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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER 0-23137
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REALNETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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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)
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(206) 674-2700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.001 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the Common Stock held by non-affiliates of the
registrant, based on the closing price on March 20, 1998, as reported on NASDAQ,
was $160,923,082.(1)
The number of shares of the registrant's Common Stock outstanding as of
March 20, 1998 was 27,658,743. In addition, there were 3,338,374 outstanding
shares of the registrant's Special Common Stock, par value $0.001 per share,
that automatically converts 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.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Proxy Statement relating to the registrant's
1998 Annual Meeting of Shareholders to be held on May 22, 1998 are incorporated
by reference into Part III of this Report.
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(1) Excludes shares held of record on that date by directors, officers and 10%
shareholders of the registrant. Exclusion of such shares should not be
construed to indicate that any such person directly or indirectly possesses
the power to direct or cause the direction of the management of the policies
of the registrant.
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TABLE OF CONTENTS
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 15
Item 4A. Executive Officers of the Registrant........................ 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Shareholder Matters....................................... 18
Item 6. Selected Consolidated Financial Data........................ 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 22
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 34
Item 8. Financial Statements and Supplementary Data................. 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................. 53
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 54
Item 11. Executive Compensation...................................... 54
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 54
Item 13. Certain Relationships and Related Transactions.............. 54
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 55
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PART I.
THIS ANNUAL REPORT ON FORM 10-K AND THE DOCUMENTS INCORPORATED HEREIN BY
REFERENCE CONTAIN FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT TO THE
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. 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
"CERTAIN RISK FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS, FUTURE OPERATING
RESULTS AND FINANCIAL CONDITION" ON PAGES 29 THROUGH 34, AS WELL AS THOSE RISKS
AND UNCERTAINTIES NOTED IN THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE.
PARTICULAR ATTENTION SHOULD ALSO BE PAID TO THE CAUTIONARY LANGUAGE IN THE
SECTIONS OF ITEM 1 ENTITLED "MICROSOFT RELATIONSHIP," "COMPETITION,"
"GOVERNMENTAL REGULATION" AND "INTELLECTUAL PROPERTY" AND IN ITEM 3: "LEGAL
PROCEEDINGS." 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 RISK FACTORS SET FORTH IN OTHER REPORTS OR DOCUMENTS THAT THE COMPANY
FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION,
PARTICULARLY THE QUARTERLY REPORTS ON FORM 10-Q AND ANY CURRENT REPORTS ON FORM
8-K.
ITEM 1. BUSINESS
THE COMPANY
RealNetworks, Inc., a Washington corporation ("RealNetworks" or the
"Company") 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 was incorporated in February 1994 and completed its initial public
offering in November 1997.
The Company's products and services include its RealSystem, a streaming
media solution that includes RealAudio and RealVideo technology, an electronic
commerce Web site designed to promote the proliferation of streaming media
products and a network of advertising-supported content aggregation Web sites.
As the Web continues to evolve as a mass communications medium, the Company
believes that certain types of content currently delivered through traditional
media, such as radio and television, increasingly will be delivered over the
Internet. The Company believes that streaming media technology is essential to
this evolution because it enables a more compelling user experience, allowing
the Internet to compete more effectively with traditional media for audience
share.
INDUSTRY BACKGROUND
The Internet has grown rapidly in recent years, driven by the development
of the Web and graphically intuitive Web browsers, the proliferation of
multimedia PCs, increasingly robust network architectures and the emergence of
compelling Web-based content and commerce applications. The broad acceptance of
the standard Internet Protocol ("IP") has also led to the emergence of intranets
and the development of a wide range of non-PC devices that allow users to access
the Internet and intranets. International Data Corporation
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estimates that the number of Web users worldwide will continue to grow rapidly
from 28 million in 1996 to 175 million in 2001. In addition, users are spending
an increasing amount of time on the Web.
The development of the Web has contributed to the transition of the
Internet from a text and e-mail-focused data-sharing network to a richer
environment, capable of delivering graphical and interactive content. The Web
has a number of features unavailable in traditional media and commerce channels
that attract online users, content providers, advertisers and merchants. The
relatively low barriers to publishing content on the Web have led to an
explosion of Web-based content and the development of a large and diverse group
of Web-based communication channels. As an interactive, searchable,
user-controlled medium, the Web provides a highly engaging user experience and
allows users to access this broad range of online content on demand and at their
convenience. The narrow-casting capabilities of the Web enable content providers
and advertisers to establish customized, personalized interactions with
consumers.
The development of streaming media technology has further enhanced the
graphical capabilities of the Internet and intranets. Streaming technology
enables the transmission and playback of continuous "streams" of multimedia
content, such as audio and video, over the Internet and intranets, and
represents a significant advancement over earlier technologies. Prior to the
advent of streaming technology, users could not initiate the playback of audio
or video clips until such content was downloaded in its entirety, resulting in
significant waiting times. As a result, live broadcasts of audio and video
content over the Internet or intranets were not possible.
MARKET OPPORTUNITY
The Company believes that the emergence of rich multimedia capabilities,
such as streaming audio and video, has significantly enhanced the effectiveness
of the Web as a global mass communications medium and has accelerated the
adoption of corporate intranets as a means to improve communications within
enterprises. Many businesses and content providers now offer interactive audio,
video and other multimedia content as a means of enriching and differentiating
their Web sites. The Company believes that more than 145,000 hours per week of
live audio and video content are broadcast over the Web using RealAudio and
RealVideo technology, with a substantially greater amount of recorded media
available on demand.
As the Web continues to evolve as a mass communications medium, the Company
believes that certain types of content currently delivered through traditional
media, such as radio and television, increasingly will be delivered over the
Internet. The Company believes that streaming media technology is essential to
this evolution because it provides a more compelling user experience, allowing
the Internet to compete more effectively with traditional media for audience
share.
The Company believes that to successfully capitalize on this opportunity,
streaming media providers must address the following challenges:
DELIVER COMPELLING STREAMING MEDIA CONTENT IN BANDWIDTH CONSTRAINED
ENVIRONMENTS. The Internet was designed to transmit discrete packets of data and
is not inherently well suited to the delivery of continuous streams of
multimedia data without additional software. In addition, bandwidth is limited
in Internet and intranet environments, posing significant technological
challenges for delivery of high-quality streaming audio and video content.
ENABLE BROAD-BASED ACCESS TO STREAMING MEDIA TECHNOLOGY. Online content
providers, advertisers and merchants must make a significant investment to
create and deliver streaming media content and need to reach a sufficiently
large audience to generate an adequate return on such investment. As a result,
content providers must consider the popularity and quality of a particular
streaming media solution before committing resources to delivering content using
that solution.
DRIVE CONSUMER USAGE. The Company believes that consumer interest in
streaming media content is driven in large part by the ability to locate and
experience such content easily. As a result, the Company believes that the
development of well-marketed, compelling Web sites that aggregate streaming
media content is central to the continued growth of multimedia content on the
Web.
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The Company believes that a substantial opportunity exists to provide
software solutions and content aggregation and delivery services that address
these challenges and support the development of large and growing advertising
and electronic commerce markets on the Web.
THE REALNETWORKS SOLUTION
RealNetworks enables and promotes the transmission of real-time streaming
media content over the Internet and intranets. The Company provides branded
streaming media software products and services, including its RealSystem, a
streaming media solution that includes RealAudio and RealVideo technology, an
electronic commerce Web site designed to promote the proliferation of streaming
media products and a network of advertising-supported content aggregation Web
sites. Each of the Company's products and services has been designed to address
the technological and market development challenges that confront streaming
media content providers.
STREAMING MEDIA TECHNOLOGY. RealNetworks has been a pioneer in the
development of streaming media technology and continues to offer leading
streaming media software solutions. The Company's products use advanced
compression and error-correction technologies to deliver acceptable performance
even in bandwidth-constrained environments. The Company has won numerous awards
for its technology, including PC Magazine's Editor's Choice award for streaming
video in October 1997 and PC Computing's five-star rating in March 1998. The
Company's RealSystem Version 5.0 offers software products with streaming
animation capabilities and improved audio and video quality, including
full-screen video at higher bandwidths. RealSystem Version 5.0 also enables
incorporation of seamless in-stream advertising into existing broadcasts or
on-demand clips. The Company believes in-stream advertising offers increased
revenue opportunities for its RealSystem Server customers. In addition,
RealSystem Version 5.0 enables password-protected access to content, allowing
content providers to incorporate subscription-based or "pay-per-view" streaming
media content access over the Internet. The Company's software runs on a broad
range of operating systems and hardware platforms, enabling content providers to
reach a broad audience and enterprises to deliver intranet content in
heterogeneous computing environments.
REALPLAYER UBIQUITY AND BRAND STRENGTH. From its inception, the Company has
strategically chosen to offer its RealPlayer software to individual users free
of charge to promote the widespread adoption of its client software and speed
the acceptance of Internet multimedia. The Company believes that more than 40
million copies of its RealPlayer software have been downloaded electronically
and that more than 260,000 Web pages use the Company's software. In addition,
over 1,200 third-party developers have joined the Company's Real Developer
Program. To continue the broad market adoption of its server products, the
Company now offers its Basic Server free of charge. As a result of these
activities and the Company's aggressive promotional programs, the Company
believes that the "Real" brand has become one of the most widely recognized
brands on the Internet.
ELECTRONIC COMMERCE DISTRIBUTION CHANNEL. The Company has pursued an
electronic commerce distribution strategy designed to further accelerate product
adoption and drive upgrade and cross-selling opportunities among its existing
installed user base. The Company's online distribution efforts have resulted in
electronic sales of over 400,000 copies of the Company's RealPlayer Plus in its
first eighteen months of distribution and the collection of a database of
information that includes over 18 million names. The Company's RealStore Web
site is an online store for the sale of the Company's products, third-party
streaming media tools and utilities, and intranet-based training products. The
Company believes that it will be able to continue to facilitate the adoption and
growth of streaming media content by providing a concentrated marketplace and a
low-cost distribution mechanism for emerging streaming media tools and their
developers.
STREAMING MEDIA CONTENT AND AGGREGATION. The Company's
advertising-supported Web sites, including Timecast, LiveConcerts.com and
Film.com, aggregate, organize and provide streaming media programming in order
to build consumer awareness and Web site traffic for streaming media content.
The Company's Daily Briefing and Destination Button services provide one-click
access to a range of third-party programming. In addition to generating
advertising revenues, the Company believes these sites and services stimulate
demand for and creation of streaming media content using the Company's
RealSystem.
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STRATEGY
The Company's objective is to be the leading streaming media company,
providing software and services that enable the delivery of a broad range of
multimedia content over the Internet and intranets, thereby facilitating the
evolution of the Internet into a mass communications and commerce medium. To
achieve this objective, the Company's strategy includes the following key
elements:
EXTEND TECHNOLOGY LEADERSHIP. The Company has established a reputation as a
leader in streaming media technology and intends to continue to maintain its
reputation for quality and innovation by expanding the features and breadth of
its product offerings. The Company introduced streaming animation, in-stream
advertising and password-protected access to content with the release of its
RealSystem Version 5.0. The Company believes that the fundamental architecture
of its products also can be expanded to support synchronized streaming of a wide
variety of other time-based data types, such as MIDI, images and multimedia
presentations. As part of its strategy, the Company has devoted and will
continue to commit significant resources to the development of technologies that
increase the scaleability of streaming media solutions.
MAXIMIZE MARKET PENETRATION AND BRAND NAME RECOGNITION. The Company
believes that it is a recognized leader in streaming media technology and that
its "Real" brand is one of the most widely recognized brand names on the
Internet. Since its inception, the Company has sought to achieve rapid and broad
adoption of its technologies and strong brand recognition. This strategy has
been pursued through various means, such as offering the Company's RealPlayer
and Basic Server free of charge over the Internet, bundling the Company's
products with those of other major vendors and using multiple distribution
channels, including both direct sales and indirect original equipment
manufacturer ("OEM") and retail relationships. The Company also intends to
continue to promote the adoption of industry standards that are either based on
or compatible with its technologies. For example, the Company is one of the
principal co-authors of the Real Time Streaming Protocol ("RTSP"), a proposed
industry standard for the control and delivery of streaming media.
LEVERAGE MARKET POSITION TO EXPAND BUSINESS MODEL. Management believes that
the Company's technology leadership, market position and brand name are
significant assets that the Company can leverage to maintain and increase its
market share and diversify its revenue base. The Company intends to leverage
these assets as follows:
- GROW STREAMING MEDIA SOFTWARE BUSINESS. The Company intends to capitalize
on the growth in demand for streaming media software by continuing to
develop, market and support industry-leading products and services. The
Company also plans to strengthen its marketing, sales and customer
support efforts as the size of its market opportunity and customer base
increases.
- EXPAND INTERNET COMMERCE BUSINESS. The Company's Web sites provide
product information and fulfillment resources for streaming media content
users and developers. The Company's RealStore Web site is an online store
for the sale of the Company's products, third-party streaming media tools
and utilities, and intranet-based training products.
- OFFER LEADING CONTENT AGGREGATION SITES FOR STREAMING MEDIA. The Company
has developed a network of Web sites that aggregate links to third-party
streaming media programming. The Company plans to continue building Web
site traffic with these activities to increase Web site advertising
revenues, increase visibility and sales of the Company's products,
promote the use of streaming media content on the Internet or intranets
and promote the Company's Internet commerce platform.
DEVELOP AND MARKET STREAMING MEDIA SOLUTIONS FOR A VARIETY OF PLATFORMS AND
BANDWIDTHS. The Company's rapid growth is attributable in part to the wide
acceptance of the streaming media solutions it has developed for PCs networked
in low-bandwidth environments. However, significant efforts are underway to make
the Internet available on a wider range of platforms, including non-PC Internet
appliances, and over higher-speed connections, including cable modems.
Accordingly, the Company seeks to design its solutions to add value in a range
of bandwidth environments and to be flexible enough to port easily to new
platforms. As a
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result, management believes that the Company is positioned to capitalize on
possibly significant platform and bandwidth changes.
STRENGTHEN STRATEGIC RELATIONSHIPS. The Company has established strategic
relationships with a variety of industry participants, including software and
hardware vendors, entertainment companies, content publishers and broadcast
media companies. The Company's relationship with Microsoft Corporation
("Microsoft") enables wider distribution of the Company's products and promotes
interoperability among numerous streaming media technologies. In addition to its
relationship with Microsoft, the Company has formed strategic relationships with
several other companies, including AudioNet, Inc., Sun Microsystems, Inc.,
Digital Equipment Corporation, Santa Cruz Operation Inc., Silicon Graphics Inc.
and Macromedia, Inc. ("Macromedia"), has formed a joint venture in Japan with
NTT PC Communications, Inc. ("NTT"), Kokusai Denshin Denwa Co., Ltd. ("KDD") and
Trans Cosmos, Inc. ("Trans Cosmos") and has entered into a pilot program with
MCI Communications Corporation ("MCI") to distribute the Real Broadcast Network.
The Company pursues strategic relationships for a variety of purposes, such as
maximizing rapid penetration, validation and adoption of its technologies;
aiding the development of compelling content to build consumer demand for
streaming media over the Internet; and expanding the range of commercial
activities based on its technology and brand name. The Company has also
collaborated with other industry leaders for the purpose of developing software
protocols for proposed adoption as industry standards. Although the Company has
not engaged in significant joint technology development relationships to date,
it anticipates that it may form third-party development relationships in the
future as it seeks to expand the fundamental architecture of its technology and
influence the direction of technological developments in the industry.
PRODUCTS AND SERVICES
The Company develops and markets software products and services that enable
the delivery of streaming audio and video content over the Internet and
intranets. The Company also conducts electronic commerce and sells advertising
through its Web sites, provides audio and video broadcast services to third
parties, and provides various other services designed to promote widespread
usage of the Company's technology.
MEDIA SYSTEM
The Company's streaming media system allows content providers to encode
content such as audio, video or other multimedia programming into discrete data
packets that can be broadcast to large numbers of simultaneous users.
BASIC SERVER. The Company offers a Basic Server free of charge from its Web
sites. This product enables content providers to stream both audio and video to
as many as 60 simultaneous users.
BASIC SERVER PLUS. The Basic Server Plus is an enhanced server that can be
downloaded from the Company's Web sites starting at $695. In addition to the
Basic Server functions, Basic Server Plus supports streaming animation and
enhanced administration capabilities and includes RealPublisher, technical
support and upgrades.
REALSERVER INTERNET SOLUTION. The Internet Solution is designed for use by
commercial Web sites, including media content providers that distribute audio,
video or animation content over the Internet to a broad base of consumers. The
Internet Solution includes the RealServer, which offers the Basic Server Plus
functions as well as advanced administrative features, the ability to reach a
larger audience and in-stream advertising insertion and rotation. The Internet
Solution also includes the RealPublisher and the RealEncoder. Internet Solution
licenses start at $2,795 and are priced based on the number of streams licensed.
REALSERVER INTRANET SOLUTION. The Intranet Solution is a RealServer
designed specifically for use in intranet applications. The Intranet Solution
includes the RealPublisher, the RealEncoder and a site license for the
RealPlayer. A 10-user Intranet Solution is available free of charge from the
Company's Web sites. Larger system licenses start at $6,995 and are priced
according to the number of licensed users.
COMMERCE SOLUTION. The Commerce Solution is an integrated system that can
be used with the Internet or Intranet Solution to provide secure, selective
access to streaming media content. The Commerce Solution is
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comprised of the Commerce RealServer, which includes all the functions of the
RealServer as well as user and workstation authentication, encrypted
challenge/response systems and broad database and Web-based commerce systems
compatibility. Commerce Solution licenses are priced based on the number of
streams licensed.
REALPUBLISHER. The RealPublisher is a software tool that enables users to
create and publish RealAudio and RealVideo content-enabled Web pages without
having to program in HTML. The RealPublisher can be downloaded from the
Company's Web sites for $49.99.
REALENCODERS. The Company's RealEncoders enable content providers to
compress live or recorded audio and video programming into the Company's file
format. This highly compressed file format increases the efficiency of
limited-bandwidth transmissions and is readable by the Company's players. The
RealEncoder can be downloaded free of charge from the Company's Web sites.
REALPRESENTER. The RealPresenter is a plug-in tool for use with Microsoft
PowerPoint. RealPresenter allows users to stream full screen audio narrated
PowerPoint presentations over the Internet or intranets. The RealPresenter can
be downloaded from the Company's Web sites for $39.99.
REAL BROADCAST NETWORK. The Company operates the Real Broadcast Network,
which uses the Company's splitter technology to broadcast content to thousands
of simultaneous users through IP multicasting or traditional unicasting. In
August 1997, the Company and MCI commenced a pilot program in which the
Company's technology is incorporated into MCI's Internet backbone. The Real
Broadcast Network enables broadcasters to reach up to 50,000 users
simultaneously by combining MCI's nationwide network of datalines and computer
centers with the Company's streaming media and splitter technologies. In select
cases, the Company has and will continue to enter into relationships with
content providers in which the providers' content is hosted on the Real
Broadcast Network at the Company's expense in exchange for a share of the
advertising or other revenue generated.
In May 1997, the Company entered into a joint venture with NTT, KDD and
Trans Cosmos in Japan to establish J-Stream Co. Inc. ("J-Stream"), which, like
the Company's Real Broadcast Network, streams audio and video content to users
through IP multicasting or traditional unicasting. The Company supplies its
RealAudio and RealVideo system and technical support for the operation of the
J-Stream broadcast network. The Company holds a 24% interest in J-Stream.
CONSULTING. The Company provides a range of consulting services that
principally relate to the creation and maintenance of streaming media networks
based on the Company's technology. Commonly provided services include sound
editing, video production assistance and network design.
CONSUMER PRODUCTS AND ELECTRONIC COMMERCE
The Company's player enables a user to listen to or view content from Web
sites that use the Company's server products. The player decompresses and
decodes audio, video or animation packets transmitted by the server, reassembles
them in the correct order, identifies and requests retransmission of any missing
data packets, and then plays back the reassembled audio, video or animation
content for the user in real-time. The players can be easily installed and used
by nontechnical computer users, even using dial-up modems over standard
voice-grade telephone lines.
REALPLAYER. RealPlayer, the Company's standard player, can be downloaded
free of charge from the Company's Web sites and currently is distributed by a
number of third parties in combination with their own products. RealPlayer
offers basic functions such as play, stop, fast-forward, rewind and volume
adjustment, as well as the ability to program six Destination Buttons, which
provide one-click access to preprogrammed audio, video or animation content.
REALPLAYER PLUS. The RealPlayer Plus is an enhanced player that can be
downloaded from the Company's Web sites or purchased in a retail store for a
suggested price of $29.99. RealPlayer Plus not only offers basic RealPlayer
functions, but also features a scan function and 40 programmable buttons that
allow
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users to preset favorite content. Customers who purchase a RealPlayer Plus also
have access to special content available only to RealPlayer Plus users.
ELECTRONIC COMMERCE AND REALSTORE. Since August 1996, the Company has sold
its products electronically. On September 8, 1997, it opened its RealStore Web
site, an online store for the sale of the Company's products, third-party
streaming media tools and utilities, and intranet-based training products.
Through this distribution channel, the Company is able to offer a broad
selection of products with little inventory risk or merchandising expense.
MEDIA PUBLISHING PRODUCTS AND SERVICES
The Company's network of Web sites aggregates, organizes and provides
streaming media programming through a variety of navigational and theme-oriented
content sites. These sites derive revenues from the sale of advertising. The
Company has been instrumental in pioneering new forms of Internet advertising,
including in-stream advertising, in which streamed audio and video
advertisements are inserted into selected programming.
In addition to its main Web site, the Company's network of Web sites
includes:
Timecast, a guide to RealAudio and RealVideo content that offers
programming information from and links to over 4,000 Web sites, including over
650 radio and television stations;
LiveConcerts.com, which, in cooperation with House of Blues, offers live
streamed music concerts using the Company's products as well as access to
services, including up-to-date concert schedules;
Film.com, which provides in-depth information about, and streaming media
clips of, movies, including reviews and previews; and
Daily Briefing, which allows customers to design their own custom streaming
media newscasts from over 50 short programs in the areas of news, sports,
entertainment, weather and business/technology, and to receive the custom
newscasts daily.
TECHNOLOGY
The Company's client/server software system is designed to optimize the
delivery of streaming media over the Internet, intranets or any IP-based
network. The system is based on open industry standards and works with a broad
range of operating systems, hardware platforms and media types.
CODECS
The Company's system uses multiple compression/decompression algorithms (or
"codecs") to translate time-based data-intensive content such as audio, video or
animation data into discrete data packets and then broadcast (or "stream") the
packets to the client (or "player"). The player then reassembles the packets in
the correct order and plays back the streaming media content in real time. The
compression process enables the data to be streamed to the player even in very
low bandwidth (14.4 kbps) or congested network environments by reducing the
amount of data to be streamed.
TRANSMISSION TECHNOLOGY AND PROTOCOLS
Neither of the two basic Internet transport protocols, User Datagram
Protocol ("UDP") and Transport Control Protocol ("TCP"), was originally designed
to handle the transmission of real-time content. UDP is able to transmit data
packets efficiently and without delays, but is not generally robust enough to
ensure delivery of all data packets. TCP generates robust and reliable
transmissions, but is not designed for efficient and continuous real-time
delivery of content. Higher level Internet protocols, such as File Transfer
Protocol and Hypertext Transfer Protocol ("HTTP"), were designed originally for
one-way continuous transmissions and as such do not efficiently allow the player
to communicate back to the server to activate functions such as fast forward,
pause and rewind or to select a particular portion of a clip for playing.
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To address the inherent limitations of the Internet with respect to
multimedia delivery, the Company has developed its own client/server software
architecture based on advanced transmission technologies and protocols. Key
elements of the Company's technology solution include:
BUFFERING: Because the streaming of continuous, time-based content
such as audio or video must occur in real-time and with minimal
transmission loss, the Company's technology incorporates a time delay (or
"buffering") feature that allows the player extra time to accumulate data
packets and, if any are missing, request retransmission of particular
packets. As a result, transmission and playback quality can be optimized,
even in highly congested transmission environments.
BIDIRECTIONAL COMMUNICATION: The Company's server and player
communicate during transmission regarding the bandwidth and quality of the
user's connection to optimize the transmission by using the system's
bandwidth negotiation and dynamic connection management capabilities. For
example, the system is able to detect the available bandwidth and the
extent of packet loss and performance degradation.
ERROR-MITIGATION: To the extent that buffering and packet
retransmission efforts are insufficient to maintain acceptable quality of
user experience, the Company's system draws on several techniques designed
to mitigate performance degradation, including interpolation methods that
"reconstruct" lost data packets based on approximations regarding adjacent
or closely related data packets, UDP-based retransmission of lost packets
and forward error correction.
SMART NETWORKING: This feature allows a server to stream content to
the player via unicasting or IP multicasting and automatically select the
appropriate transmission protocol (UDP, TCP or HTTP) depending on current
network conditions and the presence of firewalls or proxies.
VIDEO-OPTIMIZED TRANSMISSION: Because video transmissions are more
data-intensive than audio transmissions, the encoding of video streams for
low bandwidth requires a higher compression ratio. In addition to standard
compression techniques, the Company uses a technique known as interframe
compression, which reduces unnecessary repetition of redundant background
data in neighboring video frames, thereby reducing the number of data
packets being transmitted. The system also incorporates "stream thinning"
technology that responds to episodes of performance degradation by
dynamically reducing the amount of video content being streamed to the
user, thereby preserving bandwidth for audio packets to maintain the
continuity of the audio stream, which is often more central to the user
experience than video.
In addition to its core client/server technology, the Company has adopted
RTSP, a proposed protocol for standardizing the control and delivery of
streaming media over the Internet. RTSP is a unified standard for a broad range
of media data types and is intended to promote a greater level of
interoperability among various streaming media solutions. RTSP is built on top
of a number of other Internet standard protocols such as HTTP, TCP/IP and Real
Transport Protocol, and is complementary with Active Streaming Format ("ASF"), a
file format for streaming media that does not specify a method of client-server
interaction. RTSP provides the client server specification necessary to stream
ASF files (and many other file types) on the Internet. RTSP was submitted to the
Internet Engineering Task Force in October 1996 with the support of over 40
companies.
NETWORKED MULTIMEDIA FOR LARGE-SCALE DELIVERY
The Company's splitter technology allows broadcasters to transmit large
numbers of simultaneous streams. Traditionally, a stand-alone server sends a
separate signal to each individual user, which is an inefficient use of network
bandwidth because the same signal often is distributed through many of the same
links on the network.
The Company's splitter technology enables one "central" server to broadcast
a signal to a set of servers distributed around a network, which servers then
transmit the signal to the end user, thereby minimizing the use of the network
backbone and improving signal quality. The Company uses this technology in its
Real Broadcast Network, as well as in its J-Stream joint venture in Japan.
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<PAGE> 11
RESEARCH AND DEVELOPMENT
The Company devotes a substantial portion of its resources to developing
new products and product features, expanding and improving its fundamental
streaming technology, and strengthening its technological expertise. During the
fiscal years ended December 31, 1997 and December 31, 1996, the Company expended
approximately 41% and 34%, respectively, of its total net revenues on research
and development activities. The Company intends to continue to devote
substantial resources toward research and development for the next several
years. At December 31, 1997, the Company had 105 employees, or approximately 32%
of its work force, engaged in research and development activities. The Company
must hire additional skilled software engineers to further its research and
development efforts. The Company's business, financial condition and results of
operations could be adversely affected if it is not able to hire, train and
retain the required number of engineers.
