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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] Annual report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended March 31, 1996
[ ] 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
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FRACTAL DESIGN CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
California 77-0276903
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
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)
Securities registered under Section 12(b) of the Exchange Act:
Name of Each Exchange
Title of Each Class on Which Registered
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N/A N/A
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Securities registered under Section 12(g) of the Exchange Act:
Common Stock
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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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-B is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [X]
State revenues of the registrant for the most recent fiscal year.
$21,780,000 as of March 31, 1996.
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As of June 21, 1996, the aggregate market value of the 6,724,744 shares of
the registrant's common stock held by non-affiliates of the registrant was
$100,871,160 based on the $15.00 last sale price of the registrant's common
stock on the Nasdaq National Market on that date.
As of June 21, 1996, 11,695,304 shares of the registrant's common stock
were issued and outstanding.
Documents incorporated by reference: None
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Transitional Small Business Disclosure Format. [ ] Yes [X] No
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TABLE OF CONTENTS
Page
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PART I.
Item 1. Description of Business. . . . . . . . . . . . . . . . . . . . . 1
Item 2. Description of Property. . . . . . . . . . . . . . . . . . . . . 9
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . 9
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . 9
PART II.
Item 5. Market for Common Equity and Related Stockholder Matters . . . . 10
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . 10
Item 7. Financial Statements . . . . . . . . . . . . . . . . . . . . . . 23
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. . . . . . . . . . . . . . . . . . . . 36
PART III.
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act . . . . . . . 37
Item 10. Executive Compensation . . . . . . . . . . . . . . . . . . . . . 40
Item 11. Security Ownership of Certain Beneficial Owners and Management . 41
Item 12 Certain Relationships and Related Transactions . . . . . . . . . 44
PART IV.
Item 13. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . 45
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PART I
EXCEPT FOR 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.
ITEM 1. DESCRIPTION OF BUSINESS.
Fractal Design Corporation was incorporated in California in April
1991 and is a leading provider of software tools for the creation, editing and
manipulation of computer graphic images and digital art. Fractal's principal
product, FRACTAL DESIGN PAINTER ("PAINTER") for Macintosh and Windows, is used
primarily by artists, graphics professionals and animators in a number of
industries, including print and electronic publishing, print and broadcast
advertising and entertainment and content development. Creative professionals
use PAINTER and other Fractal products to create and modify images for
brochures, books, magazines and print and broadcast advertisements; to provide
on-screen graphics for television broadcasts; to edit digital video projects and
create animation; to develop multimedia content and to author World Wide Web
pages for the Internet.
Fractal provides intuitive and powerful software tools for the
creation, editing and manipulation of computer graphic images and digital art.
Fractal's products provide technologically advanced software tools that unite
traditional artistic techniques and tangible media with digital technology,
faithfully capturing the subtleties of the artist's gesture and translating them
to the computer screen. Fractal's paint and image-editing products, which
incorporate Natural-Media capabilities and currently operate on the Macintosh
and Windows platforms, closely simulate the techniques of traditional artists'
tools and the look of tangible artwork, while also offering innovative features
that extend the creative abilities of artists, graphics professionals and
animators and enable them to achieve effects not possible with traditional
methods and tools. Fractal sells its products worldwide through distributors
and mail-order catalogs, to hardware and software manufacturers for bundling
with other products, and directly to registered users.
ACQUISITION OF RAY DREAM, INC.
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
(see "Products" for a description of Ray Dream's products). As a result of the
acquisition, Ray Dream has become a wholly-owned subsidiary of Fractal. Unless
the context otherwise requires, "the Company" refers herein to the combined
company, and "Fractal" and "Ray Dream" refer herein to the separate companies
prior to the acquisition.
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.
Information with respect to Ray Dream is included throughout this
Report, but Ray Dream's financial statements are not included in Fractal's
financial statements contained herein. Pro forma financial and other
information with respect to the acquisition of Ray Dream is contained in
Fractal's Form S-4, declared effective on April 26, 1996, and the Company's Form
8-K, filed on June 6, 1996.
PRODUCTS
The Company's products include PAINTER, DABBLER, POSER and several
other products that are sold separately as complementary add-ons to PAINTER and
DABBLER (see also "Ray Dream Products" below).
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PAINTER
PAINTER, first introduced in August 1991, is an advanced paint and
image-editing application targeted at artists, animators and graphics
professionals. PAINTER 4.0, the current version of this product, was introduced
in 1995 and operates on the Macintosh and Windows platforms.
Key features of PAINTER include:
- PRESSURE-SENSITIVE INPUT. PAINTER supports pressure-sensitive
drawing tablets, which enables an artist to use a stylus to paint and draw with
PAINTER much as he or she would with traditional artists' tools. For example,
if an artist selects the chalk tool and strokes lightly on the digital pad, the
chalk image lightly covers the peaks of the paper appearing on the computer
screen. When pressed more heavily, the chalk fills the paper's valleys. Other
tools exhibit thick or thin strokes depending on the pressure applied.
- CUSTOMIZED BRUSHES. Physical bristle modeling heightens PAINTER'S
ability to simulate Natural-Media tools by providing control over bristle
characteristics like thickness and clumpiness. The "Capture Brush" feature lets
the user define and re-use a customized brush shape from thousands of possible
options to create unique image effects.
- A WIDE VARIETY OF POWERFUL IMAGE-EDITING CAPABILITIES. PAINTER
allows users to control the focus and orientation of an image and change its
surface texture. PAINTER'S "image warp" feature can distort the surface of an
image as if it were a sheet of pliable film. Combined with the cloning feature,
a scanned photograph can be transformed into an entirely new style, like a chalk
drawing or a Van Gogh-style painting.
- POWERFUL IMAGE COMPOSITION TOOLS. Multiple floating selections
(called "floaters"), consisting of separate images or design objects, allow for
a highly flexible visual environment. Floaters may be layered, grouped,
feathered, and stored in special portfolios. Images may be saved with floaters
still floating and then reopened to make additional composition changes.
- COLOR AND GRADATIONS. PAINTER'S "Color Selection Tool" feature
allows the user to create and blend a nearly unlimited variety of different
colors. PAINTER'S "edit gradation" feature enables users to create smooth
gradations of color.
- EASY-TO-UNDERSTAND, SPACE-SAVING INTERFACE. PAINTER'S wide array
of tools are placed at the user's fingertips within "drawers" that can be opened
or closed by the user as needed. The interface is customizable, so it can be
tailored to an individual's method of working.
- MULTIPLE UNDO. PAINTER enables up to 32 levels of undo. This
permits the artist or designer to reverse the creation of the image
step-by-step, in a manner not possible with traditional media. This provides
art and graphics professionals with the ability to experiment with different
possible approaches before finalizing a project, thereby improving productivity.
- SCRIPTING. PAINTER enables the user to record and play back an
editable "script" that is composed of all actions the user has made with PAINTER
in the creation of graphical images. One application of this feature is that an
artist can apply the same "script" to each frame of a movie to automate what
would otherwise be a highly repetitive manual task.
- ANIMATION AND VIDEO-EDITING TOOLS. To achieve image animation,
PAINTER creates frame stacks, or sets of images that can be individually
manipulated with PAINTER'S tools. Two-to-five-layer onion skinning lets a user
see multiple frames, including those before and after the current frame.
PAINTER also can be used to alter video imported from outside sources, and
PAINTER'S visual effects may be applied to single or multiple frames within an
animation stack. PAINTER also supports export of animation files formatted for
Video for Windows and QuickTime for Macintosh, two popular video formats.
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- THE "IMAGE HOSE." This unique feature paints with pictures
instead of dabs of color, casting a series of small detailed images with every
brush stroke. The Image Hose can create random natural and man-made patterns and
textures or ordered tiled patterns, that would be difficult or tedious to create
manually.
- DIRECT SUPPORT FOR IMAGE SCANNING. PAINTER provides direct
support for an image scanner, which allows scanned images to immediately appear
in PAINTER'S image window where they may be cloned or edited.
- SHAPES. PAINTER includes a drawing layer that floats above the
bitmap canvas of an image, allowing the seamless blending of raster-based paint
and vector-based draw images.
- MOSAICS. This new Natural-Media feature allows users to design
images in the style of historic tile mosaics, by "painting" with tiles on a
canvas or over scanned photographs or images. The mosaic tiles are independent
objects that automatically carve their shape and may be erased or reshaped
easily.
- NET PAINTING. This feature allows real-time collaborative artwork
creation between users on networked computers, including over the Internet.
Because PAINTER sends scripts over the network, rather than screen images, it
can be used effectively over low bandwidth connections.
As of March 31, 1996, PAINTER 4.0 was available on the Macintosh
platform in English, Japanese, French, and German, and on the Windows platform
in English and German. As of March 31, 1996, the suggested retail price for the
English version of this product was $549.
DABBLER
DABBLER, which was first introduced for the Macintosh and Windows
platforms in March 1994, offers many of the Natural-Media tools and textures
found in PAINTER in a less sophisticated, learn-to-draw-and-paint format for
beginning artists and hobbyists of all ages. DABBLER allows the user to
experiment with a wide variety of tools, color options, and technique and style
adjustments. DABBLER includes tutorials licensed on an exclusive basis from
Walter Foster Publishing, a leading publisher of how-to art books. Although
DABBLER can be utilized by mouse-based users, performance is enhanced by using a
pressure-sensitive digital tablet. A localized version of DABBLER is marketed
in Japan under the name "Art School." In October 1995, Fractal shipped DABBLER
2.0 for Macintosh and Windows, an enhanced version of DABBLER containing, among
other improvements, more extensive instructional tutorials, a greater variety of
paint tools and textures and animation capabilities. DABBLER 2.0 has a
suggested retail price of $69 (English version).
POSER
POSER, introduced on the Macintosh platform in May 1995, is a modeling
application that allows users to create images of human figures which can be
posed, rendered with surface textures and multiple lights, and easily
incorporated into artwork and designs. Model images created with POSER can be
exported for use in graphics design, illustration, multimedia and 3D software.
POSER is designed to work with 2D and 3D design applications such as PAINTER,
Adobe Photoshop, Macromedia Director and several other products. As of March
31, 1996, the suggested retail price for POSER was $199. In March 1996, Fractal
released POSER for the Windows platform.
OTHER PRODUCTS
The Company also offers a variety of accessory products that
complement and extend its core product line. These include libraries of
textures and brushes for use in creating images and designs with the Company's
software, such as Trees & Leaves, Patterns & Nature, Grains & Weaves, Miles of
Tiles, Walls & Reliefs and Sensational Surfaces. Sales of these products
historically have not represented a material portion of revenues.
In addition, as a result of Fractal's recent acquisition of Ray Dream,
Inc. (see below), the Company's product line includes graphics software
application tools emphasizing three-dimensional effects and animation for the
personal computer market.
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RAY DREAM PRODUCTS
The flagship product of this line, Ray Dream STUDIO, integrates
four components into one cohesive 3D illustration and animation package,
and is composed of Ray Dream DESIGNER, Ray Dream ANIMATOR, DREAM MODELS
and the Extensions Portfolio. STUDIO is available for the following major
personal computer operating platforms: Apple Macintosh, Apple Power
Macintosh, Microsoft Windows 3.x, Microsoft Windows 95, and Microsoft
Windows NT. The product is cross-platform compatible, capable of importing
and exporting graphics and animation information into the major file formats
supported by other graphics applications in each operating environment.
By combining powerful, advanced 3D techniques with an easy-to-use
intuitive graphical interface and a step-by-step interactive user-assistance
system, DESIGNER enables both experienced and first-time users to create full-
color, high resolution images with the visual impact and photorealism of three
dimensions. Ray Dream ANIMATOR then lets these users transform these three
dimensional images into animations through the use of high-end features such as
inverse kinematics, movies as textures, and deformations that enhance the
realism and impact of the computer-generated scenes.
Other products include ADDDEPTH, which allows both graphics novices
and professional artists to add the impact of 3D to two dimensional typefaces
and line art via a palette of easy-to-use controls.
Ray Dream has also invented a patented edge-smoothing technology
utilized in its JAG product for the Macintosh that allows users to enhance
resolution and clarity, regardless of the paint, animation, multimedia, or
photo-retouching software employed.
MARKETING, DISTRIBUTION AND PRODUCT SUPPORT
MARKETING
The Company believes that favorable product reviews and word-of-mouth
among creative professionals are critical to create greater awareness and
commercial acceptance of its products. The Company promotes its products
principally through ongoing contact with industry press and analysts and
participation in trade shows, such as Seybold, MacWorld, PC Expo and Siggraph.
These efforts typically include close contact with art and graphics
professionals to generate increased awareness and to obtain feedback on the
features and functionality of its products. In addition, the Company seeks to
generate awareness of its products through selective advertising in industry
publications.
The Company uses direct marketing to identify potential customers and
to conclude mail order and telephone sales. The Company also directly markets
new versions of its products and new products through mailings to its existing
registered customer base and to users of complementary graphics products. In
addition, the Company sponsors an annual design contest that invites artists to
enter their artwork created with PAINTER and DABBLER. Winning designs often are
used in promotional materials.
DISTRIBUTION
The Company sells its products worldwide through multiple
distribution channels including distributors and mail order catalogs,
hardware and software manufacturers for bundling with other products, and
directly to registered users. During fiscal 1995, Fractal's sales to
Ingram Micro accounted for 25% of Fractal's net revenues. During fiscal
1996, Fractal's sales to the three largest distributors accounted for
17%, 17%, and 11%, respectively, of Fractal's net revenues.
DOMESTIC DISTRIBUTION. Fractal's primary domestic sales channel is through
independent, non-exclusive distributors who sell Fractal's products to retail
stores and specialized resellers focused on graphics and design systems. As of
March 31, 1996, Fractal had four domestic distributors: Ingram Micro, Merisel,
Tech Data and Douglas Stewart. Fractal also sells its products to mail order
distributors, including Mac and PC Connection, Mac and Micro Warehouse, Mac and
PC Zone and Mac Mall. Fractal offers distributors discounts based upon sales
volume, and enters into arrangements for the funding of co-promotional efforts
with distributors.
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Fractal enters into agreements with its domestic and significant
international distributors and dealers that typically are cancelable by either
party upon specified prior notice. These agreements generally do not contain
required purchase commitments by the distributor or dealer. As is common
practice in the software industry, Fractal typically offers distributors and
bundling partners certain product exchange provisions and price protection.
As a result of Fractal's acquisition of Ray Dream, the Company also
markets the Ray Dream products as was previously done by Ray Dream, i.e.,
primarily to distributors for resale, including mail order distributors, and
will derive a substantial portion of its revenues from direct mail offerings.
INTERNATIONAL DISTRIBUTION. As of March 31, 1996 Fractal distributed
its products through 32 software distributors in 28 countries. During
fiscal 1995 and fiscal 1996, international sales represented approximately
28% and 46% of Fractal's net revenues, respectively, and approximately
11% and 29% of Fractal's net revenues were from customers located in
Japan. Through its wholly-owned subsidiary, Fractal Design
International, Fractal has an employee in Japan providing customer
service and technical support and an office in Europe providing
marketing support.
Through its acquisition of Ray Dream, Inc., the Company also has
increased its presence in Europe, where Ray Dream has a French subsidiary and
relationships with a variety of distributors and resellers.
SOFTWARE AND HARDWARE BUNDLING ARRANGEMENTS. The Company also distributes its
products through bundling arrangements with hardware suppliers, particularly
drawing tablet manufacturers such as Wacom, Summagraphics, and CalComp. From
time to time, Fractal also bundles its products with complementary products from
other software companies, and Ray Dream has, in the past, bundled its products
with products from Corel Corporation.
DIRECT SALES. The Company also markets and sells its products directly to
registered users in its installed base. The Company fulfills these orders
through independent sales fulfillment firms. Ray Dream markets directly to
prospects and to its users via its own catalog. Marketing activities include
direct mailings of newsletters, brochures and product upgrade offers, including
mailings targeted at users of complementary products, such as Photoshop users.
PRODUCT SUPPORT
The Company offers free telephone customer support during its normal
business hours. The Company also currently provides customer support via the
Internet and maintains a forum on both CompuServe and America Online to provide
technical information to customers.
RESEARCH AND PRODUCT DEVELOPMENT
The Company has a continuing program of product development directed
toward the enhancement of existing products based upon current and anticipated
customer needs and desired features. The Company works closely with artists,
animators and graphics professionals to understand and address their needs. The
Company also solicits suggestions from artists and creative professionals in
focus groups and at trade shows, and uses this feedback to develop and implement
new features for its products.
To date, Fractal's development efforts have focused primarily on
its painting and image-editing products, and currently are focused on new
product development, the porting of PAINTER to a popular version of the UNIX
operating system and completing international localizations of its
software. As of March 31, 1996, 16 people were employed by Fractal in
product development and quality assurance. In the fiscal years ended March
31, 1996 and 1995, Fractal expended $2.6 million, and $1.5 million,
respectively, on research and product development.
To date, Ray Dream's development efforts have focused primarily on
three-dimensional illustration and animation products and are currently focused
on Release 4.1 of Designer and Studio and a new product, now
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known as FRACTAL DESIGN EXPRESSION. As of May 24, 1996, 15 people were
employed by Ray Dream in product development and quality assurance.
