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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the quarterly period ended September 30, 1997 or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the transition period from _________ to _________.
Commission file number 0-27168
METACREATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-4102687
(State of incorporation) (I.R.S. Employer Identification Number)
6303 Carpinteria Ave, Carpinteria, CA 93013
(Address of principal executive offices)
(805) 566-6200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes [X] No [ ]
As of November 7, 1997, there were outstanding 23,560,506 shares of the
registrant's Common Stock, $0.001 par value per share, which is the only
outstanding class of common or voting stock of the registrant.
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METACREATIONS CORPORATION
FORM 10-Q
Table of Contents
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 3
Consolidated Balance Sheets - September 30, 1997 and
December 31, 1996
Consolidated Statements of Operations - Three and nine
months ended September 30, 1997 and 1996
Consolidated Statements of Cash Flows - Nine months ended
September 30, 1997 and 1996
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................. 18
SIGNATURES................................................................. 19
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
METACREATIONS CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(Unaudited) (Audited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................. $ 11,409 $ 21,605
Short-term investments................................................ 40,873 44,688
Accounts receivable, net.............................................. 25,343 16,619
Inventories........................................................... 1,569 1,512
Prepaid income taxes ................................................. 1,685 --
Deferred income taxes................................................. 3,727 2,827
Prepaid expenses...................................................... 3,125 3,826
-------- --------
Total current assets................................................ 87,731 91,077
Property and equipment, net............................................ 7,169 5,581
Other assets........................................................... 1,586 1,277
-------- --------
Total assets........................................................ $ 96,486 $ 97,935
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................... $ 5,393 $ 4,490
Accrued expenses...................................................... 5,073 6,427
Income taxes payable.................................................. -- 150
Royalties payable..................................................... 1,198 756
-------- --------
Total current liabilities........................................... 11,664 11,823
Stockholders' equity:
Preferred stock, $.001 par value, 5,000,000 shares authorized -
no shares issued and outstanding at September 30, 1997 and
December 31, 1996, respectively..................................... -- --
Common stock, $.001 par value; 75,000,000 shares authorized
23,434,758 and 22,274,398 shares issued and outstanding at
September 30, 1997 and December 31, 1996, respectively............... 23 22
Paid-in capital....................................................... 108,428 100,956
Notes receivable from stockholders.................................... (3,127) (3,000)
Cumulative translation adjustment..................................... (126) (158)
Accumulated deficit................................................... (20,376) (11,708)
-------- --------
Total stockholders' equity.......................................... 84,822 86,112
-------- --------
Total liabilities and stockholders' equity.......................... $ 96,486 $ 97,935
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1997 1996 1997 1996
------------------- --------------------
<S> <C> <C> <C> <C>
Net revenues.............................................. $21,008 $18,175 $ 53,009 $47,012
Cost of revenues.......................................... 3,023 3,284 9,254 8,695
------- ------- -------- -------
Gross profit.............................................. 17,985 14,891 43,755 38,317
Operating expenses:
Sales and marketing...................................... 8,272 7,879 24,153 21,224
General and administrative............................... 1,603 1,424 4,644 4,104
Research and development................................. 3,713 2,100 10,333 6,005
Write-off of acquired in-process technology
and other merger costs................................. -- 733 16,185 2,598
------- ------- -------- -------
Total operating expenses.................................. 13,588 12,136 55,315 33,931
------- ------- -------- -------
Income (loss) from operations............................. 4,397 2,755 (11,560) 4,386
Interest and investment income, net....................... 827 811 2,416 2,558
------- ------- -------- -------
Income (loss) before provision for income taxes........... 5,224 3,566 (9,144) 6,944
Provision for income taxes................................ 1,619 781 37 2,124
------- ------- -------- -------
Net income (loss)......................................... $ 3,605 $ 2,785 $ (9,181) $ 4,820
======= ======= ======== =======
Net income (loss) per common share........................ $0.15 $0.12 $(0.40) $0.21
======= ======= ======== =======
Weighted average number of shares outstanding............. 24,853 22,727 22,757 22,741
======= ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1997 1996
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Cash flows from operating activities:
Net income (loss)...................................................... $ (9,181) $ 4,820
Adjustment to retained earnings as a result of business combination.... 513 --
