<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,
                                                ----------------------------------------------------------------------
                                                  1992            1993           1994            1995           1996
                                                -------         -------         -------         -------        -------
                                                                 (In thousands, except per share data)
<S>                                             <C>             <C>             <C>             <C>            <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
       Software                                 $ 2,179         $ 4,702         $ 3,323         $ 3,144        $ 6,306
       Animation services                         2,038           2,127           2,267           2,469          3,947
       Film                                          --              --              --              --         18,847
       Patent licensing                              --              --              --           6,500          9,127
                                                -------         -------         -------         -------        -------

             Total revenues                       4,217           6,829           5,590          12,113         38,227
                                                -------         -------         -------         -------        -------

Cost of revenues:
       Software                                     716           1,327           1,164             513            113
       Animation services                         1,939           1,692           1,964           1,873          3,039
       Film                                          --              --              --              --          1,551
                                                -------         -------         -------         -------        -------

            Total cost of revenues                2,655           3,019           3,128           2,386          4,703
                                                -------         -------         -------         -------        -------

            Gross margin                          1,562           3,810           2,462           9,727         33,524
                                                -------         -------         -------         -------        -------

Operating expenses:
      Research and development                    2,307           1,757           2,288           4,065          6,985
      Sales and marketing                         1,851           2,368           2,180           1,588          1,768
      General and administrative                    799             715             831           3,043          5,577
                                                -------         -------         -------         -------        -------

           Total operating expenses               4,957           4,840           5,299           8,696         14,330
                                                -------         -------         -------         -------        -------

           Income (loss) from operations         (3,395)         (1,030)         (2,837)          1,031         19,194

Other income (expense)                               19            (142)            466             716          8,031
                                                -------         -------         -------         -------        -------

       Income (loss) before income taxes         (3,376)         (1,172)         (2,371)          1,747         27,225

Income taxes                                          2               1               1             120          1,906
                                                -------         -------         -------         -------        -------

Net income (loss)                               $(3,378)        $(1,173)        $(2,372)        $ 1,627        $25,319
                                                =======         =======         =======         =======        =======

Net income (loss) per share                                                     $ (0.06)        $  0.04        $  0.54
                                                                                =======         =======        =======
Shares used in computing
   net income (loss) per share                                                   39,669          40,350         46,989
                                                                                =======         =======        =======
</TABLE>

<TABLE>
<CAPTION>
                                                                         DECEMBER 31,
                                            ------------------------------------------------------------------------
                                               1992           1993            1994            1995           1996
                                            ---------      ---------        ---------     -----------    -----------
                                                                         (IN THOUSANDS)
<S>                                         <C>            <C>              <C>           <C>            <C>
BALANCE SHEET DATA:
Working capital (deficit)                   $  (924)        $  (638)        $(1,199)        $138,688        $162,983
Total assets                                  2,002           1,987           1,896          153,015         177,463
Long-term obligations                         1,346           1,460           1,573               --              --
Total shareholders' equity (deficit)         (1,333)         (1,216)         (1,675)         142,907         170,804
</TABLE>









<PAGE>   2
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

         The foregoing discussion and other sections of this Annual Report to
Shareholders contain forward-looking statements that have been made pursuant to
the provisions of the Private Securities Litigation Reform Act of 1995. Such
forward looking statements are based on current expectations, estimates and
projections about Pixar's industry, management's beliefs, and assumptions made
by management. Words such as "anticipates," "expects," "intends," "plans,"
"believes," "seeks," "estimates," variations of such words and similar
expressions are intended to identify such forward- looking statements. These
statements are not guarantees of future performance and are subject to certain
risks, uncertainties and assumptions that are difficult to predict; therefore,
actual results and outcomes may differ materially from what is expressed or
forecasted in any such forward-looking statements. Such risks and uncertainties
include those set forth herein under "Overview," "Anticipated Decline in
Operating Results in 1997 and Net Losses in 1998" and "Potential Fluctuations in
Operating Results" as well as those noted in the section entitled "Certain
Factors Affecting Business, Operating Results and Financial Condition" in
Pixar's Annual Report on Form 10-K for the year ended December 31, 1996 (the
"Form 10-K"). Particular attention should be paid to the cautionary language in
the section in the Form 10-K entitled "Certain Factors Affecting Business,
Operating Results and Financial Condition -- Anticipated Decline in Operating
Results in 1997 and Net Losses in 1998," "-- Dependence on Toy Story, Bugs and
Toy Story Video Sequel," "--Liquidity Risks," "--Scheduled Concurrent Release of
Films; Management of Growth" and "-- Risks Associated With Co-Production
Agreement." Unless required by law, Pixar undertakes no obligation to update
publicly any forward-looking statements, whether as a result of new information,
future events or otherwise.

OVERVIEW

         Pixar was formed in 1986 when Steve Jobs purchased the computer
division of LucasFilm and incorporated it as a separate company. Until 1996,
Pixar generated its recurring revenue primarily from the license of RenderMan
software, software development contracts and fees for animated television
commercials. Financial information relating to business segments is set forth in
Note 10 of Notes to Financial Statements. In 1991, Pixar entered into the
Feature Film Agreement with Walt Disney Pictures, a wholly owned subsidiary of
The Walt Disney Company (together with its subsidiaries and affiliates
collectively referred to herein as "Disney"), for the development and production
of up to three animated feature films to be marketed and distributed by Disney.
As a result, in 1992, Pixar began to place more emphasis on products sold for
their content, especially feature films, and the continued development of its
proprietary software. At the same time, Pixar reduced emphasis on the
commercialization of software and contract development work. Pixar has
implemented this shift in focus over the last four years. In accordance with
this shift in focus, Pixar adopted a new business model pursuant to which it
will develop and produce new animated feature films and related products, such
as theatrical sequels, made-for-home video sequels, merchandise and soundtracks.

         Adoption of this new business model did not materially impact Pixar's
results of operations and financial condition until 1996, when Pixar first
recognized film revenue and cost of film revenue attributable to Pixar's first
animated feature film, Toy Story, which was released in November 1995, and first
recognized CD-ROM revenue and associated costs from the release in 1996 of two
CD-ROM products related to Toy Story. Pixar's share of revenues and expenses
from Toy Story were governed by the terms of the Feature Film Agreement, and
Pixar's share of expenses and revenue from the two Toy Story CD-ROM products
were governed by a separate CD-ROM production and distribution agreement that
Pixar and Disney entered into in August 1995 (the "CD-ROM Agreement"). Those
agreements have been largely superseded by the Co-Production Agreement entered
into in February 1997, as described below, except with respect to treatment of
existing films and products developed pursuant to those agreements, such as the
Toy Story home video. Accordingly, Pixar believes that the results of its
operations for 1995 and prior years, during which time Pixar recognized no
revenue from animated feature films or related products, are not meaningful
indicators of future performance. Further, Pixar believes that its results of
operations for 1996, during which time revenue and costs attributable to feature
films and CD-ROM products were governed by the terms of the Feature Film
Agreement and the CD-ROM Agreement, are also not meaningful indicators of future
performance, although they are more meaningful than results of operations for
1995 and prior years.  See "Anticipated Decline in Operating Results in 1997
and Net Losses in 1998."
<PAGE>   3
NEW AGREEMENT WITH DISNEY

         On February 24, 1997 Pixar and Walt Disney Pictures and Television, a
wholly-owned subsidiary of Disney, entered into the Co-Production Agreement
("Co-Production Agreement") pursuant to which Pixar, on an exclusive basis, will
produce five computer animated feature-length theatrical motion pictures (the
"Pictures") for distribution by Disney over approximately the next ten years.
Pixar and Disney will co-finance the production costs of the Pictures, co-own
the Pictures (with Disney having exclusive distribution and exploitation
rights), co-brand the Pictures and share equally in the profits of each Picture
and any related merchandise and other ancillary products, after recovery of all
marketing and distribution costs (which will be financed by Disney), a
distribution fee paid to Disney and any other fees or costs, including any
participations provided to talent and the like. The Co-Production Agreement
generally provides that Pixar will produce each Picture and that Disney will
control all decisions relating to marketing, promotion, publicity, advertising
and distribution of each Picture. Disney and Pixar have agreed that the first
Picture under the Co-Production Agreement is the Picture with the working title
"Bugs." The Co-Production Agreement also contemplates that with respect to
theatrical sequels, made-for-home video sequels, television productions,
interactive media products and other derivative works related to the Pictures,
Pixar will have the opportunity to co-finance and produce such products or to
earn passive royalties on such products. Disney and Pixar have announced their
intention to produce a made-for-home video sequel to Toy Story (the "Toy Story
Video Sequel"), and Pixar has already begun work on the production under the
terms of the Co-Production Agreement. Pixar will not share in any theme park
revenues generated as a result of the Pictures. See Note 11 of Notes to
Financial Statements.

         In addition to entering into the Co-Production Agreement, Pixar agreed
to sell, and Disney agreed to purchase for cash, 1,000,000 shares of Pixar
Common Stock which Disney has agreed to hold for at least three years. Pixar
also granted two warrants, each exercisable for five years, to Disney: one
warrant to purchase 750,000 shares of Common Stock at an exercise price of
$20.00 per share and another warrant to purchase 750,000 shares of Common Stock
at an exercise price of $25.00 per share. Pixar granted certain registration
rights for the shares issuable upon exercise of the warrants.  This transaction
was consummated in late March 1997 and Pixar received gross proceeds of $15.0
million.

RESULTS OF OPERATIONS

         A number of factors may lead to a substantial decline in Pixar's
operating results in 1997 and net losses in 1998. See "Anticipated Decline in
Operating Results in 1997 and Net Losses in 1998."

