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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 Form 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 3, 2004 or  [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF
THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to. Commission File Number: 0-26976 Pixar (Exact name of registrant as specified in its charter)
 California(State or other jurisdiction of
Incorporation or organization)
    
    68-0086179(I.R.S. Employer
Identification No.)1200 Park Avenue,
Emeryville, California(Address of principal executive offices)
    
    94608(Zip code)
 (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 (the Act) during the preceding 12 months (or for such shorter period
that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [  ] Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).  The number of shares outstanding of the Registrants Common Stock as of
August 4, 2004 was 56,541,329.




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Pixar
FORM 10-Q
Index PART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited):Balance Sheets as of July 3, 2004 and January 3, 2004
    
    Page 2Statements of Income for the Quarter and Six Months Ended July 3, 2004 and June 28, 2003
    
    Page 3Statements of Cash Flows for the Six Months Ended July 3, 2004 and June 28, 2003
    
    Page 4Notes to Financial Statements
    
    Page 5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    Page 10Risk Factors
    
    Page 18Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    Page 33Item 4. Controls and Procedures
    
    Page 33PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    Page 35Item 5. Other Information
    
    Page 35Item 6. Exhibits and Reports on Form 8-K
    
    Page 35SIGNATURE
    
    Page 36EXHIBIT INDEX
    
    Page 37EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1
 1




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PART I  FINANCIAL INFORMATION 
 Item 1.Financial Statements PIXAR 
 BALANCE SHEETS (Unaudited, in thousands, except share data) July 3,
    
    January 3,2004
    
    2004ASSETSCash and cash equivalents
    
    $
    35,826
    
    
    $
    48,320Investments
    
    
    719,366
    
    
    
    473,603Trade receivables, net
    
    
    1,818
    
    
    
    2,152Receivable from Disney
    
    
    23,885
    
    
    
    206,569Other
receivables
    
    
    7,351
    
    
    
    4,465Prepaid expenses and other assets
    
    
    1,365
    
    
    
    1,047Deferred income taxes
    
    
    52,514
    
    
    
    51,496Property and equipment, net
    
    
    117,027
    
    
    
    115,026Capitalized film production costs
    
    
    122,833
    
    
    
    107,667Total assets
    
    $
    1,081,985
    
    
    $
    1,010,345LIABILITIES AND SHAREHOLDERS  EQUITYAccounts payable
    
    $
    1,132
    
    
    $
    1,803Income taxes payable
    
    
    3,567
    
    
    
    37,595Accrued liabilities
    
    
    13,279
    
    
    
    13,007Unearned revenue
    
    
    17,070
    
    
    
    17,430Total liabilities
    
    
    35,048
    
    
    
    69,835Shareholders equity:Preferred stock; no par value; 5,000,000 shares authorized and no shares issued and outstanding
    
    
    
    
    
    
    Common stock; no par value; 100,000,000 shares authorized; 56,480,505 and 55,473,176 issued
and outstanding as of July 3, 2004 and January 3, 2004, respectively
    
    
    590,878
    
    
    
    546,999Accumulated other comprehensive (loss) income
    
    
    (1,265
    )
    
    
    314Retained earnings
    
    
    457,324
    
    
    
    393,197Total shareholders equity
    
    
    1,046,937
    
    
    
    940,510Total liabilities and shareholders equity
    
    $
    1,081,985
    
    
    $
    1,010,345
 See accompanying notes to financial statements. 2




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PIXAR 
 STATEMENTS OF INCOME (Unaudited, in thousands, except per share data) Quarter Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Revenue:Film
    
    $
    63,713
    
    
    $
    45,182
    
    
    $
    114,805
    
    
    $
    61,557Software
    
    
    2,576
    
    
    
    3,694
    
    
    
    5,308
    
    
    
    5,976Total revenue
    
    
    66,289
    
    
    
    48,876
    
    
    
    120,113
    
    
    
    67,533Cost of revenue
    
    
    6,437
    
    
    
    7,805
    
    
    
    12,341
    
    
    
    10,755Gross profit
    
    
    59,852
    
    
    
    41,071
    
    
    
    107,772
    
    
    
    56,778Operating expenses:Research and development
    
    
    4,154
    
    
    
    6,599
    
    
    
    7,552
    
    
    
    8,920Sales and marketing
    
    
    635
    
    
    
    578
    
    
    
    1,007
    
    
    
    966General and administrative
    
    
    3,017
    
    
    
    4,624
    
    
    
    6,093
    
    
    
    7,009Total operating expenses
    
    
    7,806
    
    
    
    11,801
    
    
    
    14,652
    
    
    
    16,895Income from operations
    
    
    52,046
    
    
    
    29,270
    
    
    
    93,120
    
    
    
    39,883Other income
    
    
    2,489
    
    
    
    3,001
    
    
    
    5,385
    
    
    
    5,905Income before income taxes
    
    
    54,535
    
    
    
    32,271
    
    
    
    98,505
    
    
    
    45,788Income tax expense
    
    
    17,150
    
    
    
    12,747
    
    
    
    34,378
    
    
    
    18,086Net income
    
    $
    37,385
    
    
    $
    19,524
    
    
    $
    64,127
    
    
    $
    27,702Basic net income per share
    
    $
    0.66
    
    
    $
    0.36
    
    
    $
    1.14
    
    
    $
    0.52Shares used in computing basic net income per share
    
    
    56,287
    
    
    
    53,685
    
    
    
    56,039
    
    
    
    53,365Diluted net income per share
    
    $
    0.63
    
    
    $
    0.34
    
    
    $
    1.09
    
    
    $
    0.49Shares used in computing diluted net income per share
    
    
    58,987
    
    
    
    56,788
    
    
    
    58,797
    
    
    
    56,476
 See accompanying notes to financial statements. 3




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PIXAR 
 STATEMENTS OF CASH FLOWS (Unaudited, in thousands) Six Months EndedJuly 3,
    
    June 28,2004
    
    2003Cash flows from operating activities:Net income
    
    $
    64,127
    
    
    $
    27,702Adjustments to reconcile net income to net cash provided by (used in ) operating
activities:Depreciation and amortization
    
    
    3,572
    
    
    
    3,927Capitalized film production costs
    
    
    (27,323
    )
    
    
    (28,645
    )Amortization of capitalized film production costs
    
    
    12,157
    
    
    
    10,313Tax benefit from stock option exercises
    
    
    16,258
    
    
    
    16,687Deferred income taxes
    
    
    (1,018
    )
    
    
    (520
    )Gain on sales of investments
    
    
    (656
    )
    
    
    (433
    )Changes in operating assets and liabilities:Trade and other receivables, net
    
    
    (2,552
    )
    
    
    1,718Receivable from Disney
    
    
    182,684
    
    
    
    83,202Prepaid expenses and other assets
    
    
    (318
    )
    
    
    2,592Accounts payable
    
    
    (671
    )
    
    
    (464
    )Income taxes payable
    
    
    (34,028
    )
    
    
    Accrued liabilities
    
    
    272
    
    
    
    19,246Unearned revenue
    
    
    (360
    )
    
    
    3,405Net cash provided by operating activities
    
    
    212,144
    
    
    
    138,730Cash flows from investing activities:Purchases of property and equipment
    
    
    (5,573
    )
    
