<PAGE>   1
                                                                   EXHIBIT 13.1

SELECTED FINANCIAL DATA

        The following selected financial data is derived from the Company's
financial statements. This data should be read in conjunction with the Financial
Statements and Notes thereto, and with Management's Discussion and Analysis of
Financial Condition and Results of Operations.


<TABLE>
<CAPTION>
                                                                Year Ended December 31,
                                                1993       1994       1995      1996      1997
                                              --------   --------   --------  --------  --------
                                                          (In thousands, except per share data)
<S>                                           <C>        <C>        <C>       <C>       <C>
Revenue                                       $  6,829   $  5,590   $ 12,113  $ 35,218  $ 34,699
Net income (loss) from continuing operations    (1,173)    (2,372)     3,331    26,342    21,956

Net income                                      (1,173)    (2,372)     1,627    25,319    22,190

Basic net income (loss) per share from
   continuing operations(1)                                 (0.24)      0.26      0.68      0.53
Basic net income (loss) per share(1)                        (0.24)      0.13      0.66      0.54

Diluted net income (loss) per share from
   continuing operations(1)                                 (0.24)      0.10      0.56      0.46
Diluted net income (loss) per share(1)                      (0.24)      0.05      0.54      0.46



   Working capital (deficit)                      (638)    (1,199)   138,687   162,983   167,048
   Total assets                                  1,987      1,896    152,815   176,941   231,068
   Long - term obligations                       1,460      1,573       --        --        --
   Total shareholders' equity (deficit)         (1,216)    (1,675)   142,907   170,804   217,300
</TABLE>

(1) Basic and diluted net income per share have been restated in accordance
    with SFAS No. 128 and SAB No. 98.







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        The foregoing discussion, the Letter to Shareholders, and other sections
of this Annual Report to Shareholders contain forward-looking statements that
have been made pursuant to the provisions of the Private Securities Litigation
Reform Act of 1995. Such forward looking statements are based on current
expectations, estimates and projections about Pixar's industry, management's
beliefs, and assumptions made by management. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," variations of
such words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict; therefore, actual results and outcomes may differ materially from what
is expressed or forecasted in any such forward-looking statements. Such risks
and uncertainties include those set forth herein under "Overview," "Anticipated
Net Losses in 1998 and The First Half of 1999", "Dependence on Toy Story, A
Bug's Life and Toy Story Sequel," and "Liquidity Risks" as well as those noted
in the section entitled "Certain Factors Affecting Business, Operating Results
and Financial Condition" in Pixar's Annual Report on Form 10-K for the year
ended December 31, 1997 (the "Form 10-K"). Particular attention should be paid
to the cautionary language in the section in the Form 10-K entitled "Certain
Factors Affecting Business, Operating Results and Financial
Condition--Anticipated Net Losses in 1998 and the First Half of 1999, "
"--Dependence on Toy Story, A Bug's Life and Toy Story Sequel," "--Liquidity
Risks," "--Scheduled Successive Release of Films; Management of Growth" and
"--Risks Associated with Co-Production Agreement." Unless required by law, Pixar
undertakes no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise.


        MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
        RESULTS OF OPERATIONS

OVERVIEW

        Pixar was formed in 1986 when Steve Jobs purchased the computer division
of LucasFilm and incorporated it as a separate company. Until 1996, Pixar
generated its recurring revenue primarily from the license of RenderMan
software, software development contracts and fees for animated television
commercials. Financial information relating to business segments is set forth in
Note 10 of Notes to Financial Statements. In 1991, Pixar entered into 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. As a result, in 1992, Pixar began to place
more emphasis on products sold for their content, especially feature films, and
the continued development of its proprietary software. At the same time, Pixar
reduced emphasis on the commercialization of software and contract development
work. Pixar has implemented this shift in focus over the last five years. In
accordance with this shift in focus, Pixar adopted a new business model pursuant
to which it will develop and produce new animated feature films and related
products such as theatrical sequels, and will produce jointly with Disney
related products such as merchandise and soundtracks.

        Adoption of this new business model did not materially impact Pixar's
results of operations and financial condition until 1996, when Pixar first
recognized film revenue and cost of film revenue attributable to Pixar's first
animated feature film, Toy Story, which was released in November 1995. Pixar's
share of revenues and expenses from Toy Story was governed by the terms of the
Feature Film Agreement. This agreement has been superseded by the Co-Production
Agreement entered into in February 1997, as described below, except with respect
to treatment of Toy Story and products developed pursuant to the Feature Film
Agreement, such as the Toy Story home video. Accordingly, Pixar believes that
the results of its operations for 1995 and prior years, during which time Pixar
recognized no revenue from animated feature films or related products, are not
meaningful indicators of future performance. Further, Pixar believes that its
results of operations for 1996 and 1997, during which time revenue and costs
attributable to feature films were governed by the terms of the Feature Film
Agreement, are also not meaningful indicators of future performance, although
they are more meaningful than results of operations for 1995 and prior years.
See "Anticipated Net Losses in 1998 and the First Half of 1999."

        In February 1997, Pixar and Walt Disney Pictures and Television, a
wholly-owned subsidiary of Disney, entered into the Co-Production Agreement
("Co-Production Agreement") pursuant to which Pixar, on an exclusive






                                      2
<PAGE>   3

basis, will produce five computer animated feature-length theatrical motion
pictures (the "Pictures") for distribution by Disney over approximately the next
ten years. Pixar and Disney will co-finance the production costs of the
Pictures, co-own the Pictures (with Disney having exclusive distribution and
exploitation rights), co-brand the Pictures and share equally in the profits of
each Picture and any related merchandise and other ancillary products, after
recovery of all marketing and distribution costs (which will be financed by
Disney), a distribution fee paid to Disney and any other fees or costs,
including any participations provided to talent and the like. The Co-Production
Agreement generally provides that Pixar will produce each Picture and that
Disney will control all decisions relating to marketing, promotion, publicity,
advertising and distribution of each Picture. Disney and Pixar have agreed that
Pixar's second feature film, called "A Bug's Life", will be the first Picture
under the Co-Production Agreement. The Co-Production Agreement also contemplates
that with respect to theatrical sequels, made-for-home video sequels, television
productions, interactive media products and other derivative works related to
the Pictures, Pixar will have the opportunity to co-finance and produce such
products or to earn passive royalties on such products. Pixar 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 Pixar for its share of certain general and
administrative costs and certain research and development costs that benefit the
productions. See Note 4 of Notes to Financial Statements.

        In February 1998, Pixar and Disney agreed to produce a theatrical motion
picture sequel to Toy Story (with the working title, "Toy Story Sequel"), in
lieu of the Toy Story made-for-home video sequel. Toy Story Sequel will be
Pixar's third feature film and will not be released until late in 1999 at the
earliest. Because Toy Story Sequel is a derivative work of the original Toy
Story, it will not be counted toward the five Pictures to be produced under the
Co-Production Agreement. However, for all other purposes, Toy Story Sequel will
be treated as a "Picture" under the Co-Production Agreement. Accordingly, Toy
Story Sequel has been added to the definition of Pictures produced and financed
under the Co-Production Agreement and all the provisions applicable to the other
five Pictures apply. Since 1996, Pixar has been producing Toy Story Sequel for
the less expensive made-for-home video format. Therefore, Pixar will necessarily
spend substantially more production time and incur substantially higher
production costs to convert Toy Story Sequel into a feature-length and
feature-quality motion picture.

        In 1997, Pixar continued story development on its fourth theatrical film
(the "Fourth Film"). This film will be developed and distributed under the
Co-Production Agreement and will count as the second of the five original films
to be produced under the Co-Production Agreement. Production of the Fourth Film
has not yet begun, and Disney and Pixar have not yet approved the story
treatment and budget as required under the Co-Production Agreement. The Fourth
Film is not expected to be released until the end of 2000 at the earliest.

RESULTS OF OPERATIONS

        A number of factors are expected to result in net losses in 1998 and the
first half of 1999. See "Anticipated Net Losses in 1998 and the First Half of
1999."

Revenues

        In the year ended December 31, 1997, Pixar derived revenue from its
first animated feature film, Toy Story, from software licenses, from the license
of certain patents and from fees for other animation services. Revenue from
feature films is recognized upon receipt of compensation from Disney. All
payments to Pixar from Disney for development and production of Toy Story under
the Feature Film Agreement and A Bug's Life, Toy Story Sequel and the Fourth
Film under the Co-Production Agreement have been recorded as cost
reimbursements. Accordingly, no revenues have been recognized for such
reimbursements; rather, Pixar has netted the reimbursements against the related
costs. These reimbursed costs through the year ended December 31, 1997 are set
forth in Note 4 of Notes to Financial Statements. Software license revenue is
recognized upon shipment if there are no significant vendor obligations. Revenue
from patent licensing is recognized upon release of the rights to the
technology. Animation services revenues is recognized on the
percentage-of-completion method of accounting. Prior to 1996, Pixar also derived
revenue from software development contracts for which revenues were recognized
on the percentage-of-completion method of accounting. See Note 1 of Notes to
Financial Statements.





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<PAGE>   4

        Total revenues increased from $12.1 million in 1995 to $35.2 million in
1996 and declined slightly to $34.7 million in 1997. Total revenues increased
from 1995 to 1996 primarily as a result of revenues attributable to the domestic
and international theatrical release of Toy Story. The decrease in total
revenues from 1996 to 1997 was primarily attributable to a decrease in patent
licensing revenue, largely offset by higher film revenue derived from Toy Story
home video and merchandise sales.

        Software revenues include software license revenue, principally from
RenderMan and in 1995, software development contract revenues. Software revenue
increased from $3.1 million in 1995 to $3.3 million in 1996 and to $4.5 million
in 1997. Software revenues increased in each of 1996 and 1997 due primarily to a
general increase in RenderMan software license revenue. Due to Pixar's focus on
content creation for animated feature films and related products, Pixar
continues to expect that revenue derived from software licenses may decline. All
historical and future royalty income associated with Pixar's discontinued CD-ROM
division is now and will continue to be excluded from software revenue and
presented in results of discontinued operations. See "Results From Discontinued
Operations."

        Animation services revenues include revenue generated from short
projects related to Pixar's films, other short animated productions and, in 1996
and prior years, television commercials. Fees for animation services, which are
fixed in advance, depend on the relative complexity and length of each
production and may also depend on the market and other competitive conditions.
Animation services revenues increased from $2.5 million in 1995 to $3.9 million
in 1996 and decreased to $1.6 million in 1997. The increase in revenue from 1995
to 1996 was due to $2.4 million in fees from Disney for a series of televised
animation short productions related to Toy Story. The decrease in animation
services revenue from 1996 to 1997 was primarily attributable to decreased
television commercials revenue in 1997, which resulted from Pixar's decision to
substantially discontinue its production of animated television commercials for
third parties. More generally, Pixar expects that revenue in the animation
services area will vary significantly from period to period due to the sporadic
nature of this business and the need to utilize animation services employees on
other productions. For example, Pixar has transferred substantially all of its
animation services employees to assist in the completion of A Bug's Life. There
can be no assurance that Pixar will generate any animation services revenue
during periods in which its animation services employees are devoted to feature
films or other projects.

