-----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, OoyeHRaYn73GMy2L8eckHUBnjKdxGdSAg/3hRKJv1izI7pqXb53GthuntXCadxSK Glo40hC7Ud3ldnIeuxOYHQ== 0000950148-99-000658.txt : 19990402 0000950148-99-000658.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950148-99-000658 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 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-K405 SEC ACT: SEC FILE NUMBER: 000-27168 FILM NUMBER: 99581990 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-K405 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 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 AVENUE, CARPINTERIA, CA 93013 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (805) 566-6200 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $0.001 PAR VALUE 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to the Form 10-K. [X] As of March 10, 1999, there were outstanding 24,410,038 shares of the registrant's Common Stock, $0.001 par value, which is the only outstanding class of common or voting stock of the registrant. As of that date, the aggregate market value of the shares of Common Stock held by non-affiliates, based upon the last sale price of the shares as reported on the NASDAQ National Market System on such date, was approximately $115,828,322. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the registrant's definitive proxy statement relating to its 1999 Annual Meeting of Stockholders to be held in May 1999 are incorporated by reference into Part III. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 METACREATIONS CORPORATION FORM 10-K TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business.................................................... 1 Item 2. Properties.................................................. 16 Item 3. Legal Proceedings........................................... 16 Item 4. Submission of Matters to a Vote of Security Holders......... 16 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................... 18 Item 6. Selected Financial Data..................................... 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 20 Item 8. Financial Statements and Supplementary Data................. 29 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 58 PART III Item 10. Directors and Executive Officers of the Registrant.......... 58 Item 11. Executive Compensation...................................... 58 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 58 Item 13. Certain Relationships and Related Transactions.............. 58 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................................... 59
3 PART I This Annual Report on Form 10-K 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 set forth in "Additional Factors Affecting Future Results." In connection with forward-looking statements which appear in these disclosures, investors should carefully review the factors set forth in this Form 10-K under "Additional Factors Affecting Future Results." ITEM 1. BUSINESS MetaCreations Corporation ("MetaCreations" or the "Company") is a leading provider of graphics software for use in print, the World Wide Web (the "Web" or the "Internet") and computer graphics applications. The Company develops and markets 2D and 3D visualization software and technologies for use by professionals and consumers. MetaCreations offers a broad product line of award-winning graphics desktop software for both Windows and Macintosh platforms, and its products are available in more than 50 countries. In 1998, MetaCreations introduced its "Creative Web" strategy, designed to leverage the Company's 2D and 3D visualization technologies for use in a variety of applications on the Web. The Creative Web strategy is centered on the Company's new MetaStream and MetaFlash technologies, and employs an array of MetaCreations' software development tools to accelerate the creation of 2D and 3D graphics for online applications, and to make fast, interactive use of photo-realistic 3D on the Web practical, viable and easy. In connection with the Company's new business focus, on June 30, 1998, MetaCreations announced a restructuring plan aimed at reducing costs and improving competitiveness and efficiency, which was implemented during the third quarter of 1998. In connection with the restructuring, management determined that a restructuring charge of approximately $5 million was required to cover the costs of reducing certain sectors of its workforce and facilities. INDUSTRY BACKGROUND Computer graphic imaging and visual computing tools are standard tools for desktop publishers, Web site designers, production artists, multimedia developers, creative directors, digital imagers and photographers (collectively, "Creative Professionals") to develop and present their materials. Creative Professionals may use digital painting, illustration, composition, page layout and design, special effects, digitally captured images and video, animation, text, photographs, music and other audio to produce a wide variety of end products. Creative Professionals also use computer modeling tools to design 3D objects, landscapes and environments. The images and content generated by these Creative Professionals increasingly must be deliverable through a wide variety of media, including print, the Web, intranets, video, and film. Business professionals and consumers are also increasingly using graphical and digital creative productivity software tools at work and in the home. Factors influencing the use of computer graphic imaging and Internet/online design tools include: - The Rapid Expansion of the Internet and Electronic Commerce Environments. The rapid expansion of the Internet and electronic commerce environments is driving demand for tools to create enhanced digital graphic and multimedia content for use in Web sites. Examples of these uses include the electronic merchandising of products, electronic catalogs, virtual shopping malls, the 3D inspection of real estate, travel destinations and entertainment venues, electronic magazines and newspapers, financial analysis, online games, educational materials and other forms of online visual communication and data analysis. - The Enhancement of Visual Media for Communications, Commerce, Entertainment and Education. Computer graphic imaging tools are changing the way information is communicated. Increasingly, 1 4 producers of magazines, annual reports, marketing brochures, product packaging, advertising and newsletters are using software graphic arts tools to create sophisticated illustrations and graphic designs for desktop published material. Similarly, Internet/online design tools provide Web developers the ability to create high impact Web sites, sales presentations, catalogs, advertising, product demonstrations, data analysis, videos, educational materials, and game environments. - The Growing Availability of Digital Content. There is a growing body of professionally produced digital images and electronically produced media. The digital nature of this content enables Creative Professionals to enhance and manipulate this 2D and 3D content in a variety of media, including print, the Web, video and film. Information that has been digitized includes photographs, 3D objects, illustrations, video, animations, voice and music. - The Proliferation of Powerful Computers and Peripherals and Expanding Bandwidth on the Web. The increased performance, affordability and availability of powerful personal computers and graphics accelerator chips, and related high performance peripheral devices such as digital cameras, digital capture devices, scanners, Jazz and Zip drives, high-capacity hard drives, and high resolution color printers, have led to a proliferation of graphics and multimedia-capable computers in business and the home. In addition, continued increases in bandwidth for online environments is expected to increase demand for enhanced graphics and digital content for the Web. In response to these trends, Creative Professionals, including Web site developers and those providing e-commerce on the Web, are continually seeking new tools and technology to enhance their productivity to create and capture digital content. As a result, the Company believes that there is a demand for fast, powerful and easy to use tools and technologies that go beyond the capabilities of existing applications. Businesses are also looking for productivity tools to creatively manipulate, analyze and display their business data and digital imaging at work, at home, and on the Web. Further, the Company believes that high resolution, photo-realistic 3D is critical for the future of visual computing on the Internet, particularly related to the merchandising of products and services for e-commerce. STRATEGY The Company is a leading provider of computer graphics and design tools. The Company's Creative Web strategy is targeted at leveraging its powerful 2D and 3D graphics products and technologies into new markets on the Web with a focus on e-commerce applications. The Company's strategies include the following key elements. - Enhance Professional Software Products and Enable Web Capabilities. MetaCreations' priority for 1999 is to revitalize growth from its core professional graphics software products, by enhancing its leading products, Painter, Kai's Power Tools, Bryce, Poser, Infini-D, and Ray Dream Studio. To achieve this goal, the Company plans to introduce new versions of these products in 1999, which will include increased Web functionality and interactivity. - Leverage MetaStream and MetaFlash Technologies to Extend 3D Visualization to the Web. MetaStream is a 3D file format jointly developed by MetaCreations and Intel that enables the delivery of high-quality 3D graphics over the Web. MetaStream content progressively streams over the Internet, and scales to the performance of a user's particular computer system, maximizing the user's graphical experience. MetaFlash is the combination of a flash attachment for standard digital cameras and powerful software that reconstructs digital pictures into high-quality, texture-mapped 3D wire frame models. The MetaFlash technology reduces the time and cost involved in producing and capturing photo-realistic 3D images. MetaFlash outputs to the MetaStream 3D file format, which can then be streamed over the Web and viewed with the MetaStream client-side engine. The combination of MetaStream and MetaFlash, along with MetaCreations' 3D modeling and editing tools, are planned to give the Internet community an integrated, end-to-end solution for the capture, transmission, viewing and manipulation of 3D content for a variety of applications, including electronic merchandising. 2 5 - Use Strategic Acquisitions to Develop Complementary Technologies. In December 1997, the Company acquired Real Time Geometry Corp. ("RTG") whose proprietary technology has been further developed into MetaStream and the recently announced MetaFlash. In December 1998, the Company acquired Canoma, Inc., and anticipates the further development of its in-process technology which will enable the creation of photorealistic 3D models from 2D digital photographs or scanned images. This technology will be incorporated into a product expected to be released by the Company in the first half of 1999. In the future, the Company may make similar acquisitions that complement the Company's existing product line and the Creative Web strategy. - Introduce Dynamic 2D Products for the Web. MetaCreations' new 2D product, Headline Studio, features an easily accessible tool set to quickly create high quality animated banners for advertising on the Web. Late in 1998 the Company released Painter 5.5 Web Edition, which allows for the creation and output of sophisticated natural media content for Web design. Headline Studio, which was released during the first quarter of 1999, and Painter 5.5 Web Edition are expected to be part of a future suite of powerful MetaCreations 2D products for Web developers, e-commerce site designers, and hosting sites. - Leverage Strategic Alliances. During 1998, the Company entered into a series of strategic licensing and co-marketing agreements for the MetaStream and MetaFlash technologies with third party hardware and software companies. In May 1998, the Company announced its partnership with Intel Corporation ("Intel") for the joint development of the MetaStream 3-D file format designed for Intel Architecture. In June 1998, Microsoft Corporation ("Microsoft") licensed the MetaStream 3D graphics file format and related run-time engine and in November 1998 announced plans to distribute MetaStream with the Windows 98 and Windows 2000 operating systems. In January 1999, the Company announced that Intel will co-develop and acquire a license for the MetaFlash technology and assist the Company in efforts to support swift market adoption of MetaFlash. During January and February 1999, the Company announced separate agreements with Eastman Kodak Company ("Kodak") and Minolta Co., Ltd. ("Minolta") for the production and distribution of 3D digital cameras using the MetaFlash technology. These new strategic licensing and co-marketing arrangements offer MetaCreations the opportunity to establish wide market penetration and acceptance of these products and technologies. - Distribute Software Via the Web. While sustaining its strong relationship with its traditional distributors, MetaCreations plans to extend its direct distribution, employing the Web for direct-to-customer marketing and sales, with delivery of products via electronic software download or mail. In addition to increasing direct sales, this move will demonstrate the effectiveness of the Company's e-merchandising technology by making MetaCreations.com a model of online commerce and communications. - Expand Sales in International Markets. The Company is investing in its sales efforts globally to capitalize on and drive geographic expansion. Recently, MetaCreations hired a Munich-based Vice President, European Sales and Marketing, and a Tokyo-based Director of Sales for Japan. In addition, the number of international sales and marketing personnel is being increased, and as conditions warrant MetaCreations will continue to invest and expand the Company's international visibility and presence. PRODUCTS MetaCreations focuses its product development efforts on creating affordable, high performance, high quality and easy to learn and use software tools. Key features of the Company's products include the following: - Innovative User Interface Design. MetaCreations' products are designed with innovative user interfaces to facilitate ease of learning and use while providing access to advanced algorithmic-based graphics design and special effects techniques. The Company's products are designed to allow customers to control the creative process and explore new areas of graphic design without requiring a detailed understanding of the enabling technology. 3 6 - Portability. The Company develops its products in the C and C++ programming languages, facilitating portability to alternative operating systems, and focuses on the Windows and Macintosh platforms. The Company will continue to evaluate available hardware and software platforms and consider adapting its products for use on such platforms as technological advancements and market demands dictate. - Resolution Independent Imaging Technology. Many of the Company's tools create and manipulate images through the application of sophisticated proprietary mathematical algorithms, rather than by generating new bit-mapped graphics at each stage of the design process, enabling real time manipulation and rapid prototyping of creative alternatives. MetaCreations classifies it products within two categories: professional and consumer. The Company's professional product line includes both 2D products, consisting of Painter 5.5 Web Edition, Kai's Power Tools 5 and Headline Studio, and 3D products, consisting of Bryce 3D, Poser 3, Ray Dream Studio 5, Infini-D 4.5, MetaStream, and MetaFlash. The leading consumer products include Kai's Super GOO, Kai's Photo Soap 2, and Kai's Power Show. 2D PROFESSIONAL PRODUCTS Painter. Painter is an advanced paint and image-editing platform which empowers digital designers and graphics artists with more than one hundred Natural-Media brushes that simulate the look of traditional art tools and techniques, Dynamic Plug-in Floaters which perform image processing effects such as buring and tearing to the selected item in real time, and customizable palettes and tear-off tools which allow artists and designers the option to optimize their environment. The latest version, Painter 5.5 Web Edition, incorporates image slicing, dynamic text, JavaScript rollover support, easy custom button creation, and a built-in content library of more than 1,000 Web-ready images for stunning Web site graphics. Painter 5.5 Web Edition, which was released in the third quarter of 1998 and is available on the Windows and Macintosh platforms in English, Japanese, German, French, and Chinese, has a suggested retail price of $299. Kai's Power Tools ("KPT"). Kai's Power Tools is a set of creative and production extensions to graphics products that support the Adobe plug-in architecture, including Adobe's PhotoShop, Micrografx Inc.'s Picture Publisher, Corel Corporation's PhotoPaint, MetaCreation's Painter and other leading application platforms. KPT allows the creation of new graphic forms through an advanced user interface design and, in certain cases, integration of multiple-step image processing functions into a single step. The most recent version, KPT 5, which is available on the Windows and Macintosh platforms in English, Japanese, German and French, was released in the fourth quarter of 1998. The suggested retail price of KPT 5 is $199. Headline Studio is a dynamic new software for Web design professionals who want to create animated, broadcast-quality Web advertising banners. Headline Studio contains all the necessary tools in an easily accessible format to quickly create animated GIF banner ads for the Web that can be viewed on any browser at multiple bandwidths. Headline Studio, which was released in the first quarter of 1999, is available on both the Windows and Macintosh platforms via e-commerce and electronic distribution. Headline Studio is available in English, Japanese, German, and French at a suggested retail price of $199. 3D PROFESSIONAL PRODUCTS Bryce. Bryce, first released in the third quarter of 1994, is an application platform that provides Creative Professionals with the ability to generate natural and supernatural 3D landscapes and terrains. Bryce provides Creative Professionals with powerful functions, including materials and texture creation and editing capabilities, and provides non-graphic arts professionals and consumers unfamiliar with 3D graphics design an entry point into the development of photo-realistic 3D worlds. Bryce enables advanced, photo-realistic creation of skies with natural cloud formations, humidity, fog and light diffraction, as well as rivers, snowy peaks, deserts, or ocean floors, supplemented by an array of special effects including complex textures and reflective surfaces. The most recent version, Bryce 3D, which allows any property such as atmospheres, terrains, or objects to be animated, was released on both the Windows and Macintosh platforms in the fourth quarter of 1997. Bryce 3D 4 7 is available in English, Japanese, German and French. The suggested retail price of Bryce 3D is $199. The Company plans to release a new version of Bryce, Bryce 4, in the first half of 1999. Poser. Poser, introduced in the second quarter of 1995, is a modeling application that allows users to create and animate images of human figures and animals which can be posed, rendered with surface textures and multiple lights, and easily incorporated into artwork and designs. Model images created with Poser can be exported for use in graphics design, illustration, multimedia and 3D software. Poser is designed to work with 2D and 3D design application such as Painter, Adobe's PhotoShop, Macromedia's Director, and several other products. Poser 3, the most recent version, was released in the second quarter of 1998 on both the Windows and Macintosh platforms. Poser 3 is available in English, Japanese, German, and French. The suggested retail price of Poser 3 is $199. Ray Dream Studio ("Studio"). Studio is an application platform that provides Creative Professionals the ability to create lifelike 3D illustrations and animations. Studio incorporates a Mesh Form Modeler which provides exceptional control over individual polygons, lines, or vertex points on the model; a Free-Form Modeler which allows the generation of models by extruding, lathing, lofting, and sweeping; a Natural-Media renderer which allows the creation of 3D graphics that resemble cartoons, paintings, or sketches; and a set of volumetric and particle-based primitives, including fire, fog, clouds, and fountains, which allow the creation and animation of incredible natural effects. Studio 5, the most recent version, was released on the Windows and Macintosh platforms in the third quarter of 1997. Studio 5 is available in English, Japanese, German and French at a suggested retail price of $449. Infini-D. Infini-D is an application platform that gives video professionals and animation and multimedia artists in both the broadcast and corporate arenas the tight integration and fast feedback needed to create high-quality 3D animations in a production environment. Infini-D incorporates a comprehensive list of powerful special effects, including sophisticated particle systems, volumetric lighting effects, and deformation tools. Additionally, the most recent version, Infini-D 4.5, incorporates the Company's MetaStream multiresolution technology which allows artists to interactively change the resolution of any 3D model and customize the number of polygons a model uses while maintaining structural integrity. Infini-D 4.5 was released in the second quarter of 1998 on both the Windows and Macintosh platforms. The suggested retail price of Infini-D 4.5 is $899. MetaStream. MetaStream enables developers to author content to deliver high-quality 3D graphics over the Web. MetaStream content progressively streams and scales over the Internet and in PC games, adjusting to the performance of a user's particular computer system. MetaStream-enabled content also takes advantage of Direct-X-based high-performance graphics software services for multimedia and game developers. The Company has entered into licensing agreements for the MetaStream technology with Intel and Microsoft. The Company has also incorporated the MetaStream technology into a number of products released during 1997 and 1998, including Infini-D 4.5 and Ray Dream Studio 5, and plans to continue incorporating the technology into future software products. The MetaStream client-side engine, which plugs into Microsoft Internet Explorer and Netscape Navigator, is available for download on the Windows platform at www.metastream.com. MetaFlash. MetaFlash is the combination of a flash attachment for standard digital cameras and powerful software that reconstructs digital pictures into high-quality, texture-mapped 3D wire frame models. The MetaFlash technology reduces the time and cost involved in producing photo-realistic 3D Web images. MetaFlash outputs to the MetaStream 3D file format, which can then be streamed over the Web and viewed with the MetaStream client-side engine. The MetaFlash technology has been licensed by Intel, Kodak and Minolta. Cameras equipped with the MetaFlash technology are expected to be released by Kodak and Minolta in the second half of 1999. CONSUMER PRODUCTS Kai's Super GOO ("GOO"). GOO, the first consumer product offered by the Company, allows users to turn pictures into images and then stretch, grow, animate, fuse, mutate, or apply a host of other special effects to the images in real time. A library of images is included, or users can import images from a variety of 5 8 sources, including images from 35 mm film transferred to CD-ROM or diskette, digital cameras, scanners, capture devices, video cameras, or the Web. Images can be printed out or saved for use on personalized items such as t-shirts, mugs, or screen savers, or can be easily dropped into a real-time animation that instantly transforms the original still image into a movie-like sequence which can be uploaded to Quicktime and AVI movies. GOO, which is available on both the Windows and Macintosh platforms in English, Japanese, German, French, Spanish, and Italian, was released in the second quarter of 1998. The suggested retail price of GOO is $49.95. Kai's Photo Soap ("Soap"). Soap, the second of the Company's home photo digital imaging software programs, provides consumers the ability to clean, edit, and manipulate personal photographs and other images in real time, producing digital content such as slide shows that can be e-mailed, posted on a Web page, printed on a color printer, or output to imaging software and hardware for further manipulation or integration into desktop publishing applications. Soap 2, the most recent version, allows users to convert digital images to instantly viewable HTML formats or 3D picture cubes utilizing the MetaStream format for posting on the Web. Soap 2 was released in the fourth quarter of 1998 on both the Windows and Macintosh platforms in English, Japanese, German, and French, at a suggested retail price of $49.95. Kai's Power Show ("Show"). Show, which was released in the first quarter of 1998, is a home photo and business presentation software player which offers consumers a simple way to create a dynamic photo show or enhance a business presentation. Show allows