<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-23137
REALNETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 91-1628146
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
1111 THIRD AVENUE, SUITE 2900 98101
SEATTLE, WASHINGTON (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(206) 674-2700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's Common Stock outstanding as of
July 31, 1998 was 29,432,018. In addition, there were 3,338,374 outstanding
shares of the registrant's Special Common Stock, par value $0.001 per share,
that automatically convert on a one-for-one basis into Common Stock on a bona
fide sale to a purchaser who is not an affiliate of the holder.
<PAGE> 2
REALNETWORKS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements..................................................4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................17
Item 2. Changes in Securities and Use of Proceeds............................17
Item 4. Submission of Matters to a Vote of Security Holders..................18
Item 6. Exhibits and Reports on Form 8-K.....................................18
</TABLE>
3
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
December 31, June 30,
1997 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments........................ $ 92,028 $ 98,033
Trade accounts receivable, net of allowance for doubtful
accounts and sales returns........................................... 5,073 5,345
Other receivables........................................................ 10,706 227
Prepaid expenses and other current assets................................ 2,052 2,847
------------ ------------
Total current assets................................................. 109,859 106,452
Property and equipment, net................................................... 5,143 5,348
Investment in joint venture................................................... 816 599
Other assets, net............................................................. 886 2,204
------------ ------------
Total assets......................................................... $ 116,704 $ 114,603
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................................... $ 2,136 $ 2,881
Accrued compensation..................................................... 974 1,266
Other accrued expenses................................................... 2,679 5,843
Deferred revenue......................................................... 16,550 20,438
------------ ------------
Total current liabilities............................................ 22,339 30,428
Deferred revenue, net of current portion...................................... 15,500 10,667
Notes payable................................................................. 963 1,002
Shareholders' equity:
Preferred stock, $0.001 par value
Authorized 60,000 shares; no shares issued and outstanding -- --
Common stock, $0.001 par value
Authorized 292,952 shares; issued and outstanding 27,528 shares
at December 31, 1997 and 29,232 shares at June 30, 1998.............. 28 29
Special common stock, $0.001 par value
Authorized 7,048 shares; issued and outstanding 3,338 shares
at December 31, 1997 and June 30, 1998............................... 3 3
Additional paid-in capital............................................... 95,557 112,405
Accumulated deficit...................................................... (17,524) (39,716)
Accumulated other comprehensive loss..................................... (162) (215)
------------ ------------
Total shareholders' equity........................................... 77,902 72,506
------------ ------------
Total liabilities and shareholders' equity........................... $ 116,704 $ 114,603
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE> 4
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
QUARTER ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------- -----------------------------
1997 1998 1997 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net revenues:
Software license fees...................... $ 5,532 $ 10,796 $ 10,070 $ 20,214
Service revenues........................... 907 3,495 2,189 6,117
Advertising................................ 571 765 1,107 1,227
---------- ---------- ---------- ----------
Total net revenues..................... 7,010 15,056 13,366 27,558
---------- ---------- ---------- ----------
Cost of revenues:
Software license fees...................... 591 1,800 1,134 3,386
Service revenues........................... 285 755 1,612 1,276
Advertising................................ 157 406 308 738
---------- ---------- ---------- ----------
Total cost of revenues................. 1,033 2,961 3,054 5,400
---------- ---------- ---------- ----------
Gross profit........................... 5,977 12,095 10,312 22,158
---------- ---------- ---------- ----------
Operating expenses:
Research and development................... 2,738 4,789 5,463 9,208
Sales and marketing........................ 4,811 8,135 9,161 14,965
General and administrative................. 1,325 2,467 2,496 4,567
Acquisition related charges................ -- -- -- 17,879
---------- ---------- ---------- ----------
Total operating expenses............... 8,874 15,391 17,120 46,619
---------- ---------- ---------- ----------
Operating loss......................... (2,897) (3,296) (6,808) (24,461)
Other income, net.............................. 231 1,192 436 2,269
---------- ---------- ---------- ----------
Net loss....................................... $ (2,666) $ (2,104) $ (6,372) $ (22,192)
========== ========== ========== ==========
Basic and diluted net loss per share........... $ (3.99) $ (0.07) $ (10.17) $ (0.70)
========== ========== ========== ==========
Shares used to compute basic and diluted
net loss per share........................ 685 32,119 640 31,551
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 5
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------------
1997 1998
------------ ------------
<S> <C> <C>
Net cash provided by (used in) operating activities $ (5,658) $ 7,000
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment....................................... (2,163) (1,713)
Purchases of short-term investments....................................... (10,614) (43,967)
Proceeds from sales and maturities of short-term investments.............. 8,948 16,106
Investment in joint venture............................................... (998) --
Increase in other assets.................................................. (279) --
Cash obtained through acquisition......................................... -- 203
------------ ------------
Net cash used in investing activities................................. (5,106) (29,371)
------------ ------------
Cash flow from financing activities:
Proceeds from issuance of note payable.................................... 991 --
Net proceeds from sales of common stock and exercise of
stock options and warrants.............................................. 17 526
------------ ------------
Net cash provided by financing activities............................. 1,008 526
------------ ------------
Effect of exchange rate changes on cash........................................ (10) (11)
------------ ------------
Net decrease in cash and cash equivalents............................. (9,766) (21,856)
Cash and cash equivalents at beginning of period............................... 14,738 62,255
------------ ------------
Cash and cash equivalents at end of period..................................... 4,972 40,399
Short-term investments at end of period........................................ 6,524 57,634
------------ ------------
Total cash, cash equivalents and short-term investments at end of period....... $ 11,496 $ 98,033
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements
6
<PAGE> 6
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
RealNetworks, 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, video, and animation, 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 World Wide
Web (Web) site designed to promote the proliferation of streaming media products
and a network of advertising-supported content aggregation Web sites.
(b) Basis of Presentation
The accompanying unaudited condensed 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.
These statements reflect all adjustments, consisting only of normal,
recurring adjustments that, in the opinion of the Company's management, are
necessary for a fair presentation of the results of operations for the periods
presented. Operating results for the quarter and six months ended June 30, 1998
are not necessarily indicative of the results that may be expected for any
subsequent quarter or for the year ending December 31, 1998. Certain information
and footnote disclosures normally included in financial statements prepared in
conformity with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
These condensed consolidated financial statements should be read in
conjunction with the financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997.
(c) Cash, Cash Equivalents and Short-Term Investments
Cash, cash equivalents and short-term investments are comprised of the
following:
<TABLE>
<CAPTION>
December 31, 1997 June 30, 1998
----------------- -------------
(in thousands)
<S> <C> <C>
Cash and cash equivalents $62,255 $30,799
Short-term investments 29,773 57,634
Restricted cash equivalents -- 9,600
------- -------
$92,028 $98,033
======= =======
</TABLE>
Restricted cash equivalents represent a restricted escrow account
established in connection with a lease agreement for new corporate offices. The
Company expects to take occupancy of the new facilities during the quarter
ending June 30, 1999.
7
<PAGE> 7
(d) Revenue Recognition
On January 1, 1998, the Company adopted the provisions of Statement of
Position 97-2, Software Revenue Recognition (SOP 97-2), which provides specific
industry guidance and stipulates that revenue recognized from software
arrangements is to be allocated to each element of the arrangement based on the
relative fair values of the elements, such as software products, upgrades,
enhancements, post contract customer support, installation, or training. Under
SOP 97-2, the determination of fair value is based on objective evidence that is
specific to the vendor. If such evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered. The adoption of SOP 97-2 did not have a material
effect on revenue recognition for the quarter and six months ended June 30,
1998.
Prior to January 1, 1998, the Company recognized 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. If the Company anticipates
providing ongoing support to the OEM in the form of future upgrades,
enhancements or other services over the term of the contract, revenue is
recognized on the straight-line method over the term of the contract.
The Company recognizes revenue from software license agreements with
value-added resellers (VAR), when 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.
Service revenues include payments under support and upgrade contracts,
and fees from consulting and content hosting. Support and upgrade revenues are
recognized ratably over the term of the contract, which typically is 12 months.
Other service revenues are recognized when the service is performed.
Revenues from advertising appearing on the Company's Web sites are
recognized ratably 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
minimum guaranteed page impression deliveries are not met, the Company defers
recognition of the corresponding revenues until guaranteed page impression
delivery levels are achieved.
(e) Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income
(Statement 130), which establishes standards for the reporting and disclosure of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. Statement 130 is
effective for fiscal years beginning after December 15, 1997 and requires
reclassification of financial statements for earlier periods to be provided for
comparative purposes. The Company has not determined the manner in which it will
present the information required by Statement 130 in its annual financial
statements for the year ending December 31, 1998. The Company's total
comprehensive loss for the quarters ended June 30, 1997 and 1998 was
$(2,638,000) and $(2,143,000), respectively. The Company's total comprehensive
loss for the six months ended June 30, 1997 and 1998 was $(6,353,000) and
$(22,245,000), respectively. Total comprehensive loss for the quarters and six
months ended June 30, 1997 and 1998 consisted of net loss and foreign currency
translation adjustments.
8
<PAGE> 8
(f) Net Loss Per Share
Basic earnings per share is computed by dividing the sum of net loss
plus accretion of redemption value of redeemable preferred stock by the weighted
average number of common shares outstanding during the period. Diluted earnings
per share is computed by dividing the sum of net loss plus accretion of
redemption value of redeemable preferred stock by the weighted average number of
common and dilutive common equivalent shares outstanding during the period. As
the Company had a net loss attributable to common shareholders in each of the
periods presented, basic and diluted net loss per share are the same.
The following table reconciles the Company's reported net loss to net
loss attributable to common shareholders used to compute basic and diluted net
loss per share:
<TABLE>
<CAPTION>
Quarter Ended June 30, Six Months Ended June 30,
------------------------------ ------------------------------
1997 1998 1997 1998
-------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C>
Net Loss $ (2,666) $ (2,104) $ (6,372) $(22,192)
Accretion of redemption value of
redeemable preferred stock
prior to conversion into
common stock (67) -- (134) --
-------- -------- -------- --------
Net loss attributable to common
shareholders $ (2,733) $ (2,104) $ (6,506) $(22,192)
======== ======== ======== ========
</TABLE>
Excluded from the computation of diluted earnings per share for the quarter and
six months ended June 30, 1998 are options to acquire 7,604,000 shares of common
stock with a weighted-average exercise price of $6.81 and warrants to acquire
472,000 shares of common stock with a weighted-average exercise price of $9.41
because their effects would be anti-dilutive.