        Toy Story was not released until November 1995, and accordingly, there
were no film revenues in 1995. Under the Feature Film Agreement, film revenues
of $18.8 million were recognized in 1996, representing Pixar's share of both the
domestic and international theatrical releases of Toy Story and related
products. In 1997, film revenues of $26.9 million were recognized, primarily
representing Pixar's share of Toy Story worldwide home video sales and Toy Story
merchandise sales. Toy Story revenues increased in 1997 primarily because, under
the Feature Film Agreement, Pixar's percentage of Toy Story revenues is
calculated on a sliding scale with lower percentages earned by Pixar at the
outset while Disney recovered related production, marketing and distribution
costs for the film, and higher percentages earned once Disney has recovered
these costs. Disney's costs were recovered in the quarter ended June 30, 1997,
which increased Pixar's proportionate share of revenue received from all
film-related sources thereafter. In addition to the general increase in Pixar's
proportionate share, Pixar received $4.1 million additional film revenue from
Disney for two reasons. First, in the quarter ended June 30, 1997, when Disney
recovered its costs, Pixar was entitled under the Feature Film Agreement to
recoup from Disney $2.3 million of overbudget production costs originally paid
by Pixar when Toy Story was in production (see "Capitalized Film Production
Costs"). Also, in the quarter ended September 30, 1997, Pixar and Disney
determined that the date on which Disney's costs were recovered occurred earlier
than previously thought, resulting in agreement on an additional payment to
Pixar of $1.8 million. Since the Toy Story home video is the last major release
for Toy Story, and since Pixar's next feature film is not targeted for release
until the fourth quarter of 1998 at the earliest, Pixar's revenues and earnings
will decline in 1998 as compared to 1997, and Pixar expects to incur a net loss
in 1998 and in the first half of 1999.

        Patent license revenues of $6.5 million in the year ended December 31,
1995 were attributable to a patent license with Microsoft. Patent license
revenues of $9.1 million in the year ended December 31, 1996 were






                                      4
<PAGE>   5

attributable to a patent license with Silicon Graphics whereby Pixar granted to
Silicon Graphics and its subsidiaries a non-exclusive license to use certain of
Pixar's patents covering techniques for creating computer-generated
photorealistic images. Under the agreement, Silicon Graphics agreed to pay Pixar
total compensation of $11 million, $6 million in cash and $5 million in the form
of credits to purchase hardware and software from Silicon Graphics. In 1996,
Pixar recognized revenue of $9.1 million in accordance with this license. In
1997, Pixar recognized $1.7 million of the remaining $1.9 million of credits.
Pixar expects to use the remaining credits in 1998. Pixar does not expect that
patent license revenues will be generated on an on-going basis. See Note 5 of
Notes to Financial Statements.

        In the year ended December 31, 1995, Microsoft accounted for 54% of
Pixar's total revenues, attributable to a one-time patent license. In the year
ended December 31, 1996, Disney accounted for 62% of Pixar's revenues from
continuing operations, attributable to revenue generated from Toy Story and
short animated television productions based on Toy Story, and, to a lesser
degree, software license sales. Also in 1996, Silicon Graphics accounted for 26%
of total revenues, attributable to a one-time patent license. In the year ended
December 31, 1997, Disney accounted for 83% of Pixar's revenues from continuing
operations, attributable to revenue generated from Toy Story home video,
animation services and software revenues. Due to the Co-Production Agreement,
Disney is expected to continue to represent greater than 10% of Pixar's revenues
in 1998 and for the forseeable future.

Cost of Revenues

        Cost of software revenues consists of the direct cost and manufacturing
overhead required to reproduce and package Pixar's software products. Cost of
software revenues as a percentage of the related revenues decreased from 16% in
1995 to 3% in 1996 and to 2% in 1997. The decrease from 1995 to 1996 and from
1996 to 1997 was primarily due to a reduction in revenue from low margin
software development contracts and to increased sales of the RenderMan ToolKit,
which carries a higher gross margin than other software products. Cost of
software revenues includes no amortization of capitalized software development
expenses.

        Cost of animation services revenues consists of production costs, which
include salaries, benefits, facility expenses, and department overhead costs.
Cost of animation services revenues as a percentage of the related revenues
increased slightly from 76% in 1995 to 77% in 1996 and decreased to 63% in 1997.
The increase from 1995 to 1996 was due to higher costs associated with increased
complexity and reduced prices for television commercials attributable to
competitive pressures, largely offset by the higher margins earned on a series
of animated short projects related to Toy Story. The decrease from 1996 to 1997
reflects Pixar's decision in 1996 to largely discontinue its business of
producing animated television commercials, which had higher associated costs
relative to revenues, in favor of working on animated services related to
feature films, which have had lower associated costs relative to revenues. Pixar
expects that costs of revenue, and therefore gross profits, in this area will
vary significantly period to period.

        Toy Story was released in November 1995, and accordingly, there was
neither film revenue nor cost of film revenues in 1995. In 1996 and 1997 cost of
film revenue consisted of the amortized portion of Pixar's share of unreimbursed
amounts incurred to produce Toy Story. See "Capitalized Film Production Costs."
Cost of film revenues decreased from $1.6 million, or 8% of film revenues in
1996, to $1.5 million, or 6% of film revenue in 1997, due to higher than
expected film revenue which resulted in Pixar's amortizing the majority of
related film costs in 1996. As of December 31, 1997, all significant Toy Story
film costs have been fully amortized.

        Under the Feature Film Agreement all payments to Pixar from Disney for
Pixar's efforts in the development and production of feature films were recorded
as cost reimbursements and were netted against the related costs. However, under
the terms of the Co-Production Agreement, in which Pixar co-finances each film
production, amortized film production costs for future feature films will be
significantly higher, and gross profit margins on future film projects, if any,
will be substantially lower than those achieved on Toy Story.

        There are no costs of revenues associated with patent licensing
revenues.





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<PAGE>   6

Operating Expenses

        Pixar intends to continue to increase operating expenses in a number of
areas. With respect to general expense growth, as a result of intense
competition for animators, creative personnel, technical directors and certain
administrative personnel, Pixar has had to pay higher salaries to attract new
creative, technical and other personnel. Pixar expects compensation for such
personnel to continue to increase. In the year ended December 31, 1997, Pixar
funded greater levels of research and development, expanded its administrative
staff and facilities and expanded other operations. Pixar expects continued
growth in operating expenses in each of these areas. Under the Co-Production
Agreement, Disney reimburses Pixar for its share 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. See Note 4 of Notes to Financial Statements. To the extent that
personnel, facilities and other expenditures are not capitalized by Pixar nor
allocated to and paid for by Disney, and precede or are not subsequently
followed by an increase in revenues, Pixar's business, operating results and
financial condition will be materially adversely affected.

        Included in the period ended December 31, 1997 was a one time $2.2
million adjustment reducing Pixar's operating expenses. This reduction was due
to an additional reimbursement from Disney under the Co-Production Agreement
which was signed in February 1997. Under this 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. Since the Co-Production Agreement applies to A Bug's Life and Toy
Story Sequel, both of which were in development and production in 1996, Pixar
was entitled to reimbursement for Disney's share of certain of Pixar's operating
expenses incurred in 1996 and in the first two months of 1997, prior to signing
the agreement. Without this adjustment, Pixar's total operating expenses
increased from $6.9 million in 1995 to $10.2 million in 1996 and to $11.3
million in 1997.

        In 1995, Pixar recorded deferred compensation of $3.7 million for the
difference between the grant price and the deemed fair value of Pixar's Common
Stock for 9,823,900 shares subject to options granted during 1995. Amortization
of deferred compensation of $1.4 million, $1.2 million and $635,000 was recorded
in the years ended December 31, 1995, 1996 and 1997 respectively; $292,000,
$44,000 and $24,000 was capitalized to film production costs in 1995, 1996 and
1997, respectively, and the balances were charged to expense in the respective
years. See "Capitalized Film Production Costs." The remaining deferred
compensation expense of $414,000 will be amortized primarily to operating
expense over the related vesting period of the options and will therefore
continue to have an adverse effect on Pixar's results of operations. See Note 8
of Notes to Financial Statements.

        Research and Development. Research and development expenses consist
primarily of salaries and support for personnel conducting research and
development for the RenderMan product and for Pixar's proprietary Marionette and
Ringmaster animation and production management software. Research and
development expenses increased from $3.0 million in 1995 to $4.5 million in 1996
and to $4.7 million in 1997. Research and development expenses increased in each
of 1996 and 1997 as compared to the prior year due to an increase in personnel.
To date, all research and development costs not reimbursed by Disney have been
expensed as incurred. Pixar expects research and development expenses to further
increase. See Note 4 of Notes to Financial Statements.

        Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and overhead, as well as public relations, advertising, technical
support and trade show costs required to support the software segment. Sales and
marketing expenses increased slightly from $1.4 million in 1995 to $1.5 million
in each of 1996 and 1997 due to increases in public relations and corporate
marketing costs. Pixar believes that sales and marketing expenses will increase
in absolute dollars in future periods, particularly in the areas of public
relations and corporate marketing. Pixar has not received substantive amounts of
reimbursements from Disney for sales and marketing expenses pursuant to the
Co-Production Agreement.

        General and Administrative. General and administrative expenses consist
primarily of salaries of management and administrative personnel, insurance
costs and professional fees. General and administrative






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<PAGE>   7

expenses increased from $2.5 million in 1995 to $4.2 million in 1996 and to $5.1
million in 1997. The increase in general and administrative expenses from 1995
through 1997 was primarily due to increased general and administrative staffing,
increased systems costs and increased facilities costs. Pixar expects general
and administrative expenses to further increase in absolute dollars in future
periods as Pixar incurs additional costs to expand its administrative staff and
facilities. See Note 4 of Notes to Financial Statements.

Other Income, Net

        Other income, net was $715,000 in 1995, $8.0 million in 1996 and $8.8
million in 1997. In 1995, net other income consisted primarily of interest
income from investments, amounts received pursuant to settlement of an
intellectual property rights dispute and additional gain on the sale of equity
securities, offset by net interest expense attributable to interest accrued on a
promissory note issued to Pixar's majority shareholder. Other income, net in
1996 and 1997 consisted primarily of interest income from investments made with
the net proceeds from Pixar's initial public offering of common stock.

Income Taxes

        Income tax expense from continuing operations of $246,000 for the year
ended December 31, 1995 represented federal and state alternative minimum taxes
(after utilization of net operating loss carryforwards) on the earnings of Pixar
following termination of its S corporation status.

