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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-23137
REALNETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
WASHINGTON 91-1628146
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
2601 ELLIOTT AVENUE, SUITE 1000 98121
SEATTLE, WASHINGTON (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(206) 674-2700
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of the registrant's Common Stock outstanding as of
October 31, 1999 was 74,403,023.
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REALNETWORKS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
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......11
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..........................................................................37
Item 2. Changes in Securities and Use of Proceeds..................................................37
Item 6. Exhibits and Reports on Form 8-K...........................................................38
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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)
September 30, December 31,
1999 1998
------------- ------------
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 326,753 89,801
Trade accounts receivable, net of allowances for doubtful
accounts and sales returns 7,146 5,149
Prepaid expenses and other current assets 3,079 3,446
--------- ---------
Total current assets 336,978 98,396
Equipment and leasehold improvements, at cost:
Equipment and software 18,558 11,445
Leasehold improvements 13,259 1,441
--------- ---------
Total equipment and leasehold improvements 31,817 12,886
Less accumulated depreciation and amortization 8,569 6,506
--------- ---------
Net equipment and leasehold improvements 23,248 6,380
--------- ---------
Goodwill, net 7,452 9,048
Restricted cash equivalents 13,700 13,700
Other assets 1,027 1,250
--------- ---------
TOTAL ASSETS $ 382,405 128,774
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,859 3,947
Accrued and other liabilities 22,038 12,961
Deferred revenue, excluding non-current portion 38,309 23,742
--------- ---------
Total current liabilities 64,206 40,650
--------- ---------
Deferred revenue, excluding current portion -- 5,833
Note payable -- 987
Shareholders' equity:
Convertible preferred stock, no par value
Series A: authorized no shares in 1999 and 45 shares in 1998,
issued and outstanding no shares in 1999 and 17 shares in 1998 -- 3,642
Series B: authorized no shares in 1999 and 181 shares in 1998,
issued and outstanding no shares in 1999 and 103 shares in 1998 -- 1,200
Preferred stock, $0.001 par value per share, no shares issued and outstanding
Series A: authorized 200 shares -- --
Undesignated series: authorized 59,800 shares -- --
Common stock, $0.001 par value per share
Authorized 300,000 shares in 1999 and 296,291 shares in 1998;
issued and outstanding 73,961 shares in 1999 and 62,414 shares in 1998 74 62
Special common stock, $0.001 par value per share
Authorized no shares in 1999 and 3,709 shares in 1998; issued and
outstanding no shares in 1999 and 2,586 shares in 1998 -- 3
Additional paid-in capital 359,288 118,314
Accumulated deficit (40,926) (41,791)
Accumulated other comprehensive loss (237) (126)
--------- ---------
Total shareholders' equity 318,199 81,304
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 382,405 128,774
========= =========
See accompanying notes to condensed consolidated financial statements
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REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS EXCEPT PER SHARE DATA)
Quarter Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
Net revenues:
Software license fees $ 24,091 12,842 62,683 33,592
Service revenues 6,683 3,988 17,641 10,105
Advertising 4,117 843 7,464 2,070
-------- -------- -------- --------
Total net revenues 34,891 17,673 87,788 45,767
-------- -------- -------- --------
Cost of revenues:
Software license fees 3,353 2,213 9,409 5,729
Service revenues 1,877 642 4,274 1,918
Advertising 674 469 1,822 1,207
-------- -------- -------- --------
Total cost of revenues 5,904 3,324 15,505 8,854
-------- -------- -------- --------
Gross profit 28,987 14,349 72,283 36,913
-------- -------- -------- --------
Operating expenses:
Research and development 10,019 6,095 25,935 16,162
Sales and marketing 13,722 8,423 37,138 23,907
General and administrative 4,174 3,002 10,797 8,294
Goodwill amortization 532 532 1,596 1,064
Acquisition charges 1,403 -- 1,403 8,723
-------- -------- -------- --------
Total operating expenses 29,850 18,052 76,869 58,150
-------- -------- -------- --------
Operating loss (863) (3,703) (4,586) (21,237)
Other income, net 3,866 1,204 5,451 3,511
-------- -------- -------- --------
Net income (loss) $ 3,003 (2,499) 865 (17,726)
======== ======== ======== ========
Basic net income (loss) per share $ 0.04 (0.04) 0.01 (0.28)
======== ======== ======== ========
Diluted net income (loss) per share $ 0.03 (0.04) 0.01 (0.28)
======== ======== ======== ========
Shares used to compute basic net
income (loss) per share 73,661 65,804 70,194 64,374
Shares used to compute diluted net
income (loss) per share 86,422 65,804 82,075 64,374
Comprehensive income (loss):
Net income (loss) $ 3,003 (2,499) 865 (17,726)
Translation adjustment 61 (33) (111) (86)
-------- -------- -------- --------
Comprehensive income (loss) $ 3,064 (2,532) 754 (17,812)
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements
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REALNETWORKS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1999 1998
--------- ---------
Net cash provided by operating activities $ 22,771 6,014
Cash flows from investing activities:
Purchases of equipment and leasehold improvements (20,140) (2,665)
Purchases of short-term investments (119,016) (82,074)
Proceeds from sales and maturities of short-term
investments 37,239 57,117
Cash obtained through acquisition -- 203
--------- ---------
Net cash used in investing activities (101,917) (27,419)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants 1,000 650
Payments on notes payable (415) (3)
Net proceeds from sale of common stock and exercise of stock options 233,898 1,348
--------- ---------
Net cash provided by financing activities 234,483 1,995
--------- ---------
Effect of exchange rate changes on cash (162) (56)
--------- ---------
Net increase (decrease) in cash and cash equivalents 155,175 (19,466)
Cash and cash equivalents at beginning of period 51,900 63,395
--------- ---------
Cash and cash equivalents at end of period 207,075 43,929
Short-term investments at end of period 119,678 54,730
--------- ---------
Total cash, cash equivalents and short-term investments at end of period $ 326,753 98,659
========= =========
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 (Company) is a leading provider of
media delivery and distribution solutions designed for the Internet. The
Company's solutions enable consumers to experience and content providers to
deliver a broad range of multimedia content, including audio, video, text and
animation. The Company pioneered the development and commercialization of
"streaming media" systems that enable the creation, real-time delivery and
playback of multimedia content. The Company recently extended its media delivery
platform to include a digital music management system that allows consumers to
acquire, record, store, organize and play their personal music collections on
personal computers and digital playback devices.
(b) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
These statements reflect all adjustments, consisting only of normal,
recurring adjustments that, in the opinion of the Company's management, are
necessary for a fair presentation of the results of operations for the periods
presented. Operating results for the quarter and nine months ended September 30,
1999 are not necessarily indicative of the results that may be expected for any
subsequent quarter or for the year ending December 31, 1999. Certain information
and footnote disclosures normally included in financial statements prepared in
conformity with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission.
These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related notes
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1998.
On April 27, 1999, the board of directors 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. Accordingly, the accompanying condensed consolidated
financial statements and notes thereto have been retroactively restated to
reflect the stock split.
(c) Cash, Cash Equivalents and Short-Term Investments
Cash, cash equivalents and short-term investments are comprised of the
following:
September 30, December 31,
1999 1998
------------- ------------
(in thousands)
Cash and cash equivalents $207,075 51,900
Short-term investments 119,678 37,901
-------- --------
Total cash, cash equivalents and short-term investments $326,753 89,801
======== ========
Restricted cash equivalents $ 13,700 13,700
======== ========
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Restricted cash equivalents represent a restricted escrow account
established in connection with a lease agreement for the Company's corporate
headquarters. Under certain circumstances, $10,000,000 of the escrow account
will be maintained for the term of the lease. The remaining $3,700,000 will be
released as the Company funds tenant improvements. The Company took occupancy of
the new facilities during the quarter ended June 30, 1999.
(d) Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position
97-2, "Software Revenue Recognition" (SOP 97-2), which provides specific
industry guidance and stipulates that revenue recognized from software
arrangements is to be allocated to each element of the arrangement based on the
relative fair values of the elements, such as software products, upgrades,
enhancements, post contract customer support, installation, or training. Under
SOP 97-2, the determination of fair value is based on objective evidence that is
specific to the vendor. If such evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered.
Revenue from software license fees is recognized upon delivery, net of
an allowance for estimated returns, provided all the requirements of SOP 97-2
have been met.
Revenue from software license agreements with original equipment
manufacturers (OEM) is recognized when the OEM delivers its product
incorporating the Company's software to the end user. In the case of prepayments
received from an OEM, the Company generally recognizes revenue based on the
actual products sold by the OEM. If the Company anticipates providing ongoing
support to the OEM in the form of future upgrades, enhancements or other
services over the term of the contract, revenue is recognized on the
straight-line method over the term of the contract.
Service revenues include payments under support and upgrade contracts,
and fees from consulting and streaming media content hosting. Support and
upgrade revenues are recognized ratably over the term of the contract, which
typically is twelve months. Other service revenues are recognized when the
service is performed.
Revenues from advertising appearing on the Company's Web sites are
recognized ratably over the terms of the advertising contracts. The Company
guarantees to certain advertising customers a minimum number of page impressions
to be delivered to users of its Web sites for a specified period. To the extent
minimum guaranteed page impression deliveries are not met, the Company defers
recognition of the corresponding revenues until guaranteed page impression
delivery levels are achieved.
(e) Comprehensive Income (Loss)
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS 130), establishes standards for the reporting and
disclosure of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of financial statements. The Company's comprehensive
income (loss) for the quarters and nine months ended September 30, 1999 and 1998
consisted of net income (loss) and the gross amount of foreign currency
translation adjustments. The tax effect of the foreign currency translation
adjustments was insignificant.
(f) Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common shares outstanding during the
period. Diluted net income (loss) per share is computed by dividing net income
(loss) by the weighted average number of common and dilutive common equivalent
shares outstanding during the period. As the Company had a net loss attributable
to common shareholders for the quarter
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and nine month periods ended September 30, 1998, basic and diluted net loss per
share are the same for those periods.
Excluded from the computation of diluted net income per share for the
quarter and nine months ended September 30, 1999 are options to acquire
2,340,000 shares of common stock with a weighted-average exercise price of
$91.93. Excluded from the computation of diluted net loss per share for the
quarter and nine months ended September 30, 1998 are options and warrants to
acquire 16,810,000 shares of common stock with a weighted-average exercise price
of $4.82. Such options and warrants were excluded as their effects are
anti-dilutive. Additionally, 173,000 shares of common stock issuable upon
conversion of no par value preferred stock were excluded because their effects
would be anti-dilutive. The following schedule represents a reconciliation of
the numerators and denominators of basic and diluted net income (loss) per share
calculations for the quarters and nine months ended September 30, 1999 and 1998.
