-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IAvyJrddhs979DwDL0UqXTkxI+Be75G6tri6bufSM7bphasP25jvxno7Zkem8yq9 jjbu4MlCF9WgZpjVe8IWNQ== 0000891618-96-002724.txt : 19961115 0000891618-96-002724.hdr.sgml : 19961115 ACCESSION NUMBER: 0000891618-96-002724 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961113 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRACTAL DESIGN CORP CENTRAL INDEX KEY: 0000930884 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 770276903 STATE OF INCORPORATION: CA FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-26822 FILM NUMBER: 96662383 BUSINESS ADDRESS: STREET 1: 335 SPRECKLES DRIVE CITY: APTOS STATE: CA ZIP: 95003 BUSINESS PHONE: 4086885300 MAIL ADDRESS: STREET 1: 335 SPRACKELS DR CITY: APTOS STATE: CA ZIP: 95003 10QSB 1 FORM 10QSB FOR THE PERIOD ENDED SEPTEMBER 30, 1996 1 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-QSB /X/ Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended SEPTEMBER 30, 1996 or / / Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____________ to ____________ . Commission file number 0-26822 FRACTAL DESIGN CORPORATION (Exact Name of Small Business Issuer as Specified in Its Charter) CALIFORNIA 77-0276903 - ------------------------------- ------------------------------------ (State or Other Jurisdiction of (IRS Employer Identification Number) Incorporation or Organization) 5550 SCOTTS VALLEY DRIVE, SCOTTS VALLEY, CA 95066 408/430-4000 (Address, Including Zip Code and Telephone Number, Including Area Code, of Issuer's Principal Executive Offices) 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 such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ------------------ ----------------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.001 par value 11,755,015 - ----------------------------- ------------------------------- Class Number of Shares Outstanding at November 8, 1996 List of Exhibits is on Page 18 Page 1 of 20 pages 2 TABLE OF CONTENTS PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets September 30, 1996 and March 31, 1996 .......................... 3 Condensed Consolidated Statements of Income Three and Six Months Ended September 30, 1996 and 1995 ......... 4 Condensed Consolidated Statements of Cash Flows Six Months Ended September 30, 1996 and 1995 ................... 5 Notes to Condensed Consolidated Financial Statements ........... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS .................. 9 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ..............................................17 ITEM 2. CHANGES IN SECURITIES ..........................................17 ITEM 3. DEFAULTS UPON SENIOR SECURITIES ................................17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS ............17 ITEM 5. OTHER INFORMATION...............................................18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K .... ......................18 SIGNATURES................................................................19 Page 2 of 20 pages 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) ASSETS
September 30, March 31, 1996 1996 ------------- --------- (Unaudited) Current assets: Cash and cash equivalents $ 6,428 $ 7,153 Short-term investments 23,493 23,683 Accounts receivable, less allowance for doubtful accounts of $434 and $343 6,673 7,320 Inventories 1,350 1,220 Deferred income taxes 1,446 1,446 Other current assets 1,863 2,155 -------- -------- Total current assets 41,253 42,977 Property and equipment, net 2,412 958 -------- -------- $ 43,665 $ 43,935 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 3,294 $ 3,680 Accrued liabilities 6,835 6,955 Income taxes payable 414 155 Current portion of long-term debt -- 167 -------- -------- Total current liabilities 10,543 10,957 -------- -------- Long-term debt -- 250 -------- -------- Shareholders' equity: Common stock: $.001 par value, 50,000,000 shares authorized; 11,751,815 and 11,679,156 shares issued and outstanding 32,691 32,583 Cumulative translation adjustment (73) (50) Retained earnings 504 195 -------- -------- Total shareholders' equity 33,122 32,728 -------- -------- $ 43,665 $ 43,935 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 3 of 20 pages 4 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts, unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 1996 1995 1996 1995 ---------- -------- -------- -------- Net revenues $ 8,483 $ 6,327 $ 16,963 $ 12,371 Cost of net revenues 1,601 1,168 3,191 2,136 -------- -------- -------- -------- Gross profit 6,882 5,159 13,772 10,235 -------- -------- -------- -------- Operating expenses: Research and development 1,257 1,002 2,353 1,709 Sales and marketing 4,147 3,221 7,864 6,105 General and administrative 660 594 1,344 1,163 Merger expenses -- -- 1,865 -- -------- -------- -------- -------- 6,064 4,817 13,426 8,977 -------- -------- -------- -------- Income from operations 818 342 346 1,258 Other income, net 280 62 554 119 -------- -------- -------- -------- Income before income taxes 1,098 404 900 1,377 Provision for income taxes (340) (179) (591) (573) -------- -------- -------- -------- Net income $ 758 $ 225 $ 309 $ 804 ======== ======== ======== ======== Net income per share $ 0.06 $ 0.02 $ 0.02 $ 0.08 Number of shares used to compute net income per share 12,922 10,667 12,991 10,593
The accompanying notes are an integral part of these condensed consolidated financial statements Page 4 of 20 pages 5 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, unaudited)