Fractal typically develops its application software on the Macintosh
platform and ports applications to the Windows operating environment using
proprietary software developed by Altura Software, Inc., a private company
affiliated with one of the Company's directors and principal shareholders.
Fractal also relies on Altura for certain technical assistance in the porting
process, and relies on Altura to develop software and techniques for porting
Fractal's products to new platforms, such as UNIX and Windows 95. The Company
believes that its relationship with Altura has enabled Fractal to port
applications to Windows in significantly less time than through internal
efforts, and has shortened the product development cycle by permitting Fractal
to maintain a single software code base. If the agreement with Altura were
terminated or the Company's relationship with Altura is impaired for any reason,
or if Altura should have financial difficulties or lose key personnel, the
Company's ability to timely introduce versions of its products on the Windows
platform would be substantially impaired. In such event, there can be no
assurance that the Company would be able to attract and assimilate highly
qualified technical personnel to port Fractal's software to the Windows platform
or any other platforms on a timely basis. Any interruption in the availability
or quality of these services and software from Altura for any reason could have
a material adverse effect on the Company's business, operating results and
financial condition.
Ray Dream typically develops its software on the Windows operating
environment and ports its applications to the Macintosh platform using its
own proprietary software.
COMPETITION
The markets for the Company's products are intensely
competitive, subject to rapid change and characterized by constant demand
for new product features, and pressure to accelerate the release of new
products and product enhancements and to reduce prices. A number of
companies currently offer products that compete directly or indirectly
with one or more of the Company's products. These companies include,
among others, in the paint, draw and image-editing software market,
Adobe Systems Incorporated, Corel Corporation, Micrografx Incorporated,
Macromedia, Inc. (including its subsidiary, Fauve Software, a provider
of image-editing and paint software), Silicon Graphics, Inc. (through its
Alias Research subsidiary), and Microsoft Corporation (through its SOFTIMAGE
division); and in the learn-to-draw-and-paint market, Microsoft
Corporation, Adobe Systems Incorporated and Broderbund Software, Inc.
The Company's competitors in the 3D drawing and illustration software
market include, among others, Strata, Inc., Macromedia, Inc., Adobe
Systems Incorporated, Corel Corporation, Autodesk, Inc., (through its
Kinetix division), Visual Software, Inc., (which recently merged with
Micrografx Incorporated) Caligari Corporation and Specular International
Ltd. Many of the Company's competitors or potential competitors have
significantly greater financial, managerial, technical, and marketing
resources than the Company. A variety of potential actions by any of the
Company's competitors, including a reduction of product prices, increased
promotion, announcement or accelerated introduction of new or enhanced
products or features, product giveaways or product bundling could have a
material adverse effect on the Company's business, results of operations
and financial condition.
Although PAINTER includes significantly different features and
functionality than other paint and image-editing products, such as Adobe
Photoshop, common features in these programs may render them competitive for
certain users, particularly users interested primarily in paint tools for image
editing and enhancement. In addition, recent versions of Photoshop have
included features, such as multiple floating images, that were first introduced
in earlier released versions of PAINTER. There can be no assurance that future
versions of other graphics-related products, including Photoshop, will not
include features and functionality that are similar to or superior to features
in PAINTER. Also, there can be no assurance that third parties will not
introduce software products to compete with POSER, which Fractal released on the
Macintosh platform in May 1995 and on the Windows operating system in March
1996. Increased competition resulting from any such release could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Ray Dream has licensed to Corel Corporation source and object code for
versions 3 and 4 of DESIGNER and version 1 of ADDDEPTH for incorporation into
major Corel products for distribution by Corel. Corel has the right to modify
the programs to integrate them into significant Corel software application
programs, including word processing, graphics, or computer aided design
software, and is currently marketing a modified form of DESIGNER
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in its CorelDraw6 suite of graphics and multimedia programs, which retails for
$695. There can be no assurance that Corel, a significant competitor in the
graphics market, will not reduce prices for its products that incorporate
DESIGNER or ADDDEPTH to make such products competitive with Ray Dream's
products. Additionally, certain potential customers of Ray Dream may determine
that the versions of DESIGNER and ADDDEPTH included in significant Corel
products satisfy their requirements, and having purchased or determined to
purchase such Corel products, may choose to forego a purchase of subsequent
versions of DESIGNER or ADDDEPTH from the Company.
The Company believes that the primary competitive factors affecting
the market for its products include product price, features, quality,
performance, ease-of-use, name recognition and reputation, the quality of
documentation and customer support, and access to channels of distribution.
Although the Company believes that it competes favorably with respect to these
factors, there can be no assurance that the Company will be able to continue to
compete effectively with respect to these or any other factors.
The Company's present or future competitors may be able to develop
products comparable or superior to those offered by the Company or adapt more
quickly than the Company to new technologies or evolving customer requirements.
In order to be successful in the future, the Company must respond to
technological change, customer requirements and competitors' current products
and innovations. In particular, while the Company is currently developing
additional products and product enhancements that it believes address customer
requirements, there can be no assurance that it will successfully complete the
development or introduction of these additional product enhancements on a timely
basis or that these products and product enhancements will achieve market
acceptance. Accordingly, there can be no assurance that the Company will be
able to continue to compete effectively in its markets, that competition will
not intensify or that future competition will not have a material adverse effect
on the Company's business, results of operations and financial condition.
INTELLECTUAL PROPERTY
The Company regards its software as proprietary and relies primarily
on a combination of copyright, trademark and trade secret laws, employee and
third-party nondisclosure agreements, and other intellectual property protection
methods to protect its products and technology. The Company also has one patent
with respect to its Natural-Media technology and has one patent application
pending. However, the Company believes that the ownership of patents is not
presently a significant factor in its business and that its success does not
depend on the ownership of patents, but primarily on the innovative skills,
technical competence and marketing abilities of its personnel. The Company
licenses certain components of its products and related technologies used in its
product and service offerings, including certain color and file formats utilized
in its paint and drawing products. The Company also licenses its POSER product
from a third party software developer. Although the Company has a perpetual
license to distribute this product, ownership of this software was retained by
the developer. Unlike internally developed products, license arrangements with
third party software developers may limit the Company's ability to create
upgrades to its products.
The Company generally has no signed license agreements with the end
users of its products and does not copy-protect its software. In addition,
existing copyright laws afford only limited protection, and it may be possible
for unauthorized third parties to copy the Company's products or to reverse
engineer or obtain and use information that the Company regards as proprietary.
There can be no assurance that the Company's competitors will not independently
develop technologies that are substantially equivalent or superior to Fractal's
technologies. Policing unauthorized use of the Company's products is difficult,
and while the Company is unable to determine the extent to which software piracy
of its products exists, software piracy can be expected to be a persistent
problem. In addition, the laws of certain countries in which the Company's
products are or may be distributed do not protect the Company's products and
intellectual property rights to the same extent as the laws of the United
States.
Ray Dream has licensed to Corel Corporation source and object code for
versions 3 and 4 of DESIGNER and version 1 of ADDDEPTH for incorporation into
major Corel products for distribution by Corel. Corel has the right to modify
the programs to integrate them into significant Corel software application
programs, including word processing, graphics, or computer aided design
software, and is currently marketing a modified form of DESIGNER in its
CorelDraw6 suite of graphics and multimedia programs, which retails for $695.
There can be no assurance that Corel will not become a significant competitor
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with RayDream's products. Additionally, certain potential customers of the
Company may determine that the versions of DESIGNER and ADDDEPTH included
in significant Corel products satisfy their requirements, and having
purchased or determined to purchase such Corel products, may choose to
forego a purchase of subsequent versions of DESIGNER or ADDDEPTH from the
Company. Any of the foregoing could have a material adverse effect on
the business, operating results and financial condition of the Company.
There can be no assurance that third parties will not claim
infringement by the Company with respect to current or future products, and the
Company expects that it will increasingly be subject to such claims as the
number of products and competitors in the graphics software market grows and the
functionality of such products overlaps with other industry segments. From time
to time, the Company has received notices alleging that its products infringe
patents or other intellectual property rights of third parties. The Company
cannot predict the effect, if any, that these claims, including the costs of
defending any litigation or similar proceeding that may arise from such claims,
will have upon its business, operating results and financial condition. Any
such third party claims, whether or not they are meritorious, could result in
costly litigation or require the Company to enter into royalty or licensing
agreements. Such royalty or license agreements, if required, may not be
available on terms acceptable to the Company or at all. If the Company were
found to have infringed upon the proprietary rights of third parties, it could
be required to pay damages, cease sales of the infringing products and redesign
or discontinue such products, any of which could have a material adverse effect
on the Company's business, operating results and financial condition.
MANUFACTURING
The principal materials and components used in the Company's products
include computer media (diskettes and CD-ROMs), packaging and user manuals.
Manufacturing involves the duplication of computer media and user manuals,
assembly of components, sample testing the product and final packaging. The
Company currently relies upon third parties to manufacture components of its
products and assemble completed packages in accordance with the Company's
specifications. The Company believes that there is an adequate supply of and
source for the raw materials used in its products and that multiple sources are
available for manufacturing and assembling its products. The Company's products
are generally shipped as orders are received and, accordingly, Fractal has
historically operated with little backlog.
EMPLOYEES
As of March 31, 1996, Fractal had 66 full-time employees, of whom 16
were engaged in product development and quality assurance, 36 in sales,
marketing and technical support and 14 in manufacturing and administration.
With Fractal's acquisition of Ray Dream, Inc., the company added an additional
42 full-time employees, of whom 15 were engaged in product development and
quality assurance, 20 in sales, marketing and technical support and 7 in
manufacturing and administration. The Company's employees are not represented
by any collective bargaining organization, and the Company regards its relations
with employees to be good.
The Company's ability to introduce new products and product features
on a timely basis depends substantially on the continued efforts of Mark Zimmer,
Thomas Hedges, Eric Hautemont, Pierre Berkaloff, Pascal Belloncle and John
Stockholm, who are extensively involved in product development and engineering.
The Company does not carry key man insurance on its executive officers. The
Company also is dependent on its ability to retain and motivate high quality
personnel, especially its management and highly skilled development teams. The
loss of the services of any of its executive officers or other key employees
could have a material adverse effect on the business, operating results or
financial condition of the Company. The Company's future success also depends
on its continuing ability to identify, hire, train and retain other highly
qualified technical and managerial personnel. Competition for such personnel is
intense and Fractal has experienced difficulty in identifying and hiring
qualified engineering personnel, particularly personnel with expertise on the
Windows operating environment. There can be no assurance that the Company will
be able to attract, assimilate or retain other highly qualified technical and
managerial personnel in the future. The inability to attract and retain the
necessary technical and managerial personnel could have a material adverse
effect upon the Company's business, operating results and financial condition.
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ITEM 2. DESCRIPTION OF PROPERTY.
Fractal currently leases approximately 10,800 square feet of office
and warehouse space in Aptos, California. On April 9, 1996, Fractal signed a
letter-of-intent for approximately 29,600 square feet, increasing to
approximately 41,000 square feet on December 1, 1998, of office and warehouse
space in nearby Scotts Valley, California. The Company plans to relocate
its operations later this calendar year. The initial term of the proposed
lease will be for seven years with two, three year renewal options. It
also gives the Company the right of first refusal on any of the remaining
approximately 14,000 square feet in the building. The target commencement
date is no earlier than July 1, 1996 and no later than September 1, 1996.
Ray Dream, Inc. leases approximately 8,000 square feet of office space
in Mountain View , California. Ray Dream's leases expire on dates between June
30, 1996 and September 30, 1996. The Company plans to relocate Ray Dream's
operations to the new location in Scotts Valley later this calendar year.
ITEM 3. LEGAL PROCEEDINGS.
None.*
* From time to time, the Company has received notices alleging that
its products infringe patents or other intellectual property rights of third
parties. The Company cannot predict the effect, if any, that these claims,
including the costs of defending any litigation or similar proceeding that may
arise from such claims, will have upon its business, operating results and
financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
None.*
* The shareholders of Fractal approved, on May 24, 1996 (fiscal
year 1997), Fractal's acquisition of Ray Dream, Inc.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock of the Company is traded on the Nasdaq National Market
("NASDAQ") under the symbol "FRAC." The following table sets forth the high and
low sales prices for the common Stock from November 9, 1995, the date of the
Company's initial public offering, through June 21, 1996:
Fiscal Year 1996 Low High
---------------- --- ----
Third Quarter (from November 9, 1995) $11.250 $18.250
Fourth Quarter $10.000 $15.500
Fiscal Year 1997
----------------
First Quarter (through June 21, 1996) $11.50 $18.625
At June 21, 1996, there were approximately 163 shareholders of record of
the Company's common stock.
The Company has not paid dividends on its common stock and has no present
intention of paying dividends in the foreseeable future. The Company presently
intends to retain future earnings for reinvestment in its business. In
addition, the Company is prohibited from paying dividends under its existing
credit facility. Any future determination relating to dividend policy will be
made at the discretion of the Board of Directors of the Company and will depend
on a number of factors, inducing future earnings, capital requirements,
financial condition and future prospects of the Company and such other factors
as the Board of Directors may deem relevant.
Prior to the termination of the Company's Subchapter S Corporation status,
the Company made distributions to its shareholders of tax basis Subchapter S
Corporation profits. See Note 4 of Notes to Consolidated Financial Statements.
The Company has never paid any other dividends on its capital stock.
ITEM 6. 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 graphic
images and digital art. Fractal 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 the quarter ending December 31,
1995. PAINTER employs Fractal's proprietary Natural-Media technology, which
enables artists, animators and graphics professionals to simulate closely 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 Fractal's net
revenues since inception, and currently are expected to constitute a significant
portion of the Company's net revenues for the foreseeable future.
In March 1994, Fractal 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, Fractal began shipping FRACTAL DESIGN POSER, a modeling and rendering
application that allows users to create and manipulate a variety
of human figures for graphic design, illustration, multimedia applications and
3D graphics applications. Fractal distributes its products in the United States
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.
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Fractal'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 decline
and stabilize to a relatively constant level. Toward the end of a product or
product version life cycle, revenues tend to decline significantly, and Fractal
may experience returns from distributors in anticipation of new products or
product versions. The Company anticipates that Ray Dream's quarterly and annual
net revenues likely will be affected by similar factors.
In March 1996 Fractal released several products, including POSER for
Windows and foreign language releases of PAINTER 4.0 for Macintosh (Japanese,
German and French) and Windows (German). 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. 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.
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 (see
"Products" for a description of Ray Dream's products). As a result of the
acquisition, Ray Dream has become a wholly-owned subsidiary of Fractal.
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.
The transaction will be accounted as a pooling-of-interests. Transaction fees
of approximately $1.7 million will be recorded in the first quarter of fiscal
1997.
RESULTS OF OPERATIONS
Fractal's results of operations for the fiscal year ending March 31, 1996
do not reflect the acquisition of Ray Dream and involve a number of risks and
uncertainties which are described under the caption "Additional Factors That May
Affect Future Results." The issuance of Fractal common stock in connection with
the acquisition will have the effect of reducing the Company's net income per
share from levels otherwise expected and could reduce the market price of the
Company's common stock unless revenue growth or cost savings and other business
synergies sufficient to offset the effect of such issuance can be achieved.
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The following table sets forth Fractal's consolidated statement of income
data as a percentage of net revenues for the periods indicated:
Years Ended March 31,
------------------------
1996 1995
---- ----
Net revenues 100.0% 100.0%
Cost of net revenues 19.4 19.4
---- ----
Gross margin 80.6 80.6
---- ----
Operating expenses:
Research and development 12.2 11.6
Sales and marketing 41.4 44.1
General and administrative 7.5 7.2
---- ----
61.1 62.9
---- ----
Income from operations 19.5 17.7
Interest income (expense), net 2.1 (0.2)
---- ----
Income before income taxes 21.7 17.5
Provision for income taxes (8.2) (3.6)
---- ----
Net income 13.4% 13.9%
---- ----
---- ----
YEARS ENDED MARCH 31, 1996 AND 1995
NET REVENUES
Net revenues include revenues from gross sales of software products, less
promotional discounts and sales return reserves. Net revenues in fiscal 1996
increased 66% to $21.8 million from $13.1 million in fiscal 1995. This increase
was due to a 66% increase in revenues from the sales of PAINTER. This increase
was favorably affected by sales of PAINTER 3.1J (the localized version of
PAINTER 3.1 for the Japanese market) and the newest release of PAINTER VERSION
4.0. Revenues also were favorably affected by sales of POSER. International
revenues represented 46% and 28%, respectively, of net revenues in fiscal 1996
and 1995. These increases primarily reflected increases in sales in Europe and
Asia, particularly Japan, that were attributable to additional international
distribution relationships entered into during these periods. Fractal's U.S.
and international sales are principally denominated in U.S. dollars. Movements
in currency exchange rates did not have material impact on total revenues in the
periods presented. However, there can be no assurance that future movements in
currency exchange rates will not have a material adverse effect on the Company's
future revenues and results of operations.
GROSS PROFIT
Cost of net revenues includes the cost of manuals, diskettes and their
duplication, packaging materials, assembly and shipping, as well as royalties
(including royalties paid on instructional content licensed for use in DABBLER
and on color and file formats licensed for use in Fractal's paint and image
editing products), reserves for obsolescence and the purchase price of any
resold third party products. Cost of net revenues also includes personnel,
facilities and related costs for materials management, shipping and receiving.
