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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

Commission File Number: 0-26976

Pixar
(Exact name of registrant as specified in its charter)

(510) 752-3000
(Registrant’s telephone number, including area code)

     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 whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [   ].

     The number of shares outstanding of the registrant’s Common Stock as of August 5, 2003 was 54,559,606.

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Pixar
FORM 10-Q
Index

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

PIXAR

BALANCE SHEETS

See accompanying notes to financial statements.

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PIXAR

STATEMENTS OF INCOME

See accompanying notes to financial statements.

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PIXAR

STATEMENTS OF CASH FLOWS

See accompanying notes to financial statements.

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PIXAR

NOTES TO FINANCIAL STATEMENTS

(1) Basis of Presentation

     The accompanying unaudited condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited condensed financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the financial condition, results of operations, and cash flows of Pixar (or the “Company”) for the periods presented. These financial statements should be read in conjunction with the audited financial statements as of December 28, 2002 and for each of the years in the three-year period ended December 28, 2002, including notes thereto, which is included in Pixar’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2003.

     The results of operations for the three and six month periods ended June 28, 2003 are not necessarily indicative of the results expected for the current year or any other period.

     Certain amounts reported in previous periods have been reclassified to conform to the 2003 financial statement presentation.

(2) Fiscal Year

     Pixar operates on a 52- or 53-week fiscal year, whereby the year ends on the Saturday nearest December 31. Fiscal year 2003 will end on January 3, 2004 and will consist of 53 weeks.

(3) Stock Option Accounting

     The Company has elected to continue using the intrinsic-value method of accounting for stock-based compensation plans in accordance with Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted those provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” which require disclosure of the pro forma effects on net income and net income per share as if compensation cost had been recognized based upon the fair value-based method at the date of grant of options awarded.

     The following table reflects pro forma net income and net income per share had the Company elected to adopt the fair value-based method (in thousands, except per share data):

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     These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period, and additional options may be granted in future years. The pro forma amounts assume that the Company had been following the fair value-based method since the beginning of 1996.

     The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average fair value of options granted was $24.70 and $23.95 for the three and six months ended June 28, 2003, respectively, and $18.61 and $16.67 for the three and six months ended June 29, 2002, respectively. Values were estimated using zero dividend yield for all years; expected volatility of 50% and 51% for the three and six months ended June 28, 2003, respectively, and 52% for the corresponding prior year periods; risk-free interest rates of 2.55% and 2.81% for the three and six months ended June 28, 2003, respectively, and 4.55% and 4.44%, respectively, for the corresponding prior year periods; and weighted-average expected lives for all periods of 5.0 years.

(4) Net Income per Share

     Basic net income per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common and dilutive potential common shares outstanding during the period, using the treasury stock method for options. Of the outstanding options to purchase shares of common stock, for the three and six months ended June 28, 2003, options to purchase approximately 59,000 shares and 56,000 shares, respectively, of common stock were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares. Options to purchase approximately 325,000 shares and 765,000 shares, respectively, of common stock were excluded for the three and six month periods ended June 29, 2002.

     The reconciliation of basic and diluted net income per share is as follows (in thousands, except per share amounts):

(5) Comprehensive Income

     Other comprehensive income consists of unrealized holding gains or losses on the Company’s investments. The following table sets forth the calculation of comprehensive income, net of income taxes (in thousands):

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(6) Feature Film and Co-Production Agreements

Feature Film Agreement

     In 1991, the Company entered into a feature film agreement with Walt Disney Pictures, a wholly owned subsidiary of Walt Disney Pictures and Television (together with its subsidiaries and affiliates collectively referred to herein as “Disney”), to develop and produce up to three computer-animated feature films (the “Feature Film Agreement”). The Company is entitled to receive compensation based on revenue from the distribution of these films and related products. In 1995, the Company released its first feature film under the terms of the Feature Film Agreement, Toy Story. Based on the individual-film-forecast-computation method, all significant Toy Story film production costs were fully amortized by the year ended December 31, 1997.

Co-Production Agreement

     In February 1997, Pixar and Disney entered into a Co-Production Agreement (the “Co-Production Agreement”) which governs all films made by the Company since Toy Story. Under the Co-Production Agreement, Pixar, on an exclusive basis, agreed to produce five original computer-animated theatrical motion pictures (the “Pictures”) for distribution by Disney. Pixar and Disney co-own, co-brand and co-finance the production costs of the Pictures, and share equally in the profits of each Picture and any related merchandise and other ancillary products, after recovery of all of Disney’s marketing, distribution and other predefined fees and costs. The Co-Production Agreement generally provides that Pixar is responsible for the production of each Picture, and Disney is responsible for the marketing, promotion, publicity, advertising and distribution of each Picture. The first three original films produced under the Co-Production Agreement were A Bug’s Life, Monsters, Inc., and Finding Nemo. Films currently in production at Pixar that are governed by this agreement include The Incredibles and Cars. A Bug’s Life, Monsters, Inc., Finding Nemo, The Incredibles, and Cars count toward the five original Pictures, whereas Toy Story 2, as a sequel, is a derivative work that does not count toward the Pictures. Under the Co-Production Agreement, all provisions applicable to the Pictures also apply to derivative works such as Toy Story 2.

     All payments to Pixar from Disney for development and production of Toy Story under the Feature Film Agreement, and A Bug’s Life, Toy Story 2, Monsters, Inc., Finding Nemo, The Incredibles, and Cars under the Co-Production Agreement have been recorded as cost reimbursements. Accordingly, no revenue has been recognized for such reimbursements; rather, the Company has netted the reimbursements against the related costs.

Creative Group

     In addition to the films produced and in process under the Co-Production Agreement, Pixar’s creative development group is working on concept development and pre-production for several new projects that are not governed by the Co-Production Agreement. Costs related to these projects, for example, the first feature film produced outside the existing Disney relationship (“Project 2006”), are therefore neither shared nor reimbursed by Disney. Such costs are capitalized as film costs and will be amortized under the individual-film-forecast-computation method. In the event a film is not set for production within three years from the time of the first capitalized transaction, all such costs would be expensed. Project 2006 was approved for production in February 2003 and is currently targeted for a 2006 release.

Components of Capitalized Film Production Costs

     The total film production costs and related amounts capitalized are as follows (in thousands):

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(1)

In the second quarter of 2003, the Company wrote-off of $1.9 million in costs previously capitalized for future film projects, which the Company determined would not be green-lighted for production within three years following their initial cost capitalization.

     Under the Co-Production Agreement, certain operating expenses benefiting the productions, such as certain research and development and certain general and administrative expenses, are paid half by Pixar and half by Disney. From the beginning of each respective fiscal year, the Company recorded the following amounts reimbursed by Disney as offsets to the following expense categories (in thousands):

     For released films, the Company expects to amortize, based on current estimates, approximately $34 million to $39 million in capitalized film production costs over the succeeding twelve-month period. In addition, the Company has amortized more than 80% of each released film’s original production costs as of June 28, 2003, with the exception of Finding Nemo, which is projected to reach the 80% milestone in the first half of fiscal 2005.

     At June 28, 2003 and December 28, 2002, receivables from Disney aggregated $46.1 million and $129.3 million, respectively, which consists of receivables for film revenue, advances net of Disney’s actual share of production expenditures for all films under the Co-Production Agreement and amounts due for miscellaneous reimbursements.

(7) Segment Reporting

     The chief operating decision-maker is considered to be the Company’s Chief Executive Officer (“CEO”). The CEO reviews financial information presented on a summary basis accompanied by disaggregated information about film revenue for purposes of making operating decisions and assessing financial performance. The summary financial information reviewed by the CEO is identical to the information presented in the accompanying statement of income, and the Company has no foreign operations. Therefore, the Company operates in a single operating segment.

