-----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, E0FyWtC/yqZPMZ+3Gwsyteq0cKv8WPJdEtgbp0qKcjMt8QRjUHWfSIOJ4FE8tbum 5ZD64lTA53RxYP+w7PtfrA== 0000891618-97-000523.txt : 19970222 0000891618-97-000523.hdr.sgml : 19970222 ACCESSION NUMBER: 0000891618-97-000523 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970213 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: 97531022 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 10-QSB 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 DECEMBER 31, 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 (IRS Employer Identification Number) of 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 Issuer (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 11,979,647 - ------------------------------------- -------------------------------------- Class Number of Shares Outstanding at February 7, 1997 List of Exhibits is on Page 19 ================================================================================ Page 1 of 21 Pages 2 TABLE OF CONTENTS
PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets December 31, 1996 and March 31, 1996 .......................... 3 Condensed Consolidated Statements of Income Three and Nine Months Ended December 31, 1996 and 1995 ........ 4 Condensed Consolidated Statements of Cash Flows Nine Months Ended December 31, 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 ............................................. 19 ITEM 2. CHANGES IN SECURITIES ......................................... 19 ITEM 3. DEFAULTS UPON SENIOR SECURITIES ............................... 19 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS............ 19 ITEM 5. OTHER INFORMATION ............................................. 19 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K .............................. 19 SIGNATURES .............................................................. 20
Page 2 of 21 Pages 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands) ASSETS
DECEMBER 31, MARCH 31, 1996 1996 -------- -------- (UNAUDITED) Current assets: Cash and cash equivalents $ 3,944 $ 7,153 Short-term investments 24,318 23,683 Accounts receivable, less allowance for doubtful accounts of $479 and $343 10,092 7,320 Inventories 1,533 1,220 Deferred income taxes 1,446 1,446 Other current assets 2,017 2,155 -------- -------- Total current assets 43,350 42,977 Property and equipment, net 2,349 958 -------- -------- $ 45,699 $ 43,935 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,553 $ 3,680 Accrued liabilities 7,069 6,955 Income taxes payable 1,230 155 Current portion of long-term debt -- 167 -------- -------- Total current liabilities 10,852 10,957 -------- -------- Long-term debt -- 250 -------- -------- Shareholders' equity: Common stock: $.001 par value, 50,000,000 shares authorized; 11,965,376 and 11,679,156 shares issued and outstanding 32,661 32,583 Retained earnings 2,297 195 Cumulative translation adjustment (111) (50) -------- -------- Total shareholders' equity 34,847 32,728 -------- -------- $ 45,699 $ 43,935 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 3 of 21 Pages 4 CONDENSED CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts, unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, ----------------------- ----------------------- 1996 1995 1996 1995 -------- -------- -------- -------- Net revenues $ 10,934 $ 7,851 $ 27,897 $ 20,222 Cost of net revenues 2,096 1,373 5,287 3,509 -------- -------- -------- -------- Gross profit 8,838 6,478 22,610 16,713 -------- -------- -------- -------- Operating expenses: Research and development 1,225 1,128 3,578 2,837 Sales and marketing 4,522 3,428 12,386 9,533 General and administrative 729 631 2,073 1,794 Merger expenses -- -- 1,865 -- -------- -------- -------- -------- 6,476 5,187 19,902 14,164 -------- -------- -------- -------- Income from operations 2,362 1,291 2,708 2,549 Other income, net 237 167 791 286 -------- -------- -------- -------- Income before income taxes 2,599 1,458 3,499 2,835 Provision for income taxes (806) (681) (1,397) (1,254) -------- -------- -------- -------- Net income $ 1,793 $ 777 $ 2,102 $ 1,581 ======== ======== ======== ======== Net income per share $ 0.14 $ 0.06 $ 0.16 $ 0.14 Number of shares used to compute net income per share 12,934 12,135 12,962 11,107
The accompanying notes are an integral part of these condensed consolidated financial statements Page 4 of 21 Pages 5 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands, unaudited)
