PIXAR \CA\ - 10-K Annual Report

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 (the “Act”) 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 þ No o

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. þ

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o

As of June 29, 2002, the last day of the Registrant’s most recently completed second fiscal quarter, there were 50,175,152 shares of the Registrant’s Common Stock outstanding, and the aggregate market value of such shares held by non-affiliates of the Registrant (based on the closing sale price of such shares on the Nasdaq National Market on June 28, 2002) was approximately $497 million. Shares of the Registrant’s Common Stock held by each executive officer and director and by each entity that owns 5% or more of the Registrant’s 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.

As of March 4, 2003, there were 53,180,410 shares of the Registrant’s Common Stock outstanding.

This Annual Report on Form 10-K contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995, particularly statements referencing the targeted release dates of our feature films, our anticipated revenues and operating expenses, and our expectations regarding any future distribution agreement we may enter into. In some cases, forward-looking statements can be identified by the use of words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “is scheduled for,” “targeted,” and variations of such words and similar expressions. Such forward-looking statements are based on current expectations, estimates and projections about our industry and management’s beliefs and assumptions. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict; therefore, actual results and outcomes may differ materially from what is expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under “Risk Factors” on pages 16 through 30. Particular attention should be paid to the cautionary language in Risk Factors “— To meet our fiscal 2003 earnings projections, we are dependent on our feature films and the accuracy of our forecasts,” “— Our operating results have fluctuated in the past, and we expect such fluctuations to continue,” “— Our scheduled successive releases of feature films will continue to place a significant strain on our resources,” and “— The Co-Production Agreement imposes several risks and restrictions on us.” Unless required by law, we undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

Pixar was formed in 1986 when Steve Jobs purchased the computer division of Lucasfilm and incorporated it as a separate company. We are a leading digital animation studio with the creative, technical and production capabilities to create a new generation of animated feature films and related products. Our objective is to create, develop and produce computer-animated feature films with heartwarming stories and memorable characters that appeal to audiences of all ages. Through the creation of entertaining, enduring and successful films, we seek to maintain our position as a leading brand in animated feature films. To date, we have created and produced four full-length animated feature films, Toy Story, A Bug’s Life, Toy Story 2, and Monsters, Inc., which were marketed and distributed by The Walt Disney Company (along with its subsidiaries hereinafter referred to as “Disney”). Our films had combined worldwide box office receipts of more than $1.7 billion and hold four positions in the top nine grossing animated films of all time. Toy Story was released in 1995 and generated over $362 million in worldwide box office revenue. Our second animated feature film, A Bug’s Life, was released in 1998 and generated over $363 million in worldwide box office revenue. Our third film, Toy Story 2, was released in 1999 and generated over $485 million in worldwide box office revenue. Our fourth and latest animated feature film, Monsters, Inc., was released in November 2001 and generated over $524 million in worldwide box office revenue, making it the second highest grossing animated feature film of all time and the fourth highest grossing film released in 2001. Our fifth animated feature film, Finding Nemo, is scheduled for domestic theatrical release on May 30, 2003.

In 1997, we extended our original relationship with Disney (under which Toy Story was created and produced) by entering into the Co-Production Agreement. Under the Co-Production Agreement, we agreed to produce, on an exclusive basis, five original computer-animated feature films (the “Pictures”) for distribution by Disney. Pixar and Disney agreed to co-finance and co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after Disney recovers all marketing and distribution costs and fees. The first two original Pictures produced under the Co-Production Agreement were A Bug’s Life and Monsters, Inc. We are currently in various stages of production on the final three Pictures under this agreement: Finding Nemo, The Incredibles, and Cars. As a sequel, Toy Story 2 did not count toward the Pictures; however, it was produced under the Co-Production Agreement and is afforded the same financial terms as the Pictures. See “— Relationship with Disney — Co-Production Agreement.”

The term of the Co-Production Agreement continues until delivery to Disney of our fifth Picture, Cars, which is currently targeted for a 2005 holiday release. We may, however, enter into another distribution agreement with any third party after the delivery of our third Picture, Finding Nemo, which is expected to occur prior to May 30, 2003. We have produced four tremendously successful films to date, and we believe that this success combined with the strength of our financial resources position us to negotiate an arrangement with more favorable economic terms. Although we look forward to a more favorable agreement for films released after Cars, such an agreement may also increase our risks. See “— Relationship with Disney” and “Risk Factors — We face various distribution risks with respect to our feature films.”

Our principal executive offices are located at 1200 Park Avenue, Emeryville, California 94608. Our telephone number is (510) 752-3000, and our Internet home page is located at www.pixar.com; however, the information in, or that can be accessed through, our home page is not part of this report. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports are available, free of charge, on our Internet home page as soon as reasonably practicable after we electronically file such material with, or furnish it to the SEC.

Our goal is to maintain our position as a leading brand in family entertainment through the development and production of high quality animated films and related products, such as video products, toys, interactive games, and other merchandise. A critical part of our strategy to achieve our position as a leading brand was to secure strong marketing and distribution of our films. Consequently, we entered into the Co-Production Agreement with Disney, which has allowed us to leverage off Disney’s marketing expertise and substantial distribution infrastructure to market and distribute our co-branded feature films and related products.

Animated Feature Films. Our first animated feature film, Toy Story, was released in November 1995. In November 1998, we released A Bug’s Life, our second animated feature film with Disney. A Bug’s Life was the first of the Pictures to be developed and distributed under our Co-Production Agreement with Disney. In November 1999, we released Toy Story 2, the theatrical sequel to Toy Story and our third animated feature film produced for distribution by Disney. While not counting as one of the five original Pictures, Toy Story 2 is subject to the same terms as the five Pictures developed and produced under the Co-Production Agreement. In November 2001, we released Monsters, Inc., our second Picture under the Co-Production Agreement. Finding Nemo, our third Picture under the Co-Production Agreement, is scheduled for its domestic theatrical release on May 30, 2003.

We intend to continue to develop original computer-animated feature films for the family entertainment market. We are currently in various stages of production on three other original animated feature films: The Incredibles, Cars and our first feature film produced outside of our existing Disney relationship (“Project 2006”). The Incredibles and Cars will be produced and distributed under the Co-Production Agreement and will count as the remaining two films of the original five Pictures to be produced under the Co-Production Agreement. Brad Bird, who previously directed and wrote the screenplay of the critically acclaimed animated feature The Iron Giant, is currently working on The Incredibles, which is targeted for a 2004 holiday release. John Lasseter, the Director of Toy Story, A Bug’s Life, and Toy Story 2, and Executive Producer for Monsters, Inc. and Finding Nemo, is currently directing Cars, which is targeted for a 2005 holiday release. Project 2006 was approved for production in February 2003 and is currently targeted for a 2006 release. See “Risk Factors — Our scheduled successive releases of feature films will continue to place a significant strain on our resources.”