(In thousands except per share data) Weighted
Income Shares Income
(loss) Average (loss)
(Numerator) (Denominator) per share
----------- ------------- ---------
Quarter Ended September 30, 1999
Basic net income per share $ 3,003 73,661 $ 0.04
Effect of dilutive stock options and warrants -- 12,761
-------- --------
Diluted net income per share $ 3,003 86,422 $ 0.03
======== ======== ========
Quarter Ended September 30, 1998
Basic net loss per share $ (2,499) 65,804 $ (0.04)
Effect of dilutive common stock options and warrants
and convertible preferred stock -- --
-------- --------
Diluted net loss per share $ (2,499) 65,804 $ (0.04)
======== ======== ========
Nine Months Ended September 30, 1999
Basic net income per share $ 865 70,194 $ 0.01
Effect of dilutive stock options and warrants -- 11,881
-------- --------
Diluted net income per share $ 865 82,075 $ 0.01
======== ======== ========
Nine Months Ended September 30, 1998
Basic net loss per share $(17,726) 64,374 $ (0.28)
Effect of dilutive common stock options and warrants
and convertible preferred stock -- --
-------- --------
Diluted net loss per share $(17,726) 64,374 $ (0.28)
======== ======== ========
(g) Recent Accounting Pronouncements
In December 1998, the American Institute of Certified Public Accounts
(AICPA) issued Statement of Position 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions" (SOP 98-9), which
amends certain elements of SOP 97-2, "Software Revenue Recognition" and is
effective for fiscal years beginning after March 15, 1999. The Company believes
that the adoption of SOP 98-9 will not have a material effect on its results of
operations or financial position.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model
for accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning after
June 15, 2000. SFAS 133 requires that all derivatives be recognized in the
balance sheet at their fair market value, and the corresponding derivative gains
or
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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 Company does not expect the adoption
of SFAS 133 to have a material impact on its consolidated financial statements.
NOTE 2 - SEGMENT INFORMATION
The Company adopted the provisions of SFAS No. 131, "Disclosure About
Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131
establishes standards for the way that public business enterprises report
information about operating segments.
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 Nine months ended
September 30, September 30,
---------------------- ----------------------
1999 1998 1999 1998
------- ------- ------- -------
North America $25,402 11,916 62,042 30,292
Europe 3,541 1,866 9,889 4,500
Asia 2,645 1,151 6,699 3,077
Rest of world 686 323 1,507 647
------- ------- ------- -------
Subtotal 32,274 15,256 80,137 38,516
Microsoft license revenue 2,617 2,417 7,651 7,251
------- ------- ------- -------
Total $34,891 17,673 87,788 45,767
======= ======= ======= =======
Revenue from external customers by product type is as follows (in thousands):
Quarter Ended Nine months ended
September 30, September 30,
---------------------- ----------------------
1999 1998 1999 1998
------- ------- ------- -------
Media delivery license revenue $21,474 10,425 55,032 26,341
Media delivery service revenue 6,683 3,988 17,641 10,105
Microsoft license revenue 2,617 2,417 7,651 7,251
Advertising revenue 4,117 843 7,464 2,070
------- ------- ------- -------
Total net revenues $34,891 17,673 87,788 45,767
======= ======= ======= =======
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Long-lived assets by geographic location are as follows (in thousands):
September 30, December 31,
1999 1998
------------- ------------
United States $29,924 14,645
Asia and rest of world 434 454
Europe 342 329
------- -------
Total $30,700 15,428
======= =======
NOTE 3 - ACQUISITION
In August 1999, the Company completed its acquisition of Xing Technology
Corporation (Xing), a leading developer and provider of MP3 software. Under the
terms of the acquisition, the Company issued approximately 733,000 shares of its
common stock in exchange for all issued and outstanding shares of Xing common
stock. In addition, the Company issued options to purchase approximately 33,000
shares of the Company's common stock in exchange for outstanding options to
purchase Xing common stock. 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.
In connection with the merger, the Company incurred approximately $1.4
million in merger-related expenses primarily for legal and other professional
fees. As of September 30, 1999, approximately $0.9 million of these costs had
been paid. The remaining costs are expected to be paid during the quarter
ending December 31, 1999.
Separate results for the combined entities for the quarter and nine
months ended September 30, 1999 and 1998 are as follows:
Nine Months Nine Months
Quarter Ended Ended Quarter Ended Ended
September 30, September 30, September 30, September 30,
1999 1999 1998 1998
------------- ------------- ------------- -------------
Revenues:
RealNetworks, Inc. $ 34,468 86,039 17,244 44,802
Xing 423 1,749 429 965
-------- -------- -------- --------
$ 34,891 87,788 17,673 45,767
======== ======== ======== ========
Net income (loss):
RealNetworks, Inc. $ 4,337 3,331 (1,817) (15,311)
Xing (1,334) (2,466) (682) (2,415)
-------- -------- -------- --------
$ 3,003 865 (2,499) (17,726)
======== ======== ======== ========
In connection with the acquisition, approximately 73,000 shares of
common stock issued were placed in escrow to secure indemnification obligations
of former shareholders of Xing.
There were no significant intercompany transactions between the two
companies and no significant conforming accounting adjustments.
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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
We are a leading provider of media delivery and distribution solutions
designed for the Internet. Our solutions enable consumers to experience and
content providers to deliver a broad range of multimedia content, including
audio, video, text and animation. We pioneered the development and
commercialization of "streaming media" systems that enable the creation,
real-time delivery and playback of multimedia content. We believe that we have
established a leadership position in the market for these systems. We have more
than 80 million registered users of our RealPlayer product and believe that more
than 85% of all Web pages using streaming media use our technology. The broad
acceptance of the Internet as a means of content delivery, combined with recent
technological advances, has greatly increased the practicality and popularity of
a number of new online media delivery formats. In response, we have extended our
media delivery platform to include a digital music management system that allows
consumers to acquire, record, store, organize and play their personal music
collections on PCs and digital playback devices.
We were incorporated in February 1994 and were in the development stage
until July 1995, when we released the commercial version of RealAudio Version
1.0, the first version of our RealPlayer products. From inception through
December 31, 1995, our operating activities related primarily to recruiting
personnel, raising capital, purchasing operating assets, conducting research and
development, building the RealAudio brand and establishing the market for
streaming audio. During 1996, we continued to invest heavily in research and
development and marketing and in building our domestic and international sales
channels and our general and administrative infrastructure. In August 1996, we
began selling RealPlayer Plus, a premium version of our RealPlayer product.
RealPlayer continues to be available for download free of charge from our
websites. In June 1997, we released the commercial version of RealVideo Version
4.0. In December 1997, we released the commercial version of RealSystem Version
5.0, a streaming media solution that includes RealAudio and RealVideo
technology. In November 1998, we released the commercial version of RealSystem
G2, our latest generation media delivery system. In May 1999, we released
RealSystem MP as well as a beta version of RealJukebox. In September 1999, we
released RealSlideshow Plus, a complete streaming solution for sharing
photographs to communicate information and ideas. Also in September 1999, we
released the commercial versions of RealJukebox and RealJukebox Plus, which are
complete digital music systems. In November 1999, we released the beta version
of RealPlayer 7 and introducted the new Real.com Network, which gives consumers
the ability to find, organize and play audio and video on the internet and Take
5, Real.com's new programming service.
Our revenues are reported in the following three categories:
Software license fees, which include revenues from sales of our RealPlayer
Plus, RealJukebox Plus, Xing AudioCatalyst, RealServers and related
authoring and publishing tools, OEM sales of our products 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,
RealServers and tools products, broadcast hosting services we provide
through our Real Broadcast Network, and consulting services we offer to our
customers.
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Advertising revenues are derived from the sale of advertising on our
websites and the placement of channels and presets included in the
RealPlayer and the RealJukebox.
In March 1998, we acquired Vivo Software, a leading developer of
streaming media creation tools, in an acquisition accounted for using the
purchase method of accounting. In August 1999, we acquired Xing Technology
Corporation, a leading developer and provider of MP3 software, in an acquisition
accounted for using the pooling of interests method of accounting.
RESULTS OF OPERATIONS
REVENUES
Software License Fees. Software license fees were $24.1 million for the
quarter ended September 30, 1999, an increase of 88% from $12.8 million in the
comparable quarter of the prior year. Software license fees were $62.7 million
for the nine months ended September 30, 1999, an increase of 87% from $33.6
million in the comparable period of the prior year. The increases were due
primarily to a greater volume of products sold, which resulted from (1) growth
in the demand for streaming media and digital music on the Internet, (2) sales
of RealSystem G2, which was introduced in November 1998, (3) successful product
promotions, (4) increased sales of third-party products, and (5) sales of the
RealJukebox Plus during the quarter ended September 30, 1999. Software license
fees for the quarter ended September 30, 1999 and 1998 included $2.6 million and
$2.4 million, respectively, related to the Microsoft license agreement we
entered into in June 1997. Software license fees for the nine months ended
September 30, 1999 and 1998 included $7.7 million and $7.3 million,
respectively, related to the Microsoft license agreement.
Service Revenues. Service revenues were $6.7 million for the quarter
ended September 30, 1999, an increase of 68% from $4.0 million in the comparable
quarter of the prior year. Service revenues were $17.6 million for the nine
months ended September 30, 1999, an increase of 75% from $10.1 million in the
comparable period of the prior year. The increases were primarily due to a
larger installed base of our products from which we derive support and
maintenance revenues and increases in our consulting and streaming media hosting
services.
Advertising Revenues. Advertising revenues were $4.1 million for the
quarter ended September 30, 1999, an increase of 388% from $0.8 million in the
comparable quarter of the prior year. Advertising revenues were $7.5 million for
the nine months ended September 30, 1999, an increase of 261% from $2.1 million
in the comparable period of the prior year. The increase in advertising revenues
was due to increased traffic on our websites, the increased effectiveness of our
advertising sales force that resulted in increased advertising sales and higher
average advertising rates, and increased revenue associated with channels,
presets and search functionality included in the RealPlayer and RealJukebox.
Geographic Revenues. Excluding revenues from the Microsoft license
agreement, international revenues represented 21% of total net revenues for the
quarter ended September 30, 1999 and 22% of total net revenues for the quarter
ended September 30, 1998. Excluding revenues from the Microsoft license
agreement, international revenues represented 23% of total net revenues for the
nine months ended September 30, 1999 and 21% of total net revenues for the nine
months ended September 30, 1998. Revenues generated in Europe were 11% and 12%
of total net revenues (excluding revenues from the Microsoft license agreement)
for the quarters ended September 30, 1999 and 1998, respectively, and revenues
generated in Asia and rest of world were 10% of total net revenues (excluding
revenues from the Microsoft license agreement) for each of the quarters ended
September 30, 1999 and 1998. Revenues generated in Europe were 12% of total net
revenues (excluding revenues from the Microsoft license agreement) for each of
the nine months ended September 30, 1999 and 1998, and revenues generated in
Asia and rest of world were 10% of total net revenues (excluding revenues from
the Microsoft license agreement) for each of the nine months ended September 30,
1999 and 1998.
