<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the quarterly period ended September 30, 1998
or
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the transition period from ________ to_______.
Commission file number 0-27168
METACREATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-4102687
(State of incorporation) (I.R.S. Employer
Identification Number)
6303 Carpinteria Ave, Carpinteria, CA 93013
(Address of principal executive offices)
(805) 566-6200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
As of November 9, 1998, there were outstanding 23,912,345 shares of the
registrant's Common Stock, $0.001 par value per share, which is the only
outstanding class of common or voting stock of the registrant.
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METACREATIONS CORPORATION
FORM 10-Q
Table of Contents
<TABLE>
<CAPTION>
Page
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................ 3
Consolidated Balance Sheets - September 30, 1998 and
December 31, 1997
Consolidated Statements of Operations - Three and
nine month periods ended September 30, 1998 and
1997
Consolidated Statements of Cash Flows - Three and
nine month periods ended September 30, 1998 and
1997
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................. 10
PART II. OTHER INFORMATION
Item 2. Changes in Securities........................................... 25
Item 6. Exhibits and Reports on Form 8-K................................ 26
SIGNATURES ................................................................ 27
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
METACREATIONS CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
----------- ---------
(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 9,069 $ 9,653
Short-term investments ..................................................... 40,525 40,349
Accounts receivable, net ................................................... 11,900 26,604
Inventories ................................................................ 711 1,667
Income taxes receivable .................................................... 3,410 3,324
Deferred income taxes ...................................................... 2,634 2,634
Prepaid expenses ........................................................... 3,830 3,494
--------- ---------
Total current assets .................................................. 72,079 87,725
Property and equipment, net ................................................... 7,237 7,577
Other assets .................................................................. 1,463 1,988
========= =========
Total assets .......................................................... $ 80,779 $ 97,290
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................... $ 3,958 $ 4,860
Accrued expenses ........................................................... 3,239 3,971
Royalties payable .......................................................... 1,100 1,217
--------- ---------
Total current liabilities ............................................. 8,297 10,048
Stockholders' equity:
Preferred stock, $.001 par value, 5,000 shares authorized - no shares issued
and outstanding at September 30, 1998 and December 31, 1997,
respectively ............................................................ -- --
Common stock, $.001 par value; 75,000 shares authorized - 23,903 and 23,606
shares issued and outstanding at September 30, 1998 and
December 31, 1997, respectively ......................................... 24 24
Paid-in capital ............................................................ 111,420 109,896
Notes receivable from stockholders ......................................... (3,297) (3,170)
Cumulative translation adjustment .......................................... (124) (135)
Accumulated deficit ........................................................ (35,541) (19,373)
--------- ---------
Total stockholders' equity ............................................ 72,482 87,242
--------- ---------
Total liabilities and stockholders' equity ............................ $ 80,779 $ 97,290
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 4
METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues ...................................... $ 9,053 $ 21,008 $ 31,491 $ 53,009
Cost of revenues .................................. 1,544 3,023 5,437 9,254
-------- -------- -------- --------
Gross profit ...................................... 7,509 17,985 26,054 43,755
Operating expenses:
Sales and marketing ............................ 5,848 8,272 22,300 24,153
Research and development ....................... 3,665 3,713 12,314 10,333
General and administrative ..................... 1,581 1,603 5,025 4,644
Costs associated with the write-off of acquired
in-process technology, restructuring
and mergers .................................. -- -- 4,955 16,185
-------- -------- -------- --------
Total operating expenses .......................... 11,094 13,588 44,594 55,315
-------- -------- -------- --------
Income (loss) from operations ..................... (3,585) 4,397 (18,540) (11,560)
Interest and investment income, net ............... 633 827 2,019 2,416
-------- -------- -------- --------
Income (loss) before provision (benefit) for income
taxes .......................................... (2,952) 5,224 (16,521) (9,144)
Provision (benefit) for income taxes .............. -- 1,619 (353) 37
-------- -------- -------- --------
Net income (loss) ................................. $ (2,952) $ 3,605 $(16,168) $ (9,181)
======== ======== ======== ========
Net income (loss) per common share:
Basic ........................................... $ (0.12) $ 0.16 $ (0.68) $ (0.40)
======== ======== ======== ========
Diluted ......................................... $ (0.12) $ 0.15 $ (0.68) $ (0.40)
======== ======== ======== ========
Weighted average number of shares outstanding:
Basic .......................................... 23,837 23,175 23,732 22,757
======== ======== ======== ========
Diluted ........................................ 23,837 24,853 23,732 22,757
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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METACREATIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss .................................................................... $(16,168) $ (9,181)
Adjustment to retained earnings as a result of business combination ......... -- 513
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Non-cash restructuring costs ........................................... 2,919 --
Write-off of acquired in-process technology ............................ -- 5,575
Depreciation and amortization .......................................... 2,962 1,822
Provision for losses on product returns and receivables ................ 9,902 3,354
Provision for losses on inventory ...................................... 592 445
Accrued interest income ................................................ (127) (127)
Changes in operating assets and liabilities:
Accounts receivable ................................................. 3,930 (12,038)
Inventories ......................................................... (71) (459)
Income taxes receivable ............................................. 298 (746)
Prepaid expenses and other assets ................................... (1,221) 1,207
Accounts payable and accrued expenses ............................... (1,230) (1,543)
Royalties payable ................................................... (117) 442
-------- --------
Net cash provided by (used in) operating activities ............... 1,669 (10,736)
Cash flows from investing activities:
Purchases of short-term investments ......................................... (53,714) (37,079)
Proceeds from sales and maturities of short-term investments ................ 53,538 40,894
Purchases of property and equipment ......................................... (2,103) (2,929)
Purchases of software technology and product rights ......................... (721) (110)
Payments in connection with acquisition ..................................... -- (1,233)
-------- --------
Net cash used in investing activities ............................. (3,000) (457)
Cash flows from financing activities:
Repayment of notes payable .................................................. -- (274)
Proceeds from exercise of stock options ..................................... 736 1,239
-------- --------
Net cash provided by financing activities ......................... 736 965
Effect of exchange rates changes on cash ....................................... 11 32
-------- --------
Net decrease in cash and cash equivalents ...................................... (584) (10,196)
Cash and cash equivalents at beginning of period ............................... 9,653 21,605
-------- --------
Cash and cash equivalents at end of period ..................................... $ 9,069 $ 11,409
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
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METACREATIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements include the
accounts of MetaCreations Corporation and its wholly-owned subsidiaries
(collectively "MetaCreations" or the "Company"). All significant intercompany
accounts and transactions have been eliminated in consolidation.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statement presentation. In the opinion of management, the accompanying
consolidated balance sheets and related interim consolidated statements of
operations and cash flows include all adjustments (consisting only of normal
recurring items) considered necessary for their fair presentation. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses.
