<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 15, 1997
REGISTRATION NO. 333-36553
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
REALNETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
WASHINGTON 7371 91-1628146
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
1111 THIRD AVENUE, SUITE 2900
SEATTLE, WASHINGTON 98101
(206) 674-2700
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
ROBERT GLASER, CHIEF EXECUTIVE OFFICER
1111 THIRD AVENUE, SUITE 2900
SEATTLE, WASHINGTON 98101
(206) 674-2700
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
------------------------
COPIES TO:
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<S> <C>
LAURA T. PUCKETT CHARLES J. KATZ, JR.
JOHN M. STEEL SCOTT L. GELBAND
ALAN KOSLOW ELIZABETH W. KORRELL
GRAHAM & JAMES LLP/RIDDELL WILLIAMS P.S. PERKINS COIE
1001 FOURTH AVENUE PLAZA, SUITE 4500 1201 THIRD AVENUE, 40TH FLOOR
SEATTLE, WASHINGTON 98154 SEATTLE, WASHINGTON 98101-3099
</TABLE>
------------------------
Approximate date of commencement of proposed sale to public:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [ ]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering: [ ]
------------------
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [ ]
------------------
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering: [ ]
------------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [ ]
CALCULATION OF REGISTRATION FEE
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<S> <C> <C> <C> <C>
==================================================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OFFERING PRICE AGGREGATE AMOUNT OF
OF SECURITIES AMOUNT TO BE PER OFFERING REGISTRATION
TO BE REGISTERED REGISTERED(1) UNIT(2) PRICE(2) FEE(3)
- --------------------------------------------------------------------------------------------------
Common Stock, par value $.001
per share................... 3,450,000 shares $11.00 $37,950,000 $11,500
==================================================================================================
</TABLE>
(1) Includes 450,000 shares that may be purchased by the Underwriters to cover
over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(a).
(3) The Registrant paid a registration fee of $10,455 in connection with its
initial filing. The remaining portion of this registration fee, $1,045, has
been paid in connection with this Amendment No. 1 to Registration Statement.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED OCTOBER 15, 1997
3,000,000 SHARES
[REALNETWORKS LOGO] REALNETWORKS, INC.
(FORMERLY "PROGRESSIVE NETWORKS, INC.")
COMMON STOCK
(PAR VALUE $.001 PER SHARE)
------------------------
All of the 3,000,000 shares of Common Stock offered hereby are being sold
by RealNetworks, Inc. Prior to the offering, there has been no public market for
the Common Stock. It is currently estimated that the initial public offering
price will be between $9.00 and $11.00 per share. For factors considered in
determining the initial public offering price, see "Underwriting".
THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 6.
Application has been made for quotation of the Common Stock on the Nasdaq
National Market under the symbol "RNWK".
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO
OFFERING PRICE(1) DISCOUNT(2) COMPANY(3)
------------------ ------------- -----------
<S> <C> <C> <C>
Per Share.......................... $ $ $
Total(4)........................... $ $ $
</TABLE>
- ---------------
(1) In connection with the offering, the Underwriters have reserved up to
300,000 shares of Common Stock for sale at the initial public offering price
to employees and friends of the Company.
(2) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriting".
(3) Before deducting estimated expenses of $950,000 payable by the Company.
(4) The Company has granted the Underwriters an option for 30 days to purchase
up to an additional 450,000 shares at the initial public offering price per
share, less the underwriting discount, solely to cover over-allotments. If
such option is exercised in full, the total initial public offering price,
underwriting discount and proceeds to Company will be $ ,
$ and $ , respectively. See "Underwriting".
------------------------
The shares offered hereby are offered severally by the Underwriters, as
specified herein, subject to receipt and acceptance by them and subject to their
right to reject any order in whole or in part. It is expected that certificates
for the shares will be ready for delivery in New York, New York on or about
, 1997, against payment therefor in immediately available funds.
GOLDMAN, SACHS & CO.
BANCAMERICA ROBERTSON STEPHENS
NATIONSBANC MONTGOMERY SECURITIES, INC.
------------------------
The date of this Prospectus is , 1997.
<PAGE> 3
[SCREEN-SHOTS OF
WEB PAGES SUPERIMPOSED
OVER COMPANY LOGO]
CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK OF
THE COMPANY, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING
TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, IN
CONNECTION WITH THE OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING".
2
<PAGE> 4
CD-ROM INSERTED HERE
THE CD-ROM CONTAINS THE REALPLAYER, WHICH IS AVAILABLE FOR DOWNLOAD FREE OF
CHARGE FROM THE COMPANY'S WEB SITE. THE CD-ROM IS CONTAINED IN AN ENVELOPE BOUND
INTO THE PROSPECTUS, WITH A CLEAR CIRCULAR WINDOW THAT ALLOWS THE TOP OF THE CD-
ROM TO BE SEEN. THE CD-ROM IS LAMINATED WITH THE COMPANY'S LOGO AND THE
REALPLAYER LOGO, AS WELL AS THE FOLLOWING LANGUAGE: "FOR WINDOWS 95, WINDOWS NT
AND MACINTOSH."
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus, including the information under "Risk Factors."
Unless otherwise indicated, all information in this Prospectus (i) assumes
that the Underwriters' over-allotment option will not be exercised; (ii)
reflects an amendment to the Company's Amended and Restated Articles of
Incorporation (the "Articles") to change the Company's authorized capital stock
to common stock (the "Common Stock"), nonvoting special common stock (the
"Special Common Stock") and preferred stock effective on the closing of the
offering; (iii) reflects the conversion of each outstanding share of the
Company's Series A Common Stock, Series B Common Stock, Series C Common Stock,
Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock and
Series D Preferred Stock into one share of Common Stock effective on closing of
the offering; (iv) reflects the conversion of each outstanding share of the
Company's Series E Preferred Stock, at the election of the holder, into one
share of Common Stock, rather than Special Common Stock, on closing of the
offering; and (v) assumes the issuance of 998,058 shares of Common Stock
reflecting exercise of outstanding warrants at a weighted average exercise price
of $6.97 per share, on closing of the offering, except as noted hereinafter. See
"Description of Capital Stock."
THE COMPANY
RealNetworks, Inc. is a leading provider of branded software products and
services that enable the delivery of streaming media content over the Internet
and intranets. Streaming technology enables the transmission and playback of
continuous "streams" of multimedia content, such as audio and video, over the
Internet and intranets and represents a significant advancement over earlier
technologies. The Company's products and services include its RealSystem, a
streaming media solution that includes RealAudio and RealVideo technology, an
electronic commerce Web site designed to promote the proliferation of streaming
media products and a network of advertising-supported content aggregation Web
sites.
The Company believes that the emergence of rich multimedia capabilities,
such as streaming audio and video, has significantly enhanced the effectiveness
of the Web as a global mass communications medium. These enhanced multimedia
capabilities, combined with the unique interactive properties of the Internet,
are attracting a large and expanding audience, a growing number of advertisers
and an increasing breadth and depth of content and online commercial
applications. As the Web continues to evolve as a mass communications medium,
the Company believes that certain types of content currently delivered through
traditional media, such as radio and television, increasingly will be delivered
over the Internet. The Company believes that streaming media technology is
essential to this evolution because it provides a more compelling user
experience, allowing the Internet to compete more effectively with traditional
media for audience share.
From its inception, the Company has strategically chosen to offer its
RealPlayer software to individual users free of charge to promote the widespread
adoption of its client software and to speed the acceptance of Internet
multimedia. The Company believes that more than 18 million copies of its
RealPlayer software have been downloaded and that over 200,000 copies of its
premium client product, RealPlayer Plus, have been sold electronically in the
product's first year of distribution. In addition, the Company believes that
more than 100,000 hours per week of live audio and video content are broadcast
over the Web using RealAudio and RealVideo technology, and that more than
150,000 Web pages use the Company's software. As a result of these activities
and the Company's aggressive promotional programs, the Company believes that its
"Real" brand has become one of the most widely recognized brands on the
Internet. The Company's customers, including ABC Radio Net, Bloomberg L.P., The
Boeing Company, Dow Jones & Company, Inc., NBC Desktop, The News Corporation
Limited, Starwave Corporation and 3Com Corporation, use its software products
and services to deliver a broad range of
3
<PAGE> 6
streaming audio and video news, sports, entertainment and corporate information
over the Internet and intranets.
The Company's objective is to be the leading streaming media company,
providing software and services that enable the delivery of a broad range of
multimedia content over the Internet and intranets, thereby facilitating the
evolution of the Internet into a mass communications and commerce medium. The
key elements of this strategy include the extension of the Company's technology
leadership, a continued focus on product ubiquity and brand leadership, the
continued development of its electronic commerce and content aggregation
businesses, a focus on providing cross-platform product solutions that operate
in a wide variety of bandwidth environments, and the strengthening and expansion
of strategic relationships.
The Company was incorporated in Washington in February 1994. Unless the
context otherwise requires, the term "Company" or "RealNetworks" refers to
RealNetworks, Inc. and its subsidiaries: RealNetworks, SARL, RealNetworks,
Limited and Progressive Networks Kabushiki Kaisha. Prior to September 26, 1997,
the Company's name was "Progressive Networks, Inc." The Company's principal
executive offices are located at 1111 Third Avenue, Suite 2900, Seattle,
Washington 98101, and its telephone number is (206) 674-2700. Information
contained on the Company's Web sites will not be deemed to be part of this
Prospectus.
RealSystem(TM), RealAudio(R), RealVideo(R), RealPlayer(TM), RealPlayer
Plus(TM), RealPublisher(TM), RealServer(TM), RealEncoder(TM), Basic Server(TM),
RealNetworks(TM), Real(TM), the Real logo, RealStore(TM), Film.com(TM), Daily
Briefing(TM) and Timecast(TM) are registered and unregistered trademarks,
service marks and trade names of the Company. This Prospectus also includes
trademarks, service marks and trade names other than those identified in this
paragraph, all of which are the property of their respective holders.
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company........... 3,000,000 shares
Common Stock to be outstanding after the
offering:
Common Stock................................ 30,965,079 shares(1)
Special Common Stock........................ 0 shares(1)
Use of proceeds............................... Working capital requirements and other
general corporate purposes. See "Use of
Proceeds."
Proposed Nasdaq National Market symbol........ "RNWK"
</TABLE>
- ---------------
(1) Excludes (i) 6,390,014 shares of Common Stock issuable at a weighted average
exercise price of $1.80 per share upon exercise of stock options outstanding
at October 9, 1997, (ii) 4,446,992 shares of Common Stock reserved for
future issuance under the Company's stock option plans and (iii) 1,000,000
shares of Common Stock reserved for issuance under the 1998 Employee Stock
Purchase Plan. See "Management -- Benefit Plans." Also excludes up to
3,709,305 shares of Common Stock or Special Common Stock issuable on
exercise of a warrant to purchase Series E Preferred Stock at an exercise
price of $13.48 per share (the "Series E Warrant") that terminates on the
closing of the offering. Assumes 3,338,374 shares of Series E Preferred
Stock convert into an equal number of shares of Common Stock rather than
Special Common Stock. The holder of the Series E Preferred Stock may elect
to receive Common Stock or Special Common Stock, or a combination thereof,
upon conversion of the Series E Preferred Stock. The Special Common Stock
may only be converted into Common Stock upon the prior written consent of
the Company's Board of Directors. See "Risk Factors -- Control by Mr.
Glaser; Antitakeover Provisions," "-- Impact of Exercise of the Series E
Warrant; Election by Microsoft to Receive Common Stock or Special Common
Stock" and "Description of Capital Stock -- Common Stock."
4
<PAGE> 7
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following summary consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," included elsewhere in this Prospectus. The summary
consolidated financial data for the period from February 9, 1994 (inception) to
December 31, 1994, for the years ended December 31, 1995 and 1996, and for the
nine months ended September 30, 1997, and as of December 31, 1996 and September
30, 1997, are derived from the Consolidated Financial Statements of the Company
audited by KPMG Peat Marwick LLP, independent accountants. The summary
consolidated financial data for the nine months ended September 30, 1996 are
derived from unaudited consolidated financial statements prepared by the Company
on a basis consistent with the Company's audited Consolidated Financial
Statements and, in the opinion of management, include all adjustments,
consisting only of normal recurring accruals, necessary for a fair presentation
of the results for such periods. Operating results for the nine months ended
September 30, 1997 are not necessarily indicative of the results that may be
expected for any other interim period or for the year ending December 31, 1997.
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 9, 1994 YEAR ENDED NINE MONTHS ENDED
(INCEPTION) TO DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, ------------------- -------------------
1994 1995 1996 1996 1997
---------------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total net revenues................... $ -- $ 1,812 $14,012 $ 8,274 $22,417
Total cost of revenues............... -- 62 2,185 969 4,609
Gross profit......................... -- 1,750 11,827 7,305 17,808
Operating loss....................... (545) (1,595) (4,016) (2,475) (9,759)
Net loss............................. (545) (1,501) (3,789) (2,315) (8,575)
Pro forma net loss per share(1)...... $ (0.14) $ (0.32)
Shares used to compute pro forma net 27,779 28,315
loss per share(1)..................
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
DECEMBER 31, --------------------------
1996 ACTUAL AS ADJUSTED(2)
------------ ------- --------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..... $ 19,595 $67,648 $101,554
Working capital....................................... 16,893 50,762 84,668
Total assets.......................................... 26,468 84,372 118,278
Redeemable, convertible preferred stock............... 23,153 49,278 --
Shareholders' equity (deficit)........................ (3,320) (8,089) 75,095
</TABLE>
- ---------------
(1) For an explanation of pro forma net loss per share and the number of shares
used to compute pro forma net loss per share, see Note 1 of Notes to
Consolidated Financial Statements.
(2) As adjusted to give effect to the (i) conversion of all outstanding shares
of Series A Common Stock, Series B Common Stock, Series C Common Stock,
Series A Preferred Stock, Series B Preferred Stock, Series C Preferred
Stock, Series D Preferred Stock and Series E Preferred Stock into Common
Stock on closing of the offering; (ii) sale by the Company of the 3,000,000
shares of Common Stock offered hereby at an assumed initial public offering
price of $10.00 per share (after deducting the underwriting discount and
estimated expenses of the offering); (iii) application of the estimated net
proceeds of the offering; and (iv) issuance of 998,058 shares of Common
Stock issuable upon exercise of outstanding warrants at an average exercise
price of $6.97 per share (for an aggregate of $6,956,000). Excludes up to
3,709,305 shares of Common Stock or Special Common Stock (representing
additional cash and shareholders' equity of up to $50,001,431) issuable on
exercise of the Series E Warrant. See "Use of Proceeds," "Capitalization"
and "Description of Capital Stock."
5
<PAGE> 8
RISK FACTORS
In addition to the other information contained in this Prospectus,
investors should consider carefully the following risk factors before making an
investment decision concerning the Common Stock. This Prospectus contains
forward-looking statements that involve risks and uncertainties. The Company's
actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including those set
forth under "Risk Factors" and elsewhere in this Prospectus.
LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT AND ANTICIPATED FUTURE LOSSES
The Company was incorporated in February 1994 and did not recognize any
revenue until July 1995, when the Company began delivery of the commercial
version of RealAudio Version 1.0. Accordingly, the Company has a limited
operating history on which an evaluation of the Company and its prospects can be
based. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in early stages of
development, particularly companies in rapidly evolving markets such as media
delivery and electronic commerce over the Internet and intranets. The Company
has incurred significant losses since its inception and expects to continue to
incur substantial operating losses for the foreseeable future. As of September
30, 1997, the Company had an accumulated deficit of $14.8 million. To achieve
and sustain profitability, the Company must, among other things, establish
widespread market acceptance of its existing products and services, successfully
develop new products and services, respond quickly and effectively to
competitive, market and technological developments, expand sales and marketing
operations, broaden customer support capabilities, control expenses and continue
to attract and retain qualified personnel. In addition, market prices for the
Company's products must attain a level at which the Company can generate
revenues in excess of its anticipated operating and other expenses. There can be
no assurance that the Company will achieve or sustain profitability. See
"-- Unpredictability of Future Revenues; Potential Fluctuation in Quarterly
Operating Results," "-- Competition; Relationship With Microsoft" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview."
UNPREDICTABILITY OF FUTURE REVENUES; POTENTIAL FLUCTUATION IN QUARTERLY
OPERATING RESULTS
As a result of the Company's limited operating history and the emerging
nature of the markets in which it competes, the Company is unable to forecast
accurately its revenues. The Company expects to experience significant
fluctuations in its future quarterly operating results due to a variety of
factors, many of which are outside the Company's control, including (i) demand
for the Company's products and services, (ii) introduction or enhancement of
products and services by the Company and its competitors, (iii) market
acceptance of new products and services of the Company and its competitors, (iv)
price reductions by the Company or its competitors or changes in how products
and services are priced (such as the Company's recent decision to offer for
download free of charge a version of its Basic Server, which previously sold for
$295 to $995), (v) the mix of products and services sold by the Company and its
competitors, (vi) the mix of distribution channels through which the Company's
products are licensed and sold, (vii) the mix of international and U.S. and
Canadian revenues, (viii) costs of litigation and intellectual property
protection, (ix) the growth in the use of the Internet, (x) the Company's
ability to attract, train and retain qualified personnel, (xi) the amount and
timing of operating costs and capital expenditures related to expansion of the
Company's business, operations and infrastructure, (xii) technical difficulties
with respect to the use of the Company's products, (xiii) governmental
regulations and (xiv) general economic conditions and economic conditions
specifically related to the Internet. It is often difficult to forecast the
effect such factors, or any combination thereof, would have on the Company's
results of operations for any given fiscal quarter. There can be no assurance
that the Company will be able to achieve historical revenue levels or maintain
its historical growth rate. The Company has used, and expects to continue to
use, price promotions to increase trial, purchase and use of its products, as
well as to increase the overall recognition of its brands. The effect of such
promotions on revenues in a particular period may be significant and extremely
difficult to forecast. Based on the foregoing, the Company believes that its
quarterly revenues, expenses and operating results could vary
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<PAGE> 9
significantly in the future, and that period-to-period comparisons should not be
relied on as indications of future performance.
Historically, the Company has received a significant portion of its
revenues from a limited number of sales and license agreements. The Company
believes that a customer's decision to purchase its server products or license
its technology is relatively discretionary and, for large-scale users, generally
involves a significant commitment of capital resources. Therefore, any downturn
in the economy or in the business of potential customers could have a material
adverse effect on the Company's revenues and quarterly results of operations.
The Company generally makes available its software products in "beta" form
to the public prior to finalizing product features, functionality and
operability. This may cause certain customers to delay purchasing decisions
until commercial versions of the products are available, which could have a
material adverse effect on the Company's revenues and quarterly results of
operations.
The Company derives a significant portion of its revenues from the sale of
technical support services and software upgrades to its installed customer base.
There can be no assurance that a sufficient number of the Company's customers
will continue to enter into support and upgrade contracts or will renew existing
support and upgrade contracts, or that revenues therefrom will continue to be
significant. The loss of a material portion of such revenues would likely have a
material adverse effect on the Company's business, financial condition and
results of operations.
Management has observed that revenues from advertising sales have tended to
be higher in the second and fourth quarters, and retail sales have tended to be
highest in the fourth quarter. The Company typically operates with little or no
backlog. As a result, quarterly sales and operating results primarily depend on
the volume and timing of orders received in the quarter, both of which are
difficult to forecast. The Company typically recognizes a substantial portion of
its revenues in the last month of each quarter.
As a result of the Company's limited operating history, the Company does
not have relevant historical financial data for a significant number of periods
on which to base planned operating expenses. The Company's expense levels are
based in part on its expectations with regard to future revenues. The Company
may be unable to adjust spending in a timely manner to compensate for any
unexpected revenue shortfall. As a result, any significant shortfall in demand
for the Company's products and services relative to the Company's expectations
would have an immediate material adverse effect on the Company's business,
financial condition and results of operations. Due to the foregoing factors, it
is likely that in some future quarters the Company's operating results will fall
below the expectations of securities analysts and investors, which would likely
have a material adverse effect on the trading price of the Common Stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
COMPETITION; RELATIONSHIP WITH MICROSOFT
The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. The Company
expects that competition will intensify in the future. Many of the Company's
current and potential competitors have longer operating histories, greater name
recognition and significantly greater financial, technical and marketing
resources than the Company.
The Company engages primarily in the sale and licensing of audio and video
streaming products and services, electronic commerce and Internet advertising.
The Company's principal competitors in the development and distribution of audio
and video streaming solutions include Microsoft Corporation ("Microsoft"),
VXtreme, Inc. ("VXtreme"), VDOnet Corporation ("VDOnet"), Xing Technology
Corporation ("Xing"), Precept Software, Inc. ("Precept"), Cubic VideoComm, Inc.
("Cubic"), Motorola, Inc. ("Motorola"), Vivo Software, Inc. ("Vivo"), Vosaic LLC
("Vosaic") and Oracle Corporation ("Oracle"). The Company's RealSystem also
competes to a lesser degree with non-streaming audio and video delivery
technologies such as AVI and Quicktime, and indirectly with delivery systems for
multimedia
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<PAGE> 10
content other than audio and video, such as Flash by Macromedia Inc.
("Macromedia") and Enliven by Narrative Communications Corp. ("Narrative").
Competitive factors in this market include the quality and reliability of
software; features for creating, editing and adapting content; ease of use and
interactive user features; scaleability and cost per user; and compatibility
with the user's existing network components and software systems. To expand its
user base and further enhance the user experience, the Company must continue to
innovate and improve the performance of its RealSystem. The Company is committed
to the continued market penetration of its brand, products and services, which,
as a strategic response to changes in the competitive environment, may require
pricing, licensing, service or marketing changes intended to extend its current
brand and technology franchise. For example, the Company recently made its Basic
Server, which had previously sold for $295 to $995, available for download free
of charge. Continued price concessions or the emergence of other pricing or
distribution strategies by competitors may have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company derives significant revenues from sales of RealPlayer Plus, an
enhanced version of its free player product. The Company's ability to continue
to generate revenues from sales of RealPlayer Plus is in large part dependent on
its ability to differentiate the features and functionality of RealPlayer Plus
from its own and competitors' free and for sale player products. In addition,
the demand for RealPlayer Plus is in part contingent on the demand for and the
volume of free player products in the market. The Company's failure to continue
to differentiate RealPlayer Plus, or to stimulate demand for its free player or
RealPlayer Plus, may have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company anticipates that consolidation will continue in the streaming
media industry and related industries such as computer software, media and
communications. Consequently, competitors may be acquired by, receive
investments from, or enter into other commercial relationships with, larger,
well-established and well-financed companies. For instance, Microsoft recently
acquired VXtreme, a direct competitor of the Company in the market for streaming
media software. Microsoft also owns a minority interest in VDOnet, a direct
competitor of the Company in the market for streaming video software. In
addition, in June 1997 the Company and Microsoft entered into a strategic
agreement pursuant to which Microsoft purchased a minority interest in the
Company. See "-- Department of Justice Subpoena," "Business -- Microsoft
Relationship" and "Certain Transactions."
In connection with the Microsoft agreement, 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, including its basic
RealPlayer and substantial elements of its EasyStart Server (currently known as
the Basic Server), and related Company trademarks. Under the agreement,
Microsoft may sublicense its rights to the RealAudio/RealVideo Version 4.0
technology to third parties under certain circumstances. The agreement also
provides for substantial refunds to Microsoft under prescribed circumstances
that are solely within the Company's control. The amount of these refunds
diminishes over time. The Company may not assign its obligations under the
agreement without Microsoft's consent. Microsoft is obligated to distribute the
Company's RealPlayer Version 4.0 for a defined term as long as the Company's
player supports certain Microsoft architectures. The Company also agreed to work
with Microsoft and several other companies to author and promote the Active
Streaming Format ("ASF") as a standard file format for streaming media. The
agreement also requires the Company to provide Microsoft with engineering
consultation services, certain error corrections and certain technical support
over a defined term. As a result of Microsoft's agreement with the Company, its
acquisition of VXtreme and its investment in VDOnet, Microsoft will be able to
augment substantially the functionality of NetShow, its streaming media product,
which could have a material adverse effect on the competitiveness of the
Company's products. See "-- Impact of Evolving Standards," "-- Uncertain
Protection of Intellectual Property; Risks Associated With Licensed Third-Party
Technology" and "Business -- Microsoft Relationship."
Microsoft currently competes with the Company in the market for streaming
media server and player software. The Company believes that Microsoft will
compete more directly with the Company in the
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future. The Company also believes that Microsoft's commitment to and presence in
the streaming media industry will dramatically increase competitive pressure in
the overall market for streaming media software, leading to, among other things,
increased pricing pressure and longer sales cycles. Such pressures may result in
further price reductions in the Company's products and may also materially
reduce the Company's market share. The Company believes that Microsoft will
incorporate streaming media technology in its Web browser software and certain
of its server software offerings, possibly at no additional cost to the user. In
addition, notwithstanding the Company's cooperation with Microsoft regarding
ASF, Microsoft may promote technologies and standards not compatible with the
Company's technology. Microsoft has a longer operating history, a larger
installed base of customers and dramatically greater financial, distribution,
marketing and technical resources than the Company. As a result, there can be no
assurance that the Company will be able to compete effectively with Microsoft
now or in the future, or that the Company's business, financial condition and
results of operations will not be materially adversely affected by increased
competition in the streaming media industry. In addition, if considerable
industry consolidation occurs, there can be no assurance that the Company will
be able to continue to compete effectively. See "Business -- Sales, Marketing
and Distribution" and "-- Microsoft Relationship."
The Company currently derives significant revenues from the electronic
distribution of certain of its products. The Company recently opened its
RealStore Web site, an online store for the sale of the Company's products,
third-party streaming media tools and utilities, and intranet-based training
products. The Company competes with a variety of Web sites, such as
Buydirect.Com and Software.Net, which also offer software products for download.
To compete successfully in the electronic commerce market, the Company must
attract sufficient commercial traffic to its RealStore Web site by offering
high-quality merchandise in a compelling, easy-to-purchase format. There can be
no assurance that the Company will be able to compete successfully in this
market, and any failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Products and Services" and "-- Competition."
In the Internet advertising segment, the Company competes for Internet
advertising revenues with a wide variety of Web sites and Internet service
providers. While Internet advertising revenues across the industry continue to
grow, the number of Web sites competing for such revenue is also growing
rapidly. The Company's advertising sales force and infrastructure are still in
early stages of development relative to the Company's competitors. There can be
no assurance that advertisers will place advertising with the Company or that
revenues derived from such advertising will be material. In addition, if the
Company loses advertising customers, fails to attract new customers, is forced
to reduce advertising rates or otherwise modify its rate structure to retain or
attract customers, or loses Web site traffic, the Company's business, financial
condition and results of operations may be materially adversely affected. See
"Business -- Products and Services" and "-- Competition."
DEPARTMENT OF JUSTICE SUBPOENA
Shortly after the Company entered into its strategic agreement with
Microsoft, Microsoft acquired VXtreme and announced that it would incorporate
the VXtreme technology, which competes with the Company's technology licensed to
Microsoft, into its NetShow product. In addition, Microsoft owns a minority
interest in VDOnet, a direct competitor of the Company, and has selected VDOnet
as a Microsoft Solution Provider for NetShow-based products. Microsoft's
acquisitions, investments and agreements in the streaming media industry
prompted a U.S. Department of Justice investigation into horizontal merger
activities within the industry. In August 1997, the Department of Justice served
several companies, including the Company and Microsoft, with subpoenas to
produce certain documents. The investigation, including interviews of Company
officers by Department of Justice personnel and document production requests, is
ongoing. The Company is cooperating fully with the Department of Justice's
investigation. See "-- Competition; Relationship With Microsoft" and
"Business -- Microsoft Relationship" and "-- Legal Proceedings."
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As a result of the investigation, it is possible that the Department of
Justice will require certain actions by the Company, Microsoft or other
companies in the streaming media industry that could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Department of Justice could decide to take actions that could materially and
adversely affect the Company's current relationship with Microsoft or other
companies, affect Microsoft's obligations with respect to the distribution of
the Company's products, result in certain penalties, require the Company to
refund all or a portion of the license fee paid by Microsoft to the Company,
require Microsoft to limit or divest certain of its acquisitions or investments
in the streaming media industry, including its investment in the Company, and,
if Microsoft were forced to rescind its agreement with the Company, place the
Company at a significant competitive disadvantage within the industry. There can
be no assurance that any such outcome would not have an immediate material
adverse effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
DEVELOPING MARKET; DEPENDENCE ON THE INTERNET AND INTRANETS AS MEDIUMS OF
COMMERCE AND COMMUNICATIONS
The market for the Company's streaming media products and services,
especially the market for the Company's intranet products and services, has
begun only recently to develop and is evolving rapidly, with continuing new
developments in technology, product distribution methods and marketing and
licensing relationships. The development of a market for the Company's streaming
media products also depends on increased use of the Internet and intranets for
information, publication, distribution and commerce. Continued growth in the use
of the Internet may depend on potential increases in available bandwidth or
transmission speeds or on other technological improvements. In particular, the
Company believes that continued growth in the market acceptance of streaming
media, especially streaming video, depends on such developments. Changes in
network infrastructure, transmission and content delivery methods and underlying
software platforms, and the emergence of new Internet access devices, such as TV
set-top boxes, could dramatically change the structure and competitive dynamic
of the market for streaming media solutions. In particular, technological
developments or strategic partnerships that accelerate the adoption of "high
bandwidth" access technologies such as cable modems may have a material adverse
effect on the Company's business. Critical issues concerning use of the Internet
and intranets (including security, reliability, cost, ease of use and quality of
service) remain unresolved and may affect the growth of and the degree to which
business is conducted over the Internet and intranets. If the market for the
Company's products and services fails to grow, develops more slowly than
expected or becomes saturated with competing products or services, the Company's
business, financial condition and results of operations will be materially
adversely affected. See "-- Availability and Quality of Content" and "-- Online
Commerce Security Risks."
Because electronic commerce on the Internet is relatively new and evolving,
it is difficult to predict whether the Internet will be a viable commercial
marketplace or whether the Internet or intranets will be viable mediums of
communication. Although some sales of the Company's products and services will
depend on growth of intranets, sales of the Company's products will continue to
depend in large part on the emergence of the Internet as a viable commercial
marketplace with a strong and reliable infrastructure. The Internet has
experienced substantial growth in the number of users and amount of traffic, and
there can be no assurance that its technological infrastructure will be able to
support the demands placed on it by continued growth. Delays in the development
or adoption of new technological standards and protocols, or increased
governmental regulation, could also affect the degree of use of the Internet. In
addition, developments in Internet infrastructure such as broadband Internet
access may significantly affect the market for streaming media products. There
can be no assurance that the infrastructure or complementary services necessary
to make the Internet a viable commercial medium will be developed or, if
developed, that the Internet will become a viable commercial medium for products
and services such as those offered by the Company. See "Business -- Industry
Background."
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EVOLVING BUSINESS MODEL; DEVELOPMENT OF NEW PRODUCTS AND OTHER REVENUE SOURCES
The Company's success depends in part on its ability to develop new
products in a timely manner and provide new services that achieve rapid and
broad market acceptance. There can be no assurance that the Company successfully
can identify new product and service opportunities and develop and bring to
market new products and services in a timely manner or that any such product
innovations will achieve the market penetration or price stability necessary for
profitability.
As the online medium continues to evolve, the Company plans to leverage its
technology by developing complementary products and services as additional
sources of revenue. Accordingly, the Company may change its business model to
take advantage of new business opportunities, including business areas in which
the Company does not have extensive experience. For example, the Company
recently focused on, and will continue to devote significant resources to, the
development of its electronic commerce business, as well as its
advertising-supported content aggregation business, as extensions of its
business model. There can be no assurance that the Company will develop
successfully these or other business models.
In addition, the Company must continue to innovate and develop new versions
of its software to remain competitive in the market for streaming media
solutions. The Company's product and software development efforts inherently are
difficult to manage and keep on schedule. The Company on occasion has
experienced development delays and related cost overruns, and there can be no
assurance that it will not encounter such problems in the future. In addition,
products as complex as those offered by the Company may contain undetected
errors when first introduced or when new versions are released. There can be no
assurance that errors will not occur in current or new products, the result of
which may be adverse publicity, loss of or delay in market acceptance, or claims
by customers against the Company, any of which could have a material adverse
effect on the Company's business, financial condition and results of operations.
Expansion of the Company's operations to take advantage of new
opportunities and to sustain a leadership position in the market for streaming
media software may require significant additional expenditures and may strain
the Company's management, financial and operational resources. A lack of market
acceptance of new products or services or the Company's inability to generate
satisfactory revenues from such new products and services to offset their cost
could have a material adverse effect on the Company's business, financial
condition and results of operations. "Business -- Strategy."
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's performance depends substantially on the continued services
of its executive officers and key employees, in particular Mr. Glaser, the
Company's Chairman of the Board and Chief Executive Officer. The loss of the
services of Mr. Glaser or any of its other executive officers or key employees
could have a material adverse effect on the Company's business, financial
condition and results of operations. None of the Company's executive officers
has a contract that guarantees employment. Other than a $2,000,000 life
insurance policy on the life of Mr. Glaser, the Company does not maintain "key
person" life insurance policies. Given the Company's early stage of development,
the Company depends on its ability to attract, train and retain qualified
personnel, specifically those with management, technical and product development
skills. Competition for such personnel is intense, particularly in geographic
areas recognized as high technology centers such as the Pacific Northwest. There
can be no assurance that the Company will be able to attract, train or retain
additional highly qualified technical and managerial personnel in the future,
which failure could have a material adverse effect on the Company's business,
financial condition and results of operations. See "Management."
CONTROL BY MR. GLASER; ANTITAKEOVER PROVISIONS
Immediately after the closing of the offering, Mr. Glaser, the Company's
founder, will own of record 14,089,919 shares of the outstanding Common Stock,
which will represent approximately 45.5% of the outstanding Common Stock
(approximately 44.9% if the Underwriters' over-allotment option is exercised
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in full) and approximately 40.6% of the outstanding Common Stock if the Series E
Warrant is exercised in full for shares of Common Stock (approximately 40.1% if
the Underwriters' over-allotment option is exercised in full). If the holder of
the Series E Preferred Stock should instead elect to receive shares of Special
Common Stock on conversion of the Series E Preferred Stock, and assuming that
the Series E Warrant is exercised in full for shares of Special Common Stock,
Mr. Glaser will hold of record approximately 51.0% of the outstanding voting
rights (approximately 50.2% if the Underwriters' over-allotment option is
exercised in full). Immediately after the closing of the offering, Mr. Glaser
intends to donate approximately 700,000 shares of Common Stock to various
charitable organizations. Mr. Glaser will have significant influence over the
election of directors and other matters submitted to a vote of the Company's
shareholders. Control by Mr. Glaser may discourage certain types of transactions
involving an actual or potential change of control of the Company, including
transactions in which the holders of Common Stock might receive a premium for
their shares over prevailing market prices. See "-- Impact of Exercise of the
Series E Warrant; Election by Microsoft to Receive Common Stock or Special
Common Stock" and "Principal Shareholders."
