-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BZ3wTq1EMQi3iPzi1qYkvhvaIwHr/vQD3KcU/Trujrm/JB11hwr/3rmDHfkCIf31 Suqyo8aJF0a0q5qbEacRgg== 0000891020-98-001314.txt : 19980817 0000891020-98-001314.hdr.sgml : 19980817 ACCESSION NUMBER: 0000891020-98-001314 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: REALNETWORKS INC CENTRAL INDEX KEY: 0001046327 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 911628146 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-23137 FILM NUMBER: 98689857 BUSINESS ADDRESS: STREET 1: 1111 THIRD AVE STREET 2: STE 2900 CITY: SEATTLE STATE: WA ZIP: 98101 BUSINESS PHONE: 2066742700 MAIL ADDRESS: STREET 1: 1111 THIRD AVE STREET 2: STE 2900 CITY: SEATTLE STATE: WA ZIP: 98101 10-Q 1 FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1998 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998 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) 1111 THIRD AVENUE, SUITE 2900 98101 SEATTLE, WASHINGTON (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (206) 674-2700 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The number of shares of the registrant's Common Stock outstanding as of July 31, 1998 was 29,432,018. In addition, there were 3,338,374 outstanding shares of the registrant's Special Common Stock, par value $0.001 per share, that automatically convert on a one-for-one basis into Common Stock on a bona fide sale to a purchaser who is not an affiliate of the holder. 2 REALNETWORKS, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1998 TABLE OF CONTENTS
PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements..................................................4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................11 PART II. OTHER INFORMATION Item 1. Legal Proceedings....................................................17 Item 2. Changes in Securities and Use of Proceeds............................17 Item 4. Submission of Matters to a Vote of Security Holders..................18 Item 6. Exhibits and Reports on Form 8-K.....................................18
3 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS REALNETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT PER SHARE DATA)
December 31, June 30, 1997 1998 ------------ ------------ ASSETS Current assets: Cash, cash equivalents and short-term investments........................ $ 92,028 $ 98,033 Trade accounts receivable, net of allowance for doubtful accounts and sales returns........................................... 5,073 5,345 Other receivables........................................................ 10,706 227 Prepaid expenses and other current assets................................ 2,052 2,847 ------------ ------------ Total current assets................................................. 109,859 106,452 Property and equipment, net................................................... 5,143 5,348 Investment in joint venture................................................... 816 599 Other assets, net............................................................. 886 2,204 ------------ ------------ Total assets......................................................... $ 116,704 $ 114,603 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable......................................................... $ 2,136 $ 2,881 Accrued compensation..................................................... 974 1,266 Other accrued expenses................................................... 2,679 5,843 Deferred revenue......................................................... 16,550 20,438 ------------ ------------ Total current liabilities............................................ 22,339 30,428 Deferred revenue, net of current portion...................................... 15,500 10,667 Notes payable................................................................. 963 1,002 Shareholders' equity: Preferred stock, $0.001 par value Authorized 60,000 shares; no shares issued and outstanding -- -- Common stock, $0.001 par value Authorized 292,952 shares; issued and outstanding 27,528 shares at December 31, 1997 and 29,232 shares at June 30, 1998.............. 28 29 Special common stock, $0.001 par value Authorized 7,048 shares; issued and outstanding 3,338 shares at December 31, 1997 and June 30, 1998............................... 3 3 Additional paid-in capital............................................... 95,557 112,405 Accumulated deficit...................................................... (17,524) (39,716) Accumulated other comprehensive loss..................................... (162) (215) ------------ ------------ Total shareholders' equity........................................... 77,902 72,506 ------------ ------------ Total liabilities and shareholders' equity........................... $ 116,704 $ 114,603 ============ ============
See accompanying notes to condensed consolidated financial statements 4 4 REALNETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT PER SHARE DATA)
QUARTER ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------- ----------------------------- 1997 1998 1997 1998 ---------- ---------- ---------- ---------- Net revenues: Software license fees...................... $ 5,532 $ 10,796 $ 10,070 $ 20,214 Service revenues........................... 907 3,495 2,189 6,117 Advertising................................ 571 765 1,107 1,227 ---------- ---------- ---------- ---------- Total net revenues..................... 7,010 15,056 13,366 27,558 ---------- ---------- ---------- ---------- Cost of revenues: Software license fees...................... 591 1,800 1,134 3,386 Service revenues........................... 285 755 1,612 1,276 Advertising................................ 157 406 308 738 ---------- ---------- ---------- ---------- Total cost of revenues................. 1,033 2,961 3,054 5,400 ---------- ---------- ---------- ---------- Gross profit........................... 5,977 12,095 10,312 22,158 ---------- ---------- ---------- ---------- Operating expenses: Research and development................... 2,738 4,789 5,463 9,208 Sales and marketing........................ 4,811 8,135 9,161 14,965 General and administrative................. 1,325 2,467 2,496 4,567 Acquisition related charges................ -- -- -- 17,879 ---------- ---------- ---------- ---------- Total operating expenses............... 8,874 15,391 17,120 46,619 ---------- ---------- ---------- ---------- Operating loss......................... (2,897) (3,296) (6,808) (24,461) Other income, net.............................. 231 1,192 436 2,269 ---------- ---------- ---------- ---------- Net loss....................................... $ (2,666) $ (2,104) $ (6,372) $ (22,192) ========== ========== ========== ========== Basic and diluted net loss per share........... $ (3.99) $ (0.07) $ (10.17) $ (0.70) ========== ========== ========== ========== Shares used to compute basic and diluted net loss per share........................ 685 32,119 640 31,551
See accompanying notes to condensed consolidated financial statements 5 5 REALNETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Six Months Ended June 30, ------------------------------- 1997 1998 ------------ ------------ Net cash provided by (used in) operating activities $ (5,658) $ 7,000 ------------ ------------ Cash flows from investing activities: Purchases of property and equipment....................................... (2,163) (1,713) Purchases of short-term investments....................................... (10,614) (43,967) Proceeds from sales and maturities of short-term investments.............. 8,948 16,106 Investment in joint venture............................................... (998) -- Increase in other assets.................................................. (279) -- Cash obtained through acquisition......................................... -- 203 ------------ ------------ Net cash used in investing activities................................. (5,106) (29,371) ------------ ------------ Cash flow from financing activities: Proceeds from issuance of note payable.................................... 991 -- Net proceeds from sales of common stock and exercise of stock options and warrants.............................................. 17 526 ------------ ------------ Net cash provided by financing activities............................. 1,008 526 ------------ ------------ Effect of exchange rate changes on cash........................................ (10) (11) ------------ ------------ Net decrease in cash and cash equivalents............................. (9,766) (21,856) Cash and cash equivalents at beginning of period............................... 14,738 62,255 ------------ ------------ Cash and cash equivalents at end of period..................................... 4,972 40,399 Short-term investments at end of period........................................ 6,524 57,634 ------------ ------------ Total cash, cash equivalents and short-term investments at end of period....... $ 11,496 $ 98,033 ============ ============
See accompanying notes to condensed consolidated financial statements 6 6 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Description of Business RealNetworks, Inc. and subsidiaries (Company) is a leading provider of branded software products and services that enable the delivery of streaming media content over the Internet and intranets. Streaming technology enables the transmission and playback of continuous "streams" of multimedia content, such as audio, video, and animation, over the Internet and intranets. The Company's products and services include its RealSystem, a streaming media solution that includes RealAudio and RealVideo technology, an electronic commerce World Wide Web (Web) site designed to promote the proliferation of streaming media products and a network of advertising-supported content aggregation Web sites. (b) Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. These statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of the Company's management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter and six months ended June 30, 1998 are not necessarily indicative of the results that may be expected for any subsequent quarter or for the year ending December 31, 1998. Certain information and footnote disclosures normally included in financial statements prepared in conformity with generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These condensed consolidated financial statements should be read in conjunction with the financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. (c) Cash, Cash Equivalents and Short-Term Investments Cash, cash equivalents and short-term investments are comprised of the following:
December 31, 1997 June 30, 1998 ----------------- ------------- (in thousands) Cash and cash equivalents $62,255 $30,799 Short-term investments 29,773 57,634 Restricted cash equivalents -- 9,600 ------- ------- $92,028 $98,033 ======= =======
Restricted cash equivalents represent a restricted escrow account established in connection with a lease agreement for new corporate offices. The Company expects to take occupancy of the new facilities during the quarter ending June 30, 1999. 7 7 (d) Revenue Recognition On January 1, 1998, the Company adopted the provisions of Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), which provides specific industry guidance and stipulates that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post contract customer support, installation, or training. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for each element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. The adoption of SOP 97-2 did not have a material effect on revenue recognition for the quarter and six months ended June 30, 1998. Prior to January 1, 1998, the Company recognized revenue from software license fees upon delivery, net of an allowance for estimated returns, provided that no significant obligations of the Company remain and collection of the resulting receivable is deemed probable. 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. 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. The Company recognizes revenue from software license agreements with value-added resellers (VAR), when the following conditions are met: the software product has been delivered to the VAR, the fee to the Company is fixed or determinable, and collectibility is probable. Service revenues include payments under support and upgrade contracts, and fees from consulting and content hosting. Support and upgrade revenues are recognized ratably over the term of the contract, which typically is 12 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 In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (Statement 130), which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Statement 130 is effective for fiscal years beginning after December 15, 1997 and requires reclassification of financial statements for earlier periods to be provided for comparative purposes. The Company has not determined the manner in which it will present the information required by Statement 130 in its annual financial statements for the year ending December 31, 1998. The Company's total comprehensive loss for the quarters ended June 30, 1997 and 1998 was $(2,638,000) and $(2,143,000), respectively. The Company's total comprehensive loss for the six months ended June 30, 1997 and 1998 was $(6,353,000) and $(22,245,000), respectively. Total comprehensive loss for the quarters and six months ended June 30, 1997 and 1998 consisted of net loss and foreign currency translation adjustments. 8 8 (f) Net Loss Per Share Basic earnings per share is computed by dividing the sum of net loss plus accretion of redemption value of redeemable preferred stock by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing the sum of net loss plus accretion of redemption value of redeemable preferred stock by the weighted average number of common and dilutive common equivalent shares outstanding during the period. As the Company had a net loss attributable to common shareholders in each of the periods presented, basic and diluted net loss per share are the same. The following table reconciles the Company's reported net loss to net loss attributable to common shareholders used to compute basic and diluted net loss per share:
