<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 31, 1997
REGISTRATION NO. 333-36553
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
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: [ ]
------------------------
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 31, 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
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 into one share of Special Common Stock
effective 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 28 million copies of its
RealPlayer software have been downloaded electronically. Over 200,000 copies of
its premium client product, RealPlayer Plus, have been sold electronically in
its 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 streaming audio and video news, sports,
entertainment and corporate information over the Internet and intranets.
3
<PAGE> 5
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, and therefore
has a limited operating history. Unless the context otherwise requires, the term
"Company" or "RealNetworks" refers to RealNetworks, Inc. and its subsidiaries:
RealNetworks, SARL, RealNetworks, Limited and RealNetworks 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
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<S> <C>
Common Stock offered by the Company........... 3,000,000 shares
Common stock to be outstanding after the
offering:
Common Stock................................ 27,626,705 shares(1)
Special Common Stock........................ 3,338,374 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 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. See "Description of Capital Stock."
4
<PAGE> 6
SUMMARY CONSOLIDATED FINANCIAL 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
---------------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<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)
------------ ------- --------------
(IN THOUSANDS)
<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
and Series D Preferred Stock into Common Stock and Series E Preferred Stock
into Special Common Stock, in each case 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 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> 7
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 in this "Risk Factors" section 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. As a result
of taxable income generated from a license agreement with Microsoft Corporation
("Microsoft"), 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. 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, train
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
its revenues accurately. 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.
revenues, (viii) costs of litigation and intellectual property protection, (ix)
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 often is 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
6
<PAGE> 8
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 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 distributes 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 no backlog.
As a result, quarterly sales and operating results depend primarily 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 its 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, which also are
difficult to forecast. 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, VXtreme, Inc. ("VXtreme"),
VDOnet Corporation ("VDOnet"), Xing Technology Corporation ("Xing"), Precept
Software, Inc. ("Precept"), Cubic VideoComm, Inc. ("Cubic"), Motorola, Inc.
("Motorola"), Vivo
7
<PAGE> 9
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 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. See "Business -- Competition."
The Company derives significant revenues from sales of RealPlayer Plus, an
enhanced version of its free RealPlayer 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. See
"Business -- Products and Services."
The Company anticipates that the consolidation that has occurred in the
streaming media industry and related industries, such as computer software,
media and communications, will continue. 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 --
Microsoft Corporation."
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 included in 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 licensed technology to third parties
under certain circumstances. On two occasions during the first two years
following delivery under the agreement, Microsoft may acquire for $25 million
and $35 million, respectively, a nonexclusive license to subsequently developed
versions of the core audio and video technology, which currently is distributed
to end-users at no charge. Under prescribed circumstances that are solely within
the Company's control, the agreement provides for a full refund of each license
fee during the first year, declining to 0% over the following two years. The
Company may not assign its obligations under the agreement without Microsoft's
consent, and a merger, the sale of substantially all of the Company's assets and
certain other events will be deemed to be an assignment under the agreement.
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 correc-
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tions 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 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 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, competitively priced 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 also is 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 the license agreement with
Microsoft, Microsoft acquired VXtreme and announced that it would incorporate
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
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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."
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 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 over 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. 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
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<PAGE> 12
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."
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 can identify
new product and service opportunities successfully 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 these or
other business models successfully.
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, and in particular on 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 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
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<PAGE> 13
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 51.0% of the outstanding voting rights
(approximately 50.2% if the Underwriters' over-allotment option is exercised in
full). Following 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 "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 will 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 (the
"Strategic Transactions Agreement") providing Mr. Glaser 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 Strategic
Transactions Agreement also provides that so long as Mr. Glaser owns a specified
number of shares, the Company shall use its best efforts to cause him to be
nominated to, elected to, and not removed from, the Board of Directors. In
addition, the Articles provide that 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 in which 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, the Microsoft agreement and 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. These provisions may also have
the effect of limiting the price that investors might be willing to pay in the
future for the Common Stock. See "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. 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
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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 that such licensees will not 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 its business, financial condition and results of operations.
The computer software market is characterized by frequent and substantial
intellectual property litigation that often is complex and expensive, and
involves a significant diversion of resources and uncertainty of outcome. In the
future, the Company may need to pursue litigation to enforce and protect its
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
regarding alleged infringement could be avoided or settled without substantial
expense and damage awards. Any claims
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<PAGE> 15
against the Company 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 the Company's 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 with its products. If the Company were
unable to bundle compelling content with its products, 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 materially adversely affected. It is possible that
associations that represent collectives of content owners will seek to and
successfully establish minimum royalties or other conditions that apply to the
licensing or distribution of content over the Internet, which 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
for the foreseeable future. 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
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any material acquisitions or investments in third parties. 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 succeed in incorporating acquired technology and
rights into the Company's products, services and media offerings, additional
expense associated with amortization of acquired intangible assets, the
difficulty of maintaining 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 its current or future operations or that
the Company's management will be able to manage 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 on
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 co-authored the Real Time
Streaming Protocol ("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 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 22% and 27%, respectively, of the Company's total net
revenues were generated from sources outside the U.S. 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."
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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.
The Company faces potential liability for claims based on the nature and
content of the materials that it distributes over the Internet, 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 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 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 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 also could
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),
exercise of, or failure to exercise, warrants to purchase shares of the
Company's common stock (including the Series E Warrant), 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
17
<PAGE> 19
fluctuations unrelated to 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
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 on the closing of the offering. 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.
Because the Series E Warrant may be exercised at any time until the closing of
the offering, it is impossible to predict the impact that the exercise thereof
will have on the market price of the Common Stock. See "-- Volatility of Stock
Price" and "Principal Shareholders."
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."
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.
BENEFITS OF THE OFFERING TO CURRENT SHAREHOLDERS
The offering will provide benefits to the current shareholders of the
Company, including the creation of a public market for the Common Stock and the
unrealized gain of approximately $215,683,000 in the value of the total equity
interest of all current shareholders in the Company.
POSSIBLE ADVERSE EFFECT ON MARKET PRICE OF COMMON STOCK OF SHARES ELIGIBLE FOR
FUTURE SALE AFTER THE OFFERING
On the closing of the offering, the Company will have outstanding
30,965,079 shares of Common Stock and Special Common Stock (31,415,079 shares if
the Underwriters' over-allotment option is exercised in full), of which the
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 and Special Common Stock (the "Restricted Shares") outstanding on
completion of the offering
18
<PAGE> 20
(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. Of these Restricted Shares, 3,338,374 are shares of Special Common
Stock that are convertible into the same number of shares of Common Stock on a
bona fide sale to a purchaser who is not an affiliate of the holder. 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 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 of Special Common Stock, will be exercisable
prior to 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 and Special
Common Stock issuable upon exercise of outstanding warrants) 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."
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 any such charitable
donations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Donation of Net Income to Charity" and
"Business -- Position on Charitable Responsibility."
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."
19
<PAGE> 21
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
working 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 has no specific plans for the
net proceeds. 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 in third parties. 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.
20
<PAGE> 22
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 and Series D Preferred Stock into Common Stock and Series E
Preferred Stock into Special Common Stock, in each case 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;
27,599,805 shares issued and outstanding, as adjusted(2)....... 1 28
Special Common Stock, par value $0.001 per share: no shares
authorized; no shares issued and outstanding, actual; 3,338,374
shares issued and outstanding, as adjusted(2).................. -- 3
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 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 -- Microsoft Corporation," "Description of
Capital Stock -- Warrants to Purchase Preferred Stock and Common Stock" and
Note 7 of Notes to Consolidated Financial Statements.
21
<PAGE> 23
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 and Series D Preferred Stock into Common Stock
and Series E Preferred Stock into Special Common Stock, in each case on closing
of the offering; (ii) exclusion of up to 3,709,305 shares of 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 application of 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 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 -- Microsoft Corporation," "Description of
Capital Stock -- Warrants to Purchase Preferred Stock and Common Stock" and
Note 7 of Notes to Consolidated Financial Statements.
22
<PAGE> 24
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.
23
<PAGE> 25
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, 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 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, train 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.
24
<PAGE> 26
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"),
provided the following conditions are met: the software product has been
delivered to the VAR, the fee to the Company is fixed or determinable, and
collectibility is probable. 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
25
<PAGE> 27
revenues until guaranteed page impression delivery levels are achieved. Service
revenues include payments under support and upgrade contracts, commissions from
electronic sales of third-party products, and fees from consulting, content
hosting and 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 generally are 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 due primarily to a greater volume of products sold as a result
of 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 June 1997, the Company entered into a
$30,000,000 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 for 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 $630,000 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 21% and 27% 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 of the Company's international revenues were
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
therefore is subject to the risk of changes in exchange rates. The Company
expects that international revenues will continue to increase. The cost
structures of both domestic and international revenues are substantially the
same.
26
<PAGE> 28
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 due primarily 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 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
due primarily 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 the cost of
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 34% of service revenues for the nine months ended September
30, 1996 and 1997, respectively. This decrease was attributable primarily 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. 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
Septem-
27
<PAGE> 29
ber 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, 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 greater volume of products sold as a
result of 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 additional support and upgrade
28
<PAGE> 30
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 17% and 22% for 1995 and 1996, respectively. Substantially all
international revenues were generated in Europe and Asia.
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.
29
<PAGE> 31
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
fourth
30
<PAGE> 32
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 due in part
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. revenues, (viii) costs of
litigation and intellectual property protection, (ix) 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
often is 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 products or license
its technology is relatively discretionary and, for large-scale users, generally
involves a
31
<PAGE> 33
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 distributes 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 no backlog.
As a result, quarterly sales and operating results depend primarily 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.
The Company's net income will be reduced by the amount of any such charitable
donations. See "Business -- Position on Charitable Responsibility."
LIQUIDITY AND CAPITAL RESOURCES
Since its 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. See "Recent Developments."
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 of $17,047,000 from the issuance of Series D Preferred Stock. Cash
flows provided by financing activities
32
<PAGE> 34
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. The note is denominated in
Japanese yen and bears interest at a rate not to exceed the Japanese Short Term
Prime Rate (1.63% at September 30, 1997). Interest on the note is payable
monthly, and the principal is due in May 2000. The terms of the note contain no
restrictions or covenants. The note is secured by the Company's shares in its
Japanese joint venture. See "Certain Transactions -- Japanese Joint Venture."
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.
The Company conducts its operations using primarily three currencies: the
United States dollar, the Japanese yen, and the British pound. Historically,
neither fluctuations in foreign exchange rates nor changes in foreign economic
conditions has had a significant impact on the Company's financial condition or
results of operations. As a result, the Company currently does not hedge its
foreign currency transactions and is therefore subject to the risk of exchange
rates. The Company monitors its foreign exchange exposure and in the future may
choose to hedge foreign currency transactions, enter into currency contracts, or
take other such actions as deemed necessary to mitigate exchange rate risks. The
Company is unaware of any existing foreign government policies that would
significantly impact the Company's operations.
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 its 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.
RECENT DEVELOPMENTS
In June 1997, the Company entered into the license agreement with
Microsoft. The terms of the agreement provide that a $30,000,000 software
license fee will be paid to the Company in two installments. The first
installment of $20,000,000 was due within 30 days of the signing of the software
license agreement, and the remaining $10,000,000 is due within 30 days of the
earlier of (i) the
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Company's completion of six "man months" of consulting services and (ii) six
months after delivery of the specified source code to Microsoft. In July 1997,
the Company delivered the specified source code and subsequently received from
Microsoft a payment of $30,000,000 representing Microsoft's payment of both
installments under the agreement although payment of the second installment of
$10,000,000 was not due at that time. In October 1997, Microsoft requested that
the Company return the $10,000,000 installment that Microsoft had paid prior to
its due date. Although not legally required to do so, the Company refunded the
$10,000,000 to Microsoft. The Company expects Microsoft to make this second
installment payment in accordance with the terms of the agreement.
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 on
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, which is effective for fiscal years beginning after December 15, 1997,
requires reclassification of financial statements for earlier periods to be
provided for comparative purposes. The Company anticipates that implementing the
provisions of Statement 130 will not have a significant impact on the Company's
existing disclosures. 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 must be restated. The Company anticipates that implementing the provisions
of Statement 131 will not have a significant impact on the Company's existing
disclosures. 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 evolution 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 28 million copies of its
RealPlayer software have been downloaded. 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, over the Internet and intranets, 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
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downloaded in its entirety, resulting in significant 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 1995 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 28
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 that
includes 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 an
average of 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 also can 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 its 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 recently has 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 with 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 seeks to design 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 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 -- Japanese Joint Venture."
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 stand-alone server sends a
separate signal to each individual user, which is an inefficient use of network
bandwidth because the same signal often is 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. As of 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 had 103 employees,
or approximately 35% of its workforce, engaged in sales and marketing
activities.
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.
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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 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. 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 included in 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 licensed technology to third parties under certain
circumstances. On two occasions during the first two years following delivery
under the agreement, Microsoft may acquire for $25 million and $35 million,
respectively, a nonexclusive license to subsequently developed versions of the
core audio and video technology, which currently is distributed to end-users at
no charge. Under prescribed circumstances that are solely within the Company's
control, the agreement provides for a full refund of each license fee during the
first year, declining to 0% over the following two years. The Company may not
assign its obligations under the agreement without Microsoft's consent, and a
merger, the sale of substantially all of the Company's assets and certain other
events will be deemed to be an assignment under the agreement. 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
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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.
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. and various foreign countries. Sales to customers
outside the U.S., primarily in Asia and Europe, were approximately 17%, 22% and
27% 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
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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 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
Following closing of the offering, Mr. Glaser will contribute 5%, or
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
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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.
The Company faces potential liability for claims based on the nature and
content of the materials that it distributes over the Internet, 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 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 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
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 also could 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. 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
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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 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 that such licensees will not 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 its business, financial condition and results of operations.
The computer software market is characterized by frequent and substantial
intellectual property litigation that often is complex and expensive and
involves a significant diversion of resources and uncertainty of outcome. In the
future, the Company may need to pursue litigation to enforce and protect its
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
regarding alleged infringement could be avoided or settled without substantial
expense and damage awards. Any claims against the Company 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 the Company's 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
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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 "Risk Factors -- Uncertain Protection of Intellectual Property; Risks
Associated with Licensed Third-Party Technology."
EMPLOYEES
As of 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 served with a subpoena by the U.S.
Department of Justice in connection with its investigation into horizontal
merger activity within the streaming media industry. The investigation,
including interviews of Company officers by Department of Justice personnel 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 fully with 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 October 24, 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............ 39 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
Jeff Lehman............... 40 Vice President -- Advertising Sales
Philip Rosedale........... 29 Vice President -- Media Systems
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
in other communications or media in which the Company has a significant
editorial or media voice. See "Risk Factors -- Control by Mr. Glaser;
Antitakeover Provisions" and "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 has
been elected as 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 has been elected as 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
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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.
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 in various marketing
capacities as an employee of 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.
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<PAGE> 53
JEFF LEHMAN has served as Vice President -- Advertising Sales of the
Company since October 1997. From September 1985 to September 1997 Mr. Lehman was
employed by Ziff-Davis/Softbank in a number of Vice President, Director, and
other publishing positions. Mr. Lehman graduated cum laude from The University
of Central Florida with a B.S.B.A. and an M.B.A. with Honors.
PHILIP ROSEDALE has served as Vice President -- Media Systems of the
Company since October 1997. From February 1996 to October 1997, Mr. Rosedale
served as General Manager, Software Development of the Company. From June 1986
to February 1996, Mr. Rosedale was President and Chief Executive Officer of
Automated Management Systems, a developer and marketer of software applications.
Mr. Rosedale holds a B.S. in Physics from the University of California, San
Diego.
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 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 has been elected as 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 has been elected as 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 or more than seven, 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 or until the election and qualification of his or
her successor or 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. 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. Commencing with the annual shareholders meeting in
1998 and thereafter, each newly elected director shall serve for a term ending
at the third annual meeting of shareholders following such director's election.
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 was nominated by the holders of
the Series B Preferred Stock, Mr. Breyer was nominated by the holders of the
Series C Preferred Stock, and the holder of the
52
<PAGE> 54
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 them 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.
Pursuant to the terms of the Strategic Transactions 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 the Strategic Transactions
Committee. The Strategic Transactions 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, elected to, and not removed
from, the Board of Directors.
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 or Committee 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 initially will 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 will 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
53
<PAGE> 55
existence and powers of the Committee will 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 "Description of Capital Stock."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
As of the end of the Company's last fiscal year, the Company did not have a
Compensation Committee, and all decisions regarding compensation of the
Company's executive officers were made by the Board of Directors. During fiscal
year 1996, Mr. Glaser participated in deliberations of the Board of Directors
concerning executive officer compensation. No executive officer of the Company
serves as a member of the board of directors or compensation committee of any
entity that has one or more executive officers serving as a member of the
Company's Board of Directors or Compensation Committee, which was established
during fiscal year 1997.
POLICY OMBUDSMAN
The Articles provide that Mr. Glaser will serve, or will 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 in other communications or media in
which 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 will serve or appoint another officer of the Company to serve
as Mr. Glaser's 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 by the Company's Chief Executive Officer and by the other three
executive officers of the Company whose salary and bonus exceeded $100,000 in
1996 (the "Named Executive Officers") for services rendered to the Company in
all capacities during the year ended December 31, 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
-------------
ANNUAL COMPENSATION SECURITIES
-------------------------- UNDERLYING
NAME AND PRINCIPAL POSITION SALARY($)(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 $90,000, respectively.
(2) Mr. Sharpless resigned as a Senior Vice President of the Company effective
August 2, 1996; however, he continued to serve as a Vice President of the
Company until February 1997, when he terminated his employment with the
Company. Mr. Sharpless exercised this option with respect to 12,500 shares
on April 8, 1997, after terminating his employment with the Company. The
remainder
54
<PAGE> 56
of the shares subject to this option were unvested as of his termination
date and therefore were canceled.
The following table sets forth information concerning stock options granted
to the Named Executive Officers in 1996 and reflects the conversion of Series B
Common Stock and Series C Common Stock underlying such options into an equal
number of shares of Common Stock on closing of the offering.
OPTION GRANTS IN 1996
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
------------------------------------------------------- VALUE
NUMBER OF % OF TOTAL AT ASSUMED ANNUAL RATES
SECURITIES OPTIONS OF STOCK APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM(3)
OPTIONS EMPLOYEES PRICE EXPIRATION ------------------------
NAME GRANTED(#)(1) IN 1996 ($/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 service rendered by the optionee to the Company,
except for 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 is 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.
55
<PAGE> 57
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 fullest
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 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
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<PAGE> 58
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 not to 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.
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 employee of the Company or of any majority-
owned subsidiary of the Company who has been employed by the Company or such
majority-owned
57
<PAGE> 59
subsidiary of the Company for at least 90 days and for more than 20 hours per
week and more than five months per year will be eligible to participate in the
ESPP. 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 participant'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> 60
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.
59
<PAGE> 61
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 included in 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 licensed technology to third parties under certain circumstances. On two
occasions during the first two years following delivery under the agreement,
Microsoft may acquire for $25 million and $35 million, respectively, a
nonexclusive license to subsequently developed versions of the core audio and
video technology, which currently is distributed to end-users at no charge.
Under prescribed circumstances that are solely within the Company's control, the
agreement provides for a full refund of each license fee during the first year,
declining to 0% over the following two years. The Company may not assign its
obligations under the agreement without Microsoft's consent, and a merger, the
sale of substantially all of the Company's assets and certain other events will
be deemed to be an assignment under the agreement. 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.
Pursuant to the Articles, 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. This warrant terminates on
closing of the offering. Subsequent to the investment, at Microsoft's request,
the Board of Directors agreed to adopt, and recommend to the shareholders, an
amendment to the Articles providing for the automatic conversion of shares of
Special Common Stock into shares of Common Stock on a bona fide sale to a
purchaser who is not an affiliate of the holder. In consideration of the
foregoing, Microsoft gave notice to the Company of its election to receive only
Special Common Stock in connection with any conversion of shares of Series E
Preferred Stock. 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."
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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, NTT and KDD 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 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. The
note is denominated in Japanese yen and bears interest at a rate not to exceed
the Japanese Short Term Prime Rate (1.63% at September 30, 1997). Interest on
the note is payable monthly, and the principal is due in May 2000. The terms of
the note contain no restrictions or covenants. The note is secured by the
Company's shares in J-Stream, 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 to distribute the Company's server products, in Japan. Under the
distribution agreement, Trans Cosmos must 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 pursuant to the
distribution agreement. 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 them 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.
STRATEGIC TRANSACTIONS AGREEMENT
Pursuant to the terms of the Strategic Transactions 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 the Strategic Transactions
Committee. The Strategic Transactions 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, elected to, and not removed
from, 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 24, 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 into Common Stock and Series E Preferred Stock
into Special 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. See footnote (1) below regarding share
ownership by Microsoft.
<TABLE>
<CAPTION>
COMMON STOCK(1)
-------------------------------------------
NUMBER
OF PERCENT OWNERSHIP
SHARES ------------------------
BENEFICIALLY BEFORE AFTER
NAME OWNED(2) OFFERING OFFERING(3)
- ------------------------------------------------------ ------------ -------- -----------
<S> <C> <C> <C>
Robert Glaser......................................... 14,101,871(4) 59.5% 52.8%
c/o RealNetworks, Inc.
1111 Third Avenue
Suite 2900
Seattle, WA 98101
Accel IV L.P.......................................... 2,373,604(5) 9.9 8.8
c/o Accel Partners L.P.
428 University Ave.
Palo Alto, CA 94301
James W. Breyer....................................... 2,373,604(6) 9.9 8.8
Mitchell Kapor........................................ 2,258,785(7) 9.5 8.5
Kapor Enterprises, Inc.
238 Main Street
Cambridge, MA 02142
Trans Cosmos USA, Inc................................. 1,381,142(8) 5.8 5.1
4040 Lake Washington Blvd. N.E.
Suite 205
Kirkland, WA 98033
Bruce Jacobsen........................................ 562,665(9) 2.3 2.1
Andrew Sharpless...................................... 312,500 1.3 1.2
James Wells........................................... 137,500(10) * *
All directors and executive officers as a group (15
persons)(11)........................................ 20,472,204 83.2% 74.1%
</TABLE>
- ---------------
* Less than 1%.
(1) Excludes (i) 3,338,374 shares of Special Common Stock to be issued to
Microsoft on the closing of the offering upon conversion of an equal number
of shares of Series E Preferred Stock and (ii) up to 3,709,305 shares of
Special Common Stock issuable upon exercise of the Series E Warrant. If not
exercised, the Series E Warrant will terminate on closing of the offering.
Pursuant to the Articles, the holder of Series E Preferred Stock may elect
to convert such shares into Common Stock or Special Common Stock. Microsoft
has given notice of its intention and has agreed to receive only Special
Common Stock in connection with any conversion of shares of Series E
Preferred Stock (including those shares issuable upon exercise of the
Series E Warrant). Upon such conversion, Microsoft will own 100% of the
outstanding Special Common Stock. Shares of Special Common Stock have
rights identical to the Common Stock, except that shares of Special Common
Stock do not have the right to vote, unless required by applicable law. The
Special Common Stock converts automatically into Common Stock on a bona
fide sale to a purchaser who is not an affiliate of the holder. See
"Description of Capital Stock."
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(2) 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 October 24,
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.
(3) Microsoft has entered into a Lock-Up Agreement with the Underwriters,
pursuant to which Microsoft has agreed not to sell, offer to sell or
otherwise dispose of any shares of capital stock owned of record or
beneficially as of the date of this Prospectus for a period of 180 days
after the date of the Prospectus without the prior written consent of
Goldman, Sachs & Co. on behalf of the Underwriters. After the expiration of
such period, Microsoft may sell shares of Special Common Stock, which
shares will convert automatically into Common Stock as noted in footnote
(1) above. Assuming the exercise in full of the Series E Warrant and the
resale of all shares of Special Common Stock (and no changes in beneficial
ownership of the persons listed below), the resulting ownership percentages
for the other shareholders listed in the table would be as follows: Mr.
Glaser -- 41.8%; Accel IV -- 7.0%; Mr. Breyer -- 7.0%; Mr. Kapor -- 6.7%;
Trans Cosmos -- 4.1%; Mr. Jacobsen -- 1.7%; Mr. Sharpless -- .9%; Mr.
Wells -- .4%; and all directors and executive officers as a group -- 59.1%.
(4) Includes 11,952 shares of Common Stock issuable on exercise of a warrant.
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 50.2%.
(5) 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.
(6) 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 (5) above.
(7) Includes 53,675 shares of Common Stock issuable on exercise of warrants.
(8) 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.
(9) Includes 362,655 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.
(10) Includes 27,500 shares of Common Stock issuable on exercise of options.
(11) Does not include shares owned by Mr. Sharpless, who terminated his
employment with the Company in February 1997. Includes an aggregate of
611,810 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 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 Company's capital structure that will occur on
closing of the offering in accordance with the terms of the Articles.
