METACREATIONS CORP, 10-K405/A, 2000-08-21

METACREATIONS CORP
10-K405/A, 2000-08-21
PREPACKAGED SOFTWARE

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------

FORM 10-K/A
------------------------

(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

[ ] 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)

<TABLE>
<S> <C>
DELAWARE 95-4102687
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
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6303 CARPINTERIA AVENUE, CARPINTERIA, CA 93013
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

(805) 566-6200
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $0.001
PAR VALUE

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to the
Form 10-K. [X]

As of March 15, 2000, there were outstanding 27,445,446 shares of the
registrant's Common Stock, $0.001 par value, which is the only outstanding class
of common or voting stock of the registrant. As of that date, the aggregate
market value of the shares of Common Stock held by non-affiliates, based upon
the last sale price of the shares as reported on the NASDAQ National Market
System on such date, was approximately $684,150,330.

DOCUMENTS INCORPORATED BY REFERENCE:

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METACREATIONS CORPORATION

FORM 10-K/A

TABLE OF CONTENTS

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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14

PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 25
Item 8. Financial Statements and Supplementary Data................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 59

PART III
Item 10. Directors and Executive Officers of the Registrant.......... 59
Item 11. Executive Compensation...................................... 60
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 67
Item 13. Certain Relationships and Related Transactions.............. 67

PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 71
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PART I

This Annual Report on Form 10-K/A contains forward-looking statements
within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act. Words such as "anticipates," "expects," "intends," "plans,"
"believes," "seeks," "estimates," variations of such words and similar
expressions are intended to identify such forward-looking statements. These
statements are not guarantees of future performance and are subject to certain
risks, uncertainties and assumptions that are difficult to predict. Therefore,
actual results could differ materially from those expressed or forecasted in any
such forward-looking statements as a result of certain factors, including those
set forth in "Additional Factors Affecting Future Results." In connection with
forward-looking statements which appear in these disclosures, investors should
carefully review the factors set forth in this Form 10-K/A under "Additional
Factors Affecting Future Results."

ITEM 1. BUSINESS

THE COMPANY

MetaCreations Corporation, a Delaware corporation ("MetaCreations" or the
"Company") provides e-commerce visualization solutions for the World Wide Web
(the "Web" or the "Internet"). MetaCreations' strategy is centered on the
Company's Metastream technology and software tools designed to make the
interactive use of photo-realistic 3D on the Web practical and pervasive.

Metastream Corporation, a joint initiative between MetaCreations and
Computer Associates International, Inc. ("Computer Associates"), was formed in
June 1999. Metastream Corporation, which is 80% owned by MetaCreations and 20%
owned by Computer Associates, is focused on providing complete end-to-end
solutions for creating and deploying virtual products centered on the Company's
Metastream technologies for e-commerce and the Web environment. In this regard,
MetaCreations has granted to Metastream Corporation a non-exclusive license to
use all of MetaCreation's technologies existing as of June 30, 1999, including
the Metastream technologies. Metastream Corporation primary initiatives include:

- Licensing technology for specific e-commerce visualization solutions;

- Providing a full range of fee-based professional services for
implementing 3D solutions;

- Forging technological alliances with leading interactive agencies and web
content providers; and

- Maximizing market penetration and name recognition.

In December 1999, the Board of Directors of MetaCreations approved a plan
to focus exclusively on the Company's Metastream technologies and to
correspondingly divest itself of all its prepackaged graphics software products.
Accordingly, the continuing operations of MetaCreations are focused exclusively
on Metastream Corporation.

In connection with this decision in December 1999, the Company recorded a
loss on disposal of discontinued operations of approximately $21.3 million,
which is comprised of the estimated future results of operations of the
discontinued business through the estimated date of divestiture of $5.4 million,
the amounts expected to be realized upon the sale of the discontinued business
of $11.0 million, severance and related benefits of $8.4 million, and asset
write-downs of $18.5 million. The provision for loss on disposal of discontinued
operations is an estimate and subject to change. Changes in estimates will be
accounted for prospectively and included in income (loss) from discontinued
operations. The Company expects to complete the divestiture of the discontinued
business by the end of the second quarter of 2000.

---------------

Metastream is a registered trademark of the Company. This Form 10-K/A may
also contain trademarks and tradenames of other companies.

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RESTATEMENT OF FINANCIAL STATEMENTS

On August 8, 2000, the Company announced that it would restate its
consolidated financial statements for the year ended December 31, 1999. The
principal reasons for revisions are discussed below.

Beginning in June 1999, the Company entered into a series of agreements
with Computer Associates. The agreements included a non-exclusive limited-use
perpetual license to use the Company's Metastream and related technologies and a
service agreement whereby the Company would provide a defined number of
development personnel to Computer Associates on an as needed basis. Concurrent
with the license agreement, the Company also granted Computer Associates a 20%
equity interest in Metastream Corporation, the Company's newly formed
subsidiary, for certain non-monetary support as consideration. The Company had
previously ascribed the committed $7.0 million monetary consideration relating
to the licensing agreement to license revenue and, assuming that Metastream
Corporation had only nominal value at the time of inception, no value was
ascribed to the 20% interest. A recent re-examination of these transactions and
an independent valuation of Metastream Corporation as of June 30, 1999, has led
the Company to the conclusion that the series of transactions with Computer
Associates should be viewed in the aggregate and the monetary consideration
allocated to each component based on their fair values. Since the limited-use
license of Metastream and related technologies was a unique, one-time
transaction, the Company did not have the requisite evidence of its fair value
pursuant to the provisions of Statement of Position ("SOP") No. 97-2, "Software
Revenue Recognition." The independent valuation of a 20% interest in Metastream
Corporation indicated a fair value in excess of the monetary consideration
ascribed to Computer Associates limited-use licensing rights and, accordingly,
the Company concluded the appropriate recognition for the transactions was to
allocate the committed monetary consideration to the equity component. The
Company allocated the consideration received between minority interest and
"change in interest gain" pursuant to SEC Staff Accounting Bulletin No. 51,
"Accounting for Sales of Stock by a Subsidiary." The "change in interest gain"
has been recorded as paid-in capital in the Company's consolidated balance
sheets. A total of $3.5 million received through December 31, 1999 has been
ascribed to Computer Associates' purchase of equity. An additional $3.5 million
is due from Computer Associates at various dates through September 30, 2000, and
will be ascribed to the equity purchase upon receipt.

Additionally, based upon a revised estimate of the valuation of Metastream
Corporation at various dates in 1999, the Company has adjusted its estimate of
the fair value of Metastream Corporation at the time of stock option issuances
to employees and non-employees resulting in an additional charge of $4.0 million
during the three months ended December 31, 1999 for stock-based compensation
associated with stock option grants at exercise prices which were below the fair
value of Metastream Corporation stock on the date of grant.

The Company has also made certain reclassifications to the statement of
operations for the year ended December 31, 1999. The Company reduced the net
loss from discontinued operations by $5.5 million and recorded a corresponding
increase in net loss from continuing operations relating to the increase in the
Company's valuation allowance for deferred tax assets. In addition, the Company
reclassified $1.9 million to gain on sale of assets within loss from
discontinued operations. This gain was comprised of $2.0 million previously
recorded as license revenue relating to discontinued operations, net of $80,000
previously recorded as other income relating to continuing operations.

This amended Form 10 K/A filing includes restated financial information and
related disclosures for the year ended December 31, 1999.

MARKET OPPORTUNITY

The number of Internet users has increased rapidly over the past several
years. International Data Corporation estimates that the number of Internet
users in the U.S. will increase from 82 million in 1999 to 179 million in 2003.
The Company believes that as the number of Internet users increases, so will the
number of users wanting to make purchases online. According to Jupiter
Communications, over 10 million new shoppers purchased online during 1999, and
over 85 million users will be buying online by 2003. Jupiter Communications also
estimates that online shopping will reach $78.0 billion by 2003. Similarly,
Forrester
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Research estimates that the e-commerce services market will increase from $10.6
billion in 1999 to $64.8 billion in 2003.

The Company believes it is well positioned to capitalize on the growth in
online commerce and to offer online merchants a means to engage the customer's
attention and effectively communicate the features and benefits of their
products. The Company believes that the single most important issue faced by
online merchants is how to convert extremely high investments for capturing
visitors into actual product sales. The Company believes that what the market
really seeks is not just the ability to broadcast 3D models of products, but
rather a platform that would provide:

- Realistic product interaction;

- Interoperability of all other media types required for compelling product
displays (e.g., vector graphics, sound, animation, etc.);

- Compression and security; and

- Client-side data tracking of the use of downloaded page element.

The Company believes that its Metastream solution meets all of these
requirements.

THE METASTREAM STRATEGY

The Company's ongoing strategy is centered on licensing Metastream
technologies for specific e-commerce visualization solutions; providing a full
range of fee-based professional services for implementing these 3D solutions;
developing strategic alliances with market-leading technology companies,
interactive agencies and Web content providers; and maximizing market
penetration and name recognition.

LICENSING METASTREAM TECHNOLOGIES

Metastream, has become an industry-leading format for 3D over the Web
largely due to its ability to stream graphics over the Web and then scale them
to the power of the user's computer, without the need for any special
server-side software. This fundamental aspect of Metastream makes it an ideal
format for delivery of sophisticated product representations, since online
merchants wish to publish their content in the highest possible resolution for
advanced users, but still have that same file deliver a compelling presentation
to users with less bandwidth and/or who are on slower machines. The Company's
new licensing model is based on Metastream 3.0, which is expected to be launched
at the end of March 2000. The Company will offer a time-based license that will
allow online Web sites to display Metastream 3.0 content for an annual or
semi-annual license fee.

PROVIDING PROFESSIONAL SERVICES

The Company has assembled an experienced team of 3D artists, animators and
engineers with backgrounds in broadcast, cinema, location-based entertainment
and Web site projects. The Company believes, based on recent demand, that
professional services will provide a significant revenue opportunity. The
Company also expects the content creation group will serve as the training force
for the interactive agencies and customers who do not wish to perform these
functions themselves.

DEVELOPING STRATEGIC ALLIANCES

Historically, the Company has entered into marketing, distribution and
licensing agreements related to certain of its technologies, including
Metastream. The Company believes that such agreements have allowed it to more
effectively create market demand and acceptance for its technologies. Some of
the companies who have entered into such agreements include Computer Associates,
Eastman Kodak Company ("Kodak"), Intel Corporation ("Intel"), Microsoft
Corporation ("Microsoft") and Minolta Co., Ltd. ("Minolta"). The Company expects
to continue to develop strategic alliances with additional market-leading
technology companies.

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The Company also intends to develop strategic relationships with
interactive agencies and Web content providers. By developing a "VAR"
relationship with interactive agencies, the Company can accelerate access to key
customer targets and leverage an indirect sales force while minimizing sales and
marketing expenses. Additionally, the Company intends to work with the major
tools makers and other content creators to easily convert content into
Metastream format, as with hardware manufacturers for the capture of 3D models,
in order to create greater demand for Metastream licenses.

MAXIMIZING MARKET PENETRATION AND NAME RECOGNITION

The Company believes that it is the leading provider of Internet
visualization technologies and services that enable online retailers to
interactively present their products on the Internet. Since the development of
the Metastream technology, the Company has sought to achieve rapid and broad
adoption of the technology and strong name recognition. This strategy has been
pursued through various means, such as offering its Metastream 2.0 licenses to
various e-commerce sites free of charge, licensing certain of its technologies
to industry-leading strategic partners such as Computer Associates, Intel,
Kodak, Microsoft and Minolta and distributing the Metastream client-side viewer
through a number of strategic partners, including Microsoft (Metastream services
are available under the Direct Animation API included in Windows 98 SE and
Windows 2000), Intel (through its Web Outfitter Service for Pentium III users)
and Excite@Home (through its @Home 1.7 client software).

THE METASTREAM SOLUTION

METASTREAM 2.0

Metastream 2.0, the current version of Metastream, enables developers to
author content to deliver high-quality 3D graphics over the Web. Metastream 2.0
content progressively streams and scales over the Web, adjusting to the
performance of a user's particular computer system. Metastream 2.0 enables a
site visitor to "pick up" a virtual product, manipulate it, examine it from any
angle and zoom in on interesting features. To e-commerce sites, this ability
yields increased visitor interest; to the site visitor, it provides higher
quality and quantity of information about the product in less time while taking
up less screen real estate than previous Web product displays such as static GIF
and JPEG images. Metastream 2.0 scales content automatically to optimize its
display on the user's machine, thus addressing the wide disparity in client-side
rendering power, another hurdle to 3D content providers.

The Metastream 2.0 client-side engine, which plugs into Microsoft Internet
Explorer and Netscape Navigator, is available for download on both the Windows
and Macintosh platforms at www.metastream.com. Additionally, the Metastream 2.0
viewer has been distributed directly by a number of strategic partners,
including Microsoft (Metastream services are available under the Direct
Animation API included in Windows 98 SE and Windows 2000), Intel and
Excite@Home. The Company estimates that the installed base for Metastream 2.0 is
between 35 million and 45 million.

Companies and Web sites currently using Metastream 2.0 include CBS, Charles
Tyrwhitt Shirts, JCrew, Lego Mindstorms, NASA, Sony Vaio Direct and Xtras
Direct, Styleclick.com and the Warner Brothers Online Store.

METASTREAM 3.0

Metastream 3.0, which is expected to be launched at the end of the March
2000, will continue to provide the key benefits of Metastream 2.0, including its
simple deployment without special server-side software. In addition, Metastream
3.0 will incorporate the following improvements:

- High Fidelity Rendering. Utilizing technology contained in MetaCreations'
graphics products, Metastream 3.0 provides realtime anti-aliasing and
better lighting, shadow and reflection effects.

- Real-time, Client Generated Animation. Metastream 3.0 provides
client-driven interactivity, allowing users to try out product features
as they would in a retail store. Client-side mouse movements are
translated into appropriate product behaviors -- not merely triggering
pre-scripted animations, but

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generating correct physical responses. For example, the doors of a car
can open and close directly in response to mouse movements. This provides
an important sense of user control that parallels the in-store
experience.

- 2D/3D Compression. Metastream 3.0 combines a new wavelet technology
combined with MetaCreations' expertise with procedural textures to
achieve high compression with minimal image degradation. As a result, 3D
textured models can be generated from smaller files than traditional 2D
JPEGs of the same product. Additionally, the compression benefits apply
equally well to 2D image, panorama and object movie transmission.

- Support for Other Media Types. Metastream 3.0 incorporates a proprietary
compositing plane, which will allow the seamless integration of all major
Web media types, such as vector graphics, audio and panoramas, drawn
without a window anywhere on the screen. For example, a 3D product can be
embedded inside a panoramic movie or a store scene, with the product
features being displayed in vector graphics that pop up when the user
rolls the mouse over the item. This kind of media integration can provide
a far richer user experience than any single media type, and it offers
the merchandiser a much broader technology palette from which to author
Web pages.

- Caching to Reduce Site Latency. Customers often complain that it takes
too long to view various choices that a merchandiser is presenting,
because each choice requires a new round-trip to the server and a new
download. Metastream 3.0 reduces this delay, commonly referred to as site
latency, by using a system that holds the user's likely next choices in
the client-side cache, ready for instant display when selected by the
user. Moreover, the cache can assemble products quickly, so that even
when a trip to the server is required, only the differences between the
object just seen and the next choice need be downloaded. This cache can
be used to reduce site latency regardless of the media types employed.

- DataTrack. Metastream 3.0 will contain DataTrack, a new feature which
allows merchants to monitor aggregate user behavior through intermediate
caches and across reseller sites. This data collection process would
generally record behavior such as which product features have been
accessed and for how long, but can also be customized to fit the needs of
the merchant. The data, which is sent back to the Metastream Corporation
server, can then be reported to the merchants to optimize their
marketing.

- PageLock. Metastream 3.0 also will contain PageLock, a security feature
that allows site developers to "lock" content to a Web site to prevent
unauthorized copying and use of virtual products by third parties. Users
would only be able to view the content when they are live on the URL.
This is a very important feature for companies seeking to protect their
intellectual property rights or limiting redistribution of their content
to approved sites.

- Componentized Architecture. The Metastream 3.0 client-side software, or
the "Hub," is only about 50 kilobytes in size and can be installed
through a two-click download and approval process. The majority of the
functions described above are written as separate components, which
subsequently plug in to this Hub with no user disruption. Aside from
smoothing the user experience, this architecture will allow a new
component to be written and deployed based on individual merchant needs
without the need to wait for a new product release.

The Company believes that, with the incorporation of these features into
Metastream 3.0, it will be able to provide online merchants with a complete
solution to allow them to create a more compelling shopping narrative for their
customers. Additionally, the Company believes that the clear benefit of
Metastream 3.0 to online merchants will be that it will shorten the buying cycle
and create more frequent and numerous return customers.

THE METASTREAM BUSINESS MODEL

LICENSING REVENUES

The majority of the Company's revenues from continuing operations have
historically been from strategic partners. Specifically, revenues from Intel and
Computer Associates accounted for 49% and 39% of total

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revenues, respectively, in 1999; revenues from Intel, Kodak and Minolta
accounted for 66%, 15% and 15% of total revenues, respectively, in 1998; and
revenues from Real 3D Company accounted for 100% of total revenues in 1997. In
connection with its decision to focus exclusively on e-commerce visualization,
the Company decided to no longer focus on these one-time technology licenses, in
favor of implementing a recurring broadcast licensing model. This licensing
model is based on Metastream 3.0, which is expected to be launched at the end of
March 2000.

Metastream 3.0 content will only display on the client-side if the Web site
sending the content holds a valid key. The Company will offer these keys through
a time-based license that will allow the Web site to display Metastream 3.0
content for an annual or semi-annual fee. A secondary license will also be
offered to merchants who wish to broadcast content off of multiple Web sites.
Additionally, to proliferate Metastream 3.0 and to provide broad access to this
technology, free or reduced fee licenses may be offered to certain categories of
customers. This revenue model should provide an annuity-like revenue stream from
existing clients and the opportunity to scale income rapidly as new customers
are acquired.

SERVICES REVENUES

The Company also expects to generate revenues from service fees related to
content creation, Web site integration, custom engineering and general
consulting services. The Company has assembled an experienced team of 3D
artists, animators and engineers with backgrounds in broadcast, cinema,
location-based entertainment and Web site projects. The Company believes, based
on recent demand, that professional services will provide a significant revenue
opportunity. The Company also expects the content creation group will serve as
the training force for the interactive agencies and customers who do not wish to
perform these functions themselves.

MARKETING AND PROMOTION

The Company's marketing strategy is based on promoting the Metastream
brand, increasing adoption of the Metastream solution by online merchants,
developing strategic relationships with key business partners and developing
incremental licensing and service revenue opportunities. In connection with this
strategy, Metastream Corporation recently hired a Chief Marketing Officer, a
Vice President, Marketing and a Vice President, Client Services and anticipates
the hiring of additional marketing, sales and public relations personnel over
the next several quarters.

A very important aspect of the Company's business model is the use of
intermediaries, such as interactive and traditional advertising agencies, who
already have key relationships with target clients. As part of a "VAR"
relationship with these agencies, MetaCreations will provide them with authoring
tools, including the Company's proprietary 3D capture technologies, and also
with training and support. The agencies will be entitled to a reseller fee for
each license that they place. This will allow the Company to accelerate access
to key customer targets and leverage a huge indirect sales force while
minimizing sales and marketing expenses.

A second indirect sales force the Company intends to leverage is that of
the major tools makers. The Company intends to work with the major tools makers
and other content creators to easily convert content into Metastream format, as
with hardware manufacturers for the capture of 3D models, in order to create
greater demand for Metastream licenses. Additionally, because of its ability to
integrate multiple Web media types, Metastream 3.0 will enhance the value of any
given toolset and the sales force of these major tools makers and content
creators will be incented to promote Metastream 3.0.

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PRODUCT DEVELOPMENT

The Company's principal current product development efforts are focused on
the development of Metastream and other complementary technologies. From time to
time, the Company may also acquire basic software technologies that it considers
complementary to its Metastream solution.

The Company's growth will be dependent upon the introduction of new
products, technologies and services and future enhancements to existing products
and technologies. Any such new products, technologies or enhancements may not
achieve market acceptance. In addition, the Company has in the past experienced
delays in the development of new products, technologies and enhancements, and
such delays may occur in the future. If the Company were unable, due to resource
constraints or technological or other reasons, to develop and introduce such
products, technologies or enhancements in a timely manner, this inability could
have a material adverse effect on the Company's business. In particular, the
introductions of new products, technologies and enhancements, are subject to the
risk of development delays. Any delay in the availability of new products,
technologies and enhancements could have a material adverse effect on the
Company's business.

The Company's research and development expenses were approximately $2.8
million, $1.6 million, and $2.4 million for 1999, 1998 and 1997, respectively.
The Company anticipates the hiring of additional engineers in connection with
its continued product development efforts, which will result in increased
research and development expenses.

COMPETITION

The e-commerce market is new, rapidly evolving and intensely competitive.
As a result, online merchants are looking for ways to differentiate themselves
from their competition. Accordingly, various companies are developing new
technologies, which may give the online merchants this competitive advantage.
The Company's current competitors include:

- Cycore AB (Cult3D);

- Flatland Online, Inc. (3DML);

- IBM Corporation (Hotmedia);

- Macromedia, Inc.;

- Oz.Com (Fluid3D -- in conjunction with RealNetworks, Inc.'s G2 media
player);

- Shells Interactive Ltd. (3D Dreams -- in conjunction with Macromedia,
Inc.'s Shockwave);

- Virtue 3D, Inc. (Virtuoso); and

- WebGlide, Inc. (Utopia -- in conjunction with RealNetworks, Inc.'s G2
media player).

Some of the Company's competitors have longer operating histories and
significantly greater financial, management, technology, development, sales,
marketing and other resources than the Company. As the Company competes with
larger competitors across a broader range of products and technologies, the
Company may face increasing competition from such companies. If these or other
competitors develop products, technologies or solutions that offer significant
performance, price or other advantages over those of the Company, the Company's
business would be harmed.

A variety of other possible actions by the Company's competitors could also
have a material adverse effect on the Company's business, including increased
promotion or the introduction of new or enhanced products and technologies.
Moreover, new personal computer platforms and operating systems may provide new
entrants with opportunities to obtain a substantial market share in the
Company's markets.

The Company's competitors may be able to develop products or technologies
comparable or superior to those of the Company, or may be able to develop new
products or technologies more quickly. The Company also faces competition from
developers of personal computer operating systems such as Microsoft and Apple

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Computer, Inc., as well as from open-source operating systems such as Linux.
These operating systems may incorporate functions that could be superior to or
incompatible with the Company's products and technologies. Such competition
would adversely affect the Company's business.

INTELLECTUAL PROPERTY

The Company regards its patents, copyrights, service marks, trademarks,
trade dress, trade secrets, propriety technology and similar intellectual
property as critical to its success, and relies on trademark, copyright and
patent law, trade secret protection and confidentiality and/or license
agreements with its employees, partners, customers and other to protect its
proprietary rights. The Company has applied for the registration of certain of
its trademarks and service marks in the United States and internationally. In
addition, the Company has filed U.S. and international patent applications
covering certain of its proprietary technology. Effective trademark, service
mark, copyright, patent and trade secret protection may not be available in
every country in which the Company's products and services are made available
online. The Company has licensed in the past, and expects that it may license in
the future, certain of its proprietary rights, such as trademarks, technology or
copyrighted material, to third parties.