        Income tax expense from continuing operations of $2.0 million and $9.9
million for the years ended December 31, 1996 and 1997, respectively, consisted
primarily of state income taxes and federal alternative minimum tax. Income
taxes increased from 1995 to 1997 due to increased earnings and to full
utilization of state net operating loss carryforwards during 1996. Pixar had net
operating loss carryforwards for federal income tax purposes from pre-S
corporation years of approximately $3.4 million as of December 31, 1997. See
Notes 1 and 7 of Notes to Financial Statements.

Results of Discontinued Operations

        After the Co-Production Agreement was executed, Pixar determined that,
despite the fact that Pixar's first CD-ROM titles were successful on relative
terms, the resources devoted to its interactive products division would be
better allocated to other projects arising from the Co-Production Agreement.
Pixar determined in March 1997 to discontinue its business of producing CD-ROM
and other interactive products and has redirected the approximately 60 employees
in this division to film and related projects within Pixar.

        Discontinued operations, net of income taxes, resulted in losses of $1.7
million and $1.0 million in 1995 and 1996, respectively. Pixar recorded income
from discontinued operations, net of taxes, of $234,000 in 1997 primarily due to
royalty income received. Pixar anticipates that future royalty income will
exceed costs to be incurred in all future periods. See Note 12 of Notes to
Financial Statements.

ANTICIPATED NET LOSSES IN 1998 AND THE FIRST HALF OF 1999

        A number of factors are expected to result in net losses in 1998 and in
the first half of 1999, as discussed more fully below.

        End of Toy Story Revenues

        Pixar has already recognized the vast majority of the revenue it expects
to receive from Toy Story. While relatively minor amounts of revenue may be
received by Pixar in subsequent periods from sources such as Toy Story
merchandise royalties, Toy Story television airings, and minor remaining
international home video sales of Toy Story, Pixar does not expect to recognize
any further significant revenue from Toy Story in the future.





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<PAGE>   8

        Timing of A Bug's Life and Toy Story Sequel Releases

        A Bug's Life is not expected to be released until the end of 1998 at the
earliest, and revenue attributable to A Bug's Life is not expected to be
recognized until after all marketing and distribution costs and fees have been
recovered by Disney. Recovery of all costs depends on many factors and may not
occur until six to twelve months after its release at the earliest, making it
likely that Pixar will not recognize any revenue from A Bug's Life until the
second half of 1999 at the earliest. In addition, Toy Story Sequel is not
expected to be released until the end of 1999 at the earliest. As with A Bug's
Life, Pixar does not expect to recognize any revenue from Toy Story Sequel until
six to twelve months after its release at the earliest. Therefore Pixar is
unlikely to recognize any revenue from Toy Story Sequel until the second half of
2000 at the earliest.

        Limited CD-ROM Income

        Although its first two CD-ROM products were successful on relative
terms, Pixar determined in March 1997 to discontinue its business of producing
CD-ROM and other interactive products in favor of other opportunities arising,
in part, as a result of entering into the Co-Production Agreement. Pixar has not
recognized and will not recognize any CD-ROM income from this discontinued
operation in 1998 or thereafter, other than royalty income attributable to the
two existing Toy Story CD-ROM products. Pixar has reassigned all of the
approximately 60 employees previously employed in the CD-ROM division to feature
film productions and other departments within Pixar.

        Possible Decline in Sales of RenderMan Due to Shift in Focus

        As a result of Pixar's reduced emphasis on the commercialization of
software in favor of products sold for their content, Pixar continues to expect
to dedicate less time and resources to distributing and marketing RenderMan than
it has in the past and further expects that licensing of RenderMan may decline.

        Increase in Operating Expenses and Tax Rate

        In 1996 and 1997, Pixar significantly increased its operating expenses,
and Pixar plans to continue to increase its operating expenses to fund greater
levels of research and development and to expand operations. Specifically, Pixar
expects its spending levels to increase significantly due to continued
investment in proprietary software systems, increased compensation costs as a
result of intense competition for animators, creative personnel, technical
directors and other personnel, and increased costs associated with the expansion
of its facilities. A portion of Pixar's operating expenses that are allocable to
film productions are capitalized by Pixar or reimbursed by Disney under the
Co-Production Agreement. To the extent that the increases in expenses are not
capitalized by Pixar nor paid for by Disney, Pixar's operating expenses will
significantly increase in 1998. In addition, in 1998, if the story for the
Fourth Film is not approved, Pixar could be required to write-off certain
related film costs previously capitalized. Finally, Pixar's tax rate increased
in the year ended December 31, 1997 and is likely to increase in future years
due to near complete utilization of remaining net operating losses in 1997.


        Impact on Operating Results

        As a result of the above factors, Pixar expects revenue to substantially
decline in 1998 as compared to the year ended December 31, 1997. At the same
time, Pixar's operating expenses are expected to increase in 1998. Therefore,
Pixar expects revenue and operating results in 1998 to decline substantially
from revenue and operating results in 1997. Pixar expects operating and net
losses in 1998 and in the first half of 1999. Operating results thereafter will
depend upon the success of Pixar's next films, starting with A Bug's Life.





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DEPENDENCE ON TOY STORY, A BUG'S LIFE AND TOY STORY SEQUEL

        Dependence on Toy Story

        For at least 1998 and the first half of 1999, Pixar's revenue and
operating results will again be largely dependent upon whatever remains to be
received from Toy Story merchandise royalties, any remaining Toy Story home
video revenues and revenue from television airings of Toy Story. Pixar
recognized the vast majority of Toy Story home video revenue in 1997 and expects
little revenue from Toy Story or related products in 1998 and thereafter. Pixar
also expects little or no royalty income from its Toy Story CD-ROM products in
1998 or thereafter. Because A Bug's Life is not expected to be released until
the end of 1998 at the earliest, and Toy Story Sequel is not expected to be
released until the end of 1999 at the earliest, any other revenues in 1998 and
in the first half of 1999 will be primarily dependent upon Pixar's other
businesses, from which Pixar expects limited revenue.

        Dependence on A Bug's Life and Toy Story Sequel

        Beyond 1998 and the first half of 1999, Pixar expects to be
significantly dependent upon the success of A Bug's Life, Toy Story Sequel, and
the Fourth Film (the "Current Projects") and related products. Although
development and/or production on each of the Current Projects is underway, there
can be no assurance that any of the Current Projects will be successfully
produced and released when scheduled or thereafter. There can be no assurance
that Pixar will not experience difficulties that could delay or prevent the
successful development or production of any of the Current Projects or
subsequent animated feature films or related products. If Pixar is unable to
produce and develop on a timely basis the Current Projects and subsequent
animated feature films and related products that meet with broad market
acceptance, Pixar's business, operating results and financial condition will be
materially adversely affected.

        The development of the Fourth Film only began in late 1996. Although it
is currently targeted for release in 2000, to date there has been no final
approval under the Co-Production Agreement of the story treatment or the budget
for the Fourth Film and there can be no assurance that it will be released as
targeted in 2000. As a result, for the next two or three years, Pixar expects to
be significantly dependent upon A Bug's Life and Toy Story Sequel.

        Risks Associated with A Bug's Life

        Under the Co-Production Agreement, Pixar shares the production costs of
A Bug's Life. These costs will initially be capitalized as film production costs
under SFAS No. 53, Financial Reporting by Producers and Distributors of Motion
Picture Films, and then be amortized over the expected revenue stream when
revenue is recognized. If A Bug's Life is not an extraordinary box office
success similar to Toy Story, the amount of revenue recognized will not be
significant, and the capitalized production costs will have to be amortized in
large amounts over a limited number of quarters, resulting in significant costs
of film revenue in those quarters and, potentially, significant quarterly
operating and net losses. Animated feature films that become extraordinary box
office successes are rare. Pixar believes, based on available information, that
there is a reasonable basis to conclude that of the more than 40 animated
feature films introduced since 1990, only two movies generated domestic box
office revenues greater than Toy Story, and both of those films were produced
and distributed solely by Disney. During at least the last five years, Pixar
believes that there has been no fully-animated feature film (other than Toy
Story) produced or developed by a studio other than Disney that has achieved
more than $65 million in domestic box office revenues. While A Bug's Life will
be co-financed, promoted and marketed by Disney, it will have a different look,
theme and musical style than Disney's other recent animated films (except for
Toy Story), and there can be no assurance that it will have the same audience
appeal as Disney's other animated films. For example, The Nightmare Before
Christmas, released in 1993, was an animated feature film with a different
appearance than traditional, hand drawn cel animated feature films such as
Beauty and the Beast, The Lion King, Aladdin, Pocahontas, The Hunchback of Notre
Dame and Hercules and did not experience the same box office returns as those
films. As a result, A Bug's Life and related products may not generate
significant revenue and operating results for Pixar, even






                                      9
<PAGE>   10

if A Bug's Life is critically acclaimed and achieves substantial, but not
extraordinary, box office success. See "--Risks Associated with Co-Production
Agreement--Dependence on Disney for Distribution and Promotion of Feature Films
and Related Products," "Risks of Motion Picture Industry," and
"Business--Relationship with Disney. " See also Note 4 of Notes to Financial
Statements.

        Risks Associated with Toy Story Sequel.

        As a theatrical feature film release, Toy Story Sequel is subject to the
same risks associated with A Bug's Life specified above. In addition, because it
is a sequel, there are also risks unique to Toy Story Sequel. With a theatrical
sequel, the story concept and characters are not as novel as the original film.
In the vast majority of cases in which a film that achieved domestic box office
receipts of greater than $100 million was followed by the release of a sequel,
the sequel did not perform as well at the box office as the original. This was
the case for sequels to such films as Star Wars, Jurassic Park, Home Alone,
Jaws, Batman, Raiders of the Lost Ark, Beverly Hills Cop, Ghostbusters and Back
to the Future, among others. In many cases, sequels substantially under-perform
the original film. In far fewer cases have sequels performed as well or better
than the original blockbuster feature film, and in almost all of these cases,
the original feature films and related sequels were action-adventure films, such
as Lethal Weapon and Die Hard. Accordingly, there can be no assurance that Toy
Story Sequel will perform as well as Toy Story at the box office. It is possible
that Toy Story Sequel will substantially under-perform the original feature
film. In addition, fees and participations paid to key talent on Toy Story
Sequel are substantially greater than for the original film, which will have the
effect of increasing the cost of the film.

        As a result of these factors and the same factors associated with A
Bug's Life, Toy Story Sequel and related products may not generate significant
revenue and operating results for Pixar, even if Toy Story Sequel is critically
acclaimed and achieves substantial, but not extraordinary, box office success.

        Production Budgets

        Given the escalation in compensation rates of people required to work on
the Current Projects, the number of people required to work on the Current
Projects, and the equipment needs, the budget for the Current Projects and
subsequent films and related products are and will continue to be substantially
greater than the budget for Toy Story and will be financed equally by Pixar and
Disney under the Co-Production Agreement. In addition, due to production
exigencies which are often difficult to predict, Pixar believes that it is not
uncommon for film production spending to exceed film production budgets and
there can be no assurance that any of the Current Projects can be completed
within the budgeted amounts. For example, in order to meet the production
schedule, substantially all employees from Pixar's animation services group are
expected to be assigned to A Bug's Life for the duration of its production,
which will result in a larger production staff than originally anticipated and
which will generate additional production costs.