Home Videos. Home video sales, including VHS and DVD formats, continue to be among the largest contributors to lifetime revenues of our films. With the increasing popularity of the DVD format, more homes are creating DVD libraries, and we believe that DVD adoption will continue to increase. The increasing popularity of the DVD format is one factor that contributed to the tremendous success of the Monsters, Inc. domestic home video release, eventually making Monsters, Inc. the best selling home video of 2002 with sales of 20 million units in the U.S. (11.4 million DVD units and 8.6 million VHS units). Monsters, Inc. home video was released in the U.S. on September 17, 2002 in both VHS and a 2-Disc Special Edition DVD. Both

We expect DVD penetration to continue to have a favorable impact on the sales of our titles on home video, especially in many foreign territories where the DVD adoption rate has lagged behind that of the U.S. As of the end of the fourth quarter of 2002, we had recognized 10.4 million units sold in the foreign market (3.7 million DVD units and 6.7 million VHS units) for Monsters, Inc. As of the end of 2002, we have recognized Monsters, Inc. home video net sales of 30.4 million units of DVD and VHS worldwide. As more consumers worldwide build their DVD film libraries, we expect to see not only a shift in the DVD/ VHS ratio toward DVD, but also an increase in the overall sales of home videos. We believe increasing worldwide penetration of DVDs will favorably benefit the release of our new titles on home video as well as potentially create incremental sales of our existing titles.

Disney initially released Toy Story on home video in the VHS format in October 1996. In April 1999, A Bug’s Life was released on home video in VHS and DVD formats. As part of Disney’s domestic home video strategy to reinvigorate sales, Disney re-released Toy Story (in VHS format only) and A Bug’s Life (in both VHS and DVD format) as part of their Gold Collection in January 2000 and August 2000, respectively. In October 2000, Disney released Toy Story 2 in VHS and DVD formats. The Toy Story 2 DVD release occurred simultaneously with the Toy Story DVD release as both films were packaged into a 2-disc pack and a 3-disk “Ultimate Toy Box” Collector’s Edition, which includes a third disk with behind-the-scenes footage and additional supplemental materials. Distribution of home video versions of the animated feature films developed and produced under the Co-Production Agreement is governed by the Co-Production Agreement.

We continue to explore opportunities to maximize the home video sales of our library titles. For example, both Toy Story and Toy Story 2 are planned to go on a moratorium beginning May 1, 2003. This strategy is designed to boost sales volume prior to the moratorium and support a higher sales price upon re-entry into the market in future periods. In the past, this strategy has been effective for other Disney titles; however, we anticipate a shorter moratorium period for Pixar titles.

Television. The television market for our feature films generally follows the theatrical and home video release. Toy Story aired on ABC in 1997 to kick off ABC’s “Wonderful World of Disney.” It also aired on The Disney Channel for several months following its television debut on ABC. In October 2000, A Bug’s Life became the first major animated title distributed by Disney to air on Pay-Per-View. Toy Story 2 began its Pay-Per-View window in March 2001. We also broke ground in 2001 in the television market with the licensing of Toy Story, A Bug’s Life and Toy Story 2 in the domestic network market and in the international broadcast and premium television markets. Monsters, Inc. was made available to Pay-Per-View during the latter half of 2002. Monsters, Inc. made its pay television debut on Starz!/ Encore in March 2003, the first time a Pixar title has been licensed to a premium cable network. We expect Monsters, Inc., Finding Nemo, The Incredibles and Cars to be sold to all television windows, including Pay-Per-View, pay television and network television. Distribution of television rights for the animated feature films developed and produced under the Co-Production Agreement are governed by the Co-Production Agreement.

Merchandise and Interactive Games. We believe the characters, story and music created in our animated feature films provide significant revenue generation opportunities through various consumer products such as toys and interactive games. Distribution of consumer products and licensing of merchandising based on the animated feature films developed and produced under the Co-Production Agreement are governed by the Co-Production Agreement.

Short Films. Producing short films allows us to develop creative talent and computer animation technology. We have produced a number of short films since our inception and plan to continue to invest in developing new short films. For example, in 1997 we created and produced a short film titled Geri’s Game, which enabled us to further our technology in computer-generated skin and cloth. In 2000, we created and produced a short film titled For the Birds, which enabled us to further our technology in computer-generated fur and feathers. The acclaimed John Lasseter-directed Pixar short, Knick Knack, will accompany Finding Nemo in theaters.

RenderMan®. We have been selling our RenderMan® software for nearly fifteen years. RenderMan® has helped visual effects studios create visual effects in nearly 100 films. Of the last 35 films nominated to receive an Academy Award® for visual effects, 32 have used RenderMan®. RenderMan® runs on three popular platforms: IRIX, Linux and Windows. Examples of RenderMan® customers include movie and special effects studios such as Disney, Lucasfilm Ltd. through its affiliate Industrial Light and Magic (“ILM”), Sony Pictures Imageworks and Dreamworks SKG. RenderMan® is also used in television broadcasting. Customers also include government agencies and universities around the world. See “— Technology — RenderMan®” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The development and production of animated feature films is extremely complex and time consuming due to the very large number of frames and intricate detail of each frame. At 24 frames per second, a 92-minute animated feature film such as Monsters, Inc. requires approximately 133,000 individual frames. Animation for feature films has traditionally been created through hand-drawn cels, requiring hundreds of people working for two to three years. Although computers have been used to assist in some elements of cel animation during the past several years, most frames are still hand-drawn.

We believe that our 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.

We make our computer-animated feature films and other projects in four stages: creative development, pre-production, production and post-production. Because this process is iterative, there is continuous reworking of the film. The basic elements of this highly complex process are outlined below.

Creative development is an iterative process in which the story and its characters are created and developed. The first step 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 pre-production stage begins when the screenplay is turned into story boards, which are panels filled with thousands of sketches that represent the story to be animated. The story boards are then transferred to film or video so that they can be electronically edited into a photo play of the film called a story reel, a process that enables editing of the film before the production phase begins. Voices are then selected, recorded and added to the story reel. Animated dioramas, which are test sequences to prove that the major technical issues in creating the film have been addressed, are also created in pre-production. Throughout the creative development and pre-production processes, plans are developed for the style, colors and look of the film.

Our production stage consists of six phases: modeling and rigging, 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 rigs, the sets of animation controls that allow the model to be moved or animated. In some cases, a digitized 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 by changing the animation controls over time to create a motion sequence. The next step in completing a scene requires attaching to each object and model a description of its surface characteristics. These “shaders” describe the pattern, texture, finish and color for every object in the scene. Next, lighting is added by placing digital lights into the scene. In the rendering phase, the renderer takes the modeling, layout, animation, shading and lighting data and, for each frame in the sequence, computes a three-dimensional image of what the scene looks like at that point in time from the point of view of the camera. The final rendering of a single frame takes an average of one to four hours, but a small percentage of more complex frames can take much longer, between 20 and 40 hours each or more. The final rendered digital image is then sent to our PixarVision® laser recorders to be printed onto film. While film is the primary means of distributing motion pictures to theaters, digital electronic projectors have achieved the brightness and high resolution necessary to project movies on theater screens without the use of film. As our films are produced digitally, they are uniquely suited to this method of presentation. Toy Story 2 was shown digitally in 12 theaters worldwide, making it the first completely computer-animated feature film to be shown digitally. Monsters, Inc. was shown digitally in 37 theaters worldwide, and we expect that Finding Nemo will be shown even more widely on the world’s 159 digital screens.

