-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JmXpS05FA6tFOTV/uOSZA51ZVnqLY/od4RsO9AhsO3QcreIq8UUh+PV84QaEI1TQ yPoX7NDx+3WCV+Q31Qqgkw== 0000891020-00-000663.txt : 20000331 0000891020-00-000663.hdr.sgml : 20000331 ACCESSION NUMBER: 0000891020-00-000663 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: REALNETWORKS INC CENTRAL INDEX KEY: 0001046327 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 911628146 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-23137 FILM NUMBER: 586501 BUSINESS ADDRESS: STREET 1: 2601 ELLIOTT AVENUE STREET 2: STE 1000 CITY: SEATTLE STATE: WA ZIP: 98121 BUSINESS PHONE: 2066742700 MAIL ADDRESS: STREET 1: 2601 ELLIOTT AVENUE STREET 2: STE 1000 CITY: SEATTLE STATE: WA ZIP: 98121 10-K405 1 FORM 10-K405 FOR PERIOD ENDING 12/31/1999 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 COMMISSION FILE NUMBER 0-23137 REALNETWORKS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) WASHINGTON 91-1628146 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER) 2601 ELLIOTT AVENUE, SUITE 1000 SEATTLE, WASHINGTON 98121 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(206) 674-2700 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $0.001 PER SHARE (TITLE OF CLASS) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing price on March 20, 2000, as reported on NASDAQ, was $5,489,160,305.(1) The number of shares of the registrant's Common Stock outstanding as of March 20, 2000 was 154,360,374. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Proxy Statement relating to the registrant's 2000 Annual Meeting of Shareholders to be held on June 2, 2000 are incorporated by reference into Part III of this Report. - ------------------------ (1) Excludes shares held of record on that date by directors, executive officers and 10% shareholders of the registrant. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business.................................................... 3 Item 2. Properties.................................................. 13 Item 3. Legal Proceedings........................................... 13 Item 4. Submission of Matters to a Vote of Security Holders......... 14 Item 4A. Executive Officers of the Registrant........................ 15 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................... 16 Item 6. Selected Consolidated Financial Data........................ 17 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 17 Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................................ 17 Item 8. Financial Statements and Supplementary Data................. 17 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 18 PART III Item 10. Directors and Executive Officers of the Registrant.......... 18 Item 11. Executive Compensation...................................... 18 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 18 Item 13. Certain Relationships and Related Transactions.............. 18 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................................... 18 Exhibit Index......................................................... 25
2 3 PART I This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates and projections about RealNetworks' industry, management's beliefs, and certain assumptions made by management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks" and "estimates" and similar expressions, are intended to identify forward-looking statements. These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in the section of Item 1 entitled "Intellectual Property" and in Item 3 entitled "Legal Proceedings." RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. ITEM 1. BUSINESS OVERVIEW RealNetworks is a leading provider of media delivery and digital distribution solutions designed for the Internet. Our solutions enable consumers to experience and content providers to deliver a broad range of multimedia content, including audio, video, text and animation. We pioneered the development and commercialization of streaming media systems that enable the creation, real-time delivery and playback of multimedia content. We believe that we have established a leadership position in the market for these systems. We have more than 95 million registered users of our RealPlayer product and believe that more than 85% of all streaming media Web pages use our technology. The broad acceptance of the Internet as a means of content delivery and consumption, combined with recent technological advances, has greatly increased the practicality and popularity of a number of new online media delivery formats. In response, we have extended our media delivery platform to include a digital music management system that allows consumers to acquire, record, store, organize and play their personal music collections on PCs and digital playback devices. Our solutions include a variety of integrated products and services for consumers, content providers, service providers and advertisers. Our products and services include: - RealSystem G2, an open and extensible advanced streaming media solution that consists of our RealPlayer client software, through which users experience multimedia content, and our RealServer software and related software tools, which enable broadcasters and content providers to create and deliver multimedia content. - Real Broadcast Network, a service based on a distributed multi-tier network designed to enable content providers to reliably and cost-effectively deliver high-quality streaming media over the Internet to large audiences. - RealJukebox, a product that turns a PC into a digital music management system and is based on RealSystem MP, our open and extensible digital music management solution. - RealGuide, a comprehensive directory that enables easy and personalized access to high-quality media programming on the Internet. - RealStore, an electronic commerce website from which we market, sell and distribute our own and third-party media delivery products and services to our base of more than 95 million registered users. 3 4 PRODUCTS AND SERVICES RealSystem G2. RealSystem G2, introduced in November 1998, fully integrates players, servers and tools to create an end-to-end streaming media solution for consumers and content providers. RealSystem G2 provides the necessary components to generate a high-quality user experience that is scalable across the heterogeneous Internet infrastructure. It allows consumers to experience and content providers to create rich and dynamic media content that can be viewed and heard in real time across varying narrowband and broadband environments. RealSystem G2's open, extensible architecture provides third party developers the opportunity to create complementary products and services. Players. RealPlayer enables a user to listen to and view content from websites that use our server products. RealPlayer provides basic functions such as play, stop, fast-forward, rewind and volume adjustment and customizable navigational tools and services for easy and personalized access to multimedia content. We offer RealPlayer for free from our website and through bundling with third-party products. We sell our premium RealPlayer Plus, which has additional features such as clearer, sharper audio and video, high-fidelity audio quality with a graphic equalizer and picture quality controls such as contrast, brightness and tint. The RealPlayer software is currently in version 7.0. Servers. Our server technology allows broadcasters and content providers to broadcast audio, video and other multimedia programming to large numbers of simultaneous users over varying Internet connections. We price our servers based on features and streaming capacity and offer a variety of server products to meet the varying needs and requirements of broadcasters and content providers. The RealServer line is currently in version 7.0, which has demonstrated significant improvements in scalability and reliability: RealServer Basic, available for free download, supports 25 concurrent users of live and on-demand multimedia broadcasts. RealServer Plus is designed for hobbyists and small- to medium-sized businesses. It supports 60 concurrent users, with additional administrative capabilities and content creation tools. The RealServer Professional is designed for use primarily by broadcasters, ISPs, distance learning providers and large websites. It supports large audiences via both unicast and IP multicast, and provides more advanced administrative features. Custom solutions are available. For example, we offer features that are designed and priced specifically for educational institutions or teachers, and features that enable ISPs to host the streaming media content of their customers. The RealServer Intranet is designed for corporate intranets. Popular applications include live executive broadcasts at company meetings, sales force training and enterprise learning. Optional RealServer Extensions include the Authentication Extension to help ensure site security or enable pay-per-view broadcasting and to support back-end credit card and transaction-processing systems; the Splitting Extension, which allows RealServer customers to create a distributed streaming media network; and the beta Advertising Extension, which enables in-stream advertising insertion and rotation. Tools. We offer a variety of products that improve the distribution and quality of customers' RealSystem G2 content and presentations. Our tools are offered both for download from the RealNetworks.com web site and in product bundles from third parties and include: RealProducer, available for free download, is our basic multimedia creation and publishing tool. The RealProducer line is currently in version 7.0 beta. RealProducer Plus is a more advanced tool that offers Web designers and production artists building RealSystem G2 presentations the ability to reach a wider audience and produce higher-quality content. RealProducer Pro is a professional solution designed for Web authors and production experts. It includes timeline-based features for creating synchronized multimedia templates for Synchronized Multimedia Integration Language (SMIL) and Hypertext Mark-up Language (HTML) layout and flexible compression control. 4 5 RealSlideshow Basic, available for free download, allows a novice user to combine pictures with voice commentary and/or music, including MP3 support, to create a slide show experience on a Web site. The RealSlideshow line is currently in version 2.0. RealSlideshow Plus offers users additional features for slide show creation and dissemination, including built-in email, free images, and free slide show hosting with partner hosting providers. RealPresenter Basic, available for free download, integrates with Microsoft PowerPoint and allows users to easily turn PowerPoint slides into audio and video enhanced Web broadcasts for access by a workgroup. The RealSystem G2-compatible version of the RealPresenter line was co-developed with Intel and is now in its beta version 1.0. RealPresenter Plus offers users additional features and functionality, including free images, free hosting with partner hosting providers, and an integrated 25-stream RealServer Basic to enable desktop broadcasts to the Internet. RealSystem MP. RealSystem MP, introduced in May 1999 and based on the media delivery platform of RealSystem G2, is an open and extensible music management solution that provides consumers with a convenient method for recording, playing, organizing and acquiring music from the Internet and local digital sources. RealJukebox. Based on RealSystem MP (described in the Technology section below), RealJukebox is a complete digital music product that enables consumers to acquire, record, store, organize and play their personal music collections from a PC. Music is sorted by a number of categories, including artist, song title, genre and type of file, and consumers can create personal playlists by dragging and dropping songs. Consumers can acquire music for playback in the RealJukebox from a number of different sources, including free promotional music downloads, purchased Internet music downloads and music purchased through links to online music retailers. Consumers can also record CDs onto their hard disks at three to five times playback speed using their choice of several high-quality recording formats. RealJukebox plays back a number of high-quality digital audio formats, including RealAudio G2, MP3, Liquid Audio and a2b, and enables users to transfer their music to partner portable digital playback devices and other portable storage solutions. We offer RealJukebox for free from our website and bundling with third party products. We sell our premium RealJukebox Plus, which includes additional features such as a graphic equalizer and a higher MP3 encoding rate. Users with writable CD-ROM drives can also create their own custom CDs for personal use with RealJukebox Plus. The RealJukebox line is currently in Version 1, Update 1. RealStore. The RealStore is an online store for the sale of our own products and upgrades, as well as for third-party products and training products for use on corporate intranets. Through this distribution channel, we are able to offer a broad selection of products with little inventory risk or merchandising expense. Software Development Kits. RealNetworks makes available for free download and licensing to software developers two software development kits (known as SDKs) that allow developers to create new software products that are compatible with and complementary to RealSystem G2. The RealSystem G2 SDK describes programming interfaces and processes by which a developer may build plug-ins for the RealServer and RealPlayer. The RealProducer G2 SDK similarly describes interfaces and processes, and includes object code, which enables a developer to build a tool that encodes RealNetworks file formats. Take5. Introduced in November 1999, Take5 is the first daily programming service providing streaming media consumers who use the RealPlayer (version 7.0) with access to five top stories of the day in the entertainment, music, sports, comedy, and news categories. More than 100 media companies, including major broadcast and cable networks, provide the Internet programming highlighted by Take5. The content that appears on Take5 is selected daily by a RealNetworks editorial staff. Take5 programming may also be launched from the Real.com website. RealGuide. RealGuide, an integral part of the Real.com site, offers the ability to search for and locate multimedia content. RealGuide is a comprehensive directory that enables easy and personalized access to 5 6 high-quality multimedia programming information available on the Internet. RealGuide provides viewers with one-click access to the day's top stories and programming from nearly 200 Channels and Stations. Real Broadcast Network. The Real Broadcast Network is our Internet broadcast service through which we provide hosting services on behalf of broadcasters and content providers. We provide full turnkey services, including the hardware, software, personnel, network connectivity and bandwidth necessary to enable businesses to deliver live and on-demand programming over the Internet. The Real Broadcast Network features a distributed multi-tier architecture designed to improve Internet broadcasts by routing consumers to the nearest broadcast hub on the Internet or within an Internet service provider. We believe the relationships we have formed with leading backbone providers and ISPs support and enhance the services we provide. Showcase Websites and Programming. In November 1999, we divided the RealNetworks company website in two, creating Real.com and RealNetworks.com. The Real.com site showcases and organizes an array of audio and video programming from across the Internet, and offers users a free, optional message service that directly notifies users on their desktops about new programming in their interest categories. Real.com, in conjunction with RealPlayer version 7.0 and Take5, comprises the Real.com Network. The RealNetworks.com site includes information for and downloads of RealNetworks products and services, corporate information, and special interest areas for RealNetworks partners and third party developers. In addition to these two main websites, we offer theme-oriented sites which organize streaming media programming for end users with specific media interests. LiveConcerts.com offers live and on-demand streamed music concerts and services such as up-to-date concert schedules. Film.com provides in-depth information about movies, including reviews and previews, as well as streaming media clips. TECHNOLOGY Our media delivery solutions are designed to optimize the delivery of multimedia content over the Internet. Our solutions are based on open industry standards and work with a broad range of operating systems, hardware platforms, network environments and media types. RealSystem G2 Technology. RealSystem G2 is a streaming media platform based on advanced transmission technologies and protocols that address the inherent limitations of the Internet with respect to multimedia delivery. The following are key elements of our RealSystem G2 technology: - AutoUpdate, an automatic upgrade feature, notifies users and allows them to easily download new products and product upgrades as they become available. - SureStream transport technology enables reliable and continuous end-user playback by scaling dynamically to deliver high-quality RealAudio and RealVideo to users at the varying connection rates found under real-world network conditions. SureStream technology utilizes bi-directional communication that enables the server and player to communicate during transmission regarding the bandwidth and quality of the user's connection to optimize the transmission. - Buffering ensures continuous delivery by caching data packets and requesting retransmission of any missing packets. - Error-Mitigation reduces performance degradation by reconstructing lost data packets based on approximations regarding adjacent or closely related data packets. - Smart Networking allows a server to automatically select the appropriate transmission protocol depending on current network conditions and the presence of firewalls or proxies when streaming content to the player. - Video-Optimized Transmission incorporates technologies that reduce unnecessary repetition of redundant background data in neighboring video frames, and reduces the amount of video content being streamed if video performance is degraded during a given transmission. This technology instead focuses on maintaining the continuity of the audio stream, which is often more central to the user experience. 6 7 - Advertising Application allows for the insertion of banner and streaming media advertising into streaming media content while seamlessly integrating with existing ad-serving software and solutions. - Cross-Platform Support ensures that our products operate across a disparate array of broadcast platforms, such as Alpha UNIX, FreeBSD, HP/UX, Linux, SCO Unix, SGI IRIX, Sun OS and Win32, Internet infrastructures and emerging clients, such as PCs, set-top boxes, portable devices and all popular browsers. RealSystem G2 builds on industry standards, implementing Real Time Streaming Protocol, a standard client/server protocol for streaming media. RealSystem G2 also supports SMIL, which enables rich, multi-screen content to be delivered over a typical modem connection. SMIL allows content creators to easily synchronize their media presentations with a wide range of media, including voice, music, visual effects, text and graphics, to produce audio-visual content using a simple text editor. RealSystem MP Technology. Building on the technology of RealSystem G2, we developed RealSystem MP, a complete digital music management solution. RealSystem MP uses an open and extensible architecture that supports a range of third party products and hardware devices, and can be integrated with various Internet services such as online music databases. Key features of RealSystem MP include: - Content insertion services that enable consumers to create and manage their own personal music database. - A secure plug-in interface that supports a variety of security initiatives, including IBM's electronic music management system, AT&T's a2b technology and Liquid Audio's technology. - File format support for popular music formats such as MP3, WAV, MIDI and our RealAudio G2 format. - Information services that provide access to information from an online music database, including track name, artist, album and genre. - Content extraction services that enable a range of devices and products, including portable digital devices, CD recorders, flash memory cards and high-capacity disks, to use the content and information in a user's personal music database. - Home networking services that enable the distribution of music throughout a home network. Technologies Enabling Large-Scale Delivery of Streamed Multimedia. Our splitter and caching technologies allow broadcasters to transmit large numbers of simultaneous streams using reduced bandwidth by sending a separate signal to multiple users through the same network links. Our splitter technology enables a host server to broadcast a signal to a set of servers distributed around a network. Those servers then transmit the signal to the end user, thereby minimizing the use of the network backbone and improving signal quality. We use this technology in the Real Broadcast Network and license it to other Internet broadcasters, ISPs and networks. The caching and proxy server technology we co-developed with Inktomi enables widespread and efficient distribution of multimedia content by moving the data closer to the end user. The RealProxy caching technology enables ISPs and backbone providers to greatly reduce bandwidth and infrastructure costs, and provides a more compelling experience for the user. Codecs. Our RealSystem G2 uses multiple compression/decompression algorithms (or codecs) to translate time-based, data-intensive content such as audio, video or animation data into discrete data packets and then broadcasts (or streams) the packets from a server to a client, our RealPlayer or the RealJukebox. The client then reassembles the packets in the correct order and allows a user to play back the streaming media content in real time without waiting to download. The compression process enables the data to be streamed to the player even in very low bandwidths (14.4 kbps) or congested network environments by reducing the amount of data to be streamed. We have licensed and integrated Intel's streaming Web video technology into RealSystem G2, enabling significantly faster video encoding than previous streaming media delivery systems and delivery of higher-image performance and quality to consumers. RealSystem MP, the platform on which the RealJukebox is built, allows support for audio formats such as RealAudio G2, MP3, 7 8 AT&T's a2b, IBM's EMMS, Liquid Audio, Mjuice and Windows Media Audio. With the exception of RealAudio G2, our codecs are based on licenses obtained from third parties. RESEARCH AND DEVELOPMENT We devote a substantial portion of our resources to developing new products, enhancing existing products, expanding and improving our fundamental streaming technology and strengthening our technological expertise. During the years ended December 31, 1999, 1998, and 1997, we expended approximately 29%, 34%, and 43% of our total net revenues on research and development activities. As of December 31, 1999, RealNetworks had 272 full-time employees, or approximately 42% of our work force, engaged in research and development activities. SALES, MARKETING AND DISTRIBUTION We believe that any individual or company that desires to send, support or receive multimedia content over the Internet is a potential customer. To reach as many of these potential customers as possible, we sell our products and services through several distribution channels, both directly (over the Internet and through a sales force) and indirectly (through OEMs, VARs and other distributors). As of December 31, 1999, we had 241 full-time employees, or approximately 37% of our work force, engaged in sales and marketing activities. Electronic Commerce. Substantially all of the products we sell can be purchased and delivered directly from our websites. Our websites provide us with a low-cost, globally accessible sales channel that is available 24 hours per day, seven days per week on a world wide basis. Direct Sales Force. Our direct sales force primarily markets and sells our server products to corporate customers. We also have an advertising sales force that markets and sells advertising on our websites and within the media streams that we host on behalf of our corporate customers. We have subsidiaries in Japan, the United Kingdom, France and Germany, and offices in several other countries, which market and sell our products outside the United States. OEMs AND VARs. We have entered into various distribution relationships with third parties pursuant to which our products and technologies are incorporated into, bundled with or offered with third-party products for delivery by the third party to end users. Sales Through Other Distributors. We sell our software systems and services to other distributors, including content aggregators, ISPs and other hosting providers that redistribute or provide end users access to our streaming technology from their websites and systems. We have agreements with owners of many popular websites and software companies to distribute our products as a click-through or to bundle our RealPlayer G2 into their applications and software. Real Developer Program. In August 1999 we transitioned our Real Developer Program into the more comprehensive RealPartner Program, which provides development tools, training and technical assistance, and marketing opportunities to individuals and companies who work with our streaming media technology. Members of the program include independent software vendors, who are creating and marketing RealAudio-or RealVideo-enabled software or hardware products; professional services agencies that are are building interactive, mutlimedia-rich websites for clients; VARs who resell RealNetworks products stand-alone or as a part of a custom, integrated system; and ISP hosting providers who own RealServers and offer streaming media hosting to their customers. There are more than 700 members in the RealPartner Program. Marketing Programs. Our marketing programs are aimed at increasing brand awareness, stimulating market demand and educating potential customers about the economic opportunities in delivering multimedia content over the Internet. We have a number of marketing initiatives, including: - Showcasing our various products and solutions in trade shows, conferences and seminars. - Providing product-specific information through our websites. - Promoting and co-promoting special events with our broadcast partners. 8 9 - Advertising products and services in print and electronic media. - Sponsoring our annual RealNetworks Conference. CUSTOMERS Our customers include businesses and consumers located throughout the world. Sales to customers outside the United States, primarily in Asia and Europe, were approximately 23%, 22%, and 24% of total net revenues, excluding revenues from the Microsoft license agreement, in the years ended December 31, 1999, 1998, and 1997. Software license fees under a license agreement with Microsoft accounted for approximately 8%, 15%, and 13% of total net revenues for the years ended December 31, 1999, 1998, and 1997. CUSTOMER SUPPORT Our customers have a choice of support options depending on the level of service desired and the nature of the products acquired. Customer support is provided by our customer relations department and third-party contractors. Customers can access a technical support hotline to answer inquiries or initiate e-mail inquiries. We also provide an online database of technical information for customer self-service. As of December 31, 1999, we employed 24 full-time technical and customer support representatives, approximately 4% of our work force, to respond to customer requests for support. COMPETITION The market for software and services for media delivery over the Internet is relatively new, constantly changing and intensely competitive. As media delivery evolves into a central component of the Internet experience, more companies are entering the market for, and expending increasing resources to develop, media delivery software and services. We expect that competition will continue to intensify. Negative competitive developments could hurt our business and the trading price of our stock. Many of our current and potential competitors have longer operating histories, greater name recognition, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. In addition, new competitors with potentially unique or more desirable products or services are entering the market all the time. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology franchise. Price concessions or the emergence of other pricing or distribution strategies of competitors may diminish our revenues, impact our margins or lead to a reduction in our market share, any of which will harm our business. We believe that the primary competitive factors in the media delivery market include: - the quality and reliability of the overall media delivery solution; - access to distribution channels necessary to achieve broad distribution and use of products; - the availability of content for delivery over the Internet and access to necessary intellectual property rights; - the ability to license or develop and support secure formats for digital media delivery, particularly music and video; - the ability to license and support popular and emerging media formats for digital media delivery, particularly music and video, in a market where competitors may control the intellectual property rights for these formats; - the size of the active audience for streaming and digital media and its appeal to content providers and advertisers; - features for creating, editing and adapting content for the Internet; - ease of use and interactive user features in products; 9 10 - ease of finding and accessing content over the Internet; - scalability of streaming media and media delivery technology and cost per user; - pricing and licensing terms; - compatibility with new and existing media formats; - compatibility with the user's existing network components and software systems; and - challenges caused by bandwidth constraints and other limitations of the Internet infrastructure. Our failure to adequately address any of the above factors could harm our business strategy and operating results. Media Technologies. Microsoft is a principal competitor in the development and distribution of streaming media and media distribution technology. Microsoft currently competes with us in the market for streaming media server and player software and has announced its intent to compete in the market for digital distribution of media. Microsoft's commitment to and presence in the media delivery industry has increased and Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution. Microsoft distributes its competing streaming media server and tools products by bundling them with its Windows NT servers at no additional charge and by making them available for download from its website for free. While we also provide free downloads of certain of our products, including players, servers and tools, Microsoft's practices have caused, and may continue to cause, pricing pressure on our products. These practices have led in some cases, and could continue to lead to, longer sales cycles, decreased sales, loss of existing customers and reduced market share. In addition, we believe that Microsoft has used and may continue to use its monopoly position in the computer industry and its financial resources to secure preferential or exclusive distribution and bundling contracts for its streaming media products with third parties such as Internet service providers (ISPs), online service providers, content providers, entertainment companies, media companies, broadcasters, value added resellers (VARs) and original equipment manufacturers (OEMs), including third parties with whom we have relationships. In addition, Microsoft has invested significant sums of money in certain of our current and potential customers, and we expect this trend to continue, which may cause such customers to stop using or reduce their use of our products and services. Such arrangements, together with Microsoft's aggressive marketing of Windows NT and of its streaming media products, may reduce our share of the streaming media market. Microsoft's Windows Media Player competes with our RealPlayer products. The Windows Media Player is available for download from Microsoft's website for free, and is bundled by Microsoft with its Windows 98 operating system and with its Web browser, Internet Explorer. In addition, Microsoft has bundled certain audio capabilities into a radio toolkit for Internet Explorer 5.0, its latest Web browser. Internet Explorer 5.0 includes Web Events, which provides links to multimedia content on the Internet, especially content in Microsoft's streaming or digital media formats. We expect the Windows Media Player to be bundled with new versions of Windows to be released this year. We expect that by leveraging its monopoly position in operating systems and tying streaming or digital media into its operating system and its browser, Microsoft will distribute substantially more copies of the Windows Media Player in the future than it has in the past and may be able to attract more users to its streaming or digital media products. Currently, our RealPlayer has a high degree of market penetration: we have over 95 million unique registered users and estimate that more than 85% of all Web pages that use streaming media do so using our technology. Our market position will be difficult to sustain, particularly in light of Microsoft's efforts and dominant position in operating systems. In addition, Microsoft has invested in certain digital distribution technologies that compete with RealJukebox, such as the MusicMatch Jukebox. Microsoft bundles the MusicMatch Jukebox with the Microsoft Windows 98 Second Edition operating system. The MusicMatch Jukebox supports the Windows Media format, but not RealSystem G2 format. We also expect Microsoft to develop its own jukebox product or bundle jukebox capabilities into the Windows Media Player. Microsoft also supports and promotes other third party products competitive to our products. We expect Microsoft and other competitors to devote significantly greater resources to 10 11 product development in the jukebox and digital media categories. In addition, it may be difficult or impossible for us to license the Windows Media formats and other popular third party codec technology for use in our RealPlayer and RealJukebox products on terms equivalent to those offered to our competitors who do support the Windows Media format, which may harm the demand for and market for the RealPlayer and RealJukebox products. In addition, Microsoft competes with us to attract broadcasters of high quality or popular content to promote and deliver such content in Microsoft's formats, in some cases on an exclusive or preferential basis. We believe that Microsoft's commitment to and presence in the media delivery industry has increased and that Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution. In addition to Microsoft, we face increasing competition from other companies that are developing and marketing streaming media products. Apple Computer offers the QuickTime streaming media technology, including a free media player and a free streaming media server, and has made available free source code to the server under the conditions of Apple Computer's end user license agreement. We expect that Apple Computer will devote more resources to developing and marketing streaming media systems, and will seek to compete more vigorously with us in the marketplace. Other competitors include, but are not limited to, Cisco Systems/Precept Software, PictureTel/Starlight Networks and Oracle Corporation. Companies such as AOL and Yahoo! and many smaller competitors offer various products that compete with other player and jukebox products. As more companies enter the market with products that compete with our servers, players and tools, the competitive landscape could change rapidly to our disadvantage. We do not believe that clear standards have emerged with respect to non-PC wireless and cable-based systems. Likewise, no one company has gained a dominant position in the mobile device market. However, certain products and services in these markets support our technology, and certain support our competitors' technology, especially Microsoft, which can use its monopoly position in the operating system business and other financial resources to gain access to these markets, potentially to the exclusion of us. Other companies' products and services or new standards may emerge in any of these areas, which could reduce demand for our products or render them obsolete. In addition, our streaming media and media delivery products face competition from "fast download" media delivery technologies such as AVI, QuickTime and MP3. Other fast download or non-streaming IP-based content distribution methods are likely to emerge and could compete with our products and services, which could harm our business. Media Hosting. Our media hosting service, the Real Broadcast Network, competes with a variety of companies that provide streaming media hosting services. These companies include Yahoo! Broadcast Services (formerly Broadcast.com), Akamai/Intervu and emerging broadcast networks such as CMGI's Magnitude Network, Enron Communications, Global Media and Microcast. We may not establish or sustain our competitive position in this market segment. Some media hosting competitors are also customers on whom we rely to help drive product download traffic to our website through their broadcast events. We also sell servers and tools to competitors that compete with Real Broadcast Network. As our relationship becomes more competitive, such companies may choose to purchase less or more of our products or services. Microsoft does not currently offer its own media hosting services, but it does own investments in competitive hosting services and it encourages customers who use Microsoft technology to use hosting services that compete with Real Broadcast Network. Website Destinations, Content and Advertising. While Internet advertising revenues across the industry continue to grow, the number of websites competing for advertising revenues is also growing. Our websites, including Real.com, RealNetworks.com, Film.com and LiveConcerts.com, compete for user traffic and Internet advertising revenues with a wide variety of websites, Internet portals and ISPs. In particular, aggregators of audio, video and other media, such as Yahoo! Broadcast Services and Microsoft's Web Events, compete with our RealGuide. We also compete with traditional media such as television, radio and print for a share of advertisers' total advertising budgets. Our advertising sales force and infrastructure are still in early stages of development relative to those of our competitors. We cannot be certain that advertisers will place 11 12 advertising with us or that revenues derived from such advertising will be meaningful. If we lose advertising customers, fail to attract new customers, are forced to reduce advertising rates or otherwise modify our rate structure to retain or attract new customers, or if we lose website traffic, our business could be harmed. Electronic Commerce. The electronic commerce features of our websites compete with a variety of other websites for consumer traffic. To compete successfully in the electronic commerce market, we must attract sufficient traffic to our websites by offering high-quality, competitively priced, desirable merchandise in a compelling, easy-to-purchase format. In addition, we must successfully leverage our existing user base to develop the market for our products and services. We may not compete successfully in the growing and rapidly changing market for electronic commerce. Our failure to do so could harm our business. GOVERNMENT REGULATION We are not currently subject to direct regulation by any governmental agency other than laws and regulations generally applicable to businesses, although certain U.S. export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. Few existing laws or regulations specifically apply to the Internet. However, it is likely that a number of laws and regulations may be adopted in the United States and other countries with respect to the Internet. These laws may relate to areas such as content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, encryption, use of key escrow data, caching of content by server products, electronic authentication or "digital signatures," personal privacy, advertising, taxation, electronic commerce liability, e-mail, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability. Other countries and political organizations are likely to impose or favor more and different regulation than that which has been proposed in the United States, and state governments may impose regulations in addition to, inconsistent with or stricter than federal regulation, thus furthering the complexity of regulation. The adoption of such laws or regulations, and uncertainties associated with their validity and enforcement, may affect the available distribution channels for and costs associated with our products and services, and may affect the growth of the Internet. Such laws or regulations may therefore harm our business. We do not know for certain how existing laws governing issues such as property ownership, copyright and other intellectual property issues, taxation, illegal or obscene content, retransmission of media, and personal privacy and data protection apply to the Internet. The vast majority of such laws were adopted before the advent of the Internet and related technologies and do not address the unique issues associated with the Internet and related technologies. Most of the laws that relate to the Internet have not yet been interpreted. Changes to or the interpretation of these laws could: - limit the growth of the Internet; - create uncertainty in the marketplace that could reduce demand for our products and services; - increase our cost of doing business; - expose us to significant liabilities associated with content available on our websites or distributed or accessed through our products or services, with our provision of products and services, and with the features or performance of our products and websites; - lead to increased product development costs or otherwise harm our business; and - decrease the rate of growth of our user base and limit our ability to effectively communicate with and market to our user base. INTELLECTUAL PROPERTY As of January 31, 2000, we had 29 registered U.S. trademarks or service marks, and had applications pending for an additional 45 U.S. trademarks. We also have several unregistered trademarks. In addition, RealNetworks has several foreign trademark registrations and pending applications. Many of our marks begin with the word "Real" (such as RealSystem, RealAudio and RealVideo). We are aware of other companies 12 13 that use "Real" in their marks alone or in combination with other words, and we do not expect to be able to prevent all third-party uses of the word "Real" for all goods and services. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective patent, copyright, trademark and trade secret protection may not be available in such jurisdictions. As of January 31, 2000, we had 11 U.S. patents and numerous patent applications on file relating to various aspects of our technology. We are preparing additional patent applications on other features of our technology. Patents with respect to our technology may not be granted and, if granted, may be challenged or invalidated. Issued patents may not provide us with any competitive advantages and may be challenged by third parties. In addition, others could independently develop substantially equivalent intellectual property. Many of our current and potential competitors dedicate substantially greater resources to protection and enforcement of their intellectual property rights, especially patents. If a blocking patent has issued or issues in the future, we would need to either obtain a license or design around the patent. We may not be able to obtain such a license on acceptable terms, if at all, or design around the patent. As with other software products, our products are susceptible to unauthorized copying and uses that may go undetected, and policing such unauthorized use is difficult. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology, or may not prevent the development and design by others of products or technologies similar to or competitive with those we develop. EMPLOYEES At December 31, 1999, RealNetworks had 647 full-time employees and 1 part-time employee, 557 of whom were based at RealNetworks' executive offices in Seattle, Washington, 52 of whom were based at RealNetworks' offices in Japan, England, France, Canada, Germany, Brazil, Mexico or Australia and 39 of whom were sales personnel based at other locations. None of RealNetworks' employees is subject to a collective bargaining agreement, and RealNetworks believes that its relations with its employees are good. POSITION ON CHARITABLE RESPONSIBILITY RealNetworks is strongly committed to charitable responsibility, as evidenced by its donations of software to charitable organizations. For the quarter and year ended December 31, 1999, RealNetworks was profitable and accrued 5% of quarterly net income for charitable donation. If RealNetworks achieves sustained profitability, it intends to donate approximately 5% of its annual pre-tax net income to charitable organizations. RealNetworks hopes to encourage employee giving by using a portion of its intended contribution to match charitable donations made by employees. ITEM 2. PROPERTIES RealNetworks leases its corporate headquarters which are located in Seattle, Washington. The lease commenced on April 1, 1999 and expires on April 1, 2011, with an option to renew for either a three- or a ten-year period. RealNetworks is currently leasing approximately 179,000 square feet at an average monthly rent of approximately $255,000, and will be leasing approximately 87,000 square feet of additional space in stages during 2000 through 2001, at an average additional monthly rent of approximately $144,000. ITEM 3. LEGAL PROCEEDINGS In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit against us and co-defendant Broadcast.com in the United States District Court for the Northern District of Texas -- Dallas Division. The plaintiffs allege that we, individually and in combination with Broadcast.com, infringe on the plaintiffs' patent by making, using, selling and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. The plaintiffs seek to enjoin us from our alleged infringing 13 14 activity and to recover damages in an amount no less than a reasonable royalty. Although we can give no assurance as to the outcome of this lawsuit, we believe that the allegations in this action are without merit, and we intend to vigorously defend ourselves against these claims. We may be required to indemnify Broadcast.com under the terms of our license agreement with it. The plaintiffs filed a similar claim based on the same patent and seeking similar remedies as a separate lawsuit against Microsoft and Broadcast.com in the same court. The court has consolidated the lawsuit against Microsoft and Broadcast.com with the lawsuit against RealNetworks and Broadcast.com. If the plaintiffs prevail in their claims, we could be required to pay damages or other royalties, in addition to complying with injunctive relief, which could have a material adverse effect on our operating results. On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against us in the U.S. District Court for the Western District of Washington. The plaintiff alleges that we entered into an oral agreement with it in 1995 pursuant to which the plaintiff claims it is entitled to 30% of our revenues from the use of RealAudio technology to promote, sample or sell music. The plaintiff claims breach of contract, unjust enrichment, promissory estoppel and breach of implied-in-fact contract. We have denied each of the plaintiff's claims. In response to our motion to dismiss, the plaintiff withdrew its claim for breach of fiduciary duty. Trial is currently set for June 2000. Although no assurance can be given as to the outcome of this lawsuit, we believe the allegations in this action are without merit, and we intend to vigorously defend ourselves against these claims. If the plaintiffs prevail in their claims, we could be required to pay damages which could have a material adverse effect on our operating results. In response to various news reports relating to RealNetworks' privacy practices, between November 1999 and March 2000, a total of fourteen purported class action lawsuits were filed against us in state and/or federal courts in California, Illinois, Pennsylvania, Washington and Texas. The plaintiffs in federal court in Pennsylvania and in Illinois state court have voluntarily dismissed their lawsuits in response to our motions to compel arbitration of the claims under the terms of our End User License Agreements. The remaining twelve actions, which seek to certify classes of plaintiffs, allege breach of contract, invasion of privacy, deceptive trade practices, negligence, fraud and violation of certain federal and state laws in connection with various communications features of the RealPlayer and RealJukebox products. Plaintiffs are seeking both damages and injunctive relief. We have filed various answers denying the claims and have filed suit in Washington state court to compel the plaintiffs who have filed actions in Texas, California and Illinois state courts to arbitrate their claims as required by our End User License Agreements. On February 10, 2000, the federal district court for the Northern District of Illinois granted our motion to stay the court proceedings in that case because the claims are subject to arbitration under our End User License Agreements. Also on that date, the federal Judicial Panel on Multidistrict Litigation transferred all federal cases pending at that time to the federal court in Illinois that has ruled that the claims are arbitrable. Plaintiffs in the transferred federal cases are seeking to overturn the district court's ruling that the claims must be arbitrated. Although we can give no assurance as to the outcome of this lawsuit, we believe that the allegations in these actions are without merit, and we intend to vigorously defend ourselves against these claims. If the plaintiffs prevail in their claims, we could be required to pay damages or other penalties, in addition to complying with injunctive relief, which could have a material adverse effect on our operating results. From time to time we are, and expect to continue to be, subject to legal proceedings and claims in the ordinary course of our business, including contract-related claims and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, even if not meritorious, could force us to spend significant financial and managerial resources. We currently have several claims threatened against us relating to patent infringement, though we believe they are without merit. We currently are not aware of any legal proceedings or claims that we believe will have, individually or taken together, a material adverse effect on our business, prospects, financial condition and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of RealNetworks' shareholders during the fourth quarter of its fiscal year ended December 31, 1999. 14 15 ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of RealNetworks are elected annually at the meeting of the Board of Directors held in conjunction with the annual meeting of shareholders. The following are the current executive officers of RealNetworks:
NAME AGE POSITION ---- --- -------- Robert Glaser.......... 38 Chairman of the Board, Chief Executive Officer and Treasurer Thomas Frank........... 36 Chief Operating Officer Phillip Barrett........ 46 Senior Vice President -- Media Technologies Paul Bialek............ 40 Senior Vice President -- Finance and Operations and Chief Financial Officer Maria Cantwell......... 41 Senior Vice President -- Consumer and E-Commerce Len Jordan............. 33 Senior Vice President -- Media Systems Martin Plaehn.......... 42 Senior Vice President -- Media Systems
ROBERT GLASER has served as Chairman of the Board, Chief Executive Officer and Treasurer of RealNetworks since its inception in February 1994. He also serves as RealNetworks' Policy Ombudsman, with the exclusive authority to adopt or change the editorial policies of RealNetworks as reflected on its Web sites or in other communications or media in which RealNetworks has a significant editorial or media voice. From 1983 to 1993, Mr. Glaser was employed at Microsoft, most recently as Vice President of multimedia and consumer systems, where he focused on the development of new businesses related to the convergence of the computer, consumer electronics and media industries. Mr. Glaser holds a B.A. and an M.A. in Economics and a B.S. in Computer Science from Yale University. THOMAS FRANK has served as Chief Operating Officer since September 1999. From January 1999 to September 1999, Mr. Frank served as Senior Vice President -- Programming and Media Publishing of RealNetworks. From January 1995 to December 1998, Mr. Frank served as Senior Vice President of Dick Clark Productions, responsible for television program development and production. From 1992 to December 1995, Mr. Frank served as Vice President, Television Programming for The Leo Burnett Company, and was responsible for client sponsored programming. Mr. Frank previously held positions with Carolco Television and Proctor & Gamble Company. Mr. Frank holds a B.A. in English Literature from the University of Cincinnati. PHILLIP BARRETT has served as Senior Vice President -- Media Technologies of RealNetworks since July 1998. From January 1997 to July 1998, Mr. Barrett served as Senior Vice President -- Media Systems of RealNetworks, and from November 1994 to January 1997 he served as Vice President -- Software Development. From March 1986 to October 1994, Mr. Barrett was a Development Group Manager at Microsoft, where he led development efforts for Windows 386, Windows 3.0 and Windows 3.1. Mr. Barrett holds an A.B. in Mathematics from Rutgers University and an M.S. in Computer Sciences from the University of Wisconsin, Madison. PAUL BIALEK has served as Senior Vice President -- Finance and Operations and Chief Financial Officer of RealNetworks since June 1998. From March 1997 to June 1998, Mr. Bialek was Chief Financial Officer and Vice President of Finance and Operations with Metapath Software Corporation, a provider of operational support systems for telecommunications companies, marketing analysis and service providing systems. From 1993 to March 1997, Mr. Bialek was Chief Financial Officer and Vice President of Finance and Administration for Edmark Corporation, a developer and publisher of multimedia educational software products. Mr. Bialek started his career at KPMG LLP where he was employed in a variety of positions for 11 years. Mr. Bialek holds a B.A. in Business Administration from Seattle University and is a Certified Public Accountant. MARIA CANTWELL has served as Senior Vice President -- Consumer and E-Commerce of RealNetworks since July 1997. From April 1995 to July 1997, Ms. Cantwell served as Vice President -- Marketing of RealNetworks. From February 1995 to April 1995, Ms. Cantwell was a consultant to 15 16 RealNetworks. From 1992 to January 1995, Ms. Cantwell served as a member of the 103rd Congress. Ms. Cantwell holds a B.A. in Public Administration from Miami University. LEN JORDAN has served as Senior Vice President -- Media Systems of RealNetworks since January 1997. From November 1993 to November 1996, Mr. Jordan was employed at Creative Multimedia, Inc., a developer and publisher of CD-ROM/Internet products in a number of capacities, most recently as President. From September 1989 to November 1993, Mr. Jordan was employed at Central Point Software, Inc., a utility software publisher. Mr. Jordan graduated magna cum laude from the Eccles School of Business at the University of Utah with B.S. degrees in Finance and Economics. MARTIN PLAEHN has served as Senior Vice President -- Media Systems since September 1999. From April 1996 to August 1999, Mr. Plaehn served as President of Viewpoint Digital and its Chairman and CEO until its acquisition by Computer Associates in October 1998. From 1990 to 1996, Mr. Plaehn served as Executive Vice President of Business and Product Development and was a member of the Board of Directors of AliasXWavefront, a subsidiary of Silicon Graphics. Mr. Plaehn started his career as software developer at General Atomic Company in 1978, ISSCO Graphics in 1980, and Template Graphics Software from 1982 to 1990. Mr. Plaehn holds a B.A. degree from the University of California San Diego and is a graduate of UCSD's Executive Program for Scientists and Engineers. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock has been traded on the Nasdaq National Market under the symbol "RNWK" since the Company's initial public offering in November 1997. There is currently only a limited trading market for the shares of the Company's common stock and accordingly there is no assurance that any quantity of the common stock could be sold at or near reported trading prices. The following table sets forth for the periods indicated the high and low closing prices for the Company's common stock. These quotations represent prices between dealers and do not include retail markups, markdowns or commissions and may not necessarily represent actual transactions.
HIGH LOW ------- ------ Year Ended December 31, 1999 First Quarter..................................... $36.375 9.00 Second Quarter.................................... 65.938 25.500 Third Quarter..................................... 54.750 27.531 Fourth Quarter.................................... 93.000 43.875
HIGH LOW ------- ------ Year Ended December 31, 1998 First Quarter..................................... $ 7.438 3.375 Second Quarter.................................... 9.859 4.984 Third Quarter..................................... 12.063 3.813 Fourth Quarter.................................... 12.438 5.531
The Company has not paid any cash dividends and does not intend to pay any cash dividends in the foreseeable future. As of March 20, 2000, there were approximately 649 holders of record of the Company's common stock. Most shares of the Company's common stock are held by brokers and other institutions on behalf of shareholders. 16 17 RECENT SALES OF UNREGISTERED SECURITIES Between October 1, 1999 and December 31, 1999, RealNetworks issued unregistered securities as follows: (1) A warrant for the purchase of an aggregate of 3,500 shares of Common Stock was issued to one entity in December 1999 for promotional consideration. No underwriters were engaged in connection with this issuance. The transaction noted above was made in reliance upon the exemption from registration provided by either Section 3(b) or 4(2) of the Securities Act of 1933, as amended (the "Securities Act"). ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The information required by this Item is incorporated herein by reference to the information contained in the "Selected Consolidated Financial Data" section of the Company's 1999 Annual Report to Shareholders, which section is included in Exhibit 13.1 hereto. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item is incorporated herein by reference to the information contained in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of the Company's 1999 Annual Report to Shareholders, which section is included in Exhibit 13.1 hereto. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to the impact of interest rate changes and change in the market values of its investments. Interest Rate Risk. The Company's exposure to market rate risk for changes in interest rates relates primarily to the Company's short-term investment portfolio. The Company does not hold derivative financial instruments or equity investments in its short-term investment portfolio. The Company's cash equivalents and short-term investments consist of high quality securities, as specified in the Company's investment policy guidelines. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. The fair value of fixed rate securities may be adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, the Company's future interest income may be adversely impacted due to changes in interest rates. In addition, the Company may incur losses in principal if it is forced to sell securities which have declined in market value due to changes in interest rates. Because the Company has historically held its short-term investments until maturity and the substantial majority matures within one year of purchase, the Company would not expect its operating results or cash flows to be significantly impacted by a sudden change in market interest rates. Investment Risk. As of December 31, 1999, the Company had an investment in voting capital stock of a privately-held, technology company for business and strategic purposes. This investment is included in other assets and is accounted for under the cost method since ownership is less than 20% and the Company does not have significant influence. The securities do not have a quoted market price. The Company's policy is to regularly review the operating performance in assessing the carrying value of the investment. The Company reviews its long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is incorporated herein by reference to the " Consolidated Financial Statements" section of the Company's 1999 Annual Report to Shareholders, which section is included in Exhibit 13.1 hereto. 17 18 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is contained in part in the sections captioned "Board of Directors-Nominees for Director," "Board of Directors -- Continuing Directors Not Standing for Election This Year," "Board of Directors -- Contractual Arrangements" and "Voting Securities and Principal Holders-Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement for RealNetworks' Annual Meeting of Shareholders scheduled to be held on June 2, 2000, and such information is incorporated herein by reference. The remaining information required by this Item is set forth as Item 4A in Part I of this report under the caption "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the information contained in the section captioned "Compensation and Benefits" of the Proxy Statement for RealNetworks' Annual Meeting of Shareholders scheduled to be held on June 2, 2000. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the information contained in the sections captioned "Voting Securities and Principal Holders" of the Proxy Statement for RealNetworks' Annual Meeting of Shareholders scheduled to be held on June 2, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the information contained in the section captioned "Voting Securities and Principal Holders -- Certain Transactions" of the Proxy Statement for RealNetworks' Annual Meeting of Shareholders scheduled to be held on June 2, 2000. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS The following consolidated financial statements of RealNetworks, Inc. and subsidiaries are filed as part of this report: Consolidated Statements of Operations and Comprehensive Income (Loss) -- Years ended December 31, 1999, 1998 and 1997 Consolidated Balance Sheets -- December 31, 1999 and 1998 Consolidated Statements of Cash Flows -- Years ended December 31, 1999, 1998 and 1997 Consolidated Statements of Shareholders' Equity -- Years ended December 31, 1999, 1998 and 1997 Notes to Consolidated Financial Statements Independent Auditors' Report Report of Management 18 19 (a)(2) FINANCIAL STATEMENT SCHEDULES Schedule II: Valuation and Qualifying Accounts Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is included in the Consolidated Financial Statements or notes thereto. (b) REPORTS ON FORM 8-K None. (c) EXHIBITS The following exhibits are incorporated herein by reference or are filed with this report as indicated below: EXHIBIT NO. 2: PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION 2.1 Agreement and Plan of Merger among RealNetworks, Vivo Software, Inc. and RN Acquisition Corp. dated as of February 20, 1998 (incorporated by reference from Exhibit 2.1 to RealNetworks' Current Report on Form 8-K filed with the Securities and Exchange Commission on April 8, 1998) 2.2 Agreement and Plan of Merger by and among RealNetworks, Xing Technology Corporation, XTC Acquisition Corp. and certain shareholders of Xing dated as of April 12, 1999 (incorporated by reference from Exhibit 2.1 to RealNetworks' Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999 filed with the Securities and Exchange Commission on May 17, 1999) 2.3 Amendment No. 1 to Agreement and Plan of Merger among RealNetworks, Xing Technology Corporation, XTC Acquisition Corp. and certain shareholders of Xing dated as of July 28, 1999 (incorporated by reference from Exhibit 2.2 to RealNetworks' Current Report on Form 8-K filed with the Securities and Exchange Commission on August 23, 1999) 2.4 Agreement and Plan of Merger and Reorganization by and among RealNetworks, Inc., Varsity Acquisition Corp., NetZip, Inc., certain shareholders of NetZip, Inc. and ChaseMellon Shareholder Services, L.L.C., dated as of January 25, 2000 (incorporated by reference from Exhibit 2.1 to RealNetworks' Current Report on Form 8-K filed with the Securities and Exchange Commission on January 26, 2000) EXHIBIT NO. 3: ARTICLES OF INCORPORATION AND BYLAWS 3.1 Amended and Restated Articles of Incorporation (incorporated by reference from Exhibit 3.1 to RealNetworks' Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998 filed with the Securities and Exchange Commission on November 13, 1998) 3.2 Designation of Rights and Preferences of Series A Preferred Stock (incorporated by reference from Exhibit A to the Shareholder Rights Plan dated December 4, 1998 between RealNetworks and ChaseMellon Shareholder Services, L.L.C., filed as Exhibit 1 to RealNetworks' Registration Statement on Form 8-A12G filed with the Securities and Exchange Commission on December 14, 1998) 3.3 Amended and Restated Bylaws (incorporated by reference from Exhibit 3.2 to RealNetworks' Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998 filed with the Securities and Exchange Commission on November 13, 1998)
19 20 EXHIBIT NO. 4: INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS 4.1 Shareholder Rights Plan dated as of December 4, 1998 between RealNetworks and ChaseMellon Shareholder Services, L.L.C. (incorporated by reference from Exhibit 1 to RealNetworks' Registration Statement on Form 8-A12G filed with the Securities and Exchange Commission on December 14, 1998) 4.2 Amendment No. 1 dated as of January 21, 2000 to Shareholder Rights Plan between RealNetworks and ChaseMellon Shareholder Services, L.L.C. (incorporated by reference from Exhibit 1 to RealNetworks' Registration Statement on Form 8-A12G/A filed with the Securities and Exchange Commission on February 7, 2000) 4.3 Third Amended and Restated Investors' Rights Agreement dated March 24, 1998 by and among RealNetworks and certain shareholders of RealNetworks (incorporated by reference from Exhibit 10.16 to RealNetworks' Annual Report on Form 10-K for the year ended December 31, 1997 filed with the Securities and Exchange Commission on March 30, 1998) 4.4 Investor Rights Agreement dated as of March 31, 1999 between RealNetworks and the former shareholders of Ultisoft, Inc. (incorporated by reference from Exhibit 4.4 to RealNetworks' Registration Statement on Form S-3 filed with the Securities and Exchange Commission on July 28, 1999 (File No. 333-83939)) 4.5 Registration Rights Agreement dated as of December 2, 1999 by and among RealNetworks and BMG Music d/b/a BMG Entertainment North America 4.6 Declaration of Registration Rights made as of January 25, 2000 by RealNetworks for the benefit of the shareholders of NetZip, Inc. EXHIBIT NO. 10: MATERIAL CONTRACTS EXECUTIVE COMPENSATION PLANS AND AGREEMENTS 10.1 RealNetworks, Inc. 1995 Stock Option Plan (incorporated by reference from Exhibit 99.1 to RealNetworks' Registration Statement on Form S-8 filed with the Securities and Exchange Commission on September 14, 1998) 10.2 RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan (incorporated by reference from Exhibit 10.1 to RealNetworks' Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1998 filed with the Securities and Exchange Commission on November 13, 1998) 10.3 Vivo Software, Inc. 1993 Equity Incentive Plan (incorporated by reference from Exhibit 99.1 to RealNetworks' Registration Statement on Form S-8 filed with the Securities and Exchange Commission on May 20, 1998) 10.4 Form of Stock Option Agreement (incorporated by reference from Exhibit 10.4 to RealNetworks' Annual Report on Form 10-K for the year ended December 31, 1998 filed with the Securities and Exchange Commission on March 31, 1999) 10.5 1998 Employee Stock Purchase Plan, as amended and restated OTHER MATERIAL CONTRACTS 10.6 Lease dated January 21, 1998 between RealNetworks as Lessee and 2601 Elliott, LLC (incorporated by reference from Exhibit 10.1 to RealNetworks' Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1998 filed with the Securities and Exchange Commission on May 14, 1998) 10.7 Agreement between Microsoft Corporation and RealNetworks on Media Streaming Technology dated June 17, 1997 (incorporated by reference from Exhibit 10.10 to Amendment No. 4 of RealNetworks' Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 20, 1997 (File No. 333-36553))
20 21 10.8 Form of Director and Officer Indemnification Agreement (incorporated by reference from Exhibit 10.14 to Amendment No. 4 of RealNetworks' Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 20, 1997 (File No. 333-36553)) 10.9 Limited Proxy and Voting Agreement dated July 21, 1997 by and between RealNetworks and Microsoft Corporation (incorporated by reference from Exhibit 10.15 to Amendment No. 4 of RealNetworks' Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 20, 1997 (File No. 333-36553)) 10.10 Voting Agreement dated September 25, 1997 by and among RealNetworks, Robert Glaser, Accel IV L.P., Mitchell Kapor and Bruce Jacobsen (incorporated by reference from Exhibit 10.17 to Amendment No. 4 of RealNetworks' Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 20, 1997 (File No. 333-36553)) 10.11 Agreement dated September 26, 1997 by and between RealNetworks and Robert Glaser (incorporated by reference from Exhibit 10.18 to Amendment No. 4 of RealNetworks' Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 20, 1997 (File No. 333-36553)) 10.12 Representative License Agreement -- License Agreement for the RealPlayer Plus (incorporated by reference from Exhibit 10.21 to Amendment No. 4 of RealNetworks' Registration Statement on Form S-1 filed with the Securities and Exchange Commission on November 20, 1997 (File No. 333-36553)) EXHIBIT NO. 13: ANNUAL REPORT TO SECURITY HOLDERS 13.1 Portions of the RealNetworks, Inc. 1999 Annual Report to Shareholders for the year ended December 31, 1999 incorporated by reference hereto and filed herewith EXHIBIT NO. 21: SUBSIDIARIES OF THE REGISTRANT 21.1 Subsidiaries of RealNetworks EXHIBIT NO. 23: CONSENTS OF EXPERTS AND COUNSEL 23.1 Consent of KPMG LLP EXHIBIT NO. 24: POWER OF ATTORNEY 24.1 Power of Attorney (included on signature page) EXHIBIT NO. 27: FINANCIAL DATA SCHEDULE 27.1 Financial Data Schedule
21 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on March 28, 2000. REALNETWORKS, INC. By /s/ ROBERT GLASER ------------------------------------ Robert Glaser Chief Executive Officer POWER OF ATTORNEY Each person whose signature appears below hereby constitutes and appoints Robert Glaser and Paul Bialek, and each of them severally, his true and lawful attorneys-in-fact and agents, with full power to act without the other and with full power of substitution and resubstitution, to execute in his name and on his behalf, individually and in each capacity stated below, any and all amendments and supplements to this Report, and any and all other instruments necessary or incidental in connection herewith, and to file the same with the Commission. Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ ROBERT GLASER Chairman of the Board, Chief March 28, 2000 - ----------------------------------------------------- Executive Officer and Treasurer Robert Glaser (Principal Executive Officer) Senior Vice President, Finance & Operations and Chief Financial Officer /s/ PAUL BIALEK (Principal Financial Officer March 28, 2000 - ----------------------------------------------------- and Principal Accounting Paul Bialek Officer) /s/ EDWARD BLEIER Director March 28, 2000 - ----------------------------------------------------- Edward Bleier /s/ JAMES W. BREYER Director March 28, 2000 - ----------------------------------------------------- James W. Breyer /s/ BRUCE JACOBSEN Director March 28, 2000 - ----------------------------------------------------- Bruce Jacobsen /s/ MITCHELL KAPOR Director March 28, 2000 - ----------------------------------------------------- Mitchell Kapor
22 23 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders RealNetworks, Inc.: Under date of January 21, 2000, we reported on the consolidated balance sheets of RealNetworks, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive income (loss), shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999, which report is included in the 1999 annual report to shareholders of RealNetworks, Inc. These consolidated financial statements and our report thereon are incorporated by reference in the 1999 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule of valuation and qualifying accounts. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this consolidated financial statement schedule based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Seattle, Washington January 21, 2000 23 24 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS REALNETWORKS, INC. AND SUBSIDIARIES YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (IN THOUSANDS)
ADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD ----------- ---------- ---------- ---------- ---------- Year ended December 31, 1997: Valuation accounts deducted from assets Allowance for doubtful accounts receivable and sales returns........................ $ 540 $2,294 $(1,848) $ 986 Year ended December 31, 1998: Valuation accounts deducted from assets Allowance for doubtful accounts receivable and sales returns........................ 986 4,653 (4,295) 1,344 Year ended December 31, 1999: Valuation accounts deducted from assets Allowance for doubtful accounts receivable and sales returns........................ 1,344 5,569 (4,931) 1,982
24 25 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 4.5 Registration Rights Agreement dated as of December 2, 1999 by and among RealNetworks and BMG Music d/b/a BMG Entertainment North America 4.6 Declaration of Registration Rights made as of January 25, 2000 by RealNetworks for the benefit of the shareholders of NetZip, Inc. 10.5 1998 Employee Stock Purchase Plan, as amended and restated 13.1 Portions of the RealNetworks, Inc. 1999 Annual Report to Shareholders for the year ended December 31, 1999 incorporated by reference hereto and filed herewith 21.1 Subsidiaries of RealNetworks 23.1 Consent of KPMG LLP 27.1 Financial Data Schedule