SALES, MARKETING AND DISTRIBUTION
The Company believes that any individual or company that desires to
transmit or receive streaming media content over the Internet or intranets is a
potential Company customer. To reach as many customer segments as possible, the
Company markets its products and services through several direct and indirect
distribution channels, including over the Internet, through a direct sales
force, through OEMs and VARs, and internationally through distributors and the
J-Stream joint venture. As of December 31, 1997, the Company had 125 employees,
or approximately 38% of its work force, engaged in sales and marketing
activities.
ELECTRONIC COMMERCE. Substantially all of the Company's products may be
downloaded directly from the Company's Web sites, with over 40 million downloads
of its RealPlayer to date. The Company sells third-party products on its
RealStore Web site on a consignment basis and, accordingly, incurs no inventory
risk with respect to such products. Electronic distribution provides the Company
with a low-cost, globally accessible, 24-hour sales channel.
DIRECT SALES FORCE. The Company's direct sales force markets the Company's
products and services primarily to corporate customers interested in server
products for commercial Internet Web sites or intranets. A telesales group
develops and pursues leads generated from inquiries on the Company's Web sites
and from downloads of its Basic Server.
OEMS AND VARS. The Company has entered into various distribution
relationships with third parties pursuant to which the Company's products are
incorporated into, or bundled with, the third party's products for delivery by
the third party to end users.
ADVERTISING SALES. The Company's advertising sales force markets and sells
advertising on the Company's Web sites and within media streams that the Company
hosts on behalf of its corporate customers.
INTERNATIONAL SALES. The Company has four international subsidiaries that
market and sell the Company's products outside the U.S. The Company distributes
its products internationally through a direct sales force and distribution
arrangements.
MARKETING PROGRAMS. The Company participates in trade shows, conferences
and seminars, provides product information through the Company's Web sites,
promotes and co-promotes special events, places advertising for the Company's
products and services in print and electronic media, and sponsors special
programs for software developers, including its own conference. The Company's
marketing programs are aimed at informing distributors and end users about the
capabilities and benefits of the Company's products and services, increasing
brand name awareness, stimulating demand across all market segments and
encouraging independent software developers to develop products and applications
that are compatible with the Company's products and technology.
MICROSOFT RELATIONSHIP
In June 1997, the Company entered into a strategic agreement with Microsoft
pursuant to which the Company granted Microsoft a nonexclusive license to its
Standard Code (as defined in the agreement), which
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<PAGE> 12
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. Under the agreement, Microsoft may
sublicense its rights to the Standard Code to third parties under certain
circumstances. On two occasions during the first two years following delivery
under the agreement, Microsoft may acquire for $25 million and $35 million,
respectively, a nonexclusive license to subsequently developed versions of the
Standard Code, products based on which are currently distributed to end users by
the Company at no charge. If the Company elects in its sole discretion to grant
an Event License (as defined in the agreement), the agreement provides for a
full refund of each license fee during the first year, declining to 0% over the
following two years. The Company may not assign its obligations under the
agreement without Microsoft's consent, and a merger, the sale of substantially
all of the Company's assets and certain other events will be deemed to be an
assignment under the agreement. Microsoft is obligated to distribute the
Company's RealPlayer Version 4.0 for a defined term as long as the Company's
player supports certain Microsoft architectures. The Company also agreed to work
with Microsoft and several other companies to author and promote ASF as a
standard file format for streaming media. The agreement also requires the
Company to provide Microsoft with engineering consultation services, certain
error corrections and certain technical support over a defined term. In
connection with the agreement, Microsoft also purchased a minority interest in
the Company. In addition, the Company recently announced its support of
Microsoft's Windows Media Player. This will allow Windows users to use the
Windows Media Player to play audio, video and animation that is streamed from a
RealSystem 5.0 RealServer.
Microsoft competes with the Company in the market for streaming media
server and player software and offers its own streaming media product, NetShow.
Microsoft also acquired VXtreme, Inc. ("VXtreme") and purchased a minority
interest in VDOnet Corporation ("VDOnet"), both of which are competitors of the
Company in the market for streaming media software. As a result of Microsoft's
agreement with the Company, its acquisition of VXtreme and its investment in
VDOnet, Microsoft will be able to augment substantially the functionality of
NetShow, its streaming media product, which could have a material adverse effect
on the competitiveness of the Company's products.
The Company believes that Microsoft's commitment to and presence in the
streaming media industry will dramatically increase competitive pressure in the
overall market for streaming media software, leading to, among other things,
increased pricing pressure and longer sales cycles. Such pressures may result in
further price reductions in the Company's products and may also materially
reduce the Company's market share. The Company believes that Microsoft will
incorporate streaming media technology in its Web browser software and certain
of its server software offerings, possibly at no additional cost to the user. In
addition, notwithstanding the Company's cooperation with Microsoft regarding
ASF, Microsoft may promote technologies and standards not compatible with the
Company's technology. Microsoft has a longer operating history, a larger
installed base of customers and dramatically greater financial, distribution,
marketing and technical resources than the Company. As a result, there can be no
assurance that the Company will be able to compete effectively with Microsoft
now or in the future, or that the Company's business, financial condition and
results of operations will not be materially adversely affected by increased
competition in the streaming media industry. In addition, if considerable
industry consolidation occurs, there can be no assurance that the Company will
be able to continue to compete effectively.
Although Microsoft is a shareholder of the Company, it is also a competitor
and its interests may not always be a aligned with those of the Company and the
other shareholders. Microsoft has indicated that to the extent the relationship
between the parties becomes more competitive than complementary, and based on
the outcome of issues between the parties, including under the license
agreement, it is likely to re-evaluate its investment position in the Company.
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 when contractually able to do so, which
could have a material adverse effect on the market price for the Common Stock.
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<PAGE> 13
CUSTOMERS
The Company's customers consist primarily of resellers and users located in
the U.S. and various foreign countries. Sales to customers outside the U.S.,
primarily in Asia and Europe, were approximately 17%, 22% and 26% of total net
revenues in the years ended December 31, 1995, 1996 and 1997, respectively.
Software license fees under a license agreement with Microsoft accounted for
approximately 15% of total net revenues for the year ended December 31, 1997.
CUSTOMER SUPPORT
The Company's customers have a choice of support options depending on the
level of service desired. The Company maintains a technical support hotline to
answer inquiries and provides an online database of technical information. The
Company's support staff also responds to e-mail inquiries. The Company tracks
all support requests through a series of customer databases, including current
status reports and historical customer interaction logs. The Company uses
customer feedback as a source of ideas for product improvements and
enhancements. As of December 31, 1997, the Company employed 12 technical
representatives to respond to customer requests for support.
COMPETITION
The market for software and services for the Internet and intranets is
relatively new, constantly evolving and intensely competitive. The Company
expects that competition will intensify in the future. Many of the Company's
current and potential competitors have longer operating histories, greater name
recognition and significantly greater financial, technical and marketing
resources than the Company. The Company's principal competitors in the
development and distribution of audio and video streaming solutions include
Microsoft, VDOnet, Xing Technology Corporation, Precept Software, Inc.,
Motorola, Inc., Vosaic LLC and Oracle Corporation. The Company's RealSystem also
competes to a lesser degree with non-streaming audio and video delivery
technologies such as AVI and Quicktime, and indirectly with delivery systems for
multimedia content other than audio and video, such as Flash by Macromedia and
Enliven by Narrative Communications Corp. Competitive factors in this market
include the quality and reliability of software; features for creating, editing
and adapting content; ease of use and interactive user features; scaleability
and cost per user; and compatibility with the user's existing network components
and software systems. To expand its user base and further enhance the user
experience, the Company must continue to innovate and improve the performance of
its RealSystem. The Company anticipates that consolidation will continue in the
streaming media industry and related industries such as computer software, media
and communications. Consequently, competitors may be acquired by, receive
investments from or enter into other commercial relationships with, larger,
well-established and well-financed companies. There can be no assurance that the
Company can establish or sustain a leadership position in this market segment.
The Company is committed to the continued market penetration of its brand,
products and services, which, as a strategic response to changes in the
competitive environment, may require pricing, licensing, service or marketing
changes intended to extend its current brand and technology franchise. Price
concessions or the emergence of other pricing or distribution strategies by
competitors may have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company currently derives significant revenues from the electronic
distribution of certain of its products. The Company competes with a variety of
Web sites, such as Buydirect.Com and Sofware.Net, which also offer software
products for download. To compete successfully in the electronic commerce
market, the Company must attract sufficient commercial traffic to its Web sites
by offering high quality, competitively priced merchandise in a compelling,
easy-to-purchase format. There can be no assurance that the Company will be able
to compete successfully in this market, and any failure to do so could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In the Internet advertising segment, the Company competes for Internet
advertising revenues with a wide variety of Web sites and Internet service
providers. While Internet advertising revenues across the industry continue to
grow, the number of Web sites competing for such revenue is also growing
rapidly. The Company's
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advertising sales force and infrastructure are still in early stages of
development relative to the Company's competitors. There can be no assurance
that advertisers will place advertising with the Company or that revenues
derived from such advertising will be material. In addition, if the Company
loses advertising customers, fails to attract new customers, is forced to reduce
advertising rates or otherwise modify its rate structure to retain or attract
customers, or loses Web site traffic, the Company's business, financial
condition and results of operations may be materially adversely affected.
GOVERNMENTAL REGULATION
The Company currently is not subject to direct regulation by any
governmental agency, other than laws and regulations generally applicable to
businesses, although certain U.S. export controls and import controls of other
countries, including controls on the use of encryption technologies, may apply
to the Company's products. Due to the increasing popularity and use of the
Internet, it is possible that a number of laws and regulations may be adopted in
the U.S. and abroad with particular applicability to the Internet. It is
possible that governments will enact legislation that may be applicable to the
Company in areas such as content, network security, encryption and the use of
key escrow, data and privacy protection, electronic authentication or "digital"
signatures, illegal and harmful content, access charges and retransmission
activities, property ownership, taxation, defamation and personal privacy.
The Company faces potential liability for claims based on the nature and
content of the materials that it distributes over the Internet, including claims
for defamation, negligence or copyright, patent or trademark infringement, which
claims have been brought, and sometimes successfully litigated, against Internet
companies. The Company's general liability insurance may not cover claims of
this type or may not be adequate to indemnify the Company for any liability that
may be imposed. Any liability not covered by insurance or in excess of insurance
coverage could have a material adverse effect on the Company's business,
financial condition and results of operations.
INTELLECTUAL PROPERTY
The Company's success depends in part on its ability to protect its
proprietary software and other intellectual property. To protect its proprietary
rights, the Company relies generally on patent, copyright, trademark and trade
secret laws, confidentiality agreements with employees and third parties, and
license agreements with consultants, vendors and customers, although the Company
has not signed such agreements in every case. Despite such protections, a third
party could, without authorization, copy or otherwise obtain and use the
Company's products or technology, or develop similar technology. There can be no
assurance that the Company's agreements with employees, consultants and others
who participate in product development activities will not be breached, that the
Company will have adequate remedies for any breach, or that the Company's trade
secrets will not otherwise become known or independently developed by
competitors.
Many of the Company's current and potential competitors dedicate
substantially greater resources to protection and enforcement of intellectual
property rights, especially patents. If a blocking patent has issued or issues
in the future, the Company would need to either obtain a license or design
around the patent. There can be no assurance that the Company would be able to
obtain such a license on acceptable terms, if at all, or to design around the
patent. As of December 31, 1997, the Company had eleven registered U.S.
trademarks or service marks, and had applications pending for an additional 24
U.S. trademarks. A significant portion of the Company's marks begin with the
word "Real" (such as RealSystem, RealAudio and RealVideo). The Company is aware
of other companies that use "Real" in their marks alone or in combination with
other words, and the Company does not expect to be able to prevent all
third-party uses of the word "Real" for all goods and services. In addition, the
laws of some foreign countries do not protect the Company's proprietary rights
to the same extent as do the laws of the U.S., and effective patent, copyright,
trademark and trade secret protection may not be available in such
jurisdictions. As with other software products, the Company's products are
susceptible to unauthorized copying and uses that may go undetected, and
policing such unauthorized use is difficult. In general, there can be no
assurance that the Company's efforts to protect its intellectual property rights
through patent, copyright, trademark and trade secret laws will be effective to
prevent misappropriation
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of its technology, or to prevent the development and design by others of
products or technologies similar to or competitive with those developed by the
Company.
The Company has been and expects to continue to be subject to legal
proceedings and claims from time to time in the ordinary course of its business,
including claims of alleged infringement of third-party proprietary rights by
the Company and its licensees. The Company attempts to avoid infringing known
proprietary rights of third parties in its product development efforts. However,
if the Company were to discover that its products violate third-party
proprietary rights, there can be no assurance that it would be able to obtain
licenses to continue offering such products without substantial reengineering or
that any effort to undertake such reengineering would be successful, that any
such licenses would be available on commercially reasonable terms, if at all, or
that litigation regarding alleged infringement could be avoided or settled
without substantial expense and damage awards.
The Company also relies on certain technology that it licenses from third
parties, including software that is integrated with the Company's internally
developed software and used in the Company's products, to perform key functions.
There can be no assurance that such third-party technology licenses will
continue to be available to the Company on commercially reasonable terms. The
loss of any of these technologies could have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that infringement or invalidity claims arising from the
incorporation of third-party technology, and claims for indemnification from the
Company's customers resulting from such claims, will not be asserted or
prosecuted against the Company.
EMPLOYEES
At December 31, 1997, the Company had 325 full-time employees and 1
part-time employee, 280 of whom were based at the Company's executive offices in
Seattle, Washington, 30 of whom were based at the Company's offices in Japan,
England, France or Denmark and 16 of whom were salespersons based at other
locations. None of the Company's employees is subject to a collective bargaining
agreement, and the Company believes that its relations with its employees are
good.
POSITION ON CHARITABLE RESPONSIBILITY
The Company is strongly committed to charitable responsibility, as
evidenced by its donations of software to charitable organizations. If sustained
profitability is achieved, the Company intends to donate approximately 5% of its
annual net income to charitable organizations. The Company hopes to encourage
employee giving by using a portion of its intended contribution to match
charitable donations made by employees.
ITEM 2. PROPERTIES
The Company's executive offices are located in downtown Seattle, Washington
in an office building in which, as of December 31, 1997, the Company leases an
aggregate of 80,345 square feet at a current monthly rental of $122,411. The
lease agreement terminates on April 30, 2001, and may be terminated beginning
October 1998 with nine months' advance written notice. In January 1998, the
Company entered into a lease agreement for a new location for its corporate
offices. The lease commences on April 1, 1999 and expires on April 1, 2011. See
footnote 9(a) of "Notes to Consolidated Financial Statements."
ITEM 3. LEGAL PROCEEDINGS
From time to time the Company has been, and expects to continue to be,
subject to legal proceedings and claims in the ordinary course of its business,
including claims of alleged infringement of third-party trademarks and other
intellectual property rights by the Company and its licensees. Such claims, even
if not meritorious, could result in the expenditure of significant financial and
managerial resources.
In August 1997, the Company was served with a subpoena by the U.S.
Department of Justice in connection with its investigation into horizontal
merger activity within the streaming media industry. The investigation,
including interviews of Company officers by Department of Justice personnel and
document
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production requests, is ongoing. As a result of the investigation, it is
possible that the Department of Justice will require certain actions by the
Company or other companies in the streaming media industry, which could have a
material adverse effect on the Company's competitive position and on its
business, financial condition and results of operations. The Company is
cooperating fully with the investigation. The Company is not aware of any other
legal proceedings or claims that it believes will have, individually or in the
aggregate, a material adverse effect on its business, financial condition and
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Holders of 22,222,525 shares of the Company's Common Stock and 3,338,374
shares of the Company's Special Common Stock executed a consent in lieu of a
special meeting of shareholders, effective November 2, 1997, pursuant to which
the shareholders (i) approved an amendment to the Company's Amended and Restated
Articles of Incorporation that provides for the reclassification of the
Company's nonvoting Special Common Stock upon the occurrence of certain
transfers, and (ii) ratified the Company's Amended and Restated Articles of
Incorporation. The consent of holders of the remaining 1,449,472 shares of
Common Stock was not required for the consent to be effective. Pursuant to the
Washington Business Corporation Act and the Company's Amended and Restated
Articles of Incorporation, the Company was required to obtain the consent of
shareholders holding at least 66 2/3% shares in order for the consent to be
effective. Shareholders whose consent was not obtained were provided with the
required notice of shareholder action by written consent and information with
respect to the actions taken.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are elected annually at the meeting
of the Board of Directors held in conjunction with the annual meeting of
shareholders. The following are the current executive officers of the Company:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Robert Glaser........... 36 Chairman of the Board, Chief Executive Officer, Secretary
and Treasurer
Bruce Jacobsen.......... 38 President, Chief Operating Officer and Director
Mark Klebanoff.......... 36 Chief Financial Officer
Len Jordan.............. 31 Senior Vice President -- Media Systems
Phillip Barrett......... 44 Senior Vice President -- Media Systems
Maria Cantwell.......... 39 Senior Vice President -- Consumer and E-Commerce
James Higa.............. 40 Vice President -- Asia/Rest of World ("ROW")
John Atcheson........... 39 Vice President -- Media Publishing
Alex Alben.............. 39 Vice President -- Media Publishing
Kelly Jo MacArthur...... 33 Vice President and General Counsel
Erik Moris.............. 39 Vice President -- Marketing
Jeff Lehman............. 41 Vice President -- Advertising Sales
Philip Rosedale......... 29 Vice President -- Media Systems
</TABLE>
- ---------------
ROBERT GLASER has served as Chairman of the Board, Chief Executive Officer
and Treasurer of the Company since its inception in February 1994, and as
Secretary since March 1995. He also serves as the Company's Policy Ombudsman,
with the exclusive authority to adopt or change the editorial policies of the
Company as reflected on the Company's Web sites or in other communications or
media in which the Company has a significant editorial or media voice. From 1983
to 1993, Mr. Glaser was employed at Microsoft, most recently as Vice President
of multimedia and consumer systems, where he focused on the development of new
businesses related to the convergence of the computer, consumer electronics and
media industries. Mr. Glaser holds a B.A. and an M.A. in Economics and a B.S. in
Computer Science from Yale University.
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BRUCE JACOBSEN has served as President and Chief Operating Officer of the
Company since February 1996 and as a Director since July 1997. From April 1995
to February 1996, Mr. Jacobsen was Chief Operating Officer of Dreamworks
Interactive, a joint venture between Microsoft and Dreamworks SKG, a partnership
among Steven Spielberg, Jeffery Katzenberg and David Geffen. From August 1986 to
April 1995, Mr. Jacobsen was employed at Microsoft in a number of capacities,
including General Manager of the Kids/ Games business unit. Mr. Jacobsen
graduated summa cum laude with Honors from Yale University and holds an M.B.A.
from Stanford University.
MARK KLEBANOFF has served as Chief Financial Officer of the Company since
June 1996. From May 1992 to June 1996, Mr. Klebanoff was Vice President of
Finance and Operations of Industrial Systems, Inc., a client/server process
information management software vendor, which merged with Aspen Technology, Inc.
in 1995. From 1989 to 1992, Mr. Klebanoff worked in a number of general
management capacities for the Japanese trading company Itochu Corporation. Mr.
Klebanoff holds a B.A. from Yale University and a Masters degree from the Yale
School of Management.
LEN JORDAN has served as Senior Vice President -- Media Systems of the
Company since January 1997. From November 1993 to November 1996, Mr. Jordan was
employed at Creative Multimedia, Inc., a developer and publisher of
CD-ROM/Internet products in a number of capacities, most recently as President.
From September 1989 to November 1993, Mr. Jordan was employed at Central Point
Software, Inc., a utility software publisher. Mr. Jordan graduated magna cum
laude from the Eccles School of Business at the University of Utah with B.S.
degrees in Finance and Economics.
PHILLIP BARRETT has served as Senior Vice President -- Media Systems of the
Company since January 1997, and from November 1994 to January 1997 as Vice
President -- Software Development. From March 1986 to October 1994, Mr. Barrett
was a Development Group Manager at Microsoft, where he led development efforts
for Windows 386, Windows 3.0 and Windows 3.1. Mr. Barrett holds an A.B. in
Mathematics from Rutgers University and an M.S. in Computer Sciences from the
University of Wisconsin, Madison.
MARIA CANTWELL has served as Senior Vice President -- Consumer and
E-Commerce of the Company since July 1997. From April 1995 to July 1997, Ms.
Cantwell served as Vice President -- Marketing of the Company. From February
1995 to April 1995, Ms. Cantwell was a consultant to the Company. From 1992 to
January 1995, Ms. Cantwell served as a member of the 103rd Congress. Ms.
Cantwell holds a B.A. in Public Administration from Miami University.
JAMES HIGA has served as Vice President -- Asia/ROW of the Company since
September 1996. From January 1989 to August 1996, Mr. Higa was the Director for
Asia/Pacific for NeXT Software, Inc. From 1986 to 1989, Mr. Higa served as
Director of Product Marketing at Apple Japan, Inc. Mr. Higa holds a B.A. in
Political Science from Stanford University.
JOHN ATCHESON has served as Vice President -- Media Publishing of the
Company since January 1997. From March 1990 to May 1996, Mr. Atcheson was
President and Chief Executive Officer of MNI Interactive, Inc., a developer and
distributor of consumer interactive services. Mr. Atcheson holds a B.A. from
Brown University and an M.B.A. from the Stanford Graduate School of Business.
ALEX ALBEN has served as Vice President -- Media Publishing of the Company
since February 1998, with responsibility for the Company's music and
entertainment web products. From March 1997 to February 1998, Mr. Alben was a
consultant to the Company and to Film.com, Inc. From 1993 to 1996, Mr. Alben was
Director of Business Affairs, and from 1996 to 1997, Vice President of Business
Affairs of Starwave Corporation. Mr. Alben served as Associate General Counsel
in the feature film division of Warner Bros. from 1992 to 1993, and previously
served as Director of Business Affairs at Orion Pictures. Mr. Alben graduated
with distinction from Stanford University and holds a J.D. from Stanford Law
School.
KELLY JO MACARTHUR has served as Vice President and General Counsel of the
Company since October 1996. From January 1995 to March 1996, Ms. MacArthur
served as General Counsel and Director of Business Affairs for Compton's
NewMedia, Inc., which was acquired by Learning Co., Inc. in 1996. From July 1989
to December 1994, Ms. MacArthur was an attorney at Sidley & Austin. Ms.
MacArthur graduated
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summa cum laude from the University of Illinois at Champaign-Urbana and holds a
J.D. from Harvard Law School.
ERIK MORIS has served as Vice President -- Marketing of the Company since
August 1997. From April 1997 to July 1997, Mr. Moris served as a Product Manager
for the Company. From September 1996 to April 1997, Mr. Moris was a consultant
to the Company. From May 1995 to August 1996, Mr. Moris was employed at
Microsoft, where he managed advertising for the Windows 95 launch and was Group
Manager for the Internet Platform and Tools Division. From 1985 to 1994, Mr.
Moris was a Senior Vice President at McCann-Erickson Advertising. Mr. Moris
holds a B.A. in Communications and Business from Western Washington University.
JEFF LEHMAN has served as Vice President -- Advertising Sales of the
Company since October 1997. From September 1985 to September 1997, Mr. Lehman
was employed by Ziff-Davis/Softbank in a number of Vice President, Director, and
other publishing positions. Mr. Lehman graduated cum laude from the University
of Central Florida with a B.S.B.A. and an M.B.A. with Honors.
PHILIP ROSEDALE has served as Vice President -- Media Systems of the
Company since October 1997. From February 1996 to October 1997, Mr. Rosedale
served as General Manager, Software Development of the Company. From June 1986
to February 1996, Mr. Rosedale was founder and Chief Executive Officer of
Automated Management Systems, a developer and marketer of software applications.
Mr. Rosedale graduated cum laude from the University of California, San Diego
with a B.S. in Physics.
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PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company made its initial public offering on November 21, 1997 at a
price of $12.50 per share. The Company's Common Stock is listed on the Nasdaq
National Market under the symbol "RNWK." The following table sets forth the high
and low sales prices per share of the Company's common stock for the fourth
quarter of 1997.
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
1997
Fourth Quarter (beginning November 21, 1997)............... $19.375 $13.625
</TABLE>
As of March 20, 1998, there were 316 holders of record of the Company's
Common Stock. Because many of the shares of Common Stock are held by brokers and
other institutions on behalf of shareholders, the Company is unable to estimate
the total number of shareholders represented by these record holders. The
Company has never declared or paid any cash dividends on its Common Stock. Since
the Company currently intends to retain future earnings to finance future
growth, it does not anticipate paying any cash dividends in the foreseeable
future.
RECENT SALES OF UNREGISTERED SECURITIES
Since January 1, 1997, the Company has issued and sold unregistered
securities as follows:
(1) An aggregate of 1,000 shares of Series C Common Stock
(subsequently converted to Common Stock) was issued in March 1997 to one
individual in exchange for services valued at $2,000.
(2) An aggregate of 3,338,374 shares of Series E Preferred Stock
(subsequently converted to Special Common Stock) was issued in a private
placement in July 1997 to one investor. The aggregate consideration
received for such shares was $30,000,000.
(3) A warrant for the purchase of an aggregate of 3,709,305 shares of
Series E Preferred Stock (subsequently converted to Special Common Stock)
was issued in a private placement in July 1997 to one investor. The
consideration received by the Company in connection with the issuance of
such warrant was part of the aggregate consideration received by the
Company in connection with the private placement of Series E Preferred
Stock as noted above. The warrant was not exercised by, and terminated on,
November 26, 1997.
(4) An aggregate of 15,000 shares of Series C Common Stock
(subsequently converted to Common Stock) was issued in October 1997 to one
entity in a private placement in connection with the acquisition of certain
assets of that entity valued at $52,500.
(5) As of December 31, 1997, an aggregate of 1,673,294 shares of
Common Stock had been issued to employees and consultants upon the exercise
of options. The aggregate consideration received for such shares was
$302,510.
(6) An aggregate of 183,755 shares of Series B Common Stock
(subsequently converted to Common Stock) was issued to 5 investors upon the
exercise of warrants in November 1997. The aggregate consideration received
for such shares was $36,751.
(7) An aggregate of 100,000 shares of Series C Preferred Stock
(subsequently converted to Common Stock) was issued to 4 investors upon the
exercise of warrants in November 1997. The aggregate consideration received
for such shares was $196,340.
(8) An aggregate of 39,841 shares of Series D Preferred Stock
(subsequently converted to Common Stock) was issued to 6 investors upon the
exercise of warrants in November 1997. The aggregate consideration received
for such shares was $375,003.
18
<PAGE> 20
No underwriters were engaged in connection with these issuances and sales.
Each of the transactions noted above was made in reliance upon the exemption
from registration provided by either Section 3(b) or 4(2) of the Securities Act
of 1933, as amended.
