<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
Current Report Pursuant to Section 13 or 15(d)
of the Securities and Exchange Act of 1934
Date of Report (Date of Earliest Event Reported): May 29, 1997
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)
<PAGE>
METACREATIONS CORPORATION
FORM 8-K/A
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Audited Financial Statements of Fractal Design Corporation
- ----------------------------------------------------------
Report of Independent Public Accountants............................................. 2
Consolidated Balance Sheets as of March 31, 1997 and 1996............................ 3
Consolidated Statements of Operations for each of the two years in the period
ended March 31, 1997................................................................ 4
Consolidated Statements of Shareholders' Equity for each of the two years in the
period ended March 31, 1997......................................................... 5
Consolidated Statements of Cash Flows for each of the two years in the
period ended March 31, 1997......................................................... 6
Notes to Consolidated Financial Statements........................................... 7
Audited Financial Statements of MetaCreations Corporation
- ---------------------------------------------------------
Report of Independent Public Accountants of MetaCreations Corporation................ 18
Report of Independent Public Accountants of Fractal Design Corporation............... 19
Consolidated Balance Sheets as of December 31, 1996 and 1995......................... 20
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 1996............................................................. 21
Consolidated Statements of Stockholders' Equity for each of the three years in
the period ended December 31, 1996.................................................. 22
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 1996............................................................. 24
Notes to Consolidated Financial Statements........................................... 26
</TABLE>
1
<PAGE>
The Undersigned Registrant hereby amends the following items, financial
statements, exhibits, or other portions of its current report on Form 8-K,
originally filed with the Securities and Exchange Commission on June 13, 1997
(the Form 8-K) as set forth in the pages attached hereto.
Item 7. Financial Statements and Exhibits
(a) Financial Statements of Fractal Design Corporation
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Fractal Design Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Fractal
Design Corporation and its subsidiaries at March 31, 1997 and 1996, and the
results of their operations and their cash flows for the years then ended 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.
PRICE WATERHOUSE LLP
San Jose, California
April 30, 1997, except for Note 11, which
is as of May 29, 1997
2
<PAGE>
FRACTAL DESIGN CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31,
----------------------
1997 1996
----------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................. $ 2,644 $ 7,153
Short-term investments................................................ 24,092 23,683
Accounts receivable, less allowance for doubtful accounts
of $514 and $343..................................................... 9,476 7,320
Inventories........................................................... 1,260 1,220
Deferred income taxes................................................. 2,081 1,446
Other current assets.................................................. 2,212 2,155
-------------------
Total current assets................................................ 41,765 42,977
Property and equipment, net............................................. 2,458 958
-------------------
Total assets........................................................ $44,223 $43,935
===================
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Accounts payable...................................................... $ 2,221 $ 3,680
Bank borrowings....................................................... -- 167
Accrued liabilities................................................... 6,105 6,955
Income taxes payable.................................................. 616 155
-------------------
Total current liabilities........................................... 8,942 10,957
Long-term debt.......................................................... -- 250
Commitments and contingencies (Note 5)
Shareholders equity:
Preferred Stock: $.001 par value, 5,000,000 shares authorized;
none issued and outstanding.......................................... -- --
Common Stock: $.001 par value, 50,000,000 shares authorized;
12,043,811 and 11,679,156 shares issued and outstanding.............. 12 12
Additional paid-in capital............................................ 33,643 32,571
Cumulative translation adjustment..................................... (158) (50)
Retained earnings..................................................... 1,784 195
-------------------
Total shareholders equity........................................... 35,281 32,728
-------------------
Total liabilities and shareholders equity........................... $44,223 $43,935
===================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
3
<PAGE>
FRACTAL DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------
1997 1996
------------------------
<S> <C> <C>
Net revenues............................................ $ 34,901 $ 29,529
Cost of net revenues.................................... 7,117 5,146
-----------------------
Gross profit.......................................... 27,784 24,383
Operating expenses:
Research and development.............................. 4,788 4,073
Sales and marketing................................... 16,544 13,512
General and administrative............................ 2,881 2,612
Merger expenses....................................... 1,865 --
-----------------------
Total operating expenses........................... 26,078 20,197
-----------------------
Income from operations.................................. 1,706 4,186
Interest income, net.................................... 1,049 567
-----------------------
Income before income taxes.............................. 2,755 4,753
Provision for income taxes.............................. (1,166) (1,827)
-----------------------
Net income.............................................. $ 1,589 $ 2,926
=======================
Net income per share.................................... $ 0.12 $ 0.25
=======================
Number of shares used to compute net income per share... 12,965 11,603
=======================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
4
<PAGE>
FRACTAL DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL CUMULATIVE EARNINGS
------------------ PAID-IN TRANSLATION ACCUMULATED
SHARES AMOUNT CAPITAL ADJUSTMENT (DEFICIT) TOTAL
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at March 31, 1995...................... 7,934 $ 8 $ 5,469 $ (36) $ (2,148) $ 3,293
Accretion to redemption value of
mandatorily redeemable convertible
preferred stock............................. -- -- -- -- (64) (64)
Issuance of common stock, net of
issuance costs of $2,598.................... 2,579 3 24,774 -- -- 24,777
Conversion of mandatorily redeemable
convertible preferred stock................. 1,057 1 2,203 -- -- 2,204
Exercise of stock options and warrants....... 109 -- 125 -- -- 125
Translation adjustment....................... -- -- -- (14) -- (14)
Adjustment to retained earnings as a
result of business combination
(Note 1)................................... -- -- -- -- (519) (519)
Net income................................... -- -- -- -- 2,926 2,926
--------------------------------------------------------------------
Balance at March 31, 1996...................... 11,679 12 32,571 (50) 195 32,728
Common stock issued under employee
plans...................................... 365 -- 740 -- -- 740
Income tax benefit from stock options
exercised.................................. -- -- 332 -- -- 332
Translation adjustment....................... -- -- -- (108) -- (108)
Net income................................... -- -- -- -- 1,589 1,589
--------------------------------------------------------------------
Balance at March 31, 1997...................... 12,044 $12 $33,643 $ (158) $ 1,784 $35,281
====================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
5
<PAGE>
FRACTAL DESIGN CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
------------------------
1997 1996
------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................................. $ 1,589 $ 2,926
Adjustment to retained earnings as a result of business combination
(Note 1).................................................................................. -- (519)
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation and amortization........................................................... 788 448
Deferred taxes.......................................................................... (635) (583)
Changes in assets and liabilities:
Accounts receivable, net.............................................................. (2,156) (5,038)
Inventories........................................................................... (40) (900)
Other current assets.................................................................. (57) (1,502)
Accounts payable...................................................................... (1,459) 2,582
Accrued liabilities................................................................... (326) 4,192
Income taxes payable.................................................................. 461 (890)
-----------------------
Net cash (used in) provided by operating activities................................. (1,835) 716
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures....................................................................... (2,288) (795)
Purchases of short-term investments........................................................ (53,435) (23,195)
Sales of short-term investments............................................................ 53,026 --
-----------------------
Net cash used in investing activities............................................... (2,697) (23,990)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net of issuance costs............................................ -- 24,777
Common stock issued under employee plans including income tax benefit...................... 548 125
Proceeds from issuance of note payable..................................................... -- 500
Repayments of notes payable................................................................ (417) (523)
-----------------------
Net cash provided by financing activities........................................... 131 24,879
Effect of exchange rates on cash........................................................... (108) (14)
-----------------------
Net (decrease) increase in cash and cash equivalents....................................... (4,509) 1,591
Cash and cash equivalents at beginning of period........................................... 7,153 5,562
-----------------------
Cash and cash equivalents at end of period................................................. $ 2,644 $ 7,153
=======================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest................................................................................. $ 18 $ 79
Income taxes............................................................................. $ 785 $ 3,119
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS:
Accretion of mandatorily redeemable convertible preferred stock.......................... $ -- $ 64
Conversion of mandatorily redeemable convertible preferred stock......................... $ -- $ 2,204
Conversion of accrued compensation to equity upon exercise of
certain options and warrants............................................................ $ 524 $ --
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
6
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1- THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Fractal Design Corporation ("Fractal" or the "Company") is a leading provider
of software tools for the creation, editing and manipulation of computer
graphics images and digital art. The Company operates in one business segment.
On February 11, 1997, the Company entered into an Agreement and Plan of
Reorganization ("Agreement") with MetaTools, Inc. ("MetaTools"), a publicly-held
company, pursuant to which the Company would become a wholly owned subsidiary of
MetaTools. Under the terms of the Agreement, MetaTools will issue approximately
0.749 shares of its stock in exchange for each preferred and common share
outstanding of the Company, as well as assume the stock options of the Company
at the exchange rate. The merger is intended to qualify as a pooling-of-
interests for accounting and financial reporting purposes (see Note 11).
On May 24, 1996, Fractal acquired Ray Dream, Inc. ("Ray Dream"), a California
corporation which designs, develops and markets graphics software application
tools emphasizing three-dimensional effects for the personal computer market.
As a result of the acquisition, Ray Dream has become a wholly-owned subsidiary
of Fractal. As consideration for 100% of the outstanding shares of Ray Dream
capital stock, Fractal issued an aggregate of 3,165,660 shares of Fractal common
stock and reserved 219,459 shares of Fractal common stock for issuance upon the
exercise of outstanding options to purchase Ray Dream common stock. Fractal
also assumed an outstanding warrant, held by a third party software developer,
to purchase Ray Dream common stock. This warrant vested in the quarter ended
December 31, 1996 upon completion of certain development milestones, and was
fully exercised, on a net basis, for 178,256 shares of Fractal 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 $1.9 million were recorded in the
first quarter of fiscal 1997.
The Company reports its financial results on a March 31 fiscal year-end
basis, whereas Ray Dream reported its financial results on a December 31
calendar year-end basis. For the purposes of pooling-of-interests accounting,
revenues and net income of Fractal for the year ended March 31, 1996 has been
combined with those of Ray Dream for the year ended December 31, 1995. Ray
Dream's net loss of $519,000 for the three months ended March 31, 1996 has been
reflected as an adjustment to retained earnings. The results of operations of
Ray Dream for such three month period include net revenues of $2,980,000.
Separate results of operations for the period presented is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
MARCH 31,
1996
----------
<S> <C>
Net revenues:
Fractal............................... $21,780
Ray Dream............................. 7,749
----------
$29,529
==========
Net income:
Fractal............................... $ 2,924
Ray Dream............................. 2
----------
$ 2,926
==========
</TABLE>
7
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The following is a summary of the Company's significant accounting
policies.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, Ray Dream, Inc., Fractal Design Europe, Fractal
Design Foreign Sales Corporation and Fractal Design International. All
significant intercompany accounts and transactions have been eliminated.
