10-Q 1 e10-q.txt METACREATIONS CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the quarterly period ended June 30, 2000 or [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the transition period from to . ----------- -------------- Commission file number 0-27168 METACREATIONS CORPORATION (Exact name of registrant as specified in its charter) Delaware 95-4102687 (State of incorporation) (I.R.S. Employer Identification Number)
498 Seventh Ave., Suite 1810, New York, NY 10018 (Address of principal executive offices) (646) 485-9100 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of August 14, 2000, there were outstanding 28,250,869 shares of the registrant's Common Stock, $0.001 par value per share, which is the only outstanding class of common or voting stock of the registrant. 1 2 METACREATIONS CORPORATION FORM 10-Q Table of Contents
Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements.................................................... 3 Consolidated Balance Sheets - June 30, 2000 and December 31, 1999 (unaudited and restated) Consolidated Statements of Operations - Three and six month periods ended June 30, 2000 and 1999 (unaudited and restated) Consolidated Statements of Cash Flows - Six month periods ended June 30, 2000 and 1999 (unaudited and restated) Notes to Consolidated Financial Statements (unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................... 15 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K........................................ 33 SIGNATURES ........................................................................ 34
On August 8, 2000, the Company announced that it would restate its consolidated financial statements for the three months ended March 31, 2000 and for the year ended December 31, 1999. The restated financial information and related disclosures have been included in the amended Form 10-K/A filing for the year ended December 31, 1999 and the amended Form 10-Q/A filing for the quarter ended March 31, 2000, which were filed with the Securities and Exchange Commission on August 21, 2000. 2 3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements METACREATIONS CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
JUNE 30, DECEMBER 31, 2000 1999 -------------------------------- (Unaudited) (Restated) ASSETS Current assets: Cash and cash equivalents............................................. $ 20,510 $ 4,480 Short-term investments................................................ 18,073 32,836 Accounts receivable, net.............................................. 7 123 Notes receivable from related parties................................. -- 1,000 Prepaid expenses...................................................... 266 1,139 Current assets of discontinued operations............................. 10,328 4,702 -------------------------------- Total current assets.............................................. 49,184 44,280 Property and equipment, net.............................................. 2,433 614 Other assets............................................................. 248 308 Non-current assets of discontinued operations............................ 157 1,974 -------------------------------- Total assets...................................................... $ 52,022 $ 47,176 ================================ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable...................................................... $ 1,722 $ 224 Accrued expenses...................................................... 1,584 1,985 Current liabilities of discontinued operations........................ 968 9,178 Provision for loss on disposal of discontinued operations............. 211 2,653 -------------------------------- Total current liabilities......................................... 4,485 14,040 Mandatorily redeemable preferred stock of subsidiary..................... 15,574 -- Minority interest........................................................ 10,399 6,633 Stockholders' equity: Preferred stock, $.001 par value, 5,000 shares authorized - no shares issued and outstanding at June 30, 2000 and December 31, 1999, respectively..................................... -- -- Common stock, $.001 par value; 75,000 shares authorized - 27,985 and 25,496 shares issued and outstanding at June 30, 2000 and December 31, 1999, respectively................... 28 25 Paid-in capital....................................................... 133,232 119,940 Notes receivable from related parties................................. (4,967) (3,467) Deferred compensation................................................. (1,540) -- Accumulated other comprehensive loss.................................. -- (137) Accumulated deficit................................................... (105,189) (89,858) -------------------------------- Total stockholders' equity........................................ 21,564 26,503 -------------------------------- Total liabilities and stockholders' equity........................ $ 52,022 $ 47,176 ================================
The accompanying notes are an integral part of these consolidated financial statements. 3 4 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------------------ ------------------------------------ 2000 1999 2000 1999 ------------------------------------ ------------------------------------ (Unaudited) (Unaudited and (Unaudited) (Unaudited and Restated) Restated) Net revenues........................................... $ 155 $ 15 $ 317 $ 2,278 Operating expenses: Sales and marketing (excluding stock based compensation totaling $1,094 for three months ended June 30, 2000 and $3,648 for six months ended June 30, 2000).............................. 8,764 354 10,114 758 Research and development (excluding stock based compensation totaling $594 for three months ended June 30, 2000 and $1,573 for six months ended June 30, 2000).............................. 1,078 670 2,027 1,229 General and administrative (excluding stock based compensation totaling $1,459 for three months ended June 30, 2000 and $1,782 for six months ended June 30, 2000).............................. 983 1,084 2,083 2,086 Stock-based compensation............................ 3,147 -- 7,003 -- ------------------------------------ ------------------------------------ Total operating expenses............................... 13,972 2,108 21,227 4,073 ------------------------------------ ------------------------------------ Loss from operations................................... (13,817) (2,093) (20,910) (1,795) Other income........................................... 466 528 987 1,085 ------------------------------------ ------------------------------------ Loss before provision for income taxes................. (13,351) (1,565) (19,923) (710) Provision for income taxes............................. -- -- -- -- ------------------------------------ ------------------------------------ Loss before minority interest in loss of subsidiary.... (13,351) (1,565) (19,923) (710) Minority interest in loss of subsidiary................ 2,642 -- 3,327 -- ------------------------------------ ------------------------------------ Net loss from continuing operations.................... (10,709) (1,565) (16,596) (710) Discontinued operations (Note 3): Loss from discontinued operations................... -- (1,296) -- (3,243) Adjustment to loss on disposal of discontinued operations........................................ -- -- 1,265 -- ------------------------------------ ------------------------------------ Net income (loss) from discontinued operations.. -- (1,296) 1,265 (3,243) ------------------------------------ ------------------------------------ Net loss............................................... $ (10,709) $ (2,861) $ (15,331) $ (3,953) ==================================== ==================================== Basic and diluted net loss per common share: Net loss per common share from continuing operations........................................ $ (0.39) $ (0.07) $ (0.61) $ (0.03) Net income (loss) per common share from discontinued operations........................... -- (0.05) 0.05 (0.13) ------------------------------------ ------------------------------------ Net loss per common share....................... $ (0.39) $ (0.12) $ (0.56) $ (0.16) ==================================== ==================================== Weighted average number of shares outstanding - basic and diluted................................... 27,629 24,448 27,216 24,387 ==================================== ====================================
The accompanying notes are an integral part of these consolidated financial statements. 4 5 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
SIX MONTHS ENDED JUNE 30, --------------------------------- 2000 1999 --------------------------------- (Unaudited) (Unaudited and Restated) Cash flows from operating activities: Net loss.............................................................. $ (15,331) $ (3,953) Adjustments to reconcile net loss to net cash used in operating activities: Net (income) loss of discontinued operations...................... (1,265) 3,243 Amortization of deferred compensation............................. 7,003 -- Depreciation and amortization..................................... 391 316 Minority interest in loss of subsidiary........................... (3,327) -- Non-cash sales and marketing expense.............................. 5,749 -- Accrued interest income........................................... -- (88) Changes in operating assets and liabilities: Accounts receivable............................................. 116 811 Prepaid expenses and other assets............................... 758 387 Accounts payable and accrued expenses........................... 1,405 4 Net cash used for discontinued operations....................... (12,983) (4,269) --------------------------------- Net cash used in operating activities......................... (17,484) (3,549) Cash flows from investing activities: Purchases of short-term investments................................... (37,754) (39,019) Proceeds from sales and maturities of short-term investments.......... 52,517 34,130 Repayment of notes receivable from related parties.................... 1,000 122 Purchases of property and equipment................................... (2,035) (34) Net cash used for discontinued operations............................. (84) (2,888) --------------------------------- Net cash provided by (used in) investing activities........... 13,644 (7,689) Cash flows from financing activities: Issuance of notes receivable from related parties..................... (1,500) (100) Issuance of preferred stock in subsidiary, net of issuance costs of $175................................................................ 9,825 -- Collection of subscription receivable related to common stock of subsidiary.......................................................... 1,000 -- Proceeds from exercise of stock options............................... 10,537 324 --------------------------------- Net cash provided by financing activities..................... 19,862 224 Effect of exchange rates changes on cash................................. 8 (7) --------------------------------- Net increase (decrease) in cash and cash equivalents..................... 16,030 (11,021) Cash and cash equivalents at beginning of period......................... 4,480 16,297 --------------------------------- Cash and cash equivalents at end of period............................... $ 20,510 $ 5,276 =================================