USE OF PROCEEDS
The Company's Registration Statement on Form S-1 (File No. 333-36553) filed
with the Securities and Exchange Commission in connection with the Company's
initial public offering (the "Registration Statement") was declared effective at
5:00 p.m., EDT, on November 20, 1997 and the initial public offering commenced
on November 21, 1997. The offering terminated after the sale of all securities
that were registered under the Registration Statement. Goldman, Sachs & Co.,
BancAmerica Robertson Stephens and NationsBanc Montgomery Securities, Inc. were
the managing underwriters of the offering. The Company registered and sold
3,450,000 shares of common stock, par value $0.001 per share, at an aggregate
price of $43.1 million. The Company incurred a total of approximately $4.6
million of expenses in connection with the issuance and distribution of common
stock in the offering, of which approximately $3.0 million were paid in
underwriting discounts and commissions and approximately $1.6 million were paid
to third parties for other expenses. 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 the construction of
any plant, building or facilities; purchase or installation of machinery or
equipment; purchases of real estate; acquisition of other business(es); or
repayment of indebtedness. None of the expenses paid in connection with the
issuance and distribution of the common stock in the offering, and none of the
net offering proceeds, were paid directly or indirectly to directors, officers,
general partners of the Company or their associates, persons owning ten percent
(10%) or more of any class of equity securities of the Company, or affiliates of
the Company.
19
<PAGE> 21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," included in this Form 10-K. The selected consolidated
financial data as of December 31, 1994, 1995, 1996 and 1997 and for the period
from February 9, 1994 (inception) to December 31, 1994, and for the years ended
December 31, 1995, 1996 and 1997 are derived from the Consolidated Financial
Statements of the Company which have been audited by KPMG Peat Marwick LLP,
independent accountants.
<TABLE>
<CAPTION>
PERIOD FROM
FEBRUARY 9, 1994 YEAR ENDED
(INCEPTION) TO DECEMBER 31,
DECEMBER 31, -------------------------------
1994 1995 1996 1997
----------------- ------- -------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenues:
Software license fees.......................... $ -- $ 1,782 $ 11,876 $ 25,494
Service revenues............................... -- 30 1,120 4,972
Advertising.................................... -- -- 1,016 2,254
------- ------- -------- ----------
Total net revenues..................... -- 1,812 14,012 32,720
Cost of revenues:
Software license fees.......................... -- 29 1,343 3,153
Service revenues............................... -- 33 554 2,392
Advertising.................................... -- -- 288 920
------- ------- -------- ----------
Total cost of revenues................. -- 62 2,185 6,465
------- ------- -------- ----------
Gross profit................................ -- 1,750 11,827 26,255
Operating expenses:
Research and development....................... 202 1,380 4,812 13,268
Selling and marketing.......................... 47 1,218 7,540 20,124
General and administrative..................... 296 747 3,491 6,024
------- ------- -------- ----------
Total operating expenses............... 545 3,345 15,843 39,416
------- ------- -------- ----------
Operating Loss.............................. (545) (1,595) (4,016) (13,161)
------- ------- -------- ----------
Other income, net................................ -- 94 227 1,992
------- ------- -------- ----------
Net loss......................................... $ (545) $(1,501) $ (3,789) $ (11,169)
======= ======= ======== ==========
Historical basic and diluted net loss per share
(1)............................................ $ (0.05) $(59.89) $ (11.91) $ (2.88)
Shares used to compute historical basic and
diluted net loss per share (1)................. 10 25 321 4,041
Pro forma basic and diluted net loss per share
(1)............................................ $ (0.40)
Shares used to compute pro forma basic and
diluted net loss per share(1).................. 28,854
</TABLE>
20
<PAGE> 22
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1994 1995 1996 1997
---- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments.......... $ -- $ 6,116 $19,595 $ 92,028
Working capital (deficit).................................. (49) 5,948 16,893 87,519
Total assets............................................... 64 7,574 26,468 116,704
Note payable............................................... -- -- -- 963
Redeemable, convertible preferred stock.................... -- 7,655 23,153 --
Shareholders' equity (deficit)............................. 15 (1,111) (3,320) 77,902
</TABLE>
- ---------------
(1) For an explanation of historical basic and diluted net loss per share and
pro forma basic and diluted net loss per share and the number of shares used
to compute historical basic and diluted net loss per share and pro forma
basic and diluted net loss per share, see Note 1 of Notes to Consolidated
Financial Statements.
21
<PAGE> 23
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included in this Form 10-K. This
discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including, but not limited to, those set forth under "Certain Risk Factors That
May Affect the Company's Business. Future Operating Results and Financial
Condition" and elsewhere in this Form 10-K.
OVERVIEW
RealNetworks is a leading provider of branded software products and
services that enable the delivery of streaming media content over the Internet
and intranets. The Company's products and services include its RealSystem, a
streaming media solution that includes RealAudio and RealVideo technology, an
electronic commerce Web site designed to promote the proliferation of streaming
media products and a network of advertising-supported content aggregation Web
sites.
The Company was incorporated in February 1994 and did not recognize any
revenue until July 1995, when the Company began delivery of the commercial
version of RealAudio Version 1.0. From inception through December 31, 1995, the
Company's operating activities related primarily to recruiting personnel,
raising capital, purchasing operating assets, conducting research and
development, building the RealAudio brand and establishing the market for
streaming audio. During 1996, the Company continued to invest heavily in
research and development, marketing, building domestic and international sales
channels and general and administrative infrastructure. In August 1996, the
Company began selling RealPlayer Plus, a premium version of its RealPlayer
product. RealPlayer continues to be available for download free of charge from
the Company's Web sites. In February 1997, the Company released a "beta" version
of its RealVideo product and, in June 1997, it released the commercial version
of RealVideo Version 4.0. In October 1997, the Company released a "beta" version
of its RealSystem Version 5.0, a streaming media solution that includes
RealAudio and RealVideo technology. The commercial version of RealSystem Version
5.0 was released in December 1997.
The Company has a limited operating history on which an evaluation of the
Company and its prospects can be based. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in early stages of development, particularly companies
in rapidly evolving markets such as media delivery and electronic commerce over
the Internet and intranets. To achieve and sustain profitability, the Company
must, among other things, establish widespread market acceptance of its existing
products and services, successfully develop new products and services, respond
quickly and effectively to competitive, market and technological developments,
expand sales and marketing operations, broaden customer support capabilities,
control expenses and continue to attract, train and retain qualified personnel.
There can be no assurance that the Company will achieve or sustain
profitability.
The Company has incurred significant losses since its inception, and as of
December 31, 1997 had an accumulated deficit of $17,524,000. The Company
believes that its success will depend largely on its ability to extend its
technological leadership and continue to build its brand position. Accordingly,
the Company intends to invest heavily in research and development and sales and
marketing. The Company expects to continue to incur substantial operating
losses. In view of the rapidly evolving nature of the Company's business and its
limited operating history, the Company believes that period-to-period
comparisons of its revenues and operating results, including its gross profit
margin and operating expenses as a percentage of total net revenues, are not
necessarily meaningful and should not be relied upon as indications of future
performance. Although the Company has experienced significant percentage growth
in total net revenues, it does not believe that its historical growth rates are
sustainable or indicative of future growth. The Company has used, and expects to
continue to use, price promotions to increase trial, purchase and use of its
products, as well as to increase overall recognition of its brands. The effect
of such promotions on revenues in a particular period may be significant and
extremely difficult to forecast.
22
<PAGE> 24
The following table sets forth certain financial data for the periods
indicated as a percentage of total net revenues:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
----- ----- -----
<S> <C> <C> <C>
Net revenues:
Software license fees............................. 98.4% 84.8% 77.9%
Service revenues.................................. 1.6 8.0 15.2
Advertising....................................... -- 7.2 6.9
----- ----- -----
Total net revenues........................ 100.0 100.0 100.0
----- ----- -----
Cost of revenues:
Software license fees............................. 1.6 9.6 9.6
Service revenues.................................. 1.8 4.0 7.3
Advertising....................................... -- 2.0 2.8
----- ----- -----
Total cost of revenues.................... 3.4 15.6 19.7
----- ----- -----
Gross Profit................................... 96.6 84.4 80.3
Operating expenses:
Research and development.......................... 76.2 34.3 40.6
Selling and marketing............................. 67.2 53.8 61.5
General and administrative........................ 41.2 24.9 18.4
----- ----- -----
Total operating expenses.................. 184.6 113.0 120.5
----- ----- -----
Operating loss................................. (88.0) (28.6) (40.2)
Other income (expense):
Interest income, net.............................. 5.2 2.1 6.8
Other expense..................................... -- (0.5) (0.7)
----- ----- -----
Other income, net.............................. 5.2 1.6 6.1
----- ----- -----
Net loss............................................ (82.8)% (27.0)% (34.1)%
===== ===== =====
</TABLE>
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1996 AND 1997
REVENUES
The Company generates revenues primarily from three sources: software
license fees, services and advertising. Software license fees are recognized
upon delivery, net of allowances for estimated returns, provided that no
significant obligations of the Company remain and collection of the resulting
receivable is deemed probable. Revenues from software license agreements with
original equipment manufacturers ("OEMs") are recognized when the OEM delivers
its product incorporating the Company's software to the end user. In the case of
prepayments from an OEM, the Company generally recognizes revenues based on the
actual products sold by the OEM. If the Company anticipates providing ongoing
support to the OEM in the form of future upgrades, enhancements or other
services over the term of the contract, revenue generally is recognized on the
straight-line method over the term of the contract. The Company recognizes
revenues from software license agreements with value-added resellers ("VARs"),
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, commissions from electronic sales of third-party products, and fees
from consulting, content hosting and user conferences. Support and upgrade
revenues are recognized ratably over the term of the contract, which typically
is 12 months. Payments for support and upgrade contracts generally are made in
advance and are nonrefundable. Other service revenues are recognized when the
service is performed. Advertising revenues are recognized over the period in
which the advertisement is displayed on one of the Company's Web pages. The
Company guarantees to certain advertising customers a minimum number of page
impressions to be delivered to users of its Web sites for a particular period.
To the extent minimum guaranteed page impression deliveries
23
<PAGE> 25
are not met, the Company defers recognition of the corresponding advertising
revenues until guaranteed page impression delivery levels are achieved.
Software License Fees. Software license fees were $11,876,000 and
$25,494,000 for 1996 and 1997, respectively. The increase was due primarily to a
greater volume of products sold as a result of growing market acceptance of the
Company's server and player products, including the introduction of RealPlayer
Plus in August 1996, RealVideo in February 1997 and RealSystem Version 5.0 in
December 1997, successful product promotions and diversification of the
Company's sales channels, including electronic distribution. 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 1997 was $4,836,000 related to the Microsoft license agreement.
The Company began selling products electronically from its Web site in August
1996. Electronic sales for 1996 and 1997 were $2,363,000 and $8,656,000,
respectively, or 20% and 34%, respectively, of software license fees in the
period. The Company has used price promotions to increase the trial, purchase
and use of its software products. In February, 1997, the Company reduced the
prices of its server products. In July 1997, the Company made its Basic Server
available for download free of charge.
Service Revenues. Service revenues were $1,120,000 and $4,972,000 for 1996
and 1997, respectively. Revenues from upgrade and support contracts were
$1,105,000 and $3,524,000 for 1996 and 1997, respectively. This increase was
primarily due to a greater installed base of the Company's products. Service
revenues for 1997 also included fees of $498,000 related to the Company's first
RealMedia conference.
Advertising Revenues. Advertising revenues were $1,016,000 and $2,254,000
for 1996 and 1997, respectively. The Company began selling advertising space on
its Web sites in March 1996. Increased revenues in 1997 were due in part to a
full year of advertising sales and the Company's success in attracting a greater
number of advertisers.
International Revenues. International revenues were 22% and 26% of total
net revenues for 1996 and 1997, respectively. The increase in international
revenues was due in part to the creation of the Company's three foreign
subsidiaries. The Company incorporated its French and Japanese subsidiaries in
November 1996 and its U.K. subsidiary in February 1997. Substantially all of the
Company's international revenues were generated in Europe and Asia. Revenues
generated in Europe were 7% and 11% of total net revenues in 1996 and 1997,
respectively, and revenues generated in Asia were 7% and 10% of total net
revenues in 1996 and 1997, respectively. At December 31, 1997, accounts
receivable due from European and Asian customers were not significant. The
functional currency of the Company's foreign subsidiaries is the local currency
in the country in which the subsidiary is incorporated. Operations of the
Company's foreign subsidiaries are translated from local currency into U.S.
dollars based on average monthly exchange rates. The Company currently does not
hedge its foreign currency transactions and therefore is subject to the risk of
changes in exchange rates. The Company expects that international revenues will
continue to increase. The cost structures of both domestic and international
revenues are substantially the same.
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees includes cost
of product media, duplication, manuals, packaging materials, amounts paid for
licensed technology and fees paid to third party vendors for order fulfillment.
Cost of software license fees was $1,343,000 and $3,153,000 for 1996 and 1997,
respectively, and 11% and 12%, respectively, of software license fees. The
increase in absolute dollars was due primarily to higher sales volume. The
increase in percentage terms was due to a shift in product mix toward
lower-margin player products, a greater percentage of sales through indirect
channels, and the utilization of a third-party order fulfillment agency.
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing services, bandwidth expenses for
hosting services and user conference expenses. Cost of service revenues was
$554,000 and $2,392,000 for 1996 and 1997, respectively, and 49% and 48%,
respectively, of service revenues. The increase in absolute dollars was
primarily due to increased staff and other costs
24
<PAGE> 26
associated with providing these services to a greater number of customers, and,
in March 1997, the Company incurred $1,000,000 of costs associated with its
RealMedia conference. No such costs were incurred in the comparable period in
1996. Excluding the effects of the RealMedia conference, cost of service
revenues was 49% and 31% of service revenues for 1996 and 1997, respectively.
This decrease in percentage terms was attributable primarily to better
utilization of service personnel associated with an increased customer base.
Cost of Advertising Revenues. Cost of advertising revenues includes
personnel associated with content creation and bandwidth expenses related to the
Company's Web sites. Cost of advertising revenues was $288,000 and $920,000 for
1996 and 1997, respectively, and 28% and 41%, respectively, of advertising
revenues. The increase was due primarily to increased head count associated with
content creation and higher bandwidth expenses.
Gross margins may be affected by the mix of distribution channels used by
the Company, the mix of products sold, the mix of product revenues versus
service revenues and the mix of international versus U.S. revenues. The Company
typically realizes higher gross margins on direct channel sales relative to
indirect channels and higher gross margins on software license fees relative to
service revenues. If sales through indirect channels increase as a percentage of
total net revenues, or if, service revenues increase as a percentage of total
net revenues, the Company's gross margins will be adversely affected.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of salaries and consulting fees to support product development and
costs of technology acquired from third parties to incorporate into products
currently under development. To date, all research and development costs have
been expensed as incurred because technological feasibility of the Company's
products is established upon completion of a working model. To date, costs
incurred between completion of a working model and general release of products
have been insignificant. The Company believes that continued investment in
research and development is critical to attaining its strategic objectives and,
as a result, expects research and development expenses to increase
significantly. Research and development expenses were $4,812,000 and $13,268,000
for 1996 and 1997, respectively, and 34% and 41%, respectively, of total net
revenues. The increase was due primarily to increases in internal development
personnel, travel, and consulting expenses. In addition, during 1997, the
Company expensed approximately $1,533,000 related to the cost of technology
purchased from third parties. The Company expects to incur similar types of
expenditures in future periods. Research and development expenses incurred for
1997 were primarily related to development of new technology and products and
enhancements made to existing products.
Selling and Marketing. Selling and marketing expenses consist primarily of
salaries, commissions, consulting fees paid, trade show expenses, advertising
and cost of marketing collateral. The Company intends to continue its aggressive
branding and marketing campaign and therefore expects selling and marketing
expenses to increase significantly. Selling and marketing expenses were
$7,540,000 and $20,124,000 for 1996 and 1997, respectively, and 54% and 62%,
respectively, of total net revenues. The increases were due in large part to
growth in sales personnel, commissions and costs related to the continued
development and implementation of the Company's branding and marketing
campaigns. During 1997, the Company also incurred approximately $694,000 in
marketing expenses related to the launch of RealVideo.
General and Administrative. General and administrative expenses consist
primarily of salaries and fees for professional services. The Company expects
general and administrative expenses to increase as the Company expands its
staff, incurs additional costs related to growth of its business, and operates
as a publicly traded company. General and administrative expenses were
$3,491,000 and $6,024,000 for 1996 and 1997, respectively, and 25% and 18%,
respectively, of total net revenues. The increase in absolute dollars was
primarily a result of increased personnel and facility expenses necessary to
support the Company's growth. The decrease in percentage terms was a result of
revenues growing at a faster rate than expenses.
25
<PAGE> 27
OTHER INCOME, NET
Other income, net consists primarily of earnings on the Company's cash and
cash equivalents and short-term investments. Other income, net was $227,000 and
$1,992,000 for 1996 and 1997, respectively. The increase was due primarily to
interest income resulting from additional invested cash and cash equivalents and
short-term investments.
INCOME TAXES
The Company had a net operating loss for each period from inception through
December 31, 1997. As of December 31, 1997, the Company fully utilized its net
operating loss and other credit carryforwards as a result of taxable income
generated from a license agreement with Microsoft. For financial reporting
purposes, those license fees are recognized over the three-year term of the
Company's ongoing obligations. As a result, the Company has recognized deferred
tax assets to the extent of its taxes payable. See Note 4 of Notes to
Consolidated Financial Statements.
RESULTS OF OPERATIONS -- YEARS ENDED DECEMBER 31, 1995 AND 1996
REVENUES
Software License Fees. Software license fees were $1,782,000 and
$11,876,000 for 1995 and 1996, respectively. The Company first began recognizing
revenues from software license fees in July 1995. The increase in software
license fees in 1996 was due primarily to a greater volume of products sold as a
result of a full year of sales, growing market acceptance of the Company's
products, the introduction of RealPlayer Plus in August 1996 and diversification
of sales channels, including electronic distribution.
Service Revenues. Service revenues were $30,000 and $1,120,000 for 1995 and
1996, respectively. The increase in service revenues in 1996 was due primarily
to additional support and upgrade contracts associated with a larger installed
base of the Company's products. Consulting, content hosting and user conference
revenues were not significant in either period.
Advertising Revenues. Advertising revenues were $1,016,000 for 1996. The
Company began selling advertising space on its Web sites in March 1996, and, as
a result, no advertising revenues were generated in 1995.
International Revenues. International revenues as a percentage of total net
revenues were 17% and 22% for 1995 and 1996, respectively. Substantially all
international revenues were generated in Europe and Asia.
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees was $29,000
and $1,343,000 for 1995 and 1996, respectively, and 2% and 11%, respectively, of
software license fees. The increase in absolute dollars was primarily due to
higher sales volume. The increase in percentage terms was due to a shift in
product mix toward lower-margin player products, a greater percentage of sales
through indirect channels, and the utilization of a third-party order
fulfillment agency.
Cost of Service Revenues. Cost of service revenues was $33,000 and $554,000
for 1995 and 1996, respectively, and was 110% and 49%, respectively, of service
revenues. The increase in absolute dollars was due primarily to increased staff
and other costs associated with providing these services to a greater number of
customers. The decrease in percentage terms was due to better utilization of
service personnel associated with an increased customer base.
Cost of Advertising Revenues. Cost of advertising revenues was $288,000 for
1996, and was 28% of advertising revenues. Since the Company did not begin
selling advertising until 1996, all content creation costs in 1995 were charged
to research and development and selling and marketing expenses.
26
<PAGE> 28
OPERATING EXPENSES
Research and Development. Research and development expenses were $1,380,000
and $4,812,000 for 1995 and 1996, respectively, and 76% and 34%, respectively,
of total net revenues. The increase in absolute dollars was attributable
primarily to increased personnel and related costs associated with development
of new products and enhancement of existing products. The decrease in percentage
terms was a result of revenues growing at a faster rate than research and
development expenses.
Selling and Marketing. Selling and marketing expenses were $1,218,000 and
$7,540,000 for 1995 and 1996, respectively, and 67% and 54%, respectively, of
total net revenues. The increase in absolute dollars was due primarily to
increased salaries, direct sales personnel, commissions, costs associated with
international expansion and promotional expenses. The decrease in percentage
terms was a result of revenues growing at a faster rate than selling and
marketing expenses.
General and Administrative. General and administrative expenses were
$747,000 and $3,491,000 for 1995 and 1996, respectively, and 41% and 25%,
respectively of total net revenues. The increase in absolute dollars was
primarily a result of increased salaries and related expenses associated with
the hiring of additional personnel and increased facilities expenses. The
decrease in percentage terms was a result of revenues growing at a faster rate
than general and administrative expenses.
OTHER INCOME, NET
Other income, net was $94,000 and $227,000 for 1995 and 1996, respectively.
The increase was due primarily to interest income resulting from higher invested
cash and cash equivalents and short-term investments.
INCOME TAXES
As of December 31, 1996, the Company had approximately $2,802,000 of net
operating loss and other credit carryforwards for federal income tax purposes
that will expire in 2010 and 2011 if not utilized. See Note 4 of Notes to
Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through private sales of preferred stock and common stock and contributions of
capital by the Company's founder. Net proceeds from these sales and
contributions totaled $55,480,000. In addition, in November 1997 the Company
completed its initial public offering. Net proceeds to the Company were
$38,543,000.
Net cash used in operating activities was $1,240,000 and $635,000 in 1995
and 1996, respectively. Cash used in operating activities in 1995 was due
primarily to a net loss of $1,501,000. For 1996, cash used in operating
activities resulted primarily from a net loss of $3,789,000 and an increase of
$2,608,000 in trade accounts receivable, largely offset by an increase of
$2,267,000 in deferred revenue, $2,220,000 in accounts payable and $822,000 in
other accrued expenses. Net cash provided by operating activities was $8,092,000
in 1997. This was primarily attributable to a net loss of $11,169,000, an
increase of $1,828,000 in trade accounts receivable, an increase in license fee
and other receivables of $10,600,000, and an increase of $29,163,000 in deferred
revenue related primarily to the Microsoft license agreement.
Net cash used in investing activities of $3,660,000, $4,837,000, and
$30,793,000 in 1995, 1996 and 1997, respectively, was primarily related to
increases in short-term investments and purchases of property and equipment.
Cash provided by financing activities of $8,029,000 in 1995 consisted
primarily of $7,405,000 in net proceeds from the issuance of Series B and C
Preferred Stock and a capital contribution by the founder of $372,000. Cash
provided by financing activities of $17,091,000 in 1996 was primarily from net
proceeds of $17,047,000 from the issuance of Series D Preferred Stock. Cash
provided by financing activities of $70,325,000 in 1997 was primarily from net
proceeds of $29,926,000 from the issuance of Series E Preferred
27
<PAGE> 29
Stock, $38,543,000 in net proceeds from the issuance of Common Stock associated
with the Company's initial public offering, and $991,000 of proceeds from the
issuance of a note payable. In connection with the Series E Preferred Stock
financing, the Company issued a warrant to purchase up to 3,709,305 shares of
Series E Preferred Stock at an exercise price of $13.48 per share. This warrant
expired unexercised in November 1997.
As of December 31, 1997, the Company had $62,255,000 of cash and cash
equivalents and $29,773,000 in short-term investments. As of December 31, 1997,
the Company's principal commitments consisted of obligations outstanding under
operating leases and a $963,000 note payable. The note is denominated in
Japanese yen and bears interest at a rate not to exceed the Japanese Short Term
Prime Rate (1.63% at December 31, 1997). Interest on the note is payable
monthly, and the principal is due in May 2000. The terms of the note contain no
restrictions or covenants. The note is secured by the Company's shares in its
Japanese joint venture. Although the Company has no material commitments for
capital expenditures, management anticipates a substantial increase in its
capital expenditures and lease commitments consistent with anticipated growth in
operations, infrastructure and personnel. See "Recent Developments."
The Company conducts its operations using primarily three currencies: the
United States dollar, the Japanese yen, and the British pound. Historically,
neither fluctuations in foreign exchange rates nor changes in foreign economic
conditions has had a significant impact on the Company's financial condition or
results of operations. As a result, the Company currently does not hedge its
foreign currency transactions and is therefore subject to the risk of exchange
rates. The Company monitors its foreign exchange exposure and in the future may
choose to hedge foreign currency transactions, enter into currency contracts, or
take other such actions as deemed necessary to mitigate exchange rate risks. The
Company is unaware of any existing foreign government policies that would
significantly impact the Company's operations.
In August 1997, the Department of Justice commenced an investigation into
horizontal merger activities within the streaming media industry. The Department
of Justice served several companies, including the Company and Microsoft, with
subpoenas to produce certain documents. As a result of the investigation, it is
possible that the Department of Justice will require certain actions by the
Company, Microsoft or other companies in the streaming media industry that could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Department of Justice could decide to take
actions that could materially and adversely affect the Company's current
relationship with Microsoft or other companies, affect Microsoft's obligations
with respect to the distribution of the Company's products, result in certain
penalties, require the Company to refund all or a portion of the license fee
paid by Microsoft to the Company, require Microsoft to limit or divest certain
of its acquisitions or investments in the streaming media industry, including
its investment in the Company, and, if Microsoft were forced to rescind its
agreement with the Company, place the Company at a significant competitive
disadvantage within the industry. There can be no assurance that any such
outcome would not have an immediate material adverse effect on the Company's
business, financial condition and results of operations.
Since its inception, the Company has significantly increased its operating
expenses. The Company currently anticipates that it will continue to experience
significant growth in its operating expenses for the foreseeable future and that
its operating expenses will be a material use of the Company's cash resources.
The Company believes that its current cash, cash equivalents and short-term
investments will be sufficient to meet its anticipated cash needs for working
capital and capital expenditures for at least the next 12 months.
RECENT DEVELOPMENTS
In January 1998, the Company entered into a lease agreement for a new
location for its corporate offices. The lease commences on April 1, 1999, and
expires on April 1, 2011, with the option to renew the term for either a three
or ten year period, at the Company's choice. Average rent over the lease term is
approximately $4,000,000 per year.
On February 20, 1998, the Company entered into an Agreement and Plan of
Merger (the "Agreement") with RN Acquisition Corp., a wholly-owned subsidiary of
the Company, and Vivo Software, Inc. ("Vivo"), a developer of streaming media
creation tools. The merger became effective on March 24, 1998. In accordance
with the Agreement, the Company issued approximately 1.1 million new shares of
its Common Stock in
28
<PAGE> 30
exchange for all outstanding shares of Vivo Common Stock. The acquisition will
be accounted for using the purchase accounting method. The Company anticipates
that a substantial portion of the purchase price will be expensed as in-process
research and development.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income ("Statement 130"). Statement 130 establishes standards for
reporting and disclosure of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. Statement 130, which is effective for fiscal years beginning after
December 15,1997, requires reclassification of financial statements for earlier
periods to be provided for comparative purposes. The Company has not determined
the manner in which it will present the information required by Statement 130.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information ("Statement 131"). Statement 131 establishes
standards for the way that public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Statement 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years must be restated.
The Company has not determined the manner in which it will present the
information required by Statement 131.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 97-2, Software Revenue Recognition. The
statement 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 which 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. SOP 97-2 will be adopted
by the Company effective January 1, 1998 and is not expected to have any
material effect on revenue recognition.