     The Company’s revenue segment information by film category follows (in thousands):

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(8) Related Party Transaction

     In June 2003, we entered into an agreement to reimburse our CEO for expenses incurred by him in the operation of his private plane when used for Pixar business. During the three months ended June 28, 2003, we recognized a total of approximately $59,000 of such expenses.

(9) New Accounting Pronouncements

     In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. As used in this Statement, a legal obligation results from existing law, statute, ordinance, written or oral contract, or by legal construction of a contract under the doctrine of promissory estoppel. SFAS 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS 143 has not had an impact on the Company’s financial position or results of operations.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. The Company adopted SFAS 146 effective with the beginning of fiscal 2003. The adoption of SFAS 146 has not had an impact on the Company’s financial position or results of operations.

     In January 2003, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107 and a Recision of FASB Interpretation No. 34” (FIN 45). FIN 45 clarifies the requirements for a guarantor’s accounting for and disclosure of certain guarantees issued and outstanding in interim and annual financial statements. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, the liability for the fair value of the obligation undertaken. The disclosure requirements are effective for financial statements of interim and annual periods after December 31, 2002. The initial recognition and initial measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. The Company adopted the provisions of FIN 45 effective with the beginning of fiscal 2003. The adoption of FIN 45 has not had a material impact on the Company’s financial statements or results of operations.

     In November 2002, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 00-21, “Accounting for Revenue Arrangement with Multiple Deliverables,” which addresses circumstances involving the delivery or performance of multiple products, services, and/or rights to use assets, and for which performance may occur at different points in time or over different periods of time. Issue No. 00-21 also addresses whether the different revenue-generating activities, or deliverables, are sufficiently separable, and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables. The issue applies to all contractual arrangements under which a vendor will perform multiple revenue-generating activities. Issue No. 00-21 is effective for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. The Company adopted Issue No. 00-21 effective the beginning of fiscal 2003. The adoption of Issue No. 00-21 has not had a material impact on the Company’s financial statements or results of operations.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” that amends SFAS No. 123, “Accounting for Stock-Based Compensation.” The standard provides for (1) alternative methods of transition for an entity that voluntarily changes to the fair-value method of accounting for stock-based employee compensation, (2) requires more prominent disclosure of the effects of an entity’s accounting policy decisions with respect to stock-based employee compensation on reported income, and (3) amends APB Opinion No. 28, “Interim Financial Reporting,” to require disclosure of those effects in interim financial information. SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. The Company continues to account for employee stock options using the intrinsic value method in accordance with APB Opinion No. 25 and has adopted the additional disclosure requirements of SFAS No. 148.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995, particularly

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statements referencing the targeted release dates of our feature films, our target earnings per share for the third quarter and full year of fiscal 2003, our anticipated revenues and operating expenses and our expectations regarding any future distribution arrangement we may enter into. Such forward-looking statements are based on current expectations, estimates and projections about our industry, management’s beliefs, and assumptions made by management. 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,” variations of such words and similar expressions. 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 28. 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, Pixar undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

     The following discussion should be read in conjunction with the section entitled “Risk Factors” on pages 16 through 28 below and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 28, 2002 in addition to our interim financial statements and notes included elsewhere in this report.

Overview

     Pixar was formed in 1986 when Steve Jobs purchased the computer division of Lucasfilm and incorporated it as a separate company. In 1991, we entered into a feature film agreement (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. Our share of revenues and expenses from Toy Story, our first feature film, was governed by the terms of the Feature Film Agreement.

     In February 1997, we entered into the Co-Production Agreement (which superseded the Feature Film Agreement) with Disney pursuant to which we, on an exclusive basis, agreed to produce five original computer-animated feature-length theatrical motion pictures (the “Pictures”) for distribution by Disney. Pixar and Disney agreed to co-finance the production costs of the Pictures, co-own the Pictures (with Disney having exclusive distribution and exploitation rights), co-brand the Pictures, and share equally in the profits of each Picture and any related merchandise as well as other ancillary products, after recovery of all marketing and distribution costs (which Disney finances), a distribution fee paid to Disney and any other fees or costs, including any participations provided to talent and the like. The Co-Production Agreement generally provides that we will be responsible for the production of each Picture, while Disney will be responsible for the marketing, promotion, publicity, advertising and distribution of each Picture.

     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 do not share in any theme park revenues generated as a result of the Pictures. Pursuant to the Co-Production Agreement, in addition to co-financing the production costs of the Pictures, Disney will reimburse us for our share of certain general and administrative costs and certain research and development costs that benefit the productions.

     Our second feature film, A Bug’s Life, was released in November 1998 and counts as the first Picture under the Co-Production Agreement. In November 1999, Toy Story 2, our third animated feature film was released. As a theatrical sequel, Toy Story 2 is a derivative work of the original Toy Story, and therefore it does not count toward the Pictures to be produced under the Co-Production Agreement. However, as a derivative work, Toy Story 2 is treated for all other purposes as a Picture under the Co-Production Agreement, and all the provisions applicable to the Pictures apply.

     In November 2001, we released Monsters, Inc., our fourth animated feature film, which counts as the second Picture under the Co-Production Agreement. On May 30, 2003, we released Finding Nemo, our third Picture under the Co-Production Agreement. We are currently in various stages of production on the final two films under the Co-Production Agreement, The Incredibles and Cars. These films will count as the fourth and fifth films of the Pictures to be produced under the Co-Production Agreement. The Incredibles is currently targeted for release on November 5, 2004, and Cars is currently targeted for a holiday release in 2005.

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     All payments to us from Disney for development and production of Toy Story under the Feature Film Agreement, and A Bug’s Life, Toy Story 2, Monsters, Inc., Finding Nemo, The Incredibles, and Cars, under the Co-Production Agreement have been recorded as cost reimbursements. Accordingly, no revenue has been recognized for such reimbursements; rather, we have netted the reimbursements against the related costs.

     The statements regarding the targeted release dates for our future films are forward-looking, and the actual release dates may differ. Factors that could cause delays in the release of our films include, but are not limited to: (1) the uncertainties related to production delays, (2) financing requirements, (3) personnel availability, (4) external socioeconomic and political events, and (5) the release dates of competitive films. Please see “Risk Factors” for a more detailed discussion of these factors.

Target Earnings per Share for Fiscal 2003

     Our financial results for the next six months will depend primarily on the continued success of Finding Nemo in international theatrical markets, as well as its domestic home video release scheduled for November 4, 2003. By the end of the third quarter, Finding Nemo will have been released in nearly all Latin American territories and in many Asian territories, but not Japan. Given Finding Nemo’s success in the territories already in release, we expect the foreign box office results to be comparable to the rate of success experienced in the United States. Although Finding Nemo will not be released in the United Kingdom, France, Italy, Germany, Spain, and Japan until the fourth quarter of 2003, we will incur upfront marketing costs associated with Finding Nemo’s release in these larger international territories in the third quarter of 2003, as well as upfront marketing and release costs for the film’s domestic home video release. These marketing and release costs, which are anticipated to be significantly higher than any of our previous films, have been factored into our third quarter 2003 projections, which we are estimating to be $0.07 per diluted share.

