<PAGE> 1
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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 April
30, 2000 was 155,191,557.
<PAGE> 2
REALNETWORKS, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements ...................................................................... 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................ 39
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................................................... 40
Item 2. Changes in Securities and Use of Proceeds ................................................. 40
Item 6. Exhibits and Reports on Form 8-K .......................................................... 40
</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>
March 31, December 31,
2000 1999
--------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 348,685 344,627
Trade accounts receivable, net of allowances for doubtful
accounts and sales returns 9,901 6,895
Prepaid expenses and other current assets 4,792 2,870
--------- ---------
Total current assets 363,378 354,392
Equipment and leasehold improvements, at cost:
Equipment and software 25,768 21,142
Leasehold improvements 15,628 15,129
--------- ---------
Total equipment and leasehold improvements 41,396 36,271
Less accumulated depreciation and amortization 12,064 10,101
--------- ---------
Net equipment and leasehold improvements 29,332 26,170
--------- ---------
Goodwill, net 127,352 6,920
Restricted cash equivalents 13,700 13,700
Other assets 28,067 9,942
--------- ---------
TOTAL ASSETS $ 561,829 411,124
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,681 6,305
Accrued and other liabilities 30,479 26,944
Deferred revenue, excluding non-current portion 47,409 47,316
--------- ---------
Total current liabilities 85,569 80,565
--------- ---------
Deferred rent 1,603 --
Deferred revenue, excluding current portion 11,761 --
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 300,000 shares; issued and outstanding
154,402 shares in 2000 and 149,648 shares in 1999 154 150
Additional paid-in capital 642,362 366,177
Deferred stock compensation (125,352) --
Accumulated deficit (53,686) (34,865)
Accumulated other comprehensive loss (582) (903)
--------- ---------
Total shareholders' equity 462,896 330,559
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 561,829 411,124
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements
-3-
<PAGE> 4
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Quarter Ended March 31,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
Net revenues:
Software license fees $ 34,103 17,837
Service revenues 11,018 5,249
Advertising 8,407 1,266
--------- ---------
Total net revenues 53,528 24,352
--------- ---------
Cost of revenues:
Software license fees 4,348 2,857
Service revenues 2,585 920
Advertising 1,591 550
--------- ---------
Total cost of revenues 8,524 4,327
--------- ---------
Gross profit 45,004 20,025
--------- ---------
Operating expenses:
Research and development (excluding non-cash stock based
compensation of $17,755 in 2000 and $0 in 1999, included below) 11,620 7,601
Sales and marketing (excluding non-cash stock based compensation
of $866 in 2000 and $0 in 1999, included below) 22,600 10,460
General and administrative 6,933 3,207
Goodwill amortization, acquisitions charges, and stock
based compensation 27,572 532
--------- ---------
Total operating expenses 68,725 21,800
--------- ---------
Operating loss (23,721) (1,775)
Other income, net 4,900 717
--------- ---------
Net loss $ (18,821) (1,058)
========= =========
Basic and diluted net loss per share $ (0.12) (0.01)
========= =========
Shares used to compute basic and
diluted net loss per share 151,589 135,784
Comprehensive loss:
Net loss $ (18,821) (1,058)
Unrealized gain on short-term investments 381 --
Foreign currency translation adjustment (60) (115)
--------- ---------
Comprehensive loss $ (18,500) (1,173)
========= =========
</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>
QUARTER ENDED MARCH 31,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
Net cash provided by operating activities $ 23,132 6,193
Cash flows from investing activities:
Purchases of equipment and leasehold improvements (4,417) (7,496)
Purchases of short-term investments (85,376) (25,244)
Proceeds from sales and maturities of short-term
investments 103,859 8,144
Purchase of investments (17,997) --
Payment of acquisition costs (3,018) --
Cash obtained through acquisition 73 --
--------- ---------
Net cash used in investing activities (6,876) (24,596)
--------- ---------
Cash flows from financing activities:
Net proceeds from exercise
of stock options 6,299 842
--------- ---------
Net cash provided by financing activities 6,299 842
--------- ---------
Effect of exchange rate changes on cash (395) (116)
--------- ---------
Net increase (decrease) in cash and cash equivalents 22,160 (17,677)
Cash and cash equivalents at beginning of period 160,955 51,900
--------- ---------
Cash and cash equivalents at end of period 183,115 34,223
Short-term investments at end of period 165,570 55,001
--------- ---------
Total cash, cash equivalents and short-term investments at end
of period $ 348,685 89,224
========= =========
</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.
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 ended March 31, 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 January 28, 2000. Accordingly, the
accompanying condensed consolidated financial statements and related notes
thereto have been retroactively restated to reflect the stock splits.
The condensed consolidated financial statements have been prepared to
give retroactive effect to the merger with Xing Technology Corporation (Xing) on
August 10, 1999. 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.
-6-
<PAGE> 7
(c) Cash, Cash Equivalents and Short-Term Investments
Cash, cash equivalents and short-term investments are comprised of the
following:
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999
-------------- -----------------
(in thousands)
<S> <C> <C>
Cash and cash equivalents $183,115 160,955
Short-term investments 165,570 183,672
-------- --------
Total cash, cash equivalents and
short-term investments $348,685 344,627
======== ========
Restricted cash equivalents $ 13,700 13,700
======== ========
</TABLE>
Restricted cash equivalents represent a restricted escrow account
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. The remaining $3,700,000 will be released as the Company funds
tenant improvements. The Company took occupancy of the new facilities during the
quarter ended June 30, 1999.
(d) Revenue Recognition
The Company recognizes revenue in accordance with 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 anticipates providing ongoing
support to the OEM in the form of future upgrades, enhancements or other
services over the term of the contract, revenue is recognized on the
straight-line method over the term of the contract.
Service revenues include payments under support and upgrade contracts
and fees from consulting and streaming media content hosting. Support and
upgrade revenues are recognized ratably over the term of the contract, which
typically is twelve months. Other service revenues are recognized when the
service is performed.
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.
In December 1998, the American Institute of Certified Public Accounts
(AICPA) issued Statement of Position 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions" (SOP 98-9), which
amends certain elements of SOP 97-2, "Software Revenue Recognition" and is
effective for
-7-
<PAGE> 8
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 ended March 31, 2000
consisted of net loss, unrealized gains on short-term investments and the gross
amount of foreign currency translation adjustments. The Company's comprehensive
loss for the quarter ended March 31, 1999 consisted of net loss and the gross
amount of foreign currency translation adjustments. The tax effect of the
foreign currency translation adjustments and unrealized gains on short-term
investments was insignificant.
(f) Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed by dividing net loss by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. As the Company had a net loss attributable to common shareholders for
the quarters ended March 31, 2000 and 1999, 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 ended March 31, 2000 are options and warrants to acquire approximately
39,392,000 shares of common stock with a weighted-average exercise price of
$23.53. Also excluded 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 loss per share for the quarter ended March 31, 1999
are options and warrants to acquire approximately 36,008,000 shares of common
stock with a weighted-average exercise price of $6.81. Such potentially dilutive
securities were excluded, as their effects are anti-dilutive.
