-----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, KDdslVyGQZmv2NoXLikIQkSwiCU1EkH5kR1pEtjdK+qRZVierW4GSZ803CD3RtyF n28veITQBgJfUEO3EAj/zg== 0001032210-99-001100.txt : 19990729 0001032210-99-001100.hdr.sgml : 19990729 ACCESSION NUMBER: 0001032210-99-001100 CONFORMED SUBMISSION TYPE: S-3 PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19990728 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: S-3 SEC ACT: SEC FILE NUMBER: 333-83939 FILM NUMBER: 99672162 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 S-3 1 FORM S-3 As filed with the Securities and Exchange Commission on July 28, 1999 Registration No. 333- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- FORM S-3 REGISTRATION STATEMENT Under The Securities Act of 1933 -------------- REALNETWORKS, INC. (Exact name of Registrant as specified in its charter) -------------- Washington 91-1628146 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 2601 Elliott Avenue Seattle, Washington 98121 (206) 674-2700 (Address, including zip code, and telephone number, including area code, of Registrant's principal executive offices) -------------- Paul Bialek Senior Vice President--Finance and Operations and Chief Financial Officer RealNetworks, Inc. 2601 Elliott Avenue Seattle, Washington 98121 (206) 674-2700 (Name, address, including zip code, and telephone number, including area code, of agent for service) -------------- Copies to: Scott L. Gelband Perkins Coie LLP 1201 Third Avenue, 40th Floor Seattle, Washington 98101-3099 (206) 583-8888 -------------- Approximate date of commencement of proposed sale to the public: As soon as practicable and until 10 days after the effective date of this Registration Statement or until such earlier time that all of the shares registered hereunder have been sold. If the only securities being registered on this Form are to be offered pursuant to dividend or interest reinvestment plans, check the following box. [_] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [X] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] -------------- CALCULATION OF REGISTRATION FEE - --------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------
Proposed Title of Each Class of Amount Maximum Proposed Maximum Amount of Securities to Be to Be Offering Price Aggregate Registration Registered Registered Per Share(1) Offering Price(1) Fee - --------------------------------------------------------------------------------- Common Stock, par value $0.001 per share(2)... 26,666 $83.03 $2,214,078 $616 - ---------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- (1) The price of $83.03 per share, which was the average of the high and low prices of the Registrant's common stock on the Nasdaq National Market on July 27, 1999, is set forth solely for the purpose of calculating the registration fee in accordance with Rule 457(c) of the Securities Act of 1933, as amended. (2) Includes associated preferred stock purchase rights. -------------- The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this preliminary prospectus is not complete and may be + +changed. These securities may not be sold until the registration statement + +filed with the Securities and Exchange Commission is effective. This + +preliminary prospectus is not an offer to sell nor does it seek an offer to + +buy these securities in any jurisdiction where the offer or sale is not + +permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION. DATED JULY 28, 1999 26,666 Shares RealNetworks, Inc. Common Stock ----------- The selling shareholders identified on page 35 of this prospectus may offer for sale up to 26,666 shares of RealNetworks' common stock from time to time in the over-the-counter market through Nasdaq, in privately negotiated transactions, through put or call options relating to the shares, through short sales of the shares or through a combination of such methods of sale. They may sell the shares at fixed prices that may change, at market prices prevailing at the time of sale, at prices relating to prevailing market prices or at negotiated prices. Such transactions may or may not involve brokers or dealers. The selling shareholders may effect such transactions by selling the shares directly to purchasers, through broker-dealers acting as agents for the selling shareholders, or to brokers-dealers who may purchase the shares as principals and thereafter sell such securities from time to time in transactions on any exchange or market on which our securities are listed or quoted, as applicable. Any broker-dealers participating in the distribution of the shares may receive compensation in the form of discounts, concessions or commissions from the selling shareholders and/or the purchasers of the shares for whom such broker- dealers may act as agents or to whom they may sell as principals, or both. The compensation paid to a particular broker-dealer might be in excess of customary commissions. RealNetworks will not receive any of the proceeds from the sale of shares by the selling shareholders. Subject to certain exceptions, RealNetworks will pay all expenses of the registration and sale of the shares. RealNetworks' common stock is quoted on the Nasdaq National Market under the symbol "RNWK". The last reported sale price of the common stock on July 27, 1999 was $80.13 per share. See "Risk Factors" beginning on page 2 to read about certain factors you should consider before buying shares of the common stock. ----------- Our principal executive offices are located at 2601 Elliott Avenue, Seattle, Washington 98121. Our telephone number is (206) 674-2700. ----------- Neither the Securities and Exchange Commission nor any regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. ----------- Prospectus dated , 1999. RISK FACTORS You should carefully consider the risks described below together with all of the other information included in or incorporated by reference into this prospectus before making an investment decision. The risks and uncertainties described below are not the only ones facing our company. If any of the following risks actually occurs, our business, financial condition or operating results could be harmed. In such case, the trading price of our common stock could decline, and you could lose all or part of your investment. We have a limited operating history, which makes it difficult to evaluate our business We were incorporated in February 1994 and have a limited operating history. We have limited financial results on which you can assess our future success. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies in new and rapidly evolving markets, such as streaming media software, media delivery systems and electronic commerce. To address the risks and uncertainties we face, we must: . establish and maintain broad market acceptance of our products and services and convert that acceptance into direct and indirect sources of revenues; . maintain and enhance our brand name; . continue to timely and successfully develop new products, product features and services and increase the functionality and features of existing products; . successfully respond to competition from Microsoft and others; and . develop and maintain strategic relationships to enhance the distribution, features and utility of our products and services. Our business strategy may be unsuccessful and we may be unable to address the risks we face in a cost-effective manner, if at all. Our inability to successfully address these risks will harm our business. We have a history of losses and may never attain profitability We have incurred significant losses since our inception and we may never become profitable. As of June 30, 1999, we had an accumulated deficit of approximately $34.9 million. We devote significant resources to developing, enhancing, selling and marketing our products and services. As a result, we will need to generate significant revenues to achieve and maintain profitability. We may not continue our historical growth or generate sufficient revenues for profitability. If we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis in the future. Our operating results are likely to fluctuate significantly As a result of our limited operating history and the rapidly changing nature of the markets in which we compete, our quarterly and annual revenues and operating results are likely to fluctuate from period to period. These fluctuations may be caused by a number of factors, many of which are beyond our control. These factors include the following, as well as others discussed elsewhere in this section: . how and when we introduce new products and services and enhance our existing products and services; . the timing and success of our brand-building and marketing campaigns; 2 . our ability to establish and maintain strategic relationships; . the demand for Internet advertising and sponsorships; . the emergence and success of new and existing competition; . varying operating costs and capital expenditures related to the expansion of our business operations and infrastructure, domestically and internationally, including the hiring of new employees; . technical difficulties with our products, system downtime, system failures or interruptions in Internet access; . costs related to the acquisition of businesses or technology; and . costs of litigation and intellectual property protection. In addition, because the market for our products and services is relatively new and rapidly changing, it is difficult to predict future financial results. Our research and development and sales and marketing efforts, and business expenditures generally, are partially based on predictions regarding certain developments for media delivery. To the extent that these predictions prove inaccurate, our revenues and operating expenses may fluctuate. For these reasons, you should not rely on period-to-period comparisons of our financial results as indications of future results. Our future operating results could fall below the expectations of public market analysts or investors and significantly reduce the market price of our common stock. Fluctuations in our operating results will likely increase the volatility of our stock price. We may be unable to successfully compete with Microsoft and other companies in the media delivery market The market for software and services for media delivery over the Internet is relatively new, constantly changing and intensely competitive. As media delivery evolves into a central component of the Internet experience, more companies are entering the market for, and expending increasing resources to develop, media delivery software and services. We expect that competition will continue to intensify. Many of our current and potential competitors have longer operating histories, greater name recognition, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology franchise. Price concessions or the emergence of other pricing or distribution strategies of competitors may diminish our revenues, impact our margins or lead to a reduction in our market share, any of which will harm our business. We believe that the primary competitive factors in the media delivery market include: . the quality and reliability of the overall media delivery solution; . access to distribution channels necessary to achieve broad distribution and use of products; . the availability of content for delivery over the Internet and access to necessary intellectual property rights; . the ability to develop and support secure formats for digital media delivery, particularly music and video; . the size of the active audience for streaming media and its appeal to content providers and advertisers; 3 . features for creating, editing and adapting content for the Internet; . ease of use and interactive user features in products; . ease of finding and accessing content over the Internet; . scalability of streaming media and media delivery technology and cost per user; . pricing and licensing terms; . compatibility with new and existing media formats; . compatibility with the user's existing network components and software systems; and . challenges caused by bandwidth constraints and other limitations of the Internet infrastructure. Our failure to adequately address any of the above factors could harm our business strategy and operating results. Microsoft is a principal competitor in the development and distribution of streaming media and media distribution technology. Microsoft currently competes with us in the market for streaming media server and player software and has announced its intent to compete in the market for digital distribution of media. We believe that Microsoft's commitment to and presence in the media delivery industry has increased and that Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution. Microsoft distributes its competing streaming media server and tools products by bundling them with its Windows NT servers at no additional charge and by making them available for download from its website for free. While we also provide free downloads of certain of our products, including players, servers and tools, Microsoft's practices have caused, and may continue to cause, pricing pressure on our products. These practices could lead to longer sales cycles, decreased sales and reduced market share. In addition, we believe that Microsoft has used and may be able to use its dominant position in the computer industry and its financial resources to secure preferential or exclusive distribution and bundling contracts for its streaming media products with third parties such as Internet service providers (ISPs), online service providers, content providers, entertainment companies, media companies, broadcasters, value added resellers (VARs) and original equipment manufacturers (OEMs), including third parties with whom we have relationships. Such arrangements, together with Microsoft's aggressive marketing of Windows NT and of its streaming media products, may reduce our share of the streaming media market. Microsoft's Windows Media Player competes with our RealPlayer products. The Windows Media Player is available for download from Microsoft's website for free, and is bundled by Microsoft with its Windows 98 operating system and with its Web browser, Internet Explorer. In addition, Microsoft has bundled certain audio capabilities into a radio toolkit for Internet Explorer 5.0, its latest Web browser. Internet Explorer 5.0 includes Web Events, which provides links to multimedia content on the Internet, especially content in Microsoft's streaming media formats. We expect that by leveraging its dominant position in operating systems and tying streaming media into its operating system and its browser, Microsoft will distribute substantially more copies of the Windows Media Player in the future than it has in the past and may be able to attract more users to its streaming media products. Currently, our RealPlayer has a high degree of market penetration: we have over 70 million registered users and estimate that more than 85% of all Web pages that use streaming media do so using our technology. Our market position may be difficult to sustain, particularly in light of Microsoft's efforts and dominant position in operating systems. On July 23, 1998, Robert Glaser, our chief executive officer, testified before the Senate Judiciary Committee that if a consumer had the RealPlayer on his or her computer system, and then 4 downloaded the Windows Media Player, the Windows Media Player disabled important functions of our RealPlayer in certain instances. As a result, some of our customers who had downloaded the free RealPlayer, or paid for the RealPlayer Plus, found that their players did not work. We quickly incorporated a workaround solution into our RealPlayer and RealPlayer Plus and also posted this workaround solution on our website. We believe the workaround solution corrected the problem at the time and, as a result, we believe only a small number of customers were impacted by the situation. However, we believe there is a continued risk that future versions of Microsoft's products, especially Internet Explorer and the Windows Media Player, may negatively impact the experience of our customers by displaying a Windows Media Player when the customer seeks to play RealAudio or RealVideo content, or by posting an error message when the customer tries to play content available in RealNetworks' formats that may not be viewed through the Windows Media Player, without telling the customer how to obtain the latest RealPlayer. Such actions by Microsoft could materially reduce market share for the RealPlayer and have a negative effect on demand for our server software and tools. We have provided and will continue to seek to provide useful input to Microsoft to address these situations so as to provide an optimal experience for consumers. In light of these recent events, our relationship with Microsoft has become more competitive. In addition to Microsoft, we face increasing competition from other companies that are developing and marketing streaming media products. Apple Computer recently announced the availability of QuickTime 4.0 streaming media technology, including a free media player and a free streaming media server, and has made available free source code to the server under the conditions of their license agreement. We expect that Apple Computer will devote more resources to developing and marketing streaming media systems, and will seek to compete more vigorously with us in the marketplace. Other competitors include Cisco Systems/Precept Software, PictureTel/Starlight Networks and Oracle Corporation. As more companies enter the market with products that compete with our servers, players and tools, the competitive landscape could change rapidly to our disadvantage. We do not believe that clear standards have emerged with respect to non-PC wireless and cable-based systems. Likewise, no one company has gained a dominant position in the mobile device market. Other companies' products and services or new standards may emerge in any of these areas, which could reduce demand for our products or render them obsolete. In addition, our streaming media and media delivery products face competition from non-streaming, "fast download" media delivery technologies such as AVI, QuickTime and MP3. Other fast download or non-streaming IP-based content distribution methods are likely to emerge and could compete with our products and services, which could harm our business. We may be unable to successfully compete in other parts of our business Media Hosting. Our media hosting service, the Real Broadcast Network, competes with a variety of companies that provide streaming media hosting services. These companies include Broadcast.com (which has agreed to be acquired by Yahoo!) and Intervu and emerging broadcast networks such as CMGI's Magnitude Network and Enron Communications. We may not establish or sustain our competitive position in this market segment. Some media hosting competitors are also customers on whom we rely to help drive product download traffic to our website through their broadcast events. Website Destinations, Content and Advertising. While Internet advertising revenues across the industry continue to grow, the number of websites competing for advertising revenues is also growing. Our websites, including Real.com, Film.com and LiveConcerts.com, compete for user traffic and Internet advertising revenues with a wide variety of websites, Internet portals and ISPs. In particular, aggregators of audio, video and other media, such as Broadcast.com and Microsoft's Web 5 Events, compete with our RealGuide. We also compete with traditional media such as television, radio and print for a share of advertisers' total advertising budgets. Our advertising sales force and infrastructure are still in early stages of development relative to those of our competitors. We cannot be certain that advertisers will place advertising with us or that revenues derived from such advertising will be meaningful. If we lose advertising customers, fail to attract new customers, are forced to reduce advertising rates or otherwise modify our rate structure to retain or attract customers, or if we lose website traffic, our business could be harmed. Electronic Commerce. The electronic commerce features of our websites compete with a variety of other websites for consumer traffic. To compete successfully in the electronic commerce market, we must attract sufficient traffic to our websites by offering high-quality, competitively priced, desirable merchandise in a compelling, easy-to-purchase format. In addition, we must successfully leverage our existing user base to develop the market for our products and services. We may not compete successfully in the growing and rapidly changing market for electronic commerce. Our failure to do so could harm our business. Increased competition may result in price reductions, reduced margins, loss of market share, loss of customers, and a change in our business and marketing strategies, any of which could harm our business. We may not be successful in the market for downloadable media and local media delivery In May 1999, we announced the RealSystem MP, a digital music architecture enabling integration with a wide range of Internet services and hardware devices. We also released a beta version of RealJukebox, our client software based on the RealSystem MP. These products represent an extension of our business into downloadable media and local media delivery, which is a substantial evolution from our historical focus on streaming media products and services. We do not know whether there is a sustainable market for products such as RealSystem MP and RealJukebox. Even if that market exists, we may be unable to develop a revenue model or sufficient demand to take advantage of the market opportunity. While over five million copies of RealJukebox have been downloaded since its beta release on May 3, 1999, it is too soon to determine if RealJukebox will be widely received in the marketplace. There are now a number of competitive products on the market that offer certain of the features that RealJukebox offers. In addition, given the size and importance of the general market for music distribution, competitors will likely release products that directly compete with RealJukebox, which could harm our business. Even if RealJukebox achieves widespread market acceptance, it may not achieve a high level of use, which would lead to a low rate of upgrade sales and electronic commerce opportunities. RealJukebox has been released only as an early beta version. Although we tested this version prior to its release, it likely contains errors. We will spend substantial development resources to continue to test the product, to correct errors and to improve the product before we release a commercial version of RealJukebox. We may never release a commercial version. Our inability to commercially release RealJukebox, to achieve widespread acceptance for RealSystem MP and RealJukebox, or to create new revenue streams from new market segments could harm our business. RealJukebox allows users to record and play back music in a variety of technical formats, including RealAudio G2 and MP3. However, technical formats and consumer preferences evolve very rapidly, and we may be unable to adequately address consumer preferences or fulfill the market demand to the extent it exists. 