a portion of the Warrant is being exercised, the portion of the Warrant being canceled (at the date of such calculation) A = the fair market value of one share of the Company's Common Stock (at the date of such calculation) B = Exercise Price (as adjusted to the date of such calculation) 3. ISSUANCE OF SHARES Certificates for shares purchased hereunder shall be delivered to the holder hereof within a reasonable time (in no event exceeding ten (10) business days) after the date on which this Warrant shall have been exercised in accordance with the terms hereof. The Company agrees that the shares so issued shall be and shall for all purposes be deemed to have been issued to such holder as the record owner of such shares as of the close of business on the date on which this Warrant shall have been exercised or converted in accordance with the terms hereof. No fractional shares or scrip representing fractional shares shall be issued upon the exercise of this Warrant. With respect to any fraction of a share called for upon the exercise of this Warrant, an amount equal to such fraction multiplied by the fair market value of a share of Common Stock on the date of exercise shall be paid in cash or check to the holder of this Warrant (fair market value shall be the average closing price of a share of Common Stock on the NASDAQ National Market System (or any other stock exchange on which the Common Stock is listed at the time of exercise) as listed in "The Wall Street Journal" over the five consecutive business days immediately prior to surrender of this Warrant pursuant to Section 2 above). 4. REPRESENTATIONS AND COVENANTS OF THE COMPANY (a) No Liens, etc. The Company hereby represents and warrants that all shares of Common Stock which may be issued upon the exercise of this Warrant will, upon such exercise, be duly and validly authorized and issued, fully paid and nonassessable and free from all taxes, liens and charges in respect of the issuance thereof (other than liens or charges created by or imposed upon the holder of the Warrant) and not subject to preemptive or any similar rights of the stockholders of the Company. (b) Reservation of Stock. As soon as practicable after execution of this Warrant, the Company will reserve sufficient authorized but unissued securities to enable it to satisfy its obligations on exercise of this Warrant and will, if necessary, reserve additional securities during the period in which this Warrant may be exercised -2- 3 to satisfy its obligations hereunder. If at any time the Company's authorized securities shall not be sufficient to allow the exercise of this Warrant, the Company shall take such corporate action as may be necessary to increase its authorized but unissued securities to be sufficient for such purpose. (c) Furnish Information. The Company agrees to promptly deliver to the holder of this Warrant copies of all financial statements, reports and proxy statements which the Company shall have sent to its stockholders generally. (d) Rule 144 and 144A. In order to permit the holder of the Warrant to sell the Common Stock issuable upon exercise of the Warrant pursuant to Rule 144 or Rule 144A under the 1933 Act (or any successors to such rules), the Company will comply with all rules and regulations of the Commission applicable in connection with use of each of Rule 144 and Rule 144A (or any successors thereto), including the timely filing of all reports with the Commission in order to enable such holder, if it so elects, to utilize Rule 144 or Rule 144A. 5. NO RIGHTS AS SHAREHOLDERS This Warrant does not entitle the holder hereof to any voting rights or other rights as a shareholder of the Company prior to the exercise hereof. 6. TRANSFERABILITY (a) Restrictions on Warrant. This Warrant is not transferable, whether by sale, pledge or other disposition, voluntarily or by operation of law or otherwise. Any transfer in violation hereof shall be void and the Warrant shall terminate immediately upon any such purported transfer. (b) Restrictions on Common Stock Issuable Upon Exercise. In no event will the holder make a disposition of the Common Stock issuable upon exercise of this Warrant unless and until (i) it shall have notified the Company of the proposed disposition, and (ii) if requested by the Company, it shall have furnished the Company with an opinion of counsel satisfactory to the Company and its counsel to the effect that (A) appropriate action necessary for compliance with the 1933 Act provisions relating to sale of an unregistered security has been taken, or (B) an exemption from the registration requirements of the 1933 Act is available. Notwithstanding the foregoing, the restrictions imposed upon the transferability of the Common Stock issuable on the exercise of this Warrant shall terminate as to any particular share of Common Stock when (1) such security shall have been sold without registration in compliance with Rule 144 under the 1933 Act, or (2) a letter shall have been issued to the holder at its request by the staff of the Securities and Exchange Commission or a ruling shall have been issued to the holder at its request by such Commission stating that no action shall be recommended by such staff or taken by such Commission, as the case may be, if such security is transferred without registration under the 1933 Act in accordance with the conditions set forth in such letter or ruling and such letter or ruling specifies that no subsequent restrictions on transfer are required, or (3) such security shall have been registered under the 1933 Act and sold by the holder thereof in accordance with such registration. (c) Restrictive Legend. The Company may place a legend describing, in whole or in part, the restrictions imposed by sub-sections (a) and (b) to this Section 6 on this Warrant, any replacement Warrant and on any certificate representing the Common Stock issuable upon exercise of this Warrant. Whenever such restrictions shall terminate, Disney or the holder of a share of Common Stock issued upon exercise of this Warrant as to which such restrictions have terminated shall be entitled to receive from the Company one or more new certificates for such shares of Common Stock not bearing the restrictive legend. -3- 4 7. LOSS, THEFT, DESTRUCTION OR MUTILATION OF WARRANT On receipt by the Company of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant, and in case of any such loss, theft or destruction of this Warrant, on delivery of an indemnity agreement reasonably satisfactory in form and amount to the Company or, in the case of any such mutilation, on surrender and cancellation of such Warrant, the Company will execute and deliver to the holder, in lieu thereof, a new warrant in substantially identical form, dated as of such cancellation and reissuance. 8. SATURDAYS, SUNDAYS AND HOLIDAYS If the last or appointed day for the taking of any action or the expiration of any right required or granted herein shall be a Saturday or a Sunday or shall be a legal holiday, then such action may be taken or such right may be exercised on the next succeeding business day. 9. ADJUSTMENT TO NUMBER AND TYPE OF SECURITIES, EXERCISE PRICE The type and number of securities of the Company issuable upon exercise of this Warrant and the Exercise Price are subject to adjustment as set forth below: (a) Adjustment for Stock Splits. If at any time after issuance of the Warrant the outstanding shares of Common Stock are subdivided into a greater number of shares (whether by stock dividend, stock split or otherwise) or the Company declares or pays, without consideration, any right to acquire Common Stock for no consideration, then the Exercise Price will be reduced proportionately and the number of securities issued upon exercise of this Warrant will be increased proportionately. Conversely, if the outstanding Common Stock is consolidated into a smaller number of shares (whether by reverse stock split or otherwise), then the Exercise Price will be increased proportionately and the number of securities issued upon exercise of this Warrant will be reduced proportionately. (b) Adjustment for Reorganization, Consolidation, Merger, etc. In case of any consolidation or merger of the Company with or into any other corporation, entity or person, or any other corporate reorganization, in which the Company shall not be the continuing or surviving entity of such consolidation, merger or reorganization, or any merger, consolidation or similar transaction in which in excess of 50% of the Company's voting power is transferred, or any sale of all or substantially all of the assets of the Company (any such transaction being hereinafter referred to as a "Reorganization"), then, in each case, the holder of this Warrant, on exercise hereof at any time after the consummation or effective date of such Reorganization, shall receive, in lieu of that which would be issuable on such exercise prior to the date of such Reorganization, the stock, other securities and/or property (including cash) to which such holder would have been entitled upon the date of such Reorganization if such holder had exercised this Warrant immediately prior thereto (such new consideration to be subject to all further adjustments called for during the term hereof). The provisions of this Section 9(b) shall apply to successive Reorganizations. In the case of any such merger, consolidation or other similar transaction, the successor corporation shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Warrant to be performed and observed by the Company and all of the obligations and liabilities hereunder, subject to such modification as shall be necessary to provide for adjustments of the type and number of securities issuable upon exercise of this Warrant and the Exercise Price which shall be as nearly equivalent as practicable to the adjustments provided for herein. -4- 5 (c) Certificate as to Adjustments. In case of any adjustment in the Exercise Price or number and type of securities issuable on the exercise of this Warrant, the Company will promptly give written notice thereof to the holder of this Warrant in the form of a certificate, certified and confirmed by an officer of the Company, setting forth such adjustment and showing in reasonable detail the facts upon which adjustment is based. 10. REPRESENTATIONS AND COVENANTS OF DISNEY. This Warrant has been granted by the Company in reliance upon the following representations and covenants of Disney: (a) Investment Purpose. This Warrant and the Common Stock issuable upon exercise of Disney's rights contained herein will be acquired for investment for Disney's own account, and not as a nominee or agent and not with a view to the distribution of any part thereof. Disney further represents that it does not have any contract, undertaking agreement or arrangement with any person to sell, transfer or grant participations to such person, or to any third person, with respect to this Warrant. (b) Private Issue. Disney understands (i) that the Warrant and the Common Stock issuable upon exercise of this Warrant are not registered under the Securities Act of 1933, as amended, (the "1933 Act"), or qualified under applicable state securities laws on the ground that the issuance of this Warrant will be exempt from the registration and qualifications requirements thereof, and (ii) that the Company's reliance on such exemption is predicated on the representations set forth in this Section 10. (c) Sales of Common Stock. Disney acknowledges that in the event the applicable requirements of Rule 144 are not met, registration under the 1933 Act or compliance with another exemption from registration will be required for any disposition of the Common Stock issuable upon exercise of this Warrant. (d) Financial Risk. Disney has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its investment, and has the ability to bear the economic risks of its investment. (e) Accredited Investor. Disney is an "accredited investor" within the meaning of Rule 501 of Regulation D promulgated under the 1933 Act. 11. GOVERNING LAW This Warrant shall be governed by and construed in accordance with the laws of the State of California applicable to contracts made and to be performed wholly within such state. 12. COMPLETE AGREEMENT AND MODIFICATIONS This Warrant and any documents referred to herein or executed contemporaneously herewith constitute the Company's and Disney's entire agreement with respect to the subject matter hereof and supersede all agreements, representations, warranties, statements, promises and understandings, whether oral or written, with respect to the subject matter hereof. This Warrant may not be amended, altered or modified except by a writing signed by the Company and the holder of this Warrant. -5- 6 13. NOTICES Except as otherwise provided herein, all notices under this Warrant shall be in writing and shall be delivered by personal service, facsimile, courier service promising overnight delivery or certified mail (if such service is not available, then by first class mail), postage prepaid. Notices shall be addressed as follows: If to the holder of this Warrant: Disney Enterprises, Inc. 500 S. Buena Vista Street Burbank, California 91521 Facsimile: (818) 842-5865 Attention: Robert Moore With a copy to: Disney Enterprises, Inc. 500 S. Buena Vista Street Burbank, California 91521 Facsimile: (818) 566-7308 Attention: Gloria S. Lepow, Esq. If to the Company: PIXAR 1001 West Cutting Boulevard Richmond, California 94804 Facsimile: (510) 235-7772 Attention: Lawrence B. Levy, Esq. With a copy to: Wilson Sonsini Goodrich & Rosati 650 Page Mill Road Palo Alto, California 94304-1050 Facsimile: (415) 493-6811 Attention: Larry W. Sonsini, Esq. 14. WAIVERS STRICTLY CONSTRUED With regard to any power, remedy or right provided herein or otherwise available to any party hereunder (i) no waiver or extension of time shall be effective unless expressly contained in a writing signed by the waiving party; and (ii) no alteration, modification or impairment shall be implied by reason of any previous waiver, extension of time, delay or omission in exercise, or other indulgence. 15. SEVERABILITY The validity, legality or enforceability of the remainder of this Warrant shall not be affected even if one or more of its provisions shall be held to be invalid, illegal or unenforceable in any respect. -6- 7 IN WITNESS WHEREOF, the Company has caused this Warrant to be executed by its duly authorized officer. Dated: __________, 1997 PIXAR By: _________________________________ Name: Title: -7- 8 NOTICE OF EXERCISE To: PIXAR (1) / / The undersigned hereby elects to purchase __________ shares of Common Stock of PIXAR pursuant to the terms of the attached Warrant, and tenders herewith payment of the purchase price in full. / / The undersigned hereby elects to purchase __________ shares of Common Stock of PIXAR pursuant to the terms of the attached Warrant, and tenders herewith as a "cashless exercise" the attached Warrant to purchase _________ shares of Common Stock. (2) Please issue a certificate or certificates representing said shares in the name of the undersigned or in such other name as is specified below: _____________________________________ (Name) _____________________________________ (Address) (3) The undersigned represents that the aforesaid shares are being acquired for the account of the undersigned for investment and not with a view to, or for resale in connection with, the distribution thereof and that the undersigned has no present intention of distributing or reselling such shares, except in compliance with applicable federal and state securities laws. __________________________________ ________________________________ (Date) (Signature) EX-4.8 4 FORM OF REGISTRATION RIGHTS AGREEMENT 1 Exhibit 4.8 REGISTRATION RIGHTS AGREEMENT DATED AS OF __________, 1997 BY AND BETWEEN PIXAR AND DISNEY ENTERPRISES, INC. 2 REGISTRATION RIGHTS AGREEMENT THIS REGISTRATION RIGHTS AGREEMENT (the "Agreement") is made as of _________, 1997, by and between PIXAR, a California corporation (the "Company"), and Disney Enterprises, Inc., a Delaware corporation and wholly owned subsidiary of The Walt Disney Company (the "Purchaser"). A. The Purchaser intends to purchase a minority interest in the Company pursuant to the terms and conditions of a certain Common Stock and Warrant Purchase Agreement dated as of February 23, 1997 (the "Purchase Agreement"). B. The Purchase Agreement requires that the Company enter into this Agreement with the Purchaser. NOW, THEREFORE, in consideration of the foregoing, the parties to this Agreement hereby agree as follows: 1. Effectiveness. The rights and obligations of the parties hereto shall be effective only upon the closing of the transactions contemplated by the Purchase Agreement. 2. Demand Registration. (a) If, at any time after the Closing (as defined in the Purchase Agreement), the Purchaser shall request (a "Demand") the Company in writing to register under the Securities Act of 1933, as amended (the "Securities Act"), any shares of the Common Stock of the Company (the "Common Stock") acquired by the Purchaser by exercise of the Warrants (as defined in the Purchase Agreement) (the shares of Common Stock so acquired and subject to such request being herein referred to as the "Subject Stock"), the Company shall use its best efforts to cause the shares of Subject Stock specified in such request to be registered as soon as reasonably practicable so as to permit the sale thereof, and in connection therewith shall prepare and file a Form S-3 registration statement (or similar form which may be promulgated in the future) with the Securities and Exchange Commission (the "SEC") under the Securities Act to effect such registration; provided, however, that such request shall (i) specify the number of shares of Subject Stock intended to be offered and sold, which number of shares shall represent Subject Stock (A) with an aggregate market value of at least $5,000,000, based on the average closing sale price of the Common Stock for the ten (10) trading days preceding the date prior to the date of the Purchaser's request first received by the Company, and (B) that does not exceed 5% of the then outstanding Common Stock of the Company, (ii) express the present intention of the Purchaser to offer or cause the offering of such shares of Subject Stock for distribution, (iii) describe the nature or method of the proposed offer and sale thereof, and (iv) contain the undertaking of the Purchaser to provide all such information and materials and take all such action as may be required in order to permit the Company to comply with all applicable requirements of the SEC and to obtain any desired acceleration of the effective date of such registration statement. -1- 3 (b) Notwithstanding the foregoing and Section 4 hereof, upon delivery to the Purchaser of a written notice, the Company shall be entitled to postpone filing of the registration statement, and may withhold efforts to cause the registration statement to become effective, for a reasonable period of time (not to exceed ninety (90) days) if (i) the Company is contemplating filing a registration statement within ninety (90) days of such request for registration (which shall not affect the Purchaser's other rights hereunder, including without limitation the Purchaser's rights under Section 3 below), (ii) the Company determines in good faith that such registration might interfere with or affect the negotiation or completion of any transaction that is being contemplated by the Company (whether or not a final decision has been made to undertake such transaction) at the time the right to delay is exercised or (iii) the Company determines in good faith that such registration might involve initial or continuing disclosure obligations that might not be in the best interests of the Company or its shareholders. The Company shall not be required to effect more than one demand registration statement under this Agreement; provided, however, that if any postponement pursuant to the preceding sentence extends beyond the date on which the Warrants expire, the obligations of the Company hereunder shall be extended by a number of days necessary to complete the distribution of securities subject to such postponement. In a case of postponement pursuant to clause (i) of the first sentence of this paragraph (b), the request for registration will not constitute a Demand for purposes of determining the number of Demands permitted pursuant to this paragraph unless the contemplated registration by the Company is abandoned or not consummated within the ninety (90) day period and then the Company successfully registers the shares of Subject Stock pursuant to the Demand. (c) If, after a registration statement becomes effective, the Company advises the Purchaser that the Company considers it appropriate for the registration statement to be amended, the Purchaser shall suspend any further sales of the registered shares until the Company advises the Purchaser that the registration statement has been amended. The ninety (90) day time period referred to in Section 4 hereof during which the registration statement must be kept current after its effective date shall be extended for an additional number of business days equal to the number of business days during which the right to sell shares was suspended pursuant to the preceding sentence, but no event will the Company be required to update the registration statement after the expiration of this Agreement. 3. Company Registration. (a) If, at any time after the Closing the Company shall determine to register any shares of Common Stock, whether for its own account or for a security holder or holders exercising their respective demand registration rights (to the extent any may be granted in the future), other than (i) a registration relating solely to employee benefit plans on Form S-1 or S-8 or similar forms which may be promulgated in the future, or (ii) a registration on Form S-4 or similar form which may be promulgated in the future relating solely to a SEC Rule 145 transaction, the Company will promptly give to the Purchaser written notice thereof and include in such registration (and any related qualification under Blue Sky laws or other compliance), and in any underwriting involved therein, all Subject Stock specified in a written request, made within fifteen (15) business days after receipt of such written notice from the Company by the Purchaser. -2- 4 (b) If the registration of which the Company gives notice is for a registered public offering involving an underwriting, the Company shall so advise the Purchaser as a part of the written notice given pursuant to Section 3(a). In such event the right of the Purchaser to registration pursuant to this Section 3 shall be conditioned upon such Purchaser's agreeing to participate in such underwriting and in the inclusion of the Purchaser's Subject Stock in the underwriting to the extent provided herein. The Purchaser shall (together with the Company) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company. If the Purchaser disapproves of the terms of any such underwriting, the Purchaser may elect to withdraw therefrom by written notice to the Company and the underwriter. Any Common Stock excluded or withdrawn from such underwriting shall be withdrawn from such registration. (c) Notwithstanding any other provision of this Section 3, if the Company or any underwriter determines that marketing or other factors require a limitation of the number of shares to be registered or underwritten, the Company or such underwriter may exclude all or any portion of the Subject Stock requested to be included. The Company shall so advise the Purchaser and the other holders distributing their Common Stock through such underwriting, if any, and the number of shares of Subject Stock and other securities that may be included in the registration and underwriting, if any, shall be allocated among all holders thereof (other than those holders who are exercising their demand registration rights) pro rata, based, as nearly as practicable, on the respective amounts of Common Stock entitled to inclusion in such registration held by such holders at the time of filing the registration statement. Notwithstanding the foregoing, Steven P. Jobs shall not be subject to any such pro rata reduction and shall be entitled to include as many shares as he and the Company shall so agree in any such registration and underwriting. 4. Obligations of the Company. Whenever the Company is required by the provisions of this Agreement to use its best efforts to effect the registration of any Common Stock under the Securities Act, the Company shall (i) prepare and, as soon as possible, file with the SEC a registration statement with respect to the shares of Subject Stock, and shall use its best efforts to cause such registration statement to become effective and to remain effective until the earlier of the sale of the shares of Subject Stock so registered or ninety (90) days subsequent to the effective date of such registration; (ii) prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to make and to keep such registration statement effective and to comply with the provisions of the Securities Act with respect to the sale or other disposition of all securities proposed to be registered in such registration statement until the earlier of the sale of the shares of Subject Stock so registered or ninety (90) days subsequent to the effective date of such registration statement, (iii) furnish to the Purchaser such number of copies of any prospectus (including any preliminary prospectus and any amended or supplemented prospectus) in conformity with the requirements of the Securities Act as the Purchaser may reasonably request in order to effect the offering and sale of the shares of Subject Stock to be offered and sold, but only while the Company shall be required under the provisions hereof to cause the registration statement to remain current; (iv) use its best efforts to register or qualify the shares of Subject Stock covered by such registration statement under the securities or blue sky laws of such states as the Purchaser shall reasonably request, maintain any such registration or qualification current until the earlier of the sale of the shares of Subject Stock so registered or thirty (30) days subsequent to the effective date of the registration statement, and do any and all other acts and things either necessary or advisable to enable the Purchaser to consummate the public sale or other disposition of the shares of Subject Stock in jurisdictions where the Purchaser desires to effect such sales or other disposition (but the Company shall not be required to take any action that would subject it to the general jurisdiction of the courts of any jurisdiction in which it is not so subject or to qualify as a foreign corporation in any -3- 5 jurisdiction where the Company is not so qualified); (v) list the shares of Subject Stock on the NASDAQ National Market System (or any other stock exchange on which the Common Stock of the Company is listed at the time of registration); and (vi) take all such other action either necessary or desirable to permit the shares of Subject Stock held by the Purchaser to be registered and disposed of in accordance with the method of disposition described herein. If requested, and provided that the underwriter or underwriters are reasonably satisfactory to the Company, the Company shall enter into an underwriting agreement with a nationally recognized investment banking firm or firms containing representations, warranties, indemnities and agreements then customarily included by an issuer in underwriting agreements with respect to secondary distributions. The Company shall not cause the registration under the Securities Act of any other shares of its Common Stock to become effective (other than registration of any employee stock plan, or registration in connection with any Rule 145 or similar transaction) during the effectiveness of a registration requested hereunder for an underwritten public offering if, in the judgment of the underwriter or underwriters, marketing factors would adversely affect the selling price of the Subject Stock. In connection with any offering of shares of Subject Stock registered pursuant to this Agreement, the Company shall furnish the Purchaser with unlegended certificates representing ownership of the shares of Subject Stock being sold in such denominations as the Purchaser shall request. 5. Expenses. (a) All regular costs and expenses incurred in connection with any registration pursuant to Section 2 shall be borne by the Purchaser, and all regular costs and expenses, other than discounts and commissions applicable to shares not sold by the Company, incurred in connection with any registration pursuant to Section 3 shall be borne by the Company. The regular costs and expenses of any such registration shall include, without limitation, the reasonable fees and expenses of the Company's counsel and its accountants, the costs and expenses of the Company incident to the preparation, printing and filing under the Securities Act of the registration statement and all amendments and supplements thereto and the cost of furnishing copies of each preliminary prospectus, each final prospectus and each amendment or supplement thereto to underwriters, dealers and other purchasers of the securities so registered, the costs and expenses incurred in connection with the qualification of such securities so registered under the "blue sky" laws of various jurisdictions, the fees and expenses of the Company's transfer agent, listing fees and all other miscellaneous costs and expenses typically incident to such registration (collectively, "Registration Expenses"). (b) Excluding the Registration Expenses incurred in connection with any registration pursuant to Section 3 made on behalf of the Company, the Purchaser (and other holders including any Common Stock in such registration) shall pay all other expenses incurred on its behalf with respect to any registration pursuant to Section 2 or 3, including, without limitation, any counsel for the Purchaser and all underwriting discounts and selling commissions with respect to the Subject Stock sold by them pursuant to such registration statement. 6. Indemnification. (a) Indemnification by the Company. In the case of any offering registered pursuant to this Agreement, the Company agrees to indemnify and hold the Purchaser, each of its directors and officers, each underwriter of shares of Subject Stock under such registration and each person who controls any of the foregoing within the meaning of Section 15 of the Securities Act harmless against any and all losses, claims, damages or liabilities, including any of the foregoing incurred in settlement of any litigation -4- 6 commenced or threatened, to which they or any of them may become subject under the Securities Act or any other statute or common law or otherwise, and to reimburse them, from time to time upon request, for any legal or other expenses incurred by them in connection with investigating any claims and defending any actions, insofar as any such losses, claims, damages, liabilities or actions shall arise out of or shall be based upon (i) any untrue statement or alleged untrue statement of a material fact contained in the registration statement relating to the sale of such shares of Subject Stock, or the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or (ii) any untrue statement or alleged untrue statement of a material fact contained in any preliminary prospectus (as amended or supplemented if the Company shall have filed with the SEC any amendment thereof or supplement thereto) if used prior to the effective date of such registration statement or contained in the prospectus (as amended or supplemented if the Company shall have filed with the SEC any amendment thereof or supplement thereto), if used within the period during which the Company shall be required to keep the registration statement to which such prospectus relates current pursuant to the terms of this Agreement, or the omission or alleged omission to state therein (if so used) a material fact necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; provided, however, that the indemnification agreement contained in this Section 6(a) shall not apply to such losses, claims, damages, liabilities or actions which shall arise from the sale of shares of Subject Stock to any person if such losses, claims, damages, liabilities or actions shall arise out of or shall be based upon any such untrue statement or alleged untrue statement, or any such omission or alleged omission, if such statement or omission shall have been (x) made in reliance upon and in conformity with information furnished in writing to the Company by Purchaser or any such underwriter specifically for use in connection with the preparation of the registration statement or any preliminary prospectus or prospectus contained in the registration statement or any such amendment thereof or supplement thereto, or (y) made in any preliminary prospectus, and the prospectus contained in the registration statement as declared effective or in the form filed by the Company with the SEC pursuant to Rule 424 under the Securities Act shall have corrected such statement or omission and a copy of such prospectus shall not have been sent or given to such person at or prior to the confirmation of such sale to him. (b) Indemnification by the Purchaser. In the case of each offering registered pursuant to this Agreement, the Purchaser agrees, and each underwriter participating therein shall agree, in the same manner and to the same extent as set forth in Section 6(a) of this Agreement, severally to indemnify and hold harmless the Company and each person, if any, who controls the Company within the meaning of Section 15 of the Securities Act, its directors and those officers of the Company who shall have signed any such registration statement with respect to any statement in or omission from such registration statement or any preliminary prospectus (as amended or as supplemented, if amended or supplemented as aforesaid) or prospectus contained in such registration statement (as amended or as supplemented, if amended or supplemented as aforesaid), if such statement or omission shall have been made in reliance upon and in conformity with information furnished in writing to the Company by the Purchaser or such underwriter specifically for use in connection with the preparation of such registration statement or any preliminary prospectus or prospectus contained in such registration statement or any such amendment thereof or supplement thereto. (c) Notice of Claims. Each party indemnified under Section 6(a) or Section 6(b) of this Agreement shall, promptly after receipt of notice of the commencement of any action against such indemnified party in respect of which indemnity may be sought, notify the indemnifying party in writing of the commencement thereof. The failure of any indemnified party so to notify an indemnifying party of any such action shall not relieve the indemnifying party from any liability in respect of such action which it may -5- 7 have to such indemnified party on account of the indemnity agreement contained in Section 6(a) or Section 6(b) of this Agreement, unless the indemnifying party was prejudiced by such failure, and in no event shall relieve the indemnifying party from any other liability which it may have to such indemnified party. In case any such action shall be brought against any indemnified party and it shall notify an indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it may wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party, and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party under Section 6(a) or Section 6(b) of this Agreement for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation. Notwithstanding the above, however, if representation of one or more indemnified parties by the counsel retained by the indemnifying party would be inappropriate due to actual conflicting interests between such indemnified parties (the "conflicting indemnified parties") and any other party represented by such counsel in such proceeding, then such conflicting indemnified parties shall have the right to retain one separate counsel, chosen by the holders of a majority of the Subject Stock included in the registration, at the expense of the indemnifying party. No indemnifying party, (i) in the defense of any such claim or litigation, shall, except with the consent of each indemnified party, which consent shall not unreasonably be withheld, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such indemnified party of a release from all liability in respect to such claim or litigation, or (ii) shall be liable for amounts paid in any settlement if such settlement is effected without the consent of the indemnifying party, which consent shall not be unreasonably withheld. 7. Termination of Registration Rights. The registration rights granted pursuant to this Agreement shall terminate at such time as all shares of Subject Stock beneficially owned by the Purchaser can be sold within any given three-month period without compliance with the registration requirements of the Securities Act pursuant to Rule 144 and a written opinion to that effect of legal counsel for the Company is delivered to the Purchaser which shall be reasonably satisfactory in form and substance to legal counsel for the Purchaser. 