(g) Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 (FIN No. 44), "Accounting for Certain Transactions
Involving Stock Compensation, an interpretation of APB Opinion No. 25" FIN No.
44 will be effective July 1, 2000. This interpretation provides guidance for
applying APB Opinion No. 25 "Accounting for Stock Issued to Employees." The
Company does not expect the adoption of FIN No. 44 to have a material impact on
its consolidated financial statements.
In March 2000, the Emerging Issues Task Force (EITF) 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 cost in quarters
beginning after June 30, 2000. The company has not yet determined the impact, if
any, this Issue will have on its consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model
for accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning after
June 15, 2000. SFAS 133 requires that all derivatives be recognized in the
balance sheet at their fair market value, and the corresponding derivative gains
or losses be either reported in the statement of operations or as a component of
other comprehensive income
-8-
<PAGE> 9
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.
In December 1999, the United States Securities and Exchange Commission
(SEC) released Staff Accounting Bulletin No. 101 (SAB 101) "Revenue Recognition
in Financial Statements," which was adopted by the Company on January 1, 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 did not 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, the Company's Chief
Operating Officer, and the Company's Senior Vice Presidents. The COC reviews
financial information presented on a consolidated basis accompanied by
disaggregated information about products and services and geographical region
for purposes of making decisions and assessing financial performance. The COC
does not review discrete financial information regarding profitability of the
Company's different products or services and, therefore, the Company does not
have operating segments as defined by SFAS 131.
The Company's customers consist primarily of end users located in the
United States and various foreign countries. Revenues by geographic region are
as follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended
March 31,
--------------------
2000 1999
------- -------
<S> <C> <C>
North America $38,555 16,817
Europe 6,353 2,786
Asia 4,852 1,975
Rest of the world 1,151 357
------- -------
Subtotal 50,911 21,935
Microsoft license revenue 2,617 2,417
------- -------
Total $53,528 24,352
======= =======
</TABLE>
Revenue from external customers by product type is as follows (in thousands):
<TABLE>
<CAPTION>
Quarter Ended
March 31,
--------------------
2000 1999
------- -------
<S> <C> <C>
Media delivery license revenue $31,486 15,420
Media delivery service revenue 11,018 5,249
Microsoft license revenue 2,617 2,417
Advertising revenue 8,407 1,266
------- -------
Total net revenues $53,528 24,352
======= =======
</TABLE>
-9-
<PAGE> 10
Long-lived assets by geographic location are as follows (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
--------- ------------
<S> <C> <C>
United States $155,691 32,273
Asia and rest of the world 665 446
Europe 328 371
-------- --------
Total $156,684 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.
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>
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<PAGE> 11
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 recognition of the
expenses relatng to these amounts are shown below (in thousands):
<TABLE>
<CAPTION>
Years ended December 31, Goodwill Stock Based
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>
For the quarters ended March 31, goodwill amortization and acquisition charges
by acquisition are shown below (in thousands):
<TABLE>
<CAPTION>
(in thousands) 2000 1999
----- -----
<S> <C> <C>
Vivo (1998 acquisition) $ 532 532
NetZip 8,419 --
------ -----
$8,951 532
====== =====
</TABLE>
In connection with the acquisition, the Company incurred approximately
$6.1 million in acquisition-related expenditures, including $3.5 million of
relocation payments and stay bonuses for former NetZip employees and $2.6
million in professional fees and other costs. As of March 31, 2000,
approximately $3.0 million of these costs have been paid. The remaining costs
are expected to be paid during 2000. The costs of the stay bonuses will be
recognized over the related service period.
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 represented, nor is it necessarily indicative of results that may occur
in the future.
<TABLE>
<CAPTION>
Quarter ended March 31,
-----------------------
2000 1999
-------- --------
(in thousands)
<S> <C> <C>
Total net revenue $ 54,498 25,597
Net loss $(28,185) (37,227)
Net loss per share - basic and diluted $ (0.19) (0.27)
</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.
-11-
<PAGE> 12
Separate results for the combined entities for the quarter ended March 31, 1999
are as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Revenue
RealNetworks, Inc. $23,525
Xing 827
-------
$24,352
=======
Net income loss
RealNetworks, Inc. $ (736)
Xing (322)
-------
$(1,058)
=======
</TABLE>
There were no significant intercompany transactions between the two
companies and no significant conforming accounting adjustments.
Goodwill Amortization, Acquisition Charges and Stock Based Compensation
Goodwill amortization, acquisition charges and stock based compensation
is as follows:
<TABLE>
<CAPTION>
Quarter ended March 31,
-----------------------
2000 1999
--------- --------
(in thousand)
<S> <C> <C>
Goodwill Amortization and Acquisition Charges $ 8,951 532
Stock Based Compensation 18,621 --
------- ---
Total $27,572 532
======= ===
</TABLE>
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.
On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against the
Company in the U.S. District Court for the Western District of Washington. The
plaintiff alleges that the Company entered into an oral agreement with it in
1995 pursuant to which the plaintiff claims it is entitled to 30 percent of
RealNetworks' revenues from the use of RealAudio technology to promote, sample
or sell music. The plaintiff claims breach of contract, unjust enrichment,
promissory estoppel and breach of implied-in-fact contract. The Company has
denied each of the plaintiff's claims. In response to RealNetworks' motion to
dismiss, the plaintiff withdrew its claim for breach of fiduciary duty. Trial
had been set for June 2000. The parties have engaged in extensive settlement
negotiations, and RealNetworks believes that a settlement of this action may be
finalized in the near future. To allow the parties time to finalize such
settlement, the Court, on its own motion, has dismissed this action without
prejudice. Although no assurance can be given at this time as to the outcome of
this lawsuit, and in the event that a settlement is not finalized between the
parties and the action is reinstated RealNetworks intends to vigorously defend
itself against these claims. If the plaintiffs prevail in their claims, the
Company could be required to pay damages, which could have a material, adverse
effect on the Company's operating results.
Between November 1999 and March 2000, a total of fourteen purported
class action lawsuits were filed against us in state and/or federal 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 in response to our motions to compel arbitration of the
claims under the terms of our End User License Agreements. 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 various answers denying the claims
and have filed suit in Washington state court to compel the plaintiffs who have
filed actions in Texas, California and Illinois state courts to arbitrate their
claims as required by our End User License Agreements. On February 10, 2000, the
federal district court for the Northern District of Illinois granted our motion
to stay the court proceedings in that case because the claims are subject to
arbitration under our End User License Agreements. Also on that date, the
federal Judicial Panel on Multidistrict Litigation transferred all federal cases
pending at that time to the federal court in Illinois that has ruled that the
claims are arbitrable. Plaintiffs in the transferred federal cases are seeking
to overturn the district court's ruling that the claims must be arbitrated.
