<PAGE>
  
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                   FORM 10-Q

(Mark One)

[X]  Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
     Exchange Act of 1934
     For the quarterly period ended March 31, 1997 or

[_]  Transition Report pursuant to Section 13 or 15(d) of the Securities and
     Exchange Act of 1934
     For the transition period from ___________ to ___________.

                         Commission file number 0-27168

                                METATOOLS, INC.
             (Exact name of registrant as specified in its charter)

              Delaware                        95-4102687
       (State of incorporation)  (I.R.S. Employer Identification Number)

                  6303 Carpinteria Ave, Carpinteria, CA 93013
                   (Address of principal executive offices)

                                (805) 566-6200
             (Registrant's telephone number, including area code)

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

As of May 8, 1997, there were outstanding 13,796,774 shares of the registrant's
Common Stock, $0.001 par value per share, which is the only outstanding class of
common or voting stock of the registrant.

                                       1
<PAGE>
 
                                METATOOLS, INC.

                                   FORM 10-Q

                               Table of Contents
<TABLE>
<CAPTION>
 
 
                                                                            Page
                                                                            ----
 
PART I.        FINANCIAL INFORMATION
 
<S>            <C>                                                          <C>
Item 1.        Financial Statements........................................ 3
 
               Consolidated balance sheets - March 31, 1997 and
                 December 31, 1996
               Consolidated statements of operations - Three months 
                 ended March 31, 1997 and 1996
               Consolidated statements of cash flows - Three months 
                 ended March 31, 1997 and 1996
               Notes to consolidated financial statements
 
Item 2.        Management's Discussion and Analysis of Financial 
                 Condition and Results of Operations....................... 9 
 
PART II.       OTHER INFORMATION
 
Item 6.        Exhibits and Reports on Form 8-K............................ 19
  
SIGNATURES     ............................................................ 20

</TABLE> 
 

                                       2
<PAGE>
 
                         PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

                                METATOOLS, INC.

                          CONSOLIDATED BALANCE SHEETS

                                (in thousands)
<TABLE>
<CAPTION>


                                                                                        MARCH 31,             DECEMBER 31,
                                                                                          1997                    1996
                                                                                        ---------             -----------
                                                                                        (Unaudited)           (Audited)
<S>                                                                                    <C>                    <C>
ASSETS
Current assets:
 Cash and cash equivalents...........................................................  $  10,907              $  18,961
 Short-term investments..............................................................     26,085                 20,596
 Accounts receivable, net............................................................     10,149                  9,994
 Inventories.........................................................................        455                    252
 Deferred income taxes...............................................................        746                    746
 Prepaid expenses....................................................................      2,823                  2,080
                                                                                       ---------               --------
   Total current assets..............................................................     51,165                 52,629

Property and equipment, net..........................................................      4,107                  3,123
Other assets.........................................................................      1,214                  1,277
                                                                                       ---------               --------
   Total assets...................................................................... $   56,486               $ 57,029
                                                                                       =========               ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Accounts payable.................................................................... $    2,869               $ 2,269
 Accrued expenses....................................................................      2,105                 3,527
 Royalties payable...................................................................        499                   402
                                                                                       ---------               --------
   Total current liabilities.........................................................      5,473                 6,198

Stockholders' equity:
 Preferred stock, $.001 par value, 5,000,000 shares authorized - no
  shares issued and outstanding at March 31, 1997 and
  December 31, 1996, respectively ...................................................          -                     -
 Common stock, $.001 par value; 30,000,000 shares authorized -
  13,288,770 and 13,253,584 shares issued and outstanding at
  March 31, 1997 and December 31, 1996, respectively ................................         13                    13
 Paid-in capital.....................................................................     67,453                67,310
 Notes receivable from stockholders..................................................     (3,042)               (3,000)
 Accumulated deficit.................................................................    (13,411)              (13,492)
                                                                                       ---------               --------
   Total stockholders' equity........................................................     51,013                50,831
                                                                                       ---------               --------
   Total liabilities and stockholders' equity........................................ $   56,486               $57,029
                                                                                       =========               ========

</TABLE>
 
The accompanying notes are an integral part of these consolidated financial
statements.

                                       3
<PAGE>
 
                                METATOOLS, INC.