     Revenues

         In the year ended December 31, 1996, Pixar derived revenue from its
first animated feature film, Toy Story, from its first two CD-ROM products
related to Toy Story, from software licenses, from the license of certain
patents and from fees for animated television commercials and other animation
services. Revenue from feature films is recognized upon receipt of compensation
from Disney. Revenue from CD-ROM products is recognized upon shipment in the
form of a royalty from Disney after a minimum number of units have been sold.
All payments to Pixar from Disney for development and production of both Toy
Story and the Toy Story CD-ROM products under the Feature Film Agreement and the
CD-ROM Agreement, respectively, have been recorded as cost reimbursements.
Accordingly, no revenues have been recognized for such reimbursements; rather,
Pixar has netted the reimbursements against the related costs. These reimbursed
costs for the years ended December 31, 1994, 1995 and 1996 are set forth in Note
4 of Notes to Financial Statements. Software license revenue is recognized upon
shipment if there are no significant vendor obligations. Revenue from patent
licensing is recognized upon release of the rights to the technology. See Note 1
of Notes to Financial Statements. Television commercial and other animation
services revenues are recognized on the percentage-of-completion method of
accounting. Prior to 1996, Pixar also derived revenue from software development
contracts for which revenues were recognized on the percentage-of-completion
method of accounting.

         Total revenues increased from $5.6 million in 1994 to $12.1 million in
1995 and to $38.2 million in 1996. Total revenues increased from 1994 to 1995
primarily as a result of patent licensing revenues of $6.5 million recognized in
the second quarter of 1995. Total revenues increased from 1995 to 1996 primarily
as a result of revenues received attributable to Toy Story and the two related
CD-ROM products.

         Software revenues include software license revenue, principally from
RenderMan, royalties received from the 1996 release of Pixar's first two CD-ROM
products, The Toy Story Animated Storybook and The Toy Story Activity Center,
and,


<PAGE>   4
prior to 1996, software development contract revenues. Software revenue
decreased from $3.3 million in 1994 to $3.1 million in 1995 and increased to
$6.3 million in 1996. Software revenues decreased from 1994 to 1995 as an
increase in software license revenue was more than offset by a decline in
revenue from software development contracts. Software revenues increased from
1995 to 1996 due primarily to first time CD-ROM royalty revenues of $3.0 million
and, to a lesser extent, an increase in RenderMan software license revenue. Due
to Pixar's focus on content creation for animated feature films and related
products, Pixar continues to expect that revenue derived from software licenses
may decline. In addition, in 1995, Pixar completed work under all of the
software development contracts that generated revenues in 1994 and 1995. No
further development contract revenue was generated in 1996, and Pixar does not
expect to pursue future software development work for third parties, nor to
generate future revenues in this area.

        After the Co-Production Agreement was executed on February 24, 1997,
Pixar began evaluating the merits of staying in the business of producing
CD-ROM products and comparing those opportunities with opportunities in film
and other potential projects under the Co-Production Agreement.  Management
determined that, despite the fact that Pixar's first CD-ROM titles were
successful on relative terms, the resources currently devoted to its
interactive products division would be better allocated to other projects
arising from the Co-Production Agreement which Pixar believes have greater
potential than CD-ROM titles, such as theatrical films, home video sequels and
short animation projects.  Moreover, the CD-ROM and interactive product market
is not growing as fast as expected, the production costs of such products are
increasing and one project under negotiation with a third party was canceled.
For these reasons, Pixar determined in the last week of March 1997 to
discontinue its business of producing CD-ROM and other interactive products and
redirect the approximately 60 employees in this division to film and related
projects within Pixar.  This decision is expected to have a material adverse
impact on Pixar's results of operations in 1997.

         Animation services revenues include revenue generated from short
projects related to Pixar's films, animated television commercials and other
short animated productions. Fees for animation services, which are fixed in
advance, depend on the relative complexity and length of each production and may
also depend on the market and other competitive conditions. Animation services
revenues increased from $2.3 million in 1994 to $2.5 million in 1995 and to $3.9
million in 1996. The increase in revenue from 1994 to 1995 was due to an
increase in the average fee charged due to the increased complexity of the
commercials produced, which more than offset the decrease in the number of
television commercials produced due to increased emphasis on content creation
for feature films. The increase in revenue from 1995 to 1996 was due to $2.4
million in fees from Disney for a series of televised animation short
productions related to Toy Story. During 1996, Pixar announced plans to
substantially discontinue its production of animated television commercials for
third parties after fulfilling its current commitments and to redirect the
talent in its television commercial group to animated feature films and related
products. Pixar continues to expect some ongoing activity in the animation
services area primarily due to projects related to Pixar's films. Pixar may even
devote more resources to the animation services group as a result of potential
opportunities arising from the Co-Production Agreement.

         Toy Story was not released until November 1995, and accordingly, there
were no film revenues in 1994 or 1995. Under the Feature Film Agreement, film
revenues of $18.8 million were recognized in 1996, representing Pixar's share of
both the domestic and international theatrical releases of Toy Story and related
products. The Toy Story home video was released in October 1996 and, due to the
one quarter delay between the time Disney receives Toy Story revenues and the
time Disney pays Pixar its portion of these revenues, Pixar's share of Toy Story
home video revenues will not begin to be received until the first quarter of
1997. The amount of compensation payable to Pixar from the Toy Story home video
is governed by the prior Feature Film Agreement, pursuant to which Pixar's
compensation rate for home videos is less than it was for theatrical exhibitions
of Toy Story. Since the Toy Story home video is the last major release for Toy
Story, and since Pixar's next feature film is not targeted for release until the
fourth quarter of 1998 at the earliest, Pixar's revenues and earnings will
likely decrease in 1997 and 1998 as compared to 1996. Moreover, unless the Toy
Story Video Sequel is released in the first half of 1998 and achieves
extraordinary success on relative terms, Pixar will incur a net loss in 1998.

         Patent license revenues of $6.5 million in the year ended December 31,
1995 were attributable to a patent license with Microsoft. Prior to 1995, there
were no patent license revenues. Patent license revenues of $9.1 million in the
year ended December 31, 1996 were attributable to a patent license with Silicon
Graphics whereby Pixar granted to Silicon


<PAGE>   5
Graphics and its subsidiaries a non-exclusive license to use certain of Pixar's
patents covering techniques for creating computer-generated photorealistic
images. Under the agreement, Silicon Graphics agreed to pay Pixar total
compensation of $11 million, $6 million in cash and $5 million in the form of
credits to purchase hardware and software from Silicon Graphics. In 1996, Pixar
recognized revenue of $9.1 million, which included $6.0 million received in cash
in March 1996 and $3.1 million representing that portion of the $5.0 million in
hardware and software credits actually used in 1996. The remaining $1.9 million
will be recognized as revenue in future periods as hardware and software credits
are used. Pixar does not expect that patent license revenues will be generated
on an on-going basis. See Note 5 of Notes to Financial Statements.

         In the year ended December 31, 1995, Microsoft accounted for 54% of
Pixar's total revenues, attributable to a one-time patent license. In the year
ended December 31, 1996, Disney accounted for 65% of Pixar's total revenues,
attributable to revenue generated from Toy Story, two related CD-ROM games,
short animated television productions based on Toy Story, and, to a lesser
degree, software license sales. Also in 1996, Silicon Graphics accounted for 24%
of total revenues, attributable to a one-time patent license. Due to the
continuation of film-related revenues generated by Toy Story, Disney is expected
to continue to represent greater than 10% of revenues in 1997. For information
regarding Pixar's 10% customers in 1994, see Note 10 of Notes to Financial
Statements.

     Cost of Revenues

         Cost of software revenues consists of the direct cost and manufacturing
overhead required to reproduce and package Pixar's software products and, prior
to 1996, the cost of salaries and overhead associated with the software
development contracts. Because costs of development and production of the first
two CD-ROM products were paid by Disney pursuant to the CD-ROM Agreement, there
were no costs of revenue associated with CD-ROM royalty revenue. All payments to
Pixar from Disney for Pixar's efforts in the development and production of
CD-ROM products were recorded as cost reimbursements and were netted against the
related costs. Cost of software revenues as a percentage of the related revenues
decreased from 35% in 1994 to 16% in 1995 and to 2% in 1996 due to a substantial
reduction in revenue in each year from low margin software development
contracts, to increased sales of the RenderMan ToolKit in each year, which
carries a higher gross margin than other software products, and, in 1996, to
$3.0 million in CD-ROM revenue which carries no related cost. Cost of software
revenues includes no amortization of capitalized software development expenses.

         Cost of animation services revenues consists of production costs, which
include salaries, benefits and facility expenses and department overhead costs.
Cost of animation services revenues as a percentage of the related revenues
decreased from 87% in 1994 to 76% in 1995 primarily due to increased
efficiencies in the production of commercials and to slightly higher fees
charged. Cost of animation services revenues as a percentage of the related
revenues increased slightly to 77% in 1996 due to higher costs associated with
increased complexity and reduced prices for television commercials attributable
to competitive pressures, largely offset by the higher margins earned on a
series of animated short projects related to Toy Story.

         Toy Story was released in November 1995, and accordingly, there was
neither film revenue nor cost of film revenues in 1994 or 1995. In 1996, cost of
film revenues was $1.6 million, or 8% of film revenues, consisting of the
amortized portion of Pixar's share of unreimbursed amounts incurred to produce
Toy Story. See "Capitalized Film Production Costs." Film production costs are
amortized under the individual film forecast method.

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

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


<PAGE>   6
     Operating Expenses

         Pixar's total operating expenses increased in each of 1994, 1995 and
1996, and Pixar intends to continue to increase operating expenses in a number
of areas. With respect to general expense growth, as a result of intense
competition for animators, creative personnel and technical directors, Pixar has
had to pay higher salaries to attract new creative and technical personnel.
Pixar expects compensation for such personnel to continue to increase
substantially. In the year ended December 31, 1996, Pixar funded greater levels
of research and development, expanded its administrative staff and facilities,
expanded other operations, and incurred significant costs related to being a
public company. Pixar expects continued growth in operating expenses in each of
these areas. To the extent that such expenditures are not capitalized by Pixar
nor allocated to, and paid for by, Disney, and precede or are not subsequently
followed by an increase in revenues, Pixar's business, operating results and
financial condition will be materially adversely affected.

