<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
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 October
31, 2000 was 157,650,849.
<PAGE> 2
REALNETWORKS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2000
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...........15
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................45
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...............................................................................46
Item 2. Changes in Securities and Use of Proceeds.......................................................47
Item 6. Exhibits and Reports on Form 8-K................................................................47
</TABLE>
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<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>
September 30, December 31,
2000 1999
------------- -------------
ASSETS
<S> <C> <C>
Current assets:
Cash, cash equivalents and short-term investments $ 359,447 344,627
Trade accounts receivable, net of allowances for doubtful
accounts and sales returns 12,964 6,895
Prepaid expenses and other current assets 6,585 2,870
------------- -------------
Total current assets 378,996 354,392
Equipment and leasehold improvements, at cost:
Equipment and software 32,382 21,142
Leasehold improvements 23,820 15,129
------------- -------------
Total equipment and leasehold improvements 56,202 36,271
Less accumulated depreciation and amortization 16,426 10,101
------------- -------------
Net equipment and leasehold improvements 39,776 26,170
------------- -------------
Goodwill, net of accumulated amortization of $34,701
at September 30, 2000 and $3,724 at December 31, 1999 106,735 6,920
Restricted cash equivalents 18,800 13,700
Other assets 34,043 9,942
------------- -------------
TOTAL ASSETS $ 578,350 411,124
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,370 6,305
Accrued and other liabilities 39,701 26,944
Deferred revenue, excluding non-current portion 45,462 47,316
------------- -------------
Total current liabilities 90,533 80,565
------------- -------------
Deferred rent 1,940 --
Deferred revenue, excluding current portion 14,802 --
Shareholders' equity:
Preferred stock, $0.001 par value per share, no shares issued and outstanding
Series A: authorized 200 shares -- --
Undesignated series: authorized 59,800 shares -- --
Common stock, $0.001 par value per share,
Authorized 1,000,000 shares; issued and outstanding 157,411
shares in 2000 and 149,648 shares in 1999 157 150
Additional paid-in capital 668,570 366,177
Deferred stock compensation (77,110) --
Accumulated deficit (111,640) (34,865)
Accumulated other comprehensive loss (8,902) (903)
------------- -------------
Total shareholders' equity 471,075 330,559
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 578,350 411,124
============= =============
</TABLE>
See accompanying notes to condensed consolidated financial statements
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<PAGE> 4
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
--------------------------- -----------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues:
Software license fees $ 39,725 24,091 111,850 62,683
Service revenues 13,893 6,633 37,748 17,641
Advertising 13,506 4,167 33,710 7,464
--------- --------- --------- ---------
Total net revenues 67,124 34,891 183,308 87,788
--------- --------- --------- ---------
Cost of revenues:
Software license fees 3,356 3,353 11,658 9,409
Service revenues 3,753 1,877 9,899 4,274
Advertising 2,876 674 6,709 1,822
--------- --------- --------- ---------
Total cost of revenues 9,985 5,904 28,266 15,505
--------- --------- --------- ---------
Gross profit 57,139 28,987 155,042 72,283
--------- --------- --------- ---------
Operating expenses:
Research and development (excluding non-cash
stock based compensation of $24,908 and
$67,143 for the quarter and nine months ended
September 30, 2000, respectively, and $0 for the
comparable periods in 1999, included below) 16,095 10,019 41,019 25,935
Sales and marketing (excluding non-cash stock
based compensation of $1,195 and $3,256,
for the quarter and nine months ended
September 30, 2000, respectively, and $0 for the
comparable periods in 1999, included below) 27,506 13,722 77,152 37,138
General and administrative 6,991 4,174 21,182 10,797
Goodwill amortization, acquisitions charges,
and stock based compensation 38,385 1,935 103,772 2,999
--------- --------- --------- ---------
Total operating expenses 88,977 29,850 243,125 76,869
--------- --------- --------- ---------
Operating loss (31,838) (863) (88,083) (4,586)
Other income, net 5,108 3,866 15,333 5,451
--------- --------- --------- ---------
Net income (loss) before income tax provision (26,730) 3,003 (72,750) 865
Income tax provision 4,025 -- 4,025 --
--------- --------- --------- ---------
Net income (loss) $ (30,755) 3,003 (76,775) 865
========= ========= ========= =========
Basic net income (loss) per share $ (0.20) 0.02 (0.50) 0.01
========= ========= ========= =========
Diluted net income (loss) per share $ (0.20) 0.02 (0.50) 0.01
========= ========= ========= =========
Shares used to compute basic
net income (loss) per share 154,992 147,322 153,392 140,388
Shares used to compute diluted
net income (loss) per share 154,992 172,844 153,392 164,150
Comprehensive income (loss):
Net income (loss) $ (30,755) 3,003 (76,775) 865
Unrealized loss on investments (6,149) -- (7,914) --
Foreign currency translation adjustment 94 61 (85) (111)
--------- --------- --------- ---------
Comprehensive income (loss) $ (36,810) 3,064 (84,774) 754
========= ========= ========= =========
</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>
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2000 1999
--------------- ---------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (76,775) 865
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization of equipment and
leasehold improvements 6,330 3,764
Goodwill amortization and stock based compensation 101,374 2,999
Stock option income tax benefits 3,934 --
Net change in certain assets and liabilities 17,431 15,143
--------------- ---------------
Net cash provided by operating activities 52,294 22,771
Cash flows from investing activities:
Purchases of equipment and leasehold improvements (17,669) (20,140)
Purchases of short-term investments (624,396) (119,016)
Proceeds from sales and maturities of short-term investments 594,159 37,239
Purchase of equity investments (29,299)
Increase in restricted cash (5,100) --
Payment of acquisition costs (3,599) --
Cash obtained through acquisition 73 --
--------------- ---------------
Net cash used in investing activities (85,831) (101,917)
--------------- ---------------
Cash flows from financing activities:
Net proceeds from notes payable -- 1,000
Payments on notes payable -- (415)
Net proceeds from sale of common stock and
exercise of stock options 18,396 233,898
--------------- ---------------
Net cash provided by financing activities 18,396 234,483
--------------- ---------------
Effect of exchange rate changes on cash (657) (162)
--------------- ---------------
Net increase (decrease) in cash and cash equivalents (15,798) 155,175
Cash and cash equivalents at beginning of period 160,955 51,900
--------------- ---------------
Cash and cash equivalents at end of period 145,157 207,075
Short-term investments at end of period 214,290 119,678
--------------- ---------------
Total cash, cash equivalents and short-term
investments at end of period $ 359,447 326,753
=============== ===============
</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 (RealNetworks or Company) is a
leading provider of media delivery and digital 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 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 and is extending
it further to allow consumers to enjoy streaming and digital media content via
mobile networks and devices.
Inherent in the Company's business are various risks and uncertainties,
including its limited operating history and the limited history of commerce on
the Internet. The Company's success may depend in part upon the emergence of the
Internet and corporate intranets as a communications medium, the acceptance of
the Company's technology by the marketplace and the Company's ability to
generate license, service and advertising revenues from the use of its
technology on the Internet.
(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 nine months ended September 30,
2000 are not necessarily indicative of the results that may be expected for any
subsequent quarter or for the year ending December 31, 2000. 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 consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1999.
On April 27, 1999, the board of directors declared 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. Also, on January 21, 2000, the board of directors
declared a 2-for-1 split of the Company's Common Stock in the form of a stock
dividend. The stock split was effected on February 11, 2000. The accompanying
condensed consolidated financial statements and related notes thereto have been
retroactively restated to reflect the stock splits.
-6-
<PAGE> 7
The condensed consolidated financial statements have been prepared to
give retroactive effect to the merger with Xing Technology Corporation (Xing) on
August 10, 1999, which was accounted for as a pooling of interests. The
condensed consolidated financial statements have been restated for all periods
presented as if Xing and the Company had always been combined. Prior to the
merger, Xing operated on a June 30 fiscal year. The results of operations of
Xing included herein have been restated to conform to the Company's December 31
fiscal year-end.
(c) Cash, Cash Equivalents and Short-Term Investments
Cash, cash equivalents and short-term investments are comprised of the
following:
<TABLE>
<CAPTION>
September 30, 2000 December 31, 1999
------------------ ------------------
(in thousands)
<S> <C> <C>
Cash and cash equivalents $ 145,157 160,955
Short-term investments 214,290 183,672
------------------ ------------------
Total cash, cash equivalents and
short-term investments $ 359,447 344,627
================== ==================
Restricted cash equivalents $ 18,800 13,700
================== ==================
</TABLE>
Restricted cash equivalents represents (a) a restricted escrow account
of $11,500,000 established in connection with a lease agreement for the
Company's corporate headquarters. $10,000,000 of the escrow account will be
maintained for the term of the lease and the remaining $1,500,000 will be
released as the Company funds tenant improvements, and (b) cash equivalents held
as collateral against a $7,300,000 line of credit with a bank which represents
collateral on the lease of a building located near the Company's corporate
headquarters.
(d) Revenue Recognition
The Company recognizes revenue in accordance with the provisions of
Statement of Position 97-2, "Software Revenue Recognition" (SOP 97-2), which
provides specific industry guidance and stipulates that revenue recognized from
software arrangements is to be allocated to each element of the arrangement
based on the relative fair values of the elements, such as software products,
upgrades, enhancements, post contract customer support, installation or
training. Under SOP 97-2, the determination of fair value is based on objective
evidence that is specific to the vendor. If such evidence of fair value for each
element of the arrangement does not exist, all revenue from the arrangement is
deferred until such time that evidence of fair value does exist or until all
elements of the arrangement are delivered.
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 provides ongoing support to the
OEM in the form of future upgrades, enhancements or other services over the term
of the contract, revenue is recognized over the term of the contract.
Service revenues include payments under support and upgrade contracts,
RealPlayer GoldPass media subscription service, and fees from consulting
services and streaming media content hosting. Support and upgrade revenues are
recognized ratably over the term of the contract, which typically is twelve
months. Media subscription service revenues are recognized over the period that
services are provided. Other service revenues are recognized when the services
are performed.
-7-
<PAGE> 8
Fees generated from advertising appearing on the Company's Web sites,
and from advertising included in the Company's products, such as fees for
distribution of RealChannels, LiveStations, and e-commerce and other links in
the RealPlayer and RealJukebox, are recognized as revenue over the terms of the
contracts. The Company may guarantee a minimum number of advertising
impressions, click-throughs or other specified criteria on the Company's Web
sites or products for a specified period. To the extent these guarantees are not
met, the Company defers recognition of the corresponding revenues until
guaranteed delivery levels are achieved.