                     CONSOLIDATED STATEMENTS OF OPERATIONS

                   (In thousands, except per share amounts)
                                  (Unaudited)
<TABLE>
<CAPTION>

                                                                                          THREE MONTHS ENDED
                                                                                               MARCH 31,
                                                                                      -------------------------
                                                                                          1997          1996
                                                                                      -------------------------
<S>                                                                                   <C>          <C>
Net revenues......................................................................    $     6,248  $      5,503
Cost of revenues..................................................................            838         1,103
                                                                                      -----------  ------------
Gross profit......................................................................          5,410         4,400

Operating expenses:
 Sales and marketing..............................................................          3,173         2,625
 General and administrative.......................................................            824           602
 Research and development.........................................................          1,850           738
                                                                                      -----------  ------------
Total operating expenses..........................................................          5,847         3,965
                                                                                      -----------  ------------

Income (loss) from operations.....................................................           (437)          435

Other income:
 Interest and investment income, net..............................................            553           611
 Other income.....................................................................              -             3
                                                                                      -----------  ------------

Income before provision for income taxes..........................................            116         1,049
Provision for income taxes........................................................             35           325
                                                                                      -----------  ------------

Net income........................................................................    $        81  $        724
                                                                                      ===========  ============

Net income per common share.......................................................    $       .01  $        .06
                                                                                      ===========  ============
Weighted average number of shares outstanding.....................................         14,235        13,054
                                                                                      ===========  ============

</TABLE>
 
The accompanying notes are an integral part of these consolidated financial
statements.

                                       4
<PAGE>
 
                                METATOOLS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                (In thousands)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                             THREE MONTHS ENDED
                                                                                 MARCH 31,
                                                                           ----------------------
                                                                             1997          1996
                                                                           ----------------------
<S>                                                                         <C>            <C>
Cash flows from operating activities:
 Net income............................................................... $      81     $    724
 Adjustments to reconcile net income to net cash used in operating
  activities:
   Depreciation and amortization..........................................       348          161
   Reserves for receivables and product returns...........................       481          357
   Reserves for inventory.................................................         -           36
   Accrued interest income................................................       (42)           -
   Changes in operating assets and liabilities:
     Accounts receivable..................................................      (636)      (1,310)
     Inventories..........................................................      (203)          37
     Prepaid expenses and other assets....................................      (706)         (47)
     Accounts payable and accrued expenses................................      (822)        (354)
     Income taxes payable.................................................         -          325
     Royalties payable....................................................        97         (106)
                                                                           ---------     --------
      Net cash used in operating activities...............................    (1,402)        (177)

Cash flows from investing activities:
 Purchases of short-term investments......................................    (7,813)           -
 Proceeds from maturities of short-term investments.......................     2,324            -
 Purchases of property and equipment......................................    (1,244)        (313)
 Purchases of software technology and product rights......................         -          (55)
                                                                           ---------     --------
      Net cash used in investing activities...............................    (6,733)        (368)

Cash flows from financing activities:
 Proceeds from exercise of stock options..................................        81          193
                                                                           ---------     --------
      Net cash provided by financing activities...........................        81          193
                                                                           ---------     --------

Net decrease in cash and cash equivalents.................................    (8,054)        (352)
Cash and cash equivalents at beginning of period..........................    18,961       46,885
                                                                           ---------     --------
Cash and cash equivalents at end of period................................ $  10,907     $ 46,533
                                                                           =========     ========

</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.

                                       5
<PAGE>


                                METATOOLS, INC.

                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                (In thousands)
                                  (Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statement presentation. In the opinion of management, the accompanying
consolidated balance sheets and related interim consolidated statements of
operations and cash flows include all adjustments (consisting only of normal
recurring items) considered necessary for their fair presentation. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses.
Actual results could differ from those estimates. The consolidated results of
operations for the period ended March 31, 1997 are not necessarily indicative of
results to be expected for the year ended December 31, 1997. The information
included in this Form 10-Q should be read in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
Company's audited financial statements and notes thereto included in the
Company's Annual Report on Form 10-K/A for the year ended December 31, 1996.

Cash Equivalents and Short-term Investments

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

Net Income Per Common Share

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

In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share." SFAS No.
128 requires companies to adopt its provisions for fiscal years ending after
December 15, 1997 and requires restatement of all prior period earnings per
share ("EPS") data presented. Earlier application is not permitted. SFAS No. 128
specifies the computation, presentation, and disclosure

                                       6
<PAGE>
                                METATOOLS, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                                (In thousands)
                                 (Unaudited) 

requirements for EPS. The implementation of SFAS No. 128 is not expected to have
a material effect on the EPS data previously presented by the Company.

2. INVENTORIES

Inventories consist of the following:
<TABLE>
<CAPTION>
 
                              March 31,   December 31,
                                1997         1996
                              ---------   ------------
 
<S>                           <C>         <C>
Finished goods...........      $   421     $      229
Materials and supplies...           34             23
                               -------     ----------
                               $   455     $      252
                               =======     ==========
</TABLE>
3. INCOME TAXES
 
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
 
                                   THREE MONTHS ENDED 
                                       MARCH 31,
                                  --------------------
                                   1997          1996
                                  ------        ------  
<S>                               <C>           <C>
Federal.......................     $  27        $ 224
State.........................         8          101
                                   -----        -----
                                   $  35        $ 325
                                   =====        =====
</TABLE>

The provision for income taxes for the three months ended March 31, 1997 and
1996 are based on the Company's estimated annualized effective tax rate for the
respective years, after giving effect to the utilization of available net
operating loss and tax credit carryforwards.