CERTAIN RISK FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS, FUTURE OPERATING
RESULTS AND FINANCIAL CONDITION
In addition to the other information in this Report, the following factors
should be considered carefully in evaluating the Company's business and
prospects:
LIMITED OPERATING HISTORY
As a result of the Company's limited operating history and the emerging
nature of the markets in which it competes, the Company is unable to forecast
accurately its revenues. The Company's expense levels are based in part on its
expectations with regard to future revenues. The Company may be unable to adjust
spending in a timely manner to compensate for any unexpected revenue shortfall.
As a result, any significant shortfall in demand for the Company's products and
services relative to the Company's expectations would have an immediate material
adverse effect on the Company's business, financial condition and results of
operations. Further, as a strategic response to changes in the competitive
environment, the Company may from time to time implement pricing, service or
marketing changes that could have a material adverse effect on its business,
financial condition and results of operations.
UNPREDICTABILITY OF FUTURE REVENUES; POTENTIAL FLUCTUATION IN QUARTERLY
OPERATING RESULTS
The Company expects to experience significant fluctuations in its future
quarterly operating results due to a variety of factors, many of which are
outside the Company's control, including (i) demand for the Company's products
and services, (ii) introduction or enhancement of products and services by the
Company
29
<PAGE> 31
and its competitors, (iii) market acceptance of new products and services of the
Company and its competitors, (iv) price reductions by the Company or its
competitors or changes in how products and services are priced, (v) the mix of
products and services sold by the Company and its competitors, (vi) the mix of
distribution channels through which the Company's products are licensed and
sold, (vii) the mix of international and U.S. revenues, (viii) costs of
litigation and intellectual property protection, (ix) growth in the use of the
Internet, (x) the Company's ability to attract, train and retain qualified
personnel, (xi) the amount and timing of operating costs and capital
expenditures related to expansion of the Company's business, operations and
infrastructure, (xii) technical difficulties with respect to the use of the
Company's products, (xiii) governmental regulations and (xiv) general economic
conditions and economic conditions specifically related to the Internet. It
often is difficult to forecast the effect such factors, or any combination
thereof, would have on the Company's results of operations for any given fiscal
quarter. The Company has used, and expects to continue to use, price promotions
to increase trial, purchase and use of its products, as well as to increase the
overall recognition of its brands. The effect of such promotions on revenues in
a particular period may be significant and extremely difficult to forecast.
Based on the foregoing, the Company believes that its quarterly revenues,
expenses and operating results could vary significantly in the future, and that
period-to-period comparisons should not be relied upon as indications of future
performance.
Historically, the Company has received a significant portion of its
revenues from a limited number of sales and license agreements. The Company
believes that a customer's decision to purchase its server products or license
its technology is relatively discretionary and, for large-scale users, generally
involves a significant commitment of capital resources. Therefore, any downturn
in the economy or in the business of potential customers could have a material
adverse effect on the Company's revenues and quarterly results of operations.
The Company generally distributes its software products in "beta" form to
the public prior to finalizing product features, functionality and operability.
This may cause certain customers to delay purchasing decisions until commercial
versions of the products are available, which could have a material adverse
effect on the Company's revenues and quarterly results of operations.
The Company derives a significant portion of its revenues from the sale of
technical support services and software upgrades to its installed customer base.
There can be no assurance that a sufficient number of the Company's customers
will continue to enter into support and upgrade contracts or will renew existing
support and upgrade contracts, or that revenues therefrom will continue to be
significant. The loss of a material portion of such revenues would likely have a
material adverse effect on the Company's business, financial condition and
results of operations.
Management has observed that revenues from advertising sales have tended to
be higher in the second and fourth quarters, and retail sales have tended to be
highest in the fourth quarter. The Company typically operates with no backlog.
As a result, quarterly sales and operating results depend primarily on the
volume and timing of orders received in the quarter, both of which are difficult
to forecast. The Company typically recognizes a substantial portion of its
revenues in the last month of each quarter.
Due to the foregoing factors, it is likely that in some future quarters the
Company's operating results will fall below the expectations of securities
analysts and investors, which would likely have a material adverse affect on the
trading price of the Company's Common Stock.
MANAGEMENT OF GROWTH; ACQUISITION RISKS
The Company's rapid growth has placed, and is expected to continue to
place, a significant strain on the Company's managerial, technical, operational
and financial resources. None of the Company's executive officers has had senior
management experience in a public company in the position he or she currently
holds. From December 31, 1996 to December 31, 1997, the Company grew from 185
employees to 326 employees, which rapid growth the Company expects to continue
for the foreseeable future. To manage its growth, the Company must implement and
improve its operations and financial systems and expand, train and manage its
work force. The Company will also need to manage an increasing number of complex
relationships with customers, marketing partners and other third parties. In
addition, the Company may pursue the acquisition of new or complementary
businesses, products or technologies. Any such future acquisitions would be
accompa-
30
<PAGE> 32
nied by the risks commonly encountered in acquisitions of companies. Such risks
include, among other things, the difficulty of assimilating the operations and
personnel of the acquired companies, the potential disruption of the Company's
ongoing business, the inability of management to succeed in incorporating
acquired technology and rights into the Company's products, services and media
offerings, additional expense associated with amortization of acquired
intangible assets, the difficulty of maintaining uniform standards, controls,
procedures and policies, and the potential impairment of relationships with
employees, customers and strategic partners.
There can be no assurance that the Company's systems, procedures or
controls will be adequate to support its current or future operations or that
the Company's management will be able to manage the expansion and still achieve
the rapid execution necessary to exploit fully the market for the Company's
products and services. The Company's future operating results will also depend
on its ability to expand its sales and marketing organizations, implement and
manage new distribution channels to penetrate different and broader markets,
including the market for intranet software products, and expand its support
organization accordingly. If the Company were to fail to manage its growth
effectively, its business, financial condition and results of operations would
be materially adversely affected.
RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION
For the years ended December 31, 1996 and December 31, 1997, approximately
22% and 26%, respectively, of the Company's total net revenues were generated
from sources outside the U.S. As a result, the Company is subject to the risks
of doing business abroad, including unexpected changes in regulatory
requirements, export and import restrictions, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, longer payment cycles,
problems in collecting accounts receivable, potential adverse tax consequences,
exchange rate fluctuations, increased risks of piracy, limits on the Company's
ability to enforce its intellectual property rights, discontinuity of network
infrastructures, limits on repatriation of funds and political risks that may
limit or disrupt international sales. Such limitations and interruptions could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, operations of the Company's foreign
subsidiaries are translated from local currency into U.S. dollars based on
average monthly exchange rates. The Company currently does not hedge its foreign
currency transactions and is therefore subject to the risk of changes in
exchange rates.
DEVELOPING MARKET; DEPENDENCE ON THE INTERNET AND INTRANETS AS MEDIUMS OF
COMMERCE AND COMMUNICATIONS
The market for the Company's streaming media products and services,
especially the market for the Company's intranet products and services, has
begun only recently to develop and is evolving rapidly, with continuing new
developments in technology, product distribution methods and marketing and
licensing relationships. The development of a market for the Company's streaming
media products also depends on increased use of the Internet and intranets for
information, publication, distribution and commerce. Continued growth in the use
of the Internet may depend on potential increases in available bandwidth or
transmission speeds or on other technological improvements. In particular, the
Company believes that continued growth in market acceptance of streaming media,
especially streaming video, depends on such developments. Changes in network
infrastructure, transmission and content delivery methods and underlying
software platforms, and the emergence of new Internet access devices, such as TV
set-top boxes, could dramatically change the structure and competitive dynamic
of the market for streaming media solutions. In particular, technological
developments or strategic partnerships that accelerate the adoption of "high
bandwidth" access technologies such as cable modems may have a material adverse
effect on the Company's business. Critical issues concerning use of the Internet
and intranets (including security, reliability, cost, ease of use and quality of
service) remain unresolved and may affect the growth of and the degree to which
business is conducted over the Internet and intranets. If the market for the
Company's products and services fails to grow, develops more slowly than
expected or becomes saturated with competing products or services, the Company's
business, financial condition and results of operations will be materially
adversely affected.
31
<PAGE> 33
Because electronic commerce over the Internet is relatively new and
evolving, it is difficult to predict whether the Internet will be a viable
commercial marketplace or whether the Internet or intranets will be viable
mediums of communication. Sales of the Company's products will continue to
depend in large part on the emergence of the Internet as a viable commercial
marketplace with a strong and reliable infrastructure. The Internet has
experienced substantial growth in the number of users and amount of traffic, and
there can be no assurance that its technological infrastructure will be able to
support the demands placed on it by continued growth. Delays in the development
or adoption of new technological standards and protocols, or increased
governmental regulation, could also affect the degree of use of the Internet. In
addition, developments in Internet infrastructure such as broadband Internet
access may significantly affect the market for streaming media products. There
can be no assurance that the infrastructure or complementary services necessary
to make the Internet a viable commercial medium will be developed or, if
developed, that the Internet will become a viable commercial medium for products
and services such as those offered by the Company.
EVOLVING BUSINESS MODEL; DEVELOPMENT OF NEW PRODUCTS AND OTHER REVENUE SOURCES
The Company's success depends in part on its ability to develop new
products in a timely manner and provide new services that achieve rapid and
broad market acceptance. There can be no assurance that the Company can identify
new product and service opportunities successfully and develop and bring to
market new products and services in a timely manner or that any such product
innovations will achieve the market penetration or price stability necessary for
profitability.
As the online medium continues to evolve, the Company plans to leverage its
technology by developing complementary products and services as additional
sources of revenue. Accordingly, the Company may change its business model to
take advantage of new business opportunities, including business areas in which
the Company does not have extensive experience. There can be no assurance that
the Company will develop these or other business models successfully.
In addition, the Company must continue to innovate and develop new versions
of its software to remain competitive in the market for streaming media
solutions. The Company's product and software development efforts inherently are
difficult to manage and keep on schedule. The Company on occasion has
experienced development delays and related cost overruns, and there can be no
assurance that it will not encounter such problems in the future. In addition,
products as complex as those offered by the Company may contain undetected
errors when first introduced or when new versions are released. There can be no
assurance that errors will not occur in current or new products, the result of
which may be adverse publicity, loss of or delay in market acceptance, or claims
by customers against the Company, any of which could have a material adverse
effect on the Company's business, financial condition and results of operations.
Expansion of the Company's operations to take advantage of new
opportunities and to sustain a leadership position in the market for streaming
media software may require significant additional expenditures and may strain
the Company's management, financial and operational resources. A lack of market
acceptance of new products or services or the Company's inability to generate
satisfactory revenues from such new products and services to offset their cost
could have a material adverse effect on the Company's business, financial
condition and results of operations.
DEPENDENCE ON KEY PERSONNEL; NEED FOR ADDITIONAL PERSONNEL
The Company's performance depends substantially on the continued services
of its executive officers and key employees, and in particular on Robert Glaser,
the Company's Chairman of the Board and Chief Executive Officer. The loss of the
services of Mr. Glaser or any if its other executive officers or key employees
could have a material adverse effect on the Company's business, financial
condition and results of operations. None of the Company's executive officers
has a contract that guarantees employment. Other than a $2,000,000 insurance
policy on the life of Mr. Glaser, the Company does not maintain "key person"
life insurance policies. The Company depends on its ability to attract, train
and retain qualified personnel, specifically those with management, technical
and product development skills. Competition for such personnel
32
<PAGE> 34
is intense, particularly in geographic areas recognized as high technology
centers such as the Pacific Northwest. There can be no assurance that the
Company will be able to attract, train or retain additional highly qualified
technical and managerial personnel in the future.
ONLINE COMMERCE SECURITY RISKS
Online commerce and communications depend to a significant extent on the
ability to conduct secure transmission of confidential information over public
networks. The Company relies on encryption and authentication technology
licensed from third parties to provide the security and authentication intended
to effect secure transmission of confidential information, such as customer
credit card numbers. There can be no assurance that the Company's efforts in
this area or advances in computer capabilities, new discoveries in the field of
cryptography, or other events or developments will not result in a compromise or
breach of the algorithms used by the Company to protect customer transaction
data. Any compromise of the Company's security could have a material adverse
effect on the Company's business, financial condition and results of operations.
A party who is able to circumvent the Company's security measures could
misappropriate proprietary information or cause interruptions in the Company's
operations. The Company may be required to expend significant capital and other
resources to protect against such security breaches or to alleviate problems
caused by such breaches. In addition, there can be no assurance that credit card
companies will not restrict online credit card transactions in the future for
reasons such as fraudulent credit card transactions or other risks associated
with online commerce transactions, which restrictions could have a material
adverse effect on the Company's business, financial condition and results of
operations. To the extent that activities of the Company or third-party
contractors involve the storage and transmission of proprietary information,
security breaches could damage the Company's reputation and expose the Company
to a risk of litigation and possible liability. There can be no assurance that
the Company's security measures will prevent security breaches or that the
failure to prevent such security breaches will not have a material adverse
effect on the Company's business, financial condition and results of operations.
YEAR 2000
Although the Company believes that all of its current products are year
2000 compliant, 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 which 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.
VOLATILITY OF STOCK PRICE
The Company believes that factors such as announcements of developments
related to the Company's business, announcements of technological innovations or
new products or enhancements by the Company or its competitors, sales by
competitors (including sales to the Company's customers), developments in the
Company's relationships with its customers, partners, distributors and
suppliers, shortfalls or changes in revenues, gross margins, earnings or losses
or other financial results from analysts' expectations, regulatory developments,
fluctuations in results of operations and conditions in the Company's market or
the markets served by the Company's customers or the economy could cause the
price of the Company's Common Stock to fluctuate, perhaps substantially. In
addition, in recent years the stock market in general, and the market for shares
of small capitalization and technology stocks in particular, have experienced
extreme price fluctuations which have often been unrelated to the operating
performance of affected companies. There can be no assurance that the market
price of the Company's Common Stock will not experience significant fluctuations
in the future, including fluctuations unrelated to the Company's performance.
33
<PAGE> 35
DONATION OF NET INCOME TO CHARITY
The Company's philosophy includes a commitment to charitable
responsibility. If sustained profitability is achieved, the Company intends to
donate approximately 5% of its annual net income to charitable organizations.
The Company's net income will be reduced by the amount of any such charitable
donations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
34
<PAGE> 36
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
RealNetworks, Inc.:
We have audited the accompanying consolidated balance sheets of
RealNetworks, Inc. and subsidiaries as of December 31, 1996 and 1997, and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows for each of the years in the three-year period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
RealNetworks, Inc. and subsidiaries as of December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ KPMG PEAT MARWICK LLP
January 21, 1998, except for Note 9(b),
which is as of March 24, 1998
Seattle, Washington
35
<PAGE> 37
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
----------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $14,737,806 $ 62,255,129
Short-term investments.................................... 4,857,163 29,772,771
Trade accounts receivable, net of allowance for doubtful
accounts and sales returns of $383,350 and $829,347 at
December 31, 1996 and 1997, respectively................ 3,275,518 5,073,036
License fee receivable.................................... -- 10,000,000
Other receivables......................................... 105,888 705,875
Inventory................................................. 60,543 167,367
Prepaid expenses and other current assets................. 491,348 1,376,558
Deferred income taxes..................................... -- 508,000
----------- ------------
Total current assets............................... 23,528,266 109,858,736
Property and equipment, net................................. 2,678,798 5,143,162
Investment in joint venture................................. -- 816,386
Deferred income taxes....................................... -- 269,000
Other assets................................................ 261,094 617,082
----------- ------------
$26,468,158 $116,704,366
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 2,405,490 $ 2,135,878
Accrued compensation...................................... 346,011 974,755
Other accrued expenses.................................... 971,499 2,679,009
Deferred revenue.......................................... 2,911,922 16,549,705
----------- ------------
Total current liabilities.......................... 6,634,922 22,339,347
----------- ------------
Deferred revenue............................................ -- 15,500,000
Note payable................................................ -- 963,379
Redeemable, convertible preferred stock, $0.001 par value.
Authorized 16,206,998 shares; issued and outstanding
8,345,016 shares at December 31, 1996 and no shares at
December 31, 1997 (aggregate liquidation preference of
$34,645,820 and aggregate redemption value of $25,681,317
at December 31, 1996)..................................... 23,153,494 --
Shareholders' equity (deficit):
Convertible preferred stock, $0.001 par value.
Authorized 13,713,439 shares; issued and outstanding
13,713,439 shares at December 31, 1996 and no shares at
December 31, 1997 (aggregate liquidation preference of
$999,710 at December 31, 1996).......................... 13,713 --
Preferred stock, undesignated series, $0.001 par value.
Authorized 30,079,563 shares; no shares issued and
outstanding............................................. -- --
Common stock, $0.001 par value.
Authorized 292,952,321 shares; issued and outstanding
535,491 shares at December 31, 1996 and 27,527,543
shares at December 31, 1997............................. 535 27,527
Special common stock, $0.001 par value.
Authorized 7,047,679 shares; issued and outstanding no
shares at December 31, 1996 and 3,338,374 shares at
December 31, 1997....................................... -- 3,338
Additional paid-in capital................................ 2,543,587 95,556,732
Cumulative translation adjustment......................... (11,307) (162,185)
Accumulated deficit....................................... (5,866,786) (17,523,772)
----------- ------------
Total shareholders' equity (deficit)............... (3,320,258) 77,901,640
----------- ------------
Commitments, contingencies and subsequent events
$26,468,158 $116,704,366
=========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
36
<PAGE> 38
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
----------- ----------- ------------
<S> <C> <C> <C>
Net revenues:
Software license fees............................ $ 1,781,763 $11,875,945 $ 25,494,283
Service revenues................................. 29,835 1,120,479 4,972,457
Advertising...................................... -- 1,015,964 2,253,480
----------- ----------- ------------
Total net revenues....................... 1,811,598 14,012,388 32,720,220
Cost of revenues:
Software license fees............................ 29,194 1,342,942 3,153,128
Service revenues................................. 32,940 554,558 2,392,023
Advertising...................................... -- 288,024 919,519
----------- ----------- ------------
Total cost of revenues................... 62,134 2,185,524 6,464,670
----------- ----------- ------------
Gross profit.................................. 1,749,464 11,826,864 26,255,550
Operating expenses:
Research and development......................... 1,379,727 4,812,188 13,268,232
Selling and marketing............................ 1,217,900 7,539,924 20,124,919
General and administrative....................... 746,645 3,491,296 6,023,706
----------- ----------- ------------
Total operating expenses................. 3,344,272 15,843,408 39,416,857
----------- ----------- ------------
Operating loss................................ (1,594,808) (4,016,544) (13,161,307)
Other income (expense):
Interest income, net............................. 93,506 296,427 2,225,276
Other expense.................................... -- (69,128) (51,022)
Equity in net losses of joint venture............ -- -- (181,821)
----------- ----------- ------------
Other income, net............................. 93,506 227,299 1,992,433
----------- ----------- ------------
Net loss................................. $(1,501,302) $(3,789,245) $(11,168,874)
=========== =========== ============
Historical basic and diluted net loss per share.... $ (59.89) $ (11.91) $ (2.88)
Shares used to compute historical basic and diluted
net loss per share............................... 25,066 320,822 4,040,718
Pro forma basic and diluted net loss per share..... $ (0.40)
Shares used to compute pro forma basic and diluted
net loss per share............................... 28,853,714
</TABLE>
See accompanying notes to consolidated financial statements
37
<PAGE> 39
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
SPECIAL
PREFERRED STOCK COMMON STOCK COMMON STOCK
---------------------- -------------------- ------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- -------- ---------- ------- --------- ------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1994...... -- $ -- 10,000 $ 10 -- $ --
Contribution of capital by
founder.......................... -- -- -- -- -- --
Exchange of common stock for Series
A preferred stock................ 13,713,439 13,713 (9,999) (10) -- --
Exercise of common stock options... -- -- 30,750 31 -- --
Issuance of common stock in
exchange for services............ -- -- 6,197 6 -- --
Net Loss....................... -- -- -- -- -- --
----------- -------- ---------- ------- --------- ------
Balances at December 31, 1995...... 13,713,439 13,713 36,948 37 -- --
Exercise of common stock options... -- -- 498,543 498 -- --
Issuance of preferred stock
warrants......................... -- -- -- -- -- --
Accretion of redemption value of
redeemable, convertible preferred
stock............................ -- -- -- -- -- --
Translation adjustment............. -- -- -- -- -- --
Net loss....................... -- -- -- --
----------- -------- ---------- ------- --------- ------
Balances at December 31, 1996...... 13,713,439 13,713 535,491 535 -- --
Exercise of common stock options... -- -- 1,144,001 1,144 -- --
Issuance of common stock in
exchange for goods and
services......................... -- -- 16,000 16 -- --
Issuance of preferred stock
warrants......................... -- -- -- -- -- --
Accretion of redemption value of
redeemable, convertible preferred
stock............................ -- -- -- -- -- --
Exercise of common stock
warrants......................... -- -- 183,755 184 -- --
Conversion of convertible preferred
stock to common stock............ (13,713,439) (13,713) 13,713,439 13,713 -- --
Conversion of redeemable,
convertible preferred stock to
common stock and special common
stock............................ -- -- 8,484,857 8,485 3,338,374 3,338
Issuance of common stock, net of
issuance costs of $4,582,327..... -- -- 3,450,000 3,450 -- --
Translation adjustment............. -- -- -- -- -- --
Net loss....................... -- -- -- -- -- --
----------- -------- ---------- ------- --------- ------
Balances at December 31, 1997...... -- $ -- 27,527,543 $27,527 3,338,374 $3,338
=========== ======== ========== ======= ========= ======
<CAPTION>
ADDITIONAL CUMULATIVE TOTAL
PAID-IN TRANSLATION ACCUMULATED SHAREHOLDERS'
CAPITAL ADJUSTMENT DEFICIT EQUITY (DEFICIT)
------------ ------------ ------------ ----------------
<S> <C> <C> <C> <C>
Balances at December 31, 1994...... $ 560,185 $ -- $ (545,239) $ 14,956
Contribution of capital by
founder.......................... 372,283 -- -- 372,283
Exchange of common stock for Series
A preferred stock................ (13,703) -- -- --
Exercise of common stock options... 2,122 -- -- 2,153
Issuance of common stock in
exchange for services............ 428 -- -- 434
Net Loss....................... -- -- (1,501,302) (1,501,302)
----------- --------- ------------ ------------
Balances at December 31, 1995...... 921,315 -- (2,046,541) (1,111,476)
Exercise of common stock options... 43,272 -- -- 43,770
Issuance of preferred stock
warrants......................... 1,579,000 -- -- 1,579,000
Accretion of redemption value of
redeemable, convertible preferred
stock............................ -- -- (31,000) (31,000)
Translation adjustment............. -- (11,307) -- (11,307)
Net loss....................... -- -- (3,789,245) (3,789,245)
----------- --------- ------------ ------------
Balances at December 31, 1996...... 2,543,587 (11,307) (5,866,786) (3,320,258)
Exercise of common stock options... 255,443 -- -- 256,587
Issuance of common stock in
exchange for goods and
services......................... 54,484 -- -- 54,500
Issuance of preferred stock
warrants......................... 4,068,000 -- -- 4,068,000
Accretion of redemption value of
redeemable, convertible preferred
stock............................ -- -- (488,112) (488,112)
Exercise of common stock
warrants......................... 36,567 -- -- 36,751
Conversion of convertible preferred
stock to common stock............ -- -- -- --
Conversion of redeemable,
convertible preferred stock to
common stock and special common
stock............................ 50,059,428 -- -- 50,071,251
Issuance of common stock, net of
issuance costs of $4,582,327..... 38,539,223 -- -- 38,542,673
Translation adjustment............. -- (150,878) -- (150,878)
Net loss....................... -- -- (11,168,874) (11,168,874)
----------- --------- ------------ ------------
Balances at December 31, 1997...... $95,556,732 $(162,185) $(17,523,772) $ 77,901,640
=========== ========= ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
38
<PAGE> 40
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
----------- ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(1,501,302) $ (3,789,245) $(11,168,874)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization........................... 93,265 699,087 2,132,092
Common stock issued in exchange for goods and
services.............................................. 434 -- 54,500
Equity in net losses of joint venture................... -- -- 181,821
Unrealized foreign currency transaction gain............ -- -- (27,889)
Deferred income tax benefit............................. -- -- (777,000)
Change in certain assets and liabilities:
Trade accounts receivable............................. (667,847) (2,607,671) (1,827,951)
License fee and other receivables..................... -- (57,320) (10,599,987)
Inventory............................................. (3,218) (57,325) (106,824)
Prepaid expenses and other current assets............. (143,328) (348,723) (892,550)
Other assets.......................................... -- (78,298) (119,983)
Accounts payable...................................... 185,368 2,220,292 (259,700)
Accrued compensation.................................. 34,164 296,030 632,437
Other accrued expenses................................ 116,692 821,590 1,708,238
Deferred revenue...................................... 645,416 2,266,506 29,163,248
----------- ------------ ------------
Net cash provided by (used in) operating
activities....................................... (1,240,356) (635,077) 8,091,578
----------- ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment....................... (624,503) (2,783,994) (4,627,517)
Purchases of short-term investments....................... (3,035,061) (30,514,885) (203,046,046)
Proceeds from sales and maturities of short-term
investments............................................. -- 28,644,215 178,130,438
Investment in joint venture............................... -- -- (998,207)
Increase in other assets.................................. -- (181,960) (251,609)
----------- ------------ ------------
Net cash used in investing activities.............. (3,659,564) (4,836,624) (30,792,941)
----------- ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of note payable.................... -- -- 991,268
Proceeds from sale of preferred stock and stock warrants,
net..................................................... 7,404,528 17,046,966 29,926,302
Proceeds from exercise of common and preferred stock
warrants................................................ 250,000 -- 608,094
Proceeds from exercise of common stock options............ 2,153 43,770 256,587
Proceeds from sale of common stock, net................... -- -- 38,542,673
Contribution of capital by founder........................ 372,283 -- --
----------- ------------ ------------
Net cash provided by financing activities.......... 8,028,964 17,090,736 70,324,924
----------- ------------ ------------
Effect of exchange rate changes on cash..................... -- (10,623) (106,238)
----------- ------------ ------------
Net increase in cash and cash equivalents.......... 3,129,044 11,608,412 47,517,323
Cash and cash equivalents at beginning of year.............. 350 3,129,394 14,737,806
----------- ------------ ------------
Cash and cash equivalents at end of year.................... $ 3,129,394 $ 14,737,806 $ 62,255,129
=========== ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for interest.................... $ 1,853 $ 4,430 $ 26,633
Cash paid during the year for income taxes................ $ -- $ -- $ 700,000
Supplemental disclosure of noncash financing and investing
activities:
Exchange of common stock for Series A preferred stock..... $ 932,385 $ -- $ --
Accretion of redemption value of redeemable, convertible
preferred stock......................................... $ -- $ 31,000 $ 488,112
Conversion of convertible preferred stock to common
stock................................................... $ -- $ -- $ 13,713
Conversion of redeemable, convertible preferred stock to
common stock and special common stock................... $ -- $ -- $ 50,071,251
</TABLE>
See accompanying notes to consolidated financial statements.
39
<PAGE> 41
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1996, AND 1997
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Nature 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 Web site
designed to promote the proliferation of streaming media products and a network
of advertising-supported content aggregation Web sites.
