-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BC8te/FcyPqIQHQu4qMFybYN9kKlofrPm/F9zk47ASIZSeY2AmPE8M2xaH2XdM8t T2Q5v+gGX4uSwgRmKD7xtQ== 0000950148-98-002519.txt : 19981118 0000950148-98-002519.hdr.sgml : 19981118 ACCESSION NUMBER: 0000950148-98-002519 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: METACREATIONS CORP CENTRAL INDEX KEY: 0000919794 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 954102687 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-27168 FILM NUMBER: 98749654 BUSINESS ADDRESS: STREET 1: 6303 CARPINTERIA AVE CITY: CARPINTERIA STATE: CA ZIP: 93013 MAIL ADDRESS: STREET 1: 6303 CARPINTERIA AVE CITY: CARPINTERIA STATE: CA ZIP: 93013 10-Q 1 FORM 10-Q (09/30/1998) 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 September 30, 1998 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) 6303 Carpinteria Ave, Carpinteria, CA 93013 (Address of principal executive offices) (805) 566-6200 (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 November 9, 1998, there were outstanding 23,912,345 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 - September 30, 1998 and December 31, 1997 Consolidated Statements of Operations - Three and nine month periods ended September 30, 1998 and 1997 Consolidated Statements of Cash Flows - Three and nine month periods ended September 30, 1998 and 1997 Notes to Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 10 PART II. OTHER INFORMATION Item 2. Changes in Securities........................................... 25 Item 6. Exhibits and Reports on Form 8-K................................ 26 SIGNATURES ................................................................ 27
2 3 PART I. FINANCIAL INFORMATION Item 1. Financial Statements METACREATIONS CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands)
SEPTEMBER 30, DECEMBER 31, 1998 1997 ----------- --------- (UNAUDITED) (AUDITED) ASSETS Current assets: Cash and cash equivalents .................................................. $ 9,069 $ 9,653 Short-term investments ..................................................... 40,525 40,349 Accounts receivable, net ................................................... 11,900 26,604 Inventories ................................................................ 711 1,667 Income taxes receivable .................................................... 3,410 3,324 Deferred income taxes ...................................................... 2,634 2,634 Prepaid expenses ........................................................... 3,830 3,494 --------- --------- Total current assets .................................................. 72,079 87,725 Property and equipment, net ................................................... 7,237 7,577 Other assets .................................................................. 1,463 1,988 ========= ========= Total assets .......................................................... $ 80,779 $ 97,290 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ........................................................... $ 3,958 $ 4,860 Accrued expenses ........................................................... 3,239 3,971 Royalties payable .......................................................... 1,100 1,217 --------- --------- Total current liabilities ............................................. 8,297 10,048 Stockholders' equity: Preferred stock, $.001 par value, 5,000 shares authorized - no shares issued and outstanding at September 30, 1998 and December 31, 1997, respectively ............................................................ -- -- Common stock, $.001 par value; 75,000 shares authorized - 23,903 and 23,606 shares issued and outstanding at September 30, 1998 and December 31, 1997, respectively ......................................... 24 24 Paid-in capital ............................................................ 111,420 109,896 Notes receivable from stockholders ......................................... (3,297) (3,170) Cumulative translation adjustment .......................................... (124) (135) Accumulated deficit ........................................................ (35,541) (19,373) --------- --------- Total stockholders' equity ............................................ 72,482 87,242 --------- --------- Total liabilities and stockholders' equity ............................ $ 80,779 $ 97,290 ========= =========
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) (Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 1998 1997 1998 1997 -------- -------- -------- -------- Net revenues ...................................... $ 9,053 $ 21,008 $ 31,491 $ 53,009 Cost of revenues .................................. 1,544 3,023 5,437 9,254 -------- -------- -------- -------- Gross profit ...................................... 7,509 17,985 26,054 43,755 Operating expenses: Sales and marketing ............................ 5,848 8,272 22,300 24,153 Research and development ....................... 3,665 3,713 12,314 10,333 General and administrative ..................... 1,581 1,603 5,025 4,644 Costs associated with the write-off of acquired in-process technology, restructuring and mergers .................................. -- -- 4,955 16,185 -------- -------- -------- -------- Total operating expenses .......................... 11,094 13,588 44,594 55,315 -------- -------- -------- -------- Income (loss) from operations ..................... (3,585) 4,397 (18,540) (11,560) Interest and investment income, net ............... 633 827 2,019 2,416 -------- -------- -------- -------- Income (loss) before provision (benefit) for income taxes .......................................... (2,952) 5,224 (16,521) (9,144) Provision (benefit) for income taxes .............. -- 1,619 (353) 37 -------- -------- -------- -------- Net income (loss) ................................. $ (2,952) $ 3,605 $(16,168) $ (9,181) ======== ======== ======== ======== Net income (loss) per common share: Basic ........................................... $ (0.12) $ 0.16 $ (0.68) $ (0.40) ======== ======== ======== ======== Diluted ......................................... $ (0.12) $ 0.15 $ (0.68) $ (0.40) ======== ======== ======== ======== Weighted average number of shares outstanding: Basic .......................................... 23,837 23,175 23,732 22,757 ======== ======== ======== ======== Diluted ........................................ 23,837 24,853 23,732 22,757 ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 4 5 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
NINE MONTHS ENDED SEPTEMBER 30, ---------------------- 1998 1997 -------- -------- Cash flows from operating activities: Net loss .................................................................... $(16,168) $ (9,181) Adjustment to retained earnings as a result of business combination ......... -- 513 Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Non-cash restructuring costs ........................................... 2,919 -- Write-off of acquired in-process technology ............................ -- 5,575 Depreciation and amortization .......................................... 2,962 1,822 Provision for losses on product returns and receivables ................ 9,902 3,354 Provision for losses on inventory ...................................... 592 445 Accrued interest income ................................................ (127) (127) Changes in operating assets and liabilities: Accounts receivable ................................................. 3,930 (12,038) Inventories ......................................................... (71) (459) Income taxes receivable ............................................. 298 (746) Prepaid expenses and other assets ................................... (1,221) 1,207 Accounts payable and accrued expenses ............................... (1,230) (1,543) Royalties payable ................................................... (117) 442 -------- -------- Net cash provided by (used in) operating activities ............... 1,669 (10,736) Cash flows from investing activities: Purchases of short-term investments ......................................... (53,714) (37,079) Proceeds from sales and maturities of short-term investments ................ 