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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 July 31,
2000 was 156,301,462.
2
REALNETWORKS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2000
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements......................................................................3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....14
Item 3. Quantitative and Qualitative Disclosures About Market Risk...............................42
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................................................43
Item 2. Changes in Securities and Use of Proceeds................................................44
Item 6. Exhibits and Reports on Form 8-K.........................................................45
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands except per share data)
June 30, December 31,
2000 1999
--------- ---------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 341,746 344,627
Trade accounts receivable, net of allowances for doubtful
accounts and sales returns 10,424 6,895
Prepaid expenses and other current assets 6,192 2,870
--------- ---------
Total current assets 358,362 354,392
Equipment and leasehold improvements, at cost:
Equipment and software 28,903 21,142
Leasehold improvements 18,253 15,129
--------- ---------
Total equipment and leasehold improvements 47,156 36,271
Less accumulated depreciation and amortization 14,018 10,101
--------- ---------
Net equipment and leasehold improvements 33,138 26,170
--------- ---------
Goodwill, net of accumulated amortization of $23,300
at June 30, 2000 and $3,724 at December 31, 1999 116,040 6,920
Restricted cash equivalents 13,000 13,700
Other assets 37,486 9,942
--------- ---------
TOTAL ASSETS $ 558,026 411,124
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,333 6,305
Accrued and other liabilities 30,940 26,944
Deferred revenue, excluding non-current portion 42,694 47,316
--------- ---------
Total current liabilities 78,967 80,565
--------- ---------
Deferred rent 1,770 --
Deferred revenue, excluding current portion 13,496 --
Shareholders' equity:
Preferred stock, $0.001 par value per share, no shares issued and outstanding
Series A: authorized 200 shares -- --
Undesignated series: authorized 59,800 shares -- --
Common stock, $0.001 par value per share
Authorized 1,000,000 shares; issued and outstanding 155,637
shares in 2000 and 149,648 shares in 1999 156 150
Additional paid-in capital 647,046 366,177
Deferred stock compensation (99,677) --
Accumulated deficit (80,885) (34,865)
Accumulated other comprehensive loss (2,847) (903)
--------- ---------
Total shareholders' equity 463,793 330,559
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 558,026 411,124
========= =========
See accompanying notes to condensed consolidated financial statements
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REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(IN THOUSANDS EXCEPT PER SHARE DATA)
Quarter Ended June 30, Six Months Ended June 30,
-------------------------- --------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
Net revenues:
Software license fees $ 38,022 20,755 72,125 38,592
Service revenues 12,837 5,759 23,855 11,008
Advertising 11,797 2,031 20,204 3,297
--------- --------- --------- ---------
Total net revenues 62,656 28,545 116,184 52,897
--------- --------- --------- ---------
Cost of revenues:
Software license fees 3,954 3,199 8,302 6,056
Service revenues 3,561 1,477 6,146 2,397
Advertising 2,242 598 3,833 1,148
--------- --------- --------- ---------
Total cost of revenues 9,757 5,274 18,281 9,601
--------- --------- --------- ---------
Gross profit 52,899 23,271 97,903 43,296
--------- --------- --------- ---------
Operating expenses:
Research and development (excluding non-cash
stock based compensation of $24,480 and
$42,235 for the quarter and six months ended
June 30, 2000 respectively and $0 for the
comparable periods in 1999, included below) 13,304 8,315 24,924 15,916
Sales and marketing (excluding non-cash stock
based compensation of $1,195 and $2,061
for the quarter and six months ended
June 30, 2000 respectively and $0 for the
comparable periods in 1999, included below) 27,046 12,956 49,646 23,416
General and administrative 7,258 3,416 14,191 6,623
Goodwill amortization, acquisitions charges,
and stock based compensation 37,815 532 65,387 1,064
--------- --------- --------- ---------
Total operating expenses 85,423 25,219 154,148 47,019
--------- --------- --------- ---------
Operating loss (32,524) (1,948) (56,245) (3,723)
Other income, net 5,325 868 10,225 1,585
--------- --------- --------- ---------
Net loss $ (27,199) (1,080) (46,020) (2,138)
========= ========= ========= =========
Basic and diluted net loss per share $ (0.18) (0.01) (0.30) (0.02)
========= ========= ========= =========
Shares used to compute basic and
diluted net loss per share 153,428 137,936 152,510 136,860
Comprehensive loss:
Net loss $ (27,199) (1,080) (46,020) (2,138)
Unrealized loss on investments (2,146) -- (1,765) --
Foreign currency translation adjustment (119) (57) (179) (172)
--------- --------- --------- ---------
Comprehensive loss $ (29,464) (1,137) (47,964) (2,310)
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements
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REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED JUNE 30,
--------------------------
2000 1999
--------- ---------
Cash flows from operating activities:
Net loss $ (46,020) (2,138)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization of leasehold improvements 3,889 630
Goodwill amortization and stock based compensation 63,870 1,064
Net change in certain assets and liabilities 7,354 10,601
--------- ---------
Net cash provided by operating activities 29,093 10,157
Cash flows from investing activities:
Purchases of equipment and leasehold improvements (10,084) (15,531)
Purchases of short-term investments (396,595) (36,165)
Proceeds from sales and maturities of short-term investments 374,018 25,303
Purchase of investments (29,299) --
Decrease in restricted cash 700 --
Payment of acquisition costs (3,599) --
Cash obtained through acquisition 73 --
--------- ---------
Net cash used in investing activities (64,786) (26,393)
--------- ---------
Cash flows from financing activities:
Net proceeds from sale of common stock and
exercise of stock options 10,283 233,428
--------- ---------
Net cash provided by financing activities 10,283 233,428
--------- ---------
Effect of exchange rate changes on cash (429) (160)
--------- ---------
Net increase (decrease) in cash and cash equivalents (25,839) 217,032
Cash and cash equivalents at beginning of period 160,955 51,900
--------- ---------
Cash and cash equivalents at end of period 135,116 268,932
Short-term investments at end of period 206,630 48,763
--------- ---------
Total cash, cash equivalents and short-term
investments at end of period $ 341,746 317,695
========= =========
See accompanying notes to condensed consolidated financial statements
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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
RealNetworks, Inc. and subsidiaries (RealNetworks or Company) is a
leading provider of media delivery and digital distribution solutions designed
for the Internet. The Company's solutions enable consumers to experience and
content providers to deliver a broad range of multimedia content, including
audio, video, text and animation. The Company pioneered the development and
commercialization of "streaming media" systems that enable the creation,
real-time delivery and playback of multimedia content. The Company extended its
media delivery platform to include a digital music management system that allows
consumers to acquire, record, store, organize and play their personal music
collections on personal computers and digital playback devices and is extending
it further to allow consumers to enjoy streaming media content via mobile
networks and devices.
Inherent in the Company's business are various risks and uncertainties,
including its limited operating history and the limited history of commerce on
the Internet. The Company's success may depend in part upon the emergence of the
Internet and corporate intranets as a communications medium, the acceptance of
the Company's technology by the marketplace and the Company's ability to
generate license, service and advertising revenues from the use of its
technology on the Internet.
(b) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
These statements reflect all adjustments, consisting only of normal,
recurring adjustments that, in the opinion of the Company's management, are
necessary for a fair presentation of the results of operations for the periods
presented. Operating results for the quarter and six months ended June 30, 2000
are not necessarily indicative of the results that may be expected for any
subsequent quarter or for the year ending December 31, 2000. Certain information
and footnote disclosures normally included in financial statements prepared in
conformity with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1999.
On April 27, 1999, the board of directors declared a 2-for-1 split of
the Company's Common Stock in the form of a stock dividend. The stock split was
effected on May 10, 1999. Also, on January 21, 2000, the board of directors
declared a 2-for-1 split of the Company's Common Stock in the form of a stock
dividend. The stock split was effected on January 28, 2000. 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.
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(c) Cash, Cash Equivalents and Short-Term Investments
Cash, cash equivalents and short-term investments are comprised of the
following:
June 30, 2000 December 31, 1999
------------- -----------------
(in thousands)
Cash and cash equivalents $135,116 160,955
Short-term investments 206,630 183,672
-------- --------
Total cash, cash equivalents and
short-term investments $341,746 344,627
======== ========
Restricted cash equivalents $ 13,000 13,700
======== ========
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 $3,000,000 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 provides ongoing support to the
OEM in the form of future upgrades, enhancements or other services over the term
of the contract, revenue is recognized over the term of the contract.
Service revenues include payments under support and upgrade contracts
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.