NOTE 2 - ACQUISITION
In March 1998, the Company completed the acquisition of Vivo Software,
Inc. (Vivo), a developer of streaming media creation tools. Under the terms of
the acquisition, the Company issued approximately 1,102,000 shares of its common
stock in exchange for all outstanding shares of Vivo common stock. In addition,
the Company issued options to purchase approximately 48,000 shares of the
Company's common stock in exchange for outstanding unvested options to purchase
Vivo common stock. The acquisition was accounted for using the purchase method
of accounting, and, accordingly, the results of Vivo's operations are included
in the Company's condensed consolidated financial statements from the date of
acquisition.
A summary of the purchase price for the acquisition is as follows (in
thousands):
<TABLE>
<S> <C>
Stock and stock options $16,526
Direct acquisition costs 445
Accrued expenses assumed 1,640
Other current liabilities assumed 1,021
Non-current liabilities assumed 36
-------
Total $19,668
=======
</TABLE>
9
<PAGE> 9
A summary of the allocation of the purchase price is as follows (in
thousands):
<TABLE>
<S> <C>
In-process research and development $ 17,729
Cash acquired 203
Other current assets acquired 148
Property and equipment 100
Goodwill 1,488
-----
Total $ 19,668
========
</TABLE>
In-process research and development represents the fair value of
technologies acquired for use in the Company's own development efforts. The
Company determined the amount of the purchase price to be allocated to
in-process research and development based on the time and cost to incorporate
the acquired technology into the Company's development projects, expected
incremental revenues and expenses associated with the development projects
utilizing the acquired technology, and risks and uncertainties associated with
the acquired technology. Such risks and uncertainties include inherent
difficulties and uncertainties in incorporating the acquired technology into the
Company's development projects and risks related to the viability of and
potential changes to target markets. The Company also concluded that the
acquired technology had no alternative future use.
Goodwill represents the excess of the purchase price over the fair
value of identifiable tangible and intangible assets acquired and is amortized
using the straight-line method over its estimated life of five years.
The acquisition of Vivo was a tax free reorganization under the
Internal Revenue Code (IRC). Therefore, the charge for in-process research and
development is not deductible for income tax purposes. The Company acquired a
net operating loss carryforward of approximately $16,000,000, which expires from
2008 to 2012. Under the provisions of the IRC, the amount of these net operating
loss carryforwards available annually to offset future taxable income is
significantly limited. No value has been attributed to these net operating
losses in the purchase price allocation due to these limitations.
In connection with the acquisition, approximately 220,000 shares of
common stock issued were placed in escrow to secure indemnification obligations
of former shareholders of Vivo.
The following table presents pro forma results of operations as if the
acquisition had occurred at the beginning of each of the periods presented. The
pro forma results of operations exclude $17,879,000 of acquisition related
charges as the charges are not expected to have a continuing impact on the
Company's results of operations. The pro forma information is not necessarily
indicative of the combined results that would have occurred had the acquisition
taken place at the beginning of 1997 or at the beginning of 1998, nor is it
necessarily indicative of results that may occur in the future.
<TABLE>
<CAPTION>
Pro forma
Six Months Ended June 30,
---------------------------------
1997 1998
-------- ---------
(in thousands except per share data)
<S> <C> <C>
Revenues $ 14,156 $ 28,211
Net loss (9,471) (5,443)
Net loss per share (6.31) (0.17)
</TABLE>
10
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE
PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. SUCH FORWARD LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS,
ESTIMATES AND PROJECTIONS ABOUT THE COMPANY'S INDUSTRY, MANAGEMENT'S BELIEFS AND
CERTAIN ASSUMPTIONS MADE BY THE COMPANY'S MANAGEMENT. WORDS SUCH AS
"ANTICIPATES", "EXPECTS", "INTENDS", "PLANS", "BELIEVES", "SEEKS", "ESTIMATES"
AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING
STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE
SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT TO
PREDICT. THE COMPANY'S ACTUAL ACTIONS OR RESULTS MAY DIFFER MATERIALLY FROM
THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES
INCLUDE THOSE SET FORTH HEREIN UNDER "OVERVIEW", "RESULTS OF OPERATIONS", AND
"LIQUIDITY AND CAPITAL RESOURCES", IN THE SECTION TITLED "CERTAIN RISK FACTORS
THAT MAY AFFECT THE COMPANY'S BUSINESS, FUTURE OPERATING RESULTS AND FINANCIAL
CONDITION" INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR
ENDED DECEMBER 31, 1997, AND IN THE SECTIONS TITLED "RISK FACTORS" AND
"BUSINESS" INCLUDED IN THE COMPANY'S FINAL PROSPECTUS DATED NOVEMBER 21, 1997.
UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY
ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE
EVENTS OR OTHERWISE. HOWEVER, READERS SHOULD CAREFULLY REVIEW THE INFORMATION
SET FORTH IN OTHER REPORTS OR DOCUMENTS THAT THE COMPANY FILES FROM TIME TO TIME
WITH THE SECURITIES AND EXCHANGE COMMISSION.
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.
In March 1998, the Company completed the acquisition of Vivo Software,
Inc. ("Vivo"), a developer of streaming media creation tools. Under the terms of
the acquisition, the Company exchanged approximately 1,102,000 shares of its
common stock in exchange for all outstanding shares of Vivo common stock. The
acquisition was accounted for using the purchase method of accounting. Of the
total purchase price, $17,729,000 was allocated to in-process research and
development and was charged to the Company's results of operations for the six
months ended June 30, 1998. The remaining purchase price of $1,939,000 was
allocated to tangible assets acquired and goodwill. Goodwill is amortized over
its estimated life of five years. See Note 2 of Notes to Condensed Consolidated
Financial Statements. Although the Company believes that the acquisition of Vivo
is in the best interests of the Company and its shareholders, acquisitions
involve a number of special risks, including: the integration of acquired
products and technologies in a timely manner; the integration of businesses and
employees with the Company's business; adverse effects on the Company's reported
operating results from acquisition-related charges and amortization of goodwill;
potential increases in stock compensation expense and increased compensation
expense resulting from newly-hired employees; distraction of the Company's
management from the day-to-day business and operations of the Company; the
assumption of unknown liabilities; and the possible failure to retain key
acquired personnel. Because most software business acquisitions involve the
purchase of significant amounts of intangible assets, acquisitions of such
businesses typically result in goodwill and amortization charges and may also
involve charges for acquired research and development projects. If the Company
were to incur additional charges for acquired in-process research and
development and amortization of goodwill with respect to future acquisitions,
such charges could have a material adverse effect on the Company's business,
financial condition and results of operations.
11
<PAGE> 11
During the second quarter of 1998, the Company released RealSystem G2,
its next generation streaming media delivery system consisting of servers, tools
and client software, in preview form to the public prior to finalizing product
features, functionality and operability. The preview release of RealSystem G2
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 future revenues and quarterly results of operations. In
addition, software products as complex as those offered by the Company
frequently contain errors or failures, especially when new versions are
released. Although the Company conducts extensive product testing during product
development, there can be no assurance that, despite testing by the Company and
by current and potential customers, errors will not be found in new versions of
its products after commencement of commercial shipments. Potential errors could
result in the loss of revenue or delay in market acceptance of the Company's
products, diversion of development resources, damage to the Company's reputation
or increased service and warranty costs, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, there can be no assurance that the Company will not
experience delays in the development, introduction, marketing and distribution
of the final version of RealSystem G2, which delays, if they were to occur,
could have a material adverse effect on the Company's business, financial
condition and results of operations.
In June 1997, the Company entered into a strategic agreement
("Agreement") with Microsoft Corporation ("Microsoft") pursuant to which the
Company granted Microsoft a nonexclusive license to its Standard Code (as
defined in the Agreement), which is comprised of 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.
In July 1997, the Company delivered the Standard Code in exchange for a license
fee of $30,000,000. The Company recognizes revenue related to this Agreement
ratably 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.
Under the Agreement, Microsoft may sublicense its rights to the
Standard Code to third parties under certain conditions without additional
compensation to the Company. In addition, Microsoft has an option to receive
two additional deliveries of updated versions of the Standard Code. Microsoft's
right to receive the first delivery expired unexercised in July, 1998.
Microsoft may elect to receive a delivery of the then current version of the
Standard Code once before July, 1999, upon payment of a license fee of $35
million. If the Company elects in its sole discretion to grant an Event License
(as defined in the Agreement) to a third party, the Agreement provides for a
refund of a portion of the license fee paid by Microsoft, based on a declining
scale over the term of the Agreement.
In connection with the Agreement, Microsoft purchased a minority
interest in the Company in the form of 3,338,374 shares of nonvoting Series E
Preferred Stock at approximately $8.99 per share, which shares were converted
to Special Common Stock upon the completion of the Company's initial public
offering. All shares of Special Common Stock will automatically convert into
the same number of shares of Common Stock upon transfer by Microsoft to a
purchaser who is not affiliated with Microsoft. Microsoft has the right to
require the Company to register Microsoft's shares for sale under the
Securities Act of 1933. Rule 144 of the Securities Act provides, in general,
that any person who has beneficially owned shares for at least one year may
generally 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 or the
reported average weekly trading volume in the Company's Common Stock (computed
over a four-week period). Sales of substantial numbers of shares of Special
Common Stock in the public market could have a material adverse effect on the
market price for the Company's Common Stock.
Although Microsoft is a shareholder of the Company, it is also a
competitor and its interests may not always be aligned with those of the Company
and the Company's other shareholders. Microsoft has indicated that, to the
extent the relationship between the parties becomes more competitive than
complementary, it is likely to re-evaluate its investment position in the
Company. Microsoft has not formally communicated to the Company its intentions
with respect to its investment position in the Company, but at times has
indicated informally that it may sell at least a portion of its shares. There
can be no assurance that any such issues, the evolving nature of the
relationship, or economic factors would not result in Microsoft selling all or a
portion of its holdings in the Company, which could have a material adverse
effect on the market price for the Company's Common Stock.
Microsoft recently introduced the Windows Media Player, which competes
with the Company's RealPlayer software, and is available for download from
Microsoft's Web site. Microsoft has stated publicly that future releases of its
new Windows 98 operating system, likely as early as the third quarter of 1998,
will include the Windows Media Player. The Windows Media Player is based in part
on technology Microsoft licensed from the Company under the Agreement, and can
therefore play audio and video content based on earlier versions of the
Company's RealAudio and RealVideo technology. Because Microsoft has not
exercised its option to receive subsequent versions of the Standard Code, the
Windows Media Player cannot play audio or video content based on the RealSystem
5.0 or G2 technology. Therefore, consumers who are using the Windows Media
Player to receive audio and video over the Internet will not be able to access
content available in the Company's newer formats. In addition, while Microsoft
currently distributes certain older versions of the RealPlayer with Internet
Explorer, which is distributed with the Windows operating system, Microsoft has
indicated to the Company that it will not distribute the RealPlayer with future
versions of Windows 98.