EMPLOYEES

As of March 15, 2000, Metastream Corporation had 40 full time employees,
including 21 in sales and marketing; 16 in research, development and quality
assurance; and 3 in administration. In the aggregate, the Company had 130 full
time employees, including 42 in sales and marketing; 61 in research, development
and quality assurance; and 27 in finance and administration. The Company also
employs independent contractors. The employees and the Company are not parties
to any collective bargaining agreements, and the Company believes that its
relationships with its employees are good.

ADDITIONAL FACTORS AFFECTING FUTURE RESULTS

Shares of MetaCreations' Common Stock are speculative in nature and involve
a high degree of risk. The following risk factors should be considered
carefully. The risks described below are not the only ones facing MetaCreations.
Many factors could cause our results to be different, including the following
risk factors and other risks described in this document. If any of the following
risks occur, our business would likely be adversely affected and the trading
price of our Common Stock could decline. This could result in a loss of all or
part of your investment.

WE HAVE A LIMITED OPERATING HISTORY THAT MAKES AN EVALUATION OF OUR BUSINESS
DIFFICULT

We have been developing e-commerce visualization solutions for the Web
since our acquisition of Real Time Geometry Corp. in December 1996.
Additionally, the e-commerce market is relatively new and evolving rapidly.
Accordingly, we have a relatively short operating history in this market upon
which you can evaluate our business and prospects. You should consider our
prospects in light of the risks and difficulties frequently encountered by early
stage online companies, including, but not limited to:

- We have an evolving and unpredictable business model;

- We face intense competition;

- We must establish and develop broad market acceptance of our products,
technologies and services;

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<PAGE> 11

- We must continue to develop new products, technologies and enhancements;

- We must respond quickly to rapidly changing market developments, customer
demands and industry standards;

- We must attract, train and retain qualified employees; and

- We must effectively manage our growth.

If we are not successful in addressing these risks and challenges, we will
not be able to grow our business, compete effectively or achieve profitability.

WE HAVE A HISTORY OF LOSSES AND EXPECT TO INCUR LOSSES IN THE FUTURE

We have had significant quarterly and annual operating losses since our
inception, and as of December 31, 1999, we had an accumulated deficit of
approximately $89.9 million. We have recently announced our decision to divest
ourselves of all our prepackaged graphics software products and focus
exclusively on our industry-leading, patented e-commerce visualization solution,
Metastream. We believe that, despite this change in our strategic focus, we will
continue to incur operating losses for the foreseeable future.

OUR FUTURE REVENUES MAY BE UNPREDICTABLE AND MAY CAUSE OUR QUARTERLY RESULTS
TO FLUCTUATE

As a result of our limited operating history and the rapidly changing
nature of the markets in which we compete, we may be unable to forecast our
quarterly and annual revenues accurately. If our future quarterly operating
results fall below the expectations of securities analysts or investors, the
trading price of our common stock will likely drop. Our quarterly operating
results have fluctuated significantly in the past and may continue to fluctuate
in the future as a result of many factors, including:

- Ability to retain existing customers, attract new customers, and satisfy
our customers' demands;

- Market acceptance of our products, technologies and services;

- Introduction or enhancement of new products, technologies or services by
us or our competitors;

- Changes in prices for our products, technologies and services or our
competitors' products, technologies and services;

- Changes in usage of the Internet and online services and consumer
acceptance of the Internet and e-commerce;

- Costs of litigation and intellectual property protection;

- Growth in Internet use;

- Emergence of new competition;

- Varying operating costs and capital expenditures related to the expansion
of our business operations and infrastructure; and

- Technical difficulties with our technologies.

Based on these factors, we believe our revenues, expenses and operating
results could vary significantly in the future and period-to-period comparisons
should not be relied upon as indications of future results.

Additionally, in connection with our decision to focus exclusively on
e-commerce visualization, we decided to no longer focus on one-time technology
licenses, in favor of implementing a recurring broadcast licensing model. This
licensing model is based on Metastream 3.0, which is expected to be launched at
the end of March 2000. There can be no assurance that this new recurring
broadcast licensing model will result in the revenue growth rates realized in
prior years. If we are unable to implement this broadcast licensing model on a
timely basis, if at all, our business would be harmed.

10
<PAGE> 12

Our staffing and other operating expenses are based in large part on
anticipated revenues. It would be difficult for us to adjust our spending to
compensate for any unexpected shortfall. If we are unable to reduce our spending
following any such shortfall, our results of operations would be adversely
affected.

OUR STOCK PRICE IS VOLATILE AND MAY CONTINUE TO FLUCTUATE IN THE FUTURE

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, technologies or services;

- Actual or anticipated fluctuations in our operating results; and

- Developments regarding our products, technologies or services, or those
of our competitors.

In addition, the stock market has experienced extreme price and volume
fluctuations in recent months. This volatility has had a substantial effect on
our stock price, as well as the stock prices of other software companies,
particularly Internet companies. These broad market and industry fluctuations
may adversely affect the market price of our common stock. As a result, the
market price of our common stock may continue to fluctuate.

IF THE INTERNET DOES NOT CONTINUE TO EXPAND AS A WIDESPREAD COMMERCE MEDIUM,
DEMAND FOR OUR PRODUCTS AND TECHNOLOGIES MAY DECLINE SIGNIFICANTLY

The market for our products, technologies and services is new and evolving
rapidly. Growth in this market depends on increased use of the Internet for
e-commerce. If the Internet is not adopted as a method for e-commerce, or if the
adoption rate slows, the market for our products, technologies and services may
not grow, or may develop more slowly than expected.

We believe that increased Internet use may depend on the availability of
greater bandwidth or data transmission speeds or on other technological
improvements, and we are largely dependent on third party companies to provide
or facilitate these improvements. Changes in content delivery methods and
emergence of new Internet access devices such as TV set-top boxes could
dramatically change the market for streaming media products and services if new
delivery methods or devices do not use streaming media or if they provide a more
efficient method for transferring data than streaming media.

The e-commerce market is relatively new and evolving. Licensing of our
products and technologies depends in large part on the development of the
Internet as a viable commercial marketplace. There are now substantially more
users and much more "traffic" over the Internet than ever before, use of the
Internet is growing faster than anticipated, and the technological
infrastructure of the Internet may be unable to support the demands placed on it
by continued growth. Delays in development or adoption of new technological
standards and protocols, or increased government regulation, could also affect
Internet use. In addition, issues related to use of the Internet, such as
security, reliability, cost, ease of use and quality of service, remain
unresolved and may affect the amount of business that is conducted over the
Internet.

OUR MARKET IS CHARACTERIZED BY RAPIDLY CHANGING TECHNOLOGY, AND IF WE DO NOT
RESPOND IN A TIMELY MANNER, OUR PRODUCTS AND TECHNOLOGIES MAY NOT SUCCEED IN
THE MARKETPLACE

The market for e-commerce visualization is characterized by rapidly
changing technology. As a result, our success depends substantially upon our
ability to continue to enhance our products and technologies and to develop new
products and technologies that meet customers' increasing expectations.
Additionally, we may not be successful in developing and marketing enhancements
to our existing products and technologies or introducing new products and
technologies on a timely basis. Our new or enhanced products and technologies
may not succeed in the marketplace.

11
<PAGE> 13

We expect our research and development expenditures will increase in the
future. If our increased research and development spending is not accompanied by
increased revenues, our business would be harmed.

POTENTIAL DELAYS IN PRODUCT RELEASES COULD HARM OUR BUSINESS

We also depend upon internal efforts for the development of new products,
technologies and enhancements. In the past, we have had delays in the
development of new products, technologies and enhancements. We may experience
similar delays in the future, which would harm our business.

UNDETECTED ERRORS IN OUR PRODUCTS AND TECHNOLOGIES COULD RESULT IN ADVERSE
PUBLICITY, REDUCED MARKET ACCEPTANCE OR LAWSUITS BY CUSTOMERS

We offer complex software products and technologies, which may contain
undetected errors. If errors are found in our products or technologies after we
have commercially released them, we could likely experience adverse publicity,
reduced market acceptance or lawsuits by customers. This would adversely affect
our business.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS AND WE MAY BE
LIABLE FOR INFRINGING THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS

Our success and ability to compete partly depend on the uniqueness or value
of our products and technologies. We rely on a combination of copyright,
trademark, patent, trade secret laws, employee and third-party nondisclosure
agreements and exclusive contracts to protect our intellectual and proprietary
rights, products, and technologies. Policing unauthorized use of our products
and technologies is difficult and the steps we take may not prevent the
misappropriation or infringement of technology or proprietary rights. In
addition, litigation may be necessary to enforce our intellectual property
rights. Such misappropriation or litigation could result in substantial costs
and diversion of resources and the potential loss of intellectual property
rights, any of which would adversely impair our business.

Our products and technologies may be the subject of infringement claims in
the future. This could result in costly litigation and could require us to
obtain a license to the intellectual property of third parties. We may be unable
to obtain licenses from these third parties on favorable terms, if at all. Even
if a license is available, we may have to pay substantial royalties to obtain
it. If we cannot obtain necessary licenses on reasonable terms, our business
would be adversely affected.

SECURITY RISKS COULD LIMIT THE GROWTH OF E-COMMERCE AND EXPOSE US TO
LITIGATION OR LIABILITY

E-commerce depends on the ability to transmit confidential information
securely over public networks. Any compromise of our customers' ability to
transmit confidential information securely could harm our business. Online
transmissions are subject to the following risks, among others:

- Encryption and authentication technology may be subject to events or
developments that could compromise or breach the security of customer
information;

- A third party could circumvent security measures and misappropriate
proprietary information or interrupt operations;

- Credit card companies could restrict online credit card transactions; or

- Security breaches could damage our or our customers' reputation and
expose us to litigation or liability.

INCREASING GOVERNMENT REGULATION COULD INCREASE OUR COST OF DOING BUSINESS OR
INCREASE OUR LEGAL EXPOSURE

We are not currently subject to direct regulation by any governmental
agency other than laws and regulations generally applicable to businesses. It is
possible that a number of laws and regulations may be adopted in the U.S. and
abroad with particular applicability to the Internet. Governments have and may
continue to enact legislation applicable to the Internet in areas such as
content distribution, performance and

12
<PAGE> 14

copying, other copyright issues, network security, encryption, the use of key
escrow data, privacy protection, caching of content by server products,
electronic authentication or "digital" signatures, illegal or obscene content,
access charges and retransmission activities. The applicability to the Internet
of existing laws governing issues such as property ownership, content, taxation,
defamation and personal privacy is also uncertain. Export or import
restrictions, new legislation or regulation or governmental enforcement of
existing regulations may limit the growth of the Internet, increase our cost of
doing business or increase our legal exposure.

WE MAY NEED TO ENTER INTO BUSINESS COMBINATIONS AND STRATEGIC ALLIANCES WHICH
COULD BE DIFFICULT TO INTEGRATE AND MAY DISRUPT OUR BUSINESS

We may expand our operations or market presence by entering into business
combinations, investments, joint ventures or other strategic alliances with
other companies. These transactions create risks such as:

- Difficulty assimilating the operations, technology and personnel of the
combined companies;

- Disruption of our ongoing business;

- Problems retaining key technical and managerial personnel;

- Expenses associated with amortization of goodwill and other purchased
intangible assets;

- Additional operating losses and expenses of acquired businesses; and

- Impairment of relationships with existing employees, customers and
business partners.

If we enter into such business combinations and strategic alliances and are
not successful in addressing these risks, our business would be adversely
affected.

THE LOSS OF ANY OF OUR KEY PERSONNEL WOULD HARM OUR BUSINESS

We depend on the continued employment of our senior executive officers and
other key management personnel. We do not have any long-term employment
agreements with any of our key personnel, and we do not have "key person" life
insurance policies. 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 December 1999, our previous President and Chief Executive Officer,
Gary Lauer, resigned. Mark Zimmer, previously President of MetaCreations'
business graphics division, was appointed President and Chief Executive Officer.
Additionally, Robert Rice, President of Metastream Corporation, was also
appointed Chief Executive Officer of Metastream Corporation in December 1999. In
addition, in connection with our recent restructuring, several senior-level
management personnel left our Company. As a result of the shifting of our
operations to our MetaStream Corporation subsidiary, Metastream Corporation has
recently hired a Chief Marketing Officer, a Vice President, Marketing and a Vice
President, Client Services. If we do not succeed in attracting and retaining new
officers, our business would be adversely affected.

OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO IDENTIFY, HIRE, TRAIN AND RETAIN
HIGHLY QUALIFIED EMPLOYEES

Our future success depends on our continuing ability to identify, hire,
train and retain other highly qualified technical and managerial employees. The
competition for such employees is intense, and we have experienced difficulty in
identifying and hiring qualified engineering personnel. If we do not succeed in
attracting and retaining necessary technical and managerial employees in the
future, our business would be adversely affected.

Additionally, in order to attract and retain employees in the past, we have
granted options to purchase shares of common stock to employees at an exercise
price below the fair value of the common stock on the date of grant. As a
result, we have had to record deferred compensation related to the intrinsic
value of the option. This deferred compensation is amortized over the vesting
period of applicable options, which is generally four years, resulting in a
non-cash charge to earnings over the related vesting period. If we have to

13
<PAGE> 15

issue additional options at an exercise price below the fair value of the common
stock on the date of grant, our business would be adversely affected.

ITEM 2. PROPERTIES

The Company leases approximately 12,000 square feet of space in a 24-story
building in New York City, New York. This office, which will open at the end of
March 2000, will house substantially the entire Company by the end of June 2000.
The lease agreement expires in February 2010, if not renewed. The Company
believes that this office space is adequate for its current needs and that
additional space is available to provide for anticipated growth.

The Company's corporate office consists of approximately 42,000 square feet
of leased space in two one-story buildings in Carpinteria, Santa Barbara County,
California. This space houses substantially all of the Company's general and
administrative personnel as well as a portion of its sales and marketing and
research and development personnel. The lease agreements expire in December 2007
and September 2008, if not renewed. As the Company is relocating to its new
offices in New York City, the Company is in the process of subletting this
office space.

The Company also leases approximately 30,000 square feet of office space in
Scotts Valley, California, pursuant to a lease agreement which expires in
September 2003. This space houses a significant portion of the Company's sales
and marketing and research and development personnel. The lease provides for two
options to extend the term of the lease for three years each. As the Company is
relocating to its new offices in New York City, the Company is in the process of
subletting this office space.

The Company leases approximately 13,000 square feet of office space in
Princeton and Short Hills, New Jersey, pursuant to lease agreements, which
expire in November 2001 and May 2000, respectively. As the Company is relocating
to its new offices in New York City, the Company will not renew these leases.

ITEM 3. LEGAL PROCEEDINGS

The Company is engaged in certain legal actions arising in the ordinary
course of business. The Company believes it has adequate legal defenses and
believes that the ultimate outcome of these actions will not have a material
effect on the Company's consolidated financial position, results of operations,
or cash flows.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

14
<PAGE> 16

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION FOR COMMON STOCK

The Company's common stock, $0.001 par value, began trading over the
counter in December 1995, and is quoted on the Nasdaq National Market tier of
the Nasdaq Stock Market under the symbol "MCRE." The following table sets forth,
for the periods indicated, the range of high and low closing sale prices per
share as reported on the Nasdaq National Market System:

<TABLE>
<CAPTION>
HIGH LOW
------ -----
<S> <C> <C>
1999
4th Quarter................................................. $ 8.94 $5.06
3rd Quarter................................................. 7.25 5.13
2nd Quarter................................................. 7.38 4.56
1st Quarter................................................. 8.88 5.75
1998
4th Quarter................................................. $ 8.06 $3.06
3rd Quarter................................................. 5.63 3.03
2nd Quarter................................................. 12.19 4.63
1st Quarter................................................. 10.75 6.38
</TABLE>

HOLDERS

As of March 15, 2000, there were approximately 400 holders of record of the
Company's common stock.

DIVIDENDS

The Company has not paid any cash dividends on its capital stock to date.
The Company currently anticipates that it will retain all future earnings, if
any, for use in its business and does not anticipate paying any cash dividends
on its capital stock in the foreseeable future.

15
<PAGE> 17

ITEM 6. SELECTED FINANCIAL DATA

The following selected condensed financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
notes thereto appearing elsewhere in this Annual Report on Form 10-K/A.

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1999 1998 1997 1996 1995
------------- -------- ------- ------- -------
(RESTATED)(2)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Net revenues.................................. $ 3,093 $ 3,001 $ 1,262 $ -- $ --
Operating expenses:
Sales and marketing (excluding stock-based
compensation totaling $675 in 1999)....... 2,567 981 624 -- --
Research and development (excluding
stock-based compensation totaling $2,540
in 1999).................................. 2,816 1,584 2,357 -- --
General and administrative (excluding
stock-based compensation totaling $2,866
in 1999).................................. 4,065 4,409 3,471 -- --
Stock-based compensation.................... 6,081 -- -- -- --
------------- -------- ------- ------- -------
Total operating expenses............. 15,529 6,974 6,452 -- --
------------- -------- ------- ------- -------
Loss from operations.......................... (12,436) (3,973) (5,190) -- --
Other income.................................. 2,286 2,618 3,157 -- --
------------- -------- ------- ------- -------
Loss before provision (benefit) for income
taxes....................................... (10,150) (1,355) (2,033) -- --
Provision (benefit) for income taxes.......... 5,481 (353) (210) -- --
------------- -------- ------- ------- -------
Loss before minority interest in loss of
subsidiary.................................. (15,631) (1,002) (1,823) -- --
Minority interest in loss of subsidiary....... 1,048 -- -- -- --
------------- -------- ------- ------- -------
Net loss from continuing operations........... (14,583) (1,002) (1,823) -- --
Discontinued operations(1):
Income (loss) from discontinued
operations................................ (14,811) (18,829) (6,355) (7,650) 2,426
Loss on disposal of discontinued
operations................................ (21,260) -- -- -- --
------------- -------- ------- ------- -------
Net income (loss) from discontinued
operations......................... (36,071) (18,829) (6,355) (7,650) 2,426
------------- -------- ------- ------- -------
Net income (loss)............................. $ (50,654) $(19,831) $(8,178) $(7,650) $ 2,426
============= ======== ======= ======= =======
Net income (loss) applicable to common
stockholders................................ $ (50,654) $(19,831) $(8,178) $(7,650) $ 2,337
============= ======== ======= ======= =======
Basic net income (loss) per common share:
Net loss per common share from continuing
operations................................ $ (0.59) $ (0.04) $ (0.08) $ -- $ --
Net income (loss) per common share from
discontinued operations................... (1.47) (0.79) (0.28) (0.37) 0.18
------------- -------- ------- ------- -------
Net income (loss) per common share.......... $ (2.06) $ (0.83) $ (0.36) $ (0.37) $ 0.18
============= ======== ======= ======= =======
Diluted net income (loss) per common share:
Net loss per common share from continuing
operations................................ $ (0.59) $ (0.04) $ (0.08) $ -- $ --
Net income (loss) per common share from
discontinued operations................... (1.47) (0.79) (0.28) (0.37) 0.15
------------- -------- ------- ------- -------
Net income (loss) per common share.......... $ (2.06) $ (0.83) $ (0.36) $ (0.37) $ 0.15
============= ======== ======= ======= =======
Weighted average number of shares outstanding:
Basic....................................... 24,581 23,779 22,965 20,590 12,987
============= ======== ======= ======= =======
Diluted..................................... 24,581 23,779 22,965 20,590 15,267
============= ======== ======= ======= =======
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------
1999 1998 1997 1996 1995
------------- ------- ------- ------- -------
(RESTATED)(2)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash, cash equivalents and short-term
investments.................................. $ 37,316 $46,335 $50,002 $66,293 $77,721
Working capital................................ 30,240 55,439 77,677 79,254 80,135
Total assets................................... 47,176 79,116 97,257 97,935 95,017
Stockholders' equity........................... 26,503 70,181 87,242 86,112 82,916
</TABLE>

16
<PAGE> 18

---------------
(1) In December 1999, the Board of Directors of MetaCreations approved a plan to
focus exclusively on the Company's Metastream technologies, and to
correspondingly divest itself of all its prepackaged graphics software
business. Consequently, the results of operations of the prepackaged
graphics software business have been classified as loss from discontinued
operations for the years ended December 31, 1995 through 1999.
(2) See Note 2 of the notes to consolidated financial statements regarding
restatement of 1999 financial statements.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The discussion and analysis below contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Exchange Act. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, actual results could differ materially from those expressed
or forecasted in any such forward-looking statements as a result of certain
factors, including those set forth in "Additional Factors Affecting Future
Results." In connection with forward-looking statements which appear in these
disclosures, investors should carefully review the factors set forth in this
Form 10-K/A under "Additional Factors Affecting Future Results."

OVERVIEW

MetaCreations, a Delaware corporation, was formed in May 1997 as a result
of the merger of MetaTools, Inc. and Fractal Design Corporation, and includes
the acquisitions of Real Time Geometry Corp. in December 1996, Specular
International. Ltd. in April 1997, Canoma, Inc. in December 1998, RAYflect S.A.
in June 1999, as well as the previous merger of Fractal and Ray Dream, Inc. in
May 1996. The financial results for 1995 and 1996 include the pooled financial
statements of MetaTools, Inc., Fractal Design Corporation, and Ray Dream, Inc.

MetaCreations provides e-commerce visualization solutions for the World
Wide Web. MetaCreations' strategy is centered on the Company's Metastream
technology and software tools designed to make the interactive use of
photo-realistic 3D on the Web practical and pervasive.

Metastream Corporation, a joint initiative between MetaCreations and
Computer Associates, was formed in June 1999. Metastream Corporation, which is
80% owned by MetaCreations and 20% owned by Computer Associates, is focused on
providing complete end-to-end solutions for creating and deploying virtual
products centered on the Company's Metastream technologies for e-commerce and
the Web environment. Metastream Corporation's primary initiatives include:

- Licensing technology for specific e-commerce visualization solutions;

- Providing a full range of fee-based professional services for
implementing 3D solutions;

- Forging technological alliances with leading interactive agencies and web
content providers; and

- Maximizing market penetration and name recognition.

In December 1999, the Board of Directors of MetaCreations approved a plan
to focus exclusively on the Company's Metastream technologies, and to
correspondingly divest itself of all its prepackaged graphics software business.
Accordingly, the continuing operations of MetaCreations are focused exclusively
on Metastream Corporation.

In light of this change in strategic focus, MetaCreations has a limited
operating history upon which an evaluation of the Company and its prospects can
be based. MetaCreations' prospects must be considered in light of the risks and
difficulties frequently encountered by early stage online companies. There can
be no assurance that MetaCreations will achieve or sustain profitability.
MetaCreations has had significant quarterly

17
<PAGE> 19

and annual operating losses since its inception, and as of December 31, 1999,
had an accumulated deficit of approximately $89.9 million.

