-----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, R5+Qh+FouIrWywzhCI6LtBeGz8HRg1xGjt/vMipYXICr5pXU64DCtMUKYRegknRU n+8lUOAph+7ZNSSepHUAdw== 0000891020-98-001631.txt : 19981118 0000891020-98-001631.hdr.sgml : 19981118 ACCESSION NUMBER: 0000891020-98-001631 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 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: 98749543 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 PERIOD ENDED SEPTEMBER 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 SEPTEMBER 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 October 31, 1998 was 30,113,942. 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 SEPTEMBER 30, 1998 TABLE OF CONTENTS
PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements...................................................................3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................................11 PART II. OTHER INFORMATION Item 1. Legal Proceedings.....................................................................19 Item 2. Changes in Securities and Use of Proceeds.............................................19 Item 6. Exhibits and Reports on Form 8-K......................................................20
- 2 - 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, September 30, 1997 1998 --------- --------- ASSETS Current assets: Cash, cash equivalents and short-term investments..................... $ 92,028 $ 98,577 Trade accounts receivable, net of allowance for doubtful accounts and sales returns......................................... 5,073 4,806 Other receivables..................................................... 10,706 221 Prepaid expenses and other current assets............................. 2,052 3,506 --------- --------- Total current assets............................................... 109,859 107,110 Property and equipment, net................................................ 5,143 5,457 Investment in joint venture................................................ 816 499 Other assets, net.......................................................... 886 1,910 --------- --------- Total assets....................................................... $ 116,704 $ 114,976 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable...................................................... $ 2,136 $ 2,648 Accrued compensation.................................................. 974 1,555 Other accrued expenses................................................ 2,679 7,941 Deferred revenue...................................................... 16,550 21,651 --------- --------- Total current liabilities.......................................... 22,339 33,795 Deferred revenue, net of current portion................................... 15,500 8,250 Notes payable.............................................................. 963 996 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 29,620 shares at September 30, 1998....... 28 30 Special common stock, $0.001 par value Authorized 7,048 shares; issued and outstanding 3,338 shares at December 31, 1997 and September 30, 1998........................ 3 3 Additional paid-in capital............................................ 95,557 113,225 Accumulated deficit................................................... (17,524) (41,075) Accumulated other comprehensive loss.................................. (162) (248) --------- --------- Total shareholders' equity......................................... 77,902 71,935 --------- --------- Total liabilities and shareholders' equity......................... $ 116,704 $ 114,976 ========= =========
See accompanying notes to condensed consolidated financial statements - 3 - 4 REALNETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except per share data)
Quarter Ended Nine Months September 30, Ended September 30, ----------------------- ----------------------- 1997 1998 1997 1998 -------- -------- -------- -------- Net revenues: Software license fees................... $ 7,480 $ 12,413 $ 17,550 $ 32,627 Service revenues........................ 1,121 3,988 3,310 10,105 Advertising............................. 450 843 1,557 2,070 -------- -------- -------- -------- Total net revenues.................. 9,051 17,244 22,417 44,802 -------- -------- -------- -------- Cost of revenues: Software license fees................... 946 2,140 2,080 5,526 Service revenues........................ 345 642 1,957 1,918 Advertising............................. 264 469 572 1,207 -------- -------- -------- -------- Total cost of revenues.............. 1,555 3,251 4,609 8,651 -------- -------- -------- -------- Gross profit........................ 7,496 13,993 17,808 36,151 -------- -------- -------- -------- Operating expenses: Research and development................ 3,667 5,739 9,130 14,947 Sales and marketing..................... 4,863 8,203 14,024 23,168 General and administrative.............. 1,917 2,653 4,413 7,220 Acquisition related charges............. -- -- -- 17,879 -------- -------- -------- -------- Total operating expenses............ 10,447 16,595 27,567 63,214 -------- -------- -------- -------- Operating loss...................... (2,951) (2,602) (9,759) (27,063) Other income, net........................... 748 1,243 1,184 3,512 -------- -------- -------- -------- Net loss.................................... $ (2,203) $ (1,359) $ (8,575) $(23,551) ======== ======== ======== ======== Basic and diluted net loss per share........ $ (2.15) $ (0.04) $ (11.10) $ (0.74) ======== ======== ======== ======== Shares used to compute basic and diluted net loss per share..................... 1,122 32,686 804 31,971
See accompanying notes to condensed consolidated financial statements - 4 - 5 REALNETWORKS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Nine Months Ended September 30, ------------------------- 1997 1998 --------- --------- Net cash provided by operating activities.....................................$ 21,870 $ 7,722 --------- --------- Cash flows from investing activities: Purchases of property and equipment...................................... (3,496) (2,665) Purchases of short-term investments...................................... (189,419) (72,474) Proceeds from sales and maturities of short-term investments............. 171,379 57,117 Investment in joint venture.............................................. (998) -- Increase in other assets................................................. (251) -- Cash obtained through acquisition........................................ -- 203 --------- --------- Net cash used in investing activities................................. (22,785) (17,819) --------- --------- Cash flows from financing activities: Proceeds from issuance of note payable................................... 991 -- Payments on notes payable................................................ -- (3) Net proceeds from sales of preferred and common stock and exercise of stock options and warrants................................. 29,989 1,348 --------- --------- Net cash provided by financing activities............................. 30,980 1,345 --------- --------- Effect of exchange rate changes on cash....................................... (52) (56) --------- --------- Net increase (decrease) in cash and cash equivalents.................. 30,013 (8,808) Cash and cash equivalents at beginning of period.............................. 14,738 62,255 --------- --------- Cash and cash equivalents at end of period.................................... 44,751 53,447 Short-term investments at end of period....................................... 22,897 45,130 --------- --------- Total cash, cash equivalents and short-term investments at end of period......$ 67,648 $ 98,577 ========= =========
See accompanying notes to condensed consolidated financial statements - 5 - 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 nine months ended September 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, September 30, 1997 1998 ------- ------- (in thousands) Cash and cash equivalents $62,255 $43,847 Short-term investments 29,773 45,130 Restricted cash equivalents -- 9,600 ------- ------- $92,028 $98,577 ======= =======
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. - 6 - 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 nine months ended September 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 (FASB) issued Statement of Financial Accounting Standards (SFAS) 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 September 30, 1997 and 1998 was $(2,283,000) and $(1,392,000), respectively. The Company's total comprehensive loss for the nine months ended September 30, 1997 and 1998 was $(8,636,000) and $(23,637,000), respectively. Total comprehensive loss for the quarters and nine months ended September 30, 1997 and 1998 consisted of net loss and foreign currency translation adjustments. - 7 - 8 (f) Net Loss Per Share Basic net loss 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 net loss 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 Nine Months Ended September 30, September 30, -------------------------- -------------------------- 1997 1998 1997 1998 -------- -------- -------- -------- (in thousands) Net loss $ (2,203) $ (1,359) $ (8,575) $(23,551) Accretion of redemption value of redeemable preferred stock prior to conversion into common stock (212) -- (346) -- -------- -------- -------- -------- Net loss attributable to common shareholders $ (2,415) $ (1,359) $ (8,921) $(23,551) ======== ======== ======== ========
Excluded from the computation of diluted net loss per share for the quarter and nine months ended September 30, 1998 are options to acquire 7,955,000 shares of common stock with a weighted-average exercise price of $9.57 and warrants to acquire 413,000 shares of common stock with a weighted-average exercise price of $9.41 because their effects would be anti-dilutive. Excluded from the computation of basic net loss per share are approximately 110,000 shares held in escrow because all necessary conditions to release the shares from escrow were not satisfied during the quarter and nine months ended September 30, 1998. The escrow shares are excluded from the computation of diluted net loss per share as their effect would be anti-dilutive. (g) Recent Accounting Pronouncements In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information (Statement 131). Statement 131 establishes standards for the way that public business enterprises report information about operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Statement 131 is effective for fiscal years beginning after December 15, 1997. In the initial year of application, comparative information for earlier years must be restated. The Company has not determined the manner in which it will present the information required by Statement 131. In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement 133). Statement 133 establishes a new model for accounting for derivatives and hedging activities and supercedes and amends existing accounting standards. Statement 133 requires that all derivatives be recognized in the balance sheet at their fair market value, and the corresponding derivative gains or losses be either reported in the statement of operations or as a component of other comprehensive income depending on the type of hedge relationship that exists with respect to such derivative. The Company does not expect the adoption of Statement 133 to have a material impact on its consolidated financial statements. - 8 - 9 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 =======
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. As of September 30, 1998, approximately 110,000 shares remain in escrow. - 9 - 10 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 Nine Months Ended September 30, -------------------------- 1997 1998 -------- -------- (in thousands except per share data) Revenues $ 23,785 $ 45,455 Net loss (13,091) (6,802) Basic and diluted net loss per share (7.48) (0.21)
- 10 - 11 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 nine months ended September 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 - 12 During the third quarter of 1998, the Company released RealSystem G2, its next generation streaming media delivery system consisting of servers, tools, and client software, in beta form to the public prior to finalizing product features, functionality and operability. The beta 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 nonvoting 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. Commencing in July 1998, Microsoft also may be eligible to sell a portion of its holdings pursuant to Rule 144 of the Securities Act. 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 to the Company that it is re-evaluating its investment position in the Company and may sell a portion, if not all, 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. - 12 - 13 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 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 and 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 Microsoft 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 had the RealPlayer on a computer system, and thereafter downloaded the Windows Media Player, in a number of circumstances the Windows Media Player disabled certain important functions of the RealPlayer. As a result, certain of the Company's customers who had downloaded the free RealPlayer, or paid for the RealPlayer Plus, may have found that their product had ceased working. The Company raised the issue right after the Windows Media Player was released and the Company quickly incorporated a workaround solution into its RealPlayer and RealPlayer Plus and also posted this workaround solution on its Web site. The Company believes the workaround solution counteracted the situation, and, as a result, the Company believes only a small number of consumers were 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. 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. - 13 - 14 RESULTS OF OPERATIONS REVENUES Software License Fees. Software license fees were $12,413,000 for the quarter ended September 30, 1998, an increase of 66% from $7,480,000 in the comparable quarter of the prior year. Software license fees were $32,627,000 for the nine months ended September 30, 1998, an increase of 86% from $17,550,000 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 each of the quarters ended September 30, 1998 and 1997 was $2,417,000 related to the Microsoft license agreement. Included in software license fees for the nine months ended September 30, 1998 and 1997 was $7,251,000 and $2,417,000, respectively, related to the Microsoft license agreement. Service Revenues. Service revenues were $3,988,000 for the quarter ended September 30, 1998, an increase of 256% from $1,121,000 in the comparable quarter of the prior year. Service revenues were $10,105,000 for the nine months ended September 30, 1998, an increase of 205% from $3,310,000 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 during the fourth quarter of 1997 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 nine months ended September 30, 1997, also included $498,000 related to the Company's RealNetworks Conference. Advertising Revenues. Advertising revenues were $843,000 for the quarter ended September 30, 1998, an increase of 87% from $450,000 in the comparable quarter of the prior year. Advertising revenues were $2,070,000 for the nine months ended September 30, 1998, an increase of 33% from $1,557,000 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. 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 $2,140,000 for the quarter ended September 30, 1998, an increase of 126% from $946,000 in the comparable quarter in the prior year, and increased as a percentage of software license fees to 17% from 13%. Cost of software license fees was $5,526,000 for the nine months ended September 30, 1998, an increase of 166% from $2,080,000 in the comparable period in the prior year, and increased as a percentage of software license fees to 17% from 12%. 