<PAGE> 1
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-23137
REALNETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 91-1628146
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
2601 ELLIOTT AVENUE, SUITE 1000 98121
SEATTLE, WASHINGTON (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(206) 674-2700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's Common Stock outstanding as of
July 31, 1999 was 73,001,583.
<PAGE> 2
REALNETWORKS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1999
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.....................................................................3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..........................................................................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk..............................35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................36
Item 2. Changes in Securities and Use of Proceeds...............................................36
Item 4. Submission of Matters to a Vote of Security Holders.....................................37
Item 6. Exhibits and Reports on Form 8-K........................................................37
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
--------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 317,069 89,777
Trade accounts receivable, net of allowance for doubtful
accounts and sales returns 5,366 4,941
Prepaid expenses and other current assets 3,386 3,212
--------- ---------
Total current assets 325,821 97,930
Equipment and leasehold improvements, at cost:
Equipment and software 16,617 10,914
Leasehold improvements 10,018 1,441
--------- ---------
Total equipment and leasehold improvements 26,635 12,355
Less accumulated depreciation and amortization 6,676 6,082
--------- ---------
Net equipment and leasehold improvements 19,959 6,273
--------- ---------
Goodwill, net 7,984 9,048
Restricted cash equivalents 13,700 13,700
Other assets 1,102 1,108
--------- ---------
TOTAL ASSETS $ 368,566 128,059
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,715 3,563
Accrued liabilities 15,583 10,418
Deferred revenue, excluding non-current portion 36,036 23,742
--------- ---------
Total current liabilities 54,334 37,723
--------- ---------
Deferred revenue, excluding current portion -- 5,833
Note payable -- 987
Shareholders' equity:
Preferred stock, $0.001 par value, no shares issued and outstanding
Series A: authorized 200 shares -- --
Undesignated series: authorized 59,800 shares -- --
Common stock, $0.001 par value
Authorized 296,291 shares; issued and outstanding 72,790 shares
in 1999 and 61,975 shares in 1998 73 62
Special common stock, $0.001 par value
Authorized 3,709 shares; issued and outstanding no shares
in 1999 and 2,586 shares in 1998 -- 3
Additional paid-in capital 349,401 117,515
Accumulated deficit (34,944) (33,938)
Accumulated other comprehensive loss (298) (126)
--------- ---------
Total shareholders' equity 314,232 83,516
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 368,566 128,059
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
<PAGE> 4
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Quarter Ended June 30, Six Months Ended June 30,
------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues:
Software license fees $ 20,256 10,796 37,266 20,214
Service revenues 5,759 3,495 11,008 6,117
Advertising 2,031 765 3,297 1,227
-------- -------- -------- --------
Total net revenues 28,046 15,056 51,571 27,558
-------- -------- -------- --------
Cost of revenues:
Software license fees 3,010 1,800 5,821 3,386
Service revenues 1,477 755 2,397 1,276
Advertising 598 406 1,148 738
-------- -------- -------- --------
Total cost of revenues 5,085 2,961 9,366 5,400
-------- -------- -------- --------
Gross profit 22,961 12,095 42,205 22,158
-------- -------- -------- --------
Operating expenses:
Research and development 8,011 4,789 15,300 9,208
Sales and marketing 12,861 8,135 23,076 14,965
General and administrative 3,118 2,393 6,031 4,493
Goodwill amortization 532 532 1,064 532
Acquisition charges -- -- -- 8,723
-------- -------- -------- --------
Total operating expenses 24,522 15,849 45,471 37,921
-------- -------- -------- --------
Operating loss (1,561) (3,754) (3,266) (15,763)
Other income, net 1,291 1,192 2,260 2,269
-------- -------- -------- --------
Net loss $ (270) (2,562) (1,006) (13,494)
======== ======== ======== ========
Basic and diluted net loss per share $ (0.00) (0.04) (0.01) (0.21)
======== ======== ======== ========
Shares used to compute basic and diluted net loss per share 68,528 64,238 67,992 63,102
Comprehensive loss:
Net loss $ (270) (2,562) (1,006) (13,494)
Translation adjustment (57) (39) (172) (53)
-------- -------- -------- --------
Comprehensive loss $ (327) (2,601) (1,178) (13,547)
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE> 5
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
---------------------------
1999 1998
--------- ---------
<S> <C> <C>
Net cash provided by operating activities $ 11,062 7,000
Cash flows from investing activities:
Purchases of equipment and leasehold improvements (15,504) (1,713)
Purchases of short-term investments (36,165) (43,967)
Proceeds from sales and maturities of short-term
investments 25,303 16,106
Cash obtained through acquisition -- 203
--------- ---------
Net cash used in investing activities (26,366) (29,371)
--------- ---------
Cash flows from financing activities:
Net proceeds from sale of common stock and exercise of stock options 231,894 526
--------- ---------
Net cash provided by financing activities 231,894 526
--------- ---------
Effect of exchange rate changes on cash (160) (11)
--------- ---------
Net increase (decrease) in cash and cash equivalents 216,430 (21,856)
Cash and cash equivalents at beginning of period 51,876 62,255
--------- ---------
Cash and cash equivalents at end of period $ 268,306 40,399
Short-term investments at end of period 48,763 57,634
--------- ---------
Total cash, cash equivalents and short-term investments at end of period $ 317,069 98,033
========= =========
Supplemental disclosure of noncash financing and investing activities:
Common stock issued in business combination $ -- 16,526
</TABLE>
See accompanying notes to condensed consolidated financial statements
5
<PAGE> 6
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
RealNetworks, Inc. and subsidiaries (Company) is a leading provider of
media delivery and distribution solutions designed for the Internet. The
Company's solutions enable consumers to experience and content providers to
deliver a broad range of multimedia content, including audio, video, text and
animation. The Company pioneered the development and commercialization of
"streaming media" systems that enable the creation, real-time delivery and
playback of multimedia content. The Company recently extended its media delivery
platform to include a digital music management system that allows consumers to
acquire, record, store, organize and play their personal music collections on
personal computers and digital playback devices.
(b) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
These statements reflect all adjustments, consisting only of normal,
recurring adjustments that, in the opinion of the Company's management, are
necessary for a fair presentation of the results of operations for the periods
presented. Operating results for the quarter and six months ended June 30, 1999
are not necessarily indicative of the results that may be expected for any
subsequent quarter or for the year ending December 31, 1999. Certain information
and footnote disclosures normally included in financial statements prepared in
conformity with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
These condensed consolidated financial statements should be read in
conjunction with the financial statements and related notes included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1998.
On April 27, 1999, the board of directors approved a 2-for-1 split of
the Company's Common Stock in the form of a stock dividend. The stock split was
effected on May 10, 1999. Accordingly, the accompanying condensed consolidated
financial statements and notes thereto have been retroactively restated to
reflect the stock split.
(c) Cash, Cash Equivalents and Short-Term Investments
Cash, cash equivalents and short-term investments are comprised of the
following:
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
------------- -----------------
(in thousands)
<S> <C> <C>
Cash and cash equivalents $ 268,306 51,876
Short-term investments 48,763 37,901
--------- ---------
Total cash, cash equivalents and short-term investments $ 317,069 89,777
========= =========
Restricted cash equivalents $ 13,700 13,700
========= =========
</TABLE>
6
<PAGE> 7
Restricted cash equivalents represent a restricted escrow account
established in connection with a lease agreement for new corporate headquarters.
Under certain circumstances, $10,000,000 of the escrow account will be
maintained for the term of the lease. The remaining $3,700,000 will be released
as the Company funds tenant improvements. The Company took occupancy of the new
facilities during the quarter ended June 30, 1999.
(d) Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position
97-2, "Software Revenue Recognition" (SOP 97-2), which provides specific
industry guidance and stipulates that revenue recognized from software
arrangements is to be allocated to each element of the arrangement based on the
relative fair values of the elements, such as software products, upgrades,
enhancements, post contract customer support, installation, or training. Under
SOP 97-2, the determination of fair value is based on objective evidence that is
specific to the vendor. If such evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered.
Revenue from software license fees is recognized upon delivery, net of
an allowance for estimated returns, provided all the requirements of SOP 97-2
have been met.
Revenue from software license agreements with original equipment
manufacturers (OEM) is recognized when the OEM delivers its product
incorporating the Company's software to the end user. In the case of prepayments
received from an OEM, the Company generally recognizes revenue based on the
actual products sold by the OEM. If the Company anticipates providing ongoing
support to the OEM in the form of future upgrades, enhancements or other
services over the term of the contract, revenue is recognized on the
straight-line method over the term of the contract.
Service revenues include payments under support and upgrade contracts,
and fees from consulting and streaming media content hosting. Support and
upgrade revenues are recognized ratably over the term of the contract, which
typically is twelve months. Other service revenues are recognized when the
service is performed.
Revenues from advertising appearing on the Company's Web sites are
recognized ratably over the terms of the advertising contracts. The Company
guarantees to certain advertising customers a minimum number of page impressions
to be delivered to users of its Web sites for a specified period. To the extent
minimum guaranteed page impression deliveries are not met, the Company defers
recognition of the corresponding revenues until guaranteed page impression
delivery levels are achieved.
(e) Comprehensive Loss
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS 130), establishes standards for the reporting and
disclosure of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of financial statements. The Company's comprehensive
loss for the quarters and six months ended June 30, 1999 and 1998 consisted of
net loss and the gross amount of foreign currency translation adjustments. The
tax effect of the foreign currency translation adjustments was insignificant.
(f) Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed by dividing net loss by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. As the Company had a net loss attributable to common shareholders in
each of the periods presented, basic and diluted net loss per share are the
same.
7
<PAGE> 8
Excluded from the computation of diluted net loss per share for the
quarters and six months ended June 30, 1999 and 1998 are options to acquire
18,354,000 and 15,208,000 shares of common stock, respectively, with
weighted-average exercise prices of $23.04 and $3.41, respectively, because
their effects would be anti-dilutive.
(g) Recent Accounting Pronouncements
In December 1998, the American Institute of Certified Public Accounts
(AICPA) issued Statement of Position 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions" (SOP 98-9), which
amends certain elements of SOP 97-2, "Software Revenue Recognition" and is
effective for fiscal years beginning after March 15, 1999. RealNetworks believes
that the adoption of SOP 98-9 will not have a material effect on its results of
operations or financial position.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model
for accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning after
June 15, 2000. SFAS 133 requires that all derivatives be recognized in the
balance sheet at their fair market value, and the corresponding derivative gains
or losses be either reported in the statement of operations or as a component of
other comprehensive income depending on the type of hedge relationship that
exists with respect to such derivative. RealNetworks does not expect the
adoption of SFAS 133 to have a material impact on its consolidated financial
statements.
NOTE 2 - SEGMENT INFORMATION
The Company operates in one business segment, media delivery, for which
the Company receives revenues from its customers. The Company's Chief Operating
Decision Maker is considered to be the Company's Operating Committee (COC) which
is comprised of the Company's Chief Executive Officer and the Company's Senior
Vice Presidents. The COC reviews financial information presented on a
consolidated basis accompanied by disaggregated information about products and
services and geographical region for purposes of making decisions and assessing
financial performance. The COC does not review discrete financial information
regarding profitability of the Company's different products or services and,
therefore, the Company does not have operating segments as defined by SFAS 131.