         In 1995, Pixar recorded deferred compensation of $3.7 million for the
difference between the grant price and the deemed fair value of Pixar's Common
Stock for 9,823,900 shares subject to options granted during 1995. Amortization
of deferred compensation of $1.4 million was recorded in the year ended December
31, 1995 -- $292,000 was capitalized to film production costs and $1.1 million
was charged to expense -- based upon the vesting of the underlying options. In
1996, amortization of deferred compensation of $1.2 million was recorded --
$44,000 was capitalized to film production costs and the balance was charged to
expense. See "--Capitalized Film Production Costs." The remaining deferred
compensation expense will be amortized primarily to operating expense over the
related 48-month vesting period of the options and will therefore continue to
have a material adverse effect on Pixar's results of operations. See Note 8 of
Notes to Financial Statements.

         Research and Development. Research and development expenses consist
primarily of salaries and support for personnel conducting research and
development for the RenderMan product, for Pixar's proprietary Marionette and
Ringmaster software, and for Pixar's interactive products. Research and
development expenses increased from $2.3 million in 1994 to $4.1 million in 1995
and to $7.0 million in 1996. Research and development expenses increased in each
of 1995 and 1996 as compared to the prior year due to an increase in personnel
responsible for the development of interactive titles and tools, and due to
development of improvements and upgrades for Pixar's Marionette, Ringmaster and
RenderMan software systems. Additional charges of $305,000 and $472,000 were
taken in 1995 and 1996, respectively, to amortize the costs of deferred
compensation in connection with stock option grants. To date, all research and
development costs not reimbursed by Disney have been expensed as incurred. Pixar
expects research and development expenses to further increase.

         Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and overhead and public relations, advertising, technical support and
trade show costs required to support the software segment. Sales and marketing
expenses decreased from $2.2 million in 1994 to $1.6 million in 1995 due to a
reduction in salaries and advertising costs as Pixar focused on content
creation, primarily for animated feature films. Sales and marketing expenses
increased to $1.8 million in 1996 primarily as a result of the success of Toy
Story and as a result of becoming a public company, both of which caused
increases in public relations and corporate marketing costs. Pixar believes that
sales and marketing expenses may increase in absolute dollars in future periods,
particularly in the areas of corporate marketing and public relations.

         General and Administrative. General and administrative expenses consist
primarily of salaries of management and administrative personnel, insurance
costs and professional fees. Under the Feature Film Agreement, all or a portion
of the salaries of certain of Pixar's executives and other general and
administrative personnel were charged as film production costs and were
reimbursed by Disney and were therefore not included in general and
administrative expenses. General and administrative expenses increased from
$831,000 in 1994 to $3.0 million in 1995 and to $5.6 million in 1996. The
increase in general and administrative expenses from 1994 through 1996 was
primarily due to the amortization of deferred compensation expense recorded in
connection with stock option grants, increased staffing, increased professional
fees associated with the protection of intellectual property, and increased
costs and fees associated with being a public company. Charges of $788,000 and
$658,000 were taken in 1995 and 1996, respectively, to amortize the costs of
deferred compensation in connection with stock option grants. Pixar expects
general and administrative expenses to further increase in absolute dollars in
future periods as Pixar incurs additional costs related to being a public
company and expands its administrative staff and facilities.


<PAGE>   7
     Other Income, Net

         Other income, net was $466,000 in 1994, $716,000 in 1995 and $8.0
million in 1996. Other expense in each of 1994 and 1995 was primarily
attributable to net interest expense consisting primarily of interest accrued on
a promissory note issued by Pixar to its majority shareholder. In 1994, net
interest expense was more than offset by other income of $584,000 recognized as
gain on the sale of equity securities. In 1995, net interest expense was more
than offset by net other income consisting primarily of interest income from
investments, amounts received pursuant to settlement of an intellectual property
rights dispute and additional gain on the sale of equity securities. Other
income in 1996 consisted primarily of interest income from investments made with
the net proceeds from Pixar's initial public offering of Common Stock.

     Income Taxes

         Pixar elected S corporation status for federal income tax purposes as
of January 1, 1992, whereby income was taxed to its individual shareholder.
Accordingly, income tax expense in 1994 related only to the State of
California's minimum franchise tax expense. At the end of April 1995, Pixar
became a C corporation. Income tax expense for the year ended December 31, 1995
represented federal and state alternative minimum taxes (after utilization of
net operating loss carryforwards) on the earnings of Pixar following termination
of its S corporation status.

         Income tax expense for the year ended December 31, 1996 consisted
primarily of state income taxes and federal alternative minimum tax. Income
taxes increased in 1996 due to increased earnings and to full utilization of
state net operating loss carryforwards. As of December 31, 1996, Pixar had net
operating loss carryforwards from pre-S corporation years of approximately $23.0
million for federal income tax purposes. See Notes 1 and 7 of Notes to Financial
Statements.

ANTICIPATED DECLINE IN OPERATING RESULTS IN 1997 AND NET LOSSES IN 1998

         A number of factors are expected to lead to a substantial decline in
Pixar's operating results in 1997 and net losses in 1998, as discussed more
fully below.

     End of Toy Story Revenues

         Pixar has already recognized the vast majority of the revenue it
expects to receive from the domestic and international theatrical releases of
Toy Story and expects substantially all of the revenue from the home video of
Toy Story to be recognized in the first two quarters of 1997. Under the terms of
the Feature Film Agreement, which stills governs the compensation payable to
Pixar from the home video of Toy Story, Pixar is compensated for the home video
to a lesser extent than it was with respect to the theatrical release of Toy
Story. Pixar does not expect to recognize significant revenue from the Toy Story
home video in the third or fourth quarters of 1997 or in any quarter in 1998.
Pixar also expects limited revenue from the Toy Story CD-ROM products in 1997
and little or no revenue from such products in 1998.

     Reduced CD-ROM Revenue

        Pixar also expects to recognize less CD-ROM revenue in 1997 and 1998
than was previously anticipated. Although its first two CD-ROM products were
successful on relative terms, Pixar determined in the last week of March 1997
to discontinue its business of producing CD-ROM and other interactive products
in favor of other opportunities arising, in part, as a result of entering into
the Co-Production Agreement. This decision is expected to have a material
adverse impact on Pixar's operating results in 1997 and 1998. Pixar will not
recognize any CD-ROM or other interactive product revenue in 1997 or 1998,
other than revenue attributable to the two Toy Story CD-ROM products, and may
incur carrying costs associated with the approximately 60 employees currently
assigned to the interactive products division. Pixar does, however, expect to
be able to reassign most of these employees to Picture productions and other
departments within Pixar.

     Timing of Bugs and Toy Story Video Sequel Releases

         Bugs is not expected to be released until the end of 1998 at the
earliest, and revenue attributable to Bugs is not expected to be recognized
until after all costs have been recovered. Recovery of all costs depends on many
factors and may not occur until six to twelve months after its release at the
earliest, ensuring that Pixar will not recognize any revenue from

<PAGE>   8
Bugs until the second half of 1999 at the earliest. The Toy Story Video Sequel
is currently targeted for release in the second half of 1998, but its release
date could change for a number of reasons. First, Pixar may be unable, for
technical or other reasons, to complete the production of the Toy Story Video
Sequel in time for its scheduled release in the second half of 1998. Second,
even if completed, Disney and Pixar may choose to delay release of the Toy Story
Video Sequel until the 1998 holiday season or thereafter. Depending on the
timing of receipt of revenues by Disney, Pixar may not recognize revenue from
the Toy Story Video Sequel until three to six months after its release at the
earliest, meaning that if the Toy Story Video Sequel were released in late 1998
or thereafter, Pixar would not recognize any revenue from the Toy Story Video
Sequel until 1999 at the earliest. Third, it is possible that the Toy Story
Video Sequel could be released to the theaters instead of as a made-for-home
video. In such event, Pixar would not expect to recognize any revenue until six
to twelve months after the theatrical release, with the result that Pixar would
not recognize any revenue from such film until 1999, even if released to the
theaters in the second half of 1998.

     Possible Decline in Sales of RenderMan Due to Shift in Focus

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

     Increase in Operating Expenses

         In 1996, Pixar significantly increased its operating expenses, and
Pixar plans to continue to increase its operating expenses to fund greater
levels of research and development and to expand operations. Specifically, Pixar
expects operating expenses to increase significantly due to continued investment
in proprietary software systems, increased compensation costs as a result of
intense competition for animators, creative personnel and technical directors
and increased costs associated with the expansion of its facilities.
Accordingly, Pixar anticipates significant increases in operating expenses in
each of 1997 and 1998. Finally, Pixar expects its tax rate to increase in 1997
and future years as the result of utilization of net operating losses in 1996.

     Impact on Operating Results

         As a result of the above factors, the only substantial revenue expected
to be recognized in 1997 will be from the Toy Story home video, and
substantially all of that will be recognized in the first and second quarters.
Further, unless the Toy Story Video Sequel is released early in the second half
of 1998 and is an extraordinary success on relative terms, Pixar will not
recognize substantial revenue in 1998. At the same time, Pixar's operating
expenses may increase in 1997 and 1998, even after giving effect to
capitalization of film production costs and allocation of certain operating
expenses to Disney under the Co-Production Agreement. Therefore, Pixar expects
revenue and operating results in the third and fourth quarters of 1997 to
decline substantially from the first and second quarters of 1997 and from the
same quarters of 1996. It is possible that Pixar would even incur operating and
net losses in each of the last two quarters of 1997. Pixar also expects to incur
operating and net losses in each of the first three quarters of 1998 and, unless
the Toy Story Video Sequel is released early in the second half of 1998, the
fourth quarter of 1998 and for the year ending December 31, 1998.