    
    (3,088
    )Proceeds from sale of investments
    
    
    349,244
    
    
    
    112,780Purchases of investments
    
    
    (595,930
    )
    
    
    (261,416
    )Net cash used in investing activities
    
    
    (252,259
    )
    
    
    (151,724
    )Cash flows from financing activities:Proceeds from exercised stock options
    
    
    27,621
    
    
    
    28,154Net cash provided by financing activities
    
    
    27,621
    
    
    
    28,154Net (decrease) increase in cash and cash equivalents
    
    
    (12,494
    )
    
    
    15,160Cash and cash equivalents at beginning of period
    
    
    48,320
    
    
    
    44,431Cash and cash equivalents at end of period
    
    $
    35,826
    
    
    $
    59,591Supplemental disclosure of cash flow information:Cash paid during the period for income taxes
    
    $
    53,735
    
    
    $
    Supplemental disclosure of non-cash investing and financing activities:Unrealized loss on investments, net of taxes
    
    $
    (1,579
    )
    
    $
    (796
    )
 See accompanying notes to financial statements. 4




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PIXAR 
 NOTES TO FINANCIAL STATEMENTS (1) Basis of Presentation The accompanying unaudited condensed financial statements have been
prepared in conformity with U.S. generally accepted accounting principles for
interim financial information and 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 January 3, 2004 and for each of the years in the three-year period ended
January 3, 2004, including notes thereto. These audited financial statements
are included in Pixars Annual Report on Form 10-K for the year ended January
3, 2004 as filed with the Securities and Exchange Commission. The results of operations for the quarter and six months ended July 3,
2004 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 2004 financial statement presentation. (2) Fiscal Year Pixar operates on a 52 or 53-week fiscal year, whereby the fiscal year
ends on the Saturday nearest December 31. Fiscal 2004 will end on January 1,
2005 and will consist of 52 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. 5




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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):  Quarter Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Net income:As reported
    
    $
    37,385
    
    
    $
    19,524
    
    
    $
    64,127
    
    
    $
    27,702Fair value-based compensation cost, net of taxes
    
    
    (4,472
    )
    
    
    (3,630
    )
    
    
    (8,981
    )
    
    
    (5,243
    )Pro forma net income
    
    $
    32,913
    
    
    $
    15,894
    
    
    $
    55,146
    
    
    $
    22,459Basic net income per share:As reported
    
    $
    0.66
    
    
    $
    0.36
    
    
    $
    1.14
    
    
    $
    0.52Pro forma
    
    $
    0.58
    
    
    $
    0.30
    
    
    $
    0.98
    
    
    $
    0.42Diluted net income per share:As reported
    
    $
    0.63
    
    
    $
    0.34
    
    
    $
    1.09
    
    
    $
    0.49Pro forma
    
    $
    0.57
    
    
    $
    0.29
    
    
    $
    0.96
    
    
    $
    0.41
 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 $27.07 and $26.92 for the quarter and six months ended
July 3, 2004, respectively, and $24.70 and $23.95 for the quarter and six
months ended June 28, 2003, respectively. Values were estimated using zero
dividend yield for all years; expected volatility of 39% for the quarter and
six months ended July 3, 2004, and 50% and 51%, respectively, in the
corresponding prior year periods; risk-free interest rates of 3.77% and 3.59%
for the quarter and six months ended July 3, 2004, respectively, and 2.55% and
2.81%, 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 quarter and six months ended July 3, 2004, options to purchase
approximately 506,000 shares and 520,000 shares, respectively, of common stock
were not included in the computation of diluted net income per share because
the options exercise price was greater than the average market price of the
common shares. Options to purchase approximately 59,000 shares and 56,000
shares, respectively, of common stock were excluded for the quarter and six
month periods ended June 28, 2003. 6




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



Quarter EndedJuly 3,
    
    June 28,2004
    
    2003Net
    
    
    
    
    
    
    
    
    
    NetNet
    
    
    
    
    
    Income
    
    Net
    
    
    
    
    
    IncomeIncome
    
    Shares
    
    per Share
    
    Income
    
    Shares
    
    per ShareBasic net income per share
    
    $
    37,385
    
    
    
    56,287
    
    
    $
    0.66
    
    
    $
    19,524
    
    
    
    53,685
    
    
    $
    0.36Effect of dilutive shares:Options
    
    
    
    
    
    
    2,700
    
    
    
    
    
    
    
    
    
    
    
    3,103Diluted net income per share
    
    $
    37,385
    
    
    
    58,987
    
    
    $
    0.63
    
    
    $
    19,524
    
    
    
    56,788
    
    
    $
    0.34
 Six Months EndedJuly 3,
    
    June 28,2004
    
    2003Net
    
    
    
    
    
    
    
    
    
    NetNet
    
    
    
    
    
    Income
    
    Net
    
    
    
    
    
    IncomeIncome
    
    Shares
    
    per Share
    
    Income
    
    Shares
    
    per ShareBasic net income per share
    
    $
    64,127
    
    
    
    56,039
    
    
    $
    1.14
    
    
    $
    27,702
    
    
    
    53,365
    
    
    $
    0.52Effect of dilutive shares:Options
    
    
    
    
    
    
    2,758
    
    
    
    
    
    
    
    
    
    
    
    3,111Diluted net income per share
    
    $
    64,127
    
    
    
    58,797
    
    
    $
    1.09
    
    
    $
    27,702
    
    
    
    56,476
    
    
    $
    0.49
 (5) Comprehensive Income Other comprehensive income (loss) 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): Quarter Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Net income
    
    $
    37,385
    
    
    $
    19,524
    
    
    $
    64,127
    
    
    $
    27,702Unrealized holding losses on investments, net of tax benefit
    
    
    (1,203
    )
    
    
    (224
    )
    
    
    (1,579
    )
    
    
    (796
    )Comprehensive income
    
    $
    36,182
    
    
    $
    19,300
    
    
    $
    62,548
    
    
    $
    26,906
 (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). In 1995, the Company released its
first and only feature film under the terms of the Feature Film Agreement, Toy
Story.The Company continues to receive compensation based on revenue from the
distribution of Toy Storyand related products. Based on the
individual-film-forecast-computation method, all significant Toy Storyfilm
production costs were fully amortized by the year ended December 31, 1997. 7




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Co-Production Agreement In 1997, the Company entered into the Co-Production Agreement (which,
except for certain economic provisions applicable to Toy Story, superseded the
Feature Film Agreement) with Disney pursuant to which the Company, 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, co-own and co-brand the
Pictures and share equally in the profits of each Picture and any related
merchandise and other ancillary products, after Disney recovers all marketing
and distribution costs and fees. The first three original Pictures produced
under the Co-Production Agreement were A Bugs Life, Monsters, Inc.and Finding
Nemo. The Company is currently in various stages of production on the final two
Pictures under this agreement: The Incrediblesand Cars. As a sequel, Toy Story
2did not count toward the Pictures; however, it was produced under the
Co-Production Agreement and is afforded the same financial terms as the
Pictures. The term of the Co-Production Agreement continues until delivery to
Disney of the fifth Picture, Cars, which is currently targeted for a 2005
holiday release. All payments to Pixar from Disney for development and production of Toy
Storyunder the Feature Film Agreement, and A Bugs Life, Toy Story 2,
Monsters, Inc., Finding Nemo, The Incrediblesand Carsunder the Co-Production
Agreement have been recorded as cost reimbursements. Accordingly, no revenue
has been recognized for such reimbursements; rather, the Company has netted the
reimbursements against the related costs. Creative Development Group In addition to the films produced and in process under the Co-Production
Agreement, Pixars creative development group is working on concept
development, pre-production and production for new projects that are not
governed by the Co-Production Agreement. Costs related to these projects,
including 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, assuming the
concept development leads to a successful concept and realization of a film
project, when it is expected that the film will be set for production. In the
event a film is not set for production within three years from the time of the
first capitalized transaction, such costs will be expensed. Components of Capitalized Film Production Costs The total film production costs and related amounts capitalized are as
follows (in thousands): Total ThroughJuly 3,
    