To date, revenue from contracts with customers deploying content
delivery networks is recognized over the term of the arrangement commencing upon
the customer's deployment of our technology in their network build-out. These
arrangements generally consist of software licenses, consulting services, other
services, support and rights to unspecified software upgrades if and when
available. As the Company has a limited history of contracts with content
delivery networks, and there are unique aspects to each arrangement, the Company
has not established objective evidence as to the determination of fair value for
each element of the arrangement. As a result, and in accordance with SOP 97-2,
revenue is recognized ratably over the fixed term of the support contract.
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, and is effective for fiscal years beginning
after March 15, 1999. The Company adopted SOP 98-9 on January 1, 2000. The
adoption of SOP 98-9 did not have a material effect on the Company's
consolidated financial statements.
(e) Comprehensive Loss
The Company's comprehensive loss for the quarter and nine months ended
September 30, 2000 consisted of net loss, unrealized losses on investments and
the impact of foreign currency translation adjustments. The Company's
comprehensive income for the quarter and nine months ended September 30, 1999
consisted of net income and the impact of foreign currency translation
adjustments. The tax effect of the foreign currency translation adjustments and
unrealized losses on investments was insignificant.
(f) Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common and dilutive common equivalent
shares outstanding during the period. As the Company had a net loss for the
quarter and nine months ended September 30, 2000, basic and diluted net loss
per share are the same for those periods.
Excluded from the computation of diluted net loss per share for the
quarter and nine months ended September 30, 2000 are options and warrants to
acquire approximately 41,446,000 shares of common stock with a weighted-average
exercise price of $26.78. Also excluded from both periods are approximately
1,820,000 shares of common stock issued in the acquisition of NetZip, Inc., that
are subject to repurchase by the Company at a nominal price in certain
circumstances. Excluded from the computation of diluted net income per share for
the quarter and nine months ended September 30, 1999 are options to acquire
4,680,000 shares of common stock with a weighted-average exercise price of
$45.96. Such potentially dilutive securities were excluded, as their effects are
anti-dilutive. The following schedule represents a reconciliation of the
numerators and denominators of basic and diluted net income (loss) per share
calculations for the quarters and nine months ended September 30, 2000 and 1999:
-8-
<PAGE> 9
<TABLE>
<CAPTION>
(In thousands, except per share data)
Income (Loss) Weighted Average Income (Loss) per
(Numerator) Shares (Denominator) Share
--------------- -------------------- ------------------
<S> <C> <C> <C>
Quarter Ended September 30, 2000
Basic net loss per share $ (30,755) 154,992 $ (0.20)
Effect of dilutive stock options and warrants -- --
--------------- --------------------
Diluted net loss per share $ (30,755) 154,992 $ (0.20)
=============== ==================== ==================
Quarter Ended September 30, 1999
Basic net income per share $ 3,003 147,322 $ 0.02
Effect of dilutive stock options and warrants -- 25,522
--------------- --------------------
Diluted net income per share $ 3,003 172,844 $ 0.02
=============== ==================== ==================
Nine Months Ended September 30, 2000
Basic net loss per share $ (76,775) 153,392 $ (0.50)
Effect of dilutive stock options and warrants -- --
-------------- --------------------
Diluted net loss per share $ (76,775) 153,392 $ (0.50)
=============== ==================== ==================
Nine Months Ended September 30, 1999
Basic net income per share $ 865 140,388 $ 0.01
Effect of dilutive stock options and warrants -- 23,762
--------------- --------------------
Diluted net income per share $ 865 164,150 $ 0.01
=============== ==================== ==================
</TABLE>
(g) Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44 (FIN No. 44), "Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of APB Opinion No. 25." FIN No.
44 was effective July 1, 2000. This interpretation provides guidance for
applying APB Opinion No. 25 "Accounting for Stock Issued to Employees." The
adoption of FIN No. 44 did not have a material impact on the Company's
consolidated financial statements.
In March 2000, the Emerging Issues Task Force of the FASB reached a
consensus on Issue No. 00-2, "Accounting for Web Site Development Costs," which
provides guidance on when to capitalize versus expense costs incurred to develop
a Web site. The consensus is effective for Web site development costs in
quarters beginning after June 30, 2000. The Company adopted the provisions of
this issue in the third quarter of 2000. The adoption did not have a material
impact on the Company's consolidated financial statements.
In December 1999, the United States Securities and Exchange Commission
released Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in
Financial Statements," which as amended, must be adopted by the Company by the
fourth quarter of 2000. SAB 101 provides guidance on revenue recognition and the
SEC staff's views on the application of accounting principles to selected
revenue recognition issues. The adoption of SAB 101 is not expected to have a
material effect on the Company's consolidated financial statements.
-9-
<PAGE> 10
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging
Activities". SFAS 133 establishes a new model for accounting for derivatives and
hedging activities and supercedes 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. The adoption of SFAS 133 is not expected to have a material effect
on the Company's 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, Chief Operating
Officer, and Senior Vice Presidents. The COC reviews financial information
presented on a consolidated basis accompanied by disaggregated information about
products and services and geographical regions 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 Nine Months Ended
September 30, September 30,
------------------------------------------
2000 1999 2000 1999
------- ------ ------- ------
<S> <C> <C> <C> <C>
North America $48,391 25,402 130,318 62,042
Europe 11,347 3,541 25,900 9,889
Asia 5,439 2,645 15,462 6,699
Rest of the world 1,947 686 6,394 1,507
------- ------ ------- ------
Subtotal 67,124 32,274 178,074 80,137
Microsoft license revenue -- 2,617 5,234 7,651
------- ------ ------- ------
Total $67,124 34,891 183,308 87,788
======= ====== ======= ======
</TABLE>
Revenue from external customers by product type is as follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------------------------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Media delivery license revenue $39,725 21,474 106,616 55,032
Media delivery service revenue 13,893 6,683 37,748 17,641
Microsoft license revenue -- 2,617 5,234 7,651
Advertising revenue 13,506 4,117 33,710 7,464
------- ------- ------- -------
Total net revenues $67,124 34,891 183,308 87,788
======= ======= ======= =======
</TABLE>
-10-
<PAGE> 11
Long-lived assets by geographic location are as follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
United States $ 145,659 32,273
Asia and rest of the world 623 446
Europe 229 371
------------- -------------
Total $ 146,511 33,090
============= =============
</TABLE>
NOTE 3 - ACQUISITIONS
NetZip, Inc.
In January 2000, the Company completed its acquisition of NetZip, Inc.
(NetZip), a Georgia corporation. NetZip is a developer and provider of Internet
download management and utility software. As a result of the acquisition, NetZip
became a wholly-owned subsidiary of RealNetworks and RealNetworks issued
approximately 3,418,000 shares (including options to purchase shares) of its
common stock in exchange for all of the outstanding shares of NetZip common
stock and options to purchase NetZip common stock, but approximately 1,820,000
of those shares are subject to repurchase by the Company at a nominal price in
certain circumstances. The acquisition was accounted for under the purchase
method of accounting and, accordingly, the results of NetZip's operations are
included in the Company's consolidated financial statements since the date of
acquisition. The acquisition was valued at approximately $130 million, including
transaction costs. The purchase price excludes approximately $144 million of the
Company's common stock issued to former stockholders of NetZip which is subject
to forfeiture over a period of 30 months beginning January 25, 2000 upon the
occurrence of certain events.
A summary of the purchase price for the acquisition is as follows (in
thousands):
<TABLE>
<CAPTION>
<S> <C>
Stock and stock options $125,913
Direct acquisition costs 2,596
Accrued liabilities assumed 809
Other liabilities assumed 281
--------
Total purchase price 129,599
Stock based compensation not
included in purchase price 143,973
--------
Total acquisition cost and value of
common stock to be issued under
compensation agreements $273,572
========
</TABLE>
The purchase price was allocated as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Cash $ 73
Other current assets acquired 440
Equipment 324
Non-current assets acquired 15
Goodwill 128,747
--------
Total $129,599
========
</TABLE>
-11-
<PAGE> 12
Goodwill represents the excess of the purchase price over the fair value
of identifiable tangible and intangible assets acquired and liabilities assumed
and is amortized using the straight-line method over its estimated life of three
years. The value of the common stock issued to the former stockholders of NetZip
is being amortized over the 30-month forfeiture period. The expected recognition
of the expenses relating to these amounts are shown below (in thousands):
<TABLE>
<CAPTION>
Goodwill Stock Based
Years ended December 31, Amortization Compensation Total
---------------- ---------------- ----------------
<S> <C> <C> <C>
2000 $ 39,968 95,647 135,615
2001 42,916 40,877 83,793
2002 42,916 7,449 50,365
2003 2,947 -- 2,947
---------------- ---------------- ----------------
$ 128,747 143,973 272,720
================ ================ ================
</TABLE>
In connection with the acquisition of NetZip, the Company incurred
approximately $6.1 million in acquisition-related expenditures, including $3.5
million of relocation payments and stay bonuses for NetZip employees which are
dependent upon the related individuals remaining employed by the Company, and
are recognized as expense over the related employment term, and $2.6 million in
professional fees and other costs. As of September 30, 2000, approximately $3.6
million of these costs have been paid. The remaining costs are expected to be
paid during the remainder of 2000 and the first quarter of 2001.
The following table presents pro forma results of operations as if the
acquisition had occurred at the beginning of each of the periods presented. The
pro forma information is not necessarily indicative of the combined results that
would have occurred had the acquisition taken place at the beginning of the
periods presented, nor is it necessarily indicative of results that may occur in
the future.
<TABLE>
<CAPTION>
Quarter Ended September 30, Nine Months Ended September 30,
-------------------------------------------------------------------------
2000 1999 2000 1999
------------- ------------- ------------- -------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Total net revenue $ 67,124 36,000 184,278 91,303
Net loss $ (30,755) (50,195) (86,139) (124,919)
Net loss per share - basic
and diluted $ (0.20) (0.33) (0.56) (0.85)
</TABLE>
Xing Technology Corporation
In August 1999, the Company completed its acquisition of Xing Technology
Corporation (Xing), a leading developer and provider of MP3 software. The
acquisition was accounted for using the pooling-of-interests method of
accounting and, accordingly, the accounts of Xing have been included with those
of the Company for all periods presented.
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<PAGE> 13
Separate results for the combined entities are as follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, 1999 September 30, 1999
------------------ ------------------
<S> <C> <C>
Revenue
RealNetworks, Inc. $ 34,468 86,039
Xing 423 1,749
------------------ ------------------
$ 34,891 87,788
================== ==================
Net income (loss)
RealNetworks, Inc. $ 4,337 3,331
Xing (1,334) (2,466)
------------------ ------------------
$ 3,003 865
================== ==================
</TABLE>
There were no significant intercompany transactions between the two
companies and no conforming accounting adjustments.
Other
In July 2000, the Company acquired a privately held company accounted for under
the purchase method of accounting. Total consideration was $5,558,000 including
common shares valued at $3,537,000 which are subject to repurchase by the
Company under certain circumstances. Goodwill of $2,095,000 represents the
excess of the purchase price over the fair value of identifiable tangible and
intangible asserts acquired and liabilities assumed. The revenues and expenses
of the acquired company are immaterial to the Company's results of operations.