MetaCreations believes that its success will depend largely on its ability
to extend its technology and market leadership in e-commerce visualization.
Accordingly, MetaCreations intends to invest heavily in research and development
and sales and marketing. MetaCreations has experienced significant percentage
growth in net revenues. However, these revenues have been primarily from
one-time technology licenses from a limited number of strategic partners. In
connection with its decision to focus exclusively on e-commerce visualization,
the Company has decided to no longer focus on these one-time technology
licenses, in favor of implementing a recurring broadcast licensing model. This
licensing model is based on Metastream 3.0, which is expected to be launched at
the end of March 2000. There can be no assurance that this new recurring
broadcast licensing model will result in the revenue growth rates realized in
prior years. See "Additional Factors Affecting Future Results."

RESTATEMENT OF FINANCIAL STATEMENTS

OPERATING RESULTS

The following table sets forth certain selected financial information
expressed as a percentage of net revenues for the periods indicated:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
------------- ------ ------
(RESTATED)(1)
-------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Net revenues................................................ 100.0% 100.0% 100.0%
Operating expenses:
Sales and marketing....................................... 83.0 32.7 49.5
Research and development.................................. 91.0 52.8 186.8
General and administrative................................ 131.5 146.9 275.0
Stock-based compensation.................................. 196.6 -- --
------------- ------ ------
Total operating expenses.......................... 502.1 232.4 511.3
------------- ------ ------
Loss from operations........................................ (402.1) (132.4) (411.3)
Other income................................................ 73.9 87.2 250.2
------------- ------ ------
Loss before provision (benefit) for income taxes............ (328.2) (45.2) (161.1)
Provision (benefit) for income taxes........................ 177.2 (11.8) (16.7)
------------- ------ ------
Loss before minority interest in loss of subsidiary......... (505.4) (33.4) (144.4)
Minority interest in loss of subsidiary..................... 33.9 -- --
------------- ------ ------
Net loss from continuing operations......................... (471.5) (33.4) (144.4)
Discontinued operations:
Loss from discontinued operations......................... (478.9) (627.4) (503.6)
Loss on disposal of discontinued operations............... (687.3) -- --
------------- ------ ------
Net loss from discontinued operations............. (1,166.2) (627.4) (503.6)
------------- ------ ------
Net loss.................................................... (1,637.7)% (660.8)% (648.0)%
============= ====== ======
</TABLE>

---------------

(1) See Note 2 of the notes to consolidated financial statements regarding
restatement of 1999 financial statements.

NET REVENUES

<TABLE>
<CAPTION>
1999 % CHANGE 1998 % CHANGE 1997
-------- -------- ------ -------- ------
RESTATED (DOLLARS IN THOUSANDS)
--------
<S> <C> <C> <C> <C> <C>
Net revenues....................... $3,093 3% $3,001 138% $1,262
</TABLE>

18
<PAGE> 20

The Company recognizes revenue in accordance with Statement of Position
("SOP") 97-2, "Software Revenue Recognition." Accordingly, revenue from software
arrangements involving multiple elements (e.g., software products,
upgrades/enhancements, postcontract customer support, etc.) is allocated to each
element based on the relative fair value of the elements. The determination of
fair value is based on objective evidence, which is specific to the Company.

SOP 97-2 was amended in February 1998 by SOP 98-4 "Deferral of the
Effective Date of a Provision of SOP 97-2" and was amended again in December
1998 by SOP 98-9 "Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions." Those amendments deferred and then clarified,
respectively, the specification of what was considered vendor specific objective
evidence of fair value for the various elements in a multiple element
arrangement. The Company adopted the provisions of SOP 97-2 and SOP 98-4 as of
January 1, 1998.

SOP 98-9 is effective for all transactions entered into by the Company
during the year ending December 31, 2000. The adoption of this statement is not
expected to have a material impact on the Company's operating results, financial
position or cash flows.

Service revenue, which consists of fees for professional services, is
recognized as the services are performed or, if no pattern of performance is
discernible, on a straight-line basis over the period during which the services
are performed.

Net revenues primarily consist of one-time licenses for Metastream and
related technologies from a limited number of strategic partners. Specifically,
revenues from Intel and Computer Associates accounted for 49% and 39% of total
revenues, respectively, in 1999; revenues from Intel, Kodak and Minolta
accounted for 66%, 15% and 15% of total revenues, respectively, in 1998; and
revenues from Real 3D Company accounted for 100% of total revenues in 1997. In
connection with its decision to focus exclusively on e-commerce visualization,
the Company decided to no longer focus on these one-time technology licenses, in
favor of implementing a recurring broadcast licensing model. This licensing
model is based on Metastream 3.0, which is expected to be launched at the end of
March 2000. There can be no assurance that this new recurring broadcast
licensing model will result in the revenue growth rates realized in prior years.

SALES AND MARKETING

<TABLE>
<CAPTION>
1999 % CHANGE 1998 % CHANGE 1997
-------- -------- ---- -------- ----
RESTATED
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Sales and marketing................... $2,567 162% $981 57% $624
As % of net revenues................ 83% 33% 49%
</TABLE>

Sales and marketing expenses consist primarily of salaries, sales
commissions, consulting fees, advertising and required facilities costs related
to sales, marketing, business development, Web services and public relations
personnel who promote the Company's products, technologies and services. The
162% increase in sales and marketing expenses in 1999 is primarily due to
increased salaries, consulting fees, and related travel and facilities expenses
in connection with the expansion of the Company's sales, Web services and public
relations departments. The 57% increase in sales and marketing expenses in 1998
primarily relates to increased salaries, consulting fees and travel expenses in
connection with the expansion of the Company's business development group. The
Company is continuing to expand its sales and marketing presence and,
accordingly, 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

<TABLE>
<CAPTION>
1999 % CHANGE 1998 % CHANGE 1997
-------- -------- ------ -------- ------
RESTATED
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Research and development........... $2,816 78% $1,584 (33)% $2,357
As % of net revenues............. 91% 53% 187%
</TABLE>

19
<PAGE> 21

Research and development expenses consist primarily of salaries, consulting
fees, and required equipment and facilities costs related to the Company's
product development efforts. The Company expenses as incurred research and
development costs necessary to establish the technological feasibility of its
internally-developed software products and technologies. 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. Additionally, the Company
capitalizes costs of software, consulting services, hardware and payroll-related
costs incurred to purchase or develop internal-use software. The Company
expenses costs incurred during preliminary project assessment, research and
development, re-engineering, training and application maintenance.

The 78% increase in research and development expenses is primarily due to
increases in internal development personnel, consulting fees and related travel
and facilities expenses in connection with the development of Metastream 3.0.
The 33% decrease in research and development expenses is primarily due to the
downsizing and refocusing of the Company's research and development departments
at the end of 1997 and the beginning of 1998. 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

<TABLE>
<CAPTION>
1999 % CHANGE 1998 % CHANGE 1997
-------- -------- ------ -------- ------
RESTATED
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
General and administrative......... $4,065 (8)% $4,409 27% $3,471
As % of net revenues............. 131% 147% 275%
</TABLE>

General and administrative expenses primarily consist of corporate overhead
of the Company, which includes compensation costs related to finance and
administration personnel along with other administrative costs such as legal and
accounting fees and insurance expense. The 8% decrease in general and
administrative expenses in 1999 was primarily attributed to one-time expenses in
1998 in connection with the recruiting and relocation of a new chief executive
officer in February 1998, as well as consulting costs related to the preparation
of the Company's 1998 strategic plan. This decrease in expenses in 1999 was
partially offset by increased general and administrative expenses resulting from
the formation of Metastream Corporation in June 1999. The 27% increase in
general and administrative expenses in 1998 relates to the increased recruiting
and relocation and consulting costs. As the Company divests itself of its
prepackaged software business, it expects that its corporate overhead will
decrease, resulting in a corresponding decrease in general and administrative
expenses, which may vary as a percentage of net revenues.

STOCK-BASED COMPENSATION

<TABLE>
<CAPTION>
1999 % CHANGE 1998 % CHANGE 1997
-------- -------- ---- -------- ----
RESTATED
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Stock-based compensation................ $6,081 100% $-- --% $--
As % of net revenues.................. 197% --% --%
</TABLE>

In connection with the grant of stock options of Metastream Corporation to
certain employees and non-employee directors, Metastream Corporation recorded
total deferred compensation of approximately $16.8 million in 1999. This
deferred compensation represented the difference between the deemed fair value
of Metastream Corporation common stock for accounting purposes and the exercise
price of these options at the date of grant. Minority interest in the Company's
consolidated balance sheets is credited with its proportionate interest in
stock-based compensation expense that is recognized. Stock-based compensation
expense of $6.1 million was recognized during the year ended December 31, 1999.

20
<PAGE> 22

OTHER INCOME

<TABLE>
<CAPTION>
1999 % CHANGE 1998 % CHANGE 1997
-------- -------- ------ -------- ------
RESTATED
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Other income....................... $2,286 (13)% $2,618 (17)% $3,157
</TABLE>

Other income primarily consists of interest and investment income on cash
and marketable securities. Other income decreased 17% in 1998 and 13% in 1999 as
a result of decreased cash balances and short-term investments. Other income may
vary in the future based upon the timing of the receipt of proceeds from the
divestiture of the prepackaged graphics software products and from the exercise
of stock options, in addition to cash provided by or used in the future
operations of the Company.

PROVISION FOR INCOME TAXES

In the fourth quarter of 1999, the Company recorded a provision for income
taxes in the amount of $5.5 million, which provided a full valuation allowance
against its net deferred tax assets. The Company's net deferred tax assets
include substantial amounts of net operating loss carryforwards. Inability to
generate taxable income within the carryforward period would affect the ultimate
realizability of such assets. Consequently, management determined that
sufficient uncertainty exists regarding the realizability of these assets to
warrant the establishment of the full valuation allowance. Utilization of the
Company's net operating loss carryforwards, which begin to expire in 2011 for
federal purposes and 2001 for state purposes, may be subject to certain
limitations under Section 382 of the Internal Revenues Code of 1986, as amended.

MINORITY INTEREST

Metastream Corporation, a joint initiative between MetaCreations and
Computer Associates, was formed in June 1999. For financial reporting purposes,
the assets, liabilities and earnings of Metastream Corporation are included in
the Company's consolidated financial statements. Computer Associate's 20%
interest in Metastream Corporation has been recorded as minority interest in the
Company's consolidated balance sheets, and the losses attributed to their 20%
interest have been reported as minority interest in the Company's consolidated
statements of operations.

DISCONTINUED OPERATIONS

In December 1999, the Board of Directors approved a plan to focus
exclusively on its industry-leading, patented e-commerce visualization solution,
Metastream, and to correspondingly divest itself of all its prepackaged graphics
software business. Accordingly, these operations are reflected as discontinued
operations for all periods presented in the accompanying statements of
operations.

The loss on disposal of discontinued operations, which totaled
approximately $21.3 million for the year ended December 31, 1999, consists of
the estimated future results of operations of the discontinued business through
the estimated June 30, 2000 divestiture date, the amounts expected to be
realized upon the sale of the discontinued business, severance and related
benefits, and asset write-downs (see table below). The provision for loss on
disposal of discontinued operations is an estimate and subject to change.
Changes in estimates will be accounted for prospectively and included in income
(loss) from discontinued operations.

21
<PAGE> 23

The following table depicts the loss on disposal of discontinued operations
activity through December 31, 1999 (in thousands):

<TABLE>
<CAPTION>
LOSS ON DISPOSAL PROVISION AT
OF DISCONTINUED DECEMBER 31,
OPERATIONS DEDUCTIONS 1999
---------------- ---------- ------------
<S> <C> <C> <C>
Write-down of operating assets............... $ 18,445 $18,103 $ 342
Severance and benefits....................... 8,415 504 7,911
Estimated loss of discontinued operations
through divestiture date................... 5,400 -- 5,400
Estimated net proceeds from divestiture...... (11,000) -- (11,000)
-------- ------- --------
$ 21,260 $18,607 $ 2,653
======== ======= ========
</TABLE>

Operating results from discontinued operations were as follows (in
thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1999 1998 1997
-------- -------- -------
RESTATED
<S> <C> <C> <C>
Net revenues................................................ $ 33,079 $ 39,842 $67,812
Cost of revenues............................................ 6,339 7,007 11,859
-------- -------- -------
Gross profit.............................................. 26,740 32,835 55,953
Operating expenses:
Sales and marketing....................................... 25,022 27,699 31,419
Research and development.................................. 13,691 14,207 11,765
General and administrative................................ 4,758 2,453 2,939
Costs associated with mergers, acquisitions and
restructurings......................................... -- 7,305 16,185
-------- -------- -------
Total operating expenses.......................... 43,471 51,664 62,308
-------- -------- -------
Loss before gain on sale of assets.......................... (16,731) (18,829) (6,355)
Gain on sale of assets...................................... 1,920 -- --
-------- -------- -------
Loss before benefit for income taxes........................ (14,811) (18,829) (6,355)
Benefit for income taxes.................................... -- -- --
-------- -------- -------
Loss from discontinued operations........................... $(14,811) $(18,829) $(6,355)
======== ======== =======
</TABLE>

YEAR 2000 RISKS

Background

Many currently installed computer systems and software products are coded
to accept only two digit entries for the year in the date code field. Beginning
in the year 2000, these date code fields needed to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, over the
past year, computer systems and software used by many companies were upgraded to
comply with such "Year 2000" requirements. The Year 2000 problem could have
affected computers, software and other equipment used, operated, or maintained
by us, our business partners, our suppliers and our customers.

Project

We identified potential Year 2000 risks in five categories:

(1) Internal business software and systems;

(2) Systems other than information technology systems ("non-IT
systems");

(3) Software products we sell to customers;

(4) Third party distributors of our products; and

(5) Third party suppliers of products and services to us.

22
<PAGE> 24

Our Year 2000 project included the following phases for the first three
categories above:

(1) Inventorying Year 2000 items;

(2) Assessing Year 2000 compliance for items determined to be material;

(3) Assigning priorities to identified items;

(4) Implementing remediation plans for items determined to be material
and not Year 2000 compliant;

(5) Re-testing items for which corrections have been implemented; and

(6) Developing contingency plans.

With respect to the our third-party distributors and suppliers, our Year
2000 project consisted of the following phases:

(1) Contacting distributors and suppliers for information concerning
their Year 2000 readiness;

(2) Prioritizing distributors and suppliers as to relative importance;

(3) Validating distributor and supplier responses regarding Year 2000
compliance; and

(4) Developing contingency plans in the event one or more distributors
or suppliers fails to achieve Year 2000 compliance.

Assessment

Internal business software and systems consisted primarily of our business
information system, which is based in the United States and services our
worldwide operations. During 1997, we completed implementation of a Year 2000
compliant enterprise-wide information system. Additionally, during 1999, we
completed all six phases of the Year 2000 project related to our mission
critical business systems. With the implementation of our new information system
and modification to existing software, we have not experienced any Year 2000
complications.

We were advised by our suppliers of non-IT systems, which primarily consist
of environmental systems such as fire suppression, air conditioning and heating,
and security systems at various buildings we occupy, that such systems were Year
2000 compliant. We have not experienced any Year 2000 complications related to
our suppliers of non-IT systems.

The software products and technologies that we sell to customers are not
date-sensitive. As a result, we believe that the current versions of our
products and technologies are Year 2000 compliant. We have not experienced any
Year 2000 complications related to our software products and technologies.

We contract with third parties for the manufacture and distribution of our
products. As a result, we maintain ongoing communications with our key suppliers
and distributors and monitored the status of their Year 2000 readiness. We also
completed the four phases of our Year 2000 project related to our key suppliers
and distributors. We have not experienced any Year 2000 complications related to
our key suppliers and distributors.

Costs

The balance of the effort for our Year 2000 project was completed by
employees whose costs for this project were not tracked separately. The costs
for our Year 2000 project was not material to our business, financial position,
results of operations, or cash flows.

Risks

We have not experienced any Year 2000 complications. However, there can be
no assurance that our internal business software and systems, Non-IT systems,
software products and technologies we sell to

23
<PAGE> 25

customers, third party distributors of our products and third party suppliers of
products and services to us contain all date code changes necessary to prevent
processing errors potentially arising from future calculations using the Year
2000 date. If subsequent Year 2000 failures occur, our business, financial
position, results of operations, or cash flows could be materially affected.

LIQUIDITY AND CAPITAL RESOURCES

Cash and investments totaled $37.3 million at December 31, 1999, down from
$46.3 million at December 31, 1998 and $50.0 million at December 31, 1997. Net
cash used in operating activities of the Company totaled $11.9 million for 1999,
compared to net cash provided by operating activities of $498,000 for 1998 and
net cash used in operating activities of $12.0 million for 1997. Net cash used
in operating activities in 1999 primarily resulted from $14.6 million net loss
from continuing operations and $10.2 million of net cash used for discontinued
operations, offset in part by a $6.1 million non-cash stock-based compensation
charge and a $5.9 million non-cash charge related to the full valuation
allowance placed against the deferred tax assets. Net cash provided by operating
activities in 1998 primarily resulted from $1.0 million net loss from continuing
operations and $792,000 of net cash used for discontinued operations, less $1.2
million of depreciation and amortization expense. Net cash used in operating
activities in 1997 primarily resulted from $1.8 million net loss from continuing
operations, $1.4 million non-cash benefit related to a reduction in the
valuation allowance placed against the deferred tax assets, $7.9 million of net
cash used for discontinued operations and a $1.0 million increase in accounts
receivable. Net cash provided by (used in) investing activities totaled $(7.4)
million, $5.3 million and $(1.5) million for 1999, 1998 and 1997, respectively.
Net cash used in investing activities in 1999 primarily resulted from $2.8
million of net purchases of short-investments and $4.5 million of net cash used
for discontinued operations. Net cash provided by investing activities in 1998
primarily resulted from $10.3 million of net proceeds from maturities of
short-term investments, net of $3.8 million of net cash used for discontinued
operations and the issuance of $1.2 million of notes receivable from related
parties. Net cash used in investing activities in 1997 primarily resulted from
$4.3 million of net purchases of short-term investments, net of $5.0 million of
net cash used for discontinued operations. Net cash provided by financing
activities totaled $7.5 million, $840,000 and $1.6 million for 1999, 1998 and
1997, respectively. Cash provided by financing activities in 1999 primarily
resulted from $4.0 million of proceeds from the exercise of stock options and
$3.5 million received from Computer Associates relating to its investment in
Metastream Corporation. Cash provided by financing activities in 1998 resulted
from $840,000 of proceeds from the exercise of stock options. Cash provided by
financing activities in 1997 primarily resulted from $1.9 million of proceeds
from the exercise of stock options.

The Company has a $3.0 million revolving line of credit with a bank.
Borrowings under the line of credit are limited to a percentage of eligible
accounts receivable, as defined in the credit agreement. The Company was not in
compliance with certain financial covenants at December 31, 1999. The Company
intends to renew the credit agreement, which expires in March 2000. As of
December 31, 1999, the Company had no outstanding borrowings under the line of
credit and one outstanding letter of credit in the amount of $275,000, which
expires in March 2010.

The Company expects that its working capital requirements will continue to
increase to the extent the Company continues to grow. The Company believes that
its current cash and investment balances, cash 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.

NEW ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which established accounting and reporting
standards for derivative instruments and hedging activities. SFAS No. 133 is
effective for fiscal years beginning after June 15, 2000. It requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. To
date, we have not engaged in derivative and hedging activities.
24
<PAGE> 26

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements," which gives additional guidance in applying generally accepted
accounting principles to revenue recognition in the financial statements.
Management does not believe the compliance with the provisions of SAB No. 101
will have a material effect on the accompanying consolidated financial
statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company is subject to concentration of credit risk and interest rate
risk related to cash equivalents and short-term investments. The Company does
not have any derivative financial instruments as of December 31, 1999. Credit
risk is managed by limiting the amount of investments placed with any one
issuer, investing in high-quality investment securities and securities of the
U.S. government and limiting the average maturity of the overall portfolio. The
majority of the Company's portfolio, which is classified as available-for-sale,
is composed of fixed income investments that 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. The Company may suffer losses in principal if forced to
sell securities, which have declined in market value due to changes in interest
rates.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

1. Index to Financial Statements

The following financial statements are filed as part of this Report:

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AUDITED FINANCIAL STATEMENTS
Report of Independent Accountants........................... 26
Consolidated Balance Sheets as of December 31, 1999 and 1998
(restated)................................................ 27
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1999 (restated).... 28
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 1999
(restated)................................................ 29
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1999 (restated).... 31
Notes to Consolidated Financial Statements (restated)....... 33
</TABLE>

2. Index to Financial Statement Schedules

The following financial statement schedule of the Company is filed as part
of this Report and should be read in conjunction with the financial statements
and notes thereto:

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SCHEDULE
Report of Independent Accountants on Financial Statement
Schedule.................................................. 57
Schedule II -- Valuation and Qualifying Accounts
(restated)................................................ 58
</TABLE>

All other schedules are omitted because they are not applicable, or not
required, or because the required information is included in the financial
statements or notes thereto.

25
<PAGE> 27

REPORT OF INDEPENDENT ACCOUNTANTS

Board of Directors and Stockholders
MetaCreations Corporation

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity and cash
flows present fairly, in all material respects, the consolidated financial
position of MetaCreations Corporation and its subsidiaries (the "Company") as of
December 31, 1999 and 1998, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
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
auditing standards generally accepted in the United States 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.

As discussed in Note 2 to the accompanying consolidated financial
statements, the Company has restated its financial statements for the year ended
December 31, 1999.