6 We have had long-term relationships with recording companies, including major record labels, many of which offer their streaming content in our formats. However, recording companies, including those with whom we have a relationship, may be uncomfortable with some features of RealJukebox. As a result, some record companies may decide to withhold content from RealJukebox, or refrain from or delay participating in promotional opportunities with respect to RealJukebox. RealJukebox is intended to allow users of the product to acquire, record, play back and manage music for their personal use. It is possible for a user of RealJukebox to elect not to use the copyright-protection features it contains and then violate the intellectual property rights of artists and recording companies by engaging in an authorized distribution of music. The laws governing the recording, distribution and performance of digital music are new and largely untested. While we believe we have developed RealJukebox to comply with U.S. copyright laws, a court may find us in violation of these laws. Similar action or other litigation in the United States or abroad directed at us could harm our business, even if such litigation were entirely without merit. We may not successfully develop new products and services Our growth depends on our ability to continue to develop leading edge media delivery and digital distribution products and services. Our business and operating results would be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues to offset development costs. We may not timely and successfully identify, develop and market new product and service opportunities. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability. Because the markets for our products and services are rapidly changing, we must develop new offerings quickly. We have experienced development delays and cost overruns in our development efforts in the past and we may encounter such problems in the future. Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements. Our products also may contain undetected errors that could cause increased development costs, loss of revenues, adverse publicity, reduced market acceptance of the products or lawsuits by customers. We rely on content provided by third parties to increase market acceptance of our products If third parties do not develop or offer compelling content to be delivered over the Internet, our business will be harmed and our products may not achieve or sustain broad market acceptance. We rely on third-party content providers, such as radio and television stations, record labels, media companies, websites and other companies, to develop and offer content in our formats that can be delivered using our server products and played back using our player products. While we have a number of short-term agreements with third parties to provide content from their websites in our formats, most third parties are not obligated to develop or offer content using our technology. In addition, some third parties have entered into and may in the future enter into agreements with our competitors, principally Microsoft, to develop or offer all or a substantial portion of their content in our competitors' formats. Microsoft has more resources to secure preferential and even exclusive relationships with content providers. There could be less demand for and use of our products if Microsoft or another competitor were to secure preferential or exclusive relationships with the leading broadcasters, record companies or websites. We cannot guarantee that third-party content providers will continue to rely on our technology or offer compelling content in our formats to encourage and sustain broad market acceptance of our products. Their failure to do so would harm our business. As we move into the market for digital distribution of media and local media playback, our success depends on the availability of third-party content, especially music, that users of our 7 RealJukebox product can lawfully and easily access, record and play back. Our product may not achieve or sustain market acceptance if third parties are unwilling to offer their content for free download or purchase by users of RealJukebox. Competitors could secure exclusive distribution relationships with such content providers, which would harm our business. We depend on key personnel who may leave us at any time Our success substantially depends on the continued employment of our executive officers and key employees, particularly Robert Glaser, our chairman of the board and chief executive officer. The loss of the services of Mr. Glaser or any of our other executive officers or key employees could harm our business. None of our executive officers has a contract that guarantees employment. Other than the $2 million insurance policy on the life of Mr. Glaser, we do not maintain "key person" life insurance policies. Our failure to attract, train or retain highly qualified personnel could harm our business Our success also depends on our ability to attract, train and retain qualified personnel, specifically those with management and product development skills. In particular, we must hire additional skilled software engineers to further our research and development efforts. Competition for such personnel is intense, particularly in high-technology centers such as the Pacific Northwest. In making employment decisions, particularly in the Internet and high- technology industries, job candidates often consider the value of stock options they may receive in connection with their employment. As a result of recent volatility in our stock price, we may be disadvantaged in competing with companies that have not experienced similar volatility or that have not yet sold their stock publicly. If we do not succeed in attracting new personnel or retaining and motivating our current personnel, our business could be harmed. We may not successfully manage our growth We cannot successfully implement our business model if we fail to manage our growth. We have rapidly and significantly expanded our operations domestically and internationally and anticipate further expansion to take advantage of market opportunities. We have increased the number of our full- time employees from 325 on January 1, 1998 to 536 on June 30, 1999. Managing this substantial expansion has placed a significant strain on our management, operational and financial resources. If our growth continues, we will need to continue to improve our financial and managerial control and reporting systems and procedures. We are in the process of implementing new management information software systems. This will affect many aspects of our business, including our accounting, operations, electronic commerce, customer service, purchasing, sales and marketing functions. The purchase, implementation and testing of these systems has resulted, and will result, in significant capital expenditures and could disrupt our day-to-day operations. If these systems are not implemented as expected, our ability to provide products and services to our customers on a timely basis will suffer and delays in the recording and reporting of our operating results could occur. The growth of our business depends on the increased use of the Internet for communications, electronic commerce and advertising The growth of our business depends on the continued growth of the Internet as a medium for communications, electronic commerce and advertising. Our business will be harmed if Internet usage does not continue to grow, particularly as a source of media information and entertainment and as a vehicle for commerce in goods and services. Our success also depends on the efforts of third parties to develop the infrastructure and complementary products and services necessary to maintain and 8 expand the Internet as a viable commercial medium. The Internet may not be accepted as a viable commercial medium for broadcasting multimedia content or media delivery for a number of reasons, including: . potentially inadequate development of the necessary infrastructure to accommodate growth in the number of users and Internet traffic; . lack of acceptance of the Internet as a medium for distributing streaming media content or for media delivery; . unavailability of compelling multimedia content; . inadequate commercial support for Web-based advertising; and . delays in the development or adoption of new technological standards and protocols or increased governmental regulation, which could inhibit the growth and use of the Internet. In addition, we believe that other Internet-related issues, such as security, reliability, cost, ease of use and quality of service, remain largely unresolved and may affect the amount of business that is conducted over the Internet. If Internet usage grows, the Internet infrastructure may not be able to support the demands placed on it by such growth, specifically the demands of delivering high-quality media content. As a result, its performance and reliability may decline. In addition, websites have experienced interruptions in service as a result of outages and other delays occurring throughout the Internet network infrastructure. If these outages or delays occur frequently in the future, Internet usage, as well as the usage of our products, services and websites, could grow more slowly or decline. Changes in network infrastructure, transmission methods and broadband technologies pose risks to our business We believe that increased Internet use may depend on the availability of greater bandwidth or data transmission speeds (also known as broadband transmission). If broadband access becomes widely available, we believe it presents both a substantial opportunity and a significant business challenge for us. Internet access through cable television set-top boxes, digital subscriber lines or wireless connections could dramatically reduce the demand for our products and services by utilizing alternate technology that more efficiently transmits data. This could harm our business as currently conducted. Development of products and services for a broadband transmission infrastructure involves a number of additional risks, including: . changes in content delivery methods and protocols; . the availability of compelling content that takes advantage of broadband access and helps drive market acceptance of our products and services; . the emergence of new competitors, such as traditional broadcast and cable television companies, which have significant control over access to content, substantial resources and established relationships with media providers; . the development of relationships by our current competitors with companies that have significant access to or control over the broadband transmission infrastructure or content; . the need to establish new relationships with non-PC based providers of broadband access, such as providers of television set-top boxes and cable television, some of which may compete with us; and 9 . the general risks of new product and service development, including the challenges to develop error-free products and enhancements, develop compelling services and achieve market acceptance for these products and services. We depend on the efforts of third parties to develop and provide a successful infrastructure for broadband transmission. Even if broadband access becomes widely available, heavy use of the Internet may negatively impact the quality of media delivered through broadband connections. If these third parties experience delays or difficulties establishing a widespread broadband transmission infrastructure or if heavy usage limits the broadband experience, the release of our broadband products and services could be delayed. Even if a broadband transmission infrastructure is developed for widespread use, our products and services may not achieve market acceptance or generate sufficient revenues to offset our development costs. We could lose strategic relationships that are essential to our business The loss of certain current strategic relationships, the inability to find other strategic partners or the failure of our existing relationships to achieve meaningful positive results for us could harm our business. We rely in part on strategic relationships to help us: . maximize adoption of our products through distribution arrangements; . increase the amount and availability of compelling media content on the Internet to help boost demand for our products and services; . enhance our brand; . expand the range of commercial activities based on our technology; . expand the distribution of our streaming media content without a degradation in fidelity; and . increase the performance and utility of our products and services. Many of these goals are beyond our traditional strengths. We anticipate that the efforts of our strategic partners will become more important as the multimedia experience over the Internet matures. For example, we may become more reliant on strategic partners to provide multimedia content, provide more secure and easy-to-use electronic commerce solutions and build out the necessary infrastructure for media delivery. We may not be successful in forming strategic relationships. In addition, the efforts of our strategic partners may be unsuccessful. Furthermore, these strategic relationships may be terminated before we realize any benefit. Our industry is experiencing consolidation that may intensify competition The Internet industry has recently experienced substantial consolidation and a proliferation of strategic transactions. We expect this consolidation and strategic partnering to continue. Acquisitions or strategic relationships could harm us in a number of ways. For example: . competitors could acquire or partner with companies with which we have strategic relationships and discontinue our relationship, resulting in the loss of distribution opportunities for our products and services or the loss of certain enhancements or value-added features to our products and services; . competitors could obtain exclusive access to desirable multimedia content and prevent that content from being available in our formats, thus decreasing the use of our products and services to distribute and experience the content that audiences most desire, and hurting our ability to attract advertisers to our websites and product offerings; 10 . a competitor could be acquired by a party with significant resources and experience that could increase the ability of the competitor to compete with our products and services. Recent announcements and consolidations that could affect our business include: . Microsoft's strategic investments in broadband initiatives, including its recently announced $5 billion investment in AT&T; . AT&T's acquisition of TCI and its announcement that it will acquire MediaOne Communications; . At Home's acquisition of Excite; . Yahoo!'s acquisitions of Broadcast.com and GeoCities; . The Walt Disney Company's recent announcement that it intends to combine its Internet assets with, and acquire a majority ownership of, Infoseek, and create a single business called go.com; . NBC's announcement that it intends to merge its Internet assets with XOOM.com, Inc. and Snap.com, a subsidiary of CNET. Potential acquisitions involve risks we may not adequately address The failure to adequately address the financial and operational risks raised by acquisitions of technology and businesses could harm our business. We have acquired complementary technologies and businesses in the past, and intend to do so in the future. Financial risks related to acquisitions include: . potentially dilutive issuances of equity securities; . use of cash resources; . the incurrence of additional debt and contingent liabilities; . large write-offs; and . amortization expenses related to goodwill and other intangible assets. Acquisitions also involve operational risks, including: . difficulties in assimilating the operations, products, technology, information systems and personnel of the acquired company; . diversion of management's attention from other business concerns; . impairment of relationships with our employees, affiliates, advertisers and content providers; . inability to maintain uniform standards, controls, procedures and policies; . the assumption of known and unknown liabilities of the acquired company; . entrance into markets in which we have no direct prior experience; and . loss of key employees of the acquired company. We currently have an agreement to acquire Xing Technology, an MP3 software developer, in a transaction that we expect to account for as a pooling of interests. We may not adequately integrate this or any future acquisitions. In addition, we may not be able to account for future acquisitions as a pooling of interests, which could harm our operating results. 11 Our business will suffer if our systems fail or become unavailable A reduction in the performance, reliability and availability of our websites and network infrastructure will harm our ability to distribute our products and services to our users, as well as our reputation and ability to attract and retain users, customers, advertisers and content providers. Our revenues depend in large part on the number of users that download our products from our websites and access the content services on our websites. Our systems and operations could be damaged or interrupted by fire, flood, power loss, telecommunications failure, Internet breakdown, earthquake and similar events. Our systems are also subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct. Our computer and communications infrastructure is located at a single leased facility in Seattle, Washington. We do not have fully redundant systems or a formal disaster recovery plan, and we do not carry adequate business interruption insurance to compensate us for losses that may occur from a system outage. Our electronic commerce and digital distribution activities are managed by sophisticated software and computer systems. We may encounter delays in developing these systems, and the systems may contain undetected errors that could cause system failures. Any system error or failure that causes interruption in availability of products or content or an increase in response time could result in a loss of potential or existing business services customers, users, advertisers or content providers. If we suffer sustained or repeated interruptions, our products, services and websites could be less attractive to such entities or individuals and our business would be harmed. A sudden and significant increase in traffic on our websites could strain the capacity of the software, hardware and telecommunications systems that we deploy or use. This could lead to slower response times or system failures. Our operations also depend on receipt of timely feeds from our content providers, and any failure or delay in the transmission or receipt of such feeds could disrupt our operations. We depend on Web browsers, ISPs and online service providers to provide Internet users access to our websites. Many of these providers have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. In addition, certain ISPs have temporarily interrupted our website operations in response to the heavy volume of e-mail transmission we generate and send to our large user base. These types of interruptions could continue or increase in the future. Our network is subject to security risks that could harm our reputation and expose us to litigation or liability Online commerce and communications depend on the ability to transmit confidential information securely over public networks. Any compromise of our ability to transmit confidential information securely, and costs associated with preventing or eliminating any problems, could harm our business. Online transmissions are subject to a number of security risks, including: . our own or licensed encryption and authentication technology may be compromised, breached or otherwise be insufficient to ensure the security of customer information; . we could experience unauthorized access, computer viruses and other disruptive problems, whether intentional or accidental; . a third party could circumvent our security measures and misappropriate proprietary information or interrupt operations; and . credit card companies could restrict online credit card transactions. The occurrence of any of these or similar events could damage our reputation and expose us to litigation or liability. We may also be required to expend significant capital or other resources to protect against the threat of security breaches or to alleviate problems caused by such breaches. 