4. PENDING MERGER WITH FRACTAL DESIGN CORPORATION

On February 11, 1997, the Company entered into a definitive merger agreement
with Fractal Design Corporation ("Fractal"). The definitive agreement and plan
of reorganization provides that upon the effective date of the merger, each
share of Fractal common stock shall be converted into 0.749 shares of the
Company's common stock and each option to purchase Fractal common stock will be
converted into options to purchase 0.749 shares of the Company's common stock at
an exercise price equal to the exercise price to purchase Fractal options prior
to the merger divided by 0.749. It is anticipated that approximately 8,962,000
shares of MetaTools common stock will be issued in connection with the merger,
based upon the number of shares of Fractal common stock issued and outstanding
at December 31, 1996 (which number does not include shares of MetaTools common
stock to be issued to holders of options to purchase shares of Fractal common
stock). The merger is intended to be accounted for as a pooling of interests and

                                       7
<PAGE>
                                METATOOLS, INC.

                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)

                                (In thousands)
                                 (Unaudited) 

the companies intend to structure the merger to qualify as a tax free
reorganization. On April 28, 1997, the Company filed a Registration Statement on
Form S-4 with the Securities and Exchange Commission. The merger, which is
anticipated to be consummated on or about May 30, 1997, is contingent upon
customary conditions including the approval of the stockholders of the Company
and the shareholders of Fractal on May 29, 1997, the occurrence of no event
which could have a material adverse effect with respect to the other party, and
the satisfaction of any governmental or regulatory requirements to legally
effect the merger.

5. SUBSEQUENT EVENTS

On April 15, 1997, the Company completed the acquisition of Specular
International ("Specular"), a privately held software development company based
in Amherst, Massachusetts, which develops and markets 3-D animation and graphic
design tools for professionals and prosumers. Under the terms of the Purchase
Agreement, the stockholders of Specular received 546,781 shares of the Company's
common stock and $1 million in cash in exchange for all of the outstanding
shares of Specular. The Company also issued 450,000 non-qualified stock options
to purchase shares of the Company's common stock to Specular employees at an
exercise price of $7 per share, the fair market value of the Company's common
stock on April 16, 1997. The Company plans to relocate approximately 17 of
Specular's existing engineering and product management personnel to its Real
Time Geometry ("RTG") facilities in Princeton, New Jersey, closing Specular's
Amherst headquarters, and laying-off and providing severance to approximately 18
of Specular's existing operations, accounting, and sales personnel. The Company
expects to charge approximately $7 million against earnings during the second
quarter ended June 30, 1997, related to the write-off of acquired in-process
technology, the closing of the Amherst facility, and other costs related to the
acquisition.

                                       8
<PAGE>
 
Item 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
         AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the unaudited
consolidated financial statements and notes thereto.

The discussion and analysis below contains trend analysis and other forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933, and Section 21E of the Securities Exchange Act of 1934, as amended. The
Company's actual results could differ materially from those projected in the
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in the section
entitled "Factors That May Affect Future Operating Results," as well as those
discussed elsewhere in the Company's SEC reports, including without limitation,
its Annual Report on Form 10-K/A for the year ended December 31, 1996.

OVERVIEW

The Company derives a substantial majority of its revenues from a limited number
of products.  The Company's future revenues are substantially dependent upon the
continued market acceptance of the Company's existing leading products: Kai's
Power Goo, Kai's Power Tools, and Bryce.  In this regard, revenue from the sale
of these products represented a substantial majority of revenues during the
three months ended March 31, 1997.  The Company also has a number of new product
development efforts under way, and a significant portion of future revenues is
dependent upon the success of these activities.

The Company develops its products either internally or through co-development
arrangements with third parties.  These co-development arrangements generally
provide the Company with certain exclusive proprietary, copyright or marketing
rights for developed products in exchange for the payment of one-time and/or
ongoing royalties.  The Company expects to continue fostering arrangements with
external developers as part of its strategy of expanding its product portfolio.
There can be no assurance, however, that the Company will be able to continue to
supplement its product development efforts in the future through such
relationships on favorable terms or at all.  If the Company were unable to
maintain its existing co-development arrangements or to attract new co-
development partners, the Company would, at a minimum, have to increase its
research and development expenditures, which could have a material adverse
effect on the Company's business, operating results and financial condition.

The Company sells its products primarily to domestic and international
distributors, including mail order resellers and retail outlets.  The Company
also sells its products to Original Equipment Manufacturers ("OEMs") for
bundling with their hardware or software products and directly to end users,
generally through telesales and direct mail campaigns.  Fluctuations in
distributor purchases can cause significant volatility in the Company's
revenues.  Distributors generally stock the Company's products at levels which
may fluctuate significantly for a variety of reasons, including the
distributors' ability to finance the purchase of products and to devote shelf
space, catalog space or attention to the products. Distributor purchases may
also be affected by the Company's introduction of a new product or new version
of a product, the Company's end user promotions programs, anticipated product
price increases, the Company's purchases of display space at retail outlets and
other factors.  Further, OEM agreements, which generally provide for minimum
guaranteed non-refundable payments to the Company, are typically tied to the
planned introduction of OEM bundled product and are often entered into at the
end of the

                                       9
<PAGE>
 
quarter. The timing of the execution of such agreements can fluctuate
substantially throughout the year, causing volatility in the Company's revenues,
operating results, and cash flows.