Goodwill Amortization, Acquisition Charges and Stock Based Compensation
Goodwill amortization, acquisition charges and stock based compensation
are as follows:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Stock Based Compensation $ 26,103 -- 70,399 --
Goodwill Amortization and
Acquisition Charges 12,282 1,935 33,373 2,999
---------- ---------- ---------- ----------
Total $ 38,385 1,935 103,772 2,999
========== ========== ========== ==========
</TABLE>
Goodwill amortization and acquisition charges by acquisition are shown below (in
thousands):
<TABLE>
<CAPTION>
Quarter Ended September 30, Nine Months Ended September 30,
------------------------------------------ ------------------------------------------
2000 1999 2000 1999
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
NetZip $ 11,609 -- 31,636 --
Vivo (1998 acquisition) 532 532 1,596 1,596
Other 141 1,403 141 1,403
------------------ ------------------ ------------------ ------------------
$ 12,282 1,935 33,373 2,999
================== ================== ================== ==================
</TABLE>
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<PAGE> 14
NOTE 4 - LITIGATION
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against the Company and co-defendant Broadcast.com in the United States District
Court for the Northern District of Texas--Dallas Division. The plaintiffs allege
that the Company, individually and in combination with Broadcast.com, infringes
on the plaintiffs' 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 the Company from
its alleged infringing activity and to recover damages in an amount no less than
a reasonable royalty. Although no assurance can be given as to the outcome of
this lawsuit, the Company believes that the allegations in this action are
without merit, and intends to vigorously defend itself against these claims. The
Company may be required to indemnify Broadcast.com under the terms of its
license agreement. 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 the Company and
Broadcast.com. If the plaintiffs prevail in their claims, the Company could be
required to pay damages or other royalties, in addition to complying with
injunctive relief, which could have a material adverse effect on the Company's
operating results.
Between November 1999 and March 2000, fourteen lawsuits were filed
against the Company in federal and/or state courts in California, Illinois,
Pennsylvania, Washington and Texas. The plaintiffs in federal court in
Pennsylvania and in Illinois state court have voluntarily dismissed their
lawsuits. The remaining twelve actions, which seek to certify classes of
plaintiffs, allege breach of contract, invasion of privacy, deceptive trade
practices, negligence, fraud and violation of certain federal and state laws in
connection with various communications features of the RealPlayer and
RealJukebox products. Plaintiffs are seeking both damages and injunctive relief.
The Company has filed answers denying the claims and has filed suit in
Washington state court to compel the state court plaintiffs to arbitrate their
claims as required by the Company's End User License Agreements. On February 10,
2000, the federal Judicial Panel on Multidistrict Litigation transferred all
pending federal cases to the federal district court for the Northern District of
Illinois. On the same day, that court granted RealNetworks' motion to stay the
court proceedings because the claims are subject to arbitration under
RealNetworks' End User License Agreement. Although no assurance can be given as
to the outcome of these lawsuits, the Company believes that the allegations in
these actions are without merit, and intends to vigorously defend itself. If the
plaintiffs prevail in their claims, the Company could be required to pay damages
or other penalties in addition to complying with injunctive relief, which could
harm our business and our operating results.
From time to time RealNetworks is, and expects to continue to be,
subject to legal proceedings and claims in the ordinary course of its business,
including employment claims, 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 the Company to spend
significant financial and managerial resources. The Company currently has a
number of such claims threatened against it relating to intellectual property
infringement or employment, though it believes these claims are without merit.
The Company is not aware of any legal proceedings or claims that the Company
believes will have, individually or taken together, a material adverse effect on
the Company's business, prospects, financial condition or results of operations.
However, the Company may incur substantial expenses in defending against third
party claims. In the event of a determination adverse to the Company, the
Company may incur substantial monetary liability, and/or be required to change
its business practices. Either of these could have a material adverse effect on
the Company's financial position and results of operations.
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<PAGE> 15
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 that 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
RealNetworks is a leading provider of media delivery and digital
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 150 million registered users of our RealPlayer product and more
than 45 million registered users of our RealJukebox product, and we believe that
more than 85% of all streaming media Web pages utilize our technology. The broad
acceptance of the Internet as a means of content delivery and consumption,
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, and are extending it further to allow consumers to enjoy streaming and
digital media content via mobile networks and devices.
We were incorporated in February 1994 we 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 product. 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, marketing, building our domestic and international sales channels,
and in our general and administrative infrastructure. In August 1996, we began
selling RealPlayer Plus, a premium for-sale version of our RealPlayer product.
RealPlayer has always been available for download free of charge from our Web
sites. In September 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 included RealAudio and RealVideo
technology. In November 1998, we released the commercial version of RealSystem
G2, our next generation media delivery system. In May 1999, we released
RealSystem MP as well as a beta version of RealJukebox, a personal music
management solution. In September 1999, we released RealSlideshow Plus, a
complete streaming solution for sharing digital pictures over the Internet. Also
in September, we released the commercial versions of RealJukebox and RealJukebox
Plus. In November 1999, we released the beta version of RealPlayer 7.0 and
introduced the new Real.com Network, which gives consumers the ability to find,
organize and play audio and video on the Internet, including the Real.com Guide
and Take 5, Real.com's media programming guide. In December 1999, we introduced
the gold version of RealPlayer 7.0, RealServer 7.0 and RealProducer 7.0, the
latest advancements to RealSystem G2, as well as RealSlideshow 2.0 and
RealSlideshow Plus 2.0, which allow consumers to share digital pictures with
audio narration and music over the Internet. In March 2000, we introduced
Real.com Games, which offers a new online, digital distribution model for high
quality downloadable computer games. In May 2000, we introduced Real
Entertainment Center, an integrated suite of three new Internet media products
-- RealPlayer 8, RealJukebox 2, and RealDownload 4. Also in
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<PAGE> 16
May, we released a beta version of RealVideo 8, an Internet media system that we
believe delivers a high clarity, full-motion video experience to consumers using
dial-up modems, full-screen VHS quality at mainstream broadband rates, and near
DVD-quality video to those using high capacity networks or downloadable media.
In August, we released the gold version of RealPlayer 8, RealJukebox 2,
RealDownload 4 and launched RealPlayer GoldPass, a for-pay media subscription
service available today to RealPlayerPlus customers. RealPlayer GoldPass will
give subscribers access to a combination of premium software, services and
content updated monthly.
We report revenues in three categories:
- Software license fees, which include revenues from sales of our
RealPlayer Plus, RealJukebox Plus, RealSlideshow Plus, RealDownload
Plus, Real Entertainment Center Plus, Xing AudioCatalyst, RealServers
and related authoring and publishing tools, sales of our products
through OEM channels, and sales of third-party products.
- Service revenues, which include support and maintenance services that we
sell to customers who purchase our RealPlayer Plus, RealJukebox Plus,
Real Entertainment Center Plus, RealServers and tools products,
RealPlayer GoldPass subscription service, broadcast hosting services we
provide through our Real Broadcast Network, and consulting services we
offer to our customers.
- Advertising revenues, which are derived from the sale of advertising on
our Web sites and the placement and distribution of RealChannels,
LiveStations and advertising and promotional buttons and links included
in the RealPlayer and the RealJukebox products.
In March 1998, we acquired Vivo Software, Inc., a privately-held
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
privately-held provider of standards-based digital audio and video encoding and
decoding technology, including MP3 software. The transaction was accounted for
using the pooling-of-interests method of accounting. All of our financial data
presented in the consolidated financial statements and management's discussion
and analysis of financial condition and results of operations has been restated
to include the historical financial information of Xing as if it had always been
a part of RealNetworks. Prior to the merger, Xing operated on a June 30 fiscal
year. The results of Xing's operations have been restated to conform to
RealNetworks' December 31 fiscal year-end.
In January 2000, we acquired NetZip, Inc., a privately-held developer
and provider of Internet download management and utility software. The
transaction was accounted for using the purchase method of accounting.
RESULTS OF OPERATIONS
REVENUES
Software License Fees. Software license fees were $39.7 million for the
quarter ended September 30, 2000, an increase of 65% from $24.1 million in the
comparable quarter of the prior year. Software license fees were $111.9 million
for the nine months ended September 30, 2000, an increase of 78% from $62.7
million in the comparable period of the prior year. The increases were due
primarily to a greater volume of products sold as a result of growth in the
demand for media delivery on the Internet, new OEM agreements, the introduction
of new products, including RealJukebox Plus and RealSlideshow Plus, Real
Entertainment Center Plus and products associated with the NetZip acquisition in
January 2000 including RealDownload Plus. Revenue also increased as a result of
sales of our products to companies deploying content distribution networks.
Software license fees included $2.6 million for the quarter ended September 30,
1999, and $5.2 million and $7.7 million for the nine months ended September 30,
2000 and 1999, respectively, related to the Microsoft license agreement we
entered into in September 1997, which concluded in June 2000.
Service Revenues. Service revenues were $13.9 million for the quarter
ended September 30, 2000, an increase of 109% from $6.6 million in the
comparable quarter of the prior year. Service revenues were $37.7 million
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<PAGE> 17
for the nine months ended September 30, 2000, an increase of 114% from $17.6
million in the comparable period of the prior year. The increases were primarily
attributable to a larger installed base of our server products and related
increases in sales of support and upgrades to companies deploying our server
products in content distribution networks, increases in consulting and Real
Broadcast Network streaming media hosting services, increases in support and
upgrades for the RealPlayer Plus, and the introduction of support and upgrades
for RealJukebox Plus and Real Entertainment Center Plus.
Advertising Revenues. Advertising revenues were $13.5 million for the
quarter ended September 30, 2000, an increase of 224% from $4.2 million in the
comparable quarter of the prior year. Advertising revenues were $33.7 million
for the nine months ended September 30, 2000, an increase of 352% from $7.5
million in the comparable period of the prior year. The increases in advertising
revenues were due to increased traffic on our Web sites, the increased
effectiveness of our advertising sales force, higher average advertising rates,
and revenue associated with increased sales and distribution of RealChannels,
LiveStations, search functionality, and other advertisements and promotional
links included in the RealPlayer and RealJukebox products.