8. Notices. Any notice or other communication given under this Agreement shall be sufficient if in writing and sent by personal service, facsimile, courier service promising overnight delivery or registered or certified mail, return receipt requested, postage prepaid, to a party at its address set forth below (or at such other address as shall be designated for such purpose by such party in a written notice to the other party hereto): (1) if to the Company, to it at: PIXAR 1001 West Cutting Boulevard Richmond, California 94804 Facsimile: (510) 235-7772 Attn: Lawrence B. Levy, Esq. with a copy to: -6- 8 Wilson Sonsini Goodrich & Rosati 650 Page Mill Road Palo Alto, California 94304 Facsimile: (415) 493-6811 Attn: Larry W. Sonsini, Esq. (2) if to the Purchaser, to it at: Disney Enterprises, Inc. 500 S. Buena Vista Street Burbank, California 91521 Facsimile: (818) 842-5865 Attn: Robert Moore with a copy to: Disney Enterprises, Inc. 500 S. Buena Vista Street Burbank, California 91521 Facsimile: (818) 566-7308 Attn: Gloria S. Lepow, Esq. All such notices and communications shall be effective when received by the addressee. In the event that any date provided for in this Agreement falls on a Saturday, Sunday or legal holiday, such date shall be deemed extended to the next business day. 9. Captions and Headings. The captions and headings used herein are for convenience and ease of reference only and are not intended to be a part of or to affect the meaning or interpretation of this Agreement. 10. Entire Agreement; Amendments. This Agreement constitutes the full and entire understanding and agreement between the parties with regard to the subject matter hereof and supersede all prior agreements and understandings among the parties relating to the subject matter hereof. Neither this Agreement nor any term hereof may be amended, waived, discharged or terminated other than by a written instrument signed by the party against whom enforcement of any such amendment, waiver, discharge or termination is sought. 11. Governing Law. This Agreement shall be governed in all respects by the laws of the State of California as applied to contracts entered into solely between residents of, and to be performed entirely within, such state. 12. Successors and Assigns. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Agreement may not be assigned by the Purchaser without the prior written consent of the Company. -7- 9 13. Severability. If any term, provision, covenant or restriction of this Agreement is held by a court of competent jurisdiction to be invalid, void or unenforceable, the remainder of the terms, provisions, covenants and restriction of this Agreement shall remain in full force and effect and shall in no way be affected, impaired or invalidated. 14. No Third Party Rights. Nothing in this Agreement shall create or be deemed to create any rights in any person or entity not a party to this Agreement. 15. Counterparts. This Agreement may be executed in one or more counterparts. All of such counterparts together shall constitute one and the same agreement. -8- 10 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective authorized officers as of the date aforesaid. "COMPANY" PIXAR By: ___________________________ Name: Title: "PURCHASER" DISNEY ENTERPRISES, INC. By: ___________________________ Name: Title: -9- EX-10.10 5 EMPLOYMENT AGREEMENT WITH JOHN LASSETER 1 EXHIBIT 10.10 EMPLOYMENT AGREEMENT This Employment Agreement made and entered into by and between PIXAR, a California corporation (the "Company") and JOHN LASSETER ("Employee") effective as of February 24, 1997. Reference is made to that certain executed Employment Agreement ("Prior Agreement") made and entered into by and between Pixar, a California corporation Company and John Lasseter dated as of August 1, 1991. As an inducement for Pixar to enter into this Employment Agreement, the parties agree that notwithstanding anything to the contrary contained in the Prior Agreement, the Term of the Prior Agreement shall expire on February 23, 1997 and no bonus shall be payable to Employee other than as set forth in this Employment Agreement. 1. ENGAGEMENT: 1.1 Guaranteed Employment Term. (a) The Company agrees to employ Employee and Employee agrees to accept such employment, for a guaranteed period commencing on February 24, 1997 ("Start Date") and ending on February 23, 2004. Company may terminate this Employment Agreement prior to the expiration of the Term in accordance with Company's Termination Rights under 6.5 below or in the event of Employee's death, Incapacity or Default or an event of Force Majeure as more fully set forth in paragraph 6.8 below. Employee may not terminate Employee's services hereunder prior to the expiration of the Term except as more fully set forth in paragraphs 6.7 and 6.8 below. 1.2 Duties and Responsibilities. (a) During the Term and any extensions thereof, Employee shall be employed by the Company as a director of animated motion pictures and as "Vice President - Creative" of the Company (which corporate officer position has been approved by Company's Board of Directors), reporting directly to the CEO of Company or the Office of the President, as the CEO of Company may from time to time designate. Company and Employee acknowledge that Employee's first priority shall be the directing or supervision of feature length animated motion pictures ("Picture(s)") and serving, at Company's direction, as Company's representative to Walt Disney Pictures ("Disney") in the exercise of Company's creative control rights and obligations and that Employee's other duties for Company shall not materially interfere with such priority services. Employee agrees that during the Term he will render exclusive services to Company and devote his full time, effort and energies during business hours to his responsibilities for the Company, and that he shall faithfully and to the best of his ability discharge those duties. (b) During the Term, Company and Employee shall have the following creative control rights with respect to the development, pre-production, production and post-production of the -1- 2 Pictures, made for home video productions and short subject motion pictures (collectively, the "Productions"): (i) with respect to Productions for which Employee renders executive producing services (but not directing services) [*], provided that in the event of [*], the [*]; and (ii) with respect to Productions directed by Employee, [*], provided that each party shall [*] and so not to [*]. The parties acknowledge that [*]. 1.3 Location. Company agrees that Employee's services for Company will be based within a thirty (30) mile radius of Company's current headquarters in Richmond, California unless otherwise approved by Employee. Employee hereby approves the intended location of a new facility in Emeryville, California. 2. COMPENSATION: 2.1 Salary. Subject to the full and complete performance by Employee of all of Employee's material obligations hereunder, Company shall pay to Employee the following: (a) Signing Bonus. Company shall pay to Employee the sum of $1,250,000 within ten (10) business days after the execution of this Employment Agreement. (b) Salary. Company shall pay to Employee the annual salary of $700,000, with eight percent (8%) cumulative annual increases at each anniversary date of the Start Date. Employee's salary shall be payable in accordance with Company's customary payroll practices. All payments made to Employee as salary, signing bonus, theatrical motion picture bonus or otherwise shall be subject to such deductions, withholdings and limitations as shall from time to time be required by law, governmental regulations or orders, and any agreements between Company and Employee. 2.2 Theatrical Motion Picture Bonus. (a) If Employee is entitled to receive a "directed by" credit on the Picture and Employee fully performs all directing services requested by Company in accordance with this Agreement and material obligations requested by Company in accordance with the terms of this Agreement in connection with the applicable Picture, Employee shall be entitled to receive contingent bonuses (which bonuses are cumulative at each box office benchmark) based upon the domestic theatrical box office gross receipts of such Picture as reported in the Daily Variety (or if Daily Variety discontinues such service, the parties shall mutually determine an appropriate replacement, but in the event of a disagreement relating to such replacement, the decision of Company shall govern), as follows, payable within 30 days after such milestone is reported in Daily Variety: [*] - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -2- 3 (b) Vesting. If Employee's services are terminated (including, but not limited to, termination as a result of expiration of the Term of this Agreement) as director in connection with a Picture by any reason other than Employee's breach or default of a material term or condition hereunder, the contingent compensation set forth in Section 2.2(a) above with regard to such Picture shall vest each month that Employee performs services on such Picture as to a percentage equal to the quotient obtained when one is divided by the total number of months of scheduled pre-production, production and post-production of such Picture, but in no event shall the total number of scheduled pre-production, production and post-production months exceed forty-eight (48) months. As an example only, if production, pre-production and post-production for a Picture are scheduled for a total of four years (i.e., forty-eight (48) months), then vesting shall be 1/48th or 2.083% for each month of Employee's services on such Picture. Notwithstanding the foregoing, if Employee's services are terminated for any reason other than Default under Section 6.8 below, then if Employee has completed services for seventy-five percent (75%) or more of the total schedule as computed above, then the contingent compensation set forth in Section 2.2(a) above shall be deemed fully vested. 2.3 Stock Options. Company shall grant to Employee 125,000 additional non qualified options for the purchase of Company's common stock pursuant to the terms and conditions of Company's Stock Option Plan and a new Employee Stock Option Agreement consistent with the terms of Company's Stock Option Plan and the terms of this Agreement. Company agrees that the exercise price for said stock options shall be the price of Company's common stock at the close of business on Friday, February 21, 1997. Company agrees that such plan will provide for a vesting of the stock options over a four year period, with the first 25% vesting on the first anniversary date of this Agreement, and the balance vesting on an equal monthly basis over the remaining three (3) years, provided, that if Company exercises its Termination Rights under Section 6.5 below, Employee's stock options will be deemed fully vested. 2.4 Fringe Benefits. Employee shall be eligible to participate, in accordance with their terms, in all medical and health plans, life insurance and pension plans and such other employment benefits or programs (other than executive bonus plans) as are maintained by Company for its employees provided that Company shall at all times be free to modify or amend such plans on a Company wide basis in accordance with the provisions thereof. Notwithstanding the foregoing, in no event shall such fringe - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -3- 4 benefits (other than executive bonus plans) be less favorable to Employee under those accorded to any other employee of Company other than Steve Jobs. 2.5 Paid Vacations. Employee shall be entitled to paid vacation in accordance with the vacation policy of Company, but in no event less than four (4) weeks per annum. Notwithstanding the foregoing, Employee shall not be entitled to accrue any vacation time in any contract year in which Employee is [*]. Employee may use up to two (2) weeks of previously accrued vacation time in a contract year in which Employee [*], but in no event more than four (4) consecutive days at any one time during said contract year. 2.6 [*]. Company shall allow Employee [*] on each Picture which Employee directs under this Agreement. Company and Employee shall mutually determine the [*], which shall be no later than [*] from the initial theatrical release of the Picture directed by Employee, unless Employee otherwise agrees. Employee agrees to [*] no less [*] than [*]. During each [*], (i) Employee shall be entitled to [*] (ii) all terms and conditions of this Agreement (including, without limitation, exclusivity and vesting) shall remain in effect. 2.7 Expenses. Company recognizes that in connection with Employee's performance of Employee's duties and obligations hereunder Employee will incur certain ordinary and necessary expenses of a business character including, without limitation, travel and expenses relating to the Pictures. Company shall reimburse Employee for all such reasonable business expenses upon presentation of itemized statements of such expenses and appropriate substantiation thereof, in each case in accordance with Company's standard policies. With respect to business travel, Employee shall be treated no less favorably in class of travel (with respect to commercial airlines, but excluding private airplane transportation) and expenses than (i) other executives of Company or (ii) any individual on the same business trip as Employee. All such expenses shall be subject to the pre-approval of Company. 3. WRITING SERVICES: 3.1 Services. At Company's request, Employee shall render writing services and supervisory services to create stories, treatments and screenplays for the Pictures hereunder. 3.2 Credits. In the event Employee creates the applicable story and renders writing services in connection with any Picture, Employee shall receive a "story by" credit, in first position, on screen in the end titles, or the main titles if any other person receives credit in the main titles of the Picture, (which credit may be shared with no more than three (3) other writers). The Size (as hereinafter defined) of said credit shall be not less than 50% of the Size of the regular title and no less than that accorded to any other individual (other than principal cast members) receiving credit in connection with the Picture. Additionally, Employee shall receive credit in the billing block portion of paid advertising issued and controlled by Company or the distributor (subject to the distributors customary exclusions and - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -4- 5 restrictions for animated pictures) in a Size not less than 35% of the regular title. Notwithstanding the foregoing, Employee shall receive credit in excluded advertising whenever a writer, producer, director, technical director or executive producer receive credit in said billing block (other than award or congratulatory ads). "Size" shall mean height, width and thickness. All other characteristics of Employee's credit shall be at Company's sole discretion. Notwithstanding the foregoing, the parties acknowledge that Employee will receive a shared "Story By" writing credit on "Bugs" in third position behind Andrew Stanton and Joe Ranft. 4. EXECUTIVE PRODUCING SERVICES: 4.1 Services. Employee shall tender executive producing services on a non-exclusive first priority basis on all Productions produced by Company during the Term, other than with respect to those Productions which Employee directs. Employee agrees to render all such services as required by Company in accordance with this Agreement and customarily rendered by executive producers of first class productions in the entertainment industry and to comply with all reasonable instructions, requests, rules and regulations of Company in connection therewith, whether or not the same involve matters of artistic taste and judgment during the development, production and post production of the Productions. 4.2 Credits. As to each Production for which at least seventy five percent (75%) of the actual production schedule was completed during the Term and subject to Employee's full performance of all material executive producing services and material obligations in connection therewith, and further subject to the distributor's standard exclusions and exceptions as customarily negotiated for deals of this nature, Company shall accord Employee the following credit, on screen: Executive Producer, on a card which may be shared, which credit shall be in first position of all other executive producer credits, and which credit may be in the main titles (or end titles of the film if all other individual credits are in the end titles). Said credit shall be no less than 50% of the regular title and in Size of type of the title and no less than the Size of type accorded to any other individual (other than the principal cast members) of the Picture. In addition, Employee shall be entitled to receive credit in the billing block portion of paid advertising issued or controlled by Company or the distributor (subject to distributor's standard exceptions and exclusions as customarily negotiated for deals of this nature) in a Size of type not less than 35% of the Size of type of the regular title of the Picture. Employee shall also receive credit in excluded advertising in which a writer, producer, director, technical director or executive producer receive credit in said billing block (other than award or congratulatory ads). All other characteristics of the foregoing credit shall be subject to Company's sole discretion. Notwithstanding the foregoing, Employee shall not be entitled to an executive producer credit on those Productions on which Employee receives a "directed by" credit. 5. DIRECTING SERVICES: 5.1 Services. (a) Employee shall render services in the capacity of the director for three (3) Pictures during the Term, it being understood that Employee's services for the third Picture are subject to subparagraph (b) below. The parties acknowledge that the first Picture is "Bugs". Employee agrees -5- 6 to render all such services as required by Company and customarily rendered by directors of first-class feature length animated motion pictures in the motion picture industry and to comply with all reasonable directions, requests, rules and regulations of Company in connection therewith, whether or not the same involve matters of artistic taste and judgment. If Company and Employee desire to engage a co-director in connection with any Picture directed by Employee, said co-director shall be subject to the approval of Employee, which approval shall be exercised in Employee's sole discretion. Notwithstanding the foregoing, if Company elects to proceed to production of a Picture during the Term and it is reasonably anticipated by Company that the Term shall expire prior to completion of Employee's directing services in connection therewith and Employee and Company have not concluded an agreement for Employee's post term directing services under subparagraph (b) below, then Company will have the right to engage the services of a co-director in consultation with Employee. In any event, such co-director will be subject to Employee's creative direction during Employee's services as the director. (b) Notwithstanding anything to the contrary contained herein, if Company elects to proceed to production of a Picture during the Term and it is reasonably anticipated by Company that the Term shall expire prior to the completion of Employee's directing services in connection therewith (Company and Employee specifically acknowledge that the third Picture may fall under this category), either Company or Employee may initiate good faith negotiations for post term directing services in connection with the applicable Picture (with the salary and theatrical motion picture bonus set forth herein as a floor for such directing services). If the parties are unable to reach an agreement after a period of thirty (30) days from commencement of said negotiations ("Negotiation Period"), Employee shall have the right by written notice to Company within five (5) business days after expiration of the Negotiation Period to extend the Term for up to six (6) months at then current salary level. If Employee fails to submit such notice, the Term of this Agreement shall be extended on a week-to-week basis until either party terminates upon seven (7) days written notice. 5.2 Credits. As to each Picture produced for which Employee renders directing services, and subject to Employee's full performance of all material directing services requested by Company in accordance with this Agreement and material obligations in connection therewith, and further subject to the distributor's standard exclusions and exceptions as customarily negotiated for deals of this nature Company shall accord Employee the following sole credit, on screen, on a separate card, in the end titles or in the main titles if any other individual receives credit in the main titles: "Directed by John Lasseter", which shall be the last card in the main titles or the first card of individual credits in the end titles, subject to industry wide collective bargaining agreements. Said credit shall be no less than 50% of the regular title and in a Size of type not less than the Size of type accorded to any other individual (other than the cast members) of the Picture. In addition, Employee shall be entitled to receive credit in the billing block portion of paid advertising (including packaging of video devices) issued or controlled by Company or the distributors (subject to the distributor's standard exceptions and exclusions and subject to the distributor's customary restrictions as customarily negotiated for deals of this nature) in a Size of type not less than 35% of the Size of type of the regular title of the Picture and 20% of the artwork title of the Picture. Employee shall also receive credit outside of the billing block or in excluded advertising in which any individual (other than principal cast members) receives credit in said excluded ads or outside the billing block (other than award or congratulatory ads). All other characteristics of the foregoing credit shall be subject to Company's sole discretion. -6- 7 5.3 Delivery. With respect to each of the Pictures which Employee directs, Employee, to the extent within Employee's control, shall comply with the delivery and picture specification requirements of the distributor of the Picture, of which Employee is informed in writing. 5.4 Sequels/Remakes. If within twelve (12) years after the initial release (if any) of the applicable Picture directed by Employee, Company (or its successor and assigns) elects in its sole discretion to produce a theatrical sequel, theatrical remake, television motion picture, mini-series or series, or "made for video production" based on any of the Pictures directed by Employee ("Subsequent Productions") then provided that the applicable Picture was completed at a final negative cost not exceeding 110% of the approved budget excluding the contingency (excluding excess cost incurred due to Force Majeure events and other causes beyond Employee's control, changes pre-approved by Company, net insurance recoveries and retroactive increases to scale personnel under any collective bargaining agreement which are not reasonably anticipated), that Employee is not in Default hereunder and provided further that Employee is available when reasonably required by Company, then Employee shall have the first opportunity to be the director for the Subsequent Production which, if after the Term shall be upon terms to be negotiated in good faith within Company's standard parameters. If Company and Employee fail to agree on the terms for Employee's engagement on the Subsequent Productions within thirty (30) days following commencement of the negotiations, or if Employee is unavailable or elects not to direct, then Company shall have no further obligation to Employee under this paragraph 5.4. 5.5 Videocassette. If any Picture is produced and Employee performs his services hereunder, Employee shall be entitled to receive one (1) videocassette copy and one (1) laser disc copy of the Picture if and when commercially available for release to the public. 5.6 Premieres. Employee and his spouse shall be invited to all major celebrity premieres of the Picture (if any) in the United States which he directs and shall be entitled to payment of first class transportation and expenses. 5.7 No Union. The parties acknowledge that Company is not a signatory to the DGA Basic Agreement and that the DGA Basic Agreement does not currently apply to the Pictures. 5.8 E&O Insurance. Company shall include Employee as an additional insured on Company's errors and omissions insurance policy consistent with custom and practice in the industry. 6. GENERAL TERMS: 6.1 Right to Insure. Company shall have the right to secure in its own name, or otherwise, and at its own expense, life, health, accident or other insurance covering Employee and Employee shall have no right, title or interest in and to such insurance. Employee shall assist Company in procuring such insurance by submitting to examinations and by signing such applications and other instruments as may be required by the insurance carriers to which application is made for any such insurance. If Company is unable to obtain such insurance at customary rates and deductibles, Company shall have the right which must be exercised if at all within sixty (60) days from the date of this Agreement to terminate this Agreement. -7- 8 6.2 Noncompetitive Employment. (a) Employee acknowledges that the nature of the services furnished by Company to its clients requires that Employee at all times perform Employee's services under this Agreement without divided loyalties or obligations to any other person including, without limitation, to any person who may become an employer of Employee following the end of the Term. Accordingly, and without limiting the generality of the principle set forth in the preceding sentence, it shall be a breach of this Agreement for Employee, without prior written notice to and prior written consent of Company, to accept employment with any business, individual, partnership, corporation, trust, joint venture, unincorporated association or other entity or person other than the Company at any time during the Term of this Agreement. During the Term, Employee may not discuss, seek, solicit or accept future post Term employment. (b) During the Term of this Agreement Employee shall not become financially interested in (other than as a stockholder owning less than one percent (1%) of the outstanding capital stock of any publicly traded corporation) or directly associated with any other business or Person engaged in a business that is involved in (i) developing, producing, distributing or exploiting motion pictures, home videos, television programs, interactive products or other audio visual works; (ii) the development, sale, licensing or use of computer software for the creation or production of motion pictures, home videos, television programs, interactive products or other audio visual works or (iii) any other business that is competitive with the Company's business or activities without the prior written consent of Company. (c) After the expiration or termination of the Term for any reason whatsoever, Employee shall not either alone or jointly with or on behalf of others, either directly or indirectly, whether as principal, partner, agent, shareholder, director, employee, consultant or otherwise, at any time during the period of two (2) years following the expiration or termination of the Term, offer employment to, or solicit the employment or engagement of, or otherwise entice away from the employment of Company or Disney or any affiliated entity, either for Employee's own account or for any other person, firm or company, any person who is then employed by Company or Disney or any such affiliated entity, whether or not such person would commit any breach of said person's contract by reason of leaving the service of Company, Disney or any affiliated entity. 6.3 Nondisclosure Agreement. Employee acknowledges and confirms his continuing obligations under the Non-Disclosure Agreement previously executed by Company and Employee regarding confidentiality and inventions (the "Confidentiality Agreement"). Employee further acknowledges that said Confidentiality Agreement applies to the terms and conditions of the co-production agreement between Company and Disney to the extent Employee has knowledge of the terms and conditions thereof. To the extent of any inconsistency between this Agreement and the Confidentiality Agreement, this Agreement shall govern. 6.4 Ownership. The results and proceeds of Employee's services hereunder including, but not limited to, creating, designing, sketching, animation, writing and/or directing in connection with ideas, stories, screenplays and the Pictures, Productions or any other Pixar production's or works shall -8- 9 be deemed a work-made-for-hire specially ordered or commissioned by Company ("Results and Proceeds"). As between Employee and Company, Company shall exclusively own all now known or hereafter existing rights of every kind throughout the universe, in perpetuity and in all languages, pertaining to such Results and Proceeds, and all elements therein, for all now known or hereafter existing uses, media, and forms (including, without limitation, all copyrights and renewals and extension thereof), motion picture, television, sequel, remake, character and allied rights therein, and the foregoing is inclusive of a full assignment to Company thereof. In addition, Company shall have the right, throughout the world and in perpetuity, to use and reproduce, and license others to use and reproduce, Employee's name, likeness and biographical data relating to Employee in connection with the Picture and the advertising or exploitation thereof (including without limitation, in promotional films and featurettes relating to any Pictures or projects); provided that in no event shall Employee be depicted as using or endorsing any product, commodity or service. The use of Employee's credit in a billing block shall not be deemed a use or endorsement of a product, commodity or service. Company shall have the right, but not the obligation, to use, adapt, change or revise any work or product of Artist or any part thereof or the title thereof and to combine the same with other material or works and Employee hereby expressly waives any so-called "moral rights" of authors in the world. 6.5 Termination Without Cause. Company shall have the unilateral right, at any time in the Company's sole and absolute discretion, to terminate Employee's employment by the Company, without cause, and for any reason or for no reason (the Company's "Termination Rights"). The Company's Termination Rights are not limited or restricted by, and shall supersede, any policy of the Company requiring or favoring continued employment of its employees during satisfactory performance, any seniority system or any procedure governing the manner in which the Company's discretion is to be exercised. No exercise by the Company of its Termination Rights shall, under any circumstances, be deemed to constitute (i) a breach by the Company of any term of this Agreement, express or implied (including without limitation a breach of any implied covenant of good faith and fair dealing), (ii) a wrongful discharge of Employee or a wrongful termination of Employee's employment by the Company, (iii) a wrongful deprivation by the Company of Employee's office (or authority, opportunities or other benefits relating thereto), or injury to reputation, or (iv) the breach by the Company of any other duty or obligation, express or implied, which the Company may owe to Employee pursuant to any principle or provision of law (whether contract or tort), unless the Company's determination to terminate Employee pursuant to this Section 6.5 shall constitute a violation of any applicable federal, state or municipal statute, ordinance, rule or regulation, respecting which the parties may not contact otherwise. If the Company elects to terminate Employee's employment pursuant to this Section 6.5, the Company shall have no obligation or liability to Employee pursuant to this Agreement or otherwise, except to (a) pay to Employee within ten (10) business days of the exercise of the Termination Right an amount equal to seventy-five percent (75%) of the balance of the Salary due to Employee under Section 2.1(b) through the remainder of the Term, and (b) pay to Employee the vested portion of the Theatrical Motion Picture Bonus as and if due pursuant to the terms of Section 2.2. Upon exercise of such Termination Right, Employee shall have no further obligation to provide services to Company hereunder and Employee shall be free to accept third party employment. 6.6 Equitable Relief for Breach. Employee acknowledges that the services to be rendered by Employee under the terms of this Agreement, and the rights and privileges granted to -9- 10 Company by Employee under its terms, are of a special, unique, unusual, extraordinary and intellectual character, which gives them a peculiar value, the loss of which cannot be reasonably or adequately compensated in damages in any action at law, and that a material breach by Employee of any of the provisions contained in this Agreement will cause Company great and irreparable injury and damage. Employee acknowledges that Company shall be entitled, in addition to any other remedies it may have at law, to seek the remedies of injunction, specific performance, and other equitable relief for any breach of this Agreement by Employee. This provision shall not, however, be construed as a waiver of any of the rights which Company may have for damages, or otherwise. 6.7 Breach By Company. In the event of any breach of this Agreement by Company, Employee shall give Company written notice thereof. If Company does not cure such breach within thirty (30) days of receiving written notice thereof, Employee's remedy shall be limited to an action at law for damages and/or declaratory relief and Employee shall not be entitled to rescind this Agreement or to injunctive relief or other equitable remedies; provided, however, the foregoing shall not be deemed a waiver of Employee's statutory or common law right to discontinue rendering services hereunder in the event of a material breach by Company of this Agreement. No inadvertent failure to comply with the provisions of paragraphs 3.2, 4.2 or 5.2 nor any failure by third parties to comply with their agreement with Company shall constitute a breach of this Agreement by Company. Upon written notice from Employee specifying the precise nature of the failure to accord credit as herein provided, Company agrees to use reasonable efforts to cure prospectively any such breach, but Company shall not be obligated to recall any prints or advertising material. Company shall use good faith business efforts to advise third party licensees of the credit obligations to Employee under this Agreement. Notwithstanding the foregoing, Company will contractually require Disney to comply with the credit obligations hereunder. 6.8 Suspension/Termination. (a) In the event of Employee's death during the Term, Company shall terminate Employee's services and pay pursuant to paragraph 6.8(f) below. (b) If Employee is prevented from fully performing Employee's material obligations hereunder by reason of illness, accident or mental or physical disability, or by reason of any law or authority (all of which events are herein called "Incapacity"), Company may suspend the services and compensation of Employee during the period of such Incapacity and/or extend the Term of Employee's services hereunder for a period of time equal to the period of such suspension. In the event such Incapacity continues for a period of fourteen (14) consecutive days or twenty-one (21) days in the aggregate while Employee is rendering directing services during production of any Picture hereunder or six (6) consecutive weeks or ten (10) weeks in the aggregate, at any other time hereunder, Company may terminate the employment of Employee's services by giving thirty (30) days prior written notice to Employee. (c) The Company may terminate this Agreement immediately upon written notice to Employee for an event of "Default." For purposes of this Agreement, a termination for "Default" occurs if Employee is terminated for any of the following reasons: -10- 11 (i) Gross negligence by Employee of his duties pursuant to this Agreement. (ii) Conviction of Employee of any felony or any lesser crime or offense involving the property of Company. (iii) Any material breach by Employee of any of the terms or covenants of this Agreement, it being understood that Employee shall have a period of five (5) days from written notice from Company to cure an alleged breach. (d) The unearned salary provided for hereunder to Employee may, at Company's option, be suspended during any interruption of Company's business which prevents the performance of Employee's duties which has been caused by an event of force majeure, including, but not limited to, strikes, work stoppage or other labor dispute, acts of God, or other events of force majeure ("Force Majeure"). If any such period of suspension hereunder shall continue for a period of six (6) weeks or more, Company or Employee shall have the right to elect to terminate this Agreement by written notice. In the event Employee elects to submit a notice of termination, said election shall be deemed null and void if Company elects to resume its payment obligations to Employee with one (1) week of Company's receipt of said notice. If this Agreement is terminated due to an event of Force Majeure and Company elects to thereafter resume production of the applicable Picture within eighteen (18) months, Employee shall have the first opportunity upon fifteen (15) business days prior notice to the start date to be reinstated as the director under the terms and conditions of this Agreement. During any suspension for an event of Force Majeure, Employee's services to Company shall be on a non-exclusive basis. (e) In the event of any such suspension or suspensions hereunder, the Term of this Agreement shall be extended (unless earlier terminated as provided above) for an additional period of time equal to the period of such suspension or suspensions, and the dates for any increase in salary provided for herein shall be correspondingly postponed. (f) In the event of Employee's termination for death, Incapacity, Default or Force Majeure pursuant to subsections (a), (b), (c) or (d) above, Company shall be obligated to pay Employee only the specified salary, bonuses, fringe benefits, expenses and vacation accrued through the date of termination and any rights Employee may have under the Stock Option Plan shall be determined under the terms thereof. 