     During the fourth quarter, revenues will be largely comprised of Finding Nemo’s domestic home video sales, which we expect to meet or exceed those of Monsters, Inc. over the film’s lifetime, and international box office receipts from the larger European territories and Japan. There will also be merchandise revenues and ancillary royalties from Finding Nemo. We expect merchandise revenues, ongoing home video sales, international television licensing and ancillary royalties relating to the sale of products from Monsters, Inc. and our library titles to be recognized throughout the remainder of the year. Our assumptions for fiscal 2003 also include continued software sales, interest income, operating expenses and an effective tax rate of approximately 40%.

     Based on our assumptions about Finding Nemo’s continued success at the domestic box office, and our expectation for comparable success in its international box office run and a successful domestic home video release, we are estimating diluted earnings per share guidance for fiscal 2003 of approximately $1.60.

     These statements regarding our targeted earnings per share are forward-looking, and actual results may differ materially. These forward-looking statements should not be relied upon as representing Pixar’s view as of any subsequent date, and Pixar undertakes no obligation to update these forward-looking statements to reflect events or circumstances after the date they were made. Factors that could cause actual results for the third quarter and full year fiscal 2003 to differ include, but are not limited to: (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 assumptions and judgments used to estimate certain revenues and associated gross profits, (5) the market price of our Common Stock and related volatility and (6) external socioeconomic and political events that are beyond our control. Please see “Risk Factors” for a more detailed discussion of these factors.

Critical Accounting Policies

Revenue Recognition

     We recognize film revenue from the distribution of our animated feature films and related products when earned and reasonably estimable in accordance with Statement of Position 00-2 — “Accounting by Producers or Distributors of Films” (SOP 00-2). The following are the conditions that must be met in order to recognize revenue in accordance with SOP 00-2:

•		persuasive evidence of a sale or licensing arrangement with a customer exists;
•		the film is complete and, in accordance with the terms of the arrangement, has been delivered or is available for immediate and unconditional delivery;

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•		the license period of the arrangement has begun and the customer can begin its exploitation, exhibition or sale;
•		the arrangement fee is fixed or determinable; and
•		collection of the arrangement fee is reasonably assured.

     Under the Co-Production Agreement, we share equally with Disney in the profits of the Pictures after Disney recovers its marketing, distribution and other predefined costs and fees. Our revenues for Toy Story are governed by the terms of the Feature Film Agreement. Although our revenues are based on the information we receive from Disney, we may make adjustments to that information based on our estimates and judgments. For example, our theatrical revenues may be adjusted for our estimated reserves on potential uncollectible amounts to be received from theatrical exhibitors. We also make 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, such as with merchandising or home video, in accordance with the provisions of SOP 00-2. This may result in the utilization of budgeted or forecasted information rather than actual costs incurred if it is deemed to be a more accurate reflection of our participation. Similar to return reserves, these expense estimates are reviewed and may be adjusted periodically to ensure the most accurate depiction of our participation is reflected. Such adjustments were made to home video reserve and home video and merchandise expense estimates during fiscal 2002 and 2003. During fiscal 2002, one-time adjustments to A Bug’s Life and Toy Story 2 home video reserves and margins and merchandising revenues had a positive net impact of $0.19 to our diluted net income per share. During the second quarter of fiscal 2003, we recognized an adjustment which reduced our Monsters, Inc. domestic home video revenue after we received additional information from Disney which reflected higher returns of domestic home video than had been originally anticipated. This adjustment reduced our home video revenues by $4.4 million and had a net impact of $0.04 to our diluted net income per share.

     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 Disney provides us with the most current information available to enable us to recognize our share of revenue and determine our film gross profit, Disney may also make subsequent adjustments to the information that it has provided, and these adjustments could have a material impact on our operating results in later periods. As additional information becomes available from Disney on a more timely basis, it may result in a change of estimation for revenue recognition. For example, we received additional information from Disney in the first quarter of fiscal 2003 which decreased previously recorded home video expenses for all of our film titles on a cumulative basis. This resulted in an increase of $0.03 to our diluted net income per share for our first quarter of fiscal 2003. Additionally, we have the right to audit Disney’s books and records related to the Pictures according to the terms of the Co-Production Agreement, which could result in adjustments that may be material to the financial statements in any given quarter or quarters. Any revenue received in advance from Disney is deferred and recorded as revenue when earned.

     In accordance with the provisions of SOP 00-2, a film is classified as a library title after three years from the film’s initial release. Currently, Toy Story, A Bug’s Life and Toy Story 2 are classified as library titles. The term library titles is used solely for the purpose of classification and for identifying previously released films in accordance with the provisions of SOP 00-2. Revenue recognition for such titles is in accordance with our revenue recognition policy for film revenue.

     Film Production Costs

     We capitalize our share of direct film production costs in accordance with SOP 00-2. Film production costs include costs to develop and produce computer animated motion pictures, which primarily consists of salaries, equipment and overhead. Film production costs in excess of reimbursable amounts from Disney are capitalized. Production overhead, a component of film costs, includes allocable costs of individuals or departments with exclusive or significant responsibility for the production of our films. Capitalized production overhead does not include administrative, general and research and development expenses. In addition to the films produced, we are also working on concept development for several new projects.

     Once a film is released, capitalized film production costs are amortized in the proportion that the revenue during the period for each film bears to the estimated revenue to be received from all sources under the individual-film-forecast-computation method. 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. We make certain estimates and judgments of our future gross revenues to be received for each film based on information received

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from Disney and our knowledge of the industry. Estimates of anticipated total gross revenues are reviewed periodically and may be revised if necessary. A change to the estimate of gross revenues for an individual film may result in an increase or decrease to the percentage of amortization of capitalized film costs relative to a previous period. 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 would be written down to fair value.

Results of Operations

     Our results for the three and six months ended June 28, 2003 were driven primarily by domestic box office revenues from Finding Nemo, revenues from worldwide television licensing, merchandise sales and ancillary royalties from Monsters, Inc. as well as continued worldwide home video sales, television licensing, merchandise sales and ancillary royalties from our library titles.

Revenue

     Total revenue, which consists of film revenue and software revenue, was $48.9 million and $67.5 million for the three and six months ended June 28, 2003 compared to $22.8 million and $59.9 million in the corresponding prior year periods.

     Film revenue for the three months ended June 28, 2003 was $45.2 million compared with $19.3 million in the corresponding prior year period. Film revenue for the three months ended June 28, 2003 consisted of $26.3 million from Finding Nemo, which related primarily to revenue from its domestic theatrical release on May 30, 2003. Film revenue for the three months ended June 28, 2003 also included $3.6 million from Monsters, Inc., which related primarily to revenues from merchandise sales and ancillary royalties, offset by a reduction of home video revenue. During the second quarter of fiscal 2002, we received additional information from Disney, which reflected higher returns than had been originally anticipated and resulted in a reduction to our revenues of $4.4 million and our diluted earnings per share of $0.04. Also included in our film revenue for the second quarter ended June 28, 2003 was $14.9 million from our library titles, Toy Story, A Bug’s Life and Toy Story 2, which largely consisted of merchandise sales, as well as continuing worldwide home video sales, worldwide television licensing and ancillary royalties.

     Film revenue for the three months ended June 29, 2002 consisted of $12.0 million from Monsters, Inc., and $7.2 million from our library titles. Revenues from Monsters, Inc. were primarily attributable to foreign theatrical box office receipts, merchandise sales, and other ancillary royalties. These revenues were offset by upfront marketing and advertising expenses associated with the home video release of Monsters, Inc. Revenues for Toy Story 2 were comprised of merchandise sales, continuing worldwide home video sales and other ancillary royalties. Revenues from A Bug’s Life and Toy Story resulted primarily from domestic network television licensing revenues for Toy Story, as well as merchandise sales and continuing worldwide home video sales for both titles.