LIQUIDITY RISKS

        Pursuant to the Co-Production Agreement, Pixar will co-finance the next
five animated feature films which it produces, including A Bug's Life and the
Fourth Film. Pixar will also co-finance Toy Story Sequel on the same basis as
the other theatrical films. In the future, Pixar may co-finance other derivative
works such as sequels, interactive products and television productions. In
addition, Pixar is planning construction of a new headquarters and studio
facility in Emeryville, California, construction of which will begin in the
first half of 1998 and which may be financed by the use of Pixar's cash. As
Pixar does not expect to generate substantial, if any, cash from operations in
1998, the production costs of A Bug's Life, the Fourth Film, Toy Story Sequel
and possibly costs of the new Emeryville facility will have a material adverse
impact on Pixar's cash and short-term investment balances. As of December 31,
1997, Pixar had approximately $176 million in cash and short-term investments.
Pixar believes that these funds will be sufficient to meet its anticipated cash
needs for working capital and capital expenditures, including the development
and production costs of A Bug's Life, the Fourth Film and Toy Story Sequel,
until Pixar begins receiving cash from the release of these films (which is
generally not expected to occur until the second half of 1999 at the earliest).
However, even if these films generate cash, unless each is a success such that
Pixar







                                      10
<PAGE>   11

recovers on a timely basis its share of the production costs, as well as other
operating expenses and capital expenditures, Pixar will be required to seek
financing for its ongoing commitments under the Co-Production Agreement and any
other requirements of its operations. Pixar may also seek additional financing
in connection with the expansion of its facilities. See also"--Liquidity and
Capital Resources." The sale of additional equity or convertible debt securities
would result in additional dilution to Pixar's shareholders. Moreover, there can
be no assurance that Pixar will be successful in obtaining future financing, or
even if such financing is available, that it will be obtained on terms favorable
to Pixar or on terms providing Pixar with sufficient funds to meet its
obligations and objectives. The failure to obtain such financing would have a
material adverse effect on Pixar's business, operating results and financial
condition.

CAPITALIZED FILM PRODUCTION COSTS

        Although Disney funded the entire production of Toy Story, Pixar
contractually guaranteed certain of the film budget overages and was liable to
Disney for those amounts under the original Feature Film Agreement. Because
these are "production costs" under SFAS No. 53, the costs were capitalized and
amortized against film revenue. During 1996, Pixar's budget overage liability of
$2.3 million owed to Disney was satisfied through Disney's deduction of that
amount from Pixar's share of Toy Story revenues. In 1997, Pixar recovered these
overages from Disney when Toy Story reached certain predefined criteria in the
Feature Film Agreement (see "Results of Operations--Revenues"). Film production
costs of $1.6 million and $1.5 million were amortized against film revenue in
1996 and 1997, respectively. Since substantially all Toy Story revenue has been
recognized, all significant related capitalized film costs have been amortized
as of December 31, 1997.

        Pixar had $28.6 million in capitalized film production costs as of
December 31, 1997, consisting primarily of costs relating to A Bug's Life, Toy
Story Sequel and the Fourth Film, all of which are being co-financed by Disney
under the Co-Production Agreement. See Notes 1 and 4 of Notes to Financial
Statements.

LIQUIDITY AND CAPITAL RESOURCES

        Cash and short-term investments increased from $161.0 million at
December 31, 1996 to $176.0 million at December 31, 1997 due primarily to net
proceeds of $14.9 million from Disney in connection with the sale of 1,000,000
shares of Pixar Common Stock and the issuance of two warrants to purchase an
aggregate of 1,500,000 shares of Common Stock. See Note 6 of Notes to Financial
Statements.

        Cash provided by operating activities in 1995 primarily consisted of net
income resulting from patent licensing revenue of $6.5 million and an increase
in accrued liabilities, somewhat offset by growth in other receivables. Cash
provided by operating activities in 1996 primarily consisted of net income
resulting from film revenues related to Toy Story and from the cash portion of
patent licensing revenue totaling $6.0 million. In 1997, cash provided by
operating activities largely consisted of net income of $22.2 million primarily
resulting from film revenues related to Toy Story as well as growth in accounts
payable and accrued liabilities and a tax benefit from disqualifying
dispositions. Cash used in investing activities in 1995 and 1996 primarily
consisted of investments in short-term securities. In 1997, cash used in
investing activities primarily consisted of investments in short term
securities, capitalized film production costs and purchase of property and
equipment, as described below, offset by net proceeds from maturities of short
term investments. Cash flows provided by financing activities in 1995 primarily
consisted of the net proceeds of approximately $139.7 million from Pixar's
initial public offering of Common Stock. Cash used in financing activities in
1996 primarily consisted of the repayment of the note payable to the majority
shareholder. In 1997, cash flows provided by financing activities primarily
consisted of the net proceeds of approximately $14.9 million from sale of stock
to Disney in conjunction with the signing of the Co-Production Agreement. See
Note 4 and Note 6 of Notes to Financial Statements.

        At December 31, 1997, Pixar's capital commitments primarily consisted of
obligations to fund production costs of films and derivative products under the
Co-Production Agreement and costs related to a new studio facility, both
discussed below. Pixar also has obligations to pay portions of any revenue
derived from each feature film








                                      11
<PAGE>   12

produced under the Co-Production Agreement to its entertainment law firm in
consideration for services rendered and obligations under operating leases. See
Note 9 of Notes to Financial Statements. Pixar expects 1998 cash expenditures
for capital equipment to be approximately $6.0 million, excluding costs related
to the new studio facility discussed below.

        Film Production Costs Under Co-Production Agreement. Under the
Co-Production Agreement, in order to fund several films in various stages of
development and production, Pixar's share of direct film costs and other costs
benefiting the productions is expected to total approximately $42 million in
1998, which will directly impact working capital.

        New Studio Facility. In May 1997, Pixar exercised its option (which
option Pixar purchased in 1996) and paid $5.8 million to purchase approximately
15 acres of land in Emeryville, California to build a new headquarters and
studio facility. For the new facility, Pixar incurred total capital expenditures
of $7.7 million in 1997, inclusive of the property costs, and expects to spend
approximately $17 million in 1998. To date, Pixar has chosen to use its existing
cash resources to fund construction costs. Pixar may continue to use its 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.

        As of December 31, 1997, Pixar's principal source of liquidity was
approximately $176.0 million in cash and short-term investments. Pursuant to the
Co-Production Agreement, Pixar will co-finance the next five animated feature
films which it produces, including A Bug's Life and the Fourth Film. Pixar will
also co-finance Toy Story Sequel on the same basis as the other theatrical
films. In the future, Pixar may co-finance other derivative works such as
theatrical sequels, direct to home video sequels, interactive products and
television productions. As Pixar does not expect to generate substantial, if
any, cash from operations in 1998, the production costs of A Bug's Life, the
Fourth Film and Toy Story Sequel are expected to have a material adverse impact
on Pixar's cash and short-term investment balances. Pixar believes that
available funds will be sufficient to meet its anticipated cash needs for
working capital and capital expenditures, including the production costs of A
Bug's Life, the Fourth Film and Toy Story Sequel, until Pixar begins receiving
cash from the release of these films (which is generally not expected to occur
until the second half of 1999). However, even if these films generate cash,
unless each is a success such that Pixar recovers on a timely basis its share of
the production costs, as well as other operating expenses and capital
expenditures, Pixar will be required to seek financing for its ongoing
commitments under the Co-Production Agreement and any other requirements of its
operations. Pixar may also seek additional financing in connection with the
expansion of its facilities. The sale of additional equity or convertible debt
securities would result in additional dilution to Pixar's shareholders.
Moreover, there can be no assurance that Pixar will be successful in obtaining
future financing, or even if such financing is available, that it will be
obtained on terms favorable to Pixar or on terms providing Pixar with sufficient
funds to meet its obligations and objectives. The failure to obtain such
financing would have a material adverse effect on Pixar's business, operating
results and financial condition.











                                      12
<PAGE>   13


Independent Auditors' Report

The Board of Directors and Shareholders
Pixar:

        We have audited the accompanying balance sheets of Pixar as of December
31, 1996 and 1997 and the related statements of operations, shareholders' equity
(deficit), and cash flows for each of the years in the three-year period ended
December 31, 1997. These financial statements are the responsibility of Pixar's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

        We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Pixar as of December
31, 1996 and 1997, and the results of its operation and its cash flows for each
of the years in the three-year period ended December 31, 1997, in conformity
with generally accepted accounting principles.


                                                      KPMG PEAT MARWICK LLP

San Francisco, California
January 30, 1998



                                      13
<PAGE>   14
                                           PIXAR
                                       BALANCE SHEETS
                             (In thousands, except share data)


<TABLE>
<CAPTION>
                                                                                         DECEMBER 31,
                                                                                    1996              1997
                                                                                  ---------        ---------
<S>                                                                              <C>              <C>
                                     ASSETS
  Current assets:
     Cash and cash equivalents                                                    $  44,648        $ 101,847
     Short-term investments                                                         116,321           74,198
     Trade accounts receivable, net of allowance for returns and doubtful
       accounts of $259 and $257 in 1996 and 1997, respectively                         929            1,321
     Other receivables                                                                3,399            2,667
     Prepaid expenses and other current assets                                          982              781
     Net assets - discontinued operations                                             1,469                2
     Capitalized film production costs, current portion                               1,372             --
                                                                                  ---------        ---------

               Total current assets                                                 169,120          180,816

  Property and equipment, net                                                         4,655           21,462
  Capitalized film production costs, net of current portion                           1,578           28,589
  Other assets                                                                        1,588              201
                                                                                  ---------        ---------

              Total assets                                                        $ 176,941        $ 231,068
                                                                                  =========        =========

                                    LIABILITIES AND SHAREHOLDERS' EQUITY
  Current liabilities:
    Accounts payable                                                              $   1,060        $   1,694
    Income taxes payable                                                               --              1,776
    Payable to Disney                                                                  --              2,162
    Accrued liabilities                                                               4,740            7,276
    Unearned revenue                                                                    337              860
                                                                                  ---------        ---------

              Total current liabilities                                               6,137           13,768
                                                                                  ---------        ---------

  Commitments and contingencies

  Shareholders' equity:
  Preferred stock, no par value; 5,000,000 shares authorized and no
    shares issued and outstanding                                                      --               --
  Common stock, no par value; 100,000,000 shares authorized;
    39,413,102 and 42,410,707 shares issued and outstanding
    as of December 31, 1996 and 1997, respectively                                  187,308          210,902
  Unrealized gain (loss) on investments                                                 (48)              29
  Deferred compensation                                                              (1,049)            (414)
  Retained earnings (accumulated deficit)                                           (15,407)           6,783
                                                                                  ---------        ---------
              Total shareholders' equity                                            170,804          217,300
                                                                                  ---------        ---------
              Total liabilities and shareholders' equity                          $ 176,941        $ 231,068
                                                                                  =========        =========
</TABLE>



                See accompanying notes to financial statements.