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, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reported period. Actual results
could differ from those estimates.
REVENUE RECOGNITION
The Company sells its products worldwide through distributors and mail order
catalogs, to hardware and software manufacturers for bundling with other
products, and directly to end users. Revenue from the sale of software products,
including sales to distributors, is recognized when the software has been
shipped, collection of the receivable is probable and there are no significant
obligations remaining. Allowances for estimated future returns and exchanges are
provided at the time of sale based on the Company's return policies and
historical returns experience. The Company periodically offers customers free
upgrades to new product releases for a limited period of time after the
announcement of a new product. The Company's policy is to defer revenue based on
its estimate of the number of users expected to upgrade, if and when a free
upgrade is offered, in accordance with SOP 91-1 and FAS 48. This estimate is
based on the Company's historical experience. The per unit amount of revenue
that is deferred is equal to the objective price to be charged by the Company to
its existing installed user base. The Company recognizes the revenue related to
free upgrades when the customer has requested the upgrade and the new product is
shipped. At March 31, 1997 and 1996 there were no material obligations to
provide free upgrades. The Company provides a limited amount of free telephone
technical support to customers. These activities are generally considered
insignificant post-contract customer support obligations. Estimated costs of
these activities are accrued at the time revenue is recognized.
Revenues from significant customers which represented 10% or more of net
revenues for the respective periods were as follows:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------
1997 1996
----------------------
<S> <C> <C>
Customer A... 21% 16%
Customer B... -- 12%
Customer C... 14% --
</TABLE>
Revenue from foreign customers (principally export sales) was approximately
44% of the Company's net revenues in fiscal 1997 and 1996, respectively. Net
revenues from customers in Europe and Asia accounted for approximately 11% and
33% of net revenues, respectively, in fiscal 1997 and approximately 16% and 28%
of net revenues, respectively, in fiscal 1996.
8
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
FOREIGN CURRENCY TRANSLATION
The functional currency of each of the Company's foreign subsidiaries is its
local currency. Assets and liabilities of foreign operations are translated
into U.S. dollars using current exchange rates, and revenues and expenses are
translated into U.S. dollars using average exchange rates. The effects of
foreign currency translation adjustments are included as a component of
shareholders' equity.
ADVERTISING
The Company expenses the production costs of advertising the first time the
advertising takes place. Advertising expense, consisting primarily of direct
mail advertising, was $1,323,000 and $1,735,000 for the years ended March 31,
1997 and 1996, respectively.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company invests certain of its excess cash in commercial paper and debt
instruments of the U.S. Government and various municipalities. All highly
liquid debt instruments with an original maturity of three months or less are
considered cash equivalents; those with original maturities greater than three
months, consisting primarily of municipal obligations, are considered short-term
investments.
The Company accounts for short-term investments in accordance with the
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"). SFAS 115 requires
investment securities to be classified as either held to maturity, trading or
available for sale. The Company has classified all short-term investments as
available for sale. At March 31, 1997, short-term investments consisted
primarily of municipal obligations with maturities of less than one year from
their date of purchase. At that date, the fair value of the investments
approximated cost.
INVENTORIES
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method based upon the estimated useful lives of
the assets which range from one to five years.
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", and accordingly,
recognizes no compensation expense for the stock option grants.
Statement of Financial Accounting Standards No. 123, "Accounting for Awards of
Stock-Based Compensation", ("SFAS 123"), provides alternative accounting
treatment to APB Opinion No. 25 with respect to stock-based compensation and
requires certain additional disclosures, including disclosures if the Company
elects not to adopt the accounting measurement requirements of SFAS 123. The
Company has elected not to adopt the accounting measurement requirements of SFAS
123 for stock options granted to employees; however, the Company has provided
the required additional disclosures in the footnotes to the consolidated
financial statements.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to a concentration
of credit risk consist principally of cash, cash equivalents, short-term
investments and accounts receivable. The Company invests primarily in U.S.
9
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Government and municipal obligations and holds deposits in money market accounts
of high quality financial institutions. The Company's accounts receivable are
derived from sales to distributors, resellers and end-users, serving a variety
of industries located primarily in the United States, Europe and Asia. At March
31, 1997, two customers accounted for 37% and 22% of accounts receivable,
respectively, and at March 31, 1996, two customers accounted for 27% and 10%,
respectively of accounts receivable. The Company performs ongoing credit
evaluations of its customers and to date has not experienced any material
losses.
SOFTWARE DEVELOPMENT COSTS
Costs related to the conceptual formation and design of internally developed
software are expensed as research and development as incurred. It is the
Company's policy that certain internal software development costs incurred after
technological feasibility has been demonstrated and which meet recoverability
tests are capitalized and amortized over the estimated economic life of the
product. To date, the Company has incurred no significant internal software
development costs which meet the criteria for capitalization.
INCOME TAXES
The Company accounts for income taxes using the asset and liability method.
Under the asset and liability method, deferred income tax assets and liabilities
are determined based on the differences between the financial reporting and tax
bases of assets and liabilities and are measured using currently enacted tax
rates and laws.
NET INCOME PER SHARE
Net income per share is computed using the weighted-average number of shares
of common stock and common equivalent shares, when dilutive, from mandatorily
redeemable convertible preferred stock (using the if-converted method) and from
stock options and warrants (using the treasury stock method). Pursuant to
Securities and Exchange Commission Staff Accounting Bulletin No. 83, common
stock and equivalent shares, options and warrants issued by the Company during
the twelve month period prior to the Company's initial public offering have been
included in the calculation as if they were outstanding for all periods through
the effective date of the initial public offering.
For the year ended March 31, 1996, accretion to the redemption value of
mandatorily redeemable convertible preferred stocks was $64,000 resulting in net
income attributable to common shareholders of $2,862,000.
SHAREHOLDERS' EQUITY
In addition to the shares of Fractal common stock issued to the former
shareholders of Ray Dream (see Note 1), common stock as of March 31, 1996
reflects the sale of 2,375,000 shares of common stock issued in the Company's
initial public offering completed November 9, 1995. Aggregate net proceeds to
the Company were $23,540,000. In addition, common stock also reflects (i) the
conversion of all the mandatorily redeemable convertible preferred stock
outstanding into an aggregate of 1,057,505 shares of common stock, (ii) the
exercise of warrants to purchase 52,873 shares of the Company's common stock at
an exercise price of $2.00 per share and (iii) the termination of the redemption
rights on the 204,082 shares of mandatorily redeemable common stock.
10
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 2 - BALANCE SHEET COMPONENTS:
A summary of balance sheet components follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31,
------------------
1997 1996
------------------
Inventories:
<S> <C> <C>
Raw materials....................... $ 675 $ 756
Finished goods...................... 585 464
------------------
$ 1,260 $1,220
==================
Property and equipment:
Furniture and fixtures.............. $ 766 $ 327
Equipment and software.............. 2,820 1,532
Leasehold improvements.............. 595 34
------------------
4,181 1,893
Less: Accumulated depreciation and
amortization (1,723) (935)
------------------
$ 2,458 $ 958
==================
Accrued liabilities:
Reserve for returns and exchanges... $ 2,801 $2,459
Deferred revenue.................... -- 868
Payroll and related................. 1,365 1,839
Marketing and advertising........... 769 849
Royalties payable................... 354 244
Other............................... 816 696
------------------
$ 6,105 $6,955
==================
</TABLE>
NOTE 3 - BANK BORROWINGS:
In August 1995, the Company converted the outstanding balance of $440,000
under its existing line of credit to a demand loan with a bank. Interest
accrued on the loan at a rate equal to the banks reference rate plus 1.5%. The
demand loan was paid in full in November 1995.
In September 1995, the Company entered into a line of credit agreement which
provided for borrowings of up to $600,000. This line of credit agreement was
renewed in August 1996 and provides for borrowings of up to $500,000 and bears
interest equal to the bank's reference rate (8.50% as of March 31, 1997). The
line of credit agreement expires in August 1997, and is unsecured. No amounts
were outstanding under this line at March 31, 1997.
In September 1995, the Company borrowed $500,000 from a commercial bank.
Borrowings bore interest at the bank's prime rate plus 0.75% per annum. These
borrowings were paid in full during fiscal 1997.
NOTE 4 - RELATED PARTY TRANSACTIONS:
OTHER RELATED PARTY TRANSACTIONS
Businesses owned by two shareholders have provided technical and
administrative services to the Company. Amounts paid to these two firms totaled
$229,000 and $214,000 for the years ended March 31, 1997 and 1996, respectively.
Amounts due to the firms for services rendered totaled $2,000 and $24,000 at
March 31, 1997 and 1996, respectively. The Company believes that the terms of
the agreements for these services are no less favorable than could be obtained
from third-party suppliers.
11
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 5 - COMMITMENTS AND CONTINGENCIES:
The Company leases its office facilities and certain office equipment under
various operating leases. Total rent expense under the leases was $547,000 and
$434,000 for the years ended March 31, 1997 and 1996, respectively.
Aggregate future minimum lease payments under noncancelable operating leases
with initial terms of one year or more are as follows at March 31, 1997 (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDING MARCH 31,
<S> <C>
1998.................. $ 491
1999.................. 532
2000.................. 589
2001.................. 567
2002.................. 566
Thereafter............ 802
-------
$3,547
=======
</TABLE>
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 agreed to pay a total of $400,000 in
advances against product purchases of which $50,000 is included in other assets
as of March 31, 1997. The Company will pay for product purchases at a rate of
14% of net revenues (as defined) subject to adjustments for certain events. Such
payments may be offset against advances at a rate of 50%. In addition, the
Company granted a warrant with a fair market value of $348,000 to the Contractor
to purchase 437,604 shares of the Company's common stock at $7.08 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. Of the total value of these
warrants, $185,000 and $163,000 was recognized as research and development
expense in 1997 and 1996, respectively. This warrant was exercised in the
quarter ended December 31, 1996, on a net basis, for 178,256 shares of the
Company's common stock (see Note 1).
In the normal course of business, the Company from time to time receives
inquiries with regard to possible patent infringement. Management believes that
it is unlikely that the outcome of the inquiries received thus far will have a
material adverse effect on the Company's financial position or results of
operations.