Although we can give no assurance as to the outcome of these lawsuits, we
believe the allegations in these actions are without merit, and we intend to
vigorously defend ourselves against these claims. If the plaintiffs prevail in
their claims, we could be required to pay damages or other penalties, in
addition to complying with injunctive relief, which could have a material
adverse effect on 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 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 several claims
threatened against it relating to patent infringement, though believes they 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 and
results of operations.
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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 115 million registered users of our RealPlayer product and
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.
We were incorporated in February 1994 and were in the development stage
until July 1995, when we released the commercial version of RealAudio Version
1.0, the first version of our RealPlayer products. From inception through
December 31, 1995, our operating activities related primarily to recruiting
personnel, raising capital, purchasing operating assets, conducting research and
development, building the RealAudio brand and establishing the market for
streaming audio. During 1996, we continued to invest heavily in research and
development and marketing and in building our domestic and international sales
channels and our general and administrative infrastructure. In August 1996, we
began selling RealPlayer Plus, a premium version of our RealPlayer product.
RealPlayer has always been available for download free of charge from our Web
sites. In June 1997, we released the commercial version of RealVideo Version
4.0. In December 1997, we released the commercial version of RealSystem Version
5.0, a streaming media solution that included RealAudio and RealVideo
technology. In November 1998, we released the commercial version of RealSystem
G2, our latest 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 new 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 PC games.
We report revenues in three categories:
- Software license fees, which include revenues from sales of our
RealPlayer Plus, RealJukebox Plus, RealSlideshow Plus, Xing
AudioCatalyst, Download Demon, RealServers and related authoring and
publishing tools, sales of our products through OEM channels, and
sales of third-party products.
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- Service revenues, which include support and maintenance services that
we sell to customers who purchase our RealPlayer Plus, RealJukebox
Plus, RealServers and tools products, 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 leading 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 high performance, 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 have 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 $34.1 million for the
quarter ended March 31, 2000, an increase of 91% from $17.8 million in the
comparable quarter of the prior year. The increase was due primarily to a
greater volume of products sold as a result of growth in the demand for media
delivery on the Internet. In addition, we introduced new products, including
RealJukebox Plus and RealSlideshow Plus released in September 1999, and products
associated with the NetZip acquisition in January 2000. Revenue also increased
as a result of sales of our products to companies deploying content distribution
networks. Software license fees for the quarter ended March 31, 2000 and 1999
included $2.6 million and $2.4 million, respectively, related to the Microsoft
license agreement we entered into in June 1997.
Service Revenues. Service revenues were $11.0 million for the quarter
ended March 31, 2000, an increase of 110% from $5.2 million in the comparable
quarter of the prior year. The increase was primarily attributable to a larger
installed base of our server products and related increases in sales of support
and upgrades, 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.
Advertising Revenues. Advertising revenues were $8.4 million for the
quarter ended March 31, 2000, an increase of 564% from $1.3 million in the
comparable quarter of the prior year. The increase in advertising revenues was
due to increased traffic on our Web sites, the increased effectiveness of our
advertising sales force that resulted in increased advertising sales and higher
average advertising rates, and increased revenue associated with increased usage
and distribution of RealChannels, LiveStations, search functionality, and other
advertisements and promotional links included in the RealPlayer and RealJukebox
products.
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Geographic Revenues. Excluding revenues from the Microsoft license
agreement, international revenues represented 24% of total net revenues for the
quarter ended March 31, 2000 and 23% of total net revenues for the quarter ended
March 31, 1999. Revenues generated in Europe were 12% of total net revenues for
the quarter ended March 31, 2000 and 13% of total net revenue for the quarter
ended March 31, 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 quarter ended March 31, 2000 and 11% of total net revenues for
the quarter ended March 31, 1999 (excluding revenues from the Microsoft license
agreement).
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 $4.3 million for the quarter
ended March 31, 2000, an increase of 52% from $2.9 million in the comparable
quarter of the prior year, but decreased as a percentage of software license
fees to 13% from 16%. The increase in absolute dollars was due primarily to
higher sales volumes. The decrease as a percentage of software license fees was
due primarily to changes in the mix of products sold.
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing support and consulting services and
expenses incurred in providing our streaming media hosting services. Cost of
service revenues was $2.6 million for the quarter ended March 31, 2000, an
increase of 181% from $0.9 million in the comparable quarter of the prior year,
and increased as a percentage of service revenues to 23% from 18%. The increase
in cost of service revenues was 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, expansion of customer service
and technical support into international regions, and support costs related to
the introduction of RealJukebox.
Cost of Advertising Revenues. Cost of advertising revenues includes
personnel and related costs associated with development and 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
$1.6 million for the quarter ended March 31, 2000, an increase of 189% from $0.6
million in the comparable quarter of the prior year, but decreased as a
percentage of advertising revenues to 19% from 43%. The increase in absolute
dollars was primarily due to increases in the quality and quantity of content
available on our Web sites, enhancements made to existing Web sites, and the
addition of new Web sites. The decrease as a percentage of advertising revenues
was due to greater economies of scale.
Our gross margins may be adversely affected by the mix of distribution
channels used and/or the mix of products sold.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of salaries and consulting fees associated with product development
and costs of technology acquired from third parties to incorporate into products
currently under development. To date, all research and development costs have
been expensed as incurred because technological feasibility is generally not
established until substantially all development is complete. We believe that
significant investment in research and development is a critical factor in
attaining our strategic objectives and, as a result, we expect to increase
research and development expenditures in future periods. Research and
development expenses were $11.6 million for the quarter ended March 31, 2000, an
increase of 53% from $7.6 million in the comparable quarter of the prior year.
Such expenses decreased as a percentage of total net revenues to 22% from 31%.
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, sales commissions, consulting fees, tradeshow expenses, advertising
costs and cost of marketing collateral. We intend to increase our
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branding and marketing efforts and, therefore, expect sales and marketing
expenses to increase in future periods. Sales and marketing expenses were $22.6
million for the quarter ended March 31, 2000, an increase of 116% from $10.5
million in the comparable quarter of the prior year. Such expenses decreased as
a percentage of total net revenues to 42% from 43%. The increase in absolute
dollars was due to the expansion of our direct sales and marketing organization,
the creation of additional foreign and domestic sales offices, increased
advertising, and attendance at trade shows. The decrease in percentage terms was
a result of revenues growing at a faster rate than expenses.
General and Administrative. General and administrative expenses consist
primarily of salaries 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 $6.9 million for the quarter ended March 31, 2000, an increase of 116% from
$3.2 million in the comparable quarter of the prior year. These expenses as a
percentage of total net revenues stayed consistent at 13% for both the quarter
ended March 31, 2000 and 1999. The increase in absolute dollars was primarily a
result of increased personnel and litigation defense costs.
Goodwill Amortization, Acquisition Charges and Stock Based Compensation
In March 1998, we acquired Vivo Software, Inc. (Vivo), a developer of
streaming media creation tools. The acquisition was accounted for using the
purchase method of accounting and, accordingly, the results of Vivo'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. A portion of the purchase price represents acquired in-process
research and development that had not yet reached technological feasibility and
had no alternative future use. Of the total purchase price, $8.6 million was
allocated to in-process research and development expense, $10.6 million was
allocated to goodwill, and $0.5 million was allocated to tangible assets.