12 Our international operations involve risks We operate subsidiaries in Australia, England, France, Germany and Japan, and market and sell products in several other countries. For the six months ended June 30, 1999, approximately 24% of our revenues, excluding revenues derived from our license agreement with Microsoft, were derived from international operations. We are subject to the normal risks of doing business internationally, as well as risks specific to Internet-based companies in foreign markets. These risks include: . delays in the development of the Internet as a broadcast, advertising and commerce medium in international markets; . difficulties in managing operations due to distance, language and cultural differences, including issues associated with establishing management systems infrastructures in individual markets; . unexpected changes in regulatory requirements; . export and import restrictions, including those restricting the use of encryption technology; . tariffs and trade barriers and limitations on fund transfers; . difficulties in staffing and managing foreign operations; . longer payment cycles and problems in collecting accounts receivable; . potential adverse tax consequences; . exchange rate fluctuations; . increased risk of piracy and limits on our ability to enforce our intellectual property rights; and . other legal and political risks. Any of these factors could harm our business. We do not currently hedge our foreign currency exposures. We may be unable to adequately protect our proprietary rights Our inability to protect our proprietary rights, and the costs of doing so, could harm our business. Our success and ability to compete partly depend on the superiority, uniqueness or value of our technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. Despite our efforts to protect our proprietary rights, unauthorized parties may copy or infringe aspects of our technology, products, services or trademarks, or obtain and use information we regard as proprietary. Our proprietary rights may be especially difficult to protect in foreign countries, where unrelated third parties may have registered our domain names and trademarks under their own names in an attempt to prevent us from using the domain names and trademarks in those countries without paying them a significant sum of money. This could prevent us from using our valuable brands in those countries, and reduce the value of our intellectual property. In addition, others may independently develop technologies that are similar or superior to ours, which could reduce the value of our intellectual property. Companies in the computer industry have frequently resorted to litigation regarding intellectual property rights. We may have to litigate to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of other parties' proprietary rights. From time to time, other parties' proprietary rights, including patent rights, have come to our attention and on several 13 occasions we have received notice of claims of infringement of other parties' proprietary rights, and we may receive such notices in the future. In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit against us and co-defendant Broadcast.com in the United States District Court for the Northern District of Texas--Dallas Division. The plaintiffs allege that we, individually and in combination with Broadcast.com, infringe on a certain patent by making, using, selling and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. The plaintiffs seek to enjoin us from the alleged infringing activity and to recover damages in an amount no less than a reasonable royalty. We believe the allegations are without merit and intend to vigorously defend ourselves against these claims. However, litigation is inherently uncertain, and we may be unable to successfully defend ourselves against this claim. From time to time we receive claims and inquiries from third parties alleging that our internally developed technology or technology we license from third parties may infringe the third parties' proprietary rights. We are now investigating a few of such pending claims. We could be required to spend significant amounts of time and money to defend ourselves against such claims. If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products while we re-engineer them or seek licenses to necessary technology, which might not be available on reasonable terms. We could also be subject to claims for indemnification resulting from infringement claims made against our customers and strategic partners, which could increase our defense costs and potential damages. Any of these events could harm our business. We are subject to risks associated with governmental regulation and legal uncertainties We are not currently subject to direct regulation by any governmental agency other than laws and regulations generally applicable to businesses, although certain U.S. export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. Few existing laws or regulations specifically apply to the Internet. However, it is likely that a number of laws and regulations may be adopted in the United States and other countries with respect to the Internet. These laws may relate to areas such as content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, encryption, use of key escrow data, caching of content by server products, electronic authentication or "digital signatures," personal privacy, advertising, taxation, electronic commerce liability, e-mail, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability. Other countries and political organizations are likely to impose or favor more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. The adoption of such laws or regulations, and uncertainties associated with their validity and enforcement, may affect the available distribution channels for and costs associated with our products and services, and may affect the growth of the Internet. Such laws or regulations may therefore harm our business. We do not know for certain how existing laws governing issues such as property ownership, copyright and other intellectual property issues, taxation, illegal or obscene content, retransmission of media and personal privacy and data protection apply to the Internet. The vast majority of such laws were adopted before the advent of the Internet and related technologies and do not address the unique issues associated with the Internet and related technologies. Most of the laws that relate to the Internet have not yet been interpreted. Changes to or the interpretation of these laws could: . limit the growth of the Internet; . create uncertainty in the marketplace that could reduce demand for our products and services; 14 . increase our cost of doing business; . expose us to significant liabilities associated with content available on our websites or distributed or accessed through our products or services; or . lead to increased product development costs, or otherwise harm our business. On October 28, 1998, the Digital Millennium Copyright Act (DMCA) was enacted. The DMCA includes statutory licenses for the performance of sound recordings and for the making of recordings to facilitate transmissions. Under these statutory licenses, we and our broadcast customers will be required to pay licensing fees for sound recordings we deliver in original and archived programming and through retransmissions of radio broadcasts. The DMCA does not specify the rate and terms of the licenses, which will be determined either through voluntary inter-industry negotiations or arbitration. We currently anticipate that representatives of the webcasting industry will engage in arbitration with the Recording Industry Association of America to determine what, if any, licensee fee should be paid. Depending on the rates and terms adopted for the statutory licenses, our business could be harmed both by increasing our own cost of doing business, as well as by increasing the cost of doing business for our customers. The Child Online Protection Act and the Child Online Privacy Protection Act (COPA) were enacted in October 1998. The COPA impose civil and criminal penalties on persons distributing material harmful to minors (e.g., obscene material) over the Internet to persons under the age of 17, or collecting personal information from children under the age of 13. We do not currently distribute the types of materials that we believe the COPA would deem illegal, and do not knowingly collect and disclose personal information from such minors. The manner in which the COPA may be interpreted and enforced cannot be fully determined, and future legislation similar to the COPA could subject us to potential liability, which in turn could harm our business. Such laws could also damage the growth of the Internet generally and decrease the demand for our products and services. Shareholders may be unable to exercise control because management owns a large percentage of our stock Our officers, directors and affiliated persons beneficially own approximately 49.8% of our common stock. Robert Glaser, our chief executive officer and chairman of the board, beneficially owns approximately 37.9% of our common stock. As a result, our officers, directors and affiliated persons will have significant influence to: . elect or defeat the election of our directors; . amend or prevent amendment of our articles of incorporation or bylaws; . effect or prevent a merger, sale of assets or other corporate transaction; and . control the outcome of any other matter submitted to the shareholders for vote. Management's stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of RealNetworks, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price. Provisions of our charter documents, shareholder rights plan and Washington law could discourage our acquisition by a third party Our articles of incorporation provide for a strategic transaction committee of the board of directors currently comprised of Messrs. Glaser, Breyer and Kapor. Without the prior approval of this 15 committee, and subject to certain limited exceptions, the board of directors does not have the authority to: . adopt a plan of merger; . authorize the sale, lease, exchange or mortgage of: (A) assets representing more than 50% of the book value of our assets prior to the transaction; or (B) any other asset or assets on which our long-term business strategy is substantially dependent; . authorize our voluntary dissolution; or . take any action that has the effect of any of the above. RealNetworks also entered into an agreement providing Mr. Glaser with a direct contractual right to require RealNetworks to abide by and perform all terms of the articles of incorporation with respect to the strategic transactions committee. This agreement also provides that so long as Mr. Glaser owns a specified number of shares, RealNetworks will use its best efforts to cause him to be nominated to, elected to, and not removed from the board of directors. In addition, the articles provide that Mr. Glaser will serve, or will appoint another officer of RealNetworks to serve, as our policy ombudsman, with the exclusive authority to adopt or change our editorial policies as reflected on our websites or in other communications or media in which we have a significant editorial or media voice. The provisions with respect to the authority of the strategic transactions committee and the policy ombudsman may be amended only with the approval of 90% of the shares entitled to vote on an amendment to the articles. We have adopted a shareholder rights plan that provides that shares of our common stock have associated preferred stock purchase rights. These rights become exercisable and detachable from the associated common stock only following the acquisition by a person or a group of 15% or more of our outstanding common stock or 10 days following the announcement of a tender or exchange offer for 15% or more of our outstanding common stock. The rights entitle our shareholders, other than the person or entity that has acquired or made an exchange or tender offer for 15% or more of our outstanding common stock, to acquire additional shares of our capital stock at a price equal to one-half of the market price at the time of the event and, in certain circumstances, would allow our shareholders to acquire capital stock in the entity that has acquired or made an exchange or tender offer for 15% or more of our outstanding common stock at a similar discount. The exercise of these rights would make the acquisition of RealNetworks by a third party more expensive to that party and has the effect of discouraging third parties from acquiring our company without the approval of our board of directors, which has the power to redeem these rights and prevent their exercise. Washington law imposes restrictions on some transactions between a corporation and certain significant shareholders. Chapter 23B.19 of the Washington Business Corporation Act prohibits a "target corporation," with some exceptions, from engaging in certain significant business transactions with an "acquiring person," which is defined as a person or group of persons that beneficially owns 10% or more of the voting securities of the target corporation, for a period of five years after such acquisition, unless the transaction or acquisition of shares is approved by a majority of the members of the target corporation's board of directors prior to the acquisition. Such prohibited transactions include, among other things: . a merger or consolidation with, disposition of assets to, or issuance or redemption of stock to or from the acquiring person; . termination of 5% or more of the employees of the target corporation as a result of the acquiring person's acquisition of 10% or more of the shares; or 16 . allowing the acquiring person to receive any disproportionate benefit as a shareholder. After the five-year period, a "significant business transaction" may occur, as long as it complies with certain "fair price" provisions of the statute. A corporation may not opt out of this statute. This provision may have the effect of delaying, deterring or preventing a change in control of RealNetworks. The foregoing provisions of our charter documents, shareholder rights plan and Washington law, as well as those relating to a classified board of directors and the availability of "blank check" preferred stock, could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock. Our stock price has been and may continue to be volatile The trading price of our common stock has been and is likely to continue to be highly volatile. For example, during the 52-week period ended July 23, 1999, the price of our common stock ranged from $7.625 to $131.875 per share. Our stock price could be subject to wide fluctuations in response to factors such as: . actual or anticipated variations in quarterly operating results; . announcements of technological innovations, new products or services by us or our competitors; . changes in financial estimates or recommendations by securities analysts; . the addition or loss of strategic relationships; . conditions or trends in the Internet, media streaming, media delivery and online commerce markets; . changes in the market valuations of other Internet, online service or software companies; . announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; . additions or departures of key personnel; . sales of our common stock; and . general market conditions. In addition, the stock market in general, and the Nasdaq National Market and the market for Internet and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. These broad market and industry factors may reduce our stock price, regardless of our operating performance. The trading prices of the stocks of many technology companies are at or near historical highs and reflect price-earnings ratios substantially above historical levels. These trading prices and price- earnings ratios may not be sustained. We may be subject to assessment of sales and other taxes for the sale of our products, license of technology or provision of services We may have to pay past sales or other taxes that we have not collected from our customers. We do not currently collect sales or other taxes on the sale of our products, license of technology or provision of services in states and countries other than those in which we have offices or employees. 17 In October 1998, the Internet Tax Freedom Act (ITFA) was signed into law. Among other things, the ITFA imposes a three-year moratorium on discriminatory taxes on electronic commerce. Nonetheless, foreign countries or, following the moratorium, one or more states, may seek to impose sales or other tax obligations on companies that engage in such activities within their jurisdictions. Our business would be harmed if one or more states or any foreign country were able to require us to collect sales or other taxes from current or past sales of products, licenses of technology or provision of services, particularly because we would be unable to go back to customers to collect sales taxes for past sales and may have to pay such taxes out of our own funds. Year 2000 compliance issues could harm our business We are in the process of assessing and remediating any Year 2000 issues associated with our own products, and the computer systems, software, other property and equipment we use. Despite our testing and remediation efforts, our products and systems, and those of third parties, including content providers, advertisers, affiliates and end users, may contain errors or faults with respect to the year 2000. Known or unknown errors or defects that affect the operation of our products and systems or those of third parties could result in delay or loss of revenues, interruptions of services, cancellation of customer contracts, diversion of development resources, damage to our reputation, increased service and warranty costs and litigation costs, any of which could harm our business. We intend to donate a portion of net income to charity If we achieve and sustain profitability, we intend to donate approximately 5% of our annual net income to charitable organizations. This will reduce our net income. 18 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS We have made forward-looking statements in this prospectus and in the documents that are incorporated by reference in this prospectus, all of which are subject to risks and uncertainties. Forward-looking statements include information concerning our possible or assumed future business success or financial results. Such forward-looking statements include, but are not limited to, statements as to our expectations regarding: . the future development and growth of, and opportunities for, the Internet and the online media delivery market; . the future adoption of our current and future products, services and technologies; . future revenue opportunities; . the future growth of our customer base; . our ability to successfully develop and introduce future products and services; . future international revenues; . future expense levels (including research and development, sales and marketing and general and administrative expenses); . future sales and marketing efforts; . future capital needs; . the future of our relationships with Microsoft and other companies; . the effect of past and future acquisitions; . the future effectiveness of our intellectual property rights; . the effect of current litigation in which we are involved; and . the effect of the Year 2000 situation. When we use words such as "believe," "expect" and "anticipate" or similar words, we are making forward-looking statements. You should note that an investment in our common stock involves certain risks and uncertainties that could affect our future business success or financial results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in "Risk Factors" and elsewhere in this prospectus. We believe that it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. Before you invest in our common stock, you should be aware that the occurrence of the events described in the risk factors and elsewhere in this prospectus could materially and adversely affect our business, financial condition and operating results. We undertake no obligation to publicly update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. 19 USE OF PROCEEDS The proceeds from the sale of the common stock offered pursuant to this prospectus are solely for the account of the selling shareholders. Accordingly, we will not receive any proceeds from the sale of the shares from the selling shareholders. CORPORATE INFORMATION RealNetworks was incorporated in Washington in February 1994. References in this prospectus, and the documents incorporated by reference in this prospectus, to "RealNetworks," "we," "our," and "us" refer to RealNetworks, Inc., a Washington corporation, and its subsidiaries. Our principal executive offices are located at 2601 Elliott Avenue, Seattle, Washington 98121 and our telephone number is (206) 674-2700. Information contained in our website does not constitute part of this prospectus. Our registered and unregistered trademarks, trade names and service marks include, among others: . RealNetworks(R) .Real Broadcast Network(TM) .RealEncoder(TM) . RealSystem(TM) .RealGuide(TM) .RealProducer(TM) . RealAudio(R) .Real logo(R) .RealServer(TM) . RealVideo(R) .RealPlayer(R) .Basic Server(TM) . RealText(R) .RealPlayer Plus(TM) .RealStore.com(R) . RealPix(TM) .RealPublisher(TM) .Film.com(R) . RealSystem MP(TM) .RealPresenter(TM) .Daily Briefing(TM) . RealJukebox(TM) .RealDeveloper(TM) .SureStream(TM)
This prospectus and the documents incorporated by reference in this prospectus also include trademarks, trade names and service marks other than those identified above, all of which are the property of their respective holders. 20 BUSINESS Overview RealNetworks is a leading provider of media delivery and digital distribution solutions designed for the Internet. Our solutions enable consumers to experience and content providers to deliver a broad range of multimedia content, including audio, video, text and animation. We pioneered the development and commercialization of streaming media systems that enable the creation, real-time delivery and playback of multimedia content. We believe that we have established a leadership position in the market for these systems. We have more than 70 million registered users of our RealPlayer product and believe that more than 85% of all Web pages using streaming media content use our technology. The broad acceptance of the Internet as a means of content delivery, combined with recent technological advances, has greatly increased the practicality and popularity of a number of new online media delivery formats. In response, we have extended our media delivery platform to include a digital music management system that allows consumers to acquire, record, store, organize and play their personal music collections on PCs and digital playback devices. Our solutions include a variety of integrated products and services for consumers, content providers, service providers and advertisers. Our products and services include: . RealSystem G2, an open and extensible advanced streaming media solution that consists of our RealPlayer client software, through which users experience multimedia content, and our RealServer software and related software tools, which enable broadcasters and content providers to create and deliver multimedia content. . Real Broadcast Network, a service based on a distributed multi-tier network designed to enable content providers to reliably and cost- effectively deliver high-quality streaming media over the Internet to large audiences. . RealJukebox, a product that turns a PC into a digital music management system and is based on RealSystem MP, our open and extensible digital music management solution. . RealGuide, a comprehensive directory that enables easy and personalized access to high-quality media programming on the Internet. . RealStore, an electronic commerce website from which we market, sell and distribute our own and third-party media delivery products and services to our base of more than 70 million registered users. Industry Background The Internet has grown rapidly in recent years and is now recognized as a new mass medium for communication, commerce and multimedia content. As an interactive and searchable medium, the Internet offers a highly engaging experience and allows users unlimited access to a wide variety and supply of content at their convenience. The Internet also enables content providers and advertisers to establish personalized experiences for and communications with consumers. We believe that these features, combined with advances in media delivery and the increasing availability of broadband access, are enabling the further development and broad acceptance of the Internet as a powerful medium for online media delivery and distribution. We believe that the emergence of streaming media technology in 1995 transformed online media delivery. Streaming media technology enables the continuous transmission and playback of multimedia content and represents a significant advancement over earlier technologies, which required download delays before playback. As a result, streaming media has enabled live broadcasts over the Internet and has enhanced and simplified the consumer's online media experience. We believe that the amount of live video and audio content available on the Internet has increased to more than 300,000 hours per week in April 1999. As the demand for streaming media has grown 21 substantially, many new business models have emerged. Companies are publishing and aggregating streaming media for consumers over the Internet and employees over intranets, developing streaming media authoring tools, offering turnkey services and advertising in a variety of new ways. The demand for streaming media and media content has also grown with the increasing