NOTE 6 - INCOME TAXES:
The provision for income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------
1997 1996
----------------------
<S> <C> <C>
Current:
Federal... $ 1,250 $ 1,867
State..... 551 527
Foreign... -- 16
----------------------
1,801 2,410
----------------------
Deferred:
Federal... (503) (513)
State..... (132) (70)
----------------------
(635) (583)
----------------------
$ 1,166 $ 1,827
======================
</TABLE>
12
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
As of March 31, 1997, the Company had a federal net operating loss
carryforward as well as federal tax credit carryforwards from its acquired
subsidiary, Ray Dream, of approximately $67,000 and $80,000, respectively. These
carryforward items can only be used to offset future taxable income of Ray
Dream. The federal net operating loss and tax credit carryforwards will expire
in 2012 and 2011, respectively. Management believes sufficient uncertainty
exists with regard to the realization of Ray Dream's tax credit carryforwards
and certain other temporary differences. Accordingly, a valuation allowance of
$216,000 has been provided at March 31, 1997.
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
----------------------
1997 1996
----------------------
<S> <C> <C>
Reserves and accruals............. $2,073 $ 1,365
Deferred revenue.................. -- 366
Tax credit carryforwards.......... 80 234
Net operating loss carryforward... 23 227
Other............................. 121 295
----------------------
Deferred tax assets............... 2,297 2,487
Valuation allowance............... (216) (1,041)
----------------------
Net deferred tax asset............ $2,081 $ 1,446
======================
</TABLE>
A reconciliation of the provision for income taxes to the amount computed by
applying the statutory federal income tax rate is as follows:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------
1997 1996
---------------------
<S> <C> <C>
Statutory rate.......................... 34.0% 34.0%
State income taxes, net of federal tax
benefit................................ 6.3 6.4
Nondeductible merger costs.............. 17.2 --
Net operating loss utilized............. (8.2) (0.8)
Research and development credits
utilized............................... (4.0) (1.3)
Foreign income taxes.................... -- 1.1
Other, net.............................. (3.0) (1.0)
---------------------
Effective tax rate.................... 42.3% 38.4%
=====================
</TABLE>
NOTE 7 - COMMON STOCK:
In May 1996, in connection with the Company's acquisition of Ray Dream, the
Company assumed the options outstanding under the Ray Dream 1992 Stock Option
Plan. The 1992 Stock Option Plan assumed from Ray Dream and the 1993 Stock
Option Plan, as amended (the "Plans"), authorize the Board of Directors to grant
incentive stock options and nonstatutory stock options to employees, officers,
directors and consultants for up to 2,223,996 shares of common stock. Under the
Plans, incentive stock options are granted at a price that is not less than 100%
of the fair value of the stock at the date of grant, as determined by the Board
of Directors. Nonqualified stock options are to be granted at a price that is
not less than 85% of the fair value of the stock at the date of grant, as
determined by the Board of Directors. Options generally vest over a four year
period and are exercisable for a period of ten years after the date of grant.
Options granted to a shareholder who owns more than 10% of the outstanding stock
of the Company at the time of grant must be at a price not less than 110% of the
fair value of the stock on the date of grant, and are exercisable for a period
not to exceed five years. The Company will not issue new options under the
Plans.
13
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The Company's 1995 Stock Option Plan (the "1995 Option Plan") was adopted by
the Board of Directors on August 29, 1995, approved by the Company's
shareholders on September 5, 1995 and replaced the 1993 Plan. The maximum
aggregate number of shares that may be optioned and sold under the 1995 Option
Plan is the sum of (i) 1,180,420 shares plus (ii) such number of shares as are
subject to outstanding and unexercised stock options under the Company's 1993
Option Plan, as of the date of adoption of the 1995 Option Plan by the
shareholders, and which options are canceled or otherwise terminated without
exercise; provided that the total number of shares available under the 1995
Option Plan shall in no event exceed 2,291,344. The 1995 Option Plan provides
for (i) the granting to employees (including officers and employee directors) of
"incentive stock options" within the meaning of Section 422 of the Code and (ii)
the granting to employees and consultants of nonstatutory stock options. The
exercise price of all incentive stock options granted under the 1995 Option Plan
must be at least equal to the fair market value of the common stock of the
Company on the date of grant. The exercise price of any incentive stock option
granted to an optionee who owns stock representing more than 10% of the voting
power of all classes of stock of the Company must equal at least 110% of the
fair market value of the common stock on the date of grant. The exercise price
of nonstatutory stock options generally must equal at least 85% of the fair
market value of the common stock on the date of grant.
A summary of the Company's stock option plan activity is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------
WEIGHTED
OPTIONS AVERAGE
AVAILABLE NUMBER OF EXERCISE
FOR GRANT SHARES PRICE
-------------------------------------
<S> <C> <C> <C>
Options outstanding at March 31, 1995... 1,310,223 898,556 $ 0.69
Additional shares reserved.............. 362,177 -- --
Granted - exercise price equal to fair
value.................................. (576,649) 576,649 4.95
Granted - exercise price greater than
fair value............................. (38,695) 38,695 3.20
Granted - exercise price less than fair
value.................................. (100,710) 100,710 1.26
Exercised............................... -- (55,560) 0.46
Canceled................................ 45,556 (45,556) 0.31
-------------------------------------
Options outstanding at March 31, 1996... 1,001,902 1,513,494 2.43
Additional shares reserved.............. -- -- --
Reduction in shares reserved............ (63,053) -- --
Granted - exercise price equal to fair
value.................................. (605,660) 605,660 13.92
Granted - exercise price greater than
fair value............................. (60,000) 60,000 14.30
Exercised............................... -- (176,714) 0.71
Canceled................................ 233,482 (233,482) 10.05
-------------------------------------
Options outstanding at March 31, 1997... 506,671 1,768,958 $ 5.93
=====================================
</TABLE>
During fiscal 1997, certain Ray Dream options were canceled and cannot be
regranted as the Ray Dream Stock Option Plan was terminated upon the merger of
Fractal and Ray Dream (see Note 1).
In May 1995, each non-employee director received an option to purchase 10,000
shares of common stock at an exercise price of $2.00 per share ($2.20 per share
in the case of one director). Each such option has a term of ten years, and
vests over four years from the date of grant.
During fiscal 1996, 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. Management
14
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
will recognize approximately $759,000 of compensation expense over the four-year
vesting periods relating to these options. Such compensation expense was
$190,000 and $159,000 during fiscal 1997 and 1996, respectively.
On August 29, 1995, the Company's Board of Directors adopted the 1995 Director
Stock Option Plan. The plan was approved by the Company's shareholders on
September 5, 1995. A total of 175,000 shares of common stock were reserved for
issuance under the 1995 Director Stock Option Plan, which provides that each
person who becomes a non-employee director of the Company after the date of the
Company's initial public offering will be granted a nonstatutory stock option to
purchase 20,000 shares of common stock (the "First Option") on the date on which
the optionee first becomes a non-employee director of the Company. Thereafter,
on the date of each annual meeting of the Company's shareholders at which each
non-employee director is elected, each such non-employee director shall be
granted an additional option to purchase 5,000 shares of common stock (a
"Subsequent Option") if, on such date, he or she shall have served on the
Company's Board of Directors for at least six months. The options generally
become exercisable in installments of 25% of the total number of shares subject
to the First Option on each of the first, second, third and fourth anniversaries
of the date of grant of the First Option, and each Subsequent Option becomes
exercisable as to 50% on the first and second anniversaries of the date of grant
of that Subsequent Option. The exercise price of all stock options granted under
the Directors' Plan is equal to the fair market value of a share of the
Company's common stock on the date of grant of the option. Options granted under
the Directors' Plan have a term of ten years. As of March 31, 1997, 60,000
options were granted and outstanding under the Plan at a weighted average
exercise price of $14.17. No options had been exercised or canceled.
The following summarizes the weighted average fair value of options granted
during the years ended March 31, 1997 and 1996:
<TABLE>
<CAPTION>
YEARS ENDED MARCH 31,
---------------------
1997 1996
---------------------
<S> <C> <C>
Exercise price equal to fair value...... $8.28 $ 3.09
Exercise price greater than fair value.. 7.49 1.76
Exercise price less than fair value..... -- 3.86
</TABLE>
The following summarizes information about stock options outstanding at
March 31, 1997:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
---------------------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AVERAGE EXERCISE EXERCISE
EXERCISE PRICE RANGE SHARES LIFE (a) PRICE SHARES PRICE
- -------------------------------------------------------------------------- ---------------------
<S> <C> <C> <C> <C> <C>
$0.21-$0.35 84,541 3.85 $ 0.35 41,854 $ 0.35
$0.75-$0.75 463,375 7.02 0.75 283,158 0.75
$0.83-$2.00 379,930 7.68 1.51 179,261 1.35
$2.20-$12.88 431,342 8.44 8.50 100,048 7.05
$13.00-$16.00 469,770 8.67 14.34 1,520 13.51
---------------------------------- ---------------------
Total 1,828,958 7.77 $ 6.21 605,841 $ 1.97
================================== =====================
</TABLE>
(a) Average contractual life remaining in years.
The Company has adopted the disclosure-only option under SFAS 123 as of March
31, 1997. Pro forma information regarding net income and earnings per share is
required by SFAS 123, and has been determined as if the Company has accounted
for the Plans under the fair value method of the Statement. 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
15
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
weighted average assumptions for both fiscal 1996 and 1997: risk-free interest
rate of 6.0%, no dividend yield, volatility factor of the expected market price
of the Company's common stock of 70%, and a weighted-average expected life of
the options of 4.4 years. 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 income and net income per common share would
approximate the following:
<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
----------------------------
<S> <C> <C>
Year Ended March 31, 1997:
Net income.................... $1,589,000 $ 718,000
Net income per common share... 0.12 0.06
Year Ended March 31, 1996:
Net income.................... $2,926,000 $2,791,000
Net income per common share... 0.25 0.24
</TABLE>
The effects of applying SFAS 123 in this proforma disclosure are not
indicative of future amounts. SFAS 123 does not apply to awards prior to fiscal
1996, and additional awards in future years are anticipated.
NOTE 9 - MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK, MANDATORILY
REDEEMABLE COMMON STOCK AND WARRANTS:
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
In September and November 1994, the Company issued 1,057,505 shares of Series
A mandatorily redeemable convertible preferred stock (the "Series A Stock") for
$2.00 per share. Proceeds to the Company totaled $2,072,000, net of issuance
costs. The Series A Stock was redeemable at the option of the holders of at
least two thirds of the outstanding Series A Stock in three annual installments
at a price equal to the sum of $2.00 per share plus $0.12 per annum from the
date of issuance subject to adjustment for antidilution.
The excess of the redemption price over the original issuance price of the
Series A Stock was charged to retained earnings as an accretion to redemption
value with a corresponding increase in the value of the Series A Stock. The
cumulative accretion for the Series A Stock was $68,000 at March 31, 1995 and
$132,000 at November 9, 1995. Upon the closing of the Company's initial public
offering on November 9, 1995, the Series A Stock was converted into common stock
and the aggregate balance of the Series A Stock of $2,204,000 at that date was
credited to additional paid-in capital.