Goodwill is amortized over its estimated life of five years.
In August 1999, we acquired Xing Technology Corporation, a provider of
high performance, 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., (NetZip) 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 acquisition, the Company incurred approximately
$6.1 million in acquisition-related expenditures. These expenditures included
$3.5 million in relocation payments and $2.6 million in professional fees and
other costs. As of March 31, 2000, approximately $3.0 million of these costs had
been paid. The remaining costs are expected to be paid during 2000.
Also as part of the Company's acquisition of NetZip, the Company issued
common stock to the 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 March 31, 2000 was $18.6 million.
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OTHER INCOME, NET
Other income, net consists primarily of earnings on our cash, cash
equivalents and short-term investments. Other income, net was $4.9 million and
$0.7 million for the quarters ended March 31, 2000 and 1999, respectively. The
increase was primarily due to higher invested cash balances primarily as a
result of our secondary public offering of common stock completed during the
second quarter of 1999.
INCOME TAXES
At March 31, 2000, we had provided a full valuation allowance on our
deferred tax assets because of uncertainties regarding recoverability.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $23.1 million and $6.2
million for the quarter ended March 31, 2000 and 1999, respectively. Net cash
provided by operating activities for the quarter ended March 31, 2000 resulted
primarily from income from operations of $8.8 million (excluding $27.6 million
related to goodwill amortization, acquisition charges, and stock based
compensation) an increase in deferred revenue of $11.6 million, an increase in
accrued and other liabilities of $3.5 million, and depreciation of $1.9 million.
This was partially offset by an increase in accounts receivable of $2.7 million.
Net cash provided by operating activities for the quarter ended March 31, 1999
resulted primarily from an increase in current liabilities and the reported net
loss excluding the non-cash charges associated with depreciation and
amortization.
Net cash used in investing activities was $6.9 million and $24.6 million
for the quarter ended March 31, 2000 and 1999, respectively, and was primarily a
result of net purchases of short-term investments and purchases of equipment and
leasehold improvements.
Net cash provided by financing activities was $6.3 million and $0.8
million for the quarter ended March 31, 2000 and 1999, respectively, and was a
result of net proceeds from the exercise of stock options.
At March 31, 2000, we had $348.7 million in cash, cash equivalents and
short-term investments. As of March 31, 2000, our principal commitments
consisted of obligations under operating leases. Since our inception, we have
experienced a substantial increase in our capital expenditures to support
expansion of our operations and information systems.
In January 1998, we entered into a lease agreement for a new location
for our corporate headquarters. The lease commenced on April 1, 1999 and expires
on April 1, 2011, with an option to renew the lease for either a three-or
ten-year period. We are funding the tenant improvements for our 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 held
our fixed income investments until maturity, we would not expect our operating
results or cash flows to be significantly affected by a sudden change in market
interest rates on our securities portfolio.
We conduct our operations in 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 rates. We invoice our international
customers primarily in U.S. dollars, except in Japan, where we invoice our
customers primarily in yen. We are exposed to
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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 June 1997, we entered into a strategic agreement with Microsoft
pursuant to which we granted Microsoft a nonexclusive license to certain
substantial elements of the source code of our RealAudio/RealVideo Version 4.0
technology and related RealNetworks trademarks for a license fee of $30.0
million. We are recognizing revenue related to the agreement ratably over the
three-year term of our ongoing obligations. In the quarter ending June 30, 2000
we will recognize the remaining deferred balance of this contract of $2.6
million. Microsoft may sublicense its rights to the licensed source code to
third parties under certain conditions without further compensation to
RealNetworks. Under certain conditions, if we license our source code to a third
party, the agreement provides for a partial refund of the license fee paid by
Microsoft, based on a declining scale over the three-year term of the agreement.
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 continue to monitor for latent problems that could
surface at key dates or events in the future. 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; 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 March 31, 2000, we had an accumulated
deficit of approximately $53.7 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 on a quarterly
or annual basis in the future.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
As a result of our limited operating history and the rapidly changing
nature of the markets in which we compete, our quarterly and annual revenues and
operating results are likely to fluctuate from period to period. These
fluctuations may be caused by a number of factors, many of which are beyond our
control. These factors include the following, as well as others discussed
elsewhere in this section:
- how and when we introduce new products and services and enhance our
existing products and services;
- our ability to retain existing customers, attract new customers and
satisfy our customers' demands;
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- 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;
- varying operating costs and capital expenditures related to the
expansion of our business operations and infrastructure, domestically
and internationally, including the hiring of new employees;
- technical difficulties with our products, system downtime, system
failures or interruptions in Internet access;
- costs 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. To the extent that these predictions
prove inaccurate, our revenues and operating expenses may fluctuate.
For these reasons, you should not rely on period-to-period comparisons
of our financial results as indications of future results. Our future operating
results could fall below the expectations of public market analysts or investors
and significantly reduce the market price of our common stock. Fluctuations in
our operating results will likely increase the volatility of our stock price.
WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT AND OTHER COMPANIES IN
THE MEDIA DELIVERY MARKET
The market for software and services for media delivery over the
Internet is relatively new, constantly changing and intensely competitive. As
media delivery evolves into a central component of the Internet experience, more
companies are entering the market for, and expending increasing resources to
develop, media delivery software and services. We expect that competition will
continue to intensify. 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 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;
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- the availability of content for delivery over the Internet and access
to necessary intellectual property rights;
- the ability to license or develop and support secure formats for
digital media delivery, particularly music and video;
- the 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; and
- challenges caused by bandwidth constraints and other limitations of
the Internet infrastructure.
Our failure to adequately address any of the above factors could harm
our business strategy and operating results.
Microsoft is a principal competitor in the development and distribution
of streaming media and media distribution technology. Microsoft currently
competes with us in the market for streaming media server and player software
and has announced its intent to compete in the market for digital distribution
of media. 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 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), 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 we expect this trend to continue, which may cause such customers
to stop using or reduce their use of our products and services. 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.
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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 bundled by Microsoft with its Windows 98 operating system and with
its Web browser, Internet Explorer. Microsoft recently announced its plan to
bundle the Windows Media Player with its Windows Millennium edition operating
system, a significant focus of which will be media delivery. In addition,
Microsoft has bundled certain audio capabilities into a radio toolkit for
Internet Explorer 5.0. Internet Explorer 5.0 also includes Web Events, 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 system and its browser, Microsoft will distribute substantially
more copies of the Windows Media Player in the future than it has in the past
and may be able to attract more users to its streaming or digital media
products. Currently, our RealPlayer has a high degree of market penetration: we
have over 115 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. In addition, Microsoft has invested in certain
digital distribution technologies that compete with RealJukebox, such as the
MusicMatch Jukebox. The MusicMatch Jukebox supports the Windows Media format,
but not RealSystem G2 formats. Microsoft has also released an early version of
its own jukebox product incorporated into the Windows Media Player. 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.