Gross profit increased 66% to $17.6 million in fiscal 1996 from $10.6 million in
fiscal 1995, primarily as a result of higher net revenues. Gross profit as a
percentage of net revenues remained stable at 80.6% in fiscal 1996 and 1995.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of personnel, outside
consultants and equipment costs required to conduct the Company's product
development efforts. Research and development expenses were $2.6 million and
$1.5 million in fiscal 1996 and 1995, respectively, representing 12.2% and 11.6%
of net revenues, respectively. The increase in the amount of research and
development expenses over these periods was due primarily to increases in the
number of employees and related expenses to support the continued enhancement,
design, development and localization of Fractal's software products, including
the use of outside contractors to port versions of Macintosh products to Windows
and for the localization and translation of the software and documentation for
international markets.
Research and development expenditures are charged to operations as
incurred. Statement of Financial Accounting Standards No. 86, "Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,"
requires capitalization of certain software development costs subsequent to the
establishment of technological feasibility. Based on the Company's product
development process, technological feasibility is established upon completion of
a working model. Costs incurred by Fractal between completion of the working
model and the point at which the product is ready for general release have been
insignificant, and accordingly, have not been capitalized as software
development costs.
SALES AND MARKETING
Sales and marketing expenses include advertising, trade shows and other
promotional expenses, compensation and sales commissions, travel, public
relations, personnel and facilities expenses. Fractal's sales and
marketing expenses were $9.0 million and $5.8 million in fiscal 1996 and 1995,
respectively, representing 41.4%
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and 44.1% of net revenues, respectively. The increase in sales and marketing
expenses over these periods was due primarily to increased marketing activities,
such as advertising, participation in trade shows, direct mail campaigns and
increased staffing in sales and marketing and commissions paid on higher levels
of sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses are comprised primarily of the costs of
Fractal's finance and administration functions. General and administrative
expenses were $1.6 million and $0.9 million in fiscal 1996 and 1995,
respectively, representing 7.5% and 7.2% of net revenues, respectively. The
amount of general and administrative expenses increased from fiscal 1995 to
fiscal 1996 primarily due to increased staffing and related costs necessary to
support higher levels of operations, professional fees, compensation related to
stock options issued during April and May 1995, and directors and officers
liability insurance. The Company will record future compensation in the
aggregate amount of $412,000 in connection with stock options granted during
April and May 1995. The compensation will be recognized over the remainder of
the four-year vesting periods of the options.
As the result of the Company's acquisition of Ray Dream, Inc. on May 24,
1996, the Company expects to record a one-time charge, including professional
services and severance costs, of approximately $1.7 million in the quarter
ending June 30, 1996.
INCOME TAXES
Fractal's effective income tax rate was 38% and 20.5% for the fiscal years
1996 and 1995, respectively. Fractal's effective tax rate of 20.5% for fiscal
1995 compared to a combined statutory rate of approximately 40% was due to the
recognition of $630,000 of deferred tax assets which were previously reserved.
The Company anticipates its effective tax rate in future periods will more
closely approximate the statutory rates in effect for those periods, except for
utilization of Ray Dream's net operating loss carry-forwards.
FACTORS THAT MAY AFFECT FUTURE 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 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, products and
updates scheduled to ship near the end of a quarter and the volume and timing of
and 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, mix of
distribution channels through which products are sold, mix of products sold,
returns from the Company's distributors, product announcements by Apple,
Microsoft and PC manufacturers and general economic conditions. As a result,
Fractal 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. See also "Additional Factors That May Affect Future
Results."
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
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followed by increased net revenues, the Company's business, operating results
and financial condition could be materially and adversely affected.
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.
In addition, Fractal's acquisition of Ray Dream (see Item 1 for a complete
discussion) is expected to affect the Company's future results of operations and
all components thereof, including Net Revenues, Gross Profit Research and
Development expenses, Sales and Marketing expenses, General and Administrative
expenses and Income Taxes. There can be no assurance that the integration of
Fractal and Ray Dream will be completed without a disruption of Fractal's and
Ray Dream's businesses and a material adverse effect on the Company's
financial condition and future results of operations.
IMPORTANCE OF THE MACINTOSH PLATFORM AND APPLE COMPUTER; INCREASED PRESENCE ON
THE WINDOWS PLATFORM
Although Fractal offers PAINTER on both the Macintosh and Windows
platforms, approximately 77% of the sales of PAINTER during fiscal 1996 were 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 and Windows NT, continue to become more prevalent among Fractal's
customers, Fractal 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 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 March 31, 1996, Fractal's principal sources of liquidity are its
cash, cash equivalents and short-term investments of $29.1 million. On
November 9, 1995, Fractal completed its initial public offering of common stock.
The net proceeds from the offering were $23.5 million, after deducting
underwriting discounts, commissions and expenses.
The Company uses its working capital to finance ongoing operations, fund
the development and introduction of new products and acquire capital equipment.
Fractal's operating activities provided cash of $1.3 million and $2.7 million
in the fiscal years ended March 31, 1996 and 1995, respectively, principally as
a result of net income, offset by changes in working capital.
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On September 1, 1995, Fractal entered into a line of credit agreement which
provides for borrowings of up to $600,000 at variable interest rates equal to
the bank's reference rate (8.25% as of March 31, 1996) plus 1%. No amounts were
outstanding under this line at March 31, 1996. The line of credit agreement
expires on August 1, 1996, is unsecured and includes restrictive covenants which
require the Company to maintain certain financial ratios and minimum net worth,
as defined.
The Company believes that expected cash flows from operations and existing
cash balances, will be sufficient to meet its currently anticipated working
capital and capital expenditure requirements for the next 12 months.
In addition to Fractal's acquisition of Ray Dream, Inc., the Company's
capital requirements also may be affected by other acquisitions of businesses,
products and technologies that are complementary to the Company's business.
Although the Company regularly evaluates such opportunities, no such
transactions are being actively pursued by the Company as of the date of this
filing on Form 10-KSB. Any such transaction, if consummated, may use a portion
of the Company's working capital or require the issuance of equity.
In addition, the Company's operating results may be affected by changes in
the financial condition of any of its distributors. The Company is aware that
two of its distributors, Merisel and DTP (Germany), have recently experienced
financial difficulties. The Company believes that its allowance for doubtful
accounts receivable together with its insurance coverage should be sufficient to
cover exposure to amounts which may ultimately be uncollectible from such
distributors.
During the next twelve months, the Company expects significant cash
disbursements for the one-time charge of $1.7 million associated with Fractal's
acquisition of Ray Dream, as well as the Company's relocation to Scotts Valley,
California.
Potential risks and uncertainties include, among others, fluctuations in
the volume and timing of product orders, changes in demand for the Company's
products, the timing of the introduction, localization or enhancement of
products by the Company and its competitors, market acceptance of new products,
localization and upgrades, 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 and general economic conditions.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
INTEGRATION OF RAY DREAM OPERATIONS; POTENTIAL ADVERSE EFFECT ON FINANCIAL
RESULTS
The realization of the benefits sought from the acquisition of Ray Dream
depends on the ability of the Company to better 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.
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If the anticipated savings in operating costs 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.
PRODUCT TRANSITIONS AND PRODUCT RETURNS
From time to time, the Company and its competitors and Apple, Microsoft and
PC manufacturers, may announce new products, product versions, capabilities or
technologies that have the potential to replace or shorten the life cycles of
the Company's existing products. Fractal has historically experienced increased
returns of a particular product version following the announcement of a planned
release of a new version of that product. For example, following the new
product announcement of PAINTER 4.0, Fractal received approximately $1,050,000
worth of returns of the previous version of PAINTER from its distributors.
These returns were adequately covered by previously established reserves.
Although the Company provides allowances for anticipated returns, there can be
no assurance that product returns will not exceed such allowances in the future.
The Company also typically offers free upgrades to purchasers of a product
following announcement of a new release and before shipment of the new version
of that product. In addition, the Company may offer price discounts for new
products and product releases in order to facilitate market acceptance. The
announcement of currently planned or other new products may cause customers to
delay their purchasing decisions in anticipation of such products, which could
have a material adverse effect on business, operating results and financial
condition of the Company.
PRODUCT CONCENTRATION; LACK OF PRODUCT REVENUE DIVERSIFICATION
Fractal currently markets three primary products, PAINTER, DABBLER and
POSER. Sales of PAINTER have been the primary source of Fractal's net revenues
since inception, and currently are expected to constitute a substantial majority
of the Company's net revenues for the foreseeable future. Sales of Ray Dream's
principal products, DESIGNER and STUDIO, have and are expected to continue to
constitute a substantial majority of the Company's net revenues for the
foreseeable future. Continued market acceptance of PAINTER, DESIGNER and STUDIO
is therefore critical to the future success of the Company. Any decline in
demand for or failure to achieve continued market acceptance of these products
or any new version of these products as a result of competition, technological
change, failure of the Company to timely release new versions of these products,
or otherwise, could have a material adverse effect on the business, operating
results and financial condition of the Company. There can be no assurance that
localization of these versions will be accomplished and the products released on
a timely basis, or that the product will operate successfully in commercial use
or achieve market acceptance.
DEPENDENCE ON AND NEED FOR NEW PRODUCTS AND PRODUCT VERSIONS; POTENTIAL DELAYS
IN PRODUCT RELEASES
The market for graphics software products is characterized by rapid
technological developments, evolving industry standards, swift changes in
customer requirements and computer operating environments, and frequent new
product introductions and enhancements. As a result, the success of the Company
depends substantially upon its ability to continue to enhance its existing
products, to develop and introduce in a timely manner new products incorporating
technological advances and to meet increasing customer expectations. To the
extent one or more competitors introduce products that better address customer
needs, the Company's business could be adversely affected. There can be no
assurance that the Company will be successful in developing and marketing
enhancements to its existing products or new products on a timely basis or that
any new or enhanced products will adequately address the changing needs of the
marketplace. Also, negative reviews of the Company's new products or product
versions in industry publications could have a material adverse effect on
product sales.
The Company depends substantially upon internal efforts for the development
of new products and product enhancements. Both Fractal and Ray Dream have in
the past experienced delays in the development of new products and product
versions, most recently in Fractal's release of DABBLER 2.0 and PAINTER 4.0 for
UNIX,
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and Ray Dream's release of DESIGNER 3, each of which was released or is
scheduled to be released several months later than originally scheduled. There
can be no assurance that the Company will not experience further delays in
connection with its current product development or future development
activities. Also, software products as complex as those offered by the Company
may contain undetected errors when first introduced or as new versions are
released. Fractal and Ray Dream have in the past discovered software errors in
certain of their new products and enhancements after the introduction of these
products. For example, Ray Dream's release of DESIGNER 3 was affected by
product errors sufficient to necessitate various updates and an interim release
of the product in June 1994. There can be no assurance that errors will not be
found in new products or releases after commencement of commercial shipments,
resulting in adverse product reviews and a loss of or delay in market
acceptance, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
Fractal has scheduled the release of a UNIX version of PAINTER 4.0 in
the quarter ending December 31, 1996, and a new product, EXPRESSION, in the
quarter ending September 30, 1996. Due to the inherent uncertainties of
software development, the exact timing of shipment of a new product,
localization or version release on any particular platform cannot be
accurately predicted. For example, the Company has scheduled the next
release of POSER for the quarter ending December 31, 1996. This product
originally was scheduled to ship in September 1996. Also, the Company
currently believes it will be in a position to accelerate shipment of a new
product, currently named VOODOO, to the quarter ending September 31, 1996.
Any such or other 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
business, results of operations and financial condition of the Company.
The Company uses certain products and technologies of both domestic and
foreign third party software developers, including both complete products
offered as extensions of the companies' product lines and technologies used in
the enhancement of internally developed products. For example, the Company
licenses its POSER and EXPRESSION products from third party software developers.
Such products and technologies are obtained from third party providers under
contractual license agreements, which in some cases are for limited time periods
and in some cases provide that such licenses may be terminated under certain
circumstances. There can be no assurance that the Company will be able to
maintain adequate relationships with any such third party providers (including,
in particular, Ray Dream's relationships to be maintained by the Company after
the acquisition), that these third party providers will commit adequate
development resources to maintain these products and technologies, or that the
license agreements for limited time periods will be renewed upon termination.
In such circumstances, the Company's inability to obtain or develop substitute
technology could adversely affect its business, results of operations and
financial condition. Unlike internally developed products, these license
arrangements also may limit the companies' ability to timely create and release
product upgrades and to effectively control the product development process.
From time to time, the Company has worked and may continue to work with
foreign third-party developers in the development of future products and
components to existing products. There can be no assurance that products
developed in conjunction with these third-party developers, which may make use
of unproven and untested technologies, will be produced in a timely fashion (if
at all), will be free of significant defects, or ultimately will be accepted by
customers.
LIMITED OPERATING HISTORY; UNCERTAIN PROFITABILITY; FLUCTUATING RATES OF GROWTH
The Company has only a limited operating history on which an evaluation of
its business and prospects can be based. Fractal was incorporated in April 1991
and commenced shipment of its initial product in August 1991. Although Fractal
has experienced revenue growth in recent periods, and has experienced
profitability on a quarterly basis since the quarter ended March 31, 1994, there
can be no assurance that the net revenues of the Company will continue at their
current level or will grow, or that the Company will be able to achieve
sustained profitability on a quarterly or annual basis. Fractal's historical
net revenue growth rates both domestically and internationally have varied
significantly between monthly and quarterly periods. Therefore, recent net
revenue comparisons should not be taken as indicative of the rate of net revenue
growth, if any, that can be expected in the future.
Ray Dream was incorporated in December 1989 and commenced shipment of its
initial product in December 1990. Ray Dream incurred operating losses in each
fiscal year since inception, and at December 31, 1995, had an accumulated
deficit of $2.6 million. Although Ray Dream experienced annual revenue growth
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<PAGE>
during the three years ended December 31, 1995, there can be no assurance that
growth in revenues from sales of Ray Dream's products will continue following
the acquisition.
DEPENDENCE ON KEY PERSONNEL AND DIFFICULTY OF IDENTIFYING AND HIRING CERTAIN
PERSONNEL
The future performance of Fractal and Ray Dream is substantially dependent
on the performance of its executive officers and key employees. In particular,
Fractal's ability to introduce new products and product features on a timely
basis depends substantially on the continued efforts of Mark Zimmer, Thomas
Hedges, Eric Hautemont, Pierre Berkaloff, Pascal Belloncle and John Stockholm,
who are extensively involved in product development and engineering. Fractal
recently announced that Stephen Manousos, Fractal's Vice President, Sales,
has informed the Company that he will resign as Vice President, Sales
effective June 30, 1996. To replace Mr. Manousos, the Company promoted Karen
Bria from Director of International Sales & Marketing to Vice President,
International Sales and Marketing and Michael Popolo from Area Sales Manager
for the Eastern Region and Canada to Vice President, North American Sales
(see Part III, Item 9 "Directors, Executive Officers, Promoters and Control
Persons; compliance with Section 16(A) of the Exchange Act").
There can be no assurance that the Company will be able to successfully complete
the transition of Mr. Manousos' replacements, and any failure to do so could
have a material adverse effect on the Company's sales and results of operations.
The future success of the Company also depends on its continuing ability to
identify, hire, train and retain other highly qualified technical and managerial
personnel. Competition for such personnel is intense and Fractal and Ray Dream
have experienced difficulty in identifying and hiring qualified engineering
personnel, particularly in hiring experienced programmers on the Windows
operating environment. There can be no assurance that the Company will be able
to attract, assimilate or retain other highly qualified technical and managerial
personnel in the future. The inability to attract and retain the necessary
technical and managerial personnel could have a material adverse effect upon the
Company's business, operating results and financial condition.
HIGHLY COMPETITIVE MARKETS
The markets for graphics software products such as those offered by the
Company are intensely competitive, subject to rapid change and characterized by
constant demand for new product features, pressure to accelerate the release of
new products and product enhancements and to reduce prices. A number of
companies currently offer products that compete directly or indirectly with one
or more of the Company's products. Competitors of the Company include, among
others, in the paint, draw and image-editing software markets, Adobe Systems
Incorporated, Corel Corporation, Micrografx Incorporated, Macromedia, Inc.
(through its subsidiary, Fauve Software, a provider of image-editing and paint
software) Silicon Graphics, Inc. (through its Alias/Wavefront division), and
Microsoft Corporation (through its SOFTIMAGE division); and in the learn-to-
draw-and-paint market, Microsoft Corporation, Adobe Systems Incorporated and
Broderbund Software, Inc. The Company's competitors in the 3D drawing and
illustration software market include, among others, Strata, Inc., Macromedia,
Inc., Adobe Systems Incorporated, Corel Corporation, Autodesk, Inc. (through its
Kinetix division), Visual Software, Inc., which recently merged with Micrografx
Incorporated, Caligari Corporation and Specular International Ltd. Many of the
Company's competitors or potential competitors have significantly greater
financial, managerial, technical, and marketing resources. The Company
anticipates that it may need to reduce the price on some of its flagship
products in order to penetrate the market for Windows software, and such price
reductions could have a material adverse effect on the Company's business,
operating results and financial condition. A variety of potential actions by
any of these competitors, including a reduction of product prices, increased
promotion, announcement or accelerated introduction of new or enhanced products
or features, acquisitions of software applications or technologies from third
parties, product giveaways or product bundling could have a material adverse
effect on the business, operating results and financial condition of the
Company. In the event of price erosion, the Company may be unable to
successfully reposition itself to accommodate these shifting marketing
conditions.