POTENTIAL FLUCTUATIONS IN OPERATING RESULTS

         In addition to the factors set forth above, Pixar expects to generally
experience significant fluctuations in its future annual and quarterly operating
results caused by a variety of factors. Pixar expects that its annual and
quarterly operating results, particularly its revenue, will fluctuate due to
factors such as the timing of the domestic and international releases of the
animated feature films, the success of the animated feature films (which can
fluctuate significantly from film to film), the timing of the release of related
products into their respective markets, the demand for the related products
(which is often a function of the success of the related animated feature film),
film production costs, Disney's costs to distribute and promote the feature
films and related products, Disney's success at marketing the films and related
products, the timing of receipt of proceeds from the animated feature films and
related products by Disney, the timing of revenue recognition under the
Co-Production Agreement, the Feature Film Agreement or the CD-ROM Agreement, as
the case may be, the introduction of new feature films or products by Pixar's
competitors, and general economic conditions. In particular, since Pixar's
revenue under the


<PAGE>   9
Co-Production Agreement is directly related to the success of a feature film,
Pixar's operating results are likely to fluctuate depending on the level of
success of its animated feature films and related products. The revenues derived
from the production and distribution of an animated feature film depend
primarily on the film's acceptance by the public, which cannot be predicted and
does not necessarily bear a direct correlation to the production or distribution
costs incurred. The commercial success of a motion picture also depends upon
promotion and marketing, production costs and other factors. Further, the
theatrical success of a feature film can be a significant factor in determining
the amount of revenues generated from the sale of the related products.

         Moreover, Pixar's operating expenses will be extremely difficult to
forecast. The direct costs of film production are budgeted in agreement with
Disney and shared equally. Pixar's share of these direct costs of film
production are capitalized by Pixar in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 53, "Financial Reporting by Producers and
Distributors of Motion Picture Films." A substantial portion of all of Pixar's
other costs are incurred for the benefit of feature films ("Pixar's Overhead"),
including research and development expenses and general and administrative
expenses. Portions of Pixar's Overhead are included in the budgets for the
Pictures and will be shared equally with Disney under the Co-Production
Agreement. The remaining portion of Pixar's Overhead is either capitalized as
film production costs, if required under SFAS No. 53, or charged to operating
expense in the period incurred. Because a substantial portion of Pixar's
Overhead is allocated to the Pictures and reimbursed by Disney and other amounts
are capitalized by Pixar in accordance with SFAS No. 53, Pixar's future reported
operating expenses will not reflect the true level of spending on the production
of animated feature films, related products and overhead.

         Pixar has a valuation allowance as of December 31, 1996 which fully
offsets its gross deferred tax assets due to Pixar's historical losses and the
fact that there is no guarantee Pixar will generate sufficient taxable income in
the future to be able to realize any or all of its deferred tax assets. As a
result, Pixar may not be able to realize a benefit in the future from its net
operating loss carryforwards, nor may it be able to recognize the tax benefits
of net operating losses to be generated in the future.

         As a result of all of the foregoing, Pixar believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful, and its annual and quarterly results of operations should not be
relied upon as any indication of future performance. Due to all of the foregoing
factors, it is likely that in some future period Pixar's operating results will
be below the expectations of public market analysts and investors. In such
event, the price of Pixar's Common Stock would likely be materially adversely
affected.

CAPITALIZED FILM PRODUCTION COSTS

         Although Disney funded the entire production of Toy Story, Pixar
contractually guaranteed certain of the film budget overages and is liable to
Disney for these amounts under the original Feature Film Agreement. Because
these are "production costs" under SFAS No. 53, the costs were capitalized and
amortized against future film revenue. As of December 31, 1995, Pixar had
approximately $3.6 million of capitalized film production costs, $3.3 million of
which represents the overage liability to Disney. During 1996, Pixar's overage
liability was reduced by $1.0 million as a result of budget savings and the
balance of $2.3 million owed to Disney was satisfied through a deduction from
the amount due from Disney to Pixar for Pixar's compensation, which is based on
Toy Story revenues. Pixar is entitled to recover any overages that it has
funded, either directly or through its compensation under the original Feature
Film Agreement, if Toy Story meets certain predefined criteria.

         During 1996, $1.6 million of Toy Story film production costs were
amortized against film revenues. As of December 31, 1996, Pixar had $3.0 million
in capitalized film production costs, $1.5 million of which represents remaining
film production costs related to Toy Story. The balance represents costs
relating to Pixar's second and third theatrical film productions and Pixar's
first sequel production based on Toy Story. See Notes 1 and 4 of Notes to
Financial Statements.


<PAGE>   10
LIQUIDITY AND CAPITAL RESOURCES

         Until 1995, Pixar financed its operations primarily through financial
support from its majority shareholder in the form of capital infusions and
promissory notes. In December 1995, Pixar completed the initial public offering
of its Common Stock, which resulted in net proceeds of approximately $139.7
million from the sale of 6,900,000 shares of Common Stock. Cash and short-term
investments increased to $161.0 million at December 31, 1996 from $144.3 million
at December 31, 1995 due primarily to net income of $25.3 million in 1996.

         Net cash used in operating activities in 1994 was primarily
attributable to a net loss. Net cash provided by operating activities in 1995
was primarily attributable to net income resulting from patent licensing revenue
of $6.5 million and an increase in accrued liabilities, somewhat offset by
growth in other receivables. Net cash provided by operating activities in 1996
was primarily attributable to net income resulting from film and CD-ROM revenues
related to Toy Story which generated $20.3 million in cash and from the cash
portion of patent licensing revenue totaling $6.0 million. Net cash used in
investing activities in 1994 was due primarily to the purchase of property and
equipment, largely offset by the proceeds from sale of equity securities in an
unrelated company. See Note 2 of Notes to Financial Statements. Net cash used in
investing activities in 1995 and 1996 was due primarily to investments in
short-term securities. Cash flows provided by financing activities in 1994 were
attributable to a capital infusion from Pixar's majority shareholder. Cash flows
provided by financing activities 1995 were primarily attributable to the net
proceeds of approximately $139.7 million from Pixar's initial public offering of
Common Stock. Net cash used in financing activities in 1996 was due primarily to
the repayment of the note payable to the majority shareholder. See Note 6 of
Notes to Financial Statements.

         As of February 24, 1997, Pixar's capital commitments primarily
consisted of obligations to fund production costs of films and derivative
products under the new Co-Production Agreement, obligations to pay portions of
any revenue derived from each feature film produced under the Co-Production
Agreement to its entertainment law firm in consideration for services rendered,
obligations under operating leases and commitments to purchase certain computer
equipment. Excluding costs related to the possible new studio facility discussed
below, Pixar expects 1997 cash expenditures for capital equipment to be
approximately $4.0 million. This will consist primarily of computer equipment,
tenant improvements and furniture, some of which are more fully described below.

         Film Production Costs Under Co-Production Agreement. Under the
Co-Production Agreement, Pixar's share of costs required to fund several films
in various stages of production is expected to total approximately $33 million
in 1997, which will directly impact working capital. Because Disney has already
funded the costs incurred to date on these productions under the terms of the
prior Feature Film Agreement, a significant portion of Pixar's 1997 production
spending will represent reimbursement to Disney of Pixar's share of these film
production costs already funded by Disney.

         Facilities Expansion. In 1996, Pixar entered into two new lease
agreements to expand the total square footage of its existing corporate
headquarters by approximately 72,000 square feet. The first lease agreement, for
approximately 26,000 square feet, resulted in additional cash commitments for
lease payments of approximately $540,000 per year beginning August 1996 and
continuing through July 1999. Tenant improvements and capital equipment
purchases related to that expansion totaled approximately $800,000 during 1996.
The second lease agreement, for approximately 46,000 additional square feet,
will begin during the second quarter of 1997 and result in additional cash
commitments for lease payments of $846,000 per year for four years, with an
option to terminate the lease after 30 months. Tenant improvements and capital
equipment purchases related to this expansion are expected to total
approximately $1.0 million during 1997.

         Also in 1996, Pixar paid a $150,000 refundable deposit on the purchase
of land to build a new studio facility. In January 1997, Pixar paid an
additional deposit of $150,000. At that time, the entire deposit of $300,000
became nonrefundable and will be applied to the purchase price of the property
should Pixar elect to purchase the property. If Pixar purchases the property and
builds a new studio facility, which it currently intends to do, Pixar currently
expects to incur capital expenditures of more than $10 million in 1997 and more
than $12 million in 1998. Pixar may choose to use its existing cash resources
for such expenditures or to finance such capital expenditures through the
issuance of additional equity or debt securities, by obtaining a credit facility
or by some other financing mechanism. If Pixar does not choose to purchase the
property and build a new facility, Pixar would need to write-off more than
$900,000 of capitalized expenses associated with site development and
engineering and architectural plans related to the new building, and would incur
an additional $300,000 charge related to Pixar's share of the site preparation.


<PAGE>   11
         Computer Equipment. In October 1996, Pixar entered into agreements to
purchase certain computer and network equipment from several vendors to be used
on the second film and other projects, requiring cash commitments of
approximately $3.0 million for the year ending December 31, 1997. A portion of
these costs will be reimbursed by Disney. Additional equipment will be purchased
from other sources, including equipment purchased in the form of credits in
conjunction with the patent licensing agreement with Silicon Graphics.

         As of December 31, 1996, Pixar's principal source of liquidity was
approximately $161.0 million in cash and short-term investments.  In March 1997,
Pixar received $15.0 million, before deduction of expenses, from Disney in
connection with the sale of 1,000,000 shares of Pixar Common Stock and the
issuance of two warrants to purchase an aggregate of 1,500,000 shares of Common
Stock.

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


<PAGE>   12
                          INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
Pixar:

         We have audited the accompanying balance sheets of Pixar as of December
31, 1995 and 1996, and the related statements of operations, shareholders'
equity (deficit), and cash flows for each of the years in the three-year period
ended December 31, 1996. These financial statements are the responsibility of
Pixar's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Pixar as of December
31, 1995 and 1996, and the results of its operations and its cash flows for each
of the years in the three-year period ended December 31, 1996, in conformity
with generally accepted accounting principles.