Adjustments to reconcile net income to net cash used in operating
activities:
Write-off of acquired in-process technology.......................... 5,575 363
Deferred incomes taxes............................................... -- (483)
Depreciation and amortization........................................ 1,822 1,047
Reserves for receivables and product returns......................... 3,354 4,731
Reserves for inventory............................................... 445 452
Accrued interest income.............................................. (127) --
Loss on disposal of property and equipment........................... (93) --
Changes in operating assets and liabilities:
Accounts receivable................................................ (12,038) (10,701)
Inventories........................................................ (459) (363)
Prepaid expenses and other assets.................................. 1,207 (816)
Accounts payable and accrued expenses.............................. (1,543) (1,484)
Royalties payable.................................................. 442 68
Income taxes payable............................................... (746) 1,075
-------- --------
Net cash used in operating activities............................. (10,829) (1,291)
Cash flows from investing activities:
Purchases of short-term investments.................................... (37,079) (86,842)
Proceeds from sales and maturities of short-term investments........... 40,894 48,262
Purchases of property and equipment.................................... (2,836) (2,801)
Purchases of software technology and product rights.................... (110) (125)
Payments in connection with acquisition................................ (1,233) (139)
-------- --------
Net cash used in investing activities............................. (364) (41,645)
Cash flows from financing activities:
Repayment of notes payable............................................. (274) (417)
Proceeds from exercise of stock options................................ 1,239 627
-------- --------
Net cash provided by financing activities......................... 965 210
Effect of exchange rate changes on cash................................. 32 (61)
-------- --------
Net decrease in cash and cash equivalents............................... (10,196) (42,787)
Cash and cash equivalents at beginning of period........................ 21,605 54,038
-------- --------
Cash and cash equivalents at end of period.............................. $ 11,409 $ 11,251
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
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 ("MetaCreations"). Accordingly, the term
"Company," as used herein, refers to either MetaTools or MetaCreations,
depending on the context of the discussion.
The accompanying unaudited consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statement presentation. In the opinion of management, the accompanying
consolidated balance sheets and related interim consolidated statements of
operations and cash flows include all adjustments (consisting only of normal
recurring items) considered necessary for their fair presentation. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses.
Actual results could differ from those estimates. The consolidated results of
operations for the period ended September 30, 1997 are not necessarily
indicative of results to be expected for the year ending December 31, 1997. The
information included in this Form 10-Q should be read in conjunction with the
Company's audited consolidated financial statements and notes thereto as of
December 31, 1996 and 1995, and for the three years in the period ended December
31, 1996, as filed on Form 8-K/A.
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. 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 charged approximately $9.8 million against
earnings during the three months ended June 30, 1997 related to transaction
costs and other costs associated with integrating the two companies.
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 three and nine months ended September 30, 1996 have been combined with
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METACREATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
those of Fractal for the three and nine months ended December 30, 1996. As a
result of the presentation above, Fractal's net loss of $513,000 for the three
months ended March 31, 1997 is reflected as an adjustment to retained earnings.
Separate results of operations for the periods presented are as follows (in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1996 1996
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Net revenues:
MetaCreations......................... $ 7,241 $19,115
Fractal............................... 10,934 27,897
------- -------
$18,175 $47,012
======= =======
Net income:
MetaCreations......................... $ 992 $ 2,718
Fractal............................... 1,793 2,102
------- -------
$ 2,785 $ 4,820
======= =======
</TABLE>
Net Income Per Common Share
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.
Statement of Financial Accounting Standards Not Yet Adopted
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 requires companies to adopt its provisions for fiscal years
ending after December 15, 1997 and requires restatement of all prior period
earnings per share ("EPS") data presented. Earlier application is not permitted.
SFAS No. 128 specifies the computation, presentation, and disclosure
requirements for EPS. The implementation of SFAS No. 128 is not expected to have
a material effect on the EPS data previously presented by the Company.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130, which requires companies to adopt its provisions for fiscal years
ending after December 15, 1997, 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. The impact of adopting SFAS No.
130 has not been determined by the Company.