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COST OF REVENUES
Cost of Software License Fees. Cost of software license fees includes
costs of product media, duplication, manuals, packaging materials, amounts paid
for licensed technology, and fees paid to third-party vendors for order
fulfillment. Cost of software license fees was $3.4 million for the quarter
ended September 30, 1999, an increase of 52% from $2.2 million in the comparable
quarter of the prior year, but decreased as a percentage of software license
fees to 14% from 17%. Cost of software license fees was $9.4 million for the
nine months ended September 30, 1999, an increase of 64% from $5.7 million in
the comparable period of the prior year, but decreased as a percentage of
software license fees to 15% from 17%. The increases in absolute dollars were
due primarily to higher sales volumes. The decreases as a percentage of software
license fees were due primarily to changes in the mix of products sold.
Cost of Service Revenues. Cost of service revenues includes the cost of
in-house and contract personnel providing support and other services and
expenses incurred in expanding our streaming media hosting services. Cost of
service revenues was $1.9 million for the quarter ended September 30, 1999, an
increase of 192% from $0.6 million in the comparable quarter of the prior year,
and increased as a percentage of service revenues to 28% from 16%. Cost of
service revenues was $4.3 million for the nine months ended September 30, 1999,
an increase of 123% from $1.9 million in the comparable period of the prior
year, and increased as a percentage of service revenues to 24% from 19%. 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,
expansion of customer service and technical support into international regions,
and support costs related to the introduction of RealJukebox.
Cost of Advertising Revenues. Cost of advertising revenues includes the
cost of personnel associated with content creation and maintenance and fees paid
to third parties for content included in our websites. Cost of advertising
revenues was $0.7 million for the quarter ended September 30, 1999, an increase
of 44% from $0.5 million in the comparable quarter of the prior year, but
decreased as a percentage of advertising revenues to 16% from 56%. Cost of
advertising revenues was $1.8 million for the nine months ended September 30,
1999, an increase of 51% from $1.2 million in the comparable period of the prior
year, but decreased as a percentage of advertising revenues to 24% from 58%. The
increases in absolute dollars were primarily due to increases in the quality and
quantity of content available on our websites, enhancements made to existing
websites, and the addition of new websites. The decreases as a percentage of
advertising revenues were due to greater economies of scale.
Our gross margins may be adversely affected by the mix of distribution
channels used and the mix of products sold.
OPERATING EXPENSES
Research and Development. Research and development expenses consist
primarily of salaries and consulting fees associated with product development
and costs of technology acquired from third parties to incorporate into products
currently under development. To date, all research and development costs have
been expensed as incurred because technological feasibility is generally not
established until substantially all development is complete. We believe that
significant investment in research and development is a critical factor in
attaining our strategic objectives and, as a result, we expect to increase
research and development expenditures in future periods. Research and
development expenses were $10.0 million for the quarter ended September 30,
1999, an increase of 64% from $6.1 million in the comparable quarter of the
prior year. Such expenses decreased as a percentage of total net revenues to 29%
from 34%. Research and development expenses were $25.9 million for the nine
months ended September 30, 1999, an increase of 60% from $16.2 million in the
comparable period of the prior year, but decreased as a percentage of total net
revenues to 30% from 35%. Research and development expenses were primarily
related to the development of new technology and products, including RealSystem
MP, RealJukebox, RealSlideshow, and the beta version of RealPlayer 7 as well as
enhancements made to existing products. The increases in absolute dollars were
primarily due to increases in internal development personnel, consulting
expenses and contract labor. The decreases in percentage terms were a result of
revenues growing at a faster rate than expenses.
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, sales commissions, consulting fees, trade show expenses, advertising
costs and cost of marketing collateral. We intend to increase our
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branding and marketing efforts and, therefore, expect sales and marketing
expenses to increase significantly in future periods. Sales and marketing
expenses were $13.7 million for the quarter ended September 30, 1999, an
increase of 63% from $8.4 million in the comparable quarter of the prior year.
Such expenses decreased as a percentage of total net revenues to 39% from 48%.
Sales and marketing expenses were $37.1 million for the nine months ended
September 30, 1999, an increase of 55% from $23.9 million in the comparable
period of the prior year, but decreased as a percentage of total net revenues to
42% from 52%. The increases in absolute dollars were due to the expansion of our
direct sales and marketing organization, the creation of additional foreign and
domestic sales offices, increased tradeshow attendance, advertising, promotions
and other expenses related to the continued development of the "Real" brand. The
decreases in percentage terms were a result of revenues growing at a faster rate
than expenses.
General and Administrative. General and administrative expenses consist
primarily of salaries, fees for professional services and bad debt expense. We
expect general and administrative expenses to increase as we expand our staff
and incur additional costs related to growth of our business. General and
administrative expenses were $4.2 million for the quarter ended September 30,
1999, an increase of 39% from $3.0 million in the comparable quarter of the
prior year. Such expenses decreased as a percentage of total net revenues to 12%
from 17%. General and administrative expenses were $10.8 million for the nine
months ended September 30, 1999, an increase of 30% from $8.3 million in the
comparable period of the prior year, but decreased as a percentage of total net
revenues to 12% from 18%. The increases in absolute dollars were primarily a
result of increased personnel and professional fees necessary to support our
growth. The decreases in percentage terms were due to revenues growing at a
faster rate than expenses.
Goodwill Amortization and Acquisition Charges
In March 1998, we acquired Vivo Software, Inc., a developer of streaming
media creation tools. We issued approximately 2.2 million shares of our common
stock in exchange for all outstanding shares of Vivo common stock and assumed
options to purchase approximately 95,000 shares of our common stock. The
acquisition was accounted for using the purchase method of accounting and,
accordingly, the results of Vivo's operations are included in our consolidated
financial statements since the date of acquisition.
The purchase price was allocated to the fair value of the acquired
assets and assumed liabilities based on their fair values at the date of the
acquisition. A portion of the purchase price represents acquired in-process
research and development that had not yet reached technological feasibility and
had no alternative future use. Of the total purchase price, $8.6 million was
allocated to in-process research and development expense, $10.6 million was
allocated to goodwill, and $0.5 million was allocated to tangible assets.
Goodwill is amortized over its estimated life of five years.
The in-process research and development projects acquired in the
acquisition of Vivo consisted of the development of encoder tools and server and
client codecs. The encoder tools allow users to create media content to be
streamed over the Internet or intranets. The server and client codecs enhance
the compression and decompression of multimedia content streamed over the
Internet or intranets.
We completed the development of the encoder tools in 1998. The total
cost to complete development of the encoder tools was approximately $1.0
million. The server and client codec projects were completed in 1999. The
aggregate cost to complete the server and client codecs was approximately $0.7
million.
Since the acquisition, we have continued to market Vivo's existing
products on a limited basis.
In August 1999, we acquired Xing Technology Corporation, a developer and
provider of MP3 software. We issued approximately 733,000 shares of our common
stock in exchange for all outstanding shares of Xing stock. The acquisition was
accounted for as a pooling of interests and, accordingly, the consolidated
financial statements include the accounts of Xing for all periods presented. As
a result of the transaction, we incurred acquisition charges of $1.4 million
during the quarter ended September 30, 1999 primarily for legal and other
professional fees.
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OTHER INCOME, NET
Other income, net consists primarily of earnings on our cash, cash
equivalents and short-term investments. Other income, net was $3.9 million and
$5.5 million for the quarter and nine months ended September 30, 1999,
respectively, and $1.2 million and $3.5 million for the quarter and nine months
ended September 30, 1998, respectively. The increases were primarily due to
higher invested cash balances primarily as a result of our secondary public
offering of common stock completed during the second quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $22.8 million and $6.0
million for the nine months ended September 30, 1999 and 1998, respectively. Net
cash provided by operating activities for the nine months ended September 30,
1999 resulted primarily from an increase in accrued and other liabilities of
$9.1 million, an increase in deferred revenue of $8.7 million, net income of
$0.9 million, and the non-cash charges associated with depreciation and
amortization partially offset by the increase in accounts receivable of $2.0
million. Net cash provided by operating activities for the nine months ended
September 30, 1998 resulted primarily from a decrease in other receivables, an
increase in accrued expenses and non-cash charges associated with depreciation
and acquisition related charges, partially offset by the reported net loss.
Net cash used in investing activities was $101.9 million and $27.4
million for the nine months ended September 30, 1999 and 1998, respectively, and
was primarily a result of net purchases of short-term investments and purchases
of equipment and leasehold improvements.
Net cash provided by financing activities was $234.5 million and $2.0
million for the nine months ended September 30, 1999 and 1998, respectively, and
was a result of net proceeds from the sale of common stock and the exercise of
stock options and warrants as well as the proceeds from the issuance of notes
payable and related warrants. In the second quarter of 1999, we sold 4,125,000
shares of our common stock in a secondary public offering. Net proceeds of the
offering were $228.8 million.
At September 30, 1999, we had $326.8 million in cash, cash equivalents
and short-term investments. As of September 30, 1999, our principal commitments
consisted of obligations under operating leases. Since our inception, we have
experienced a substantial increase in our capital expenditures to support
expansion of our operations and information systems.
In January 1998, we entered into a lease agreement for a new location
for our corporate headquarters. The lease commenced on April 1, 1999 and expires
on April 1, 2011, with an option to renew the lease for either a three-or
ten-year period. We took occupancy of the new facilities in the second quarter
1999. We will continue to fund tenant improvements as additional space is
occupied. In addition, we are in the process of upgrading and replacing our
existing internal information systems. We anticipate that the costs of the
tenant improvements and information systems will total approximately $15.7
million in 1999. We have incurred approximately $12 million of such costs
through September 30, 1999.
We do not hold derivative financial instruments or equity securities in
our investment portfolio. Our cash equivalents and short-term investments
consist of high-quality securities, as specified in our investment policy
guidelines. The policy limits the amount of credit exposure to any one issue or
issuer to a maximum of 5% of the total portfolio and requires that all
short-term investments mature in two years or less, with the average maturity
being one year or less. These securities are subject to interest rate risk and
will decrease in value if interest rates increase. If market interest rates were
to increase immediately and uniformly by 10% from levels at September 30, 1999,
the fair value of the portfolio would decline by an immaterial amount. Because
we have historically held our fixed-income investments until maturity, we would
not expect our operating results or cash flows to be significantly affected by a
sudden change in market interest rates on our securities portfolio.