    January 3,2004
    
    2004Released films
    
    $
    188,040
    
    
    $
    187,210Less: Cummulative amortization of film production costs
    
    
    (169,847
    )
    
    
    (157,690
    )Total film production costs capitalized for released films
    
    
    18,193
    
    
    
    29,520Films in production
    
    
    103,010
    
    
    
    77,301Films in development or pre-production
    
    
    1,630
    
    
    
    846Total film production costs capitalized
    
    $
    122,833
    
    
    $
    107,667
 8




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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): Six Months EndedJuly 3,
    
    June 28,2004
    
    2003Research and development
    
    $
    3,834
    
    
    $
    5,174General and administrative
    
    
    1,795
    
    
    
    2,472Total
    
    $
    5,629
    
    
    $
    7,646
 For released films, the Company expects to amortize, based on current
estimates, approximately $5 million to $8 million in capitalized film
production costs over the succeeding twelve-month period. This forecast does
not include amortization for The Incredibles, which is targeted for release on
November 5, 2004. The Company has amortized more than 80% of each released
films original production costs as of July 3, 2004, with the exception of
Finding Nemo, which is projected to reach the 80% milestone by the end of
fiscal 2004. At July 3, 2004 and January 3, 2004, receivables from Disney aggregated
$23.9 million and $206.6 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): Quarter Ended
    
    Six Months EndedJuly 3,
    
    June 28,
    
    July 3,
    
    June 28,2004
    
    2003
    
    2004
    
    2003Finding
Nemo
    
    $
    49,412
    
    
    $
    26,291
    
    
    $
    89,595
    
    
    $
    26,291Monsters,
Inc.(1)
    
    
    4,209
    
    
    
    3,582
    
    
    
    6,652
    
    
    
    12,155Library titles (2)
    
    
    9,960
    
    
    
    14,900
    
    
    
    18,292
    
    
    
    22,611Animation services
    
    
    132
    
    
    
    409
    
    
    
    266
    
    
    
    500$
    63,713
    
    
    $
    45,182
    
    
    $
    114,805
    
    
    $
    61,557
 (1) During the three months ended June 28, 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. (2) Library
titles include Toy Story, A Bugs Life and Toy Story 2. 9




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(8) New Accounting Pronouncements On March 31, 2004, the FASB issued a proposed Statement, Share-Based
Payment,that addresses the accounting for share-based payment transactions in
which an enterprise receives employee services in exchange for (a) equity
instruments of the enterprise or (b) liabilities that are based on the fair
value of the enterprises equity instruments or that may be settled by the
issuance of such equity instruments. The proposed Statement would eliminate the
ability to account for share-based compensation transactions using APB Opinion
No. 25 and generally would require instead that such transactions be accounted
for using a fair-value-based method. If adopted in its current form, the
proposed Statement would be effective for fiscal years beginning after December
15, 2004. In March 2004, the FASBs Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments.Issue No. 03-1 states that companies
carrying debt and equity securities at amounts higher than the securities fair
values will soon have to use more detailed criteria to evaluate whether to
record a loss and will have to disclose additional information about unrealized
losses. Issue No. 03-1 is effective for reporting periods beginning after June
15, 2004 and the disclosure requirements are effective for annual reporting
periods ending after June 15, 2004. The Company believes that the adoption of
EITF No. 03-1 will not have a material effect on its results of operations,
financial position or cash flows. 
 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 statements referencing the targeted release dates of our
feature films, our anticipated operating expenses and capital expenditures, and our expectations
regarding any future distribution agreement into which we may enter. In some
cases, forward-looking statements can be identified by the use of words such as
may, could, would, might, will, should, expect, forecast,
predict, potential, continue, anticipates, expects, intends,
plans, believes, seeks, estimates, is scheduled for, targeted, and
variations of such words and similar expressions. Such forward-looking
statements are based on current expectations, estimates, and projections about
our industry, managements beliefs, and assumptions made by management. 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 18 through 33.
Particular attention should be paid to the cautionary language in Risk Factors
" Our operating results are primarily dependent on the success of our feature
films, and forecasting is extremely difficult,  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 18 through 33 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 January 3, 2004 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. It was pursuant to the Feature Film
agreement that Toy Story 10




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was developed, produced, and distributed. Our share of revenues and
expenses from Toy Storyis governed by the terms of the Feature Film Agreement. In February 1997, we entered into the Co-Production Agreement (which,
except for certain economic provisions applicable to Toy Story, 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 predefined fees or costs,
including any participations provided to talent. 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 will not share in any theme park
revenues generated as a result of the Pictures. Pursuant to the Co-Production
Agreement, in addition to co-financing the production costs of the Pictures,
Disney will reimburse us for our share of certain general and administrative
costs and certain research and development costs that benefit the productions. Our second feature film, A Bugs Life, was released in November 1998 and
counted as the first original 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 2is a derivative work of the original Toy Story
and therefore it does not count toward the five original Pictures to be
produced under the Co-Production Agreement. As a derivative work, Toy Story 2
is treated as a Picture under the Co-Production Agreement, and all the
provisions applicable to the five original Pictures apply. In November 2001, we released Monsters, Inc., our fourth animated feature
film, which counts as the second original Picture under the Co-Production
Agreement. In May 2003, we released Finding Nemo, our fifth animated feature
film, which counts as the third original Picture under the Co-Production
Agreement. We are currently in post-production on The Incrediblesand in
production on Cars. These films will be produced and distributed under the
Co-Production Agreement and will count as the fourth and fifth films of the
Pictures to be produced under the Co-Production Agreement. The domestic
theatrical release of The Incrediblesis scheduled for
November 5, 2004, and
Carsis currently scheduled for a 2005 holiday release. We are also in
production on Project 2006,our first feature film outside of our Disney
relationship. The term of the Co-Production Agreement continues until delivery to Disney
of Cars.Since the delivery of Finding Nemo,we have had the ability to
negotiate and enter into another distribution agreement with any other third
party. We have produced five highly successful films to date, and we believe
that this success combined with the strength of our financial resources,
position us to negotiate a distribution arrangement beyond the Co-Production
Agreement with more favorable economic terms and full ownership of our films.
Although we look forward to a more favorable arrangement for films released
after Cars, we also understand that ending our relationship with Disney may
increase some of the risks we face in the motion picture industry. See Risk
Factors  The Co-Production Agreement imposes several risks and restrictions on
us, Risk Factors  We experience intense competition with respect to our
animated feature films, animation products, and software and Risk Factors 
We face various distribution risks with respect to our feature films. 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 Incrediblesand Carsunder 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. 11