In connection with the issuance of Series A Stock, the Company issued warrants
to purchase 52,873 shares of common stock at an exercise price of $2.00 per
share. The warrants were exercisable for a period of five years after date of
issuance. The warrants expired upon the consummation of the Companys initial
public offering. A total of 52,873 shares of common stock were issued upon
conversion of the warrants.
MANDATORILY REDEEMABLE COMMON STOCK
On July 21, 1995, the Company and certain shareholders entered into an
agreement (the "Agreement") to sell 204,082 and 122,449 shares, respectively, of
common stock to Adobe Ventures, L.P. ("Adobe"), a subsidiary of Adobe Systems,
Inc., for $6.125 per share. Aggregate net proceeds to the Company were
$1,237,000. Upon the closing of the Company's initial public offering, the
mandatory redemption rights of this stock were automatically terminated.
16
<PAGE>
FRACTAL DESIGN CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE 10 - 401(K) PLAN AMENDMENT:
Effective March 1, 1995, the Company implemented an employee savings and
retirement plan (the "401(k) Plan") covering substantially all of the Company's
employees. Pursuant to the 401(k) Plan, eligible employees may elect to reduce
their current compensation by up to the statutorily prescribed limit and have
the amount of such reduction contributed to the 401(k) Plan. The Company may
make contributions to the 401(k) Plan on behalf of eligible employees.
Employees become 25% vested in the Company contributions after two years of
service, and increase their vested percentages by an additional 25 percent for
each year of service thereafter.
On August 29, 1995, the Board of Directors approved an amendment to the
Company's 401(k) Plan which provides for matching contributions to be made by
the Company in the form of Company common stock. A total of 100,000 shares of
the Company's common stock has been reserved for matching contributions under
the 401(k) Plan. The Company contributed 9,865 shares of the Company's common
stock with an aggregate fair market value of approximately $88,000 during fiscal
1997.
NOTE 11 - SUBSEQUENT EVENT:
In May 1997, the shareholders of Fractal and MetaTools, Inc. ("MetaTools"), a
publicly held company, approved MetaTools' acquisition of Fractal. Effective
immediately upon approval by the two companies, the combined company was renamed
MetaCreations Corporation ("MetaCreations"). As a result of the acquisition,
MetaCreations issued approximately 9,055,000 shares of MetaCreations common
stock for all of the outstanding shares of common stock of Fractal and has
reserved 0.749 shares of MetaCreations common stock for issuance upon exercise
of each outstanding option to purchase Fractal common stock. Pursuant to this
merger, which will be accounted for as a pooling-of-interests, Fractal became a
wholly owned subsidiary of MetaCreations.
17
<PAGE>
(b) Financial Statements of MetaCreations Corporation
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
MetaCreations Corporation
We previously audited and reported on the consolidated balance sheets of
MetaCreations Corporation as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1996 prior to
their restatement for the 1997 pooling of interests with Fractal Design
Corporation ("Fractal"). The contribution of Fractal to the combined revenues
and net income represented approximately 56% and 21%; 64% and 121%; and 65% and
388% of the respective restated totals for the years ended December 31, 1996,
1995, and 1994. The total assets of Fractal represented 42% and 44% of the
respective restated totals as of December 31, 1996 and 1995. Separate financial
statements of Fractal included in the related restated consolidated balance
sheets, statements of operations, shareholders' equity, and cash flows were
audited and reported on separately by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included
for Fractal, is based solely on the report of the other auditors. We also
audited the combination of the accompanying consolidated balance sheets as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1996, after restatement for the 1997
pooling of interests; in our opinion, such consolidated statements have been
properly combined on the basis described in Note 1 of the notes to consolidated
financial statements.
We conducted our audits in accordance with generally accepted auditing
standards. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditor,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of MetaCreations Corporation as of
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Sherman Oaks, California
February 3, 1997, except for Note 1 as to
which the date is May 29, 1997
18
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Fractal Design Corporation
In our opinion, the consolidated balance sheets and the related consolidated
statements of operations, of shareholders' equity and of cash flows of Fractal
Design Corporation and its subsidiaries (not presented separately herein)
present fairly, in all material respects, their financial position at March 31,
1997 and 1996, and the results of their operations and their cash flows for each
of the three years in the period ended March 31, 1997, 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.
PRICE WATERHOUSE LLP
San Jose, California
April 30, 1997, except as to Note 11 of the Fractal Design Corporation
financial statements, which is as of May 29, 1997
19
<PAGE>
METACREATIONS CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
--------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............... $ 21,605 $54,038
Short-term investments.................. 44,688 23,683
Accounts receivable, net of allowance
for returns and doubtful accounts of
$4,554 and $3,805 in 1996
and 1995, respectively................. 16,619 7,538
Inventories............................. 1,512 2,132
Deferred income taxes................... 2,827 1,550
Prepaid expenses........................ 3,826 3,045
--------------------
Total current assets................. 91,077 91,986
Property and equipment, net............... 5,581 2,535
Other assets.............................. 1,277 496
--------------------
Total assets......................... $ 97,935 $95,017
====================
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Bank borrowings......................... $ -- $ 167
Accounts payable........................ 4,490 5,475
Accrued expenses........................ 6,427 5,222
Royalties payable....................... 756 832
Income taxes payable.................... 150 155
--------------------
Total current liabilities............ 11,823 11,851
Long-term debt............................ -- 250
Commitments and contingencies
Stockholders equity:
Preferred stock, $.001 par value;
5,000,000 shares authorized--none
issued and outstanding at
December 31, 1996 and 1995............. -- --
Common stock, $.001 par value;
75,000,000 shares authorized--
22,274,398 and 20,345,596 shares
issued and outstanding at December 31,
1996 and 1995, respectively............ 22 21
Paid-in capital......................... 100,956 87,003
Cumulative translation loss............. (158) (50)
Notes receivable from stockholders...... (3,000) --
Accumulated deficit..................... (11,708) (4,058)
--------------------
Total stockholders equity............ 86,112 82,916
--------------------
Total liabilities and stockholders
equity.............................. $ 97,935 $95,017
====================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
20
<PAGE>
METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
-------------------------------
<S> <C> <C> <C>
Net revenues............................ $62,936 $46,260 $28,308
Cost of revenues........................ 11,677 10,081 6,627
-------------------------------
Gross profit.......................... 51,259 36,179 21,681
Operating expenses:
Sales and marketing................... 28,936 22,331 14,378
General and administrative............ 5,883 4,590 3,735
Research and development.............. 8,224 5,639 3,559
Write-off of acquired in-process
technology and other acquisition
costs................................ 17,047 -- --
-------------------------------
Total operating expenses.......... 60,090 32,560 21,672
-------------------------------
Income (loss) from operations........... (8,831) 3,619 9
Interest and investment income, net..... 3,397 634 11
-------------------------------
Income (loss) before provision for
income taxes........................... (5,434) 4,253 20
Provision for income taxes.............. 2,216 1,827 473
-------------------------------
Net income (loss)....................... $(7,650) $ 2,426 $ (453)
===============================
Net income (loss)....................... $(7,650) $ 2,426 $ (453)
Amortization of costs related to the
issuance of mandatory redeemable
Series B convertible preferred stock... -- (89) (99)
Preferred stock dividend requirement.... -- -- (140)
-------------------------------
Net income (loss) applicable to common
stockholders........................... $(7,650) $ 2,337 $ (692)
===============================
Net income (loss) per common share...... $ (0.37) $ 0.15 $ (0.06)
===============================
Weighted average number of shares
outstanding............................ 20,590 15,267 11,584
===============================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
21
<PAGE>
METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES A NOTES
PREFERRED STOCK COMMON STOCK CUMULATIVE RECEIVABLE
--------------------------------------- PAID-IN TRANSLATION FROM
SHARES AMOUNT SHARES AMOUNT CAPITAL ADJUSTMENT STOCKHOLDERS
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1993...... 841 $ 841 9,134 $ 9 $ 5,528 $(18) $ (10)
Issuance of common stock to
employees in exchange for
services.......................... -- -- 29 -- 2 -- --
Issuance of common stock
upon the exercise of stock
options........................... -- -- 9 -- 7 -- --
Repurchase of common stock......... -- -- (100) -- (3) -- --
Amortization of costs
related to the issuance of
mandatory redeemable Series
B preferred stock................. -- -- -- -- -- -- --
Preferred stock dividend
requirement....................... -- -- -- -- -- -- --
Accretion to redemption
value of mandatorily
redeemable convertible
preferred stock................... -- -- -- -- -- -- --
Translation adjustment............. -- -- -- -- -- (18) --
Notes receivable from
stockholders...................... -- -- -- -- -- -- (435)
Net loss........................... -- -- -- -- -- -- --
---------------------------------------------------------------------------------
Balances at December 31, 1994...... 841 841 9,072 9 5,534 (36) (445)
Issuance of common stock
upon the exercise of stock
options and warrants.............. -- -- 707 1 191 -- --
Repurchase of common stock......... -- -- (6) -- -- -- --
Amortization of costs
related to the issuance of
mandatory redeemable Series
B preferred stock................. -- -- -- -- -- -- --
Reversal of preferred stock
dividend requirement in
connection with conversion
of Series B preferred stock....... -- -- -- -- (140) -- --
Accretion to redemption
value of mandatorily
redeemable convertible
preferred stock................... -- -- -- -- -- -- --
Conversion of Series A
preferred stock................... (841) (841) 1,682 2 839 -- --
Conversion of Series B
preferred stock................... -- -- 3,390 3 8,445 -- --
Conversion of mandatorily
redeemable convertible
preferred stock................... -- -- 792 1 2,203 -- --
Issuance of common stock,
net of offering costs
totaling $3,935................... -- -- 4,709 5 69,931 -- --
Translation adjustment............. -- -- -- -- -- (14) --
Repayment of notes receivable
from stockholders................. -- -- -- -- -- -- 445
Adjustment to retained
earnings as a result of
business combination
(Note 3).......................... -- -- -- -- -- -- --
Net income......................... -- -- -- -- -- -- --
---------------------------------------------------------------------------------
Balances at December 31, 1995...... -- -- 20,346 21 87,003 (50) --
<CAPTION>
TOTAL
STOCKHOLDERS'
ACCUMULATED EQUITY
(DEFICIT) (DEFICIT)
------------------------------
<S> <C> <C>
Balances at December 31, 1993...... $(5,192) $ 1,158
Issuance of common stock to
employees in exchange for
services.......................... -- 2
Issuance of common stock
upon the exercise of stock
options........................... -- 7
Repurchase of common stock......... -- (3)
Amortization of costs
related to the issuance of
mandatory redeemable Series
B preferred stock................. (99) (99)
Preferred stock dividend
requirement....................... (140) (140)
Accretion to redemption
value of mandatorily
redeemable convertible
preferred stock................... (68) (68)
Translation adjustment............. -- (18)
Notes receivable from
stockholders...................... -- (435)
Net loss........................... (453) (453)
------------------------------
Balances at December 31, 1994...... (5,952) (49)
Issuance of common stock
upon the exercise of stock
options and warrants.............. -- 192
Repurchase of common stock......... -- --
Amortization of costs
related to the issuance of
mandatory redeemable Series
B preferred stock................. (89) (89)
Reversal of preferred stock
dividend requirement in
connection with conversion
of Series B preferred stock....... 140 --
Accretion to redemption
value of mandatorily
redeemable convertible
preferred stock................... (64) (64)
Conversion of Series A
preferred stock................... -- --
Conversion of Series B
preferred stock................... -- 8,448