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To date, revenue from contracts with customers deploying content
delivery networks is recognized over the term of the arrangement commencing upon
the completion of the network build-out. These arrangements generally consist of
software licenses, consulting services, other services, support and rights to
unspecified software upgrades if and when available. As the Company has a
limited history of contracts with content delivery networks, and there are
unique aspects to each arrangement, the Company has not established objective
evidence as to the determination of fair value for each element of the
arrangement. As a result, and in accordance with SOP 97-2, revenue is recognized
ratably over the fixed term of the support contract commencing upon the
completion and customer acceptance of the network build-out.
In December 1998, the American Institute of Certified Public Accounts
(AICPA) issued Statement of Position 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions" (SOP 98-9), which
amends certain elements of SOP 97-2, and is effective for fiscal years beginning
after March 15, 1999. The Company adopted SOP 98-9 on January 1, 2000. The
adoption of SOP 98-9 did not have a material effect on the Company's
consolidated financial statements.
(e) Comprehensive Loss
The Company's comprehensive loss for the quarter and six months ended
June 30, 2000 consisted of net loss, unrealized losses on investments and the
gross amount of foreign currency translation adjustments. The Company's
comprehensive loss for the quarter and six months ended June 30, 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
losses on 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 for the quarters and six months ended June
30, 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 and six months ended June 30, 2000 are options and warrants to acquire
approximately 42,517,000 shares of common stock with a weighted-average exercise
price of $25.17. Also excluded from both periods are approximately 1,820,000
shares of common stock issued in the acquisition of NetZip, Inc., that are
subject to repurchase by the Company at a nominal price in certain
circumstances. Excluded from the computation of diluted net loss per share for
the quarter and six months ended June 30, 1999 are options to acquire
approximately 36,708,000 shares of common stock with a weighted-average exercise
price of $11.52. Such potentially dilutive securities were excluded, as their
effects are anti-dilutive.
(g) Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44 (FIN No. 44), "Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of APB Opinion No. 25" FIN No.
44 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 of the FASB reached a
consensus on Issue No. 00-2, "Accounting for Web Site Development Costs" which
provides guidance on when to capitalize versus expense costs incurred to develop
a Web site. The consensus is effective for Web site development costs in
quarters beginning after June 30, 2000. The Company has not yet determined the
impact, if any, this issue will have on its consolidated financial statements.
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In December 1999, the United States Securities and Exchange Commission
released Staff Accounting Bulletin No. 101 (SAB 101) "Revenue Recognition in
Financial Statements," which as amended, must be adopted by the Company by the
forth quarter of 2000. SAB 101 provides guidance on revenue recognition and the
SEC staff's views on the application of accounting principles to selected
revenue recognition issues. The adoption of SAB 101 is not expected to have a
material effect on the Company's consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model
for accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning after
June 15, 2000. SFAS 133 requires that all derivatives be recognized in the
balance sheet at their fair market value, and the corresponding derivative gains
or losses be either reported in the statement of operations or as a component of
other comprehensive income depending on the type of hedge relationship that
exists with respect to such derivative. The adoption of SFAS 133 is not expected
to have a material effect on the Company's consolidated financial statements.
NOTE 2 - SEGMENT INFORMATION
The Company operates in one business segment, media delivery, for which
the Company receives revenues from its customers. The Company's Chief Operating
Decision Maker is considered to be the Company's Operating Committee (COC) which
is comprised of the Company's Chief Executive Officer, 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):
Quarter Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------- ------- ------- -------
North America $43,372 19,823 81,927 36,640
Europe 8,200 3,562 14,553 6,348
Asia 5,171 2,079 10,023 4,054
Rest of the world 3,296 464 4,447 821
------- ------- ------- -------
Subtotal 60,039 25,928 110,950 47,863
Microsoft license revenue 2,617 2,617 5,234 5,034
------- ------- ------- -------
Total $62,656 28,545 116,184 52,897
======= ======= ======= =======
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Revenue from external customers by product type is as follows (in thousands):
Quarter Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------- ------- ------- -------
Media delivery license revenue $35,405 18,138 66,891 33,558
Media delivery service revenue 12,837 5,759 23,855 11,008
Microsoft license revenue 2,617 2,617 5,234 5,034
Advertising revenue 11,797 2,031 20,204 3,297
------- ------- ------- -------
Total net revenues $62,656 28,545 116,184 52,897
======= ======= ======= =======
Long-lived assets by geographic location are as follows (in thousands):
June 30, December 31,
2000 1999
-------- --------
United States $148,253 32,273
Asia and rest of the world 656 446
Europe 269 371
-------- --------
Total $149,178 33,090
======== ========
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):
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
========
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The purchase price was allocated as follows (in thousands):
Cash $ 73
Other current assets acquired 440
Equipment 324
Non-current assets acquired 15
Goodwill 128,747
--------
Total $129,599
========
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 relating to these amounts are shown below (in thousands):
Goodwill Stock Based
Years ended December 31, Amortization Compensation Total
- ------------------------ ------------ ------------ -----
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
======== ======== ========
Goodwill amortization and acquisition charges by acquisition are shown below (in
thousands):
Quarter Ended June 30, Six Months Ended June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
------- ------- ------- -------
Vivo (1998 acquisition) $ 532 532 1,064 1,064
NetZip 11,608 -- 20,027 --
------- ------- ------- -------
$12,140 532 21,091 1,064
======= ======= ======= =======
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 June 30, 2000, approximately
$3.6 million of these costs have been paid. The remaining costs are expected to
be paid during the remainder of 2000. The cost of the stay bonuses is being
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.
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Quarter Ended June 30, Six Months Ended June 30,
------------------------------- ------------------------------
2000 1999 2000 1999
-------- ------ ------- ------
(in thousands, except per share amounts)
Total net revenue $ 62,656 29,706 117,154 55,303
Net loss $(27,199) (37,497) (55,384) (74,724)
Net loss per share - basic
and diluted $ (0.18) (0.26) (0.36) (0.52)
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.
Separate results for the combined entities are as follows (in
thousands):
Quarter Ended Six Months Ended
June 30, 1999 June 30, 1999
------------- -------------
Revenue
RealNetworks, Inc. $ 28,046 51,571
Xing 499 1,326
-------- --------
$ 28,545 52,897
======== ========
Net loss
RealNetworks, Inc. $ (270) (1,006)
Xing (810) (1,132)
-------- --------
$ (1,080) (2,138)
======== ========
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
are as follows:
Quarter Ended June 30, Six Months Ended June 30,
------------------------ ----------------------------
2000 1999 2000 1999
------- --- ------- -------
(in thousands)
Stock Based Compensation $25,675 -- 44,296 --
Goodwill Amortization and
Acquisition Charges 12,140 532 21,091 1,064
------- --- ------- -------
Total $37,815 532 65,387 1,064
======= === ======= =======
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
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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
claiming breach of contract, unjust enrichment, promissory estoppel and breach
of implied-in-fact contract. The Company denied each of the plaintiff's claims.
The parties entered into a confidential settlement of this dispute in June 2000,
the costs of which are reflected in the quarter ended June 30, 2000.
Between November 1999 and March 2000, fourteen lawsuits were filed
against the Company in federal and/or state courts in California, Illinois,
Pennsylvania, Washington and Texas. The plaintiffs in federal court in
Pennsylvania and in Illinois state court have voluntarily dismissed their
lawsuits. The remaining twelve actions, which seek to certify classes of
plaintiffs, allege breach of contract, invasion of privacy, deceptive trade
practices, negligence, fraud and violation of certain federal and state laws in
connection with various communications features of the RealPlayer and
RealJukebox products. Plaintiffs are seeking both damages and injunctive relief.
The Company has filed answers denying the claims and has filed suit in
Washington state court to compel the state court plaintiffs to arbitrate their
claims as required by our End User License Agreements. On February 10, 2000, the
federal Judicial Panel on Multidistrict Litigation transferred all pending
federal cases to the federal district court for the Northern District of
Illinois. On the same day, that court granted RealNetworks' motion to stay the
court proceedings because the claims are subject to arbitration under
RealNetworks' End User License Agreement. Although no assurance can be given as
to the outcome of these lawsuits, the Company believes that the allegations in
these actions are without merit, and intends to vigorously defend itself. If the
plaintiffs prevail in their claims, the Company could be required to pay damages
or other penalties in addition to complying with injunctive relief, which could
harm our business and our operating results.