The Articles provide that on closing of the offering, a Strategic
Transactions Committee of the Board of Directors shall be created, which
Committee shall be comprised of three directors. Without the prior approval of
such Committee, and subject to certain limited exceptions, the Board of
Directors shall not have the authority to (i) adopt a plan of merger, (ii)
authorize the sale, lease, exchange or mortgage of (A) assets representing more
than 50% of the book value of the Company's assets prior to the transaction or
(B) any other asset or assets on which the long-term business strategy of the
Company is substantially dependent, (iii) authorize the Company's voluntary
dissolution or (iv) take any action that has the effect of clauses (i) through
(iii). In connection therewith, the Company entered into an agreement with Mr.
Glaser (the "Glaser Agreement") providing him with a direct contractual right to
require the Company to abide by and perform all terms of the Articles with
respect to the Strategic Transactions Committee. The Glaser Agreement also
provides that so long as Mr. Glaser owns a specified number of shares, the
Company shall use its best efforts to cause Mr. Glaser to be nominated to, not
removed from, and elected to, the Board of Directors. In addition, the Articles
provide that on closing of the offering, Mr. Glaser shall serve, or shall
appoint another officer of the Company to serve, as the Company's Policy
Ombudsman, with the exclusive authority to adopt or change the editorial
policies of the Company as reflected on the Company's Web sites or other
communications or media where the Company has 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.
The foregoing provisions, as well as those relating to a classified Board of
Directors, the availability of "blank check" preferred stock and certain
provisions of Washington corporate law and of the shareholder rights plan that
the Company intends to adopt prior to closing of the offering, 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
the Company. See " -- Competition; Relationship with Microsoft,"
"Business -- Microsoft Relationship," "Certain Transactions -- Microsoft
Corporation," "Management" and "Description of Capital Stock."
UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY; RISKS ASSOCIATED WITH LICENSED
THIRD-PARTY TECHNOLOGY
The Company's success depends in part on its ability to protect its
proprietary software and other intellectual property. To protect its proprietary
rights, the Company relies generally on patent, copyright, trademark and trade
secret laws, confidentiality agreements with employees and third parties, and
license agreements with consultants, vendors and customers, although the Company
has not signed such agreements in every case. Despite such protections, a third
party could, without authorization, copy or otherwise obtain and use the
Company's products or technology, or develop similar technology independently.
There can be no assurance that the Company's agreements with employees,
consultants and others who participate in product development activities will
not be breached, that the Company will
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have adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known or independently developed by competitors.
The Company currently has two patents pending in the U.S. relating to its
product architecture and technology and holds one patent entitled "Method and
Apparatus for Recommending Selections Based on Preferences in a Multi-User
System." There can be no assurance that any pending or future patent
applications will be granted, that any existing or future patent will not be
challenged, invalidated or circumvented, or that the rights granted under any
patent that has issued or may issue will provide competitive advantages to the
Company. Many of the Company's current and potential competitors dedicate
substantially greater resources to protection and enforcement of intellectual
property rights, especially patents. If a blocking patent has issued or issues
in the future, the Company would need to either obtain a license or design
around the patent. There can be no assurance that the Company would be able to
obtain such a license on acceptable terms, if at all, or to design around the
patent. The Company pursues the registration of certain of its trademarks and
service marks in the U.S. and in certain other countries, although it has not
secured registration of all its marks. A significant portion of the Company's
marks begin with the word "Real" (such as RealSystem, RealAudio and RealVideo).
The Company is aware of other companies that use "Real" in their marks alone or
in combination with other words, and the Company does 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 the Company's
proprietary rights to the same extent as do the laws of the U.S., and effective
patent, copyright, trademark and trade secret protection may not be available in
such jurisdictions. The Company licenses certain of its proprietary rights to
third parties, and there can be no assurance that such licensees will abide by
compliance and quality control guidelines with respect to such proprietary
rights or otherwise take actions that would materially adversely affect the
Company's business, financial condition and results of operations.
To license many of its products, the Company relies in part on "shrinkwrap"
and "clickwrap" licenses that are not signed by the end user and, therefore, may
be unenforceable under the laws of certain jurisdictions. As with other software
products, the Company's products are susceptible to unauthorized copying and
uses that may go undetected, and policing such unauthorized use is difficult. In
general, there can be no assurance that the Company's efforts to protect its
intellectual property rights through patent, copyright, trademark and trade
secret laws will be effective to prevent misappropriation of its technology, or
to prevent the development and design by others of products or technologies
similar to or competitive with those developed by the Company, and the Company's
failure or inability to protect its proprietary rights could materially
adversely affect the Company's business, financial condition and results of
operations.
The computer software market is characterized by frequent and substantial
intellectual property litigation that is often complex and expensive, and
involves a significant diversion of resources and uncertainty of outcome.
Litigation may be necessary in the future to enforce and protect the Company's
intellectual property and trade secrets or to defend against a claim of
infringement or invalidity. The Company has been and expects to continue to be
subject to legal proceedings and claims from time to time in the ordinary course
of its business, including claims of alleged infringement of third-party
proprietary rights by the Company and its licensees. The Company attempts to
avoid infringing known proprietary rights of third parties in its product
development efforts. However, the Company has not conducted and does not conduct
comprehensive patent searches to determine whether the technology used in its
products infringes patents held by third parties. In addition, it is difficult
to proceed with certainty in a rapidly evolving technological environment in
which there may be numerous patent applications pending, many of which are
confidential when filed, with regard to similar technologies. If the Company
were to discover that its products violate third-party proprietary rights, there
can be no assurance that it would be able to obtain licenses to continue
offering such products without substantial reengineering or that any effort to
undertake such reengineering would be successful, that any such licenses would
be available on commercially reasonable terms, if at all, or that litigation
could be avoided or settled without substantial expense and damage awards. Any
claims relating to the infringement of
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third-party proprietary rights, even if not meritorious, could result in the
expenditure of significant financial and managerial resources and in injunctions
preventing the Company from distributing certain products. Such claims could
materially adversely affect the Company's business, financial condition and
results of operations.
The Company also relies on certain technology that it licenses from third
parties, including software that is integrated with internally developed
software and used in the Company's products, to perform key functions. There can
be no assurance that such third-party technology licenses will continue to be
available to the Company on commercially reasonable terms. The loss of any of
these technologies could have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, although the
Company is generally indemnified against claims that such third-party technology
infringes the proprietary rights of others, such indemnification is not always
available for all types of intellectual property rights (for example, patents
may be excluded) and in some cases the scope of such indemnification is limited.
Even if the Company receives broad indemnification, third-party indemnitors are
not always well capitalized and may not be able to indemnify the Company in the
event of infringement, resulting in substantial exposure to the Company. There
can be no assurance that infringement or invalidity claims arising from the
incorporation of third-party technology, and claims for indemnification from the
Company's customers resulting from such claims, will not be asserted or
prosecuted against the Company. Such claims, even if not meritorious, could
result in the expenditure of significant financial and managerial resources in
addition to potential product redevelopment costs and delays, all of which could
materially adversely affect the Company's business, financial condition and
results of operations. See "Business -- Intellectual Property."
AVAILABILITY AND QUALITY OF CONTENT
The availability of compelling content for the Internet and intranets is
critical to the continued and increasing use and sales of the Company's
RealSystem software. The willingness of content providers to offer and license
content that appeals to end users and attracts advertisers is an important
factor in promoting the continued and increasing use of the Company's products
and services. There can be no assurance that such content will continue to be
available on acceptable terms, if at all. Historically, the Company has
recognized increased revenues from sales of RealPlayer Plus in months in which
the Company bundled compelling content. If the Company were unable to bundle
compelling content, license desirable content on favorable terms, or otherwise
offer content that is widely accepted by a broad market audience, the Company's
business, financial condition and results of operations would likely be
adversely affected. It is possible that associations that represent collectives
of content owners may seek to and may successfully establish minimum royalties
or other conditions that apply to the licensing or distribution of content over
the Internet and that may limit the availability of such content or increase the
cost to the Company to use such content. The imposition of any such mandatory
royalty payments may increase the Company's cost of revenues significantly,
which would have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business -- Products and
Services -- Media Publishing Products and Services."
MANAGEMENT OF GROWTH; ACQUISITION RISKS
The Company's rapid growth has placed, and is expected to continue to
place, a significant strain on the Company's managerial, technical, operational
and financial resources. None of the Company's executive officers has had senior
management experience in a public company in the position he or she currently
holds. From September 30, 1996 to September 30, 1997, the Company grew from 157
employees to 297 employees, which rapid growth the Company expects to continue.
To manage its growth, the Company must implement and improve its operational and
financial systems and expand, train and manage its workforce. The Company will
also need to manage an increasing number of complex relationships with
customers, marketing partners and other third parties. In addition, the Company
may pursue the acquisition of new or complementary businesses, products or
technologies, although it has no present understandings, commitments or
agreements with respect to any material acquisitions or
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investments. Any such future acquisitions would be accompanied by the risks
commonly encountered in acquisitions of companies. Such risks include, among
other things, the difficulty of assimilating the operations and personnel of the
acquired companies, the potential disruption of the Company's ongoing business,
the inability of management to incorporate successfully acquired technology and
rights into the Company's products, services and media offerings, additional
expense associated with amortization of acquired intangible assets, the
maintenance of uniform standards, controls, procedures and policies, and the
potential impairment of relationships with employees, customers and strategic
partners.
There can be no assurance that the Company's systems, procedures or
controls will be adequate to support the Company's current or future operations
or that the Company's management will be able to manage effectively the
expansion and still achieve the rapid execution necessary to exploit fully the
market for the Company's products and services. The Company's future operating
results will also depend on its ability to expand its sales and marketing
organizations, implement and manage new distribution channels to penetrate
different and broader markets, including the market for intranet software
products, and expand its support organization accordingly. If the Company were
to fail to manage its growth effectively, its business, financial condition and
results of operations would be materially adversely affected. See "-- Dependence
on Key Personnel; Need for Additional Personnel" and "-- Risk of Capacity
Constraints; Reliance or Internally Developed Systems; System Development
Risks."
IMPACT OF EVOLVING STANDARDS
The Company's current streaming media products are based on protocols
designed around certain standards, and the Company's business, financial
condition and results of operations would be materially adversely affected if
any of the Company's competitors were to establish a competing technology as the
de facto industry standard for streaming audio and video transmission. The
Company and Netscape Communications Corporation ("Netscape") co-authored the
Real Time Streaming Protocol ("RTSP"), a proposed protocol for standardizing the
control and delivery of streaming media over the Internet. RTSP can be used with
a broad range of data types and is intended to promote a greater level of
interoperability among various streaming media solutions by providing a standard
way for clients and servers from multiple vendors to stream multimedia content.
RTSP is built on top of a number of other Internet standard protocols and is
complementary with ASF, a file format for streaming media that does not specify
a method of client-server interaction. RTSP provides the client-server
specification necessary to stream ASF files (and many other file types) on the
Internet. There can be no assurance that RTSP will be established as the de
facto industry standard or, if so accepted, that existing competitors and new
entrants would not be able to compete more effectively with the Company's
products. See "-- Competition; Relationship With Microsoft" and
"Business -- Technology."
RISK OF CAPACITY CONSTRAINTS; RELIANCE ON INTERNALLY DEVELOPED SYSTEMS; SYSTEM
DEVELOPMENT RISKS
The satisfactory performance, reliability and availability of the Company's
Web sites, transaction-processing systems and network infrastructure are
critical to the Company's reputation and ability to attract and retain customers
and maintain adequate customer service. Any system interruptions that result in
the unavailability of the Company's Web sites would adversely affect the
Company's ability to conduct business. The Company's Web sites are complex and
require considerable technical expertise to maintain. Personnel with
technological expertise in this area are in great demand, and there can be no
assurance that the Company can attract, train or retain such personnel. Many of
the software systems used to support the Company's Web sites, including its
electronic commerce operations, were developed internally. These systems will
need to be enhanced over time or replaced with equivalent commercial products,
either of which could entail considerable effort and expense.
The Company's ability to provide a consistent level of high-quality
customer service depends in part on the efficient and uninterrupted operation of
its computer and communications hardware systems. Substantially all of the
Company's computer and communications hardware is located at a single leased
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facility in Seattle, Washington. The Company's systems and operations are
vulnerable to damage or interruption from fire, flood, power loss,
telecommunications failure, break-ins, earthquake and similar events. Because
the Company does not presently have fully redundant systems or a formal disaster
recovery plan, there can be no assurance that a system failure would not have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company's servers are vulnerable to computer viruses,
physical or electronic break-ins and similar disruptions, which could lead to
interruptions, delays, loss of data or the inability to accept and fulfill
customer orders. The occurrence of any of the foregoing risks could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Technology."
ONLINE COMMERCE SECURITY RISKS
Online commerce and communications depend to a significant extent on the
ability to conduct secure transmission of confidential information over public
networks. The Company relies on encryption and authentication technology
licensed from third parties to provide the security and authentication intended
to effect secure transmission of confidential information, such as customer
credit card numbers. There can be no assurance that the Company's efforts in
this area or advances in computer capabilities, new discoveries in the field of
cryptography, or other events or developments will not result in a compromise or
breach of the algorithms used by the Company to protect customer transaction
data. Any compromise of the Company's security could have a material adverse
effect on the Company's business, financial condition and results of operations.
A party who is able to circumvent the Company's security measures could
misappropriate proprietary information or cause interruptions in the Company's
operations. The Company may be required to expend significant capital and other
resources to protect against such security breaches or to alleviate problems
caused by such breaches. In addition, there can be no assurance that credit card
companies will not restrict online credit card transactions in the future for
reasons such as fraudulent credit card transactions or other risks associated
with online commerce transactions, which restrictions could have a material
adverse effect on the Company's business, financial condition and results of
operations. To the extent that activities of the Company or third-party
contractors involve the storage and transmission of proprietary information,
security breaches could damage the Company's reputation and expose the Company
to a risk of litigation and possible liability. There can be no assurance that
the Company's security measures will prevent security breaches or that the
failure to prevent such security breaches will not have a material adverse
effect on the Company's business, financial condition and results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION
For the year ended December 31, 1996 and the nine months ended September
30, 1997, approximately 19% and 24%, respectively, of the Company's total net
revenues were generated from sources outside the U.S. and Canada. As a result,
the Company is subject to the risks of doing business abroad, including
unexpected changes in regulatory requirements, export and import restrictions,
tariffs and other trade barriers, difficulties in staffing and managing foreign
operations, longer payment cycles, problems in collecting accounts receivable,
potential adverse tax consequences, exchange rate fluctuations, increased risks
of piracy, limits on the Company's ability to enforce its intellectual property
rights, discontinuity of network infrastructures, limits on repatriation of
funds and political risks that may limit or disrupt international sales. Such
limitations and interruptions could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
operations of the Company's foreign subsidiaries are translated from local
currency into U.S. dollars based on average monthly exchange rates. The Company
currently does not hedge its foreign currency transactions and is therefore
subject to the risk of changes in exchange rates. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and
"Business -- Sales, Marketing and Distribution."
16
<PAGE> 19
GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES
The Company currently is not 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 the Company's products. Due to the increasing popularity and use of the
Internet, it is possible that a number of laws and regulations may be adopted in
the U.S. and abroad with particular applicability to the Internet. It is
possible that governments will enact legislation that may be applicable to the
Company in areas such as content, network security, encryption and the use of
key escrow, data and privacy protection, electronic authentication or "digital"
signatures, illegal and harmful content, access charges and retransmission
activities. Moreover, the applicability to the Internet of existing laws
governing issues such as property ownership, content, taxation, defamation and
personal privacy is uncertain. The majority of such laws were adopted before the
widespread use and commercialization of the Internet and, as a result, do not
contemplate or address the unique issues of the Internet and related
technologies. Any such export or import restrictions, new legislation or
regulation or governmental enforcement of existing regulations may limit the
growth of the Internet, increase the Company's cost of doing business or
increase the Company's legal exposure, which could have a material adverse
effect on the Company's business, financial condition and results of operations.
By distributing content over the Internet, the Company faces potential
liability for claims based on the nature and content of the materials that it
distributes, including claims for defamation, negligence or copyright, patent or
trademark infringement, which claims have been brought, and sometimes
successfully litigated, against Internet companies. The Company's general
liability insurance may not cover potential claims of this type or may not be
adequate to indemnify the Company for any liability that may be imposed. Any
liability not covered by insurance or in excess of insurance coverage could have
a material adverse effect on the Company's business, financial condition and
results of operations. Although those sections of the Communications Decency Act
of 1996 (the "CDA") that, among other things, proposed to impose criminal
penalties on anyone distributing "indecent" material to minors over the
Internet, were held to be unconstitutional by the U.S. Supreme Court, there can
be no assurance that similar laws will not be proposed and adopted. While the
Company does not currently distribute the types of materials that the CDA may
have deemed illegal, the nature of such similar legislation and the manner in
which it may be interpreted and enforced cannot be fully determined and,
therefore, legislation similar to the CDA could subject the Company to potential
liability, which in turn could have an adverse effect on the Company's business,
financial condition and results of operations. Such laws could also damage the
growth of the Internet generally and decrease the demand for the Company's
products and services, which could adversely affect the Company's business,
financial condition and results of operations. See "Business -- Governmental
Regulation" and "-- Intellectual Property."
VOLATILITY OF STOCK PRICE
The Company believes that factors such as announcements of developments
related to the Company's business, announcements of technological innovations,
or new products or enhancements by the Company or its competitors, sales by
competitors (including sales to the Company's customers), sales of the Common
Stock into the public market (including sales by members of management),
developments in the Company's relationships with its customers, partners,
distributors and suppliers, shortfalls or changes in revenues, gross margins,
earnings or losses or other financial results from analysts' expectations,
regulatory developments, fluctuations in results of operations and conditions in
the Company's market or the markets served by the Company's customers or the
economy could cause the price of the Common Stock to fluctuate, perhaps
substantially. In addition, in recent years the stock market in general, and the
market for shares of small capitalization and technology stocks in particular,
have experienced extreme price fluctuations, which have often been unrelated to
the operating performance of affected companies. There can be no assurance that
the market price of the Common Stock will not experience significant
fluctuations in the future, including fluctuations that are unrelated to
17
<PAGE> 20
the Company's performance. Such fluctuations could materially adversely affect
the market price of the Common Stock.
SALES AND OTHER TAXES
The Company currently does not collect sales or similar taxes with respect
to the sale of products, license of technology, or provision of services in
states and countries other than states in which the Company has offices.
However, one or more states or foreign countries may seek to impose sales or
other tax obligations on companies that engage in online commerce within their
jurisdictions. A successful assertion by one or more states or any foreign
country that the Company should collect sales or other taxes on the sale of
products, license of technology or provision of services, or remit payment of
sales or other taxes for prior periods, could have a material adverse effect on
the Company's business, financial condition and results of operations.
IMPACT OF EXERCISE OF THE SERIES E WARRANT; ELECTION BY MICROSOFT TO RECEIVE
COMMON STOCK OR SPECIAL COMMON STOCK
In connection with Microsoft's investment in the Company in July 1997, the
Company issued the Series E Warrant. If it is not exercised, the Series E
Warrant will terminate upon the earliest of (i) the closing of an initial public
offering, (ii) completion of a merger in which the Company is not the survivor,
or the sale of substantially all the assets of the Company, (iii) Microsoft's
breach of its agreement with the Company, which breach is not cured, and (iv)
January 21, 2002. Microsoft may elect to convert the shares of Series E
Preferred Stock issuable on exercise of the Series E Warrant into Common Stock
or Special Common Stock or in part into each of such classes. If Microsoft
elects to convert shares of Series E Preferred Stock into $15,000,000 or more of
Common Stock, it may be required to make a filing under the Hart-Scott-Rodino
Antitrust Improvements Act and obtain approval from the Department of Justice
and the Federal Trade Commission before completing the conversion into Common
Stock. If the Series E Warrant is exercised in full, Microsoft will own of
record approximately 20.3% of the Company's outstanding capital stock
immediately after the offering. There can be no assurance that Microsoft will
exercise any or all of the Series E Warrant. In addition, there can be no
assurance that if the Series E Warrant is exercised for shares of Series E
Preferred Stock, Microsoft will elect to take any particular percentage of
Common Stock or Special Common Stock.
Because the Series E Warrant may be exercised at any time until the closing
of the offering, it is impossible to predict with any certainty the ultimate
impact that the exercise thereof would have on the Company's resulting
capitalization, liquidity and capital resources, percentage of shares
beneficially owned by the Company's shareholders, and certain matters involving
corporate control. See "-- Competition; Relationship With Microsoft,"
"-- Department of Justice Subpoena," "-- Control by Mr. Glaser; Antitakeover
Provisions," "Capitalization," "Dilution," "Management's Discussion and Analysis
of Financial Condition and Results of Operations," "Business -- Microsoft
Relationship," "Principal Shareholders" and "Description of Capital Stock."
NO SPECIFIC USE OF PROCEEDS
The Company has not designated any specific use for the net proceeds from
the sale of the Common Stock offered hereby. The Company intends to use the net
proceeds primarily for general corporate purposes, including working capital to
fund anticipated operating losses and capital expenditures. Accordingly,
management will have significant flexibility in applying the net proceeds of the
offering. The failure of management to apply such funds effectively could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Use of Proceeds."
18
<PAGE> 21
NO PRIOR MARKET FOR COMMON STOCK
Prior to the offering, there has been no public market for the Common
Stock. The initial public offering price of the Common Stock will be determined
by negotiations between the Company and the representatives of the Underwriters
and may not be indicative of the market price of the Common Stock in the future.
There can be no assurance that an active trading market will develop or be
sustained after the offering. See "Underwriting" for a discussion of the factors
considered in determining the initial public offering price.
POSSIBLE ADVERSE EFFECT ON MARKET PRICE OF COMMON STOCK OF SHARES ELIGIBLE FOR
FUTURE SALE AFTER THE OFFERING
On closing of the offering, the Company will have outstanding 30,965,079
shares of Common Stock (31,415,079 shares if the Underwriters' over-allotment
option is exercised in full), of which 3,000,000 shares offered hereby
(3,450,000 shares if the Underwriters' over-allotment option is exercised in
full) will be freely transferable in the public market without restriction or
further registration under the Securities Act of 1933, as amended (the
"Securities Act"), except to the extent such shares are held by affiliates of
the Company. The remaining 27,965,079 shares of Common Stock (the "Restricted
Shares") outstanding on completion of the offering (assuming no exercise of
options after October 9, 1997) were issued by the Company in reliance on
exemptions from registration under the Securities Act, and public sale thereof
is restricted except to the extent they are registered under the Securities Act
or sold in accordance with an exemption from such registration. The Company and
certain holders of these Restricted Shares have entered into lock-up agreements
(the "Lock-Up Agreements") with the Underwriters not to sell, offer to sell or
otherwise dispose of any shares of Common Stock owned of record or beneficially
as of the date of this Prospectus, including securities convertible into or
exercisable or exchangeable for shares of Common Stock as of such date, as well
as any shares of Common Stock later acquired by reason of the conversion,
exercise or exchange of such securities, for a period of 180 days after the date
of this Prospectus without the prior written consent of Goldman, Sachs & Co. on
behalf of the Underwriters, except that persons other than officers, directors
and holders of 1% or more of the capital stock of the Company will be free to
sell or otherwise dispose of up to 5,000 shares of Common Stock to the extent
permissible under Rule 144 or Rule 701 under the Securities Act. On closing of
the offering, 27,670,989 of the Restricted Shares will be subject to restriction
pursuant to the Lock-Up Agreements. Of the remaining 294,090 Restricted Shares,
11,947 shares will be eligible for immediate public sale under Rule 144(k) under
the Securities Act as currently in effect, 281,143 shares will be eligible for
public sale 90 days after the date of this Prospectus pursuant to Rule 701 under
the Securities Act, and the remaining 1,000 shares of Common Stock will be
eligible for public sale subject to compliance with the holding period and
volume and manner of sale restrictions of Rule 144, unless earlier registered
under the Securities Act. At October 9, 1997, options for 6,390,014 shares of
Common Stock were outstanding, of which options for 1,673,755 shares may be
exercised during the 180 days following the date of this Prospectus and
potentially will be eligible for public sale 90 days after the date of this
Prospectus pursuant to Rule 701 under the Securities Act; of these shares,
1,301,463 will be subject to Lock-Up Agreements. Warrants to purchase an
additional 4,707,363 shares of Common Stock, including the Series E Warrant to
purchase up to 3,709,305 shares, which may be exercised in whole or in part for
shares of either Common Stock or Special Common Stock, will be exercisable prior
to or on closing of the offering, and the shares issued upon exercise thereof
will be eligible for public sale, subject to compliance with Rule 144. All of
these shares are subject to Lock-Up Agreements. The holders of an aggregate of
16,390,753 shares of Common Stock (including shares of Common Stock issuable
upon exercise of outstanding warrants and assuming that the Series E Preferred
Stock converts into Common Stock and the Series E Warrant is exercised in its
entirety for shares of Common Stock) have the right to require the Company to
register their shares for sale under the Securities Act beginning six months
after the closing of the offering. Sales of substantial numbers of shares of
Common Stock in the public market following the offering could have a material
adverse effect on the market price for the Common Stock. See "Shares Eligible
for Future Sale."
19
<PAGE> 22
DONATION OF NET INCOME TO CHARITY
The Company's philosophy includes a commitment to charitable
responsibility. If sustained profitability is achieved, the Company intends to
donate approximately 5% of its annual net income to charitable organizations.
The Company's net income will be reduced by the amount of these charitable
donations. See "Business -- Position on Charitable Responsibility" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Donation of Net Income to Charity."
ABSENCE OF DIVIDENDS
The Company has never declared or paid cash dividends on its capital stock
and does not anticipate paying any cash dividends in the foreseeable future. See
"Dividend Policy."
DILUTION
Investors in Common Stock in the offering will experience immediate and
substantial dilution in the net tangible book value of their shares. Assuming an
initial public offering price of $10.00 per share, dilution to new investors
would be $7.57 per share. Additional dilution will occur upon exercise of
outstanding stock options. See "Dilution."
20
<PAGE> 23
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,000,000 shares of
Common Stock offered hereby at an assumed initial public offering price of
$10.00 per share, after deducting the underwriting discount and estimated
offering expenses payable by the Company, are estimated to be $26,950,000
($31,135,000 if the Underwriters' over-allotment option is exercised in full).
The principal purposes of the offering are to increase the Company's equity
capital, to create a public market for the Common Stock, to increase the
visibility of the Company in the marketplace and to facilitate future access by
the Company to public equity markets. The Company intends to use the net
proceeds primarily for general corporate purposes, including working capital to
fund anticipated operating losses and capital expenditures. The Company may,
when and if the opportunity arises, use an unspecified portion of the net
proceeds to acquire or invest in complementary businesses, products and
technologies. The Company has no present understandings, commitments or
agreements with respect to any material acquisition or investment. Pending use
of the net proceeds for the above purposes, the Company intends to invest such
funds in interest-bearing, investment-grade securities.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its capital stock.
The Company currently anticipates that it will retain all of its future
earnings, if any, for use in the expansion and operations of its business and,
therefore, does not anticipate paying any cash dividends in the foreseeable
future.
21
<PAGE> 24
CAPITALIZATION
The following table sets forth the capitalization of the Company at
September 30, 1997 and as adjusted to give effect to the (i) conversion of all
outstanding shares of Series A Common Stock, Series B Common Stock, Series C
Common Stock, Series A Preferred Stock, Series B Preferred Stock, Series C
Preferred Stock, Series D Preferred Stock and Series E Preferred Stock into
Common Stock on closing of the offering; (ii) sale by the Company of the
3,000,000 shares of Common Stock offered hereby at an assumed initial public
offering price of $10.00 per share (after deducting the underwriting discount
and estimated expenses of the offering); and (iii) issuance of 998,058 shares of
Common Stock reflecting exercise of outstanding warrants at an average exercise
price of $6.97 per share on the closing of the offering, except as noted below.
See "Use of Proceeds" and Note 7 of Notes to Consolidated Financial Statements.
The information set forth below is unaudited and should be read in conjunction
with the Company's Consolidated Financial Statements and Notes thereto.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
------------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Note payable........................................................ $ 959 $ 959
Redeemable, convertible preferred stock, par value $0.001 per share:
16,206,998 shares authorized; 11,683,390 shares issued and
outstanding, actual; no shares authorized, issued and outstanding,
as adjusted(1).................................................... 49,278 --
Shareholders' equity (deficit):
Convertible preferred stock, par value $0.001 per share:
13,713,439 shares authorized; 13,713,439 issued and
outstanding, actual; no shares authorized, issued and
outstanding, as adjusted(1).................................... 14 --
Preferred stock, undesignated, par value $0.001 per share:
30,079,563 shares authorized; no shares issued and
outstanding(1)................................................. -- --
Common stock, par value $0.001 per share: 300,000,000 shares
authorized; 1,543,292 shares issued and outstanding, actual;
30,938,179 shares issued and outstanding, as adjusted(2)....... 1 31
Additional paid-in capital........................................ 6,755 89,923
Foreign currency translation adjustment........................... (72) (72)
Accumulated deficit............................................... (14,787) (14,787)
-------- --------
Total shareholders' equity (deficit)........................... (8,089) 75,095
-------- --------
Total capitalization...................................... $ 42,148 $ 76,054
======== ========
</TABLE>
- ---------------
(1) At September 30, 1997, the Company had 60,000,000 shares of preferred stock
authorized, of which 13,713,439 shares were designated Series A Preferred
Stock, 3,059,701 shares were designated Series B Preferred Stock, 3,004,305
shares were designated Series C Preferred Stock, 3,095,313 shares were
designated Series D Preferred Stock, and 7,047,679 shares were designated
Series E Preferred Stock.
(2) Excludes (i) 6,442,714 shares of Common Stock issuable at a weighted average
exercise price of $1.80 per share upon exercise of stock options outstanding
at September 30, 1997, (ii) 4,421,192 shares of Common Stock reserved for
future issuance under the Company's stock option plans, (iii) 1,000,000
shares of Common Stock reserved for issuance under the 1998 Employee Stock
Purchase Plan, and (iv) up to 3,709,305 shares of Common Stock or Special
Common Stock (representing additional cash and shareholders' equity of up to
$50,001,431) issuable on exercise of the Series E Warrant. See
"Management -- Benefit Plans," "Certain Transactions," "Description of
Capital Stock -- Warrants to Purchase Preferred Stock and Common Stock" and
Note 7 of Notes to Consolidated Financial Statements.
22
<PAGE> 25
DILUTION
The pro forma net tangible book value of the Company at September 30, 1997
is $48,145,000, or $1.72 per share, as adjusted to give effect to the (i)
conversion of all outstanding shares of Series A Common Stock, Series B Common
Stock, Series C Common Stock, Series A Preferred Stock, Series B Preferred
Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred
Stock into Common Stock upon closing of the offering; (ii) exclusion of up to
3,709,305 shares of Common Stock or Special Common Stock (representing
additional cash and shareholders' equity of up to $50,001,431 and an increase to
tangible book value per share of $1.58) issuable on exercise of the Series E
Warrant; and (iii) issuance of 998,058 shares of Common Stock, reflecting
exercise of outstanding warrants at an average exercise price of $6.97 per share
on closing of the offering. Pro forma net tangible book value per share
represents total tangible assets of the Company less total liabilities divided
by the aggregate number of shares of Common Stock and Special Common Stock
outstanding. After giving effect to the estimated net proceeds from the sale of
3,000,000 shares of Common Stock offered by the Company at an assumed initial
public offering price of $10.00 per share, the adjusted pro forma net tangible
book value of the Company at September 30, 1997 would have been approximately
$75,095,000, or $2.43 per share of Common Stock and Special Common Stock. This
represents an immediate increase in the pro forma net tangible book value of
$0.71 per share of Common Stock and Special Common Stock to existing
shareholders and an immediate dilution of $7.57 per share to new investors. The
following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............................... $10.00
Pro forma net tangible book value per share at September 30, 1997............. $1.72
Increase per share attributable to new investors.............................. 0.71
-----
Adjusted pro forma net tangible book value per share after the offering....... 2.43
------
Dilution per share to new investors........................................... $ 7.57
======
</TABLE>
The following table summarizes on a pro forma basis at September 30, 1997,
after giving effect to the offering, the difference between existing
shareholders and investors in the offering with respect to the number of shares
of Common Stock and Special Common Stock purchased from the Company, the total
consideration paid and the average price paid per share.
<TABLE>
<CAPTION>
SHARES PURCHASED(1)(2) TOTAL CONSIDERATION
---------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
----------- ------- ------------ ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders............ 27,938,179 90.3% $ 63,767,800 68.0% $ 2.28
-----
New investors.................... 3,000,000 9.7 30,000,000 32.0 10.00
---------- ----- ---------- -----
Total................... 30,938,179 100.0% $ 93,767,800 100.0%
========== ===== ========== =====
</TABLE>
- ---------------
(1) The table assumes no exercise of the Underwriters' over-allotment option.
Exercise of the over-allotment option in full would (i) reduce the
proportion of shares held by existing shareholders to 89.0% of the total
number of shares outstanding after the offering and (ii) increase the number
of shares held by investors in the offering to 3,450,000 shares, or 11.0% of
the total number of shares.
(2) Excludes (i) 6,442,714 shares of Common Stock issuable at a weighted average
exercise price of $1.80 per share upon exercise of stock options outstanding
at September 30, 1997, (ii) 4,421,192 shares of Common Stock reserved for
future issuance under the Company's stock option plans, (iii) 1,000,000
shares of Common Stock reserved for issuance under the 1998 Employee Stock
Purchase Plan, and (iv) up to 3,709,305 shares of Common Stock or Special
Common Stock (representing additional cash and shareholders' equity of up to
$50,001,431) issuable on exercise of the Series E Warrant. See
"Management -- Benefit Plans," "Certain Transactions," "Description of
Capital Stock -- Warrants to Purchase Preferred Stock and Common Stock" and
Note 7 of Notes to Consolidated Financial Statements.
23
<PAGE> 26
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," included elsewhere in this Prospectus. The selected
consolidated financial data as of December 31, 1994, and for the period from
February 9, 1994 (inception) to December 31, 1994, as of and for the years ended
December 31, 1995 and 1996 and as of and for the nine months ended September 30,
1997 are derived from the Consolidated Financial Statements of the Company
audited by KPMG Peat Marwick LLP, independent accountants. The selected
consolidated financial data for the nine months ended September 30, 1996 are
derived from unaudited consolidated financial statements prepared by the Company
on a basis consistent with the Company's audited Consolidated Financial
Statements and, in the opinion of management, include all adjustments,
consisting only of normal recurring accruals, necessary for a fair presentation
of the results for such periods. Operating results for the nine months ended
September 30, 1997 are not necessarily indicative of the results that may be
expected for any other interim period or for the year ending December 31, 1997.