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 final color correction, and final prints are made. If the film is shown digitally, as was the case in a small number of theaters with Toy Story 2 and Monsters, Inc., we transfer the original rendered data for each frame onto a digital image compression device, which is then used to project the movie electronically. In the sound process, the sound effects and musical score are added and the final sound is mixed. Our post-production is simpler than post-production in a live-action film, which requires more significant editing. In most live-action films, many hours of film are shot, and the film is then significantly edited and re-edited in the post-production stage to create a feature film. We, like other animation studios, edit the film throughout the entire creative development and production process. Thus post-production involves only final editing and scoring.

Our creative and technical personnel have collaborated since our founding to produce three-dimensional computer-animated films. The principal objective of our creative group is to create heartwarming stories with memorable characters utilizing the medium of computer animation. The members of our 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 Animated Short Film. In 1988, another of our short films, Tin Toy, became the first computer-animated film to win the Academy Award® for Best Animated Short Film. In 1998, our animated short film, Geri’s Game, also won an Academy Award® for Best Short Animated Film. In 2000, Toy Story 2 won a Golden Globe Award for Best Picture, Musical or Comedy. In

2002, Monsters, Inc. was nominated for four Academy Awards® including Best Animated Feature Film, Best Song, Best Original Score and Best Sound Editing and received the Academy Award® for Best Song. Our short film For the Birds won an Academy Award® for Best Animated Short Film in 2001 and our latest short film, Mike’s New Car, was nominated for an Oscar® in 2002 for Best Animated Short Film. 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.

John Lasseter is Executive Vice President, Creative and the senior creative officer at Pixar. Mr. Lasseter is an Academy Award®-winning director and animator, the Director of Toy Story, A Bug’s Life, and Toy Story 2 and Executive Producer for Monsters, Inc. and Finding Nemo. Other directors working with Mr. Lasseter include Andrew Stanton, Brad Bird and Pete Docter. Finding Nemo, scheduled for release on May 30, 2003, is written and directed by Academy Award®-nominee Andrew Stanton, who served as co-director and co-screenwriter of A Bug’s Life and was co-screenwriter of Toy Story, Toy Story 2, and Monsters, Inc. Brad Bird previously directed and wrote the screenplay of the critically acclaimed animated feature, The Iron Giant, and is currently working on The Incredibles, which is targeted for a 2004 holiday release. Also working with Mr. Lasseter is Pete Docter, the Director of Monsters, Inc. and Academy Award®-nominee for his role in creating the original story for Toy Story. Mr. Docter is working on our projects beyond Project 2006.

Under each director is a strong creative team consisting of highly skilled story artists, animators and other artists trained in the art of animation, especially computer-animation. 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, sets, color, textures, shading and lighting. Animators are responsible for bringing the characters to life. It is also common for creative contributions to come from the technical group. Our research and development department is responsible for creating and further advancing our distinctive computer animated visual effects, such as the moving fur in Monsters, Inc. or the underwater “murk” in our upcoming film, Finding Nemo. Our proprietary software tools enable artists unfamiliar with computers to quickly become skilled in the art of three-dimensional animation. All groups work closely together in an iterative process. We have a cooperative working environment and a non-hierarchical culture whereby each member of the creative team, regardless of position or department, considers the ideas of any other member of the team. See “Risk Factors — Our success depends on certain key employees.”

The success of each animated film developed and produced by us depends in large part upon our ability to produce the type of content that will appeal to a broad audience and to develop compelling stories and characters. Traditionally, this process has been extremely difficult. While we have enjoyed box office success with Toy Story, A Bug’s Life, Toy Story 2, and Monsters, Inc., there can be no assurance that similar levels of success will be achieved by our subsequent films, including Finding Nemo, The Incredibles, and Cars. In addition, there can be no assurance that voices and other intellectual property rights used in the animated feature film will be available for use in any sequel or other products related to each feature film. See “Risk Factors — In order for our feature films and related products to be successful, we must develop appealing creative content.”

Our technology is an important component of our films, and our research and development department is a key strategic asset of the company. Members of this group were responsible for many of the key, award-winning inventions that make three-dimensional computer animation possible, including texturing, shading, motion blur and cloth simulation. We continue to make a significant investment in technology in order to help maintain a competitive advantage in this fast moving field.

We have three core proprietary technologies: (1) Marionette^TM, an animation software system for articulating, animating and lighting, (2) Ringmaster^TM, a production management software system for scheduling, coordinating and tracking of a computer animation project and (3) RenderMan®, a rendering software system for high quality photo-realistic image synthesis that we use internally and licenses to third

Marionette^TM. Marionette^TM is our software system for articulating, animating and lighting for computer animation. Marionette^TM 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, computer video games or cinematic special effects, Marionette^TM has been designed and optimized for character articulation and animation. Marionette^TM is used on Linux and Unix workstations.

Ringmaster^TM. Ringmaster^TM 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. Our production coordination staff uses Ringmaster^TM to plan and track projects ranging from short animation projects to animated feature films.

A key component of Ringmaster^TM is a distributed rendering system for managing the huge quantity of images and data that must be rendered to create our products. We do our rendering on a large array of powerful computers, which are dedicated to rendering 24 hours a day. These machines, which we call the RenderFarm, are connected via a local area network. To achieve the desired quality level, the average time to render a single frame at film resolution is between one and four hours. Since an animated feature film contains well over 100,000 frames, each of which may be rendered several times in the production process, we typically have a large number of frames to render at any given time. To manage this process, Ringmaster^TM coordinates and schedules all the processors in the RenderFarm. Ringmaster^TM 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^TM 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 we use internally and also license to third parties. Today, RenderMan® is used by many major film studios and special effects firms. RenderMan® was designed to be easily portable. It is available on three popular platforms: IRIX, Linux and Windows.

A critical component of our objective to maintain our position as a leading brand in the animated feature film market is to secure strong promotion, marketing and distribution of our films and related products. We believe that Disney is a leader in the marketing and distribution of animated feature films and related products and one of the industry’s most widely recognized brand names. We have enjoyed a long relationship with Disney that dates back to 1986, when we entered into a joint technical development effort with Disney that resulted in the Computer Assisted Production System (“CAPS”), a production system owned and used by Disney in some of its two-dimensional cel-based animated feature films. Disney first used CAPS for The Rescuers Down Under and has continued to use it for its subsequent animated feature films, such as The Lion King and Tarzan. In 1992, certain employees of Pixar and Disney were jointly awarded an Academy Award® for Scientific and Engineering Achievement for the development of CAPS.

In May 1991, we entered into the 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 was pursuant to the Feature Film Agreement that Toy Story was developed, produced and distributed. In 1997, we extended our existing relationship with Disney by entering into the Co-Production Agreement. This agreement generally provides that we will be responsible for the development, pre-production and production of each Picture, while Disney will be responsible for the marketing, promotion, publicity, advertising and distribution of each Picture. The profits from the Pictures are shared equally between Pixar and Disney after Disney recovers a distribution fee and pre-agreed distribution costs. The term of this arrangement continues until the delivery of Cars to Disney, which we expect to occur in 2005.