Quarter Ended June 30, Six Months Ended June 30, ------------------------------ ------------------------------ 1997 1998 1997 1998 -------- -------- -------- -------- (in thousands) Net Loss $ (2,666) $ (2,104) $ (6,372) $(22,192) Accretion of redemption value of redeemable preferred stock prior to conversion into common stock (67) -- (134) -- -------- -------- -------- -------- Net loss attributable to common shareholders $ (2,733) $ (2,104) $ (6,506) $(22,192) ======== ======== ======== ========
Excluded from the computation of diluted earnings per share for the quarter and six months ended June 30, 1998 are options to acquire 7,604,000 shares of common stock with a weighted-average exercise price of $6.81 and warrants to acquire 472,000 shares of common stock with a weighted-average exercise price of $9.41 because their effects would be anti-dilutive. NOTE 2 - ACQUISITION In March 1998, the Company completed the acquisition of Vivo Software, Inc. (Vivo), a developer of streaming media creation tools. Under the terms of the acquisition, the Company issued approximately 1,102,000 shares of its common stock in exchange for all outstanding shares of Vivo common stock. In addition, the Company issued options to purchase approximately 48,000 shares of the Company's common stock in exchange for outstanding unvested options to purchase Vivo common stock. The acquisition was accounted for using the purchase method of accounting, and, accordingly, the results of Vivo's operations are included in the Company's condensed consolidated financial statements from the date of acquisition. A summary of the purchase price for the acquisition is as follows (in thousands): Stock and stock options $16,526 Direct acquisition costs 445 Accrued expenses assumed 1,640 Other current liabilities assumed 1,021 Non-current liabilities assumed 36 ------- Total $19,668 =======
9 9 A summary of the allocation of the purchase price is as follows (in thousands): In-process research and development $ 17,729 Cash acquired 203 Other current assets acquired 148 Property and equipment 100 Goodwill 1,488 ----- Total $ 19,668 ========
In-process research and development represents the fair value of technologies acquired for use in the Company's own development efforts. The Company determined the amount of the purchase price to be allocated to in-process research and development based on the time and cost to incorporate the acquired technology into the Company's development projects, expected incremental revenues and expenses associated with the development projects utilizing the acquired technology, and risks and uncertainties associated with the acquired technology. Such risks and uncertainties include inherent difficulties and uncertainties in incorporating the acquired technology into the Company's development projects and risks related to the viability of and potential changes to target markets. The Company also concluded that the acquired technology had no alternative future use. Goodwill represents the excess of the purchase price over the fair value of identifiable tangible and intangible assets acquired and is amortized using the straight-line method over its estimated life of five years. The acquisition of Vivo was a tax free reorganization under the Internal Revenue Code (IRC). Therefore, the charge for in-process research and development is not deductible for income tax purposes. The Company acquired a net operating loss carryforward of approximately $16,000,000, which expires from 2008 to 2012. Under the provisions of the IRC, the amount of these net operating loss carryforwards available annually to offset future taxable income is significantly limited. No value has been attributed to these net operating losses in the purchase price allocation due to these limitations. In connection with the acquisition, approximately 220,000 shares of common stock issued were placed in escrow to secure indemnification obligations of former shareholders of Vivo. The following table presents pro forma results of operations as if the acquisition had occurred at the beginning of each of the periods presented. The pro forma results of operations exclude $17,879,000 of acquisition related charges as the charges are not expected to have a continuing impact on the Company's results of operations. The pro forma information is not necessarily indicative of the combined results that would have occurred had the acquisition taken place at the beginning of 1997 or at the beginning of 1998, nor is it necessarily indicative of results that may occur in the future.
Pro forma Six Months Ended June 30, --------------------------------- 1997 1998 -------- --------- (in thousands except per share data) Revenues $ 14,156 $ 28,211 Net loss (9,471) (5,443) Net loss per share (6.31) (0.17)
10 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONTAINS FORWARD-LOOKING STATEMENTS THAT HAVE BEEN MADE PURSUANT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. SUCH FORWARD LOOKING STATEMENTS ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS ABOUT THE COMPANY'S INDUSTRY, MANAGEMENT'S BELIEFS AND CERTAIN ASSUMPTIONS MADE BY THE COMPANY'S MANAGEMENT. WORDS SUCH AS "ANTICIPATES", "EXPECTS", "INTENDS", "PLANS", "BELIEVES", "SEEKS", "ESTIMATES" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY SUCH FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS THAT ARE DIFFICULT TO PREDICT. THE COMPANY'S ACTUAL ACTIONS OR RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE THOSE SET FORTH HEREIN UNDER "OVERVIEW", "RESULTS OF OPERATIONS", AND "LIQUIDITY AND CAPITAL RESOURCES", IN THE SECTION TITLED "CERTAIN RISK FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS, FUTURE OPERATING RESULTS AND FINANCIAL CONDITION" INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997, AND IN THE SECTIONS TITLED "RISK FACTORS" AND "BUSINESS" INCLUDED IN THE COMPANY'S FINAL PROSPECTUS DATED NOVEMBER 21, 1997. UNLESS REQUIRED BY LAW, THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. HOWEVER, READERS SHOULD CAREFULLY REVIEW THE INFORMATION SET FORTH IN OTHER REPORTS OR DOCUMENTS THAT THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION. OVERVIEW RealNetworks is a leading provider of branded software products and services that enable the delivery of streaming media content over the Internet and intranets. The Company's products and services include its RealSystem, a streaming media solution that includes RealAudio and RealVideo technology, an electronic commerce Web site designed to promote the proliferation of streaming media products and a network of advertising-supported content aggregation Web sites. In March 1998, the Company completed the acquisition of Vivo Software, Inc. ("Vivo"), a developer of streaming media creation tools. Under the terms of the acquisition, the Company exchanged approximately 1,102,000 shares of its common stock in exchange for all outstanding shares of Vivo common stock. The acquisition was accounted for using the purchase method of accounting. Of the total purchase price, $17,729,000 was allocated to in-process research and development and was charged to the Company's results of operations for the six months ended June 30, 1998. The remaining purchase price of $1,939,000 was allocated to tangible assets acquired and goodwill. Goodwill is amortized over its estimated life of five years. See Note 2 of Notes to Condensed Consolidated Financial Statements. Although the Company believes that the acquisition of Vivo is in the best interests of the Company and its shareholders, acquisitions involve a number of special risks, including: the integration of acquired products and technologies in a timely manner; the integration of businesses and employees with the Company's business; adverse effects on the Company's reported operating results from acquisition-related charges and amortization of goodwill; potential increases in stock compensation expense and increased compensation expense resulting from newly-hired employees; distraction of the Company's management from the day-to-day business and operations of the Company; the assumption of unknown liabilities; and the possible failure to retain key acquired personnel. Because most software business acquisitions involve the purchase of significant amounts of intangible assets, acquisitions of such businesses typically result in goodwill and amortization charges and may also involve charges for acquired research and development projects. If the Company were to incur additional charges for acquired in-process research and development and amortization of goodwill with respect to future acquisitions, such charges could have a material adverse effect on the Company's business, financial condition and results of operations. 11 11 During the second quarter of 1998, the Company released RealSystem G2, its next generation streaming media delivery system consisting of servers, tools and client software, in preview form to the public prior to finalizing product features, functionality and operability. The preview release of RealSystem G2 may cause certain customers to delay purchasing decisions until commercial versions of the products are available, which could have a material adverse effect on the Company's future revenues and quarterly results of operations. In addition, software products as complex as those offered by the Company frequently contain errors or failures, especially when new versions are released. Although the Company conducts extensive product testing during product development, there can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found in new versions of its products after commencement of commercial shipments. Potential errors could result in the loss of revenue or delay in market acceptance of the Company's products, diversion of development resources, damage to the Company's reputation or increased service and warranty costs, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, there can be no assurance that the Company will not experience delays in the development, introduction, marketing and distribution of the final version of RealSystem G2, which delays, if they were to occur, could have a material adverse effect on the Company's business, financial condition and results of operations. In June 1997, the Company entered into a strategic agreement ("Agreement") with Microsoft Corporation ("Microsoft") pursuant to which the Company granted Microsoft a nonexclusive license to its Standard Code (as defined in the Agreement), which is comprised of certain substantial elements of the source code of the Company's RealAudio/RealVideo Version 4.0 technology included in its basic RealPlayer and substantial elements of its EasyStart Server (currently known as the Basic Server), and related Company trademarks. In July 1997, the Company delivered the Standard Code in exchange for a license fee of $30,000,000. The Company recognizes revenue related to this Agreement ratably over the three-year term of its ongoing obligations. The portion of the license fee that has not yet been recognized as revenue is included in deferred revenue. Under the Agreement, Microsoft may sublicense its rights to the Standard Code to third parties under certain conditions without additional compensation to the Company. In addition, Microsoft has an option to receive two additional deliveries of updated versions of the Standard Code. Microsoft's right to receive the first delivery expired unexercised in July, 1998. Microsoft may elect to receive a delivery of the then current version of the Standard Code once before July, 1999, upon payment of a license fee of $35 million. If the Company elects in its sole discretion to grant an Event License (as defined in the Agreement) to a third party, the Agreement provides for a refund of a portion of the license fee paid by Microsoft, based on a declining scale over the term of the Agreement. In connection with the Agreement, Microsoft purchased a minority interest in the Company in the form of 3,338,374 shares of nonvoting Series E Preferred Stock at approximately $8.99 per share, which shares were converted to Special Common Stock upon the completion of the Company's initial public offering. All shares of Special Common Stock will automatically convert into the same number of shares of Common Stock upon transfer by Microsoft to a purchaser who is not affiliated with Microsoft. Microsoft has the right to require the Company to register Microsoft's shares for sale under the Securities Act of 1933. Rule 144 of the Securities Act provides, in general, that any person who has beneficially owned shares for at least one year may generally sell, within any three-month