In addition, the consummation of the acquisition may induce more highly
capitalized competitors of the Company either to enter the 3D drawing and
illustration market or to acquire companies that compete with the Company.
Potential participants in such activity could include, among others, Adobe
Systems Incorporated, Corel Corporation, Micrografx Incorporated and Autodesk,
Inc. Other companies that currently market products in the "high end" graphics
market, such as Microsoft's SOFTIMAGE division and Silicon Graphics Inc.'s
Alias/Wavefront division may also alter their development and marketing focus to
compete with the Company.
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<PAGE>
Such actions could have a material adverse effect on the Company's business,
operating results and financial condition.
Although PAINTER includes significantly different features and
functionality than other paint and image-editing products, such as Adobe
Photoshop, common features in these programs may render them competitive for
certain users, particularly users interested primarily in paint tools for image
editing and enhancement. In addition, recent versions of Photoshop have
included features, such as multiple floating images, that were first introduced
in earlier released versions of PAINTER. There can be no assurance that future
versions of other graphics-related products, including Photoshop, will not
include features and functionality that are similar to or superior to features
in PAINTER. Also, there can be no assurance that third parties will not
introduce software products to compete with POSER. Increased competition
resulting from any such release could have a material adverse effect on the
Company's business, operating results and financial condition. Autodesk, Inc.'s
3D Studio product provides a substantially similar feature set to STUDIO and
DESIGNER, although the Autodesk product is currently shipping solely for the
Microsoft DOS platform, and is priced significantly higher than STUDIO. There
can be no assurance, however, that Autodesk will not offer products at prices
that are competitive with STUDIO, which could have a material adverse effect on
the Company's operating results.
Ray Dream has licensed to Corel Corporation source and object code for
versions 3 and 4 of DESIGNER and version 1 of ADDDEPTH for incorporation into
major Corel products for distribution by Corel. Corel has the right to modify
the programs to integrate them into significant Corel software application
programs, including word processing, graphics, or computer aided design
software, and is currently marketing a modified form of DESIGNER in its
CorelDraw6 suite of graphics and multimedia programs, which retails for $695.
There can be no assurance that Corel, a significant competitor in the graphics
market, will not reduce prices for its products that incorporate DESIGNER or
ADDDEPTH to make such products competitive with Ray Dream's products.
Additionally, certain potential customers of Ray Dream may determine that the
versions of DESIGNER and ADDDEPTH included in significant Corel products satisfy
their requirements, and having purchased or determined to purchase such Corel
products, may choose to forego a purchase of subsequent versions of DESIGNER or
ADDDEPTH from Ray Dream. Any of the foregoing could have a material adverse
effect on the business, operating results and financial condition of the
Company.
Present or future competitors may be able to develop products comparable or
superior to those offered by the companies or adapt more quickly to new
technologies or evolving customer requirements. In addition, developers of
personal computer operating systems, including Apple Computer, Inc. and
Microsoft Corporation, may incorporate 3D functionality into their operating
systems, which may be superior to or incompatible with the products of the
Company, thus adversely affecting the Company's operating results. In
particular, while the Company currently is developing additional product
enhancements to its products that it believes address customer requirements,
there can be no assurance that the development or introduction of these
additional product enhancements will be successfully completed on a timely basis
or that these product enhancements will achieve market acceptance. Accordingly,
there can be no assurance that the Company will be able to continue to compete
effectively in its markets, that competition will not intensify or that future
competition will not have a material adverse effect on the business, operating
results and financial condition of the Company.
DEPENDENCE ON DISTRIBUTORS
Fractal sells its software products primarily to distributors for resale,
including mail-order distributors. Sales to a limited number of distributors
have constituted, and are anticipated to continue to constitute, a significant
portion of the Company's net revenues. For the fiscal years ended March 31,
1995 and 1996, aggregate sales to Fractal's five principal distributors,
including Ingram Micro, Inc., represented 46% and 57%, respectively, of
Fractal's net revenues and sales to Ingram Micro represented 25% and 17%,
respectively, of net revenues. Ray Dream also markets its software products
primarily to distributors for resale, including mail order distributors, but
derives a substantial portion of its revenues from direct mail offerings by Ray
Dream or direct mail organizations with which Ray Dream contracts.
Internationally, Ray Dream distributes its products principally through a
network of resellers and distributors. For the fiscal years ended December 31,
1995 and 1994, sales to Ray Dream's primary distributor, Ingram Micro, Inc.,
accounted for 13% and 18% of net revenues, respectively.
-19-
<PAGE>
Any termination or significant disruption of any relationship with any
major distributor or retailer, particularly the relationships with Ingram Micro,
or a significant reduction in sales volume attributable to the Company's
principal resellers, could materially and adversely affect the business,
operating results and financial condition of the Company. The distribution
channels through which consumer software products are sold have been
characterized by rapid change, including consolidations and financial
difficulties of distributors and retailers, including certain of the Company's
current distributors. The bankruptcy, deterioration in financial condition or
other business difficulties of a distributor or retailer could render the
Company's accounts receivable from such entity uncollectible, which could result
in a material adverse effect on the Company's business, operating results and
financial condition. For example, the Company is aware that one of its
distributors, Merisel, has recently experienced financial difficulties. In
addition, one of the Company's distributors in Germany, DTP Partner, has
recently filed for bankruptcy and owes the Company a total of approximately
$80,000. Insurance maintained by the Company is expected to cover only a
portion of any losses resulting from the nonpayment of receivables by
distributors or retailers. Retailers of the companies' products typically have
a limited amount of shelf space and promotional resources for which there is
intense competition, and the companies depend in part upon promotional efforts
of distributors in placing products with retailers. There can be no assurance
that distributors and retailers will continue to purchase the companies'
products or provide the companies' products with adequate levels of shelf space
and promotional support. Failure of distributors or retailers to do so could
have a material and adverse effect on the business, operating results and
financial condition of the Company. Ray Dream anticipates that the announcement
of the acquisition, and related uncertainty with respect to the future channels
of distribution for Ray Dream's products, may have a material adverse effect on
its relationships with distributors and their activities in promoting Ray
Dream's products. Some current Ray Dream and Fractal distributors may perceive
that the combination of Fractal and Ray Dream will adversely affect distribution
relationships in regions where, upon consummation of the Merger, there will be
overlapping distribution and marketing channels. This may result in diminished
promotional activity on the part of these distributors, in light of concerns
that their distribution contracts may be terminated. Ray Dream's direct mail
distribution of its products exposes the Company to additional risks, including,
among others, rising costs of paper in printing marketing materials, reliance on
the costs and operations of the United States and international postal services,
susceptibility to weather conditions and similar circumstances beyond the
Company's control.
GRAPHICS SOFTWARE MARKET
The market for graphics software in general, and the painting, drawing,
image-editing and 3D illustration and animation segments of such market
addressed by Fractal's and Ray Dream's products in particular, are relatively
new. The future financial performance of the Company will depend in part on the
continued expansion of this market and these market segments and the growth in
the demand for other applications developed by the Company, as well as increased
acceptance of its products by art and graphics professionals. The growth in the
use of desktop graphics software has been fueled by rapid increases in the
performance of computers available to desktop users, and there can be no
assurance as to the continued rate of performance increases in these computers.
There can be no assurance that the graphics software market and the painting,
drawing, image-editing and 3D graphics segments of the market will continue to
grow, that the Company will be able to respond effectively to the evolving
requirements of the market and market segments, including the shift to Internet-
based publishing, or that art and graphics professionals will accept the
Company's products. If the Company is not successful in developing, marketing,
localizing and selling applications that gain commercial acceptance in these
markets and market segments on a timely basis, the Company's business, operating
results and financial condition could be materially and adversely affected.
MANAGEMENT OF POTENTIAL GROWTH; INTEGRATION OF POTENTIAL ACQUISITIONS
In recent years, Fractal has experienced expansion of its operations that
has placed significant demands on Fractal's administrative, operational and
financial resources, which demands are expected to intensify as a result of the
acquisition of Ray Dream. To manage future growth, if any, the Company must
improve its financial and management controls, reporting systems and procedures
on a timely basis and expand, train and manage its work force. There can be no
assurance that the Company will be able to perform such actions successfully.
The
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<PAGE>
Company intends to continue to invest in improving its financial systems and
controls in connection with higher levels of operations. In the future, the
Company may make additional 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 achieve growth, or manage any such growth, and failure to do so
could have a material adverse effect on the Company's operating results.
DEPENDENCE ON THIRD PARTY PORTING SOFTWARE AND ASSISTANCE
Fractal typically develops its application software on the Macintosh
platform and ports applications to the Windows operating environment using
proprietary software developed by Altura Software, Inc. ("Altura"), a private
company affiliated with one of Fractal's directors and principal shareholders.
Fractal also relies on Altura for certain technical assistance in the porting
process, and relies on Altura to develop software and techniques for porting
Fractal's products to new platforms, such as UNIX and Windows 95. If the
agreement with Altura were terminated or Fractal's relationship with Altura is
impaired for any reason, or if Altura should have financial difficulties or lose
key personnel, Fractal's ability to introduce versions of its products on the
Windows platform on a timely basis would be substantially impaired. In such
event, there can be no assurance that Fractal would be able to attract and
assimilate highly qualified technical personnel to port Fractal's software to
the Windows platform or any other platforms on a timely basis. The Company also
relies from time to time on other third parties for engineering services,
including, for example, the current efforts to port POSER to the Windows
operating environment. Any interruption in the availability or quality of these
services and software from Altura or any other third party for any reason could
have a material adverse effect on the Company's business, operating results and
financial condition.
PROPRIETARY RIGHTS
The success and ability of the Company to compete is dependent in part upon
its proprietary technology. While the Company relies on trademark, trade secret
and copyright laws to protect its technology, the Company believes that factors
such as the technological and creative skills of its personnel, new product
developments, frequent product enhancements, name recognition and customer
support are more essential to establishing and maintaining a technology
leadership position. Fractal has one patent with respect to its Natural-Media
technology and has one patent application pending. Ray Dream has one patent
with respect to its edge-smoothing technology and one patent with respect
to three-dimensional manipulation techniques. However, the Company
believes that the ownership of patents is not presently a significant factor in
their businesses and that its success does not depend on the ownership of
patents, but primarily on the innovative skills, technical competence and
marketing abilities of their personnel. Also, there can be no assurance that
others will not develop technologies that are similar or superior to those of
the Company. The source code for the Company's proprietary software is
protected both as a trade secret and as a copyrighted work. Despite these
precautions, it may be possible for a third party to copy or otherwise obtain
and use their products or technology without authorization, or to develop
similar technology independently. In addition, effective copyright and trade
secret protection may be unavailable or limited in certain foreign countries.
The Company generally enters into confidentiality or license agreements
with employees, consultants and vendors, and generally control access to and
distribution of its software, documentation and other proprietary information.
To license their products, the companies primarily rely on "shrink wrap"
licenses that are not signed by the end-user and, therefore, may be
unenforceable under the laws of certain jurisdictions. Despite efforts to
protect proprietary rights, unauthorized parties may attempt to copy aspects of
the Company's products or to obtain and use information that is regarded as
proprietary. Policing such unauthorized use is difficult. There can be no
assurance that the steps taken by the Company will prevent misappropriation of
its technology or that such agreements will be enforceable. In addition,
litigation may be necessary in the future to enforce intellectual property
rights, to protect trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation could result in substantial costs
and diversion of resources and could have a material adverse effect on the
business, operating results and financial condition of the Company.
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<PAGE>
The Company licenses its POSER and EXPRESSION products from third party
software developers. Such products are obtained under contractual license
agreements, which in some cases are for limited time periods and in some cases
provide that such licenses may be terminated under certain circumstances. The
Company relies on representations from such third party developers that they own
the technology that the Company licenses from them, particularly with respect to
POSER and DABBLER and EXPRESSION. Any disruption in the licensing arrangements
or breach of such representations could have a material adverse impact on the
Company's business, operating results and financial condition.
Ray Dream has licensed to Corel Corporation source and object code for
versions 3 and 4 of DESIGNER and version 1 of ADDDEPTH for incorporation into
major Corel products for distribution by Corel. Corel has the right to modify
the programs to integrate them into significant Corel software application
programs, including word processing, graphics, or computer aided design
software, and is currently marketing a modified form of DESIGNER in its
CorelDraw6 suit of graphics and multimedia programs, which retails for $695.
There can be no assurance that Corel, a significant competitor in the graphics
market, will not reduce prices for its products that incorporate DESIGNER or
ADDDEPTH to make such product competitive with Ray Dream's products.
Additionally, certain potential customers of Ray Dram may determine that the
versions of DESIGNER and ADDDEPTH included in significant Corel products satisfy
their requirements, and having purchased or determined to purchase such Corel
products, may choose to forego a purchase of subsequent versions of DESIGNER or
ADDDEPTH from Ray Dream. Any of the foregoing could have a material adverse
effect on the business, operating results and financial conditions of the
Company.
There can be no assurance that third parties will not claim infringement by
the Company with respect to current or future products, and the Company expects
that it will increasingly be subject to such claims as the number of products
and competitors in the graphics software market grows and the functionality of
such products overlaps with other industry segments. From time to time, Fractal
and Ray Dream have received notice alleging that their products infringe patents
or other intellectual property rights of third parties. Any such third party
claims, whether or not they are meritorious, could result in costly litigation
or require the Company to enter into royalty or licensing agreements. Such
royalty or license agreements, if required, may not be available on terms
acceptable to the Company, or at all. If either Fractal or Ray Dream were found
to have infringed upon the proprietary rights of third parties, it could be
required to pay damages, cease sales of the infringing products and redesign or
discontinue such products, any of which could have a material adverse effect on
the business, operating results and financial condition of the Company.
SHARES ELIGIBLE FOR FUTURE SALE
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 tradeable 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 eligible 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, l996 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
tradeable 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.