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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. 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;
    
    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 Finding Nemo, Monsters, Inc., Toy Story 2and A Bugs Lifeafter
Disney recovers its marketing, distribution and other predefined costs and
fees. Our revenues for Toy Storyare governed by the terms of the Feature Film
Agreement. The amount of revenue recognized in any given quarter or quarters
from all of our films, depends on the timing, accuracy, and sufficiency of
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, in the past we have made adjustments, and we are likely to make
adjustments in the future, to that information based on our estimates and
judgments. For example, in the past, our theatrical revenues have been 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.
Disney may provide us with reserve information that may differ substantially
from our historical experience with our previous titles. Unless we obtain
compelling explanations for such differences, we have and may continue to
record reserves more in line with our historical experience. The estimates on
reserves may be adjusted in future periods as additional information becomes
available, such as actual rates of returns, inventory levels in the
distribution channel, as well as other business and industry information. We also 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. We also have the right to audit Disneys books and
records related to the Pictures according to the terms of the Co-Production
Agreement. Any revenue received in advance from Disney is deferred and
recorded as revenue when earned. Any adjustments resulting from changes to our estimated reserves, margin
normalization or updated information from Disney, noted above, could have a
material effect on our financial statements in any given quarter or quarters.
For example, during 2002 and 2003, there were a number of adjustments to our
earnings resulting from the 12




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aforementioned estimates, as well as our reliance on Disney. During fiscal
2002, one-time adjustments to A Bugs Lifeand Toy Story 2home video reserves
and margins and merchandising revenues had a positive net impact of $0.19 to
our diluted net income per share. We also received updated information from
Disney in the first quarter of fiscal 2003, which decreased previously recorded
home video expenses by $3.2 million 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. During the second quarter of fiscal
year 2003, we recognized an adjustment which reduced our Monsters, Inc.
domestic home video revenue after we received updated 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 in the second
quarter of fiscal 2003. We also received a settlement on Monsters, Inc.
merchandise revenue for the third quarter of fiscal 2003, which resulted in an
increase of $3.5 million to our revenues and $0.03 to our diluted net income
per share. 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 Lifeand Toy Story 2are classified as library titles. Monsters,
Inc.will be classified as a library title beginning in the fourth quarter of
fiscal 2004. 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. Software Revenue Revenue for software licenses are recognized in compliance with SOP 97-2
Software Revenue Recognition as amended by SOP 98-9 Modification of SOP
97-2, With Respect to Certain Transactions. Under SOP 97-2, as amended, we
recognize revenues when all of the following conditions are met:  
    
    persuasive evidence of an agreement exists;
    
    delivery of the product has occurred;
    
    the fee is fixed or determinable; and
    
    collection of these fees is probable. SOP 97-2, as amended, generally requires revenue earned on software
arrangements involving multiple elements to be allocated to each element based
on the relative fair values of the elements. Revenue recognized from
multiple-element arrangements is allocated to undelivered elements of the
arrangement, such as support services, based on the relative fair values of the
elements. Our determination of fair value of each element in multi-element
arrangements is based on vendor-specific objective evidence (VSOE). We limit
our assessment of VSOE for each element to either the price charged when the
same element is sold separately or the price established by management, having
the relevant authority to do so, for an element not yet sold separately. Software maintenance is recorded as deferred revenue and is recognized
ratably over the term of the agreement, which is generally twelve months. 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. With regard to the Pictures, we capitalize film production costs in
excess of reimbursable amounts from Disney. For film projects outside of our
existing Disney relationship, beginning with Project 2006, we capitalize all
film production costs. 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. 13




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Once a film is released, capitalized film production costs will be
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 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 will
be written down to fair value. Results of Operations Our results for the quarter and six months ended July 3, 2004 were driven
primarily by revenues from Finding Nemoas well as continued contributions from
Monsters, Inc.and our library titles. Revenue Total revenue, which consists of film revenue and software revenue, was
$66.3 million and $120.1 million for the quarter and six months ended July 3,
2004 compared to $48.9 million and $67.5 million in the corresponding prior
year periods. The period-over-period increase was largely due to the timing and
success of Finding Nemosworldwide home video performance and continued
foreign theatrical revenues in the first half of fiscal 2004. Film revenue for the quarter ended July 3, 2004 was $63.7 million compared
with $45.2 million in the corresponding prior year period. The increase in
revenues for the current quarter as compared to the corresponding prior year
quarter was due primarily to the continuing success of Finding Nemo. Film
revenue for the quarter ended July 3, 2004 consisted of $49.4 million from
Finding Nemorelated primarily to worldwide home video revenue, domestic pay
television and merchandise sales and ancillary royalties. Also included in film revenues for
the quarter ended July 3, 2004 was $10.0 million from our library titles, Toy
Story, A Bugs Lifeand Toy Story 2,which consisted of foreign home video
sales, foreign television licensing, merchandise sales and ancillary royalties,
and $4.2 million from Monsters, Inc.primarily from foreign home video revenue
and foreign television licensing. Film revenue for the quarter 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 quarter ended June 28,
2003 also included $3.6 million from Monsters, Inc.,primarily from merchandise
sales and ancillary royalties, offset by a reduction of home video revenue.
During the second quarter of fiscal 2003, 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 film revenue for the quarter ended June 28, 2003 was $14.9
million from our library titles, which largely consisted of merchandise sales,
as well as continuing worldwide home video sales, worldwide television
licensing and ancillary royalties. Film revenue for the six months ended July 3, 2004 was $114.8 million
compared to $61.6 million in the corresponding prior year period. Film revenue
for the first six months of fiscal 2004 consisted of $89.6 million from Finding
Nemorelated primarily to worldwide home video revenue, worldwide theatrical
revenue, merchandise sales and ancillary royalties, and worldwide television
licensing. Also included in film revenues for the six months ended July 3, 2004
was $18.3 million from our library titles, which consisted of worldwide home
video and television revenue as well as merchandise and ancillary royalties,
and $6.7 million from Monsters, Inc.primarily from foreign television
licensing, foreign home video and merchandise and ancillary royalties. Film revenue for the six months ended June 28, 2003 was primarily
comprised of domestic theatrical revenue from Finding Nemoof $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. In May 2003, two of our library titles, Toy
Storyand Toy Story 2, were placed on a domestic home video sales moratorium. 14