consumers to import and organize digital media such as digital photos, artwork, and video clips; sequence these elements; and add real time TV-like transitions and animated placement of digital photos, text, artwork, and video clips. The completed show can then be shared with family, friends, or business associates via a computer display, projector, stand-alone player, printer, or videotape. Show, which is available on both the Windows and Macintosh platforms in English, Japanese, German, and French, has a suggested retail sales price of $49.95. MARKETING, SALES AND DISTRIBUTION MetaCreations develops awareness and demand for its products through public relations activities, advertising, product reviews, tradeshows, the Company's Web site, seminars, keynote speeches and lectures at major digital design, multimedia and online conferences throughout the world. The Company also utilizes direct mail and e-mail to introduce, educate and sell to customers new products and upgrades in conjunction with activities of the Company's distributors, dealers and in-house telemarketing operations. In addition, the Company has begun advertising through the use of banner ads, e-mail, and links from Web sites on the Internet. The Company also focuses on building a user community through a number of initiatives, including producing and co-sponsoring events at major tradeshows, at which the press, distributors and complementary hardware and software manufacturers can gather to demonstrate technology, make contacts and exchange ideas regarding digital graphic arts, multimedia and Internet/online communications. MetaCreations sells its products worldwide through multiple distribution channels, including traditional software distributors, hardware and software Original Equipment Manufacturers ("OEMs"), international distributors, educational distributors, value-added resellers ("VARs"), computer superstores, retail dealers, mail order and direct sales. The Company's primary sales channel is through large software distributors such as Ingram Micro, Inc. and Tech Data, which in turn distribute the Company's products through large retail chains, catalogs, and smaller retail dealers. In 1998, 1997, and 1996, Ingram Micro, Inc., the Company's largest domestic distributor, accounted for approximately 8%, 17%, and 20% of net revenues, respectively. The Company supports this channel by referring retail dealer sales, educational distributor sales and mail order sales to these major distributors. The Company receives inventory and sales reports from its distributors and certain major retailers to help monitor sales through this channel. As is typical in the personal computer software industry, the Company grants its distributors limited rights under a stock balancing policy to return unsold inventories of the Company's products in exchange for new purchases. In addition, the Company provides price protection to its distributors in certain instances when it reduces the price of its products. The Company offers product sales and upgrades directly to qualified third-party resellers and end users. By selling to repeat customers in the Company's installed base of registered customers, the Company 6 9 complements its primary distribution channels. MetaCreations also sells its products directly to end users over the Web through its online store and has recently begun to deliver certain of its products via electronic software download from its Web site. The Company currently distributes its products through over 70 international distributors in over 50 countries worldwide, with approximately 29%, 38%, and 41% of the Company's net revenues coming from international markets in 1998, 1997, and 1996, respectively. In some cases, the distributor has exclusive distribution rights to certain products in its country. Effective February 1996, MetaCreations entered into a distribution agreement with Marubeni Corporation, a leading software distributor in Japan, for the exclusive distribution rights of certain of its products in Japan. In 1998, 1997, and 1996, Marubeni Corporation accounted for approximately 15%, 12%, and 2% of net revenues, respectively. During the fourth quarter of 1996, MetaCreations entered into a similar agreement with Prisma Express Distributionsgesellschaft GmbH, a leading software distributor in Germany, for the exclusive distribution rights of certain of its products in Germany, Austria, and Switzerland. In addition, the Company established its international operations headquarters in Dublin, Ireland in September 1996, where the Company localizes, manufactures and distributes international versions of its products. In August 1998, the Company hired a Vice President, European Sales and Marketing, and in February 1999, the Company hired a Director of Sales for Japan. The Company intends to continue to make strategic investments in additional markets throughout Europe, Asia and Latin America. MetaCreations sells its products to educational institutions primarily through a distributor which specializes in the education market, including campus resellers, bookstores and educational mail order houses. The Company views the education market as a strategic opportunity to establish product and brand preferences early in the careers of future graphic arts and business professionals. Accordingly, the Company offers substantial educational discounts. MetaCreations actively maintains OEM relationships with many hardware and software vendors that bundle MetaCreations products with their own complementary hardware or software products and pay the Company royalties. The Company believes that OEM sales increase the brand recognition of its products and expand its customer and revenue base. In addition, these relationships give the Company early access to computer graphic imaging, multimedia and Internet/online technologies, which assist MetaCreations in quickly adapting its products for compatibility with, or in releasing new products based on, such technologies. Some of the Company's OEM customers include 3Com Corporation; Acer Peripherals, Inc.; Apple Computer, Inc.; Bayer Corporation (AGFA division); Digital Equipment Corporation; Epson America, Inc.; Matrox Graphics, Inc.; Play, Inc.; Ricoh Corporation; UMAX Technologies, Inc.; and Wacom Computer Systems. The Company has also pursued and entered into marketing, distribution and licensing agreements related to certain of its technologies, including MetaStream and MetaFlash. The Company believes that such agreements allow it to more effectively create market demand and acceptance for new technologies. Some of the companies who have entered into such agreements include Eastman Kodak Company; Intel Corporation; Microsoft Corporation; and Minolta Co., Ltd. PRODUCT DEVELOPMENT The Company's principal current product development efforts are focused on utilizing its core enabling technologies to develop enhanced digital graphic and content creation tools for Creative Professionals and the Internet and commercial online environments. From time to time, the Company may also acquire basic software technologies that it considers critical to building computer graphic imaging and Internet/online design tools. The Company has supplemented its internal product development efforts by licensing on an exclusive basis products developed by or co-developed with third parties. MetaCreations believes that outsourcing certain of its product development activities enables it to capitalize on the latest technological innovations. 7 10 The Company's growth will be dependent upon the introduction of new products and new versions of existing products. There can be no assurance that any such new products or versions will achieve market acceptance. In addition, the Company has in the past experienced delays in the development of new products and the enhancement of existing products, and such delays may occur in the future. If the Company were unable, due to resource constraints or technological or other reasons, to develop and introduce such products in a timely manner, this inability could have a material adverse effect on the Company's business, operating results, financial condition, and cash flows. In particular, the introductions of new products or enhanced versions of existing products, are subject to the risk of development delays. Any delay in the availability of new products could have a material adverse effect on the Company's business, operating results, financial condition, and cash flows. The Company's research and development expenses were approximately $15.8 million, $14.1 million, and $8.2 million for 1998, 1997, and 1996, respectively. CUSTOMER AND TECHNICAL SUPPORT The Company has built a customer education and technical support organization focused on providing value to the Company's customers beyond the purchase of the Company's products. MetaCreations provides customer and technical support to customers via e-mail on the Internet and through online services, fax and telephonic communication. In addition, the Company supports an online community through its presence on the Web, where technical support, tips and tricks and an entire electronic book on advanced imaging techniques can be found. The Company also conducts seminars regularly for prospective and current customers at leading tradeshows and conferences throughout the world, providing education and insight into the uses of the Company's technology. COMPETITION The Company faces competition from a number of sources, including other vendors of personal computer graphic imaging and Internet/online design application tools and other personal computer software industry participants, including: Adobe Systems Incorporated; Autodesk, Inc.; Corel Corporation; Macromedia, Inc.; and Microsoft Corporation. Many of the Company's competitors or potential competitors have longer operating histories and significantly greater financial, management, technology, development, sales, marketing and other resources than the Company. As the Company competes with larger competitors across a broader range of product lines, the Company 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 those of the Company, the Company's business, operating results, financial condition, and cash flows would be materially adversely affected. A variety of other possible actions by the Company's competitors could also have a material adverse effect on the Company's business, operating results, financial condition, and cash flows, including increased promotion, the bundling of competitive products with other third-party products such as application platforms or operating systems, and the introduction of new or enhanced products. Moreover, in the event that price competition significantly increases, competitive pressures could cause the Company to reduce the prices of its products, which would result in reduced margins. Furthermore, new personal computer platforms and operating systems, or new software distribution and delivery systems, such as the Internet and commercial online services, may provide new entrants with opportunities to obtain a substantial market share in the Company's markets. The Company may also face competition from general personal computer market participants who decide to offer graphic arts or multimedia design products. Such new market entrants could have a significant, disruptive effect on the markets in which the Company participates. In particular, Microsoft Corporation currently holds a dominant position in the personal computer software market in general, allowing it to exert considerable influence throughout the market. The Company's products also compete with graphic design and multimedia solutions based on other hardware platforms. 8 11 MANUFACTURING AND SHIPPING The manufacture of the Company's products consists of the duplicating of diskettes and/or the pressing of CD-ROMs, the printing of manuals and the packaging and assembling of final products, all of which are performed in accordance with the Company's specifications and forecasts. While the Company's current manufacturer, Modus Media International, maintains multiple site facilities, there can be no assurance that their services could not become subject to undue delays. Such delays, if they occur, may have a material adverse effect on the Company's business, operating results, financial condition, and cash flows. To date, the Company has not experienced any material difficulties or delays in the manufacture or assembly of its products or material returns due to product defects. ADDITIONAL FACTORS AFFECTING FUTURE RESULTS This Annual Report on Form 10-K 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. 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. FLUCTUATIONS IN QUARTERLY RESULTS Our quarterly operating results depend on a number of factors that are difficult to forecast. 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: - Introduction or enhancement of new products or technologies by us or our competitors; - Market acceptance of our 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. 9 12 In addition, we ship our products as we receive orders. As a result, we have little or no backlog. A large portion of our revenues occurs in the third month of each quarter. In addition, demand for our products tends to increase at the end of the calendar year due to year-end holiday buying trends. Revenues may also be affected by the volume and timing of the orders we receive, our ability to fulfill these orders, and our ability to close distribution and licensing agreements during a particular quarter. Any delays in the receipt and shipment of orders, the failure of our suppliers and manufacturers to produce and ship products that we have requested or our inability to close distribution and licensing agreements would adversely affect our revenues. 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 results of operations would be adversely affected. The Company has had operating losses the last four quarters. We have recently restructured and have focused on reducing our operating expenses to levels more consistent with expected revenues. 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 or technologies; - Actual or anticipated fluctuations in our operating results; and - Developments regarding our products, or our competitors' products. 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 graphics software companies. These broad market and industry fluctuations may continue to adversely affect the market price of our common stock. As a result, the market price of our common stock may continue to fluctuate. RISKS ASSOCIATED WITH PRODUCT TRANSITIONS AND PRODUCT RETURNS We may announce new products, product versions or technologies that may replace or shorten the life cycles of our existing products. Our competitors may also make similar announcements about their products which may replace or shorten the life cycles of our products. During the second quarter of 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, actual product returns may exceed these allowances. This would adversely affect our business. In certain cases we sell our new products and product versions at a discounted price to achieve market acceptance. These price discounts could adversely affect our revenues. In addition, when we announce plans for new products or new releases, or when our competitors make similar announcements, customers may delay purchasing our current products. This would also adversely affect our business. DEPENDENCE ON DISTRIBUTORS AND ON OTHER THIRD PARTIES Although we 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 international distributors, educational distributors, resellers, hardware superstores, retail dealers, direct marketers, and hardware and software OEM's. Our future financial results depend in large part on our relationship with third party distributors and their continued financial stability. Any 10 13 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, would adversely affect our business. The distribution channels 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 not be able to collect on accounts receivable from that distributor. It is also possible that new channels of distribution will develop which compete with existing channels. For example, the Internet is currently evolving as a new distribution channel for computer software. If we are unable to adapt our products for distribution through the Internet, to the extent they need adapting, our business could be adversely affected. We depend in part on our third party distributors to promote our products to retailers. These retailers 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. NEED TO EXPAND INTERNATIONAL OPERATIONS We sell a large percentage of our products outside of the United States. International sales accounted for approximately 29%, 38%, and 41% of net revenues for the years ended December 31, 1998, 1997 and 1996, respectively. The decrease in international sales resulted primarily from a decrease in international OEM and licenses revenues and the economic weakness in Japan. An important element of our business strategy is to continue to expand our sales in international markets, primarily Japan, Western Europe and Asia Pacific. 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: - Difficulties in staffing and managing foreign operations; - Problems and delays in collecting accounts receivable; - Fluctuations in currency exchange rates; - Unexpected changes in regulatory requirements; - Tariffs and other trade barriers; - Political instability; and - Potentially adverse tax consequences. Currently we sell our products in U.S. dollars. Any increase in the value of the U.S. dollar as compared to currencies in our principal overseas markets would increase the cost of our products in these markets. 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. The occurrence of any of these risks would adversely affect the success of our international operations and 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 11 14 financial crisis in the Asia Pacific region continues or worsens, our business will be adversely affected. For example, during 1998, our net revenues from Japan and the Asia Pacific region decreased as a result of depressed demand for our products due to the current Asian financial crisis. HIGHLY COMPETITIVE GRAPHICS SOFTWARE 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, product enhancements and lower price points. 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 promotions of their 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, Apple Computer and Linux. These companies 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. However, 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 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; Vice President, Product Management and Design; and Vice President, Corporate Communications left our Company. We have recently hired a Senior Vice President, Marketing; a Senior Vice President, Product Development; and a Vice President, European Sales and Marketing. We are also seeking to hire a Senior Vice President, Sales and Marketing. If we do not succeed in attracting and retaining new officers, our business would be adversely affected. DIFFICULTY OF IDENTIFYING AND HIRING CERTAIN PERSONNEL 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. RAPID TECHNOLOGICAL CHANGE AND DEPENDENCE ON NEW PRODUCTS AND PRODUCT VERSIONS The market for graphics software products 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 12 15 our ability to continue to enhance our products and to develop new products that meet customers' increasing expectations and that incorporate the latest technology. We may not be successful in developing and marketing enhancements to our existing products or introducing new products on a timely basis. Our new or enhanced products may not succeed in the marketplace. If 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 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 adversely affected. We have supplemented our research and development efforts by exclusively licensing products developed by or co-developed with third parties. We may not 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 have to further increase our research and development spending. This would adversely affect our business. POTENTIAL DELAYS IN PRODUCT RELEASES 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 may experience similar delays in the future. RISK OF UNDETECTED ERRORS We offer complex software products which may contain undetected errors. In the past, we discovered software errors in certain new products and enhancements after these products were introduced to the marketplace. 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 OUR COMPUTER GRAPHIC IMAGING AND INTERNET/ONLINE DESIGN TOOLS The markets for computer graphic imaging and Internet/online design tools are still emerging. Digital graphic and Internet/online content developers may not adopt our products. We also may not have sufficient distribution resources to market our products successfully or these products may not 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 these tools fail to grow or grow more slowly than we currently anticipate, then our business would be adversely affected. RISKS OF INFRINGEMENT AND PROPRIETARY RIGHTS 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 technology, such as MetaStream and MetaFlash. 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. 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 13 16 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. 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. YEAR 2000 RISKS Background Many currently installed computer systems and software products are coded to accept only two digit entries for the year 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, over the next year, 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 us, our business partners, our suppliers and our customers. Project We have identified potential Year 2000 risks in five categories: (1) Internal business software and systems; (2) Systems other than information technology systems ("Non-IT systems"); (3) Software products we sell to customers; (4) Third party distributors of our products; and (5) Third party suppliers of products and services to us. Our Year 2000 project includes the following phases for the first three categories above: (1) Inventorying Year 2000 items; (2) Assessing Year 2000 compliance for items determined to be material; (3) Assigning priorities to identified items; (4) Implementing remediation plans for items determined to be material and not Year 2000 compliant; (5) Re-testing items for which corrections have been implemented; and (6) Developing contingency plans. With respect to the our third-party distributors and suppliers, our Year 2000 project consists of the following phases: (1) Contacting distributors and suppliers for information concerning their Year 2000 readiness; (2) Prioritizing distributors and suppliers as to relative importance; (3) Validating distributor and supplier responses regarding Year 2000 compliance; and (4) Developing contingency plans in the event one or more distributors or suppliers fails to achieve Year 2000 compliance. Assessment Internal business software and systems consist primarily of our business information system which is based in the United States and services our worldwide operations. During 1997, we completed implementation of a Year 2000 compliant enterprise-wide information system. Additionally, we have completed the first three 14 17 phases of the Year 2000 project related to our business systems, and have substantially completed the fourth phase. We currently expect completion of the remediation and re-testing phases of our business systems, in addition to the development of applicable contingency plans, by June 30, 1999. We presently believe that with the implementation of our new information system and modification to existing software, Year 2000 compliance will not adversely affect our business. However, there can be no assurance that our internal business software and systems will contain all date code changes necessary to prevent processing errors potentially arising from calculations using the Year 2000 date. If our business systems are not compliant, we could experience interruptions to our development programs and general business operations. We have been advised by our suppliers of non-IT systems, which primarily consist of environmental systems such as fire suppression, air conditioning and heating, and security systems at various buildings we occupy, that either such systems are currently Year 2000 compliant or that such systems will be replaced by June 30, 1999. The computer graphics software products that we sell to customers are not date-sensitive. As a result, we believe that the current versions of our products are Year 2000 compliant. However, there can be no assurance that our current products do not contain undetected errors or defects associated with Year 2000 that may result in costs which adversely affect our business. We contract with third parties for the manufacture and distribution of our products. As a result, we have initiated communications with our key suppliers and distributors and plan to monitor the status of their Year 2000 readiness. We expect to complete the first three phases of our Year 2000 project related to our key distributors by April 30, 1999. We have reviewed the Year 2000 project plan implemented by our key supplier and have held quarterly meetings with them since the middle of 1998 in order to monitor their progress. Based on these meetings, we expect completion of their Year 2000 remediation and testing phases, by June 30, 1999. If any of our principal suppliers and distributors fail to demonstrate Year 2000 readiness, then we 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 our risk, but cannot eliminate the potential for disruption due to third party failure to achieve Year 2000 compliance. We expect the development of contingency plans, if necessary, to be completed by August 31, 1999. Should any of our key suppliers or distributors not achieve Year 2000 readiness, we may be unable to effectively manufacture our products or distribute our products to our customers. Costs The balance of the effort for our Year 2000 project has been by employees whose costs for this project are not tracked separately. We believe that costs for the remainder of the project will not be material to our business, financial position, results of operations, or cash flows. Risks Our business, financial position, results of operations, and cash flows could be materially adversely affected if we or our key suppliers, distributors, or customers do not achieve Year 2000 compliance. Although our Year 2000 project is expected to minimize our risks of experiencing a Year 2000 problem, inherent risks and uncertainties exist despite our efforts. As a result, we are unable to determine at this time whether the consequences of Year 2000 failures resulting from these inherent risks and uncertainties will have a material effect on our business, financial position, results of operations, or cash flows. CONCENTRATION OF STOCK OWNERSHIP As of March 10, 1999, the directors and executive officers of the Company and their respective affiliates beneficially own approximately 17% of the Company's outstanding Common Stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. 