1
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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 JUNE 30, 1996
or
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period ____________ to ____________ .
Commission file number 0-26822
FRACTAL DESIGN CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
CALIFORNIA 77-0276903
- --------------------------------------------- ------------------------------------
(State or Other Jurisdiction of Incorporation (IRS Employer Identification Number)
or Organization)
335 SPRECKELS DRIVE, APTOS CA 95003
408/ 688-5300
(Address, Including Zip Code and Telephone Number,
Including Area Code, of Registrant'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 11,709,817
- ----------------------------- -------------------------------
Class Number of Shares Outstanding at
August 9, 1996
List of Exhibits is on Page 16
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Page 1 of 18 pages
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TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets
June 30, 1996 and March 31, 1996............................... 3
Condensed Consolidated Statements of Income
Three Months Ended June 30, 1996 and 1995...................... 4
Condensed Consolidated Statements of Cash Flows
Three Months Ended June 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.............................................. 15
ITEM 2. CHANGES IN SECURITIES ......................................... 15
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................ 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS............ 15
ITEM 5. OTHER INFORMATION ............................................. 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K .............................. 16
Page 2 of 18 pages
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
ASSETS
JUNE 30, 1996 MARCH 31, 1996
------------- --------------
(UNAUDITED)
Current assets:
Cash and cash equivalents $ 7,028 $ 7,153
Short-term investments 22,947 23,683
Accounts receivable, less allowance for
doubtful accounts of $390 and $343 6,620 7,320
Inventories 1,238 1,220
Deferred income taxes 1,446 1,446
Other current assets 1,596 2,155
-------- --------
Total current assets 40,875 42,977
Property and equipment, net 1,110 958
-------- --------
$ 41,985 $ 43,935
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,649 $ 3,680
Accrued liabilities 7,065 7,110
Current portion of long-term debt -- 167
-------- --------
Total current liabilities 9,714 10,957
-------- --------
Long-term debt -- 250
-------- --------
Shareholders' equity:
Common stock: $.001 par value, 50,000,000
shares authorized; 11,695,204 and 10,375,832
shares issued and outstanding 32,596 32,583
Cumulative translation adjustment (71) (50)
Retained earnings (254) 195
-------- --------
Total shareholders' equity 32,271 32,728
-------- --------
$ 41,985 $ 43,935
======== ========
The accompanying notes are an integral part of these financial statements.
Page 3 of 18 pages
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
THREE MONTHS ENDED
JUNE 30,
-------------------------
1996 1995
-------- --------
(UNAUDITED)
Net revenues $ 8,480 $ 6,044
Cost of net revenues 1,590 968
-------- --------
Gross profit 6,890 5,076
-------- --------
Operating expenses:
Research and development 1,096 707
Sales and marketing 3,717 2,884
General and administrative 684 569
Merger expenses 1,865 --
-------- --------
7,362 4,160
-------- --------
Income (loss) from operations (472) 916
Interest income, net 274 57
-------- --------
Income (loss) before income taxes (198) 973
Provision for income taxes 251 394
-------- --------
Net income (loss) ($ 449) $ 579
======== ========
Net income (loss) per share ($ 0.04) $ 0.06
Number of shares used to compute
net income (loss) per share 11,686 10,519
The accompanying notes are an integral part of these financial statements
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
THREE MONTHS ENDED
JUNE 30,
-------------------
1996 1995
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ($ 449) $ 579
Adjustment to retained earnings as a result of
business combination (see Note 1) -- (57)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 140 101
Deferred taxes -- (112)
Changes in assets and liabilities:
Accounts receivable, net 700 (2,139)
Inventories (18) (231)
Other current assets 559 (228)
Accounts payable (1,031) 851
Accrued liabilities (176) 783
Income taxes payable 131 (408)
------- -------
Net cash used in operations (144) (861)
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CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (292) (193)
Purchases of short-term investments, net 736 (7)
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Net cash provided by (used in) investing
activities 444 (200)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment on notes payable (417) --
Issuance of common stock upon exercise of warrants
and stock options 13 --
------- -------
Net cash (used in) provided by financing
activities (404) --
------- -------
EFFECT OF EXCHANGE RATES ON CASH (21) (24)
Net (decrease) increase in cash and cash equivalents (125) (1,085)
Cash and cash equivalents at beginning of period 7,153 5,562
------- -------
Cash and cash equivalents at end of period $ 7,028 $ 4,477
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The accompanying notes are an integral part of these financial statements.