7
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METACREATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131, which requires companies
to adopt its provisions for fiscal years ending after December 15, 1997,
requires publicly-held companies to report financial and other information about
key revenue-producing segments of the entity for which such information is
available and is utilized by the chief operating decision maker. Specific
information to be reported for individual segments includes profit or loss,
certain revenue and expense items and total assets. A reconciliation of segment
financial information to amounts reported in the financial statements would be
provided. The impact on the Company of adopting SFAS No. 131 has not been
determined.
2. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
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Finished goods........................ $1,178 $ 814
Materials and supplies................ 391 698
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$1,569 $1,512
====== ======
</TABLE>
3. INCOME TAXES
The provisions for income taxes for the three and nine months ended September
30, 1997 and 1996 are based on the Company's estimated annualized effective tax
rate for the respective years, after giving effect to the utilization of
available net operating losses and tax credits and available tax planning
opportunities. In addition, the provision for income taxes for the nine months
ended September 30, 1997 is net of tax benefits relating to deductible expenses
incurred in connection with the merger with Fractal and the acquisition of
Specular International Ltd. ("Specular").
4. ACQUISITIONS
On April 15, 1997, the Company completed the acquisition of Specular, a
privately held software development company based in Amherst, Massachusetts,
which develops and markets 3-D animation and graphic design tools for
professionals and prosumers. Under the terms of the Purchase Agreement, the
stockholders of Specular received approximately 547,000 shares of the Company's
common stock, valued at approximately $4.1 million, and $1 million in cash in
exchange for all of the outstanding shares of Specular. The Company also issued
450,000 non-qualified stock options to purchase shares of the Company's common
stock to Specular employees at an exercise price of $7 per share, the fair
market value of the Company's common stock on April 16, 1997. The Company has
relocated Specular's existing engineering and product management personnel to
its Real Time Geometry ("RTG") facilities in Princeton, New Jersey, closed
Specular's Amherst headquarters, and laid-off and provided severance to
Specular's administrative and sales personnel. In addition, the Company assumed
the net liabilities of Specular, which totaled $1.6 million at April 15, 1997.
The Company charged approximately
8
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METACREATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
$6.4 million against earnings during the three months ended June 30, 1997,
comprised of the write-off of acquired in-process technology of $5.6 million,
transaction costs of $300,000, and relocation and severance costs of $555,000.
In addition, the Company recognized a deferred income tax asset of $900,000
relating to Federal net operating losses and tax credits of Specular. In
accordance with SFAS No. 109, the tax benefits were first applied to reduce to
zero goodwill totaling $280,000, with the remainder applied against current
technology acquired from Specular. After recognition of the deferred tax asset,
acquired current technology totaled $280,000.
9
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and notes thereto.
The discussion and analysis below contains trend analysis and other forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, and Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's actual results could differ materially from those projected in the
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the section
entitled "Factors That May Affect Future Operating Results," as well as those
discussed elsewhere in the Company's SEC reports, including without limitation,
the Company's audited consolidated financial statements and notes thereto as of
December 31, 1996 and 1995, and for the three years in the period ended December
31, 1996, as filed on Form 8-K/A.
OVERVIEW
In connection with the merger of Fractal with MetaCreations in May 1997 and
MetaCreations' acquisition of Specular in April 1997, the Company has
significantly expanded its product line. However, the Company's future revenues
are substantially dependent upon the continued market acceptance of the
Company's existing leading products: Art Dabbler, Bryce, Kai's Photo Soap, Kai's
Power GOO, Kai's Power Tools, Painter, Poser, and Ray Dream Studio. In this
regard, revenue from the sale of these products represented a substantial
majority of revenues during the three and nine months ended September 30, 1997.
The Company also has a number of new product and technology development efforts
under way, and a significant portion of future revenues is dependent upon the
success of these activities.
The Company develops substantially all of its products internally and
occassionally through co-development arrangements with third parties. These co-
development arrangements generally provide the Company with certain exclusive
proprietary, copyright or marketing rights for developed products in exchange
for the payment of one-time and/or ongoing royalties. The Company expects to
continue fostering arrangements with external developers as part of its strategy
of expanding its product portfolio. There can be no assurance, however, that the
Company will be able to continue to supplement its product development efforts
in the future through such relationships.