25 EX-4.5 2 REGISTRATION RIGHTS AGREEMENT DATED 12/2/1999 1 EXHIBIT 4.5 REGISTRATION RIGHTS AGREEMENT THIS AGREEMENT is made as of December 2, 1999 (the "Agreement"), by and among RealNetworks, Inc., a Washington corporation ("RealNetworks"), and BMG Music d/b/a BMG Entertainment North America (the "Holder"). RECITALS A. As of the date of this Agreement, the Holder holds a warrant (the "Warrant") to purchase 1,750 shares of common stock of RealNetworks (the "RealNetworks Common Stock"). B. RealNetworks and the Holder wish to establish an arrangement whereby, under certain circumstances, the Holder can effect an orderly distribution of the shares of RealNetworks Common Stock owned by the Holder. C. The Board of Directors of RealNetworks has determined that it is in the best interests of RealNetworks and its shareholders to enter into this Agreement. D. The Holder has determined that it is in its best interest to enter into this Agreement. NOW THEREFORE, in consideration of the foregoing and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Certain Definitions. For purposes of this Agreement, the following terms shall have the following respective meanings: (a) "Commission" shall mean the United States Securities and Exchange Commission, or any other federal agency at the time administering the Exchange Act or the Securities Act, whichever is the relevant statute for the particular purpose. (b) "Effective Time" shall mean the date on which the Commission declares the Registration Statement effective or on which the Registration Statement otherwise becomes effective. (c) "Exchange Act" shall mean the Securities Exchange Act of 1934, or any successor thereto, as the same shall be amended from time to time. (d) "Holder's Requisite Information" shall have the meaning set forth in Section 3(h) hereof. (e) "person" means, where applicable, an individual, a partnership, a corporation, a limited liability company, an association, a joint stock company, a trust, a joint venture, an 2 unincorporated organization and a governmental entity or any department, agency or political subdivision thereof. (f) "Prospectus" means the prospectus included in the Registration Statement (including, without limitation, a prospectus that discloses information previously omitted from a prospectus filed as part of an effective registration statement in reliance upon Rule 430A under the Securities Act), as amended or supplemented by any prospectus supplement. (g) "RealNetworks Common Stock" shall have the meaning set forth in the recitals to this Agreement. (h) "Register." The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act, and the declaration or ordering of the effectiveness of such registration statement by the Commission. (i) "Registrable Securities" means (i) up to 1,750 shares of RealNetworks Common Stock issuable upon exercise of the Warrant held by the Holder as of the date of this Agreement and (ii) any other securities issuable in respect of the shares of RealNetworks Common Stock issuable upon exercise of the Warrant (including, without limitation, by reason of a stock split, stock dividend, recapitalization, merger, consolidation or similar event). Notwithstanding the foregoing, shares of RealNetworks Common Stock and such other securities shall only be treated as Registrable Securities if and so long as they have not been sold to or through a broker or dealer or underwriter in a public distribution or a sale pursuant to Rule 144 or Rule 145. (j) "Registration Expenses" shall mean all expenses, except as otherwise stated below, incurred by RealNetworks in complying with Sections 2 and 3 hereof, including, without limitation, the registration, qualification and filing fees, printing expenses, escrow fees, fees and disbursements of counsel and accountants for RealNetworks, blue sky fees and expenses and all internal expenses of RealNetworks (including, without limitation, all salaries and expenses of its officers and employees performing legal or accounting duties). (k) "Registration Statement" shall mean the registration statement of RealNetworks filed with the Commission which covers the Registrable Securities on an appropriate form under the Securities Act, together with all amendments and supplements to such registration statement, including post-effective amendments, including the Prospectus contained therein, all exhibits thereto and all material incorporated by reference into the registration statement, all amendments and supplements and the Prospectus. (l) "Securities Act" shall mean the Securities Act of 1933, or any successor thereto, as the same shall be amended from time to time. (m) "Selling Expenses" shall mean all underwriting discounts, selling commissions and stock transfer taxes applicable to the Registrable Securities. (n) "Underwriter" means any underwriter of Registrable Securities in connection with an offering thereof. -2- 3 2. RealNetworks Registration. (a) Notice of Registration. If at any time or from time to time RealNetworks shall determine to register any of its equity securities, either for its own account or the account of a security holder or holders, other than (x) a registration relating solely to employee benefits plans, or (y) a registration relating solely to a Rule 145 transaction, RealNetworks will: (1) promptly give to the Holder written notice thereof; and (2) include in such registration (and any related qualification under blue sky laws or other compliance), and in any underwriting involved therein, all the Registrable Securities specified in a written request by the Holder made within ten (10) business days after receipt of such written notice from RealNetworks. (b) Underwriting. If the registration of which RealNetworks gives notice is for a registered public offering involving an underwriting, RealNetworks shall so advise the Holder as a part of the written notice given pursuant to Section 2(a). In such event, the right of the Holder to registration pursuant to this Section 2 shall be conditioned upon the Holder's participation in such underwriting and the inclusion of Registrable Securities in the underwriting to the extent provided herein. In such event, the Holder shall (together with RealNetworks and the other holders of RealNetworks Common Stock distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the Underwriters selected for such underwriting by RealNetworks. Notwithstanding any other provision of this Section 2, if the managing underwriter determines that marketing factors require a limitation of the number of shares to be underwritten, the managing underwriter may limit the Registrable Securities to be included in such registration. RealNetworks shall so advise the Holder and other holders distributing their securities through such underwriting and the number of shares of Registrable Securities that may be included in the registration and underwriting shall be reduced to an amount reasonably acceptable to the managing underwriter. If the Holder disapproves of the terms of any such underwriting, it may elect to withdraw therefrom by written notice to RealNetworks and the managing underwriter. (c) Right to Terminate Registration. RealNetworks shall have the right to terminate or withdraw any registration initiated by it pursuant to Section 2 prior to the effectiveness of such registration whether or not the Holder has elected previously to include securities in such registration. 3. Registration Procedures. In connection with the Registration Statement, the following provisions shall apply: (a) RealNetworks shall, if necessary, supplement or make amendments to the Registration Statement, if required by the rules, regulations or instructions applicable to the registration form used by RealNetworks for the Registration Statement or by the Securities Act or the rules or regulations thereunder. (b) RealNetworks shall take such action as may be necessary so that (i) the Registration Statement, and any amendment thereto, and any Prospectus forming a part thereof, and -3- 4 any amendment or supplement thereto (and each report or other document incorporated therein by reference in each case) complies in all material respects with the Securities Act and the Exchange Act and the respective rules and regulations thereunder, (ii) the Registration Statement, and any amendment thereto, does not, when it becomes effective, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading and (iii) any Prospectus forming part of the Registration Statement, and any amendment or supplement to such Prospectus, does not include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading. (c) RealNetworks shall advise the Holder and, if requested by the Holder, confirm such advice in writing: (i) when the Registration Statement, and any amendment thereto, has been filed with the Commission and when the Registration Statement or any post-effective amendment thereto has become effective; (ii) of the issuance by the Commission of any stop order suspending effectiveness of the Registration Statement or the initiation of any proceedings for that purpose; and (iii) of the receipt by RealNetworks of any notification with respect to the suspension of the qualification of the securities included in the Registration Statement therein for sale in any jurisdiction or the initiation of any proceeding for such purpose. (d) RealNetworks shall use its reasonable efforts to prevent the issuance, and, if issued, to obtain the withdrawal, of any order suspending the effectiveness of the Registration Statement at the earliest possible time. (e) RealNetworks shall furnish to the Holder at least one copy of the Registration Statement and any post-effective amendments thereto, including financial statements and schedules contained therein. (f) RealNetworks shall register or qualify or cooperate with the Holder in connection with the registration or qualification of the Registrable Securities for offer and sale under the securities or blue sky laws of such jurisdictions in the United States as the Holder reasonably request in writing and do any and all other acts or things necessary or advisable to enable the offer and sale in such jurisdictions of the Registrable Securities covered by the Registration Statement; provided, however, that in no event shall RealNetworks be obligated to (i) qualify generally to do business or as a foreign corporation or as a dealer in securities in any jurisdiction where it would not otherwise be required to so qualify but for this Section 3(f), (ii) file any general consent to service of process in any jurisdiction where it is not as of the date hereof then so subject or (iii) subject itself to taxation in any such jurisdiction if it is not so subject. (g) RealNetworks may require the Holder to furnish to RealNetworks such information regarding the Holder (which shall not include information regarding RealNetworks -4- 5 required to be included by RealNetworks in the Registration Statement) and the distribution by the Holder of such Registrable Securities as is required by law to be disclosed in the Registration Statement (the "Holder's Requisite Information"). (h) RealNetworks will use its best efforts to cause the Registrable Securities to be listed on the Nasdaq National Market (or such other national securities exchange on which the RealNetworks Common Stock is then listed) on or prior to the effective date of the Registration Statement hereunder. (i) RealNetworks shall deliver to the Holder as many copies of the Prospectus (including each preliminary prospectus) included in the Registration Statement and any amendment or supplement thereto as the Holder may reasonably request, and RealNetworks consents (except upon and during the continuance of any event described in Section 3(c)(ii) or (iii)) to the use of the Prospectus or any amendment or supplement thereto by the Holder in connection with the offering and sale or delivery of the Registrable Securities covered by the Prospectus or any amendment or supplement thereto pursuant to the Registration Statement. 4. Registration Expenses. All Registration Expenses incident to RealNetworks' performance of or compliance with this Agreement shall be paid by RealNetworks. The Holder shall pay all Selling Expenses incurred by the Holder in connection with the registration and distribution of the Registrable Securities. 5. Additional Covenants of RealNetworks. RealNetworks agrees with the Holder that, with a view to making available the benefits of certain rules and regulations of the Commission which may at any time permit the sale of the Registrable Securities to the public without registration, RealNetworks will use its reasonable efforts to: (a) Make and keep public information available, as those terms are understood and defined in Rule 144 under the Securities Act, at all times after the effective date on which the Company becomes subject to the reporting requirements of the Securities Act or the Exchange Act, or any similar federal statute and the rules and regulations promulgated thereunder, all as the same shall be in effect at the time; (b) Use its best efforts to file with the Commission in a timely manner all reports and other documents required of RealNetworks under the Securities Act and the Exchange Act; and (c) So long as the Holder owns any Registrable Securities, to furnish to the Holder forthwith upon request a written statement by RealNetworks as to its compliance with the reporting requirements of said Rule 144 and of the Securities Act and the Exchange Act, a copy of the most recent annual or quarterly report of RealNetworks and such other reports and documents of RealNetworks and other information in the possession of or reasonably obtainable by RealNetworks as the Holder may reasonably request in availing itself of any rule or regulation of the Commission allowing the Holder to sell any such securities without registration. 6. Representations and Warranties of the Holder. The Holder represents and warrants to RealNetworks that this Agreement has been duly authorized, executed and delivered by the Holder. -5- 6 7. Indemnification. (a) Indemnification by RealNetworks. RealNetworks shall, and it hereby agrees to, indemnify and hold harmless the Holder, each person, if any, who controls the Holder within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act and each of their respective directors, officers, employees, trustees and agents (collectively, the "Holder's Indemnified Parties"), against any losses, claims, damages or liabilities, joint or several, to which the Holder's Indemnified Parties may become subject, under the Securities Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in the Registration Statement, or any preliminary, final or summary Prospectus contained therein or furnished by RealNetworks to the Holder, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and RealNetworks shall, and it hereby agrees to, reimburse the Holder's Indemnified Parties for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such action or claim as such expenses are incurred; provided, however, that the indemnity agreement contained in this Section 7(a) shall not apply to amounts paid in settlement of any such losses, claims, damages or liabilities if such settlement is effected without the consent of RealNetworks (which consent shall not be unreasonably withheld); provided, further, that, in the case of the Holder, RealNetworks shall not be liable to any such person in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, or preliminary, final or summary prospectus, or amendment or supplement in reliance upon and in conformity with written information furnished to RealNetworks by such person expressly for use therein; provided, further, that, RealNetworks shall not be liable in any such case to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any preliminary prospectus if (i) the Holder failed to send or deliver a copy of the Prospectus with or prior to the delivery of written confirmation of the sale of Registrable Securities and (ii) the Prospectus corrected such untrue statement or omission; and provided, further, RealNetworks shall not be liable to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission in the Prospectus, if such untrue statement or alleged untrue statement, omission, or alleged omission is corrected in an amendment or supplement to the Prospectus and if having previously been furnished by or on behalf of the Holder with copies of the Prospectus as so amended or supplemented, the Holder thereafter fail to deliver such Prospectus as so amended or supplemented prior to or concurrently with the sale of Registrable Securities to the person asserting such loss, claim, damage, liability or expense who purchased such Registrable Securities which is the subject thereof from the Holder. (b) Indemnification by the Holder. The Holder shall indemnify and hold harmless RealNetworks and each person, if any, who controls RealNetworks within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act and each of their respective directors, officer, employees, trustees and agents (collectively, the "RealNetworks Indemnified Parties") against any losses, claims, damages or liabilities to which the RealNetworks Indemnified Parties may become subject, under the Securities Act or otherwise, insofar as such losses, claims, damages -6- 7 or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in the Registration Statement, or any preliminary, final or summary Prospectus contained therein or furnished by RealNetworks to the Holder, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to RealNetworks by the Holder expressly for use therein, and the Holder shall, and hereby agree to, reimburse the RealNetworks Indemnified Parties for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such action or claim as such expenses are incurred; provided, however, that the indemnity agreement contained in this Section 7(b) shall not apply to amounts paid in settlement of any such losses, claims, damages or liabilities if such settlement is effected without the consent of the Holder (which consent shall not be unreasonably withheld). Notwithstanding the provisions of this Section 7(b), the Holder shall not be liable to RealNetworks Indemnified Parties pursuant to Section 7(b) in an amount in excess of the proceeds received by it from the sale of the Registrable Securities (after deducting any fees, discounts and commissions applicable thereto) registered by the Registration Statement. (c) Notices of Claims, Etc. Promptly after receipt by an indemnified party under Section 7(a) or 7(b) above of written notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against an indemnifying party pursuant to the indemnification provisions of or contemplated by this Section 7, notify such indemnifying party in writing of the commencement of such action; but the omission so to notify the indemnifying party shall not relieve it from any liability which it may have to any indemnified party other than under the indemnification provisions of or contemplated by Section 7(a) or 7(b) hereof. In case any such action shall be brought against any indemnified party and it shall notify an indemnifying party of the commencement thereof, such indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel satisfactory to such indemnified party (who shall not, except with the consent of the indemnified party, be counsel to the indemnifying party), and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, such indemnifying party shall not be liable to such indemnified party for any legal expenses of other counsel or any other expenses, in each case subsequently incurred by such indemnified party, in connection with the defense thereof other than reasonable costs of investigation. (d) Contribution. Each party hereto agrees that, if for any reason the indemnification provisions contemplated by Section 7(a) or Section 7(b) are unavailable to or insufficient to hold harmless an indemnified party in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative fault of the indemnifying party and the indemnified party in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations. The relative fault of such indemnifying party and indemnified party shall be determined by reference to, among other things, -7- 8 whether the untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by such indemnifying party or by such indemnified party, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The parties hereto agree that it would not be just and equitable if contributions pursuant to this Section 7(d) were determined by pro rata allocation (even if the Holder's Indemnified Parties were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in this Section 7(d). The amount paid or payable by an indemnified party as a result of the losses, claims, damages, or liabilities (or actions in respect thereof) referred to above shall be deemed to include any legal or other fees or expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 7(d), the Holder shall not be required to contribute any amount in excess of the amount by which the dollar amount of the proceeds received by it from the sale of the Registrable Securities (after deducting any fees, discounts and commissions applicable thereto) registered by the Registration Statement exceeds the amount of any damages which the Holder would have otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. (e) The indemnification provided for under this Agreement shall remain in full force and effect regardless of any investigation made by or on behalf of the indemnified party or any officer, director or controlling Person of such indemnified party and shall survive the transfer of securities. 8. Limitations on Registration Rights. RealNetworks shall have no obligations pursuant to Section 2 hereof if, in the reasonable opinion of RealNetworks and its counsel, Registrable Securities held by the Holder may be sold in a three-month period without registration pursuant to the Securities Act in accordance with Rule 144 or Rule 145 promulgated pursuant to the Securities Act. 9. Miscellaneous. (a) Remedies. Any Person having rights under any provision of this Agreement shall be entitled to enforce such rights specifically to recover damages caused by reason of any breach of any provision of this Agreement and to exercise all other rights granted by law. The parties hereto agree and acknowledge that money damages may not be an adequate remedy for any breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity of competent jurisdiction (without posting any bond or other security) for specific performance and for other injunctive relief in order to enforce or prevent violation of the provisions of this Agreement. (b) Amendments and Waivers. Except as otherwise provided herein, the provisions of this Agreement may be amended or waived only upon the prior written consent of RealNetworks and the Holder. -8- 9 (c) Successors and Assigns. All covenants and agreements in this Agreement by or on behalf of any of the parties hereto shall bind and inure to the benefit of the respective successors and assigns of the parties hereto whether so expressed or not. The Holder's rights pursuant to this Agreement may not be assigned without the prior written consent of RealNetworks. (d) Severability. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement is held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of this Agreement. (e) Counterparts. This Agreement may be executed simultaneously in two or more counterparts (including by means of telecopied signature pages), any one of which need not contain the signatures of more than one party, but all such counterparts taken together shall constitute one and the same Agreement. (f) Descriptive Headings. The descriptive headings of this Agreement are inserted for convenience only and do not constitute a part of this Agreement. (g) Governing Law. All issues and questions concerning the construction, validity, interpretation and enforcement of this Agreement and the exhibits and schedules hereto shall be governed by, and construed in accordance with, the laws of the State of Washington, without giving effect to any choice of law or conflict of law rules or provisions (whether of the State of Washington or any other jurisdiction) that would cause the application of the laws of any jurisdiction other than the State of Washington. (h) Notices. All notices and other communications required or permitted hereunder shall be in writing, shall be effective when given, and shall in any event be deemed to be given upon receipt or, if earlier, (i) five (5) days after deposit with the U.S. Postal Service or other applicable postal service, if delivered by first class mail, postage prepaid, (ii) upon delivery, if delivered by hand, (iii) one business day after the business day of deposit with Federal Express or similar overnight courier, freight prepaid or (iv) one business day after the business day of facsimile transmission, if delivered by facsimile transmission with copy by first class mail, postage prepaid, and shall be addressed as follows, or at such other address as a party may designate by ten (10) days' advance written notice to the other parties to this Agreement pursuant to the provisions of this Section 9: (x) if to RealNetworks, to: RealNetworks, Inc. 2601 Elliott Avenue Seattle, Washington 98121 Facsimile: (206) 674-2695 Attention: Kelly Jo MacArthur, General Counsel -9- 10 With a copy to Wilson Sonsini Goodrich & Rosati 5300 Carillon Point Kirkland, Washington 98033 Facsimile: (425) 576-5899 Attention: Patrick J. Schultheis, Esq. (y) if to Holder, to: BMG Music d/b/a BMG Entertainment North America 1540 Broadway New York, New York 10036 Facsimile: (212) 930-4946 Attention: Senior Vice President of Worldwide Marketing With a copy to: BMG Music d/b/a BMG Entertainment North America 1540 Broadway New York, New York 10036 Facsimile: (212) 930-4029 Attention: General Counsel and Senior Vice President of Legal & Business Affairs -10- 11 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first written above. REALNETWORKS, INC. a Washington corporation By: /s/ Robert Glaser ------------------------------------------- Title: Chief Executive Officer HOLDER BMG MUSIC d/b/a BMG Entertainment North America By: /s/ Bill Wilson ------------------------------------------- Title: Vice President, Worldwide Marketing -11- EX-4.6 3 DECLARATION OF REGISTRATION RIGHTS 1 EXHIBIT 4.6 REALNETWORKS, INC. DECLARATION OF REGISTRATION RIGHTS This Declaration of Registration Rights ("Declaration") is made as of January 25, 2000, by RealNetworks, Inc., a Washington corporation ("Parent"), for the benefit of shareholders of NetZip, Inc, a Georgia corporation (the "Company"), acquiring shares of Parent Common Stock pursuant to that Agreement and Plan of Merger and Reorganization dated as of January 25, 2000 (the "Reorganization Agreement"), among the Company, Parent and Varsity Acquisition Corp., a Georgia corporation and wholly-owned subsidiary of Parent ("Merger Sub"), and pursuant to the related Agreement of Merger (the "Agreement of Merger") between the Company and Merger Sub and in consideration of such shareholders' approving the principal terms of the Reorganization Agreement and the transactions contemplated thereby. 1. Definitions. As used in this Declaration: (a) "Effective Time" means the time of acceptance by the Georgia Secretary of State of the Certificate of Merger referred to in Section 12.2 of the Reorganization Agreement. (b) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (c) "Form S-3" means such form under the Securities Act as is in effect on the date hereof or any registration form under the Securities Act subsequently adopted by the SEC which similarly permits inclusion or incorporation of substantial information by reference to other documents filed by Parent with the SEC. (d) "Holder" means a shareholder of the Company to whom shares of Common Stock of Parent are issued pursuant to the Reorganization Agreement and the Agreement of Merger or a transferee to whom registration rights granted under this Declaration are assigned pursuant to Section 6 of this Declaration. (e) "Registrable Securities" means for each Holder the number of shares of Parent Common Stock issued to such Holder pursuant to the Reorganization Agreement, and for all Holders the sum of the Registrable Securities held by them; provided, however, that such shares of Parent Common Stock held by a particular Holder shall cease to be Registrable Securities (i) after a registration statement on Form S-3 with respect to the sale of such securities shall have been declared effective under the Securities Act and such securities shall have been disposed of in accordance with such registration statement and with Section 2 hereof or (ii) at such time as such Holder is able to sell such shares (including all Registrable Securities held by Affiliates of such Holder, as defined pursuant to Rule 144 of the Securities Act) in their entirety within a single 90 day period under Rule 144 of the Securities Act. 2 (f) "Securities Act" means the Securities Act of 1933, as amended. (g) "SEC" means the United States Securities and Exchange Commission. Terms not otherwise defined herein have the meanings given to them in the Reorganization Agreement. 2. Registration on Form S-3. (a) Parent shall use its best efforts to cause the Registrable Securities then held by each Holder to be registered under the Securities Act so as to permit the sale thereof, and in connection therewith shall prepare and file with the SEC within 30 days of the Effective Time, a registration statement on Form S-3 (or any successor form to Form S-3, or if Form S-3 is not available, another appropriate form) covering all Registrable Securities; provided, that each Holder shall provide all such information and materials regarding such Holder and take all such action as may be required by a Holder under applicable laws and regulations in order to permit Parent to comply with all applicable requirements of the Securities Act and the Exchange Act and to obtain any desired acceleration of the effective date of such registration statement, such provision of information and materials to be a condition precedent to the obligations of Parent pursuant to this Declaration to register the Registrable Securities held by each such Holder. The offerings made pursuant to such registration shall not be underwritten. (b) Parent shall (i) prepare and file with the SEC the registration statement in accordance with Section 2 hereof with respect to the Registrable Securities and shall use commercially reasonable efforts to cause such registration statement to become effective as promptly as practicable after filing and to keep such registration statement effective until the sooner to occur of (A) the date on which all Registrable Securities included within such registration statement have been sold or (B) the expiration of twelve (12) months after such registration statement has been declared effective (the "Termination Date"); (ii) prepare and file with the SEC such amendments to such registration statement and amendments or supplements to the prospectus used in connection therewith as may be necessary to comply with the provisions of the Securities Act with respect to the sale or other disposition of all securities registered by such registration statement; (iii) furnish to each Holder such number of copies of any prospectus (including any preliminary prospectus and any amended or supplemented prospectus) in conformity with the requirements of the Securities Act, and such other documents, as each Holder may reasonably request in order to effect the offering and sale of the Registrable Securities to be offered and sold, but only while Parent shall be required under the provisions hereof to cause the registration statement to remain effective; (iv) use commercially reasonable efforts to register or qualify the Registrable Securities covered by such registration statement under the securities or blue sky laws of such jurisdictions as each Holder shall reasonably request (provided that Parent shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such jurisdiction where it has not been qualified or is not otherwise subject to a general consent for service of process), and do any and all other acts or things which may be necessary or advisable to enable each Holder to consummate the public sale or other disposition of such Registrable Securities in such jurisdictions; and (v) notify each Holder, promptly after it shall receive notice thereof, of the date and -2- 3 time the registration statement and each post-effective amendment thereto has become effective or a supplement to any prospectus forming a part of such registration statement has been filed. (c) Notwithstanding the foregoing obligation of Parent under this Section 2, if Parent shall furnish to the Shareholder Representative (as defined in the Reorganization Agreement) a certificate signed by the President of Parent stating that in the good faith judgment of Parent, it would be detrimental to Parent and its stockholders for such registration statement to be filed at such time and it is therefore essential to defer the filing of such registration statement, Parent shall have the right to defer such filing for a period of not more than 30 days beyond the date specified under Section 2(a) above. As of the date hereof, Parent is not aware of any facts which would cause it to exercise its rights under this subsection if Parent were otherwise obligated to file such registration statement on the date hereof. 3. Notice of Sale. (a) If a Holder of Registrable Securities proposes to dispose of Registrable Securities, such Holder shall cause to be delivered to Parent notice of such proposed disposition at least five (5) days prior to effecting such disposition (the "Disposal Notice"). The Disposal Notice shall identify the Holder, the number of shares proposed to be transferred and the date on which such disposition is proposed to be effected. The Disposal Notice must be delivered to the person(s) designated on Exhibit A hereto (or such additional or alternative persons designated in Parent by delivery of such designation in writing to the Shareholders' Representative), which exhibit shall contain the name and other contact information of such designated person(s); provided the information on Exhibit A may be amended by Parent by providing written notice of such change to the Shareholder Representative. Unless Parent agrees otherwise (with such agreement confirmed by e-mail or in writing), in order for a Disposal Notice to be valid, it must be received between the hours of 9:00 a.m. and 5:00 p.m. Seattle, Washington time. The Disposal Notice shall be delivered telephonically, by the Holder or his/her representative talking directly with the employee of Parent designated as the appropriate recipient of Disposal Notices (the time of day of Parent's receipt of such telephonic delivery, the "Receipt Time"). Parent shall exercise good faith efforts to respond to the Holder by the Receipt Time on the business day next following the day the Disposal Notice was received by Parent, but not later than at the Receipt Time on the second business day after the day of Parent's receipt of the Disposal Notice. Such response shall indicate whether Parent approves of the proposed disposition of Registrable Securities described in the Disposal Notice (such response, a "Response Notice"). For purposes of this Declaration, a "business day" shall mean a day on which banks are generally open for business in Seattle, Washington. The Response Notice may be preliminarily delivered telephonically, provided that such Response Notice is validly delivered only in writing; provided that e-mail delivery shall be considered a "writing" for this purpose. The Response Notice shall indicate whether the disposition is approved or disapproved. Parent may disapprove of a proposed disposition of Registrable Securities, and a Holder will not be able to dispose of such Registrable Securities, if (a) Parent shall have determined that a delay in the disposition of such Registrable Securities is necessary because Parent, in its reasonable judgment, has determined in good faith that such sales would require public disclosure by Parent of material nonpublic information that is not included in such registration statement and that immediate disclosure of such information would be detrimental to the Company or (b) such proposed -3- 4 disposition of Registrable Securities is proposed to be effected during the periods during which Parent restricts transactions in its securities by its officers pursuant to a written policy setting forth such restrictions. As of the date hereof, Parent is not aware of any facts that would cause it to exercise its right to restrict disposition if a request to dispose were received on the date hereof. If Parent responds to a Disposal Notice by timely causing to be delivered to the Holder a Response Notice approving of the proposed disposition or if Parent fails to timely cause to be delivered to the Holder a Response Notice satisfying the delivery requirements described above with respect to a Disposal Notice, the Holder identified in the Disposal Notice may dispose of Registrable Securities during the five (5) business day period (or such shorter period as is specified in the Response Notice) (the "Trading Period" for such proposed disposition) immediately following the Trading Period Start Date (as defined below) with respect to the Disposal Notice. "Trading Period Start Date" with respect to a Disposal Notice shall mean (i) in the case of a proposed disposition for which a Response Notice approving of the disposition is timely delivered, the date on which the Parent causes the Response Notice approving the disposition described in the Disposal Notice to be delivered to the Holder or (ii) in the case of a proposed disposition for which a Response Notice is not timely delivered, the last day on which such Response Notice could have been timely delivered. If a Holder does not dispose of Registrable Securities during the Trading Period for such proposed disposition, a new Disposal Notice for such disposition must be delivered. (b) The provisions of Section 2(b) shall apply only with respect to a Holder's disposition of shares of Parent Common Stock which are, at the time of such disposition, Registrable Securities as defined in this Declaration. 4. Expenses. All of the out-of-pocket expenses incurred in connection with any registration of Registrable Securities pursuant to this Declaration, including, without limitation, all SEC, Nasdaq National Market and blue sky registration and filing fees, printing expenses, transfer agents' and registrars' fees and the reasonable fees and disbursements of Parent's outside counsel and independent accountants shall be paid by Parent. Parent shall not be responsible to pay any legal fees for any Holder or any selling expenses of any Holder (including, without limitation, any broker's fees or commissions). 5. Indemnification. In the event of any offering registered pursuant to this Declaration: (a) Parent will indemnify each Holder, each of its officers, directors and partners and such Holder's legal counsel, and each person controlling such Holder within the meaning of Section 15 of the Securities Act (each, a "Seller Indemnified Party"), with respect to which registration, qualification or compliance has been effected pursuant to this Declaration, against all expenses, claims, losses, damages and liabilities (or actions in respect thereof), including any of the foregoing incurred in settlement of any litigation, commenced or threatened, arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any registration statement, prospectus, offering circular or other document, or any amendment or supplement thereto, incident to any such registration, qualification or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading, or any violation by Parent of any rule or regulation promulgated under the Securities Act, or state securities -4- 5 laws, or common law, applicable to Parent in connection with any such registration, qualification or compliance, and will reimburse each Seller Indemnified Party for any legal and any other expenses reasonably incurred in connection with investigating, preparing or defending any such claim, loss, damage, liability or action; provided, however, that Parent will not be liable to any Seller Indemnified Party to the extent that any such claim, loss, damage, liability or expense arises out of or is based in any untrue statement or omission or alleged untrue statement or omission, made in reliance upon and in conformity with written information furnished by any Seller Indemnified Party to Parent in an instrument duly executed by such Seller Indemnified Party and stated to be specifically for use therein. (b) Each Holder will, if Registrable Securities held by such Holder are included in the securities as to which such registration, qualification or compliance is being effected, indemnify Parent, each of its directors and officers and its legal counsel and independent accountants, and each other such Holder, each of its officers and directors and each person controlling such Holder within the meaning of Section 15 of the Securities Act (each a "Parent Indemnified Party"), against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other document, or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each Parent Indemnified Party for any legal or any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular or other document in reliance upon and in conformity with written information furnished to Parent by an instrument duly executed by such Holder and stated to be specifically for use therein; provided, however, that the obligations of such Holders hereunder shall be limited to an amount equal to the gross proceeds (after deducting reasonable commissions) received by each such Holder of Registrable Securities sold as contemplated herein. (c) Each party entitled to indemnification under this Section 5 (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has written notice of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom, provided that counsel for the Indemnifying Party, who shall conduct the defense of such claim or litigation, shall be approved by the Indemnified Party (whose approval shall not be unreasonably withheld), and the Indemnified Party may participate in such defense at such party's expense, and provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Declaration, except to the extent, but only to the extent, that the Indemnifying Party's ability to defend against such claim or litigation is compared as a result of such failure to give notice. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to the Indemnified Party of a release from all liability in respect to such claim or litigation. -5- 6 (d) The obligations of Parent and each Holder under this Section 5 shall survive the completion of any offering of Registrable Securities in a registration statement under this Declaration and otherwise. (e) Notwithstanding the foregoing, to the extent the provisions of this Section 5 are inconsistent with or conflict with the terms of any indemnification, selling or similar agreement entered into by a Holder in connection with the offer and sale of Registrable Securities pursuant to a registration effected pursuant to this Declaration, the terms of such agreement shall govern and shall supersede the provisions of this Declaration. 6. Limitation on Assignment of Registration Rights. The rights to cause Parent to register Registrable Securities pursuant to this Declaration may not be assigned by a Holder unless such a transfer is to shareholders, partners or retired partners, or members or retired members of a Holder (including spouses and ancestors, lineal descendants, and siblings of such shareholders, partners, members or spouses who acquire Registrable Securities by right, will or intestate succession). Prior to a permitted transfer of registration rights under this Declaration, Holder must furnish Parent with written notice of the name and address of such transferee and the Registrable Securities with respect to which such registration rights are being assigned and a copy of a duly executed written instrument in form reasonably satisfactory to Parent by which such transferee assumes all of the obligations and liabilities of its transferor hereunder and agrees itself to be bound hereby. No transfer of registration rights under this Declaration shall be permitted if immediately following such transfer the disposition of such Registrable Securities by the transferee is not restricted under the Securities Act. 7. Reports Under Exchange Act. Parent agrees to: (a) use commercially reasonable efforts to file with the SEC in a timely manner all reports and other documents required of Parent under the Securities Act and the Exchange Act; and (b) furnish to each Holder, forthwith upon request (i) a written statement by Parent that it has complied with the reporting requirements of the Securities Act and the Exchange Act, or that it qualifies as a registrant whose securities may be resold pursuant to Form S-3 (at any time after it so qualifies), and (ii) a copy of the most recent annual or quarterly report of Parent. 8. Amendment of Registration Rights. Holders of a majority of the Registrable Securities from time to time outstanding may, with the consent of Parent, amend the registration rights granted hereunder. 9. Governing Law. This Declaration shall be governed in all respects by and construed in accordance with the laws of the State of Washington. -6- 7 IN WITNESS WHEREOF, this Declaration of Registration Rights is executed as of the date first above written. REALNETWORKS, INC. By: /s/ Robert Glaser ------------------------------ Robert Glaser Its: Chief Executive Officer 8 EXHIBIT A DESIGNATED DISPOSAL NOTICE RECIPIENTS
------------------------------------------------------------------------------- CONTACT NAME PHONE NUMBER ------------------------------------------------------------------------------- Kelly Jo MacArthur 206-674-2700 ------------------------------------------------------------------------------- Paul Bialek 206-674-2700 -------------------------------------------------------------------------------