                                      14
<PAGE>   15


                                           PIXAR
                                 STATEMENTS OF OPERATIONS
                          (In thousands, except per share data)


<TABLE>
<CAPTION>
                                                                               Year Ended December 31,
                                                                         1995            1996            1997
                                                                       --------        --------        --------
<S>                                                                    <C>             <C>             <C>
Revenues:
   Software                                                            $  3,144        $  3,297        $  4,499
   Animation services                                                     2,469           3,947           1,556
   Film                                                                    --            18,847          26,914
   Patent licensing                                                       6,500           9,127           1,730
                                                                       --------        --------        --------
                  Total revenues                                         12,113          35,218          34,699
                                                                       --------        --------        --------

Cost of revenues:
   Software                                                                 513             113              81
   Animation services                                                     1,873           3,041             973
   Film                                                                    --             1,551           1,484
                                                                       --------        --------        --------
                  Total cost of revenues                                  2,386           4,705           2,538
                                                                       --------        --------        --------
                  Gross profit                                            9,727          30,513          32,161
                                                                       --------        --------        --------
Operating expenses:
   Research and development                                               2,994           4,501           4,712
   Sales and marketing                                                    1,392           1,471           1,450
   General and administrative                                             2,479           4,249           5,129
   Operating expense reimbursement                                         --              --            (2,184)
                                                                       --------        --------        --------
                  Total operating expenses                                6,865          10,221           9,107
                                                                       --------        --------        --------
                  Income from continuing operations                       2,862          20,292          23,054

Other income, net                                                           715           8,033           8,766
                                                                       --------        --------        --------
                  Income from continuing operations before taxes          3,577          28,325          31,820
Income tax expense                                                          246           1,983           9,864
                                                                       --------        --------        --------
                  Income from continuing operations                       3,331          26,342          21,956

Income (loss) from discontinued operations (includes income tax
   benefit of $126 and $77 in 1995 and 1996, respectively, and
   income tax expense of $105 in 1997)                                   (1,704)         (1,023)            234
                                                                       --------        --------        --------
                  Net income                                           $  1,627        $ 25,319        $ 22,190
                                                                       ========        ========        ========
Basic net income per share from continuing operations                  $   0.26        $   0.68        $   0.53
Basic net income (loss) per share from discontinued operations            (0.13)          (0.02)           0.01
                                                                       --------        --------        --------
Basic net income per share                                             $   0.13        $   0.66        $   0.54
                                                                       ========        ========        ========
Shares used in computing basic net income (loss) per share               12,955          38,632          41,224
                                                                       ========        ========        ========
Diluted net income per share from continuing operations                $   0.10        $   0.56        $   0.46
Diluted net income (loss) per share from discontinued operations          (0.05)          (0.02)           0.00
                                                                       --------        --------        --------
Diluted net income per share                                           $   0.05        $   0.54        $   0.46
                                                                       ========        ========        ========
Shares used in computing diluted net income (loss) per share             33,216          46,989          48,144
                                                                       ========        ========        ========
</TABLE>



                 See accompanying notes to financial statements.







                                      15
<PAGE>   16


                                          PIXAR
                       STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
                                      (In thousands)



<TABLE>
<CAPTION>

                                                                                   Unrealized               Retained      Total
                                                                                      Gain                  Earnings      Share-
                                          Preferred Stock         Common Stock      (Loss) on   Deferred    (Accum-      holders'
                                      ---------------------  --------------------    Invest-     Compen-     ulated       Equity
                                        Shares     Amount      Shares     Amount      ments      sation      Deficit)   (Deficit)
                                      ---------   ---------  ---------  ---------   ---------   ---------   ---------   ---------
<S>                                  <C>         <C>        <C>         <C>         <C>         <C>         <C>         <C>
Balances, December 31, 1994                --          --           20  $  48,255   $      63        --     $ (49,993)  $  (1,675)

Recapitalization (conversion of note
   payable to the majority shareholder
   and existing common stock into
   Series A preferred stock and
   common stock)                         10,000   $  47,900      9,980    (46,288)       --          --          --         1,612
Recapitalization of S corporation
   net operating losses                    --          --         --       (7,640)       --          --         7,640        --
Exercise of stock options                  --          --        1,386        277        --          --          --           277
Deferred compensation related to
   grant of stock options                  --          --         --        3,680        --     $  (3,680)       --          --
Amortization of deferred
   compensation                            --          --         --         --          --         1,419        --         1,419
Conversion of existing preferred
   stock into common stock              (10,000)    (47,900)    20,000     47,900        --          --          --          --
Initial public offering, net of
   expenses of $1,892                      --          --        6,900    139,661        --          --          --       139,661
Unrealized gain on investments             --          --         --         --            76        --          --            76
Realized gain on investment                --          --         --         --           (90)       --          --           (90)
Net income                                 --          --         --         --          --          --         1,627       1,627
                                      ---------   ---------  ---------  ---------   ---------   ---------   ---------   ---------
Balances, December 31, 1995                --          --       38,286    185,845          49      (2,261)    (40,726)    142,907

Exercise of stock options,
   including tax benefit from
   disqualifying dispositions              --          --        1,127      1,463        --          --          --         1,463
Amortization of deferred
   compensation                            --          --         --         --          --         1,212        --         1,212
Unrealized loss on investments             --          --         --         --           (97)       --          --           (97)
Net income                                 --          --         --         --          --          --        25,319      25,319
                                      ---------   ---------  ---------  ---------   ---------   ---------   ---------   ---------
Balances, December 31, 1996                --          --       39,413    187,308         (48)     (1,049)    (15,407)    170,804

Exercise of stock options,
   including tax benefit from
   disqualifying dispositions              --          --        1,998      8,709        --          --          --         8,709
Issuance of common stock and
   warrants, net of expenses of $115       --          --        1,000     14,885        --          --          --        14,885
Amortization of deferred
   compensation                            --          --         --         --          --           635        --           635
Unrealized gain on investments             --          --         --         --            77        --          --            77
Net income                                 --          --         --         --          --          --        22,190      22,190
                                      ---------   ---------  ---------  ---------   ---------   ---------   ---------   ---------
Balances, December 31, 1997                --          --       42,411  $ 210,902   $      29   $    (414)  $   6,783   $ 217,300
                                      =========   =========  =========  =========   =========   =========   =========   =========
</TABLE>





                 See accompanying notes to financial statements.






                                      16
<PAGE>   17

                                      PIXAR
                            STATEMENTS OF CASH FLOWS
                                 (In thousands)


<TABLE>
<CAPTION>
                                                                                           Year Ended December 31,
                                                                                         1995       1996        1997
                                                                                      ---------   ---------   ---------
<S>                                                                                   <C>         <C>         <C>
Cash flows from operating activities:
   Net income                                                                         $   1,627   $  25,319   $  22,190
   Adjustments to reconcile net income to net cash provided by
    operating activities:
      Discontinued operations                                                             1,704       1,023        (234)
      Amortization of deferred compensation, net of
        capitalization                                                                    1,127       1,168         611
      Non-cash revenue attributable to film overbudget                                     --        (2,324)       --
      Depreciation and amortization                                                         467         732       3,182
      Amortization of capitalized film production costs                                    --         1,551       1,484
      Tax benefit from disqualifying dispositions                                          --         1,236       7,688
      Licenses exchanged for equipment                                                     --        (1,465)     (1,594)
      Loss on disposition of property and equipment                                          13        --           718
      Gain on sale of equity securities                                                     (90)       --          --
      Changes in operating assets and liabilities:
        Trade accounts receivable                                                          (473)       (144)       (392)
        Other receivables                                                                (1,625)     (1,614)        732
        Prepaid expenses and other current assets                                           (85)       (673)        288
        Accounts payable                                                                     86         318         634
        Other liabilities                                                                 2,456       1,539       4,698
        Income taxes payable                                                               --          --         1,776
        Unearned revenue                                                                   (142)         68         584
                                                                                      ---------   ---------   ---------
            Net cash provided by continuing operations                                    5,065      26,734      42,365
            Net cash provided by (used in) discontinued operations                       (1,688)     (2,508)      1,701
                                                                                      ---------   ---------   ---------
            Net cash provided by operating activities                                     3,377      24,226      44,066
                                                                                      ---------   ---------   ---------
Cash flows from investing activities:
   Purchase of property and equipment                                                      (968)     (2,371)    (17,761)
   Proceeds from sale of property and equipment                                              33        --            31
   Proceeds from sale of short term securities                                               90     175,360     169,210
   Investments in short term securities                                                 (46,953)   (244,776)   (127,010)
   Capitalized film production costs                                                       --        (1,840)    (27,098)
   Other assets                                                                            (497)     (1,091)       (145)
                                                                                      ---------   ---------   ---------
       Net cash used in investing activities                                            (48,295)    (74,718)     (2,773)
                                                                                      ---------   ---------   ---------
Cash flows from financing activities:
   Net proceeds from initial public offering                                            139,661        --          --
   Net proceeds from issuance of common stock and warrants                                 --          --        14,885
   Proceeds from exercised stock options                                                    277         227       1,021
   Proceeds from (repayment of) note payable to shareholder                               2,225      (2,373)       --
                                                                                      ---------   ---------   ---------
      Net cash provided by (used in) financing activities                               142,163      (2,146)     15,906
                                                                                      ---------   ---------   ---------
Net increase (decrease) in cash and cash equivalents                                     97,245     (52,638)     57,199
Cash and cash equivalents at beginning of period                                             41      97,286      44,648
                                                                                      ---------   ---------   ---------
Cash and cash equivalents at end of period                                            $  97,286   $  44,648   $ 101,847
                                                                                      =========   =========   =========
Supplemental disclosure of cash flow information:
        Cash paid during the period for income taxes                                  $     172   $     523   $     390
                                                                                      =========   =========   =========
Supplemental disclosure of non-cash investing and financing activities:
        Credits used to purchase equipment                                            $      --   $   3,127   $   1,730
                                                                                      =========   =========   =========
        Film overbudget reductions                                                    $      --   $   3,324   $      --
                                                                                      =========   =========   =========
        Non-cash film production costs capitalized                                    $   3,616   $      44   $      24
                                                                                      =========   =========   =========
        Conversion of note payable to shareholder, and accrued
        interest, to equity                                                           $   1,612   $      --   $      --
                                                                                      =========   =========   =========
        Accrual of stock option deferred compensation                                 $   3,680   $      --   $      --
                                                                                      =========   =========   =========
        Unrealized gain (loss) on investments                                         $     (14)  $     (97)  $      77
                                                                                      =========   =========   =========
</TABLE>


                See accompanying notes to financial statements.