The authorized capital stock of the Company consists of 300,000,000 shares
of common stock, par value $0.001 per share, which is divided into Common Stock
and Special Common Stock, and 60,000,000 shares of preferred stock, par value
$0.001 per share.
COMMON STOCK
As of October 9, 1997, 23,628,647 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 rights identical to the Common Stock, except that they do not have the
right to vote unless required by applicable law. The Special Common Stock
converts automatically into Common Stock on a bona fide sale to a purchaser who
is not an affiliate of the holder. As of October 9, 1997, 3,338,374 shares of
Special Common Stock were outstanding and held of record by one holder.
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 Plan."
WARRANTS TO PURCHASE PREFERRED STOCK AND COMMON STOCK
As of 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 of each class of the Company's
capital stock 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 at least a
majority of the outstanding shares of Common Stock in most instances.
ARTICLES AND BYLAWS
The Articles provide that Mr. Glaser will serve, or will 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 in other communications or media in
which 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 will serve or appoint another officer of the Company to serve
as Mr. Glaser's 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 initially will be Messrs. Glaser, Breyer and
Kapor. Without the prior approval of such Committee, and subject to certain
limited exceptions, the Board of Directors will 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 will 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 will 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 of 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 limited voting rights of Microsoft's shares of Special Common Stock.
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The Proxy Agreement does not apply to voting with respect to certain matters,
such as any amendment 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 in
the event of dissolution, bankruptcy or insolvency of the Company, or at such
time as there is only one remaining party to the Buy-Sell Agreement. The Company
and the requisite holders have entered into an agreement to terminate the
Buy-Sell Agreement, effective immediately prior to effectiveness of the
offering.
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. After the five-year period, the Company may engage in otherwise
proscribed transactions, so long as the transaction complies with certain fair
price provisions of the statute or is approved by a majority of disinterested
shareholders within each voting group entitled to vote separately. 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 plans to enter 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. Shares of Common
Stock issued in the offering (assuming no triggering event) automatically would
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
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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 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 (other than those Rights held by an acquiring person or group),
when exercisable, would entitle their holders 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 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, which is intended to encourage a potential acquiring
person or group to negotiate directly with the Board, 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 and Special 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. Of these
Restricted Shares, 3,338,374 are shares of Special Common Stock that convert
automatically into the same number of shares of Common Stock on a bona fide sale
to a purchaser who is not an affiliate of the holder.
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
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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
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 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, 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
276,267 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 exercise of all outstanding warrants) 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 (including pursuant to this
offering), Registrable Shares may be included, subject to any limitation set by
the underwriters on the number of shares included in such registration. The
Company and the holders of the requisite number of shares have waived the rights
of the holders of Registrable Securities to have their shares registered in
68
<PAGE> 70
connection with this offering. 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 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 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 also
are 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 hereby 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> 71
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> 72
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, except as to Note 9,
which is as of October 30, 1997
Seattle, Washington
F-2
<PAGE> 73
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 (23,601,747 pro forma)............................... 23,602
Special common stock, $0.001 par value
Authorized, issued and outstanding; no shares
(3,338,374 pro forma)..................................... -- -- -- 3,338
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> 74
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 -- -- -- -- (73,291)
venture......................
--------- ---------- ---------- ---------- ----------
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 27,779,321 28,315,053
forma net loss per share.....
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 75
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> 76
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> 77
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 had contractual maturities of two years or
less.
F-7
<PAGE> 78
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.
The Company's investment in the joint venture was funded with proceeds from
a loan from Trans Cosmos, Inc., one of the joint venture's partners (see note
6). The Company and Trans Cosmos, Inc. are parties to a Master Distribution
Agreement pursuant to which the Company granted Trans Cosmos, Inc. a
nonexclusive, nontransferable license to reproduce and distribute the Company's
products in Japan.
(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.
F-8
<PAGE> 79
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
(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 of the Company remain 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 generally is 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), provided the following conditions are met: the
software product has been delivered to the VAR, the fee to the Company is fixed
or determinable, and collectibility is probable.
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> 80
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.................................. 83% 78% 79% 73%
Asia........................................... 8% 7% 8% 11%
Europe......................................... 5% 7% 7% 10%
Canada......................................... 2% 3% 3% 3%
Other.......................................... 2% 5% 3% 3%
</TABLE>
One customer accounted for approximately 14% of total net revenues in 1995.
No single customer accounted for more than 10% of total net revenues in 1996 or
in 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 its
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 uses 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 to 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.
F-10
<PAGE> 81
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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. 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,
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 is 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.
F-11
<PAGE> 82
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(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 warrants and stock options that 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 a registration statement for 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 on 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, which is effective for fiscal years beginning after December 15, 1997,
requires reclassification of financial statements for earlier periods to be
provided for comparative purposes. The Company anticipates that implementing the
provisions of Statement 130 will not have a significant impact on the Company's
existing disclosures. 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 must be restated.
The Company anticipates that implementing the provisions of Statement 131 will
not have a significant impact on the Company's existing disclosures. The Company
has not determined the manner in which it will present the information required
by Statement 131.
F-12
<PAGE> 83
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
pursuant to which 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> 84
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) INCOME TAXES
The components of income tax expense (benefit) are:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, ENDED
---------------------- 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 by $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> 85
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> 86
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 prices at date of issuance
were $0.67, $1.9634, $7.53 and $8.99 per share for the Series B, C, D and
E Preferred Stock, respectively, and are 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> 87
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 and Special
Common Stock (see note 9(b)) as of September 30, 1997.
(c) Common Stock
Common stock at December 31, 1995 and 1996, and September 30, 1997,
consisted 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 his or her 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
F-17
<PAGE> 88
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
one vote, or Special Common Stock, with no voting rights except as required by
applicable law. The Special Common Stock has all other rights and privileges of
the Common Stock.
(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 two 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
F-18
<PAGE> 89
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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
of the option 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> 90
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 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 included in 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 licensed technology to third parties under certain
conditions. On two occasions during the first two years following delivery under
the agreement, Microsoft may acquire for $25 million and $35 million,
respectively, a nonexclusive license to subsequently developed versions of the
core audio and video technology, which currently is distributed to end-users at
no charge. Under prescribed circumstances that are solely within the Company's
control, the agreement provides for a full refund of each license fee during the
first year, declining to 0% over the following two years. The Company may not
assign its obligations under the agreement without Microsoft's consent, and a
merger, the sale of substantially all of the Company's assets and certain other
F-20
<PAGE> 91
REALNETWORKS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
events will be deemed to be an assignment under the agreement. 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 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.
(9) SUBSEQUENT EVENTS
(a) License Agreement
The terms of the Company's strategic agreement with Microsoft provide that
the $30,000,000 software license fee will be paid to the Company in two
installments. The first installment of $20,000,000 was due within 30 days of the
signing of the software license agreement, and the remaining $10,000,000 is due
within 30 days of the earlier of (1) the Company's completion of six "man
months" of consulting services, or (2) six months after delivery of the
specified source code to Microsoft. In July 1997, the Company delivered the
specified source code and subsequently received from Microsoft a payment of
$30,000,000 representing Microsoft's payment of both installments under the
agreement although payment of the second installment of $10,000,000 was not due
at that time. In October 1997, Microsoft requested that the Company return the
$10,000,000 installment that Microsoft had paid prior to its due date. Although
not legally required to do so, the Company refunded the $10,000,000 to
Microsoft. The Company expects Microsoft to make this second installment payment
in accordance with the terms of the agreement.
(b) Special Common Stock
In October 1997, the Company's Board of Directors and shareholders approved
an amendment to the Company's Amended and Restated Articles of Incorporation to
provide that any shares of Special Common Stock held by Microsoft will convert
automatically into Common Stock upon transfer by a purchaser who is not
affiliated with the holder.
In October 1997, Microsoft agreed in writing to accept Special Common Stock
in connection with any conversion of shares of Series E Preferred Stock held by
Microsoft.
F-21
<PAGE> 92
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 at the initial public offering price per
share, less the underwriting discount, solely 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
U-1
<PAGE> 93
capital stock) have agreed that they will not offer, sell or otherwise dispose
of any shares of Common 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 any such gift 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> 94
[SCREEN-SHOTS OF
WEB PAGES SUPERIMPOSED
OVER COMPANY LOGO]
<PAGE> 95
============================================================
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........................... 20
Dividend Policy........................... 20
Capitalization............................ 21
Dilution.................................. 22
Selected Consolidated Financial Data...... 23
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 24
Business.................................. 35
Management................................ 50
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> 96
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> 97
(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.
(14) An aggregate of 15,000 shares of Series C Common Stock was issued
in October 1997 to one entity in a private placement in connection with the
acquisition of certain assets of that entity.
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
II-2
<PAGE> 98
in reliance upon the exemption from registration provided by either Section 3(b)
or 4(2) of the Securities Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------- -------------------------------------------------------------------------------
<S> <C>
1.1 Form of Underwriting Agreement
3.1 Form of Amended and Restated Articles of Incorporation
3.2** Bylaws (previously filed as Exhibit 3.4 to Amendment No. 1 filed on October 15,
1997)
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
10.20 Agreement to Terminate Shareholders' Buy-Sell Agreement dated October 24, 1997
10.21 Representative License Agreement -- License Agreement for the RealPlayer Plus
11.1** Statement re: Computation of Pro Forma Net Loss Per Share
21.1** Subsidiaries of the Registrant
</TABLE>
II-3
<PAGE> 99
<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>
- ---------------
** Previously filed.
(b) FINANCIAL STATEMENT SCHEDULE
Schedule II -- Valuation and Qualifying Accounts
II-4
<PAGE> 100
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> 101
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 2 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 31, 1997.
REALNETWORKS, INC.
By: /s/ ROBERT GLASER
------------------------------------
Robert Glaser
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to Registration Statement has been signed by the following persons in the
capacities indicated below on October 31, 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> 102
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> 103
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- ----------------------------------------------------------------------
<S> <C> <C>
1.1 Form of Underwriting Agreement........................................
3.1 Form of Amended and Restated Articles of Incorporation................
3.2** Bylaws (previously filed as Exhibit 3.4 to Amendment No. 1 filed on
October 15, 1997......................................................
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............................................................
10.20 Agreement to Terminate Shareholders' Buy-Sell Agreement dated October
24, 1997..............................................................
10.21 Representative License Agreement -- License Agreement for the
RealPlayer Plus
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>
- ---------------
** Previously filed.
<PAGE> 1
EXHIBIT 1.1
RealNetworks, Inc.
Common Stock
Underwriting Agreement
November __, 1997
Goldman, Sachs & Co.
NationsBanc Montgomery Securities, Inc.
BancAmerica Robertson Stephens
As representatives of the several Underwriters
named in Schedule I hereto
c/o Goldman, Sachs & Co.
85 Broad Street
New York, New York 10004
Ladies and Gentlemen:
RealNetworks, Inc., a Washington corporation (the "Company"), proposes,
subject to the terms and conditions stated herein, to issue and sell to the
Underwriters named in Schedule I hereto (the "Underwriters") an aggregate of
3,000,000 shares (the "Firm Shares") and, at the election of the Underwriters,
up to 450,000 additional shares (the "Optional Shares") of Common Stock, par
value $.001 per share (the "Stock"), of the Company (the Firm Shares and the
Optional Shares that the Underwriters elect to purchase pursuant to Section 2
hereof being collectively called the "Shares").
1. The Company represents and warrants to, and agrees with, each of the
Underwriters that:
(a) A registration statement on Form S-1 (File No. 333-36553)
(the "Initial Registration Statement") in respect of the Shares has
been filed with the Securities and Exchange Commission (the
"Commission"); the Initial Registration Statement and any
post-effective amendment thereto, each in the form heretofore delivered
to you, and, excluding exhibits thereto, to you for each of the other
Underwriters, have been declared effective by the Commission in such
form; other than a registration statement, if any, increasing the size
of the offering (the "Rule 462(b) Registration Statement") filed
pursuant to Rule 462(b) under the Securities Act of 1933, as amended
(the "Act"), which became effective upon filing, no other document with
respect to the Initial Registration Statement has heretofore been filed
with the Commission; and no stop order suspending the effectiveness of
the Initial Registration Statement, any post-effective amendment
thereto or the Rule 462(b) Registration Statement, if any, has been
issued and no proceeding for that purpose has been initiated or
threatened by the Commission (any preliminary prospectus included in
the Initial Registration Statement and the Rule 462(b) Registration
Statement, if any, or filed with the Commission pursuant to Rule 424(a)
of the rules and regulations of the Commission under the Act is
hereinafter called a "Preliminary Prospectus"; the various parts of the
Initial Registration
<PAGE> 2
Statement and the Rule 462(b) Registration Statement, if any, including
all exhibits thereto and including the information contained in the
form of final prospectus filed with the Commission pursuant to Rule
424(b) under the Act in accordance with Section 5(a) hereof and deemed
by virtue of Rule 430A under the Act to be part of the Initial
Registration Statement at the time it was declared effective or such
part of the Rule 462(b) Registration Statement, if any, which became or
hereafter becomes effective, each as amended at the time such part of
the registration statement became effective, is hereinafter
collectively called the "Registration Statement"; and such final
prospectus, in the form first filed pursuant to Rule 424(b) under the
Act, is hereinafter called the "Prospectus");
(b) No order preventing or suspending the use of any
Preliminary Prospectus has been issued by the Commission, and each
Preliminary Prospectus, at the time of filing thereof, conformed in all
material respects to the requirements of the Act and the rules and
regulations of the Commission thereunder, and did not contain an untrue
statement of a material fact or omit to state a material fact required
to be stated therein or necessary to make the statements therein, in
the light of the circumstances under which they were made, not
misleading; provided, however, that this representation and warranty
shall not apply to any statements or omissions made in reliance upon
and in conformity with information furnished in writing to the Company
by an Underwriter through Goldman, Sachs & Co. expressly for use
therein;
(c) The Registration Statement conforms, and the Prospectus
and any further amendments or supplements to the Registration Statement
or the Prospectus will conform, in all material respects to the
requirements of the Act and the rules and regulations of the Commission
thereunder and do not and will not, as of the applicable effective date
as to the Registration Statement and any amendment thereto and as of
the applicable filing date as to the Prospectus and any amendment or
supplement thereto, contain an untrue statement of a material fact or
omit to state a material fact required to be stated therein or
necessary to make the statements therein not misleading; provided,
however, that this representation and warranty shall not apply to any
statements or omissions made in reliance upon and in conformity with
information furnished in writing to the Company by an Underwriter
through Goldman, Sachs & Co. expressly for use therein;
(d) Neither the Company nor any of its subsidiaries has
sustained since the date of the latest audited financial statements
included in the Prospectus any material loss or interference with its
business from fire, explosion, flood or other calamity, whether or not
covered by insurance, or from any labor dispute or court or
governmental action, order or decree, otherwise than as set forth or
contemplated in the Prospectus; and, since the respective dates as of
which information is given in the Registration Statement and the
Prospectus, there has not been any change in the capital stock (other
than as a result of the exercise of options or warrants outstanding as
of the date of this Agreement) or any increase in the long-term debt of
the Company or any of its subsidiaries in excess of $____________ or
any material adverse change, or any development that could reasonably
be expected to result in a material adverse change, in or affecting the
general affairs, management, financial position, shareholders' equity
or results of operations of the Company and its subsidiaries, taken as
a whole, otherwise than as set forth or contemplated in the Prospectus;
-2-
<PAGE> 3
(e) The Company and its subsidiaries have good and marketable
title in fee simple to all real property and good and marketable title
to all personal property owned by them, in each case free and clear of
all liens, encumbrances and defects except such as are described in the
Prospectus or such as do not and will not have a material adverse
effect upon the assets, business, financial condition or results of
operations of the Company and its subsidiaries, taken as a whole, or on
the consummation of any of the transactions contemplated hereby (a
"Material Adverse Effect"); and any real property and buildings held
under lease by the Company and its subsidiaries are held by them under
valid, subsisting and enforceable leases with such exceptions as are
not material and do not interfere with the use made and proposed to be
made of such property and buildings by the Company and its
subsidiaries;
(f) The Company has been duly incorporated and is duly
authorized to transact business in the corporate form under the laws of
the state of Washington, with power and authority (corporate and other)
to own its properties and conduct its business as described in the
Prospectus, and has been duly qualified as a foreign corporation for
the transaction of business and is in good standing under the laws of
each other jurisdiction in which it owns or leases properties or
conducts any business so as to require such qualification, except where
the failure to be so qualified in any such jurisdiction would not have
a Material Adverse Effect; and each subsidiary of the Company has been
duly incorporated and is validly existing as a corporation in good
standing under the laws of its jurisdiction of incorporation;
(g) The Company has an authorized capitalization as set forth
in the Prospectus, and all of the issued shares of capital stock of the
Company have been duly and validly authorized and issued, are fully
paid and non-assessable and conform to the description of the various
classes and series of capital stock contained in the Prospectus; and
all of the issued shares of capital stock of each wholly owned
subsidiary of the Company have been duly and validly authorized and
issued, are fully paid and non-assessable and are owned directly by the
Company, free and clear of all liens, encumbrances, equities or claims;
(h) The Shares have been duly and validly authorized and, when
issued and delivered against payment therefor as provided herein, will
be duly and validly issued and fully paid and non-assessable and will
conform to the description of the Stock contained in the Prospectus;
(i) The issue and sale of the Shares by the Company hereunder
and the compliance by the Company with all of the provisions of this
Agreement and the consummation of the transactions herein contemplated
will not conflict with or result in a breach or violation of any of the
terms or provisions of, or constitute a default under, any indenture,
mortgage, deed of trust, loan agreement or other agreement or
instrument to which the Company or any of its subsidiaries is a party
or by which the Company or any of its subsidiaries is bound or to which
any of the property or assets of the Company or any of its subsidiaries
is subject, nor will such action result in any violation of the
provisions of the Amended and Restated Articles of Incorporation or
Restated Bylaws of the Company or any statute or any order, rule or
regulation of any court or governmental agency or body having
jurisdiction over the Company or any of its subsidiaries or any of
their properties; and no consent, approval, authorization, order,
registration or qualification of or with any such court or governmental
agency or
-3-
<PAGE> 4
body is required for the issue and sale of the Shares or the
consummation by the Company of the transactions contemplated by this
Agreement, except the registration under the Act of the Shares, and
such consents, approvals, authorizations, registrations or
qualifications as may be required under state securities or Blue Sky
laws in connection with the purchase and distribution of the Shares by
the Underwriters;
(j) The Amended and Restated Articles of Incorporation and the
Restated Bylaws of the Company are not in conflict with or in violation
of the provisions of the Washington Business Corporation Act (the
"WBCA"). Neither the Company nor any of its subsidiaries is in
violation of its articles of incorporation or bylaws or in default in
the performance or observance of any material obligation, agreement,
covenant or condition contained in any indenture, mortgage, deed of
trust, loan agreement, lease or other agreement or instrument to which
it is a party or by which it or any of its properties may be bound;
(k) The statements set forth in the Prospectus (i) under the
caption "Description of Capital Stock," insofar as they purport to
constitute a summary of the terms of the various classes and series of
capital stock of the Company and (ii) under the caption "Underwriting,"
insofar as they purport to describe the provisions of the laws and
documents referred to therein, are in each case accurate and complete;
(l) Other than as set forth or contemplated in the Prospectus,
there are no legal or governmental proceedings pending to which the
Company or any of its subsidiaries is a party or of which any property
of the Company or any of its subsidiaries is the subject that, if
determined adversely to the Company or any of its subsidiaries, would
individually or in the aggregate have a Material Adverse Effect; and,
to the best of the Company's knowledge, no such proceedings are
threatened or contemplated by governmental authorities or threatened by
others;
(m) The Company is not and, after giving effect to the
offering and sale of the Shares, will not be an "investment company" or
an entity "controlled" by an "investment company," as such terms are
defined in the Investment Company Act of 1940, as amended (the
"Investment Company Act");
(n) Neither the Company nor any of its affiliates does
business with the government of Cuba or with any person or affiliate
located in Cuba within the meaning of Section 517.075, Florida
Statutes;
(o) KPMG Peat Marwick LLP, who have certified certain
financial statements of the Company and its subsidiaries, are
independent public accountants as required by the Act and the rules and
regulations of the Commission thereunder;
(p) Except as described in the Prospectus, the Company and
each of its subsidiaries own or possess adequate licenses or other
rights to use all patents, patent applications, trademarks, trademark
applications, service marks, service mark applications, trade names,
copyrights, manufacturing or other processes, formulae, trade secrets,
know-how, franchises and other material intangible property and assets
(collectively, "Intellectual Property") that are necessary or material
to the conduct of their businesses as conducted and as proposed to be
conducted as described in the
-4-
<PAGE> 5
Prospectus. Except as described in the Prospectus, there are no facts
that would preclude it from having rights to the patent and patent
applications referenced in the Prospectus. Except as described in the
Prospectus, the Company is not aware that it or any of its subsidiaries
lacks or will be unable to obtain any rights or licenses to use any of
the Intellectual Property necessary to conduct the business now
conducted or proposed to be conducted by it as described in the
Prospectus. The Prospectus fairly and accurately describes the
Company's rights with respect to the Intellectual Property. The Company
is not aware of any material violation or infringement by a third party
of any of the Intellectual Property and, except as described in the
Prospectus, no third party has an interest in or right to a license to
use, or the right to license others to use, any of the Intellectual
Property. No material claim is pending or, to the Company's knowledge,
threatened to the effect that the operations of the Company infringe
upon or conflict with the asserted rights of any other person or entity
under any Intellectual Property, and there is no known basis for any
such material claim (whether or not pending or threatened). No material
claim is pending or, to the Company's knowledge, threatened to the
effect that any such Intellectual Property owned or licensed by the
Company, or which the Company otherwise has the right to use, is
invalid or unenforceable by the Company, and there is no known basis
for any such material claim (whether or not pending or threatened). To
the Company's knowledge, all material proprietary trade secrets
developed by or belonging to the Company that have not been patented
have been kept confidential. Each current and prior employee (other
than clerical staff and other employees without access to proprietary
trade secrets) has executed an agreement regarding confidentiality,
proprietary information and assignment of inventions to the Company
and, to the Company's knowledge, no such person is in breach of any
agreement or arrangement with employers relating to proprietary
information or assignment of inventions. Except as described in the
Prospectus, to the Company's knowledge, the business conducted or
proposed to be conducted by the Company will not cause the Company to
infringe or violate any of the patents, trademarks, service marks,
trade names, copyrights, licenses, trade secrets or other proprietary
rights of any other person or entity. Except as described in the
Prospectus, to the Company's knowledge, no person or entity, including
any prior or current employer of any prior or current employee, has any
right to or interest in any material inventions, improvements,
discoveries or other information assigned to the Company by such
employee;
(q) The Company and its subsidiaries possess all consents,
licenses, certificates, authorizations and permits issued by the
appropriate federal, state or foreign regulatory authorities necessary
to conduct their respective businesses, and the Company is not aware of
any proceedings relating to the revocation or modification of any such
certificate, authorization or permit that, individually or in the
aggregate, if the subject of an unfavorable decision, ruling or
finding, would have a Material Adverse Effect, except as described in
or contemplated by the Prospectus;
(r) The Company and its subsidiaries maintain a system of
internal accounting controls sufficient to provide reasonable
assurances that (i) transactions are executed in accordance with
management's general or specific authorizations, (ii) transactions are
recorded as necessary to permit preparation of financial statements in
conformity with generally accepted accounting principles and to
maintain accountability for assets, and (iii) access to assets is
permitted only in accordance with management's general or specific
authorization; and
-5-
<PAGE> 6
(s) Except as set forth in the Prospectus, (i) no preemptive
right, co-sale right, right of first refusal or other similar rights of
securityholders exist with respect to any class or series of capital
stock, including the issuance and sale of the Shares, other than those
that have been expressly waived or terminated prior to the date hereof,
(ii) no holder of securities of the Company has the right to cause the
Company to include such holder's securities in the Registration
Statement, (iii) no further approval or authorization of any
securityholder, the Board of Directors or any duly appointed committee
thereof or others is required under the Act, the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), or under state securities
or Blue Sky laws and (iv) the Company does not have outstanding any
options or warrants to purchase, or any preemptive rights or other
rights to subscribe for or to purchase, any securities or obligations
convertible into, or any contracts or commitments to issue or sell,
shares of its capital stock or any such options, rights, convertible
securities or obligations.
2. Subject to the terms and conditions herein set forth, (a) the
Company agrees to issue and sell to each of the Underwriters, and each of the
Underwriters agrees, severally and not jointly, to purchase from the Company, at
a purchase price per share of $[_____], the number of Firm Shares set forth
opposite the name of such Underwriter in Schedule I hereto and (b) in the event
and to the extent that the Underwriters shall exercise the election to purchase
Optional Shares as provided below, the Company agrees to issue and sell to each
of the Underwriters, and each of the Underwriters agrees, severally and not
jointly, to purchase from the Company, at the purchase price per share set forth
in clause (a) of this Section 2, that portion of the number of Optional Shares
as to which such election shall have been exercised (to be adjusted by you so as
to eliminate fractional shares) determined by multiplying such number of
Optional Shares by a fraction, the numerator of which is the maximum number of
Optional Shares that such Underwriter is entitled to purchase as set forth
opposite the name of such Underwriter in Schedule I hereto and the denominator
of which is the maximum number of Optional Shares that all of the Underwriters
are entitled to purchase hereunder.