Actual results could differ from those estimates. The consolidated results of
operations for the period ended September 30, 1998 are not necessarily
indicative of results to be expected for the year ending December 31, 1998. The
information included in this Form 10-Q should be read in conjunction with the
Company's audited consolidated financial statements and notes thereto as of
December 31, 1997 and 1996, and for the three years in the period ended December
31, 1997, as filed on Form 10-K.
Revenue Recognition
During the three months ended March 31, 1998, the Company adopted Statement of
Position ("SOP") 97-2, "Software Revenue Recognition," which superceded SOP
91-1. SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements (e.g., software products, upgrades/enhancements,
postcontract customer support, etc.) to be allocated to each element based on
the relative fair value of the elements. The fair value of an element must be
based on evidence which is specific to the Company. The revenue allocated to
software products (including specified upgrades/enhancements) generally is
recognized upon delivery of the products. The revenue allocated to postcontract
customer support generally is recognized ratably over the term of the support.
If the Company does not have evidence of the fair value for all elements in a
multiple-element arrangement, all revenue from the arrangement is deferred until
such evidence exists or until all elements are delivered. The impact of adopting
SOP 97-2 was not material to the Company's financial position, results of
operations or cash flows.
The Company provides an allowance for estimated returns at the time of product
shipments and adjusts this allowance as needed based on actual return history.
Such reserves as a percentage of net revenues have varied over recent years,
reflecting the Company's experience in product returns as it has significantly
expanded the proportion of its sales through third-party distribution
6
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METACREATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
channels and increased its product portfolio. The Company expects reserves will
continue to vary in the future. The Company's agreements with its distributors
generally provide the distributors with limited rights to return unsold
inventories under a stock balancing program. The Company monitors the activities
of its distributors in an effort to minimize excessive returns and establishes
its reserves based on its estimates of expected returns.
Comprehensive Income
During the three months ended March 31, 1998, the Company adopted Statement of
Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. Comprehensive income is defined as the change in equity of
a business enterprise during a period from transactions and other events and
circumstances from nonowner sources. Differences between comprehensive income
and net income were not material to the Company's financial position, results of
operations or cash flows for the three and nine months ended September 30, 1998
and 1997.
Statement of Financial Accounting Standards Not Yet Adopted
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 requires publicly-held companies to report financial and other information
about key revenue-producing segments of the entity for which such information is
available and is utilized by the chief operating decision maker. Specific
information to be reported for individual segments includes profit or loss,
certain revenue and expense items and total assets. A reconciliation of segment
financial information to amounts reported in the financial statements would be
provided. SFAS No. 131 requires companies to adopt its provisions for fiscal
years beginning after December 15, 1997, but does not require that segment
information be reported in financial statements for interim periods in the
initial year of application. Management is currently evaluating the requirements
of adopting SFAS No. 131 and the effects, if any, on the Company's current
reporting and disclosures.
2. RESTRUCTURING
On June 30, 1998, the Company announced a restructuring plan aimed at reducing
costs and improving competitiveness, which was implemented during the quarter
ended September 30, 1998. In connection with the restructuring, management
considered the Company's future operating costs and levels of revenue in 1998
and beyond, and determined that a restructuring charge of approximately $5.0
million was required to cover the costs of reducing certain sectors of its
workforce and facilities. The restructuring charge included an accrual of
approximately $2.0 million related to severance and benefits associated with the
reduction of approximately 75 positions during July 1998, as well as the related
reduction of certain of the Company's facilities. Non-cash restructuring costs,
which totaled approximately $3.0 million, primarily related to the write-down of
non-strategic business assets made redundant or obsolete due to the streamlining
of the Company's product lines and/or reduction of facilities. The Company
expects completion of the restructuring plan during the remainder of 1998.
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METACREATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The following table depicts the restructuring activity through September 30,
1998 (in thousands):
<TABLE>
<CAPTION>
TOTAL
RESTRUCTURING BALANCE AT
CHARGES SPENDING / CHARGES SEPTEMBER 30, 1998
--------------- ------------------ ------------------
<S> <C> <C> <C>
Write-down of operating assets.................... $ 2,919 $ 2,919 $ --
Severance and benefits............................ 1,640 1,322 318
Vacated facilities................................ 131 66 65
Other............................................. 265 206 59
--------------- --------------- ---------------
$ 4,955 $ 4,513 $ 442
=============== =============== ===============
</TABLE>
3. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
--------------- ---------------
<S> <C> <C>
Finished goods......................................................... $ 655 $ 1,465
Materials and supplies................................................. 56 202
--------------- ---------------
$ 711 $ 1,667
=============== ===============
</TABLE>
4. INCOME TAXES
Based upon a review of the Company's deferred income tax assets, available tax
carrybacks, recent quarterly losses, and expected future taxable income, the
Company did not record a benefit for income taxes for the three months ended
September 30, 1998. Management believes that it is more likely than not that any
additional income tax benefit would not be realized at this point in time. The
benefits for income taxes for the three and nine months ended September 30, 1997
were based on the Company's estimated annualized effective tax rate for the
year, after giving effect to the utilization of available tax credits and tax
planning opportunities.
8
<PAGE> 9
METACREATIONS CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
5. LOSS PER SHARE
The following table provides a reconciliation of the numerators and denominators
of the basic and diluted per-share computations for the three and nine months
ended September 30, 1998 and 1997 in accordance with SFAS No. 128, "Earnings per
Share" (in thousands, except per share amounts):
<TABLE>
<CAPTION>
LOSS SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
---------- ------------ ---------
<S> <C> <C> <C>
Three Months Ended:
September 30, 1998:
Basic EPS ................... $ (2,952) 23,837 $(0.12)
Effect of dilutive securities -- --
-------- --------
Diluted EPS ................. $ (2,952) 23,837 $(0.12)
======== ========
September 30, 1997:
Basic EPS ................... $ 3,605 23,175 $ 0.16
Effect of dilutive securities -- 1,678
-------- --------
Diluted EPS ................. $ 3,605 24,853 $ 0.15
======== ========
Nine Months Ended:
September 30, 1998:
Basic EPS ................... $(16,168) 23,732 $(0.68)
Effect of dilutive securities -- --
-------- --------
Diluted EPS ................. $(16,168) 23,732 $(0.68)
======== ========
September 30, 1997:
Basic EPS ................... $ (9,181) 22,757 $(0.40)
Effect of dilutive securities -- --
-------- --------
Diluted EPS ................. $ (9,181) 22,757 $(0.40)
======== ========
</TABLE>
The computation of the diluted number of shares excludes unexercised stock
options which are anti-dilutive. Stock options to purchase 6,992,000 and
5,684,000 shares of common stock were outstanding as of September 30, 1998 and
1997, respectively. The stock options outstanding at September 30, 1998 were
excluded from the three and nine month computation while the stock options
outstanding at September 30, 1997 were excluded from the nine month computation.