The Company's customers consist primarily of end users located in the
United States and various foreign countries. Revenues by geographic region are
as follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
North America $ 19,324 9,828 35,314 17,840
Europe 3,562 1,615 6,348 2,634
Asia 2,079 1,013 4,054 1,926
Rest of world 464 183 821 324
-------- -------- -------- --------
Subtotal 25,429 12,639 46,537 22,724
Microsoft license revenue 2,617 2,417 5,034 4,834
-------- -------- -------- --------
Total $ 28,046 15,056 51,571 27,558
======== ======== ======== ========
</TABLE>
8
<PAGE> 9
Revenue from external customers by product type is as follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended June 30, Six Months Ended June 30,
---------------------- -------------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Streaming media license revenue $17,639 8,379 32,232 15,380
Streaming media service revenue 5,759 3,495 11,008 6,117
Microsoft license revenue 2,617 2,417 5,034 4,834
Advertising revenue 2,031 765 3,297 1,227
------- ------- ------- -------
Total net revenues $28,046 15,056 51,571 27,558
======= ======= ======= =======
</TABLE>
Long-lived assets by geographic location are as follows (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------- -------
<S> <C> <C>
United States $27,204 14,538
Japan 395 454
Europe 344 329
------- -------
Total $27,943 15,321
======= =======
</TABLE>
NOTE 3 - SUBSEQUENT EVENT
On August 10, 1999, the Company completed the acquisition of privately
held Xing Technology Corp. (Xing), a developer and provider of MP3 software. The
Company issued 732,000 shares of its common stock valued at approximately $48
million in exchange for all outstanding shares of Xing stock. The acquisition is
being accounted for as a pooling of interests.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in this report contains forward-looking statements that
involve risks and uncertainties. RealNetworks' actual results could differ
materially from those discussed below. Factors that could cause or contribute to
such differences include, but are not limited to, those identified below, and
those discussed in the section titled "Factors that May Affect Our Business,
Future Operating Results and Financial Condition", included elsewhere in this
Report. You should also carefully review the risk factors set forth in other
reports or documents RealNetworks files from time to time with the Securities
and Exchange Commission, particularly Quarterly Reports on Form 10-Q and any
Current Reports on Form 8-K.
OVERVIEW
We are a leading provider of media delivery and distribution solutions
designed for the Internet. Our solutions enable consumers to experience and
content providers to deliver a broad range of multimedia content, including
audio, video, text and animation. We pioneered the development and
commercialization of "streaming media" systems that enable the creation,
real-time delivery and playback of multimedia content. We believe that we have
established a leadership position in the market for these systems. We have more
than 70 million registered users of our RealPlayer product and believe that 85%
of all Web pages using streaming media use our technology. The broad acceptance
of the Internet as a means of content delivery, combined with recent
technological advances, has greatly increased the practicality and popularity of
a number of new online media delivery formats. In response, we have extended our
media delivery platform to include a digital music management system that allows
consumers to acquire, record, store, organize and play their personal music
collections on PCs and digital playback devices.
We were incorporated in February 1994 and were in the development stage
until July 1995, when we released the commercial version of RealAudio Version
1.0, the first version of our RealPlayer products. From inception through
December 31, 1995, our operating activities related primarily to recruiting
personnel, raising capital, purchasing operating assets, conducting research and
development, building the RealAudio brand and establishing the market for
streaming audio. During 1996, we continued to invest heavily in research and
development and marketing and in building our domestic and international sales
channels and our general and administrative infrastructure. In August 1996, we
began selling RealPlayer Plus, a premium version of our RealPlayer product.
RealPlayer continues to be available for download free of charge from our
websites. In June 1997, we released the commercial version of RealVideo Version
4.0. In December 1997, we released the commercial version of RealSystem Version
5.0, a streaming media solution that includes RealAudio and RealVideo
technology. In November 1998, we released the commercial version of RealSystem
G2, our latest generation medial delivery system. In May 1999, we released
RealSystem MP, as well as a beta version of RealJukebox.
Our revenues are reported in the following three categories:
o Software license fees, which include revenues from sales of our
RealPlayer Plus, RealServers and related authoring and publishing tools,
OEM sales of our products and sales of third-party products.
o Service revenues, which include support and maintenance services that we
sell to customers who purchase our RealPlayer Plus, RealServers and
tools products, broadcast hosting services we provide through our Real
Broadcast Network, and consulting services we offer to our customers.
o Advertising revenues are derived from the sale of advertising on our
websites and the placement of channels and presets included in the
RealPlayer.
10
<PAGE> 11
In March 1998, we acquired Vivo Software, a leading developer of streaming
media creation tools, in an acquisition accounted for using the purchase method
of accounting. In August 1999, we acquired Xing Technology Corporation, a
leading developer and provider of MP3 software, in an acquisition accounted for
as a pooling of interests.
RESULTS OF OPERATIONS
REVENUES
Software License Fees. Software license fees were $20.3 million for the
quarter ended June 30, 1999, an increase of 88% from $10.8 million in the
comparable quarter of the prior year. Software license fees were $37.3 million
for the six months ended June 30, 1999, an increase of 84% from $20.2 million in
the comparable period of the prior year. The increases were due primarily to a
greater volume of products sold, which resulted from (1) growth in the demand
for streaming media on the Internet, (2) sales of RealSystem G2 which was
introduced in November 1998, (3) successful product promotions and (4) increased
sales of third-party products. Software license fees for the quarter ended June
30, 1999 and 1998, included $2.6 million and $2.4 million, respectively, related
to the Microsoft license agreement we entered into in June 1997. Software
license fees for the six months ended June 30, 1999 and 1998, included $5.0
million and $4.8 million, respectively, related to the Microsoft license
agreement.
Service Revenues. Service revenues were $5.8 million for the quarter
ended June 30, 1999, an increase of 65% from $3.5 million in the comparable
quarter of the prior year. Service revenues were $11.0 million for the six
months ended June 30, 1999, an increase of 80% from $6.1 million in the
comparable period of the prior year. The increases were primarily due to a
larger installed base of our products from which we derive support and
maintenance revenues and increases in our consulting and streaming media hosting
services.
Advertising Revenues. Advertising revenues were $2.0 million for the
quarter ended June 30, 1999, an increase of 165% from $0.8 million in the
comparable quarter of the prior year. Advertising revenues were $3.3 million for
the six months ended June 30, 1999, and increase of 169% from $1.2 million in
the comparable period of the prior year. The increase in advertising revenues
was due to increased traffic on our websites, the increased effectiveness of our
advertising sales force that resulted in increased advertising sales and higher
average advertising rates. In addition, in the second quarter of 1999, we began
recognizing revenues from sales of channels, presets and search functionality
included in the RealPlayer.
Geographic Revenues. Excluding revenues from the Microsoft license
agreement, international revenues represented 24% of total net revenues for the
quarter ended June 30, 1999 and 22% of total net revenues for the quarter ended
June 30, 1998. Excluding revenues from the Microsoft license agreement,
international revenues represented 24% of total net revenues for the six months
ended June 30, 1999 and 21% of total net revenues for the six months ended June
30, 1998. Revenues generated in Europe were 14% and 13% of total net revenues
(excluding revenues from the Microsoft license agreement) for the quarters ended
June 30, 1999 and 1998, respectively, and revenues generated in Japan/Asia
Pacific were 8% of total net revenues (excluding revenues from the Microsoft
license agreement) for each of the quarters ended June 30, 1999 and 1998.
Revenues generated in Europe were 14% and 12% of total net revenues (excluding
revenues from the Microsoft license agreement) for the six months ended June 30,
1999 and 1998, respectively, and revenues generated in Japan/Asia Pacific were
9% and 8% of total net revenues (excluding revenues from the Microsoft license
agreement) for the six months ended June 30, 1999 and 1998, respectively.
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees includes
costs of product media, duplication, manuals, packaging materials, amounts paid
for licensed technology, and fees paid to third-party vendors for order
fulfillment. Cost of software license fees was $3.0 million for the quarter
ended June 30, 1999, an increase of 67%
11
<PAGE> 12
from $1.8 million in the comparable quarter of the prior year, and decreased as
a percentage of software license fees to 15% from 17%. Cost of software license
fees was $5.8 million for the six months ended June 30, 1999, an increase of 72%
from $3.4 million in the comparable period of the prior year, and decreased as a
percentage of software license fees to 16% from 17%. The increases in absolute
dollars were due primarily to higher sales volumes. The decreases as a
percentage of software license fees were due primarily to changes in the mix of
products sold.
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing support and other services and
expenses incurred in expanding our streaming media hosting services. Cost of
service revenues was $1.5 million for the quarter ended June 30, 1999, an
increase of 96% from $0.8 million in the comparable quarter of the prior year,
and increased as a percentage of service revenues to 26% from 22%. Cost of
service revenues was $2.4 million for the six months ended June 30, 1999, an
increase of 88% from $1.3 million in the comparable period of the prior year,
and increased as a percentage of service revenues to 22% from 21%. The increases
in cost of service revenues were primarily due to increased staff and contract
personnel needed to provide services to a greater number of customers and
expansion of customer service and technical support into international regions.
Cost of Advertising Revenues. Cost of advertising includes the cost of
personnel associated with content creation and maintenance and fees paid to
third parties for content included in our websites. Cost of advertising was $0.6
million for the quarter ended June 30, 1999, an increase of 47% from $0.4
million in the comparable quarter of the prior year, but decreased as a
percentage of advertising revenues to 29% from 53%. Cost of advertising was $1.1
million for the six months ended June 30, 1999, an increase of 56% from $0.7
million in the comparable period of the prior year, but decreased as a
percentage of advertising revenues to 35% from 60%. The increases in absolute
dollars were primarily due to increases in the quality and quantity of content
available on our websites and the addition of new websites. The decreases as a
percentage of advertising revenues were due to greater economies of scale.
Our gross margins may be adversely affected by the mix of distribution
channels used and the mix of products sold.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of salaries and consulting fees associated with product development
and costs of technology acquired from third parties to incorporate into products
currently under development. To date, all research and development costs have
been expensed as incurred because technological feasibility is generally not
established until substantially all development is complete. We believe that
significant investment in research and development is a critical factor in
attaining our strategic objectives and, as a result, we expect to increase
research and development expenditures in future periods. Research and
development expenses were $8.0 million for the quarter ended June 30, 1999, an
increase of 67% from $4.8 million in the comparable quarter of the prior year,
but decreased as a percentage of total net revenues to 29% from 32%. Research
and development expenses were $15.3 million for the six months ended June 30,
1999, and increase of 66% from $9.2 million in the comparable period of the
prior year, but decreased as a percentage of total net revenues to 30% from 33%.