We conduct our operations in six primary functional currencies: the
United States dollar, the Japanese yen, the British pound, the French franc, the
German mark, and the Australian dollar. Historically, neither fluctuations in
foreign exchange rates nor changes in foreign economic conditions have had a
significant impact on
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our financial condition or results of operations. We currently do not hedge our
foreign currency exposures and are therefore subject to the risk of exchange
rates. We invoice the customers of our international subsidiaries primarily in
U.S. dollars, except in Japan, where we invoice our customers primarily in yen.
We are exposed to foreign exchange rate fluctuations as the financial results of
foreign subsidiaries are translated into U.S. dollars in consolidation. Our
exposure to foreign exchange rate fluctuations also arises from intercompany
payables and receivables to and from our foreign subsidiaries. Foreign exchange
rate fluctuations did not have a material impact in 1999 and 1998.
On January 1, 1999, the participating member countries of the European
Union converted to a common currency, the euro. On that same date they
established fixed conversion rates between their existing sovereign currencies
and the euro. Even though legacy currencies are scheduled to remain legal tender
in the participating countries as denominations of the euro until January 1,
2002, the participating countries will no longer be able to direct independent
interest rates for the legacy currencies. The authority to set monetary policy
will now reside with the new European Central Bank. We do not anticipate any
material impact from the euro conversion on our financial information systems,
which currently accommodate multiple currencies. Due to numerous uncertainties,
we cannot reasonably estimate the effect that the euro conversion issue will
have on our pricing or market strategies or the impact, if any, it will have on
our financial condition and results of operations.
Since our inception, we have significantly increased our operating
expenses. We currently anticipate that we will continue to experience
significant growth in our operating expenses and that such expenses will be a
material use of our cash resources. We believe that our current cash, cash
equivalents and short-term investments will be sufficient to meet our
anticipated cash needs for working capital and capital expenditures for at least
the next 12 months. In the future, we may seek to raise additional funds through
public or private equity financing, or through other sources such as credit
facilities. The sale of additional equity securities could result in dilution to
our shareholders.
Microsoft Relationship
In June 1997, we entered into a strategic agreement with Microsoft
pursuant to which we granted Microsoft a nonexclusive license to certain
substantial elements of the source code of our RealAudio/RealVideo Version 4.0
technology and related RealNetworks trademarks for a license fee of $30.0
million. We are recognizing revenue related to the agreement ratably over the
three-year term of our ongoing obligations. Microsoft may sublicense its rights
to the licensed source code to third parties under certain conditions without
further compensation to RealNetworks. In addition, Microsoft was granted an
option to receive two additional deliveries of updated versions of the source
code both of which were unexercised and have since expired. Under certain
conditions, if we license our source code to a third party, the agreement
provides for a partial refund of the license fee paid by Microsoft, based on a
declining scale over the three-year term of the agreement.
Year 2000 Compliance
The "Year 2000" problem exists because many existing computer programs
use only the last two digits to refer to a year. As a result, date-sensitive
computer programs may not be able to distinguish whether a two-digit date
designated as "00" refers to 1900 or 2000. This problem could cause system
failures or the creation of wrong information and disrupt our operations.
We have developed a phased plan to achieve Year 2000 compliance for our
internal processing and operational systems and the current versions of our
software products. During the first quarter of 1999, we assessed the state of
our internal and external Year 2000 compliance. During the second quarter of
1999, we developed a remediation plan to identify and correct problems. During
the third quarter of 1999, we began implementation of this remediation plan,
consisting of upgrading and replacing certain product versions, if necessary,
and testing them for compliance. During the fourth quarter of 1999, we will be
testing our internal systems for Year 2000 compliance.
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We have publicly made and continue to update Year 2000 readiness
disclosures stating that the current versions of our products are "Year 2000
compliant." "Year 2000 compliant" means that software products and systems are
able to function properly before, during and after the year 2000 without loss of
functionality due to date changes. This assurance assumes that:
- our products are configured and used in accordance with the related
documentation;
- the underlying operating system of the host machine for our products and
any other software used with or in such host machine are also Year 2000
compliant; and
- all other products, whether hardware, software, or firmware, used with one
of our products properly exchange data with it.
We are currently testing and will continue to test our products and
systems and may find errors or defects associated with Year 2000 date functions.
We have not tested our products on all platforms or all versions of operating
systems that we currently support. We believe that all of the latest production
versions of our products will be Year 2000 compliant by the end of 1999. We have
not specifically tested software obtained from third parties, such as licensed
software, shareware and freeware, that is incorporated into our products, but we
are seeking assurances from certain vendors that licensed software is Year 2000
compliant. We may not have received assurances from such vendors by January 1,
2000. Despite our testing, testing by our current and potential customers, and
whatever assurances, if any, we may receive from developers of technology
incorporated into our products, our products and those of our vendors may
contain undetected errors or defects associated with Year 2000 date functions.
We rely on third parties for services and supplies such as
telecommunications, Internet service and utilities. We are seeking confirmation
from certain service providers that their systems are Year 2000 compliant. We
may not have received assurances from such service providers by January 1, 2000.
Interruption of those services or supplies due to Year 2000 issues could
adversely affect our operations. We are also subject to external forces that
might generally affect industry and commerce, such as utility or transportation
company Year 2000 compliance failures and related service interruptions. We are
in the process of updating and upgrading our internal information systems.
Although the replacement of information systems is not in direct response to
Year 2000 concerns, we expect, but cannot assume, that all new internal
information systems implemented in 1999 will be Year 2000 compliant.
Known or unknown Year 2000 errors or defects in our internal systems and
products, lack of Year 2000 compliance by third-party software incorporated in
our products and/or interruption of services from our external service providers
due to Year 2000 problems could result in failure or disruption of our products
and operations, delay or loss of revenue, diversion of development resources,
damage to our reputation, claims or litigation and increased service and
warranty costs, any of which could impair our finances or business prospects.
Some commentators have predicted significant litigation regarding Year 2000
compliance issues, and we are aware of such lawsuits against other software
vendors. Because of the unprecedented nature of such litigation, we are
uncertain whether or to what extent we may be affected by it.
We currently respond to customer concerns about our products on a
case-by- case basis. In addition, we have posted and continue to update a web
page on our primary website indicating the Year 2000 status of our products. We
believe that the purchasing patterns of customers and potential customers may be
affected by Year 2000 issues in a variety of ways, including the decision to
delay purchasing our products until the Year 2000. We believe that it is not
possible to predict the overall impact of these decisions.
At this stage in our analysis and remediation process, it is difficult
to specifically identify the cause and the magnitude of any adverse economic
impact of the most reasonably likely worst case Year 2000 scenario. Our
reasonably likely worst case scenario would include the unavailability of our
major internal systems to our employees and the failure of our products to
operate properly, causing customers' systems and/or operations to fail or be
disrupted. This worst case scenario also would include the failure of key
vendors and/or suppliers to
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correct their own Year 2000 issues, which could cause failure or disruption of
our operations or products. If a worst case scenario occurs, we may incur
expenses to repair our systems or upgrade our products, face interruptions in
the work of our employees, lose advertising, service and product license
revenue, be unable to support the broadcast of other companies' content over the
Internet, be unable to deliver downloads of our products, incur increased
warranty and service expenses and suffer damage to our reputation. In addition,
customers may sue us or otherwise seek compensation for their losses. We have
agreed to indemnify certain customers for claims and losses if our products are
not Year 2000 compliant. Any or all of the above events could harm our business.
We have not yet fully finalized a comprehensive contingency plan to
address situations that may result if we are unable to achieve Year 2000
readiness of our critical operations. The cost of developing and implementing
such a plan may itself be material. To date, we have not incurred significant
expenditures for our Year 2000 remediation efforts. Although we do not
anticipate the costs to complete addressing our Year 2000 issues to be material,
the costs of Year 2000 remediation work and the date on which we plan to
complete such work are based on management's best estimates. These estimates are
derived from assumptions about future events, including the availability of
certain resources, third- party remediation plans and other factors. In
addition, undetected errors or the failure of such systems to be Year 2000
compliant could create significant record-keeping and operational deficiencies.
Accordingly, if Year 2000 modifications, evaluations, assessments and
conversions are not made or are not completed in time, the Year 2000 problem
could harm our business.
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FACTORS THAT MAY AFFECT OUR BUSINESS, FUTURE OPERATING RESULTS AND
FINANCIAL CONDITION
You should carefully consider the risks described below together with
all of the other information included in this quarterly report on Form 10-Q
before making an investment decision. The risks and uncertainties described
below are not the only ones facing our company. If any of the following risks
actually occurs, our business, financial condition or operating results could be
harmed. In such case, the trading price of our common stock could decline, and
you could lose all or part of your investment.
WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO EVALUATE OUR
BUSINESS
We were incorporated in February 1994 and have a limited operating
history. We have limited financial results on which you can assess our future
success. Our prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by growing companies in new and rapidly
evolving markets, such as streaming media software, media delivery systems and
electronic commerce.
To address the risks and uncertainties we face, we must:
- establish and maintain broad market acceptance of our products and
services and convert that acceptance into direct and indirect sources
of revenues;
- maintain and enhance our brand name;
- continue to timely and successfully develop new products, product
features and services and increase the functionality and features of
existing products;
- successfully respond to competition from Microsoft and others; and
- develop and maintain strategic relationships to enhance the
distribution, features and utility of our products and services.
Our business strategy may be unsuccessful and we may be unable to
address the risks we face in a cost-effective manner, if at all. Our inability
to successfully address these risks will harm our business.
WE HAVE A HISTORY OF LOSSES AND MAY NOT MAINTAIN PROFITABILITY
We have incurred significant losses since our inception and we may never
sustain or increase profitability. As of September 30, 1999, we had an
accumulated deficit of approximately $40.9 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. We may not continue our historical growth or generate sufficient
revenues to sustain or increase profitability on a quarterly or annual basis in
the future.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
As a result of our limited operating history and the rapidly changing
nature of the markets in which we compete, our quarterly and annual revenues and
operating results are likely to fluctuate from period to period. These
fluctuations may be caused by a number of factors, many of which are beyond our
control. These factors include the following, as well as others discussed
elsewhere in this section:
- how and when we introduce new products and services and enhance our
existing products and services;
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- the timing and success of our brand-building and marketing campaigns;
- our ability to establish and maintain strategic relationships;
- our ability to attract, train and retain key personnel;
- the demand for Internet advertising and sponsorships;
- the emergence and success of new and existing competition;
- varying operating costs and capital expenditures related to the
expansion of our business operations and infrastructure, domestically
and internationally, including the hiring of new employees;
- technical difficulties with our products, system downtime, system
failures or interruptions in Internet access;
- costs related to the acquisition of businesses or technology; and
- costs of litigation and intellectual property protection.