15 18 EMPLOYEES As of March 10, 1999, the Company had 218 full time employees, including 72 in sales and marketing, 90 in development, quality assurance and documentation, 12 in customer service and technical support, and 44 in finance, administration and operations. The employees and the Company are not parties to any collective bargaining agreements, and the Company believes that its relationships with its employees are good. ITEM 2. PROPERTIES The Company's corporate offices consists of approximately 42,000 square feet of leased space in two one-story buildings in Carpinteria, Santa Barbara County, California. This space houses substantially all of the Company's general and administrative personnel as well as a portion of its sales and marketing and research and development personnel. The lease agreement expires in September 2008, if not renewed. The Company believes that the current facilities are adequate for current and near term needs and that additional space is available to provide for anticipated growth. The Company also leases approximately 30,000 square feet of office space in Scotts Valley, California, pursuant to a lease agreement which expires in September 2003. This space houses a significant portion of the Company's sales and marketing and research and development personnel. The lease provides for two options to extend the term of the lease for three years each. The facilities for RTG consists of approximately 13,000 square feet of leased office space in Princeton and Short Hills, New Jersey, pursuant to lease agreements which expire in December 1999 and May 2000, respectively. The Company believes that this office space is adequate for the current needs of RTG and that additional space is available to provide for anticipated growth. The Company's Irish facility consists of approximately 4,000 square feet of leased space in an office building in Dublin, Ireland, pursuant to a lease agreement which expires in August 1999. The Company believes that this office space is adequate for current and near term needs and that additional space is available to provide for anticipated growth. ITEM 3. LEGAL PROCEEDINGS The Company is engaged in certain legal actions arising in the ordinary course of business. The Company believes it has adequate legal defenses and believes that the ultimate outcome of these actions will not have a material effect on the Company's consolidated financial position, results of operations, or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information regarding the Company's current executive officers as of March 10, 1999:
NAME AGE POSITION ---- --- -------- Gary Lauer......................... 46 Director, President and Chief Executive Officer Kai Krause......................... 42 Director and Chief Design Officer Mark Zimmer........................ 42 Director and Chief Technology Officer Terance Kinninger.................. 43 Senior Vice President, Finance and Operations and Chief Financial Officer Robert Rice........................ 44 Vice President, Business Development and General Counsel John Dearborn...................... 43 Senior Vice President, Marketing John Leddy......................... 40 Senior Vice President, Product Development
16 19 Mr. Lauer joined the Company as director, President and Chief Executive Office in February 1998. From 1988 to 1997, Mr. Lauer served in various capacities at Silicon Graphics, Inc. ("SGI"), including Vice President, North American Marketing; Vice President and subsequently Senior Vice President, North American Field Operations; and most recently as President of SGI's World Trade Group and Executive Vice President of Worldwide Field Operations. Prior to joining SGI, Mr. Lauer was with International Business Machines Corporation ("IBM") for eleven years where he held a variety of senior management positions, the last of which included responsibility for field operations for IBM's U.S. Marketing and Services Group in the Silicon Valley. Mr. Lauer holds a B.S. from the University of Southern California Business School. Mr. Krause co-founded MetaTools and has been a director since 1992. For more than eleven years prior to joining the Company on a full-time basis in 1993, Mr. Krause designed and developed advanced graphics, audio and systems software as an independent consultant. Mr. Krause attended college in Essen, West Germany, where he majored in foreign languages, math and philosophy. He also attended the Music Conservatory, where he studied classical piano. Mr. Zimmer became a director and Chief Technology Officer of the Company in May 1997 in connection with the merger with Fractal. In addition to co-founding Fractal in April 1991, Mr. Zimmer was its Chief Executive Officer and director since its inception. Mr. Zimmer also served as Fractal's President from March 1993 until May 1996, and resumed the position in February 1997 until the merger with MetaCreations in May 1997. In 1985, Mr. Zimmer co-founded Fractal Software, a predecessor of Fractal, and was a partner in Fractal Software from 1985 to 1990. At Fractal Software, Mr. Zimmer co-developed two graphics software programs, ImageStudio and ColorStudio, as well as the initial version of Painter. Mr. Zimmer attended California Institute of Technology. Mr. Kinninger joined the Company as Senior Vice President, Finance and Operations and Chief Financial Officer in July 1995. Mr. Kinninger was employed by Delphi Information Systems, Inc. ("Delphi") from October 1990 to June 1995, initially as Chief Financial Officer and, from December 1993 to November 1994 as Senior Vice President of Corporate Development. He then served as Senior Vice President and General Manager of Delphi's SMART Division from December 1994 to June 1995. Prior to working at Delphi, he served as Chief Financial Officer of Integral Systems, Inc. from June 1983 to September 1990. Before his tenure at Integral Systems, Inc., Mr. Kinninger was employed at Coopers & Lybrand. Mr. Kinninger holds a B.S. from Miami University. Mr. Rice joined the Company as Vice President, Business Development and General Counsel in connection with the Company's acquisition of RTG in December 1996. In addition to co-founding RTG in 1996, Mr. Rice served as its Chairman. From 1983 to 1996, Mr. Rice was a partner at the international law firm of Milbank, Tweed, Hadley and McCloy. Mr. Rice holds a B.S. and a J.D. from Florida State University. Mr. Dearborn joined the Company as Senior Vice President, Marketing in December 1998. Mr. Dearborn comes to MetaCreations from Micrografx, Inc. ("Micrografx"), where he most recently served as Executive Vice President of Worldwide Sales and Marketing. Mr. Dearborn was also responsible for business development and general management of the US subsidiary. Prior to Micrografx, Mr. Dearborn was a co-founder and Vice President of Astral Development Corporation, a privately held start-up that developed Picture Publisher, the first image-editing application for Microsoft Windows. Astral Development Corporation merged with Micrografx in 1991. Mr. Dearborn, who began his sales and marketing career at Xerox Corporation, holds a B.S. from the University of New Hampshire. Mr. Leddy joined the Company as Vice President and General Manager, Professional Products Group in August 1998 and was subsequently promoted to Senior Vice President, Product Development in December 1998. Prior to joining the Company, Mr. Leddy was employed by Adobe Systems Inc. ("Adobe"), where he most recently served as group product manager for imaging products. For five years, he was responsible for overseeing Adobe's flagship product, Photoshop, and for helping to develop new graphics tools. Prior to Adobe, Mr. Leddy held product management positions at Macromedia Inc., where he managed the Authorware professional product line, and Symantec Corporation. Mr. Leddy holds a B.A. from the University of California at Berkeley. 17 20 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION FOR COMMON STOCK The Company's common stock, $0.001 par value, began trading over the counter in December 1995, and is quoted on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol "MCRE." The following table sets forth, for the periods indicated, the range of high and low closing sale prices per share as reported on the Nasdaq National Market System:
HIGH LOW ------ ------ 1998 4th Quarter.................................... $ 8.06 $ 3.06 3rd Quarter.................................... 5.63 3.03 2nd Quarter.................................... 12.19 4.63 1st Quarter.................................... 10.75 6.38 1997 4th Quarter.................................... $19.50 $ 8.25 3rd Quarter.................................... 16.00 9.88 2nd Quarter.................................... 13.38 6.50 1st Quarter.................................... 19.00 10.00
HOLDERS As of March 10, 1999, there were approximately 583 holders of record of the Company's common stock. DIVIDENDS The Company has not paid any cash dividends on its capital stock to date. The Company currently anticipates that it will retain all future earnings, if any, for use in its business and does not anticipate paying any cash dividends on its capital stock in the foreseeable future. RECENT SALES OF UNREGISTERED SECURITIES In December 1998, in connection with the Company's acquisition of Canoma, Inc., the Company issued to the former stockholders of Canoma, Inc. an aggregate of 300,000 shares of the Company's common stock valued at approximately $1,305,000. The transaction was exempt from the registration requirements of Section 5 of the Securities Act of 1933, as amended, pursuant to Section 4127. 18 21 ITEM 6. SELECTED FINANCIAL DATA The following selected condensed financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and related notes thereto appearing elsewhere in this Annual Report on Form 10-K.
YEARS ENDED DECEMBER 31, ----------------------------------------------------- 1998 1997 1996 1995 1994 -------- -------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA Net revenues........................... $ 42,843 $ 69,074 $62,936 $46,260 $28,308 Cost of revenues....................... 7,007 11,859 11,677 10,081 6,627 -------- -------- ------- ------- ------- Gross profit......................... 35,836 57,215 51,259 36,179 21,681 Operating expenses: Sales and marketing.................. 28,680 32,043 28,936 22,331 14,378 Research and development............. 15,791 14,122 8,224 5,639 3,559 General and administrative........... 6,862 6,410 5,883 4,590 3,735 Costs associated with mergers, acquisitions and restructurings, including the related write-off of acquired in-process technology.... 7,305 16,185 17,047 -- -- -------- -------- ------- ------- ------- Total operating expenses..... 58,638 68,760 60,090 32,560 21,672 -------- -------- ------- ------- ------- Income (loss) from operations.......... (22,802) (11,545) (8,831) 3,619 9 Interest and investment income (expense), net....................... 2,618 3,157 3,397 634 11 -------- -------- ------- ------- ------- Income (loss) before provision (benefit) for income taxes........... (20,184) (8,388) (5,434) 4,253 20 Provision (benefit) for income taxes... (353) (210) 2,216 1,827 473 -------- -------- ------- ------- ------- Net income (loss)...................... $(19,831) $ (8,178) $(7,650) $ 2,426 $ (453) ======== ======== ======= ======= ======= Net income (loss) applicable to common stockholders......................... $(19,831) $ (8,178) $(7,650) $ 2,337 $ (692) ======== ======== ======= ======= ======= Net income (loss) per common share (diluted)............................ $ (0.83) $ (0.36) $ (0.37) $ 0.15 $ (0.06) ======== ======== ======= ======= ======= Weighted average number of shares outstanding (diluted)................ 23,779 22,965 20,590 15,267 11,584 ======== ======== ======= ======= ======= BALANCE SHEET DATA Cash, cash equivalents and short-term investments.......................... $ 46,335 $ 50,002 $66,293 $77,721 $ 9,307 Working capital........................ 60,201 77,677 79,254 80,135 9,086 Total assets........................... 77,965 97,257 97,935 95,017 18,488 Series B redeemable convertible preferred stock...................... -- -- -- 8,359 -- Stockholders' equity (deficit)......... 69,030 87,242 86,112 82,916 (49)
19 22 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 "Additional Factors Affecting Future Results." In connection with forward-looking statements which appear in these disclosures, investors should carefully review the factors set forth in this Form 10-K under "Additional Factors Affecting Future Results." OVERVIEW MetaCreations was formed in May 1997, as a result of the merger of MetaTools, Inc. and Fractal Design Corporation, 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 1994 through 1996 include the pooled financial statements of MetaTools, Inc., Fractal Design Corporation, and Ray Dream, Inc. Revenue growth for MetaCreations from 1994 to 1997 was substantially achieved through the Company's continued introduction of new products and the release of enhanced versions of its existing products, as well as significant investment in the expansion of its sales and marketing activities to address broader distribution channels. However, revenues declined during 1998 due to lower than expected demand in the retail channel 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 in the third quarter of 1998 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 and technologies: Bryce, Infini-D, Kai's Photo Soap, Kai's Super GOO, Kai's Power Show, Kai's Power Tools, MetaFlash, MetaStream, Painter, Poser, and Ray Dream Studio. In this regard, revenue from the sale of these products and licensing of the technologies represented a substantial majority of net revenues during 1998. 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 activities. In 1998, MetaCreations introduced its Creative Web strategy designed to leverage the Company's 2D and 3D technologies for use on the Internet through both new and existing products. The Company's future revenues will also be dependent upon the Company's ability to successfully develop and market new products based on this strategy. 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 OEMs for bundling with their hardware or 20 23 software products and directly to end users, generally through telesales, direct mail campaigns, and the Internet from the Company's online store. 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 and licensing 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 to focus on the Creative Web strategy have also entailed significant research and development expenditures. These higher expense levels combined with costs associated with periodic 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 recent annual and quarterly losses, as well as fluctuations in its operating results. The Company intends to continue to invest significant amounts both in expanding its product portfolio and in maintaining and enhancing brand awareness of its products, and accordingly may continue to experience losses and volatility of net revenues and operating results in future periods. OPERATING RESULTS The following table sets forth certain selected financial information expressed as a percentage of net revenues for the periods indicated:
YEARS ENDED DECEMBER 31, -------------------------- 1998 1997 1996 ------ ------ ------ Net revenues................................................ 100.0% 100.0% 100.0% Cost of revenues............................................ 16.4 17.2 18.6 ----- ----- ----- Gross margin........................................... 83.6 82.8 81.4 Operating expenses: Sales and marketing....................................... 66.9 46.4 46.0 Research and development.................................. 36.8 20.4 13.0 General and administrative................................ 16.0 9.3 9.3 Costs associated with mergers, acquisitions and restructurings, including the related write-off of acquired in-process technology......................... 17.1 23.4 27.1 ----- ----- ----- Total operating expenses.......................... 136.8 99.5 95.4 ----- ----- ----- Loss from operations........................................ (53.2) (16.7) (14.0) Interest and investment income, net......................... 6.1 4.6 5.4 ----- ----- ----- Loss before provision (benefit) for income taxes............ (47.1) (12.1) (8.6) Provision (benefit) for income taxes........................ (0.8) (0.3) 3.5 ----- ----- ----- Net loss.................................................... (46.3)% (11.8)% (12.1)% ===== ===== =====
21 24 NET REVENUES Net revenues totaled $42.8 million in 1998, which represented a 38% decrease compared to 1997 net revenues of $69.1 million. The decrease in net revenues was attributed to lower than expected demand in the retail channel and lower OEM and licensing revenues. New products and new versions of existing products released during 1998 included Dance Studio, Infini-D 4.5, Kai's Photo Soap 2, Kai's Power Tools 5, Kai's Power Show, Kai's Super GOO, Painter 3D, Painter 5.5 Web Edition, Painter Classic, and Poser 3. The number of new products released by the Company increased in 1998 compared to previous years, and as a result, the Company experienced a higher return rate in 1998 compared to the Company's historical return rate, particularly related to its consumer products. As a result, the Company increased its return reserve as a percentage of gross revenues in 1998. International sales comprised 29% of net revenues in 1998, compared to 38% of net revenues in 1997. Net revenues totaled $69.1 million in 1997, compared to $62.9 million in 1996, an increase of 10%. Net revenues increased in 1997 as a result of volume increases from the Company's release of new products and new versions of its existing products during 1997 and the second half of 1996, along with increased revenues from OEM and licensing agreements. New products and new versions of existing products released during 1997 include Bryce 3D, Infini-D 4, Kai's Photo Soap, Painter 5, Ray Dream 3D, and Studio 5. International sales comprised 38% of net revenues in 1997, compared to 41% of net revenues in 1996. The decrease was primarily due to flat revenues in Japan attributed to the consolidation of the Company's Japanese distributors. During the year ended December 31, 1998, the Company adopted Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-4, "Deferral of the Effective Date of Certain Provisions of SOP 97-2." SOP 97-2 and SOP 98-4, which supercede SOP 91-1, generally require 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 Company recognizes product revenues upon shipment to the customer, satisfaction of Company obligations, if any, and reasonable assurance regarding the collectability of the corresponding receivable. Revenue allocated to postcontract customer support 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 and SOP 98-4 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 gross 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. The Company has entered into agreements whereby it licenses products to original equipment manufacturers ("OEM's") and foreign publishers which provide such customers the right to produce and distribute multiple copies of its software. Nonrefundable fixed fees are recognized as revenue at delivery of the product master to the customer, satisfaction of Company obligations, if any, and reasonable assurance regarding the collectability of the corresponding receivable. Per copy royalties in excess of fixed amounts are recognized as revenue when such amounts exceed fixed minimum royalties. Revenues under OEM contracts without nonrefundable fixed fees are recognized as earned over the term of the contract. 22 25 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 $7.0 million, or 16% of net revenues, in 1998, down from cost of revenues of $11.9 million, or 17% of net revenues, in 1997. The changing mix of product sales toward lower royalty products contributed to the decrease in cost of revenues as a percentage of net revenues. Royalties represented 3% and 4% of net revenues for 1998 and 1997, respectively. Cost of revenues totaled $11.9 million, or 17% of net revenues in 1997, compared to $11.7 million, or 19% of net revenues, in 1996. The decrease in cost of revenues as a percentage of net revenues was due to a higher percentage of revenues from OEM and licensing agreements and improved management of production and inventories. Royalties represented 4% of net revenues for both 1997 and 1996. The Company expects that cost of revenues will increase in the future commensurate with the increase in net revenues, but may vary as a percentage of net revenues. 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 $28.7 million in 1998, down from $32.0 million in 1997. The decrease in sales and marketing expenses primarily resulted from the restructuring programs implemented during the third quarter of 1998, which included reductions in sales and marketing personnel and promotional activities. However, as a percentage of net revenues, sales and marketing expenses increased from 46% in 1997 to 67% in 1998. The increase in sales and marketing as a percentage of net revenues resulted from the decrease in net revenues for the respective periods. Sales and marketing expenses totaled $32.0 million in 1997, compared to $28.9 million in 1996, but remained flat at 46% of net revenues for both periods. The increase in sales and marketing expenses in 1997 reflected the Company's efforts to expand its sales and marketing presence and distribution channels, both domestically and internationally, through the hiring of additional personnel and increased marketing programs. The Company expects sales and marketing expenses will 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. The Company expenses as incurred research and development costs necessary to establish the technological feasibility of its internally-developed software products. 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. Research and development expenses totaled $15.8 million in 1998, up from $14.1 million in 1997. The increase in research and development expenses resulted from costs related to additional engineers obtained via the acquisition of Specular in April 1997 and the increased number of products translated to foreign languages. As a percentage of net revenues, research and development expenses increased from 20% in 1997 to 37% in 1998. The significant increase in research and development expense as a percentage of net revenues is attributed to the decrease in net revenues for the respective periods. Research and development expenses totaled $14.1 million in 1997, up from $8.2 million in 1996. Research and development expenses represented 20% and 13% of net revenues in 1997 and 1996, respectively. The increase in research and development expenses was attributed to increased personnel resulting from the 23 26 acquisitions of RTG in December 1996 and Specular in April 1997, in addition to increased personnel associated with the expansion of the Company's product portfolio. 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 finance and administration personnel of the Company along with other administrative costs including legal and accounting fees, insurance, and bad debt expenses. General and administrative expenses totaled $6.9 million in 1998, compared to $6.4 million in 1997. The increase in general and administrative expenses in 1998 was attributed to recruiting and relocation costs related to the hiring of a new chief executive officer in February 1998, as well as to consulting costs related to the preparation of the Company's new strategic plan. As a percentage of net revenues, general and administrative expenses increased from 9% in 1997 to 16% in 1998. The increase general and administrative as a percentage of net revenues resulted from the decrease in net revenues for the respective periods. General and administrative expenses totaled $6.4 million in 1997, up from $5.9 million in 1996, but remained flat at 9% of net revenues for both periods. The increase in general and administrative dollars in 1997 was due to increased administrative expenses related to increased headcount and general corporate expenses associated with the 1997 growth of the Company. 