Since 1992, the Company has focused on building its product portfolio and
establishing brandname awareness of its products.  These activities have
resulted in significant increases in all expense categories.  In particular, the
Company's shift from direct sales to end users toward expanded indirect
distribution channels has required a substantial increase in the Company's sales
and marketing activities.  The Company's recent product development efforts have
also entailed significant research and development expenditures.  These higher
expense levels combined with the write-off of acquired in-process research and
development from periodic acquisitions and quarterly fluctuations in net
revenues have contributed to the Company's annual losses and periodic quarterly
losses, as well as fluctuations in its operating results.  The Company intends
to continue to invest significant amounts both in expanding its product
portfolio and in maintaining and enhancing brand awareness of its products, and
accordingly may continue to experience losses and volatility of net revenues and
operating results in future periods.

OPERATING RESULTS

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


<TABLE>
<CAPTION>  
                                            THREE MONTHS ENDED
                                                MARCH 31,
                                            ------------------
                                             1997        1996
                                             ----        ---- 

<S>                                          <C>        <C>
Net revenues............................     100.0%     100.0%
Cost of revenues........................      13.4       20.0
                                             -----      ----- 
  Gross margin..........................      86.6       80.0
 
Operating expenses:
 Sales and marketing....................      50.8       47.8
 General and administrative.............      13.2       10.9
 Research and development...............      29.6       13.4
                                             -----      -----   
  Total operating expenses..............      93.6       72.1
                                             -----      ----- 
 
Income (loss) from operations...........      (7.0)       7.9
Other income, net.......................       8.9       11.2
                                             -----      ----- 
 
Net income before provision for income         
 taxes..................................       1.9       19.1
Provision for income taxes..............       0.6        5.9
                                             -----      ----- 
 
Net income..............................       1.3 %     13.2 %
                                             =====      =====   

</TABLE> 
                                       10
<PAGE>
 
Net Revenues

The Company recognizes revenue from the sale of its products upon shipment to
the customer and satisfaction of significant Company obligations, if any.  Net
revenues increased 14% from $5.5 million for the three months ended March 31,
1996 to $6.2 million for the three months ended March 31, 1997.  Net revenues
increased as a result of the Company's release of new products and new versions
of its existing products, increased expansion of sales through OEM's, and
increased international sales. The Company released Kai's Power Goo, Final
Effects for Adobe's Premiere on the Windows platform, and PowerPhotos Series IV
in the second quarter of 1996; Bryce 2 for Windows and MetaPhotos in the third
quarter of 1996, and Life in the Universe in the first quarter of 1997.
International sales increased from 18% of net revenues for the three months
ended March 31, 1996 to 38% of net revenues for the three months ended March 31,
1997.  The growth in international revenues was mainly attributed to increased
sales in Japan resulting from the transition to a new publisher and distributor,
Marubeni Corporation, in the first quarter of 1996.

The Company offers two principal product types consisting of stand-alone
applications and application platforms (principally consisting of Kai's Power
Goo, Bryce, Life in the Universe, and MetaPhotos) and plug-in extensions
(including Kai's Power Tools, Vector Effects, and Final Effects).  Net revenue
contribution by each product family for the three months ended March 31, 1997
and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
 
                                            THREE MONTHS ENDED
                                                MARCH 31,
                                            ------------------
                                              1997       1996
                                              ----       ---- 
<S>                                          <C>        <C>
Stand-alone applications and                
 application platforms..................     $3,806     $2,487
Plug-in extensions......................      2,442      3,016
                                             ------     ------   
  Total net revenues....................     $6,248     $5,503
                                             ======     ======
</TABLE>

The Company provides an allowance for estimated returns at the time of product
shipments and adjusts this allowance as needed based on actual returns history.
Such reserves as a percentage of net revenues have varied significantly over
recent years, reflecting the Company's experience in product returns as it has
significantly expanded the proportion of its sales through third-party
distribution channels and increased its product portfolio.  The Company expects
reserves will continue to vary in the future.  The Company's agreements with its
distributors generally provide the distributors with limited rights to return
unsold inventories under a stock balancing program.  The Company monitors the
activities of its distributors in an effort to minimize excessive returns and
establishes its reserves based on its estimates of expected returns.  While
historically the Company's returns have been within management's expectations,
the establishment of reserves requires judgments regarding such factors as
future competitive conditions and product life cycles, which can be difficult to
predict.  As a result, there can be no assurance that established reserves will
be adequate to cover actual future returns.