SIX MONTHS ENDED SEPTEMBER 30, ----------------------- 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: ------- ------- Net income $ 309 $ 804 Adjustment to retained earnings as a result of business combination (see Note 1) -- (323) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 289 216 Deferred taxes -- (162) Changes in assets and liabilities: Accounts receivable, net 647 (1,393) Inventories (130) (281) Other current assets 292 (1,006) Accounts payable (386) 1,058 Accrued liabilities (120) 1,770 Income taxes payable 259 (1,045) ------- ------- Net cash provided by (used in) operations 1,160 (362) ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (1,743) (415) Sales of short-term investments, net 190 488 ------- ------- Net cash (used in) provided by investing activities (1,553) 73 ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable (417) -- Proceeds from notes payable -- 491 Issuance of mandatorily redeemable common stock, net -- 1,236 Issuance of common stock upon exercise of warrants and stock options 108 1 ------- ------- Net cash (used in) provided by financing activities (309) 1,728 ------- ------- EFFECT OF EXCHANGE RATES ON CASH (23) (21) Net (decrease) increase in cash and cash equivalents (725) 1,418 Cash and cash equivalents at beginning of period 7,153 5,562 ------- ------- Cash and cash equivalents at end of period $ 6,428 $ 6,980 ======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 5 of 20 pages 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. BASIS OF PRESENTATION The consolidated financial information contained herein has been prepared without audit in accordance with the Company's accounting policies, as described in its registration statement filed with the Securities and Exchange Commission on Form S-4, declared effective by the Commission on April 26, 1996, and the Company's Form 10-KSB for the year ended March 31, 1996, filed on July 1, 1996. In the opinion of management, all adjustments, including normal recurring accruals, necessary for a fair presentation of the Company's financial position, results of operations and cash flows for the interim periods presented have been made. As permitted by Form 10-QSB, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted where such disclosure would substantially duplicate previous disclosures. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company's Registration Statement on Form S4, declared effective on April 26, 1996, the Company's Form 10-KSB for the year ended March 31, 1996, filed on July 1, 1996, and the Company's Form 10-QSB for the quarter ended June 30, 1996, filed on August 14, 1996. The interim results are not necessarily indicative of the results to be expected for the entire year. In May 1996, the shareholders of Fractal and Ray Dream approved Fractal's acquisition of Ray Dream. As a result of the acquisition, the Company issued 3,165,660 shares of common stock for all of the outstanding shares of common stock of Ray Dream and reserved 219,459 shares of Fractal common stock for issuance upon exercise of previously outstanding options to purchase Ray Dream stock. In addition, Fractal assumed an outstanding warrant to purchase Ray Dream common stock which, when vested, will be exercisable for up to 437,604 shares of Fractal common stock. This warrant vests upon completion of certain development milestones, which the Company expects to be completed during the quarter ending December 31, 1996. The acquisition was accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements were restated to include the accounts of Ray Dream for all periods presented. The Company reports its financial results on a March 31 fiscal year-end basis, whereas Ray Dream reported its financial results on a December 31 fiscal year-end basis. For the purposes of pooling-of-interests accounting, the balance sheet of the Company as of March 31, 1996 has been combined with that of Ray Dream as of March 31, 1996. The statements of operations of the Company for the three and six month periods ended September 30, 1995 have been combined with those of Ray Dream for the three and six month periods ended June 30, 1995. As a result of the presentation noted above, Ray Dream's net loss for the three months ended September 30, 1995 is reflected as an adjustment to retained earnings. The net loss of Ray Dream for the three months ended September 30, 1995 was $323,000. 2. CASH AND SHORT-TERM INVESTMENTS The Company invests certain of its excess cash in debt instruments of various municipalities and the U.S. Government. All highly liquid debt instruments with an original maturity of three months or less are considered cash equivalents; those with original maturities greater than three months are considered short-term investments. Page 6 of 20 pages 7 The Company has classified all short-term investments as available for sale. At September 30, 1996, short-term investments consisted primarily of municipal obligations with maturities of less than one year from their date of purchase. At that date, the fair value of the investments approximated cost. 3. BALANCE SHEET COMPONENTS (IN THOUSANDS)
SEPTEMBER 30, March 31, 1996 1996 ------- ------- Inventories: Raw materials $ 831 $ 756 Finished goods 519 464 ------- ------- $ 1,350 $ 1,220 ======= ======= Property and equipment: Leasehold improvements $ 519 $ -- Furniture and fixtures 798 327 Equipment and software 2,319 1,566 ------- ------- 3,636 1,893 Less: Accumulated depreciation and amortization (1,224) (935) ------- ------- $ 2,412 $ 958 ======= ======= Accrued liabilities: Reserve for returns and exchanges $ 2,792 $ 2,459 Deferred revenue 102 768 Payroll and related 1,488 1,839 Marketing and advertising 1,053 634 Other 1,400 1,410 ------- ------- $ 6,835 $ 7,110 ======= =======