The Company hereby grants to the Underwriters the right to purchase at
their election up to 450,000 Optional Shares, at the purchase price per share
set forth in the paragraph above, for the sole purpose of covering
overallotments in the sale of the Firm Shares. Any such election to purchase
Optional Shares may be exercised only by written notice from you to the Company,
given within a period of 30 calendar days after the date of this Agreement,
setting forth the aggregate number of Optional Shares to be purchased and the
date on which such Optional Shares are to be delivered, as determined by you but
in no event earlier than the First Time of Delivery (as defined in Section 4
hereof) or, unless you and the Company otherwise agree in writing, earlier than
two or later than ten business days after the date of such notice.
3. Upon the authorization by you of the release of the Firm Shares, the
several Underwriters propose to offer the Firm Shares for sale upon the terms
and conditions set forth in the Prospectus.
4. (a) The Shares to be purchased by each Underwriter hereunder, in
definitive form and in such authorized denominations and registered in such
names as Goldman, Sachs & Co. may request upon at least forty-eight hours' prior
notice to the Company, shall be delivered by or on behalf of the Company to
Goldman, Sachs & Co., for the account of such Underwriter, against payment by or
on behalf of such Underwriter of the purchase price therefor by wire transfer,
payable to the Company in Federal (same day) funds. The Company will cause the
certificates representing the Shares to be made available for checking and
packaging at least twenty-four hours prior to the Time of Delivery (as defined
below) with respect thereto at the
-6-
<PAGE> 7
office of Goldman, Sachs & Co., 85 Broad Street, New York, New York 10004 (the
"Designated Office"). The time and date of such delivery and payment shall be,
with respect to the Firm Shares, 9:30 a.m., New York City time, on [_____], 1997
or such other time and date as Goldman, Sachs & Co. and the Company may agree
upon in writing, and, with respect to the Optional Shares, 9:30 a.m., New York
time, on the date specified by Goldman, Sachs & Co. in the written notice given
by Goldman, Sachs & Co. of the Underwriters' election to purchase such Optional
Shares, or such other time and date as Goldman, Sachs & Co. and the Company may
agree upon in writing. Such time and date for delivery of the Firm Shares is
herein called the "First Time of Delivery," such time and date for delivery of
the Optional Shares, if not the First Time of Delivery, is herein called the
"Second Time of Delivery," and each such time and date for delivery is herein
called a "Time of Delivery."
(b) The documents to be delivered at each Time of Delivery by or on
behalf of the parties hereto pursuant to Section 7 hereof, including the cross
receipt for the Shares and any additional documents requested by the
Underwriters pursuant to Section 7(i) hereof, will be delivered at the offices
of Perkins Coie, 1201 Third Avenue, Seattle, Washington 98101 (the "Closing
Location"), and the Shares will be delivered at the Designated Office, all at
such Time of Delivery. A meeting will be held at the Closing Location at [__]
p.m., New York City time, on the New York Business Day next preceding such Time
of Delivery, at which meeting the final drafts of the documents to be delivered
pursuant to the preceding sentence will be available for review by the parties
hereto. For the purposes of this Section 4, "New York Business Day" shall mean
each Monday, Tuesday, Wednesday, Thursday and Friday that is not a day on which
banking institutions in New York are generally authorized or obligated by law or
executive order to close.
5. The Company agrees with each of the Underwriters:
(a) To prepare the Prospectus in a form mutually approved by the
Company and you and to file such Prospectus pursuant to Rule 424(b) under the
Act not later than the Commission's close of business on the second business
day following the execution and delivery of this Agreement, or, if applicable,
such earlier time as may be required by Rule 430A(a)(3) under the Act; to make
no further amendment or any supplement to the Registration Statement or
Prospectus without your prior written approval; to advise you, promptly after
it receives notice thereof, of the time when any amendment to the Registration
Statement has been filed or becomes effective or any supplement to the
Prospectus or any amended Prospectus has been filed and to furnish you with
copies thereof; to advise you, promptly after it receives notice thereof, of
the issuance by the Commission of any stop order or of any order preventing or
suspending the use of any Preliminary Prospectus or prospectus, of the
suspension of the qualification of the Shares for offering or sale in any
jurisdiction, of the initiation or threatening of any proceeding for any such
purpose, or of any request by the Commission for amending or supplementing the
Registration Statement or Prospectus or for additional information; and, in
the event of the issuance of any stop order or of any order preventing or
suspending the use of any Preliminary Prospectus or prospectus or suspending
any such qualification, promptly to use its best efforts to obtain the
withdrawal of such order;
(b) Promptly from time to time to take such action as you may
reasonably request to qualify the Shares for offering and sale under the
securities laws of such jurisdictions as you may request and to comply with
such laws so as to permit the continuance of sales and dealings therein in
such jurisdictions for as long as may be necessary to complete the
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<PAGE> 8
distribution of the Shares, provided that in connection therewith the Company
shall not be required to qualify as a foreign corporation or to file a general
consent to service of process in any jurisdiction;
(c) Prior to 10:00 a.m., New York City time, on the New York Business
Day next succeeding the date of this Agreement and from time to time, to furnish
the Underwriters with copies of the Prospectus in New York City in such
quantities as you may from time to time reasonably request, and, if the delivery
of a prospectus is required at any time prior to the expiration of nine months
after the time of issue of the Prospectus in connection with the offering or
sale of the Shares and if at such time any event shall have occurred as a result
of which the Prospectus as then amended or supplemented would include an untrue
statement of a material fact or omit to state any material fact necessary in
order to make the statements therein, in the light of the circumstances under
which they were made when such Prospectus is delivered, not misleading, or, if
for any other reason it shall be necessary during such period to amend or
supplement the Prospectus in order to comply with the Act, to notify you and
upon your request to prepare and furnish without charge to each Underwriter and
to any dealer in securities as many copies as you may from time to time
reasonably request of an amended Prospectus or a supplement to the Prospectus
that will correct such statement or omission or effect such compliance, and in
case any Underwriter is required to deliver a prospectus in connection with
sales of any of the Shares at any time nine months or more after the time of
issue of the Prospectus, upon your request but at the expense of such
Underwriter, to prepare and deliver to such Underwriter as many copies as you
may request of an amended or supplemented Prospectus complying with Section
10(a)(3) of the Act;
(d) To make generally available to its securityholders as soon as
practicable, but in any event not later than eighteen months after the effective
date of the Registration Statement (as defined in Rule 158(c) under the Act), an
earnings statement of the Company and its subsidiaries (which need not be
audited) complying with Section 11(a) of the Act and the rules and regulations
thereunder (including, at the option of the Company, Rule 158);
(e) During the period beginning from the date hereof and continuing to
and including the date 180 days after the date of the Prospectus, not to offer,
sell, contract to sell or otherwise dispose of, except as provided hereunder,
any securities of the Company that are substantially similar to the Shares,
including, but not limited to, any securities that are convertible into or
exchangeable for, or that represent the right to receive, Stock or any such
substantially similar securities (other than pursuant to employee stock option
or employee stock purchase plans existing on, or upon the conversion or exchange
of convertible or exchangeable securities outstanding as of, the date of this
Agreement), without your prior written consent;
(f) To furnish to its shareholders as soon as practicable after the end
of each fiscal year an annual report (including a balance sheet and statements
of income, shareholders' equity and cash flows of the Company and its
consolidated subsidiaries certified by independent public accountants) and, as
soon as practicable after the end of each of the first three quarters of each
fiscal year (beginning with the fiscal quarter ending after the effective date
of the Registration Statement), consolidated summary financial information of
the Company and its subsidiaries for such quarter in reasonable detail;
(g) During a period of five years from the effective date of the
Registration Statement, to furnish to you copies of all reports or other
communications (financial or other)
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<PAGE> 9
furnished to shareholders, and to deliver to you (i) as soon as they are
available, copies of any reports and financial statements furnished to or filed
with the Commission or any national securities exchange on which any class of
securities of the Company is listed and (ii) such additional information
concerning the business and financial condition of the Company as you may from
time to time reasonably request (such financial statements to be on a
consolidated basis to the extent the accounts of the Company and its
subsidiaries are consolidated in reports furnished to the Company's shareholders
generally or to the Commission);
(h) To use the net proceeds received by it from the sale of the Shares
pursuant to this Agreement in the manner specified in the Prospectus under the
caption "Use of Proceeds";
(i) To use its best efforts to list for quotation the Shares on the
Nasdaq National Market ("Nasdaq"); and
(j) If the Company elects to rely upon Rule 462(b), the Company shall
file a Rule 462(b) Registration Statement with the Commission in compliance with
Rule 462(b) by 10:00 p.m., Washington, D.C. time, on the date of this Agreement,
and the Company shall at the time of filing either pay to the Commission the
filing fee for the Rule 462(b) Registration Statement or give irrevocable
instructions for the payment of such fee pursuant to Rule 111(b) under the Act.
6. The Company covenants and agrees with the several Underwriters that
the Company will pay or cause to be paid the following: (i) the fees,
disbursements and expenses of the Company's counsel and accountants in
connection with the registration of the Shares under the Act and all other
expenses in connection with the preparation, printing and filing of the
Registration Statement, any Preliminary Prospectus and the Prospectus and
amendments and supplements thereto and the mailing and delivering of copies
thereof to the Underwriters and dealers; (ii) the cost of producing any
Agreement Among Underwriters, this Agreement, the Blue Sky Memorandum, closing
documents (including compilations thereof) and any other documents in connection
with the offering, purchase, sale and delivery of the Shares; (iii) all expenses
in connection with the qualification of the Shares for offering and sale under
state securities laws as provided in Section 5(b) hereof, including the fees and
disbursements of counsel for the Underwriters in connection with such
qualification and in connection with the Blue Sky survey; (iv) all fees and
expenses in connection with listing the Shares on Nasdaq; (v) the filing fees
incident to, and the fees and disbursements of counsel for the Underwriters in
connection with, securing any required review by the National Association of
Securities Dealers, Inc. of the terms of the sale of the Shares; (vi) the cost
of preparing stock certificates; (vii) the cost and charges of any transfer
agent or registrar; and (viii) all other costs and expenses incident to the
performance of its obligations hereunder that are not otherwise specifically
provided for in this Section. It is understood, however, that, except as
provided in this Section, and Sections 8 and 11 hereof, the Underwriters will
pay all of their own costs and expenses, including the fees of their counsel,
stock transfer taxes on resale of any of the Shares by them, and any advertising
expenses connected with any offers they may make.
7. The obligations of the Underwriters hereunder, as to the Shares to
be delivered at each Time of Delivery, shall be subject, in their discretion, to
the condition that all representations and warranties and other statements of
the Company herein are, at and as of such Time of Delivery, true and correct,
the condition that the Company shall have performed all of its obligations
hereunder theretofore to be performed, and the following additional conditions:
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<PAGE> 10
(a) The Prospectus shall have been filed with the Commission pursuant
to Rule 424(b) within the applicable time period prescribed for such filing by
the rules and regulations under the Act and in accordance with Section 5(a)
hereof; if the Company has elected to rely upon Rule 462(b), the Rule 462(b)
Registration Statement shall have become effective by 10:00 p.m., Washington,
D.C. time, on the date of this Agreement; no stop order suspending the
effectiveness of the Registration Statement or any part thereof shall have been
issued and no proceeding for that purpose shall have been initiated or
threatened by the Commission; and all requests for additional information on the
part of the Commission shall have been complied with to your reasonable
satisfaction;
(b) Perkins Coie, counsel for the Underwriters, shall have furnished to
you such opinion or opinions, (a draft of each such opinion is attached as Annex
II(a) hereto) dated such Time of Delivery, with respect to the matters covered
in paragraphs (i), (ii), (vi), (x) and (xv) of subsection (c) below as well as
such other related matters as you may reasonably request, and such counsel shall
have received such papers and information as they may reasonably request to
enable them to pass upon such matters;
(c) Graham & James LLP/Riddell Williams P.S., counsel for the Company,
shall have furnished to you their written opinion, dated such Time of Delivery,
in form and substance satisfactory to you, to the effect that:
(i) The Company has been duly incorporated and is duly
authorized to transact business in the corporate form under
the laws of the state of Washington, with power and authority
(corporate and other) to own its properties and conduct its
business as described in the Prospectus;
(ii) The Company has an authorized capitalization as
set forth in the Prospectus, and all of the issued shares of
capital stock of the Company (including the Shares being
delivered at such Time of Delivery) have been duly and validly
authorized and issued and are fully paid and nonassessable;
and the Shares conform to the description of the Stock
contained in the Prospectus;
(iii) The Company has been duly qualified as a foreign
corporation for the transaction of business and is in good
standing under the laws of each other jurisdiction in which it
owns or leases properties or conducts any business so as to
require such qualification, except where the reason for
failure to be so qualified in any such jurisdiction does not
have a Material Adverse Effect (such counsel being entitled to
rely in respect of the opinion in this clause upon opinions of
local counsel and in respect of matters of fact upon
certificates of officers of the Company, provided that such
counsel shall state that they believe that both you and they
are justified in relying upon such opinions and certificates);
(iv) Each wholly owned subsidiary of the Company has
been duly incorporated and is validly existing as a
corporation in good standing under the laws of its
jurisdiction of incorporation; and all of the issued shares of
capital stock of each such subsidiary have been duly and
validly authorized and issued, are fully paid and
non-assessable, and are owned directly by the Company, free
and clear of all liens, encumbrances, equities or claims (such
counsel being entitled to rely in respect of the opinion in
this clause upon opinions of local counsel and in respect to
matters of fact upon certificates of officers of the
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<PAGE> 11
Company or its subsidiaries, provided that such counsel shall
state that they believe that both you and they are justified
in relying upon such opinions and certificates);
(v) To the best of such counsel's knowledge and other
than as set forth in the Prospectus, there are no legal or
governmental proceedings pending to which the Company or any
of its subsidiaries is a party or of which any property of the
Company or any of its subsidiaries is the subject which, if
determined adversely to the Company or any of its
subsidiaries, would individually or in the aggregate have a
material adverse effect on the current consolidated financial
position, shareholders' equity or results of operations of the
Company and its subsidiaries taken as a whole; and, to the
best of such counsel's knowledge, no such proceedings are
threatened or contemplated by governmental authorities or
threatened by others;
(vi) This Agreement has been duly authorized, executed
and delivered by the Company;
(vii) The issue and sale of the Shares being delivered
at such Time of Delivery by the Company and the compliance by
the Company with all of the provisions of this Agreement and
the consummation of the transactions herein contemplated will
not conflict with or result in a breach or violation of any of
the terms or provisions of, or constitute a default under, any
indenture, mortgage, deed of trust, loan agreement or other
agreement or instrument known to such counsel to which the
Company or any of its subsidiaries is a party or by which the
Company or any of its subsidiaries is bound or to which any of
the property or assets of the Company or any of its
subsidiaries is subject, nor will such action result in any
violation of the provisions of the Amended and Restated
Articles of Incorporation or Restated Bylaws of the Company or
any statute or any order, rule or regulation known to such
counsel of any court or governmental agency or body having
jurisdiction over the Company or any of its subsidiaries or
any of their properties;
(viii) No consent, approval, authorization, order,
registration or qualification of or with any such court or
governmental agency or body is required for the issue and sale
of the Shares or the consummation by the Company of the
transactions contemplated by this Agreement, except the
registration under the Act of the Shares, and such consents,
approvals, authorizations, registrations or qualifications as
may be required under state securities or Blue Sky laws in
connection with the purchase and distribution of the Shares by
the Underwriters;
(ix) The Amended and Restated Articles of Incorporation
and the Bylaws of the Company are not in conflict with or in
violation of the provisions of the WBCA. Neither the Company
nor any of its subsidiaries is in violation of its articles of
incorporation or bylaws or, to the best of such counsel's
knowledge, in default in the performance or observance of any
material obligation, agreement, covenant or condition
contained in any indenture, mortgage, deed of trust, loan
agreement, lease or other agreement or instrument to which it
is a party or by which it or any of its properties may be
bound;
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<PAGE> 12
(x) The statements set forth in the Prospectus (i)
under the caption "Description of Capital Stock," insofar as
they purport to constitute a summary of the terms of the
various classes and series of capital stock of the Company and
(ii) under the caption "Underwriting," insofar as they purport
to describe the provisions of the laws and documents referred
to therein, are in each case accurate and fair summaries of
such laws and documents;
(xi) The Company is not an "investment company" or an
entity "controlled" by an "investment company," as such terms
are defined in the Investment Company Act;
(xii) Except as described in the Prospectus, the
Company and each of its subsidiaries own or possess adequate
licenses or other rights to use the Intellectual Property that
are necessary or material to the conduct of their businesses
as conducted and as proposed to be conducted as described in
the Prospectus. Except as described in the Prospectus, such
counsel is not aware of any facts that would preclude the
Company from having rights to its patent and patent
applications referenced in the Prospectus. The Prospectus
fairly and accurately describes the Company's rights with
respect to the Intellectual Property. Such counsel is not
aware of any material violation or infringement by a third
party of any of the Intellectual Property and, except as
described in the Prospectus, no third party has a material
interest in or right to a license to use, or the right to
license others to use any of the Intellectual Property. No
material claim is pending or, to such counsel's knowledge,
threatened to the effect that the operations of the Company
infringe upon or conflict with the asserted rights of any
other person or entity under any Intellectual Property. No
material claim is pending or, to such counsel's knowledge,
threatened to the effect that any such Intellectual Property
owned or licensed by the Company, or which the Company
otherwise has the right to use, is invalid or unenforceable by
the Company.
(xiii)The Company and its subsidiaries possess all
material consents, licenses, certificates, authorizations and
permits issued by the appropriate federal, state or foreign
regulatory authorities necessary to conduct their respective
businesses, and the Company has not received any notice of
proceedings relating to the revocation or modification of any
such certificate, authorization or permit that, individually
or in the aggregate, if the subject of an unfavorable
decision, ruling or finding, would have a materially adverse
effect on the current or future consolidated financial
position, shareholders' equity or results of operations of the
Company and its subsidiaries, except as described in or
contemplated by the Prospectus;
(xiv) Except as set forth in the Prospectus, to the
best of such counsel's knowledge, (A) no preemptive right,
co-sale right, right of first refusal or other similar rights
of securityholders exists with respect to any class or series
of capital stock, including the issuance and sale of the
Shares, other than those that have been expressly waived or
terminated prior to the date hereof, (B) no holder of
securities of the Company has the right to cause the Company
to include such holder's securities in the Registration
Statement, (C) no further approval or authorization of any
securityholder, the Board of Directors or any
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<PAGE> 13
duly appointed committee thereof or others is required under
the Act, the Exchange Act or under state securities or Blue
Sky laws and (D) the Company does not have outstanding any
options or warrants to purchase, or any preemptive rights or
other rights to subscribe for or to purchase, any securities
or obligations convertible into, or any contracts or
commitments to issue or sell, shares of its capital stock or
any such options, rights, convertible securities or
obligations; and
(xv) The Registration Statement and the Prospectus and
any further amendments and supplements thereto made by the
Company prior to such Time of Delivery (other than the
financial statements and related schedules therein, as to
which such counsel need express no opinion) comply as to form
in all material respects with the requirements of the Act and
the rules and regulations thereunder, although they do not
assume any responsibility for the accuracy, completeness or
fairness of the statements contained in the Registration
Statement or the Prospectus, except for those referred to in
the opinion in subsection (x) of this Section 7(c). In
addition, such counsel shall state that they have no reason to
believe that, as of its effective date, the Registration
Statement or any further amendment thereto made by the Company
prior to such Time of Delivery (other than the financial
statements and related statements and related schedules
therein, as to which such counsel need express no opinion)
contained an untrue statement of a material fact or omitted to
state a material fact required to be stated therein or
necessary to make the statements therein not misleading or
that, as of its date, the Prospectus or any further amendment
or supplement thereto made by the Company prior to such Time
of Delivery (other than the financial statements and related
schedules therein, as to which such counsel need express no
opinion) contained an untrue statement of a material fact or
omitted to state a material fact necessary to make the
statements therein, in the light of the circumstances under
which they were made, not misleading or that, as of such Time
of Delivery, either the Registration Statement or the
Prospectus or any further amendment or supplement thereto made
by the Company prior to such Time of Delivery (other than the
financial statements and related schedules therein, as to
which such counsel need express no opinion) contains an untrue
statement of a material fact or omits to state a material fact
necessary to make the statements therein, in the light of the
circumstances under which they were made, not misleading; and
they do not know of any amendment to the Registration
Statement required to be filed or of any contracts or other
documents of a character required to be filed as an exhibit to
the Registration Statement or required to be described in the
Registration Statement or the Prospectus that are not filed or
described as required.
In rendering such opinion, such counsel may state that they
express no opinion as to the laws of any jurisdiction outside the
United States.
(d) On the date of the Prospectus at a time prior to the
execution of this Agreement, at 9:30 a.m., New York City time, on the
effective date of any post-effective amendment to the Registration
Statement filed subsequent to the date of this Agreement and also at
each Time of Delivery, KPMG Peat Marwick LLP shall have furnished to
you a letter or letters, dated the respective dates of delivery
thereof, in
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<PAGE> 14
form and substance satisfactory to you, to the effect set forth in
Annex I hereto (the executed copy of the letter delivered prior to the
execution of this Agreement is attached as Annex I(a) hereto and a
draft of the form of letter to be delivered on the effective date of
any post-effective amendment to the Registration Statement and as of
each Time of Delivery is attached as Annex I(b) hereto);
(e) (i) Neither the Company nor any of its subsidiaries shall
have sustained since the date of the latest audited financial
statements included in the Prospectus any loss or interference with its
business from fire, explosion, flood or other calamity, whether or not
covered by insurance, or from any labor dispute or court or
governmental action, order or decree, otherwise than as set forth or
contemplated in the Prospectus and (ii) since the respective dates as
of which information is given in the Prospectus there shall not have
been any change in the capital stock (other than as a result of the
exercise of options or warrants outstanding as of the date of this
Agreement) or any increase in the long-term debt of the Company or any
of its subsidiaries in excess of $___________ or any change, or any
development that could reasonably be expected to result in a change, in
or affecting the general affairs, management, financial position,
shareholders' equity or results of operations of the Company and its
subsidiaries, otherwise than as set forth or contemplated in the
Prospectus, the effect of which, in any such case described in Clause
(i) or (ii), is in the judgment of the Representatives so material and
adverse as to make it impracticable or inadvisable to proceed with the
public offering or the delivery of the Shares being delivered at such
Time of Delivery on the terms and in the manner contemplated in the
Prospectus;
(f) On or after the date hereof there shall not have occurred
any of the following: (i) a suspension or material limitation in
trading in securities generally on the New York Stock Exchange or on
Nasdaq; (ii) a suspension or material limitation in trading in the
Company's securities on Nasdaq; (iii) a general moratorium on
commercial banking activities declared by either Federal or New York or
Washington State authorities; or (iv) the outbreak or escalation of
hostilities involving the United States or the declaration by the
United States of a national emergency or war, if the effect of any such
event specified in this Clause (iv) in the judgment of the
Representatives makes it impracticable or inadvisable to proceed with
the public offering or the delivery of the Shares being delivered at
such Time of Delivery on the terms and in the manner contemplated in
the Prospectus;
(g) The Shares to be sold at such Time of Delivery shall have
been duly listed for quotation on Nasdaq;
(h) The Company has obtained and delivered to the Underwriters
executed copies of an agreement from each of the Company's shareholders
named in Schedule II hereto substantially to the effect set forth in
Subsection 5(e) hereof in form and substance satisfactory to you;
(i) The Company shall have complied with the provisions of
Section 5(c) hereof with respect to the furnishing of prospectuses on
the New York Business Day next succeeding the date of this Agreement;
and
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<PAGE> 15
(j) The Company shall have furnished or caused to be furnished
to you at such Time of Delivery certificates of officers of the Company
satisfactory to you as to the accuracy of the representations and
warranties of the Company herein at and as of such Time of Delivery, as
to the performance by the Company of all of its obligations hereunder
to be performed at or prior to such Time of Delivery, as to the matters
set forth in subsections (a) and (e) of this Section and as to such
other matters as you may reasonably request.