The Company sells its products primarily to domestic and international
distributors, including mail order resellers and retail outlets. The Company
also sells its products to Original Equipment Manufacturers ("OEMs") for
bundling with their hardware or software products and directly to end users,
generally through telesales and direct mail campaigns. Fluctuations in
distributor purchases can cause significant volatility in the Company's
revenues. Distributors generally stock the Company's products at levels which
may fluctuate significantly for a variety of reasons, including the
distributors' ability to finance the purchase of products and to devote shelf
space, catalog space or attention to the products. Distributor purchases may
also be affected by the Company's introduction of a new product or new version
of a product, the Company's end user promotions programs, anticipated product
price increases, the Company's purchases of display space at retail outlets and
other factors. Further, OEM agreements, which generally provide for minimum
guaranteed non-refundable payments to the Company, typically coincide with the
planned introduction of OEM bundled products and are often entered into at
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the end of the quarter. The timing of the execution of such agreements can
fluctuate substantially throughout the year, causing volatility in the Company's
revenues, operating results, and cash flows.
Since its inception, the Company has focused on building its product portfolio
and establishing brandname awareness of its products. These activities have
resulted in significant increases in all expense categories. The Company's
recent product development efforts have also entailed significant research and
development expenditures. These higher expense levels combined with the write-
off of acquired in-process research and development and other costs associated
with periodic mergers and acquisitions and quarterly fluctuations in net
revenues have contributed to the Company's periodic annual and quarterly losses,
as well as fluctuations in its operating results. The Company intends to
continue to invest significant amounts 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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- ---------------------------------
1997 1996 1997 1996
--------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Net revenues................................. 100.0 % 100.0 % 100.0 % 100.0 %
Cost of revenues............................. 14.4 18.1 17.5 18.5
--------------------------------- ---------------------------------
Gross margin................................ 85.6 81.9 82.5 81.5
Operating expenses:
Sales and marketing......................... 39.4 43.4 45.6 45.1
General and administrative.................. 7.6 7.8 8.8 8.7
Research and development.................... 17.7 11.6 19.5 12.8
Write-off of acquired in-process technology
and other merger costs..................... - 4.0 30.5 5.6
--------------------------------- ---------------------------------
Total operating expenses.................. 64.7 66.8 104.4 72.2
--------------------------------- ---------------------------------
Income (loss) from operations................ 20.9 15.1 (21.9) 9.3
Interest and investment income, net.......... 3.9 4.5 4.6 5.5
--------------------------------- ---------------------------------
Net income (loss) before provision for
income taxes................................ 24.8 19.6 (17.3) 14.8
Provision for income taxes................... 7.7 4.3 0.1 4.5
--------------------------------- ---------------------------------
Net income (loss)............................ 17.1 % 15.3 % (17.4)% 10.3 %
================================= =================================
</TABLE>
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NET REVENUES
Net revenues increased 16% from $18.2 million for the three months ended
September 30, 1996 to $21.0 million for the three months ended September 30,
1997. Net revenues increased as a result of the Company's release of new
versions of its existing products, increased expansion of sales through OEM's,
and increased international sales. The Company released Painter 5, Kai's Photo
Soap, and Infini-D 4.0 in the second quarter of 1997, and Art Dabbler, Ray Dream
Studio 5, and Ray Dream 3D in the third quarter of 1997. International sales
accounted for $7.4 million, or 35% of net revenues, for the three months ended
September 30, 1997, compared to $6.2 million, or 34% of net revenues, for the
three months ended September 30, 1996.
Net revenues totaled $53.0 million for the nine months ended September 30, 1997,
compared to $47.0 million for the nine months ended September 30, 1996, an
increase of 13%. The increase in net revenues is attributed to the development
and release of new products, the enhancement and release of new versions of the
Company's existing products, increased expansion of sales through OEM's,
increased marketing activities, and increased international sales. International
sales accounted for $20.3 million, or 38% of net revenues, for the nine months
ended September 30, 1997, compared to $16.4 million, or 35% of net revenues, for
the nine months ended September 30, 1996.
The Company recognizes revenue from the sale of its products upon shipment to
the customer and satisfaction of significant Company obligations, if any. The
Company provides an allowance for estimated returns at the time of product
shipments and adjusts this allowance as needed based on actual return history.