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 On June 30, 1998, the Company announced a restructuring plan aimed at reducing costs and improving competitiveness and efficiency, which was implemented during the third quarter of 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 $2.2 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 $2.8 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 first quarter of 1999. COSTS ASSOCIATED WITH MERGERS AND ACQUISITIONS, INCLUDING THE RELATED WRITE-OFF OF ACQUIRED IN-PROCESS TECHNOLOGY On December 31, 1998, the Company completed the acquisition of Canoma, Inc. ("Canoma"), a privately held development-stage software company based in Northern California, that was developing software technology that creates 3-D digital images and content from 2-D digital images. The acquisition was accounted for by the Company under the purchase method of accounting. Under the terms of the Purchase Agreement, the stockholders of Canoma received 300,000 shares of the Company's common stock valued at approximately $1.3 million at December 31, 1998, the closing date, and cash consideration totaling approximately $1.8 million. As of December 31, 1998, neither technological feasibility nor commercial viability had been reached with regard to Canoma's technology or potential products. Based upon projected future cash flows, risk-adjusted using a 33% discount rate, Canoma's in-process technology was valued at approximately $2.3 million, which, including acquisition costs totaling approximately $100,000, resulted in a one time charge to earnings of approximately $2.4 million for the year ended December 31, 1998. The remaining purchase price of approximately $805,000 was capitalized by the Company as goodwill and will be 24 27 amortized over 5 years. As of the date of acquisition, Canoma's two research and development engineers joined the Company's research and development team in Scotts Valley, California. On April 15, 1997, the Company completed the acquisition of Specular International, Ltd., a privately held software development company based in Amherst, Massachusetts, that developed and marketed 3-D animation and graphic design tools for professionals and pro-sumers. 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 $1.0 million in cash in 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. 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 year ended December 31, 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. In connection with the acquisition, 14 of Specular's research and development and product management personnel were relocated to the Company's RTG facilities in Princeton, New Jersey. On December 31, 1996, the Company completed the acquisition of Real Time Geometry Corp., a privately held development stage company based in Princeton, New Jersey, that developed real time 3D graphics and visualization technologies. The acquisition was accounted for by the Company under the purchase method of accounting. Under the terms of the Purchase Agreement, the stockholders and optionholders of RTG received a combination of shares of the Company's common stock and options to purchase shares of the Company's common stock valued at approximately $11.2 million and $607,000, respectively, at December 31, 1996, the closing date. In addition, the Company assumed the net liabilities of RTG, which totaled $1.4 million at December 31, 1996. As of December 31, 1996, neither technological feasibility nor commercial viability had been reached with regard to RTG's core technology, comprised of advanced geometry-based algorithms which transform images in real-time to a series of triangles to produce three-dimensional images. Based upon projected future cash flows, risk-adjusted using a 40% discount rate, RTG's core in-process technology was valued in excess of the amount written-off as acquired in-process technology of $13.3 million, which combined with acquisition costs totaling $1.2 million, resulted in a one time charge to earnings of $14.4 million for the year ended December 31, 1996. As of the date of acquisition, RTG's 21 research and development personnel remained in Princeton, New Jersey, continuing visual computing research and development activities. On August 31, 1996, the Company acquired Dive Laboratories, Inc., a privately held company based in Santa Cruz, California, that developed 3D modeling and rendering environments for high-end applications and the visualization of streaming online data. In connection with the acquisition, which was accounted for under the purchase method of accounting, the Company recorded a one-time charge to earnings of approximately $733,000 for the year ended December 31, 1996, comprised of relocation expenses of $215,000, acquisition costs of $155,000, and in-process research and development expenses of $363,000. The Company paid $509,000 in cash and assumed $224,000 of net liabilities of Dive. The four Dive research and development personnel relocated to Santa Barbara. LOSS FROM OPERATIONS The loss from operations for the year ended December 31, 1998 was $22.8 million. Excluding costs related to the Company's acquisition of Canoma in December 1998, proforma operating income for 1998 was $20.4 million or 48% of net revenues. The loss from operations for the year ended December 31, 1997 was $11.6 million and included $16.2 million in costs related to the merger of MetaTools, Inc. and Fractal Design Corporation and the acquisition of Specular International, Ltd. Excluding these costs, proforma operating income for 1997 was $4.6 million or 7% of net revenues. The proforma operating loss in 1998 primarily 25 28 resulted from the 38% reduction in net revenues from 1997 to 1998, $5.0 million of restructuring costs, and increased research and development expenses. The loss from operations for the year ended December 31, 1996, totaled $8.8 million and included $17.0 million in costs related to the acquisitions of Real Time Geometry Corp. and Dive Laboratories, Inc., in addition to the merger of Ray Dream, Inc. into Fractal Design Corporation. Excluding these costs, proforma operating income for 1996 was $8.2 million, or 13% of revenues. The decline in proforma operating income in 1997 over 1996 is primarily attributed to higher spending on research and development as a percentage of revenues as a result of increased personnel resulting from the acquisitions of RTG in December 1996 and Specular in April 1997, in addition to increased personnel associated with the expansion of the Company's product portfolio. PROVISION (BENEFIT) FOR INCOME TAXES The Company records income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." During 1998, the Company recorded a tax benefit of $353,000, relating to the net loss incurred by the Company in the first quarter of 1998. The valuation allowance for deferred taxes was increased by approximately $5.2 million during 1998 based on management's assessment of the recoverability of the deferred tax assets. Management's assessment included an evaluation of the Company's deferred income tax assets; available tax carrybacks; cumulative net income, excluding costs related to mergers and acquisitions; available tax planning strategies; and future financial statement projections. Based on this assessment and interpretation of the provisions of SFAS No. 109, management has concluded that additional net operating losses and other tax benefits generated during 1998 require a valuation allowance. Management's assessment with respect to the amount of deferred tax assets considered realizable may be revised over the near term based on actual operating results and revised financial statement projections. The effective tax rates of 3% and (41)% for the years ended December 31, 1997 and 1996, respectively, differed from the respective United States statutory tax rates primarily due to changes in the valuation allowance against the deferred income tax assets and the non-deductibility of certain costs associated with mergers and acquisitions. NET LOSS Net loss totaled $(19.8) million, or $(0.83) per common share, in 1998, compared to net loss of $(8.2) million, or $(0.36) per common share, in 1997, and net loss of $(7.7) million, or $(0.37) per common share, in 1996. YEAR 2000 RISKS BACKGROUND Many currently installed computer systems and software products are coded to accept only two digit entries for the year 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, over the next year, 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 us, our business partners, our suppliers and our customers. PROJECT We have identified potential Year 2000 risks in five categories: (1) Internal business software and systems; (2) Systems other than information technology systems ("Non-IT systems"); 26 29 (3) Software products we sell to customers; (4) Third party distributors of our products; and (5) Third party suppliers of products and services to us. Our Year 2000 project includes the following phases for the first three categories above: (1) Inventorying Year 2000 items; (2) Assessing Year 2000 compliance for items determined to be material; (3) Assigning priorities to identified items; (4) Implementing remediation plans for items determined to be material and not Year 2000 compliant; (5) Re-testing items for which corrections have been implemented; and (6) Developing contingency plans. With respect to the our third-party distributors and suppliers, our Year 2000 project consists of the following phases: (1) Contacting distributors and suppliers for information concerning their Year 2000 readiness; (2) Prioritizing distributors and suppliers as to relative importance; (3) Validating distributor and supplier responses regarding Year 2000 compliance; and (4) Developing contingency plans in the event one or more distributors or suppliers fails to achieve Year 2000 compliance. ASSESSMENT Internal business software and systems consist primarily of our business information system which is based in the United States and services our worldwide operations. During 1997, we completed implementation of a Year 2000 compliant enterprise-wide information system. Additionally, we have completed the first three phases of the Year 2000 project related to our business systems, and have substantially completed the fourth phase. We currently expect completion of the remediation and re-testing phases of our business systems, in addition to the development of applicable contingency plans, by June 30, 1999. We presently believe that with the implementation of our new information system and modification to existing software, Year 2000 compliance will not adversely affect our business. However, there can be no assurance that our internal business software and systems will contain all date code changes necessary to prevent processing errors potentially arising from calculations using the Year 2000 date. If our business systems are not compliant, we could experience interruptions to our development programs and general business operations. We have been advised by our suppliers of non-IT systems, which primarily consist of environmental systems such as fire suppression, air conditioning and heating, and security systems at various buildings we occupy, that either such systems are currently Year 2000 compliant or that such systems will be replaced by June 30, 1999. The computer graphics software products that we sell to customers are not date-sensitive. As a result, we believe that the current versions of our products are Year 2000 compliant. However, there can be no assurance that our current products do not contain undetected errors or defects associated with Year 2000 that may result in costs which adversely affect our business. We contract with third parties for the manufacture and distribution of our products. As a result, we have initiated communications with our key suppliers and distributors and plan to monitor the status of their Year 2000 readiness. We expect to complete the first three phases of our Year 2000 project related to our key distributors by April 30, 1999. We have reviewed the Year 2000 project plan implemented by our key supplier and have held quarterly meetings with them since the middle of 1998 in order to monitor their progress. Based 27 30 on these meetings, we expect completion of their Year 2000 remediation and testing phases, by June 30, 1999. If any of our principal suppliers and distributors fail to demonstrate Year 2000 readiness, then we 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 our risk, but cannot eliminate the potential for disruption due to third party failure to achieve Year 2000 compliance. We expect the development of contingency plans, if necessary, to be completed by August 31, 1999. Should any of our key suppliers or distributors not achieve Year 2000 readiness, we may be unable to effectively manufacture our products or distribute our products to our customers. COSTS The balance of the effort for our Year 2000 project has been by employees whose costs for this project are not tracked separately. We believe that costs for the remainder of the project will not be material to our business, financial position, results of operations, or cash flows. RISKS Our business, financial position, results of operations, and cash flows could be materially adversely affected if we or our key suppliers, distributors, or customers do not achieve Year 2000 compliance. Although our Year 2000 project is expected to minimize our risks of experiencing a Year 2000 problem, inherent risks and uncertainties exist despite our efforts. As a result, we are unable to determine at this time whether the consequences of Year 2000 failures resulting from these inherent risks and uncertainties will have a material effect on our business, financial position, results of operations, or cash flows. LIQUIDITY AND CAPITAL RESOURCES Cash and investments totaled $46.3 million at December 31, 1998, down from $50.0 million at December 31, 1997 and $66.3 million at December 31, 1996. Net cash provided by operating activities of the Company totaled $498,000 for 1998, compared to net cash used in operating activities of $12.0 million and $3.1 million for 1997 and 1996, respectively. The 1998 change primarily resulted from significant reductions in both accounts receivable and inventory, primarily due to the decrease in net revenues in 1998 compared to 1997, and to increased reserves for returns resulting from a higher return rate in 1998 compared to the Company's historical return rate. The increase in cash used in operating activities in 1997 is primarily attributed to the approximately $11 million paid in connection with the merger with Fractal and the acquisition of Specular, and the increase in accounts receivable resulting from growth in revenues, in particular, growth in OEM revenues which include guaranteed fixed minimum royalties that may have extended payment terms up to 12 months from the contract date. Net cash provided by (used in) investing activities totaled $6.4 million, $(1.5) million, and $(25.2) million for 1998, 1997 and 1996, respectively. The 1998 and 1997 changes resulted primarily from increasing net proceeds from maturities of short-term investments and decreasing purchases of property and equipment. Net cash (used in) provided by financing activities totaled $(310,000), $1.6 million, and $(4.0) million for 1998, 1997 and 1996, respectively. Cash used in financing activities in 1998 resulted from $1.2 million in notes payable issued to stockholders, net of proceeds from the exercise of stock options by the Company's employees. Cash provided by financing activities in 1997 primarily resulted from proceeds from the exercise of stock options by the Company's employees, while cash used in financing activities in 1996 primarily related to the repayment of notes payable to stockholders and the issuance of notes receivable from stockholders during the year. The Company has a $3.0 million revolving line of credit with a bank which expires during March 2000, if not renewed. Borrowings under the credit facility are limited to a percentage of eligible accounts receivable, as defined in the credit agreement. As of December 31, 1998, the Company had no outstanding borrowings under the line of credit. 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, cash 28 31 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. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 1. Index to Financial Statements The following financial statements are filed as part of this Report:
PAGE NO. -------- AUDITED FINANCIAL STATEMENTS Report of Independent Accountants........................... 30 Consolidated Balance Sheets as of December 31, 1998 and 1997...................................................... 31 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1998............... 32 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1998............... 33 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1998............... 34 Notes to Consolidated Financial Statements.................. 36
2. Index to Financial Statement Schedules The following financial statement schedule of the Company is filed as part of this Report and should be read in conjunction with the financial statements and notes thereto:
PAGE NO. -------- SCHEDULES Report of Independent Accountants on Financial Statement Schedule.................................................. 56 Schedule II -- Valuation and Qualifying Accounts............ 57
All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto. 29 32 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors and Stockholders MetaCreations Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity and cash flows present fairly, in all material respects, the financial position of MetaCreations Corporation and its subsidiaries (the "Company") as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Woodland Hills, California January 28, 1999 30 33 METACREATIONS CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) ASSETS
DECEMBER 31, -------------------- 1998 1997 -------- -------- Current assets: Cash and cash equivalents................................. $ 16,297 $ 9,653 Short-term investments.................................... 30,038 40,349 Accounts receivable, net of allowance for returns and doubtful accounts of $2,725 and $3,250 at December 31, 1998 and 1997, respectively............................ 12,375 26,604 Inventories............................................... 526 1,667 Income taxes receivable................................... 220 772 Deferred income taxes..................................... 5,913 5,153 Prepaid expenses.......................................... 3,767 3,494 -------- -------- Total current assets.............................. 69,136 87,692 Property and equipment, net................................. 6,829 7,577 Other assets................................................ 2,000 1,988 -------- -------- Total assets...................................... $ 77,965 $ 97,257 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 3,777 $ 4,860 Accrued expenses.......................................... 4,200 3,938 Royalties payable......................................... 958 1,217 -------- -------- Total current liabilities......................... 8,935 10,015 Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value; 5,000,000 shares authorized -- none issued and outstanding at December 31, 1998 and 1997...................................... -- -- Common stock, $.001 par value; 75,000,000 shares authorized -- 24,242,784 and 23,605,645 shares issued and outstanding at December 31, 1998 and 1997, respectively........................................... 24 24 Paid-in capital........................................... 112,829 109,896 Cumulative translation adjustment......................... (128) (135) Notes receivable from stockholders........................ (4,491) (3,170) Accumulated deficit....................................... (39,204) (19,373) -------- -------- Total stockholders' equity........................ 69,030 87,242 -------- -------- Total liabilities and stockholders' equity........ $ 77,965 $ 97,257 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 31 34 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, --------------------------------------- 1998 1997 1996 -------- -------- ------- Net revenues........................................ $ 42,843 $ 69,074 $62,936 Cost of revenues.................................... 7,007 11,859 11,677 -------- -------- ------- Gross profit...................................... 35,836 57,215 51,259 Operating expenses: Sales and marketing............................... 28,680 32,043 28,936 Research and development.......................... 15,791 14,122 8,224 General and administrative........................ 6,862 6,410 5,883 Costs associated with mergers, acquisitions and restructurings, including the related write-off of acquired in-process technology.............. 7,305 16,185 17,047 -------- -------- ------- Total operating expenses.................. 58,638 68,760 60,090 -------- -------- ------- Loss from operations................................ (22,802) (11,545) (8,831) Interest and investment income, net................. 2,618 3,157 3,397 -------- -------- ------- Loss before provision (benefit) for income taxes.... (20,184) (8,388) (5,434) Provision (benefit) for income taxes................ (353) (210) 2,216 -------- -------- ------- Net loss............................................ $(19,831) $ (8,178) $(7,650) ======== ======== ======= Net loss per common share: Basic and diluted................................. $ (0.83) $ (0.36) $ (0.37) ======== ======== ======= Weighted average number of shares outstanding: Basic and diluted................................. 23,779 22,965 20,590 ======== ======== =======
The accompanying notes are an integral part of these consolidated financial statements. 32 35 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
SERIES A NOTES PREFERRED STOCK COMMON STOCK CUMULATIVE RECEIVABLE --------------- --------------- PAID-IN TRANSLATION FROM ACCUMULATED SHARES AMOUNT SHARES AMOUNT CAPITAL ADJUSTMENT STOCKHOLDERS (DEFICIT) ------ ------ ------ ------ -------- ----------- ------------ ----------- Balances at December 31, 1995......... -- $-- 20,346 $21 $ 87,003 $ (50) $ -- $ (4,058) Issuance of common stock upon the exercise of stock options and warrants............................ -- -- 561 -- 1,288 -- -- -- Issuance of common stock in connection with the employee stock purchase plan and 401k plan.................. -- -- 15 -- 214 -- -- -- Issuance of common stock.............. -- -- 20 -- 138 -- -- -- Issuance of common stock in connection with the acquisition of Real Time Geometry Corp....................... -- -- 1,332 1 11,241 -- -- -- Tax benefit related to stock options............................. -- -- -- -- 1,072 -- -- -- Translation adjustment................ -- -- -- -- -- (108) -- -- Notes receivable from stockholders.... -- -- -- -- -- -- (3,000) -- Net loss.............................. -- -- -- -- -- -- -- (7,650) -- -- ------ --- -------- ----- ------- -------- Balances at December 31, 1996......... -- -- 22,274 22 100,956 (158) (3,000) (11,708) Issuance of common stock upon the exercise of stock options........... -- -- 756 1 1,851 -- -- -- Issuance of common stock in connection with the employee stock purchase plan................................ -- -- 29 -- 245 -- -- -- Issuance of common stock in connection with the acquisition of Specular International, Ltd.................. -- -- 547 1 4,087 -- -- -- Tax benefit related to stock options............................. -- -- -- -- 2,396 -- -- -- Conversion of accrued compensation to equity upon exercise of certain options............................. -- -- -- -- 361 -- -- -- Translation adjustment................ -- -- -- -- -- 23 -- -- Interest on notes receivable from stockholders........................ -- -- -- -- -- -- (170) -- Adjustment to retained earnings as a result of business combination (Note 1).................................. -- -- -- -- -- -- -- 513 Net loss.............................. -- -- -- -- -- -- -- (8,178) -- -- ------ --- -------- ----- ------- -------- Balances at December 31, 1997......... -- -- 23,606 24 109,896 (135) (3,170) (19,373) Issuance of common stock upon the exercise of stock options........... -- -- 231 -- 840 -- -- -- Issuance of common stock in connection with the employee stock purchase plan................................ -- -- 106 -- 404 -- -- -- Issuance of common stock in connection with the acquisition of Canoma, Inc................................. -- -- 300 -- 1,305 -- -- -- Tax benefit related to stock options............................. -- -- -- -- 376 -- -- -- Conversion of accrued compensation to equity upon exercise of certain options............................. -- -- -- -- 8 -- -- -- Translation adjustment................ -- -- -- -- -- 7 -- -- Notes receivable from stockholders.... -- -- -- -- -- -- (1,150) -- Interest on notes receivable from stockholders........................ -- -- -- -- -- -- (171) -- Net loss.............................. -- -- -- -- -- -- -- (19,831) -- -- ------ --- -------- ----- ------- -------- Balances at December 31, 1998......... -- $-- 24,243 $24 $112,829 $(128) $(4,491) $(39,204) == == ====== === ======== ===== ======= ======== TOTAL STOCKHOLDERS' EQUITY ------------- Balances at December 31, 1995......... $ 82,916 Issuance of common stock upon the exercise of stock options and warrants............................ 1,288 Issuance of common stock in connection with the employee stock purchase plan and 401k plan.................. 214 Issuance of common stock.............. 138 Issuance of common stock in connection with the acquisition of Real Time Geometry Corp....................... 11,242 Tax benefit related to stock options............................. 1,072 Translation adjustment................ (108) Notes receivable from stockholders.... (3,000) Net loss.............................. (7,650) -------- Balances at December 31, 1996......... 86,112 Issuance of common stock upon the exercise of stock options........... 1,852 Issuance of common stock in connection with the employee stock purchase plan................................ 245 Issuance of common stock in connection with the acquisition of Specular International, Ltd.................. 4,088 Tax benefit related to stock options............................. 2,396 Conversion of accrued compensation to equity upon exercise of certain options............................. 361 Translation adjustment................ 23 Interest on notes receivable from stockholders........................ (170) Adjustment to retained earnings as a result of business combination (Note 1).................................. 513 Net loss.............................. (8,178) -------- Balances at December 31, 1997......... 87,242 Issuance of common stock upon the exercise of stock options........... 840 Issuance of common stock in connection with the employee stock purchase plan................................ 404 Issuance of common stock in connection with the acquisition of Canoma, Inc................................. 1,305 Tax benefit related to stock options............................. 376 Conversion of accrued compensation to equity upon exercise of certain options............................. 8 Translation adjustment................ 7 Notes receivable from stockholders.... (1,150) Interest on notes receivable from stockholders........................ (171) Net loss.............................. (19,831) -------- Balances at December 31, 1998......... $ 69,030 ========