On July 23, 1998, Robert Glaser, the Company's Chief Executive Officer,
testified before the Senate Judiciary Committee that if a consumer already has
the RealPlayer on a computer system, and thereafter downloads the Windows Media
Player or installs Windows 98 with the Windows Media Player included on it, in a
number of circumstances the Windows Media Player will disable certain important
functions of the RealPlayer. As a result, certain of the Company's customers who
have downloaded the free RealPlayer or paid for the RealPlayer Plus, may find
that their product has ceased working. Because the Company raised the issue
right after the Windows Media Player was released, and because the Company
quickly posted a workaround solution on its Web site that the Company believes
will counteract the situation, the Company believes only a small number of
consumers will be impacted by the situation. In light of these recent events,
the Company's relationship with Microsoft has become more competitive.
Microsoft has a longer operating history, greater name recognition, and
significantly greater financial, technical, marketing, and distribution
resources than the Company. The Company's inability to sustain or maintain its
leadership position in its market segment could have a material adverse effect
on the Company's business, financial condition and results of operations and
on the market price for the Company's Common Stock.
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. The Company continues
to supply documents and information in response to the subpoenas. 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.
12
<PAGE> 12
Due to the foregoing factors, it is likely that the Company's operating
results in some future quarters will fall below the expectations of securities
analysts and investors, which would likely have a material adverse affect on the
trading price of the Company's common stock.
RESULTS OF OPERATIONS
REVENUES
Software License Fees. Software license fees were $10,796,000 for the
quarter ended June 30, 1998, an increase of 95% from $5,532,000 in the
comparable quarter of the prior year. Software license fees were $20,214,000 for
the six months ended June 30, 1998, an increase of 101% from $10,070,000 in the
comparable period of the prior year. The increases were due primarily to a
greater volume of products sold as a result of growing market acceptance of the
Company's products, the introduction of new products, successful product
promotions and increased sales from electronic distribution. In addition, 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 software license fees for the quarter and six months ended June 30,
1998, were $2,418,000 and $4,836,000, respectively, related to the Microsoft
license agreement.
Service Revenues. Service revenues were $3,495,000 for the quarter
ended June 30, 1998, an increase of 285% from $907,000 in the comparable quarter
of the prior year. Service revenues were $6,117,000 for the six months ended
June 30, 1998, an increase of 179% from $2,189,000 in the comparable period of
the prior year. The increases were primarily due to the introduction of support
and upgrade contracts for the Company's RealPlayer Plus and a larger installed
base of the Company's products. The larger installed base of the Company's
products promotes increases in revenues through the purchase of support and
upgrade contracts and other services performed by the Company. Service revenues
for the six months ended June 30, 1997, also included $498,000 related to the
Company's RealNetworks Conference.
Advertising Revenues. Advertising revenues were $765,000 for the
quarter ended June 30, 1998, an increase of 34% from $571,000 in the comparable
quarter of the prior year. Advertising revenues were $1,227,000 for the six
months ended June 30, 1998, an increase of 11% from $1,107,000 in the comparable
period of the prior year. The increases in advertising revenues were due to a
larger sales force and greater success in attracting advertisers.
13
<PAGE> 13
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees includes
costs of product media, duplication, manuals, packaging materials, royalties
paid for licensed technology, and order fulfillment costs. Cost of software
license fees was $1,800,000 for the quarter ended June 30, 1998, an increase of
205% from $591,000 in the comparable quarter in the prior year, and increased as
a percentage of software license fees to 17% from 11%. Cost of software license
fees was $3,386,000 for the six months ended June 30, 1998, an increase of 199%
from $1,134,000 in the comparable period in the prior year, and increased as a
percentage of software license fees to 17% from 11%. These increases were due
primarily to higher sales volumes and royalties related to new third-party
technologies incorporated into the Company's products. The increases in cost of
software license fees as a percentage of software license fees were due to
changes in the mix of products sold.
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing support and other services and
bandwidth expenses for hosting services. Cost of service revenues was $755,000
for the quarter ended June 30, 1998, an increase of 165% from $285,000 in the
comparable quarter in the prior year, but decreased as a percentage of service
revenues to 22% from 31%. Cost of service revenues was $1,276,000 for the six
months ended June 30, 1998, a decrease of 21% from $1,612,000 in the comparable
period in the prior year, and decreased as a percentage of service revenues to
21% from 74%. Cost of service revenues for the six months ended June 30, 1997,
includes $1,000,000 of costs associated with the Company's RealNetworks
Conference. Excluding the impact of the RealNetworks Conference, cost of service
revenues was $612,000, or 36% of service revenues, for the six months ended June
30, 1997. The increases in cost of service revenues excluding the RealNetworks
Conference were primarily due to increased staff and contract personnel to
provide services to a greater number of customers. The decreases in percentage
terms were primarily due to economies of scale in providing support services.
Cost of Advertising Revenues. Cost of advertising revenues includes
personnel associated with content creation, bandwidth expenses and fees paid to
third-parties for content included in the Company's Web sites. Cost of
advertising revenues was $406,000 for the quarter ended June 30, 1998, an
increase of 159% from $157,000 in the comparable quarter in the prior year, and
increased as a percentage of advertising revenues to 53% from 27%. Cost of
advertising revenues was $738,000 for the six months ended June 30, 1998, an
increase of 140% from $308,000 in the comparable period in the prior year, and
increased as a percentage of advertising revenues to 60% from 28%. These
increases were primarily due to increases in the quality and quantity of content
available on the Company's Web pages and increased costs associated with the
maintenance of newly developed Web sites.
Gross margins may be affected by the mix of distribution channels used,
the mix of products sold, licensed third-party technology incorporated into the
Company's products, the mix of product versus services revenues and the mix of
international versus U.S. revenues. If sales through indirect channels increase
as a percentage of total net revenues, service revenues increase as a percentage
of total net revenues, or sales of the Company's lower margin products 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
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. Costs incurred between
completion of a working model and general release of products have been
insignificant. Research and development expenses were $4,789,000 for the quarter
ended June 30, 1998, an increase of 75% from $2,738,000 in the comparable
quarter in the prior year, but decreased as a percentage of total net revenues
to 32% from 39%. Research and development expenses were $9,208,000 for the six
months ended June 30, 1998, an increase of 69% from $5,463,000 in the
comparable period in the prior year, but decreased as a percentage of total net
revenues to 33% from 41%. The increases in absolute dollars were primarily due
to increases in internal development personnel and consulting expenses. The
decreases in percentage terms were a result of revenues growing at a faster rate
than expenses. Research and development expenses were primarily related to the
14
<PAGE> 14
development of new technology and products and enhancements made to existing
products. The Company believes that significant investments in research and
development is a critical factor in attaining its strategic objectives and, as a
result, expects to increase research and development expenditures in future
periods.
Sales and Marketing. Sales and marketing expenses consist principally
of salaries, commissions, consulting fees paid, trade show expenses,
advertising, promotional expenses and cost of marketing collateral. Sales and
marketing expenses were $8,135,000 for the quarter ended June 30, 1998, an
increase of 69% from $4,811,000 in the comparable quarter of the prior year, but
decreased as a percentage of total net revenues to 54% from 69%. Sales and
marketing expenses were $14,965,000 for the six months ended June 30, 1998, an
increase of 63% from $9,161,000 in the comparable period of the prior year, but
decreased as a percentage of total net revenues to 54% from 69%. The increases
in absolute dollars were due to the expansion of the Company's direct sales
organization, the creation of additional sales offices, promotions and expenses
related to the continued development of the "Real" brand. For the quarter ended
June 30, 1998, sales and marketing expenses included the net costs of the 1998
RealNetworks Conference. The decreases in percentage terms were a result of
revenues growing at a faster rate than expenses. The Company intends to continue
its branding and marketing efforts and, therefore, expects sales and marketing
expenses to increase significantly in future periods.
General and Administrative. General and administrative expenses consist
primarily of personnel costs, fees for professional services and corporate
infrastructure costs. General and administrative expenses were $2,467,000 for
the quarter ended June 30, 1998, an increase of 86% from $1,325,000 in the
comparable quarter of the prior year, but decreased as a percentage of total net
revenues to 16% from 19%. General and administrative expenses were $4,567,000
for the six months ended June 30, 1998, an increase of 83% from $2,496,000 in
the comparable period of the prior year, but decreased as a percentage of total
net revenues to 17% from 19%. The increases in absolute dollars were primarily a
result of increased personnel and facility expenses necessary to support the
Company's growth and costs associated with operating as a public company. The
decreases in percentage terms were due to revenues growing at a faster rate than
expenses. The Company expects general and administrative expenses to increase as
the Company expands its staff, incurs additional costs related to the growth of
its business, and incurs additional costs related to operating as a public
company.
Acquisition Related Charges. Acquisition related charges include
acquired in-process research and development and other acquisition related
costs. During the six months ended June 30, 1998, the Company incurred
$17,879,000 in expenses associated with the acquisition of Vivo. The Company
may, in the future, acquire businesses or technologies that are complimentary to
those of the Company, the results of which could include significant charges for
acquired in-process research and development and the amortization of acquired
intangible assets.
OTHER INCOME, NET
Other income, net consists primarily of earnings on the Company's cash,
cash equivalents and short-term investments. Other income, net was $1,192,000
and $2,269,000 for the quarter and six months ended June 30, 1998, respectively,
and $231,000 and $436,000 for the quarter and six months ended June 30, 1997,
respectively. The increases were due primarily to interest earned on proceeds
from the sales of common and preferred stock in 1997, including the Company's
initial public offering in November, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $7,000,000 for the six
months ended June 30, 1998. Net cash used in operating activities was $5,658,000
for the six months ended June 30, 1997. Cash provided by operating activities
for the six months ended June 30, 1998, was due to a decrease in other
receivables and non-cash charges associated with depreciation and acquisition
related charges, partially offset by the reported net loss. Cash used in
operating activities for the six months ended June 30, 1997 was due primarily to
the reported net loss.
Net cash used in investing activities was $29,371,000 and $5,106,000
for the six months ended June 30, 1998 and 1997, respectively. Cash used in
investing activities for the six months ended June 30, 1998, was primarily a
result of net purchases of short-term investments and purchases of equipment.
Cash used in investing
15
<PAGE> 15
activities for the six months ended June 30, 1997, was due to net purchases of
short-term investments and purchases of equipment.