In addition, because the market for our products and services is
relatively new and rapidly changing, it is difficult to predict future financial
results. Our research and development and sales and marketing efforts, and
business expenditures generally, are partially based on predictions regarding
certain developments for media delivery. To the extent that these predictions
prove inaccurate, our revenues and operating expenses may fluctuate.
For these reasons, you should not rely on period-to-period comparisons
of our financial results as indications of future results. Our future operating
results could fall below the expectations of public market analysts or investors
and significantly reduce the market price of our common stock. Fluctuations in
our operating results will likely increase the volatility of our stock price.
WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT AND OTHER COMPANIES IN
THE MEDIA DELIVERY MARKET
The market for software and services for media delivery over the
Internet is relatively new, constantly changing and intensely competitive. As
media delivery evolves into a central component of the Internet experience, more
companies are entering the market for, and expending increasing resources to
develop, media delivery software and services. We expect that competition will
continue to intensify.
Many of our current and potential competitors have longer operating
histories, greater name recognition, more employees and significantly greater
financial, technical, marketing, public relations and distribution resources
than we do. The competitive environment may require us to make changes in our
products, pricing, licensing, services or marketing to maintain and extend our
current brand and technology franchise. Price concessions or the emergence of
other pricing or distribution strategies of competitors may diminish our
revenues, impact our margins or lead to a reduction in our market share, any of
which will harm our business.
We believe that the primary competitive factors in the media delivery
market include:
- the quality and reliability of the overall media delivery solution;
- access to distribution channels necessary to achieve broad
distribution and use of products;
- the availability of content for delivery over the Internet and access
to necessary intellectual property rights;
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- 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, particulary music and video, in a market
where competitors may control the intellectual property rights for
these formats;
- the size of the active audience for streaming and digital media and
its appeal to content providers and advertisers;
- features for creating, editing and adapting content for the Internet;
- ease of use and interactive user features in products;
- ease of finding and accessing content over the Internet;
- scalability of streaming media and media delivery technology and cost
per user;
- pricing and licensing terms;
- compatibility with new and existing media formats;
- compatibility with the user's existing network components and
software systems; and
- challenges caused by bandwidth constraints and other limitations of
the Internet infrastructure.
Our failure to adequately address any of the above factors could harm our
business strategy and operating results.
Microsoft is a principal competitor in the development and distribution
of streaming media and media distribution technology. Microsoft currently
competes with us in the market for streaming media server and player software
and has announced its intent to compete in the market for digital distribution
of media. We believe that Microsoft's commitment to and presence in the media
delivery industry has increased and that Microsoft will continue to increase
competitive pressure in the overall market for streaming media and media
distribution.
Microsoft distributes its competing streaming media server and tools
products by bundling them with its Windows NT servers at no additional charge
and by making them available for download from its website for free. While we
also provide free downloads of certain of our products, including players,
servers and tools, Microsoft's practices have caused, and may continue to cause,
pricing pressure on our products. These practices could lead to longer sales
cycles, decreased sales and reduced market share. In addition, we believe that
Microsoft has used and may be able to use its dominant position in the computer
industry and its financial resources to secure preferential or exclusive
distribution and bundling contracts for its streaming media products with third
parties such as Internet service providers (ISPs), online service providers,
content providers, entertainment companies, media companies, broadcasters, value
added resellers (VARs) and original equipment manufacturers (OEMs), including
third parties with whom we have relationships. Such arrangements, together with
Microsoft's aggressive marketing of Windows NT and of its streaming media
products, may reduce our share of the streaming media market.
Microsoft's Windows Media Player competes with our RealPlayer products.
The Windows Media Player is available for download from Microsoft's website for
free, and is bundled by Microsoft with its Windows 98 operating system and with
its Web browser, Internet Explorer. In addition, Microsoft has bundled certain
audio capabilities into a radio toolkit for Internet Explorer 5.0, its latest
Web browser. Internet Explorer 5.0 includes Web Events, which provides links to
multimedia content on the Internet, especially content in Microsoft's streaming
media formats. We expect that by leveraging its dominant position in operating
systems and tying streaming media into its operating system and its browser,
Microsoft will distribute substantially more copies of the Windows Media Player
in the future than it has in the past and may be able to attract more users to
its
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streaming media products. Currently, our RealPlayer has a high degree of market
penetration: we have over 80 million registered users and estimate that more
than 85% of all Web pages that use streaming media do so using our technology.
Our market position may be difficult to sustain, particularly in light of
Microsoft's efforts and dominant position in operating systems. In addition,
Microsoft has invested in certain digital distribution technologies that compete
with RealJukebox, such as the MusicMatch Jukebox. Microsoft has announced that
it plans to bundle this year the MusicMatch Jukebox with the Microsoft Windows
98 Second Edition operating system, and that the MusicMatch Jukebox will support
the Windows Media format. We expect Microsoft and other competitors to devote
significantly greater resources to product development in the jukebox and
digital media categories. It may be difficult or impossible for us to obtain
access to the Windows Media format on terms equivalent to those offered to our
competitors, which may harm the demand for and market for the RealJukebox
products.
In addition to Microsoft, we face increasing competition from other
companies that are developing and marketing streaming media products. Apple
Computer has introduced the QuickTime 4.0 streaming media technology, including
a free media player and a free streaming media server, and has made available
free source code to the server under the conditions of their license agreement.
We expect that Apple Computer will devote more resources to developing and
marketing streaming media systems, and will seek to compete more vigorously with
us in the marketplace. Other competitors include Cisco Systems/Precept Software,
PictureTel/Starlight Networks and Oracle Corporation. As more companies enter
the market with products that compete with our servers, players and tools, the
competitive landscape could change rapidly to our disadvantage.
We do not believe that clear standards have emerged with respect to
non-PC wireless and cable-based systems. Likewise, no one company has gained a
dominant position in the mobile device market. Other companies' products and
services or new standards may emerge in any of these areas, which could reduce
demand for our products or render them obsolete.
In addition, our streaming media and media delivery products face
competition from non-streaming, "fast download" media delivery technologies such
as AVI, QuickTime and MP3. Other fast download or non-streaming IP-based content
distribution methods are likely to emerge and could compete with our products
and services, which could harm our business.
WE MAY BE UNABLE TO SUCCESSFULLY COMPETE IN OTHER PARTS OF OUR BUSINESS
Media Hosting. Our media hosting service, the Real Broadcast Network,
competes with a variety of companies that provide streaming media hosting
services. These companies include Yahoo Broadcast Services (formerly
Broadcast.com), Intervu and emerging broadcast networks such as CMGI's Magnitude
Network, Enron Communications, GlobalMedia, and Microcast. We may not establish
or sustain our competitive position in this market segment. Some media hosting
competitors are also customers on whom we rely to help drive product download
traffic to our website through their broadcast events.
Website Destinations, Content and Advertising. While Internet
advertising revenues across the industry continue to grow, the number of
websites competing for advertising revenues is also growing. Our websites,
including Real.com, RealNetworks.com, Film.com and LiveConcerts.com, compete for
user traffic and Internet advertising revenues with a wide variety of websites,
Internet portals and ISPs. In particular, aggregators of audio, video and other
media, such as Yahoo Broadcast Services and Microsoft's Web Events, compete with
our RealGuide. We also compete with traditional media such as television, radio
and print for a share of advertisers' total advertising budgets. Our advertising
sales force and infrastructure are still in early stages of development relative
to those of our competitors. We cannot be certain that advertisers will place
advertising with us or that revenues derived from such advertising will be
meaningful. If we lose advertising customers, fail to attract new customers, are
forced to reduce advertising rates or otherwise modify our rate structure to
retain or attract customers, or if we lose website traffic, our business could
be harmed.
Electronic Commerce. The electronic commerce features of our websites
compete with a variety of other websites for consumer traffic. To compete
successfully in the electronic commerce market, we must attract
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sufficient traffic to our websites by offering high-quality, competitively
priced, desirable merchandise in a compelling, easy-to-purchase format. In
addition, we must successfully leverage our existing user base to develop the
market for our products and services. We may not compete successfully in the
growing and rapidly changing market for electronic commerce. Our failure to do
so could harm our business.
Increased competition may result in price reductions, reduced margins,
loss of market share, loss of customers, and a change in our business and
marketing strategies, any of which could harm our business.
WE MAY NOT BE SUCCESSFUL IN THE MARKET FOR DOWNLOADABLE MEDIA AND LOCAL MEDIA
DELIVERY
In May 1999, we announced the RealSystem MP, a digital music
architecture enabling integration with a wide range of Internet services and
hardware devices. In September 1999, we released RealJukebox, our client
software based on the RealSystem MP. These products represent an extension of
our business into downloadable media and local media delivery, which is a
substantial evolution from our historical focus on streaming media products and
services. We do not know whether there is a sustainable market for products such
as RealSystem MP and RealJukebox. Even if that market exists, we may be unable
to develop a revenue model or sufficient demand to take advantage of the market
opportunity.
While over twelve 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 such as WinAmp Player, MusicMatch Jukebox, Liquid Audio
Player, and a2b Player. In addition, given the size and importance of the
general market for music distribution, competitors will likely release products
that directly compete with RealJukebox, which could harm our business. Even if
RealJukebox achieves widespread market acceptance, it may not achieve a high
level of use, which would lead to a low rate of upgrade sales and electronic
commerce opportunities. Our inability to achieve widespread acceptance for
RealSystem MP and RealJukebox or to create new revenue streams from new market
segments could harm our business.
RealJukebox allows users to record and play back music in a variety of
technical formats, including RealAudio G2, MP3, Liquid Audio, 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 be uncomfortable with some features of RealJukebox. As a result, some record
companies may decide to withhold content from RealJukebox, or refrain from or
delay participating in promotional opportunities with respect to RealJukebox.
RealJukebox is intended to allow users of the product to acquire,
record, play back and manage music for their personal use. It is possible for a
user of RealJukebox to elect not to use the copyright-protection features it
contains and then violate the intellectual property rights of artists and
recording companies by engaging in an un-authorized distribution of music. The
laws governing the recording, distribution and performance of digital music are
new and largely untested. While we believe we have developed RealJukebox to
comply with U.S. copyright laws, a court may find us in violation of these laws.
Similar action or other litigation in the United States or abroad directed at us
could harm our business, even if such litigation were entirely without merit.
WE MAY NOT SUCCESSFULLY DEVELOP NEW PRODUCTS AND SERVICES
Our growth depends on our ability to continue to develop leading edge
media delivery and digital distribution products and services. Our business and
operating results would be harmed if we fail to develop products and services
that achieve widespread market acceptance or that fail to generate significant
revenues to offset development costs. We may not timely and successfully
identify, develop and market new product and service opportunities. If we
introduce new products and services, they may not attain broad market acceptance
or contribute meaningfully to our revenues or profitability.