The increases in absolute dollars were primarily due to increases in internal
development personnel, consulting expenses and contract labor. Research and
development expenses were primarily related to the development of new technology
and products, including RealSystem MP and RealJukebox, and enhancements made to
existing products. The decreases in percentage terms were a result of revenues
growing at a faster rate than expenses.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, sales commissions, consulting fees, trade show expenses, advertising
costs and cost of marketing collateral. We intend to increase our branding and
marketing efforts and, therefore, expect sales and marketing expenses to
increase significantly in future periods. Sales and marketing expenses were
$12.9 million for the quarter ended June 30, 1999, an increase of 58% from $8.1
million in the comparable quarter of the prior year, but decreased as a
percentage of total net revenues to 46% from 54%. Sales and marketing expenses
were $23.1 million for the six months ended June 30, 1999, an increase of 54%
from $15.0 million in the comparable period of the prior year, but decreased as
a percentage of total net revenues to 45% from 54%. The increases in absolute
dollars were due to the expansion of our direct sales and
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marketing organization, the creation of additional foreign and domestic sales
offices, promotions and other expenses related to the continued development of
the "Real" brand. For the quarters ended June 30, 1999 and 1998, sales and
marketing expenses included the net costs of the annual RealNetworks Conference.
The decreases in percentage terms were a result of revenues growing at a faster
rate than expenses.
General and Administrative. General and administrative expenses consist
primarily of salaries, fees for professional services and bad debt expense. We
expect general and administrative expenses to increase as we expand our staff
and incur additional costs related to growth of our business. General and
administrative expenses were $3.1 million for the quarter ended June 30, 1999,
an increase of 30% from $2.4 million in the comparable quarter of the prior
year, but decreased as a percentage of total net revenues to 11% from 16%.
General and administrative expenses were $6.0 million for the six months ended
June 30, 1999, an increase of 34% from $4.5 million in the comparable period of
the prior year, but decreased as a percentage of total net revenues to 12% from
16%. The increases in absolute dollars were primarily a result of increased
personnel and facility expenses necessary to support our growth. The decreases
in percentage terms were due to revenues growing at a faster rate than expenses.
Goodwill Amortization and Acquisition Charges
In March 1998, we acquired Vivo Software, Inc., a developer of streaming
media creation tools. We issued approximately 2.2 million shares of our common
stock in exchange for all outstanding shares of Vivo common stock and assumed
options to purchase approximately 95,000 shares of our common stock. The
acquisition was accounted for using the purchase method of accounting and,
accordingly, the results of Vivo's operations are included in our financial
statements since the date of acquisition.
The purchase price was allocated to the fair value of the acquired
assets and assumed liabilities based on their fair values at the date of the
acquisition. A portion of the purchase price represents acquired in-process
research and development that has not yet reached technological feasibility and
has no alternative future use. Of the total purchase price, $8.6 million was
allocated to in-process research and development expense, $10.6 million was
allocated to goodwill, and $0.5 million was allocated to tangible assets.
Goodwill is amortized over its estimated life of five years.
The in-process research and development projects acquired in the
acquisition of Vivo consisted of the development of encoder tools and server and
client codecs. The encoder tools allow users to create media content to be
streamed over the Internet or intranets. The server and client codecs enhance
the compression and decompression of multimedia content streamed over the
Internet or intranets.
We completed the development of the encoder tools in 1998. The total
cost to complete development of the encoder tools was approximately $1.0
million. The server and client codec projects were completed in 1999. The
aggregate cost to complete the server and client codecs was approximately $0.7
million.
Since the acquisition, we have continued to market Vivo's existing
products on a limited basis.
OTHER INCOME, NET
Other income, net consists primarily of earnings on our cash, cash
equivalents and short-term investments. Other income, net was $1.3 million and
$2.3 million for the quarter and six months ended June 30, 1999, respectively,
and $1.2 million and $2.3 million for the quarter and six months ended June 30,
1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $11.1 million and $7.0
million for the six months ended June 30, 1999 and 1998, respectively. Net cash
provided by operating activities for the six months ended June 30, 1999 resulted
primarily from an increase in accrued liabilities of $5.2 million, an increase
in deferred revenue of $6.5
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million and from non-cash charges associated with depreciation and amortization,
partially offset by the net loss of $1.0 million. Net cash provided by operating
activities for the six months ended June 30, 1998 resulted primarily from a
decrease in other receivables and non-cash charges associated with depreciation
and acquisition related charges, partially offset by the reported net loss.
Net cash used in investing activities was $26.4 million and $29.4
million for the six months ended June 30, 1999 and 1998, respectively, and was
primarily a result of net purchases of short-term investments and purchases of
equipment and leasehold improvements.
Net cash provided by financing activities was $231.9 million and $0.5
million for the six months ended June 30, 1999 and 1998, respectively, and was a
result of net proceeds from the sale of common stock and the exercise of stock
options and warrants. In the second quarter of 1999, we sold 4,125,000 shares of
our common stock in a secondary public offering. Net proceeds of the offering
were $228.8 million.
At June 30, 1999, we had $317.1 million in cash, cash equivalents and
short-term investments. As of June 30, 1999, our principal commitments consisted
of obligations under operating leases. Since our inception, we have experienced
a substantial increase in our capital expenditures to support expansion of our
operations and information systems.
In January 1998, we entered into a lease agreement for a new location
for our corporate headquarters. The lease commenced on April 1, 1999 and expires
on April 1, 2011, with an option to renew the lease for either a three-or
ten-year period. We took occupancy of the new facilities in the second quarter
1999. We will continue to fund tenant improvements as additional space is
occupied. In addition, we are in the process of upgrading and replacing our
existing internal information systems. We anticipate that the costs of the
tenant improvements and information systems will total approximately $14.0
million in 1999. We have incurred approximately $11 million of such costs
through June 30, 1999.
We do not hold derivative financial instruments or equity securities in
our investment portfolio. Our cash equivalents and short-term investments
consist of high-quality securities, as specified in our investment policy
guidelines. The policy limits the amount of credit exposure to any one issue or
issuer to a maximum of 5% of the total portfolio and requires that all
short-term investments mature in two years or less, with the average maturity
being one year or less. These securities are subject to interest rate risk and
will decrease in value if interest rates increase. If market interest rates were
to increase immediately and uniformly by 10% from levels at June 30, 1999, the
fair value of the portfolio would decline by an immaterial amount. Because we
have historically held our fixed-income investments until maturity, we would not
expect our operating results or cash flows to be significantly affected by a
sudden change in market interest rates on our securities portfolio.
We conduct our operations in five primary functional currencies: the
United States dollar, the Japanese yen, the British pound, the French franc and
the German mark. Historically, neither fluctuations in foreign exchange rates
nor changes in foreign economic conditions have had a significant impact on our
financial condition or results of operations. We currently do not hedge our
foreign currency exposures and are therefore subject to the risk of exchange
rates. We invoice the customers of our international subsidiaries primarily in
U.S. dollars, except in Japan, where we invoice our customers primarily in yen.
We are exposed to foreign exchange rate fluctuations as the financial results of
foreign subsidiaries are translated into U.S. dollars in consolidation. Our
exposure to foreign exchange rate fluctuations also arises from intercompany
payables and receivables to and from our foreign subsidiaries. Foreign exchange
rate fluctuations did not have a material impact in 1999 and 1998.
On January 1, 1999, the participating member countries of the European
Union converted to a common currency, the euro. On that same date they
established fixed conversion rates between their existing sovereign currencies
and the euro. Even though legacy currencies are scheduled to remain legal tender
in the participating countries as denominations of the euro until January 1,
2002, the participating countries will no longer be able to direct independent
interest rates for the legacy currencies. The authority to set monetary policy
will now reside with the new European Central Bank. We do not anticipate any
material impact from the euro conversion on our financial information systems,
which currently accommodate multiple currencies. Due to numerous uncertainties,
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we cannot reasonably estimate the effect that the euro conversion issue will
have on our pricing or market strategies or the impact, if any, it will have on
our financial condition and results of operations.
Since our inception, we have significantly increased our operating
expenses. We currently anticipate that we will continue to experience
significant growth in our operating expenses and that such expenses will be a
material use of our cash resources. We believe that our current cash, cash
equivalents and short-term investments will be sufficient to meet our
anticipated cash needs for working capital and capital expenditures for at least
the next 12 months. In the future, we may seek to raise additional funds through
public or private equity financing, or through other sources such as credit
facilities. The sale of additional equity securities could result in dilution to
our shareholders.
Microsoft Relationship
In June 1997, we entered into a strategic agreement with Microsoft
pursuant to which we granted Microsoft a nonexclusive license to certain
substantial elements of the source code of our RealAudio/RealVideo Version 4.0
technology and related RealNetworks trademarks for a license fee of $30.0
million. We are recognizing revenue related to the agreement ratably over the
three-year term of our ongoing obligations.
Microsoft may sublicense its rights to the licensed source code to third
parties under certain conditions without further compensation to RealNetworks.
In addition, Microsoft was granted an option to receive two additional
deliveries of updated versions of the source code. Microsoft's right to receive
the first delivery expired unexercised in July 1998. Microsoft's right to
receive the second delivery expired unexercised in July 1999. Under certain
conditions, if we license our source code to a third party, the agreement
provides for a partial refund of the license fee paid by Microsoft, based on a
declining scale over the three-year term of the agreement.
On July 23, 1998, Robert Glaser, our chief executive officer, testified
before the Senate Judiciary Committee that if a consumer had the RealPlayer on
his or her computer system, and then downloaded the Windows Media Player, the
Windows Media Player disabled important functions of our RealPlayer in certain
instances. As a result, some of our customers who had downloaded the free
RealPlayer, or paid for the RealPlayer Plus, found that their players did not
work. We quickly incorporated a workaround solution into our RealPlayer and
RealPlayer Plus and also posted this workaround solution on our website. We
believe the workaround solution corrected the problem at the time and, as a
result, we believe only a small number of customers were impacted by the
situation. However, we believe there is a continued risk that future versions of
Microsoft's products, especially Internet Explorer and the Windows Media Player,
may negatively impact the experience of our customers by displaying a Windows
Media Player when the customer seeks to play RealAudio or RealVideo content, or
by posting an error message when the customer tries to play content available in
RealNetworks' formats that may not be viewed through the Windows Media Player,
without telling the customer how to obtain the latest RealPlayer. Such actions
by Microsoft could materially reduce market share for the RealPlayer and have a
negative effect on demand for our server software and tools. We have provided
and will continue to seek to provide useful input to Microsoft to address these
situations so as to provide an optimal experience for consumers. In light of
these recent events, our relationship with Microsoft has become more
competitive. See "--Factors That May Affect Our Business, Future Operating
Results and Financial Condition--We may be unable to successfully compete with
Microsoft and other companies in the media delivery market."
Year 2000 Compliance
The "Year 2000" problem exists because many existing computer programs
use only the last two digits to refer to a year. As a result, date-sensitive
computer programs may not be able to distinguish whether a two-digit date
designated as "00" refers to 1900 or 2000. This problem could cause system
failures or the creation of wrong information and disrupt our operations.
We have developed a phased plan to achieve Year 2000 compliance for our
internal processing and operational systems and the current versions of our
software products. During the first quarter of 1999, we assessed the state of
our internal and external Year 2000 compliance. Currently, a plan to correct
problems found
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during the assessment is being developed and tested. During the third quarter of
1999, we will implement this remediation plan, consisting of upgrading and
replacing certain product versions, if necessary, and testing them for
compliance.