availability of new broadband access technologies such as cable modems and digital subscriber lines. Cost-effective broadband access makes it possible for consumers to experience higher-quality streaming media and enables content providers to deliver to large audiences more compelling and engaging media content. The emergence of television set-top boxes and other non-PC Internet devices further extends the reach of online media. We believe that as the Internet provides the means to deliver content at quality levels comparable to those of traditional media, there will be a significant market opportunity for media companies and advertisers to provide customized, interactive targeted programming and advertising. Recently, new online media delivery formats such as MP3 have become popular with consumers as a method of online media distribution. These formats enable users to store and play back versions of music and other media types directly on PCs and non-PC multimedia devices. Today, consumers can download music and other content from websites or record from local sources, such as CDs. Advances in encoding and playback technologies have significantly reduced download times and storage requirements, thereby greatly increasing the practicality and popularity of these distribution formats. A number of systems that encode, store and play back content have been designed to capitalize on this opportunity. Systems are also being designed to provide security and copyright protection for content owners. Forrester Research forecasts that the market for online music downloads will grow from $1 million in 1999 to over $1 billion by 2003. Today, many businesses are using corporate intranets and websites to improve communications with their employees, customers and suppliers. In addition, there has been a proliferation of broadcasters and content providers that offer interactive audio, video and other multimedia content to enrich their websites and compete with traditional media. We believe that the broadened acceptance of new online media delivery and distribution formats are creating a significant market opportunity for providers of these solutions. We believe that the following key challenges must be addressed to capitalize on this market opportunity: . Deliver compelling content in bandwidth-constrained environments. The Internet was designed to transmit discrete packets of data and is not inherently well-suited to the delivery of continuous streams of multimedia data. Despite the increasing availability of broadband access, bandwidth remains limited in many Internet environments because of network congestion caused by an increasing number of users and growing popularity of higher-bandwidth content and applications. For the foreseeable future, bandwidth constraints will continue to pose significant technological challenges for reliable delivery of high-quality streaming media. . Maintain compatibility with numerous developing standards and evolving technologies. The evolving nature and strategic importance of online media delivery and distribution have resulted in the development of numerous competing formats, platforms and technologies that are not necessarily compatible. We believe that consumers and content providers desire a widely accepted solution that will provide them with a broad selection of media and access to a large audience, will address the security concerns of content providers and can be updated easily as technologies and standards evolve. . Enable cost-effective delivery of content. Online media providers and advertisers must make significant investments to create and distribute content to large audiences. To generate an adequate return on their investments, they need to cost-effectively reach a 22 sufficiently large or clearly targeted audience and have the ability to appropriately capitalize on advertising or commerce opportunities. . Drive consumer usage. We believe that consumer interest in online media content is driven in large part by the ability to find and experience that content easily and cost-effectively. There is a strong need for well-marketed websites or other branded navigational tools that connect consumers effectively with an array of online media content. The RealNetworks Solution RealNetworks is a leading provider of media delivery and digital distribution solutions designed for the Internet. Our solutions enable consumers to experience and content providers to deliver a broad range of multimedia content, including audio, video, text and animation. Our products and services are designed to address the technological and market development challenges that confront multimedia content providers and service providers and enhance the experience of users by offering: Advanced technology. We pioneered the development and commercialization of streaming media technology and continue to offer advanced streaming media software solutions. Our products use advanced compression, decompression, transmission and error-correction technologies to facilitate high-quality delivery, management and playback of multimedia content within bandwidth- constrained environments. We have designed our products to be flexible and compatible with heterogeneous operating systems, hardware and media formats. Our products use an open and extensible architecture to allow developers and content providers to enhance the utility and user experience of our products by developing "add-on" applications and tools that can be easily integrated into or used with our products. In addition, we have developed the Real Broadcast Network, a distributed multi-tier Internet broadcast network, to reliably and cost-effectively deliver high-quality streaming media over the Internet to large audiences. Product presence and brand strength. From our inception, we have strategically chosen to offer our RealPlayer software to consumers free of charge. Our newest product, RealJukebox, is also offered to consumers free of charge. Our Basic Server is offered free of charge to broadcasters and media content providers. We believe we have created a significant audience for advertising and other commerce opportunities. . More than half of the 70 million registered users of RealPlayer are registered users of our latest generation RealPlayer G2. . Since its beta release on May 3, 1999, more than five million copies of RealJukebox have been downloaded. . We have sold approximately 1.4 million copies of RealPlayer Plus. . Approximately 1,300 third-party developers are members of our Real Developer Program. This program assists members in developing websites and streaming media products that include or work with our technology. . We believe that more than 85% of all Web pages using streaming media use our technology. As a result of these activities and our extensive promotional efforts, we believe that the "Real" brand has become one of the most widely recognized brands on the Internet. Connection of consumers to content. Our network of websites highlights third-party streaming media programming and organizes links to this programming. This makes it easy for consumers to quickly find and link to streaming media and for content providers to promote their offerings. We provide: 23 . Our programming guide. Our recently enhanced RealGuide provides access to programming from our nearly 200 RealChannels and RealStations, more than 1,700 live radio and television stations broadcasting on the Internet and over 4,500 third-party multimedia websites. . Navigational tools. The RealPlayer incorporates navigational tools such as RealChannels, Presets and Destination Buttons to provide one- click access to popular third-party programming. Similar capabilities are incorporated into RealJukebox. . Our showcase websites and programming. Our websites and programming, Real.com, Film.com, Daily Briefing and LiveConcerts.com, organize and present streaming media programming. We believe that these services and sites stimulate demand for multimedia content that uses our system, which in turn generates advertising revenues for RealNetworks and our broadcasters and content providers. Distribution capabilities. Our more than 70 million registered users represent a significant direct channel for the digital distribution of our own and others' products and services. Since January 1, 1999, we have averaged more than 150,000 downloads of RealPlayer each day. We designed our electronic commerce distribution program to increase the use of our products and services and to drive sales of upgrades, our new products and services and related products of other companies. Our AutoUpdate capability, a feature of RealPlayer G2, enables users to automatically download new products and product upgrades as they become available from us. Our RealStore website is an online store through which we sell our products and third-party multimedia products. We believe that our distribution strategy will continue to facilitate the growth of the streaming media and digital media distribution industries by providing a centralized and low-cost marketplace for developers of new and innovative tools and other products. Strategic relationships. We have established strategic relationships with a variety of leaders in the entertainment, online and traditional media and software, hardware and Internet infrastructure industries. We believe these relationships will (1) increase the adoption of our technologies, (2) accelerate the development of compelling multimedia content, (3) expand the range of commercial activities based on our technology and brand name and (4) foster the development of industry standard software protocols. The reach of our strategic relationships includes: . Product distribution. RealPlayer G2 is a bundled feature of AOL's installation software and Netscape's Navigator Web browser, and is bundled by several leading PC manufacturers. RealServer G2 technology is integrated with server offerings from companies such as Lotus, Sun Microsystems and SGI. . Content delivery. Our streaming media technology is deployed by leading Internet broadcasters such as CNN, ESPN, ABC, AOL, Fox News, Bloomberg, CBS SportsLine and Broadcast.com. . Technology innovation. We have strategic relationships to develop and/or deploy our streaming media solution with backbone providers such as Cable & Wireless, Sprint and AT&T, broadband access providers such as At Home and Enron Communications, infrastructure technology providers such as Inktomi, and ISPs such as Concentric Networks, MindSpring and Earthlink. . Development tools. We have agreements with Intel, CBT, Avid Technology, Adobe Systems, Macromedia and others to develop and deploy tools for RealSystem G2 to enable the production and development of richer, more dynamic media presentations. . Digital music distribution. We are working with IBM, AT&T (a2b), Liquid Audio and others to develop secure digital download capabilities for RealJukebox and RealSystem MP. 24 Strategy Our objective is to be the leading provider of media delivery and distribution products and services that enable and promote the creation, delivery and playback of multimedia content over the Internet. We believe that our continuing efforts to foster an "ecosystem" of partners, including consumers, broadcasters, content providers, advertisers and technology partners, and our efforts to create meaningful economic opportunities for each of these parties, is central to the execution of our strategy. Our strategy for pursuing these goals includes the following: Increase our number of users. We intend to continue our aggressive drive to increase the number of consumers using our products and services and to promote the availability of multimedia content for their consumption. To that end, we will continue to heavily promote our RealPlayer, RealServer and RealJukebox products and to seek additional mass distribution opportunities, such as our relationships with AOL and a variety of OEMs. We believe that our more than 70 million registered users is a strategic asset that is attractive to broadcasters, content providers and advertisers. This audience represents a significant market for the sale of our own and third-party products and services. Drive higher consumer adoption and usage of online media. By creating a simple, easy-to-use and engaging consumer experience, we believe that we help accelerate the adoption and use of online media. We focus our efforts on enhancing the consumer experience through superior technology and on ensuring that consumers have ready access to the high-quality media programming on the Web. We will continue to enhance and develop our navigational tools and programming guides to enable deeper personalization by consumers. Continue to diversify revenue opportunities. We believe that we can continue to expand the number and size of revenue opportunities available to us as our user base and the level of product use grow. . Electronic commerce. With most of the approximately 1.4 million sales of RealPlayer Plus originating from our website, we believe that we are a leading electronic commerce site. We are expanding the range of our own and third-party products sold at our RealStore electronic commerce site to capitalize on this opportunity. . Advertising and sponsorships. We believe that our ability to connect our large base of registered users with multimedia content on the Internet represents a significant business opportunity. We intend to increase our advertising and sponsorship revenues through our recently launched RealGuide, through our network of advertiser-supported websites and programming and by selling placements on the navigational tools on our RealPlayer and RealJukebox client software. Further expand our presence in digital music distribution. With the introduction of RealJukebox and our RealSystem MP digital music distribution solution, we have expanded our presence beyond our traditional streaming media market into the rapidly emerging market for digital music distribution. We intend to continue expanding into this area by aggressively marketing our new products to our large base of RealPlayer users, developing additional products and facilitating the sale and digital distribution of music over the Internet. We expect to drive downloads of RealJukebox through the AutoUpdate capability on RealPlayer G2. We believe our RealJukebox product contains a number of features that will enable it to be the preferred method for consumers to access, browse and download digital music on the Internet for local playback and management. Extend our technology leadership and focus on broadband opportunities. We are focused on maintaining our technology leadership by aggressively introducing new products and services and by driving the development of industry-wide technology standards. A central element of our technology strategy is our ongoing effort to maximize the scalability of our software solutions to 25 accommodate and enable the rapid growth of multimedia content on the Internet. In addition, we intend to focus on developing products designed for media delivery over broadband access technologies such as digital subscriber lines and cable modems. We believe that our experience in delivering media over bandwidth-constrained networks will enable us to deliver solutions to broadband providers to enhance quality of service and network efficiency. Products and Services RealSystem G2 RealSystem G2, introduced in November 1998, fully integrates players, servers and tools to create an end-to-end streaming media solution for consumers and content providers. RealSystem G2 provides the necessary components to generate a high-quality user experience that is scalable across the heterogeneous Internet infrastructure. It allows consumers to experience and content providers to create rich and dynamic media content that can be viewed and heard in real time across varying narrowband and broadband environments. Players. RealPlayer G2 enables a user to listen to and view content from websites that use our server products. RealPlayer G2 provides basic functions such as play, stop, fast-forward, rewind and volume adjustment and customizable navigational tools for easy and personalized access to multimedia content. We offer RealPlayer G2 for free from our website and through bundling with third- party products. We sell our premium RealPlayer Plus, which has additional features such as clearer, sharper audio and video, high-fidelity audio quality with a graphic equalizer and picture quality controls such as contrast, brightness and tint. Servers. Our server technology allows broadcasters and content providers to broadcast audio, video and other multimedia programming to large numbers of simultaneous users over varying Internet connections. We price our servers based on features and streaming capacity and offer four server products to meet the varying needs and requirements of broadcasters and content providers: Basic Server G2, available for free download, supports 25 concurrent users of live and on-demand multimedia broadcasts. Basic Server Plus G2 is designed for hobbyists and small- to medium-sized businesses. It supports 40 concurrent users, with additional administrative capabilities and content creation tools. The RealServer G2 Internet Solution is designed for use primarily by broadcasters, ISPs, distance learning providers and large websites. It supports large audiences and provides more advanced administrative features and new in- stream advertising insertion and rotation capabilities. Customized solutions are available. For example, we offer authentication features to help ensure site security or enable pay-per-view broadcasting and to support back-end credit card and transaction-processing systems, features that are designed and priced specifically for educational institutions or teachers and features that enable ISPs to host the streaming media content of their customers. RealSystem G2 Enterprise Solution is designed for corporate intranets. Popular applications include live executive broadcasts at company meetings, sales force training and enterprise learning. Tools. We offer a variety of products that improve the distribution and quality of customers' RealSystem G2 content and presentations. Our products include: RealProducer G2, available for free download, is our basic multimedia creation and publishing tool. RealProducer Plus G2 is a more advanced tool that offers Web designers and production artists building RealSystem G2 presentations the ability to reach a wider audience and produce higher-quality content. 26 RealProducer Pro G2 is a professional solution designed for Web authors and production experts. It includes timeline-based features for creating synchronized multimedia templates for Synchronized Multimedia Integration Language (SMIL) and Hypertext Mark-up Language (HTML) layout and flexible compression control. RealSystem MP RealSystem MP, introduced in May 1999 and based on the media delivery platform of RealSystem G2, is an open and extensible digital music management solution that provides consumers with a convenient method for recording, playing, organizing and acquiring music from the Internet and local digital sources. RealSystem MP provides the music industry and content owners with a secure method for digital distribution of their music. RealSystem MP can be integrated with various Internet services and supports a range of products and hardware devices. Key features of RealSystem MP include: . Content insertion services that enable consumers to create and manage their own personal music database. . A secure plug-in interface that supports a variety of security initiatives, including IBM's electronic music management system, AT&T's a2b technology and Liquid Audio's technology. RealSystem MP's open architecture will enable it to comply with the goals of the Recording Industry Association of America's task force on the Secure Digital Music Initiative. . File format support for popular music formats such as MP3, WAV, MIDI and our RealAudio G2 format. . Information services that provide access to information from an online music database, including track name, artist, album and genre. . Content extraction services that enable a range of devices and products, including portable digital devices, CD recorders, flash memory cards and high-capacity disks, to use the content and information in a user's personal music database. . Home networking services that enable the distribution of music throughout a home network. RealJukebox. RealJukebox, a beta version of which was introduced in May 1999, is based on RealSystem MP. RealJukebox is a completely digital music product that enables consumers to acquire, record, store, organize and play their personal music collections. Using RealJukebox, consumers can acquire music from a number of different sources, including free promotional music downloads, purchased Internet music downloads and music purchased through links to online music retailers. Consumers can also record CDs onto their hard disks at three to five times playback speed. RealJukebox records to a number of high- quality digital audio formats, including RealAudio G2 and MP3. RealJukebox enables consumers to listen to music at their convenience from a PC, in a home network and on their digital playback devices. Music is sorted by a number of categories, including artist, song title, genre and type of file. Consumers can create personal playlists by dragging and dropping songs. We intend to sell a premium version of our RealJukebox product in the future. Other Products RealStore is an online store for the sale of our own products and upgrades, as well as for third-party products and training products for use on corporate intranets. Through this distribution channel, we are able to offer a broad selection of products with little inventory risk or merchandising expense. 