We have produced four tremendously successful films to date. We believe that the success of our track record combined with the strength of our financial resources position us to negotiate an arrangement with more favorable economic terms. Although we look forward to a more favorable agreement for films released after Cars, such an agreement may also increase our risks. See “Risk Factors — We face various distribution risks with respect to our feature films” and “Risk Factors — The Co-Production Agreement imposes several risks and restrictions on us.”

The following is a summary of the Co-Production Agreement, which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 1996 (the “1996 Form 10-K”). The following summary is not complete, and reference is made to the Co-Production Agreement filed as an exhibit to the 1996 Form 10-K. This summary is qualified in all respects by such reference. Prospective investors in our Common Stock are encouraged to read the Co-Production Agreement.

Overview. On February 24, 1997, we entered into the Co-Production Agreement with Disney pursuant to which we, on an exclusive basis, agreed to produce the Pictures for distribution by Disney. Pixar and Disney agreed to co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all marketing and distribution costs (which are 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 we are responsible for the production of each Picture and that Disney is responsible for the marketing, promotion, publicity, advertising and distribution of each Picture. The first two original Pictures under the Co-Production Agreement were A Bug’s Life and Monsters, Inc., which were released in November 1998 and November 2001, respectively. The third original Picture governed by the Co-Production Agreement will be Finding Nemo, which is scheduled to be released on May 30, 2003. Toy Story 2, the theatrical sequel to Toy Story, was released in November 1999, and is also governed by the Co-Production Agreement, although it does not count towards the Pictures. The Co-Production Agreement also contemplates that with respect to theatrical sequels, made-for-home video sequels, television productions, interactive media products and other derivative works related to the Pictures, we will have the opportunity to co-finance and produce such products or to earn passive royalties on such products. We will not share in any theme park revenues generated as a result of the Pictures.

Production. The Co-Production Agreement provides a green lighting mechanism for the five films to be developed and produced as Pictures. The Incredibles and Cars are the fourth and fifth films, respectively, to be green lit. After the green light, we have final control over 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 share equally in all production costs. Production costs are defined in the Co-Production Agreement to mean all costs and expenses we incur directly related to or fairly allocable to the creation, development, pre-production, production, post-production and delivery to Disney of the Pictures. Production costs, whether capitalized as film costs or expensed as incurred, include, among other things, all carrying costs we incur for retention of employees for production purposes and their associated overhead expenses, the costs of all treatments we prepare for submission to Disney, all costs of computer hardware and software used to develop the Pictures, and fair allocations of all costs and expenses we incur that are associated with or benefiting the Picture, including research and development, general and administrative and overhead expenses. The Co-Production Agreement provides mechanisms for the establishment of production budgets for each Picture. We may not exceed these contractually established production budgets without Disney’s written approval, subject to certain limited exceptions.

Distribution. Disney is solely responsible for financing the costs and expenses of the marketing, promotion, publicity, advertising and distribution of each Picture, subject to certain requirements, and has final control over all related decisions. Disney is obligated to consult with us regarding all such major marketing and distribution decisions, and we are entitled to designate a representative to monitor marketing and distribution of the Pictures. As the remaining three films under the Co-Production Agreement have been

approved for production, Disney has committed to initially release each Picture within certain windows and not to release other Disney family films during certain windows. Further, each Picture is to be distributed and marketed under the Walt Disney Pictures brand (or the then current Disney brand for premier 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. In addition, the costs for marketing, distribution and promotion of the films and related products are incurred well in advance of the release of such films and products, and consequently, we experience a delay in the receipt of cash proceeds from such films and products until after Disney recovers such costs.

Division of Gross Receipts. Pixar and Disney are entitled to share equally in all gross receipts remaining after deduction of: (1) a distribution fee to Disney, (2) mutually agreed participations (payments to third parties such as actors, composers and other artists contingent upon the success of the Pictures), if any, paid by either Disney or us, and (3) Disney’s distribution costs. Gross receipts include 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. 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, we receive statements and payments of our share of gross receipts monthly within 45 days after the end of each calendar month, subject to certain exceptions, and we have the right to audit Disney’s books and records relating to the Pictures and Merchandise.

Derivative Works. Subject to certain exceptions, Disney and Pixar have mutual control of the decision to develop, produce or otherwise exploit any derivative works (or to transfer or license any rights to exploit any derivative works) during the term of the Co-Production Agreement or thereafter. Derivative works include theatrical sequels such as Toy Story 2, made-for-home video sequels, television productions such as Buzz Lightyear of Star Command, interactive media products such as Monsters, Inc. and Finding Nemo interactive games, 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. We are to be given the option to co-finance and produce, or to participate on a passive financial basis with respect to, a Derivative Work that is (1) a theatrical motion picture, (2) a made-for-home video production, (3) a television production, (4) location-based entertainment that uses unique characters or other elements from any of the Pictures or Toy Story as its primary theme, or (5) an interactive product such as CD-ROMs, DVDs, video games and arcade games (collectively, “Interactive Products”).

If we elect to co-finance and produce a Derivative Work, the Co-Production Agreement provides for the following:


	(1) with respect to theatrical motion pictures and made-for-home video productions, the terms and conditions of the Co-Production Agreement are to be extended to cover such Derivative Works, subject to certain exceptions;

	(2) with respect to (A) location-based entertainment using characters or other elements from a Picture or Toy Story as its primary theme and (B) television productions, Pixar and Disney are to mutually agree upon the terms and the conditions under which such work will be financed, produced and distributed, subject to certain specified requirements in the case of television productions; and

	(3) with respect to Interactive Products, Disney and Pixar are to mutually agree upon the terms and conditions under which such Interactive Products shall be financed, produced and distributed, subject to certain commitments by Disney with respect to marketing and distribution and provided that there will be no distribution fee payable to Disney.

For live entertainment such as stage plays or ice shows, we are entitled to participate on a passive financial basis as specified in the Co-Production Agreement. For all other Derivative Works except theme parks, we are 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 us, 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 under the Co-Production Agreement. Accordingly, Toy Story 2 does not count as one of the five Pictures to be produced. Under the Co-Production Agreement, all provisions applicable to the original five Pictures apply to Toy Story 2 as well.

Creative Controls. Pixar and Disney have mutual creative control of the production of The Incredibles. Pixar has creative control of the production of Cars. The Co-Production Agreement provides for certain dispute resolution procedures in the event of a disagreement.

Brand/Credit. The Co-Production Agreement sets forth Disney’s and Pixar’s intent that the Pixar brand be established as an 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 that is perceptually equal to the Disney logo, animated logo and credit, subject to certain specific requirements.

Exclusivity. We have agreed not to release or authorize the release of any feature-length animated theatrical motion picture we produce, other than the Pictures and Derivative Works we produce under the Co-Production Agreement, until twelve months from delivery of the fifth Picture, Cars, under the Co-Production Agreement. We have further agreed that we will not enter into any agreement with any third party for the development, production or distribution of any feature-length animated theatrical motion picture until after we have delivered the third Picture, Finding Nemo, to Disney under the Co-Production Agreement, which is currently scheduled to occur prior to May 30, 2003. We have also agreed that we will not develop or produce any rides or attractions for major theme parks not owned or operated by Disney, and to give Disney a right to negotiate with respect to animated television productions or animated made-for-home video productions that we propose to produce during the term of the Co-Production Agreement. Disney, however, is not similarly restricted by the exclusivity provisions that bind us under the Co-Production Agreement and, therefore, may develop, produce, or distribute other feature-length animated and computer-animated theatrical motion pictures itself or enter into similar agreements with third parties. See “— Competition.”