/s/ PricewaterhouseCoopers LLP

New York, New York
February 2, 2000, except for
Note 2 which is as of August 11, 2000

26
<PAGE> 28

METACREATIONS CORPORATION

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

ASSETS

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1999 1998
------------ --------
(RESTATED
SEE NOTE 2)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 4,480 $ 16,297
Short-term investments.................................... 32,836 30,038
Accounts receivable (Notes 9 and 16)...................... 123 913
Notes receivable from related parties..................... 1,000 1,151
Prepaid expenses.......................................... 1,139 735
Current assets related to discontinued operations (Note
3)..................................................... 4,702 15,240
-------- --------
Total current assets.............................. 44,280 64,374
Property and equipment, net................................. 614 725
Deferred income taxes....................................... -- 5,913
Other assets................................................ 308 510
Non-current assets related to discontinued operations (Note
3)........................................................ 1,974 7,594
-------- --------
Total assets...................................... $ 47,176 $ 79,116
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 224 $ 162
Accrued expenses.......................................... 1,985 1,578
Current liabilities related to discontinued operations
(Note 3)............................................... 9,178 7,195
Provision for loss on disposal of discontinued operations
(Note 3)............................................... 2,653 --
-------- --------
Total current liabilities......................... 14,040 8,935

Minority interest........................................... 6,633 --

Commitments and contingencies

Stockholders' equity:
Preferred stock, $.001 par value; 5,000 shares
authorized -- none issued and outstanding at December
31, 1999 and 1998...................................... -- --
Common stock, $.001 par value; 75,000 shares
authorized -- 25,496 and 24,243 shares issued and
outstanding at December 31, 1999 and 1998,
respectively........................................... 25 24
Paid-in capital........................................... 119,940 112,829
Notes receivable from related parties..................... (3,467) (3,340)
Accumulated other comprehensive loss...................... (137) (128)
Accumulated deficit....................................... (89,858) (39,204)
-------- --------
Total stockholders' equity........................ 26,503 70,181
-------- --------
Total liabilities and stockholders' equity........ $ 47,176 $ 79,116
======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
27
<PAGE> 29

METACREATIONS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
----------- -------- -------
(RESTATED
SEE NOTE 2)
<S> <C> <C> <C>
Net revenues (Notes 9 and 16).............................. $ 3,093 $ 3,001 $ 1,262
Operating expenses:
Sales and marketing (excluding stock-based compensation
totaling $675 in 1999)................................ 2,567 981 624
Research and development (excluding stock-based
compensation totaling $2,540 in 1999)................. 2,816 1,584 2,357
General and administrative (excluding stock-based
compensation totaling $2,866 in 1999)................. 4,065 4,409 3,471
Stock-based compensation................................. 6,081 -- --
-------- -------- -------
Total operating expenses......................... 15,529 6,974 6,452
-------- -------- -------
Loss from operations....................................... (12,436) (3,973) (5,190)
Other income............................................... 2,286 2,618 3,157
-------- -------- -------
Loss before provision (benefit) for income taxes........... (10,150) (1,355) (2,033)
Provision (benefit) for income taxes....................... 5,481 (353) (210)
-------- -------- -------
Loss before minority interest in loss of subsidiary........ (15,631) (1,002) (1,823)
Minority interest in loss of subsidiary.................... 1,048 -- --
-------- -------- -------
Net loss from continuing operations........................ (14,583) (1,002) (1,823)
Discontinued operations (Note 3):
Loss from discontinued operations........................ (14,811) (18,829) (6,355)
Loss on disposal of discontinued operations.............. (21,260) -- --
-------- -------- -------
Net loss from discontinued operations................. (36,071) (18,829) (6,355)
-------- -------- -------
Net loss................................................... $(50,654) $(19,831) $(8,178)
======== ======== =======
Basic and diluted net loss per share:
Net loss per common share from continuing operations..... $ (0.59) $ (0.04) $ (0.08)
Net loss per common share from discontinued operations... (1.47) (0.79) (0.28)
-------- -------- -------
Net loss per common share................................ $ (2.06) $ (0.83) $ (0.36)
======== ======== =======
Weighted average number of shares outstanding -- basic and
diluted.................................................. 24,581 23,779 22,965
======== ======== =======
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
28
<PAGE> 30

METACREATIONS CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
NOTES
SERIES A RECEIVABLE ACCUMULATED
PREFERRED STOCK COMMON STOCK FROM OTHER
--------------- --------------- PAID-IN RELATED COMPREHENSIVE ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL PARTIES INCOME (LOSS) (DEFICIT)
------ ------ ------ ------ -------- ------------ ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31,
1996....................... -- $-- 22,274 $22 $100,956 $(3,000) $(158) $(11,708)
Issuance of common stock upon
the exercise of stock
options.................... -- -- 756 1 1,851 -- -- --
Issuance of common stock in
connection with the
employee stock purchase
plan....................... -- -- 29 -- 245 -- -- --
Issuance of common stock in
connection with the
acquisition of Specular
International, Ltd......... -- -- 547 1 4,087 -- -- --
Tax benefit related to stock
options.................... -- -- -- -- 2,396 -- -- --
Conversion of accrued
compensation to equity upon
exercise of certain
options.................... -- -- -- -- 361 -- -- --
Interest on notes receivable
from related parties....... -- -- -- -- -- (170) -- --
Adjustment to retained
earnings as a result of
business combination (Note
1)......................... -- -- -- -- -- -- -- 513
Translation adjustment....... -- -- -- -- -- -- 23 --
Net loss..................... -- -- -- -- -- -- -- (8,178)
-- -- ------ --- -------- ------- ----- --------
Balances at December 31,
1997....................... -- -- 23,606 24 109,896 (3,170) (135) (19,373)
Issuance of common stock upon
the exercise of stock
options.................... -- -- 233 -- 840 -- -- --
Issuance of common stock in
connection with the
employee stock purchase
plan....................... -- -- 104 -- 404 -- -- --
Issuance of common stock in
connection with the
acquisition of Canoma,
Inc........................ -- -- 300 -- 1,305 -- -- --
Tax benefit related to stock
options.................... -- -- -- -- 376 -- -- --
Conversion of accrued
compensation to equity upon
exercise of certain
options.................... -- -- -- -- 8 -- -- --
Interest on notes receivable
from related parties....... -- -- -- -- -- (170) -- --
Translation adjustment....... -- -- -- -- -- -- 7 --
Net loss..................... -- -- -- -- -- -- -- (19,831)
-- -- ------ --- -------- ------- ----- --------
Balances at December 31,
1998....................... -- -- 24,243 24 112,829 (3,340) (128) (39,204)

TOTAL TOTAL
STOCKHOLDERS' COMPREHENSIVE
EQUITY LOSS
------------- -------------
<S> <C> <C>
Balances at December 31,
1996....................... $ 86,112
Issuance of common stock upon
the exercise of stock
options.................... 1,852
Issuance of common stock in
connection with the
employee stock purchase
plan....................... 245
Issuance of common stock in
connection with the
acquisition of Specular
International, Ltd......... 4,088
Tax benefit related to stock
options.................... 2,396
Conversion of accrued
compensation to equity upon
exercise of certain
options.................... 361
Interest on notes receivable
from related parties....... (170)
Adjustment to retained
earnings as a result of
business combination (Note
1)......................... 513
Translation adjustment....... 23 $ 23
Net loss..................... (8,178) (8,178)
-------- --------
Balances at December 31,
1997....................... 87,242 $ (8,155)
========
Issuance of common stock upon
the exercise of stock
options.................... 840
Issuance of common stock in
connection with the
employee stock purchase
plan....................... 404
Issuance of common stock in
connection with the
acquisition of Canoma,
Inc........................ 1,305
Tax benefit related to stock
options.................... 376
Conversion of accrued
compensation to equity upon
exercise of certain
options.................... 8
Interest on notes receivable
from related parties....... (170)
Translation adjustment....... 7 $ 7
Net loss..................... (19,831) (19,831)
-------- --------
Balances at December 31,
1998....................... 70,181 $(19,824)
========
</TABLE>

29
<PAGE> 31
<TABLE>
<CAPTION>
NOTES
SERIES A RECEIVABLE ACCUMULATED
PREFERRED STOCK COMMON STOCK FROM OTHER
--------------- --------------- PAID-IN RELATED COMPREHENSIVE ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL PARTIES INCOME (LOSS) (DEFICIT)
------ ------ ------ ------ -------- ------------ ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock upon
the exercise of stock
options.................... -- -- 959 1 4,004 -- -- --
Issuance of common stock in
connection with the
employee stock purchase
plan....................... -- -- 168 -- 584 -- -- --
Issuance of common stock in
connection with the
acquisition of RAYflect
S.A. ...................... -- -- 126 -- 597 -- -- --
Conversion of accrued
compensation to equity upon
exercise of certain
options.................... -- -- -- -- 26 -- -- --
Issuance of notes receivable
from related parties....... -- -- -- -- -- (100) -- --
Repayment of notes receivable
from related parties....... -- -- -- -- -- 100 -- --
Interest on notes receivable
from stockholders.......... -- -- -- -- -- (127) -- --
Change in interest gain
related to subsidiary...... -- -- -- -- 1,900 -- -- --
Translation adjustment....... -- -- -- -- -- -- (9) --
Net loss..................... -- -- -- -- -- -- -- (50,654)
-- -- ------ --- -------- ------- ----- --------
Balances at December 31, 1999
(restated -- see Note 2)... -- $-- 25,496 $25 $119,940 $(3,467) $(137) $(89,858)
== == ====== === ======== ======= ===== ========

TOTAL TOTAL
STOCKHOLDERS' COMPREHENSIVE
EQUITY LOSS
------------- -------------
<S> <C> <C>
Issuance of common stock upon
the exercise of stock
options.................... 4,005
Issuance of common stock in
connection with the
employee stock purchase
plan....................... 584
Issuance of common stock in
connection with the
acquisition of RAYflect
S.A. ...................... 597
Conversion of accrued
compensation to equity upon
exercise of certain
options.................... 26
Issuance of notes receivable
from related parties....... (100)
Repayment of notes receivable
from related parties....... 100
Interest on notes receivable
from stockholders.......... (127)
Change in interest gain
related to subsidiary...... 1,900
Translation adjustment....... (9) $ (9)
Net loss..................... (50,654) (50,654)
-------- --------
Balances at December 31, 1999
(restated -- see Note 2)... $ 26,503 $(50,663)
======== ========
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
30
<PAGE> 32

METACREATIONS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1999 1998 1997
------------- -------- --------
RESTATED
(SEE NOTE 2)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss................................................. $(50,654) $(19,831) $ (8,178)
Adjustment to retained earnings as a result of business
combination (Note 1)................................... -- -- 513
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Net loss of discontinued operations................. 36,071 18,829 6,355
Amortization of deferred compensation............... 6,081 -- --
Deferred income taxes............................... 5,913 (760) (1,446)
Depreciation and amortization....................... 670 1,223 355
Accrued interest income............................. (130) (171) (170)
Minority interest in loss of subsidiary............. (1,048) -- --
Changes in operating assets and liabilities:
Accounts receivable............................... 790 109 (1,022)
Prepaid expenses and other assets................. (466) 1,390 (753)
Accounts payable and accrued expenses............. 1,079 501 213
Net cash used for discontinued operations......... (10,209) (792) (7,889)
-------- -------- --------
Net cash (used in) provided by operating
activities................................... (11,903) 498 (12,022)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment...................... (295) (48) (830)
Purchases of short-term investments...................... (79,282) (63,549) (55,339)
Proceeds from maturities of short-term investments....... 76,484 73,860 59,678
Issuance of notes receivable from related parties........ -- (1,150) --
Repayment of notes receivable from related parties....... 154 -- --
Net cash used for discontinued operations................ (4,471) (3,814) (5,040)
-------- -------- --------
Net cash (used in) provided by investing
activities................................... (7,410) 5,299 (1,531)
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of notes receivable from related parties........ (100) -- --
Repayment of notes receivable from related parties....... 100 -- --
Repayment of notes payable............................... -- -- (274)
Collection of subscription receivable related to
subsidiary common stock................................ 3,500 -- --
Proceeds from exercise of stock options.................. 4,005 840 1,852
-------- -------- --------
Net cash provided by (used in) financing
activities................................... 7,505 840 1,578
Effect of exchange rates on cash......................... (9) 7 23
-------- -------- --------
Net (decrease) increase in cash and cash equivalents..... (11,817) 6,644 (11,952)
Cash and cash equivalents at beginning of period......... 16,297 9,653 21,605
-------- -------- --------
Cash and cash equivalents at end of period............... $ 4,480 $ 16,297 $ 9,653
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES
Cash paid during the year for interest................... $ -- $ -- $ --
Cash paid during the year for income taxes............... 2 147 294
</TABLE>

(Table continued on next page)
31
<PAGE> 33

METACREATIONS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1999 1998 1997
------------- -------- --------
(RESTATED
SEE NOTE 2)
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURES OF NON-CASH ACTIVITIES
Issuance of common stock in connection with acquisition
of RAYflect S.A........................................ $ 597 $ -- $ --
Issuance of common stock in connection with acquisition
of Canoma, Inc......................................... -- 1,305 --
Issuance of common stock and stock options in connection
with acquisition of Specular International, Ltd........ -- -- 4,088
Net assets acquired in connection with acquisition of
RAYflect S.A.:
Property and equipment.............................. 6 -- --
Prepaid expenses and other assets................... 1,300 -- --
Accounts payable and accrued expenses............... 20 -- --
Net liabilities acquired in connection with acquisition
of Specular International, Ltd.:
Accounts receivable, net............................ -- -- 40
Inventories, net.................................... -- -- 43
Property and equipment.............................. -- -- 43
Deferred income taxes............................... -- -- 900
Prepaid expenses and other assets................... -- -- 331
Accounts payable and accrued expenses............... -- -- 1,337
Notes payable....................................... -- -- 274
Tax benefit related to stock options..................... -- 376 2,396
Conversion of accrued compensation to equity upon
exercise of certain options and warrants............... 26 8 361
Issuance of common stock in connection with employee
stock purchase plan.................................... 584 404 245
Change in interest gain related to subsidiary............ 1,900 -- --
</TABLE>

The accompanying notes are an integral part of these consolidated financial
statements.
32
<PAGE> 34

METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS AND ORGANIZATION

MetaCreations Corporation ("MetaCreations" or the "Company") provides
e-commerce visualization solutions for the World Wide Web (the "Web").
MetaCreations' strategy is centered on the Company's Metastream technology and
software tools designed to make the interactive use of photo-realistic 3D on the
Web practical and pervasive.

In December 1999, the Board of Directors approved a plan to focus
exclusively on its industry-leading, patented e-commerce visualization solution,
Metastream, and to correspondingly divest itself of all its prepackaged graphics
software business (Note 3). Accordingly, these operations are reflected as
discontinued operations for all periods presented in the accompanying
consolidated statements of operations and the related assets and liabilities are
aggregated and presented separately in the accompanying consolidated balance
sheets.

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. Accordingly, Fractal's net loss of $513,000 for the
three months ended March 31, 1997 has been reflected as an adjustment to
retained earnings. The results of operations of Fractal for such three-month
period include net revenues of $7,004,000, which are included in loss from
discontinued operations in the Company's consolidated statements of operations.

Inherent in the Company's business are various risks and uncertainties,
including its limited operating history in the e-commerce visualization business
and the limited history of commerce on the World Wide Web. 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 and technologies. The Company's success may depend in part
upon its ability to develop and introduce such products and technologies in a
timely manner, the acceptance of the Company's products and technologies by the
marketplace and its ability to generate license and service revenues from the
use of its products and technologies on the Web.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of MetaCreations
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

Revenue Recognition

33
<PAGE> 35
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

various elements in a multiple element arrangement. The Company adopted the
provisions of SOP 97-2 and SOP 98-4 as of January 1, 1998.

SOP 98-9 is effective for all transactions entered into by the Company in
Fiscal year 2000. The adoption of this statement is not expected to have a
material impact on the Company's operating results, financial position or cash
flows.

With respect to its discontinued prepackaged graphics software business
(Note 3), the Company recognizes product revenue upon shipment to the customer,
satisfaction of Company obligations, if any, and reasonable assurance regarding
the collectability of the corresponding receivable. 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'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.

With respect to its discontinued prepackaged graphics software business
(Note 3), the Company has also entered into agreements whereby it licenses
products to original equipment manufacturers ("OEM's") and foreign publishers,
which provide such customers the right to produce and distribute multiple copies
of its software. Nonrefundable fixed fees are recognized as revenue at delivery
of the product master to the customer, satisfaction of Company obligations, if
any, and reasonable assurance regarding the collectability of the corresponding
receivable. Per copy royalties in excess of fixed amounts are recognized as
revenue when such amounts exceed fixed minimum royalties.

Software Development Costs

In accordance with Statement of Financial Accounting Standards ("SFAS") No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," the Company provides for capitalization of certain software
development costs once technological feasibility is established. The costs
capitalized are 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.

Software Developed for Internal Use

In accordance with SOP No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," the Company capitalizes costs
of software, consulting services, hardware and payroll-related costs incurred to
purchase or develop internal-use software. The Company expenses costs incurred
during preliminary project assessment, research and development, re-engineering,
training and application maintenance.

Income Taxes

The Company accounts for income taxes using the liability method as
required by SFAS No. 109, "Accounting for Income Taxes." Under SFAS No. 109,
deferred income taxes are determined based on the
34
<PAGE> 36
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

differences between the financial statement and tax bases of assets and
liabilities, using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amounts expected to be realized.

Stock-Based Compensation

The Company accounts for stock option grants in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock Based Compensation." Under APB No. 25, compensation
expense is recognized over the vesting period based on the difference, if any,
at the date of grant between the deemed fair value of the Company's stock for
accounting purposes and the exercise price. The Company accounts for stock
issued to non-employees in accordance with SFAS No. 123 and the Emerging Issues
Task Force ("EITF") Issue No. 96-18.

Cash Equivalents and Short-term Investments

The Company considers all highly liquid investments purchased with an
original maturity of three months or less at date of acquisition to be cash
equivalents.

The Company considers its investment portfolio available-for-sale as
defined in SFAS No. 115. These available-for-sale securities are accounted for
at their fair value, and unrealized gains and losses on these securities are
reported as a separate component of stockholders' equity. At December 31, 1999
and 1998, net unrealized gains or losses on available-for-sale securities were
not significant.

The Company invests its cash in accordance with a policy that seeks to
maximize returns while ensuring both liquidity and minimal risk of principal
loss. The policy limits investments to certain types of instruments issued by
institutions with investment grade credit ratings, and places restrictions on
maturities and concentration by type and issuer. The majority of the Company's
portfolio is composed of fixed income investments that 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.

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 statements of operations. Maintenance and minor replacements are
expensed as incurred.

Long-Term Assets

The carrying value of long-term assets, primarily consisting of property
and equipment, goodwill, and other intangible assets, is periodically reviewed
by management. Impairment losses, if any, are recognized when the expected
nondiscounted future operating cash flows derived from such assets are less than
their carrying value.

Foreign Currency Translation

The functional currency of each of the Company's foreign subsidiaries is
its local currency. Financial statements of these foreign subsidiaries are
translated to U.S. dollars for consolidation purposes using current rates of
exchange for assets and liabilities and average rates of exchange for revenues
and expenses. The effects of currency translation adjustments are included as a
component of stockholders' equity. Gains and losses on foreign currency
transactions for 1999, 1998 and 1997 were not significant.
35
<PAGE> 37
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. With respect to its discontinued prepackaged graphics software
business (Note 3), 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, prior
to its decision to discontinue its prepackaged graphics software business (Note
3), 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.

Concentration of Risk

The Company is subject to concentration of credit risk and interest rate
risk related to cash equivalents and short-term investments. Credit risk is
managed by limiting the amount of investments placed with any one issuer,
investing in high-quality investment securities and securities of the U.S.
government and limiting the average maturity of the overall portfolio.

With respect to its discontinued prepackaged graphics software business
(Note 3), 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, 1999, and periodically throughout 1997 to December 31,
1999, the Company has maintained balances with various financial institutions in
excess of the federally insured limits.

Net Loss Per Common Share

Basic net loss per common share is computed using the weighted average
number of shares of common stock and diluted net loss per common share is
computed using the weighted average number of shares of common stock and common
equivalent shares outstanding. Common equivalent shares related to stock
options, warrants and preferred stock are excluded from the computation when
their effect is antidilutive.

Comprehensive Loss

In accordance with SFAS No. 130, "Reporting Comprehensive Income," all
components of comprehensive income, including net income (loss), are reported in
the financial statements in the period in which they are recognized.
Comprehensive income (loss) is defined as the change in equity during a period
from transactions and other events and circumstances from non-owner sources. Net
income (loss) and other comprehensive income (loss), including unrealized gains
and losses on investments, are reported net of their related tax effect, to
arrive at comprehensive income (loss). Differences between comprehensive income
(loss) and net income (loss) were not significant to the Company's financial
position, results of operations or cash flows for the years ended December 31,
1999, 1998, and 1997.

Segment Information and Enterprise-Wide Disclosures

The Company's chief decision maker, as defined under SFAS No. 131,
"Disclosure About Segments of an Enterprise and Related Information," is the
Chief Executive Officer. The Company's continuing operations are focused on one
business segment, e-commerce visualization. As a result, the financial
information
36
<PAGE> 38
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

disclosed herein materially represents all of the financial information related
to the Company's principal operating segment.

Inventories

Inventories consist of finished products and software components, primarily
instruction manuals, diskettes, CD ROMs and packaging ready for assembly,
related to the discontinued prepackaged software business (Note 3). The Company
periodically evaluates the carrying value of its inventories, including a review
for potentially excess or obsolete products, and adjusts these as necessary.
Inventories are stated at the lower of cost or market, with cost determined
using the first-in, first-out method.

Royalty Expense

With respect to its discontinued prepackaged graphics software business
(Note 3), 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 the related sublicense revenue is
recognized. Royalty expense, which is included as a component of cost of
revenues, amounted to approximately $1,075,000, $1,302,000 and $2,563,000 for
the years ended December 31, 1999, 1998 and 1997, respectively, and has been
included in loss from discontinued operations in the Company's consolidated
statements of operations.

Advertising Expense

The Company reports the cost of all advertising as expense in the period in
which those costs are incurred. Advertising expense, which primarily relates to
co-op advertising, catalog advertising, direct mailings and placement in
business and consumer publications in connection with its discontinued
prepackaged graphics software business (Note 3), totaled approximately
$9,267,000, $11,816,000 and $12,060,000 for the years ended December 31, 1999,
1998 and 1997, respectively, and has been included in loss from discontinued
operations in the Company's consolidated statements of operations.

Minority Interest

For financial reporting purposes, the assets, liabilities and earnings of
Metastream Corporation are included in the Company's consolidated financial
statements. Computer Associate's 20% interest in Metastream Corporation has been
recorded as minority interest in the Company's consolidated balance sheets, and
the losses attributable to their 20% interest have been reported as minority
interest in the Company's consolidated statements of operations. Cash receipts
assigned to Computer Associates purchase of a 20% interest in Metastream
Corporation are included in minority interest in the Company's consolidated
balance sheet. A total of $3.5 million received through December 30, 1999 was
ascribed to Computer Associates purchase. An additional $3.5 million is due from
Computer Associates at various dates through September 30, 2000 and will be
ascribed to its purchase upon receipt. In connection with the $3.5 million cash
receipt, a "change in interest gain" of $1.9 million was credited to paid-in
capital pursuant to SEC Staff Accounting Bulletin ("SAB") No. 51 "Accounting for
Sales of Stock of a Subsidiary."

In connection with the grant of stock options of Metastream Corporation to
certain employees and non-employee directors, Metastream Corporation recorded
total deferred compensation of approximately $16,811,000. Minority interest in
the Company's consolidated balance sheets is credited with its proportionate
interest in stock-based compensation expense that is recognized. Stock-based
compensation expense of $6,081,000 was recognized during the year ended December
31, 1999.

37
<PAGE> 39
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Stock Sales by Subsidiary

Gains realized as a result of stock sales by the Company's subsidiary are
recorded in the Company's consolidated statements of operations, except for any
transaction which may be credited directly to equity in accordance with the
provisions of SAB No. 51, "Accounting for Sales of Stock of a Subsidiary."

Reclassifications

Certain reclassifications have been made to the 1997 and 1998 consolidated
financial statements to conform to the 1999 presentation.

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board issued SFAS No, 133,
"Accounting for Derivative Instruments and Hedging Activities," which
established accounting and reporting standards for derivative instruments and
hedging activities. SFAS No. 133 is effective for fiscal years beginning after
June 15, 2000. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. To date, the Company has not engaged in derivative
and hedging activities.

In December 1999, the Securities and Exchange Commission issued SAB No.
101, "Revenue Recognition in Financial Statements," which gives additional
guidance in applying generally accepted accounting principles to revenue
recognition in the financial statements. Management does not believe the
compliance with the provisions of SAB No. 101 will have a material effect on the
accompanying consolidated financial statements.