     Film revenue for the six months ended June 28, 2003 was $61.6 million compared to $55.2 million in the corresponding prior year period. Film revenue for the first six months of fiscal 2003 was primarily comprised of domestic theatrical revenue from Finding Nemo of $26.3 million, merchandise sales and ancillary royalties, domestic television and foreign home video revenues from Monsters, Inc. totaling $12.2 million and home video revenue, merchandise sales, and other ancillary royalties from our library titles totaling $22.6 million. Monsters, Inc. revenue was offset by a reduction in domestic home video revenues as described above. Film revenue for the six months ended June 29, 2002 was comprised of foreign theatrical revenue, merchandise sales, and other ancillary royalties from Monsters, Inc. totaling $37.8 million. These revenues were offset by upfront advertising expenses associated with the home video release of Monsters, Inc. Revenues from our library titles of $15.7 million were comprised of merchandise sales, continuing worldwide home video sales, incremental worldwide television licensing and other ancillary royalties.

     On May 1, 2003, the home videos of two of our library titles, Toy Story and Toy Story 2, were placed on a sales moratorium. Although this strategy is designed to potentially increase sales over the lifetime of a title and to support a higher sales price upon re-release, it is difficult to predict the impact this strategy will actually have on our sales, particularly since these are our first feature films to be placed on a sales moratorium. See “Risk Factors — To meet our fiscal 2003 earnings projections, we are dependent on our feature films and the accuracy of our forecasts.”

     Software revenue includes software license revenue, principally from RenderMan®. Software revenue for the three and six months ended June 28, 2003 was $3.7 million and $6.0 million compared to $3.5 million and $4.6 million in the corresponding prior year periods, resulting from increases in RenderMan® software licensing sales during such periods. We continue to expect ongoing

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variability in revenues derived from software licenses, and we expect future software revenues will be comparable with the average results from previous quarters.

     For the three and six months ended June 28, 2003, Disney accounted for 92% and 91%, respectively, of our total revenue compared to 85% and 90%, respectively, for the corresponding prior year periods. The revenue from Disney consisted primarily of film related revenue. Because of our relationship with Disney under the Co-Production Agreement, Disney is expected to continue to represent significantly greater than 10% of our revenue in 2003 and for the near future.

Cost of Revenue

     Cost of film revenue for the three and six months ended June 28, 2003 was $7.8 million and $10.7 million compared to $3.6 million and $11.9 million in the corresponding prior year periods. Cost of film revenue represents amortization of capitalized film production costs. See “Capitalized Film Production Costs” below. For the three and six months ended June 28, 2003, cost of film revenue represented amortization of capitalized film production costs associated with Finding Nemo, Monsters, Inc., Toy Story 2 and A Bug’s Life, and represented 17% and 17%, respectively, of total film revenue as compared to 18% and 22% for the corresponding prior year periods. Our cost of revenue as a percentage of film revenue may vary for any given period due to changes in the mix of film revenue as the gross profit varies by film, as well as for revisions to estimates on revenue to be received under the individual-film-forecast-computation method for an individual film. A change to an individual film’s estimate of revenue to be received may result in an increase or decrease to the amortization of the capitalized film costs relative to a previous period. For the three and six months ended June 28, 2003, the decrease in our cost of revenue amortization as compared to the prior periods was due primarily to revisions to our estimates of ultimate revenue. The amortization of costs for our library titles and Monsters, Inc. have decreased relative to their respective amortization percentages in the prior year due to increases in their ultimate revenues.

     Cost of software revenue consists of the direct costs and manufacturing overhead required to reproduce and package our software products, and for periods prior to fiscal 2003, amortization of purchased technology. Cost of software revenue as a percentage of the related revenue was 0.1% and 0.4% for the three and six months ended June 28, 2003 as compared to 4% and 6% for the corresponding prior year periods. Cost of software revenue for the three and six months ended June 28, 2003 related primarily to direct costs and manufacturing overhead; however, for the three and six months ended June 29, 2002 costs of software revenue related primarily to amortization of purchased technology of $120,000 and $240,000, respectively. We had fully amortized this purchased technology against related license revenue by the end of fiscal 2002.

Operating Expenses

     Total operating expenses were $11.8 million and $16.9 million, respectively, for the three and six months ended June 28, 2003 compared to $4.2 million and $9.0 million in the corresponding prior year periods. Although we expect our operating expenses to increase as a result of the growth experienced by the studio as we ramp up to meet the demands of multiple films in production, during the three-month period ended June 28, 2003, we expensed approximately $3.2 million of costs related to a one-time incentive compensation to our employees in recognition of their contribution to the box office success of Finding Nemo. Additionally, a portion of the increase over the prior year periods was due to the write-off of $1.9 million in costs previously capitalized for future film projects. In reviewing our projects in development, we determined it unlikely that these projects will be green-lighted for production within three years following their initial cost capitalization. Therefore, under SOP 00-2, these amounts were expensed in the second quarter of fiscal 2003.

     Under the Co-Production Agreement, Disney reimburses us for half of certain general and administrative costs and certain research and development costs that benefit the productions. The funding received from Disney is treated as operating expense reimbursements. To the extent that personnel, facilities and other expenditures are not capitalized by us nor allocated to and paid for by Disney, and precede or are not subsequently followed by an increase in revenue, our business, operating results and financial condition will be materially adversely affected. For example, in February 2003, we approved our first feature film outside our existing Disney relationship (“Project 2006”) for production, and because it is our first feature film to be produced outside of the existing relationship with Disney, certain costs that have been reimbursed by Disney in our previous films will now be expensed as incurred.

     Research and Development. Research and development expenses consist primarily of salaries and support for personnel conducting research and development for our RenderMan® software and for our proprietary Marionette™ and Ringmaster™ animation and production management software and for creative development for future films. Research and development expenses increased to $6.6 million and $8.9 million, respectively, for the three and six months ended June 28, 2003 from $2.2 million and $4.6 million for

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the corresponding prior year periods. The increases were due to additional investments in research and development, higher employee related costs resulting from the one-time incentive compensation and the write-off of $1.9 million in previously capitalized development costs referred to above. Research and development expenses may increase in future periods. To date, all research and development costs not reimbursed by Disney have been expensed as incurred.

     Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related overhead, as well as public relations, advertising, technical support and trade show costs required to support our software sales. Sales and marketing expenses increased to $578,000 and $966,000, respectively, for the three and six months ended June 28, 2003, from $203,000 and $454,000 in the corresponding prior year periods. The increase was due to higher promotional costs as well as higher employee related costs resulting from the one-time incentive compensation. We believe that sales and marketing expenses may increase in future periods, particularly in the areas of public relations and corporate marketing related to our films.

     General and Administrative. General and administrative expenses consist primarily of salaries of management and administrative personnel, insurance costs, and legal and professional fees. General and administrative expenses increased to $4.6 million and $7.0 million, respectively, for the three and six months ended June 28, 2003 from $1.8 million and $4.0 million in the corresponding prior year periods. The increase for the three and six months ended June 28, 2003 was due primarily to increased employee related costs resulting from the one-time incentive compensation and legal and professional fees. General and administrative expenses may increase in future periods.

Other Income, Net

     Other income, net was $3.0 million and $5.9 million, respectively, for the three and six months ended June 28, 2003, compared to $2.6 million and $5.1 million in the corresponding prior year periods. The increase in other income over the comparable prior year periods is primarily due to an increase in interest income.

Income Tax Expense

     Income tax expense for the three and six months ended June 28, 2003 approximates the federal and state statutory income tax rate of 39.5% versus 40.4% in the same periods of the prior year.