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 $642,000 for the quarter ended September 30, 1998, an increase of 86% from $345,000 in the comparable quarter in the prior year, but decreased as a percentage of service revenues to 16% from 31%. Cost of service revenues was $1,918,000 for the nine months ended September 30, 1998, a decrease of 2% from $1,957,000 in the comparable period in the prior year, and decreased as a percentage of service revenues to 19% from 59%. Cost of service revenues for the nine months ended September 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 $957,000, or 34% of service revenues, for the nine months ended September 30, 1997. The increases in cost of service revenues excluding the RealNetworks Conference were primarily due to increased staff and contract - 14 - 15 personnel to provide services to a greater number of customers and increases in bandwidth expenses. The decreases in percentage terms were primarily due to economies of scale in providing support services to a larger customer base. 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 $469,000 for the quarter ended September 30, 1998, an increase of 78% from $264,000 in the comparable quarter in the prior year, but decreased as a percentage of advertising revenues to 56% from 59%. Cost of advertising revenues was $1,207,000 for the nine months ended September 30, 1998, an increase of 111% from $572,000 in the comparable period in the prior year, and increased as a percentage of advertising revenues to 58% from 37%. 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, 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 $5,739,000 for the quarter ended September 30, 1998, an increase of 57% from $3,667,000 in the comparable quarter in the prior year, but decreased as a percentage of total net revenues to 33% from 41%. Research and development expenses were $14,947,000 for the nine months ended September 30, 1998, an increase of 64% from $9,130,000 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 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 $8,203,000 for the quarter ended September 30, 1998, an increase of 69% from $4,863,000 in the comparable quarter of the prior year, but decreased as a percentage of total net revenues to 48% from 54%. Sales and marketing expenses were $23,168,000 for the nine months ended September 30, 1998, an increase of 65% from $14,024,000 in the comparable period of the prior year, but decreased as a percentage of total net revenues to 52% from 63%. 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 nine months ended September 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 $2,653,000 for the quarter ended September 30, 1998, an increase of 38% from $1,917,000 in the comparable quarter of the prior year, but decreased as a percentage of total net revenues to 15% from 21%. General and administrative expenses were $7,220,000 for the nine months ended September 30, 1998, an increase of 64% from $4,413,000 in the comparable period of the prior year, but decreased as a percentage of total net revenues to 16% from 20%. The - 15 - 16 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 charges. In connection with the acquisition of Vivo in March 1998, the Company allocated $17,729,000 of the total purchase price to in-process research and development projects. This allocation represents the estimated fair value based on projected cash flows related to the in-process research and development projects. At the date of acquisition, this amount was expensed as part of acquisition related charges as the in-process technology had not yet reached technological feasibility and had no alternative future uses. The value assigned to acquired in-process research and development was determined by estimating the present value of the operating cash flows expected to be generated by the in-process projects. The revenue projections were based upon the revenues likely to be generated upon completion of the projects and the beginning of commercial sales. Net cash flow estimates include cost of goods sold, other operating expenses and taxes forecasted based upon historical operating characteristics. In addition, net cash flow estimates were adjusted to allow for a fair return on working capital and fixed assets and return on other intangibles. Discount rates of 42% and 43%, which represent premiums to the Company's cost of capital, were used to discount the net cash flows back to their present value. The nature of the efforts required to develop the acquired in-process projects into commercially viable products principally relate to the completion of planning, designing and testing activities necessary to establish that the Vivo technology can be successfully combined with the Company's products and that the resulting products can be produced to meet their design requirements including functions, features and performance. Although the Company currently expects that the in-process projects will be successfully developed, there can be no assurance that commercial or technical viability of these products will be achieved. Significant uncertainty exists as to the extent of compatibility of the Vivo technology with the Company's technology. Furthermore, future developments in streaming technology may impact the market for the in-process projects. If the projects are not successfully developed, the Company may not realize the value assigned to the in-process research and development projects. In addition, the value of other acquired intangible assets may also become impaired. 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 $1,243,000 and $3,512,000 for the quarter and nine months ended September 30, 1998, respectively, and $748,000 and $1,184,000 for the quarter and nine months ended September 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 $7,722,000 for the nine months ended September 30, 1998. Net cash provided by operating activities was $21,870,000 for the nine months ended September 30, 1997. Cash provided by operating activities for the nine months ended September 30, 1998 was due to a decrease in other receivables, an increase in accrued expenses and non-cash charges associated with depreciation and acquisition related charges, partially offset by the reported net loss. Cash provided by operating activities for the nine months ended September 30, 1997 was primarily due to an increase in deferred revenue, partially offset by the reported net loss. Net cash used in investing activities was $17,819,000 and $22,785,000 for the nine months ended September 30, 1998 and 1997, respectively. Cash used in investing activities for the nine months ended September 30, 1998 was primarily a result of net purchases of short-term investments and purchases of equipment. Cash used in investing activities for the nine months ended September 30, 1997 was due to net purchases of short-term investments, purchases of equipment, and investment in a joint venture. Net cash provided by financing activities was $1,345,000 and $30,980,000 for the nine months ended September 30, 1998 and 1997, respectively. Cash provided by financing activities for the nine months ended September 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 nine months ended September 30, 1997 was a result of the exercise of stock options, sales of preferred stock and proceeds from a note payable. At September 30, 1998, the Company had $98,577,000 in cash, cash equivalents and short-term investments. As of September 30, 1998, the Company's principal commitments consisted of obligations under operating leases and $996,000 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. - 16 - 17 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. YEAR 2000 What is commonly referred to as the "Year 2000" problem arose because many existing computer programs use only the last two digits to refer to a year. As a result, such date-sensitive computer programs are unable to recognize two-digit date fields designated as "00" as the year 2000. Such inability could result in system failures or miscalculations causing disruptions to operations. The Company believes that its current products are Year 2000 Compliant, although the Company is continually identifying, evaluating, testing and implementing changes to minimize or eliminate the effect of the Year 2000 risk on the Company's recently developed products and newly acquired technologies. As used herein, "Year 2000 Compliant" means that software products and systems are able to function properly before, during and after the Year 2000 without loss of functionality resulting from date changes. The Company believes that all of its products will be ready for the Year 2000 by the end of 1999 and that no material costs will remain at that time. However, 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 believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues in a variety of ways. The Company believes that it is not possible to predict the overall impact of these decisions. With regard to the Company's internal processing and operational systems, the Company is in the process of identifying and testing its systems for Year 2000 compliance. The Company will continue its Year 2000 assessment during 1998 and 1999. Based on the preliminary analysis of these internal systems, the Company does not believe the cost of addressing their Year 2000 readiness will be material. However, the Company believes that undetected errors or the failure of such systems to be Year 2000 Compliant could create significant record-keeping and operational deficiencies, the results of which could have material adverse effects on the Company's business, financial condition and results of operations. The Company relies on third-parties for services such as telecommunications, internet service, utilities and other key services and supplies. Interruption of those services or supplies due to Year 2000 issues could adversely affect the Company's operations. Furthermore, 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 assurance from such third-parties that their products are Year 2000 Compliant, the Company may experience additional costs or liabilities that could have a material adverse effect on the Company's business, financial condition and results of operations. To date, the Company has not incurred significant expenditures associated with the costs of Year 2000 remediation efforts. Although the Company does not anticipate the costs to address the Company's Year 2000 issues to be material, the costs of the Company's Year 2000 remediation work and the date on which the Company plans to complete such work are based on management's best estimates, which were derived from numerous assumptions about future events, including the availability of certain resources, third-party remediation plans and other factors. Accordingly, if Year 2000 modifications, evaluations, assessments and conversions are not made, or are not completed in time, the Year 2000 problem could have a material adverse impact on the Company's business, financial condition and results of operations. At this stage in the Company's analysis and remediation process, it is difficult to specifically identify the cause, and the magnitude of any adverse economic impact, of the most reasonably likely worst case Year 2000 scenario. Such reasonably likely worst case scenario would include the failure of the Company's products to operate properly, causing customers' systems and/or operations to fail or be disrupted. In the event of such - 17 - 18 failures or disruptions customers may commence legal action against the Company or otherwise seek compensation for their losses. In addition, the Company has on occasion agreed to indemnify certain of its customers for claims and losses arising out of the failure of the Company's products to be Year 2000 Compliant, which indemnification, claims or losses could have a material adverse economic impact on the Company's business, financial condition and results of operations. Such reasonably likely worst case scenario also would include the failure of key vendors and/or suppliers to correct their own Year 2000 issues, which failures could cause failure or disruption of the Company's operations, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's contingency plans to address the most reasonably likely worst case Year 2000 scenarios include developing or obtaining upgrades for products that have been tested and found to be non-compliant and seeking a second source of supply in the event the Company believes that any of its key suppliers are unlikely to be able to resolve their Year 2000 issues. - 18 - 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On or about August 25, 1998, a lawsuit was filed against the Company and co-defendant, Broadcast.com, Inc. in the United States District Court for the Northern District of Texas - Dallas Division by Venson M. Shaw and Steven M. Shaw. In this action, the plaintiffs allege that the Company, individually and in combination with Broadcast.com, infringes on a certain patent by making, using, selling, and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. Plaintiffs seek to enjoin the Company from its alleged infringing activity and to recover damages in an amount no less than a reasonable royalty. Although no assurance can be given as to the outcome of this lawsuit, the Company believes that the allegations in this action are without merit, and the Company intends to vigorously defend against the complaint. 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 July 1, 1998, the Company has issued and sold unregistered securities as follows: (1) An aggregate of 15,029 shares of Common Stock was issued to one investor upon the cashless exercise of a warrant in July 1998. The aggregate consideration received for such shares was the cancellation of a warrant to acquire 19,920 shares of Common Stock at an exercise price of $9.41. (2) An aggregate of 39,841 shares of Common Stock was issued to one investor upon the exercise of a warrant in July 1998. The aggregate consideration received for such shares was $375,003. (3) During the third quarter, an aggregate of 60,000 shares of Common Stock were issued to Film.com, Inc. in connection with the satisfaction of certain performance criteria pursuant to that certain Asset Purchase Agreement by and between the Company and Film.com, Inc. dated October 24, 1997. A total of 30,000 of such shares were issued on July 28, 1998, and the remaining 30,000 shares were issued on September 1, 1998. (4) Between July 1, 1998 and September 30, 1998, an aggregate of 253,818 shares of Common Stock were issued to employees upon the exercise of options. The aggregate consideration received for such shares was $261,987. 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. - 19 - 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits required by Item 601 of Regulation S-K: 3.1 Restated Articles of Incorporation filed September 14, 1998 3.2 Amended and Restated Bylaws 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: None - 20 - 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 13, 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 - 21 - 22 INDEX TO EXHIBITS