53,538 40,894 Purchases of property and equipment ......................................... (2,103) (2,929) Purchases of software technology and product rights ......................... (721) (110) Payments in connection with acquisition ..................................... -- (1,233) -------- -------- Net cash used in investing activities ............................. (3,000) (457) Cash flows from financing activities: Repayment of notes payable .................................................. -- (274) Proceeds from exercise of stock options ..................................... 736 1,239 -------- -------- Net cash provided by financing activities ......................... 736 965 Effect of exchange rates changes on cash ....................................... 11 32 -------- -------- Net decrease in cash and cash equivalents ...................................... (584) (10,196) Cash and cash equivalents at beginning of period ............................... 9,653 21,605 -------- -------- Cash and cash equivalents at end of period ..................................... $ 9,069 $ 11,409 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 5 6 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying unaudited consolidated financial statements include the accounts of MetaCreations Corporation and its wholly-owned 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 September 30, 1998 are not necessarily indicative of results to be expected for the year ending December 31, 1998. 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, 1997 and 1996, and for the three years in the period ended December 31, 1997, as filed on Form 10-K. Revenue Recognition During the three months ended March 31, 1998, the Company adopted Statement of Position ("SOP") 97-2, "Software Revenue Recognition," which superceded SOP 91-1. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements (e.g., software products, upgrades/enhancements, postcontract customer support, etc.) to be allocated to each element based on the relative fair value of the elements. The fair value of an element must be based on evidence which is specific to the Company. The revenue allocated to software products (including specified upgrades/enhancements) generally is recognized upon delivery of the products. The revenue allocated to postcontract customer support generally is recognized ratably over the term of the support. If the Company does not have evidence of the fair value for all elements in a multiple-element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. The impact of adopting SOP 97-2 was not material to the Company's financial position, results of operations or cash flows. The Company provides an allowance for estimated returns at the time of product shipments and adjusts this allowance as needed based on actual return history. Such reserves as a percentage of net revenues have varied over recent years, reflecting the Company's experience in product returns as it has significantly expanded the proportion of its sales through third-party distribution 6 7 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) channels and increased its product portfolio. The Company expects reserves will continue to vary in the future. The Company's agreements with its distributors generally provide the distributors with limited rights to return unsold inventories under a stock balancing program. The Company monitors the activities of its distributors in an effort to minimize excessive returns and establishes its reserves based on its estimates of expected returns. Comprehensive Income During the three months ended March 31, 1998, the Company adopted Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. Differences between comprehensive income and net income were not material to the Company's financial position, results of operations or cash flows for the three and nine months ended September 30, 1998 and 1997. Statement of Financial Accounting Standards Not Yet Adopted In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue-producing segments of the entity for which such information is available and is utilized by the chief operating decision maker. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. A reconciliation of segment financial information to amounts reported in the financial statements would be provided. SFAS No. 131 requires companies to adopt its provisions for fiscal years beginning after December 15, 1997, but does not require that segment information be reported in financial statements for interim periods in the initial year of application. Management is currently evaluating the requirements of adopting SFAS No. 131 and the effects, if any, on the Company's current reporting and disclosures. 2. RESTRUCTURING On June 30, 1998, the Company announced a restructuring plan aimed at reducing costs and improving competitiveness, which was implemented during the quarter ended September 30, 1998. In connection with the restructuring, management considered the Company's future operating costs and levels of revenue in 1998 and beyond, and determined that a restructuring charge of approximately $5.0 million was required to cover the costs of reducing certain sectors of its workforce and facilities. The restructuring charge included an accrual of approximately $2.0 million related to severance and benefits associated with the reduction of approximately 75 positions during July 1998, as well as the related reduction of certain of the Company's facilities. Non-cash restructuring costs, which totaled approximately $3.0 million, primarily related to the write-down of non-strategic business assets made redundant or obsolete due to the streamlining of the Company's product lines and/or reduction of facilities. The Company expects completion of the restructuring plan during the remainder of 1998. 7 8 METACREATIONS CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) The following table depicts the restructuring activity through September 30, 1998 (in thousands):
TOTAL RESTRUCTURING BALANCE AT CHARGES SPENDING / CHARGES SEPTEMBER 30, 1998 --------------- ------------------ ------------------ Write-down of operating assets.................... $ 2,919 $ 2,919 $ -- Severance and benefits............................ 1,640 1,322 318 Vacated facilities................................ 131 66 65 Other............................................. 265 206 59 --------------- --------------- --------------- $ 4,955 $ 4,513 $ 442 =============== =============== ===============
3. INVENTORIES Inventories consist of the following (in thousands):
SEPTEMBER 30, DECEMBER 31, 1998 1997 --------------- --------------- Finished goods......................................................... $ 655 $ 1,465 Materials and supplies................................................. 56 202 --------------- --------------- $ 711 $ 1,667 =============== ===============
4. INCOME TAXES Based upon a review of the Company's deferred income tax assets, available tax carrybacks, recent quarterly losses, and expected future taxable income, the Company did not record a benefit for income taxes for the three months ended September 30, 1998. Management believes that it is more likely than not that any additional income tax benefit would not be realized at this point in time. The benefits for income taxes for the three and nine months ended September 30, 1997 were based on the Company's estimated annualized effective tax rate for the year, after giving effect to the utilization of available tax credits and tax planning opportunities. 8 9 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 nine months ended September 30, 1998 and 1997 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: September 30, 1998: Basic EPS ................... $ (2,952) 23,837 $(0.12) Effect of dilutive securities -- -- -------- -------- Diluted EPS ................. $ (2,952) 23,837 $(0.12) ======== ======== September 30, 1997: Basic EPS ................... $ 3,605 23,175 $ 0.16 Effect of dilutive securities -- 1,678 -------- -------- Diluted EPS ................. $ 3,605 24,853 $ 0.15 ======== ======== Nine Months Ended: September 30, 1998: Basic EPS ................... $(16,168) 23,732 $(0.68) Effect of dilutive securities -- -- -------- -------- Diluted EPS ................. $(16,168) 23,732 $(0.68) ======== ======== September 30, 1997: Basic EPS ................... $ (9,181) 22,757 $(0.40) Effect of dilutive securities -- -- -------- -------- Diluted EPS ................. $ (9,181) 22,757 $(0.40) ======== ========