8. (a) The Company will indemnify and hold harmless each
Underwriter against any losses, claims, damages or liabilities, joint
or several, to which such Underwriter may become subject, under the Act
or otherwise, insofar as such losses, claims, damages or liabilities
(or actions in respect thereof) arise out of or are based upon an
untrue statement or alleged untrue statement of a material fact
contained in any Preliminary Prospectus, the Registration Statement or
the Prospectus, or any amendment or supplement thereto, or arise out of
or are based upon the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the
statements therein not misleading, and will reimburse each Underwriter
for any legal or other expenses reasonably incurred by such Underwriter
in connection with investigating or defending any such action or claim
as such expenses are incurred; provided, however, that the Company
shall not be liable in any such case to the extent that any such loss,
claim, damage or liability arises out of or is based upon an untrue
statement or alleged untrue statement or omission or alleged omission
made in any Preliminary Prospectus, the Registration Statement or the
Prospectus or any such amendment or supplement in reliance upon and in
conformity with written information furnished to the Company by any
Underwriter through Goldman, Sachs & Co. expressly for use therein.
(b) Each Underwriter will indemnify and hold harmless the
Company against any losses, claims, damages or liabilities to which the
Company may become subject, under the Act or otherwise, insofar as such
losses, claims, damages or liabilities (or actions in respect thereof)
arise out of or are based upon an untrue statement or alleged untrue
statement of a material fact contained in any Preliminary Prospectus,
the Registration Statement or the Prospectus, or any amendment or
supplement thereto, or arise out of or are based upon the omission or
alleged omission to state therein a material fact required to be stated
therein or necessary to make the statements therein not misleading, in
each case to the extent, but only to the extent, that such untrue
statement or alleged untrue statement or omission or alleged omission
was made in any Preliminary Prospectus, the Registration Statement or
the Prospectus or any such amendment or supplement in reliance upon and
in conformity with written information furnished to the Company by such
Underwriter through Goldman, Sachs & Co. expressly for use therein; and
will reimburse the Company for any legal or other expenses reasonably
incurred by the Company in connection with investigating or defending
any such action or claim as such expenses are incurred.
(c) Promptly after receipt by an indemnified party under
subsection (a) or (b) above of notice of the commencement of any
action, such indemnified party shall, if a claim in respect thereof is
to be made against the indemnifying party under such subsection, notify
the indemnifying party in writing of the commencement thereof; but the
omission so to notify the indemnifying party shall not relieve it from
any liability which it may have to any indemnified party otherwise than
under such subsection. In
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<PAGE> 16
case any such action shall be brought against any indemnified party and
it shall notify the indemnifying party of the commencement thereof, the
indemnifying party shall be entitled to participate therein and, to the
extent that it shall wish, jointly with any other indemnifying party
similarly notified, to assume the defense thereof, with counsel
satisfactory to such indemnified party (who shall not, except with the
consent of the indemnified party, be counsel to the indemnifying
party), and, after notice from the indemnifying party to such
indemnified party of its election so to assume the defense thereof, the
indemnifying party shall not be liable to such indemnified party under
such subsection for any legal expenses of other counsel or any other
expenses, in each case subsequently incurred by such indemnified party,
in connection with the defense thereof other than reasonable costs of
investigation. No indemnifying party shall, without the written consent
of the indemnified party, effect the settlement or compromise of, or
consent to the entry of any judgment with respect to, any pending or
threatened action or claim in respect of which indemnification or
contribution may be sought hereunder (whether or not the indemnified
party is an actual or potential party to such action or claim) unless
such settlement, compromise or judgment (i) includes an unconditional
release of the indemnified party from all liability arising out of such
action or claim and (ii) does not include a statement as to or an
admission of fault, culpability or a failure to act, by or on behalf of
any indemnified party.
(d) If the indemnification provided for in this Section 8 is
unavailable to or insufficient to hold harmless an indemnified party
under subsection (a) or (b) above in respect of any losses, claims,
damages or liabilities (or actions in respect thereof) referred to
therein, then each indemnifying party shall contribute to the amount
paid or payable by such indemnified party as a result of such losses,
claims, damages or liabilities (or actions in respect thereof) in such
proportion as is appropriate to reflect the relative benefits received
by the Company on the one hand and the Underwriters on the other from
the offering of the Shares. If, however, the allocation provided by the
immediately preceding sentence is not permitted by applicable law or if
the indemnified party failed to give the notice required under
subsection (c) above, then each indemnifying party shall contribute to
such amount paid or payable by such indemnified party in such
proportion as is appropriate to reflect not only such relative benefits
but also the relative fault of the Company on the one hand and the
Underwriters on the other in connection with the statements or
omissions that resulted in such losses, claims, damages or liabilities
(or actions in respect thereof), as well as any other relevant
equitable considerations. The relative benefits received by the Company
on the one hand and the Underwriters on the other shall be deemed to be
in the same proportion as the total net proceeds from the offering of
the Shares purchased under this Agreement (before deducting expenses)
received by the Company bear to the total underwriting discounts and
commissions received by the Underwriters with respect to the Shares
purchased under this Agreement, in each case as set forth in the table
on the cover page of the Prospectus. The relative fault shall be
determined by reference to, among other things, whether the untrue or
alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by
the Company on the one hand or the Underwriters on the other and the
parties' relative intent, knowledge, access to information and
opportunity to correct or prevent such statement or omission. The
Company and the Underwriters agree that it would not be just and
equitable if contributions pursuant to this subsection (d) were
determined by pro rata allocation (even if the Underwriters were
treated as one entity for such purpose) or by any other method of
allocation which does not take account of
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<PAGE> 17
the equitable considerations referred to above in this subsection (d).
The amount paid or payable by an indemnified party as a result of the
losses, claims, damages or liabilities (or actions in respect thereof)
referred to above in this subsection (d) shall be deemed to include any
legal or other expenses reasonably incurred by such indemnified party
in connection with investigating or defending any such action or claim.
Notwithstanding the provisions of this subsection (d), no Underwriter
shall be required to contribute any amount in excess of the amount by
which the total price at which the Shares underwritten by it and
distributed to the public were offered to the public exceeds the amount
of any damages that such Underwriter has otherwise been required to pay
by reason of such untrue or alleged untrue statement or omission or
alleged omission. No person guilty of fraudulent misrepresentation
(within the meaning of Section 11(f) of the Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent
misrepresentation. The Underwriters' obligations in this subsection (d)
to contribute are several in proportion to their respective
underwriting obligations and not joint.
(e) The obligations of the Company under this Section 8 shall
be in addition to any liability that the Company may otherwise have and
shall extend, upon the same terms and conditions, to each person, if
any, who controls any Underwriter within the meaning of the Act; and
the obligations of the Underwriters under this Section 8 shall be in
addition to any liability that the respective Underwriters may
otherwise have and shall extend, upon the same terms and conditions, to
each officer and director of the Company and to each person, if any,
who controls the Company within the meaning of the Act.
9. (a) If any Underwriter shall default in its obligation to purchase
the Shares that it has agreed to purchase hereunder at a Time of Delivery, you
may in your discretion arrange for you or another party or other parties to
purchase such Shares on the terms contained herein. If within thirty-six hours
after such default by any Underwriter you do not arrange for the purchase of
such Shares, then the Company shall be entitled to a further period of
thirty-six hours within which to procure another party or other parties
satisfactory to you to purchase such Shares on such terms. In the event that,
within the respective prescribed periods, you notify the Company that you have
so arranged for the purchase of such Shares, or the Company notifies you that it
has so arranged for the purchase of such Shares, you or the Company shall have
the right to postpone such Time of Delivery for a period of not more than seven
days in order to effect whatever changes may thereby be made necessary in the
Registration Statement or the Prospectus, or in any other documents or
arrangements, and the Company agrees to file promptly any amendments to the
Registration Statement or the Prospectus that in your opinion may thereby be
made necessary. The term "Underwriter" as used in this Agreement shall include
any person substituted under this Section with like effect as if such person had
originally been a party to this Agreement with respect to such Shares.
(b) If, after giving effect to any arrangements for the purchase of the
Shares of a defaulting Underwriter or Underwriters by you and the Company as
provided in subsection (a) above, the aggregate number of such Shares that
remains unpurchased does not exceed one-eleventh of the aggregate number of all
the Shares to be purchased at such Time of Delivery, then the Company shall have
the right to require each non-defaulting Underwriter to purchase the number of
Shares that such Underwriter agreed to purchase hereunder at such Time of
Delivery and, in addition, to require each non-defaulting Underwriter to
purchase its pro rata share (based on the number of Shares that such Underwriter
agreed to purchase hereunder) of the Shares of such defaulting Underwriter or
Underwriters for which such
-17-
<PAGE> 18
arrangements have not been made; but nothing herein shall relieve a defaulting
Underwriter from liability for its default.
(c) If, after giving effect to any arrangements for the purchase of the
Shares of a defaulting Underwriter or Underwriters by you and the Company as
provided in subsection (a) above, the aggregate number of such Shares that
remains unpurchased exceeds one-eleventh of the aggregate number of all the
Shares to be purchased at such Time of Delivery, or if the Company shall not
exercise the right described in subsection (b) above to require non-defaulting
Underwriters to purchase Shares of a defaulting Underwriter or Underwriters,
then this Agreement (or, with respect to the Second Time of Delivery, the
obligations of the Underwriters to purchase and of the Company to sell the
Optional Shares) shall thereupon terminate, without liability on the part of any
non-defaulting Underwriter or the Company, except for the expenses to be borne
by the Company and the Underwriters as provided in Section 6 hereof and the
indemnity and contribution agreements in Section 8 hereof; but nothing herein
shall relieve a defaulting Underwriter from liability for its default.
10. The respective indemnities, agreements, representations, warranties
and other statements of the Company and the several Underwriters, as set forth
in this Agreement or made by or on behalf of them, respectively, pursuant to
this Agreement, shall remain in full force and effect, regardless of any
investigation (or any statement as to the results thereof) made by or on behalf
of any Underwriter or any controlling person of any Underwriter, or the Company,
or any officer or director or controlling person of the Company, and shall
survive delivery of and payment for the Shares.
11. If this Agreement shall be terminated pursuant to Section 9 hereof,
the Company shall not then be under any liability to any Underwriter except as
provided in Sections 6 and 8 hereof; but, if for any other reason, any Shares
are not delivered by or on behalf of the Company as provided herein, the Company
will reimburse the Underwriters through you for all out-of-pocket expenses
approved in writing by you, including fees and disbursements of counsel,
reasonably incurred by the Underwriters in making preparations for the purchase,
sale and delivery of the Shares not so delivered, but the Company shall then be
under no further liability to any Underwriter in respect of the Shares not so
delivered except as provided in Sections 6 and 8 hereof.
12. In all dealings hereunder, you shall act on behalf of each of the
Underwriters, and the parties hereto shall be entitled to act and rely upon any
statement, request, notice or agreement on behalf of any Underwriter made or
given by you jointly or by Goldman, Sachs & Co. on behalf of you as the
representatives.
All statements, requests, notices and agreements hereunder shall be in
writing, and if to the Underwriters shall be delivered or sent by mail, telex or
facsimile transmission to you as the representatives in care of Goldman, Sachs &
Co., 85 Broad Street, New York, New York 10004, Attention: Registration
Department; and if to the Company shall be delivered or sent by mail, telex or
facsimile transmission to the address of the Company set forth in the
Registration Statement, Attention: Secretary; provided, however, that any notice
to an Underwriter pursuant to Section 8(c) hereof shall be delivered or sent by
mail, telex or facsimile transmission to such Underwriter at its address set
forth in its Underwriters' Questionnaire, or telex constituting such
Questionnaire, which address will be supplied to the Company by you upon
request. Any such statements, requests, notices or agreements shall take effect
at the time of receipt thereof.
13. This Agreement shall be binding upon, and inure solely to the
benefit of, the Underwriters, the Company and, to the extent provided in
Sections 8 and 10 hereof, the officers and directors of the Company and each
person who controls the Company or any
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<PAGE> 19
Underwriter, and their respective heirs, executors, administrators, successors
and assigns, and no other person shall acquire or have any right under or by
virtue of this Agreement. No purchaser of any of the Shares from any Underwriter
shall be deemed a successor or assign by reason merely of such purchase.
14. Time shall be of the essence of this Agreement. As used herein, the
term "business day" shall mean any day when the Commission's office in
Washington, D.C. is open for business.
15. This Agreement shall be governed by and construed in accordance
with the laws of the state of New York.
16. This Agreement may be executed by any one or more of the parties
hereto in any number of six (6) counterparts, each of which shall be deemed to
be an original, but all such counterparts shall together constitute one and the
same instrument.
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<PAGE> 20
If the foregoing is in accordance with your understanding, please sign
and return to us counterparts hereof, and upon the acceptance hereof by you, on
behalf of each of the Underwriters, this letter and such acceptance hereof shall
constitute a binding agreement between each of the Underwriters and the Company.
It is understood that your acceptance of this letter on behalf of each of the
Underwriters is pursuant to the authority set forth in a form of Agreement Among
Underwriters the form of which shall be submitted to the Company for examination
upon request, but without warranty on your part as to the authority of the
signers thereof.
Very truly yours,
RealNetworks, Inc.
By:
-------------------------------
Name:
Title:
Accepted as of the date hereof:
Goldman, Sachs & Co.
NationsBanc Montgomery Securities, Inc.
BancAmerica Robertson Stephens
By:-------------------------------
(Goldman, Sachs & Co.)
On behalf of each of the Underwriters
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<PAGE> 21
SCHEDULE I
<TABLE>
<CAPTION>
Number of
Optional
Total Number Shares to Be
of Purchased if
Firm Shares Maximum Option
Underwriter to Be Purchased Exercised
----------- --------------- ---------
<S> <C> <C>
Goldman, Sachs & Co.........................
NationsBanc Montgomery Securities, Inc......
BancAmerica Robertson Stephens..............
[Names of other Underwriters]...............
--------------- ---------
Total.....................
=============== =========
</TABLE>
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<PAGE> 22
ANNEX I
[FORM OF COMFORT LETTER]
Pursuant to Section 7(d) of the Underwriting Agreement, the accountants
shall furnish letters to the Underwriters to the effect that:
(i) They are independent certified public accountants with
respect to the Company and its subsidiaries within the meaning of the
Act and the applicable published rules and regulations thereunder;
(ii) In their opinion, the financial statements and any
supplementary financial information and schedules (and, if applicable,
financial forecasts and/or pro forma financial information) examined by
them and included in the Prospectus or the Registration Statement
comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations thereunder; and, if applicable, they have made a review in
accordance with standards established by the American Institute of
Certified Public Accountants of the unaudited consolidated interim
financial statements, selected financial data, pro forma financial
information, financial forecasts and/or condensed financial statements
derived from audited financial statements of the Company for the
periods specified in such letter, as indicated in their reports
thereon, copies of which have been furnished separately to the
representatives of the Underwriters (the "Representatives");
(iii) They have made a review in accordance with standards
established by the American Institute of Certified Public Accountants
of the unaudited condensed consolidated statements of income,
consolidated balance sheets and consolidated statements of cash flows
included in the Prospectus as indicated in their reports thereon copies
of which have been separately furnished to the Representatives, and on
the basis of specified procedures including inquiries of officials of
the Company who have responsibility for financial and accounting
matters regarding whether the unaudited condensed consolidated
financial statements referred to in paragraph (vi)(A)(i) below comply
as to form in all material respects with the applicable accounting
requirements of the Act and the related published rules and
regulations, nothing came to their attention that caused them to
believe that the unaudited condensed consolidated financial statements
do not comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published rules and
regulations;
(iv) The unaudited selected financial information with respect
to the consolidated results of operations and financial position of the
Company for the period from February 4, 1994 through December 31, 1996
included in the Prospectus agrees with the corresponding amounts (after
restatements where applicable) in the audited consolidated financial
statements for such fiscal years;
<PAGE> 23
(v) They have compared the information in the Prospectus under
selected captions with the disclosure requirements of Regulation S-K
and on the basis of limited procedures specified in such letter nothing
came to their attention as a result of the foregoing procedures that
caused them to believe that this information does not conform in all
material respects with the disclosure requirements of Items 301, 302,
402 and 503(d), respectively, of Regulation S-K;
(vi) On the basis of limited procedures, not constituting an
examination in accordance with generally accepted auditing standards,
consisting of a reading of the unaudited financial statements and other
information referred to below, a reading of the latest available
interim financial statements of the Company and its subsidiaries,
inspection of the minute books of the Company and its subsidiaries
since the date of the latest audited financial statements included in
the Prospectus, inquiries of officials of the Company and its
subsidiaries responsible for financial and accounting matters and such
other inquiries and procedures as may be specified in such letter,
nothing came to their attention that caused them to believe that:
(A) (i) the unaudited consolidated statements of
income, consolidated balance sheets and consolidated
statements of cash flows included in the Prospectus do not
comply as to form in all material respects with the applicable
accounting requirements of the Act and the related published
rules and regulations, or (ii) any material modifications
should be made to the unaudited condensed consolidated
statements of income, consolidated balance sheets and
consolidated statements of cash flows included in the
Prospectus for them to be in conformity with generally
accepted accounting principles;
(B) any other unaudited income statement data and
balance sheet items included in the Prospectus do not agree
with the corresponding items in the unaudited consolidated
financial statements from which such data and items were
derived, and any such unaudited data and items were not
determined on a basis substantially consistent with the basis
for the corresponding amounts in the audited consolidated
financial statements included in the Prospectus;
(C) the unaudited financial statements that were not
included in the Prospectus but from which were derived any
unaudited condensed financial statements referred to in Clause
(A) and any unaudited income statement data and balance sheet
items included in the Prospectus and referred to in Clause (B)
were not determined on a basis substantially consistent with
the basis for the audited consolidated financial statements
included in the Prospectus;
(D) any unaudited pro forma condensed consolidated
financial statements included in the Prospectus do not comply
as to form in all material respects with the applicable
accounting requirements of the Act and the published rules and
regulations thereunder or the pro forma adjustments
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<PAGE> 24
have not been properly applied to the historical amounts in
the compilation of those statements;
(E) as of a specified date not more than five days
prior to the date of such letter, there have been any changes
in the consolidated capital stock (other than issuances of
capital stock upon exercise of options and stock appreciation
rights, upon earn-outs of performance shares and upon
conversions of convertible securities, in each case that were
outstanding on the date of the latest financial statements
included in the Prospectus) or any increase in the
consolidated long-term debt of the Company and its
subsidiaries, or any decreases in consolidated net current
assets or shareholders' equity or other items specified by the
Representatives, or any increases in any items specified by
the Representatives, in each case as compared with amounts
shown in the latest balance sheet included in the Prospectus,
except in each case for changes, increases or decreases that
the Prospectus discloses have occurred or may occur or that
are described in such letter; and
(F) for the period from the date of the latest
financial statements included in the Prospectus to the
specified date referred to in Clause (E), there were any
decreases (increases) in consolidated net revenues or
operating profit (loss) or the total or per share amounts of
consolidated net income (loss) or other items specified by the
Representatives, or any increases in any items specified by
the Representatives, in each case as compared with the
comparable period of the preceding year and with any other
period of corresponding length specified by the
Representatives, except in each case for decreases or
increases that the Prospectus discloses have occurred or may
occur or that are described in such letter; and
(vii) In addition to the examination referred to in their
report(s) included in the Prospectus and the limited procedures,
inspection of minute books, inquiries and other procedures referred to
in paragraphs (iii) and (vi) above, they have carried out certain
specified procedures, not constituting an examination in accordance
with generally accepted auditing standards, with respect to certain
amounts, percentages and financial information specified by the
Representatives, which are derived from the general accounting records
of the Company and its subsidiaries, which appear in the Prospectus, or
in Part II of, or in exhibits and schedules to, the Registration
Statement specified by the Representatives, and have compared certain
of such amounts, percentages and financial information with the
accounting records of the Company and its subsidiaries and have found
them to be in agreement.
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<PAGE> 1
EXHIBIT 3.1
AMENDED AND RESTATED
ARTICLES OF INCORPORATION
OF
REALNETWORKS, INC.
RealNetworks, Inc., a Washington corporation, by its Chief Financial
Officer, hereby submits the following Amended and Restated Articles of
Incorporation of said Corporation pursuant to the provisions of RCW 23B.10.070.
These Amended and Restated Articles of Incorporation supersede the original
Articles of Incorporation and all amendments and prior restatements thereto.
ARTICLE I
NAME
The name of this Corporation is RealNetworks, Inc.
ARTICLE II
DURATION
This Corporation is organized under the Washington Business Corporation
Act (the "Act") and shall have perpetual existence.
ARTICLE III
PURPOSE AND POWERS
The purpose and powers of this Corporation are as follows: (a) to engage
in any lawful business; (b) to engage in any and all activities that, in the
judgment of the Board of Directors, may at any time be incidental or conducive
to the attainment of the foregoing purpose; and (c) to exercise any and all
powers that a corporation formed under the Act, or any amendment thereto or
substitute therefor, is entitled at the time to exercise.
ARTICLE IV
CAPITAL STOCK
4.1 AUTHORIZED CAPITAL. The aggregate number of shares of capital stock
which this Corporation shall be authorized to issue shall be Three Hundred Sixty
Million (360,000,000), divided into two classes as follows: Three Hundred
Million (300,000,000) shares of common
<PAGE> 2
stock, $.001 par value per share (the "Common Stock"), and Sixty Million
(60,000,000) shares of preferred stock, $.001 par value per share (the
"Preferred Stock").
4.2 ISSUANCE OF COMMON STOCK IN SERIES.
4.2.1 AUTHORITY VESTED IN BOARD OF DIRECTORS. The Common Stock may be
divided into and issued in series from time to time. Authority is vested in the
Board of Directors, subject to the limitations and procedures prescribed by law,
to divide any part or all of such Common Stock into any number of series, to fix
and determine the relative rights and preferences of the shares of any series to
be established, and to amend the rights and preferences of the shares of any
series that has been established but is wholly unissued.
4.2.2 AMENDMENT TO SERIES DECREASING SHARES. Within any limits stated
in these Articles of Incorporation or in the resolution of the Board of
Directors establishing a series, the Board of Directors, after the issuance of
shares of a series, may amend the resolution establishing the series to decrease
(but not below the number of shares of such series then outstanding) the number
of shares of that series, and the number of shares constituting the decrease
shall thereafter constitute authorized but undesignated shares.
4.2.3 AUTHORITY LIMITED TO UNISSUED SHARES. The authority herein
granted to the Board of Directors to determine the relative rights and
preferences of the Common Stock shall be limited to unissued shares, and no
power shall exist to alter or change the rights and preferences of any shares
that have been issued.
4.3 DESIGNATION OF SERIES A COMMON STOCK, SERIES B COMMON STOCK, SERIES
C COMMON STOCK, SERIES D COMMON STOCK AND SERIES E COMMON STOCK.
The following series of Common Stock are hereby designated, and each
such series shall have the following rights, preferences and limitations:
4.3.1 DESIGNATION. Two Hundred Seven Million Forty-Seven Thousand Six
Hundred Seventy-Nine (207,047,679) shares of Common Stock shall be designated
and known as "Series A Common Stock"; Thirty Million (30,000,000) shares of
Common Stock shall be designated and known as "Series B Common Stock"; Thirty
Million (30,000,000) shares of Common Stock shall be designated and known as
"Series C Common Stock"; one (1) share shall be designated and known as "Series
D Common Stock" and Seven Million Forty-Seven Thousand Six Hundred Seventy-Nine
(7,047,679) shares of Common Stock shall be designated and known as "Series E
Common Stock." Except as otherwise provided in these Articles of Incorporation,
all shares of Series A Common Stock, Series B Common Stock, Series C Common
Stock, Series D Common Stock and Series E Common Stock shall be identical and
shall entitle the holders thereof to the same rights and privileges. The
designations of the Series A Common Stock, Series B Common Stock, Series C
Common Stock, Series D Common Stock and Series E Common Stock in this Article
are expressly subject to the provisions of Section 4.3.6, Section 4.3.7, Section
4.3.8 and 4.3.9.
2
<PAGE> 3
4.3.2 ISSUANCE. Shares of Series A Common Stock, Series B Common Stock,
Series C Common Stock, Series D Common Stock and Series E Common Stock may be
issued, upon authorization by the Board of Directors, to such persons and
entities, and for such consideration permitted by the Act, as the Board of
Directors shall determine; provided, that shares of Series B Common Stock shall
be issued only to persons or entities who, at the time of issuance, are either
(a) employees of the Corporation, or (b) directors, or affiliates of directors,
of the Corporation. For purposes of this section, an "affiliate" shall be a
person or entity that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common control with,
a director; and provided further, that shares of Series D Common Stock shall be
issued only in compliance with Section 4.3.7.
4.3.3 VOTING RIGHTS. Except as otherwise required by law and except as
otherwise provided in these Articles of Incorporation, on all matters submitted
to the Corporation's shareholders, each share of Series A Common Stock shall
entitle the holder to fifteen (15) votes, each share of Series B Common Stock
shall entitle the holder to fifteen (15) votes, each share of Series D Common
Stock shall entitle the holder to fifteen (15) votes, each share of Series C
Common Stock shall entitle the holder to one (1) vote, and 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 (1) vote. Except with regard to
those matters required by law to be voted on by one or more voting groups and
except as otherwise provided in these Articles of Incorporation, all shares of
Series A Common Stock, Series B Common Stock, Series C Common Stock and Series D
Common Stock shall vote and be counted together and not separately as a voting
group upon all matters submitted to a vote of shareholders. Where the Series E
Common Stock is entitled to voting rights by law, all shares of Series E Common
Stock shall vote and be counted together with the Series A Common Stock, the
Series B Common Stock, the Series C Common Stock and the Series D Common Stock
and not separately as a voting group, except as required by law.