                                       11
<PAGE>
  
Cost of Revenues

Cost of revenues includes the costs of goods sold, royalties due to external
developers, inventory management costs, freight and handling costs and reserves
for inventory obsolescence.  Cost of revenues decreased from $1.1 million, or
20% of net revenues, for the three months ended March 31, 1996 to $838,000, or
13% of net revenues, for the three months ended March 31, 1997.  Cost of
revenues decreased as a result of a changing mix of product sales toward lower
royalty products, increased revenue generated from OEM agreements, and improved
management of production and inventory levels.  Royalties represented 4% and 3%
of net revenues for the three months ended March 31, 1996 and 1997,
respectively.

Sales and Marketing

Sales and marketing expenses include advertising, promotional materials, mail
campaigns, trade shows and the compensation costs of sales, marketing, customer
service and public relations personnel who promote the Company's products,
including related facilities costs.  Sales and marketing expenses increased from
$2.6 million, or 48% of net revenues, to $3.2 million, or 51% of net revenues,
for the three months ended March 31, 1996 and 1997, respectively.  Such increase
was a result of the continued efforts to expand sales and marketing activities
and distribution channels, both domestically and internationally, through the
hiring of additional personnel.  The Company intends to continue such expansion
and anticipates that sales and marketing expenses will continue to increase
significantly in future periods as the Company's product offerings expand,
although they may vary as a percentage of net revenues.

General and Administrative

General and administrative expenses include compensation costs related to
executive management, finance and administration personnel of the Company along
with other administrative costs including legal and accounting fees, insurance,
and bad debt expenses.  General and administrative expenses increased from
$602,000, or 11% of net revenues, to $824,000, or 13%, for the three months
ended March 31, 1996 and 1997, respectively.  The increase in general and
administrative expenses resulted from the increased internal staffing to support
the Company's growth since the first quarter of 1996.  The Company expects that
its general and administrative expenses will continue to increase in the future
as the Company expands its staffing to support expanded operations, but may vary
as a percentage of net revenues.

Research and Development

Research and development expenses consist primarily of personnel costs,
consultant fees and required equipment and facilities costs related to the
Company's product development efforts. Research and development expenses
increased from $738,000, or 13% of net revenues, for the three months ended
March 31, 1996, to $1.9 million, or 30% of net revenues, for the three months
ended March 31, 1997, as a result of operating expenses related to the RTG
laboratory, as well as additional personnel hired to expand the Company's
product portfolio, enhance its existing products, migrate its products to the
Windows operating system, and translate its products to foreign languages.  The
Company expects research and development expenses will continue to increase in
future periods, but may vary as a percentage of net revenues.

                                       12
<PAGE>
 
Provision for Income Taxes

The Company records income taxes in accordance with Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes." The provision for
income taxes for the three months ended March 31, 1997 and 1996 are based on the
Company's estimated annualized effective tax rate for the respective years,
after giving effect to the utilization of available net operating loss and tax
credit carryforwards.

Net Income

Net income was $81,000, or $0.01 per share, for the three months ended March 31,
1997, compared to net income of $724,000, or $0.06 per share, for the three
months ended March 31, 1996.

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

Fluctuations in Quarterly Results

The Company has experienced in the past and expects in the future to continue to
experience significant fluctuations in quarterly operating results. There can be
no assurance that the Company's future revenues, operating results and cash
flows will not also vary substantially. The Company generally ships products as
orders are received and, therefore, has little or no backlog. As a result,
quarterly revenues, operating results and cash flows of the Company will
generally depend on a number of factors that are difficult to forecast,
including, among others, the volume and timing of and ability to fulfill orders
received within a quarter. Quarterly revenues, operating results and cash flows
also may fluctuate due to factors such as demand for the Company's products;
introduction, localization or enhancement of products by the Company and its
competitors; customer or distributor order deferrals in anticipation of new
versions of products; market acceptance of new products; reviews in the industry
press concerning the products of the Company or its competitors; changes or
anticipated changes in pricing by the Company or its competitors; the mix of
distribution channels through which products are sold; the mix of products sold;
returns from distributors; and general economic conditions. Revenues, operating
results and cash flows from the Company's products also may be negatively
affected by delays in the introduction or availability of new hardware and
software products from third parties. The Company experiences some effect of
seasonality in its business, as demand for its products tends to increase during
the quarter ending December 31 as a result of timing of year-end holiday season
buying.

As is common in the software industry, the Company's experience has been that a
disproportionately large percentage of revenues in each fiscal quarter occurs in
the latter half of the third month of that quarter. Because the Company's
staffing and other operating expenses are based in part on anticipated net
revenues, a substantial portion of which may not be realized until shortly
before the end of each fiscal quarter, delays in the receipt or shipment of
orders, including delays that may be occasioned by failures of third party
product fulfillment firms to produce and ship products, and delays or deferrals
in the execution of OEM arrangements can cause significant variations in
revenues, operating results and cash flows from quarter to quarter. The Company
will most likely be unable to adjust spending in a timely manner to compensate
for any unexpected revenue shortfall. Accordingly, any significant shortfall in
revenues from the Company's products in relation to expectations could have an
immediate adverse impact on business, operating results, financial condition and
cash flows of the Company. In addition, the

                                       13
<PAGE>
 
Company currently intends to increase its operating expenses to fund greater
levels of research and product development, to increase its sales and marketing
operations and to expand its distribution channels. To the extent that such
expenses precede, or are not subsequently followed by, increased revenues, the
business, operating results, financial condition and cash flows of the Company
will be materially and adversely affected.