Conversion of mandatorily
redeemable convertible
preferred stock................... -- 2,204
Issuance of common stock,
net of offering costs
totaling $3,935................... -- 69,936
Translation adjustment............. -- (14)
Repayment of notes receivable
from stockholders................. -- 445
Adjustment to retained
earnings as a result of
business combination
(Note 3).......................... (519) (519)
Net income......................... 2,426 2,426
------------------------------
Balances at December 31, 1995...... (4,058) 82,916
</TABLE>
(Table continued on next page)
22
<PAGE>
METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES A NOTES
PREFERRED STOCK COMMON STOCK CUMULATIVE RECEIVABLE
------------------------------------ PAID-IN TRANSLATION FROM
SHARES AMOUNT SHARES AMOUNT CAPITAL ADJUSTMENT STOCKHOLDERS
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31,
1995........................ -- -- 20,346 21 87,003 (50) --
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..................... -- -- -- -- -- -- --
-------------------------------------------------------------------------------------
Balances at December 31,
1996........................ -- $ -- 22,274 $ 22 $100,956 $ (158) $(3,000)
=====================================================================================
<CAPTION>
TOTAL
STOCKHOLDERS'
ACCUMULATED EQUITY
(DEFICIT) (DEFICIT)
-------------------------------
<S> <C> <C>
Balances at December 31,
1995........................ (4,058) 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) (7,650)
-------------------------------
Balances at December 31,
1996........................ $ (11,708) $ 86,112
===============================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
23
<PAGE>
METACREATIONS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
-----------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss).............................................................. $ (7,650) $ 2,426 $ (453)
Adjustment to retained earnings as a result of business combination (Note 3)... -- (519) --
Adjustments to reconcile net income (loss) to net cash (used in) provided by
operating activities:
Write-off of acquired in-process technology.................................. 13,623 -- --
Deferred income taxes........................................................ (1,381) (583) (863)
Depreciation and amortization................................................ 1,574 753 293
Provision for losses on receivables and returns.............................. 6,467 5,814 3,257
Provision for losses on inventory............................................ 724 796 190
Issuance of common stock to employees in exchange for services............... -- -- 2
Changes in operating assets and liabilities:
Accounts receivable........................................................ (15,548) (9,436) (5,737)
Inventories................................................................ (104) (2,005) (833)
Prepaid expenses and other assets.......................................... (88) (2,144) (141)
Accounts payable and accrued expenses...................................... (922) 6,151 1,906
Royalties payable.......................................................... (76) 261 380
Income taxes payable....................................................... 327 (890) 1,045
-----------------------------------------
Net cash (used in) provided by operating activities...................... (3,054) 624 (954)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment............................................ (3,960) (1,951) (1,115)
Purchases of software technology and product rights............................ (125) (395) --
Purchases of short-term investments............................................ (104,373) (23,195) (488)
Proceeds from maturities of short-term investments............................. 83,368 -- --
Payment in connection with acquisition......................................... (139) -- --
Purchase of certificate of depositrestricted use............................... -- -- (240)
Sale of certificate of depositrestricted use................................... -- 240 --
-----------------------------------------
Net cash used in investing activities.................................... (25,229) (25,301) (1,843)
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in notes receivable from stockholders................................. (3,000) -- (435)
Repayment of notes receivable from stockholders................................ -- 445 --
Proceeds from bank note payable................................................ -- 415 340
Repayment of bank note payable................................................. -- (815) --
Repayment of notes payable to stockholders..................................... (1,477) -- (1,509)
Proceeds from issuance of notes payable........................................ -- 500 --
Repayment of notes payable..................................................... (417) (523) --
Proceeds from exercise of warrants and stock options........................... 852 192 7
Net proceeds from issuance of preferred stock.................................. -- -- 9,867
Net proceeds from issuance of common stock..................................... -- 69,936 --
Payment for repurchase of common stock......................................... -- -- (3)
-----------------------------------------
Net cash (used in) provided by financing activities...................... (4,042) 70,150 8,267
Effect of exchange rates on cash............................................... (108) (14) (18)
-----------------------------------------
Net (decrease) increase in cash and cash equivalents........................... (32,433) 45,459 5,452
Cash and cash equivalents at beginning of period............................... 54,038 8,579 3,127
-----------------------------------------
Cash and cash equivalents at end of period..................................... $ 21,605 $ 54,038 $ 8,579
=========================================
</TABLE>
(Table continued on next page)
24
<PAGE>
METACREATIONS CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1996 1995 1994
---------------------------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES
Cash paid during the year for interest......................................... $ 18 $ 175 $ 219
Cash paid during the year for income taxes..................................... 2,162 3,119 293
SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES
Issuance of common stock and stock options in connection with acquisition
of Real Time Geometry Corp.................................................... $11,849 $ -- $ --
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........................................... 1,072 -- --
Covenant not-to-compete with an officer of the Company......................... 600 -- --
Conversion of accrued compensation to equity upon exercise of certain options
and warrants................................................................. 524 -- --
Issuance of common stock in exchange for software technology and product
rights........................................................................ 138 -- --
Issuance of common stock in connection with employee stock purchase plan....... 126 -- --
Conversion of Series B redeemable convertible preferred stock to common stock.. -- 8,448 --
Conversion of Series A convertible preferred stock to common stock............. -- 841 --
Conversion of mandatorily redeemable convertible preferred stock to common
stock......................................................................... -- 2,204 --
Reversal of preferred stock dividend requirement in connection with
conversion of Series B redeemable convertible preferred stock................. -- 140 --
Accretion of mandatorily redeemable convertible preferred stock................ -- 64 68
Issuance of Series B redeemable convertible preferred stock in exchange for
reduction of notes payable to stockholders.................................... -- -- 325
Issuance of Series B redeemable convertible preferred stock in exchange for
services relating to equity funding received.................................. -- -- 250
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
25
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION
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 consolidated financial statements include the accounts of MetaCreations
Corporation ("MetaCreations" or the "Company") and its wholly-owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation.
MetaCreations is a leading developer of visual computing and graphics software
and technologies for professionals and consumers for Windows, Macintosh and
other digital editing operating systems. MetaCreations designs, develops,
publishes, markets and supports visual computing software tools and technologies
for the creation, editing, and manipulation of computer graphic images, digital
art, and Internet/online content.
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.
The computer graphic 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
sheets of the Company as of December 31, 1996 and 1995 have been combined with
that of Fractal as of March 31, 1997 and 1996. The statements of operations of
the Company for each of the three years in the period ended December 31, 1996
have been combined with that of Fractal for each of the three years in the
period ended March 31, 1997.
26
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS)
Separate results of operations for the periods presented are as follows (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
-----------------------------------------
<S> <C> <C> <C>
Net revenues:
MetaCreations... $28,035 $16,731 $ 9,832
Fractal......... 34,901 29,529 18,476
-----------------------------------------
$62,936 $46,260 $28,308
=========================================
Net income (loss):
MetaCreations... $(9,239) $ (500) $(2,212)
Fractal......... 1,589 2,926 1,759
-----------------------------------------
$(7,650) $ 2,426 $ (453)
=========================================
</TABLE>
On April 15, 1997, the Company completed the acquisition of Specular
International Ltd. ("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 approximately 13 of 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 approximately 22 of Specular's existing
operations, accounting, and sales personnel. In addition, the Company assumed
the net liabilities of Specular, which totaled $1.6 million at April 15, 1997.
The Company charged approximately $6.4 million against earnings during the three
months ended June 30, 1997 related to the write-off of acquired in-process
technology, the closing of the Amherst facility, and other costs related to the
acquisition.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
The Company recognizes revenue in accordance with Statement of Position 91-1
("SOP 91-1"), "Software Revenue Recognition," issued by the American Institute
of Certified Public Accountants. Product revenues are recognized upon shipment
to the customer, satisfaction of significant Company obligations, if any, and
reasonable assurance regarding the collectability of the corresponding
receivable. At the time of shipment, the Company accrues for the estimated cost
of post contract support in accordance with SOP 91-1. The Company provides an
allowance for estimated returns at the time of product shipment and adjusts this
allowance as needed based on actual returns history. At December 31, 1996 and
1995, the Company had an allowance for potential returns of approximately
$3,618,000 and $3,060,000, 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 significant 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.
27
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 value of its inventories, including
a review for potentially excess or obsolete products, and adjusts these as
necessary. At December 31, 1996 and 1995, the Company had reserves of
approximately $631,000 and $871,000, 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.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
SOFTWARE DEVELOPMENT COSTS
The Company accounts for its software development costs in accordance with
Statement of Financial Accounting Standard ("SFAS") No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed." This
statement 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 was approximately $4,707,000, $4,188,000, and $2,130,000
for the years ended December 31, 1996, 1995, and 1994, 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 SFAS No. 115. The amortized cost of securities, which approximate market
value at December 31, 1996, are adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization, realized gains and
losses, interest and dividends, and declines in value judged to be other than
temporary are included in investment income. The cost of securities sold is
based on the specific identification method.
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
28
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 $2,487,000, $2,553,000 and $1,538,000 for the years ended
December 31, 1996, 1995, and 1994, respectively.
MAJOR CUSTOMERS AND 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, 1996 and 1995, the Company has an allowance for
doubtful accounts of approximately $936,000 and $745,000, respectively.
Revenues from one of the Company's major domestic distributors represented
approximately 20%, 19%, and 19% of net revenues for the years ended December 31,
1996, 1995, and 1994. Revenues from international customers (principally export
sales) accounted for approximately 41%, 38%, and 24% of net revenues for the
years ended December 31, 1996, 1995, and 1994.