The accompanying notes are an integral part of these consolidated financial statements. 5 6 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying unaudited consolidated financial statements include the accounts of MetaCreations Corporation and its subsidiaries (collectively "MetaCreations" or the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statement presentation. In the opinion of management, the accompanying consolidated balance sheets and related interim consolidated statements of operations and cash flows include all adjustments (consisting only of normal recurring items) considered necessary for their fair presentation. 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, liabilities, revenues and expenses. Actual results could differ from those estimates. The consolidated results of operations for the period ended June 30, 2000 are not necessarily indicative of results to be expected for the year ending December 31, 2000. The information included in this Form 10-Q should be read in conjunction with the Company's audited consolidated financial statements and notes thereto as of December 31, 1999 and 1998, and for the three years in the period ended December 31, 1999, as filed on Form 10-K/A. Concentration of Risk In connection with the sale of the MetaCreations' Painter, Kai's Power Tools, KPT Vector Effects and Bryce product lines (see Note 3), the Company has an outstanding note receivable from Corel Corporation ("Corel") in the amount of $8,000,000 at June 30, 2000. This note receivable, which is payable within one year, has been classified as a current asset of discontinued operations in the accompanying balance sheets. In a July 2000 press release, Corel announced that it would run out of cash by the end of August 2000 if it did not take special action. As of August 18, 2000, the Company has collected $4,000,000 of the original $10,000,000 promissory note, which is in accordance with the payment schedule. The Company has not provided a reserve for the remaining $6,000,000, as management believes such amount is collectible. 6 7 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Deferred Compensation In connection with the issuance of 200,000 shares of restricted common stock of MetaCreations Corporation to an officer of the Company, the Company recorded deferred compensation of approximately $1,625,000 during the three months ended June 30, 2000. This deferred compensation, which is being amortized over four years, represented the fair value of the common stock at the date of issuance. Stock-based compensation expense of $85,000 was recognized during the three months ended June 30, 2000. Mandatorily Redeemable Preferred Stock of Subsidiary In June 2000, Metastream Corporation issued 1,500,000 shares of Series A Convertible Preferred Stock to America Online, Inc. ("AOL") for cash consideration totaling $10,000,000. Each share of Series A Convertible Preferred Stock may be exchanged, at AOL's option, into the number of shares of MetaCreations' common stock as is equal to $6.67 divided by the exchange price in effect at the time of exchange (the "Exchange Price"). The Exchange Price is calculated as 87% of the lesser of (a) $6.67 or (b) the average closing price of MetaCreations common stock over the 15 day period prior to the date that AOL submits notice of its exercise of the option. In the event of a merger of Metastream Corporation into MetaCreations, each share of Series A Convertible Preferred Stock may be exchanged by MetaCreations, at MetaCreations' option, into the number of shares of MetaCreations common stock as is equal to the greater of (a) $6.67 divided by the exchange price in effect at the time of exchange (the "Merger Exchange Price") or (b) the number of shares that AOL would have received if it continued to hold the preferred shares but exercised its rights to convert the preferred shares immediately prior to the merger. The Merger Exchange Price is calculated as 87% of the lesser of (a) $6.67 or (b) the average closing price of MetaCreations common stock over the 15 day period prior to the date that the MetaCreations enters into arrangements for the combination of the two companies. In connection with the issuance of the shares of Series A Convertible Preferred Stock to AOL, the Company recorded a one-time non-cash sales and marketing charge of $5,749,000 related to the difference between the fair value of the MetaCreations common shares into which AOL could have converted the Metastream preferred shares on the date of issuance and the $10,000,000 cash consideration paid by AOL. The Series A Convertible Preferred Stock held by AOL also contains a put right (the "Put Right") whereby AOL may require the Company to purchase the preferred shares at a price equal to the original purchase price paid by AOL, plus interest. The Put Right expires on June 12, 2002. The Series A Convertible Preferred Stock has been classified as mandatorily redeemable preferred stock of subsidiary in the Company's consolidated balance sheets. Minority Interest For financial reporting purposes, the assets, liabilities and earnings of Metastream Corporation are included in the Company's consolidated financial statements. Cash receipts assigned to Computer Associates purchase of a 20% interest in Metastream Corporation are included in minority interest in the Company's consolidated balance sheets. Computer Associates 20% interest in Metastream Corporation has been recorded as minority interest in the Company's 7 8 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) consolidated balance sheets, and the losses attributed to their 20% interest have been reported as minority interest in the Company's consolidated statements of operations. In connection with the grant of stock options of Metastream Corporation to certain employees and non-employee directors, Metastream Corporation recorded deferred compensation of $7,334,000 and $21,818,000 for the three and six month periods ended June 30, 2000, respectively. Minority interest in the Company's consolidated balance sheets is credited with its proportionate interest in stock-based compensation that is recognized. Stock-based compensation expense of $3,147,000 and $6,918,000 was recognized during the three and six month periods ended June 30, 2000, respectively. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No, 133, "Accounting for Derivative Instruments and Hedging Activities," which established accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. To date, we have not engaged in derivative and hedging activities. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," which gives additional guidance in applying generally accepted accounting principles to revenue recognition in the financial statements. SAB No. 101 is applicable beginning in the fourth quarter of fiscal 2000. Management does not believe the compliance with the provisions of SAB No. 101 will have a material effect on the accompanying consolidated financial statements. In March 2000, the FASB issued Financial Interpretation ("FIN") No. 44, "Accounting for Certain Transactions Involving Stock Compensation," which is an interpretation of Accounting Principal Board Opinion ("APB") No. 25. This interpretation clarifies: - The definition of employee for purposes of applying APB No. 25, which deals with stock compensation issues; - The criteria for determining whether a plan qualifies as a noncompensatory plan; - The accounting consequence of various modifications to the terms of a previously fixed stock option or award; and - The accounting for an exchange of stock compensation awards in a business combination. The interpretation is effective July 1, 2000, but certain conclusions in this interpretation cover specific events prior to such date. The adoption of FIN No. 44 is not expected to have a material impact on our financial statements. 