Exhibit Number Description -------------- ----------- 3.1 Restated Articles of Incorporation filed September 14, 1998 3.2 Amended and Restated Bylaws 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-3.1 2 RESTATED ARTICLES OF INCORPORATION 1 EXHIBIT 3.1 RESTATED ARTICLES OF INCORPORATION OF REALNETWORKS, INC. Pursuant to RCW 23B.10.070, the following constitutes Restated Articles of Incorporation of RealNetworks, Inc., a Washington corporation. ARTICLE I NAME The name of this Corporation is RealNetworks, Inc. ARTICLE II DURATION This Corporation is organized under the Washington Business Corporation Act (the "Act") and shall have perpetual existence. ARTICLE III PURPOSE AND POWERS The purpose and powers of this Corporation are as follows: (a) to engage in any lawful business; (b) to engage in any and all activities that, in the judgment of the Board of Directors, may at any time be incidental or conducive to the attainment of the foregoing purpose; and (c) to exercise any and all powers that a corporation formed under the Act, or any amendment thereto or substitute therefor, is entitled at the time to exercise. ARTICLE IV CAPITAL STOCK 4.1 AUTHORIZED CAPITAL. The aggregate number of shares of capital stock which this Corporation shall be authorized to issue shall be Three Hundred Sixty Million (360,000,000), divided into two classes as follows: Three Hundred Million (300,000,000) shares of common stock, $.001 par value per share (the "Common Stock"), and Sixty Million (60,000,000) shares of preferred stock, $.001 par value per share (the "Preferred Stock"). -1- 2 4.2 SPECIAL COMMON STOCK. 4.2.1 DESIGNATION. Seven Million Forty-Seven Thousand Six Hundred Seventy-Nine (7,047,679) shares of Common Stock shall be designated and known as "Special Common Stock." 4.2.2 RECLASSIFICATION OF SPECIAL COMMON STOCK. (a) If any shares of Special Common Stock are sold in a Qualified Sale (as defined in Section 4.2.2(b)), then, effective immediately upon such sale (A) the number of authorized but undesignated shares of Common Stock of the Corporation shall be increased by the number of shares of Special Common Stock so sold; (B) each share of Special Common Stock so sold shall thereafter constitute one (1) share of Common Stock, the holder of which shall be entitled to one (1) vote upon all matters submitted to a vote of shareholders; (C) the certificate or certificates representing the shares of Special Common Stock that were outstanding immediately prior to such sale shall, by virtue of the sale and without any action on the part of the holder, thereafter represent (I) to the extent of the number of shares of Special Common Stock so sold, the corresponding number of shares of Common Stock, and (II) the shares of Special Common Stock represented by such certificate or certificates immediately prior to such sale, if any, that have not been so sold; and (D) if no shares of Special Common Stock remain outstanding following the Qualified Sale, the designation of the Special Common Stock as a separate series of Common Stock having the respective rights, preferences and limitations set forth in this Section 4.2 shall automatically terminate. Upon surrender of any such certificate to the Corporation, the Corporation shall issue and deliver to the person entitled thereto a new certificate or certificates to represent the shares of Common Stock and Special Common Stock, if any, represented by the surrendered certificate. (b) For purposes of this Section 4.2.2, a "Qualified Sale" of shares of Special Common Stock shall mean a bona fide sale of the shares by the holder thereof to a purchaser who is not directly, or acting on behalf of, an affiliate (as that term is defined in Rule 405 promulgated under the Securities Act of 1933, as amended (the "Securities Act")) of the holder. 4.2.3 VOTING RIGHTS. Each share of Common Stock shall be entitled to one (1) vote on all matters submitted to the shareholders of the Corporation and each share of Special Common Stock shall not be entitled to vote, except as required by law, in which case each share of Special Common Stock shall be entitled to one (1) vote. 4.2.4 RANKING. The rights and preferences of the Common Stock and the Special Common Stock shall be in all respects identical, except as otherwise required by law or expressly provided in these Articles of Incorporation. 4.3 ISSUANCE OF PREFERRED STOCK IN SERIES. 4.3.1 AUTHORITY VESTED IN BOARD OF DIRECTORS. The Preferred Stock may be divided into and issued in series from time to time. Authority is vested in the Board of Directors, subject to the limitations and procedures set forth in these Articles of Incorporation or prescribed by law, to divide any part or all of such Preferred Stock into any number of series, to fix and determine the relative rights and preferences of the shares of any series to be established, and to -2- 3 amend the rights and preferences of the shares of any series that has been established but is wholly unissued. 4.3.2 AMENDMENT TO SERIES DECREASING SHARES. Within any limits stated in these Articles of Incorporation or in the resolution of the Board of Directors establishing a series, the Board of Directors, after the issuance of shares of a series, may amend the resolution establishing the series to decrease (but not below the number of shares of such series then outstanding or reserved for issuance pursuant to the exercise of any outstanding warrants) the number of shares of that series, and the number of shares constituting the decrease shall thereafter constitute authorized but undesignated shares. 4.3.3 AUTHORITY LIMITED TO UNISSUED SHARES. The authority herein granted to the Board of Directors to determine the relative rights and preferences of the Preferred Stock shall be limited to unissued shares, and no power shall exist to alter or change the rights and preferences of any shares that have been issued. 4.4 ISSUANCE OF CERTIFICATES. The Board of Directors shall have the authority to issue shares of the capital stock of this Corporation and the certificates therefor subject to such transfer restrictions and other limitations as it may deem necessary to promote compliance with applicable federal and state securities laws, and to regulate the transfer thereof in such manner as may be calculated to promote such compliance or to further any other reasonable purpose. 4.5 NO CUMULATIVE RIGHTS. Shareholders of this Corporation shall not have the right to cumulate votes for the election of directors. 4.6 NO PREEMPTIVE RIGHTS. No shareholder of this Corporation shall have, solely by reason of being a shareholder, any preemptive or preferential right or subscription right to any stock of this Corporation or to any obligations convertible into stock of this Corporation, or to any warrant or option for the purchase thereof, except to the extent provided by written agreement with this Corporation. 4.7 QUORUM FOR MEETING OF SHAREHOLDERS. A quorum shall exist at any meeting of shareholders if a majority of the votes entitled to be cast is represented in person or by proxy. In the case of any meeting of shareholders that is adjourned more than once because of the failure of a quorum to attend, those who attend the third convening of such meeting, although less than a quorum, shall nevertheless constitute a quorum for the purpose of electing directors, provided that the percentage of shares represented at the third convening of such meeting shall not be less than one-third of the shares entitled to vote. 4.8 CONTRACTS WITH INTERESTED SHAREHOLDERS. Subject to the limitations set forth in RCW 23B.19.040, to the extent applicable: 4.8.1 The Corporation may enter into contracts and otherwise transact business as vendor, purchaser, lender, borrower, or otherwise with its shareholders and with corporations, associations, firms, and entities in which they are or may be or become interested as directors, officers, shareholders, members, or otherwise. -3- 4 4.8.2 Any such contract or transaction shall not be affected or invalidated or give rise to liability by reason of the shareholder's having an interest in the contract or transaction. 4.9 SHAREHOLDER VOTING REQUIREMENTS. Subject to the requirements of RCW 23B.08.730, and 23B.19.040, any contract, transaction, or act of the Corporation or of any director or officer of the Corporation that shall be authorized, approved, or ratified by a majority of the votes entitled to be cast at a meeting at which a quorum is present shall, insofar as permitted by law, be as valid and as binding as though ratified by every shareholder of the Corporation. 4.10 EXECUTION OF CONSENT OF SHAREHOLDERS BY LESS THAN UNANIMOUS CONSENT. To the extent permitted by the Act, the taking of action by shareholders without a meeting by less than unanimous written consent of all shareholders entitled to vote on the action shall be permitted. Before the date on which the action becomes effective, notice of the taking of such action shall be given to those shareholders entitled to vote on the action who have not consented in writing (and, if the Act would otherwise require that notice of a meeting of shareholders to consider the action be given to nonvoting shareholders, to all nonvoting shareholders), in writing, describing with reasonable clarity and specifying the general nature of the action, and accompanied by the same material that, under the Act, would have been required to be sent to nonconsenting (or nonvoting) shareholders in a notice of meeting at which the action would have been submitted for shareholder action. Such notice shall be given as follows: (i) if mailed, by deposit in the U.S. mail at least seventy-two (72) hours prior to the specified effective time of such action, with first-class postage thereon prepaid, correctly addressed to each shareholder entitled thereto at the shareholder's address as it appears on the current record of shareholders of the Corporation; or (ii) if delivered by personal delivery, by courier service, by wire or wireless equipment, by telegraphic or other facsimile transmission, or by any other electronic means which transmits a facsimile of such communication correctly addressed to each shareholder entitled thereto at the shareholder's physical address, electronic mail address, or facsimile number, as it appears on the current record of shareholders of the Corporation, at least twenty-four (24) hours prior to the specified effective time of such action. 4.11 SPECIAL MEETINGS OF SHAREHOLDERS. Subsequent to the date of closing of a firm commitment underwritten public offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Corporation to the public, special meetings of the shareholders for any purpose or purposes may be called at any time only by a majority of the Board of Directors or the Chairman of the Board of Directors (if one be appointed) or the President or one or more shareholders holding not less than twenty-five percent (25%) of all the shares entitled to be cast on any issue proposed to be considered at that meeting. 4.12 MAJORITY VOTE REQUIRED. Unless otherwise provided in these Articles of Incorporation, subsequent to the date of closing of a firm commitment underwritten public offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Corporation to the public, pursuant to authority granted under Sections 23B.10.030, 23B.11.030, 23B.12.020, and 23B.14.020 of the Act, the vote of shareholders of the Corporation required in order to approve amendments to the Articles of Incorporation, a plan of merger or share exchange, the sale, lease, exchange, or other disposition of all or substantially all of the property of the Corporation not in the usual and -4- 5 regular course of business, or dissolution of the Corporation shall be a majority of all of the votes entitled to be cast by each voting group entitled to vote thereon, regardless of whether or not the Corporation is a "public company," as that term is defined in Section 23B.01.400 of the Act. ARTICLE V DIRECTORS 5.1 NUMBER OF DIRECTORS. 5.1.1 The number of directors of the Corporation shall be fixed as provided in the Bylaws and may be changed from time to time by amending the Bylaws. 5.1.2 When the Board of Directors shall consist of four or more members, the directors shall be divided into three classes: Class 1, Class 2 and Class 3. Such classes shall be as nearly equal in number of directors as possible. Except as provided in Section 5.1.4, each director shall serve for a term ending at the third annual meeting of shareholders following the director's election; provided, that the director or directors first elected to Class 1 shall serve for a term ending at the first annual meeting of shareholders following such election, the director or directors first elected to Class 2 shall serve for a term ending at the second annual meeting of shareholders following such election, and the director or directors first elected to Class 3 shall serve for a term ending at the third annual meeting of shareholders following such election. 5.1.3 At each annual meeting of shareholders, the directors nominated to succeed those whose terms then expire shall be identified as being of the same class as the directors they succeed unless, by reason of any intervening changes in the authorized number of directors, the Board of Directors shall designate one or more directorships whose terms then expire as directorships of another class in order more nearly to achieve equality in the number of directors in the respective classes. When the Board of Directors fills a vacancy resulting from the death, resignation or removal of a director, the director chosen to fill that vacancy shall be of the same class as the director he succeeds. 5.1.4 Notwithstanding the foregoing provisions of this Section 5.1, in all cases, including upon any change in the authorized number of directors, each director then continuing to serve as such will nevertheless continue as a director of the class of which he is a member until the expiration of his or her term or his or her earlier death, resignation or removal. Any vacancy in any class resulting from the death, resignation or removal of a director or an increase in the number of authorized directors may be filled by the directors in any manner permitted by the Act; provided, if the term of the director or directors in that class is not scheduled to expire at the next annual meeting of shareholders, the term of the director chosen to fill such vacancy shall continue only until the next annual meeting of shareholders at which a successor shall be chosen for a term to expire at the scheduled date for expiration of the term of the director or directors in that class. -5- 6 5.2 REMOVAL. 5.2.1 Any director or the entire Board of Directors may be removed with cause by the holders of not less than a majority of the shares then entitled to vote at an election of directors. No director may be removed without "cause," as defined below. Action to remove a director may be taken at any annual or special meeting of the shareholders of this Corporation, provided that notice of the proposed removal, which shall include a statement of the charges alleged against the director, shall have been duly given to the shareholders together with or as a part of the notice of the meeting. 5.2.2 Where a proposal to remove a director for cause is to be presented for shareholder consideration, an opportunity shall be provided the director to present the director's defense to the shareholders in a statement to accompany or precede the notice of the meeting at which such proposal is to be presented. The director shall also be served with notice of the meeting at which such proposal is to be presented, together with a statement of the specific charges alleged against the director, and shall be given an opportunity to be present and to be heard at the meeting. 5.2.3 For purposes of this Section 5.2, "cause" for removal shall be limited to (a) action by a director involving willful malfeasance having a material adverse effect on the Corporation and (b) conviction of a director of a felony; provided, that action by a director shall not constitute "cause" if, in good faith, the director believed such action to be in or not opposed to the best interests of the Corporation, or if the director is entitled, under applicable law or the Articles of Incorporation or Bylaws of this Corporation, to be indemnified with respect to such action. 5.3 AUTHORITY OF BOARD OF DIRECTORS TO AMEND BYLAWS. Subject to the limitation(s) of RCW 23B.10.210, and subject to the power of the shareholders of the Corporation to change or repeal the Bylaws, the Board of Directors is expressly authorized to make, amend, or repeal the Bylaws of the Corporation unless the shareholders in amending or repealing a particular bylaw provide expressly that the Board of Directors may not amend or repeal that bylaw. 5.4 CONTRACTS WITH INTERESTED DIRECTORS. Subject to the limitations set forth in RCW 23B.08.700 through 23B.08.730: 5.4.1 The Corporation may enter into contracts and otherwise transact business as vendor, purchaser, lender, borrower, or otherwise with its directors and with corporations, associations, firms, and entities in which they are or may be or become interested as directors, officers, shareholders, members, or otherwise. 5.4.2 Any such contract or transaction shall not be affected or invalidated or give rise to liability by reason of the director's having an interest in the contract or transaction. 5.5 INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS. 5.5.1 The capitalized terms in this Section 5.5 shall have the meanings set forth in RCW 23B.08.500. -6- 7 5.5.2 The Corporation shall indemnify and hold harmless each individual who is or was serving as a Director or officer of the Corporation or who, while serving as a Director or officer of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against any and all Liability incurred with respect to any Proceeding to which the individual is or is threatened to be made a Party because of such service, and shall make advances of reasonable Expenses with respect to such Proceeding, to the fullest extent permitted by law, without regard to the limitations in RCW 23B.08.510 through 23B.08.550; provided that no such indemnity shall indemnify any Director or officer from or on account of (1) acts or omissions of the Director or officer finally adjudged to be intentional misconduct or a knowing violation of law; (2) conduct of the Director or officer finally adjudged to be in violation of RCW 23B.08.310; or (3) any transaction with respect to which it was finally adjudged that such Director or officer personally received a benefit in money, property, or services to which the Director or officer was not legally entitled. 