EX-10.5 4 1998 EMPLOYEE STOCK PURCHCHASE PLAN 1 EXHIBIT 10.5 REALNETWORKS, INC. 1998 EMPLOYEE STOCK PURCHASE PLAN, AS AMENDED AND RESTATED REALNETWORKS, INC., a Washington corporation (the "Company"), hereby establishes this 1998 Employee Stock Purchase Plan (the "Plan"). 1. PURPOSE OF PLAN. The purpose of the Plan is to enable Eligible Employees (as defined in Section 3) who wish to become shareholders of the Company a convenient and favorable method of doing so. The Plan is intended to constitute an "employee stock purchase plan," as defined in Section 423(b) of the Internal Revenue Code of 1986, as amended (the "Code"), and shall be interpreted and administered to further that intent. 2. ADMINISTRATION OF THE PLAN. The Plan will be administered by the Compensation Committee (the "Committee") of the Board of Directors of the Company (the "Board"). Subject to the provisions of the Plan, the Committee will have the complete authority to interpret the Plan, to adopt, amend and rescind rules and procedures relating to the Plan, and to make all of the determinations necessary or advisable for the administration of the Plan. All such interpretations, rules, procedures and determinations will, in the absent of fraud or patent mistake, be conclusive and binding on all persons with any interest in the Plan. 3. ELIGIBLE EMPLOYEES. The term "Eligible Employees" means all common law employees of the Company and its current majority-owned subsidiaries (and each other corporation designated by the Committee that hereafter becomes a majority-owned subsidiary of the Company), except the following: (a) employees who have been employed for less than 30 days; (b) employees whose customary employment is 20 hours or less per week; and (c) employees whose customary employment is for not more than five months in any calendar year. Except as otherwise expressly provided in the Plan and permitted by Section 423 of the Code, all Eligible Employees shall have the same rights and obligations under the Plan. 4. STOCK SUBJECT TO THE PLAN. The stock subject to the Plan shall be shares of the Company's authorized but unissued voting Common Stock, $.001 par value per share (the "Common Stock"). The aggregate number of shares of Common Stock that may be purchased by Eligible Employees pursuant to the Plan is 1,000,000, subject to adjustment as provided in Section 13. 5. OFFERING PERIODS. The Common Stock shall be offered under the Plan during ten consecutive six-month periods (the "Offering Periods"). The first Offering Period shall begin on January 1, 1998 and end on June 30, 1998. Thereafter, the Offering Periods will begin on the first day and end on the last day of each subsequent six-month period. 6. PARTICIPANTS; PAYROLL DEDUCTIONS 6.1 A person who is an Eligible Employee at the beginning of an Offering Period may elect to have the Company make deductions from the person's Compensation (as defined in Section 6.4), at a specified percentage rate, to be used to purchase of shares of -1- 2 Common Stock pursuant to the Plan. Such election shall be made prior to the beginning of the Offering Period in accordance with such procedures as the Committee may adopt (each Eligible Employee who so elects to have such deductions made will be referred to as a "Participant"). 6.2 The maximum rate of deduction that a Participant may elect for any Offering Period is 10%. An amount equal to the elected percentage shall be deducted from the Participant's pay each time during the Offering Period that any Compensation is paid to the Participant. The Committee may set such minimum level of payroll deductions as the Committee determines to be appropriate. Any minimum level of deductions set by the Committee shall apply equally to all Eligible Employees. A Participant's accumulated payroll deductions shall remain the property of the Participant until applied toward the purchase of shares of Common Stock under the Plan, but may be commingled with the general funds of the Company. No interest will be paid on payroll deductions accumulated under the Plan. 6.3 A Participant in the Plan on the last day of an Offering Period shall automatically continue to participate in the Plan during the next Offering Period unless he or she withdraws in the manner described in Section 11. 6.4 The term "Compensation" means all cash salary, wages, bonuses, commissions and other amounts paid to or on behalf of a Participant for services performed or on account of holidays, vacation, sick leave or other similar events, including any amounts by which such amounts are reduced, at the election of a Participant, pursuant to a cafeteria plan described in Section 125 of the Code, a dependent care assistance program described in Section 129 of the Code, a cash or deferred arrangement described in Section 401(k) of the Code, or any similar plan, program or arrangement, but excluding the value of any noncash benefits under any employee benefit plans and any special amounts paid to the Participant that are specifically excluded by the Committee. 7. PURCHASE OF SHARES 7.1 At the end of an Offering Period, a Participant's accumulated payroll deductions for the Offering Period will, subject to the limitations in Section 9 and the termination provisions of Section 16, be applied toward the purchase of shares of Common Stock at a purchase price (the "Purchase Price") equal to the lesser of -- (a) 85% of the Market Price (as defined in Section 8.1) of the Common Stock on the first Business Day (as defined in Section 8.2) of the Offering Period; or (b) 85% of the Market Price for the Common Stock on the last Business Day of the Offering Period; in either event rounded to the nearest whole cent. 7.2 Shares of Common Stock may be purchased under the Plan only with a Participant's accumulated payroll deductions. Fractional shares cannot be purchased. Any portion of a Participant's accumulated payroll deductions for an Offering Period not used for the purchase of Common Stock shall be applied to the purchase of Common Stock in the next Offering Period, if the Participant is participating in the Plan during that Offering Period, or returned to the Participant. -2- 3 7.3 Each Participant who purchases shares of Common Stock under the Plan shall thereby be deemed to have agreed that the Company or the subsidiary of the Company that employs the Participant shall be entitled to withhold, from any other amounts that may be payable to the Participant at or around the time of the purchase, such federal, state, local and foreign income, employment and other taxes may be required to be withheld under applicable laws. In lieu of such withholding, the Company or such subsidiary may require the Participant to remit such taxes to the Company or such subsidiary as a condition of the purchase. 8. MARKET PRICE 8.1 For purposes of the Plan, the term "Market Price" on any day means, if the Common Stock is publicly traded, the last sales price (or, if no last sales price is reported, the average of the high bid and low asked prices) for a share of Common Stock on that day as reported by the principal exchange on which the Common Stock is listed, or, if the Common Stock is publicly traded but not listed on an exchange, as reported by The Nasdaq Stock Market, or, if such prices or quotations are not reported by The Nasdaq Stock Market, as reported by any other available source of prices or quotations selected by the Committee. 8.2 For purposes of the Plan, the term "Business Day" means a day on which prices or quotations for the Common Stock are reported by a national securities exchange, the Nasdaq Stock Market, or any other available source of prices or quotations selected by the Committee, whichever is applicable pursuant to the preceding paragraph. 8.3 If the Market Price of the Common Stock must be determined for purposes of the Plan at a time when the Common Stock is not publicly traded, then the term "Market Price" shall mean the fair market value of the Common Stock as determined by the Committee, after taking into consideration all the factors it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. 9. LIMITATIONS ON SHARE PURCHASES 9.1 Notwithstanding Section 3, an employee will not be an Eligible Employee for purposes of the Plan if the employee owns stock possessing 5% or more of the total combined voting power or value of all classes of stock of the Company. For purposes of this 5% limitation, an employee shall be treated as owning any stock the ownership of which is attributed to him or her under the rules of Section 424(d) of the Code, as well as any stock that, in the absence of this paragraph, the employee could purchase under the Plan with his or her payroll deductions held pursuant to Section 6 but not yet applied to the purchase of shares of Common Stock under the Plan. 9.2 During any calendar year, the maximum value of the Common Stock that may be purchased by a Participant under the Plan is $10,000, said value to be determined on the basis of the Market Price of the Common Stock on the first Business Day of each Offering Period that ends in the calendar year. 9.3 The limitations in Section 9.1 and Section 9.2 are intended to and shall be interpreted in such a manner as will comply with Section 423(b)(3) and Section 423(b)(8) of the Code, respectively. -3- 4 10. CHANGES IN PAYROLL DEDUCTIONS. The rate of payroll deductions for an Offering Period may not be increased or decreased by a Participant during the Offering Period. However, the Participant may change the rate of payroll deduction for a subsequent Offering Period. In addition, a Participant may withdraw in full from the Plan in the manner described in Section 11. 11. WITHDRAWAL FROM THE PLAN 11.1 A Participant may elect to withdraw from the Plan, effective for the Offering Period in progress, by delivering to the Committee written notice thereof prior to the end of the Offering Period. If a Participant so withdraws, all of the Participant's payroll deductions for that Offering Period will be promptly returned to the Participant. If a Participant's payroll deductions are interrupted by any legal process, the Participant will be deemed to have elected to withdraw from the Plan for the Offering Period in which the interruption occurs. 11.2 A Participant may elect to withdraw from the Plan, effective for an Offering Period that has not yet commenced, by delivering to the Committee written notice thereof prior to the first day of the Offering Period. 11.3 Following withdrawal from the Plan, in order to participate in the Plan for any subsequent Offering Period, the Participant must again elect to participate in the manner described in Section 6.1. 12. ISSUANCE OF COMMON STOCK. 12.1 Certificates for the shares of Common Stock purchased by Participants will be delivered by the Company's transfer agent as soon as practicable after each Offering Period. In lieu of issuing certificates for such shares directly to Participants, the Company shall be entitled to issue such shares to a bank, broker-dealer or similar custodian (the "Custodian") that has agreed to hold such shares for the accounts of the respective Participants. Fees and expenses of the Custodian shall be paid by the Company or allocated among the respective Participants in such manner as the Committee determines. 12.2 A Participant may direct, in accordance with such procedures as the Committee may adopt, that shares purchased by the Participant shall be issued (or, if such shares are issued to the Custodian, that the account for such shares be held) in the names of the Participant and one other person designated by the Participant, as joint tenants with right of survivorship, tenants in common, or community property, to the extent and in the manner permitted by applicable law. 12.3 A Participant may at any time, in the manner described in Section 18, undertake a disposition (as that term is defined in Section 424(c) of the Code), whether by sale, exchange, gift or other transfer of legal title, of any or all of the shares held for the Participant by the Custodian. In the absence of such a disposition of the shares, the shares shall continue to be held by the Custodian until the holding period set forth in Section 423(a) of the Code has been satisfied. If a Participant so requests, shares for which such holding period has been satisfied will be transferred to another brokerage account specified by the Participant, or a stock certificate for such shares will be issued and delivered to the Participant or his or her designee. -4- 5 13. CHANGES IN CAPITALIZATION 13.1 Upon the happening of any of the following described events, a Participant's right to purchase shares of Common Stock under the Plan shall be adjusted as hereinafter provided: (a) If the shares of Common Stock are subdivided or combined into a greater or smaller number of shares of Common Stock or if, upon a recapitalization, split-up or other reorganization of the Company, the shares of Common Stock are exchanged for other securities of the Company, the rights of each Participant shall be modified so that the Participant is entitled to purchase, in lieu of the shares of Common Stock that the Participant would otherwise have been entitled to purchase for the Offering Period in progress at the time of such subdivision, combination or exchange (the "Offering Period Shares"), such number of shares of Common Stock or such number and type of other securities as the Participant would have received if such Offering, Period Shares had been issued and outstanding at the time of such subdivision, combination or exchange (unless in the case of an exchange the Committee determines that the nature of the exchange is such that it is not feasible or advisable that the rights of Participants be so modified, in which event the exchange shall be deemed a Terminating Event under Section 14); and (b) If the Company issues any of its shares as a stock dividend upon or with respect to the Common Stock, each Participant who purchases shares of Common Stock under the Plan at the end of the Offering Period in progress on the record date for the stock dividend shall be entitled to receive the shares so purchased (the "Purchased Shares") and shall also be entitled to receive at no additional cost, but only if the Purchase Price for the Purchased Shares was determined with reference to the Market Price of the Common Stock on the first Business Day of the Offering Period, the number of shares of the class of stock issued as a stock dividend, and the amount of cash in lieu of fractional shares, that the Participant would have received if he or she had been the holder of the Purchased Shares on the record date for the stock dividend. 13.2 Upon the happening of an event specified in clause (a) or (b) above, the class and aggregate number of shares available under the Plan, as set forth in Section 4, shall be appropriately adjusted to reflect the event. Notwithstanding the foregoing, such adjustments shall be made only to the extent that the Committee, based on advice of counsel for the Company, determines that such adjustments will not constitute a change requiring shareholder approval under Section 423(b)(2) of the Code. 14. TERMINATING EVENTS 14.1 Upon (a) the dissolution or liquidation of the Company, (b) a merger or other reorganization of the Company with one or more corporations as a result of which the Company will not be a surviving corporation, (c) the sale of all or substantially all of the assets of the Company or a material division of the Company, (d) a sale or other transfer, pursuant to a tender offer or otherwise, of more than fifty percent (50%) of the then outstanding shares of Common Stock of the Company, (e) an acquisition by the Company resulting in an extraordinary expansion of the Company's business or the addition of a material new line of business, or (f) any exchange that is subject to this Section 14 in accordance with the provisions of Section 13 (any of such events is herein referred to as a "Terminating Event"), the Committee may but shall not be required to -- -5- 6 (a) make provision for the continuation of the Participants' rights under the Plan on such terms and conditions as the Committee determines to be appropriate and equitable, including where applicable, but not limited to, an arrangement for the substitution on an equitable basis, for each share of Common Stock that could otherwise be purchased at the end of the Offering Period in progress at the time of the Terminating Event, of any consideration payable with respect to each then outstanding share of Common Stock in connection with the Terminating Event; or (b) terminate all rights of Participants under the Plan for such Offering Period and -- (i) return to the Participants all of their payroll deductions for such Offering Period; and (ii) for each share of Common Stock, if any, that otherwise could have been purchased under the Plan by a Participant at the end of such Offering Period (determined by assuming that payroll deductions at the rate elected by the Participant were continued to the end of the Payroll Period and used to purchase shares based on the Market Price of the Common Stock on the first Business Day of the Offering Period) and with respect to which (A) the Purchase Price at which such share could be purchased (determined with reference only to the Market Price of the Common Stock on the first Business Day of the Offering Period) is exceeded by (B) the Market Price on the date of the Terminating Event of a share of Common Stock, as determined by the Committee, pay to the Participant an amount equal to such excess. 14.2 The Committee shall make all determinations necessary or advisable in connection with Terminating Events, and its determinations shall, in the absent of fraud or patent mistake, be conclusive and binding on all persons with any interest in the Plan. 15. NO TRANSFER OR ASSIGNMENT OF EMPLOYEE'S RIGHTS. An Eligible Employee's rights under the Plan are the Eligible Employee's alone and may not be voluntarily or involuntarily transferred or assigned to, or availed of by, any other person other than by will or the laws of descent and distribution. An Eligible Employee's rights under the Plan are exercisable during his or her lifetime by the Eligible Employee alone. 16. TERMINATION OF EMPLOYEE'S RIGHTS 16.1 Subject to Section 16.2, a Participant's rights under the Plan will terminate if he or she for any reason (including death, disability or voluntary or involuntary termination of employment) ceases to be an employee of the Company or one of its subsidiaries. 16.2 Notwithstanding the foregoing, effective for Offering Periods beginning on or before July 15, 1999, if a Participant ceases to be an employee of the Company or one of its subsidiaries, the termination of the Participant's rights under the preceding paragraph shall not apply to any right the Participant may have to purchase shares of Common Stock at the end of the Offering Period in progress when the Participant ceases to be an employee. Such purchases of shares of Common Stock shall, to the extent of payroll deductions accumulated for the purchases -6- 7 of shares of Common Stock shall, to the extent payroll deductions accumulated for the Offering Period, occur automatically at the end of the Offering Period, unless the Participant or his or her personal representative withdraws from the Plan for the Offering Period in the manner described in Section 11. To the extent that the rights of a Participant terminate in accordance with this Section 16, any of the Participant's payroll deductions not used to purchase shares of Common Stock will be promptly returned (without interest thereon) to the Participant or his or her personal representative. 16.3 Effective for Offering Periods commencing after July 15, 1999, if a Participant ceases to be an employee of the Company or one of its subsidiaries, then as soon as practicable after such cessation, the Participant's payroll deductions shall cease and any of the Participant's accumulated payroll deductions shall be promptly returned (without interest thereon) to the Participant or his or her personal representative. 17. TERMINATION AND AMENDMENT OF PLAN 17.1 The Plan shall terminate on December 31, 2002. The Plan may be terminated at any earlier time by the Board, but, except as provided in Section 14, such termination shall not affect the rights of Participants under the Plan for the Offering Period in progress at the time of termination. The Plan will also terminate in any case when all or substantially all of the unissued shares of Common Stock reserved for the purposes of the Plan have been purchased. If at any time shares of Common Stock reserved for the purpose of the Plan remain available for purchase but not in sufficient number to satisfy all then unfilled purchase requirements, the available shares shall be apportioned among Participants in proportion to the respective amounts of their accumulated payroll deductions, and the Plan shall terminate. Upon such termination or any other termination of the Plan, all payroll deductions not used to purchase shares of Common Stock will be refunded to the Participants entitled thereto. 17.2 The Committee or the Board may from time to time adopt amendments to the Plan; PROVIDED, HOWEVER, that, without the approval of the shareholders of the Company, no amendment may increase the number of shares that may be issued under the Plan or make any other change for which shareholder approval is required by Section 423 of the Code or the regulations thereunder. 18. DISPOSITION OF SHARES. Subject to compliance with any applicable federal and state securities and other laws and any policy of the Company in effect from time to time with respect to trading in its shares, a Participant may effect a disposition (as that term is defined in Section 424(c) of the Code) of Common Stock purchased under the Plan at any time the Participant chooses; PROVIDED, HOWEVER, each Participant agrees, by purchasing shares of Common Stock under the Plan, that (a) the Company shall be entitled to withhold, from any other amounts that may be payable to the Participant by the Company at or around the time of such disposition, such federal, state, local and foreign income, employment and other taxes as the Company may be required to withhold under applicable law; and (b) in lieu of such withholding, the Participant will, upon request of the Company, promptly remit such taxes to the Company. EACH EMPLOYEE PURCHASING SHARES OF COMMON STOCK UNDER THE PLAN ASSUMES THE RISK OF ANY MARKET FLUCTUATIONS IN THE PRICE THEREOF. -7- 8 19. NO SHAREHOLDER RIGHTS; INFORMATION TO PARTICIPANTS. A Participant shall not have any rights as a shareholder of the Company (other than the right potentially to receive stock dividends under Section 13) on account of shares of Common Stock that may be purchased under the Plan prior to the time such shares are actually purchased by and issued to the Participant. Notwithstanding the foregoing, the Company shall deliver to each Participant under the Plan who does not otherwise receive such materials (a) a copy of the Company's annual financial statements (which shall be delivered annually as promptly as practical following each fiscal year of the Company and review or audit of such statements by the Company's auditors), together with management's discussion and analysis of financial condition and results of operations for the fiscal year, and (b) a copy of all reports, proxy statements and other communications distributed to the Company's security holders generally. 20. USE OF PROCEEDS. The proceeds received by the Company from the sale of shares of Common Stock under the Plan will be used for general corporate purposes. 21. GOVERNMENTAL REGULATIONS. The Company's obligation to sell and deliver shares of the Common Stock under the Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares, including the Securities and Exchange Commission, the securities administrators of the states in which Participants reside, and the Internal Revenue Service. 22. MISCELLANEOUS PROVISIONS 22.1 Nothing contained in the Plan shall obligate the Company or any of its subsidiaries to employ a Participant for any period, nor shall the Plan interfere in any way with the right of the Company or any of its subsidiaries to reduce a Participant's compensation. 22.2 The provisions of the Plan shall be binding upon each Participant and, subject to the provisions of Section 15, the heirs, successors and assigns of each Participant. 22.3 Where the context so requires, references in the Plan to the singular shall include the plural, and vice versa, and references to a particular gender shall include either or both additional genders. 22.4 The Plan shall be construed, administered and enforced in accordance with the laws of the United States, to the extent applicable thereto, as well as the laws of the State of Washington. 23. APPROVAL OF SHAREHOLDERS. The Plan shall be effective January 1, 1998, subject to approval by the shareholders of the Company in a manner that complies with Section 423(b)(2) of the Code. If such approval does not occur prior to January 1, 1998, the Plan shall be void and of no effect. -8- EX-13.1 5 PORTIONS OF REALNETWORKS ANNUAL REPORT 1 EXHIBIT 13.1 SELECTED CONSOLIDATED FINANCIAL DATA RealNetworks, Inc. and Subsidiaries The following selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and Notes included elsewhere in this document.
years ended December 31, 1999 1998 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------------------- (in thousands, except per share data) Consolidated Statement of Operations Data: Net revenues: Software license fees $ 90,627 48,487 29,165 19,447 5,465 Service revenues 26,466 14,742 4,972 1,120 30 Advertising 14,149 3,148 2,254 1,016 -- - -------------------------------------------------------------------------------------------------------------------------------- Total net revenues 131,242 66,377 36,391 21,583 5,495 - -------------------------------------------------------------------------------------------------------------------------------- Cost of revenues: Software license fees 13,006 8,308 3,800 2,907 762 Service revenues 6,579 2,631 2,392 554 33 Advertising 2,906 1,727 920 288 -- - -------------------------------------------------------------------------------------------------------------------------------- Total cost of revenues 22,491 12,666 7,112 3,749 795 - -------------------------------------------------------------------------------------------------------------------------------- Gross profit 108,751 53,711 29,279 17,834 4,700 - -------------------------------------------------------------------------------------------------------------------------------- Operating expenses: Research and development 38,415 22,480 15,651 6,310 2,144 Sales and marketing 53,465 33,460 22,954 10,155 2,112 General and administrative 16,380 11,540 7,635 5,756 1,744 Goodwill amortization 2,128 1,596 -- -- -- Acquisition charges 1,403 8,723 -- -- -- - -------------------------------------------------------------------------------------------------------------------------------- Total operating expenses 111,791 77,799 46,240 22,221 6,000 - -------------------------------------------------------------------------------------------------------------------------------- Operating loss (3,040) (24,088) (16,961) (4,387) (1,300) - -------------------------------------------------------------------------------------------------------------------------------- Other income (expense): Interest income, net 11,523 4,928 2,178 308 62 Other income (expense) (1,557) (793) (286) 14 (141) - -------------------------------------------------------------------------------------------------------------------------------- Other income (expense), net 9,966 4,135 1,892 322 (79) - -------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 6,926 (19,953) (15,069) (4,065) (1,379) ================================================================================================================================ Basic net income (loss) per share $ 0.05 (0.15) (0.92) (2.06) (1.98) Diluted net income (loss) per share $ 0.04 (0.15) (0.92) (2.06) (1.98) Shares used to compute basic net income (loss) per share 142,016 130,156 16,906 1,984 698 Shares used to compute diluted net income (loss) per share 166,576 130,156 16,906 1,984 698
Consolidated Balance Sheet Data: December 31, 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------------- (in thousands) Cash, cash equivalents and short-term investments $344,627 89,801 93,677 21,039 6,606 Working capital 273,827 57,746 87,216 18,766 6,109 Total assets 411,124 128,774 119,469 31,346 8,909 Redeemable, convertible preferred stock -- -- -- 23,153 7,655 Shareholders' equity (deficit) 330,559 81,304 78,680 134 (1,214)
17 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries The discussion in this report contains forward-looking statements that involve risks and uncertainties. RealNetworks' actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Factors that May Affect Our Business, Future Operating Results and Financial Condition", included elsewhere in this Report. You should also carefully review the risk factors set forth in other reports or documents that RealNetworks files from time to time with the Securities and Exchange Commission, particularly Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. You should also read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included in this report. OVERVIEW RealNetworks is a leading provider of media delivery and digital distribution solutions designed for the Internet. Our solutions enable consumers to experience and content providers to deliver a broad range of multimedia content, including audio, video, text and animation. We pioneered the development and commercialization of streaming media systems that enable the creation, real-time delivery and playback of multimedia content. We believe that we have established a leadership position in the market for these systems. We have more than 95 million registered users of our RealPlayer product and believe that more than 85% of all streaming media Web pages utilize our technology. The broad acceptance of the Internet as a means of content delivery and consumption, combined with recent technological advances, has greatly increased the practicality and popularity of a number of new online media delivery formats. In response, we have extended our media delivery platform to include a digital music management system that allows consumers to acquire, record, store, organize and play their personal music collections on PCs and digital playback devices. We were incorporated in February 1994 and were in the development stage until July 1995, when we released the commercial version of RealAudio Version 1.0, the first version of our RealPlayer products. From inception through December 31, 1995, our operating activities related primarily to recruiting personnel, raising capital, purchasing operating assets, conducting research and development, building the RealAudio brand and establishing the market for streaming audio. During 1996, we continued to invest heavily in research and development and marketing and in building our domestic and international sales channels and our general and administrative infrastructure. In August 1996, we began selling RealPlayer Plus, a premium version of our RealPlayer product. RealPlayer has always been available for download free of charge from our websites. In June 1997, we released the commercial version of RealVideo Version 4.0. In December 1997, we released the commercial version of RealSystem Version 5.0, a streaming media solution that included RealAudio and RealVideo technology. In November 1998, we released the commercial version of RealSystem G2, our latest generation media delivery system. In May 1999, we released RealSystem MP as well as a beta version of RealJukebox, a personal music management solution. In September 1999, we released RealSlideshow Plus, a complete streaming solution for sharing digital pictures over the Internet. Also in September, we released the commercial versions of RealJukebox and RealJukebox Plus, which are complete digital music systems. In November, we released the beta version of RealPlayer 7.0 and introduced the new Real.com Network, which gives consumers the ability to find, organize and play audio and video on the Internet, and Take 5, Real.com's new media programming guide. In December, we introduced RealServer 7.0 and RealProducer 7.0, the latest advancements to RealSystem G2 as well as RealSlideshow 2.0, and RealSlideshow Plus 2.0 which allows consumers to share digital pictures with audio narration and music over the Internet. 18 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries We report revenues in three categories: - - Software license fees, which include revenues from sales of our RealPlayer Plus, RealJukebox Plus, RealSlideshow Plus, Xing AudioCatalyst, RealServers and related authoring and publishing tools, sales of our products through OEM channels, and sales of third-party products. - - Service revenues, which include support and maintenance services that we sell to customers who purchase our RealPlayer Plus, RealJukebox Plus, RealServers and tools products, broadcast hosting services we provide through our Real Broadcast Network, and consulting services we offer to our customers. - - Advertising revenues, which are derived from the sale of advertising on our websites and the placement of channel and preset buttons included in the RealPlayer and the RealJukebox products. In March 1998, we acquired Vivo Software, Inc. (Vivo), a leading privately-held developer of streaming media creation tools, in an acquisition accounted for using the purchase method of accounting. In August 1999, we acquired Xing Technology Corporation, a privately-held provider of high performance, standards based digital audio and video encoding and decoding technology, including MP3 software. The transaction was accounted for using the pooling-of-interests method of accounting. All of our financial data presented in the consolidated financial statements and management's discussion and analysis of financial condition and results of operations have been restated to include the historical financial information of Xing as if it had always been a part of RealNetworks. Prior to the merger, Xing operated on a June 30 fiscal year. The results of Xing's operations have been restated to conform to RealNetworks' December 31 fiscal year-end. The following table sets forth certain financial data for the periods indicated as a percentage of total net revenues:
years ended December 31, 1999 1998 1997 - ------------------------------------------------------------------------------------- Net revenues: Software license fees 69.0% 73.0% 80.1% Service revenues 20.2 22.2 13.7 Advertising 10.8 4.8 6.2 - ------------------------------------------------------------------------------------- Total net revenues 100.0 100.0 100.0 - ------------------------------------------------------------------------------------- Cost of revenues: Software license fees 9.9 12.5 10.4 Service revenues 5.0 4.0 6.6 Advertising 2.2 2.6 2.5 - ------------------------------------------------------------------------------------- Total cost of revenues 17.1 19.1 19.5 - ------------------------------------------------------------------------------------- Gross profit 82.9 80.9 80.5 - ------------------------------------------------------------------------------------- Operating expenses: Research and development 29.3 33.9 43.0 Sales and marketing 40.7 50.4 63.1 General and administrative 12.5 17.4 21.0 Goodwill amortization 1.6 2.4 -- Acquisition charges 1.1 13.1 -- - ------------------------------------------------------------------------------------- Total operating expenses 85.2 117.2 127.1 - ------------------------------------------------------------------------------------- Operating loss (2.3) (36.3) (46.6) - ------------------------------------------------------------------------------------- Other income (expense): Interest income, net 8.8 7.4 6.0 Other expense (1.2) (1.2) (0.8) - ------------------------------------------------------------------------------------- Other income, net 7.6 6.2 5.2 - ------------------------------------------------------------------------------------- Net income (loss) 5.3% (30.1)% (41.4)% - -------------------------------------------------------------------------------------
19 4 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries REVENUES
1999 change 1998 change 1997 - ----------------------------------------------------------------------------------------------------------------- (dollars in thousands) Software license fees $ 90,627 87% $ 48,487 66% $ 29,165 Service revenues 26,466 80 14,742 197 4,972 Advertising 14,149 349 3,148 40 2,254 -------------------------------------- -------- -------- Total net revenues $131,242 98% $ 66,377 82% $ 36,391 ====================================== ======== ========
Software License Fees. Software license fees were $90.6 million in 1999, an increase of 87% from $48.5 million in 1998. Software license fees increased 66% in 1998 from $29.2 million in 1997. The increases during 1999 and 1998 were due primarily to a greater volume of products sold as a result of growth in the demand for streaming media on the Internet, the introduction of new products, including RealJukebox Plus, and RealSlideshow Plus in 1999, RealSystem G2 in 1998, and RealSystem Version 5.0 and RealVideo Version 4.0 in 1997, and due to successful product promotions, increased sales from electronic distribution and increased sales of third-party products. In June 1997, we entered into a $30.0 million license agreement with Microsoft, which is being recognized as revenue over the three-year term of our ongoing support obligations. Software license fees for 1999, 1998 and 1997 included $10.3 million, $9.7 million and $4.8 million, respectively, related to the Microsoft license agreement. Service Revenues. Service revenues were $26.5 million in 1999, an increase of 80% from $14.7 million in 1998. The increase during 1999 was primarily attributable to higher revenues from sales of support and upgrade contracts on RealPlayer Plus and RealJukebox Plus, a larger installed base of our server products and increases in consulting and streaming media hosting services. Service revenues were $14.7 million in 1998, an increase of 197% from $5.0 million in 1997. The increase during 1998 was primarily attributable to higher revenues from sales of support and upgrade contracts on RealPlayer Plus, which we began selling during the fourth quarter of 1997, a larger installed base of our server products and increases in consulting and streaming media hosting. Advertising. Advertising revenues were $14.1 million in 1999, an increase of 349% from $3.1 million in 1998. Advertising revenues were $3.1 million in 1998, an increase of 40% from $2.3 million in 1997. The increases in advertising revenues for 1999 and 1998 were due to higher traffic on our websites, our larger advertising sales force resulting in more advertising sales, higher average advertising rates, and revenue associated with channels, presets and search functionality included in the RealPlayer and RealJukebox. GEOGRAPHIC REVENUES
1999 change 1998 change 1997 - ------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) North America $ 93,277 111% $ 44,149 84% $ 24,017 Europe 15,124 112 7,144 109 3,425 Japan/Asia Pacific 9,992 126 4,429 37 3,225 Rest of world 2,581 161 987 11 890 - ---------------------------------------------- -------- -------- Subtotal 120,974 113 56,709 80 31,557 Microsoft license agreement 10,268 6 9,668 100 4,834 - ---------------------------------------------- -------- -------- Total $131,242 98% $ 66,377 82% $ 36,391 ============================================== ======== ========
20 5 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries International revenues represented 23% of total net revenues in 1999 and 22% in 1998, excluding revenues from the Microsoft license agreement. Revenues generated in Europe were 13% of total net revenues (excluding revenues from the Microsoft license agreement) in 1999 and 1998, and revenues generated in Japan/Asia Pacific were 8% of total net revenues (excluding revenues from the Microsoft license agreement) in 1999 and 1998. At December 31, 1999, accounts receivable due from European and Asian customers were not significant. The functional currency of our foreign subsidiaries is the local currency of the country in which the subsidiary is incorporated. Results of operations of our foreign subsidiaries are translated from local currency into U.S. dollars based on average monthly exchange rates. We currently do not hedge our foreign currency exposures and therefore are subject to the risk of changes in exchange rates. We expect that international revenues will increase over time in both absolute dollars and as a percentage of total net revenues. The costs of both domestic and international revenues are substantially the same.