Proprietary Rights. Under the Co-Production Agreement, 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 ancillary rights relating thereto, shall be jointly owned by Disney and Pixar on an undivided 50/50 basis, subject to our ownership rights in the technology and excluding any intellectual property rights previously owned by us or Disney. Notwithstanding the foregoing, Disney has the exclusive distribution and exploitation rights with respect to the Pictures, Derivative Works and ancillary rights relating thereto. We own the copyright and all other intellectual property rights in and to all computer programs and other technology we develop or discover before, during or after the term of the Co-Production Agreement.

Term and Termination. The term of the Co-Production Agreement continues until delivery to Disney of the fifth Picture produced and financed under the Co-Production Agreement, unless earlier terminated. For example, Disney is 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 we merge or consolidate into such a competitor. Upon termination by Disney pursuant to the example above, Disney has certain rights to compel us 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 that we have delivered to Disney or which Disney elects to have completed, as well as all future Merchandise and future Derivative Works relating thereto, but otherwise terminates.

Effect on Prior Agreements. All Derivative Works based on Toy Story including Toy Story 2 are to be governed by the Co-Production Agreement and not the original Feature Film Agreement. 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 certain 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), subject to certain exceptions, and otherwise has no further force or effect.

We experience intense competition with respect to animated feature films, animation products and software. Our animated feature films compete and will continue to compete with family-oriented animated and live action feature films and other family-oriented entertainment products produced by major movie studios, including Disney (as somewhat limited by the Co-Production Agreement), DreamWorks SKG, Warner Brothers, Sony Pictures Entertainment (“Sony”), Fox Entertainment Group Inc. (“Fox”), Paramount Pictures (“Paramount”), Lucasfilm Ltd. (“Lucasfilm”), Universal Studios, Inc. and MGM/UA, as well as numerous other independent motion picture production companies. We expect new entrants to our market as more studios achieve success in their animated films. Independent studios may also seek production and distribution partners.

Intense competition exists in the family-oriented, animated and live action feature film market. Some of the family-oriented animated and live action feature films released theatrically in 2002 included the following:


	•	Ice Age by 20th Century Fox/ Blue Sky Studios,

	•	The Rookie by Disney,

	•	Spiderman by Sony,

	•	Spirit: Stallion of the Cimarron by Dreamworks,

	•	Scooby-Doo by Warner Brothers,

	•	Lilo and Stitch by Disney,

	•	Miyazaki’s Spirited Away by Studio Ghibli,

	•	Harry Potter and the Chamber of Secrets by Warner Brothers, and

	•	The Wild Thornberrys Movie by Paramount.

The release of Monsters, Inc. in 2001 was highly successful, resulting in worldwide box office revenues exceeding $524 million. Another animated family-oriented feature film released during 2001, Shrek, achieved worldwide box office revenues of over $477 million. We also experienced competition from a non-animated family-oriented film, Harry Potter and the Sorcerer’s Stone, which was released by Warner Bros. during November 2001. There appears to be increasing widespread acceptance for those films created by using Computer Graphics Imagery (CGI), as demonstrated by the success of Monsters, Inc., Shrek, and Jimmy Neutron: Boy Genius, which had combined worldwide box office revenues of approximately $1.1 billion. Additionally, all three Oscar® nominations in the new Best Animated Feature Film category for 2001 were awarded to these three CGI films. In addition to box office competition, other family-oriented films may continue to compete with Monsters, Inc. and Finding Nemo, as well as our film library, with respect to related television, merchandise, home video, and other future revenue sources.

We believe competition from animated feature films and family-oriented feature films may intensify over the next several years, possibly affecting Finding Nemo, which is currently targeted for release on May 30, 2003, The Incredibles, which is currently targeted for a 2004 holiday release, and Cars, which is currently targeted for a 2005 holiday release. Due to a potentially large number of family-oriented films scheduled for release over the next few years, it is possible that the market for these films, whether animated or live action,

Our films will continue to compete with the feature films of other movie studios for optimal release dates, audience acceptance, and exhibition outlets. In addition, we compete and will continue to compete with other movie studios for the services of performing artists, and the services of other creative and technical personnel, particularly in the fields of animation and technical direction. Some of the movie studios with which we compete have significantly greater financial, marketing and other resources than we do.

Several movie studios have developed their own internal computer animation capability specifically for the production of animated films and live action films. For example, DreamWorks SKG (with PDI) successfully produced Antz in 1998 and Shrek in 2001. Fox successfully produced, through its subsidiary Blue Sky, Ice Age, which was released in 2002. Other movie studios may internally develop, enter into a co-production agreement with a third party, license or sub-contract three-dimensional animation capability. Further, we believe that continuing enhancements in commercially available computer hardware and software technology have lowered and will continue to lower barriers to entry for studios or special effects companies which intend to produce computer-animated feature films or other products. For example, SGI’s Alias/ Wavefront subsidiary licenses “Maya,” which is its next generation three-dimensional software for creating high quality animation and visual effects. “Maya” incorporates many new features and could be used to make a computer-animated feature film.

The Co-Production Agreement provides that we will develop and produce five original computer-animated feature films. Because Disney co-finances the films developed and produced under the Co-Production Agreement, distributes the films under the “Walt Disney Pictures” label, and enjoys the financial benefits in the event that such films achieve significant box office revenues, we believe that Disney desires such films to be successful. Nonetheless, during its long history, Disney has been a very successful producer and distributor of its own animated feature films, and while the Co-Production Agreement imposes restrictions prohibiting Disney from releasing G-rated films, whether live action or animated, within certain release windows for our films, it is possible that other family-oriented motion pictures distributed by Disney or its affiliates will overlap in the market and compete with our animated feature films. Our contractual agreement with Disney also presents other risks. See “Risk Factors — The Co-Production Agreement imposes several risks and restrictions on us.”

We believe that the primary competitive factors in the market for animated feature films include creative content and talent, product quality, technology, access to distribution channels and marketing resources. Due in part to our creative and technical resources and to the Co-Production Agreement with Disney, pursuant to which Disney co-finances the production of our feature films, markets our feature films and provides creative assistance and access to significant distribution channels, we believe that we compete favorably with respect to each of these factors.

Computer Graphics Special Effects Firms. We also expect to compete with computer graphics special effects firms, including ILM, Rhythm & Hues/VIFX, Tippett Studios, Digital Domain, and Sony Pictures Imageworks. 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 us. For example, ILM has already created and produced three-dimensional character animation which was used for several central characters in the live action film Star Wars Episode II: Attack of the Clones, and ILM has a royalty-free, paid-up license to use our RenderMan® software and to obtain at no cost all enhancements and upgrades thereto. Other computer graphics special effects firms have licensed or may license RenderMan®. Accordingly, our RenderMan® software may not provide us with a competitive advantage. We also compete, or may in the future compete, with the above firms with respect to animation products other than feature films. We believe that the primary competitive factors in the market for three-dimensional computer animation for animated feature films and other animation products include creative content and talent, product quality, technology, access to distribution channels and marketing resources. We believe that we presently compete favorably with respect to each of these factors.