The computation of the diluted number of shares excludes unexercised stock options which are anti-dilutive. Stock options to purchase 6,992,000 and 5,684,000 shares of common stock were outstanding as of September 30, 1998 and 1997, respectively. The stock options outstanding at September 30, 1998 were excluded from the three and nine month computation while the stock options outstanding at September 30, 1997 were excluded from the nine month computation. 9 10 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 the Company's audited consolidated financial statements and notes thereto as of December 31, 1997 and 1996, and for the three years in the period ended December 31, 1997, as filed on Form 10-K. In connection with forward-looking statements which appear in these disclosures, investors should carefully review the factors set forth in this Form 10-Q under "Factors That May Affect Future Operating Results." OVERVIEW MetaCreations was formed in May 1997, as a result of the merger of MetaTools, Inc. and Fractal Design Corporation ("Fractal"), and included the acquisitions of Real Time Geometry Corp. in December 1996 and Specular International. Ltd. in April 1997, as well as the previous merger of Fractal and Ray Dream, Inc. in May 1996. The financial results for the nine months ended September 30, 1997 include the pooled financial statements of MetaTools, Inc. and Fractal Design Corporation. Net revenues decreased during the three months ended September 30, 1998 as a result of lower than expected demand in the domestic retail channels, weak demand in Japan, and lower OEM and licensing revenues. On June 30, 1998, the Company announced a restructuring plan aimed at reducing costs and improving competitiveness, which was implemented during the quarter ended September 30, 1998. In connection with the restructuring, the Company recorded a one-time charge to earnings of approximately $5.0 million to cover the costs of reducing certain sectors of its workforce and facilities to levels more appropriate to current business requirements. As a result of the restructuring programs, the Company reduced operating expenses by approximately $3.5 million, or 24%, compared to the second quarter of 1998. The Company's future revenues continue to be substantially dependent upon the continued market acceptance of the Company's existing leading products: Bryce, Dance Studio, Infini-D, Kai's Photo Soap, Kai's Super GOO, Kai's Power SHOW, Kai's Power Tools, Painter, Poser, and Ray Dream Studio. In this regard, revenue from the sale of these products represented a substantial majority of net revenues during the three and nine months ended September 30, 1998. 10 11 The Company also has a number of new product development efforts under way, and a significant portion of future revenues is dependent upon the timely introduction and ultimate success of these products. The Company develops substantially all of its products either internally or occasionally through co-development arrangements with third parties. These co-development arrangements generally provide the Company with certain exclusive proprietary, copyright or marketing rights for developed products in exchange for the payment of one-time and/or ongoing royalties. The Company expects to continue fostering arrangements with external developers as part of its strategy of expanding its product portfolio. There can be no assurance, however, that the Company will be able to continue to supplement its product development efforts in the future through such relationships. The Company sells its products primarily to domestic and international distributors, including mail order resellers and retail outlets. The Company also sells its products to Original Equipment Manufacturers ("OEMs") for bundling with their hardware or software products and directly to end users, generally through telesales and direct mail campaigns. Fluctuations in distributor purchases can cause significant volatility in the Company's revenues. Distributors generally stock the Company's products at levels which may fluctuate significantly for a variety of reasons, including the distributors' ability to finance the purchase of products and to devote shelf space, catalog space or attention to the products. Distributor purchases may also be affected by the Company's introduction of a new product or new version of a product, the Company's end user promotions programs, anticipated product price increases, the Company's purchases of display space at retail outlets and other factors. Further, OEM agreements, which generally provide for minimum guaranteed non-refundable payments to the Company, typically coincide with the planned introduction of OEM bundled products and are often entered into at the end of the quarter. The timing of the execution of such agreements can fluctuate substantially throughout the year, causing volatility in the Company's revenues, operating results, and cash flows. Since its inception, the Company has focused on building its product portfolio and establishing brandname awareness of its products. These activities have resulted in significant increases in all expense categories. The Company's recent product development efforts have also entailed significant research and development expenditures. Higher operating expenses, combined with costs associated with periodic restructurings, mergers, and acquisitions, including the related write-off of acquired in-process technology, and quarterly fluctuations in net revenues, have contributed to the Company's periodic annual and quarterly losses, as well as fluctuations in its operating results. The Company intends to continue to invest significant amounts in developing new markets for its products, as well as maintaining and enhancing brand awareness, and accordingly, may continue to experience losses and volatility of net revenues and operating results in future periods. 11 12 OPERATING RESULTS The following table sets forth certain selected financial information expressed as a percentage of net revenues for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ------------------- 1998 1997 1998 1997 ------ ------ ------ ------ Net revenues ............................... 100.0% 100.0% 100.0% 100.0% Cost of revenues ........................... 17.1 14.4 17.3 17.5 ------ ------ ------ ------ Gross margin ............................ 82.9 85.6 82.7 82.5 Operating expenses: Sales and marketing ........................ 64.6 39.4 70.8 45.6 Research and development ................... 40.5 17.7 39.1 19.5 General and administrative ................. 17.4 7.6 16.0 8.8 Write-off of acquired in-process technology, restructuring and mergers ............... -- -- 15.7 30.5 ------ ------ ------ ------ Total operating expenses .............. 122.5 64.7 141.6 104.4 ------ ------ ------ ------ Income (loss) from operations .............. (39.6) 20.9 (58.9) (21.9) Interest and investment income, net ........ 7.0 3.9 6.5 4.6 ------ ------ ------ ------ Net income (loss) before provision (benefit) for income taxes ........................ (32.6) 24.8 (52.4) (17.3) Provision (benefit) for income taxes ....... -- 7.7 (1.1) .1 ------ ------ ------ ------ Net income (loss) .......................... (32.6)% 17.1% (51.3)% (17.4)% ====== ====== ====== ======