Such reserves as a percentage of net revenues have varied over recent years,
reflecting the Company's experience in product returns as it has significantly
expanded the proportion of its sales through third-party distribution channels
and increased its product portfolio. The Company expects reserves will continue
to vary in the future. The Company's agreements with its distributors generally
provide the distributors with limited rights to return unsold inventories under
a stock balancing program. The Company monitors the activities of its
distributors in an effort to minimize excessive returns and establishes its
reserves based on its estimates of expected returns. While historically the
Company's returns have been within management's expectations, the establishment
of reserves requires judgments regarding such factors as future competitive
conditions and product life cycles, which can be difficult to predict. As a
result, there can be no assurance that established reserves will be adequate to
cover actual future returns.
COST OF REVENUES
Cost of revenues includes the costs of goods sold, royalties due to external
developers, inventory management costs, freight and handling costs and reserves
for inventory obsolescence. Cost of revenues decreased from $3.3 million, or 18%
of net revenues, for the three months ended September 30, 1996, to $3.0 million,
or 14% of net revenues, for the three months ended September 30, 1997. The
decrease in cost of revenues resulted from the changing mix of product sales and
increased sales through OEM's. Royalties represented 4% of net revenues for both
the three months ended September 30, 1996 and 1997.
Cost of revenues increased from $8.7 million for the nine months ended September
30, 1996, to $9.3 million for the nine months ended September 30, 1997, but
decreased as a percentage of net revenues from 18% to 17%, primarily due to the
increase in OEM revenues and to reduced manufacturing costs. Royalties
represented 4% of net revenues for both the nine months ended
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September 30, 1996 and 1997. 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 increased from
$7.9 million for the three months ended September 30, 1996 to $8.3 million for
the three months ended September 30, 1997, but decreased as a percentage of net
revenues from 43% to 39%, respectively. The increase in sales and marketing
expenses resulted from the continued efforts to expand sales and marketing
activities and distribution channels, both domestically and internationally, and
through the hiring of additional personnel.
Sales and marketing expenses increased from $21.2 million, or 45% of net
revenues, for the nine months ended September 30, 1996, to $24.2 million, or 46%
of net revenues, for the nine months ended September 30, 1997. The increase
reflected the Company's efforts to expand its sales and marketing presence and
distribution channels through the hiring of additional personnel and increased
advertising, mail campaigns, and public relations expenditures. The Company
intends to continue such expansion and anticipates that sales and marketing
expenses will continue to increase significantly in future periods as the
Company's product offerings expand, although they may vary as a percentage of
net revenues.
GENERAL AND ADMINISTRATIVE
General and administrative expenses include compensation costs related to
executive management, finance, and administration personnel of the Company along
with other administrative costs including legal and accounting fees, insurance,
and bad debt expenses. General and administrative expenses increased from $1.4
million for the three months ended September 30, 1996 to $1.6 million for the
three months ended September 30, 1997, but remained flat at 8% of net revenues.
The increase in expenses is due to increased administrative expenses related to
the continued growth of the Company.
For the nine months ended September 30, 1997, general and administrative
expenses totaled $4.6 million, or 9% of net revenues, an increase of 13% over
general and administrative expenses of $4.1 million, or 9% of net revenues, for
the nine months ended September 30, 1996. The increase in general and
administrative expenses resulted from increased internal staffing to support the
Company's growth since the second quarter of 1996. The Company expects that its
general and administrative expenses will continue to increase in the future as
the Company expands its staffing to support expanded operations, but may vary as
a percentage of net revenues.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of personnel costs,
consultant fees and required equipment and facilities costs related to the
Company's product development efforts. Research and development expenses
increased from $2.1 million, or 12% of net revenues, for the three months ended
September 30, 1996, to $3.7 million, or 18% of net revenues, for the three
months ended September 30, 1997. The increase was attributed to increased
personnel resulting
13
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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.
For the nine months ended September 30, 1997, research and development expenses
totaled $10.3 million, or 20% of net revenues, an increase of 72% over research
and development expenses of $6.0 million, or 13% of net revenues, for the nine
months ended September 30, 1997. The increase was attributed to the additional
RTG and Specular employees as well as additional personnel hired to expand the
Company's product portfolio, enhance its existing products, and translate its
products to foreign languages. The Company expects research and development
expenses will continue to increase in future periods, but may vary as a
percentage of net revenues.