From time to time RealNetworks is, and expects to continue to be,
subject to legal proceedings and claims in the ordinary course of its business,
including employment claims, contract-related claims and claims of alleged
infringement of third-party patents, trademarks and other intellectual property
rights. These claims, even if not meritorious, could force the Company to spend
significant financial and managerial resources. The Company currently has
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. However, the Company may incur
substantial expenses in defending against third party claims. In the event of a
determination adverse to the Company, the Company may incur substantial monetary
liability, and be required to change its business practices. Either of these
could have a material adverse effect on the Company's financial position and
results of operations.
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ITEM 2. 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 135 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, and is extending it further to allow consumers to
enjoy streaming media content via mobile networks and 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 for-sale 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 next generation media delivery system. In May 1999, we released
RealSystem MP as well as a beta version of RealJukebox, a personal music
management solution. In September 1999, we released RealSlideshow Plus, a
complete streaming solution for sharing digital pictures over the Internet. Also
in September, we released the commercial versions of RealJukebox and RealJukebox
Plus. In November 1999, we released the beta version of RealPlayer 7.0 and
introduced the new Real.com Network, which gives consumers the ability to find,
organize and play audio and video on the Internet, including the Real.com Guide
and Take 5, Real.com's media programming guide. In December 1999, we introduced
the gold version of RealPlayer 7.0, RealServer 7.0 and RealProducer 7.0, the
latest advancements to RealSystem G2, as well as RealSlideshow 2.0 and
RealSlideshow Plus 2.0, which allow consumers to share digital pictures with
audio narration and music over the Internet. In March 2000, we introduced
Real.com Games, which offers a new online, digital distribution model for high
quality downloadable Computer games. In May 2000, we introduced Real
Entertainment Center, an integrated suite of three new leading Internet media
products -- RealPlayer 8, RealJukebox 2, and RealDownload 4. Also in May, we
released a beta version of RealVideo 8, an Internet media system that we believe
delivers a high clarity, full-motion video experience to consumers using dial-up
modems, full-screen VHS quality at mainstream broadband rates, and near
DVD-quality video to those using high capacity networks or downloadable media.
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We report revenues in three categories:
- - Software license fees, which include revenues from sales of our
RealPlayer Plus, RealJukebox Plus, RealSlideshow Plus, RealDownload
Plus, Real Entertainment Center Plus, Xing AudioCatalyst, RealServers
and related authoring and publishing tools, sales of our products
through OEM channels, and sales of third-party products.
- - Service revenues, which include support and maintenance services that we
sell to customers who purchase our RealPlayer Plus, RealJukebox Plus,
Real Entertainment Center Plus, RealServers and tools products,
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 $38.0 million for the
quarter ended June 30, 2000, an increase of 83% from $20.8 million in the
comparable quarter of the prior year. Software license fees were $72.1 million
for the six months ended June 30, 2000, an increase of 87% from $38.6 million in
the comparable period of the prior year. The increases were due primarily to a
greater volume of products sold as a result of growth in the demand for media
delivery on the Internet and the introduction of new products, including
RealJukebox Plus and RealSlideshow Plus released in September 1999, products
associated with the NetZip acquisition in January 2000 including RealDownload
Plus, and Real Entertainment Center Plus in May 2000. Revenue also increased as
a result of sales of our products to companies deploying content distribution
networks. Software license fees included $2.6 million for each of the quarters
ended June 30, 2000 and 1999, and $5.2 million and $5.0 million for the six
months ended June 30, 2000 and 1999, respectively, related to the Microsoft
license agreement we entered into in June 1997.
Service Revenues. Service revenues were $12.8 million for the quarter
ended June 30, 2000, an increase of 123% from $5.8 million in the comparable
quarter of the prior year. Service revenues were $23.9 million for the six
months ended June 30, 2000, an increase of 117% from $11.0 million in the
comparable period of the prior year. The increases were primarily attributable
to a larger installed base of our server products and related increases in sales
of support and upgrades, increases in consulting and Real Broadcast Network
streaming media hosting
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services, increases in support and upgrades for the RealPlayer Plus, and the
introduction of support and upgrades for RealJukebox Plus and Real Entertainment
Center Plus.
Advertising Revenues. Advertising revenues were $11.8 million for the
quarter ended June 30, 2000, an increase of 481% from $2.0 million in the
comparable quarter of the prior year. Advertising revenues were $20.2 million
for the six months ended June 30, 2000, an increase of 513% from $3.3 million in
the comparable period of the prior year. The increases in advertising revenues
were due to increased traffic on our Web sites, the increased effectiveness of
our advertising sales force, higher average advertising rates, and revenue
associated with increased usage and distribution of RealChannels, LiveStations,
search functionality, and other advertisements and promotional links included in
the RealPlayer and RealJukebox products.
Geographic Revenues. Excluding revenues from the Microsoft license
agreement, international revenues represented 28% of total net revenues for the
quarter ended June 30, 2000 and 24% of total net revenues for the quarter ended
June 30, 1999. Revenues generated in Europe were 14% of total net revenues for
the quarters ended June 30, 2000 and 1999 (excluding revenues from the Microsoft
license agreement). Revenues generated in Asia and the rest of the world were
14% of total net revenues for the quarter ended June 30, 2000 and 10% of total
net revenues for the quarter ended June 30, 1999 (excluding revenues from the
Microsoft license agreement). Excluding revenues from the Microsoft license
agreement, international revenues represented 26% of total net revenues for the
six months ended June 30, 2000 and 23% of total net revenues for the six months
June 30, 1999. Revenues generated in Europe were 13% of total net revenues for
the six months ended June 30, 2000 and 1999 (excluding revenues from the
Microsoft license agreement). Revenues generated in Asia and the rest of the
world were 13% of total net revenues for the six months ended June 30, 2000 and
10% of total net revenues for the six months ended June 30, 1999 (excluding
revenues from the Microsoft license agreement).
Deferred Revenues. The Company has deferred revenue of $56.2 million as
of June 30, 2000 and $47.3 million as of December 31, 1999. To date, revenue
from contracts with customers developing content delivery networks is recognized
over the term of the arrangement commencing upon the completion of the network
build-out. As most of the agreements related to the content delivery networks
have been with companies that have had limited operating histories, the Company
has historically required prepayments related to such customers. Cash
prepayments associated with these contracts is recorded as deferred revenue and
amounted to $27.6 million and $19.9 million at June 30, 2000 and December 31,
1999, respectively. If in the future the Company enters into agreements with
more established companies, the Company may not require these prepayments and as
such, the Company anticipates its deferred revenue balances may decline as a
result. As of June 30, 2000 and December 31, 1999, $0 and $5.2 million,
respectively, of the deferred revenue balances related to the Microsoft license
agreement. The remaining balance of deferred revenue is comprised of the
unrecognized portion of support contracts, prepayments under OEM arrangements,
and other prepayments for which the earnings process has not been completed.
COST OF REVENUES
Cost of Software License Fees. Cost of software license fees includes
costs of product media, duplication, manuals, packaging materials, amounts paid
for licensed technology, and fees paid to third-party vendors for order
fulfillment. Cost of software license fees was $4.0 million for the quarter
ended June 30, 2000, an increase of 24% from $3.2 million in the comparable
quarter of the prior year, but decreased as a percentage of software license
fees to 10% from 15%. Cost of software license fees was $8.3 million for the six
months ended June 30, 2000, an increase of 37% from $6.1 million in the
comparable period of the prior year, but decreased as a percentage of software
license fees to 12% from 16%. The increases in absolute dollars were due
primarily to higher sales volumes. The decreases as a percentage of software
license fees were due primarily to changes in the mix of products sold.
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing support and consulting services and
expenses incurred in providing our streaming media hosting services. Cost of
service revenues was $3.6 million for the quarter ended June 30, 2000, an
increase of 141% from $1.5 million in the comparable quarter of the prior year,
and increased as a percentage of service revenues to 28% from
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26%. Cost of service revenues was $6.1 million for the six months ended June 30,
2000, an increase of 156% from $2.4 million in the comparable period of the
prior year, and increased as a percentage of service revenues to 26% from 22%.
The increases in cost of service revenues were primarily due to increased staff
and contract personnel needed to provide services to a greater number of
customers, including consulting and streaming media hosting services, expansion
of customer service and technical support into international regions, and
support costs related to the introduction of RealJukebox and RealDownload.
Cost of Advertising Revenues. Cost of advertising revenues includes
personnel and related costs associated with 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
$2.2 million for the quarter ended June 30, 2000, an increase of 275% from $0.6
million in the comparable quarter of the prior year, but decreased as a
percentage of advertising revenues to 19% from 29%. Cost of advertising revenues
was $3.8 million for the six months ended June 30, 2000, an increase of 234%
from $1.1 million in the comparable period of the prior year, but decreased as a
percentage of advertising revenues to 19% from 35%. The increases in absolute
dollars were 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 decreases as a percentage of advertising revenues
were due to greater economies of scale.