9
<PAGE> 10
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the unaudited
consolidated financial statements and notes thereto.
The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, actual results could differ materially from those expressed
or forecasted in any such forward-looking statements as a result of certain
factors, including those set forth in "Factors That May Affect Future Operating
Results," as well as those discussed elsewhere in the Company's SEC reports,
including the Company's audited consolidated financial statements and notes
thereto as of December 31, 1997 and 1996, and for the three years in the period
ended December 31, 1997, as filed on Form 10-K. In connection with
forward-looking statements which appear in these disclosures, investors should
carefully review the factors set forth in this Form 10-Q under "Factors That May
Affect Future Operating Results."
OVERVIEW
MetaCreations was formed in May 1997, as a result of the merger of MetaTools,
Inc. and Fractal Design Corporation ("Fractal"), and included the acquisitions
of Real Time Geometry Corp. in December 1996 and Specular International. Ltd. in
April 1997, as well as the previous merger of Fractal and Ray Dream, Inc. in May
1996. The financial results for the nine months ended September 30, 1997 include
the pooled financial statements of MetaTools, Inc. and Fractal Design
Corporation.
Net revenues decreased during the three months ended September 30, 1998 as a
result of lower than expected demand in the domestic retail channels, weak
demand in Japan, and lower OEM and licensing revenues. On June 30, 1998, the
Company announced a restructuring plan aimed at reducing costs and improving
competitiveness, which was implemented during the quarter ended September 30,
1998. In connection with the restructuring, the Company recorded a one-time
charge to earnings of approximately $5.0 million to cover the costs of reducing
certain sectors of its workforce and facilities to levels more appropriate to
current business requirements. As a result of the restructuring programs, the
Company reduced operating expenses by approximately $3.5 million, or 24%,
compared to the second quarter of 1998.
The Company's future revenues continue to be substantially dependent upon the
continued market acceptance of the Company's existing leading products: Bryce,
Dance Studio, Infini-D, Kai's Photo Soap, Kai's Super GOO, Kai's Power SHOW,
Kai's Power Tools, Painter, Poser, and Ray Dream Studio. In this regard, revenue
from the sale of these products represented a substantial majority of net
revenues during the three and nine months ended September 30, 1998.
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<PAGE> 11
The Company also has a number of new product development efforts under way, and
a significant portion of future revenues is dependent upon the timely
introduction and ultimate success of these products.
The Company develops substantially all of its products either internally or
occasionally through co-development arrangements with third parties. These
co-development arrangements generally provide the Company with certain exclusive
proprietary, copyright or marketing rights for developed products in exchange
for the payment of one-time and/or ongoing royalties. The Company expects to
continue fostering arrangements with external developers as part of its strategy
of expanding its product portfolio. There can be no assurance, however, that the
Company will be able to continue to supplement its product development efforts
in the future through such relationships.
The Company sells its products primarily to domestic and international
distributors, including mail order resellers and retail outlets. The Company
also sells its products to Original Equipment Manufacturers ("OEMs") for
bundling with their hardware or software products and directly to end users,
generally through telesales and direct mail campaigns. Fluctuations in
distributor purchases can cause significant volatility in the Company's
revenues. Distributors generally stock the Company's products at levels which
may fluctuate significantly for a variety of reasons, including the
distributors' ability to finance the purchase of products and to devote shelf
space, catalog space or attention to the products. Distributor purchases may
also be affected by the Company's introduction of a new product or new version
of a product, the Company's end user promotions programs, anticipated product
price increases, the Company's purchases of display space at retail outlets and
other factors. Further, OEM agreements, which generally provide for minimum
guaranteed non-refundable payments to the Company, typically coincide with the
planned introduction of OEM bundled products and are often entered into at the
end of the quarter. The timing of the execution of such agreements can fluctuate
substantially throughout the year, causing volatility in the Company's revenues,
operating results, and cash flows.
Since its inception, the Company has focused on building its product portfolio
and establishing brandname awareness of its products. These activities have
resulted in significant increases in all expense categories. The Company's
recent product development efforts have also entailed significant research and
development expenditures. Higher operating expenses, combined with costs
associated with periodic restructurings, mergers, and acquisitions, including
the related write-off of acquired in-process technology, and quarterly
fluctuations in net revenues, have contributed to the Company's periodic annual
and quarterly losses, as well as fluctuations in its operating results. The
Company intends to continue to invest significant amounts in developing new
markets for its products, as well as maintaining and enhancing brand awareness,
and accordingly, may continue to experience losses and volatility of net
revenues and operating results in future periods.
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OPERATING RESULTS
The following table sets forth certain selected financial information expressed
as a percentage of net revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net revenues ............................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues ........................... 17.1 14.4 17.3 17.5
------ ------ ------ ------
Gross margin ............................ 82.9 85.6 82.7 82.5
Operating expenses:
Sales and marketing ........................ 64.6 39.4 70.8 45.6
Research and development ................... 40.5 17.7 39.1 19.5
General and administrative ................. 17.4 7.6 16.0 8.8
Write-off of acquired in-process technology,
restructuring and mergers ............... -- -- 15.7 30.5
------ ------ ------ ------
Total operating expenses .............. 122.5 64.7 141.6 104.4
------ ------ ------ ------
Income (loss) from operations .............. (39.6) 20.9 (58.9) (21.9)
Interest and investment income, net ........ 7.0 3.9 6.5 4.6
------ ------ ------ ------
Net income (loss) before provision (benefit)
for income taxes ........................ (32.6) 24.8 (52.4) (17.3)
Provision (benefit) for income taxes ....... -- 7.7 (1.1) .1
------ ------ ------ ------
Net income (loss) .......................... (32.6)% 17.1% (51.3)% (17.4)%
====== ====== ====== ======
</TABLE>
Net Revenues
Net revenues totaled $9.1 million for the three months ended September 30, 1998,
representing a 57% decrease from net revenues of $21.0 million for the three
months ended September 30, 1997. Net revenues decreased as a result of lower
than expected demand in the domestic retail channels, weak demand in Japan, and
lower OEM and licensing revenues. During the three months ended September 30,
1998, the Company released one new product, Dance Studio, and one new version of
an existing product, Painter 5.5 Web Edition. International sales accounted for
$2.2 million, or 25% of net revenues, for the three months ended September 30,
1998, compared to $7.4 million, or 35% of net revenues, for the three months
ended September 30, 1997.