27 Services RealGuide. RealGuide offers the ability to search for and locate multimedia content. RealGuide is a comprehensive directory that enables easy and personalized access to high-quality multimedia programming information available on the Internet. RealGuide provides viewers with one-click access to the day's top stories and programming from nearly 200 RealChannels and RealStations, more than 1,700 live radio and television stations broadcasting on the Internet and over 4,500 third-party multimedia websites. Real Broadcast Network. The Real Broadcast Network is our Internet broadcast service through which we provide hosting services on behalf of broadcasters and content providers. We provide full turnkey services, including the hardware, software, personnel, network connectivity and bandwidth necessary to enable businesses to deliver live and on-demand programming over the Internet. The Real Broadcast Network features a distributed multi-tier architecture designed to improve Internet broadcasts by routing consumers to the nearest broadcast hub on the Internet or within an Internet service provider. We believe the relationships we have formed with leading backbone providers and ISPs support and enhance the services we provide. Showcase websites and programming. In addition to our main website, Real.com, we offer websites that organize and offer streaming media programming through navigational and theme-oriented sites. LiveConcerts.com offers live streamed music concerts and services such as up-to-date concert schedules. Film.com provides in-depth information about movies, including reviews and previews, as well as streaming media clips. Daily Briefing allows users to design and receive customized daily streaming media newscasts in the areas of current events, sports, entertainment, music, business and technology. Technology Our media delivery solutions are designed to optimize the delivery of multimedia content over the Internet. Our solutions are based on open industry standards and work with a broad range of operating systems, hardware platforms, network environments and media types. RealSystem G2 technology. RealSystem G2 is a streaming media platform based on advanced transmission technologies and protocols that address the inherent limitations of the Internet with respect to multimedia delivery. The following are key elements of our RealSystem G2 technology: . AutoUpdate, an automatic upgrade feature, notifies users and allows them to easily download new products and product upgrades as they become available. . SureStream transport technology enables reliable and continuous end- user playback by scaling dynamically to deliver high-quality RealAudio and RealVideo to users at the varying connection rates found under real-world network conditions. SureStream technology utilizes bi- directional communication that enables the server and player to communicate during transmission regarding the bandwidth and quality of the user's connection to optimize the transmission. . Buffering ensures continuous delivery by caching data packets and requesting retransmission of any missing packets. . Error-Mitigation reduces performance degradation by reconstructing lost data packets based on approximations regarding adjacent or closely related data packets. . Smart Networking allows a server to automatically select the appropriate transmission protocol depending on current network conditions and the presence of firewalls or proxies when streaming content to the player. 28 . Video-Optimized Transmission incorporates technologies that reduce unnecessary repetition of redundant background data in neighboring video frames, and reduces the amount of video content being streamed if video performance is degraded during a given transmission. This technology instead focuses on maintaining the continuity of the audio stream, which is often more central to the user experience. . Advertising Application allows for the insertion of banner and streaming media advertising into streaming media content while seamlessly integrating with existing ad-serving software and solutions. . Cross-Platform Support ensures that our products operate across a disparate array of broadcast platforms, such as Alpha UNIX, FreeBSD, HP/UX, Linux, SCO Unix, SGI IRIX, Sun OS and Win32, Internet infrastructures and emerging clients, such as PCs, set-top boxes, portable devices and all popular browsers. RealSystem G2 builds on industry standards, implementing Real Time Streaming Protocol, a standard client/server protocol for streaming media. RealSystem G2 also supports SMIL, which enables rich, multi-screen content to be delivered over a typical modem connection. SMIL allows content creators to easily synchronize their media presentations with a wide range of media, including voice, music, visual effects, text and graphics, to produce audio- visual content using a simple text editor. RealSystem MP technology. Building on the technology of RealSystem G2, we developed RealSystem MP, a complete digital music management solution. RealSystem MP uses an open and extensible architecture that enables its integration with a wide range of Internet services and media formats, including secure digital download, extraction to consumer playback devices and access to online music information databases. Technologies enabling large-scale delivery of streamed multimedia. Our splitter and caching technologies allow broadcasters to transmit large numbers of simultaneous streams using reduced bandwidth by sending a separate signal to multiple users through the same network links. Our splitter technology enables a host server to broadcast a signal to a set of servers distributed around a network. Those servers then transmit the signal to the end user, thereby minimizing the use of the network backbone and improving signal quality. We use this technology in the Real Broadcast Network and license it to other Internet broadcasters, ISPs and networks. The caching and proxy server technology we co- developed with Inktomi enables widespread and efficient distribution of multimedia content by moving the data closer to the end user. This proxy caching technology enables ISPs and backbone providers to greatly reduce bandwidth and infrastructure costs, and provides a more compelling experience for the user. Codecs. Our RealSystem G2 uses multiple compression/decompression algorithms (or codecs) to translate time-based, data-intensive content such as audio, video or animation data into discrete data packets and then broadcasts (or streams) the packets from a server to a client, our RealPlayer. RealPlayer then reassembles the packets in the correct order and allows a user to play back the streaming media content in real time without waiting to download. The compression process enables the data to be streamed to the player even in very low bandwidths (14.4 kbps) or congested network environments by reducing the amount of data to be streamed. We have licensed and integrated Intel's streaming Web video technology into RealSystem G2, enabling significantly faster video encoding than previous streaming media delivery systems and delivery of higher-image performance and quality to consumers. RealSystem MP is compatible with both the RealAudio G2 and MP3 codecs. Our MP3 codecs are based on licenses obtained from third parties. We plan to continue to develop proprietary codecs and license third-party codec technology to improve our products' capabilities. 29 Research and Development We devote a substantial portion of our resources to developing new products, enhancing existing products, expanding and improving our fundamental streaming technology and strengthening our technological expertise. During the years ended December 31, 1996, 1997 and 1998, and the six months ended June 30, 1999, we expended approximately 34%, 41%, 32% and 30% of our total net revenues on research and development activities. We intend to continue to devote substantial resources to research and development for the next several years. As of June 30, 1999, RealNetworks had 225 full-time employees, or approximately 42% of our work force, engaged in research and development activities. Sales, Marketing and Distribution We believe that any individual or company that desires to send, support or receive multimedia content over the Internet is a potential customer. To reach as many of these potential customers as possible, we sell our products and services through several distribution channels, both directly (over the Internet and through a sales force) and indirectly (through OEMs, VARs and other distributors). As of June 30, 1999, we had 199 full-time employees, or approximately 37% of our work force, engaged in sales and marketing activities. Electronic commerce. Substantially all of the products we sell can be purchased and delivered directly from our websites. Our websites provide us with a low-cost, globally accessible sales channel that is available 24 hours per day, seven days per week. Direct sales force. Our direct sales force primarily markets and sells our server products to corporate customers. We also have an advertising sales force that markets and sells advertising on our websites and within the media streams that we host on behalf of our corporate customers. We have subsidiaries in Japan, the United Kingdom, France and Germany, and offices in several other countries, which market and sell our products outside the United States. OEMs and VARs. We have entered into various distribution relationships with third parties pursuant to which our products and technologies are incorporated into, bundled with or offered with third-party products for delivery by the third party to end users. Sales through other distributors. We sell our software systems and services to other distributors, including content aggregators, ISPs and other hosting providers that redistribute or provide end users access to our streaming technology from their websites and systems. We have agreements with owners of many popular websites and software companies to distribute our products as a click-through or to bundle our RealPlayer G2 into their applications and software. Real Developer Program. We provide development tools, technical assistance and marketing opportunities to those who work with our streaming media technology. We offer a program targeted to Web masters, Web designers and content creators who are building interactive, multimedia-rich websites. We also assist application developers who create and market RealAudio- or RealVideo-enabled applications and who develop datatypes for integration into the RealSystem G2 client/server architecture. Approximately 1,300 developers are members of our Real Developer Program. Marketing programs. Our marketing programs are aimed at increasing brand awareness, stimulating market demand and educating potential customers about the economic opportunities in delivering multimedia content over the Internet. We have a number of marketing initiatives, including: . Showcasing our various products and solutions in trade shows, conferences and seminars. . Providing product-specific information through our websites. . Promoting and co-promoting special events with our broadcast partners. 30 . Advertising products and services in print and electronic media. . Sponsoring our annual RealNetworks Conference. Customers Our customers include businesses and consumers located throughout the world. Sales to customers outside the United States, primarily in Asia and Europe, were approximately 19%, 27%, 23% and 24% of total net revenues, excluding revenues from the Microsoft license agreement, in the years ended December 31, 1996, 1997 and 1998 and the six months ended June 30, 1999. Software license fees under a license agreement with Microsoft accounted for approximately 15%, 15% and 10% of total net revenues for the years ended December 31, 1997 and 1998 and the six months ended June 30, 1999. Customer Support Our customers have a choice of support options depending on the level of service desired and the nature of the products acquired. Customer support is provided by our customer relations department and third-party contractors. Customers can access a technical support hotline to answer inquiries or initiate e-mail inquiries. We also provide an online database of technical information for customer self-service. As of June 30, 1999, we employed 21 full-time technical and customer support representatives, approximately 4% of our work force, to respond to customer requests for support. Competition The market for software and services for media delivery over the Internet is relatively new, constantly changing and intensely competitive. As media delivery evolves into a central component of the Internet experience, more companies are entering the market for, and expending increasing resources to develop, media delivery software and services. We expect that competition will continue to intensify. Many of our current and potential competitors have longer operating histories, greater name recognition, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. We are committed to the continued market penetration of our brand, products and services. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology franchise. Price concessions or the emergence of other pricing or distribution strategies of competitors may diminish our revenues, impact our margins or lead to a reduction in our market share, any of which will harm our business. Microsoft is a principal competitor in the development and distribution of streaming media and media distribution technology. Microsoft currently competes with us in the market for streaming media server and player software and has announced its intent to compete in the market for digital distribution of media. In addition, Microsoft competes with us to attract broadcasters of high- quality or popular content to promote and deliver such content in Microsoft's formats, in some cases on an exclusive or preferential basis. We believe that Microsoft's commitment to and presence in the media delivery industry has increased and that Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution. In addition to Microsoft, we face increasing competition from other companies that are developing and marketing streaming media products. Competitors include Apple Computer, which has just announced the availability of QuickTime 4.0 with a streaming media server, Cisco Systems/Precept Software, PictureTel/Starlight Networks and Oracle. As more companies enter the market with products that compete with our servers, players and tools, the competitive landscape could change rapidly to our disadvantage. 31 Our media hosting service, the Real Broadcast Network, competes with a variety of companies that provide streaming media hosting services. These companies include Broadcast.com (which has agreed to be acquired by Yahoo!) and Intervu and emerging broadcast networks such as CMGI's Magnitude Network and Enron Communications. Some media hosting competitors are also customers on whom we rely to help drive product download traffic to our website through their broadcast events. While Internet advertising revenues across the industry continue to grow, the number of websites competing for advertising revenues is also growing. Our websites, including Real.com, Film.com and LiveConcerts.com, compete for user traffic and Internet advertising revenues with a wide variety of websites, Internet portals and ISPs. In particular, aggregators of audio, video and other media, such as Broadcast.com and Microsoft's Web Events, compete with our RealGuide. We also compete with traditional media such as television, radio and print for a share of advertisers' total advertising budgets. The electronic commerce features of our websites compete with a variety of other websites for consumer traffic. To compete successfully in the electronic commerce market, we must attract sufficient traffic to our websites by offering high-quality, competitively priced merchandise in a compelling, easy-to- purchase format. In addition, we must successfully leverage our existing user base to develop the market for our products and services. Governmental Regulation We are not currently subject to direct regulation by any governmental agency other than laws and regulations generally applicable to businesses, although certain U.S. export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. Few existing laws or regulations specifically apply to the Internet. However, it is likely that a number of laws and regulations may be adopted in the United States and other countries with respect to the Internet. These laws may relate to areas such as content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, encryption, use of key escrow data, caching of content by server products, electronic authentication or "digital signatures," personal privacy, advertising, taxation, electronic commerce liability, e-mail, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability. Other countries and political organizations are likely to impose or favor more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. The adoption of such laws or regulations, and uncertainties associated with their validity and enforcement, may affect the available distribution channels for and costs associated with our products and services, and may affect the growth of the Internet. Such laws or regulations may therefore harm our business. We do not know for certain how existing laws governing issues such as property ownership, copyright and other intellectual property issues, taxation, illegal or obscene content, retransmission of media and personal privacy and data protection apply to the Internet. The vast majority of such laws were adopted before the advent of the Internet and related technologies and do not address the unique issues associated with the Internet and related technologies. Most of the laws that relate to the Internet have not yet been interpreted. Changes to or the interpretation of these laws could: . limit the growth of the Internet; . create uncertainty in the marketplace that could reduce demand for our products and services; . increase our cost of doing business; . expose us to significant liabilities associated with content available on our websites or distributed or accessed through our products or services; or . lead to increased product development costs or otherwise harm our business. 32 Intellectual Property As of May 14, 1999, we had 25 registered U.S. trademarks or service marks, and had applications pending for an additional 39 U.S. trademarks. We also have several unregistered trademarks. In addition, RealNetworks has several foreign trademark registrations and pending applications. Many of our marks begins with the word "Real" (such as RealSystem, RealAudio and RealVideo). We are aware of other companies that use "Real" in their marks alone or in combination with other words, and we do not expect to be able to prevent all third-party uses of the word "Real" for all goods and services. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective patent, copyright, trademark and trade secret protection may not be available in such jurisdictions. As of May 14, 1999, we had nine U.S. patents and 11 patent applications on file relating to various aspects of our technology. We are preparing additional patent applications on other features of our technology. Patents with respect to our technology may not be granted and, if granted, may be challenged or invalidated. Issued patents may not provide us with any competitive advantages and may be challenged by third parties. In addition, others could independently develop substantially equivalent intellectual property. Many of our current and potential competitors dedicate substantially greater resources to protection and enforcement of their intellectual property rights, especially patents. If a blocking patent has issued or issues in the future, we would need to either obtain a license or design around the patent. We may not be able to obtain such a license on acceptable terms, if at all, or design around the patent. As with other software products, our products are susceptible to unauthorized copying and uses that may go undetected, and policing such unauthorized use is difficult. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology, or may not prevent the development and design by others of products or technologies similar to or competitive with those we develop. Employees As of June 30, 1999, we had 536 full-time employees, 462 of whom were based at our executive offices in Seattle, Washington, 40 of whom were based in our foreign offices and 34 of whom were based in our domestic sales offices. None of our employees is subject to a collective bargaining agreement, and we believe that our relations with our employees are good. Position on Charitable Responsibility We are strongly committed to charitable responsibility, as evidenced by our donations of software to charitable organizations. If we achieve sustained profitability, we intend to donate approximately 5% of our annual net income to charitable organizations. We hope to encourage employee giving by using a portion of our intended contribution to match charitable donations made by employees. Properties We have entered into a lease agreement for our new corporate headquarters in Seattle, Washington. The lease commenced on April 1, 1999 and expires on April 1, 2011, with an option to renew for either a three- or a ten-year period. We are initially leasing approximately 148,000 square feet at an average monthly rent of approximately $210,000. We will be leasing approximately 114,000 square feet of additional space in stages during 1999 through 2001, at an average additional 33 monthly rent of approximately $185,000. We moved into the new location in May 1999. This move could cause a disruption in our operations and unexpected costs, which would adversely affect our business. Legal Proceedings In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit against us and co-defendant Broadcast.com in the United States District Court for the Northern District of Texas--Dallas Division. The plaintiffs allege that we, individually and in combination with Broadcast.com, infringe on a certain patent by making, using, selling and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. The plaintiffs seek to enjoin us from our alleged infringing activity and to recover damages in an amount no less than a reasonable royalty. Although we can give no assurance as to the outcome of this lawsuit, we believe that the allegations in this action are without merit, and intend to vigorously defend ourselves against these claims. We may be required to indemnify Broadcast.com under the terms of our license agreement with it. The plaintiffs filed a similar claim based on the same patent and seeking similar remedies as a separate lawsuit against Microsoft and Broadcast.com in the same court. The court has consolidated the lawsuit against Microsoft and Broadcast.com with the lawsuit against RealNetworks and Broadcast.com. On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against us in the U.S. District Court for the Western District of Washington. The plaintiff alleges that we entered into an oral agreement with it in 1995 pursuant to which the plaintiff claims it is entitled to 30% of our revenues from the use of RealAudio technology to promote, sample or sell music. The plaintiff claims breach of contract, unjust enrichment, promissory estoppel and breach of implied-in-fact contract. We have denied each of the plaintiff's claims. In response to our motion to dismiss, the plaintiff withdrew its claim for breach of fiduciary duty. Although no assurance can be given as to the outcome of this lawsuit, we believe the allegations in this action are without merit, and we intend to vigorously defend ourselves against these claims. From time to time we are, and expect to continue to be, subject to legal proceedings and claims in the ordinary course of our business, including contract-related claims and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, even if not meritorious, could force us to spend significant financial and managerial resources. We currently are not aware of any legal proceedings or claims that we believe will have, individually or taken together, a material adverse effect on our business, prospects, financial condition and operating results. 34 SELLING SHAREHOLDERS The following table sets forth information known to us with respect to the beneficial ownership of our common stock held by each selling shareholder as of July 26, 1999, and as adjusted to reflect the sale of common stock offered by such shareholder. As of July 26, 1999, there were 72,977,641 shares of common stock outstanding. Beneficial ownership is determined in accordance with the rules of the SEC.