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 9, 1994 YEAR ENDED NINE MONTHS ENDED
(INCEPTION) TO DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, --------------------- -----------------------
1994 1995 1996 1996 1997
---------------- ------- ------- ----------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues:
Software license fees....................... $ -- $ 1,782 $11,876 $ 7,213 $17,550
Advertising................................. -- -- 1,016 426 1,557
Service revenues............................ -- 30 1,120 635 3,310
----- ------- ------- ------- -------
Total net revenues................... -- 1,812 14,012 8,274 22,417
Cost of revenues:
Software license fees....................... -- 29 1,343 470 2,080
Advertising................................. -- -- 288 187 572
Service revenues............................ -- 33 554 312 1,957
----- ------- ------- ------- -------
Total cost of revenues............... -- 62 2,185 969 4,609
----- ------- ------- ------- -------
Gross profit.............................. -- 1,750 11,827 7,305 17,808
Operating expenses:
Research and development.................... 202 1,380 4,812 3,073 9,130
Selling and marketing....................... 47 1,218 7,540 4,389 14,024
General and administrative.................. 296 747 3,491 2,318 4,413
----- ------- ------- ------- -------
Total operating expenses............. 545 3,345 15,843 9,780 27,567
----- ------- ------- ------- -------
Operating loss............................ (545) (1,595) (4,016) (2,475) (9,759)
Net other income.............................. -- 94 227 160 1,184
----- ------- ------- ------- -------
Net loss...................................... $ (545) $(1,501) $(3,789) $ (2,315) $(8,575)
===== ======= ======= ======= =======
Pro forma net loss per share(1)............... $ (0.14) $ (0.32)
Shares used to compute pro forma net loss per
share(1).................................... 27,779 28,315
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------- SEPTEMBER 30,
1994 1995 1996 1997
------- ------- ------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments............. $ -- $ 6,116 $19,595 $67,648
Working capital (deficit)..................................... (49) 5,948 16,893 50,762
Total assets.................................................. 64 7,574 26,468 84,372
Redeemable, convertible preferred stock....................... -- 7,655 23,153 49,278
Shareholders' equity (deficit)................................ 15 (1,111) (3,320) (8,089)
</TABLE>
- ---------------
(1) For an explanation of pro forma net loss per share and the number of shares
used to compute pro forma net loss per share, see Note 1 of Notes to
Consolidated Financial Statements.
24
<PAGE> 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included elsewhere in this Prospectus.
This discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including, but not limited to, those set forth under "Risk Factors" and
elsewhere in this Prospectus.
OVERVIEW
RealNetworks is a leading provider of branded software products and
services that enable the delivery of streaming media content over the Internet
and intranets. The Company's products and services include its RealSystem family
of software products, an electronic commerce Web site designed to promote the
proliferation of streaming media products and a network of advertising-supported
content aggregation Web sites.
The Company was incorporated in February 1994 and did not recognize any
revenue until July 1995, when the Company began delivery of the commercial
version of RealAudio Version 1.0. From inception through December 31, 1995, the
Company's 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, the Company continued to invest heavily in
research and development, marketing, building domestic and international sales
channels and general and administrative infrastructure. In August 1996, the
Company began selling RealPlayer Plus, a premium version of its RealPlayer
product. RealPlayer continues to be available for download free of charge from
the Company's Web sites. In February 1997, the Company released a beta version
of its RealVideo product and in June 1997, it released the commercial version of
RealVideo Version 4.0. In October 1997, the Company released a beta version of
its RealSystem Version 5.0, a streaming media solution that includes RealAudio
and RealVideo technology.
The Company has a limited operating history on which an evaluation of the
Company and its prospects can be based. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in early stages of development, particularly companies
in rapidly evolving markets such as media delivery and electronic commerce over
the Internet and intranets. To achieve and sustain profitability, the Company
must, among other things, establish widespread market acceptance of its existing
products and services, successfully develop new products and services, respond
quickly and effectively to competitive, market and technological developments,
expand sales and marketing operations, broaden customer support capabilities,
control expenses and continue to attract and retain qualified personnel. There
can be no assurance that the Company will achieve or sustain profitability.
The Company has incurred significant losses since its inception, and as of
September 30, 1997 had an accumulated deficit of $14,787,000. The Company
believes that its success will depend largely on its ability to extend its
technological leadership and continue to build its brand position. Accordingly,
the Company intends to invest heavily in research and development and sales and
marketing. The Company expects to continue to incur substantial operating losses
for the foreseeable future. In view of the rapidly evolving nature of the
Company's business and its limited operating history, the Company believes that
period-to-period comparisons of its revenues and operating results, including
its gross profit margin and operating expenses as a percentage of total net
revenues, are not necessarily meaningful and should not be relied upon as
indications of future performance. Although the Company has experienced
significant percentage growth in total net revenues, it does not believe that
its historical growth rates are sustainable or indicative of future growth. The
Company has used, and expects to continue to use, price promotions to increase
trial, purchase and use of its products, as well as to increase overall
recognition of its brands.
25
<PAGE> 28
The effect of such promotions on revenues in a particular period may be
significant and extremely difficult to forecast.
The following table sets forth certain financial data for the periods
indicated as a percentage of total net revenues:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
------------------ ------------------
1995 1996 1996 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Net revenues:
Software license fees............ 98.4% 84.8% 87.2% 78.3%
Advertising...................... -- 7.2 5.1 6.9
Service revenues................. 1.6 8.0 7.7 14.8
----- ----- ----- -----
Total net revenues....... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenues:
Software license fees............ 1.6 9.6 5.7 9.3
Advertising...................... -- 2.0 2.2 2.6
Service revenues................. 1.8 4.0 3.8 8.7
----- ----- ----- -----
Total cost of revenues... 3.4 15.6 11.7 20.6
----- ----- ----- -----
Gross profit.................. 96.6 84.4 88.3 79.4
Operating expenses:
Research and development......... 76.2 34.3 37.1 40.7
Selling and marketing............ 67.2 53.8 53.1 62.6
General and administrative....... 41.2 24.9 28.0 19.7
----- ----- ----- -----
Total operating
expenses............... 184.6 113.0 118.2 123.0
----- ----- ----- -----
Operating loss................ (88.0) (28.6) (29.9) (43.6)
Other income (expense):
Interest income, net............. 5.2 2.1 2.3 5.4
Other expense.................... -- (0.5) (0.4) (0.1)
----- ----- ----- -----
Net other income................... 5.2 1.6 1.9 5.3
----- ----- ----- -----
Net loss........................... (82.8)% (27.0)% (28.0)% (38.3)%
===== ===== ===== =====
</TABLE>
RESULTS OF OPERATIONS -- NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
REVENUES
The Company generates revenues primarily from three sources: software
license fees, advertising and services. Software license fees are recognized
upon delivery, net of allowances for estimated future returns, provided that no
significant obligations of the Company remain and collection of the resulting
receivable is deemed probable. Revenues from software license agreements with
original equipment manufacturers ("OEM") are recognized when the OEM delivers
its product incorporating the Company's software to the end user. In the case of
prepayments from an OEM, the Company generally recognizes revenues 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 generally is recognized on the
straight-line method over the term of the contract. The Company recognizes
revenues from software license agreements with value-added resellers ("VAR")
upon delivery to the VAR, provided necessary conditions are met. If these
conditions are not met, revenue is recognized upon redistribution by the VAR to
the end user. Advertising revenues are recognized over the period in which the
advertisement is displayed on one of the Company's Web pages. The Company
guarantees to certain advertising customers a minimum number of page impressions
to be delivered to users of its Web sites for a particular period. To the extent
minimum guaranteed page impression deliveries are not met, the Company defers
recognition of the corresponding advertising revenues until
26
<PAGE> 29
guaranteed page impression delivery levels are achieved. Service revenues
include support and upgrade contracts, commissions from electronic sales of
third-party products, consulting, content hosting and fees from user
conferences. Support and upgrade revenues are recognized ratably over the term
of the contract, which typically is 12 months. Payments for support and upgrade
contracts are generally made in advance and are nonrefundable. Other service
revenues are recognized when the service is performed.
Software License Fees. Software license fees were $7,213,000 and
$17,550,000 for the nine months ended September 30, 1996 and 1997, respectively.
The increase was primarily due to growing market acceptance of the Company's
server and player products, including the introduction of RealPlayer Plus in
August 1996 and RealVideo in February 1997, successful product promotions and
diversification of the Company's sales channels, including electronic
distribution. Server product sales were $5,799,000 and $10,379,000 for the nine
months ended September 30, 1996 and 1997, respectively. In July 1997, the
Company received a $30,000,000 prepayment related to a license agreement with
Microsoft. The agreement requires the Company to provide Microsoft with
engineering consultation services, certain error corrections and certain
technical support over a defined term. The Company recognizes revenue from the
agreement over the three-year term of the Company's ongoing obligations.
Included in server product sales for the nine months ended September 30, 1997
was $2,417,000 related to the Microsoft license agreement. Player product sales
were $1,414,000 and $7,171,000 over the same respective periods. The Company
began selling products electronically from its Web site in August 1996.
Electronic sales of both server and player products for the nine months ended
September 30, 1996 and 1997 were $650,000 and $6,038,000, respectively, or 9%
and 34%, respectively, of software license fees in the period. The Company has
used price promotions to increase the trial, purchase and use of its software
products. In February 1997, the Company reduced the prices of its server
products. In July 1997, the Company made its Basic Server available to customers
to download free of charge.
Advertising Revenues. Advertising revenues were $426,000 and $1,557,000
for the nine months ended September 30, 1996 and 1997, respectively. The Company
began selling advertising space on its Web sites in March 1996. Increased
revenues in 1997 were due in part to a full period of advertising sales and the
Company's success in attracting a greater number of advertisers.
Service Revenues. Service revenues were $635,000 and $3,310,000 for the
nine months ended September 30, 1996 and 1997, respectively. Revenues from
upgrade and support contracts were $499,000 and $2,453,000 for the nine months
ended September 30, 1996 and 1997, respectively. This increase was primarily due
to a greater installed base of the Company's products. Service revenues for the
nine months ended September 30, 1997 also included fees of $498,000 related to
the Company's first RealMedia conference.
International Revenues. International revenues were 18% and 24% of total
net revenues for the nine months ended September 30, 1996 and 1997,
respectively. The increase in international revenues was due in part to the
creation of the Company's three foreign subsidiaries. The Company incorporated
its French and Japanese subsidiaries in November 1996 and its U.K. subsidiary in
February 1997. Substantially all international revenue was generated in Europe
and Asia. The functional currency of the Company's foreign subsidiaries is the
local currency in the country in which the subsidiary is incorporated.
Operations of the Company's foreign subsidiaries are translated from local
currency into U.S. dollars based on average monthly exchange rates. The Company
currently does not hedge its foreign currency transactions and is therefore
subject to the risk of changes in exchange rates.
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees includes cost
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 $470,000 and $2,080,000 for the nine months
ended September 30, 1996 and 1997, respectively, and 7% and 12%, respectively,
of software license fees. The increase in absolute dollars was primarily due to
higher sales volume. The increase in percentage terms was due to a shift in
product mix toward lower-margin player products, a
27
<PAGE> 30
greater percentage of sales through indirect channels, and the utilization of a
third-party order fulfillment agency.
Cost of Advertising Revenues. Cost of advertising revenues includes
personnel associated with content creation and bandwidth expenses related to the
Company's Web sites. Cost of advertising revenues was $187,000 and $572,000 for
the nine months ended September 30, 1996 and 1997, respectively, and 44% and
37%, respectively, of advertising revenues. The increase in absolute dollars was
primarily due to increased head count associated with content creation and
higher bandwidth expenses. The decrease in percentage terms was due to revenues
growing at a faster rate than expenses.
Cost of Service Revenues. Cost of service revenues includes in-house and
contract personnel providing services, bandwidth expenses for hosting services
and user conference expenses. Cost of service revenues was $312,000 and
$1,957,000 for the nine months ended September 30, 1996 and 1997, respectively,
and 49% and 59%, respectively, of service revenues. The increase in absolute
dollars was primarily due to increased staff and other costs associated with
providing these services to a greater number of customers, and, in March 1997,
the Company incurred $1,000,000 of costs associated with its RealMedia
conference. No such costs were incurred in the comparable period in 1996.
Excluding the effects of the RealMedia conference, cost of service revenues was
49% and 29% of service revenues for the nine months ended September 30, 1996 and
1997, respectively. This decrease was primarily attributable to better
utilization of service personnel associated with an increased customer base.
Gross margins may be affected by the mix of distribution channels used by
the Company, the mix of products sold, the mix of product revenues versus
service revenues and the mix of international versus U.S. and Canada revenues.
The Company typically realizes higher gross margins on direct channel sales
relative to indirect channels and higher gross margins on software license fees
relative to service revenues. If sales through indirect channels increase as a
percentage of total net revenues, or if, as the Company anticipates, service
revenues increase as a percentage of total net revenues, the Company's gross
margins will be adversely affected.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of salaries and consulting fees to support product development and
costs of technology acquired from third parties to incorporate into products
currently under development. To date, all research and development costs have
been expensed as incurred because technological feasibility of the Company's
products is established upon completion of a working model. To date, costs
incurred between completion of a working model and general release of products
have been insignificant. The Company believes that continued investment in
research and development is critical to attaining its strategic objectives and,
as a result, expects research and development expenses to increase
significantly. Research and development expenses were $3,073,000 and $9,130,000
for the nine months ended September 30, 1996 and 1997, respectively, and 37% and
41%, respectively, of total net revenues. The increase was due primarily to
increases in internal development personnel, travel, and consulting expenses. In
addition, during the nine months ended September 30, 1997, the Company expensed
approximately $998,000 related to the cost of technology purchased from third
parties. The Company expects to incur similar types of expenditures in future
periods. Research and development expenses incurred for the nine months ended
September 30, 1997 were primarily related to enhancements made to existing
products and development of new technology and products.
Selling and Marketing. Selling and marketing expenses consist primarily of
salaries, commissions, consulting fees paid, trade show expenses, advertising
and cost of marketing collateral. The Company intends to continue its aggressive
branding and marketing campaign and therefore expects selling and marketing
expenses to increase significantly. Selling and marketing expenses were
$4,389,000 and $14,024,000 for the nine months ended September 30, 1996 and
1997, respectively, and 53% and 63%, respectively, of total net revenues. The
increases were due in large part to growth in sales personnel,
28
<PAGE> 31
commissions and costs related to the continued development and implementation of
the Company's branding and marketing campaigns. During the nine months ended
September 30, 1997, the Company also incurred approximately $694,000 in
marketing expenses related to the launch of RealVideo.
General and Administrative. General and administrative expenses consist
primarily of salaries and fees for professional services. The Company expects
general and administrative expenses to increase as the Company expands its
staff, incurs additional costs related to growth of its business, and becomes a
publicly traded company. General and administrative expenses were $2,318,000 and
$4,413,000 for the nine months ended September 30, 1996 and 1997, respectively,
and 28% and 20%, respectively, of total net revenues. The increase in absolute
dollars was primarily a result of increased personnel and facility expenses
necessary to support the Company's growth. The decrease in percentage terms was
a result of revenues growing at a faster rate than expenses.
NET OTHER INCOME
Net other income consists primarily of earnings on the Company's cash and
cash equivalents and short-term investments. Net other income was $160,000 and
$1,184,000 for the nine months ended September 30, 1996 and 1997, respectively.
The increase was due primarily to interest income resulting from additional
invested cash and cash equivalents and short-term investments.
INCOME TAXES
The Company had a net operating loss for each period from inception through
December 31, 1996. As of September 30, 1997, the Company anticipates fully
utilizing its net operating loss and other credit carryforwards by December 31,
1997 as a result of taxable income generated from a license agreement with
Microsoft. For financial reporting purposes, those license fees are recognized
over the three-year term of the Company's ongoing obligations. As a result, the
Company has recognized deferred tax assets to the extent of its accrued income
taxes. See Note 4 of Notes to Consolidated Financial Statements.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1995 AND 1996
REVENUES
Software License Fees. Software license fees were $1,782,000 and
$11,876,000 for 1995 and 1996, respectively. The Company first began recognizing
revenues from software license fees in July 1995. The increase in software
license fees in 1996 was due primarily to a full period of sales, growing market
acceptance of the Company's products, the introduction of RealPlayer Plus in
August 1996 and diversification of sales channels, including electronic
distribution. All of the Company's software license fees in 1995 were from the
sale of its server software. In 1996, server product sales were $8,188,000 and
player product sales were $3,688,000.
Advertising Revenues. Advertising revenues were $1,016,000 for 1996. The
Company began selling advertising space on its Web sites in March 1996, and, as
a result no advertising revenues were generated in 1995.
Service Revenues. Service revenues were $30,000 and $1,120,000 for 1995
and 1996, respectively. The increase in service revenues in 1996 was due
primarily to support and upgrade contracts associated with a larger installed
base of the Company's products. Consulting, content hosting and user conference
revenues were not significant in either period.
International Revenues. International revenues as a percentage of total
net revenues were 15% and 19% for 1995 and 1996, respectively. Substantially all
international revenues were generated in Europe and Asia.
29
<PAGE> 32
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees was $29,000
and $1,343,000 for 1995 and 1996, respectively, and 2% and 11%, respectively, of
software license fees. The increase in absolute dollars was primarily due to
higher sales volume. The increase in percentage terms was due to a shift in
product mix toward lower-margin player products, a greater percentage of sales
through indirect channels, and the utilization of a third-party order
fulfillment agency.
Cost of Advertising Revenues. Cost of advertising revenues was $288,000
for 1996, and was 28% of advertising revenues. Since the Company did not begin
selling advertising until 1996, all content creation costs in 1995 were charged
to research and development and selling and marketing expenses.
Cost of Service Revenues. Cost of service revenues was $33,000 and
$554,000 for 1995 and 1996, respectively, and was 110% and 49%, respectively, of
service revenues. The increase in absolute dollars was due primarily to
increased staff and other costs associated with providing these services to a
greater number of customers. The decrease in percentage terms was due to better
utilization of service personnel associated with an increased customer base.
OPERATING EXPENSES
Research and Development. Research and development expenses were
$1,380,000 and $4,812,000 for 1995 and 1996, respectively, and 76% and 34%,
respectively, of total net revenues. The increase in absolute dollars was
attributable primarily to increased personnel and related costs associated with
enhancement of existing products and development of new products. The decrease
in percentage terms was a result of revenues growing at a faster rate than
research and development expenses.
Selling and Marketing. Selling and marketing expenses were $1,218,000 and
$7,540,000 for 1995 and 1996, respectively, and 67% and 54%, respectively, of
total net revenues. The increase in absolute dollars was due primarily to
increased salaries, direct sales personnel, commissions, costs associated with
international expansion and promotional expenses. The decrease in percentage
terms was a result of revenues growing at a faster rate than selling and
marketing expenses.
General and Administrative. General and administrative expenses were
$747,000 and $3,491,000 for 1995 and 1996, respectively, and 41% and 25%,
respectively of total net revenues. The increase in absolute dollars was
primarily a result of increased salaries and related expenses associated with
the hiring of additional personnel and increased facilities expenses. The
decrease in percentage terms was a result of revenues growing at a faster rate
than general and administrative expenses.
NET OTHER INCOME
Net other income was $94,000 and $227,000 for 1995 and 1996, respectively.
The increase was due primarily to interest income resulting from higher invested
cash and cash equivalents and short-term investments.
INCOME TAXES
As of December 31, 1996, the Company had approximately $2,802,000 of net
operating loss and other credit carryforwards for federal income tax purposes
that will expire in 2010 and 2011 if not utilized. See Note 4 of Notes to
Consolidated Financial Statements.
30
<PAGE> 33
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited quarterly statement of
operations data for the five quarters ended September 30, 1997. In the opinion
of management, this information has been prepared substantially on the same
basis as the audited Consolidated Financial Statements appearing elsewhere in
this Prospectus, and all necessary adjustments, consisting only of normal
recurring adjustments, have been included in the amounts stated below to present
fairly the unaudited quarterly results of operations. The quarterly data should
be read in conjunction with the audited Consolidated Financial Statements of the
Company and the Notes thereto appearing elsewhere in this Prospectus. The
operating results for any quarter are not necessarily indicative of the
operating results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
SEPT.
SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 30,
1996 1996 1997 1997 1997
--------- -------- --------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Total net revenues........................ $4,030 $ 5,738 $ 6,356 $ 7,010 $ 9,051
Total cost of revenues.................... 575 1,216 2,021 1,033 1,555
---- ------ ------- ------- -------
Gross profit......................... 3,455 4,522 4,335 5,977 7,496
Operating expenses:
Research and development................. 1,334 1,739 2,725 2,738 3,667
Selling and marketing.................... 2,125 3,151 4,350 4,811 4,863
General and administrative............... 906 1,173 1,171 1,325 1,917
---- ------ ------- ------- -------
Total operating expenses........ 4,365 6,063 8,246 8,874 10,447
---- ------ ------- ------- -------
Operating loss....................... (910) (1,541) (3,911) (2,897) (2,951)
Net other income.......................... 43 67 205 231 748
---- ------ ------- ------- -------
Net loss.................................. $ (867) $(1,474) $(3,706) $(2,666) $(2,203)
==== ====== ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
------------------------------------------------------
SEPT.
SEPT. 30, DEC. 31, MARCH 31, JUNE 30, 30,
1996 1996 1997 1997 1997
--------- -------- --------- -------- --------
(AS A PERCENTAGE OF TOTAL NET REVENUES)
<S> <C> <C> <C> <C> <C>
Total net revenues........................ 100.0% 100.0% 100.0% 100.0% 100.0%
Total cost of revenues.................... 14.3 21.2 31.8 14.7 17.2
----- ----- ----- ----- -----
Gross profit......................... 85.7 78.8 68.2 85.3 82.8
Operating expenses:
Research and development................ 33.1 30.3 42.9 39.1 40.5
Selling and marketing................... 52.7 54.9 68.4 68.6 53.7
General and administrative.............. 22.5 20.5 18.4 18.9 21.2
----- ----- ----- ----- -----
Total operating expenses........ 108.3 105.7 129.7 126.6 115.4
----- ----- ----- ----- -----
Operating loss....................... (22.6) (26.9) (61.5) (41.3) (32.6)
Net other income.......................... 1.1 1.2 3.2 3.3 8.3
----- ----- ----- ----- -----
Net loss.................................. (21.5)% (25.7)% (58.3)% (38.0)% (24.3)%
===== ===== ===== ===== =====
</TABLE>
The Company's total net revenues have increased in all quarters presented
as a result of increasing market acceptance of the Company's products,
diversification of the Company's sales channels, including electronic
distribution, expansion of the Company's direct sales efforts, and continued
increases in its installed customer base. In the third quarter of 1996, the
Company released RealPlayer Plus. During the first quarter of 1997, the Company
released a beta version of RealVideo and began recognizing revenues on the
commercial release of RealVideo in the second quarter of 1997. In the third
quarter of 1997, the Company recognized $2,417,000 related to a license
agreement with Microsoft. The Company recognizes revenues from the agreement
over the three-year term of the Company's ongoing obligations. The increases in
total cost of revenues as a percentage of total net revenues in the third and
31
<PAGE> 34
fourth quarters of 1996 were due to a shift in product mix toward RealPlayer
Plus products, a greater percentage of sales through indirect channels and the
utilization of a third-party order fulfillment agency. In the first quarter of
1997, the Company held its first RealMedia conference and recognized revenues
and cost of revenues of $498,000 and $1,000,000, respectively, which increased
total cost of revenues as a percentage of total net revenues.
Operating expenses increased in each quarter reflecting increased spending
on developing, selling, marketing and supporting the Company's products, as well
as building the Company's market presence. Research and development expenses
have increased as a result of continued enhancements to existing products and
development of new products. Selling and marketing expenses increased as a
result of increased sales personnel and commissions. In the first and second
quarters of 1997, the Company increased marketing activities associated with the
release of RealVideo. The trend of increasing general and administrative
expenses is due primarily to additional personnel and facilities costs. In the
third quarter of 1997, general and administrative expenses increased in part due
to costs incurred in responding to the Department of Justice subpoena.
FACTORS AFFECTING OPERATING RESULTS
As a result of the Company's limited operating history and the emerging
nature of the markets in which it competes, the Company is unable to forecast
accurately its revenues. The Company's expense levels are based in part on its
expectations with regard to future revenues. The Company may be unable to adjust
spending in a timely manner to compensate for any unexpected revenue shortfall.
As a result, any significant shortfall in demand for the Company's products and
services relative to the Company's expectations would have an immediate material
adverse effect on the Company's business, financial condition and results of
operations. Further, as a strategic response to changes in the competitive
environment, the Company may from time to time implement pricing, service or
marketing changes that could have a material adverse effect on its business,
financial condition and results of operations. See "Risk
Factors -- Unpredictability of Future Revenues; Potential Fluctuation in
Quarterly Operating Results," "-- Competition; Relationship With Microsoft" and
"Business -- Competition."
The Company expects to experience significant fluctuations in its future
quarterly operating results due to a variety of factors, many of which are
outside the Company's control, including (i) demand for the Company's products
and services, (ii) introduction or enhancement of products and services by the
Company and its competitors, (iii) market acceptance of new products and
services of the Company and its competitors, (iv) price reductions by the
Company or its competitors or changes in how products and services are priced
(such as the Company's recent decision to offer for download free of charge a
version of its Basic Server, which previously sold for $295 to $995), (v) the
mix of products and services sold by the Company and its competitors, (vi) the
mix of distribution channels through which the Company's products are licensed
and sold, (vii) the mix of international and U.S. and Canadian revenues, (viii)
costs of litigation and intellectual property protection, (ix) the growth in the
use of the Internet, (x) the Company's ability to attract, train and retain
qualified personnel, (xi) the amount and timing of operating costs and capital
expenditures related to expansion of the Company's business, operations and
infrastructure, (xii) technical difficulties with respect to the use of the
Company's products, (xiii) governmental regulations and (xiv) general economic
conditions and economic conditions specifically related to the Internet. It is
often difficult to forecast the effect such factors, or any combination thereof,
would have on the Company's results of operations for any given fiscal quarter.
The Company has used, and expects to continue to use, price promotions to
increase trial, purchase and use of its products, as well as to increase the
overall recognition of its brands. The effect of such promotions on revenues in
a particular period may be significant and extremely difficult to forecast.
Based on the foregoing, the Company believes that its quarterly revenues,
expenses and operating results could vary significantly in the future, and that
period-to-period comparisons should not be relied upon as indications of future
performance.
Historically, the Company has received a significant portion of its
revenues from a limited number of sales and license agreements. The Company
believes that a customer's decision to purchase its server
32
<PAGE> 35
products or license its technology is relatively discretionary and, for
large-scale users, generally involves a significant commitment of capital
resources. Therefore, any downturn in the economy or in the business of
potential customers could have a material adverse effect on the Company's
revenues and quarterly results of operations.
The Company generally makes available its software products in "beta" form
to the public prior to finalizing product features, functionality and
operability. This may cause certain customers to delay purchasing decisions
until commercial versions of the products are available, which could have a
material adverse effect on the Company's revenues and quarterly results of
operations.
The Company derives a significant portion of its revenues from the sale of
technical support services and software upgrades to its installed customer base.
There can be no assurance that a sufficient number of the Company's customers
will continue to enter into support and upgrade contracts or will renew existing
support and upgrade contracts, or that revenues therefrom will continue to be
significant. The loss of a material portion of such revenues would likely have a
material adverse effect on the Company's business, financial condition and
results of operations.
Management has observed that revenues from advertising sales have tended to
be higher in the second and fourth quarters, and retail sales have tended to be
highest in the fourth quarter. The Company typically operates with little or no
backlog. As a result, quarterly sales and operating results primarily depend on
the volume and timing of orders received in the quarter, both of which are
difficult to forecast. The Company typically recognizes a substantial portion of
its revenues in the last month of each quarter.
Due to the foregoing factors, it is likely that in some future quarters the
Company's operating results will fall below the expectations of securities
analysts and investors, which would likely have a material adverse affect on the
trading price of the Common Stock.
DONATION OF NET INCOME TO CHARITY
The Company's philosophy includes a commitment to charitable
responsibility. If sustained profitability is achieved, the Company intends to
donate approximately 5% of its annual net income to charitable organizations. As
a result, the Company's net income will be reduced by the amount of these
charitable donations. See "Business -- Position on Charitable Responsibility."
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily through
private sales of preferred stock and common stock and contributions of capital
by the Company's founder. Net proceeds from these sales and contributions
totaled $55,480,000.
Net cash used in operating activities was $1,240,000 and $635,000 in 1995
and 1996, respectively. Cash used in operating activities in 1995 was due
primarily to a net loss of $1,501,000. For 1996, cash used in operating
activities resulted primarily from a net loss of $3,789,000 and an increase of
$2,608,000 in trade accounts receivable, largely offset by increases of
$2,267,000 in deferred revenue, $2,220,000 in accounts payable and $822,000 in
other accrued expenses. Net cash provided by operating activities was
$21,870,000 for the nine months ended September 30, 1997. This was primarily
attributable to a net loss of $8,575,000, an increase of $1,079,000 in trade
accounts receivable, and an increase of $29,406,000 in deferred revenue related
primarily to the Microsoft license agreement.
Net cash used in investing activities of $3,660,000, $4,837,000, and
$22,785,000 for the years ended December 31, 1995 and 1996 and the nine months
ended September 30, 1997, respectively, was primarily related to purchases of
property and equipment and increases in short-term investments.
Cash provided by financing activities of $8,029,000 in 1995 consisted
primarily of $7,405,000 in net proceeds from the issuance of Series B and C
Preferred Stock and a capital contribution by the founder of $372,000. Cash
provided by financing activities of $17,091,000 in 1996 was primarily from net
proceeds
33
<PAGE> 36
of $17,047,000 from the issuance of Series D Preferred Stock. Cash flows
provided by financing activities of $30,980,000 for the nine months ended
September 30, 1997 were primarily from net proceeds of $29,869,000 from the
issuance of Series E Preferred Stock and $991,000 of proceeds from the issuance
of a note payable. In connection with the Series E Preferred Stock financing,
the Company issued a warrant to purchase up to 3,709,305 shares of Series E
Preferred Stock at an exercise price of $13.48 per share.
As of September 30, 1997, the Company had $44,751,000 of cash and cash
equivalents and $22,897,000 in short-term investments. As of September 30, 1997,
the Company's principal commitments consisted of obligations outstanding under
operating leases and a $959,000 note payable. Although the Company has no
material commitments for capital expenditures, management anticipates a
substantial increase in its capital expenditures and lease commitments
consistent with anticipated growth in operations, infrastructure and personnel.
In August 1997, the Department of Justice commenced an investigation into
horizontal merger activities within the streaming media industry. The Department
of Justice served several companies, including the Company and Microsoft, with
subpoenas to produce certain documents. As a result of the investigation, it is
possible that the Department of Justice will require certain actions by the
Company, Microsoft or other companies in the streaming media industry that could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Department of Justice could decide to take
actions that could materially and adversely affect the Company's current
relationship with Microsoft or other companies, affect Microsoft's obligations
with respect to the distribution of the Company's products, result in certain
penalties, require the Company to refund all or a portion of the license fee
paid by Microsoft to the Company, require Microsoft to limit or divest certain
of its acquisitions or investments in the streaming media industry, including
its investment in the Company, and, if Microsoft were forced to rescind its
agreement with the Company, place the Company at a significant competitive
disadvantage within the industry. There can be no assurance that any such
outcome would not have an immediate material adverse effect on the Company's
business, financial condition and results of operations. See "Risk
Factors -- Department of Justice Subpoena."
Since inception, the Company has significantly increased its operating
expenses. The Company currently anticipates that it will continue to experience
significant growth in its operating expenses for the foreseeable future and that
its operating expenses will be a material use of the Company's cash resources.
The Company believes that the net proceeds from the offering, together with its
current cash, cash equivalents and short-term investments, will be sufficient to
meet its anticipated cash needs for working capital and capital expenditures for
at least the next 12 months.
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share
("Statement 128"). Statement 128 establishes standards for the computation,
presentation and disclosure of earnings per share ("EPS"), replacing the
presentation of the currently required Primary EPS with a presentation of Basic
EPS. It also requires dual presentation of Basic EPS and Diluted EPS on the face
of the income statement for entities with complex capital structures. Basic EPS
is based on the weighted average number of common shares outstanding during the
period. Diluted EPS is based on the potential dilution that would occur upon
exercise or conversion of securities into common stock using the treasury stock
method. Statement 128 is effective for financial statements for periods ending
after December 15, 1997, including interim periods; earlier application is not
permitted. When adopted, the Company will be required to restate its EPS data
for all prior periods presented. The Company does not expect the impact of the
adoption of Statement 128 to be material to its reported EPS amounts.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
("Statement 130"). Statement 130 establishes standards for reporting and
disclosure of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements. Statement 130
is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial
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statements for earlier periods provided for comparative purposes is required.
The Company has not determined the manner in which it will present the
information required by Statement 130.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information("Statement 131"). Statement 131 establishes
standards for the way that public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Statement 131 is
effective for financial statements for periods beginning after December 15,
1997. In the initial year of application, comparative information for earlier
years is to be restated. The Company has not determined the manner in which it
will present the information required by Statement 131.
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BUSINESS
THE COMPANY
RealNetworks is a leading provider of branded software products and
services that enable the delivery of streaming media content over the Internet
and intranets. The Company's products and services include its RealSystem, a
streaming media solution that includes RealAudio and RealVideo technology, an
electronic commerce Web site designed to promote the proliferation of streaming
media products and a network of advertising-supported content aggregation Web
sites. As the Web continues to evolve as a mass communications medium, the
Company believes that certain types of content currently delivered through
traditional media, such as radio and television, increasingly will be delivered
over the Internet. The Company believes that streaming media technology is
essential to this transition because it enables a more compelling user
experience, allowing the Internet to compete more effectively with traditional
media for audience share.
From its inception, the Company has strategically chosen to offer its
RealPlayer software to individual users free of charge to promote the widespread
adoption of its client software and to speed the acceptance of Internet
multimedia. The Company believes that more than 18 million copies of its
RealPlayer software have been downloaded and that over 200,000 copies of its
premium client product, RealPlayer Plus, have been sold electronically in the
product's first year of distribution. In addition, the Company believes that
more than 100,000 hours per week of live audio and video content are broadcast
over the Web using RealAudio and RealVideo technology, and that more than
150,000 Web pages use the Company's software. The Company's customers, including
ABC Radio Net, Bloomberg L.P., The Boeing Company, Dow Jones & Company, Inc.
("Dow Jones"), NBC Desktop, The News Corporation Limited ("News Corp."),
Starwave Corporation ("Starwave") and 3Com Corporation ("3Com"), use its
software products and services to deliver a broad range of streaming audio and
video news, sports, entertainment and corporate information over the Internet
and intranets.
INDUSTRY BACKGROUND
The Internet has grown rapidly in recent years, driven by the development
of the Web and graphically intuitive Web browsers, the proliferation of
multimedia PCs, increasingly robust network architectures and the emergence of
compelling Web-based content and commerce applications. The broad acceptance of
the standard Internet Protocol ("IP") has also led to the emergence of intranets
and the development of a wide range of non-PC devices that allow users to access
the Internet and intranets. International Data Corporation ("IDC") estimates
that the number of Web users worldwide will continue to grow rapidly from 28
million in 1996 to 175 million in 2001. In addition, users are spending an
increasing amount of time on the Web. A recent study by the Georgia Institute of
Technology indicates that 51% of total Internet users access the Internet for 10
or more hours per week as of April 1997, compared with 29% as of April 1995.
The development of the Web has contributed to the transition of the
Internet from a text and e-mail-focused data-sharing network to a richer
environment, capable of delivering graphical and interactive content. The Web
has a number of features unavailable in traditional media and commerce channels
that attract online users, content providers, advertisers and merchants. The
relatively low barriers to publishing content on the Web have led to an
explosion of Web-based content and the development of a large and diverse group
of Web-based communication channels. As an interactive, searchable,
user-controlled medium, the Web provides a highly engaging user experience and
allows users to access this broad range of online content on demand and at their
convenience. The narrow-casting capabilities of the Web enable content providers
and advertisers to establish customized, personalized interactions with
consumers.