5.5.3 The Corporation may purchase and maintain insurance on behalf of an individual who is or was a Director, officer, employee, or agent of the Corporation or, who, while a Director, officer, employee, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise against Liability asserted against or incurred by the individual in that capacity or arising from the individual's status as a Director, officer, employee, or agent, whether or not the Corporation would have power to indemnify the individual against such Liability under RCW 23B.08.510 or 23B.08.520. 5.5.4 If, after the effective date of this Section 5.5, the Act is amended to authorize further indemnification of Directors or officers, then Directors and officers of the Corporation shall be indemnified to the fullest extent permitted by the Act as so amended. 5.5.5 To the extent permitted by law, the rights to indemnification and advance of reasonable Expenses conferred in this Section 5.5 shall not be exclusive of any other right which any individual may have or hereafter acquire under any statute, provision of the Bylaws, agreement, vote of shareholders or disinterested Directors, or otherwise. The right to indemnification conferred in this Section 5.5 shall be a contract right upon which each Director or officer shall be presumed to have relied in determining to serve or to continue to serve as such. Any amendment to or repeal of this Section 5.5 shall not adversely affect any right or protection of a Director or officer of the Corporation for or with respect to any acts or omissions of such Director or officer occurring prior to such amendment or repeal. 5.5.6 If any provision of this Section 5.5 or any application thereof shall be invalid, unenforceable, or contrary to applicable law, the remainder of this Section 5.5, and the application of such provisions to individuals or circumstances other than those as to which it is held invalid, unenforceable, or contrary to applicable law, shall not be affected thereby. 5.6 LIMITATION OF DIRECTORS' LIABILITY. To the fullest extent permitted by the Act, as it exists on the date hereof or may hereafter be amended, a director of this Corporation shall not be personally liable to the Corporation or its shareholders for monetary damages for conduct as a director. Any amendment to or repeal of this Section 5.6 shall not adversely affect a director of -7- 8 this Corporation with respect to any conduct of such director occurring prior to such amendment or repeal. ARTICLE VI OTHER MATTERS 6.1 CERTAIN CORPORATE GOVERNANCE MATTERS. 6.1.1 STRATEGIC TRANSACTIONS COMMITTEE. (a) MEMBERS. There shall be a Strategic Transactions Committee (the "Committee") of the Board of Directors which shall consist of three (3) directors. The members of the initial Committee shall be Robert Glaser, the Corporation's Founder, James Breyer and Mitchell Kapor. A member of the Committee shall automatically cease to be a member of the Committee upon the earlier of: (i) his or her death, resignation or removal as a director, or (ii) at the option of the Chairman of the Committee, his or her ceasing to hold or control, directly or indirectly, at least five percent (5%) of the outstanding shares of capital stock of the Corporation. Neither the Board of Directors nor the shareholders shall have any authority to remove any member of the Committee or to otherwise reconstitute the Committee or its membership. (b) CHAIRMAN OF COMMITTEE. Mr. Glaser shall serve as Chairman of the Committee as long as he is a member of the Committee. At such time as Mr. Glaser is no longer a member of the Committee, the Committee shall select one of its members as Chairman. (c) POWER OF COMMITTEE. Without the prior approval of the Committee, the Board of Directors of the Corporation shall not have the power and authority to: (i) adopt a plan of merger, (ii) authorize the sale, lease, exchange or mortgage of (A) assets representing more than fifty percent (50%) of the book value of the Corporation's assets prior to the transaction, or (B) any other asset or assets on which the long-term business strategy of the Corporation is substantially dependent, (iii) authorize the voluntary dissolution of the Corporation, or (iv) take any action that has the effect of clauses (i) through (iii) of this Section 6.1.1(c). (d) MEETINGS AND NOTICE. The Committee shall meet from time to time on the call of its Chairman or of the other two members. Each meeting of the Committee shall be held at the date, time and place as may be designated in the notice of the meeting given by the person or persons authorized to call the meeting. Notice of the date, time and place of each meeting of the Committee shall be given to each member of the Committee in any manner permitted by the Act not less than one (1) day prior to the meeting; such notice need not state the purpose or purposes of the meeting. The Committee shall keep regular minutes of its meetings and proceedings. (e) QUORUM. At any meeting of the Committee, presence of the Chairman and at least one other member thereof shall constitute a quorum. The act of at least two (2) members of the Committee at a meeting at which a quorum is present shall be the act of the Committee. All action of the Committee shall be taken at a meeting of the Committee or as otherwise provided or allowed by law. -8- 9 (f) VACANCIES. Any vacancy on the Committee shall be filled by the remaining member or members of the Committee, regardless of whether or not a quorum. If two members of the Committee remain and they are unable to agree on an individual to fill the vacancy, the vacancy may be filled by the member who holds or controls, directly or indirectly, the larger percentage of the outstanding shares of capital stock of the Corporation. (g) TERMINATION OF COMMITTEE. The Committee, by vote of the Chairman of the Committee and one additional member, may limit the powers of the Committee or may terminate the Committee. The existence and powers of the Committee shall terminate when the members in the aggregate cease to hold or control, directly or indirectly, at least ten percent (10%) of the outstanding shares of capital stock of the Corporation. The Board of Directors shall have and succeed to any and all power and authority of the Committee that have been limited or eliminated as a result of actions taken pursuant to this Section 6.1.1(g). 6.1.2 POLICY OMBUDSMAN. Mr. Glaser shall serve, or shall appoint another officer of the Corporation who shall serve, as the Corporation's Policy Ombudsman. The Policy Ombudsman shall have exclusive responsibility for adopting or changing the editorial policies of the Corporation as reflected on the Corporation's Web sites or in other communications or media where the Corporation has a significant editorial or media voice. The Policy Ombudsman may be removed only by the unanimous approval of all members of the Board of Directors. Upon the death, resignation or removal of Mr. Glaser as the Policy Ombudsman, the Chief Executive Officer or another officer of the Corporation appointed by the Chief Executive Officer, shall serve as his or her successor. 6.1.3 AUTHORITY FOR SECTION 6.1. The provisions of this Section 6.1 are intended to modify the authority of the Board of Directors in a manner permitted by RCW 23B.08.010(3) and shall be construed consistent with that provision of the Act. Except as otherwise provided in these Articles of Incorporation, as amended from time to time, the Committee shall have all of the powers and authority of a committee of the Board of Directors created pursuant to RCW 23B.08.250. 6.1.4 AMENDMENT OF SECTION 6.1. Notwithstanding any provision of these Articles of Incorporation or the Corporation's Bylaws, as either may be amended from time to time by the Board of Directors or the shareholders of the Corporation, this Section 6.1 cannot be amended without the approval of the holders of ninety percent (90%) of the shares entitled to be voted on such proposed amendment(s). 6.2 AMENDMENTS TO ARTICLES OF INCORPORATION. Except as otherwise provided in these Articles of Incorporation, as amended from time to time, the Corporation reserves the right to amend, alter, change, or repeal any provisions contained in these Articles of Incorporation in any manner now or hereafter prescribed or permitted by statute. All rights of shareholders of the Corporation are subject to this reservation. A shareholder of the Corporation does not have a vested property right resulting from any provision of these Articles of Incorporation. 6.3 CORRECTION OF CLERICAL ERRORS. The Corporation shall have authority to correct clerical errors in any documents filed with the Secretary of State of Washington, including these -9- 10 Articles of Incorporation or any amendments hereto, without the necessity of special shareholder approval of such corrections. Executed this 18th day of August, 1998. By: /s/ Robert Glaser, Chief Executive Officer -------------------------------------------- Robert Glaser, Chief Executive Officer -10- EX-3.2 3 AMENDED AND RESTATED BYLAWS 1 EXHIBIT 3.2 AMENDED AND RESTATED BYLAWS OF REALNETWORKS, INC. ADOPTED JULY 16, 1998 2 TABLE OF CONTENTS
Page ARTICLE I...................................................................................1 1.1 Annual Meeting......................................................................1 1.1.1 Time and Place of Meeting....................................................1 1.1.2 Business Conducted at Meeting................................................1 1.2 Special Meetings....................................................................2 1.3 Notice of Meetings..................................................................3 1.3.1 Notice of Special Meeting....................................................3 1.3.2 Proposed Articles of Amendment, Merger, Exchange, Sale, Lease or Disposition...............................................................3 1.3.3 Proposed Dissolution.........................................................3 1.3.4 Declaration of Mailing.......................................................4 1.3.5 Waiver of Notice.............................................................4 1.4 Quorum; Vote Requirement............................................................4 1.5 Adjourned Meetings..................................................................4 1.6 Fixing Record Date..................................................................5 1.7 Shareholders' List for Meeting......................................................5 1.8 Ratification........................................................................5 1.9 Action by Shareholders Without a Meeting............................................6 1.10 Telephonic Meetings.................................................................6 ARTICLE II..................................................................................6 2.1 Responsibility of Board of Directors................................................6 2.2 Number of Directors; Qualification..................................................7 2.3 Election of Directors; Nominations..................................................7 2.3.1 Election and Term of Office..................................................7 2.3.2 Nominations for Directors....................................................7 2.4 Vacancies...........................................................................8 2.5 Removal.............................................................................9 2.6 Resignation.........................................................................9 2.7 Annual Meeting......................................................................9
-i- 3 2.8 Regular Meetings....................................................................9 2.9 Special Meetings....................................................................9 2.10 Notice of Meeting...................................................................9 2.11 Quorum of Directors................................................................10 2.12 Dissent by Directors...............................................................11 2.13 Action by Directors Without a Meeting..............................................11 2.14 Telephonic Meetings................................................................11 2.15 Compensation.......................................................................11 2.16 Committees.........................................................................11 ARTICLE III................................................................................12 3.1 Appointment........................................................................12 3.2 Qualification......................................................................12 3.3 Officers Enumerated................................................................12 3.3.1 Chairman of the Board.......................................................12 3.3.2 President...................................................................13 3.3.3 Vice Presidents.............................................................13 3.3.4 Secretary...................................................................13 3.3.5 Treasurer...................................................................14 3.4 Delegation.........................................................................14 3.5 Resignation........................................................................14 3.6 Removal............................................................................15 3.7 Vacancies..........................................................................15 3.8 Other Officers and Agents..........................................................15 3.9 Compensation.......................................................................15 3.10 General Standards for Officers.....................................................15 ARTICLE IV.................................................................................15 4.1 Contracts..........................................................................15 4.2 Checks, Drafts, Etc................................................................16 4.3 Deposits...........................................................................16 ARTICLE V..................................................................................16 5.1 Issuance of Shares.................................................................16
-ii- 4 5.2 Certificates of Stock...............................................................16 5.3 Stock Records.......................................................................17 5.4 Restrictions on Transfer............................................................17 5.5 Transfers...........................................................................17 ARTICLE VI..................................................................................18 ARTICLE VII.................................................................................18 ARTICLE VIII................................................................................18 ARTICLE IX..................................................................................19 ARTICLE X...................................................................................19 10.1 Definitions.........................................................................19 10.2 Mandatory Indemnification...........................................................19 10.3 Insurance...........................................................................19 10.4 Changes in Law......................................................................20 10.5 Exclusivity; Nature of Rights; Amendment............................................20 ARTICLE XI..................................................................................20 11.1 Communications by Facsimile.........................................................20 11.2 Inspector of Elections..............................................................20 11.3 Rules of Order......................................................................21 11.4 Construction........................................................................21 11.5 Severability........................................................................21 ARTICLE XII.................................................................................21 ARTICLE XIII................................................................................22