The accompanying notes are an integral part of these consolidated financial statements. 33 36 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, --------------------------------- 1998 1997 1996 -------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss.................................................. $(19,831) $ (8,178) $ (7,650) Adjustment to retained earnings as a result of business combination (Notes 1 and 3)............................. -- 513 -- Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Write-off of acquired in-process technology.......... 2,250 5,575 13,623 Non-cash restructuring costs......................... 2,747 -- -- Deferred income taxes................................ (760) (1,446) (1,381) Depreciation and amortization........................ 3,956 2,666 1,574 Provision for losses on receivables and returns...... 12,637 5,201 6,467 Provision for losses on inventory.................... 442 860 724 Accrued interest income.............................. (171) (170) -- Changes in operating assets and liabilities: Accounts receivable................................ 704 (15,146) (15,548) Inventories........................................ 264 (972) (104) Income taxes receivable............................ 928 1,474 327 Prepaid expenses and other assets.................. (1,000) (30) (88) Accounts payable and accrued expenses.............. (1,409) (2,830) (922) Royalties payable.................................. (259) 461 (76) -------- -------- --------- Net cash provided by (used in) operating activities.................................... 498 (12,022) (3,054) CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment....................... (2,368) (3,944) (3,960) Purchases of software technology and product rights....... (744) (693) (125) Purchases of short-term investments....................... (63,549) (55,339) (104,373) Proceeds from maturities of short-term investments........ 73,860 59,678 83,368 Payment in connection with acquisition.................... (750) (1,233) (139) -------- -------- --------- Net cash provided by (used in) investing activities.................................... 6,449 (1,531) (25,229) CASH FLOWS FROM FINANCING ACTIVITIES Increase in notes receivable from stockholders............ (1,150) -- (3,000) Repayment of notes payable to stockholders................ -- -- (1,477) Repayment of notes payable................................ -- (274) (417) Proceeds from exercise of warrants and stock options...... 840 1,852 852 -------- -------- --------- Net cash (used in) provided by financing activities.................................... (310) 1,578 (4,042) Effect of exchange rates on cash.......................... 7 23 (108) -------- -------- --------- Net increase (decrease) in cash and cash equivalents...... 6,644 (11,952) (32,433) Cash and cash equivalents at beginning of period.......... 9,653 21,605 54,038 -------- -------- --------- Cash and cash equivalents at end of period................ $ 16,297 $ 9,653 $ 21,605 ======== ======== =========
(Table continued on next page) 34 37 METACREATIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (IN THOUSANDS)
YEARS ENDED DECEMBER 31, --------------------------------- 1998 1997 1996 -------- -------- --------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES Cash paid during the year for interest.................... $ -- $ -- $ 18 Cash paid during the year for income taxes................ 147 294 2,162 SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES Issuance of common stock in connection with acquisition of Canoma, Inc............................................. 1,305 -- -- Issuance of common stock and stock options in connection with acquisition of Specular International, Ltd......... -- 4,088 -- Issuance of common stock and stock options in connection with acquisition of Real Time Geometry Corp............. -- -- 11,849 Net liabilities acquired in connection with acquisition of Specular International, Ltd.: Accounts receivable, net............................. -- 40 -- Inventories, net..................................... -- 43 -- Property and equipment............................... -- 43 -- Deferred income taxes................................ -- 900 -- Prepaid expenses and other assets.................... -- 331 -- Accounts payable and accrued expenses................ -- 1,337 -- Notes payable........................................ -- 274 -- Net liabilities acquired in connection with acquisitions of Dive Laboratories, Inc. and Real Time Geometry Corp.: Property and equipment............................... -- -- 498 Prepaid expenses and other assets.................... -- -- 33 Accounts payable and accrued expenses................ -- -- 689 Notes payable to stockholder......................... -- -- 1,477 Tax benefit related to stock options...................... 376 2,396 1,072 Conversion of accrued compensation to equity upon exercise of certain options and warrants......................... 8 361 524 Issuance of common stock in connection with employee stock purchase plan........................................... 404 245 126 Covenant not-to-compete with an officer of the Company.... -- -- 600 Issuance of common stock in exchange for software technology and product rights........................... -- -- 138
The accompanying notes are an integral part of these consolidated financial statements. 35 38 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND ORGANIZATION MetaCreations Corporation ("MetaCreations" or the "Company") is focused on developing and marketing 2D and 3D visualization software for graphic artists, and the World Wide Web. The consolidated financial statements include the accounts of MetaCreations and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. In May 1997, the stockholders of MetaTools, Inc. ("MetaTools") approved the Amendment to Restated Articles of Incorporation, changing the name of the Company to MetaCreations Corporation. Accordingly, the term "Company," as used herein, refers to either MetaTools or MetaCreations, depending on the context of the discussion. The computer graphics imaging and visual computing markets, and the personal computer industry in general, are characterized by rapidly changing technology, resulting in short product life cycles and price declines. The Company must continuously update its existing products to keep them current with changing technology and must develop new products to take advantage of new technologies that could render the Company's existing products obsolete. The Company's future prospects are highly dependent on its ability to keep pace with its competitors' innovations, to adapt to new operating systems, hardware platforms, and emerging industry standards, and to provide additional functionality to the Company's existing products. The inability of the Company to develop and introduce such products in a timely manner would have a material adverse effect on the Company's future business, operating results, financial condition, and cash flows. In May 1997, the stockholders of MetaCreations and Fractal Design Corporation ("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 and assumed approximately 1,653,000 options to purchase Fractal common stock. The merger was accounted for as a pooling of interests and, accordingly, the consolidated financial statements were restated to include the accounts of Fractal for all periods presented. The Company reports its financial results on a December 31 fiscal year-end basis, whereas Fractal reported its financial results on a March 31 fiscal year-end basis. For the purposes of pooling-of-interests accounting, the balance sheet of the Company as of December 31, 1996 has been combined with that of Fractal as of March 31, 1997. The statements of operations of the Company for the year ended December 31, 1996 has been combined with that of Fractal for the year ended March 31, 1997. Accordingly, Fractal's net loss of $513,000 for the three months ended March 31, 1997 has been reflected as an adjustment to retained earnings. The results of operations of Fractal for such three month period include net revenues of $7,004,000. Separate results of operations for the period presented is as follows (in thousands):
YEAR ENDED DECEMBER 31, 1996 ------------ Net revenues: MetaCreations......................................... $28,035 Fractal............................................... 34,901 ------- $62,936 ======= Net income (loss): MetaCreations......................................... $(9,239) Fractal............................................... 1,589 ------- $(7,650) =======
36 39 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition During the year ended December 31, 1998, the Company adopted Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-4, "Deferral of the Effective Date of Certain Provisions of SOP 97-2." SOP 97-2 and SOP 98-4, which supercede SOP 91-1, generally require 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 Company recognizes product revenues upon shipment to the customer, satisfaction of Company obligations, if any, and reasonable assurance regarding the collectability of the corresponding receivable. Revenue allocated to postcontract customer support 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 and SOP 98-4 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 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. At December 31, 1998 and 1997, the Company had an allowance for potential returns of approximately $1,720,000 and $2,034,000, respectively. The Company has entered into agreements whereby it licenses products to original equipment manufacturers ("OEM's") and foreign publishers which provide such customers the right to produce and distribute multiple copies of its software. Nonrefundable fixed fees are recognized as revenue at delivery of the product master to the customer, satisfaction of Company obligations, if any, and reasonable assurance regarding the collectability of the corresponding receivable. Per copy royalties in excess of fixed amounts are recognized as revenue when such amounts exceed fixed minimum royalties. Revenues under OEM contracts without nonrefundable fixed fees are recognized as earned over the term of the contract. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. 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 establishing of reserves requires judgments regarding such factors as future competitive conditions and product life cycles, which can be difficult to predict. Actual results could differ from those estimates. Inventories Inventories consist of finished products and software components, primarily instruction manuals, diskettes, CD ROMs and packaging ready for assembly. The Company periodically evaluates the carrying 37 40 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) value of its inventories, including a review for potentially excess or obsolete products, and adjusts these as necessary. At December 31, 1998 and 1997, the Company had reserves of approximately $418,000 and $719,000, respectively, for potentially excess or obsolete inventory items. Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method. Property and Equipment Property and equipment are stated at cost. Assets are depreciated on the straight-line method over their estimated useful lives, which range from 3 to 7 years. Leasehold improvements are amortized over the shorter of the life of the lease or the life of the asset. Upon sale, any gain or loss is included in the consolidated statement of operations. Maintenance and minor replacements are expensed as incurred. Long-Term Assets The carrying value of long-term assets, primarily consisting of property and equipment, goodwill, and other intangible assets, is periodically reviewed by management. Impairment losses, if any, are recognized when the expected nondiscounted future operating cash flows derived from such assets are less than their carrying value. Research and Development Research and development costs are expensed as incurred. Software Development Costs The Company provides for capitalization of certain software development costs once technological feasibility is established. The costs so capitalized are then amortized on a straight-line basis over the estimated product life (generally eighteen months to three years), or on the ratio of current revenue to total projected product revenues, whichever is greater. 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. Advertising The Company reports the costs of all advertising as expenses in the periods in which those costs are incurred. The Company shares portions of certain distributors' advertising expenses through co-op advertising arrangements. Advertising expense, primarily consisting of co-op advertising, catalog advertising, direct mailings, and placements in business and consumer publications, was approximately $11,816,000, $12,060,000, and $10,315,000 for the years ended December 31, 1998, 1997, and 1996 respectively. Cash Equivalents and Short-term Investments The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The Company considers its investment portfolio available-for-sale as defined in Statement of Financial Accounting Standard ("SFAS") No. 115. These available-for-sale securities are accounted for at their fair value, and unrealized gains and losses on these securities are reported as a separate component of stockholders' equity. At December 31, 1998 and 1997, net unrealized gains or losses on available-for-sale securities were not significant. 38 41 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company invests its cash in accordance with a policy that seeks to maximize returns while ensuring both liquidity and minimal risk of principal loss. The policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings, and places restrictions on maturities and concentration by type and issuer. The majority of the Company's portfolio is composed of fixed income investments which 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. Royalty Expense The Company licenses certain third-party software and code for inclusion in its products. Royalties are payable to developers of the software or code at various rates and amounts, generally based on net unit sales or net revenues. These agreements may include royalty advances against future expected sales, which advances are recorded as prepaid expenses until such royalties are earned. Royalty expense, which is included as a component of cost of revenues, amounted to approximately $1,302,000, $2,563,000, and $2,487,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Credit Risk The Company sells its retail products domestically through unaffiliated distributors and OEM's, as well as directly to end-users. International sales are generally made through distributors in each of the foreign countries in which the Company markets its products. Credit is extended based on an evaluation of each customer's financial condition, and generally collateral is not required. Estimated credit losses and returns, if any, have been provided for in the financial statements and have generally been within management's expectations. At December 31, 1998 and 1997, the Company has an allowance for doubtful accounts of approximately $1,005,000 and $1,216,000, respectively. At December 31, 1998, and periodically throughout 1996 to December 31, 1998, the Company has maintained balances with various financial institutions in excess of the federally insured limits. Foreign Currency Translation The functional currency of each of the Company's foreign subsidiaries is its local currency. Financial statements of these foreign subsidiaries are translated to U.S. dollars for consolidation purposes using current rates of exchange for assets and liabilities and average rates of exchange for revenues and expenses. The effects of currency translation adjustments are included as a component of stockholders' equity. Gains and losses on foreign currency translations for 1998, 1997, and 1996 were insignificant. Income Taxes The Company accounts for income taxes using the liability method as required by SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred income taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Stock-Based Compensation The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees." 39 42 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Net Income (Loss) Per Common Share Basic net income (loss) per common share is computed using the weighted average number of shares of common stock and diluted net income (loss) per common share is computed using the weighted average number of shares of common stock and common equivalent shares outstanding. Common equivalent shares related to stock options, warrants and preferred stock are excluded from the computation when their effect is antidilutive. Comprehensive Income During the year ended December 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 years ended December 31, 1998, 1997, and 1996. Segment Information and Enterprise-Wide Disclosures During the year ended December 31, 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 supercedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. Specific information to be reported for individual segments includes profit or loss, certain revenue and expense items and total assets. SFAS No. 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS No. 131 did not have a material impact on the Company's financial position, results of operations or cash flows for the years ended December 31, 1998, 1997, and 1996, but did affect enterprise-wide disclosures for the respective periods (Note 17). Reclassifications Certain reclassifications have been made to the 1997 consolidated financial statements to conform to the 1998 presentation. 3. RESTRUCTURING On June 30, 1998, the Company announced a restructuring plan aimed at reducing costs and improving competitiveness and efficiency, which was implemented during the third quarter of 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 $4,955,000 was required to cover the costs of reducing certain sectors of its workforce and facilities. The restructuring charge included an accrual of approximately $2,208,000 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 $2,747,000, 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 first quarter of 1999. 40 43 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following table depicts the restructuring activity through December 31, 1998 (in thousands):
TOTAL BALANCE AT RESTRUCTURING SPENDING/ DECEMBER 31, CHARGES CHARGES 1998 ------------- --------- ------------ Write-down of operating assets......... $2,747 $2,747 $ -- Severance and benefits................. 1,801 1,684 117 Vacated facilities..................... 116 116 -- Other.................................. 291 291 -- ------ ------ ---- $4,955 $4,838 $117 ====== ====== ====
4. MERGERS AND ACQUISITIONS Ray Dream, Inc. On May 24, 1996, the Company acquired Ray Dream, Inc. ("Ray Dream"), a California corporation which designed, developed and marketed graphics software application tools emphasizing three-dimensional effects for the personal computer market. As a result of the acquisition, Ray Dream became a wholly-owned subsidiary of Fractal. As consideration for 100% of the outstanding shares of Ray Dream capital stock, the Company issued an aggregate of approximately 2,371,000 shares of common stock and reserved approximately 164,000 shares of common stock for issuance upon the exercise of outstanding options to purchase Ray Dream common stock. The Company also assumed an outstanding warrant, held by a third party software developer, to purchase Ray Dream common stock. This warrant vested during the third quarter of 1996 upon completion of certain development milestones, and was fully exercised, on a net basis, for approximately 134,000 shares of common stock. The acquisition of Ray Dream was accounted for as a pooling-of-interests and accordingly, the Company's consolidated financial statements have been restated for all periods prior to the acquisition to include the financial statements of Ray Dream. Transaction fees of approximately $1,865,000 were recorded during the year ended December 31, 1996. Dive Laboratories On August 31, 1996, the Company acquired Dive Laboratories, Inc. ("Dive"), a privately held company based in Santa Cruz, California, that developed 3D modeling and rendering environments for high-end applications and the visualization of streaming online data. In connection with the acquisition, which was accounted for under the purchase method of accounting, the Company recorded a one-time charge to earnings of approximately $733,000 for the year ended December 31, 1996, comprised of relocation expenses of $215,000, acquisition costs of $155,000, and in-process research and development expenses of $363,000. The Company paid $509,000 in cash and assumed $224,000 of net liabilities of Dive. The operating results of Dive have been included in the accompanying consolidated financial statements from the date of acquisition. Real Time Geometry On December 31, 1996, the Company completed the acquisition of Real Time Geometry Corp. ("RTG"), a privately held development stage company based in Princeton, New Jersey, that developed real time 3D graphics and visualization technologies. The acquisition was accounted for by the Company under the purchase method of accounting. Under the terms of the Purchase Agreement, the stockholders and optionholders of RTG received a combination of shares of the Company's common stock and options to purchase shares of the Company's common stock valued at approximately $11,242,000 and $607,000, respectively, at December 31, 1996, the closing date. In addition, the Company assumed the net liabilities of RTG, which totaled $1,411,000 at December 31, 1996. As of December 31, 1996, neither technological feasibility nor commercial viability had been reached with regard to RTG's core technology, comprised of 41 44 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) advanced geometry-based algorithms to accelerate the display of three-dimensional images. Based upon projected future cash flows, risk-adjusted using a 40% discount rate, RTG's core in-process technology was valued in excess of the amount written-off as acquired in-process technology of $13,260,000, which combined with acquisition costs totaling $1,189,000, resulted in a one time charge to earnings of $14,449,000 for the year ended December 31, 1996. The operating results of RTG have been included in the accompanying consolidated financial statements from the date of acquisition. The following unaudited pro forma information presents a summary of the consolidated results of operations of the Company and RTG as if the acquisition had taken place on February 1, 1996 (date of inception of RTG). In management's opinion, the following unaudited pro forma consolidated information is not indicative of the actual results that would have occurred had the acquisition been consummated on February 1, 1996 or of future operations of the consolidated entities under the ownership and management of the Company (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31, 1996 ------------ (UNAUDITED) Net revenues............................................ $62,936 Net income.............................................. 4,739 Net income per common share............................. 0.20