In addition, Microsoft 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. 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 has made available 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. Other competitors include, but are not
limited to, Cisco Systems/Precept Software, and Oracle Corporation. Companies
such as AOL and Yahoo! and many smaller competitors offer various products that
compete with our player and jukebox products. As more companies enter the market
with products that compete with our servers, players and tools, the competitive
landscape could change rapidly to our disadvantage.
We do not believe that clear standards have emerged with respect to
non-PC wireless and cable-based systems. Likewise, no one company has gained a
dominant position in the mobile device market. However, certain products and
services in these markets support our technology, and certain support our
competitors' technology, especially 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, which
could reduce demand for our products or render them obsolete.
In addition, our streaming media and media delivery products face
competition from "fast download" media delivery technologies such as AVI,
QuickTime and MP3. Other fast download or non-streaming IP-based content
distribution methods are likely to emerge and could compete with our products
and services, which could harm our business.
WE MAY BE UNABLE TO SUCCESSFULLY COMPETE IN OTHER PARTS OF OUR BUSINESS
Media Hosting. Our media hosting service, the Real Broadcast Network,
competes with a variety of companies that provide streaming media hosting
services. These companies include Yahoo! Broadcast Services (formerly
Broadcast.com), Akamai/Intervu and emerging broadcast networks such as CMGI's
Magnitude
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Network, Enron Communications, GlobalMedia and Microcast. 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 site 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. While Internet
advertising revenues across the industry continue to grow, the number of Web
sites competing for advertising revenues is also growing. Our Web sites and the
Real.com Network, including Real.com, RealNetworks.com, Real.com Guide, Take 5,
Musicnet, 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 and other media, such as Yahoo!
Broadcast Services and Microsoft's Web Events, compete with our RealGuide. We
also compete with traditional media such as television, radio and print for a
share of advertisers' total advertising budgets. Our advertising sales force and
infrastructure are still in early stages of development relative to those of our
competitors. We cannot be certain that advertisers will place advertising with
us or that revenues derived from such advertising will be meaningful. If we lose
advertising customers, fail to attract new customers, are forced to reduce
advertising rates or otherwise modify our rate structure to retain or attract
customers, or if we lose Web site traffic, our business could be harmed.
Electronic Commerce. 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 may not compete successfully in the growing and
rapidly changing market for electronic commerce. Our failure to do so could harm
our business.
Increased competition may result in price reductions, reduced margins,
loss of customers, and a change in our business and marketing strategies, any of
which could harm our business.
WE MAY NOT BE SUCCESSFUL IN THE MARKET FOR DOWNLOADABLE MEDIA AND LOCAL MEDIA
DELIVERY
In May 1999, we announced the RealSystem MP, a digital music
architecture enabling integration with a wide range of Internet services and
hardware devices. In May 1999, we released RealJukebox, our client software
based on the RealSystem MP. 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 RealSystem MP and RealJukebox. Even if that market exists, we may be
unable to develop a revenue model or sufficient demand to take advantage of the
market opportunity.
While over 25 million copies of RealJukebox have been downloaded since
its beta release on May 3, 1999, and over 250,000 copies of RealJukebox Plus
have been sold since its introduction in September 1999, it is too soon to
determine if RealJukebox will be widely received in the marketplace. There are
now a number of competitive products on the market that offer certain of the
features that RealJukebox offers. These products include WinAmp Player,
MusicMatch Jukebox, Liquid Audio Player and a2b Player. In addition, given the
size and importance of the general market for music distribution, competitors
will likely release products that directly compete with RealJukebox, which could
harm our business. Even if RealJukebox achieves widespread market acceptance, it
may not achieve a high level of use, which would lead to a low rate of upgrade
sales and electronic commerce opportunities. Our inability to achieve widespread
acceptance for RealSystem MP and RealJukebox or to create new revenue streams
from new market segments could harm our business.
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,
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technical formats and consumer preferences evolve very rapidly, and we may be
unable to adequately address consumer preferences or fulfill the market demand
to the extent it exists.
We have had long-term relationships with recording companies, including
major record labels, many of which offer their streaming content in our formats.
However, recording companies, including those with whom we have a relationship,
may be uncomfortable with some features of RealJukebox. As a result, some record
companies may decide to withhold content from RealJukebox, or refrain from or
delay participating in promotional opportunities with respect to RealJukebox.
RealJukebox is intended to allow users of the product to acquire,
record, play back and manage music for their personal use. It is possible for a
user of RealJukebox to elect not to use the copyright-protection features it
contains and then violate the intellectual property rights of artists and
recording companies by engaging in an unauthorized distribution of music. The
laws governing the recording, distribution and performance of digital music are
new and largely untested. While we believe we have developed RealJukebox to
comply with U.S. copyright laws, a court may find us in violation of these laws.
Similar action or other litigation in the United States or abroad directed at us
could harm our business, even if such litigation were entirely without merit. In
addition, we may be required to pay royalties associated with the digital
distribution and performance of music, which could adversely impact our
financial results.
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.
POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS
The failure to adequately address the financial and operational risks
raised by acquisitions of technology and businesses could harm our business. We
have acquired complementary technologies and businesses in the past, and intend
to do so in the future. Financial risks related to acquisitions include:
- potentially dilutive issuances of equity securities;
- use of cash resources;
- the incurrence of additional debt and contingent liabilities;
- large write-offs; and
- amortization expenses related to goodwill and other intangible assets.
Acquisitions also involve operational risks, including:
- difficulties in assimilating the operations, products, technology,
information systems and personnel of the acquired company;
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- diversion of management's attention from other business concerns;
- impairment of relationships with our employees, affiliates,
advertisers and content providers;
- inability to maintain uniform standards, controls, procedures and
policies;
- the assumption of known and unknown liabilities of the acquired
company;
- entrance into markets in which we have no direct prior experience; and
- loss of key employees of the acquired company.
In August 1999, we acquired Xing Technology Corporation, an MP3 software
developer, in a transaction that was accounted for 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. In January 2000, we acquired NetZip, 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.
WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO INCREASE MARKET ACCEPTANCE OF
OUR PRODUCTS
If third parties do not develop or offer compelling content to be
delivered over the Internet, our business will be harmed and our products may
not achieve or sustain broad market acceptance. We rely on third-party content
providers, such as radio and television stations, record labels, media
companies, 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. 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 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 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:
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- 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.
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 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 management
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, specifically those with management and product development
skills. In particular, we must hire additional skilled software engineers to
further our research and development efforts. At times, we have experienced
difficulties in hiring personnel with the right 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 often consider
the value of stock options they may receive in connection with their employment.
As a result of recent volatility in our stock price, we may be disadvantaged in
competing with companies that have not experienced similar volatility or that
have not yet sold their stock publicly. If we do not succeed in attracting new
personnel or retaining and motivating our current personnel, our business could
be harmed.