WRITE-OFF OF ACQUIRED IN-PROCESS TECHNOLOGY AND OTHER MERGER COSTS
In May 1997, the stockholders of MetaCreations and Fractal approved the merger
of the two companies. As a result of the merger, the Company issued
approximately 9,055,000 shares of MetaCreations common stock for all of the
outstanding shares of Fractal. The Company charged approximately $9.8 million
against earnings during the three months ended June 30, 1997 related to
transaction costs and other costs associated with integrating the two companies.
On April 15, 1997, the Company completed the acquisition of Specular, a
privately held software development company based in Amherst, Massachusetts,
which develops and markets 3-D animation and graphic design tools for
professionals and prosumers. Under the terms of the Purchase Agreement, the
stockholders of Specular received approximately 547,000 shares of the Company's
common stock, valued at approximately $4.1 million, and $1 million in cash in
exchange for all of the outstanding shares of Specular. The Company also issued
450,000 non-qualified stock options to purchase shares of the Company's common
stock to Specular employees at an exercise price of $7 per share, the fair
market value of the Company's common stock on April 16, 1997. The Company has
relocated Specular's existing engineering and product management personnel to
its RTG facilities in Princeton, New Jersey, closed Specular's Amherst
headquarters, and laid-off and provided severance to Specular's administrative
and sales personnel. In addition, the Company assumed the net liabilities of
Specular, which totaled $1.6 million at April 15, 1997. The Company charged
approximately $6.4 million against earnings during the three months ended June
30, 1997, comprised of the write-off of acquired in-process technology of $5.6
million, transaction costs of $300,000, and relocation and severance costs of
$555,000. In addition, the Company recognized a deferred income tax asset of
$900,000 relating to Federal net operating losses and tax credits of Specular.
In accordance with SFAS No. 109, the tax benefits were first applied to reduce
to zero goodwill totaling $280,000, with the remainder applied against current
technology acquired from Specular. After recognition of the deferred tax asset,
acquired current technology totaled $280,000.
PROVISION FOR INCOME TAXES
The Company records income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." The provisions for
income taxes for the three and nine months ended September 30, 1997 and 1996 are
based on the Company's estimated annualized effective tax rate for the
respective years, after giving effect to the utilization of available net
operating loss and tax credit carryforwards. In addition, the provision for
income taxes for the nine months ended September 30, 1997 is net of tax benefits
relating to
14
<PAGE>
deductible expenses incurred in connection with the merger with Fractal and the
acquisition of Specular.
NET INCOME
Net income was $3.6 million, or $0.15 per share, for the three months ended
September 30, 1997, compared to net income of $2.8 million, or $0.12 per share,
for the three months ended September 30, 1996. For the nine months ended
September 30, 1997, net loss was $9.2 million, or $0.40 per share, compared to
net income of $4.8 million, or $0.21 per share, for the nine months ended
September 30, 1996.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
Factors that may affect future operating results include, but are not limited
to, those discussed below, as well as those discussed elsewhere in the Company's
SEC reports, including without limitation, the Company's audited consolidated
financial statements and notes thereto as of December 31, 1996 and 1995, and for
the three years in the period ended December 31, 1996, as filed on Form 8-K/A.
INTEGRATION OF OPERATIONS; MANAGEMENT OF POTENTIAL GROWTH, INTEGRATION OF
POTENTIAL ACQUISITIONS, ADVERSE EFFECT OF FINANCIAL RESULTS
In recent years, the Company has experienced expansion of its operations that
have placed significant demands on its administrative, operational and financial
resources. In addition, the Company's acquisitions of RTG in December 1996 and
Specular in April 1997 and its merger with Fractal in May 1997, have placed
significant demands on these resources. The Company has substantially
assimilated its acquired operations and is currently in the process of improving
its financial and management controls, management processes, business and
management information systems and procedures, and expanding, training and
managing its work force. There can be no assurance that the Company will be able
to perform such actions successfully.