6.9 Assignment. Company may not assign its rights under this contract unless to a company which acquires all or substantially all of Company's assets or to a single purpose production entity which is formed by Company for purposes of producing the Pictures (in which event Company may only assign Employee's services and Company shall remain liable for all obligations of said single purpose entity), without Employee's consent. This Agreement is personal to Employee and Employee shall not have the right to assign Employee's interest in this Agreement, any rights under this Agreement or any duties imposed under this Agreement nor shall Employee have the right to pledge, hypothecate or -11- 12 otherwise encumber Employee's right to receive compensation hereunder without the prior written notice to Company. 6.10 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. 6.11 Notices. Any notice, consent or other communication under this Agreement shall be in writing and shall be considered given when mailed by registered or certified mail, postage prepaid, to the parties at the addresses set forth below (or at such other address as a party may specify by notice in accordance with the provisions hereof to the other). Company: PIXAR 1001 W. Cutting Boulevard #200 Richmond, CA 94804-2452 With a copy to: Ziffren, Brittenham, Branca & Fischer 2121 Avenue of the Stars 32nd Floor Los Angeles, CA 90067 Attention: Sam Fischer, Esq. John Lasseter 590 Daniel Young Dr. Sonoma, CA 95476 With a copy to: Crosby, Heafey, Roach & May 700 S. Flower Suite 2200 Los Angeles, CA 90017 Attention: Nancy Newhouse Porter 6.12 Governing Law. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of California (regardless of that jurisdiction or any other jurisdictions' choice of law principles). 6.13 Complete Agreement, Modification and Termination. This agreement, along with the Stock Option Plan, and the Confidentiality Agreement, contains a complete statement of all the arrangements between the parties with respect to Employee's employment by Company, supersedes all -12- 13 existing agreements, whether written or oral, between them concerning Employee's employment, and may be changed only in a writing executed by all parties hereto. In entering into this Agreement, neither party has relied upon any representation, warranty, assurance or statement of intention not expressly set forth herein. 6.14 Validity. If any one or more of the provisions (or any part thereof) of this Agreement shall be held to be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions (or any part thereof) shall not in any way be affected or impaired thereby. 6.15 Waiver. The failure of a party to insist upon strict adherence to any term, condition or other provision of this Agreement shall not be considered a waiver or deprive that party of the right thereafter to insist upon strict adherence to that term or any other term, condition or other provision of this Agreement. 6.16 Commitment to Others. Employee shall not have any right or authority to and shall not employ any person in any capacity nor contract or purchase or rent any article or material, nor make any commitment, agreement or obligation whereby Company shall be required to pay any monies or other consideration without Company's prior consent in each instance. 6.17 I-9. All of Company's obligations under this Agreement are expressly conditioned upon Employee's completion to Company's reasonable satisfaction of an I-9 Form (Employee Eligibility Verification Form) and upon Employee's submission to Company of original documents reasonably satisfactory to Company to demonstrate Employee's employment eligibility. 6.18 Headings. The headings of this Agreement are solely for convenience of reference and shall not affect its interpretation. 6.19 Arbitration. Any controversy or claim arising out of, or relating to, this Agreement, or the making, performance or interpretation thereof, shall be fully and finally settled by binding arbitration in San Francisco, California, in accordance with the rules of the American Arbitration Association the existing, and judgment on the arbitration award may be entered in any court having jurisdiction over the subject matter of the controversy; provided, however, that this arbitration provision shall not apply to any dispute concerning any obligations arising under paragraphs 6.2, 6.3 and 6.4 of this Agreement. 6.20 Indemnity. Company shall indemnify and hold harmless Employee from and against any and all liability, costs, damages and expenses (including reasonable attorneys' fees and court costs) which Employee may sustain or suffer by reason of any third party claim resulting from the development, production or distribution of the Picture and which is not caused by a breach by Employee hereunder. -13- 14 6.21 EMPLOYEE ACKNOWLEDGES THAT HE HAS HAD THE OPPORTUNITY TO CONSULT WITH THE ADVISOR OF HIS CHOICE AND THAT HE HAS FREELY AND VOLUNTARILY ENTERED INTO THIS AGREEMENT. IN WITNESS WHEREOF, the parties have executed this Agreement as of February 23, 1997. PIXAR By /s/ Steve Jobs ---------------------------------------- EMPLOYEE /s/ John Lasseter ------------------------------------------- JOHN LASSETER -14- EX-10.16 6 CO-PRODUCTION AGREEMENT 1 EXHIBIT 10.16 CO-PRODUCTION AGREEMENT WALT DISNEY PICTURES AND TELEVISION AND PIXAR FEBRUARY 24, 1997 2 CO-PRODUCTION AGREEMENT TABLE OF CONTENTS
Page ---- 1. Pictures.......................................................................1 2. Term...........................................................................1 3. Creative Controls..............................................................1 a. Treatments............................................................1 b. Development and Production............................................2 c. Final Cut.............................................................3 d. Ancillary Rights......................................................3 4. Production.....................................................................4 a. Production Control....................................................4 b. Disney Representative.................................................5 5. Computational Resources........................................................5 a. Computational Resources...............................................5 b. Acquisition and Funding of Computational Resources....................5 c. Use On other Projects.................................................5 d. Buy Out...............................................................6 6. Distribution...................................................................6 a. Initial Release.......................................................6 b. Release Period........................................................6 c. [*]...................................................................6 d. Walt Disney Pictures Brand............................................7 e. Distribution and Marketing............................................7 f. Consultation with Pixar...............................................7 g. Pixar Representative..................................................7 h. [*] Licensing.........................................................8 i. Short Subjects........................................................8 j. Subdistributors and Flat Sales........................................8 k. "Making of" Films.....................................................8 7. Financing of Development and Production........................................9 8. Budgets........................................................................9 a. Treatment Budget......................................................9 b. Development Budgets...................................................10 c. Picture Budgets.......................................................10 d. [*]...................................................................11 9. Definition of Gross Receipts...................................................11
- ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. 3 a. Gross Receipts........................................................12 b. Exclusions from Gross Receipts........................................12 c. Ancillary Rights......................................................13 d. Home Video............................................................13 e. Affiliates............................................................13 10. Division of Gross Receipts.....................................................14 a. Division..............................................................14 b. Separate Accounting Units.............................................14 c. Statements............................................................14 d. Audit Rights..........................................................15 e. Payments..............................................................16 11. Distribution Costs.............................................................16 a. Definition............................................................16 b. Exclusions............................................................17 c. Cross Promotions......................................................17 d. Disney Responsible....................................................17 e. Accrual...............................................................18 12. Brand/Credit...................................................................18 a. On Screen Credits.....................................................18 b. Paid Advertising......................................................18 c. Packaging.............................................................19 d. Billing Block.........................................................19 e. Stationary Logo.......................................................19 f. [*]...................................................................20 g. Credits...............................................................20 h. Prospective Cure......................................................20 13. Proprietary Rights.............................................................20 a. Pictures and Ancillary Rights.........................................20 b. Corporate Promotional Use.............................................21 c. Pixar Technology......................................................21 d. Treatments............................................................22 14. Defense of Claims..............................................................22 a. By Disney.............................................................22 b. By Pixar..............................................................22 15. Derivative Works...............................................................23 a. Definition of Derivative Works........................................23 b. Decision to Produce...................................................23 c. Theatrical Motion Pictures............................................24 d. Made-for-Home Video Productions.......................................24 e. Television Productions................................................25 f. Interactive Works.....................................................26 g. Live Entertainment....................................................26 h. Location Based Entertainment..........................................27
- ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. ii 4 i. All Other Works Other Than Theme Parks................................27 j. Theme Parks...........................................................27 k. Creative Control of Derivative Works Not Produced by Pixar............27 16. Toy Story......................................................................28 a. Derivative Works......................................................28 b. Toy Story Agreement...................................................28 c. Ancillary Rights......................................................28 17. Exclusivity....................................................................28 a. No Other Feature Length Animated Theatrical Motion Pictures...........28 b. Theme Parks...........................................................28 c. First Look at TV Productions and Home Video Productions...............29 d. No Material Interference..............................................29 e. Employment Agreement with John Lasseter...............................29 18. Exchange of Information........................................................29 19. Publicity and Confidentiality..................................................30 a. Publicity.............................................................30 b. Confidentiality of Terms of Agreement.................................30 c. Protection of Confidential Information................................30 20. Non-Solicitation...............................................................31 21. Assignment.....................................................................31 22. Change of Control of Pixar.....................................................31 23. Termination....................................................................31 24. Interest On Late Payments......................................................32 25. Governing Law..................................................................32 26. General Provisions.............................................................32 a. Right to Cure.........................................................32 b. Remedies..............................................................32 c. Force Majeure.........................................................33 d. No Waivers............................................................33 e. No Violation of Law...................................................34 f. Notice................................................................34 27. Entire Agreement...............................................................34 28. Execution in Counterparts......................................................34 Exhibit A - Certain Entertainment Companies....................................37 Exhibit B - Distribution Costs.................................................38 Appendix - Glossary of Terms...................................................42
iii 5 CO-PRODUCTION AGREEMENT This Co-Production Agreement ("Agreement") is entered into as of February 24, 1997, by and between Pixar, a California corporation ("Pixar), and Walt Disney Pictures and Television, a California corporation ("Disney"). 1. PICTURES. Pixar and Disney agree to develop, produce, finance and distribute five (5) computer-animated feature-length theatrical motion pictures ("Picture(s)") pursuant to the terms of this Agreement. Pixar and Disney hereby designate the picture currently entitled Bugs as the first Picture hereunder. 2. TERM. The term of this Agreement ("Term") shall commence upon the execution hereof and shall continue until Delivery to Disney of the fifth Picture produced and financed hereunder. For purposes of this Agreement, "Delivery" shall mean delivery pursuant to terms to be mutually agreed upon by Pixar and Disney no later than six (6) months before the delivery of Bugs. The provisions of paragraphs 5(d), 6, 9 through 16, 17(a), and 18 through 28 of this Agreement shall survive expiration of the Term. 3. CREATIVE CONTROLS. Pixar and Disney shall collaborate in the creative process of developing and producing the Pictures, as follows: a. Treatments. (i) For each of the four remaining Pictures, Pixar shall submit one or more Treatments for Disney's consideration as the basis for the Picture ("Treatment"). Each Treatment shall be either (a) a written treatment of not less than three pages in length setting forth a story to be used as the basis for the screenplay or (b) an oral presentation of not more than one (1) hour, accompanied by rough sketches, conceptual art and rudimentary story boards sufficient to communicate the essential idea for the Picture comparable to the presentation previously made for Bugs and the first presentation for the second Picture. Each such Treatment shall be based on a new idea and not be a sequel, prequel or remake of a prior picture. Treatments may be submitted by Pixar singly or in one or more groups. Disney shall accept or reject each Treatment within forty-five (45) days after such Treatment -1- 6 is submitted by Pixar. [*] for [*] of the [*] within [*] by [*] of the [*], then [*], whether or not it [*], to [*], by giving written notice of [*] at any time [*] unless [*] the parties have [*] or [*] this Agreement under the provisions of subparagraph (ii) below: (A) [*] of the [*] as the [*] for a [*], provided in the event of [*] under this subparagraph A the [*] to [*] and [*] shall be [*] (unless [*] to [*] and with the [*] specified in [*], or (B) in the case of [*] of the [*] as the [*] for such [*] and in the event of [*] under this subparagraph B [*] and [*] shall be [*] (unless [*] to [*]) and with the [*] specified in [*]. (ii) In the event that no Treatment has been approved or selected under the provisions of subparagraph 3(a)(i) above within one (1) year after the initial theatrical release of the last Picture for which a Treatment has previously been approved or selected, then Disney shall be entitled to terminate this Agreement upon thirty (30) days written notice to be served on Pixar not more than sixty (60) days after the end of such one (1) year period, unless within such thirty day notice period either; (A) the parties have mutually approved a Treatment for a Picture or (B) [*] has [*] under the provisions of subparagraph 3(a)(i)(A) or (if still applicable) subparagraph 3(a)(i)(B), provided that Pixar has otherwise satisfied the conditions in paragraph 3(a)(i) above for such selection under subparagraph 3(a)(i)(A) or 3(a)(i)(B) above. In the event of such termination, the provisions of paragraph 23 shall apply. b. Development and Production. After approval or selection of a Treatment, Disney and Pixar shall have mutual creative control of the further development, pre-production and production of each Picture, provided that in the event of a disagreement with respect to any particular creative matter in such Picture final creative control with respect to such creative matter shall be as follows: (i) [*] shall have [*] in any of the Pictures which [*]; - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -2- 7 (ii) [*] shall have [*] in any of the [*] have previously [*] for [*] with [*]; or (iii) if neither subparagraph (i) or (ii) is applicable, the [*] and [*] shall have [*] of such [*]. The [*] shall be [*] so long as [*] is [*] (unless [*] , on [*] or [*] to [*]); otherwise [*] shall appoint the [*], or if [*] is no longer employed by [*] will [*] the [*] . The [*] shall be [*] so long as [*] is [*] (and not [*]); otherwise [*] (or if [*] is no longer employed by [*], the [*] of [*]) shall appoint the [*]. c. Final Cut/Rating. Disney and Pixar shall have mutual control over the final cut of each Picture, provided that each party shall exercise its final cut rights in good faith and so not to frustrate or delay the release of the Picture. Each Picture shall be produced hereunder so as to receive a G rating (or substitute equivalent). If for any reason a G rating (or substitute equivalent) is not received or the Picture does not qualify for such rating, Pixar agrees to make such changes as necessary to obtain or qualify for such rating prior to Delivery. Within a reasonable time after completion of the final cut as provided herein, Pixar shall deliver the Picture to Disney. d. Ancillary Rights. (i) Disney and Pixar shall have mutual creative control with respect to the creation and design of any Ancillary Rights, provided that in the event of a disagreement Disney's decision shall govern. (ii) For purposes of this Agreement, the terms "Ancillary Rights", "Merchandising Rights" and "Interactive Works" shall have the following meanings: (A) "Ancillary Rights" means items created in the exercise of Merchandising Rights, literary publishing, soundtrack and publishing rights in and to any of the Pictures, any Derivative Works or, subject to the provisions of paragraph 16, Toy Story. Ancillary Rights does not include any works within the scope of Derivative Works, as defined in paragraph 15 below, but does include any items created in the exercise of Merchandising Rights, literary publishing, soundtrack and publishing rights in and to any Derivative Works. (B) "Merchandising Rights" means the right to make, use, sell, exercise or otherwise exploit and license or authorize others to make, use, sell, exercise or otherwise exploit tangible personal property, of any and all kinds, based upon, utilizing or - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -3- 8 embodying any Picture or Derivative Work or subject to the provisions of paragraph 16, Toy Story, or any of the characters or story or other unique elements thereof, including without limitation any unique names, likenesses or characteristics of any character portrayed therein other than pre-existing Disney characters, or any unique title, catch word, slogan, situations, designs, equipment or events depicted therein, or any trademark, trade name or copyright related thereto other than pre-existing Disney marks; provided that Merchandising Rights shall not include Interactive Works. (C) "Interactive Work" means any audio-visual work or other work, regardless of the physical medium in which the work is fixed (including without limitation CD ROMs, DVDs, video games and arcade games), now known or hereafter coming into being, which work is designed with a primary purpose of permitting the viewer to modify or control the sequence or performance of the presentation in a non-linear fashion. 4. PRODUCTION. a. Production Control. Subject to the provisions of paragraph 3 above and this paragraph 4, Pixar shall control the production of each Picture. Pixar, or at Pixar's option an entity established and controlled by Pixar, shall serve as the production entity, provided that none of the entities described in Exhibit A may own any interest in the production entity. Pixar may also establish a separate entity (which may or may not be owned by Pixar but over which Pixar shall exercise production control by contract or otherwise) for purposes of undertaking all or certain portions of production services, such as hiring voice, writers and other artistic talent, provided that none of the entities described in Exhibit A may own any interest in such separate entity. Pixar shall designate and approve all production personnel. Pixar shall consult with Disney concerning the selection of the producers and directors for each Picture, provided that in the event of disagreement the decision of Pixar shall govern. [*] shall [*] talent [*] the [*] then [*] by [*] for [*] in [*] (as defined in paragraph 6(c) below). In contracting with third parties in connection with the production of each Picture, Pixar shall, in addition to following the other terms of this Agreement, follow Disney's then customary policies for Premiere Disney Movies with respect to the scope of any grant of rights for use in the Picture ( and the exercise of Ancillary Rights or Derivative Works derived therefrom) obtained from such third parties, provisions limiting such third parties' right to interfere with distribution or other exploitation of the Picture and product placement in the Picture. b. Disney Representative. Disney may designate a Disney representative (the "Disney Production Representative"), who shall be subject to the reasonable approval of Pixar. The Disney Production Representative shall be entitled to maintain an office at Pixar's facilities, to monitor production of the Pictures, to review production and production finance books, records and documentation, including creative materials (e.g. dailies, story boards and scripts), to have access to Pixar production personnel and production meetings solely relating to the Pictures on a regular basis, and to receive periodic briefings from Pixar on production and production finance issues. Pixar will also furnish the Disney Production Representative, - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -4- 9 upon request, weekly cost reports, production reports and backup data with respect to carrying costs incurred by Pixar relating to the retaining of employees for production purposes. The Disney Production Representative shall not have decision-making authority over Pixar, and shall not have access to Pixar Technology (as defined in paragraph 13(c)). The Disney Production Representative shall have entered into a confidentiality agreement with Disney which covers and protects Pixar Confidential Information as provided in this Agreement or shall enter into a confidentiality agreement with Pixar. The salary and expenses of the Disney Production Representative shall not be included in the Picture Budget and shall be the sole responsibility of Disney. Pixar preapproves [*] as the Disney Production Representative. 5. COMPUTATIONAL RESOURCES. Pixar shall have control over the selection, acquisition, placement and use of Computational Resources as provided in this paragraph 5. a. "Computational Resources" means all workstations, servers and other computers, network and networking equipment, storage systems and other computational equipment and third party software used by Pixar to develop and produce the Pictures or any Derivative Works, other than any such equipment and software owned or controlled by Disney (and not financed by Pixar) used by Pixar at Pixar's request to develop or produce the Pictures or Derivative Works. b. Acquisition and Funding of Computational Resources. Pixar shall pay fifty percent (50%) and Disney shall pay fifty percent (50%) of the purchase price of all such Computational Resources as provided in paragraph 7. Pixar (or a production entity established by Pixar) shall convey to Disney an undivided fifty percent (50%) interest in all Computational Resources co-funded by Disney immediately upon acquisition and funding by Disney of such Computational Resources. The purchase price of Computational Resources shall be determined net of any discounts or rebates, but before the application of any credits granted to Pixar unrelated to the Pictures (e.g. equipment credits granted to Pixar in connection with its patent license agreement with Silicon Graphics Inc.). Pixar shall have the right to attempt to secure Computational Resources at less than market costs in exchange for providing to the supplier any of the following promotional or marketing consideration relating to one or more Pictures: (i) private screenings of the Picture(s), (ii) permitting the supplier to mention the Picture(s) in its advertisements and marketing materials, (iii) in the case of a supplier who contributes Computational Resources or provides equipment credits worth U.S.$[*] or more (at list price), [*] for use of such Computational Resources in the Picture(s), and (iv) in the case of a supplier who contributes Computational Resources or provides equipment credits worth U.S.$[*] or more (at list price), providing [*] from the Picture(s) for unaltered use after the initial theatrical release of the Picture in the [*] which mention the Picture, provided that such [*] do not mention a competing motion picture and are in circulation for no more than a [*] from initial use. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -5- 10 c. Use on Other Projects. Pixar shall have the right to use Computational Resources for Pixar productions and activities not covered by the terms of this Agreement, provided that such productions and activities are not prohibited by the terms of this Agreement. Pixar shall reimburse Disney a reasonable amount in proportion to Pixar's use of the Computational Resources on non-Disney productions and activities, except for network and networking equipment, including wires, routers and other dedicated network equipment and networked file servers, for which no such reimbursement shall be due. d. Buy-Out. Pixar shall have the right at any time to purchase Disney's interest in any Computational Resource for a buy-out price equal to fifty percent (50%) of the greater of (A) the depreciated book value of such resource, calculated using a three (3) year straight line depreciation schedule or (B) ten percent (10%) of the original purchase price of such resource. 6. DISTRIBUTION. Disney shall have control over all decisions relating to the marketing, promotion, publicity, advertising and distribution of each Picture, subject to the following: a. Initial Release. Disney shall initially release each Picture theatrically in the United States within twelve (12) months, or if the Picture is a holiday-themed motion picture (e.g. A Christmas Carol), fifteen (15) months, after Delivery of the Picture by Pixar. Disney shall release each Picture in the home video market in the United States within fifteen (15) months after the initial United States theatrical release date of the Picture. The exact release dates shall be determined by Disney, subject to the provisions of this paragraph 6, in consultation with Pixar. b. Release Period. Disney shall initially release each Picture theatrically in the United States either during the period from May 15 to August 15 ("Summer Period") or during the period from November 15 to December 31 ("Holiday Period"). c. [*]. (i) Neither Disney nor any of its Affiliates shall [*] any [*] (other than [*] shown with a [*] any of the following [*]: (A) during the [*] before and [*] after the initial theatrical release of the Picture; (B) during a [*] in which a [*] is [*]; or -6- - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. 11 (C) during the period commencing [*] before a [*] or [*] after [*], and ending at the end of [*] in which a Picture is [*], except that Disney may [*] or [*] another [*] during such period provided that [*] and is not [*] or [*] until at least [*] after the [*] of such Picture in the [*]. For purposes of this Agreement, [*] means a premiere animated feature-length theatrical motion picture (e.g. [*] or [*] and not [*] or [*]) fully financed and distributed by Disney. (ii) Neither Disney nor any of its Affiliates shall [*] or [*] any Disney branded or G-rated live action motion picture distributed by Disney or its Affiliates (e.g. [*] or [*]) during the period commencing [*] before and ending [*] after the [*] of the Picture, or ending [*] after the [*] of the Picture in the case of a Picture [*]. (iii) For purposes of this Agreement, "Affiliate" means any person or entity (i) in which Disney owns or controls directly or indirectly at least a 25% ownership interest, (ii) which owns or controls directly or indirectly at least a 25% ownership interest in Disney, or (iii) in which a person or entity owns or controls directly or indirectly at least a 25% ownership interest that also owns or controls directly or indirectly a 25% ownership in Disney. d. Walt Disney Pictures Brand. Each Picture shall be distributed and marketed under the Walt Disney Pictures brand (or the then current Disney brand for Premiere Disney Movies) and with the credits and branding specified in paragraph 12. e. Distribution and Marketing. Each Picture shall be distributed and marketed by Disney in all markets and media and on a worldwide basis in a manner similar to that in which Disney then currently distributes and markets[*]. f. Consultation with Pixar. Disney shall consult with Pixar relating to all such major marketing and distribution decisions including, without limitation, the initial release plan of each Picture in each primary market (i.e., theatrical, non-theatrical, pay-per-view, pay televisions, network, first cycle free television syndication and home video), any theatrical re-release, the initial advertising campaign, home video pricing and commercial tie-ins and cross-promotion deals, provided that Disney shall have the final decision on such matters. Upon request by Pixar, Disney shall [*] with [*] and [*], provided that at Disney's option such [*] and [*] may be in either [*] or [*]. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -7- 12 g. Pixar Representative. Pixar may designate a representative (the "Pixar Marketing and Distribution Representative"), who shall be subject to the reasonable approval of Disney. The Pixar Marketing and Distribution Representative shall be [*] to monitor marketing and distribution of the Pictures, Ancillary Rights and Derivative Works and the Distribution Costs related thereto, to review marketing and distribution and Distribution Cost [*], to have access to Disney's marketing and distribution personnel and marketing and distribution [*] solely related to the Pictures on a regular basis, and to receive periodic briefings from Disney on marketing and distribution issues. Disney will also furnish the Pixar Marketing and Distribution representative, upon request, [*] relating to anticipated [*] and [*] relating to the Pictures, Ancillary Rights and Derivative Works. The Pixar Marketing and Distribution Representative shall not have decision-making authority over Disney. The Pixar Marketing and Distribution Representative shall have entered into a confidentiality agreement with Pixar which covers and protects Disney Confidential Information as provided in this Agreement or shall sign a confidentiality agreement with Disney. The salary and expenses of the Pixar Marketing and Distribution Representative shall not be included in Distribution Costs and shall be the sole responsibility of Pixar. h. [*] Licensing. Disney shall not have the right to [*] (including without limitation per-pay-view distribution) if such Picture has [*], without the prior written consent of Pixar. If any Picture [*] within [*] after its initial United States theatrical release, Disney shall have the right to [*], provided that any such [*] shall be consistent with Disney's standard [*] practices and terms for all of its own animated motion pictures of similar performance. Any payments received by Disney attributable to [*] motion picture or television program shall be fairly [*] among such [*]. i. Short Subjects. Disney may not exhibit a short subject motion picture with any Picture without the prior written consent of Pixar, unless required to do so by local law or the Picture is less than seventy (70) minutes in length. If Disney determines to exhibit a short subject with such Picture in accordance with this paragraph, Disney shall consult with Pixar with respect to using a Pixar motion picture as such short subject, but Disney's decision shall govern. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -8- 13 j. Subdistributors and Flat Sales . Disney shall have the right to utilize a subdistributor in connection with the initial release or other distribution of a Picture in any medium in any territory only if, at the time such [*] is to be made, Disney [*] utilizes a subdistributor in connection with the [*] of its own motion pictures in such medium and/or territory, including [*]. Disney shall have the right to conclude a "flat sale" of a Picture in any medium and/or territory only if, at the time such license is to be made, Disney [*] in connection with the [*] of [*] in such medium and/or territory, including [*]. k. "Making of" Films. The parties shall have [*] over the development and production of any "making of" or other promotional films relating to any of the Pictures, provided that [*]. The costs of developing and producing such films shall be included within Distribution Costs, and any [*] (to the extent a [*] can be attributed to such [*]) actually [*], or [*], Disney and its Affiliates (including any Affiliates acting as subdistributors) from the exploitation of such films [*], of such Picture. 7. FINANCING OF DEVELOPMENT AND PRODUCTION. Pixar (or a production entity established by Pixar in accordance with this Agreement) shall finance or cause to be financed fifty percent (50%) and Disney shall finance or cause to be financed fifty percent (50%) of all costs and expenses incurred by Pixar directly related to or fairly allocable to the creation, development, pre-production, production, post-production and delivery to Disney of the Pictures ("Production Costs"). Production Costs shall include without limitation (a) the costs of all Treatments prepared by Pixar for submission to Disney under this Agreement, (b) all carrying costs incurred by Pixar for retaining of employees for production purposes under this Agreement and the overhead attendant thereto, (c) all costs of Computational Resources, and (d) fair allocations of all costs and expenses of Pixar associated with or benefiting the Picture, including research and development, general and administrative and overhead expenses and facilities. All such Production Costs shall be financed by Pixar and Disney on a current, as needed basis. Without limiting the generality of the foregoing, Disney's share of the costs of purchasing Computational Resources shall be paid at the time of purchase of such Computational Resources, and Disney's share of carrying costs and other costs shall be paid on an on-going basis as Pixar incurs such arrying osts and other costs. Disney and Pixar shall establish a mutually acceptable funding mechanism to ensure that sums will be available in a timely manner to finance all such expenditures pursuant to a cash flow projections prepared and updated from time to time by Pixar. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -9- 14 8. BUDGETS. a. Treatment Budget. Pixar and Disney shall mutually agree on a budget for the creation of Treatments ("Treatment Budget") for each Picture, which shall be separate from and not include carrying costs or the costs of Computational Resources. If Pixar and Disney are unable to reach agreement on a Treatment Budget for a Picture within forty-five (45) days after submission by Pixar of a proposed budget, the decision of Pixar as to such Treatment Budget shall govern, so long as such Treatment Budget does not exceed [*] dollars (U.S.$[*]) for the second Picture. Such amount shall increase by [*] percent ([*]%) for each subsequent Picture. The Treatment Budget shall be based on the assumption that as many as three (3) Treatments will be created by Pixar in connection with such Picture. If more than three Treatments are created by Pixar, the Treatment Budget shall be increased by an amount equal to [*] of the Treatment Budget for each Treatment above three created by Pixar. If a Treatment with respect to such Picture is approved or selected under paragraph 3(a), any unused portion of the Treatment Budget shall be applied to the Development Budget for such Picture. b. Development Budgets. Pixar and Disney shall mutually agree on a development budget for the costs and expenses of the creation, development, pre-production and production of each Picture (after Bugs) after approval or selection of the Treatment and prior to the approval of the Picture Budget for such Picture ("Development Budget"). The Development Budget shall be separate from and not include carrying costs or the costs of Computational Resources. Pixar and Disney shall seek to reach mutual agreement on the Development Budget for each Picture. If Pixar and Disney are unable to reach agreement on a Development Budget for a Picture within forty-five (45) days after approval or selection of the Treatment for such Picture, the decision of Pixar as to such Development Budget shall govern, so long as such Development Budget does not exceed [*] dollars (U.S.$[*]) for the second Picture. Such amount shall increase by [*] percent ([*]) or each subsequent Picture. c. Picture Budgets. (i) Approval of Picture Budgets. A budget for each Picture (the "Picture Budget") shall be established as provided in this subparagraph (c). Pixar shall be responsible for proposing a Picture Budget and submitting it to Disney. The Development Budget for the Picture shall be included in the Picture Budget for the Picture. Pixar and Disney will seek to reach mutual agreement on the Picture Budget within sixty (60) days after submission by Pixar. If Pixar and Disney are unable to reach agreement on the Picture Budget within that period of time, the decision of Pixar as to the Picture Budget shall govern, so long as such Picture Budget does not exceed [ * ] percent ([*]%) of the largest Picture Budget for any prior Picture (determined on the basis of the originally approved Picture Budget for such Picture plus [*] percent ([*]%) of any approved increases or overages in such Picture Budget), whether released or in production, provided that the facilities - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -10- 15 allocation in such budget shall not exceed [*] percent ([*]%) of the facilities allocation in the Picture Budget for the immediately preceding Picture. The Picture Budget may be revised from time to time during production of the Picture upon written mutual agreement of Disney and Pixar, and when so revised such revised Picture Budget shall be deemed the Picture Budget of such Picture. No charges for Disney services or personnel shall be charged to the Picture except those services or personnel separately contracted for by Pixar (or the production entity established by Pixar). (ii) Contents of Picture Budgets. Each Picture Budget shall include the following items: (A) All direct costs and expenses previously incurred or to be incurred in the creation, development, pre-production, production, post-production and delivery to Disney of the Picture, including the cost of the Treatment used as the basis for the screenplay funded under the Treatment Budget for such Picture and the costs and expenses of creation, development, pre-production and production funded under the Development Budget for such Picture; (B) All carrying costs incurred by Pixar for retaining of employees for production purposes under this Agreement for the applicable Picture and the overhead attendant thereto; (C) Fair allocations of all costs and expenses of Pixar associated with or benefiting the Picture, including research and development, general and administrative and overhead expenses and facilities; (D) All Picture - specific costs, or fair allocations of all costs, as applicable, of Computational Resources used in connection with development or production of the Picture; and (E) A [*] in the amount of [*] percent ([*]%) of the sum of [*] and [*] under subparagraphs ([*]) through ([*])(the "[*]"). (iii) Production Costs To Be Within Budget. Pixar shall have the right to reallocate costs among individual budget categories in the Picture, subject to the following: (1) Pixar shall advise the Disney Production Representative of any reallocation within the Picture Budget and shall obtain Disney's written approval for any reallocation which exceeds [*] percent ([*]%) in any budget category; and (2) use of the Contingency shall be subject to written mutual approval of Pixar and Disney, except that Pixar may, without prior approval of Disney, apply the Contingency to cover increases in salary, benefits and other compensation paid to personnel included within the Picture Budget (but not to increase the number of such personnel) up to a total of [*] percent ([*]%) of the costs of salary, benefits and other compensation for such personnel included within items (A) through (D) of - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -11- 16 such Picture Budget. Any expenditures in excess of the Picture Budget for such Picture shall be subject to mutual written approval. d. [*]. All [*] must be jointly approved in writing by Disney and Pixar. Disney will account for and pay all [*] other than those paid to Pixar employees, which Pixar will account for and pay, subject to recoupment as provided in paragraph 10(a). For purposes of this Agreement, "[*]" means all mutually approved [*] or other [*] to [*] of [*] of the Pictures or Ancillary Rights, excluding [*] as defined in Exhibit B. [*] payable to [*] for [*] of [*] pursuant to the agreement in effect as of the date of this Agreement between Disney and [*], if the parties mutually agree to use [*] on a Picture, and [*] payable to [*] pursuant to the [*] entered or to be entered under paragraph [*] between Pixar with [*] are deemed jointly approved by Disney and Pixar under this paragraph. 9. DEFINITION OF GROSS RECEIPTS. a. "Gross Receipts". Except as otherwise expressly provided in this paragraph 9, "Gross Receipts" shall include one hundred percent (100%) of all revenues, money or other consideration (to the extent a cash value can be attributed to such other consideration) actually received by, or credited to, Disney and its Affiliates (including any Affiliates acting as subdistributors) from the exploitation of (i) the Picture, or any elements or portions thereof, in any and all media and markets throughout the universe (including without limitation, theatrical, non-theatrical, home video and all forms of television), whether now known or hereafter devised, and (ii) all Ancillary Rights relating to such Picture or to any Derivative Works based on such Picture. Without limiting the generality of the foregoing, Gross Receipts shall include, but not be limited to, [*], revenue generated from [*] which [*] (or the [*] if such [*] more than one [*]) and income received for [*] on or in [*] of any of the Pictures. With respect to [*] not yet known or devised, any other [*] not currently being [*] or [*] shall be included within Gross Receipts if, and to the extent, such inclusion is consistent with the provisions of this Agreement. Gross Receipts shall be calculated using the [*] so [*] (to the extent [*]) are [*] if the [*] has not yet occurred for the [*] Disney may establish [*] only for [*] and [*] for [*] and [*] (subject to paragraph 11(e) below), provided that (1) such [*] do not [*] of the Gross Receipts from [*] less any [*] or [*] of the Gross Receipts from [*] less any [*], (2) such [*] are [*] within a reasonable time not to exceed [*] for [*] and [*] for [*], and (3) [*] shall [*] on any [*] portion of [*], at the rate specified in paragraph 24, from the mid-point of the applicable - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -12- 17 month or quarter in which [*] until such [*] is [*]. To the extent that [*] receive an [*] shall [*] on [*] from the date [*] until [*] is either [*] in Gross Receipts, at the rate specified in paragraph 24. b. Exclusions from Gross Receipts. Notwithstanding anything to the contrary in this Agreement, Gross Receipts shall not include: (i) [*] of any [*] for [*] of the Pictures [*], (ii) receipts of [*] (including without limitation [*]) for the [*] of the Pictures or the [*] thereof [*], (iii) receipts of [*], including without limitation [*] in [*] (as defined in paragraph [*])[*], (iv) receipts from [*] (as defined in paragraph [*]), (v) amounts [*] or for [*] or [*], and similar [*], (vi) amounts [*] on or for [*] or any portion thereof, or the [*] or [*] of [*], including any [*], (vii) receipts from the [*] except as specified in this paragraph or in paragraph [*], (viii) receipts from [*] contributed to [*], and (ix) [*] including [*]. c. Ancillary Rights. Subject to the exclusions set forth in paragraph 9(b) and the provisions of this paragraph 9(c), an amount equal to one hundred percent (100%) of all revenues, money or other consideration (to the extent a cash value can be attributed to such other consideration) actually received by, or credited to, Disney and its Affiliates (including any Affiliates acting as subdistributors) with respect to Ancillary Rights [*] shall be [*] Gross Receipts, and not [*]. In the case of Ancillary Rights which are [*] or [*] for - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -13- 18 [*], the amount included in Gross Receipts shall be [*] or the [*] received by [*] for [*] of its [*] of [*] of the [*] of such items. d. Home Video. With respect to the home video exploitation of the Picture, subject to the exclusions set forth in paragraph 9(b) [*] percent ([*]%) of all [*] or [*] (to the extent a [*] can be attributed to such [*]) [*] (including any [*]) [*] shall be included in Gross Receipts, and not [*]. e. Affiliates. Gross Receipts shall be calculated by aggregating the Gross Receipts of all Affiliates, subject to the exclusions set forth in paragraph 9(b). Any license or distribution agreement entered into by Disney (or any Affiliate) with any Affiliates serving as [*] (e.g. [*]) shall be on terms [*] of the following, in each case taking into account applicable windows, runs and the box office performance of the respective works: (i) terms obtained by Disney (or any Affiliate) from such [*] for [*], (ii) terms given by such [*] to [*] for [*], and (iii) terms given by [*] other than [*], (e.g. [*]) for [*]. In the case where the same items or license rights are made available to both Affiliates and non-Affiliates, the [*] or other [*] to Affiliates for purposes of determining Gross Receipts shall be [*] or other [*] charged by Disney or its Affiliates to [*] for the [*] or [*] at [*]. 10. DIVISION OF GROSS RECEIPTS. a. Division. Gross Receipts from each Picture and all Ancillary Rights relating thereto, shall be disbursed in the following order, on a continuing and cumulative basis: (i) To Disney, a distribution fee ("Distribution Fee") equal to [*] of Gross Receipts excluding any Gross Receipts consisting of interest or insurance recoveries. (ii) To Disney and Pixar, on a prorata basis, an amount equal to any [*] paid on behalf of the production entity) for such Picture and related Ancillary Rights as pro-rata recoupment by Disney and Pixar for any [*] paid by each such party. (iii) To Disney, an amount equal to its "Distribution Costs" as defined in paragraph 11 with respect to such Picture and related Ancillary Rights; and - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -14- 19 (iv) All remaining Gross Receipts shall be disbursed fifty percent (50%) to Pixar and fifty percent (50%) to Disney. b. Separate Accounting Units. Each Picture and the Ancillary Rights relating thereto shall be treated as a separate accounting unit and there shall be no cross-collateralization of the Gross Receipts or Distribution Costs, as defined in paragraph 11 below, among the Pictures hereunder or between the Pictures and any Derivative Works. Cross-collateralization of Gross Receipts and Distribution Costs in different markets and media (including home video and Ancillary Rights) within each Picture is permissible. c. Statements. Disney shall render detailed statements to Pixar of Gross Receipts, Distribution Costs and Distribution Fees with respect to each Picture and its Ancillary Rights, together with payment of Pixar's share of such Gross Receipts, monthly (on a calendar month basis), within forty-five (45) days after the end of the calendar month, for the first three (3) years commencing with the first month in which there are Gross Receipts from such Picture, and thereafter quarterly (on a calendar quarter basis), within forty-five (45) days after the end of the quarter. Each statement shall include a statement of the applicable Gross Receipts, and the manner in which they have been disbursed, and an itemization of the Distribution Costs paid during the applicable period. Notwithstanding the foregoing, starting three (3) years after the initial theatrical release of a Picture, Disney shall not be required to render statements with respect to such Picture (and its Ancillary Rights) for any quarter in which Gross Receipts are less than $200,000 or in which no net payment is due to Pixar after division of Gross Receipts as provided in this Agreement, unless Pixar requests Disney in writing to render such statements such request to be made not more than once per year. d. Audit Rights. (i) General. Pixar shall have the right to audit Disney's and its Affiliates' books and records (other than tax returns) relating to the Pictures and Ancillary Rights, such audit to be conducted during normal business hours by a certified public accountant selected by Pixar. Each audit shall be completed within one (1) year from the time such audit commences. Only one such audit may be conducted with respect to any one statement of Disney. Pixar shall not have the right to commence an audit of any statement after the expiration of thirty-six (36) months after the receipt of such statement by Pixar, but shall be entitled to complete any audit of such statements commenced prior to the expiration of such period. Disney shall be entitled to receive a copy of any report of the audit furnished by the auditors to Pixar. [*] of any audit of Disney, unless the audit reveals an underpayment by Disney of amounts payable under this Agreement for any period of more than five percent (5%)(excluding any subjective accounting judgments, such as subjective judgments as to allocation of costs or revenues, with respect to which there is a good faith dispute between the parties), [*]. Disney shall designate [*] one employee in its finance department who shall be available - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -15- 20 [*] to provide information to Pixar or its auditor, but who may also perform other duties when not requested for such assistance by Pixar and its auditor. Pixar shall also [*] its subdistributors and agents, the costs of which shall be included in Distribution Costs (as defined in paragraph 11). (ii) [*]. If so required by its contract with [*] (or [*]) Pixar's audit under subparagraph (i) above, if any, of Disney's contract with [*] (or [*]) will be separate from the general audit rights set forth above and will subject to the following additional conditions: the audit must be conducted by Disney's auditor from Price Waterhouse, and the auditor will confirm in writing the following: "We have examined the calculation of Disney's Distribution Costs reported on the participated statement rendered for the period __________ with respect to the motion picture entitled "_________________". Our examination was performed in accordance with standards established by the American Institute of Certified Public Accountants and, accordingly, included such procedures as we considered necessary in the circumstances. In our opinion, in so far as the "Distribution Costs" referred to above relate to amounts paid to [*] (or [*]) such Distribution Costs were calculated and reported on the participation statement rendered for the period _____________ in conformity with the terms of the Agreement between Disney and Pixar dated ______________________ e. Payments. All payments to Pixar shall be in U.S. dollars, and shall be converted by Disney from any currency other than U.S. dollars into U.S. dollars at the exchange rate at which such currency is converted by Disney for its internal accounting purposes (with respect to Disney's other revenue and expenses). Sums derived outside the United States which are not remittable to Disney in the United States in U.S. dollars by reason of currency or other government restrictions shall be deemed "Blocked Funds" for purposes of this Agreement. With respect to such portion of the Blocked Funds as would have been payable to Pixar hereunder, Disney shall deposit such portion into a Pixar interest bearing bank account in the same bank as Disney uses in the applicable jurisdiction. To the extent Disney or its Affiliates expend or utilize any Blocked Funds, including without limitation as a loan, Disney shall credit Gross Receipts with the amount of Blocked Funds so expended or utilized. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -16- 21 11. DISTRIBUTION COSTS. a. Definition. For purposes of this Agreement, "Distribution Costs" shall include only: (i) all out-of-pocket costs paid (or subject to paragraph 11(e) accrued for payment) to third parties by Disney and its Affiliates (other than Affiliates whose receipts are not included in the computation of Gross Receipts) net of discounts, credits, refunds and rebates, provided that such out-of-pocket costs are directly related or fairly allocable to distribution of a Picture in any and all media and markets and the Ancillary Rights relating thereto and are either: (A) [*] or (B) for [*] undertaken for the sole purpose of [*] or [*] or [*] to [*] of a Picture in [*] not utilized by [*] as of the date of this Agreement, provided that the [*] by this subparagraph (B) shall not [*] of the Distribution Costs of such Picture [*]; (ii) [*] for each Picture as the [*] for the services of [*]. b. Exclusions. No payments by Disney or any Affiliate to Disney or any Affiliate, [*], shall be included within Distribution Costs, except that Distribution Costs otherwise within the definition of Distribution Costs may include payments to an Affiliate for [*] or [*] hereafter acquired by Disney for [*] from a [*]. The payments for such [*] or [*] must be [*] as though based on an [*] and in no event [*] the [*] of the rate [*] for similar services for other [*] or the rate charged by such [*] to [*] for similar services for [*]. Except as included in the payments for the services covered by the preceding sentence, [*] or other [*] or its [*] (including without limitation [*] of [*] and [*] shall be included in Distribution Costs beyond the [*] specified in item [*] above. Distribution Costs shall not include any financing costs [*]. Any Distribution Costs allocable to more than one motion picture shall be [*] to the Picture, with no [*]. Distribution Costs shall not include any - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -17- 22 amounts related to creation, development, pre-production, production, post-production or delivery to Disney of any of the Pictures or any Participations. c. Cross Promotions. Cross promotion within the Theme Parks or other Disney attractions or with another product distributed by Disney (e.g. advertisement on a videocassette of another motion picture) will not be included in Distribution Costs. Special projects (e.g. [*]) and promotional activities related to a Picture (e.g. [*]) shall not be included in Distribution Costs unless they are constructed or undertaken for the sole purpose of marketing and promoting a Picture. Thus, for example, the cost of a [*] in a [*] relating to a Picture would not be included in Distribution Costs because such [*] also serves to promote the [*]. If a special project included in Distribution Costs in accord with this paragraph is later used in a [*] at any time after sixty (60) days following the release of the video release of such Picture or for other purposes other than solely promotion of a Picture, the costs of such special project shall be deducted from Distribution Costs. One hundred percent (100%) of all costs of relocating or reconstructing such special projects shall be excluded from Distribution Costs. d. Disney Responsible. As between Disney and Pixar, Disney shall be responsible for financing one hundred percent (100%) of the costs and expenses of marketing, promotion, publicity, advertising and distribution (including costs of goods) of each Picture and all Ancillary Rights relating thereto, including without limitation all items listed in Exhibit B and all Participations, subject to recoupment of Distribution Costs and Participations as provided in paragraph 10, and Pixar shall not be responsible or liable for any costs, expenses or losses incurred in connection therewith. e. Accrual. Distribution Costs shall be calculated based on [*] and [*] (applying generally accepted accounting principles), provided that commencing [*] after [*] and [*] may be [*] only if such [*] by an [*] or other [*] and are payable within [*] following the end of the period covered by the statement to Pixar [*], are payable within [*] following the end of such period) and are paid within such [*] or [*], respectively. 12. BRAND/CREDIT. It is the parties' intent that the Pixar brand be established as a co-equal brand to the Disney brand in connection with the Pictures, Ancillary Rights and Derivative Works. To this end, the Pixar logo, animated logo and credit as specified by Pixar from time to time shall be used in a manner which is [*] (as defined in subparagraph (f) below) to the Disney logo, animated logo and credit, in connection with all Pictures, Ancillary Rights and Derivative Works, subject where applicable to the requirements set forth below. [*] - Confidential treatment requested. -18- 23 a. On Screen Credits. With respect to theatrical motion pictures and made for home video productions, screen credits to Pixar and Disney shall be in the main titles, in the following order of appearance and on separate cards: (A) opening credit - the Walt Disney Pictures animated logo; (B) the Pixar animated logo, for the same duration accorded Disney's animated logo; (C) a credit in the form "Walt Disney Pictures Presents"; (iv) a credit in the form "A Pixar Animation Studio Film" or "A Pixar Film", as Pixar may timely elect; for each Picture, for the [*] and in an [*] than the [*] utilized for [*] and in an [*] than [*] of the [*] used to display the [*], and (E) the title of the Picture. With respect to television productions, the on screen credits shall be the last two credits of the program, each on a separate card, as follows: (A) the Pixar logo, which may be animated, for the [*] accorded the [*], and (B) the Disney (or Walt Disney Television) logo, which may be animated. Credits in compliance with this subparagraph (a) shall be deemed [*]. b. Paid Advertising (i) With respect to all paid advertising within Disney's control relating to the distribution or exploitation of the Pictures and Derivative Works (other than as specified in subparagraph (ii) below), the credits shall be, in order of appearance: (A) first line- "Walt Disney Pictures"; (B) second line - "Presents"; (C) third line - "A Pixar Film"; and (D) fourth line - the artwork title of the Picture. Pixar's credit shall be [*] in size to the [*] credit. (ii) With respect to so called "teaser" and "trailers" or other similar advertising (including promotional films) within Disney's control, on the screen or by radio or television, the credits accorded to the parties shall be as set forth in subparagraph (a), provided that if Disney elects not to display its animated logo, Pixar shall not be entitled to an animated logo. Notwithstanding the foregoing, if only a verbal credit is utilized, the credit shall contain references to both parties in similar fashion (e.g. "From Disney and Pixar" or "Walt Disney Pictures Presents a Pixar Film") immediately before the title, with the [*] made with [*] and [*] to the Disney credit. (iii) Each party will insure (to the extent within its control) that any publicity relating to the Pictures, Derivative Works and Ancillary Rights shall reflect the co-equal brand established hereunder. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -19- 24 c. Packaging. (i) With respect to packaging of home video devices, the credit sets forth in subparagraph (b) (i) shall apply. (ii) With respect to packaging of Ancillary Rights (including without limitation, so called hang tags on merchandising items), the credits shall be in order of appearance: (A) first line - the artwork title of the Picture, it being understood that there should be no above title credit unless otherwise mutually agreed and (B) second line - "A Disney/Pixar Production", provided that Pixar's credit shall be [*] in size to the [*] credit. (iii) With respect to the packaging of Interactive Works, the credits shall be in order of appearance: (A) "Disney Interactive and Pixar Animation Studios Presents" or "Disney Interactive and Pixar Presents", as Pixar may timely elect for each Interactive Work and (B) the artwork title of the product provided that Pixar's credit shall be [*] in size to the Disney credit. d. Billing Block. Wherever a billing block is utilized in paid advertising or packaging hereunder, the credits shall be, in order of appearance: (A) a credit in the form "Walt Disney Pictures Presents"; (B) a credit in the form " A Pixar Film", immediately following and on the same line as the Disney presentation credit, in an average size of type [*] of the average size of type used to display the [*] of the Picture and in an average size of type [*] the average size of type utilized for the [*]; and (C) the regular title of the Picture. e. Stationary Logo. Wherever Disney accords a stationary logo credit in paid advertising or packaging hereunder, Pixar shall also be accorded a stationary logo credit (side by side), which logo credit shall be [*] in size to the Disney credit. f. [*]. "[*]" shall mean that Pixar's credit shall [*] appear [*] to the [*] when [*] in context, even if they are [*] in [*]. For example, the parties agree that a logo [*] than the same logo [*] with [*] letters, and that a credit positioned [*] of [*] may [*]. These [*] effects shall be included in any assessment to determine the [*] of each party's credit. If the parties cannot agree as to the [*] of a credit, then [*] and [*] (or their replacements as determined under paragraph 3.b. above) shall decide the issue. If they are unable to decide for any reason, then each party shall select one individual and those two individuals shall select a third individual mutually - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -20- 25 acceptable to both parties, and such three individuals shall decide the issue. No individual which has or had a commercial tie to either party during the preceding five years may be selected. g. Credits. Pixar shall have the right, in consultation with Disney, to designate all credits in the Pictures; provided that the types and placement of credits shall be materially consistent with the then current Disney credit policy. Disney shall comply with any such credits of which Pixar advises Disney in writing. Disney acknowledges that John Lasseter will receive Executive Producer credit on all Pictures on which he renders such services. h. Prospective Cure. In the event of failure by a party to accord credit or branding in accordance with the terms of this paragraph 12, such party shall upon receipt of written notice promptly cure the failure on a prospective basis, it being understood that Disney will correct all prints in a manner which will not materially interfere with the distribution of the Picture. Disney will use good faith efforts to correct any material failure with respect to any existing packaging within Disney's control. The foregoing shall not be deemed a [*] of any other [*] of Pixar in the event of a breach of this paragraph, other than as set forth in paragraph 26(b) below. The credits and branding contained in any Completed Work (as defined in paragraph 26(b) below) delivered to Pixar by Disney shall be deemed approved by Pixar for such work. 13. PROPRIETARY RIGHTS. a. Pictures and Ancillary Rights. The copyright, trademarks and other intellectual property rights in and to the Pictures, all new and unique characters and story elements thereof and the audio-visual images thereof, and the Ancillary Rights relating thereto, excluding Pixar Technology as defined in subparagraph (c) below and further excluding any trademarks and other intellectual property rights not uniquely associated with the Pictures or Ancillary Rights related thereto owned by Pixar (e.g. "Pixar") or Disney (e.g. "Disney"), shall be jointly owned by Disney and Pixar on an undivided 50/50 basis, provided, however, that Disney shall have (i) the sole and exclusive right and obligation to register, administer and enforce such jointly-owned copyrights, trademarks and other intellectual property rights in the joint name of Pixar and Disney, and (ii) exclusive distribution and exploitation rights to the Pictures, Derivative Works and Ancillary Rights relating thereto in perpetuity in any and all media now known or unknown and by any and all means or devices now known or unknown throughout the universe, subject to the provisions of this Agreement. Upon request, Pixar will cooperate with Disney in connection with the registration, administration and enforcement of such rights. The parties will execute, promptly upon request, all further reasonable and necessary documents to effectuate the provisions of this paragraph 13. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -21- 26 b. Corporate Promotional Use. Each party shall have the right to use the characters, trademarks and all unique story elements of the Pictures and of Toy Story and excerpts of the Pictures and Toy Story not more than five (5) minutes in length for purposes of corporate identification and marketing, including without limitation in or on any of the following: corporate advertising and promotional materials, stationery, stock certificates, business cards, annual reports and other shareholder materials, recruiting materials, press kits (multimedia and printed), corporate trade shows, Internet web pages and in corporate facilities. Pixar shall include a copyright notice in the form "O Pixar" on all such materials of Pixar, and Disney shall include a copyright notice in the form "O Disney" on all such materials of Disney. [*] any new characters of a Picture under this paragraph 13(b) [*] the initial theatrical release of the Picture and [*] a [*] throughout its corporate identification and marketing over [*] in such manner as to create the [*] that [*] is its [*]. Each party will grant the other party access to any key advertising artwork and materials for the foregoing purposes. c. Pixar Technology. As between Disney and Pixar, Pixar shall own the copyright and all other intellectual property rights in and to all computer programs, computer models, software, data, tools, algorithms, inventions, film scanning and film recording technology and other technology developed or discovered by Pixar before, during or after the Term of the Agreement, including without limitation all computer programs, computer models, software, data, tools, algorithms, inventions, film scanning and film recording technology and other technology discovered or developed by Pixar in developing or producing any of the Pictures or Derivative Works or used to produce images included in any of the Pictures or Derivative Works (collectively, "Pixar Technology"). Notwithstanding any other provision of this Agreement, no license is granted to Disney under this Agreement to use or to authorize the use of Pixar Technology in any manner. Nothing in this Agreement shall be deemed to grant a license by Disney to Pixar of any technology owned by Disney or to amend or supersede any existing end user license by Pixar to Disney of Pixar's Renderman product or other software product. Nothing in this Agreement shall prevent or restrict Pixar from using Pixar Technology (but not the unique characters or story elements of the Pictures) in non-Disney projects, subject to the provisions of paragraph 17. If Pixar grants a security interest or other lien in Pixar Technology to a third party, it will require the third party to enter into a non-disturbance agreement under which the third party agrees not to foreclose or otherwise enforce its security interest or lien in such a manner as to prevent Pixar from completing and delivering the Pictures or frustrate the distribution or other exploitation of the Pictures under this Agreement. d. Treatments . To the extent Pixar develops any Treatments based on a Pixar original idea, an idea acquired by Pixar or a public domain idea (but not an original idea or material assigned by Disney to Pixar, which idea or material shall be owned by Disney) which were rejected by Disney pursuant to the procedure set forth in paragraph 3 above, [*] shall [*] all [*] in and to such Treatments. Pixar shall have the right to - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -22- 27 continue to develop and use such Treatments subject to the provisions of paragraph 17(a) below, provided that for any Treatment which Pixar uses as the basis for a motion picture, Pixar shall reimburse Disney upon commencement of production animation for the amount paid by Disney for such Treatment, with interest at the Bank of America reference rate plus 125 basis points from the date of Disney's payment. Nothing in this provision shall be deemed to place either party in a worse position with respect to use of public domain ideas and public domain materials than a member of the general public. 14. DEFENSE OF CLAIMS. a. By Disney. Disney shall defend, and pay any judgment or settlement of, any claims or actions asserted by any third party against Disney, its Affiliates, Pixar, any production entity established by Pixar or any of their respective officers, directors, employees, agents or representatives, arising out of or in connection with the Pictures or any Ancillary Rights relating thereto, or the development, production, distribution, exploitation or exhibition thereof, including without limitation any claim or actions alleging that any Picture or any element or part thereof, or the reproduction, distribution, exploitation or exhibition thereof, infringes the copyright, publicity rights or other intellectual property rights of any person or entity, other than those claims or actions which Pixar is required to defend under paragraph 14(b). Disney shall pay all expenses, court costs and outside attorneys' fees incurred in connection with any of the foregoing claims or actions. [*] shall obtain [*] to any [*], which [*] shall not be [*]. Any amounts paid to third parties by Disney in connection with such claims or actions shall be recoupable by Disney as [*] as provided in paragraphs [*]. b. By Pixar. Pixar shall defend, and pay any judgment or settlement of, any claims or actions asserted by any third party against Disney, its Affiliates, Pixar, any production entity established by Pixar or any of their respective officers, directors, employees, agents or representatives, arising out of or in connection with personal injury, property damage or breach of contract in connection with the development or production of the Pictures, excluding any claim or action relating in whole or part to distribution, exploitation or exhibition of any of the Pictures or alleging infringement of copyright, publicity rights or other intellectual property rights. Pixar shall pay all expenses, court costs and outside attorneys' fees incurred in connection with any of the foregoing claims or actions. [*] shall obtain [*] to any [*] or [*], which [*] shall not be [*]. Any amounts paid to third parties by Pixar in connection with such claims or actions shall be considered [*] to be [*] and [*] under the provisions of [*]. 