4. SHAREHOLDERS' EQUITY Common Stock as of September 30, 1996 reflects the sale of 2,375,000 shares of common stock issued in the Company's initial public offering completed November 9, 1995. Aggregate net proceeds to the Company were $23,540,000. In addition, Common Stock reflects (i) the conversion of all the Mandatorily Redeemable Convertible Preferred Stock outstanding into an aggregate of 1,057,505 shares of common stock, (ii) the termination of the redemption rights of the Mandatorily Redeemable Preferred Stock, (iii) the exercise of warrants to purchase 52,873 shares of the Company's common stock at an exercise price of $2.00 per share, (iv) the conversion of all the Mandatorily Redeemable Common Stock outstanding into an aggregate of 204,082 shares of common stock, and (v) an increase in shares as a result of Fractal's acquisition of Ray Dream, Inc. (see Note 1). On May 24, 1996, Fractal acquired Ray Dream Inc. As consideration for 100% of the outstanding shares of Ray Dream capital stock, Fractal issued an aggregate 3,165,660 shares of Fractal common stock and reserved 219,459 shares of Fractal common stock for issuance upon exercise of previously outstanding options to purchase Ray Dream stock. Fractal also assumed an outstanding warrant held by a third party Page 7 of 20 pages 8 software developer to purchase Ray Dream common stock which, when vested, will be exercisable for up to 437,604 shares of Fractal common stock. This warrant vests upon completion of certain development milestones, which the Company expects to be completed during the quarter ending December 31, 1996. 5. INCOME TAXES The provision for income taxes reflects the estimated annualized effective rate applied to earnings for the interim period. 6. NET INCOME PER SHARE Net income per share is computed using the weighted-average number of shares of common stock and common equivalent shares, when dilutive, from mandatorily redeemable convertible preferred stock (using the if-converted method) and from stock options and warrants (using the treasury stock method). Pursuant to Securities and Exchange Commission Staff Accounting Bulletins, common and common equivalent shares, options and warrants issued by the Company during the 12-month period prior to the Company's initial public offering have been included in the calculation as if they were outstanding for all periods presented. Page 8 of 20 pages 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS SET FORTH HEREIN, IN PARTICULAR THE SHIPMENT OF NEW PRODUCTS, AND FOREIGN LANGUAGE VERSIONS OF THE COMPANY'S PRODUCTS, THE COMPANY'S ABILITY TO STRENGTHEN ITS WINDOWS BASED BUSINESS, AND THE CONTINUED SUCCESSFUL INTEGRATION OF RAY DREAM INTO FRACTAL'S OPERATIONS, INCLUDE FORWARD LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE RESULTS ACHIEVED THIS QUARTER ARE NOT NECESSARILY AN INDICATION OF FUTURE PROSPECTS FOR THE COMPANY. ACTUAL RESULTS IN FUTURE QUARTERS MAY DIFFER MATERIALLY. POTENTIAL RISKS AND UNCERTAINTIES INCLUDE, AMONG OTHERS, FLUCTUATIONS IN THE VOLUME AND TIMING OF PRODUCT ORDERS, CHANGES IN DEMAND FOR THE COMPANY'S PRODUCTS, INCLUDING THE SHIFT IN DEMAND FROM THE MACINTOSH TO THE WINDOWS PLATFORM, THE TIMING OF THE INTRODUCTION, LOCALIZATION OR ENHANCEMENT OF PRODUCTS BY THE COMPANY AND ITS COMPETITORS, MARKET ACCEPTANCE OF NEW PRODUCTS, IN PARTICULAR DETAILER AND EXPRESSION, REVIEWS IN THE INDUSTRY PRESS CONCERNING THE PRODUCTS OF THE COMPANY OR ITS COMPETITORS, PRICING CHANGES, CHANGES IN DISTRIBUTION MIX, RETURNS FROM THE COMPANY'S DISTRIBUTORS, LOSS OF KEY PERSONNEL AND GENERAL ECONOMIC CONDITIONS. MORE INFORMATION ABOUT POTENTIAL FACTORS WHICH COULD AFFECT THE COMPANY'S FINANCIAL RESULTS IS INCLUDED IN THE COMPANY'S REGISTRATION STATEMENT ON FORM S-4, RELATING TO THE ACQUISITION OF RAY DREAM, WHICH IS ON FILE WITH SECURITIES AND EXCHANGE COMMISSION, AND IN PARTICULAR THE INFORMATION UNDER THE HEADINGS "RISK FACTORS," "FRACTAL MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," AND "RAY DREAM MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB FOR THE FISCAL YEAR ENDED MARCH 31, 1996, AND THE COMPANY'S QUARTERLY REPORT ON FORM 10-QSB FOR THE QUARTER ENDED JUNE 30, 1996, WHICH ARE ON FILE WITH THE SEC, AND IN PARTICULAR THE INFORMATION UNDER THE CAPTION, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." INTRODUCTION Fractal Design Corporation was founded in 1991 to develop, market and support software for the creation, editing and manipulation of computer graphics images and digital art. The Company began shipments of its principal product, Fractal Design Painter, in August 1991, and initiated shipments of its most recent release of this product, Painter 4.0, in November 1995. Painter employs the Company's proprietary Natural-Media technology, which enables artists, animators and graphics professionals to closely simulate the techniques of traditional artists' tools and the look of tangible media while offering innovative effects and productivity advantages made possible by digital technologies. Sales of Painter have been the primary source of the Company's net revenues since inception, and currently are expected to constitute the largest single component of the Company's net revenues for the foreseeable future. In March 1994, the Company introduced Fractal Design Dabbler, a consumer-level product targeted at beginning artists and hobbyists. Dabbler integrates many of the advanced Natural-Media features developed for Painter, with a simplified interface and extensive tutorials. The newest release of this product, Dabbler 2.0 for both the Macintosh and Windows began shipping in October 1995. In June 1995, the Company began shipping Fractal Design Poser, a modeling and rendering application that allows users to create and manipulate a nearly infinite variety of human figures for graphic design, illustration, multimedia applications and 3D graphics applications. On May 24, 1996, Fractal acquired Ray Dream, Inc. a California corporation which designs, develops and markets graphics software application tools emphasizing three-dimensional effects for the personal computer market. As a result of the acquisition, Ray Dream has become a wholly-owned subsidiary