Capitalized Film Production Costs

     We had $110.4 million in capitalized film production costs as of June 28, 2003, consisting of costs relating to Toy Story 2, A Bug’s Life, Monsters, Inc., Finding Nemo, The Incredibles and Cars, all of which are being co-financed by Disney under the Co-Production Agreement. Capitalized film production costs also include costs related to Project 2006, our first Pixar-only financed film. In the quarter ended June 28, 2003, we wrote off $1.9 million in costs previously capitalized for future film projects. In reviewing our projects in development, we determined it unlikely that these projects will be green-lighted for production within three years following their initial cost capitalization. Therefore, under SOP 00-2, these amounts were expensed in the second quarter of fiscal 2003. All Toy Story capitalized film costs were fully amortized as of December 31, 1997.

Liquidity and Capital Resources

     Cash, cash equivalents and investments increased to $502.5 million by the end of the second quarter of fiscal 2003, an increase of $163.4 million since December 28, 2002. The increase was primarily due to cash received from Disney for our share of film revenue, particularly relating to Monsters, Inc. worldwide home video revenue, along with proceeds from stock option exercises, interest income and software revenue, offset by film production costs.

     Net cash provided by operating activities for the six months ended June 28, 2003 of $139.2 million was primarily attributable to a decrease of $83.2 million in our receivable from Disney as a result of cash received and net income of $27.7 million, partially offset by capitalized film production costs of $28.6 million. Net cash used in investing activities of $152.2 million consisted primarily of investments in securities of $261.8 million, offset by proceeds from the sales of investment securities of $112.8 million. Net cash provided by financing activities consisted entirely of proceeds of $28.2 million from exercised stock options.

     As of June 28, 2003, our principal source of liquidity was approximately $502.5 million in cash, cash equivalents and investments. Our future capital commitments primarily consist of obligations to fund production costs of films and derivative products under the Co-Production Agreement and beyond. We are currently co-financing The Incredibles and Cars under the Co-Production Agreement.

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In the future, we may co-finance other derivative works such as theatrical sequels, direct to home video sequels, interactive products and television productions. Additionally, we have already approved for production Project 2006, our first film beyond the Co-Production Agreement, and will finance production costs related to Project 2006 entirely. We also have obligations to pay portions of any revenue derived from each feature film produced under the Co-Production Agreement to our entertainment law firm in consideration for services rendered.

     Film Production Costs. For the remainder of fiscal 2003, we expect to spend approximately $30 million to $33 million, net of Disney’s film cost reimbursements, on direct film costs and other costs to fund our ongoing film projects under the Co-Production Agreement and beyond, which will directly impact working capital.

     Capital Expenditures. For the remainder of fiscal 2003, we expect to spend approximately $7 million to $9 million related to capital expenditures for our Emeryville headquarters and studio and other projects.

     We believe that our currently available funds and forecasted cash from operations for the remainder of fiscal 2003 will be sufficient to satisfy our currently anticipated cash needs for working capital and capital expenditures, including the production costs of The Incredibles and Cars, as well as the production and development costs associated with films not covered under the Co-Production Agreement. There can be no assurance that current and forecasted cash from operations will be sufficient to fund operations. To date, we have chosen to use our existing cash resources to fund both the construction on our Emeryville facility and film production costs. We may continue to use our cash resources for such expenditures, or may choose to finance such capital expenditures through issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism.

Recent Accounting Pronouncements

     In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. As used in this Statement, a legal obligation results from existing law, statute, ordinance, written or oral contract, or by legal construction of a contract under the doctrine of promissory estoppel. SFAS 143 is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS 143 has not had a material impact on our financial position or results of operations.

     In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 requires recording costs associated with exit or disposal activities at their fair values when a liability has been incurred. Under previous guidance, certain exit costs were accrued upon management’s commitment to an exit plan, which is generally before an actual liability has been incurred. We adopted SFAS 146 effective with the beginning of fiscal 2003. The adoption of SFAS 146 has not had an impact on our financial position or results of operations.

     In January 2003, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107 and a Recission of FASB Interpretation No. 34” (FIN 45). FIN 45 clarifies the requirements for a guarantor’s accounting for and disclosure of certain guarantees issued and outstanding in interim and annual financial statements. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, the liability for the fair value of the obligation undertaken. The disclosure requirements are effective for financial statements of interim and annual periods after December 31, 2002. The initial recognition and initial measurement provisions of FIN 45 are applicable to guarantees issued or modified after December 31, 2002. We adopted the provisions of FIN 45 effective with the beginning of fiscal 2003. The adoption of FIN 45 has not had an impact on our financial statements or results of operations.

     In November 2002, the FASB’s Emerging Issues Task Force reached a consensus on Issue No. 00-21, “Accounting for Revenue Arrangement with Multiple Deliverables,” which addresses circumstances involving the delivery or performance of multiple products, services, and/or rights to use assets, and for which performance may occur at different points in time or over different periods of time. Issue No. 00-21 also addresses whether the different revenue-generating activities, or deliverables, are sufficiently separable, and there exists sufficient evidence of their fair values to separately account for some or all of the deliverables. The issue applies to all contractual arrangements under which a vendor will perform multiple revenue-generating activities. Issue No. 00-21 is effective for all revenue arrangements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. We adopted Issue

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No. 00-21 effective the beginning of fiscal 2003. The adoption of Issue No. 00-21 has not had a material impact on our financial statements or results of operations.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” that amends SFAS No. 123, “Accounting for Stock-Based Compensation.” The standard provides for (1) alternative methods of transition for an entity that voluntarily changes to the fair-value method of accounting for stock-based employee compensation; (2) requires more prominent disclosure of the effects of an entity’s accounting policy decisions with respect to stock-based employee compensation on reported income; and (3) amends Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting,” to require disclosure of those effects in interim financial information. SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. We continue to account for employee stock options using the intrinsic value method in accordance with APB Opinion No. 25 and have adopted the additional disclosure requirements of SFAS No. 148.

Risk Factors

     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 primarily dependent on our feature films and the accuracy of our forecasts.

     For the remainder of fiscal 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 assumptions and judgments used to estimate certain revenues and associated gross profits, (5) the market price of our Common Stock and related volatility and (6) external socioeconomic and political events that are beyond our control.

Dependence on revenue from our feature films.

     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 five feature films, this level of success is unusual in the motion picture industry and our future releases may not achieve similar results. For the remainder of 2003, we will be dependent on the continuing success of Finding Nemo. Although Finding Nemo has had tremendous success in the domestic theatrical market, unless Finding Nemo achieves continued worldwide box office success and is successful in home video, television licensing, and merchandise sales, it may not generate sufficient revenue and operating results for us to meet our projections in 2003 and beyond.

     A significant portion of our anticipated revenues for the remainder of fiscal 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, for the remainder of 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.

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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 worldwide box office success of Finding Nemo. Even with Finding Nemo experiencing 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 into 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 the 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. Both Toy Story and Toy Story 2 home videos are currently subject to a sales moratorium, which began on May 1, 2003. Although this strategy is designed to increase sales over the lifetime of a title and to support a higher sales price upon re-release, it is difficult to predict the actual impact of this strategy, particularly since these are our first titles to be placed on a sales moratorium, and it may not generate the results we expect in future years.

     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 is 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, estimated sell-throughs and the related inventory levels in the distribution channel, as well as other business and industry information. For example, during the second quarter of fiscal 2003, we recognized an adjustment, which reduced our revenues for Monsters, Inc. domestic home video after we received additional information from Disney which reflected higher returns of domestic home video than had been originally anticipated. This adjustment reduced our home video revenues by $4.4 million and had a net impact of $0.04 to our diluted net income per share. Furthermore, 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.”