We have publicly made Year 2000 readiness disclosures stating that the
current versions of our products are "Year 2000 compliant." "Year 2000
compliant" means that software products and systems are able to function
properly before, during and after the year 2000 without loss of functionality
due to date changes. This assurance assumes that:
o our products are configured and used in accordance with the related
documentation;
o the underlying operating system of the host machine for our products and
any other software used with or in such host machine are also Year 2000
compliant; and
o all other products, whether hardware, software, or firmware, used with
one of our products properly exchange data with it.
We are currently testing and will continue to test our products and
systems and may find errors or defects associated with Year 2000 date functions.
We have not tested our products on all platforms or all versions of operating
systems that we currently support. We believe that all of the current versions
of our products will be Year 2000 compliant by the end of 1999. We have not
specifically tested software obtained from third parties, such as licensed
software, shareware and freeware, that is incorporated into our products, but we
are seeking assurances from our vendors that licensed software is Year 2000
compliant. Despite our testing, testing by our current and potential customers,
and whatever assurances, if any, we may receive from developers of technology
incorporated into our products, our products and those of our vendors may
contain undetected errors or defects associated with Year 2000 date functions.
We rely on third parties for services and supplies such as
telecommunications, Internet service and utilities. We are seeking confirmation
from such service providers that their systems are Year 2000 compliant.
Interruption of those services or supplies due to Year 2000 issues could
adversely affect our operations. We are also subject to external forces that
might generally affect industry and commerce, such as utility or transportation
company Year 2000 compliance failures and related service interruptions. We are
in the process of updating and upgrading our internal information systems.
Although the replacement of information systems is not in direct response to
Year 2000 concerns, we expect that all new internal information systems
implemented in 1999 will be Year 2000 compliant.
Known or unknown Year 2000 errors or defects in our internal systems and
products, lack of Year 2000 compliance by third-party software incorporated in
our products and/or interruption of services from our external service providers
due to Year 2000 problems could result in failure or disruption of our products
and operations, delay or loss of revenue, diversion of development resources,
damage to our reputation, claims or litigation and increased service and
warranty costs, any of which could impair our finances or business prospects.
Some commentators have predicted significant litigation regarding Year 2000
compliance issues, and we are aware of such lawsuits against other software
vendors. Because of the unprecedented nature of such litigation, we are
uncertain whether or to what extent we may be affected by it.
We currently respond to customer concerns about our products on a
case-by-case basis. In addition, we have posted a web page on our primary
website indicating the Year 2000 status of our products. We believe that the
purchasing patterns of customers and potential customers may be affected by Year
2000 issues in a variety of ways, including the decision to delay purchasing our
products until the Year 2000. We believe that it is not possible to predict the
overall impact of these decisions.
At this stage in our analysis and remediation process, it is difficult
to specifically identify the cause and the magnitude of any adverse economic
impact of the most reasonably likely worst case Year 2000 scenario. Our
reasonably likely worst case scenario would include the unavailability of our
major internal systems to our employees and the failure of our products to
operate properly, causing customers' systems and/or operations to
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fail or be disrupted. This worst case scenario also would include the failure of
key vendors and/or suppliers to correct their own Year 2000 issues, which could
cause failure or disruption of our operations or products. If a worst case
scenario occurs, we may incur expenses to repair our systems or upgrade our
products, face interruptions in the work of our employees, lose advertising,
service and product license revenue, be unable to support the broadcast of other
companies' content over the Internet, be unable to deliver downloads of our
products, incur increased warranty and service expenses and suffer damage to our
reputation. In addition, customers may sue us or otherwise seek compensation for
their losses. We have agreed to indemnify certain customers for claims and
losses if our products are not Year 2000 compliant. Any or all of the above
events could harm our business.
We have not yet fully developed a comprehensive contingency plan to
address situations that may result if we are unable to achieve Year 2000
readiness of our critical operations. The cost of developing and implementing
such a plan may itself be material. To date, we have not incurred significant
expenditures for our Year 2000 remediation efforts. Although we do not
anticipate the costs to address our Year 2000 issues to be material, the costs
of Year 2000 remediation work and the date on which we plan to complete such
work are based on management's best estimates. These estimates are derived from
assumptions about future events, including the availability of certain
resources, third- party remediation plans and other factors. In addition,
undetected errors or the failure of such systems to be Year 2000 compliant could
create significant record-keeping and operational deficiencies. Accordingly, if
Year 2000 modifications, evaluations, assessments and conversions are not made
or are not completed in time, the Year 2000 problem could harm our business.
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FACTORS THAT MAY AFFECT OUR BUSINESS, FUTURE OPERATING RESULTS AND
FINANCIAL CONDITION
You should carefully consider the risks described below together with
all of the other information included in this quarterly report on Form 10-Q
before making an investment decision. The risks and uncertainties described
below are not the only ones facing our company. If any of the following risks
actually occurs, our business, financial condition or operating results could be
harmed. In such case, the trading price of our common stock could decline, and
you could lose all or part of your investment.
WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO EVALUATE OUR
BUSINESS
We were incorporated in February 1994 and have a limited operating
history. We have limited financial results on which you can assess our future
success. Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by growing companies in new and rapidly
evolving markets, such as streaming media software, media delivery systems and
electronic commerce.
To address the risks and uncertainties we face, we must:
- establish and maintain broad market acceptance of our products
and services and convert that acceptance into direct and
indirect sources of revenues;
- maintain and enhance our brand name;
- continue to timely and successfully develop new products,
product features and services and increase the functionality and
features of existing products;
- successfully respond to competition from Microsoft and others;
and
- develop and maintain strategic relationships to enhance the
distribution, features and utility of our products and services.
Our business strategy may be unsuccessful and we may be unable to
address the risks we face in a cost-effective manner, if at all. Our inability
to successfully address these risks will harm our business.
WE HAVE A HISTORY OF LOSSES AND MAY NEVER ATTAIN PROFITABILITY
We have incurred significant losses since our inception and we may never
become profitable. As of June 30, 1999, we had an accumulated deficit of
approximately $34.9 million. We devote significant resources to developing,
enhancing, selling and marketing our products and services. As a result, we will
need to generate significant revenues to achieve and maintain profitability. We
may not continue our historical growth or generate sufficient revenues for
profitability. If we do achieve profitability, we may not sustain or increase
profitability on a quarterly or annual basis in the future.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
As a result of our limited operating history and the rapidly changing
nature of the markets in which we compete, our quarterly and annual revenues and
operating results are likely to fluctuate from period to period. These
fluctuations may be caused by a number of factors, many of which are beyond our
control. These factors include the following, as well as others discussed
elsewhere in this section:
- how and when we introduce new products and services and enhance
our existing products and services;
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- the timing and success of our brand-building and marketing
campaigns;
- our ability to establish and maintain strategic relationships;
- the demand for Internet advertising and sponsorships;
- the emergence and success of new and existing competition;
- varying operating costs and capital expenditures related to the
expansion of our business operations and infrastructure,
domestically and internationally, including the hiring of new
employees;
- technical difficulties with our products, system downtime,
system failures or interruptions in Internet access;
- costs related to the acquisition of businesses or technology;
and
- costs of litigation and intellectual property protection.
In addition, because the market for our products and services is
relatively new and rapidly changing, it is difficult to predict future financial
results. Our research and development and sales and marketing efforts, and
business expenditures generally, are partially based on predictions regarding
certain developments for media delivery. To the extent that these predictions
prove inaccurate, our revenues and operating expenses may fluctuate.
For these reasons, you should not rely on period-to-period comparisons
of our financial results as indications of future results. Our future operating
results could fall below the expectations of public market analysts or investors
and significantly reduce the market price of our common stock. Fluctuations in
our operating results will likely increase the volatility of our stock price.
WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT AND OTHER COMPANIES IN
THE MEDIA DELIVERY MARKET
The market for software and services for media delivery over the
Internet is relatively new, constantly changing and intensely competitive. As
media delivery evolves into a central component of the Internet experience, more
companies are entering the market for, and expending increasing resources to
develop, media delivery software and services. We expect that competition will
continue to intensify.
Many of our current and potential competitors have longer operating
histories, greater name recognition, more employees and significantly greater
financial, technical, marketing, public relations and distribution resources
than we do. The competitive environment may require us to make changes in our
products, pricing, licensing, services or marketing to maintain and extend our
current brand and technology franchise. Price concessions or the emergence of
other pricing or distribution strategies of competitors may diminish our
revenues, impact our margins or lead to a reduction in our market share, any of
which will harm our business.
We believe that the primary competitive factors in the media delivery
market include:
- the quality and reliability of the overall media delivery
solution;
- access to distribution channels necessary to achieve broad
distribution and use of products;
- the availability of content for delivery over the Internet and
access to necessary intellectual property rights;
- the ability to develop and support secure formats for digital
media delivery, particularly music and video;
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- the size of the active audience for streaming media and its
appeal to content providers and advertisers;
- features for creating, editing and adapting content for the
Internet;
- ease of use and interactive user features in products;
- ease of finding and accessing content over the Internet;
- scalability of streaming media and media delivery technology and
cost per user;
- pricing and licensing terms;
- compatibility with new and existing media formats;
- compatibility with the user's existing network components and
software systems; and
- challenges caused by bandwidth constraints and other limitations
of the Internet infrastructure.
Our failure to adequately address any of the above factors could harm our
business strategy and operating results.
Microsoft is a principal competitor in the development and distribution
of streaming media and media distribution technology. Microsoft currently
competes with us in the market for streaming media server and player software
and has announced its intent to compete in the market for digital distribution
of media. We believe that Microsoft's commitment to and presence in the media
delivery industry has increased and that Microsoft will continue to increase
competitive pressure in the overall market for streaming media and media
distribution.
Microsoft distributes its competing streaming media server and tools
products by bundling them with its Windows NT servers at no additional charge
and by making them available for download from its website for free. While we
also provide free downloads of certain of our products, including players,
servers and tools, Microsoft's practices have caused, and may continue to cause,
pricing pressure on our products. These practices could lead to longer sales
cycles, decreased sales and reduced market share. In addition, we believe that
Microsoft has used and may be able to use its dominant position in the computer
industry and its financial resources to secure preferential or exclusive
distribution and bundling contracts for its streaming media products with third
parties such as Internet service providers (ISPs), online service providers,
content providers, entertainment companies, media companies, broadcasters, value
added resellers (VARs) and original equipment manufacturers (OEMs), including
third parties with whom we have relationships. Such arrangements, together with
Microsoft's aggressive marketing of Windows NT and of its streaming media
products, may reduce our share of the streaming media market.
Microsoft's Windows Media Player competes with our RealPlayer products.
The Windows Media Player is available for download from Microsoft's website for
free, and is bundled by Microsoft with its Windows 98 operating system and with
its Web browser, Internet Explorer. In addition, Microsoft has bundled certain
audio capabilities into a radio toolkit for Internet Explorer 5.0, its latest
Web browser. Internet Explorer 5.0 includes Web Events, which provides links to
multimedia content on the Internet, especially content in Microsoft's streaming
media formats. We expect that by leveraging its dominant position in operating
systems and tying streaming media into its operating system and its browser,
Microsoft will distribute substantially more copies of the Windows Media Player
in the future than it has in the past and may be able to attract more users to
its streaming media products. Currently, our RealPlayer has a high degree of
market penetration: we have over 70 million registered users and estimate that
more than 85% of all Web pages that use streaming media do so using our
technology. Our market position may be difficult to sustain, particularly in
light of Microsoft's efforts and dominant position in operating systems.