The realization of the benefits sought from the merger of MetaCreations with
Fractal depends on the ability of the Company to utilize product development
capabilities, sales and marketing capabilities, administrative organizations,
and facilities better that either company could do separately. The inability of
the Company to better utilize resources and to achieve integration in a timely
and coordinated fashion could result in a material adverse effect on the
Company's financial condition, results of operations, and cash flows. There can
be no assurance that these steps actually will reduce costs to the extent, or as
quickly, as planned or that these steps will not adversely affect future
revenues and results of operations.
FLUCTUATIONS IN QUARTERLY RESULTS
The Company has experienced in the past and expects in the future to continue to
experience significant fluctuations in quarterly operating results. There can be
no assurance that the Company's future revenues, operating results and cash
flows will not also vary substantially. The Company generally ships products as
orders are received and, therefore, has little or no backlog. As a result,
quarterly revenues, operating results and cash flows of the Company will
generally depend on a number of factors that are difficult to forecast,
including, among others, the volume and timing of and ability to fulfill orders
received within a quarter. Quarterly revenues, operating results and cash flows
also may fluctuate due to factors such as demand for the Company's
15
<PAGE>
products; introduction, localization or enhancement of products by the Company
and its competitors; customer or distributor order deferrals in anticipation of
new versions of products; market acceptance of new products; reviews in the
industry press concerning the products of the Company or its competitors;
changes or anticipated changes in pricing by the Company or its competitors; the
mix of distribution channels through which products are sold; the mix of
products sold; returns from distributors; and general economic conditions.
Revenues, operating results and cash flows from the Company's products also may
be negatively affected by delays in the introduction or availability of new
hardware and software products from third parties. The Company experiences some
effect of seasonality in its business, as demand for its products tends to
increase during the quarter ending December 31 as a result of timing of year-end
holiday season buying.
As is common in the software industry, the Company's experience has been that a
disproportionately large percentage of revenues in each fiscal quarter occurs in
the third month of that quarter. Because the Company's staffing and other
operating expenses are based in part on anticipated net revenues, a substantial
portion of which may not be realized until shortly before the end of each fiscal
quarter, delays in the receipt and shipment of orders, including delays that may
be occasioned by failures of third party product fulfillment firms to produce
and ship products, and delays or deferrals in the execution of OEM arrangements
can cause significant variations in the Company's financial position, results of
operations, and cash flows from quarter to quarter. The Company will most likely
be unable to adjust spending in a timely manner to compensate for any unexpected
revenue shortfall. Accordingly, any significant shortfall in revenues from the
Company's products in relation to expectations could have an immediate adverse
impact on Company's financial position, results of operations, and cash flows.
In addition, the Company currently intends to increase its operating expenses to
fund greater levels of research and product development, to increase its sales
and marketing operations and to expand its distribution channels. To the extent
that such expenses precede, or are not subsequently followed by, increased
revenues, the Company's financial position, results of operations, and cash
flows will be materially and adversely affected.
Due to the foregoing factors, it is likely that the operating results of the
Company for some future quarters may fall below the expectations of securities
analysts and investors. In such event, the trading price of the Company's Common
Stock could be materially and adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
Historically, net cash used in operating activities and investing activities of
the Company has been significant due to operating losses from acquisitions and
mergers and working capital requirements resulting from the growth of the
Company, including increases in accounts receivable. Net cash used in operating
activities of the Company totaled $10.8 million and $1.3 million for the nine
months ended September 30, 1997 and 1996, respectively. The increase in cash
used in operating activities is primarily attributed to the approximately $11
million paid in connection with the merger with Fractal and the acquisition of
Specular, the increase in accounts receivable resulting from increased product
offerings and the growth in revenues since September 30, 1996, and the increase
in income taxes receivable relating to tax benefits resulting from deductible
expenses incurred in connection with the $16.2 million write-off of acquired in-
process technology and other costs resulting from the merger with Fractal and
acquisition of Specular. Net cash used in investing activities totaled $364,000
and $41.6 million for the nine months ended September 30, 1997 and 1996. The
change resulted primarily from net sales and purchases of short-term investments
and purchases of property and equipment. Net cash
16
<PAGE>
provided by financing activities totaled $965,000 and $210,000 for the nine
months ended September 30, 1997 and 1996, respectively. The increase in cash
provided by financing activities resulted from proceeds from the exercise of
stock options by the Company's employees during the respective periods.