     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.

Forecasting our operating expenses is extremely difficult.

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     Our operating expenses will continue to be extremely difficult to forecast. We budget the direct costs of the Pictures 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 first half of fiscal 2003 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 capitalized or not shared with Disney.

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 The Incredibles and Cars and subsequent films and related products are expected to be greater than the budgets for our previous films. We will continue to finance the budgets of 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, “Project 2006.” 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.

Software revenue.

     We continue to maintain minimal emphasis and resources on the commercialization of software products. Our fiscal 2003 earnings projections include revenues attributable to non-film related sources including software revenue; however, there can be no assurance that the timing and amount of such revenues will be sufficient to meet our 2003 earnings projection.

Other non-film revenue and expenses.

     Our fiscal 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 fiscal 2002, interest income decreased when compared to fiscal 2001 due to declining interest rates during fiscal 2002. Income tax expense may also fluctuate. Our income tax rate for fiscal 2002 approximated statutory rates, and we expect that our income tax rate for fiscal 2003 will also approximate 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 fiscal 2003 earnings projection.

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

     Our revenues fluctuate significantly

     We continue to expect significant fluctuations in our future quarterly and annual 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,

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	•		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
	•		external socioeconomic and political events that are beyond our control.

     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.

     Our operating expenses fluctuate

     Operating expenses for the first half of fiscal 2003 increased in comparison to the same period in fiscal 2002, and we expect to continue to increase our operating expenses to fund greater levels of research and development, to ramp up to meet the demands of multiple films in production and to expand operations. In addition, we expect our spending levels may increase due to the following:

	•		continued investment in proprietary software systems,
	•		continued and potentially increasing 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 have multiple films in parallel production,
	•		increased investment in creative development and our Pixar-only financed films, 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 reimburse) 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 is 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.

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     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 primarily on 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 five 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 has been and will continue to 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 our future films.

     To continue to accommodate growth, we have and will be implementing 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 adequate facilities and other resources for them. We cannot provide any assurance we will be successful in accomplishing all of these activities on a timely and cost-effective basis. Any failure to accomplish one or more of these activities on a timely and cost-effective basis would have a material adverse effect on our business, financial condition and results of operations.

The Co-Production Agreement imposes several risks and restrictions on us.

We are dependent on Disney for the distribution and promotion of our feature films and related products.

     The decisions regarding the timing of the theatrical release and related products and which of Disney’s motion pictures and related products will receive extensive promotional support from Disney are important factors in determining the success of our motion pictures and related products. Under the terms of the Co-Production Agreement, we have some general protections with respect to the marketing and distribution of our 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. We ultimately do not control (1) the manner in which Disney distributes our animated feature films and related products, (2) the number of theaters to which Disney distributes our feature films, (3) the specific timing of release of our feature films and related products or (4) the specific amount or quality of marketing and promotional support of the feature films and related products as well as the associated promotional and marketing budgets. 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 substantial financial benefits in the event that such films achieve significant box office revenues, we believe that Disney desires such films to be successful. Nonetheless, Disney could make certain decisions as to marketing, distribution or promotion of the animated feature films or related products or the marketing and promotion of its own animated or other family films that could have a material adverse effect on our business, operating results or financial condition. 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 we experience a delay in the receipt of proceeds from such films and products until after Disney recovers such costs. We are also dependent on Disney for receiving accurate information on a timely basis on which we base estimates to recognize revenue and associated gross profit from the animated feature films and related products. If we fail to receive accurate information from Disney, or fail to receive it on a timely basis, it could have a material adverse effect on our business, operating results or financial condition.

Disney has an exclusive arrangement with us.

     We have agreed not to release or authorize the release of any of our feature length animated theatrical motion pictures, other than our feature films that we produce under the Co-Production Agreement, until twelve months from our delivery of the fifth original feature film under the Co-Production Agreement. We currently anticipate that we will not deliver the fifth Picture, Cars, until 2005 at the earliest. However, now that we have delivered Finding Nemo, the third original feature film under the Co-Production Agreement, to Disney, we are free to enter into any agreement with any third party for the development, production or distribution of any feature length animated theatrical motion picture (other than the Pictures). Finding Nemo was delivered in April 2003 for its May 30, 2003

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domestic theatrical release. 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 “Risk Factors — We experience intense competition with respect to our animated feature films, animation products, and software” below.

We have an obligation to co-finance production costs.

     Under the Co-Production Agreement, we will continue to co-finance each of the two remaining unreleased original animated feature films and may co-finance other related products to be developed and produced pursuant to the Co-Production Agreement. We co-financed A Bug’s Life, Toy Story 2, Monsters, Inc. and Finding Nemo. We are currently co-financing The Incredibles and Cars, under the Co-Production Agreement. We also have approved for production and have begun financing Project 2006, our first Pixar-only financed film. If our feature films and related products do not generate proceeds sufficient to more than offset our share of their production costs, our business, operating results and financial condition will be materially adversely affected.

Disney retains the exclusive distribution and exploitation rights.

     We share equally with Disney in the profits of each Picture and any related merchandise after Disney recovers certain costs; however, Disney retains the exclusive distribution and exploitation rights to all of our feature films, all characters and story elements of our feature films and all related products we develop under the Co-Production Agreement. Accordingly, except in certain specified circumstances, we are not able to exploit or distribute any of our feature films or characters or elements of any of our feature films or related products developed under the Co-Production Agreement without a license from Disney. We cannot provide any assurances that such a license would be available to us on commercially reasonable terms or at all.

Disney can terminate the agreement under various circumstances.

     Under the terms of the Co-Production Agreement, Disney may terminate the agreement under certain circumstances. 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 Pixar merges or consolidates into such a competitor. Disney would not lose any of its rights to distribute and exploit all feature films and all characters and elements of our feature films and other products we develop under the Co-Production Agreement, except for feature films or related products then in development or production as to which Disney does not elect to proceed, as to which we would regain the rights subject to a lien in favor of Disney for the costs advanced to date. Further, in the event that Disney terminated the Co-Production Agreement, we would be required to seek alternative channels for distribution of our animated feature films and related products.

There are significant risks associated with the motion picture industry.

     The completion and commercial success of a motion picture is extremely unpredictable, and 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 completion and commercial success of a motion picture also depends upon other factors, such as:

	•		personnel availability,
	•		financing requirements,
	•		distribution strategy, including the time of the year and the number of screens on which it is shown,
	•		the number, 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,

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	•		general socioeconomic conditions and political events,
	•		weather conditions, and
	•		other tangible and intangible factors.

     All of these factors 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. Under the terms of the Co-Production Agreement, Pixar is guaranteed theatrical release either during the summer or holiday period. Finding Nemo, which was released on May 30, 2003, is our first film to be released domestically during the summer months, as all of our previous film releases occurred during holiday periods. Although Finding Nemo has been very successful in the domestic theatrical market, it is difficult to predict the film’s performance in the international theatrical markets, or its success in other ancillary revenue streams such as merchandising due to the different timing of its release relative to our other films. Further, due to the expected release of a large number of family films by Disney and other movie studios in the next several years, it is possible that further saturation of the family film market, particularly those films created by computer graphics imagery (“CGI”), may adversely impact the commercial success of our films, and therefore have a material adverse effect on our business, financial condition and results of operations.

In order for our feature films and related products to be successful, we must develop appealing creative content.

     The success of each animated film developed and produced by us will depend in large part upon our creative team’s ability to produce content that will appeal to a broad audience and to develop compelling stories and characters that will achieve broad market acceptance. Traditionally, this process has been extremely difficult. While we have enjoyed worldwide box office success with Toy Story, A Bug’s Life, Toy Story 2, and Monsters, Inc., and domestic box office success with Finding Nemo, there can be no assurance that similar levels of success will be achieved by our subsequent films, including The Incredibles, Cars and Project 2006.