8 9 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 2. RESTATEMENT OF FINANCIAL STATEMENTS On August 8, 2000, the Company announced that it would restate its consolidated financial statements for the three months ended March 31, 2000 and for the year ended December 31, 1999. As discussed in Note 2 to the consolidated financial statements in the Company's Annual Report on Form 10-K/A for the year ended December 31, 1999, the principal reason for the revisions to the December 31, 1999 financial statements was to reallocate the entire $7,000,000 monetary consideration committed by Computer Associates as part of license agreements, and recorded as license revenue in 1999, to minority interest and "change in interest gain" (pursuant to SAB No. 51, "Accounting for Sales of Stock of a Subsidiary") relating to Computer Associates simultaneous agreement to obtain a 20% equity interest in the Company's subsidiary, Metastream Corporation. The "change in interest gain" has been recorded as paid-in capital in the Company's consolidated balance sheets. As part of the restatement of financial statements during the three months ended June 30, 1999, the Company also reclassified $1,920,000 to gain on sale of assets within loss from discontinued operations. This gain was comprised of $2,000,000 previously recorded as license revenue relating to discontinued operations, net of $80,000 previously recorded as other income relating to continuing operations. Additionally, based upon a revised estimate of the valuation of Metastream Corporation at various dates during the year ended December 31, 1999 and during the three months ended March 31, 2000, the Company adjusted its estimate of the fair value of Metastream Corporation at the time of stock option issuances to employees and non-employees resulting in an additional charge of $4,000,000 and $1,841,000 during the three months ended December 31, 1999 and March 31, 2000, respectively, for stock-based compensation associated with stock option grants at exercise prices which were below the fair value of Metastream Corporation stock on the date of grant. The restated financial information and related disclosures have been included in the amended Form 10-K/A filing for the year ended December 31, 1999 and the amended Form 10-Q/A filing for the quarter ended March 31, 2000, which were filed with the Securities and Exchange Commission on August 21, 2000. Accordingly, the unaudited financial statements for the three and six months ended June 30, 1999 presented in this Form 10-Q have been restated as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, 1999 JUNE 30, 1999 --------------------------------------------------- AS AS REPORTED RESTATED REPORTED RESTATED --------------------------------------------------- STATEMENT OF OPERATIONS DATA: Net revenues....................................... $ 3,015 $ 15 $ 5,278 2,278 Income (loss) from operations...................... 907 (2,093) 1,205 (1,795) Income (loss) before provision for income taxes.... 1,355 (1,565) 2,210 (710) Income (loss) before minority interest............. 1,355 (1,565) 2,210 (710) Net income (loss) from continuing operations....... 1,355 (1,565) 2,210 (710) Net income (loss).................................. 139 (2,861) (953) (3,953) Basic and diluted net income (loss) per common share: Net income (loss) per common share from continuing operations....................... 0.06 (0.07) 0.09 (0.03) Net loss per common share from discontinued operations.................................. (0.05) (0.05) (0.13) (0.13) --------------------------------------------------- Net loss per common share................... 0.01 (0.12) (0.04) (0.16)
9 10 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 3. DISCONTINUED OPERATIONS In December 1999, the Board of Directors approved a plan to focus exclusively on its industry-leading, patented marketing visualization solution, Metastream, and to correspondingly divest itself of its prepackaged graphics software business. Accordingly, these operations are reflected as discontinued operations for all periods presented in the accompanying consolidated statements of operations. The loss on disposal of discontinued operations, which totaled approximately $21,260,000 for the year ended December 31, 1999, consisted of the estimated future results of operations of the discontinued business through the estimated date of divestiture, the amounts expected to be realized upon the sale of the discontinued business, severance and related benefits, and asset write-downs (see table below). The Company recorded an adjustment to net loss on disposal of discontinued operations of $1,265,000 during the three months ended March 31, 2000 as a result of better than expected net revenues during the quarter from the discontinued business. During April 2000, the Company completed the sale of a substantial portion of the Company's graphics software product lines. Specifically, Corel Corporation acquired the MetaCreations' Painter, Kai's Power Tools, KPT Vector Effects and Bryce product lines; egi.sys AG acquired the Poser product line; and fractal.com Corporation acquired the Headline Studio product line for total consideration of $11,250,000, consisting of cash and promissory notes, plus future royalties. The $11,250,000 is payable within one year. At June 30, 2000, $8,500,000 is classified as a current asset of discontinued operations in the accompanying consolidated balance sheets. The provision for loss on disposal of discontinued operations is an estimate and subject to change. Changes in estimates will be accounted for prospectively and included in income (loss) from discontinued operations. The following table depicts the loss on disposal of discontinued operations activity through June 30, 2000 (in thousands):
LOSS ON DISPOSAL OF PROVISION AT DISCONTINUED DECEMBER 31, CHARGED TO PROVISION AT OPERATIONS DEDUCTIONS 1999 EXPENSE DEDUCTIONS JUNE 30, 2000 -------------------------------------------------------------------------------------- Write-down of operating assets...................... $ 18,445 $ 18,103 $ 342 $ 1,266 $ 762 $ 846 Severance and benefits........ 8,415 504 7,911 26 7,937 -- Estimated loss of discontinued operations through divesture date...... 5,400 -- 5,400 (2,072) 3,328 -- Estimated net proceeds from divestiture................. (11,000) -- (11,000) (485) (10,850) (635) -------------------------------------------------------------------------------------- $ 21,260 $ 18,607 $ 2,653 $ (1,265) $ 1,177 $ 211 --------------------------------------------------------------------------------------
10 11 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) Operating results from discontinued operations were as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------------------------------------- 2000 1999 2000 1999 ---------------------------------------------------------- (Restated) (Restated) Net revenues............................ $ 699 $ 9,365 $ 5,275 $ 19,170 Cost of revenues........................ 77 1,746 1,066 3,393 ---------------------------------------------------------- Gross profit......................... 622 7,619 4,209 15,777 Operating expenses: Sales and marketing.................. 245 6,587 3,045 12,632 Research and development............. 849 3,492 3,743 6,821 General and administrative........... 413 756 749 1,487 ---------------------------------------------------------- Total operating expenses....... 1,507 10,835 7,537 20,940 ---------------------------------------------------------- Loss before gain on sale of assets...... (885) (3,216) (3,328) (5,163) Gain on sale of assets.................. -- 1,920 -- 1,920 ---------------------------------------------------------- Loss before provision for income taxes.. (885) (1,296) (3,328) (3,243) Provision for income taxes.............. -- -- -- -- ---------------------------------------------------------- Loss from discontinued operations....... $ (885) $ (1,296) $ (3,328) $ (3,243) ==========================================================
11 12 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The net assets of the discontinued operations included in the accompanying consolidated balance sheets consist of the following (in thousands):
JUNE 30, DECEMBER 31, 2000 1999 ------------------------------- (Restated) Current assets of discontinued operations: Notes receivable............................................... $ 8,500 $ -- Accounts receivable, net....................................... 1,804 1,800 Inventories, net............................................... -- 92 Prepaid expenses............................................... 24 2,810 ------------------------------- Current assets of discontinued operations.................... $ 10,328 $ 4,702 =============================== Non-current assets of discontinued operations: Property and equipment, net.................................... $ -- $ 1,574 Other assets................................................... 157 400 ------------------------------- Non-current assets of discontinued operations................ $ 157 $ 1,974 =============================== Current liabilities of discontinued operations: Accounts payable............................................... $ 805 $ 5,631 Accrued expenses............................................... 121 2,824 Royalties payable.............................................. 42 723 ------------------------------- Current liabilities of discontinued operations............... $ 968 $ 9,178 ===============================
4. INCOME TAXES The Company did not provide any current or deferred income tax provision or benefit for any of the periods presented because of its historical operating losses. The Company has provided a full valuation allowance on the deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding its realizability. Utilization of the Company's net operating loss carryforwards, which begin to expire in 2011 for federal purposes and 2001 for state purposes, may be subject to certain limitations under Section 382 of the Internal Revenue Code of 1986, as amended. 12 13 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 5. LOSS PER SHARE The following table provides a reconciliation of the numerators and denominators of the basic and diluted per-share computations for the three and six month periods ended June 30, 2000 and 1999, in accordance with SFAS No. 128, "Earnings per Share" (in thousands, except per share amounts):
LOSS SHARES PER-SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ------------------------------------------------------- Three Months Ended June 30, 2000: Basic EPS...................................$ (10,709) 27,629 $ (0.39) Effect of dilutive securities............... -- -- ------------------------------------- Diluted EPS.................................$ (10,709) 27,629 $ (0.39) ===================================== Three Months Ended June 30, 1999 (Restated): Basic EPS...................................$ (2,861) 24,448 $ (0.12) Effect of dilutive securities............... -- -- ------------------------------------- Diluted EPS.................................$ (2,861) 24,448 $ (0.12) ===================================== Six Months Ended June 30, 2000: Basic EPS...................................$ (15,331) 27,216 $ (0.56) Effect of dilutive securities............... -- -- ------------------------------------- Diluted EPS.................................$ (15,331) 27,216 $ (0.56) ===================================== Six Months Ended June 30, 1999 (Restated): Basic EPS...................................$ (3,953) 24,387 $ (0.16) Effect of dilutive securities............... -- -- ------------------------------------- Diluted EPS.................................$ (3,953) 24,387 $ (0.16) =====================================