                                                      KPMG PEAT MARWICK LLP

Palo Alto, California
January 31, 1997, except as to Note 11,
which is as of March 25, 1997



                                      -1-

<PAGE>   13
                    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                                      PIXAR
                                 BALANCE SHEETS
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                                        December 31,
                                                                                                    1995              1996
                                                                                                 ---------         ---------
<S>                                                                                              <C>               <C>
                                     ASSETS
   Current assets:
      Cash and cash equivalents                                                                  $  97,286         $  44,648
      Short-term investments                                                                        47,002           116,321
      Trade accounts receivable, net of allowance for returns and doubtful accounts
        of $256 and $259 in 1995 and 1996, respectively                                                784               929
      Other receivables                                                                              1,969             5,390
      Prepaid expenses and other current assets                                                        309               982
      Capitalized film production costs                                                              1,446             1,372
                                                                                                 ---------         ---------

         Total current assets                                                                      148,796           169,642

   Property and equipment, net                                                                       1,552             4,655
   Capitalized film production costs, net of current portion                                         2,170             1,578
   Other assets                                                                                        497             1,588
                                                                                                 ---------         ---------

         Total assets                                                                            $ 153,015         $ 177,463
                                                                                                 =========         =========

                      LIABILITIES AND SHAREHOLDERS' EQUITY
   Current liabilities:
      Accounts payable                                                                           $     742         $   1,060
      Note payable to the majority shareholder and accrued interest                                  2,373                --
      Film production costs payable                                                                  3,324                --
      Accrued liabilities                                                                            3,400             5,262
      Unearned revenue                                                                                 269               337
                                                                                                 ---------         ---------

         Total current liabilities                                                                  10,108             6,659
                                                                                                 ---------         ---------

   Commitments

   Shareholders' equity:
      Preferred stock; no par value; 5,000,000 shares authorized; no
       shares issued and outstanding                                                                    --                --
      Common stock; no par value; 100,000,000 shares authorized; 38,286,500 and 39,413,102
       shares issued and outstanding as of December 31, 1995 and 1996, respectively                185,845           187,308
      Unrealized gain (loss) on investments                                                             49               (48)
      Deferred compensation                                                                         (2,261)           (1,049)
      Accumulated deficit                                                                          (40,726)          (15,407)
                                                                                                 ---------         ---------
         Total shareholders' equity                                                                142,907           170,804
                                                                                                 ---------         ---------

         Total liabilities and shareholders' equity                                              $ 153,015         $ 177,463
                                                                                                 =========         =========
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.


                                      -2-

<PAGE>   14
                                      PIXAR
                            STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                 Year Ended December 31,
                                                          1994             1995          1996
                                                        --------         -------        -------
<S>                                                     <C>              <C>            <C>
Revenues:
    Software                                            $  3,323         $ 3,144        $ 6,306
    Animation services                                     2,267           2,469          3,947
    Film                                                      --              --         18,847
    Patent licensing                                          --           6,500          9,127
                                                        --------         -------        -------

         Total revenues                                    5,590          12,113         38,227
                                                        --------         -------        -------

Cost of revenues:
    Software                                               1,164             513            113
    Animation services                                     1,964           1,873          3,039
    Film                                                      --              --          1,551
                                                        --------         -------        -------

         Total cost of revenues                            3,128           2,386          4,703
                                                        --------         -------        -------

         Gross margin                                      2,462           9,727         33,524
                                                        --------         -------        -------

Operating expenses:
    Research and development                               2,288           4,065          6,985
    Sales and marketing                                    2,180           1,588          1,768
    General and administrative                               831           3,043          5,577
                                                        --------         -------        -------

         Total operating expenses                          5,299           8,696         14,330
                                                        --------         -------        -------

         Income (loss) from operations                    (2,837)          1,031         19,194


Other income, net                                            466             716          8,031
                                                        --------         -------        -------

Income (loss) before income taxes                         (2,371)          1,747         27,225

Income tax expense                                             1             120          1,906
                                                        --------         -------        -------

         Net income (loss)                              $ (2,372)        $ 1,627        $25,319
                                                        ========         =======        =======

Net income (loss) per share (see Note 1)                $  (0.06)        $  0.04        $  0.54
                                                        ========         =======        =======

Shares used in computing net income (loss) share
    per share                                             39,669          40,350         46,989
                                                        ========         =======        =======
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.


                                      -3-

<PAGE>   15
                                     PIXAR
                  STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                                                                  Total
                                                                          Unrealized                              Share-
                                Preferred Stock         Common Stock      Gain (Loss)  Deferred      Accum-      holders'
                               ------------------   --------------------  on Invest-    Compen-      ulated       Equity
                                Shares    Amount     Shares     Amount       ments      sation       Deficit     (Deficit)
                               --------  --------   --------  ----------   --------   ----------     -------  --------------
<S>                            <C>        <C>         <C>      <C>          <C>         <C>         <C>         <C>
Balances, December 31, 1993       --      $   --          20   $  46,405    $   --      $   --      $(47,621)   $  (1,216)
Capital infusion from
  shareholder                     --          --        --         1,850        --          --          --          1,850
Unrealized gain on
  investments                     --          --        --          --            63        --          --             63
Net loss                          --          --        --          --          --          --        (2,372)      (2,372)
                               -------    --------    ------   ---------    --------    --------    --------    ---------
Balances, December 31, 1994       --          --          20      48,255          63        --       (49,993)      (1,675)

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

Exercise of stock options,
  including tax benefit
  from disqualifying
  dispositions                    --          --       1,127       1,463        --          --          --          1,463

Amortization of deferred
  compensation                    --          --        --          --          --         1,212        --          1,212
Unrealized loss on
  investments                     --          --        --          --           (97)       --          --            (97)
Net income                        --          --        --          --          --          --       25,319       25,319
                               -------    --------    ------   ---------    --------    --------    --------    ---------
Balances, December 31, 1996       --      $   --      39,413   $ 187,308    $    (48)   $ (1,049)   $(15,407)   $ 170,804
                               =======    ========    ======   =========    ========    ========    ========    =========
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.


                                      -4-

<PAGE>   16
                                     PIXAR
                            STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                         Year Ended December 31,
                                                                                     1994         1995         1996
                                                                                    -------    ---------    ---------
<S>                                                                                 <C>        <C>          <C>
Cash flows from operating activities:
Net income (loss)                                                                   $(2,372)   $   1,627    $  25,319
Adjustments to reconcile net income (loss) to net cash
    provided by (used in) operating activities:
    Amortization of deferred compensation                                              --          1,127        1,168
    Noncash revenue attributable to film overbudget                                    --           --         (2,324)
    Provision for returns and doubtful accounts                                         191           29            3
    Depreciation and amortization                                                       374          467        2,283
    Tax benefit from disqualifying dispositions                                        --           --          1,236
    Licenses exchanged for equipment                                                   --           --         (1,465)
    Gain on sale of equity securities                                                  (584)         (90)        --
    Changes in operating assets and liabilities:
        Trade accounts receivable                                                       143         (502)        (148)
        Other receivables                                                              (128)      (1,809)      (3,421)
        Prepaid expenses and other current assets                                       127          (85)        (673)
        Accounts payable                                                                167           86          318
        Accrued liabilities                                                             205        2,656        1,862
        Unearned revenue                                                                 (4)        (142)          68
                                                                                    -------    ---------    ---------
            Net cash provided by (used in) operating activities                      (1,881)       3,364       24,226
                                                                                    -------    ---------    ---------

Cash flows from investing activities:
    Purchase of property and equipment                                                 (589)        (955)      (2,371)
    Proceeds from sale of property and equipment                                       --             33         --
    Proceeds from sale of equity securities                                             584           90      175,360
    Investments in short-term securities                                               --        (46,953)    (244,776)
    Capitalized film production costs                                                  --           --         (1,840)
    Change in other assets                                                             --           (497)      (1,091)
                                                                                    -------    ---------    ---------
            Net cash used in investing activities                                        (5)     (48,282)     (74,718)
                                                                                    -------    ---------    ---------

Cash flows from financing activities:
    Net proceeds from initial public offering                                          --        139,661         --
    Proceeds from capital infusion                                                    1,850         --           --
    Proceeds from exercised stock options                                              --            277          227
    Repayment of note payable to shareholder                                           --           --         (2,373)
    Proceeds from note payable to shareholder                                          --          2,225         --
                                                                                    -------    ---------    ---------
            Net cash provided by (used in) financing activities                       1,850      142,163       (2,146)
                                                                                    -------    ---------    ---------

Net increase (decrease) in cash and cash equivalents                                    (36)      97,245      (52,638)
Cash and cash equivalents at beginning of year                                           77           41       97,286
                                                                                    -------    ---------    ---------
Cash and cash equivalents at end of year                                            $    41    $  97,286    $  44,648
                                                                                    =======    =========    =========

Supplemental disclosure of cash flow information:
    Cash paid during the year for income taxes                                      $  --      $     172    $     523
                                                                                    =======    =========    =========
Supplemental disclosures of noncash investing and financing activities:
    Credits used to purchase equipment                                              $  --      $    --      $   3,127
                                                                                    =======    =========    =========
    Film overbudget reductions                                                      $  --      $    --      $   3,324
                                                                                    =======    =========    =========
    Noncash film production costs capitalized                                       $  --      $   3,616    $      44
                                                                                    =======    =========    =========
    Conversion of note payable to shareholder, and accrued interest, to equity      $  --      $   1,612    $    --
                                                                                    =======    =========    =========
    Accrual of stock option deferred compensation                                   $  --      $   3,680    $    --
                                                                                    =======    =========    =========
    Unrealized gain (loss) on investments                                           $    63    $     (14)   $     (97)
                                                                                    =======    =========    =========
</TABLE>


                 SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS


                                      -5-

<PAGE>   17
                                      PIXAR

                          NOTES TO FINANCIAL STATEMENTS

(1)      SUMMARY OF PIXAR AND SIGNIFICANT ACCOUNTING POLICIES

         The Company

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

         Cash and Cash Equivalents

         Pixar considers all highly liquid instruments with an original maturity
of 90 days or less to be cash equivalents. Cash equivalents as of December 31,
1996 consisted primarily of U.S. Treasury Bills, demand notes, commercial paper
and federal agency obligations.