Net cash provided by financing activities was $526,000 and $1,008,000
for the six months ended June 30, 1998 and 1997, respectively. Cash provided by
financing activities for the six months ended June 30, 1998, was a result of net
proceeds from the sales of common stock and the exercise of stock options and
warrants. Cash provided by financing activities for the six months ended June
30, 1997, was a result of the exercise of stock options and proceeds from a note
payable.
At June 30, 1998, the Company had $98,033,000 in cash, cash equivalents
and short-term investments. As of June 30, 1998, the Company's principal
commitments consisted of obligations under operating leases and $1,002,000 in
notes payable. Since its inception, the Company has experienced a substantial
increase in its capital expenditures to support expansion of the Company's
operations and information systems. In January 1998, the Company entered into a
lease agreement for a new location for its corporate offices. The Company
anticipates the new lease will require significant capital expenditures
associated with leasehold improvements. In the past, the Company has completed
acquisitions of businesses and technologies, and will continue to evaluate
acquisitions of, or investments in, businesses, products, joint-ventures, or
technologies that are complementary to the operations of the Company. Such
acquisitions or investments, which the Company believes have been, and will
continue to be, in the best interest of the Company, involve risks and may
require additional cash investments by the Company.
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 and that such expenses
will be a material use of the Company's cash resources. The Company believes
that 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. The Company may, in the future,
seek to raise additional funds through public or private equity financing, or
through other sources such as credit facilities. The sale of additional equity
securities could result in dilution to the Company's shareholders.
Although the Company believes that all of its current products are Year
2000 compliant, it has not yet completed sufficient internal testing of
recently developed and newly acquired technologies, and there can be no
assurance that the Company's current products do not contain undetected errors
related to Year 2000 that may result in material additional costs or
liabilities that could have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, the
Company has on occasion agreed to indemnify certain of its customers for claims
and losses arising out of the failure of its products to be Year 2000
compliant. To the extent that the Company is not able to test the technology
provided to it by third-parties for its own use or for redistribution, or to
obtain assurances from such third-parties that their products are Year 2000
compliant, the Company may experience material additional costs or liabilities
that could have a material adverse effect on the Company's business, financial
condition, and results of operations. With regard to the Company's internal
processing and operational systems, the Company is in the process of
identifying and testing all systems for Year 2000 compliance. Although the
Company is not aware of any material operational issues or costs associated
with preparing internal systems for the Year 2000, there can be no assurance
that the Company will not experience material adverse effects from undetected
errors or the failure of such systems to be Year 2000 compliant. Any such
failures could have a material adverse effect on the Company's business,
financial condition and results of operations.
16
<PAGE> 16
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time the Company has been, and continues 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Since April 1, 1998, the Company has issued and sold unregistered
securities as follows:
(1) An aggregate of 28,126 shares of Common Stock was issued
to one investor upon the cashless exercise of a warrant in April 1998. The
aggregate consideration received for such shares was the cancellation of a
warrant to acquire 39,841 shares of Common Stock at an exercise price of $9.41.
(2) An aggregate of 81,182 shares of Common Stock was issued
to two investors upon the cashless exercise of warrants in May 1998. The
aggregate consideration received for such shares was the cancellation of
warrants to acquire 119,522 shares of Common Stock at an exercise price of
$9.41.
(3) An aggregate of 26,096 shares of Common Stock was issued
to two investors upon the cashless exercise of warrants in June 1998. The
aggregate consideration received for such shares was the cancellation of
warrants to acquire 39,840 shares of Common Stock at an exercise price of $9.41.
(4) An aggregate of 2,826 shares of Common Stock was issued to
one investor upon the exercise of a warrant in June 1998. The aggregate
consideration received for such shares was $26,600.
(5) An aggregate of 6,437 shares of Common Stock was issued in
June 1998 to four individuals in exchange for 144,644 shares of Common Stock of
Vivo Software, Inc., a Massachusetts corporation. The aggregate consideration
received for such shares was valued at $99,900.
(6) Between April 1, 1998 and June 30, 1998, an aggregate of
289,932 shares of Common Stock had been issued to employees upon the exercise of
options. The aggregate consideration received for such shares was $133,193.
Use of Proceeds
The Company's registration statement under the Securities Act of 1933,
as amended, for its initial public offering became effective on November 21,
1997. Offering proceeds, net of aggregate expenses of approximately $4.6
million, were approximately $38.5 million. The Company has used all of the net
offering proceeds for the purchase of temporary investments consisting of cash,
cash equivalents and short-term investments. The Company has not used any of the
net offering proceeds for construction of plant, building or facilities,
purchases of real estate, acquisition of other businesses, or repayment of
indebtedness. None of the net offering proceeds were paid directly or indirectly
to directors, officers, or general partners of the Company or their associates,
persons owning 10% or more of any class of the Company's securities, or
affiliates of the Company.
17
<PAGE> 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An Annual Meeting of Shareholders of RealNetworks, Inc. was held on May
22, 1998. Matters voted on at the meeting and votes cast on each were as
follows:
1. To elect one director to serve until the 2001 Annual Meeting of
Shareholders or until his earlier retirement, resignation or removal, or the
election of his successor. The terms of office of Robert Glaser, Bruce Jacobsen,
and James Breyer, the other directors of the Company, continued after the
meeting.
For Withheld
--- --------
Mitchell Kapor 24,806,402 16,056
2. To approve an amendment to the Company's Amended and Restated 1996
Stock Option Plan to increase by 2,500,000 the number of shares of Common Stock
that may be issued thereunder.
For 22,650,735
Against 425,755
Abstain 11,432
Broker Non-Votes 1,734,536
3. To ratify the appointment of KPMG Peat Marwick LLP as independent
auditors for the Company's fiscal year ending December 31, 1998.
For 24,782,539
Against 31,920
Abstain 7,999
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K:
10.1 RealNetworks, Inc. Amended and Restated 1996 Stock
Option Plan
27.1 Financial Data Schedule which is submitted
electronically to the Securities and Exchange
Commission for information purposes only and not
filed
(b) Reports on Form 8-K:
On April 8, 1998, the Company filed a report on Form 8-K
(as amended by Form 8-K/A filed on June 4, 1998 to include
Financial Statements of Business Acquired and Pro Forma
Financial Information ), that, pursuant to Item 2 of such
Form, announced that it had acquired all of the outstanding
capital stock of Vivo Software, Inc.
18
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 14, 1998.
REALNETWORKS, INC.
By /s/ Robert Glaser
------------------------------------
Robert Glaser
Chairman of the Board, Chief
Executive Officer and Treasurer
By /s/ Paul Bialek
------------------------------------
Paul Bialek
Senior Vice President, Finance and
Operations and Chief Financial Officer
19
<PAGE> 19
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
10.1 RealNetworks, Inc. Amended and Restated 1996 Stock
Option Plan
27.1 Financial Data Schedule which is submitted
electronically to the Securities and Exchange
Commission for information purposes only and not
filed
</TABLE>
<PAGE> 1
REALNETWORKS, INC.
AMENDED AND RESTATED
1996 STOCK OPTION PLAN
(AS AMENDED AND RESTATED
AS OF APRIL 9, 1998)
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C> <C>
ARTICLE 1 PURPOSE AND EFFECTIVENESS...................................................................... 1
1.1 Purpose........................................................................................ 1
1.2 Effective Date................................................................................. 1
ARTICLE 2 DEFINITIONS.................................................................................... 1
2.1 Certain Defined Terms.......................................................................... 1
ARTICLE 3 ADMINISTRATION................................................................................. 4
3.1 Administrative Committee....................................................................... 4
3.2 Appointment of Administrative Committee........................................................ 4
3.3 Powers; Regulations............................................................................ 4
3.4 Limits on Authority............................................................................ 4
3.5 Exercise of Authority.......................................................................... 4
ARTICLE 4 SHARES SUBJECT TO THE PLAN..................................................................... 5
4.1 Number of Shares............................................................................... 5
4.2 Adjustments.................................................................................... 5
ARTICLE 5 ELIGIBILITY.................................................................................... 5
ARTICLE 6 STOCK OPTIONS.................................................................................. 6
6.1 Grant of Options............................................................................... 6
6.2 Purchase Price................................................................................. 6
6.3 Limitations on Grants.......................................................................... 6
6.4 Term of Options................................................................................ 7
6.5 Option Agreement............................................................................... 7
6.6 Exercise of Options............................................................................ 7
6.7 Manner of Exercise............................................................................. 8
6.8 Legends........................................................................................ 8
6.9 Nontransferability............................................................................. 9
6.10 Repurchase of Shares........................................................................... 9
6.11 Class of Common Stock......................................................................... 10
6.12 Delegation to Executive Officer of Authority to Grant Options................................. 11
ARTICLE 7 GENERAL PROVISIONS............................................................................ 11
7.1 Acceleration of Options___Approved Transactions; Control Purchase............................. 11
7.2 Termination of Services....................................................................... 12
</TABLE>
<PAGE> 3
<TABLE>
<S> <C> <C>
7.3 Right to Terminate Services................................................................... 13
7.4 Nonalienation of Benefits..................................................................... 13
7.5 Shareholders Agreement........................................................................ 13
7.6 Termination and Amendment..................................................................... 13
7.7 Government and Other Regulations.............................................................. 14
7.8 Withholding................................................................................... 14
7.9 Separability.................................................................................. 15
7.10 Non-Exclusivity of the Plan................................................................... 15
7.11 Exclusion from Pension and Profit-Sharing Computation......................................... 15
7.12 No Shareholder Rights......................................................................... 15
7.13 Governing Law................................................................................. 15
7.14 Company's Rights.............................................................................. 15
</TABLE>
<PAGE> 4
REALNETWORKS, INC.
AMENDED AND RESTATED 1996 STOCK OPTION PLAN
1
PURPOSE AND EFFECTIVENESS
1.1 PURPOSE. The purpose of the 1996 Stock Option Plan (the "Plan")
is to provide a method by which selected individuals rendering services to
RealNetworks, Inc., a Washington corporation (the "Company"), may be offered an
opportunity to invest in capital stock of the Company, thereby increasing their
personal interest in the growth and success of the Company. The Plan is also
intended to aid in attracting persons of exceptional ability to become officers
and employees of the Company.
1.2 EFFECTIVE DATE; SHAREHOLDER APPROVAL. The Plan shall be
effective at the time specified in the resolutions of the Board adopting the
Plan (the "Effective Date"). The Plan shall be subject to the requirement of RCW
21.20.310(10) that the Administrator of Securities of the Department of
Financial Institutions of the State of Washington be provided with notification
of the adoption of the Plan. No Option shall be granted hereunder until this
notification requirement has been satisfied. The issuance of Incentive Stock
Options shall be subject to approval of the Plan by holders of shares of Common
Stock constituting at least a majority of the shares of Common Stock represented
in person or by proxy at the meeting at which the approval is sought. If this
shareholder approval requirement is not satisfied within twelve (12) months
after the Effective Date, all Incentive Stock Options issued under the Plan
shall automatically become Nonqualified Stock Options.