Geographic Revenues. Excluding revenues from the Microsoft license
agreement, international revenues represented 28% of total net revenues for the
quarter ended September 30, 2000 and 21% of total net revenues for the quarter
ended September 30, 1999. Revenues generated in Europe were 17% of total net
revenues for the quarter ended September 30, 2000 and 11% of total net revenues
for the quarter ended September 30, 1999 (excluding revenues from the Microsoft
license agreement). Revenues generated in Asia and the rest of the world were
11% of total net revenues for the quarter ended September 30, 2000 and 10% of
total net revenues for the quarter ended September 30, 1999 (excluding revenues
from the Microsoft license agreement). Excluding revenues from the Microsoft
license agreement, international revenues represented 27% of total net revenues
for the nine months ended September 30, 2000 and 23% of total net revenues for
the nine months September 30, 1999. Revenues generated in Europe were 15% of
total net revenues for the nine months ended September 30, 2000 and 12% of total
net revenues for the nine months ended September 30, 1999 (excluding revenues
from the Microsoft license agreement). Revenues generated in Asia and the rest
of the world were 12% of total net revenues for the nine months ended September
30, 2000 and 10% of total net revenues for the nine months ended September 30,
1999 (excluding revenues from the Microsoft license agreement).
Deferred Revenues. We had deferred revenue of $60.3 million as of
September 30, 2000 and $47.3 million as of December 31, 1999. To date, revenue
from contracts with customers developing content delivery networks is recognized
over the term of the arrangement commencing upon the customer's deployment of
our technology in their network build-out. As many of the agreements related to
the content delivery networks have been with companies that have had limited
operating histories, we had historically required prepayments related to such
customers. Cash prepayments associated with these contracts are recorded as
deferred revenue and amounted to $34.6 million and $19.9 million at September
30, 2000 and December 31, 1999, respectively. If in the future we enter into
agreements with more established companies, we may not require these prepayments
and as such, we anticipate our deferred revenue balances may decline as a
result. As of September 30, 2000 and December 31, 1999, $0 and $5.2 million,
respectively, of the deferred revenue balances related to the Microsoft license
agreement. The remaining balance of deferred revenue is comprised of the
unrecognized portion of support contracts, prepayments under OEM arrangements,
and other prepayments for which the earnings process has not been completed.
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 $3.4 million for the quarters
ended September 30, 2000 and 1999. Cost of software license fees decreased as a
percentage of software license fees to 8% from 14%. Cost of software license
fees was $11.7 million for the nine months ended September 30, 2000, an increase
of 24% from $9.4 million in the comparable period of the prior year, but
decreased as a percentage of software license fees to 10% from 15%. 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.
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<PAGE> 18
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing support and consulting services and
expenses incurred in providing our streaming media hosting services. Cost of
service revenues was $3.8 million for the quarter ended September 30, 2000, an
increase of 100% from $1.9 million in the comparable quarter of the prior year,
but decreased as a percentage of service revenues to 27% from 28%. Cost of
service revenues was $9.9 million for the nine months ended September 30, 2000,
an increase of 132% from $4.3 million in the comparable period of the prior
year, and increased as a percentage of service revenues to 26% from 24%. 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,
including consulting and streaming media hosting services, increased bandwidth
costs as a result of increased streaming media hosting services, expansion of
customer service and technical support into international regions, and support
costs related to the introduction of RealJukebox and RealDownload.
Cost of Advertising Revenues. Cost of advertising revenues includes
personnel and related costs associated with maintenance of programming services,
content creation and maintenance and fees paid to third parties for content
included in our Web sites. Cost of advertising revenues was $2.9 million for the
quarter ended September 30, 2000, an increase of 327% from $0.7 million in the
comparable quarter of the prior year, and increased as a percentage of
advertising revenues to 21% from 16%. Cost of advertising revenues was $6.7
million for the nine months ended September 30, 2000, an increase of 268% from
$1.8 million in the comparable period of the prior year, but decreased as a
percentage of advertising revenues to 20% from 24%. The increases in absolute
dollars were primarily due to increases in the quality and quantity of content
available on our Web sites and enhancements and updates made to existing Web
sites.
Our gross margins may be adversely affected by the mix of products and
services sold.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of salaries and related personnel costs, related personnel costs,
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 $16.1 million for the quarter ended September 30, 2000, an increase of 61%
from $10.0 million in the comparable quarter of the prior year. Such expenses
decreased as a percentage of total net revenues to 24% from 29%. Research and
development expenses were $41.0 million for the nine months ended September 30,
2000, an increase of 58% from $25.9 million in the comparable period of the
prior year. Such expenses decreased as a percentage of total net revenues to 22%
from 30%. Research and development expenses were primarily related to the
development of new technology and products, as well as enhancements made to
existing products. The increase in absolute dollars was primarily due to
increases in internal development personnel, consulting expenses and contract
labor. The decrease in percentage terms was a result of revenues growing at a
faster rate than expenses.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries and related personnel costs, sales commissions, consulting fees,
tradeshow 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 in future periods. Sales and marketing
expenses were $27.5 million for the quarter ended September 30, 2000, an
increase of 100% from $13.7 million in the comparable quarter of the prior year.
Such expenses increased as a percentage of total net revenues to 41% from 39%.
Sales and marketing expenses were $77.2 million for the nine months ended
September 30, 2000, an increase of 108% from $37.1 million in the comparable
period of the prior year. Such expenses remained constant at 42% of total net
revenues. The increases in absolute dollars were due to the expansion of our
direct sales and marketing organization, the creation of additional foreign and
domestic sales offices, consulting expenses, increased advertising, attendance
at trade shows, and expenses related to the annual RealNetworks conference and
the RealNetworks Europe conference. The increase in percentage terms was a
result of expenses growing at a faster rate than revenues.
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<PAGE> 19
General and Administrative. General and administrative expenses consist
primarily of salaries, related personnel costs and fees for professional
services. 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 $7.0 million for the quarter ended September
30, 2000, an increase of 67% from $4.2 million in the comparable quarter of the
prior year. Such expenses decreased as a percentage of total net revenues to 10%
from 12%. General and administrative expenses were $21.2 million for the nine
months ended September 30, 2000, an increase of 96% from $10.8 million in the
comparable period of the prior year. Such expenses remained constant at 12% of
total net revenues. The increases in absolute dollars were primarily a result of
increased personnel, litigation defense costs, and charitable contributions of
5% of our pre-tax net income (excluding amortization of goodwill and stock-based
compensation expense).
Goodwill Amortization, Acquisition Charges and Stock Based Compensation
In August 1999, we acquired Xing Technology Corporation, a provider of
standards-based digital audio and video encoding and decoding technology,
including MP3 software. We issued approximately 1,464,000 shares of our common
stock in exchange for all outstanding shares of Xing stock. The acquisition was
accounted for using the pooling of interests method of accounting and,
accordingly, the consolidated financial statements include the accounts of Xing
for all periods presented.
In January 2000, we acquired NetZip, Inc., a developer and provider of
Internet download management and utility software. The acquisition was accounted
for using the purchase method of accounting and, accordingly, the results of
NetZip's operations are included in our consolidated 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. Of the total purchase price, $128.7 million was
allocated to goodwill, and $0.9 million was allocated to tangible assets.
Goodwill is amortized over its estimated life of three years.
In connection with the NetZip acquisition, we incurred approximately
$6.1 million in acquisition-related expenditures. These expenditures included
$3.5 million in relocation payments, and retention bonuses for NetZip employees,
and $2.6 million in professional fees and other costs. As of September 30, 2000,
approximately $3.6 million of these costs had been paid. The remaining costs are
expected to be paid during the remainder of 2000 and the first quarter of 2001.
The cost of the retention bonuses is being recognized over the related service
period.
Also as part of our acquisition of NetZip, common stock was issued to
certain former stockholders of NetZip. The common stock is subject to forfeiture
over a period of 30 months beginning January 25, 2000. The value of $144 million
is being amortized over the forfeiture period. Stock-based compensation expense
for the quarter ended September 30, 2000 was $26.1 million. Stock-based
compensation expense for the nine months ended September 30, 2000 was $70.4
million. Goodwill amortization expense for the quarter ended September 30, 2000
was $11.6 million. Goodwill amortization expense for the nine months ended
September 30, 2000 was $31.6 million.
OTHER INCOME, NET
Other income, net consists primarily of earnings on cash, cash
equivalents and short-term investments. Other income, net was $5.1 million and
$3.9 million for the quarters ended September 30, 2000 and 1999, respectively.
Other income, net was $15.3 million and $5.5 million for the nine months ended
September 30, 2000 and 1999, respectively. The increases were primarily due to
higher returns on invested cash balances primarily as a result of cash generated
from operations, proceeds from exercises of stock options and the cash proceeds
from our secondary public offering of common stock completed during the second
quarter of 1999.
INCOME TAXES
For the quarter ended September 30, 2000, we recorded an income tax
provision, although we do not expect to pay federal income taxes in the near
future, due primarily to tax deductions related to the exercise of employee
stock options, the benefit of which is recorded directly to shareholder equity.
During the quarter ended September 30, 2000, our effective income tax rate
differed from the amount computed by applying the statutory
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<PAGE> 20
federal rate principally due to nondeductible amortization of goodwill and
stock compensation charges related to the acquisition of NetZip. Excluding these
nondeductible charges, our effective tax rate was approximately 35%. For the
nine months ended September 30, 2000, our effective tax rate differed from the
amount computed by applying the statutory federal rate primarily due to a
reduction in the valuation allowance for deferred tax assets and due to
nondeductible amortization of goodwill and stock compensation charges related to
the acquisition of NetZip. For the quarter and nine months ended September 30,
1999, we did not recognize income tax expense as a result of reductions in our
valuation allowance for deferred tax assets. As of September 30, 2000, we had
net operating loss carryforwards of approximately $363.0 million. Substantially
all of the net operating loss carryforwards results from stock option
deductions, the realization of which would increase shareholders' equity.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $52.3 million and $22.8
million for the nine months ended September 30, 2000 and 1999, respectively. Net
cash provided by operating activities for the nine months ended September 30,
2000 resulted primarily from income from operations of $27.0 million (excluding
$103.8 million of goodwill amortization, acquisition charges, and stock based
compensation), an increase in deferred revenue of $12.6 million, an increase in
accrued and other liabilities of $12.0 million, and depreciation of $6.3
million. This was partially offset by an increase in accounts receivable of $6.1
million. Net cash provided by operating activities for the nine months ended
September 30, 1999 resulted primarily from an increase in current liabilities
and non-cash charges associated with depreciation and amortization, which was
partially offset by net loss from operations.
Net cash used in investing activities was $85.8 million and $101.9
million for the nine months ended September 30, 2000 and 1999, respectively.
This was primarily a result of the purchase of equity securities held as
long-term investments of $29.3 million for the nine months ended September 30,
2000, net purchases of short-term investments, and purchases of equipment and
leasehold improvements.
Net cash provided by financing activities was $18.4 million and $234.5
million for the nine months ended September 30, 2000 and 1999, respectively. 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 September 30, 2000, we had $359.4 million in cash, cash equivalents
and short-term investments. As of September 30, 2000, our principal commitments
consisted of obligations under operating leases. Since our inception, we have
experienced and expect to continue to experience 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. In August 2000, we entered into a 10-year lease agreement for
additional office space for our corporate headquarters.