4.3.4 DIVIDENDS.
(a) IN CASH OR SECURITIES. Subject to any preferential rights
granted for any series of Common Stock or Preferred Stock, the holders of Series
A Common Stock, the holders of Series B Common Stock, the holders of Series C
Common Stock, the holders of the Series D Common Stock and the holders of Series
E Common Stock shall be entitled to receive dividends equally, share for share,
if, when and as declared by the Board of Directors out of funds of this
Corporation legally available for that purpose; provided, that if such dividends
are declared, they will be payable at the same rate on each other series of
Common Stock and payable in Common Stock of the series with respect to which it
is declared or in Common Stock of one or more newly designated series with
substantially similar rights to the series with respect to which it is declared,
as determined by the Board of Directors in its sole discretion.
(b) SUBDIVISIONS AND COMBINATIONS OF SHARES. Any increase or
decrease in the number of shares of any series of Common Stock resulting from a
subdivision or combination of shares or other capital reclassification shall not
be permitted unless parallel action
3
<PAGE> 4
is taken with respect to each other series of Common Stock, so that the number
of shares of each series of Common Stock outstanding shall be increased or
decreased proportionately.
4.3.5 AUTOMATIC CONVERSION OF SERIES B COMMON STOCK.
(a) CONVERSION EVENT/CONVERSION DATE FOR EMPLOYEE HOLDERS. Each
share of Series B Common Stock held by a holder who was an employee at the time
of issuance shall automatically convert into one (1) share of Series C Common
Stock upon the termination of the holder's employment with the Corporation for
any reason, including but not limited to death, disability, retirement,
resignation or involuntary termination by the Corporation. In addition, if any
such holder, while an employee, makes or attempts to make any transfer of shares
of Series B Common Stock to any person or entity, whether voluntary or
involuntary, each such share that the holder has transferred or attempted to
transfer shall automatically convert into one (1) share of Series C Common Stock
simultaneously with such transfer or attempted transfer. If it is necessary for
any reason to determine whether the holder's employment has terminated or the
time thereof, or whether the holder has made or attempted to make any transfer
of any shares of Series B Common Stock or the time thereof, the Board of
Directors shall make such determination and it shall be binding on the holder
and any other person having any interest therein.
(b) CONVERSION EVENT/CONVERSION DATE FOR DIRECTOR OR AFFILIATE
HOLDERS. Each share of Series B Common Stock held by a holder who was a director
or an affiliate of a director (as defined above) at the time of issuance shall
automatically convert into one (1) share of Series C Common Stock upon the
termination of the holder's status as a director or an affiliate of a director
for any reason, including but not limited to death, resignation or removal by
the shareholders. In addition, if any such holder, while a director or an
affiliate of a director, makes or attempts to make any transfer of shares of
Series B Common Stock, whether voluntary or involuntary, each such share that
the holder has transferred or attempted to transfer shall automatically convert
into one (1) share of Series C Common Stock simultaneously with such transfer or
attempted transfer. If it is necessary for any reason to determine whether the
holder has made or attempted to make any transfer of any shares of Series B
Common Stock or the time thereof, the Board of Directors shall make such
determination and it shall be binding on the holder and any other person having
any interest therein.
(c) STATUS OF CERTIFICATES. If one or more shares of Series B Common
Stock are so converted, the certificate(s) representing such share or shares
shall, by virtue of the conversion and without any action on the part of the
holder, thereafter represent, to the extent of the number of shares so
converted, the corresponding number of shares of Series C Common Stock, and the
share or shares of Series B Common Stock previously represented by such
certificate(s) shall be canceled and revert to the status of authorized but
unissued share(s) of Series B Common Stock. Upon surrender of any such
certificate to the Corporation, the Corporation shall issue and deliver to the
person entitled thereto a new certificate or certificates to represent the
shares of Series C Common Stock (and, if applicable, any remaining shares of
Series B Common Stock) represented by the surrendered certificate.
4
<PAGE> 5
(d) RESERVATION AND ISSUANCE OF SERIES C COMMON STOCK. The
Corporation shall reserve at all times, for so long as any shares of Series B
Common Stock remain outstanding, free from preemptive rights, out of its
authorized but unissued shares of Series C Common Stock, solely for the purpose
of effecting the conversion of the shares of Series B Common Stock, sufficient
shares of Series C Common Stock to provide for the conversion of all outstanding
shares of Series B Common Stock. All shares of Series C Common Stock issued upon
conversion of the shares of Series B Common Stock will be duly and validly
issued, fully paid and nonassessable to the same extent as the shares of Series
B Common Stock from which they were converted.
4.3.6 TERMINATION OF DESIGNATION OF SERIES A COMMON STOCK, SERIES B
COMMON STOCK AND SERIES C COMMON STOCK. Upon the earlier of the following events
(a "Designated Event"):
(a) the written election delivered to the Corporation at any time by
the holders of a majority of: (i) the then outstanding shares of Series A
Preferred Stock, or (ii) the then outstanding shares of Series A Common Stock
issued upon the conversion of Series A Preferred as provided in Article V; or
(b) the closing of a Public Offering (as defined in Section 5.4(b)),
provided: (i) immediately following the closing of the Public Offering, the
persons who held shares of Series A Preferred prior to the Public Offering, or
prior to the conversion of the Series A Preferred into Common Stock as provided
in Article V, hold more than fifty percent (50%) of all of the outstanding
shares of the Corporation, assuming the issuance and exercise of all options
under the Corporation's 1995 -------- Stock Option Plan, 1996 Stock Option Plan
or any other stock option, employee stock bonus or restricted stock plan
designated and approved by the Board of Directors, (ii) in the opinion of the
underwriters, delivered to the Corporation prior to the closing of the Public
Offering, the existence of multiple classes of Common Stock will lower the price
in the Public Offering by more than twenty-five percent (25%), and (iii) the
Public Offering does not constitute a Qualified Public Offering (as defined in
Section 4.3.9);
the designation of the Series A Common Stock, Series B Common Stock and Series C
Common Stock as separate series of Common Stock having the respective rights,
preferences and limitations set forth in this Section 4.3, and the authority of
the Board of Directors under Section 4.2 to divide the Common Stock into series
and to fix and determine the relative rights and preferences therefor, shall
automatically terminate. Effective immediately upon such termination (A) the
number of authorized but undesignated shares of Common Stock of the Corporation
shall be increased by the number of authorized shares of Series A Common Stock,
Series B Common Stock, and Series C Common Stock, without any distinctions
between any of such shares (except as provided in Section 4.3.7); (B) each share
of Series A Common Stock, Series B Common Stock and Series C Common Stock then
outstanding shall thereafter constitute one (1) share of Common Stock, the
holder of which shall be entitled to one (1) vote upon all matters submitted to
a vote of shareholders; and (C) each certificate representing shares of Series A
Common Stock, Series B Common Stock or Series C Common Stock that were
outstanding immediately prior to the termination shall, by virtue of the
termination and without
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any action on the part of the holder, thereafter represent the corresponding
number of shares of Common Stock. Upon surrender of any such certificate to the
Corporation, the Corporation shall issue and deliver to the person entitled
thereto a new certificate to represent the shares of Common Stock represented by
the surrendered certificate.
4.3.7 SERIES D COMMON STOCK. Following a Designated Event,
notwithstanding anything in Section 4.3.6 to the contrary, one (1) share of
Common Stock shall remain designated a share of Series D Common Stock, and, as
provided in Section 5.4(a), the holders of Series A Preferred shall have the
nontransferable right to convert one (1) share of Series A Preferred into one
(1) share of Series D Common Stock provided the Corporation has received, in
connection with the Designated Event, an opinion of a recognized investment
banking firm that the existence of this class of stock will not impair the value
of the Series A Common Stock. Upon the transfer of that one (1) share of Series
D Common Stock, the one (1) share of Series D Common Stock shall automatically
convert into one (1) share of Series A Common Stock or Conversion Stock (as
defined in Section 5.4(a)). The one (1) share of Series D Common Stock, which
shall be issued as described in Section 5.4(a), shall have the right (in
addition to its right to vote with the Common Stock) to elect one (1) member of
the Board of Directors of the Corporation (the "Policy Director") who shall have
the rights and authority to adopt or change the editorial policies of the
Corporation.
4.3.8 TERMINATION OF DESIGNATION OF SERIES E COMMON STOCK. If a holder
of Series E Preferred elects to convert such shares into shares of Series A
Common Stock, then, at any time following such conversion, the Board of
Directors may amend the resolution establishing the Series E Common Stock to
decrease (but not below the number of Series E Preferred then outstanding) the
number of shares of Series E Common Stock, and the number of shares constituting
the decrease shall thereafter constitute authorized but undesignated shares of
Common Stock. In addition, if all of the Series E Preferred are converted into
shares of Series A Common Stock, the designation of the Series E Common Stock as
a separate series of Common Stock shall automatically terminate. Effective
immediately upon such termination, the number of authorized but undesignated
shares of Common Stock of the Corporation shall be increased by the number of
authorized shares of Series E Common Stock.
4.3.9 QUALIFIED PUBLIC OFFERING. The provisions of this Section 4.3.9
shall apply in the event of the closing of a firm commitment underwritten public
offering pursuant to an effective registration statement under the Securities
Act of 1933, as amended (the "Securities Act"), covering the offer and sale of
Common Stock for the account of the Corporation to the public with aggregate
proceeds to the Corporation of not less than $20,000,000 (prior to deduction of
underwriter commissions and offering expenses), provided, the holders of not
less than Sixty-Six and Two-Thirds Percent (66_%) of the then outstanding shares
of Series D Preferred, by affirmative vote or written consent, have consented to
such offering ("Qualified Public Offering").
(a) TERMINATION OF DESIGNATION OF SERIES A COMMON STOCK, SERIES B
COMMON STOCK, SERIES C COMMON STOCK AND SERIES D COMMON STOCK. Effective upon
closing of a Qualified Public Offering, the designation of the Series A Common
Stock, Series B
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Common Stock, Series C Common Stock and Series D Common Stock as separate series
of Common Stock having the respective rights, preferences and limitations set
forth in this Section 4.3, and the authority of the Board of Directors under
Section 4. to divide the Common Stock into series and to fix and determine the
relative rights and preferences therefor, shall automatically terminate.
Effective immediately upon such termination (i) the number of authorized but
undesignated shares of Common Stock of the Corporation shall be increased by the
number of authorized shares of Series A Common Stock, Series B Common Stock,
Series C Common Stock and Series D Common Stock without any distinctions between
any of such shares; (ii) each share of Series A Common Stock, Series B Common
Stock, Series C Common Stock and Series D Common Stock then outstanding shall
thereafter constitute one (1) share of Common Stock, the holder of which shall
be entitled to one (1) vote upon all matters submitted to a vote of
shareholders; and (iii) each certificate representing shares of Series A Common
Stock, Series B Common Stock, Series C Common Stock or Series D Common Stock
that were outstanding immediately prior to the termination shall, by virtue of
the termination and without any action on the part of the holder, thereafter
represent the corresponding number of shares of Common Stock. Upon surrender of
any such certificate to the Corporation, the Corporation shall issue and deliver
to the person entitled thereto a new certificate to represent the shares of
Common Stock represented by the surrendered certificate.
(b) DESIGNATION OF SPECIAL COMMON STOCK; RECLASSIFICATION OF SERIES
E COMMON STOCK. Effective upon closing of a Qualified Public Offering (i) the
designation of the Seven Million Forty-Seven Thousand Six Hundred Seventy-Nine
(7,047,679) shares of Series E Common Stock shall automatically terminate and be
replaced by the designation of a new series of Common Stock to be known as
"Special Common Stock," consisting of the same number of shares, which series
shall have the rights described in this Section 4.3.9, and (ii) each share of
Series E Common Stock then outstanding shall automatically be reclassified as
one (1) share of Special Common Stock; and (iii) each certificate representing
shares of Series E Common Stock that were outstanding immediately prior to the
reclassification shall, by virtue of the reclassification and without any action
on the part of the holder, thereafter represent the corresponding number of
shares of Special Common Stock. Upon surrender of any such certificate to the
Corporation, the Corporation shall issue and deliver to the person entitled
thereto a new certificate to represent the shares of Special Common Stock
represented by the surrendered certificate.
(c) RECLASSIFICATION OF SPECIAL COMMON STOCK OR SERIES E COMMON
STOCK UPON QUALIFIED TRANSFER.
(i) If any shares of Special Common Stock are sold in a Qualified
Sale (as defined in Section 4.3.9(c)(iii)), then, effective immediately upon
such sale (A) the number of authorized but undesignated shares of Common Stock
of the Corporation shall be increased by the number of shares of Special Common
Stock so sold; (B) each share of Special Common Stock so sold shall thereafter
constitute one (1) share of Common Stock, the holder of which shall be entitled
to one (1) vote upon all matters submitted to a vote of shareholders; (C) the
certificate or certificates representing the shares of Special Common Stock that
were outstanding immediately prior to such sale shall, by virtue of the sale and
without any action on the part of
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the holder, thereafter represent (I) to the extent of the number of shares of
Special Common Stock so sold, the corresponding number of shares of Common
Stock, and (II) the shares of Special Common Stock represented by such
certificate or certificates immediately prior to such sale, if any, that have
not been so sold; and (D) if no shares of Special Common Stock remain
outstanding following the Qualified Sale, the designation of the Special Common
Stock as a separate series of Common Stock having the respective rights,
preferences and limitations set forth in this Section 4.3.9 shall automatically
terminate. Upon surrender of any such certificate to the Corporation, the
Corporation shall issue and deliver to the person entitled thereto a new
certificate or certificates to represent the shares of Common Stock and Special
Common Stock, if any, represented by the surrendered certificate.
(ii) If any shares of Series E Common Stock are sold in a
Qualified Sale, then, effective immediately upon such sale (A) the number of
authorized shares of Series E Common Stock shall be decreased, and the number of
authorized but undesignated shares of Common Stock of the Corporation shall be
increased, by the number of shares of Series E Common Stock so sold; (B) each
share of Series E Common Stock so sold shall automatically be converted into one
(1) share of Series A Common Stock; (C) the certificate or certificates
representing the shares of Series E Common Stock that were outstanding
immediately prior to such sale shall, by virtue of the sale and without any
action on the part of the holder, thereafter represent (I) to the extent of the
number of shares of Series E Common Stock so sold, the corresponding number of
shares of Common Stock, and (II) the shares of Series E Common Stock represented
by such certificate or certificates immediately prior to such sale, if any, that
have not been so sold; and (D) if no shares of Series E Common Stock remain
outstanding following the Qualified Sale, the designation of the Series E Common
Stock as a separate series of Common Stock having the respective rights,
preferences and limitations set forth in this Section 4.3 shall automatically
terminate. Upon surrender of any such certificate to the Corporation, the
Corporation shall issue and deliver to the person entitled thereto a new
certificate or certificates to represent the shares of Series A Common Stock and
Series E Common Stock, if any, represented by the surrendered certificate.
Nothing in the first sentence of this Section 4.3.9 shall limit the
effectiveness of this Section 4.3.9(c)(ii), notwithstanding that a Qualified
Public Offering has not occurred.
(iii) For purposes of this Section 4.3.9(c), a "Qualified Sale" of
shares of Special Common Stock or Series E Common Stock shall mean a bona fide
sale of the shares by the holder thereof to a purchaser who is not directly, or
acting on behalf of, an affiliate (as that term is defined in Rule 405
promulgated under the Securities Act) of the holder.
(d) VOTING RIGHTS. Each share of Common Stock shall be entitled to
one (1) vote on all matters submitted to the shareholders of the Corporation and
each share of Special Common Stock shall not be entitled to vote, except as
required by law, in which case each share of Special Common Stock shall be
entitled to one (1) vote.
(e) RANKING. The rights and preferences of the Common Stock and the
Special Common Stock shall be in all respects identical, except as otherwise
required by law or expressly provided in these Articles of Incorporation.
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4.4 ISSUANCE OF PREFERRED STOCK IN SERIES.
4.4.1 AUTHORITY VESTED IN BOARD OF DIRECTORS. The Preferred Stock may
be divided into and issued in series from time to time. Authority is vested in
the Board of Directors, subject to the limitations and procedures set forth in
these Articles of Incorporation or prescribed by law, to divide any part or all
of such Preferred Stock into any number of series, to fix and determine the
relative rights and preferences of the shares of any series to be established,
and to amend the rights and preferences of the shares of any series that has
been established but is wholly unissued.
4.4.2 DESIGNATION OF SERIES A PREFERRED STOCK, SERIES B PREFERRED
STOCK, SERIES C PREFERRED STOCK, SERIES D PREFERRED STOCK AND SERIES E PREFERRED
STOCK.
The following series of Preferred Stock are hereby designated, and each
such series shall have the following rights, preferences and limitations:
4.4.3 DESIGNATION. Thirteen Million Seven Hundred Thirteen Thousand
Four Hundred Thirty Nine (13,713,439) shares of Preferred Stock shall be
designated and known as "Series A Preferred Stock" or "Series A Preferred";
Three Million Fifty-Nine Thousand Seven Hundred One (3,059,701) shares of
Preferred Stock shall be designated and known as "Series B Preferred Stock" or
"Series B Preferred"; Three Million Four Thousand Three Hundred Five (3,004,305)
shares of Preferred Stock shall be designated and known as "Series C Preferred
Stock" or "Series C Preferred"; Three Million Ninety-Five Thousand Three Hundred
Thirteen (3,095,313) shares of Preferred Stock shall be designated and known as
"Series D Preferred Stock" or "Series D Preferred"; and Seven Million
Forty-Seven Thousand Six Hundred Seventy-Nine (7,047,679) shares of Preferred
Stock shall be designated as "Series E Preferred Stock" or "Series E Preferred."
Except as otherwise provided in these Articles of Incorporation, all shares of
Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock,
Series D Preferred Stock and Series E Preferred Stock shall be identical and
shall entitle the holders thereof to the same rights and privileges.
4.4.4 AMENDMENT TO SERIES DECREASING SHARES. Within any limits stated
in these Articles of Incorporation or in the resolution of the Board of
Directors establishing a series, the Board of Directors, after the issuance of
shares of a series, may amend the resolution establishing the series to decrease
(but not below the number of shares of such series then outstanding or reserved
for issuance pursuant to the exercise of any outstanding warrants) the number of
shares of that series, and the number of shares constituting the decrease shall
thereafter constitute authorized but undesignated shares.
4.4.5 AUTHORITY LIMITED TO UNISSUED SHARES. The authority herein
granted to the Board of Directors to determine the relative rights and
preferences of the Preferred Stock shall be limited to unissued shares, and no
power shall exist to alter or change the rights and preferences of any shares
that have been issued.
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4.5 ISSUANCE OF CERTIFICATES. The Board of Directors shall have the
authority to issue shares of the capital stock of this Corporation and the
certificates therefor subject to such transfer restrictions and other
limitations as it may deem necessary to promote compliance with applicable
federal and state securities laws, and to regulate the transfer thereof in such
manner as may be calculated to promote such compliance or to further any other
reasonable purpose.
4.6 NO CUMULATIVE RIGHTS. Shareholders of this Corporation shall not
have the right to cumulate votes for the election of directors.
4.7 NO PREEMPTIVE RIGHTS. No shareholder of this Corporation shall have,
solely by reason of being a shareholder, any preemptive or preferential right or
subscription right to any stock of this Corporation or to any obligations
convertible into stock of this Corporation, or to any warrant or option for the
purchase thereof, except to the extent provided by written agreement with this
Corporation.
4.8 QUORUM FOR MEETING OF SHAREHOLDERS. A quorum shall exist at any
meeting of shareholders if a majority of the votes entitled to be cast is
represented in person or by proxy. In the case of any meeting of shareholders
that is adjourned more than once because of the failure of a quorum to attend,
those who attend the third convening of such meeting, although less than a
quorum, shall nevertheless constitute a quorum for the purpose of electing
directors, provided that the percentage of shares represented at the third
convening of such meeting shall not be less than one-third of the shares
entitled to vote.
4.9 CONTRACTS WITH INTERESTED SHAREHOLDERS. Subject to the limitations
set forth in RCW 23B.19.040, to the extent applicable:
4.9.1 The Corporation may enter into contracts and otherwise transact
business as vendor, purchaser, lender, borrower, or otherwise with its
shareholders and with corporations, associations, firms, and entities in which
they are or may be or become interested as directors, officers, shareholders,
members, or otherwise.
4.9.2 Any such contract or transaction shall not be affected or
invalidated or give rise to liability by reason of the shareholder's having an
interest in the contract or transaction.
4.10 SHAREHOLDER VOTING REQUIREMENTS. Subject to the requirements of RCW
23B.08.730, and 23B.19.040, any contract, transaction, or act of the Corporation
or of any director or officer of the Corporation that shall be authorized,
approved, or ratified by a majority of the votes entitled to be cast at a
meeting at which a quorum is present shall, insofar as permitted by law, be as
valid and as binding as though ratified by every shareholder of the Corporation.
4.11 EXECUTION OF CONSENT OF SHAREHOLDERS BY LESS THAN UNANIMOUS
CONSENT. To the extent permitted by the Act, the taking of action by
shareholders without a meeting by less than unanimous written consent of all
shareholders entitled to vote on the action shall be permitted. Before the date
on which the action becomes effective, notice of the taking of such action shall
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be given to those shareholders entitled to vote on the action who have not
consented in writing (and, if the Act would otherwise require that notice of a
meeting of shareholders to consider the action be given to nonvoting
shareholders, to all nonvoting shareholders), in writing, describing with
reasonable clarity and specifying the general nature of the action, and
accompanied by the same material that, under the Act, would have been required
to be sent to nonconsenting (or nonvoting) shareholders in a notice of meeting
at which the action would have been submitted for shareholder action. Such
notice shall be given as follows: (i) if mailed, by deposit in the U.S. mail at
least seventy-two (72) hours prior to the specified effective time of such
action, with first-class postage thereon prepaid, correctly addressed to each
shareholder entitled thereto at the shareholder's address as it appears on the
current record of shareholders of the Corporation; or (ii) if delivered by
personal delivery, by courier service, by wire or wireless equipment, by
telegraphic or other facsimile transmission, or by any other electronic means
which transmits a facsimile of such communication correctly addressed to each
shareholder entitled thereto at the shareholder's physical address, electronic
mail address, or facsimile number, as it appears on the current record of
shareholders of the Corporation, at least twenty-four (24) hours prior to the
specified effective time of such action.
4.12 SPECIAL MEETINGS OF SHAREHOLDERS. Subsequent to the date of closing
of a firm commitment underwritten public offering pursuant to an effective
registration statement under the Securities Act covering the offer and sale of
Common Stock for the account of the Corporation to the public, special meetings
of the shareholders for any purpose or purposes may be called at any time only
by a majority of the Board of Directors or the Chairman of the Board of
Directors (if one be appointed) or the President or one or more shareholders
holding not less than twenty-five percent (25%) of all the shares entitled to be
cast on any issue proposed to be considered at that meeting.
4.13 MAJORITY VOTE REQUIRED. Unless otherwise provided in these Articles
of Incorporation, subsequent to the date of closing of a firm commitment
underwritten public offering pursuant to an effective registration statement
under the Securities Act covering the offer and sale of Common Stock for the
account of the Corporation to the public, pursuant to authority granted under
Sections 23B.10.030, 23B.11.030, 23B.12.020, and 23B.14.020 of the Act, the vote
of shareholders of the Corporation required in order to approve amendments to
the Articles of Incorporation, a plan of merger or share exchange, the sale,
lease, exchange, or other disposition of all or substantially all of the
property of the Corporation not in the usual and regular course of business, or
dissolution of the Corporation shall be a majority of all of the votes entitled
to be cast by each voting group entitled to vote thereon, regardless of whether
or not the Corporation is a "public company," as that term is defined in Section
23B.01.400 of the Act.
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ARTICLE V
ADDITIONAL TERMS OF CAPITAL STOCK
In addition to the relative rights, preferences, privileges and
restrictions granted to or imposed on the respective classes of the shares of
capital stock or the holders thereof as set forth in Article IV, the relative
rights, preferences, privileges and restrictions granted to or imposed on the
respective classes of the shares of capital stock or the holders thereof are as
follows:
5.1 DIVIDENDS. No dividends or other distributions shall be made with
respect to the Common Stock, other than dividends payable solely in Common
Stock, unless at the same time an equivalent dividend with respect to the Series
A Preferred, Series B Preferred, Series C Preferred, Series D Preferred and
Series E Preferred has been paid or set apart or such equivalent dividend has
been waived by the affirmative vote or written consent of the holders of not
less than Sixty-Six and Two-Thirds Percent (66_%) of the outstanding shares of
each of Series A Preferred, Series B Preferred, Series C Preferred, Series D
Preferred and Series E Preferred. Any declared but unpaid dividends on the
shares of Series A Preferred, Series B Preferred, Series C Preferred, Series D
Preferred and Series E Preferred shall be paid upon the conversion of such
shares into Common Stock either (at the option of the Corporation) by payment of
cash or by the issuance of additional shares of Common Stock based upon the fair
market value of the Common Stock at the time of conversion, as determined by the
Corporation's Board of Directors.