-iii- 5 AMENDED AND RESTATED BYLAWS OF REALNETWORKS, INC. These Bylaws are promulgated pursuant to the Washington Business Corporation Act, as set forth in Title 23B of the Revised Code of Washington (the "Act"). ARTICLE I SHAREHOLDERS 1.1 Annual Meeting. 1.1.1 Time and Place of Meeting. The annual meeting of the shareholders of the corporation for the election of Directors and for the transaction of such other business as may properly come before the meeting shall be held each year at a place, day, and time to be set by the Board of Directors. 1.1.2 Business Conducted at Meeting. (a) At an annual meeting of shareholders, an item of business may be conducted, and a proposal may be considered and acted upon, only if such item or proposal is brought before the meeting (i) by, or at the direction of, the Board of directors, or (ii) by any shareholder of the corporation who is entitled to vote at the meeting and who complies with the procedures set forth in the remainder of this Section 1.1.2. This Section 1.1.2 shall not apply to matters of procedure that, pursuant to Section 11.3(a) of these Bylaws, are subject to the authority of the chairman of the meeting. (b) For an item of business or proposal to be brought before an annual meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the corporation. To be timely, a shareholder's notice must be delivered to, or mailed and received at, the principal office of the corporation not less than one hundred twenty (120) days prior to the first anniversary of the date that the Company's proxy statement was released to shareholders in connection with the previous year's annual meeting, or, if the date of this year's annual meeting has been changed by more than thirty (30) days from the date of the previous year's meeting, then the deadline is a reasonable time before the Company begins to print and mail its proxy materials. (c) A shareholder's notice to the Secretary under Section 1.1.2(b) shall set forth, as to each item of business or proposal the shareholder intends to bring before the meeting (i) a brief description of the item of business or proposal and the reasons for bringing it before the meeting, (ii) the name and address, as they appear on the corporation's books, of the shareholder and of any other shareholders that the shareholder knows or anticipates will support the item of business or proposal, (iii) the number and class of shares of stock of the corporation that are beneficially owned on the date of such notice by the shareholder and by any such other -1- 6 shareholders, and (iv) any financial interest of the shareholder or any such other shareholders in such item of business or proposal. (d) The Board of Directors, or a designated committee thereof, may reject a shareholder's notice that is not timely given in accordance with the terms of Section 1.1.2(b). If the Board of Directors, or a designated committee thereof, determines that the information provided in a timely shareholder's notice does not satisfy the requirements of Section 1.1.2(c) in any material respect, the Secretary of the corporation shall notify the shareholder of the deficiency in the notice. The shareholder shall have an opportunity to cure the deficiency by providing additional information to the Secretary within such period of time, not to exceed five (5) days from the date such deficiency notice is given to the shareholder, as the Board of Directors or such committee shall reasonably determine. If the deficiency is not cured within such period, or if the Board of Directors or such committee determines that the additional information provided by the shareholder, together with information previously provided, does not satisfy the requirements of Section 1.1.2(c) in any material respect, then the Board of Directors or such committee may reject the shareholder's notice. (e) Notwithstanding the procedures set forth in Section 1.1.2(d), if a shareholder desires to bring an item of business or proposal before an annual meeting, and neither the Board of Directors nor any committee thereof has made a prior determination of whether the shareholder has complied with the procedures set forth in this Section 1.1.2 in connection with such item of business or proposal, then the chairman of the meeting shall determine and declare at the meeting whether the shareholder has so complied. If the chairman determines that the shareholder has so complied, then the chairman shall so state and ballots shall be provided for use at the meeting with respect to such item of business or proposal. If the chairman determines that the shareholder has not so complied, then, unless the chairman, in his sole and absolute discretion, determines to waive such compliance, the chairman shall state that the shareholder has not so complied and the item of business or proposal shall not be brought before the meeting. (f) This Section 1.1.2 shall not prevent the consideration and approval or disapproval at the annual meeting of reports of officers, directors and committees of the Board of Directors, but, in connection with such reports, no item of business may be conducted, and no proposal may be considered and acted upon, unless there has been compliance with the procedures set forth in this Section 1.1.2 in connection therewith. 1.2 Special Meetings. Special meetings of the shareholders for any purpose or purposes may be called at any time by the Board of Directors or by the Chairman of the Board (if one be appointed) or by the President or by one or more shareholders holding at least twenty-five percent (25%) of all the shares entitled to be cast on any issue proposed to be considered at that meeting, to be held at such time and place as the Board or the Chairman (if one be appointed) or the President may prescribe. If a special meeting is called by any person or persons other than the Board of Directors or the Chairman of the Board (if one be appointed) or the President, then a written demand, -2- 7 describing with reasonable clarity the purpose or purposes for which the meeting is called and specifying the general nature of the business proposed to be transacted, shall be delivered personally or sent by registered mail or by telegraphic or other facsimile transmission to the Secretary of the corporation. Upon receipt of such a demand, the Secretary shall cause notice of such meeting to be given, within thirty (30) days after the date the demand was delivered to the Secretary, to the shareholders entitled to vote, in accordance with the provisions of Section 1.3 of these Bylaws. Except as provided below, if the notice is not given by the Secretary within thirty (30) days after the date the demand was delivered to the Secretary, then the person or persons demanding the meeting may specify the time and place of the meeting and give notice thereof. 1.3 Notice of Meetings. Except as otherwise provided below, the Secretary, Assistant Secretary, or any transfer agent of the corporation shall give, in any manner permitted by law, not less than ten (10) nor more than sixty (60) days before the date of any meeting of shareholders, written notice stating the place, day, and time of the meeting to each shareholder of record entitled to vote at such meeting. If mailed, notice to a shareholder shall be effective when mailed, with first-class postage thereon prepaid, correctly addressed to the shareholder at the shareholder's address as it appears on the current record of shareholders of the corporation. Otherwise, written notice shall be effective at the earliest of the following: (a) when received, (b) five (5) days after its deposit in the United States mail, as evidenced by the postmark, if mailed with first-class postage, prepaid, and correctly addressed, or (c) on the date shown on the return receipt, if sent by registered or certified mail, return receipt requested, and the receipt is signed by or on behalf of the addressee. 1.3.1 Notice of Special Meeting. In the case of a special meeting, the written notice shall also state with reasonable clarity the purpose or purposes for which the meeting is called and the general nature of the business proposed to be transacted at the meeting. No business other than that within the purpose or purposes specified in the notice may be transacted at a special meeting. 1.3.2 Proposed Articles of Amendment, Merger, Exchange, Sale, Lease or Disposition. If the business to be conducted at any meeting includes any proposed amendment to the Articles of Incorporation or any proposed merger or exchange of shares, or any proposed sale, lease, exchange, or other disposition of all or substantially all of the property and assets (with or without the goodwill) of the corporation not in the usual or regular course of its business, then the written notice shall state that the purpose or one of the purposes is to consider the proposed amendment or plan of merger, exchange of shares, sale, lease, exchange, or other disposition, as the case may be, shall describe the proposed action with reasonable clarity, and shall be accompanied by a copy of the proposed amendment or plan. Written notice of such meeting shall be given to each shareholder of record, whether or not entitled to vote at such meeting, not less than twenty (20) days before such meeting, in the manner provided in Section 1.3 above. 1.3.3 Proposed Dissolution. If the business to be conducted at any meeting includes the proposed voluntary dissolution of the corporation, then the written notice shall state that the purpose or one of the purposes is to consider the advisability thereof. Written notice of -3- 8 such meeting shall be given to each shareholder of record, whether or not entitled to vote at such meeting, not less than twenty (20) days before such meeting, in the manner provided in Section 1.3 above. 1.3.4 Declaration of Mailing. A declaration of the mailing or other means of giving any notice of any shareholders' meeting, executed by the Secretary, Assistant Secretary, or any transfer agent of the corporation giving the notice , shall be prima facie evidence of the giving of such notice. 1.3.5 Waiver of Notice. A shareholder may waive notice of any meeting at any time, either before or after such meeting. Except as provided below, the waiver must be in writing, be signed by the shareholder entitled to the notice, and be delivered to the corporation for inclusion in the minutes or filing with the corporate records. A shareholder's attendance at a meeting in person or by proxy waives objection to lack of notice or defective notice of the meeting unless the shareholder at the beginning of the meeting objects to holding the meeting or transacting business at the meeting on the ground that the meeting is not lawfully called or convened. In the case of a special meeting, or an annual meeting at which fundamental corporate changes are considered, a shareholder waives objection to consideration of a particular matter that is not within the purpose or purposes described in the meeting notice unless the shareholder objects to considering the matter when it is presented. 1.4 Quorum; Vote Requirement. A quorum shall exist at any meeting of shareholders if a majority of the votes entitled to be cast is represented in person or by proxy. Once a share is represented for any purpose at a meeting other than solely to object to holding the meeting or transacting business at the meeting, it is deemed present for quorum purposes for the remainder of the meeting and for any adjournment of that meeting unless a new record date is or must be set for that adjourned meeting. Subject to the foregoing, the determination of the voting groups entitled to vote (as required by law), and the quorum and voting requirements applicable thereto, must be made separately for each matter being considered at a meeting. In the case of any meeting of shareholders that is adjourned more than once because of the failure of a quorum to attend, those who attend the third convening of such meeting, although less than a quorum, shall nevertheless constitute a quorum for the purpose of electing directors, provided that the percentage of shares represented at the third convening of such meeting shall not be less than one-third of the shares entitled to vote. If a quorum exists, action on a matter (other than the election of directors) is approved by a voting group if the votes cast within the voting group favoring the action exceed the votes cast within the voting group opposing the action unless a greater number of affirmative votes is required by law or by the Articles of Incorporation. 1.5 Adjourned Meetings. An adjournment or adjournments of any shareholders' meeting, whether by reason of the failure of a quorum to attend or otherwise, may be taken to such date, time, and place as the chairman of the meeting may determine without new notice being given if the date, time, and place are announced at the meeting at which the adjournment is taken. However, if the adjournment is for more than one hundred twenty (120) days from the -4- 9 date set for the original meeting, a new record date for the adjourned meeting shall be fixed and a new notice of the adjourned meeting shall be given to each shareholder of record entitled to vote at the adjourned meeting, in accordance with the provisions of Section 1.3 of these Bylaws. At any adjourned meeting, the corporation may transact any business which might have been transacted at the original meeting. Any meeting at which directors are to be elected shall be adjourned only from day to day until such directors are elected. 1.6 Fixing Record Date. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders (or, subject to Section 1.5 above, any adjournment thereof), the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than seventy (70) days prior to the meeting. If no such record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, then the day before the first notice is delivered to shareholders shall be the record date for such determination of shareholders. If no notice is given because all shareholders entitled to notice have waived notice, then the record date for the determination of shareholders entitled to notice of or to vote at a meeting shall be the date on which the last such waiver of notice was obtained. When a determination of shareholders entitled to vote at any meeting of shareholders has been made as provided in this section, such determination shall apply to any adjournment thereof, except as provided in Section 1.5 of these Bylaws. If no notice is given because all shareholders entitled to notice have signed a consent as described in Section 1.9 below, the record date for determining shareholders entitled to take action without a meeting is the date the first shareholder signs the consent. 1.7 Shareholders' List for Meeting. The corporation shall cause to be prepared an alphabetical list of the names of all of its shareholders on the record date who are entitled to notice of a shareholders' meeting or any adjournment thereof. The list must be arranged by voting group (and within each voting group by class or series of shares) and show the address of and the number of shares held by each shareholder. The shareholders' list must be available for inspection by any shareholder, beginning ten (10) days prior to the meeting and continuing through the meeting, at the principal office of the corporation or at a place identified in the meeting notice in the city where the meeting will be held. Such list shall be produced and kept open at the time and place of the meeting. During such ten-day period, and during the whole time of the meeting, the shareholders' list shall be subject to the inspection of any shareholder, or the shareholder's agent or attorney. In cases where the record date is fewer than ten (10) days prior to the meeting because notice has been waived by all shareholders, the Secretary shall keep such record available for a period from the date the first waiver of notice was delivered to the date of the meeting. Failure to comply with the requirements of this section shall not affect the validity of any action taken at the meeting. 