         Short-Term Investments

         Pixar has classified its short-term investments as
"available-for-sale." Such investments are recorded at fair value, and
unrealized gains and losses, if material, are reported as a separate component
of equity until realized. Interest income is recorded using an effective
interest rate with the associated premium or discount amortized to interest
income. The cost of securities sold is based upon the specific identification
method. See Note 2 for a description of short-term investments.

         Property and Equipment

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

         Film Production Costs

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

         Research and Development Costs

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



                                      -6-

<PAGE>   18
                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS


         Revenue Recognition

         Software licensing revenue is recognized upon shipment if there are no
significant vendor obligations and if collection is probable.

         Software development contracts and animated television commercial
revenues are recognized on the percentage-of-completion method of accounting.

         Patent licensing revenue is recognized upon release of the rights to
the technology.

         Compensation based on the revenues from the distribution of animated
feature films and related products is recognized as earned and reasonably
estimable. The related revenue cycle is generally five to seven years, with the
substantial majority expected to be recognized in the first two years.

         Financial Instruments and Concentration of Credit Risk

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

         The Company licenses its products and provides its services to a large
number of customers in several business segments, primarily in the United
States, as outlined in Note 10. The Company performs ongoing credit evaluations
of its customers and generally does not require collateral. The Company
maintains reserves for potential credit losses and such losses have been within
management's expectations.

         Accounting Estimates

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

         Income Taxes

         Pixar accounts for income taxes under the asset and liability method of
accounting. Under the asset and liability method, deferred tax assets and
liabilities are recognized based on the future tax consequences attributable to
differences between the financial statement carrying amount of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of
changes in tax rates is recognized in income in the period that includes the
enactment date.

         Pixar elected to be treated as an S corporation for federal income tax
purposes as of January 1, 1992, whereby income was taxed to its individual
shareholder. In 1995, Pixar's S corporation election terminated as a result of
the recapitalization described in Note 7. The accompanying pro forma net income
(loss) data for the year ended December 31, 1995, reflect provision for income
taxes on a pro forma basis, using the asset and liability method, as if Pixar
had been a C corporation since the beginning of that period, fully subject to
federal and state income taxes. Undistributed losses during the period in which
Pixar was an S corporation were reclassified from accumulated deficit to common
stock, resulting in a $7,600,000 decrease in both accumulated deficit and common
stock on the accompanying balance sheet as of December 31, 1995.

         Pro forma income taxes reflected in the pro forma net income data for
the year ended December 31, 1995 primarily reflect the alternative minimum tax
liability after utilization of net operating loss carryforwards recorded prior
to the S corporation termination event described in Note 7.



                                      -7-

<PAGE>   19

                                    PIXAR

                          NOTES TO FINANCIAL STATEMENTS


         Net Income (Loss) per Share

         Net income (loss) per share for the years ended December 31, 1994 and
1995, is computed using pro forma net income (loss), assuming C corporation
income tax expense. Net income (loss) per share for all periods presented is
computed using the weighted-average number of shares of common stock outstanding
and common equivalent shares from stock options (under the treasury stock
method, if dilutive). In accordance with SEC Staff Accounting Bulletins, such
computations include all common and common equivalent shares issued within 12
months of the initial public offering (IPO) as described in Note 8 for all
pre-IPO periods presented.

         Reclassifications

         Certain amounts reported in previous years have been reclassified to
conform to the 1996 financial statement presentation.

         Stock Option Plans

         Prior to January 1, 1996, the Company accounted for its stock option
plan in accordance with the provisions of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting
for Stock-Based Compensation, which permits entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the date of
grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosures for employee stock option grants made in 1995 and
future years as if the fair value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.

         Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of

         Pixar adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, on
January 1, 1996. This statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. Adoption of SFAS No. 121 did not have a material impact on the Company's
financial position, results of operations, or liquidity.

(2)      SHORT-TERM INVESTMENTS

         In 1993, Pixar licensed certain technology in exchange for a 10% equity
interest in the licensee. As of the date of this transaction, management
determined that there was no reasonable basis to determine the fair value of the
assets exchanged and, accordingly, the preferred stock received was valued at
zero.

         In 1994, the licensee was acquired by another company. As a result,
Pixar received 10,310 shares of common stock of the acquiring entity in exchange
for its equity in the licensee. In 1994, Pixar recognized a gain on this
transaction amounting to $584,000, which represents the fair value of the 9,279
shares received and the proceeds received from their subsequent sale. The
remaining 1,031 shares were placed in escrow to secure certain indemnification
obligations of the licensee and were valued at zero as of the date of the
transaction. As of December 31, 1994, Pixar had valued the 1,031 shares at fair
value and recorded unrealized gains of $63,000 under the belief that no
obligations existed under the escrow agreement. Pixar recognized a gain of
$90,000 from the sale of the remaining 1,031 shares in the year ended December
31, 1995.



                                      -8-

<PAGE>   20

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS


         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>
As of December 31, 1995:

U. S. Treasury Bills           $ 71,846     $ 50      $    --        $ 71,896
Demand notes                     14,499      --            --          14,499
Commercial paper                 34,833      --              (3)       34,830
Federal Agency obligations       19,861        2           --          19,863
                               --------     ----      ---------      --------
                               $141,039     $ 52      $      (3)     $141,088
                               ========     ====      =========      ========

As Of December 31, 1996:

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

         The contractual maturities of available-for-sale debt securities,
regardless of their balance sheet classification, are as follows (in thousands):
<TABLE>
<CAPTION>
                                            December 31, 1995         December 31, 1996

                                            Cost      Fair Value      Cost      Fair Value
                                          --------     --------     --------     --------
<S>                                       <C>          <C>          <C>          <C>
Due within one year                       $141,039     $141,088     $ 95,095     $ 95,072
Due after one year through five years         --           --         60,578       60,553
                                          --------     --------     --------     --------
                                          $141,039     $141,088     $155,673     $155,625
                                          ========     ========     ========     ========
</TABLE>

(3)      BALANCE SHEET COMPONENTS

         Balance sheet components are as follows (in thousands):

<TABLE>
<CAPTION>
                                                       December 31,
                                                    1995           1996
                                                 ----------      ---------
<S>                                                <C>            <C>
Property and equipment:
   Equipment                                       $3,298         $6,238
   Leasehold improvements                             265          1,007
                                                   ------         ------
                                                    3,563          7,245
Less accumulated depreciation and amortization      2,011          2,590
                                                   ------         ------
                                                   $1,552         $4,655
                                                   ======         ======

Accrued liabilities:
   Employee-related expenses                       $1,277         $2,280
   IPO costs payable                                1,071           --
   Professional services                              206          1,157
   Other                                              846          1,825
                                                   ------         ------
                                                   $3,400         $5,262
                                                   ======         ======
</TABLE>



                                      -9-

<PAGE>   21

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS


(4)      FEATURE FILM AND CD-ROM PRODUCTION

         Feature Film Agreement

         In 1991, Pixar entered into a feature film agreement with Walt Disney
Pictures, a wholly owned subsidiary of the Walt Disney Company (together with
its subsidiaries and affiliates collectively referred to herein as "Disney") to
develop and produce up to three computer animated feature films (the Feature
Film Agreement). Pixar is entitled to receive compensation based on revenue from
the distribution of animated feature films and related products. The first
feature film, Toy Story, was in production as of December 31, 1994, and released
in November 1995. The second and third feature films, and a made-for-home video
sequel to Toy Story were in development as of December 31, 1996. On February 24,
1997, Pixar and Disney entered into a co-production agreement which will now
govern the second and third feature films, three additional films, and
made-for-home video sequels (see Note 11).

         Under the terms of the Feature Film Agreement, Disney funded each
motion picture produced up to the total budgeted film costs. Costs incurred by
Pixar, inclusive of salaries and overhead, were billed to Disney and reimbursed
on a current basis.  All payments to Pixar from Disney for costs of feature film
production have been recorded as cost reimbursements; accordingly, no revenues
have been recorded for such reimbursements; rather, Pixar has netted the
reimbursements against the related costs.  The Feature Film Agreement provided
that, in the event that production costs for the motion picture exceeded the
total budget, Disney would pay a specified amount of the over budget costs (a
portion of which has since been deducted from Pixar's Toy Story film revenue)
plus all over budget costs that were preapproved in writing by a Disney
executive. Pixar was obligated to fund unapproved production cost overages in
excess of that specified amount, but was entitled to recover any overages that
it had funded if the motion picture met certain criteria.

         As of December 31, 1995, total film production costs incurred exceeded
budget by approximately $9,300,000, a portion of which was assumed by Disney, as
defined above. Pixar's portion of the film production cost overage incurred,
approximately $3,300,000, and amortization of deferred compensation were
capitalized as film production costs as of December 31, 1995. During the year
ended December 31, 1996, Pixar's portion of the film production cost overage was
reduced by $1,000,000. Additional costs capitalized as film production costs
during the year ended December 31, 1996, included additional amortization of
deferred compensation, participation fees related to the first feature film, and
costs related to additional films in process. Based on the individual film
forecast method, substantially all of the film production costs capitalized
related to the first feature film will be substantially amortized by December
31, 1997. Film production costs capitalized related to additional films in
process will be amortized when the respective films are released.