Our gross margins may be adversely affected by the mix of products and
services 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 $13.3 million for the quarter ended June 30, 2000, an
increase of 60% from $8.3 million in the comparable quarter of the prior year.
Such expenses decreased as a percentage of total net revenues to 21% from 29%.
Research and development expenses were $24.9 million for the six months ended
June 30, 2000, an increase of 57% from $15.9 million in the comparable period of
the prior year. Such expenses decreased as a percentage of total net revenues to
21% from 30%. Research and development expenses were primarily related to the
development of new technology and products, as well as enhancements made to
existing products. The increase in absolute dollars was primarily due to
increases in internal development personnel, consulting expenses and contract
labor. The decrease in percentage terms was a result of revenues growing at a
faster rate than expenses.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, sales commissions, consulting fees, tradeshow expenses, advertising
costs and cost of marketing collateral. We intend to increase our branding and
marketing efforts and, therefore, expect sales and marketing expenses to
increase in future periods. Sales and marketing expenses were $27.0 million for
the quarter ended June 30, 2000, an increase of 109% from $13.0 million in the
comparable quarter of the prior year. Such expenses decreased as a percentage of
total net revenues to 43% from 45%. Sales and marketing expenses were $49.6
million for the six months ended June 30, 2000, an increase of 112% from $23.4
million in the comparable period of the prior year. Such expenses decreased as a
percentage of total net revenues to 43% from 44%. 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, consulting
expenses, increased advertising, attendance at trade shows, and expenses related
to the annual RealNetworks conference and the RealNetworks Europe conference.
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 $7.3 million for the quarter ended June 30, 2000, an increase of 112% from
$3.4 million in the comparable quarter of the prior year. The expenses as a
percentage of total net revenues were 12% for both the quarters ended June 30,
2000 and 1999.
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General and administrative expenses were $14.2 million for the six months ended
June 30, 2000, an increase of 114% from $6.6 million in the comparable period of
the prior year. Such expenses decreased as a percentage of total net revenues to
12% from 13%. The increase in absolute dollars was primarily a result of
increased personnel, litigation defense costs and charitable contributions of 5%
of our annual net income (excluding amortization of goodwill and stock based
compensation expense).
Goodwill Amortization, Acquisition Charges and Stock Based Compensation
In August 1999, we acquired Xing Technology Corporation, a provider of
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., a developer and provider of
Internet download management and utility software. The acquisition was accounted
for using the purchase method of accounting and, accordingly, the results of
NetZip's operations are included in our consolidated financial statements since
the date of acquisition. The purchase price was allocated to the fair value of
the acquired assets and assumed liabilities based on their fair values at the
date of the acquisition. Of the total purchase price, $128.7 million was
allocated to goodwill, and $0.9 million was allocated to tangible assets.
Goodwill is amortized over its estimated life of three years.
In connection with the NetZip acquisition, we incurred approximately
$6.1 million in acquisition-related expenditures. These expenditures included
$3.5 million in relocation payments and $2.6 million in professional fees and
other costs. As of June 30, 2000, approximately $3.6 million of these costs had
been paid. The remaining costs are expected to be paid during the remainder of
2000.
Also as part of our acquisition of NetZip, common stock was issued to
certain former stockholders of NetZip. The common stock is subject to forfeiture
over a period of 30 months beginning January 25, 2000. The value of $144 million
is being amortized over the forfeiture period. Stock-based compensation expense
for the quarter ended June 30, 2000 was $25.7 million. Stock-based compensation
expense for the six months ended June 30, 2000 was $44.3 million.
OTHER INCOME, NET
Other income, net consists primarily of earnings on cash, cash
equivalents and short-term investments. Other income, net was $5.3 million and
$0.9 million for the quarters ended June 30, 2000 and 1999, respectively. Other
income, net was $10.2 million and $1.6 million for the six months ended June 30,
2000 and 1999, respectively. The increase was primarily due to higher invested
cash balances primarily as a result of the cash proceeds from our secondary
public offering of common stock completed during the second quarter of 1999.
INCOME TAXES
During the quarter and six month periods ended June 30, 2000, income tax
expense was offset by a reduction in the valuation allowance for deferred tax
assets. To the extent the Company is profitable, (excluding amortization of
goodwill and stock based compensation expense) the Company expects to record an
income tax provision, although it does not expect to pay Federal income taxes in
the near future, due primarily to tax deductions related to the exercise of
employee stock options. As of June 30, 2000 the Company had net operating loss
carryforwards of approximately $344 million. Substantially all of the net
operating loss carryforwards results from stock option deductions, the
realization of which would increase shareholders' equity.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $29.1 million and $10.2
million for the six months ended June 30, 2000 and 1999, respectively. Net cash
provided by operating activities for the six months ended June 30, 2000 resulted
primarily from income from operations of $19.4 million (excluding $65.4 million
of goodwill amortization,
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acquisition charges, and stock based compensation), an increase in deferred
revenue of $8.6 million, an increase in accrued and other liabilities of $4.7
million, and depreciation of $3.9 million. This was partially offset by an
increase in accounts receivable of $3.2 million. Net cash provided by operating
activities for the six months ended June 30, 1999 resulted primarily from an
increase in current liabilities, non-cash charges associated with depreciation
and amortization, partially offset by net loss from operations.
Net cash used in investing activities was $64.8 million and $26.4
million for the six months ended June 30, 2000 and 1999, respectively. This was
primarily a result of the purchase of investments of $29.3 million for the six
months ended June 30, 2000, net purchases of short-term investments, and
purchases of equipment and leasehold improvements.
Net cash provided by financing activities was $10.3 million and $233.4
million for the six months ended June 30, 2000 and 1999, respectively. In the
second quarter of 1999, we sold 4,125,000 shares of our common stock in a
secondary public offering. Net proceeds of the offering were $228.8 million.
At June 30, 2000, we had $341.7 million in cash, cash equivalents and
short-term investments. As of June 30, 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 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.
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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. For the quarter ended June 30, 2000
we recognized the remaining deferred balance of this contract of $2.6 million.
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, including
emerging technologies and solutions; and
- - develop and maintain strategic relationships to enhance the
distribution, features and utility of our products and services.
Our business strategy may be unsuccessful and we may be unable to
address the risks we face in a cost-effective manner, if at all. Our inability
to successfully address these risks will harm our business.
WE HAVE A HISTORY OF LOSSES AND MAY NOT MAINTAIN PROFITABILITY
We have incurred significant losses since our inception and we may never
sustain or increase profitability. As of June 30, 2000, we had an accumulated
deficit of approximately $80.9 million. We devote significant resources to
developing, enhancing, selling and marketing our products and services. As a
result, we will need to generate significant revenues to maintain profitability.
While we had net income in 1999, we may not continue our historical growth or
generate sufficient revenues to sustain or increase profitability (excluding
acquisition charges) on a quarterly or annual basis in the future.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
As a result of our limited operating history and the rapidly changing
nature of the markets in which we compete, our quarterly and annual revenues and
operating results are likely to fluctuate from period to period. These
fluctuations may be caused by a number of factors, many of which are beyond our
control. These factors include the following, as well as others discussed
elsewhere in this section:
- - how and when we introduce new products and services and enhance our
existing products and services;
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- - our ability to retain existing customers, attract new customers and
satisfy our customers' demands;
- - the timing and success of our brand-building and marketing campaigns;
- - our ability to establish and maintain strategic relationships;
- - our ability to attract, train and retain key personnel;
- - the demand for Internet advertising and sponsorships;
- - the emergence and success of new and existing competition;
- - varying operating costs and capital expenditures related to the
expansion of our business operations and infrastructure, domestically
and internationally, including the hiring of new employees;
- - technical difficulties with our products, system downtime, system
failures or interruptions in Internet access;
- - changes in the mix of products and services that we sell to our
customers;
- - costs and effects related to the acquisition of businesses or technology
and related integration; and
- - costs of litigation and intellectual property protection.
In addition, because the market for our products and services is
relatively new and rapidly changing, it is difficult to predict future financial
results. Our research and development and sales and marketing efforts, and
business expenditures generally, are partially based on predictions regarding
certain developments for media delivery and digital media distribution. To the
extent that these predictions prove inaccurate, our revenues and operating
expenses may fluctuate.