Inherent in the Company's business are various risks and uncertainties,
including its limited operating history and the limited history of commerce on
the Internet. The Company's success may depend in part upon the emergence of the
Internet as a communications medium, the acceptance of the Company's technology
by the marketplace and the Company's ability to generate license and advertising
revenues from the use of its technology on the Internet.
(b) Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(c) Cash and Cash Equivalents and Short-Term Investments
The Company considers all short-term investments with a remaining
contractual maturity at date of purchase of three months or less to be cash
equivalents.
The Company considers all short-term investments as available-for-sale.
Accordingly, these investments are carried at fair value. The fair value of such
securities approximated cost, and there were no unrealized holding gains or
losses at December 31, 1996 and 1997. At December 31, 1997, all short-term
investments had contractual maturities of two years or less.
The Company's cash and cash equivalents and short-term investments as of
December 31, 1996 and 1997 consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
Cash and cash equivalents:
Cash............................................ $ 1,016,728 $ 4,679,008
Commercial paper................................ 13,721,078 57,576,121
----------- -----------
Total cash and cash equivalents......... 14,737,806 62,255,129
----------- -----------
Short-term investments:
Corporate notes................................. 4,857,163 6,208,283
U.S. Government agency securities............... -- 21,064,611
Certificates of deposit......................... -- 2,499,877
----------- -----------
Total short-term investments............ 4,857,163 29,772,771
----------- -----------
Total cash and cash equivalents and
short-term investments................ $19,594,969 $92,027,900
=========== ===========
</TABLE>
40
<PAGE> 42
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
(d) Inventory
Inventory is stated at the lower of cost or market, with cost determined on
the first-in, first-out basis.
(e) Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets,
generally three years. Leasehold improvements are amortized over the lesser of
the term of the lease or the estimated useful life of the asset.
(f) Investment in Joint Venture
The Company has a 24% interest in a Japanese limited liability company and
accounts for this investment using the equity method. Accordingly, the initial
investment is recorded at cost. Subsequently, the carrying amount of the
investment is increased or decreased to reflect the Company's share of income or
losses of the joint venture and is reduced to reflect dividends received from
the joint venture. The Company's share of income or losses of the joint venture
is included in the Company's consolidated statements of operations.
The Company's investment in the joint venture was funded with proceeds from
a loan from Trans Cosmos, Inc., one of the joint venture's partners (see note
6). The Company and Trans Cosmos, Inc. are parties to a Master Distribution
Agreement pursuant to which the Company granted Trans Cosmos, Inc. a
nonexclusive, nontransferable license to reproduce and distribute the Company's
products in Japan.
(g) Research and Development
Research and development costs are charged to operations as incurred.
Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed, requires
capitalization of certain software development costs subsequent to the
establishment of technological feasibility.
Based on the Company's product development process, technological
feasibility is established upon completion of a working model. Costs incurred by
the Company between completion of the working model and the point at which the
product is ready for general release have not been significant.
(h) Revenue Recognition
The Company recognizes revenue from software license fees upon delivery,
net of an allowance for estimated returns, provided that no significant
obligations of the Company remain and collection of the resulting receivable is
deemed probable.
Revenue from software license agreements with original equipment
manufacturers (OEM) is recognized when the OEM delivers its product
incorporating the Company's software to the end user. In the case of prepayments
received from an OEM, the Company generally recognizes revenue based on the
actual products sold by the OEM. If the Company anticipates providing ongoing
support to the OEM in the form of future upgrades, enhancements or other
services over the term of the contract, revenue generally is recognized on the
straight-line method over the term of the contract.
The Company recognizes revenue from software license agreements with
value-added resellers (VAR), 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,
commissions from sales of third-party products and fees from consulting, content
hosting, and user conferences. Support and upgrade revenues are recognized
ratably over the term of the contract, which typically is 12 months. Other
service revenues are recognized when the service is performed.
41
<PAGE> 43
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
Revenues from advertising appearing on the Company's World Wide Web (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. As of December 31, 1996 and 1997, no
revenues had been deferred as a result of these guarantees.
(i) Financial Instruments and Concentrations of Risk
The Company's financial instruments consist of cash and cash equivalents,
short-term investments, trade accounts receivable, license fee receivable,
accounts payable, accrued expenses, and note payable. The fair value of these
instruments approximates their financial statement carrying amount. Credit is
extended to customers based on an evaluation of their financial condition, and
collateral is not required. The Company performs ongoing credit evaluations of
its customers and maintains an allowance for potential credit losses.
The Company is subject to concentrations of credit risk and interest rate
risk related to its short-term investments. The Company's credit risk is managed
by limiting the amount of investments placed with any one issuer, investing in
high-quality investment securities and securities of the U.S. government, and
limiting the average maturity of the overall portfolio.
The Company's customers consist primarily of resellers and end users
located in the United States and various foreign countries. Revenues in the
years ended December 31, 1995, 1996 and 1997 by geographic region, as a percent
of total net revenues, are as follows:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
United States....................................... 83% 78% 74%
Asia................................................ 8% 7% 10%
Europe.............................................. 5% 7% 11%
Canada.............................................. 2% 3% 3%
Other............................................... 2% 5% 2%
</TABLE>
One customer accounted for approximately 14% of total net revenues in 1995.
No single customer accounted for more than 10% of total net revenues in 1996.
Software license fees under a license agreement with Microsoft Corporation
(Microsoft) (see note 8) accounted for approximately 15% of total net revenues
for the year ended December 31, 1997.
(j) Advertising Expenses
The Company expenses the cost of advertising and promoting its products as
incurred. Such costs are included in selling and marketing expense and totaled
approximately $68,000, $665,000, and $1,110,000 during the years ended December
31, 1995, 1996 and 1997, respectively.
(k) Income Taxes
The Company was an S corporation for federal income tax purposes from its
inception through April 8, 1995. Consequently, taxable income or loss of the
Company through April 8, 1995 was attributed to the Company's shareholders.
Effective April 8, 1995, the Company changed its election to utilize the
provisions of subchapter S of the Internal Revenue Code of 1986, as amended, and
elected to be taxed as a subchapter C corporation.
The Company uses the asset and liability method of accounting for income
taxes. Under this method, deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and to operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using
42
<PAGE> 44
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
results of operations in the period that includes the enactment date.
Pro forma income tax information has not been provided for the period from
January 1, 1995 to April 8, 1995. As a result of the operating losses recognized
prior to April 8, 1995, any income tax benefit would have been fully offset by
the establishment of a valuation allowance for deferred tax assets had the
Company been taxed as a subchapter C corporation.
(l) Foreign Currency
The functional currency of the Company's foreign subsidiaries is the local
currency in the country in which the subsidiary is incorporated. Assets and
liabilities of foreign operations are translated into U.S. dollars using rates
of exchange in effect at the end of the reporting period. Income and expense
accounts are translated into U.S. dollars using average rates of exchange. The
net gain or loss resulting from translation is shown as a cumulative translation
adjustment in shareholders' equity. Gains and losses from foreign currency
transactions are included in the consolidated statement of operations. There
were no foreign currency transaction gains or losses in 1995 or 1996. In 1997,
the Company recorded an unrealized foreign currency transaction gain of $27,889.
(m) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(n) Stock-Based Compensation
The Company accounts for its stock option plans for employees in accordance
with the provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As such,
compensation expense related to employee stock options is recorded only if, on
the date of grant, the fair value of the underlying stock exceeded the exercise
price. On January 1, 1996, the Company adopted the disclosure-only requirements
of SFAS No. 123, Accounting for Stock-Based Compensation, which allows entities
to continue to apply the provisions of APB Opinion No. 25 for transactions with
employees and provide pro forma net income and pro forma earnings per share
disclosures as if the fair-value based method of accounting in SFAS No. 123 had
been applied to employee stock option grants made in 1995 and future years.
(o) Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of their carrying amount or fair value less costs
to sell.
(p) Reclassifications
Certain reclassifications have been made to the 1995 and 1996 consolidated
financial statements to conform with the 1997 presentation.
43
<PAGE> 45
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
(q) Net Loss Per Share
The Financial Accounting Standards Board (FASB) recently issued SFAS No.
128, Earnings Per Share. SFAS No. 128 requires the presentation of basic
earnings per share, and for companies with complex capital structures, diluted
earnings per share. Basic earnings per share is computed using the weighted
average number of common shares outstanding during the period. Diluted earnings
per share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. The Company has
presented historical basic and diluted net loss per share in accordance with
SFAS No. 128. As the Company had a net loss in each of the periods presented,
basic and diluted net loss per share is the same.
The following table reconciles the Company's reported net loss to net loss
attributable to common shareholders used to compute historical basic and diluted
net loss per share:
<TABLE>
<CAPTION>
1995 1996 1997
----------- ----------- ------------
<S> <C> <C> <C>
Net loss........................... $(1,501,302) $(3,789,245) $(11,168,874)
Accretion of redemption value of
redeemable preferred stock prior
to conversion into common
stock............................ -- (31,000) (488,112)
----------- ----------- ------------
Net loss attributable to common
shareholders..................... $(1,501,302) $(3,820,245) $(11,656,986)
=========== =========== ============
</TABLE>
Excluded from the computation of historical diluted earnings per share for
1997 are options to acquire 6,932,214 shares of Common Stock with a
weighted-average exercise price of $2.92 and warrants to acquire 674,462 shares
of Common Stock with a weighted-average exercise price of $9.4125 because their
effects would be anti-dilutive. Also excluded from the computation of historical
diluted earnings per share for 1997 are the common equivalent shares resulting
from the assumed conversion of the redeemable convertible preferred stock Series
B through E and the convertible preferred stock Series A, because their effects
were anti-dilutive prior to their conversion into common stock upon the closing
of the Company's initial public offering on November 21, 1997.
On January 28, 1998 when the Company announced its results of operations
for 1997, the Company had computed pro forma basic and diluted net loss per
share using the provisions of the Securities and Exchange Commission (SEC) Staff
Accounting Bulletin (SAB) No. 83 which requires that all common and common
equivalent shares issued during the twelve months immediately preceding the
initial filing of a registration statement for the Company's initial public
offering be included in the calculation of common and common equivalent shares
outstanding as if they were outstanding for all periods presented, including
loss years where the impact is antidilutive. Additionally, the provisions of SAB
No. 83 allowed the presentation of pro forma net loss per share in lieu of
historical net loss per share when management has deemed a pro forma
presentation to be more meaningful than the historical presentation.
Because of the significance of the conversion of preferred stock to common
stock upon the closing of the Company's initial public offering, the Company has
presented pro forma basic and diluted net loss per share as if these series of
convertible preferred stock and redeemable convertible preferred stock had been
converted into common stock on January 1, 1997, or their date of issuance if
later.
The following table reconciles shares used to compute 1997 historical basic
and diluted net loss per share to shares used to compute pro forma basic and
diluted net loss per share:
<TABLE>
<S> <C>
Shares used to compute historical basic and diluted net loss
per share................................................. 4,040,718
Impact of assumed conversion of preferred stock as of
January 1, 1997........................................... 22,751,326
Impact of shares included pursuant to SAB 83................ 2,061,670
----------
Shares used to compute pro forma basic and diluted net loss
per share................................................. 28,853,714
==========
</TABLE>
44
<PAGE> 46
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
On February 3, 1998, the SEC issued SAB No. 98 which superceded SAB No. 83.
Had the Company computed pro forma basic and diluted net loss per share using
the provisions of SAB No. 98, antidilutive common equivalent shares previously
included pursuant to SAB No. 83 would have been omitted and pro forma basic and
diluted net loss per share for 1997 would have been $(0.44).
(r) New Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income
(Statement 130). Statement 130 establishes standards for reporting and
disclosure of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general-purpose financial statements. Statement
130, which is effective for fiscal years beginning after December 15, 1997,
requires reclassification of financial statements for earlier periods to be
provided for comparative purposes. The Company has not determined the manner in
which it will present the information required by Statement 130.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information (Statement 131). Statement 131 establishes
standards for the way that public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. Statement 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years must be restated.
The Company has not determined the manner in which it will present the
information required by Statement 131.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 97-2, Software Revenue Recognition. The
statement 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 which 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. SOP 97-2 will be adopted
by the Company effective January 1, 1998 and is not expected to have any
material effect on revenue recognition.
2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
---------- ----------
<S> <C> <C>
Computer equipment and software..................... $2,210,799 $5,128,637
Furniture, fixtures and leasehold improvements...... 1,251,354 2,767,633
---------- ----------
$3,462,153 $7,896,270
Less accumulated depreciation and amortization...... 783,355 2,753,108
---------- ----------
$2,678,798 $5,143,162
========== ==========
</TABLE>
45
<PAGE> 47
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
3. COMMITMENTS
(a) Leases
The Company leases facilities under operating lease agreements expiring
through April 2001. Under lease agreements in place at December 31, 1997, future
minimum lease payments are:
<TABLE>
<CAPTION>
NET MINIMUM
MINIMUM LEASE SUBLEASE LEASE
YEARS ENDING DECEMBER 31, PAYMENTS RECEIPTS PAYMENTS
------------------------- ------------- --------- -----------
<S> <C> <C> <C>
1998................................ $1,926,119 $(191,100) $1,735,019
1999................................ 1,743,608 (47,775) 1,695,833
2000................................ 1,646,251 -- 1,646,251
2001................................ 548,749 -- 548,749
---------- --------- ----------
Total minimum lease
payments................ $5,864,727 $(238,875) $5,625,852
========== ========= ==========
</TABLE>
Rent expense totaled approximately $76,000, $610,000 and $1,772,000 for the
years ended December 31, 1995, 1996 and 1997, respectively.
In April 1996, the Company entered into operating lease agreements for
additional corporate office space, with the lease term extending through April
2001. These leases can be terminated beginning October 1998 with nine months'
advance written notice and contain options for two five-year renewals. See
additional disclosure in note 9(a).
(b) Royalties
The Company has arrangements with several Internet content providers
pursuant to which it is committed to pay a percentage of certain advertising
revenues generated from its Web sites. As of December 31, 1997, royalties under
these arrangements have not been significant.
4. INCOME TAXES
The components of income tax expense (benefit) are:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
-------- -------- ---------
<S> <C> <C> <C>
Current................................... $ -- $ -- $ 777,000
Deferred.................................. -- -- (777,000)
-------- -------- ---------
$ -- $ -- $ --
======== ======== =========
</TABLE>
The expected U.S. federal income tax benefit determined by applying the
statutory U.S. federal income tax rate of 34% to pretax loss for the years ended
December 31, 1995, 1996 and 1997 differs from the U.S. federal income tax
benefit in the consolidated financial statements due primarily to the increase
in the valuation allowance for deferred tax assets and losses of foreign
subsidiaries for which a net operating loss carryforward is not permitted.
46
<PAGE> 48
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
The tax effects of temporary differences and tax loss and credit
carryforwards that give rise to significant portions of federal deferred tax
assets are comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
---------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.................. $ 918,000 $ --
Deferred revenue.................................. 530,000 6,552,000
Allowances for doubtful accounts and sales
returns........................................ 130,000 282,000
Start-up costs capitalized for tax purposes....... 70,000 43,000
Research and experimentation credit
carryforwards.................................. 102,000 --
Other............................................. 78,000 341,000
---------- ----------
Gross deferred tax assets........................... 1,828,000 7,218,000
Less valuation allowance............................ 1,828,000 6,441,000
---------- ----------
Net deferred tax assets............................. $ -- $ 777,000
========== ==========
</TABLE>
The valuation allowance for deferred tax assets increased by $493,000,
$1,335,000, and $4,613,000 for the years ended December 31, 1995, 1996 and 1997,
respectively.
At December 31, 1996, the Company had net operating loss and other credit
carryforwards of $2,802,000. As of December 31, 1997, the Company fully utilized
its net operating loss and other credit carryforwards as a result of taxable
income generated from a license agreement with Microsoft (see note 8). For
financial reporting purposes, those license fees are recognized over the
three-year term of the Company's ongoing obligations. As a result, the company
has recognized deferred tax assets to the extent of its taxes payable. The
Company believes it is more likely than not that its net deferred tax assets as
of December 31, 1997 will be realized through the reversal of temporary
differences in 1998 and 1999.
5. 401(K) RETIREMENT SAVINGS PLAN
The Company has a 401(k) Retirement Savings Plan that covers all employees
who have met certain employment requirements. Employees can contribute a portion
of their salary to the maximum allowed by the federal tax guidelines. The
Company currently does not provide matching contributions.
6. BANK LINE OF CREDIT AND TERM LOAN AND NOTE PAYABLE
At December 31, 1996, the Company had available a $1,000,000 domestic bank
line of credit and a $1,500,000 bank term loan. There were no borrowings
outstanding under the line of credit or the term loan as of December 31, 1996,
and the Company terminated the line of credit and term loan in September 1997.
At December 31, 1997, the Company had outstanding a note payable to one of
its joint venture partners. The note is denominated in Japanese yen, bears
interest at a rate not to exceed the Japanese Short Term Prime Rate (1.63% at
December 31, 1997) and is secured by the Company's shares in the joint venture.
Interest on the note is payable monthly and the principal is due in May 2000.
The principal amount of the note is 115,200,000 Japanese yen ($963,379 at
December 31, 1997), and the Company may, under certain circumstances, tender its
shares in the joint venture as repayment of the note.
47
<PAGE> 49
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
7. SHAREHOLDERS' EQUITY
(a) Authorized Capital
In September 1997, the Company increased its authorized capital to
300,000,000 shares of common stock and 60,000,000 shares of preferred stock and
established a par value of $0.001 for both common and preferred stock. The
accompanying consolidated financial statements have been restated in all periods
presented to reflect this action.
(b) Initial Public Offering
On November 21, 1997, the Company completed its initial public offering of
3,450,000 shares of its Common Stock, including the exercise of the
underwriters' overallotment option, at a price of $12.50 per share. Net proceeds
to the Company aggregated approximately $38,543,000, net of underwriting
discounts and other offering costs. As of the closing date of the offering, all
of the outstanding shares of redeemable convertible preferred stock and
convertible preferred stock were converted into 22,198,296 shares of Common
Stock and 3,338,374 shares of Special Common Stock.
(c) Common Stock and Special Common Stock
At January 1, 1995, 10,000 shares of common stock were issued and
outstanding. In April 1995, these 10,000 shares of common stock were exchanged
for 13,713,439 shares of Series A Preferred Stock and one share of Series A
Common Stock.
Common stock outstanding at December 31, 1996 consisted of the following:
<TABLE>
<S> <C>
Series A........................................... 1
Series B........................................... 463,018
Series C........................................... 72,472
Series D........................................... --
Series E........................................... --
</TABLE>
Series A, B and D Common Stock entitled the holder to fifteen votes for
each share held. Series C Common Stock entitled the holder to one vote for each
share held. Each share of Series E Common Stock was not entitled to vote, except
as required by law, in which case it would entitle the holder to one vote.
Series B Common Stock was reserved for issuance to employees, directors or
affiliates of directors. Each share of Series B Common Stock automatically
converted to one share of Series C Common Stock upon termination of the holder's
employment, or his or her status as a director or an affiliate of a director.
Upon completion of the Company's initial public offering, the designations
of Series A through E Common Stock terminated, Series A through D Common Stock
converted into one class of Common Stock with each share entitled to one vote,
and Series E Common Stock converted into Special Common Stock with no voting
rights except as required by applicable law. The Special Common Stock has all
other rights and privileges identical to the Common Stock.
(d) Preferred Stock
Convertible preferred stock and redeemable, convertible preferred stock
outstanding at December 31, 1996 consisted of the following:
<TABLE>
<CAPTION>
SERIES
------
<S> <C> <C>
Convertible Preferred...................................... A 13,713,439
Redeemable, convertible preferred.......................... B 3,059,701
Redeemable, convertible preferred.......................... C 2,904,305
Redeemable, convertible preferred.......................... D 2,381,010
Redeemable, convertible preferred.......................... E --
</TABLE>
48
<PAGE> 50
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
On November 21, 1997, the Company completed its initial public offering and
all outstanding shares of preferred stock were converted to Common Stock and
Special Common Stock.
The following table summarizes activity of the Company's redeemable,
convertible preferred stock for the years ended December 31, 1995, 1996 and
1997:
<TABLE>
<CAPTION>
PRICE
DESCRIPTION PER SHARE SHARES AMOUNT
----------- --------- ----------- ------------
<S> <C> <C> <C>
Balances at December 31, 1994............................. -- $ --
Sale of Series B preferred stock, net of issuance costs of
$40,000................................................. $ 0.67 2,686,567 1,760,000
Sales of Series C preferred stock, net of issuance costs
of $57,784.............................................. 1.9634 2,904,305 5,644,528
Exercise of warrants for Series B preferred stock......... 0.67 373,134 250,000
----------- ------------
Balances at December 31, 1995............................. 5,964,006 7,654,528
Sale of Series D preferred stock, net of issuance costs
and warrant value of $889,186 and $1,579,000,
respectively............................................ 7.53 2,381,010 15,467,966
Accretion of redemption value............................. -- 31,000
----------- ------------
Balances at December 31, 1996............................. 8,345,016 23,153,494
Issuance costs related to sale of Series D preferred
stock................................................... -- (22,807)
Sale of Series E preferred stock, net of issuance costs
and warrant value of $50,891 and $4,068,000,
respectively............................................ 8.99 3,338,374 25,881,109
Exercise of warrants for Series C preferred stock......... 1.9634 100,000 196,340
Exercise of warrants for Series D preferred stock......... 9.4125 39,841 375,003
Accretion of redemption value............................. -- 488,112
Conversion of preferred stock to Common Stock and Special
Common Stock............................................ (11,823,231) (50,071,251)
----------- ------------
Balances at December 31, 1997............................. -- $ --
=========== ============
</TABLE>
The rights, preferences and restrictions of the Series A, B, C, D and E
Preferred Stock are as follows:
- Each of the Series B, C, D and E Preferred Stock was redeemable by the holder
on, or at any time after, December 31, 2002 with the written consent of at
least two-thirds of the respective outstanding Series B, C, D and E
shareholders. The Company accounted for the difference between the carrying
amount of redeemable preferred stock and the redemption amount by increasing
the carrying amount for periodic accretion against accumulated deficit using
the interest method, so that the carrying amount would equal the redemption
amount at the redemption date.
- Each share of Series A, B, C and D Preferred Stock was convertible at the
option of the holder at any time into one share of Series A Common Stock,
subject to certain antidilution provisions.
- Each share of Series E Preferred Stock was convertible at the option of the
holder at any time into one share of either Series A Common Stock or Series E
Common Stock.
- Series A, B, C, D and E Preferred Stock had a liquidation preference of
$0.0729, $0.67, $1.9634, $11.295 and $8.99 per share, respectively, plus all
declared but unpaid dividends, if any. No dividends had been declared through
December 31, 1997.
Pursuant to the rules and regulations of the SEC, the Company has
classified redeemable, convertible preferred stock outside of shareholders'
equity (deficit).
49
<PAGE> 51
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
(e) Stock Warrants
In connection with the sale of Series B Preferred Stock, the Company issued
a warrant to purchase 373,134 additional shares of Series B Preferred Stock at
an exercise price of $0.67 per share. No separate value was assigned to the
warrant as the value was not significant at the date of issuance. This warrant
was exercised in 1995.
In connection with the sale of Series C Preferred Stock, the Company issued
warrants to purchase up to 100,000 additional shares of Series C Preferred Stock
at an exercise price of $1.9634 per share, and warrants to purchase up to
183,755 shares of Series B Common Stock at an exercise price of approximately
$0.20 per share. No separate value has been assigned to the warrants as the
values were not significant at the date of issuance. During the year ended
December 31, 1997, all of the Series C Preferred Stock warrants and Series B
Common Stock warrants were exercised.
In connection with the sale of Series D Preferred Stock, the Company issued
warrants to purchase up to 714,303 additional shares of Series D Preferred Stock
at an exercise price of $9.4125 per share. The value of the warrants,
$1,579,000, was recorded as additional paid-in capital. These warrants are
exercisable at December 31, 1997, and expire on November 27, 1998. The value of
these warrants was determined using a Black-Scholes valuation model with the
following assumptions: expected life of two years, expected dividend yield of
0%, expected volatility of 60% and a risk-free interest rate of 6%. Upon a
merger or consolidation in which the Company is not the survivor, the warrants
are canceled and all rights granted shall terminate. If an event causing
conversion of the Company's Series D Preferred Stock shall have occurred prior
to the exercise of the warrants, then all warrants shall be exercisable for the
number of shares of common stock of the Company into which the Series D
Preferred Stock not purchased upon any prior exercise of the warrants would have
been so converted. During the year ended December 31, 1997, 39,841 warrants were
exercised.
In connection with the sale of Series E Preferred Stock, the Company issued
a warrant to purchase up to 3,709,305 additional shares of Series E Preferred
Stock at an exercise price of $13.48 per share. The value of the warrant,
$4,068,000, was recorded as additional paid-in capital. This warrant was
exercisable at any time through January 21, 2000 and would terminate
automatically upon either closing of an initial public offering by the Company,
or completion of a merger or consolidation in which the Company is not a
survivor. The value of the warrant was determined using a Black-Scholes
valuation model with the following assumptions: expected life of one year,
expected dividend yield of 0%, expected volatility of 60% and a risk-free
interest rate of 6%. If an event causing conversion of the Company's Series E
Preferred Stock shall have occurred prior to the exercise of the warrant, in
whole or in part, then the warrant would have been exercisable for the number of
shares of common stock of the Company into which the Series E Preferred Stock
not purchased upon any prior exercise of the warrant would have been so
converted. None of the warrants were exercised and the warrants expired upon the
closing of the Company's initial public offering.
(f) Stock Option Plans
Under the Company's 1995 Stock Option Plan (1995 Plan), 3,600,000 shares of
Common Stock were reserved for the issuance of stock options. Under the
Company's Amended and Restated 1996 Stock Option Plan (1996 Plan), 8,800,000
shares of Common Stock are reserved for the issuance of stock options. In
September 1997, the Company discontinued granting stock options under the 1995
Plan. In accordance with the provisions of the 1996 Plan, in addition to the
8,800,000 shares of Common Stock reserved, shares of Common Stock previously
available for grant under the 1995 Plan are available for grant under the 1996
Plan, and to the extent options outstanding under the 1995 Plan terminate
without having been exercised in full, the terminated options become available
under the 1996 Plan.
Options granted under the 1996 Plan may be designated as qualified or
nonqualified at the discretion of the Board of Directors, generally vest over a
period of one to five years from the date of grant, expire 20 years
50
<PAGE> 52
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
from the date of grant and terminate, to the extent not exercised, three months
after the termination of employment.