We do not hold derivative financial instruments or equity securities in
our short-term 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
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. Because we have historically had
the ability to hold 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 eight primary functional currencies: the
United States dollar, the Japanese yen, the British pound, the French franc, the
euro, the Mexican peso, the Brazilian real 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 rate fluctuations. We invoice our
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international customers primarily in U.S. dollars, except in Japan and Germany,
where we invoice our customers primarily in yen and euros, respectively. 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 on our financial results in
2000 and 1999.
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,
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 September 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 recognized revenue related to the agreement ratably over the
three-year term of our obligations under the agreement. The agreement concluded
during the quarter ended June 30, 2000. In that quarter we recognized the
remaining deferred balance of this contract.
YEAR 2000 COMPLIANCE
In order to minimize or eliminate the effect of the Year 2000 risk on
our products, business systems and applications, we identified, evaluated,
implemented and tested changes to our products, computer systems, applications
and software necessary to achieve Year 2000 compliance. Our products, computer
systems, and equipment successfully transitioned to the Year 2000 with no
significant issues. We do not anticipate any significant problems related to
these events. Total expenses related to Year 2000 compliance were not material.
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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. 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,
including emerging technologies and solutions; 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 NOT MAINTAIN PROFITABILITY
We have incurred significant losses since our inception and we may
never sustain or increase profitability. As of September 30, 2000, we had an
accumulated deficit of approximately $111.6 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 maintain
profitability. While we had net income in 1999, we may not continue our
historical growth or generate sufficient revenues to sustain or increase
profitability (excluding acquisition charges) 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 and uncertain nature of the markets in which we compete, our quarterly
and annual revenues and operating results are likely to fluctuate from
period-to-period, and period-to-period results are not likely to be meaningful.
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 report:
- how and when we introduce new products and services and enhance our
existing products and services;
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- our ability to retain existing customers, attract new customers and
satisfy our customers' demands;
- the timing and success of our brand-building and marketing
campaigns;
- our ability to establish and maintain strategic relationships;
- our ability to attract, train and retain key personnel;
- the demand for Internet advertising and sponsorships;
- the emergence and success of new and existing competition and
technological solutions;
- 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;
- changes in the mix of products and services that we sell to our
customers;
- costs and effects related to the acquisition of businesses or
technology and related integration; 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 and digital media distribution. To the
extent that these predictions prove inaccurate, our revenues and operating
expenses may fluctuate.
In recent periods, many Internet related companies have experienced
financial difficulties, in part as a result of their inability to access
capital from financial markets. This has impacted, either directly or
indirectly, the internet ecosystem which directly impacted both our customers
and prospective customers. The result is that some of these companies have
ceased operations, some are continuing to experience financial difficulty, and
sales cycles for some of our customers and potential customers have taken
longer to close than in the past. In the event that a substantial number of our
customers or potential customers experience financial difficulties in the
future, our ability to increase or maintain sales to such customers will be
adversely affected.
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.
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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. Negative competitive developments could hurt our business
and the trading price of our stock.
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. In addition, new competitors with potentially unique or more
desirable products or services are entering the market all the time. 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 or technology solutions 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;
- our ability to license or develop and support secure formats for
digital media delivery, particularly music and video;
- our ability to license and support popular and emerging media
formats for digital media delivery, particularly music and video, in
a market where competitors may control the intellectual property
rights for these formats;
- the size of the active audience for streaming and digital 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;
- the build-out and deployment of broadband infrastructures and
technologies; and
- challenges caused by bandwidth constraints and other limitations of
the Internet infrastructure.
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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 recently began to compete in the market for digital distribution of
media. Microsoft's commitment to and presence in the media delivery industry has
increased and 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 Web site 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 have led in some cases, and
could continue to lead to, longer sales cycles, decreased sales, loss of
existing and potential customers and reduced market share. In addition, we
believe that Microsoft has used and may continue to use its monopoly 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), content delivery
networks, 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. In addition, Microsoft has invested significant sums of money in
certain of our current and potential customers and content suppliers, and we
expect this trend to continue, which may cause such customers to stop using or
reduce their use of our products and services, or withhold desirable media
content from us or end users of our products. 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
Web site for free, and is integrated into Microsoft's Internet Explorer Web
browser, the Windows 98 and Windows 2000 operating systems and the new Windows
Millennium edition operating system, a significant focus of which is media
delivery. In addition, Microsoft has bundled certain audio capabilities into a
radio toolkit for Internet Explorer 5.0. Internet Explorer also includes Window
Media Guide, which provides links to multimedia content on the Internet,
especially content in Microsoft's streaming or digital media formats. We expect
that by leveraging its monopoly position in operating systems and tying
streaming or digital media into its operating systems and its Web 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 or digital media products. Currently, our RealPlayer has a high
degree of market penetration: we have over 150 million unique registered users
and estimate that more than 85% of all streaming media Web pages use our
technology. Our market position will be difficult to sustain, particularly in
light of Microsoft's efforts and dominant position in operating systems.
Microsoft's Windows Media Player also competes with our RealJukebox
products, and Microsoft has invested in other digital distribution technologies
that compete with RealJukebox, like the MusicMatch Jukebox. The Windows Media
Player and MusicMatch Jukebox support the Windows Media format, but not
RealNetworks' media formats. Microsoft has also announced Windows Media
Technologies 7, a platform for authoring, delivering and playing digital media
intended to compete with RealSystem. Microsoft also supports and promotes other
third party products competitive to our products. We expect Microsoft and other
competitors to devote significantly greater resources to product development in
the jukebox and digital media categories.
Microsoft also competes with us to attract broadcasters of high
quality or popular content to promote and deliver such content in Microsoft's
formats, in some cases on an exclusive or preferential basis. While we have
rights to playback certain content in Microsoft formats through our RealPlayer
and RealJukebox product, we may not secure necessary rights from Microsoft to
enable our products to play back all such content or content in Microsoft's
newest formats. Microsoft has entered into agreements with content providers,
such as Warner Music Group, under which such content providers will make their
music or other content available in Windows Media formats using the Windows
Media Digital Rights Management technology. RealJukebox and/or RealPlayer may be
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disadvantaged if they cannot play content in Windows Media formats or secured by
the Windows Media Digital Rights Management technology, or if such content
providers do not also make their content available in RealNetworks' media
formats. In some cases, we believe Microsoft uses its financial resources and
monopoly leverage to obtain rights to such content. 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.
In addition to Microsoft, we face increasing competition from other
companies that are developing and marketing streaming media products. Apple
Computer offers the QuickTime streaming media technology, including a free media
player and a free streaming media server, and licenses for free source code to
the server under the conditions of Apple Computer's end user 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. Companies such as AOL and Yahoo! and many smaller
competitors offer various products that compete with our player and jukebox
products and more companies are attempting to develop competitive products all
the time. 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 yet gained
a dominant position in the mobile device market. However, certain products and
services in these markets support our technology, and certain support our
competitors' technology, especially that of Microsoft, which can use its
monopoly position in the operating system business and other financial resources
to gain access to these markets, potentially to the exclusion of us. Other
companies' products and services or new standards may emerge in any of these
areas, and differing standards may emerge among different global markets, which
could reduce demand for our technology and products or render them obsolete.
In addition, our media delivery products face competition from "fast
download" media delivery technologies such as AVI, QuickTime and MP3. We also
face competition from recently emergent and rapidly accepted peer-to-peer file
sharing services, which allow computer users to connect with each other and
directly access and copy many types of program files, including music and other
media, from one another's hard drives, such a Napster and Gnutella. Such
services allow consumers to directly access content without relying on content
providers to make the content available for streaming or digital download, and
without relying on products such as the RealPlayer or RealJukebox to be able to
play, record and store such content. 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 and broadcast services. These companies include Yahoo! Broadcast
Services, Akamai/Intervu, Enron Communications, Digital Island, Globix, Intel,
iBeam, Panamsat and others who are building out broadcast networks. Some of
these competitors offer other services which Real Broadcast Network does not
offer, such as web page hosting or broadcast hosting in media formats not
supported by Real Broadcast Network. 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 Web
sites through their broadcast events. We also sell servers and tools to
companies that compete with Real Broadcast Network. As our relationship becomes
more competitive, such companies may choose to purchase less or more of our
products or services. Microsoft does not currently offer its own media hosting
services, but it does own investments in competitive hosting services and it
encourages customers who use Microsoft technology to use hosting services that
compete with Real Broadcast Network.
Web Site Destinations, Content and Advertising. The number of Web
sites competing for advertising revenues is growing. Our Web sites and the
Real.com Network, including Real.com, RealNetworks.com, Real.com Guide, Take 5,
Film.com and LiveConcerts.com, compete for user traffic and Internet advertising
revenues with a wide variety of Web sites, Internet portals and ISPs. In
particular, aggregators of audio, video
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and other media, such as Yahoo! Broadcast Services and Microsoft's Windows Media
Guide, compete with our Real.com Guide. 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 many of our competitors. We
cannot be certain that advertisers will place advertising with us or that
revenues derived from such advertising will be meaningful. Certain recent
slowdowns in funding for Internet-related companies appears to have had a
negative effect on Internet advertising markets. 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 Web site traffic, our business could be harmed.
Electronic Commerce and Subscription Services. The electronic
commerce features of our Web sites compete with a variety of other Web sites for
consumer traffic. To compete successfully in the electronic commerce market, we
must attract sufficient traffic to our Web sites 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 recently introduced the
RealPlayer GoldPass subscription service, which provides customers access to a
combination of premium software, services and content, updated monthly, in
exchange for a monthly fee. While we intend for GoldPass to create meaningful
opportunities for long-term recurring revenue and enable us to deepen our
relationship with our end users through personalization of services to their
interests, it is too early to predict its acceptance by consumers or potential
for success in the market. We may not compete successfully in the growing and
rapidly changing market for electronic commerce and subscription services. Our
failure to do so could harm our business.
Increased competition may result in price reductions, reduced
margins, 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, now called the Real
Digital Distribution SDK, a digital music architecture enabling integration with
a wide range of Internet services and hardware devices. In May 1999, we released
a beta version of RealJukebox, our client software based on this new
architecture. In September 1999, we released commercial versions of RealJukebox
and RealJukebox Plus. These products represent an extension of our business into
downloadable media and local media delivery, which is a substantial evolution
from our historical focus on streaming media products and services. We do not
yet know whether there is a sustainable market for products such as 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 45 million copies of RealJukebox have been downloaded
since its beta release on May 3, 1999, it is too soon to determine whether
consumers will adopt RealJukebox as their primary application to play, record,
download and manage their digital music. Even if RealJukebox achieves a high
degree of 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. There
are a number of competitive products on the market that offer certain of the
features offered by RealJukebox. These products include WinAmp Player,
MusicMatch Jukebox, Sonique Player, Liquid Audio Player, a2b Player, AOL 6.0,
Windows Media Player and others. Because free versions are available for all of
these competing products, our ability to sell RealJukebox upgrades, and the
prices we charge, may be affected. Given the size and importance of the general
market for music distribution, competitors will likely release additional
products that directly compete with RealJukebox, which could harm our business.