Ownership Prior to Ownership After Offering Offering(1) -------------------- -------------------- Number of Shares Being Number of Beneficial Owner Shares Percentage Offered Shares Percentage ---------------- --------- ---------- ------------ --------- ---------- Michael Comish........... 32,000 * 16,000 16,000 * Mark Comish.............. 21,334 * 10,668 10,666 *
- -------- * Less than 1% of the outstanding shares of common stock. (1) Assumes the sale of all the shares of common stock offered by each of the selling shareholders. None of the selling shareholders has had any material relationship with RealNetworks or its affiliates within the past three years. The selling shareholders received all the shares from RealNetworks on April 1, 1999 in a private transaction, pursuant to which Ultisoft Inc., a company owned by the selling shareholders, merged with a wholly owned subsidiary of RealNetworks. All the shares were "restricted securities" under the Securities Act prior to this registration. The selling shareholders have represented to us that they acquired the shares for their own account for investment only and not with a view toward selling or distributing them, except pursuant to sales registered under the Securities Act or exemptions from the registration requirements of the Securities Act. In recognition of the fact that the selling shareholders, even though acquiring the shares for investment, may wish to be legally permitted to sell their shares, RealNetworks agreed with the selling shareholders to file the registration statement to register the resale of the shares. RealNetworks agreed to prepare and file all necessary amendments and supplements to the registration statement to keep it effective until the earlier of (1) ten trading days after the date of this prospectus and (2) the date on which the selling shareholders have sold all the shares. 35 PLAN OF DISTRIBUTION We are registering the shares of common stock on behalf of the selling shareholders and their successors (including donees, pledgees, transferees or other successors-in-interest, who may sell shares they receive from the selling shareholders as a gift, pledge, partnership distribution or other non-sale- related transfer after the date of this prospectus). The selling shareholders or their successors may sell all of the shares from time to time in transactions (which may include block transactions) in the over-the-counter market through Nasdaq, in privately negotiated transactions, through put or call option transactions relating to the shares, through short sales of the shares or through a combination of such methods of sale. They may sell the shares at fixed prices that may change, at market prices prevailing at the time of sale, at prices relating to prevailing market prices or at negotiated prices. Such transactions may or may not involve brokers or dealers. The selling shareholders have advised us that they have not entered into any arrangements for the sale of the shares with any underwriters or broker- dealers and that no underwriter or coordinating broker is now acting in connection with the proposed sale of shares. The selling shareholders may effect such transactions by selling the shares directly to purchasers, through broker-dealers acting as agents for the selling shareholders, or to brokers-dealers who may purchase the shares as principals and thereafter sell such securities from time to time in transactions on any exchange or market on which our securities are listed or quoted, as applicable. The selling shareholders will act independently of us in making decisions with respect to the timing, manner and size of each sale. In connection with distributions of the shares or otherwise, the selling shareholders may enter into hedging transactions with broker-dealers. In connection with such transactions, broker-dealers may engage in short sales of the shares in the course of hedging the positions they assume with the selling shareholders. The selling shareholders may also sell shares short and redeliver the shares to close out such short positions. The selling shareholders may also enter into option or other transactions with broker-dealers which require the delivery to the broker-dealer of the shares, which the broker-dealer may resell or otherwise transfer pursuant to this prospectus. The selling shareholders may also loan or pledge the shares to a broker-dealer and the broker-dealer may sell the shares so loaned or, upon a default, the broker-dealer may effect sales of the pledged shares pursuant to this prospectus. The selling shareholders also may resell all or a portion of the shares in open market transactions in reliance upon Rule 144 under the Securities Act, rather than pursuant to this prospectus, provided they meet the criteria and conform to the requirements of such rule. Any broker-dealers participating in the distribution of the shares may receive compensation in the form of discounts, concessions or commissions from the selling shareholders and/or the purchasers of the shares for whom such broker-dealers may act as agents or to whom they may sell as principals, or both. The compensation paid to a particular broker-dealer might be in excess of customary commissions. The selling shareholders and broker-dealers who assist in the sale of the shares may be "underwriters" within the meaning of Section 2(11) of the Securities Act. Any commissions paid or any discounts or concessions allowed to any such broker-dealers, and any profits received on the resale of such shares of common stock purchased by them, may be underwriting discounts and commissions under the Securities Act. Selling shareholders who are "underwriters" within the meaning of Section 2(11) of the Securities Act will be subject to the prospectus delivery requirements of the Securities Act. 36 The rules of the SEC generally prohibit underwriters, brokers, dealers and certain other persons engaged or participating in the distribution of these shares, including the selling shareholders, from making a market in such shares during the "cooling off" period preceding the commencement of such distribution, which may limit the timing of purchases and sales of our common stock by the selling shareholders. We have informed the selling shareholders that the antimanipulative provisions of Regulation M of the Exchange Act may apply to sales of the shares in the market and to the activities of the selling shareholders and their affiliates. To comply with the securities laws of certain states, if applicable, our common stock will be sold in such jurisdictions only through registered or licensed brokers or dealers. In addition, in certain states, our common stock may not be sold unless such shares have been registered or qualified for sale in the applicable state or an exemption from the registration or qualification requirement is available and is complied with. To the extent required, the number of the shares to be sold, the purchase prices or public offering prices of the shares, the names of any agents, dealers or underwriters, any applicable commissions or discounts with respect to a particular offer and any other material facts will be set forth by us in a supplement to this prospectus or, if appropriate, a post-effective amendment to the registration statement of which this prospectus is a part. In addition, a supplement to this prospectus will be filed upon notification to us by a selling shareholder that one or more of his donees, pledgees, transferees or other successors-in-interest intends to sell more than 500 shares. RealNetworks will pay all expenses (other than selling commissions and fees, stock transfer taxes and fees and expenses of legal counsel for the selling shareholders) of the registration and sale of the shares. However, the selling shareholders have agreed to reimburse RealNetworks for the first $20,000 in legal fees and associated costs incurred by RealNetworks in connection with the registration and sale of the shares. RealNetworks also has agreed to indemnify the selling shareholders against certain liabilities, including liabilities under the Securities Act. The selling shareholders may indemnify any agent, dealer or broker-dealer that assists them in selling the shares against certain liabilities, including liabilities arising under the Securities Act. We have agreed to use our best efforts to maintain the effectiveness of this registration statement with respect to the shares of common stock offered by the selling shareholders until the earlier of the sale of such shares or ten trading days after the date of this prospectus. No sales may be made pursuant to this prospectus after such date unless we amend or supplement this prospectus to indicate that we have agreed to extend such period of effectiveness. RealNetworks may suspend use of this prospectus under certain circumstances. We cannot guarantee that the selling shareholders will sell any or all of the shares. RealNetworks will not receive any proceeds from the sale of the shares by the selling shareholders. 37 LEGAL MATTERS The validity of the securities offered by this prospectus will be passed upon for RealNetworks by Perkins Coie LLP, Seattle, Washington. EXPERTS The consolidated financial statements and schedule of RealNetworks, Inc. and subsidiaries as of December 31, 1997 and 1998 and for each of the years in the three-year period ended December 31, 1998, have been included in this prospectus and in the registration statement in reliance upon the report of KPMG LLP, independent auditors, appearing elsewhere in this prospectus, and upon the authority of that firm as experts in accounting and auditing. WHERE YOU CAN FIND MORE INFORMATION We file annual, quarterly and special reports, proxy statements and other information with the SEC. Our SEC filings are available to the public over the Internet at the SEC's website at http://www.sec.gov. You may also read and copy any document we file with the SEC at its Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can also obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of its Public Reference Room. The SEC allows us to "incorporate by reference" into this prospectus the information we have filed with it. The information incorporated by reference is an important part of this prospectus and the information that we file subsequently with the SEC will automatically update this prospectus. The information incorporated by reference is considered to be part of this prospectus. We incorporate by reference the documents listed below and any filings we make with the SEC under Section 13(a), 13(c), 14, or 15(d) of the Securities Exchange Act of 1934, after the initial filing of the registration statement that contains this prospectus and before the time that all the securities offered by this prospectus are sold: . Our Annual Report on Form 10-K for the fiscal year ended December 31, 1998; . Our Quarterly Report on Form 10-Q for the quarter ended March 31, 1999; . Our Current Report on Form 8-K, filed on May 4, 1999; and . The description of our capital stock contained in the Registration Statements on Form 8-A filed on September 26, 1997 and December 14, 1998 under Section 12 of the Exchange Act, including any amendment or report updating such description. You may request a copy of these filings, at no cost, by writing or telephoning us at the following address: RealNetworks, Inc. Kelly Jo MacArthur Vice President, General Counsel and Secretary 2601 Elliott Avenue Seattle, Washington 98121 (206) 674-2700 38 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Independent Auditors' Report............................................... F-2 Consolidated Statements of Operations and Comprehensive Loss............... F-3 Consolidated Balance Sheets................................................ F-4 Consolidated Statements of Shareholders' Equity (Deficit).................. F-5 Consolidated Statements of Cash Flows...................................... F-6 Notes to Consolidated Financial Statements................................. F-7
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders RealNetworks, Inc.: We have audited the accompanying consolidated balance sheets of RealNetworks, Inc. and subsidiaries as of December 31, 1997 and 1998, and the related consolidated statements of operations and comprehensive loss, shareholders' equity (deficit) and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of RealNetworks, Inc. and subsidiaries as of December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ KPMG LLP Seattle, Washington January 21, 1999, except for Note 10(a), which is as of May 10, 1999 F-2 REALNETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Quarter Ended Year Ended December 31, March 31, --------------------------- ----------------- 1996 1997 1998 1998 1999 ------- -------- -------- -------- ------- (unaudited) (in thousands, except per share data) Net revenues: Software license fees....... $11,876 $ 25,494 $ 46,949 $ 9,418 $17,010 Service revenues............ 1,120 4,972 14,742 2,622 5,249 Advertising................. 1,016 2,254 3,148 462 1,266 ------- -------- -------- -------- ------- Total net revenues........ 14,012 32,720 64,839 12,502 23,525 ------- -------- -------- -------- ------- Cost of revenues: Software license fees....... 1,343 3,153 8,032 1,586 2,811 Service revenues............ 554 2,392 2,631 521 920 Advertising................. 288 920 1,727 332 550 ------- -------- -------- -------- ------- Total cost of revenues.... 2,185 6,465 12,390 2,439 4,281 ------- -------- -------- -------- ------- Gross profit.............. 11,827 26,255 52,449 10,063 19,244 ------- -------- -------- -------- ------- Operating expenses: Research and development.... 4,812 13,268 20,828 4,419 7,289 Sales and marketing......... 7,540 20,124 32,451 6,830 10,215 General and administrative.. 3,491 6,024 9,841 2,100 2,913 Goodwill amortization....... -- -- 1,596 -- 532 Acquisition charges......... -- -- 8,723 8,723 -- ------- -------- -------- -------- ------- Total operating expenses.. 15,843 39,416 73,439 22,072 20,949 ------- -------- -------- -------- ------- Operating loss............ (4,016) (13,161) (20,990) (12,009) (1,705) ------- -------- -------- -------- ------- Other income (expense): Interest income............. 296 2,225 5,325 1,266 1,308 Other expense............... (69) (233) (749) (189) (339) ------- -------- -------- -------- ------- Other income, net......... 227 1,992 4,576 1,077 969 ------- -------- -------- -------- ------- Net loss.................. $(3,789) $(11,169) $(16,414) $(10,932) $ (736) ======= ======== ======== ======== ======= Basic and diluted net loss per share........................ $ (5.95) $ (1.44) $ (0.25) $ (0.18) $ (0.01) ======= ======== ======== ======== ======= Shares used to compute basic and diluted net loss per share........................ 642 8,081 64,646 62,084 67,457 Comprehensive loss: Net loss.................... $(3,789) $(11,169) $(16,414) $(10,932) $ (736) Translation adjustment...... (11) (151) 36 (14) (115) ------- -------- -------- -------- ------- Comprehensive loss........ $(3,800) $(11,320) $(16,378) $(10,946) $ (851) ======= ======== ======== ======== =======
See accompanying notes to consolidated financial statements. F-3 REALNETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, -------------------------- March 31, 1997 1998 1999 ------------ ------------ ----------------- (unaudited) (in thousands, except per share data) ASSETS Current assets: Cash, cash equivalents and short- term investments................. $ 92,537 $ 89,777 $ 89,120 Trade accounts receivable, net of allowances for doubtful accounts and sales returns of $829 in 1997, $1,166 in 1998 and $1,287 in 1999.......................... 5,270 4,941 5,031 License fee receivable............ 10,000 -- -- Prepaid expenses and other current assets........................... 2,052 3,212 3,276 ------------ ------------ ------------ Total current assets.............. 109,859 97,930 97,427 ------------ ------------ ------------ Equipment and leasehold improvements, at cost: Equipment and software............ 6,549 10,914 12,497 Leasehold improvements............ 1,347 1,441 7,384 ------------ ------------ ------------ Total equipment and leasehold improvements..................... 7,896 12,355 19,881 Less accumulated depreciation and amortization..................... 2,753 6,082 6,945 ------------ ------------ ------------ Net equipment and leasehold improvements..................... 5,143 6,273 12,936 ------------ ------------ ------------ Restricted cash equivalents........ -- 13,700 13,700 Other assets....................... 1,702 1,108 1,160 Goodwill, net of accumulated amortization of $1,596 in 1998 and $2,128 in 1999.................... -- 9,048 8,516 ------------ ------------ ------------ Total assets...................... $ 116,704 $ 128,059 $ 133,739 ============ ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable.................. $ 2,136 $ 3,563 $ 3,256 Accrued liabilities............... 3,653 10,418 13,810 Deferred revenue, excluding non- current portion.................. 16,550 23,742 30,145 ------------ ------------ ------------ Total current liabilities......... 22,339 37,723 47,211 ------------ ------------ ------------ Deferred revenue, excluding current portion........................... 15,500 5,833 2,617 Note payable....................... 963 987 994 Shareholders' equity: Preferred stock, $0.001 par value, no shares issued and outstanding Series A: authorized 200 shares... -- -- -- Undesignated series: authorized 59,800 shares.................... -- -- -- Common stock, $0.001 par value Authorized 293,704 shares (295,791 shares authorized in 1999); issued and outstanding 55,055 shares in 1997, 61,975 shares in 1998 and 66,604 shares in 1999... 55 62 66 Special common stock, $0.001 par value Authorized 6,296 shares (4,209 shares authorized in 1999); issued and outstanding 3,338 shares in 1997, 2,586 shares in 1998 and 500 shares in 1999...... 3 3 1 Additional paid-in capital........ 95,530 117,515 117,765 Accumulated other comprehensive loss............................. (162) (126) (241) Accumulated deficit............... (17,524) (33,938) (34,674) ------------ ------------ ------------ Total shareholders' equity........ 77,902 83,516 82,917 ------------ ------------ ------------ Commitments, contingencies and subsequent events Total liabilities and shareholders' equity............. $ 116,704 $ 128,059 $ 133,739 ============ ============ ============
See accompanying notes to consolidated financial statements. F-4 REALNETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