Cost of Revenues 1999 change 1998 change 1997 - ------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Software license fees $13,006 57% $ 8,308 119% $ 3,800 Service revenues 6,579 150 2,631 10 2,392 Advertising 2,906 68 1,727 88 920 - ---------------------------------------------------------------- ---------------- -------------- Total cost of revenues $22,491 78% $12,666 78% $ 7,112 - ---------------------------------------------------------------- ---------------- -------------- As a percentage of total net revenues 17% 19% 20%
Cost of Software License Fees. Cost of software license fees includes costs of product media, duplication, manuals, packaging materials, amounts paid for licensed technology, and fees paid to third-party vendors for order fulfillment. Cost of software license fees was $13.0 million in 1999, an increase of 57% from $8.3 million in 1998, but decreased as a percentage of software license fees to 14% from 17% in 1998. Cost of software license fees was $8.3 million in 1998, an increase of 119% from $3.8 million in 1997, and increased as a percentage of software license fees to 17% from 13% in 1997. The increases in absolute dollars were due primarily to higher sales volumes. The changes in percentage terms were due to shifts in product mix. Cost of Service Revenues. Cost of service revenues includes the cost of in-house and contract personnel providing support and other services and expenses incurred in expanding our streaming media hosting services. Cost of service revenues was $6.6 million in 1999, an increase of 150% from $2.6 million in 1998, and increased as a percentage of service revenues to 25% from 18% in 1998. Cost of service revenues was $2.6 million in 1998, an increase of 10% from $2.4 million in 1997, but decreased as a percentage of service revenues to 18% from 48% in 1997. The 1999 and 1998 increases in absolute dollars were primarily due to increased staff and contract personnel to provide services to a greater number of customers, expansion of customer service and technical support into international regions, and support costs related to the introduction of new products. Cost of Advertising. Cost of advertising includes the cost of personnel associated with content creation and maintenance and fees paid to third parties for content included in our websites. Cost of advertising was $2.9 million in 1999, an increase of 68% from $1.7 million in 1998, but decreased as a percentage of advertising revenues to 21% from 55% in 1998. Cost of advertising was $1.7 million in 1998, an increase of 88% from $0.9 million in 1997, and increased as a percentage of advertising revenues to 55% from 41% in 1997. The increases in absolute dollars were primarily due to increases in the quality and quantity of content available on our websites, enhancements made to existing websites, and the addition of new websites. 21 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries Operating Expenses Research and Development
1999 change 1998 change 1997 - ------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Research and development $38,415 71% $22,480 44% $15,651 As a percentage of total net revenues 29% 34% 43%
Research and development expenses consist primarily of salaries and related personnel costs and consulting fees associated with product development and costs of technology acquired from third parties to incorporate into products currently under development. To date, all research and development costs, including those associated with software development, have been expensed as incurred because technological feasibility is generally not established until substantially all development is complete. We believe that significant investment in research and development is a critical factor in attaining our strategic objectives and, as a result, we expect research and development to continue to increase. Research and development expenses were $38.4 million in 1999, an increase of 71% from $22.5 million in 1998, but decreased as a percentage of net revenues to 29% from 34% in 1998. The 1999 increase in absolute dollars was primarily due to increases in internal development personnel, consulting expenses, and contract labor associated with the development of new technology and products, including RealSystem MP, RealJukebox, RealSlideshow, and RealPlayer 7.0 as well as enhancements made to existing products. Research and development expenses were $22.5 million in 1998, an increase of 44% from $15.7 million in 1997, but decreased as a percentage of total net revenues to 34% from 43% in 1997. The 1998 increase in absolute dollars was due to increases in internal development personnel, consulting expenses and contract labor. Research and development expenses incurred in 1998 were primarily related to development of new technology and products, including RealSystem G2, the commercial version of which we released in November 1998, Xing AudioCatalyst, and enhancements made to existing products. The decrease in percentage terms in 1999, 1998 and 1997 were a result of revenues growing at a faster rate than expenses. Sales and Marketing
1999 change 1998 change 1997 - ------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Sales and marketing $53,465 60% $33,460 46% $22,954 As a percentage of total net revenues 41% 50% 63%
Sales and marketing expenses consist primarily of salaries, sales commissions, consulting fees, trade show expenses, advertising costs and costs of marketing collateral. We intend to increase our branding and marketing efforts and therefore we expect sales and marketing expenses to increase in future periods. Sales and marketing expenses were $53.5 million in 1999, an increase of 60% from $33.5 million in 1998, but decreased as a percentage of total net revenues to 41% from 50% in 1998. Sales and marketing expenses were $33.5 million in 1998, an increase of 46% from $23.0 million in 1997, but decreased as a percentage of total net revenues to 50% from 63% in 1997. The increases in absolute dollars were due to the expansion of our direct sales and marketing organization, the creation of additional foreign and domestic sales offices, increased trade show attendance, advertising, promotions and expenses related to the continued development of the "Real" brand. The decreases in percentage terms in 1999, 1998 and 1997 were a result of revenues growing at a faster rate than expenses. 22 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS REALNETWORKS, Inc. and Subsidiaries GENERAL AND ADMINISTRATIVE
1999 change 1998 change 1997 - ------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) General and administrative $16,380 42% $11,540 51% $ 7,635 As a percentage of total net revenues 12% 17% 21%
General and administrative expenses consist primarily of salaries and fees for professional and temporary services. We expect general and administrative expenses to increase as we expand our staff and incur additional costs related to growth of our business. General and administrative expenses were $16.4 million in 1999, an increase of 42% from $11.5 million in 1998, but decreased as a percentage of total net revenues to 12% from 17% in 1998. General and administrative expenses were $11.5 million in 1998, an increase of 51% from $7.6 million in 1997, but decreased as a percentage of total net revenues to 17% from 21% in 1997. The increases in absolute dollars for 1999, 1998 and 1997 were primarily due to increased personnel and professional fees as well as facility expenses necessary to support our growth. The decreases in percentage terms in 1999, 1998 and 1997 were due to revenues growing at a faster rate than expenses. Goodwill Amortization and Acquisition Charges In March 1998, we acquired Vivo Software, Inc. (Vivo), a developer of streaming media creation tools. We issued approximately 4.4 million shares of our common stock in exchange for all outstanding shares of Vivo common stock. In addition, Vivo employees received options to purchase approximately 190,000 shares of our common stock. The acquisition was accounted for using the purchase method of accounting and, accordingly, the results of Vivo's operations are included in our consolidated financial statements since the date of acquisition. The purchase price was allocated to the fair value of the acquired assets and assumed liabilities based on their fair values at the date of the acquisition. A portion of the purchase price represented acquired in-process research and development that had not yet reached technological feasibility at the time of the acquisition and has no alternative future use. Of the total purchase price, $8.6 million was allocated to in-process research and development expense, $10.6 million was allocated to goodwill, and $0.5 million was allocated to tangible assets. Goodwill is amortized over its estimated life of five years. The in-process research and development projects acquired in the acquisition of Vivo consisted of the development of encoder tools and server and client codecs. The encoder tools allow users to create media content to be streamed over the Internet or intranets. The server and client codecs enhance the compression and decompression of multimedia content streamed over the Internet or intranets. The percentage completion of the projects at the time of acquisition was as follows: Encoder tools 40%-70% Server codec 30% Client codec 30%
We completed the development of the encoder tools in 1998. The total cost to complete development of the encoder tools was approximately $1.0 million. The server and client codec projects were completed in 1999. The aggregate costs to complete the server and client codecs were approximately $0.7 million. The fair value of the in-process technology was based on projected cash flows that were discounted based on the risks associated with achieving such projected cash flows upon successful completion of the acquired projects. Associated risks include the inherent difficulties and uncertainties in completing each project and achieving technological feasibility and risks related to the impact of potential changes in market conditions and technology. In developing cash flow projections, revenues were forecasted based on relevant factors, including aggregate revenue growth rates for the business as a whole, characteristics of the potential market for the technology and the anticipated life of the underlying technology. Operating expenses and resulting profit margins were forecasted based on the characteristics and cash-flow-generating potential of the acquired in-process technology. 23 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries The fair value of the in-process research and development was allocated to the projects as follows (in thousands): Encoder tools $6,500 Server codec 1,500 Client codec 600 ------ $8,600 ======
Projected annual revenues for each of the in-process development projects were assumed to increase from product release through 2001, decline slightly in 2002 and decline significantly in 2003 and 2004. An insignificant amount of revenue was projected for in-process technology in the first quarter of 2005, which is estimated to be the end of the in-process technology's economic life. Gross profit was assumed to be 80% for the encoder tools and client codec and 94% for the server codec. The projected gross profit percentages were based on estimated costs of revenues, which include duplication, manuals, packaging materials and third-party order fulfillment costs. Gross profit projections were based on our experience with similar products. Estimated operating expenses, income taxes and capital charges to provide a return on other acquired assets were deducted from gross profit to arrive at net operating income for each of the in-process development projects. Operating expenses were estimated as a percentage of total net revenues and included sales and marketing expenses and development costs to maintain the technology once it has achieved technological feasibility. We discounted the net cash flows of the in-process research and development projects to their present values using a discount rate of 42%. This discount rate approximates the overall rate of return for the acquisition of Vivo as a whole and reflects the inherent uncertainties surrounding the successful development of the in-process research and development projects and the uncertainty of technological advances that may occur in the future. Since the acquisition, we have continued to market and support Vivo's existing products on a limited basis. The acquisition of Vivo was a tax-free reorganization under the Internal Revenue Code. Therefore, the charge for in-process research and development and amortization of acquired intangible assets is not deductible for income tax purposes. In August 1999, we acquired Xing Technology Corporation, a developer and provider of MP3 software. We issued approximately 1,464 shares of our common stock in exchange for all outstanding shares of Xing stock. The acquisition was accounted for using the pooling-of-interests method of accounting and, accordingly, the consolidated financial statements include the accounts of Xing for all periods presented. As a result of the transaction, we incurred acquisition charges of $1.4 million primarily for legal and other professional fees. Approximately $160,000 of acquisition charges remained unpaid at December 31, 1999, substantially all of which is expected to be paid in 2000. Other Income, Net
1999 change 1998 change 1997 - ------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Other income, net $9,966 141% $4,135 119% $1,892
Other income, net consists primarily of interest earnings on our cash, cash equivalents and short-term investments. The increase in 1999 was primarily due to higher invested cash balances primarily as a result of our sale of common stock completed during the second quarter. The increase in 1998 was due primarily to investment earnings on higher average cash balances. Income taxes At December 31, 1999, we had provided a full valuation allowance on our deferred tax assets because of uncertainties regarding recoverability. See Note 7 of Notes to Consolidated Financial Statements. 24 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries Recent Events In January 2000, we acquired NetZip, Inc. NetZip is a leading developer and provider of Internet download management and utility software. As a result of the acquisition, NetZip became a wholly-owned subsidiary of RealNetworks and we issued approximately 3,418,000 shares (including options to purchase shares) of common stock in exchange for all of the outstanding shares of NetZip common stock and options to purchase NetZip common stock. Approximately 1,820,000 of those shares are subject to repurchase by the Company at a nominal repurchase price in certain circumstances. The acquisition will be accounted for under the purchase method of accounting and is valued at approximately $126 million, including transaction costs, based on the closing price of our common stock on January 25, 2000. The purchase price excludes approximately $144 million of RealNetworks' common stock, or approximately 1,820,000 shares, issued to former stockholders of NetZip which is subject to forfeiture for a period of 30 months after January 25, 2000. In January 2000, we completed a $15.0 million common stock investment in BackWeb Technologies, Inc., a leading provider of push technology for e-business solutions. This technology enables companies to deliver multimedia-rich digital packages, including audio, video, graphics and html. In January 2000, we also announced that our board of directors approved a two-for-one split of our common stock. Shareholders received one additional share for every share held on the record date of January 28, 2000. This document reflects the impact of the stock split for all periods presented. Liquidity and Capital Resources Since our inception, we have financed our operations primarily through sales of preferred and common stock and cash from operations. In addition, during 1997 we entered into a strategic agreement with Microsoft pursuant to which we granted Microsoft a nonexclusive license to certain technology and related trademarks for a license fee of $30.0 million. Net cash provided by operating activities was $48.2 million, $7.5 million, and $6.7 million in 1999, 1998 and 1997, respectively. Net cash provided by operating activities in 1999 resulted primarily from net income of $6.9 million as well as increases in accounts payable and accrued and other liabilities of $16.2 million and deferred revenue of $17.8 million. Net cash provided by operating activities in 1998 resulted primarily from a decrease in license fee receivable of $10.0 million, partially offset by a net loss of $20.0 million, which was offset by a noncash acquisition charge of $8.7 million. Net cash provided by operating activities in 1997 was primarily attributable to an increase of $29.2 million in deferred revenue, related primarily to the Microsoft license agreement, partially offset by a net loss of $15.1 million, an increase of $0.8 million in trade accounts receivable and an increase in license fee receivable of $10.0 million. Net cash used in investing activities of $179.7 million, $25.5 million, and $31.2 million in 1999, 1998 and 1997, respectively, was primarily related to net increases in short-term investments and purchases of equipment and leasehold improvements. Purchases of equipment and leasehold improvements have primarily related to supporting the increased number of employees. Net cash provided by financing activities of $240.7 million in 1999 primarily consisted of net proceeds from the sale of common stock and from the exercise of stock options. Net cash provided by financing activities of $6.5 million in 1998 primarily consisted of proceeds from the exercise of stock options and warrants. Net cash provided by financing activities of $71.9 million in 1997 was primarily from net proceeds from sales of preferred stock and net proceeds from the sale of common stock associated with our initial public offering. As of December 31, 1999, we had $358.3 million of cash and cash equivalents, short-term investments and restricted cash equivalents. As of December 31, 1999, our principal commitments consisted of a $1.0 million note payable and obligations outstanding under operating leases. During 1998, we entered into a lease agreement for our current corporate headquarters. The lease commenced on April 1, 1999 and expires in April 2011, with an option to renew the lease for either a three or ten-year period. We are funding the tenant improvements for our headquarters. We do not hold derivative financial instruments or equity securities in our short-term investment portfolio. Our cash equivalents and short-term investments consist of high quality securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one issue or issuer to a maximum of 5% of the total portfolio and requires that all investments mature in two years or less, with the average maturity being one year or less. These securities are subject to interest rate risk and will decrease in value if interest rates increase. 25 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries Because we have historically held our fixed income investments until maturity, we would not expect our operating results or cash flows to be significantly affected by a sudden change in market interest rates on our securities portfolio. We conduct our operations in eight primary functional currencies: the United States dollar, the Japanese yen, the British pound, the French franc, the Euro, the Mexican peso, the Brazilian real and the German mark. Historically, neither fluctuations in foreign exchange rates nor changes in foreign economic conditions have had a significant impact on our financial condition or results of operations. We currently do not hedge our foreign currency exposures and are therefore subject to the risk of exchange rates. We invoice our international customers primarily in U.S. dollars, except in Japan, where we invoice our customers primarily in yen. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Our exposure to foreign exchange rate fluctuations also arises from intercompany payables and receivables to and from our foreign subsidiaries. Foreign exchange rate fluctuations did not have a material impact on our financial results in 1999 and 1998. On January 1, 1999, the participating member countries of the European Union converted to a common currency, the Euro. On that same date they established fixed conversion rates between their existing sovereign currencies and the Euro. Even though legacy currencies are scheduled to remain legal tender in the participating countries as denominations of the Euro until January 1, 2002, the participating countries will no longer be able to direct independent interest rates for the legacy currencies. The authority to set monetary policy will now reside with the new European Central Bank. We do not anticipate any material impact from the Euro conversion on our financial information systems, which currently accommodate multiple currencies. Due to numerous uncertainties, we cannot reasonably estimate the effect that the Euro conversion issue will have on our pricing or market strategies or the impact, if any, it will have on our financial condition and results of operations. Since our inception, we have significantly increased our operating expenses. We currently anticipate that we will continue to experience significant growth in our operating expenses for the foreseeable future and that our operating expenses will be a material use of our cash resources. We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Year 2000 Compliance The "Year 2000" problem exists because many existing computer programs use only the last two digits to refer to a year. As a result, date-sensitive computer programs may not be able to distinguish whether a two-digit date designated as "00" refers to 1900 or 2000. This problem could cause system failures or the creation of wrong information and disrupt our operations. We developed a phased plan to achieve Year 2000 compliance for our internal processing and operational systems and the current versions of our software products. We have publicly made Year 2000 readiness disclosures stating that the current versions of our products are "Year 2000 compliant." "Year 2000 compliant" means that software products and systems are able to function properly before, during and after the year 2000 without loss of functionality due to date changes. This assurance assumes that: - - our products are configured and used in accordance with the related documentation; - - the underlying operating system of the host machine for our products and any other software used with or in such host machine are also Year 2000 compliant; and - - all other products, whether hardware, software, or firmware, used with one of our products properly exchange data with it. To date, we have not experienced any material adverse affects with respect to our products, material services and supplies from third parties on which we rely, or our internal systems as a result of the Year 2000 problem. We will continue to monitor the operation of our products and internal systems as well as the services and supplies we receive from third parties, to identify any Year 2000 effects that occur in the future. 26 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries Microsoft Relationship In June 1997, we entered into a strategic agreement with Microsoft pursuant to which we granted Microsoft a nonexclusive license to certain substantial elements of the source code of our RealAudio/RealVideo Version 4.0 technology and related RealNetworks trademarks for a license fee of $30.0 million. We are recognizing revenue related to the agreement ratably over the three-year term of our ongoing obligations. Microsoft may sublicense its rights to the licensed source code to third parties under certain conditions without further compensation to RealNetworks. Under certain conditions, if we license our source code to a third party, the agreement provides for a partial refund of the license fee paid by Microsoft, based on a declining scale over the three-year term of the agreement. FACTORS THAT MAY AFFECT OUR BUSINESS, FUTURE OPERATING RESULTS AND FINANCIAL CONDITION In addition to reviewing other information in this Annual Report, the following factors should be considered in evaluating us and our business before purchasing shares of our common stock. WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS We were incorporated in February 1994 and have a limited operating history. We have limited financial results on which you can assess our future success. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies in new and rapidly evolving markets, such as streaming media software, media delivery systems and electronic commerce. To address the risks and uncertainties we face, we must: - - establish and maintain broad market acceptance of our products and services and convert that acceptance into direct and indirect sources of revenues; - - maintain and enhance our brand name; - - continue to timely and successfully develop new products, product features and services and increase the functionality and features of existing products; - - successfully respond to competition from Microsoft and others; and - - develop and maintain strategic relationships to enhance the distribution, features and utility of our products and services. Our business strategy may be unsuccessful and we may be unable to address the risks we face in a cost-effective manner, if at all. Our inability to successfully address these risks will harm our business. WE HAVE A HISTORY OF LOSSES AND MAY NOT MAINTAIN PROFITABILITY We have incurred significant losses since our inception and we may never sustain or increase profitability. As of December 31, 1999, we had an accumulated deficit of approximately $34.9 million. We devote significant resources to developing, enhancing, selling and marketing our products and services. As a result, we will need to generate significant revenues to maintain profitability. While we had net income in 1999, we may not continue our historical growth or generate sufficient revenues to sustain or increase profitability on a quarterly or annual basis in the future. OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY As a result of our limited operating history and the rapidly changing nature of the markets in which we compete, our quarterly and annual revenues and operating results are likely to fluctuate from period to period. These fluctuations may be caused by a number of factors, many of which are beyond our control. These factors include the following, as well as others discussed elsewhere in this section: 27 12 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries - - how and when we introduce new products and services and enhance our existing products and services; - - our ability to retain existing customers, attract new customers and satisfy our customers' demands; - - the timing and success of our brand-building and marketing campaigns; - - our ability to establish and maintain strategic relationships; - - our ability to attract, train and retain key personnel; - - the demand for Internet advertising and sponsorships; - - the emergence and success of new and existing competition; - - varying operating costs and capital expenditures related to the expansion of our business operations and infrastructure, domestically and internationally, including the hiring of new employees; - - technical difficulties with our products, system downtime, system failures or interruptions in Internet access; - - costs and effects related to the acquisition of businesses or technology and related integration; and - - costs of litigation and intellectual property protection. In addition, because the market for our products and services is relatively new and rapidly changing, it is difficult to predict future financial results. Our research and development and sales and marketing efforts, and business expenditures generally, are partially based on predictions regarding certain developments for media delivery. To the extent that these predictions prove inaccurate, our revenues and operating expenses may fluctuate. For these reasons, you should not rely on period-to-period comparisons of our financial results as indications of future results. Our future operating results could fall below the expectations of public market analysts or investors and significantly reduce the market price of our common stock. Fluctuations in our operating results will likely increase the volatility of our stock price. WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT AND OTHER COMPANIES IN THE MEDIA DELIVERY MARKET The market for software and services for media delivery over the Internet is relatively new, constantly changing and intensely competitive. As media delivery evolves into a central component of the Internet experience, more companies are entering the market for, and expending increasing resources to develop, media delivery software and services. We expect that competition will continue to intensify. Negative competitive developments could hurt our business and the trading price of our stock. Many of our current and potential competitors have longer operating histories, greater name recognition, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. In addition, new competitors with potentially unique or more desirable products or services are entering the market all the time. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology franchise. Price concessions or the emergence of other pricing or distribution strategies of competitors may diminish our revenues, impact our margins or lead to a reduction in our market share, any of which will harm our business. We believe that the primary competitive factors in the media delivery market include: - - the quality and reliability of the overall media delivery solution; - - access to distribution channels necessary to achieve broad distribution and use of products; - - the availability of content for delivery over the Internet and access to necessary intellectual property rights; - - the ability to license or develop and support secure formats for digital media delivery, particularly music and video; - - the ability to license and support popular and emerging media formats for digital media delivery, particularly music and video, in a market where competitors may control the intellectual property rights for these formats; - - the size of the active audience for streaming and digital media and its appeal to content providers and advertisers; - - features for creating, editing and adapting content for the Internet; - - ease of use and interactive user features in products; - - ease of finding and accessing content over the Internet; 28 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries - - scalability of streaming media and media delivery technology and cost per user; - - pricing and licensing terms; - - compatibility with new and existing media formats; - - compatibility with the user's existing network components and software systems; and - - challenges caused by bandwidth constraints and other limitations of the Internet infrastructure. Our failure to adequately address any of the above factors could harm our business strategy and operating results. Microsoft is a principal competitor in the development and distribution of streaming media and media distribution technology. Microsoft currently competes with us in the market for streaming media server and player software and has announced its intent to compete in the market for digital distribution of media. Microsoft's commitment to and presence in the media delivery industry has increased and Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution. Microsoft distributes its competing streaming media server and tools products by bundling them with its Windows NT servers at no additional charge and by making them available for download from its website for free. While we also provide free downloads of certain of our products, including players, servers and tools, Microsoft's practices have caused, and may continue to cause, pricing pressure on our products. These practices have led in some cases, and could continue to lead to, longer sales cycles, decreased sales, loss of existing customers and reduced market share. In addition, we believe that Microsoft has used and may continue to use its monopoly position in the computer industry and its financial resources to secure preferential or exclusive distribution and bundling contracts for its streaming media products with third parties such as Internet service providers (ISPs), online service providers, content providers, entertainment companies, media companies, broadcasters, value added resellers (VARs) and original equipment manufacturers (OEMs), including third parties with whom we have relationships. In addition, Microsoft has invested significant sums of money in certain of our current and potential customers, and we expect this trend to continue, which may cause such customers to stop using or reduce their use of our products and services. Such arrangements, together with Microsoft's aggressive marketing of Windows NT and of its streaming media products, may reduce our share of the streaming media market. Microsoft's Windows Media Player competes with our RealPlayer products. The Windows Media Player is available for download from Microsoft's website for free, and is bundled by Microsoft with its Windows 98 operating system and with its Web browser, Internet Explorer. In addition, Microsoft has bundled certain audio capabilities into a radio toolkit for Internet Explorer 5.0, its latest Web browser. Internet Explorer 5.0 includes Web Events, which provides links to multimedia content on the Internet, especially content in Microsoft's streaming or digital media formats. We expect the Windows Media Player to be bundled with new versions of Windows to be released this year. We expect that by leveraging its monopoly position in operating systems and tying streaming or digital media into its operating system and its browser, Microsoft will distribute substantially more copies of the Windows Media Player in the future than it has in the past and may be able to attract more users to its streaming or digital media products. Currently, our RealPlayer has a high degree of market penetration: we have over 95 million unique registered users and estimate that more than 85% of all streaming media Web pages use our technology. Our market position will be difficult to sustain, particularly in light of Microsoft's efforts and dominant position in operating systems. In addition, Microsoft has invested in certain digital distribution technologies that compete with RealJukebox, such as the MusicMatch Jukebox. Microsoft bundles the MusicMatch Jukebox with the Microsoft Windows 98 Second Edition operating system. The MusicMatch Jukebox supports the Windows Media format, but not RealSystem G2 formats. We also expect Microsoft to develop its own jukebox product or bundle jukebox capabilities into the Windows Media Player. Microsoft also supports and promotes other third party products competitive to our products. We expect Microsoft and other competitors to devote significantly greater resources to product development in the jukebox and digital media categories. In addition, it may be difficult or impossible for us to license the Windows Media formats and other popular third party codec technology for use in our RealPlayer and RealJukebox products on terms equivalent to those offered to our competitors who do support the Windows Media format, which may harm the demand for and market for the RealPlayer and RealJukebox products. In addition, Microsoft competes with us to attract broadcasters of high quality or popular content to promote and deliver such content in Microsoft's formats, in some cases on an exclusive or preferential basis. We believe that Microsoft's commitment to and presence in the media delivery industry has increased and that Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution. In addition to Microsoft, we face increasing competition from other companies that are developing and marketing streaming media products. Apple Computer offers the QuickTime streaming media technology, including a free 29 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries media player and a free streaming media server, and has made available free source code to the server under the conditions of Apple Computer's end user license agreement. We expect that Apple Computer will devote more resources to developing and marketing streaming media systems, and will seek to compete more vigorously with us in the marketplace. Other competitors include, but are not limited to, Cisco Systems/Precept Software, PictureTel/Starlight Networks and Oracle Corporation. Companies such as AOL and Yahoo! and many smaller competitors offer various products that compete with other player and jukebox products. As more companies enter the market with products that compete with our servers, players and tools, the competitive landscape could change rapidly to our disadvantage. We do not believe that clear standards have emerged with respect to non-PC wireless and cable-based systems. Likewise, no one company has gained a dominant position in the mobile device market. However, certain products and services in these markets support our technology, and certain support our competitors' technology, especially Microsoft, which can use its monopoly position in the operating system business and other financial resources to gain access to these markets, potentially to the exclusion of us. Other companies' products and services or new standards may emerge in any of these areas, which could reduce demand for our products or render them obsolete. In addition, our streaming media and media delivery products face competition from "fast download" media delivery technologies such as AVI, QuickTime and MP3. Other fast download or non-streaming IP-based content distribution methods are likely to emerge and could compete with our products and services, which could harm our business. WE MAY BE UNABLE TO SUCCESSFULLY COMPETE IN OTHER PARTS OF OUR BUSINESS Media Hosting. Our media hosting service, the Real Broadcast Network, competes with a variety of companies that provide streaming media hosting services. These companies include Yahoo! Broadcast Services (formerly Broadcast.com), Akamai/Intervu and emerging broadcast networks such as CMGI's Magnitude Network, Enron Communications, GlobalMedia and Microcast. We may not establish or sustain our competitive position in this market segment. Some media hosting competitors are also customers on whom we rely to help drive product download traffic to our website through their broadcast events. We also sell servers and tools to companies that compete with Real Broadcast Network. As our relationship becomes more competitive, such companies may choose to purchase less or more of our products or services. Microsoft does not currently offer its own media hosting services, but it does own investments in competitive hosting services and it encourages customers who use Microsoft technology to use hosting services that compete with Real Broadcast Network. Website Destinations, Content and Advertising. While Internet advertising revenues across the industry continue to grow, the number of websites competing for advertising revenues is also growing. Our websites, including Real.com, RealNetworks.com, Film.com and LiveConcerts.com, compete for user traffic and Internet advertising revenues with a wide variety of websites, Internet portals and ISPs. In particular, aggregators of audio, video and other media, such as Yahoo! Broadcast Services and Microsoft's Web Events, compete with our RealGuide. We also compete with traditional media such as television, radio and print for a share of advertisers' total advertising budgets. Our advertising sales force and infrastructure are still in early stages of development relative to those of our competitors. We cannot be certain that advertisers will place advertising with us or that revenues derived from such advertising will be meaningful. If we lose advertising customers, fail to attract new customers, are forced to reduce advertising rates or otherwise modify our rate structure to retain or attract customers, or if we lose website traffic, our business could be harmed. Electronic Commerce. The electronic commerce features of our websites compete with a variety of other websites for consumer traffic. To compete successfully in the electronic commerce market, we must attract sufficient traffic to our websites by offering high-quality, competitively priced, desirable merchandise in a compelling, easy-to-purchase format. In addition, we must successfully leverage our existing user base to develop the market for our products and services. We may not compete successfully in the growing and rapidly changing market for electronic commerce. Our failure to do so could harm our business. Increased competition may result in price reductions, reduced margins, loss of customers, and a change in our business and marketing strategies, any of which could harm our business. 30 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries WE MAY NOT BE SUCCESSFUL IN THE MARKET FOR DOWNLOADABLE MEDIA AND LOCAL MEDIA DELIVERY In May 1999, we announced the RealSystem MP, a digital music architecture enabling integration with a wide range of Internet services and hardware devices. In May 1999, we released RealJukebox, our client software based on the RealSystem MP. These products represent an extension of our business into downloadable media and local media delivery, which is a substantial evolution from our historical focus on streaming media products and services. We do not yet know whether there is a sustainable market for products such as RealSystem MP and RealJukebox. Even if that market exists, we may be unable to develop a revenue model or sufficient demand to take advantage of the market opportunity. While over 25 million copies of RealJukebox have been downloaded since its beta release on May 3, 1999, and over 250,000 copies of RealJukebox Plus have been sold since its introduction in September 1999, it is too soon to determine if RealJukebox will be widely received in the marketplace. There are now a number of competitive products on the market that offer certain of the features that RealJukebox offers. These products include WinAmp Player, MusicMatch Jukebox, Liquid Audio Player and a2b Player. In addition, given the size and importance of the general market for music distribution, competitors will likely release products that directly compete with RealJukebox, which could harm our business. Even if RealJukebox achieves widespread market acceptance, it may not achieve a high level of use, which would lead to a low rate of upgrade sales and electronic commerce opportunities. Our inability to achieve widespread acceptance for RealSystem MP and RealJukebox or to create new revenue streams from new market segments could harm our business. RealJukebox supports a variety of audio formats, including RealAudio G2, MP3, Liquid Audio, Mjuice, Windows Media Audio, IBM's EMMS, and a2b. However, technical formats and consumer preferences evolve very rapidly, and we may be unable to adequately address consumer preferences or fulfill the market demand to the extent it exists. We have had long-term relationships with recording companies, including major record labels, many of which offer their streaming content in our formats. However, recording companies, including those with whom we have a relationship, may be uncomfortable with some features of RealJukebox. As a result, some record companies may decide to withhold content from RealJukebox, or refrain from or delay participating in promotional opportunities with respect to RealJukebox. RealJukebox is intended to allow users of the product to acquire, record, play back and manage music for their personal use. It is possible for a user of RealJukebox to elect not to use the copyright-protection features it contains and then violate the intellectual property rights of artists and recording companies by engaging in an unauthorized distribution of music. The laws governing the recording, distribution and performance of digital music are new and largely untested. While we believe we have developed RealJukebox to comply with U.S. copyright laws, a court may find us in violation of these laws. Similar action or other litigation in the United States or abroad directed at us could harm our business, even if such litigation were entirely without merit. In addition, we may be required to pay royalties associated with the digital distribution and performance of music, which could adversely impact our financial results. WE MAY NOT SUCCESSFULLY DEVELOP NEW PRODUCTS AND SERVICES Our growth depends on our ability to continue to develop leading edge media delivery and digital distribution products and services. Our business and operating results would be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues to offset development costs. We may not timely and successfully identify, develop and market new product and service opportunities. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability. Because the markets for our products and services are rapidly changing, we must develop new offerings quickly. We have experienced development delays and cost overruns in our development efforts in the past and we may encounter such problems in the future. Delays and cost overruns could affect our ability to respond to technolog- 31 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries ical changes, evolving industry standards, competitive developments or customer requirements. Our products also may contain undetected errors that could cause increased development costs, loss of revenues, adverse publicity, reduced market acceptance of the products or lawsuits by customers. POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS The failure to adequately address the financial and operational risks raised by acquisitions of technology and businesses could harm our business. We have acquired complementary technologies and businesses in the past, and intend to do so in the future. Financial risks related to acquisitions include: - - potentially dilutive issuances of equity securities; - - use of cash resources; - - the incurrence of additional debt and contingent liabilities; - - large write-offs; and - - amortization expenses related to goodwill and other intangible assets. Acquisitions also involve operational risks, including: - - difficulties in assimilating the operations, products, technology, information systems and personnel of the acquired company; - - diversion of management's attention from other business concerns; - - impairment of relationships with our employees, affiliates, advertisers and content providers; - - inability to maintain uniform standards, controls, procedures and policies; - - the assumption of known and unknown liabilities of the acquired company; - - entrance into markets in which we have no direct prior experience; and - - loss of key employees of the acquired company. In August 1999, we acquired Xing Technology Corporation, an MP3 software developer, in a transaction that was accounted for as a pooling of interests. We may not be able to account for future acquisitions as a pooling of interests, which could result in the future incurrence of substantial expenses relating to the amortization of goodwill. In January 2000, we acquired NetZip, Inc., a developer and marketer of download management software, in a transaction that was accounted for using the purchase method of accounting. The NetZip transaction poses particular integration risks because NetZip has been based in Atlanta, Georgia, and we plan to relocate its operations to Seattle, Washington. We may not adequately integrate these or any future acquisitions. WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO INCREASE MARKET ACCEPTANCE OF OUR PRODUCTS If third parties do not develop or offer compelling content to be delivered over the Internet, our business will be harmed and our products may not achieve or sustain broad market acceptance. We rely on third-party content providers, such as radio and television stations, record labels, media companies, websites and other companies, to develop and offer content in our formats that can be delivered using our server products and played back using our player products. While we have a number of short-term agreements with third parties to provide content from their websites in our formats, most third parties are not obligated to develop or offer content using our technology. In addition, some third parties have entered into and may in the future enter into agreements with our competitors, principally Microsoft, to develop or offer all or a substantial portion of their content in our competitors' formats. Microsoft has more resources to secure preferential and even exclusive relationships with content providers. There could be less demand for and use of our products if Microsoft or another competitor were to secure preferential or exclusive relationships with the leading broadcasters, record companies or websites. We cannot guarantee that third-party content providers will continue to rely on our technology or offer compelling content in our formats to encourage and sustain broad market acceptance of our products. Their failure to do so would harm our business. As we move into the market for digital distribution of media and local media playback, our success depends on the availability of third-party content, especially music, that users of our RealJukebox product can lawfully and easily access, record and play back. Our product may not achieve or sustain market acceptance if third parties are 32 17 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS REALNETWORKS, Inc. and Subsidiaries unwilling to offer their content for free download or purchase by users of RealJukebox. Current concerns regarding the secure distribution of music over the Internet are causing content owners to delay or refuse to make content available for distribution. Competitors could secure exclusive distribution relationships with such content providers, which would harm our business. THE RATE STRUCTURE OF SOME OF OUR ADVERTISING AND SPONSORSHIP ARRANGEMENTS SUBJECTS US TO FINANCIAL RISK. We generate advertising revenues in part through sponsored services and placements by third parties in our products and on our websites, in addition to banner advertising. We may receive sponsorship fees or a portion of transaction revenues in return for minimum levels of user impressions to be provided by us. These arrangements expose us to potentially significant financial risks in the event our usage levels decrease, including the following: - - the fees we are entitled to receive may be adjusted downwards; - - we may be required to "make good" on our obligations by providing alternative services; - - the sponsors may not renew the agreements or may renew at lower rates; and - - the arrangements may not generate anticipated levels of shared transaction revenues, or sponsors may default on the payment commitments in such agreements. Accordingly, any leveling off or decrease of our user base or the failure to generate anticipated levels of shared transaction revenues could result in a meaningful decrease in our revenue levels. WE DEPEND ON KEY PERSONNEL WHO MAY NOT CONTINUE TO WORK FOR US Our success substantially depends on the continued employment of our executive officers and key employees, particularly Robert Glaser, our chairman of the board and chief executive officer. The loss of the services of Mr. Glaser or any of our other executive officers or key employees could harm our business. Each of these individuals has acquired specialized knowledge and skills with respect to RealNetworks and its operations. As a result, if any of these individuals were to leave RealNetworks, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor obtains the necessary training and experience. Several of our personnel have reached or will soon reach the five-year anniversary of their RealNetworks hiring date and, as a result, will have become or will shortly become fully vested in their initial stock option grants. While management personnel are typically granted additional stock options, which will usually vest over a period of five years, subsequent to their hire date to provide additional incentive to remain at RealNetworks, the initial option grant is typically the largest and an employee may be more likely to leave our employ upon completion of the vesting period for the initial option grant. None of our executive officers has a contract that guarantees employment. Other than the $2 million insurance policy on the life of Mr. Glaser, we do not maintain "key person" life insurance policies. If we do not succeed in retaining and motivating existing personnel, our business could be harmed. OUR FAILURE TO ATTRACT, TRAIN OR RETAIN HIGHLY QUALIFIED PERSONNEL COULD HARM OUR BUSINESS Our success also depends on our ability to attract, train and retain qualified personnel, specifically those with management and product development skills. In particular, we must hire additional skilled software engineers to further our research and development efforts. At times, we have experienced difficulties in hiring personnel with the right training or experience, particularly in technical areas. Competition for qualified personnel is intense, particularly in high-technology centers such as the Pacific Northwest, where our corporate headquarters are located. In making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of stock options they may receive in connection with their employment. As a result of recent volatility in our stock price, we may be disadvantaged in competing with companies that have not experienced similar volatility or that have not yet sold their stock publicly. If we do not succeed in attracting new personnel or retaining and motivating our current personnel, our business could be harmed. 33 18 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS REALNETWORKS, Inc. and Subsidiaries WE MAY NOT SUCCESSFULLY MANAGE OUR GROWTH We cannot successfully implement our business model if we fail to manage our growth. We have rapidly and significantly expanded our operations domestically and internationally and anticipate further expansion to take advantage of market opportunities. We have increased the number of our full- time employees from 325 on January 1, 1998 to 648 on December 31, 1999. Managing this substantial expansion has placed a significant strain on our management, operational and financial resources. If our growth continues, we will need to continue to improve our financial and managerial control and reporting systems and procedures. We are in the process of implementing new management information software systems. This will affect many aspects of our business, including our accounting, operations, electronic commerce, customer service, purchasing, sales and marketing functions. The purchase, implementation and testing of these systems have resulted, and will result, in significant capital expenditures and could disrupt our day-to-day operations. If these systems are not implemented as expected, our ability to provide products and services to our customers on a timely basis will suffer and delays in the recording and reporting of our operating results could occur. THE GROWTH OF OUR BUSINESS DEPENDS ON THE INCREASED USE OF THE INTERNET FOR COMMUNICATIONS, ELECTRONIC COMMERCE AND ADVERTISING The growth of our business depends on the continued growth of the Internet as a medium for communications, electronic commerce and advertising. Our business will be harmed if Internet usage does not continue to grow, particularly as a source of media information and entertainment and as a vehicle for commerce in goods and services. Our success also depends on the efforts of third parties to develop the infrastructure and complementary products and services necessary to maintain and expand the Internet as a viable commercial medium. The Internet may not be accepted as a viable commercial medium for broadcasting multimedia content or media delivery for a number of reasons, including: - - potentially inadequate development of the necessary infrastructure to accommodate growth in the number of users and Internet traffic; - - lack of acceptance of the Internet as a medium for distributing streaming media content or for media delivery; - - unavailability of compelling multimedia content; - - inadequate commercial support for Web-based advertising; and - - delays in the development or adoption of new technological standards and protocols or increased governmental regulation, which could inhibit the growth and use of the Internet. In addition, we believe that other Internet-related issues, such as security, reliability, cost, ease of use and quality of service, remain largely unresolved and may affect the amount of business that is conducted over the Internet. If Internet usage grows, the Internet infrastructure may not be able to support the demands placed on it by such growth, specifically the demands of delivering high-quality media content. As a result, its performance and reliability may decline. In addition, websites have experienced interruptions in service as a result of outages and other delays occurring throughout the Internet network infrastructure. If these outages or delays occur frequently in the future, Internet usage, as well as the usage of our products, services and websites, could grow more slowly or decline. 34 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries CHANGES IN NETWORK INFRASTRUCTURE, TRANSMISSION METHODS AND BROADBAND TECHNOLOGIES POSE RISKS TO OUR BUSINESS We believe that increased Internet use may depend on the availability of greater bandwidth or data transmission speeds (also known as broadband transmission). If broadband access becomes widely available, we believe it presents both a substantial opportunity and a significant business challenge for us. Internet access through cable television set-top boxes, digital subscriber lines or wireless connections could dramatically reduce the demand for our products and services by utilizing alternate technology that more efficiently transmits data. This could harm our business as currently conducted. Development of products and services for a broadband transmission infrastructure involves a number of additional risks, including: - - changes in content delivery methods and protocols; - - the availability of compelling content that takes advantage of broadband access and helps drive market acceptance of our products and services; - - the emergence of new competitors, such as traditional broadcast and cable television companies, which have significant control over access to content, substantial resources and established relationships with media providers; - - the development of relationships by our current competitors with companies that have significant access to or control over the broadband transmission infrastructure or content; - - the need to establish new relationships with non-PC based providers of broadband access, such as providers of television set-top boxes and cable television, some of which may compete with us; and - - the general risks of new product and service development, including the challenges to develop error-free products and enhancements, develop compelling services and achieve market acceptance for these products and services. We depend on the efforts of third parties to develop and provide a successful infrastructure for broadband transmission. Even if broadband access becomes widely available, heavy use of the Internet may negatively impact the quality of media delivered through broadband connections. If these third parties experience delays or difficulties establishing a widespread broadband transmission infrastructure or if heavy usage limits the broadband experience, the release of our broadband products and services could be delayed. Even if a broadband transmission infrastructure is developed for widespread use, our products and services may not achieve market acceptance or generate sufficient revenues to offset our development costs. WE COULD LOSE STRATEGIC RELATIONSHIPS THAT ARE ESSENTIAL TO OUR BUSINESS The loss of certain current strategic relationships or key licensing arrangements, the inability to find other strategic partners or the failure of our existing relationships to achieve meaningful positive results for us could harm our business. We rely in part on strategic relationships to help us: - - increase adoption of our products through distribution arrangements; - - increase the amount and availability of compelling media content on the Internet to help boost demand for our products and services; - - enhance our brand; - - expand the range of commercial activities based on our technology; - - expand the distribution of our streaming media content without a degradation in fidelity; and - - increase the performance and utility of our products and services. We would be unable to accomplish many of these goals without the assistance of third parties. We anticipate that the efforts of our strategic partners will become more important as the multimedia experience over the Internet matures. For example, we may become more reliant on strategic partners to provide multimedia content, provide more secure and easy-to-use electronic commerce solutions and build out the necessary infrastructure for media delivery. We may not be successful in forming strategic relationships. In addition, the efforts of our strategic partners may be unsuccessful. Furthermore, these strategic relationships may be terminated before we realize any benefit. 35 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries OUR INDUSTRY IS EXPERIENCING CONSOLIDATION THAT MAY INTENSIFY COMPETITION The Internet industry has recently experienced substantial consolidation and a proliferation of strategic transactions. We expect this consolidation and strategic partnering to continue. Acquisitions or strategic relationships could harm us in a number of ways. For example: - - competitors could acquire or enter into relationships with companies with which we have strategic relationships and discontinue our relationship, resulting in the loss of distribution opportunities for our products and services or the loss of certain enhancements or value-added features to our products and services; - - competitors could obtain exclusive access to desirable multimedia content and prevent that content from being available in our formats, thus decreasing the use of our products and services to distribute and experience the content that audiences most desire, and hurting our ability to attract advertisers to our websites and product offerings; - - a competitor could be acquired by a party with significant resources and experience that could increase the ability of the competitor to compete with our products and services; and - - other companies with related interests could combine to form new, formidable competition, which could preclude us from obtaining access to certain markets or content, or which could dramatically change the market for our products and services. Announcements and consolidations that could affect our business include: - - Microsoft's strategic investments in broadband initiatives, including its $5 billion investment in AT&T; - - AT&T's acquisition of TCI and its proposed acquisition of MediaOne Communications; - - At Home's acquisition of Excite; - - Yahoo!'s acquisitions of Broadcast.com and GeoCities; - - The Walt Disney Company's combination of its Internet assets with, and acquisition of a majority ownership of, Infoseek, to create a single business called Go.com; - - NBC's merger of its Internet assets with XOOM.com, Inc. and Snap.com, a subsidiary of CNET; - - AOL's recent announcement that it intends to acquire Time-Warner, and Time-Warner's announcement that it intends to form a joint venture with EMI Music; and - - Akamai's recent announcement of its planned acquisition of Intervu. OUR BUSINESS WILL SUFFER IF OUR SYSTEMS FAIL OR BECOME UNAVAILABLE A reduction in the performance, reliability and availability of our websites and network infrastructure will harm our ability to distribute our products and services to our users, as well as our reputation and ability to attract and retain users, customers, advertisers and content providers. Our revenues depend in large part on the number of users that download our products from our websites and access the content services on our websites. Our systems and operations are susceptible to, and could be damaged or interrupted by outages caused by fire, flood, power loss, telecommunications failure, Internet breakdown, earthquake and similar events. Our systems are also subject to computer viruses, break-ins, "denial of service" attacks, sabotage, intentional acts of vandalism and tampering designed to disrupt our computer systems, websites and network communications. Our computer and communications infrastructure is located at a single leased facility in Seattle, Washington. We do not have fully redundant systems or a formal disaster recovery plan, and we do not carry adequate business interruption insurance to compensate us for losses that may occur from a system outage. Our electronic commerce and digital distribution activities are managed by sophisticated software and computer systems. We may encounter delays in developing these systems, and the systems may contain undetected errors that could cause system failures. Any system error or failure that causes interruption in availability of products or 36 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries content or an increase in response time could result in a loss of potential or existing business services customers, users, advertisers or content providers. If we suffer sustained or repeated interruptions, our products, services and websites could be less attractive to such entities or individuals and our business would be harmed. A sudden and significant increase in traffic on our websites could strain the capacity of the software, hardware and telecommunications systems that we deploy or use. This could lead to slower response times or system failures. Our operations also depend on receipt of timely feeds from our content providers, and any failure or delay in the transmission or receipt of such feeds could disrupt our operations. We depend on Web browsers, ISPs and online service providers to provide Internet users access to our websites. Many of these providers have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. In addition, certain ISPs have temporarily interrupted our website operations in response to the heavy volume of e-mail transmission we generate and send to our large user base. These types of interruptions could continue or increase in the future. OUR NETWORK IS SUBJECT TO SECURITY RISKS THAT COULD HARM OUR REPUTATION AND EXPOSE US TO LITIGATION OR LIABILITY Online commerce and communications depend on the ability to transmit confidential information securely over public networks. Any compromise of our ability to transmit confidential information securely, and costs associated with preventing or eliminating any problems, could harm our business. Online transmissions are subject to a number of security risks, including: - - our own or licensed encryption and authentication technology may be compromised, breached or otherwise be insufficient to ensure the security of customer information; - - we could experience unauthorized access, computer viruses, system interference or destruction, "denial of service" attacks and other disruptive problems, whether intentional or accidental, that may inhibit or prevent access to our websites or use of our products and services; - - a third party could circumvent our security measures and misappropriate our, our partners' and our customer's proprietary information or interrupt operations; and - - credit card companies could restrict online credit card transactions. The occurrence of any of these or similar events could damage our reputation and expose us to litigation or liability. In February 2000, many commercial and governmental websites were the subject of intentional denial of service attacks designed to disrupt or disable the operation of such websites. We may also be required to expend significant capital or other resources to protect against the threat of security breaches or hacker attacks or to alleviate problems caused by such breaches or attacks. OUR INTERNATIONAL OPERATIONS INVOLVE RISKS We operate subsidiaries in Australia, England, France, Germany, Japan, Mexico, Brazil and Hong Kong, and market and sell products in several other countries. For the year ended December 31, 1999, approximately 23% of our revenues, excluding revenues derived from our license agreement with Microsoft, were derived from international operations. We have also entered into joint ventures internationally. A key part of our strategy is to develop localized products and services in international markets. To date, we have only limited experience in developing localized versions of our products and marketing and operating our products and services internationally and we rely on the efforts and abilities of our foreign business partners in such activities. International markets we have selected may not develop at a rate that supports our level of investment. In particular, international markets typically have been slower in adoption of the Internet as an advertising and commerce medium. In addition to uncertainty about our ability to continue to generate revenues from our foreign operations and expand our international presence, there 37 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries are certain risks inherent in doing business on an international level. We are subject to the normal risks of doing business internationally, as well as risks specific to Internet-based companies in foreign markets. These risks include: - - delays in the development of the Internet as a broadcast, advertising and commerce medium in international markets; - - difficulties in managing operations due to distance, language and cultural differences, including issues associated with establishing management systems infrastructures in individual markets; - - unexpected changes in regulatory requirements; - - export and import restrictions, including those restricting the use of encryption technology; - - tariffs and trade barriers and limitations on fund transfers; - - difficulties in staffing and managing foreign operations; - - longer payment cycles and problems in collecting accounts receivable; - - potential adverse tax consequences; - - exchange rate fluctuations; - - increased risk of piracy and limits on our ability to enforce our intellectual property rights; and - - other legal and political risks. Any of these factors could harm our business. We do not currently hedge our foreign currency exposures. WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS Our inability to protect our proprietary rights, and the costs of doing so, could harm our business. Our success and ability to compete partly depend on the superiority, uniqueness or value of our technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. Despite our efforts to protect our proprietary rights, unauthorized parties may copy or infringe aspects of our technology, products, services or trademarks, or obtain and use information we regard as proprietary. Our proprietary rights may be especially difficult to protect in foreign countries, where unrelated third parties may have registered our domain names and trademarks under their own names in an attempt to prevent us from using the domain names and trademarks in those countries without paying them a significant sum of money. This could prevent us from using our valuable brands in those countries, and reduce the value of our intellectual property. In addition, others may independently develop technologies that are similar or superior to ours, which could reduce the value of our intellectual property. As of January 31, 2000, we had 29 registered U.S. trademarks or service marks, and had applications pending for an additional 45 U.S. trademarks. We also have several unregistered trademarks. In addition, RealNetworks has several foreign trademark registrations and pending applications. Many of our marks begin with the word "Real" (such as RealSystem, RealAudio and RealVideo). We are aware of other companies that use "Real" in their marks alone or in combination with other words, and we do not expect to be able to prevent all third-party uses of the word "Real" for all goods and services. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective patent, copyright, trademark and trade secret protection may not be available in such jurisdictions. As of January 31, 2000, we had 11 U.S. patents and numerous patent applications on file relating to various aspects of our technology. We are preparing additional patent applications on other features of our technology. Patents with respect to our technology may not be granted and, if granted, may be challenged or invalidated. Issued patents may not provide us with any competitive advantages and may be challenged by third parties. In addition, others could independently develop substantially equivalent intellectual property. 38 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries Many of our current and potential competitors dedicate substantially greater resources to protection and enforcement of their intellectual property rights, especially patents. If a blocking patent has issued or issues in the future, we would need to either obtain a license or design around the patent. We may not be able to obtain such a license on acceptable terms, if at all, or design around the patent. As with other software products, our products are susceptible to unauthorized copying and uses that may go undetected, and policing such unauthorized use is difficult. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology, or may not prevent the development and design by others of products or technologies similar to or competitive with those we develop. Companies in the computer industry have frequently resorted to litigation regarding intellectual property rights. We may have to litigate to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of other parties' proprietary rights. From time to time, other parties' proprietary rights, including patent rights, have come to our attention and on several occasions we have received notice of claims of infringement of other parties' proprietary rights, and we may receive such notices in the future. In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit against us and co-defendant Broadcast.com in the United States District Court for the Northern District of Texas - Dallas Division. The plaintiffs allege that we, individually and in combination with Broadcast.com, infringe on a certain patent by making, using, selling and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. The plaintiffs seek to enjoin us from the alleged infringing activity and to recover damages in an amount no less than a reasonable royalty. We believe the allegations are without merit and intend to vigorously defend ourselves against these claims. However, litigation is inherently uncertain, and we may be unable to successfully defend ourselves against this claim. From time to time we receive claims and inquiries from third parties alleging that our internally developed technology or technology we license from third parties may infringe the third parties' proprietary rights. We are now investigating several of such pending claims. We could be required to spend significant amounts of time and money to defend ourselves against such claims. If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products while we re-engineer them or seek licenses to necessary technology, which might not be available on reasonable terms. We could also be subject to claims for indemnification resulting from infringement claims made against our customers and strategic partners, which could increase our defense costs and potential damages. Any of these events could harm our business. WE ARE SUBJECT TO RISKS ASSOCIATED WITH GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES Few existing laws or regulations specifically apply to the Internet, other than laws and regulations generally applicable to businesses. Certain U.S. export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. However, it is likely that a number of laws and regulations may be adopted in the United States and other countries with respect to the Internet. These laws may relate to areas such as content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, encryption, use of key escrow data, caching of content by server products, electronic authentication or "digital signatures," personal privacy, advertising, taxation, electronic commerce liability, e-mail, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability. Other countries and political organizations are likely to impose or favor more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. In addition, state and local governments may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity and enforcement, may affect the available distribution channels for and costs associated with our products and services, and may affect the growth of the Internet. Such laws or regulations may therefore harm our business. We do not know for certain how existing laws governing issues such as property ownership, copyright and other intellectual property issues, taxation, illegal or obscene content, retransmission of media, and personal privacy and data protection apply to the Internet. The vast majority of such laws were adopted before the advent of the Internet 39 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries and related technologies and do not address the unique issues associated with the Internet and related technologies. Most of the laws that relate to the Internet have not yet been interpreted. Changes to or the interpretation of these laws could: - - limit the growth of the Internet; - - create uncertainty in the marketplace that could reduce demand for our products and services; - - increase our cost of doing business; - - expose us to significant liabilities associated with content available on our websites or distributed or accessed through our products or services, and with our provision of products and services, and with the features or performance of our products and websites; - - lead to increased product development costs, or otherwise harm our business; or - - decrease the rate of growth of our user base and limit our ability to effectively communicate with and market to our user base. On October 28, 1998, the Digital Millennium Copyright Act (DMCA) was enacted. The DMCA includes statutory licenses for the performance of sound recordings and for the making of recordings to facilitate transmissions. Under these statutory licenses, we and our broadcast customers will be required to pay licensing fees for sound recordings we deliver in original and archived programming and through retransmissions of radio broadcasts. The DMCA does not specify the rate and terms of the licenses, which will be determined either through voluntary inter-industry negotiations or arbitration. We will soon engage in arbitration with the Recording Industry Association of America to determine what, if any, licensee fee should be paid. Depending on the rates and terms adopted for the statutory licenses, our business could be harmed both by increasing our own cost of doing business, as well as by increasing the cost of doing business for our customers. The Child Online Protection Act and the Child Online Privacy Protection Act (COPPA) were enacted in October 1998. The COPPA impose civil and criminal penalties on persons distributing material harmful to minors (e.g., obscene material) over the Internet to persons under the age of 17, or collecting personal information from children under the age of 13. We do not knowingly collect and disclose personal information from such minors. The manner in which the COPPA may be interpreted and enforced cannot be fully determined, and future legislation similar to the COPPA could subject us to potential liability, which in turn could harm our business. Such laws could also damage the growth of the Internet generally and decrease the demand for our products and services. WE MAY BE SUBJECT TO MARKET RISK AND LEGAL LIABILITY IN CONNECTION WITH THE DATA COLLECTION CAPABILITIES OF OUR PRODUCTS AND SERVICES Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate. To provide better consumer experiences and to operate effectively, our products occasionally send information to servers at RealNetworks. Many of the services we provide also require that a user provides certain information to us. We post privacy policies concerning the use and disclosure of our user data. Any failure by us to comply with our posted privacy policies or the consent order could impact the market for our products and services, subject us to litigation and harm our business. Between November 1999 and March 2000, a total of fourteen purported class action lawsuits were filed against us in state and/or federal courts in California, Illinois, Pennsylvania, Washington and Texas. The plaintiffs in federal court in Pennsylvania and in Illinois state court have voluntarily dismissed their lawsuits in response to our motion to compel arbitration of the claims under the terms of our End User License Agreements. The remaining twelve actions, which seek to certify classes of plaintiffs, allege breach of contract, invasion of privacy, deceptive trade practices, negligence, fraud and violation of certain federal and state laws in connection with various communications features of our RealPlayer and RealJukebox products. Plaintiffs are seeking both damages and injunctive relief. We have filed various answers denying the claims and have filed suit in Washington state court to compel the plaintiffs who have filed actions in Texas, California and Illinois state courts to arbitrate their claims as required by our End User License Agreements. 40 25 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries On February 10, 2000, the federal district court for the Northern District of Illinois granted our motion to stay the court proceedings in that case because the claims are subject to arbitration under our End User License Agreements. Also on that date, the federal Judicial Panel on Multidistrict Litigation transferred all federal cases pending at that time to the federal court in Illinois that has ruled that the claims are arbitrable. Plaintiffs in the transferred federal cases are seeking to overturn the district court's ruling that the claims must be arbitrated. Although we can give no assurance as to the outcome of these lawsuits, we believe the allegations in these actions are without merit, and we intend to vigorously defend ourselves against these claims. If the plaintiffs prevail in their claims, we could be required to pay damages or other penalties, in addition to complying with injunctive relief, which could have a material adverse effect on our operating results. WE MAY BE SUBJECT TO LEGAL LIABILITY FOR THE PROVISION OF THIRD-PARTY PRODUCTS, SERVICES OR CONTENT We periodically enter into arrangements to offer third-party products, services, or content under the RealNetworks' brand or via distribution on various RealNetworks' websites or in RealNetworks' products. We may be subject to claims concerning these products, services or content by virtue of our involvement in marketing, branding, broadcasting or providing access to them, even if we do not ourselves host, operate, provide, or provide access to these products, services or content. While our agreements with these parties often provide that we will be indemnified against such liabilities, such indemnification may not be adequate. It is also possible that, if any information provided directly by us contains errors or is otherwise negligently provided to users, third parties could make claims against us, including for defamation, negligence, copyright or trademark infringement, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information that we provide links to. Investigating and defending any of these types of claims is expensive, even to the extent that the claims do not result in liability. REALNETWORKS' DIRECTORS AND EXECUTIVE OFFICERS BENEFICIALLY OWN APPROXIMATELY 47.7% OF OUR STOCK; THEIR INTERESTS COULD CONFLICT WITH YOURS; SIGNIFICANT SALES OF STOCK HELD BY THEM COULD HAVE A NEGATIVE EFFECT ON REALNETWORKS' STOCK PRICE; SHAREHOLDERS MAY BE UNABLE TO EXERCISE CONTROL As of December 31, 1999, our executive officers, directors and affiliated persons beneficially own approximately 47.7% of our common stock. Robert Glaser, our chief executive officer and chairman of the board, beneficially owns approximately 36.4% of our common stock. As a result, our executive officers, directors and affiliated persons will have significant influence to: - - elect or defeat the election of our directors; - - amend or prevent amendment of our articles of incorporation or bylaws; - - effect or prevent a merger, sale of assets or other corporate transaction; and - - control the outcome of any other matter submitted to the shareholders for vote. As a result of their ownership and positions, our directors and executive officers collectively are able to significantly influence all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. In addition, sales of significant amounts of shares held by RealNetworks' directors and executive officers, or the prospect of these sales, could adversely affect the market price of RealNetworks common stock. Management's stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of RealNetworks, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price. 