We experience intense competition with respect to our animated feature films, animation products, and software.

     We experience intense competition with respect to our 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 Bros., 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.

     In 2003, competition is expected to continue to intensify in the family-oriented, animated and live action feature film market and may affect the ultimate box office success of Finding Nemo, which was released domestically on May 30, 2003. Some of the family-oriented animated and live action feature films that have been released during summer 2003 that competed with Finding Nemo include the following:

	•		X2: X-Men United by Fox,
	•		The Lizzie McGuire Movie by Disney,
	•		Daddy Day Care by Columbia,
	•		The Matrix Reloaded by Warner Bros.,
	•		Bruce Almighty by Universal,
	•		Rugrats Go Wild by Paramount,
	•		The Hulk by Universal,
	•		Sinbad: Legend of the Seven Seas by Dreamworks,

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	•		Terminator 3: Rise of the Machines by Warner Bros.,
	•		Pirates of the Caribbean: The Curse of the Black Pearl by Disney,
	•		Spy Kids 3D: Game Over by Miramax, and
	•		Freaky Friday by Disney.

     We believe competition from animated feature films and family-oriented feature films may intensify over the next several years, possibly affecting The Incredibles, which is currently targeted for release on November 5, 2004, 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, will become further saturated before we release The Incredibles and Cars. This could result in the failure of such films to achieve the commercial success required for us to profit from such films.

     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 other movie studios with which we compete have significantly greater financial, marketing and other resources than we do.

     There appears to be increasing widespread acceptance for films created by CGI. Animated feature films currently in production that are primarily CGI include Shrek 2, Sharkslayer, Madagascar, Over the Hedge, Jimmy Neutron 2, Robots, Ice Age 2 and Valiant, among others. Disney is also considering developing and producing feature-length CGI-animated films based on classic fairy tales, such as Rapunzel and Snow Queen. 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.

     Furthermore, due to the recent success of CGI-animated films, several movie studios have developed their own internal computer animation capability which may be used for special effects in animated films and live action films. For example, DreamWorks SKG (with PDI) successfully produced Antz in 1998 and Shrek in 2001. In addition, Fox successfully produced, through its subsidiary Blue Sky, Ice Age, which was released in March 2002. Other movie studios may internally develop, license or sub-contract three-dimensional animation capability, or enter into co-production agreements with other studios capable of developing and producing three-dimensional CGI-animated films. 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 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 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. While the Co-Production Agreement imposes restrictions prohibiting Disney from releasing G-rated films, whether live action or animated, within certain release windows from our films, it is likely that other family-oriented motion pictures distributed by Disney or its affiliates will overlap in the market and compete with our animated feature films. For example, Mighty Joe Young, released during the 1998 holiday season, competed with A Bug’s Life in the domestic theatrical market, and Pirates of the Caribbean: The Curse of the Black Pearl, which was released July 9, 2003, Spy Kids 3D: Game Over, which was released on July 25, 2003 and Freaky Friday, which was released on August 6, 2003, compete directly with Finding Nemo. Our contractual arrangement with Disney also presents other risks. See “Risk Factors — The Co-Production Agreement imposes several risks and restrictions on us.”

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

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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.

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 we are willing to offer for RenderMan®. 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 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 depends on certain key employees.

     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, Edwin E. Catmull, Ann Mather, Sarah McArthur and Lois Scali. 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 Pixar’s relationship with Disney; however, such employment agreement does not necessarily assure the services of Mr. Lasseter. Moreover, although it is standard in the motion picture industry to rely on employment agreements as a method of retaining the services of key employees, we have not required our employees, other than Mr. Lasseter, to enter into employment agreements. The loss of the services of any of Messrs. Jobs, Lasseter, Dr. Catmull, Ms. Mather, Ms. McArthur, Ms. Scali or of other key employees, especially our film directors, producers, animators, creative personnel and technical directors, could have a material adverse effect on our business, operating results or financial condition. Although none of our employees is represented by a labor union, it is common for film directors, producers, animators and actors at film production companies to belong to a union. 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. There can be no assurance that our employees will not join or form a labor union, or that we will not be directly or indirectly impacted by industry related work stoppages or that we, for certain purposes, will not be required to become a union signatory.

Our Chief Executive Officer has divided responsibilities.

     Pixar’s Chief Executive Officer and Chairman, Steve Jobs, is also Chief Executive Officer at Apple Computer, Inc. Although Mr. Jobs spends time at Pixar and is active in our management, he does not devote his full time and resources to Pixar.

To be successful, we need to attract and retain qualified personnel.

     Our success continues to depend to a significant extent on our ability to identify, attract, hire, train and retain qualified professional, creative, technical and managerial personnel. Competition for the caliber of talent required to make our films, particularly our film directors, producers, animators, creative personnel and technical directors, will continue to intensify as more studios build their in-house CGI-animation or special effects capabilities. There can be no assurance that we will be successful in identifying, attracting, hiring, training and retaining such personnel in the future. If we were unable to hire, assimilate and retain

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qualified personnel in the future, particularly film directors, producers, animators, creative personnel and technical directors, such inability would have a material adverse effect on our business, operating results and financial condition.

We face various distribution risks with respect to our feature films.

     Under the Feature Film Agreement and the Co-Production Agreement, Disney is required to distribute the animated feature films in a manner consistent with those of Disney’s premier animated films. Currently, distribution of our films generally includes (1) worldwide theatrical exhibition, (2) worldwide home video sales, (3) worldwide television licensing, including Pay-Per-View, pay television, network, basic cable and syndication, (4) non-theatrical exhibition, such as airlines, schools and armed forces facilities and (5) marketing of other rights of the picture, which may include licensing of merchandise, such as toys, interactive games and soundtrack recordings. Although the Co-Production Agreement provides us with some protection, we cannot provide any assurances that our feature films made under the Co-Production Agreement will be distributed through all of these outlets.

     Although we have enjoyed a tremendously successful track record with our first five feature films, we cannot provide any assurances that our future films will enjoy the same level of success. Currently, Disney shares our financial risks associated with the production of the films under the Co-Production Agreement. As our co-production partner, Disney is currently sharing the risk of our films by financing 50% of the production costs. In addition, under the Co-Production Agreement, Disney is responsible for financing 100% of the costs related to the marketing and distribution of the films. In the event that a film does not generate sufficient revenues to offset such costs, Pixar is not responsible for any losses Disney incurs. We cannot provide any assurances that future distribution agreements will provide us with the same level of risk minimization. In addition, as additional entrants emerge in the animation marketplace, there may be increased competition for distribution partners.

We have a limited operating history.

     Until 1996, we had generated recurring revenue primarily from the license of our RenderMan® software, amounts we received under software development contracts and fees for animated television commercial development. We expect to generate a substantial majority of our future revenue from the development and production of animated feature films and related products, as we have since 1996. We have, to date, developed, produced and released only five animated feature films, Toy Story, A Bug’s Life, Toy Story 2, Monsters, Inc., and Finding Nemo. Accordingly, we have a limited operating history in implementing our business model upon which an evaluation of our prospects can be based. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of a business enterprise, particularly companies in highly competitive markets. To address these risks, we must, among other things, respond to changes in the competitive environment, continue to attract, retain and motivate qualified persons, and continue to upgrade our technologies. We cannot provide any assurances that we will be successful in addressing such risks.

Our current and future commitments may have an adverse impact on our cash balances.