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Because the markets for our products and services are rapidly changing,
we must develop new offerings quickly. We have experienced development delays
and cost overruns in our development efforts in the past and we may encounter
such problems in the future. Delays and cost overruns could affect our ability
to respond to technological changes, evolving industry standards, competitive
developments or customer requirements. Our products also may contain undetected
errors that could cause increased development costs, loss of revenues, adverse
publicity, reduced market acceptance of the products or lawsuits by customers.
WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO INCREASE MARKET ACCEPTANCE OF
OUR PRODUCTS
If third parties do not develop or offer compelling content to be
delivered over the Internet, our business will be harmed and our products may
not achieve or sustain broad market acceptance. We rely on third-party content
providers, such as radio and television stations, record labels, media
companies, websites and other companies, to develop and offer content in our
formats that can be delivered using our server products and played back using
our player products. While we have a number of short-term agreements with third
parties to provide content from their websites in our formats, most third
parties are not obligated to develop or offer content using our technology. In
addition, some third parties have entered into and may in the future enter into
agreements with our competitors, principally Microsoft, to develop or offer all
or a substantial portion of their content in our competitors' formats. Microsoft
has more resources to secure preferential and even exclusive relationships with
content providers. There could be less demand for and use of our products if
Microsoft or another competitor were to secure preferential or exclusive
relationships with the leading broadcasters, record companies or websites. We
cannot guarantee that third-party content providers will continue to rely on our
technology or offer compelling content in our formats to encourage and sustain
broad market acceptance of our products. Their failure to do so would harm our
business.
As we move into the market for digital distribution of media and local
media playback, our success depends on the availability of third-party content,
especially music, that users of our RealJukebox product can lawfully and easily
access, record and play back. Our product may not achieve or sustain market
acceptance if third parties are unwilling to offer their content for free
download or purchase by users of RealJukebox. Competitors could secure exclusive
distribution relationships with such content providers, which would harm our
business.
WE DEPEND ON KEY PERSONNEL WHO MAY LEAVE US AT ANY TIME
Our success substantially depends on the continued employment of our
executive officers and key employees, particularly Robert Glaser, our chairman
of the board and chief executive officer. The loss of the services of Mr. Glaser
or any of our other executive officers or key employees could harm our business.
None of our executive officers has a contract that guarantees employment. Other
than the $2 million insurance policy on the life of Mr. Glaser, we do not
maintain "key person" life insurance policies.
OUR FAILURE TO ATTRACT, TRAIN OR RETAIN HIGHLY QUALIFIED PERSONNEL COULD HARM
OUR BUSINESS
Our success also depends on our ability to attract, train and retain
qualified personnel, specifically those with management and product development
skills. In particular, we must hire additional skilled software engineers to
further our research and development efforts. Competition for such personnel is
intense, particularly in high-technology centers such as the Pacific Northwest.
In making employment decisions, particularly in the Internet and high-technology
industries, job candidates often consider the value of stock options they may
receive in connection with their employment. As a result of recent volatility in
our stock price, we may be disadvantaged in competing with companies that have
not experienced similar volatility or that have not yet sold their stock
publicly. If we do not succeed in attracting new personnel or retaining and
motivating our current personnel, our business could be harmed
WE MAY NOT SUCCESSFULLY MANAGE OUR GROWTH
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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 600 on September 30, 1999.
Managing this substantial expansion has placed a significant strain on our
management, operational and financial resources. If our growth continues, we
will need to continue to improve our financial and managerial control and
reporting systems and procedures.
We are in the process of implementing new management information
software systems. This will affect many aspects of our business, including our
accounting, operations, electronic commerce, customer service, purchasing, sales
and marketing functions. The purchase, implementation and testing of these
systems has resulted, and will result, in significant capital expenditures and
could disrupt our day-to-day operations. If these systems are not implemented as
expected, our ability to provide products and services to our customers on a
timely basis will suffer and delays in the recording and reporting of our
operating results could occur.
THE GROWTH OF OUR BUSINESS DEPENDS ON THE INCREASED USE OF THE INTERNET FOR
COMMUNICATIONS, ELECTRONIC COMMERCE AND ADVERTISING
The growth of our business depends on the continued growth of the
Internet as a medium for communications, electronic commerce and advertising.
Our business will be harmed if Internet usage does not continue to grow,
particularly as a source of media information and entertainment and as a vehicle
for commerce in goods and services. Our success also depends on the efforts of
third parties to develop the infrastructure and complementary products and
services necessary to maintain and expand the Internet as a viable commercial
medium. The Internet may not be accepted as a viable commercial medium for
broadcasting multimedia content or media delivery for a number of reasons,
including:
- potentially inadequate development of the necessary infrastructure to
accommodate growth in the number of users and Internet traffic;
- lack of acceptance of the Internet as a medium for distributing
streaming media content or for media delivery;
- unavailability of compelling multimedia content;
- inadequate commercial support for Web-based advertising; and
- delays in the development or adoption of new technological standards
and protocols or increased governmental regulation, which could
inhibit the growth and use of the Internet.
In addition, we believe that other Internet-related issues, such as
security, reliability, cost, ease of use and quality of service, remain largely
unresolved and may affect the amount of business that is conducted over the
Internet.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by such growth, specifically the demands of
delivering high-quality media content. As a result, its performance and
reliability may decline. In addition, websites have experienced interruptions in
service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently in
the future, Internet usage, as well as the usage of our products, services and
websites, could grow more slowly or decline.
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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;
- the availability of compelling content that takes advantage of
broadband access and helps drive market acceptance of our products
and services;
- the emergence of new competitors, such as traditional broadcast and
cable television companies, which have significant control over
access to content, substantial resources and established
relationships with media providers;
- the development of relationships by our current competitors with
companies that have significant access to or control over the
broadband transmission infrastructure or content;
- the need to establish new relationships with non-PC based providers
of broadband access, such as providers of television set-top boxes
and cable television, some of which may compete with us; and
- the general risks of new product and service development, including
the challenges to develop error-free products and enhancements,
develop compelling services and achieve market acceptance for these
products and services.
We depend on the efforts of third parties to develop and provide a
successful infrastructure for broadband transmission. Even if broadband access
becomes widely available, heavy use of the Internet may negatively impact the
quality of media delivered through broadband connections. If these third parties
experience delays or difficulties establishing a widespread broadband
transmission infrastructure or if heavy usage limits the broadband experience,
the release of our broadband products and services could be delayed. Even if a
broadband transmission infrastructure is developed for widespread use, our
products and services may not achieve market acceptance or generate sufficient
revenues to offset our development costs.
WE COULD LOSE STRATEGIC RELATIONSHIPS THAT ARE ESSENTIAL TO OUR BUSINESS
The loss of certain current strategic relationships, the inability to
find other strategic partners or the failure of our existing relationships to
achieve meaningful positive results for us could harm our business. We rely in
part on strategic relationships to help us:
- maximize adoption of our products through distribution arrangements;
- increase the amount and availability of compelling media content on
the Internet to help boost demand for our products and services;
- enhance our brand;
- expand the range of commercial activities based on our technology;
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- expand the distribution of our streaming media content without a
degradation in fidelity; and
- increase the performance and utility of our products and services.
Many of these goals are beyond our traditional strengths. We anticipate
that the efforts of our strategic partners will become more important as the
multimedia experience over the Internet matures. For example, we may become more
reliant on strategic partners to provide multimedia content, provide more secure
and easy-to-use electronic commerce solutions and build out the necessary
infrastructure for media delivery. We may not be successful in forming strategic
relationships. In addition, the efforts of our strategic partners may be
unsuccessful. Furthermore, these strategic relationships may be terminated
before we realize any benefit.
OUR INDUSTRY IS EXPERIENCING CONSOLIDATION THAT MAY INTENSIFY COMPETITION
The Internet industry has recently experienced substantial consolidation
and a proliferation of strategic transactions. We expect this consolidation and
strategic partnering to continue. Acquisitions or strategic relationships could
harm us in a number of ways. For example:
- competitors could acquire or partner with companies with which we
have strategic relationships and discontinue our relationship,
resulting in the loss of distribution opportunities for our products
and services or the loss of certain enhancements or value-added
features to our products and services;
- competitors could obtain exclusive access to desirable multimedia
content and prevent that content from being available in our formats,
thus decreasing the use of our products and services to distribute
and experience the content that audiences most desire, and hurting
our ability to attract advertisers to our websites and product
offerings;
- a competitor could be acquired by a party with significant resources
and experience that could increase the ability of the competitor to
compete with our products and services.
Recent announcements and consolidations that could affect our business
include:
- Microsoft's strategic investments in broadband initiatives, including
its recently announced $5 billion investment in AT&T;
- AT&T's acquisition of TCI and its announcement that it will acquire
MediaOne Communications;
- At Home's acquisition of Excite;
- Yahoo!'s acquisitions of Broadcast.com and GeoCities;
- The Walt Disney Company's recent announcement that it intends to
combine its Internet assets with, and acquire a majority ownership
of, Infoseek, and create a single business called go.com;
- NBC's announcement that it intends to merge its Internet assets with
XOOM.com, Inc. and Snap.com, a subsidiary of CNET.
POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS
The failure to adequately address the financial and operational risks
raised by acquisitions of technology and businesses could harm our business. We
have acquired complementary technologies and businesses in the past, and intend
to do so in the future. Financial risks related to acquisitions include:
- potentially dilutive issuances of equity securities;
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- 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;
- impairment of relationships with our employees, affiliates,
advertisers and content providers;
- inability to maintain uniform standards, controls, procedures and
policies;
- the assumption of known and unknown liabilities of the acquired
company;
- entrance into markets in which we have no direct prior experience;
and
- loss of key employees of the acquired company.
In August 1999, we acquired Xing Technology Corporation, an MP3 software
developer, in a transaction that was accounted for as a pooling of interests. We
may not adequately integrate this or any future acquisitions. In addition, we
may not be able to account for future acquisitions as a pooling of interests,
which could harm our operating results.
OUR BUSINESS WILL SUFFER IF OUR SYSTEMS FAIL OR BECOME UNAVAILABLE
A reduction in the performance, reliability and availability of our
websites and network infrastructure will harm our ability to distribute our
products and services to our users, as well as our reputation and ability to
attract and retain users, customers, advertisers and content providers. Our
revenues depend in large part on the number of users that download our products
from our websites and access the content services on our websites. Our systems
and operations could be damaged or interrupted by fire, flood, power loss,
telecommunications failure, Internet breakdown, earthquake and similar events.
Our systems are also subject to break-ins, sabotage, intentional acts of
vandalism and similar misconduct. Our computer and communications infrastructure
is located at a single leased facility in Seattle, Washington. We do not have
fully redundant systems or a formal disaster recovery plan, and we do not carry
adequate business interruption insurance to compensate us for losses that may
occur from a system outage.