                                      17
<PAGE>   18
                                     PIXAR


                          NOTES TO FINANCIAL STATEMENTS


(1)     SUMMARY OF PIXAR AND SIGNIFICANT ACCOUNTING POLICIES

        The Company

        Pixar was incorporated in the state of California on December 9, 1985.
The Company is a digital animation studio with the technical, creative and
production capabilities to create a new generation of animated feature films and
related products.

        Cash and Cash Equivalents

        Pixar considers all highly liquid instruments with an original maturity
of 90 days or less to be cash equivalents. Cash equivalents as of December 31,
1997 consisted primarily of U.S. Treasury Bills, demand notes, commercial paper
and government agency bonds.

        Short-Term Investments

        Pixar has classified its investments as "available-for-sale." Such
investments are recorded at fair value, and unrealized gains and losses, if
material, are reported as a separate component of equity until realized.
Interest income is recorded using an effective interest rate with the associated
premium or discount amortized to interest income. The cost of securities sold is
based upon the specific identification method.

        Property and Equipment

        Property and equipment are stated at cost. Depreciation of property and
equipment is calculated using the straight-line method over estimated useful
lives ranging from three to seven years. Leasehold improvements are amortized
over the lesser of the related lease term or the life of the improvement.

        Film Production Costs

        Film production costs include costs to develop and produce computer
animated motion pictures, mainly salaries, equipment and overhead. Film
production costs in excess of reimbursable amounts are capitalized. Once a film
is released, any film production costs capitalized will be amortized in the
proportion that the revenue during the year for each film bears to the estimated
revenue to be received from all sources under the individual film forecast
method. Estimates of anticipated total gross revenues will be reviewed
periodically and revised when necessary. Unamortized film production costs will
be compared with net realizable value each reporting period on a film-by-film
basis. If estimated gross revenues are not sufficient to recover the unamortized
film production costs, the unamortized film production costs will be written
down to net realizable value. The costs of released feature films are classified
as current assets to the extent such costs are expected to be recovered from
primary markets. Costs of released feature films recoverable from secondary
markets and unreleased films are classified as noncurrent assets.

        Research and Development Costs

        Research and development costs are charged to operations as incurred. In
accordance with Statement of Financial Accounting Standards (SFAS) No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed, development costs related to software products are expensed as
incurred until the technological feasibility of the product has been
established. After technological feasibility is established, additional costs
would be capitalized. To date, Pixar has not capitalized any software
development costs after technological feasibility has been established on its
software products since Pixar believes its process for developing





                                      18
<PAGE>   19

software is essentially completed concurrently with the establishment of
technological feasibility and costs incurred thereafter have not been material.

        Revenue Recognition

        Compensation based on the revenues from the distribution of animated
feature films and related products is recognized as earned and reasonably
estimable. The related revenue cycle is generally five to seven years, with the
substantial majority expected to be recognized in the first two years. Software
licensing revenue is recognized upon shipment if there are no significant vendor
obligations and if collection is probable. Animation service revenues are
recognized on the percentage-of-completion method of accounting. Patent
licensing revenue is recognized upon release of the rights to the technology.

        Financial Instruments and Concentration of Credit Risk

        The carrying value of financial instruments, including marketable
securities and accounts receivable, approximate fair value. Financial
instruments that potentially subject the Company to concentrations of credit
risk consist primarily of cash equivalents, short-term investments and trade
accounts receivable. The Company invests its excess cash in a variety of
investment grade, interest-bearing securities with a major bank. This
diversification of risk is consistent with the Company's policy to ensure safety
of principal and maintain liquidity.

        Excluding its software business, the Company's revenue is concentrated
in a few large customers, as outlined in Note 10. The Company maintains reserves
for potential credit losses and such losses have been within management's
expectations.

        Accounting Estimates

        The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

        Income Taxes

        Pixar utilizes SFAS No. 109, Accounting for Income Taxes, which requires
the use of the asset and liability method of accounting for income taxes.

        Net Income per Share

        On October 1, 1997, Pixar adopted SFAS No. 128, Earnings per Share. In
accordance with SFAS No. 128, 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 common equivalent shares outstanding during the period and using the
treasury stock method for options and warrants (see Note 11). On February 3,
1998, the Securities and Exchange Commission issued Staff Accounting Bulletin
(SAB) No. 98 which supersedes the previous method used, SAB No. 83, for the
calculation of earnings per share in periods including or prior to initial
public offerings. The Company has restated net income per share in accordance
with SAB No. 98 and SFAS No. 128.

        Reclassifications

        Certain amounts reported in previous years have been reclassified to
conform to the 1997 financial statement presentation.





                                      19
<PAGE>   20

        Stock Option Plans

        The Company uses the intrinsic value-based method to account for all of
 its employee stock-based compensation plans.

        Recently Issued Accounting Pronouncements

        In June 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 130, Reporting Comprehensive Income, which establishes standards for
reporting and displaying comprehensive income and its components in the
financial statements. The Company is in the process of determining its preferred
format. This Statement is effective for fiscal years beginning after December
15, 1997.

        Also, in June 1997, the FASB issued SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. The Statement establishes
standards for companies to report information about operating segments in annual
and interim financial statements. The Company is in the process of determining
its preferred format. This Statement is effective for financial statements for
periods beginning after December 15, 1997.

        In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 97-2, Software Revenue Recognition. The
Company will be required to adopt SOP 97-2 for software transactions entered
into beginning January 1, 1998, and retroactive application to years prior to
adoption is prohibited. SOP 97-2 generally requires revenue earned on software
arrangements involving multiple elements (i.e., software products,
upgrades/enhancements, postcontract customer support, etc.) to be allocated to
each element based on the relative values of the elements and revenue of each
element to be recognized individually using the most appropriate accounting
method. The Company believes that adoption of SOP 97-2 will not have a material
impact on the Company's results of operations.

(2)     SHORT-TERM INVESTMENTS

        All investments were considered available-for-sale securities and
consisted of the following (in thousands):


<TABLE>
<CAPTION>
                                               UNREALIZED UNREALIZED     ESTIMATED
                                       COST      GAINS      LOSSES       FAIR VALUE
                                    ----------------------------------------------
<S>                                 <C>       <C>         <C>           <C>
        DECEMBER 31, 1996:

        U.S. Treasury Bills         $  39,186         --     $     (33)  $  39,153
        Demand notes                   22,106         --            --      22,106
        Commercial paper               20,000         --            --      20,000
        Federal Agency obligations     69,495  $       6           (21)     69,480
        Banker's Acceptances            4,886         --            --       4,886
                                    ----------------------------------------------
                                    $ 155,673  $       6     $     (54)  $ 155,625
                                    ==============================================

        DECEMBER 31, 1997:

        U.S. Treasury Bills         $  41,993  $      27            --   $  42,020
        Demand notes                   77,817         --            --      77,817
        Commercial paper               16,474         --            --      16,474
        Federal Agency obligations     32,175          2            --      32,177
        Time Deposits                   5,000         --            --       5,000
                                    ----------------------------------------------
                                    $ 173,459  $      29            --   $ 173,488
                                    ==============================================
</TABLE>





                                      20
<PAGE>   21


        The contractual maturities of available-for-sale debt securities as of
December 31, 1997, regardless of their balance sheet classification, are as
follows (in thousands):

<TABLE>
<CAPTION>
                                                      COST     FAIR VALUE
                                                  ------------------------
<S>                                                 <C>        <C>
        Due within one year                          $158,501   $158,523
        Due after one year through five years          14,958     14,965
                                                  ------------------------
                                                     $173,459   $173,488
                                                  ========================
</TABLE>

 (3)    BALANCE SHEET COMPONENTS

        Selected balance sheet components are as follows (in thousands):



<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                            1996           1997
                                                          -------        -------
<S>                                                       <C>           <C>
Property and equipment:
  Land                                                       --          $ 7,669
  Equipment                                               $ 6,238         14,751
  Leasehold improvements                                    1,007          2,867
  Construction in proces                                     --            1,571
                                                          -------        -------
                                                            7,245         26,858
Less accumulated depreciation and  amortization             2,590          5,396
                                                          -------        -------
                                                          $ 4,655        $21,462
                                                          =======        =======

Accrued liabilities:
  Employee-related expenses                               $ 2,249        $ 4,213
  Professional services                                     1,544          1,375
  Other                                                       947          1,688
                                                          -------        -------
                                                          $ 4,740        $ 7,276
                                                          =======        =======
</TABLE>


(4)     FEATURE FILM AND CO-PRODUCTION AGREEMENTS

        Feature Film Agreement

        In 1991, Pixar 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"). Pixar is entitled to receive compensation based
on revenue from the distribution of these films and related products. In 1995,
Pixar released its first feature film under the terms of the Feature Film
Agreement, Toy Story. Under that agreement, Disney fully funded Toy Story
production costs. All production costs incurred by Pixar were reimbursed by
Disney on a current basis, and recorded by Pixar as cost reimbursements.
Accordingly, no revenues were recorded.

        The Feature Film Agreement provided that, if production costs for Toy
Story exceeded the agreed-upon budget, Pixar was obligated to fund certain of
the cost overages, but was entitled to recover those cost overages if Toy Story
met certain criteria with respect to profitability. Pixar's share of the film
cost overage was approximately $3,300,000 as of December 31, 1995, which was
reduced by $1,000,000 during the year ended December 31, 1996. Additional costs
capitalized as Toy Story film production costs in the three year period ended
December 31, 1997 included amortization of deferred compensation expense and
certain participation fees. Based on the individual film forecast method, Toy
Story film production costs were fully amortized by the year ended December 31,
1997.




                                      21
<PAGE>   22

        Co-Production Agreement

        In February 1997, Pixar and Disney entered into a new co-production
agreement (the Co-Production Agreement) which now governs all films made by
Pixar since Toy Story. Films in development or production at Pixar as of
December 31, 1997 include A Bug's Life, Toy Story Sequel, and Pixar's fourth
film (the "Fourth Film"). Under the Co-Production Agreement, Pixar, on an
exclusive basis, will produce five computer animated theatrical motion pictures
(the Pictures) for distribution by Disney. A Bug's Life and the Fourth Film
count toward the five Pictures, whereas Toy Story Sequel is a derivative work
that will not count toward the five Pictures. However, Pixar and Disney have
agreed that all provisions of the Co-Production Agreement applicable to the
Pictures will also apply to Toy Story Sequel. Pixar and Disney will co-own,
co-brand and co-finance the production costs of the Pictures, and will share
equally in the profits of each Picture and any related merchandise and other
ancillary products, after recovery of all marketing, distribution and other
predefined fees and costs. The Co-Production Agreement generally provides that
Pixar will produce each Picture and Disney will control decisions relating to
film marketing and distribution.