Net Revenues Net revenues totaled $9.1 million for the three months ended September 30, 1998, representing a 57% decrease from net revenues of $21.0 million for the three months ended September 30, 1997. Net revenues decreased as a result of lower than expected demand in the domestic retail channels, weak demand in Japan, and lower OEM and licensing revenues. During the three months ended September 30, 1998, the Company released one new product, Dance Studio, and one new version of an existing product, Painter 5.5 Web Edition. International sales accounted for $2.2 million, or 25% of net revenues, for the three months ended September 30, 1998, compared to $7.4 million, or 35% of net revenues, for the three months ended September 30, 1997. Net revenues totaled $31.5 million for the nine months ended September 30, 1998, compared to $53.0 million for the nine months ended September 30, 1997, a decrease of 41%. The decrease in net revenues is attributed to lower than expected demand in the domestic retail channels and in Japan, as well as lower OEM and licensing revenues. International sales accounted for $9.3 million, or 30% of net revenues, for the nine months ended September 30, 1998, compared to $20.3 million, or 38% of net revenues, for the nine months ended September 30, 1997. 12 13 The Company recognizes revenue from the sale of its products in accordance with SOP 97-2, which generally requires revenue earned on software arrangements involving multiple elements (e.g., software products, upgrades/enhancements, postcontract customer support, etc.) to be allocated to each element based on the relative fair value of the elements. The fair value of an element must be based on evidence which is specific to the Company. The revenue allocated to software products (including specified upgrades/enhancements) generally is recognized upon delivery of the products. The revenue allocated to postcontract customer support generally is recognized ratably over the term of the support. If the Company does not have evidence of the fair value for all elements in a multiple-element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. The Company provides an allowance for estimated returns at the time of product shipments and adjusts this allowance as needed based on actual return history. Such reserves as a percentage of net revenues have varied over recent years, reflecting the Company's experience in product returns as it has significantly expanded the proportion of its sales through third-party distribution channels and increased its product portfolio. The Company expects reserves will continue to vary in the future. The Company's agreements with its distributors generally provide the distributors with limited rights to return unsold inventories under a stock balancing program. The Company monitors the activities of its distributors in an effort to minimize excessive returns and establishes its reserves based on its estimates of expected returns. While historically the Company's returns have been within management's expectations, the establishment of reserves requires judgments regarding such factors as future competitive conditions and product life cycles, which can be difficult to predict. As a result, there can be no assurance that established reserves will be adequate to cover actual future returns. Cost of Revenues Cost of revenues includes the costs of goods sold, royalties due to external developers, inventory management costs, freight and handling costs and reserves for inventory obsolescence. Cost of revenues totaled $1.5 million, or 17% of net revenues, for the three months ended September 30, 1998, compared to $3.0 million, or 14% of net revenues, for the three months ended September 30, 1997. The increase in cost of revenues as a percent of net revenues resulted from the decrease in OEM and licensing revenues from 36% of net revenues for the three months ended September 30, 1997 to 20% of net revenues for the three months ended September 30, 1998. Royalties represented 5% and 4% of net revenues for the three months ended September 30, 1998 and 1997, respectively. Cost of revenues totaled $5.4 million for the nine months ended September 30, 1998, compared to $9.3 million for the nine months ended September 30, 1997, but remained flat at 17% of net revenues. Royalties represented 4% of net revenues for both the nine months ended September 30, 1998 and 1997. The Company expects that cost of revenues will increase in the future commensurate with any increase in net revenues, but may vary as a percentage of net revenues. 13 14 Sales and Marketing Sales and marketing expenses include advertising, promotional materials, mail campaigns, trade shows and the compensation costs of sales, marketing, customer service and public relations personnel who promote the Company's products, including related facilities costs. Sales and marketing expenses totaled $5.8 million for the three months ended September 30, 1998, a 29% decrease from sales and marketing expenses of $8.3 million for the three months ended September 30, 1997. The decrease in sales and marketing expenses resulted from the restructuring programs implemented during the third quarter of 1998 which included reductions in sales and marketing personnel and promotional activities. As a percentage of net revenues, sales and marketing expenses increased from 39% for the three months ended September 30, 1997 to 65% for the three months ended September 30, 1998, as a result of the significant decrease in net revenues for the respective periods. Sales and marketing expenses totaled $22.3 million, or 71% of net revenues, for the nine months ended September 30, 1998, a decrease of 8% over sales and marketing expenses of $24.2 million, or 46% of net revenues, for the nine months ended September 30, 1997. The decrease in sales and marketing expenses primarily resulted from the restructuring programs implemented during the third quarter of 1998, while the increase in sales and marketing expenses as a percent of net revenues resulted from the significant decrease in net revenues for the respective periods. The Company expects sales and marketing expenses will continue to increase in future periods, but such expenses may vary as a percentage of net revenues. Research and Development Research and development expenses consist primarily of personnel costs, consultant fees and required equipment and facilities costs related to the Company's product development efforts. Research and development expenses totaled $3.7 million for both the three months ended September 30, 1998 and 1997. As a percent of net revenues, research and development expenses increased from 18% for the three months ended September 30, 1997 to 41% for the three months ended September 30, 1998, as a result of the decrease in net revenues for the respective periods. For the nine months ended September 30, 1998, research and development expenses totaled $12.3 million, or 39% of net revenues, an increase of 19% over research and development expenses of $10.3 million, or 19% of net revenues, for the nine months ended September 30, 1997. The increase was attributed to additional personnel hired to expand the Company's product portfolio, enhance its existing products, and translate its products to foreign languages. 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 include compensation costs related to executive management, finance, and administration personnel of the Company along with other administrative costs including legal and accounting fees, insurance, and bad debt expenses. 14 15 General and administrative expenses, which totaled $1.6 million for both the three months ended September 30, 1998 and 1997, increased as a percentage of net revenues from 8% for the three months ended September 30, 1997 to 17% for the three months ended September 30, 1998, as a result of the decrease in net revenues for the respective periods. For the nine months ended September 30, 1998, general and administrative expenses totaled $5.0 million, or 16% of net revenues, an increase of 8% over general and administrative expenses of $4.6 million, or 9% of net revenues, for the nine months ended September 30, 1997. The dollar increase in general and administrative expenses resulted from increased corporate expenses. The Company expects that its general and administrative expenses will continue to increase in the future, but such expenses may vary as a percentage of net revenues. Restructuring Costs On June 30, 1998, the Company announced a restructuring plan aimed at reducing costs and improving competitiveness, which was implemented during the quarter ended September 30, 1998. In connection with the restructuring, management considered the Company's future operating costs and levels of revenue in 1998 and beyond, and determined that a restructuring charge of approximately $5.0 million was required to cover the costs of reducing certain sectors of its workforce and facilities. The restructuring charge included an accrual of approximately $2.0 million related to severance and benefits associated with the reduction of approximately 75 positions during July 1998, as well as the related reduction of certain of the Company's facilities. Non-cash restructuring costs, which totaled approximately $3.0 