Our electronic commerce and digital distribution activities are managed
by sophisticated software and computer systems. We may encounter delays in
developing these systems, and the systems may contain undetected errors that
could cause system failures. Any system error or failure that causes
interruption in availability of products or content or an increase in response
time could result in a loss of potential or existing business services
customers, users, advertisers or content providers. If we suffer sustained or
repeated interruptions, our products, services and websites could be less
attractive to such entities or individuals and our business would be harmed.
A sudden and significant increase in traffic on our websites could
strain the capacity of the software, hardware and telecommunications systems
that we deploy or use. This could lead to slower response times or system
failures. Our operations also depend on receipt of timely feeds from our content
providers, and any failure or delay in the transmission or receipt of such feeds
could disrupt our operations. We depend on Web browsers, ISPs and online service
providers to provide Internet users access to our websites. Many of these
providers have
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experienced significant outages in the past, and could experience outages,
delays and other difficulties due to system failures unrelated to our systems.
In addition, certain ISPs have temporarily interrupted our website operations in
response to the heavy volume of e-mail transmission we generate and send to our
large user base. These types of interruptions could continue or increase in the
future.
OUR NETWORK IS SUBJECT TO SECURITY RISKS THAT COULD HARM OUR REPUTATION AND
EXPOSE US TO LITIGATION OR LIABILITY
Online commerce and communications depend on the ability to transmit
confidential information securely over public networks. Any compromise of our
ability to transmit confidential information securely, and costs associated with
preventing or eliminating any problems, could harm our business. Online
transmissions are subject to a number of security risks, including:
- our own or licensed encryption and authentication technology may be
compromised, breached or otherwise be insufficient to ensure the
security of customer information;
- we could experience unauthorized access, computer viruses and other
disruptive problems, whether intentional or accidental;
- a third party could circumvent our security measures and
misappropriate proprietary information or interrupt operations; and
- credit card companies could restrict online credit card transactions.
The occurrence of any of these or similar events could damage our
reputation and expose us to litigation or liability. We may also be required to
expend significant capital or other resources to protect against the threat of
security breaches or to alleviate problems caused by such breaches.
OUR INTERNATIONAL OPERATIONS INVOLVE RISKS
We operate subsidiaries in Australia, England, France, Germany and
Japan, and market and sell products in several other countries. For the nine
months ended September 30, 1999, approximately 23% of our revenues, excluding
revenues derived from our license agreement with Microsoft, were derived from
international operations. We are subject to the normal risks of doing business
internationally, as well as risks specific to Internet-based companies in
foreign markets. These risks include:
- delays in the development of the Internet as a broadcast, advertising
and commerce medium in international markets;
- difficulties in managing operations due to distance, language and
cultural differences, including issues associated with establishing
management systems infrastructures in individual markets;
- unexpected changes in regulatory requirements;
- export and import restrictions, including those restricting the use
of encryption technology;
- tariffs and trade barriers and limitations on fund transfers;
- difficulties in staffing and managing foreign operations;
- longer payment cycles and problems in collecting accounts receivable;
- potential adverse tax consequences;
- exchange rate fluctuations;
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- increased risk of piracy and limits on our ability to enforce our
intellectual property rights; and
- other legal and political risks.
Any of these factors could harm our business. We do not currently hedge
our foreign currency exposures.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS
Our inability to protect our proprietary rights, and the costs of doing
so, could harm our business. Our success and ability to compete partly depend on
the superiority, uniqueness or value of our technology, including both
internally developed technology and technology licensed from third parties. To
protect our proprietary rights, we rely on a combination of patent, trademark,
copyright and trade secret laws, confidentiality agreements with our employees
and third parties, and protective contractual provisions. Despite our efforts to
protect our proprietary rights, unauthorized parties may copy or infringe
aspects of our technology, products, services or trademarks, or obtain and use
information we regard as proprietary. Our proprietary rights may be especially
difficult to protect in foreign countries, where unrelated third parties may
have registered our domain names and trademarks under their own names in an
attempt to prevent us from using the domain names and trademarks in those
countries without paying them a significant sum of money. This could prevent us
from using our valuable brands in those countries, and reduce the value of our
intellectual property. In addition, others may independently develop
technologies that are similar or superior to ours, which could reduce the value
of our intellectual property.
Companies in the computer industry have frequently resorted to
litigation regarding intellectual property rights. We may have to litigate to
enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of other parties' proprietary rights. From time
to time, other parties' proprietary rights, including patent rights, have come
to our attention and on several occasions we have received notice of claims of
infringement of other parties' proprietary rights, and we may receive such
notices in the future.
In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit
against us and co-defendant Broadcast.com in the United States District Court
for the Northern District of Texas--Dallas Division. The plaintiffs allege that
we, individually and in combination with Broadcast.com, infringe on a certain
patent by making, using, selling and/or offering to sell software products and
services directed to media delivery systems for the Internet and corporate
intranets. The plaintiffs seek to enjoin us from the alleged infringing activity
and to recover damages in an amount no less than a reasonable royalty. We
believe the allegations are without merit and intend to vigorously defend
ourselves against these claims. However, litigation is inherently uncertain, and
we may be unable to successfully defend ourselves against this claim.
From time to time we receive claims and inquiries from third parties
alleging that our internally developed technology or technology we license from
third parties may infringe the third parties' proprietary rights. We are now
investigating a few of such pending claims. We could be required to spend
significant amounts of time and money to defend ourselves against such claims.
If any of these claims were to prevail, we could be forced to pay damages,
comply with injunctions, or stop distributing our products while we re-engineer
them or seek licenses to necessary technology, which might not be available on
reasonable terms. We could also be subject to claims for indemnification
resulting from infringement claims made against our customers and strategic
partners, which could increase our defense costs and potential damages. Any of
these events could harm our business.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH GOVERNMENTAL REGULATION AND LEGAL
UNCERTAINTIES
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
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relate to areas such as content issues (such as obscenity, indecency and
defamation), copyright and other intellectual property rights, encryption, use
of key escrow data, caching of content by server products, electronic
authentication or "digital signatures," personal privacy, advertising, taxation,
electronic commerce liability, e-mail, network and information security and the
convergence of traditional communication services with Internet communications,
including the future availability of broadband transmission capability. Other
countries and political organizations are likely to impose or favor more and
different regulation than that which has been proposed in the United States,
thus furthering the complexity of regulation. The adoption of such laws or
regulations, and uncertainties associated with their validity and enforcement,
may affect the available distribution channels for and costs associated with our
products and services, and may affect the growth of the Internet. Such laws or
regulations may therefore harm our business.
We do not know for certain how existing laws governing issues such as
property ownership, copyright and other intellectual property issues, taxation,
illegal or obscene content, retransmission of media and personal privacy and
data protection apply to the Internet. The vast majority of such laws were
adopted before the advent of the Internet and related technologies and do not
address the unique issues associated with the Internet and related technologies.
Most of the laws that relate to the Internet have not yet been interpreted.
Changes to or the interpretation of these laws could:
- limit the growth of the Internet;
- create uncertainty in the marketplace that could reduce demand for
our products and services;
- increase our cost of doing business;
- expose us to significant liabilities associated with content
available on our websites or distributed or accessed through our
products or services; or
- lead to increased product development costs, or otherwise harm our
business.
On October 28, 1998, the Digital Millennium Copyright Act (DMCA) was
enacted. The DMCA includes statutory licenses for the performance of sound
recordings and for the making of recordings to facilitate transmissions. Under
these statutory licenses, we and our broadcast customers will be required to pay
licensing fees for sound recordings we deliver in original and archived
programming and through retransmissions of radio broadcasts. The DMCA does not
specify the rate and terms of the licenses, which will be determined either
through voluntary inter-industry negotiations or arbitration. We currently
anticipate that representatives of the webcasting industry will engage in
arbitration with the Recording Industry Association of America to determine
what, if any, licensee fee should be paid. Depending on the rates and terms
adopted for the statutory licenses, our business could be harmed both by
increasing our own cost of doing business, as well as by increasing the cost of
doing business for our customers.
The Child Online Protection Act and the Child Online Privacy Protection
Act (COPA) were enacted in October 1998. The COPA impose civil and criminal
penalties on persons distributing material harmful to minors (e.g., obscene
material) over the Internet to persons under the age of 17, or collecting
personal information from children under the age of 13. We do not knowingly
collect and disclose personal information from such minors. The manner in which
the COPA may be interpreted and enforced cannot be fully determined, and future
legislation similar to the COPA could subject us to potential liability, which
in turn could harm our business. Such laws could also damage the growth of the
Internet generally and decrease the demand for our products and services.
SHAREHOLDERS MAY BE UNABLE TO EXERCISE CONTROL BECAUSE MANAGEMENT OWNS A LARGE
PERCENTAGE OF OUR STOCK
As of October 31, 1999, our executive officers, directors and affiliated
persons beneficially own approximately 47.0% of our common stock. Robert Glaser,
our chief executive officer and chairman of the board, beneficially owns
approximately 35.6% of our common stock. As a result, our executive officers,
directors and affiliated persons will have significant influence to:
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- 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.
Management's stock ownership may discourage a potential acquirer from
making a tender offer or otherwise attempting to obtain control of RealNetworks,
which in turn could reduce our stock price or prevent our shareholders from
realizing a premium over our stock price.
PROVISIONS OF OUR CHARTER DOCUMENTS, SHAREHOLDER RIGHTS PLAN AND WASHINGTON LAW
COULD DISCOURAGE OUR ACQUISITION BY A THIRD PARTY
Our articles of incorporation provide for a strategic transaction
committee of the board of directors currently comprised of Messrs. Glaser,
Breyer and Kapor. Without the prior approval of this committee, and subject to
certain limited exceptions, the board of directors does not have the authority
to:
- adopt a plan of merger;
- authorize the sale, lease, exchange or mortgage of:
- (A) assets representing more than 50% of the book value of our
assets prior to the transaction; or
- (B) any other asset or assets on which our long-term business
strategy is substantially dependent;
- authorize our voluntary dissolution; or
- take any action that has the effect of any of the above.
RealNetworks also entered into an agreement providing Mr. Glaser with a
direct contractual right to require RealNetworks to abide by and perform all
terms of the articles of incorporation with respect to the strategic
transactions committee. This agreement also provides that so long as Mr. Glaser
owns a specified number of shares, RealNetworks will use its best efforts to
cause him to be nominated to, elected to, and not removed from the board of
directors. In addition, the articles provide that Mr. Glaser will serve, or will
appoint another officer of RealNetworks to serve, as our policy ombudsman, with
the exclusive authority to adopt or change our editorial policies as reflected
on our websites or in other communications or media in which we have a
significant editorial or media voice. The provisions with respect to the
authority of the strategic transactions committee and the policy ombudsman may
be amended only with the approval of 90% of the shares entitled to vote on an
amendment to the articles.