Net revenues totaled $31.5 million for the nine months ended September 30, 1998,
compared to $53.0 million for the nine months ended September 30, 1997, a
decrease of 41%. The decrease in net revenues is attributed to lower than
expected demand in the domestic retail channels and in Japan, as well as lower
OEM and licensing revenues. International sales accounted for $9.3 million, or
30% of net revenues, for the nine months ended September 30, 1998, compared to
$20.3 million, or 38% of net revenues, for the nine months ended September 30,
1997.
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<PAGE> 13
The Company recognizes revenue from the sale of its products in accordance with
SOP 97-2, which generally requires revenue earned on software arrangements
involving multiple elements (e.g., software products, upgrades/enhancements,
postcontract customer support, etc.) to be allocated to each element based on
the relative fair value of the elements. The fair value of an element must be
based on evidence which is specific to the Company. The revenue allocated to
software products (including specified upgrades/enhancements) generally is
recognized upon delivery of the products. The revenue allocated to postcontract
customer support generally is recognized ratably over the term of the support.
If the Company does not have evidence of the fair value for all elements in a
multiple-element arrangement, all revenue from the arrangement is deferred until
such evidence exists or until all elements are delivered.
The Company provides an allowance for estimated returns at the time of product
shipments and adjusts this allowance as needed based on actual return history.
Such reserves as a percentage of net revenues have varied over recent years,
reflecting the Company's experience in product returns as it has significantly
expanded the proportion of its sales through third-party distribution channels
and increased its product portfolio. The Company expects reserves will continue
to vary in the future. The Company's agreements with its distributors generally
provide the distributors with limited rights to return unsold inventories under
a stock balancing program. The Company monitors the activities of its
distributors in an effort to minimize excessive returns and establishes its
reserves based on its estimates of expected returns. While historically the
Company's returns have been within management's expectations, the establishment
of reserves requires judgments regarding such factors as future competitive
conditions and product life cycles, which can be difficult to predict. As a
result, there can be no assurance that established reserves will be adequate to
cover actual future returns.
Cost of Revenues
Cost of revenues includes the costs of goods sold, royalties due to external
developers, inventory management costs, freight and handling costs and reserves
for inventory obsolescence. Cost of revenues totaled $1.5 million, or 17% of net
revenues, for the three months ended September 30, 1998, compared to $3.0
million, or 14% of net revenues, for the three months ended September 30, 1997.
The increase in cost of revenues as a percent of net revenues resulted from the
decrease in OEM and licensing revenues from 36% of net revenues for the three
months ended September 30, 1997 to 20% of net revenues for the three months
ended September 30, 1998. Royalties represented 5% and 4% of net revenues for
the three months ended September 30, 1998 and 1997, respectively.
Cost of revenues totaled $5.4 million for the nine months ended September 30,
1998, compared to $9.3 million for the nine months ended September 30, 1997, but
remained flat at 17% of net revenues. Royalties represented 4% of net revenues
for both the nine months ended September 30, 1998 and 1997.
The Company expects that cost of revenues will increase in the future
commensurate with any increase in net revenues, but may vary as a percentage of
net revenues.
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Sales and Marketing
Sales and marketing expenses include advertising, promotional materials, mail
campaigns, trade shows and the compensation costs of sales, marketing, customer
service and public relations personnel who promote the Company's products,
including related facilities costs. Sales and marketing expenses totaled $5.8
million for the three months ended September 30, 1998, a 29% decrease from sales
and marketing expenses of $8.3 million for the three months ended September 30,
1997. The decrease in sales and marketing expenses resulted from the
restructuring programs implemented during the third quarter of 1998 which
included reductions in sales and marketing personnel and promotional activities.
As a percentage of net revenues, sales and marketing expenses increased from 39%
for the three months ended September 30, 1997 to 65% for the three months ended
September 30, 1998, as a result of the significant decrease in net revenues for
the respective periods.
Sales and marketing expenses totaled $22.3 million, or 71% of net revenues, for
the nine months ended September 30, 1998, a decrease of 8% over sales and
marketing expenses of $24.2 million, or 46% of net revenues, for the nine months
ended September 30, 1997. The decrease in sales and marketing expenses primarily
resulted from the restructuring programs implemented during the third quarter of
1998, while the increase in sales and marketing expenses as a percent of net
revenues resulted from the significant decrease in net revenues for the
respective periods.
The Company expects sales and marketing expenses will continue to increase in
future periods, but such expenses may vary as a percentage of net revenues.
Research and Development
Research and development expenses consist primarily of personnel costs,
consultant fees and required equipment and facilities costs related to the
Company's product development efforts. Research and development expenses totaled
$3.7 million for both the three months ended September 30, 1998 and 1997. As a
percent of net revenues, research and development expenses increased from 18%
for the three months ended September 30, 1997 to 41% for the three months ended
September 30, 1998, as a result of the decrease in net revenues for the
respective periods.
For the nine months ended September 30, 1998, research and development expenses
totaled $12.3 million, or 39% of net revenues, an increase of 19% over research
and development expenses of $10.3 million, or 19% of net revenues, for the nine
months ended September 30, 1997. The increase was attributed to additional
personnel hired to expand the Company's product portfolio, enhance its existing
products, and translate its products to foreign languages.
The Company expects research and development expenses will continue to increase
in future periods, but such expenses may vary as a percentage of net revenues.
General and Administrative
General and administrative expenses include compensation costs related to
executive management, finance, and administration personnel of the Company along
with other administrative costs including legal and accounting fees, insurance,
and bad debt expenses.
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General and administrative expenses, which totaled $1.6 million for both the
three months ended September 30, 1998 and 1997, increased as a percentage of net
revenues from 8% for the three months ended September 30, 1997 to 17% for the
three months ended September 30, 1998, as a result of the decrease in net
revenues for the respective periods.
For the nine months ended September 30, 1998, general and administrative
expenses totaled $5.0 million, or 16% of net revenues, an increase of 8% over
general and administrative expenses of $4.6 million, or 9% of net revenues, for
the nine months ended September 30, 1997. The dollar increase in general and
administrative expenses resulted from increased corporate expenses.
The Company expects that its general and administrative expenses will continue
to increase in the future, but such expenses may vary as a percentage of net
revenues.