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:
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- - the quality and reliability of the overall media delivery solution;
- - access to distribution channels necessary to achieve broad distribution
and use of products;
- - the availability of content for delivery over the Internet and access to
necessary intellectual property rights;
- - the ability to 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 recently began to compete in the market for digital distribution of media.
Microsoft's commitment to and presence in the media delivery industry has
increased and Microsoft will continue to increase competitive pressure in the
overall market for streaming media and media distribution.
Microsoft distributes its competing streaming media server and tools
products by bundling them with its Windows NT servers at no additional charge
and by making them available for download from its Web site for free. While we
also provide free downloads of certain of our products, including players,
servers and tools, Microsoft's practices have caused, and may continue to cause,
pricing pressure on our products. These practices have led in some cases, and
could continue to lead to, longer sales cycles, decreased sales, loss of
existing 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 content suppliers, and we expect this trend to continue, which may
cause such customers to stop using or reduce their use of our products and
services, or withhold desirable media content from
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us or our end users. Such arrangements, together with Microsoft's aggressive
marketing of Windows NT and of its streaming media products, may reduce our
share of the streaming media market.
Microsoft's Windows Media Player competes with our RealPlayer products.
The Windows Media Player is available for download from Microsoft's Web site for
free, and is integrated into the Windows 98 and Windows 2000 operating systems
and into 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 Window Media
Guide, which provides links to multimedia content on the Internet, especially
content in Microsoft's streaming or digital media formats. We expect that by
leveraging its monopoly position in operating systems and tying streaming or
digital media into its operating 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 135 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
announced Windows Media Technologies 7, a platform for authoring, delivering and
playing digital media intended to compete with RealSystem. Microsoft has also
released an early version of its own jukebox product incorporated into the
Windows Media Player. Microsoft also announced Windows Media Technologies 7, a
platform for authoring, delivering and playing digital media intended to compete
with the RealSystem. Microsoft also supports and promotes other third party
products competitive to our products. We expect Microsoft and other competitors
to devote significantly greater resources to product development in the jukebox
and digital media categories.
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, In some cases, we
believe Microsoft uses its financial resources and monopoly leverage to obtain
rights to such content. We believe that Microsoft's commitment to and presence
in the media delivery industry has increased and that Microsoft will continue to
increase competitive pressure in the overall market for streaming media and
media distribution.
In addition to Microsoft, we face increasing competition from other
companies that are developing and marketing streaming media products. Apple
Computer offers the QuickTime streaming media technology, including a free media
player and a free streaming media server, and 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. 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.
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WE MAY BE UNABLE TO SUCCESSFULLY COMPETE IN OTHER PARTS OF OUR BUSINESS
Media Hosting. Our media hosting service, the Real Broadcast Network,
competes with a variety of companies that provide streaming media hosting and
broadcast services. These companies include Yahoo! Broadcast Services,
Akamai/Intervu, Enron Communications, Digital Island, Globix, Intel, iBeam,
Panamsat and others who are building out broadcast networks. Some of these
competitors offer other services which Real Broadcast Network does not offer,
such as web page hosting or broadcast hosting in media formats not supported by
Real Broadcast Network. We may not establish or sustain our competitive position
in this market segment. Some media hosting competitors are also customers on
whom we rely to help drive product download traffic to our Web 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. The number of Web sites
competing for advertising revenues is growing. Our Web sites and the Real.com
Network, including Real.com, RealNetworks.com, Real.com Guide, Take 5, Film.com
and LiveConcerts.com, compete for user traffic and Internet advertising revenues
with a wide variety of Web sites, Internet portals and ISPs. In particular,
aggregators of audio, video and other media, such as Yahoo! Broadcast Services
and Microsoft's Windows Media Guide, 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
many of our competitors. We cannot be certain that advertisers will place
advertising with us or that revenues derived from such advertising will be
meaningful. 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, now called the Real Digital
Distribution SDK, a digital music architecture enabling integration with a wide
range of Internet services and hardware devices. In May 1999, we released a beta
version of RealJukebox, our client software based on this new architecture. In
September 1999, we released commercial versions of RealJukebox and RealJukebox
Plus. These products represent an extension of our business into downloadable
media and local media delivery, which is a substantial evolution from our
historical focus on streaming media products and services. We do not yet know
whether there is a sustainable market for products such as RealJukebox. Even if
that market exists, we may be unable to develop a revenue model or sufficient
demand to take advantage of the market opportunity.
While over 35 million copies of RealJukebox have been downloaded since
its beta release on May 3, 1999, it is too soon to determine if RealJukebox will
be widely received in the marketplace. There are now a number of competitive
products on the market that offer certain of the features that RealJukebox
offers. These products include WinAmp Player, MusicMatch Jukebox, Liquid Audio
Player and a2b Player. Microsoft has also incorporated certain music management
capabilities into the Windows Media Player 7. 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
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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 the digital music architecture 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, 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 not make their desirable content available for download or playback in
formats supported by RealJukebox, may impose technical restrictions designed to
secure intellectual property rights that may impact the user experience or
demand for RealJukebox, or may refrain from or delay participating in
promotional opportunities with respect to RealJukebox.
WE MAY NOT SUCCESSFULLY DEVELOP NEW PRODUCTS AND SERVICES
Our growth depends on our ability to continue to develop leading edge
media delivery and digital distribution products and services. Our business and
operating results would be harmed if we fail to develop products and services
that achieve widespread market acceptance or that fail to generate significant
revenues to offset development costs. We may not timely and successfully
identify, develop and market new product and service opportunities. If we
introduce new products and services, they may not attain broad market acceptance
or contribute meaningfully to our revenues or profitability.
Because the markets for our products and services are rapidly changing,
we must develop new offerings quickly. We have experienced development delays
and cost overruns in our development efforts in the past and we may encounter
such problems in the future. Delays and cost overruns could affect our ability
to respond to technological changes, evolving industry standards, competitive
developments or customer requirements. Our products also may contain undetected
errors that could cause increased development costs, loss of revenues, adverse
publicity, reduced market acceptance of the products or lawsuits by customers.
POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS
The failure to adequately address the financial and operational risks
raised by acquisitions of technology and businesses could harm our business. We
have acquired complementary technologies and businesses in the past, and intend
to do so in the future. Financial risks related to acquisitions include:
- - potentially dilutive issuances of equity securities;
- - use of cash resources;
- - the incurrence of additional debt and contingent liabilities;
- - large write-offs; and
- - amortization expenses related to goodwill and other intangible assets.
Acquisitions also involve operational risks, including:
- - difficulties in assimilating the operations, products, technology,
information systems and personnel of the acquired company;
- - diversion of management's attention from other business concerns;
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- - impairment of relationships with our employees, affiliates, advertisers
and content providers;
- - inability to maintain uniform standards, controls, procedures and
policies;
- - the assumption of known and unknown liabilities of the acquired company;
- - entrance into markets in which we have no direct prior experience; and
- - loss of key employees of the acquired company.
In August 1999, we acquired Xing Technology Corporation, an MP3 software
developer, in a transaction that was accounted for 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, Inc., a developer and marketer of
download management software, in a transaction that was accounted for using the
purchase method of accounting. The NetZip transaction poses particular
integration risks because NetZip has been based in Atlanta, Georgia, and we have
relocated its operations to Seattle, Washington. We may not adequately integrate
these or any future acquisitions, may not derive revenues from them and they may
pose substantial risks to our business.
WE 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 founder,
chairman of the board and chief executive officer. The loss of the services of
Mr. Glaser or any of our other executive officers or key employees could harm
our business. Each of these individuals has acquired specialized knowledge and
skills with respect to RealNetworks and its operations. As a result if certain
individuals were to leave RealNetworks, we could face substantial difficulty in
hiring qualified successors and could experience a loss in productivity while
any such successor obtains the necessary training and experience. Several of our
personnel have reached or will soon reach the five-year anniversary of their
RealNetworks hiring date and, as a result, will have become or will shortly
become fully vested in their initial stock option grants. While 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 in all areas, especially 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 proper training or
experience, particularly in technical areas. Competition for qualified personnel
is intense, particularly in high-technology centers such as the Pacific
Northwest, where our corporate headquarters are located. In making employment
decisions, particularly in the Internet and high-technology industries, job
candidates 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 884 on June 30, 2000. Managing this
substantial expansion has placed a significant strain on our management,
operational and financial resources. If our growth continues, we will need to
continue to improve our financial and managerial control and reporting systems
and procedures.