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In addition to Microsoft, we face increasing competition from other
companies that are developing and marketing streaming media products. Apple
Computer recently announced the availability of QuickTime 4.0 streaming media
technology, including a free media player and a free streaming media server, and
has made available free source code to the server under the conditions of their
license agreement. We expect that Apple Computer will devote more resources to
developing and marketing streaming media systems, and will seek to compete more
vigorously with us in the marketplace. Other competitors include Cisco
Systems/Precept Software, PictureTel/Starlight Networks and Oracle Corporation.
As more companies enter the market with products that compete with our servers,
players and tools, the competitive landscape could change rapidly to our
disadvantage.
We do not believe that clear standards have emerged with respect to
non-PC wireless and cable-based systems. Likewise, no one company has gained a
dominant position in the mobile device market. Other companies' products and
services or new standards may emerge in any of these areas, which could reduce
demand for our products or render them obsolete.
In addition, our streaming media and media delivery products face
competition from non-streaming, "fast download" media delivery technologies such
as AVI, QuickTime and MP3. Other fast download or non-streaming IP-based content
distribution methods are likely to emerge and could compete with our products
and services, which could harm our business.
WE MAY BE UNABLE TO SUCCESSFULLY COMPETE IN OTHER PARTS OF OUR BUSINESS
Media Hosting. Our media hosting service, the Real Broadcast Network,
competes with a variety of companies that provide streaming media hosting
services. These companies include Broadcast.com (which has been acquired by
Yahoo!) and Intervu and emerging broadcast networks such as CMGI's Magnitude
Network and Enron Communications. We may not establish or sustain our
competitive position in this market segment. Some media hosting competitors are
also customers on whom we rely to help drive product download traffic to our
website through their broadcast events.
Website Destinations, Content and Advertising. While Internet
advertising revenues across the industry continue to grow, the number of
websites competing for advertising revenues is also growing. Our websites,
including Real.com, Film.com and LiveConcerts.com, compete for user traffic and
Internet advertising revenues with a wide variety of websites, Internet portals
and ISPs. In particular, aggregators of audio, video and other media, such as
Broadcast.com and Microsoft's Web Events, compete with our RealGuide. We also
compete with traditional media such as television, radio and print for a share
of advertisers' total advertising budgets. Our advertising sales force and
infrastructure are still in early stages of development relative to those of our
competitors. We cannot be certain that advertisers will place advertising with
us or that revenues derived from such advertising will be meaningful. If we lose
advertising customers, fail to attract new customers, are forced to reduce
advertising rates or otherwise modify our rate structure to retain or attract
customers, or if we lose website traffic, our business could be harmed.
Electronic Commerce. The electronic commerce features of our websites
compete with a variety of other websites for consumer traffic. To compete
successfully in the electronic commerce market, we must attract sufficient
traffic to our websites by offering high-quality, competitively priced,
desirable merchandise in a compelling, easy-to-purchase format. In addition, we
must successfully leverage our existing user base to develop the market for our
products and services. We may not compete successfully in the growing and
rapidly changing market for electronic commerce. Our failure to do so could harm
our business.
Increased competition may result in price reductions, reduced margins,
loss of market share, loss of customers, and a change in our business and
marketing strategies, any of which could harm our business.
WE MAY NOT BE SUCCESSFUL IN THE MARKET FOR DOWNLOADABLE MEDIA AND LOCAL MEDIA
DELIVERY
In May 1999, we announced the RealSystem MP, a digital music
architecture enabling integration with a wide range of Internet services and
hardware devices. We also released a beta version of RealJukebox, our client
software based on the RealSystem MP. These products represent an extension of
our business into downloadable
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media and local media delivery, which is a substantial evolution from our
historical focus on streaming media products and services. We do not know
whether there is a sustainable market for products such as RealSystem MP and
RealJukebox. Even if that market exists, we may be unable to develop a revenue
model or sufficient demand to take advantage of the market opportunity.
While over five million copies of RealJukebox have been downloaded since
its beta release on May 3, 1999, it is too soon to determine if RealJukebox will
be widely received in the marketplace. There are now a number of competitive
products on the market that offer certain of the features that RealJukebox
offers. In addition, given the size and importance of the general market for
music distribution, competitors will likely release products that directly
compete with RealJukebox, which could harm our business. Even if RealJukebox
achieves widespread market acceptance, it may not achieve a high level of use,
which would lead to a low rate of upgrade sales and electronic commerce
opportunities.
RealJukebox has been released only as an early beta version. Although we
tested this version prior to its release, it likely contains errors. We will
spend substantial development resources to continue to test the product, to
correct errors and to improve the product before we release a commercial version
of RealJukebox. We may never release a commercial version. Our inability to
commercially release RealJukebox, to achieve widespread acceptance for
RealSystem MP and RealJukebox, or to create new revenue streams from new market
segments could harm our business.
RealJukebox allows users to record and play back music in a variety of
technical formats, including RealAudio G2 and MP3. However, technical formats
and consumer preferences evolve very rapidly, and we may be unable to adequately
address consumer preferences or fulfill the market demand to the extent it
exists.
We have had long-term relationships with recording companies, including
major record labels, many of which offer their streaming content in our formats.
However, recording companies, including those with whom we have a relationship,
may be uncomfortable with some features of RealJukebox. As a result, some record
companies may decide to withhold content from RealJukebox, or refrain from or
delay participating in promotional opportunities with respect to RealJukebox.
RealJukebox is intended to allow users of the product to acquire,
record, play back and manage music for their personal use. It is possible for a
user of RealJukebox to elect not to use the copyright-protection features it
contains and then violate the intellectual property rights of artists and
recording companies by engaging in an un-authorized distribution of music. The
laws governing the recording, distribution and performance of digital music are
new and largely untested. While we believe we have developed RealJukebox to
comply with U.S. copyright laws, a court may find us in violation of these laws.
Similar action or other litigation in the United States or abroad directed at us
could harm our business, even if such litigation were entirely without merit.
WE MAY NOT SUCCESSFULLY DEVELOP NEW PRODUCTS AND SERVICES
Our growth depends on our ability to continue to develop leading edge
media delivery and digital distribution products and services. Our business and
operating results would be harmed if we fail to develop products and services
that achieve widespread market acceptance or that fail to generate significant
revenues to offset development costs. We may not timely and successfully
identify, develop and market new product and service opportunities. If we
introduce new products and services, they may not attain broad market acceptance
or contribute meaningfully to our revenues or profitability.
Because the markets for our products and services are rapidly changing,
we must develop new offerings quickly. We have experienced development delays
and cost overruns in our development efforts in the past and we may encounter
such problems in the future. Delays and cost overruns could affect our ability
to respond to technological changes, evolving industry standards, competitive
developments or customer requirements. Our products also may contain undetected
errors that could cause increased development costs, loss of revenues, adverse
publicity, reduced market acceptance of the products or lawsuits by customers.
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WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO INCREASE MARKET ACCEPTANCE OF
OUR PRODUCTS
If third parties do not develop or offer compelling content to be
delivered over the Internet, our business will be harmed and our products may
not achieve or sustain broad market acceptance. We rely on third-party content
providers, such as radio and television stations, record labels, media
companies, websites and other companies, to develop and offer content in our
formats that can be delivered using our server products and played back using
our player products. While we have a number of short-term agreements with third
parties to provide content from their websites in our formats, most third
parties are not obligated to develop or offer content using our technology. In
addition, some third parties have entered into and may in the future enter into
agreements with our competitors, principally Microsoft, to develop or offer all
or a substantial portion of their content in our competitors' formats. Microsoft
has more resources to secure preferential and even exclusive relationships with
content providers. There could be less demand for and use of our products if
Microsoft or another competitor were to secure preferential or exclusive
relationships with the leading broadcasters, record companies or websites. We
cannot guarantee that third-party content providers will continue to rely on our
technology or offer compelling content in our formats to encourage and sustain
broad market acceptance of our products. Their failure to do so would harm our
business.
As we move into the market for digital distribution of media and local
media playback, our success depends on the availability of third-party content,
especially music, that users of our RealJukebox product can lawfully and easily
access, record and play back. Our product may not achieve or sustain market
acceptance if third parties are unwilling to offer their content for free
download or purchase by users of RealJukebox. Competitors could secure exclusive
distribution relationships with such content providers, which would harm our
business.
WE DEPEND ON KEY PERSONNEL WHO MAY LEAVE US AT ANY TIME
Our success substantially depends on the continued employment of our
executive officers and key employees, particularly Robert Glaser, our chairman
of the board and chief executive officer. The loss of the services of Mr. Glaser
or any of our other executive officers or key employees could harm our business.
None of our executive officers has a contract that guarantees employment. Other
than the $2 million insurance policy on the life of Mr. Glaser, we do not
maintain "key person" life insurance policies.
OUR FAILURE TO ATTRACT, TRAIN OR RETAIN HIGHLY QUALIFIED PERSONNEL COULD HARM
OUR BUSINESS
Our success also depends on our ability to attract, train and retain
qualified personnel, specifically those with management and product development
skills. In particular, we must hire additional skilled software engineers to
further our research and development efforts. Competition for such personnel is
intense, particularly in high-technology centers such as the Pacific Northwest.
In making employment decisions, particularly in the Internet and high-technology
industries, job candidates often consider the value of stock options they may
receive in connection with their employment. As a result of recent volatility in
our stock price, we may be disadvantaged in competing with companies that have
not experienced similar volatility or that have not yet sold their stock
publicly. If we do not succeed in attracting new personnel or retaining and
motivating our current personnel, our business could be harmed.
WE MAY NOT SUCCESSFULLY MANAGE OUR GROWTH
We cannot successfully implement our business model if we fail to manage
our growth. We have rapidly and significantly expanded our operations
domestically and internationally and anticipate further expansion to take
advantage of market opportunities. We have increased the number of our full-
time employees from 325 on January 1, 1998 to 536 on June 30, 1999. Managing
this substantial expansion has placed a significant strain on our management,
operational and financial resources. If our growth continues, we will need to
continue to improve our financial and managerial control and reporting systems
and procedures.
We are in the process of implementing new management information
software systems. This will affect many aspects of our business, including our
accounting, operations, electronic commerce, customer service,
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purchasing, sales and marketing functions. The purchase, implementation and
testing of these systems has resulted, and will result, in significant capital
expenditures and could disrupt our day-to-day operations. If these systems are
not implemented as expected, our ability to provide products and services to our
customers on a timely basis will suffer and delays in the recording and
reporting of our operating results could occur.
THE GROWTH OF OUR BUSINESS DEPENDS ON THE INCREASED USE OF THE INTERNET FOR
COMMUNICATIONS, ELECTRONIC COMMERCE AND ADVERTISING
The growth of our business depends on the continued growth of the
Internet as a medium for communications, electronic commerce and advertising.