Specular International, Ltd. On April 15, 1997, the Company completed the acquisition of Specular International, Ltd. ("Specular"), a privately held software development company based in Amherst, Massachusetts, that developed and marketed 3-D animation and graphic design tools for professionals and pro-sumers. 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 $4,088,000, and $1,000,000 in cash in 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. In addition, the Company assumed the net liabilities of Specular, which totaled $1,601,000 at April 15, 1997. The Company charged approximately $6,430,000 against earnings during the year ended December 31, 1997, comprised of the write-off of acquired in-process technology of $5,575,000, 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. The operating results of Specular have been included in the accompanying consolidated financial statements from the date of acquisition. Canoma, Inc. On December 31, 1998, the Company completed the acquisition of Canoma, Inc. ("Canoma"), a privately held development-stage software company based in Northern California, that was developing software technology that creates 3-D digital images and content from 2-D digital images for use primarily over the Internet, and in other applications. The acquisition was accounted for by the Company under the purchase method of accounting. Under the terms of the Purchase Agreement, the stockholders of Canoma received 300,000 shares of the Company's common stock valued at approximately $1,305,000 at December 31, 1998, the closing date, and cash consideration totaling $1,750,000. As of December 31, 1998, neither technological feasibility nor commercial viability had been reached with regard to Canoma's technology or potential 42 45 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) products. Based upon projected future cash flows, risk-adjusted using a 33% discount rate, Canoma's in-process technology was valued at approximately $2,250,000, which, including acquisition costs totaling approximately $100,000, resulted in a one time charge to earnings of approximately $2,350,000 for the year ended December 31, 1998. The remaining purchase price of approximately $805,000 was capitalized by the Company as goodwill and will be amortized over 5 years. The operating results of Canoma have been included in the accompanying consolidated financial statements from the date of acquisition. 5. INVESTMENTS The Company considers its investment portfolio available-for-sale as defined in SFAS No. 115. There were no material gross realized or unrealized gains or losses nor any material differences between the estimated fair values and costs of securities in the investment portfolio at December 31, 1998. The cost of the investment portfolio by type of security, contractual maturity, and its classification in the balance sheet, is as follows (in thousands):
DECEMBER 31, ------------------ 1998 1997 ------- ------- Type of security: Corporate debt securities.............................. $32,954 $37,393 Government agencies.................................... 8,978 1,980 Money market funds..................................... 880 688 U.S. Treasury securities............................... -- 5,465 ------- ------- $42,812 $45,526 ======= ======= Contractual maturity: Due in one year or less................................ $34,125 $43,413 Due in one to three years.............................. 8,687 2,113 ------- ------- $42,812 $45,526 ======= ======= Classification in balance sheet: Cash and cash equivalents.............................. $16,297 $ 9,653 Marketable securities.................................. 30,038 40,349 ------- ------- 46,335 50,002 Less cash.............................................. 3,523 4,476 ------- ------- $42,812 $45,526 ======= =======
6. INVENTORIES Inventories consist of the following (in thousands):
DECEMBER 31, -------------- 1998 1997 ---- ------ Finished goods.............................................. $434 $1,465 Materials and supplies...................................... 92 202 ---- ------ $526 $1,667 ==== ======
43 46 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. PROPERTY AND EQUIPMENT Property and equipment consist of the following (in thousands):
DECEMBER 31, ------------------ 1998 1997 ------- ------- Computer equipment....................................... $ 7,256 $ 7,687 Office furniture and equipment........................... 3,599 3,633 Leasehold improvements................................... 1,301 1,028 ------- ------- 12,156 12,348 Less accumulated depreciation and amortization........... (5,327) (4,771) ------- ------- $ 6,829 $ 7,577 ======= =======
8. ACCRUED EXPENSES Accrued expenses consist of the following (in thousands):
DECEMBER 31, ---------------- 1998 1997 ------ ------ Accrued compensation....................................... $2,043 $2,520 Accrued acquisition costs.................................. 1,100 -- Covenant-not-to-compete.................................... 150 300 Accrued restructuring costs................................ 117 -- Accrued advertising........................................ 53 688 Other accrued expenses..................................... 737 430 ------ ------ $4,200 $3,938 ====== ======
9. RELATED PARTY TRANSACTIONS A director of the Company rendered services to the Company for which he received $59,000, $47,000, and $44,000, in each of 1998, 1997, and 1996. Another director of the Company rendered services to the Company for which he received $48,000 and $44,000 in each of 1998 and 1997. The Company believes that the terms of the agreements for these services are no less favorable than could be obtained from third-party suppliers. During 1996, the Company leased space for development activities at the residence of an officer and director of the Company at a rental rate of $2,500 per month. In connection with the acquisition of RTG on December 31, 1996 (Note 4), the Company entered into a noncompetition agreement with one of RTG's founders who is now an executive of the Company. The agreement, which carries a term of four years, provided for payments to the executive in the amount of $300,000 in 1997 and $150,000 in each of 1998 and 1999. In addition, the Company loaned $2,000,000 to the executive. The loan, which accrues interest semi-annually at 5.67% and is payable on December 31, 1999, is collateralized by shares of common stock of the Company owned by the executive. The Company also loaned $1,000,000 to another of RTG's founders who is now an officer of the Company. The loan, which accrues interest semi-annually at 5.67% and is payable on December 31, 2002, is collateralized by certain options to purchase shares of common stock of the Company owned by the officer. The loans are classified as a component of stockholders' equity. During 1998, the Company loaned $1,000,000 to an officer and director of the Company. The loan, which is non-interest bearing, is payable on February 20, 2002. The loan is collateralized by a first deed trust on the 44 47 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) officer's residence. The Company also loaned $150,000 to another officer and director of the Company. The loan, which bears interest semi-annually at 4.47%, is payable on May 18, 2000. The loan is collateralized by certain shares of common stock of the Company owned by the officer as well as options to purchase shares of the common stock of the Company. The loans are classified as a component of stockholders' equity. 10. NOTES PAYABLE TO BANK The Company has a credit facility (the "Facility") with its principal lending institution (the "Bank") which provides a Line of Credit (the "Line") under which borrowings can be made based upon eligible accounts receivable (as defined), up to aggregate amount of $3.0 million. The Line accrues interest at the Bank's prevailing prime interest rate (7.75% at December 31, 1998). The Facility also provides for letter of credit and foreign exchange contracts subfacilities up to the $3.0 million credit limit. The Facility expires in March 2000, if not renewed. There were no borrowings against the Line during the years ended December 31, 1998, 1997 and 1996. In addition, there were no outstanding letters of credit or foreign exchange contracts at December 31, 1998. The Facility contains certain covenants which provide, among other things, a restriction on dividend payments and the requirement for the maintenance of certain measures of liquidity and equity. 11. STOCKHOLDERS' EQUITY Warrants In June 1995, the Company entered into a Software Development and Purchasing Agreement (the "Agreement") with a software development company (the "Contractor") pursuant to which the Contractor would develop a software product defined in the Agreement. The Company pays a royalty for product purchases at a rate of 14% of net revenues (as defined) subject to adjustments for certain events. The Company paid a total of $400,000 in advances against such product purchases. Royalty payments were offset against the advances at a rate of 50%. At December 31, 1997, advances totaling $147,000 were included in prepaid expenses. No advances were outstanding at December 31, 1998. In addition, The Company granted a warrant with a fair market value of $348,000 to the Contractor to purchase approximately 328,000 shares of common stock at $9.45 per share. The exercise of the warrants was subject to the Contractor meeting certain milestones in the Agreement and provided for reductions in the royalty payments to the Contractor as the warrants were exercised. This warrant was exercised during the year ended December 31, 1996, on a net basis, for approximately 134,000 shares of common stock (see Note 4). Of the total value of these warrants, $185,000 was recognized as research and development expense during the year ended December 31, 1996. 12. EMPLOYEE BENEFIT PLANS Employee Stock Purchase Plan The Company's 1995 Employee Stock Purchase Plan (the "1995 Purchase Plan"), which is qualified under Section 423 of the Internal Revenue Code of 1986, as amended, permits eligible employees of the Company, via payroll deductions, to purchase shares of the Company's common stock semi-annually at 85 percent of the market price, on either the purchase date or the offering date, whichever is lower. As of December 31, 1998, approximately 138,000 shares of common stock have been issued under the 1995 Purchase Plan. At December 31, 1998, an aggregate of approximately 287,000 shares of common stock were reserved for future issuance under the 1995 Purchase Plan. 401(k) Plan In September 1995, the Company adopted a Defined Contribution Plan (the "401(k) Plan"). Participation in the 401(k) Plan is available to substantially all employees. Employees can contribute up to 15% of their 45 48 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) salary, up to the Federal maximum allowable limit, on a before tax basis to the 401(k) Plan. Company contributions to the 401(k) Plan are discretionary. The Company made contributions totaling $161,000 and $139,000 to the 401(k) Plan during the years ended December 31, 1998 and 1997. No contributions were made during the year ended December 31, 1996. In March 1995, the Company adopted a Defined Contribution Plan (the "Fractal 401(k) Plan"). Participation in the Fractal 401(k) Plan was available to substantially all Fractal employees. Employees could contribute up to 15% of their salary, up to the Federal maximum allowable limit, on a before tax basis to the 401(k) Plan. Effective August 1996, the Company began making matching contributions in the form of common stock. During the year ended December 31, 1996, the Company contributed approximately 7,000 shares of common stock with an aggregate fair market value of $88,000. Upon consummation of the merger, the Fractal 401(k) Plan was merged with and into the 401(k) Plan. Stock Option Plans (the "Plans") 1992 Incentive Stock Option Plan The Company's 1992 Incentive Stock Option Plan (the "1992 Plan") provides for the grant to employees of incentive stock options and nonstatutory stock options and for the sale or award of restricted common stock to employees and consultants of the Company. As of December 31, 1998, options to purchase an aggregate of 584,000 shares of common stock were outstanding under the 1992 Plan, with vesting provisions ranging up to five years. Options granted under the 1992 Plan are exercisable for a period of ten years. At December 31, 1998, no shares of common stock were reserved for additional grants of options or awards of restricted stock under the 1992 Plan. 1994 Incentive Stock Option, Non-Qualified Stock Option and Restricted Stock Purchase Plan The Company's 1994 Incentive Stock Option, Non-Qualified Stock Option and Restricted Stock Purchase Plan (the "1994 Plan") provides for the grant to employees of incentive stock options and nonstatutory stock options and for the sale of restricted common stock to employees and consultants of the Company, with vesting provisions ranging up to five years. Options granted under the 1994 Plan are exercisable for a period of ten years. As of December 31, 1998, options to purchase an aggregate of 344,000 shares of common stock were outstanding under the 1994 Plan. At December 31, 1998, no shares of common stock were reserved for additional grants of options or awards of restricted stock under the 1994 Plan. 1995 Stock Plan The Company's 1995 Stock Plan (the "1995 Plan") provides for the grant to employees (including officers and employee directors) of incentive stock options and for the grant to employees (including officers and employee directors) and consultants of nonstatutory stock options and stock purchase rights. As of December 31, 1998, options to purchase an aggregate of 3,333,000 shares of common stock were outstanding under the 1995 Plan, with vesting provisions ranging up to four years. Options granted under the 1995 Plan are exercisable for a period of ten years. At December 31, 1998, an aggregate of 156,000 shares of common stock were reserved for future issuance under the 1995 Plan. 1995 Director Option Plan The Company's 1995 Director Option Plan (the "Director Plan") provides for an automatic grant of options to purchase shares of common stock to each non-employee director of the Company. Options granted under the 1995 Director Plan vest over four years and are exercisable for a period of ten years. As of December 31, 1998, 55,000 options were outstanding under the 1995 Director Plan. At December 31, 1998, an aggregate of 95,000 shares of common stock were reserved for future issuance under the 1995 Director Plan. 46 49 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1996 Dive Option Plan In connection with the acquisition of Dive in August 1996 (Note 4), the Company issued options to purchase an aggregate of 211,000 shares of common stock to the previous stockholders and employees of Dive (the "Dive Plan"). The non-statutory stock options vest over four years and are exercisable for a period of ten years. As of December 31, 1998, 129,000 options were outstanding under the Dive Plan. At December 31, 1998, no shares of common stock were reserved for future issuance under the Dive Plan. 1996 Nonstatutory Stock Option Plan The Company's 1996 Nonstatutory Stock Option Plan (the "1996 Nonstatutory Plan") provides for the grant to employees (including officers and employee directors) and consultants of nonstatutory stock options and stock purchase rights. As of December 31, 1998, options to purchase an aggregate of 2,341,000 shares of common stock were outstanding under the 1996 Nonstatutory Plan, with vesting provisions ranging up to four years. Options granted under the 1996 Nonstatutory Plan are exercisable for a period of ten years. At December 31, 1998, an aggregate of 673,000 shares of common stock were reserved for future issuance under the 1996 Nonstatutory Plan. Fractal Stock Option Plan In connection with the Company's merger with Fractal, which became effective on May 30, 1997, the Company assumed all of the options outstanding under the Ray Dream 1992 Stock Option Plan, the Fractal 1993 Stock Option Plan, the Fractal 1995 Stock Option Plan, the Fractal Director Plan and the Fractal Outside Plan (collectively, the "Fractal Plans"). All such options were converted into options to purchase 0.749 shares of MetaCreations common stock at an exercise price equal to the exercise price of the converted option divided by 0.749. Options granted under the Fractal Plans generally vest over a four year period and are exercisable for a period of ten years. As of December 31, 1998, options to purchase an aggregate of 289,000 shares of common stock were outstanding under the Fractal Plans. At December 31, 1998, no shares of common stock were reserved for future issuance under the Fractal Plans. 47 50 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Options Issued Under Plans The following summarizes activity in the Plans for the years ended December 31, 1996, 1997, and 1998 (in thousands, except per share data):
OPTIONS OUTSTANDING --------------------- OPTIONS WEIGHTED AVAILABLE AVERAGE FOR NUMBER OF EXERCISE GRANT SHARES PRICE --------- --------- -------- Options outstanding at December 31, 1995..... 1,299 2,980 $3.66 Shares reserved under new plans............ 1,511 -- -- Reduction in shares reserved under plans... (187) -- -- Granted -- exercise price equal to fair value................................... (1,409) 1,409 16.35 Granted -- exercise price greater than fair value................................... (854) 854 13.06 Exercised.................................. -- (428) 1.79 Canceled................................... 329 (329) 11.30 ------ ------ ----- Options outstanding at December 31, 1996..... 689 4,486 8.83 Shares reserved under new plans............ 2,140 -- -- Reduction in shares reserved under plans... (592) -- -- Granted -- exercise price equal to fair value................................... (3,258) 3,258 9.77 Granted -- exercise price greater than fair value................................... (35) 35 7.16 Exercised.................................. -- (756) 2.45 Canceled................................... 1,520 (1,520) 14.57 ------ ------ ----- Options outstanding at December 31, 1997..... 464 5,503 $8.66 Shares reserved under new plans............ 2,700 -- -- Reduction in shares reserved under plans... (426) -- -- Granted -- exercise price equal to fair value................................... (5,412) 5,412 6.07 Granted -- exercise price greater than fair value................................... (1,577) 1,577 5.09 Exercised.................................. -- (233) 3.66 Canceled................................... 5,176 (5,176) 9.38 ------ ------ ----- Options outstanding at December 31, 1998..... 925 7,083 $5.53 ====== ====== =====
The following summarizes options exercisable at December 31, 1998, 1997, and 1996 (in thousands):
DECEMBER 31, ----------------------- 1998 1997 1996 ----- ----- ----- Options exercisable................................. 1,847 1,642 1,036
48 51 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following summarizes information about stock options outstanding at December 31, 1998 (in thousands, except per share data and lives):
OUTSTANDING EXERCISABLE ----------------------------- ------------------ WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE PRICE RANGE SHARES LIFE(A) PRICE SHARES PRICE -------------------- ------ ------- -------- ------ -------- $0.08 - $ 3.31................ 779 6.09 $ 1.21 729 $ 1.07 $3.38 - $ 5.03................ 806 7.17 4.03 312 4.23 $5.09 - $ 5.09................ 3,752 8.60 5.09 172 5.09 $5.25 - $ 7.94................ 976 9.05 6.72 127 7.25 $8.00 - $25.13................ 770 7.26 12.09 507 12.10 ----- ---- ------ ----- ------ Total............... 7,083 8.08 $ 5.53 1,847 $ 5.43 ===== ==== ====== ===== ======
- --------------- (a) Average contractual life remaining in years. The Company accrued compensation expense of $607,000 for the difference between the grant price and the deemed fair value of the common stock underlying options, which are fully vested, issued in connection with the RTG acquisition (Note 4) in December 1996. At December 31, 1998, accrued compensation related to the options totaled $568,000. During the year ended December 31, 1995, the Company granted to employees stock options for the purchase of shares of common stock at exercise prices less than the fair market value of the Company's common stock on the grant date. During the year ended December 31, 1996, the Company recognized approximately $190,000 of compensation expense relating to these options. Pro Forma Information Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Company has accounted for the Plans under the fair value method of SFAS No. 123. The fair value of options issued under the Plans was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
YEARS ENDED DECEMBER 31, ------------------------- 1998 1997 1996 ----- ---- ---- Risk-free interest rate............................ 5.6% 5.6% 6.0% Dividend yield..................................... -- -- -- Volatility factor.................................. 1.00 .80 .70 Weighted average expected life in years............ 4.3 4.5 4.3
The following summarizes the weighted average fair value of options granted during the years ended December 31, 1998, 1997, and 1996:
YEARS ENDED DECEMBER 31, ------------------------ 1998 1997 1996 ----- ----- ------ Exercise price equal to fair value................. $4.46 $6.40 $10.19 Exercise price greater than fair value............. 2.23 4.13 7.71 Exercise price less than fair value................ -- -- --
49 52 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma net loss and net loss per common share would approximate the following (in thousands, except per share amounts):
AS REPORTED PRO FORMA ----------- --------- Year Ended December 31, 1998: Net loss............................................ $(19,831) $(21,732) Net loss per common share (diluted)................. (0.83) (0.91) Year Ended December 31, 1997: Net loss............................................ $ (8,178) $(10,499) Net loss per common share (diluted)................. (0.36) (0.46) Year Ended December 31, 1996: Net loss............................................ $ (7,650) $ (9,938) Net loss per common share (diluted)................. (0.37) (0.48)
The effects of applying SFAS No. 123 in this proforma disclosure are not indicative of future amounts. The Company anticipates grants of additional awards in future years. 13. INCOME TAXES The components of the provision (benefit) for income taxes for the years ended December 31, 1998, 1997, and 1996 are as follows (in thousands):
YEARS ENDED DECEMBER 31, ---------------------------- 1998 1997 1996 ------ ------- ------- Current: Federal...................................... $ 190 $ 1,210 $ 2,593 State........................................ 1 2 984 Foreign...................................... 216 24 -- ------ ------- ------- Total current........................ 407 1,236 3,577 Deferred: Federal...................................... 67 (712) (1,233) State........................................ (394) (408) (128) Foreign...................................... (433) (326) -- ------ ------- ------- Total deferred....................... (760) (1,446) (1,361) ------ ------- ------- $ (353) $ (210) $ 2,216 ====== ======= =======
50 53 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The differences between the Company's effective income tax rate and the United States statutory rate are as follows:
YEARS ENDED DECEMBER 31, ---------------------------- 1998 1997 1996 ------ ------- ------- Federal tax benefit at the statutory rate...... (34.0)% (35.0)% (34.0)% State income taxes, net of Federal income tax benefit.................................. (5.1) (4.3) (5.3) Nondeductible acquisition costs................ 3.9 42.0 94.3 Other.......................................... 7.7 (1.0) 10.6 Change in valuation reserve.................... 25.7 (4.2) (24.8) ------ ------- ------- (1.8)% (2.5)% 40.8% ====== ======= =======
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, together with net operating loss and tax credit carryforwards. Significant components of the Company's deferred tax assets and liabilities are as follows (in thousands):
DECEMBER 31, ----------------- 1998 1997 ------- ------ Deferred tax assets: Balance sheet reserves.................................. $ 268 $ 747 Accrued expenses........................................ 502 617 Tax credit carryforwards................................ 2,260 -- Net operating loss carryforwards........................ 9,019 4,733 ------- ------ 12,049 6,097 Valuation allowance..................................... (6,102) (911) ------- ------ Net deferred tax assets.............................. 5,947 5,186 Deferred tax liabilities: Depreciation and amortization........................... (34) (33) ------- ------ Net deferred tax liabilities......................... (34) (33) ------- ------ Net deferred taxes................................... $ 5,913 $5,153 ======= ======