Due to the foregoing factors, it is likely that the operating results of the
Company for some future quarters will fall below the expectations of securities
analysts and investors. In such event, the trading price of the Company's Common
Stock could be materially and adversely affected.

Uncertainty as to the Future of the Macintosh Platform and Apple Computer

Apple Computer, Inc. ("Apple Computer") has recently experienced significant
financial difficulties and losses in market share and acceptance. On April 16,
1997, Apple Computer announced a substantial loss of approximately $708 million
for its second fiscal quarter of 1997 due to the purchase of NeXT Software Inc.
and certain restructuring charges including layoffs. This and previous
announcements, and the overall perception of Apple Computer's prospects and
continuing commercial vitality, may negatively impact the Company's Macintosh-
based business.

Product Transitions and Product Returns

From time to time, the Company and its competitors may announce new products,
product versions, capabilities or technologies that have the potential to
replace or shorten the life cycles of the Company's existing products. The
Company has historically experienced increased returns of a particular product
version following the announcement of a planned release of a new version of that
product. Although the Company provides allowances for anticipated returns, there
can be no assurance that product returns will not exceed such allowances in the
future.

Product Concentration; Lack of Product Revenue Diversification

A substantial percentage of the Company's revenues to date have been derived
from a limited number of products, and such products are expected to continue to
account for a substantial majority of the Company's revenues in the near term.
Collective sales of Kai's Power Goo, Kai's Power Tools and Bryce accounted for a
substantial majority of the Company's net revenues for the three months ended
March 31, 1997. Continued market acceptance of the Company's primary products
are therefore critical to the future success of the Company. Any decline in
demand for or failure to achieve continued market acceptance of such products or
any new version of these products, if any, as a result of competition,
technological change, failure of the Company to timely release new versions of
these products, or otherwise, could have a material adverse effect on the
business, operating results, financial condition and cash flows of the Company.

Rapid Technological Change; Dependence on and Need for New Products and Product
Versions; Potential Delays in Product Releases

The market for visual computing graphics software products, and the personal
computer industry in general, is characterized by rapidly changing technology,
resulting in short product life cycles and strong pricing pressures. As a
result, the success of the Company depends substantially upon its ability to
continue to enhance its existing products, to develop and introduce in a timely
manner new products incorporating technological advances and to meet increasing
customer

                                       14
<PAGE>
  
expectations. To the extent one or more competitors introduce products that
better address customer needs, the Company's business could be adversely
affected.

The Company depends upon internal efforts for the development of new products
and product enhancements. The Company has in the past experienced delays in the
development of new products and product versions. There can be no assurance that
the Company will not experience further delays in connection with the current
product development or future development activities.

The Company is also expending significant resources to develop the in-process
research and development obtained in the acquisition of RTG. There can be no
assurances that the further development of the in-process research and
development of the Company will result in commercially viable products.

Dependence Upon Third Party Software Developers

The Company uses certain products and technologies of both domestic and foreign
third party software developers, including both complete products offered as
extensions of the Company's product lines and technologies used in the
enhancement of internally developed products. Such products and technologies are
obtained from third party providers under contractual license agreements, which
in some cases are for limited time periods and may be terminated under certain
circumstances. There can be no assurance that the Company will be able to
maintain adequate relationships with any such third party providers, that these
third party providers will commit adequate development resources to maintain
these products and technologies, or that any license agreement for a limited
time period will be renewed upon termination.

Limited Operating History; Uncertain Profitability; Fluctuating Rates of Growth

The Company has only limited operating history on which an evaluation of its
business and prospects can be based. The Company was incorporated in March 1987
and did not introduce its first internally developed product until January 1993.
The Company experienced losses in each quarter of 1994 and in the first two
quarters of 1995. The Company also realized a loss in the fourth quarter of 1996
due to a one-time write-off of acquired in-process technology and other costs
related to the acquisition of RTG. There can be no assurance, however, that the
net revenues of the Company will continue at their current level or will grow,
or that the Company will be able to achieve sustained profitability on a
quarterly or annual basis. The Company's historical net revenue growth rates,
both domestically and internationally, have varied significantly between monthly
and quarterly periods. Therefore, recent net revenue comparisons should not be
taken as indicative of the rate of net revenue growth, if any, that can be
expected in the future.