Our business will be harmed if Internet usage does not continue to grow,
particularly as a source of media information and entertainment and as a vehicle
for commerce in goods and services. Our success also depends on the efforts of
third parties to develop the infrastructure and complementary products and
services necessary to maintain and expand the Internet as a viable commercial
medium. The Internet may not be accepted as a viable commercial medium for
broadcasting multimedia content or media delivery for a number of reasons,
including:
- potentially inadequate development of the necessary
infrastructure to accommodate growth in the number of users and
Internet traffic;
- lack of acceptance of the Internet as a medium for distributing
streaming media content or for media delivery;
- unavailability of compelling multimedia content;
- inadequate commercial support for Web-based advertising; and
- delays in the development or adoption of new technological
standards and protocols or increased governmental regulation,
which could inhibit the growth and use of the Internet.
In addition, we believe that other Internet-related issues, such as
security, reliability, cost, ease of use and quality of service, remain largely
unresolved and may affect the amount of business that is conducted over the
Internet.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by such growth, specifically the demands of
delivering high-quality media content. As a result, its performance and
reliability may decline. In addition, websites have experienced interruptions in
service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently in
the future, Internet usage, as well as the usage of our products, services and
websites, could grow more slowly or decline.
CHANGES IN NETWORK INFRASTRUCTURE, TRANSMISSION METHODS AND BROADBAND
TECHNOLOGIES POSE RISKS TO OUR BUSINESS
We believe that increased Internet use may depend on the availability of
greater bandwidth or data transmission speeds (also known as broadband
transmission). If broadband access becomes widely available, we believe it
presents both a substantial opportunity and a significant business challenge for
us. Internet access through cable television set-top boxes, digital subscriber
lines or wireless connections could dramatically reduce the demand for our
products and services by utilizing alternate technology that more efficiently
transmits data. This could harm our business as currently conducted.
Development of products and services for a broadband transmission
infrastructure involves a number of additional risks, including:
- changes in content delivery methods and protocols;
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- the availability of compelling content that takes advantage of
broadband access and helps drive market acceptance of our
products and services;
- the emergence of new competitors, such as traditional broadcast
and cable television companies, which have significant control
over access to content, substantial resources and established
relationships with media providers;
- the development of relationships by our current competitors with
companies that have significant access to or control over the
broadband transmission infrastructure or content;
- the need to establish new relationships with non-PC based
providers of broadband access, such as providers of television
set-top boxes and cable television, some of which may compete
with us; and
- the general risks of new product and service development,
including the challenges to develop error-free products and
enhancements, develop compelling services and achieve market
acceptance for these products and services.
We depend on the efforts of third parties to develop and provide a
successful infrastructure for broadband transmission. Even if broadband access
becomes widely available, heavy use of the Internet may negatively impact the
quality of media delivered through broadband connections. If these third parties
experience delays or difficulties establishing a widespread broadband
transmission infrastructure or if heavy usage limits the broadband experience,
the release of our broadband products and services could be delayed. Even if a
broadband transmission infrastructure is developed for widespread use, our
products and services may not achieve market acceptance or generate sufficient
revenues to offset our development costs.
WE COULD LOSE STRATEGIC RELATIONSHIPS THAT ARE ESSENTIAL TO OUR BUSINESS
The loss of certain current strategic relationships, the inability to
find other strategic partners or the failure of our existing relationships to
achieve meaningful positive results for us could harm our business. We rely in
part on strategic relationships to help us:
- maximize adoption of our products through distribution
arrangements;
- increase the amount and availability of compelling media content
on the Internet to help boost demand for our products and
services;
- enhance our brand;
- expand the range of commercial activities based on our
technology;
- expand the distribution of our streaming media content without a
degradation in fidelity; and
- increase the performance and utility of our products and
services.
Many of these goals are beyond our traditional strengths. We anticipate
that the efforts of our strategic partners will become more important as the
multimedia experience over the Internet matures. For example, we may become more
reliant on strategic partners to provide multimedia content, provide more secure
and easy-to-use electronic commerce solutions and build out the necessary
infrastructure for media delivery. We may not be successful in forming strategic
relationships. In addition, the efforts of our strategic partners may be
unsuccessful. Furthermore, these strategic relationships may be terminated
before we realize any benefit.
OUR INDUSTRY IS EXPERIENCING CONSOLIDATION THAT MAY INTENSIFY COMPETITION
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The Internet industry has recently experienced substantial consolidation
and a proliferation of strategic transactions. We expect this consolidation and
strategic partnering to continue. Acquisitions or strategic relationships could
harm us in a number of ways. For example:
- competitors could acquire or partner with companies with which
we have strategic relationships and discontinue our
relationship, resulting in the loss of distribution
opportunities for our products and services or the loss of
certain enhancements or value-added features to our products and
services;
- competitors could obtain exclusive access to desirable
multimedia content and prevent that content from being available
in our formats, thus decreasing the use of our products and
services to distribute and experience the content that audiences
most desire, and hurting our ability to attract advertisers to
our websites and product offerings;
- a competitor could be acquired by a party with significant
resources and experience that could increase the ability of the
competitor to compete with our products and services.
Recent announcements and consolidations that could affect our business
include:
- Microsoft's strategic investments in broadband initiatives,
including its recently announced $5 billion investment in AT&T;
- AT&T's acquisition of TCI and its announcement that it will
acquire MediaOne Communications;
- At Home's acquisition of Excite;
- Yahoo!'s acquisitions of Broadcast.com and GeoCities;
- The Walt Disney Company's recent announcement that it intends to
combine its Internet assets with, and acquire a majority
ownership of, Infoseek, and create a single business called
go.com;
- NBC's announcement that it intends to merge its Internet assets
with XOOM.com, Inc. and Snap.com, a subsidiary of CNET.
POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS
The failure to adequately address the financial and operational risks
raised by acquisitions of technology and businesses could harm our business. We
have acquired complementary technologies and businesses in the past, and intend
to do so in the future. Financial risks related to acquisitions include:
- potentially dilutive issuances of equity securities;
- use of cash resources;
- the incurrence of additional debt and contingent liabilities;
- large write-offs; and
- amortization expenses related to goodwill and other intangible
assets.
Acquisitions also involve operational risks, including:
- difficulties in assimilating the operations, products,
technology, information systems and personnel of the acquired
company;
- diversion of management's attention from other business
concerns;
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- impairment of relationships with our employees, affiliates,
advertisers and content providers;
- inability to maintain uniform standards, controls, procedures
and policies;
- the assumption of known and unknown liabilities of the acquired
company;
- entrance into markets in which we have no direct prior
experience; and
- loss of key employees of the acquired company.
In August 1999, we acquired Xing Technology Corporation, an MP3 software
developer, in a transaction that was accounted for as a pooling of interests. We
may not adequately integrate this or any future acquisitions. In addition, we
may not be able to account for future acquisitions as a pooling of interests,
which could harm our operating results.
OUR BUSINESS WILL SUFFER IF OUR SYSTEMS FAIL OR BECOME UNAVAILABLE
A reduction in the performance, reliability and availability of our
websites and network infrastructure will harm our ability to distribute our
products and services to our users, as well as our reputation and ability to
attract and retain users, customers, advertisers and content providers. Our
revenues depend in large part on the number of users that download our products
from our websites and access the content services on our websites. Our systems
and operations could be damaged or interrupted by fire, flood, power loss,
telecommunications failure, Internet breakdown, earthquake and similar events.
Our systems are also subject to break-ins, sabotage, intentional acts of
vandalism and similar misconduct. Our computer and communications infrastructure
is located at a single leased facility in Seattle, Washington. We do not have
fully redundant systems or a formal disaster recovery plan, and we do not carry
adequate business interruption insurance to compensate us for losses that may
occur from a system outage.
Our electronic commerce and digital distribution activities are managed
by sophisticated software and computer systems. We may encounter delays in
developing these systems, and the systems may contain undetected errors that
could cause system failures. Any system error or failure that causes
interruption in availability of products or content or an increase in response
time could result in a loss of potential or existing business services
customers, users, advertisers or content providers. If we suffer sustained or
repeated interruptions, our products, services and websites could be less
attractive to such entities or individuals and our business would be harmed.
A sudden and significant increase in traffic on our websites could
strain the capacity of the software, hardware and telecommunications systems
that we deploy or use. This could lead to slower response times or system
failures. Our operations also depend on receipt of timely feeds from our content
providers, and any failure or delay in the transmission or receipt of such feeds
could disrupt our operations. We depend on Web browsers, ISPs and online service
providers to provide Internet users access to our websites. Many of these
providers have experienced significant outages in the past, and could experience
outages, delays and other difficulties due to system failures unrelated to our
systems. In addition, certain ISPs have temporarily interrupted our website
operations in response to the heavy volume of e-mail transmission we generate
and send to our large user base. These types of interruptions could continue or
increase in the future.
OUR NETWORK IS SUBJECT TO SECURITY RISKS THAT COULD HARM OUR REPUTATION AND
EXPOSE US TO LITIGATION OR LIABILITY
Online commerce and communications depend on the ability to transmit
confidential information securely over public networks. Any compromise of our
ability to transmit confidential information securely, and costs associated with
preventing or eliminating any problems, could harm our business. Online
transmissions are subject to a number of security risks, including:
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- our own or licensed encryption and authentication technology may
be compromised, breached or otherwise be insufficient to ensure
the security of customer information;
- we could experience unauthorized access, computer viruses and
other disruptive problems, whether intentional or accidental;
- a third party could circumvent our security measures and
misappropriate proprietary information or interrupt operations;
and
- credit card companies could restrict online credit card
transactions.
The occurrence of any of these or similar events could damage our
reputation and expose us to litigation or liability. We may also be required to
expend significant capital or other resources to protect against the threat of
security breaches or to alleviate problems caused by such breaches.
OUR INTERNATIONAL OPERATIONS INVOLVE RISKS
We operate subsidiaries in Australia, England, France, Germany and
Japan, and market and sell products in several other countries. For the six
months ended June 30, 1999, approximately 24% of our revenues, excluding
revenues derived from our license agreement with Microsoft, were derived from
international operations. We are subject to the normal risks of doing business
internationally, as well as risks specific to Internet-based companies in
foreign markets. These risks include:
- delays in the development of the Internet as a broadcast,
advertising and commerce medium in international markets;
- difficulties in managing operations due to distance, language
and cultural differences, including issues associated with
establishing management systems infrastructures in individual
markets;
- unexpected changes in regulatory requirements;
- export and import restrictions, including those restricting the
use of encryption technology;
- tariffs and trade barriers and limitations on fund transfers;
- difficulties in staffing and managing foreign operations;
- longer payment cycles and problems in collecting accounts
receivable;
- potential adverse tax consequences;
- exchange rate fluctuations;
- increased risk of piracy and limits on our ability to enforce
our intellectual property rights; and
- other legal and political risks.