5.2 LIQUIDATION PREFERENCES. In the event of any liquidation,
dissolution, or winding up of the Corporation, either voluntary or involuntary,
distributions to the shareholders of the Corporation shall be made in the
following manner:
(a) The holders of each of the Series D Preferred and the Series E
Preferred shall be entitled to receive, prior and in preference to any
distribution of any of the assets or surplus funds of the Corporation to the
holders of the Series A Preferred, the Series B Preferred, the Series C
Preferred or the Common Stock by reason of their ownership of such stock, an
amount equal to the greater of: (1) $11.295 per share, in the case of Series D
Preferred, and $8.99 per share, in the case of Series E Preferred, adjusted for
any combinations, consolidations, subdivisions, or stock dividends with respect
to such shares and, in addition, an amount equal to all declared but unpaid
dividends on such shares; or (2) the amount per share the holder would have
received if he/she/it had converted his/her/its shares into Common Stock as
provided in these Articles of Incorporation, provided, that the holders of
Series D Preferred and the Series E Preferred shall receive such amounts
simultaneously with the receipt by the holders of Common Stock of the amounts to
which they are entitled, as described in Section 5.2(c). If the assets and funds
thus distributed among the holders of the Series D Preferred and Series E
Preferred shall be insufficient to permit the payment to such holders of the
full aforesaid preferential amount, then the entire assets and funds of the
Corporation legally available for distribution shall be distributed, first, pro
rata among the holders of the Series E Preferred in proportion to the full
preferential amount each such holder is otherwise entitled to receive under
clause (1) above, and among the holders of the Series D Preferred in proportion
to Sixty-Six and Two-Thirds Percent
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(66_%) of the full preferential amount each such holder is otherwise entitled to
receive under clause (1) above, and, second, among the holders of the Series D
Preferred in proportion to the remaining full preferential amount each such
holder is otherwise entitled to receive under clause (1) above.
(b) After payment has thus been made to the holders of each of the
Series D Preferred and the Series E Preferred of the full amounts to which they
shall be entitled as aforesaid, the holders of each of the Series A Preferred,
the Series B Preferred and the Series C Preferred shall be entitled to receive
prior and in preference to any distribution of any of the assets or surplus
funds of the Corporation to the holders of the Common Stock by reason of their
ownership of such stock, an amount equal to the greater of: (1) $0.0729 per
share, in the case of Series A Preferred, $0.67 per share, in the case of Series
B Preferred, and $1.9634 per share, in the case of Series C Preferred, adjusted
for any combinations, consolidations, subdivisions, or stock dividends with
respect to such shares and, in addition, an amount equal to all declared but
unpaid dividends on such shares; or (2) the amount per share the holder would
have received if he/she/it had converted his/her/its shares into Common Stock as
provided in these Articles of Incorporation, provided, that the holders of the
Series A Preferred, the Series B Preferred and the Series C Preferred shall
receive such amounts simultaneously with the receipt by the holders of Common
Stock of the amounts to which they are entitled, as described in Section 5.2(c).
If the assets and funds thus distributed among the holders of the Series A
Preferred, the Series B Preferred and the Series C Preferred shall be
insufficient to permit the payment to such holders of the full aforesaid
preferential amount, then the entire assets and funds of the Corporation legally
available for distribution shall be distributed among the holders of the Series
A Preferred, the Series B Preferred and the Series C Preferred in proportion to
the full preferential amount each such holder is otherwise entitled to receive
under clause (1) above.
(c) After payment has thus been made to the holders of each of the
Series A Preferred, the Series B Preferred, the Series C Preferred, the Series D
Preferred and the Series E Preferred of the full amounts to which they shall be
entitled as aforesaid, the holders of the Common Stock shall be entitled to
receive ratably on a per-share basis all the remaining assets.
(d) For purposes of this Section 5.2, a merger or consolidation of
the Corporation with or into any other corporation or corporations, or the
merger of any other corporation or corporations into the Corporation, in which
the shareholders of the Corporation receive distributions in cash or securities
of another corporation or corporations as a result of such consolidation or
merger, or a sale of all or substantially all of the assets of the Corporation,
shall be treated as a liquidation, dissolution or winding up of the Corporation
unless the Corporation's stockholders immediately prior to such an event hold,
immediately after such event, at least 50% of the general voting power of the
surviving or acquiring entity by virtue of their ownership of the Corporation's
equity securities.
5.3 VOTING RIGHTS. Except as otherwise required by law or by Section
5.6, the holder of each share of Common Stock issued and outstanding shall have
the votes set forth in Section 4.3.3, and the holder of each share of Series A
Preferred, Series B Preferred, Series C Preferred and Series D Preferred shall
be entitled to the number of votes equal to the number of
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votes entitled to be cast by the number of shares of Common Stock into which
such share of Series A Preferred, Series B Preferred, Series C Preferred or
Series D Preferred could be converted at the record date for determination of
the shareholders entitled to vote on such matters, such votes to be counted
together with all other shares of the Corporation having general voting power
and not separately as a class. Fractional votes by the holders of Series A
Preferred, Series B Preferred, Series C Preferred and Series D Preferred shall
not, however, be permitted and any fractional voting right shall (after
aggregating all shares into which shares of Series A Preferred, Series B
Preferred, Series C Preferred and Series D Preferred held by each holder could
be converted) be rounded to the nearest whole number. Except as otherwise
required by law, in which case the holder of each share of Series E Preferred
shall be entitled to one (1) vote, the holders of Series E Preferred shall not
be entitled to vote. Where the Series E Preferred is entitled to voting rights
by law, all shares of Series E Preferred shall vote and be counted together with
the Series A Preferred, the Series B Preferred, the Series C Preferred and
Series D Preferred and not separately as a voting group, except as otherwise
required by law. Holders of Common Stock and Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred and Series E Preferred shall
be entitled to notice of any shareholders' meeting in accordance with the Bylaws
of the Corporation.
5.4 CONVERSION. The holders of Series A Preferred, Series B Preferred,
Series C Preferred, Series D Preferred and Series E Preferred shall have
conversion rights as follows (the "Conversion Rights"):
(a) RIGHT TO CONVERT. Each share of Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred and Series E Preferred shall
be convertible, at the option of the holder thereof, at any time after the date
of issuance of such share (including immediately prior to any liquidation,
dissolution or winding up of the Corporation as set forth in Section 5.2 above)
at the office of the Corporation or any transfer agent for each of the Series A
Preferred, Series B Preferred, Series C Preferred, Series D Preferred or Series
E Preferred (whichever is appropriate), into such number of fully paid and
nonassessable shares of Series A Common Stock, or if, pursuant to Section 4.3.6
or Section 4.3.9, the Articles of Incorporation as amended from time to time do
not, at the time of conversion, provide for Series A Common Stock, into shares
of Common Stock, or for the Series E Preferred, into shares of Series E Common
Stock, or if, pursuant to Section 4.3.9, the Articles of Incorporation as
amended from time to time do not, at the time of conversion, provide for Series
E Common Stock, into shares of Special Common Stock (such Series A Common Stock,
Series E Common Stock, Common Stock or Special Common Stock, as the case may be,
the "Conversion Stock"), as is determined by dividing $8.99, in the case of the
Series E Preferred, $7.53, in the case of the Series D Preferred, $1.9634, in
the case of the Series C Preferred, $0.67, in the case of the Series B
Preferred, and $0.0729, in the case of the Series A Preferred, by the Conversion
Price (determined as hereinafter provided) for such series in effect at the time
of the conversion (the "Conversion Rate"). The price at which shares of
Conversion Stock shall be deliverable upon conversion (the "Conversion Price")
shall initially be $8.99, in the case of the Series E Preferred, $7.53, in the
case of the Series D Preferred, $1.9634, in the case of the Series C Preferred,
$0.67, in the case of the Series B Preferred, and $0.0729, in the case of the
Series A Preferred. Such initial Conversion Price shall be subject to adjustment
as hereinafter provided.
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Notwithstanding anything in this Section 5.4(a) to the contrary, in the event of
a Public Offering that is not a Qualified Public Offering, the holders of the
Series A Preferred (including for this purpose any shares of Conversion Stock
issued upon conversion of the Series A Preferred prior to a Public Offering)
will have the-non-transferable right to convert one (1) such share, unless
otherwise provided in Section 4.3.7, into one (1) share of Series D Common Stock
with the rights provided in Section 4.3.7.
(b) AUTOMATIC CONVERSION. Each share of Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred and Series E Preferred shall
automatically be converted into the number and class of fully paid and
nonassessable shares of Conversion Stock into which such share would then
convert upon voluntary conversion under Section 5.4(a), effective upon the
closing of a firm commitment underwritten public offering (a "Public Offering")
pursuant to an effective registration statement under the Securities Act
covering the offer and sale of Common Stock for the account of the Corporation
to the public, if either (x) the price to the public in the offering is at least
$13.554 per share (as adjusted to reflect subsequent stock dividends, stock
splits, combinations and recapitalizations) and the aggregate proceeds of the
offering are not less than $20,000,000 (prior to deduction of underwriter
commissions and offering expenses), or (y) the holders of not less than
Sixty-Six and Two-Thirds Percent (66_%) of the then outstanding shares of Series
D Preferred, by affirmative vote or written consent, have consented to the
automatic conversion.
(c) MECHANICS OF CONVERSION. No fractional shares of Conversion
Stock shall be issued upon conversion of Series A Preferred, Series B Preferred,
Series C Preferred, Series D Preferred or Series E Preferred. In lieu of any
fractional shares to which the holder would otherwise be entitled, the
Corporation shall pay cash equal to such fraction multiplied by the then
effective Conversion Price. Before any holder of Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred or Series E Preferred shall be
entitled to convert the same into full shares of Conversion Stock and to receive
certificates therefor, such holder shall surrender the certificate or
certificates therefor, duly endorsed, at the office of the Corporation or of any
transfer agent for the Series A Preferred, Series B Preferred, Series C
Preferred, Series D Preferred or Series E Preferred (whichever is appropriate),
and shall give written notice to the Corporation at such office that such holder
elects to convert the same; provided, however, that in the event of an automatic
conversion pursuant to Section 5.4(b), the outstanding shares of Series A
Preferred, Series B Preferred, Series C Preferred, Series D Preferred and Series
E Preferred shall be converted automatically without any further action by the
holders of such shares and whether or not the certificates representing such
shares are surrendered to the Corporation or its transfer agent, and provided
further, that the Corporation shall not be obligated to issue certificates
evidencing the shares of Conversion Stock issuable upon such automatic
conversion unless the certificates evidencing such shares of Series A Preferred,
Series B Preferred, Series C Preferred, Series D Preferred or Series E Preferred
are either delivered to the Corporation or its transfer agent as provided above,
or the holder notifies the Corporation or its transfer agent that such
certificates have been lost, stolen or destroyed and executes an agreement
satisfactory to the Corporation to indemnify the Corporation from any loss
incurred by it in connection with such certificates. The Corporation shall, as
soon as practicable after delivery of such certificate, or such agreement of
indemnification in the case of
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a lost certificate, issue and deliver at such office to such holder of Series A
Preferred, Series B Preferred, Series C Preferred, Series D Preferred or Series
E Preferred, a certificate or certificates for the number of shares of
Conversion Stock to which such holder shall be entitled as aforesaid and a check
payable to the holder in the amount of any cash amounts payable as the result of
a conversion into fractional shares of Conversion Stock. Such conversion shall
be deemed to have been made immediately prior to the close of business on the
date of such surrender of the shares of Series A Preferred, Series B Preferred,
Series C Preferred, Series D Preferred or Series E Preferred to be converted, or
in the case of automatic conversion under Section 5.4(b), on the date of closing
of the Public Offering, and the person or persons entitled to receive the shares
of Conversion Stock issuable upon such conversion shall be treated for all
purposes as the record holder or holders of such shares of Conversion Stock on
such date.
(d) ADJUSTMENTS TO CONVERSION PRICE FOR DILUTIVE ISSUES.
(i) SPECIAL DEFINITIONS. For purposes of this Section 5.4(d), the
following definitions shall apply:
(1) "OPTIONS" shall mean rights, options or warrants to
subscribe for, purchase or otherwise acquire either Common Stock or Convertible
Securities.
(2) "ORIGINAL ISSUE DATE" shall mean the date on which the first
share of Series E Preferred was first issued.
(3) "CONVERTIBLE SECURITIES" shall mean any evidence of
indebtedness, shares of capital stock (other than the Common Stock) or other
securities convertible into or exchangeable for Common Stock.
(4) "ADDITIONAL SHARES OF COMMON STOCK" shall mean all shares of
Common Stock issued (or, pursuant to Section 5.4(d)(ii), deemed to be issued) by
the Corporation after the Original Issue Date, other than:
(A) shares of Common Stock issued or issuable at any time
upon conversion of the shares of Series A Preferred, Series B Preferred, Series
C Preferred, Series D Preferred or Series E Preferred authorized herein;
(B) shares of Common Stock issued or issuable at any time to
officers, directors, and employees of, and consultants to, the Corporation
pursuant to the Corporation's 1995 Stock Option Plan, 1996 Stock Option Plan or
any other stock option, restricted stock plan or employee stock bonus program or
grant designated and approved by the Board of Directors by unanimous vote if
there are three or fewer directors then serving or, if there are greater than
three directors then serving, by a two-thirds majority vote thereof (provided
that any shares repurchased by the Corporation from employees, officers,
directors and consultants pursuant to the terms of stock repurchase agreements
approved by the Board of Directors shall not, unless reissued, be counted as
issued for purposes of this calculation) other than shares issued to Rob Glaser,
the Corporation's Founder, without the written consent of the
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<PAGE> 17
holders of a majority of the Series B Preferred, Series C Preferred, Series D
Preferred and Series E Preferred (provided, for purposes of calculating the
majority for purposes of this clause (B), the shares of Series E Preferred to be
issued upon exercise, if ever, of the Series E Preferred Stock Purchase Warrant
issued pursuant to the Series E Preferred Stock Purchase Agreement dated July
21, 1997, shall not be deemed to be outstanding, regardless of whether such
Series E Preferred Stock Purchase Warrant has been exercised);
(C) shares of Common Stock issued or issuable at any time as
a dividend or distribution on Series A Preferred, Series B Preferred, Series C
Preferred, Series D Preferred or Series E Preferred or any other event for which
adjustment is made pursuant to Section 5.4(e)(i) hereof;
(D) shares of Common Stock issued upon conversion of Series
B Common Stock to Series C Common Stock pursuant to Section 4.3.5 of these
Articles;
(E) shares of Common Stock issued upon exercise of the
Series B Common Stock Warrants which were issued pursuant to the Series C
Preferred Stock Purchase Agreement by and among the Corporation and certain
purchasers dated October 26, 1995;
(F) shares of Common Stock issued or issuable in connection
with: (i) the acquisition, by this Corporation or any subsidiary, of any assets,
stock or other interest in any partnership, corporation or other entity approved
by a majority of this Corporation's Board of Directors, or (ii) the formation of
any research and development partnerships, licensing or collaborative agreements
or other similar venture approved by a majority of this corporation's Board of
Directors; provided, that the number of shares issued or issuable pursuant to
this clause (F) shall not exceed 330,000 (as adjusted to reflect subsequent
stock dividends, stock splits and recapitalizations) in any one transaction or
series of related transactions and shall not exceed 990,000 (as adjusted to
reflect subsequent stock dividends, stock splits and recapitalizations) in the
aggregate; and
(G) shares of Common Stock issued or issuable at any time by
way of dividend or other distribution on shares of Common Stock (x) excluded
from the definition of Additional Shares of Common Stock by the foregoing
clauses (A), (B), (C), (D), (E), and (F) or this clause (G) or (y) on shares of
Common Stock so excluded under Subsection (x).
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<PAGE> 18
(ii) DEEMED ISSUANCE OF ADDITIONAL SHARES OF COMMON STOCK.
(1) OPTIONS AND CONVERTIBLE SECURITIES. In the event the
Corporation at any time or from time to time after the Original Issue Date shall
issue any Options or Convertible Securities, then the maximum number of shares
(as set forth in the instrument relating thereto without regard to any
provisions contained therein for a subsequent adjustment of such number) of
Common Stock issuable upon the exercise of such Options or, in the case of
Convertible Securities and Options therefor, the conversion or exchange of such
Convertible Securities, shall, except as otherwise provided in Section
5.4(d)(i)(4), be deemed to be Additional Shares of Common Stock issued as of the
time of such issuance, provided that, with respect to a particular series of
Preferred Stock, Additional Shares of Common Stock shall not be deemed to have
been issued unless the consideration per share (determined pursuant to Section
5.4(d)(iv) hereof) of such Additional Shares of Common Stock would be less than
the Conversion Price in effect for such series on the date of and immediately
prior to such issuance, and, provided further that in any such case in which
Additional Shares of Common Stock are deemed to be issued (notwithstanding the
foregoing):
(A) no further adjustment in the Conversion Price for such
series shall be made upon the subsequent issuance of Convertible Securities or
shares of Common Stock upon the exercise of such Options or conversion or
exchange of such Convertible Securities;
(B) if such Options or Convertible Securities by their terms
provide, with the passage of time or otherwise, except as provided in this
Section 5.4(d), for any increase or decrease in the consideration payable to the
Corporation, or in the number of shares of Common Stock issuable, upon the
exercise, conversion or exchange thereof (a "Change Event"), the Conversion
Price for any series of Preferred Stock recomputed upon the original issuance
thereof, and any subsequent adjustments based thereon, shall, upon any such
increase or decrease becoming effective, again be recomputed to reflect such
increase or decrease insofar as it affects such Options or the rights of
conversion or exchange under such Convertible Securities; provided, however,
that anything to the contrary notwithstanding, if the Change Event is triggered
or caused by a Dilutive Issue (as defined in Section 5.4(d)(iii)), this Section
5.4(d)(ii)(B) shall be inapplicable and no adjustment shall be made to any
Conversion Price as a result of the Change Event;
(C) upon the expiration of any such Options or any rights of
conversion or exchange under such Convertible Securities which shall not have
been exercised, the Conversion Price computed upon the original issuance
thereof, and any subsequent adjustments based thereon, shall, upon such
expiration, be recomputed as if,
(I) in the case of Convertible Securities or Options for
Common Stock, only the shares of Common Stock, if any, actually issued upon the
exercise of such Options or the conversion or exchange of such Convertible
Securities were issued at the
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time of the issuance of such Convertible Securities or Options and the
consideration received therefor was the consideration actually received by the
Corporation for the issue of all such Options or Convertible Securities, whether
or not exercised, converted, or exchanged, plus the consideration actually
received by the Corporation upon such exercise, conversion or exchange, and
(II) in the case of Options for Convertible Securities,
only the Convertible Securities, if any, actually issued upon the exercise
thereof were issued at the time of issue of such Options, and the consideration
received by the Corporation for the Additional Shares of Common Stock deemed to
have been then issued was the consideration actually received by the Corporation
for the issue of all such Options, whether or not exercised, plus the
consideration deemed to have been received by the Corporation upon the issue of
the Convertible Securities with respect to which such Options were actually
exercised;
(D) no readjustment pursuant to clause (B) or (C) above
shall have the effect of increasing the Conversion Price to an amount which
exceeds the lower of (i) the Conversion Price on the original adjustment date,
or (ii) the Conversion Price that would have resulted from any other issuance of
Additional Shares of Common Stock between the original adjustment date and such
readjustment date; and
(E) in the case of any options which expire by their terms
not more than 90 days after the date of issuance thereof, no adjustment of the
Conversion Price shall be made until all such Options have either expired or
been exercised.
In the event that a record date is established for the purpose of
determining the holders of the Corporation's securities who shall be entitled to
receive Options or Convertible Securities as a dividend or a distribution, the
Options or Convertible Securities to be so distributed or issued shall, for
purposes of this Section 5.4(d), be deemed to have been issued as of such record
date (provided that the Conversion Price so computed shall be recomputed if such
Options or Convertible Securities are not so distributed or issued).
(2) STOCK DIVIDENDS. In the event the Corporation at any time or
from time to time after the Original Issue Date shall declare or pay any
dividend on the Common Stock payable in Common Stock, then and in any such
event, Additional Shares of Common Stock shall be deemed to have been issued
immediately after the close of business on the record date for the determination
of holders of any class of securities entitled to receive such dividend;
provided, however, that if such record date is fixed and such dividend is not
fully paid, the only Additional Shares of Common Stock deemed to have been
issued will be the number of shares of Common Stock actually issued in such
dividend, and such shares will be deemed to have been issued as of the close of
business on such record date, and the Conversion Price shall be recomputed
accordingly.
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<PAGE> 20
(iii) ADJUSTMENT OF CONVERSION PRICE UPON ISSUANCE OF ADDITIONAL
SHARES OF COMMON STOCK.
(1) If at any time or from time to time after the Original Issue
Date this Corporation shall issue Additional Shares of Common Stock (including
Additional Shares of Common Stock deemed to be issued pursuant to Section
5.4(d)(ii)) without consideration or for a consideration (as determined in
Section 5.4(d)(iv)) per share issued or deemed to have been issued under Section
5.4(d)(ii), less than: (I) in the case of the Series A Preferred, the Conversion
Price for the Series A Preferred in effect on the date of and immediately prior
to such issuance, (II) in the case of the Series B Preferred, the Conversion
Price for the Series B Preferred in effect on the date of and immediately prior
to such issuance, (III) in the case of the Series C Preferred, the Conversion
Price for the Series C Preferred in effect on the date of and immediately prior
to such issuance, (IV) in the case of the Series D Preferred, the Conversion
Price for the Series D Preferred in effect on the date of and immediately prior
to such issuance, or (V) in the case of the Series E Preferred, the Conversion
Price for the Series E Preferred in effect on the date of and immediately prior
to such issuance, then and in such event (a "Dilutive Issue"), any one or all of
such Conversion Prices shall be reduced, concurrently with such issuance, to a
price determined by multiplying such Conversion Price by a fraction, the
numerator of which shall be the number of shares of Common Stock outstanding
immediately prior to such issuance on a fully diluted basis (including for such
purpose Convertible Securities the conversion rights of which, are then
exercisable but excluding all Options) plus the number of shares of Common Stock
which the aggregate consideration received by the Corporation for the total
number of Additional Shares of Common Stock so issued would purchase at such
Conversion Price; and the denominator of which shall be the number of shares of
Common Stock outstanding immediately prior to such issuance on a fully-diluted
basis (including for such purpose Convertible Securities the conversion rights
of which, are then exercisable but excluding all Options) plus the number of
such Additional Shares of Common Stock so issued.
(2) In addition to any adjustments to the Conversion Price for
the Series E Preferred made pursuant to Section 5.4(d)(iii)(1), if this
Corporation sells shares of Common Stock to the public in a Public Offering
pursuant to Section 5.4(b)(y) at a price per share less than $8.99, (as adjusted
to reflect subsequent stock dividends, stock splits and recapitalizations), the
Conversion Price for the Series E Preferred in effect on the date of and
immediately prior to such Public Offering, shall be reduced, immediately prior
to but contingent upon the effectiveness of the Public Offering, to $7.53 (as
adjusted to reflect subsequent stock dividends, stock splits and
recapitalizations).
(iv) DETERMINATION OF CONSIDERATION. For purposes of this Section
5.4(d), the consideration received by the Corporation for the issuance of any
Additional Shares of Common Stock shall be computed as follows:
(1) CASH AND PROPERTY: Such consideration shall:
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(A) insofar as it consists of cash, be computed at the
aggregate amount of cash received by the Corporation excluding amounts paid or
payable for accrued interest or accrued dividends;
(B) insofar as it consists of property other than cash, be
computed at the fair value thereof at the time of such issuance, as determined
in good faith by the Corporation's Board of Directors; and
(C) in the event Additional Shares of Common Stock are
issued together with other shares or securities or other assets of the
Corporation for consideration which covers both, be the proportion of such
consideration so received, computed as provided in clauses (A) and (B) above, as
determined in good faith by the Corporation's Board of Directors.
(2) OPTIONS AND CONVERTIBLE SECURITIES. The consideration per
share received by the Corporation for Additional Shares of Common Stock deemed
to have been issued pursuant to Section 5.4(d)(ii)(1), relating to Options and
Convertible Securities, shall be determined by dividing: (x) the total amount,
if any, received or receivable by the Corporation as consideration for the issue
of such Options or Convertible Securities, plus the minimum aggregate amount of
additional consideration (as set forth in the instruments relating thereto,
without regard to any provision contained therein for a subsequent adjustment of
such consideration) payable to the Corporation upon the exercise of such Options
or the conversion or exchange of such Convertible Securities, or in the case of
Options for Convertible Securities, the exercise of such Options for Convertible
Securities and the conversion or exchange of such Convertible Securities; by (y)
the maximum number of shares of Common Stock (as set forth in the instruments
relating thereto, without regard to any provision contained therein for a
subsequent adjustment of such number) issuable upon the exercise of such Options
or the conversion or exchange of such Convertible Securities.