Dependence on Key Personnel and Difficulty of Identifying and Hiring Certain
Personnel

The future performance of the Company is substantially dependent on the
performance of its executive officers and key employees. The loss of the
services of any of the executive officers or other key employees of the Company
for any reason could have a material adverse effect on the business, operating
results, financial condition and cash flows of the Company.

                                       15
<PAGE>
  
The future success of the Company also depends on its continuing ability to
identify, hire, train and retain other highly qualified technical and managerial
personnel. Competition for such personnel is intense, and the Company has
experienced difficulty in identifying and hiring qualified engineering
personnel. There can be no assurance that the Company will be able to attract,
assimilate or retain other highly qualified technical and managerial personnel
in the future.

Highly Competitive Markets

The markets for graphics software products such as those offered by the Company
are intensely competitive, subject to rapid change and characterized by constant
demand for new product features, pressure to accelerate the release of new
products and product enhancements and pressure to reduce prices. A number of
companies currently offer products that compete directly or indirectly with one
or more the Company's products. Many of the Company's competitors or potential
competitors have significantly greater financial, managerial, technical, and
marketing resources. A variety of potential actions by any of these competitors,
including a reduction of product prices, increased promotion, announcement or
accelerated introduction of new or enhanced products or features, acquisitions
of software applications or technologies from third parties, product giveaways
or product bundling could have a material adverse effect on the business,
operating results, financial condition and cash flows of the Company.

Dependence on Distributors and on Other Third Parties

While the Company derives some revenues from direct sales, most of its revenues
are derived from the sale of products through third parties. The Company sells
its products worldwide through multiple distribution channels, including
traditional software distributors, hardware and software OEMs, international
distributors, educational distributors, VARs, hardware superstores, retail
dealers, and direct marketers. In addition, the Company's products are
manufactured by third party manufacturing and fulfillment providers.  The
Company will be dependent on the continued viability and financial stability of
these third parties. Any termination or significant disruption of the Company's
relationship with any major distributor or retailer, or a significant reduction
in sales volume attributable to the Company's principal resellers could
materially and adversely affect the business, operating results, financial
condition and cash flows of the Company.

An integral element of the Company's strategy is to enhance and diversify its
channels of distribution both domestically and internationally. The Company is
currently investing, and the Company plans to continue to invest, a significant
portion of its cash and personnel resources to expand its domestic and
international direct sales and marketing force and develop distribution
relationships with additional third-party distributors and resellers. The
Company's ability to achieve significant revenue growth in the future will
depend in large part on its success in recruiting and training sufficient sales
personnel, distributors and resellers.

Certain of the Company's products operate as plug-in extensions and enhancements
for specific print, animation, video and multimedia application platforms,
including Adobe's PhotoShop, Illustrator, After Effects and Premiere; Autodesk's
Animator Studio and 3D Studio; Corel's PhotoPaint; Macromedia's Freehand;
Micrografx's Picture Publisher; and other application platforms. Market
acceptance of the Company's plug-in products is dependent upon market acceptance
of these third-party application platforms as well as the willingness of the

                                       16
<PAGE>
  
manufacturers of such platforms to permit their platforms to be extended and
enhanced by plug-in products such as those of the Company.

Evolving Markets for Computer Graphic Imaging and Internet/Online Design Tools

The markets for computer graphic imaging and Internet/online design tools are
still emerging. There can be no assurance that the markets for the Company's
existing products will grow, that digital graphic and Internet/online content
developers will adopt the Company's products, that sufficient distribution
resources will be available to market the Company's products in a timely manner
or that such products will be successful in achieving market acceptance.

International Operations and Expansion

A key component of the Company's strategy is continued expansion into
international markets, primarily Japan and Western Europe, and the Company
currently anticipates that international sales will represent an increasing
portion of the Company's net revenues. The Company will need to retain effective
distributors and hire, retain and motivate qualified personnel internationally
to expand its international presence. There can be no assurance that the Company
will be able to successfully market, sell, localize and deliver its products in
these international markets.

In addition to the uncertainty as to the Company's ability to expand its
international presence, there are certain risks inherent in doing business on an
international level, such as unexpected changes in regulatory requirements,
problems and delays in collecting accounts receivable, tariffs and other trade
barriers, difficulties in staffing and managing foreign operations, longer
payment cycles, political instability, fluctuations in currency exchange rates,
seasonal reductions in business activity during summer months in Europe and
certain other parts of the world and potentially adverse tax consequences, any
of which could adversely impact the success of international operations.

Management of Potential Growth; Integration of Potential Acquisitions

In recent years, the Company has experienced expansion of its operations that
have placed significant demands on its administrative, operational and financial
resources. In addition, the Company's acquisitions of RTG in December 1996 and
Specular in April 1997 and its pending merger with Fractal, which is anticipated
to be consummated on or about May 30, 1997, have placed significant demands on
these resources. To manage future growth, if any, the Company must assimilate
its acquired operations; improve its financial and management controls,
management processes, business and management information systems and procedures
on a timely basis; and expand, train and manage its work force. There can be no
assurance that the Company will be able to perform such actions successfully.