1.8 Ratification. Subject to the requirements of RCW 23B.08.730 and 23B.19.040, any contract, transaction, or act of the corporation or of any director or officer of the corporation that shall be authorized, approved, or ratified by the affirmative vote of a majority of shares represented at a meeting at which a quorum is present shall, insofar as permitted by law, be as valid and as binding as though ratified by every shareholder of the corporation. -5- 10 1.9 Action by Shareholders Without a Meeting. Any action which may be or which is required by law to be taken at any meeting of shareholders may be taken, without a meeting or notice of a meeting, if one or more consents in writing, setting forth the action so taken, are signed by all of the shareholders entitled to vote or, in the place of any one or more of such shareholders, by a person holding a valid proxy to vote with respect to the subject matter thereof, and are delivered to the corporation for inclusion in the minutes or filing with the corporate records. If notice of the proposed action to be taken by unanimous consent of the voting shareholders is required by law to be given to nonvoting shareholders, the corporation must give its nonvoting shareholders written notice of the proposed action at least ten (10) days before the action is taken. The notice must contain or be accompanied by the same material that, by law, would have been required to be sent to nonvoting shareholders in a notice of meeting at which the proposed action would have been submitted to such shareholders for action. Action taken by unanimous written consent is effective when all consents are in possession of the corporation, unless the consent specifies a later effective date. Such consent shall have the same force and effect as a meeting vote of shareholders and may be described as such in any articles or other document filed with the Secretary of State of the State of Washington. 1.10 Telephonic Meetings. Shareholders may participate in a meeting by means of a conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other at the same time, and participation by such means shall constitute presence in person at a meeting. ARTICLE II BOARD OF DIRECTORS 2.1 Responsibility of Board of Directors. The business and affairs and property of the corporation shall be managed under the direction of a Board of Directors. A director shall discharge the duties of a director, including duties as a member of a committee, in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director reasonably believes to be in the best interests of the corporation. In discharging the duties of a director, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: (a) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented; (b) legal counsel, public accountants, or other persons as to matters the director reasonably believes are within the person's professional or expert competence; or (c) a committee of the Board of Directors of which the director is not a member, if the director reasonably believes the committee merits confidence. A director is not acting in good faith if the director has knowledge concerning the matter in question that makes reliance otherwise permitted above unwarranted. The creation of, delegation of authority to, or action by a committee does not alone constitute compliance by a director with the standards of conduct imposed by law upon directors. A director is not liable for any action taken as a director, or any failure to take any action, if the director performed the duties of the director's office in compliance with this section. -6- 11 2.2 Number of Directors; Qualification. The Board shall be composed of not less than two nor more than seven directors, the specific number to be set by resolution of the Board or the shareholders. No reduction of the authorized number of directors shall have the effect of removing any director before that director's term of office expires. If a greater or lesser number of directors than is specified in this section is elected by the shareholders, then election of that number shall automatically be deemed to constitute an amendment to these Bylaws. No director need be a shareholder of the corporation or a resident of Washington. Each director must be at least eighteen (18) years of age. 2.3 Election of Directors; Nominations. 2.3.1 Election and Term of Office. At the first annual meeting of shareholders and at each annual meeting thereafter, the shareholders shall elect directors. Except in the case of death, resignation or removal, each director shall hold office until the next succeeding annual meeting or, in the case of staggered terms as permitted by RCW 23B.08.060, for the term for which he/she is elected, and in each case until his/her successor shall have been elected and qualified. 2.3.2 Nominations for Directors. (a) Nominations of candidates for election as directors at an annual meeting of shareholders may only be made (i) by, or at the direction of, the Board of Directors or (ii) by any shareholder of the corporation who is entitled to vote at the meeting and who complies with the procedures set forth in the remainder of this Section 2.3.2. (b) If a shareholder proposes to nominate one or more candidates for election as directors at an annual meeting, the shareholder must have given timely notice thereof in writing to the Secretary of the corporation. To be timely, a shareholder's notice must be delivered to, or mailed and received at, the principal office of the corporation not less than one hundred twenty (120) days prior to the first anniversary of the date that the Company's proxy statement was released to shareholders in connection with the previous year's annual meeting, or, if the date of this year's annual meeting has been changed by more than thirty (30) days from the date of the previous year's meeting, then the deadline is a reasonable time before the Company begins to print and mail its proxy materials. (c) A shareholder's notice to the Secretary under Section 2.3.2(b) shall set forth, as to each person whom the shareholder proposes to nominate for election as a director (i) the name, age, business address and residence address of such person, (ii) the principal occupation or employment of such person, (iii) the number and class of shares of stock of the corporation that are beneficially owned on the date of such notice by such person and (iv) if the corporation at such time has any security registered pursuant to Section 12 of the Exchange Act, any other information relating to such person required to be disclosed in solicitations of proxies with respect to nominees for election as directors pursuant to Regulation 14A under the Exchange Act, including but not limited to information required to be disclosed by Schedule 14A of Regulation 14A, and any other information that the shareholder would be required to file with -7- 12 the Securities and Exchange Commission in connection with the shareholder's nomination of such person as a candidate for director or the shareholder's opposition to any candidate for director nominated by, or at the direction of, the Board of Directors. In addition to the above information, a shareholder's notice to the Secretary under Section 2.3.2(b) shall (A) set forth (i) the name and address, as they appear on the corporation's books, of the shareholder and of any other shareholders that the shareholder knows or anticipates will support any candidate or candidates nominated by the shareholder and (ii) the number and class of shares of stock of the corporation that are beneficially owned on the date of such notice by the shareholder and by any such other shareholders and (B) be accompanied by a written statement, signed and acknowledged by each candidate nominated by the shareholder, that the candidate agrees to be so nominated and to serve as a director of the corporation if elected at the annual meeting. (d) The Board of Directors, or a designated committee thereof, may reject any shareholder's nomination of one or more candidates for election as directors if the nomination is not made pursuant to a shareholder's notice timely given in accordance with the terms of Section 2.3.2(b). If the Board of Directors, or a designated committee thereof, determines that the information provided in a shareholder's notice does not satisfy the requirements of Section 2.3.2(c) in any material respect, the Secretary of the corporation shall notify the shareholder of the deficiency in the notice. The shareholder shall have an opportunity to cure the deficiency by providing additional information to the Secretary within such period of time, not to exceed five (5) days from the date such deficiency notice is given to the shareholder, as the Board of Directors or such committee shall reasonably determine. If the deficiency is not cured within such period, or if the Board of Directors or such committee determines that the additional information provided by the shareholder, together with information previously provided, does not satisfy the requirements of Section 2.3.2(c) in any material respect, then the Board of Directors or such committee may reject the shareholder's notice. (e) Notwithstanding the procedures set forth in Section 2.3.2(d), if a shareholder proposes to nominate one or more candidates for election as directors at an annual meeting, and neither the Board of Directors nor any committee thereof has made a prior determination of whether the shareholder has complied with the procedures set forth in this Section 2.3.2 in connection with such nomination, then the chairman of the annual meeting shall determine and declare at the annual meeting whether the shareholder has so complied. If the chairman determines that the shareholder has so complied, then the chairman shall so state and ballots shall be provided for use at the meeting with respect to such nomination. If the chairman determines that the shareholder has not so complied, then, unless the chairman, in his sole and absolute discretion, determines to waive such compliance, the chairman shall state that the shareholder has not so complied and the defective nomination shall be disregarded. 2.4 Vacancies. Except as otherwise provided by law, any vacancy occurring in the Board of Directors (whether caused by resignation, death, or otherwise) may be filled by the affirmative vote of a majority of the directors present at a meeting of the Board at which a quorum is present, or, if the directors in office constitute less than a quorum, by the affirmative vote of a majority of all of the directors in office. Notice shall be given to all of the remaining -8- 13 directors that such vacancy will be filled at the meeting. However, if the vacant office was held by a director elected by a voting group composed of less than all of the voting shareholders, then the Board of Directors shall not have the power to fill such vacancy. A director elected to fill any vacancy shall hold office until the next meeting of shareholders at which directors are elected, and until his/her successor shall have been elected and qualified. 2.5 Removal. One or more members of the Board of Directors (including the entire Board) may be removed, with or without cause, at a special meeting of shareholders called expressly for that purpose. A director (or the entire Board) may be removed if the number of votes cast in favor of removing such director (or the entire Board) exceeds the number of votes cast against removal; provided that, if a director (or the entire Board) has been elected by one or more voting groups, only those voting groups may participate in the vote as to removal. However, if the Articles of Incorporation grant shareholders the right to cumulate their votes in the election of directors, a director may not be removed if a number of votes sufficient to elect such director under cumulative voting (computed on the basis of the number of votes actually cast at the meeting on the question of removal) is cast against such director's removal. 2.6 Resignation. A director may resign at any time by delivering written notice to the Board of Directors, its Chairman, the President, or the Secretary. A resignation is effective when the notice is delivered unless the notice specifies a later effective date. 2.7 Annual Meeting. The first meeting of each newly elected Board of Directors shall be known as the annual meeting thereof and shall be held without notice immediately after the annual shareholders' meeting or any special shareholders' meeting at which a Board is elected. Such meeting shall be held at the same place as such shareholders' meeting unless some other place shall be specified by resolution of the shareholders. 2.8 Regular Meetings. Regular meetings of the Board of Directors may be held at such place, day, and time as shall from time to time be fixed by resolution of the Board without notice other than the delivery of such resolution as provided in Section 2.10 below. 2.9 Special Meetings. Special meetings of the Board of Directors may be called by the President or the Chairman of the Board (if one be appointed) or any two or more directors, to be held at such place, day, and time as specified by the person or persons calling the meeting. 2.10 Notice of Meeting. Notice of the place, day, and time of any meeting of the Board of Directors for which notice is required shall be given, at least two (2) days preceding the day on which the meeting is to be held, by the Secretary or an Assistant Secretary, or by the person calling the meeting, in any manner permitted by law, including orally. Any oral notice given by personal communication over the telephone or otherwise may be communicated either to the director or to a person at the office of the director who, the person giving the notice has reason to believe, will promptly communicate it to the director. Notice shall be deemed to have been given on the earliest of (a) the day of actual receipt, (b) five (5) days after the day on which written notice is deposited in the United States mail, as evidenced by the postmark, with first-class postage prepaid, and correctly addressed, or (c) on the date shown on the return receipt, if -9- 14 sent by registered or certified mail, return receipt requested, and the receipt is signed by or on behalf of the addressee. No notice of any regular meeting need be given if the place, day, and time thereof have been fixed by resolution of the Board of Directors and a copy of such resolution has been delivered to every director at least two (2) days or deposited in the United States mail, as evidenced by the postmark, with first-class postage prepaid, and correctly addressed at least five (5) days preceding the day of the first meeting held in pursuance thereof. Notice of a meeting of the Board of Directors need not be given to any director if it is waived by the director in writing, whether before or after such meeting is held. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the Board of Directors need be specified in the notice or waiver of notice of such meeting unless required by law, the Articles of Incorporation, or these Bylaws. A director's attendance at or participation in a meeting shall constitute a waiver of notice of such meeting except when a director attends or participates in a meeting for the express purpose of objecting on legal grounds prior to or at the beginning of the meeting (or promptly upon the director's arrival) to the holding of the meeting or the transaction of any business and does not thereafter vote for or assent to action taken at the meeting. Any meeting of the Board of Directors shall be a legal meeting without any notice thereof having been given if all of the directors have received valid notice thereof, are present without objecting, or waive notice thereof, or any combination thereof. 