The valuation allowance for deferred taxes was increased approximately $5,191,000 during 1998 based on management's assessment of the recoverability of the deferred tax assets. Management's assessment included an evaluation of the Company's deferred income tax assets; available tax carrybacks; cumulative net income, excluding costs related to mergers and acquisitions; available tax planning strategies; and future financial statement projections. Based on this assessment and interpretation of the provisions of SFAS No. 109, management has concluded that additional net operating losses and other tax benefits generated during 1998 require a valuation allowance. Management's assessment with respect to the amount of deferred tax assets considered realizable may be revised over the near term based on actual operating results and revised financial statement projections. For 1997, the valuation allowance for deferred taxes decreased approximately $353,000, primarily as a result of the recognition of a state deferred tax asset. At December 31, 1997, a valuation allowance was placed against the net operating losses of RTG due to potential limitations on the Company's ability to utilize the loss carryforwards in light of RTG's earnings history and pursuant to the ownership rule changes of the Internal Revenue Code, Section 382. 51 54 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) At December 31, 1998, the Company has net operating loss and tax credit carryforwards of approximately $23,027,000 and $1,565,000, respectively, for federal income tax purposes, which begin expiring in 2011. The Company's Federal net operating loss carryforward relates to the Company's acquisitions of RTG and Specular, its merger with Ray Dream, and the net loss incurred by the Company during the year ended December 31, 1998. The Company also has net operating loss and tax credit carryforwards of approximately $10,678,000 and $503,000, respectively, for state income tax purposes, which begin expiring in 2001. The Company's state net operating loss carryforward primarily relates to the net loss incurred by the Company during the year ended December 31, 1998. Additionally, the Company has net operating loss and tax credit carryforwards of approximately $5,667,000 and $192,000, respectively, for foreign income tax purposes, which do not expire. The Company's foreign net operating loss carryforward relates to net losses incurred by the Company's Irish subsidiary during the years ended December 31, 1998 and 1997. The net operating loss carryforwards may be used to offset any future taxable income, subject to potential limitations on the Company's ability to utilize such carryforwards pursuant to the ownership rule changes of the Internal Revenue Code, Section 382. 14. EARNINGS PER SHARE The following table provides a reconciliation of the numerators and denominators of the basic and diluted per-share computations for the years ended December 31, 1998, 1997, and 1996 (in thousands, except per share amounts):
LOSS SHARES PER-SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- --------- Year Ended December 31, 1998: Basic EPS.................................... $(19,831) 23,779 $(0.83) Effect of dilutive securities -- stock options................................... -- -- -------- ------ Diluted EPS.................................. $(19,831) 23,779 $(0.83) ======== ====== Year Ended December 31, 1997: Basic EPS.................................... $ (8,178) 22,965 $(0.36) Effect of dilutive securities -- stock options................................... -- -- -------- ------ Diluted EPS.................................. $ (8,178) 22,965 $(0.36) ======== ====== Year Ended December 31, 1996: Basic EPS.................................... $ (7,650) 20,590 $(0.37) Effect of dilutive securities -- stock options................................... -- -- -------- ------ Diluted EPS.................................. $ (7,650) 20,590 $(0.37) ======== ======
The computation of the diluted number of shares excludes unexercised stock options which are anti-dilutive. Stock options to purchase 7,083,000, 5,503,000, and 4,486,000 shares of common stock were outstanding as of December 31, 1998, 1997, and 1996, respectively, and excluded from the computation. 15. COMMITMENTS The Company leases office space in Carpinteria under a lease agreement which expires in September 2008. The lease agreement provides the Company with three options to extend the term of the lease through September 2018, in addition to granting the Company the first right of purchase in the event the lessor decides to sell the related property. The Company also leases office space for its facility in Scotts Valley, California, its research facility in Princeton, New Jersey, its international headquarters in Dublin, Ireland, and its various international sales offices pursuant to non-cancelable lease agreements with terms through 2003. The lease 52 55 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) agreement for the Scotts Valley facility, which expires in 2003, provides for two options to extend the term of the lease for three years each. The Company also leases certain equipment and four vehicles for officers and executives of the Company with lease terms of three years. Rent expense for office space, equipment, and vehicles amounted to approximately $1,552,000, $1,480,000, and $972,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Future minimum lease payments under non-cancelable operating leases for each twelve-month period subsequent to December 31, 1998 are as follows (in thousands): 1999............................... $ 1,875 2000............................... 1,704 2001............................... 1,647 2002............................... 1,573 2003............................... 1,379 Thereafter......................... 4,250 ------- $12,428 =======
16. CONTINGENCIES The Company is engaged in certain legal actions arising in the ordinary course of business. On advice of counsel, the Company believes it has adequate legal defenses and believes that the ultimate outcome of these actions will not have a material adverse effect on the Company's consolidated financial position, results of operations, or cash flows. 17. SEGMENT INFORMATION AND ENTERPRISE-WIDE DISCLOSURES MetaCreations is focused on developing and marketing 2D and 3D visualization software for graphic artists, and the World Wide Web. The Company is organized into a single reporting segment which is evaluated by management for making operating decisions and assessing performance. Product and Services Net revenues by product group for the years ended December 31, 1998, 1997, and 1996 are as follows (in thousands):
YEARS ENDED DECEMBER 31, ----------------------------- 1998 1997 1996 ------- ------- ------- Professional.................................. $33,175 $50,938 $51,124 Consumer...................................... 9,668 18,136 11,812 ------- ------- ------- $42,843 $69,074 $62,936 ======= ======= =======
53 56 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Geographic Areas Net revenues by geographic location of external customers for the years ended December 31, 1998, 1997, and 1996 are as follows (in thousands):
YEARS ENDED DECEMBER 31, ----------------------------- 1998 1997 1996 ------- ------- ------- North America................................. $30,495 $42,494 $37,377 Japan......................................... 5,877 12,291 12,096 Europe........................................ 4,480 12,126 10,689 Rest of World................................. 1,991 2,163 2,774 ------- ------- ------- $42,843 $69,074 $62,936 ======= ======= =======
Long-lived assets by geographic area where the Company held assets at December 31, 1998 and 1997 are as follows (in thousands):
DECEMBER 31, ----------------- 1998 1997 ------ ------- United States............................................. $8,472 $ 9,238 Ireland................................................... 286 230 Rest of Europe............................................ 71 97 ------ ------- $8,829 $ 9,565 ====== =======
Major Customers Customers whose net revenues represent greater than 10 percent of the Company's consolidated net revenues for the years ended December 31, 1998, 1997, and 1996 are as follows:
YEARS ENDED DECEMBER 31, ----------------------------- 1998 1997 1996 ------- ------- ------- Customer A -- domestic........................ 8% 17% 20% Customer B -- international................... 15% 12% 2%
Customers whose accounts receivable represent greater than 10 percent of the Company's consolidated net accounts receivable at December 31, 1998 and 1997 are as follows:
DECEMBER 31, ----------------- 1998 1997 ------ ------- Customer A -- domestic.................................... 30% 24% Customer C -- domestic.................................... 13% 5% Customer D -- international............................... 8% 12% Customer B -- international............................... 7% 15%
54 57 METACREATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Summarized quarterly financial information for fiscal years 1998 and 1997, are as follows (in thousands, except per share amounts):
QUARTER ENDED --------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 -------- -------- ------------ ----------- Fiscal year 1998: Net revenues....................... $14,423 $ 8,015 $ 9,053 $11,352 Gross profit....................... 12,092 6,453 7,509 9,782 Net loss........................... (823) (12,393) (2,952) (3,663) Net loss per share (diluted)....... (0.03) (0.52) (0.12) (0.15) Fiscal year 1997: Net revenues....................... $13,252 $ 18,749 $21,008 $16,065 Gross profit....................... 10,584 15,186 17,985 13,460 Net income (loss).................. (432) (12,354) 3,605 1,003 Net income (loss) per share (diluted)....................... (0.02) (0.54) 0.15 0.04
The net loss incurred for the quarter ended June 30, 1998 included costs associated with the restructuring of the Company (Note 3). The net loss incurred for the quarter ended December 31, 1998 included costs associated with the acquisition of Canoma (Note 4), including the related write-off of acquired in-process technology. The net loss incurred for the quarter ended June 30, 1997 resulted from cost associated with the merger with Fractal (Note 1) and the acquisition of Specular (Note 4), including the related write-off of acquired in-process technology. 55 58 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE Board of Directors and Stockholders MetaCreations Corporation Our report on the consolidated financial statements of MetaCreations Corporation and its subsidiaries is included on page 30 of this Form 10-K. In connection with our audits of such financial statements, we have audited the related financial statement schedule at December 31, 1998, 1997 and 1996 and for each of the three years in the period ended December 31, 1998, as listed on the index on page 29 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. PricewaterhouseCoopers LLP Woodland Hills, California January 28, 1999 56 59 METACREATIONS CORPORATION SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
BALANCE AT BALANCE AT BEGINNING CHARGED TO OTHER COSTS AND END OF DESCRIPTION OF PERIOD EXPENSE ADDITIONS DEDUCTIONS PERIOD ----------- ---------- ---------- --------- ---------- ---------- ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year Ended December 31, 1998............. $1,216 $ 765 $316(1) $ 1,292 $1,005 Year Ended December 31, 1997............. 936 630 6(2) 356 1,216 Year Ended December 31, 1996............. 745 597 -- 406 936 ALLOWANCE FOR RETURNS: Year Ended December 31, 1998............. $2,034 $11,872 $572(1) $12,758 $1,720 Year Ended December 31, 1997............. 3,618 4,571 113(2) 6,268 2,034 Year Ended December 31, 1996............. 3,060 5,870 -- 5,312 3,618 ALLOWANCE FOR INVENTORY OBSOLESCENCE: Year Ended December 31, 1998............. $ 719 $ 442 $435(1) $ 1,178 $ 418 Year Ended December 31, 1997............. 631 860 96(2) 868 719 Year Ended December 31, 1996............. 871 724 -- 964 631 VALUATION ALLOWANCE FOR DEFERRED TAX ASSETS: Year Ended December 31, 1998............. $ 911 $ 5,191 $ -- $ -- $6,102 Year Ended December 31, 1997............. 1,264 -- -- 353 911 Year Ended December 31, 1996............. 2,612 -- -- 1,348 1,264
- --------------- (1) Reserves established in connection with the restructuring on June 30, 1998. (2) Reserves obtained in connection with the acquisition of Specular International, Ltd. on April 15, 1997. 57 60 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III Certain information required by Part III is omitted from this Report since the Company plans to file with the Securities and Exchange Commission the definitive proxy statement for its 1999 Annual Meeting of Stockholders (the "Proxy Statement") not later than 120 days after the end of the fiscal year covered by this Report, and certain information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information concerning the Company's directors required by this item is incorporated by reference to the section in the Company's Proxy Statement entitled "Election of Directors." The information concerning the Company's executive officers required by this item is incorporated by reference herein to Part I, Item 4, entitled "Executive Officers of the Registrant," on page 16 of this Report. ITEM 11. EXECUTIVE COMPENSATION The information required by this item, except for such information as need not be incorporated herein by reference under rules promulgated by the Securities and Exchange Commission, is incorporated by reference to the section in the Company's Proxy Statement entitled "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information concerning the Company's directors required by this item is incorporated by reference to the section in the Company's Proxy Statement entitled "Security Ownership." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information concerning the Company's directors required by this item is incorporated by reference to the section in the Company's Proxy Statement entitled "Employment Arrangements." 58 61 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. Financial Statements and Financial Statement Schedules. See Index to Financial Statements at Item 8 on page 29 of this Report. 2. Exhibits.
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 2.1 Form of Agreement and Plan of Merger by and between the Registrant and MetaTools, Inc., a California corporation(1) 2.2 Stock Purchase Agreement between the Registrant and Real Time Geometry Corp. dated December 23, 1996 (the exhibits listed therein have been omitted and filed separately as Exhibits 10.22, 10.23, 10.24, and 10.26)(5) 2.3 Agreement and Plan of Reorganization, dated as of February 11, 1997, among MetaTools, Inc., a Delaware corporation, Fractal Design Corporation, a Delaware corporation, and Rook Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of MetaTools(8) 2.4 Agreement and Plan of Merger among Fractal Design Corporation, a California corporation, and Rook Acquisition Corp., a Delaware corporation, dated as of May 29, 1997(9) 3.4 Restated Certificate of Incorporation of Registrant(3) 3.5 Certificate of Amendment of Restated Certificate of Incorporation of Registrant(9) 3.6 Bylaws of Registrant, as amended on July 24, 1998(12) 4.1 Specimen of Common Stock Certificate of Registrant(9) 10.1 Indemnification Agreement for Executive Officers and Directors(1) 10.2 Investors' Rights Agreement, as amended(1) 10.3 1992 Incentive Stock Plan(1) 10.4 1994 Incentive Stock Option, Non-Qualified Stock Option and Restricted Stock Purchase Plan(1) 10.5 1995 Stock Plan, as amended on May 6, 1998(12) 10.6 1995 Employee Stock Purchase Plan, as amended on May 6, 1998(11) 10.7 1995 Director Option Plan(2) 10.8 Employment Agreement between the Registrant and John J. Wilczak dated April 15, 1992, as amended(1) 10.9 Employment Agreement between the Registrant and Kai Krause dated January 26, 1994(1) 10.10 Employment Agreement between the Registrant and Terance A. Kinninger dated September 27, 1995(1) 10.15 Loan and Security Agreement between the Registrant and Silicon Valley Bank dated September 25, 1994, as amended on December 6, 1996 and March 12, 1998(1)(3)(10) 10.16 * Distribution Agreement between the Registrant and Ingram Micro Inc. dated October 19, 1992, as amended on November 10, 1997(1)(10) 10.19 Form of Employee Invention, Copyright, and Secrecy Agreement(1)
59 62
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 10.20 Employment Agreement between the Registrant and Fred Brown dated November 13, 1995(1) 10.21 * International Software Distribution Agreement between the Registrant and Marubeni Corporation dated as of August 1, 1997(10) 10.22 * Turnkey/Inventory Agreement between the Registrant and Modus Media International, Inc. dated as of June 1, 1997(10) 10.23 Employment Agreement between the Registrant and Robert Rice dated December 31, 1996(5) 10.24 Noncompetition Agreement between the Registrant and Alexander Migdal dated December 31, 1996(5) 10.25 Amended and Restated Investors' Rights Agreement(5) 10.26 Employment Agreement between the Registrant and Alexander Migdal dated December 31, 1996(5) 10.27 1996 Dive Option Plan(6) 10.28 1996 Nonstatutory Stock Option Plan(10) 10.29 * Software Licensing Agreement between the Registrant and Prisma Express Distributionsgesellschaft GmbH dated as of December 30, 1996(7) 10.30 Letter Agreement between the Registrant and Mark Zimmer dated February 11, 1997(10) 10.31 * Software Licensing Agreement between the Registrant and Prisma Express Distributionsgesellschaft GmbH dated as of September 10, 1997(10) 10.32 Severance Agreement between the Registrant and Terance A. Kinninger dated October 31, 1997(10) 10.33 Severance Agreement between the Registrant and Fred Brown dated October 31, 1997(10) 10.34 Lease Agreement between the Registrant and Bluffs Group III dated December 8, 1998(10) 10.35 Second Lease Agreement between the Registrant and Bluffs Group III dated December 8, 1998(10) 10.36 Lease Agreement between the Registrant and HKH Partners dated December 8, 1998(10) 10.37 Consulting and Release Agreement between the Registrant and John J. Wilczak dated February 20, 1998(10) 10.38 Employment Agreement between the Registrant and Gary L. Lauer dated February 20, 1998(10) 10.39 Amendment to Employment Agreement between the Registrant and Gary L. Lauer dated July 16, 1998(12) 10.40 Employment Agreement between the Registrant and John Leddy dated August 24, 1998 10.41 Offer Letter between the Registrant and John E. Dearborn dated December 11, 1998 21.1 Listing of Registrant's Subsidiaries 23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants 24.1 Power of Attorney (included on the signature pages of this Annual Report on Form 10-K)
60 63
EXHIBIT NUMBER EXHIBIT TITLE ------- ------------- 27.1 Financial Data Schedule
- --------------- * Confidential treatment for this exhibit has been requested pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended. (1) Incorporated by reference to the Company's Registration Statement on Form SB-2, filed December 11, 1995, as amended (File No. 33-98628LA). (2) Incorporated by reference to the Company's Registration Statement on Form S-8, filed on or about April 1, 1996 (File No. 333-3070). (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1995. (4) Incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 1996. (5) Incorporated by reference to the Company's Current Report on Form 8-K, filed on or about January 15, 1997. (6) Incorporated by reference to the Company's Registration Statement on Form S-8, filed on or about December 3, 1996 (File No. 333-17209). (7) Incorporated by reference to the Company's Form 10-K for the year ended December 31, 1996. (8) Incorporated by reference to the Company's Registration Statement on Form S-4, filed April 28, 1997 (File No. 333-25939). (9) Incorporated by reference to the Company's Form 8-K, filed June 13, 1997. (10) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997. (11) Incorporated by reference to the Company's Form 10-Q for the quarter ended March 31, 1998. (12) Incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 1998. (b) Reports on Form 8-K No reports have been filed with the Securities and Exchange Commission during the fourth quarter ended December 31, 1998. (c) Exhibits See Item 14(a)(2) above. (d) Financial Statement Schedules See Item 14(a)(1) above. 61 64 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Carpinteria, State of California, on the 31st day of March 1999. METACREATIONS CORPORATION By: /s/ TERANCE A. KINNINGER ------------------------------------ Terance A. Kinninger Sr. Vice President and Chief Financial Officer POWER OF ATTORNEY KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Terance A. Kinninger, his attorney-in-fact, with the power of substitution, for him and any and all capacities, to sign any amendments to this Report on Form 10-K, and to file same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ GARY L. LAUER Director, President and Chief March 26, 1999 - ------------------------------------------ Executive Officer (Principal Gary L. Lauer Executive Officer) /s/ TERANCE A. KINNINGER Vice President and Chief Financial March 26, 1999 - ------------------------------------------ Officer (Principal Financial and Terance A. Kinninger Accounting Officer) /s/ KAI KRAUSE Director and Chief Design Officer March 26, 1999 - ------------------------------------------ Kai Krause /s/ MARK ZIMMER Director and Chief Technology Officer March 26, 1999 - ------------------------------------------ Mark Zimmer /s/ SAMUEL H. JONES, JR. Director March 26, 1999 - ------------------------------------------ Samuel H. Jones, Jr. /s/ BERT KOLDE Director March 26, 1999 - ------------------------------------------ Bert Kolde /s/ WILLIAM H. LANE III Director March 26, 1999 - ------------------------------------------ William H. Lane III /s/ HOWARD L. MORGAN Director March 26, 1999 - ------------------------------------------ Howard L. Morgan
62 EX-10.40 2 EXHIBIT 10.40 1 EXHIBIT 10.40 METACREATIONS CORPORATION EMPLOYMENT AGREEMENT This Employment Agreement (the "Agreement") is made and entered into effective as of August 24, 1998 (the "Effective Date"), by and between John P. Leddy (the "Executive") and MetaCreations Corporation, a Delaware corporation (the "Company"). Recital The Company desires to retain the services of Executive, and Executive desires to be employed by the Company, on the terms and subject to the conditions set forth in this Agreement; NOW, THEREFORE, in consideration of the mutual covenants herein contained, and in other good and valuable consideration, the parties agree as follows: 1. Duties and Scope of Employment. As of the Effective Date, the Company agrees to employ Executive in the position of Vice President and General Manger, Professional Products Group. Executive shall report directly to the Company's Chief Executive Officer (the "CEO"). Executive shall comply with and be bound by the Company's operating policies, procedures and practices from time to time in effect during his employment. During the term of Executive's employment with the Company, Executive shall continue to devote his full time, skill and attention to his duties and responsibilities, and shall perform them faithfully, diligently and competently, and Executive shall use his best efforts to further the business of the Company and its affiliated entities. 2. Base Compensation. The Company shall pay Executive as compensation for his services a base salary of $13,334 per month. Such salary shall be paid periodically on the 15th and last day of each month in accordance with normal Company payroll practices. The annual compensation specified in this Section, together with any increases in such compensation as the Board may direct from time to time, is referred to in this Agreement as "Base Compensation." 3. At-Will Employment. The Company and Executive acknowledge and agree that Executive's employment is "at-will", as defined under applicable law and may be terminated for any reason, with or without cause, or notice. No provision of this Agreement shall be construed as conferring upon Executive a right to continue as an employee of the Company. If Executive's employment terminates for any reason, Executive shall not be entitled to any payments, benefits, damages, awards or compensation other than as provided by this Agreement, or as may otherwise be available in accordance with the Company's established employee plans and policies at the time of termination. -1- 2 4. Bonus. (a) Performance Incentive. Executive shall be eligible for a performance incentive of up to $15,000 each fiscal quarter if performance goals for such quarter are achieved. The performance goals shall be determined by the CEO. Notwithstanding the foregoing, for the first two fiscal quarters of Executive's employment with the Company, the Executive shall be guaranteed a $15,000 performance incentive. (b) Signing Bonus. Executive shall receive a signing bonus of $10,000 payable within fifteen (15) days of the start of Executive's employment with the Company. 5. Stock Option. The Company will recommend that the Board of Directors (the "Board") grant Executive an option to purchase 130,000 shares of the Company's common stock (the "Option"). The per share exercise price of the Option shall be the fair market value of the Company's common stock on the date of such grant, and the Option shall vest and become exercisable as to 25% of the shares one year after the [date of grant/the date you start your employment with the Company] and as to 1/36th of the remaining shares at the end of each month thereafter. The term of the Option shall be ten years subject to earlier termination upon Executive's termination of employment as provided for in the stock option agreement. In all other respects, except as otherwise provided in this Agreement, the Option shall conform to the Company's standard policies with respect to options and shall be granted pursuant to and governed by, the Company's stock option plan and standard stock option agreement. The Option shall be an incentive stock option to the extent possible under the tax laws. 6. Executive Benefits. Executive shall be eligible to participate in employee benefit plans maintained by the Company applicable to other key executives of the Company, including (without limitation) retirement plans, savings or profit-sharing plans, life, disability, health, accident and other insurance programs, paid vacations, and similar plans or programs, subject in each case to the generally applicable terms and conditions of the applicable plan or program in question and to the sole determination of the Board or any committee administering such plan or program. 