We are in the process of implementing new management information
software systems. This will affect many aspects of our business, including our
accounting, operations, electronic commerce, customer service,
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purchasing, sales and marketing functions. The purchase, implementation and
testing of these systems have 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 ultimately be accepted as a viable commercial
medium for broadcasting multimedia content or media delivery for a number of
reasons which could inhibit the growth and use of the Internet, including:
- - potentially inadequate development of the necessary infrastructure to
accommodate growth in the number of users and Internet traffic;
- - lack of acceptance of the Internet as a medium for distributing digital
media content or for media delivery;
- - unavailability of compelling multimedia content;
- - inadequate commercial support for Web-based advertising or electronic
commerce transactions; and
- - delays in the development or adoption of new technological standards and
protocols, and increased governmental regulation, or inconsistent
regulations between state, federal and foreign governments.
In addition, we believe that other Internet-related issues, such as
security, privacy, reliability, cost, speed, ease of use and access, quality of
service and necessary increases in bandwidth availability, remain largely
unresolved and may affect the amount 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, system attacks and other delays occurring
throughout the Internet network infrastructure. If these outages, attacks or
delays occur frequently or on a broad scale in the future, Internet usage, as
well as the usage of our products, services and Web sites, could grow more
slowly or decline.
CHANGES IN NETWORK INFRASTRUCTURE, TRANSMISSION METHODS AND BROADBAND
TECHNOLOGIES POSE RISKS TO OUR BUSINESS
We believe that increased Internet use 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.
MORE INDIVIDUALS ARE UTILIZING NON-PC DEVICES TO ACCESS THE INTERNET AND WE MAY
NOT BE SUCCESSFUL IN DEVELOPING A VERSION OF OUR SERVICE THAT WILL GAIN
WIDESPREAD ADOPTION BY USERS OF SUCH DEVICES
In the coming years, the number of individuals who access the internet
through devices other than a personal computer such as personal digital
assistants, cellular telephones and television set-top devices is expected to
increase dramatically. Our products and services are designed for rich,
graphical environments such as those available on personal and laptop computers.
The lower resolution, functionality and memory associated with alterative
devices may make the use of our products and services through such devices
difficult, and we may be unsuccessful in our efforts to modify our online
offerings to provide a compelling experience for users of alternative devices.
As we have limited experience to date in creating versions of our products of
services optimized for users of alternative devices, it is difficult to predict
the problems we may encounter in doing so and we may need to devote significant
resources to the creation, support and maintenance of such versions. If we are
unable to attract and retain substantial number of alternative device
manufacturers to license and incorporate our technology into their devices, we
will fail to capture a sufficient share of an increasingly important portion of
the market for digital media delivery. Further, a failure to develop
revenue-generating relationships with enough device manufacturers whose products
are adopted by a significant number of device users could have a material
adverse effect on our business, operating results and financial condition.
WE COULD LOSE STRATEGIC RELATIONSHIPS THAT ARE ESSENTIAL TO OUR BUSINESS
The loss of certain current strategic relationships or key licensing
arrangements, the inability to find other strategic partners or the failure of
our existing relationships to achieve meaningful positive results for us could
harm our business. We rely in part on strategic relationships to help us:
- - increase adoption of our products through distribution arrangements;
- - increase the amount and availability of compelling media content on the
Internet to help boost demand for our products and services;
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- - 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
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 investments in broadband cable, including its $5 billion
investment in AT&T, and Microsoft's strategic investments focusing on
content delivery networks and Internet service providers;
- - AT&T's consolidation of the broadband cable industry, including its
acquisitions of TCI and MediaOne Communications;
- - 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;
- - 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
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- - 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. The Real
Broadcast Network's business is dependent on providing customers with efficient
and reliable services to enable its customers to broadcast content to large
audiences on an as-needed basis. Our systems and operations are susceptible to,
and could be damaged or interrupted by outages caused by fire, flood, power
loss, telecommunications failure, Internet breakdown, earthquake and similar
events. Our systems are also subject to human error, security breaches, power
losses, computer viruses, break-ins, "denial of service" attacks, sabotage,
intentional acts of vandalism and tampering designed to disrupt our computer
systems, Web sites and network communications. Our computer and communications
infrastructure is located at a single leased facility in Seattle, Washington. We
do not have fully redundant systems or a formal disaster recovery plan, and we
may not have adequate business interruption insurance to compensate us for
losses that may occur from a system outage. Despite our efforts, our network
infrastructure could be subject to service interruptions or damage and any
resulting interruption of services could harm our business, operating results
and reputation.
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 transmissions we generate
and send to our large user base. These types of interruptions could continue or
increase in the future.
Real Broadcast Network's operations are also dependent in part upon
transmission capacity provided by third-party telecommunications network
providers. Any failure of such network providers to provide the capacity we
require may result in a reduction in, or interruption of, service to our
customers. If we do not have access to third-party transmission capacity, we
could lose customers and if we are unable to obtain such capacity on terms
commercially acceptable to us, our business and operating results could suffer.
OUR 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;
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- - 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 June 30, 2000, approximately 28% 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 through joint ventures, subsidiaries and branch offices. 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. We believe that in light of substantial anticipated competition, we
need to continue to expand quickly into international markets in order to
effectively obtain market share. International markets we have selected may not
develop at a rate that supports our level of investment. In particular,
international markets typically have been slower in adoption of the Internet as
an advertising and commerce medium. In addition to uncertainty about our ability
to continue to generate revenues from our foreign operations and expand our
international presence, there are certain risks inherent in doing business on an
international level. We are subject to the normal risks of doing business
internationally, as well as risks specific to Internet-based companies in
foreign markets. These risks include:
- - delays in the development of the Internet as a broadcast, advertising
and commerce medium in international markets;
- - difficulties in managing operations due to distance, language and
cultural differences, including issues associated with establishing
management systems infrastructures in individual markets;
- - unexpected changes in regulatory requirements;
- - export and import restrictions, including those restricting the use of
encryption technology;
- - tariffs and trade barriers and limitations on fund transfers;
- - longer payment cycles and problems in collecting accounts receivable;
- - potential adverse tax consequences;
- - higher costs of doing business in foreign countries;
- - seasonal reductions in business activity;
- - exchange rate fluctuations;
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- - increased risk of piracy and limits on our ability to enforce our
intellectual property rights;
- - the need to comply with different and often conflicting laws and
regulations; and
- - other legal and political risks.
Any of these factors could harm our future international operations, and
consequently our business, operating results and financial condition. We do not
currently hedge our foreign currency exposures.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS
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 June 30, 2000, we had 32 registered U.S. trademarks or service
marks, and had applications pending for an additional 27 U.S. trademarks. We
also have several unregistered trademarks. In addition, RealNetworks has several
foreign trademark registrations and pending applications. Many of our marks
begin with the word "Real" (such as RealSystem, RealAudio and RealVideo). We are
aware of other companies that use "Real" in their marks alone or in combination
with other words, and we do not expect to be able to prevent all third-party
uses of the word "Real" for all goods and services. In addition, the laws of
some foreign countries do not protect our proprietary rights to the same extent
as the laws of the United States, and effective patent, copyright, trademark and
trade secret protection may not be available in such jurisdictions.
As of June 30, 2000, we had twelve U.S. patents and numerous patent
applications on file relating to various aspects of our technology. We are
preparing additional patent applications on other features of our technology.
Patents with respect to our technology may not be granted and, if granted, may
be challenged or invalidated. Issued patents may not provide us with any
competitive advantages and may be challenged by third parties. In addition,
others could independently develop substantially equivalent intellectual
property.
Many of our current and potential competitors dedicate substantially
greater resources to protection and enforcement of their intellectual property
rights, especially patents. 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.
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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 authentication or "digital
signatures," personal privacy, advertising, taxation, electronic commerce
liability, e-mail, gambling, sweepstakes, promotions, content regulation,
quality of products and services, network and information security and the
convergence of traditional communication services with Internet communications,
including the future availability of broadband transmission capability. Other
countries and political organizations are likely to impose or favor more and
different regulation than that which has been proposed in the United States,
thus furthering the complexity of regulation. In addition, state and local
governments may impose regulations in addition to, inconsistent with, or
stricter than federal regulations. The adoption of such laws or regulations, and
uncertainties associated with their validity and enforcement, may affect the
available distribution channels for and costs associated with our products and
services, and may affect the growth of the Internet. Such laws or regulations
may therefore harm our business.
We do not know for certain how existing laws governing issues such as
property ownership, copyright and other intellectual property issues, taxation,
illegal or obscene content, retransmission of media, and personal privacy and
data protection apply to the Internet. The vast majority of such laws were
adopted before the advent of the Internet and related technologies and do not
address the unique issues associated with the Internet and related technologies.