A summary of stock option activity under the 1995 Plan and the 1996 Plan is
as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
----------------------------
SHARES WEIGHTED
AVAILABLE NUMBER AVERAGE
FOR GRANT OF SHARES EXERCISE PRICE
---------- ---------- --------------
<S> <C> <C> <C>
Balances at December 31, 1994................. -- -- $ --
Plan introduction........................... 3,600,000 -- --
Options granted............................. (3,313,214) 3,313,214 0.07
Options exercised........................... -- (30,750) 0.07
Options canceled............................ 450,000 (450,000) 0.07
---------- ----------
Balances at December 31, 1995................. 736,786 2,832,464 0.07
Plan introduction........................... 3,000,000 -- --
Options granted............................. (3,766,364) 3,766,364 0.34
Options exercised........................... -- (498,543) 0.09
Options canceled............................ 765,250 (765,250) 0.10
---------- ----------
Balances at December 31, 1996................. 735,672 5,335,035 0.27
Plan amendment.............................. 5,800,000 -- --
Options granted............................. (3,671,930) 3,671,930 5.50
Options exercised........................... -- (1,144,001) 0.22
Options canceled............................ 930,750 (930,750) 1.32
---------- ----------
Balances at December 31, 1997................. 3,794,492 6,932,214 $2.92
========== ==========
</TABLE>
The Company applies APB Opinion No. 25 in accounting for the 1995 Plan and
the 1996 Plan, and no compensation cost has been recognized for its employee
stock options in the consolidated financial statements. Had the Company
determined compensation cost of employee stock options based on the fair value
of the option at the grant date for its stock options under SFAS No. 123, the
Company's net loss would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------
1995 1996 1997
----------- ----------- ------------
<S> <C> <C> <C>
Net loss:
As reported.............................. $(1,501,302) $(3,789,245) $(11,168,874)
Pro forma................................ (1,510,513) (3,865,415) (11,642,963)
Historical basic and diluted net loss per
share:
As reported.............................. $ (59.89) $ (11.91) $ (2.88)
Pro forma................................ (60.26) (12.15) (3.00)
Pro forma basic and diluted net loss per
share:
As reported.............................. $ (0.40)
As adjusted.............................. (0.42)
</TABLE>
The full impact of calculating compensation cost for stock options under
SFAS No. 123 is not reflected in the pro forma net loss and net loss per share
amounts presented above because compensation cost is recognized over the
options' vesting period for option grants made in 1995 and future years.
The per share weighted-average fair value of stock options granted during
the years ended December 31, 1995, 1996 and 1997 was $0.01, $0.07 and $1.12
respectively, on the date of grant. Prior to the Company's
51
<PAGE> 53
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
initial public offering, the fair value of each option grant was determined on
the date of grant using the minimum value method. Subsequent to the offering,
the fair value was determined using the Black-Scholes model. Except for the
volatility assumption which was only used under the Black-Scholes model, the
following weighted average assumptions were used to perform the calculations:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------
1995 1996 1997
-------------- -------------- ---------
<S> <C> <C> <C>
Expected dividend yield.................... 0% 0% 0%
Risk-free interest rate.................... 5.9% 6.1% 6.1%
Expected life.............................. 3.5 years 4.5 years 3.5 years
Volatility................................. not applicable not applicable 60%
</TABLE>
The following table summarizes information about stock options
outstanding under the 1995 Plan and the 1996 Plan at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- ------------------------
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
--------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 0.07............................ 1,058,123 17.32 years $0.07 299,373 $0.07
0.20............................ 1,910,006 18.16 years 0.20 550,253 0.20
0.85 - 1.50.................... 1,263,185 18.88 years 1.25 104,585 1.11
2.00 - 3.50.................... 881,400 19.38 years 2.55 200 2.00
7.25 - 9.00.................... 1,497,500 19.74 years 8.04 -- --
11.00 - 15.38.................... 322,000 19.92 years 12.15 -- --
--------- -------
6,932,214 18.74 years $2.92 954,411 $0.26
========= =======
</TABLE>
(g) Employee Stock Purchase Plan
In September 1997, the Board and the Company's shareholders adopted and
approved the 1998 Employee Stock Purchase Plan (ESPP), which became effective
January 1, 1998. The Company has reserved 1,000,000 shares of Common Stock for
issuance under the ESPP. The ESPP will be implemented through a series of
offering periods of six months' duration, with new offering periods commencing
on January 1 and July 1 of each year. The ESPP permits eligible employees to
purchase Common Stock at a price equal to 85% of the lower of the fair market
value of the Common Stock at the beginning or end of the offering period.
8. LICENSE AGREEMENT
In June 1997, the Company entered into a strategic agreement with Microsoft
pursuant to which the Company granted Microsoft a nonexclusive license to 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. Under the agreement, Microsoft may sublicense its rights to
the Standard Code to third parties under certain conditions. On two occasions
during the first two years following delivery under the Agreement, Microsoft may
acquire for $25 million and $35 million, respectively, a nonexclusive license to
subsequently developed versions of the Standard Code, products based on which
are currently distributed to end users by the Company at no charge. If the
Company elects in its sole discretion to grant an Event License the agreement
provides for a full refund of each license fee during the first year, declining
to 0% over the following two years. The Company may not assign its obligations
under the agreement without Microsoft's consent, and a merger, the sale of
substantially all of the
52
<PAGE> 54
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1995, 1996, AND 1997
Company's assets and certain other events will be deemed to be an assignment
under the agreement. Microsoft is obligated to distribute the Company's
RealPlayer Version 4.0 for a defined term as long as the Company's player
supports certain Microsoft architectures. The Company also agreed to work with
Microsoft and several other companies to author and promote the Active Streaming
Format as a standard file format for streaming media. The agreement also
requires the Company to provide Microsoft with engineering consultations
services, certain error corrections, and certain technical support over a
defined term. In July 1997, the Company delivered the Standard Code in exchange
for a license fee of $30,000,000. The Company recognizes revenue, commencing
with delivery of the source code, over the three-year term of its ongoing
obligations. The portion of the license fee that has not yet been recognized as
revenue is included in deferred revenue.
The terms of the Company's strategic agreement with Microsoft provide that
the $30,000,000 software license fee will be paid to the Company in two
installments. The first installment of $20,000,000 was due within 30 days of the
signing of the software license agreement, and the remaining $10,000,000 is due
within 30 days of the earlier of (1) the Company's completion of six "man
months" of consulting services, or (2) six months after delivery of the
specified source code to Microsoft. The Company expects Microsoft to make this
second installment payment in accordance with the terms 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 Series E Preferred Stock at
$8.99 per share which were converted to Special Common Stock upon the completion
of the Company's initial public offering. Any shares of Special Common Stock
held by Microsoft will convert automatically into Common Stock upon transfer to
a purchaser who is not affiliated with the holder.
9. SUBSEQUENT EVENTS
(a) Lease Agreement
In January 1998, the Company entered into a lease agreement for a new
location for its corporate offices. The lease commences on April 1, 1999, and
expires on April 1, 2011, with the option to renew the term for either a three
or ten year period, at the Company's choice. Average rent over the lease term is
approximately $4,000,000 per year.
(b) Merger Agreement
On February 20, 1998, the Company entered into an Agreement and Plan of
Merger (Agreement) with RN Acquisition Corp., a wholly-owned subsidiary of the
Company, and Vivo Software, Inc. (Vivo), a developer of streaming media creation
tools. The merger became effective on March 24, 1998. In accordance with the
Agreement, the Company issued approximately 1.1 million new shares of its Common
Stock in exchange for all outstanding shares of Vivo Common Stock. The
acquisition will be accounted for using the purchase accounting method. The
Company anticipates that a substantial portion of the purchase price will be
expensed as in-process research and development.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
53
<PAGE> 55
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is contained in part in the sections
captioned "Board of Directors -- Nominee for Director," "Board of
Directors -- Continuing Directors -- Not Standing for Election This Year,"
"Board of Directors -- Contractual Arrangements" and "Voting Securities and
Principal Holders -- Section 16(a) Beneficial Ownership Reporting Compliance" in
the Proxy Statement for the Company's Annual Meeting of Shareholders scheduled
to be held on May 22, 1998, and such information is incorporated herein by
reference.
The remaining information required by this Item is set forth as Item 4A in
Part I of this report under the caption "Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
information contained in the section captioned "Compensation and Benefits" of
the Proxy Statement for the Company's Annual Meeting of Shareholders scheduled
to be held on May 22, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information contained in the sections captioned "Voting Securities and Principal
Holders" of the Proxy Statement for the Company's Annual Meeting of Shareholders
scheduled to be held on May 22, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information contained in the section captioned "Voting Securities and Principal
Holders -- Certain Transactions" of the Proxy Statement for the Company's Annual
Meeting of Shareholders scheduled to be held on May 22, 1998.
54
<PAGE> 56
PART IV.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
The following consolidated financial statements of RealNetworks, Inc. and
subsidiaries are filed as part of this report:
Consolidated Statements of Operations -- Years ended December 31, 1997,
1996 and 1995
Consolidated Balance Sheets -- December 31, 1997 and 1996
Consolidated Statements of Cash Flows -- Years ended December 31, 1997,
1996 and 1995
Consolidated Statements of Shareholders' Equity (Deficit) -- Years ended
December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
Independent Auditors' Report
(a) (2) FINANCIAL STATEMENT SCHEDULES
Schedule II: Valuation and Qualifying Accounts
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is included in the
Consolidated Financial Statements or notes thereto.
(b) REPORTS ON FORM 8-K
None.
(c) EXHIBITS
The following exhibits are filed with this report:
EXHIBIT NO. 3: ARTICLES OF INCORPORATION AND BYLAWS
<TABLE>
<S> <C>
3.1 Amended and Restated Articles of Incorporation (incorporated
by reference from Exhibit 3.1 to Amendment No. 4 of the
Company's Registration Statement on Form S-1 filed with the
Securities and Exchange Commission on November 20, 1997
(File No. 333-36553))
3.2 Bylaws (incorporated by reference from Exhibit 3.2 to
Amendment No. 4 of the Company's Registration Statement on
Form S-1 filed with the Securities and Exchange Commission
on November 20, 1997 (File No. 333-36553))
</TABLE>
EXHIBIT NO. 10: MATERIAL CONTRACTS
EXECUTIVE COMPENSATION PLANS AND AGREEMENTS
<TABLE>
<S> <C>
10.1 RealNetworks, Inc. 1995 Stock Option Plan (incorporated by
reference from Exhibit 10.1 to Amendment No. 4 of the
Company's Registration Statement on Form S-1 filed with the
Securities and Exchange Commission on November 20, 1997
(File No. 333-36553))
10.2 RealNetworks, Inc. Amended and Restated 1996 Stock Option
Plan (incorporated by reference from Exhibit 10.2 to
Amendment No. 4 of the Company's Registration Statement on
Form S-1 filed with the Securities and Exchange Commission
on November 20, 1997 (File No. 333-36553))
10.3 Form of Stock Option Agreement
10.4 1998 Employee Stock Purchase Plan (incorporated by reference
from Exhibit 10.4 to Amendment No. 4 of the Company's
Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on November 20, 1997 (File No.
333-36553))
</TABLE>
55
<PAGE> 57
<TABLE>
<S> <C>
10.4.1 Amendment No. 1 to 1998 Employee Stock Purchase Plan
10.5 Offer letter dated February 16, 1996 between the Company and
Bruce Jacobsen (incorporated by reference from Exhibit 10.11
to Amendment No. 4 of the Company's Registration Statement
on Form S-1 filed with the Securities and Exchange
Commission on November 20, 1997 (File No. 333-36553))
10.6 Offer letter dated May 2, 1995 between the Company and James
Wells (incorporated by reference from Exhibit 10.12 to
Amendment No. 4 of the Company's Registration Statement on
Form S-1 filed with the Securities and Exchange Commission
on November 20, 1997 (File No. 333-36553))
OTHER MATERIAL CONTRACTS
10.7 Form of Warrant to Purchase Series D Preferred Stock
(incorporated by reference from Exhibit 10.5 to Amendment
No. 4 of the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on
November 20, 1997 (File No. 333-36553))
10.8 Lease Agreement dated March 4, 1996 by and between the
Company as Lessee and Wright Runstad Properties L.P. as
Lessor (incorporated by reference from Exhibit 10.7 to
Amendment No. 4 to the Company's Registration Statement on
Form S-1 filed with the Securities and Exchange Commission
on November 20, 1997 (File No. 333-36553))
10.9 Sublease Agreement dated March, 1996 by and between the
Company as Sublessee and Legent Corporation as Sublessor
(incorporated by reference from Exhibit 10.8 to Amendment
No. 4 of the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on
November 20, 1997 (File No. 333-36553))
10.10 Antenna Site License Agreement dated August 12, 1997 by and
between the Company and Wright Runstad & Company
(incorporated by reference from Exhibit 10.9 to Amendment
No. 4 of the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on
November 20, 1997 (File No. 333-36553))
10.11 Agreement between Microsoft Corporation and the Company on
Media Streaming Technology dated June 17, 1997 (incorporated
by reference from Exhibit 10.10 to Amendment No. 4 of the
Company's Registration Statement on Form S-1 filed with the
Securities and Exchange Commission on November 20, 1997
(File No. 333-36553))
10.12 Form of Director and Officer Indemnification Agreement
(incorporated by reference from Exhibit 10.14 to Amendment
No. 4 of the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on
November 20, 1997 (File No. 333-36553))
10.13 Limited Proxy and voting Agreement dated July 21, 1997 by
and between the Company and Microsoft Corporation
(incorporated by reference from Exhibit 10.15 to Amendment
No. 4 of the Company's Registration Statement on Form S-1
filed with the Securities and Exchange Commission on
November 20, 1997 (File No. 333-36553))
10.14 Voting Agreement dated September 25, 1997 by and among the
Company, Robert Glaser, Accel IV L.P., Mitchell Kapor and
Bruce Jacobsen (incorporated by reference from Exhibit 10.17
to Amendment No. 4 of the Company's Registration Statement
on Form S-1 filed with the Securities and Exchange
Commission on November 20, 1997 (File No. 333-36553))
10.15 Agreement dated September 26, 1997 by and between the
Company and Robert Glaser (incorporated by reference from
Exhibit 10.18 to Amendment No. 4 of the Company's
Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on November 20, 1997 (File No.
333-36553))
10.16 Third Amended and Restated Investors' Rights Agreement dated
March 24, 1998 by and among the Company and certain
shareholders of the Company
</TABLE>
56
<PAGE> 58
<TABLE>
<S> <C>
10.17 Representative License Agreement -- License Agreement for
the RealPlayer Plus (incorporated by reference from Exhibit
10.21 to Amendment No. 4 of the Company's Registration
Statement on Form S-1 filed with the Securities and Exchange
Commission on November 20, 1997 (File No. 333-36553))
</TABLE>
EXHIBIT NO. 21: SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<S> <C>
21.1 Subsidiaries of the Company (incorporated by reference from
Exhibit 21.1 to Amendment No 4. of the Company's
Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on November 20, 1997 (File No.
333-36553))
</TABLE>
EXHIBIT NO. 23: CONSENTS OF EXPERTS AND COUNSEL
23.1 Consent of KPMG Peat Marwick LLP
EXHIBIT NO. 24: POWER OF ATTORNEY
24.1 Power of Attorney (included on signature page)
EXHIBIT NO. 27: FINANCIAL DATA SCHEDULE
27.1 Financial Data Schedule
(b) FINANCIAL STATEMENT SCHEDULE
Schedule II -- Valuation and Qualifying Accounts
57
<PAGE> 59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Seattle, State of Washington, on March 30, 1998.
REALNETWORKS, INC.
By: /s/ ROBERT GLASER
------------------------------------
Robert Glaser
Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints
Robert Glaser and Bruce Jacobsen, and each of them severally, his true and
lawful attorneys-in-fact and agents, with full power to act without the other
and with full power of substitution and resubstitution, to execute in his name
and on his behalf, individually and in each capacity stated below, any and all
amendments and supplements to this Report, and any and all other instruments
necessary or incidental in connection herewith, and to file the same with the
Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ ROBERT GLASER Chairman of the Board, Chief Executive March 30, 1998
- ------------------------------------------ Officer, Secretary and Treasurer
Robert Glaser (Principal Executive Officer)
/s/ BRUCE JACOBSEN President, Chief Operating Officer and March 30, 1998
- ------------------------------------------ Director
Bruce Jacobsen
/s/ MARK KLEBANOFF Chief Financial Officer (Principal March 30, 1998
- ------------------------------------------ Financial Officer)
Mark Klebanoff
/s/ KEITH ADAMS Controller (Principal Accounting Officer) March 30, 1998
- ------------------------------------------
Keith Adams
/s/ JAMES W. BREYER Director March 30, 1998
- ------------------------------------------
James W. Breyer
/s/ MITCHELL KAPOR Director March 30, 1998
- ------------------------------------------
Mitchell Kapor
</TABLE>
58
<PAGE> 60
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
RealNetworks, Inc.:
Under date of January 21, 1998, except for note 9(b), which is as of March
24, 1998, we reported on the consolidated balance sheets of RealNetworks, Inc.
and subsidiaries as of December 31, 1996 and 1997, and the related consolidated
statements of operations, shareholders' equity (deficit), and cash flows for
each of the years in the three-year period ended December 31, 1997, which are
included in the 1997 Annual Report on Form 10-K of RealNetworks, Inc. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule of valuation and qualifying accounts. This consolidated financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on this consolidated financial statement
schedule based on our audits.
In our opinion, such consolidated financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
/s/ KPMG PEAT MARWICK LLP
Seattle, Washington
January 21, 1998, except for note 9(b),
which is as of March 24, 1998
59
<PAGE> 61
SCHEDULE II -- VALUTION AND QUALIFYING ACCOUNTS
REALNETWORKS, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
BALANCE CHARGED BALANCE
AT TO AT
BEGINNING COSTS AND COSTS AND END OF
DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS(1) PERIOD
----------- ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Valuation accounts deduced from
assets:
Allowance for doubtful accounts
receivable and sales returns.... $ 383,350 $2,293,835 $(1,847,838) $ 829,347
Valuation allowance for deferred
tax assets...................... 1,828,000 4,613,000 -- 6,441,000
========== ========== =========== ==========
Year ended December 31, 1996:
Valuation accounts deduced from
assets:
Allowance for doubtful accounts
receivable and sales returns.... 129,869 563,046 (309,565) 383,350
Valuation allowance for deferred
tax assets...................... 493,000 1,335,000 -- 1,828,000
========== ========== =========== ==========
Year ended December 31, 1995:
Valuation accounts deduced from
assets:
Allowance for doubtful accounts
receivable and sales returns.... -- 129,869 -- 129,869
Valuation allowance for deferred
tax assets...................... -- 493,000 -- 493,000
========== ========== =========== ==========
</TABLE>
- ---------------
(1) represents amounts written off
60
<PAGE> 62
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C> <C>
</TABLE>
EXHIBIT NO. 10: MATERIAL CONTRACTS
EXECUTIVE COMPENSATION PLANS AND AGREEMENTS
<TABLE>
<S> <C> <C>
10.3 Form of Stock Option Agreement
10.4.1 Amendment No. 1 to 1998 Employee Stock Purchase Plan
OTHER MATERIAL CONTRACTS
10.16 Third Amended and Restated Investors' Rights Agreement dated
March 24, 1998 by and among the Company and certain
shareholders of the Company
</TABLE>
EXHIBIT NO. 23: CONSENTS OF EXPERTS AND COUNSEL
<TABLE>
<S> <C> <C>
23.1 Consent of KPMG Peat Marwick LLP
</TABLE>
EXHIBIT NO. 24: POWER OF ATTORNEY
<TABLE>
<S> <C> <C>
24.1 Power of Attorney (included on signature page)
</TABLE>
EXHIBIT NO. 27: FINANCIAL DATA SCHEDULE
<TABLE>
<S> <C> <C>
27.1 Financial Data Schedule
</TABLE>
<PAGE> 1
EXHIBIT 10.3
================================================================================
THE SECURITIES OFFERED BY THIS INSTRUMENT HAVE NOT BEEN REGISTERED OR QUALIFIED
UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES LAWS OF ANY
STATE, AND ANY SALE OF SUCH SECURITIES IS SUBJECT TO COMPLIANCE WITH, OR THE
AVAILABILITY OF EXEMPTIONS FROM COMPLIANCE WITH, THE REGISTRATION AND
QUALIFICATION REQUIREMENTS OF SUCH ACT AND ANY APPLICABLE STATE SECURITIES LAWS.
THIS INSTRUMENT DOES NOT CONSTITUTE AN OFFER OR SOLICITATION TO ANY PERSON IN
ANY JURISDICTION WHERE SUCH OFFER OR SOLICITATION MAY NOT LAWFULLY BE MADE.
TRANSFER OF THIS INSTRUMENT AND THE SECURITIES OFFERED HEREBY IS RESTRICTED AS
PROVIDED IN SECTIONS 7, 8 AND 9 BELOW.
================================================================================
STOCK OPTION AGREEMENT
THIS STOCK OPTION AGREEMENT (this "Agreement") is entered into effective
as of _________________, 19__ (the "Grant Date"), by REALNETWORKS, INC., a
Washington corporation (the "Company") and _____________ (the "Holder").
R E C I T A L S
A. The Company has adopted the RealNetworks, Inc. 1996 Stock Option
Plan, as amended and restated (the "Plan"), a copy of which is attached as
Exhibit A (capitalized terms that are used but not defined in this Agreement
will have the meanings given those terms in the Plan).
B. The Holder is an employee of the Company, and has been designated by
the Administrative Committee to receive a stock option under the Plan.
NOW, THEREFORE, the Company and the Holder covenant and agree as
follows:
1. GRANT OF THE OPTION. The Company hereby grants to the Holder a stock
option (the "Option") to acquire from the Company _____________ (_____) shares
of Common Stock, par value $.001, of the Company (the "Common Stock"), at the
price of $____ per share (the "Option Price"). The Option is not intended to
qualify as an "incentive stock option," as that term is defined in Section 422
of the Internal Revenue Code of 1986, as amended.
2. TERM OF THE OPTION. Unless earlier terminated in accordance with the
provisions of the Plan, the Option will terminate on the earliest to occur of
(a) the expiration of twenty (20) years from the Grant Date; (b) the expiration
of ninety (90) days following termination of the Holder's employment with the
Company for any reason other than death, Disability or cause (as defined in
Section 7.2(b) of the Plan); (c) the expiration of one (1) year following
termination of the Holder's employment with the Company on account of death or
Disability; and (d) the date of termination of the Holder's employment with the
Company for cause (as defined in Section 7.2(b) of the Plan).
3. VESTING. The vesting schedule applicable to the Option shall commence
on __________, 19__ (the "Vest Date"). The Option shall vest and become
exercisable in accordance with the following schedule:
<PAGE> 2
<TABLE>
<CAPTION>
Cumulative Number
Date of Shares Vested (Percent)
---- ----------------- ---------
<S> <C> <C>
__ MONTHS AFTER VEST DATE _________________ (30%)
__ MONTHS AFTER VEST DATE _________________ (40%)
__ MONTHS AFTER VEST DATE _________________ (50%)
__ MONTHS AFTER VEST DATE _________________ (60%)
__ MONTHS AFTER VEST DATE _________________ (70%)
__ MONTHS AFTER VEST DATE _________________ (80%)
__ MONTHS AFTER VEST DATE _________________ (90%)
__ MONTHS AFTER VEST DATE _________________ (100%)
</TABLE>
PROVIDED, HOWEVER, that, if the Holder's employment with the Company terminates
for any reason, the Option will not vest further following such termination. To
the extent the Option is vested, it shall be exercisable at any time and from
time to time prior to its termination as provided in Section 2.
4. OTHER LIMITATIONS ON THE OPTION. The Option is subject to all of the
provisions of the Plan, including but not limited to Section 4.2 (which permits
adjustments to the Option upon the occurrence of certain corporate events such
as stock dividends, extraordinary cash dividends, reclassifications,
recapitalizations, reorganizations, split-ups, spin-offs, combinations,
exchanges of shares, and warrants or rights offerings) and Section 7.1 (which
applies in the event of an Approved Transaction or Control Purchase).
5. EXERCISE OF THE OPTION. To exercise the Option, the Holder must do
the following:
(a) deliver to the Company a written notice, in the form attached to
this Agreement as Exhibit B, specifying the number of shares of Common Stock for
which the Option is being exercised;
(b) surrender this Agreement to the Company;
(c) tender payment of the aggregate Option Price for the shares for
which the Option is being exercised, which payment may be made (i) in cash or by
check; or (ii) by such other means as the Administrative Committee, in its sole
discretion, shall permit at the time of exercise;
(d) pay, or make arrangements satisfactory to the Administrative
Committee for payment to the Company of all federal, state and local taxes, if
any, required to be withheld by the Company in connection with the exercise of
the Option;
(e) if requested by the Administrative Committee, deliver to the
Company, at the Holder's expense, a legal opinion, satisfactory in form and
substance to the Company, of legal counsel designated by the Holder and
satisfactory to the Company, to the effect that exercise of the Option by the
Holder, and the acquisition of shares of Common Stock pursuant thereto, may be
effected without registration or qualification of such shares under the
Securities Act of 1933, as amended (the "1933 Act"), or any applicable state
securities laws; and
OPTION No. NQ____
<PAGE> 3
(f) execute and deliver to the Company and any other documents
required from time to time by the Administrative Committee in order to promote
compliance with the Plan, the 1933 Act, applicable state securities laws, or any
other applicable law, rule or regulation.
6. DELIVERY OF SHARE CERTIFICATE. As soon as practicable after the
Option has been duly exercised, the Company will deliver to the Holder a
certificate for the shares of Common Stock for which the Option was exercised.
Unless the Option has expired or been exercised in full, the Company and the
Holder agree to execute a new Stock Option Agreement, covering the remaining
shares of Common Stock that may be acquired upon exercise of the Option, which
will be identical to this Agreement except as to the number of shares of Common
Stock subject thereto. In lieu of replacing this Agreement in such manner, the
Company may affix to this Agreement an appropriate notation indicating the
number of shares for which the Option was exercised and return this Agreement to
the Holder.
7. NONTRANSFERABILITY. The Option is not transferable other than by will
or the laws of descent and distribution, and the Option may be exercised during
the lifetime of the Holder only by the Holder or the Holder's court appointed
legal representative.
8. WARRANTIES AND REPRESENTATIONS OF THE HOLDER. By executing this
Agreement, the Holder accepts the Option and represents and warrants to the
Company and covenants and agrees with the Company as follows:
(a) The Holder agrees to comply with all of the provisions of this
Agreement and the Plan.
(b) The Holder recognizes, agrees and acknowledges that no
registration statement under the 1933 Act, or under any state securities laws,
has been or will be filed with respect to the Option or any shares of Common
Stock that may be acquired upon exercise of the Option.
(c) The Holder warrants and represents that the Option and any
shares of Common Stock acquired upon exercise of the Option will be acquired and
held by the Holder for the Holder's own account, for investment purposes only,
and not with a view towards the distribution or public offering thereof nor with
any present intention of reselling or distributing the same at any particular
future time.
(d) The Holder agrees not to sell, transfer or otherwise dispose of
any shares of Common Stock that may be acquired upon exercise of the Option
unless (i) there is an effective registration statement under the 1933 Act
covering the proposed disposition and compliance with governing state securities
laws, (ii) the Holder delivers to the Company, at the Holder's expense, a
"no-action" letter or similar interpretative opinion, satisfactory in form and
substance to the Company, from the staff of each appropriate securities agency,
to the effect that such shares may be disposed of by the Holder in the manner
proposed, or (iii) the Holder delivers to the Company, at the Holder's expense,
a legal opinion, satisfactory in form and substance to the Company, of legal
counsel designated by the Holder and satisfactory to the Company, to the effect
that the proposed disposition is exempt from registration under the 1933 Act and
governing state securities laws.