Unexercised stock options that were not included in the computation of diluted EPS, because to do so would have been anti-dilutive for the periods presented, are as follows (in thousands). Three Months Ended June 30,: 2000........................................ 2,286 1999........................................ 8,453 Six Months Ended June 30,: 2000........................................ 2,286 1999........................................ 8,453
13 14 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 6. SUBSEQUENT EVENTS Issuance of Series B Mandatorily Redeemable Convertible Preferred Stock of Metastream Corporation to Adobe Corporation On July 18, 2000, Metastream Corporation issued 1,500,000 shares of Series B Convertible Preferred Stock to Adobe Corporation ("Adobe") for cash consideration totaling $10,000,000. Each share of Series B Convertible Preferred Stock may be exchanged, at Adobe's option, into the number of shares of MetaCreations' common stock as is equal to $6.67 divided by the exchange price in effect at the time of exchange (the "Exchange Price"). The Exchange Price is calculated as 87% of the lesser of (a) $6.67 or (b) the average closing price of MetaCreations common stock over the 15 day period prior to the date that Adobe submits notice of its exercise of the option. In the event of a merger of Metastream Corporation into MetaCreations, each share of Series B Convertible Preferred Stock may be exchanged by MetaCreations, at MetaCreations' option, into the number of shares of MetaCreations common stock as is equal to the greater of (a) $6.67 divided by the exchange price in effect at the time of exchange (the "Merger Exchange Price") or (b) the number of shares that Adobe would have received if it continued to hold the preferred shares but exercised its rights to convert the preferred shares immediately prior to the merger. The Merger Exchange Price is calculated as 87% of the lesser of (a) $6.67 or (b) the average closing price of MetaCreations common stock over the 15 day period prior to the date that the MetaCreations enters into arrangements for the combination of the two companies. In connection with the issuance of the shares of Series B Convertible Preferred Stock to Adobe, the Company expects to record a one-time non-cash sales and marketing charge during the three months ended September 30, 2000 related to the difference between the fair value of the MetaCreations common shares into which Adobe could have converted the Metastream preferred shares on the date of issuance and the $10,000,000 cash consideration paid by Adobe. The Series B Convertible Preferred Stock issued to Adobe also contains a put whereby Adobe may require the Company to purchase the preferred shares at a price equal to the original purchase price paid by Adobe, plus interest. The Put Right expires on July 18, 2002. Acquisition of Viewpoint Digital, Inc. On July 24, 2000, the Company announced that it had signed a letter of intent to acquire Viewpoint Digital, Inc. ("Viewpoint Digital"), a wholly-owned subsidiary of Computer Associates that publishes the world's largest library of 3D digital content and provides creative 3D services to thousands of customers in entertainment, advertising, visual simulation, computer-based training and corporate communications. Computer Associates also will retain a license to use the Viewpoint technology. The financial terms of this transaction have not yet been finalized. The Company expects to complete the acquisition during the third quarter of 2000. 14 15 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the unaudited consolidated financial statements and notes thereto. The discussion and analysis below contains trend analysis and other forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. 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 could differ materially from those expressed or forecasted in any such forward-looking statements as a result of certain factors, including those set forth in "Factors That May Affect Future Operating Results," as well as those discussed elsewhere in the Company's SEC reports, including without limitation, the Company's audited consolidated financial statements and notes thereto as of December 31, 1999 and 1998, and for the three years in the period ended December 31, 1999, as filed on Form 10-K/A. OVERVIEW MetaCreations provides marketing visualization solutions for the World Wide Web. MetaCreations' strategy is centered on the Company's Metastream technology and software tools designed to make the interactive use of photo-realistic 3D on the Web practical and pervasive. Metastream Corporation was initially formed as a joint initiative between MetaCreations and Computer Associates in June 1999. In June 2000, Metastream Corporation issued 1,500,000 shares of Series A Mandatorily Redeemable Convertible Preferred Stock to AOL for consideration totaling $10,000,000. In July 2000, Metastream Corporation issued 1,500,000 shares of Series B Mandatorily Redeemable Convertible Preferred Stock to Adobe for consideration totaling $10,000,000. In July 2000, MetaStream Corporation also announced plans to acquire Viewpoint Digital, Inc., a wholly-owned subsidiary of Computer Associates. Viewpoint Digital publishes the world's largest library of 3D digital content and provides creative 3D services to thousands of customers in entertainment, advertising, visual simulation, computer-based training and corporate communications. Metastream Corporation expects to complete this acquisition during the third quarter of 2000. Metastream Corporation is focused on providing complete end-to-end solutions for creating and deploying virtual products centered on the Company's Metastream technologies for e-commerce and the Web environment. Metastream Corporation's primary initiatives include: - Licensing technology for specific marketing visualization solutions; - Providing a full range of fee-based professional services for implementing 3D solutions; - Forging technological alliances with leading interactive agencies and web content providers; and - Maximizing market penetration and name recognition. 15 16 In December 1999, the Board of Directors of MetaCreations approved a plan to focus exclusively on the Company's Metastream technologies, and to correspondingly divest itself of its prepackaged graphics software business. Accordingly, the continuing operations of MetaCreations are focused exclusively on Metastream Corporation. In light of this change in strategic focus, MetaCreations has a limited operating history upon which an evaluation of the Company and its prospects can be based. MetaCreations' prospects must be considered in light of the risks and difficulties frequently encountered by early stage online companies. There can be no assurance that MetaCreations will achieve or sustain profitability. MetaCreations has had significant quarterly and annual operating losses since its inception, and as of June 30, 2000, had an accumulated deficit of approximately $105.2 million. MetaCreations believes that its success will depend largely on its ability to extend its technology and market leadership in e-commerce visualization. Accordingly, MetaCreations intends to invest heavily in research and development and sales and marketing. Net revenues from continuing operations primarily have been from one-time technology licenses from a limited number of strategic partners. In connection with its decision to focus exclusively on e-commerce visualization, the Company has decided to no longer focus on these one-time technology licenses, in favor of implementing a recurring broadcast licensing model. This licensing model is based on Metastream 3.0, which was launched to developers at the end of March 2000 and is expected to be released to the public during the third quarter of 2000. There can be no assurance that this new recurring broadcast licensing model will result in net revenues comparable to those realized in prior years. See "Factors That May Affect Future Operating Results." OPERATING RESULTS Net Revenues The Company recognizes revenue in accordance with Statement of Position ("SOP") 97-2, "Software Revenue Recognition." Accordingly, revenue from software arrangements involving multiple elements (e.g., software products, upgrades/enhancements, postcontract customer support, etc.) is allocated to each element based on the relative fair value of the elements. The determination of fair value is based on objective evidence, which is specific to the Company. Service revenue, which consists of fees for professional services, is recognized as the services are performed or, if no pattern of performance is discernable, on a straight-line basis over the period during which the services are performed. 16 17
THREE MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Net revenues $ 155 933% $ 15
Net revenues of $155,000 for the three months ended June 30, 2000 were related to services performed during the quarter, with 81% of the revenues being attributed to Computer Associates. Historically, net revenues primarily consisted of one-time licenses for Metastream and related technologies from a limited number of strategic partners. In connection with its decision to focus exclusively on e-commerce visualization, the Company decided to no longer focus on these one-time technology licenses, in favor of implementing a recurring broadcast licensing model. This licensing model is based on Metastream 3.0, which was launched to developers at the end of March 2000 and is expected to be released to the public during the third quarter of 2000. No revenue was recorded during the three months ended June 30, 2000 related to the licensing of Metastream 3.0.