2.11 Quorum of Directors. Except in particular situations where a lesser number is expressly permitted by law, and unless a greater number is required by the Articles of Incorporation, a majority of the number of directors specified in or fixed in accordance with these Bylaws shall constitute a quorum for the transaction of business, and the affirmative vote of a majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors. If the number of directors in office at any time is less than the number specified in or fixed in accordance with these Bylaws, then a quorum shall consist of a majority of the number of directors in office; provided that in no event shall a quorum consist of fewer than one-third of the number specified in or fixed in accordance with these Bylaws. Directors at a meeting of the Board of Directors at which a quorum is initially present may continue to transact business notwithstanding the withdrawal of directors, provided such withdrawal does not reduce the number of directors attending the meeting below the level of a quorum. A majority of the directors present, whether or not constituting a quorum, may adjourn any meeting of the Board of Directors to another time and place. If the meeting is adjourned for more than forty-eight (48) hours, then notice of the time and place of the adjourned meeting shall be given before the adjourned meeting takes place, in the manner specified in Section 2.10 of these Bylaws, to the directors who were not present at the time of the adjournment. -10- 15 2.12 Dissent by Directors. Any director who is present at any meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action taken unless the director objects at the beginning of the meeting (or promptly upon the director's arrival) to the holding of, or the transaction of business at, the meeting; or unless the director's dissent or abstention shall be entered in the minutes of the meeting; or unless the director delivers written notice of the director's dissent or abstention to the presiding officer of the meeting before the adjournment thereof or to the corporation within a reasonable time after the adjournment of the meeting. Such right to dissent or abstention shall not be available to any director who votes in favor of such action. 2.13 Action by Directors Without a Meeting. Any action required by law to be taken or which may be taken at a meeting of the Board of Directors may be taken without a meeting if one or more consents in writing, setting forth the action so taken, shall be signed either before or after the action so taken by all of the directors and delivered to the corporation for inclusion in the minutes or filing with the corporate records. Such consent shall have the same effect as a meeting vote. Action taken under this section is effective when the last director signs the consent, unless the consent specifies a later effective date. 2.14 Telephonic Meetings. Except as may be otherwise restricted by the Articles of Incorporation, members of the Board of Directors may participate in a meeting of the Board by any means of communication by which all directors participating in the meeting may simultaneously hear each other during the meeting. Participation by such means shall constitute presence in person at a meeting. 2.15 Compensation. By resolution of the Board of Directors, the directors may be paid their expenses, if any, and may be paid a fixed sum or a stated salary as a director, for attendance at each meeting of the Board. No such payment shall preclude any director from serving the corporation in any other capacity and receiving compensation therefor. 2.16 Committees. The Board of Directors, by resolution adopted by the greater of (a) a majority of all of the directors in office, or (b) the number of directors required by the Articles of Incorporation or these Bylaws to take action may from time to time create, and appoint individuals to, one or more committees, each of which must have at least two (2) members. If a committee is formed for the purpose of exercising functions of the Board, the committee must consist solely of directors. If the only function of a committee is to study and make recommendations for action by the full Board, the committee need not consist of directors. Members of a committee composed solely of directors, in fulfilling their standard of conduct, may rely upon Section 2.1 above. Committees of directors may exercise the authority of the Board of Directors to the extent specified by such resolution or in the Articles of Incorporation or these Bylaws. However, no committee shall: (a) authorize or approve a distribution (as defined in RCW 23B.01.400) except according to a general formula or method prescribed by the Board of Directors; -11- 16 (b) approve or propose to shareholders action that by law is required to be approved by shareholders; (c) fill vacancies on the Board of Directors or on any of its committees; (d) amend the Articles of Incorporation; (e) adopt, amend, or repeal Bylaws; (f) approve a plan of merger not requiring shareholder approval; or (g) authorize or approve the issuance or sale or contract for sale of shares, or determine the designation and relative rights, preferences, and limitations of a class or series of shares, except that the Board of Directors may authorize a committee of directors (or a senior executive officer of the corporation) to do so within limits specifically prescribed by the Board of Directors. Committees shall be governed by the same provisions as govern the meetings, actions without meetings, notice and waiver of notice, quorum and voting requirements, and standards of conduct of the Board of Directors. The Executive Committee (if one be established) shall meet periodically between meetings of the full Board. All committees shall keep regular minutes of their meetings and shall cause them to be recorded in books kept for that purpose at the office of the corporation. ARTICLE III OFFICERS 3.1 Appointment. The officers of the corporation shall be appointed annually by the Board of Directors at its annual meeting held after the annual meeting of the shareholders. If the appointment of officers is not held at such meeting, such appointment shall be held as soon thereafter as a Board meeting conveniently may be held. Except in the case of death, resignation, or removal, each officer shall hold office until the next annual meeting of the Board and until his/her successor is appointed and qualified. 3.2 Qualification. None of the officers of the corporation need be a director, except as specified below. Any two or more of the corporate offices may be held by the same person. 3.3 Officers Enumerated. Except as otherwise provided by resolution of the Board of Directors, the officers of the corporation and their respective powers and duties shall be as follows: 3.3.1 Chairman of the Board. The Chairman of the Board (if such an officer be appointed) shall be a director and shall perform such duties as shall be assigned to him/her by the Board of Directors and in any employment agreement. The Chairman shall preside at all meetings of the shareholders and at all meetings of the Board at which he/she is present. The Chairman may sign deeds, mortgages, bonds, contracts, and other instruments, except when the -12- 17 signing thereof has been expressly delegated by the Board or by these Bylaws to some other officer or agent of the corporation or is otherwise required by law to be signed by some other officer or in some other manner. If the President dies or becomes unable to act, the Chairman shall perform the duties of the President, except as may be limited by resolution of the Board of Directors, with all the powers of and subject to all the restrictions upon the President. 3.3.2 President. Subject to such supervisory powers as may be given by the Board of Directors to the Chairman of the Board (if such an officer be appointed), the President shall be the chief executive officer of the corporation unless some other officer is so designated by the Board and, subject to the control of the Board and the Executive Committee (if one be established), shall supervise and control all of the assets, business, and affairs of the corporation. The President may sign certificates for shares of the corporation, deeds, mortgages, bonds, contracts, and other instruments, except when the signing thereof has been expressly delegated by the Board or by these Bylaws to some other officer or agent of the corporation or is otherwise required by law to be signed by some other officer or in some other manner. The President shall vote the shares owned by the corporation in other corporations, domestic or foreign, unless otherwise prescribed by law or resolution of the Board. In general, the President shall perform all duties incident to the office of President and such other duties as may be prescribed by the Board from time to time. In the absence of the Chairman of the Board, the President, if a director, shall preside over all meetings of the shareholders and over all meetings of the Board of Directors. The President shall have the authority to appoint one or more Assistant Secretaries and Assistant Treasurers, as he/she deems necessary. 3.3.3 Vice Presidents. If no Chairman of the Board has been appointed, in the absence or disability of the President, the Vice Presidents, if any, in order of their rank as fixed by the Board of Directors or, if not ranked, a Vice President designated by the Board shall perform all the duties of the President and when so acting shall have all the powers of, and be subject to all the restrictions upon, the President; provided that no such Vice President shall assume the authority to preside as Chairman of meetings of the Board unless such Vice President is a member of the Board. The Vice Presidents shall have such other powers and perform such other duties as from time to time may be respectively prescribed for them by the Board, these Bylaws, the President, or the Chairman of the Board (if one be appointed). 3.3.4 Secretary. The Secretary shall: (a) have responsibility for preparing minutes of meetings of the shareholders and the Board of Directors and for authenticating records of the corporation; (b) see that all notices are duly given in accordance with the provisions of Sections 1.3, 1.5, 2.8, and 2.10 of these Bylaws and as required by law; (c) be custodian of the corporate records and seal of the corporation, if one be adopted; (d) keep a register of the post office address of each shareholder and director; -13- 18 (e) attest certificates for shares of the corporation; (f) have general charge of the stock transfer books of the corporation; (g) when required by law or authorized by resolution of the Board of Directors, sign with the President, or other officer authorized by the President or the Board, deeds, mortgages, bonds, contracts, and other instruments; and (h) in general, perform all duties incident to the office of Secretary and such other duties as from time to time may be assigned by the President or the Board of Directors. In the absence of the Secretary, an Assistant Secretary may perform the duties of the Secretary. 3.3.5 Treasurer. If required by the Board of Directors, the Treasurer shall give a bond for the faithful discharge of his/her duties in such sum and with such surety or sureties as the Board shall determine. The Treasurer shall: (a) have charge and custody of and be responsible for all funds and securities of the corporation; (b) receive and give receipts for moneys due and payable to the corporation from any source whatsoever and deposit all such moneys in the name of the corporation in banks, trust companies, or other depositories selected in accordance with the provisions of these Bylaws; and (c) in general, perform all of the duties incident to the office of Treasurer and such other duties as from time to time may be assigned by the President or the Board of Directors. In the absence of the Treasurer, an Assistant Treasurer may perform the duties of the Treasurer. 3.4 Delegation. In case of the absence or inability to act of any officer of the corporation and of each person herein authorized to act in his/her place, the Board of Directors may from time to time delegate the powers and duties of such officer to any other officer or other person whom it may select. 3.5 Resignation. Any officer may resign at any time by delivering notice to the corporation. Any such resignation shall take effect at the time the notice is delivered unless the notice specifies a later effective date. Unless otherwise specified therein, acceptance of such resignation by the corporation shall not be necessary to make it effective. Any resignation shall be without prejudice to the rights, if any, of the corporation under any contract to which the officer is a party. -14- 19 3.6 Removal. Any officer or agent may be removed by the Board with or without cause. An officer empowered to appoint another officer or assistant officer also has the power with or without cause to remove any officer he/she would have the power to appoint whenever in his/her judgment the best interests of the corporation would be served thereby. The removal of an officer or agent shall be without prejudice to the contract rights, if any, of the corporation or the person so removed. Appointment of an officer or agent shall not of itself create contract rights. 3.7 Vacancies. A vacancy in any office because of death, resignation, removal, disqualification, creation of a new office, or any other cause may be filled by the Board of Directors for the unexpired portion of the term or for a new term established by the Board. 3.8 Other Officers and Agents. One or more Vice Presidents and such other officers and assistant officers as may be deemed necessary or advisable may be appointed by the Board of Directors or, to the extent provided in Section 3.3.2 above, by the President. Such other officers and assistant officers shall hold office for such periods, have such authorities, and perform such duties as are provided in these Bylaws or as may be provided by resolution of the Board. Any officer may be assigned by the Board any additional title that the Board deems appropriate. The Board may delegate to any officer or agent the power to appoint any such assistant officers or agents and to prescribe their respective terms of office, authorities, and duties. 3.9 Compensation. Compensation, if any, for officers and other agents and employees of the corporation shall be determined by the Board of Directors, or by the President to the extent such authority may be delegated to his/her by the Board. No officer shall be prevented from receiving compensation in such capacity by reason of the fact that he/she is also a director of the corporation. 3.10 General Standards for Officers. Officers with discretionary authority shall discharge their duties under that authority in accordance with the same standards of conduct applicable to directors as specified in Section 2.1 above (except for subsection (c) thereof). ARTICLE IV CONTRACTS, CHECKS AND DRAFTS 4.1 Contracts. The Board of Directors may authorize any officer or officers or agent or agents to enter into any contract or execute and deliver any instrument in the name of and on behalf of the corporation. Such authority may be general or confined to specific instances. Subject to the limitations set forth in RCW 23B.08.700 through 23B.08.730 and 23B.19.040, to the extent applicable: (a) The corporation may enter into contracts and otherwise transact business as vendor, purchaser, lender, borrower, or otherwise with its directors and shareholders and with corporations, associations, firms, and entities in which they are or may be or become interested as directors, officers, shareholders, members, or otherwise. -15- 20 (b) Any such contract or transaction shall not be affected or invalidated or give rise to liability by reason of the director's or shareholder's having an interest in the contract or transaction. 4.2 Checks, Drafts, Etc. All checks, drafts, and other orders for the payment of money, notes, and other evidences of indebtedness issued in the name of the corporation shall be signed by such officer or officers or agent or agents of the corporation and in such manner as may be determined from time to time by resolution of the Board of Directors. 4.3 Deposits. All funds of the corporation not otherwise employed shall be deposited from time to time to the credit of the corporation in such banks, trust companies, or other depositories as the Treasurer, subject to the direction of the Board of Directors, may select. ARTICLE V STOCK 5.1 Issuance of Shares. No shares of the corporation shall be issued unless authorized by the Board of Directors, which authorization shall include the maximum number of shares to be issued, the consideration to be received for each share, and, if the consideration is in a form other than cash, the determination of the value of the consideration. 