2
DEFINITIONS
2.1 CERTAIN DEFINED TERMS. Capitalized terms not defined elsewhere
in the Plan shall have the following meanings (whether used in the singular or
plural):
"Administrative Committee" is defined in Section 3.1.
"Affiliate" of the Company means any corporation, partnership, or other
business association that, directly or indirectly, through one or more
intermediaries, controls, is controlled by, or is under common control with the
Company.
"Approved Transaction" means (a) any merger, consolidation or binding
share exchange pursuant to which shares of Common Stock are changed or converted
into or exchanged for cash, securities or other property, other than any such
transaction in which the persons who hold Common Stock immediately prior to the
transaction have immediately following the transaction the same proportionate
ownership of the common stock of, and the same voting power with respect to, the
surviving corporation; (b) any merger, consolidation or binding share exchange
in which the
-1-
<PAGE> 5
persons who hold Common Stock immediately prior to the transaction have
immediately following the transaction less than a majority of the combined
voting power of the outstanding capital stock of the Company ordinarily (and
apart from rights accruing under special circumstances) having the right to vote
in the election of directors; (c) any liquidation or dissolution of the Company;
and (d) any sale, lease, exchange or other transfer not in the ordinary course
of business (in one transaction or a series of related transactions) of all, or
substantially all, of the assets of the Company.
"Board" means the Board of Directors of the Company.
"Code" means the Internal Revenue Code of 1986, as amended from time to
time, or any successor statute or statutes thereto. Reference to any specific
section of the Code shall include any successor section.
"Common Stock" means the Series B Common Stock or the Series C Common
Stock of the Company.
"Company" means RealNetworks, Inc., a Washington corporation.
"Control Purchase" means any transaction (or series of related
transactions), consummated without the approval or recommendation of the Board,
in which (a) any person, corporation or other entity (including any "person" as
defined in Sections 13(d)(3) and 14(d)(2) of the Exchange Act, but excluding the
Company and any employee benefit plan sponsored by the Company) purchases any
Common Stock (or securities convertible into Common Stock) for cash, securities
or any other consideration pursuant to a tender offer or exchange offer; or (b)
any person, corporation or other entity (including any "person" as defined in
Sections 13(d)(3) and 14(d)(2) of the Exchange Act, but excluding the Company
and any employee benefit plan sponsored by the Company) becomes the "beneficial
owner" (as that term is defined in Rule 13d-3 under the Exchange Act), directly
or indirectly, of securities of the Company representing fifty percent (50%) or
more of the combined voting power of the then outstanding securities of the
Company ordinarily (and apart from rights accruing under special circumstances)
having the right to vote in the election of directors (calculated as provided in
Rule 13d-3(d) under the Exchange Act in the case of rights to acquire the
Company's securities).
"Disability" means the inability to engage in any substantial gainful
activity by reason of any medically determinable physical or mental impairment
that can be expected to result in death or that has lasted or can be expected to
last for a continuous period of not less than twelve (12) months.
"Disinterested Person" is defined in Section 3.2(b).
"Effective Date" is defined in Section 1.2.
"Eligible Person" is defined in Section 5.
"Equity Securities" has the meaning given that term in Rule 3a11-1
promulgated under the Exchange Act, as amended from time to time, or any
successor rule thereto.
-2-
<PAGE> 6
"Exchange Act" means the Securities Exchange Act of 1934, as amended
from time to time, or any successor statute or statutes thereto. Reference to
any specific section of the Exchange Act shall include any successor section.
"Executive Officer" means any employee of the company who is an
"officer" within the meaning of Rule 16a-1(f) of the Exchange Act, as amended
from time to time, or any successor rule thereto.
"Fair Market Value" on any day means, if the Common Stock is publicly
traded, the last sales price (or, if no last sales price is reported, the
average of the high bid and low asked prices) for a share of Common Stock on
that day (or, if that day is not a trading day, on the next preceding trading
day), as reported by the principal exchange on which the Common Stock is listed,
or, if the Common Stock is publicly traded but not listed on an exchange, as
reported by The Nasdaq Stock Market, or, if such prices or quotations are not
reported by The Nasdaq Stock Market, as reported by any other available source
of prices or quotations selected by the Administrative Committee. If the Common
Stock is not publicly traded, or if the Fair Market Value is not determinable by
any of the foregoing means, the Fair Market Value on any day shall be determined
in good faith by the Administrative Committee on the basis of such
considerations as the Administrative Committee deems appropriate.
"Holder" means an Eligible Person who has received an Option under this
Plan or, if rights continue under the Option following the death of the Eligible
Person, the person who succeeds to those rights by will or by the laws of
descent and distribution.
"Incentive Stock Option" means an Option that is an incentive stock
option within the meaning of Section 422 of the Code.
"Nonqualified Stock Option" means an Option that is designated as a
nonqualified stock option.
"Option" means an option with respect to shares of Common Stock awarded
pursuant to Article 6.
"Option Agreement" is defined in Section 6.5.
"Plan" is defined in Section 1.1.
"Securities Act" means the Securities Act of 1933, as amended from time
to time, or any successor statute or statutes thereto. Reference to any specific
section of the Securities Act shall include any successor section.
"10% Shareholder" means a person who owns (or is considered as owning
within the meaning of Section 424 of the Code) stock possessing more than 10% of
the total combined voting power of all classes of capital stock of the Company.
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3
ADMINISTRATION
3.1 ADMINISTRATIVE COMMITTEE. The Plan shall be administered by the
Board unless the Board, either voluntarily or as required by Section 3.2 below,
appoints a separate committee of the Board to administer the Plan (the Board, or
such committee, if it is administering the Plan, will be referred to in the Plan
as the "Administrative Committee"). The Administrative Committee shall select
one of its members as its chairman and shall hold its meetings at such times and
places as it shall deem advisable. A majority of its members shall constitute a
quorum and all determinations shall be made by a majority of that quorum. Any
determination reduced to writing and signed by all of the members of the
Administrative Committee shall be fully as effective as if it had been made by a
majority vote at a meeting duly called and held.
3.2 APPOINTMENT OF ADMINISTRATIVE COMMITTEE. The Board may appoint a
committee consisting of two or more of its members to administer the Plan. Once
appointed, the committee shall continue to serve until otherwise directed by the
Board. From time to time the Board may increase the size of the committee and
appoint additional members, remove members (with or without cause) and appoint
new members in their place, fill vacancies however caused, and/or remove all
members of the committee and thereafter directly administer the Plan.
3.3 POWERS; REGULATIONS. The Administrative Committee shall have
full power and authority, subject only to the express provisions of the Plan (a)
to designate the Eligible Persons to whom Options are to be granted under the
Plan; (b) to determine the number of shares subject to, and all of the other
terms and conditions (which need not be identical) of, all Options so granted;
(c) to interpret the provisions of the Plan and the Option Agreements evidencing
the Options so granted; (d) to correct any defect, supply any information and
reconcile any inconsistency in such manner and to such extent as shall be deemed
necessary or advisable to carry out the purpose of the Plan; (e) to supervise
the administration of the Plan; and (f) to take such other actions in connection
with or in relation to the Plan as it deems necessary or advisable. The
Administrative Committee is authorized to establish, amend and rescind such
rules and regulations not inconsistent with the terms and conditions of the Plan
as it deems necessary or advisable for the proper administration of the Plan. In
making determinations hereunder, the Administrative Committee may give such
consideration to the recommendations of management of the Company as the
Administrative Committee deems desirable.
3.4 LIMITS ON AUTHORITY. Exercise by the Administrative Committee of
its authority under the Plan shall be consistent (a) with the intent that all
Incentive Stock Options issued under the Plan be qualified under the terms of
Section 422 of the Code (including any amendments thereto and any similar
successor provision), and (b) if the Company registers any class of Equity
Security pursuant to Section 12 of the Exchange Act, with the intent that the
Plan be administered in a manner so that, to the extent possible, the grant of
Options and all other transactions with respect to the Plan, to Options and to
any Common Stock acquired upon exercise of Options, shall be exempt from the
operation of Section 16(b) of the Exchange Act.
3.5 EXERCISE OF AUTHORITY. Each action and determination made or
taken pursuant to the Plan by the Administrative Committee, including but not
limited to any interpretation or
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<PAGE> 8
construction of the Plan and the Option Agreements, shall be final and
conclusive for all purposes and upon all persons. No member of the
Administrative Committee shall be liable for any action or determination made or
taken by the member or the Administrative Committee in good faith with respect
to the Plan.
4
SHARES SUBJECT TO THE PLAN
4.1 NUMBER OF SHARES. Subject to the provisions of this Article 4,
the maximum number of shares of Common Stock with respect to which Options may
be granted during the term of the Plan shall be the sum of (a) 11,300,000, plus
(b) an additional 1,045,436 shares of Common Stock previously reserved for
issuance pursuant to Section 4.1 of the Company's 1995 Stock Option Plan (the
"1995 Plan"), plus (c) any of the 1,269,123 shares of Common Stock subject to
options currently outstanding under the 1995 Plan to the extent the options
terminate without having been exercised in full. Shares of Common Stock will be
made available from the authorized but unissued shares of the Company or from
shares reacquired by the Company. If any Option terminates for any reason
without having been exercised in full, the shares of Common Stock subject to the
Option for which it has not been exercised shall again be available for purposes
of the Plan.
4.2 ADJUSTMENTS. If the Company subdivides its outstanding shares of
Common Stock into a greater number of shares of Common Stock (by stock dividend,
stock split, reclassification or otherwise) or combines its outstanding shares
of Common Stock into a smaller number of shares of Common Stock (by reverse
stock split, reclassification or otherwise), or if the Administrative Committee
determines, in its sole discretion, that any stock dividend, extraordinary cash
dividend, reclassification, recapitalization, reorganization, split-up,
spin-off, combination, exchange of shares, warrants or rights offering to
purchase Common Stock, or other similar corporate event (including a merger or
consolidation other than one that constitutes an Approved Transaction) affects
the Common Stock such that an adjustment is required in order to preserve the
benefits or potential benefits intended to be made available under this Plan,
then the Administrative Committee shall, in its sole discretion and in such
manner as the Administrative Committee may deem equitable and appropriate, make
adjustments to any or all of (a) the number and kind of shares with respect to
which Options may thereafter be granted under this Plan; (b) the number and kind
of shares subject to outstanding Options, and (c) the purchase price under
outstanding Options; PROVIDED, HOWEVER, that the number of shares subject to an
Option shall always be a whole number. The Administrative Committee may, if
deemed appropriate, provide for a cash payment to any Holder of an Option in
connection with any adjustment made pursuant to this Section 4.2.