million, primarily related to the write-down of non-strategic business assets made redundant or obsolete due to the streamlining of the Company's product lines and/or reduction of facilities. As a result of the restructuring programs, the Company reduced operating expenses by approximately $3.5 million, or 24%, compared to the second quarter of 1998. The Company expects completion of the restructuring plan during the remained of 1998. There can be no assurance that such decreases in operating expenses will be achieved or that, if achieved, that such reductions will be sufficient to restore profitability to the Company's operations. Write-off of Acquired In-process Technology and Other Merger Costs In May 1997, the stockholders of MetaCreations and Fractal approved the merger of the two companies. As a result of the merger, the Company issued approximately 9,055,000 shares of MetaCreations common stock for all of the outstanding shares of Fractal. During the three months ended June 30, 1997, the Company charged approximately $9.8 million against earnings related to transaction costs and other costs associated with integrating the two companies. On April 15, 1997, the Company completed the acquisition of Specular, a privately held software development company based in Amherst, Massachusetts, which develops and markets 3-D animation and graphic design tools for professionals and prosumers. Under the terms of the Purchase Agreement, the stockholders of Specular received approximately 547,000 shares of the Company's common stock, valued at approximately $4.1 million, and $1 million in cash in 15 16 exchange for all of the outstanding shares of Specular. The Company also issued 450,000 non-qualified stock options to purchase shares of the Company's common stock to Specular employees at an exercise price of $7 per share, the fair market value of the Company's common stock on April 16, 1997. The Company relocated approximately 13 of Specular's existing engineering and product management personnel to its Real Time Geometry facilities in Princeton, New Jersey, closed Specular's Amherst headquarters, and laid-off and provided severance to approximately 22 of Specular's existing operations, accounting, and sales personnel. In addition, the Company assumed the net liabilities of Specular, which totaled $1.6 million at April 15, 1997. The Company charged approximately $6.4 million against earnings during the three months ended June 30, 1997, comprised of the write-off of acquired in-process technology of $5.6 million, transaction costs of $300,000, and relocation and severance costs of $555,000. In addition, the Company recognized a deferred income tax asset of $900,000 relating to Federal net operating losses and tax credits of Specular. In accordance with SFAS No. 109, the tax benefits were first applied to reduce to zero goodwill totaling $280,000, with the remainder applied against current technology acquired from Specular. After recognition of the deferred tax asset, acquired current technology totaled $280,000. Benefit for Income Taxes Based upon a review of the Company's deferred income tax assets, available tax carrybacks, recent quarterly losses, and expected future taxable income, the Company did not record a benefit for income taxes for the three months ended September 30, 1998. Management believes that it is more likely than not that any additional income tax benefit would not be realized at this point in time. The benefits for income taxes for the three and nine months ended September 30, 1997 were based on the Company's estimated annualized effective tax rate for the year, after giving effect to the utilization of available tax credits and tax planning opportunities. Net Income (Loss) Net loss was $3.0 million, or $0.12 per share, for the three months ended September 30, 1998, compared to net income of $3.6 million, or $0.15 per share, for the three months ended September 30, 1997. For the nine months ended September 30, 1998, net loss was $16.2 million, or $0.68 per share, compared to net loss of $9.2 million, or $0.40 per share, for the nine months ended September 30, 1997. Year 2000 Compliance Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. Beginning in the year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. The Year 2000 problem could affect computers, software and other equipment used, operated, or maintained by the Company, its business partners, its suppliers and its customers. The Company has initiated an assessment project within the Company that addresses those significant systems that may have Year 2000 compliance issues. During 1997, the Company 16 17 completed implementation of a Year 2000 compliant enterprise-wide information system. Currently, the Company is in the process of inventorying and analyzing its remaining centralized computer and embedded systems to identify any potential Year 2000 issues. The Company currently expects assessment, remediation and validation of its internal systems, in addition to the development of applicable contingency plans, to be completed by the middle of 1999. The Company does not expect the cost of remediation to be material to the Company's financial condition, results of operations, or cash flows. Additionally, the Company presently believes that with the implementation of its new information system and modification to existing software, Year 2000 compliance will not have a material adverse effect on the financial condition, results of operations, or cash flows of the Company. However, there can be no assurance that the Company's internal software will contain all date code changes necessary to prevent processing errors potentially arising from calculations using the Year 2000 date. Any disruptions in product development or other operations of the Company as a result of Year 2000 noncompliance would materially and adversely affect the Company's business, financial condition, results of operations, and cash flows. Furthermore, there can be no assurance that third parties utilized by the Company are or will be Year 2000 compliant. Specifically, the Company contracts with third parties for the manufacture and distribution of the Company's products. Should any of the Company's key suppliers or distributors not achieve Year 2000 readiness, the Company may be unable to manufacture its products or effectively distribute its products to the Company's customers. As a result, the Company has initiated communications with its key suppliers and distributors and plans to monitor the status of their Year 2000 readiness. The Company expects to complete the readiness assessment of its key suppliers and distributors by March 31, 1999. To the extent that any of the Company's principal suppliers and distributors fail to demonstrate Year 2000 readiness, the Company will evaluate alternatives that could include the identification of alternate suppliers or distributors which have demonstrated Year 2000 readiness and/or the accumulation of inventory to assure production capability where feasible or warranted. These activities are intended to provide a means of managing the Company's risk, but cannot eliminate the potential for disruption due to third party failure to achieve Year 2000 compliance. Consequently, failure of any of the Company's principal suppliers or distributors to achieve Year 2000 compliance would materially and adversely affect the Company's business, financial condition, results of operations, and cash flows. The Company believes that the current versions of its products are Year 2000 compliant; however, there can be no assurance that the Company's current products do not contain undetected errors or defects associated with Year 2000 that may result in costs which are material to the Company's business, financial condition, results of operations, and cash flows. FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS 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 17 18 differ materially from those expressed or forecasted in any such forward-looking statements as a result of certain factors, including those set below, as well as those discussed elsewhere in the Company's SEC reports, including the Company's audited consolidated financial statements and notes thereto as of December 31, 1997 and 1996, and for the three years in the period ended December 31, 1997, as