SIX MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Net revenues $ 317 (86)% $ 2,278
Net revenues of $317,000 for the six months ended June 30, 2000 were related to services performed during the quarter, with 79% of the revenues being attributed to Computer Associates. Revenues from one-time licenses from Intel Corporation and Computer Associates accounted for 44% and 42% of total revenues, respectively, for the six months ended June 30, 1999. No revenue was recorded during the six months ended June 30, 2000 related to the licensing of Metastream 3.0. There can be no assurance that this new recurring broadcast licensing model will result in the revenue growth rates realized in prior years. Sales and Marketing Sales and marketing expenses consist primarily of salaries, consulting fees, advertising and facilities costs related to sales, marketing, business development, Web services and public relations personnel who promote the Company's products, technologies and services. 17 18
THREE MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Sales and marketing $ 8,764 2,376% $ 354 As % of net revenues 5,654% 2,360%
The 2,376% increase in sales and marketing expenses is primarily due to a one-time non-cash sales and marketing charge of $5.7 million recorded during the three months ended June 30, 2000 related to the difference between the fair value of the MetaCreations common shares into which AOL could have converted the Metastream preferred shares on the date of issuance and the $10.0 million cash consideration paid by AOL. In addition, sales and marketing expenses increased due to increased salaries, travel expenses and recruiting fees related to increased headcount; consulting fees related to the development of a new corporate Web site; and public relations agency fees.
SIX MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Sales and marketing $ 10,114 1,234% $ 758 As % of net revenues 3,191% 33%
Sales and marketing expenses have increased compared to the prior year due to a one-time non-cash sales and marketing charge of $5.7 million recorded during the six months ended June 30, 2000 related to the difference between the fair value of the MetaCreations common shares into which AOL could have converted the Metastream preferred shares on the date of issuance and the $10.0 million cash consideration paid by AOL. In addition, sales and marketing expenses increased due to increased salaries, travel expenses, and recruiting fees related to increased headcount; consulting fees related to the development of a new corporate Web site; public relations agency fees; and other direct expenses related to the launch of Metastream 3.0 at the end of the first quarter of 2000. The Company is continuing to expand its sales and marketing presence and, accordingly, expects sales and marketing expenses will continue to increase in future periods, but such expenses may vary as a percentage of net revenues. In addition, the Company expects to record an additional one-time non-cash sales and marketing charge during the three months ended September 30, 2000 in connection with the issuance of 1,500,000 shares of Series B Convertible Preferred Stock of Metastream Corporation issued to Adobe Corporation in July 2000. 18 19 Research and Development Research and development expenses consist primarily of salaries, consulting fees, and required equipment and facilities costs related to the Company's product development efforts. The Company expenses as incurred research and development costs necessary to establish the technological feasibility of its internally-developed software products and technologies. To date, the establishment of technological feasibility of the Company's products and general release have substantially coincided. As a result, the Company has not capitalized any internal software development costs since costs qualifying for such capitalization have not been significant. Additionally, the Company capitalizes costs of software, consulting services, hardware and payroll-related costs incurred to purchase or develop internal-use software. The Company expenses costs incurred during preliminary project assessment, research and development, re-engineering, training and application maintenance.
THREE MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Research and development $ 1,078 61% $ 670 As % of net revenues 695% 4,467%
The 61% increase in research and development expenses is primarily due to increased salaries, travel and facilities expenses related to increased internal development personnel, in addition to consulting fees in connection with the development of Metastream 3.0.
SIX MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Research and development $ 2,027 65% $ 1,229 As % of net revenues 639% 54%
Research and development expenses have increased compared to the prior year due to increased salaries and travel expenses resulting from increased headcount as well as increased consulting fees. The Company expects research and development expenses will continue to increase in future periods, but such expenses may vary as a percentage of net revenues. General and Administrative General and administrative expenses primarily consist of corporate overhead of the Company, which includes compensation costs related to finance and administration personnel along with other administrative costs such as legal and accounting fees and insurance expense. 19 20
THREE MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) General and administrative $ 983 (9)% $ 1,084 As % of net revenues 634% 7,227%
The 9% decrease in general and administrative expenses was primarily attributed to reduced compensation and related costs associated with fewer administrative personnel.
SIX MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) General and administrative $ 2,083 --% $ 2,086 As % of net revenues 657% 92%
General and administrative expenses have remained consistent compared to the prior year with compensation and related costs decreasing period over period due to fewer administrative personnel, and legal fees increasing period over period as a result of additional patent filings with respect to the Company's technologies. The Company expects general and administrative expenses will continue to increase in future periods, but such expenses may vary as a percentage of net revenues. Stock-based Compensation
THREE MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Stock-based compensation $ 3,147 100% $ -- As % of net revenues 2,030% --%
In connection with the grant of stock options of Metastream Corporation to certain employees and non-employee directors, Metastream Corporation recorded deferred compensation of approximately $7.3 million during the three months ended June 30, 2000. This deferred compensation represented the difference between the deemed fair value of Metastream Corporation common stock for accounting purposes and the exercise price of these options at the date of grant. Stock-based compensation expense of $3.1 million was recognized during the three months ended June 30, 2000. 20 21 In connection with the issuance of 200,000 shares of restricted common stock of MetaCreations Corporation to an officer of the Company, the Company recorded deferred compensation of approximately $1.6 million during the three months ended June 30, 2000. This deferred compensation, which is being amortized over four years, represented the fair value of the common stock at the date of issuance. Stock-based compensation expense of $85,000 was recognized during the three months ended June 30, 2000.