At December 31, 1996, and periodically throughout 1994 to December 31, 1996,
the Company has maintained balances with various financial institutions in
excess of the federally insured limits.
FOREIGN CURRENCY TRANSLATION
The Company uses the U.S. dollar as its functional currency for its Irish
subsidiaries. Financial statements of the Irish subsidiaries are translated to
U.S. dollars for consolidation purposes using current rates of exchange for
monetary assets and liabilities and historical rates of exchange for nonmonetary
assets and related elements of expense. Sales and other expense elements are
translated at rates that approximate the rates in effect on the transaction
dates. Gains and losses from this process are included in the Company's
consolidated statement of operations.
The functional currency of each of the Company's remaining 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.
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
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.
29
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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," and accordingly,
recognizes no compensation expense for the stock option grants.
SFAS No. 123, "Accounting for Awards of Stock-Based Compensation to
Employees," provides alternative accounting treatment to APB Opinion No. 25 with
respect to stock-based compensation and requires certain additional disclosures,
including disclosures if the Company elects not to adopt the accounting
measurement requirements of SFAS No. 123. The Company has elected not to adopt
the accounting measurement requirements of SFAS No. 123 for stock options
granted to employees; however, the Company has provided the required additional
disclosures in the footnotes to the consolidated financial statements.
NET INCOME (LOSS) 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, except
that, pursuant to the Securities and Exchange Commission Staff Accounting
Bulletins, common and common equivalent shares, issued at prices below the
public offering price during the twelve months immediately preceding the initial
filing date of the Company's initial public offering have been included in the
calculation as if they were outstanding for all periods presented, using the
treasury stock method and the initial public offering price. The net income
(loss) attributable to common stockholders excludes the impact of approximately
$192,000 and $21,000 for the years ended December 31, 1995 and 1994,
respectively, which represents the preferred stock dividend on redeemable
convertible preferred stock issued within the twelve-month period immediately
preceding the initial filing (2,044,000 shares) as these shares were included in
the determination of the number of shares used in the per share calculations.
3. MERGERS AND ACQUISITIONS
RAY DREAM, INC.
On May 24, 1996, the Company acquired Ray Dream, Inc. ("Ray Dream"), a
California corporation which designs, develops and markets 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 three months ended September
30, 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 $1.9 million were recorded during
the three months ended March 31, 1996.
Fractal reported its financial results on a March 31 fiscal year-end basis,
whereas Ray Dream reported its financial results on a December 31 calendar year-
end basis. For the purposes of pooling-of-interests accounting, the balance
sheet of Fractal as of March 31, 1996 was combined with that of Ray Dream as of
December 31, 1995. The statements of operations of Fractal for each of the two
years in the period ended March 31, 1996 were combined with that of Ray Dream
for each of the two years in the period ended December 31, 1995. Accordingly,
Ray Dream's net loss of $519,000 for the three months ended March 31, 1996 has
been reflected as an adjustment to retained earnings
30
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
for the year ended December 31, 1995. The results of operations of Ray Dream for
such three month period include net revenues of $2,980,000.
Separate results of operations for the years ended December 31, 1995 and 1994
are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1995 1994
---------------------------
<S> <C> <C>
Net revenues:
MetaCreations...... $38,511 $22,965
Ray Dream.......... 7,749 5,343
---------------------------
$46,260 $28,308
===========================
Net income (loss):
MetaCreations...... $ 2,424 $ (380)
Ray Dream.......... 2 (73)
---------------------------
$ 2,426 $ (453)
===========================
</TABLE>
DIVE LABORATORIES
On August 31, 1996, the Company acquired Dive Laboratories, Inc. ("Dive"), a
privately held company based in Santa Cruz, California, developing 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, comprised of relocation expenses
of $215,000, acquisition costs of $155,000, and in-process research and
development expenses of $363,000, for the year ended December 31, 1996. 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, developing 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 advanced geometry-based algorithms to accelerate the
display 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):
31
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
(UNAUDITED)
YEAR ENDED
DECEMBER 31,
1996
---------------
<S> <C>
Net revenues.................. $62,936
Net income.................... 4,739
Net income per common share... 0.20
</TABLE>
4. 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, 1996. The cost of the
investment portfolio by type of security, contractual maturity, and its
classification in the balance sheet, is as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1995
----------------------
<S> <C> <C>
Type of security:
Corporate debt securities.............. $24,491 $44,055
Municipal obligations.................. 23,145 23,477
U.S. Treasury securities............... 15,129 149
Money market funds..................... 2,091 8,594
Certificates of deposit................ -- 251
----------------------
$64,856 $76,526
======================
Contractual maturity:
Due in one year or less................ $47,576 $75,494
Due in one to three years.............. 17,280 1,032
----------------------
$64,856 $76,526
======================
Classification in balance sheet:
Cash and cash equivalents.............. $21,605 $54,038
Marketable securities.................. 44,688 23,683
----------------------
66,293 77,721
Less cash.............................. 1,437 1,195
----------------------
$64,856 $76,526
======================
</TABLE>
5. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1995
----------------------
<S> <C> <C>
Finished goods......................... $ 814 $ 952
Materials and supplies................. 698 1,180
----------------------
$ 1,512 $ 2,132
======================
</TABLE>
32
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
---------------------
<S> <C> <C>
Computer equipment...................... $ 5,945 $ 2,942
Office furniture and equipment.......... 1,757 927
Leasehold improvements.................. 659 34
---------------------
8,361 3,903
Less accumulated depreciation and
amortization........................... (2,780) (1,368)
---------------------
$ 5,581 $ 2,535
=====================
</TABLE>
7. ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1995
--------------------
<S> <C> <C>
Accrued compensation........ $2,648 $2,217
Accrued acquisition costs... 790 --
Covenant-not-to-compete..... 600 --
Accrued advertising......... 817 1,044
Other accrued expenses...... 1,572 1,857
--------------------
$6,427 $5,118
====================
</TABLE>
8. RELATED PARTY TRANSACTIONS
In April 1993, the Series A Preferred stockholders, an officer and certain
directors loaned $725,000 to the Company as bridge financing until the Series B
Redeemable Convertible Preferred Stock ("Series B Preferred") financing was
completed in February 1994. The loans were convertible into Series B Preferred
at the same purchase price paid by the other Series B Preferred stockholders, or
the loans would begin accruing interest at 6% per annum until paid. A portion of
the above bridge financing totaling $325,000 was converted into Series B
Preferred at $2.50 per share and the remaining amounts were repaid, including
interest totaling $22,000. Further, each Series B Preferred investor who
converted a loan into shares received Series C Warrants, as described in
Note 10.
Additional officer/stockholder loans in the amount of $137,000 were repaid in
1994.
In 1994, the Company loaned $435,000 to an officer and director of the
Company to relocate his residence, against which he had pledged his stock in the
Company. The loans, consisting of $80,000 at the prime interest rate and
$355,000 at 7% per annum, were repaid during December 1995. Further, the Company
leases space for development activities at this officers residence at a rental
rate of $2,500 per month.
A director of the Company rendered services to the Company for which he
received $44,000, $42,000, and $30,000 in each of 1996, 1995, and 1994.
Businesses owned by two stockholders have provided technical and administrative
services to the Company. Amounts paid to these two firms totaled $229,000 and
$214,000, and $129,000 for the years ended December 31, 1996, 1995, and 1994,
respectively. The Company believes that the terms of the agreements for these
services are no less favorable than could be obtained from third-party
suppliers.
33
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In connection with the acquisition of RTG on December 31, 1996 (Note 3), the
Company entered into a noncompetition agreement with one of RTG's founders who
is now an officer of the Company. The agreement, which carries a term of four
years, provides for payments to the officer in the amount of $450,000 in 1997
and $150,000 in 1998. In addition, the Company loaned $2,000,000 and $1,000,000
to two founders of RTG, who are now officers of the Company. The loans accrue
interest semi-annually at 5.67% and are payable on December 31, 1999. The loans,
which are classified as a component of stockholders' equity, are collateralized
by shares of common stock of the Company owned by the officers.
9. NOTES PAYABLE TO BANK
In September 1994, the Company entered into a credit facility (the "Facility")
with its principal lending institution (the "Bank"); the Facility was
collateralized by substantially all of the Company's assets. The Facility
enabled the Company to borrow up to $500,000 as a Term Loan (the "Term Loan")
for new equipment purchased through March 1995 and also included a Line of
Credit (the "Line") under which borrowings could be made based upon eligible
accounts receivable (as defined), up to aggregate amount of $1 million. The Term
Loan accrued interest at 2% above the Bank's prevailing prime interest rate and
the Line accrued interest at 1.5% above the Bank's prevailing prime interest
rate. Borrowings under both the Term Loan and the Line were repaid in December
1995.
In December 1995, the Company amended its Facility (the "Amended Facility")
with the Bank, increasing available borrowings under the Line to $3 million and
decreasing interest on borrowings under the Line to the Bank's prevailing prime
interest rate. Additionally, the Amended Facility revised the Line to provide
for a $500,000 letter of credit subfacility and a $250,000 foreign exchange
contract subfacility. There were no borrowings against the Line during the year
ended December 31, 1996. In addition, there were no outstanding letters of
credit or foreign exchange contracts at December 31, 1996. The Amended Facility
expires in November 1997, if not renewed. Interest expense for the years ended
December 31, 1995 and 1994 totaled $96,000 and $71,000, respectively. The
weighted average interest rate for the years ended December 31, 1995 and 1994
were 10.8% and 8.6% per annum, respectively.
The Amended 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.
The Company also had a $900,000 line of credit with a bank (the "Bank Line")
bearing interest at 2% per annum above the bank's prime rate. In August 1995,
The Company converted the outstanding balance of $440,000 under the Bank Line to
a demand loan (the "Demand Loan") with a bank. Interest accrued on the loan at a
rate equal to the bank's reference rate plus 1.5%. The Demand Loan was paid in
full in November 1995.
In September 1995, the Company entered into a line of credit agreement (the
"Line of Credit") which provided for borrowings of up to $600,000. The Line of
Credit was renewed in August 1996 and provided for borrowings of up to $500,000
and bore interest equal to the bank's reference rate (8.50% as of December 31,
1996). The line of credit agreement expired in August 1997, and was unsecured.
No amounts were outstanding under this line at December 31, 1996.
In September 1995, the Company borrowed $500,000 from a commercial bank.
Borrowings bore interest at the bank's prime rate plus 0.75% per annum. These
borrowings were repaid in full during the year ended December 31, 1996.