period, a number of shares that does not exceed the greater of 1% of the shares of Common Stock then outstanding or the reported average weekly trading volume in the Company's Common Stock (computed over a four-week period). Sales of substantial numbers of shares of Special Common Stock in the public market could have a material adverse effect on the market price for the Company's Common Stock. Although Microsoft is a shareholder of the Company, it is also a competitor and its interests may not always be aligned with those of the Company and the Company's other shareholders. Microsoft has indicated that, to the extent the relationship between the parties becomes more competitive than complementary, it is likely to re-evaluate its investment position in the Company. Microsoft has not formally communicated to the Company its intentions with respect to its investment position in the Company, but at times has indicated informally that it may sell at least a portion of its shares. There can be no assurance that any such issues, the evolving nature of the relationship, or economic factors would not result in Microsoft selling all or a portion of its holdings in the Company, which could have a material adverse effect on the market price for the Company's Common Stock. Microsoft recently introduced the Windows Media Player, which competes with the Company's RealPlayer software, and is available for download from Microsoft's Web site. Microsoft has stated publicly that future releases of its new Windows 98 operating system, likely as early as the third quarter of 1998, will include the Windows Media Player. The Windows Media Player is based in part on technology Microsoft licensed from the Company under the Agreement, and can therefore play audio and video content based on earlier versions of the Company's RealAudio and RealVideo technology. Because Microsoft has not exercised its option to receive subsequent versions of the Standard Code, the Windows Media Player cannot play audio or video content based on the RealSystem 5.0 or G2 technology. Therefore, consumers who are using the Windows Media Player to receive audio and video over the Internet will not be able to access content available in the Company's newer formats. In addition, while Microsoft currently distributes certain older versions of the RealPlayer with Internet Explorer, which is distributed with the Windows operating system, Microsoft has indicated to the Company that it will not distribute the RealPlayer with future versions of Windows 98. On July 23, 1998, Robert Glaser, the Company's Chief Executive Officer, testified before the Senate Judiciary Committee that if a consumer already has the RealPlayer on a computer system, and thereafter downloads the Windows Media Player or installs Windows 98 with the Windows Media Player included on it, in a number of circumstances the Windows Media Player will disable certain important functions of the RealPlayer. As a result, certain of the Company's customers who have downloaded the free RealPlayer or paid for the RealPlayer Plus, may find that their product has ceased working. Because the Company raised the issue right after the Windows Media Player was released, and because the Company quickly posted a workaround solution on its Web site that the Company believes will counteract the situation, the Company believes only a small number of consumers will be impacted by the situation. In light of these recent events, the Company's relationship with Microsoft has become more competitive. Microsoft has a longer operating history, greater name recognition, and significantly greater financial, technical, marketing, and distribution resources than the Company. The Company's inability to sustain or maintain its leadership position in its market segment could have a material adverse effect on the Company's business, financial condition and results of operations and on the market price for the Company's Common Stock. In August 1997, the Department of Justice commenced an investigation into horizontal merger activities within the streaming media industry. The Department of Justice served several companies, including the Company and Microsoft, with subpoenas to produce certain documents. The Company continues to supply documents and information in response to the subpoenas. As a result of the investigation, it is possible that the Department of Justice will require certain actions by the Company, Microsoft or other companies in the streaming media industry that could have a material adverse effect on the Company's business, financial condition and results of operations. 12 12 Due to the foregoing factors, it is likely that the Company's operating results in some future quarters will fall below the expectations of securities analysts and investors, which would likely have a material adverse affect on the trading price of the Company's common stock. RESULTS OF OPERATIONS REVENUES Software License Fees. Software license fees were $10,796,000 for the quarter ended June 30, 1998, an increase of 95% from $5,532,000 in the comparable quarter of the prior year. Software license fees were $20,214,000 for the six months ended June 30, 1998, an increase of 101% from $10,070,000 in the comparable period of the prior year. The increases were due primarily to a greater volume of products sold as a result of growing market acceptance of the Company's products, the introduction of new products, successful product promotions and increased sales from electronic distribution. In addition, in June 1997, the Company entered into a $30,000,000 license agreement with Microsoft. The agreement requires the Company to provide Microsoft with engineering consultation services, certain error corrections and certain technical support over a defined term. The Company recognizes revenue from the agreement over the three-year term of the Company's ongoing obligations. Included in software license fees for the quarter and six months ended June 30, 1998, were $2,418,000 and $4,836,000, respectively, related to the Microsoft license agreement. Service Revenues. Service revenues were $3,495,000 for the quarter ended June 30, 1998, an increase of 285% from $907,000 in the comparable quarter of the prior year. Service revenues were $6,117,000 for the six months ended June 30, 1998, an increase of 179% from $2,189,000 in the comparable period of the prior year. The increases were primarily due to the introduction of support and upgrade contracts for the Company's RealPlayer Plus and a larger installed base of the Company's products. The larger installed base of the Company's products promotes increases in revenues through the purchase of support and upgrade contracts and other services performed by the Company. Service revenues for the six months ended June 30, 1997, also included $498,000 related to the Company's RealNetworks Conference. Advertising Revenues. Advertising revenues were $765,000 for the quarter ended June 30, 1998, an increase of 34% from $571,000 in the comparable quarter of the prior year. Advertising revenues were $1,227,000 for the six months ended June 30, 1998, an increase of 11% from $1,107,000 in the comparable period of the prior year. The increases in advertising revenues were due to a larger sales force and greater success in attracting advertisers. 13 13 COST OF REVENUES Cost of Software License Fees. Cost of software license fees includes costs of product media, duplication, manuals, packaging materials, royalties paid for licensed technology, and order fulfillment costs. Cost of software license fees was $1,800,000 for the quarter ended June 30, 1998, an increase of 205% from $591,000 in the comparable quarter in the prior year, and increased as a percentage of software license fees to 17% from 11%. Cost of software license fees was $3,386,000 for the six months ended June 30, 1998, an increase of 199% from $1,134,000 in the comparable period in the prior year, and increased as a percentage of software license fees to 17% from 11%. These increases were due primarily to higher sales volumes and royalties related to new third-party technologies incorporated into the Company's products. The increases in cost of software license fees as a percentage of software license fees were due 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 bandwidth expenses for hosting services. Cost of service revenues was $755,000 for the quarter ended June 30, 1998, an increase of 165% from $285,000 in the comparable quarter in the prior year, but decreased as a percentage of service revenues to 22% from 31%. Cost of service revenues was $1,276,000 for the six months ended June 30, 1998, a decrease of 21% from $1,612,000 in the comparable period in the prior year, and decreased as a percentage of service revenues to 21% from 74%. Cost of service revenues for the six months ended June 30, 1997, includes $1,000,000 of costs associated with the Company's RealNetworks Conference. Excluding the impact of the RealNetworks Conference, cost of service revenues was $612,000, or 36% of service revenues, for the six months ended June 30, 1997. The increases in cost of service revenues excluding the RealNetworks Conference were primarily due to increased staff and contract personnel to provide services to a greater number of customers. The decreases in percentage terms were primarily due to economies of scale in providing support services. Cost of Advertising Revenues. Cost of advertising revenues includes personnel associated with content creation, bandwidth expenses and fees paid to third-parties for content included in the Company's Web sites. Cost of advertising revenues was $406,000 for the quarter ended June 30, 1998, an increase of 159% from $157,000 in the comparable quarter in the prior year, and increased as a percentage of advertising revenues to 53% from 27%. Cost of advertising revenues was $738,000 for the six months ended June 30, 1998, an increase of 140% from $308,000 in the comparable period in the prior year, and increased as a percentage of advertising revenues to 60% from 28%. These increases were primarily due to increases in the quality and quantity of content available on the Company's Web pages and increased costs associated with the maintenance of newly developed Web sites. Gross margins may be affected by the mix of distribution channels used, the mix of products sold, licensed third-party technology incorporated into the Company's products, the mix of product versus services revenues and the mix of international versus U.S. revenues. If sales through indirect channels increase as a percentage of total net revenues, service revenues increase as a percentage of total net revenues, or sales of the Company's lower margin products increase as a percentage of total net revenues, the Company's gross margins will be adversely affected. OPERATING EXPENSES Research and Development. Research and development expenses consist primarily of salaries and consulting fees to support product development and costs of technology acquired from third parties to incorporate into products under development. To date, all research and development costs have been expensed as incurred because technological feasibility of the Company's products is established upon completion of a working model. Costs incurred between completion of a working model and general release of products have been insignificant. Research and development expenses were $4,789,000 for the quarter ended June 30, 1998, an increase of 75% from $2,738,000 in the comparable quarter in the prior year, but decreased as a percentage of total net revenues to 32% from 39%. Research and development expenses were $9,208,000 for the six months ended June 30, 1998, an increase of 69% from $5,463,000 in the comparable period in the prior year, but decreased as a percentage of total net revenues to 33% from 41%. The increases in absolute dollars were primarily due to increases in internal development personnel and consulting expenses. The decreases in percentage terms were a result of revenues growing at a faster rate than expenses. Research and development expenses were primarily related to the 14 14 development of new technology and products and enhancements made to existing products. The Company believes that significant investments in research and development is a critical factor in attaining its strategic objectives and, as a result, expects to increase research and development expenditures in future periods. Sales and Marketing. Sales and marketing expenses consist principally of salaries, commissions, consulting fees paid, trade show expenses, advertising, promotional expenses and cost of marketing collateral. Sales and marketing expenses were $8,135,000 for the quarter ended June 30, 1998, an increase of 69% from $4,811,000 in the comparable quarter of the prior year, but decreased as a percentage of total net revenues to 54% from 69%. Sales and marketing expenses were $14,965,000 for the six months ended June 30, 1998, an increase of 63% from $9,161,000 in the comparable period of the prior year, but decreased as a percentage of total net revenues to 54% from 69%. The increases in absolute dollars were due to the expansion of the Company's direct sales organization, the creation of additional sales offices, promotions and expenses related to the continued development of the "Real" brand. For the quarter ended June 30, 1998, sales and marketing expenses included the net costs of the 1998 RealNetworks