15. DERIVATIVE WORKS. a. Definition of Derivative Works. For purposes of this Agreement, "Derivative Works" means any work based upon any of the Pictures or Toy Story, or any original [*] - Confidential treatment requested. -23- 28 characters therefrom or story or other elements thereof, including without limitation sequels, prequels, remakes, made-for-home video productions, television productions, Interactive Works, shorts, commercials and interstitial works, stage plays, [*], Internet websites, [*], [*] and [*]. b. Decision to Produce. (i) Subject to the provisions of this paragraph 15, Disney and Pixar shall have mutual control of whether or not to develop, produce or otherwise exploit any Derivative Works (or transfer or license any rights to exploit any Derivative Works) during the Term or thereafter. Within a reasonable time after request of Disney or Pixar, Disney and Pixar will seek to reach agreement on the terms of development and production of any Derivative Work. In the event of a disagreement of whether or not to develop, produce or otherwise exploit any Derivative Work, Disney's decision shall govern, [*]. Prior to commencement of the development or production of any Derivative Work (or transfer or license of any rights to exploit any Derivative Work), Disney shall notify Pixar and afford Pixar the opportunity to make its election with respect to such work as provided in this paragraph 15. Pixar shall notify Disney of its applicable election as set forth in the following paragraphs, within thirty (30) days after written notice from Disney specifying the Derivative Work to be developed and produced. Disney will consult with Pixar during this thirty (30) day period in order to discuss the proposed Derivative Work in order to assist Pixar in making its election. If Pixar fails to notify Disney of its election within such thirty (30) period, Disney may serve on Pixar a notice demanding Pixar to make its election, and if Pixar fails to make its election within fifteen (15) days after such demand notice, Pixar shall be deemed to have elected to participate on a passive financial basis under the terms provided in this paragraph 15. (ii) If any Picture [*] or more in domestic box office receipts, [*] with a made-for-home video sequel or prequel of such Picture under the terms set forth in paragraph (d)(i) below, [*] within [*] after the end of the statement period in which such Picture [*], subject to the following: Upon request by Disney, Pixar and Disney will discuss during the sixty (60) days following such [*] whether the sequel or prequel should be a made-for-home video or a theatrical motion picture. Following such discussion, the [*] whether to proceed with such sequel or prequel in the form of a made-for-home video [*] that in the case of one but only one such sequel or prequel, [*] that the sequel or prequel be a [*]. c. Theatrical Motion Pictures. In the case of any Derivative Work which is a theatrical motion picture, including a sequel, prequel or remake, whether during the Term or thereafter, Pixar shall be entitled, at its election, to do any one of the following: - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -24- 29 (i) Co-finance and produce such Derivative Work. If Pixar elects to co-finance and produce such work, such motion picture shall be added to the definition of Pictures produced and financed hereunder and all the provisions of this Agreement shall apply to such motion picture, subject to the following: Such Derivative Work shall not count toward the five Pictures to be produced under this Agreement. Disney shall be entitled to approve the Treatment. The provisions of paragraphs) 3(a)(i) and (ii) shall not apply to such Derivative Work. (ii) Participate on a passive financial basis in such Derivative Work. If Pixar elects to participate on a passive financial basis, Pixar shall be entitled to a participation equal to [*] of the Gross Receipts of such motion picture, permanently escalating on a prospective basis to [*] of Gross Receipts at Cash Breakeven, and permanently escalating on a prospective basis to [*] of Gross Receipts at Second Cash Breakeven. For purposes of this Agreement, "Cash Breakeven" means the first accounting period in which cumulative Gross Receipts equal or exceed the sum of Distribution Costs and Distribution Fees with respect to the applicable work and the direct cost of production of the applicable work, and "Second Cash Breakeven" means the first accounting period in which the cumulative Gross Receipts equal or exceed the sum of Distribution Costs and Distribution Fees computed as if Distribution Fees were [*] with respect to the applicable work and the direct cost of production of the applicable work. If Pixar elects to participate on a passive financial basis with a theatrical motion picture under this provision, it shall not be entitled thereafter to elect to co-finance and produce a subsequent theatrical motion picture or made-for-home video production based upon the same Picture. d. Made-for-Home Video Productions. In the case of any Derivative Work which is a made-for-home video production, including a sequel, prequel or remake, whether during the Term or thereafter, Pixar shall be entitled, at its election, to do any one of the following: (i) Co-finance and produce such Derivative Work. If Pixar elects to co-finance and produce such work, the terms and conditions of this Agreement shall apply or be extended to cover such work, and the provisions of this Agreement shall apply to such work in the same manner as they apply to Pictures, subject to following: Disney shall be entitled to approve the Treatment. Creative control shall be governed by the terms of this Agreement as if such work were a Picture. Pixar and Disney shall mutually agree on a Picture Budget for such Derivative Work. If Pixar and Disney are unable to reach agreement on the Picture Budget for such Derivative Work within sixty (60) days after submission by Pixar of a proposed budget and the domestic box office receipts of the Picture on which such Derivative Work is based are $[*] million or more, the decision of Pixar as to such budget shall govern, so long as such Picture Budget does not exceed $[*] million (including the Treatment Budget for such Derivative Work but excluding voice talent). Disney shall release such video within six (6) months after delivery of the work to Disney by Pixar; the work shall be distributed and marketed by Disney, under the Disney brand if the work is G-rated and the Picture on which - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -25- 30 it is based was distributed and marketed by Disney under the Disney brand, and with the credits and branding specified in paragraph 12, throughout the universe in a [*] that in which [*] and [*] (e.g. [*]) financed and distributed by Disney. The [*] under [*] as the [*] for Disney's [*] department in connection with such Derivative Work shall be [*] dollars ($[*]). Disney agrees that it and its Affiliates will not [*] any other made-for-home video within the [*] or the [*] the [*] of such work. The following provisions of this Agreement shall not apply to such Derivative Work: 3(a)(i), 3(a)(ii), 6(a), 6(b), 6(c), 6(d), and 6(e). Pixar and Disney hereby designate the made-for-home video sequel to Toy Story as a video production Derivative Work which Pixar has elected to co-finance and produce under this subparagraph. (ii) Participate on a passive financial basis in such Derivative Work. If Pixar elects to participate on a passive financial basis, Pixar shall be entitled to a royalty equal to [*] of the Gross Receipts of such made-for-home video production, permanently escalating on a prospective basis to [*] of Gross Receipts at Cash Breakeven. If Pixar elects to participate on a passive financial basis with a made-for-home video production under this provision, it shall not be entitled thereafter to elect to co-finance and produce a subsequent theatrical motion picture or made-for-home video production based upon the same Picture. e. Television Productions. In the case of any Derivative Work which is a television production (including without limitation any series, specials, "movie of the week" or mini-series), whether during the Term or thereafter, Pixar shall be entitled, at its election, to do any one of the following: (i) Co-finance and produce such Derivative Work. If Pixar elects to co-finance and produce such work, the parties shall mutually agree upon the terms and conditions under which such work shall be financed, produced and distributed, subject to the following: The Treatment for such television production (or the pilot thereof in the case of a series) shall be subject to mutual approval; the parties will have mutual creative control of the work; the financial terms (including the financing of production and division of Gross Receipts) shall be the same as under this Agreement, and the branding and credits for such work shall be consistent with the terms of paragraph 12. (ii) Participate on a passive financial basis in such Derivative Work. If Pixar elects to participate on a passive financial basis, Pixar shall be entitled to a royalty equal to (A) $[*] per episode plus [*] of [*] of the net profits (the definition of which will be negotiated in good faith by the parties in accordance with Disney's customary parameters for deals of this kind) in the case of a television production which is broadcast only during non-prime time, and (B) an amount to be mutually agreed in advance in the case of any other television production. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -26- 31 f. Interactive Works. In the case of Derivative Work which is an Interactive Work, including without limitation any interactive CD ROM-based and DVD-based products, whether during the Term or thereafter, Pixar shall be entitled, at its election, to do any one of the following: (i) Co-finance and produce such Interactive Work. If Pixar elects to co-finance and produce such work, the parties shall mutually agree upon the terms and conditions under which such work shall be financed, produced and distributed, subject to the following. Disney shall be entitled to approve the Treatment, and subject to Disney's approval of the Treatment, Pixar [*] with respect to such Derivative Work. The parties shall mutually agree upon a budget for such work. The financial terms (including the financing of production and division of Gross Receipts) shall be the same as under this Agreement, except that the parties shall mutually agree upon a budget for Distribution Costs and there shall be no distribution fee. Disney shall release such work within six (6) months after delivery of the work to Disney by Pixar; the work shall be distributed and marketed by Disney, under the Disney Interactive brand, and with the branding and credits specified in paragraph 12, in all markets and media throughout the universe in a [*] Interactive Works financed and distributed by Disney based upon [*]. (ii) Participate on a passive financial basis in such Interactive Work. If Pixar elects to participate on a passive financial basis, Pixar shall be entitled to a royalty equal to [*] of the Gross Receipts of such Interactive Work. g. Live Entertainment. In the case of any Derivative Work which is a live entertainment, including without limitation stage plays and [*], whether during the Term or thereafter, Pixar shall be entitled to participate on a passive financial basis in such Derivative Work as follows: In the case of a stage play, Pixar shall receive [*] of the gross weekly box office receipts. In the case of an [*], Pixar shall receive a fee of [*] dollars ($[*]) per year on a title by title basis (pro rated if other non-Pixar characters are also used in the production). In the case of other live entertainment, Pixar shall receive a participation in an amount to be mutually agreed in advance. Notwithstanding the foregoing, if an [*] or other live entertainment (other than a stage play ) is fully financed and produced under license from Disney by a third party which is not Disney or an Affiliate of Disney, the proceeds from such license shall be split [*], after deducting a distribution fee for Disney of [*]. h. Location Based Entertainment. In the case of all Derivative Works which are venues, retail operations or location-based entertainment which use unique characters or other elements of any of the Pictures or Toy Story as their primary theme ("Picture-Themed Location-Based Entertainment"), Pixar shall be entitled either to [*] or to [*], upon terms and conditions to be mutually agreed in advance by the parties. If a venue, retail operation or location-based - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -27- 32 entertainment uses some unique characters or other elements of any of the Pictures or Toy Story in combination with other characters or elements such that the unique characters or other elements of the Pictures or Toy Story are not the primary theme, such venue, retail operation or location-based entertainment shall be treated pursuant to subparagraph (j) below. By way only of example, a [*] would be a Picture-Themed Location-Based Entertainment, but a [*] which included a [*] area along with substantial other areas themed from other characters or elements not based on any of the Pictures or Toy Story would not be a Picture-Themed Location-Based Entertainment. i. All Other Works other than Theme Parks. Except as otherwise provided in subparagraph (h) below, in the case of all Derivative Works not covered by subparagraphs 15(c) through (h), including shorts, commercials, Internet websites, interstitial works and radio productions, whether during the Term or thereafter, Pixar shall be entitled to [*] in such work and receive a [*] to be [*] agreed if the work is a revenue-producing work, provided that if Pixar requests to produce such work, or elements thereof, the parties will negotiate in good faith within sixty (60) days appropriate terms under which Pixar may do so. j. Theme Parks. Disney shall have the sole and exclusive right in perpetuity to use each Picture, the characters therefrom and unique story elements thereof (excluding Pixar Technology) and/or footage from each Picture [*] in any of the following: (i) venues, retail operations and location-based entertainment which are not Picture-Themed Location-Based Entertainment,(ii) Disney's major theme parks currently in Anaheim, California; Orlando, Florida; Paris, France; and Tokyo, Japan, or future Disney theme parks of similar magnitude (collectively "Theme Parks"), and (iii) cruise ships throughout the universe (collectively "Theme Park Rights") with no financial obligation to Pixar. Such use may include use of the characters from the Pictures and unique story elements thereof (excluding Pixar Technology) as so called "walking characters", or in parades, stage shows or similar activities therein, as elements thereof (e.g., standees, props, etc.) , and as rides and attractions. Disney shall consult with Pixar as to the exploitation of the said Theme Park Rights, but Disney's decision shall govern. k. Creative Control of Derivative Works Not Produced by Pixar. In the case of all Derivative Works not produced by Pixar, Disney shall have creative control over the development and production of the work, provided that Disney and Pixar shall [*] of any 3D computer animation embodied or used in production of such work but in the event of disagreement the [*]. 16. TOY STORY. a. Derivative Works. The parties acknowledge that any Derivative Works based on Toy Story including, without limitation, a theatrical motion picture sequel, a made-for-home video sequel, a television production, or a third or subsequent CD-ROM product, but excluding the first and second Interactive Works developed under the CD-ROM - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -28- 33 Development and Publishing Agreement dated as of August 24, 1995 between Disney Interactive and Pixar (the "CD ROM Agreement"), shall be governed by this Agreement and treated in accordance with paragraph 15 above. b. Toy Story Agreement. Upon execution of this Agreement, the parties agree that the agreement between Disney and Pixar dated as of May 3, 1991, as amended, ("1991 Agreement") shall apply only to the rights and obligations of the parties relating to the financial participation in and the production and distribution of the theatrical motion picture Toy Story and to financial participation in Ancillary Rights related to Toy Story as provided in paragraph (c) below, and shall have no further force nor effect and that this Agreement shall supersede the terms thereof with respect to Pixar's arrangement with Disney relating to future services and productions. The CD ROM Agreement shall remain in full force and effect with respect to the first and second Interactive Works developed under that agreement. c. Ancillary Rights. For purposes of this Agreement, Gross Receipts for any Toy Story sequel or prequel shall include Gross Receipts from Ancillary Rights based upon Toy Story, and unique characters or story or other elements thereof, only to the extent that such Gross Receipts exceed, in any [*] of the total amount of Gross Receipts from Toy Story Ancillary Rights in the [*] period commencing [*] before and ending [*] before the initial release of the sequel or prequel of Toy Story. The remaining Gross Receipts from Toy Story Ancillary Rights shall continue to be accounted for under the 1991 Agreement. Distribution Costs relating to Toy Story Ancillary Rights shall be apportioned between this Agreement and the 1991 Agreement in the same proportion as Gross Receipts from such Ancillary Rights are apportioned between this Agreement and the 1991 Agreement. 17. EXCLUSIVITY. a. No Other Feature Length Animated Theatrical Motion Pictures. Pixar agrees that it will not release or authorize the release of any feature length animated theatrical motion picture produced by Pixar other than the Pictures and Derivative Works, produced by Pixar hereunder until a date which is twelve (12) months from delivery of the fifth Picture hereunder. Pixar further agrees that it will not enter into an agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture until after Pixar has delivered the third Picture to Disney hereunder. b. Theme Parks. Pixar agrees that it will not develop or produce any rides or attractions for use in major theme parks not owned or operated by Disney (e.g. Universal Studios or Six Flags). Nothing in this paragraph (b) shall prohibit [*] from [*] for [*] not used in any such [*] not [*], subject to the terms and conditions of this Agreement. c. First Look at TV Productions and Home Video Productions. Pixar will give Disney advance notice of any animated television production or animated made-for-home - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -29- 34 video production owned and controlled by Pixar that Pixar proposes to produce during the term of this Agreement before commencing production thereof. Disney shall notify Pixar within thirty (30) days after Pixar's notice whether Disney wishes to obtain distribution rights to such television production or home video production. If Disney notifies Pixar that it does wish to obtain such rights, Disney and Pixar shall negotiate in good faith to reach mutually agreeable terms under which Disney may do so. If for any reason the parties have failed to reach mutual agreement on such terms within sixty (60) days after such original notice, Pixar shall have no further obligation to Disney with respect to the work which was the subject of such notice. d. No Material Interference. Pixar agrees that non-Disney activities undertaken by Pixar will be managed so as not to materially interfere with Pixar's obligations to Disney under this Agreement. e. Employment Agreement with John Lasseter. Pixar shall enter into a new exclusive agreement for a period of seven (7) years from the commencement date of the Term for the services of John Lasseter; provided that Pixar shall have no liability for Lasseter's failure to render services under such agreement due to his default, disability or death. Pixar shall not terminate Lasseter's employment without cause without Disney's approval. Without limiting any other rights or remedies, if any, of Disney, Disney shall be free, notwithstanding the provisions of paragraph 20, to seek to employ Lasseter after termination of his employment by Pixar, whether such termination is with or without cause; provided that Disney shall not solicit or offer employment to Lasseter prior to such termination. Pixar agrees that Lasseter will direct one of the remaining four Pictures under this Agreement after Bugs. Disney acknowledges and agrees that Lasseter will be rendering services at Pixar for non-Disney projects, provided that Pixar agrees that Lasseter's first priority during his employment at Pixar will be rendering services for Disney-related projects. Lasseter's salary and signing bonus (other than any Pixar stock) shall be allocated to the Production Costs of the Pictures and Derivative Works in development or production at the time paid, and Disney shall fund Disney's fifty-percent (50%) share of such salary and signing bonus as part of such Production Costs. 18. EXCHANGE OF INFORMATION. In order for the parties to exercise effectively their rights hereunder, and to the extent the same would not violate Disney's or Pixar's confidentiality obligations to third parties, the parties shall provide, upon request, [*] relating to [*] relating to the Pictures, provided that nothing in such disclosed information shall constitute or be deemed to be a representation, warranty or covenant by either party with respect to such matters. Such information may be furnished orally. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -30- 35 19. PUBLICITY AND CONFIDENTIALITY. a. Publicity. Within seven (7) days after execution of this Agreement, Disney and Pixar will make a joint press announcement concerning this Agreement, which will be mutually agreed upon by the parties. b. Confidentiality of Terms of Agreement. Disney and Pixar shall be free to disclose the terms of this Agreement to third parties, except that each party shall limit disclosure of the provisions of [*] to substantially the information to be mutually agreed by the parties. c. Protection of Confidential Information. (i) For purposes of this Agreement, "Confidential Information" shall mean all information which is received by one party (the "Recipient") from the other (the "Discloser") under or in the course of performance of this Agreement. (ii) The Recipient shall maintain Confidential Information in confidence, shall not disclose Confidential Information, or any portion thereof, to any third party except as permitted by this Agreement or as reasonably necessary to carry out the provisions of this Agreement, and shall protect Confidential Information with at least the same degree of care as the Recipient uses in maintaining as secret its own confidential and proprietary information, but in no case less than a reasonable degree of care. (iii) This Agreement imposes no obligation on the Recipient with respect to any portion of Confidential Information which (A) was generally available to the public prior to Discloser's first disclosure thereto to Recipient or subsequently becomes generally available to the public through no fault of the Recipient; (B) was in Recipient's possession prior to receipt from Discloser and not acquired directly or indirectly from Discloser; (C) is lawfully received by the Recipient from a third party not directly or indirectly associated with Discloser and having no obligation of confidentiality with respect thereto; or (D) is independently developed by the receiving party without the benefit of the other party's Confidential Information; provided that each party shall use reasonable efforts to instruct its employees not to confirm or otherwise respond to Confidential Information or an inquiry about same presented by a third party. (iv) Nothing in this Agreement shall prohibit the Recipient from disclosing Confidential Information (a) as required to prepare and report financial statements in accordance with generally accepted accounting principles or (b) if legally required to do so, by statute, regulation, judicial or Governmental order or by deposition, interrogatory, request for documents, subpoena, civil investigative demand or similar process in a judicial or Governmental proceeding. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -31- 36 20. NON-SOLICITATION. During the Term and continuing for a period of two (2) years thereafter, Pixar and Disney shall not engage the services of any person who was employed by Pixar or Disney, as the case may be, during the prior six (6) months before such engagement, without prior approval of the applicable party. 21. ASSIGNMENT. Neither party may assign its rights or obligations under this Agreement without the consent of the other party except as follows: a. Either party may freely assign its rights to payments from the other party hereunder, but such assignment will be made pursuant to Disney's customary notice of irrevocable authority and acknowledgement of such notice. b. Either party may assign or delegate any of its rights or obligations under this Agreement to any entity with or into which such party may merge or consolidate, or which may succeed to all or substantially all of such party's assets related to the subject matter of this Agreement, subject to the provisions of paragraph 23. c. Disney may enter into subdistribution agreements for sale or distribution of the Pictures or Ancillary Rights related thereto; provided that such agreements are subject to and consistent with the terms and conditions of this Agreement. 22. CHANGE OF CONTROL OF PIXAR. In the event that any entity described in Exhibit B directly or indirectly acquires or controls fifty percent (50%) or greater ownership interest in Pixar or Pixar merges or consolidates into such an entity, or such an entity succeeds to all or substantially all of Pixar's assets related to the subject matter of this Agreement, Disney shall be entitled to terminate this Agreement upon thirty (30) days written notice to Pixar given not later than ten (10) days after notice from Pixar of such event. In the event of such termination, the provisions of paragraph 23 shall apply. 23. TERMINATION. a. Effect of Termination. Upon termination of this Agreement by Disney under paragraphs 3(a)(ii) or 22, the terms and conditions of this Agreement shall continue to apply to Pictures, Ancillary Rights and Derivative Works which have been delivered by Pixar to Disney as of the date of such termination, or are at Disney's option delivered by Pixar to Disney under the terms of this subparagraph 23(b) after such termination, and to all future Ancillary Rights and future Derivative Works relating thereto. Upon such termination, this Agreement shall terminate as to any Pictures which have not been delivered to Disney as of -32- 37 the date of such termination and which Disney does not elect to have completed under the terms of this subparagraph 23(b), whether or not in development or production ("Uncompleted Pictures") and to all future Ancillary Rights and future Derivative Works relating thereto. Upon such termination, Pixar shall own all copyright, trademark and other intellectual property rights in and to Uncompleted Pictures, including the Treatments on which such Uncompleted Pictures are or would be based, and all unique character and story elements thereof and the audio visual images thereof, and the Ancillary Rights and Derivative Works relating thereto. Nothing in this provision shall be deemed to place either party in a worse position with respect to use of public domain ideas and public domain materials than a member of the general public. If at any time after such termination Pixar elects to complete and release or have an Uncompleted Picture released or to use the Treatment thereof as the basis for any motion picture, Pixar shall so notify Disney and reimburse Disney, no later than ninety (90) days after Pixar's notice of election, for the amount paid by Disney for such Uncompleted Picture, with interest at the Bank of America reference rate plus 125 basis points from the date of Disney's payment of such amounts . Upon such termination, the provisions of paragraphs 1, 2 and 17 shall terminate and be of no further force or effect. b. Completion of Works in Production. If any Picture is within [*] of its target delivery date as of the date of such termination, Disney shall be entitled at its option to have Pixar proceed to complete production and delivery of such Picture under the terms of this Agreement, and in such event this Agreement shall continue to apply to such Picture, and to all Ancillary Rights and Derivative Works relating thereto. If Pixar has as of the date of such termination elected to co-finance and produce a Derivative Work and a budget for such Derivative Work has been approved under this Agreement as of the date of such termination, Pixar shall complete and deliver such Derivative Work to Disney and Disney shall finance and distribute such work in accordance with the terms of this Agreement. 24. INTEREST ON LATE PAYMENTS. Any late payments (including as a result of any inaccurate accounting) owed by either party to the other party hereunder shall bear interest from the date such payment was due until paid. The applicable interest rate shall be Bank of America's reference rate plus 125 basis points in effect on the first day of each calendar month, which rate shall apply for the calendar month. 25. GOVERNING LAW This Agreement shall be governed by the laws of State of California without regard to its conflict of law principles. 26. GENERAL PROVISIONS a. Right to Cure. No act or omission of any party shall constitute an event of default or breach by such party of the Agreement unless the non-breaching party shall first - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -33- 38 notify such party in writing setting forth such alleged breach or default and such party shall not cure the same within thirty (30) days after receipt of such notice. b. Remedies. (i) Notwithstanding any provision of this Agreement to the contrary, after production of a Picture or a Derivative Work is completed, if Pixar claims that Disney has breached this Agreement with regard to any such completed Picture or completed Derivative Work or completed Ancillary Right relating thereto ("Completed Work"), Pixar shall not be entitled to seek and/or obtain equitable or injunctive relief to enjoin or restrain the distribution, exhibition, advertising or any other means of exploitation by Disney of such Completed Work. To be considered "completed", a Picture, Derivative Work or Ancillary Right must in the case of any works produced by Pixar have been completed and delivered by Pixar to Disney under this Agreement. Nothing in this paragraph shall [*] from [*] to comply with the terms and conditions of this Agreement in connection with the distribution, exhibition, advertising and other means of exploitation of such Completed Work ; provided that [*] shall [*] distribution, exhibition, advertising or any other means of exploitation by Disney of any such Completed Work. Nothing in this paragraph shall apply to, or be construed to limit in any way [*] with respect to distribution, exhibition, advertising or any other form of exploitation of any work other than a Completed Work. (ii) Subject to subparagraph (b)(i). above, if either party claims the other party has breached this Agreement, then before the party claiming such breach seeks [*] against the other party, the claiming party must notify the other party. For a period of [*] after such notice is given (the "Resolution Period"), both parties shall attempt to cure (if curable) or otherwise resolve the claim. During such Resolution Period either party may [*] the claim. If after expiration of the Resolution Period the parties are not able to resolve such claim, the claiming party may [*] against the other party, subject to any and all claims and/or defenses of the other party and to subparagraph (b)(i). (iii) Nothing under this paragraph shall prevent or limit either party from [*] of the copyright or other rights in a Picture or Derivative Work to the extent any such [*] would be a breach of this Agreement. c. Force Majeure. No party shall be liable to the other party because of any failure to perform hereunder caused by any cause beyond said party's control, including without limitation fire, earthquake, flood, epidemic, accident, explosion, casualty, strike, lockout, labor controversy, riot, civil disturbance, act of public enemy, embargo, war, act of God or law, except as expressly provided herein to the contrary. - ------- [*] Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to the omitted portions. -34- 39 d. No Waivers. No waiver by either party hereto of any breach of this Agreement shall be deemed to be a waiver of any preceding or succeeding breach of the same or any other provision hereof. The exercise of any right granted to either party hereunder shall not operate as a waiver. e. No Violation of Law. Nothing contained in this Agreement shall be construed so as to require the commission or any act contrary to law, and wherever there is any conflict between any provisions of this Agreement and any material statute, law or ordinance contrary to which the parties have no legal right to contract, the latter shall prevail, but in such event the provision of this Agreement affected shall be curtailed and limited only to the extent necessary to bring it within the legal requirements. f. Notice. Any notices required or permitted by this Agreement shall be in wirting and shall be delivered either by personal delivery or by overnight commercial delivery service, such as Federal Express or DHL, addressed as follows: If to Disney: Walt Disney Pictures and Television 500 South Buena Vista Burbank, CA 91521 Attention: Senior Vice President - Legal and Business Affairs With copies to: Senior Vice President-Legal and Business Affairs Walt Disney Feature Animation 500 South Buena Vista Burbank, CA 91521 Senior Vice President - Finance Walt Disney Feature Animation 500 South Buena Vista Burbank, CA 91521 If to Pixar: Pixar Animation Studio 1001 W. Cutting Blvd. Richmond, CA 94804 Attention: Chief Financial Officer With copies to: Ziffren, Brittenham, Branca & Fischer 2121 Avenue of the Stars, 32nd Floor Los Angeles, CA 90067 Attn: Sam Fischer, Esq. -35- 40 McCutchen, Doyle, Brown & Enersen Three Embarcadero Center San Francisco, CA 94111 Attn: Gary H. Moore, Esq. Either party shall be entitled to change its address for purposes of this section by notice to the other. Notices shall be effectiive upon receipt. g. Headings. The headings in this Agreement are solely for convenience of reference and shall not effect its interpretation. 27. ENTIRE AGREEMENT. This Agreement, including its exhibits, constitutes the entire agreement between the parties with respect to the subject matter hereof, and supersedes and replaces any prior correspondence, negotiations, agreements, understandings and representations with respect thereto, except for the 1991 Agreement and the CD ROM Agreement to the extent provided in paragraph 16(b). This Agreement may not be modified or amended unless in a writing signed by both parties. 28. EXECUTION IN COUNTERPARTS. This Agreement may be executed in counterparts and transmitted by facsimile copy, each of which shall constitute an original and which taken together shall constitute the Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. PIXAR WALT DISNEY PICTURES AND TELEVISION By: /s/ LAWRENCE B. LEVY By: /s/ ROBERT MOORE ---------------------------- --------------------------- Name: Lawrence B. Levy Name: Robert Moore Title: Executive VP & CFO Title: Executive VP & CFO -36- EX-11.1 7 COMPUTATION OF NET INCOME (LOSS) PER SHARE 1 EXHIBIT 11.1 PIXAR COMPUTATION OF NET INCOME (LOSS) PER SHARE (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, 1994 1995 1996 -------- ------- ------- Weighted-average number of shares outstanding: Preferred stock 20,000 -- -- Common stock 10,000 31,202 38,632 Number of common and common equivalent shares issued in accordance with Staff Accounting Bulletin No. 83 9,669 7,024 -- Common stock equivalents -- 2,124 8,357 -------- ------- ------- Total shares used in computing net income (loss) per share 39,669 40,350 46,989 ======== ======= ======= Net income (loss) $ (2,372) $ 1,627 $25,319 ======== ======= ======= Net income (loss) per share $ (0.06) $ 0.04 $ 0.54 ======== ======= ======= Pro forma net income (loss) data (unaudited): Income (loss) before taxes as reported $ (2,371) $ 1,747 Pro forma income taxes* 1 90 -------- ------- Pro forma net income (loss) $ (2,372) $ 1,657 ======== ======= Pro forma net income (loss) per share** $ (0.06) $ 0.04 ======== =======
- ---------- * Computed assuming Pixar had been a C corporation since the beginning of those respective periods, and fully subject to federal and state income taxes. ** Pro forma net income (loss) per share is not materially different from actual net income (loss) per share. EX-13.1 8 PORTIONS OF ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13.1 SELECTED FINANCIAL DATA The following selected financial data is derived from the Company's financial statements. This data should be read in conjunction with the Financial Statements and Notes thereto, and with Management's Discussion and Analysis of Financial Condition and Results of Operations.