Proprietary Rights and Licenses

The Company relies on a combination of copyright, trademark, patent, trade
secret laws, employee and third-party nondisclosure agreements and exclusive
contracts to protect its intellectual and proprietary rights and products. The
Company distributes its software under shrinkwrap license agreements but
generally does not obtain signed license agreements from its end users. In
keeping with software industry standards, the Company does not copy protect
their software. Accordingly, it may be possible for unauthorized third parties
to copy or reverse

                                       17
<PAGE>
  
engineer the Company's products or otherwise obtain and use information that the
Company regards as proprietary. Furthermore, there can be no assurance that
competitors will not independently develop technologies that are substantially
equivalent or superior to the technologies of the Company.

Possible Volatility of Stock Price

The price of the Company's Common Stock has fluctuated significantly in the
past. The management of the Company believes that such fluctuations may have
been caused by announcements of new products, quarterly fluctuations in the
results of operations and other factors. Stock markets in general have also
experienced extreme price volatility in recent years. This volatility has had a
substantial effect on the market prices of securities issued by the Company and
other software companies, particularly graphics software companies, often for
reasons unrelated to the operating performance of the specific companies. The
Company anticipates that prices for the Company's Common Stock will continue to
be volatile in the future.

LIQUIDITY AND CAPITAL RESOURCES

The Company has a $3.0 million revolving line of credit with a bank which
expires during November 1997, if not renewed, and is collateralized by
substantially all of the assets of the Company.  Borrowings under the credit
facility are limited to a percentage of eligible accounts receivable, as defined
in the credit agreement.  As of March 31, 1997, the Company had no outstanding
borrowings under the line of credit.

Historically, net cash used in operating activities and investing activities of
the Company has been significant due to operating losses and working capital
requirements resulting from the growth of the Company, including increases in
accounts receivable.  Net cash used in operating activities of the Company
totaled $1.4 million and $177,000 for the three months ended March 31, 1997 and
1996, respectively.  The increase is primarily attributed to the increase in
accounts receivable resulting from increased product offerings and the growth in
revenues since March 31, 1996, the increase in prepaid expenses resulting from
the deferral of expenses related to the acquisition of Specular International
which was completed in April 1997 and the merger with Fractal Design Corporation
which is expected to close by June 30, 1997, and the increase in accounts
payable and accrued expenses resulting from the continued growth of the Company.
Net cash used in investing activities, which totaled $6.7 million and $368,000
for the three months ended March 31, 1997 and 1996, respectively, also increased
significantly due to the purchase of short-term investments and to increased
capital expenditures.  Net cash provided by financing activities, which
consisted of proceeds from the exercise of stock options, totaled $81,000 and
193,000 for the three months ended March 31, 1997 and 1996, respectively.

The Company anticipates investing a significant amount of working capital during
1997 for upgraded management information systems; equipment and software for
development purposes; and leasehold improvements, furniture, and fixtures
related to expansion of the Company's facilities.  In addition, the Company
expects that its working capital requirements will continue to increase to the
extent the Company continues to grow.

The Company believes that its current cash balances, cash provided by future
operations, if any, and available borrowings under the Company's line of credit
are sufficient to meet its working

                                       18
<PAGE>
 
capital needs and anticipated capital expenditure requirements through at least
the next twelve months.

STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NOT YET ADOPTED

In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128 "Earnings Per Share." SFAS No.
128 requires companies to adopt its provisions for fiscal years ending after
December 15, 1997 and requires restatement of all prior period earnings per
share ("EPS") data presented. Earlier application is not permitted. SFAS No. 128
specifies the computation, presentation, and disclosure requirements for EPS.
The implementation of SFAS No. 128 is not expected to have a material effect on
the EPS data previously presented by the Company.


                          PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

  None

Item 2.  Changes in Securities

  None

Item 3.  Defaults upon Senior Securities

  None

Item 4.  Submission of Matters to a Vote of Security Holders

  None

Item 5.  Other Information

  None

Item 6.  Exhibits and Reports on Form 8-K

(a)   Exhibits

<TABLE>
<CAPTION>
 
  Exhibit                         
  Number                      Exhibit Title
  -------                     -------------
  <S>       <C>
 
  11.1      Statement Regarding Computation of Net Income per Common Share

  27.1      Financial Data Schedule
</TABLE>

(b)  Reports on Form 8-K

  The Company filed two reports on Form 8-K with the Securities and Exchange
  Commission during the first quarter ended March 31, 1997 relating to its
  acquisition of Real Time Geometry Corp.

                                       19
<PAGE>
 
                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.


                                           METATOOLS, INC.
                                           (Registrant)



 
 
Date:  May 13, 1997                        /s/ TERANCE A. KINNINGER
                                           ------------------------
                                           Terance A. Kinninger
                                           Vice President and
                                           Chief Financial Officer


                                       20