Our competitors may develop new features and technology not available in
RealJukebox, including advanced codecs and digital rights management technology,
which could harm our business.
RealJukebox also faces competition from the emergence of widespread
peer-to-peer file sharing services and programs like Napster and Gnutella.
Napster recently announced an agreement under which Bertelsmann Music Group
would license its content to Napster for legal distribution as part of a
subscription program. Our inability to achieve widespread acceptance for
RealNetworks digital music architecture and RealJukebox or to create new revenue
streams from the new market segments, including digital music content, could
harm our business.
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We have announced that RealJukebox supports or will support a
variety of audio formats, including RealAudio G2, MP3, Liquid Audio, Mjuice,
Windows Media Audio, IBM's EMMS, and a2b. 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. In addition we must provide digital rights management solutions and
other security mechanisms in order to address concerns of content providers, and
we cannot be certain that we can develop, license or acquire such solutions, or
that consumers will accept them.
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 not make their desirable content available for download or
playback in formats supported by RealJukebox, may impose technical restrictions
designed to secure intellectual property rights that may impact the user
experience or demand for RealJukebox, or may refrain from or delay participating
in promotional opportunities with respect to RealJukebox.
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.
WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO INCREASE MARKET ACCEPTANCE OF
OUR PRODUCTS AND SERVICES
If third parties do not develop or offer compelling content to be
delivered over the Internet, or grant necessary licenses to us or our customers
to distribute or perform such content, our business will be harmed and our
products and services 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, Web sites 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, or downloaded using our download
products. While we have a number of short-term agreements with third parties to
provide content from their Web sites 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 than us that may enable it 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 Web
sites. 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. Current concerns regarding the
secure distribution of music over the Internet are causing content owners to
delay or refuse
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to make content available for distribution. Competitors could secure exclusive
distribution relationships with such content providers, which would harm our
business.
THE RATE STRUCTURE OF SOME OF OUR ADVERTISING AND SPONSORSHIP ARRANGEMENTS
SUBJECTS US TO FINANCIAL RISK
We generate advertising revenues in part through sponsored services
and placements by third parties in our products and on our Web sites, in
addition to banner advertising. We may receive sponsorship fees or a portion of
transaction revenues in return for minimum levels of user impressions to be
provided by us. These arrangements expose us to potentially significant
financial risks in the event our usage levels decrease, including the following:
- the fees we are entitled to receive may be adjusted downwards;
- we may be required to "make good" on our obligations by providing
alternative services;
- the sponsors may not renew the agreements or may renew at lower
rates; and
- the arrangements may not generate anticipated levels of shared
transaction revenues, or sponsors may default on the payment
commitments in such agreements.
Accordingly, any leveling off or decrease of our user base or the
failure to generate anticipated levels of shared transaction revenues could
result in a meaningful decrease in our revenue levels.
To the extent that our advertisers are experiencing slow-downs in
their businesses or tighter resources to fund advertising, our anticipated
revenue results could be harmed.
WE DEPEND ON KEY PERSONNEL WHO MAY NOT CONTINUE TO WORK FOR US
Our success substantially depends on the continued employment of our
executive officers and key employees, particularly Robert Glaser, our founder,
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. Each of these individuals has acquired specialized knowledge and
skills with respect to RealNetworks and its operations. As a result, if certain
individuals were to leave RealNetworks, we could face substantial difficulty in
hiring qualified successors and could experience a loss in productivity while
any such successor obtains the necessary training and experience. Several of our
personnel have reached or will soon reach the five-year anniversary of their
RealNetworks hiring date and, as a result, will have become or will shortly
become fully vested in their initial stock option grants. While most personnel
are typically granted additional stock options, which will usually vest over a
period of five years, subsequent to their hire date to provide additional
incentive to remain at RealNetworks, the initial option grant is typically the
largest and an employee may be more likely to leave our employ upon completion
of the vesting period for the initial option grant. 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. If we do not succeed in retaining and motivating existing
personnel, our business could be harmed.
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 in all areas, especially those with management and product
development skills. In particular, we must hire additional experienced
management personnel to help us continue to grow and manage our business, and
skilled software engineers to further our research and development efforts. At
times, we have experienced difficulties in hiring personnel with the proper
training or experience, particularly in technical areas. Competition for
qualified personnel is intense, particularly in high-technology centers such as
the Pacific Northwest, where our corporate headquarters are located. In making
employment decisions, particularly in the Internet and high-technology
industries, job candidates and even our current personnel 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
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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 968 on September 30, 2000. 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, purchasing, sales
and marketing functions. The purchase, implementation and testing of these
systems have resulted, and will result, in significant capital expenditures and
disruptions to our day-to-day operations. If these systems are not implemented
or do not operate 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.
POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS
As part of our business strategy, we have acquired technologies and
businesses in the past, and intend to do so in the future. The failure to
adequately address the financial and operational risks raised by acquisitions of
technology and businesses could harm our business. Acquisition or business
combination transactions are accompanied by a number of significant risks.
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 the correct assessment of the relative
percentages of in-process research and development expense that can
be immediately written off as compared to the amount which must be
amortized over the appropriate life of the asset; 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 and
the potential disruption of our ongoing business;
- the difficulty of incorporating acquired technology or content and
rights into our products and services and unanticipated expenses
related to such integrations;
- impairment of relationships with our employees, affiliates,
advertisers and content providers;
- inability to maintain uniform standards, controls, procedures and
policies;
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- 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 using the pooling of
interests method of accounting. We may not be able to use the pooling of
interests method of accounting for future acquisitions, which could result in
the future incurrence of substantial expenses relating to the amortization of
goodwill. The Xing transaction includes risk associated with the fact that most
of the Xing employees have remained in the San Lois Obispo, California office of
Xing and have not relocated to Seattle, which may make it more difficult to
successfully manage.
In January 2000, we acquired NetZip, Inc., a developer and marketer
of download management software, in a transaction that was accounted for using
the purchase method of accounting. The NetZip transaction poses particular
integration risks because NetZip has been based in Atlanta, Georgia, and we have
relocated its operations to Seattle, Washington. We may not adequately integrate
these or any future acquisitions, may not derive revenues from them and they may
pose substantial risks to our business.
We may not be successful in addressing the risks associated with the
above or other acquisitions and may encounter other problems as well.
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 ultimately be accepted as a viable commercial
medium for broadcasting multimedia content or media delivery for a number of
reasons which could inhibit the growth and use of the Internet, 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
digital media content or for media delivery;
- unavailability of compelling multimedia content;
- inadequate commercial support for Web-based advertising or
electronic commerce transactions; and
- delays in the development or adoption of new technological standards
and protocols, and increased governmental regulation, or
inconsistent regulations between state, federal and foreign
governments.
In addition, we believe that other Internet-related issues, such as
security, privacy, reliability, cost, speed, ease of use and access, quality of
service and necessary increases in bandwidth availability, remain largely
unresolved and may affect the amount and type of business that is conducted over
the Internet, and impact our ability to sell our products and services and
ultimately impact our business results.
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, Web sites have experienced interruptions
in service as a result of outages,
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system attacks and other delays occurring throughout the Internet network
infrastructure. If these outages, attacks or delays occur frequently or on a
broad scale in the future, Internet usage, as well as the usage of our products,
services and Web sites, 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 and especially the use of
media over the Internet 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 and media. 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;
- 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.
MORE INDIVIDUALS ARE UTILIZING NON-PC DEVICES TO ACCESS THE INTERNET AND WE MAY
NOT BE SUCCESSFUL IN DEVELOPING A VERSION OF OUR SERVICE THAT WILL GAIN
WIDESPREAD ADOPTION BY USERS OF SUCH DEVICES
In the coming years, the number of individuals who access the
Internet through devices other than a personal computer, such as personal
digital assistants, cellular telephones and television set-top devices, is
expected to increase dramatically. Our products and services are primarily
designed for rich, graphical environments such as those available on personal
and laptop computers. The lower resolution, functionality and memory associated
with alterative devices may make the use of our products and services through
such devices difficult, and we may be unsuccessful in our efforts to modify our
current products and services to provide a compelling experience for users of
alternative devices. As we have limited experience to date in creating versions
of our products and services optimized for users of alternative devices, it is
difficult to predict the problems we
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may encounter in doing so and we may need to devote significant resources to
create, support and maintain such versions. If we are unable to attract and
retain substantial number of alternative device manufacturers to license and
incorporate our technology into their devices, we will fail to capture a
sufficient share of an increasingly important portion of the market for digital
media delivery. Further, a failure to develop revenue-generating relationships
with enough device manufacturers whose products are adopted by a significant
number of device users could have a material adverse effect on our business,
operating results and financial condition.
WE COULD LOSE STRATEGIC RELATIONSHIPS THAT ARE ESSENTIAL TO OUR BUSINESS
The loss of certain current strategic relationships or key licensing
arrangements, 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:
- increase 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.
We would be unable to accomplish many of these goals without the
assistance of third parties. 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 or managing 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
The Internet and media distribution industries have 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 enter into relationships 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 Web sites and
product offerings;
- suppliers of important or emerging technologies could be acquired by
a competitor or other company which could prevent us from being able
to utilize such technologies in our offerings, and disadvantage our
offerings relative to those of competitors;
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- 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; and
- other companies with related interests could combine to form new,
formidable competition, which could preclude us from obtaining
access to certain markets or content, or which could dramatically
change the market for our products and services.
Announcements and consolidations that could affect our business include:
- AOL's plan to acquire Time-Warner;
- Bertelsmann Music Group's recent announcement that it would license
its content to Napster for legal distribution as part of a
subscription program, and make a substantial investment in Napster;
- Microsoft's investments in broadband cable, including its $5 billion
investment in AT&T, and Microsoft's strategic investments focusing
on content delivery networks and Internet service providers;
- Yahoo!'s acquisitions of Broadcast.com and GeoCities;
- The Walt Disney Company's combination of its Internet assets with,
and acquisition of a majority ownership of, Infoseek, to create a
single business called Go.com;
- Akamai's acquisition of Intervu.