SIX MONTHS ENDED JUNE 30, ------------------------------------------------ 1999 2000 % CHANGE (RESTATED) ------------- ------------------- ------------ (DOLLARS IN THOUSANDS) Stock-based compensation $ 7,003 100% $ -- As % of net revenues 2,209% --%
In connection with the grant of stock options of Metastream Corporation to certain employees and non-employee directors, Metastream Corporation recorded deferred compensation of approximately $21.8 million during the six months ended June 30, 2000. Stock-based compensation expense of $6.9 million was recognized during the six months ended June 30, 2000. In connection with the issuance of 200,000 shares of restricted common stock of MetaCreations Corporation to an officer of the Company, the Company recorded deferred compensation of approximately $1.6 million during the three months ended June 30, 2000. This deferred compensation, which is being amortized over four years, represented the fair value of the common stock at the date of issuance. Stock-based compensation expense of $85,000 was recognized during the six months ended June 30, 2000. Other Income Other income consists of interest and investment income on cash and marketable securities. As a result, other income fluctuates commensurate with changes in the Company's cash and marketable securities balances and market interest rates. The Company expects that its cash and marketable securities balances, as well as other income, will continue to fluctuate in the future due to the timing of the receipt of proceeds from the divestiture of the prepackaged graphics software products and from the exercise of stock options, in addition to cash provided by or used in the operations of the Company. Provision for Income Taxes The Company did not provide any current or deferred income tax provision or benefit for any of the periods presented because of its historical operating losses. The Company has provided a full valuation allowance on the deferred tax assets, consisting primarily of net operating loss carryforwards, because of uncertainty regarding its realizability. Utilization of the Company's net operating loss carryforwards, which begin to expire in 2011 for federal purposes and 2001 for state purposes, may be subject to certain limitations under Section 382 of the Internal Revenues Code of 1986, as amended. 21 22 Minority Interest in Loss of Subsidiary For financial reporting purposes, the assets, liabilities and earnings of Metastream Corporation are included in the Company's consolidated financial statements. Computer Associates interest in Metastream Corporation has been recorded as minority interest in the Company's consolidated balance sheets, and the losses attributed to their 20% interest have been reported as minority interest in the Company's consolidated statements of operations. Discontinued Operations In December 1999, the Board of Directors approved a plan to focus exclusively on its industry-leading, patented marketing visualization solution, Metastream, and to correspondingly divest itself of its prepackaged graphics software business. Accordingly, these operations are reflected as discontinued operations for all periods presented in the accompanying consolidated statements of operations. The loss on disposal of discontinued operations, which totaled approximately $21.3 million for the year ended December 31, 1999, consisted of the estimated future results of operations of the discontinued business through the estimated date of divestiture, the amounts expected to be realized upon the sale of the discontinued business, severance and related benefits, and asset write-downs (see table below). The Company recorded an adjustment to net loss on disposal of discontinued operations of $1.3 million during the three months ended March 31, 2000 as a result of better than expected net revenues during the quarter from the discontinued business. During April 2000, the Company completed the sale of a substantial portion of the Company's graphics software product lines. Specifically, Corel Corporation acquired the MetaCreations' Painter, Kai's Power Tools, KPT Vector Effects and Bryce product lines; egi.sys AG acquired the Poser product line; and fractal.com Corporation acquired the Headline Studio product line for total consideration of $11.3 million, consisting of cash and promissory notes, plus future royalties. The $11.3 million is payable within one year. At June 30, 2000, $8.5 million is classified as a current asset of discontinued operations in the accompanying consolidated balance sheets. The provision for loss on disposal of discontinued operations is an estimate and subject to change. Changes in estimates will be accounted for prospectively and included in income (loss) from discontinued operations. The following table depicts the loss on disposal of discontinued operations activity through June 30, 2000 (in thousands):
LOSS ON DISPOSAL OF PROVISION AT DISCONTINUED DECEMBER 31, CHARGED TO PROVISION AT OPERATIONS DEDUCTIONS 1999 EXPENSE DEDUCTIONS JUNE 30, 2000 ------------------------------------------------------------------------------------ Write-down of operating assets...................... $ 18,445 $ 18,103 $ 342 $ 1,266 $ 762 $ 846 Severance and benefits........ 8,415 504 7,911 26 7,937 -- Estimated loss of discontinued operations through divesture date...... 5,400 -- 5,400 (2,072) 3,328 -- Estimated net proceeds from divestiture................. (11,000) -- (11,000) (485) (10,850) (635) ------------------------------------------------------------------------------------ $ 21,260 $ 18,607 $ 2,653 $ (1,265) $ 1,177 $ 211 ====================================================================================
22 23 Operating results from discontinued operations were as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------------------------------------- 2000 1999 2000 1999 ---------------------------------------------------------- Net revenues........................... $ 699 $ 9,365 $ 5,275 $ 19,170 Cost of revenues....................... 77 1,746 1,066 3,393 ---------------------------------------------------------- Gross profit........................... 622 7,619 4,209 15,777 Operating expenses: Sales and marketing.................... 245 6,587 3,045 12,632 Research and development............... 849 3,492 3,743 6,821 General and administrative............. 413 756 749 1,487 ---------------------------------------------------------- Total operating expenses........... 1,507 10,835 7,537 20,940 ---------------------------------------------------------- Loss before gain on sale of assets..... (885) (3,216) (3,328) (5,163) Gain on sale of assets................. -- 1,920 -- 1,920 ---------------------------------------------------------- Loss before provision for income taxes. (885) (1,296) (3,328) (3,243) Provision for income taxes............. -- -- -- -- ---------------------------------------------------------- Loss from discontinued operations...... $ (885) $ (1,296) $ (3,328) $ (3,243) ==========================================================
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. 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 could differ materially from those expressed or forecasted in any such forward-looking statements as a result of certain factors, including those listed below. Shares of MetaCreations' Common Stock are speculative in nature and involve a high degree of risk. The following risk factors should be considered carefully. The risks described below are not the only ones facing MetaCreations. Many factors could cause our results to be different, including the following risk factors and other risks described in this document, as well as those discussed elsewhere in the Company's SEC reports, including without limitation, the Company's audited consolidated financial statements and notes thereto as of December 31, 1999 and 1998, and for the three years in the period ended December 31, 1999, as filed on Form 10-K/A. If any of the following risks occur, our business would likely be adversely affected and the trading price of our Common Stock could decline. This could result in a loss of all or part of your investment. 23 24 We Have A Limited Operating History That Makes An Evaluation Of Our Business Difficult We have been developing marketing visualization solutions for the Web since our acquisition of Real Time Geometry Corp. in December 1996. Additionally, the e-commerce market is relatively new and evolving rapidly. Accordingly, we have a relatively short operating history in this market upon which you can evaluate our business and prospects. You should consider our prospects in light of the risks and difficulties frequently encountered by early stage online companies, including, but not limited to: - We have an evolving and unpredictable business model; - We face intense competition; - We must establish and develop broad market acceptance of our products, technologies and services; - We must continue to develop new products, technologies and enhancements; - We must respond quickly to rapidly changing market developments, customer demands and industry standards; - We must attract, train and retain qualified employees; and - We must effectively manage our growth. If we are not successful in addressing these risks and challenges, we will not be able to grow our business, compete effectively or achieve profitability. We Have A History of Losses And Expect To Incur Losses In The Future We have had significant quarterly and annual operating losses since our inception, and as of June 30, 2000, we had an accumulated deficit of approximately $105.2 million. With the divestiture of our prepackaged graphics software business substantially complete, we have focused exclusively on our industry-leading, patented marketing visualization solution, Metastream. We believe that, despite this change in our strategic focus, we will continue to incur operating losses for the foreseeable future. Our Future Revenues May Be Unpredictable and May Cause Our Quarterly Results To Fluctuate As a result of our limited operating history and the rapidly changing nature of the markets in which we compete, we may be unable to forecast our quarterly and annual revenues accurately. If our future quarterly operating results fall below the expectations of securities analysts or investors, the trading price of our common stock will likely drop. Our quarterly operating results have fluctuated significantly in the past and may continue to fluctuate in the future as a result of many factors, including: - Ability to retain existing customers, attract new customers, and satisfy our customers' demands; - Market acceptance of our products, technologies and services; - Introduction or enhancement of new products, technologies or services by us or our competitors; - Changes in prices for our products, technologies and services or our competitors' products, technologies and services; 24 25 - Changes in usage of the Internet and online services and consumer acceptance of the Internet and e-commerce; - Costs of litigation and intellectual property protection; - Growth in Internet use; - Emergence of new competition; - Varying operating costs and capital expenditures related to the expansion of our business operations and infrastructure; and - Technical difficulties with our technologies. Based on these factors, we believe our revenues, expenses and operating results could vary significantly in the future and period-to-period comparisons should not be relied upon as indications of future results. Additionally, in connection with our decision to focus exclusively on e-commerce visualization, we decided to no longer focus on one-time technology licenses, in favor of implementing a recurring broadcast licensing model. This licensing model is based on Metastream 3.0, which was launched to developers at the end of March 2000 and is expected to be released to the public during the third quarter of 2000. There can be no assurance that this new recurring broadcast licensing model will result in net revenues comparable to those realized in prior years. If we are unable to implement this broadcast licensing model on a timely basis, if at all, our results of operations would be adversely affected. Our staffing and other operating expenses are based in large part on anticipated revenues. It would be difficult for us to adjust our spending to compensate for any unexpected shortfall. If we are unable to reduce our spending following any such shortfall, our business would be harmed. Our Stock Price Is Volatile And May Continue To Fluctuate In The Future The market price of our common stock has fluctuated significantly in the past. The price at which our common stock will trade in the future will depend on a number of factors including: - Our historical and anticipated operating results; - General market and economic conditions; - Our announcement of new products, technologies or services; - Actual or anticipated fluctuations in our operating results; and - Developments regarding our products, technologies or services, or those of our competitors. In addition, the stock market has experienced extreme price and volume fluctuations in recent months. This volatility has had a substantial effect on our stock price, as well as the stock prices of other software companies, particularly Internet companies. These broad market and industry fluctuations may adversely affect the market price of our common stock. As a result, the market price of our common stock may continue to fluctuate. 25 26 Our Markets Are Highly Competitive The e-commerce market is new, rapidly evolving and intensely competitive. As a result, online merchants are looking for ways to differentiate themselves from their competition. Accordingly, various companies are developing new technologies, which may give the online merchants this competitive advantage. Our current competitors include: - Cycore AB (Cult3D); - Flatland Online, Inc. (3DML); - IBM Corporation (Hotmedia); - Macromedia, Inc. - Oz.Com (Fluid3D - in conjunction with RealNetworks, Inc.'s G2 media player); - RichFX, Inc. (RichFX Player - in conjunction with RealNetworks, Inc.'s G2 media player). - Shells Interactive Ltd. (3D Dreams - in conjunction with Macromedia, Inc.'s Shockwave); - Virtue 3D, Inc. (Virtuoso); and Some of our competitors have longer operating histories and significantly greater financial, management, technology, development, sales, marketing and other resources than we have. As we compete with larger competitors across a broader range of products and technologies, we may face increasing competition from such companies. If these or other competitors develop products, technologies or solutions that offer significant performance, price or other advantages over our product, technologies or solutions, our business would be harmed. A variety of other possible actions by our competitors could also have a material adverse effect on our business, including increased promotion or the introduction of new or enhanced products and technologies. Moreover, new personal computer platforms and operating systems may provide new entrants with opportunities to obtain a substantial market share in our markets. Our competitors may be able to develop products or technologies comparable or superior to ours, or may be able to develop new products or technologies more quickly. We also face competition from developers of personal computer operating systems such as Microsoft and Apple Computer, Inc., as well as from open-source operating systems such as Linux. These operating systems may incorporate functions that could be superior to or incompatible with our products and technologies. Such competition would harm our business. If The Internet Does Not Continue To Expand As A Widespread Commerce Medium, Demand For Our Products And Technologies May Decline Significantly The market for our products, technologies and services is new and evolving rapidly. Growth in this market depends on increased use of the Internet for e-commerce. If the Internet is not adopted as a method for e-commerce, or if the adoption rate slows, the market for our products, technologies and services may not grow, or may develop more slowly than expected. We believe that increased Internet use may depend on the availability of greater bandwidth or data transmission speeds or on other technological improvements, and we are largely dependent on third party companies to provide or facilitate these improvements. Changes in content 26 27 delivery methods and emergence of new Internet access devices such as TV set-top boxes could dramatically change the market for streaming media products and services if new delivery methods or devices do not use streaming media or if they provide a more efficient method for transferring data than streaming media. The e-commerce market is relatively new and evolving. Licensing of our products and technologies depends in large part on the development of the Internet as a viable commercial marketplace. There are now substantially more users and much more "traffic" over the Internet than ever before, use of the Internet is growing faster than anticipated, and the technological infrastructure of the Internet may be unable to support the demands placed on it by continued growth. Delays in development or adoption of new technological standards and protocols, or increased government regulation, could also affect Internet use. In addition, issues related to use of the Internet, such as security, reliability, cost, ease of use and quality of service, remain unresolved and may affect the amount of business that is conducted over the Internet. Our Market Is Characterized By Rapidly Changing Technology, And If We Do Not Respond In A Timely Manner, Our Products and Technologies May Not Succeed In The Marketplace The market for marketing visualization is characterized by rapidly changing technology. As a result, our success depends substantially upon our ability to continue to enhance our products and technologies and to develop new products and technologies that meet customers' increasing expectations. Additionally, we may not be successful in developing and marketing enhancements to our existing products and technologies or introducing new products and technologies on a timely basis. Our new or enhanced products and technologies may not succeed in the marketplace. We expect our research and development expenditures will increase in the future. If our increased research and development spending is not accompanied by increased revenues, our business would be harmed. Potential Delays in Product Releases Could Harm Our Business We also depend upon internal efforts for the development of new products, technologies and enhancements. In the past, we have had delays in the development of new products, technologies and enhancements. We may experience similar delays in the future, which would harm our business. Undetected Errors In Our Products And Technologies Could Result In Adverse Publicity, Reduced Market Acceptance Or Lawsuits By Customers We offer complex software products and technologies, which may contain undetected errors. If errors are found in our products or technologies after we have commercially released them, we could likely experience adverse publicity, reduced market acceptance or lawsuits by customers. This would adversely affect our business. 27 28 We May Be Unable To Protect Our Intellectual Property Rights And We May Be Liable For Infringing The Intellectual Property Rights of Others Our success and ability to compete partly depend on the uniqueness or value of our products and technologies. We rely on a combination of copyright, trademark, patent, trade secret laws, employee and third-party nondisclosure agreements and exclusive contracts to protect our intellectual and proprietary rights, products, and technologies. Policing unauthorized use of our products and technologies is difficult and the steps we take may not prevent the misappropriation or infringement of technology or proprietary rights. In addition, litigation may be necessary to enforce our intellectual property rights. Such misappropriation or litigation could result in substantial costs and diversion of resources and the potential loss of intellectual property rights, any of which would adversely impair our business. Our products and technologies may be the subject of infringement claims in the future. This could result in costly litigation and could require us to obtain a license to the intellectual property of third parties. We may be unable to obtain licenses from these third parties on favorable terms, if at all. Even if a license is available, we may have to pay substantial royalties to obtain it. If we cannot obtain necessary licenses on reasonable terms, our business would be adversely affected. Security Risks Could Limit The Growth Of E-Commerce And Expose Us To Litigation Or Liability E-commerce depends on the ability to transmit confidential information securely over public networks. Any compromise of our customers' ability to transmit confidential information securely could harm our business. Online transmissions are subject to the following risks, among others: - Encryption and authentication technology may be subject to events or developments that could compromise or breach the security of customer information; - A third party could circumvent security measures and misappropriate proprietary information or interrupt operations; - Credit card companies could restrict online credit card transactions; or - Security breaches could damage our or our customers' reputation and expose us to litigation or liability. Increasing Government Regulation Could Increase Our Cost Of Doing Business Or Increase Our Legal Exposure We are not currently subject to direct regulation by any governmental agency other than laws and regulations generally applicable to businesses. It is possible that a number of laws and regulations may be adopted in the U.S. and abroad with particular applicability to the Internet. Governments have and may continue to enact legislation applicable to the Internet in areas such as content distribution, performance and copying, other copyright issues, network security, encryption, the use of key escrow data, privacy protection, caching of content by server products, electronic authentication or "digital" signatures, illegal or obscene content, access charges and retransmission activities. The applicability to the Internet of existing laws governing issues such as property ownership, content, taxation, defamation