7. Severance Benefits. (a) Involuntary Termination. If Executive's employment terminates as a result of an Involuntary Termination and Executive signs a release of claims in a form satisfactory to the Company, Executive shall be entitled to receive the following severance benefits: (i) Severance Payments. Severance payments equal to six (6) months of Executive's Base Compensation for the Company's fiscal year then in effect. The severance payments to which Executive is entitled pursuant to this Section 7(a)(i) shall be paid to Executive over a six (6) month period (or to Executive's estate or beneficiary in the event of Executive's death) in accordance with the Company's standard payroll practices. -2- 3 (ii) Medical Benefits. The Company shall pay Executive's COBRA premiums (the "Company-Paid Coverage"). If Executive's health insurance coverage included Executive's dependents immediately prior to Executive's termination, such dependent shall also be covered at Company expense. Company-Paid Coverage shall continue until the earlier of (a) six (6) months after the date of termination of Executive's employment or (b) the date Executive becomes covered under another employer's health insurance plan. (iii) Options. Subject to Sections 9 and 10 below, if Executive's termination occurs within one (1) year of a Change of Control, then (i) during the first year of Executive's employment with the Company, fifty percent (50%) of the unvested portion of any stock option(s) granted to Executive by the Company shall vest and (ii) after the first year of Executive's employment with the Company, one hundred percent (100%) of the unvested portion of any stock option(s) granted to Executive by the Company shall vest. Executive shall have the right to exercise such additional vested portion of such stock option(s), in addition to any portion of the option vested and exercisable prior to the application of this Section. (b) Voluntary Resignation; Termination For Cause. If Executive voluntarily resigns from the Company (other than as a result of an Involuntary Termination), or if the Company terminates Executive's employment for Cause, then Executive shall not be entitled to receive severance or other benefits pursuant to this Agreement. (c) Disability; Death. If the Company terminates Executive's employment as a result of Executive's Disability or if Executive's employment terminates due to the death of Executive, then Executive shall not be entitled to receive severance or other benefits pursuant to this Agreement. However, Executive shall remain eligible for those severance and other benefits (if any) as may then be available under the Company's then existing severance and benefits plans and policies at the time of death. 8. Covenants Not to Compete and Not to Solicit. (a) Until Executive has received all Severance Payments as provided in Section 7, upon the termination of Executive's employment with the Company for any reason, Executive agrees that he shall not, on his own behalf, or as owner, manager, advisor, principal, agent, partner, consultant, director, officer, stockholder or employee of any business entity, or otherwise in any territory in which the Company is actively engaged in business (1) open or operate business which is in competition with any business of the Company, (2) act as an employee, agent, advisor or consultant of any competitor of the Company, (3) solicit or accept business from any of the Company's competitors, (4) take any action to or do anything reasonably intended to divert business from the Company or influence or attempt to influence any existing customers of the Company to cease doing business with the Company or to alter its business relationship with the Company, or (5) take any action or do anything reasonably intended to influence any suppliers of the Company to cease doing business with the Company or to alter its business relationship with the Company. Executive further covenants and agrees that he will not for himself or on behalf of any other person, partnership, firm, association or corporation in any territory -3- 4 served by the Company, directly or indirectly solicit or accept business from any of the Company's existing customers for the purchase or sale of products or services of a like kind to those sold or provided the Company. The foregoing covenant shall not be deemed to prohibit Executive from acquiring an investment not more than one percent (1%) of the capital stock of a competing business, whose stock is traded on a national securities exchange or through the automated quotation system of a registered securities association. (b) Until twelve (12) months after termination of Executive's employment, upon the termination of Executive's employment with the Company for any reason, Executive agrees that he shall not either directly or indirectly solicit, induce, attempt to hire, recruit, encourage, take away, hire any employee of the Company or cause an employee to leave their employment either for Executive or for any other entity or person. (c) Executive represents that he (i) is familiar with the foregoing covenants not to compete and not to solicit, and (ii) is fully aware of his obligations hereunder, including, without limitation, the reasonableness of the length of time, scope and geographic coverage of these covenants. 9. Definition of Terms. The following terms referred to in this Agreement shall have the following meanings: (a) Cause. "Cause" shall mean (i) any act of personal dishonesty taken by Executive in connection with his responsibilities as an Executive and intended to result in substantial personal enrichment of Executive, (ii) conviction of a felony that is injurious to the Company, (iii) a willful act by Executive which constitutes gross misconduct and which is injurious to the Company, and (iv) continued violations by Executive of Executive's obligations under Section 1 of this Agreement that are demonstrably willful and deliberate on Executive's part after there has been delivered to Executive a written demand for performance from the Company which describes the basis for the Company's belief that Executive has not substantially performed his duties. (b) Change of Control. "Change of Control" shall mean the occurrence of any of the following events: (i) The acquisition by any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) (other than the Company or a person that directly or indirectly controls, is controlled by, or is under common control with, the Company) of the "beneficial ownership" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the total voting power represented by the Company's then outstanding voting securities; or (ii) A change in the composition of the Board of Directors of the Company occurring within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. "Incumbent Directors" shall mean directors who either (A) are directors of the Company as of the date hereof, or (B) are elected, or nominated for election, to the Board of Directors -4- 5 of the Company with the affirmative votes of at least a majority of the Incumbent Directors at the time of such election or nomination (but shall not include an individual not otherwise an Incumbent Director whose election or nomination is in connection with an actual or threatened proxy contest relating to the election of directors to the Company); (iii) A merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the approval by the stockholders of the Company of a plan of complete liquidation of the Company or of an agreement for the sale or disposition by the Company of all or substantially all the Company's assets. (c) Disability. "Disability" shall mean that Executive has been unable to perform his duties under this Agreement, with or without reasonable accommodation, as the result of his incapacity due to physical or mental illness, and such inability, at least ninety (90) days after its commencement, is determined to be total and permanent by a physician selected by the Company or its insurers and acceptable to Executive or Executive's legal representative (such Agreement as to acceptability not to be unreasonably withheld). Termination resulting from Disability may only be effected after at least 30 days' written notice by the Company of its intention to terminate Executive's employment. In the event that Executive resumes the performance of substantially all of his duties hereunder before the termination of his employment becomes effective, the notice of intent to terminate shall automatically be deemed to have been revoked. (d) Exchange Act. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (e) Involuntary Termination. "Involuntary Termination" shall mean: (i) the Company's termination of Executive's employment with the Company not for Cause; (ii) without Executive's express written consent, the significant reduction of Executive's duties, authority or responsibilities relative to Executive's duties, authority and responsibilities as in effect immediately prior to such reduction or the assignment to Executive of such reduced duties, authority or responsibilities; (iii) without Executive's express written consent, a reduction by the Company in the Base Compensation of Executive as in effect immediately prior to such reduction other than a reduction which is part of, and generally consistent with, a general reduction of officer salaries; (iv) a material reduction by the Company in the kind or level of Executive benefits to which Executive is entitled immediately prior to such reduction with the result that Executive's overall -5- 6 benefits package is significantly reduced, other than a reduction applicable to officers of the company generally; or (v) the failure of the Company to obtain the assumption of this agreement by any successors contemplated in Section 11 below. 10. Limitation on Payments. (a) In the event that the severance and other benefits provided for in this Agreement or otherwise payable to Executive (i) constitute "parachute payments" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code") and (ii) but for this Section would be subject to the excise tax imposed by Section 4999 of the Code, then Executive's severance benefits under Section 7 shall be payable either (i) in full, or (ii) as to such lesser amount which would result in no portion of such severance benefits being subject to excise tax under Section 4999 of the Code, whichever of the foregoing amounts, taking into account the applicable federal, state and local income taxes and the excise tax imposed by Section 4999, results in the receipt by Executive on an after-tax basis, of the greatest amount of severance benefits under this Agreement, notwithstanding that all or some portion of such severance benefits may be taxable under Section 4999 of the Code. (b) If a reduction in the payments and benefits that would otherwise be paid or provided to Executive under the terms of this Agreement is necessary to comply with the provisions of Section 10(a), Executive shall be entitled to select which payments or benefits will be reduced and the manner and method of any such reduction of such payments or benefits (including but not limited to the number of options that would vest under Sections 7(a)(iii) subject to reasonable limitations (including, for example, express provisions under the Company's benefit plans) (so long as the requirements of Section 10(a) are met). Within thirty (30) days after the amount of any required reduction in payments and benefits is finally determined in accordance with the provisions of Section 10(c), Executive shall notify the Company in writing regarding which payments or benefits are to be reduced. If no notification is given by Executive, the Company will determine which amounts to reduce. If, as a result of any reduction required by Section 10(a), amounts previously paid to Executive exceed the amount to which Executive is entitled, Executive will promptly return the excess amount to the Company. (c) Unless the Company and Executive otherwise agree in writing, any determination required under this Section shall be made in writing by the Company's independent public accountants (the "Accountants"), whose determination shall be conclusive and binding upon Executive and the Company for all purposes. For purposes of making the calculations required by this Section, the Accountants may make reasonable assumptions and approximations concerning applicable taxes and may rely on reasonable, good faith interpretations concerning the application of Sections 280G and 4999 of the Code. The Company and Executive shall furnish to the Accountants such information and documents as the Accountants may reasonably request in order to make a determination under this Section. The Company shall bear all costs the Accountants may reasonably incur in connection with any calculations contemplated by this Section. 11. Successors. -6- 7 (a) Company's Successors. Any successor to the Company (whether direct or indirect and whether by purchase, lease, merger, consolidation, liquidation or otherwise) to all or substantially all of the Company's business and assets shall assume the obligations under this Agreement and agree expressly to perform the obligations under this Agreement in the same manner and to the same extent as the Company would be required to perform such obligations in the absence of a succession. For all purposes under this Agreement, the term "Company" shall include any successor to the Company's business and assets which executes and delivers the assumption agreement described in this Section or which becomes bound by the terms of this Agreement by operation of law. (b) Executive's Successors. Without the written consent of the Company, Executive shall not assign or transfer this Agreement or any right or obligation under this Agreement to any other person or entity. Notwithstanding the foregoing, the terms of this Agreement and all rights of Executive hereunder shall inure to the benefit of, and be enforceable by, Executive's personal or legal representatives, executors, administrators, successors, heirs, devisees and legatees. 12. Notice. (a) General. Notices and all other communications contemplated by this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered or the third day after it is mailed by U.S. registered or certified mail, return receipt requested and postage prepaid. In the case of Executive, mailed notices shall be addressed to him at the home address which he most recently communicated to the Company in writing. In the case of the Company, mailed notices shall be addressed to its corporate headquarters, and all notices shall be directed to the attention of its CEO. (b) Notice of Termination. Any termination by the Company for Cause or by Executive as a result of an Involuntary Termination shall be communicated by a notice of termination to the other party hereto given in accordance with Section 12(a) of this Agreement. Such notice shall indicate the specific termination provision in this Agreement relied upon, shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination under the provision so indicated, and shall specify the termination date (which shall be not more than 15 days after the giving of such notice). The failure by Executive to include in the notice any fact or circumstance which contributes to a showing of Involuntary Termination shall not waive any right of Executive hereunder or preclude Executive from asserting such fact or circumstance in enforcing his rights hereunder. 13. Arbitration. (a) The Company and Executive agree that any dispute or controversy arising out of, relating to, or in connection with this Agreement, the interpretation, validity, construction, performance, breach, or termination hereof, or any of the matters herein shall be settled by binding arbitration to be held in Santa Barbara County, California in accordance with the National Rules for the Resolution of Employment Disputes then in effect of the American Arbitration Association (the "Rules"). The arbitrator may grant injunctions or other relief in such dispute or controversy. The decision of the -7- 8 arbitrator shall be final, conclusive and binding on the parties to the arbitration. Judgment may be entered on the arbitrator's decision in any court having jurisdiction. (b) The arbitrator(s) shall apply California law to the merits of any dispute or claim, without reference to conflicts of law rules. Executive hereby consents to the personal jurisdiction of the state and federal courts located in California for any action or proceeding arising from or relating to this Agreement or relating to any arbitration in which the Parties are participants. (c) The Company and Executive shall each pay one-half of the costs and expenses of such arbitration, and each shall separately pay its counsel fees and expenses, unless otherwise required by law. (d) EXECUTIVE HAS READ AND UNDERSTANDS THIS SECTION, WHICH DISCUSSES ARBITRATION. EXECUTIVE UNDERSTANDS THAT BY SIGNING THIS AGREEMENT, EXECUTIVE AGREES TO SUBMIT ANY CLAIMS ARISING OUT OF, RELATING TO, OR IN CONNECTION WITH THIS AGREEMENT, THE INTERPRETATION, VALIDITY, CONSTRUCTION, PERFORMANCE, BREACH OR TERMINATION THEREOF, OR ANY OF THE MATTERS HEREIN TO BINDING ARBITRATION, AND THAT THIS ARBITRATION CLAUSE CONSTITUTES A WAIVER OF EXECUTIVE'S RIGHT TO A JURY TRIAL AND RELATES TO THE RESOLUTION OF ALL DISPUTES RELATING TO ALL ASPECTS OF THIS SEVERANCE AGREEMENT AND RELEASE OF ALL CLAIMS. 14. Miscellaneous Provisions. (a) Waiver. No provision of this Agreement shall be modified, waived or discharged unless the modification, waiver or discharge is agreed to in writing and signed by Executive and by an authorized officer of the Company (other than Executive). No waiver by either party of any breach of, or of compliance with, any condition or provision of this Agreement by the other party shall be considered a waiver of any other condition or provision or of the same condition or provision at another time. (b) Whole Agreement. Except for Executive's stock option agreements and Employee Invention, Copyright and Secrecy Agreement, no agreements, representations or understandings (whether oral or written and whether express or implied) which are not expressly set forth in this Agreement have been made or entered into by either party with respect to the subject matter hereof. (c) Choice of Law. The validity, interpretation, construction and performance of this Agreement shall be governed by and construed in accordance with the substantive laws, but not the choice of law rules, of the State of California. (d) Severability. The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision hereof, which shall remain in full force and effect. -8- 9 (e) No Assignment of Benefits. The rights of any person to payments or benefits under this Agreement shall not be made subject to option or assignment, either by voluntary or involuntary assignment or by operation of law, including (without limitation) bankruptcy, garnishment, attachment or other creditor's process, and any action in violation of this Section 14(e) shall be void. (f) Employment Taxes. All payments made pursuant to this Agreement will be subject to withholding of applicable income and employment taxes. (g) Assignment by Company. The Company may assign its rights under this Agreement to an affiliate, and an affiliate may assign its rights under this Agreement to another affiliate of the Company or to the Company; provided, however, that no assignment shall be made if the net worth of the assignee is less than the net worth of the Company at the time of assignment. In the case of any such assignment, the term "Company" when used in a section of this Agreement shall mean the corporation that actually employs Executive. (h) Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument. IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by its duly authorized officer, as of the day and year first above written. COMPANY: METACREATIONS CORPORATION Gary Lauer ------------------------------------- By Chief Executive Officer ------------------------------------- Title EXECUTIVE: JOHN P. LEDDY /s/John P. Leddy ------------------------------------- Signature John P. Leddy ------------------------------------- Printed Name -9- EX-10.41 3 EXHIBIT 10.41 1 EXHIBIT 10.41 December 11, 1998 John E. Dearborn 5212 MacKenzie Way Plano, Texas 79093 Re: Senior Vice President of Marketing with MetaCreations Corporation Dear John: We are pleased to offer you the full time, regular position of Senior Vice President of Marketing with MetaCreations Corporation commencing on or about December 15, 1998. Our team is excited that you will be joining us. You will be located at our corporate headquarters in Santa Barbara and will report directly to me. You will be an exempt, salaried employee and your starting base compensation shall be $15,417 per month, payable on the 15th and last day of each month. This compensation will be reviewed annually. You will be eligible for any benefit programs which are generally available to all employees. You will receive a $750 monthly auto allowance. You may also be eligible for a quarterly $10,000 performance incentive bonus, based on performance goals to be determined and agreed upon, and an additional $30,000 annual performance bonus based on company performance. The Company will provide you with a $10,000 signing bonus payable within fifteen (15) days of your employment at MetaCreations. Additionally, MetaCreations will recommend to the Board of Directors that you be granted a stock option entitling you to purchase 150,000 shares of the common stock of the Company at the fair market value on the date of the grant as determined by the Board. Options granted will vest at 25% of the total grant one year from the date of any grant and, thereafter, the balance shall vest at a rate of 1/36th of the balance per month. Said options shall be subject to the Company's then operative Stock Option Plans. 2 John Dearborn December 11, 1998 Page 2 The Company will also provide you with a relocation package from Texas to the Santa Barbara area which will include: reimbursement of customary costs (including points) associated with selling your existing home in Texas, reimbursement of customary costs incurred in connection with purchasing a home in the Santa Barbara area, reimbursement of reasonable travel expenses incurred while searching for a home in the Santa Barbara area, reimbursement of reasonable, documented physical relocation costs, and an interim housing allowance for up to six (6) months in the Santa Barbara area. In the event you are involuntarily terminated without cause, you shall receive base salary continuation, including health benefits, for which MetaCreations will pay the premium, for six (6) months following your termination. In the event that, within the first 12 months of your employment with MetaCreations, Micrografx seeks to enforce the Non-Compete provision of your agreement, in effect with them, MetaCreations will reimburse you for expenses associated with obtaining and incurring legal services, up to a maximum of $20,000. Nothing in the grant of options or in this offer of employment should be construed as a guarantee of continued employment for any set period of time. As with all MetaCreations employees, either party may end the employment relationship at any time, with or without cause. Employment at MetaCreations is strictly at the will of each of the parties. This offer and the Confidentiality agreement represent the entire agreement between you and MetaCreations regarding your employment with the Company and supersede any previous oral or written agreements. This offer is expressly contingent upon your supplying proof of your ability to work in the United States in compliance with the Immigration Reform and Control Act of 1986, within three days of your commencement date. We are delighted that you will be joining MetaCreations Corporation. I know I speak for the rest of the team in saying that we are looking forward to working with you as you bring your unique and significant skills to the Company. Sincerely, Accepted: /s/ Gary Lauer /s/ John Dearborn - ------------------------------- ------------------------------- Chief Executive Officer John Dearborn EX-21.1 4 EXHIBIT 21.1 1 EXHIBIT 21.1 METACREATIONS CORPORATION LIST OF REGISTRANT'S SUBSIDIARIES MetaCreations Holding (Ireland), Ltd. MetaCreations International, Ltd. MetaCreations Europe SARL MetaCreations (Barbados) Corporation Real Time Geometry Corp. Fractal Design International 63 EX-23.1 5 EXHIBIT 23.1 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the following Registration Statements of MetaCreations Corporation on Form S-8 (Registration Nos. 333-3070, 333-17209, 333-20939, 333-26557, 333-28403, and 333-67223) of our report dated January 28, 1999 on our audits of the consolidated financial statements and financial statement schedule of MetaCreations Corporation as of December 31, 1998 and 1997, and for the years ended December 31, 1998, 1997 and 1996, which report is included in this Annual Report on Form 10-K. PricewaterhouseCoopers LLP Woodland Hills, California March 29, 1999 64 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 1000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 16,297 30,038 15,100 2,725 526 69,136 12,156 5,327 77,965 8,935 0 0 0 24 69,006 77,745 42,843 42,843 7,007 7,007 58,638 765 0 (20,184) (353) (19,831) 0 0 0 (19,831) (0.83) (0.83)
-----END PRIVACY-ENHANCED MESSAGE-----