NINE MONTHS ENDED DECEMBER 31, ----------------------- 1996 1995 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,102 $ 1,581 Adjustment to retained earnings as a result of business combination (see Note 1) -- 427 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 513 326 Deferred taxes -- (357) Changes in assets and liabilities: Accounts receivable, net (2,772) (3,693) Inventories (313) (759) Other current assets 138 (961) Accounts payable (1,127) 1,589 Accrued liabilities 114 2,567 Income taxes payable 1,075 (493) -------- -------- Net cash (used in) provided by operations (270) 227 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (1,904) (547) Purchases of short-term investments, net (635) (14,319) -------- -------- Net cash used in investing activities (2,539) (14,866) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of notes payable (417) -- Proceeds from notes payable -- 19 Conversion of mandatorily redeemable common stock, net -- (2,204) Issuance of common stock 78 27,098 -------- -------- Net cash (used in) provided by financing activities (339) 24,913 -------- -------- EFFECT OF EXCHANGE RATES ON CASH (61) (45) Net (decrease) increase in cash and cash equivalents (3,209) 10,229 Cash and cash equivalents at beginning of period 7,153 5,562 -------- -------- Cash and cash equivalents at end of period $ 3,944 $ 15,791 ======== ========
The accompanying notes are an integral part of these condensed consolidated financial statements. Page 5 of 21 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 S-4, 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 September 30, 1996, filed on November 13, 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. Fractal also assumed an outstanding warrant, held by a third-party software developer, to purchase Ray Dream common stock. This warrant vested in the quarter ended December 31, 1996 upon completion of certain development milestones, and was fully exercised, on a net basis, for 178,256 shares of Fractal common stock. The Ray Dream 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 nine month periods ended December 31, 1995 have been combined with those of Ray Dream for the three and nine month periods ended September 30, 1995. As a result of the presentation noted above, Ray Dream's net income for the three months ended December 31, 1995 is reflected as an adjustment to retained earnings. The net income of Ray Dream for the three months ended December 31, 1995 was $427,000. 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 21 Pages 7 The Company has classified all short-term investments as available for sale. At December 31, 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)
DECEMBER 31, MARCH 31, 1996 1996 ------- ------- Inventories: Raw materials $ 610 $ 756 Finished goods 923 464 ------- ------- $ 1,533 $ 1,220 ======= ======= Property and equipment: Leasehold improvements $ 596 $ -- Furniture and fixtures 732 327 Equipment and software 2,469 1,566 ------- ------- 3,797 1,893 Less: Accumulated depreciation and amortization (1,448) (935) ------- ------- $ 2,349 $ 958 ======= ======= Accrued liabilities: Reserve for returns and exchanges $ 2,951 $ 2,459 Payroll and related 1,752 1,839 Deferred revenue 102 768 Marketing and advertising 1,117 634 Other 1,147 1,255 ------- ------- $ 7,069 $ 6,955 ======= =======
4. SHAREHOLDERS' EQUITY Common Stock as of December 31, 1996 reflects the sale of 2,375,000 shares of common stock issued in the Company's initial public offering completed November 9, 1995. Aggregate net proceeds to the Company were $23,540,000. In addition, Common Stock 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 Page 7 of 21 Pages 8 warrant held by a third party software developer to purchase Ray Dream common stock which, when vested, was exercisable for up to 437,604 shares of Fractal common stock. This warrant vested during the quarter ending December 31, 1996, upon completion of certain development milestones, and was fully exercised, on a net basis, for 178,256 shares of Fractal common stock. 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, even if anti-dilutive. Page 8 of 21 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 STATEMENTS PERTAINING TO ANTICIPATED REVENUES AND EARNINGS LEVELS, 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. ACTUAL RESULTS FOR THE QUARTER ENDING MARCH 31, 1997 WILL BE LESS THAN THE RESULTS OF THE QUARTER ENDED DECEMBER 31, 1996. 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 ABILITY TO ACHIEVE AND/OR SUSTAIN GROWTH IN INTERNATIONAL MARKETS, THE ABILITY TO REALIZE REVENUES FROM OEM SOURCES, 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 SEPTEMBER 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 are expected to constitute one of the largest components 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 platforms 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. Page 9 of 21 Pages 10 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 became 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 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. This warrant vested upon completion of certain development milestones during the quarter ending December 31, 1996, and was fully exercised, on a net basis, for 178,256 shares of Fractal common stock. 