Restructuring Costs
On June 30, 1998, the Company announced a restructuring plan aimed at reducing
costs and improving competitiveness, which was implemented during the quarter
ended September 30, 1998. In connection with the restructuring, management
considered the Company's future operating costs and levels of revenue in 1998
and beyond, and determined that a restructuring charge of approximately $5.0
million was required to cover the costs of reducing certain sectors of its
workforce and facilities. The restructuring charge included an accrual of
approximately $2.0 million related to severance and benefits associated with the
reduction of approximately 75 positions during July 1998, as well as the related
reduction of certain of the Company's facilities. Non-cash restructuring costs,
which totaled approximately $3.0 million, primarily related to the write-down of
non-strategic business assets made redundant or obsolete due to the streamlining
of the Company's product lines and/or reduction of facilities. As a result of
the restructuring programs, the Company reduced operating expenses by
approximately $3.5 million, or 24%, compared to the second quarter of 1998. The
Company expects completion of the restructuring plan during the remained of
1998.
There can be no assurance that such decreases in operating expenses will be
achieved or that, if achieved, that such reductions will be sufficient to
restore profitability to the Company's operations.
Write-off of Acquired In-process Technology and Other Merger Costs
In May 1997, the stockholders of MetaCreations and Fractal approved the merger
of the two companies. As a result of the merger, the Company issued
approximately 9,055,000 shares of MetaCreations common stock for all of the
outstanding shares of Fractal. During the three months ended June 30, 1997, the
Company charged approximately $9.8 million against earnings related to
transaction costs and other costs associated with integrating the two companies.
On April 15, 1997, the Company completed the acquisition of Specular, a
privately held software development company based in Amherst, Massachusetts,
which develops and markets 3-D animation and graphic design tools for
professionals and prosumers. Under the terms of the Purchase Agreement, the
stockholders of Specular received approximately 547,000 shares of the Company's
common stock, valued at approximately $4.1 million, and $1 million in cash in
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exchange for all of the outstanding shares of Specular. The Company also issued
450,000 non-qualified stock options to purchase shares of the Company's common
stock to Specular employees at an exercise price of $7 per share, the fair
market value of the Company's common stock on April 16, 1997. The Company
relocated approximately 13 of Specular's existing engineering and product
management personnel to its Real Time Geometry facilities in Princeton, New
Jersey, closed Specular's Amherst headquarters, and laid-off and provided
severance to approximately 22 of Specular's existing operations, accounting, and
sales personnel. In addition, the Company assumed the net liabilities of
Specular, which totaled $1.6 million at April 15, 1997. The Company charged
approximately $6.4 million against earnings during the three months ended June
30, 1997, comprised of the write-off of acquired in-process technology of $5.6
million, transaction costs of $300,000, and relocation and severance costs of
$555,000. In addition, the Company recognized a deferred income tax asset of
$900,000 relating to Federal net operating losses and tax credits of Specular.
In accordance with SFAS No. 109, the tax benefits were first applied to reduce
to zero goodwill totaling $280,000, with the remainder applied against current
technology acquired from Specular. After recognition of the deferred tax asset,
acquired current technology totaled $280,000.
Benefit for Income Taxes
Based upon a review of the Company's deferred income tax assets, available tax
carrybacks, recent quarterly losses, and expected future taxable income, the
Company did not record a benefit for income taxes for the three months ended
September 30, 1998. Management believes that it is more likely than not that any
additional income tax benefit would not be realized at this point in time. The
benefits for income taxes for the three and nine months ended September 30, 1997
were based on the Company's estimated annualized effective tax rate for the
year, after giving effect to the utilization of available tax credits and tax
planning opportunities.
Net Income (Loss)
Net loss was $3.0 million, or $0.12 per share, for the three months ended
September 30, 1998, compared to net income of $3.6 million, or $0.15 per share,
for the three months ended September 30, 1997. For the nine months ended
September 30, 1998, net loss was $16.2 million, or $0.68 per share, compared to
net loss of $9.2 million, or $0.40 per share, for the nine months ended
September 30, 1997.
Year 2000 Compliance
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and software used by many companies may need to
be upgraded to comply with such "Year 2000" requirements. The Year 2000 problem
could affect computers, software and other equipment used, operated, or
maintained by the Company, its business partners, its suppliers and its
customers.
The Company has initiated an assessment project within the Company that
addresses those significant systems that may have Year 2000 compliance issues.
During 1997, the Company
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completed implementation of a Year 2000 compliant enterprise-wide information
system. Currently, the Company is in the process of inventorying and analyzing
its remaining centralized computer and embedded systems to identify any
potential Year 2000 issues. The Company currently expects assessment,
remediation and validation of its internal systems, in addition to the
development of applicable contingency plans, to be completed by the middle of
1999. The Company does not expect the cost of remediation to be material to the
Company's financial condition, results of operations, or cash flows.
Additionally, the Company presently believes that with the implementation of its
new information system and modification to existing software, Year 2000
compliance will not have a material adverse effect on the financial condition,
results of operations, or cash flows of the Company. However, there can be no
assurance that the Company's internal software will contain all date code
changes necessary to prevent processing errors potentially arising from
calculations using the Year 2000 date. Any disruptions in product development or
other operations of the Company as a result of Year 2000 noncompliance would
materially and adversely affect the Company's business, financial condition,
results of operations, and cash flows.
Furthermore, there can be no assurance that third parties utilized by the
Company are or will be Year 2000 compliant. Specifically, the Company contracts
with third parties for the manufacture and distribution of the Company's
products. Should any of the Company's key suppliers or distributors not achieve
Year 2000 readiness, the Company may be unable to manufacture its products or
effectively distribute its products to the Company's customers. As a result, the
Company has initiated communications with its key suppliers and distributors and
plans to monitor the status of their Year 2000 readiness. The Company expects to
complete the readiness assessment of its key suppliers and distributors by March
31, 1999. To the extent that any of the Company's principal suppliers and
distributors fail to demonstrate Year 2000 readiness, the Company will evaluate
alternatives that could include the identification of alternate suppliers or
distributors which have demonstrated Year 2000 readiness and/or the accumulation
of inventory to assure production capability where feasible or warranted. These
activities are intended to provide a means of managing the Company's risk, but
cannot eliminate the potential for disruption due to third party failure to
achieve Year 2000 compliance. Consequently, failure of any of the Company's
principal suppliers or distributors to achieve Year 2000 compliance would
materially and adversely affect the Company's business, financial condition,
results of operations, and cash flows.
The Company believes that the current versions of its products are Year 2000
compliant; however, there can be no assurance that the Company's current
products do not contain undetected errors or defects associated with Year 2000
that may result in costs which are material to the Company's business, financial
condition, results of operations, and cash flows.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, actual results could
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differ materially from those expressed or forecasted in any such forward-looking
statements as a result of certain factors, including those set below, as well as
those discussed elsewhere in the Company's SEC reports, including the Company's
audited consolidated financial statements and notes thereto as of December 31,
1997 and 1996, and for the three years in the period ended December 31, 1997, as
filed on Form 10-K. The risks described below are not the only ones facing
MetaCreations. Many factors could cause results to be different, including the
following risk factors and other risks described in this Form 10-Q. If any of
these risks occur, our business would likely be adversely affected and the
trading price of our common stock could decline, resulting in a loss of all or
part of your investment.