OUR BUSINESS WILL SUFFER IF OUR SYSTEMS FAIL OR BECOME UNAVAILABLE
A reduction in the performance, reliability and availability of our
Web sites 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 Web sites and access the content services on our Web sites. Our systems
and operations are susceptible to, and could be damaged or interrupted by,
outages caused by fire, flood, power loss, telecommunications failure, Internet
breakdown, earthquake and similar events. Our systems are also subject to human
error, security breaches, power losses, computer viruses, break-ins, "denial of
service" attacks, sabotage, intentional acts of vandalism and tampering designed
to disrupt our computer systems, Web sites and network communications. A sudden
and significant increase in traffic on our Web sites 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 Web sites. 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 Web site operations and ability to
communicate with certain customers in response to the heavy volume of e-mail
transmissions we generate and send to our large user base. These types of
interruptions could continue or increase in the future.
Our electronic commerce and digital distribution activities are
managed by sophisticated software and computer systems. We continually develop
and update these systems over time as our business and business needs grow and
change, and these systems may not adequately reflect the current needs of our
business. 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 Web sites
could be less attractive to such entities or individuals and our business would
be harmed.
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Real Broadcast Network's business is dependent on providing
customers with efficient and reliable services to enable such customers to
broadcast content to large audiences on an as-needed basis. Real Broadcast
Network's operations are also dependent in part upon transmission capacity
provided by third-party telecommunications network providers. Any failure of
such network providers to provide the capacity we require may result in a
reduction in, or interruption of, service to our customers. If we do not have
access to third-party transmission capacity, we could lose customers and if we
are unable to obtain such capacity on terms commercially acceptable to us, our
business and operating results could suffer.
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 may not have adequate
business interruption insurance to compensate us for losses that may occur from
a system outage. Despite our efforts, our network infrastructure and systems
could be subject to service interruptions or damage and any resulting
interruption of services could harm our business, operating results and
reputation.
OUR NETWORK IS SUBJECT TO SECURITY RISKS THAT COULD HARM OUR BUSINESS AND
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:
- 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, system
interference or destruction, "denial of service" attacks and other
disruptive problems, whether intentional or accidental, that may
inhibit or prevent access to our Web sites or use of our products
and services;
- a third party could circumvent our security measures and
misappropriate our, our partners' and our customer's 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
business, hurt our ability to distribute products and services and collect
revenue, threaten the proprietary or confidential nature of our technology, harm
our reputation, and expose us to litigation or liability. For example, though we
have not personally been impacted by these events, in February 2000, many
commercial and governmental Web sites were the subject of intentional denial of
service attacks designed to disrupt or disable the operation of such Web sites.
Also, Microsoft recently announced that hackers had infiltrated its system and
may have accessed source code to certain of its products. We may be required to
expend significant capital or other resources to protect against the threat of
security breaches or hacker attacks or to alleviate problems caused by such
breaches or attacks.
OUR INTERNATIONAL OPERATIONS INVOLVE RISKS
We operate subsidiaries in Australia, England, France, Germany,
Japan, Mexico, Brazil and Hong Kong, and market and sell products in several
other countries. We have also entered into joint ventures internationally. For
the quarter ended September 30, 2000, approximately 28% of our revenues,
excluding revenues derived from our license agreement with Microsoft, were
derived from international operations.
A key part of our strategy is to develop localized products and
services in international markets through joint ventures, subsidiaries and
branch offices. To date, we have only limited experience in developing localized
versions of our products and services and marketing and operating our products
and services internationally, and we rely on the efforts and abilities of our
foreign business partners in such activities. We believe that in light of the
potential size of the customer base and the audience for content, and the
substantial anticipated competition,
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we need to continue to expand quickly into international markets in order to
effectively obtain and maintain market share. International markets we have
selected may not develop at a rate that supports our level of investment. In
particular, international markets typically have been slower in adoption of the
Internet as an advertising and commerce medium. In addition to uncertainty about
our ability to continue to generate revenues from our foreign operations and
expand our international presence, there are certain risks inherent in doing
business on an international level. 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;
- incompatible technology or distribution infrastructures, and
different or incompatible standards-based technologies;
- 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;
- longer payment cycles and problems in collecting accounts
receivable;
- potential adverse tax consequences;
- higher costs of doing business in foreign countries;
- seasonal reductions in business activity;
- exchange rate fluctuations;
- increased risk of piracy and limits on our ability to enforce our
intellectual property rights;
- the need to comply with different and often conflicting laws and
regulations; and
- other legal and political risks.
Any of these factors could harm our future international operations,
and consequently our business, operating results and financial condition. We do
not currently hedge our foreign currency exposures.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS AND MAY BE SUBJECT
TO INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS, WHICH ARE COSTLY TO DEFEND AND
COULD LIMIT OUR ABILITY TO USE CERTAIN TECHNOLOGIES IN THE FUTURE
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, 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
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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.
To protect our proprietary rights, 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.
These efforts to protect our intellectual property rights may not be effective
in preventing misappropriation of our technology, or may not prevent the
development and design by others of products or technologies similar to or
competitive with, or superior to those we develop which could reduce the value
of our intellectual property. Effective trademark, copyright and trade secret
protection may not be available in every country in which our products and
services are distributed or made available through the Internet, and while we
attempt to ensure that the quality of our brand is maintained by our licensees,
our licensees may take action that could materially and adversely affect the
value of our proprietary rights or the reputation of our products and services.
Portions of the distinctive elements of our products and Web sites may not be
available under copyright law. We cannot guarantee that the steps we have taken
to protect our proprietary rights will be adequate. As with other software
products, our products are susceptible to unauthorized copying and uses that may
go undetected, and policing such unauthorized use is difficult.
As of September 30, 2000, we had 32 registered U.S. trademarks or
service marks, and had applications pending for an additional 27 U.S.
trademarks. We also have several unregistered trademarks. In addition,
RealNetworks has several foreign trademark registrations and pending
applications. Many of our marks begin with the word "Real" (such as RealSystem,
RealAudio and RealVideo). We are aware of other companies that use "Real" in
their marks alone or in combination with other words, and we do not expect to be
able to prevent all third-party uses of the word "Real" for all goods and
services. In addition, the laws of some foreign countries do not protect our
proprietary rights to the same extent as the laws of the United States, and
effective patent, copyright, trademark and trade secret protection may not be
available in such jurisdictions.
As of September 30, 2000, we had twelve U.S. patents and numerous
patent applications on file relating to various aspects of our technology. We
are preparing additional patent applications on other features of our
technology. Patents with respect to our technology may not be granted and, if
granted, may be challenged or invalidated. Issued patents may not provide us
with any competitive advantages and may be challenged by third parties. In
addition, others could independently develop substantially equivalent
intellectual property.
Many of our current and potential competitors dedicate substantially
greater resources to protection and enforcement of their intellectual property
rights, especially patents. Many parties are actively developing streaming media
and digital distribution-related technologies, e-commerce and other Web-related
technologies, as well as a variety of online business methods and models. We
believe that these parties will continue to take steps to protect these
technologies, including, but not limited to seeking patent protection. As a
result, disputes regarding the ownership of these technologies and rights
associated with streaming media and digital distribution, and online businesses,
are likely to arise in the future. In addition to existing patents and
intellectual property rights, we anticipate that additional third-party patents
related to our products and services will be issued in the future. If a blocking
patent has issued or issues in the future, we would need to either obtain a
license or design around the patent. We may not be able to obtain such a license
on acceptable terms, if at all, or design around the patent.
Companies in the technology and content-related industries 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. In addition, we believe these industries are experiencing an
increased level of litigation to determine the applicability of current laws to,
and impact of new technologies on, the use and distribution of content over the
Internet and through new devices. The existence and/or outcome of such
litigation could involve us or affect our business.
From time to time we receive claims and inquiries from third parties
in the form of letters, lawsuits and other forms of communications, alleging
that our internally developed technology or technology we license from third
parties may infringe the third parties' proprietary rights, especially patents.
Third parties have also asserted and most likely will continue to assert claims
against us alleging infringement of copyrights, trademark rights,
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trade secret rights or other proprietary rights, or alleging unfair competition
or violations of privacy rights. We are now investigating several 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 and services 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 require us to change our business practices and harm our business.
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.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH GOVERNMENTAL REGULATION AND LEGAL
UNCERTAINTIES
Few existing laws or regulations specifically apply to the Internet,
other than laws and regulations generally applicable to businesses. Certain U.S.
export controls and import controls of other countries, including controls on
the use of encryption technologies, may apply to our products. However, many
laws and regulations are pending and may be adopted in the United States,
individual states and local jurisdictions 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, gambling,
sweepstakes, promotions, content regulation, quality of products and services,
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. In addition, state and local governments may impose
regulations in addition to, inconsistent with, or stricter than federal
regulations. 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.
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 Web sites or distributed or accessed through our
products or services, with our provision of products and services,
and with the features or performance of our products and Web sites;
- lead to increased product development costs, or otherwise harm our
business; or
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- decrease the rate of growth of our user base and limit our ability
to effectively communicate with and market to our user base.
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 may be required to pay
licensing fees for digital 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 plan to engage
in arbitration before a tribunal of the United States Copyright Office with the
Recording Industry Association of America during 2001 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 (COPPA) were enacted in October 1998. The COPPA 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
knowingly collect and disclose personal information from such minors. The manner
in which the COPPA may be interpreted and enforced cannot be fully determined,
and future legislation similar to the COPPA 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.
There are a large number of legislative proposals before the United
States Congress and various state legislatures regarding privacy issues related
to our business. It is not possible to predict whether or when such legislation
may be adopted, and certain proposals, if adopted, could materially and
adversely affect our business through a decrease in user registration and
revenue, and influence how and whether we can communicate with our customers.
WE MAY BE SUBJECT TO MARKET RISK AND LEGAL LIABILITY IN CONNECTION WITH THE DATA
COLLECTION CAPABILITIES OF OUR PRODUCTS AND SERVICES
Many of our products are interactive Internet applications that by
their very nature require communication between a client and server to operate.
To provide better consumer experiences and to operate effectively, our products
occasionally send information to servers at RealNetworks. Many of the services
we provide also require that a user provide certain information to us. We post
privacy policies concerning the use, collection and disclosure of our user data.
Any failure by us to comply with our posted privacy policies and existing or new
legislation regarding privacy issues could impact the market for our products
and services, subject us to litigation and harm our business.
Between November 1999 and March 2000, fourteen lawsuits were filed
against us in federal and/or state courts in California, Illinois, Pennsylvania,
Washington and Texas. The plaintiffs in federal court in Pennsylvania and in
Illinois state court have voluntarily dismissed their lawsuits. The remaining
twelve actions, which seek to certify classes of plaintiffs, allege breach of
contract, invasion of privacy, deceptive trade practices, negligence, fraud and
violation of certain federal and state laws in connection with various
communications features of our RealPlayer and RealJukebox products. Plaintiffs
are seeking both damages and injunctive relief. We have filed answers denying
the claims and have filed suit in Washington state court to compel the state
court plaintiffs to arbitrate their claims as required by our End User License
Agreements. On February 10, 2000, the federal Judicial Panel on Multidistrict
Litigation transferred all pending federal cases to the federal district court
for the Northern District of Illinois. On the same day, that court granted
RealNetworks' motion to stay the court proceedings because the claims are
subject to arbitration under our End User License Agreement. Although no
assurance can be given as to the outcome of these lawsuits, we believe that the
allegations in these actions are without merit, and intend to vigorously defend
ourselves. If the plaintiffs prevail in their claims, we could be
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required to pay damages or other penalties, in addition to complying with
injunctive relief, which could harm our business and our operating results.