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 related to the acquisition 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. During the quarter ending December 31, 1996, Fractal released the Macintosh version of Expression, the Windows version of Detailer, and the Macintosh version of Poser 2. In addition, the Company shipped the Japanese and French language versions of Expression and Detailer, on both the Macintosh and Windows platforms. The German language versions of Expression and Detailer for both the Macintosh and Windows platforms are scheduled for release in the quarter ending 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 announced that it would 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 its products, in particular 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, financial condition, business outlook and share price. 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. A number of uncertainties are inherent in the indirect distribution of the Company's products through distributors and mail-order catalogs. Uncertainty over demand for the Company's products, in particular newer products such as Detailer and Expression, may cause third-party resellers to reduce their ordering and marketing of the Company's products. Resellers may also return products to the Company based upon insufficient levels of sell-through of the Company's products. The Company has begun to experience a reduction in ordering from historical levels by resellers as a result of lower levels of demand industry-wide. Page 10 of 21 Pages 11 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, net revenues of Painter, Designer, and Studio have exhibited sequential decreases in growth rates from both the September 30, 1996 and June 30, 1996 quarters. This is likely to occur again in the March 31, 1997 quarter. The Company believes it has progressed over the prior fiscal year. This progress includes the acquisition of Ray Dream, the launch of two new award-winning products, Detailer and Expression, and the overall growth of its business. In the past, however, Fractal has experienced fourth quarter revenue that is flat, or less than that of the same year's third quarter. The Company expects this to occur again in the current fiscal year, particularly in light of overall lower growth rates in the graphics markets. The Company also expects its expenses to increase during the quarter ending March 31, 1997, due to anticipated trade show and new product marketing efforts. The Company estimates that the impact of these revenue and expense trends will be that revenue growth is unlikely to exceed 10% on a year-over-year basis, and that earnings per share, at best, will be the same when compared to the March 31, 1996 quarter. Specifically, data published by The Software Publishers Association reflects a decline in drawing and painting software for the nine-month period ending September 30, 1996, compared to the nine-month period ending September 30, 1995. In addition, Macromedia, which is a large graphics and multimedia software vendor, recently announced that it experienced a decline in revenues of 9% for the three-month period ending December 31, 1996, over the comparable three-month period ended December 31, 1995. It attributed the decline to revenue shortfalls in part to lower demand primarily in Europe. Other factors that the Company believes are currently affecting the graphics software market include: the effect on software revenues of sluggish demand recently reported by major retailers of desktop hardware and software; the lower-than-expected industry-wide demand in European markets; and the continued decline of Apple Computer's revenues and its losses reported for both the quarter ended December 27, 1996 and the year ended September 27, 1996, (indicating continuing uncertainty for a platform that represents between 50-60% of Fractal's revenues). These issues, as well as the Company's product cycles, have added a greater level of uncertainty and reduced visibility in its current business operations. The Company believes that, compared to one year ago, it has strengthened its product line-up and its product development organization, while reducing its dependence on Macintosh-based revenues. These improvements, however, will not necessarily neutralize the issues outlined in the preceding paragraphs. Page 11 of 21 Pages 12 Net Revenues The Company's net revenues for the three and nine-month periods ended December 31, 1996 increased by 39% and 38% to $10.9 million and $27.9 million, respectively, from $7.8 million and $20.2 million for the comparable periods ended December 31, 1995. Sales of newly released products Expression (released in September 1996 on the Windows platform and November 1996 on the Macintosh platform) and Detailer (released in September 1996 on the Macintosh platform and November 1996 on the Windows platform), as well as worldwide growth in 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. Future revenues will be affected by the items discussed under the caption "Factors That May Affect Future Results" further in this document. For the same three- and nine-month periods, domestic net revenues grew 24% and 30%, respectively, from the prior