The development of streaming media technology has further enhanced the
graphical capabilities of the Internet and intranets. Streaming technology
enables the transmission and playback of continuous "streams" of multimedia
content, such as audio and video, and represents a significant advancement over
earlier technologies. Prior to the advent of streaming technology, users could
not initiate the playback of audio or video clips until such content was
downloaded in its entirety, resulting in significant
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waiting times. As a result, live broadcasts of audio and video content over the
Internet or intranets were not possible.
MARKET OPPORTUNITY
The Company believes that the emergence of rich multimedia capabilities,
such as streaming audio and video, has significantly enhanced the effectiveness
of the Web as a global mass communications medium and has accelerated the
adoption of corporate intranets as a means to improve communications within
enterprises. Many businesses and content providers now offer interactive audio,
video and other multimedia content as a means of enriching and differentiating
their Web sites. The Company believes that more than 100,000 hours per week of
live audio and video content are broadcast over the Web using RealAudio and
RealVideo technology, with a substantially greater amount of recorded media
available on demand.
These enhanced multimedia capabilities, combined with the unique
interactive properties of the Internet, are attracting a large and expanding
audience, a growing number of advertisers and an increasing breadth and depth of
content and online commercial applications. The market for Web advertising
revenues is expected to grow from $180 million in 1996 to $2.9 billion in 2000,
according to IDC. Overall usage growth, together with the Internet's unique
interactive properties, has also led to a rapidly evolving online commerce
opportunity. IDC estimates that worldwide revenues generated by Web-based
commerce will grow from $2.6 billion in 1996 to $223 billion in 2001. As a
result of the growth in business opportunities on the Internet, the market for
software solutions that focus on the Internet and intranets is also growing
rapidly. IDC estimates that Internet-focused software revenues will grow from
$359 million in 1996 to $4.3 billion in 2000.
As the Web continues to evolve as a mass communications medium, the Company
believes that certain types of content currently delivered through traditional
media, such as radio and television, increasingly will be delivered over the
Internet. The Company believes that streaming media technology is essential to
this evolution because it provides a more compelling user experience, allowing
the Internet to compete more effectively with traditional media for audience
share.
The Company believes that to successfully capitalize on this opportunity,
streaming media providers must address the following challenges:
DELIVER COMPELLING STREAMING MEDIA CONTENT IN BANDWIDTH CONSTRAINED
ENVIRONMENTS. The Internet was designed to transmit discrete packets of data and
is not inherently well suited to the delivery of continuous streams of
multimedia data without additional software. In addition, bandwidth is limited
in Internet and intranet environments, posing significant technological
challenges for delivery of high-quality streaming audio and video content.
ENABLE BROAD-BASED ACCESS TO STREAMING MEDIA TECHNOLOGY. Online content
providers, advertisers and merchants must make a significant investment to
create and deliver streaming media content and need to reach a sufficiently
large audience to generate an adequate return on such investment. As a result,
content providers must consider the popularity and quality of a particular
streaming media solution before committing resources to delivering content using
that solution.
DRIVE CONSUMER USAGE. The Company believes that consumer interest in
streaming media content is driven in large part by the ability to locate and
experience such content easily. As a result, the Company believes that the
development of well-marketed, compelling Web sites that aggregate streaming
media content is central to the continued growth of multimedia content on the
Web.
The Company believes that a substantial opportunity exists to provide
software solutions and content aggregation and delivery services that address
these challenges and support the development of large and growing advertising
and electronic commerce markets on the Web.
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THE REALNETWORKS SOLUTION
RealNetworks enables and promotes the transmission of real-time streaming
media content over the Internet and intranets. The Company provides branded
streaming media software products and services, including its RealSystem, a
streaming media solution that includes RealAudio and RealVideo technology, an
electronic commerce Web site designed to promote the proliferation of streaming
media products and a network of advertising-supported content aggregation Web
sites. Each of the Company's products and services has been designed to address
the technological and market development challenges that confront streaming
media content providers.
STREAMING MEDIA TECHNOLOGY. RealNetworks has been a pioneer in the
development of streaming media technology and continues to offer leading
streaming media software solutions. The Company's products use advanced
compression and error-correction technologies to deliver acceptable performance
even in bandwidth-constrained environments. The Company has won numerous awards
for its technology, including PC Magazine Editor's Choice award for streaming
video in October 1997. The Company's recent "beta" release of its RealSystem
Version 5.0 offers software products with streaming animation capabilities and
improved audio and video quality, including full-screen video at higher
bandwidths. RealSystem Version 5.0 also enables incorporation of seamless
in-stream advertising into existing broadcasts or on-demand clips. The Company
believes in-stream advertising offers increased revenue opportunities for its
RealSystem Server customers. In addition, RealSystem Version 5.0 enables
password-protected access to content, allowing content providers to incorporate
subscription-based or "pay-per-view" streaming media content access over the
Internet. The Company's software runs on a broad range of operating systems and
hardware platforms, enabling content providers to reach a broad audience and
enterprises to deliver intranet content in heterogeneous computing environments.
REALPLAYER UBIQUITY AND BRAND STRENGTH. From its inception, the Company has
strategically chosen to offer its RealPlayer software to individual users free
of charge to promote the widespread adoption of its client software and speed
the acceptance of Internet multimedia. The Company estimates that more than 18
million copies of its RealPlayer software have been downloaded and that more
than 150,000 Web pages use the Company's software. In addition, over 1,200
third-party developers have joined the Company's Real Developer Program. To
continue the broad market adoption of its server products, the Company now
offers its Basic Server free of charge. As a result of these activities and the
Company's aggressive promotional programs, the Company believes that the "Real"
brand has become one of the most widely recognized brands on the Internet.
ELECTRONIC COMMERCE DISTRIBUTION CHANNEL. The Company has pursued an
electronic commerce distribution strategy designed to further accelerate product
adoption and drive upgrade and cross-selling opportunities among its existing
installed user base. The Company's online distribution efforts have resulted in
electronic sales of over 200,000 copies of the Company's RealPlayer Plus in its
first year of distribution and the collection of a database of information of
over 7 million names. Recently, the Company opened its RealStore Web site, an
online store for the sale of the Company's products, third-party multimedia
tools and utilities, and intranet-based training products. The Company believes
that it will be able to continue to facilitate the adoption and growth of
streaming media content by providing a concentrated marketplace and a low-cost
distribution mechanism for emerging streaming media tools and their developers.
STREAMING MEDIA CONTENT AND AGGREGATION. The Company's
advertising-supported Web sites, including Timecast, LiveConcerts.com, and
Film.com, aggregate, organize and provide streaming media programming in order
to build consumer awareness and Web site traffic for streaming media content.
According to I/Pro, Inc., the Company's network of Web sites attracted on
average over 380,000 visitors and generated over 2 million page impressions per
day. The Company's Daily Briefing and Destination Button services provide
one-click access to a range of third-party programming. In addition to
generating advertising revenues, the Company believes these sites and services
stimulate demand for and creation of streaming media content using the Company's
RealSystem.
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STRATEGY
The Company's objective is to be the leading streaming media company,
providing software and services that enable the delivery of a broad range of
multimedia content over the Internet and intranets, thereby facilitating the
evolution of the Internet into a mass communications and commerce medium. To
achieve this objective, the Company's strategy includes the following key
elements:
EXTEND TECHNOLOGY LEADERSHIP. The Company has established a reputation as
a leader in streaming media technology and intends to continue to maintain its
reputation for quality and innovation by expanding the features and breadth of
its audio and video product offerings. The Company recently introduced streaming
animation, in-stream advertising and password-protected access to content as
part of the "beta" release of its RealSystem Version 5.0. The Company believes
that the fundamental architecture of its products can also be expanded to
support synchronized streaming of a wide variety of other time-based data types,
such as MIDI, images and multimedia presentations. As part of this strategy, the
Company has devoted and will continue to commit significant resources to the
development of technologies that increase the scaleability of streaming media
solutions.
MAXIMIZE MARKET PENETRATION AND BRAND NAME RECOGNITION. The Company
believes that it is a recognized leader in the streaming media technology and
that its "Real" brand is one of the most widely recognized brand names on the
Internet. Since its inception, the Company has sought to achieve rapid and broad
adoption of its technologies and strong brand recognition. This strategy has
been pursued through various means, such as offering the Company's RealPlayer to
individual users free of charge over the Internet, bundling the Company's
products with those of other major vendors and using multiple distribution
channels, including both direct sales and indirect OEM and retail relationships.
The Company has recently intensified its efforts to proliferate its streaming
technology by offering its Basic Server free of charge and entering into a
licensing and distribution agreement with Microsoft. The Company also intends to
continue to promote the adoption of industry standards that are either based on
or compatible with its technologies. For example, the Company is one of the
principal co-authors of RTSP, a proposed industry standard for the control and
delivery of streaming media.
LEVERAGE MARKET POSITION TO EXPAND BUSINESS MODEL. Management believes
that the Company's technology leadership, market position and brand name are
significant assets that the Company can leverage to maintain and increase its
market share and diversify its revenue base. The Company intends to leverage
these assets as follows:
- GROW STREAMING MEDIA SOFTWARE BUSINESS. The Company intends to
capitalize on the growth in demand for streaming media software by
continuing to develop, market and support industry-leading products and
services. The Company also plans to strengthen its marketing, sales and
customer support efforts as the size of its market opportunity and
customer base increases.
- EXPAND INTERNET COMMERCE BUSINESS. The Company's Web sites provide
product information and fulfillment resources for streaming media content
users and developers. The Company recently opened its RealStore Web site,
an online store for the sale of the Company's products, third-party
streaming media tools and utilities, and intranet-based training
products. The Company believes that it will be able to continue to
facilitate the adoption and growth of streaming media content by
providing a concentrated marketplace and a low-cost distribution
mechanism for emerging streaming media tools and their developers.
- OFFER LEADING CONTENT AGGREGATION SITES FOR STREAMING MEDIA. The Company
has developed a network of Web sites that aggregate links to third-party
streaming media programming. The Company plans to continue building Web
site traffic from these activities to increase Web site advertising
revenues, increase visibility and sales of the Company's products,
promote the use of streaming media content on the Internet or intranets
and promote the Company's Internet commerce platform.
DEVELOP AND MARKET STREAMING MEDIA SOLUTIONS FOR A VARIETY OF PLATFORMS AND
BANDWIDTHS. The Company's rapid growth is attributable in part to the wide
acceptance of the
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streaming media solutions it has developed for PCs networked in low-bandwidth
environments. However, significant efforts are underway to make the Internet
available on a wider range of platforms, including non-PC Internet appliances,
and over higher-speed connections, including cable modems. Accordingly, the
Company has designed its solutions to add value in a range of bandwidth
environments and to be flexible enough to port easily to new platforms. As a
result, management believes that the Company is positioned to capitalize on
possibly significant platform and bandwidth changes.
STRENGTHEN STRATEGIC RELATIONSHIPS. The Company has established strategic
relationships with a variety of industry participants, including software and
hardware vendors, entertainment companies, content publishers and broadcast
media companies. The Company's relationship with Microsoft enables wider
distribution of the Company's products and promotes interoperability among
numerous streaming media technologies. In addition to its relationship with
Microsoft, the Company has formed strategic distribution relationships with
several other companies, including Starlight Networks Incorporated and
Macromedia, has formed a joint venture in Japan with NTT PC Communications, Inc.
("NTT"), Kokusai Denshin Denwa Co., Ltd. ("KDD") and Trans Cosmos, Inc. ("Trans
Cosmos") and has entered into a pilot program with MCI Communications
Corporation ("MCI") to distribute the RealNetwork broadcast service. The Company
pursues strategic relationships for a variety of purposes, such as maximizing
rapid penetration, validation and adoption of its technologies; aiding the
development of compelling content to build consumer demand for streaming media
over the Internet; and expanding the range of commercial activities based on its
technology and brand name. The Company has also collaborated with other industry
leaders for the purpose of developing software protocols for proposed adoption
as industry standards. Although the Company has not engaged in significant joint
technology development relationships to date, it anticipates that it may form
third-party development relationships in the future as it seeks to expand the
fundamental architecture of its technology and influence the direction of
technological developments in the industry.
PRODUCTS AND SERVICES
The Company develops and markets software products and services that enable
the delivery of streaming audio and video content over the Internet and
intranets. The Company also conducts electronic commerce and sells advertising
through its Web sites, provides audio and video broadcast services to third
parties, and provides various other services designed to promote widespread
usage of the Company's technology.
MEDIA SYSTEM
The Company's streaming media system allows content providers to encode
content such as audio, video or other multimedia programming into discrete data
packets that can be broadcast to large numbers of simultaneous users.
BASIC SERVER. The Company offers a Basic Server free of charge from its Web
sites. This product enables content providers to stream both audio and video to
as many as 60 simultaneous users.
BASIC SERVER PLUS. The Basic Server Plus is an enhanced server that can be
downloaded from the Company's Web sites for $695. In addition to the Basic
Server functions, Basic Server Plus supports streaming animation and enhanced
administration capabilities and includes RealPublisher, technical support and
upgrades.
REALSERVER INTERNET SOLUTION. The Internet Solution is designed for use by
commercial Web sites, including media content providers that distribute audio,
video or animation content over the Internet to a broad base of consumers. The
Internet Solution includes the RealServer, which offers the Basic Server Plus
functions as well as advanced administrative features, the ability to reach a
larger audience and in-stream advertising insertion and rotation. The Internet
Solution also includes the RealPublisher and the RealEncoder. Internet Solution
licenses start at $4,995 and are priced based on the number of streams licensed.
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REALSERVER INTRANET SOLUTION. The Intranet Solution is a RealServer
designed specifically for use in intranet applications. The Intranet Solution
includes the RealPublisher, the RealEncoder and a site license for the
RealPlayer. A 10-user Intranet Solution is available free of charge from the
Company's Web sites. Larger system licenses start at $6,995 and are priced
according to the number of licensed users.
COMMERCE SOLUTION. The Commerce Solution is an integrated system that can
be used with the Internet or Intranet Solution to provide secure, selective
access to streaming media content. The Commerce Solution is comprised of the
Commerce RealServer, which includes all the functions of the RealServer as well
as user and workstation authentication, encrypted challenge/response systems and
broad database and Web-based commerce systems compatibility. Commerce Solution
licenses are priced based on the number of streams licensed.
REALPUBLISHER. The RealPublisher is a software tool that enables users to
create and publish RealAudio and RealVideo content-enabled Web pages without
having to program in HTML. The RealPublisher can be downloaded from the
Company's Web sites for $49.95.
REALENCODERS. The Company's RealEncoders enable content providers to
compress live or recorded audio and video programming into the Company's file
format. This highly compressed file format increases the efficiency of
limited-bandwidth transmissions and is readable by the Company's players. The
RealEncoder can be downloaded free of charge from the Company's Web site.
REALNETWORK BROADCAST SERVICE. The Company operates the RealNetwork
broadcast service, which uses the Company's splitter technology to broadcast
content to thousands of simultaneous users through IP multicasting or
traditional unicasting. In August 1997, the Company and MCI announced that they
had commenced a pilot program in which the Company's technology will be
incorporated into MCI's Internet backbone. The RealNetwork broadcast service
enables broadcasters to reach up to 50,000 users simultaneously by combining
MCI's nationwide network of datalines and computer centers with the Company's
streaming media and splitter technologies. Current content providers using the
RealNetwork broadcast service include ABC News, Inc., Atlantic Recording
Corporation, ESPN, Inc., and Major League Baseball teams, including the Los
Angeles Dodgers and the Seattle Mariners. The Company often uses the RealNetwork
broadcast service to host its own content. In select cases, the Company has and
will continue to enter into relationships with content providers in which the
providers' content is hosted on the RealNetwork broadcast service at the
Company's expense in exchange for a share of the advertising or other revenue
generated.
In May 1997, the Company entered into a joint venture with NTT, KDD and
Trans Cosmos in Japan to establish J-Stream Co. Inc. ("J-Stream"), which, like
the Company's RealNetwork broadcast service, streams audio and video content to
users through IP multicasting or traditional unicasting. The Company supplies
its RealAudio and RealVideo system and technical support for the operation of
the J-Stream broadcast network. The Company holds a 24% interest in J-Stream.
See "Certain Transactions."
CONSULTING. The Company provides a range of consulting services that
principally relate to the creation and maintenance of streaming media networks
based on the Company's technology. Commonly provided services include sound
editing, video production assistance and network design.
CONSUMER PRODUCTS AND ELECTRONIC COMMERCE
The Company's player enables a user to listen to or view content from Web
sites that use the Company's server products. The player decompresses and
decodes audio, video or animation packets transmitted by the server, reassembles
them in the correct order, identifies and requests retransmission of any missing
data packets, and then plays back the reassembled audio, video or animation
content for the user in real-time. The players can be easily installed and used
by nontechnical computer users, even using dial-up modems over standard
voice-grade telephone lines.
REALPLAYER. RealPlayer, the Company's standard player, can be downloaded
free of charge from the Company's Web site and currently is distributed by a
number of third parties in combination with their own products. RealPlayer
offers basic functions such as play, stop, fast-forward, rewind and volume
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adjustment, as well as the ability to program six Destination Buttons, which
provide one-click access to preprogrammed audio, video or animation content.
REALPLAYER PLUS. The RealPlayer Plus is an enhanced player that can be
downloaded from the Company's Web site or purchased in a retail store for a
suggested price of $29.95. RealPlayer Plus not only offers basic RealPlayer
functions, but also features a scan function and 40 programmable buttons that
allow users to preset favorite content. Customers who purchase a RealPlayer Plus
also have access to special content available only to RealPlayer Plus users.
ELECTRONIC COMMERCE AND REALSTORE. Since August 1996, the Company has sold
its products electronically. On September 8, 1997, it opened its RealStore Web
site, an online store for the sale of the Company's products, third-party
streaming media tools and utilities, and intranet-based training products.
Through this distribution channel, the Company is able to offer a broad
selection of products with little inventory risk or merchandising expense.
MEDIA PUBLISHING PRODUCTS AND SERVICES
The Company's network of Web sites aggregates, organizes and provides
streaming media programming through a variety of navigational and theme-oriented
content sites. These sites derive revenues from the sale of advertising to third
parties such as General Motors Corporation, International Business Machines
Corporation, AT&T Corp. and Microsoft. The Company has been instrumental in
pioneering new forms of Internet advertising, including in-stream advertising,
in which streamed audio and video advertisements are inserted into selected
programming.
In addition to its main Web site, the Company's network of Web sites
includes:
Timecast, a guide to RealAudio and RealVideo content that offers
programming information from and links to over 2,500 Web sites, including
over 500 radio and television stations;
LiveConcerts.com, which, in cooperation with House of Blues, offers
live streamed music concerts using the Company's products as well as access
to services, including up-to-date concert schedules;
Film.com, which the Company began hosting in September 1997, provides
in-depth information about, and streaming media clips of, movies, including
reviews and previews; and
Daily Briefing, which allows customers to design their own custom
streaming media newscasts from over 35 short programs in the areas of news,
sports, entertainment, weather and business/technology, and to receive the
custom newscasts daily. Daily Briefing providers include NBC News, The
Weather Channel, CBS/SportsLine and Warner Bros. Inc.
TECHNOLOGY
The Company's client/server software system is designed to optimize the
delivery of streaming media over the Internet, intranets or any IP-based
network. The system is based on open industry standards and works with a broad
range of operating systems, hardware platforms and media types.
CODECS
The Company's system 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 broadcast (or "stream") the
packets to the client (or "player"). The player then reassembles the packets in
the correct order and plays back the streaming media content in real-time. The
compression process enables the data to be streamed to the player even in very
low bandwidth (14.4 kbps) or congested network environments by reducing the
amount of data to be streamed.
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TRANSMISSION TECHNOLOGY AND PROTOCOLS
Neither of the two basic Internet transport protocols, User Datagram
Protocol ("UDP") and Transport Control Protocol ("TCP"), was originally designed
to handle the transmission of real-time content. UDP is able to transmit data
packets efficiently and without delays, but is not generally robust enough to
ensure delivery of all data packets. TCP generates robust and reliable
transmissions, but is not designed for efficient and continuous real-time
delivery of content. Higher level Internet protocols, such as File Transfer
Protocol ("FTP") and Hypertext Transfer Protocol ("HTTP"), were designed
originally for one-way continuous transmissions and as such do not efficiently
allow the player to communicate back to the server to activate functions such as
fast forward, pause and rewind or to select a particular portion of a clip for
playing.
To address the inherent limitations of the Internet with respect to
multimedia delivery, the Company has developed its own client/server software
architecture based on advanced transmission technologies and protocols. Key
elements of the Company's technology solution include:
- BUFFERING: Because the streaming of continuous, time-based content such
as audio or video must occur in real-time and with minimal transmission
loss, the Company's technology incorporates a time delay (or "buffering")
feature that allows the player extra time to accumulate data packets and,
if any are missing, request retransmission of particular packets. As a
result, transmission and playback quality can be optimized, even in highly
congested transmission environments.
- BIDIRECTIONAL COMMUNICATION: The Company's server and player communicate
during transmission regarding the bandwidth and quality of the user's
connection to optimize the transmission by using the system's bandwidth
negotiation and dynamic connection management capabilities. For example,
the system is able to detect the available bandwidth and the extent of
packet loss and performance degradation.
- ERROR-MITIGATION: To the extent that buffering and packet retransmission
efforts are insufficient to maintain acceptable quality of user
experience, the Company's system draws on several techniques designed to
mitigate performance degradation, including interpolation methods that
"reconstruct" lost data packets based on approximations regarding adjacent
or closely related data packets, UDP-based retransmission of lost packets
and forward error correction.
- SMART NETWORKING: This feature allows a server to stream content to the
player via unicasting or IP multicasting and automatically select the
appropriate transmission protocol (UDP, TCP or HTTP) depending on current
network conditions and the presence of firewalls or proxies.
- VIDEO-OPTIMIZED TRANSMISSION: Because video transmissions are more
data-intensive than audio transmissions, the encoding of video streams for
low bandwidth requires a higher compression ratio. In addition to standard
compression techniques, the Company uses a technique known as interframe
compression, which reduces unnecessary repetition of redundant background
data in neighboring video frames, thereby reducing the number of data
packets being transmitted. The system also incorporates "stream thinning"
technology that responds to episodes of performance degradation by
dynamically reducing the amount of video content being streamed to the
user, thereby preserving bandwidth for audio packets to maintain the
continuity of the audio stream, which is often more central to the user
experience than video.
In addition to its core client/server technology, the Company has adopted
RTSP, a proposed protocol for standardizing the control and delivery of
streaming media over the Internet. RTSP is a unified standard for a broad range
of media data types and is intended to promote a greater level of
interoperability among various streaming media solutions. RTSP is built on top
of a number of other Internet standard protocols such as HTTP, TCP/IP and Real
Transport Protocol, and is complementary with ASF, a file format for streaming
media that does not specify a method of client-server interaction. RTSP provides
the client-server specification necessary to stream ASF files (and many other
file types)
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on the Internet. RTSP was submitted to the IETF in October 1996 with the support
of over 40 companies. See "-- Microsoft Relationship" and "Risk
Factors -- Impact of Evolving Standards."
NETWORKED MULTIMEDIA FOR LARGE-SCALE DELIVERY
The Company's splitter technology allows broadcasters to transmit large
numbers of simultaneous streams. Traditionally, a standalone server sends a
separate signal to each individual user, which is an inefficient use of network
bandwidth because the same signal is often being distributed through many of the
same links on the network.
The Company's splitter technology enables one "central" server to broadcast
a signal to a set of servers distributed around a network, which servers then
transmit the signal to the end user, thereby minimizing the use of the network
backbone and improving signal quality. The Company uses this technology in its
RealNetwork broadcasting service, as well as in its J-Stream joint venture in
Japan. See "-- Strategy -- Strengthen Strategic Relationships" and "-- Products
and Services -- Media System."
RESEARCH AND DEVELOPMENT
The Company devotes a substantial portion of its resources to developing
new products and product features, expanding and improving its fundamental
streaming technology, and strengthening its technological expertise. During the
fiscal year ended December 31, 1996, and the nine months ended September 30,
1997, the Company expended approximately 34% and 41%, respectively, of its total
net revenues on research and development activities. The Company intends to
continue to devote substantial resources toward research and development for the
next several years. At September 30, 1997, the Company had 93 employees, or
approximately 31% of its workforce, engaged in research and development
activities. The Company must hire additional skilled software engineers to
further its research and development efforts. The Company's business, financial
condition and results of operations could be adversely affected if it is not
able to hire and retain the required number of engineers.
SALES, MARKETING AND DISTRIBUTION
The Company believes that any individual or company that desires to
transmit or receive streaming media content over the Internet or intranets is a
potential Company customer. To reach as many customer segments as possible, the
Company markets its products and services through several direct and indirect
distribution channels, including over the Internet, through a direct sales
force, through OEMs and VARs, and internationally through distributors and the
J-Stream joint venture. As of September 30, 1997, the Company employed 103 sales
and marketing personnel worldwide.
ELECTRONIC COMMERCE. The Company's Consumer and E-Commerce Divisions are
responsible for electronic commerce sales and marketing of the Company's
products as well as third-party multimedia development products sold on the
Company's RealStore Web site. Substantially all of the Company's products may be
downloaded directly from the Company's Web sites, with over 18 million product
downloads to date. The Company sells third-party products on its RealStore Web
site on a consignment basis and, accordingly, incurs no inventory risk with
respect to such products. Electronic distribution provides the Company with a
low-cost, globally accessible, 24-hour sales channel.
DIRECT SALES FORCE. The Company's direct sales force markets the Company's
products and services primarily to corporate customers worldwide. The direct
sales force is comprised of the Major Accounts, National Accounts and Telesales
groups of the Company's Media Systems Division. The Major Accounts and National
Accounts groups market and sell to corporate customers primarily interested in
server products for commercial Internet Web sites or intranets. The Telesales
group develops and pursues leads generated from inquiries on the Company's Web
sites and from downloads of its EasyStart Server.
OEMS AND VARS. The Strategic Channels, OEM and Consulting groups of the
Company's Media Systems Division market and establish indirect distribution
agreements. The Company has entered into
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various distribution relationships with third parties pursuant to which the
Company's products are incorporated into, or bundled with, the third party's
products for delivery by the third party to end users. Such third parties
include Creative Labs, Inc., Apple Computer, Inc., Network Computer, Inc., WebTV
Networks, Inc. and Microsoft.
ADVERTISING SALES. The Company's Advertising Sales group markets and sells
advertising on the Company's Web sites and within media streams that the Company
hosts on behalf of its corporate customers.
INTERNATIONAL SALES. The Company has three international subsidiaries that
market and sell the Company's products outside the U.S. and Canada. The Company
distributes its products internationally through a direct sales force and
distribution arrangements.
MARKETING PROGRAMS. The Company participates in trade shows, conferences
and seminars, provides product information through the Company's Web sites,
promotes and co-promotes special events, places advertising for the Company's
products and services in print and electronic media, and sponsors special
programs for software developers, including its own conference. The Company's
marketing programs are aimed at informing distributors and end users about the
capabilities and benefits of the Company's products and services, increasing
brand name awareness, stimulating demand across all market segments and
encouraging independent software developers to develop products and applications
that are compatible with the Company's products and technology.
MICROSOFT RELATIONSHIP
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, including its basic RealPlayer and
substantial elements of its EasyStart Server (currently known as the Basic
Server), and related Company trademarks. Under the agreement, Microsoft may
sublicense its rights to the RealAudio/RealVideo Version 4.0 technology to third
parties under certain circumstances. The agreement also provides for substantial
refunds to Microsoft under prescribed circumstances that are solely within the
Company's control. The amount of these refunds diminishes over time. The Company
may not assign its obligations under the agreement without Microsoft's consent.
Microsoft is obligated to distribute the Company's RealPlayer Version 4.0 for a
defined term as long as the Company's player supports certain Microsoft
architectures. The Company also agreed to work with Microsoft and several other
companies to author and promote ASF as a standard file format for streaming
media. The agreement also requires the Company to provide Microsoft with
engineering consultation services, certain error corrections and certain
technical support over a defined term.
In connection with the agreement, Microsoft also purchased a minority
interest in the Company. Microsoft currently offers its own streaming media
product, NetShow. In addition, Microsoft recently acquired VXtreme, a direct
competitor of the Company in the market for streaming media software. Microsoft
also owns a minority interest in VDOnet, a direct competitor of the Company in
the market for streaming video software. As a result of Microsoft's agreement
with the Company, its acquisition of VXtreme, and its investment in VDOnet,
Microsoft will be able to augment substantially the functionality of NetShow,
its streaming media product, which could have a material adverse effect on the
competitiveness of the Company's products. See "Risk Factors -- Department of
Justice Subpoena."
Microsoft currently competes with the Company in the market for streaming
media server and player software. The Company believes that Microsoft will
compete more directly with the Company in the future. The Company also believes
that Microsoft's commitment to and presence in the streaming media industry will
dramatically increase competitive pressure in the overall market for streaming
media software, leading to, among other things, increased pricing pressure and
longer sales cycles. Such pressures may result in further price reductions in
the Company's products and may also materially reduce the Company's market
share. The Company believes that Microsoft will incorporate streaming media
technology in its Web browser software and certain of its server software
offerings, possibly at no
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additional cost to the user. In addition, notwithstanding the Company's
cooperation with Microsoft regarding ASF, Microsoft may promote technologies and
standards not compatible with the Company's technology. Microsoft has a longer
operating history, a larger installed base of customers and dramatically greater
financial, distribution, marketing and technical resources than the Company. As
a result, there can be no assurance that the Company will be able to compete
effectively with Microsoft now or in the future, or that the Company's business,
financial condition and results of operations will not be materially adversely
affected by increased competition in the streaming media industry. In addition,
if considerable industry consolidation occurs, there can be no assurance that
the Company will be able to continue to compete effectively.
CUSTOMERS
Since the Company's inception, the following companies have paid $45,000 or
more to the Company for the purchase of products or services or the license of
technology: ABC Radio Net, Apple Computer, Inc., Bandai Digital Entertainment
Corporation, Bloomberg L.P., Boeing-Inform, Cisco Systems, Inc., Creative Labs,
Inc., Dow Jones, Forefront Graphics Corporation, Internet Canada Corporation,
Merrill Lynch & Co. Inc, Microsoft, Multiple Zones International, Inc., Muzak
Limited Partners, Navio Communications, Inc., NBC Desktop, NetRadio Network,
Network Computer Inc., News Corp., Prodigy Inc., Starwave, Tele2 Danmark A/S,
Teledanmark In, Telia AB, 3Com, United Technologies Corporation, WavePhore, Inc.
and WebTV Networks, Inc. The Company's customers consist primarily of resellers
and users located in the U.S., Canada and various foreign countries. Sales to
customers outside the U.S. and Canada, primarily Asia and Europe, were
approximately 15%, 19% and 24% of total net revenues in the years ended December
31, 1995 and 1996 and the nine months ended September 30, 1997, respectively.
Software license fees under a license agreement with Microsoft accounted for
approximately 11% of total net revenues for the nine months ended September 30,
1997.
CUSTOMER SUPPORT
The Company's customers have a choice of support options depending on the
level of service desired. The Company maintains a technical support hotline to
answer inquiries and provides an online database of technical information. The
Company's support staff also responds to e-mail inquiries. The Company tracks
all support requests through a series of customer databases, including current
status reports and historical customer interaction logs. The Company uses
customer feedback as a source of ideas for product improvements and
enhancements. As of September 30, 1997, the Company employed 8 technical
representatives to respond to customer requests for support.
COMPETITION
The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. The Company
expects that competition will intensify in the future. Many of the Company's
current and potential competitors have longer operating histories, greater name
recognition and significantly greater financial, technical and marketing
resources than the Company. The Company's principal competitors in the
development and distribution of audio and video streaming solutions include
Microsoft, VXtreme, VDOnet, Xing, Precept, Cubic, Motorola, Vivo, Vosaic and
Oracle. The Company's RealSystem also competes to a lesser degree with
non-streaming audio and video delivery technologies such as AVI and Quicktime,
and indirectly with delivery systems for multimedia content other than audio and
video, such as Flash by Macromedia and Enliven by Narrative. Competitive factors
in this market include the quality and reliability of software; features for
creating, editing and adapting content; ease of use and interactive user
features; scaleability and cost per user; and compatibility with the user's
existing network components and software systems. To expand its user base and
further enhance the user experience, the Company must continue to innovate and
improve the performance of its RealSystem. The Company anticipates that
consolidation will continue in the streaming media industry and related
industries such as computer software, media and communications. Consequently,
competitors may be acquired by, receive investments from or enter into other
commercial
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relationships with, larger, well-established and well-financed companies. There
can be no assurance that the Company can establish or sustain a leadership
position in this market segment. See "-- Microsoft Relationship."
The Company is committed to the continued market penetration of its brand,
products and services, which, as a strategic response to changes in the
competitive environment, may require pricing, licensing, service or marketing
changes intended to extend its current brand and technology franchise. For
example, the Company recently made its Basic Server, which had previously sold
for $295 to $995, available for download free of charge. Continued price
concessions or the emergence of other pricing or distribution strategies by
competitors may have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company currently derives significant revenues from the electronic
distribution of certain of its products. The Company recently opened its
RealStore Web site, an online store for the sale of the Company's products,
third-party streaming media tools and utilities, and intranet-based training
products. The Company competes with a variety of Web sites, such as
Buydirect.Com and Sofware.Net, which also offer software products for download.
To compete successfully in the electronic commerce market, the Company must
attract sufficient commercial traffic to its RealStore Web site by offering
high-quality merchandise in a compelling, easy-to-purchase format. There can be
no assurance that the Company will be able to compete successfully in this
market, and any failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations.
In the Internet advertising segment, the Company competes for Internet
advertising revenues with a wide variety of Web sites and Internet service
providers. While Internet advertising revenues across the industry continue to
grow, the number of Web sites competing for such revenue is also growing
rapidly. The Company's advertising sales force and infrastructure are still in
early stages of development relative to the Company's competitors. There can be
no assurance that advertisers will place advertising with the Company or that
revenues derived from such advertising will be material. In addition, if the
Company loses advertising customers, fails to attract new customers, is forced
to reduce advertising rates or otherwise modify its rate structure to retain or
attract customers, or loses Web site traffic, the Company's business, financial
condition and results of operations may be materially adversely affected.
POSITION ON CHARITABLE RESPONSIBILITY
Immediately subsequent to the offering, Mr. Glaser will contribute 5%,
approximately 700,000 shares, of his Common Stock to charitable organizations.
In addition, Mr. Jacobsen intends to contribute approximately 60,000 shares of
his Common Stock to charitable organizations. The Company is strongly committed
to charitable responsibility, as evidenced by its donations of software to
charitable organizations. If sustained profitability is achieved, the Company
intends to donate approximately 5% of its annual net income to charitable
organizations. The Company hopes to encourage employee giving by using a portion
of its intended contribution to match charitable donations made by employees.
See "Risk Factors -- Donation of Net Income to Charity."