Year Ended December 31, ---------------------------------------------------------------------- 1992 1993 1994 1995 1996 ------- ------- ------- ------- ------- (In thousands, except per share data) STATEMENT OF OPERATIONS DATA: Revenues: Software $ 2,179 $ 4,702 $ 3,323 $ 3,144 $ 6,306 Animation services 2,038 2,127 2,267 2,469 3,947 Film -- -- -- -- 18,847 Patent licensing -- -- -- 6,500 9,127 ------- ------- ------- ------- ------- Total revenues 4,217 6,829 5,590 12,113 38,227 ------- ------- ------- ------- ------- Cost of revenues: Software 716 1,327 1,164 513 113 Animation services 1,939 1,692 1,964 1,873 3,039 Film -- -- -- -- 1,551 ------- ------- ------- ------- ------- Total cost of revenues 2,655 3,019 3,128 2,386 4,703 ------- ------- ------- ------- ------- Gross margin 1,562 3,810 2,462 9,727 33,524 ------- ------- ------- ------- ------- Operating expenses: Research and development 2,307 1,757 2,288 4,065 6,985 Sales and marketing 1,851 2,368 2,180 1,588 1,768 General and administrative 799 715 831 3,043 5,577 ------- ------- ------- ------- ------- Total operating expenses 4,957 4,840 5,299 8,696 14,330 ------- ------- ------- ------- ------- Income (loss) from operations (3,395) (1,030) (2,837) 1,031 19,194 Other income (expense) 19 (142) 466 716 8,031 ------- ------- ------- ------- ------- Income (loss) before income taxes (3,376) (1,172) (2,371) 1,747 27,225 Income taxes 2 1 1 120 1,906 ------- ------- ------- ------- ------- Net income (loss) $(3,378) $(1,173) $(2,372) $ 1,627 $25,319 ======= ======= ======= ======= ======= Net income (loss) per share $ (0.06) $ 0.04 $ 0.54 ======= ======= ======= Shares used in computing net income (loss) per share 39,669 40,350 46,989 ======= ======= =======
DECEMBER 31, ------------------------------------------------------------------------ 1992 1993 1994 1995 1996 --------- --------- --------- ----------- ----------- (IN THOUSANDS) BALANCE SHEET DATA: Working capital (deficit) $ (924) $ (638) $(1,199) $138,688 $162,983 Total assets 2,002 1,987 1,896 153,015 177,463 Long-term obligations 1,346 1,460 1,573 -- -- Total shareholders' equity (deficit) (1,333) (1,216) (1,675) 142,907 170,804
2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The foregoing discussion and other sections of this Annual Report to Shareholders contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward looking statements are based on current expectations, estimates and projections about Pixar's industry, management's beliefs, and assumptions made by management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," variations of such words and similar expressions are intended to identify such forward- looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under "Overview," "Anticipated Decline in Operating Results in 1997 and Net Losses in 1998" and "Potential Fluctuations in Operating Results" as well as those noted in the section entitled "Certain Factors Affecting Business, Operating Results and Financial Condition" in Pixar's Annual Report on Form 10-K for the year ended December 31, 1996 (the "Form 10-K"). Particular attention should be paid to the cautionary language in the section in the Form 10-K entitled "Certain Factors Affecting Business, Operating Results and Financial Condition -- Anticipated Decline in Operating Results in 1997 and Net Losses in 1998," "-- Dependence on Toy Story, Bugs and Toy Story Video Sequel," "--Liquidity Risks," "--Scheduled Concurrent Release of Films; Management of Growth" and "-- Risks Associated With Co-Production Agreement." Unless required by law, Pixar undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. OVERVIEW Pixar was formed in 1986 when Steve Jobs purchased the computer division of LucasFilm and incorporated it as a separate company. Until 1996, Pixar generated its recurring revenue primarily from the license of RenderMan software, software development contracts and fees for animated television commercials. Financial information relating to business segments is set forth in Note 10 of Notes to Financial Statements. In 1991, Pixar entered into the Feature Film Agreement with Walt Disney Pictures, a wholly owned subsidiary of The Walt Disney Company (together with its subsidiaries and affiliates collectively referred to herein as "Disney"), for the development and production of up to three animated feature films to be marketed and distributed by Disney. As a result, in 1992, Pixar began to place more emphasis on products sold for their content, especially feature films, and the continued development of its proprietary software. At the same time, Pixar reduced emphasis on the commercialization of software and contract development work. Pixar has implemented this shift in focus over the last four years. In accordance with this shift in focus, Pixar adopted a new business model pursuant to which it will develop and produce new animated feature films and related products, such as theatrical sequels, made-for-home video sequels, merchandise and soundtracks. Adoption of this new business model did not materially impact Pixar's results of operations and financial condition until 1996, when Pixar first recognized film revenue and cost of film revenue attributable to Pixar's first animated feature film, Toy Story, which was released in November 1995, and first recognized CD-ROM revenue and associated costs from the release in 1996 of two CD-ROM products related to Toy Story. Pixar's share of revenues and expenses from Toy Story were governed by the terms of the Feature Film Agreement, and Pixar's share of expenses and revenue from the two Toy Story CD-ROM products were governed by a separate CD-ROM production and distribution agreement that Pixar and Disney entered into in August 1995 (the "CD-ROM Agreement"). Those agreements have been largely superseded by the Co-Production Agreement entered into in February 1997, as described below, except with respect to treatment of existing films and products developed pursuant to those agreements, such as the Toy Story home video. Accordingly, Pixar believes that the results of its operations for 1995 and prior years, during which time Pixar recognized no revenue from animated feature films or related products, are not meaningful indicators of future performance. Further, Pixar believes that its results of operations for 1996, during which time revenue and costs attributable to feature films and CD-ROM products were governed by the terms of the Feature Film Agreement and the CD-ROM Agreement, are also not meaningful indicators of future performance, although they are more meaningful than results of operations for 1995 and prior years. See "Anticipated Decline in Operating Results in 1997 and Net Losses in 1998." 3 NEW AGREEMENT WITH DISNEY On February 24, 1997 Pixar and Walt Disney Pictures and Television, a wholly-owned subsidiary of Disney, entered into the Co-Production Agreement ("Co-Production Agreement") pursuant to which Pixar, on an exclusive basis, will produce five computer animated feature-length theatrical motion pictures (the "Pictures") for distribution by Disney over approximately the next ten years. Pixar and Disney will co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which will be financed by Disney), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. The Co-Production Agreement generally provides that Pixar will produce each Picture and that Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Disney and Pixar have agreed that the first Picture under the Co-Production Agreement is the Picture with the working title "Bugs." The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, Pixar will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. Disney and Pixar have announced their intention to produce a made-for-home video sequel to Toy Story (the "Toy Story Video Sequel"), and Pixar has already begun work on the production under the terms of the Co-Production Agreement. Pixar will not share in any theme park revenues generated as a result of the Pictures. See Note 11 of Notes to Financial Statements. In addition to entering into the Co-Production Agreement, Pixar agreed to sell, and Disney agreed to purchase for cash, 1,000,000 shares of Pixar Common Stock which Disney has agreed to hold for at least three years. Pixar also granted two warrants, each exercisable for five years, to Disney: one warrant to purchase 750,000 shares of Common Stock at an exercise price of $20.00 per share and another warrant to purchase 750,000 shares of Common Stock at an exercise price of $25.00 per share. Pixar granted certain registration rights for the shares issuable upon exercise of the warrants. This transaction was consummated in late March 1997 and Pixar received gross proceeds of $15.0 million. RESULTS OF OPERATIONS A number of factors may lead to a substantial decline in Pixar's operating results in 1997 and net losses in 1998. See "Anticipated Decline in Operating Results in 1997 and Net Losses in 1998." Revenues In the year ended December 31, 1996, Pixar derived revenue from its first animated feature film, Toy Story, from its first two CD-ROM products related to Toy Story, from software licenses, from the license of certain patents and from fees for animated television commercials and other animation services. Revenue from feature films is recognized upon receipt of compensation from Disney. Revenue from CD-ROM products is recognized upon shipment in the form of a royalty from Disney after a minimum number of units have been sold. All payments to Pixar from Disney for development and production of both Toy Story and the Toy Story CD-ROM products under the Feature Film Agreement and the CD-ROM Agreement, respectively, have been recorded as cost reimbursements. Accordingly, no revenues have been recognized for such reimbursements; rather, Pixar has netted the reimbursements against the related costs. These reimbursed costs for the years ended December 31, 1994, 1995 and 1996 are set forth in Note 4 of Notes to Financial Statements. Software license revenue is recognized upon shipment if there are no significant vendor obligations. Revenue from patent licensing is recognized upon release of the rights to the technology. See Note 1 of Notes to Financial Statements. Television commercial and other animation services revenues are recognized on the percentage-of-completion method of accounting. Prior to 1996, Pixar also derived revenue from software development contracts for which revenues were recognized on the percentage-of-completion method of accounting. Total revenues increased from $5.6 million in 1994 to $12.1 million in 1995 and to $38.2 million in 1996. Total revenues increased from 1994 to 1995 primarily as a result of patent licensing revenues of $6.5 million recognized in the second quarter of 1995. Total revenues increased from 1995 to 1996 primarily as a result of revenues received attributable to Toy Story and the two related CD-ROM products. Software revenues include software license revenue, principally from RenderMan, royalties received from the 1996 release of Pixar's first two CD-ROM products, The Toy Story Animated Storybook and The Toy Story Activity Center, and, 4 prior to 1996, software development contract revenues. Software revenue decreased from $3.3 million in 1994 to $3.1 million in 1995 and increased to $6.3 million in 1996. Software revenues decreased from 1994 to 1995 as an increase in software license revenue was more than offset by a decline in revenue from software development contracts. Software revenues increased from 1995 to 1996 due primarily to first time CD-ROM royalty revenues of $3.0 million and, to a lesser extent, an increase in RenderMan software license revenue. Due to Pixar's focus on content creation for animated feature films and related products, Pixar continues to expect that revenue derived from software licenses may decline. In addition, in 1995, Pixar completed work under all of the software development contracts that generated revenues in 1994 and 1995. No further development contract revenue was generated in 1996, and Pixar does not expect to pursue future software development work for third parties, nor to generate future revenues in this area. After the Co-Production Agreement was executed on February 24, 1997, Pixar began evaluating the merits of staying in the business of producing CD-ROM products and comparing those opportunities with opportunities in film and other potential projects under the Co-Production Agreement. Management determined that, despite the fact that Pixar's first CD-ROM titles were successful on relative terms, the resources currently devoted to its interactive products division would be better allocated to other projects arising from the Co-Production Agreement which Pixar believes have greater potential than CD-ROM titles, such as theatrical films, home video sequels and short animation projects. Moreover, the CD-ROM and interactive product market is not growing as fast as expected, the production costs of such products are increasing and one project under negotiation with a third party was canceled. For these reasons, Pixar determined in the last week of March 1997 to discontinue its business of producing CD-ROM and other interactive products and redirect the approximately 60 employees in this division to film and related projects within Pixar. This decision is expected to have a material adverse impact on Pixar's results of operations in 1997. Animation services revenues include revenue generated from short projects related to Pixar's films, animated television commercials and other short animated productions. Fees for animation services, which are fixed in advance, depend on the relative complexity and length of each production and may also depend on the market and other competitive conditions. Animation services revenues increased from $2.3 million in 1994 to $2.5 million in 1995 and to $3.9 million in 1996. The increase in revenue from 1994 to 1995 was due to an increase in the average fee charged due to the increased complexity of the commercials produced, which more than offset the decrease in the number of television commercials produced due to increased emphasis on content creation for feature films. The increase in revenue from 1995 to 1996 was due to $2.4 million in fees from Disney for a series of televised animation short productions related to Toy Story. During 1996, Pixar announced plans to substantially discontinue its production of animated television commercials for third parties after fulfilling its current commitments and to redirect the talent in its television commercial group to animated feature films and related products. Pixar continues to expect some ongoing activity in the animation services area primarily due to projects related to Pixar's films. Pixar may even devote more resources to the animation services group as a result of potential opportunities arising from the Co-Production Agreement. Toy Story was not released until November 1995, and accordingly, there were no film revenues in 1994 or 1995. Under the Feature Film Agreement, film revenues of $18.8 million were recognized in 1996, representing Pixar's share of both the domestic and international theatrical releases of Toy Story and related products. The Toy Story home video was released in October 1996 and, due to the one quarter delay between the time Disney receives Toy Story revenues and the time Disney pays Pixar its portion of these revenues, Pixar's share of Toy Story home video revenues will not begin to be received until the first quarter of 1997. The amount of compensation payable to Pixar from the Toy Story home video is governed by the prior Feature Film Agreement, pursuant to which Pixar's compensation rate for home videos is less than it was for theatrical exhibitions of Toy Story. Since the Toy Story home video is the last major release for Toy Story, and since Pixar's next feature film is not targeted for release until the fourth quarter of 1998 at the earliest, Pixar's revenues and earnings will likely decrease in 1997 and 1998 as compared to 1996. Moreover, unless the Toy Story Video Sequel is released in the first half of 1998 and achieves extraordinary success on relative terms, Pixar will incur a net loss in 1998. Patent license revenues of $6.5 million in the year ended December 31, 1995 were attributable to a patent license with Microsoft. Prior to 1995, there were no patent license revenues. Patent license revenues of $9.1 million in the year ended December 31, 1996 were attributable to a patent license with Silicon Graphics whereby Pixar granted to Silicon 5 Graphics and its subsidiaries a non-exclusive license to use certain of Pixar's patents covering techniques for creating computer-generated photorealistic images. Under the agreement, Silicon Graphics agreed to pay Pixar total compensation of $11 million, $6 million in cash and $5 million in the form of credits to purchase hardware and software from Silicon Graphics. In 1996, Pixar recognized revenue of $9.1 million, which included $6.0 million received in cash in March 1996 and $3.1 million representing that portion of the $5.0 million in hardware and software credits actually used in 1996. The remaining $1.9 million will be recognized as revenue in future periods as hardware and software credits are used. Pixar does not expect that patent license revenues will be generated on an on-going basis. See Note 5 of Notes to Financial Statements. In the year ended December 31, 1995, Microsoft accounted for 54% of Pixar's total revenues, attributable to a one-time patent license. In the year ended December 31, 1996, Disney accounted for 65% of Pixar's total revenues, attributable to revenue generated from Toy Story, two related CD-ROM games, short animated television productions based on Toy Story, and, to a lesser degree, software license sales. Also in 1996, Silicon Graphics accounted for 24% of total revenues, attributable to a one-time patent license. Due to the continuation of film-related revenues generated by Toy Story, Disney is expected to continue to represent greater than 10% of revenues in 1997. For information regarding Pixar's 10% customers in 1994, see Note 10 of Notes to Financial Statements. Cost of Revenues Cost of software revenues consists of the direct cost and manufacturing overhead required to reproduce and package Pixar's software products and, prior to 1996, the cost of salaries and overhead associated with the software development contracts. Because costs of development and production of the first two CD-ROM products were paid by Disney pursuant to the CD-ROM Agreement, there were no costs of revenue associated with CD-ROM royalty revenue. All payments to Pixar from Disney for Pixar's efforts in the development and production of CD-ROM products were recorded as cost reimbursements and were netted against the related costs. Cost of software revenues as a percentage of the related revenues decreased from 35% in 1994 to 16% in 1995 and to 2% in 1996 due to a substantial reduction in revenue in each year from low margin software development contracts, to increased sales of the RenderMan ToolKit in each year, which carries a higher gross margin than other software products, and, in 1996, to $3.0 million in CD-ROM revenue which carries no related cost. Cost of software revenues includes no amortization of capitalized software development expenses. Cost of animation services revenues consists of production costs, which include salaries, benefits and facility expenses and department overhead costs. Cost of animation services revenues as a percentage of the related revenues decreased from 87% in 1994 to 76% in 1995 primarily due to increased efficiencies in the production of commercials and to slightly higher fees charged. Cost of animation services revenues as a percentage of the related revenues increased slightly to 77% in 1996 due to higher costs associated with increased complexity and reduced prices for television commercials attributable to competitive pressures, largely offset by the higher margins earned on a series of animated short projects related to Toy Story. Toy Story was released in November 1995, and accordingly, there was neither film revenue nor cost of film revenues in 1994 or 1995. In 1996, cost of film revenues was $1.6 million, or 8% of film revenues, consisting of the amortized portion of Pixar's share of unreimbursed amounts incurred to produce Toy Story. See "Capitalized Film Production Costs." Film production costs are amortized under the individual film forecast method. Under the Feature Film Agreement, with the exception of overbudget amounts discussed above, all payments to Pixar from Disney for Pixar's efforts in the development and production of feature films were recorded as cost reimbursements and were netted against the related costs. However, under the terms of the Co-Production Agreement, in which Pixar co-finances each film production, amortized film production costs for future feature films will be significantly higher, and gross profit margins on future film projects, if any, will be substantially lower than those achieved on Toy Story. There are no costs of revenues associated with technology licensing revenues. 6 Operating Expenses Pixar's total operating expenses increased in each of 1994, 1995 and 1996, and Pixar intends to continue to increase operating expenses in a number of areas. With respect to general expense growth, as a result of intense competition for animators, creative personnel and technical directors, Pixar has had to pay higher salaries to attract new creative and technical personnel. Pixar expects compensation for such personnel to continue to increase substantially. In the year ended December 31, 1996, Pixar funded greater levels of research and development, expanded its administrative staff and facilities, expanded other operations, and incurred significant costs related to being a public company. Pixar expects continued growth in operating expenses in each of these areas. To the extent that such expenditures are not capitalized by Pixar nor allocated to, and paid for by, Disney, and precede or are not subsequently followed by an increase in revenues, Pixar's business, operating results and financial condition will be materially adversely affected. In 1995, Pixar recorded deferred compensation of $3.7 million for the difference between the grant price and the deemed fair value of Pixar's Common Stock for 9,823,900 shares subject to options granted during 1995. Amortization of deferred compensation of $1.4 million was recorded in the year ended December 31, 1995 -- $292,000 was capitalized to film production costs and $1.1 million was charged to expense -- based upon the vesting of the underlying options. In 1996, amortization of deferred compensation of $1.2 million was recorded -- $44,000 was capitalized to film production costs and the balance was charged to expense. See "--Capitalized Film Production Costs." The remaining deferred compensation expense will be amortized primarily to operating expense over the related 48-month vesting period of the options and will therefore continue to have a material adverse effect on Pixar's results of operations. See Note 8 of Notes to Financial Statements. Research and Development. Research and development expenses consist primarily of salaries and support for personnel conducting research and development for the RenderMan product, for Pixar's proprietary Marionette and Ringmaster software, and for Pixar's interactive products. Research and development expenses increased from $2.3 million in 1994 to $4.1 million in 1995 and to $7.0 million in 1996. Research and development expenses increased in each of 1995 and 1996 as compared to the prior year due to an increase in personnel responsible for the development of interactive titles and tools, and due to development of improvements and upgrades for Pixar's Marionette, Ringmaster and RenderMan software systems. Additional charges of $305,000 and $472,000 were taken in 1995 and 1996, respectively, to amortize the costs of deferred compensation in connection with stock option grants. To date, all research and development costs not reimbursed by Disney have been expensed as incurred. Pixar expects research and development expenses to further increase. Sales and Marketing. Sales and marketing expenses consist primarily of salaries and overhead and public relations, advertising, technical support and trade show costs required to support the software segment. Sales and marketing expenses decreased from $2.2 million in 1994 to $1.6 million in 1995 due to a reduction in salaries and advertising costs as Pixar focused on content creation, primarily for animated feature films. Sales and marketing expenses increased to $1.8 million in 1996 primarily as a result of the success of Toy Story and as a result of becoming a public company, both of which caused increases in public relations and corporate marketing costs. Pixar believes that sales and marketing expenses may increase in absolute dollars in future periods, particularly in the areas of corporate marketing and public relations. General and Administrative. General and administrative expenses consist primarily of salaries of management and administrative personnel, insurance costs and professional fees. Under the Feature Film Agreement, all or a portion of the salaries of certain of Pixar's executives and other general and administrative personnel were charged as film production costs and were reimbursed by Disney and were therefore not included in general and administrative expenses. General and administrative expenses increased from $831,000 in 1994 to $3.0 million in 1995 and to $5.6 million in 1996. The increase in general and administrative expenses from 1994 through 1996 was primarily due to the amortization of deferred compensation expense recorded in connection with stock option grants, increased staffing, increased professional fees associated with the protection of intellectual property, and increased costs and fees associated with being a public company. Charges of $788,000 and $658,000 were taken in 1995 and 1996, respectively, to amortize the costs of deferred compensation in connection with stock option grants. Pixar expects general and administrative expenses to further increase in absolute dollars in future periods as Pixar incurs additional costs related to being a public company and expands its administrative staff and facilities. 