         The total film production costs and related amounts capitalized are as
follows (in thousands):
<TABLE>
<CAPTION>
                                                                 Year ended                            Total as of
                                                                 December 31,                          December 31,

                                               1992       1993       1994      1995        1996               1996
                                               ----       ----       ----      ----        ----               ----
<S>                                            <C>         <C>       <C>       <C>          <C>         <C>
Released film:

Disney production costs (unaudited)            $   382     $5,006    $5,299    $  8,158     $   754     $     19,599
Pixar reimbursed film production costs             585      1,899     2,570       3,015          53            8,122
                                               ----------------------------------------------------     ------------
Total film production costs (unaudited)        $   967     $6,905     $7,869    $11,173     $   807           27,721
                                               ====================================================
Disney reimbursements of budgeted costs
      and approved overages (unaudited)                                                                      (25,396)
Amortization of deferred compensation                                                                            336
Participation fees                                                                                               350
Amortization of film production costs                                                                         (1,551)
                                                                                                        ------------
Total film production costs capitalized
     for released film                                                                                         1,460
                                                                                                        ------------
</TABLE>


                                      -10-

<PAGE>   22

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS




<TABLE>
<CAPTION>
                                                                                  Year ended              Total as of
                                                                                  December 31,            December 31,

                                                                               1995        1996               1996
                                                                               ----        ----               ----
<S>                                                                         <C>         <C>              <C>
Films in process:


Disney production costs (unaudited)                                          $   903     $ 5,996                 6,899

Pixar reimbursed film production costs                                         1,904      11,786                13,690
                                                                             -------------------          ------------
Total film production costs (unaudited)                                      $ 2,807     $17,782                20,589
                                                                             ===================
Disney reimbursements of budgeted costs
      and approved overages (unaudited)                                                                        (19,099)
                                                                                                          ------------
Total film production costs capitalized
     for films in process                                                                                        1,490
                                                                                                          ------------

Total film production costs capitalized                                                                   $      2,950
                                                                                                          ============
</TABLE>



    The reimbursements receivable from Disney for the first feature film were
$220,000 as of December 31, 1995, and are included in other receivables on the
accompanying balance sheet. There were no reimbursements receivable for the
first film as of December 31, 1996. The reimbursements receivable from Disney
for the second film were $943,000 and $1,313,000 as of December 31, 1995 and
1996, respectively, and are included in other receivables on the accompanying
balance sheet. The reimbursement receivable from Disney for the made-for-home
video sequel to the first feature film was $617,000 as of December 31, 1996,
which is included in other receivables on the accompanying balance sheet.

    Pixar was obligated to pay 5% of its compensation based on revenue from the
distribution of the first feature film up to $350,000 to a third party in
consideration for services rendered.

    CD-ROM Agreement

         Pixar has entered into an agreement with Disney to develop and produce
interactive CD-ROM titles based on the first motion picture. Disney pays Pixar a
development fee for the development of the titles and Pixar is entitled to
receive a per-unit royalty on sales of the CD-ROM titles after a certain minimum
number of units has been sold. Pixar recognized $3,009,000 of royalties from
sales of CD-ROM titles for the year ended December 31, 1996. Amounts
required to develop the titles in excess of the development fees are funded by
Pixar and are recorded as research and development fees, unless Disney agrees to
provide additional fees. Total development fees recorded as an offset in
research and development pursuant to this agreement were $3,011,000 for the year
ended December 31, 1996.

(5)      PATENT LICENSING ARRANGEMENTS

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

         For the year ended December 31, 1996, fees of $9,100,000 were
recognized with respect to the licensing of certain patents. The Company
delivered all rights to utilize the technology underlying the license to the
licensee, and received a nonrefundable fixed-fee cash payment of $6,000,000 and
$5,000,000 in the form of credits for products to be purchased from the licensee
by Pixar over the next four years. Following the release of the rights to
utilize the patents to the licensee, Pixar maintained no significant vendor
obligations to the licensee, so the Company recognized as revenue the fixed and
determinable amounts of the $6,000,000 cash payment received, plus $3,127,000
that represents the portion of the credits Pixar has used in the year ended
December 31, 1996.



                                      -11-

<PAGE>   23

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS



(6)      RELATED PARTY TRANSACTIONS

         Notes Payable to Shareholder

         Pixar had a note payable upon demand to its majority shareholder
amounting to $1,137,000 as of December 31, 1994, bearing simple interest of 10%.
Interest expense related to the note was $113,000 for 1994. The note, plus
accrued interest of $474,000, was converted to common stock in 1995.

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

         Note Receivable from Shareholder

         In 1995, Pixar loaned $200,000 to an employee and shareholder, due in
May 1998. The note was secured by certain assets, included an interest rate of
6.62% compounded annually, and was included in other assets on the accompanying
balance sheet as of December 31, 1995. During the year ended December 31, 1996,
the note and accrued interest was paid in full.

(7)      INCOME TAXES

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

         The pro forma provisions for income taxes reflect the income tax
expense that would have been reported if Pixar had been a C corporation. The
components of income taxes are as follows (in thousands):

<TABLE>
<CAPTION>
                                                            Year ended
                                                           December 31,

                                       1994                     1995                   1996
                                 -------------------    --------------------    -------------------
                                   (Pro Forma)              (Pro Forma)              (Actual)
                                                (Unaudited)

<S>                                <C>                     <C>                     <C>
Income taxes:
     Current:
     Federal                       $            --         $            69         $          620
     State                                       1                      21                  1,286
                                   ---------------         ---------------         --------------
        Total income taxes         $             1         $            90         $        1,906
                                   ===============         ===============         ==============
</TABLE>



         The following tabulation reconciles the statutory corporate federal
income tax expense (benefit) (computed by multiplying Pixar's income (loss)
before income taxes by 34%) to Pixar's pro forma or actual income tax expense
(in thousands):

<TABLE>
<CAPTION>
                                                                     Year ended
                                                                    December 31,

                                                         1994           1995            1996
                                                     -------------   ---------      ------------
                                                      (Pro Forma)   (Pro Forma)       (Actual)
                                                             (Unaudited)
<S>                                                     <C>            <C>            <C>
Expected income tax expense (benefit)                   $(806)         $ 594          $ 9,257
State income taxes, net of federal  tax effect              1             14            1,286
Unutilized net operating losses                           806             --               --
Change in beginning of year valuation allowance            --           (539)          (9,261)
Alternative minimum tax                                    --             --               37
Other, net                                                 --             21              587
                                                        -----          -----          -------
        Income taxes                                    $   1          $  90          $ 1,906
                                                        =====          =====          =======
</TABLE>



                                      -12-

<PAGE>   24
                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS



         The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets are presented below (in thousands):
<TABLE>
<CAPTION>
                                                         December 31,
                                                    1995              1996
                                                  --------          --------
<S>                                               <C>               <C>
Deferred tax assets:
   Reserves and accruals                          $  1,496          $  2,113
   Net operating loss carryforwards                 13,603             7,749
   Credit carryforwards                                637               748
                                                  --------          --------
      Total gross deferred  tax assets              15,736            10,610
   Valuation allowance                             (15,736)          (10,610)
                                                  --------          --------
      Net deferred tax assets                       $   --            $   --
                                                  ========          ========
</TABLE>

         Pixar has a valuation allowance as of December 31, 1996, which fully
offsets its gross deferred tax assets due to the Company's historical losses and
the fact that there is no guarantee the Company will generate sufficient taxable
income in the future to be able to realize any or all of the deferred tax
assets.

         Included in the deferred tax assets above is approximately $4,000,000
related to stock option compensation for which the benefit when realized will be
an adjustment to equity. As of December 31, 1996, Pixar had net operating loss
carryforwards from pre-S corporation years of approximately $23,000,000 for
federal income tax purposes. Pixar has research credit carryforwards of
approximately $400,000 and $50,000 for federal and California income tax
purposes, respectively. In addition, Pixar has alternative minimum tax credit
carryforwards for federal and California tax purposes of approximately $320,000
and $50,000, respectively. If not utilized, the federal and California
carryforwards will expire in years 2002 through 2011.

(8)      SHAREHOLDERS' EQUITY

         Recapitalization and Stock Split

         As of December 31,1994, Pixar had 100,000 shares of common stock
authorized, 20,000 shares of common stock issued and outstanding, and no
preferred stock authorized, issued and outstanding. In April 1995, the sole
shareholder approved the recapitalization of Pixar, whereby the 20,000 shares of
common stock then outstanding and a note payable to the sole shareholder (see
the second paragraph of Note 6 above) were converted into 9,999,999 shares of
Series A preferred stock and 10,000,002 shares of common stock.

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

         Initial Public Offering

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

         Deferred Compensation

         Pixar has recorded deferred compensation of $3,680,000 for the
difference between the grant price and the deemed fair value of the common stock
underlying certain options granted in 1995. This amount is being amortized over
the vesting period of the individual options, generally four years. Amortization
of deferred compensation was approximately $1,419,000 for the year ended
December 31, 1995, $292,000 of which was capitalized as film production costs
and $1,127,000 of which was expensed. For the year ended December 31, 1996,
amortization of deferred compensation was approximately $1,212,000, $44,000 of
which was capitalized as film production costs and $1,168,000 of which was
expensed.


                                      -13-

<PAGE>   25

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS


        Stock Option Plans

        As of December 31, 1996, the Company has two stock option plans, which
are described below.

1995 Stock Plan

        Pixar has reserved 13,000,000 shares of common stock for issuance under
the 1995 Stock Plan (the Plan), as approved in October 1995. The Plan provides
for stock options to be granted to employees and consultants at an exercise
price not less than 100% of the fair market value (110% of fair value in certain
instances), at the grant date, as determined by the Board of Directors or a
committee of the Board of Directors, for incentive stock options; at prices
determined by the Board of Directors or a committee of the Board of Directors
for nonstatutory stock options; and at prices and terms determined by the Board
of Directors or a committee of the Board of Directors for stock purchase rights.
All options are to have a term not greater than 10 years from the date of grant.
The Board of Directors or a committee of the Board of Directors determines the
number of shares for which an option may be granted. Options issued generally
vest 25% after one year and then ratably 1/48 per month thereafter.