5.2 Certificates of Stock. All shares of the corporation shall be represented by certificates in such form, not inconsistent with the Articles of Incorporation, as the Board of Directors may from time to time prescribe. Certificates of stock shall be issued in numerical order and shall be signed by the President or a Vice President, attested to by the Secretary or an Assistant Secretary, and sealed with the corporate seal, if any. If any certificate is manually signed by a transfer agent or a transfer clerk and by a registrar, the signatures of the President, Vice President, Secretary or Assistant Secretary upon that certificate may be facsimiles that are engraved or printed. If any person who has signed or whose facsimile signature has been placed on a certificate no longer is an officer when the certificate is issued, the certificate may nevertheless be issued with the same effect as if the person were still an officer at the time of its issue. Every certificate of stock shall state: (a) The state of incorporation; (b) The name of the registered holder of the shares represented thereby; (c) The number and class of shares, and the designation of the series, if any, which such certificate represents; (d) If the corporation is authorized to issue different classes of shares or different series within a class, either a summary of (on the face or back of the certificate), or a statement that the corporation will furnish to any shareholder upon written request and without charge a summary of, the designations, relative rights, preferences, and limitations applicable to -16- 21 each class and the variations in rights, preferences and limitations determined for each series, and the authority of the Board of Directors to determine variations for future series; and (e) If the shares are subject to transfer or other restrictions under applicable securities laws or contracts with the corporation, either a complete description of or a reference to the existence and general nature of such restrictions on the face or back of the certificate. 5.3 Stock Records. The corporation or its agent shall maintain at the registered office or principal office of the corporation, or at the office of the transfer agent or registrar of the corporation, if one be designated by the Board of Directors, a record of its shareholders, in a form that permits preparation of a list of the names and addresses of all shareholders in alphabetical order by class of shares showing the number and class of shares held by each. The person in whose name shares stand on the books of the corporation shall be deemed by the corporation to be the owner thereof for all purposes. 5.4 Restrictions on Transfer. The Board of Directors shall have the authority to issue shares of the capital stock of this corporation and the certificates therefor subject to such transfer restrictions and other limitations as it may deem necessary to promote compliance with applicable federal and state securities laws, and to regulate the transfer thereof in such manner as may be calculated to promote such compliance or to further any other reasonable purpose. Except to the extent that the corporation has obtained an opinion of counsel acceptable to the corporation that transfer restrictions are not required under applicable securities laws, all certificates representing shares of the corporation shall bear the following legend (or a legend of substantially the same import) on the face of the certificate or on the reverse of the certificate if a reference to the legend is contained on the face: NOTICE: RESTRICTIONS ON TRANSFER The securities represented by this certificate have not been registered under the Securities Act of 1933, or any state 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 or its legal counsel. 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. 5.5 Transfers. Shares of stock may be transferred by delivery of the certificates therefor, accompanied by: (a) an assignment in writing on the back of the certificate, or an assignment separate from certificate, or a written power of attorney to sell, assign, and transfer the same, signed by the record holder of the certificate; and -17- 22 (b) such additional documents, instruments, and other items of evidence as may be reasonably necessary to satisfy the requirements of any transfer restrictions applicable to such shares, whether arising under applicable securities or other laws, or by contract, or otherwise. Except as otherwise specifically provided in these Bylaws, no shares of stock shall be transferred on the books of the corporation until the outstanding certificate therefor has been surrendered to the corporation. All certificates surrendered to the corporation for transfer shall be canceled, and no new certificate shall be issued until the former certificate for a like number of shares shall have been surrendered and canceled, except that, in case of a lost, destroyed, or mutilated certificate, a new one may be issued therefor upon such terms (including indemnity to the corporation) as the Board of Directors may prescribe. ARTICLE VI RECORDS OF CORPORATE MEETINGS The corporation shall keep, as permanent records, minutes of all meetings of its shareholders and Board of Directors, a record of all actions taken by the shareholders or Board of Directors without a meeting, and a record of all actions taken by a committee of the Board of Directors exercising the authority of the Board of Directors on behalf of the corporation. The corporation shall keep at its principal office a copy of the minutes of all shareholders' meetings that have occurred, and records of all action taken by shareholders without a meeting, within the past three (3) years. Any person dealing with the corporation may rely upon a copy of any of the records of the proceedings, resolutions, or votes of the Board or shareholders when certified by the President or Secretary. ARTICLE VII FINANCIAL MATTERS The corporation shall maintain appropriate accounting records at its principal office and shall prepare the annual financial statements required by RCW 23B.16.200. Except to the extent otherwise expressly determined by the Board of Directors or otherwise required by law, the accounting records of the corporation shall be kept and prepared in accordance with generally accepted accounting principles applied on a consistent basis from period to period. The fiscal year of the corporation shall be the calendar year unless otherwise expressly determined by the Board of Directors. ARTICLE VIII DISTRIBUTIONS The Board of Directors may from time to time authorize, and the corporation may make, distributions (as defined in RCW 23B.01.400) to its shareholders to the extent permitted by RCW 23B.06.400, subject to any limitation in the Articles of Incorporation. A director who votes for or assents to a distribution made in violation of RCW 23B.06.400 is personally liable to the corporation for the amount of the distribution that exceeds that which could have been -18- 23 distributed without violating RCW 23B.06.400 if it is established that the director did not perform the director's duties in compliance with Section 2.1 above. ARTICLE IX CORPORATE SEAL The Board of Directors may, but shall not be required to, adopt a corporate seal for the corporation in such form and with such inscription as the Board may determine. If such a corporate seal shall at any time be so adopted, the application of or the failure to apply such seal to any document or instrument shall have no effect upon the validity or invalidity of such document or instrument under otherwise applicable principles of law. ARTICLE X INDEMNIFICATION As provided by Section 5.4 of the Articles of Incorporation: 10.1 Definitions. The capitalized terms in this Article X shall have the meanings set forth in RCW 23B.08.500. 10.2 Mandatory Indemnification. The Corporation shall indemnify and hold harmless each individual who is or was serving as a Director or officer of the Corporation or who, while serving as a Director or officer of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise, against any and all Liability incurred with respect to any Proceeding to which the individual is or is threatened to be made a Party because of such service, and shall make advances of reasonable Expenses with respect to such Proceeding, to the fullest extent permitted by law, without regard to the limitations in RCW 23B.08.510 through 23B.08.550; provided that no such indemnity shall indemnify any Director or officer from or on account of (a) acts or omissions of the Director or officer finally adjudged to be intentional misconduct or a knowing violation of law; (b) conduct of the Director or officer finally adjudged to be in violation of RCW 23B.08.310; or (c) any transaction with respect to which it was finally adjudged that such Director or officer personally received a benefit in money, property, or services to which the Director or officer was not legally entitled. 10.3 Insurance. The Corporation may purchase and maintain insurance on behalf of an individual who is or was a director, officer, employee, or agent of the Corporation or, who, while a director, officer, employee, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, or agent of another foreign or domestic corporation, partnership, joint venture, trust, employee benefit plan, or other enterprise against Liability asserted against or incurred by the individual in that capacity or arising from the individual's status as a director, officer, employee, or agent, whether or not the Corporation would have power to indemnify the individual against such Liability under RCW 23B.08.510 or 23B.08.520. -19- 24 10.4 Changes in Law. If, after the effective date of this Article X, the Act is amended to authorize further indemnification of Directors or officers, then Directors and officers of the Corporation shall be indemnified to the fullest extent permitted by the Act as so amended. 10.5 Exclusivity; Nature of Rights; Amendment. To the extent permitted by law, the rights to indemnification and advance of reasonable Expenses conferred in this Article X shall not be exclusive of any other right which any individual may have or hereafter acquire under any statute, provision of the Bylaws, agreement, vote of shareholders or disinterested directors, or otherwise. The right to indemnification conferred in this Article X shall be a contract right upon which each Director or officer shall be presumed to have relied in determining to serve or to continue to serve as such. Any amendment to or repeal of this Article X shall not adversely affect any right or protection of a Director or officer of the Corporation for or with respect to any acts or omissions of such Director or officer occurring prior to such amendment or repeal. ARTICLE XI MISCELLANY 11.1 Communications by Facsimile. Whenever these Bylaws require notice, consent, or other communication to be delivered for any purpose, transmission by phone, wire, or wireless equipment which transmits a facsimile of such communication shall constitute sufficient delivery for such purpose. Such communication shall be deemed to have been received by or in the possession of the addressee upon completion of the transmission. 11.2 Inspector of Elections. Before any annual meeting of shareholders, the Board of Directors may appoint an inspector of elections to act at the meeting and any adjournment thereof. If no inspector of elections is so appointed by the Board, then the chairman of the meeting may appoint an inspector of elections to act at the meeting. If any person appointed as inspector fails to appear or fails or refuses to act, then the chairman of the meeting may, and upon the request of any shareholder or a shareholder's proxy shall, appoint a person to fill that vacancy. Such inspector of elections shall: (a) determine the number of shares outstanding and the voting power of each, the number of shares represented at the meeting, the existence of a quorum, and, with the advice of legal counsel to the corporation, the authenticity, validity, and effect of proxies pursuant to RCW 23B.07.220 and 23B.07.240 and any procedure adopted by the Board of Directors pursuant to RCW 23B.07.230; (b) receive votes, ballots, or consents; (c) hear and determine all challenges and questions in any way arising in connection with the right to vote; (d) count and tabulate all votes or consents; -20- 25 (e) determine the result; and (f) do any other acts that may be proper to conduct the election or vote with fairness to all shareholders. 11.3 Rules of Order. The rules contained in the most recent edition of Robert's Rules of Order, Revised, shall govern all meetings of shareholders and directors where those rules are not inconsistent with the Articles of Incorporation or Bylaws, subject to the following: (a) The chairman of the meeting shall have absolute authority over matters of procedure, and there shall be no appeal from the ruling of the chairman. If the chairman in his/her absolute discretion deems it advisable to dispense with the rules of parliamentary procedure for any meeting or any part thereof, the chairman shall so state and shall clearly state the rules under which the meeting or appropriate part thereof shall be conducted. (b) If disorder should arise which prevents continuation of the legitimate business of the meeting, the chairman may quit the chair and announce the adjournment of the meeting; upon so doing, the meeting shall be deemed immediately adjourned, subject to being reconvened in accordance with Section 1.5 or 2.11 of these Bylaws, as the case may be. (c) The chairman may ask or require that anyone not a bona fide shareholder or proxy leave the meeting of shareholders. (d) A resolution or motion at a meeting of shareholders shall be considered for vote only if proposed by a shareholder or duly authorized proxy and seconded by an individual who is a shareholder or duly authorized proxy other than the individual who proposed the resolution or motion. 11.4 Construction. Within these Bylaws, words of any gender shall be construed to include any other gender, and words in the singular or plural number shall be construed to include the plural or singular, respectively, unless the context otherwise requires. 11.5 Severability. If any provision of these Bylaws or any application thereof shall be invalid, unenforceable, or contrary to applicable law, the remainder of these Bylaws, and the application of such provisions to individuals or circumstances other than those as to which it is held invalid, unenforceable, or contrary to applicable law, shall not be affected thereby. ARTICLE XII AMENDMENT OF BYLAWS Subject to the requirements of RCW 23B.10.210 relating to supermajority quorum provisions for the Board of Directors, the Bylaws of the corporation may be amended or repealed, or new Bylaws may be adopted, by: (a) the shareholders, even though the Bylaws may also be amended or repealed, or new Bylaws may also be adopted, by the Board of Directors; or (b) subject to the power of the shareholders of the corporation to change or repeal the Bylaws, the Board of Directors, unless such power is reserved, by the Articles of Incorporation or by law, -21- 26 exclusively to the shareholders in whole or in part or unless the shareholders, in amending or repealing a particular bylaw, provide expressly that the Board of Directors may not amend or repeal that bylaw. ARTICLE XIII AUTHENTICATION The foregoing Amended and Restated Bylaws were approved, and duly adopted by the Board of Directors of RealNetworks, Inc. on the 16th day of July, 1998. /s/ Kelly Jo MacArthur -------------------------------- Kelly Jo MacArthur, Secretary -22- EX-10.1 4 AMENDED AND RESTATED 1996 STOCK OPTION PLAN 1 EXHIBIT 10.1 REALNETWORKS, INC. AMENDED AND RESTATED 1996 STOCK OPTION PLAN (AS AMENDED AND RESTATED AS OF JULY 16, 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 Common Stock, par value $.001 per share, 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 5 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS DEC-31-1998 JAN-01-1998 SEP-30-1998 53,447 45,130 4,806 1,155 203 107,110 10,562 5,105 114,976 33,795 996 0 0 33 71,902 114,976 0 44,802 0 8,651 63,214 0 0 (23,551) 0 (23,551) 0 0 0 (23,551) (0.74) (0.74)
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