Software Publishers. We also experience competition with respect to our RenderMan® software product. In particular, we compete with makers of computer graphics imaging and animation software, principally SGI (which acquired Wavefront Technologies, Inc. (“Wavefront”) and Alias Research, Inc. (“Alias”)), MentalImage GMD and Avid Technologies (which distributes the MentalImage product). MentalImage, Avid and SGI (which through its Alias/ Wavefront subsidiary licenses “Maya”, a three-dimensional software for creating high quality animation and visual effects), are each marketing competing rendering software products, usually at lower prices than ours. SGI has licensed several of our patents that cover certain rendering techniques and may therefore be better able to market products that compete with our RenderMan® software. Under appropriate circumstances, we might elect to license our rendering technology patents to other companies, some of which may compete with us. In addition, as PC’s become more powerful, software suppliers may also be able to introduce products for PC’s that would be competitive with RenderMan® in terms of price and performance for professional users. We believe that the primary competitive factors in the market for rendering software include product quality, price/performance, technology, functionality, breadth of features and customer service and support. We believe that we presently compete favorably with respect to each of these factors.

We expect competition to persist, intensify and increase in each of our business areas in the future. Some of our current and potential competitors have longer operating histories, larger installed customer bases and significantly greater financial, technical, marketing and other resources than we do. There can be no assurance that we will be able to compete successfully against current or future competitors. Such competition could materially adversely affect our business, operating results or financial condition.

Our success and ability to compete is dependent in part upon our proprietary technology. While we rely on a combination of patents, copyright and trade secret protection, nondisclosure agreements and cross-licensing arrangements to establish and protect our proprietary rights, we believe that factors such as the technical and creative skills of our personnel are more essential to our success and ability to compete. We currently own twenty four patents issued in the United States and fourteen issued in foreign countries. In addition, we have a number of patent applications pending in the United States and in foreign countries. There can be no assurance that patents will issue from any of these pending applications or that, if patents do issue, any claims allowed will be sufficiently broad to protect our technology. In addition, there can be no assurance that any patents that have been issued to us, or that we may license from third parties, will not be challenged, invalidated or circumvented, or that any rights granted thereunder would provide proprietary protection to us.

The source code for our proprietary software is protected both as trade secrets and as a copyrighted work. We generally enter into confidentiality or license agreements with our employees, consultants and vendors, and generally control access to and distribution of our software, documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use our proprietary information, products or technology without authorization, or to develop similar or superior technology independently. Policing unauthorized use of our products is difficult. In addition, effective copyright and trade secret protection may be unavailable or limited in certain foreign countries. Although we generally obtain end user license agreements for our RenderMan® software product, we have also relied on “shrink wrap” licenses that are not signed by the end-user, which may be unenforceable under the laws of certain jurisdictions. There can be no assurance that the steps we take will prevent misappropriation of our technology or that our confidentiality or license agreements will be enforceable. In addition, litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results or financial condition.

One of the risks of the film production business are claims that our productions infringe on the intellectual property rights of third parties with respect to previously developed films, stories, characters or other entertainment. In addition, our technology and software may be subject to patent, copyright or other intellectual property claims of third parties. We have received, and are likely to receive in the future, claims of

infringement of other parties’ proprietary rights. There can be no assurance that infringement or invalidity claims (or claims for indemnification resulting from infringement claims) will not be asserted or prosecuted against us or that any assertions or prosecutions will not materially adversely affect our business, financial condition or results of operations. Irrespective of the validity or the successful assertion of such claims, we would incur significant costs and diversion of resources with respect to the defense thereof which could have a material adverse effect on our business, financial condition or results of operations. If any claims or actions are asserted against us, we may seek to obtain a license under a third party’s intellectual property rights. There can be no assurance, however, that under such circumstances a license would be available on reasonable terms or at all.

We also rely on certain technology that we license 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 us on commercially reasonable terms. The loss of or inability to maintain any of these technology licenses could result in delays in feature film releases or product shipments until equivalent technology could be identified, licensed and integrated. Any such delays in feature film releases or product shipments could materially adversely affect our business, operating results or financial condition.

In 1996, we entered into a license agreement with SGI whereby we granted to SGI and its subsidiaries a non-exclusive license to use certain of our patents covering techniques for creating computer-generated photo-realistic images. These same patents were licensed to Microsoft Corporation in 1995. These patents relate to pseudo-random point sampling techniques in computer graphics, which are incorporated into our RenderMan® software. The license agreements with SGI and Microsoft will expire no later than the year 2010. SGI and Microsoft may use the licensed technology in rendering products, which compete with our RenderMan® software, and could adversely impact sales of RenderMan®.

As of March 4, 2003, we had approximately 700 employees and contractors. Although none of our employees are represented by a labor union, it is common for film directors, producers, animators and actors at film production companies to belong to a union. There can be no assurance that our employees will not join or form a labor union or that we, for certain purposes, will not be required to become a union signatory. Further, we may be directly or indirectly dependent upon union members, and work stoppages or strikes organized by such unions could materially adversely impact our business, financial condition or results of operations. We have not experienced any work stoppages, and we consider relations with our employees to be good.

Our success depends to a significant extent on the performance of a number of senior management personnel and other key employees, especially our film directors, producers, animators, creative personnel and technical directors. In particular, we are dependent upon the services of Steve Jobs, John Lasseter, Ed Catmull, Sarah McArthur and Ann Mather. We do not maintain “key person” life insurance for any of our employees. We do have an employment agreement with Mr. Lasseter, who is fundamental to our relationship with Disney; however, this employment agreement does not necessarily assure his services. See “— Employment Agreements.” The loss of the services of any of Messrs. Jobs, Lasseter, Dr. Catmull, Ms. McArthur, Ms. Mather or of other key employees, especially our film directors, producers, animators, other creative personnel and technical directors, could have a material adverse effect on our business, operating results or financial condition.

The following is a discussion of certain factors that currently impact or may impact our business, operating results and/or financial condition. You should carefully consider these factors before making an investment decision with respect to our Common Stock.

To meet our fiscal 2003 earnings projections, we are dependent on our feature films and the accuracy of our forecasts.

In 2003, our revenue and operating results will be largely dependent upon (1) the timing and amount of worldwide revenues and distribution costs from Finding Nemo, Monsters, Inc. and other titles in our film library, (2) the timing, accuracy, and sufficiency of the information we receive from Disney to determine revenues and associated gross profits, (3) the timing and amount of non-film related revenues and expenses, (4) the accuracy of our assumptions and judgments used to estimate certain revenues and associated gross profits, (5) the market price of our Common Stock and related volatility, (6) potential delays in the release date of our film, and (7) external economic and political events.

Under the Co-Production Agreement, Pixar and Disney share equally in the profits of our animated feature films after Disney recovers its distribution fee and its marketing and distribution costs. Distribution costs include worldwide theatrical release costs, costs related to merchandise, Disney’s costs to market and distribute home videos in the United States and foreign markets, Disney’s distribution fee, and other distribution costs including talent participation and residuals. We remain dependent on the timing, accuracy, and sufficiency of the information provided by Disney.