1995 Director Option Plan

        Pixar has reserved 200,000 shares of common stock for issuance under the
1995 Director Option Plan. The Director Option Plan provides for the automatic
grant of nonstatutory options to nonemployee directors (eligible directors) of
Pixar. Each eligible director will be granted an option to purchase 30,000
shares of common stock on the date on which the optionee first becomes a
director of Pixar. One-third of the options will vest one year after their date
of grant and an additional one-third at the end of each year thereafter. On the
third and subsequent anniversaries of a nonemployee director's first becoming a
director, that director is automatically granted an option to purchase an
additional 10,000 shares of common stock that will vest in full one year after
the date of the respective grant.

        The Company applies APB Opinion No. 25 and related interpretations in
accounting for its plans. Accordingly, no compensation cost, except for the
$3,680,000 of deferred compensation and subsequent amortization, has been
recognized for its fixed stock options. Had compensation cost for the Company's
two stock option plans been determined consistent with SFAS No. 123, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below (in thousands, except per share data):

<TABLE>
<CAPTION>
                                           1995                  1996
                                        -----------          -----------
<S>                                      <C>                  <C>
Net Income:
           As reported                   $  1,627             $  25,319
           Pro Forma                     $    880             $  24,017


Earnings per share:
           As reported                   $   0.04             $    0.54
           Pro Forma                     $   0.02             $    0.51
</TABLE>



        The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants: 1995 - zero dividend yield, expected volatility of
50 percent, risk-free interest rates of 5.90 percent, and weighted-average
expected life of 2.42 years; 1996 - zero dividend yield, expected volatility of
50 percent, risk-free interest rate of 6.06 percent, and weighted-average
expected life of 3.52 years.

        The effects of applying SFAS No. 123 in this pro forma disclosure is not
indicative of the effects on reported results for future years. SFAS No. 123
does not apply to awards prior to 1995, and additional awards in future years
are anticipated.



                                      -14-

<PAGE>   26

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS




        A summary of the status of the Company's two fixed stock option plans as
of December 31, 1995 and 1996, is as follows:

<TABLE>
<CAPTION>
                                                      1995                                 1996
                                         -------------------------------    -------------------------------------
                                                       Weighted-average                      Weighted-average
                                            Shares      exercise price         Shares         exercise price
                                            ------      --------------         ------         --------------
<S>                                       <C>           <C>                 <C>                 <C>
Outstanding at beginning of year                --      $        --          9,140,900          $    1.00

Granted                                   10,641,400             0.89        1,297,000              15.18

Exercised                                 (1,386,500)            0.20       (1,126,602)              0.20

Forfeited                                   (114,000)            0.20         (447,458)             15.79
                                         -----------                        ----------

Outstanding at end of year                 9,140,900    $        1.00        8,863,840          $    2.41
                                         ===========                        ==========


Options exercisable at year-end            2,282,251                         3,878,682               0.96
                                         ===========                        ==========

Weighted-average fair value of           $      0.31                        $     6.51
                                         ===========                        ==========
options granted during the year
</TABLE>


        The following table summarizes information about fixed stock options
outstanding as of December 31, 1996:

<TABLE>
<CAPTION>

                                 Options Outstanding                                Options Exercisable
                     ----------------------------------------------------   --------------------------------
                       Number of   Weighted-average          Weighted-         Number of       Weighted-
                        options       remaining          average exercise       options     average exercise
 Exercise Prices      outstanding  contractual life            price          outstanding       price
 ---------------      -----------  ----------------            -----          -----------       -----
<C>                    <C>               <C>                  <C>              <C>             <C>
$           0.20       7,006,365         8.35                 $ 0.20           3,502,741       $ 0.20

$ 1.25 to $ 9.60         843,350         8.79                   7.35             344,597         7.79

$10.80 to $15.00         738,125         9.49                  12.56              31,344        10.94

$15.38 to $19.00         276,000         9.80                  16.25                --           --
                       ---------                                               ---------

$0.20 to $19.00        8,863,840         8.53                 $ 2.41           3,878,682       $ 0.96
                       =========                                               =========
</TABLE>


         Employee Benefit Plans

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



                                      -15-

<PAGE>   27

                                     PIXAR

                         NOTES TO FINANCIAL STATEMENTS



(9)     COMMITMENTS

         Future minimum lease payments under noncancelable operating leases
(with initial or remaining lease terms in excess of one year) as of December 31,
1996, were as follows (in thousands):
<TABLE>
<CAPTION>
Year ending
December 31,
------------
<S>                                     <C>
     1997                               $ 1,922
     1998                                 2,388
     1999                                 2,175
     2000                                 1,486
     2001                                   267
                                        -------
Total minimum lease payments            $ 8,238
                                        =======
</TABLE>

         Rental expense from operating leases amounted to approximately
$887,000, $925,000 and $1,236,000 for the years ended December 31, 1994, 1995,
and 1996, respectively.

(10)     SIGNIFICANT CUSTOMERS AND SEGMENT REPORTING

         The following table summarizes the annual percentage contribution to
revenues by customers when revenues from such customers exceeded 10% of total
revenues in 1994, 1995 and 1996, and the amounts due from these customers as a
percentage of total accounts receivable at the corresponding year-end:

<TABLE>
<CAPTION>
                                              Percentage of Total                          Percentage of Total
                                                    Revenues                            Accounts Receivable as of
                                            Year Ended December 31,                           December 31,

                                         1994         1995         1996               1994        1995         1996
                                    ----------------------------------------     ---------------------------------------
<S>                                      <C>          <C>          <C>                <C>         <C>          <C>
J. Walter Thompson USA, Inc.             13%          ---          ---                ---         ---          ---
Eastman Kodak Company                    11%          ---          ---                16%         ---          ---
Microsoft Corporation                    ---          54%          ---                ---         ---          ---
Disney                                   ---          ---          65%                ---         ---          34%
Silicon Graphics, Inc.                   ---          ---          24%                ---         ---          ---
</TABLE>



                                      -16-

<PAGE>   28

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS



         Pixar operates principally in three business segments: software,
animation services, and film. Financial information relating to business
segments follows (in thousands):
<TABLE>
<CAPTION>
                                             Year Ended December 31,
                                       1994             1995            1996
                                    ---------        ---------        --------
<S>                                 <C>              <C>              <C>
Revenues:
   Software                         $   3,323        $   3,144        $  6,306
   Animation services                   2,267            2,469           3,947
   Film                                  --               --            18,847
   Corporate  and other                  --              6,500           9,127
                                    ---------        ---------        --------
                                    $   5,590        $  12,113        $ 38,227
                                    =========        =========        ========

Income (loss) from operations:
   Software                         $  (2,416)       $    (495)       $  1,587
   Animation services                      63              (55)            302
   Film                                  (484)          (3,826)          9,308
   Corporate  and other                  --              5,407           7,997
                                    ---------        ---------        --------
                                    $  (2,837)       $   1,031        $ 19,194
                                    =========        =========        ========

Depreciation expense:
   Software                         $     111        $     125        $    176
   Animation services                     153              158              95
   Film                                    35              104             251
   Corporate  and other                    75               80             210
                                    ---------        ---------        --------
                                    $     374        $     467        $    732
                                    =========        =========        ========
Capital expenditures:
   Software                         $      70        $     317        $    942
   Animation services                     300              133              51
   Film                                   207              340           1,694
   Corporate  and other                    12              178           1,149
                                    ---------        ---------        --------
                                    $     589        $     968        $  3,836
                                    =========        =========        ========
Identifiable assets:
   Software                         $     784        $   1,104        $  3,832
   Animation services                     485              769             627
   Film                                   389            5,534           6,882
   Corporate  and other                   238          145,608         166,122
                                    ---------        ---------        --------
                                    $   1,896        $ 153,015        $177,463
                                    =========        =========        ========
</TABLE>
(11)     SUBSEQUENT EVENTS

         On February 24, 1997 Pixar and Disney entered into a co-production
agreement (Co-Production Agreement) pursuant to which Pixar, on an exclusive
basis, will produce five computer animated feature-length theatrical motion
pictures (the Pictures) for distribution by Disney over approximately the next
ten years. Pixar and Disney will co-own and co-brand the Pictures, and
co-finance the production costs. Pixar and Disney will share equally in the
profits of each Picture and any related merchandise and other ancillary
products, after recovery of certain costs. The Co-Production Agreement generally
provides that Pixar will produce each Picture and Disney will control all
decisions relating to marketing, promotion, publicity, advertising and
distribution of each Picture.

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

         The Co-Production Agreement provides Pixar with the option to produce
and co-finance any future CD-ROM or interactive products based on the Pictures
and to share equally in the profits, after recovery of marketing and
distribution costs.  However, after entering into the Co-Production Agreement,
Pixar made a decision to discontinue its business of producing CD-ROM
and other interactive products and to devote related resources to
other projects arising from the Co-Production Agreement.  The CD-ROM and
interactive products division reported revenues of $-0- and $3,009,000 in 1995
and 1996, respectively, and losses from operations of $1,830,000 and $1,101,000
in 1995 and 1996, respectively.  The CD-ROM and interactive products division
will be recorded as discontinued operations during the first quarter of 1997.



                                      -17-
<PAGE>   29

                                     PIXAR

                          NOTES TO FINANCIAL STATEMENTS



         In connection with the Co-Production Agreement, Pixar sold to Disney
1,000,000 shares of Pixar Common Stock which Disney has agreed to hold for at
least three years. Pixar also granted two warrants to Disney: one warrant to
purchase 750,000 shares of Common Stock at an exercise price of $20.00 per
share, and another warrant to purchase 750,000 shares of Common Stock at an
exercise price of $25.00 per share. Pixar granted certain registration rights
for the shares issuable upon exercise of the warrants. Gross proceeds on the
transaction were $15,000,000.


                                      -18-