7 Other Income, Net Other income, net was $466,000 in 1994, $716,000 in 1995 and $8.0 million in 1996. Other expense in each of 1994 and 1995 was primarily attributable to net interest expense consisting primarily of interest accrued on a promissory note issued by Pixar to its majority shareholder. In 1994, net interest expense was more than offset by other income of $584,000 recognized as gain on the sale of equity securities. In 1995, net interest expense was more than offset by net other income consisting primarily of interest income from investments, amounts received pursuant to settlement of an intellectual property rights dispute and additional gain on the sale of equity securities. Other income in 1996 consisted primarily of interest income from investments made with the net proceeds from Pixar's initial public offering of Common Stock. Income Taxes Pixar elected S corporation status for federal income tax purposes as of January 1, 1992, whereby income was taxed to its individual shareholder. Accordingly, income tax expense in 1994 related only to the State of California's minimum franchise tax expense. At the end of April 1995, Pixar became a C corporation. Income tax expense for the year ended December 31, 1995 represented federal and state alternative minimum taxes (after utilization of net operating loss carryforwards) on the earnings of Pixar following termination of its S corporation status. Income tax expense for the year ended December 31, 1996 consisted primarily of state income taxes and federal alternative minimum tax. Income taxes increased in 1996 due to increased earnings and to full utilization of state net operating loss carryforwards. As of December 31, 1996, Pixar had net operating loss carryforwards from pre-S corporation years of approximately $23.0 million for federal income tax purposes. See Notes 1 and 7 of Notes to Financial Statements. ANTICIPATED DECLINE IN OPERATING RESULTS IN 1997 AND NET LOSSES IN 1998 A number of factors are expected to lead to a substantial decline in Pixar's operating results in 1997 and net losses in 1998, as discussed more fully below. End of Toy Story Revenues Pixar has already recognized the vast majority of the revenue it expects to receive from the domestic and international theatrical releases of Toy Story and expects substantially all of the revenue from the home video of Toy Story to be recognized in the first two quarters of 1997. Under the terms of the Feature Film Agreement, which stills governs the compensation payable to Pixar from the home video of Toy Story, Pixar is compensated for the home video to a lesser extent than it was with respect to the theatrical release of Toy Story. Pixar does not expect to recognize significant revenue from the Toy Story home video in the third or fourth quarters of 1997 or in any quarter in 1998. Pixar also expects limited revenue from the Toy Story CD-ROM products in 1997 and little or no revenue from such products in 1998. Reduced CD-ROM Revenue Pixar also expects to recognize less CD-ROM revenue in 1997 and 1998 than was previously anticipated. Although its first two CD-ROM products were successful on relative terms, Pixar determined in the last week of March 1997 to discontinue its business of producing CD-ROM and other interactive products in favor of other opportunities arising, in part, as a result of entering into the Co-Production Agreement. This decision is expected to have a material adverse impact on Pixar's operating results in 1997 and 1998. Pixar will not recognize any CD-ROM or other interactive product revenue in 1997 or 1998, other than revenue attributable to the two Toy Story CD-ROM products, and may incur carrying costs associated with the approximately 60 employees currently assigned to the interactive products division. Pixar does, however, expect to be able to reassign most of these employees to Picture productions and other departments within Pixar. Timing of Bugs and Toy Story Video Sequel Releases Bugs is not expected to be released until the end of 1998 at the earliest, and revenue attributable to Bugs is not expected to be recognized until after all costs have been recovered. Recovery of all costs depends on many factors and may not occur until six to twelve months after its release at the earliest, ensuring that Pixar will not recognize any revenue from 8 Bugs until the second half of 1999 at the earliest. The Toy Story Video Sequel is currently targeted for release in the second half of 1998, but its release date could change for a number of reasons. First, Pixar may be unable, for technical or other reasons, to complete the production of the Toy Story Video Sequel in time for its scheduled release in the second half of 1998. Second, even if completed, Disney and Pixar may choose to delay release of the Toy Story Video Sequel until the 1998 holiday season or thereafter. Depending on the timing of receipt of revenues by Disney, Pixar may not recognize revenue from the Toy Story Video Sequel until three to six months after its release at the earliest, meaning that if the Toy Story Video Sequel were released in late 1998 or thereafter, Pixar would not recognize any revenue from the Toy Story Video Sequel until 1999 at the earliest. Third, it is possible that the Toy Story Video Sequel could be released to the theaters instead of as a made-for-home video. In such event, Pixar would not expect to recognize any revenue until six to twelve months after the theatrical release, with the result that Pixar would not recognize any revenue from such film until 1999, even if released to the theaters in the second half of 1998. Possible Decline in Sales of RenderMan Due to Shift in Focus As a result of Pixar's reduced emphasis on the commercialization of software in favor of products sold for their content, Pixar expects to dedicate less time and resources to distributing and marketing RenderMan than it has in the past, particularly shrink-wrapped versions of RenderMan, and further expects that sales of RenderMan may decline. Increase in Operating Expenses In 1996, Pixar significantly increased its operating expenses, and Pixar plans to continue to increase its operating expenses to fund greater levels of research and development and to expand operations. Specifically, Pixar expects operating expenses to increase significantly due to continued investment in proprietary software systems, increased compensation costs as a result of intense competition for animators, creative personnel and technical directors and increased costs associated with the expansion of its facilities. Accordingly, Pixar anticipates significant increases in operating expenses in each of 1997 and 1998. Finally, Pixar expects its tax rate to increase in 1997 and future years as the result of utilization of net operating losses in 1996. Impact on Operating Results As a result of the above factors, the only substantial revenue expected to be recognized in 1997 will be from the Toy Story home video, and substantially all of that will be recognized in the first and second quarters. Further, unless the Toy Story Video Sequel is released early in the second half of 1998 and is an extraordinary success on relative terms, Pixar will not recognize substantial revenue in 1998. At the same time, Pixar's operating expenses may increase in 1997 and 1998, even after giving effect to capitalization of film production costs and allocation of certain operating expenses to Disney under the Co-Production Agreement. Therefore, Pixar expects revenue and operating results in the third and fourth quarters of 1997 to decline substantially from the first and second quarters of 1997 and from the same quarters of 1996. It is possible that Pixar would even incur operating and net losses in each of the last two quarters of 1997. Pixar also expects to incur operating and net losses in each of the first three quarters of 1998 and, unless the Toy Story Video Sequel is released early in the second half of 1998, the fourth quarter of 1998 and for the year ending December 31, 1998. POTENTIAL FLUCTUATIONS IN OPERATING RESULTS In addition to the factors set forth above, Pixar expects to generally experience significant fluctuations in its future annual and quarterly operating results caused by a variety of factors. Pixar expects that its annual and quarterly operating results, particularly its revenue, will fluctuate due to factors such as the timing of the domestic and international releases of the animated feature films, the success of the animated feature films (which can fluctuate significantly from film to film), the timing of the release of related products into their respective markets, the demand for the related products (which is often a function of the success of the related animated feature film), film production costs, Disney's costs to distribute and promote the feature films and related products, Disney's success at marketing the films and related products, the timing of receipt of proceeds from the animated feature films and related products by Disney, the timing of revenue recognition under the Co-Production Agreement, the Feature Film Agreement or the CD-ROM Agreement, as the case may be, the introduction of new feature films or products by Pixar's competitors, and general economic conditions. In particular, since Pixar's revenue under the 9 Co-Production Agreement is directly related to the success of a feature film, Pixar's operating results are likely to fluctuate depending on the level of success of its 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. Moreover, Pixar's operating expenses will be extremely difficult to forecast. The direct costs of film production are budgeted in agreement with Disney and shared equally. Pixar's share of these direct costs of film production are capitalized by Pixar in accordance with Statement of Financial Accounting Standards ("SFAS") No. 53, "Financial Reporting by Producers and Distributors of Motion Picture Films." A substantial portion of all of Pixar's other costs are incurred for the benefit of feature films ("Pixar's Overhead"), including research and development expenses and general and administrative expenses. Portions of Pixar's Overhead are included in the budgets for the Pictures and will be shared equally with Disney under the Co-Production Agreement. The remaining portion of Pixar's Overhead is either capitalized as film production costs, if required under SFAS No. 53, or charged to operating expense in the period incurred. Because a substantial portion of Pixar's Overhead is allocated to the Pictures and reimbursed by Disney and other amounts are capitalized by Pixar in accordance with SFAS No. 53, Pixar's future reported operating expenses will not reflect the true level of spending on the production of animated feature films, related products and overhead. Pixar has a valuation allowance as of December 31, 1996 which fully offsets its gross deferred tax assets due to Pixar's historical losses and the fact that there is no guarantee Pixar will generate sufficient taxable income in the future to be able to realize any or all of its deferred tax assets. As a result, Pixar may not be able to realize a benefit in the future from its net operating loss carryforwards, nor may it be able to recognize the tax benefits of net operating losses to be generated in the future. As a result of all of the foregoing, Pixar believes that period-to-period comparisons of its results of operations are not necessarily meaningful, and its annual and quarterly results of operations should not be relied upon as any indication of future performance. Due to all of the foregoing factors, it is likely that in some future period Pixar's operating results will be below the expectations of public market analysts and investors. In such event, the price of Pixar's Common Stock would likely be materially adversely affected. CAPITALIZED FILM PRODUCTION COSTS Although Disney funded the entire production of Toy Story, Pixar contractually guaranteed certain of the film budget overages and is liable to Disney for these amounts under the original Feature Film Agreement. Because these are "production costs" under SFAS No. 53, the costs were capitalized and amortized against future film revenue. As of December 31, 1995, Pixar had approximately $3.6 million of capitalized film production costs, $3.3 million of which represents the overage liability to Disney. During 1996, Pixar's overage liability was reduced by $1.0 million as a result of budget savings and the balance of $2.3 million owed to Disney was satisfied through a deduction from the amount due from Disney to Pixar for Pixar's compensation, which is based on Toy Story revenues. Pixar is entitled to recover any overages that it has funded, either directly or through its compensation under the original Feature Film Agreement, if Toy Story meets certain predefined criteria. During 1996, $1.6 million of Toy Story film production costs were amortized against film revenues. As of December 31, 1996, Pixar had $3.0 million in capitalized film production costs, $1.5 million of which represents remaining film production costs related to Toy Story. The balance represents costs relating to Pixar's second and third theatrical film productions and Pixar's first sequel production based on Toy Story. See Notes 1 and 4 of Notes to Financial Statements. 10 LIQUIDITY AND CAPITAL RESOURCES Until 1995, Pixar financed its operations primarily through financial support from its majority shareholder in the form of capital infusions and promissory notes. In December 1995, Pixar completed the initial public offering of its Common Stock, which resulted in net proceeds of approximately $139.7 million from the sale of 6,900,000 shares of Common Stock. Cash and short-term investments increased to $161.0 million at December 31, 1996 from $144.3 million at December 31, 1995 due primarily to net income of $25.3 million in 1996. Net cash used in operating activities in 1994 was primarily attributable to a net loss. Net cash provided by operating activities in 1995 was primarily attributable to net income resulting from patent licensing revenue of $6.5 million and an increase in accrued liabilities, somewhat offset by growth in other receivables. Net cash provided by operating activities in 1996 was primarily attributable to net income resulting from film and CD-ROM revenues related to Toy Story which generated $20.3 million in cash and from the cash portion of patent licensing revenue totaling $6.0 million. Net cash used in investing activities in 1994 was due primarily to the purchase of property and equipment, largely offset by the proceeds from sale of equity securities in an unrelated company. See Note 2 of Notes to Financial Statements. Net cash used in investing activities in 1995 and 1996 was due primarily to investments in short-term securities. Cash flows provided by financing activities in 1994 were attributable to a capital infusion from Pixar's majority shareholder. Cash flows provided by financing activities 1995 were primarily attributable to the net proceeds of approximately $139.7 million from Pixar's initial public offering of Common Stock. Net cash used in financing activities in 1996 was due primarily to the repayment of the note payable to the majority shareholder. See Note 6 of Notes to Financial Statements. As of February 24, 1997, Pixar's capital commitments primarily consisted of obligations to fund production costs of films and derivative products under the new Co-Production Agreement, obligations to pay portions of any revenue derived from each feature film produced under the Co-Production Agreement to its entertainment law firm in consideration for services rendered, obligations under operating leases and commitments to purchase certain computer equipment. Excluding costs related to the possible new studio facility discussed below, Pixar expects 1997 cash expenditures for capital equipment to be approximately $4.0 million. This will consist primarily of computer equipment, tenant improvements and furniture, some of which are more fully described below. Film Production Costs Under Co-Production Agreement. Under the Co-Production Agreement, Pixar's share of costs required to fund several films in various stages of production is expected to total approximately $33 million in 1997, which will directly impact working capital. Because Disney has already funded the costs incurred to date on these productions under the terms of the prior Feature Film Agreement, a significant portion of Pixar's 1997 production spending will represent reimbursement to Disney of Pixar's share of these film production costs already funded by Disney. Facilities Expansion. In 1996, Pixar entered into two new lease agreements to expand the total square footage of its existing corporate headquarters by approximately 72,000 square feet. The first lease agreement, for approximately 26,000 square feet, resulted in additional cash commitments for lease payments of approximately $540,000 per year beginning August 1996 and continuing through July 1999. Tenant improvements and capital equipment purchases related to that expansion totaled approximately $800,000 during 1996. The second lease agreement, for approximately 46,000 additional square feet, will begin during the second quarter of 1997 and result in additional cash commitments for lease payments of $846,000 per year for four years, with an option to terminate the lease after 30 months. Tenant improvements and capital equipment purchases related to this expansion are expected to total approximately $1.0 million during 1997. Also in 1996, Pixar paid a $150,000 refundable deposit on the purchase of land to build a new studio facility. In January 1997, Pixar paid an additional deposit of $150,000. At that time, the entire deposit of $300,000 became nonrefundable and will be applied to the purchase price of the property should Pixar elect to purchase the property. If Pixar purchases the property and builds a new studio facility, which it currently intends to do, Pixar currently expects to incur capital expenditures of more than $10 million in 1997 and more than $12 million in 1998. Pixar may choose to use its existing cash resources for such expenditures or to finance such capital expenditures through the issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. If Pixar does not choose to purchase the property and build a new facility, Pixar would need to write-off more than $900,000 of capitalized expenses associated with site development and engineering and architectural plans related to the new building, and would incur an additional $300,000 charge related to Pixar's share of the site preparation. 11 Computer Equipment. In October 1996, Pixar entered into agreements to purchase certain computer and network equipment from several vendors to be used on the second film and other projects, requiring cash commitments of approximately $3.0 million for the year ending December 31, 1997. A portion of these costs will be reimbursed by Disney. Additional equipment will be purchased from other sources, including equipment purchased in the form of credits in conjunction with the patent licensing agreement with Silicon Graphics. As of December 31, 1996, Pixar's principal source of liquidity was approximately $161.0 million in cash and short-term investments. In March 1997, Pixar received $15.0 million, before deduction of expenses, from Disney in connection with the sale of 1,000,000 shares of Pixar Common Stock and the issuance of two warrants to purchase an aggregate of 1,500,000 shares of Common Stock. Pursuant to the Co-Production Agreement, Pixar will co-finance the next five animated feature films which it produces, including Bugs and the second theatrical film being developed under the Co-Production Agreement (the "Second Theatrical Film"), and will also co-finance the Toy Story Video Sequel. In the future, Pixar may co-finance other derivative works such as theatrical sequels, interactive products and television productions. As Pixar does not expect to generate substantial, if any, cash from operations in 1997 and 1998, the production costs of Bugs, the Second Theatrical Film and the Toy Story Video Sequel are expected to have a material adverse impact on Pixar's cash and short-term investment balances. Pixar believes that available funds will be sufficient to meet its anticipated cash needs for working capital and capital expenditures, including the production costs of Bugs, the Second Theatrical Film and the Toy Story Video Sequel, until Pixar begins receiving cash from the release of these films (which is generally not expected to occur until 1999). However, even if these films generate cash, unless each is a success such that Pixar recovers on a timely basis its share of the production costs, as well as other operating expenses and capital expenditures, Pixar will be required to seek financing for its ongoing commitments under the Co-Production Agreement and any other requirements of its operations. Pixar may also seek additional financing in connection with the expansion of its facilities. The sale of additional equity or convertible debt securities would result in additional dilution to Pixar's shareholders. Moreover, there can be no assurance that Pixar will be successful in obtaining future financing, or even if such financing is available, that it will be obtained on terms favorable to Pixar or on terms providing Pixar with sufficient funds to meet its obligations and objectives. The failure to obtain such financing would have a material adverse effect on Pixar's business, operating results and financial condition. 12 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders Pixar: We have audited the accompanying balance sheets of Pixar as of December 31, 1995 and 1996, and the related statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1996. These financial statements are the responsibility of Pixar's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Pixar as of December 31, 1995 and 1996, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. KPMG PEAT MARWICK LLP Palo Alto, California January 31, 1997, except as to Note 11, which is as of March 25, 1997 -1- 13 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA PIXAR BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
December 31, 1995 1996 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 97,286 $ 44,648 Short-term investments 47,002 116,321 Trade accounts receivable, net of allowance for returns and doubtful accounts of $256 and $259 in 1995 and 1996, respectively 784 929 Other receivables 1,969 5,390 Prepaid expenses and other current assets 309 982 Capitalized film production costs 1,446 1,372 --------- --------- Total current assets 148,796 169,642 Property and equipment, net 1,552 4,655 Capitalized film production costs, net of current portion 2,170 1,578 Other assets 497 1,588 --------- --------- Total assets $ 153,015 $ 177,463 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 742 $ 1,060 Note payable to the majority shareholder and accrued interest 2,373 -- Film production costs payable 3,324 -- Accrued liabilities 3,400 5,262 Unearned revenue 269 337 --------- --------- Total current liabilities 10,108 6,659 --------- --------- Commitments Shareholders' equity: Preferred stock; no par value; 5,000,000 shares authorized; no shares issued and outstanding -- -- Common stock; no par value; 100,000,000 shares authorized; 38,286,500 and 39,413,102 shares issued and outstanding as of December 31, 1995 and 1996, respectively 185,845 187,308 Unrealized gain (loss) on investments 49 (48) Deferred compensation (2,261) (1,049) Accumulated deficit (40,726) (15,407) --------- --------- Total shareholders' equity 142,907 170,804 --------- --------- Total liabilities and shareholders' equity $ 153,015 $ 177,463 ========= =========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. -2- 14 PIXAR STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
Year Ended December 31, 1994 1995 1996 -------- ------- ------- Revenues: Software $ 3,323 $ 3,144 $ 6,306 Animation services 2,267 2,469 3,947 Film -- -- 18,847 Patent licensing -- 6,500 9,127 -------- ------- ------- Total revenues 5,590 12,113 38,227 -------- ------- ------- Cost of revenues: Software 1,164 513 113 Animation services 1,964 1,873 3,039 Film -- -- 1,551 -------- ------- ------- Total cost of revenues 3,128 2,386 4,703 -------- ------- ------- Gross margin 2,462 9,727 33,524 -------- ------- ------- Operating expenses: Research and development 2,288 4,065 6,985 Sales and marketing 2,180 1,588 1,768 General and administrative 831 3,043 5,577 -------- ------- ------- Total operating expenses 5,299 8,696 14,330 -------- ------- ------- Income (loss) from operations (2,837) 1,031 19,194 Other income, net 466 716 8,031 -------- ------- ------- Income (loss) before income taxes (2,371) 1,747 27,225 Income tax expense 1 120 1,906 -------- ------- ------- Net income (loss) $ (2,372) $ 1,627 $25,319 ======== ======= ======= Net income (loss) per share (see Note 1) $ (0.06) $ 0.04 $ 0.54 ======== ======= ======= Shares used in computing net income (loss) share per share 39,669 40,350 46,989 ======== ======= =======
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. -3- 15 PIXAR STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (IN THOUSANDS)
Total Unrealized Share- Preferred Stock Common Stock Gain (Loss) Deferred Accum- holders' ------------------ -------------------- on Invest- Compen- ulated Equity Shares Amount Shares Amount ments sation Deficit (Deficit) -------- -------- -------- ---------- -------- ---------- ------- -------------- Balances, December 31, 1993 -- $ -- 20 $ 46,405 $ -- $ -- $(47,621) $ (1,216) Capital infusion from shareholder -- -- -- 1,850 -- -- -- 1,850 Unrealized gain on investments -- -- -- -- 63 -- -- 63 Net loss -- -- -- -- -- -- (2,372) (2,372) ------- -------- ------ --------- -------- -------- -------- --------- Balances, December 31, 1994 -- -- 20 48,255 63 -- (49,993) (1,675) Recapitalization (conversion of note payable to the majority shareholder and existing common stock into Series A preferred stock and common stock) 10,000 47,900 9,980 (46,288) -- -- -- 1,612 Reclassification of S corporation net operating losses -- -- -- (7,640) -- -- 7,640 -- Exercise of stock options -- -- 1,386 277 -- -- -- 277 Deferred compensation related to grant of stock options -- -- -- 3,680 -- (3,680) -- -- Amortization of deferred compensation -- -- -- -- -- 1,419 -- 1,419 Conversion of existing preferred stock into common stock (10,000) (47,900) 20,000 47,900 -- -- -- -- Initial public offering net of expenses of $1,892 -- -- 6,900 139,661 -- -- -- 139,661 Unrealized gain on investments -- -- -- -- 76 -- -- 76 Realized gain on investment -- -- -- -- (90) -- -- (90) Net income -- -- -- -- -- -- 1,627 1,627 ------- -------- ------ --------- -------- -------- -------- --------- Balances, December 31, 1995 -- -- 38,286 185,845 49 (2,261) (40,726) 142,907 Exercise of stock options, including tax benefit from disqualifying dispositions -- -- 1,127 1,463 -- -- -- 1,463 Amortization of deferred compensation -- -- -- -- -- 1,212 -- 1,212 Unrealized loss on investments -- -- -- -- (97) -- -- (97) Net income -- -- -- -- -- -- 25,319 25,319 ------- -------- ------ --------- -------- -------- -------- --------- Balances, December 31, 1996 -- $ -- 39,413 $ 187,308 $ (48) $ (1,049) $(15,407) $ 170,804 ======= ======== ====== ========= ======== ======== ======== =========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS. -4- 16 PIXAR STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Year Ended December 31, 1994 1995 1996 ------- --------- --------- Cash flows from operating activities: Net income (loss) $(2,372) $ 1,627 $ 25,319 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Amortization of deferred compensation -- 1,127 1,168 Noncash revenue attributable to film overbudget -- -- (2,324) Provision for returns and doubtful accounts 191 29 3 Depreciation and amortization 374 467 2,283 Tax benefit from disqualifying dispositions -- -- 1,236 Licenses exchanged for equipment -- -- (1,465) Gain on sale of equity securities (584) (90) -- Changes in operating assets and liabilities: Trade accounts receivable 143 (502) (148) Other receivables (128) (1,809) (3,421) Prepaid expenses and other current assets 127 (85) (673) Accounts payable 167 86 318 Accrued liabilities 205 2,656 1,862 Unearned revenue (4) (142) 68 ------- --------- --------- Net cash provided by (used in) operating activities (1,881) 3,364 24,226 ------- --------- --------- Cash flows from investing activities: Purchase of property and equipment (589) (955) (2,371) Proceeds from sale of property and equipment -- 33 -- Proceeds from sale of equity securities 584 90 175,360 Investments in short-term securities -- (46,953) (244,776) Capitalized film production costs -- -- (1,840) Change in other assets -- (497) (1,091) ------- --------- --------- Net cash used in investing activities (5) (48,282) (74,718) ------- --------- --------- Cash flows from financing activities: Net proceeds from initial public offering -- 139,661 -- Proceeds from capital infusion 1,850 -- -- Proceeds from exercised stock options -- 277 227 Repayment of note payable to shareholder -- -- (2,373) Proceeds from note payable to shareholder -- 2,225 -- ------- --------- --------- Net cash provided by (used in) financing activities 1,850 142,163 (2,146) ------- --------- --------- Net increase (decrease) in cash and cash equivalents (36) 97,245 (52,638) Cash and cash equivalents at beginning of year 77 41 97,286 ------- --------- --------- Cash and cash equivalents at end of year $ 41 $ 97,286 $ 44,648 ======= ========= ========= Supplemental disclosure of cash flow information: Cash paid during the year for income taxes $ -- $ 172 $ 523 ======= ========= ========= Supplemental disclosures of noncash investing and financing activities: Credits used to purchase equipment $ -- $ -- $ 3,127 ======= ========= ========= Film overbudget reductions $ -- $ -- $ 3,324 ======= ========= ========= Noncash film production costs capitalized $ -- $ 3,616 $ 44 ======= ========= ========= Conversion of note payable to shareholder, and accrued interest, to equity $ -- $ 1,612 $ -- ======= ========= ========= Accrual of stock option deferred compensation $ -- $ 3,680 $ -- ======= ========= ========= Unrealized gain (loss) on investments $ 63 $ (14) $ (97) ======= ========= =========