of Fractal. For 100% of the outstanding shares of Ray Dream capital stock, Fractal issued an aggregate 3,165,660 shares of Fractal common stock and reserved 219,459 shares of Fractal common stock for issuance Page 9 of 20 pages 10 upon exercise of previously outstanding options to purchase Ray Dream stock. Fractal also assumed an outstanding warrant held by a third party software developer to purchase Ray Dream common stock which, when vested, will be exercisable for up to 437,604 shares of Fractal common stock. This warrant vests upon completion of certain development milestones, which the Company expects to be completed during the quarter ending December 31, 1996. The acquisition was accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements were restated to include the accounts of Ray Dream for all periods presented. Transaction fees of approximately $1.9 million were recorded in the first quarter of fiscal 1997 (see discussion of "Merger Expenses" below). Ray Dream's flagship products, Ray Dream Studio and Ray Dream Designer for Macintosh and Windows, are used by graphic design professionals, business users, and progressive amateurs to create graphics and multimedia projects containing three dimensional ("3D") and animation effects and elements for incorporation and distribution via a broad spectrum of print and electronic media. In June 1996, Fractal released several products, including Designer and Studio 4.1 for Windows and the Japanese version of Painter 4.0 for Windows. In the quarter ended September 30, 1996, Fractal released two new products: Expression for Windows, a Natural-Media illustration program, and Detailer for the Macintosh, a graphics application that allows users to paint on the surface of 3D models. In the quarter ending December 31, 1996, Fractal expects to ship the Macintosh version of Expression, the Windows version of Detailer and version 2 of Poser. Fractal also expects to release the Japanese, French and German language versions of Expression and Detailer, on both the Macintosh and Windows platforms, in the quarters ending December 31, 1996 and March 31, 1997. A UNIX version of Painter 4.0 originally was scheduled for release in mid-calendar 1996; however, after reviewing Fractal's priorities and resources, the Company has announced that it will not be delivering a UNIX version of Painter as originally intended. Due to the inherent uncertainties of software development, the Company cannot accurately predict the exact timing of shipment of a new product, localization or version release on any particular platform. Any delays in the scheduled release of these, or any other products or product versions, any failure of special marketing and sales programs surrounding Painter, Detailer and Expression, or any failure to achieve market acceptance and sell-through of the new products among new and upgrade customers, could have a material adverse effect on the Company's business, results of operations and financial condition. The Company distributes its products in the U.S. and internationally through multiple distribution channels including distributors and mail-order catalogs, hardware and software manufacturers for bundling with other products, and directly to registered users. The Company's quarterly and annual net revenues have been affected historically by, among other factors, the timing of releases of new products and new versions of existing products. Historically, sales volumes of new products have increased in the first few months following introduction of a new product due to the purchase of initial inventory by distributors and resellers and the purchase of upgrades by existing users. Thereafter, net revenues have tended to stabilize or decline at a relatively constant rate. Toward the end of a product or product version life cycle, revenues tend to decline significantly, and the Company may experience returns from distributors in anticipation of new products or product versions. For example, although the Company has experienced world-wide growth during the three and six months ending September 30, 1996 over comparable prior year periods in sales of Painter and Designer, these two products are beginning to exhibit sequential decreases in revenue growth rates from the June 30, 1996 quarter. Net Revenues The Company's net revenues for the three and six-month periods ended September 30, 1996 increased by 34% and 37% to $8.5 million and $17.0 million, respectively, from $6.3 million and $12.4 Page 10 of 20 pages 11 million for the comparable periods ended September 30, 1995. Worldwide growth in sales of Painter for Windows, as well as sales of Studio, which began shipping in November 1995 on the Windows platform and in December 1995 on the Macintosh platform, were the primary components of the increase in revenues year over year. For the same three and six-month periods, domestic net revenues grew 28% and 34%, respectively, from the prior year, primarily as a result of increased sales of Designer and Studio, and the release of Detailer and Expression. Net revenues from the Company's indirect distribution channel grew 40% and 26%, respectively, from the comparable three- and six-month fiscal 1996 periods and represent 44% and 33%, respectively, of net revenues for the three and six months ending September 30, 1996. The increases in net revenues from the Company's indirect distribution channel in the three months ended September 30, 1996 over the comparable prior fiscal year period offset negative growth rates in the Company's domestic direct and OEM channels, which comprised 12% and 1% respectively of the Company's net revenues for the three months ended September 30, 1996. For the six month period ended September 30, 1996, net revenues from domestic direct and OEM channels grew 19% and 69%, respectively, over