For our business to be successful, our films must achieve box office success. While we have been successful in the release of our first four feature films, this level of success is unusual in the motion picture industry and our future releases may not achieve similar results. In 2003, we will be dependent on the success of Finding Nemo. Unless Finding Nemo achieves box office success and is successful in home video, television licensing, and merchandise sales, it may not generate significant revenue and operating results for us to meet our projections in 2003 and beyond.

A significant portion of our anticipated revenues for fiscal year 2003 is based on the assumption that Finding Nemo will be a success in the worldwide theatrical, domestic home video and worldwide merchandising markets. Therefore, if Finding Nemo does not generate sufficient worldwide box office receipts, domestic home video sales, or worldwide merchandise sales to be deemed successful, it would adversely impact our 2003 operating results. In addition, during 2003, we expect continued contributions from Monsters, Inc. through worldwide television licensing as well as continued worldwide home video and merchandise sales. If Monsters, Inc. does not generate sufficient revenues from these sources, our 2003 results could be adversely affected. To date, we have recognized most of the revenues we expect to recognize over the lifetime of the Toy Story franchise and A Bug’s Life. For Monsters, Inc., we have recognized essentially all of the theatrical revenues and a substantial portion of the home video revenues. Although our forecast assumes some continued revenues from these titles, there can be no assurance that revenues from continuing international television licensing, worldwide home video and merchandise sales will be sufficient to achieve our 2003 earnings projection.

Forecasting film revenue and associated gross profits from our feature films is extremely difficult.

Although we have experienced a successful track record with the releases of our feature films, it is difficult to predict the box office success of Finding Nemo. Even if Finding Nemo experiences a very successful domestic theatrical run, it is difficult to predict the ultimate worldwide theatrical revenues as well as related home video, merchandising and ancillary revenue streams. While customer acceptance is initially measured by box office success, customer acceptance within each follow-on product category, such as home video, merchandise or television, depends on factors unique to each type of product, such as pricing, competitive products, and the time of year or state of the economy in which a product is released, among many other

factors. In addition, we have found that the degree of customer acceptance varies widely among foreign countries. While box office success is often a good indicator of general customer acceptance, the relative success of follow-on products is not always directly correlated, and the degree of correlation is difficult to predict.

It is also difficult to forecast the amount of revenues from Monsters, Inc. and our other titles in our film library. The revenues generated from continued home video and merchandise sales can fluctuate due to various market factors. Because the revenues from films nearing the end of life cycle tend to be relatively small, minor fluctuations can result in notable variances from forecast. Additionally, while we expect the moratorium on Toy Story and Toy Story 2 to enhance our home video sales, the impact of this strategy is difficult to predict, particularly since these are our first titles to go on a moratorium, and may not generate the results we expect.

With respect to the difficulty of forecasting the timing of revenues, Disney distributes our films and film-related products and therefore determines the timing of product releases. While the timing of domestic release is typically known well in advance of release, the timing of international releases are less predictable. A foreign product release is often marked by a rollout across many countries over the course of many months. Therefore, the timing of international revenues is inherently more difficult to predict than the timing of domestic revenues.

In addition, the amount of revenue recognized in any given quarter or quarters from all of our films depends on the timing, accuracy, and sufficiency of the information we receive from Disney to determine revenues and associated gross profits. Although we obtain from Disney the most current information available to recognize our share of revenue and to determine our film gross profit, Disney may make subsequent adjustments to the information that it has provided, which could have a material impact on us in later periods. For instance, towards the end of the life cycle for a revenue stream, Disney may inform us, and has in the past informed us, of additional distribution costs to those previously forecasted. Such adjustments have and may continue to impact our revenue share and our film gross profit. In addition, through information we obtain from other sources, we may make certain judgments and/or assumptions and adjust the information we receive from Disney. For example, in the past, we have made adjustments to our home video revenues for estimates on return reserves that may differ from those reported by Disney. The estimates on reserves may be adjusted periodically based on actual rates of returns, inventory levels in the distribution channel, as well as other business and industry information. In addition, we utilize margin normalization in estimating associated costs, such as with merchandising or home video, in accordance with the provisions of Statement of Position 00-2 — “Accounting by Producers or Distributors of Films” (SOP 00-2). Due to these factors, the amount and timing of our future revenues and associated expenses from our films are difficult to forecast, and it is possible, in any given quarter, that we will not recognize sufficient film revenue to generate significant earnings. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of this Form 10-K.

With respect to capitalized film production costs, our policy is to amortize these costs over the expected revenue streams as we recognize revenues from the associated films. The amount of film costs that will be amortized each quarter will depend on how much future revenue we expect to receive from each film. Unamortized film production costs are compared with net realizable value each reporting period on a film-by-film basis. If estimated remaining 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. In any given quarter, if we lower our previous forecast with respect to total anticipated revenue from any individual feature film, we would be required to accelerate amortization of related film costs, resulting in lower gross margins. Such lower gross margins would adversely impact our business, operating results, and financial condition.

Our operating expenses will continue to be extremely difficult to forecast. We budget the direct costs of film productions with Disney, and we share such costs equally. We capitalize our share of these direct costs of film production in accordance with SOP 00-2. A substantial portion of all of our other costs are incurred for

the benefit of feature films (“Overhead”), including research and development expenses and general and administrative expenses. Portions of our Overhead are included in the budgets for the Pictures under the Co-Production Agreement, and we will share such costs equally with Disney under the Co-Production Agreement. With respect to the portion of our Overhead that is not reimbursed by Disney, we either (1) capitalize such portion as film production costs, if required under SOP 00-2, or (2) charge it to operating expense in the period incurred. Since a substantial portion of our Overhead is related to the Pictures, and is therefore reimbursed by Disney, and since we capitalize other amounts in accordance with SOP 00-2, our reported operating expenses for the fiscal years 2000, 2001 and 2002 have not reflected, and future reported operating expenses will not reflect, our true level of spending on the production of animated feature films, related products and Overhead. Further, as we begin production of our films beyond the Co-Production Agreement, we expect our operating expenses to continue to increase to the extent that they are not shared.

Film production budgets may increase, and film production spending may exceed such budgets.

Our future film budgets may continue to increase due to factors including, but not limited to, (1) escalation in compensation rates of people required to work on our current projects, (2) number of personnel required to work on our current projects, (3) equipment needs, (4) the enhancement of existing or the development of new proprietary technology and (5) the expansion of our facilities to accommodate the growth of the studio. Therefore, the budget for Finding Nemo, The Incredibles and Cars and subsequent films and related products may continue to be greater than the budgets for our previous films. We will continue to finance the budgets of Finding Nemo, The Incredibles and Cars equally with Disney under the Co-Production Agreement. In addition, we have approved for production our first Pixar-only financed film. Due to production exigencies which are often difficult to predict, it is not uncommon for film production spending to exceed film production budgets, and our current projects may not be completed within the budgeted amounts. In addition, when production of each film is completed, we may incur significant carrying costs associated with transitioning personnel on creative and development teams from one project to another. These carrying costs, which are currently shared with Disney and treated as film costs, increase overall production budgets and could have a material adverse effect on our results of operations and financial condition.