filed on Form 10-K. The risks described below are not the only ones facing MetaCreations. Many factors could cause results to be different, including the following risk factors and other risks described in this Form 10-Q. If any of these risks occur, our business would likely be adversely affected and the trading price of our common stock could decline, resulting in a loss of all or part of your investment. Seasonality and Fluctuations in Quarterly Results 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 we expect that they may continue to fluctuate in the future, as a result of many factors, including: - Demand for our products; - Introduction or enhancement of new products by our company or our competitors; - Market acceptance of our new products; - Industry press reviews of our products; - Changes in our prices or our competitors' prices; - The mix of distribution channels for our products; - The mix of products we sell; - Distributors' returns of our products; and - General economic conditions. In addition, we ship our products as orders are received and we therefore have little or no backlog. Hence, our quarterly operating results generally depend on a number of factors that are difficult to forecast, including the volume and timing of the orders we receive and our ability to fulfill these orders, and our ability to close distribution and licensing agreements during a particular quarter. We also experience some seasonality in our revenues as demand for our products tends to increase during the quarter ending December 31 because of year-end holiday buying trends. As is common in the software industry, our past experience shows that a disproportionately large percentage of revenues in each fiscal quarter occurs in the third month of that quarter. We generally base our staffing and other operating expenses in part on anticipated net revenues. Because a substantial portion of these net revenues may not be realized until shortly before the end of each fiscal quarter, significant variations in our financial position, results of operations and cash flows can result if there are delays in the receipt and shipment of orders. Such delays may stem, for example, from the failure of other companies to produce and ship products we have requested. We will most likely be unable to adjust spending to compensate for any unexpected revenue shortfall. Accordingly, our financial position, results of operations and cash flows would be adversely affected by any significant shortfall in revenues. Additionally, we have recently 18 19 restructured and have focused on reducing our operating expenses to levels more consistent with expected revenues. However, we cannot guarantee that such reductions in operating expenses will be enough to restore our profitability. Possible Volatility of Stock Price 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; - Actual or anticipated fluctuations in our operating results; and - Developments regarding our products, our competitors and their products. In addition, the stock market in general 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 graphics software companies. These broad market and industry fluctuations may continue to adversely affect the market price of our common stock. Product Transitions and Product Returns From time to time, we may announce the introduction of new products, product versions or technologies that may replace or shorten the life cycles of our existing products. Our competitors may also make such announcements about their products which may replace or shorten the life cycles of our products. In the past, when we announced the anticipated release of a new version of a product, we experienced increased returns of the current version of that particular product. For the three months ended June 30, 1998, we increased our reserves for returns because of lower than expected revenues in our domestic retail channels and decreased demand in Japan. Although we provide allowances for anticipated returns, we cannot guarantee that product returns will be less than these allowances, and this would adversely affect our business. From time to time, we have offered free upgrades to customers who have purchased a product following an announcement of a new release and prior to shipment of the new product version. Such free upgrades could adversely affect our revenues, and hence, our business. In certain cases we may also sell our new products and product versions at a discounted price to achieve market acceptance. These price discounts could also adversely affect our revenues and hence, our business. In addition, when we announce plans for new products or new releases, or when our competitors make such announcements, customers may delay purchasing our current products in anticipation of new products or new releases. This would also adversely affect our business. Dependence on Distributors and on Other Third Parties Although we do make some direct sales to customers, we generate most of our revenues from sales through third party distributors. We use many different distribution channels to sell our products worldwide. Examples of distribution channels include hardware and software OEMs, 19 20 international distributors, educational distributors, VARs, hardware superstores, retail dealers and direct marketers. Our future financial results depend in large part on our relationship with third party distributors and their continued financial stability. Any termination or significant disruption of our relationship with any major distributor or retailer, or any significant reduction in sales volume attributable to a major distributor or retailer, could adversely affect our business. Distribution channels through which we sell our products are subject to rapid change, significant margin pressures, consolidation and other financial difficulties. For example, if one of our distributors experienced financial difficulties such as a bankruptcy, we might be unable to collect on accounts receivable from that distributor which would adversely affect our business. It is also possible that new channels of distribution will develop and that we may not be able to effectively distribute our products through such new channels. We depend in part on our third party distributors to promote our products to retailers, who typically have a limited amount of shelf space subject to high demand. We cannot be sure that our distributors and retailers will continue to purchase our products or provide our products with adequate shelf space and promotional support. Their failure to continue to do so would adversely affect our business. An important part of our strategy is to enhance and diversify our domestic and international distribution channels. We are currently restructuring our domestic and international sales and marketing force. We are also continuing to develop relationships with new third-party distributors and resellers. Our ability to increase our sales and market share will depend in large part on our success in recruiting and training sales personnel, distributors and resellers. International Operations Our future success depends in part on our ability to expand our international presence. We sell a large percentage of our products outside of the United States. International sales accounted for approximately 25% of our net revenues for the three months ended September 30, 1998 and approximately 35% of our net revenues for the three months ended September 30, 1997. The decrease in international sales resulted primarily from a decrease in international OEM and licensing revenues. An important element of our business strategy is to continue to expand our sales in international markets, primarily Japan and Western Europe. Our ability to expand our international presence depends on our success in retaining effective international distributors and our ability to hire and retain qualified employees abroad. There are risks inherent in expanding and doing business internationally such as: - Unexpected changes in regulatory requirements; - Problems and delays in collecting accounts receivable; - Tariffs and other trade barriers; - Difficulties in staffing and managing foreign operations; - Longer payment cycles; - Political instability; - Fluctuations in currency exchange rates; - Seasonal reductions in business activity during summer (vacation) months in Europe and certain other parts of the world; and - Potentially adverse tax consequences. 