Seasonality and Fluctuations in Quarterly Results
If our future quarterly operating results fall below the expectations of
securities analysts or investors, the trading price of our common stock will
likely drop. Our quarterly operating results have fluctuated significantly in
the past, and we expect that they may continue to fluctuate in the future, as a
result of many factors, including:
- Demand for our products;
- Introduction or enhancement of new products by our company or
our competitors;
- Market acceptance of our new products;
- Industry press reviews of our products;
- Changes in our prices or our competitors' prices;
- The mix of distribution channels for our products;
- The mix of products we sell;
- Distributors' returns of our products; and
- General economic conditions.
In addition, we ship our products as orders are received and we therefore have
little or no backlog. Hence, our quarterly operating results generally depend on
a number of factors that are difficult to forecast, including the volume and
timing of the orders we receive and our ability to fulfill these orders, and our
ability to close distribution and licensing agreements during a particular
quarter. We also experience some seasonality in our revenues as demand for our
products tends to increase during the quarter ending December 31 because of
year-end holiday buying trends.
As is common in the software industry, our past experience shows that a
disproportionately large percentage of revenues in each fiscal quarter occurs in
the third month of that quarter. We generally base our staffing and other
operating expenses in part on anticipated net revenues. Because a substantial
portion of these net revenues may not be realized until shortly before the end
of each fiscal quarter, significant variations in our financial position,
results of operations and cash flows can result if there are delays in the
receipt and shipment of orders. Such delays may stem, for example, from the
failure of other companies to produce and ship products we have requested.
We will most likely be unable to adjust spending to compensate for any
unexpected revenue shortfall. Accordingly, our financial position, results of
operations and cash flows would be adversely affected by any significant
shortfall in revenues. Additionally, we have recently
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restructured and have focused on reducing our operating expenses to levels more
consistent with expected revenues. However, we cannot guarantee that such
reductions in operating expenses will be enough to restore our profitability.
Possible Volatility of Stock Price
The market price of our common stock has fluctuated significantly in the past.
The price at which our common stock will trade in the future will depend on a
number of factors including:
- Our historical and anticipated operating results;
- General market and economic conditions;
- Our announcement of new products;
- Actual or anticipated fluctuations in our operating results;
and
- Developments regarding our products, our competitors and their
products.
In addition, the stock market in general has experienced extreme price and
volume fluctuations in recent months. This volatility has had a substantial
effect on our stock price, as well as the stock prices of other software
companies, particularly graphics software companies. These broad market and
industry fluctuations may continue to adversely affect the market price of our
common stock.
Product Transitions and Product Returns
From time to time, we may announce the introduction of new products, product
versions or technologies that may replace or shorten the life cycles of our
existing products. Our competitors may also make such announcements about their
products which may replace or shorten the life cycles of our products. In the
past, when we announced the anticipated release of a new version of a product,
we experienced increased returns of the current version of that particular
product. For the three months ended June 30, 1998, we increased our reserves for
returns because of lower than expected revenues in our domestic retail channels
and decreased demand in Japan. Although we provide allowances for anticipated
returns, we cannot guarantee that product returns will be less than these
allowances, and this would adversely affect our business.
From time to time, we have offered free upgrades to customers who have purchased
a product following an announcement of a new release and prior to shipment of
the new product version. Such free upgrades could adversely affect our revenues,
and hence, our business. In certain cases we may also sell our new products and
product versions at a discounted price to achieve market acceptance. These price
discounts could also adversely affect our revenues and hence, our business. In
addition, when we announce plans for new products or new releases, or when our
competitors make such announcements, customers may delay purchasing our current
products in anticipation of new products or new releases. This would also
adversely affect our business.
Dependence on Distributors and on Other Third Parties
Although we do make some direct sales to customers, we generate most of our
revenues from sales through third party distributors. We use many different
distribution channels to sell our products worldwide. Examples of distribution
channels include hardware and software OEMs,
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international distributors, educational distributors, VARs, hardware
superstores, retail dealers and direct marketers. Our future financial results
depend in large part on our relationship with third party distributors and their
continued financial stability. Any termination or significant disruption of our
relationship with any major distributor or retailer, or any significant
reduction in sales volume attributable to a major distributor or retailer, could
adversely affect our business.
Distribution channels through which we sell our products are subject to rapid
change, significant margin pressures, consolidation and other financial
difficulties. For example, if one of our distributors experienced financial
difficulties such as a bankruptcy, we might be unable to collect on accounts
receivable from that distributor which would adversely affect our business. It
is also possible that new channels of distribution will develop and that we may
not be able to effectively distribute our products through such new channels. We
depend in part on our third party distributors to promote our products to
retailers, who typically have a limited amount of shelf space subject to high
demand. We cannot be sure that our distributors and retailers will continue to
purchase our products or provide our products with adequate shelf space and
promotional support. Their failure to continue to do so would adversely affect
our business.
An important part of our strategy is to enhance and diversify our domestic and
international distribution channels. We are currently restructuring our domestic
and international sales and marketing force. We are also continuing to develop
relationships with new third-party distributors and resellers. Our ability to
increase our sales and market share will depend in large part on our success in
recruiting and training sales personnel, distributors and resellers.
International Operations
Our future success depends in part on our ability to expand our international
presence. We sell a large percentage of our products outside of the United
States. International sales accounted for approximately 25% of our net revenues
for the three months ended September 30, 1998 and approximately 35% of our net
revenues for the three months ended September 30, 1997. The decrease in
international sales resulted primarily from a decrease in international OEM and
licensing revenues. An important element of our business strategy is to continue
to expand our sales in international markets, primarily Japan and Western
Europe. Our ability to expand our international presence depends on our success
in retaining effective international distributors and our ability to hire and
retain qualified employees abroad.
There are risks inherent in expanding and doing business internationally such
as:
- Unexpected changes in regulatory requirements;
- Problems and delays in collecting accounts receivable;
- Tariffs and other trade barriers;
- Difficulties in staffing and managing foreign operations;
- Longer payment cycles;
- Political instability;
- Fluctuations in currency exchange rates;
- Seasonal reductions in business activity during summer
(vacation) months in Europe and certain other parts of the
world; and
- Potentially adverse tax consequences.
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Sales of our products are currently denominated in U.S. dollars. Accordingly,
any increase in the value of the U.S. dollar as compared to currencies in our
principal overseas markets would increase the cost in foreign denominated
currency of our products. This may adversely affect our sales in those markets.