Conference. The decreases in percentage terms were a result of revenues growing at a faster rate than expenses. The Company intends to continue its branding and marketing efforts and, therefore, expects sales and marketing expenses to increase significantly in future periods. General and Administrative. General and administrative expenses consist primarily of personnel costs, fees for professional services and corporate infrastructure costs. General and administrative expenses were $2,467,000 for the quarter ended June 30, 1998, an increase of 86% from $1,325,000 in the comparable quarter of the prior year, but decreased as a percentage of total net revenues to 16% from 19%. General and administrative expenses were $4,567,000 for the six months ended June 30, 1998, an increase of 83% from $2,496,000 in the comparable period of the prior year, but decreased as a percentage of total net revenues to 17% from 19%. The increases in absolute dollars were primarily a result of increased personnel and facility expenses necessary to support the Company's growth and costs associated with operating as a public company. The decreases in percentage terms were due to revenues growing at a faster rate than expenses. The Company expects general and administrative expenses to increase as the Company expands its staff, incurs additional costs related to the growth of its business, and incurs additional costs related to operating as a public company. Acquisition Related Charges. Acquisition related charges include acquired in-process research and development and other acquisition related costs. During the six months ended June 30, 1998, the Company incurred $17,879,000 in expenses associated with the acquisition of Vivo. The Company may, in the future, acquire businesses or technologies that are complimentary to those of the Company, the results of which could include significant charges for acquired in-process research and development and the amortization of acquired intangible assets. OTHER INCOME, NET Other income, net consists primarily of earnings on the Company's cash, cash equivalents and short-term investments. Other income, net was $1,192,000 and $2,269,000 for the quarter and six months ended June 30, 1998, respectively, and $231,000 and $436,000 for the quarter and six months ended June 30, 1997, respectively. The increases were due primarily to interest earned on proceeds from the sales of common and preferred stock in 1997, including the Company's initial public offering in November, 1997. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities was $7,000,000 for the six months ended June 30, 1998. Net cash used in operating activities was $5,658,000 for the six months ended June 30, 1997. Cash provided by operating activities for the six months ended June 30, 1998, was due to a decrease in other receivables and non-cash charges associated with depreciation and acquisition related charges, partially offset by the reported net loss. Cash used in operating activities for the six months ended June 30, 1997 was due primarily to the reported net loss. Net cash used in investing activities was $29,371,000 and $5,106,000 for the six months ended June 30, 1998 and 1997, respectively. Cash used in investing activities for the six months ended June 30, 1998, was primarily a result of net purchases of short-term investments and purchases of equipment. Cash used in investing 15 15 activities for the six months ended June 30, 1997, was due to net purchases of short-term investments and purchases of equipment. Net cash provided by financing activities was $526,000 and $1,008,000 for the six months ended June 30, 1998 and 1997, respectively. Cash provided by financing activities for the six months ended June 30, 1998, was a result of net proceeds from the sales of common stock and the exercise of stock options and warrants. Cash provided by financing activities for the six months ended June 30, 1997, was a result of the exercise of stock options and proceeds from a note payable. At June 30, 1998, the Company had $98,033,000 in cash, cash equivalents and short-term investments. As of June 30, 1998, the Company's principal commitments consisted of obligations under operating leases and $1,002,000 in notes payable. Since its inception, the Company has experienced a substantial increase in its capital expenditures to support expansion of the Company's operations and information systems. In January 1998, the Company entered into a lease agreement for a new location for its corporate offices. The Company anticipates the new lease will require significant capital expenditures associated with leasehold improvements. In the past, the Company has completed acquisitions of businesses and technologies, and will continue to evaluate acquisitions of, or investments in, businesses, products, joint-ventures, or technologies that are complementary to the operations of the Company. Such acquisitions or investments, which the Company believes have been, and will continue to be, in the best interest of the Company, involve risks and may require additional cash investments by the Company. Since its inception, the Company has significantly increased its operating expenses. The Company currently anticipates that it will continue to experience significant growth in its operating expenses and that such expenses will be a material use of the Company's cash resources. The Company believes that its current cash, cash equivalents, and short-term investments will be sufficient to meet its anticipated cash needs for working capital and capital expenditures for at least the next 12 months. The Company may, in the future, 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 the Company's shareholders. Although the Company believes that all of its current products are Year 2000 compliant, it has not yet completed sufficient internal testing of recently developed and newly acquired technologies, and there can be no assurance that the Company's current products do not contain undetected errors related to Year 2000 that may result in material additional costs or liabilities that could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company has on occasion agreed to indemnify certain of its customers for claims and losses arising out of the failure of its products to be Year 2000 compliant. To the extent that the Company is not able to test the technology provided to it by third-parties for its own use or for redistribution, or to obtain assurances from such third-parties that their products are Year 2000 compliant, the Company may experience material additional costs or liabilities that could have a material adverse effect on the Company's business, financial condition, and results of operations. With regard to the Company's internal processing and operational systems, the Company is in the process of identifying and testing all systems for Year 2000 compliance. Although the Company is not aware of any material operational issues or costs associated with preparing internal systems for the Year 2000, there can be no assurance that the Company will not experience material adverse effects from undetected errors or the failure of such systems to be Year 2000 compliant. Any such failures could have a material adverse effect on the Company's business, financial condition and results of operations. 16 16 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS From time to time the Company has been, and continues to be, subject to legal proceedings and claims in the ordinary course of its business, including claims of alleged infringement of third-party trademarks and other intellectual property rights by the Company and its licensees. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (c) Since April 1, 1998, the Company has issued and sold unregistered securities as follows: (1) An aggregate of 28,126 shares of Common Stock was issued to one investor upon the cashless exercise of a warrant in April 1998. The aggregate consideration received for such shares was the cancellation of a warrant to acquire 39,841 shares of Common Stock at an exercise price of $9.41. (2) An aggregate of 81,182 shares of Common Stock was issued to two investors upon the cashless exercise of warrants in May 1998. The aggregate consideration received for such shares was the cancellation of warrants to acquire 119,522 shares of Common Stock at an exercise price of $9.41. (3) An aggregate of 26,096 shares of Common Stock was issued to two investors upon the cashless exercise of warrants in June 1998. The aggregate consideration received for such shares was the cancellation of warrants to acquire 39,840 shares of Common Stock at an exercise price of $9.41. (4) An aggregate of 2,826 shares of Common Stock was issued to one investor upon the exercise of a warrant in June 1998. The aggregate consideration received for such shares was $26,600. (5) An aggregate of 6,437 shares of Common Stock was issued in June 1998 to four individuals in exchange for 144,644 shares of Common Stock of Vivo Software, Inc., a Massachusetts corporation. The aggregate consideration received for such shares was valued at $99,900. (6) Between April 1, 1998 and June 30, 1998, an aggregate of 289,932 shares of Common Stock had been issued to employees upon the exercise of options. The aggregate consideration received for such shares was $133,193. Use of Proceeds The Company's registration statement under the Securities Act of 1933, as amended, for its initial public offering became effective on November 21, 1997. Offering proceeds, net of aggregate expenses of approximately $4.6 million, were approximately $38.5 million. The Company has used all of the net offering proceeds for the purchase of temporary investments consisting of cash, cash equivalents and short-term investments. The Company 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 the Company or their associates, persons owning 10% or more of any class of the Company's securities, or affiliates of the Company. 17 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS An Annual Meeting of Shareholders of RealNetworks, Inc. was held on May 22, 1998. Matters voted on at the meeting and votes cast on each were as follows: 1. To elect one director to serve until the 2001 Annual Meeting of Shareholders or until his earlier retirement, resignation or removal, or the election of his successor. The terms of office of Robert Glaser, Bruce Jacobsen, and James Breyer, the other directors of the Company, continued after the meeting. For Withheld --- -------- Mitchell Kapor 24,806,402 16,056 2. To approve an amendment to the Company's Amended and Restated 1996 Stock Option Plan to increase by 2,500,000 the number of shares of Common Stock that may be issued thereunder. For 22,650,735 Against 425,755 Abstain 11,432 Broker Non-Votes 1,734,536 3. To ratify the appointment of KPMG Peat Marwick LLP as independent auditors for the Company's fiscal year ending December 31, 1998. For 24,782,539 Against 31,920 Abstain 7,999 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits required by Item 601 of Regulation S-K: 10.1 RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan 27.1 Financial Data Schedule which is submitted electronically to the Securities and Exchange Commission for information purposes only and not filed (b) Reports on Form 8-K: On April 8, 1998, the Company filed a report on Form 8-K (as amended by Form 8-K/A filed on June 4, 1998 to include Financial Statements of Business Acquired and Pro Forma Financial Information ), that, pursuant to Item 2 of such Form, announced that it had acquired all of the outstanding capital stock of Vivo Software, Inc. 18 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on August 14, 1998. REALNETWORKS, INC. By /s/ Robert Glaser ------------------------------------ Robert Glaser Chairman of the Board, Chief Executive Officer and Treasurer By /s/ Paul Bialek ------------------------------------ Paul Bialek Senior Vice President, Finance and Operations and Chief Financial Officer 19 19 INDEX TO EXHIBITS
Exhibit Number Description -------------- ----------- 10.1 RealNetworks, Inc. Amended and Restated 1996 Stock Option Plan 27.1 Financial Data Schedule which is submitted electronically to the Securities and Exchange Commission for information purposes only and not filed
EX-10.1 2 AMENDED AND RESTATED 1996 STOCK OPTION PLAN 1 REALNETWORKS, INC. AMENDED AND RESTATED 1996 STOCK OPTION PLAN (AS AMENDED AND RESTATED AS OF APRIL 9, 1998) 2 TABLE OF CONTENTS