For 2002, software revenue represented 4% of our total revenues, and we continue to maintain minimal emphasis on the commercialization of software products. We are not increasing the time and resources necessary to generate higher RenderMan® licensing revenues; therefore, we expect that revenue from the licensing of RenderMan® may decline. However, our 2003 earnings are expected to include revenues attributable to non-film related sources including software revenue. There can be no assurance that the timing and amount of such revenues will be sufficient to meet our 2003 earnings projection.

Our 2003 earnings are expected to include our forecast of other non-film related sources such as interest income and our effective tax rate. Interest income is difficult to predict and can fluctuate depending on our cash balance as well as external factors beyond our control, such as economic conditions and interest rates available to us during the year. For example, although our average cash, cash equivalents and investment balances increased during 2002, interest income decreased due to declining interest rates during 2002. Income tax expense may also fluctuate. Our income tax rate for 2002 approximated statutory rates; however, our effective tax rate may fluctuate in future periods. There can be no assurance that the amount of other non-film revenues and expenses forecasted such as those noted above will be achieved to meet our 2003 earnings projection.

Our operating results have fluctuated in the past, and we expect such fluctuations to continue.

We continue to expect significant fluctuations in our future annual and quarterly revenues because of a variety of factors, including the following:


	•	the timing of the domestic and international theatrical releases of our animated feature films,

	•	the success of our animated feature films,

	•	the timing of the release of related products into their respective markets, such as home videos, television, and merchandising,

	•	the demand for such related products, which is often a function of the success of the related animated feature film,

	•	Disney’s costs to distribute and promote our feature films and related products under the Co-Production Agreement,

	•	Disney’s success at marketing our feature films and related products under the Co-Production Agreement,

	•	the timing and accuracy of information received from Disney and other sources on which we base estimates of revenue to be recognized from our animated feature films and related products,

	•	the timing and amount of non-film related revenues, such as the licensing of our software.

	•	the introduction of new feature films or products by our competitors, and

	•	general political and economic conditions.

In particular, since our revenue under the Co-Production Agreement is directly related to the success of our animated feature films, our operating results are likely to fluctuate depending on the level of success of our animated feature films and related products. The revenues derived from the production and distribution of an animated feature film depend primarily on the film’s acceptance by the public, which cannot be predicted and does not necessarily bear a direct correlation to the production or distribution costs incurred. The commercial success of a motion picture also depends upon promotion and marketing, production costs and other factors. Further, the theatrical success of a feature film can be a significant factor in determining the amount of revenues generated from the sale of the related products.

Operating expenses for fiscal year 2002 increased in comparison to fiscal year 2001, and we expect to continue to increase our operating expenses to fund greater levels of research and development, to ramp up our production on our current film projects and to expand operations. We expect our spending levels may still increase significantly due to the following:


	•	continued investment in proprietary software systems,

	•	increased competition costs for creative, technical and administrative talent,

	•	increased costs associated with the expansion of our facilities,

	•	increased number of personnel required to support studio growth as we move towards multiple films in parallel production,

	•	increased investment in creative development, and

	•	increased investment in administrative functions to support our expanding operations.

A portion of our operating expenses that are allocable to film productions is either capitalized by us or reimbursed by Disney under the Co-Production Agreement. To the extent that we do not capitalize (or Disney

does not pay for) the increases in expenses, our operating expenses will significantly increase in 2003. In addition, as we increase the resources allocated to our productions beyond our feature film Cars, which will be the last film to be co-financed with Disney under the current Co-Production Agreement, we expect our operating expenses to increase significantly.

Our scheduled successive releases of feature films will continue to place a significant strain on our resources.

In order to meet our obligations pursuant to the Co-Production Agreement, we have established parallel creative teams so that we can develop more than one film at a time. These teams are currently working on Finding Nemo, which is currently scheduled for release on May 30, 2003, and The Incredibles and Cars, as well as future projects, including Project 2006, our first Pixar-only financed film, as we move towards producing one feature film per year. We have only produced four feature films to date and have limited experience with respect to producing animated feature films in parallel. Due to the strain on our personnel from the effort required for the release of an upcoming film and the time required for creative development of future films, it is possible that we would be unable to release a new film in successive years. In the past, we have been required, and may continue to be required, to expand our employee base, increase capital expenditures and procure additional resources and facilities in order to accomplish the scheduled releases of our animated feature films. This growth and expansion has placed, and continues to place, a significant strain on our resources. We cannot provide any assurances that The Incredibles, Cars, Project 2006 or any future animated film will be released as targeted or that this strain on resources will not have a material adverse effect on our business, financial condition or results of operations.

In addition, John Lasseter’s availability has been a key ingredient in the successful completion of our prior films. As we move towards achieving one film a year, there will be additional demands placed on his availability. In addition to Mr. Lasseter’s role as our Creative Executive, he is also directing his next feature film, Cars. A lack of his availability may adversely impact the success and timing of all our films.

To continue to accommodate growth, we will be required to implement a variety of new and upgraded operational and financial systems, procedures and controls, including improvement and maintenance of our accounting system, other internal management systems and backup systems. In addition, this growth and these diversification activities, along with the corresponding increase in the number of our employees and rapidly increasing costs, have resulted in increased responsibility for our management team. We will need to continue to improve our operational, financial and management information systems, to hire, train, motivate and manage our employees, to integrate them into Pixar and to provide


California		68-0086179
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1200 Park Avenue, Emeryville, California (Address of principal executive offices)		94608 (Zip Code)


PART I
	Item 1. Business
	Item 2. Properties
	Item 3. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
PART II
	Item 5. Market for Registrant’s Common Stock and Related Shareholder Matters
	Item 6. Selected Financial Data
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A. Quantitative and Qualitative Disclosures About Market Risk
	Item 8. Financial Statements and Supplementary Data
	Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
PART III
	Item 10. Directors and Executive Officers of the Company
	Item 11. Executive Compensation
	Item 12. Security Ownership of Certain Beneficial Owners and Management andRelated Shareholder Matters
	Item 13. Certain Relationships and Related Transactions
	Item 14. Controls and Procedures
PART IV
	Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
SIGNATURES
CERTIFICATIONS
INDEX TO EXHIBITS
EXHIBIT 10.2
EXHIBIT 23.1
EXHIBIT 99.1


		Page

PART I
Item 1.	Business		2
	Risk Factors		16
Item 2.	Properties		30
Item 3.	Legal Proceedings		30
Item 4.	Submission of Matters to a Vote of Security Holders		30
	Executive Officers of the Company		31
PART II
Item 5.	Market for Registrant’s Common Stock and Related Shareholder Matters		32
Item 6.	Selected Financial Data		33
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		33
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		41
Item 8.	Financial Statements and Supplementary Data		42
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		42
PART III
Item 10.	Directors and Executive Officers of the Company		42
Item 11.	Executive Compensation		44
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters		47
Item 13.	Certain Relationships and Related Transactions		48
Item 14.	Controls and Procedures		48
PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		49
Signatures			73
Certifications			75

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		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


Item 1.	*Business*


	*Co-Production Agreement*


	*Our revenues fluctuate significantly*


	*Our operating expenses fluctuate*