WE MAY NOT SUCCESSFULLY MANAGE OUR GROWTH
We cannot successfully implement our business model if we fail to manage
our growth. We have rapidly and significantly expanded our operations
domestically and internationally and anticipate further expansion to take
advantage of market opportunities. We have increased the number of our full-time
employees from 325 on January 1, 1998 to 798 on March 31, 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
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resulted, and will result, in significant capital expenditures and could disrupt
our day-to-day operations. If these systems are not implemented as expected, our
ability to provide products and services to our customers on a timely basis will
suffer and delays in the recording and reporting of our operating results could
occur.
THE GROWTH OF OUR BUSINESS DEPENDS ON THE INCREASED USE OF THE INTERNET FOR
COMMUNICATIONS, ELECTRONIC COMMERCE AND ADVERTISING
The growth of our business depends on the continued growth of the
Internet as a medium for communications, electronic commerce and advertising.
Our business will be harmed if Internet usage does not continue to grow,
particularly as a source of media information and entertainment and as a vehicle
for commerce in goods and services. Our success also depends on the efforts of
third parties to develop the infrastructure and complementary products and
services necessary to maintain and expand the Internet as a viable commercial
medium. The Internet may not be accepted as a viable commercial medium for
broadcasting multimedia content or media delivery for a number of reasons,
including:
- potentially inadequate development of the necessary infrastructure to
accommodate growth in the number of users and Internet traffic;
- lack of acceptance of the Internet as a medium for distributing
streaming media content or for media delivery;
- unavailability of compelling multimedia content;
- inadequate commercial support for Web-based advertising; and
- delays in the development or adoption of new technological standards
and protocols or increased governmental regulation, which could
inhibit the growth and use of the Internet.
In addition, we believe that other Internet-related issues, such as
security, reliability, cost, ease of use and quality of service, remain largely
unresolved and may affect the amount of business that is conducted over the
Internet.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by such growth, specifically the demands of
delivering high-quality media content. As a result, its performance and
reliability may decline. In addition, Web sites have experienced interruptions
in service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently in
the future, Internet usage, as well as the usage of our products, services and
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 may depend on the availability of
greater bandwidth or data transmission speeds (also known as broadband
transmission). If broadband access becomes widely available, we believe it
presents both a substantial opportunity and a significant business challenge for
us. Internet access through cable television set-top boxes, digital subscriber
lines or wireless connections could dramatically reduce the demand for our
products and services by utilizing alternate technology that more efficiently
transmits data. This could harm our business as currently conducted.
Development of products and services for a broadband transmission
infrastructure involves a number of additional risks, including:
- changes in content delivery methods and protocols;
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- the availability of compelling content that takes advantage of
broadband access and helps drive market acceptance of our products and
services;
- the emergence of new competitors, such as traditional broadcast and
cable television companies, which have significant control over access
to content, substantial resources and established relationships with
media providers;
- the development of relationships by our current competitors with
companies that have significant access to or control over the
broadband transmission infrastructure or content;
- the need to establish new relationships with non-PC based providers of
broadband access, such as providers of television set-top boxes and
cable television, some of which may compete with us; and
- the general risks of new product and service development, including
the challenges to develop error-free products and enhancements,
develop compelling services and achieve market acceptance for these
products and services.
We depend on the efforts of third parties to develop and provide a
successful infrastructure for broadband transmission. Even if broadband access
becomes widely available, heavy use of the Internet may negatively impact the
quality of media delivered through broadband connections. If these third parties
experience delays or difficulties establishing a widespread broadband
transmission infrastructure or if heavy usage limits the broadband experience,
the release of our broadband products and services could be delayed. Even if a
broadband transmission infrastructure is developed for widespread use, our
products and services may not achieve market acceptance or generate sufficient
revenues to offset our development costs.
WE COULD LOSE STRATEGIC RELATIONSHIPS THAT ARE ESSENTIAL TO OUR BUSINESS
The loss of certain current strategic relationships 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 strategic relationships. In
addition, the efforts of our strategic partners may be unsuccessful.
Furthermore, these strategic relationships may be terminated before we realize
any benefit.
OUR INDUSTRY IS EXPERIENCING CONSOLIDATION THAT MAY INTENSIFY COMPETITION
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The Internet industry has recently experienced substantial consolidation
and a proliferation of strategic transactions. We expect this consolidation and
strategic partnering to continue. Acquisitions or strategic relationships could
harm us in a number of ways. For example:
- competitors could acquire or 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;
- 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:
- Microsoft's strategic investments in broadband initiatives, including
its $5 billion investment in AT&T;
- AT&T's acquisition of TCI and its proposed acquisition of MediaOne
Communications;
- At Home's acquisition of Excite;
- 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;
- NBC's merger of its Internet assets with XOOM.com, Inc. and Snap.com,
a subsidiary of CNET;
- AOL's recent announcement that it intends to acquire Time-Warner, and
Time-Warner's announcement that it intends to form a joint venture
with EMI Music; and
- Akamai's recent announcement of its planned 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
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. Our computer and communications infrastructure
is located at a single leased facility in Seattle, Washington. We do not have
fully redundant systems or a formal disaster recovery plan, and we do not carry
adequate business interruption insurance to compensate us for losses that may
occur from a system outage.
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Our electronic commerce and digital distribution activities are managed
by sophisticated software and computer systems. We may encounter delays in
developing these systems, and the systems may contain undetected errors that
could cause system failures. Any system error or failure that causes
interruption in availability of products or content or an increase in response
time could result in a loss of potential or existing business services
customers, users, advertisers or content providers. If we suffer sustained or
repeated interruptions, our products, services and Web sites could be less
attractive to such entities or individuals and our business would be harmed.
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 in response to the heavy volume of e-mail transmission we generate
and send to our large user base. These types of interruptions could continue or
increase in the future.
OUR NETWORK IS SUBJECT TO SECURITY RISKS THAT COULD HARM OUR REPUTATION AND
EXPOSE US TO LITIGATION OR LIABILITY
Online commerce and communications depend on the ability to transmit
confidential information securely over public networks. Any compromise of our
ability to transmit confidential information securely, and costs associated with
preventing or eliminating any problems, could harm our business. Online
transmissions are subject to a number of security risks, including:
- 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
reputation and expose us to litigation or liability. 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.
We may also 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. For the quarter ended March 31, 2000, approximately 25% of our
revenues, excluding revenues derived from our license agreement with Microsoft,
were derived from international operations.
We have also entered into joint ventures internationally. A key part of
our strategy is to develop localized products and services in international
markets. To date, we have only limited experience in developing localized
versions of our products 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. International markets we have selected may not
develop at a rate that supports our level of investment. In particular,
international markets typically have been
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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;
- unexpected changes in regulatory requirements;
- export and import restrictions, including those restricting the use of
encryption technology;
- tariffs and trade barriers and limitations on fund transfers;
- difficulties in staffing and managing foreign operations;
- longer payment cycles and problems in collecting accounts receivable;
- potential adverse tax consequences;
- exchange rate fluctuations;
- increased risk of piracy and limits on our ability to enforce our
intellectual property rights; and
- other legal and political risks.