Restatement of Financial Statements

On August 8, 2000, the Company announced that it would restate its
consolidated financial statements for the year ended December 31, 1999. The
principal reasons for revisions are discussed below.

Beginning in June 1999, the Company entered into a series of agreements
with Computer Associates. The agreements included a non-exclusive limited-use
perpetual license to use the Company's Metastream and related technologies and a
service agreement whereby the Company would provide a defined number of
development personnel to Computer Associates on an as needed basis. Concurrent
with the license agreement, the Company also granted Computer Associates a 20%
equity interest in Metastream Corporation, the Company's newly formed
subsidiary, for certain non-monetary support as consideration. The Company had
previously ascribed the committed $7.0 million monetary consideration relating
to the licensing agreement to license revenue and, assuming that Metastream
Corporation had only nominal value at the time of inception, no value was
ascribed to the 20% interest. A recent re-examination of these transactions and
an independent valuation of Metastream Corporation as of June 30, 1999, has led
the Company to the conclusion that the series of transactions with Computer
Associates should be viewed in the aggregate and the monetary consideration
allocated to each component based on their fair values. Since the limited-use
license of Metastream and related technologies was a unique, one-time
transaction, the Company did not have the requisite evidence of its fair value
pursuant to the provisions of SOP No. 97-2, "Software Revenue Recognition." The
independent valuation of a 20% interest in Metastream Corporation indicated a
fair value in excess of the monetary consideration ascribed to Computer
Associates limited-use licensing rights and, accordingly, the Company concluded
the appropriate recognition for the transactions was to allocate the committed
monetary consideration to the equity component. The Company allocated the
consideration received between minority interest and "change in interest gain"
pursuant to SAB No. 51, "Accounting for Sales of Stock by a Subsidiary." The
"change in interest gain" has been recorded to paid-in capital in the Company's
consolidated balance sheets. A total of $3.5 million received through December
31, 1999 has been

38
<PAGE> 40
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

ascribed to Computer Associates' purchase of equity. An additional $3.5 million
is due from Computer Associates at various dates through September 30, 2000, and
will be ascribed to the equity purchase upon receipt.

This amended Form 10 K/A filing includes restated financial information and
related disclosures for the year ended December 31, 1999.

39
<PAGE> 41
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Accordingly, the financial statements for the year ended December 31, 1999
have been restated as follows:

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1999
-----------------------
AS REPORTED RESTATED
----------- --------
<S> <C> <C>
Statement of Operations Data:
Net revenues.............................................. $ 10,179 $ 3,093
Operating expenses........................................ 11,629 15,529
-------- --------
Loss from operations...................................... (1,450) (12,436)
Other income.............................................. 2,206 2,286
-------- --------
Income (loss) before provision for income taxes........... 756 (10,150)
Provision for income taxes................................ -- 5,481
-------- --------
Income (loss) before minority interest in loss of
subsidiary............................................. 756 (15,631)
Minority interest in subsidiary........................... 684 1,048
-------- --------
Net income (loss) from continuing operations.............. 1,440 (14,583)
Discontinued operations:
Loss from discontinued operations...................... (14,731) (14,811)
Loss on disposal of discontinued operations............ (26,741) (21,260)
-------- --------
Net loss from discontinued operations..................... (41,472) (36,071)
-------- --------
Net loss.................................................. (40,032) (50,654)

Basic net income (loss) per common share:
Net income (loss) per common share from continuing
operations............................................ 0.06 (0.59)
Net loss per common share from discontinued
operations............................................ (1.69) (1.47)
-------- --------
Net loss per common share.............................. (1.63) (2.06)

Diluted net income (loss) per common share:
Net income (loss) per common share from continuing
operations............................................ 0.06 (0.59)
Net loss per common share from discontinued
operations............................................ (1.61) (1.47)
-------- --------
Net loss per common share.............................. (1.55) (2.06)

Balance Sheet Data:
Accounts receivable, net.................................. 3,999 123
Other assets.............................................. 1,225 308
Accrued expenses.......................................... 1,899 1,985
Minority interest......................................... 2,414 6,633
Paid-in capital........................................... 118,040 119,940
Accumulated deficit....................................... (79,236) (89,858)
</TABLE>

3. DISCONTINUED OPERATIONS

The loss on disposal of discontinued operations, which totaled
approximately $21,260,000 for the year ended December 31, 1999, consists of the
estimated future results of operations of the discontinued business

40
<PAGE> 42
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

through the estimated June 30, 2000 divestiture date, the amounts expected to be
realized upon the sale of the discontinued business, severance and related
benefits, and asset write-downs (see table below). The provision for loss on
disposal of discontinued operations is an estimate and subject to change.
Changes in estimates will be accounted for prospectively and included in income
(loss) from discontinued operations.

As part of the restatement of financial statements (Note 2), the Company
reclassified $1.9 million to gain on sale of assets within loss from
discontinued operations. This gain was comprised of $2.0 million previously
recorded as license revenue relating to discontinued operations, net of $80,000
previously recorded as other income relating to continuing operations. The gain
on sale related to the sale of certain of the Company's consumer graphic
technologies to a third party in June 1999. In addition the provisions
(benefits) for income taxes previously reported as components of the loss on
disposal of discontinued operations has been reclassified as a component of
continuing operations.

The following table depicts the loss on disposal of discontinued operations
activity through December 31, 1999 (in thousands):

<TABLE>
<CAPTION>
LOSS ON DISPOSAL PROVISION AT
OF DISCONTINUED DECEMBER 31,
OPERATIONS DEDUCTIONS 1999
---------------- ---------- ------------
<S> <C> <C> <C>
Write-down of operating assets............... $ 18,445 $18,103 $ 342
Severance and benefits....................... 8,415 504 7,911
Estimated loss of discontinued operations
through divesture date..................... 5,400 -- 5,400
Estimated net proceeds from divesture........ (11,000) -- (11,000)
-------- ------- --------
$ 21,260 $18,607 $ 2,653
======== ======= ========
</TABLE>

Operating results from discontinued operations were as follows (in
thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1999 1998 1997
---------- -------- -------
(RESTATED)
<S> <C> <C> <C>
Net revenues........................................ $ 33,079 $ 39,842 $67,812
Cost of revenues.................................... 6,339 7,007 11,859
-------- -------- -------
Gross profit...................................... 26,740 32,835 55,953
Operating expenses:
Sales and marketing............................... 25,022 27,699 31,419
Research and development.......................... 13,691 14,207 11,765
General and administrative........................ 4,758 2,453 2,939
Costs associated with mergers, acquisitions and
restructurings................................. -- 7,305 16,185
-------- -------- -------
Total operating expenses.................. 43,471 51,664 62,308
-------- -------- -------
Loss before gain on sale of assets.................. (16,731) (18,829) (6,355)
Gain on sale of assets.............................. 1,920 -- --
-------- -------- -------
Loss before benefit for income taxes................ (14,811) (18,829) (6,355)
Benefit for income taxes............................ -- -- --
-------- -------- -------
Loss from discontinued operations................... $(14,811) $(18,829) $(6,355)
======== ======== =======
</TABLE>

In June 1999, the Company sold certain of its consumer graphics products
and licensed rights to certain of its technologies to a third party for total
consideration of $2,600,000. Expenses incurred by the Company in connection with
this transaction totaled $680,000. The net gain of $1,920,000 was recorded as
gain on sale of assets related to discontinued operations in the accompanying
statements of operations.

41
<PAGE> 43
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The net assets of the discontinued operations included in the accompanying
consolidated balance sheets consist of the following (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1999 1998
------ -------
<S> <C> <C>
Current assets of discontinued operations:
Accounts receivable, net.................................. $1,800 $11,462
Inventories, net.......................................... 92 526
Prepaid expenses.......................................... 2,810 3,252
------ -------
Current assets of discontinued operations.............. $4,702 $15,240
====== =======
Non-current assets of discontinued operations:
Property and equipment, net............................... $1,574 $ 6,104
Other assets.............................................. 400 1,490
------ -------
Non-current assets of discontinued operations.......... $1,974 $ 7,594
====== =======
Current liabilities of discontinued operations:
Accounts payable.......................................... $5,631 $ 3,615
Accrued expenses.......................................... 2,824 2,622
Royalties payable......................................... 723 958
------ -------
Current liabilities of discontinued operations......... $9,178 $ 7,195
====== =======
</TABLE>

Inventories relating to discontinued operations consist of the following
(in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
------------
1999 1998
---- ----
<S> <C> <C>
Finished goods.............................................. $92 $434
Materials and supplies...................................... -- 92
--- ----
$92 $526
=== ====
</TABLE>

Property and equipment relating to discontinued operations consist of the
following (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1999 1998
------ ------
<S> <C> <C>
Computer equipment......................................... $4,218 $6,216
Office furniture and equipment............................. 2,060 3,362
Leasehold improvements..................................... 492 1,168
------ ------
6,770 10,746
Less accumulated depreciation and amortization............. 5,196 4,642
------ ------
$1,574 $6,104
====== ======
</TABLE>

42
<PAGE> 44
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Accrued expenses relating to discontinued operations consist of the following
(in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1999 1998
------ ------
<S> <C> <C>
Accrued compensation....................................... $1,128 $1,062
Accrued acquisition costs.................................. -- 1,100
Accrued restructuring costs................................ -- 110
Accrued advertising........................................ 260 53
Other accrued expenses..................................... 1,436 297
------ ------
$2,824 $2,622
====== ======
</TABLE>

4. RESTRUCTURING

On June 30, 1998, the Company announced a restructuring plan aimed at
reducing costs and improving competitiveness and efficiency, which was
implemented during the third quarter of 1998. In connection with the
restructuring, management considered the Company's future operating costs and
levels of revenue in 1998 and beyond, and determined that a restructuring charge
of approximately $4,955,000 was required to cover the costs of reducing certain
sectors of its workforce and facilities. The restructuring charge included an
accrual of approximately $2,208,000 related to severance and benefits associated
with the reduction of approximately 75 positions during July 1998, as well as
the related reduction of certain of the Company's facilities. Non-cash
restructuring costs, which totaled approximately $2,747,000, primarily related
to the write-down of non-strategic business assets made redundant or obsolete
due to the streamlining of the Company's product lines and/or reduction of
facilities. The restructuring plan was completed during the first quarter of
1999. The restructuring charge has been included within discontinued operations
in the Company's consolidated statements of operations.

The following table depicts the restructuring activity through December 31,
1999 (in thousands):

<TABLE>
<CAPTION>
SPENDING/ SPENDING/
TOTAL CHARGES BALANCE AT CHARGES BALANCE AT
RESTRUCTURING DURING DECEMBER 31, DURING DECEMBER 31,
CHARGES 1998 1998 1999 1999
------------- --------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C>
Write-down of operating assets....... $2,747 $2,747 $ -- $ -- $ --
Severance and benefits............... 1,801 1,684 117 117 --
Vacated facilities................... 116 116 -- -- --
Other................................ 291 291 -- -- --
------ ------ ---- ---- ----
$4,955 $4,838 $117 $117 $ --
====== ====== ==== ==== ====
</TABLE>

5. ACQUISITIONS

Specular International, Ltd.

On April 15, 1997, the Company completed the acquisition of Specular
International, Ltd. ("Specular"), a privately held software development company
based in Amherst, Massachusetts, that developed and marketed 3-D animation and
graphic design tools for professionals and pro-sumers. The acquisition was
accounted for by the Company under the purchase method of accounting. Under the
terms of the Purchase Agreement, the stockholders of Specular received
approximately 547,000 shares of the Company's common

43
<PAGE> 45
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

stock, valued at approximately $4,088,000, and $1,000,000 in cash in exchange
for all of the outstanding shares of Specular. The Company also issued 450,000
non-qualified stock options to purchase shares of the Company's common stock to
Specular employees at an exercise price of $7 per share, the fair market value
of the Company's common stock on April 16, 1997. In addition, the Company
assumed the net liabilities of Specular, which totaled $1,601,000 at April 15,
1997. The Company charged approximately $6,430,000 against earnings during the
year ended December 31, 1997, comprised of the write-off of acquired in-process
technology of $5,575,000, transaction costs of $300,000, and relocation and
severance costs of $555,000. In addition, the Company recognized a deferred
income tax asset of $900,000 relating to Federal net operating losses and tax
credits of Specular. In accordance with SFAS No. 109, the tax benefits were
first applied to reduce to zero goodwill totaling $280,000, with the remainder
applied against current technology acquired from Specular. After recognition of
the deferred tax asset, acquired current technology totaled $280,000. The
operating results of Specular have been included in the accompanying
consolidated financial statements from the date of acquisition and classified as
discontinued operations for all periods presented.

Canoma, Inc.

On December 31, 1998, the Company completed the acquisition of Canoma, Inc.
("Canoma"), a privately held development-stage software company based in
Northern California, that was developing software technology that creates 3-D
digital images and content from 2-D digital images for use primarily over the
Internet and in other applications. The acquisition was accounted for by the
Company under the purchase method of accounting. Under the terms of the Purchase
Agreement, the stockholders of Canoma received 300,000 shares of the Company's
common stock valued at approximately $1,305,000 at December 31, 1998, the
closing date, and cash consideration totaling $1,750,000. As of December 31,
1998, neither technological feasibility nor commercial viability had been
reached with regard to Canoma's technology or potential products. Based upon
projected future cash flows, risk-adjusted using a 33% discount rate, Canoma's
in-process technology was valued at approximately $2,250,000, which, including
acquisition costs totaling approximately $100,000, resulted in a one time charge
to earnings of approximately $2,350,000 for the year ended December 31, 1998.
The remaining purchase price of approximately $805,000 was capitalized by the
Company as goodwill and acquired technology and is being amortized over 5 years.
The operating results of Canoma have been included in the accompanying
consolidated financial statements from the date of acquisition and classified as
discontinued operations for all periods presented.

RAYFlect S.A.

On June 29, 1999, the Company completed the acquisition of RAYflect S.A.
("RAYflect"), a privately held company based in France that developed and
marketed 3-D graphic design tools for professionals. The acquisition was
accounted for by the Company under the purchase method of accounting. Under the
terms of the Purchase Agreement, the stockholders of RAYflect received 125,996
shares of the Company's common stock valued at approximately $597,000 at June
29, 1999, the closing date, and cash consideration totaling $622,000. The
purchase price of approximately $1,277,000 was capitalized by the Company as
goodwill and is being amortized over 3 years.

The operating results of RAYflect have been included in the accompanying
consolidated financial statements from the date of acquisition and classified as
discontinued operations for all periods presented. The following unaudited pro
forma information presents a summary of the consolidated results of discontinued
operations of the Company and RAYflect as if the acquisition had taken place on
January 1, 1998. 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 January 1, 1998 or of future

44
<PAGE> 46
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

discontinued operations of the consolidated entities under the ownership and
management of the Company (in thousands, except per share amounts):

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1999 1998
---------- ----------
(UNAUDITED)
<S> <C> <C>
Net revenues from discontinued operations.............. $ 33,167 $ 40,219
Net loss from discontinued operations.................. (36,071) (18,830)
Net loss per common share from discontinued operations
(diluted)............................................ (1.47) (0.79)
</TABLE>

6. 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, 1999. 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,
------------------
1999 1998
------- -------
<S> <C> <C>
Type of security:
Corporate debt securities.............................. $32,016 $32,954
Government agencies.................................... 3,048 8,978
Money market funds..................................... 253 880
U.S. Treasury securities............................... -- --
------- -------
$35,317 $42,812
======= =======
Contractual maturity:
Due in one year or less................................ $26,456 $34,125
Due in one to three years.............................. 8,861 8,687
------- -------
$35,317 $42,812
======= =======
Classification in balance sheet:
Cash and cash equivalents.............................. $ 4,480 $16,297
Marketable securities.................................. 32,836 30,038
------- -------
37,316 46,335
Less cash.............................................. 1,999 3,523
------- -------
$35,317 $42,812
======= =======
</TABLE>

7. PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1999 1998
----- ------
<S> <C> <C>
Computer equipment......................................... $ 573 $1,040
Office furniture and equipment............................. 129 237
Leasehold improvements..................................... 104 133
----- ------
806 1,410
Less accumulated depreciation and amortization............. (192) (685)
----- ------
$ 614 $ 725
===== ======
</TABLE>

45
<PAGE> 47
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

8. ACCRUED EXPENSES

Accrued expenses consist of the following (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1999 1998
------ ------
<S> <C> <C>
Accrued compensation....................................... $ 974 $1,124
Deferred revenue........................................... 369 --
Other accrued expenses..................................... 642 454
------ ------
$1,985 $1,578
====== ======
</TABLE>

9. RELATED PARTY TRANSACTIONS

In March 1999, the Company recorded revenue from Computer Associates
totaling $1,200,000, of which $950,000 related to an agreement granting Computer
Associates a license to Metastream-related technologies, which date was prior to
Computer Associates becoming a minority interest owner in Metastream Corporation
(Note 2), and $250,000 related to services performed on behalf of Computer
Associates during 1999. In addition, the Company entered into other transactions
with Computer Associates as described in Note 2.

A director of the Company rendered services to the Company for which he
received $34,000, $59,000 and $47,000 in each of 1999, 1998 and 1997. Another
director of the Company rendered services to the Company for which he received
$33,000, $48,000 and $44,000 in each of 1999, 1998 and 1997. The Company
believes that the terms of the agreements for these services are no less
favorable than could be obtained from third-party suppliers.

During 1998, the Company loaned $1,000,000 to an officer and director of
the Company. The loan, which was non-interest bearing, is payable on or before
December 31, 2000. The Company also loaned $150,000 to another officer and
director of the Company. The loan, which bore interest semi-annually at 4.47%,
was repaid in three installments during 1999.

In connection with the acquisition of Real Time Geometry Corp. ("RTG") in
December 1996, the Company entered into a noncompetition agreement with one of
RTG's founders who is an executive of the Company. The agreement, which carries
a term of four years, provided for payments to the executive in the amount of
$300,000 in 1997 and $150,000 in each of 1998 and 1999. In addition, the Company
loaned $2,000,000 to the executive. The loan, which accrues interest
semi-annually at 5.67% and is payable on January 15, 2001, is collateralized by
shares of common stock of the Company owned by the executive. The Company also
loaned $1,000,000 to another of RTG's founders who is an executive of the
Company. The loan, which accrues interest semi-annually at 5.67% and is payable
on December 31, 2002, is collateralized by certain options to purchase shares of
common stock of the Company owned by the executive. The loans are classified as
a component of stockholders' equity in the Company's consolidated balance
sheets.

10. NOTES PAYABLE TO BANK

The Company has a credit facility (the "Facility") with its principal
lending institution (the "Bank") which provides a Line of Credit (the "Line")
under which borrowings can be made based upon eligible accounts receivable (as
defined), up to aggregate amount of $3.0 million. The Line accrues interest at
the Bank's prevailing prime interest rate (8.5% at December 31, 1999). The
Facility contains certain covenants that provide, among other things, a
restriction on dividend payments and the requirement for the maintenance of
certain measures of liquidity and equity. The Company was not in compliance with
certain financial covenants at December 31, 1999. The Company intends to renew
the Facility, which expires in March 2000. The Facility also provides for letter
of credit and foreign exchange contracts subfacilities up to the $3.0 million
credit limit. There were no borrowings against the Line during the years ended
December 31, 1999, 1998 and

46
<PAGE> 48
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1997. At December 31, 1999, the Company had one outstanding letter of credit in
the amount of $275,000 as a security deposit on a building lease. The letter of
credit expires on July 31, 2010. There were no foreign exchange contracts at
December 31, 1999.

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, 1999, approximately 251,000 shares of common stock
have been issued under the 1995 Purchase Plan. At December 31, 1999, an
aggregate of approximately 174,000 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 made
contributions totaling $164,000, $161,000 and $139,000 to the 401(k) Plan during
the years ended December 31, 1999, 1998 and 1997, respectively.

MetaCreations 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, 1999, options to purchase an
aggregate of 455,000 shares of common stock were outstanding under the 1992
Plan, with vesting provisions ranging up to five years. Options granted under
the 1992 Plan are exercisable for a period of ten years. At December 31, 1999,
no shares of common stock were reserved for additional grants of options or
awards of restricted stock under the 1992 Plan.

1994 Incentive Stock Option, Non-Qualified Stock Option and Restricted
Stock Purchase Plan

The Company's 1994 Incentive Stock Option, Non-Qualified Stock Option and
Restricted Stock Purchase Plan (the "1994 Plan") provides for the grant to
employees of incentive stock options and nonstatutory stock options and for the
sale of restricted common stock to employees and consultants of the Company,
with vesting provisions ranging up to five years. Options granted under the 1994
Plan are exercisable for a period of ten years. As of December 31, 1999, options
to purchase an aggregate of 153,000 shares of common stock were outstanding
under the 1994 Plan. At December 31, 1999, 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

47
<PAGE> 49
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

December 31, 1999, options to purchase an aggregate of 3,062,000 shares of
common stock were outstanding under the 1995 Plan, with vesting provisions
ranging up to four years. Options granted under the 1995 Plan are exercisable
for a period of ten years. At December 31, 1999, an aggregate of 933,000 shares
of common stock were reserved for future issuance under the 1995 Plan.

1995 Director Option Plan

The Company's 1995 Director Option Plan (the "Director Plan") provides for
an automatic grant of options to purchase shares of common stock to each
non-employee director of the Company. Options granted under the 1995 Director
Plan vest over four years and are exercisable for a period of ten years. As of
December 31, 1999, 75,000 options were outstanding under the 1995 Director Plan.
At December 31, 1999, an aggregate of 75,000 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, the Company
issued options to purchase an aggregate of 211,000 shares of common stock to the
previous stockholders and employees of Dive (the "Dive Plan"). The non-statutory
stock options vest over four years and are exercisable for a period of ten
years. As of December 31, 1999, 22,000 options were outstanding under the Dive
Plan. At December 31, 1999, no shares of common stock were reserved for future
issuance under the Dive Plan.

1996 Nonstatutory Stock Option Plan

The Company's 1996 Nonstatutory Stock Option Plan (the "1996 Nonstatutory
Plan") provides for the grant to employees (including officers and employee
directors) and consultants of nonstatutory stock options and stock purchase
rights. As of December 31, 1999, options to purchase an aggregate of 2,481,000
shares of common stock were outstanding under the 1996 Nonstatutory Plan, with
vesting provisions ranging up to four years. Options granted under the 1996
Nonstatutory Plan are exercisable for a period of ten years. At December 31,
1999, an aggregate of 690,000 shares of common stock were reserved for future
issuance under the 1996 Nonstatutory Plan.

Fractal Stock Option Plan

In connection with the Company's merger with Fractal, which became
effective on May 30, 1997, the Company assumed all of the options outstanding
under the Ray Dream 1992 Stock Option Plan, the Fractal 1993 Stock Option Plan,
the Fractal 1995 Stock Option Plan, the Fractal Director Plan and the Fractal
Outside Plan (collectively, the "Fractal Plans"). All such options were
converted into options to purchase 0.749 shares of MetaCreations common stock at
an exercise price equal to the exercise price of the converted option divided by
0.749. Options granted under the Fractal Plans generally vest over a four year
period and are exercisable for a period of ten years. As of December 31, 1999,
options to purchase an aggregate of 211,000 shares of common stock were
outstanding under the Fractal Plans. At December 31, 1999, no shares of common
stock were reserved for future issuance under the Fractal Plans.