year, primarily as a result of increased sales of Studio, and the release of Detailer and Expression. Net revenues from the Company's indirect distribution channel grew 31% and 28%, respectively, from the comparable three- and nine-month fiscal 1996 periods and represent 34% and 33%, respectively, of net revenues for the three and nine months ending December 31, 1996. The increases in net revenues from the Company's indirect distribution channel in the three months ended December 31, 1996 over the comparable prior fiscal year period offset declining growth rates in the Company's domestic direct and OEM channels, which comprised 17% and 1% respectively of the Company's net revenues for the three months ended December 31, 1996. For the nine month period ended December 31, 1996, net revenues from domestic direct, mail order, and OEM channels grew 8%, 11% and 19%, respectively, over the comparable prior fiscal year period, and represented 16%, 5% and 5%, respectively of the Company's total net revenues for the nine month period ended December 31, 1996. The Company believes that in order to achieve its revenue goals, it must, among other actions, increase the percentage of its net revenues from the OEM channel. International net revenues grew 76% and 52%, respectively, from the prior year for the three- and nine-months ended December 31, 1996. The primary component of international growth occurred in Japan, where net revenues grew 164% and 130% for the three and nine months, respectively, over the comparable prior year periods and represented 28% and 30%, respectively, of the Company's net revenues. The revenue growth in Japan was primarily due to increased sales of Studio and Designer, the release of Detailer J and Expression J on both the Macintosh and Windows platforms in December 1996, and the release of Painter 4J Macintosh in March 1996 and Painter 4J Windows in June 1996. The Company believes that the growth rate in its Japanese market will decline, resulting in lower total international net revenue growth rates. The Company believes that in order to achieve its revenue goals, it must, among other actions, increase the level of net revenues in its European markets. Gross Profit Gross profit increased 36% to $8.8 million for the three months ended December 31, 1996, from $6.5 million for the three months ended December 31, 1995. For the nine months ended December 31, 1996, gross profit increased 35% to $22.6 million, from $16.7 million for the comparable fiscal 1996 period. The increase in the amount of gross profit for the three- and nine-month periods was primarily attributable to higher revenues. Gross profit as a percentage of net revenues, however, decreased to 81% in the three- and nine-months ended December 31, 1996, from 83% in the three- and nine- months ended December 31, 1995. This decrease in gross profit as a percentage of net revenues is largely a result of increased royalties to third-party software developers related to new products and increased inventory reserves related to product transition. Page 12 of 21 Pages 13 Research and Development Research and development expenses were 11% and 13% of net revenues, respectively, for the three- and nine-month periods ended December 31, 1996, compared to 14% for both of the comparable fiscal 1996 periods. The amount of research and development expenses increased 9% to $1.2 million for the quarter ended December 31, 1996, from $1.1 million in the same quarter of the prior year, and increased 26%, to $3.6 million, for the nine months ended December 31, 1996 from $2.8 million for the comparable prior year period. The increase in the amount of research and development expenses was a result of increased staffing in research and development, increases in wages and benefits, fees paid to independent consultants involved in the development of new products, higher costs related to the translation and localization of a greater number of products, and a higher level of expenditures for the development of documentation and user manuals for the Company's products. The decrease from fiscal 1996 in research and development expenses as a percentage of net revenues was primarily a function of higher net revenues in fiscal 1997. 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 continues to invest resources to enhance and further develop its products. Sales and Marketing Sales and marketing expenses increased $1.1 million to $4.5 million, or 41% of net revenues, for the three-month period ended December 31, 1996 from $3.4 million, or 44% of net revenues, in the comparable fiscal 1996 period. For the nine-month period ending December 31, 1996, sales and marketing expenses increased $2.9 million to $12.4 million, or 44% of net revenues, from $9.5 million, or 47% of net revenues, in the comparable prior year period. The increase in the amount of sales and marketing expenses was attributable to increased marketing activities, such as advertising and joint marketing with distributors, participation