and personal privacy is also uncertain. Export or import restrictions, new legislation or regulation or governmental enforcement of 28 29 existing regulations may limit the growth of the Internet, increase our cost of doing business or increase our legal exposure. We May Need To Enter Into Business Combinations And Strategic Alliances Which Could Be Difficult To Integrate And May Disrupt Our Business We may expand our operations or market presence by entering into business combinations, investments, joint ventures or other strategic alliances with other companies. These transactions create risks such as: - Difficulty assimilating the operations, technology and personnel of the combined companies; - Disruption of our ongoing business; - Problems retaining key technical and managerial personnel; - Expenses associated with amortization of goodwill and other purchased intangible assets; - Additional operating losses and expenses of acquired businesses; and - Impairment of relationships with existing employees, customers and business partners. If we enter into such business combinations and strategic alliances and are not successful in addressing these risks, our business would be adversely affected. The Loss Of Any Of Our Key Personnel Would Harm Our Business We depend on the continued employment of our senior executive officers and other key management personnel. During the three months ended June 30, 2000, we entered into long-term employment agreements with our President and Chief Executive Officer, Robert Rice, as well as our Senior Vice President and Chief Financial Officer, James Abate. We do not have "key person" life insurance policies. If any of our senior officers or other key employees leave our company and are not adequately replaced, our business would be adversely affected. In December 1999, our previous President and Chief Executive Officer, Gary Lauer, resigned. Mark Zimmer, previously President of MetaCreations' business graphics division, was appointed President and Chief Executive Officer from December 1999 through April 2000. In April 2000, Robert Rice, previously President and Chief Executive Officer of Metastream Corporation, was appointed President and Chief Executive Officer of MetaCreations Corporation and James Abate was appointed Senior Vice President and Chief Financial Officer of both MetaCreations Corporation and Metastream Corporation. In addition, in connection with our recent restructuring, several senior-level management personnel left our Company. As a result of the shifting of our operations to our Metastream Corporation subsidiary, Metastream Corporation has recently hired a Chief Marketing Officer, a Vice President, Marketing and a Vice President, Client Services. If we do not succeed in attracting and retaining new officers, our business would be adversely affected. 29 30 Our Future Success Depends On Our Ability To Identify, Hire, Train and Retain Highly Qualified Employees Our future success depends on our continuing ability to identify, hire, train and retain other highly qualified technical and managerial employees. The competition for such employees is intense, and we have experienced difficulty in identifying and hiring qualified engineering personnel. If we do not succeed in attracting and retaining necessary technical and managerial employees in the future, our business would be adversely affected. Additionally, in order to attract and retain employees in the past, we have granted options to purchase shares of common stock to employees at an exercise price below the fair value of the common stock on the date of grant. As a result, we have had to record deferred compensation related to the intrinsic value of the option. This deferred compensation is amortized over the vesting period of applicable options, which is generally four years, resulting in a non-cash charge to earnings over the related vesting period. If we have to issue additional options at an exercise price below the fair value of the common stock on the date of grant, our financial condition and results of operations would be adversely affected. LIQUIDITY AND CAPITAL RESOURCES Cash and investments totaled $38.6 million at June 30, 2000, up from $37.3 million at December 31, 1999. Net cash used in operating activities of the Company totaled $17.5 million for the six months ended June 30, 2000, compared to $3.5 million for the six months ended June 30, 1999. Net cash used in operating activities for the six months ended June 30, 2000 primarily related to $16.6 million net loss from continuing operations, $13.0 million net cash used for discontinued operations (principally severance and related expenses) and $3.3 million minority interest in loss of subsidiary, net of $7.0 non-cash stock-based compensation charge and $5.7 million non-cash sales and marketing charge related to the issuance of Metastream preferred stock to AOL. Net cash used in operating activities for the six months ended June 30, 1999 primarily related to $4.3 million net cash used for discontinued operations. Net cash provided by investing activities totaled $13.6 million for the six months ended June 30, 2000, compared to net cash used in investing activities of $7.7 million for the six months ended June 30, 1999. Net cash provided by investing activities for the six months ended June 30, 2000 primarily resulted from $14.8 million of net proceeds from sales and maturities of short-term investments and 1.0 million of proceeds from the repayment of a note receivable from an officer of the Company, net of $2.0 used for purchases of property and equipment. Net cash used in investing activities for the six months ended June 30, 1999 primarily resulted from $4.9 million of net purchases of short-term investments and $2.9 million of net cash used for discontinued operations. Net cash provided by financing activities totaled $19.9 million and $224,000 for the six months ended June 30, 2000 and 1999, respectively. Net cash provided by financing activities for the six months ended June 30, 2000 resulted from $10.5 million of proceeds received from the exercise of stock options by the Company's employees, $9.8 million of net proceeds from the issuance of Series A Convertible Preferred Stock in Metastream to AOL and $1.0 million collected from 30 31 Computer Associates in connection with a subscription receivable related to Metastream common stock, net of a $1.5 million note receivable issued to an officer of the Company. Net cash provided by investing activities for the six months ended June 30, 1999 primarily resulted from $324,000 of proceeds received from the exercise of stock options by the Company's employees. The Company expects that its working capital requirements will continue to increase to the extent the Company continues to grow. The Company believes that its current cash and investment balances and cash provided by future operations, if any, are sufficient to meet its working capital needs and anticipated capital expenditure requirements through at least the next twelve months. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No, 133, "Accounting for Derivative Instruments and Hedging Activities," which established accounting and reporting standards for derivative instruments and hedging activities. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. To date, we have not engaged in derivative and hedging activities. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial Statements," which gives additional guidance in applying generally accepted accounting principles to revenue recognition in the financial statements. Management does not believe the compliance with the provisions of SAB No. 101 will have a material effect on the accompanying consolidated financial statements. In March 2000, the FASB issued Financial Interpretation ("FIN") No. 44, "Accounting for Certain Transactions Involving Stock Compensation," which is an interpretation of Accounting Principal Board Opinion ("APB") No. 25. This interpretation clarifies: - The definition of employee for purposes of applying APB No. 25, which deals with stock compensation issues; - The criteria for determining whether a plan qualifies as a noncompensatory plan; - The accounting consequence of various modifications to the terms of a previously fixed stock option or award; and - The accounting for an exchange of stock compensation awards in a business combination. The interpretation is effective July 1, 2000, but certain conclusions in this interpretation cover specific events prior to such date. The adoption of FIN No. 44 is not expected to have a material impact on our financial statements. 31 32 QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company is subject to concentration of credit risk and interest rate risk related to cash equivalents and short-term investments. The Company does not have any derivative financial instruments as of June 30, 2000. Credit risk is managed by limiting the amount of investments placed with any one issuer, investing in high-quality investment securities and securities of the U.S. government and limiting the average maturity of the overall portfolio. The majority of the Company's portfolio, which is classified as available-for-sale, is composed of fixed income investments that are subject to the risk of market interest rate fluctuations, and all of the Company's investments are subject to risks associated with the ability of the issuers to perform their obligations under the instruments. The Company may suffer losses in principal if forced to sell securities, which have declined in market value due to changes in interest rates. PART II. OTHER INFORMATION Item 1. Legal Proceedings None Item 2. Changes in Securities None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None 32 33 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits
Exhibit Number Exhibit Title ------ ------------- 10.1 Amended Employment Agreement between the Registrant and Robert Rice dated June 29, 2000 10.2 Letter Agreement between the Registrant and James A. Abate, dated April 14, 2000 10.3 Amended and Restated Series A Preferred Stock Purchase Agreement and Related Exchange Agreement between Registrant and America Online, Inc. dated June 12, 2000. 27.1 Financial Data Schedule
(b) Reports on Form 8-K On April 6, 2000, the Registrant filed a report on Form 8-K to file a press release issued by the Registrant on April 3, 2000 announcing the appointment of James A. Abate as Chief Financial Officer of both MetaCreations and Metastream and Paul Kadin as Chief Marketing Officer of Metastream. On April 13, 2000, the Registrant filed a report on Form 8-K to file a press release issued by the Registrant on April 10, 2000 announcing the appointment of Robert Rice as President and Chief Executive Officer of MetaCreations Corporation. On April 13, 2000, the Registrant filed a report on Form 8-K to file a press release issued by the Registrant on April 10, 2000 announcing Corel Corporation's acquisition of MetaCreations' Painter, Kai's Power Tools and Bryce product lines. 33 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. METACREATIONS CORPORATION (Registrant) Date: August 21, 2000 /s/ JAMES A. ABATE ------------------------ James A. Abate Sr. Vice President and Chief Financial Officer 34