Any of these factors could harm our business. We do not currently hedge
our foreign currency exposures.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS
Our inability to protect our proprietary rights, and the costs of doing
so, could harm our business. Our success and ability to compete partly depend on
the superiority, uniqueness or value of our technology, including both
internally developed technology and technology licensed from third parties. To
protect our proprietary rights,
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we rely on a combination of patent, trademark, copyright and trade secret laws,
confidentiality agreements with our employees and third parties, and protective
contractual provisions. Despite our efforts to protect our proprietary rights,
unauthorized parties may copy or infringe aspects of our technology, products,
services or trademarks, or obtain and use information we regard as proprietary.
Our proprietary rights may be especially difficult to protect in foreign
countries, where unrelated third parties may have registered our domain names
and trademarks under their own names in an attempt to prevent us from using the
domain names and trademarks in those countries without paying them a significant
sum of money. This could prevent us from using our valuable brands in those
countries, and reduce the value of our intellectual property. In addition,
others may independently develop technologies that are similar or superior to
ours, which could reduce the value of our intellectual property.
Companies in the computer industry have frequently resorted to
litigation regarding intellectual property rights. We may have to litigate to
enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of other parties' proprietary rights. From time
to time, other parties' proprietary rights, including patent rights, have come
to our attention and on several occasions we have received notice of claims of
infringement of other parties' proprietary rights, and we may receive such
notices in the future.
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against us and co-defendant Broadcast.com in the United States District Court
for the Northern District of Texas--Dallas Division. The plaintiffs allege that
we, individually and in combination with Broadcast.com, infringe on a certain
patent by making, using, selling and/or offering to sell software products and
services directed to media delivery systems for the Internet and corporate
intranets. The plaintiffs seek to enjoin us from the alleged infringing activity
and to recover damages in an amount no less than a reasonable royalty. We
believe the allegations are without merit and intend to vigorously defend
ourselves against these claims. However, litigation is inherently uncertain, and
we may be unable to successfully defend ourselves against this claim.
From time to time we receive claims and inquiries from third parties
alleging that our internally developed technology or technology we license from
third parties may infringe the third parties' proprietary rights. We are now
investigating a few of such pending claims. We could be required to spend
significant amounts of time and money to defend ourselves against such claims.
If any of these claims were to prevail, we could be forced to pay damages,
comply with injunctions, or stop distributing our products while we re-engineer
them or seek licenses to necessary technology, which might not be available on
reasonable terms. We could also be subject to claims for indemnification
resulting from infringement claims made against our customers and strategic
partners, which could increase our defense costs and potential damages. Any of
these events could harm our business.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH GOVERNMENTAL REGULATION AND LEGAL
UNCERTAINTIES
We are not currently subject to direct regulation by any governmental
agency other than laws and regulations generally applicable to businesses,
although certain U.S. export controls and import controls of other countries,
including controls on the use of encryption technologies, may apply to our
products. Few existing laws or regulations specifically apply to the Internet.
However, it is likely that a number of laws and regulations may be adopted in
the United States and other countries with respect to the Internet. These laws
may relate to areas such as content issues (such as obscenity, indecency and
defamation), copyright and other intellectual property rights, encryption, use
of key escrow data, caching of content by server products, electronic
authentication or "digital signatures," personal privacy, advertising, taxation,
electronic commerce liability, e-mail, network and information security and the
convergence of traditional communication services with Internet communications,
including the future availability of broadband transmission capability. Other
countries and political organizations are likely to impose or favor more and
different regulation than that which has been proposed in the United States,
thus furthering the complexity of regulation. The adoption of such laws or
regulations, and uncertainties associated with their validity and enforcement,
may affect the available distribution channels for and costs associated with our
products and services, and may affect the growth of the Internet. Such laws or
regulations may therefore harm our business.
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We do not know for certain how existing laws governing issues such as
property ownership, copyright and other intellectual property issues, taxation,
illegal or obscene content, retransmission of media and personal privacy and
data protection apply to the Internet. The vast majority of such laws were
adopted before the advent of the Internet and related technologies and do not
address the unique issues associated with the Internet and related technologies.
Most of the laws that relate to the Internet have not yet been interpreted.
Changes to or the interpretation of these laws could:
- limit the growth of the Internet;
- create uncertainty in the marketplace that could reduce demand
for our products and services;
- increase our cost of doing business;
- expose us to significant liabilities associated with content
available on our websites or distributed or accessed through our
products or services; or
- lead to increased product development costs, or otherwise harm
our business.
On October 28, 1998, the Digital Millennium Copyright Act (DMCA) was
enacted. The DMCA includes statutory licenses for the performance of sound
recordings and for the making of recordings to facilitate transmissions. Under
these statutory licenses, we and our broadcast customers will be required to pay
licensing fees for sound recordings we deliver in original and archived
programming and through retransmissions of radio broadcasts. The DMCA does not
specify the rate and terms of the licenses, which will be determined either
through voluntary inter-industry negotiations or arbitration. We currently
anticipate that representatives of the webcasting industry will engage in
arbitration with the Recording Industry Association of America to determine
what, if any, licensee fee should be paid. Depending on the rates and terms
adopted for the statutory licenses, our business could be harmed both by
increasing our own cost of doing business, as well as by increasing the cost of
doing business for our customers.
The Child Online Protection Act and the Child Online Privacy Protection
Act (COPA) were enacted in October 1998. The COPA impose civil and criminal
penalties on persons distributing material harmful to minors (e.g., obscene
material) over the Internet to persons under the age of 17, or collecting
personal information from children under the age of 13. We do not currently
distribute the types of materials that we believe the COPA would deem illegal,
and do not knowingly collect and disclose personal information from such minors.
The manner in which the COPA may be interpreted and enforced cannot be fully
determined, and future legislation similar to the COPA could subject us to
potential liability, which in turn could harm our business. Such laws could also
damage the growth of the Internet generally and decrease the demand for our
products and services.
SHAREHOLDERS MAY BE UNABLE TO EXERCISE CONTROL BECAUSE MANAGEMENT OWNS A LARGE
PERCENTAGE OF OUR STOCK
Our officers, directors and affiliated persons beneficially own
approximately 49.7% of our common stock. Robert Glaser, our chief executive
officer and chairman of the board, beneficially owns approximately 37.9% of our
common stock. As a result, our officers, directors and affiliated persons will
have significant influence to:
- elect or defeat the election of our directors;
- amend or prevent amendment of our articles of incorporation or
bylaws;
- effect or prevent a merger, sale of assets or other corporate
transaction; and
- control the outcome of any other matter submitted to the
shareholders for vote.
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Management's stock ownership may discourage a potential acquirer from
making a tender offer or otherwise attempting to obtain control of RealNetworks,
which in turn could reduce our stock price or prevent our shareholders from
realizing a premium over our stock price.
PROVISIONS OF OUR CHARTER DOCUMENTS, SHAREHOLDER RIGHTS PLAN AND WASHINGTON LAW
COULD DISCOURAGE OUR ACQUISITION BY A THIRD PARTY
Our articles of incorporation provide for a strategic transaction
committee of the board of directors currently comprised of Messrs. Glaser,
Breyer and Kapor. Without the prior approval of this committee, and subject to
certain limited exceptions, the board of directors does not have the authority
to:
- adopt a plan of merger;
- authorize the sale, lease, exchange or mortgage of:
- (A) assets representing more than 50% of the book value
of our assets prior to the transaction; or
- (B) any other asset or assets on which our long-term
business strategy is substantially dependent;
- authorize our voluntary dissolution; or
- take any action that has the effect of any of the above.
RealNetworks also entered into an agreement providing Mr. Glaser with a
direct contractual right to require RealNetworks to abide by and perform all
terms of the articles of incorporation with respect to the strategic
transactions committee. This agreement also provides that so long as Mr. Glaser
owns a specified number of shares, RealNetworks will use its best efforts to
cause him to be nominated to, elected to, and not removed from the board of
directors. In addition, the articles provide that Mr. Glaser will serve, or will
appoint another officer of RealNetworks to serve, as our policy ombudsman, with
the exclusive authority to adopt or change our editorial policies as reflected
on our websites or in other communications or media in which we have a
significant editorial or media voice. The provisions with respect to the
authority of the strategic transactions committee and the policy ombudsman may
be amended only with the approval of 90% of the shares entitled to vote on an
amendment to the articles.
We have adopted a shareholder rights plan that provides that shares of
our common stock have associated preferred stock purchase rights. These rights
become exercisable and detachable from the associated common stock only
following the acquisition by a person or a group of 15% or more of our
outstanding common stock or 10 days following the announcement of a tender or
exchange offer for 15% or more of our outstanding common stock. The rights
entitle our shareholders, other than the person or entity that has acquired or
made an exchange or tender offer for 15% or more of our outstanding common
stock, to acquire additional shares of our capital stock at a price equal to
one-half of the market price at the time of the event and, in certain
circumstances, would allow our shareholders to acquire capital stock in the
entity that has acquired or made an exchange or tender offer for 15% or more of
our outstanding common stock at a similar discount. The exercise of these rights
would make the acquisition of RealNetworks by a third party more expensive to
that party and has the effect of discouraging third parties from acquiring our
company without the approval of our board of directors, which has the power to
redeem these rights and prevent their exercise.
Washington law imposes restrictions on some transactions between a
corporation and certain significant shareholders. Chapter 23B.19 of the
Washington Business Corporation Act prohibits a "target corporation," with some
exceptions, from engaging in certain significant business transactions with
an"acquiring person," which is defined as a person or group of persons that
beneficially owns 10% or more of the voting securities of the target
corporation, for a period of five years after such acquisition, unless the
transaction or acquisition of shares is approved by a majority of the members of
the target corporation's board of directors prior to the acquisition. Such
prohibited transactions include, among other things:
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- a merger or consolidation with, disposition of assets to, or
issuance or redemption of stock to or from the acquiring person;
- termination of 5% or more of the employees of the target
corporation as a result of the acquiring person's acquisition of
10% or more of the shares; or
- allowing the acquiring person to receive any disproportionate
benefit as a shareholder.
After the five-year period, a "significant business transaction" may
occur, as long as it complies with certain "fair price" provisions of the
statute. A corporation may not opt out of this statute. This provision may have
the effect of delaying, deterring or preventing a change in control of
RealNetworks.
The foregoing provisions of our charter documents, shareholder rights
plan and Washington law, as well as those relating to a classified board of
directors and the availability of "blank check" preferred stock, could have the
effect of making it more difficult or more expensive for a third party to
acquire, or of discouraging a third party from attempting to acquire, control of
us. These provisions may therefore have the effect of limiting the price that
investors might be willing to pay in the future for our common stock.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE
The trading price of our common stock has been and is likely to continue
to be highly volatile. For example, during the 52-week period ended July 23,
1999, the price of our common stock ranged from $7.625 to $131.875 per share.
Our stock price could be subject to wide fluctuations in response to factors
such as:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations, new products or
services by us or our competitors;
- changes in financial estimates or recommendations by securities
analysts;
- the addition or loss of strategic relationships;
- conditions or trends in the Internet, media streaming, media
delivery and online commerce markets;
- changes in the market valuations of other Internet, online
service or software companies;
- announcements by us or our competitors of significant
acquisitions, strategic partnerships, joint ventures or capital
commitments;
- additions or departures of key personnel;
- sales of our common stock; and
- general market conditions.