GOVERNMENTAL REGULATION
The Company currently is not 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 the Company's products. Due to the increasing popularity and use of the
Internet, it is possible that a number of laws and regulations may be adopted in
the U.S. and abroad with particular applicability to the Internet. It is
possible that governments will enact legislation that may be applicable to the
Company in areas such as content, network security, encryption and the use of
key escrow, data and privacy protection, electronic authentication or "digital"
signatures, illegal and harmful content, access charges and retransmission
activities. Moreover, the applicability to the Internet of existing laws
governing issues such as property ownership, content, taxation, defamation and
personal privacy is uncertain. The majority of
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such laws were adopted before the widespread use and commercialization of the
Internet and, as a result, do not contemplate or address the unique issues of
the Internet and related technologies. Any such export or import restrictions,
new legislation or regulation or governmental enforcement of existing
regulations may limit the growth of the Internet, increase the Company's cost of
doing business or increase the Company's legal exposure, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
By distributing content over the Internet, the Company faces potential
liability for claims based on the nature and content of the materials that it
distributes, including claims for defamation, negligence or copyright, patent or
trademark infringement, which claims have been brought, and sometimes
successfully litigated, against Internet companies. The Company's general
liability insurance may not cover potential claims of this type or may not be
adequate to indemnify the Company for any liability that may be imposed. Any
liability not covered by insurance or in excess of insurance coverage could have
a material adverse effect on the Company's business, financial condition and
results of operations. Although those sections of the CDA that, among other
things, proposed to impose criminal penalties on anyone distributing "indecent"
material to minors over the Internet, were held to be unconstitutional by the
U.S. Supreme Court, there can be no assurance that similar laws will not be
proposed and adopted. While the Company does not currently distribute the types
of materials that the CDA may have deemed illegal, the nature of such similar
legislation and the manner in which it may be interpreted and enforced cannot be
fully determined and, therefore, legislation similar to the CDA could subject
the Company to potential liability, which in turn could have an adverse effect
on the Company's business, financial condition and results of operations. Such
laws could also damage the growth of the Internet generally and decrease the
demand for the Company's products and services, which could adversely affect the
Company's business, financial condition and results of operations.
INTELLECTUAL PROPERTY
The Company's success depends in part on its ability to protect its
proprietary software and other intellectual property. To protect its proprietary
rights, the Company relies generally on patent, copyright, trademark and trade
secret laws, confidentiality agreements with employees and third parties, and
license agreements with consultants, vendors and customers, although the Company
has not signed such agreements in every case. Despite such protections, a third
party could, without authorization, copy or otherwise obtain and use the
Company's products or technology, or develop similar technology independently.
There can be no assurance that the Company's agreements with employees,
consultants and others who participate in product development activities will
not be breached, that the Company will have adequate remedies for any breach, or
that the Company's trade secrets will not otherwise become known or
independently developed by competitors.
The Company currently has two patents pending in the U.S. relating to its
product architecture and technology and holds one patent entitled "Method and
Apparatus for Recommending Selections Based on Preferences in a Multi-User
System." There can be no assurance that any pending or future patent
applications will be granted, that any existing or future patent will not be
challenged, invalidated or circumvented, or that the rights granted under any
patent that has issued or may issue will provide competitive advantages to the
Company. Many of the Company's current and potential competitors dedicate
substantially greater resources to protection and enforcement of intellectual
property rights, especially patents. If a blocking patent has issued or issues
in the future, the Company would need to either obtain a license or design
around the patent. There can be no assurance that the Company would be able to
obtain such a license on acceptable terms, if at all, or to design around the
patent. The Company pursues the registration of certain of its trademarks and
service marks in the U.S. and in certain other countries, although it has not
secured registration of all its marks. As of September 30, 1997, the Company had
nine registered U.S. trademarks or service marks, and had applications pending
for an additional 27 U.S. trademarks. A significant portion of the Company's
marks begin with the word "Real" (such as RealSystem, RealAudio and RealVideo).
The Company is aware of other companies that use "Real" in their marks alone or
in combination with other words, and the Company does not expect to be
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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 the
Company's proprietary rights to the same extent as do the laws of the U.S., and
effective patent, copyright, trademark and trade secret protection may not be
available in such jurisdictions. The Company licenses certain of its proprietary
rights to third parties, and there can be no assurance that such licensees will
abide by compliance and quality control guidelines with respect to such
proprietary rights or otherwise take actions that would materially adversely
affect the Company's business, financial condition and results of operations.
To license many of its products, the Company relies in part on "shrinkwrap"
and "clickwrap" licenses that are not signed by the end user and, therefore, may
be unenforceable under the laws of certain jurisdictions. As with other software
products, the Company's products are susceptible to unauthorized copying and
uses that may go undetected, and policing such unauthorized use is difficult. In
general, there can be no assurance that the Company's efforts to protect its
intellectual property rights through patent, copyright, trademark and trade
secret laws will be effective to prevent misappropriation of its technology, or
to prevent the development and design by others of products or technologies
similar to or competitive with those developed by the Company, and the Company's
failure or inability to protect its proprietary rights could materially
adversely affect the Company's business, financial condition and results of
operations.
The computer software market is characterized by frequent and substantial
intellectual property litigation that is often complex and expensive, and
involves a significant diversion of resources and uncertainty of outcome.
Litigation may be necessary in the future to enforce and protect the Company's
intellectual property and trade secrets or to defend against a claim of
infringement or invalidity. The Company has been and expects to continue to be
subject to legal proceedings and claims from time to time in the ordinary course
of its business, including claims of alleged infringement of third-party
proprietary rights by the Company and its licensees. The Company attempts to
avoid infringing known proprietary rights of third parties in its product
development efforts. However, the Company has not conducted and does not conduct
comprehensive patent searches to determine whether the technology used in its
products infringes patents held by third parties. In addition, it is difficult
to proceed with certainty in a rapidly evolving technological environment in
which there may be numerous patent applications pending, many of which are
confidential when filed, with regard to similar technologies. If the Company
were to discover that its products violate third-party proprietary rights, there
can be no assurance that it would be able to obtain licenses to continue
offering such products without substantial reengineering or that any effort to
undertake such reengineering would be successful, that any such licenses would
be available on commercially reasonable terms, if at all, or that litigation
could be avoided or settled without substantial expense and damage awards. Any
claims relating to the infringement of third-party proprietary rights, even if
not meritorious, could result in the expenditure of significant financial and
managerial resources and in injunctions preventing the Company from distributing
certain products. Such claims could materially adversely affect the Company's
business, financial condition and results of operations.
The Company also relies on certain technology that it licenses from third
parties, including software that is integrated with internally developed
software and used in the Company's products, to perform key functions. There can
be no assurance that such third-party technology licenses will continue to be
available to the Company on commercially reasonable terms. The loss of any of
these technologies could have a material adverse effect on the Company's
business, financial condition and results of operations. Moreover, although the
Company is generally indemnified against claims that such third-party technology
infringes the proprietary rights of others, such indemnification is not always
available for all types of intellectual property rights (for example, patents
may be excluded) and in some cases the scope of such indemnification is limited.
Even if the Company receives broad indemnification, third-party indemnitors are
not always well capitalized and may not be able to indemnify the Company in the
event of infringement, resulting in substantial exposure to the Company. There
can be no assurance that infringement or invalidity claims arising from the
incorporation of third-party technology, and claims for indemnification from the
Company's customers resulting from such claims, will not be asserted or
prosecuted against the
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Company. Such claims, even if not meritorious, could result in the expenditure
of significant financial and managerial resources in addition to potential
product redevelopment costs and delays, all of which could materially adversely
affect the Company's business, financial condition and results of operations.
See "Risk Factors -- Uncertain Protection of Intellectual Property; Risks
Associated with Licensed Third-Party Technology."
EMPLOYEES
At September 30, 1997, the Company had 296 full-time employees and one
part-time employee, 268 of whom were based at the Company's executive offices in
Seattle, Washington, 24 of whom were based at the Company's offices in Japan,
England or France and five of whom were salespersons based at other locations.
None of the Company's employees is subject to a collective bargaining agreement,
and the Company believes that its relations with its employees are good.
FACILITIES
The Company's executive offices are located in downtown Seattle, Washington
in an office building in which, as of September 30, 1997, the Company leases an
aggregate of 80,345 square feet at a current monthly rental of $122,411. The
lease agreement terminates on April 30, 2001. The Company has an option to
extend the lease agreement for two additional five-year terms.
The Company anticipates that it will require additional space within the
next 12 months, but that suitable additional space will be available on
commercially reasonable terms, although there can be no assurance in this
regard. The Company does not own any real estate.
LEGAL PROCEEDINGS
From time to time the Company has been, and expects to continue to be,
subject to legal proceedings and claims in the ordinary course of its business,
including claims of alleged infringement of third-party trademarks and other
intellectual property rights by the Company and its licensees. Such claims, even
if not meritorious, could result in the expenditure of significant financial and
managerial resources. In August 1997, the Company was subpoenaed by the
Department of Justice in connection with its investigation into horizontal
merger activity within the streaming media industry. The investigation,
including interviews by the Department of Justice of Company officers, and
document production requests, is ongoing. As a result of the investigation, it
is possible that the Department of Justice will require certain actions by the
Company or other companies in the streaming media industry, which could have a
material adverse effect on the Company's competitive position, and on its
business, financial condition and results of operations. The Company is
cooperating in the investigation. The Company is not aware of any other legal
proceedings or claims that it believes will have, individually or in the
aggregate, a material adverse effect on its business, financial condition and
results of operations. See "Risk Factors -- Department of Justice Subpoena" and
"-- Uncertain Protection of Intellectual Property; Risks Associated With
Licensed Third-Party Technology."
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company as of September 30,
1997 are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------- --- ---------------------------------------------------------------
<S> <C> <C>
Robert Glaser(1).......... 35 Chairman of the Board, Chief Executive Officer, Secretary and
Treasurer
Bruce Jacobsen(2)......... 37 President, Chief Operating Officer and Director
Mark Klebanoff............ 35 Chief Financial Officer
Len Jordan................ 31 Senior Vice President -- Media Systems
Phillip Barrett........... 44 Senior Vice President -- Media Systems
Maria Cantwell............ 38 Senior Vice President -- Consumer and E-Commerce
James Higa................ 39 Vice President -- Asia/Rest of World ("ROW")
John Atcheson............. 38 Vice President -- Media Publishing
James Wells............... 50 Vice President -- Sales
Kelly Jo MacArthur........ 33 Vice President and General Counsel
Erik Moris................ 38 Vice President -- Marketing
James Breyer(1)(2)........ 36 Director
Mitchell Kapor(1)(2)...... 46 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Set forth below is certain information regarding the business experience
during the past five years for each of the above-named persons.
ROBERT GLASER has served as Chairman of the Board, Chief Executive Officer
and Treasurer of the Company since its inception in February 1994, and as
Secretary since March 1995. On closing of the offering, he will also serve as
the Company's Policy Ombudsman, with the exclusive authority to adopt or change
the editorial policies of the Company as reflected on the Company's Web sites or
other communications or media in which the Company has a significant editorial
or media voice. See "Description of Capital Stock -- Certain Voting and Other
Matters." 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. Mr. Glaser is
a Class 3 director.
BRUCE JACOBSEN has served as President and Chief Operating Officer of the
Company since February 1996 and as a Director since August 1997. From April 1995
to February 1996, Mr. Jacobsen was Chief Operating Officer of Dreamworks
Interactive, a joint venture between Microsoft and Dreamworks SKG, a partnership
among Steven Spielberg, Jeffery Katzenberg and David Geffen. From August 1986 to
April 1995, Mr. Jacobsen was employed at Microsoft in a number of capacities,
including General Manager of the Kids/Games business unit. Mr. Jacobsen
graduated summa cum laude with Honors from Yale University and holds an M.B.A.
from Stanford University. Mr. Jacobsen is a Class 2 director.
MARK KLEBANOFF has served as Chief Financial Officer of the Company since
June 1996. From May 1992 to June 1996, Mr. Klebanoff was Vice President of
Finance and Operations of Industrial Systems, Inc., a client/server process
information management software vendor that merged with Aspen Technology, Inc.
in 1995. From 1989 to 1992, Mr. Klebanoff worked in a number of general
management capacities for the Japanese trading company Itochu Corporation. Mr.
Klebanoff holds a B.A. from Yale University and a Masters degree from the Yale
School of Management.
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LEN JORDAN has served as Senior Vice President -- Media Systems of the
Company 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.
PHILLIP BARRETT has served as Senior Vice President -- Media Systems of the
Company since January 1997, and from November 1994 to January 1997 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.
MARIA CANTWELL has served as Senior Vice President -- Consumer and
E-Commerce of the Company since July 1997. From April 1995 to July 1997, Ms.
Cantwell served as Vice President -- Marketing of the Company. From February
1995 to April 1995, Ms. Cantwell was a consultant to the Company. 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.
JAMES HIGA has served as Vice President -- Asia/ROW of the Company since
September 1996. From January 1989 to August 1996, Mr. Higa was the Director for
Asia/Pacific for NeXT Software, Inc. From 1986 to 1989, Mr. Higa served as
Director of Product Marketing at Apple Computer Japan, Inc. Mr. Higa holds a
B.A. in Political Science from Stanford University.
JOHN ATCHESON has served as Vice President -- Media Publishing of the
Company since January 1997. From March 1990 to May 1996, Mr. Atcheson was
President and Chief Executive Officer of MNI Interactive, Inc., a developer and
distributor of consumer interactive services. Mr. Atcheson holds a B.A. from
Brown University and an M.B.A. from the Stanford Graduate School of Business.
JAMES WELLS has served as Vice President -- Sales of the Company since May
1995. From March 1994 to April 1995, Mr. Wells served as a consultant in sales,
marketing and product strategy at Aldus Corporation, a developer and marketer of
publishing software. From January 1991 to February 1994, Mr. Wells served in
various senior sales and marketing positions with Apple Computer, Inc. Mr. Wells
holds a B.S. in Engineering from Lamar University and an M.B.A. from the
University of Delaware.
KELLY JO MACARTHUR has served as Vice President and General Counsel of the
Company since October 1996. From January 1995 to March 1996, Ms. MacArthur
served as General Counsel and Director of Business Affairs for Compton's
NewMedia, Inc., which was acquired by Learning Co., Inc. in 1996. From July 1989
to December 1994, Ms. MacArthur was an attorney at Sidley & Austin. Ms.
MacArthur graduated summa cum laude from the University of Illinois at
Champaign-Urbana and holds a J.D. from Harvard Law School.
ERIK MORIS has served as Vice President -- Marketing of the Company since
August 1997. From April 1997 to July 1997, Mr. Moris served as a Product Manager
for the Company. From September 1996 to April 1997, Mr. Moris was a consultant
to the Company. From April 1995 to August 1996, Mr. Moris worked at Microsoft,
first as a consultant and later as an employee, where he managed advertising for
the Windows 95 launch and was Group Manager for the Internet Platform and Tools
Division. From 1985 to 1994, Mr. Moris was a Senior Vice President at
McCann-Erickson Advertising. Mr. Moris holds a B.A. in Communications and
Business from Western Washington University.
JAMES BREYER has been a Director of the Company since October 1995. Mr.
Breyer has served as a Managing Partner of Accel Partners L.P. in Palo Alto/San
Francisco since November 1995 and as a general partner from 1990 to 1995. At
Accel Partners L.P., Mr. Breyer has sponsored investments in over a dozen
companies that have completed public offerings or successful mergers.
Previously, Mr. Breyer was a management consultant at McKinsey & Company, Inc.,
and worked in product management and
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<PAGE> 55
marketing at Apple Computer, Inc. and Hewlett-Packard Corporation. Mr. Breyer
holds a B.S. from Stanford University and an M.B.A. from Harvard University,
where he was named a Baker Scholar. Mr. Breyer is a Class 2 director.
MITCHELL KAPOR has been a Director of the Company since October 1995. From
1990 to 1993, Mr. Kapor was President, from 1993 to 1995 he was Chairman and
from 1995 to 1996 he was a director, of the Electronic Frontier Foundation, a
nonprofit public Internet organization that he co-founded in 1990. Mr. Kapor
designed Lotus 1-2-3, and founded Lotus Development Corporation in 1982 and
served as its President and Chief Executive Officer from April 1982 to July
1986. Mr. Kapor holds a B.A. in Cybernetics from Yale University and an M.A. in
Psychology from Beacon College. Mr. Kapor is a Class 1 director.
NUMBER, TERM AND ELECTION OF DIRECTORS
The Articles provide that the number of directors shall be determined in
the manner provided by the Company's Bylaws. The Bylaws provide that the number
of directors shall not be less than one, with the precise number to be
determined by resolution of the Board of Directors. The Board of Directors has
determined that the number of directors shall be seven. Four directors currently
serve on the Board, with three vacancies currently existing.
Prior to October 1997, each director was elected to serve until the next
annual meeting of shareholders and the election and qualification of his or her
successor or until his or her earlier resignation or removal. In October 1997,
the Company established a classified Board of Directors with three classes
(Class 1, Class 2 and Class 3), each class as nearly equal in number of
directors as possible. Each of the current directors was elected in October 1997
to one of these three classes. Commencing with the annual shareholders meeting
in 1998 and thereafter, each director shall serve for a term ending at the third
annual meeting of shareholders following such director's election. Mr. Kapor was
elected to Class 1 with a term expiring at the annual shareholders meeting in
1998; Messrs. Breyer and Jacobsen were elected to Class 2 with terms expiring at
the annual shareholders meeting in 1999; and Mr. Glaser was elected to Class 3
with a term expiring at the annual shareholders meeting in 2000.
CONTRACTUAL ARRANGEMENTS
Pursuant to the terms of a Second Amended and Restated Investors' Rights
Agreement (the "Investors' Rights Agreement"), the holders of Series B Preferred
Stock are entitled to nominate one member to the Board of Directors, the holders
of Series C Preferred Stock are entitled to nominate one member to the Board of
Directors and the holders of Series E Preferred Stock are entitled to nominate
one member to the Board of Directors. Mr. Kapor is the director nominated by the
holders of the Series B Preferred Stock, Mr. Breyer is the director nominated by
the holders of the Series C Preferred Stock, and the holder of the Series E
Preferred Stock currently has not nominated a director. The right to nominate
directors pursuant to the Investors' Rights Agreement will terminate on closing
of the offering.
Under a voting agreement (the "Voting Agreement") entered into in September
1997 among the Company, Accel IV L.P. ("Accel IV") and Messrs. Jacobsen, Kapor
and Glaser, each of Accel IV and Messrs. Jacobsen and Kapor have agreed,
effective on closing of the offering, to vote all shares of stock of the Company
owned by such shareholders to elect Mr. Glaser to the Board of Directors of the
Company in each election in which he is a nominee. The obligations under the
Voting Agreement terminate with respect to shares transferred by the parties
thereto. The Voting Agreement terminates upon the death of Mr. Glaser.
Pursuant to the terms of the Glaser Agreement, the Company granted Mr.
Glaser a direct contractual right to require the Company to abide by and perform
all terms of the Articles with respect to strategic transactions. The Glaser
Agreement also provides that so long as Mr. Glaser owns a specified number of
shares, the Company shall use its best efforts to cause Mr. Glaser to be
nominated to, not removed from, and elected to, the Board of Directors.
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<PAGE> 56
COMPENSATION OF DIRECTORS
Directors of the Company do not receive cash compensation for their
services as directors or members of committees of the Board of Directors, but
are reimbursed for their reasonable expenses incurred in attending Board of
Directors meetings. The Company has not made option grants to outside directors,
but intends to make such grants to outside directors in the future.
BOARD COMMITTEES
The Company has established an Audit Committee, a Compensation Committee
and a Strategy Committee. In addition, the Articles provide that, following the
closing of the offering, the Company will establish a Strategic Transactions
Committee. Following the closing of the offering, the Company also intends to
establish a Nominating Committee.
The Audit Committee consists of Messrs. Breyer, Jacobsen and Kapor. The
functions of the Audit Committee are to make recommendations to the Board of
Directors regarding the selection of independent auditors, review the results
and scope of the audit and other services provided by the Company's independent
auditors and evaluate the Company's internal controls.
The Compensation Committee consists of Messrs. Breyer, Glaser and Kapor.
The functions of the Compensation Committee are to review and approve the
compensation and benefits for the Company's executive officers, administer the
Company's stock option and stock purchase plans and make recommendations to the
Board of Directors regarding such matters.
The Strategy Committee consists of Messrs. Breyer, Glaser, Jacobsen and
Kapor. The functions of the Strategy Committee are to make recommendations to
the Board of Directors regarding the overall strategic goals of the Company and
review significant business transactions that affect the future strategic
direction of the Company.
The Strategic Transactions Committee shall be comprised of three directors,
who shall initially be Messrs. Glaser, Breyer and Kapor. Without the prior
approval of such Committee, and subject to certain limited exceptions, the Board
of Directors shall not have the authority to (i) adopt a plan of merger, (ii)
authorize the sale, lease, exchange or mortgage of (A) assets representing more
than 50% of the book value of the Company's assets prior to the transaction or
(B) any other asset or assets on which the long-term business strategy of the
Company is substantially dependent, (iii) authorize the Company's voluntary
dissolution or (iv) take any action that has the effect of clauses (i) through
(iii). Any vacancy on the Committee shall be filled by the remaining members of
the Committee. If two members of the Committee remain and are unable to agree on
an individual to fill the vacancy, such vacancy may be filled by the member who
holds or controls, directly or indirectly, the larger percentage of the
outstanding shares of the Company's capital stock. The Committee, by vote of the
Chairman of the Committee and one additional member, may limit the powers of the
Committee or may terminate the Committee. The existence and powers of the
Committee shall terminate when the members in the aggregate cease to hold or
control, directly or indirectly, at least 10% of the outstanding shares of the
Company's capital stock. See "Risk Factors -- Control by Mr. Glaser;
Antitakeover Provisions" and "Certain Transactions."
The Nominating Committee will be comprised of the Company's Chief Executive
Officer and certain other directors of the Company. The function of the
Nominating Committee will be to recommend persons for election to the Board of
Directors.
POLICY OMBUDSMAN
Under the Articles, Mr. Glaser shall serve, or shall appoint another
officer of the Company to serve, as the Company's Policy Ombudsman, with the
exclusive authority to adopt or change the editorial policies of the Company as
reflected on the Company's Web sites or other communications or media where the
Company has a significant editorial or media voice. Upon the death, resignation
or removal of Mr. Glaser as the Policy Ombudsman, the Chief Executive Officer
shall serve or appoint another officer of the
54
<PAGE> 57
Company to serve as his or her successor. See "Risk Factors -- Control by Mr.
Glaser; Antitakeover Provisions" and "Certain Transactions."
EXECUTIVE COMPENSATION
The following table sets forth information concerning the compensation
received for services rendered to the Company in all capacities during the year
ended December 31, 1996 by the Company's Chief Executive Officer and by the
other three executive officers of the Company whose salary and bonus exceeded
$100,000 in 1996 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
-------------
ANNUAL COMPENSATION SECURITIES
-------------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY($)(1) BONUS($) OPTIONS(#)
- ------------------------------------------------ ------------ -------- -------------
<S> <C> <C> <C>
Robert Glaser................................... $100,000 $ -- --
Chairman, Chief Executive Officer, Secretary
and Treasurer
Bruce Jacobsen.................................. 118,158 -- 1,176,367
President and Chief Operating Officer
James Wells..................................... 90,000 23,625 --
Vice President -- Sales
Andrew Sharpless................................ 102,295 -- 125,000(2)
Senior Vice President
</TABLE>
- ---------------
(1) The current annual salaries for Messrs. Glaser, Jacobsen and Wells are
$100,000, $135,000 and $90,000, respectively.
(2) Mr. Sharpless resigned as an officer of the Company effective August 2,
1996, after which time he served as a Vice President of the Company until
February 1997, when he terminated his employment with the Company. Mr.
Sharpless exercised this option with respect to 12,500 shares on April 8,
1997, after terminating his employment with the Company. The remainder of
the shares subject to this option were unvested as of his termination date
and therefore were canceled.
The following table sets forth information concerning stock options granted
to the Named Executive Officers in 1996 and reflects the conversion of Series B
Common Stock and Series C Common Stock underlying such options into an equal
number of shares of Common Stock on closing of the offering.
OPTION GRANTS IN 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
------------------------------------------------------- VALUE
NUMBER OF % OF TOTAL AT ASSUMED ANNUAL RATES
SECURITIES OPTIONS OF STOCK APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM(3)
OPTIONS EMPLOYEES PRICE EXPIRATION ------------------------
NAME GRANTED(#)(1) IN 1996 ($/SHARE)(2) DATE 5%($) 10%($)
- -------------------- ------------- ---------- ------------ ----------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Robert Glaser....... -- -- -- -- $ -- $ --
Bruce Jacobsen...... 1,176,367 31.2% $ 0.20 2/16/2016 388,977 1,347,528
James Wells......... -- -- -- -- -- --
Andrew Sharpless.... 125,000 3.3% $ 0.20 5/29/1997(4) 41,332 143,187
</TABLE>
- ---------------
(1) All options granted to the Named Executive Officers in 1996 were
nonqualified stock options that vest with respect to 20% of the shares on
the first anniversary of the date of grant and thereafter at a rate of 10%
for each six months of services rendered by the optionee to the Company,
except for
55
<PAGE> 58
one option granted to Mr. Jacobsen on February 16, 1996 for the purchase of
470,544 shares of Common Stock, of which 50% vests one year from date of grant
and 25% vests every six months thereafter.
(2) The exercise price of each option was the estimated fair market value of the
underlying securities on the date of grant, as determined by the Company's
Board of Directors.
(3) Based on the estimated fair market value of the underlying securities on the
date of grant and assumed appreciation over the original 20-year option term
at the respective annual rates of stock appreciation shown. Potential gains
are net of the exercise price but before taxes associated with the exercise.
The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the rules of the Securities and Exchange Commission (the
"Commission") and do not represent the Company's estimate of the future
price of the Common Stock. Actual gains, if any, on stock option exercises
depend on the future financial performance of the Company and overall market
conditions. The actual value realized may be greater or less than the
potential realizable value set forth in the table.
(4) Mr. Sharpless exercised this option with respect to 12,500 shares on April
8, 1997, after terminating his employment with the Company. The remainder of
the shares subject to this option were unvested as of his termination date
and therefore were canceled.
The following table sets forth information regarding option exercises, and
the fiscal year-end values of stock options held, by each of the Named Executive
Officers during the year ended December 31, 1996. The table reflects the
conversion of Series B Common Stock and Series C Common Stock underlying such
options into an equal number of shares of Common Stock on closing of the
offering.
AGGREGATED OPTION EXERCISES IN 1996 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT AT DECEMBER 31,
SHARES VALUE REALIZED($) DECEMBER 31, 1996(#) 1996($)
ACQUIRED (MARKET PRICE AT ---------------------- --------------------
ON EXERCISE LESS EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) EXERCISE PRICE) UNEXERCISABLE UNEXERCISABLE(1)
- ------------------------- ----------- -------------------- ---------------------- --------------------
<S> <C> <C> <C> <C>
Robert Glaser............ -- $ -- --/-- --/$--
Bruce Jacobsen........... -- -- --/1,176,367 --/941,094
James Wells.............. -- -- 82,500/192,500 76,725/179,025
Andrew Sharpless(2)...... 300,000 87,750 12,500/112,500(3) 10,000/90,000
</TABLE>
- ---------------
(1) The fair market value of the underlying securities at the close of business
on December 31, 1996 was estimated to be approximately $1.00 per share, as
determined by the Company's Board of Directors.
(2) The fair market value of the underlying securities at the close of business
on the dates of exercise of Mr. Sharpless' options to purchase 225,000
shares and 75,000 shares were estimated to be approximately $0.20 and $0.85
per share, respectively, as determined by the Company's Board of Directors.
(3) Mr. Sharpless exercised this option with respect to 12,500 shares on April
8, 1997, after terminating his employment with the Company. The remainder of
the shares subject to this option were unvested as of his termination date
and therefore were canceled.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
The Articles limit the liability of the Company's directors to the full
extent permitted by Washington law. The Washington Business Corporation Act (the
"Washington Act") provides that a corporation's articles of incorporation may
contain a provision eliminating or limiting the personal liability of directors
for monetary damages for breach of their fiduciary duty as directors, except for
liability for (i) acts or
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<PAGE> 59
omissions that involve intentional misconduct or a knowing violation of law,
(ii) unlawful payments of dividends or unlawful stock repurchases or redemptions
as provided in Section 23B.08.310 of the Washington Act or (iii) any transaction
from which the director derived an improper personal benefit. The Articles
provide that the Company shall indemnify its directors and officers, and may
indemnify its employees and agents, to the fullest extent permitted by law.
The Company has entered into agreements with its directors and executive
officers that, among other things, indemnify them for certain expenses
(including attorneys' fees), judgments, fines and settlement amounts incurred by
such persons in any action or proceeding, including any action by or in the
right of the Company, arising out of such person's services as a director or
officer of the Company, any subsidiary of the Company or any other company or
enterprise to which the person provides services at the request of the Company.
The Company believes that these provisions and agreements are necessary to
attract and retain qualified directors and officers. These agreements also
provide officers with the same limitation of liability for monetary damages that
the Washington Act and the Articles provide to directors.
BENEFIT PLANS
1995 STOCK OPTION PLAN. The Company's 1995 Stock Option Plan (the "1995
Plan") was adopted by the Board of Directors, and approved by the Company's
shareholders, in March 1995. The 1995 Plan provides for the grant of incentive
and nonqualified options to purchase up to an aggregate of 3,600,000 shares of
Common Stock to employees, officers, directors, consultants and independent
contractors of the Company. As of October 9, 1997, options to purchase 1,521,173
shares of Common Stock were outstanding under the 1995 Plan, with exercise
prices ranging from $0.07 to $1.00 per share and options to purchase 1,177,091
shares had been exercised. The Company has resolved to not grant any additional
options under the 1995 Plan, and has amended its Amended and Restated 1996 Stock
Option Plan to provide for a corresponding increase in the number of shares
reserved for issuance thereunder. See "-- Amended and Restated 1996 Stock Option
Plan."
The provisions of the 1995 Plan with respect to the administration of the
1995 Plan and options granted thereunder, and the term and termination of
options granted, including any provision regarding the acceleration of
exercisability thereof, are as set forth below with respect to the Amended and
Restated 1996 Stock Option Plan.
AMENDED AND RESTATED 1996 STOCK OPTION PLAN. The Company's Amended and
Restated 1996 Stock Option Plan (the "1996 Plan") was originally adopted by the
Board of Directors in February 1996, and was approved by the Company's
shareholders in September 1997. The 1996 Plan provides for the grant of
incentive and nonqualified options to purchase up to an aggregate of 9,701,736
shares of Common Stock to employees, officers, directors, consultants and
independent contractors of the Company or any of its affiliates (the "Initial
Option Amount"). The Initial Option Amount can be increased to up to 11,222,909
shares after taking into account 1,521,173 shares of Common Stock subject to
options outstanding under the 1995 Plan on October 9, 1997, to the extent that
such options terminate without having been exercised in full. As of October 9,
1997, options to purchase 4,868,841 shares of Common Stock were outstanding
under the 1996 Plan, with exercise prices ranging from $0.20 to $8.50 per share,
options to purchase 4,446,992 shares of Common Stock were available for grant,
and options to purchase 385,903 shares of Common Stock had been exercised.
The 1996 Plan is administered by the Board of Directors, which has the
authority to grant options and to specify the terms and conditions of each
option so granted, including the number of shares covered by the option, the
type of option, the exercise price and the vesting provisions.
Options granted under the 1996 Plan must be exercised within three months
following termination of the optionee's employment with, or service to, the
Company, or within one year after the optionee's termination due to death or
disability, but in no event later than the expiration of the option term.
Options granted under the 1996 Plan are not transferable by the optionee except
by will or the laws of descent and distribution and generally are exercisable
during the optionee's lifetime only by the optionee.
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<PAGE> 60
In the event of a sale of all or substantially all of the Company's assets,
a merger or reorganization in which the Company is not the surviving
corporation, or the sale or other transfer of shares representing more than 50%
of the combined voting power of the then outstanding securities of the Company
(each, a "Terminating Event"), the Board may determine whether provision will be
made for assumption of, or substitution for, the stock options granted under the
1996 Plan by the successor corporation. If, with respect to a Terminating Event
that has been approved by the Board, the Board determines that no such
assumption or substitution will be made, then all options will become fully
vested, and each optionee will have the right to exercise any unexercised
options prior to closing of the Terminating Event. All options not so exercised
will expire upon closing of the Terminating Event.
1998 EMPLOYEE STOCK PURCHASE PLAN. The Company's 1998 Employee Stock
Purchase Plan (the "ESPP"), which was adopted by the Board of Directors and
approved by the Company's shareholders in September 1997, will become effective
on January 1, 1998. The Company has reserved 1,000,000 shares of Common Stock
for issuance under the ESPP. The ESPP is intended to qualify for favorable tax
treatment under Section 423 of the Internal Revenue Code of 1986, as amended.
The ESPP will be implemented through a series of offering periods of six months'
duration, with new offering periods commencing on January 1 and July 1 of each
year. The ESPP will be administered by the Compensation Committee of the Board
of Directors of the Company. Each eligible employee of the Company or of any
majority-owned subsidiary of the Company who has been employed by the Company or
such majority-owned subsidiary of the Company for at least 90 days will be
eligible to participate in the ESPP if such employee is employed by the Company
or any such subsidiary for more than 20 hours per week and more than five months
per year. The ESPP permits an eligible employee to purchase Common Stock through
payroll deductions, which may not exceed 10% of his or her compensation, at a
price equal to 85% of the lower of the fair market value of the Common Stock at
the beginning or end of the offering period. Employees may terminate their
participation in the ESPP any time during the offering period; provided,
however, that employees may not change their level of participation in the ESPP
at any time during the offering period. Participation in the ESPP terminates
automatically on the employee's termination of employment with the Company.
401(K) PLAN. The Company maintains a 401(k) plan that covers all employees
who satisfy certain eligibility requirements relating to minimum age, length of
service and hours worked. Under the profit-sharing portion of the plan, the
Company may make an annual contribution for the benefit of eligible employees in
an amount determined by the Board of Directors. The Company has not made any
such contribution to date and currently has no plans to do so. Under the 401(k)
portion of the plan, eligible employees may make pretax elective contributions
of up to 20% of their compensation, subject to maximum limits on contributions
prescribed by law.