Page 5 of 18 pages
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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.
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 financial statements and
related notes included in the Company's Registration Statement on Form SB-2
dated November 9, 1995 and the Company's Form 10-KSB for the year ended March
31, 1996, filed on July 1, 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 the
merger of the two companies. As a result of the merger, 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. The merger 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 statement of operations of the Company for the
three months to June 30, 1995 has been combined with that of Ray Dream for the
three months to March 31, 1995.
As a result of the presentation noted above, Ray Dream's net loss for
the three months ended June 30, 1995 is reflected as an adjustment to retained
earnings. The net loss of Ray Dream for the three months ended June 30, 1995
was $57,000.
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.
Effective April 1, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS 115"). SFAS 115 requires investment securities to be
classified as either held to maturity, trading or available for sale. The
adoption of SFAS 115 did not have a material impact on the Company's financial
condition or results of operations.
The Company has classified all short-term investments as available for
sale. At June 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.
Page 6 of 18 pages
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3. BALANCE SHEET COMPONENTS
JUNE 30, MARCH 31,
1996 1996
-------- ---------
Inventories:
Raw materials $ 727 $ 756
Finished goods 511 464
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$ 1,238 $ 1,220
======= =======
Property and equipment:
Furniture and fixtures $ 352 $ 327
Equipment and software 1,833 1,566
------- -------
2,185 1,893
Less: Accumulated depreciation and amortization (1,075) (935)
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$ 1,110 $ 958
======= =======
Accrued liabilities:
Reserve for returns and exchanges $ 2,820 $ 2,459
Deferred revenue 110 768
Payroll and related 1,376 1,839
Marketing and advertising 993 634
Other 1,766 1,410
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$ 7,065 $ 7,110
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4. SHAREHOLDERS' EQUITY
Common Stock as of June 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 below).
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
to purchase Ray Dream common stock which, when vested, will be exercisable for
up to 437,604 shares of Fractal common stock.
Page 7 of 18 pages
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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.
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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 INCLUDE FORWARD-LOOKING STATEMENTS THAT ARE DEPENDENT ON CERTAIN
RISKS AND UNCERTAINTIES INCLUDING THOSE DISCUSSED HEREIN, THE COMPANY'S
REGISTRATION STATEMENT ON FORM S-4, DECLARED EFFECTIVE ON APRIL 26, 1996, AND
THE COMPANY'S OTHER FILINGS WITH THE COMMISSION.
INTRODUCTION
Fractal Design Corporation was founded in 1991 to develop, market and
support software for the creation, editing and manipulation of computer graphic
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 a majority of
the Company's net revenues for the foreseeable future.
On May 24, 1996, Fractal acquired Ray Dream, Inc. a California
corporation which designs, develops and markets graphic software application
tools emphasizing three-dimensional effects for the personal computer market.
Ray Dream's flagship products, Ray Dream Studio and Ray Dream Designer for
Macintosh and Windows, are used by graphics 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 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. 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.
In June 1996, Fractal released several products, including Designer 4.1
for Windows and the Japanese version of Painter 4.0 for Windows. A UNIX version
of Painter 4.0 originally was scheduled for release in mid-calendar 1996, and
now is scheduled for release in the quarter ending December 31, 1996. In the
quarter ending September 30, 1996, Fractal expects to ship two new products:
Expression, a Natural-
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Media illustration program, and Detailer, a graphics application that allows
users to paint on the surface of 3D models in real-time. 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, or any failure to achieve market acceptance
among new and upgrade customers, could have a material adverse effect on the
Company's business, results of operations and financial condition.
As a result of the May 24, 1996 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
upon exercise of previously outstanding options to purchase Ray Dream stock.
Fractal also 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. The merger 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).