the comparable prior fiscal year period, and represented 16% and 8%, respectively of the Company's total net revenues for the six month period ended September 30, 1996. International net revenues grew 43% and 41% from the prior year for the three- and six-months ended September 30, 1996, respectively. Additionally, net revenues from Japan grew 126% and 114%, respectively, for the three and six months over the comparable prior year periods, representing 31% and 32%, respectively, of the Company's net revenues, primarily due to increased sales of Designer and Studio, and the release of Painter 4J Macintosh in March 1996 and Painter 4J Windows in June 1996. Any failure of the Company to sustain comparable growth in the Japanese markets to offset lower growth in Europe may affect future international net revenue growth rates. Gross Profit Gross profit increased 33% to $6.9 million for the three months ended September 30, 1996, from $5.2 million for the three months ended September 30, 1995. Gross profit increased 35% to $13.8 million for the six months ended September 30, 1996, from $10.2 million for the comparable fiscal 1996 period. The increase in the amount of gross profit for the three- and six-month periods was primarily a result of higher revenues. Gross profit as a percentage of net revenues, however, decreased to 81% in the three and six months ended September 30, 1996 from 82% and 83% in the three months and six months ended September 30, 1995, respectively. The decrease in gross profit as a percentage of net revenues was a result primarily of increased royalties to third-party software developers and increased expenses associated with obsolete inventories. Research and Development Research and development expenses were 15% and 14% of net revenues, respectively, for the three- and six-month periods ended September 30, 1996, compared to 16% and 14%, respectively, for the comparable fiscal 1996 periods. The amount of research and development expenses increased 25% to $1.3 million for the quarter ended September 30, 1996 from $1.0 million for the same quarter in the prior year, and increased 38% to $2.4 million for the six months ended September 30, 1996 from $1.7 million for the comparable prior year period. The increase in the amount of research and development expenses was due primarily to increased staffing in research and development and increases in wages and benefits, fees paid to independent consultants involved in the development of new products, higher costs from a greater number of products having been translated and localized, and a higher level of expenditures for the development of documentation and user manuals for the Page 11 of 20 pages 12 Company's products. The decrease in research and development expenses as a percentage of net revenues was primarily a result of higher net revenues. The Company believes that a significant investment in research and development activities is essential to the Company's future prospects. Accordingly, the Company currently believes that the amount of research and development expenses will increase in future periods as the Company invests resources to further enhance and develop its products. Sales and Marketing Sales and marketing expenses increased $0.9 million to $4.1 million, or 49% of net revenues, for the three-month period ended September 30, 1996 from $3.2 million, or 51% of net revenues, in the comparable fiscal 1996 period. For the six month period ending September 30, 1996, sales and marketing expenses increased $1.8 million to $7.9 million, or 46% of net revenues, from $6.1 million, or 49% of net revenues, in the comparable prior year period. The increase in the amount of sales and marketing expenses was due primarily to increased marketing activities, such as advertising and joint marketing with distributors, participation in trade shows and direct mail campaigns, increased staffing in sales and marketing, and commissions paid on higher levels of sales. The decrease in sales and marketing expenses as a percentage of net revenues was primarily a result of higher net revenues. The Company currently expects that the amount of sales and marketing expenses will increase in future periods as a result of additional expansion in sales and marketing activities. General and Administrative General and administrative expenses were 8% of net revenues for both of the three- and six-month periods ended September 30, 1996, compared to 9% for both of the comparable fiscal 1996 periods. The amount of general and administrative expenses increased 11% to $0.7 million for the quarter ended September 30, 1996 from $0.6 million for the same quarter in the prior year and increased 16% to $1.3 million for the six months ended September 30, 1996 from $1.2 million for the comparable prior year period. The increases were primarily due to directors and officers liability insurance, increased reserves for bad debts associated with higher levels of revenue, and increased staffing. The Company currently expects that the amount of general and administrative expenses will continue to increase in future periods. Merger Expenses Merger expenses of approximately $1.9 million related to the business combination between Fractal and Ray Dream consummated on May 24, 1996 are included in the operating expenses for the six months ended September 30, 1996. Approximately $450,000 was related to payments under transition and severance agreements, $135,000 pertained to the closure of duplicate facilities, $950,000 was related to transaction costs, and $330,000 pertained to other miscellaneous costs. Transaction costs included fees to financial advisors and legal, accounting, printing, and other related expenses. Income Taxes The effective tax rate for the three and six months ended September 30, 1996 was approximately 31%, before