WE MAY BE SUBJECT TO LEGAL LIABILITY FOR THE PROVISION OF THIRD-PARTY PRODUCTS,
SERVICES OR CONTENT
We periodically enter into arrangements to offer third-party
products, services or content under the RealNetworks brand or via distribution
on our Web sites, in products or service offerings. We may be subject to claims
concerning these products, services or content by virtue of our involvement in
marketing, branding, broadcasting or providing access to them, even if we do not
ourselves host, operate, provide, or provide access to these products, services
or content. While our agreements with these parties often provide that we will
be indemnified against such liabilities, such indemnification may not be
adequate. It is also possible that, if any information provided directly by us
contains errors or is otherwise negligently provided to users, third parties
could make claims against us, including, for example, for defamation,
negligence, copyright or trademark infringement, unlawful activity, or tort,
including personal injury, fraud, or other theories based on the nature and
content of information to which we provide links. Investigating and defending
any of these types of claims is expensive, even to the extent that the claims do
not result in liability. If the claims do result in liability, we could be
required to pay damages or other penalties, which could harm our business and
our operating results.
REALNETWORKS' DIRECTORS AND EXECUTIVE OFFICERS BENEFICIALLY OWN APPROXIMATELY
44.8% OF OUR STOCK; THEIR INTERESTS COULD CONFLICT WITH YOURS; SIGNIFICANT SALES
OF STOCK HELD BY THEM COULD HAVE A NEGATIVE EFFECT ON REALNETWORKS' STOCK PRICE;
SHAREHOLDERS MAY BE UNABLE TO EXERCISE CONTROL
As of September 30, 2000, our executive officers, directors and
affiliated persons beneficially own approximately 44.8% of our common stock.
Robert Glaser, our chief executive officer and chairman of the board,
beneficially owns approximately 34.0% of our common stock. As a result, our
executive 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.
As a result of their ownership and positions, our directors and
executive officers collectively are able to significantly influence all matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. In addition, sales of significant amounts
of shares held by RealNetworks directors and executive officers, or the prospect
of these sales, could adversely affect the market price of RealNetworks common
stock. 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
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(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 Web sites 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:
- 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.
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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
September 30, 2000, the price of our common stock ranged from $29.625 to $96.00
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 or relationships
with our key customers;
- conditions or trends in the Internet, streaming media, 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;
- legal, regulatory or political developments;
- additions or departures of key personnel;
- sales of our common stock; and
- general market conditions.
The historical volatility of our stock price may make it more
difficult for you to resell shares when you want at prices you find attractive.
Sharp increases in our stock price could have a negative impact on our financial
condition.
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 has and may in the future reduce our stock price,
regardless of our operating performance.
WE MAY BE SUBJECT TO ASSESSMENT OF SALES AND OTHER TAXES FOR THE SALE OF OUR
PRODUCTS, LICENSE OF TECHNOLOGY OR PROVISION OF SERVICES
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.
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WE DONATE A PORTION OF NET INCOME TO CHARITY
For the year ended December 31, 1999 and the nine months ended
September 30, 2000, we were profitable (before goodwill amortization,
acquisition charges, and stock-based compensation) and set aside 5% of our
pretax net income for donations to charity. If we sustain profitability, we
intend to donate such 5% of our annual net income (before goodwill amortization,
acquisition charges, and stock-based compensation) to charitable organizations,
and plan to begin to make charitable donations in the fourth quarter of 2000.
This will reduce our net income. We have recently incorporated the non-profit
RealNetworks Foundation to manage our charitable giving efforts.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this document, all of
which are subject to risks and uncertainties. When we use words such as
"believe," "intend," "plan," "expect" and "anticipate" or similar words, we are
making forward-looking statements. 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 features and functionality of our future products, services and
technologies;
- 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 cost of revenues, research and
development, sales and marketing and general and administrative
expenses);
- future sales and marketing efforts;
- future capital needs;
- 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; and
- the effect of current litigation in which we are involved;
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
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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.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements.
Interest Rate Risk. Our exposure to market rate risk for changes in
interest rates relates primarily to our short-term investment portfolio. We do
not hold derivative financial instruments or equity investments in our
short-term investment portfolio. Our cash equivalents and short-term investments
consist of high quality securities, as specified in our investment policy
guidelines. Investments in both fixed rate and floating rate interest-earning
instruments carry a degree of interest rate risk. The fair value of fixed rate
securities may be adversely affected by a rise in interest rates, while floating
rate securities may produce less income than expected if interest rates fall.
Due in part to these factors, our future interest income may be adversely
affected by changes in interest rates. In addition, we may incur losses in
principal if we sell securities that have declined in market value due to
changes in interest rates. If market interest rates were to increase immediately
and uniformly by 10% from levels at December 31, 1999, the fair value of the
short-term investment portfolio would decline by an immaterial amount. Because
we have historically had the ability to hold short-term investments until
maturity and the substantial majority of our investments mature within one year
of purchase, we do not expect our operating results or cash flows to be
significantly impacted by a sudden change in market interest rates.
Investment Risk. As of September 30, 2000, we had investments in
voting capital stock of privately-held, technology companies for business and
strategic purposes. These investments are included in other assets and are
accounted for under the cost method since ownership in each case is less than
20% and we do not have significant influence. Our policy is to regularly review
the operating performance in assessing the carrying value of the investments. To
date, no impairment has been recorded. We have an investment in a joint venture
and account for this investment using the equity method. We also have
investments in voting common stock of publicly traded, technology companies for
business and strategic purposes. These investments are subject to significant
fluctuations in fair market value due to the volatility of the stock market. The
cost of our investments in publicly traded equity securities was $17,999,000 and
the related carrying value was $9,246,000 at September 30, 2000.
Foreign Currency Risk. International revenues from our foreign
subsidiaries accounted for approximately 28% of total net revenues in the
quarter ended September 30, 2000, (excluding revenues from the Microsoft license
agreement). These subsidiaries incur most of their expenses in the local
currency. Accordingly, all foreign subsidiaries use the local currency as their
functional currency.
Our international business is subject to risks typical of an
international business, including, but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, foreign exchange rate volatility, and other
factors discussed in this document. Accordingly, our future results could be
materially adversely impacted by changes in these or other factors.
Our exposure to foreign exchange rate fluctuations arises in part
from intercompany payables and receivables to and from our foreign subsidiaries.
These intercompany accounts are typically denominated in the functional currency
of the foreign subsidiary in order to centralize foreign exchange risk with the
parent company in the United States. We are also exposed to foreign exchange
rate fluctuations as the financial results of foreign subsidiaries are
translated into U.S. dollars in consolidation. As exchange rates vary, these
results, when translated, may vary from expectations and adversely impact
overall expected profitability. The effect of foreign exchange rate fluctuations
on us for the quarter and nine months ended September 30, 2000 was not material.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against the Company and co-defendant Broadcast.com in the United States District
Court for the Northern District of Texas--Dallas Division. The plaintiffs allege
that the Company, individually and in combination with Broadcast.com, infringes
on the plaintiffs' 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 the Company from
its alleged infringing activity and to recover damages in an amount no less than
a reasonable royalty. Although no assurance can be given as to the outcome of
this lawsuit, the Company believes that the allegations in this action are
without merit, and intends to vigorously defend itself against these claims. The
Company may be required to indemnify Broadcast.com under the terms of its
license agreement. 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 the Company and
Broadcast.com. If the plaintiffs prevail in their claims, the Company could be
required to pay damages or other royalties, in addition to complying with
injunctive relief, which could have a material adverse effect on the Company's
operating results.
Between November 1999 and March 2000, fourteen lawsuits were filed
against the Company in federal and/or state courts in California, Illinois,
Pennsylvania, Washington and Texas. The plaintiffs in federal court in
Pennsylvania and in Illinois state court have voluntarily dismissed their
lawsuits. The remaining twelve actions, which seek to certify classes of
plaintiffs, allege breach of contract, invasion of privacy, deceptive trade
practices, negligence, fraud and violation of certain federal and state laws in
connection with various communications features of the RealPlayer and
RealJukebox products. Plaintiffs are seeking both damages and injunctive relief.
The Company has filed answers denying the claims and has filed suit in
Washington state court to compel the state court plaintiffs to arbitrate their
claims as required by our End User License Agreements. On February 10, 2000, the
federal Judicial Panel on Multidistrict Litigation transferred all pending
federal cases to the federal district court for the Northern District of
Illinois. On the same day, that court granted RealNetworks' motion to stay the
court proceedings because the claims are subject to arbitration under
RealNetworks' End User License Agreement. Although no assurance can be given as
to the outcome of these lawsuits, the Company believes that the allegations in
these actions are without merit, and intends to vigorously defend itself. If the
plaintiffs prevail in their claims, the Company could be required to pay damages
or other penalties in addition to complying with injunctive relief, which could
harm our business and our operating results.
From time to time RealNetworks is, and expects to continue to be,
subject to legal proceedings and claims in the ordinary course of its business,
including employment claims, 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 the Company to spend
significant financial and managerial resources. The Company currently has a
number of such claims threatened against it relating to intellectual property
infringement or employment, though it believes these claims are without merit.
The Company is not aware of any legal proceedings or claims that the Company
believes will have, individually or taken together, a material adverse effect on
the Company's business, prospects, financial condition or results of operations.
However, the Company may incur substantial expenses in defending against third
party claims. In the event of a determination adverse to the Company, the
Company may incur substantial monetary liability, and/or be required to change
its business practices. Either of these could have a material adverse effect on
the Company's financial position and results of operations.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Between July 1, 2000 and September 30, 2000, the Company has issued
and sold unregistered securities as follows:
(1) An aggregate of 109,835 shares of Common Stock was issued in
July 2000 in connection with a business combination. The
aggregate consideration received for such shares was valued at
approximately $2,021,130.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Required by Item 601 of Regulation S-K:
27.1 Financial Data Schedule which is submitted electronically to
the Securities and Exchange Commission for information
purposes only and is not filed
(b) Reports on Form 8-K:
None
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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 November 14, 2000.
REALNETWORKS, INC.
By /s/ Paul Bialek
---------------------------------------------------
Paul Bialek
Senior Vice President, Finance and Operations,
Chief Financial Officer, and Treasurer
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INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
27.1 Financial Data Schedule which is submitted
electronically to the Securities and
Exchange Commission for information
purposes only and is not filed
</TABLE>