Metastream Option Plan

Metastream Corporation's 1995 Stock Plan (the "Metastream Option Plan")
provides for the grant to employees (including officers and employee directors),
non-employee directors and consultants of nonstatutory stock options and stock
purchase rights. As of December 31, 1999, options to purchase an aggregate of
3,623,000 shares of Metastream common stock were outstanding under the
Metastream Option Plan, with vesting provisions ranging up to four years.
Options granted under the Metastream Option Plan are exercisable for a period of
ten years. At December 31, 1999, 2,377,000 shares of Metastream common stock
were reserved for additional grants of options under the Metastream Option Plan.
48
<PAGE> 50
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Options Issued Under MetaCreations Plans

The following summarizes activity in the MetaCreations Plans for the years
ended December 31, 1997, 1998, and 1999 (in thousands, except per share data and
lives):

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER OF AVERAGE
FOR GRANT SHARES EXERCISE PRICE
--------- --------- --------------
<S> <C> <C> <C>
Options outstanding at December 31, 1996.... 689 4,486 $ 8.83
Shares reserved under new plans........... 2,140 -- --
Reduction in shares reserved under
plans.................................. (592) -- --
Granted -- exercise price equal to fair
value.................................. (3,258) 3,258 9.77
Granted -- exercise price greater than
fair value............................. (35) 35 7.16
Exercised................................. -- (756) 2.45
Canceled.................................. 1,520 (1,520) 14.57
------ ------ ------

Options outstanding at December 31, 1997.... 464 5,503 $ 8.66
Shares reserved under new plans........... 2,700 -- --
Reduction in shares reserved under
plans.................................. (426) -- --
Granted -- exercise price equal to fair
value.................................. (5,412) 5,412 6.07
Granted -- exercise price greater than
fair value............................. (1,577) 1,577 5.09
Exercised................................. -- (233) 3.66
Canceled.................................. 5,176 (5,176) 9.38
------ ------ ------

Options outstanding at December 31, 1998.... 925 7,083 5.53
Shares reserved under new plans........... 1,225 -- --
Reduction in shares reserved under
plans.................................. (117) -- --
Granted -- exercise price equal to fair
value.................................. (2,113) 2,113 5.74
Exercised................................. -- (959) 4.24
Canceled.................................. 1,778 (1,778) 5.58
------ ------ ------

Options outstanding at December 31, 1999.... 1,698 6,459 $ 5.78
====== ====== ======
</TABLE>

The following summarizes options exercisable at December 31, 1999, 1998,
and 1997 (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Options exercisable................................. 3,592 1,847 1,642
</TABLE>

49
<PAGE> 51
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following summarizes information about MetaCreations stock options
outstanding at December 31, 1999 (in thousands, except per share data and
lives):

<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 - $5.06................. 1,077 6.28 $ 2.58 842 $ 2.12
$5.06 - $5.09................. 1,543 7.88 5.09 1,004 5.09
$5.09 - $5.38................. 1,295 7.66 5.14 825 5.11
$5.50 - $6.44................. 1,440 9.16 5.88 125 6.30
$6.51 - $25.13................ 1,104 7.51 10.47 796 11.26
----- -----
Total....................... 6,459 7.79 $ 5.78 3,592 $ 5.81
===== =====
</TABLE>

---------------
(a) Average contractual life remaining in years.

The Company accrued compensation expense of $607,000 for the difference
between the grant price and the deemed fair value of the common stock underlying
options, which are fully vested, issued in connection with the RTG acquisition
in December 1996. At December 31, 1999, accrued compensation related to the
options totaled $557,000.

Options Issued Under Metastream Plan

The following summarizes activity in the Metastream Plan for the year ended
December 31, 1999 (in thousands, except per share data and lives):

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------
OPTIONS WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR OF EXERCISE
GRANT SHARES PRICE
--------- ------- ---------
<S> <C> <C> <C>
Shares reserved under new plan............................. 6,000 -- $ --
Granted -- exercise price below fair value............... (3,663) 3,663 1.00
Exercised................................................ -- -- --
Canceled................................................. 40 (40) 1.00
------ ----- -----
Options outstanding at December 31, 1999................... 2,377 3,623 $1.00
====== ===== =====
</TABLE>

At December 31, 1999, 1,041,000 options were exercisable under the
Metastream Plan.

Metastream Corporation recorded deferred compensation expense of
$16,811,000 for the difference between the grant price and the deemed fair value
of the common stock underlying 3,623,000 options to purchase shares of common
stock of Metastream Corporation issued during the year ended December 31, 1999.
Minority interest in the Company's consolidated balance sheets, is credited with
its proportionate interest in stock-based compensation expense that is
recognized. Stock-based compensation of $6,081,000 was recognized during the
year ended December 31, 1999 in the Company's consolidated statements of
operations.

Pro Forma Information

Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company has
accounted for the Plans under the fair value method of SFAS

50
<PAGE> 52
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

No. 123. The fair value of options issued under the Plans was estimated at the
date of grant using a Black-Scholes option pricing model with the following
weighted average assumptions:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
METACREATIONS:
Risk-free interest rate.............................. 5.8% 5.6% 5.6%
Dividend yield....................................... -- -- --
Volatility factor.................................... .90 1.00 .80
Weighted average expected life in years.............. 4.5 4.3 4.5

METASTREAM:
Risk-free interest rate.............................. 5.8% --% --%
Dividend yield....................................... -- -- --
Volatility factor.................................... 1.00 -- --
Weighted average expected life in years.............. 4.5 -- --
</TABLE>

The following summarizes the weighted average fair value of options granted
during the years ended December 31, 1999, 1998 and 1997:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
METACREATIONS:
Exercise price equal to fair value.................. $4.04 $4.46 $6.40
Exercise price greater than fair value.............. -- 2.23 4.13

METASTREAM:
Exercise price less than fair value................. 5.14 -- --
</TABLE>

For purposes of pro forma disclosures, the estimated fair value of the
MetaCreations and Metastream options is amortized to expense over the options'
vesting period. The Company's pro forma net loss and net loss per common share
would approximate the following (in thousands, except per share amounts):

<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
----------- ---------
<S> <C> <C>
Year Ended December 31, 1999:
Net loss............................................ $ 50,654 $(54,600)
Net loss per common share (diluted)................. (2.06) (2.22)
Year Ended December 31, 1998:
Net loss............................................ $(19,831) $(21,732)
Net loss per common share (diluted)................. (0.83) (0.91)
Year Ended December 31, 1997:
Net loss............................................ $ (8,178) $(10,499)
Net loss per common share (diluted)................. (0.36) (0.46)
</TABLE>

The effects of applying SFAS No. 123 in this proforma disclosure are not
indicative of future amounts. The Company anticipates grants of additional
awards in future years.

51
<PAGE> 53
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

12. INCOME TAXES

The components of the provision (benefit) for income taxes for the years
ended December 31, 1999, 1998 and 1997 are as follows (in thousands):

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------ ----- -------
<S> <C> <C> <C>
Current:
Federal........................................ $ (435) $ 190 $ 1,210
State.......................................... 3 1 2
Foreign........................................ -- 216 24
------ ----- -------
Total current............................... (432) 407 1,236
Deferred:
Federal........................................ 3,971 67 (712)
State.......................................... 1,184 (394) (408)
Foreign........................................ 758 (433) (326)
------ ----- -------
Total deferred.............................. 5,913 (760) (1,446)
------ ----- -------
$5,481 $(353) $ (210)
====== ===== =======
</TABLE>

The differences between the United States statutory rate and the Company's
effective income tax rate are as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Federal tax benefit at the statutory rate........... (34.0)% (34.0)% (35.0)%
State income taxes, net of Federal income tax
benefit........................................... (4.4) (5.1) (4.3)
Nondeductible acquisition costs..................... -- 3.9 42.0
Other............................................... 3.7 7.7 (1.0)
Change in valuation reserve......................... 50.3 25.7 (4.2)
----- ----- -----
Effective income tax rate......................... 15.6% (1.8)% (2.5)%
===== ===== =====
</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):

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- -------
<S> <C> <C>
Deferred tax assets:
Balance sheet reserves................................ $ 3,623 $ 268
Accrued expenses...................................... 1,057 502
Tax credit carryforwards.............................. 3,290 2,260
Net operating loss carryforwards...................... 15,679 9,019
-------- -------
23,649 12,049
Valuation allowance................................... (23,611) (6,102)
-------- -------
Net deferred tax assets............................ 38 5,947
Deferred tax liabilities:
Depreciation and amortization......................... (38) (34)
-------- -------
Net deferred tax liabilities....................... (38) (34)
-------- -------
Net deferred taxes................................. $ -- $ 5,913
======== =======
</TABLE>

52
<PAGE> 54
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The valuation allowance for deferred taxes was increased by approximately
$17,509,000 during 1999, providing a full valuation allowance against the
Company's net deferred tax assets. The Company's net deferred tax assets include
substantial amounts of net operating loss carryforwards. Inability to generate
taxable income within the carryforward period would affect the ultimate
realizability of such assets. Consequently, management determined that
sufficient uncertainty exists regarding the realizability of these assets to
warrant the establishment of the full valuation allowance. Management's
assessment with respect to the amount of deferred tax assets considered
realizable may be revised over the near term based on actual operating results
and revised financial statement projections.

The valuation allowance for deferred taxes was increased by approximately
$5,191,000 during 1998 based on management's assessment of the recoverability of
the deferred tax assets. Management's assessment included an evaluation of the
Company's deferred income tax assets; available tax carrybacks; cumulative net
income, excluding costs related to mergers and acquisitions; available tax
planning strategies; and future financial statement projections. Based on this
assessment and interpretation of the provisions of SFAS No. 109, management
concluded that additional net operating losses and other tax benefits generated
during 1998 required a valuation allowance.

At December 31, 1999, the Company has net operating loss and tax credit
carryforwards of approximately $38,960,000 and $2,175,000, respectively, for
federal income tax purposes, which begin expiring in 2011. The Company's federal
net operating loss carryforward relates to the Company's acquisitions of RTG and
Specular and the net losses incurred by the Company during the years ended
December 31, 1998 and 1999. The Company also has net operating loss and tax
credit carryforwards of approximately $23,440,000 and $903,000, respectively,
for state income tax purposes, which begin expiring in 2001. The Company's state
net operating loss carryforward primarily relates to the net losses incurred by
the Company during the years ended December 31, 1998 and 1999. Additionally, the
Company has net operating loss and tax credit carryforwards of approximately
$11,458,000 and $211,000, respectively, for foreign income tax purposes, which
do not expire. The Company's foreign net operating loss carryforward relates to
net losses incurred by the Company's Irish subsidiary during the years ended
December 31, 1997, 1998 and 1999 which have been included in discontinued
operations. The net operating loss carryforwards may be used to offset any
future taxable income, subject to potential limitations on the Company's ability
to utilize such loss carryforwards pursuant to the ownership rule changes of the
Internal Revenue Code, Section 382.

53
<PAGE> 55
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

13. EARNINGS PER SHARE

The following table provides a reconciliation of the numerators and
denominators of the basic and diluted per-share computations for the years ended
December 31, 1999, 1998 and 1997 (in thousands, except per share amounts):

<TABLE>
<CAPTION>
LOSS SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Year Ended December 31, 1999:
Basic EPS.................................... $(50,654) 24,581 $(2.06)
Effect of dilutive securities -- stock
options................................... -- --
-------- ------
Diluted EPS.................................. $(50,654) 24,581 $(2.06)
======== ======
Year Ended December 31, 1998:
Basic EPS.................................... $(19,831) 23,779 $(0.83)
Effect of dilutive securities -- stock
options................................... -- --
-------- ------
Diluted EPS.................................. $(19,831) 23,779 $(0.83)
======== ======
Year Ended December 31, 1997:
Basic EPS.................................... $ (8,178) 22,965 $(0.36)
Effect of dilutive securities -- stock
options................................... -- --
-------- ------
Diluted EPS.................................. $ (8,178) 22,965 $(0.36)
======== ======
</TABLE>

The computation of diluted EPS excluded stock options to purchase
approximately 6,459,000, 7,083,000 and 5,503,000 shares of common stock for the
years ended December 31, 1999, 1998 and 1997, respectively, because to do so
would have been anti-dilutive for the periods presented.

14. COMMITMENTS

The Company leases office space in Carpinteria under a lease agreement
which expires in September 2008. The lease agreement provides the Company with
three options to extend the term of the lease through September 2018, in
addition to granting the Company the first right of purchase in the event the
lessor decides to sell the related property. The Company also leases office
space for its facility in Scotts Valley, California, its research facility in
Princeton, New Jersey, its international headquarters in Dublin, Ireland, and
its various international sales offices pursuant to non-cancelable lease
agreements with terms through 2003. The lease 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, the Company leases office space in
New York City under a lease agreement which expires in February 2010. As a
result of the Company's decision to discontinue its prepackaged software
business and to relocate to New York City, the Company is in the process of
subletting its additional office space.

The Company also leases certain equipment and two vehicles for executives
of the Company with lease terms of three years. Rent expense for office space,
equipment, and vehicles totaled approximately $2,028,000, $1,552,000 and
$1,480,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
Sublease income totaled approximately $382,000 and $24,000 for the years ended
December 31, 1999 and 1998, respectively. The Company did not earn sublease
income during the year ended December 31, 1997.

54
<PAGE> 56
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Future minimum lease payments relating to continuing operations under
non-cancelable operating leases for each twelve-month period subsequent to
December 31, 1999 are as follows (in thousands):

<TABLE>
<S> <C>
2000........................................................ $ 464
2001........................................................ 451
2002........................................................ 397
2003........................................................ 391
2004........................................................ 402
Thereafter.................................................. 2,575
------
$4,680
======
</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 adverse effect on the Company's consolidated financial position,
results of operations, or cash flows.

16. SEGMENT INFORMATION AND ENTERPRISE-WIDE DISCLOSURES

The Company's continuing operations are focused on one business segment,
e-commerce visualization. The Company is organized into a single reporting
segment, which is evaluated by management for making operating decisions and
assessing performance. The Company's customers consist primarily of companies
located in the United States. The Company's long-lived assets from continuing
operations are located solely in the United States.

Major Customers

Customers whose net revenues represent greater than 10 percent of the
Company's consolidated net revenues from continuing operations for the years
ended December 31, 1999, 1998 and 1997 are as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Customer A (Note 9)................................. 39% --% --%
Customer B.......................................... 49% 66% --%
Customer C.......................................... --% 15% --%
Customer D.......................................... --% 15% --%
Customer E.......................................... --% --% 100%
</TABLE>

Customers whose accounts receivable represent greater than 10 percent of
the Company's consolidated net accounts receivable from continuing operations at
December 31, 1999 and 1998 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
------------
1999 1998
---- ----
<S> <C> <C>
Customer C.................................................. --% 49%
Customer D.................................................. --% 49%
Customer F.................................................. 100% --%
</TABLE>

55
<PAGE> 57
METACREATIONS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Summarized quarterly financial information for fiscal years 1999 and 1998,
are as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------
MARCH 31 JUNE 30 JUNE 30 SEPTEMBER 30 SEPTEMBER 30
------------- ------------- ---------- ------------- ------------
(AS REPORTED) (AS REPORTED) (RESTATED) (AS REPORTED) (RESTATED)
<S> <C> <C> <C> <C> <C>
Fiscal year 1999:
Net revenues................ $ 2,263 $ 3,015 $ 15 $ 4,714 $ 646
Net income (loss) from
continuing operations..... 855 1,355 (1,565) 2,936 (1,132)
Net loss from discontinued
operations................ (1,947) (1,216) (1,296) (2,543) (2,543)
Net income (loss)........... (1,092) 139 (2,861) 393 (3,675)
Net income (loss) per share
(diluted)................. (0.04) 0.01 (0.12) 0.02 (0.15)
Fiscal year 1998:
Net revenues................ $ 101 $ 1,000 $ 1,000 $ -- $ --
Net income (loss) from
continuing operations..... (1,036) 145 145 (1,119) (1,119)
Net loss from discontinued
operations................ 213 (12,538) (12,538) (1,833) (1,833)
Net loss.................... (823) (12,393) (12,393) (2,952) (2,952)
Net loss per share
(diluted)................. (0.03) (0.52) (0.52) (0.12) (0.12)

<CAPTION>
QUARTER ENDED
---------------------------
DECEMBER 31 DECEMBER 31
------------- -----------
(AS REPORTED) (RESTATED)
<S> <C> <C>
Fiscal year 1999:
Net revenues................ $ 187 $ 169
Net income (loss) from
continuing operations..... (3,706) (12,741)
Net loss from discontinued
operations................ (35,766) (30,285)
Net income (loss)........... (39,472) (43,026)
Net income (loss) per share
(diluted)................. (1.59) (1.73)
Fiscal year 1998:
Net revenues................ $ 1,900 $ 1,900
Net income (loss) from
continuing operations..... 655 655
Net loss from discontinued
operations................ (4,318) (4,318)
Net loss.................... (3,663) (3,663)
Net loss per share
(diluted)................. (0.15) (0.15)
</TABLE>

The restated quarterly information for fiscal 1999 is the result of matters
described in Notes 2 and 3.

The net loss incurred for the quarter ended December 31, 1999 included the
loss on disposal of discontinued operations relating to the Company's
prepackaged graphics software business (Note 3).

The net loss incurred for the quarter ended June 30, 1998 included costs
associated with the restructuring of the Company (Note 4). The net loss incurred
for the quarter ended December 31, 1998 included costs associated with the
acquisition of Canoma (Note 5), including the related write-off of acquired
in-process technology.

56
<PAGE> 58

REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE

Board of Directors and Stockholders
MetaCreations Corporation

Our report on the consolidated financial statements of MetaCreations
Corporation and its subsidiaries is included on page 26 of this Form 10-K/A. In
connection with our audits of such consolidated financial statements, we have
audited the related consolidated financial statement schedule at December 31,
1999, 1998 and 1997 and for each of the three years in the period ended December
31, 1999, as listed on the index on page 25 of this Form 10-K/A.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.

/s/ PricewaterhouseCoopers LLP

New York, New York
February 2, 2000, except for
Note 2 which is as of
August 11, 2000

57
<PAGE> 59

METACREATIONS CORPORATION

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING REVENUE/ OTHER COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSE ADDITIONS DEDUCTIONS PERIOD
----------- ---------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
ALLOWANCE FOR DOUBTFUL ACCOUNTS FROM
DISCONTINUED OPERATIONS:
Year Ended December 31, 1999........... $1,005 $ 1,690 $ -- $ 655 $ 2,040
Year Ended December 31, 1998........... 1,216 765 316(2) 1,292 1,005
Year Ended December 31, 1997........... 936 630 6(3) 356 1,216
ALLOWANCE FOR RETURNS FROM DISCONTINUED
OPERATIONS:
Year Ended December 31, 1999........... $1,720 $13,787 $9,852(1) $13,768 $11,591
Year Ended December 31, 1998........... 2,034 11,872 572(2) 12,758 1,720
Year Ended December 31, 1997........... 3,618 4,571 113(3) 6,268 2,034
ALLOWANCE FOR INVENTORY OBSOLESCENCE FROM
DISCONTINUED OPERATIONS:
Year Ended December 31, 1999........... $ 418 $ 777 $ 847(1) $ 928 $ 1,114
Year Ended December 31, 1998........... 719 442 435(2) 1,178 418
Year Ended December 31, 1997........... 631 860 96(3) 868 719
VALUATION ALLOWANCE FOR DEFERRED TAX ASSETS
FROM CONTINUING OPERATIONS:
Year Ended December 31, 1999........... $6,102 $17,509 $ -- $ -- $23,611
Year Ended December 31, 1998........... 911 5,191 -- -- 6,102
Year Ended December 31, 1997........... 1,264 -- -- 353 911
</TABLE>

---------------
(1) Reserves established in connection with the disposal of discontinued
operations in December 1999.

(2) Reserves established in connection with the restructuring on June 30, 1998.

(3) Reserves obtained in connection with the acquisition of Specular
International, Ltd. on April 15, 1997.

58
<PAGE> 60

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS OF THE REGISTRANT

The following table sets forth certain information regarding the Company's
directors as of March 15, 2000:

<TABLE>
<CAPTION>
NAME AGE PRINCIPAL OCCUPATION
---- --- --------------------
<S> <C> <C>
Samuel H. Jones, Jr........................ 66 President of S-J Venture Capital Company
and President of S-J Transportation Company
William H. Lane III........................ 61 President of Canyon Vista, Inc.
Gary L. Lauer.............................. 47 President and Chief Executive Officer of
eHealthInsurance.com
Mark Zimmer................................ 43 President and Chief Executive Officer of
the Company
</TABLE>

Except as set forth below, each nominee has been engaged in his principal
occupation described above during the past five years. There is no family
relationship among any directors or executive officers of the Company.

Mr. Jones has been a director of the Company since April 1992. He has been
President of S-J Venture Capital Company since 1991 and President of S-J
Transportation Company, an industrial waste transportation company, since 1971.
Mr. Jones is a director of Fulton Financial Corp. and Jevic Transportation, Inc.

Mr. Lane has been a director of the Company since September 1995. In
addition, Mr. Lane served as interim President and Chief Operating Officer of
the Company from January 1998 to February 1998. Mr. Lane is currently the
President of Canyon Vista, Inc., a management consulting company. Mr. Lane
retired from Intuit Inc. in July 1996, having served as its Vice President,
Chief Financial Officer, Secretary and Treasurer from January 1994 to April
1996. Mr. Lane served in a similar capacity at ChipSoft, a tax preparation
software company, from July 1991 until its acquisition by Intuit in December
1993. Mr. Lane is also a director of Cyberian Outpost, Inc., Digital Now, Inc.
and DigitalThink, Inc.

Mr. Lauer has been a director of the Company since February 1997 and
Chairman of the Board since May 1999. Mr. Lauer has been President and Chief
Executive Officer of eHealthInsurance.com since January 2000. From February 1997
to December 1999, Mr. Lauer served as President and Chief Executive Officer of
MetaCreations. From 1988 to 1997, Mr. Lauer served in various capacities at
Silicon Graphics, Inc. ("SGI"), including Vice President, North American
Marketing; Vice President and subsequently Senior Vice President, North American
Field Operations; and most recently as President of SGI's World Trade Group and
Executive Vice President of Worldwide Field Operations. Prior to joining SGI,
Mr. Lauer was with International Business Machines Corporation ("IBM") for
eleven years where he held a variety of senior management positions, the last of
which included responsibility for field operations for IBM's U.S. Marketing and
Services Group.

Mr. Zimmer became a director and Chief Technology Officer of the Company in
May 1997 in connection with the merger with Fractal Design Corporation
("Fractal"). In addition to co-founding Fractal in April 1991, Mr. Zimmer was
its Chief Executive Officer and a director since its inception. Mr. Zimmer also
served as Fractal's President from March 1993 until May 1996, and resumed the
position in February 1997 until the merger with MetaCreations in May 1997. In
1985, Mr. Zimmer founded Fractal Software, a predecessor of Fractal and was a
partner in Fractal Software from 1985 to 1990.