giving effect to the one-time charge, compared to 42% for the six months ended September 30, Page 12 of 20 pages 13 1995. The lower tax rate for fiscal 1997 reflects the Company's expectation that it will be able to utilize a substantial portion of Ray Dream's net operating loss carry-forward. There is no guarantee, however, that Ray Dream's operating profits will be sufficient to allow the Company to fully utilize Ray Dream's net operating loss. FACTORS THAT MAY AFFECT FUTURE RESULTS The following factors should be read in conjunction with additional factors discussed under the caption "Factors That May Affect Future Results" in the Company's Annual Report on Form 10-KSB, filed with the Commission on July 1, 1996, under the caption "Risk Factors" in the Company's Registration Statement on Form S-4, declared effective by the Commission on April 26, 1996, and under the caption "Factors That May Affect Future Results" in the Company's Form 10-QSB for the quarter ended June 30, 1996, filed on August 14, 1996. Fluctuations in Operating Results The Company has experienced in the past and expects in the future to continue to experience significant fluctuations in quarterly operating results. The Company has at times recognized a substantial portion of its net revenues in the last month or the last few weeks of a quarter. The Company generally ships products as orders are received and, therefore, has little or no backlog. As a result, quarterly sales and operating results generally depend on a number of factors that are difficult to forecast, including, among others, the volume and timing of and the ability to fulfill orders received within the quarter. Operating results 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, 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 the Company's distributors and general economic conditions. As a result, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as any indication of future performance. In addition, 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 generated until the end of each quarter, delays in the receipt or shipment of orders and ability to achieve anticipated revenue levels can cause significant variations in operating results from quarter to quarter. The Company is unlikely to be able to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall in sales of the Company's products in relation to the Company's expectations could have an immediate adverse impact on the Company's business, operating results and financial condition. In addition, the Company currently intends to increase its operating expenses to fund greater levels of research and product development, increase its sales and marketing operations and expand distribution channels. To the extent that such expenses precede or are not subsequently followed by increased net revenues, the Company's business, operating results and financial condition could be materially and adversely affected. Acquisition Risks; Potential Adverse Effect on Financial Results The realization of the benefits sought from the acquisition of Ray Dream in May 1996 continues to depend on the ability of the Company to utilize more efficiently product development capabilities, sales and marketing capabilities, administrative organizations and facilities than either company could do separately. In addition, the company anticipates that it will be able to utilize Ray Dream's net operating loss Page 13 of 20 pages 14 carry-forwards to achieve a more beneficial effective income tax rate in fiscal 1997. These benefits may not be achieved if the activities of Fractal and Ray Dream are not fully integrated in a coordinated, timely and efficient manner, and there can be no assurance that adequate levels of this will occur. The combination of the two organizations also requires the dedication of management resources. There can be no assurance that the integration will be completed without disrupting Fractal and Ray Dream's businesses. Should Fractal and Ray Dream not be able to achieve adequate levels of integration in a timely and coordinated fashion, it could result in a material adverse effect on operating results. As a result of the acquisition, the company has sought to reduce operating costs over time by eliminating duplicative operations and facilities that otherwise would have been required by each of the two companies operating on a stand-alone basis. There can be no assurance that these steps will reduce costs to the extent, or as quickly, as planned or that these steps will not adversely affect continuing revenues and results of operations. These reductions could have a material adverse effect on employee morale and on the ability of the Company to retain the key management, engineering, and sales and marketing personnel who are critical to the Company's future operations. If the anticipated savings in operating costs due to the Ray Dream acquisition are not achieved, or if the acquisition has other adverse effects that are not currently anticipated, the acquisition could result in a reduction in per share earnings of the Company (as compared to the per share earnings that either or both of the companies would have achieved if the acquisition had not occurred). Even if the effects of the acquisition prove to be as anticipated, there can be no assurance that future earnings will not be adversely affected by any number of economic, market or other factors that are not related to the acquisition. In the future, the Company may make acquisitions of complementary companies, products or technologies. Managing acquired businesses entails numerous operational and financial risks, including difficulties in assimilating acquired operations, diversion of management's attention to other business concerns, amortization of acquired intangible assets and potential loss of