58
<PAGE> 61
CERTAIN TRANSACTIONS
SALES OF PREFERRED STOCK
Since the Company's inception in February 1994, the Company has issued, in
private placement transactions, shares of Preferred Stock as follows: (i) in
April 1995, an aggregate of 2,686,567 shares of Series B Preferred Stock at
$0.67 per share, (ii) in October 1995, an aggregate of 2,904,305 shares of
Series C Preferred Stock at approximately $1.96 per share, (iii) in November
1996, an aggregate of 2,381,010 shares of Series D Preferred Stock at $7.53 per
share and (iv) in July 1997, an aggregate of 3,338,374 shares of Series E
Preferred Stock at $8.99 per share. In addition, in connection with these
private placements, the Company issued warrants as follows: (i) in April 1995, a
warrant to purchase up to 373,134 shares of Series B Preferred Stock at an
exercise price of $0.67 per share, which warrant was exercised in October 1995,
(ii) in October 1995, warrants to purchase up to 100,000 shares of Series C
Preferred Stock at an exercise price of approximately $1.96 per share and
warrants to purchase up to 183,755 shares of Series B Common Stock at an
exercise price of approximately $0.20 per share, (iii) in November 1996,
warrants to purchase up to 714,303 shares of Series D Preferred Stock at an
exercise price of approximately $9.41 per share and (iv) in July 1997, the
Series E Warrant to purchase up to 3,709,305 shares of Series E Preferred Stock
at an exercise price of $13.48 per share. In April 1995, in connection with the
Company's Series B Preferred Stock financing, Mr. Glaser exchanged 10,000 shares
of the capital stock of the Company for one share of Series A Common Stock and
13,713,439 shares of Series A Preferred Stock to reflect capital contributions
made by Mr. Glaser of approximately $0.07 per share. The purchasers of record of
the Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock
and Series E Preferred Stock and the accompanying warrants to purchase Series B
Common Stock and Series C, Series D and Series E Preferred Stock included, among
others, the following 5% shareholders, executive officers, directors and
entities associated with directors:
<TABLE>
<CAPTION>
PREFERRED STOCK
---------------------------------------------------------------------------------
NAME SERIES B SERIES C SERIES D SERIES E
- ---------------------- --------------- ------------------ --------------- ------------------
<S> <C> <C> <C> <C>
Robert Glaser......... 287,313 50,825 39,841
Mitchell Kapor........ 1,492,537 656,172 66,401
Accel Entities(1)..... 2,037,282 66,401
Microsoft
Corporation......... 3,338,374
Phillip Barrett....... 373,134
</TABLE>
<TABLE>
<CAPTION>
WARRANTS
---------------------------------------------------------------------------------
SERIES B SERIES C SERIES D SERIES E
NAME COMMON STOCK(2) PREFERRED STOCK(2) PREFERRED STOCK PREFERRED STOCK(2)
- ---------------------- --------------- ------------------ --------------- ------------------
<S> <C> <C> <C> <C>
Robert Glaser......... 11,952
Mitchell Kapor........ 33,755 19,920
Accel Entities(1)..... 150,000 100,000 19,921
Microsoft
Corporation......... 3,709,305
</TABLE>
- ---------------
(1) The "Accel Entities" include Accel IV, Accel Investors '95 L.P., Accel
Keiretsu L.P. and Ellmore C. Patterson Partners. James Breyer, a director of
the Company, is affiliated with the Accel Entities. See "Principal
Shareholders."
(2) These warrants terminate automatically on closing of the offering.
In addition, members of Mr. Glaser's immediate family purchased an
aggregate of 223,881 shares of Series B Preferred Stock in April 1995, and an
aggregate of 39,498 shares of Series C Preferred Stock in October 1995, in each
case on the same terms as the other investors.
In addition, Trans Cosmos and Encompass Group, Inc., an affiliate of Trans
Cosmos, purchased 796,813 and 265,604 shares of Series D Preferred Stock,
respectively, in November 1996 on the same terms as the other investors. In
connection with those purchases, Trans Cosmos and Encompass received warrants to
acquire 239,043 and 79,682 shares of Series D Preferred Stock, respectively.
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<PAGE> 62
Pursuant to the terms of the Investors' Rights Agreement, the holders of
Series B Preferred Stock are entitled to nominate one member to the Board of
Directors, the holders of Series C Preferred Stock are entitled to nominate one
member to the Board of Directors and the holders of Series E Preferred Stock are
entitled to nominate one member to the Board of Directors. In addition, all
holders of preferred stock hold preemptive rights to purchase their pro rata
share of new securities issued by the Company. The rights to nominate directors
and the preemptive rights will terminate on closing of the offering. In
addition, the Investors' Rights Agreement grants to the investors certain
registration rights that obligate the Company, under certain circumstances, to
effect a registration under the Securities Act of any common stock issued upon
conversion of the Preferred Stock, and any Common Stock issued pursuant to the
exercise of the Series B Common Stock warrants. See "Shares Eligible for Future
Sale -- Registration Rights." All shares of Preferred Stock will be converted
into an equivalent number of shares of Common Stock or Special Common Stock, as
applicable, on closing of the offering.
The Company has entered into indemnification agreements with each of its
executive officers and directors. See "Management -- Limitation of Liability and
Indemnification Matters."
MICROSOFT CORPORATION
The Company and Microsoft entered into an agreement in June 1997 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, including its basic RealPlayer and substantial elements
of its EasyStart Server (currently known as the Basic Server), and related
Company trademarks. Under the agreement, Microsoft may sublicense its rights to
the RealAudio/RealVideo Version 4.0 technology to third parties under certain
circumstances. The agreement also provides for substantial refunds to Microsoft
under prescribed circumstances that are solely within the Company's control. The
amount of these refunds diminishes over time. The Company may not assign its
obligations under the agreement without Microsoft's consent. Microsoft is
obligated to distribute the Company's RealPlayer Version 4.0 for a defined term
as long as the Company's player supports certain Microsoft architectures. The
Company also agreed to work with Microsoft and several other companies to author
and promote ASF as a standard file format for streaming media. The agreement
also requires the Company to provide Microsoft with engineering consultation
services, certain error corrections and certain technical support over a defined
term. In connection with the agreement, Microsoft purchased 3,338,374 shares of
nonvoting Series E Preferred Stock at $8.99 per share for approximately
$30,000,000. Each share of Series E Preferred Stock is convertible at the option
of Microsoft into either one share of Common Stock or one share of Special
Common Stock. Microsoft also received a warrant to purchase 3,709,305 shares of
Series E Preferred Stock at an exercise price of $13.48 per share. If exercised,
each share of Series E Preferred Stock acquired upon exercise will be
automatically converted, at the election of the holder, into either one share of
Common Stock or one share of Special Common Stock. If Microsoft elects to
convert shares of Series E Preferred Stock into $15,000,000 or more of Common
Stock, it may be required to make a filing under the Hart-Scott-Rodino Antitrust
Improvements Act, and obtain approval from the Department of Justice and the
Federal Trade Commission before completing the conversion into Common Stock.
This warrant terminates on closing of the offering. In connection with its
equity investment, Microsoft also granted a limited proxy to the Company. See
"Risk Factors -- Competition; Relationship With Microsoft," "-- Department of
Justice Subpoena," "Business -- Microsoft Relationship" and "Description of
Capital Stock -- Certain Voting and Other Matters."
JAPANESE JOINT VENTURE
Trans Cosmos is the beneficial owner of 1,381,142 shares of Common Stock of
the Company. In May 1997, Trans Cosmos, the Company and two other parties
entered into a joint venture agreement with respect to the establishment and
management of J-Stream to operate an Internet streaming business in Japan. Trans
Cosmos owns 28% of J-Stream, and each of the Company and the other two parties
own 24%. Trans Cosmos is responsible for managing J-Stream, and the Company
supplies J-Stream with software and technology for streaming on Internet
networks. Trans Cosmos contributed
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approximately $1,165,000 for its 28% interest, and the Company contributed
approximately $998,000 for its 24% interest in J-Stream. Trans Cosmos loaned the
Company the amount of the Company's contribution, and the Company may, under
certain circumstances, tender its 24% interest to Trans Cosmos as repayment of
the loan. See "Principal Shareholders."
TRANS COSMOS RELATIONSHIP
The Company and Trans Cosmos are parties to a Master Distribution Agreement
pursuant to which the Company granted Trans Cosmos a nonexclusive,
nontransferable license to reproduce and distribute RealPlayer and RealPlayer
Plus, and distribute the Company's server products, in Japan. Trans Cosmos is
required to comply with certain marketing requirements, personnel commitments
and specified minimum distribution requirements. Trans Cosmos paid the Company
$820,000 in 1996, and approximately $469,000 from January 1, 1997 through
September 30, 1997. The distribution agreement became effective on July 22, 1996
and terminated in accordance with its terms on July 22, 1997. The Company and
Trans Cosmos have continued to adhere to the terms of the agreement and are
currently renegotiating the agreement.
The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties.
CHANGES TO CAPITAL STRUCTURE
In connection with the offering, the Board recommended, and the Company's
shareholders approved, amendments to the Articles that, among other things, will
reduce the number of series of authorized Common Stock from five to two (Common
Stock and Special Common Stock), establish the Strategic Transactions Committee
and provide for a Policy Ombudsman with authority to determine certain matters
related to editorial policies of the Company. These amendments will become
effective on closing of the offering. See "Management -- Policy Ombudsman" and
"Description of Capital Stock -- Certain Voting and Other Matters."
VOTING AGREEMENT
Under the Voting Agreement, each of Accel IV and Messrs. Jacobsen and Kapor
have agreed, effective on closing of the offering, to vote all shares of stock
of the Company owned by such shareholders to elect Mr. Glaser to the Board of
Directors of the Company in each election in which he is a nominee. The
obligations under the Voting Agreement terminate with respect to shares
transferred by the parties thereto. The Voting Agreement terminates on the death
of Mr. Glaser.
AGREEMENT BETWEEN THE COMPANY AND MR. GLASER
Pursuant to the terms of the Glaser Agreement, the Company granted Mr.
Glaser a direct contractual right to require the Company to abide by and perform
all terms of the Articles with respect to strategic transactions. The Glaser
Agreement also provides that so long as Mr. Glaser owns a specified number of
shares, the Company shall use its best efforts to cause Mr. Glaser to be
nominated to, not removed from, and elected to, the Board of Directors. See
"Management -- Contractual Arrangements."
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PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock as of October 9, 1997, assuming the conversion of
all shares of Series A Common Stock, Series B Common Stock, Series C Common
Stock, Series A Preferred Stock, Series B Preferred Stock, Series C Preferred
Stock, Series D Preferred Stock and Series E Preferred Stock into Common Stock,
and as adjusted to reflect the sale of 3,000,000 shares of Common Stock in the
offering for (i) each person known to the Company to own beneficially more than
5% of the Common Stock, (ii) each of the Company's directors, (iii) each of the
Named Executive Officers and (iv) all executive officers and directors as a
group.
<TABLE>
<CAPTION>
COMMON STOCK
-------------------------------------------
NUMBER
OF PERCENT OWNERSHIP
SHARES ------------------------
BENEFICIALLY BEFORE AFTER
NAME OWNED(1) OFFERING OFFERING(2)
- ------------------------------------------------------ ------------ -------- -----------
<S> <C> <C> <C>
Accel IV L.P.......................................... 2,373,604(3) 8.7% 7.9%
c/o Accel Partners L.P.
One Embarcadero Center
Suite 3820
San Francisco, CA 94111
Robert Glaser......................................... 14,101,871(4) 52.3 47.0
c/o RealNetworks, Inc.
1111 Third Avenue
Suite 2900
Seattle, WA 98101
Mitchell Kapor........................................ 2,258,785(5) 8.4 7.5
Kapor Enterprises, Inc.
238 Main Street
Cambridge, MA 02142
Microsoft Corporation................................. 7,047,679** 23.0 20.9
One Microsoft Way
Redmond, WA 98052-6399
Trans Cosmos USA, Inc................................. 1,381,142(6) 5.1 4.6
4040 Lake Washington Blvd. N.E.
Suite 205
Kirkland, WA 98033
Bruce Jacobsen........................................ 492,073(7) 1.8 1.6
James W. Breyer....................................... 2,373,604(8) 8.7 7.9
James Wells........................................... 137,500(9) * *
Andrew Sharpless...................................... 312,500 1.2 1.0
All directors and executive officers as a group (13
persons)(10)........................................ 20,305,867 73.2% 66.0%
</TABLE>
- ---------------
* Less than 1%.
** Includes 3,709,305 shares of Common Stock issuable on exercise of the
Series E Warrant. The Series E Warrant has an exercise price of $13.48 per
share and, if not exercised, will automatically terminate on closing of the
offering. Excluding shares subject to the Series E Warrant, Microsoft
currently owns of record 12.4% of the Common Stock and will own of record
11.1% of the Common Stock immediately after closing. See "Risk
Factors -- Competition; Relationship With Microsoft,"
"Business -- Microsoft Relationship" and "Description of Capital
Stock -- Warrants to Purchase Preferred Stock and Common Stock."
(1) Beneficial ownership is determined in accordance with rules of the
Commission and includes shares over which the beneficial owner exercises
voting or investment power. Shares of Common Stock subject to options or
warrants currently exercisable or exercisable within 60 days of
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<PAGE> 65
October 9, 1997 are deemed outstanding for the purpose of computing the
percentage ownership of the person holding the options or warrants, but are not
deemed outstanding for the purpose of computing the percentage ownership of any
other person. Except as indicated, and subject to community property laws
where applicable, the Company believes, based on information provided by
such persons, that the persons named in the table above have sole voting
and investment power with respect to all shares of Common Stock shown as
beneficially owned by them.
(2) In the event that Microsoft elects to exercise the Series E Warrant in its
entirety for the purchase of shares of Common Stock, the resulting
ownership percentages immediately following closing of the offering for the
other shareholders listed in the table would be as follows: Accel
IV -- 7.0%; Mr. Kapor -- 6.7%; Mr. Glaser -- 41.9%; Trans Cosmos -- 4.1%;
Mr. Jacobsen -- 1.4%; Mr. Breyer -- 7.0%; Mr. Wells -- .4%; Mr.
Sharpless -- .9%; and all directors and executive officers as a
group -- 58.9%.
(3) Includes 1,926,973 shares owned by Accel IV, 39,970 shares owned by Accel
Keiretsu L.P., 90,459 shares owned by Accel Investors '95 L.P. and 46,281
shares owned by Ellmore C. Patterson Partners. Also includes 247,247
shares, 5,129 shares, 11,607 shares, and 5,938 shares of Common Stock
issuable on exercise of warrants owned by Accel IV, Accel Keiretsu L.P.,
Accel Investors '95 L.P. and Ellmore C. Patterson Partners, respectively.
(4) Includes 11,952 shares of Common Stock issuable on exercise of a warrant.
Immediately following closing of the offering, Mr. Glaser intends to donate
approximately 700,000 shares of Common Stock to various charitable
organizations. These gifts will reduce the percentage of Common Stock that
he owns following closing of the offering to approximately 44.7%.
(5) Includes 53,675 shares of Common Stock issuable on exercise of warrants.
(6) Includes 796,813 shares of Common Stock owned by Trans Cosmos and 265,604
shares of Common Stock owned by Encompass Group, Inc., an affiliate of
Trans Cosmos ("Encompass"). Also includes 239,043 and 79,682 shares of
Common Stock issuable on exercise of warrants owned by Trans Cosmos and
Encompass, respectively.
(7) Includes 292,073 shares of Common Stock issuable on exercise of options.
Following closing of the offering, Mr. Jacobsen intends to donate
approximately 60,000 shares of Common Stock to various charitable
organizations.
(8) Mr. Breyer may be deemed to be the beneficial owner of the 2,373,604 shares
of Common Stock beneficially owned by the Accel Entities because he is a
general partner of Accel Partners L.P., which is the general partner of
Accel IV. Mr. Breyer disclaims beneficial ownership of these shares except
to the extent of his pecuniary interest therein. See footnote (3) above.
(9) Includes 27,500 shares of Common Stock issuable on exercise of options.
(10) Does not include shares owned by Mr. Sharpless, who terminated his
employment with the Company in February 1997. Includes an aggregate of
455,473 shares and 335,548 shares, respectively, of Common Stock issuable
upon exercise of options and warrants.
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DESCRIPTION OF CAPITAL STOCK
The following description of the capital stock of the Company and certain
provisions of the Articles and the Bylaws is a summary and is qualified in its
entirety by reference to the Articles and the Bylaws, copies of which have been
filed with the Commission as exhibits to the Company's Registration Statement,
of which this Prospectus forms a part. The descriptions of the common stock and
preferred stock reflect changes to the capital structure that will occur on
closing of the offering.
The authorized capital stock of the Company consists of 300,000,000 shares
of common stock, which is divided into Common Stock and Special Common Stock,
and 60,000,000 shares of preferred stock.
COMMON STOCK
As of October 9, 1997, 26,967,021 shares of Common Stock were outstanding
and held of record by 166 shareholders, assuming no exercise after October 9,
1997 of outstanding options or warrants. Each holder of Common Stock is entitled
to one vote per share. Subject to the rights of the holders of any preferred
stock that may be outstanding, holders of Common Stock on the applicable record
date are entitled to receive such dividends as may be declared by the Board of
Directors out of funds legally available therefor and, in the event of
liquidation, to share pro rata in any distribution of the Company's assets after
payment or providing for the payment of liabilities and the liquidation
preference of any outstanding preferred stock. Holders of Common Stock have no
cumulative voting rights or preemptive rights to purchase or subscribe for any
shares of Common Stock or other securities of the Company.
SPECIAL COMMON STOCK
The Company has 7,047,679 authorized shares of Special Common Stock that
have identical rights to the Common Stock, except that they have voting rights
only to the extent provided by applicable law. The Special Common Stock may be
converted into Common Stock only with the prior written consent of the Board of
Directors. As of October 9, 1997, no shares of Special Common Stock were
outstanding.
PREFERRED STOCK
The Company's Board of Directors has the authority to issue shares of
preferred stock in one or more series and to fix and determine the relative
rights and preferences of the shares constituting any series to be established,
without any further vote or action by the shareholders. Any shares of preferred
stock so issued may have priority over the common stock with respect to dividend
or liquidation rights or both. On closing of the offering, no shares of
preferred stock will be outstanding. The Company has no current intention to
issue any shares of preferred stock, except with respect to the proposed
Shareholder Rights Plan. See " -- Shareholder Rights Plans."
WARRANTS TO PURCHASE PREFERRED STOCK AND COMMON STOCK
At October 9, 1997 the Company had outstanding warrants to purchase 183,755
shares of Series B Common Stock at an exercise price of approximately $0.20 per
share, warrants to purchase 100,000 shares of Series C Preferred Stock at an
exercise price of approximately $1.96 per share, warrants to purchase 714,303
shares of Series D Preferred Stock at an exercise price of approximately $9.41
per share and a warrant to purchase 3,709,305 shares of Series E Preferred Stock
at an exercise price of $13.48 per share. The warrants to purchase shares of
Series B Common Stock, Series C Preferred Stock and Series E Preferred Stock
will terminate on closing of the offering. The warrants to purchase shares of
Series D Preferred Stock expire on November 27, 1998 and, following the
offering, will be exercisable for an equivalent number of shares of Common
Stock. All of the Company's outstanding warrants currently are exercisable.
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CERTAIN VOTING AND OTHER MATTERS
Holders of preferred stock or other capital stock hereafter issued by the
Company may be entitled to vote in connection with certain mergers and share
exchanges, certain proposals to sell substantially all of the Company's assets
or certain other actions, and separate approval may be required to the extent
class voting rights are accorded to the holders of other capital stock of the
Company. Amendments to the Articles must be approved by the Board of Directors
and the holders of a majority of the outstanding shares of Common Stock in most
instances.
ARTICLES AND BYLAWS
Under the Articles, Mr. Glaser shall serve, or shall appoint another
officer of the Company to serve, as the Company's Policy Ombudsman, with the
exclusive authority to adopt or change the editorial policies of the Company as
reflected on the Company's Web sites or other communications or media where the
Company has a significant editorial or media voice. On the death, resignation or
removal of Mr. Glaser as the Policy Ombudsman, the Chief Executive Officer shall
serve or appoint another officer of the Company to serve as his or her
successor. The provisions delineating the authority of the Policy Ombudsman may
be amended only with the approval of 90% of the shares entitled to vote on an
amendment to the Articles.
In addition, the Articles provide for a Strategic Transactions Committee
comprised of three directors, who shall initially be Messrs. Glaser, Breyer and
Kapor. Without the prior approval of such Committee, and subject to certain
limited exceptions, the Board of Directors shall not have the authority to (i)
adopt a plan of merger, (ii) authorize the sale, lease, exchange or mortgage of
(A) assets representing more than 50% of the book value of the Company's assets
prior to the transaction or (B) any other asset or assets on which the long-term
business strategy of the Company is substantially dependent, (iii) authorize the
Company's voluntary dissolution or (iv) take any action that has the effect of
clauses (i) through (iii). Any vacancy on the Committee shall be filled by the
remaining members of the Committee. If two members of the Committee remain and
are unable to agree on an individual to fill the vacancy, such vacancy may be
filled by the member who holds or controls, directly or indirectly, the larger
percentage of the outstanding shares of the Company's capital stock. The
Committee, by vote of the Chairman of the Committee and one additional member,
may limit the powers of the Committee or may terminate the Committee. The
existence and powers of the Committee shall terminate when the members in the
aggregate cease to hold or control, directly or indirectly, at least 10% of the
outstanding shares of the Company's capital stock. The provisions with respect
to the authority of the Strategic Transactions Committee may be amended only
with the approval of 90% of the shares entitled to vote on an amendment to the
Articles.
Special meetings of the shareholders may be called only by the Board of
Directors, the Chairman of the Board, the President or the holders of at least
25% of all votes entitled to be cast on any issue proposed to be considered at
such special meeting. The Company's Bylaws provide that shareholders seeking to
bring business before, or to nominate directors at, any meeting of shareholders
must provide timely notice thereof in writing. To be timely, a shareholder's
notice must be delivered to, or mailed and received at, the principal executive
offices of the Company not less than 70 days prior to the date of the meeting,
or the tenth day after notice of the meeting is first given to shareholders,
whichever is later, if the meeting is an annual meeting or a special meeting at
which directors are to be elected. The Bylaws also contain specific requirements
for the form of a shareholder's notice. These provisions may preclude or deter
some shareholders from bringing matters before the shareholders or from making
nominations for directors.
CONTRACTUAL AGREEMENTS
On July 21, 1997, the Company and Microsoft entered into a Limited Proxy
and Voting Agreement (the "Proxy Agreement") that gives Mr. Glaser, or Mr.
Jacobsen if Mr. Glaser is unable to act, an irrevocable proxy with respect to
the voting of Microsoft's shares of the Company's nonvoting capital stock. The
Proxy Agreement does not apply to voting with respect to certain matters, such
as certain
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amendments to the Articles in which the class of shares held by Microsoft is
treated adversely or disproportionately relative to other classes. The Proxy
Agreement terminates upon the earliest of (i) the date on which Microsoft no
longer holds any nonvoting shares, (ii) the conversion of the Series E Preferred
Stock into Common Stock and (iii) July 21, 2007.
Under the Voting Agreement entered into in September 1997 among the
Company, Accel IV and Messrs. Jacobsen, Kapor and Glaser, each of Accel IV and
Messrs. Jacobsen and Kapor have agreed, effective on closing of the offering, to
vote all shares of stock of the Company owned by such shareholders to elect Mr.
Glaser to the Board of Directors of the Company in each election in which he is
a nominee. The obligations under the Voting Agreement terminate with respect to
shares transferred by the parties thereto. The Voting Agreement terminates on
the death of Mr. Glaser.
The Company, Mr. Glaser and certain holders of Series B Common Stock and
Series C Common Stock (together, the "Shares") have entered into a Shareholders'
Buy-Sell Agreement dated March 31, 1995 (the "Buy-Sell Agreement") that
restricts the free transferability of the Shares held by parties to the Buy-Sell
Agreement. The Buy-Sell Agreement gives the Company and other parties to the
Buy-Sell Agreement a right of first refusal with respect to a party's proposed
transfer of Shares, other than transfers to the Company, to certain family
members and to trusts that are created and administered for the exclusive
benefit of certain family members. The Buy-Sell Agreement is terminable upon the
written agreement of the Company and the holders of two-thirds of the Shares on
the dissolution, bankruptcy or insolvency of the Company, or at such time as
there is only one remaining party to the Buy-Sell Agreement.
WASHINGTON ANTITAKEOVER STATUTE
Washington law contains certain provisions that may have the effect of
delaying, deterring or preventing a takeover or change in control of the
Company. Chapter 23B.19 of the Washington Act prohibits the Company, with
certain exceptions, from engaging in certain significant business transactions
with an "acquiring person" (defined as a person who acquires 10% or more of the
Company's voting securities without the prior approval of the Company's Board of
Directors) for a period of five years after such acquisition. The prohibited
transactions include, among others, a merger with, disposition of assets to, or
issuance or redemption of stock to or from, the acquiring person, or otherwise
allowing the acquiring person to receive any disproportionate benefit as a
shareholder. The Company may not exempt itself from coverage of this statute.
These statutory provisions may have the effect of delaying, deterring or
preventing a change in control of the Company.
SHAREHOLDER RIGHTS PLAN
The Company currently is contemplating entering into a Shareholder Rights
Plan (the "Rights Plan") by and between the Company and a rights agent to be
selected by the Company that would be adopted prior to the closing of the
offering. Under the proposed Rights Plan, the Board would declare and distribute
to the shareholders of record of the Company as of the date selected by the
Board a dividend of one right ("Right") for each outstanding share of Common
Stock and Special Common Stock, if any. Shares of Common Stock issued in the
offering (assuming no triggering event) would automatically receive the Rights.
The Rights would not be exercisable or transferable separately from shares of
Common Stock and Special Common Stock, if any, until the earlier of: (i) 10 days
following a public announcement that a person or group has acquired, or obtained
the right to acquire, beneficial ownership of a designated percentage of the
outstanding shares of the Common Stock and (ii) 10 days following the
commencement or announcement of an intention to make a tender or exchange offer
that would result in an acquiring person or group beneficially owning a
designated percentage of outstanding shares of Common Stock, unless the Board
sets a later date (the earlier of such dates, the "Distribution Date"). The
Board would have the option to redeem the Rights at a nominal cost or prevent
the Rights from being triggered by designating offers for all outstanding Common
Stock as a permitted offer. Prior to the Distribution Date, the Company would be
able to amend or supplement the Rights Plan without the consent of any of the
holders of the Rights. Following the Distribution Date, the Rights Plan could be
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amended to cure any ambiguity, to correct or supplement any inconsistent
provision or any other provision so long as such amendment or supplement would
not adversely affect the holders of the Rights (other than an acquiring person
or group). The Rights would expire 10 years after the date of adoption of the
Rights Plan by the Board unless earlier redeemed by the Company.
The Rights, when exercisable, would entitle their holders (other than those
Rights held by an acquiring person or group) to purchase a specified fraction of
a share of preferred stock (subject to adjustment) or, in certain instances,
other securities of the Company. In certain circumstances, if the Company, in a
merger or consolidation, is not the surviving entity or disposes of more than
50% of the Company's assets or earnings power, the Rights would also entitle
their holders (other than an acquiring person or group) to purchase the highest
priority voting shares in the surviving entity or its affiliates having a market
value of two times the exercise price of the Rights.
The Rights Plan is intended to encourage a potential acquiring person or
group to negotiate directly with the Board, but may have certain antitakeover
effects. The Rights Plan, if adopted, could significantly dilute the interests
in the Company of an acquiring person or group. The Rights Plan could therefore
have the effect of delaying, deterring or preventing a change in control of the
Company.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services, Ridgefield Park, New Jersey.
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the offering, there has been no public market for the Common
Stock, and there can be no assurance that a significant public market for the
Common Stock will be developed or be sustained after the offering. Sales of
substantial amounts of Common Stock in the public market after the offering, or
the possibility of such sales occurring, could adversely affect prevailing
market prices for the Common Stock or the future ability of the Company to raise
capital through an offering of equity securities.
On closing of the offering, the Company will have outstanding 30,965,079
shares of Common Stock (31,415,079 shares if the Underwriters' over-allotment
option is exercised in full), of which 3,000,000 shares offered hereby
(3,450,000 shares if the Underwriters' over-allotment option is exercised in
full) will be freely transferable in the public market without restriction or
further registration under the Securities Act unless purchased by "affiliates"
of the Company as that term is defined in Rule 144 under the Securities Act (an
"Affiliate"), which shares will be subject to the resale limitations of Rule
144. The remaining 27,965,079 Restricted Shares outstanding on completion of the
offering (assuming no exercise of options after October 9, 1997) and held by
existing shareholders will be "Restricted Securities" as that term is defined
under Rule 144. The Restricted Shares were issued in private transactions in
reliance on exemptions from registration under the Securities Act. Restricted
Shares may be sold in the public market only if registered or if they qualify
for an exemption from registration under Rule 144 or 701 of the Securities Act,
which rules are summarized below.
Pursuant to the Lock-Up Agreements, certain holders of Restricted Shares,
including all officers and directors of the Company, have agreed with the
representatives of the Underwriters that, for a period of 180 days following the
date of this Prospectus, they will not sell, offer to sell or otherwise dispose
of any shares of Common Stock owned of record or beneficially by such persons as
of the date of this Prospectus, including securities convertible into or
exercisable or exchangeable for shares of Common Stock as of said date, as well
as any shares of Common Stock later acquired by reason of the conversion,
exercise or exchange of such securities, except that persons other than
officers, directors and holders of 1% or more of the capital stock of the
Company each will be free to sell or otherwise dispose of up to 5,000 shares of
Common Stock to the extent permissible under Rule 144 or Rule 701. On closing of
the offering, 27,670,989 of the Restricted Shares will be subject to restriction
pursuant to Lock-Up
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Agreements. The Lock-Up Agreements may be released at any time as to all or any
portion of the shares subject to such agreements at the sole discretion of
Goldman, Sachs & Co. on behalf of the Underwriters.
Based on the provisions of the Lock-Up Agreements and the provisions of
Rules 144 and 701 of the Securities Act, additional shares of Common Stock will
be available for sale in the public market as follows: (i) 11,947 shares will be
eligible for immediate sale in the public market on the date of this Prospectus
pursuant to Rule 144(k) under the Securities Act, (ii) 281,143 shares issued
upon exercise of options prior to October 9, 1997 not subject to Lock-Up
Agreements will be eligible for sale in the public market in accordance with
Rule 701 as soon as 90 days after the date of this Prospectus, (iii) 1,000
shares will be eligible for public sale subject to compliance with the holding
period and volume and manner of sale restrictions of Rule 144, (iv) 4,707,363
shares issuable upon the exercise of warrants (assuming all outstanding warrants
are exercised) will not be available for sale until expiration of the applicable
holding period under Rule 144 and (v) 27,670,989 currently outstanding shares
will be eligible for sale upon expiration of Lock-Up Agreements. At October 9,
1997, options for 6,390,014 shares of Common Stock were outstanding, of which
options for 1,673,755 shares may be exercised during the 180 days following the
date of this Prospectus, which shares potentially will be eligible for public
sale 90 days after the date of this Prospectus pursuant to Rule 701 under the
Securities Act; of the shares exercisable within 180 days, 1,301,463 will be
subject to Lock-Up Agreements.
In general, Rule 144 provides that any person who has beneficially owned
shares for at least one year, including an "affiliate" (as defined in Rule 144),
is generally entitled to sell, within any three-month period, a number of shares
that does not exceed the greater of 1% of the shares of Common Stock then
outstanding (approximately 309,651 shares immediately after the offering) or the
reported average weekly trading volume of the Common Stock during the four
calendar weeks immediately preceding the date on which notice of the sale is
sent to the Commission. Sales under Rule 144 are subject to certain manner of
sale restrictions, notice requirements and availability of current public
information concerning the Company. A person who is not an Affiliate of the
Company, and who has not been an Affiliate within three months prior to the
sale, generally may sell shares without regard to the limitations of Rule 144
provided that the person has held such shares for at least two years.
Any employee, director or officer of, or consultant to, the Company holding
shares purchased pursuant to a written compensatory plan or contract (including
options) entered into prior to the offering is entitled to rely on the resale
provisions of Rule 701, which permit nonaffiliates to sell such shares without
having to comply with the public information, holding period, volume limitation
or notice requirements of Rule 144 and permit Affiliates to sell their Rule 701
shares without having to comply with the holding period restrictions of Rule
144, in each case beginning 90 days after the date of this Prospectus.
REGISTRATION RIGHTS
Pursuant to the Investors' Rights Agreement, which provides registration
rights to certain holders of shares of the Company's capital stock, holders of
16,390,753 shares of Common Stock or their permitted transferees (collectively,
the "Registrable Shares") (assuming (i) exercise of all outstanding warrants to
purchase shares of Common Stock, (ii) conversion of the Series E Preferred Stock
into Common Stock and (iii) exercise of the Series E Warrant in its entirety for
shares of Common Stock have certain rights with respect to the registration of
the Registrable Shares under the Securities Act). Under the terms of the
Investors' Rights Agreement, if the Company proposes to register any of its
securities under the Securities Act for its own account or for the account of
others, Registrable Shares may be included, subject to any limitation set by the
underwriters on the number of shares included in such registration. Holders of
not less than 30% of the Registrable Shares may also require the Company, not
more than twice, to file a registration statement under the Securities Act, at
the Company's expense, with respect to any Registrable Shares holders desire to
include. In addition, Holders of Registrable Shares may require the Company to
file up to three registration statements on Form S-3, at the expense of the
holders, for public offerings of Registrable Shares, provided that the aggregate
offering price for such registration is
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not less than $250,000. The Company is required to use its best efforts to
effect all such registrations, subject to certain conditions and limitations.
LEGAL MATTERS
The validity of the Common Stock being offered hereby will be passed upon
for the Company by Graham & James LLP/Riddell Williams P.S., Seattle,
Washington. Certain legal matters in connection with the offering will be passed
upon for the Underwriters by Perkins Coie, Seattle, Washington.
EXPERTS
The consolidated balance sheets at December 31, 1995 and 1996 and September
30, 1997, and the consolidated statements of operations, shareholders' equity
(deficit) and cash flows for the period from February 9, 1994 (inception) to
December 31, 1994, the years ended December 31, 1995 and 1996, and the nine
months ended September 30, 1997 included in this Prospectus and in the
Registration Statement of which this Prospectus forms a part have been included
herein in reliance on the report of KPMG Peat Marwick LLP, independent
accountants, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 (together with all amendments and exhibits thereto, the "Registration
Statement") under the Securities Act with respect to the offer and sale of
Common Stock pursuant to this Prospectus. This Prospectus, filed as a part of
the Registration Statement, does not contain all the information set forth in
the Registration Statement or the exhibits thereto in accordance with the rules
and regulations of the Commission, and reference is hereby made to such omitted
information. Statements made in this Prospectus concerning the contents of any
contract, agreement or other document filed as an exhibit to the Registration
Statement are summaries of the terms of such contracts, agreements or documents
and are not necessarily complete. Reference is made to each such exhibit for a
more complete description of the matters involved and such statements shall be
deemed qualified in their entirety by such reference. The Registration Statement
and the exhibits thereto filed with the Commission may be inspected, without
charge, and copies may be obtained at prescribed rates, at the public reference
facility maintained by the Commission at Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the regional offices of the Commission
located at 7 World Trade Center, 13th Floor, New York, New York 10048 and
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
60661-2511. The Registration Statement and other information filed by the
Company with the Commission are also available at the Web site maintained by the
Commission on the World Wide Web at http://www.sec.gov. For further information
pertaining to the Company and the Common Stock offered by this Prospectus,
reference is made to the Registration Statement.
The Company intends to furnish its shareholders with annual reports
containing consolidated financial statements audited by its independent
accountants and quarterly reports for the first three quarters of each fiscal
year containing unaudited consolidated financial statements.