To date, we have not engaged in currency hedging transactions to reduce the
effect of fluctuations in currency exchange rates. In addition, effective
copyright and trade secret protection may be limited or unavailable under the
laws of certain foreign jurisdictions. If any of these risks were to occur, they
would adversely affect the success of our international operations and would
adversely affect our business.
A significant portion of our net revenues stem from the Asia Pacific region,
primarily Japan. Japan has recently experienced weaknesses in their currency,
banking and equity markets. We cannot guarantee that the financial condition in
Japan and in the Asia Pacific region will improve in the near future. If the
current financial crisis in the Asia Pacific region continues or worsens, our
business will be adversely affected. For example, during the three months ended
June 30, 1998, our net revenues from the Asia Pacific region were decreased as a
result of depressed demand for our products due to the current Asian financial
crisis.
Highly Competitive Markets
We face intense competition in the market for graphics software products. The
market for our products can change rapidly, and customers constantly demand new
product features, accelerated releases of new products and product enhancements.
We experience constant pressure to reduce the prices of our products.
Our products compete directly or indirectly with products offered by many other
large companies, including:
- Adobe Systems Incorporated;
- Autodesk, Inc.;
- Corel Corporation;
- Macromedia, Inc.;
- Silicon Graphics, Inc. (through its Alias/Wavefront division);
- Microsoft Corporation; and
- Broderbund Software, Inc.
Many of our competitors or potential competitors are larger than we are and have
significantly greater financial, managerial, technical and marketing resources
than we have. Our business would be adversely affected if any of our competitors
cut prices, increased their promotions of their products (including bundling or
giveaways of products), announced or accelerated introduction of new products or
enhanced product features or acquired additional applications or technologies
from third parties.
Our present or future competitors may be able to develop products comparable or
superior to ours or may be able to develop new products faster than we can. We
also face competition from developers of personal computer operating systems,
such as Microsoft and Apple Computer,
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which may incorporate functions into their operating systems which could be
superior to or incompatible with our products. Such competition would also
adversely affect our business.
We are currently developing additional product enhancements that we believe will
address customer requirements, but we cannot be sure that we will complete our
development and introduction of these products on a timely basis. In addition,
we cannot be sure that these product enhancements will achieve market
acceptance. If we are unable to compete effectively in our markets, or if
competition becomes increasingly intense, our business would be adversely
affected.
Dependence on Key Personnel and Difficulty of Identifying and Hiring Certain
Personnel
We depend on the continued employment of our senior executive officers and other
key management personnel. If any of our senior officers or other key employees
leave our company and are not adequately replaced, our business would be
adversely affected.
During February 1998, our previous Chief Executive Officer, John Wilczak,
resigned. Gary Lauer, who had most recently served as President of Silicon
Graphics, Inc.'s ("SGI") World Trade Group and Executive Vice President of SGI's
Worldwide Field Operations, succeeded Mr. Wilczak as our Chief Executive
Officer. In addition, in connection with our recent restructuring, our Senior
Vice President, Sales and Marketing; Vice President, Marketing; and Vice
President, Product Management and Design have left our company. We have hired a
Vice President, European Sales and Marketing, and a Vice President and General
Manager, Professional Products Group, and are seeking to hire at least one
additional Vice President, Sales and Marketing. If we do not succeed in
attracting new officers, our business would be adversely affected.
Our future success also depends on our continuing ability to identify, hire,
train and retain other highly qualified technical and managerial employees. The
competition for such employees is intense, and we have experienced difficulty in
identifying and hiring qualified engineering personnel. If we do not succeed in
attracting and retaining necessary technical and managerial employees in the
future, our business would be adversely affected.
Rapid Technological Change; Dependence on and Need for New Products and Product
Versions; Potential Delays in Product Releases
The market for visual computing graphics software products, and the personal
computer industry in general, is characterized by rapidly changing technology.
Product life cycles are short and downward pricing pressures are strong. As a
result, our success depends substantially upon our ability to continue to
enhance our products and to develop new products that meet customers' increasing
expectations and that incorporate the latest technology.
If our competitors introduce products that better address customers' needs, our
business would be adversely affected. We cannot guarantee that we will be
successful in developing and marketing enhancements to our existing products or
introducing new products on a timely basis. Nor can we guarantee whether any new
or enhanced products will be successful in the marketplace. If
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our new products or product versions receive bad reviews in industry
publications, this would likely decrease their potential market acceptance and
our business would be adversely affected.
We intend to continue to increase our research and development expenditures. If
our increased research and development spending is not accompanied by increased
revenues, our business would be adversely affected. We have supplemented our
research and development efforts by exclusively licensing products developed by
or co-developed with third parties. We cannot guarantee that we will be able to
continue to obtain such outside product development capabilities on terms
favorable to us or at all. If we cannot maintain existing development
arrangements or fail to attract new product development partners, then we would,
at the least, have to further increase our research and development spending.
This would adversely affect our business. Furthermore, we cannot guarantee that
such additional research and development expenditures would result in the
production of commercially acceptable products or profitability.
We also depend upon internal efforts for the development of new products and
product enhancements. In the past, we have had delays in the development of new
products and product versions. We cannot guarantee that we can avoid delays
regarding our current product development or future development activities.
We offer complex software products and they may contain undetected errors when
first introduced or as new versions are released. In the past, we have
discovered software errors in certain new products and enhancements after these
products were introduced to the marketplace. We cannot guarantee that our new
products or releases will be free of errors. If errors are found in our products
after we have commercially shipped them, we would likely experience bad product
reviews and a loss or delay of market acceptance.
This would adversely affect our business.
Evolving Markets for Computer Graphic Imaging and Internet/Online Design Tools
The markets for computer graphic imaging and Internet/online design tools are
still emerging. We cannot guarantee that digital graphic and Internet/online
content developers will adopt our products or that our existing products will
grow. Nor can we guarantee that we will have sufficient distribution resources
to market our products successfully or that any of our products will achieve
market acceptance.
The demand for computer graphic imaging and Internet/online design tools depends
on many factors including:
- Installed base of digital graphic and multimedia capable
personal
- computers; Widespread availability of digital media; and
Number and
- expertise of skilled content producers.
If the markets for such tools fail to grow or grow more slowly than we currently
anticipate, or if our products fail to achieve market acceptance, our business
would be adversely affected.
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Proprietary Rights and Licenses
We rely on a combination of copyright, trademark, patent, trade secret laws,
employee and third-party nondisclosure agreements and exclusive contracts to
protect our intellectual and proprietary rights and products. We distribute our
software under shrinkwrap license agreements. We generally do not obtain signed
license agreements from the end users of our software.