Any of these factors could harm our business. We do not currently hedge
our foreign currency exposures.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS
Our inability to protect our proprietary rights, and the costs of doing
so, could harm our business. Our success and ability to compete partly depend on
the superiority, uniqueness or value of our technology, including both
internally developed technology and technology licensed from third parties. To
protect our proprietary rights, we rely on a combination of patent, trademark,
copyright and trade secret laws, confidentiality agreements with our employees
and third parties, and protective contractual provisions. Despite our efforts to
protect our proprietary rights, unauthorized parties may copy or infringe
aspects of our technology, products, services or trademarks, or obtain and use
information we regard as proprietary. Our proprietary rights may be especially
difficult to protect in foreign countries, where unrelated third parties may
have registered our domain names and trademarks under their own names in an
attempt to prevent us from using the domain names and trademarks in those
countries without paying them a significant sum of money. This could prevent us
from using our valuable brands in those countries, and reduce the value of our
intellectual property. In addition, others may independently develop
technologies that are similar or superior to ours, which could reduce the value
of our intellectual property.
As of March 31, 2000, we had 30 registered U.S. trademarks or service
marks, and had applications pending for an additional 23 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
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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 March 31, 2000, we had 13 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. 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. 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.
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 those we develop.
Companies in the computer industry have frequently resorted to
litigation regarding intellectual property rights. We may have to litigate to
enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of other parties' proprietary rights. From time
to time, other parties' proprietary rights, including patent rights, have come
to our attention and on several occasions we have received notice of claims of
infringement of other parties' proprietary rights, and we may receive such
notices in the future.
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against us and co-defendant Broadcast.com in the United States District Court
for the Northern District of Texas - Dallas Division. The plaintiffs allege that
we, individually and in combination with Broadcast.com, infringe on a certain
patent by making, using, selling and/or offering to sell software products and
services directed to media delivery systems for the Internet and corporate
intranets. The plaintiffs seek to enjoin us from the alleged infringing activity
and to recover damages in an amount no less than a reasonable royalty. We
believe the allegations are without merit and intend to vigorously defend
ourselves against these claims. However, litigation is inherently uncertain, and
we may be unable to successfully defend ourselves against this claim.
From time to time we receive claims and inquiries from third parties
alleging that our internally developed technology or technology we license from
third parties may infringe the third parties' proprietary rights. We are now
investigating 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 while we re-engineer
them or seek licenses to necessary technology, which might not be available on
reasonable terms. We could also be subject to claims for indemnification
resulting from infringement claims made against our customers and strategic
partners, which could increase our defense costs and potential damages. Any of
these events could harm our business.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH GOVERNMENTAL REGULATION AND LEGAL
UNCERTAINTIES
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, it is
likely that a number of laws and regulations may be adopted in the United States
and other countries with respect to the Internet. These laws may relate to areas
such as content issues (such as obscenity, indecency and defamation), copyright
and other intellectual property rights, encryption, use of key escrow data,
caching of content by server products, electronic
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authentication or "digital signatures," personal privacy, advertising, taxation,
electronic commerce liability, e-mail, network and information security and the
convergence of traditional communication services with Internet communications,
including the future availability of broadband transmission capability. Other
countries and political organizations are likely to impose or favor more and
different regulation than that which has been proposed in the United States,
thus furthering the complexity of regulation. 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, and 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
- 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 will be required to pay
licensing fees for sound recordings we deliver in original and archived
programming and through retransmissions of radio broadcasts. The DMCA does not
specify the rate and terms of the licenses, which will be determined either
through voluntary inter-industry negotiations or arbitration. We will engage in
arbitration with the Recording Industry Association of America during 2000 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.
WE MAY BE SUBJECT TO MARKET RISK AND LEGAL LIABILITY IN CONNECTION WITH THE DATA
COLLECTION CAPABILITIES OF OUR PRODUCTS AND SERVICES
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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 and disclosure of our user data. Any failure
by us to comply with our posted privacy policies could impact the market for our
products and services, subject us to litigation and harm our business.
Between November 1999 and March 2000, a total of fourteen purported
class action lawsuits were filed against us in state and/or federal 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 in response to our motions to compel arbitration of the
claims under the terms of our End User License Agreements. 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 various answers denying the claims
and have filed suit in Washington state court to compel the plaintiffs who have
filed actions in Texas, California and Illinois state courts to arbitrate their
claims as required by our End User License Agreements. On February 10, 2000, the
federal district court for the Northern District of Illinois granted our motion
to stay the court proceedings in that case because the claims are subject to
arbitration under our End User License Agreements. Also on that date, the
federal Judicial Panel on Multidistrict Litigation transferred all federal cases
pending at that time to the federal court in Illinois that has ruled that the
claims are arbitrable. Plaintiffs in the transferred federal cases are seeking
to overturn the district court's ruling that the claims must be arbitrated.
Although we can give no assurance as to the outcome of these lawsuits, we
believe the allegations in these actions are without merit, and we intend to
vigorously defend ourselves against these claims. If the plaintiffs prevail in
their claims, we could be required to pay damages or other penalties, in
addition to complying with injunctive relief, which could have a material
adverse effect on 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
various RealNetworks' Web sites or in RealNetworks' products. 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
defamation, negligence, copyright or trademark infringement, unlawful activity,
tort, including personal injury, fraud, or other theories based on the nature
and content of information that we provide links to. Investigating and defending
any of these types of claims is expensive, even to the extent that the claims do
not result in liability.
REALNETWORKS' DIRECTORS AND EXECUTIVE OFFICERS BENEFICIALLY OWN APPROXIMATELY
45.8% 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 December 31, 1999, our executive officers, directors and
affiliated persons beneficially own approximately 45.8% of our common stock.
Robert Glaser, our chief executive officer and chairman of the board,
beneficially owns approximately 34.6% 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
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- 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
(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.
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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.
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 March 31,
2000, the price of our common stock ranged from $25.50 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, media streaming, media delivery
and online commerce markets;
- changes in the market valuations of other Internet, online service or
software companies;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
- legal or regulatory developments;
- additions or departures of key personnel;
- sales of our common stock; and
- general market conditions.
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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 may reduce our stock price, regardless of our
operating performance. The trading prices of the stocks of many technology
companies are at or near historical highs and reflect price-earnings ratios
substantially above historical levels. These trading prices and price-earnings
ratios may not be sustained.
WE MAY BE SUBJECT TO ASSESSMENT OF SALES AND OTHER TAXES FOR THE SALE OF OUR
PRODUCTS, LICENSE OF TECHNOLOGY OR PROVISION OF SERVICES
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.
WE INTEND TO DONATE A PORTION OF NET INCOME TO CHARITY
For the year ended December 31, 1999, we were profitable and donated 5%
of our pretax net income to charity. If we sustain profitability, we intend to
donate 5% of our annual net income excluding amortization of goodwill and stock
based compensation expense to charitable organizations. 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. Forward-looking statements include
information concerning our possible or assumed future business success or
financial results. Such forward-looking statements include, but are not limited
to, statements as to our expectations regarding:
- the future development and growth of, and opportunities for, the
Internet and the online media delivery market;
- the future adoption of our current and future products, services and
technologies;
- future revenue opportunities;
- the future growth of our customer base;
- our ability to successfully develop and introduce future products and
services;
- future international revenues;
- future expense levels (including cost of revenues, research and
development, sales and marketing and general and administrative
expenses);
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- 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;
When we use words such as "believe," "expect" and "anticipate" or
similar words, we are making forward-looking statements.