Special Accumulated Preferred Stock Common Stock Common Stock Additional Other Total ------------------ ------------- -------------- Paid-In Comprehensive Accumulated Shareholders' Shares Amount Shares Amount Shares Amount Capital Income (Loss) Deficit Equity (Deficit) --------- ------- ------ ------ ------ ------ ---------- ------------- ----------- ---------------- (in thousands) Balances at December 31, 1995.............. 13,713 $ 14 74 $-- -- $-- $ 922 $ -- $ (2,047) $ (1,111) Exercise of common stock options..... -- -- 997 1 -- -- 43 -- -- 44 Issuance of preferred stock warrants.......... -- -- -- -- -- -- 1,579 -- -- 1,579 Accretion of redemption value of redeemable, convertible preferred stock... -- -- -- -- -- -- -- -- (31) (31) Translation adjustment........ -- -- -- -- -- -- -- (11) -- (11) Net loss......... -- -- -- -- -- -- -- -- (3,789) (3,789) --------- ------ ------ ---- ------ ---- -------- ----- -------- -------- Balances at December 31, 1996.............. 13,713 14 1,071 1 -- -- 2,544 (11) (5,867) (3,319) Exercise of common stock options..... -- -- 2,288 2 -- -- 254 -- -- 256 Issuance of common stock in exchange for services...... -- -- 32 -- -- -- 55 -- -- 55 Issuance of preferred stock warrants.......... -- -- -- -- -- -- 4,068 -- -- 4,068 Accretion of redemption value of redeemable, convertible preferred stock... -- -- -- -- -- -- -- -- (488) (488) Exercise of common stock warrants.... -- -- 368 -- -- -- 37 -- -- 37 Conversion of convertible preferred stock into common stock............. (13,713) (14) 27,426 28 -- -- (14) -- -- -- Conversion of redeemable, convertible preferred stock into common stock and special common stock............. -- -- 16,970 17 3,338 3 50,051 -- -- 50,071 Sale of common stock for cash, net of issuance costs of $4,582... -- -- 6,900 7 -- -- 38,535 -- -- 38,542 Translation adjustment........ -- -- -- -- -- -- -- (151) -- (151) Net loss......... -- -- -- -- -- -- -- -- (11,169) (11,169) --------- ------ ------ ---- ------ ---- -------- ----- -------- -------- Balances at December 31, 1997.............. -- -- 55,055 55 3,338 3 95,530 (162) (17,524) 77,902 Exercise of common stock options..... -- -- 1,785 2 -- -- 744 -- -- 746 Exercise of common stock warrants.... -- -- 1,333 1 -- -- 3,846 -- -- 3,847 Common stock sold pursuant to Employee Stock Purchase Plan..... -- -- 95 -- -- -- 873 -- -- 873 Issuance of common stock and stock options in business combination....... -- -- 2,203 2 -- -- 16,524 -- -- 16,526 Conversion of special common stock to common stock............. -- -- 1,504 2 (752) -- (2) -- -- -- Translation adjustment........ -- -- -- -- -- -- -- 36 -- 36 Net loss......... -- -- -- -- -- -- -- -- (16,414) (16,414) --------- ------ ------ ---- ------ ---- -------- ----- -------- -------- Balances at December 31, 1998.............. -- -- 61,975 62 2,586 3 117,515 (126) (33,938) 83,516 Exercise of common stock options (unaudited)....... -- -- 456 -- -- -- 252 -- -- 252 Conversion of special common stock to common stock (unaudited)....... -- -- 4,173 4 (2,086) (2) (2) -- -- -- Translation adjustment (unaudited)....... -- -- -- -- -- -- -- (115) -- (115) Net loss (unaudited)...... -- -- -- -- -- -- -- -- (736) (736) --------- ------ ------ ---- ------ ---- -------- ----- -------- -------- Balances at March 31, 1999 (unaudited)....... -- $ -- 66,604 $ 66 500 $ 1 $117,765 $(241) $(34,674) $ 82,917 ========= ====== ====== ==== ====== ==== ======== ===== ======== ========
See accompanying notes to consolidated financial statements. F-5 REALNETWORKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Quarter Ended Year Ended December 31, March 31, ----------------------------- ------------------ 1996 1997 1998 1998 1999 -------- --------- -------- -------- -------- (unaudited) (in thousands) Cash flows from operating activities: Net loss................... $ (3,789) $ (11,169) $(16,414) $(10,932) $ (736) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization.............. 699 2,132 5,053 706 1,318 Acquisition charges........ -- -- 8,723 8,723 -- Other...................... -- 27 -- -- -- Equity in net losses of joint venture............. -- 182 448 125 152 Deferred income tax expense (benefit)................. -- (777) 777 -- -- Change in certain assets and liabilities: Trade accounts receivable............... (2,665) (1,919) 512 237 (128) License fee receivable.... -- (10,000) 10,000 -- -- Prepaid expenses and other current assets........... (484) (1,119) (1,686) (770) (290) Accounts payable.......... 2,220 (260) 853 86 (287) Accrued liabilities....... 1,118 2,340 4,267 456 3,462 Deferred revenue.......... 2,266 29,163 (3,028) 349 3,206 -------- --------- -------- -------- -------- Net cash provided by (used in) operating activities............... (635) 8,600 9,505 (1,020) 6,697 -------- --------- -------- -------- -------- Cash flows from investing activities: Purchases of equipment and leasehold improvements.... (2,784) (4,627) (4,373) (637) (7,490) Purchases of short-term investments............... (30,515) (203,046) (93,161) (25,594) (25,244) Sales of short-term investments............... 28,644 177,621 85,542 10,105 8,144 Investment in joint venture................... -- (998) -- -- -- Increase in other assets... (182) (251) -- -- -- Increase in restricted cash equivalents............... -- -- (13,700) -- -- Cash obtained through acquisition............... -- -- 203 203 -- -------- --------- -------- -------- -------- Net cash used in investing activities............... (4,837) (31,301) (25,489) (15,923) (24,590) -------- --------- -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of note payable.............. -- 991 -- -- -- Net proceeds from sales of preferred and common stock and exercise of stock options and warrants...... 17,091 69,333 5,667 2 252 -------- --------- -------- -------- -------- Net cash provided by financing activities..... 17,091 70,324 5,667 2 252 -------- --------- -------- -------- -------- Effect of exchange rate changes on cash............ (11) (106) (62) (5) (116) -------- --------- -------- -------- -------- Net increase (decrease) in cash and cash equivalents.............. 11,608 47,517 (10,379) (16,946) (17,757) Cash and cash equivalents at beginning of period........ 3,130 14,738 62,255 62,255 51,876 -------- --------- -------- -------- -------- Cash and cash equivalents at end of period.............. $ 14,738 $ 62,255 $ 51,876 $ 45,309 $ 34,119 ======== ========= ======== ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for interest.............. $ 4 $ 27 $ -- $ -- $ -- Cash paid during the period for income taxes.......... $ -- $ 700 $ 600 $ -- $ -- Supplemental disclosure of noncash financing and investing activities: Accretion of preferred stock..................... $ 31 $ 488 $ -- $ -- $ -- Conversion of redeemable, convertible preferred stock to common stock and special common stock...... $ -- $ 50,071 $ -- $ -- $ -- Common stock issued in business combination...... $ -- $ -- $ 16,526 $ 16,526 $ --
See accompanying notes to consolidated financial statements. F-6 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) 1. Description of Business and Summary of Significant Accounting Policies (a) Description of Business RealNetworks, Inc. and subsidiaries (Company) is a leading provider of media delivery and digital distribution solutions designed for the Internet. The Company's solutions enable consumers to experience and content providers to deliver a broad range of multimedia content, including audio, video, text and animation. The Company pioneered the development and commercialization of "streaming media" systems that enable the creation, real-time delivery and playback of multimedia content. The Company extended its media delivery platform to include a digital music management system that allows consumers to acquire, record, store, organize and play their personal music collections on personal computers and digital playback devices. Inherent in the Company's business are various risks and uncertainties, including its limited operating history and the limited history of commerce on the Internet. The Company's success may depend in part upon the emergence of the Internet and corporate intranets as a communications medium, the acceptance of the Company's technology by the marketplace and the Company's ability to generate license, service and advertising revenues from the use of its technology on the Internet. (b) Basis of Presentation The 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. (c) Cash, Cash Equivalents and Short-Term Investments The Company considers all short-term investments with a remaining contractual maturity at date of purchase of three months or less to be cash equivalents. The Company considers all short-term investments as available-for-sale. Accordingly, these investments are carried at fair value. The fair value of such securities approximated cost, and there were no unrealized holding gains or losses at December 31, 1997 and 1998 and March 31, 1999. At December 31, 1997 and 1998 and March 31, 1999, all short-term investments had original contractual maturities of two years or less. F-7 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) The Company's cash, cash equivalents and short-term investments consist of the following:
December 31, --------------- March 31, 1997 1998 1999 ------- ------- --------- Cash and cash equivalents: Cash............................................... $ 4,679 $ 5,876 $ 5,329 Commercial paper................................... 57,576 42,000 28,790 U.S. Government agency securities.................. -- 4,000 -- ------- ------- ------- Total cash and cash equivalents.................. 62,255 51,876 34,119 ------- ------- ------- Short-term investments: Corporate notes.................................... 6,717 30,602 38,188 U.S. Government agency securities.................. 21,065 5,300 16,813 Certificates of deposit............................ 2,500 1,999 -- ------- ------- ------- Total short-term investments..................... 30,282 37,901 55,001 ------- ------- ------- Total cash, cash equivalents and short-term investments..................................... $92,537 $89,777 $89,120 ======= ======= ======= Restricted cash equivalents.......................... $ -- $13,700 $13,700 ======= ======= =======
Restricted cash equivalents represent a restricted escrow account established in connection with a lease agreement for new corporate headquarters. Under certain circumstances, $10,000 of the escrow account will be maintained for the term of the lease. The remaining $3,700 will be released as the Company funds tenant improvements. The Company expects to take occupancy of the new facilities during the quarter ending June 30, 1999. (d) Depreciation and Amortization Depreciation and amortization of equipment and leasehold improvements is computed using the straight-line method over the estimated useful lives of the assets, generally three years, or the lease term if shorter. Goodwill represents the excess of the purchase price over the fair value of identifiable tangible and intangible assets acquired in a business combination accounted for under the purchase accounting method. Goodwill is amortized using the straight-line method over five years. (e) Stock-Based Compensation The Company has elected to apply the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation" (SFAS 123). Accordingly, the Company accounts for stock- based compensation transactions with employees using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Options Issued to Employees," and related interpretations. Compensation cost for employee stock options is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the stock option exercise price. F-8 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) (f) 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 or the Company's results of operations. Revenue from software license fees is recognized upon delivery, net of an allowance for estimated returns, provided all the requirements of SOP 97-2 have been met. 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 remained and collection of the resulting receivable was 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. In the case of prepayments received from an OEM, the Company generally recognizes revenue based on the actual products sold by the OEM. If the Company anticipates providing ongoing support to the OEM in the form of future upgrades, enhancements or other services over the term of the contract, revenue is recognized on the straight-line method over the term of the contract. Service revenues include payments under support and upgrade contracts and fees from consulting and streaming media content hosting. Support and upgrade revenues are recognized ratably over the term of the contract, which typically is twelve months. Other service revenues are recognized when the service is performed. Revenues from advertising appearing on the Company's websites 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 websites 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. (g) Research and Development Costs incurred in research and development are expensed as incurred. Software development costs are required to be capitalized when a product's technological feasibility has been established through the date the product is available for general release to customers. The Company has not capitalized any software development costs as technological feasibility is generally not established until substantially all development is complete. F-9 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) (h) Advertising Expenses The Company expenses the cost of advertising and promoting its products as incurred. Such costs are included in sales and marketing expense and totaled approximately $665 in 1996, $1,110 in 1997, and $783 in 1998. (i) Income Taxes The Company computes income taxes using the asset and liability method, under which deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. (j) Financial Instruments and Concentrations of Risk The Company's financial instruments consist of cash, cash equivalents, short-term investments, trade accounts receivable, accounts payable, accrued liabilities and note payable. The fair value of these instruments approximates their financial statement carrying amount. Credit is extended to customers based on an evaluation of their financial condition, and collateral is not required. The Company performs ongoing credit evaluations of its customers and maintains an allowance for potential credit losses. The Company is subject to concentrations of credit risk and interest rate risk related to its short-term investments. The Company's credit risk is managed by limiting the amount of investments placed with any one issuer, investing in high-quality investment securities and securities of the U.S. government, and limiting the average maturity of the overall portfolio. (k) 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 Year Ended December 31, March 31, --------------------------- --------------- 1996 1997 1998 1998 1999 ------- -------- -------- -------- ----- Net loss...................... $(3,789) $(11,169) $(16,414) $(10,932) $(736) Accretion of redemption value of redeemable preferred stock prior to conversion into common stock................. (31) (488) -- -- -- ------- -------- -------- -------- ----- Net loss attributable to common shareholders.......... $(3,820) $(11,657) $(16,414) $(10,932) $(736) ======= ======== ======== ======== =====
F-10 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) The computation of diluted net loss per share excludes the following options to acquire shares of common stock for the periods indicated because the effect would be anti-dilutive:
Year Ended December Quarter Ended 31, March 31, -------------------- ------------- 1996 1997 1998 1998 1999 ------ ------ ------ ------ ------ Shares of common stock.................. 10,668 13,862 16,320 15,110 18,004 Weighted average exercise price per share.................................. $ 0.14 $ 1.46 $ 6.06 $ 2.46 $13.62
(l) Comprehensive Loss On January 1, 1998, the Company adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 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 financial statements. The Company's comprehensive loss for the years ended December 31, 1996, 1997 and 1998 and the quarters ended March 31, 1998 and 1999 consisted of net loss and the gross amount of foreign currency translation adjustments. The tax effect of the translation adjustments was insignificant. Prior year financial statements have been reclassified to conform to the requirements of SFAS 130. (m) Foreign Currency The functional currency of the Company's foreign subsidiaries is the local currency of the country in which the subsidiary is incorporated. Assets and liabilities of foreign operations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. Income and expense accounts are translated into U.S. dollars using average rates of exchange. The net gain or loss resulting from translation is shown as translation adjustment and included in accumulated other comprehensive income (loss) in shareholders' equity. Gains and losses from foreign currency transactions are included in the consolidated statement of operations. There were no significant foreign currency transaction gains or losses in 1996, 1997 and 1998 and in the quarters ended March 31, 1998 and 1999. (n) Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (o) Impairment of Long-Lived Assets and Goodwill The Company reviews its long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used, including goodwill, is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell. F-11 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) (p) Reclassifications Certain reclassifications have been made to the 1996 and 1997 consolidated financial statements to conform with the 1998 presentation. (q) New Accounting Pronouncements In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 requires the capitalization of certain costs incurred in connection with developing or obtaining software for internal use. The Company adopted SOP 98-1 on January 1, 1999. There was no material impact on the consolidated financial statements as a result of adoption of SOP 98-1. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model for accounting for derivatives and hedging activities and supersedes and amends existing accounting standards and is effective for fiscal years beginning after June 15, 1999. SFAS 133 requires that all derivatives be recognized in the balance sheet at their fair market value, and the corresponding derivative gains or losses be either reported in the statement of operations or as a component of other comprehensive income depending on the type of hedge relationship that exists with respect to such derivative. The Company does not expect the adoption of SFAS 133 to have a material impact on its consolidated financial statements. In December 1998, the AICPA issued Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions" (SOP 98-9) which amends certain elements of SOP 97-2 and is effective for fiscal years beginning after March 15, 1999. The Company believes that the adoption of SOP 98-9 will not have a material effect on the Company's results of operations or financial position. (r) Unaudited Interim Consolidated Financial Statements In the opinion of the Company's management, the unaudited interim consolidated financial statements as of March 31, 1999 and for the quarters ended March 31, 1998 and 1999 include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation. 2. Acquisition In March 1998, the Company completed the acquisition of Vivo Software, Inc. (Vivo), a developer of streaming media creation tools. Under terms of the acquisition, the Company issued approximately 2,203 shares of its common stock in exchange for all outstanding shares of Vivo common stock. In addition, the Company issued options to purchase approximately 95 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 consolidated financial statements since the date of acquisition. F-12 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) A summary of the purchase price for the acquisition is as follows: Stock and stock options......................................... $16,526 Direct acquisition costs........................................ 445 Accrued liabilities assumed..................................... 1,640 Other liabilities assumed....................................... 1,057 ------- Total......................................................... $19,668 =======
The purchase price was allocated as follows: Cash acquired................................................... $ 203 Other current assets acquired................................... 148 Equipment....................................................... 100 Goodwill........................................................ 10,644 In-process research and development............................. 8,573 ------- 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 qualified as 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 net operating loss carryforwards of approximately $16,000, which expire 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. Any utilization of the net operating loss carryforwards in the future will result in a reduction of the carrying amount of goodwill. In connection with the acquisition, approximately 441 shares of common stock issued were placed in escrow to secure indemnification obligations of former shareholders of Vivo. As of December 31, 1998 and March 31, 1999, 220 and no shares remained in escrow, respectively. The following table presents pro forma results of operations as if the acquisition had occurred at the beginning of each of the years presented. The pro forma results of operations exclude $8,723 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 F-13 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) 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.