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ITEM 7. FINANCIAL STATEMENTS.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Fractal Design Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of shareholders' equity (deficit) and of cash
flows present fairly, in all material respects, the financial position of
Fractal Design Corporation and its subsidiaries at March 31, 1996 and 1995, and
the results of their operations and their cash flows for the years then
ended, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PRICE WATERHOUSE LLP
PRICE WATERHOUSE LLP
San Jose, California
April 22, 1996, except as to Note 11,
which is as of May 24, 1996
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CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
ASSETS
March 31,
----------------------
1996 1995
-------- --------
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . $ 5,422 $3,345
Short-term investments . . . . . . . . . . . . . . . 23,683 488
Accounts receivable, less allowance for doubtful
accounts of $91 and $139. . . . . . . . . . . . . . 4,070 1,644
Inventories. . . . . . . . . . . . . . . . . . . . . 804 254
Deferred income taxes. . . . . . . . . . . . . . . . 1,446 863
Other current assets . . . . . . . . . . . . . . . . 1,462 352
-------- --------
Total current assets . . . . . . . . . . . . . . . 36,887 6,946
Property and equipment, net. . . . . . . . . . . . . . 587 383
-------- --------
$37,474 $7,329
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank borrowings. . . . . . . . . . . . . . . . . . . $ -- $ 440
Accounts payable . . . . . . . . . . . . . . . . . . 2,482 713
Accrued liabilities. . . . . . . . . . . . . . . . . 4,364 2,437
Income taxes payable . . . . . . . . . . . . . . . . 118 1,045
-------- --------
Total current liabilities. . . . . . . . . . . . . 6,964 4,635
-------- --------
Mandatorily redeemable convertible preferred stock
(Note 8). . . . . . . . . . . . . . . . . . . . . . . -- 2,140
-------- --------
Commitments (Note 5) . . . . . . . . . . . . . . . . . -- --
Shareholders' equity (deficit):
Preferred Stock: $.001 par value, 5,000,000 shares
authorized; none issued and outstanding . . . . . . -- --
Common Stock: $.001 par value, 50,000,000 shares
authorized; 8,513,496, and 4,808,656 shares issued 5
and outstanding . . . . . . . . . . . . . . . . . . 9
Additional paid-in capital . . . . . . . . . . . . . 27,144 52
Retained earnings. . . . . . . . . . . . . . . . . . 3,357 497
-------- --------
Total shareholders' equity 30,510 554
-------- --------
$37,474 $7,329
-------- --------
-------- --------
The accompanying notes are an integral part of these consolidated
financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended March 31,
-------------------------
1996 1995
---------- ----------
<S> <C> <C>
Net revenues . . . . . . . . . . . . . . . . $21,780 $13,133
Cost of net revenues . . . . . . . . . . . . 4,219 2,545
---------- ----------
Gross profit . . . . . . . . . . . . . . . . 17,561 10,588
---------- ----------
Operating expenses:
Research and development . . . . . . . . 2,647 1,520
Sales and marketing. . . . . . . . . . . 9,020 5,789
General and administrative . . . . . . . 1,640 944
---------- ----------
Total operating expenses. . . . . 13,307 8,253
---------- ----------
Income from operations . . . . . . . . . . . 4,254 2,335
Interest income (expense), net . . . . . . . 464 (30)
---------- ----------
Income before income taxes . . . . . . . . . 4,718 2,305
Provision for income taxes . . . . . . . . . 1,794 473
---------- ----------
Net income . . . . . . . . . . . . . . . . . $2,924 $1,832
---------- ----------
---------- ----------
Net income per share . . . . . . . . . . . . $ 0.36 $ 0.25
---------- ----------
---------- ----------
Number of shares used to compute net
income per share . . . . . . . . . . . . . 8,147 7,234
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
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<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(in thousands)
<TABLE>
<CAPTION>
Retained
Common Stock Additional Earnings
----------------- Paid-in (Accumulated
Shares Amount Capital Deficit) Total
------- ------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Balance at March 31, 1994. . . . . . 4,800 $ 5 $ 45 $(1,267) $(1,217)
Exercise of stock options . . . . . 9 -- 7 -- 7
Accretion to redemption value
of mandatorily redeemable
convertible preferred stock. . . . -- -- -- (68) (68)
Net income. . . . . . . . . . . . . -- -- -- 1,832 1,832
------- ------- --------- --------- ---------
Balance at March 31, 1995. . . . . . 4,809 5 52 497 554
Accretion to redemption value
of mandatorily redeemable
convertible preferred stock . . . . -- -- -- (64) (64)
Sale of common stock, net of
issuance costs of $2,598. . . . . . 2,579 3 24,774 -- 24,777
Conversion of mandatorily
redeemable convertible
preferred stock. . . . . . . . . . 1,057 1 2,203 -- 2,204
Exercise of stock options and
warrants . . . . . . . . . . . . . 68 -- 115 -- 115
Net income. . . . . . . . . . . . . -- -- -- 2,924 2,924
------- ------- --------- -------- ---------
Balance at March 31, 1996. . . . . . 8,513 $ 9 $27,144 $3,357 $30,510
------- ------- --------- -------- ---------
------- ------- --------- -------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
-26-
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended March 31,
----------------------
1996 1995
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . $2,924 $1,832
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization . . . . . . . . . . . 262 145
Deferred taxes. . . . . . . . . . . . . . . . . . . (583) (863)
Changes in assets and liabilities:
Accounts receivable, net. . . . . . . . . . . . . . (2,426) (651)
Inventories . . . . . . . . . . . . . . . . . . . . (550) (139)
Other current assets. . . . . . . . . . . . . . . . (1,110) (118)
Accounts payable. . . . . . . . . . . . . . . . . . 1,769 189
Accrued liabilities . . . . . . . . . . . . . . . . 1,927 1,309
Income taxes payable. . . . . . . . . . . . . . . . (927) 1,045
-------- --------
Net cash provided by operating activities . . . . 1,286 2,749
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures. . . . . . . . . . . . . . . . (466) (323)
Purchases of short-term investments . . . . . . . . (23,690) (488)
Sales of short-term investments . . . . . . . . . . 495 --
-------- --------
Net cash used in investing activities . . . . . . (23,661) (811)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of mandatorily redeemable
convertible preferred stock, net . . . . . . . . . -- 2,072
Proceeds from issuance of common stock, net . . . . 24,777 --
Repayment on notes payable. . . . . . . . . . . . . (440) --
Issuance of common stock upon exercise of
warrants and stock options . . . . . . . . . . . . 115 7
Repayment of notes payable to shareholders. . . . . -- (972)
-------- --------
Net cash provided by financing activities . . . . 24,452 1,107
-------- --------
Net increase in cash and cash equivalents. . . . . . . . 2,077 3,045
Cash and cash equivalents at beginning of period . . . . 3,345 300
-------- --------
Cash and cash equivalents at end of period . . . . . . . $5,422 $3,345
-------- --------
-------- --------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest . . . . . . . . . . . . . . . . . . . . . . $ 67 $ 126
Income taxes . . . . . . . . . . . . . . . . . . . . $3,118 $ 292
SUPPLEMENTAL SCHEDULE OF NON-CASH TRANSACTIONS:
Accretion of mandatorily redeemable convertible $ 64 $ 68
preferred stock . . . . . . . . . . . . . . . . . . .
Conversion of mandatorily redeemable convertible
preferred stock . . . . . . . . . . . . . . . . . . . $2,204 $ --
The accompanying notes are an integral part of these consolidated
financial statements.
-27-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fractal Design Corporation (the "Company") provides software tools
for the creation, editing and manipulation of computer graphic images and
digital art. The Company operates in one business segment.
The following is a summary of the Company's significant accounting
policies.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, Fractal Design Foreign Sales
Corporation and Fractal Design International. All significant intercompany
accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and
expenses during the reported period. Actual results could differ from
those estimates.
REVENUE RECOGNITION
The Company sells its products worldwide through distributors and mail
order catalogs, to hardware and software manufacturers for bundling with other
products, and directly to end users. Revenue from the sale of software
products, including sales to distributors, is recognized when the software has
been shipped, collection of the receivable is probable and there are no
significant obligations remaining. Allowances for estimated future returns and
exchanges are provided at the time of sale based on the Company's return
policies and historical returns experience. The Company periodically offers
customers free upgrades to new product releases for a limited period of time
after the announcement of a new product. The Company's policy is to defer
revenue based on its estimate of the number of users expected to upgrade, if and
when a free upgrade is offered, in accordance with SOP 91-1 and FAS 48. This
estimate is based on the Company's historical experience. The per unit amount
of revenue that is deferred is equal to the objective price to be charged by the
Company to its existing installed user base. The Company recognizes the revenue
related to free upgrades when the customer has requested the upgrade and the new
product is shipped. At March 31, 1996 and 1995 there were no material
obligations to provide free upgrades. The Company provides for future warranty
costs based upon historical experience. The Company provides a limited amount
of free telephone technical support to customers. These activities are
generally considered insignificant post contract customer support obligations.
Estimated costs of these activities are accrued at the time revenue is
recognized.
Revenues from significant customers which represented 10% or more of
net revenues for the respective periods were as follows:
Years Ended
March 31,
--------------------
1996 1995
-------- --------
Customer A . . . . . . . . . . . . . . 17% 25%
Customer B . . . . . . . . . . . . . . 17% --
Customer C . . . . . . . . . . . . . . 11% --
Revenue from foreign customers was 45% and 28% of the Company's net
revenues in fiscal 1996 and 1995, respectively. Net revenues from customers in
Europe and Asia accounted for 13% and 32% of net revenues, respectively, in
fiscal 1996 and 14% and 13% of net revenues, respectively, in fiscal 1995.
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<PAGE>
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company invests certain of its excess cash in debt instruments of
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 and all municipal obligations are
considered short-term investments.
The Company accounts for short-term investments in accordance with
the 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 Company has classified all short-term investments as
available for sale. At March 31, 1996, short-term investments consist 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.
INVENTORIES
Inventories are stated at the lower of cost, using the first-in,
first-out method, or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and
amortization are computed using the straight-line method based upon estimated
useful lives of the assets ranging from one to five years.
STOCK COMPENSATION
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). FAS 123 requires companies that elect not to adopt
the fair value based method of accounting for stock compensation plans to make
pro forma disclosures of net income and earnings per share as if they had
adopted the fair value accounting method. Upon adopting FAS 123 in fiscal 1997,
the Company plans to present the required pro forma disclosures rather than
change its present method of accounting for employee stock options.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentration of credit risk consist principally of cash, cash equivalents,
short-term investments and accounts receivable. The Company invests primarily
in municipal obligations and holds deposits in money market accounts of high
quality financial institutions. The Company's accounts receivable are derived
from sales to distributors, resellers and end-users, serving a variety of
industries located primarily in the United States, Europe and the Far East. At
March 31, 1996, three customers accounted for 33%, 17% and 11% of accounts
receivable, respectively, and at March 31, 1995, two customers accounted for 41%
and 11% of accounts receivable, respectively. The Company performs ongoing
credit evaluations of its customers and to date has not experienced any material
losses.
SOFTWARE DEVELOPMENT COSTS
Costs related to the conceptual formation and design of internally
developed software are expensed as research and development as incurred. It is
the Company's policy that certain internal software development costs incurred
after technological feasibility has been demonstrated and which meet
recoverability tests are capitalized and amortized over the estimated economic
life of the product. To date, the Company has incurred no significant internal
software development costs which meet the criteria for capitalization.
-29-
<PAGE>
INCOME TAXES
The Company accounts for income taxes using the asset and liability
method. Under the asset and liability method, deferred income tax assets and
liabilities are determined based on the differences between the financial
reporting and tax bases of assets and liabilities and are measured using
currently enacted tax rates and laws.
The Company elected to be taxed as a Subchapter S Corporation from its
inception through September 30, 1993, whereby the tax effects of the Company's
activities accrued directly to its shareholders. Effective October 1, 1993, the
Company elected to terminate its status as a Subchapter S Corporation for income
tax purposes. As a result, deferred income taxes were established on the date
the Subchapter S Corporation status was terminated.
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
prior to and including September 30, 1995.
For the years ended March 31, 1996 and 1995, accretion to the
redemption value of mandatorily redeemable convertible preferred stocks was
$64,000 and $68,000, respectively, resulting in net income attributable to
common shareholders of $2,860,000 and $1,764,000, respectively.
SHAREHOLDERS' EQUITY
Common Stock as of March 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 also 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 exercise of warrants to purchase
52,873 shares of the Company's common stock at an exercise price of $2.00 per
share and (iii) the termination of the redemption rights on the 204,082 shares
of Mandatorily Redeemable Common Stock.
-30-
<PAGE>
NOTE 2. BALANCE SHEET COMPONENTS
A summary of balance sheet components follows (in thousands):
March 31,
-------------------
1996 1995
Inventories: ------ ------
Raw materials. . . . . . . . . . . . . . . . . . . . $ 562 $ 173
Finished goods . . . . . . . . . . . . . . . . . . . 242 81
------ ------
$ 804 $ 254
------ ------
------ ------
Property and equipment:
Furniture and fixtures . . . . . . . . . . . . . . . $ 133 $ 108
Equipment and software . . . . . . . . . . . . . . . 1,009 555
------ ------
1,142 663
Less: Accumulated depreciation and amortization . . 555 280
------ ------
$ 587 $ 383
------ ------
------ ------
Accrued liabilities:
Reserve for returns and exchanges. . . . . . . . . . $1,746 $ 1,117
Payroll and related. . . . . . . . . . . . . . . . . 1,366 632
Marketing and advertising. . . . . . . . . . . . . . 634 343
Other. . . . . . . . . . . . . . . . . . . . . . . . 618 345
------ ------
$4,364 $2,437
------ ------
------ ------
NOTE 3. BANK BORROWINGS
The Company had a $900,000 line of credit with a bank with interest at
2% per annum above the bank's prime rate, of which $440,000 was outstanding at
March 31, 1995. On August 23, 1995, the Company converted the outstanding
balance of $440,000 under its existing line of credit to a demand loan with a
bank. Interest accrued on the loan at a rate equal to the bank's reference rate
plus 1.5%. The remaining outstanding balance of $421,000 was paid in full on
November 16, 1995. In addition, on September 1, 1995, the Company entered into
a line of credit agreement which provides for borrowings of up to $600,000 at
variable interest rates equal to the bank's reference rate (8.25% as of March
31, 1996) plus 1%. No amounts were outstanding under this line at March 31,
1996. The line of credit agreement expires on August 1, 1996, is unsecured and
includes restrictive covenants which require the Company to maintain certain
financial ratios and minimum net worth, as defined.
NOTE 4. RELATED PARTY TRANSACTIONS
Distribution and notes payable to shareholders
In September 1993, in connection with the termination of the Company's
Subchapter S Corporation status (see Note 1), the Company distributed to its
shareholders undistributed tax basis Subchapter S Corporation profits of
$1,500,000. The distribution to shareholders consisted of $600,000 of cash and
the issuance of $900,000 of 7% unsecured notes payable. The Company repaid the
notes payable during fiscal 1995.
Other related party transactions
Businesses owned by two shareholders have provided technical and
administrative services to the Company. Amounts paid to these two firms totaled
$214,000 and $129,000 for the years ended March 31, 1996 and 1995, respectively.
Amounts due to the firms for services rendered totaled $24,000 and $10,000 at
March 31, 1996 and 1995, respectively. The Company believes that the terms of
the agreements for these services are no less favorable than could be obtained
from third-party suppliers.
NOTE 5. COMMITMENTS AND CONTINGENCIES
The Company leases its office facilities and certain office equipment
under various operating leases. Total rent expense under the leases was
$288,000 and $139,000 for the years ended March 31, 1996 and 1995, respectively.
On April 9, 1996, the Company signed a letter of intent
for approximately 29,600 square feet, increasing to approximately 41,000
square feet on December 1, 1998, of office and warehouse space in nearby
Scotts Valley, California. The Company plans to relocate its operations
later this calendar year without any anticipated material disruption to
the Company's business or operations. The initial term of the proposed
lease will be for seven years with two three-year renewal options. It
also gives the Company the right of first refusal on any of the remaining
approximately 14,000 square feet in the building. The target commencement
date is no earlier than July 1, 1996 and no later than September 1, 1996.
Minimum lease payments for the proposed seven-year lease total $4,563,000 over
the lease term.
Ray Dream, Inc. leases approximately 8,000 square feet of
office space in Mountain View, California. Ray Dream's leases expire on
dates between June 30, 1996 and September 30, 1996. The Company plans to
relocate Ray Dream's operations to the new location in Scotts Valley later
this calendar year without any anticipated material dislocation to
Fractal's business or operations.
-31-
<PAGE>
Aggregate future minimum lease payments under noncancelable operating
leases with initial terms of one year or more are as follows at March 31, 1996:
Years Ended March 31,
---------------------
1997. . . . . . . . . . . . . . $132,000
1998. . . . . . . . . . . . . . 4,000
----------
$136,000
----------
----------
In the normal course of business, the Company from time to time
receives inquiries with regard to possible patent infringement. Management
believes that it is unlikely that the outcome of the inquiries received thus far
will have a material adverse effect on the Company's financial position or
results of operations.
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<PAGE>
NOTE 6. INCOME TAXES
The provision for income taxes is as follows (in thousands):
Years Ended March
-------------------
1996 1995
-------- --------
Current:
Federal. . . . . . . . . . . . . . . . . . . . $1,855 $ 846
State. . . . . . . . . . . . . . . . . . . . . 522 472
Foreign. . . . . . . . . . . . . . . . . . . . -- 18
-------- --------
2,377 1,336
-------- --------
Deferred:
Federal. . . . . . . . . . . . . . . . . . . . (513) (679)
State. . . . . . . . . . . . . . . . . . . . . (70) (184)
-------- --------
(583) (863)
-------- --------
$1,794 $ 473
-------- --------
-------- --------
The Company provides a valuation allowance for deferred tax assets
when it is more likely than not, based on available evidence, that some portion
or all of the deferred tax assets will not be realized. Based on a re-
evaluation of the reliability of future tax benefits based on income earned in
1995, creating available tax carrybacks, the Company released $630,000 of the
previously established valuation allowance during fiscal 1995. Significant
components of the Company's deferred tax assets were as follows (in thousands):
Years Ended March 31,
---------------------
1996 1995
-------- --------
Reserves and accruals. . . . . . . . . . . . . . . . $1,068 $ 676
Deferred revenue . . . . . . . . . . . . . . . . . . 66 25
Research and development credit. . . . . . . . . . . -- --
Other. . . . . . . . . . . . . . . . . . . . . . . . 312 162
-------- --------
1,446 863
Deferred tax asset valuation allowance . . . . . . . -- --
-------- --------
Net deferred tax asset . . . . . . . . . . . . . . . $1,446 $ 863
-------- --------
-------- --------
A reconciliation of the provision for income taxes to the amount
computed by applying the statutory federal income tax rate is as follows:
Years Ended March 31,
---------------------
1996 1995
-------- --------
Statutory rate . . . . . . . . . . . . . . . . . . . 34.0% 34.0%
State income taxes, net of federal tax benefit . . . 6.4 8.9
Release of previously established valuation
allowance . . . . . . . . . . . . . . . . . . . . . -- (27.3)
Research and development credits . . . . . . . . . . (1.3) (8.4)
Foreign income taxes . . . . . . . . . . . . . . . . -- 4.1
Other, net . . . . . . . . . . . . . . . . . . . . . (1.2) 9.2
-------- -------
Effective tax rate . . . . . . . . . . . . . . . . . 37.9% 20.5%
-------- -------
-------- -------
NOTE 7. STOCK OPTION PLAN
The 1993 Stock Option Plan (the "Plan"), as amended, authorizes the
Board of Directors to grant incentive stock options and nonstatutory stock
options to employees, officers, directors and consultants for up to 2,000,000
shares of Common Stock. Under the Plan, incentive stock options are granted at
a price that is not less
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<PAGE>
than 100% of the fair value of the stock at the date of grant, as determined by
the Board of Directors. Nonqualified stock options are to be granted at a price
that is not less than 85% of the fair value of the stock at the date of grant,
as determined by the Board of Directors. Options generally vest over a four year
period and are exercisable for a period of ten years after the date of grant.
Options granted to a shareholder who owns more than 10% of the outstanding stock
of the Company at the time of grant must be at a price not less than 110% of the
fair value of the stock on the date of grant, and are exercisable for a period
not to exceed five years.