PAGE ARTICLE 1 PURPOSE AND EFFECTIVENESS...................................................................... 1 1.1 Purpose........................................................................................ 1 1.2 Effective Date................................................................................. 1 ARTICLE 2 DEFINITIONS.................................................................................... 1 2.1 Certain Defined Terms.......................................................................... 1 ARTICLE 3 ADMINISTRATION................................................................................. 4 3.1 Administrative Committee....................................................................... 4 3.2 Appointment of Administrative Committee........................................................ 4 3.3 Powers; Regulations............................................................................ 4 3.4 Limits on Authority............................................................................ 4 3.5 Exercise of Authority.......................................................................... 4 ARTICLE 4 SHARES SUBJECT TO THE PLAN..................................................................... 5 4.1 Number of Shares............................................................................... 5 4.2 Adjustments.................................................................................... 5 ARTICLE 5 ELIGIBILITY.................................................................................... 5 ARTICLE 6 STOCK OPTIONS.................................................................................. 6 6.1 Grant of Options............................................................................... 6 6.2 Purchase Price................................................................................. 6 6.3 Limitations on Grants.......................................................................... 6 6.4 Term of Options................................................................................ 7 6.5 Option Agreement............................................................................... 7 6.6 Exercise of Options............................................................................ 7 6.7 Manner of Exercise............................................................................. 8 6.8 Legends........................................................................................ 8 6.9 Nontransferability............................................................................. 9 6.10 Repurchase of Shares........................................................................... 9 6.11 Class of Common Stock......................................................................... 10 6.12 Delegation to Executive Officer of Authority to Grant Options................................. 11 ARTICLE 7 GENERAL PROVISIONS............................................................................ 11 7.1 Acceleration of Options___Approved Transactions; Control Purchase............................. 11 7.2 Termination of Services....................................................................... 12
3 7.3 Right to Terminate Services................................................................... 13 7.4 Nonalienation of Benefits..................................................................... 13 7.5 Shareholders Agreement........................................................................ 13 7.6 Termination and Amendment..................................................................... 13 7.7 Government and Other Regulations.............................................................. 14 7.8 Withholding................................................................................... 14 7.9 Separability.................................................................................. 15 7.10 Non-Exclusivity of the Plan................................................................... 15 7.11 Exclusion from Pension and Profit-Sharing Computation......................................... 15 7.12 No Shareholder Rights......................................................................... 15 7.13 Governing Law................................................................................. 15 7.14 Company's Rights.............................................................................. 15
4 REALNETWORKS, INC. AMENDED AND RESTATED 1996 STOCK OPTION PLAN 1 PURPOSE AND EFFECTIVENESS 1.1 PURPOSE. The purpose of the 1996 Stock Option Plan (the "Plan") is to provide a method by which selected individuals rendering services to RealNetworks, Inc., a Washington corporation (the "Company"), may be offered an opportunity to invest in capital stock of the Company, thereby increasing their personal interest in the growth and success of the Company. The Plan is also intended to aid in attracting persons of exceptional ability to become officers and employees of the Company. 1.2 EFFECTIVE DATE; SHAREHOLDER APPROVAL. The Plan shall be effective at the time specified in the resolutions of the Board adopting the Plan (the "Effective Date"). The Plan shall be subject to the requirement of RCW 21.20.310(10) that the Administrator of Securities of the Department of Financial Institutions of the State of Washington be provided with notification of the adoption of the Plan. No Option shall be granted hereunder until this notification requirement has been satisfied. The issuance of Incentive Stock Options shall be subject to approval of the Plan by holders of shares of Common Stock constituting at least a majority of the shares of Common Stock represented in person or by proxy at the meeting at which the approval is sought. If this shareholder approval requirement is not satisfied within twelve (12) months after the Effective Date, all Incentive Stock Options issued under the Plan shall automatically become Nonqualified Stock Options. 2 DEFINITIONS 2.1 CERTAIN DEFINED TERMS. Capitalized terms not defined elsewhere in the Plan shall have the following meanings (whether used in the singular or plural): "Administrative Committee" is defined in Section 3.1. "Affiliate" of the Company means any corporation, partnership, or other business association that, directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with the Company. "Approved Transaction" means (a) any merger, consolidation or binding share exchange pursuant to which shares of Common Stock are changed or converted into or exchanged for cash, securities or other property, other than any such transaction in which the persons who hold Common Stock immediately prior to the transaction have immediately following the transaction the same proportionate ownership of the common stock of, and the same voting power with respect to, the surviving corporation; (b) any merger, consolidation or binding share exchange in which the -1- 5 persons who hold Common Stock immediately prior to the transaction have immediately following the transaction less than a majority of the combined voting power of the outstanding capital stock of the Company ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors; (c) any liquidation or dissolution of the Company; and (d) any sale, lease, exchange or other transfer not in the ordinary course of business (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Company. "Board" means the Board of Directors of the Company. "Code" means the Internal Revenue Code of 1986, as amended from time to time, or any successor statute or statutes thereto. Reference to any specific section of the Code shall include any successor section. "Common Stock" means the Series B Common Stock or the Series C Common Stock of the Company. "Company" means RealNetworks, Inc., a Washington corporation. "Control Purchase" means any transaction (or series of related transactions), consummated without the approval or recommendation of the Board, in which (a) any person, corporation or other entity (including any "person" as defined in Sections 13(d)(3) and 14(d)(2) of the Exchange Act, but excluding the Company and any employee benefit plan sponsored by the Company) purchases any Common Stock (or securities convertible into Common Stock) for cash, securities or any other consideration pursuant to a tender offer or exchange offer; or (b) any person, corporation or other entity (including any "person" as defined in Sections 13(d)(3) and 14(d)(2) of the Exchange Act, but excluding the Company and any employee benefit plan sponsored by the Company) becomes the "beneficial owner" (as that term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing fifty percent (50%) or more of the combined voting power of the then outstanding securities of the Company ordinarily (and apart from rights accruing under special circumstances) having the right to vote in the election of directors (calculated as provided in Rule 13d-3(d) under the Exchange Act in the case of rights to acquire the Company's securities). "Disability" means the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than twelve (12) months. "Disinterested Person" is defined in Section 3.2(b). "Effective Date" is defined in Section 1.2. "Eligible Person" is defined in Section 5. "Equity Securities" has the meaning given that term in Rule 3a11-1 promulgated under the Exchange Act, as amended from time to time, or any successor rule thereto. -2- 6 "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time, or any successor statute or statutes thereto. Reference to any specific section of the Exchange Act shall include any successor section. "Executive Officer" means any employee of the company who is an "officer" within the meaning of Rule 16a-1(f) of the Exchange Act, as amended from time to time, or any successor rule thereto. "Fair Market Value" on any day means, if the Common Stock is publicly traded, the last sales price (or, if no last sales price is reported, the average of the high bid and low asked prices) for a share of Common Stock on that day (or, if that day is not a trading day, on the next preceding trading day), as reported by the principal exchange on which the Common Stock is listed, or, if the Common Stock is publicly traded but not listed on an exchange, as reported by The Nasdaq Stock Market, or, if such prices or quotations are not reported by The Nasdaq Stock Market, as reported by any other available source of prices or quotations selected by the Administrative Committee. If the Common Stock is not publicly traded, or if the Fair Market Value is not determinable by any of the foregoing means, the Fair Market Value on any day shall be determined in good faith by the Administrative Committee on the basis of such considerations as the Administrative Committee deems appropriate. "Holder" means an Eligible Person who has received an Option under this Plan or, if rights continue under the Option following the death of the Eligible Person, the person who succeeds to those rights by will or by the laws of descent and distribution. "Incentive Stock Option" means an Option that is an incentive stock option within the meaning of Section 422 of the Code. "Nonqualified Stock Option" means an Option that is designated as a nonqualified stock option. "Option" means an option with respect to shares of Common Stock awarded pursuant to Article 6. "Option Agreement" is defined in Section 6.5. "Plan" is defined in Section 1.1. "Securities Act" means the Securities Act of 1933, as amended from time to time, or any successor statute or statutes thereto. Reference to any specific section of the Securities Act shall include any successor section. "10% Shareholder" means a person who owns (or is considered as owning within the meaning of Section 424 of the Code) stock possessing more than 10% of the total combined voting power of all classes of capital stock of the Company. -3- 7 3 ADMINISTRATION 3.1 ADMINISTRATIVE COMMITTEE. The Plan shall be administered by the Board unless the Board, either voluntarily or as required by Section 3.2 below, appoints a separate committee of the Board to administer the Plan (the Board, or such committee, if it is administering the Plan, will be referred to in the Plan as the "Administrative Committee"). The Administrative Committee shall select one of its members as its chairman and shall hold its meetings at such times and places as it shall deem advisable. A majority of its members shall constitute a quorum and all determinations shall be made by a majority of that quorum. Any determination reduced to writing and signed by all of the members of the Administrative Committee shall be fully as effective as if it had been made by a majority vote at a meeting duly called and held. 3.2 APPOINTMENT OF ADMINISTRATIVE COMMITTEE. The Board may appoint a committee consisting of two or more of its members to administer the Plan. Once appointed, the committee shall continue to serve until otherwise directed by the Board. From time to time the Board may increase the size of the committee and appoint additional members, remove members (with or without cause) and appoint new members in their place, fill vacancies however caused, and/or remove all members of the committee and thereafter directly administer the Plan. 3.3 POWERS; REGULATIONS. The Administrative Committee shall have full power and authority, subject only to the express provisions of the Plan (a) to designate the Eligible Persons to whom Options are to be granted under the Plan; (b) to determine the number of shares subject to, and all of the other terms and conditions (which need not be identical) of, all Options so granted; (c) to interpret the provisions of the Plan and the Option Agreements evidencing the Options so granted; (d) to correct any defect, supply any information and reconcile any inconsistency in such manner and to such extent as shall be deemed necessary or advisable to carry out the purpose of the Plan; (e) to supervise the administration of the Plan; and (f) to take such other actions in connection with or in relation to the Plan as it deems necessary or advisable. The Administrative Committee is authorized to establish, amend and rescind such rules and regulations not inconsistent with the terms and conditions of the Plan as it deems necessary or advisable for the proper administration of the Plan. In making determinations hereunder, the Administrative Committee may give such consideration to the recommendations of management of the Company as the Administrative Committee deems desirable. 