(3) STOCK DIVIDENDS. Any Additional Shares of Common Stock
relating to stock dividends shall be deemed to have been issued for no
consideration.
(e) ADDITIONAL ADJUSTMENTS TO CONVERSION PRICE.
(i) ADJUSTMENTS FOR SUBDIVISIONS, COMBINATIONS OR CONSOLIDATION OF
COMMON STOCK. In the event the outstanding shares of Common Stock (whether
Series A Common Stock, Series E Common Stock or Common Stock) shall be
subdivided, by stock split, or otherwise (but other than by stock dividend,
which is addressed in Section 5.4(d)(ii)(2) of these Articles of Incorporation),
into a greater number of shares of Common Stock, the Conversion Price for each
series of Preferred Stock then in effect shall, concurrently with the
effectiveness of such subdivision, be proportionately decreased. In the event
the outstanding shares of Common Stock shall be combined or consolidated, by
reclassification or otherwise, into a lesser number of shares of Common Stock,
the Conversion Price for each series of Preferred Stock then in effect shall,
concurrently with the effectiveness of such combination or consolidation, be
proportionately increased.
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(ii) ADJUSTMENTS FOR OTHER DISTRIBUTIONS. In the event the
Corporation at any time or from time to time makes, or fixes a record date for
the determination of holders of Common Stock entitled to receive, any
distribution payable in securities of the Corporation other than shares of
Common Stock and other than as otherwise adjusted in this Section 5.4, then and
in each such event provision shall be made so that the holders of Series A
Preferred, Series B Preferred, Series C Preferred, Series D Preferred and Series
E Preferred shall receive upon conversion thereof, in addition to the number of
shares of Common Stock (whether Series A Common Stock, Series E Common Stock or
Common Stock) receivable thereupon, the amount of securities of the Corporation
which they would have received had their Series A Preferred, Series B Preferred,
Series C Preferred, Series D Preferred and Series E Preferred been converted
into Common Stock on the date of such event and had then thereafter, during the
period from the date of such event to and including the date of conversion,
retained such securities receivable by them as aforesaid during such period,
subject to all other adjustments called for during such period under this
Section 5.4 with respect to the rights of the holders of the Series A Preferred,
Series B Preferred, Series C Preferred, Series D Preferred and Series E
Preferred.
(iii) ADJUSTMENTS FOR RECLASSIFICATION, EXCHANGE AND SUBSTITUTION.
If the Common Stock (whether Series A Common Stock, Series E Common Stock or
Common Stock) issuable upon conversion of the Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred and Series E Preferred shall
be changed into the same or a different number of shares of any other class or
classes of stock, whether by capital reorganization, reclassification or
otherwise (other than a subdivision or combination of shares provided for
above), the terms of the Series A Preferred, Series B Preferred, Series C
Preferred, Series D Preferred and Series E Preferred shall, concurrently with
the effectiveness of such reorganization or reclassification, be modified such
that the Series A Preferred, Series B Preferred, Series C Preferred, Series D
Preferred and Series E Preferred, as the case may be, shall be convertible into,
in lieu of the number of shares of Common Stock which the holders would
otherwise have been entitled to receive, a number of shares of such other class
or classes of stock equivalent to the number of shares of Common Stock that
would have been subject to receipt by the holders upon conversion of the Series
A Preferred, Series B Preferred, Series C Preferred, Series D Preferred and
Series E Preferred immediately before that change.
(f) NO IMPAIRMENT. Except as provided in Section 5.6, the
Corporation will not, by amendment of its Articles of Incorporation or through
any reorganization, transfer of assets, consolidation, merger, dissolution,
issuance or sale of securities or any other voluntary action, avoid or seek to
avoid the observance or performance of any of the terms to be observed or
performed hereunder by the Corporation but will at all times in good faith
assist in the carrying out of all the provisions of this Section 5.4 and in the
taking of all such actions as may be necessary or appropriate in order to
protect the Conversion Rights of the holders of the Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred and Series E Preferred against
impairment.
(g) CERTIFICATE AS TO ADJUSTMENTS. Upon the occurrence of each
adjustment or readjustment of the Conversion Price for the Series A Preferred,
Series B Preferred, Series C Preferred, Series D Preferred or Series E Preferred
pursuant to this Section 5.4, the Corporation
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<PAGE> 23
at its expense shall promptly compute such adjustment or readjustment in
accordance with the terms hereof and furnish to each holder of Series A
Preferred, Series B Preferred, Series C Preferred, Series D Preferred or Series
E Preferred a certificate setting forth such adjustment or readjustment and
showing in detail the facts upon which such adjustment or readjustment is based.
The Corporation shall, upon the written request at any time of any holder of
Series A Preferred, Series B Preferred, Series C Preferred, Series D Preferred
or Series E Preferred, furnish or cause to be furnished to such holder a like
certificate setting forth (i) such adjustments and readjustments, (ii) the
Conversion Price in effect at the time for such series, and (iii) the number of
shares of Common Stock and the amount, if any, of other property which at the
time would be received upon the conversion of such series of Preferred Stock.
(h) NOTICES OF RECORD DATE. In the event that this Corporation shall
propose at any time:
(i) to declare any dividend or distribution upon its Common
Stock, whether in cash, property, stock or other securities, whether or not a
regular cash dividend and whether or not out of earnings or earned surplus;
(ii) to offer for subscription, pro rata to the holders of any
class or series of its stock, any additional shares of stock of any class or
series or any other similar rights;
(iii) to effect any reclassification or recapitalization of its
Common Stock outstanding which results in a change in the Common Stock; or
(iv) to merge or consolidate with or into any other corporation,
or sell, lease or convey all or substantially all its property or business, or
to liquidate, dissolve or wind up; then, in connection with each such event;
this Corporation shall send to the holders of the Series A Preferred, Series B
Preferred, Series C Preferred, Series D Preferred and Series E Preferred:
(1) at least twenty (20) days prior written notice of (x)
the record date for such dividend, distribution or subscription rights (and
specifying the date on which the holders of Common Stock shall be entitled
thereto) or (y) the record date at which the rights to vote on the matters
referred to in (iii) and (iv) above will be determined; and
(2) in the case of the matters referred to in (iii) and (iv)
above, at least twenty (20) days prior written notice of the date when the same
shall take place and specifying the date on which the holders of Common Stock
shall be entitled to exchange their Common Stock for securities or other
property deliverable upon the occurrence of such event or the record date for
the determination of such holders if such record date is earlier.
Each such written notice shall (x) be delivered personally; (y) given by
certified or registered mail, postage prepaid; or (z) to the extent receipt is
confirmed, by telecopy, telefax or other electronic transmission service;
addressed to the holders of the Series A Preferred, Series B
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<PAGE> 24
Preferred, Series C Preferred, Series D Preferred and Series E Preferred at the
address for each such holder as shown on the books of this Corporation.
(i) ELECTION UPON CONVERSION OF SERIES E PREFERRED STOCK. In the
event that a holder of Series E Preferred elects to convert its shares of Series
E Preferred pursuant to Section 5.4(a) or there occurs an event requiring
automatic conversion of the Series E Preferred pursuant to Section 5.4(b), such
holder may elect to convert all of such shares into Series E Common Stock with
the rights provided in these Articles of Incorporation.
5.5 REDEMPTION.
(a) NO CALL. The Corporation shall not have the right to call for
redemption all or any part of the Series B Preferred, Series C Preferred, Series
D Preferred or Series E Preferred.
(b) OPTION TO REQUIRE REDEMPTION. On or at any time after December
31, 2002, within sixty (60) days after the receipt by the Corporation of the
written request (a "Redemption Notice") by one or more holders of shares of
Series B Preferred, Series C Preferred, Series D Preferred or Series E Preferred
(the "Requesting Holders"), together with the written approval of the holders of
not less than two-thirds of the Series B Preferred then outstanding if any
shares of Series B Preferred are to be redeemed, and with the written approval
of not less than two-thirds of the Series C Preferred then outstanding if any
shares of Series C Preferred are to be redeemed, and with the written approval
of not less than two-thirds of the Series D Preferred then outstanding if any
shares of Series D Preferred are to be redeemed, and with the written approval
of not less than two-thirds of the Series E Preferred then outstanding if any
shares of Series E Preferred are to be redeemed (each series for which such
approval is granted being hereinafter referred to as an "Approved Series"), the
Corporation shall, to the extent it may lawfully do so, redeem the number of
whole shares of each Approved Series most nearly equal to one-third of the
shares specified in the Redemption Notice by paying therefor in cash the Series
B Redemption Price, Series C Redemption Price, Series D Redemption Price, or
Series E Redemption Price (each as defined below), as appropriate. The date of
this payment shall be referred to as an "Initial Redemption Date." The remaining
shares of each Approved Series specified in the Redemption Notice shall be
redeemed in two (2) additional equal installments (or, if such number of shares
is not evenly divisible by two, then the first such installment shall be rounded
to the nearest whole number of shares) on an annual basis in a similar manner,
beginning one (1) year from the Initial Redemption Date, with all remaining
shares of each Approved Series specified in the Redemption Notice being
purchased on the second anniversary of the Initial Redemption Date (the "Initial
Redemption Date" and each of the two following redemption dates shall be
referred to as a "Redemption Date"). The Corporation shall effect any redemption
pursuant to this Section 5.5 on a pro rata basis according to the aggregate
amounts which would be received upon redemption by each Requesting Holder.
(c) REDEMPTION PRICE. The redemption price to be paid by the
Corporation shall be $0.67 per share, in the case of the Series B Preferred (as
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adjusted to reflect subsequent stock dividends, stock splits or
recapitalizations), $1.9634, in the case of the Series C Preferred (as adjusted
to reflect subsequent stock dividends, stock splits or recapitalizations), $7.53
in the case of the Series D Preferred (as adjusted to reflect subsequent stock
dividends, stock splits or recapitalizations) and $8.99, in the case of the
Series E Preferred (as adjusted to reflect subsequent stock dividends, stock
splits or recapitalizations) (in each case, the "Issue Price"), in each case
plus: (i) all declared but unpaid dividends thereon as of the Initial Redemption
Date, and (ii) an amount per share equal to the percentage increase (if any) in
the Implicit Price Deflator for Gross Domestic Product, as published by the
United States Department of Commerce, Economics and Statistics Administration,
Bureau of Economic Analysis, or any successor thereto (1987 = 100), from the
date of the original issuance of the share to the date of the Corporation's
receipt of the Redemption Notice multiplied by the applicable Issue Price (such
totals are referred to as the "Series B Redemption Price," the "Series C
Redemption Price," the "Series D Redemption Price," and the "Series E Redemption
Price," respectively).
(d) NOTICE OF REDEMPTION. Within ten (10) days of the Corporation's
receipt of a Redemption Notice and the related written approval of the holders
of two-thirds of the then outstanding shares of each Approved Series, the
Corporation shall deliver (by (i) personal delivery; (ii) certified or
registered mail, postage prepaid; or (iii) to the extent receipt is confirmed,
by telecopy, telefax or other electronic transmission service) written notice to
each holder of Series B Preferred, Series C Preferred, Series D Preferred or
Series E Preferred who did not approve the Redemption Notice, at the address of
such holder last shown on the records of the Corporation for the purpose of
notice or, if no such address appears or is given, at the place where the
principal executive office of the Corporation is located, identifying each
Requesting Holder and specifying the number of shares to be redeemed by such
holder. If, within ten (10) days of receiving such notice, the holders of Series
B Preferred, Series C Preferred, Series D Preferred or Series E Preferred who
did not approve the Redemption Notice give written notice to the Corporation of
their wish to have any of their shares of Series B Preferred, Series C
Preferred, Series D Preferred or Series E Preferred redeemed simultaneously with
the redemption of the Requesting Holders, such holders shall become Requesting
Holders for purposes of such redemption.
(e) SURRENDER OF CERTIFICATES. On the Initial Redemption Date, each
Requesting Holder shall surrender to the Corporation the certificate or
certificates representing the number of shares of Series B Preferred, Series C
Preferred, Series D Preferred and Series E Preferred specified in the Redemption
Notice or pursuant to Section 5.5(d). Simultaneously, the Corporation shall pay
one-third of the Series B Redemption Price, the Series C Redemption Price, the
Series D Redemption Price or the Series E Redemption Price (as applicable) of
such shares to be redeemed on that date to the order of the person whose name
appears on such certificate or certificates as the owner thereof and each
surrendered certificate shall be canceled. In the event that less than all the
shares represented by any such certificate are to be redeemed pursuant to the
Redemption Notice, a new certificate shall be issued representing the shares not
subject to redemption and delivered to the Requesting Holder. In the event that
less than all the shares represented by any such certificate have been redeemed
on a Redemption Date, a new certificate shall be issued representing the shares
not redeemed and such certificate shall be retained by the Corporation for
cancellation on the next Redemption Date(s).
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<PAGE> 26
(f) STATUS OF SHARES SPECIFIED IN THE REDEMPTION NOTICE. From and
after the Initial Redemption Date, unless there has been a default in payment of
the Series B Redemption Price, the Series C Redemption Price, the Series D
Redemption Price or the Series E Redemption Price, all rights of the Requesting
Holders with respect to the shares of Series B Preferred, Series C Preferred,
Series D Preferred or Series E Preferred specified in the Redemption Notice
(except the right to receive the Series B Redemption Price, the Series C
Redemption Price, the Series D Redemption Price or the Series E Redemption
Price) shall cease with respect to such shares, and such shares shall not
thereafter be transferred on the books of the Corporation or be deemed to be
outstanding for any purpose whatsoever. If the funds of the Corporation legally
available for redemption of such shares on any Redemption Date are insufficient
to redeem the total number of shares of Series B Preferred, Series C Preferred,
Series D Preferred or Series E Preferred to be redeemed on such date, those
funds which are legally available shall be used to redeem the maximum possible
number of such shares, and the shares of Series B Preferred, Series C Preferred,
Series D Preferred and Series E Preferred not redeemed shall be deemed to be
outstanding and shall be entitled to all the rights and preferences provided
herein. At any time thereafter when additional funds of the Corporation are
legally available for the redemption of such shares, such funds will immediately
be used to redeem the balance of the shares that the Corporation has become
obligated to redeem on any Redemption Date but that it has not redeemed.
(g) PARTIAL REVOCATION OF REDEMPTION NOTICE. Notwithstanding any
provision in this Section 5.5 to the contrary, if, after the Initial Redemption
Date, while a Requesting Holder has not yet received in full the Series B
Redemption Price, the Series C Redemption Price, the Series D Redemption Price
or the Series E Redemption Price, as applicable, for all shares specified in
his/her/its Redemption Notice (the shares for which the applicable redemption
price has not been received shall be referred to as the "Shares Being
Redeemed"), the Corporation enters into any transaction described in Section
5.2(d) in which the Requesting Holder would have received an amount per share,
in cash or securities of another corporation or corporations, greater than the
Series B Redemption Price, the Series C Redemption Price, the Series D
Redemption Price or the Series E Redemption Price, as applicable, for the Shares
Being Redeemed had the shares not been the subject of the Redemption Notice, the
Corporation shall notify the Requesting Holder in writing of such transaction,
in accordance with Section 5.4(h), as if his/her/its rights with respect to the
Shares Being Redeemed had not terminated in accordance with Section 5.5, and if,
within seven (7) days of receipt of such notice, the Requesting Holder delivers
written notice to the Corporation of his/her/its election to convert the Shares
Being Redeemed into Common Stock, such shares shall be converted to Common Stock
in accordance with Section 5.4 and simultaneously the Requesting Holder's right
to receive the applicable redemption price for the Shares Being Redeemed shall
terminate.
5.6 COVENANTS.
(a) SERIES A PREFERRED, SERIES B PREFERRED, SERIES C PREFERRED AND
SERIES D PREFERRED. In addition to any other rights provided by law, this
Corporation shall not, without first obtaining the affirmative vote or written
consent of the holders of not less than a majority of
26
<PAGE> 27
the outstanding shares of Series A Preferred, Series B Preferred, Series C
Preferred and Series D Preferred, voting as a single voting group:
(i) amend or repeal any provision of, or add any provision to, the
Corporation's Articles of Incorporation if such action would alter or change the
preferences, rights, or privileges of the Series A Preferred, Series B
Preferred, Series C Preferred or Series D Preferred;
(ii) increase or decrease the authorized number of shares of
Series A Preferred, Series B Preferred, Series C Preferred, Series D Preferred
or Common Stock;
(iii) authorize, create or issue any shares of (A) Preferred Stock
or securities convertible into Common Stock equal or senior to the Series A
Preferred, Series B Preferred, Series C Preferred or Series D Preferred as to
dividends, conversion rights, redemption rights or liquidation preference or (B)
Common Stock equal or senior to the Series D Preferred as to redemption rights
or liquidation preference or senior to the Series D Preferred as to dividends or
voting rights (other than shares issuable upon exercise of the Series C
Preferred Stock Warrants issued pursuant to the Series C Preferred Stock
Purchase Agreement dated October 25, 1995 or the Series D Preferred Stock
Purchase Warrants issued pursuant to the Series D Preferred Stock Purchase
Agreement dated November 19, 1996);
(iv) merge or consolidate with one or more other corporations if,
after such merger or consolidation, the stockholders of the Corporation would
hold stock representing less than a majority of the voting power of the
outstanding stock of the surviving corporation; or
(v) declare or pay any dividend on the Common Stock.
(b) SERIES D PREFERRED. In addition to any other rights provided by
law, this Corporation shall not, without first obtaining the affirmative vote or
written consent of the holders of not less than Sixty-Six and Two-Thirds Percent
(66_%) of the outstanding shares of Series D Preferred:
(i) amend or repeal any provision of, or add any provision to, the
Corporation's Articles of Incorporation if such action would adversely alter or
change the preferences, rights, or privileges of the Series D Preferred;
(ii) increase the authorized number of shares of Series D
Preferred;
(iii) authorize, create or issue any shares of (A) Preferred Stock
or securities convertible into Common Stock equal or senior to the Series D
Preferred as to dividends, conversion rights, redemption rights or liquidation
preference or (B) Common Stock equal or senior to the Series D Preferred as to
redemption rights or liquidation preference or senior to the Series D Preferred
as to dividends or voting rights (other than shares issuable upon exercise of
the Series C Preferred Stock Warrants issued pursuant to the Series C Preferred
Stock Purchase
27
<PAGE> 28
Agreement dated October 25, 1995 or the Series D Preferred Stock
Purchase Warrants issued pursuant to the Series D Preferred Stock Purchase
Agreement dated November 19, 1996); or
(iv) declare or pay any dividend.
28
<PAGE> 29
ARTICLE VI
DIRECTORS
6.1 NUMBER OF DIRECTORS.
6.1.1 The number of directors of the Corporation shall be fixed as
provided in the Bylaws and may be changed from time to time by amending the
Bylaws.
6.1.2 When the Board of Directors shall consist of four or more
members, the directors shall be divided into three classes: Class 1, Class 2 and
Class 3. Such classes shall be as nearly equal in number of directors as
possible. Except as provided in Section 6.1.4, each director shall serve for a
term ending at the third annual meeting of shareholders following the director's
election; provided, that the director or directors first elected to Class 1
shall serve for a term ending at the first annual meeting of shareholders
following such election, the director or directors first elected to Class 2
shall serve for a term ending at the second annual meeting of shareholders
following such election, and the director or directors first elected to Class 3
shall serve for a term ending at the third annual meeting of shareholders
following such election.
6.1.3 At each annual meeting of shareholders, the directors nominated
to succeed those whose terms then expire shall be identified as being of the
same class as the directors they succeed unless, by reason of any intervening
changes in the authorized number of directors, the Board of Directors shall
designate one or more directorships whose terms then expire as directorships of
another class in order more nearly to achieve equality in the number of
directors in the respective classes. When the Board of Directors fills a vacancy
resulting from the death, resignation or removal of a director, the director
chosen to fill that vacancy shall be of the same class as the director he
succeeds.
6.1.4 Notwithstanding the foregoing provisions of this Section 6.1, in
all cases, including upon any change in the authorized number of directors, each
director then continuing to serve as such will nevertheless continue as a
director of the class of which he is a member until the expiration of his or her
term or his or her earlier death, resignation or removal. Any vacancy in any
class resulting from the death, resignation or removal of a director or an
increase in the number of authorized directors may be filled by the directors in
any manner permitted by the Act; provided, if the term of the director or
directors in that class is not scheduled to expire at the next annual meeting of
shareholders, the term of the director chosen to fill such vacancy shall
continue only until the next annual meeting of shareholders at which a successor
shall be chosen for a term to expire at the scheduled date for expiration of the
term of the director or directors in that class.
6.1.5 If a Qualified Public Offering does not occur on or prior to
January 31, 1998, then the provisions of Sections 6.1.2 through 6.1.4 shall
automatically cease to apply, and each director then in office shall continue in
office, without class designation, until the next annual meeting of shareholders
or until his or her earlier death, resignation or removal.
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<PAGE> 30
6.2 REMOVAL.
6.2.1 Any director or the entire Board of Directors may be removed with
or without cause by the holders of not less than a majority of the shares then
entitled to vote at an election of directors; provided, that, following a
Qualified Public Offering, no director may be removed without "cause," as
defined below. Action to remove a director may be taken at any annual or special
meeting of the shareholders of this Corporation, provided that notice of the
proposed removal, which shall include a statement of the charges alleged against
the director in the event of removal for cause, shall have been duly given to
the shareholders together with or as a part of the notice of the meeting.
6.2.2 Where a proposal to remove a director for cause is to be
presented for shareholder consideration following a Qualified Public Offering,
an opportunity shall be provided the director to present the director's defense
to the shareholders in a statement to accompany or precede the notice of the
meeting at which such proposal is to be presented. The director shall also be
served with notice of the meeting at which such proposal is to be presented,
together with a statement of the specific charges alleged against the director,
and shall be given an opportunity to be present and to be heard at the meeting.
6.2.3 For purposes of this Section 6.2, "cause" for removal shall be
limited to (a) action by a director involving willful malfeasance having a
material adverse effect on the Corporation and (b) conviction of a director of a
felony; provided, that action by a director shall not constitute "cause" if, in
good faith, the director believed such action to be in or not opposed to the
best interests of the Corporation, or if the director is entitled, under
applicable law or the Articles of Incorporation or Bylaws of this Corporation,
to be indemnified with respect to such action.
6.3 AUTHORITY OF BOARD OF DIRECTORS TO AMEND BYLAWS. Subject to the
limitation(s) of RCW 23B.10.210, and subject to the power of the shareholders of
the Corporation to change or repeal the Bylaws, the Board of Directors is
expressly authorized to make, amend, or repeal the Bylaws of the Corporation
unless the shareholders in amending or repealing a particular bylaw provide
expressly that the Board of Directors may not amend or repeal that bylaw.
6.4 CONTRACTS WITH INTERESTED DIRECTORS. Subject to the limitations set
forth in RCW 23B.08.700 through 23B.08.730:
6.4.1 The Corporation may enter into contracts and otherwise transact
business as vendor, purchaser, lender, borrower, or otherwise with its directors
and with corporations, associations, firms, and entities in which they are or
may be or become interested as directors, officers, shareholders, members, or
otherwise.
6.4.2 Any such contract or transaction shall not be affected or
invalidated or give rise to liability by reason of the director's having an
interest in the contract or transaction.
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<PAGE> 31
6.5 INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS.
6.5.1 The capitalized terms in this Section 6.5 shall have the meanings
set forth in RCW 23B.08.500.
6.5.2 The Corporation shall indemnify and hold harmless each individual
who is or was serving as a Director or officer of the Corporation or who, while
serving as a Director or officer of the Corporation, is or was serving at the
request of the Corporation as a director, officer, partner, trustee, employee,
or agent of another foreign or domestic corporation, partnership, joint venture,
trust, employee benefit plan, or other enterprise, against any and all Liability
incurred with respect to any Proceeding to which the individual is or is
threatened to be made a Party because of such service, and shall make advances
of reasonable Expenses with respect to such Proceeding, to the fullest extent
permitted by law, without regard to the limitations in RCW 23B.08.510 through
23B.08.550; provided that no such indemnity shall indemnify any Director or
officer from or on account of (1) acts or omissions of the Director or officer
finally adjudged to be intentional misconduct or a knowing violation of law; (2)
conduct of the Director or officer finally adjudged to be in violation of RCW
23B.08.310; or (3) any transaction with respect to which it was finally adjudged
that such Director or officer personally received a benefit in money, property,
or services to which the Director or officer was not legally entitled.