(e) The Holder acknowledges and consents to the appearance of the
restrictive legends, in the form required by Section 6.8 of the Plan, on each
certificate representing shares of Common Stock issued upon exercise of the
Option.
(f) The Holder agrees not to sell, transfer or otherwise dispose of
the Option or any shares of Common Stock acquired upon exercise of the Option,
except as specifically permitted by this Agreement, the Plan and any applicable
securities laws.
OPTION No. NQ____
<PAGE> 4
9. PROCEDURES UPON PERMITTED TRANSFER. Prior to any sale, transfer or
other disposition of any of the shares of Common Stock acquired upon exercise of
the Option, the Holder agrees to give written notice to the Company of the
Holder's intention to effect such disposition. The notice must describe the
circumstances of the proposed transfer in reasonable detail and must specify the
manner in which the requirements of Section 8(d) above will be satisfied in
connection with the proposed disposition. After (a) legal counsel to the Company
has determined that the requirements of Section 8(d) above will be satisfied,
(b) the Holder has executed such documentation as may be necessary to effect the
proposed disposition, and (c) the Holder has paid, or made arrangements
satisfactory to the Administrative Committee for the payment of, all federal,
state and local taxes, if any, required to be withheld by the Company in
connection with the proposed disposition, the Company will, as soon as
practicable, transfer such shares in accordance with the terms of the notice.
Any stock certificate issued upon such transfer will bear the restrictive
legends, in the form required by Section 6.8 of the Plan, unless in the opinion
of legal counsel to the Company such legends are not required. Compliance with
the foregoing procedures are in addition to compliance with any separate
requirements applicable to the Holder under the Company's Articles of
Incorporation or otherwise.
10. RIGHTS AS SHAREHOLDER. The Holder will have no rights as a
shareholder of the Company on account of the Option or on account of shares of
Common Stock which will be acquired upon exercise of the Option (but with
respect to which no certificates have been delivered to the Holder).
11. TAX WITHHOLDING. The Holder agrees to pay, or to make arrangements
satisfactory to the Administrative Committee for payment to the Company of, all
federal, state and local income and employment taxes, if any, required to be
withheld by the Company in connection with the exercise of the Option or any
sale, transfer or other disposition of any shares of Common Stock acquired upon
exercise of the Option. If the Holder fails to do so, then the Holder hereby
authorizes the Company to deduct all or any portion of such taxes from any
payment of any kind otherwise due to the Holder.
12. FURTHER ASSURANCES. The Holder agrees from time to time to execute
such additional documents as the Company may reasonably require to effectuate
the purposes of the Plan and this Agreement.
13. BINDING EFFECT. This Agreement shall be binding upon the Holder and
the Holder's heirs, successors and assigns.
14. ENTIRE AGREEMENT; MODIFICATIONS. This Agreement, together with the
Plan and agreements referenced in this Agreement and/or the Plan, constitutes
the entire agreement and understanding between the Company and the Holder
regarding the subject matter hereof. Except as otherwise provided in the Plan,
no modification of the Option or this Agreement, or waiver of any provision of
this Agreement or the Plan, shall be valid unless in writing and duly executed
by the Company and the Holder. The failure of any party to enforce any of that
party's rights against the other party for breach of any of the terms of this
Agreement shall not be construed as a waiver of such rights as to any continued
or subsequent breach.
15. COST OF LITIGATION. In any action at law or in equity to enforce any
of the provisions or rights under this Agreement, the unsuccessful party to such
litigation, as determined by the court in a final judgment or decree, shall pay
the successful party or parties all costs, expenses and reasonable attorneys'
fees incurred by the successful party or parties (including without limitation
costs, expenses and fees in any appellate proceedings), and if the successful
party recovers judgment in any such action or proceeding, such costs, expenses
and attorneys' fees shall be included as part of the judgment.
OPTION No. NQ____
<PAGE> 5
16. GOVERNING LAW. This Agreement shall be governed by the laws of the
State of Washington.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.
"COMPANY" REALNETWORKS, INC.
BY _____________________________________
ITS ____________________________________
"HOLDER"
_________________________________________
_________________________________________
OPTION No. NQ-
----
<PAGE> 6
EXHIBIT A
(REALNETWORKS, INC. 1996 STOCK OPTION PLAN, AS AMENDED AND RESTATED)
<PAGE> 7
EXHIBIT B
FORM OF EXERCISE OF OPTION
To: RealNetworks, Inc.
1111 Third Avenue, Suite 2900
Seattle, WA 98101
The undersigned holds Option Number NQ-___ (the "Option"), represented
by a Stock Option Agreement dated effective as of ___________, 19__ (the
"Agreement"), granted to the undersigned pursuant to the RealNetworks, Inc. 1996
Stock Option Plan, as Amended and Restated (the "Plan"). The undersigned hereby
exercises the Option and elects to purchase _______________ shares (the
"Shares") of Common Stock of RealNetworks, Inc. (the "Company") pursuant to the
Option. This notice is accompanied by full payment of the Option Price of $____
per share for the Shares in cash or by check or in another manner permitted by
Section 5(c) of the Agreement. The undersigned has also paid, or made
arrangements satisfactory to the Administrative Committee administering the Plan
for payment of, all federal, state and local taxes, if any, required to be
withheld by the Company in connection with the exercise of the Option.
The undersigned acknowledges that no registration statement under the
1933 Act, or under any state securities laws, has been or will be filed with
respect to the Shares. The undersigned warrants and represents that the
undersigned is acquiring and will hold the Shares for the undersigned's own
account, for investment purposes only, and not with a view towards the
distribution or public offering of the Shares nor with any present intention of
reselling or distributing the Shares at any particular future time. The
undersigned consents to the appearance of restrictive legends, in the form
required by Section 6.8 of the Plan, on the certificate for the Shares. The
undersigned agrees not to sell, transfer or otherwise dispose of the Shares
except as specifically permitted by the Agreement, the Plan and any applicable
securities laws.
Date: ____________________
Signature of Holder
________________________________________
________________________________________
<PAGE> 1
EXHIBIT 10.4.1
REALNETWORKS, INC.
AMENDMENT NO. 1
DATED JANUARY 23, 1998
TO
1998 EMPLOYEE STOCK PURCHASE PLAN
Section 3 of the RealNetworks, Inc. 1998 Employee Stock Purchase Plan
(the "Plan") is hereby amended in its entirety to read as follows:
"3. ELIGIBLE EMPLOYEES. The term "Eligible Employees" means all common
law employees of the Company and its current majority-owned subsidiaries
(and each other corporation designated by the Committee that hereafter
becomes a majority-owned subsidiary of the Company), except the
following: (a) employees who have been employed for less than 30 days;
(b) employees whose customary employment is 20 hours or less per week;
and (c) employees whose customary employment is for not more than five
months in any calendar year. Except as otherwise expressly provided in
the Plan and permitted by Section 423 of the Code, all Eligible
Employees shall have the same rights and obligations under the Plan."
The effective date of such amendment shall be January 23, 1998, the date
of its adoption by the Board of Directors of RealNetworks, Inc.
<PAGE> 1
EXHIBIT 10.16
REALNETWORKS, INC.
THIRD AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT
March 24, 1998
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
1. REGISTRATION RIGHTS................................................................ 1
1.1 Certain Definitions......................................................... 1
1.2 Registrable Securities...................................................... 2
(a) Definition ....................................................... 2
(b) Transfer of Registration Rights...................................... 2
(c) Conditions to Participation.......................................... 3
1.3 Demand Registration......................................................... 3
1.4 S-3 Registration............................................................ 4
(a) S-3 Registrations.................................................... 4
(b) Priority S-3 Registrations........................................... 5
(c) Restrictions on Purchasers and S-3 Registrations..................... 5
(d) Limited Number of S-3 Registrations.................................. 6
(e) Selection of Underwriters............................................ 6
1.5 Piggyback Registrations..................................................... 6
(a) Right to Piggyback................................................... 6
(b) Priority on Primary Registrations.................................... 6
(c) Priority on Secondary Registrations.................................. 6
(d) Piggyback Rights of Vivo Shareholders................................ 7
1.6 Lockup Agreements........................................................... 7
1.7 Registration Procedures..................................................... 7
1.8 Registration Expenses....................................................... 9
1.9 Indemnification............................................................. 10
1.10 Termination................................................................. 11
2. COVENANTS OF THE COMPANY........................................................... 12
</TABLE>
i
<PAGE> 3
<TABLE>
<S> <C> <C>
3. MISCELLANEOUS...................................................................... 12
3.1 Parties in Interest......................................................... 12
3.2 Entire Agreement: Amendments and Waivers.................................... 12
3.3 Governing Law, Severability................................................. 13
3.4 Notices..................................................................... 13
3.5 Counterparts................................................................ 13
3.6 Captions.................................................................... 14
Exhibit A Company Shareholders
Exhibit B Vivo Shareholders
</TABLE>
ii
<PAGE> 4
THIRD AMENDED AND RESTATED
INVESTORS' RIGHTS AGREEMENT
This Third Amended and Restated Investors' Rights Agreement (this
"Agreement") is entered into effective as of the 24 day of March, 1998, by and
among REALNETWORKS, INC., a Washington corporation (the "Company"), the holders
of the Company Common Stock listed on Exhibit A, certain former shareholders of
Vivo Software, Inc., a Massachusetts corporation (the "Vivo Shareholders")
identified on attached Exhibit B, and Microsoft Corporation, a Washington
corporation ("Microsoft").
RECITALS
The Company and Vivo Software, Inc. ("Vivo") are parties to that certain
Agreement and Plan of Merger dated February 20, 1998 (the "Merger Agreement"),
pursuant to which shareholders of Vivo will become shareholders of the Company
and entitled to certain benefits provided for in this Agreement.
NOW, THEREFORE, in consideration of the mutual promises and covenants
set forth herein, the parties hereto agree as follows:
1. REGISTRATION RIGHTS
1.1 Certain Definitions. As used in this Agreement, the following terms
shall have the following respective meanings:
(a) "Exchange Act" shall mean the Securities Exchange Act of 1934,
as amended, or any similar successor federal statute and the rules and
regulations thereunder, all as the same shall be in effect from time to time.
(b) "Exempt Registrations" shall mean registrations relating solely
to employee benefit plans on Form S-1 or Form S-8 or similar forms that may be
promulgated in the future, or registrations relating solely to a Commission Rule
145 transaction on Form S-4 or similar forms that may be promulgated in the
future.
(c) "Investors" shall mean investors who purchased shares pursuant
to the Series B Preferred Stock Purchase Agreement by and among the Series B
Holders and the Company dated April 8, 1995 (the "Series B Agreement"), the
Series C Preferred Stock Purchase Agreement by and among the Series C Holders
and the Company dated October 26, 1995 (the "Series C Agreement"), the Series D
Preferred Stock Purchase Agreement by and among the Series D Holders and the
Company dated November 27, 1996 (the "Series D Agreement"), and/or the Series E
Preferred Stock Purchase Agreement dated July 21, 1997 (the "Series E
Agreement") and persons or entities who received any of such shares from such
Investors.
(d) "Rule 144" shall mean Rule 144 as promulgated by the Securities
and Exchange Commission (the "Commission") under the Securities Act, as such
Rule may be
<PAGE> 5
amended from time to time, or any similar successor rule that may be
promulgated by the Commission.
(e) "Rule 145" shall mean Rule 145 as promulgated by the Commission
under the Securities Act, as such Rule may be amended from time to time, or any
similar successor rule that may be promulgated by the Commission.
(f) "Securities Act" shall mean the Securities Act of 1933, as
amended, or any similar successor federal statute and the rules and regulations
thereunder, all as the same shall be in effect from time to time, corresponding
to such act.
1.2 Registrable Securities.
(a) Definition. The term "Registrable Securities" means (i) any
common stock ("Common Stock") and other securities issued upon conversion of any
Series B Preferred, Series C Preferred, Series D Preferred or Series E Preferred
Stock (including without limitation the Series C Preferred issuable upon
exercise of those certain Series C Warrants, as defined in the Series C
Agreement, the Series D Preferred issuable upon the exercise of those certain
Series D Warrants, as defined in the Series D Agreement and the Series E
Preferred issuable upon the exercise of that certain Series E Warrant, as
defined in the Series E Agreement), (ii) any Common Stock and other securities
issued upon exercise of those certain Series B Common Warrants, as defined in
the Series C Agreement, (iii) common stock issued to Vivo Shareholders upon
consummation of the Merger (as defined in the Merger Agreement), including
common stock issued upon exercise of former Vivo Stock Options (as defined in
the Merger Agreement) or (iv) any securities issued with respect to the Series B
Preferred, Series C Preferred, Series D Preferred, Series E Preferred or the
Common Stock and other securities referred to in clauses (i), (ii) and (iii) by
way of a stock dividend or stock split or in connection with a combination of
shares, recapitalization, merger, consolidation or other reorganization. For
purposes of this Agreement, a person will be deemed to be a holder of
Registrable Securities whenever such person has the right to acquire such
Registrable Securities whether or not such acquisition has actually been
effected. Registrable Securities, if transferred in accordance with Section
1.2(b), will remain Registrable Securities; provided, however, that Registrable
Securities shall not include shares (a) registered under the Securities Act
pursuant to an effective registration statement filed thereunder and disposed of
in accordance with the registration statement covering them or (b) that may be
publicly sold pursuant to Rule 144 under the Securities Act.
(b) Transfer of Registration Rights. The rights granted under this
Section may be assigned or otherwise conveyed by any holder of Registrable
Securities, in compliance with federal and applicable state securities laws, to
any transferee or assignee who, after such assignment or transfer, holds at
least 50,000 shares of Registrable Securities (subject to appropriate adjustment
for stock splits, stock dividends, combinations and other recapitalizations),
provided that the Company is given written notice by such transferee at the time
of or within thirty (30) days after said transfer, stating the name and address
of said transferee and said transferee's agreement to be bound by the provisions
of this Agreement. For the purposes of determining the number of shares of
Registrable Securities held by a transferee or
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<PAGE> 6
assignee, the holdings of a transferee or assignee who is (A) a shareholder,
partner, retired partner, member, retired member or beneficiary of a Purchaser;
(B) a spouse or child of a shareholder, partner, retired partner, member,
retired member or beneficiary of a Purchaser; (C) a trust for the benefit of the
persons set forth in (A) or (B) or for the issue of the persons set forth in (A)
or (B); and (D) an entity (corporation, partnership, limited liability company
or other juridical entity) of which at least 75 percent in interest is owned or
controlled, directly or indirectly through other entities, or by one or more of
the persons set forth in (A), (B) or (C), shall be aggregated together with the
corporation, partnership or limited liability company as the case may be;
provided that all assignees and transferees who would not qualify individually
for assignment of registration rights shall have a single attorney-in-fact for
the purpose of exercising any rights, receiving notices or taking any action
under this Agreement.
(c) Conditions to Participation. No holder of Registrable Securities
may participate in any underwritten registration hereunder unless such holder
(i) agrees to sell such holder's securities on the basis provided in any
underwriting arrangements and (ii) completes and executes all questionnaires,
indemnities, underwriting agreements and other documents reasonably required
under the terms of such underwriting arrangements, provided that such documents
shall not provide for indemnification or contribution obligations to the
Company, or obligations to the Company to provide information, of holders of
Registrable Securities greater than those obligations to the Company provided
for in Section 1.9.
1.3 Demand Registration.
(a) If at any time after the earlier of (i) two (2) years after the
date of this Agreement or (ii) six (6) months after the effective date of the
Initial Public Offering (as such term is defined in Section 2 of this
Agreement), the Company shall receive a written request from Investors holding
at least 30% of the Registrable Securities then outstanding that the Company
file a registration statement (other than on Form S-3 pursuant to Section 1.4 of
this Agreement) under the Securities Act covering the registration of all or
part of the Registrable Securities, then the Company shall, within ten (10) days
of the receipt of such request, give written notice of such request to all
holders of Registrable Securities and shall, subject to the limitations of
Section 1.3(b), use its best efforts to effect as soon as practicable the
registration under the Securities Act of all Registrable Securities which the
Investors request to be registered in a written request to be given within
twenty (20) days of the giving of such notice by the Company.
(b) The Investors initiating the registration request under this
Section 1.3 (the "Initiating Investors") must distribute the Registrable
Securities covered by their request by means of a public offering underwritten
by a recognized national or regional underwriter, which underwriter shall be
reasonably acceptable to the Company. The right of any Investor to include its
Registrable Securities in such registration shall be conditioned upon such
Investor's participation in such underwriting and the inclusion of such
Investor's Registrable Securities in the underwriting to the extent provided
herein. All Investors proposing to distribute their Registrable Securities
through such underwriting shall (together with the Company as provided in
Section 1.7(h)) enter into an underwriting agreement in customary form with the
underwriter or underwriters selected for such underwriting by a majority in
interest of the Initiating Investors.
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<PAGE> 7
Notwithstanding any other provision of this Section 1.3, if the underwriter
advises the Initiating Investors in writing that marketing factors require a
limitation of the number of shares to be underwritten, then the Initiating
Investors shall so advise all Investors who are holders of Registrable
Securities which would otherwise be underwritten pursuant hereto, and the number
of shares of Registrable Securities that may be included in the underwriting
shall be allocated among all holders thereof, including the Initiating
Investors, in proportion (as nearly as practicable) to the amount of Registrable
Securities of the Company owned by each Investor and requested to be registered
in such registration. Any Registrable Securities excluded or withdrawn from such
underwriting shall be withdrawn from the registration.
(c) The Company is obligated to effect only two registrations
pursuant to this Section 1.3. A request for registration under this Section 1.3
cannot be made within six (6) months of the effective date of a registration
statement for a public offering of the Company's securities (other than Exempt
Registrations).
(d) Notwithstanding the foregoing, if the Company shall furnish to
the Investors requesting a registration statement pursuant to this Section 1.3 a
certificate signed by the President of the Company, stating that in the good
faith judgment of the Board of Directors of the Company it would be seriously
detrimental to the Company and its shareholders for such registration statement
to be filed and it is therefore essential to defer the filing of such
registration statement, the Company shall have the right to defer such filing
for a period of not more than ninety (90) days after receipt of the request of
the Initiating Investors; provided, however, that the Company may not utilize
this right more than once in any twelve (12) month period.
(e) The Company shall not be obligated to take any action to effect
any registration pursuant to this Section 1.3, if, within ten (10) days of the
receipt of a request from Initiating Investors the Company gives the Initiating
Investors written notice that it has begun substantive discussions with an
underwriter with respect to a public offering of securities that would give rise
to registration rights under Section 1.5. The Company must promptly notify the
Investors of any abandonment of such offering.
1.4 S-3 Registration.
(a) S-3 Registrations. Subject to the terms hereof, the holders
of Registrable Securities, including transferees that have acquired the
Registrable Securities in accordance with Section 1.2(b) (the "Holders"), may
request in writing registration under the Securities Act of all or part of their
Registrable Securities (an "S-3 Registration") on Form S-3 (or any other form of
offering permitted under applicable securities laws involving effort and expense
reasonably similar to that involved in effecting a registration on Form S-3 for
which the Company may then be eligible). Any such request shall state the number
of Registrable Securities to be disposed of and the intended disposition of such
shares by their Holders, provided that the aggregate offering price must be not
less than $250,000 for each such registration and on not more than three
occasions, provided, further, however, that the Vivo Shareholders shall be
entitled to request only one S-3 Registration, which must be requested by
holders of at least 50% of the then outstanding Registrable Securities held by
the Vivo Shareholders or their transferees. Such S-3
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<PAGE> 8
Registration shall be in addition to the three S-3 Registrations which may be
requested by the other Holders. The Company hereby agrees that it will file an
S-3 Registration Statement in November 1998 and that all Vivo Shareholders shall
be entitled to register their shares therein. S-3 Registrations will be effected
on Form S-3 (or any similar short-form registration for which the Company may
then be eligible) whenever the Company is permitted to use such a form.
Following the initial public offering of its securities, the Company will use
its best efforts to qualify for registration on Form S-3 (or any similar
short-form registration for which the Company may then be eligible) and maintain
such registration in effect for not less than one hundred twenty (120) days.
(b) Priority S-3 Registrations. If any S-3 Registration is an
underwritten offering, the Company may request that securities to be sold on its
behalf be included in such S-3 Registration, and if the managing underwriters
advise the Company in writing that in their opinion the number of securities
requested to be included exceeds the number that can be sold in such offering
without adversely affecting such underwriters' ability to effect an orderly
distribution of the securities, the Company will include in such registration:
first, the securities the Company proposes to sell; and second, the number of
Registrable Securities that the Holders propose to sell and that in the opinion
of such underwriters can be sold; provided that in the event that the number of
Registrable Securities that the Holders propose to sell is reduced by more than
ten percent (10%), such registration will not be counted as a S-3 Registration.
Anything in this subsection (b) to the contrary notwithstanding, for a period of
twelve months following the conclusion of any offering from which, pursuant to
this subsection (b), there were excluded any Registrable Securities requested to
be included (an "Exclusion Offering"), the Company shall not exercise its right
to priority so as to exclude such Registrable Securities from a subsequent S-3
Registration; provided, however, that a S-3 Registration may not be requested by
the Holders of Registrable Securities for a period of four (4) months following
the conclusion of any such Exclusion Offering. If any S-3 Registration in which
the Company does not have the right to priority is an underwritten offering, the
Company may have securities to be sold on its behalf included in such S-3
Registration, to the extent deemed practicable by the managing underwriters,
provided the number of Registrable Securities included therein is not reduced.
(c) Restrictions on Purchasers and S-3 Registrations. The Company
may postpone for up to ninety (90) days the filing or the effectiveness of a
registration statement for a S-3 Registration if the Company's Chief Executive
Officer delivers a written certification to each Holder of the Registrable
Securities requested to be included therein stating that the Company's Board of
Directors has declared that such S-3 Registration would not be in the best
interests of the Company; provided that in any such event, the Holders of
Registrable Securities requesting such registration will be entitled to withdraw
such requests and, if the remaining requests that are not withdrawn are not
sufficient to initiate such registration, such registration need not be effected
by the Company and will not count as a S-3 Registration; provided further, that
if such event occurs during the twelve (12) month period during which the
Company may not conduct an Exclusion Offering (as described in Clause (b)
above), then such twelve (12) month period shall be extended by the length of
any such postponement. The Company may only make one election in any
twelve-month period to postpone a S-3 Registration pursuant hereto.
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<PAGE> 9
(d) Limited Number of S-3 Registrations. The Company is obligated to
effect only three (3) registrations pursuant to this Section 1.4, plus the one
(1) registration which may be requested only by the Vivo Shareholders owning at
least 50% of the Registrable Securities held by the Vivo Shareholders or their
transferees.
(e) Selection of Underwriters. In a S-3 Registration, the holders of
Registrable Securities will have the right to determine the method of
distribution and, if the offering is underwritten, to select the investment
banker(s) and manager(s) to administer the offering.
1.5 Piggyback Registrations.
(a) Right to Piggyback. Whenever the Company proposes to register
any of its securities under the Securities Act (other than pursuant to a
registration primarily for sales of securities to employees of the Company or in
connection with a transaction to which Rule 145 or any similar rule of the SEC
under the Securities Act is applicable) and the registration form to be used
also may be used for the registration of Registrable Securities, the Company
will give prompt written notice to all holders of Registrable Securities of its
intention to effect such a registration (a "Piggyback Registration") and will
use its best efforts to include in such registration all Registrable Securities
with respect to which the Company has received written requests for inclusion
therein within thirty (30) days after the receipt of the Company's notice except
as set forth in paragraph (b) below. Such written request may specify all or
part of a holder's Registrable Securities to be included in the registration.
(b) Priority on Primary Registrations. If a Piggyback Registration
is an underwritten primary registration on behalf of the Company, and the
managing underwriters advise the Company in writing that in their opinion the
number of securities requested to be included in such registration exceeds the
number that can be sold in such offering without adversely affecting such
underwriters' ability to effect an orderly distribution of such securities, the
Company will include in such registration: first, the securities the Company
proposes to sell; second, the Registrable Securities requested to be included in
such registration, pro rata among the holders of such securities on the basis of
the number of shares of Common Stock (or equivalents) represented by the
Registrable Securities owned by the holders thereof and requested to be
registered, but in no event in an offering following the Company's initial
public offering shall the number of Registrable Securities included in such
registration be less than 30% of the total of all securities included in such
registration; and third, other securities requested to be included in such
registration.
(c) Priority on Secondary Registrations. If a Piggyback Registration
is an underwritten secondary registration on behalf of holders of the Company's
securities and there are no newly issued securities of the Company being
registered thereunder, and the managing underwriters advise the Company in
writing that in their opinion the number of securities requested to be included
in such registration exceeds the number that can be sold in such offering
without adversely affecting such underwriters' ability to effect an orderly
distribution of such securities, the Company will include in such registration:
first, any Registrable Securities
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<PAGE> 10
requested to be included in such registration, pro rata among the holders of
such securities on the basis of the number of shares of Common Stock (or
equivalents) represented by the Registrable Securities owned by the holders
thereof and requested to be registered, and second, other securities requested
to be included in such registration. If any holder of Registrable Securities who
has requested inclusion in such registration or offering disapproves of the
terms of the underwriting, he may elect to withdraw therefrom by written notice
to the Company, the underwriter and the holders of Registrable Securities who
initiated the offering.
(d) Absence of Piggyback Rights for Vivo Shareholders.
Notwithstanding anything herein to the contrary, Vivo Shareholders and their
transferees shall not have any rights to piggyback registration as described
under this Section 1.5, except with respect to the S-3 Registration demanded by
the Vivo Shareholders.
1.6 Lockup Agreements. Each holder of the Registrable Securities agrees
not to effect any public sale or distribution of Registrable Securities, or any
securities convertible into or exchangeable or exercisable for Registrable
Securities, during the seven (7) days prior to and the period after (as
requested by the underwriters, but not to exceed 180 days) the effectiveness of
the first registration of the Company's securities to be sold in an underwritten
public offering for the account of the Company, provided that all officers and
directors of the Company and all other holders of more than one percent (1%) of
the Company's equity securities agree to be similarly bound with respect to
equity securities of the Company held by such officers, directors and one
percent (1%) holders, provided further that any discretionary waiver or
termination of the restrictions of such agreements by the representatives of the
underwriters shall apply to all persons subject to such agreements pro rata
based on the number of equity securities held by such persons and subject to
such agreements, provided further that such holders are given reasonable notice
of such Registration, and provided further, that the provisions of this Section
1.6 shall bind The Goldman Sachs Group, L.P. and any transferee of its
Registrable Securities only with respect to the Registrable Securities held by
such person and shall not otherwise in any manner bind or restrict Goldman,
Sachs & Co. (whether as a broker, dealer, underwriter or otherwise) or The
Goldman Sachs Group. L.P. or any of their affiliates or general or limited
partners. Without limiting the foregoing, it is expressly agreed that the
provisions of this Section 1.6 shall not (a) apply to any shares of Common Stock
or any securities convertible into or exercisable or exchangeable for Common
Stock acquired by a Holder directly from the underwriters in a registered public
offering of the Company's securities or in an established trading market from
any party other than the Company, or (b) prevent the exercise of the Series B
Common Warrants, the Series C Warrants, the Series D Warrants, or the Series E
Warrant described in Section 1.2(a) during such lockup period.