A summary of the Plan activity is as follows:
Available Options Price
for grant outstanding per share
--------- ----------- ---------
Balance at March 31, 1994. . . . . 15,064 374,936
Additional shares reserved. . . 1,610,000 -- --
Options granted . . . . . . . . (1,081,873) 1,081,873 $0.75-$2.20
Options exercised . . . . . . . -- (8,656) $0.75-$0.825
Options canceled. . . . . . . . 713,779 (713,779) $0.75-$2.20
----------- -----------
Balance at March 31, 1995. . . . . 1,256,970 734,374
Additional shares reserved. . . 300,000 -- --
Options granted . . . . . . . . (600,800) 600,800 $2.00-$13.50
Options exercised . . . . . . . -- (15,562) $0.75
Options canceled. . . . . . . . 24,875 (24,875) $0.75-$2.00
----------- -----------
Balance at March 31, 1996. . . . . 981,045 1,294,737
----------- -----------
----------- -----------
Options to purchase 271,598 and 46,095 shares were exercisable at
March 31, 1996 and March 31, 1995, respectively, at prices ranging from $0.75 to
$9.00.
In September 1994, each non-employee director of the Company received
an option to purchase 50,000 shares of the Company's Common Stock at an exercise
price of $0.75 per share ($0.825 per share in the case of one director). In May
1995, each non-employee director received an option to purchase 10,000 shares of
Common Stock at an exercise price of $2.00 per share ($2.20 per share in the
case of one director). Each such option has a term of ten years, and vests over
four years from the date of grant.
In September 1994, the Board of Directors approved a proposal under
which option holders could elect to cancel certain options in exchange for
grants of new options with exercise prices equal to the fair market value of the
Company's Common Stock on the date of the Board's approval. Options for the
purchase of a total of 698,561 shares were canceled in exchange for newly issued
options for the purchase of 698,561 shares.
During April and May 1995, the Company granted to employees stock
options for the purchase of 357,300 shares of Common Stock at exercise prices
ranging from $2.00 to $3.50 per share. Management will amortize approximately
$508,000 of compensation expense over the four-year vesting periods relating to
these options. Such compensation expense was $329,000 during fiscal 1996.
On August 29, 1995, the Company's Board of Directors adopted the 1995
Director Stock Option Plan and the 1995 Stock Option Plan. The plans were
approved by the Company's shareholders on September 15, 1995.
A total of 175,000 shares of Common Stock were reserved for issuance
under the 1995 Director Stock Option Plan, which provides that each person who
becomes a non-employee director of the Company after the date of the Company's
initial public offering will be granted a nonstatutory stock option to purchase
20,000 shares of Common Stock (the "First Option") on the date on which the
optionee first becomes a non-employee director of the Company. Thereafter, on
the date of each annual meeting of the Company's shareholders at which each
non-employee director is elected, each such non-employee director shall be
granted an additional option to purchase 5,000 shares of Common Stock (a
"Subsequent Option") if, on such date, he or she shall have served on the
Company's Board of Directors for at least six months. The options generally
become exercisable in
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<PAGE>
installments of 25% of the total number of shares subject to the First Option on
each of the first, second, third and fourth anniversaries of the date of grant
of the First Option, and each Subsequent Option becomes exercisable as to 50% on
the first and second anniversaries of the date of grant of that Subsequent
Option. The exercise price of all stock options granted under the Directors'
Plan is equal to the fair market value of a share of the Company's Common Stock
on the date of grant of the option. Options granted under the Directors' Plan
have a term of ten years.
The Company's 1995 Stock Option Plan (the "1995 Option Plan") was
adopted by the Board of Directors on August 29, 1995 and will replace the 1993
Option Plan. The maximum aggregate number of shares that may be optioned and
sold under the 1995 Option Plan is the sum of (i) 1,180,420 shares plus (ii)
such number of shares as are subject to outstanding and unexercised stock
options under the Company's 1993 Option Plan, as of the date of adoption of the
1995 Option Plan by the shareholders, and which options are canceled or
otherwise terminated without exercise; provided that the total number of shares
available under the 1995 Option Plan shall in no event exceed 2,291,344. The
1995 Option Plan provides for (i) the granting to employees (including officers
and employee directors) of "incentive stock options" within the meaning of
Section 422 of the Code and (ii) the granting to employees and consultants of
nonstatutory stock options. The exercise price of all incentive stock options
granted under the 1995 Option Plan must be at least equal to the fair market
value of the Common Stock of the Company on the date of grant. The exercise
price of any incentive stock option granted to an optionee who owns stock
representing more than 10% of the voting power of all classes of stock of the
Company must equal at least 110% of the fair market value of the Common Stock on
the date of grant. The exercise price of nonstatutory stock options generally
must equal at least 85% of the fair market value of the Common Stock on the date
of grant.
NOTE 8. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND WARRANTS
In September and November 1994, the Company issued 1,057,505 shares
of Series A Mandatorily Redeemable Convertible Preferred Stock (the "Series A
Stock") for $2.00 per share. Proceeds to the Company totaled $2,072,000, net of
issuance costs. The Series A Stock was redeemable at the option of the holders
of at least two thirds of the outstanding Series A Stock in three annual
installments at a price equal to the sum of $2.00 per share plus $0.12 per annum
from the date of issuance subject to adjustment for antidilution.
The excess of the redemption price over the original issuance price of
the Series A Stock was charged to retained earnings as an accretion to
redemption value with a corresponding increase in the value of the Series A
Stock. The cumulative accretion for the Series A Stock was $68,000 at March 31,
1995 and $132,000 at November 9, 1995. Upon the closing of the Company's
initial public offering on November 9, 1995, the Mandatorily Redeemable
Convertible Preferred Stock was converted into common stock and the aggregate
amount of the Mandatorily Redeemable Convertible Preferred Stock of $2,204,000
at that date was credited to additional paid-in capital.
In connection with the issuance of Series A Stock, the Company issued
warrants to purchase 52,873 shares of Common Stock at an exercise price of $2.00
per share. The warrants were exercisable for a period of five years after date
of issuance. The warrants expired upon the consummation of the Company's
initial public offering. A total of 52,873 shares of Common Stock were issued
upon conversion of the warrants.
NOTE 9. MANDATORILY REDEEMABLE COMMON STOCK
On July 21, 1995, the Company and certain shareholders entered into an
agreement (the "Agreement") to sell 204,082 and 122,449 shares, respectively, of
Common Stock to Adobe Ventures, L.P. ("Adobe"), a subsidiary of Adobe Systems,
Inc., for $6.125 per share. Aggregate net proceeds to the Company were
$1,236,000. Upon the closing of the Company's initial public offering, the
mandatory redemption rights of this stock were automatically terminated.
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<PAGE>
NOTE 10. 401(k) PLAN AMENDMENT
On August 29, 1995, the Board of Directors approved an amendment to
the Company's 401(k) plan which provides for matching contributions to be made
by the Company in the form of Company Common Stock. A total of 100,000 shares
of the Company's Common Stock has been reserved for matching contributions under
the 401(k) plan.
NOTE 11. SUBSEQUENT EVENT
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
(see "Products" for a description of Ray Dream's products). As a result of the
acquisition, Ray Dream has become a wholly-owned subsidiary of Fractal.
As consideration for 100% of 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 transaction will be accounted as a pooling-of-interests. Transaction fees
of approximately $1.7 million will be recorded in the first quarter of fiscal
1997.
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 calendar year-end basis. For the purposes of
pooling-of-interests, accounting revenues and net income of Fractal for the
years ended March 31, 1996 and 1995 will be combined with those of Ray
Dream for the years ended December 31, 1995 and 1994. Ray Dream's net
change in equity for the three months ended March 31, 1996 will be
reflected as an adjustment to retained earnings.
The following table summarizes the restated consolidated revenues
and net income of the Company after giving effect to this transaction (in
thousands, except per share data):
Year Ended March 31, 1996 Year Ended March 31, 1995
------------------------- -------------------------
Net Revenues Net Income Net Revenues Net Income
------------ ---------- ------------ ----------
As presently reported. . $21,780 $2,924 $13,133 $1,832
Subsequent Pooling . . . 7,749 2 5,343 (73)
------------ ---------- ------------ ----------
As restated. . . . . . . $29,529 $2,926 $18,476 $1,759
------------ ---------- ------------ ----------
------------ ---------- ------------ ----------
Net income (loss) per
share, as restated. . . $ 0.25 $ 0.17
---------- ----------
---------- ----------
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
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<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The following table sets forth information as of June 21, 1996,
regarding the directors and executive officers of Fractal:
Name Age Position
---- --- --------
Mark Zimmer 40 Chief Executive Officer and Chairman of the Board
Thomas Hedges 46 Vice President, Engineering and Vice Chairman of
the Board
Eric Hautemont 30 President and Director
Leslie E. Wright 42 Chief Operating Officer and Chief Financial Officer
Karen J. Bria 34 Vice President, International Sales and Marketing
Joseph C. Consul 36 Vice President, Operations
John E. Derry 44 Vice President, Creative Design
Steve I. Guttman 38 Vice President, Marketing
Michael Popolo 36 Vice President, North American Sales
Braden L. Rippetoe 46 Vice President, Finance
Craig W. Johnson (2) 49 Secretary and Director
Arthur J. Collmeyer (1) 54 Director
Lee Jay Lorenzen (2) 36 Director
Stephen E. Manousos 45 Director
Alain Rossmann 40 Director
Anthony Sun 43 Director
Thomas I. Unterberg (1) 64 Director
(1) Member of the Audit Committee of the Board of Directors.
(2) Member of the Compensation Committee of the Board of Directors.
MR. ZIMMER, a founder of Fractal, has been Chief Executive Officer and
a director of Fractal since its inception and Chairman of the Board since May
1996. Mr. Zimmer founded Fractal Software, a predecessor of Fractal, with
Mr. Hedges in 1985 and was a partner in Fractal Software from 1985 to 1990.
Mr. Zimmer served as President of Fractal until May 1996. At Fractal Software
Mr. Zimmer co-developed two graphics software programs, ImageStudio and
ColorStudio. He also developed the initial versions of Painter that became the
initial product of Fractal. From 1981 to 1985, Mr. Zimmer co-founded and served
at TRICAD, a software firm specializing in computer-aided design. Prior to that
time, Mr. Zimmer worked at Calma Corporation, a computer aided design software
company where he designed several versions of CAD software.
MR. HEDGES, a founder of Fractal, has served as Vice President,
Engineering and a director of Fractal since its inception. From March 1993
until May 1996, Mr. Hedges served Fractal as Chairman of the Board. He as
served as Vice-Chairman of the Board since May 1996. From 1985 to 1990,
Mr. Hedges was a partner in Fractal Software with Mr. Zimmer where he
co-developed ImageStudio, ColorStudio, and the initial versions of Painter.
From 1975 to 1985, Mr. Hedges was a lead scientist and software engineer at
Calma Corporation.
MR. HAUTEMONT has been President and a director of Fractal since May
1996. Mr. Hautemont was a co-founder of Ray Dream, and served as President,
Chief Executive Officer and a director of Ray Dream from December 1989 until May
1996. Prior to forming Ray Dream, Mr. Hautemont was a consultant to Matra
Technology, Inc. from October 1988 to December 1989.
MR. WRIGHT has served as Chief Operating Officer of Fractal since
April 1995, and as Chief Financial Officer since April 1994. From April 1994 to
May 1996, Mr. Wright also served as Vice President, Finance and
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<PAGE>
Administration of Fractal. From 1984 to 1994, Mr. Wright served in various
positions with ASK Group, Inc., a software company, most recently as Executive
Vice President and Chief Financial Officer.
MS. BRIA was promoted to Vice President, International Sales &
Marketing in May 1996, after serving as Director of International Sales &
Marketing since June 1994, and Director of Marketing from April 1993 to May
1995. From August 1991 to March 1993, Ms. Bria served as Director of the Asia
Pacific Region for PLI, a graphics peripheral company. Prior to that time, Ms.
Bria served as Director of Asia Pacific Sales & Marketing for Borland
International from 1987 to 1991. Prior to Borland, from 1983 to 1987, Ms. Bria
served in various sales roles for the Santa Cruz Operation, Inc., most recently
as International Sales manager, where she was responsible for building SCO's
entire international distribution channel for UNIX PC operating systems and
applications.
MR. CONSUL has served as Vice President, Operations of Fractal since
May 1996. From October 1991 to May 1996, Mr. Consul served as Chief Financial
Officer of Ray Dream, Inc. Mr. Consul was elected Vice President, Finance and
Administration of Ray Dream, Inc. in April 1994. From December 1989 to August
1991, Mr. Consul served as Director of Finance and Administration for XA Systems
Corporation. Prior to December 1989, Mr. Consul was Corporate Controller for
Adobe Systems, Inc.
MR. DERRY has served as Vice President, Creative Design of Fractal
since March 1994, after serving as Creative Director since September 1992. From
June 1989 to March 1992, Mr. Derry served as Director, Creative Services of Time
Arts Inc., a multi-platform creative graphics software company ("Time Arts").
In this position, Mr. Derry was chief interface designer for Oasis, a paint
application for the Macintosh. From 1987 to 1989, Mr. Derry was Creative
Director of ChromaSet, a San Francisco pre-press facility. From 1985 to 1987,
Mr. Derry served as Director of Application Development at Time Arts.
MR. GUTTMAN has served as Vice President, Marketing of Fractal since
July 1994. From July 1989 to July 1994, Mr. Guttman served in various positions
with Adobe Systems Incorporated, most recently as Senior Product Marketing
Manager in charge of Macintosh graphics products. From 1981 to 1987, he worked
in engineering and management capacities for PMB Systems Engineering, a Bechtel
subsidiary.
MR. POPOLO has served as Vice President, North American Sales of
Fractal since May 1996, after serving as Area Sales Manager for the Eastern
Region and Canada since March 1992. From August 1986 to March 1992, Mr. Popolo
was employed at Letraset USA in various sales positions, including Regional
Account Manager, OEM Manager, and National Sales Manager.
MR. RIPPETOE has served as Vice President, Finance of Fractal since
May 1996, after serving as Controller from May 1995. From May 1994 to October
1994, Mr. Rippetoe served as Corporate Controller for Interactive Network, a
company providing interactive entertainment systems for live sporting events and
game shows. From May 1986 to March 1994 Mr. Rippetoe served in various
positions with The ASK Group, Inc., a software company, most recently as Vice
President, Treasurer.
MR. JOHNSON has been Secretary of Fractal since January 1994 and a
director of Fractal since January 1994. Mr. Johnson has been a Director in
Venture Law Group, A Professional Corporation, and a Partner in its predecessor
partnership, since February 1993. From 1980 to February 1993, Mr. Johnson was a
member of the law firm of Wilson, Sonsini, Goodrich & Rosati, P.C. Mr. Johnson
is also a director of Collagen Corporation, a biomaterials company, and Retix, a
network equipment manufacturer.
MR. COLLMEYER has been a director of Fractal since January 1994. From
July 1994 until January 1995, Mr. Collmeyer served as President and Chief
Executive Officer of Dyna Logic Corporation, a development stage company
specializing in field programmable gate arrays. Prior to that time,
Mr. Collmeyer served as an officer of Weitek Corporation, a producer of
graphics-related semiconductors, for 12 years, most recently as Chief Executive
Officer. Prior to joining Weitek, Mr. Collmeyer served for seven years as Vice
President of Research and Development and as General Manager of the
Microelectronics Division of Calma Corporation, and for five years each with
Xerox Corporation and Motorola Inc. in various engineering roles. He also
presently serves as a director of Weitek Corporation.
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<PAGE>
MR. LORENZEN, a founder of Fractal, has served Fractal as a director
since its inception. Since November 1990, Mr. Lorenzen has owned and currently
serves as President of Altura Software, Inc., a company providing porting
software and services. In 1985, Mr. Lorenzen founded Ventura Software Inc., a
provider of desktop publishing products, for which he served as a Director and
Vice President of Research and Development until 1991. Prior to 1985,
Mr. Lorenzen worked for Digital Research and Xerox Corporation developing user
interface technology. Mr. Lorenzen also is a director of several private
companies, including Aptos Post, Jump Software, Inc., a developer and
distributor of consumer music software, PGSoft, Inc., a developer and
distributor of disk storage management utility software, and InfoHut, Inc., a
developer and distributor of Internet advertising and multimedia kiosk software
and services.
MR. MANOUSOS, a founder of Fractal, served as Vice President, Sales
from March 1992 until June 1996, Vice President, Sales and Marketing from
February 1993 until July 1994, and Vice President, Operations from the inception
of Fractal until March 1992. He has also served as a director of Fractal since
its inception. From 1981 to present, Mr. Manousos also has owned and operated
Aptos Post, Inc. ("Aptos Post"), a Postscript image setting service bureau.
Prior to that time, Mr. Manousos published a weekly newspaper in Aptos and
served as an editor on the National Desk of the Los Angeles Times.
MR. ROSSMANN has served as a director of Fractal since May 1996. From
December 1989 to May 1996, Mr. Rossmann served as a director of Ray Dream.
Mr. Rossmann founded Libris, Incorporated in September 1994 and currently serves
as President, Chief Executive Officer, and director of Libris. From June 1991
until March 1994, Mr. Rossmann was President and Chief Executive Officer of EO,
Inc. Prior to that time Mr. Rossmann had been the Vice President of Operations
of C Cube Microsystems from May 1989 to March 1991. Prior to such time,
Mr. Rossmann was a co-founder and served as Vice President of Marketing and
Sales of Radius Inc. from July 1986 to February 1989.