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 balances, cash provided by future operations, if any, and
available borrowings under the Company's line of credit are sufficient to meet
its working capital needs and anticipated capital expenditure requirements
through at least the next twelve months.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share." SFAS No.
128 requires companies to adopt its provisions for fiscal years ending after
December 15, 1997 and requires restatement of all prior period earnings per
share ("EPS") data presented. Earlier application is not permitted. SFAS No. 128
specifies the computation, presentation, and disclosure requirements for EPS.
The implementation of SFAS No. 128 is not expected to have a material effect on
the EPS data previously presented by the Company.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130, which requires companies to adopt its provisions for fiscal years
ending after December 15, 1997, 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. The impact of adopting SFAS No.
130 has not been determined by the Company.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131, which requires companies
to adopt its provisions for fiscal years ending after December 15, 1997,
requires publicly-held companies to report financial and other information about
key revenue-producing segments of the entity for which such information is
available and is utilized by the chief operating decision maker. Specific
information to be reported for individual segments include profit or loss,
certain revenue and expense items and total assets. A reconciliation of segment
financial information to amounts reported in the financial statements would be
provided. The impact on the Company of adopting SFAS No. 131 has not been
determined.
17
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Exhibit Title
------- -------------
11.1 Statement Regarding Computation of Net Income (Loss) per
Common Share
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On August 12, 1997, the Company filed a report on Form 8-K/A to file the
consolidated financial statements of Fractal as of March 31, 1997 and 1996,
and for the two years in the period ended March 31, 1997, and the consolidated
financial statements of MetaCreations as of December 31, 1996 and 1995, and
for the three years in the period ended December 31, 1996, reflecting its
merger with Fractal.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
METACREATIONS CORPORATION
(Registrant)
Date: November 13, 1997 /s/TERANCE A. KINNINGER
-----------------------
Terance A. Kinninger
Sr. Vice President and
Chief Financial Officer
19
<PAGE>
Exhibit 11.1
METACREATIONS CORPORATION
STATEMENT REGARDING COMPUTATION OF
NET INCOME (LOSS) PER COMMON SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ --------------------------
1997 1996 1997 1996
------------------------ --------------------------
PRIMARY AND FULLY DILUTED (1)
<S> <C> <C> <C> <C>
Weighted average shares outstanding for
the period............................... 23,175 20,649 22,757 20,488
Common equivalent shares, including items
pursuant to Staff Accounting Bulletin
No. 83................................... 1,678 2,078 -- 2,253
------------------------ --------------------------
Shares used in per share calculation...... 24,853 22,727 22,757 22,741
======================== ==========================
Net income (loss)......................... $ 3,605 $ 2,785 $(9,181) $ 4,820
======================== ==========================
Net income (loss) per common share........ $ 0.15 $ 0.12 $ (0.40) $ 0.21
======================== ==========================
</TABLE>
(1) Primary and fully diluted calculations are substantially the same.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> JUL-01-1997 JAN-01-1997
<PERIOD-END> SEP-30-1997 SEP-30-1997
<CASH> 11,409 11,409
<SECURITIES> 40,873 40,873
<RECEIVABLES> 25,343 25,343
<ALLOWANCES> 0 0
<INVENTORY> 1,569 1,569
<CURRENT-ASSETS> 87,731 87,731
<PP&E> 11,240 11,240
<DEPRECIATION> 4,071 4,071
<TOTAL-ASSETS> 96,486 96,486
<CURRENT-LIABILITIES> 11,664 11,664
<BONDS> 0 0
0 0
0 0
<COMMON> 23 23
<OTHER-SE> 84,799 84,799
<TOTAL-LIABILITY-AND-EQUITY> 96,486 96,486
<SALES> 21,008 53,009
<TOTAL-REVENUES> 21,008 53,009
<CGS> 3,023 9,254
<TOTAL-COSTS> 3,023 9,254
<OTHER-EXPENSES> 13,588 55,315
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> 5,224 (9,144)
<INCOME-TAX> 1,619 37
<INCOME-CONTINUING> 3,605 (9,181)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 3,605 (9,181)
<EPS-PRIMARY> 0.15 (0.40)
<EPS-DILUTED> 0.15 (0.40)
</TABLE>