41 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries PROVISIONS OF OUR CHARTER DOCUMENTS, SHAREHOLDER RIGHTS PLAN AND WASHINGTON LAW COULD DISCOURAGE OUR ACQUISITION BY A THIRD PARTY Our articles of incorporation provide for a strategic transaction committee of the board of directors currently comprised of Messrs. Glaser, Breyer and Kapor. Without the prior approval of this committee, and subject to certain limited exceptions, the board of directors does not have the authority to: - - adopt a plan of merger; - - authorize the sale, lease, exchange or mortgage of: (A) assets representing more than 50% of the book value of our assets prior to the transaction; or (B) any other asset or assets on which our long-term business strategy is substantially dependent; - - authorize our voluntary dissolution; or - - take any action that has the effect of any of the above. RealNetworks also entered into an agreement providing Mr. Glaser with a direct contractual right to require RealNetworks to abide by and perform all terms of the articles of incorporation with respect to the strategic transactions committee. This agreement also provides that so long as Mr. Glaser owns a specified number of shares, RealNetworks will use its best efforts to cause him to be nominated to, elected to, and not removed from the board of directors. In addition, the articles provide that Mr. Glaser will serve, or will appoint another officer of RealNetworks to serve, as our policy ombudsman, with the exclusive authority to adopt or change our editorial policies as reflected on our websites or in other communications or media in which we have a significant editorial or media voice. The provisions with respect to the authority of the strategic transactions committee and the policy ombudsman may be amended only with the approval of 90% of the shares entitled to vote on an amendment to the articles. We have adopted a shareholder rights plan that provides that shares of our common stock have associated preferred stock purchase rights. These rights become exercisable and detachable from the associated common stock only following the acquisition by a person or a group of 15% or more of our outstanding common stock or 10 days following the announcement of a tender or exchange offer for 15% or more of our outstanding common stock. The rights entitle our shareholders, other than the person or entity that has acquired or made an exchange or tender offer for 15% or more of our outstanding common stock, to acquire additional shares of our capital stock at a price equal to one-half of the market price at the time of the event and, in certain circumstances, would allow our shareholders to acquire capital stock in the entity that has acquired or made an exchange or tender offer for 15% or more of our outstanding common stock at a similar discount. The exercise of these rights would make the acquisition of RealNetworks by a third party more expensive to that party and has the effect of discouraging third parties from acquiring our company without the approval of our board of directors, which has the power to redeem these rights and prevent their exercise. Washington law imposes restrictions on some transactions between a corporation and certain significant shareholders. Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target corporation," with some exceptions, from engaging in certain significant business transactions with an "acquiring person," which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation, for a period of five years after such acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the acquisition. Such prohibited transactions include, among other things: - - a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from the acquiring person; - - termination of 5% or more of the employees of the target corporation as a result of the acquiring person's acquisition of 10% or more of the shares; or - - allowing the acquiring person to receive any disproportionate benefit as a shareholder. After the five-year period, a "significant business transaction" may occur, as long as it complies with certain "fair price" provisions of the statute. A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a change in control of RealNetworks. 42 27 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RealNetworks, Inc. and Subsidiaries The foregoing provisions of our charter documents, shareholder rights plan and Washington law, as well as those relating to a classified board of directors and the availability of "blank check" preferred stock, could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock. OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE The trading price of our common stock has been and is likely to continue to be highly volatile. For example, during the 52-week period ended January 31, 2000, the price of our common stock ranged from $13.25 to $93.00 per share. Our stock price could be subject to wide fluctuations in response to factors such as: - - actual or anticipated variations in quarterly operating results; - - announcements of technological innovations, new products or services by us or our competitors; - - changes in financial estimates or recommendations by securities analysts; - - the addition or loss of strategic relationships or relationships with our key customers; - - conditions or trends in the Internet, media streaming, media delivery and online commerce markets; - - changes in the market valuations of other Internet, online service or software companies; - - announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; - - legal or regulatory developments; - - additions or departures of key personnel; - - sales of our common stock; and - - general market conditions. The historical volatility of our stock price may make it more difficult for you to resell shares when you want at prices you find attractive. Sharp increases in our stock price could have a negative impact on our financial condition. In addition, the stock market in general, and the Nasdaq National Market and the market for Internet and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. These broad market and industry factors may reduce our stock price, regardless of our operating performance. The trading prices of the stocks of many technology companies are at or near historical highs and reflect price-earnings ratios substantially above historical levels. These trading prices and price-earnings ratios may not be sustained. WE MAY BE SUBJECT TO ASSESSMENT OF SALES AND OTHER TAXES FOR THE SALE OF OUR PRODUCTS, LICENSE OF TECHNOLOGY OR PROVISION OF SERVICES We may have to pay past sales or other taxes that we have not collected from our customers. We do not currently collect sales or other taxes on the sale of our products, license of technology or provision of services in states and countries other than those in which we have offices or employees. In October 1998, the Internet Tax Freedom Act (ITFA) was signed into law. Among other things, the ITFA imposes a three-year moratorium on discriminatory taxes on electronic commerce. Nonetheless, foreign countries or, following the moratorium, one or more states, may seek to impose sales or other tax obligations on companies that engage in such activities within their jurisdictions. Our business would be harmed if one or more states or any foreign country were able to require us to collect sales or other taxes from current or past sales of products, licenses of technology or provision of services, particularly because we would be unable to go back to customers to collect sales taxes for past sales and may have to pay such taxes out of our own funds. WE INTEND TO DONATE A PORTION OF NET INCOME TO CHARITY For the year ended December 31, 1999, we were profitable and accrued 5% of our pretax net income for charitable donation. If we sustain profitability, we intend to donate 5% of our annual net income to charitable organizations. This will reduce our net income. 43 28 CONSOLIDATED BALANCE SHEETS RealNetworks, Inc. and Subsidiaries
December 31, 1999 1998 - --------------------------------------------------------------------------------------------------------------------- (In thousands except per share data) ASSETS Current assets: Cash, cash equivalents and short-term investments $ 344,627 89,801 Trade accounts receivable, net of allowances for doubtful accounts and sales returns of $1,982 in 1999 and $1,344 in 1998 6,895 5,149 Prepaid expenses and other current assets 2,870 3,446 - --------------------------------------------------------------------------------------------------------------------- Total current assets 354,392 98,396 - --------------------------------------------------------------------------------------------------------------------- Equipment and leasehold improvements, at cost: Equipment and software 21,142 11,445 Leasehold improvements 15,129 1,441 - --------------------------------------------------------------------------------------------------------------------- Total equipment and leasehold improvements 36,271 12,886 Less accumulated depreciation and amortization 10,101 6,506 - --------------------------------------------------------------------------------------------------------------------- Net equipment and leasehold improvements 26,170 6,380 - --------------------------------------------------------------------------------------------------------------------- Restricted cash equivalents 13,700 13,700 Other assets 9,942 1,250 Goodwill, net of accumulated amortization of $3,724 in 1999 and $1,596 in 1998 6,920 9,048 - --------------------------------------------------------------------------------------------------------------------- Total assets $ 411,124 128,774 - --------------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 6,305 $ 3,947 Accrued and other liabilities 26,944 12,961 Deferred revenue, excluding non-current portion 47,316 23,742 - --------------------------------------------------------------------------------------------------------------------- Total current liabilities 80,565 40,650 - --------------------------------------------------------------------------------------------------------------------- Deferred revenue, excluding current portion -- 5,833 Note payable -- 987 Shareholders' equity: Convertible preferred stock, no par value: Series A: authorized no shares in 1999 and 45 shares in 1998, issued and outstanding no shares in 1999 and 17 shares in 1998 -- 3,642 Series B: authorized no shares in 1999 and 181 shares in 1998, issued and outstanding no shares in 1999 and 103 shares in 1998 -- 1,200 Preferred stock, $0.001 par value, no shares issued and outstanding Series A: authorized 200 shares -- -- Undesignated series: authorized 59,800 shares -- -- Common stock, $0.001 par value Authorized 300,000 shares in 1999 and 293,704 shares in 1998; issued and outstanding 149,648 shares in 1999 and 124,828 shares in 1998 150 125 Special common stock, $0.001 par value Authorized no shares in 1999 and 6,296 shares in 1998; issued and outstanding no shares in 1999 and 2,586 shares in 1998 -- 3 Additional paid-in capital 366,177 118,251 Accumulated other comprehensive loss (903) (126) Accumulated deficit (34,865) (41,791) - --------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 330,559 81,304 - --------------------------------------------------------------------------------------------------------------------- Commitments, contingencies and subsequent events Total liabilities and shareholders' equity $ 411,124 128,774 =====================================================================================================================
See accompanying notes to consolidated financial statements 44 29 CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) RealNetworks, Inc. and Subsidiaries
years ended December 31, 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------ (in thousands, except per share data) Net revenues: Software license fees $ 90,627 48,487 29,165 Service revenues 26,466 14,742 4,972 Advertising 14,149 3,148 2,254 - ------------------------------------------------------------------------------------------------------------ Total net revenues 131,242 66,377 36,391 - ------------------------------------------------------------------------------------------------------------ Cost of revenues: Software license fees 13,006 8,308 3,800 Service revenues 6,579 2,631 2,392 Advertising 2,906 1,727 920 - ------------------------------------------------------------------------------------------------------------ Total cost of revenues 22,491 12,666 7,112 - ------------------------------------------------------------------------------------------------------------ Gross profit 108,751 53,711 29,279 - ------------------------------------------------------------------------------------------------------------ Operating expenses: Research and development 38,415 22,480 15,651 Sales and marketing 53,465 33,460 22,954 General and administrative 16,380 11,540 7,635 Goodwill amortization 2,128 1,596 -- Acquisition charges 1,403 8,723 -- - ------------------------------------------------------------------------------------------------------------ Total operating expenses 111,791 77,799 46,240 - ------------------------------------------------------------------------------------------------------------ Operating loss (3,040) (24,088) (16,961) - ------------------------------------------------------------------------------------------------------------ Other income (expense): Interest income, net 11,523 4,928 2,178 Other expense (1,557) (793) (286) - ------------------------------------------------------------------------------------------------------------ Other income (expense), net 9,966 4,135 1,892 - ------------------------------------------------------------------------------------------------------------ Net income (loss) $ 6,926 (19,953) (15,069) - ------------------------------------------------------------------------------------------------------------ Basic net income (loss) per share $ 0.05 (0.15) (0.92) Diluted net income (loss) per share $ 0.04 (0.15) (0.92) Shares used to compute basic net income (loss) per share 142,016 130,156 16,906 Shares used to compute diluted net income (loss) per share 166,576 130,156 16,906 Comprehensive income (loss): Net income (loss) $ 6,926 (19,953) (15,069) Unrealized loss on securities (670) -- -- Foreign currency translation adjustments (107) 36 (151) - ------------------------------------------------------------------------------------------------------------ Comprehensive income (loss) $ 6,149 (19,917) (15,220) - ------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 45 30 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY RealNetworks, Inc. and Subsidiaries
Series A Convertible Series B Convertible Preferred Stock Preferred Stock Preferred Stock - ----------------------------------------------------------------------------------------------------------------------------- Shares Amount Shares Amount Shares Amount - ----------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 17 $ 3,642 - $ - 13,713 $ 14 Exercise of common stock options - - - - - - Issuance of common stock in exchange for services - - - - - - Issuance of preferred stock warrants - - - - - - Sale of preferred stock - - 103 1,200 - - Accretion of redemption value of redeemable, convertible preferred stock - - - - - - Exercise of common stock warrants - - - - - - Conversion of convertible preferred stock into common stock - - - - (13,713) (14) Conversion of redeemable, convertible preferred stock into common stock and special common stock - - - - - - Sale of common stock for cash, net of issuance costs of $4,582 - - - - - - Translation adjustment - - - - - - Net loss - - - - - - - ----------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 17 3,642 103 1,200 - - Exercise of common stock options - - - - - - Exercise of common stock warrants - - - - - - Common stock sold pursuant to Employee Stock Purchase Plan - - - - - - Issuance of common stock and stock options in business combination - - - - - - Conversion of special common stock into common stock - - - - - - Issuance of stock warrants - - - - - - Translation adjustment - - - - - - Net loss - - - - - - - ----------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1998 17 3,642 103 1,200 - - Exercise of common stock options - - - - - - Exercise of common stock warrants - - - - - - Common stock sold pursuant to Employee Stock Purchase Plan - - - - - - Remeasurement of preferred stock warrants due to debt term extension - - - - - - Sale of common stock for cash, net of issuance costs of $10,438 - - - - - - Conversion of Series A convertible preferred stock into common stock (17) (3,642) - - - - Conversion of Series B convertible preferred stock into common stock - - (103) (1,200) - - Conversion of special common stock into common stock - - - - - - Issuance of common stock warrants in exchange for services - - - - - - Unrealized loss on investments - - - - - - Translation adjustment - - - - - - Net income - - - - - - - ----------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1999 - $ - - $ - - $ - - -----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 46 31
Accumulated Additional Other Total Special Paid-in Comprehensive Accumulated Shareholder's Common Stock Common Stock Capital Income (loss) Deficit Equity - ------------------------------------------------------------------------------------------------------------ Shares Amount Shares Amount - ------------------------------------------------------------------------------------------------------------ (in thousands) 2,868 $ 3 - $- 2,767 (11) (6,281) 134 4,592 4 - - 273 - - 277 64 - - - 59 - - 59 - - - - 4,068 - - 4,068 - - - - - - - 1,200 - - - - - - (488) (488) 736 1 - - 36 - - 37 54,852 55 - - (41) - - - 33,940 34 3,338 3 50,034 - - 50,071 13,932 14 - - 38,528 - - 38,542 - - - - - (151) - (151) - - - - - - (15,069) (15,069) - ----------------------------------------------------------------------------------------------------------- 110,984 111 3,338 3 95,724 (162) (21,838) 78,680 3,574 4 - - 741 - - 745 2,666 3 - - 3,844 - - 3,847 190 - - - 873 - - 873 4,406 4 - - 16,522 - - 16,526 3,008 3 (752) - (3) - - - - - - - 550 - - 550 - - - - - 36 - 36 - - - - - - (19,953) (19,953) - ------------------------------------------------------------------------------------------------------------ 124,828 125 2,586 3 118,251 (126) (41,791) 81,304 5,446 6 - - 9,785 - - 9,791 326 - - - 1,399 - - 1,399 112 - - - 1,563 - - 1,563 - - - - 1,383 - - 1,383 8,250 8 - - 228,804 - - 228,812 136 - - - 3,642 - - - 206 - - - 1,200 - - - 10,344 11 (2,586) (3) (8) - - - - - - - 158 - - 158 - - - - - (670) - (670) - - - - - (107) - (107) - - - - - - 6,926 6,926 - ------------------------------------------------------------------------------------------------------------ 149,648 $ 150 - $ - 366,177 (903) (34,865) 330,559 - ------------------------------------------------------------------------------------------------------------
32 CONSOLIDATED STATEMENTS OF CASH FLOWS RealNetworks, Inc. and Subsidiaries
years ended December 31, 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------- (in thousands) Cash flows from operating activities: Net income (loss) $ 6,926 (19,953) (15,069) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 6,974 5,212 2,569 Amortization of discount on debt 841 367 - Common stock warrant issued for services 158 - - Loss on disposal of equipment and leasehold improvements - 644 - Non-cash acquisition charges - 8,723 - Other (26) - 27 Equity in net losses of joint venture 368 448 182 Deferred income taxes - 777 (777) Changes in certain assets and liabilities: Trade accounts receivable (1,686) 413 (806) License fee receivable - 10,000 (10,000) Prepaid expenses and other current assets 576 (1,486) (920) Accounts payable 2,343 949 (206) Accrued and other liabilities 13,899 4,444 2,496 Deferred revenue 17,814 (3,028) 29,163 - ------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 48,187 7,510 6,659 - ------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchases of equipment and leasehold improvements (24,559) (4,373) (4,627) Purchases of short-term investments (193,358) (93,161) (203,046) Sales of short-term investments 46,934 85,542 177,621 Investment in joint venture - - (998) Purchase of long-term investment (9,000) - Decrease (increase) in other assets 310 30 (192) Increase in restricted cash equivalents - (13,700) - Cash obtained through acquisition - 203 - - ------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (179,673) (25,459) (31,242) - ------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Proceeds from issuance of notes payable and notes payable with warrants 1,000 735 1,343 Repayments of notes payable (628) (150) - Net proceeds from sales of preferred and common stock and exercise of stock options and warrants 240,291 5,931 70,559 - ------------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 240,663 6,516 71,902 - ------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash (122) (62) (106) - ------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 109,055 (11,495) 47,213 Cash and cash equivalents at beginning of year 51,900 63,395 16,182 - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 160,955 51,900 63,395 - ------------------------------------------------------------------------------------------------------------------- Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 90 65 84 Cash paid during the year for income taxes - 600 700 Supplemental disclosure of noncash financing and investing activities: Accretion of preferred stock - - 488 Conversion of redeemable, convertible preferred stock and special common stock to common stock - - 50,071 Common stock issued in business combination - 16,526 - Notes payable tendered as exercise price of common stock warrants 1,585 - - Remeasurement of preferred stock warrants due to debt term extension 1,383 - -
See accompanying notes to consolidated financial statements. 48 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries Note 1. Description of Business and Summary of Significant Accounting Policies A. Description of Business. RealNetworks, Inc. and subsidiaries (RealNetworks or Company) is a leading provider of media delivery and digital distribution solutions designed for the Internet. The Company's solutions enable consumers to experience and content providers to deliver a broad range of multimedia content, including audio, video, text and animation. The Company pioneered the development and commercialization of "streaming media" systems that enable the creation, real-time delivery and playback of multimedia content. The Company extended its media delivery platform to include a digital music management system that allows consumers to acquire, record, store, organize and play their personal music collections on personal computers and digital playback devices. Inherent in the Company's business are various risks and uncertainties, including its limited operating history and the limited history of commerce on the Internet. The Company's success may depend in part upon the emergence of the Internet and corporate intranets as a communications medium, the acceptance of the Company's technology by the marketplace and the Company's ability to generate license, service and advertising revenues from the use of its technology on the Internet. B. Basis of Presentation. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. On April 27, 1999 and January 21, 2000, the board of directors declared a 2-for-1 split of the Company's Common Stock in the form of a stock dividend. The stock splits were effected on May 10, 1999 and January 28, 2000, respectively. Accordingly, the accompanying consolidated financial statements and notes thereto have been retroactively restated to reflect the stock splits. The consolidated financial statements have been prepared to give retroactive effect to the merger with Xing Technology Corporation (Xing) on August 10, 1999. The consolidated financial statements have been restated for all periods pre- sented as if Xing and the Company had always been combined. Prior to the merger Xing operated on a June 30 fiscal year. The results of operations of Xing included herein have been restated to conform to the Company's December 31 fiscal year-end. C. Depreciation and Amortization. Depreciation and amortization of equipment and leasehold improvements is computed using the straight-line method over the lesser of the estimated useful lives of the assets, generally three to 12 years, or the lease term. Goodwill represents the excess of the purchase price over the fair value of identifiable tangible and intangible assets acquired and liabilities assumed in a business combination accounted for under the purchase accounting method. Goodwill is amortized using the straight-line method over five years. 49 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) 50 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries D. Other Investments. The cost method is used to account for equity investments in companies in which the Company holds less than a 20 percent voting interest. The Company does not exercise significant influence and the securities do not have a quoted market price. E. Stock-Based Compensation. The Company has elected to apply the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Accordingly, the Company accounts for stock-based compensation transactions with employees using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Options Issued to Employees," and related interpretations. Compensation cost for employee stock options is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the stock option exercise price. F. Cash, Cash Equivalents and Short-Term Investments. The Company considers all short-term investments with a remaining contractual maturity at date of purchase of three months or less to be cash equivalents. The Company considers all short-term investments as available-for-sale. Accordingly, these investments are carried at fair value which is based on quoted market prices. Unrealized holding losses were $670 at December 31, 1999. There were no significant unrealized gains or losses at December 31, 1998. All short-term investments have original contractual maturities of two years or less. The Company's cash, cash equivalents and short-term investments consist of the following:
Gross Gross Estimated Amortized Unrealized Unrealized Fair December 31, 1999 Cost Gains Losses Value - ------------------------------------------------------------------------------------------ Cash and cash equivalents: Cash $122,569 - - 122,569 Commercial paper 32,161 - (17) 32,144 Other 6,242 - - 6,242 - ------------------------------------------------------------------------------------------ Total cash and cash equivalents 160,972 - (17) 160,955 - ------------------------------------------------------------------------------------------ Short-term investments: Corporate notes 47,572 2 (162) 47,412 Commercial paper 44,889 - (229) 44,660 U.S. Government agency securities 76,011 13 (277) 75,747 Other 15,853 - - 15,853 - ------------------------------------------------------------------------------------------ Total short-term investments 184,325 15 (668) 183,672 - ------------------------------------------------------------------------------------------ Total cash, cash equivalents and short-term investments $345,297 15 (685) 344,627 - ------------------------------------------------------------------------------------------ Restricted cash equivalents $ 13,700 - - 13,700 - ------------------------------------------------------------------------------------------
Gross Gross Estimated Amortized Unrealized Unrealized Fair December 31, 1998 Cost Gains Losses Value - ------------------------------------------------------------------------------------------ Cash and cash equivalents: Cash $ 5,900 - - 5,900 Commercial paper 42,000 - - 42,000 Other 4,000 - - 4,000 - ------------------------------------------------------------------------------------------ Total cash and cash equivalents 51,900 - - 51,900 - ------------------------------------------------------------------------------------------ Short-term investments: Corporate notes 30,602 - - 30,602 U.S. Government agency securities 5,300 - - 5,300 Other 1,999 - - 1,999 - ------------------------------------------------------------------------------------------ Total short-term investments 37,901 - - 37,901 - ------------------------------------------------------------------------------------------ Total cash, cash equivalents and short-term investments $89,801 - - 89,801 - ------------------------------------------------------------------------------------------ Restricted cash equivalents $13,700 - - 13,700 - ------------------------------------------------------------------------------------------
Restricted cash equivalents represent a restricted escrow account established in connection with a lease agreement for the Company's corporate headquarters. Under certain circumstances, $10,000 of the escrow account will be maintained for the term of the lease. The remaining $3,700 will be released as the Company funds tenant improvements. Realized gains or losses on sales of available-for-sale securities for 1999 and 1998 were not significant. The cost of securities sold is based on the specific identification method. The contractual maturities of available-for-sale debt securities at December 31, 1999 are as follows:
Amortized Fair December 31, 1999 Cost Value - ----------------------------------------------------------- Within one year $151,762 151,301 Between one year to two years 32,563 32,371 - ----------------------------------------------------------- Short-term investments $184,325 183,672 - -----------------------------------------------------------
G. Revenue Recognition. The Company recognizes revenue in accordance with the provisions of Statement of Position 97-2, "Software Revenue Recognition" (SOP 97-2), which provides specific industry guidance and stipulates that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post contract customer support, installation or training. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for each element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. Revenue from software license fees is recognized upon delivery, net of an allowance for estimated returns, provided all the requirements of SOP 97-2 have been met. Revenue from software license agreements with original equipment manufacturers (OEM) is recognized when the OEM delivers its product incorporating the Company's software to the end user. In the case of prepayments received from an OEM, the Company generally recognizes revenue based on the actual products sold by the OEM. If the Company anticipates providing ongoing support to the OEM in the form of future upgrades, enhancements or other services over the term of the contract, revenue is recognized on the straight-line method over the term of the contract. Service revenues include payments under support and upgrade contracts and fees from consulting and streaming media content hosting. Support and upgrade revenues are recognized ratably over the term of the contract, which typically is twelve months. Other service revenues are recognized when the service is performed. Fees generated from advertising appearing on the Company's websites, and from advertising and channel presets included in the Company's products are recognized as revenue over the terms of the contracts. The Company may guarantee a minimum number of page impressions on the Company's websites for a specified period, click-throughs or other specified criteria. To the extent these guarantees are not met, the Company defers recognition of the corresponding revenues until guaranteed delivery levels are achieved. 51 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries H. Research and Development. Costs incurred in research and development are expensed as incurred. Software development costs are required to be capitalized when a product's technological feasibility has been established through the date the product is available for general release to customers. The Company has not capitalized any software development costs as technological feasibility is generally not established until substantially all development is complete. I. Advertising Expenses. The Company expenses the cost of advertising and promoting its products as incurred. Such costs are included in sales and marketing expense and totaled approximately $2,900 in 1999, $783 in 1998, and $1,110 in 1997. J. Income Taxes. The Company computes income taxes using the asset and liability method, under which deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and operating loss and tax credit carryforwards. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled. K. Financial Instruments and Concentrations of Risk. The Company's financial instruments consist of cash, cash equivalents, short-term investments, trade accounts receivable, other investments, accounts payable, accrued liabilities and note payable. Except for other investments the fair value of these instruments approximates their financial statement carrying amounts due to their short maturities. It was not practicable to estimate the fair value of other investments which consisted of a capital stock investment in a nonpublic company. Credit is extended to customers based on an evaluation of their financial condition, and collateral is not required. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. The Company is subject to concentrations of credit risk and interest rate risk related to its short-term investments. The Company's credit risk is managed by limiting the amount of investments placed with any one issuer, investing in high-quality securities and securities of the U.S. government, and limiting the average maturity of the overall portfolio. L. Net Income (Loss) Per Share. Basic net income (loss) per share is computed by dividing net income (loss) (plus, in 1997, accretion of the redemption value of redeemable preferred stock) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) (plus, in 1997, accretion of redemption value of redeemable preferred stock) by the weighted average number of common and dilutive common equivalent shares outstanding during the period. As the Company had a net loss attributable to common shareholders for 1998 and 1997, basic and diluted net loss per share are the same for those periods. 52 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries The following schedule represents a reconciliation of the numerators and denominators of basic and diluted net income (loss) per share calculations for 1999, 1998, and 1997.
Weighted Income Average Income (loss) Shares (loss) (Numerator) (Denominator) per share - ------------------------------------------------------------------------------------------------------- Year Ended December 31, 1999 Basic net income per share $ 6,926 142,016 $ 0.05 Effect of dilutive stock options and warrants - 24,560 - ----------------------------------------------------------------------------------------- Diluted net income per share $ 6,926 166,576 $ 0.04 - ----------------------------------------------------------------------------------------- Year Ended December 31, 1998 Basic and diluted net loss per share $(19,953) 130,156 $(0.15) Year Ended December 31, 1997 Net loss $(15,069) Accretion of redemption value of redeemable preferred stock prior to conversion into common stock (488) - ------------------------------------------------------------------------- Basic and diluted net loss per share (15,557) 16,906 $(0.92) - -------------------------------------------------------------------------------------------------------
The computation of diluted net income (loss) per share excludes the following options to acquire shares of common stock for the years indicated because their effect would be anti-dilutive:
years ended December 31, 1999 1998 1997 - ----------------------------------------------------------------------------------------- Common stock options 1,462 32,770 27,756 Weighted average exercise price per share $ 66.42 3.03 0.73
M. Comprehensive Income (Loss). On January 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130), which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, unrealized gains and losses) in a full set of financial statements. The Company's comprehensive income (loss) for 1999, 1998 and 1997 consisted of net loss, unrealized gains (losses) on short-term investments and the gross amount of foreign currency translation adjustments. The tax effect of the foreign currency translation adjustments and unrealized gains (losses) on short-term investments was insignificant. N. Foreign Currency. The functional currency of the Company's foreign subsidiaries is the local currency of the country in which the subsidiary is incorporated. Assets and liabilities of foreign operations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. Income and expense accounts are translated into U.S. dollars using average rates of exchange. The net gain or loss resulting from translation is shown as translation adjustment and included in accumulated other comprehensive income (loss) in shareholders' equity. Gains and losses from foreign currency transactions are included in the consolidated statements of operations. There were no significant gains or losses on foreign currency transactions in 1999, 1998 and 1997. 53 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries O. 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 reporting period. Actual results could differ from those estimates. P. Impairment of Long-Lived Assets and Goodwill. The Company reviews its long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used, including goodwill, is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell. Q. Reclassifications. Certain reclassifications have been made to the 1998 and 1997 consolidated financial statements to conform with the 1999 presentation. R. New Accounting Pronouncements. In March 1998, the AICPA issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 requires the capitalization of certain costs incurred in connection with developing or obtaining software for internal use. The Company adopted SOP 98-1 on January 1, 1999. There was no material impact on the consolidated financial statements as a result of adoption of SOP 98-1. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model for accounting for derivatives and hedging activities and supersedes and amends existing accounting standards and is effective for fiscal years beginning after June 15, 2000. SFAS 133 requires that all derivatives be recognized in the balance sheet at their fair market value, and the corresponding derivative gains or losses be either reported in the statement of operations or as a component of other comprehensive income depending on the type of hedge relationship that exists with respect to such derivative. The Company does not expect the adoption of SFAS 133 to have a material impact on its consolidated financial statements. In December 1998, the AICPA issued Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions" (SOP 98-9) which amends certain elements of SOP 97-2 and is effective for fiscal years beginning after March 15, 1999. The Company believes that the adoption of SOP 98-9 will not have a material effect on the Company's results of operations or financial position. In December 1999, the United States Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 101 (SAB 101) "Revenue Recognition in Financial Statements," which will be adopted by the Company on January 1, 2000. SAB 101 provides guidance on revenue recognition and the SEC staff's views on the application of accounting principles to selected revenue recognition issues. The Company does not expect that the adoption of SAB 101 will have a material effect on its consolidated financial statements. Note 2. Acquisitions A. Vivo Software, Inc. In March 1998, the Company completed the acquisition of Vivo Software, Inc. (Vivo), a developer of streaming media creation tools. Under the terms of the acquisition, the Company issued approximately 4,406 shares of its common stock in exchange for all outstanding shares of Vivo common stock. In addition, the Company issued options to purchase approximately 190 shares of the Company's common stock in exchange for outstanding unvested options to purchase Vivo common stock. The acquisition was accounted for using the purchase method of accounting, and, accordingly, the results of Vivo's operations are included in the Company's consolidated financial statements since the date of acquisition. A summary of the purchase price for the acquisition is as follows: 54 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries Stock and stock options $16,526 Direct acquisition costs 445 Accrued liabilities assumed 1,640 Other liabilities assumed 1,057 - ---------------------------------------------------------- Total $19,668 - ----------------------------------------------------------
The purchase price was allocated as follows: Cash acquired $ 203 Other current assets acquired 148 Equipment 100 Goodwill 10,644 In-process research and development 8,573 - ---------------------------------------------------------- Total $19,668 - ----------------------------------------------------------
In-process research and development represents the fair value of technologies acquired for use in the Company's own development efforts. The Company determined the amount of the purchase price to be allocated to in-process research and development based on the time and cost to incorporate the acquired technology into the Company's development projects, expected incremental revenues and expenses associated with the development projects utilizing the acquired technology, and risks and uncertainties associated with the acquired technology. Such risks and uncertainties include inherent difficulties and uncertainties in incorporating the acquired technology into the Company's development projects and risks related to the viability of and potential changes to target markets. The Company also concluded that the acquired technology had no alternative future use. Goodwill represents the excess of the purchase price over the fair value of identifiable tangible and intangible assets acquired and liabilities assumed and is amortized using the straight-line method over its estimated life of five years. The acquisition of Vivo qualified as a tax-free reorganization under the Internal Revenue Code (IRC). Therefore, the charge for in-process research and development was not deductible for income tax purposes. The Company acquired net operating loss carryforwards of approximately $16,000, which expire from 2008 to 2012. Under the provisions of the IRC, the amount of these net operating loss carryforwards available annually to offset future taxable income is significantly limited. No value has been attributed to these net operating losses in the purchase price allocation due to these limitations. Any utilization of the net operating loss carryforwards in the future will result in a reduction of the carrying amount of goodwill. In connection with the acquisition, approximately 882 shares of common stock issued were placed in escrow to secure indemnification obligations of former shareholders of Vivo. As of December 31, 1999 and December 31, 1998, 0 and 440 shares remained in escrow, respectively. The following table presents pro forma results of operations as if the acquisition had occurred at the beginning of each of the years presented. The pro forma results of operations exclude $8,723 of acquisition related charges as the charges are not expected to have a continuing impact on the Company's results of operations. The pro forma information is not necessarily indicative of the combined results that would have occurred had the acquisition taken place at the beginning of 1998, nor is it necessarily indicative of results that may occur in the future.