3.4 LIMITS ON AUTHORITY. Exercise by the Administrative Committee of its authority under the Plan shall be consistent (a) with the intent that all Incentive Stock Options issued under the Plan be qualified under the terms of Section 422 of the Code (including any amendments thereto and any similar successor provision), and (b) if the Company registers any class of Equity Security pursuant to Section 12 of the Exchange Act, with the intent that the Plan be administered in a manner so that, to the extent possible, the grant of Options and all other transactions with respect to the Plan, to Options and to any Common Stock acquired upon exercise of Options, shall be exempt from the operation of Section 16(b) of the Exchange Act. 3.5 EXERCISE OF AUTHORITY. Each action and determination made or taken pursuant to the Plan by the Administrative Committee, including but not limited to any interpretation or -4- 8 construction of the Plan and the Option Agreements, shall be final and conclusive for all purposes and upon all persons. No member of the Administrative Committee shall be liable for any action or determination made or taken by the member or the Administrative Committee in good faith with respect to the Plan. 4 SHARES SUBJECT TO THE PLAN 4.1 NUMBER OF SHARES. Subject to the provisions of this Article 4, the maximum number of shares of Common Stock with respect to which Options may be granted during the term of the Plan shall be the sum of (a) 11,300,000, plus (b) an additional 1,045,436 shares of Common Stock previously reserved for issuance pursuant to Section 4.1 of the Company's 1995 Stock Option Plan (the "1995 Plan"), plus (c) any of the 1,269,123 shares of Common Stock subject to options currently outstanding under the 1995 Plan to the extent the options terminate without having been exercised in full. Shares of Common Stock will be made available from the authorized but unissued shares of the Company or from shares reacquired by the Company. If any Option terminates for any reason without having been exercised in full, the shares of Common Stock subject to the Option for which it has not been exercised shall again be available for purposes of the Plan. 4.2 ADJUSTMENTS. If the Company subdivides its outstanding shares of Common Stock into a greater number of shares of Common Stock (by stock dividend, stock split, reclassification or otherwise) or combines its outstanding shares of Common Stock into a smaller number of shares of Common Stock (by reverse stock split, reclassification or otherwise), or if the Administrative Committee determines, in its sole discretion, that any stock dividend, extraordinary cash dividend, reclassification, recapitalization, reorganization, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock, or other similar corporate event (including a merger or consolidation other than one that constitutes an Approved Transaction) affects the Common Stock such that an adjustment is required in order to preserve the benefits or potential benefits intended to be made available under this Plan, then the Administrative Committee shall, in its sole discretion and in such manner as the Administrative Committee may deem equitable and appropriate, make adjustments to any or all of (a) the number and kind of shares with respect to which Options may thereafter be granted under this Plan; (b) the number and kind of shares subject to outstanding Options, and (c) the purchase price under outstanding Options; PROVIDED, HOWEVER, that the number of shares subject to an Option shall always be a whole number. The Administrative Committee may, if deemed appropriate, provide for a cash payment to any Holder of an Option in connection with any adjustment made pursuant to this Section 4.2. 5 ELIGIBILITY The persons eligible to participate in the Plan and to receive Options under the Plan ("Eligible Persons") shall be (a) employees (including officers and directors who are also employees) of the Company or any of its Affiliates, and (b) consultants (and directors who are not employees) rendering services to the Company or any of its Affiliates in the capacity of independent contractors. Options may be granted to Eligible Persons even if they hold or have held Options -5- 9 under this Plan or options or similar awards under any other plan of the Company or any of its Affiliates. 6 STOCK OPTIONS 6.1 GRANT OF OPTIONS. Subject to the limitations of the Plan, the Administrative Committee shall designate from time to time each Eligible Person who is to be granted an Option, the time when the Option shall be granted, the number of shares subject to the Option, whether the Option is to be an Incentive Stock Option or a Nonqualified Stock Option and, subject to Section 6.2, the purchase price of the shares of Common Stock subject to the Option; PROVIDED, HOWEVER, that Incentive Stock Options may only be granted to Eligible Persons who are employees of the Company or an Affiliate that constitutes a "parent corporation" or a "subsidiary corporation" within the meaning of Section 424 of the Code. Each Option granted under this Plan shall also be subject to such other terms and conditions not inconsistent with this Plan as the Administrative Committee, in its sole discretion, determines. Subject to the limitations of the Plan, the same Eligible Person may receive Incentive Stock Options and Nonqualified Stock Options at the same time and pursuant to the same Option Agreement, provided that Incentive Stock Options and Nonqualified Stock Options are clearly designated as such. 6.2 PURCHASE PRICE. The price at which shares may be purchased upon exercise of an Option shall be fixed by the Administrative Committee and may be more than, less than or equal to the Fair Market Value of the Common Stock as of the date the Option is granted; PROVIDED, HOWEVER, that the purchase price of an Incentive Stock Option shall be (a) at least 110% of the Fair Market Value as of the date of grant of the Common Stock subject thereto, if the Incentive Stock Option is being granted to a 10% Shareholder, and (b) at least 100% of the Fair Market Value as of the date of grant of the Common Stock subject thereto, if the Incentive Stock Option is being granted to any other Eligible Person. 6.3 LIMITATIONS ON GRANTS. (a) ANNUAL LIMITATION ON GRANTS OF INCENTIVE STOCK OPTIONS. The aggregate Fair Market Value of the shares of Common Stock with respect to which, during any calendar year, one or more Incentive Stock Options under this Plan (and/or one or more options under any other plan maintained by the Company or any of its Affiliates for the granting of options intended to qualify under Section 422 of the Code) become exercisable for the first time by a Holder shall not exceed $100,000 (said value to be determined as of the respective dates on which the options are granted to the Holder). If (i) a Holder holds one or more Incentive Stock Options under this Plan (and/or one or more options under any other plan maintained by the Company or any of its Affiliates for the granting of options intended to qualify under Section 422 of the Code), and (ii) the aggregate Fair Market Value of the shares of Common Stock with respect to which, during any calendar year, such options become exercisable for the first time exceeds $100,000 (said value to be determined as provided above), then such option or options are intended to qualify under Section 422 of the Code with respect to the maximum number of such shares as can, in light of the foregoing limitation, be so qualified, with the shares so qualified to be the shares subject to the option or options earliest granted to the Holder. If an Option that would otherwise qualify as an Incentive Stock Option becomes exercisable for the first time in any calendar year for shares of -6- 10 Common Stock that would cause such aggregate Fair Market Value to exceed $100,000, then the portion of the Option in respect of such shares shall be deemed to be a Nonqualified Stock Option. (b) ANNUAL LIMITATION ON GRANTS FOLLOWING EXCHANGE ACT REGISTRATION. If the Company registers any class of any Equity Security pursuant to Section 12 of the Exchange Act, then, from the effective date of the registration until six (6) months after the termination of the registration, the number of shares subject to one or more Options granted during any calendar year to an Eligible Person shall not exceed one million (1,000,000). 6.4 TERM OF OPTIONS. Subject to the provisions of the Plan with respect to termination of Options upon death, Disability or termination of services, the term of each Option shall be for such period as the Administrative Committee shall determine, but not more than (a) five (5) years from the date of grant in the case of Incentive Stock Options held by 10% Shareholders; (b) ten (10) years from the date of grant in the case of Incentive Stock Options held by persons other than 10% Shareholders; and (c) twenty (20) years from the date of grant in the case of all other Options, provided, however, that the term for a Nonqualified Stock Option granted more than one (1) year following the Effective Date shall be ten (10) years unless otherwise determined by the Administrative Committee. 6.5 OPTION AGREEMENT. Each Option granted under the Plan shall be evidenced by an agreement (the "Option Agreement") which shall designate the Option as an Incentive Stock Option or a Nonqualified Stock Option and contain such terms and provisions not inconsistent with the provisions of the Plan as the Administrative Committee from time to time approves. Each grantee of an Option shall be notified promptly of the grant, an Option Agreement shall be executed and delivered by the Company to the grantee within sixty (60) days after the date the Administrative Committee approves the grant, and, in the discretion of the Administrative Committee, the grant shall terminate if the Option Agreement is not signed by the grantee (or his or her attorney) and delivered to the Company within sixty (60) days after it is delivered to the grantee. An Option Agreement may contain (but shall not be required to contain) such provisions as the Administrative Committee deems appropriate to insure that the penalty provisions of Section 4999 of the Code will not apply to any stock received by the Holder from the Company. An Option Agreement may be modified from time to time pursuant to Section 7.6(b). 6.6 EXERCISE OF OPTIONS. An Option granted under the Plan shall become and remain exercisable during the term of the Option to the extent provided in the Option Agreement evidencing the Option and in this Plan and, unless the Option Agreement otherwise provides, may be exercised to the extent exercisable, in whole or in part, at any time and from time to time during such term; PROVIDED, HOWEVER, that subsequent to the grant of an Option, the Administrative Committee, at any time before complete termination of the Option, may accelerate the time or times at which the Option may be exercised in whole or in part (without reducing the term of the Option). If an Option is scheduled to become exercisable on one or more dates specified in its Option Agreement, and its Holder has a leave of absence without pay, such date or dates shall be postponed for a period equal to the duration of the leave unless the Administrative Committee determines otherwise. -7- 11 6.7 MANNER OF EXERCISE. (a) FORM OF PAYMENT. An Option shall be exercised by written notice to the Company upon such terms and conditions as the Option Agreement evidencing the Option may provide and in accordance with such other procedures for the exercise of Options as the Administrative Committee may establish from time to time. The method or methods of payment of the purchase price for the shares to be purchased upon exercise of an Option and of any amounts required by Section 7.8 shall be determined by the Administrative Committee and may consist of (i) cash, (ii) check, (iii) promissory note, (iv) whole shares of Common Stock already owned by the Holder, (v) the withholding of shares of Common Stock issuable upon exercise of the Option, (vi) the delivery, together with a properly executed exercise notice, of irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds required to pay the purchase price, (vii) any combination of the foregoing methods of payment, or (viii) such other consideration and method of payment as may be permitted for the issuance of shares under applicable securities and other laws. The permitted methods or methods of payment of the amounts payable upon exercise of an Option, if other than in cash, shall be set forth in the Option Agreement evidencing the Option and may be subject to such conditions as the Administrative Committee deems appropriate. Without limiting the generality of the foregoing, if a Holder is permitted to elect to have shares of Common Stock issuable upon exercise of an Option withheld to pay all or any part of the amounts payable in connection with the exercise, then the Administrative Committee shall have the sole discretion to approve or disapprove the election, which approval or disapproval shall be given after the election is made. (b) VALUE OF SHARES. Shares of Common Stock delivered in payment of all or any part of the amounts payable in connection with the exercise of an Option, and shares of Common Stock withheld for the payment, shall be valued for such purpose at their Fair Market Value as of the exercise date. (c) ISSUANCE OF SHARES. The Company shall effect the issuance of the shares of Common Stock purchased under the Option as soon as practicable after the exercise thereof and payment in full of the purchase price therefor and of any amounts required by Section 7.8, and within a reasonable time thereafter the issuance shall be evidenced on the books of the Company. Following the exercise of an Incentive Stock Option, the Administrative Committee shall cause the information statement required by Section 6039 of the Code to be furnished to the Holder within the time and in the manner prescribed by law. 6.8 LEGENDS. Each certificate representing shares of Common Stock issued under the Plan upon exercise of an Option shall, unless the Administrative Committee otherwise determines, contain on its face the notice "SEE TRANSFER RESTRICTIONS ON REVERSE" and on its reverse a legend in form substantially as follows, together with any other legends that are required by the terms and conditions of the Plan or that the Administrative Committee in its discretion deems necessary or appropriate: NOTICE: TRANSFER AND OTHER RESTRICTIONS THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, OR ANY STATE -8- 12 SECURITIES LAWS, AND MAY NOT BE OFFERED, SOLD, TRANSFERRED, ENCUMBERED, OR OTHERWISE DISPOSED OF EXCEPT UPON SATISFACTION OF CERTAIN CONDITIONS. INFORMATION CONCERNING THESE RESTRICTIONS MAY BE OBTAINED FROM THE CORPORATION. ANY OFFER OR DISPOSITION OF THESE SECURITIES WITHOUT SATISFACTION OF SAID CONDITIONS WILL BE WRONGFUL AND WILL NOT ENTITLE THE TRANSFEREE TO REGISTER OWNERSHIP OF THE SECURITIES WITH THE CORPORATION. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE ALSO SUBJECT TO RESTRICTIONS ON TRANSFER, AND MAY BE SUBJECT TO REPURCHASE BY THE CORPORATION OR ONE OR MORE OF ITS SHAREHOLDERS PURSUANT TO THE PROVISIONS OF THE CORPORATION'S 1996 STOCK OPTION PLAN AND/OR AN AGREEMENT BETWEEN THE HOLDER AND THE CORPORATION AND/OR AN AGREEMENT AMONG THE CORPORATION AND ITS SHAREHOLDERS. INFORMATION CONCERNING THESE RESTRICTIONS MAY BE OBTAINED FROM THE CORPORATION. The Company may cause the transfer agent for the Common Stock to place a stop transfer order with respect to such shares. 6.9 NONTRANSFERABILITY. Unless the Administrative Committee determines otherwise at the time an Option is granted (or at any later time when the Administrative Committee, by written notice to the Holder, releases in whole or in part the restrictions under this Section 6.9), an Option shall not be transferable other than by will or the laws of descent and distribution, and may be exercised during the lifetime of the Holder thereof only by the Holder (or his or her court appointed legal representative). Options shall not be transferable other than by will or the laws of descent and distribution, and Options may be exercised during the lifetime of the Holder thereof only by the Holder (or his or her court appointed legal representative). 6.10 REPURCHASE OF SHARES. (a) RIGHT OF REPURCHASE. If so specified by the Administrative Committee at the time an Option is granted to a Holder who is an employee of the Company or any of its Affiliates or a party to a consulting arrangement with the Company or any of its Affiliates, the Company shall have the right, but shall not be required, to repurchase from the Holder all or part of (i) the shares of Common Stock that the Holder acquires upon the exercise of the Option, and (ii) any other shares of Common Stock or other securities issued or acquired with respect to the shares specified in the preceding clause (i) or this clause (ii) in connection with any stock dividend, stock split, reclassification, recapitalization, reorganization, split-up, spin-off, combination, exchange of shares, warrants or rights offering to purchase Common Stock, or other similar corporate event. Such right shall be exercisable at any time and from time to time during the period of ninety (90) days commencing on the date of termination of the Holder's employment or consulting agreement with the Company or any of its Affiliates for "cause," as defined in Section 7.2(b). -9- 13 (b) EXERCISE OF REPURCHASE RIGHT. The Company's right of repurchase under this Section 6.10 shall be exercised by delivery written notice to the Holder specifying the number of shares or other securities to be repurchased and the effective date of the repurchase, which date shall not be earlier than the date of the notice nor later than the date of termination of the Company's right of repurchase. If a Holder transfers shares or other securities that are subject to the Company's right of repurchase, the shares or other securities shall remain subject to the Company's right of repurchase during the period specified in the last sentence of Section 6.10(a) (exercise of the right of repurchase in such even shall be effected by notice to the person or entity holding the shares or other securities at the time of exercise). (c) REPURCHASE PRICE. With respect to each share or other security to be repurchased by the Company upon its exercise of its right of repurchase under this Section 6.10, the repurchase price shall be the Fair Market Value of the share or security as of the effective date of the repurchase. The Company may elect to pay the amount owed to the Holder (or to the person or entity holding the share or other security to be repurchased) either (i) in cash, in which case the amount shall be paid, without interest, within thirty (30) days following the effective date of the repurchase, or (ii) in three equal installments, with the first installment payable on the first anniversary of the effective date of the repurchase, and the remaining installments payable on the corresponding date in each of the next two years, with each installment to include interest on the unpaid principal computed at the prime rate published in the Wall Street Journal for the first business day of the month in which the effective date of the repurchase occurs, for the period from the effective date of the repurchase or the date of the most recent installment, as the case may be, to the due date of the installment being paid. (d) TERMINATION OF RIGHT OF REPURCHASE. Any right of repurchase of the Company under this Section 6.10 shall terminate upon the occurrence of a Control Purchase or an Approved Transaction (other than an Approved Transaction in connection with which the Administrative Committee determines, in accordance with the last sentence of Section 7.1, that Options otherwise subject to such right of repurchase will not vest or become exercisable on an accelerated basis and/or will not terminate if not exercised prior to consummation of the Approved Transaction). Any right of repurchase of the Company under this Section 6.10 shall also terminate upon the effective date of the registration by the Company of any class of any Equity Security pursuant to Section 12 of the Exchange Act. 6.11 CLASS OF COMMON STOCK. The class of shares subject to each Option and the class of shares to be received upon exercise of each Option shall depend upon the employment status of the Eligible Person at the date the Option is granted and at the date the Option is exercised. If the Eligible Person is an employee (including officers and directors who are also employees) of the Company or one of its Affiliates as of the date the Option is granted, the shares subject to the Option shall be shares of Series B Common Stock, which are automatically convertible into the shares of Series C Common Stock upon the occurrence of certain events (a "Conversion Event") as described in the Company's Articles of Incorporation, as amended from time to time (the "Articles"), provided, that if a Conversion Event occurs prior to the exercise of an Option, the shares subject to the Option shall be shares of Series C Common Stock, with the rights defined in the Articles. If the Eligible Person is a consultant (other than a director) rendering services to the Company or any of its Affiliates in the capacity of an independent contractor as of the date the Option is granted, the shares subject to the Option shall be shares of Series C Common Stock, with the rights defined in -10- 14 the Articles, regardless of the Eligible Person's employment status with the Company at the date the Option is exercised. 6.12 DELEGATION TO EXECUTIVE OFFICER OF AUTHORITY TO GRANT OPTIONS. The Board may delegate to an Executive Officer the authority to determine from time to time (a) the Eligible Persons to whom Options are to be granted; (b) the number of shares of Common Stock for which the Options are exercisable and the purchase price of such shares; (c) whether the Options are Incentive Stock Options or Nonqualified Stock Options; and (d) all of the other terms and conditions (which need not be identical) of the Options; PROVIDED, HOWEVER, that (i) the authority delegated to the Executive Officer under this Section 6.12 shall not exceed that of the Administrative Committee under the foregoing provisions of this Article 6 and shall be subject to such limitations, in addition to those specified in this Section 6.12, as may be specified by the Board at the time of delegation; (ii) the Executive Officer may not be delegated authority under this Section 6.12 to grant any Option to any person who is an Executive Officer or a director of the Company at the time of the grant; (iii) the purchase price of each share of Common Stock under an Option granted under this Section 6.12 shall not be less than the Fair Market Value of such share on the date of grant of the Option; and (iv) the Executive Officer shall promptly provide a report to the Administrative Committee of each person to whom an Option has been granted under this Section 6.12 and the material terms and conditions of the Option. 7 GENERAL PROVISIONS 7.1 ACCELERATION OF OPTIONS -- APPROVED TRANSACTIONS; CONTROL PURCHASE. In the event of any Approved Transaction or Control Purchase, each outstanding Option under the Plan shall become exercisable in full in respect of the aggregate number of shares covered thereby, notwithstanding any contrary vesting schedule in the Option Agreement evidencing the Option (except to the extent the Option Agreement expressly provides otherwise), effective upon the Control Purchase or immediately prior to consummation of the Approved Transaction. In the case of an Approved Transaction, the Company shall provide notice of the pendency of the Approved Transaction, at least fifteen (15) days prior to the expected date of consummation thereof, to each Holder of an outstanding Option. Each Holder shall thereupon be entitled to exercise the Option at any time prior to consummation of the Approved Transaction. Any such exercise as to any portion of the Option that will only become vested immediately prior to the consummation of the Approved Transaction in accordance with the foregoing acceleration provision shall be contingent on such consummation. Any such exercise as to any other portion of the Option will not be contingent on such consummation unless so elected by the Holder in a notice delivered to the Company simultaneously with the exercise. Upon consummation of the Approved Transaction, all Options shall expire to the extent such exercise has not occurred. Notwithstanding the foregoing, except to the extent otherwise provided in one or more Option Agreements evidencing Options, the Administrative Committee may, in its discretion, determine that any or all outstanding Options will not vest or become exercisable on an accelerated basis in connection with an Approved Transaction and/or will not terminate if not exercised prior to consummation of the Approved Transaction, if the Board or the surviving or acquiring corporation, as the case may be, shall take, or made effective provision for the taking of, such action as in the opinion of the Administrative Committee is equitable and appropriate in order to substitute new Options for such Options, or to assume such Options (which assumption may be effected by any means determined by the Administrative -11- 15 Committee, in its discretion, including, but not limited to, by a cash payment to each Holder, in cancellation of the Options held by him or her, of such amount as the Administrative Committee determines, in its sole discretion, represents the then value of the Options) and in order to make such new or assumed Options, as nearly as practicable, equivalent to the old Options (before giving effect to any acceleration of the vesting or exercisability thereof), taking into account, to the extent applicable, the kind and amount of securities, cash or other assets into or for which the Common Stock may be changed, converted or exchanged in connection with the Approved Transaction. 