34
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCKHOLDERS' EQUITY
SERIES A CONVERTIBLE PREFERRED STOCK
At December 31, 1994, the Company had authorized 841,000 shares of Series A
Convertible Preferred Stock ("Series A Preferred"), of which 841,000 shares were
issued and outstanding. The Series A Preferred was entitled to noncumulative,
quarterly dividends, if earned and declared, commencing March 1, 1994 at a rate
of $0.0125 per share. The Series A Preferred was convertible into common stock
at the rate of two shares of common stock for each share of preferred stock, had
voting rights equal to its common stock conversion, voted with the common stock
and carried a stated value of $1.00 per share and a liquidation preference of
$1.00 per share, plus any dividends declared and unpaid. During 1995, 841,000
shares of Series A Preferred were converted into 1,682,000 shares of common
stock. No shares of Series A Preferred were authorized at December 31, 1996.
MANDATORILY REDEEMABLE COMMON STOCK
On July 21, 1995, the Company and certain shareholders entered into an
agreement to sell approximately 153,000 and 92,000 shares, respectively, of
common stock to Adobe Ventures, L.P. ("Adobe"), a subsidiary of Adobe Systems,
Inc., for $8.178 per share. Aggregate net proceeds to the Company were
$1,237,000. Upon the closing of the Company's initial public offering, the
mandatory redemption rights of this stock were automatically terminated.
SERIES A AND B WARRANTS
The Company had issued 54,000 Series A and 54,000 Series B Warrants to
purchase common stock. During 1995, 54,000 Series A and 54,000 Series B Warrants
were exercised for the purchase of approximately 105,000 net shares of common
stock at $1.00 per share.
SERIES C WARRANTS
The Company had authorized and issued 510,000 Series C Warrants to purchase
common stock as follows:
. In June 1993 and January 1994, the Company issued 100,000 and 20,000
warrants, respectively, to officers and directors of the Company for
significant contributions relating to development of the Company's
products and obtaining a line of credit.
. In February 1994, the Company issued 130,000 warrants to the Series B
Preferred holders who had converted their bridge loans as discussed in
Note 8.
. In January and September 1994, the Company issued 220,000 and 40,000
warrants, respectively, to a director of the Company as consideration
for his agreement to extend his bridge loan to the Company and for the
subordination of such loan in favor of notes payable to a bank (Note 8).
During 1995, 510,000 Series C Warrants were exercised for the purchase of
approximately 482,000 net shares of common stock at $1.00 per share.
OTHER WARRANTS
In September 1994, the Company issued 30,000 warrants to a bank to purchase
shares of Series B Preferred at a purchase price of $2.50 per share. During
1995, 30,000 warrants were exercised for the purchase of approximately 26,000
net shares of common stock at $2.50 per share.
35
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 agreed to pay a total of $400,000 in
advances against product purchases of which $50,000 is included in other assets
as of December 31, 1996. The Company will pay for product purchases at a rate
of 14% of net revenues (as defined) subject to adjustments for certain events.
Such payments may be offset against advances at a rate of 50%. 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. Of the total value of these
warrants, $185,000 and $163,000 was recognized as research and development
expense during the years ended December 31, 1996 and 1995, respectively. This
warrant was exercised during the three months ended September 30, 1996, on a
net basis, for approximately 134,000 shares of common stock (see Note 3).
11. 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, 1996, approximately 8,000 shares of common stock have
been issued under the 1995 Purchase Plan. At December 31, 1996, an aggregate of
approximately 142,000 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 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 did not
make any contributions to the 401(k) Plan during the years ended December 31,
1996 and 1995.
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, 1996, options to purchase an
aggregate of 718,000 shares of common stock were outstanding under the 1992
Plan, with vesting provisions ranging up to five years. At December 31, 1996, no
shares of common stock were reserved for additional grants of options or awards
of restricted stock under the 1992 Plan.
36
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. As of December 31, 1996,
options to purchase an aggregate of 644,000 shares of common stock were
outstanding under the 1994 Plan. At December 31, 1996, 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, 1996, options to purchase an aggregate of 430,000 shares of
common stock have been granted under the 1995 Plan, with vesting provisions
ranging up to four years. At December 31, 1996, an aggregate of 70,000
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. As of December 31, 1996, 15,000 options have
been granted under the 1995 Director Plan. At December 31, 1996, an aggregate of
135,000 shares of common stock were reserved for future issuance under the 1995
Director Plan.
1996 Dive Option Plan
In connection with the acquisition of Dive in August 1996 (Note 3), 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 Option
Plan"). The non-statutory stock options vest over four years. At December 31,
1996, no shares of common stock were reserved for future issuance under the Dive
Option 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, 1996, options to purchase an aggregate of 1,099,000
shares of common stock have been granted under the 1996 Nonstatutory Plan, with
vesting provisions ranging up to four years. At December 31, 1996, an aggregate
of 201,000 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. Upon
consummation of the merger, no shares of common stock were reserved for
issuance under the Fractal Plans.
37
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Common Stock Issued Under Plans
In 1994, 28,000 shares of common stock were issued at $0.065 per share and
100,000 shares were repurchased at prices ranging from $0.025 to $0.065 per
share (original issuance prices). The above issuances of common stock were in
exchange for services rendered by employees.
In addition, in January 1994 the Company issued 500 shares of common stock at
$0.50 per share outside the Stock Option Plans in exchange for services
rendered.
Options Issued Under Plans
The Company has adopted the disclosure-only option under SFAS No. 123,
"Accounting for Stock Based Compensation," as of December 31, 1996. The
following summarizes activity in the Plans for the years ended December 31,
1994, 1995, and 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------
OPTIONS WEIGHTED
AVAILABLE FOR NUMBER OF AVERAGE
GRANT SHARES EXERCISE PRICE
-----------------------------------------------
<S> <C> <C> <C>
Options outstanding at December 31,
1993................................... 1,025 397 $ 0.64
Shares reserved under new plans......... 2,358 -- --
Grantedexercise price equal to fair
value.................................. (1,720) 1,720 1.17
Exercised............................... -- (9) 0.47
Canceled................................ 546 (546) 1.34
-----------------------------------------------
Options outstanding at December 31,
1994................................... 2,209 1,562 0.95
Shares reserved under new plans......... 921 -- --
Reduction in shares reserved under
plans.................................. (358) -- --
Grantedexercise price equal to fair
value.................................. (1,526) 1,526 5.94
Grantedexercise price greater than fair
value.................................. (29) 29 4.27
Grantedexercise price less than fair
value.................................. (76) 76 1.68
Exercised............................... -- (55) 0.69
Canceled................................ 158 (158) 2.09
-----------------------------------------------
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
Grantedexercise 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
===============================================
</TABLE>
38
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following summarizes the weighted average fair value of options granted
during the years ended December 31, 1996 and 1995:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------
1996 1995
----------------
<S> <C> <C>
Exercise price equal to fair value...... $10.19 $3.79
Exercise price greater than fair value.. 7.71 2.35
Exercise price less than fair value..... -- 5.15
</TABLE>
The following summarizes information about stock options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
--------------------------------- -------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AVERAGE EXERCISE EXERCISE
EXERCISE PRICE RANGE SHARES LIFE(A) PRICE SHARES PRICE
------------------------------------------------------------ -------------------
<S> <C> <C> <C> <C> <C>
$0.08--$1.00............. 787 7.57 $ 0.94 473 $ 0.95
$1.10--$10.68............ 1,442 5.98 3.46 430 4.19
$11.75--$12.50........... 1,031 9.79 12.29 42 12.02
$13.75--$25.13........... 1,226 9.22 17.07 91 17.13
--------------------------------- -------------------
Total.................. 4,486 8.02 $ 8.78 1,036 $ 4.17
================================= ===================
</TABLE>
(a) Average contractual life remaining in years.
The Company has 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 3) in December 1996.
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 years ended December 31, 1996 and 1995, the Company recognized
approximately $190,000 and $159,000 of compensation expense relating to these
options, respectively.
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 the Statement. 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 for both
1995 and 1996: risk-free interest rate of 6.0%, no dividend yield, volatility
factor of the expected market price of the Company's common stock of between 70%
and 80%, and a weighted-average expected life of the options of between 4.3 and
4.4 years. 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, net loss applicable to common stockholders, and
net loss per common share would approximate the following (in thousands, except
per share amounts):
<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
---------------------------
<S> <C> <C>
Year Ended December 31, 1996:
Net loss................................ $(7,650) $(9,938)
Net loss applicable to common
stockholders........................... (7,650) (9,938)
Net loss per common share............... (0.37) (0.48)
</TABLE>
39
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
-------------------------------
<S> <C> <C>
Year Ended December 31, 1995:
Net income.............................. $2,426 $2,071
Net income applicable to common
stockholders............................ 2,337 1,982
Net income per common share............. 0.15 0.13
</TABLE>
The effects of applying SFAS No. 123 in this proforma disclosure are not
indicative of future amounts. SFAS No. 123 does not apply to awards prior to
1995. The Company anticipates grants of additional awards in future years.
12. REDEEMABLE CONVERTIBLE PREFERRED STOCK
At December 31, 1994, the Company had authorized 3,600,000 shares of Series B
Preferred, of which 3,390,000 shares were issued and outstanding. The Series B
Preferred accrued cumulative, quarterly dividends, whether or not earned or
declared, commencing March 1, 1994 at a rate of $0.03125 per share. The Series B
Preferred was convertible into common stock of the Company at a conversion rate
of one share of common stock for each share of preferred, had voting rights
equal to its common stock conversion, voted with the common stock and carried a
stated value of $2.50 per share and a liquidation preference of $2.50 per share
plus any accrued and unpaid dividends, whether or not declared. At the option of
the majority of the holders of the Series B Preferred, the Series B Preferred
was redeemable by the Company based on certain dates and terms. The Company
recorded an increase in the value of the Series B Preferred of $89,000 and
$99,000 for December 31, 1995 and 1994, respectively, for the amortization of
costs related to the issuance of the Series B Preferred. In addition, the
Company recorded an increase in the value of the Series B Preferred of $140,000
for December 31, 1994, for accrued and unpaid dividends, which subsequently
reversed in 1995 upon the conversion of 3,390,000 shares of Series B Preferred
into 3,390,000 shares of common stock. No shares of Series B Preferred were
authorized at December 31, 1995.