In addition, the stock market in general, and the Nasdaq National Market
and the market for Internet and technology companies in particular, have
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of these companies. These broad
market and industry factors may reduce our stock price, regardless of our
operating performance. The trading prices of the stocks of many technology
companies are at or near historical highs and reflect price-earnings ratios
substantially above historical levels. These trading prices and price-earnings
ratios may not be sustained.
WE MAY BE SUBJECT TO ASSESSMENT OF SALES AND OTHER TAXES FOR THE SALE OF OUR
PRODUCTS, LICENSE OF TECHNOLOGY OR PROVISION OF SERVICES
32
<PAGE> 33
We may have to pay past sales or other taxes that we have not collected
from our customers. We do not currently collect sales or other taxes on the sale
of our products, license of technology or provision of services in states and
countries other than those in which we have offices or employees.
In October 1998, the Internet Tax Freedom Act (ITFA) was signed into
law. Among other things, the ITFA imposes a three-year moratorium on
discriminatory taxes on electronic commerce. Nonetheless, foreign countries or,
following the moratorium, one or more states, may seek to impose sales or other
tax obligations on companies that engage in such activities within their
jurisdictions. Our business would be harmed if one or more states or any foreign
country were able to require us to collect sales or other taxes from current or
past sales of products, licenses of technology or provision of services,
particularly because we would be unable to go back to customers to collect sales
taxes for past sales and may have to pay such taxes out of our own funds.
YEAR 2000 COMPLIANCE ISSUES COULD HARM OUR BUSINESS
We are in the process of assessing and remediating any Year 2000 issues
associated with our own products, and the computer systems, software, other
property and equipment we use. Despite our testing and remediation efforts, our
products and systems, and those of third parties, including content providers,
advertisers, affiliates and end users, may contain errors or faults with respect
to the year 2000. Known or unknown errors or defects that affect the operation
of our products and systems or those of third parties could result in delay or
loss of revenues, interruptions of services, cancellation of customer contracts,
diversion of development resources, damage to our reputation, increased service
and warranty costs and litigation costs, any of which could harm our business.
WE INTEND TO DONATE A PORTION OF NET INCOME TO CHARITY
If we achieve and sustain profitability, we intend to donate
approximately 5% of our annual net income to charitable organizations. This will
reduce our net income.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this document, all of which
are subject to risks and uncertainties. Forward-looking statements include
information concerning our possible or assumed future business success or
financial results. Such forward-looking statements include, but are not limited
to, statements as to our expectations regarding:
- the future development and growth of, and opportunities for, the
Internet and the online media delivery market;
- the future adoption of our current and future products, services
and technologies;
- future revenue opportunities;
- the future growth of our customer base;
- our ability to successfully develop and introduce future
products and services;
- future international revenues;
- future expense levels (including research and development, sales
and marketing and general and administrative expenses);
- future sales and marketing efforts;
- future capital needs;
33
<PAGE> 34
- the future of our relationships with Microsoft and other
companies;
- the effect of past and future acquisitions;
- the future effectiveness of our intellectual property rights;
- the effect of current litigation in which we are involved; and
- the effect of the Year 2000 situation.
When we use words such as "believe," "expect" and "anticipate" or
similar words, we are making forward-looking statements.
You should note that an investment in our common stock involves certain
risks and uncertainties that could affect our future business success or
financial results. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in "Factors That May Affect Our Business, Future
Operating Results and Financial Condition" and elsewhere in this Quarterly
Report on Form 10-Q.
We believe that it is important to communicate our expectations to our
investors. However, there may be events in the future that we are not able to
predict accurately or over which we have no control. Before you invest in our
common stock, you should be aware that the occurrence of the events described in
the "Factors That May Affect Our Business, Future Operating Results and
Financial Condition" and elsewhere in this Quarterly Report on Form 10-Q could
materially and adversely affect our business, financial condition and operating
results. We undertake no obligation to publicly update any forward-looking
statements for any reason, even if new information becomes available or other
events occur in the future.
34
<PAGE> 35
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information relating to quantitative and qualitative disclosure about
market risk is set forth under the caption "Liquidity and Capital Resources" in
Part I, Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations.
35
<PAGE> 36
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against us and co-defendant Broadcast.com in the United States District Court
for the Northern District of Texas--Dallas Division. The plaintiffs allege that
we, individually and in combination with Broadcast.com, infringe on a certain
patent by making, using, selling and/or offering to sell software products and
services directed to media delivery systems for the Internet and corporate
intranets. The plaintiffs seek to enjoin us from our alleged infringing activity
and to recover damages in an amount no less than a reasonable royalty. Although
we can give no assurance as to the outcome of this lawsuit, we believe that the
allegations in this action are without merit, and intend to vigorously defend
ourselves against these claims. We may be required to indemnify Broadcast.com
under the terms of our license agreement with it. The plaintiffs filed a similar
claim based on the same patent and seeking similar remedies as a separate
lawsuit against Microsoft and Broadcast.com in the same court. The court has
consolidated the lawsuit against Microsoft and Broadcast.com with the lawsuit
against RealNetworks and Broadcast.com.
On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against us
in the U.S. District Court for the Western District of Washington. The plaintiff
alleges that we entered into an oral agreement with it in 1995 pursuant to which
the plaintiff claims it is entitled to 30% of our revenues from the use of
RealAudio technology to promote, sample or sell music. The plaintiff claims
breach of contract, unjust enrichment, promissory estoppel and breach of
implied-in-fact contract. We have denied each of the plaintiff's claims. In
response to our motion to dismiss, the plaintiff withdrew its claim for breach
of fiduciary duty. Although no assurance can be given as to the outcome of this
lawsuit, we believe the allegations in this action are without merit, and we
intend to vigorously defend ourselves against these claims.
From time to time we are, and expect to continue to be, subject to legal
proceedings and claims in the ordinary course of our business, including
contract-related claims and claims of alleged infringement of third-party
patents, trademarks and other intellectual property rights. These claims, even
if not meritorious, could force us to spend significant financial and managerial
resources. We currently are not aware of any legal proceedings or claims that we
believe will have, individually or taken together, a material adverse effect on
our business, prospects, financial condition and operating results.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Since April 1, 1999, the Company has issued and sold
unregistered securities as follows:
(1) An aggregate of 53,334 shares of Common Stock was issued
in April 1999 to two individuals in exchange for all of
the outstanding shares of common stock of Ultisoft,
Inc., an Oregon corporation. The aggregate consideration
received for such shares was valued at approximately
$3.7 million.
(d) Use of Proceeds
RealNetworks' registration statement under the Securities Act of 1933,
as amended, for its initial public offering became effective on November 20,
1997. Offering proceeds, net of aggregate expenses of approximately $4.6
million, were approximately $38.5 million. RealNetworks has used all of the net
offering proceeds for the purchase of temporary investments consisting of cash,
cash equivalents and short-term investments. RealNetworks has not used any of
the net offering proceeds for construction of plant, building or facilities,
purchases of real estate, acquisition of other businesses, or repayment of
indebtedness. None of the net offering proceeds were paid directly or indirectly
to directors, officers, or general partners of RealNetworks or their associates,
persons owning 10% or more of any class of RealNetworks' securities, or
affiliates of RealNetworks.
36
<PAGE> 37
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An Annual Meeting of Shareholders of RealNetworks, Inc. (the "Annual
Meeting") was held on May 21, 1999. Matters voted on at the meeting and votes
cast on each were as follows:
1. To elect two Class 2 directors to serve until the 2002 Annual
Meeting of Shareholders or until their earlier retirement, resignation or
removal, or the election of their successors.
<TABLE>
<CAPTION>
For Withheld
---------- ---------
<S> <C> <C>
James Breyer 27,778,633 2,716,446
Bruce Jacobsen 27,755,513 2,739,566
</TABLE>
2. To ratify the appointment of KPMG LLP as independent auditors
for the Company's fiscal year ending December 31, 1999.
<TABLE>
<S> <C>
For 30,462,402
Against 8,440
Abstain 24,237
</TABLE>
3. To elect Edward Bleier as a Class 1 director to serve until
the 2001 Annual Meeting of Shareholders or until his earlier retirement,
resignation or removal, or the election of his successor.*
<TABLE>
<S> <C>
For 17,726,679
Against 0
Abstain 0
</TABLE>
*Mr. Bleier was elected to serve on the Company's Board of Directors on
April 27, 1999. The proposal to add Mr. Bleier as a nominee for election at the
Annual Meeting was reflected in the Supplement to Proxy Statement mailed to the
Company's shareholders on or around May 12, 1999.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K:
<TABLE>
<CAPTION>
<S> <C>
27.1 Restated Financial Data Schedule which is submitted
electronically to the Securities and Exchange Commission
for information purposes only and is not filed
27.2 Financial Data Schedule which is submitted
electronically to the Securities and Exchange Commission
for information purposes only and is not filed
</TABLE>
(b) Reports on Form 8-K:
On May 4, 1999, RealNetworks filed a report on Form 8-K announcing the
approval by the Board of Directors of a 2-for-1 stock split of its common stock.
37
<PAGE> 38
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 13, 1999.
REALNETWORKS, INC.
By /s/ Paul Bialek
--------------------------------------
Paul Bialek
Senior Vice President,
Finance and Operations
and Chief Financial Officer
38
<PAGE> 39
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
27.1 Restated Financial Data Schedule which is submitted
electronically to the Securities and Exchange Commission
for information purposes only and is not filed
27.2 Financial Data Schedule which is submitted
electronically to the Securities and Exchange Commission
for information purposes only and is not filed
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 268,306
<SECURITIES> 48,763
<RECEIVABLES> 6,998
<ALLOWANCES> 1,632
<INVENTORY> 184
<CURRENT-ASSETS> 325,821
<PP&E> 26,635
<DEPRECIATION> 6,676
<TOTAL-ASSETS> 368,566
<CURRENT-LIABILITIES> 54,334
<BONDS> 0
0
0
<COMMON> 73
<OTHER-SE> 314,159
<TOTAL-LIABILITY-AND-EQUITY> 368,566
<SALES> 0
<TOTAL-REVENUES> 51,571
<CGS> 0
<TOTAL-COSTS> 9,366
<OTHER-EXPENSES> 45,471
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,006)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,006)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,006)
<EPS-BASIC> (0.01)
<EPS-DILUTED> (0.01)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 40,399
<SECURITIES> 57,634
<RECEIVABLES> 5,345
<ALLOWANCES> 1,164
<INVENTORY> 209
<CURRENT-ASSETS> 106,452
<PP&E> 9,593
<DEPRECIATION> 4,245
<TOTAL-ASSETS> 123,301
<CURRENT-LIABILITIES> 30,428
<BONDS> 0
0
0
<COMMON> 64
<OTHER-SE> 81,140
<TOTAL-LIABILITY-AND-EQUITY> 123,301
<SALES> 0
<TOTAL-REVENUES> 27,558
<CGS> 0
<TOTAL-COSTS> 5,400
<OTHER-EXPENSES> 37,921
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (13,494)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,494)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,494)
<EPS-BASIC> (0.21)
<EPS-DILUTED> (0.21)
</TABLE>