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Software revenue includes software license revenue, principally from
RenderMan®, and royalty revenue from licensing Physical Effects, Inc. (PEI)
technology to a third party. PEI, a company we acquired in 1998, licensed
certain of its technology to a third party, from which we receive associated
royalty revenue on a quarterly basis. Software revenue for the quarter and six
months ended July 3, 2004 was $2.6 million and $5.3 million compared to $3.7
million and $6.0 million in the corresponding prior year periods. Our primary
focus is on content creation for animated feature films and related products,
and as a result, we have not increased the time and resources necessary to
generate consistently higher RenderMan® license revenues. Therefore, we
continue to expect ongoing variability in revenues derived from software
licenses. Software maintenance contracts are recorded as unearned revenue and
recognized ratably over the term of the agreement, which is generally twelve
months. For the quarter and six months ended July 3, 2004, Disney accounted for
93% and 92%, respectively, of our total revenue compared to 92% and 91%,
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 2004 and for the
near future. Cost of Revenue Cost of revenue includes cost of film revenue and cost of software
revenue. Cost of film revenue for the quarter and six months ended July 3, 2004
was $6.4 million and $12.3 million compared to $7.8 million and $10.7 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 quarter and six months ended July 3, 2004,
cost of film revenue represented amortization of capitalized film production
costs associated with Finding Nemo, Monsters, Inc., and our library titles and
represented 10% and 11% of total film revenue as compared to 17% for each of
the corresponding prior year periods. Our cost of film 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. A change to our estimate of
revenue to be received from an individual film may result in an increase or
decrease to the amortization of the capitalized film costs relative to a
previous period. Toy Storyrevenue has no related cost, as film costs were
fully amortized by December 31, 1997. The decrease in cost of film revenue as
a percentage of total film revenue for the quarter and six months ended July 3,
2004 compared to the prior year period can be attributable to higher estimates
of revenue to be received under the individual-film-forecast-computation method
for Finding Nemo, Monsters, Inc.,and our library titles. Cost of revenue also includes cost of software revenue consisting of the
direct costs and manufacturing overhead required to reproduce and package our
software products. Cost of software revenue as a percentage of the related
revenue was less than 1% for the quarter and six months ended July 3, 2004,
which is comparable to the corresponding prior year periods. Operating Expenses Total operating expenses were $7.8 million and $14.7 million, respectively
for the quarter and six months ended July 3, 2004 compared to
$11.8 million and $16.9
million in the corresponding prior year periods. The decrease in operating
expenses over the prior year period was primarily due to certain unanticipated
expenses recorded in the second quarter of fiscal 2003, which included
approximately $3.2 million of costs associated with a one-time incentive
compensation for our employees in recognition of their contribution to the box
office success of Finding Nemoand a write-off of $1.9 million in costs
previously capitalized for future film projects. Relative to operating expense
levels of more recent quarters, our second quarter operating expenses reflect
the ongoing growth of the studio as well as our increased proportion of
operating expenses previously shared with Disney. 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. In February 2003, we approved 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. 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. 15




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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 decreased to
$4.2 million and $7.6 million for the quarter and six months ended July 3, 2004
from $6.6 million and $8.9 million for the corresponding prior year periods as
a result of the one-time incentive compensation and the write-off of
$1.9 million in previously capitalized development costs
referred to above. This decrease was offset
by increased costs in fiscal 2004 for creative development, short films, and
certain legal costs. We expect research and development expenses to increase
in future periods. To date, all research and development costs not reimbursed
by Disney have been expensed as incurred. Sales and Marketing.Sales and marketing expenses consist primarily of
salaries and related overhead, as well as public relations, advertising,
technical support and trade show costs required to support our software sales.
Sales and marketing expenses increased to $635,000 and $1.0 million for the
quarter and six months ended July 3, 2004, from $578,000 and $966,000,
respectively, in the corresponding prior year periods due primarily to increased
employee costs. This increase was partially offset by the one-time incentive
compensation in fiscal 2003. 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 professional fees. General and administrative expenses decreased to
$3.0 million and $6.1 million for the quarter and six months ended July 3, 2004
from $4.6 million and $7.0 million in the corresponding prior year periods
primarily due to the one-time incentive compensation in fiscal 2003.
General and administrative expenses may increase in future periods. Other Income, Net Other income, net was $2.5 million and $5.4 million, respectively for the
quarter and six months ended July 3, 2004, compared to $3.0 million and $5.9
million in the corresponding prior year periods and consists primarily of
interest income on investments. Even though cash, cash equivalents and
investments increased over the comparable prior year period, lower interest
income rates for the quarter and six months ended July 3, 2004 caused interest
income to be lower than the prior year periods. Income Tax Expense Our income tax rates for the quarter and six months ended July 3, 2004 were
31.4% and 34.9%, respectively, compared to 39.5% in each of the corresponding
prior year periods. This decrease in rate from the prior year is primarily
attributable to the recognition of a federal tax benefit associated with
certain income earned outside the U.S. for fiscal years 2000 through 2003. We recorded this benefit in the second quarter of 2004 since the
identification, analysis and conclusions with respect to this benefit were
conducted during that period. Capitalized Film Production Costs We had $122.8 million in capitalized film production costs as of July 3,
2004, consisting primarily of costs relating to A Bugs Life, Toy Story 2,
Monsters, Inc., Finding Nemo, The Incredibles, Cars,and Project 2006. With
the exception of Project 2006, all of the above films are being co-financed by
Disney under the Co-Production Agreement. Project 2006 is our first Pixar-only
financed film. In the second quarter of fiscal 2003, we wrote off $1.9 million
in costs previously capitalized for future film projects. In reviewing our
projects in development, we determined that it was unlikely that these projects
would 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 Storycapitalized film
costs were fully amortized as of December 31, 1997. 16




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Liquidity and Capital Resources Cash, cash equivalents and investments increased to $755.2 million by the
end of the second quarter of fiscal 2004, an increase of $233.3 million since
January 3, 2004. The increase was primarily due to cash received from Disney
for our share of film revenue, particularly relating to Finding Nemoworldwide
theatrical revenue and home video sales, along with proceeds from stock option
exercises, interest income and software revenue, offset by film production
costs, capital expenditures and tax payments. Net cash provided by operating activities for the
quarter ended July 3, 2004 of $212.1 million was attributable to net income of
$64.1 million resulting primarily from film revenue related to Finding Nemo,
Monsters, Inc.,and our film library, the non-cash impact of the tax benefit
from stock option exercises of $16.3 million, the non-cash impact of
depreciation and amortization expense and amortization of capitalized film
production costs of $15.7 million, a decrease in our receivable from Disney of
$182.7 million, an increase in accrued liabilities of $272,000, offset by a
decrease in income taxes payable of $34.0 million, capitalized film production
costs of $27.3 million, an increase in other receivables of $2.9 million, a
decrease in accounts payable of $671,000, and a decrease in unearned revenue of
$360,000. Net cash used in investing activities of $252.3 million consisted
primarily of the purchase of investments of $595.9 million and property and
equipment of $5.6 million, offset by net proceeds from sales of investments of
$349.2 million. Net cash provided by financing activities consisted entirely of
proceeds of $27.6 million from exercised stock options. Net cash provided by operating activities for the six months ended June
28, 2003 of $138.7 million was primarily attributable to net income of $27.7
million, the non-cash impact of the tax benefit from stock option exercises of
$16.7 million, the non-cash impact of depreciation and amortization expense and
amortization of capitalized film production costs of $14.2 million, a decrease
in our receivable from Disney of $83.2 million, an increase in accrued
liabilities of $19.2 million and an increase in unearned revenue of $3.4
million, offset by capitalized film production costs of $28.6 million. Net cash
used in investing activities of $151.7 million consisted primarily of purchases
of investments of $261.4 million and property and equipment of $3.1 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 July 3, 2004, our principal source of liquidity was approximately
$755.2 million in cash, cash equivalents and investments. Our future capital
commitments consist primarily of obligations to fund production costs of films
and derivative products under the Co-Production Agreement and beyond. Pursuant
to the Co-Production Agreement, we will co-finance the next two original
animated feature films we have in production, The Incrediblesand Cars. We are
also entirely financing Project 2006, our first production outside of the
Co-Production Agreement. In the future, we may co-finance other derivative
works such as theatrical sequels, direct to home video sequels, interactive
products and television productions. 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 2004, we expect to spend
approximately $37 million to $42 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 2004, we expect to spend
approximately $8 million to $10 million related to capital expenditures for our
Emeryville headquarters and studio and other facility related projects. We believe that our current available funds and forecasted cash from
operations for the remainder of 2004 will be sufficient to satisfy our
currently anticipated cash needs for working capital and capital expenditures,
including the post-production costs for The Incrediblesand production costs
for 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 17