MR. SUN has been a director of Fractal since May 1996. From October
1991 to May 1996, Mr. Sun served as a director of Ray Dream. Mr. Sun has been a
general partner at Venrock Associates, a venture capital firm, since 1979. He
is a director of Cognex Corporation, a computer systems company, Conductus,
Inc., a superconductive electronics company, Gupta Corporation, a client/server
software company, Inference Corporation, a client/server and Internet help desk
software company, Komag, Inc., a computer storage component company, Photonics
Corporation, a computer peripherals company, and StrataCom, Inc., a
telecommunications company.
MR. UNTERBERG has been a director of Fractal since September 1994. He
is co-founder and has served as Managing Director of Unterberg Harris, an
investment banking firm, since June 1989. He was Managing Director of Shearson
Lehman Brothers Inc. from 1987 to 1989. Prior to that time, he was Chairman of
the Board, Chief Executive Officer and Senior Managing Director of L.F.
Rothschild, Unterberg Towbin Holdings Inc., and was associated with such firm or
its predecessors since 1956. Mr. Unterberg also is a director of The AES
Corporation, an independent power producer, AES China Generating Co. Ltd., a
subsidiary of AES (serving China's power market), Electronics for Imaging, Inc.,
the manufacturer of the Fiery server for color desktop publishing and Systems
and Computer Technology Corporation, a supplier of software and facilities
management services to the utility, educational and government markets.
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<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth information for Named Executive
Officers with respect to executive compensation for the fiscal years ended
March 31, 1995 and March 31, 1996.
<TABLE>
SECURITIES
UNDERLYING
OTHER OPTIONS (#)
ANNUAL LONG-TERM ALL OTHER
FISCAL COMPENSATION COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) ($) (1) AWARDS ON ($) (2)
- - --------------------------- ------ --------- -------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Mark Zimmer 1996 $187,927 $130,625 $12,845 12,500 $3,293
President and Chief 1995 176,537 75,000 11,064 50,000 1,656
Executive Officer
Thomas Hedges 1996 169,941 85,750 13,083 12,500 3,293
Vice President, Engineering 1995 170,079 56,250 11,153 50,000 1,656
Stephen E. Manousos 1996 130,349 86,133 12,294 10,500 3,293
Vice President, Sales 1995 145,196 56,250 10,064 42,000 1,656
Leslie E. Wright 1996 154,504 78,750 12,000 100,000 3,293
Chief Operating Officer, 1995 119,159 62,500 11,500 75,000 693
Vice President, Finance and
Administration and Chief
Financial Officer
Steve I. Guttman 1996 130,347 68,906 12,000 25,000 3,293
Vice President, Marketing (3) 1995 87,893 37,500 8,000 100,000 2,547
Karen J. Bria (4) 1996 77,797 167,531 --- 6,000 ---
Director, International 1995 97,341 20,961 --- 16,500 ---
Sales and Marketing
</TABLE>
_____________________________________
(1) Represents automobile expense allowance
(2) Represents health insurance premiums and, in the case of Mr. Guttman,
relocation expenses in fiscal year 1995.
(3) Mr. Guttman joined Fractal in July 1994
(4) Information with respect to Ms. Bria, who was not an executive officer of
the Company as of March 31, 1996, pursuant to Item 402(a)(2)(iii) of
Regulation S-B.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information for Named Executive
Officers with respect to grants of options to purchase Common Stock of Fractal
made during the fiscal year ended March 31, 1996:
INDIVIDUAL GRANTS (1)
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS GRANTED EXERCISE
OPTIONS TO EMPLOYEES IN PRICE EXPIRATION
NAME GRANTED (#) FISCAL YEAR (1) $/SHARE DATE
- - ------------------- ----------- --------------- -------- ----------
Mark Zimmer 12,500 2.08% $2.20 5/01/05
Thomas Hedges 12,500 2.08 2.20 5/01/05
Stephen E. Manousos 10,500 1.75 2.00 5/01/05
Leslie E. Wright 100,000 16.64 2.00 5/01/05
Steve I. Guttman 25,000 4.16 2.00 5/01/05
Karen J. Bria (2) 6,000 1.00 2.00 4/20/05
____________________
(1) Options to purchase a total of 600,800 shares of Common Stock were granted
under Fractal's 1993 and 1995 Stock Option Plan during the fiscal year ended
March 31, 1996. These options vest over a period of four years, provided
however, that the stock options of the officers listed vest automatically in the
event of any sale of all or substantially all of Fractal's assets or any merger,
consolidation or stock sale which results in the holders of Fractal's capital
stock immediately prior to such transaction owning less than 50% of the voting
power of Fractal's capital stock immediately after such transaction.
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<PAGE>
(2) Information with respect to Ms. Bria, who was not an executive officer of
the Company as of March 31, 1996, is provided pursuant to Item 402(a)(2)(iii) of
Regulation S-B.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
The following table sets forth information for the Named Executive
Officers with respect to options to purchase Common Stock of Fractal held as of
March 31, 1996:
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT FISCAL YEAR FISCAL YEAR-END ($)(1)
END (#) EXERCISABLE/ EXERCISABLE/
NAME UNEXERCISABLE UNEXERCISABLE
- - ---- ---------------------- ------------------------
Mark Zimmer 18,750 / 43,750 $214,219 / $482,656
Thomas Hedges 18,750 / 43,750 214,219 / 482,656
Stephen Manousos 21,000 / 31,500 241,500 / 349,125
Leslie E. Wright 28,125 / 146,875 323,438 / 1,564,063
Steve I. Guttman 31,250 / 93,750 359,375 / 1,046,875
Karen J. Bria (2) 8,062 / 14,438 92,713 / 158,537
- - ------------
(1) Based on a closing price of $12.25 on March 29, 1996, the last trading day
before March 31, 1996.
(2) Information with respect to Ms. Bria, who was not an executive officer of
the Company as of March 31, 1996, is provided pursuant to Item 402(a)(2)(iii) of
Regulation S-B.
DIRECTOR COMPENSATION
The Company reimburses its directors for their out-of-pocket expenses
incurred in the performance of their duties as directors of the Company. The
Company does not pay fees to its directors for attendance at meetings. In
September 1994, each non-employee director of the Company received an option to
purchase 50,000 shares of the Company's Common Stock at an exercise price of
$0.75 per share ($0.825 per share in the case of Mr. Lorenzen). In May 1995,
each non-employee director received an option to purchase 10,000 shares of
Common Stock at an exercise price of $2.00 per share ($2.20 per share in the
case of Mr. Lorenzen). Each such option has a term of ten years, and vests over
four years from the date of grant. Such options become fully exercisable in the
event of any sale of all or substantially all of the Company's assets or any
merger, consolidation or stock sale which results in the holders of the
Company's capital stock immediately prior to such transaction owning less than
50% of the voting power of the Company's capital stock immediately after such
transaction. The Company's non-employee directors also are eligible to receive
certain stock options under the Company's 1995 Directors' Stock Option plan.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
(a) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS. The following
table set forth information for certain beneficial owners as of March 31, 1996.
Information with respect to beneficial ownership after Fractal's acquisition of
Ray Dream is set forth in the Company's Registration Statement on Form S-4,
declared effective April 26, 1996.
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<PAGE>
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF
NAME AND ADDRESS OF BENEFICIAL PERCENT
TITLE OF CLASS OF BENEFICIAL OWNER OWNERSHIP (1) OF CLASS
- - -------------- ------------------- -------------- ----------
<S> <C> <C> <C>
Common Stock Mark Zimmer (2) 1,069,690 12.53%
c/o Fractal Design Corporation
335 Spreckels Drive
Aptos, CA 95003
Common Stock Thomas I. Hedges (3) 919,690 10.78
Fractal Design Corporation
335 Spreckels Drive
Aptos, CA 95003
Common Stock Lee Jay Lorenzen (4) 989,868 11.59
c/o Altura Software, Inc.
510 Lighthouse Avenue, Suite 5
Pacific Grove, CA 93950
Common Stock Thomas I. Unterberg and entities 695,000 8.15
affiliated with Unterberg Harris (5)
c/o Unterberg Harris
275 Battery Street, Suite 2980
San Francisco, CA 94111
Common Stock Stephen Thomas (6) 516,374 6.07
1901 Diamond Cluster
Carrollton, TX 75010
</TABLE>
- - ------------------
(1) Beneficial ownership is determined in accordance with the rules
of the Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of the person,
shares of Common Stock subject to options or warrants held by that person that
are exercisable on or before May 30, 1996 are deemed outstanding. Such shares,
however, are not deemed outstanding for purposes of computing the ownership of
each other person. Except as indicated in the footnotes to this table and
pursuant to applicable community property laws, the shareholder named in the
table has sole voting and investment power with respect to the shares set forth
opposite such shareholder's name.
(2) Includes 1,047,815 shares held in joint tenancy and 21,875 shares
issuable upon exercise of options within 60 days of March 31, 1996 under
Fractal's 1993 Stock Option Plan.
(3) Includes 897,815 shares held in joint tenancy and 21,875 shares
issuable upon exercise of options within 60 days of March 31, 1996 under
Fractal's 1993 Stock Option Plan.
(4) Includes 962,936 shares held by a family trust for which Mr.
Lorenzen is a trustee, 1,932 shares which Mr. Lorenzen holds as a custodian, and
25,000 shares issuable upon exercise of options within 60 days of March 31, 1996
under Fractal's 1993 Stock Option Plan.
(5) Includes 52,500 shares held by Thomas I. Unterberg. In addition,
includes 105,000 shares held by Unterberg Harris L.L. C., 52,999 shares held by
Unterberg Harris Private Equity Partners, C.V., 209,501 shares held by Unterberg
Harris Private Equity Partners, L.P., 262,500 shares held by Unterberg Harris
Interactive Media, L.P. I. (the "Unterberg Entities"), and 12,500 shares
issuable upon exercise of options within 60 days of March 31, 1996 under
Fractal's 1993 Stock Option Plan held by Mr. Unterberg directly. Mr. Unterberg
disclaims beneficial ownership of all shares held by the Unterberg Entities,
except to the extent of his pecuniary interests therein.
(6) Includes 516,374 shares held in joint tenancy.
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<PAGE>
(b) SECURITY OWNERSHIP OF MANAGEMENT. The following table set
forth information the Company's directors, named individually, and the
Company's officers and directors as a group, as of March 31, 1996.
Information with respect to beneficial ownership after Fractal's acquisition
of Ray Dream is set forth in the Company's Registration Statement on Form
S-4, declared effective April 26, 1996.
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF
NAME AND ADDRESS OF BENEFICIAL PERCENT
TITLE OF CLASS OF BENEFICIAL OWNER OWNERSHIP (1) OF CLASS
- - -------------- ------------------- -------------- ----------
<S> <C> <C> <C>
Common Stock Mark Zimmer (see (a) above)
Common Stock Thomas Hedges (see (a) above)
Common Stock Lee Jay Lorenzen (see (a) above)
Common Stock Thomas I. Unterberg (see (a) above)
Common Stock Stephen E. Manousos (2) 365,192 4.28%
c/o Fractal Design Corporation
335 Spreckels Drive
Aptos, CA 95003
Common Stock Arthur Collmeyer (3) 38,125 *
350 Bean Avenue
Los Gatos, CA 95030
Common Stock Craig W. Johnson (4) 38,125 *
c/o Venture Law Group
2800 Sand Hill Road
Menlo Park, CA 94025
Common Stock All directors and executive officers 4,220,173 48.25%
as a group (10 persons)(5)
</TABLE>
- - ---------------------
* Less than 1 percent.
(1) See Note 1 to (a) above.
(2) Includes 341,567 shares held in a family trust for which Mr.
Manousos is a trustee and 23,625 shares issuable upon exercise of options within
60 days of March 31, 1996 under Fractal's 1993 Stock Option Plan.
(3) Includes 25,000 shares issuable upon exercise of options within
60 days of March 31, 1996 under Fractal's 1993 Stock Option Plan.
(4) Includes 5,000 shares issuable upon exercise of options within 60
days of March 31, 1996 under Fractal's 1993 Stock Option Plan. Also includes
20,000 shares issuable upon exercise of options within 60 days of March 31, 1996
under Fractal's Stock Option Plan held by an affiliated partnership.
(5) Includes 630,000 shares beneficially owned by the Unterberg
Entities affiliated with Mr. Unterberg for which he disclaims beneficial
ownership other than to the extent of his pecuniary interest therein. Also
includes 232,968 shares issuable upon exercise of options within 60 days of
March 31, 1996 under Fractal's 1993 Stock Option Plan.
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<PAGE>
(c) CHANGES IN CONTROL.
None.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Aptos Post, an image setting service bureau, provides services to
Fractal in connection with the preparation and printing of product manuals and
other materials. During the fiscal years ended March 31, 1995 and 1996, Fractal
paid an aggregate of $80,200 and $151,000, respectively, to Aptos Post in
connection with these services. Stephen E. Manousos, a director of Fractal, and
Lee Jay Lorenzen, a director and a principal shareholder of Fractal, own 51% and
49% equity interests, respectively, in Aptos Post and are officers of such
company.
Fractal has entered into an agreement with Altura Software, Inc.
("Altura") under which Altura provides technical services to Fractal in
connection with the porting of Fractal's products. Under this Agreement,
Fractal licenses software from Altura, including software that facilitates the
porting of Macintosh program applications to the Windows platform, in exchange
for certain payments which totaled less than $60,000 and $63,000 in the fiscal
years ended March 31, 1995 and 1996, respectively. Lee Jay Lorenzen, one of
Fractal's directors and principal shareholders, is President of Altura and
beneficially owns a majority of Altura's capital stock.
During 1994, Fractal sold an aggregate of 1,057,505 shares of its
Series A Preferred Stock and warrants to purchase an aggregate of 52,873 shares
of Fractal's Common Stock, at a purchase price of $2.00 per unit, with each unit
consisting of one share of Series A Preferred Stock and a warrant to purchase
one-twentieth of one share of Common Stock. The warrants were exercised on
November 14, 1995 in an aggregate net amount of 52,691 shares of Common Stock at
an exercise price of $2.00 per share. The following officers, directors and
holders of more than 5% of the voting securities of Fractal invested more than
$60,000 in this financing:
Shares of Series A Warrants to Purchase
Name Preferred Stock Common Stock
- - ---- ------------------ --------------------
Lee Jay Lorenzen and certain
affiliated trusts ............. 149,194 7,460
Entities affiliated with
Thomas I. Unterberg ........... 650,000 32,500
Craig Johnson, secretary and a director of the Company, is a
director and shareholder of Venture Law Group, Fractal's corporate counsel.
Unterberg Harris, an investment bank at which Mr. Unterberg, one of
Fractal's directors, is a managing director, served as lead-manager for
Fractal's initial public offering in November 1995. In connection with this
transaction, Unterberg Harris received underwriting discounts of $645,000.
Fractal believes that the foregoing transactions were on terms no less
favorable to Fractal than Fractal could have obtained from unaffiliated third
parties. All future transactions between Fractal and its officers, directors
and principal shareholders and their affiliates will be approved by a majority
of the disinterested members of the Board of Directors, and will be on terms no
less favorable to the Company than could be obtained from unaffiliated third
parties.
Fractal has entered into indemnification agreements with each of its
directors and executive officers. The agreements require Fractal to indemnify
such individuals for certain liabilities to which they may be subject as a
result of their affiliation with Fractal, to the fullest extent allowed by law.
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<PAGE>
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
The following exhibits are filed herewith or incorporated herein
by reference.
<TABLE>
<CAPTION>
Exhibit
Number Description
- - ---------- -------------
<S> <C>
3.1** Articles of Incorporation of the Registrant.
3.2*** Bylaws of the Registrant.
10.1** Form of Indemnification Agreement with the Registrant's officers and directors.
10.2** 1993 Stock Option Plan, as amended, and forms of option agreement thereunder.
10.3** 1995 Stock Option Plan and form of option agreement thereunder.
10.4** 1995 Directors' Option Plan and form of Option Agreement.
10.5** Amended and Restated Investor Rights Agreement among the Registrant and certain
security holders of the Registrant, dated as of July 21, 1995.
10.6** Distribution Agreement by and between the Registrant and Ingram Micro, Inc. dated
December 5, 1991.
10.7** Distribution Agreement by and between the Registrant and Merisel dated April 14,
1992.
10.8** Distribution Agreement by and between the Registrant and Letraset Japan Limited
dated June 24, 1992.
10.9** Distribution Agreement by and between the Registrant and Tech Data dated March 26,
1993.
10.10** Software Distribution Agreement by and between the Registrant and Altura Software,
Inc. dated October 4, 1993.
10.11** International Software Distribution Agreement by and between the Registrant and
Media Vision, Inc. dated September 29, 1994, and General Amendment thereto dated
January 1, 1995.
10.12** Software Purchase, Sale, License, Development and Maintenance Agreement between
the Registrant, Fractal Software, Mark Zimmer and Thomas Hedges, dated May 6,
1991; and Amendment No. 1 thereto dated September 7, 1994.
10.13** License Agreement by and between the Registrant and Pantone, Inc. dated
February 15, 1992, and Amendment No. 2 of said License dated October 1, 1994.
10.14** Amended and Restated Exclusive Publishing Agreement by and between the Registrant
and Walter Foster Publishing ("Publisher") dated August 28, 1995.