Most of the laws that relate to the Internet have not yet been interpreted.
Changes to or the interpretation of these laws could:
- - limit the growth of the Internet;
- - create uncertainty in the marketplace that could reduce demand for our
products and services;
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- - 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 may be required to pay
licensing fees for digital sound recordings we deliver in original and archived
programming and through retransmissions of radio broadcasts. The DMCA does not
specify the rate and terms of the licenses, which will be determined either
through voluntary inter-industry negotiations or arbitration. We plan to engage
in arbitration before a tribunal of the United States Copyright Office with the
Recording Industry Association of America during 2000 or 2001 to determine what,
if any, licensee fee should be paid. Depending on the rates and terms adopted
for the statutory licenses, our business could be harmed both by increasing our
own cost of doing business, as well as by increasing the cost of doing business
for our customers.
The Child Online Protection Act and the Child Online Privacy Protection
Act (COPPA) were enacted in October 1998. The COPPA impose civil and criminal
penalties on persons distributing material harmful to minors (e.g., obscene
material) over the Internet to persons under the age of 17, or collecting
personal information from children under the age of 13. We do not knowingly
collect and disclose personal information from such minors. The manner in which
the COPPA may be interpreted and enforced cannot be fully determined, and future
legislation similar to the COPPA could subject us to potential liability, which
in turn could harm our business. Such laws could also damage the growth of the
Internet generally and decrease the demand for our products and services.
WE MAY BE SUBJECT TO MARKET RISK AND LEGAL LIABILITY IN CONNECTION WITH THE DATA
COLLECTION CAPABILITIES OF OUR PRODUCTS AND SERVICES
Many of our products are interactive Internet applications that by their
very nature require communication between a client and server to operate. To
provide better consumer experiences and to operate effectively, our products
occasionally send information to servers at RealNetworks. Many of the services
we provide also require that a user provide certain information to us. We post
privacy policies concerning the use, collection, and disclosure of our user
data. Any failure by us to comply with our posted privacy policies and existing
or new legislation regarding privacy issues could impact the market for our
products and services, subject us to litigation and harm our business.
Between November 1999 and March 2000, fourteen lawsuits were filed
against the Company in federal and/or state courts in California, Illinois,
Pennsylvania, Washington and Texas. The plaintiffs in federal court in
Pennsylvania and in Illinois state court have voluntarily dismissed their
lawsuits. The remaining twelve actions, which seek to certify classes of
plaintiffs, allege breach of contract, invasion of privacy, deceptive trade
practices, negligence, fraud and violation of certain federal and state laws in
connection with various communications features of our RealPlayer and
RealJukebox products. Plaintiffs are seeking both damages and injunctive relief.
We have filed answers denying the claims and have filed suit in Washington state
court to compel the state court plaintiffs to arbitrate their claims as required
by our End User License Agreements. On February 10, 2000, the federal Judicial
Panel on Multidistrict Litigation transferred all pending federal cases to the
federal district court for the Northern District of Illinois. On the same day,
that court granted RealNetworks' motion to stay the court proceedings because
the claims are subject to arbitration under our End User License Agreement.
Although no assurance can be given as to the outcome of these lawsuits, the
Company believes that the allegations in these actions are without merit, and
intends to vigorously defend itself. If the plaintiffs prevail in their claims,
the
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Company could be required to pay damages or other penalties, in addition to
complying with injunctive relief, which could harm our business and our
operating results.
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 example, for defamation,
negligence, copyright or trademark infringement, unlawful activity, or tort,
including personal injury, fraud, or other theories based on the nature and
content of information to which we provide links. Investigating and defending
any of these types of claims is expensive, even to the extent that the claims do
not result in liability. If the claims do result in liability, we could be
required to pay damages of other penalties, which could harm our business.
REALNETWORKS' DIRECTORS AND EXECUTIVE OFFICERS BENEFICIALLY OWN APPROXIMATELY
45.5% 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 June 30, 2000, our executive officers, directors and affiliated
persons beneficially own approximately 45.5% of our common stock. Robert Glaser,
our chief executive officer and chairman of the board, beneficially owns
approximately 34.4% of our common stock. As a result, our executive officers,
directors and affiliated persons will have significant influence to:
- - elect or defeat the election of our directors;
- - amend or prevent amendment of our articles of incorporation or bylaws;
- - effect or prevent a merger, sale of assets or other corporate
transaction; and
- - control the outcome of any other matter submitted to the shareholders
for vote.
As a result of their ownership and positions, our directors and
executive officers collectively are able to significantly influence all matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. In addition, sales of significant amounts
of shares held by RealNetworks directors and executive officers, or the prospect
of these sales, could adversely affect the market price of RealNetworks common
stock. Management's stock ownership may discourage a potential acquirer from
making a tender offer or otherwise attempting to obtain control of RealNetworks,
which in turn could reduce our stock price or prevent our shareholders from
realizing a premium over our stock price.
PROVISIONS OF OUR CHARTER DOCUMENTS, SHAREHOLDER RIGHTS PLAN AND WASHINGTON LAW
COULD DISCOURAGE OUR ACQUISITION BY A THIRD PARTY
Our articles of incorporation provide for a strategic transaction
committee of the board of directors currently comprised of Messrs. Glaser,
Breyer and Kapor. Without the prior approval of this committee, and subject to
certain limited exceptions, the board of directors does not have the authority
to:
- - adopt a plan of merger;
- - authorize the sale, lease, exchange or mortgage of:
(A) assets representing more than 50% of the book value of our
assets prior to the transaction; or
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(B) any other asset or assets on which our long-term business
strategy is substantially dependent;
- - authorize our voluntary dissolution; or
- - take any action that has the effect of any of the above.
RealNetworks also entered into an agreement providing Mr. Glaser with a
direct contractual right to require RealNetworks to abide by and perform all
terms of the articles of incorporation with respect to the strategic
transactions committee. This agreement also provides that so long as Mr. Glaser
owns a specified number of shares, RealNetworks will use its best efforts to
cause him to be nominated to, elected to, and not removed from the board of
directors. In addition, the articles provide that Mr. Glaser will serve, or will
appoint another officer of RealNetworks to serve, as our policy ombudsman, with
the exclusive authority to adopt or change our editorial policies as reflected
on our Web sites or in other communications or media in which we have a
significant editorial or media voice. The provisions with respect to the
authority of the strategic transactions committee and the policy ombudsman may
be amended only with the approval of 90% of the shares entitled to vote on an
amendment to the articles.
We have adopted a shareholder rights plan that provides that shares of
our common stock have associated preferred stock purchase rights. These rights
become exercisable and detachable from the associated common stock only
following the acquisition by a person or a group of 15% or more of our
outstanding common stock or 10 days following the announcement of a tender or
exchange offer for 15% or more of our outstanding common stock. The rights
entitle our shareholders, other than the person or entity that has acquired or
made an exchange or tender offer for 15% or more of our outstanding common
stock, to acquire additional shares of our capital stock at a price equal to
one-half of the market price at the time of the event and, in certain
circumstances, would allow our shareholders to acquire capital stock in the
entity that has acquired or made an exchange or tender offer for 15% or more of
our outstanding common stock at a similar discount. The exercise of these rights
would make the acquisition of RealNetworks by a third party more expensive to
that party and has the effect of discouraging third parties from acquiring our
company without the approval of our board of directors, which has the power to
redeem these rights and prevent their exercise.
Washington law imposes restrictions on some transactions between a
corporation and certain significant shareholders. Chapter 23B.19 of the
Washington Business Corporation Act prohibits a "target corporation," with some
exceptions, from engaging in certain significant business transactions with an
"acquiring person," which is defined as a person or group of persons that
beneficially owns 10% or more of the voting securities of the target
corporation, for a period of five years after such acquisition, unless the
transaction or acquisition of shares is approved by a majority of the members of
the target corporation's board of directors prior to the acquisition. Such
prohibited transactions include, among other things:
- - a merger or consolidation with, disposition of assets to, or issuance or
redemption of stock to or from the acquiring person;
- - termination of 5% or more of the employees of the target corporation as
a result of the acquiring person's acquisition of 10% or more of the
shares; or
- - allowing the acquiring person to receive any disproportionate benefit as
a shareholder.