1.7 Registration Procedures. Whenever the holders of Registrable
Securities have requested that any Registrable Securities be registered pursuant
to this Agreement, the Company will use its best efforts to effect the
registration of such Registrable Securities in accordance with the intended
method of disposition thereof, and pursuant thereto the Company will, without
limiting the generality of the foregoing, as expeditiously as possible:
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<PAGE> 11
(a) prepare and file with the Securities and Exchange Commission a
registration statement with respect to such Registrable Securities, which
registration statement will state that the holders of Registrable Securities
covered thereby may sell such Registrable Securities either under such
registration statement or pursuant to Rule 144 (or any similar rule then in
effect), and use its best efforts to cause such registration statement to become
effective (provided that before filing a registration statement or prospectus or
any amendments or supplements thereto, the Company will furnish to the counsel
selected by the holders of a majority of the voting interest of the Registrable
Securities covered by such registration statement copies of all such documents
proposed to be filed);
(b) prepare and file with the Commission, if applicable, such
amendments and supplements to such registration statement and the prospectus
used in connection therewith as may be necessary to keep such registration
statement effective for a period of not less than one hundred eighty (180) days
in the case of the Company's initial registration of Common Stock under the
Securities Act and one hundred twenty (120) days in the case of any subsequent
registration, provided, however, that if the Company files an S-3 Registration
at the request of the Vivo Shareholders, the Company shall maintain the
effectiveness of such S-3 Registration until the later of the first anniversary
of the consummation of the Merger Agreement or 120 days;
(c) furnish to each seller of Registrable Securities such number of
copies of such registration statement, each amendment and supplement thereto,
and the prospectus included in such registration statement (including each
preliminary prospectus) as such seller may reasonably request in order to
facilitate the disposition of the Registrable Securities owned by such seller;
(d) use its best efforts to register or qualify such Registrable
Securities under such other securities or blue sky laws of such jurisdictions of
the United States as any seller reasonably requests and do any other related
acts that may be reasonably necessary to enable such seller to consummate the
disposition in such jurisdictions of the Registrable Securities owned by such
seller (provided that the Company will not be required to (i) qualify generally
to do business in any jurisdiction where it would not otherwise be required to
qualify but for this Section 1.7(d) or (ii) consent to general service of
process in any such jurisdiction);
(e) notify each seller of such Registrable Securities, at any time
when a prospectus relating thereto is or would be required to be delivered under
the Securities Act, of the happening of any event as a result of which the
prospectus included in such registration statement contains an untrue statement
of a material fact or omits any fact necessary to make the statements therein
not misleading, and, at the request of any such seller, the Company will prepare
a supplement or amendment to such prospectus so that, as thereafter delivered to
the purchasers of such Registrable Securities, such prospectus will not contain
any untrue statement of a material fact or omit any fact necessary to make the
statements therein not misleading;
(f) upon the request of the holders of 20% or more of the
Registrable Securities or such lesser number of Registrable Securities as are
actually registered pursuant to
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this Agreement, cause all such Registrable Securities to be listed on each
securities exchange or quotation system on which similar securities issued by
the Company are then listed;
(g) provide a transfer agent and registrar for all such Registrable
Securities not later than the effective date of such registration statement;
(h) enter into such customary agreements (including underwriting
agreements on customary terms) and take all such other actions as are reasonably
required in order to expedite or facilitate the disposition of such Registrable
Securities (including, without limitation, effecting a stock split or a
combination of shares);
(i) make available for inspection by any seller of Registrable
Securities, any underwriter participating in any disposition pursuant to such
registration statement, and any attorney, accountant or any other agent retained
by any such seller or underwriter, all financial and other records, pertinent
corporate documents and properties of the Company, and cause the Company's
officers, directors and employees to supply all information reasonably requested
by any such seller, underwriter, attorney, accountant or agent in connection
with such registration statement;
(j) comply with all necessary filing and other requirements,
including without limitation listing shares on any national securities exchange
on which similar securities of the Company are then listed, so as to enable the
holders of Registrable Securities to sell Registrable Securities under Rule 144
(or any similar rule then in effect) after any initial public offering of the
Company's Common Stock; and
(k) obtain a comfort letter from the Company's independent
accountants in customary form and covering such matters of the type customarily
covered by comfort letters and an opinion from the Company's counsel in
customary form covering such matters normally covered in a public issuance of
securities, in each case addressed to the holders of the Registrable Securities.
1.8 Registration Expenses.
(a) All expenses incident to the Company's performance of or
compliance with this Agreement with respect to any Demand Registration, S-3
Registration or Piggyback Registration, including, without limitation, all
registration and filing fees, fees and expenses of compliance with securities or
blue sky laws, printing expenses, messenger and delivery expenses, and fees and
disbursements of counsel for the Company and all independent certified public
accountants, underwriters (excluding discounts and commissions, which in all
cases shall be borne by the party selling the securities with respect to which
the discounts or commissions are incurred or paid) and other persons retained by
the Company, will be borne by the Company.
(b) In connection with any Demand Registration, S-3 Registration or
Piggyback Registration, the Company will reimburse the holders of Registrable
Securities
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covered by such registration for the reasonable fees and disbursements of one
counsel chosen by the holders of a majority of the voting interest of such
Registrable Securities.
1.9 Indemnification.
(a) Incident to any registration statement referred to in this
Section 1 and subject to applicable law, the Company will indemnify and hold
harmless each underwriter, each holder of Registrable Securities (including its
respective directors, officers, members, employees and agents) so registered,
and each person who controls any of them within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act and the rules and regulations
promulgated thereunder, from and against any and all losses, claims, damages,
expenses and liabilities, joint or several (including any investigation, legal
and other expenses incurred in connection with, and any amount paid in
settlement of, any action, suit or proceeding or any claim asserted), to which
they, or any of them, may become subject under the Securities Act, the Exchange
Act or other federal or state statutory law or regulation, at common law or
otherwise, insofar as such losses, claims, damages or liabilities arise out of
or are based on (i) any untrue statement or alleged untrue statement of a
material fact contained in such registration statement (including any related
preliminary or definitive prospectus, or any amendment or supplement to such
registration statement or prospectus), (ii) any omission or alleged omission to
state in such document a material fact required to be stated in it or necessary
to make the statements in it not misleading, or (iii) any violation by the
Company of the Securities Act, any state securities or "blue sky" laws or any
rule or regulation thereunder in connection with such registration, provided
that the Company will not be liable to the extent that such loss, claim, damage,
expense or liability arises from and is based on an untrue statement or omission
or alleged untrue statement or omission made in reliance on and in conformity
with information furnished in writing to the Company by such underwriter, holder
or controlling person expressly for use in such registration statement. With
respect to such untrue statement or omission or alleged untrue statement or
omission in the information furnished in writing to the Company by such holder
expressly for use in such registration statement, such holder will indemnify and
hold harmless each underwriter, the Company (including its directors, officers,
members, employees and agents), each other holder of Registrable Securities
(including its respective directors, officers, employees and agents) so
registered, and each person who controls any of them within the meaning of
Section 15 of the Securities Act or Section 20 of the Exchange Act, from and
against any and all losses, claims, damages, expenses and liabilities, joint or
several, to which they, or any of them, may become subject under the Securities
Act, the Exchange Act or other federal or state statutory law or regulation, at
common law or otherwise to the same extent provided in the immediately preceding
sentence. In no event, however, shall the liability of a holder for
indemnification under this Section 1.9(a) exceed the lesser of (i) that
proportion of the total of such losses, claims, damages or liabilities
indemnified against equal to the proportion of the total Registrable Securities
sold under such registration statement which is being sold by such holder of
Registrable Securities or (ii) the proceeds received by such holder from its
sale of Registrable Securities under such registration statement.
(b) If the indemnification provided for in Section 1.9(a) above for
any reason is held by a court of competent jurisdiction to be unavailable to an
indemnified party in respect of
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any losses, claims, damages, expenses or liabilities referred to therein, then
each indemnifying party under this Section 1.9, in lieu of indemnifying such
indemnified party thereunder, shall contribute to the amount paid or payable by
such indemnified party as a result of such losses, claims, damages, expenses or
liabilities (i) in such proportion as is appropriate to reflect the relative
benefits received by the Company, the other selling holders of Registrable
Securities and the underwriters from the offering of the Registrable Securities
or (ii) if the allocation provided by clause (i) above is not permitted by
applicable law, in such proportion as is appropriate to reflect not only the
relative benefits referred to in clause (i) above but also the relative fault of
the Company, the other selling holders of Registrable Securities and the
underwriters in connection with the statements or omissions which resulted in
such losses, claims, damages, expenses or liabilities, as well as any other
relevant equitable considerations. The relative benefits received by the
Company, the selling holders of Registrable Securities and the underwriters
shall be deemed to be in the same respective proportions as the net proceeds
from the offering (before deducting expenses) received by the Company and the
selling holders and the underwriting discount received by the underwriters, in
each case as set forth in the table on the cover page of the applicable
prospectus, bear to the aggregate public offering price of the Registrable
Securities. The relative fault of the Company, the selling holders of
Registrable Securities and the underwriters shall be determined by reference to,
among other things, whether the untrue or alleged untrue statement of a material
fact or the omission or alleged omission to state a material fact relates to
information supplied by the Company, the selling holders or the underwriters and
the parties' relative intent, knowledge, access to information and opportunity
to correct or prevent such statement or omission. The Company, the holders of
Registrable Securities, and the underwriters agree that it would not be just and
equitable if contribution pursuant to this Section 1.9(b) were determined by pro
rata or per capita allocation or by any other method of allocation which does
not take account of the equitable considerations referred to in the first
sentence of this Section 1.9(b). In no event, however, shall a holder of
Registrable Securities be required to contribute any amount under this Section
1.9(b) in excess of the lesser of (i) that proportion of the total of such
losses, claims, damages or liabilities indemnified against equal to the
proportion of the total Registrable Securities sold under such registration
statement which is being sold by such holder or (ii) the proceeds received by
such holder from its sale of Registrable Securities under such registration
statement. No person found guilty of fraudulent misrepresentation (within the
meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent
misrepresentation.
(c) The amount paid or payable by an indemnified party as a result
of the losses, claims, damages and liabilities referred to in this Section 1.9
shall be deemed to include, subject to the limitations set forth above, any
legal or other expenses reasonably incurred by such indemnified party in
connection with investigating or defending any such action or claim. The
indemnification and contribution provided for in this Section 1.9 will remain in
full force and effect regardless of any investigation made by or on behalf of
the indemnified parties or any officer, director, employee, agent or controlling
person of the indemnified parties.
1.10 Termination. The rights to registration of Registrable Securities
set forth in this Section shall terminate and have no further effect on the
seventh (7th) anniversary of the closing of the Company's Initial Public
Offering, as defined below, provided, however, that the Vivo
-11-
<PAGE> 15
Shareholders shall have no further registration rights, and the Common Stock
issued to Vivo Shareholders pursuant to the Merger Agreement shall no longer be
considered Registrable Securities, upon the later of the first anniversary of
the consummation of the Merger Agreement or 120 days after filing of the Vivo
S-3 Registration Statement.
2. COVENANTS OF THE COMPANY
During the term of this Agreement, the Company covenants and agrees that
for so long as any (a) Common Stock issued upon conversion of the Series B
Preferred, Series C Preferred, Series D Preferred, or Series E Preferred
(including without limitation the Series C Preferred issuable upon exercise of
the Series C Warrants, Series D Preferred issuable upon exercise of the Series D
Warrants, and Series E Preferred issuable upon exercise of the Series E
Warrant), or pursuant to Section 1.2(a)(iii) of this Agreement, or (b)
securities issued with respect to the securities referred to in clause (a) above
by way of a stock dividend or stock split or in connection with a combination of
shares, recapitalization, merger, consolidation or other reorganization
(hereinafter collectively referred to as "Restricted Securities"), remain
outstanding (the Series C Preferred issuable upon exercise of the Series C
Warrants, the Series D Preferred issuable upon exercise of the Series D
Warrants, and the Series E Preferred issuable upon exercise of the Series E
Warrant being deemed outstanding for purposes of this Section 2), at all times
after the Company has filed a registration statement pursuant to the
requirements of the Securities Act, or the Exchange Act, the Company will file
all reports required to be filed by it under the Securities Act or the Exchange
Act and the rules and regulations adopted by the Securities and Exchange
Commission (the "Commission") thereunder, and will take such further action as
any holder or holders of Restricted Securities may reasonably request, all to
the extent required to enable each such holder to sell Restricted Securities
pursuant to (i) Rule 144 under the Securities Act, or (ii) any similar rule or
regulation hereafter adopted by the Commission. Upon request, the Company will
deliver to each such holder a written statement as to whether the Company has
complied with such requirements.
3. MISCELLANEOUS
3.1 Parties in Interest. All covenants, agreements, representations,
warranties and undertakings in this Agreement made by and on behalf of any of
the parties hereto shall bind and inure to the benefit of their respective
successors and assigns.
3.2 Entire Agreement: Amendments and Waivers. This Agreement (including
the attachments hereto) and the other documents delivered pursuant hereto
constitute the full and entire understanding and agreement between the parties
with regard to the subjects hereof and thereof. This Agreement may be amended,
or compliance with any term, covenant, agreement, condition or provision set
forth herein may be omitted or waived (either generally or in a particular
instance and either retroactively or prospectively) if agreed to in writing by
the Company and either: (a) the holders of at least two-thirds (2/3) of the
outstanding Registrable Securities (other than those held by Microsoft), and
two-thirds (2/3) of the Common Stock issuable upon conversion of the Series E
Preferred Stock, or (b) the holders of at least 51% of the outstanding Common
Stock issued upon conversion of the Series B Preferred Stock, the holders
-12-
<PAGE> 16
of at least 51% of the outstanding Common Stock issued upon conversion of the
Series C Preferred Stock, the holders of at least 51% of the outstanding Common
Stock issued upon conversion of the Series D Preferred Stock, the holders of at
least 51% of the Common Stock issued upon conversion of the Series E Preferred
Stock; and 51% of the Registrable Securities held by the Vivo Shareholders;
provided, however, that the holder(s) of the Series E Preferred Stock hereby
agree to: (i) any amendment that is limited to adding holders of Common Stock or
a new series of Common Stock or Preferred Stock or securities convertible into
or carrying the rights to purchase Common Stock or a new series of Common Stock
or Preferred Stock (the "New Securities") as parties to this Agreement as long
as the New Securities have rights under this Agreement that are equivalent or
subordinate to those of the Series E Preferred, and (ii) any amendment that does
not (A) adversely affect the holders of Series E Preferred Stock but not the
holders of the other series of Preferred Stock or (B) otherwise disadvantage
disproportionately the holders of Series E Preferred Stock; and provided
further, that if any amendment or omission or waiver of compliance with any
term, covenant, agreement or condition or provision affects any Holder
disproportionately, the written agreement of such Holder shall also be required.
The Series B Holders and the Company expressly agree that this Agreement
supersedes Sections 4 and 5 of the Series B Agreement in their entirety and that
such sections of the Series B Agreement are no longer in force or effect, the
Series B Holders, Series C Holders and the Company expressly agree that this
Agreement supersedes the C Rights Agreement in its entirety and the C Rights
Agreement is no longer in force and effect; and the Series B Holders, Series C
Holders, Series D Holders, and the Company expressly agree that this Agreement
supersedes the D Rights Agreement in its entirety and the D Rights Agreement is
no longer in force and effect.
3.3 Governing Law, Severability. This Agreement, together with the
rights and obligations of the parties hereunder, shall be governed by, construed
and enforced in accordance with the laws of the State of Washington without
regard to principles of conflicts of laws. In the event any provision of this
Agreement or the application of any such provision to any party shall be held by
a court of competent jurisdiction to be contrary to law, the remaining
provisions of this Agreement shall remain in full force and effect.
3.4 Notices. All notices, requests, consents, and demands shall be in
writing and shall be deemed to have been sufficiently given if sent, postage
prepaid, by registered or certified mail, return receipt requested, to the
Company at RealNetworks, Inc., 1111 Third Avenue, Suite 500, Seattle, WA 98101,
Attention: President, with a second copy addressed separately to the General
Counsel; to the Investors at the addresses listed in Exhibits A and B and to
Microsoft at Microsoft Corporation, One Microsoft Way, Redmond, Washington
98052-6399, Attention: Robert A. Eshelman, Assistant Secretary; or to such other
address as may from time to time be furnished in writing to the other parties
hereto.
3.5 Counterparts. This Agreement may be executed in counterparts, each
of which shall be deemed an original, but all of which together shall constitute
one and the same instrument.
-13-
<PAGE> 17
3.6 Captions. The captions and headings of this Agreement are for
convenience only and are not to be construed as defining or limiting the scope
or intent of any of the provisions hereof.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the date first set forth above.
REALNETWORKS, INC.
By: ____________________________________
Its: ___________________________________
The undersigned, who are parties to that certain Second Amended and Restated
Investors' Rights Agreement dated July 21, 1997 (the "Agreement"), hereby
consent to amend and restate such Agreement in its entirety as set forth in this
Third Amended and Restated Investors' Rights Agreement:
INVESTOR: ______________________________
(Please Print Name)
By: ____________________________________
Its: ___________________________________
-14-
<PAGE> 18
EXHIBIT A
FORMER SERIES B PREFERRED HOLDERS
Name and Address
Phillip Barrett
13224 - 178th N.E.
Redmond, WA 98052
Howard P. Welt
820 - 34th Avenue E.
Seattle, WA 98112
Jeanine Tang
16015 Olympic Drive N.W.
Seattle, WA 98177
Elaine Yeomelakis
3 Spruce Street
Stoneham, MA 02180
Julius and Barbara Glaser TR U/A 09-03-91
Julius and Barbara Glaser, Trustees
424 Trail Ridge Place
Santa Rosa, California 95409
Martha E. Glaser
7720 Bodega Avenue, #11
Sebastapol, CA 95472
Rob Glaser
c/o RealNetworks, Inc.
1111 Third Avenue, Suite 2900
Seattle, Washington 98101-3207
Dennis L. Heck
1518 South Columbia
Olympia, Washington 98501
Mitchell Kapor
Kapor Enterprises, Inc.
238 Main Street, Suite 400
Cambridge, Massachusetts 02142
<PAGE> 19
Michael B. Slade
3732 East High Lane
Seattle, Washington 98112
<PAGE> 20
FORMER SERIES C PREFERRED HOLDERS
Name and Address
Accel IV L.P.
c/o Accel Partners
428 University Avenue
Palo Alto, CA 94301
Attn: James W. Breyer
Accel Keiretsu L.P.
c/o Accel Partners
428 University Avenue
Palo Alto, CA 94301
Attn: James W. Breyer
Accel Investors '95 L.P.
c/o Accel Partners
428 University Avenue
Palo Alto, CA 94301
Attn: James W. Breyer
Ellmore C. Patterson Partners
c/o Accel Partners
428 University Avenue
Palo Alto, CA 94301
Attn: James W. Breyer
Jeanine Tang
16015 Olympic Drive N.W.
Seattle, WA 98177
Julius and Barbara Glaser TR U/A 09-03-91
Julius and Barbara Glaser, Trustees
424 Trail Ridge Place
Santa Rosa, CA 95409
Martha E. Glaser
7720 Bodega Avenue, #11
Sebastapol, CA 95472
Rob Glaser
c/o RealNetworks, Inc.
1111 Third Avenue, Suite 2900
Seattle, WA 98101-3207
<PAGE> 21
Dennis L. Heck
1518 South Columbia
Olympia, WA 98501
Mitchell Kapor
Kapor Enterprises, Inc.
238 Main Street, Suite 400
Cambridge, MA 02142
Michael B. Slade
3732 East High Lane
Seattle, WA 98112
Howard P. Welt
820 - 34th Avenue E.
Seattle, WA 98112
<PAGE> 22
FORMER SERIES D PREFERRED HOLDERS
Name and Address
Bayview Investors, Ltd.
555 California St.
San Francisco, CA 94104
Attn: Jennifer Sherrill
IPG Network, Inc.
1700 Montgomery Street, Suite 420
San Francisco, CA 94111
Attn: Yoshiteru Sagiya
Ziff Asset Management, L.P.
153 E. 53rd St., 43rd Floor
New York, NY 10022
Attn: Philip B. Korsant
Technology Crossover Ventures, L.P.
56 Main Street, Suite 210
Millburn, NJ 07041
Attn: Robert C. Bensky
Technology Crossover Ventures, C.V.
56 Main Street, Suite 210
Millburn, NJ 07041
Attn: Robert C. Bensky
Accel IV L.P.
428 University Avenue
Palo Alto, CA 94301
Attn: James W. Breyer
Accel Keiretsu L.P.
428 University Avenue
Palo Alto, CA 94301
Attn: James W. Breyer
Accel Investors '95 L.P.
428 University Avenue
Palo Alto, CA 94301
Attn.: James W. Breyer
<PAGE> 23
Ellmore C. Patterson Partners
c/o Accel Partners
428 University Avenue
Palo Alto, CA 94301
Attn.: James W. Breyer
Velocity Technology and
Communications Trust B
260 Hamilton Avenue, Suite 212
Palo Alto, CA 94301
Attn: Andy Kessler
Dennis L. Heck
1518 S. Columbia
Olympia, WA 98501
Norma Ann Crampton
820 - 34th Avenue E.
Seattle, WA 98112
Elaine Yeomelakis
3 Spruce Street
Stoneham, MA 02180
Jeanine Tang
16015 Olympic Drive N.W.
Seattle, WA 98177
Rob Glaser
c/o RealNetworks, Inc.
1111 Third Avenue, Suite 2900
Seattle, WA 98101-3207
Merrill Lynch KECALP L.P. 1994
Attn.: Robert Tully
World Financial Center, South Tower
225 Liberty Street
New York, NY 10080
CSK Venture Capital Co., Ltd.
Kenchiku Kaikan, 7th Floor
26-20 Shiba, 5-chome, Minato-ku
Tokyo 105, Japan
Attn: Kenji Suzuki
<PAGE> 24
CSK Corporation
Shinjuku Sumitomo Bldg.
2-6-1 Nishi-Shinjuku, Shinjuku-ku
Tokyo 163-02 Japan
Attn: Tadashi Fujisawa
Encompass Group, Inc.
Suite 205
4040 Lake Washington Blvd. N.E.
Kirkland, WA 98033
Attn: Yasuki Matsumoto
Trans Cosmos USA, Inc.
Suite 205
4040 Lake Washington Blvd. N.E.
Kirkland, WA 98033
Attn.: Yasuki Matsumoto
The Goldman Sachs Group, L.P.
c/o Goldman Sachs & Co.
85 Broad Street, 19th Floor
New York, NY 10004
Attn: Joseph Gleberman
Mitchell Kapor
c/o Kapor Enterprises
238 Main Street, Suite 400
Cambridge, MA 02142
Peter J. Rubin Trustee,
PSP and Trust
PS Plan DTD 11/14/96,
FBO Peter J. Rubin
400 Seward Square, S.E., Apt. 42
Washington, DC 20003
<PAGE> 25
EXHIBIT B
VIVO SHAREHOLDERS
Accel IV L.P.
Accel Japan L.P.
Accel Investors '93 L.P.
Accel Keiretsu L.P.
Prosper Partners
Ellmore C. Patterson Partners
St Paul Venture Capital IV, LLC
St Paul Venture Capital Affiliates Fund I, LLC
Morgenthaler Venture Partners III
Matrix Partners III L.P.
CMP Media Inc.
PictureTel Corp.
Sigma Partners III
Sigma Associates III
Sigma Investors III
Gardner Hendrie
Susanne Lilly Hutcheson Trust
David M Lilly
Flach & Associates
James Flach
Staffan Ericsson
Anthony Antonuccio
Bernd Girod
Zenas Hutcheson
Mark Bretl
Daud Power
Oliver Jones
Peter Zaballos
Dean Wiltse
John Bruder
George Madaus
Roz Hoffman
John Carlton
Andreas Wanka
Joseph Rovine
Lesley Peebles
Enna Rojas
Stephanie Woiciechowski
Bin Zhang
Corinne Howard
Vadim Matskin
<PAGE> 26
H Bondar
Ann-Marie Sweeney
Matt Greer
Hugh Montague
Thomas Wolf
Lisa Nalewak
Meg Munger
Jane Spencer
Karen Crine
Dan Cronin
Joe Schoendorf
Ted Adelson
Randy Smith
Robert Pryor
Ted Mina
Ken Faubel
Joe Kluck
Dan Brown
Gene Su
Win Crofton
Weili Zhang
Mary Campbell
Pauline L McCormack
Peter Haimovitz
Jeff Miller
John Wolfe
Mary Deshon
Chet Graham
Gerry Hall
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
RealNetworks, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-42579) on Form S-8 of RealNetworks, Inc. of our reports dated January 21,
1998, except for note 9(b), which is as of March 24, 1998, relating to the
consolidated balance sheets of RealNetworks, Inc. and subsidiaries as of
December 31, 1996 and 1997, and the related consolidated statements of
operations, shareholders' equity (deficit) and cash flows, and the related
consolidated financial statement schedule for each of the years in the
three-year period ended December 31, 1997, which reports appear in the December
31, 1997 Annual Report on Form 10-K of RealNetworks, Inc.
/s/ KPMG Peat Marwick LLP
Seattle, Washington
March 27, 1998
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<PERIOD-TYPE> YEAR 9-MOS YEAR 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1996 DEC-31-1997
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<PERIOD-END> DEC-31-1997 SEP-30-1997 DEC-31-1996 JUN-30-1997
<CASH> 62,255,129 44,751,298 14,737,806 4,971,916
<SECURITIES> 29,772,771 22,897,196 4,857,163 6,523,710
<RECEIVABLES> 15,073,036 4,350,464 3,275,518 4,352,334
<ALLOWANCES> 829,347 688,572 383,350 581,219
<INVENTORY> 167,367 66,029 60,543 80,270
<CURRENT-ASSETS> 109,858,736 75,068,866 23,528,266 16,535,286
<PP&E> 7,896,270 6,953,498 3,462,153 5,644,834
<DEPRECIATION> 2,753,108 2,180,018 783,355 1,625,579
<TOTAL-ASSETS> 116,704,366 84,371,634 26,468,158 22,147,854
<CURRENT-LIABILITIES> 22,339,347 24,307,049 6,634,922 7,656,583
<BONDS> 963,379 959,380 0 991,268
0 49,277,652 23,153,494 23,264,467
0 13,713 13,713 932,385
<COMMON> 30,865 1,543 535 88,617
<OTHER-SE> 77,870,775 (8,104,363) (3,334,506) (10,785,466)
<TOTAL-LIABILITY-AND-EQUITY> 116,704,366 84,371,634 26,468,158 22,147,854
<SALES> 0 0 0 0
<TOTAL-REVENUES> 32,720,220 22,416,804 14,012,388 13,366,177
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<TOTAL-COSTS> 6,464,670 4,608,661 2,185,524 3,054,277
<OTHER-EXPENSES> 39,416,857 27,567,116 15,843,408 17,119,451
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<INCOME-PRETAX> (11,168,874) (8,574,716) (3,789,245) (6,371,786)
<INCOME-TAX> 0 0 0 0
<INCOME-CONTINUING> (11,168,874) (8,574,716) (3,789,245) (6,371,786)
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