5
ELIGIBILITY
The persons eligible to participate in the Plan and to receive Options
under the Plan ("Eligible Persons") shall be (a) employees (including officers
and directors who are also employees) of the Company or any of its Affiliates,
and (b) consultants (and directors who are not employees) rendering services to
the Company or any of its Affiliates in the capacity of independent contractors.
Options may be granted to Eligible Persons even if they hold or have held
Options
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<PAGE> 9
under this Plan or options or similar awards under any other plan of the Company
or any of its Affiliates.
6
STOCK OPTIONS
6.1 GRANT OF OPTIONS. Subject to the limitations of the Plan, the
Administrative Committee shall designate from time to time each Eligible Person
who is to be granted an Option, the time when the Option shall be granted, the
number of shares subject to the Option, whether the Option is to be an Incentive
Stock Option or a Nonqualified Stock Option and, subject to Section 6.2, the
purchase price of the shares of Common Stock subject to the Option; PROVIDED,
HOWEVER, that Incentive Stock Options may only be granted to Eligible Persons
who are employees of the Company or an Affiliate that constitutes a "parent
corporation" or a "subsidiary corporation" within the meaning of Section 424 of
the Code. Each Option granted under this Plan shall also be subject to such
other terms and conditions not inconsistent with this Plan as the Administrative
Committee, in its sole discretion, determines. Subject to the limitations of the
Plan, the same Eligible Person may receive Incentive Stock Options and
Nonqualified Stock Options at the same time and pursuant to the same Option
Agreement, provided that Incentive Stock Options and Nonqualified Stock Options
are clearly designated as such.
6.2 PURCHASE PRICE. The price at which shares may be purchased upon
exercise of an Option shall be fixed by the Administrative Committee and may be
more than, less than or equal to the Fair Market Value of the Common Stock as of
the date the Option is granted; PROVIDED, HOWEVER, that the purchase price of an
Incentive Stock Option shall be (a) at least 110% of the Fair Market Value as of
the date of grant of the Common Stock subject thereto, if the Incentive Stock
Option is being granted to a 10% Shareholder, and (b) at least 100% of the Fair
Market Value as of the date of grant of the Common Stock subject thereto, if the
Incentive Stock Option is being granted to any other Eligible Person.
6.3 LIMITATIONS ON GRANTS.
(a) ANNUAL LIMITATION ON GRANTS OF INCENTIVE STOCK OPTIONS.
The aggregate Fair Market Value of the shares of Common Stock with respect to
which, during any calendar year, one or more Incentive Stock Options under this
Plan (and/or one or more options under any other plan maintained by the Company
or any of its Affiliates for the granting of options intended to qualify under
Section 422 of the Code) become exercisable for the first time by a Holder shall
not exceed $100,000 (said value to be determined as of the respective dates on
which the options are granted to the Holder). If (i) a Holder holds one or more
Incentive Stock Options under this Plan (and/or one or more options under any
other plan maintained by the Company or any of its Affiliates for the granting
of options intended to qualify under Section 422 of the Code), and (ii) the
aggregate Fair Market Value of the shares of Common Stock with respect to which,
during any calendar year, such options become exercisable for the first time
exceeds $100,000 (said value to be determined as provided above), then such
option or options are intended to qualify under Section 422 of the Code with
respect to the maximum number of such shares as can, in light of the foregoing
limitation, be so qualified, with the shares so qualified to be the shares
subject to the option or options earliest granted to the Holder. If an Option
that would otherwise qualify as an Incentive Stock Option becomes exercisable
for the first time in any calendar year for shares of
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<PAGE> 10
Common Stock that would cause such aggregate Fair Market Value to exceed
$100,000, then the portion of the Option in respect of such shares shall be
deemed to be a Nonqualified Stock Option.
(b) ANNUAL LIMITATION ON GRANTS FOLLOWING EXCHANGE ACT
REGISTRATION. If the Company registers any class of any Equity Security pursuant
to Section 12 of the Exchange Act, then, from the effective date of the
registration until six (6) months after the termination of the registration, the
number of shares subject to one or more Options granted during any calendar year
to an Eligible Person shall not exceed one million (1,000,000).
6.4 TERM OF OPTIONS. Subject to the provisions of the Plan with
respect to termination of Options upon death, Disability or termination of
services, the term of each Option shall be for such period as the Administrative
Committee shall determine, but not more than (a) five (5) years from the date of
grant in the case of Incentive Stock Options held by 10% Shareholders; (b) ten
(10) years from the date of grant in the case of Incentive Stock Options held by
persons other than 10% Shareholders; and (c) twenty (20) years from the date of
grant in the case of all other Options, provided, however, that the term for a
Nonqualified Stock Option granted more than one (1) year following the Effective
Date shall be ten (10) years unless otherwise determined by the Administrative
Committee.
6.5 OPTION AGREEMENT. Each Option granted under the Plan shall be
evidenced by an agreement (the "Option Agreement") which shall designate the
Option as an Incentive Stock Option or a Nonqualified Stock Option and contain
such terms and provisions not inconsistent with the provisions of the Plan as
the Administrative Committee from time to time approves. Each grantee of an
Option shall be notified promptly of the grant, an Option Agreement shall be
executed and delivered by the Company to the grantee within sixty (60) days
after the date the Administrative Committee approves the grant, and, in the
discretion of the Administrative Committee, the grant shall terminate if the
Option Agreement is not signed by the grantee (or his or her attorney) and
delivered to the Company within sixty (60) days after it is delivered to the
grantee. An Option Agreement may contain (but shall not be required to contain)
such provisions as the Administrative Committee deems appropriate to insure that
the penalty provisions of Section 4999 of the Code will not apply to any stock
received by the Holder from the Company. An Option Agreement may be modified
from time to time pursuant to Section 7.6(b).
6.6 EXERCISE OF OPTIONS. An Option granted under the Plan shall
become and remain exercisable during the term of the Option to the extent
provided in the Option Agreement evidencing the Option and in this Plan and,
unless the Option Agreement otherwise provides, may be exercised to the extent
exercisable, in whole or in part, at any time and from time to time during such
term; PROVIDED, HOWEVER, that subsequent to the grant of an Option, the
Administrative Committee, at any time before complete termination of the Option,
may accelerate the time or times at which the Option may be exercised in whole
or in part (without reducing the term of the Option). If an Option is scheduled
to become exercisable on one or more dates specified in its Option Agreement,
and its Holder has a leave of absence without pay, such date or dates shall be
postponed for a period equal to the duration of the leave unless the
Administrative Committee determines otherwise.
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<PAGE> 11
6.7 MANNER OF EXERCISE.
(a) FORM OF PAYMENT. An Option shall be exercised by written
notice to the Company upon such terms and conditions as the Option Agreement
evidencing the Option may provide and in accordance with such other procedures
for the exercise of Options as the Administrative Committee may establish from
time to time. The method or methods of payment of the purchase price for the
shares to be purchased upon exercise of an Option and of any amounts required by
Section 7.8 shall be determined by the Administrative Committee and may consist
of (i) cash, (ii) check, (iii) promissory note, (iv) whole shares of Common
Stock already owned by the Holder, (v) the withholding of shares of Common Stock
issuable upon exercise of the Option, (vi) the delivery, together with a
properly executed exercise notice, of irrevocable instructions to a broker to
deliver promptly to the Company the amount of sale or loan proceeds required to
pay the purchase price, (vii) any combination of the foregoing methods of
payment, or (viii) such other consideration and method of payment as may be
permitted for the issuance of shares under applicable securities and other laws.
The permitted methods or methods of payment of the amounts payable upon exercise
of an Option, if other than in cash, shall be set forth in the Option Agreement
evidencing the Option and may be subject to such conditions as the
Administrative Committee deems appropriate. Without limiting the generality of
the foregoing, if a Holder is permitted to elect to have shares of Common Stock
issuable upon exercise of an Option withheld to pay all or any part of the
amounts payable in connection with the exercise, then the Administrative
Committee shall have the sole discretion to approve or disapprove the election,
which approval or disapproval shall be given after the election is made.
(b) VALUE OF SHARES. Shares of Common Stock delivered in
payment of all or any part of the amounts payable in connection with the
exercise of an Option, and shares of Common Stock withheld for the payment,
shall be valued for such purpose at their Fair Market Value as of the exercise
date.
(c) ISSUANCE OF SHARES. The Company shall effect the
issuance of the shares of Common Stock purchased under the Option as soon as
practicable after the exercise thereof and payment in full of the purchase price
therefor and of any amounts required by Section 7.8, and within a reasonable
time thereafter the issuance shall be evidenced on the books of the Company.
Following the exercise of an Incentive Stock Option, the Administrative
Committee shall cause the information statement required by Section 6039 of the
Code to be furnished to the Holder within the time and in the manner prescribed
by law.
6.8 LEGENDS. Each certificate representing shares of Common Stock
issued under the Plan upon exercise of an Option shall, unless the
Administrative Committee otherwise determines, contain on its face the notice
"SEE TRANSFER RESTRICTIONS ON REVERSE" and on its reverse a legend in form
substantially as follows, together with any other legends that are required by
the terms and conditions of the Plan or that the Administrative Committee in its
discretion deems necessary or appropriate:
NOTICE: TRANSFER AND OTHER RESTRICTIONS
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, OR ANY STATE
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<PAGE> 12
SECURITIES LAWS, AND MAY NOT BE OFFERED, SOLD, TRANSFERRED, ENCUMBERED,
OR OTHERWISE DISPOSED OF EXCEPT UPON SATISFACTION OF CERTAIN CONDITIONS.
INFORMATION CONCERNING THESE RESTRICTIONS MAY BE OBTAINED FROM THE
CORPORATION. ANY OFFER OR DISPOSITION OF THESE SECURITIES WITHOUT
SATISFACTION OF SAID CONDITIONS WILL BE WRONGFUL AND WILL NOT ENTITLE
THE TRANSFEREE TO REGISTER OWNERSHIP OF THE SECURITIES WITH THE
CORPORATION.
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE ALSO SUBJECT
TO RESTRICTIONS ON TRANSFER, AND MAY BE SUBJECT TO REPURCHASE BY THE
CORPORATION OR ONE OR MORE OF ITS SHAREHOLDERS PURSUANT TO THE
PROVISIONS OF THE CORPORATION'S 1996 STOCK OPTION PLAN AND/OR AN
AGREEMENT BETWEEN THE HOLDER AND THE CORPORATION AND/OR AN AGREEMENT
AMONG THE CORPORATION AND ITS SHAREHOLDERS. INFORMATION CONCERNING THESE
RESTRICTIONS MAY BE OBTAINED FROM THE CORPORATION.