10.15** Software Licensing and Distribution Agreement by and between the Registrant and
Larry Weinberg dated June 17, 1994.
10.16** Amended and Restated Software License, Development and Maintenance Agreement,
dated as of September 9, 1994, between the Registrant and Altura Software, Inc.,
Lee J. Lorenzen and Stephen R. Thomas and First Amendment thereto, dated April 20,
1995.
10.17** Services and Confidentiality Agreement by and between the Registrant and Inquiry
Handling Service, Inc., dated October 13, 1994.
10.18** Lease by and between the Registrant and Mal Hetzer & Associates and Charles P.
Holcomb and Lois A. Holcomb, as co-trustees under that certain Declaration of
Trust dated August 31, 1990.
10.19** Lease by and between the Registrant and A. M. Hetzer dated March 1, 1992.
10.20** Second Lease Agreement by and between the Registrant and A. M. Hetzer dated
April 22, 1993.
10.21** Sublease by and between the Registrant and Mal Hetzer & Associates dated
December 17, 1993.
10.22** Promissory Note and Security Agreement between the Registrant and Coast Commercial
Bank dated August 23, 1995 in connection with a term loan in the amount of
$440,000.
10.23** Promissory Note and Security Agreement between the Registrant and Coast Commercial
Bank dated September 1, 1995 in connection with a line-of-credit of up to
$600,000.
10.24** Common Stock Purchase Agreement between the Registrant and Adobe Ventures, L.P.,
dated July 21, 1995.
</TABLE>
-45-
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
- - ---------- -------------
<S> <C>
10.25** Contract Addendum dated October 2, 1995, to Lease by and between the Registrant
and Mal Hetzer & Associates and Charles P. Holcomb and Lois A. Holcomb, as
co-trustees under that certain Declaration of Trust dated August 31, 1990.
10.26** First, Second and Third Addendums dated September 30, 1994, August 27, 1995 and
September 14, 1995, respectively, to Lease by and between the Registrant and A.M.
Hertzer dated March 1, 1992.
10.27** Employment Agreement by and between the Registrant and Eric Hautemont dated
February 17, 1996.
10.28** Form of Non-Competition Agreement dated as of February 17, 1996 between the
Registrant, Ray Dream and certain key employees of Ray Dream.
10.29** Ray Dream, Inc. 1992 Stock Option Plan and forms of option agreements thereunder.
10.30**+ Software Development and Purchasing Agreement by and between Ray Dream and a third
party software developer, dated June 15, 1995.
10.31**+ Warrant to Purchase Shares of Common Stock of Ray Dream, dated June 15, 1995.
10.32** Software License Agreement by and between Corel Corporation and Ray Dream, dated
November 23, 1994; and Addendum No. 1 thereto dated December 1, 1995.
10.33* Agreement and Plan of Reorganization dated February 17, 1996 by and among the
Registrant, Fractal Acquisition Corporation and Ray Dream, Inc.
10.34* Form of Agreement of Merger among the Registrant, Fractal Acquisition Corporation
and Ray Dream, Inc.
10.35*** Assumed 1992 Ray Dream, Inc. Stock Option Plan.
10.36 Letter of Intent dated April 9, 1996 for lease of office space in Scotts Valley,
California.
11.1** Statement re Computation of Pro Forma Net Income (Loss) Per Share.
21.1** Subsidiaries of the Registrant.
23.1 Consent of Price Waterhouse LLP, Independent Accountants, with respect to
financial statements of Registrant.
24.1 Power of Attorney (included on page 47).
27 Financial Data Schedule.
</TABLE>
- - --------------
* Incorporated by reference to the corresponding document previously
filed as an Exhibit to the Company's Form S-4 (File No. 333-2110), declared
effective April 26, 1996.
** Incorporated by reference to the corresponding document previously filed as
an Exhibit to Registrant's Registration Statement on Form SB-2 (File No.
33-96942-LA), declared effective November 9, 1995.
*** Incorporated by reference to the corresponding document previously filed as
an Exhibit to the Company's Registration Statement on Form S-8, filed with
the Commission and effective on May 24, 1996.
+ Confidential Treatment Requested.
(b) REPORTS ON FORM 8-K
None.*
* The Company filed with the Commission a report on Form 8-K on June
6, 1996 in connection with the acquisition of Ray Dream, Inc.
-46-
<PAGE>
SIGNATURES
In accordance with the Exchange Act, the Registrant, Fractal Design
Corporation, a corporation organized and existing under the laws of the State of
California, has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Aptos, State of
California, on this 28th day of June, 1996.
FRACTAL DESIGN CORPORATION
By: /s/ MARK ZIMMER
------------------------------
Mark Zimmer
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Mark Zimmer, his or her attorney-in-fact
and agent, with the power of substitution and resubstitution, for him or her and
in his or her name, place or stead, in any and all capacities, to sign any
amendments to this report on Form 10-KSB, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, granting into said attorney-in-fact and agent, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully as he or she might or
could do in person, and ratifying and confirming all that said attorney-in-fact
and agent, or his or her substitute or substitutes, may do or cause to be done
by virtue hereof.
Pursuant to the requirements of the Exchange Act, this form has been
signed by the following persons in the capacities and on the dates indicated.
Signature Title Date
--------------- ------- --------
/s/ MARK ZIMMER Chief Executive Officer and June 26, 1996
------------------------ Chairman of the Board of
Mark Zimmer Directors (Principal
Executive Officer)
/s/ THOMAS HEDGES Vice-President, Engineering June 26, 1996
------------------------ and Vice-Chairman of the
Thomas Hedges Board of Directors
/s/ ERIC HAUTEMONT President and Director June 26, 1996
-----------------------
Eric Hautemont
/s/ LESLIE WRIGHT Chief Operating Officer and June 26, 1996
----------------------- Chief Financial Officer
Leslie Wright (Principal Financial Officer)
/s/ BRADEN RIPPETOE Vice President, Finance June 26, 1996
----------------------- (Principal Accounting
Braden Rippetoe Officer)
/s/ CRAIG JOHNSON Secretary and Director June 26, 1996
-----------------------
Craig Johnson
/s/ ARTHUR COLLMEYER Director June 26, 1996
-----------------------
Arthur Collmeyer
/s/ LEE JAY LORENZEN Director June 26, 1996
-----------------------
Lee Jay Lorenzen
/s/ STEPHEN E. MANOUSOS Director June 26, 1996
-----------------------
Stephen E. Manousos
/s/ ALAIN ROSSMANN Director June 26, 1996
-----------------------
Alain Rossmann
/s/ ANTHONY SUN Director June 26, 1996
- - ------------------------
Anthony Sun
/s/ THOMAS UNTERBERG Director June 26, 1996
- - ------------------------
Thomas Unterberg
-47-
<PAGE>
[LETTERHEAD]
April 9, 1996
Mr. Brad Krouskup
TOENISKOETTER & BREEDING, INC.
1960 The Alameda, #20
San Jose, CA 95126
RE: Fractal Design/5550 Scotts Valley Drive
Letter of Intent
Dear Brad:
We have revised the subject Letter of Intent ("LOT") for the above referenced
lease for your review and approval.
1. LANDLORD: American Development II, a California general
partnership ("Landlord")
2. TENANT: Fractal Design Corporation ("Tenant")
3. LOCATION: 5550 Scotts Valley Drive, Scotts Valley, CA.
4. USE: Tenant will use and occupy the Premises for the purpose
of general, administrative and sales offices, product
service, software engineering and product storage. Any
other use will be required to conform to existing and
future governmental restrictions and will be subject to
Landlord's approval which will not be unreasonably
withheld.
5. INITIAL PREMISES: Tenant's Initial Premises will be approximately 29,571
square feet of rentable building area, consisting of
approximately 27,510 rsf, being the entire second (2nd)
floor and approximately 2,061 rsf on the first (1st)
floor. Tenant's first floor area shall include
exclusive use of the at grade truck door and freight
elevator. The rentable square footage will include the
usable area within the Premises, determined in
accordance with BOMA standards plus a load factor for
common areas not to exceed eight percent (8%) of the
usable square feet.
6. EXPANSION
PREMISES: On December 1, 1998 Tenant shall expand into an
additional approximate 11,467 rentable square foot
area, being the first floor area surrounding the
shipping/receiving area. The monthly rent for said
<PAGE>
April 9, 1996
Mr. Krouskup
Page Two
Expansion Premises will be at the same per square foot
rate as the Initial Premises. The Lease Term for the
Expansion Premises shall co-terminate with the Lease
Term for the Initial Premises. Landlord shall also
provide a Tenant Improvement Allowance as provided in
Paragraph 11.
7. RIGHT OF FIRST
REFUSAL: If at any time, during the subject Lease Term all or
any portion of the remaining approximate 14,282
rentable square feet on the first floor becomes
available for lease, Tenant shall have the Right of
First Refusal to lease said space.
Said Right may be exercised by Tenant in the event
Landlord or its current tenant (Comerica) agree to a
Letter of Intent with a third party tenant. By
exercising its Right, Tenant agrees to lease said space
upon the same terms and conditions as contained in the
third party Letter of Intent.
Tenant shall respond to Landlord within five (5)
business days of receipt of written notice.
8. LEASE
COMMENCEMENT
DATE: The Lease Term will commence thirty (30) days after
Landlord's substantial completion of the Tenant
improvements and receipt of a certificate of occupancy
but no earlier than July 1, 1996 and no later than
September 1, 1996.
9. LEASE TERM: Seven (7) years.
10. OPTIONS
TO RENEW: Two (2), three (3) year Options to Renew. The monthly
rent for each Option period will be the equivalent of
ninety-five percent (95%) of the then fair market
rate.
11. TENANT
IMPROVEMENT
ALLOWANCE: Landlord shall provide Tenant with an allowance for
interior improvements in an amount equal to ten dollars
($10.00) per rentable square foot.
<PAGE>
April 9, 1996
Mr. Krouskup
Page Three
Landlord shall contract with Toeniskoetter & Breeding,
Inc., Construction who will provide general contractor
services and cost estimating at a fee equal to five
percent (5%) of the reimbursable construction costs.
All subcontractor costs will be competitively bid and
will be subject to Tenant's review and approval prior
to construction. Tenant shall provide Landlord all
information necessary for the construction of the
Initial Premises as soon as reasonably possible.
12. BASE NNN RENT: Tenant shall pay to Landlord Base Triple Net (NNN) Rent
in an amount equal to $1.15 per square foot per month,
subject to increases as provided for in Paragraph 13.
13. RENT
ADJUSTMENTS: The Base NNN Rent shall be increased at the beginning
of the third (3rd), fifth (5th) and seventh (7th) years
of the term to reflect increases in the Consumer Price
Index. However, in no event shall the increases be less
than four percent (4%) nor more than eight percent (8%)
per adjustment.
14. OPERATING
EXPENSES: Tenant shall pay, as additional rent, its proportional
share of the triple net expenses which shall include
interior and exterior building maintenance (excluding
janitorial within the Premises), real property taxes
and building insurance, estimated to be approximately
eighteen cents ($.18) per square foot per month.
15. UTILITIES: Electrical utilities for the Premises will be
separately metered, provided that such costs are
reasonable. In the event of no separation of meters,
Tenant shall pay its pro-rata share, subject to
engineered audit of electrical costs for the building.
All other utilities will be billed on a proportional
basis.
16. ADVANCED RENT/
SECURITY DEPOSIT: Upon full execution of the Lease Agreement, Tenant
shall pay to Landlord a sum equal to the first two (2)
months of rent due under the Lease. One half of such
amount will be credited toward to the first months rent
payment and the balance shall serve as Security
Deposit.
<PAGE>
April 9, 1996
Mr. Krouskup
Page Five
The parties agree that the elements of the transaction contemplated by this LOI
are subject to definitive written agreements, satisfactory in form and substance
to, and executed by, Landlord and Tenant and subject to appropriate corporate
approvals as necessary. The parties mutually intend that nothing herein shall
bind the parties in any way or create any liability between the parties unless
and until such definitive written agreements are executed and delivered by the
parties.
We appreciate the coordinated effort between yourself and Mr. Lon Hansen of
Comerica Bank. We acknowledge the stated contingency concerning Comerica Bank in
your February 27, 1996 letter.
Sincerely,
COOPER/BRADY CORPORATE REAL ESTATE SERVICES
AGENT FOR FRACTAL DESIGN CORPORATION
/s/ JOHN BRADY /s/ FLETCHER BAKER
John Brady Fletcher Baker
If the above LOI terms and conditions are acceptable, please acknowledge
acceptance by signing this letter below.
ACCEPTED:
AMERICAN DEVELOPMENT II FRACTAL DESIGN
A California General Partnership CORPORATION
By: /s/ BRAD KROUSKUP By: /s/ LES WRIGHT
-------------------------- ----------------------
Brad W. Krouskup Les Wright
General Partner, TBI-SVII Chief Operating Officer
ACKNOWLEDGMENT:
COMERICA BANK - CALIFORNIA
By: /s/ LON HANSEN
-------------------------
Lon Hansen
NOTICE TO LESSOR AND LESSEE: COOPER/BRADY CORPORATE REAL ESTATE SERVICES,
BROKER IS NOT AUTHORIZED TO GIVE LEGAL OR TAX ADVISE: NO REPRESENTATION OR
RECOMMENDATION IS MADE BY COOPER/BRADY CORPORATE REAL ESTATE SERVICES, OR ITS
AGENTS OR EMPLOYEES AS TO THE LEGAL EFFECT OR TAX CONSEQUENCES OF THIS DOCUMENT
OR ANY TRANSACTION RELATED THERETO, SINCE THESE ARE MATTERS WHICH WOULD BE
DISCUSSED WITH YOUR ATTORNEY.
<PAGE>
SCHEDULE OF LEASE COMMISSIONS
TENANT: FRACTAL DESIGN CORP.
------------------------------------------------------
FOR PROPERTY AT: 5550 Scotts Valley Drive, Scotts Valley, CA
-------------------------------------------------
Commissions shall be payable on execution of a lease by Landlord and
Tenant, in accordance with the following rates:
6% of the total base rental for the first 36 months in which rent is to be
paid, plus
4% of the total base rental for the next 24 months in which rent is to be
paid, plus
3% of the total base rental for the remainder of the term.
The above rates are subject to the following provisions:
1. PAYMENT OF LEASE COMMISSIONS:
Commissions shall be due and payable one-half (1/2) on execution of a lease
and one-half (1/2) on lease commencement date, or when Tenant takes
occupancy of the premises, whichever occurs first.
2. ADDITIONAL SPACE TAKEN:
If a lease for which a commission is payable hereunder contains an
option(s) to expand, or Tenant leases additional space whether by virtue of
such option or otherwise, then Landlord shall pay a leasing commission in
accordance with the provisions of this Schedule on the additional rental to
be paid, calculated at the commission rate applicable hereunder to the
years of the lease in which the additional rental is payable. Said
commission shall be earned and payable at the time the additional space is
leased.
In the event Landlord fails to make payments within the time limits set
forth herein, then from the date due until paid the delinquent amount shall
bear interest at the maximum rate permitted in the state in which the
office Broker executing this Schedule is located. If Broker is required to
institute legal action against Landlord relating to this Schedule or any
agreement of which it is a part, Broker shall be entitled to reasonable
attorneys' fees and costs.
Landlord hereby acknowledges receipt of a copy of this Schedule and agrees
that it shall be binding upon its heirs, successors and assignees. In the
event Landlord sells or otherwise disposes of its interest in the Property,
Landlord shall remain liable for payment of the commissions provided for in
this Schedule.
BROKER: LANDLORD:
COOPER/BRADY CORPORATE AMERICAN DEVELOPMENT II
REAL ESTATE SERVICES
By: /s/ BRAD KROUSKUP
By: /s/ JOHN BRADY ------------------------------
-------------------------- Date: 4/19/96
----------------------------
Date: 3/26/96
------------------------
TENANT:
COMERICA BANK - CALIFORNIA
By: /s/ LON HANSEN
------------------------------
Date: 4/19/96
----------------------------
However, in no event shall the commission payable for the Initial Premises
exceed five ($5.00) dollars per rentable square foot.
<PAGE>
FRACTAL DESIGN CORPORATION EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-04599) of our report dated April 22, 1996,
except as to Note 11, which is as of May 24, 1996, which appears on page 23
of this Form 10-K.
/s/ PRICE WATERHOUSE LLP
Price Waterhouse LLP
San Jose, California
June 28, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-KSB FOR FISCAL YEAR 1996 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-START> APR-01-1995
<PERIOD-END> MAR-31-1996
<CASH> 5,422
<SECURITIES> 23,683
<RECEIVABLES> 4,070
<ALLOWANCES> 91
<INVENTORY> 804
<CURRENT-ASSETS> 36,887
<PP&E> 1,142
<DEPRECIATION> 555
<TOTAL-ASSETS> 37,474
<CURRENT-LIABILITIES> 6,964
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 30,501
<TOTAL-LIABILITY-AND-EQUITY> 37,474
<SALES> 21,780
<TOTAL-REVENUES> 21,780
<CGS> 4,219
<TOTAL-COSTS> 4,219
<OTHER-EXPENSES> 13,307
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (464)
<INCOME-PRETAX> 4,718
<INCOME-TAX> 1,794
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,924
<EPS-PRIMARY> 0.36
<EPS-DILUTED> 0.36
</TABLE>