Net Revenues
The Company's net revenues for the three-month period ended June 30,
1996 increased by 40% to $8.5 million, from $6.0 million for the three-month
period ended June 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 Mac platform, were the primary components
of the increase in revenues for the three months ended June 30, 1996. For the
same three-month period, international revenues grew 39%, while domestic
revenues grew 41%. Revenues from OEM customers grew 199% and represent 14% of
net revenues for the three months ending June 30, 1996. Additionally, revenues
from Japan grew 105% and represent 33% of the Company's net revenues for the
three months ending June 30, 1996, primarily due to the release of Painter 4J
Macintosh in March 1996 and Painter 4J Windows in June 1996.
Gross Profit
Gross profit increased 36% to $6.9 million for the three months ended
June 30, 1996, from $5.1 million for the three months ended June 30, 1995. The
increase in the amount of gross profit was primarily a result of higher net
revenues. Gross profit as a percentage of net revenues, however, decreased to
81% in the three months ended June 30, 1996 from 84% in the three months ended
June 30, 1995. The decrease in gross profit as a percentage of net revenues was
a result of increased royalties to third-party software developers and increased
expenses associated with obsolete inventories.
Research and Development
Research and development expenses were 13% of revenue for the
three-month period ended June 30, 1996, compared to 12% for the comparable
fiscal 1996 period. The amount of research and development expenses increased
55% to $1.1 million for the quarter ended June 30, 1996 from $0.7 million for
the same quarter in the prior year. The increase in research and development
expenses was due primarily to 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 Company's products. 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
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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 $3.7 million, or to 44% of
revenue, for the three-month period ended June 30, 1996 from $2.9 million, or
48% of revenue, in the comparable fiscal 1996 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, increase 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 increased $0.1 million (20%) for
the three-month period ended June 30, 1996 from $0.6 million for the three-month
period ended June 30, 1995 to $0.7 million for the comparable fiscal 1997
period. The increases are primarily due to directors and officers liability
insurance and increased reserves for bad debt associated with higher levels of
revenue. 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 three months ended June 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 months ended June 30, 1996 was
approximately 31%, before giving effect to the one-time charge, compared to 40%
for the three months ended June 30, 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 in the Company's Annual Report on Form 10-KSB, filed with the
Commission on July 1, 1996, and the Company's Registration Statement on Form
S-4, declared effective by the Commission on April 26, 1996.
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
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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 may be unable 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.
The realization of the benefits sought from the acquisition of Ray
Dream in May 1996 depends on the ability of the Company better to utilize
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 use Ray
Dream's net operating loss carry forwards. These benefits may not be achieved if
the activities of Fractal and Ray Dream are not integrated in a coordinated,
timely and efficient manner, and there can be no assurance that this will occur.
The combination of the two organizations will also require the dedication of
management resources, which will temporarily detract attention from the
day-to-day business of the Company. 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 integration in a
timely and coordinated fashion, it could result in a material adverse effect on
operating results. Following the acquisition, the company intends to seek 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
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integrate acquisitions, and failure to do so could have a material adverse
effect on the Company's operating results.
Fractal issued 3,165,660 shares of Fractal Common Stock in the
acquisition of Ray Dream and reserved 219,459 shares of Fractal Common Stock for
issuance upon exercise of previously outstanding Ray Dream options. Fractal
assumed an outstanding Ray Dream warrant, which became a warrant exercisable for
437,604 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, are holders of 6,286,464 shares of
Fractal common stock (on an as-converted basis) have agreed that they will not
transfer, sell, exchange, pledge or otherwise dispose of any Fractal Common
Stock until the date Fractal shall have publicly released financial results for
a period that includes at least 30 days of combined operations of Fractal and
Ray Dream (the "Affiliates Expiration Date"). Immediately after the Affiliates
Expiration Date, these shares will be for sale in the public market, subject to
compliance with Rules 144 and 145 under the Securities Act. In addition, 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 merger 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. 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 77% of the sales of Painter to date 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.
Apple Computer recorded a $740 million loss in its second quarter of
fiscal 1996, significantly exceeding its first quarter loss of $69 million.