years ended December 31, 1998 1997 - --------------------------------------------------------------------- Total net revenues $ 67,030 38,172 Net loss (12,818) (22,630) Net loss per share - basic and diluted (0.10) (1.11)
55 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries B. Xing Technology Corporation In August 1999, the Company acquired all of the outstanding capital stock of Xing in a transaction accounted for using the pooling-of-interests method of accounting. The Company issued an aggregate of 1,464 shares of its common stock and all outstanding options and warrants of Xing were replaced by options and warrants to acquire shares of the Company's common stock. Xing is a leading provider of high performance, standards-based digital audio and video encoding and decoding technology, including MP3 software. The historical consolidated financial statements of the Company have been restated to include the accounts of Xing as if it had always been a part of the Company. There were no material transactions between the Company and Xing prior to the merger. Prior to the merger, Xing operated on a June 30 fiscal year. The results of operations of Xing have been restated to conform to the Company's December 31 fiscal year-end. Although certain reclassifications were made to Xing's accounts to confirm to RealNetworks' presentation, no adjustments were required to conform Xing's accounting policies to the Company's. In August 1999, the Company incurred acquisition costs of approximately $1,403 in connection with the merger with Xing. This included $860 of merger-related costs and $543 of integration expenses. Included in the integration expenses were $165 for severance for employees involved in duplicate functions and $378 for other obligations. There was approximately $160 included in accrued liabilities as of December 31, 1999 related to Xing acquisition costs, substantially all of which is expected to be paid in 2000. Separate results for the combined entities are as follows:
Nine Months Ended September 30, Years Ended December 31, 1999 1998 1997 - ------------------------------------------------------------------ Revenues: RealNetworks $ 86,039 64,839 32,720 Xing 1,749 1,538 3,671 - ------------------------------------------------------------------ $ 87,788 66,377 36,391 - ------------------------------------------------------------------ Net income (loss): RealNetworks $ 3,331 (16,414) (11,169) Xing (2,466) (3,539) (3,900) - ------------------------------------------------------------------ $ 865 (19,953) (15,069) - ------------------------------------------------------------------
Note 3. Other Investments In 1999, the Company made a minority interest investment through the purchase of voting capital stock of WebGlide Ltd. (WebGlide) a developer of computer generated video technology and provider of an e-shopping solution. The Company does not have significant influence over WebGlide and uses the cost based method of accounting for the investment. The carrying value of the investment at December 31, 1999 was $9,000. Note 4. Bank Notes Payable In May 1998, the Company entered into a secured credit agreement with a related party under which the Company could borrow up to $500. In September 1998, the credit agreement was amended to increase the available amount to $1,000. Funds borrowed under the credit agreement bore interest at 8.25% per annum, payable quarterly, with any outstanding principal amounts due at the expiration of the credit agreement. The credit agreement originally expired on November 30, 1998. However, on the expiration date the agreement was extended to February 28, 1999, at which time it was extended again to February 28, 2000. Principal amounts outstanding under the credit agreement were $0 at December 31, 1999 and $1,000 at December 31, 1998 In April 1999, the Company obtained additional financing through a $1,000 note payable issued under a borrowing agreement. Principal and interest, accruing at 12% per annum is payable in February 2000. In addition, the Company issued the lender a warrant to purchase 96 shares of common stock at an exercise price of $10.40 per share. The warrant is excercisable and expires 30 days following final maturity date of the note. 56 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries The proceeds under the secured credit agreement and additional financing in April 1999 were allocated to the notes payable and the common stock purchase warrants based on their relative fair values. The value allocated to warrants was recorded as a discount on the notes payable with a corresponding increase in additional paid-in capital. The fair value of the warrants was determined using the Black-Scholes option pricing model. When the credit agreement was extended on November 30, 1998, a new measurement date was also established for the common stock purchase warrants. The discount related to the first warrant in May 1998 was $10, the discount related to the second warrant in September 1998 was $265, the discount related to the extension of the credit agreement on November 30, 1998 was $275, the discount related to the extension on February 20, 1999, was $570 and the discount related to the additional financing in April 1999 was $813. The weighted average grant date fair value was determined using expected volatility of 70 percent, warrant term of one year, risk free interest rate of 5 percent and a dividend yield of zero. In August 1999, the warrants were exercised and the balance outstanding on the related notes was exchanged for the exercise price of the stock warrants, as permitted by the warrant agreement. Note 5. Shareholders' Equity A. Sales of Common Stock In May 1999, the Company sold 8,250 shares of common stock for net proceeds of $228,812. In November 1997, the Company completed its initial public offering and all outstanding shares of preferred stock were converted to either common stock or special common stock. B. Special Common Stock Special common stock is not entitled to vote, except as required by law. All other rights and preferences of the special common stock are identical to common stock, except as otherwise required by law or expressly provided in the Company's Articles of Incorporation. All shares of special common stock were held by Microsoft Corporation (Microsoft) and each share automatically converts into four shares of common stock upon sale or transfer by Microsoft to an unaffiliated third party. During 1998, Microsoft sold 752 shares which were converted into 3,008 shares of common stock. During 1999, Microsoft sold the remaining 2,586 shares which were converted into 10,344 shares of common stock. At December 31, 1999, there were no shares of special common stock outstanding. C. Convertible Preferred Stock In November 1997, the Company issued 103 shares of Series B Convertible Preferred Stock at a price of $11.65 per share, for total proceeds of $1,200. The Series A and Series B Convertible Preferred Stock were convertible, at any time at the option of the holder, into shares of common stock. Each share of Series A Convertible Preferred Stock was convertible into eight shares of common stock and each share of Series B Convertible Preferred Stock converts into two shares of common stock. The shares of Series A and B Convertible Preferred Stock had preference in liquidation of $3,870 and $1,200 or $228 and $11.65 per share, respectively. The Series A and B Convertible Preferred Stock had voting rights equal to the number of full shares of common stock into which the preferred stock could be converted. In September 1999, all of the outstanding shares of Series A and Series B convertible preferred stock were converted into 342 shares of common stock. D. Preferred Stock Each share of Series A preferred stock entitles the holder to one thousand votes and dividends equal to one thousand times the aggregate per share amount of dividends declared on the common stock. Undesignated preferred stock will have rights and preferences that are determinable by the Board of Directors when determination of a new series of preferred stock has been established. E. Shareholder Rights Plan On October 16, 1998, the Company's board of directors declared a dividend of one preferred share purchase right (Right) in connection with its adoption of a Shareholder Rights Plan dated December 4, 1998, for each outstanding share of the Company's common stock on December 14, 1998 (Record Date). Each share of common stock issued after the Record Date will be issued with an attached Right. The Rights will not immediately be exercisable and detachable from the common stock. The Rights will become exercisable and detachable only following the acquisition by a person or a group of 15 percent or more of the outstanding common 57 42 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries stock or ten days following the announcement of a tender or exchange offer for 15 percent or more of the outstanding common stock (Distribution Date). After the Distribution Date, each Right will entitle the holder to purchase for $37.50 (Exercise Price), a fraction of a share of the Company's Series A preferred stock with economic terms similar to that of one share of the Company's common stock. Upon a person or a group acquiring 15 percent or more of the outstanding common stock, each Right will allow the holder (other than the acquiror) to purchase common stock or securities of the Company having a then current market value of two times the Exercise Price of the Right. In the event that following the acquisition of 15 percent of the common stock by an acquiror, the Company is acquired in a merger or other business combination or 50 percent or more of the Company's assets or earning power are sold, each Right will entitle the holder to purchase for the Exercise Price, common stock or securities of the acquiror having a then current market value of two times the Exercise Price. In certain circumstances, the Rights may be redeemed by the Company at a redemption price of $0.0025 per Right. If not earlier exchanged or redeemed, the Rights will expire on December 4, 2008. F. Stock Warrants In connection with the sales of preferred stock in 1997, the Company issued warrants to purchase 2,666 shares of common stock. During 1998, these warrants were exercised. None of these warrants were outstanding at December 31, 1998. In connection with a service agreement in 1999, the Company issued a warrant to purchase 4 shares of the Company's common stock. The Company recorded an expense in the amount of $158 for the fair value of the consideration received. The weighted average grant-date fair value of the warrant with an exercise price of $52.28 per share was $45.19 per share using assumptions of expected volatility of 100 percent, warrant term of two years, risk free interest rate of 6.0 percent and a dividend yield of zero. The warrants were outstanding at December 31, 1999. G. Stock Option Plan The Company has stock option plans (Plans) to compensate employees for past and future services and has reserved 59,600 shares of common stock for option grants under the Plans. Generally, options vest based on continuous employment, over a five-year period. The options expire twenty years from the date of grant and are exercisable at the fair market value of the common stock at the grant date. A summary of stock option related activity is as follows:
Options Outstanding ----------------------- Weighted Shares Average Available Number of Exercise for Grant Shares Price - --------------------------------------------------------------------------------------- Balances at December 31, 1996 2,842 21,384 $ 0.07 Plan amendment 23,200 - - Options granted (14,760) 14,760 1.38 Options exercised - (4,592) 0.06 Options canceled 3,796 (3,796) 0.33 - ------------------------------------------------------------------------ Balances at December 31, 1997 15,078 27,756 0.73 Plan amendment 10,000 - - Options granted (12,028) 12,028 7.07 Options assumed in acquisition of Vivo - 192 0.06 Options exercised - (3,574) 0.21 Options canceled 3,632 (3,632) 1.86 - ------------------------------------------------------------------------ Balances at December 31, 1998 16,682 32,770 3.03 Options granted (16,728) 16,728 38.63 Options exercised - (5,446) 1.80 Options canceled 5,796 (5,796) 7.40 - ------------------------------------------------------------------------ Balances at December 31, 1999 5,750 38,256 $18.07 - ------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at December 31, 1999: 58 43 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries
Options Outstanding Options Exercisable ------------------------------------------------------------------ Weighted Average Weighted Weighted Weighted Remaining Average Average Average Number of Contractual Exercise Number of Exercise Exercise Prices Shares Life (Years) Price Shares Price - --------------------------------------------------------------------------------------------------------- $ 0.02 - $1.81 11,814 16.55 $ 0.53 6,402 $ 0.50 2.13 - 8.69 8,721 18.36 5.94 1,058 5.90 8.72 - 35.44 8,511 19.09 21.11 70 9.83 37.63 - 88.88 9,210 19.57 63.70 180 45.91 ------- ------- 38,256 18.25 $18.07 7,710 $ 2.12 ------- -------
In accordance with the disclosure requirements of SFAS 123, if the Company had elected to recognize compensation cost based on the fair value of options granted at grant date as prescribed, net income (loss) and net income (loss) per share would have been increased (decreased) to the pro forma amounts indicated in the table below:
years ended December 31, 1999 1998 1997 - ----------------------------------------------------------------------------------------- Net income (loss): As reported $ 6,926 (19,953) (15,069) Pro forma (87,998) (29,548) (15,543) Basic net income (loss) per share: As reported 0.05 (0.15) (0.92) Pro forma (0.62) (0.23) (0.95) Diluted net income (loss) per share: As reported 0.04 (0.15) (0.92) Pro forma (0.62) (0.23) (0.95)
The per share weighted average fair value of stock options granted during 1999, 1998 and 1997 was $24.21, $4.14, and $0.28, respectively, on the date of grant. Prior to the Company's initial public offering, the fair value of each option grant was determined on the date of grant using the minimum value method. Subsequent to the offering, the fair value was determined using the Black-Scholes model. Except for the volatility assumption which was only used under the Black-Scholes model, the following weighted average assumptions were used to perform the calculations:
years ended December 31, 1999 1998 1997 - -------------------------------------------------------------------- Expected dividend yield 0% 0% 0% Risk-free interest rate 5.35% 5.15% 6.10% Expected life (years) 3.1 3.5 3.5 Volatility 100% 85% 60%
59 44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries H. Employee Stock Purchase Plan Effective January 1998, the Company adopted an Employee Stock Purchase Plan (ESPP), and has reserved 4,000 shares of common stock for issuance under the ESPP. Under the ESPP, an eligible employee may purchase shares of common stock, based on certain limitations, at a price equal to the lesser of 85 percent of the fair market value of the common stock at the beginning or end of the respective semi-annual offering periods. There were 112 and 190 shares purchased under the ESPP during 1999 and 1998, respectively. The weighted average fair value of the employee stock purchase rights was $7.10 in 1999 and $2.81 in 1998. The following assumptions were used to perform the calculation:
years ended December 31, 1999 1998 - ------------------------------------------------------ Expected dividend yield 0% 0% Risk-free interest rate 5.06% 5.15% Expected life (years) 0.5 0.5 Volatility 100% 85%
Note 6. Significant Customer In June 1997, the Company entered into a strategic agreement with Microsoft pursuant to which the Company granted Microsoft a nonexclusive license to certain substantial elements of the source code of the Company's RealAudio/RealVideo Version 4.0 technology. The $30 million license fee is being recognized ratably over the three-year term of the Company's ongoing support obligations. Microsoft may sublicense its rights to the Standard Code (as defined in the Agreement) to third parties under certain conditions without additional compensation to the Company. If the Company elects to grant an Event License (as defined in the agreement) to a third party during the three-year term of the Agreement, it must refund a portion of the license fee paid by Microsoft, based on a declining scale over the term. In connection with the agreement, Microsoft made a $30 million minority investment in the Company in the form of 3,338 shares of nonvoting preferred stock, which shares were converted into 3,338 shares of nonvoting special common stock upon the completion of the Company's initial public offering in 1997. These shares were subsequently sold to third party investors in 1999 and 1998. Software license fees under the license agreement with Microsoft accounted for approximately 8%, 15% and 13% of total net revenues in 1999, 1998 and 1997, respectively. Note 7. Income Taxes The components of income (loss) before income taxes are as follows:
years ended December 31, 1999 1998 1997 - ----------------------------------------------------------------------- U.S. operations $ 7,018 (19,747) (12,380) Foreign operations (92) (206) (2,689) - ----------------------------------------------------------------------- $ 6,926 (19,953) (15,069) - -----------------------------------------------------------------------
The components of income tax expense (benefit) are as follows:
December 31, 1999 1998 1997 - --------------------------------------------------------- Current $ - (777) 777 Deferred - 777 (777) - --------------------------------------------------------- $ - - - - ---------------------------------------------------------
60 45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries Income tax expense (benefit) differs from "expected" income tax expense (benefit) (computed by applying the U.S. Federal income tax rate of 34 percent) in 1999 and 1998 due to nondeductible acquisition charges and related amortization of goodwill, and an increase in the valuation allowance on deferred tax assets. The 1997 effective rate differed principally due to the change in the valuation allowance related to deferred tax assets. The tax effects of temporary differences and operating loss carryforwards that give rise to significant portions of net deferred tax assets are comprised of the following:
December 31, 1999 1998 - --------------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforwards $80,435 7,650 Deferred revenue 4,363 6,649 Allowances for doubtful accounts and sales returns 628 467 Depreciation and amortization 249 472 Other 756 1,650 - --------------------------------------------------------------------------------- Gross deferred tax assets 86,431 16,888 Less valuation allowance (86,431) (16,888) - --------------------------------------------------------------------------------- Net deferred tax assets $ - - - ---------------------------------------------------------------------------------
The valuation allowance for deferred tax assets increased by $69,543, $9,076, and $5,357 for 1999, 1998 and 1997, respectively. At December 31, 1999, $80,435 of the valuation allowance for deferred tax assets relates to net operating loss carryforwards. Due to operating losses and the uncertainty regarding the recoverability of deferred tax assets, the Company has provided a full valuation allowance for deferred tax assets at December 31, 1999 and 1998. At December 31, 1999, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $236,575, which begin to expire in 2013. Substantially all of the net operating loss carryforwards results from stock option deductions, the realization of which would increase shareholders' equity. The net operating loss carryforwards excludes $16,000 and $2,524 of net operating loss carryforwards acquired from Vivo and Xing, respectively, which are subject to significant limitations. In the event net operating loss carryforwards related to Vivo prior to its acquisition are utilized, goodwill will be reduced for the related income tax benefit. Note 8. Segment Information During 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 131, "Disclosure About Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 establishes standards for the way that public business enterprises report information about operating segments. The Company operates in one business segment, media delivery, for which the Company receives revenues from its customers. The Company's Chief Operating Decision Maker is considered to be the Company's Operating Committee (COC), which is comprised of the Company's Chief Executive Officer, the Company's Chief Operating Officer, and the Company's Senior Vice Presidents. The COC reviews financial information presented on a consolidated basis accompanied by disaggregated information about products and services and geographical regions for purposes of making decisions and assessing financial performance. The COC does not review discrete financial information regarding profitability of the Company's different products or services and, therefore, the Company does not have operating segments as defined by SFAS 131. 61 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries The Company's customers consist primarily of end users located in the United States and various foreign countries. Revenues by geographic region are as follows:
years ended December 31, 1999 1998 1997 - ------------------------------------------------------------------------- North America $ 93,277 44,149 24,017 Europe 15,124 7,144 3,425 Japan/Asia Pacific 9,992 4,429 3,225 Rest of world 2,581 987 890 - ------------------------------------------------------------------------- Subtotal 120,974 56,709 31,557 Microsoft license agreement 10,268 9,668 4,834 - ------------------------------------------------------------------------- Total $131,242 66,377 36,391 - -------------------------------------------------------------------------
Revenue from external customers by product type is as follows:
years ended December 31, 1999 1998 1997 - ---------------------------------------------------------------------------- Media delivery license revenue $ 80,359 38,819 24,331 Media delivery service revenue 26,466 14,742 4,972 Microsoft license agreement 10,268 9,668 4,834 Advertising revenue 14,149 3,148 2,254 - ---------------------------------------------------------------------------- Total net revenues $131,242 66,377 36,391 - ----------------------------------------------------------------------------
Long-lived assets by geographic location are as follows:
December 31 1999 1998 - ------------------------------------------ United States $32,273 14,645 Japan 446 454 Europe 371 329 - ------------------------------------------ Total $33,090 15,428 - ------------------------------------------
Note 9. Commitments A. Lease Commitments The Company leases its office facilities under terms of operating lease agreements expiring through April 2011. Future minimum lease payments are as follows:
Minimum lease payments - ------------------------------------------ 2000 $ 3,813 2001 4,443 2002 4,613 2003 4,703 2004 4,673 Thereafter 33,196 - ------------------------------------------ Total minimum lease payments $55,441 - ------------------------------------------
Rent expense was approximately $2,825 in 1999, $2,600 in 1998, and $1,800 in 1997. 62 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries B. 401(k) Retirement Savings Plan The Company has a salary deferral plan (401(k) Plan) that covers substantially all employees. The Company, at its discretion, may make contributions to the 401(k) Plan, although it has not made any contributions to date. Employees can contribute a portion of their salary to the maximum allowed by the federal tax guidelines. The Company has no other post-employment or post-retirement benefit plans. C. Litigation In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit against the Company and co-defendant Broadcast.com in the United States District Court for the Northern District of Texas--Dallas Division. The plaintiffs allege that the Company, individually and in combination with Broadcast.com, infringes on the plaintiffs' patent by making, using, selling and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. The plaintiffs seek to enjoin the Company from its alleged infringing activity and to recover damages in an amount no less than a reasonable royalty. Although no assurance can be given as to the outcome of this lawsuit, the Company believes that the allegations in this action are without merit, and intends to vigorously defend itself against these claims. The Company may be required to indemnify Broadcast.com under the terms of its license agreement. The plaintiffs filed a similar claim based on the same patent and seeking similar remedies as a separate lawsuit against Microsoft and Broadcast.com in the same court. The court has consolidated the lawsuit against Microsoft and Broadcast.com with the lawsuit against the Company and Broadcast.com. If the plaintiffs prevail in their claims, the Company could be required to pay damages or other royalties, in addition to complying with injunctive relief, which could have a material adverse effect on the Company's operating results. On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against the Company in the U.S. District Court for the Western District of Washington. The plaintiff alleges that the Company entered into an oral agreement with it in 1995 pursuant to which the plaintiff claims it is entitled to 30 percent of RealNetworks' revenues from the use of RealAudio technology to promote, sample or sell music. The plaintiff claims breach of contract, unjust enrichment, promissory estoppel and breach of implied-in-fact contract. The Company has denied each of the plaintiff's claims. In response to RealNetworks' motion to dismiss, the plaintiff withdrew its claim for breach of fiduciary duty. Trial is currently set for June 2000. Although no assurance can be given as to the outcome of this lawsuit, the Company believes the allegations in this action are without merit, and intends to vigorously defend itself against these claims. If the plaintiffs prevail in their claims, the Company could be required to pay damages, which could have a material, adverse effect on the Company's operating results. In response to various news reports relating to RealNetworks' privacy practices, between November 1999 and March 2000, a total of fourteen purported class action lawsuits were filed against the Company in state and/or federal courts in California, Illinois, Pennsylvania, Washington and Texas. The plaintiffs in federal court in Pennsylvania and in Illinois state court have voluntarily dismissed their lawsuits in response to the Company's motions to compel arbitration of the claims under the terms of its End User License Agreements. The remaining twelve actions, which seek to certify classes of plaintiffs, allege breach of contract, invasion of privacy, deceptive trade practices, negligence, fraud and violation of certain federal and state laws in connection with various communications features of the RealPlayer and RealJukebox products. Plaintiffs are seeking both damages and injunctive relief. The Company has filed various answers denying the claims and has filed suit in Washington state court to compel the plaintiffs who have filed actions in Texas, California and Illinois state courts to arbitrate their claims as required by our End User License Agreements. On February 10, 2000, the federal district court for the Northern District of Illinois granted RealNetworks' motion to stay the court proceedings in that case because the claims are subject to arbitration under RealNetworks' End User License Agreement. Also on that date, the federal Judicial Panel on Multidistrict Litigation transferred all federal cases pending at that time to the federal court in Illinois that has ruled that the claims are arbitrable. Plaintiffs in the transferred federal cases are seeking to overturn the district court's ruling that the claims must be arbitrated. Although no assurance can be given as to the outcome of these lawsuits, the Company believes that the allegations in these actions are without merit, and intends to vigorously defend itself against these claims. If the plaintiffs prevail in their claims, the Company could be required to pay damages or other penalties in addition to complying with injunctive relief, which could have a material adverse effect on the Company's operating results. From time to time RealNetworks is, and expects to continue to be, subject to legal proceedings and claims in the ordinary course of its business, including contract-related claims and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, even if not meritorious, could force the Company to spend significant financial and managerial resources. The Company currently has several claims threatened against it relating to patent infringement, though believes they are without merit. The Company is not aware of any legal proceedings or claims that the Company believes will have, individually or taken together, a material adverse effect on the Company's business, prospects, financial condition and results of operations. 63 48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999, 1998 and 1997 (in thousands, except per share data) RealNetworks, Inc. and Subsidiaries Note 10. Subsequent Events A. Investment in BackWeb Technologies, Inc. In January 2000 the Company completed a $15 million investment in BackWeb Technologies, Inc., a leading provider of push technology for e-business solutions. B. Acquisition. In January 2000, the Company completed its acquisition of NetZip, Inc. (NetZip), a Georgia corporation. NetZip is a developer and provider of Internet download management and utility software. As a result of the acquisition, NetZip became a wholly-owned subsidiary of RealNetworks and RealNetworks issued approximately 3,418 shares (including options to purchase shares) of its common stock in exchange for all of the outstanding shares of Netzip common stock and options to purchase Netzip common stock, but approximately 1,820 of those shares are subject to repurchase by the Company at a nominal repurchase price in certain circumstances. The acquisition will be accounted for under the purchase method of accounting and is valued at approximately $126 million, including transaction costs based on the closing price of the Company's common stock on January 25, 2000. The purchase price excludes approximately $144 million of the Company's common stock issued to former stockholders of NetZip which is subject to forfeiture for a period of 30 months after January 25, 2000. Note 11. Quarterly Information (Unaudited) The following table summarizes the unaudited statement of operations for each quarter of 1999 and 1998.
Mar.31 June 30 Sept. 30 Dec.31 Total ------ ------- -------- ------ ----- 1999 Net revenues $ 24,352 28,545 34,891 43,454 131,242 Gross profit 20,025 23,271 28,987 36,468 108,751 Operating income (loss) (1,775) (1,948) (863) 1,546 (3,040) Net income (loss) (1,058) (1,080) 3,003 6,061 6,926 Basic net income (loss) per share (0.01) (0.01) 0.02 0.04 0.05 Diluted net income (loss) per share (0.01) (0.01) 0.02 0.03 0.04 1998 Net revenues $ 12,879 15,215 17,673 20,610 66,377 Gross profit 10,396 12,168 14,349 16,798 53,711 Operating loss (12,620) (4,914) (3,703) (2,851) (24,088) Net loss (11,552) (3,675) (2,499) (2,227) (19,953) Basic and diluted net loss per share (0.09) (0.03) (0.02) (0.02) (0.15)
The Board of Directors and Shareholders 64 49 INDEPENDENT AUDITORS' REPORT RealNetworks, Inc. and Subsidiaries The Board of Directors and Shareholders RealNetworks, Inc.: We have audited the accompanying consolidated balance sheets of RealNetworks, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive income (loss), shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RealNetworks, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. /s/ KPMG LLP - ------------------ Seattle, Washington January 21, 2000 65 50 REPORT OF MANAGEMENT RealNetworks, Inc. and Subsidiaries Management is responsible for preparing RealNetworks' consolidated financial statements and related information that appears in this Annual Report. Management believes that the consolidated financial statements have been prepared in conformity with generally accepted accounting principles in all material respects to present fairly RealNetworks' financial condition and results of operations. Management has included in RealNetworks' consolidated financial statements certain amounts that are based on estimates and judgements, which it believes are reasonable under the circumstances. RealNetworks maintains a system of internal accounting policies, procedures and controls intended to provide reasonable assurance that assets are safeguarded and transactions are executed in accordance with RealNetworks authorization and are properly recorded and reported in the consolidated financial statements. Even an effective internal control system, no matter how well designed, has inherent limitations, including the possibility of circumvention or overriding of controls, and therefore can provide only reasonable assurance with respect to financial statement presentation. The system of accounting and other controls is continuously improved and modified in response to changes in business conditions and operations. The RealNetworks Board of Directors has an Audit Committee that includes nonmanagement Directors. The Committee meets with financial management and RealNetworks' independent auditors to review internal accounting controls and accounting, auditing and financial reporting matters. KPMG LLP audits RealNetworks' consolidated financial statements in accordance with generally accepted auditing standards to express an opinion on RealNetworks' consolidated financial statements. Their opinion is based on procedures believed by them to be sufficient to provide reasonable assurance that the consolidated financial statements are free from material misstatement. /s/ ROBERT GLASER /s/ PAUL BIALEK - --------------------------------- ----------------------------------- Robert Glaser Paul Bialek Chairman of the Board Senior Vice President of and Chief Executive Officer Finance and Operations and Chief Financial Officer 66 51 COMMON STOCK RealNetworks, Inc. and Subsidiaries The Company's common stock has been traded on the Nasdaq National Market under the symbol "RNWK" since the Company's initial public offering in November 1997. There is currently only a limited trading market for shares of the Company's common stock and accordingly there is no assurance that any quantity of the common stock could be sold at or near reported trading prices. The following table sets forth for the periods indicated the high and low closing prices for the Company's common stock. These quotations represent prices between dealers and do not include retail markups, markdowns or commissions and may not necessarily represent actual transactions.
year ended December 31, 1999 high low - ------------------------------------------------------ First quarter $ 36.375 9.000 Second quarter 65.938 25.500 Third quarter 54.750 27.531 Fourth quarter 93.000 43.875
year ended December 31, 1998 high low - ------------------------------------------------------ First quarter $ 7.438 3.375 Second quarter 9.859 4.984 Third quarter 12.063 3.813 Fourth quarter 12.438 5.531
The Company has not paid any cash dividends and does not intend to pay any cash dividends in the foreseeable future. As of March 20, 2000, there were approximately 649 holders of record of the Company's common stock. Most shares of the Company's common stock are held by brokers and other institutions on behalf of shareholders. 67 EX-21.1 6 SUBSIDIARIES OF REALNETWORKS 1 EXHIBIT 21.1 SUBSIDIARIES OF REALNETWORKS, INC. Entity Jurisdiction - ------ ------------ RealNetworks, Ltd. United Kingdom RealNetworks K.K. Japan RealNetworks, SARL France RealNetworks GmbH Germany RealNetworks Australia Pty. Limited Australia RealNetworks of Brazil LtDA Brazil RealNetworks of Mexico, Inc. Mexico RealNetworks E-Commerce LLC Delaware RealNetworks Investments LLC Delaware NetZip, Inc. Georgia Xing Technology Corporation California EX-23.1 7 CONSENT OF KPMG LLP 1 Exhibit 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors RealNetworks, Inc.: We consent to the incorporation by reference in the registration statements (Nos. 333-42579, 333-53127 and 333-63333) on Form S-8 of RealNetworks, Inc., and subsidiaries of our reports dated January 21, 2000, relating to the consolidated balance sheets of RealNetworks, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations and comprehensive income (loss), shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999, and the related consolidated financial statement schedule, which reports appear in the 1999 Annual Report on Form 10-K of RealNetworks, Inc., or are incorporated by reference therein from the 1999 annual report to shareholders of RealNetworks, Inc. /s/ KPMG LLP Seattle, Washington March 28, 2000 EX-27.1 8 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 160,955 183,672 8,877 1,982 0 354,392 36,271 10,101 411,124 80,565 1,011 0 0 150 330,409 411,124 0 131,242 0 22,491 111,791 0 841 6,926 0 6,926 0 0 0 6,926 0.05 0.04
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