69
<PAGE> 72
REALNETWORKS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of KPMG Peat Marwick LLP, Independent Accountants.............................. F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996 and September 30, 1997... F-3
Consolidated Statements of Operations for the period from February 9, 1994 (inception)
to December 31, 1994, the years ended December 31, 1995 and 1996, and the nine
months ended September 30, 1996 (unaudited) and 1997................................ F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the period from February
9, 1994 (inception) to December 31, 1994, the years ended December 31, 1995 and
1996, and the nine months ended September 30, 1997.................................. F-5
Consolidated Statements of Cash Flows for the period from February 9, 1994 (inception)
to December 31, 1994, the years ended December 31, 1995 and 1996, and the nine
months ended September 30, 1996 (unaudited) and 1997................................ F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE> 73
INDEPENDENT AUDITORS' REPORT
The Board of Directors
RealNetworks, Inc.:
We have audited the accompanying consolidated balance sheets of RealNetworks,
Inc. (formerly Progressive Networks, Inc.) and subsidiaries as of December 31,
1995 and 1996 and September 30, 1997, and the related consolidated statements of
operations, shareholders' equity (deficit) and cash flows for the period from
February 9, 1994 (inception) to December 31, 1994, the years ended December 31,
1995 and 1996 and the nine months ended September 30, 1997. 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, 1995 and 1996 and September 30, 1997, and
the results of their operations and their cash flows for the period from
February 9, 1994 (inception) to December 31, 1994, the years ended December 31,
1995 and 1996 and the nine months ended September 30, 1997 in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
October 10, 1997
Seattle, Washington
F-2
<PAGE> 74
REALNETWORKS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
PRO FORMA
SHAREHOLDERS'
DECEMBER 31, SEPTEMBER EQUITY AT
--------------------------- 30, SEPTEMBER 30,
1995 1996 1997 1997
----------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents..................................... $ 3,129,394 $14,737,806 $ 44,751,298
Short-term investments........................................ 2,986,493 4,857,163 22,897,196
Trade accounts receivable, net of allowance for doubtful 667,847 3,275,518 4,350,464
accounts and sales returns of $129,869 in 1995, $383,350 in
1996 and $688,572 in 1997...................................
Other receivables............................................. 48,568 105,888 474,691
Inventory..................................................... 3,218 60,543 66,029
Prepaid expenses and other current assets..................... 143,328 491,348 319,188
Deferred income taxes......................................... -- -- 2,210,000
----------- ----------- ------------
Total current assets.................................... 6,978,848 23,528,266 75,068,866
Property and equipment, net.................................... 594,042 2,678,798 4,773,480
Investment in joint venture.................................... -- -- 924,917
Deferred income taxes.......................................... -- -- 2,990,000
Other assets................................................... 836 261,094 614,371
----------- ----------- ------------
$ 7,573,726 $26,468,158 $ 84,371,634
=========== =========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable.............................................. $ 185,368 $ 2,405,490 $ 1,193,543
Accrued compensation.......................................... 49,981 346,011 769,215
Other accrued expenses........................................ 149,909 971,499 2,745,782
Accrued income taxes.......................................... -- -- 5,200,000
Deferred revenue.............................................. 645,416 2,911,922 14,398,509
----------- ----------- ------------
Total current liabilities............................... 1,030,674 6,634,922 24,307,049
----------- ----------- ------------
Deferred revenue.............................................. -- -- 17,916,660
Note payable.................................................. -- -- 959,380
Redeemable, convertible preferred stock, $0.001 par value.
Authorized 16,206,998 shares; issued and outstanding 7,654,528 23,153,494 49,277,652
5,964,006 shares at December 31, 1995, 8,345,016 shares at
December 31, 1996 and 11,683,390 shares at September 30,
1997 (none pro forma) (aggregate liquidation preference of
$7,752,312 at December 31, 1995, $34,645,820 at December
31, 1996 and $64,657,802 at September 30, 1997 and
aggregate redemption value of $7,752,312 at December 31,
1995, $25,681,317 at December 31, 1996 and $55,693,300 at
September 30, 1997)....................................... $ --
SHAREHOLDERS' EQUITY (DEFICIT):
Convertible preferred stock, $0.001 par value.
Authorized, issued and outstanding; 13,713,439 shares at 13,713 13,713 13,713
December 31, 1995 and 1996, and September 30, 1997 (none
pro forma) (aggregate liquidation preference of $999,710
at December 31, 1995 and 1996, and September 30, 1997).... --
Preferred stock, undesignated series, $0.001 par value.
Authorized 30,079,563 shares; no shares issued and -- -- --
outstanding............................................... --
Common stock, $0.001 par value.
Authorized 300,000,000 shares; issued and outstanding; 37 535 1,543
36,948 shares at December 31, 1995, 535,491 shares
at December 31, 1996 and 1,543,292 shares at September 30,
1997 (26,940,121 pro forma)............................... 26,940
Additional paid-in capital.................................... 921,315 2,543,587 6,755,080 56,021,048
Cumulative translation adjustment............................. -- (11,307) (72,041) (72,041)
Accumulated deficit........................................... (2,046,541) (5,866,786) (14,787,402) (14,787,402)
----------- ----------- ------------ -------------
Total shareholders' equity (deficit).................... (1,111,476) (3,320,258) (8,089,107) $ 41,188,545
=============
Commitments and contingencies
----------- ----------- ------------
$ 7,573,726 $26,468,158 $ 84,371,634
=========== =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 75
REALNETWORKS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 9,
1994 NINE MONTHS ENDED SEPTEMBER
(INCEPTION) TO YEAR ENDED DECEMBER 31, 30,
DECEMBER 31, --------------------------- ---------------------------
1994 1995 1996 1996 1997
-------------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
NET REVENUES:
Software license fees.......... $ -- $ 1,781,763 $11,875,945 $ 7,213,357 $17,550,387
Advertising.................... -- -- 1,015,964 426,035 1,556,540
Service revenues............... -- 29,835 1,120,479 634,787 3,309,877
--------- ---------- ---------- ---------- ----------
Total net revenues...... -- 1,811,598 14,012,388 8,274,179 22,416,804
COST OF REVENUES:
Software license fees.......... -- 29,194 1,342,942 470,440 2,080,167
Advertising.................... -- -- 288,024 186,909 571,595
Service revenues............... -- 32,940 554,558 311,916 1,956,899
--------- ---------- ---------- ---------- ----------
Total cost of -- 62,134 2,185,524 969,265 4,608,661
revenues..............
--------- ---------- ---------- ---------- ----------
Gross profit................. -- 1,749,464 11,826,864 7,304,914 17,808,143
OPERATING EXPENSES:
Research and development....... 201,847 1,379,727 4,812,188 3,073,031 9,129,668
Selling and marketing.......... 47,181 1,217,900 7,539,924 4,389,030 14,024,617
General and administrative..... 296,211 746,645 3,491,296 2,318,173 4,412,831
--------- ---------- ---------- ---------- ----------
Total operating 545,239 3,344,272 15,843,408 9,780,234 27,567,116
expenses..............
--------- ---------- ---------- ---------- ----------
Operating loss............... (545,239) (1,594,808) (4,016,544) (2,475,320) (9,758,973)
OTHER INCOME (EXPENSE):
Interest income, net........... -- 93,506 296,427 189,320 1,220,374
Other income (expense)......... -- -- (69,128) (28,977) 37,174
Equity in net losses of joint
venture...................... -- -- -- -- (73,291)
--------- ---------- ---------- ---------- ----------
Net other income............. -- 93,506 227,299 160,343 1,184,257
--------- ---------- ---------- ---------- ----------
Net loss..................... $ (545,239) $(1,501,302) $(3,789,245) $(2,314,977) $(8,574,716)
========= ========== ========== ========== ==========
Pro forma net loss per share... $ (0.14) $ (0.32)
Shares used to compute pro
forma net loss per share..... 27,779,321 28,315,053
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 76
REALNETWORKS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
PREFERRED STOCK COMMON STOCK ADDITIONAL CUMULATIVE SHAREHOLDERS'
-------------------- ------------------ PAID-IN TRANSLATION ACCUMULATED EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL ADJUSTMENT DEFICIT (DEFICIT)
---------- ------- --------- ------ ---------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sale of common stock....... -- $ -- 10,000 $ 10 $ 72,828 $ -- $ -- $ 72,838
Contribution of capital by
founder.................. -- -- -- -- 487,357 -- -- 487,357
Net loss................. -- -- -- -- -- -- (545,239) (545,239)
---------- -------- -------- --------- --------- -------- ----------- -----------
Balances at December 31,
1994..................... -- -- 10,000 10 560,185 -- (545,239) 14,956
Contribution of capital by
founder.................. -- -- -- -- 372,283 -- -- 372,283
Exchange of common stock
for Series A preferred
stock.................... 13,713,439 13,713 (9,999) (10) (13,703) -- -- --
Exercise of common stock
options.................. -- -- 30,750 31 2,122 -- -- 2,153
Issuance of common stock in
exchange for services.... -- -- 6,197 6 428 -- -- 434
Net loss................. -- -- -- -- -- -- (1,501,302) (1,501,302)
---------- -------- -------- --------- --------- -------- ----------- -----------
Balances at December 31,
1995..................... 13,713,439 13,713 36,948 37 921,315 -- (2,046,541) (1,111,476)
Exercise of common stock
options.................. -- -- 498,543 498 43,272 -- -- 43,770
Issuance of preferred stock
warrants................. -- -- -- -- 1,579,000 -- -- 1,579,000
Translation adjustment..... -- -- -- -- -- (11,307) -- (11,307)
Accretion of redemption
value of redeemable,
convertible preferred
stock.................... -- -- -- -- -- -- (31,000) (31,000)
Net loss................. -- -- -- -- -- -- (3,789,245) (3,789,245)
---------- -------- -------- --------- --------- -------- ----------- -----------
Balances at December 31,
1996..................... 13,713,439 13,713 535,491 535 2,543,587 (11,307) (5,866,786) (3,320,258)
Exercise of common stock
options.................. -- -- 1,006,801 1,007 141,494 -- -- 142,501
Issuance of common stock in
exchange for services.... -- -- 1,000 1 1,999 -- -- 2,000
Issuance of preferred stock
warrants................. -- -- -- -- 4,068,000 -- -- 4,068,000
Translation adjustment..... -- -- -- -- -- (60,734) -- (60,734)
Accretion of redemption
value of redeemable,
convertible preferred
stock.................... -- -- -- -- -- -- (345,900) (345,900)
Net loss................. -- -- -- -- -- -- (8,574,716) (8,574,716)
---------- -------- -------- --------- --------- -------- ----------- -----------
Balances at September 30,
1997..................... 13,713,439 $13,713 1,543,292 $1,543 $6,755,080 $ (72,041) $ (14,787,402) $(8,089,107)
========== ======== ======== ========= ========= ======== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 77
REALNETWORKS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 9, 1994 YEAR ENDED NINE MONTHS ENDED
(INCEPTION) TO DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, --------------------------- ----------------------------
1994 1995 1996 1996 1997
---------------- ----------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss..................................... $ (545,239) $(1,501,302) $ (3,789,245) $ (2,314,977) $ (8,574,716)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization.............. 5,295 93,265 699,087 333,242 1,397,108
Common stock issued in exchange for
services................................. -- 434 -- -- 2,000
Equity in net losses of joint venture...... -- -- -- -- 73,291
Foreign currency transaction gain.......... -- -- -- -- (31,888)
Deferred income tax benefit................ -- -- -- -- (5,200,000)
Change in certain assets and liabilities:
Trade accounts receivable................ -- (667,847) (2,607,671) (1,536,816) (1,079,435)
Other receivables........................ -- -- (57,320) (246,591) (368,803)
Inventory................................ -- (3,218) (57,325) (65,875) (5,486)
Prepaid expenses and other current
assets................................. -- (143,328) (348,723) (342,262) 168,876
Other assets............................. -- -- (78,298) 355 (104,858)
Accounts payable......................... -- 185,368 2,220,292 842,186 (1,210,809)
Accrued compensation..................... 15,817 34,164 296,030 217,119 423,951
Other accrued expenses................... 33,217 116,692 821,590 333,622 1,774,984
Accrued income taxes..................... -- -- -- -- 5,200,000
Deferred revenue......................... -- 645,416 2,266,506 1,338,432 29,405,712
-------- ---------- ---------- ---------- ----------
Net cash provided by (used in)
operating activities................. (490,910) (1,240,356) (635,077) (1,441,565) 21,869,927
-------- ---------- ---------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment.......... (67,542) (624,503) (2,783,994) (1,705,783) (3,496,171)
Purchases of short-term investments.......... -- (3,035,061) (30,514,885) (11,836,281) (189,419,284)
Proceeds from sales and maturities of
short-term investments..................... -- -- 28,644,215 13,279,604 171,379,251
Investment in joint venture.................. -- -- -- -- (998,208)
Increase in other assets..................... (1,393) -- (181,960) (237,708) (250,575)
-------- ---------- ---------- ---------- ----------
Net cash used in investing
activities........................... (68,935) (3,659,564) (4,836,624) (500,168) (22,784,987)
-------- ---------- ---------- ---------- ----------
Cash flows from financing activities:
Proceeds from issuance of note payable....... -- -- -- -- 991,268
Proceeds from sale of preferred stock and
stock warrants, net........................ -- 7,404,528 17,046,966 -- 29,846,258
Proceeds from exercise of preferred stock
warrant.................................... -- 250,000 -- -- --
Proceeds from exercise of common stock
options.................................... -- 2,153 43,770 42,749 142,501
Proceeds from sale of common stock........... 72,838 -- -- -- --
Contribution of capital by founder........... 487,357 372,283 -- -- --
-------- ---------- ---------- ---------- ----------
Net cash provided by financing
activities........................... 560,195 8,028,964 17,090,736 42,749 30,980,027
-------- ---------- ---------- ---------- ----------
Effect of exchange rate changes on cash........ -- -- (10,623) -- (51,475)
-------- ---------- ---------- ---------- ----------
Net increase (decrease) in cash and
cash equivalents..................... 350 3,129,044 11,608,412 (1,898,984) 30,013,492
Cash and cash equivalents at beginning of
period....................................... -- 350 3,129,394 3,129,394 14,737,806
-------- ---------- ---------- ---------- ----------
Cash and cash equivalents at end of period..... $ 350 $ 3,129,394 $ 14,737,806 $ 1,230,410 $ 44,751,298
======== ========== ========== ========== ==========
Supplemental disclosure of cash flow
information -- cash paid during the period
for interest................................. $ -- $ 1,853 $ 4,430 $ -- $ 26,633
Supplemental disclosure of noncash financing
and investing activities:
Exchange of common stock for Series A
preferred stock............................ $ -- $ 932,385 $ -- $ -- $ --
Accretion of redemption value of redeemable,
convertible preferred stock................ $ -- $ -- $ 31,000 $ -- $ 345,900
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 78
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994, 1995 AND 1996, AND SEPTEMBER 30, 1996 AND 1997
(INFORMATION FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996 IS UNAUDITED)
(1) NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Business
RealNetworks, Inc. (formerly Progressive Networks, Inc.) and subsidiaries
(Company) is a leading provider of branded software products and services that
enable the delivery of streaming media content over the Internet and intranets.
Streaming technology enables the transmission and playback of continuous
"streams" of multimedia content, such as audio and video, over the Internet and
intranets. The Company's products and services include its RealSystem, a
streaming media solution that includes RealAudio and RealVideo technology, an
electronic commerce Web site designed to promote the proliferation of streaming
media products and a network of advertising-supported content aggregation Web
sites.
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 as a communications medium, the acceptance of the Company's technology
by the marketplace and the Company's ability to generate license 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.
(c) Cash and 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 classifies its short-term investments as available-for-sale.
Accordingly, these investments are carried at fair value. The fair value of such
securities approximated cost, and there were no unrealized holding gains or
losses at December 31, 1995 and 1996, and September 30, 1997. At September 30,
1997, all short-term investments have contractual maturities of two years or
less.
F-7
<PAGE> 79
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company's cash and cash equivalents and short-term investments as of
December 31, 1995 and 1996 and September 30, 1997 consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------- SEPTEMBER 30,
1995 1996 1997
---------- ----------- -------------
<S> <C> <C> <C>
Cash and cash equivalents:
Cash........................................ $1,104,358 $ 1,016,728 $ 1,538,598
Commercial paper............................ 2,025,036 13,721,078 35,648,430
U.S. Government agency securities........... -- -- 7,564,270
--------- ---------- ----------
Total cash and cash equivalents..... 3,129,394 14,737,806 44,751,298
Short-term investments:
Corporate notes............................. 2,986,493 4,857,163 10,416,565
U.S. Government agency securities........... -- -- 9,980,935
Certificates of deposit..................... -- -- 2,499,696
--------- ---------- ----------
Total short-term investments........ 2,986,493 4,857,163 22,897,196
--------- ---------- ----------
Total cash and cash equivalents and
short-term investments............ $6,115,887 $19,594,969 $67,648,494
========= ========== ==========
</TABLE>
(d) Inventory
Inventory is stated at the lower of cost or market, with cost determined on
the first-in, first-out basis.
(e) Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets,
generally three years. Leasehold improvements are amortized over the lesser of
the term of the lease or the estimated useful life of the asset.
(f) Investment in Joint Venture
The Company has a 24% interest in a Japanese limited liability company and
accounts for this investment using the equity method. Accordingly, the initial
investment is recorded at cost. Subsequently, the carrying amount of the
investment is increased or decreased to reflect the Company's share of income or
losses of the joint venture and is reduced to reflect dividends received from
the joint venture. The Company's share of income or losses of the joint venture
is included in the Company's consolidated statements of operations.
(g) Research and Development
Research and development costs are charged to operations as incurred.
Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed, requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility.
Based on the Company's product development process, technological
feasibility is established upon completion of a working model. Costs incurred by
the Company between completion of the working model and the point at which the
product is ready for general release have been insignificant.
F-8
<PAGE> 80
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(h) Revenue Recognition
The Company recognizes revenue from software license fees upon delivery,
net of an allowance for estimated returns, provided that no significant
obligations remain on the Company's behalf and collection of the resulting
receivable is deemed probable.
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 generally recognized on the
straight-line method over the term of the contract.
The Company recognizes revenue from software license agreements with
value-added resellers (VAR) upon delivery to the VAR, provided necessary
conditions are met. If these conditions are not met, revenue is recognized upon
redistribution by the VAR to the end user.
Revenues from advertising appearing on the Company's World Wide Web (Web)
sites are recognized on the straight-line method over the terms of the
advertising contracts. The Company guarantees to certain advertising customers a
minimum number of page impressions to be delivered to users of its Web sites for
a specified period. To the extent guaranteed minimum page impression deliveries
are not met, the Company defers recognition of the corresponding revenues until
guaranteed page impression delivery levels are achieved. As of December 31, 1996
and September 30, 1997, no revenues had been deferred as a result of these
guarantees.
Service revenues include revenues from upgrade and support agreements,
consulting, content hosting, and fees from user conferences. Service revenues
from upgrade and support agreements are recognized ratably over the term of the
related agreements. Other service revenues are recognized when the service is
performed.
(i) Financial Instruments and Concentrations of Risk
The Company's financial instruments consist of cash and cash equivalents,
short-term investments, trade accounts receivable, accounts payable, accrued
expenses, and note payable. The fair value of these instruments approximates
their financial statement carrying amount. 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. Substantially all of the Company's
accounts receivable are derived from domestic sales.
The Company is subject to concentrations of credit 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 investment securities and securities of the U.S. government, and
limiting the average maturity of the overall portfolio.
F-9
<PAGE> 81
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The Company's customers consist primarily of resellers and end users
located in the United States and various foreign countries. Revenues in the
years ended December 31, 1995 and 1996 and the nine months ended September 30,
1996 and 1997 by geographic region, as a percent of total net revenues, are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------- -------------
1995 1996 1996 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
United States and Canada....................... 85% 81% 82% 76%
Asia........................................... 8% 7% 8% 11%
Europe......................................... 5% 7% 7% 10%
Other.......................................... 2% 5% 3% 3%
</TABLE>
One customer accounted for approximately 14% of total net revenues in 1995.
No one customer accounted for more than 10% of total net revenues in 1996 and
the nine months ended September 30, 1996. Software license fees under a license
agreement with Microsoft Corporation (Microsoft) (see note 8) accounted for
approximately 11% of total net revenues for the nine months ended September 30,
1997.
(j) Advertising Expenses
The Company expenses the cost of advertising and promoting its products as
incurred. Such costs are included in selling and marketing expense and totaled
approximately $68,000 and $665,000 during the years ended December 31, 1995 and
1996, respectively, and $365,000 and $751,000 during the nine months ended
September 30, 1996 and 1997, respectively.
(k) Income Taxes
The Company was an S corporation for federal income tax purposes from
inception through April 8, 1995. Consequently, taxable income or loss of the
Company through April 8, 1995 was attributed to the Company's shareholders.
Effective April 8, 1995, the Company changed its election to utilize the
provisions of subchapter S of the Internal Revenue Code of 1986, as amended, and
elected to be taxed as a subchapter C corporation.
The Company utilizes the asset and liability method of accounting for
income taxes. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in results of
operations in the period that includes the enactment date.
Pro forma income tax information has not been provided for the period from
inception to April 8, 1995. As a result of the operating losses recognized prior
to April 8, 1995, any income tax benefit would have been fully offset by the
establishment of a valuation allowance for deferred tax assets had the Company
been taxed as a subchapter C corporation.
(l) Foreign Currency Translation
The functional currency of the Company's foreign subsidiaries is the local
currency in the country in which the subsidiary is incorporated. Assets and
liabilities of foreign operations are translated into U.S.
F-10
<PAGE> 82
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 a
cumulative translation adjustment in shareholders' equity. Gains and losses from
foreign currency transactions are included in the consolidated statement of
operations.
(m) 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 and
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.
(n) Stock-Based Compensation
The Company accounts for its stock option plans for employees in accordance
with the provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As such,
compensation expense related to employee stock options would be recorded only
if, on the date of grant, the fair value of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted the disclosure-only
requirements of SFAS No. 123, Accounting for Stock-Based Compensation, which
allows entities to continue to apply the provisions of APB Opinion No. 25 for
transactions with employees and provide pro forma net income and pro forma
earnings per share disclosures for employee stock option grants made in 1995 and
future years as if the fair-value-based method of accounting in SFAS No. 123 had
been applied to these transactions.
(o) Impairment of Long-Lived Assets
The Company reviews its long-lived assets 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 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.
(p) Reclassifications
Certain reclassifications have been made to the 1994, 1995 and 1996
consolidated financial statements to conform with the 1997 presentation.
(q) Unaudited Interim Financial Statements
In the opinion of the Company's management, the September 30, 1996
unaudited interim financial statements include all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation.
(r) Pro Forma Net Loss Per Share
Pro forma net loss per share is computed by dividing the sum of net loss
plus accretion of redemption value of redeemable, convertible preferred stock by
the weighted average number of shares of common stock and common stock
equivalents outstanding during each period and the shares resulting from the
conversion of all outstanding shares of preferred stock. Common stock
equivalents include all
F-11
<PAGE> 83
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
warrants and stock options which would have a dilutive effect, applying the
treasury stock method. Additionally, common and common equivalent shares issued
during the twelve months immediately preceding the initial filing of the
Company's initial public offering (IPO) have been included in the calculation of
common and common equivalent shares as if they were outstanding for all periods
presented, including loss years where the impact of the incremental shares is
antidilutive, using the treasury stock method and an assumed initial public
offering price of $10.00 per share. Due to the significant impact of the assumed
conversion of the preferred stock upon closing of the IPO, historical net loss
per share is not meaningful and, therefore, is not presented.
(s) New Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, Earnings Per Share (Statement 128). Statement 128 establishes
standards for the computation, presentation and disclosure of earnings per share
(EPS), replacing the presentation of currently required Primary EPS with a
presentation of Basic EPS. It also requires dual presentation of Basic EPS and
Diluted EPS on the face of the income statement for entities with complex
capital structures. Basic EPS is based on the weighted average number of common
shares outstanding during the period. Diluted EPS is based on the potential
dilution that would occur upon exercise or conversion of securities into common
stock using the treasury stock method. Statement 128 is effective for periods
ending after December 15, 1997, including interim periods; earlier application
is not permitted. When adopted, the Company will be required to restate its EPS
data for all prior periods presented. The Company does not expect the impact of
the adoption of Statement 128 to be material to its reported EPS amounts.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
(Statement 130). Statement 130 establishes standards for reporting and
disclosure of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements. Statement 130
is effective for fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The Company has not determined the manner in
which it will present the information required by Statement 130.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information (Statement 131). Statement 131 establishes
standards for the way that public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Statement 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years is to be
restated. The Company has not determined the manner in which it will present the
information required by Statement 131.
F-12
<PAGE> 84
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ SEPTEMBER 30,
1995 1996 1997
--------- ----------- -------------
<S> <C> <C> <C>
Computer equipment and software... $ 529,705 $ 2,210,799 $ 4,255,153
Furniture, fixtures and leasehold
improvements.................... 162,340 1,251,354 2,698,345
-------- ---------- ----------
692,045 3,462,153 6,953,498
Less accumulated depreciation and
amortization.................... 98,003 783,355 2,180,018
-------- ---------- ----------
$ 594,042 $ 2,678,798 $ 4,773,480
======== ========== ==========
</TABLE>
(3) COMMITMENTS
(a) Leases
The Company leases facilities under operating lease agreements expiring
through April 2001. Future minimum lease payments under these leases are:
<TABLE>
<CAPTION>
NET
MINIMUM MINIMUM
LEASE SUBLEASE LEASE
YEARS ENDING SEPTEMBER 30: PAYMENTS RECEIPTS PAYMENTS
---------- --------- ----------
<S> <C> <C> <C>
1998....................................... $1,906,415 $(191,100) $1,715,315
1999....................................... 1,828,750 (95,500) 1,733,250
2000....................................... 1,646,251 -- 1,646,251
2001....................................... 946,933 -- 946,933
---------- --------- ----------
Total minimum lease payments..... $6,328,349 $(286,600) $6,041,749
========== ========= ==========
</TABLE>
Rent expense totaled approximately $76,000 and $610,000 for the years ended
December 31, 1995 and 1996, respectively, and $418,000 and $1,260,000 for the
nine months ended September 30, 1996 and 1997, respectively.
In April 1996, the Company entered into operating lease agreements for
additional corporate office space, with the lease term extending through April
2001. These leases can be terminated beginning October 1998 with nine months'
advance written notice and contain options for two five-year renewals.
(b) Royalties
The Company has arrangements with several Internet content providers
whereby it is committed to pay a percentage of certain advertising revenues
generated from its Web sites. As of December 31, 1996 and September 30, 1997,
royalties under these arrangements have not been significant.
F-13
<PAGE> 85
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) INCOME TAXES
The components of income tax expense (benefit) are:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1995 1996 1997
--------- --------- -------------
<S> <C> <C> <C>
Current............................. $ -- $ -- $ 5,200,000
Deferred............................ -- -- (5,200,000)
-------- -------- -----------
$ -- $ -- $ --
======== ======== ===========
</TABLE>
The expected U.S. federal income tax benefit determined by applying the
statutory U.S. federal income tax rate of 34% to pretax loss for the period from
February 9, 1994 (inception) to December 31, 1994, the years ended December 31,
1995 and 1996 and the nine months ended September 30, 1997 differs from the U.S.
federal income tax benefit in the consolidated financial statements due
primarily to the increase in the valuation allowance for deferred tax assets.
The tax effects of temporary differences and tax loss and credit
carryforwards that give rise to significant portions of federal deferred tax
assets are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ SEPTEMBER 30,
1995 1996 1997
--------- ----------- -------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......... $ 216,000 $ 918,000 $ --
Deferred revenue.......................... 112,000 530,000 10,154,000
Allowances for doubtful accounts and
sales returns.......................... 44,000 130,000 232,000
Start-up costs capitalized for tax
purposes............................... 84,000 70,000 48,000
Research and experimentation credit
carryforwards.......................... 7,000 102,000 --
Other..................................... 30,000 78,000 276,000
-------- ---------- ----------
Gross deferred tax assets................... 493,000 1,828,000 10,710,000
Less valuation allowance.................. 493,000 1,828,000 5,510,000
-------- ---------- ----------
Net deferred tax assets..................... $ -- $ -- $ 5,200,000
======== ========== ==========
</TABLE>
The valuation allowance for deferred tax assets increased $493,000,
$1,335,000, and $3,682,000 for the years ended December 31, 1995 and 1996 and
the nine months ended September 30, 1997, respectively.
At December 31, 1996, the Company had net operating loss and other credit
carryforwards of $2,802,000. As of September 30, 1997, the Company anticipates
fully utilizing its net operating loss and other credit carryforwards by
December 31, 1997 as a result of taxable income generated from a license
agreement with Microsoft (see note 8). For financial reporting purposes, those
license fees are recognized over the three-year term of the Company's ongoing
obligations. As a result, the Company has recognized deferred tax assets to the
extent of its accrued taxes. The Company believes it is more likely than not
that its net deferred tax assets as of September 30, 1997 will be realized
through the reversal of temporary differences in 1998 and 1999.
F-14
<PAGE> 86
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(5) 401(K) RETIREMENT SAVINGS PLAN
The Company has a 401(k) Retirement Savings Plan that covers all employees
who have met certain employment requirements. Employees can contribute a portion
of their salary to the maximum allowed by the federal tax guidelines.
(6) BANK LINE OF CREDIT AND TERM LOAN AND NOTE PAYABLE
At December 31, 1996, the Company had available a $1,000,000 domestic bank
line of credit and a $1,500,000 bank term loan. There were no borrowings
outstanding under the line of credit or the term loan as of December 31, 1996,
and the Company terminated the line of credit and term loan in September 1997.
At September 30, 1997, the Company had outstanding a note payable to one of
its joint venture partners. The note is denominated in Japanese yen, bears
interest at a rate not to exceed the Japanese Short Term Prime Rate (1.63% at
September 30, 1997) and is secured by the Company's shares in the joint venture.
Interest on the note is payable monthly and the principal is due in May 2000.
The principal amount of the note is 115,200,000 Japanese yen ($959,380 at
September 30, 1997), and the Company may, under certain circumstances, tender
its shares in the joint venture as repayment of the note.
(7) SHAREHOLDERS' EQUITY
(a) Authorized Capital
In September 1997, the Company increased its authorized capital to
300,000,000 shares of common stock and 60,000,000 shares of preferred stock and
established a par value of $0.001 for both common and preferred stock. The
accompanying consolidated financial statements have been restated in all periods
presented to reflect this action.
(b) Preferred Stock
The Company has authorized and issued convertible preferred stock and
redeemable, convertible preferred stock as follows:
<TABLE>
<CAPTION>
ISSUED AND OUTSTANDING SHARES
-----------------------------------------
DECEMBER 31, SEPTEMBER
AUTHORIZED -------------------------- 30,
SERIES SHARES 1995 1996 1997
------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Convertible preferred....... A 13,713,439 13,713,439 13,713,439 13,713,439
Redeemable, convertible
preferred................. B 3,059,701 3,059,701 3,059,701 3,059,701
Redeemable, convertible
preferred................. C 3,004,305 2,904,305 2,904,305 2,904,305
Redeemable, convertible
preferred................. D 3,095,313 -- 2,381,010 2,381,010
Redeemable, convertible
preferred................. E 7,047,679 -- -- 3,338,374
</TABLE>
F-15
<PAGE> 87
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes activity of the Company's redeemable,
convertible preferred stock for the years ended December 31, 1995 and 1996, and
the nine months ended September 30, 1997:
<TABLE>
<CAPTION>
PRICE
DESCRIPTION PER SHARE SHARES AMOUNT
- ----------------------------------------------------- --------- ---------- -----------
<S> <C> <C> <C>
Balances at December 31, 1994........................ -- $ --
Sale of Series B preferred stock, net of issuance
costs of $40,000................................... $0.67 2,686,567 1,760,000
Sale of Series C preferred stock, net of issuance
costs of $57,784................................... 1.9634 2,904,305 5,644,528
Exercise of warrants for Series B preferred stock.... 0.67 373,134 250,000
--------- -----------
Balances at December 31, 1995........................ 5,964,006 7,654,528
Sale of Series D preferred stock, net of issuance
costs and warrant value of $889,186 and $1,579,000,
respectively....................................... 7.53 2,381,010 15,467,966
Accretion of redemption value........................ -- 31,000
--------- -----------
Balances at December 31, 1996........................ 8,345,016 23,153,494
Issuance costs related to sale of Series D preferred
stock.............................................. -- (22,807)
Sale of Series E preferred stock, net of issuance
costs and warrant value of $130,935 and $4,068,000,
respectively....................................... 8.99 3,338,374 25,801,065
Accretion of redemption value........................ -- 345,900
--------- -----------
Balances at September 30, 1997....................... 11,683,390 $49,277,652
========= ===========
</TABLE>
The rights, preferences and restrictions of the Series A, B, C, D and E
preferred stock are as follows:
- Each of the Series B, C, D and E preferred stock are redeemable by the
holder, on, or at any time after, December 31, 2002 with the written
consent of at least two-thirds of the respective outstanding Series B, C,
D and E shareholders. The stated redemption price at date of issuance was
$0.67, $1.9634, $7.53 and $8.99 per share for the Series B, C, D and E
preferred stock, respectively, and is to be adjusted for inflation from
the issuance date to the redemption date. Redemption payments would be
made in three equal installments commencing on the initial redemption
request date, and each year thereafter, for a period of two years. The
Company accounts for the difference between the carrying amount of
redeemable preferred stock and the redemption amount by increasing the
carrying amount for periodic accretion against accumulated deficit using
the interest method, so that the carrying amount will equal the
redemption amount at the redemption date.
- Each share of Series A, B, C and D preferred stock is convertible at the
option of the holder at any time into one share of Series A common stock,
subject to certain antidilution provisions. The holders of Series A
preferred stock have the right, under certain circumstances, to convert
one share of Series A preferred stock to one share of Series D common
stock.
- Each share of Series E preferred stock is convertible at the option of
the holder at any time into one share of either Series A common stock or
Series E common stock.
- Conversion of all Series A, B, C, D and E preferred stock is automatic
upon the closing of a public offering of the Company's common stock if
either (a) the price to the public in the offering is at least $13.554
per share and the aggregate proceeds of the offering are not less than
$20,000,000, or (b) the holders of not less than two-thirds of the then
outstanding shares of Series D preferred stock, by affirmative vote or
written consent, have consented to the automatic conversion.
F-16
<PAGE> 88
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
- Series A, B, C, D and E preferred stock have a liquidation preference of
$0.0729, $0.67, $1.9634, $11.295 and $8.99 per share, respectively, plus
all declared but unpaid dividends, if any. No dividends have been
declared through December 31, 1996 and September 30, 1997.
- Series A, B, C and D preferred stock have the same voting rights as
Series A common stock based upon the number of shares of Series A common
stock into which they are convertible. Series E preferred stock is
nonvoting except as otherwise required by law, in which case the holders
of each share of Series E preferred stock shall be entitled to one vote
per share. Series A, B, C, D and E preferred stock have preferential
treatment over all common stock with respect to any payment of dividends
when and if declared by the board of directors and any distributions of
assets upon liquidation.
Pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC), the Company has classified redeemable, convertible preferred
stock outside of shareholders' deficit.
In September 1997, the Board of Directors authorized the filing of a
registration statement with the SEC to permit the Company to sell shares of its
common stock to the public. In connection therewith, the Company received the
approval of the holders of two-thirds of the Series D preferred stock to convert
the Series A, B, C, D and E preferred stock into common stock on closing of the
IPO.
Unaudited pro forma shareholders' equity included on the face of the
balance sheet reflects the assumed conversion of redeemable, convertible
preferred stock and convertible preferred stock into common stock as of
September 30, 1997.