     We are currently co-financing our remaining two unreleased original animated feature films, The Incredibles and Cars pursuant to the Co-Production Agreement. We are also solely financing Project 2006. In the future, we may co-finance other derivative works such as sequels and television productions. The future development and production costs of The Incredibles, Cars, Project 2006 and films beyond, and any possible future expansion of our studio and headquarters in Emeryville, California, may have an adverse impact on our cash and investment balances. We expect to fully finance films for release after Cars. As of June 28, 2003, we had approximately $502.5 million in cash, cash equivalents and investments. We believe that these funds, along with cash provided by operating activities, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures, and the development and production costs of The Incredibles and Cars, as well as development and production costs for Project 2006. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.” To date, we have chosen to use our existing cash resources to fund film production costs and construction costs. We may continue to use our cash resources for such expenditures, or may choose to finance such capital expenditures through issuance of additional equity or debt securities, by obtaining a credit facility or by some other financing mechanism. The sale of additional equity or convertible debt securities would result in additional dilution to our shareholders. Moreover, we cannot provide any assurances that we will be successful in obtaining future financing, or even if such financing is available, that we will obtain it on favorable terms or on terms providing us with sufficient funds to meet our obligations and objectives.

We depend on our proprietary technology and computer systems for the timely and successful development of our feature films and related products.

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     We cannot provide any assurances that we 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 we are dependent upon a large base of software and a large number of computers for the development and production of our animated feature films and related products, an error or defect in the software, a failure in the hardware or a failure of the backup facilities could result in a significant delay in one or more productions in process which, in turn, could result in potentially significant delays in the release dates of our feature films or other products. In the past we have experienced minor delays as a result of such matters. Significant delays in production and significant delays in release dates could have a material adverse effect on our business, operating results or financial condition. Further, because we rely mostly on internally developed software, we would not be able to rely upon assistance from third parties in the event that the software fails.

A single shareholder owns a large percentage of our outstanding stock.

     Our Chief Executive Officer, Steve Jobs, beneficially owns approximately 55.4% of our outstanding Common Stock as of June 28, 2003. 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, impeding a merger, consolidation, takeover or other business combination involving Pixar, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of Pixar.

Business interruptions could adversely affect our operations.

     Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. Although we have a disaster recovery plan that we regularly update, there can be no assurance that it will be effective in the event of a disaster. Our facilities in the State of California have in the past and may in the future be subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event these blackouts continue or increase in severity, they could disrupt the operations of our affected facilities. In the event of a short-term power outage, we have installed UPS (uninterrupted power supply) equipment to protect our RenderFarm and other sensitive equipment, along with two 1.5 Megawatt backup generators. In connection with the shortage of available power, prices for electricity have in the past risen dramatically and may increase in the future. An increase in prices would increase our operating costs, which could in turn adversely affect our profitability. Although we carry business interruption insurance, there can be no assurance that such insurance will be sufficient to compensate us for losses that may occur and any losses or damages incurred by us could have a material adverse effect on our business.

Recent terrorist activities and resulting military and other actions could adversely affect our business.

     The terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the United States and Europe. In response to such attacks, the United States is actively using military force to pursue those behind these attacks and is initiating broader actions against global terrorism. The continued threat of terrorism within the United States, the escalation of military action and heightened security measures in response to such further threats, as well as the recent military action against the government of Iraq or any other country, may cause significant disruption to commerce, including the entertainment industry, throughout the world. Such disruption in the future could have a material and adverse effect on our business and results of operations.

Work stoppages could adversely impact our operations.

     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. We are directly or indirectly dependent upon certain union members, and work stoppages or strikes organized by such unions could materially adversely impact our business, financial condition or results of operations.

To be successful, we will need to continuously enhance our existing proprietary technology and develop new technology.

     Substantially all of our revenues have been derived, and substantially all of our future revenues are expected to be derived, from the use and license of our proprietary technologies. We expect that we will be required to enhance these technologies and to develop new technologies in order to be successful in our industry and in the licensing of our RenderMan® software. We cannot provide any assurances that we will be successful in enhancing our existing technologies or in developing and utilizing new technologies, or that competitors will not develop technology that is equivalent or superior to our technologies or that makes our technologies obsolete. If

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we are unable to develop enhancements to our existing technologies or new technologies as required, or if the costs associated with developing those technologies continue to increase, our business, operating results or financial condition could be materially adversely affected.

There are various risks associated with our proprietary rights.

Our efforts to protect our proprietary technologies may not succeed.

     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 have twenty two patents in force in the United States and eleven patents in force in foreign countries. In addition, we have a number of patent applications pending in the United States and in foreign countries. We cannot provide any assurances 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, we cannot provide any assurances 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 us with any proprietary protection. Failure of the patents to provide protection of our technology may make it easier for our competitors to offer technology equivalent to or superior to our technology.

     The source code for our proprietary software is protected both as a trade secret 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 and expensive. 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. We cannot provide any assurances that the steps we take will prevent misappropriation of our technology or that our confidentiality or license agreements will be enforceable.

Enforcing our proprietary rights may require litigation.

     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.

Others may assert infringement claims against us.

     One of the risks of the film production business is the possibility of 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. We cannot provide any assurances, however, that under such circumstances a license would be available on reasonable terms or at all.

Third-party technology licenses may not continue to be available to us in the future.

     We also rely on certain technology that we license from third parties, including software that we integrate and use with our internally developed software. We cannot provide any assurances 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 releases until equivalent technology could be identified, licensed and integrated. Any such

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delays in feature film releases or product releases could materially adversely affect our business, operating results and financial condition.

The market price of our Common Stock has been volatile in the past, and we expect such volatility to continue.

     The market price of our Common Stock is highly volatile and is subject to wide fluctuations in response to a wide variety of factors, including the publication of box office results for our feature films and those of our competitors, fluctuations in our quarterly or annual results of operations, changes in financial estimates by securities analysts, announcements made by us, Disney, or our competitors, budget increases, delays in or cancellation of feature film or other product release dates, or socioeconomic, political or other factors. For example, during 2002, our Common Stock closed as low as $30.67 and as high as $61.42 per share. Moreover, in recent years, the stock market has experienced extreme price and volume fluctuations, some of which have been unrelated or disproportionate to the operating performances of the companies affected. These broad market and industry fluctuations may adversely affect the market price of our 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. If brought against Pixar, such litigation could result in substantial costs and a diversion of management’s attention and resources, which could have a material adverse effect on our business, operating results or financial condition.

     As described in “Risk Factors — Our operating results have fluctuated in the past, and we expect such fluctuations to continue” above, we believe that period-to-period comparisons of our results of operations may not be necessarily meaningful. Accordingly, you should not rely on our annual and quarterly results of operations as any indication of future performance. In addition, it is possible that in some future period our operating results will be below the expectations of public market analysts and investors or the guidance we have provided. In such event, the price of our Common Stock may be materially adversely affected. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     Investment Portfolio. We invest in a variety of investment grade, interest-bearing securities, including fixed rate obligations of corporations and national governmental entities and agencies. This diversification of risk is consistent with our policy to ensure safety of our principal and maintain liquidity. We only invest in securities with maturities of 24 months or less, with only government obligations exceeding 12 months. Our investments are primarily fixed rate obligations and carry a certain degree of interest rate risk. A rise in interest rates could adversely impact the fair market value of these securities.

     All of our financial instruments are held for purposes other than trading and are considered “available for sale” per SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” The table below provides information regarding our investment portfolio at June 28, 2003. The table presents principal cash flows and related weighted-average fixed interest rates presented by expected maturity date (dollars in thousands):