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS -5- 17 PIXAR NOTES TO FINANCIAL STATEMENTS (1) SUMMARY OF PIXAR AND SIGNIFICANT ACCOUNTING POLICIES The Company Pixar was incorporated in the state of California on December 9, 1985. The Company is a digital animation studio with the technical, creative and production capabilities to create a new generation of animated feature films and related products. Cash and Cash Equivalents Pixar considers all highly liquid instruments with an original maturity of 90 days or less to be cash equivalents. Cash equivalents as of December 31, 1996 consisted primarily of U.S. Treasury Bills, demand notes, commercial paper and federal agency obligations. Short-Term Investments Pixar has classified its short-term investments as "available-for-sale." Such investments are recorded at fair value, and unrealized gains and losses, if material, are reported as a separate component of equity until realized. Interest income is recorded using an effective interest rate with the associated premium or discount amortized to interest income. The cost of securities sold is based upon the specific identification method. See Note 2 for a description of short-term investments. Property and Equipment Property and equipment are stated at cost. Depreciation of property and equipment is calculated using the straight-line method over estimated useful lives ranging from three to seven years. Leasehold improvements are amortized over the lesser of the related lease term or the life of the improvement. Film Production Costs Film production costs include costs to develop and produce computer animated motion pictures, mainly salaries, equipment and overhead. Film production costs in excess of reimbursable amounts are capitalized. Once a film is released, any film production costs capitalized will be amortized in the proportion that the compensation revenue during the year for each film bears to the estimated compensation revenue to be received from all sources under the individual film forecast method. Estimates of anticipated total gross revenues will be reviewed periodically and revised when necessary. Unamortized film production costs will be compared with net realizable value each reporting period on a film-by-film basis. If estimated gross revenues are not sufficient to recover the unamortized film production costs, the unamortized film production costs will be written down to net realizable value. The costs of feature films are classified as current assets to the extent such costs are expected to be recovered from primary markets. Costs of feature films recoverable from secondary markets are classified as noncurrent assets. Research and Development Costs Research and development costs are charged to operations as incurred. In accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, development costs related to software products are expensed as incurred until the technological feasibility of the product has been established. After technological feasibility is established, additional costs would be capitalized. To date, Pixar has not capitalized any software development costs after technological feasibility has been established on its software products since Pixar believes its process for developing software is essentially completed concurrently with the establishment of technological feasibility and costs incurred thereafter have not been material. -6- 18 PIXAR NOTES TO FINANCIAL STATEMENTS Revenue Recognition Software licensing revenue is recognized upon shipment if there are no significant vendor obligations and if collection is probable. Software development contracts and animated television commercial revenues are recognized on the percentage-of-completion method of accounting. Patent licensing revenue is recognized upon release of the rights to the technology. Compensation based on the revenues from the distribution of animated feature films and related products is recognized as earned and reasonably estimable. The related revenue cycle is generally five to seven years, with the substantial majority expected to be recognized in the first two years. Financial Instruments and Concentration of Credit Risk The carrying value of the Company's financial instruments, including marketable securities and accounts receivable, approximates fair market value. Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term investments and trade accounts receivable. The Company invests its excess cash in a variety of investment grade, interest-bearing securities with a major bank. This diversification of risk is consistent with the Company's policy to ensure safety of principal and maintain liquidity. The Company licenses its products and provides its services to a large number of customers in several business segments, primarily in the United States, as outlined in Note 10. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Income Taxes Pixar accounts for income taxes under the asset and liability method of accounting. Under the asset and liability method, deferred tax assets and liabilities are recognized based on the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period that includes the enactment date. Pixar elected to be treated as an S corporation for federal income tax purposes as of January 1, 1992, whereby income was taxed to its individual shareholder. In 1995, Pixar's S corporation election terminated as a result of the recapitalization described in Note 7. The accompanying pro forma net income (loss) data for the year ended December 31, 1995, reflect provision for income taxes on a pro forma basis, using the asset and liability method, as if Pixar had been a C corporation since the beginning of that period, fully subject to federal and state income taxes. Undistributed losses during the period in which Pixar was an S corporation were reclassified from accumulated deficit to common stock, resulting in a $7,600,000 decrease in both accumulated deficit and common stock on the accompanying balance sheet as of December 31, 1995. Pro forma income taxes reflected in the pro forma net income data for the year ended December 31, 1995 primarily reflect the alternative minimum tax liability after utilization of net operating loss carryforwards recorded prior to the S corporation termination event described in Note 7. -7- 19 PIXAR NOTES TO FINANCIAL STATEMENTS Net Income (Loss) per Share Net income (loss) per share for the years ended December 31, 1994 and 1995, is computed using pro forma net income (loss), assuming C corporation income tax expense. Net income (loss) per share for all periods presented is computed using the weighted-average number of shares of common stock outstanding and common equivalent shares from stock options (under the treasury stock method, if dilutive). In accordance with SEC Staff Accounting Bulletins, such computations include all common and common equivalent shares issued within 12 months of the initial public offering (IPO) as described in Note 8 for all pre-IPO periods presented. Reclassifications Certain amounts reported in previous years have been reclassified to conform to the 1996 financial statement presentation. Stock Option Plans Prior to January 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of Pixar adopted the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on January 1, 1996. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of SFAS No. 121 did not have a material impact on the Company's financial position, results of operations, or liquidity. (2) SHORT-TERM INVESTMENTS In 1993, Pixar licensed certain technology in exchange for a 10% equity interest in the licensee. As of the date of this transaction, management determined that there was no reasonable basis to determine the fair value of the assets exchanged and, accordingly, the preferred stock received was valued at zero. In 1994, the licensee was acquired by another company. As a result, Pixar received 10,310 shares of common stock of the acquiring entity in exchange for its equity in the licensee. In 1994, Pixar recognized a gain on this transaction amounting to $584,000, which represents the fair value of the 9,279 shares received and the proceeds received from their subsequent sale. The remaining 1,031 shares were placed in escrow to secure certain indemnification obligations of the licensee and were valued at zero as of the date of the transaction. As of December 31, 1994, Pixar had valued the 1,031 shares at fair value and recorded unrealized gains of $63,000 under the belief that no obligations existed under the escrow agreement. Pixar recognized a gain of $90,000 from the sale of the remaining 1,031 shares in the year ended December 31, 1995. -8- 20 PIXAR NOTES TO FINANCIAL STATEMENTS All investments were considered available-for-sale securities and consisted of the following (in thousands):
Unrealized Unrealized Estimated Cost Gains Losses Fair Value -------- ---------- ---------- ---------- As of December 31, 1995: U. S. Treasury Bills $ 71,846 $ 50 $ -- $ 71,896 Demand notes 14,499 -- -- 14,499 Commercial paper 34,833 -- (3) 34,830 Federal Agency obligations 19,861 2 -- 19,863 -------- ---- --------- -------- $141,039 $ 52 $ (3) $141,088 ======== ==== ========= ======== As Of December 31, 1996: U. S. Treasury Bills $ 39,186 $-- $ (33) $ 39,153 Demand notes 22,106 -- -- 22,106 Commercial paper 20,000 -- -- 20,000 Federal Agency obligations 69,495 6 (21) 69,480 Banker's Acceptance 4,886 -- -- 4,886 -------- ---- --------- -------- $155,673 $ 6 $ (54) $155,625 ======== ==== ========= ========
The contractual maturities of available-for-sale debt securities, regardless of their balance sheet classification, are as follows (in thousands):
December 31, 1995 December 31, 1996 Cost Fair Value Cost Fair Value -------- -------- -------- -------- Due within one year $141,039 $141,088 $ 95,095 $ 95,072 Due after one year through five years -- -- 60,578 60,553 -------- -------- -------- -------- $141,039 $141,088 $155,673 $155,625 ======== ======== ======== ========
(3) BALANCE SHEET COMPONENTS Balance sheet components are as follows (in thousands):
December 31, 1995 1996 ---------- --------- Property and equipment: Equipment $3,298 $6,238 Leasehold improvements 265 1,007 ------ ------ 3,563 7,245 Less accumulated depreciation and amortization 2,011 2,590 ------ ------ $1,552 $4,655 ====== ====== Accrued liabilities: Employee-related expenses $1,277 $2,280 IPO costs payable 1,071 -- Professional services 206 1,157 Other 846 1,825 ------ ------ $3,400 $5,262 ====== ======
-9- 21 PIXAR NOTES TO FINANCIAL STATEMENTS (4) FEATURE FILM AND CD-ROM PRODUCTION Feature Film Agreement In 1991, Pixar entered into a feature film agreement with Walt Disney Pictures, a wholly owned subsidiary of the Walt Disney Company (together with its subsidiaries and affiliates collectively referred to herein as "Disney") to develop and produce up to three computer animated feature films (the Feature Film Agreement). Pixar is entitled to receive compensation based on revenue from the distribution of animated feature films and related products. The first feature film, Toy Story, was in production as of December 31, 1994, and released in November 1995. The second and third feature films, and a made-for-home video sequel to Toy Story were in development as of December 31, 1996. On February 24, 1997, Pixar and Disney entered into a co-production agreement which will now govern the second and third feature films, three additional films, and made-for-home video sequels (see Note 11). Under the terms of the Feature Film Agreement, Disney funded each motion picture produced up to the total budgeted film costs. Costs incurred by Pixar, inclusive of salaries and overhead, were billed to Disney and reimbursed on a current basis. All payments to Pixar from Disney for costs of feature film production have been recorded as cost reimbursements; accordingly, no revenues have been recorded for such reimbursements; rather, Pixar has netted the reimbursements against the related costs. The Feature Film Agreement provided that, in the event that production costs for the motion picture exceeded the total budget, Disney would pay a specified amount of the over budget costs (a portion of which has since been deducted from Pixar's Toy Story film revenue) plus all over budget costs that were preapproved in writing by a Disney executive. Pixar was obligated to fund unapproved production cost overages in excess of that specified amount, but was entitled to recover any overages that it had funded if the motion picture met certain criteria. As of December 31, 1995, total film production costs incurred exceeded budget by approximately $9,300,000, a portion of which was assumed by Disney, as defined above. Pixar's portion of the film production cost overage incurred, approximately $3,300,000, and amortization of deferred compensation were capitalized as film production costs as of December 31, 1995. During the year ended December 31, 1996, Pixar's portion of the film production cost overage was reduced by $1,000,000. Additional costs capitalized as film production costs during the year ended December 31, 1996, included additional amortization of deferred compensation, participation fees related to the first feature film, and costs related to additional films in process. Based on the individual film forecast method, substantially all of the film production costs capitalized related to the first feature film will be substantially amortized by December 31, 1997. Film production costs capitalized related to additional films in process will be amortized when the respective films are released. The total film production costs and related amounts capitalized are as follows (in thousands):
Year ended Total as of December 31, December 31, 1992 1993 1994 1995 1996 1996 ---- ---- ---- ---- ---- ---- Released film: Disney production costs (unaudited) $ 382 $5,006 $5,299 $ 8,158 $ 754 $ 19,599 Pixar reimbursed film production costs 585 1,899 2,570 3,015 53 8,122 ---------------------------------------------------- ------------ Total film production costs (unaudited) $ 967 $6,905 $7,869 $11,173 $ 807 27,721 ==================================================== Disney reimbursements of budgeted costs and approved overages (unaudited) (25,396) Amortization of deferred compensation 336 Participation fees 350 Amortization of film production costs (1,551) ------------ Total film production costs capitalized for released film 1,460 ------------
-10- 22 PIXAR NOTES TO FINANCIAL STATEMENTS
Year ended Total as of December 31, December 31, 1995 1996 1996 ---- ---- ---- Films in process: Disney production costs (unaudited) $ 903 $ 5,996 6,899 Pixar reimbursed film production costs 1,904 11,786 13,690 ------------------- ------------ Total film production costs (unaudited) $ 2,807 $17,782 20,589 =================== Disney reimbursements of budgeted costs and approved overages (unaudited) (19,099) ------------ Total film production costs capitalized for films in process 1,490 ------------ Total film production costs capitalized $ 2,950 ============
The reimbursements receivable from Disney for the first feature film were $220,000 as of December 31, 1995, and are included in other receivables on the accompanying balance sheet. There were no reimbursements receivable for the first film as of December 31, 1996. The reimbursements receivable from Disney for the second film were $943,000 and $1,313,000 as of December 31, 1995 and 1996, respectively, and are included in other receivables on the accompanying balance sheet. The reimbursement receivable from Disney for the made-for-home video sequel to the first feature film was $617,000 as of December 31, 1996, which is included in other receivables on the accompanying balance sheet. Pixar was obligated to pay 5% of its compensation based on revenue from the distribution of the first feature film up to $350,000 to a third party in consideration for services rendered. CD-ROM Agreement Pixar has entered into an agreement with Disney to develop and produce interactive CD-ROM titles based on the first motion picture. Disney pays Pixar a development fee for the development of the titles and Pixar is entitled to receive a per-unit royalty on sales of the CD-ROM titles after a certain minimum number of units has been sold. Pixar recognized $3,009,000 of royalties from sales of CD-ROM titles for the year ended December 31, 1996. Amounts required to develop the titles in excess of the development fees are funded by Pixar and are recorded as research and development fees, unless Disney agrees to provide additional fees. Total development fees recorded as an offset in research and development pursuant to this agreement were $3,011,000 for the year ended December 31, 1996. (5) PATENT LICENSING ARRANGEMENTS As of December 31, 1995, fees of $6,500,000 were recognized on the licensing of certain patents. For the year ended December 31, 1996, fees of $9,100,000 were recognized with respect to the licensing of certain patents. The Company delivered all rights to utilize the technology underlying the license to the licensee, and received a nonrefundable fixed-fee cash payment of $6,000,000 and $5,000,000 in the form of credits for products to be purchased from the licensee by Pixar over the next four years. Following the release of the rights to utilize the patents to the licensee, Pixar maintained no significant vendor obligations to the licensee, so the Company recognized as revenue the fixed and determinable amounts of the $6,000,000 cash payment received, plus $3,127,000 that represents the portion of the credits Pixar has used in the year ended December 31, 1996. -11- 23 PIXAR NOTES TO FINANCIAL STATEMENTS (6) RELATED PARTY TRANSACTIONS Notes Payable to Shareholder Pixar had a note payable upon demand to its majority shareholder amounting to $1,137,000 as of December 31, 1994, bearing simple interest of 10%. Interest expense related to the note was $113,000 for 1994. The note, plus accrued interest of $474,000, was converted to common stock in 1995. As of December 31, 1995, Pixar had a $2,225,000 note payable to its majority shareholder, plus accrued interest of $148,000, which bears simple variable interest equal to prime rate revised quarterly (8.75% as of December 31, 1995). The note plus accrued interest was repaid in January 1996. Note Receivable from Shareholder In 1995, Pixar loaned $200,000 to an employee and shareholder, due in May 1998. The note was secured by certain assets, included an interest rate of 6.62% compounded annually, and was included in other assets on the accompanying balance sheet as of December 31, 1995. During the year ended December 31, 1996, the note and accrued interest was paid in full. (7) INCOME TAXES Pixar elected to be treated as an S corporation for federal income tax purposes as of January 1, 1992. The S corporation status was terminated as a result of the recapitalization described in Note 8. Accordingly, Pixar was taxed as a C corporation following the recapitalization. The pro forma provisions for income taxes reflect the income tax expense that would have been reported if Pixar had been a C corporation. The components of income taxes are as follows (in thousands):
Year ended December 31, 1994 1995 1996 ------------------- -------------------- ------------------- (Pro Forma) (Pro Forma) (Actual) (Unaudited) Income taxes: Current: Federal $ -- $ 69 $ 620 State 1 21 1,286 --------------- --------------- -------------- Total income taxes $ 1 $ 90 $ 1,906 =============== =============== ==============
The following tabulation reconciles the statutory corporate federal income tax expense (benefit) (computed by multiplying Pixar's income (loss) before income taxes by 34%) to Pixar's pro forma or actual income tax expense (in thousands):
Year ended December 31, 1994 1995 1996 ------------- --------- ------------ (Pro Forma) (Pro Forma) (Actual) (Unaudited) Expected income tax expense (benefit) $(806) $ 594 $ 9,257 State income taxes, net of federal tax effect 1 14 1,286 Unutilized net operating losses 806 -- -- Change in beginning of year valuation allowance -- (539) (9,261) Alternative minimum tax -- -- 37 Other, net -- 21 587 ----- ----- ------- Income taxes $ 1 $ 90 $ 1,906 ===== ===== =======
-12- 24 PIXAR NOTES TO FINANCIAL STATEMENTS The tax effects of temporary differences that give rise to significant portions of the deferred tax assets are presented below (in thousands):
December 31, 1995 1996 -------- -------- Deferred tax assets: Reserves and accruals $ 1,496 $ 2,113 Net operating loss carryforwards 13,603 7,749 Credit carryforwards 637 748 -------- -------- Total gross deferred tax assets 15,736 10,610 Valuation allowance (15,736) (10,610) -------- -------- Net deferred tax assets $ -- $ -- ======== ========
Pixar has a valuation allowance as of December 31, 1996, which fully offsets its gross deferred tax assets due to the Company's historical losses and the fact that there is no guarantee the Company will generate sufficient taxable income in the future to be able to realize any or all of the deferred tax assets. Included in the deferred tax assets above is approximately $4,000,000 related to stock option compensation for which the benefit when realized will be an adjustment to equity. As of December 31, 1996, Pixar had net operating loss carryforwards from pre-S corporation years of approximately $23,000,000 for federal income tax purposes. Pixar has research credit carryforwards of approximately $400,000 and $50,000 for federal and California income tax purposes, respectively. In addition, Pixar has alternative minimum tax credit carryforwards for federal and California tax purposes of approximately $320,000 and $50,000, respectively. If not utilized, the federal and California carryforwards will expire in years 2002 through 2011. (8) SHAREHOLDERS' EQUITY Recapitalization and Stock Split As of December 31,1994, Pixar had 100,000 shares of common stock authorized, 20,000 shares of common stock issued and outstanding, and no preferred stock authorized, issued and outstanding. In April 1995, the sole shareholder approved the recapitalization of Pixar, whereby the 20,000 shares of common stock then outstanding and a note payable to the sole shareholder (see the second paragraph of Note 6 above) were converted into 9,999,999 shares of Series A preferred stock and 10,000,002 shares of common stock. In October 1995, the Board of Directors approved a two-for-one stock split of the common stock. The accompanying financial statements have been retroactively restated for all periods presented to reflect the effect of the stock split on the common stock. Initial Public Offering In November 1995, Pixar completed an IPO of 6,900,000 shares of common stock for $22 per share, which resulted in proceeds to the Company of approximately $139,700,000, net of issuance costs of approximately $1,900,000. Deferred Compensation Pixar has recorded deferred compensation of $3,680,000 for the difference between the grant price and the deemed fair value of the common stock underlying certain options granted in 1995. This amount is being amortized over the vesting period of the individual options, generally four years. Amortization of deferred compensation was approximately $1,419,000 for the year ended December 31, 1995, $292,000 of which was capitalized as film production costs and $1,127,000 of which was expensed. For the year ended December 31, 1996, amortization of deferred compensation was approximately $1,212,000, $44,000 of which was capitalized as film production costs and $1,168,000 of which was expensed. -13- 25 PIXAR NOTES TO FINANCIAL STATEMENTS Stock Option Plans As of December 31, 1996, the Company has two stock option plans, which are described below. 1995 Stock Plan Pixar has reserved 13,000,000 shares of common stock for issuance under the 1995 Stock Plan (the Plan), as approved in October 1995. The Plan provides for stock options to be granted to employees and consultants at an exercise price not less than 100% of the fair market value (110% of fair value in certain instances), at the grant date, as determined by the Board of Directors or a committee of the Board of Directors, for incentive stock options; at prices determined by the Board of Directors or a committee of the Board of Directors for nonstatutory stock options; and at prices and terms determined by the Board of Directors or a committee of the Board of Directors for stock purchase rights. All options are to have a term not greater than 10 years from the date of grant. The Board of Directors or a committee of the Board of Directors determines the number of shares for which an option may be granted. Options issued generally vest 25% after one year and then ratably 1/48 per month thereafter. 1995 Director Option Plan Pixar has reserved 200,000 shares of common stock for issuance under the 1995 Director Option Plan. The Director Option Plan provides for the automatic grant of nonstatutory options to nonemployee directors (eligible directors) of Pixar. Each eligible director will be granted an option to purchase 30,000 shares of common stock on the date on which the optionee first becomes a director of Pixar. One-third of the options will vest one year after their date of grant and an additional one-third at the end of each year thereafter. On the third and subsequent anniversaries of a nonemployee director's first becoming a director, that director is automatically granted an option to purchase an additional 10,000 shares of common stock that will vest in full one year after the date of the respective grant. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost, except for the $3,680,000 of deferred compensation and subsequent amortization, has been recognized for its fixed stock options. Had compensation cost for the Company's two stock option plans been determined consistent with SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data):
1995 1996 ----------- ----------- Net Income: As reported $ 1,627 $ 25,319 Pro Forma $ 880 $ 24,017 Earnings per share: As reported $ 0.04 $ 0.54 Pro Forma $ 0.02 $ 0.51
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants: 1995 - zero dividend yield, expected volatility of 50 percent, risk-free interest rates of 5.90 percent, and weighted-average expected life of 2.42 years; 1996 - zero dividend yield, expected volatility of 50 percent, risk-free interest rate of 6.06 percent, and weighted-average expected life of 3.52 years. The effects of applying SFAS No. 123 in this pro forma disclosure is not indicative of the effects on reported results for future years. SFAS No. 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. -14- 26 PIXAR NOTES TO FINANCIAL STATEMENTS A summary of the status of the Company's two fixed stock option plans as of December 31, 1995 and 1996, is as follows:
1995 1996 ------------------------------- ------------------------------------- Weighted-average Weighted-average Shares exercise price Shares exercise price ------ -------------- ------ -------------- Outstanding at beginning of year -- $ -- 9,140,900 $ 1.00 Granted 10,641,400 0.89 1,297,000 15.18 Exercised (1,386,500) 0.20 (1,126,602) 0.20 Forfeited (114,000) 0.20 (447,458) 15.79 ----------- ---------- Outstanding at end of year 9,140,900 $ 1.00 8,863,840 $ 2.41 =========== ========== Options exercisable at year-end 2,282,251 3,878,682 0.96 =========== ========== Weighted-average fair value of $ 0.31 $ 6.51 =========== ========== options granted during the year
The following table summarizes information about fixed stock options outstanding as of December 31, 1996:
Options Outstanding Options Exercisable ---------------------------------------------------- -------------------------------- Number of Weighted-average Weighted- Number of Weighted- options remaining average exercise options average exercise Exercise Prices outstanding contractual life price outstanding price --------------- ----------- ---------------- ----- ----------- ----- $ 0.20 7,006,365 8.35 $ 0.20 3,502,741 $ 0.20 $ 1.25 to $ 9.60 843,350 8.79 7.35 344,597 7.79 $10.80 to $15.00 738,125 9.49 12.56 31,344 10.94 $15.38 to $19.00 276,000 9.80 16.25 -- -- --------- --------- $0.20 to $19.00 8,863,840 8.53 $ 2.41 3,878,682 $ 0.96 ========= =========
Employee Benefit Plans In 1992, Pixar adopted a 401(k) Profit Sharing Plan (the 401(k) Plan) that is intended to qualify under Section 401(k) of the Internal Revenue Code of 1986, as amended. The 401(k) Plan covers substantially all of Pixar's employees. Participants may elect to contribute a percentage of their compensation to this plan, up to the statutory maximum amount. Pixar may make discretionary contributions to the 401(k) Plan; none have been made to the 401(k) Plan to date. -15- 27 PIXAR NOTES TO FINANCIAL STATEMENTS (9) COMMITMENTS Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 1996, were as follows (in thousands):
Year ending December 31, - ------------ 1997 $ 1,922 1998 2,388 1999 2,175 2000 1,486 2001 267 ------- Total minimum lease payments $ 8,238 =======
Rental expense from operating leases amounted to approximately $887,000, $925,000 and $1,236,000 for the years ended December 31, 1994, 1995, and 1996, respectively. (10) SIGNIFICANT CUSTOMERS AND SEGMENT REPORTING The following table summarizes the annual percentage contribution to revenues by customers when revenues from such customers exceeded 10% of total revenues in 1994, 1995 and 1996, and the amounts due from these customers as a percentage of total accounts receivable at the corresponding year-end:
Percentage of Total Percentage of Total Revenues Accounts Receivable as of Year Ended December 31, December 31, 1994 1995 1996 1994 1995 1996 ---------------------------------------- --------------------------------------- J. Walter Thompson USA, Inc. 13% --- --- --- --- --- Eastman Kodak Company 11% --- --- 16% --- --- Microsoft Corporation --- 54% --- --- --- --- Disney --- --- 65% --- --- 34% Silicon Graphics, Inc. --- --- 24% --- --- ---
-16- 28 PIXAR NOTES TO FINANCIAL STATEMENTS Pixar operates principally in three business segments: software, animation services, and film. Financial information relating to business segments follows (in thousands):
Year Ended December 31, 1994 1995 1996 --------- --------- -------- Revenues: Software $ 3,323 $ 3,144 $ 6,306 Animation services 2,267 2,469 3,947 Film -- -- 18,847 Corporate and other -- 6,500 9,127 --------- --------- -------- $ 5,590 $ 12,113 $ 38,227 ========= ========= ======== Income (loss) from operations: Software $ (2,416) $ (495) $ 1,587 Animation services 63 (55) 302 Film (484) (3,826) 9,308 Corporate and other -- 5,407 7,997 --------- --------- -------- $ (2,837) $ 1,031 $ 19,194 ========= ========= ======== Depreciation expense: Software $ 111 $ 125 $ 176 Animation services 153 158 95 Film 35 104 251 Corporate and other 75 80 210 --------- --------- -------- $ 374 $ 467 $ 732 ========= ========= ======== Capital expenditures: Software $ 70 $ 317 $ 942 Animation services 300 133 51 Film 207 340 1,694 Corporate and other 12 178 1,149 --------- --------- -------- $ 589 $ 968 $ 3,836 ========= ========= ======== Identifiable assets: Software $ 784 $ 1,104 $ 3,832 Animation services 485 769 627 Film 389 5,534 6,882 Corporate and other 238 145,608 166,122 --------- --------- -------- $ 1,896 $ 153,015 $177,463 ========= ========= ========
(11) SUBSEQUENT EVENTS On February 24, 1997 Pixar and Disney entered into a co-production agreement (Co-Production Agreement) pursuant to which Pixar, on an exclusive basis, will produce five computer animated feature-length theatrical motion pictures (the Pictures) for distribution by Disney over approximately the next ten years. Pixar and Disney will co-own and co-brand the Pictures, and co-finance the production costs. Pixar and Disney will share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of certain costs. The Co-Production Agreement generally provides that Pixar will produce each Picture and Disney will control all decisions relating to marketing, promotion, publicity, advertising and distribution of each Picture. Pixar is obligated to pay 5% of its compensation based on revenue from the distribution of each of the Pictures under the Co-Production Agreement to a third party in consideration for services rendered. The compensation is subject to a cap of $500,000 for each theatrical motion picture and a cap of $200,000 for each sequel or remake, with a total aggregate cap of $3,000,000. The Co-Production Agreement provides Pixar with the option to produce and co-finance any future CD-ROM or interactive products based on the Pictures and to share equally in the profits, after recovery of marketing and distribution costs. However, after entering into the Co-Production Agreement, Pixar made a decision to discontinue its business of producing CD-ROM and other interactive products and to devote related resources to other projects arising from the Co-Production Agreement. The CD-ROM and interactive products division reported revenues of $-0- and $3,009,000 in 1995 and 1996, respectively, and losses from operations of $1,830,000 and $1,101,000 in 1995 and 1996, respectively. The CD-ROM and interactive products division will be recorded as discontinued operations during the first quarter of 1997. -17- 29 PIXAR NOTES TO FINANCIAL STATEMENTS In connection with the Co-Production Agreement, Pixar sold to Disney 1,000,000 shares of Pixar Common Stock which Disney has agreed to hold for at least three years. Pixar also granted two warrants to Disney: one warrant to purchase 750,000 shares of Common Stock at an exercise price of $20.00 per share, and another warrant to purchase 750,000 shares of Common Stock at an exercise price of $25.00 per share. Pixar granted certain registration rights for the shares issuable upon exercise of the warrants. Gross proceeds on the transaction were $15,000,000. -18- EX-23.1 9 CONSENT OF INDEPENDENT AUDITORS 1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Pixar: We consent to the incorporation by reference in the registration statement (No. 33-99838) on Form S-8 of Pixar of our reports dated January 31, 1997, except as to Note 11, which is as of March 25, 1997 relating to the balance sheets of Pixar as of December 31, 1995 and 1996, and the related statements of operations, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1996, and the related schedule, which reports appear or are incorporated by reference in the December 31, 1996, annual report on Form 10-K of Pixar. KPMG PEAT MARWICK LLP Palo Alto, California March 25, 1997 EX-27.1 10 FINANCIAL DATA SCHEDULE
5 1,000 US DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 44,648 116,321 6,319 (323) 0 169,642 7,245 (2,590) 177,463 6,659 0 0 0 187,308 (16,504) 177,463 0 38,227 0 4,703 14,330 0 0 27,225 1,906 0 0 0 0 25,319 .54 .54
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