key employees or customers of acquired operations. There can be no assurance that the Company will be able to effectively complete or integrate acquisitions, and failure to do so could have a material adverse effect on the Company's operating results. Shares Eligible for Future Sale On May 24, 1996, Fractal issued 3,165,660 shares of Fractal Common Stock as a result of the acquisition of Ray Dream and reserved 219,459 shares of Fractal Common Stock for issuance upon exercise of previously outstanding Ray Dream options. Also in connection with the acquisition, Fractal assumed an outstanding warrant held by a third party software developer to purchase Ray Dream common stock which, when vested, will be exercisable for up to 437,604 shares of Fractal common stock. This warrant vests upon completion of certain development milestones, which the Company expects to be completed during the quarter ending December 31, 1996. In general, the shares issued or reserved for issuance in the acquisition, other than to Ray Dream affiliates, in exchange for outstanding shares of Ray Dream Capital are freely tradable following the acquisition (and any applicable vesting). The issuance of shares after the acquisition upon the exercise of the assumed Ray Dream options has been registered pursuant to a registration statement on Form S-8 filed by Fractal, and effective, upon closing of the acquisition. In addition, certain persons who, following the acquisition, were holders of 6,286,464 shares of Fractal common stock (on an as-converted basis) agreed that they would not transfer, sell, exchange, pledge or otherwise dispose of any Fractal Common Stock until the date Fractal publicly released financial results for a period that included at least 30 days of combined operations of Fractal and Ray Dream (the "Affiliates Page 14 of 20 pages 15 Expiration Date"). Immediately after the Affiliates Expiration Date of July 25, 1996, these shares were available for sale in the public market, subject to compliance with Rules 144 and 145 under the Securities Act. Upon expiration on May 6, 1996 of certain lock-up agreements entered into at the time of Fractal's initial public offering of securities, substantially all of the shares of Fractal common stock outstanding prior to the acquisition became freely tradable in the public market, subject in the case of affiliates to compliance with the volume restrictions of Rule 144 and the additional restrictions upon sales by affiliates as described above. Also, 316,556 shares of Fractal Common Stock issuable to former shareholders of Ray Dream were deposited into an escrow fund to secure certain indemnification obligations of the Ray Dream Shareholders. The escrow terminated on September 30, 1996 and the shares were subsequently distributed to the shareholders. The sale of any of the foregoing shares may cause substantial fluctuations in the price of Fractal common stock over short time periods. IMPORTANCE OF THE MACINTOSH PLATFORM AND APPLE COMPUTER Although the Company offers Painter on both the Macintosh and Windows platforms, approximately 73% of the cumulative sales of Painter in the last three years have been for the Macintosh platform, which historically has been a popular platform among art and graphics professionals. To the extent that other operating systems, such as Windows 95, continue to become more prevalent among the Company's customers, the Company may be required to modify its development, personnel recruiting, marketing and distribution efforts to more effectively address these platforms. Although Apple Computer recorded a $25 million profit for its fourth quarter ended September 27, 1996, Apple experienced an $816 million loss for the fiscal year. These announcements, and the overall perception of Apple Computer, the Company believes have negatively impacted its Macintosh-based business. North America Macintosh-based Painter revenues in fiscal 1997 have remained flat with comparable fiscal 1996 periods, while sales of Windows-based Painter have increased 21% and 27% in the three and six months ended September 30, 1996 over the comparable prior year periods. World-wide, Painter revenues continue to increase over the prior fiscal year. World-wide sales of Windows-based Painter in the three and six months ended September 30, 1996 have increased 143% and 121% over the comparable fiscal 1996 periods, offsetting decreases in Painter Macintosh revenues of 24% and 5%, respectively. A principal factor in the rate of the Company's Painter Windows revenue growth was the initial shipment of Painter 4J Windows in June 1996; therefore, the Company does not believe that these Painter Windows growth rates will continue. Further, there can be no assurance that the Windows growth will offset any further decline in Macintosh revenues. The Company is reviewing the balance of its sales and marketing efforts between the Macintosh and Windows environment to determine if additional investments or changes in its sales and marketing programs are necessary to address the relative momentum in the Macintosh and Windows environments. The Company currently does not anticipate a reversal of the trend of the Macintosh environment losing market share in the graphics market to the Windows environment. In addition, Fractal believes that sales of Ray Dream's products, including Designer and Studio, overseas are substantially dependent upon the acceptance of the Windows 95 operating system abroad, and Page 15 of 20 pages 16 that slow adoption of the Windows 95 operating system abroad, particularly in Europe, could adversely affect sales of Ray Dream's products, and thus could adversely affect the operating results of the Company. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1996, the Company's principal sources of liquidity are its cash, cash equivalents and short-term investments of $30 million. In May 1996, Fractal Design Corporation acquired Ray Dream, Inc. and incurred a one-time charge of $1,865,000; substantially all of which was related to cash expenditures. As of September 30, 1996, approximately $1.7 million of the cash expenditures had been paid. Subsequent to the acquisition, Ray Dream repaid $0.4 million under an existing bank loan. On July 19, 1996, the Company signed a seven year lease for 29,000 square feet of office space in Scotts Valley, California. The Company relocated its operations to this location in September 1996. In connection with this move, the Company expended approximately $1.2 million for leasehold improvements and capital equipment during the fiscal quarter ended September 30, 1996. The Company currently has a $500,000 unsecured line of credit (bearing interest at the bank's reference rate) which was unused as of September 30, 1996. The Company uses its working capital to finance ongoing operations, fund the development and introduction of new products and acquire capital equipment. The Company's operating activities provided cash of $1.2 million during the six months ended September 30, 1996, while in the comparable prior year period the Company's operating activities consumed cash of $0.4 million. For the six months ended September 30, 1996, the Company's operating activities reflect the one-time charge related to the acquisition of Ray Dream. The Company believes that expected cash flows from operations and existing cash and short-term investment balances, will be sufficient to meet the Company's currently anticipated working capital and capital expenditure requirements for the next 12 months. The Company's capital requirements also may be affected by acquisitions of businesses, products and technologies that are complementary to the Company's business, which the Company considers from time to time. The Company regularly evaluates such opportunities. Any such transaction, if consummated, may use a portion of the Company's working capital or require the issuance of equity. Page 16 of 20 pages 17 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. On October 16, the Annual Meeting of the Company's shareholders was held. On the record date of August 30, 1996, 11,750,692 shares of Common Stock were issued and outstanding. At the meeting, shareholders owning 8,620,887 shares of Common Stock were present in person or by proxy. The following matters were submitted to a vote of the Company's shareholders: 1. To elect ten (10) directors of the Company to serve until the 1997 Annual Meeting of Shareholders or until their respective successors are elected and qualified. The following nominees for election as directors received the number of votes set opposite their respective names and were accordingly elected as Directors for the term set forth above:
NOMINEE VOTES WITHHELD ------- ----- -------- Mark Zimmer 8,614,977 5,910 Thomas Hedges 8,614,977 5,910 Eric Hautemont 8,613,577 7,310 Arthur J. Collmeyer 8,614,277 6,610 Craig W. Johnson 8,613,577 7,310 Lee Jay Lorenzen 8,614,177 6,710 Stephen E. Manousos 8,613,177 7,710 Alain Rossmann 8,614,157 6,730 Anthony Sun 8,614,577 6,310 Thomas I. Unterberg 8,614,277 6,610
Page 17 of 20 pages 18 2. To ratify the appointment of Price Waterhouse LLP as the independent accountants for the Company for the fiscal year ending March 31, 1997. This matter was approved as follows:
VOTES ----- FOR 8,617,911 AGAINST 820 ABSTAIN 2,156 BROKER NON-VOTES 0
ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) List of Exhibits The following exhibits are filed herewith or incorporated herein by reference: EXHIBIT NUMBER EXHIBIT DESCRIPTION ------ ------------------- 11.1 Statement of Computation of Net Income per Common Share. 27 Financial Data Schedule (b) Reports on Form 8-K The Company filed a report on Form 8-K on June 6, 1996, as amended on August 7, 1996, which reported the Company's acquisition of Ray Dream, Inc. and included certain financial statements of Ray Dream and pro forma financial statements of the Company in accordance with the Commission's rules and regulations. Page 18 of 20 pages 19 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. FRACTAL DESIGN CORPORATION By:/s/LESLIE E. WRIGHT Leslie E. Wright Chief Operating Officer and Chief Financial Officer and Duly Authorized Officer By:/s/BRADEN L. RIPPETOE Braden L. Rippetoe Principal Accounting Officer Date: November 13, 1996 Page 19 of 20 pages 20 EXHIBIT INDEX Exhibit Description 11.1 Statement of Computation of Net Income per Common Share. 27 Financial Data Schedule Page 20 of 20 pages EX-11.1 2 COMPUTATION OF NET INCOME PER COMMON SHARE 1 EXHIBIT 11.1 COMPUTATION OF NET INCOME PER COMMON SHARE (in thousands, except per share amounts)
Three Months Ended Six Months Ended September 30, September 30, --------------------- --------------------- 1996 1995 1996 1995 --------------------- ------ ------- Weighted average common shares outstanding 11,710 7,926 11,706 7,926 Dilutive effect of stock options 1,041 1,302 1,088 1,290 Mandatorily redeemable common stock issued to Adobe Ventures, L.P. on July 21, 1995 -- 204 -- 204 Mandatorily redeemable convertible preferred stock -- 1,057 -- 1,057 Dilutive effect of warrants 171 178 197 116 Number of shares used to compute net income per share 12,922 10,667 12,991 10,593 ======= ======= ======= ======= Net income $ 758 $ 225 $ 309 $ 804 ======= ======= ======= ======= Net income per share $ 0.06 $ 0.02 $ 0.02 $ 0.08 ======= ======= ======= =======
EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS MAR-31-1997 SEP-30-1996 6,428 23,493 7,107 434 1,350 41,253 3,636 1,224 43,665 10,543 0 0 0 32,691 431 43,665 16,963 16,963 3,191 3,191 13,426 0 (554) 900 591 309 0 0 0 309 .02 .02
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