As is typical in the software industry, we do not copy-protect our software. As
a result, unauthorized third parties may be able to copy or reverse engineer our
products. In addition, our competitors may independently develop technologies
that are substantially equivalent or superior to our technology. We may not be
able to police unauthorized uses of our products, and we expect that software
piracy could be a chronic problem. We also distribute or plan to distribute our
products in other countries which do not protect the intellectual property of
our products to the same extent as laws in the United States.
We also believe that the growing number of software products available and the
increasing overlap of products may lead to a greater number of infringement
claims. Our products may be the subject of infringement claims in the future,
which could result in costly litigation and could require us to obtain a license
to the intellectual property of third parties. We may be unable to obtain
licenses from these third parties on favorable terms, if at all. Even if a
license is available, we may have to pay substantial royalties to obtain it. If
we cannot obtain necessary licenses on reasonable terms, our business would be
adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
Historically, net cash used in operating activities and investing activities of
the Company has been significant due to operating losses from restructurings,
acquisitions and mergers and working capital requirements resulting from the
growth of the Company. Cash and investments totaled $49.6 million at September
30, 1998, compared to cash and investments of $50.0 million at December 31,
1997. Net cash provided by operating activities of the Company totaled $1.7
million for the nine months ended September 30, 1998, compared to net cash used
in operating activities of $(10.7) million for the nine months ended September
30, 1997. The increase in cash provided by operating activities is primarily
attributed to the decrease in accounts receivable during the nine months ended
September 30, 1998. Net cash provided by investing activities totaled $3.0
million and $457,000 for the nine months ended September 30, 1998 and 1997,
respectively. The change resulted primarily from net purchases of short-term
investments during the nine months ended September 30, 1998, compared to net
sales of short-term investments, in addition to higher purchases of property and
equipment during the nine months ended September 30, 1997. Additionally, the
Company made cash payments totaling $1.2 million in connection with its
acquisition of Specular in April 1997. Net cash provided by financing activities
totaled $736,000 and $965,000 for the nine months ended September 30, 1998 and
1997, respectively, resulting from proceeds received from the exercise of stock
options by the Company's employees during the respective periods. Additionally,
the Company paid off notes payable totaling $274,000 during the nine months
ended September 30, 1997, in connection with its acquisition of Specular.
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The Company expects that its working capital requirements will continue to
increase to the extent the Company grows. The Company believes that its current
cash and investment balances, cash provided by future operations, if any, and
available borrowings under the Company's line of credit are sufficient to meet
its working capital needs and anticipated capital expenditure requirements
through at least the next twelve months.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 requires publicly-held companies to report financial and other information
about key revenue-producing segments of the entity for which such information is
available and is utilized by the chief operating decision maker. Specific
information to be reported for individual segments includes profit or loss,
certain revenue and expense items and total assets. A reconciliation of segment
financial information to amounts reported in the financial statements would be
provided. SFAS No. 131 requires companies to adopt its provisions for fiscal
years beginning after December 15, 1997, but does not require that segment
information be reported in financial statements for interim periods in the
initial year of application. Management is currently evaluating the requirements
of adopting SFAS No. 131 and the effects, if any, on the Company's current
reporting and disclosures.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES
On July 24, 1998, the Board of Directors of the Company announced that it had
declared a dividend distribution of one Preferred Share Purchase Right (the
"Rights") on each outstanding share of the Company's Common Stock. The Rights
are designed to assure that the Company's stockholders receive fair and equal
treatment in the event of any proposed takeover of the Company and to guard
against partial tender offers and other abusive tactics to gain control of
MetaCreations without paying all stockholders the fair value of their shares,
including a "control premium."
Each right will entitle stockholders to buy one one-thousandth of a share of the
Company's Series A Participating Preferred Stock at an exercise price of $38.00.
The Rights will become exercisable following the tenth day after a person or
group announces acquisition of 15% or more of the Company's Common Stock or
announces commencement of a tender offer the consummation of which would result
in ownership by the person or group of 15% or more of the Common Stock. The
Company will be entitled to redeem the Rights at $0.01 per Right at any time on
or before the tenth day following acquisition by a person or group of 15% or
more of the Company's Common Stock.
25
<PAGE> 26
If, prior to redemption of the Rights, a person or group acquires 15% or more of
the Company's Common Stock, each Right not owned by a holder of 15% or more of
the Common Stock will entitle its holder to purchase, at the Right's then
current exercise price, that number of shares of Common Stock of the Company
(or, in certain circumstances as determined by the Board, cash, other property
or other securities) having a market value at that time of twice the Right's
exercise price. If, after the tenth day following acquisition by a person or
group of 15% or more of the Company's Common Stock, MetaCreations sells more
than 50% of its assets or earning power or is acquired in a merger or other
business combination transaction, the acquiring person must assume the
obligations under the Rights and the Rights will become exercisable to acquire
Common Stock of the acquiring person at the discounted price. At any time after
an event triggering exercisability of the Rights at a discounted price and prior
to the acquisition by the acquiring person of 50% or more of the outstanding
Common Stock, the Board of Directors of the Company may exchange the Rights
(other than those owned by the acquiring person or its affiliates) for Common
Stock of the Company at an exchange ratio of one share of Common Stock per
Right.
The dividend distribution was made on August 13, 1998, payable to stockholders
of record on August 13, 1998. The Rights will expire on August 13, 2008.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit Number Exhibit Title
-------------- -------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
None
26
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
METACREATIONS CORPORATION
(Registrant)
Date: November 13, 1998 /s/ TERANCE A. KINNINGER
---------------------------------------
Terance A. Kinninger
Sr. Vice President and
Chief Financial Officer
27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
ACCOMPANYING UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> APR-01-1998 JAN-01-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 9,069 9,069
<SECURITIES> 40,525 40,525
<RECEIVABLES> 11,900 11,900
<ALLOWANCES> 0 0
<INVENTORY> 711 711
<CURRENT-ASSETS> 72,079 72,079
<PP&E> 14,335 14,335
<DEPRECIATION> 7,098 7,098
<TOTAL-ASSETS> 80,779 80,779
<CURRENT-LIABILITIES> 8,297 8,297
<BONDS> 0 0
0 0
0 0
<COMMON> 24 24
<OTHER-SE> 72,458 72,458
<TOTAL-LIABILITY-AND-EQUITY> 80,779 80,779
<SALES> 9,053 31,491
<TOTAL-REVENUES> 9,053 31,491
<CGS> 1,544 5,437
<TOTAL-COSTS> 1,544 5,437
<OTHER-EXPENSES> 11,094 44,594
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> (2,952) (16,521)
<INCOME-TAX> 0 (353)
<INCOME-CONTINUING> (2,952) (16,168)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (2,952) (16,168)
<EPS-PRIMARY> (0.12) (0.68)
<EPS-DILUTED> (0.12) (0.68)
</TABLE>