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

<TABLE>
<CAPTION>
                                                                             TOTAL AS OF
                                               1995 AND      DECEMBER 31,    DECEMBER 31,
                                                 PRIOR      1996      1997      1997
                                               --------   --------  --------  --------
<S>                                            <C>        <C>       <C>       <C>
RELEASED FILM:
Disney production costs (unaudited)            $ 18,845   $    754      --    $ 19,599
Pixar reimbursed film production  costs           8,069         53      --       8,122
                                               ---------------------------------------
  Total film production costs  (unaudited)     $ 26,914   $    807      --      27,721
                                               ===========================

Disney reimbursements of budgeted
      costs and approved overages (unaudited)                                 (25,396)
Amortization of deferred compensation                                             360
Participation fees                                                                350
Amortization of film production  costs                                         (3,035)
                                                                              --------
  Total film production costs
    capitalized for released films                                                  --
                                                                              --------

FILMS IN PROCESS:
Pixar production costs                             --         --    $ 28,339    28,339
Disney production funding (unaudited)          $  2,807   $ 17,782     7,750    28,339
                                               ---------------------------------------
  Total film production costs (unaudited)      $  2,807   $ 17,782  $ 36,089    56,678
                                               =============================
Disney reimbursements of
  production costs (unaudited)                                                 (28,339)
Participation fees                                                                 250
                                                                              --------
  Total film production costs
    capitalized for films in process                                            28,589
                                                                              --------
   Total film production costs capitalized                                    $ 28,589
                                                                              ========
</TABLE>


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







                                      22
<PAGE>   23

                                       February 24 to
                                        December 31,
                                            1997
                                       --------------
Research and development                   $2,012
General and administrative                  1,277
                                           ------
     Total                                 $3,289
                                           ======

        Since the Co-Production Agreement begins with Pixar's next films, A
Bug's Life and Toy Story Sequel, both in various stages of production in 1996
and 1997, Pixar was entitled to reimbursement for Disney's share of certain of
Pixar's operating expenses incurred in 1996 and the first two months of 1997,
prior to signing the Co-Production Agreement. The determination of this
$2,184,000 one-time operating expense reimbursement was finalized in the quarter
ended September 30, 1997. The amount recorded represented reimbursements of the
following expense categories (in thousands):

<TABLE>
<CAPTION>
                                              Year Ended        January 1 to
                                           December 31, 1996   February 24, 1997      Total
                                           -----------------   -----------------      -----
<S>                                             <C>               <C>               <C>
Research and development                         $  936            $  179            $1,115
General and administrative                          620               449             1,069
                                           -----------------   -----------------      -----
    Total                                        $1,556            $  628            $2,184
                                           =================   =================     ======
</TABLE>


        There were no reimbursements receivable from Disney for Toy Story as of
December 31, 1996 and December 31, 1997. The reimbursements receivable from
Disney for A Bug's Life was $1,313,000 as of December 31, 1996. The
reimbursements receivable from Disney for Toy Story Sequel was $617,000 as of
December 31, 1996. All of these items are included in other receivables on the
accompanying balance sheet. At December 31, 1997 the Disney payable of
$2,162,000 consisted of advances in excess of Disney's actual share of
expenditures for all films.

(5)     PATENT LICENSING ARRANGEMENTS

        As of December 31, 1995, fees of $6,500,000 were recognized on the
licensing of certain patents.

        For the year ended December 31, 1996, fees of $9,127,000 were recognized
on the licensing of certain patents. The Company delivered all rights to utilize
the technology underlying the license to the licensee, and received a
non-refundable fixed-fee payment of $6,000,000 in cash and $5,000,000 of credits
for products to be purchased from the licensee by Pixar over the next four
years. Following the release of the rights to utilize the patents to the
licensee, Pixar maintained no significant vendor obligations to the licensee, so
the Company recognized as revenue the fixed and determinable amounts of the
$6,000,000 cash payment received, plus $3,127,000 that represented the portion
of the credits Pixar used during the year ended December 31, 1996. Patent
licensing revenue of $1,730,000 recognized in 1997 represents additional credits
used. The remaining $143,000 of credits are expected to be utilized in 1998.

(6)     RELATED PARTY TRANSACTIONS

        Notes Payable to Shareholder

        As of December 31, 1995, Pixar had a $2,225,000 note payable to the
majority shareholder, plus accrued interest of $148,000, which bore simple
variable interest equal to prime rate revised quarterly (8.75% as of December
31, 1995). The note plus accrued interest was repaid in January 1996.

      Disney

        In conjunction with signing the Co-Production Agreement, Disney
purchased for cash 1,000,000 shares of Pixar Common Stock, which Disney has
agreed to hold for at least three years, and two warrants each exercisable for
five years: one warrant to purchase 750,000 shares of Common Stock at an
exercise price of $20.00 per share







                                      23
<PAGE>   24

and another warrant to purchase 750,000 shares of Common Stock at an exercise
price of $25.00 per share. Pixar granted certain registration rights for the
shares issuable upon exercise of the warrants. Upon consummation of this
agreement in March 1997, Pixar received net proceeds of $14,885,000.

(7)     INCOME TAXES

        Pixar elected to be treated as an S corporation for federal income tax
purposes as of January 1, 1992. The S corporation status was terminated as a
result of the recapitalization described in Note 8. Accordingly, Pixar was taxed
as a C corporation following the recapitalization.

        The components of income taxes from continuing operations are as follows
(in thousands):


<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31,
                                                          1995              1996              1997
                                                         ------------------------------------------
<S>                                                     <C>               <C>               <C>
    Income taxes:
       Current:
         Federal                                         $  203            $  340            $  944
         State                                               43               136             1,288
         Foreign                                             --                --                26
                                                         ------------------------------------------
         Total current taxes                                246               476             2,258
                                                         ------------------------------------------
      Charge in lieu of taxes attributable to
          employer stock option plans                      --               1,507             7,606
                                                         ------------------------------------------
         Total tax provision                             $  246            $1,983            $9,864
                                                         ==========================================
</TABLE>

        The following tabulation reconciles the statutory corporate federal
income tax expense (benefit) (computed by multiplying Pixar's income from
continuing operations, before income taxes by 34% for the years ended December
31, 1995 and 1996 and 35% for the year ended December 31, 1997) to Pixar's
income tax expense (in thousands):


<TABLE>
<CAPTION>
<S>                                                     <C>               <C>               <C>
                                                                    YEAR ENDED DECEMBER 31,
                                                          1995              1996              1997
                                                         ------------------------------------------
<S>                                                     <C>               <C>               <C>
Expected income tax expense                              $  1,216        $  9,631           $11,137
State income taxes, net of federal tax effect                  15             882             1,742
Change in beginning of year valuation
allowance                                                  (1,028)         (9,179)           (3,370)
Alternative minimum tax                                       --              611               --
Other, net                                                     43              38               355
                                                         ------------------------------------------
        Income taxes                                     $    246         $ 1,983          $  9,864
                                                         ==========================================
</TABLE>

        The tax effects of temporary differences attributable to continuing
operations that give rise to significant portions of the deferred tax assets are
presented below (in thousands):

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                         1996            1997
                                                       --------        --------
<S>                                                    <C>             <C>
Deferred tax assets:
Deferred compensation                                  $  1,016        $    733
Capitalized film costs                                      539           5,981
Capitalized research expenses                               210             134
Credit carryforwards                                        748           1,490
Net operating loss carryforwards                          7,749           1,207
Reserves and accruals                                       348           1,536
                                                       --------        --------
 Total gross deferred  tax assets                        10,610          11,081
 Valuation allowance                                    (10,610)        (11,081)
                                                       --------        --------
        Net deferred tax assets                        $   --          $   --
                                                       ========        ========
</TABLE>









                                      24
<PAGE>   25

        Pixar has a valuation allowance as of December 31, 1997 which fully
offsets its gross deferred tax assets due to the fact that there is no guarantee
the Company will generate sufficient taxable income in the future to be able to
realize any or all of the deferred tax assets. The increase in the valuation
allowance for the year ended December 31, 1997 was $471,000.

        Included in the deferred tax assets above is approximately $7,600,000
related to stock option compensation for which the benefit when realized will be
an adjustment to equity. As of December 31, 1997, Pixar had net operating loss
carryforwards from pre-S corporation years of approximately $3,400,000 for
federal income tax purposes. Pixar has research credit carryforwards of
approximately $700,000 for federal income tax purposes. In addition, Pixar has
alternative minimum tax credit carryforwards for federal income tax purposes of
approximately $400,000. If not utilized, the federal operating loss and research
credit carryforwards will expire in years 2004 through 2012.

(8)     SHAREHOLDERS' EQUITY

        Recapitalization and Stock Split

        As of December 31, 1994, Pixar had 100,000 shares of common stock
authorized, 20,000 shares of common stock issued and outstanding, and no
preferred stock authorized, issued and outstanding. In April 1995, the sole
shareholder approved the recapitalization of Pixar, whereby the 20,000 shares of
common stock then outstanding and a note payable to the sole shareholder were
converted into 9,999,999 shares of Series A preferred stock and 10,000,002
shares of common stock.

        In October 1995, the Board of Directors approved a two-for-one stock
split of the common stock. The 1995 financial statements have been retroactively
restated to reflect the effect of the stock split on the common stock.

        Initial Public Offering

        In November 1995, Pixar completed an IPO of 6,900,000 shares of common
stock for $22 per share, which resulted in proceeds to the Company of
approximately $139,700,000, net of issuance costs of approximately $1,900,000.

        Deferred Compensation

        Pixar recorded deferred compensation of $3,680,000 for the difference
between the grant price and the deemed fair value of the common stock underlying
certain options granted in 1995. This amount is being amortized over the vesting
period of the individual options, generally four years. Amortization of deferred
compensation was approximately $1,419,000, $1,212,000 and $635,000 for the years
ended December 31, 1995, 1996 and 1997, respectively. Of these amounts $292,000,
$44,000 and $24,000 were capitalized as film production costs in 1995, 1996 and
1997, respectively. The remaining amounts of $1,127,000, $1,168,000 and $611,000
were expensed in 1995, 1996 and 1997, respectively.

        Stock Option Plans

        Pixar has stock option plans for employees, consultants and nonemployee
directors which provide incentive and nonstatutory stock options. The option
exercise price for incentive stock options is not less than the fair market
value at the grant date. Nonstatutory options are granted at prices and terms
determined by the Board of Directors, or a committee of the Board of Directors.
Employee and consultant options generally vest 25% per year over four years.
Initial grants to non-employee directors vest one-third annually for three
years; subsequent grants vest after one year. All options have a term not
greater than 10 years from the date of grant. As of December 31, 1997, Pixar had
15,472,321 shares reserved for issuance under the plans.