You should note that an investment in our common stock involves certain
risks and uncertainties that could affect our future business success or
financial results. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in "Factors That May Affect Our Business, Future
Operating Results and Financial Condition" and elsewhere in this Quarterly
Report on Form 10-Q.
We believe that it is important to communicate our expectations to our
investors. However, there may be events in the future that we are not able to
predict accurately or over which we have no control. Before you invest in our
common stock, you should be aware that the occurrence of the events described in
the "Factors That May Affect Our Business, Future Operating Results and
Financial Condition" and elsewhere in this Quarterly Report on Form 10-Q could
materially and adversely affect our business, financial condition and operating
results. We undertake no obligation to publicly update any forward-looking
statements for any reason, even if new information becomes available or other
events occur in the future.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of interest rate changes and change
in the market values of its investments.
Interest Rate Risk. The Company's exposure to market rate risk for
changes in interest rates relates primarily to the Company's short-term
investment portfolio. The Company does not hold derivative financial instruments
or equity investments in its short-term investment portfolio. The Company's cash
equivalents and short-term investments consist of high quality securities, as
specified in the Company's 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
impacted due to 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, the Company's future interest income may be adversely impacted due to
changes in interest rates. In addition, the Company may incur losses in
principal if it is forced to sell securities which have declined in market value
due to changes in interest rates. Because the Company has historically held its
short-term investments until maturity and the substantial majority matures
within one year of purchase, the Company would not expect its operating results
or cash flows to be significantly impacted by a sudden change in market interest
rates.
Investment Risk. As of March 31, 2000, the Company had an investment in
voting capital stock of a privately-held, technology company for business and
strategic purposes. This investment is included in other assets and is accounted
for under the cost method since ownership is less than 20% and the Company does
not have significant influence. The securities do not have a quoted market
price. The Company's policy is to regularly review the operating performance in
assessing the carrying value of the investment. The Company also had an
investment in voting capital stock of a publicly traded, technology company for
business and strategic purposes. The investment is subject to significant
fluctuations in fair market value due to the volatility of the stock market.
The Company reviews its long-lived assets, including goodwill, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable.
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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.
On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against the
Company in the U.S. District Court for the Western District of Washington. The
plaintiff alleges that the Company entered into an oral agreement with it in
1995 pursuant to which the plaintiff claims it is entitled to 30 percent of
RealNetworks' revenues from the use of RealAudio technology to promote, sample
or sell music. The plaintiff claims breach of contract, unjust enrichment,
promissory estoppel and breach of implied-in-fact contract. The Company has
denied each of the plaintiff's claims. In response to RealNetworks' motion to
dismiss, the plaintiff withdrew its claim for breach of fiduciary duty. Trial
had been set for June 2000. The parties have engaged in extensive settlement
negotiations, and RealNetworks believes that a settlement of this action may be
finalized in the near future. To allow the parties time to finalize such
settlement, the Court, on its own motion, has dismissed this action without
prejudice. Although no assurance can be given at this time as to the outcome of
this lawsuit, and in the event that a settlement is not finalized between the
parties and the action is reinstated RealNetworks intends to vigorously defend
itself against these claims. If the plaintiffs prevail in their claims, the
Company could be required to pay damages, which could have a material, adverse
effect on the Company's operating results.
Between November 1999 and March 2000, a total of fourteen purported
class action lawsuits were filed against us in state and/or federal 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 in response to our motions to compel arbitration of the
claims under the terms of our End User License Agreements. 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 various answers denying the claims
and have filed suit in Washington state court to compel the plaintiffs who have
filed actions in Texas, California and Illinois state courts to arbitrate their
claims as required by our End User License Agreements. On February 10, 2000, the
federal district court for the Northern District of Illinois granted our motion
to stay the court proceedings in that case because the claims are subject to
arbitration under our End User License Agreements. Also on that date, the
federal Judicial Panel on Multidistrict Litigation transferred all federal cases
pending at that time to the federal court in Illinois that has ruled that the
claims are arbitrable. Plaintiffs in the transferred federal cases are seeking
to overturn the district court's ruling that the claims must be arbitrated.
Although we can give no assurance as to the outcome of these lawsuits, we
believe the allegations in these actions are without merit, and we intend to
vigorously defend ourselves against these claims. If the plaintiffs prevail in
their claims, we could be required to pay damages or other penalties, in
addition to complying with injunctive relief, which could have a material
adverse effect on 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 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 several claims
threatened against it relating to patent infringement, though believes they 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 and
results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Since January 1, 2000, the Company has issued and sold unregistered
securities as follows:
(1) An aggregate of 3,235,180 shares of Common Stock was issued in
January 2000 to fourteen individuals in exchange for all of the
outstanding shares of common stock of NetZip, Inc., a Georgia
corporation. The aggregate consideration received for such
shares was valued at approximately $130 million.
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:
On January 26, 2000, RealNetworks filed a report on Form 8-K that
announced that RealNetworks had acquired all of the outstanding capital stock of
NetZip, Inc., and that the Board of Directors had approved a 2-for-1 stock split
of its common stock.
On February 8, 2000 RealNetworks filed a report on Form 8-K/A that
amended the Form 8-K filed on January 26, 2000, in connection with its
acquisition of NetZip, Inc. to include financial statements, pro forma financial
information and exhibits.
On February 8, 2000 RealNetworks filed a report on form 8-K that
included audited consolidated financial statements of RealNetworks, Inc. and
subsidiaries as of December 31, 1998 and 1997, and for each of the years in the
three-year period ended December 31, 1998 and related financial statement
schedule to give retroactive effect to the acquisition of Xing which was
accounted for as a pooling of interests.
-40-
<PAGE> 41
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 May 12, 2000.
REALNETWORKS, INC.
By /s/ Paul Bialek
---------------------------------
Paul Bialek
Senior Vice President, Finance
and Operations, Chief Financial
Officer, and Treasurer
-41-
<PAGE> 42
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>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 183,115
<SECURITIES> 165,570
<RECEIVABLES> 11,769
<ALLOWANCES> 1,868
<INVENTORY> 13
<CURRENT-ASSETS> 363,378
<PP&E> 41,396
<DEPRECIATION> 12,064
<TOTAL-ASSETS> 561,829
<CURRENT-LIABILITIES> 85,569
<BONDS> 0
0
0
<COMMON> 154
<OTHER-SE> 462,742
<TOTAL-LIABILITY-AND-EQUITY> 561,829
<SALES> 0
<TOTAL-REVENUES> 53,528
<CGS> 0
<TOTAL-COSTS> 8,524
<OTHER-EXPENSES> 68,725
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (18,821)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,821)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,821)
<EPS-BASIC> (.12)
<EPS-DILUTED> (.12)
</TABLE>