59
<PAGE> 61

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information regarding the Company's
current executive officers as of March 15, 2000:

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Mark Zimmer............................... 43 Director, President and Chief Executive
Officer
Jay Jennings.............................. 32 Vice President, Finance and Chief
Financial Officer
John Leddy................................ 41 Senior Vice President, Product Development
</TABLE>

Mr. Jennings assumed the responsibilities of Chief Financial Officer in
December 1999. Mr. Jennings has been with the Company since January 1996 in
various financial management roles, including Corporate Controller and Vice
President, Finance. From September 1989 to January 1996, Mr. Jennings was
employed at Ernst & Young LLP, most recently serving as a manager in the
Entrepreneurial Services Group. Mr. Jennings holds a B.A. from Claremont McKenna
College.

Mr. Leddy joined the Company as Vice President and General Manager,
Professional Products Group in August 1998 and was subsequently promoted to
Senior Vice President, Product Development in December 1998. Prior to joining
the Company, Mr. Leddy was employed by Adobe Systems Inc. ("Adobe"), where he
most recently served as group product manager for imaging products. For five
years, he was responsible for overseeing Adobe's flagship product, Photoshop,
and for helping to develop new graphics tools. Prior to Adobe, Mr. Leddy held
product management positions at Macromedia Inc., where he managed the Authorware
professional product line, and Symantec Corporation. Mr. Leddy holds a B.A. from
the University of California at Berkeley.

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT

Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's executive officers and directors and
persons who own more than ten percent (10%) of a registered class of the
Company's equity securities to file an initial report of ownership on Form 3 and
changes in ownership on Form 4 or 5 with the SEC and the National Association of
Securities Dealers, Inc. Executive officers, directors and greater than ten
percent stockholders are also required by SEC rules to furnish the Company with
copies of all Section 16(a) forms they file. Based solely on its review of the
copies of such forms received by it, or written representations from certain
reporting persons, the Company believes that, with respect to fiscal 1999, all
filing requirements applicable to its officers, directors and ten percent
stockholders were satisfied.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth certain information with respect to annual
compensation and long-term compensation awarded during fiscal 1997, 1998 and
1999 to each person who served as the Company's Chief Executive Officer and the
Company's four other most highly compensated executive officers during 1999
(collectively, the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

60
<PAGE> 62

<TABLE>
<CAPTION>
LONG TERM COMPENSATION AWARDS
ANNUAL COMPENSATION -------------------------------------------
----------------------------------- SECURITIES SECURITIES
OTHER UNDERLYING UNDERLYING
ANNUAL COMPANY METASTREAM ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS OPTIONS COMPENSATION
--------------------------- ---- -------- -------- ------------ --------------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Terance A. Kinninger(2)... 1999 186,667 81,000 17,701(10) 125,000 -- --
Senior Vice President, 1998 173,333 18,000(8) 13,088(10) 115,000 -- --
Finance and Operations 1997 160,750 28,000(9) 9,207(10) 30,000 -- --
and Chief Financial
Officer
Robert Rice............... 1999 185,000 65,000(7) 8,923(10) 25,000 750,000 --
Vice President, Strategic 1998 173,333 100,000(8) 7,481(10) 294,500 -- --
Affairs; President and 1997 154,154 100,000(9) 4,607(10) -- -- --
Chief Executive Officer
of Metastream Corporation
John Leddy................ 1999 177,500 50,000(6) 6,882(10) 75,000 -- --
Senior Vice President, 1998 57,028 25,000(6) 1,875(10) 130,000 -- --
Product Development
Gary Lauer(3)............. 1999 350,000 -- 73,644(11) -- 50,000 146,376(12)
Former President and 1998 288,189 -- 31,626(11) 1,000,000 -- 67,365(13)
Chief Executive Officer
Kai Krause(4)............. 1999 83,333 -- 24,629(10) -- --
Former Chief Design 1998 239,375 -- 28,824(10) 300,000 -- 166,667(14)
Officer 1997 240,000 42,000(9) 26,035(10) 50,000 -- --
</TABLE>

---------------
(1) Mr. Zimmer served as Chief Technical Officer until his promotion to
President and Chief Executive Officer on December 14, 1999. Of the $250,000
salary Mr. Zimmer received in 1999, $239,583 was paid to Mr. Zimmer for his
services as Chief Technical Officer of the Company and $10,417 was paid to
Mr. Zimmer for his services as the President and Chief Executive Officer of
the Company. Mr. Zimmer resigned as President and Chief Executive Officer
effective April 7, 2000.

(2) Mr. Kinninger resigned as Senior Vice President and Chief Financial Officer
effective December 31, 1999.

(3) Mr. Lauer resigned as President and Chief Executive Officer effective
December 14, 1999 and continued as the Chairman of the Company until his
resignation on March 31, 2000.

(4) Mr. Krause resigned as Chief Design Officer effective May 1, 1999.

(5) Includes $125,000 paid in 1999 for services to be performed in 2000.

(6) Includes $15,000 paid in 1999 for services in 1998.

(7) Represents amount paid in 2000 for services in 1999.

(8) Represents amount paid in 1999 for services in 1998.

(9) Represents amount paid in 1998 for services in 1997.

(10) Represents auto allowance and the cost of providing health, life and
disability insurance.

(11) Represents auto allowance, the cost of providing health, life and
disability insurance, and loan interest discount ($55,750 in 1999 and
$16,749 in 1998).

(12) Represents reimbursement for relocation expenses ($100,000) and
miscellaneous perquisites.

(13) Represents reimbursement for relocation expenses ($50,000) and
miscellaneous perquisites.

(14) Represents amount paid as a consultant.

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<PAGE> 63

OPTION GRANTS AND EXERCISES

The following tables set forth information regarding stock options granted
to and exercised by the Named Executive Officers during fiscal year 1999, as
well as options held by such officers as of December 31, 1999, the last day of
the Company's 1999 fiscal year. In accordance with the rules of the SEC, also
shown below is the potential realizable value over the term of the option (the
period from the grant date to the expiration date) based on assumed rates of
stock appreciation from the option exercise price of 5% and 10%, compounded
annually. These amounts do not represent the Company's estimate of future stock
price. Actual gains, if any, on stock option exercises will depend on the future
performance of Company common stock.

COMPANY OPTION GRANTS IN 1999

<TABLE>
<CAPTION>
POTENTIAL
INDIVIDUAL GRANTS REALIZABLE VALUES
----------------------------------------------------- AT ASSUMED ANNUAL
NUMBER OF PERCENT OF RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION
UNDERLYING GRANTED TO FOR OPTION TERM
OPTIONS EMPLOYEES IN EXERCISE OR EXPIRATION -------------------
NAME AND PRINCIPAL POSITION GRANTED(1) FISCAL YEAR BASE PRICE DATE 5% 10%
--------------------------- ---------- ------------- ----------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Terance A. Kinninger............. 50,000 2.4% $6.34 2/24/09 $199,479 $505,519
25,000 1.2% 5.63 6/24/09 88,438 224,120
50,000 2.4% 5.63 6/24/09 176,877 448,240
Robert E. Rice................... 25,000 1.2% 5.63 6/24/09 88,438 224,120
John Leddy....................... 75,000 3.6% 5.63 6/24/09 265,315 672,360
</TABLE>

---------------
(1) Of the securities underlying the options, 25% vest on the first anniversary
of the date of grant and one forty-eighth vests each month thereafter.
Unless each outstanding option is assumed or an equivalent option is
substituted by the successor corporation in connection with any merger, or
sale of assets, all the options, including those not then vested, become
fully exercisable.

METASTREAM OPTION GRANTS IN 1999

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------------------- POTENTIAL REALIZABLE VALUES AT
NUMBER OF PERCENT OF ASSUMED ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS PRICE APPRECIATION FOR OPTION
UNDERLYING GRANTED TO TERM
NAME AND PRINCIPAL OPTIONS EMPLOYEES IN EXERCISE OR EXPIRATION ------------------------------
POSITION GRANTED FISCAL YEAR BASE PRICE DATE 5% 10%
------------------ ---------- ------------- ----------- ---------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Mark Zimmer.......... 50,000(1) 1.4% $1.00 12/31/01 $ 177,660 $ 448,380
Robert E. Rice....... 750,000(2) 20.5% 1.00 7/1/09 $2,664,900 $6,725,700
Gary Lauer........... 50,000(1) 1.4% 1.00 12/31/01 $ 177,660 $ 448,380
</TABLE>

---------------
(1) Options fully vested on the date of grant.

(2) Of the securities underlying the options 20% vested on the date of grant, an
additional 20% vests on the first anniversary of the date of grant, and an
additional one thirty-sixth vests each month thereafter. Unless each
outstanding option is assumed or an equivalent option is substituted by the
successor corporation in connection with any merger, or sale of assets, all
the options, including those not then vested, are fully exercisable.

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<PAGE> 64

The following table sets forth information with respect to options to
purchase Company common stock exercised during fiscal 1999 by the Named
Executive Officers and the value of unexercised options at December 31, 1999.

COMPANY OPTION EXERCISES IN 1999 AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1999 DECEMBER 31, 1999(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Terance A. Kinninger........ 22,600 $124,300 $ 69,900 $176,250 $ 221,917 $ 471,756
Mark Zimmer................. -- -- 93,456 31,014 360,311 25,683
Robert E. Rice.............. -- -- 352,894 56,771 1,213,772 142,542
John Leddy.................. -- -- 43,333 161,667 226,155 674,990
Gary Lauer.................. -- -- 595,556 404,444 2,086,828 1,417,172
Kai Krause.................. -- -- 604,271 230,729 3,329,190 431,300
</TABLE>

---------------
(1) The value of unexercised, in-the-money options is the difference between the
exercise price of the options and the fair market value of Company common
stock at December 31, 1999 ($8.59).

The following table sets forth information with respect to options to
purchase Metastream common stock exercised during fiscal 1999 by the Named
Executive Officers and the value of unexercised options at December 31, 1999.

METASTREAM OPTION EXERCISES IN 1999 AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1999 DECEMBER 31, 1999(1)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Mark Zimmer.................... -- -- 50,000 -- $232,000 --
Robert E. Rice................. -- -- 150,000 600,000 $696,000 $2,784,000
Gary Lauer..................... -- -- 50,000 -- $232,000 --
</TABLE>

---------------
(1) The value of unexercised, in-the-money options is the difference between the
exercise price of the options and the fair market value of Metastream's
common stock at December 31, 1999 ($5.64).

COMPENSATION OF DIRECTORS

The Company reimburses each of its non-employee directors as follows: each
non-employee director is paid (i) $2,500 at the end of each fiscal quarter in
which he or she is a director, (ii) $1,000 for each regular Board meeting he or
she attends, and (iii) $500 for each Board committee meeting he or she attends;
provided, however, that if more than one committee meeting is held on the same
day or a Board meeting and one or more committee meetings are held on the same
day, no more than the initial $500 or $1,000, as the case may be, is paid to any
director for all such meetings attended by such director on such date. From
March 1997 through February 1999, Dr. Howard L. Morgan received a monthly
consulting fee of $4,500 for services rendered to the Company. In addition, from
February 1997 through February 1999, Mr. William H. Lane III received a monthly
consulting fee of $4,000 for services rendered to the Company. Effective March
1, 1999, each of Mr. Morgan and Mr. Lane's consulting fees was reduced to $2,500
per month.

Non-employee directors participate in the Company's 1995 Director Option
Plan (the "Director Plan"). Under the Director Plan, each non-employee director
who joins the Board in the future will automatically be granted a nonstatutory
option to purchase 20,000 shares of Common Stock on the date upon which such

63
<PAGE> 65

person first becomes a director. In addition, each non-employee director,
including current non-employee directors, automatically receives a nonstatutory
option to purchase 5,000 shares of Common Stock on January 1 of each year,
provided the director has been a member of the Board for at least six months.
The exercise price of each option granted under the Director Plan is equal to
the fair market value of the Common Stock on the date of grant. The 20,000 share
grant vests at a rate of one-eighth of the option shares upon the end of the
first six-month period after the date of grant and one-forty-eighth of the
option shares per month thereafter; provided the optionee remains a director of
the Company. The 5,000 share grant vests at the rate of one-half of the option
shares upon the end of the first six-month period after the date of grant and
one-twelfth of the option shares per month thereafter; provided the optionee
remains a director of the Company. Options granted under the Director Plan have
a term of ten (10) years unless terminated sooner, whether upon termination of
the optionee's status as a director or otherwise pursuant to the Director Plan.

In January 1999, Messrs. Lane, Bert Kolde and Samuel H. Jones, Jr. and Dr.
Morgan were each granted an option to purchase 5,000 shares of Common Stock
under the Director Plan at an exercise price of $6.625 per share. In December
1999, in recognition for the substantial contribution of the Company's directors
to the formation and success of Metastream Corporation, Messrs. Kolde, Lane and
Jones and Dr. Morgan were each granted a fully-vested option to purchase 50,000
shares of Common Stock of Metastream Corporation under the Metastream Stock
Option Plan at an exercise price of $1.00 per share. In January 2000, Messrs.
Kolde, Lane and Jones were each granted an option to purchase 5,000 shares of
Common Stock under the Director Plan at an exercise price of $9.00 per share.
For their participation as a director of Metastream Corporation, in January
2000, Mr. Jones and Dr. Morgan were each granted an option to purchase 75,000
shares of Common Stock of Metastream Corporation under the Metastream Stock
Option Plan at an exercise price of $1.00 per share. Additionally, for his
participation as a director of Metastream Corporation, in February 2000, Mr.
Lane was granted an option to purchase 75,000 shares of Common Stock of
Metastream Corporation under the Metastream Stock Option Plan at an exercise
price of $1.00 per share. The 75,000 share grants vest one-fifth of the option
shares on the date of grant, one-fifth of the option shares at the end of the
first year and one-thirty-sixth of the option shares per month thereafter.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

During fiscal 1999, the Compensation Committee (the "Committee") of the
Board of Directors consisted of Messrs. Jones and Lane and Dr. Morgan. Since
January 1, 2000, the Committee has consisted of Messrs. Jones and Lane. None of
the members of the Compensation Committee was an officer or employee of the
Company. No interlocking relationship exists between any member of the Company's
Compensation Committee and any member of any other company's board of directors
or compensation committee.

REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS

The Committee recommends, subject to the Board's approval, compensation for
executive officers and evaluates performance of management.

Compensation Philosophy

The Company operates in the competitive and rapidly changing environment of
high technology businesses. The Committee seeks to establish compensation
policies that allow the Company flexibility to respond to changes in its
business environment. The Company's compensation philosophy is based on the
belief that achievement in this environment is enhanced by the coordinated
efforts of all individuals working toward common objectives. The goals of the
Company's compensation program are to align compensation with the Company's
business objectives and performance, to foster teamwork and to enable the
Company to attract, retain and reward employees who contribute to the Company's
long-term success.

Compensation Components

The Company's executive officers are compensated with a salary, and are
eligible for bonus and stock option awards. The Committee assesses the past
performance and anticipated future contribution, and

64
<PAGE> 66

considers the total compensation (earned or potentially available) of each
executive officer in establishing each element of compensation.

Salary. The salaries of the executive officers, including the Chief
Executive Officer, are determined annually by the Committee with reference to
several surveys of salaries paid to executive with similar responsibilities at
comparable companies, generally in the high technology industry. The peer group
for each executive officer is composed of executives whose responsibilities are
similar in scope and content. The Company seeks to set executive compensation
levels that are competitive with the average levels of peer group compensation.

Bonus. The Company has a discretionary key employee incentive pool pursuant
to which executive officers and a limited number of key employees may receive
annual cash bonuses. Targets for sales growth and operating income influence the
amount of the pool. Individual payments are made based on the Company's
achievement of these targets and upon the individual's personal and departmental
performance.

Stock Options. Stock options awards are designed to align the interests of
executives with the long-term interests of the stockholders. The Committee
approves option grants subject to vesting periods (usually 48 months) to retain
executives and encourage sustained contributions. The exercise price of options
are not less than the closing market price on the date of grant. These options
will acquire value only to the extent that the price of the Company's Common
Stock increases relative to the market price at the date of grant.

Chief Executive Officer's Compensation

Mr. Lauer's compensation for fiscal 1999 reflects the Committee's
evaluation of his overall leadership of the Company as its Chief Executive
Officer. In determining Mr. Lauer's compensation, the Committee considered,
among other factors, the continued sequential growth of revenues since the
second quarter of 1998 and the release of new products and versions of existing
products. The Company paid Mr. Lauer a base salary of $350,000 for 1999.

The Committee has considered the potential impact of Section 162(m) of the
Internal Revenue Code of 1986, as amended (the "Code"), and proposed regulations
thereunder (the "Section"). The Section disallows a tax deduction for any
publicly-held corporation for individual compensation exceeding $1 million in
any taxable year for any of the Named Executive Officers, unless such
compensation is performance-based. The Company's policy is to qualify, to the
extent reasonable, its executive officers' compensation for deductibility under
applicable tax laws. However, the Committee believes that its primary
responsibility is to provide a compensation program that will attract, retain
and reward the executive talent necessary to the Company's success.
Consequently, the Committee recognizes that the loss of a tax deduction could be
necessary in some circumstances.

COMPENSATION COMMITTEE

William H. Lane III
Howard L. Morgan
Samuel H. Jones, Jr.

65
<PAGE> 67

PERFORMANCE GRAPH

The graph below compares the cumulative total return on the Company's
Common Stock for the period commencing December 12, 1995 and ending December 31,
1999 compared to the CRSP Total Return Index for the Nasdaq Stock Market (U.S.
companies) and the CRSP Total Return Index for the Nasdaq Computer and Data
Processing Services Stocks (SIC 737). The graph assumes that $100 was invested
on the date of the Company's initial public offering, December 12, 1995, and
that all dividends are reinvested. Historic stock price performance should not
be considered indicative of future stock price performance.

COMPARISON OF 3 YEAR CUMULATIVE TOTAL RETURN
AMONG METACREATIONS CORPORATION, THE NASDAQ STOCK MARKET -- US INDEX,
AND THE NASDAQ COMPUTER AND DATA PROCESSING INDEX

<TABLE>
<CAPTION>
NASDAQ STOCK MARKET E NASDAQ COMPUTER AND
METACREATIONS US DATA PROCESSING
------------- --------------------- -------------------
<S> <C> <C> <C>
12/12/95 100 100 100
12/31/95 96 99 98
12/31/96 44 122 122
12/31/97 41 150 150
12/31/98 20 211 267
12/31/99 32 391 587
</TABLE>

66
<PAGE> 68

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information known to the Company
with respect to beneficial ownership of the Company's Common Stock as of March
15, 2000 by (i) each beneficial owner of more than 5% of the Company's Common
Stock, (ii) each director and each nominee, (iii) each Named Executive Officer
and (iv) all directors and executive officers as a group. Except as otherwise
indicated, each person has sole voting and investment power with respect to all
shares shown as beneficially owned, subject to community property laws where
applicable.

<TABLE>
<CAPTION>
NUMBER OF SHARES
-------------------------------------------------
COMMON STOCK
AND PERCENTAGE OF
NAME OF BENEFICIAL OWNER COMMON STOCK VESTED OPTIONS(1) VESTED OPTIONS TOTAL(2)
------------------------ ------------ ----------------- -------------- -------------
<S> <C> <C> <C> <C>
Samuel H. Jones, Jr. ................... 980,055 33,750 1,013,805 3.7%
Mark Zimmer............................. 282,406 99,072 381,478 1.4
Robert Rice............................. -- 352,894 352,894 1.3
William H. Lane III..................... 15,000 73,750 88,750 *
Gary Lauer.............................. 24,664 -- 24,664 *
John Leddy.............................. 3,972 19,167 23,139 *
Jay Jennings............................ -- 10,541 10,541 *
--------- ------- --------- ---
All directors and executive officers as
a group (8 persons)................... 1,306,097 589,174 1,895,271 6.8%
========= ======= ========= ===
</TABLE>

---------------
* Percentage of shares beneficially owned is less than one percent of total.

(1) Represents shares issuable upon exercise of options to purchase
MetaCreations Common Stock that are exercisable within 60 days of March 15,
2000.

(2) Beneficial ownership is determined in accordance with the rules of the SEC.
In computing the number of shares beneficially owned by a person and the
percentage ownership of that person, shares of Common Stock subject to
options or warrants held by that person that are currently exercisable or
exercisable within sixty (60) days of March 15, 2000 are deemed outstanding.
Such shares, however, are not deemed outstanding for the purposes of
computing the percentage ownership of any other person. Except as indicated
in the footnotes to this table and pursuant to applicable community property
laws, each stockholder named in the table has sole voting and investment
power with respect to the shares set forth opposite such stockholder's name.
Percentage ownership is based on 27,445,446 shares of Common Stock
outstanding on March 15, 2000.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The Company has entered into employment agreements with Messrs. Zimmer,
Kinninger, Rice, Leddy, Lauer and Krause. Pursuant to the terms of an employment
offer letter dated February 11, 1998 from the Company to Mr. Zimmer, following
the closing of the acquisition of Fractal in May 1997, Mr. Zimmer commenced
employment with the Company at an annual base salary of $240,000. In May 1998,
Mr. Zimmer's annual base salary was increased to $250,000 by the Company's Board
of Directors. In May 1998, Mr. Zimmer received an option to purchase 40,000
shares of Common Stock at an exercise price of $7.94. In connection with the
Company's restructuring activities, Mr. Zimmer agreed to a 10% salary reduction
from September 16, 1998 through December 31, 1998. In November 1998, the Company
loaned Mr. Zimmer $150,000, collateralized by certain shares of common stock of
the Company owned by Mr. Zimmer, as well as options to purchase shares of the
common stock of the Company. The loan bore interest semi-annually at 4.47% and
was repaid in September 1999. In February 1999, Mr. Zimmer received a bonus of
$15,000 for services performed in 1998. In September 1999, Mr. Zimmer received
an advance of $125,000 against a bonus to be earned in 2000. In December 1999,
Mr. Zimmer received a bonus of $44,743 for services performed in 1999. Pursuant
to the terms of a letter agreement dated December 10, 1999 and in connection
with Mr. Zimmer's promotion to President and Chief Executive Officer of the
Company, the Company's Board of Directors agreed to pay Mr. Zimmer a bonus of
$1,250,000 on May 31, 2000, provided

67
<PAGE> 69

that Mr. Zimmer does not voluntarily resign his position prior to that date. In
December 1999, Mr. Zimmer received an option to purchase 50,000 shares of
Metastream Corporation Common Stock at an exercise price equal to $1.00.