                                      25
<PAGE>   26

         A summary of stock options outstanding as of December 31, 1995, 1996
and 1997 were as follows:


<TABLE>
<CAPTION>
                                                      Weighted-average
                                         Shares        exercise price
                                         ------        --------------
<S>                                    <C>                    <C>
Outstanding at January 1, 1995                 --        $      --
    Granted                            10,641,400             0.89
    Exercised                          (1,386,500)            0.20
    Forfeited                            (114,000)            0.20
                                       ----------
Outstanding at December 31,1995         9,140,900             1.00
    Granted                             1,297,000            15.18
    Exercised                          (1,126,602)            0.20
    Forfeited                            (447,458)           15.79
                                       ----------
Outstanding at December 31,1996         8,863,840             2.41
    Granted                             1,671,700            15.52
    Exercised                          (1,997,605)            0.52
    Forfeited                            (163,317)           12.53
                                       ----------
Outstanding at December 31,1997         8,374,618             5.28
                                       ==========
</TABLE>

        For various price ranges, weighted average characteristics of
outstanding stock options at December 31, 1997 were as follows:


<TABLE>
<CAPTION>
                                        OPTIONS OUTSTANDING                         OPTIONS VESTED
                         -------------------------------------------------     -----------------------------
                                            Remaining     Weighted-average                  Weighted-average
Exercise prices          Shares            life (years)    exercise price      Shares         exercise price
---------------          ------            ------------    --------------      ------         --------------
<S>                    <C>                <C>             <C>              <C>               <C>
$ 0.20                 5,049,980               7.35        $    0.20        3,055,802         $    0.20
$1.25  to $ 9.60         819,227               7.79             7.44          504,286              7.54
$10.80 to $15.00       1,707,503               8.97            13.29          225,653             12.57
$15.13 to $19.00         519,408               9.13            16.25           46,565             16.60
$19.13 to $25.88         278,500               9.61            21.50             --
                       ---------                                            ---------              --
                       8,374,618                                5.28        3,832,306              2.09
                       =========                                            =========
</TABLE>

        The Company uses the intrinsic value-based method to account for all of
its employee stock-based compensation plans. Had compensation cost for the
Company's two stock option plans been determined consistent with SFAS No. 123,
the Company's net income and net income per share would have been reduced to the
pro forma amounts indicated below (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                            -----------------------------------------
                                              1995           1996           1997
                                            --------       --------        --------
<S>                                         <C>            <C>             <C>
Pro forma net income                        $    880        $24,017        $18,710
Pro forma basic net income per share        $   0.07        $  0.62        $  0.45
Pro forma diluted net income per share      $   0.03        $  0.51        $  0.39
</TABLE>

        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 $0.31, $6.51 and $6.27 for the years ended December 31,
1995, 1996 and 1997, respectively. Values were estimated using zero dividend
yield for all years, expected volatility of 50 percent for all years; risk-free
interest rates of 5.90%, 6.06%, and 6.17%, for 1995, 1996 and 1997,
respectively; and weighted-average expected lives of 2.42 years, 3.52 years and
3.15 years, for 1995, 1996, and 1997, respectively for both plans.






                                      26
<PAGE>   27
     EMPLOYEE BENEFIT PLANS

     In 1992, Pixar adopted a 401(k) Profit Sharing Plan (the 401(k) Plan) that
is intended to qualify under Section 401(k) of the Internal Revenue Code of
1986, as amended. The 401(k) Plan covers substantially all of Pixar's employees.
Participants may elect to contribute a percentage of their compensation to this
plan, up to the statutory maximum amount, Pixar may make discretionary
contributions to the 401(k) Plan; none have been made to the 401(k) Plan to
date.

(9)  COMMITMENTS AND CONTINGENCIES

     Lease Commitments

     Future minimum lease payments under noncancelable operating leases (with
initial or remaining lease terms in excess of one year) as of December 31, 1997
were as follows (in thousands):

     <TABLE>
     <CAPTION>

     YEAR ENDING
     DECEMBER 31,
     ------------
      <S>                                     <C>
       1998                                 $ 2,496
       1999                                   2,279
       2000                                   1,595
       2001                                     356
                                            -------
           Total minimum lease payments     $ 6,726
                                            =======
</TABLE>

     Rental expense from operating leases amounted to approximately $925,000,
$1,236,000 and $2,095,000 for the years ended December 31, 1995, 1996 and 1997,
respectively.

     Participation Commitment

     Pixar is obligated to pay 5% of its revenue from the distribution of each
of the Pictures under the Co-Production Agreement to a third party in
consideration for services rendered. The compensation is subject to a cap of
$500,000 for each theatrical motion picture and a cap of $200,000 for each
sequel or remake, with a total aggregate cap of $3,000,000.

     Legal Matters

     Pixar is involved in claims arising in the ordinary course of business.
Pixar believes these matters will be resolved without material adverse effect on
the Company's financial position, results of operations or cash flows.

(10) SIGNIFICANT CUSTOMERS AND SEGMENT REPORTING

     The following table summarizes the annual percentage contribution to
revenues by customers when revenues from such customers exceeded 10% of total
revenues in 1995, 1996 and 1997 and the amounts due from these customers as a
percentage of total accounts receivable at the corresponding year-end:


<TABLE>
<CAPTION>

                                  PERCENTAGE OF TOTAL            PERCENTAGE OF TOTAL
                                       REVENUES                ACCOUNTS RECEIVABLE AS OF
                               YEAR ENDED DECEMBER 31,              DECEMBER 31,
                               1995      1996     1997         1995      1996      1997
                               ------------------------        ------------------------
<S>                            <C>                              <C>
Microsoft Corporation          54%      --        --             --        --        --
Disney                         --       62%       83%            --        34%       23%
Silicon Graphics, Inc.        --        26%       --             --        --        --

</TABLE>




                                      27
<PAGE>   28

        Pixar operates principally in three business segments: software,
animation services, and film. Financial information relating to business
segments follows (in thousands):

<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31,
                                                   1995         1996       1997
                                                 ---------   ---------  ---------
<S>                                              <C>         <C>        <C>
Revenues:
   Software                                      $   3,144   $   3,297  $   4,499
   Animation services                                2,469       3,947      1,556
   Film                                               --        18,847     26,914
   Corporate and other                               6,500       9,127      1,730
                                                 --------------------------------
                                                 $  12,113   $  35,218  $  34,699
                                                 ================================
Income (loss) from continuing operations:
   Software                                      $   1,336   $   2,685  $   3,885
   Animation services                                  (55)        302         16
   Film                                             (3,826)      9,308     18,016
   Corporate and other                               5,407       7,997      1,137
                                                 --------------------------------
                                                 $   2,862   $  20,292  $  23,054
                                                 ================================
Depreciation expense:
   Software                                      $     125   $     176  $      24
   Animation services                                  158          95        148
   Film                                                104         251      1,666
   Corporate and other                                  80         210      1,344
                                                 --------------------------------
                                                 $     467   $     732  $   3,182
                                                 ================================
Capital expenditures:
   Software                                      $     317   $     942  $      32
   Animation services                                  133          51        392
   Film                                                340       1,694      6,565
   Corporate and other                                 178       1,149     12,366
                                                 --------------------------------
                                                 $     968   $   3,836  $  19,355
                                                 ================================
Identifiable assets (continuing operations):
   Software                                      $     920   $   1,841  $   1,308
   Animation services                                  769         627        840
   Film                                              5,534       6,882     34,854
   Corporate and other                             145,608     166,122    194,064
                                                 --------------------------------
                                                 $ 152,831   $ 175,472  $ 231,066
                                                 ================================
</TABLE>


(11)    EARNINGS PER SHARE CALCULATION

        Reconciliation of basic and diluted net income per share (in thousands,
except per share amounts):


<TABLE>
<CAPTION>
                                                                  Year Ended December 31,
                                        1995                              1996                              1997
                          ---------------------------------    ------------------------------    ---------------------------------
                             Net                                Net                                Net
                           Income      Shares        EPS       Income   Shares          EPS       Income   Shares           EPS
                          -------      ------     ---------    ------   ------     ----------    -------   ------     ------------
<S>                       <C>          <C>        <C>         <C>       <C>        <C>           <C>       <C>        <C>
Basic net income per
  share                   $ 1,627      12,955     $    0.13   $25,319   38,632     $     0.66    $22,190   41,224     $       0.54

Effect of dilutive
  shares:
Convertible preferred
  stock                      --        20,000                      --       --                     --       --
Warrants/options             --           261                      --    8,357                     --       6,920
                          -------------------                 -------   ------                   -------   ------
Diluted net income
  per share               $ 1,627      33,216     $    0.05   $25,319   46,989     $     0.54    $22,190   48,144     $       0.46
                          ===================                 =======   ======                   =======   ======
</TABLE>











                                      28
<PAGE>   29


         A warrant to purchase 750,000 shares of common stock issued in 1997 at
an exercise price of $20.00 per share and another warrant to purchase 750,000
shares of common stock issued in 1997 at an exercise price of $25.00 per share
were excluded from the calculation of diluted net income per share because their
effect was antidilutive for the year ended December 31, 1997. (See Note 6).

(12)    DISCONTINUED OPERATIONS

        Pixar determined in March of 1997 to discontinue its business of
producing CD-ROM and other interactive products. Pixar had no CD-ROM revenue in
1995 and revenue of $3,009,000 and $1,212,000 in 1996 and 1997, respectively.
Pixar recorded losses from discontinued operations, net of income taxes, of
$1,704,000 and $1,023,000 in 1995 and 1996, respectively. In 1997, Pixar
recorded income from discontinued operations of $234,000, net of income taxes,
primarily due to royalty income received for the Toy Story CD-ROM products.
Pixar anticipates future royalty income will exceed costs to be incurred in all
future periods. Net assets of the discontinued operations of $1,469,000 and
$2,000 at December 31, 1996 and 1997, respectively, primarily consist of
reimbursements and royalties receivable from Disney.























                                      29
<PAGE>   30

QUARTERLY FINANCIAL INFORMATION  (unaudited)
        The unaudited financial statements have been prepared on substantially
 the same basis as the audited financial statements and, in the opinion of
 management, include all adjustments, consisting only of normal recurring
 adjustments, necessary for a fair presentation of the results of operations for
 such periods.

(in thousands, except per share data)

<TABLE>
<CAPTION>
                                                             Three Months Ended
                                          March 31         June 30        September 30    December 31
                                          -------          -------          -------          -------
<S>                                       <C>              <C>              <C>              <C>
1996

Revenue                                   $ 8,267          $ 6,917          $13,486          $ 6,548

Gross profit                                7,488            5,711           11,688            5,626

Net income                                  6,279            4,790            9,600            4,650

Basic net income per share (1)               0.16             0.12             0.25             0.12
Diluted net income per share (1)             0.13             0.10             0.21             0.10


1997

Revenue                                   $ 7,867          $14,376          $ 5,341          $ 7,115

Gross profit                                7,300           13,419            4,698            6,744

Net income                                  5,148            8,929            3,672            4,441

Basic net income per share (1)               0.13             0.22             0.09             0.11
Diluted net income per share (1)             0.11             0.19             0.08             0.09
</TABLE>



(1) Basic and diluted net income per share amounts have been restated in
accordance with SFAS No. 128.




                                      30