After the five-year period, a "significant business transaction" may
occur, as long as it complies with certain "fair price" provisions of the
statute. A corporation may not opt out of this statute. This provision may have
the effect of delaying, deterring or preventing a change in control of
RealNetworks. The foregoing provisions of our charter documents, shareholder
rights plan and Washington law, as well as those relating to a classified board
of directors and the availability of "blank check" preferred stock, could have
the effect of making it more difficult or more expensive for a third party to
acquire, or of discouraging a third party from attempting to acquire, control of
us. These provisions may therefore have the effect of limiting the price that
investors might be willing to pay in the future for our common stock.
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OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE
The trading price of our common stock has been and is likely to continue
to be highly volatile. For example, during the 52-week period ended June 30,
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, regulatory or political developments;
- - additions or departures of key personnel;
- - sales of our common stock; and
- - general market conditions.
The historical volatility of our stock price may make it more difficult
for you to resell shares when you want at prices you find attractive. Sharp
increases in our stock price could have a negative impact on our financial
condition.
In addition, the stock market in general, and the Nasdaq National Market
and the market for Internet and technology companies in particular, have
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of these companies. These broad
market and industry factors 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.
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WE INTEND TO DONATE A PORTION OF NET INCOME TO CHARITY
For the year ended December 31, 1999, we were profitable and set aside
5% of our pretax net income for donations 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);
- - 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
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in our common stock, you should be aware that the occurrence of the events
described in the "Factors That May Affect Our Business, Future Operating Results
and Financial Condition" and elsewhere in this Quarterly Report on Form 10-Q
could materially and adversely affect our business, financial condition and
operating results. We undertake no obligation to publicly update any
forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The 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 June 30, 2000, the Company had investments in
voting capital stock of privately-held, technology companies for business and
strategic purposes. These investments are included in other assets and are
accounted for under the cost method since ownership 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 investments. The Company also
has investments in voting capital stock of publicly traded, technology companies
for business and strategic purposes. These investments are subject to
significant fluctuations in fair market value due to the volatility of the stock
market.
The 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.
Foreign Currency Risk. International revenues from the Company's foreign
subsidiaries accounted for approximately 28% of total revenues in the quarter
ended June 30, 2000, excluding revenues from the Microsoft license agreement.
These subsidiaries incur most of their expenses in the local currency.
Accordingly, all foreign subsidiaries use the local currency as their functional
currency.
The Company's international business is subject to risks typical of an
international business, including, but not limited to differing economic
conditions, changes in political climate, differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility. Accordingly,
the Company's future results could be materially adversely impacted by changes
in these or other factors.
The Company's exposure to foreign exchange rate fluctuations arises in
part from intercompany accounts in which costs incurred in the United States are
charged to the Company's foreign sales subsidiaries. These intercompany accounts
are typically denominated in the functional currency of the foreign subsidiary
in order to centralize foreign exchange risk with the parent company in the
United States. The Company is also exposed to foreign exchange rate fluctuations
as the financial results of foreign subsidiaries are translated into U.S.
dollars in consolidation. As exchange rates vary, these results, when
translated, may vary from expectations and adversely impact overall expected
profitability. The effect of foreign exchange rate fluctuations on the Company
in the quarter ended June 30, 2000 was not material.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against the Company and co-defendant Broadcast.com in the United States District
Court for the Northern District of Texas--Dallas Division. The plaintiffs allege
that the Company, individually and in combination with Broadcast.com, infringes
on the plaintiffs' patent by making, using, selling and/or offering to sell
software products and services directed to media delivery systems for the
Internet and corporate intranets. The plaintiffs seek to enjoin the Company from
its alleged infringing activity and to recover damages in an amount no less than
a reasonable royalty. Although no assurance can be given as to the outcome of
this lawsuit, the Company believes that the allegations in this action are
without merit, and intends to vigorously defend itself against these claims. The
Company may be required to indemnify Broadcast.com under the terms of its
license agreement. The plaintiffs filed a similar claim based on the same patent
and seeking similar remedies as a separate lawsuit against Microsoft and
Broadcast.com in the same court. The court has consolidated the lawsuit against
Microsoft and Broadcast.com with the lawsuit against the Company and
Broadcast.com. If the plaintiffs prevail in their claims, the Company could be
required to pay damages or other royalties, in addition to complying with
injunctive relief, which could have a material adverse effect on the Company's
operating results.
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,
claiming breach of contract, unjust enrichment, promissory estoppel and breach
of implied-in-fact contract. The Company denied each of the plaintiff's claims.
The parties entered into a confidential settlement of the dispute in June 2000,
the costs of which are reflected in the quarter ended June 30, 2000.
Between November 1999 and March 2000, fourteen lawsuits were filed
against the Company in federal and/or state courts in California, Illinois,
Pennsylvania, Washington and Texas. The plaintiffs in federal court in
Pennsylvania and in Illinois state court have voluntarily dismissed their
lawsuits. The remaining twelve actions, which seek to certify classes of
plaintiffs, allege breach of contract, invasion of privacy, deceptive trade
practices, negligence, fraud and violation of certain federal and state laws in
connection with various communications features of the RealPlayer and
RealJukebox products. Plaintiffs are seeking both damages and injunctive relief.
The Company has filed answers denying the claims and has filed suit in
Washington state court to compel the state court plaintiffs to arbitrate their
claims as required by our End User License Agreements. On February 10, 2000, the
federal Judicial Panel on Multidistrict Litigation transferred all pending
federal cases to the federal district court for the Northern District of
Illinois. On the same day, that court granted RealNetworks' motion to stay the
court proceedings because the claims are subject to arbitration under
RealNetworks' End User License Agreement. Although no assurance can be given as
to the outcome of these lawsuits, the Company believes that the allegations in
these actions are without merit, and intends to vigorously defend itself. If the
plaintiffs prevail in their claims, the Company could be required to pay damages
or other penalties in addition to complying with injunctive relief, which could
harm our business and our operating results.
From time to time RealNetworks is, and expects to continue to be,
subject to legal proceedings and claims in the ordinary course of its business,
including 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. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Between April 1, 2000 and June 30, 2000, the Company has issued
and sold unregistered securities as follows:
(1) An aggregate of 1,000 shares of Common Stock was issued
in June 2000 to one individual in exchange for services
valued at $33,771.
(2) A warrant for the purchase of an aggregate of 1,600
shares of Common Stock having an exercise price of
$30.56 was issued to a service provider in April 2000
pursuant to a contractual agreement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An Annual Meeting of Shareholders of RealNetworks, Inc. (the "Annual
Meeting") was held on June 2, 2000. Matters voted on at the Annual Meeting and
votes cast on each were as follows:
1. The election of one Class 3 director to serve until the 2003 Annual
Meeting of Shareholders or until his earlier retirement, resignation or removal,
or the election of his successor:
For Withheld
--- --------
Robert Glaser 129,209,853 8,661,634
The terms of the following directors continued after the Annual Meeting:
Edward Bleier
James W. Breyer
Bruce Jacobsen
Mitchell Kapor
2. The approval of amendments to the Company's Restated Articles of
Incorporation, as amended, to increase the number of authorized shares of Common
Stock from 300,000,000 to 1,000,000,000 shares, to delete provisions that are
not applicable to a public company and to delete a designation of non-voting
stock that is no longer outstanding:
For 122,298,573
Against 15,484,999
Abstain 87,915
Broker non-votes 0
3. The approval of the Company's Amended and Restated 1996 Stock Option
Plan, which increases the number of shares of Common Stock that may be issued
thereunder from 45,200,000 shares to 60,200,000 shares:
For 80,250,863
Against 25,127,435
Abstain 123,681
4. The ratification of the appointment of KPMG LLP as independent
auditors for the Company's fiscal year ending December 31, 2000:
For 137,769,435
Against 58,359
Abstain 43,693
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Required by Item 601 of Regulation S-K:
3.1 Amended and Restated Articles of Incorporation
10.1 RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan
10.2 RealNetworks, Inc. 2000 Stock Option Plan
27.1 Financial Data Schedule which is submitted electronically to the
Securities and Exchange Commission for information purposes only
and is not filed
(b) Reports on Form 8-K:
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 11, 2000.
REALNETWORKS, INC.
By /s/ Paul Bialek
---------------------------------
Paul Bialek
Senior Vice President, Finance
and Operations, Chief Financial
Officer, and Treasurer
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INDEX TO EXHIBITS
Exhibit Number Description
-------------- -----------
3.1 Amended and Restated Articles of Incorporation
10.1 RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan
10.2 RealNetworks, Inc. 2000 Stock Option Plan
27.1 Financial Data Schedule which is submitted electronically to the
Securities and Exchange Commission for information purposes only
and is not filed