These announcements, and the overall perception of Apple Computer, have
negatively impacted Fractal's Macintosh-based business. While North America
Macintosh-based Painter revenue increased in fiscal 1996, the growth rate has
declined during this period, including an absolute decline in the fourth quarter
compared to the fourth quarter of the prior year. This trend in the past has
been offset by growth in international markets on the Macintosh platform, but
there can be no guarantee that this will continue to be the case.
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 13 of 18 pages
14
that slow adoption of the Windows 95 operating system abroad 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 June 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; $105,000 of which was related to
non-cash expenditures, while $1,760,000 was related to cash expenditures. As of
June 30, 1996, approximately $1 million of the cash expenditures had been paid,
with the remaining cash expenditures to be made primarily in the quarter ending
September 30, 1996. Subsequent to the acquisition, Ray Dream repaid $417,000
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 plans to
relocate its operations to this location in September 1996. In connection with
this move, the Company expects to expend approximately $1 million for leasehold
improvements and capital equipment. These expenditures should be completed by
December 31, 1996.
On September 1, 1995 the Company obtained a $600,000 line of credit
(which bears interest at the bank's reference rate plus 1%), which was unused as
of June 30, 1996. This line was renewed on August 1, 1996. Although the lender
agreed to increase the line of credit up to $1 million, the Company chose to
renew only $500,000. The line of credit is unsecured and bears interest at the
bank's reference rate.
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 $144,000 and
$861,000 in the three months ended June 30, 1996 and 1995, respectively. For the
quarter ended June 30, 1996, the operating activities reflect the one-time
charge related to the acquisition. For the quarter ended June 30, 1995, the cash
used reflected a large increase in accounts receivable due to two new products
shipping in the last month of the quarter and a significant increase in Ray
Dream's sales through distributors who traditionally receive payment terms
compared with direct response sales in earlier periods where payments were
received with the customer order.
The Company believes that expected cash flows from operations and
existing cash 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 14 of 18 pages
15
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 May 24, 1996, a special meeting of the Company's shareholders was
convened. There were issued and outstanding on April 19, 1996, the record date,
8,513,496 shares of Common Stock. At the meeting, shareholders of 7,871,235
shares of Common Stock were present in person or by proxy. The following
matters were submitted to a vote of the Company's shareholders:
a. To approve and adopt the Merger Agreement between Fractal and Ray
Dream. (See part I, Item 2 for a discussion of the terms of the Ray Dream
acquisition.)
VOTES
-----
In Favor 6,159,865
Against 4,501
Abstain 3,650
Broker Non-Vote 1,673,219
b. To approve the Amendment to the 1995 Stock Option Plan increasing
the number of shares of Common Stock reserved for issuance by 300,000 shares.
VOTES
-----
In Favor 7,451,554
Against 364,802
Abstain 6,346
Broker Non-Vote 18,533
ITEM 5. OTHER INFORMATION.
None.
Page 15 of 18 pages
16
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
2.1* Agreement of Merger dated as of May 24, 1996 among Registrant,
Fractal Acquisition Corporation and Ray Dream, Inc. as filed
with the California Secretary of State on May 24, 1996.
3.1** By-laws of the Company....
10.1 Lease Agreement, dated July 19,1996 for 5550 Scotts Valley
Drive, Scotts Valley, CA.
11.1 Statement of Computation of Net Income per Common Share.
23.1*** Joint Proxy Statement/Prospectus sent to shareholders of the
Company on April 30, 1996.
- -------------------------
* Incorporated by reference from an exhibit on the Company's report
on Form 8-K, as amended, filed with the Commission on June 6,
1996.
** Incorporated by reference from an exhibit on the Company's
Registration Statement on Form S-8, filed with the Commission and
effective on May 24, 1996.
*** Incorporated by reference from the Company's Joint Proxy
Statement/Prospectus filed with the Commission on May 2, 1996.
(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
financial statements of Ray Dream and pro forma financial statements of the
Company in accordance with the Commission's rules and regulations.
Page 16 of 18 pages
17
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: August 14, 1996
Page 17 of 18 pages