6.5.3 The Corporation may purchase and maintain insurance on behalf of
an individual who is or was a Director, officer, employee, or agent of the
Corporation or, who, while a Director, officer, employee, or agent of the
Corporation, is or was serving at the request of the Corporation as a director,
officer, partner, trustee, employee, or agent of another foreign or domestic
corporation, partnership, joint venture, trust, employee benefit plan, or other
enterprise against Liability asserted against or incurred by the individual in
that capacity or arising from the individual's status as a Director, officer,
employee, or agent, whether or not the Corporation would have power to indemnify
the individual against such Liability under RCW 23B.08.510 or 23B.08.520.
6.5.4 If, after the effective date of this Section 6.5, the Act is
amended to authorize further indemnification of Directors or officers, then
Directors and officers of the Corporation shall be indemnified to the fullest
extent permitted by the Act as so amended.
6.5.5 To the extent permitted by law, the rights to indemnification and
advance of reasonable Expenses conferred in this Section 6.5 shall not be
exclusive of any other right which any individual may have or hereafter acquire
under any statute, provision of the Bylaws, agreement, vote of shareholders or
disinterested Directors, or otherwise. The right to indemnification conferred in
this Section 6.5 shall be a contract right upon which each Director or officer
shall be presumed to have relied in determining to serve or to continue to serve
as such. Any amendment to or repeal of this Section 6.5 shall not adversely
affect any right or protection of a Director or officer of the Corporation for
or with respect to any acts or omissions of such Director or officer occurring
prior to such amendment or repeal.
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<PAGE> 32
6.5.6 If any provision of this Section 6.5 or any application thereof
shall be invalid, unenforceable, or contrary to applicable law, the remainder of
this Section 6.5, and the application of such provisions to individuals or
circumstances other than those as to which it is held invalid, unenforceable, or
contrary to applicable law, shall not be affected thereby.
6.6 LIMITATION OF DIRECTORS' LIABILITY. To the fullest extent permitted
by the Act, as it exists on the date hereof or may hereafter be amended, a
director of this Corporation shall not be personally liable to the Corporation
or its shareholders for monetary damages for conduct as a director. Any
amendment to or repeal of this Section 6.6 shall not adversely affect a director
of this Corporation with respect to any conduct of such director occurring prior
to such amendment or repeal.
ARTICLE VII
OTHER MATTERS
7.1 CERTAIN CORPORATE GOVERNANCE MATTERS. At all times following the
closing of a Qualified Public Offering, the following provisions will apply:
7.1.1 STRATEGIC TRANSACTIONS COMMITTEE.
(a) MEMBERS. There shall be a Strategic Transactions Committee (the
"Committee") of the Board of Directors which shall consist of three (3)
directors. The members of the initial Committee shall be Robert Glaser, the
Corporation's Founder, James Breyer and Mitchell Kapor. A member of the
Committee shall automatically cease to be a member of the Committee upon the
earlier of: (i) his or her death, resignation or removal as a director, or (ii)
at the option of the Chairman of the Committee, his or her ceasing to hold or
control, directly or indirectly, at least five percent (5%) of the outstanding
shares of capital stock of the Corporation. Neither the Board of Directors nor
the shareholders shall have any authority to remove any member of the Committee
or to otherwise reconstitute the Committee or its membership.
(b) CHAIRMAN OF COMMITTEE. Mr. Glaser shall serve as Chairman of the
Committee as long as he is a member of the Committee. At such time as Mr. Glaser
is no longer a member of the Committee, the Committee shall select one of its
members as Chairman.
(c) POWER OF COMMITTEE. Without the prior approval of the Committee,
the Board of Directors of the Corporation shall not have the power and authority
to: (i) adopt a plan of merger, (ii) authorize the sale, lease, exchange or
mortgage of (A) assets representing more than fifty percent (50%) of the book
value of the Corporation's assets prior to the transaction, or (B) any other
asset or assets on which the long-term business strategy of the Corporation is
substantially dependent, (iii) authorize the voluntary dissolution of the
Corporation, or (iv) take any action that has the effect of clauses (i) through
(iii) of this Section 7.1.1(c).
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(d) MEETINGS AND NOTICE. The Committee shall meet from time to time
on the call of its Chairman or of the other two members. Each meeting of the
Committee shall be held at the date, time and place as may be designated in the
notice of the meeting given by the person or persons authorized to call the
meeting. Notice of the date, time and place of each meeting of the Committee
shall be given to each member of the Committee in any manner permitted by the
Act not less than one (1) day prior to the meeting; such notice need not state
the purpose or purposes of the meeting. The Committee shall keep regular minutes
of its meetings and proceedings.
(E) QUORUM. At any meeting of the Committee, presence of the
Chairman and at least one other member thereof shall constitute a quorum. The
act of at least two (2) members of the Committee at a meeting at which a quorum
is present shall be the act of the Committee. All action of the Committee shall
be taken at a meeting of the Committee or as otherwise provided or allowed by
law.
(F) VACANCIES. Any vacancy on the Committee shall be filled by the
remaining member or members of the Committee, regardless of whether or not a
quorum. If two members of the Committee remain and they are unable to agree on
an individual to fill the vacancy, the vacancy may be filled by the member who
holds or controls, directly or indirectly, the larger percentage of the
outstanding shares of capital stock of the Corporation.
(G) TERMINATION OF COMMITTEE. 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 ten percent (10%) of the outstanding
shares of capital stock of the Corporation. The Board of Directors shall have
and succeed to any and all power and authority of the Committee that have been
limited or eliminated as a result of actions taken pursuant to this Section
7.1.1(g).
7.1.2 POLICY OMBUDSMAN. Mr. Glaser shall serve, or shall appoint
another officer of the Corporation who shall serve, as the Corporation's Policy
Ombudsman. The Policy Ombudsman shall have exclusive responsibility for adopting
or changing the editorial policies of the Corporation as reflected on the
Corporation's Web sites or in other communications or media where the
Corporation has a significant editorial or media voice. The Policy Ombudsman may
be removed only by the unanimous approval of all members of the Board of
Directors. Upon the death, resignation or removal of Mr. Glaser as the Policy
Ombudsman, the Chief Executive Officer or another officer of the Corporation
appointed by the Chief Executive Officer, shall serve as his or her successor.
7.1.3 AUTHORITY FOR SECTION 7.1. The provisions of this Section 7.1 are
intended to modify the authority of the Board of Directors in a manner permitted
by RCW 23B.08.010(3) and shall be construed consistent with that provision of
the Act. Except as otherwise provided in these Articles of Incorporation, as
amended from time to time, the Committee shall have all of the powers and
authority of a committee of the Board of Directors created pursuant to RCW
23B.08.250.
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7.1.4 AMENDMENT OF SECTION 7.1. Notwithstanding any provision of these
Articles of Incorporation or the Corporation's Bylaws, as either may be amended
from time to time by the Board of Directors or the shareholders of the
Corporation, this Section 7.1 cannot be amended without the approval of the
holders of ninety percent (90%) of the shares entitled to be voted on such
proposed amendment(s).
7.2 AMENDMENTS TO ARTICLES OF INCORPORATION. Except as otherwise
provided in these Articles of Incorporation, as amended from time to time, the
Corporation reserves the right to amend, alter, change, or repeal any provisions
contained in these Articles of Incorporation in any manner now or hereafter
prescribed or permitted by statute. All rights of shareholders of the
Corporation are subject to this reservation. A shareholder of the Corporation
does not have a vested property right resulting from any provision of these
Articles of Incorporation.
7.3 CORRECTION OF CLERICAL ERRORS. The Corporation shall have authority
to correct clerical errors in any documents filed with the Secretary of State of
Washington, including these Articles of Incorporation or any amendments hereto,
without the necessity of special shareholder approval of such corrections.
Executed this ___ day of October, 1997.
--------------------------------------------
Mark Klebanoff, Chief Financial Officer
34
<PAGE> 1
EXHIBIT 4.1
<TABLE>
<CAPTION>
<S> <C>
- -----------------------------------------------------------------------------------------------------------------------------------
[NUMBER] [RealNetworks Logo] [SHARES]
RN
INCORPORATED UNDER THE LAWS OF SEE REVERSE FOR
THE STATE OF WASHINGTON CERTAIN DEFINITIONS
CUSIP 75605L 10 4
THIS IS TO CERTIFY THAT
IS THE OWNER OF
FULLY-PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK, $.001 PAR VALUE, OF
________________________________________________________ RealNetworks, Inc. _______________________________________________________
(hereinafter called the "Corporation") transferable on the books of the Corporation by said owner person or by duly authorized
attorney, upon surrender of this certificate properly endorsed. This certificate and the shares represented hereby are issued and
shall be held subject to all the provisions of the Articles of Incorporation and all amendments thereto, and the Bylaws of the
Corporation, as amended, copies of which are on file at the office of the Transfer Agent, and the holder hereof, by acceptance of
this certificate, consents and agrees to be bound by all of said provisions. This certificate is not valid unless countersigned and
registered by the Transfer Agent and Registrar.
WITNESS the facsimile seal of the Corporation and the signatures of its duly authorized officers.
Dated: [ S E A L ]
/s/ ROBERT GLASER /s/ BRUCE JACOBSEN
CHAIRMAN OF THE BOARD, PRESIDENT AND
CHIEF EXECUTIVE OFFICER AND SECRETARY CHIEF OPERATING OFFICER
COUNTERSIGNED AND REGISTERED:
CHASEMELLON SHAREHOLDER SERVICES, L.L.C.
TRANSFER AGENT AND REGISTRAR
BY
AUTHORIZED SIGNATURE
</TABLE>
<PAGE> 2
The Corporation will furnish without charge to any shareholder upon
written request a statement of the designations, relative rights, preferences,
and limitations applicable to each class of stock which the Corporation is
authorized to issue, the variations in the rights, preferences, and limitations
of the shares of each series of each such class of stock insofar as the same
may have been fixed and determined, and the authority of the Board of Directors
to determine variations for future series.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations:
<TABLE>
<CAPTION>
<S> <C>
TEN COM -- as tenants in common UNIF GIFT MIN ACT -- ............ Custodian ...............
TEN ENT -- as tenants by the entireties (Cust) (Minor)
JT TEN -- as joint tenants with right of
survivorship and not as tenants under Uniform Gifts to Minors
in common Act ..................................
(State)
</TABLE>
Additional abbreviations may also be used though not in the above list.
FOR VALUE RECEIVED,___________________________hereby sell, assign and
transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------
- --------------------------------------
_______________________________________________________________________________
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
_______________________________________________________________________________
_______________________________________________________________________________
________________________________________________________________________ Shares
of the capital stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
______________________________________________________________________ Attorney
to transfer the said stock on the books of the within named Corporation
with full power of substitution in the premises.
Dated________________________
_______________________________________________
_______________________________________________
THE SIGNATURE(S) TO THIS ASSIGNMENT MUST
CORRESPOND WITH THE NAME(S) AS WRITTEN UPON THE
NOTICE: FACE OF THE CERTIFICATE IN EVERY PARTICULAR,
WITHOUT ALTERATION OR ENLARGEMENT OR ANY
CHANGE WHATEVER.
SIGNATURE(S) GUARANTEED
By___________________________________
THE SIGNATURE(S) MUST BE GUARANTEED
BY AN ELIGIBLE GUARANTOR INSTITUTION
(BANKS, STOCKBROKERS, SAVINGS AND
LOAN ASSOCIATIONS AND CREDIT UNIONS
WITH MEMBERSHIP IN AN APPROVED
SIGNATURE GUARANTEE MEDALLION PROGRAM),
PURSUANT TO S.E.C. RULE 17Ad-15.
<PAGE> 1
EXHIBIT 5.1
[GRAHAM & JAMES LLP/RIDDELL WILLIAMS P.S. LETTERHEAD]
October 30, 1997
RealNetworks, Inc.
1111 Third Avenue, Suite 2900
Seattle, WA 98101
RE: 3,450,000 SHARES OF COMMON STOCK OF REALNETWORKS, INC.
Ladies and Gentlemen:
We have acted as counsel for RealNetworks, Inc. (the "Company"), a Washington
corporation, in connection with (i) the authorization and issuance of 3,000,000
shares of common stock of the Company, $.001 par value per share (the "Issuer
Shares"), (ii) the sale of up to an additional 450,000 shares of common stock of
the Company by the Company pursuant to an over-allotment option granted to the
underwriters (the "Option Shares"), and (iii) the preparation of a Registration
Statement on Form S-1 (the "Registration Statement") under the Securities Act of
1933, as amended. We have examined the Registration Statement and such other
documents as we deem necessary for the purpose of this opinion.
Based on the foregoing, we are of the opinion that:
1. The Issuer Shares will, upon due execution by the Company and the
registration by its registrar of the certificates for such shares and
issuance thereof by the Company and receipt by the Company of the
consideration from the sale of such shares as contemplated by the
Registration Statement, be duly authorized, validly issued, fully paid
and non-assessable.
2. The Option Shares will, upon due execution by the Company and the
registration by its registrar of the certificates for such shares and
issuance thereof by the Company and receipt by the Company of the
consideration from the sale of such shares as contemplated by the
Registration Statement, be duly authorized, validly issued, fully paid
and non-assessable.
<PAGE> 2
RealNetworks, Inc.
October 30, 1997
Page 2
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the reference to our firm in the Registration
Statement under the caption "Legal Matters."
Very truly yours,
GRAHAM & JAMES LLP/RIDDELL WILLIAMS P.S.
<PAGE> 1
EXHIBIT 10.20
REALNETWORKS, INC.
AGREEMENT TO TERMINATE SHAREHOLDERS' BUY-SELL AGREEMENT
THIS AGREEMENT TO TERMINATE SHAREHOLDERS' BUY-SELL AGREEMENT (the
"Termination Agreement") is entered into as of October ___, 1997, by and among
RealNetworks, Inc., a Washington corporation formerly known as Progressive
Networks, Inc. (the "Company"), Robert Glaser (the "Founder"), and the holders
of shares of common stock (the "Shares") of the Company who have agreed in
writing to be bound by the Shareholders' Buy-Sell Agreement dated as of March
31, 1995 (the Founder and the holders of the Shares are collectively referred to
herein as the "Shareholders").
RECITALS
A. The Company, the Founder and the holders of the Shares have entered
into a Shareholders' Buy-Sell Agreement dated as of March 31, 1995 (the
"Buy-Sell Agreement"), which Buy-Sell Agreement restricts the free
transferability of the Shares.
B. The Company has filed a Registration Statement on Form S-1 with the
Securities and Exchange Commission.
C. The Buy Sell Agreement may be terminated upon the written agreement
of the Company and the Shareholders holding two-thirds (2/3) of the outstanding
Shares of Capital Stock (as defined in Section 3.3.4 of the Buy-Sell Agreement).
D. The Company and the Shareholders holding at least two-thirds (2/3) of
the outstanding Shares of Capital Stock desire to terminate the Agreement
immediately prior to the Registration Statement being declared effective by the
SEC.
AGREEMENT
1. TERMINATION OF BUY-SELL AGREEMENT. Effective immediately prior to the
effectiveness of a firm commitment underwritten public offering pursuant to an
effective registration statement under the Securities Act of 1933, as amended,
covering the offer and sale of the Company's capital stock for the account of
the Company to the public with aggregate proceeds to the Company of not less
than $20,000,000 (prior to deduction of underwriter commissions and offering
expenses), the Buy-Sell Agreement shall be terminated in its entirety.
2. NOTICE. Within fifteen (15) days after the termination of the
Buy-Sell Agreement, the Company shall give written notice of such termination to
each of the Shareholders by delivering such notice in person, or by depositing
such notice in the United States mail, first
<PAGE> 2
class, postage prepaid, addressed to each Shareholder at the last address
provided to the Company by each such Shareholder.
IN WITNESS WHEREOF, the parties have executed this Agreement effective
as of the date first written above.
COMPANY:
REALNETWORKS, INC.
By________________________________________
Its_______________________________________
FOUNDER:
__________________________________________
Robert Glaser
<PAGE> 1
EXHIBIT 10.21
LICENSE AGREEMENT FOR THE REALPLAYER PLUS
IMPORTANT -- READ CAREFULLY: By clicking on the "I Accept" button or by opening
the sealed packet(s) to make and utilize copies of the RealPlayer Plus and
accompanying software ("Software") Licensee agrees to be and is hereby bound by
the terms of this License Agreement ("License Agreement"). If Licensee does not
agree to the terms of this License Agreement, Licensee must promptly destroy all
copies of the Software and accompanying documentation ("Documentation") and
obtain a full refund of any fees paid from RealNetworks Inc.
I. GRANT OF LICENSE:
RealNetworks Inc. and it's suppliers and licensors (collectively "RN") hereby
grants to Licensee a non-exclusive license to use the Software and Documentation
subject to the following terms:
Licensee may: (i) use the Software on any single computer; (ii) use the Software
on a second computer so long as the first and second computers are not used
simultaneously; (iii) copy the Software for back-up, archival purposes provided
any copy must contain all of the original Software's proprietary notices.
Licensee may not: (i) permit other individuals to use the Software except under
the terms listed above; (ii) modify, translate, reverse engineer, decompile,
disassemble (except to the extent that this restriction is expressly prohibited
by law) or create derivative works based upon the Software or Documentation;
(iii) copy the Software or Documentation (except for back-up purposes); (iv)
rent, lease, transfer, or otherwise transfer rights to the Software or
Documentation; or (v) remove any proprietary notices or labels on the Software
or Documentation.
II. SOFTWARE:
If Licensee receives the first copy of the Software electronically and a second
copy on media the second copy may be used for archival purposes only and may not
be transferred to or used by any other person. This license does not grant
Licensee any right to any enhancement or update.
III. TITLE:
Title, ownership, rights, and intellectual property rights in and to the
Software and Documentation shall remain in RN and/or its suppliers. The Software
is protected by the copyright laws of the United States and international
copyright treaties. Title, ownership rights and intellectual property rights in
and to the content accessed through the Software including the content contained
in the Software media demonstration files shall be retained by the applicable
content owner and may be protected by applicable copyright or other law. This
license gives Licensee no rights to such content.
IV. LIMITED WARRANTY:
RN warrants that for a period of ninety (90) days from the date of acquisition
the Software if operated as directed will substantially achieve the
functionality described in the Documentation. RN does not warrant however that
Licensee's use of the Software will be uninterrupted or that the operation of
the Software will be error-free or secure. RN also warrants that the media
containing the Software if provided by RN is free from defects in material and
workmanship and will so remain for ninety (90) days from the date Licensee
acquires the Software.
NO OTHER WARRANTIES: TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW RN AND
ITS SUPPLIERS DISCLAIM ALL OTHER WARRANTIES EITHER EXPRESS OR IMPLIED INCLUDING
BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTIBILITY AND FITNESS FOR A
PARTICULAR PURPOSE WITH REGARD TO THE SOFTWARE THE ACCOMPANYING WRITTEN
MATERIALS AND ANY ACCOMPANYING HARDWARE. If any modifications are made to the
Software by Licensee during the warranty period; if the media is subjected to
accident abuse or improper use; or if Licensee violates the terms of this
License Agreement, this warranty shall immediately terminate. This warranty
shall not apply if the Software is used on or in conjunction with hardware or
software other than the unmodified version of hardware and software with which
the Software was designed to be used as described in the Documentation. THIS
LIMITED WARRANTY GIVES LICENSEE SPECIFIC LEGAL RIGHTS. LICENSEE MAY HAVE OTHERS
WHICH VARY FROM STATE/JURISDICTION TO STATE/JURISDICTION.
V. CUSTOMER REMEDIES:
RN's sole liability for any breach of this warranty shall be in RN's sole
discretion: (i) to replace Licensee's defective media; or (ii) to advise
Licensee how to achieve substantially the same functionality with the Software
as described in the Documentation through a procedure different from that set
forth in the Documentation; or (iii) if the above remedies are impracticable, to
refund the license fee, if any, Licensee paid for the Software.
RealPlayer Plus 5.0 License Pub. Date (10-6-97)
<PAGE> 2
Repaired, corrected or replaced Software and Documentation shall be covered by
this limited warranty for the period remaining under the warranty that covered
the original Software or if longer for thirty (30) days after the date RN either
shipped to Licensee the repaired or replaced Software or advised Licensee as to
how to operate the Software so as to achieve the functionality described in the
Documentation, whichever is applicable. Only if Licensee informs RN of the
problem with the Software during the applicable warranty period and provides
evidence of the date Licensee acquired the Software will RN be obligated to
honor this warranty.
VI. LIMITATION OF LIABILITY:
UNDER NO CIRCUMSTANCES AND UNDER NO LEGAL THEORY WHETHER IN TORT CONTRACT OR
OTHERWISE SHALL RN OR ITS SUPPLIERS OR RESELLERS BE LIABLE TO LICENSEE OR ANY
OTHER PERSON FOR ANY INDIRECT, SPECIAL, INCIDENTAL OR CONSEQUENTIAL DAMAGES OF
ANY CHARACTER INCLUDING WITHOUT LIMITATION DAMAGES FOR LOSS OF GOODWILL, WORK
STOPPAGE, COMPUTER FAILURE OR MALFUNCTION OR ANY AND ALL OTHER COMMERCIAL
DAMAGES OR LOSSES EVEN IF RN SHALL HAVE BEEN INFORMED OF THE POSSIBILITY OF SUCH
DAMAGES OR FOR ANY CLAIM BY ANY OTHER PARTY. FURTHER, IN NO EVENT SHALL RN'S
LIABILITY UNDER ANY PROVISION OF THIS AGREEMENT EXCEED THE LICENSE FEE PAID TO
RN FOR THE SOFTWARE AND DOCUMENTATION. BECAUSE SOME STATES/JURISDICTIONS DO NOT
ALLOW THE EXCLUSION OR LIMITATION OF LIABILITY FOR CONSEQUENTIAL OR INCIDENTAL
DAMAGES, THE ABOVE LIMITATION MAY NOT APPLY TO LICENSEE.
VII. INDEMNIFICATION
Licensee represents and warrants that it will utilize the "Selective Record"
feature only for data or content for which Licensee has obtained all necessary
clearances and permissions, or for which the owner of such data or content has
expressly granted permission to record in writing adjacent to such data or
content on the owner's website. Licensee assumes the entire risk resulting from
its breach of this warranty and agrees to hold harmless, indemnify, and defend
RN its officers, directors, and employees from and against any losses, damages,
fines and expenses (including attorneys' fees and costs) arising out of or
relating to any claims that the Licensee has recorded and/or transmitted
materials in violation of another party's rights.
VIII. TERMINATION:
This License Agreement shall terminate automatically if Licensee fails to comply
with the limitations described in this license. No notice shall be required from
RN to effectuate such termination. On termination Licensee must destroy all
copies of the Software and Documentation.
IX. U.S. GOVERNMENT RESTRICTED RIGHTS AND EXPORT RESTRICTIONS:
The Software is provided with RESTRICTED RIGHTS. Use, duplication, or disclosure
by the Government is subject to restrictions as set forth in subparagraph
(c)(1)(ii) of The Rights in Technical Data and Computer Software clause of DFARS
252.227-7013 or subparagraphs (c)(i) and (2) of the Commercial Computer
Software-Restricted Rights at 48 CFR 52.227-19, as applicable. Manufacturer is
RealNetworks, 1111 Third Avenue, Suite 2900, Seattle, Washington 98101. Licensee
acknowledges that none of the Software or underlying information or technology
may be downloaded or otherwise exported or re-exported into (or to a national or
resident of) Angola, Cuba, Iran, Iraq, Libya,North Korea, Sudan, Syria, or any
other country to which the U.S. has embargoed goods; or anyone on the U.S.
Treasury Department's list of Specially Designated Nationals or the U.S.
Commerce Department's Table of Denial Orders. By using the Software, Licensee is
agreeing to the foregoing, and is representing and warranting that it is not
located in or under the control of a national or resident of any such country or
on any such list.
X. GOVERNING LAW:
This License Agreement shall be governed by the laws of the State of Washington,
without regard to conflicts of law provisions, and Recipient consents to the
exclusive jurisdiction of the state and federal courts sitting in the State of
Washington. Any and all unresolved disputes arising under this License Agreement
shall be submitted to arbitration in the State of Washington. The arbitration
shall be conducted under the rules then prevailing of the American Arbitration
Association. The award of the arbitrator shall be binding and may be entered as
a judgment in any court of competent jurisdiction. This License Agreement will
not be governed by the United Nations Convention of Contracts for the
International Sale of Goods, the application of which is hereby expressly
excluded.
XI. ENTIRE AGREEMENT:
This License Agreement constitutes the complete and exclusive agreement between
RN and Licensee with respect to the subject matter hereof and supersedes all
prior oral or written understandings, communications or agreements not
specifically incorporated herein. This License Agreement may not be modified
except in a writing duly signed by an authorized representative of RN and
Licensee. THE ACCEPTANCE OF ANY PURCHASE ORDER PLACED BY LICENSEE IS EXPRESSLY
MADE CONDITIONAL ON THE CONSENT OFLICENSEE TO THE TERMS SET FORTH HEREIN.
RealPlayer Plus 5.0 License Pub. Date (10-6-97)
<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, except as to
Note 9, which is as of October 30, 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 31, 1997