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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. Contractual Obligations.At July 3, 2004, we had contractual commitments
to make payments under operating leases. Payments due under these long-term
obligations are as follows (in thousands): Payments Due by PeriodLess than
    
    1-3
    
    3-5
    
    More thanTotal
    
    1 Year
    
    Years
    

Years
    
    5 YearsOperating lease obligations
    
    $

1,040
    
    
    $

501
    
    
    $
    481
    
    
    $

58
    
    $
    Total
    
    $
    1,040
    
    
    $
    501
    
    
    $
    481
    
    
    $
    58
    
    $
    
 Off-Balance Sheet Arrangements As of July 3, 2004, we did not have any off-balance sheet arrangements. Recent Accounting Pronouncements On March 31, 2004, the FASB issued a proposed Statement, Share-Based
Payment,that addresses the accounting for share-based payment transactions in
which an enterprise receives employee services in exchange for (a) equity
instruments of the enterprise or (b) liabilities that are based on the fair
value of the enterprises equity instruments or that may be settled by the
issuance of such equity instruments. The proposed Statement would eliminate the
ability to account for share-based compensation transactions using APB Opinion
No. 25 and generally would require instead that such transactions be accounted
for using a fair-value-based method. If adopted in its current form, the
proposed Statement would be effective for fiscal years beginning after December
15, 2004. In March 2004, the FASBs Emerging Issues Task Force (EITF) reached a
consensus on Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments.Issue No. 03-1 states that companies
carrying debt and equity securities at amounts higher than the securities fair
values will soon have to use more detailed criteria to evaluate whether to
record a loss and will have to disclose additional information about unrealized
losses. Issue No. 03-1 is effective for reporting periods beginning after June
15, 2004 and the disclosure requirements are effective for annual reporting
periods ending after June 15, 2004. We believe the adoption of EITF No. 03-1
will not have a material effect on our results of operations, financial
position or cash flows. 
 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. Our operating results are primarily dependent on the success of our feature
films and forecasting is extremely difficult. For the remainder of 2004, our revenue and operating results will be
largely dependent upon (1) the timing and amount of worldwide revenues and
distribution costs for The Incredibles, Finding Nemo, Monsters, Inc., and to a
lesser extent, the titles in our film library, (2) the timing, accuracy, and
sufficiency of information we receive from Disney to determine revenues and
associated gross profits, (3) the timing and amount of non-film related
revenues and expenses, (4) the accuracy of our assumptions and judgments used
to estimate certain revenues and associated gross profits, (5) the market price
of our Common Stock and related volatility, (6) potential delays in the release
date of The Incredibles, (7) the terms of our next distribution arrangement and
(8) external socioeconomic and political events that are beyond our control. 18




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Dependence on revenue from our feature films. Under the current Co-Production Agreement, which governs our relationship
with Disney regarding the Pictures, 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 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 highly unusual in the motion picture industry,
and our future releases may not achieve similar results. For the remainder of
fiscal 2004, we will be dependent primarily on the continuing worldwide home
video and merchandise sales of all of our films, domestic free television
licensing of Monsters, Inc., foreign pay television licensing of Finding Nemo,
and the worldwide theatrical and merchandising success of our sixth feature
film, The Incredibles. If our films do not generate sufficient revenues from
these sources, our 2004 results would be adversely affected. To date, we have
recognized most of the revenues we expect to recognize over the lifetime of the
Toy Storyfranchise and A Bugs Life. 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 The Incrediblesbefore its theatrical release on November 5, 2004.
Moreover, The Incrediblesis our first film to be released with a PG rating, as
all of our previous films have been released with a G rating. It is difficult
to predict what impact a PG rating may have on the performance of the film.
Even if The Incrediblesexperiences a very successful worldwide theatrical run,
it is difficult to predict the related home video, television licensing,
merchandising and ancillary revenue streams. While the popularity of the film
is initially measured by box office success, the films success 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 Finding Nemo,
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 their life cycle
tend to be relatively small, minor fluctuations can result in notable variances
from our forecast. Both Toy Storyand Toy Story 2domestic home videos are
currently subject to a domestic sales moratorium, which began on May 1, 2003.
Although this strategy is designed to increase potential sales over the
lifetime of a title, to prevent a declining sales price and to support a
potentially 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 we are targeting the worldwide
theatrical releases of The
Incrediblesand Carsfor the holiday periods of 2004
and 2005, respectively, the specific dates of the international releases will
depend on territory-specific factors, such as the local competitive environment
and school holidays. In some instances, the holiday period may not be the
optimal release window for the films. Therefore, the timing of international
revenues could span over several months, and the forecasting of such revenues
is inherently more difficult. In addition, the amount of revenue recognized in any given quarter or
quarters from all of our films depends on the timing, accuracy, and amount of
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 19




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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 impacted 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, we
also make adjustments to our home video revenues for estimates on return
reserves that may differ from those reported by Disney. Disney may provide us
with reserve information that may differ substantially from our historical
experience with our previous titles. Unless we obtain compelling explanations
for such differences, we have and may continue to record reserves more in line
with our historical experience. The estimates on reserves may be adjusted in
future periods as additional information becomes available, such as actual
rates of returns, inventory levels in the distribution channel, as well as
other business and industry information. We also 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. We also have the right to audit Disneys books and
records related to the Pictures according to the terms of the Co-Production
Agreement. Any revenue received in advance from Disney is deferred and
recorded as revenue when earned. Any adjustments resulting from changes to our estimated reserves, margin
normalization or updated information from Disney, noted above, could have a
material effect on our financial statements in any given quarter or quarters.
For example, during fiscal 2002 and 2003, there were a number of adjustments to
our earnings resulting from the aforementioned estimates, as well as our
reliance on Disney. During fiscal 2002, one-time adjustments to A Bugs Life
and Toy Story 2home video reserves and margins and merchandising revenues had
a positive net impact of $0.19 to our diluted net income per share. We also
received updated information from Disney in the first quarter of fiscal 2003
which decreased previously recorded home video expenses by $3.2 million 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.
During the second quarter of fiscal year 2003, we recognized an adjustment
which reduced our Monsters, Inc. domestic home video revenue after we received
updated 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 in the second quarter of fiscal 2003. We also
received a settlement on Monsters, Inc.merchandise revenue for the third
quarter of fiscal 2003, which resulted in an increase of $3.5 million to our
revenues and $0.03 to our diluted net income per share. 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 depends 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. 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 direct costs of film production
in accordance with SOP 00-2. A substantial portion of all of our other costs is
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 share such costs equally with Disney under the Co-Production
Agreement. With respect to the portion of our Overhead that is 20