20 21 Sales of our products are currently denominated in U.S. dollars. Accordingly, any increase in the value of the U.S. dollar as compared to currencies in our principal overseas markets would increase the cost in foreign denominated currency of our products. This may adversely affect our sales in those markets. To date, we have not engaged in currency hedging transactions to reduce the effect of fluctuations in currency exchange rates. In addition, effective copyright and trade secret protection may be limited or unavailable under the laws of certain foreign jurisdictions. If any of these risks were to occur, they would adversely affect the success of our international operations and would adversely affect our business. A significant portion of our net revenues stem from the Asia Pacific region, primarily Japan. Japan has recently experienced weaknesses in their currency, banking and equity markets. We cannot guarantee that the financial condition in Japan and in the Asia Pacific region will improve in the near future. If the current financial crisis in the Asia Pacific region continues or worsens, our business will be adversely affected. For example, during the three months ended June 30, 1998, our net revenues from the Asia Pacific region were decreased as a result of depressed demand for our products due to the current Asian financial crisis. Highly Competitive Markets We face intense competition in the market for graphics software products. The market for our products can change rapidly, and customers constantly demand new product features, accelerated releases of new products and product enhancements. We experience constant pressure to reduce the prices of our products. Our products compete directly or indirectly with products offered by many other large companies, including: - Adobe Systems Incorporated; - Autodesk, Inc.; - Corel Corporation; - Macromedia, Inc.; - Silicon Graphics, Inc. (through its Alias/Wavefront division); - Microsoft Corporation; and - Broderbund Software, Inc. Many of our competitors or potential competitors are larger than we are and have significantly greater financial, managerial, technical and marketing resources than we have. Our business would be adversely affected if any of our competitors cut prices, increased their promotions of their products (including bundling or giveaways of products), announced or accelerated introduction of new products or enhanced product features or acquired additional applications or technologies from third parties. Our present or future competitors may be able to develop products comparable or superior to ours or may be able to develop new products faster than we can. We also face competition from developers of personal computer operating systems, such as Microsoft and Apple Computer, 21 22 which may incorporate functions into their operating systems which could be superior to or incompatible with our products. Such competition would also adversely affect our business. We are currently developing additional product enhancements that we believe will address customer requirements, but we cannot be sure that we will complete our development and introduction of these products on a timely basis. In addition, we cannot be sure that these product enhancements will achieve market acceptance. If we are unable to compete effectively in our markets, or if competition becomes increasingly intense, our business would be adversely affected. Dependence on Key Personnel and Difficulty of Identifying and Hiring Certain Personnel We depend on the continued employment of our senior executive officers and other key management personnel. If any of our senior officers or other key employees leave our company and are not adequately replaced, our business would be adversely affected. During February 1998, our previous Chief Executive Officer, John Wilczak, resigned. Gary Lauer, who had most recently served as President of Silicon Graphics, Inc.'s ("SGI") World Trade Group and Executive Vice President of SGI's Worldwide Field Operations, succeeded Mr. Wilczak as our Chief Executive Officer. In addition, in connection with our recent restructuring, our Senior Vice President, Sales and Marketing; Vice President, Marketing; and Vice President, Product Management and Design have left our company. We have hired a Vice President, European Sales and Marketing, and a Vice President and General Manager, Professional Products Group, and are seeking to hire at least one additional Vice President, Sales and Marketing. If we do not succeed in attracting new officers, our business would be adversely affected. Our future success also 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. Rapid Technological Change; Dependence on and Need for New Products and Product Versions; Potential Delays in Product Releases The market for visual computing graphics software products, and the personal computer industry in general, is characterized by rapidly changing technology. Product life cycles are short and downward pricing pressures are strong. As a result, our success depends substantially upon our ability to continue to enhance our products and to develop new products that meet customers' increasing expectations and that incorporate the latest technology. If our competitors introduce products that better address customers' needs, our business would be adversely affected. We cannot guarantee that we will be successful in developing and marketing enhancements to our existing products or introducing new products on a timely basis. Nor can we guarantee whether any new or enhanced products will be successful in the marketplace. If 22 23 our new products or product versions receive bad reviews in industry publications, this would likely decrease their potential market acceptance and our business would be adversely affected. We intend to continue to increase our research and development expenditures. If our increased research and development spending is not accompanied by increased revenues, our business would be adversely affected. We have supplemented our research and development efforts by exclusively licensing products developed by or co-developed with third parties. We cannot guarantee that we will be able to continue to obtain such outside product development capabilities on terms favorable to us or at all. If we cannot maintain existing development arrangements or fail to attract new product development partners, then we would, at the least, have to further increase our research and development spending. This would adversely affect our business. Furthermore, we cannot guarantee that such additional research and development expenditures would result in the production of commercially acceptable products or profitability. We also depend upon internal efforts for the development of new products and product enhancements. In the past, we have had delays in the development of new products and product versions. We cannot guarantee that we can avoid delays regarding our current product development or future development activities. We offer complex software products and they may contain undetected errors when first introduced or as new versions are released. In the past, we have discovered software errors in certain new products and enhancements after these products were introduced to the marketplace. We cannot guarantee that our new products or releases will be free of errors. If errors are found in our products after we have commercially shipped them, we would likely experience bad product reviews and a loss or delay of market acceptance. This would adversely affect our business. Evolving Markets for Computer Graphic Imaging and Internet/Online Design Tools The markets for computer graphic imaging and Internet/online design tools are still emerging. We cannot guarantee that digital graphic and Internet/online content developers will adopt our products or that our existing products will grow. Nor can we guarantee that we will have sufficient distribution resources to market our products successfully or that any of our products will achieve market acceptance. The demand for computer graphic imaging and Internet/online design tools depends on many factors including: - Installed base of digital graphic and multimedia capable personal - computers; Widespread availability of digital media; and Number and - expertise of skilled content producers. If the markets for such tools fail to grow or grow more slowly than we currently anticipate, or if our products fail to achieve market acceptance, our business would be adversely affected. 