We have adopted a shareholder rights plan that provides that shares of
our common stock have associated preferred stock purchase rights. These rights
become exercisable and detachable from the associated common stock only
following the acquisition by a person or a group of 15% or more of our
outstanding common stock or 10 days following the announcement of a tender or
exchange offer for 15% or more of our outstanding common stock. The rights
entitle our shareholders, other than the person or entity that has acquired or
made an exchange or tender offer for 15% or more of our outstanding common
stock, to acquire additional shares of our capital stock at a price equal to
one-half of the market price at the time of the event and, in certain
circumstances, would allow our shareholders to acquire capital stock in the
entity that has acquired or made an exchange or tender offer for 15% or more of
our outstanding common stock at a similar discount. The exercise of these rights
would make the acquisition of RealNetworks by a third party more expensive to
that party and has the effect of discouraging
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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.
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 October 29,
1999, the price of our common stock ranged from $16.875 to $123.500 per share.
Our stock price could be subject to wide fluctuations in response to factors
such as:
- actual or anticipated variations in quarterly operating results;
- announcements of technological innovations, new products or services
by us or our competitors;
- changes in financial estimates or recommendations by securities
analysts;
- the addition or loss of strategic relationships;
- conditions or trends in the Internet, media streaming, media delivery
and online commerce markets;
- changes in the market valuations of other Internet, online service or
software companies;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
- legal or regulatory developments;
- additions or departures of key personnel;
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- sales of our common stock; and
- general market conditions.
In addition, the stock market in general, and the Nasdaq National Market
and the market for Internet and technology companies in particular, have
experienced extreme price and volume fluctuations that have often been unrelated
or disproportionate to the operating performance of these companies. These broad
market and industry factors may reduce our stock price, regardless of our
operating performance. The trading prices of the stocks of many technology
companies are at or near historical highs and reflect price-earnings ratios
substantially above historical levels. These trading prices and price-earnings
ratios may not be sustained.
WE MAY BE SUBJECT TO ASSESSMENT OF SALES AND OTHER TAXES FOR THE SALE OF OUR
PRODUCTS, LICENSE OF TECHNOLOGY OR PROVISION OF SERVICES
We may have to pay past sales or other taxes that we have not collected
from our customers. We do not currently collect sales or other taxes on the sale
of our products, license of technology or provision of services in states and
countries other than those in which we have offices or employees.
In October 1998, the Internet Tax Freedom Act (ITFA) was signed into
law. Among other things, the ITFA imposes a three-year moratorium on
discriminatory taxes on electronic commerce. Nonetheless, foreign countries or,
following the moratorium, one or more states, may seek to impose sales or other
tax obligations on companies that engage in such activities within their
jurisdictions. Our business would be harmed if one or more states or any foreign
country were able to require us to collect sales or other taxes from current or
past sales of products, licenses of technology or provision of services,
particularly because we would be unable to go back to customers to collect sales
taxes for past sales and may have to pay such taxes out of our own funds.
YEAR 2000 COMPLIANCE ISSUES COULD HARM OUR BUSINESS
We are in the process of assessing and remediating any Year 2000 issues
associated with our own products, and the computer systems, software, other
property and equipment we use. Despite our testing and remediation efforts, our
products and systems, and those of third parties, including content providers,
advertisers, affiliates and end users, may contain errors or faults with respect
to the year 2000. Known or unknown errors or defects that affect the operation
of our products and systems or those of third parties could result in delay or
loss of revenues, interruptions of services, cancellation of customer contracts,
diversion of development resources, damage to our reputation, increased service
and warranty costs and litigation costs, any of which could harm our business.
WE INTEND TO DONATE A PORTION OF NET INCOME TO CHARITY
For the quarter ended September 30, 1999, we were profitable and accrued
5% of quarterly net income for charitable donation. If we sustain profitability,
we intend to donate 5% of our annual net income to charitable organizations.
This will reduce our net income.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this document, all of which
are subject to risks and uncertainties. Forward-looking statements include
information concerning our possible or assumed future business success or
financial results. Such forward-looking statements include, but are not limited
to, statements as to our expectations regarding:
- the future development and growth of, and opportunities for, the
Internet and the online media delivery market;
- the future adoption of our current and future products, services and
technologies;
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- 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;
- the effect of current litigation in which we are involved; and
- the effect of the Year 2000 situation.
When we use words such as "believe," "expect" and "anticipate" or
similar words, we are making forward-looking statements.
You should note that an investment in our common stock involves certain
risks and uncertainties that could affect our future business success or
financial results. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in "Factors That May Affect Our Business, Future
Operating Results and Financial Condition" and elsewhere in this Quarterly
Report on Form 10-Q.
We believe that it is important to communicate our expectations to our
investors. However, there may be events in the future that we are not able to
predict accurately or over which we have no control. Before you invest in our
common stock, you should be aware that the occurrence of the events described in
the "Factors That May Affect Our Business, Future Operating Results and
Financial Condition" and elsewhere in this Quarterly Report on Form 10-Q could
materially and adversely affect our business, financial condition and operating
results. We undertake no obligation to publicly update any forward-looking
statements for any reason, even if new information becomes available or other
events occur in the future.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information relating to quantitative and qualitative disclosure about
market risk is set forth under the caption "Liquidity and Capital Resources" in
Part I, Item 2, Management's Discussion and Analysis of Financial Condition and
Results of Operations.
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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 us and co-defendant Broadcast.com in the United States District Court
for the Northern District of Texas--Dallas Division. The plaintiffs allege that
we, individually and in combination with Broadcast.com, infringe on a certain
patent by making, using, selling and/or offering to sell software products and
services directed to media delivery systems for the Internet and corporate
intranets. The plaintiffs seek to enjoin us from our alleged infringing activity
and to recover damages in an amount no less than a reasonable royalty. Although
we can give no assurance as to the outcome of this lawsuit, we believe that the
allegations in this action are without merit, and intend to vigorously defend
ourselves against these claims. We may be required to indemnify Broadcast.com
under the terms of our license agreement with it. The plaintiffs filed a similar
claim based on the same patent and seeking similar remedies as a separate
lawsuit against Microsoft and Broadcast.com in the same court. The court has
consolidated the lawsuit against Microsoft and Broadcast.com with the lawsuit
against RealNetworks and Broadcast.com.
On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against us
in the U.S. District Court for the Western District of Washington. The plaintiff
alleges that we entered into an oral agreement with it in 1995 pursuant to which
the plaintiff claims it is entitled to 30% of our revenues from the use of
RealAudio technology to promote, sample or sell music. The plaintiff claims
breach of contract, unjust enrichment, promissory estoppel and breach of
implied-in-fact contract. We have denied each of the plaintiff's claims. In
response to our motion to dismiss, the plaintiff withdrew its claim for breach
of fiduciary duty. Trial is currently set for May 2000. Although no assurance
can be given as to the outcome of this lawsuit, we believe the allegations in
this action are without merit, and we intend to vigorously defend ourselves
against these claims.
On November 1, 1999, we announced a software update to RealJukebox to
prevent RealJukebox from sending potentially personally identifiable data
without a user's consent to RealNetworks or any other third party during the
operation of RealJukebox. Prior to the issuance of this software update,
RealJukebox had the ability to send certain data, including a Globally Unique
Identifier ("GUID"), to RealNetworks when RealJukebox was used, although no
personally identifiable information was logged or stored by RealNetworks about
the music played or recorded by RealJukebox. Subsequent to our announcement,
litigation has been initiated against us in state or federal courts in
California, Illinois, Pennsylvania and Texas. These suits, 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 features of RealNetworks' consumer products. Due
to the recent nature of these filings, we have not had an opportunity to fully
evaluate the claims. However, we intend to vigorously defend ourselves against
these claims. If the plaintiffs prevail in their claims, we could be required to
pay damages or other penalties, which could have a material adverse effect on
our operating results.
From time to time we are, and expect to continue to be, subject to legal
proceedings and claims in the ordinary course of our business, including
contract-related claims and claims of alleged infringement of third-party
patents, trademarks and other intellectual property rights. These claims, even
if not meritorious, could force us to spend significant financial and managerial
resources. We currently are not aware of any legal proceedings or claims that we
believe will have, individually or taken together, a material adverse effect on
our business, prospects, financial condition and operating results.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Since July 1, 1999, the Company has issued and sold unregistered
securities as follows:
(1) An aggregate of 733,155 shares of Common Stock was issued in August
1999 to 97 individuals and entities in exchange for all of the
outstanding shares of common stock of Xing Technology Corporation, a
California corporation. The aggregate consideration received for
such shares was valued at approximately $47.7 million. The issuance
was made in reliance upon the exemption from
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registration set forth in Section 3(a)(10) of the Securities Act of
1933 as amended (the "Securities Act").
(d) Use of Proceeds
RealNetworks' registration statement under the Securities Act for its
initial public offering became effective on November 20, 1997. Offering
proceeds, net of aggregate expenses of approximately $4.6 million, were
approximately $38.5 million. RealNetworks has used all of the net offering
proceeds for the purchase of temporary investments consisting of cash, cash
equivalents and short-term investments. RealNetworks has not used any of the net
offering proceeds for construction of plant, building or facilities, purchases
of real estate, acquisition of other businesses, or repayment of indebtedness.
None of the net offering proceeds were paid directly or indirectly to directors,
officers, or general partners of RealNetworks or their associates, persons
owning 10% or more of any class of RealNetworks' securities, or affiliates of
RealNetworks.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits Required by Item 601 of Regulation S-K:
10.2 Amendment No. 2 to 1998 Employee Stock Purchase Plan
27.1 Financial Data Schedule which is submitted electronically
to the Securities and Exchange Commission for information
purposes only and is not filed
27.2 Restated Financial Data Schedule which is submitted
electronically to the Securities and Exchange Commission
for information purposes only and is not filed
(b) Reports on Form 8-K:
On August 23, 1999, RealNetworks filed a report on Form 8-K that,
pursuant to Item 5 of such form, announced that RealNetworks had acquired all of
the outstanding capital stock of Xing Technology Corporation.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, on November 15, 1999.
REALNETWORKS, INC.
By /s/ Paul Bialek
--------------------------------------
Paul Bialek
Senior Vice President, Finance and
Operations and Chief Financial Officer
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INDEX TO EXHIBITS
Exhibit Number Description
-------------- -----------
10.2 Amendment No. 2 to 1998 Employee Stock
Purchase Plan
27.1 Financial Data Schedule which is submitted
electronically to the Securities and Exchange
Commission for information purposes only and
is not filed
27.2 Restated Financial Data Schedule which is
submitted electronically to the Securities and
Exchange Commission for information purposes
only and is not filed