in direct mail campaigns, increased staffing in sales and marketing, and commissions paid on higher levels of sales. The decrease from fiscal 1996 in sales and marketing expenses as a percentage of net revenues was primarily a result of higher net revenues in fiscal 1997. The Company currently expects that the amount of sales and marketing expenses will increase in future periods as a result of continued expansion of its sales and marketing activities. General and Administrative General and administrative expenses were 7% of net revenues for both the three- and nine-month periods ended December 31, 1996, compared to 8% and 9% for the comparable fiscal 1996 periods. The amount of general and administrative expenses increased 16% to $0.7 million for the quarter ended December 31, 1996, from $0.6 million in the same quarter of the prior year. For the nine months ended December 31, 1996, general and administrative expenses increased 16%, to $2.1 million, from $1.8 million for the comparable prior year period. These increases were largely a consequence of expenses related to the adoption of directors and officers liability insurance, reserves for bad debts associated with higher levels of revenue, and increased staffing. Page 13 of 21 Pages 14 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 nine months ended December 31, 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 nine months ended December 31, 1996 was approximately 31%, before giving effect to the one-time charge, compared to 47% and 44%, for the three and nine months, respectively, ended December 31, 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. 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 September 30, 1996, filed on November 13, 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. It expects this trend to occur during the current fiscal 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. Page 14 of 21 Pages 15 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 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. Page 15 of 21 Pages 16 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. This warrant vested upon completion of certain development milestones, which were accomplished during the quarter ending December 31, 1996, and was fully exercised, on a net basis, for 178,256 shares of Fractal common stock. 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 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 Apple Computer recently announced a net loss of $120 million for its first quarter ended December 27, 1996. This follows Apple's announcement of a loss of $816 million for its fiscal year ended September 27, 1996. These announcements, and the overall perception of Apple Computer, the Company believes, have negatively impacted its Macintosh-based business. Fractal's North America Macintosh-based revenues in fiscal 1997 have remained flat with comparable fiscal 1996 periods. World-wide, Fractal's revenues of Windows-based products in the three and nine months ended December 31, 1996 have increased 80% and 101%, respectively, over the comparable fiscal 1996 periods, while for comparable periods Macintosh-based revenues have increased 2% and 4%. There can Page 16 of 21 Pages 17 be no assurance, however, that the Company's Windows growth will continue to offset any further decline in Macintosh revenues. For the three- and nine- month periods ended December 31, 1996, approximately 59% and 55%, respectively, of net revenues were Macintosh-based, while 41% and 45%, respectively, were Windows-based. To the extent that other operating systems, such as Windows 95, Windows 97, and NT, 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. The Company continues to review 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 international sales of several of its products, including Designer and Studio, are substantially dependent upon the acceptance of the Windows 95, Windows 97, and NT operating systems abroad, and that slow adoption of these operating systems abroad, particularly in Europe, could adversely affect sales of Designer and Studio, and thus could adversely affect the operating results of the Company. Painter, Studio and Designer Product Life Cycles The current versions of Painter, Studio and Designer underwent their last major update cycle in November 1995. As these products have matured, their sequential quarterly net revenues have begun to decline. These trends will continue until the Company releases major updates to these products. International Revenues The Company has experienced significant growth in its international markets. It currently believes, however, that the overall market for personal computers and related software is exhibiting declining growth rates. As a result, the Company believes it will be unable to sustain its previous rate of growth in Japan, and, therefore, the Company's total international rate of growth will decline. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1996, the Company's principal sources of liquidity are its cash, cash equivalents and short-term investments of $28 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 December 31, 1996, substantially all 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 and as a result of further expansion, during the three and nine months Page 17 of 21 Pages 18 ended December 31, 1996, the Company expended approximately $0.2 million and $1.9 million, respectively for leasehold improvements and capital equipment. The Company currently has a $500,000 unsecured line of credit (bearing interest at the bank's reference rate) which was unused as of December 31, 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 consumed cash of $0.3 million during the nine months ended December 31, 1996, while in the comparable prior year period the Company's operating activities provided cash of $0.2 million. For the nine months ended December 31, 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 18 of 21 Pages 19 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. On January 30, 1997, Fractal Design Corporation announced the resignation of Eric Hautemont, President, effective February 1, 1997. Mark Zimmer, the Company's co-Founder and Chief Executive Officer and current Chairman of the Board, has reassumed the position of President, an office he held prior to the acquisition of Ray Dream. Co-Founder Tom Hedges, the Company's Vice President, Engineering and Vice-Chairman of the Board, has reassumed his former position as Chairman of the Board. A copy of the press release is attached to this report, and is incorporated herein by reference. 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. 99.1 Press Release dated January 30, 1996, announcing the resignation of Eric Hautemont, President. (b) Reports on Form 8-K None. Page 19 of 21 Pages 20 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: February 12, 1997 Page 20 of 21 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 NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------- -------------------- 1996 1995 1996 1995 ------- ------- ------- ------- Weighted average common shares outstanding 11,754 10,652 11,724 8,690 Dilutive effect of stock options 1,002 1,295 1,060 1,291 Mandatorily redeemable common stock issued to Adobe Ventures, L.P. on July 21, 1995 -- -- -- 159 Mandatorily redeemable convertible preferred stock -- -- -- 822 Dilutive effect of warrants 178 188 178 145 ------- ------- ------- ------- Number of shares used to compute net income per share 12,934 12,135 12,962 11,107 ======= ======= ======= ======= Net income $ 1,793 $ 777 $ 2,102 $ 1,581 ======= ======= ======= ======= Net income per share $ 0.14 $ 0.06 $ 0.16 $ 0.14 ======= ======= ======= =======
Page 21 of 21 Pages EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS MAR-31-1997 APR-01-1996 DEC-31-1996 3,944 24,318 10,571 479 1,533 43,350 3,797 1,448 45,699 10,852 0 0 0 32,661 2,186 45,699 27,897 27,897 5,287 5,287 19,902 45 (791) 3,499 1,397 2,102 0 0 0 2,102 0.16 0.16
EX-99.1 4 PRESS RELEASE 1 EXHIBIT 99.1 [FRACTAL DESIGN LETTERHEAD] Press Contact: MARK ZIMMER CEO (408) 430-4000 mark_zimmer@fractal.com For Immediate Release FRACTAL DESIGN ANNOUNCES MANAGEMENT CHANGE Scotts Valley, CA - January 30, 1997 - Fractal Design Corporation (NASDAQ: FRAC) today announced that Eric Hautemont, the Company's President, will resign as an officer and director of the Company effective February 1, 1997. Mr. Hautemont, who joined Fractal as part of Fractal's acquisition of Ray Dream, Inc., in March 1996, is leaving the Company to spend more time with his family. Mark Zimmer, Fractal's co-founder and Chief Executive Officer and currently Chairman of the Board, will reassume the position of President, an office he held prior to the acquisition of Ray Dream. Co-founder Tom Hedges will reassume his position of Chairman. "Fractal is extremely appreciative of Eric's efforts in the successful integration of Ray Dream and Fractal," said Zimmer. "Together we have created a combined company with unparalleled development talent. We'll continue doing that," added Hedges. Zimmer continued, "As I resume the role of president, I'm thankful for Eric's contribution and the team that he brought to Fractal. Together we look forward to continue building the best graphics products on the planet." "It has been a great pleasure for me to participate in putting together a company with such outstanding products as Fractal has today," said Hautemont. "I look forward to the Company's ongoing success." Fractal Design Corporation is a major force in multi-platform graphic software, developing and marketing products that unite traditional artist techniques with digital technology. Fractal Design products are designed to facilitate and extend the range of creativity for artists and designers working on desktop computers. Fractal Design Corporation is headquartered in California at 5550 Scotts Valley Drive, P.O. Box 66959, Scotts Valley, CA 95067-6959. # # # -----END PRIVACY-ENHANCED MESSAGE-----