7.2 TERMINATION OF SERVICES. The provisions of this Section 7.2 shall apply to any Holder who is an employee of the Company or any of its Affiliates or a party to a written consulting agreement with the Company or any of its Affiliates. (a) GENERAL. If such a Holder's employment or consulting agreement terminates prior to the complete exercise of an Option, then the Option shall, except to the extent the Option Agreement evidencing the Option expressly provides otherwise, thereafter be exercisable, to the extent that the Holder was entitled to exercise the Option on the date of such termination, for a period of three (3) months following such termination (but not later than the scheduled expiration date of the Option); PROVIDED, HOWEVER, that (i) if the Holder's employment or consulting agreement terminates by reason of death or Disability, then, except to the extent the Option Agreement evidencing the Option expressly provides otherwise, the Option shall be exercisable, to the extent that the Holder was entitled to exercise the Option on the date of such termination, for a period of one (1) year following such termination (but not later than the scheduled expiration of the Option), and (ii) any termination by the Company or any of its Affiliates for cause will be treated in accordance with the provisions of Section 7.2(b) (except to the extent the Option Agreement expressly provides otherwise). (b) TERMINATION BY COMPANY FOR CAUSE. If a Holder's employment or consulting agreement with the Company or any of its Affiliates is terminated for cause, then all Options held by the Holder shall immediately terminate and, accordingly, may not be exercised, except to the extent one or more of the Option Agreements evidencing the Options expressly provides otherwise. For purposes of this Plan, "cause" shall have the meaning given that term in any employment agreement or consulting agreement to which the Holder is a party or, in the absence thereof, the conduct that shall constitute "cause" for purposes of this Plan shall be insubordination, a knowing violation of a state or federal law involving the commission of a crime against the Company or any of its Affiliates or a felony, any misrepresentation, deception, fraud or dishonesty that is materially injurious to the Company or any of its Affiliates, incompetence, moral turpitude, the refusal to perform the Holder's duties and responsibilities for any reason other than illness or incapacity, and any other misconduct of any kind that the Administrative Committee determines constitutes "cause" for purposes of this Plan; PROVIDED, HOWEVER, that if a termination occurs within twelve (12) months after an Approved Transaction or Control Purchase, termination for cause shall mean only a felony conviction for fraud, misappropriation or embezzlement. Following termination of a Holder's employment or consulting agreement, if the Holder engages in any act that would have constituted cause if the Holder had remained employed by or in a consulting relationship with the Company or any of its Affiliates, then the Administrative Committee shall be entitled to terminate any Options held by the Holder. -12- 16 (c) MISCELLANEOUS. The Administrative Committee may determine whether any given leave of absence of a Holder constitutes a termination of the Holder's employment or consulting agreement; PROVIDED, HOWEVER, that for purposes of the Plan -- (i) a leave of absence, duly authorized in writing by the Company or any of its Affiliates for military service or sickness, or for any other purpose approved by the Company or any of its Affiliates, if the period of the leave does not exceed ninety (90) days, and (ii) a leave of absence in excess of ninety (90) days, duly authorized in writing by the Company or any of its Affiliates, provided the Holder's right to return to service with the Company or the Affiliate is guaranteed either by statute or by contract -- shall not be deemed a termination of the Holder's employment or consulting agreement. Options granted under the Plan shall not be affected by any change of a Holder's employment or consulting agreement so long as the Holder continues to be an employee of or consultant to the Company or any of its Affiliates. Except to the extent an Option Agreement evidencing an Option expressly provides otherwise, if a Holder has an employment or consulting agreement with an Affiliate of the Company that ceases to be an Affiliate, such event shall be deemed to constitute a termination of the Holder's employment or consulting agreement for a reason other than death or Disability. 7.3 RIGHT TO TERMINATE SERVICES. Nothing contained in the Plan or in any Option Agreement, and no action of the Company or the Administrative Committee with respect thereto, shall confer or be construed to confer on any Holder any right to continue in the service of the Company or any of its Affiliates or interfere in any way with the right of the Company or any of its Affiliates, subject to the provisions of any agreement between the Holder and the Company or any of its Affiliates, to terminate at any time, with or without cause, the employment or consulting agreement with the Holder. 7.4 NONALIENATION OF BENEFITS. Except as provided in Section 6.9, no right or benefit under the Plan shall be subject to anticipation, alienation, sale, assignment, hypothecation, pledge, exchange, transfer, encumbrance or charge, and any attempt to anticipate, alienate, sell, assign, hypothecate, pledge, exchange, transfer, encumber or charge the same shall be void. No right or benefit hereunder shall in any manner be liable for or subject to the debts, contracts, liabilities or torts of the person entitled to the right or benefit. 7.5 SHAREHOLDERS AGREEMENT. Unless the Option Agreement evidencing an Option expressly provides otherwise, the Holder of the Option shall be required, as a condition to the issuance of any shares of Common Stock that the Holder acquires upon the exercise of the Option, to execute and deliver to the Company a shareholders agreement in such form as may be in use by the Company at the time of such exercise, or a counterpart thereof, together with, unless the Holder is unmarried, a spousal consent in the form required thereby, unless the Holder has previously executed and delivered such documents and they are in effect at the time the shares are to be issued. 7.6 TERMINATION AND AMENDMENT. (a) GENERAL. Unless the Plan shall previously have been terminated as hereinafter provided, no Options may be granted under the Plan on or after the tenth (10th) anniversary of the Effective Date. The Board or the Administrative Committee may at any time -13- 17 prior to the tenth (10th) anniversary of the Effective Date terminate the Plan, and may, from time to time, suspend or discontinue the Plan or modify or amend the Plan in such respects as it shall deem advisable; PROVIDED, HOWEVER, that any such modification or amendment shall comply with all applicable laws and stock exchange listing requirements and, with respect to Incentive Stock Options granted or to be granted under the Plan, shall be subject to any approval by shareholders of the Company required under the Code. (b) MODIFICATION. No termination, modification or amendment of the Plan may adversely affect the rights of the Holder of an outstanding Option in any material way unless the Holder consents thereto. No modification, extension, renewal or other change in any Option granted under the Plan shall be made after the grant of the Option, unless the same is consistent with the provisions of the Plan. With the consent of the Holder and subject to the terms and conditions of the Plan (including Section 7.6(a)), the Administrative Committee may amend outstanding Option Agreements with any Holder, including, without limitation, any amendment that would (i) accelerate the time or times at which the Option may be exercised, and/or (ii) extend the scheduled expiration date of the Option. Without limiting the generality of the foregoing, the Administrative Committee may, but solely with the Holder's consent unless otherwise provided in the Option Agreement, agree to cancel any Option under the Plan and issue a new Option in substitution therefor, provided that the Option so substituted shall satisfy all of the requirements of the Plan as of the date the new Option is granted. Nothing contained in the foregoing provisions of this Section 7.6(b) shall be construed to prevent the Administrative Committee from providing in any Option Agreement that the rights of the Holder with respect to the Option are subject to such rules and regulations as the Administrative Committee may, subject to the express provisions of the Plan, adopt from time to time, or impair the enforceability of any such provision. 7.7 GOVERNMENT AND OTHER REGULATIONS. The obligation of the Company with respect to Options shall be subject to all applicable laws, rules and regulations and such approvals by any governmental agencies as may be required, including, without limitation, the effectiveness of any registration statement required under the Securities Act, and the rules and regulations of any securities exchange or association on which the Common Stock may be listed or quoted. As long as the Common Stock is not registered under the Exchange Act, the Company intends that all offers and sales of Options and shares of Common Stock issuable upon exercise of Options shall be exempt from registration under the provisions of Section 5 of the Securities Act, and the Plan shall be administered in a manner so as to preserve such exemption. The Company also intends that the Plan shall constitute a written compensatory benefit plan, within the meaning of Rule 701(b) promulgated under the Securities Act, and that each Option granted under the Plan at a time when the Common Stock is not registered under the Exchange Act shall, unless otherwise provided by the Administrative Committee at the time the Option is granted, be granted in reliance on the exemption from the registration requirements of Section 5 of the Securities Act provided by Rule 701. As long as the Common Stock is registered under the Exchange Act, the Company shall use its reasonable efforts to comply with any legal requirements to file in a timely manner all reports required to be filed by it under the Exchange Act. 7.8 WITHHOLDING. The Company's obligation to deliver shares of Common Stock upon exercise of an Option shall be subject to applicable federal, state and local tax withholding requirements. Federal, state and local withholding tax due at the time an Option is exercised may, in the discretion of the Administrative Committee, be paid in shares of Common Stock already owned by the Holder or through the withholding of shares otherwise issuable to the Holder, upon such -14- 18 terms and conditions as the Administrative Committee shall determine. If the Holder shall fail to pay, or make arrangements satisfactory to the Administrative Committee for the payment of, all such federal, state and local taxes, then the Company or any of its Affiliates shall, to the extent not prohibited by law, have the right to deduct from any payment of any kind otherwise due to the Holder an amount equal to any federal, state or local taxes of any kind required to be withheld by the Company or any of its Affiliates with respect to the Option. 7.9 SEPARABILITY. With respect to Incentive Stock Options, if this Plan does not contain any provision required to be included herein under Section 422 of the Code, such provision shall be deemed to be incorporated herein with the same force and effect as if such provision had been set out at length herein; PROVIDED, HOWEVER, that to the extent any Option that is intended to qualify as an Incentive Stock Option cannot so qualify, the Option, to that extent, shall be deemed to be a Nonqualified Stock Option for all purposes of the Plan. 7.10 NON-EXCLUSIVITY OF THE PLAN. Neither the adoption of the Plan by the Board nor the submission of the Plan to the shareholders of the Company for approval shall be construed as creating any limitations on the power of the Board to adopt such other incentive arrangements as it may deem desirable, including, without limitation, the granting of stock options and the awarding of stock and cash otherwise than under the Plan, and such arrangements may be either generally applicable or applicable only in specific cases. 7.11 EXCLUSION FROM PENSION AND PROFIT-SHARING COMPUTATION. By acceptance of an Option, unless otherwise provided in the Option Agreement evidencing the Option, the Holder shall be deemed to have agreed that the Option is special incentive compensation that will not be taken into account, in any manner, as salary, compensation or bonus in determining the amount of any payment under any pension, retirement or other employee benefit plan, program or policy of the Company or any of its Affiliates. 7.12 NO SHAREHOLDER RIGHTS. No Holder or other person shall have any voting or other shareholder rights with respect to shares of Common Stock subject to an Option until the Option has been duly exercised, full payment of the purchase price has been made, all conditions under the Option and this Plan to issuance of the shares have been satisfied, and a certificate for the shares has been issued. No adjustment shall be made for cash or other dividends or distributions to shareholders for which the record date is prior to the date of such issuance. 7.13 GOVERNING LAW. The Plan shall be governed by, and construed in accordance with, the laws of the State of Washington. 7.14 COMPANY'S RIGHTS. The grant of Options pursuant to the Plan shall not affect in any way the right or power of the Company to make reclassifications, reorganizations or other changes of or to its capital or business structure or to merge, consolidate, liquidate, sell or otherwise dispose of all or any part of its business or assets. -15- EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 40,399 57,634 5,345 1,164 209 106,452 9,593 4,245 114,603 30,428 1,002 0 0 32 72,474 114,603 0 27,558 0 5,400 46,619 0 0 (22,192) 0 (22,192) 0 0 0 (22,192) (0.70) (0.70)
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