The Company may cause the transfer agent for the Common Stock to place a stop
transfer order with respect to such shares.
6.9 NONTRANSFERABILITY. Unless the Administrative Committee
determines otherwise at the time an Option is granted (or at any later time when
the Administrative Committee, by written notice to the Holder, releases in whole
or in part the restrictions under this Section 6.9), an Option shall not be
transferable other than by will or the laws of descent and distribution, and may
be exercised during the lifetime of the Holder thereof only by the Holder (or
his or her court appointed legal representative). Options shall not be
transferable other than by will or the laws of descent and distribution, and
Options may be exercised during the lifetime of the Holder thereof only by the
Holder (or his or her court appointed legal representative).
6.10 REPURCHASE OF SHARES.
(a) RIGHT OF REPURCHASE. If so specified by the
Administrative Committee at the time an Option is granted to a Holder who is an
employee of the Company or any of its Affiliates or a party to a consulting
arrangement with the Company or any of its Affiliates, the Company shall have
the right, but shall not be required, to repurchase from the Holder all or part
of (i) the shares of Common Stock that the Holder acquires upon the exercise of
the Option, and (ii) any other shares of Common Stock or other securities issued
or acquired with respect to the shares specified in the preceding clause (i) or
this clause (ii) in connection with any stock dividend, stock split,
reclassification, recapitalization, reorganization, split-up, spin-off,
combination, exchange of shares, warrants or rights offering to purchase Common
Stock, or other similar corporate event. Such right shall be exercisable at any
time and from time to time during the period of ninety (90) days commencing on
the date of termination of the Holder's employment or consulting agreement with
the Company or any of its Affiliates for "cause," as defined in Section 7.2(b).
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<PAGE> 13
(b) EXERCISE OF REPURCHASE RIGHT. The Company's right of
repurchase under this Section 6.10 shall be exercised by delivery written notice
to the Holder specifying the number of shares or other securities to be
repurchased and the effective date of the repurchase, which date shall not be
earlier than the date of the notice nor later than the date of termination of
the Company's right of repurchase. If a Holder transfers shares or other
securities that are subject to the Company's right of repurchase, the shares or
other securities shall remain subject to the Company's right of repurchase
during the period specified in the last sentence of Section 6.10(a) (exercise of
the right of repurchase in such even shall be effected by notice to the person
or entity holding the shares or other securities at the time of exercise).
(c) REPURCHASE PRICE. With respect to each share or other
security to be repurchased by the Company upon its exercise of its right of
repurchase under this Section 6.10, the repurchase price shall be the Fair
Market Value of the share or security as of the effective date of the
repurchase. The Company may elect to pay the amount owed to the Holder (or to
the person or entity holding the share or other security to be repurchased)
either (i) in cash, in which case the amount shall be paid, without interest,
within thirty (30) days following the effective date of the repurchase, or (ii)
in three equal installments, with the first installment payable on the first
anniversary of the effective date of the repurchase, and the remaining
installments payable on the corresponding date in each of the next two years,
with each installment to include interest on the unpaid principal computed at
the prime rate published in the Wall Street Journal for the first business day
of the month in which the effective date of the repurchase occurs, for the
period from the effective date of the repurchase or the date of the most recent
installment, as the case may be, to the due date of the installment being paid.
(d) TERMINATION OF RIGHT OF REPURCHASE. Any right of
repurchase of the Company under this Section 6.10 shall terminate upon the
occurrence of a Control Purchase or an Approved Transaction (other than an
Approved Transaction in connection with which the Administrative Committee
determines, in accordance with the last sentence of Section 7.1, that Options
otherwise subject to such right of repurchase will not vest or become
exercisable on an accelerated basis and/or will not terminate if not exercised
prior to consummation of the Approved Transaction). Any right of repurchase of
the Company under this Section 6.10 shall also terminate upon the effective date
of the registration by the Company of any class of any Equity Security pursuant
to Section 12 of the Exchange Act.
6.11 CLASS OF COMMON STOCK. The class of shares subject to each
Option and the class of shares to be received upon exercise of each Option shall
depend upon the employment status of the Eligible Person at the date the Option
is granted and at the date the Option is exercised. If the Eligible Person is an
employee (including officers and directors who are also employees) of the
Company or one of its Affiliates as of the date the Option is granted, the
shares subject to the Option shall be shares of Series B Common Stock, which are
automatically convertible into the shares of Series C Common Stock upon the
occurrence of certain events (a "Conversion Event") as described in the
Company's Articles of Incorporation, as amended from time to time (the
"Articles"), provided, that if a Conversion Event occurs prior to the exercise
of an Option, the shares subject to the Option shall be shares of Series C
Common Stock, with the rights defined in the Articles. If the Eligible Person is
a consultant (other than a director) rendering services to the Company or any of
its Affiliates in the capacity of an independent contractor as of the date the
Option is granted, the shares subject to the Option shall be shares of Series C
Common Stock, with the rights defined in
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<PAGE> 14
the Articles, regardless of the Eligible Person's employment status with the
Company at the date the Option is exercised.
6.12 DELEGATION TO EXECUTIVE OFFICER OF AUTHORITY TO GRANT OPTIONS.
The Board may delegate to an Executive Officer the authority to determine from
time to time (a) the Eligible Persons to whom Options are to be granted; (b) the
number of shares of Common Stock for which the Options are exercisable and the
purchase price of such shares; (c) whether the Options are Incentive Stock
Options or Nonqualified Stock Options; and (d) all of the other terms and
conditions (which need not be identical) of the Options; PROVIDED, HOWEVER, that
(i) the authority delegated to the Executive Officer under this Section 6.12
shall not exceed that of the Administrative Committee under the foregoing
provisions of this Article 6 and shall be subject to such limitations, in
addition to those specified in this Section 6.12, as may be specified by the
Board at the time of delegation; (ii) the Executive Officer may not be delegated
authority under this Section 6.12 to grant any Option to any person who is an
Executive Officer or a director of the Company at the time of the grant; (iii)
the purchase price of each share of Common Stock under an Option granted under
this Section 6.12 shall not be less than the Fair Market Value of such share on
the date of grant of the Option; and (iv) the Executive Officer shall promptly
provide a report to the Administrative Committee of each person to whom an
Option has been granted under this Section 6.12 and the material terms and
conditions of the Option.
7
GENERAL PROVISIONS
7.1 ACCELERATION OF OPTIONS -- APPROVED TRANSACTIONS; CONTROL
PURCHASE. In the event of any Approved Transaction or Control Purchase, each
outstanding Option under the Plan shall become exercisable in full in respect of
the aggregate number of shares covered thereby, notwithstanding any contrary
vesting schedule in the Option Agreement evidencing the Option (except to the
extent the Option Agreement expressly provides otherwise), effective upon the
Control Purchase or immediately prior to consummation of the Approved
Transaction. In the case of an Approved Transaction, the Company shall provide
notice of the pendency of the Approved Transaction, at least fifteen (15) days
prior to the expected date of consummation thereof, to each Holder of an
outstanding Option. Each Holder shall thereupon be entitled to exercise the
Option at any time prior to consummation of the Approved Transaction. Any such
exercise as to any portion of the Option that will only become vested
immediately prior to the consummation of the Approved Transaction in accordance
with the foregoing acceleration provision shall be contingent on such
consummation. Any such exercise as to any other portion of the Option will not
be contingent on such consummation unless so elected by the Holder in a notice
delivered to the Company simultaneously with the exercise. Upon consummation of
the Approved Transaction, all Options shall expire to the extent such exercise
has not occurred. Notwithstanding the foregoing, except to the extent otherwise
provided in one or more Option Agreements evidencing Options, the Administrative
Committee may, in its discretion, determine that any or all outstanding Options
will not vest or become exercisable on an accelerated basis in connection with
an Approved Transaction and/or will not terminate if not exercised prior to
consummation of the Approved Transaction, if the Board or the surviving or
acquiring corporation, as the case may be, shall take, or made effective
provision for the taking of, such action as in the opinion of the Administrative
Committee is equitable and appropriate in order to substitute new Options for
such Options, or to assume such Options (which assumption may be effected by any
means determined by the Administrative
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<PAGE> 15
Committee, in its discretion, including, but not limited to, by a cash payment
to each Holder, in cancellation of the Options held by him or her, of such
amount as the Administrative Committee determines, in its sole discretion,
represents the then value of the Options) and in order to make such new or
assumed Options, as nearly as practicable, equivalent to the old Options (before
giving effect to any acceleration of the vesting or exercisability thereof),
taking into account, to the extent applicable, the kind and amount of
securities, cash or other assets into or for which the Common Stock may be
changed, converted or exchanged in connection with the Approved Transaction.
7.2 TERMINATION OF SERVICES. The provisions of this Section 7.2
shall apply to any Holder who is an employee of the Company or any of its
Affiliates or a party to a written consulting agreement with the Company or any
of its Affiliates.
(a) GENERAL. If such a Holder's employment or consulting
agreement terminates prior to the complete exercise of an Option, then the
Option shall, except to the extent the Option Agreement evidencing the Option
expressly provides otherwise, thereafter be exercisable, to the extent that the
Holder was entitled to exercise the Option on the date of such termination, for
a period of three (3) months following such termination (but not later than the
scheduled expiration date of the Option); PROVIDED, HOWEVER, that (i) if the
Holder's employment or consulting agreement terminates by reason of death or
Disability, then, except to the extent the Option Agreement evidencing the
Option expressly provides otherwise, the Option shall be exercisable, to the
extent that the Holder was entitled to exercise the Option on the date of such
termination, for a period of one (1) year following such termination (but not
later than the scheduled expiration of the Option), and (ii) any termination by
the Company or any of its Affiliates for cause will be treated in accordance
with the provisions of Section 7.2(b) (except to the extent the Option Agreement
expressly provides otherwise).