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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 2004 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 continue 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 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. The budget for The
Incrediblesand Carsand subsequent films and related products are expected to
be greater than the budgets for our previous films. Under the Co-Production
Agreement, we will continue to finance the budgets of The Incrediblesand Cars
equally with Disney. 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. Our fiscal 2004 earnings are expected to include revenues attributable to
non-film related sources including software revenue; however, there can be no
assurance as to the timing and amount of such revenues. Other non-film revenue and expenses. Our fiscal 2004 earnings are expected to include 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, in the first half of fiscal
2004, our average cash, cash equivalents and investment balances increased;
however, net interest income decreased when compared to the corresponding prior
year period due to declining interest rates. Income tax expense may also
fluctuate. We expect that our income tax rate for fiscal 2004 will be lower
than statutory rates due to the utilization of certain tax credits related to
foreign income for the years 2000 through 2003. The timing and availability of
this tax credit were uncertain until the second quarter of this year. Our
effective tax rate may fluctuate in future periods. 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, 21




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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,
    
    the final terms of our next distribution arrangement, 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 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 significantly 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,
    
    increased proportion of operating expenses previously shared with Disney, 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 22




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not reimburse) the increases in expenses, our operating expenses will
increase in fiscal 2004. 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. We have only recently established parallel creative teams so that we can
develop more than one film at a time. These teams are presently working
primarily on The Incredibles, Cars,and Project 2006, our first Pixar-only
financed film. We have only produced and released 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 Executive Vice President, Creative, 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. We continuously implement a variety of new and upgraded operational and
financial systems, procedures and controls, including improvement and
maintenance of our accounting system, other internal management systems and
backup systems. Our growth and these diversification activities, along with the
corresponding increase in the number of our employees and our 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, the marketing and distribution strategy, and the extent of
promotional support are important factors in determining the success of our
motion pictures and related products. Under the terms of the Co-Production
Agreement, Disney is required to market and distribute our feature films in the
same manner as their premier animated films, and Disney is required to consult
with us with respect to all major marketing and distribution decisions. While
Disney is prohibited from distributing potential competing films within certain
release collars, 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 23




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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 the Pictures,
until twelve months from our delivery of the fifth Picture under the
Co-Production Agreement. We currently anticipate the delivery of the fifth
Picture, Cars, approximately mid-2005. However, since we have delivered Finding
Nemo, 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). In January 2004, we
announced that we had ended our discussions with Disney regarding a new
arrangement with them for films released beyond Cars. We are currently
exploring other alternatives. We 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. However, if Disney produces
any derivative works without Pixar, we are entitled to receive passive
royalties pursuant to the terms of the Co-Production Agreement. See Risk
Factors  We experience intense competition with respect to our animated
feature films, animation products, and software. We have an obligation to co-finance production costs. Under the Co-Production Agreement, we will continue to co-finance The
Incrediblesand Carsand 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 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 of each Picture, all
characters and story elements of each Picture 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 24




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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:  
    
    talent and crew 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,
    
    piracy and unauthorized recording, transmission and distribution of motion pictures,
    
    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. In addition, 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 computer graphics imagery (CGI) animated
films, 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, Monsters, Inc., and Finding Nemo, there
can be no assurance that similar levels of success will be achieved by our
subsequent films, including The Incredibles, Carsand Project 2006. 25




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We experience intense competition with respect to our animated feature films,
animation products, and software. Animated Feature Films. 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, including its proposed spin-off, DreamWorks Animation
(DreamWorks), 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 2004, 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 The Incredibles, which will be released on
November 5, 2004. Some of the family-oriented animated and live action feature
films that will be released during the 2004 holiday period that could compete
with The Incrediblesinclude the following:  
    
    Shark Taleby DreamWorks,
    
    Finding Neverlandby Miramax,
    
    Alexanderby Warner Brothers,
    
    The Polar Expressby Warner Brothers,
    
    The SpongeBob Squarepants Movieby Paramount,
    
    National Treasureby Disney,
    
    Christmas with the Kranksby Sony,
    
    Oceans Twelveby Warner Brothers,
    
    The Brothers Grimmby Dimension Films,
    
    Lemony Snickets A Series of Unfortunate Eventsby Paramount,
    
    The Aviatorby Warner Brothers,
    
    Meet the Fockersby Universal,
    
    Ice Princessby Disney, and
    
    Fat Albertby Fox. We believe competition from animated feature films and family-oriented
feature films may continue to intensify over the next several years, possibly
affecting Cars, which is currently targeted for a 2005 holiday release, as well
as Project 2006 and subsequent films. 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, Cars,Project 2006
and subsequent films. 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. 26




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There
appears to be increasing widespread acceptance for CGI-animated
films. In 2004, a significant increase is expected in the number of
CGI-animated films to be released, a trend that is likely to carry through 2005 and
beyond. Primarily CGI-animated feature films that we understand to be currently
in production or pre-production include Robots, Madagascar, Chicken Little, The
Barnyard, A Day With Wilbur Robinson, Shrek 3, Open Season, Over the Hedge,
Flushed Away, Rapunzel Unbraided, Jimmy Neutron 2, Ice Age 2and Valiant, among
others. In addition to box office and home video 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, 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 has successfully produced and released Antzin
1998, Shrekin 2001, and Shrek 2in May 2004 and they currently have plans to
release Shark Talein October 2004. The company has recently announced plans to
spin off its animation unit into an independent, publicly-traded company. 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 to 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. The Co-Production Agreement provides that we will develop and produce five
original computer-animated feature films. Because Disney co-finances the films
developed and produced under the Co-Production Agreement, distributes the films
under the Walt Disney Pictures label and enjoys 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, Pirates of the Caribbean: The Curse of the Black Pearl, Spy Kids 3D:
Game Over, and Freaky Friday, competed directly with Finding Nemofor domestic
theatrical market share during summer 2003. The home video releases of Pirates
of the Caribbean: The Curse of the Black Pearland Freaky Fridayhave also
competed with Finding Nemoin the worldwide home video market. We expect the
theatrical release of J.M. Barries Neverlandby Miramax on October 22, 2004
and National Treasureon November 24, 2004 to compete with the worldwide
theatrical release of The Incredibles. Beyond Cars, Disney may begin to release
their movies during our release windows. This could have an adverse impact on
the commercial success required for us to profit from future films. 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, WETA Digital, Digital
Domain, and Sony Pictures Imageworks. These computer graphics special effects
firms may be capable of creating their own three-dimensional computer animated
feature films or may produce three-dimensional computer-animated feature films
for movie studios that compete with us. For example, ILM has already created
and produced three-dimensional character animation which was used for several
central characters in the live action film Star Wars Episode II: Attack of the
Clones, and ILM has a royalty-free, paid-up license to use our RenderMan®
software and to obtain at no cost all enhancements and upgrades thereto. Other
computer graphics special effects firms have licensed or may license
RenderMan®. Accordingly, our RenderMan® software may not provide us with a
competitive advantage. We also compete, or may in the future compete, with the
above firms with respect to animation products other than feature films. 27




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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 Discreet (a division of Autodesk), Mental
Images GmbH and Avid Technologies. Mental Images and Avid are each marketing
competing rendering software products, usually at lower prices than the price
at which we offer RenderMan®. 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. In addition, there have been advances in
graphics processing unit technology that may impinge on the market for software
rendering solutions. Faster and lower cost graphic cards provide capability for
users to produce pictures of higher complexity than previously available. 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, Simon Bax, Sarah McArthur and Lois Scali. We do not currently
have key person life insurance for any of our employees. We do have an
employment agreement with Mr. Lasseter, who has been 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, Bax, Dr. Catmull, 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. 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 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. 28