In September and November 1994, the Company issued approximately 792,000
shares of mandatorily redeemable convertible preferred stock (the "Preferred
Stock") for $2.67 per share. Proceeds to the Company totaled $2,072,000, net of
issuance costs. The Preferred Stock was redeemable at the option of the holders
of at least two thirds of the outstanding Preferred Stock in three annual
installments at a price equal to the sum of $2.67 per share plus $0.16 per annum
from the date of issuance subject to adjustment for antidilution. The excess of
the redemption price over the original issuance price of the Preferred Stock was
charged to retained earnings as an accretion to redemption value with a
corresponding increase in the value of the Preferred Stock. Upon the closing of
the Company's initial public offering, the Preferred Stock was converted into
common stock and the aggregate balance of the Preferred Stock of $2,204,000 at
that date was credited to additional paid-in capital.
In connection with the issuance of Preferred Stock, the Company issued
warrants to purchase approximately 40,000 shares of common stock at an exercise
price of $2.67 per share. The warrants were exercisable for a period of five
years after date of issuance. The warrants expired upon the consummation of the
Company's initial public offering. A total of approximately 40,000 shares of
common stock were issued upon conversion of the warrants.
40
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. INCOME TAXES
The components of the provision for income taxes for the years ended December
31, 1996, 1995, and 1994 are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
----------------------------
<S> <C> <C> <C>
Current:
Federal................................. $ 2,593 $1,867 $ 846
State................................... 984 527 472
Foreign................................. -- 16 18
----------------------------
Total current........................... 3,577 2,410 1,336
Deferred:
Federal................................. (1,233) (513) (679)
State................................... (128) (70) (184)
----------------------------
Total deferred.......................... (1,361) (583) (863)
----------------------------
$ 2,216 $1,827 $ 473
============================
</TABLE>
The differences between the Company's effective income tax rate and the United
States statutory rate are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
----------------------------
<S> <C> <C> <C>
Federal tax benefit at the statutory
rate.................................. (34.0)% 34.0% 34.0%
State income taxes, net of Federal
income tax benefit.................... 8.8 7.3 1,026.7
Foreign income taxes................... -- 1.2 468.7
Nondeductible acquisition costs........ 94.3
Nondeductible expenses................. 2.7 0.1 1,247.5
Change in valuation reserve............ (29.0) (0.9) (3,035.5)
Net operating loss and tax credit
carryforwards......................... (2.0) 1.3 2,623.6
----------------------------
40.8 % 43.0% 2,365.0%
============================
</TABLE>
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):
41
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
---------------------
<S> <C> <C>
Deferred tax assets:
Allowance for returns and doubtful
accounts............................... $ 1,864 $ 1,180
Inventory reserves...................... 244 428
Accrued expenses........................ 863 1,332
State income taxes...................... 136 371
Tax credit carryforwards................ 80 234
Net operating loss carryforwards........ 904 617
------------------
4,091 4,162
Valuation allowance..................... (1,264) (2,612)
------------------
Net deferred tax assets............... 2,827 1,550
Deferred tax liabilities:
Depreciation and amortization........... (20) (104)
------------------
Net deferred tax liabilities.......... (20) (104)
------------------
Net deferred taxes.................... $ 2,807 $ 1,446
==================
</TABLE>
The net change in the valuation allowance for deferred taxes during the year
ended December 31, 1996 was a reduction of approximately $1,348,000 as a result
of the recognition of a Federal deferred tax asset. The Company's management
believes a valuation allowance is required for the net operating losses of RTG
due to potential limitations on the Company's ability to utilize the loss
carryforwards pursuant to the ownership rule changes of the Internal Revenue
Code, Section 382. The valuation allowance increased by approximately $146,000
in 1995 as a result of the increase in current temporary differences, offset by
changes in the net operating loss carryforwards.
At December 31, 1996, the Company has net operating loss carryforwards of
approximately $2,658,000 for federal income tax purposes, which begin expiring
in 2011. The Company's net operating loss carryforwards relate to the Company's
acquisition of RTG and Ray Dream (Note 3). Additionally, the Company has a
federal tax credit carryforward relating to Ray Dream of approximately $80,000,
which expires in 2011. The net operating loss and federal tax credit
carryforwards, may be used to offset future taxable income from the related
subsidiaries.
14. COMMITMENTS
Through September 1994, the Company leased office space in Santa Monica,
California. This lease was terminated in September 1994, at which time the
Company relocated its facilities to Carpinteria, California. The Company entered
into a lease agreement for office space in Carpinteria, which expires in
December 1998, if not renewed. In addition, the Company 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 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. Additionally, effective December 1, 1998, the lease agreement
for the Scotts Valley facility requires the Company to assume additional office
space.
The Company also leases certain equipment and three vehicles for officers of
the Company with lease terms of three to five years. Rent expense for office
space, equipment, and vehicles amounted to approximately $972,000, $765,000 and
$423,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
42
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Future minimum lease payments under non-cancelable operating leases for
each twelve-month period subsequent to December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997................ $1,129
1998................ 1,169
1999................ 714
2000................ 585
2001................ 566
Thereafter.......... 802
------
$4,965
======
</TABLE>
15. 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 effect on the Company's consolidated financial position, results of
operations, or cash flows.
16. INDUSTRY AND GEOGRAPHIC AREA SEGMENT INFORMATION
The Company operates in one industry segment, prepackaged software. The
Company designs, develops, publishes, markets and supports visual computing
software tools and technologies for the creation, editing, and manipulation of
computer graphic images, digital art, and Internet/online content.
Substantially all of the Company's international revenues were export sales
from the Company's United States operations. Net revenues by geographic area for
the years ended December 31, 1996, 1995, and 1994 are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1996 1995 1994
------------------------------
<S> <C> <C> <C>
United States... $37,377 $28,651 $21,632
Pacific Rim..... 14,248 9,984 3,526
Europe.......... 10,689 6,896 2,990
Rest of world... 622 729 160
-----------------------------
$62,936 $46,260 $28,308
=============================
</TABLE>
17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Summarized quarterly financial information for fiscal years 1996 and 1995, are
as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------------------------------------------------
<S> <C> <C> <C> <C>
Fiscal year 1996:
Net revenues.................. $13,983 $14,854 $18,175 $ 15,924
Gross profit.................. 11,290 12,136 14,891 12,942
Net income (loss)............. 275 1,760 2,785 (12,470)
Net income (loss) per share... 0.01 0.08 0.12 (0.60)
</TABLE>
43
<PAGE>
METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------------------------------------------------
<S> <C> <C> <C> <C>
Fiscal year 1995:
Net revenues.................. $9,464 $10,298 $12,255 $14,243
Gross profit.................. 7,141 7,808 9,788 11,442
Net income (loss)............. 149 (211) 857 1,631
Net income (loss) per share... 0.01 (0.02) 0.05 0.09
</TABLE>
The net loss incurred for the quarter ended December 31, 1996 resulted from
the write-off of acquired in-process technology and other costs related to the
acquisition of RTG (Note 3).
44
<PAGE>
(c) Exhibits
<TABLE>
<CAPTION>
Exhibit Number Exhibit Title
-------------- -------------
<S> <C>
2.1 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. (1)
2.2 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. (2)
2.3 Certificate of Amendment of Restated Certificate
of Incorporation of MetaTools, Inc. (2)
2.4 Specimen Common Stock Certificate of Registrant.
(2)
11.1 Statement Regarding Computations of Net Income
(Loss) per Common Share
23.1 Consent of Coopers & Lybrand L.L.P., Independent
Accountants
23.2 Consent of Price Waterhouse L.L.P., Independent
Accountants
---------------------
</TABLE>
(1) Incorporated by reference to the Company's Registration Statement on Form
S-4 (File No. 333-25939), filed with the Securities and Exchange
Commission on or about April 28, 1997.
(2) Incorporated by reference to the Company's Current Report on Form 8-K,
filed with the Securities and Exchange Commission on or about June 13,
1997.
45
<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: August 12, 1997 /s/TERANCE A. KINNINGER
-----------------------
Terance A. Kinninger
Sr. Vice President and
Chief Financial Officer
46
<PAGE>
EXHIBIT 11.1
METACREATIONS CORPORATION
STATEMENT REGARDING COMPUTATION OF
NET INCOME (LOSS) PER COMMON SHARE
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------
1996 1995 1994
-----------------------------
<S> <C> <C> <C>
PRIMARY AND FULLY DILUTED (1)
Weighted average shares outstanding for
the period............................. 20,590 10,620 9,107
Common equivalent shares, including
items pursuant to Staff Accounting
Bulletin No. 83........................ -- 4,647 2,477
-----------------------------
Shares used in per share calculation.... 20,590 15,267 11,584
=============================
Net income (loss) before preferred
stock dividend requirement and
amortization of issuance costs......... $(7,650) $ 2,426 $ (453)
Preferred stock dividend requirements
and amortization of issuance costs..... -- (89) (239)
-----------------------------
Net income (loss) available for common
stockholders........................... $(7,650) $ 2,337 $ (692)
=============================
Net income (loss) per common share...... $ (0.37) $0.15 $(0.06)
=============================
</TABLE>
(1) Primary and fully diluted calculations are substantially the same.
<PAGE>
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 and 333-28403) of our report dated February 3,
1997, except for Note 1 as to which the date is May 29, 1997, on our audits of
the consolidated financial statements of MetaCreations Corporation as of
December 31, 1996 and 1994, and for the years ended December 31, 1996, 1995 and
1994, which report is included in this Current Report on Form 8-K/A.
COOPERS & LYBRAND L.L.P.
Sherman Oaks, California
August 8, 1997
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 of MetaCreations Corporation (Registration Nos. 333-3070,
333-17209, 333-20939, 333-26557, and 333-28403) of our report dated April 30,
1997, except as to Note 11, which is as of May 29, 1997, relating to the
consolidated financial statements of Fractal Design Corporation, which appears
in the Current Report on Form 8-K/A of MetaCreations Corporation.
PRICE WATERHOUSE LLP
San Jose, California
August 11, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY OF 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>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 21,605
<SECURITIES> 44,688
<RECEIVABLES> 21,208
<ALLOWANCES> 4,589
<INVENTORY> 1,512
<CURRENT-ASSETS> 91,077
<PP&E> 8,361
<DEPRECIATION> 2,780
<TOTAL-ASSETS> 97,935
<CURRENT-LIABILITIES> 11,823
<BONDS> 0
0
0
<COMMON> 22
<OTHER-SE> 86,090
<TOTAL-LIABILITY-AND-EQUITY> 97,935
<SALES> 62,936
<TOTAL-REVENUES> 62,936
<CGS> 11,677
<TOTAL-COSTS> 11,677
<OTHER-EXPENSES> 60,090
<LOSS-PROVISION> 597
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (5,434)
<INCOME-TAX> 2,216
<INCOME-CONTINUING> (7,650)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,650)
<EPS-PRIMARY> (0.37)
<EPS-DILUTED> (0.37)
</TABLE>