23 24 Proprietary Rights and Licenses 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 and products. We distribute our software under shrinkwrap license agreements. We generally do not obtain signed license agreements from the end users of our software. As is typical in the software industry, we do not copy-protect our software. As a result, unauthorized third parties may be able to copy or reverse engineer our products. In addition, our competitors may independently develop technologies that are substantially equivalent or superior to our technology. We may not be able to police unauthorized uses of our products, and we expect that software piracy could be a chronic problem. We also distribute or plan to distribute our products in other countries which do not protect the intellectual property of our products to the same extent as laws in the United States. We also believe that the growing number of software products available and the increasing overlap of products may lead to a greater number of infringement claims. Our products may be the subject of infringement claims in the future, which 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. LIQUIDITY AND CAPITAL RESOURCES Historically, net cash used in operating activities and investing activities of the Company has been significant due to operating losses from restructurings, acquisitions and mergers and working capital requirements resulting from the growth of the Company. Cash and investments totaled $49.6 million at September 30, 1998, compared to cash and investments of $50.0 million at December 31, 1997. Net cash provided by operating activities of the Company totaled $1.7 million for the nine months ended September 30, 1998, compared to net cash used in operating activities of $(10.7) million for the nine months ended September 30, 1997. The increase in cash provided by operating activities is primarily attributed to the decrease in accounts receivable during the nine months ended September 30, 1998. Net cash provided by investing activities totaled $3.0 million and $457,000 for the nine months ended September 30, 1998 and 1997, respectively. The change resulted primarily from net purchases of short-term investments during the nine months ended September 30, 1998, compared to net sales of short-term investments, in addition to higher purchases of property and equipment during the nine months ended September 30, 1997. Additionally, the Company made cash payments totaling $1.2 million in connection with its acquisition of Specular in April 1997. Net cash provided by financing activities totaled $736,000 and $965,000 for the nine months ended September 30, 1998 and 1997, respectively, resulting from proceeds received from the exercise of stock options by the Company's employees during the respective periods. Additionally, the Company paid off notes payable totaling $274,000 during the nine months ended September 30, 1997, in connection with its acquisition of Specular. 24 25 The Company expects that its working capital requirements will continue to increase to the extent the Company grows. The Company believes that its current cash and investment balances, cash provided by future operations, if any, and available borrowings under the Company's line of credit are sufficient to meet its working capital needs and anticipated capital expenditure requirements through at least the next twelve months. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 requires publicly-held companies to report financial and other information about key revenue-producing segments of the entity for which such information is available and is utilized by the chief operating decision maker. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. A reconciliation of segment financial information to amounts reported in the financial statements would be provided. SFAS No. 131 requires companies to adopt its provisions for fiscal years beginning after December 15, 1997, but does not require that segment information be reported in financial statements for interim periods in the initial year of application. Management is currently evaluating the requirements of adopting SFAS No. 131 and the effects, if any, on the Company's current reporting and disclosures. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS None Item 2. CHANGES IN SECURITIES On July 24, 1998, the Board of Directors of the Company announced that it had declared a dividend distribution of one Preferred Share Purchase Right (the "Rights") on each outstanding share of the Company's Common Stock. The Rights are designed to assure that the Company's stockholders receive fair and equal treatment in the event of any proposed takeover of the Company and to guard against partial tender offers and other abusive tactics to gain control of MetaCreations without paying all stockholders the fair value of their shares, including a "control premium." Each right will entitle stockholders to buy one one-thousandth of a share of the Company's Series A Participating Preferred Stock at an exercise price of $38.00. The Rights will become exercisable following the tenth day after a person or group announces acquisition of 15% or more of the Company's Common Stock or announces commencement of a tender offer the consummation of which would result in ownership by the person or group of 15% or more of the Common Stock. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the tenth day following acquisition by a person or group of 15% or more of the Company's Common Stock. 25 26 If, prior to redemption of the Rights, a person or group acquires 15% or more of the Company's Common Stock, each Right not owned by a holder of 15% or more of the Common Stock will entitle its holder to purchase, at the Right's then current exercise price, that number of shares of Common Stock of the Company (or, in certain circumstances as determined by the Board, cash, other property or other securities) having a market value at that time of twice the Right's exercise price. If, after the tenth day following acquisition by a person or group of 15% or more of the Company's Common Stock, MetaCreations sells more than 50% of its assets or earning power or is acquired in a merger or other business combination transaction, the acquiring person must assume the obligations under the Rights and the Rights will become exercisable to acquire Common Stock of the acquiring person at the discounted price. At any time after an event triggering exercisability of the Rights at a discounted price and prior to the acquisition by the acquiring person of 50% or more of the outstanding Common Stock, the Board of Directors of the Company may exchange the Rights (other than those owned by the acquiring person or its affiliates) for Common Stock of the Company at an exchange ratio of one share of Common Stock per Right. The dividend distribution was made on August 13, 1998, payable to stockholders of record on August 13, 1998. The Rights will expire on August 13, 2008. Item 3. DEFAULTS UPON SENIOR SECURITIES None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
Exhibit Number Exhibit Title -------------- ------------- 27.1 Financial Data Schedule
(b) Reports on Form 8-K None 26 27 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: November 13, 1998 /s/ TERANCE A. KINNINGER --------------------------------------- Terance A. Kinninger Sr. Vice President and Chief Financial Officer 27 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE ACCOMPANYING UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 9-MOS DEC-31-1998 DEC-31-1998 APR-01-1998 JAN-01-1998 SEP-30-1998 SEP-30-1998 9,069 9,069 40,525 40,525 11,900 11,900 0 0 711 711 72,079 72,079 14,335 14,335 7,098 7,098 80,779 80,779 8,297 8,297 0 0 0 0 0 0 24 24 72,458 72,458 80,779 80,779 9,053 31,491 9,053 31,491 1,544 5,437 1,544 5,437 11,094 44,594 0 0 0 0 (2,952) (16,521) 0 (353) (2,952) (16,168) 0 0 0 0 0 0 (2,952) (16,168) (0.12) (0.68) (0.12) (0.68)
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