(b) TERMINATION BY COMPANY FOR CAUSE. If a Holder's
employment or consulting agreement with the Company or any of its Affiliates is
terminated for cause, then all Options held by the Holder shall immediately
terminate and, accordingly, may not be exercised, except to the extent one or
more of the Option Agreements evidencing the Options expressly provides
otherwise. For purposes of this Plan, "cause" shall have the meaning given that
term in any employment agreement or consulting agreement to which the Holder is
a party or, in the absence thereof, the conduct that shall constitute "cause"
for purposes of this Plan shall be insubordination, a knowing violation of a
state or federal law involving the commission of a crime against the Company or
any of its Affiliates or a felony, any misrepresentation, deception, fraud or
dishonesty that is materially injurious to the Company or any of its Affiliates,
incompetence, moral turpitude, the refusal to perform the Holder's duties and
responsibilities for any reason other than illness or incapacity, and any other
misconduct of any kind that the Administrative Committee determines constitutes
"cause" for purposes of this Plan; PROVIDED, HOWEVER, that if a termination
occurs within twelve (12) months after an Approved Transaction or Control
Purchase, termination for cause shall mean only a felony conviction for fraud,
misappropriation or embezzlement. Following termination of a Holder's employment
or consulting agreement, if the Holder engages in any act that would have
constituted cause if the Holder had remained employed by or in a consulting
relationship with the Company or any of its Affiliates, then the Administrative
Committee shall be entitled to terminate any Options held by the Holder.
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<PAGE> 16
(c) MISCELLANEOUS. The Administrative Committee may
determine whether any given leave of absence of a Holder constitutes a
termination of the Holder's employment or consulting agreement; PROVIDED,
HOWEVER, that for purposes of the Plan --
(i) a leave of absence, duly authorized in writing
by the Company or any of its Affiliates for military service or sickness, or for
any other purpose approved by the Company or any of its Affiliates, if the
period of the leave does not exceed ninety (90) days, and
(ii) a leave of absence in excess of ninety (90)
days, duly authorized in writing by the Company or any of its Affiliates,
provided the Holder's right to return to service with the Company or the
Affiliate is guaranteed either by statute or by contract --
shall not be deemed a termination of the Holder's employment or consulting
agreement. Options granted under the Plan shall not be affected by any change of
a Holder's employment or consulting agreement so long as the Holder continues to
be an employee of or consultant to the Company or any of its Affiliates. Except
to the extent an Option Agreement evidencing an Option expressly provides
otherwise, if a Holder has an employment or consulting agreement with an
Affiliate of the Company that ceases to be an Affiliate, such event shall be
deemed to constitute a termination of the Holder's employment or consulting
agreement for a reason other than death or Disability.
7.3 RIGHT TO TERMINATE SERVICES. Nothing contained in the Plan or in
any Option Agreement, and no action of the Company or the Administrative
Committee with respect thereto, shall confer or be construed to confer on any
Holder any right to continue in the service of the Company or any of its
Affiliates or interfere in any way with the right of the Company or any of its
Affiliates, subject to the provisions of any agreement between the Holder and
the Company or any of its Affiliates, to terminate at any time, with or without
cause, the employment or consulting agreement with the Holder.
7.4 NONALIENATION OF BENEFITS. Except as provided in Section 6.9, no
right or benefit under the Plan shall be subject to anticipation, alienation,
sale, assignment, hypothecation, pledge, exchange, transfer, encumbrance or
charge, and any attempt to anticipate, alienate, sell, assign, hypothecate,
pledge, exchange, transfer, encumber or charge the same shall be void. No right
or benefit hereunder shall in any manner be liable for or subject to the debts,
contracts, liabilities or torts of the person entitled to the right or benefit.
7.5 SHAREHOLDERS AGREEMENT. Unless the Option Agreement evidencing
an Option expressly provides otherwise, the Holder of the Option shall be
required, as a condition to the issuance of any shares of Common Stock that the
Holder acquires upon the exercise of the Option, to execute and deliver to the
Company a shareholders agreement in such form as may be in use by the Company at
the time of such exercise, or a counterpart thereof, together with, unless the
Holder is unmarried, a spousal consent in the form required thereby, unless the
Holder has previously executed and delivered such documents and they are in
effect at the time the shares are to be issued.
7.6 TERMINATION AND AMENDMENT.
(a) GENERAL. Unless the Plan shall previously have been
terminated as hereinafter provided, no Options may be granted under the Plan on
or after the tenth (10th) anniversary of the Effective Date. The Board or the
Administrative Committee may at any time
-13-
<PAGE> 17
prior to the tenth (10th) anniversary of the Effective Date terminate the Plan,
and may, from time to time, suspend or discontinue the Plan or modify or amend
the Plan in such respects as it shall deem advisable; PROVIDED, HOWEVER, that
any such modification or amendment shall comply with all applicable laws and
stock exchange listing requirements and, with respect to Incentive Stock Options
granted or to be granted under the Plan, shall be subject to any approval by
shareholders of the Company required under the Code.
(b) MODIFICATION. No termination, modification or amendment
of the Plan may adversely affect the rights of the Holder of an outstanding
Option in any material way unless the Holder consents thereto. No modification,
extension, renewal or other change in any Option granted under the Plan shall be
made after the grant of the Option, unless the same is consistent with the
provisions of the Plan. With the consent of the Holder and subject to the terms
and conditions of the Plan (including Section 7.6(a)), the Administrative
Committee may amend outstanding Option Agreements with any Holder, including,
without limitation, any amendment that would (i) accelerate the time or times at
which the Option may be exercised, and/or (ii) extend the scheduled expiration
date of the Option. Without limiting the generality of the foregoing, the
Administrative Committee may, but solely with the Holder's consent unless
otherwise provided in the Option Agreement, agree to cancel any Option under the
Plan and issue a new Option in substitution therefor, provided that the Option
so substituted shall satisfy all of the requirements of the Plan as of the date
the new Option is granted. Nothing contained in the foregoing provisions of this
Section 7.6(b) shall be construed to prevent the Administrative Committee from
providing in any Option Agreement that the rights of the Holder with respect to
the Option are subject to such rules and regulations as the Administrative
Committee may, subject to the express provisions of the Plan, adopt from time to
time, or impair the enforceability of any such provision.
7.7 GOVERNMENT AND OTHER REGULATIONS. The obligation of the Company
with respect to Options shall be subject to all applicable laws, rules and
regulations and such approvals by any governmental agencies as may be required,
including, without limitation, the effectiveness of any registration statement
required under the Securities Act, and the rules and regulations of any
securities exchange or association on which the Common Stock may be listed or
quoted. As long as the Common Stock is not registered under the Exchange Act,
the Company intends that all offers and sales of Options and shares of Common
Stock issuable upon exercise of Options shall be exempt from registration under
the provisions of Section 5 of the Securities Act, and the Plan shall be
administered in a manner so as to preserve such exemption. The Company also
intends that the Plan shall constitute a written compensatory benefit plan,
within the meaning of Rule 701(b) promulgated under the Securities Act, and that
each Option granted under the Plan at a time when the Common Stock is not
registered under the Exchange Act shall, unless otherwise provided by the
Administrative Committee at the time the Option is granted, be granted in
reliance on the exemption from the registration requirements of Section 5 of the
Securities Act provided by Rule 701. As long as the Common Stock is registered
under the Exchange Act, the Company shall use its reasonable efforts to comply
with any legal requirements to file in a timely manner all reports required to
be filed by it under the Exchange Act.
7.8 WITHHOLDING. The Company's obligation to deliver shares of
Common Stock upon exercise of an Option shall be subject to applicable federal,
state and local tax withholding requirements. Federal, state and local
withholding tax due at the time an Option is exercised may, in the discretion of
the Administrative Committee, be paid in shares of Common Stock already owned by
the Holder or through the withholding of shares otherwise issuable to the
Holder, upon such
-14-
<PAGE> 18
terms and conditions as the Administrative Committee shall determine. If the
Holder shall fail to pay, or make arrangements satisfactory to the
Administrative Committee for the payment of, all such federal, state and local
taxes, then the Company or any of its Affiliates shall, to the extent not
prohibited by law, have the right to deduct from any payment of any kind
otherwise due to the Holder an amount equal to any federal, state or local taxes
of any kind required to be withheld by the Company or any of its Affiliates with
respect to the Option.
7.9 SEPARABILITY. With respect to Incentive Stock Options, if this
Plan does not contain any provision required to be included herein under Section
422 of the Code, such provision shall be deemed to be incorporated herein with
the same force and effect as if such provision had been set out at length
herein; PROVIDED, HOWEVER, that to the extent any Option that is intended to
qualify as an Incentive Stock Option cannot so qualify, the Option, to that
extent, shall be deemed to be a Nonqualified Stock Option for all purposes of
the Plan.
7.10 NON-EXCLUSIVITY OF THE PLAN. Neither the adoption of the Plan by
the Board nor the submission of the Plan to the shareholders of the Company for
approval shall be construed as creating any limitations on the power of the
Board to adopt such other incentive arrangements as it may deem desirable,
including, without limitation, the granting of stock options and the awarding of
stock and cash otherwise than under the Plan, and such arrangements may be
either generally applicable or applicable only in specific cases.
7.11 EXCLUSION FROM PENSION AND PROFIT-SHARING COMPUTATION. By
acceptance of an Option, unless otherwise provided in the Option Agreement
evidencing the Option, the Holder shall be deemed to have agreed that the Option
is special incentive compensation that will not be taken into account, in any
manner, as salary, compensation or bonus in determining the amount of any
payment under any pension, retirement or other employee benefit plan, program or
policy of the Company or any of its Affiliates.
7.12 NO SHAREHOLDER RIGHTS. No Holder or other person shall have any
voting or other shareholder rights with respect to shares of Common Stock
subject to an Option until the Option has been duly exercised, full payment of
the purchase price has been made, all conditions under the Option and this Plan
to issuance of the shares have been satisfied, and a certificate for the shares
has been issued. No adjustment shall be made for cash or other dividends or
distributions to shareholders for which the record date is prior to the date of
such issuance.
7.13 GOVERNING LAW. The Plan shall be governed by, and construed in
accordance with, the laws of the State of Washington.
7.14 COMPANY'S RIGHTS. The grant of Options pursuant to the Plan
shall not affect in any way the right or power of the Company to make
reclassifications, reorganizations or other changes of or to its capital or
business structure or to merge, consolidate, liquidate, sell or otherwise
dispose of all or any part of its business or assets.
-15-
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<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 40,399
<SECURITIES> 57,634
<RECEIVABLES> 5,345
<ALLOWANCES> 1,164
<INVENTORY> 209
<CURRENT-ASSETS> 106,452
<PP&E> 9,593
<DEPRECIATION> 4,245
<TOTAL-ASSETS> 114,603
<CURRENT-LIABILITIES> 30,428
<BONDS> 1,002
0
0
<COMMON> 32
<OTHER-SE> 72,474
<TOTAL-LIABILITY-AND-EQUITY> 114,603
<SALES> 0
<TOTAL-REVENUES> 27,558
<CGS> 0
<TOTAL-COSTS> 5,400
<OTHER-EXPENSES> 46,619
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (22,192)
<INCOME-TAX> 0
<INCOME-CONTINUING> (22,192)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (22,192)
<EPS-PRIMARY> (0.70)
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