(c) Common Stock
Common stock at December 31, 1995 and 1996, and September 30, 1997,
consists of the following:
<TABLE>
<CAPTION>
ISSUED AND OUTSTANDING SHARES
------------------------------------
DECEMBER 31,
------------------ SEPTEMBER 30,
AUTHORIZED SHARES 1995 1996 1997
----------------- ------ ------- -------------
<S> <C> <C> <C> <C>
Series A............................... 207,047,679 1 1 1
Series B............................... 30,000,000 2,400 463,018 1,044,649
Series C............................... 30,000,000 34,547 72,472 498,642
Series D............................... 1 -- -- --
Series E............................... 7,047,679 -- -- --
</TABLE>
At January 1, 1995, 10,000 shares of common stock were issued and
outstanding. In April 1995, these 10,000 shares of common stock were exchanged
for 13,713,439 shares of Series A preferred stock and one share of Series A
common stock.
Series A, B and D common stock entitle the holder to fifteen votes for each
share held. Each share of Series E common stock shall not be entitled to vote,
except as required by law, in which case it shall entitle the holder to one
vote. Series C common stock entitles the holder to one vote for each share held.
Series B common stock is reserved for issuance to employees, directors or
affiliates of directors. Each share of Series B common stock automatically
converts to one share of Series C common stock upon termination of the holder's
employment, or status as a director or an affiliate of a director.
On the closing of a Qualified Offering of the Company's stock, as defined
in the Company's Amended and Restated Articles of Incorporation, the
designations of Series A through D common stock terminate and Series A through D
common stock convert into one class of common stock, with each share entitled to
one vote; and the designation of Series E common stock terminates and Series E
common stock converts at the option of the holder into either common stock, with
each share entitled to one vote, or Special Common Stock, with no voting rights
except as required by applicable law.
F-17
<PAGE> 89
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(d) Stock Warrants
In connection with the sale of Series B preferred stock, the Company issued
a warrant to purchase 373,134 additional shares of Series B preferred stock at
an exercise price of $0.67 per share. No separate value was assigned to the
warrant as the value was not significant at the date of issuance. This warrant
was exercised in 1995.
In connection with the sale of Series C preferred stock, the Company issued
warrants to purchase up to 100,000 additional shares of Series C preferred stock
at an exercise price of $1.9634 per share, and warrants to purchase up to
183,755 shares of Series B common stock at an exercise price of approximately
$0.20 per share. No separate value has been assigned to the warrants as the
values were not significant at the date of issuance. These warrants vest on the
earlier of January 26, 1997 or, if certain conditions are met, upon the closing
of an IPO of the Company's common stock. These warrants expire on the earlier of
the closing of an IPO by the Company with aggregate proceeds of not less than
$10,000,000 and at not less than $4.00 per share or October 26, 2000. No
warrants to purchase Series C preferred stock or Series B common stock have been
exercised as of December 31, 1996 and September 30, 1997.
In connection with the sale of Series D preferred stock, the Company issued
warrants to purchase up to 714,303 additional shares of Series D preferred stock
at an exercise price of $9.4125 per share. The value of the warrants,
$1,579,000, was recorded as additional paid-in capital. These warrants are
exercisable at December 31, 1996, and expire on November 27, 1998. The value of
these warrants was determined using a Black-Scholes valuation model with the
following assumptions: expected life of six years, expected dividend yield of
0%, expected volatility of 60% and a risk-free interest rate of 6%. Upon a
merger or consolidation in which the Company is not the survivor, the warrants
are canceled and all rights granted shall terminate. If an event causing
conversion of the Company's Series D preferred stock shall have occurred prior
to the exercise of the warrants, then all warrants shall be exercisable for the
number of shares of common stock of the Company into which the Series D
preferred stock not purchased upon any prior exercise of the warrants would have
been so converted.
In connection with the sale of Series E preferred stock, the Company issued
a warrant to purchase up to 3,709,305 additional shares of Series E preferred
stock at an exercise price of $13.48 per share. The value of the warrant,
$4,068,000, was recorded as additional paid-in capital. This warrant is
exercisable at any time through January 21, 2000 and will terminate
automatically upon either closing of an IPO by the Company, or completion of a
merger or consolidation in which the Company is not a survivor. The value of the
warrant was determined using a Black-Scholes valuation model with the following
assumptions: expected life of one year, expected dividend yield of 0%, expected
volatility of 60% and a risk-free interest rate of 6%. If an event causing
conversion of the Company's Series E preferred stock shall have occurred prior
to the exercise of the warrant, in whole or in part, then the warrant shall be
exercisable for the number of shares of common stock of the Company into which
the Series E preferred stock not purchased upon any prior exercise of the
warrant would have been so converted.
(e) Stock Option Plans
Under the Company's 1995 Stock Option Plan (1995 Plan), 3,600,000 shares of
common stock were reserved for the issuance of stock options. Under the
Company's Amended and Restated 1996 Stock Option Plan (1996 Plan), 8,800,000
shares of common stock are reserved for the issuance of stock options. In
September 1997, the Company discontinued granting stock options under the 1995
Plan. In accordance with the provisions of the 1996 Plan, in addition to the
8,800,000 shares of common stock reserved, shares of common stock previously
available for grant under the 1995 Plan are available
F-18
<PAGE> 90
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
for grant under the 1996 Plan, and to the extent options outstanding under the
1995 Plan terminate without having been exercised in full, the terminated
options become available under the 1996 Plan.
Options granted under the 1996 Plan may be designated as qualified or
nonqualified at the discretion of the Board of Directors, generally vest over a
period of one to five years from the date of grant, expire 20 years from the
date of grant and terminate, to the extent not exercised, three months after the
termination of employment.
A summary of stock option activity under the 1995 Plan and the 1996 Plan is
as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-----------------------------
SHARES WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR GRANT OF SHARES EXERCISE PRICE
---------- ---------- --------------
<S> <C> <C> <C>
Balances at December 31, 1994...... -- -- $ --
Plan introduction.................. 3,600,000 -- --
Options granted.................... (3,313,214) 3,313,214 0.07
Options exercised.................. -- (30,750) 0.07
Options canceled................... 450,000 (450,000) 0.07
---------- ---------
Balances at December 31, 1995...... 736,786 2,832,464 0.07
Plan introduction.................. 3,000,000 -- --
Options granted.................... (3,766,364) 3,766,364 0.34
Options exercised.................. -- (498,543) 0.09
Options canceled................... 765,250 (765,250) 0.10
---------- ---------
Balances at December 31, 1996...... 735,672 5,335,035 0.27
Plan amendment..................... 5,800,000 -- --
Options granted.................... (2,739,930) 2,739,930 3.94
Options exercised.................. -- (1,006,801) 0.14
Options canceled................... 625,450 (625,450) 0.71
---------- ---------
Balances at September 30, 1997..... 4,421,192 6,442,714 $ 1.80
========== =========
</TABLE>
The Company applies APB Opinion No. 25 in accounting for the 1995 Plan and
the 1996 Plan, and no compensation cost has been recognized for its employee
stock options in the consolidated financial statements. Had the Company
determined compensation cost of employee stock options based on the fair value
at the grant date for its stock options under SFAS No. 123, the Company's net
loss would have been increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------- SEPTEMBER 30,
1995 1996 1997
----------- ----------- -------------
<S> <C> <C> <C>
Net loss:
As reported................... $(1,501,302) $(3,789,245) $ (8,574,716)
Pro forma..................... (1,510,513) (3,865,415) (8,770,334)
Net loss per share:
As reported................... $ (0.14) $ (0.32)
Pro forma..................... (0.14) (0.32)
</TABLE>
F-19
<PAGE> 91
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The full impact of calculating compensation cost for stock options under
SFAS No. 123 is not reflected in the pro forma net loss and net loss per share
amounts presented above because compensation cost is recognized over the
options' vesting period.
The per share weighted-average fair value of stock options granted during
the years ended December 31, 1995 and 1996 and the nine months ended September
30, 1997 was $.01, $.07 and $.70, respectively, on the date of grant using the
minimum value method with the following weighted average assumptions:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- SEPTEMBER 30,
1995 1996 1997
--------- --------- -------------
<S> <C> <C> <C>
Expected dividend yield............... 0% 0% 0%
Risk-free interest rate............... 5.9% 6.1% 6.1%
Expected life......................... 3.5 years 4.5 years 3.5 years
</TABLE>
The following table summarizes information about stock options outstanding
under the 1995 Plan and the 1996 Plan at September 30, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- -------------------------
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ---------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 0.07 1,193,473 17.58 years $0.07 123,873 $0.07
0.20 1,993,206 18.42 years 0.20 480,438 0.20
0.85-1.50 1,349,535 19.12 years 1.23 62,135 0.93
2.00-3.50 970,000 19.64 years 2.60 4,600 2.30
7.25-8.50 936,500 19.90 years 7.38 4,000 7.25
--------- -------
6,442,714 18.81 years $1.80 675,046 $0.30
--------- -------
</TABLE>
(f) Employee Stock Purchase Plan
In September 1997, the Company adopted the 1998 Employee Stock Purchase
Plan (ESPP) which will become effective January 1, 1998. The Company has
reserved 1,000,000 shares of common stock for issuance under the ESPP. The ESPP
will be implemented through a series of offering periods of six months'
duration, with new offering periods commencing on January 1 and July 1 of each
year. The ESPP permits eligible employees to purchase the Company's common stock
at a price equal to 85% of the lower of the fair market value of the common
stock at the beginning or end of the offering period.
(8) LICENSE AGREEMENT
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, including its basic RealPlayer and
substantial elements of its EasyStart Server (currently known as the Basic
Server), and related Company trademarks. Under the agreement, Microsoft may
sublicense its rights to the RealAudio/RealVideo Version 4.0 technology to third
parties under certain conditions. The agreement also provides for substantial
refunds to Microsoft under prescribed circumstances that are solely within the
Company's control. The amount of these refunds diminishes over time. The Company
may not assign its obligations under the agreement without Microsoft's consent.
Microsoft is obligated to distribute the Company's RealPlayer Version 4.0 for a
defined term as long as the Company's player supports certain Microsoft
architectures. The Company also agreed to work with Microsoft and several other
companies to author and promote the Active Streaming Format as a standard file
format for streaming media. The agreement
F-20
<PAGE> 92
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
also requires the Company to provide Microsoft with engineering consultation
services, certain error corrections, and certain technical support over a
defined term. In July 1997, the Company delivered the specified source code in
exchange for a license fee of $30,000,000. The Company recognizes revenue,
commencing with delivery of the source code, over the three-year term of its
ongoing obligations. The portion of the license fee that has not yet been
recognized as revenue is included in deferred revenue.
In connection with the agreement, Microsoft purchased a minority interest
in the Company in the form of 3,338,374 shares of Series E preferred stock at
$8.99 per share.
F-21
<PAGE> 93
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company has agreed to sell to each of the Underwriters named below, and each of
such Underwriters, for whom Goldman, Sachs & Co., BancAmerica Robertson Stephens
and NationsBanc Montgomery Securities, Inc. are acting as representatives, has
severally agreed to purchase from the Company, the respective number of shares
of Common Stock set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES OF
COMMON
UNDERWRITER STOCK
-------------------------------------------------------------------- ----------
<S> <C>
Goldman, Sachs & Co.................................................
BancAmerica Robertson Stephens......................................
NationsBanc Montgomery Securities, Inc..............................
---------
Total............................................................. 3,000,000
=========
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares offered hereby,
if any are taken.
The Underwriters propose to offer the shares of Common Stock in part
directly to the public at the initial public offering price set forth on the
cover page of this Prospectus and in part to certain securities dealers at such
price less a concession of $ per share. The Underwriters may allow, and
such dealers may reallow, a concession not in excess of $ per share to
certain brokers and dealers. After the shares of Common Stock are released for
sale to the public, the offering price and other selling terms may from time to
time be varied by the representatives.
The Company has granted the Underwriters an option exercisable for 30 days
after the date of this Prospectus to purchase up to an aggregate of 450,000
additional shares of Common Stock to cover over-allotments, if any. If the
Underwriters exercise their over-allotment option, the Underwriters have
severally agreed, subject to certain conditions, to purchase approximately the
same percentage thereof that the number of shares to be purchased by each of
them, as shown in the foregoing table, bears to the 3,000,000 shares of Common
Stock offered.
As of the date of this Prospectus, The Goldman Sachs Group, L.P., an
affiliate of Goldman, Sachs & Co., beneficially owns 66,401 shares, and a
warrant to purchase 19,920 shares, of Series D Preferred Stock. These shares and
the warrant were purchased on November 27, 1996 in reliance on the exemption
from registration set forth in Section 4(2) of the Securities Act relating to
sales by an issuer not involving a public offering. Goldman, Sachs & Co. acted
as placement agent for the Company in connection with the Company's sale of
2,381,010 shares of Series D Preferred Stock and warrants to purchase 714,303
shares of Series D Preferred Stock in November 1996. In connection with its
services as placement agent, Goldman, Sachs & Co. received total fees of
$889,186.
The Company has agreed that, during the period beginning from the date of
this Prospectus and continuing to and including the date 180 days after the date
of this Prospectus, it will not offer, sell, contract to sell or otherwise
dispose of any securities of the Company (other than pursuant to employee stock
option or stock purchase plans existing, or on the conversion or exchange of
convertible or exchangeable securities outstanding, on the date of this
Prospectus) which are substantially similar to the Common Stock or which are
convertible into or exchangeable for securities which are substantially similar
to the Common Stock without the prior written consent of the representatives,
except for the shares of Common Stock offered in connection with the offering.
In addition, the officers, directors and certain persons who prior to
closing of the offering hold shares of capital stock of the Company (including
but not limited to all holders of 1% or more of the Company's capital stock)
have agreed that they will not offer, sell or otherwise dispose of any shares of
Common
U-1
<PAGE> 94
Stock owned of record or beneficially as of the date of the Prospectus,
including securities convertible into or exercisable or exchangeable for shares
of Common Stock as of said date, as well as any shares of Common Stock later
acquired by reason of the conversion, exercise or exchange of such securities,
or enter into any swap or other transaction with respect to the shares that
would transfer the economic consequences of ownership of the Common Stock to
another person, for a period of 180 days following the date of this Prospectus,
except that (i) persons other than officers, directors and holders of 1% or more
of the capital stock of the Company each will be free to sell or otherwise
dispose of up to 5,000 shares of Common Stock to the extent permissible under
Rule 144 or Rule 701 and (ii) directors, officers and holders of 1% of the
Company's capital stock may dispose of shares of Common Stock as bona fide gifts
if the recipient of such gifts agrees in writing with the Underwriters to be
bound by the terms of this 180-day transfer restriction.
At the request of the Company, the Underwriters have reserved up to 300,000
shares of Common Stock for sale, at the initial public offering price, to
employees and friends of the Company through a directed share program. The
number of shares of Common Stock available for sale to the general public in the
public offering will be reduced to the extent such persons purchase such
reserved shares.
The representatives of the Underwriters have informed the Company that they
do not expect sales to accounts over which the Underwriters exercise
discretionary authority to exceed 5% of the total number of shares of Common
Stock offered by them.
Prior to the offering, there has been no public market for the shares. The
initial public offering price will be negotiated among the Company and the
representatives. Among the factors to be considered in determining the initial
public offering price of the Common Stock, in addition to prevailing market
conditions, will be the Company's historical performance, estimates of the
business potential and earnings prospects of the Company, an assessment of the
Company's management and the consideration of the above factors in relation to
market valuation of companies in related businesses.
In connection with the offering, the Underwriters may purchase and sell the
Common Stock in the open market. These transactions may include over-allotment
and stabilizing transactions and purchases to cover syndicate short positions
created by the Underwriters in connection with the offering. Stabilizing
transactions consist of certain bids or purchases for the purpose of preventing
or retarding a decline in the market price of the Common Stock; and syndicate
short positions created by the Underwriters involve the sale by the Underwriters
of a greater number of shares of Common Stock than they are required to purchase
from the Company in the offering. The Underwriters also may impose a penalty
bid, whereby selling concessions allowed to syndicate members or other
broker-dealers in respect of the securities sold in the offering for their
account may be reclaimed by the syndicate if such shares of Common Stock are
repurchased by the syndicate in stabilizing or covering transactions. These
activities may stabilize, maintain or otherwise affect the market price of the
Common Stock which may be higher than the price that might otherwise prevail in
the open market; and these activities, if commenced, may be discontinued at any
time. These transactions may be effected on the Nasdaq National Market in the
over-the-counter market or otherwise.
Application has been made for quotation of the Common Stock on the Nasdaq
National Market under the symbol "RNWK." The Company has agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act.
U-2
<PAGE> 95
[SCREEN-SHOTS OF
WEB PAGES SUPERIMPOSED
OVER COMPANY LOGO]
<PAGE> 96
============================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SUCH
SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Prospectus Summary........................ 3
Risk Factors.............................. 6
Use of Proceeds........................... 21
Dividend Policy........................... 21
Capitalization............................ 22
Dilution.................................. 23
Selected Consolidated Financial Data...... 24
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 25
Business.................................. 36
Management................................ 51
Certain Transactions...................... 59
Principal Shareholders.................... 62
Description of Capital Stock.............. 64
Shares Eligible for Future Sale........... 67
Legal Matters............................. 69
Experts................................... 69
Additional Information.................... 69
Index to Consolidated Financial
Statements.............................. F-1
Underwriting.............................. U-1
THROUGH AND INCLUDING , 1997 (THE
25TH DAY AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON
STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION
OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
=================================================
</TABLE>
============================================================
3,000,000 SHARES
REALNETWORKS, INC.
(FORMERLY "PROGRESSIVE NETWORKS, INC.")
COMMON STOCK
(PAR VALUE $.001 PER SHARE)
[REALNETWORKS LOGO]
GOLDMAN, SACHS & CO.
BANCAMERICA ROBERTSON
STEPHENS
NATIONSBANC MONTGOMERY
SECURITIES, INC.
REPRESENTATIVES OF THE UNDERWRITERS
============================================================
<PAGE> 97
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION*
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee.............. $ 11,500
NASD Filing Fee.................................................. 3,950
Nasdaq National Market Listing Fee............................... 50,000
Legal Fees and Expenses.......................................... 325,000
Accountants' Fees and Expenses................................... 225,000
Blue Sky Filing and Counsel Fees and Expenses.................... 5,000
Printing and Engraving Expenses.................................. 150,000
Transfer Agent and Registrar Fees................................ 10,000
Miscellaneous Expenses........................................... 169,550
--------
Total.................................................. $ 950,000
========
</TABLE>
- ---------------
* All expenses other than the Securities and Exchange Commission Registration
Fee, the NASD Filing Fee and the Nasdaq National Market Fee are estimated.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Sections 23B.08.500 through 23B.08.600 of the Washington Business
Corporation Act (the "Washington Act") authorize a court to award, or a
corporation's board of directors to grant, indemnification to directors and
officers on terms sufficiently broad to permit indemnification under certain
circumstances for liabilities arising under the Securities Act of 1933, as
amended (the "Securities Act"). Article VI, Section 6.5, of the Registrant's
Amended and Restated Articles of Incorporation (Exhibit 3.1 hereto) and Article
X of the Registrant' Restated Bylaws (Exhibit 3.2 hereto) provide for
indemnification of the Registrant's directors, officers, employees and agents to
the maximum extent permitted by Washington law. The Registrant has entered into
agreements with all officers and directors to indemnify them against certain
liabilities arising out of their service as officers and directors, as
applicable, and to advance expenses to defend claims subject to indemnification.
The directors and officers of the Registrant also may be indemnified against
liability they may incur for serving in that capacity pursuant to a liability
insurance policy maintained by the Registrant for such purpose.
Section 23B.08.320 of the Washington Act authorizes a corporation to limit
a director's liability to the corporation or its shareholders for monetary
damages for acts or omissions as a director, except in certain circumstances
involving intentional misconduct, self-dealing or illegal corporate loans or
distributions, or any transaction from which the director personally receives a
benefit in money, property or services to which the director is not legally
entitled. Article VI, Section 6.6, of the Registrant's Amended and Restated
Articles of Incorporation contains provisions implementing, to the fullest
extent permitted by Washington law, such limitations on a director's liability
to the Registrant and its shareholders.
Reference is also made to the Form of Underwriting Agreement to be filed as
Exhibit 1.1 to this Registration Statement for certain provisions regarding the
indemnification of officers and directors of the Registrant by the Underwriters.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since September 1, 1994, the Registrant has issued and sold unregistered
securities as follows:
(1) An aggregate of 2,686,567 shares of Series B Preferred Stock was
issued in a private placement in April 1995 to nine investors. The
aggregate consideration received for such shares was $1,800,000.
II-1
<PAGE> 98
(2) A warrant for the purchase of an aggregate of 373,134 shares of
Series B Preferred Stock was issued in a private placement in April 1995 to
one investor. The consideration received by the Registrant in connection
with the issuance of such warrant was part of the aggregate consideration
received by the Registrant in connection with the private placement of
Series B Preferred Stock noted above.
(3) An aggregate of 2,600 shares of Series B Common Stock was issued
in September 1995 to 26 employees in exchange for services, and 100 shares
of Series C Common Stock were issued in September 1995 to one individual in
exchange for services, in each case in connection with a product launch.
(4) An aggregate of 373,134 shares of Series B Preferred Stock was
issued to one investor upon the exercise of a warrant in October 1995. The
aggregate consideration received for such shares was $250,000.
(5) An aggregate of 3,497 shares of Series C Common Stock was issued
in October 1995 to one individual in exchange for services.
(6) An aggregate of 2,904,305 shares of Series C Preferred Stock was
issued in a private placement in October 1995 to 12 investors. The
aggregate consideration received for such shares was $5,702,312.
(7) Warrants for the purchase of an aggregate of 183,755 shares of
Series B Common Stock were issued in a private placement in October 1995 to
five investors, and warrants for the purchase of an aggregate of 100,000
shares of Series C Preferred Stock were issued in a private placement in
October 1995 to four investors. The consideration received by the
Registrant in connection with the issuance of such warrants was part of the
aggregate consideration received by the Registrant in connection with the
private placement of Series C Preferred Stock noted above.
(8) An aggregate of 2,381,010 shares of Series D Preferred Stock was
issued in a private placement in November 1996 to 23 investors. The
aggregate consideration received for such shares was $17,929,005.
(9) Warrants for the purchase of an aggregate of 714,303 shares of
Series D Preferred Stock were issued in connection with the Series D
Preferred Stock private placement in November 1996 to 23 investors. The
aggregate consideration received for such warrants was $7,143.
(10) An aggregate of 1,000 shares of Series C Common Stock was issued
in March 1997 to one individual in exchange for services.
(11) An aggregate of 3,338,374 shares of Series E Preferred Stock was
issued in a private placement in July 1997 to one investor. The aggregate
consideration received for such shares was $30,000,000.
(12) A warrant for the purchase of an aggregate of 3,709,305 shares of
Series E Preferred Stock was issued in a private placement in July 1997 to
one investor. The consideration received by the Registrant in connection
with the issuance of such warrant was part of the aggregate consideration
received by the Registrant in connection with the private placement of
Series E Preferred Stock noted above.
(13) As of October 9, 1997, an aggregate of 1,562,994 shares of Series
B Common Stock and Series C Common Stock has been issued to employees and
consultants upon the exercise of options. The aggregate consideration
received for such shares was $211,374.
Except in connection with the Series D Preferred Stock private placement,
no underwriters were engaged in connection with these issuances and sales. Each
of the transactions noted above was made in reliance upon the exemption from
registration provided by either Section 3(b) or 4(2) of the Securities Act.
II-2
<PAGE> 99
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------- -------------------------------------------------------------------------------
<S> <C>
1.1* Form of Underwriting Agreement
3.1** Amended and Restated Articles of Incorporation filed September 19, 1997
3.2** Articles of Amendment to the Amended and Restated Articles of Incorporation
filed September 25, 1997
3.3** Form of Amended and Restated Articles of Incorporation
3.4** Bylaws
4.1* Specimen Stock Certificate
5.1* Opinion of Graham & James LLP/Riddell Williams P.S.
10.1** RealNetworks, Inc. 1995 Stock Option Plan
10.2** RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan
10.3** Form of Stock Option Agreement
10.4** 1998 Employee Stock Purchase Plan
10.5** Form of Warrant to Purchase Series D Preferred Stock
10.6** Warrant to Purchase Series E Preferred Stock dated July 21, 1997 between the
Registrant and Microsoft Corporation
10.7** Lease Agreement dated March 4, 1996 by and between the Registrant as Lessee and
Wright Runstad Properties L.P. as Lessor
10.8** Sublease Agreement dated March 1996 by and between the Registrant as Sublessee
and Legent Corporation as Sublessor
10.9** Antenna Site License Agreement dated August 12, 1997 by and between the
Registrant and Wright Runstad & Company
10.10** Agreement between Microsoft Corporation and the Registrant on Media Streaming
Technology dated June 17, 1997 (confidential treatment requested)
10.11** Offer letter dated February 16, 1996 between the Registrant and Bruce Jacobsen
10.12** Offer letter dated May 2, 1995 between the Registrant and James Wells
10.13** Offer letter dated May 24, 1994 between the Registrant and Andrew Sharpless
10.14** Form of Director and Officer Indemnification Agreement
10.15** Limited Proxy and Voting Agreement dated July 21, 1997 by and between the
Registrant and Microsoft Corporation
10.16** Shareholders' Buy-Sell Agreement dated March 31, 1995 by and among the
Registrant, Robert Glaser and certain shareholders of the Registrant
10.17** Voting Agreement dated September 25, 1997 by and among the Registrant, Robert
Glaser, Accel IV L.P., Mitchell Kapor and Bruce Jacobsen
10.18** Agreement dated September 26, 1997 by and between the Registrant and Robert
Glaser
10.19** Second Amended and Restated Investors' Rights Agreement dated July 21, 1997 by
and among the Registrant and certain shareholders of the Registrant
11.1 Statement re: Computation of Pro Forma Net Loss Per Share
21.1** Subsidiaries of the Registrant
</TABLE>
II-3
<PAGE> 100
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------- -------------------------------------------------------------------------------
<S> <C>
23.1 Consent of Graham & James LLP/Riddell Williams P.S. (included in its opinion to
be filed as Exhibit 5.1 hereto)
23.2 Consent of KPMG Peat Marwick LLP
24.1** Power of Attorney
27.1 Financial Data Schedule
</TABLE>
- ---------------
* To be filed by amendment.
** Previously filed.
(b) FINANCIAL STATEMENT SCHEDULE
Schedule II -- Valuation and Qualifying Accounts
II-4
<PAGE> 101
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes to provide to the
Underwriters, at the closing specified in the Underwriting Agreement,
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be a part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-5
<PAGE> 102
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 1 to Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Seattle, State of Washington, on October 14, 1997.
REALNETWORKS, INC.
By: /s/ ROBERT GLASER
------------------------------------
Robert Glaser
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities indicated below on October 14, 1997.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------- -------------------------
<C> <S> <C>
/s/ ROBERT GLASER Chairman of the Board,
- --------------------------------------------- Chief Executive
Robert Glaser Officer, Secretary and
Treasurer (Principal
Executive Officer)
* BRUCE JACOBSEN President, Chief
- --------------------------------------------- Operating Officer and
Bruce Jacobsen Director
* MARK KLEBANOFF Chief Financial Officer
- --------------------------------------------- (Principal Financial
Mark Klebanoff and Accounting Officer)
* JIM BREYER Director
- ---------------------------------------------
James Breyer
* MITCHELL KAPOR Director
- ---------------------------------------------
Mitchell Kapor
*By /s/ ROBERT GLASER
- ---------------------------------------------
Robert Glaser
Attorney-in-fact
</TABLE>
II-6
<PAGE> 103
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
REALNETWORKS, INC. AND SUBSIDIARIES
PERIOD FROM FEBRUARY 9, 1994 (INCEPTION) TO DECEMBER 31, 1994,
THE YEARS ENDED DECEMBER 31, 1995 AND 1996
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) PERIOD
- ------------------------------------ ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
Nine months ended September 30,
1997:
Valuation accounts deducted from
assets:
Allowance for doubtful accounts
receivable and sales
returns...................... $ 383,350 $1,502,273 $(1,197,051) $ 688,572
Valuation allowance for
deferred tax assets.......... 1,828,000 3,682,000 -- 5,510,000
======= ========= =========== =========
Year ended December 31, 1996:
Valuation accounts deducted from
assets:
Allowance for doubtful accounts
receivable and sales
returns...................... 129,869 563,046 (309,565) 383,350
Valuation allowance for
deferred tax assets.......... 493,000 1,335,000 -- 1,828,000
======= ========= =========== =========
Year ended December 31, 1995:
Valuation accounts deducted from
assets:
Allowance for doubtful accounts
receivable and sales
returns...................... -- 129,869 -- 129,869
Valuation allowance for
deferred tax assets.......... -- 493,000 -- 493,000
======= ========= =========== =========
Period from February 9, 1994
(inception) to December 31, 1994:
Valuation accounts deducted from
assets:
Allowance for doubtful accounts
receivable and sales
returns...................... -- -- -- --
Valuation allowance for
deferred tax assets.......... -- -- -- --
======= ========= =========== =========
</TABLE>
- ---------------
(1) Represents amounts written off.
<PAGE> 104
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ----------------------------------------------------------------------
<S> <C> <C>
1.1* Form of Underwriting Agreement........................................
3.1** Amended and Restated Articles of Incorporation filed September 19,
1997..................................................................
3.2** Articles of Amendment to the Amended and Restated Articles of
Incorporation filed September 25, 1997................................
3.3** Form of Amended and Restated Articles of Incorporation................
3.4** Bylaws................................................................
4.1* Specimen Stock Certificate............................................
5.1* Opinion of Graham & James LLP/Riddell Williams P.S....................
10.1** RealNetworks, Inc. 1995 Stock Option Plan.............................
10.2** RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan........
10.3** Form of Stock Option Agreement........................................
10.4** 1998 Employee Stock Purchase Plan.....................................
10.5** Form of Warrant to Purchase Series D Preferred Stock..................
10.6** Warrant to Purchase Series E Preferred Stock dated July 21, 1997
between the Registrant and Microsoft Corporation......................
10.7** Lease Agreement dated March 4, 1996 by and between the Registrant as
Lessee and Wright Runstad Properties L.P. as Lessor...................
10.8** Sublease Agreement dated March, 1996 by and between the Registrant as
Sublessee and Legent Corporation as Sublessor.........................
10.9** Antenna Site License Agreement dated August 12, 1997 by and between
the Registrant and Wright Runstad & Company...........................
10.10** Agreement between Microsoft Corporation and the Registrant on Media
Streaming Technology dated June 17, 1997 (confidential treatment
requested)............................................................
10.11** Offer letter dated February 16, 1996 between the Registrant and Bruce
Jacobsen..............................................................
10.12** Offer letter dated May 2, 1995 between the Registrant and James
Wells.................................................................
10.13** Offer letter dated May 24, 1994 between the Registrant and Andrew
Sharpless.............................................................
10.14** Form of Director and Officer Indemnification Agreement................
10.15** Limited Proxy and Voting Agreement dated July 21, 1997 by and between
the Registrant and Microsoft Corporation..............................
10.16** Shareholders' Buy-Sell Agreement dated March 31, 1995 by and among the
Registrant, Robert Glaser and certain shareholders of the
Registrant............................................................
10.17** Voting Agreement dated September 25, 1997 by and among the Registrant,
Robert Glaser, Accel IV L.P., Mitchell Kapor and Bruce Jacobsen.......
10.18** Agreement dated September 26, 1997 by and between the Registrant and
Robert Glaser.........................................................
10.19** Second Amended and Restated Investors' Rights Agreement dated July 21,
1997 by and among the Registrant and certain shareholders of the
Registrant............................................................
11.1 Statement re: Computation of Pro Forma Net Loss Per Share.............
21.1** Subsidiaries of the Registrant........................................
23.1 Consent of Graham & James LLP/Riddell Williams P.S. (included in its
opinion to be filed as Exhibit 5.1 hereto)............................
23.2 Consent of KPMG Peat Marwick LLP......................................
24.1** Power of Attorney.....................................................
27.1 Financial Data Schedule...............................................
</TABLE>
- ---------------
* To be filed by amendment.
** Previously filed.
<PAGE> 1
EXHIBIT 11.1
REALNETWORKS, INC. AND SUBSIDIARIES
PRO FORMA NET LOSS PER SHARE CALCULATION
With SAB 83 Adjustment
<TABLE>
<CAPTION>
Year ended Nine months ended
December 31, September 30,
1996 1997
------------ -----------------
<S> <C> <C>
SUMMARY INFORMATION
Net loss $(3,789,245) $(8,574,716)
Accretion of difference
between carrying amount
and redemption amount of
redeemable, convertible
preferred stock (31,000) (345,900)
----------- -----------
Net loss used in calculation
of pro forma net loss per
share $(3,820,245) $(8,920,616)
=========== ===========
Common shares outstanding at
beginning of period 36,948 535,491
Weighted average common stock
issued upon exercise of
employee stock options 283,874 320,396
Weighted average common stock
issued for services -- 667
Stock warrants and options --
not dilutive (SAB 83 effect
included in adjustment below) -- --
----------- -----------
Weighted average outstanding
common stock 320,822 856,554
Assumed conversion of
redeemable, convertible
preferred stock and
convertible preferred stock 25,396,829 25,396,829
SAB 83 adjustment 2,061,670 2,061,670
----------- -----------
Shares used in computing
pro forma net loss per share 27,779,321 28,315,053
=========== ===========
Pro forma net loss per share $ (0.14) $ (0.32)
=========== ===========
</TABLE>
<PAGE> 1
EXHIBIT 23.2
REPORT AND CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
RealNetworks, Inc.:
The audits referred to in our report dated October 10, 1997 included the
related financial statement schedule for the period from February 9, 1994
(inception) to December 31, 1994, the years ended December 31, 1995 and 1996,
and the nine months ended September 30, 1997 included in the registration
statement on Form S-1 of RealNetworks, Inc. This financial statement schedule is
the responsibility of the Company's management. Our responsibility is to express
an opinion on this financial statement schedule based on our audits. In our
opinion, such financial statement schedule, when considered in relation to the
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
We consent to the use of our reports and to the reference of our firm under
the headings "Summary Consolidated Financial Data", "Selected Consolidated
Financial Data" and "Experts" in the prospectus.
KPMG Peat Marwick LLP
Seattle, Washington
October 15, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997
<PERIOD-START> JAN-01-1996 JAN-01-1997
<PERIOD-END> DEC-31-1996 SEP-30-1997
<CASH> 14,737,806 44,751,298
<SECURITIES> 4,857,163 22,897,196
<RECEIVABLES> 3,275,518 4,350,464
<ALLOWANCES> 383,350 688,572
<INVENTORY> 60,543 66,029
<CURRENT-ASSETS> 23,528,266 75,068,866
<PP&E> 3,462,153 6,953,498
<DEPRECIATION> 783,355 2,180,018
<TOTAL-ASSETS> 26,468,158 84,371,634
<CURRENT-LIABILITIES> 6,634,922 24,307,049
<BONDS> 0 959,380
23,153,494 49,277,652
13,713 13,713
<COMMON> 535 1,543
<OTHER-SE> (3,334,506) (8,104,363)
<TOTAL-LIABILITY-AND-EQUITY> 26,468,158 84,371,634
<SALES> 0 0
<TOTAL-REVENUES> 14,012,388 22,416,804
<CGS> 0 0
<TOTAL-COSTS> 2,185,524 4,608,661
<OTHER-EXPENSES> 15,843,408 27,567,116
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 0 0
<INCOME-PRETAX> (3,789,245) (8,574,716)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (3,789,245) (8,574,716)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (3,789,245) (8,574,716)
<EPS-PRIMARY> (0.14) (0.32)
<EPS-DILUTED> 0 0
</TABLE>