Mr. Kinninger's original employment offer letter from the Company dated
June 27, 1995 provided that the Company would pay Mr. Kinninger an annual base
salary of $120,000. Pursuant to the offer letter, the Company granted Mr.
Kinninger options to purchase 65,000 shares of Common Stock at an exercise price
of $4.25 per share. Such options vest over a period of four years, but become
fully vested upon a change in control of the Company. In accordance with the
offer letter, 16,250 shares of Mr. Kinninger's options became fully vested upon
the closing of the Company's initial public offering. In March 1996, the
Company's Board of Directors increased Mr. Kinninger's annual base salary to
$140,000. In January 1997, the Company's Board of Directors increased Mr.
Kinninger's annual base salary to $160,000. Mr. Kinninger's employment agreement
with the Company was amended by a severance agreement dated October 31, 1997.
Pursuant to the terms of the agreement, if within one year following a change of
control of the Company, Mr. Kinninger's employment is involuntarily terminated,
Mr. Kinninger is entitled to receive severance payments equal to twelve months
of his base compensation, medical benefits and accelerated vesting of 50% of any
then unvested stock options. In May 1998, the Company's Board of Directors
increased Mr. Kinninger's annual base salary to $180,000. In May 1998, Mr.
Kinninger received an option to purchase 25,000 shares of Common Stock at an
exercise price equal to $7.94. In August 1998, Mr. Kinninger received an option
to purchase 25,000 shares of Common Stock at an exercise price equal to $5.09.
In connection with the Company's exchange of certain outstanding options in
September 1998, certain of Mr. Kinninger's options were exchanged for new
options with exercise prices equal to $5.09. In February 1999, Mr. Kinninger
received a bonus of $18,000 for services performed in 1998. In February 1999,
Mr. Kinninger received an option to purchase 50,000 shares of Common Stock at an
exercise price equal to $6.34. In June 1999, Mr. Kinninger received options to
purchase 25,000 and 50,000 shares of Common Stock at an exercise price equal to
$5.63. In September 1999, the Company's Board of Directors increased Mr.
Kinninger's annual base salary to $200,000. On December 31, 1999, Mr. Kinninger
resigned as Vice President and Chief Financial Officer. Pursuant to the terms of
a letter agreement dated December 10, 1999, Mr. Kinninger received a bonus of
$81,000 for services performed in 1999. In addition, Mr. Kinninger was retained
as a consultant to the Company for the period from January 1, 2000 through March
31, 2000 for a fee of $8,000 per month.

The Company's employment agreement with Mr. Rice, dated December 31, 1996,
provided for employment commencing January 1, 1997 at an annual base salary of
$150,000. The agreement, which expires as of December 31, 1999, guaranteed that
the Company would pay Mr. Rice a bonus of not less than $100,000 for his first
year of employment. With respect to subsequent years of employment, the
agreement provides that the Company will pay Mr. Rice bonuses commensurate with
the bonuses awarded to other senior executives of the Company. Mr. Rice received
an option to purchase 244,500 shares of Common Stock at an exercise price of
$12.50, with one-third of such option to vest at the conclusion of each year,
and an option to purchase 90,165 shares of Common Stock at an exercise price of
$5.03, which was fully vested. In the event that Mr. Rice's employment is
terminated by the Company without cause, or by Mr. Rice for good reason, or
following a change of control, Mr. Rice shall be entitled to accelerated vesting
of 100% of any then unvested stock options. Pursuant to the terms of the
employment offer, if the Company terminates Mr. Rice's employment without cause,
or if Mr. Rice terminates his employment for good reason, prior to December 31,
1999, Mr. Rice is entitled to receive severance pay equal to his base salary and
annual bonus through December 31, 1999 and continuation of coverage of certain
benefits. Pursuant to the terms of the agreement, the Company loaned Mr. Rice
$1,000,000, collateralized by shares of the Company's Common Stock underlying
certain vested and exercisable options held by Mr. Rice. The loan is payable on
December 31, 2002 and bears interest at 5.67%, compounded semi-annually. In May
1998, the Company's Board of Directors increased Mr. Rice's annual base salary
to $185,000. In May 1998, Mr. Rice received an option to purchase 25,000 shares
of Common Stock at an exercise price equal to $7.94. In August 1998, Mr. Rice
received an option to purchase 25,000 shares of Common Stock at an exercise
price equal to $5.09. In connection with the Company's exchange of certain
outstanding options in September 1998, Mr. Rice's option to purchase 244,500
shares of Common Stock was exchanged for an option to purchase 244,500 shares of
Common Stock at an exercise price equal to $5.09. In February 1999, Mr. Rice
received a bonus of $100,000 for services performed
68
<PAGE> 70

in 1998. In June 1999, Mr. Rice received an option to purchase 25,000 shares of
Common Stock at an exercise price equal to $5.63. In December 1999, Mr. Rice
received an option to purchase 750,000 shares of Metastream Corporation Common
Stock at an exercise price equal to $1.00. In February 2000, Mr. Rice received a
bonus of $65,000 for services performed in 1999.

The Company's employment agreement with Mr. Leddy, dated August 24, 1998,
provided for an annual base salary of $160,000. The agreement also provided for
a signing bonus of $10,000 and a performance incentive of up to $15,000 per
quarter with the bonus for the first two quarters guaranteed. Mr. Leddy received
an option to purchase 130,000 shares of Common Stock at an exercise price equal
to $3.38, with 25% of such option to vest at the conclusion of one year and
1/36 of the remaining option to vest monthly thereafter. In the event that Mr.
Leddy's employment is terminated by the Company following a change of control
during the first year of his employment, Mr. Leddy shall be entitled to
accelerated vesting of 50% of any then unvested stock options. In the event that
Mr. Leddy's employment is terminated by the Company following a change of
control after the first year of his employment, Mr. Leddy shall be entitled to
accelerated vesting of 100% of any then unvested stock options. Pursuant to the
terms of the employment offer, if the Company terminates Mr. Leddy's employment
without cause, Mr. Leddy is entitled to receive severance pay equal to his base
salary for a six month period and continuation of coverage of certain benefits.
In June 1999, Mr. Leddy received an option to purchase 75,000 shares of Common
Stock at an exercise price equal to $5.63. In July 1999, Mr. Leddy's annual base
salary was increased to $195,000 by the Company's Board of Directors. Pursuant
to the terms of a letter agreement dated December 12, 1999, the Company agreed
to pay Mr. Leddy a bonus of $250,000 on May 1, 2000, provided that Mr. Leddy
does not voluntarily resign his position prior to that date. Additionally, the
Company agreed to pay Mr. Leddy a bonus of $100,000 on or before May 1, 2000,
provided that Mr. Leddy does not voluntarily resign his position prior to that
date and the Company has successfully divested itself of its core prepackaged
professional software product lines.

Pursuant to the terms of an employment offer letter dated February 20,
1998, from the Company to Mr. Lauer, the Company agreed to pay Mr. Lauer an
annual base salary of $350,000 plus a targeted annual bonus for 1998. The
payment of future bonuses would be determined by the Compensation Committee of
the Company's Board of Directors. The Company paid premiums on a term life
insurance policy on Mr. Lauer in the amount of $1,000,000, the beneficiaries of
which were designated by Mr. Lauer. Mr. Lauer received an option to purchase
800,000 shares of Common Stock at an exercise price equal to $7.9063, with 30%
of such option to vest at the conclusion of one year and 1/36 of the remaining
option to vest monthly thereafter. Mr. Lauer also received an option to purchase
200,000 additional shares of Common Stock at a price equal to $7.9063, with such
option to vest at the conclusion of four years of employment, with possible
accelerated vesting based upon achievement of performance goals. In connection
with the Company's exchange of certain outstanding options in September 1998,
Mr. Lauer's options were exchanged for options to purchase 800,000 shares and
200,000 shares of Common Stock, each at an exercise price equal to $5.09.
Pursuant to the terms of the employment offer, if the Company terminated Mr.
Lauer's employment without cause, Mr. Lauer was entitled to receive severance
pay equal to twelve months of his base salary, and accelerated vesting of 50% of
then unvested options. In the event of a change in control of the Company
between the first and beginning of the fourth years of Mr. Lauer's employment
that results in termination without cause, resignation due to the change of
control, or a material change in duties, Mr. Lauer was entitled to receive
severance payments equal to twelve months of his base compensation plus standard
employee benefits for twelve months, and accelerated vesting of 100% of any then
unvested stock options. Pursuant to the terms of a letter agreement dated July
16, 1998 from the Company to Mr. Lauer, the Company agreed to offer Mr. Lauer a
collateralized loan of up to $1,000,000 to assist Mr. Lauer with the purchase of
a home in the Santa Barbara, California area. Mr. Lauer has executed a
promissory note dated November 9, 1998 in favor of the Company in the amount of
$1,000,000, collateralized by a first trust deed on Mr. Lauer's Santa Barbara
residence. The note was non-interest bearing and was payable on February 20,
2002. The letter agreement provided that if Mr. Lauer sold such Santa Barbara
residence on or before February 19, 2002 for a loss, as defined in the letter
agreement, the Company would reimburse Mr. Lauer for such loss. However, in the
event that Mr. Lauer proposed to undertake a sale of the Santa Barbara residence
that would result in such a loss, Mr. Lauer and the Company would transfer
control of the sale to an independent third party. In the event that such third
party was able to broker a sale of the residence for a gain to Mr. Lauer, as
defined in the letter agreement, Mr. Lauer would
69
<PAGE> 71

reimburse the Company for the third party's expenses in an amount not to exceed
his gain. In connection with the Company's restructuring activities, Mr. Lauer
agreed to a 10% salary reduction from September 16, 1998 through December 31,
1998. In December 1999, Mr. Lauer received an option to purchase 50,000 shares
of Metastream Corporation Common Stock at an exercise price equal to $1.00. Mr.
Lauer resigned as President and Chief Executive Officer effective December 14,
1999. Pursuant to the terms of a letter agreement dated December 31, 1999, the
due date of the $1,000,000 collateralized loan was extended to the earlier of
the close of escrow or December 31, 2000. Additionally, the loan was further
collateralized by shares of the Company's Common Stock underlying certain vested
and exercisable options held by Mr. Lauer.

The Company's employment agreement with Mr. Krause, dated January 26, 1994,
provided for an annual base salary of $160,000, with the opportunity to
participate in any incentive or bonus plans adopted in the discretion of the
Board of Directors. The agreement provided for an employment term through
December 31, 1998. Pursuant to the agreement, the Company pays premiums on a
term life insurance policy on Mr. Krause in the amount of $3,000,000, the
beneficiaries of which may be designated by Mr. Krause. The employment agreement
may be terminated by the Company at any time upon a material breach of Mr.
Krause's obligations to perform under the agreement, including failure to
perform by reason of illness, incapacity or otherwise. In May 1995, Mr. Krause's
annual base salary was increased to $195,000 by the Company's Board of
Directors. In January 1996, Mr. Krause's annual base salary was increased to
$215,000 by the Company's Board of Directors. In January 1997, Mr. Krause's
annual base salary was increased to $240,000 by the Company's Board of
Directors. In January 1998, Mr. Krause received an option to purchase 300,000
shares of Common Stock at an exercise price of $6.44. In May 1998, Mr. Krause's
annual base salary was increased to $250,000 by the Company's Board of
Directors. In connection with the Company's restructuring activities, Mr. Krause
agreed to a 10% salary reduction from September 16, 1998 through December 31,
1998. Mr. Krause resigned as Chief Design Officer effective May 1, 1999.
Pursuant to the terms of a Severance Agreement and Release dated May 1, 1999,
the Company retained the services of Mr. Krause for a twelve-month period at Mr.
Krause's annual base salary of $250,000.

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PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following documents are filed as part of this report:

1. Financial Statements and Financial Statement Schedules. See Index to
Financial Statements at Item 8 on page 25 of this Report.

2. Exhibits.

<TABLE>
<C> <S>
Exhibit No. 2: Plan of Acquisition, Reorganization, Arrangement,
Liquidation or Succession
2.1 Form of Agreement and Plan of Merger by and between the
Registrant and MetaTools, Inc., a California corporation
(incorporated by reference from Exhibit 2.1 to the
Registrant's Registration Statement on Form SB-2, filed on
December 11, 1995, as amended (File No. 33-98628LA))
2.2 Stock Purchase Agreement between the Registrant and Real
Time Geometry Corp. dated December 23, 1996 (incorporated by
reference from Exhibits 2.2, 10.22, 10.23, 10.24 and 10.25
to the Registrant's Current Report on Form 8-K, filed on
January 15, 1997 (File No. 000-27168))
2.3 Agreement and Plan of Reorganization, dated as of February
11, 1997, among MetaTools, Inc., a Delaware corporation,
Fractal Design Corporation, a Delaware corporation, and Rook
Acquisition Corp., a Delaware corporation and wholly-owned
subsidiary of MetaTools (incorporated by reference from
Annex A to the Registrant's Registration Statement on Form
S-4, filed on April 28, 1997 (File No. 333-25939))
2.4 Agreement and Plan of Merger among Fractal Design
Corporation, a California corporation, and Rook Acquisition
Corp., a Delaware corporation, dated as of May 29, 1997
(incorporated by reference from Exhibit 2.2 to the
Registrant's Form 8-K, filed on June 13, 1997 (File No.
000-27168))

Exhibit No. 3: Articles of Incorporation and Bylaws
3.1 Restated Certificate of Incorporation of Registrant
(incorporated by reference from Exhibit 3.4 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995, filed on March 30, 1996 (File No.
000-27168))
3.2 Restated Certificate of Incorporation of Registrant
(incorporated by reference from Exhibit 3.4 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995, filed on March 30, 1996 (File No.
000-27168))
3.3 Certificate of Amendment of Restated Certificate of
Incorporation of Registrant (incorporated by reference from
Exhibit 2.3 to the Registrant's Form 8-K, filed on June 13,
1997 (File No. 000-27168))
3.4 Bylaws of Registrant, as amended on July 24, 1998
(incorporated by reference from Exhibit 3.6 to the
Registrant's Form 10-Q for the quarter ended June 30, 1998,
filed on August 14, 1998 (File No. 000-27168))

Exhibit No. 4: Instruments Defining the Rights of Security Holders
4.1 Specimen of Common Stock Certificate of Registrant
(incorporated by reference from Exhibit 2.4 to the
Registrant's Form 8-K, filed on June 13, 1997 (File No.
000-27168))
4.2 Amended and Restated Rights Agreement, dated as of June 24,
1999 between MetaCreations Corporation and BankBoston, N.A.,
including form of Certificate of Designations, Rights
Certificate and the Summary of Rights attached thereto as
Exhibits A, B, and C respectively (incorporated by reference
from Exhibit 4 to the Registrant's Form 8-A/A, filed on
October 29, 1999 (File No. 000-27168))
</TABLE>

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<TABLE>
<C> <S>
Exhibit No. 10: Material Contracts
Executive Compensation Plans and Agreements
10.1 1992 Incentive Stock Plan (incorporated by reference from
Exhibit 10.3 to the Registrant's Registration Statement on
Form SB-2, filed on December 11, 1995, as amended (File No.
33-98628LA))
10.2 1994 Incentive Stock Option, Non-Qualified Stock Option and
Restricted Stock Purchase Plan (incorporated by reference
from Exhibit 10.4 to the Registrant's Registration Statement
on Form SB-2, filed on December 11, 1995, as amended (File
No. 33-98628LA))
10.3 1995 Stock Plan, as amended on May 26, 1999 (incorporated by
reference from Exhibit 4.1 to the Registrant's Registration
Statement on Form S-8, filed on September 9, 1999 (File No.
333-86817))
10.4 1995 Employee Stock Purchase Plan, as amended on May 6, 1998
(incorporated by reference from Exhibit 10.6 to the
Registrant's Form 10-Q for the quarter ended March 31, 1998,
as filed on May 14, 1998 (File No. 000-27168))
10.5 1995 Director Option Plan (incorporated by reference from
Exhibit 10.7 to the Registrant's Registration Statement on
Form SB-2, filed on December 11, 1995, as amended (File No.
33-98628LA))
10.6 1996 Dive Option Plan (incorporated by reference from
Exhibit 10.23 to the Registrant's Registration Statement on
Form S-8, filed on December 3, 1996 (File No. 333-17209))
10.7 1996 Nonstatutory Stock Option Plan, as amended on June 29,
1999 (incorporated by reference from Exhibit 4.2 to the
Registrant's Registration Statement on Form S-8, filed on
September 9, 1999 (File No. 333-86817))
10.8 Letter Agreement between the Registrant and Mark Zimmer and
Thomas Hedges, dated February 11, 1997 (incorporated by
reference from Exhibit 10.30 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1997,
filed on March 31, 1998 (File No. 000-27168))
10.9 Letter Agreement between the Registrant and Mark Zimmer,
dated December 10, 1999
10.10 Employment Agreement between the Registrant and Terance A.
Kinninger dated September 27, 1995 (incorporated by
reference from Exhibit 10.10 to the Registrant's
Registration Statement on Form SB-2, filed on December 11,
1995, as amended (File No. 33-98628LA))
10.11 Severance Agreement between the Registrant and Terance A.
Kinninger dated October 31, 1997 (incorporated by reference
from Exhibit 10.32 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1997, filed on March
31, 1998 (File No. 000-27168))
10.12 Letter Agreement between the Registrant and Terance
Kinninger, dated December 10, 1999
10.13 Employment Agreement between the Registrant and Robert Rice
dated December 31, 1996 (incorporated by reference from
Exhibit 10.23 to the Registrant's Current Report on Form
8-K, filed on January 15, 1997 (File No. 000-27168))
10.14 Employment Agreement between the Registrant and John Leddy
dated August 24, 1998 (incorporated by reference from
Exhibit 10.40 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1998, filed on March 31,
1999 (File No. 000-27168))
10.15 Letter Agreement between the Registrant and John Leddy,
dated December 12, 1999
10.16 Employment Agreement between the Registrant and Gary L.
Lauer dated February 20, 1998 (incorporated by reference
from Exhibit 10.38 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1997, filed on March
31, 1998 (File No. 000-27168))
</TABLE>

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<TABLE>
<C> <S>
10.17 Amendment to Employment Agreement between the Registrant and
Gary L. Lauer dated July 16, 1998 (incorporated by reference
from Exhibit 10.39 to the Registrant's Form 10-Q for the
quarter ended June 30, 1998, filed on August 14, 1998 (File
No. 000-27168))
10.18 Letter Agreement between the Registrant and Gary Lauer,
dated December 31, 1999
10.19 Employment Agreement between the Registrant and Kai Krause
dated January 26, 1994 (incorporated by reference from
Exhibit 10.9 to the Registrant's Registration Statement on
Form SB-2, filed on December 11, 1995, as amended (File No.
33-98628LA))
10.20 Severance Agreement and Release between the Registrant and
Kai Krause, dated May 1, 1999

Other Material Contracts
10.21 Form of Indemnification Agreement for Executive Officers and
Directors (incorporated by reference from Exhibit 10.1 to
the Registrant's Registration Statement on Form SB-2, filed
on December 11, 1995, as amended (File No. 33-98628LA))
10.22 Investors' Rights Agreement, as amended (incorporated by
reference from Exhibit 10.2 to the Registrant's Registration
Statement on Form SB-2, filed on December 11, 1995, as
amended (File No. 33-98628LA))
10.23 Amended and Restated Investors' Rights Agreement
(incorporated by reference from Exhibit C to Exhibit 2.2 to
the Registrant's Current Report on Form 8-K, filed on
January 15, 1997 (File No. 000-27168))
10.24* Distribution Agreement between the Registrant and Ingram
Micro Inc. dated October 19, 1992, as amended on November
10, 1997 (incorporated by reference from Exhibit 10.16 to
the Registrant's Registration Statement on Form SB-2, filed
on December 11, 1995, as amended (File No. 33-98628LA) and
Exhibit 10.16 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, filed on March 31,
1998 (File No. 000-27168))
10.25* International Software Distribution Agreement between the
Registrant and Marubeni Corporation dated as of August 1,
1997 (incorporated by reference from Exhibit 10.21 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997, filed on March 31, 1998 (File No.
000-27168))
10.26 Licensing and Services Agreement dated June 30, 1999 by and
among MetaStream.com Corporation, Computer Associates
International, Inc. and Registrant
10.27 Licensing and Services Agreement dated September 30, 1999 by
and among MetaStream.com Corporation, Computer Associates
International, Inc. and Registrant
10.28* Turnkey/Inventory Agreement between the Registrant and Modus
Media International, Inc. dated as of June 1, 1997
(incorporated by reference from Exhibit 10-22 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1997, filed on March 31, 1998 (File No.
000-27168))
10.29 Lease Agreement between the Registrant and Bluffs Group III
dated December 8, 1998 (incorporated by reference from
Exhibit 10.34 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, filed on March 31,
1998 (File No. 000-27168))
10.30 Second Lease Agreement between the Registrant and Bluffs
Group III dated December 8, 1998 (incorporated by reference
from Exhibit 10.35 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1997, filed on March
31, 1998 (File No. 000-27168))
</TABLE>

73
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<TABLE>
<C> <S>
10.31 Lease Agreement between the Registrant and HKH Partners
dated December 8, 1998 (incorporated by reference from
Exhibit 10.36 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, filed on March 31,
1998 (File No. 000-27168))

Exhibit No. 21: Subsidiaries of the Registrant
21.1 Listing of Registrant's Subsidiaries

Exhibit No. 23: Consents of Experts and Counsel
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants

Exhibit No. 24: Power of Attorney
24.1 Power of Attorney (included on the signature pages of this
Annual Report on Form 10-K)

Exhibit No. 27: Financial Data Schedule
27.1 Financial Data Schedule
</TABLE>

---------------

* Confidential treatment for this exhibit has been requested pursuant to Rule
24b-2 under the Securities Exchange Act of 1934, as amended.

(b) Reports on Form 8-K

On December 20, 1999, the Registrant filed a report on Form 8-K to file a
press release issued by the Registrant on December 14, 1999 announcing the
Registrant's decision to focus solely on e-commerce visualization solutions for
the Web and to divest itself of non-strategic software assets. On December 20,
1999, the Registrant filed a report on Form 8-K to file a press release issued
by the Registrant on December 14, 1999 announcing the resignation of Gary Lauer
as President and Chief Executive Officer of the Registrant and the appointment
of Mark Zimmer as the new President and Chief Executive Officer. On January 6,
2000, the Registrant filed a report on Form 8-K to file a press release issued
by the Registrant on December 30, 1999 announcing the election of Howard Morgan
as Chairman of the Board for Metastream Corporation and other management
changes.

See Item 14(a)(2) above.

(d) Financial Statement Schedules

See Item 14(a)(1) above.

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<PAGE> 76

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of New
York, State of New York, on the 21st day of August 2000.

METACREATIONS CORPORATION

By: /s/ JAMES A. ABATE
------------------------------------
James A. Abate
Sr. Vice President and
Chief Financial Officer

POWER OF ATTORNEY

KNOW ALL PERSON BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints James A. Abate, his attorney-in-fact, with the
power of substitution, for him and any and all capacities, to sign any
amendments to this Report on Form 10-K/A, and to file same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitutes, may do or cause to be done by virtue
hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ ROBERT RICE Director, President and August 21, 2000
----------------------------------------------------- Chief Executive Officer
Robert Rice (Principal Executive
Officer)

/s/ JAMES A. ABATE Sr. Vice President and August 21, 2000
----------------------------------------------------- Chief Financial Officer
James A. Abate (Principal Financial and
Accounting Officer)

/s/ SAMUEL H. JONES, JR. Director August 21, 2000
-----------------------------------------------------
Samuel H. Jones, Jr.

/s/ WILLIAM H. LANE III Director August 21, 2000
-----------------------------------------------------
William H. Lane III
</TABLE>