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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 the
financial risks associated with the production of our films under the
Co-Production Agreement 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. However, because we anticipate
to finance 100% of the production costs of our films under any future
distribution agreement, we expect to bear all of the financial risks associated
with a future films production costs. In addition, we cannot provide any
assurances that future distribution agreements will provide us with our current
level of risk minimization related to the financing of marketing and
distribution expenses. 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 Pictures, The
Incrediblesand Carspursuant 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
subsequent films, and any 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 the production costs of films for release
after Cars. As of July 3, 2004, we had approximately $755.2 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, post- production costs
for The Incredibles,production costs for Cars, as well as production and
development costs for Project 2006 and future development projects. 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 29




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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. 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 processes 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
53.1% of our outstanding Common Stock as of July 3, 2004. 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 developed certain plans to respond in the event of a disaster, there
can be no assurance that they will be effective in the event of a specific
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 of a short-term power outage, we have
installed UPS (uninterrupted power source) equipment to protect our RenderFarm
and other sensitive equipment, along with two 1.5 Megawatt backup generators;
however, a long-term power outage could disrupt our operations. 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. We do not carry earthquake insurance for
earthquake related losses and although we carry business interruption insurance
for other potential losses, 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 and
results of operations. Terrorist activities and resulting military and other actions could adversely
affect our business. The continued threat of terrorism within the United States and abroad,
military action and heightened security measures in response to such threats,
as well as other socioeconomic and political events, may cause significant
disruption to commerce, including the entertainment industry, throughout the
world. For example, the terrorist attacks in New York and Washington, D.C. on
September 11, 2001 disrupted commerce throughout the United States and Europe.
Such disruption in the future could have a material adverse effect on our
business and results of operations. 30




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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 may be 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. For example, many of the actors who provide
voice talent for the Pictures and Derivative Works are members of the Screen
Actors Guild (SAG) and/or the American Federation of Television and Radio
Artists (AFTRA) and the current SAG and AFTRA contract expires June 30, 2005.
If a work stoppage did occur, it could delay the completion of our films and
have a material adverse effect on our business operating results or financial
condition. 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 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-eight
patents in force in the United States and fourteen 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. 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, patent and trade secret protection may be
unavailable or limited in certain foreign countries. We generally rely on
electronically delivered software licenses that include an electronic
acceptance by the purchaser, 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 protect our patents, to
determine the validity and scope of the proprietary rights of others, or to
defend against 31




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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 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, speculation about the negotiation
of terms or conditions of our next distribution arrangement, or socioeconomic,
political or other factors. For example, since the beginning of fiscal 2003,
our Common Stock closed as low as $50.19 and as high as $74.20 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, 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. 32




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Our reported financial results could be affected if significant changes in
current accounting principles are adopted. Recent actions and public comments from the SEC have focused on the
integrity of financial reporting generally. Similarly, Congress has considered
a variety of bills that could affect certain accounting principles. The FASB
and other regulatory accounting agencies have recently introduced several new
or proposed accounting standards, such as accounting for stock options, some of
which represent a significant change from current practices. Changes in our
accounting for stock options could materially increase our reported expenses. We are subject to risks caused by the availability and cost of insurance. Changing conditions in the insurance industry have affected most areas of
corporate insurance. These changes have equated to higher premium costs, higher
deductibles and lower insurance coverage limits. Due to these factors, we have
elected to self-insure certain risks. For example, we do not carry earthquake
insurance due to its high cost; however, our primary facility in Emeryville,
California was designed to withstand a 7.0 Richter scale magnitude earthquake
with minimal structural damage to the building. 
 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 July 3, 2004. The table
presents principal cash flows and related weighted-average fixed interest rates
presented by expected maturity date (dollars in thousands): Less than
    
    Over1 Year
    
    1 Year
    
    TotalAvailable-for-sale securities.
    
    $
    515,748
    
    
    $
    203,618
    
    
    $
    719,366Weighted-average interest rate
    
    
    1.85
    %
    
    
    3.00
    %
    
    
    2.17
    %
 Impact of Foreign Currency Rate Changes.Disney and its affiliates
distribute our products in foreign markets; therefore, we are not directly
exposed to foreign currency rate fluctuations. We recognize revenues from
foreign territories based on an average foreign currency exchange rate used by
Disney for revenue reporting. This rate may differ from the actual exchange
rate at the time cash is remitted to Disney and subsequently to us. Therefore,
there may be some indirect foreign currency exchange rate exposure as managed
by Disney. 
 Item 4.Controls and Procedures Evaluation of disclosure controls and procedures.Our management
evaluated, with the participation of our President and our Chief Financial
Officer, the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this Quarterly Report on Form 10-Q. Based on this
evaluation, our President and our Chief Financial Officer have concluded that
our disclosure controls and procedures are effective to ensure that information
we are required to disclose in reports that we file or submit under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. 33




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Changes in internal control over financial reporting.There was no change
in our internal control over financial reporting that occurred during the
period covered by this Quarterly Report on Form 10-Q that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 34




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PART II  OTHER INFORMATION 
 Item 1.Legal Proceedings Pixar is regularly subject to certain legal proceedings and claims that
arise in the ordinary course of business. Many of these have not yet been fully
adjudicated. In the opinion of management, Pixar does not have a potential
liability related to any current legal proceedings and claims that would have a
material adverse effect on its financial condition, liquidity or results of
operations. However, the results of legal proceedings cannot be predicted with
certainty. Should Pixar fail to prevail in any of these legal matters or should
several of these legal matters be resolved against Pixar in the same reporting
period, the operating results of a particular reporting period could be
materially adversely affected. 
 Item 5.Other Information On the weekend of July 31, 2004, Steve Jobs, Pixars Chairman and Chief
Executive Officer, underwent successful surgery to remove an islet cell
neuroendocrine tumor from his pancreas. He will be recuperating during the
month of August and expects to return to work in September. During this time,
Mr. Edwin E. Catmull, President, will continue to run Pixars day-to-day
operations. 
 Item 6.Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 31.1
    
    Certification of President Pursuant to Exchange Act Rule
13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.Exhibit 31.2
    
    Certification of Chief Financial Officer Pursuant to Exchange
Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.Exhibit 32.1
    
    Certifications of President and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 (b) Reports onForm 8-K.The following current report on Form 8-K was
filed by Pixar during Pixars second fiscal quarter ended July 3, 2004: Current Report on Form 8-K dated May 6, 2004, furnishing pursuant to Item
12 Pixars press release regarding its financial results for the first
quarter ended April 3, 2004. Items 2, 3, and 4 are not applicable and have been omitted. 35




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SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. PIXARBy:
    
    /s/ SIMON T. BAXSimon T. BaxExecutive Vice President and Chief Financial Officer(Principal Financial and Accounting Officer and Duly Authorized Officer)
 Date: August 12, 2004 36




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EXHIBIT INDEX ExhibitNumber
    
    Description31.1
    
    Certification of President Pursuant to Exchange Act Rule 13a-14(a) or
15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Exchange Act Rule
13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certifications of President and Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 37