Year Ended December 31, ---------------- Quarter Ended 1997 1998 March 31, 1998 ------- ------- -------------- Total net revenues....................... $34,501 $65,492 $13,155 Net loss................................. (18,730) (9,279) (3,797) Net loss per share--basic and diluted.... (1.91) (0.14) (0.06)
3. Investment in Joint Venture and Note Payable The Company has a 24% interest in a Japanese limited liability company that operates an Internet streaming business in Japan. The Company accounts for this investment using the equity method. At December 31, 1998, the Company had outstanding a note payable to one of its joint venture partners, which is due in May 2000. The note is denominated in Japanese yen, bears interest at a rate not to exceed the Japanese Short Term Prime Rate (1.5% at December 31, 1998) and is secured by the Company's shares in the joint venture. The Company may, under certain circumstances, tender its shares in the joint venture as repayment of the note. Equity in net losses of the joint venture was $125 and $152 in the quarters ended March 31, 1998 and 1999, respectively and $182 and $448 in the years ended December 31, 1997 and 1998, respectively. The carrying amount of the Company's investment in joint venture was $216 at March 31, 1999 and $816 and $368 at December 31, 1997 and 1998, respectively. 4. Shareholders' Equity (a) Initial Public Offering On November 21, 1997, the Company completed its initial public offering and all outstanding shares of preferred stock were converted to either common stock or special common stock. (b) Special Common Stock Special common stock is not entitled to vote, except as required by law. All other rights and preferences of the special common stock are identical to common stock, except as otherwise required by law or expressly provided in the Company's Articles of Incorporation. All shares of special common stock are held by Microsoft Corporation (Microsoft) and each share automatically converts into two shares of common stock upon sale or transfer by Microsoft to an unaffiliated third party. During 1998, Microsoft sold 752 shares which were converted into 1,504 shares of common stock. During the quarter ended March 31, 1999, Microsoft sold an additional 2,086 shares, which were converted into 4,173 shares of common stock. (c) Preferred Stock Each share of Series A preferred stock entitles the holder to one thousand votes and dividends equal to one thousand times the aggregate per share amount of dividends declared on the common stock. F-14 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) Undesignated preferred stock will have rights and preferences that are determinable by the Board of Directors when determination of a new series of preferred stock has been established. (d) Shareholder Rights Plan On October 16, 1998, the Company's board of directors declared a dividend of one preferred share purchase right (Right) in connection with its adoption of a Shareholder Rights Plan dated December 4, 1998, for each outstanding share of the Company's common stock on December 14, 1998 (Record Date). Each share of common stock issued after the Record Date will be issued with an attached Right. The Rights will not immediately be exercisable and detachable from the common stock. The Rights will become exercisable and detachable only following the acquisition by a person or a group of 15 percent or more of the outstanding common stock or ten days following the announcement of a tender or exchange offer for 15 percent or more of the outstanding common stock (Distribution Date). After the Distribution Date, each Right will entitle the holder to purchase for $75 (Exercise Price), a fraction of a share of the Company's Series A preferred stock with economic terms similar to that of one share of the Company's common stock. Upon a person or a group acquiring 15 percent or more of the outstanding common stock, each Right will allow the holder (other than the acquiror) to purchase common stock or securities of the Company having a then current market value of two times the Exercise Price of the Right. In the event that following the acquisition of 15 percent of the common stock by an acquiror, the Company is acquired in a merger or other business combination or 50 percent or more of the Company's assets or earning power are sold, each Right will entitle the holder to purchase for the Exercise Price, common stock or securities of the acquiror having a then current market value of two times the Exercise Price. In certain circumstances, the Rights may be redeemed by the Company at a redemption price of $0.005 per Right. If not earlier exchanged or redeemed, the Rights will expire on December 4, 2008. (e) Stock Warrants In connection with the sales of preferred stock in 1996 and 1997, the Company issued warrants to purchase additional shares of stock. During 1997 and 1998, 368 and 1,333 warrants were exercised, respectively. No warrants were outstanding at December 31, 1998. (f) Stock Option Plan The Company has a stock option plan (Plan) to compensate employees for past and future services and has reserved 29,800 shares of common stock for option grants under the Plan. Generally, options vest based on continuous employment, over a five year period. The options expire twenty years from the date of grant and are exercisable at the fair market value of the common stock at the grant date. F-15 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) A summary of stock option related activity is as follows:
Options Outstanding ---------------------- Weighted Shares Average Available Number of Exercise for Grant Shares Price --------- ---------- --------- Balances at December 31, 1995................ 1,474 5,664 $ 0.04 Plan introduction.......................... 6,000 -- -- Options granted............................ (7,532) 7,532 0.17 Options exercised.......................... -- (997) 0.05 Options canceled........................... 1,530 (1,531) 0.05 ------ --------- Balances at December 31, 1996................ 1,472 10,668 0.14 Plan amendment............................. 11,600 -- -- Options granted............................ (7,344) 7,344 2.75 Options exercised.......................... -- (2,288) 0.11 Options canceled........................... 1,862 (1,862) 0.66 ------ --------- Balances at December 31, 1997................ 7,590 13,862 1.46 Plan amendment............................. 5,000 -- -- Options granted............................ (5,964) 5,964 14.11 Options assumed in acquisition............. -- 95 0.12 Options exercised.......................... -- (1,785) 0.42 Options canceled........................... 1,816 (1,816) 3.71 ------ --------- Balances at December 31, 1998................ 8,442 16,320 6.06 Options granted............................ (3,234) 3,234 46.93 Options exercised.......................... -- (456) 0.56 Options canceled........................... 1,094 (1,094) 2.68 ------ --------- Balances at March 31, 1999................... 6,302 18,004 $ 13.62 ====== =========
The following table summarizes information about stock options outstanding at December 31, 1998:
Options Outstanding Options Exercisable ------------------------------- --------------------- Weighted Average Weighted Weighted Remaining Average Average Number of Contractual Exercise Number of Exercise Exercise Prices Shares Life (Years) Price Shares Price - --------------- --------- ------------ -------- ---------- --------- $0.04-$ 0.75 6,268 17.06 $ 0.23 2,670 $ 0.16 1.00- 3.63 2,634 18.52 2.46 382 1.74 4.25- 7.50 2,136 18.90 5.45 2 4.25 7.69- 16.44 3,234 19.44 12.41 -- -- 16.50- 21.07 2,048 19.70 18.18 -- -- ------ --------- 16,320 18.39 $ 6.06 3,054 $ 0.36 ====== =========
F-16 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) In accordance with the disclosure requirements of SFAS 123, if the Company had elected to recognize compensation cost based on the fair value of options granted at grant date as prescribed, net loss and net loss per share would have been increased to the pro forma amounts indicated in the table below:
Year Ended December 31, --------------------------- 1996 1997 1998 ------- -------- -------- Net loss: As reported.................................. $(3,789) $(11,169) $(16,414) Pro forma.................................... (3,865) (11,643) (26,009) Basic and diluted net loss per share: As reported.................................. (5.95) (1.44) (0.25) Pro forma.................................... (6.07) (1.50) (0.40)
The per share weighted average fair value of stock options granted during the years ended December 31, 1996, 1997 and 1998 was $0.04, $0.56 and $8.27 respectively, on the date of grant. Prior to the Company's initial public offering, the fair value of each option grant was determined on the date of grant using the minimum value method. Subsequent to the offering, the fair value was determined using the Black-Scholes model. Except for the volatility assumption which was only used under the Black-Scholes model, the following weighted average assumptions were used to perform the calculations:
Year Ended December 31, ---------------- 1996 1997 1998 ---- ---- ---- Expected dividend yield.................................... 0% 0% 0% Risk-free interest rate.................................... 6.10% 6.10% 5.15% Expected life (years)...................................... 4.5 3.5 3.5 Volatility................................................. n/a 60% 85%
(g) Employee Stock Purchase Plan Effective January 1998, the Company adopted an Employee Stock Purchase Plan (ESPP), and has reserved 2,000 shares of common stock for issuance under the ESPP. Under the ESPP, an eligible employee may purchase shares of common stock, based on certain limitations, at a price equal to the lesser of 85% of the fair market value of the common stock at the beginning or end of the respective semi-annual offering periods. There were 95 shares purchased under the ESPP during 1998. The weighted average fair value of the employee stock purchase rights was $5.61 in 1998. The following assumptions were used to perform the calculation: expected dividend yield--0%; risk-free interest rate--5.15%; expected life--six months; volatility--85%. 5. Significant Customer In June 1997, the Company entered into a strategic agreement with Microsoft pursuant to which the Company granted Microsoft a nonexclusive license to certain substantial elements of the source code of the Company's RealAudio/RealVideo Version 4.0 technology. The $30 million license fee is being recognized ratably over the three-year term of the Company's ongoing support obligations. F-17 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) 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 made a $30 million minority investment in the Company in the form of 3,338 shares of nonvoting preferred stock, which shares were converted into 3,338 shares of nonvoting special common stock upon the completion of the Company's initial public offering in 1997. Software license fees under the license agreement with Microsoft accounted for approximately 15% of total net revenues in 1997 and 1998 and 19% and 10% of total net revenues for the quarters ended March 31, 1998 and 1999, respectively. No single customer accounted for more than 10% of total net revenues in 1996. 6. Income Taxes The components of loss before income taxes are as follows:
Year Ended December 31, --------------------------- 1996 1997 1998 ------- -------- -------- U.S. operations................................. $(3,789) $ (8,480) $(16,208) Foreign operations.............................. -- (2,689) (206) ------- -------- -------- $(3,789) $(11,169) $(16,414) ======= ======== ========
The components of income tax expense (benefit) are as follows:
December 31, ----------------- 1996 1997 1998 ---- ----- ----- Current................................................... $-- $ 777 $(777) Deferred.................................................. -- (777) 777 ---- ----- ----- $-- $ -- $ -- ==== ===== =====
Income tax expense (benefit) differs from "expected" income tax expense (benefit) (computed by applying the U.S. Federal income tax rate of 34%) in 1998 due to nondeductible acquisition charges and related amortization of goodwill and an increase in the valuation allowance on deferred tax assets. The 1996 and 1997 effective rate differed principally due to the change in the valuation allowance related to deferred tax assets. F-18 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) The tax effects of temporary differences that give rise to significant portions of net deferred tax assets are comprised of the following:
December 31, -------------- 1997 1998 ------ ------- Deferred tax assets: Net operating loss carryforwards........................... $ -- $ 7,650 Deferred revenue........................................... 6,552 6,649 Allowances for doubtful accounts and sales returns......... 282 404 Depreciation............................................... 217 472 Other...................................................... 167 1,121 ------ ------- Gross deferred tax assets.................................... 7,218 16,296 Less valuation allowance................................... 6,441 16,296 ------ ------- Net deferred tax assets...................................... $ 777 $ -- ====== =======
The valuation allowance for deferred tax assets increased by $1,335, $4,613 and $9,855 for the years ended December 31, 1996, 1997 and 1998, respectively. Due to operating losses and the uncertainty regarding the recoverability of deferred tax assets, the Company has provided a full valuation allowance at December 31, 1998. At December 31, 1998, the Company had net operating loss carryforwards for Federal income tax purposes of approximately $22,500, expiring in the year 2013. A majority of the net operating loss carryforward results from stock option deductions, the realization of which would result in a credit to shareholders' equity. This net operating loss carryforward excludes $16,000 of net operating loss carryforwards acquired from Vivo which are subject to significant limitations. 7. Segment Information During 1998, the Company adopted the provisions of SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 establishes standards for the way that public business enterprises report information about operating segments. The Company operates in one business segment, streaming media, for which the Company receives revenues from its customers. The Company's Chief Operating Decision Maker is considered to be the Company's Operating Committee (COC) which is comprised of the Company's Chief Executive Officer and the Company's Senior Vice Presidents. The COC reviews financial information presented on a consolidated basis accompanied by disaggregated information about products and services and geographical region for purposes of making decisions and assessing financial performance. The COC does not review discrete financial information regarding profitability of the Company's different products or services and, therefore, the Company does not have operating segments as defined by SFAS 131. F-19 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) The Company's customers consist primarily of end users located in the United States and various foreign countries. Revenues by geographic region are as follows:
Quarter Ended Year Ended December 31, March 31, ----------------------- --------------- 1996 1997 1998 1998 1999 ------- ------- ------- ------- ------- North America....................... $11,308 $20,346 $42,611 $ 8,012 $15,990 Europe.............................. 1,037 3,425 7,144 1,019 2,786 Asia................................ 1,013 3,225 4,429 913 1,975 Rest of world....................... 654 890 987 141 357 ------- ------- ------- ------- ------- Subtotal.......................... 14,012 27,886 55,171 10,085 21,108 Microsoft license agreement......... -- 4,834 9,668 2,417 2,417 ------- ------- ------- ------- ------- Total............................. $14,012 $32,720 $64,839 $12,502 $23,525 ======= ======= ======= ======= =======
Revenue from external customers by product type is as follows:
Quarter Ended Year Ended December 31, March 31, ----------------------- --------------- 1996 1997 1998 1998 1999 ------- ------- ------- ------- ------- Streaming media license revenue.... $11,876 $20,660 $37,281 $ 7,001 $14,593 Streaming media service revenue.... 1,120 4,972 14,742 2,622 5,249 Microsoft license agreement........ -- 4,834 9,668 2,417 2,417 Advertising revenue................ 1,016 2,254 3,148 462 1,266 ------- ------- ------- ------- ------- Total net revenues............... $14,012 $32,720 $64,839 $12,502 $23,525 ======= ======= ======= ======= =======
Long-lived assets by geographic location are as follows:
December 31, -------------- March 31, 1997 1998 1999 ------ ------- --------- United States....................................... $4,369 $14,538 $20,692 Japan............................................... 404 454 412 Europe.............................................. 370 329 348 ------ ------- ------- Total............................................. $5,143 $15,321 $21,452 ====== ======= =======
F-20 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) 8. Commitments (a) Lease Commitments The Company leases its office facilities under terms of operating lease agreements expiring through May 1999. During 1998, the Company entered into a lease agreement for a new location for its corporate headquarters. The lease commences on April 1, 1999 and expires in April 2011. Future minimum lease payments are:
Years Ending December 31, Minimum Lease Payments ------------------------- ---------------------- 1999............................................... $ 3,071 2000............................................... 3,294 2001............................................... 4,065 2002............................................... 4,633 2003............................................... 4,744 Thereafter......................................... 37,092 ------- Total minimum lease payments..................... $56,899 =======
Rent expense was approximately $600 in 1996, $1,800 in 1997 and $2,600 in 1998. (b) 401(k) Retirement Savings Plan The Company has a salary deferral plan (401(k) Plan) that covers substantially all employees. The Company, at its discretion, may make contributions to the 401(k) Plan, although it has not made any contributions to date. Employees can contribute a portion of their salary to the maximum allowed by the federal tax guidelines. The Company currently does not provide matching contributions. The Company has no other post-employment or post-retirement benefit plans. (c) Litigation In August 1998, Venson M. Shaw and Steven M. Shaw filed a lawsuit against the Company and co-defendant Broadcast.com in the United States District Court for the Northern District of Texas--Dallas Division. The plaintiffs allege that the Company, individually and in combination with Broadcast.com, infringes on a certain patent by making, using, selling and/or offering to sell software products and services directed to media delivery systems for the Internet and corporate intranets. The plaintiffs seek to enjoin the Company from its alleged infringing activity and to recover damages in an amount no less than a reasonable royalty. Although the Company can give no assurance as to the outcome of this lawsuit, it believes that the allegations in this action are without merit, and intends to vigorously defend itself against these claims. The Company may be required to indemnify Broadcast.com under the terms of the Company's license agreement with it. The plaintiffs filed a similar claim based on the same patent and seeking similar remedies as a separate lawsuit against Microsoft and Broadcast.com in the same court. The court has consolidated the lawsuit against Microsoft and Broadcast.com with the lawsuit against the Company and Broadcast.com. On July 29, 1998, Left Bank Management, Inc. filed a lawsuit against the Company in the U.S. District Court for the Western District of Washington. The plaintiff alleges that the Company entered into an oral agreement with it in 1995 pursuant to which the plaintiff claims it is entitled to 30% of the Company's revenues from the use of RealAudio technology to promote, sample or sell music. F-21 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) The plaintiff claims breach of contract, unjust enrichment, promissory estoppel and breach of implied-in-fact contract. The Company has denied each of the plaintiff's claims. In response to the Company's motion to dismiss, the plaintiff withdrew its claim for breach of fiduciary duty. Although no assurance can be given as to the outcome of this lawsuit, the Company believes the allegations in this action are without merit, and it intends to vigorously defend itself against these claims. From time to time the Company is, and expects to continue to be, subject to legal proceedings and claims in the ordinary course of its business, including contract-related claims and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, even if not meritorious, could force the Company to spend significant financial and managerial resources. The Company currently is not aware of any legal proceedings or claims that it believes will have, individually or taken together, a material adverse effect on its business, prospects, financial condition and operating results. 9. Quarterly Information (Unaudited) The following table summarizes the unaudited statement of operations for each quarter of 1998 and 1997. In response to recent Securities and Exchange Commission interpretative guidance surrounding the valuation methodology used in determining charges associated with acquisition related in-process research and development, the Company has revised the original accounting for the purchase price allocation related to the 1998 acquisition of Vivo and the related amortization of goodwill. This adjustment decreased the amount previously allocated to in-process research and development by $9,156, which has been capitalized as goodwill and is being amortized using the straight-line method over five years.
Quarter Ended ----------------------------------- Mar. 31 June 30 Sept. 30 Dec. 31 Total ------- ------- -------- ------- ------- 1998 As originally reported: Net Revenues..................... $12,502 $15,056 $17,244 $20,037 $64,839 Gross Profits.................... 10,063 12,095 13,993 16,298 52,449 Operating Loss................... (21,165) (3,296) (2,602) (2,167) (29,230) Net Loss......................... (20,088) (2,104) (1,359) (1,103) (24,654) Net Loss per share............... (0.32) (0.03) (0.02) (0.02) (0.38) As restated: Net Revenues..................... 12,502 15,056 17,244 20,037 64,839 Gross Profits.................... 10,063 12,095 13,993 16,298 52,449 Operating Loss................... (12,009) (3,754) (3,060) (2,167) (20,990) Net Loss......................... (10,932) (2,562) (1,817) (1,103) (16,414) Net Loss per share............... (0.18) (0.04) (0.03) (0.02) (0.25) 1997 Net Revenues..................... 6,356 7,010 9,051 10,303 32,720 Gross Profits.................... 4,335 5,977 7,496 8,447 26,255 Operating Loss................... (3,911) (2,897) (2,951) (3,402) (13,161) Net Loss......................... (3,706) (2,666) (2,203) (2,594) (11,169) Net Loss per share............... (3.17) (1.99) (1.08) (0.10) (1.44)
F-22 REALNETWORKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) December 31, 1996, 1997 and 1998 and March 31, 1998 and 1999 (information as of and for the quarters ended March 31, 1998 and 1999 is unaudited) (in thousands, except per share data) 10. Subsequent Events (a) Stock Split On April 27, 1999, the board of directors approved a 2-for-1 split of the Company's common stock payable in the form of a stock dividend. The stock split was effected on May 10, 1999. Accordingly, the accompanying consolidated financial statements have been retroactively restated to reflect the stock split. (b) Pending Acquisition (unaudited) On April 13, 1999, the Company entered into a definitive agreement to acquire privately held Xing Technology Corporation (Xing), a leading developer and provider of MP3 software. The Company will acquire Xing in exchange for shares of common stock of the Company with a maximum value of $75 million. The acquisition, which is expected to be accounted for as a pooling of interests and is subject to certain customary conditions, is expected to be completed no later than the third quarter of 1999. F-23 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. ---------------- TABLE OF CONTENTS
Page ---- Risk Factors............................................................... 2 Special Note Regarding Forward-Looking Statements.......................... 19 Use of Proceeds............................................................ 20 Corporate Information...................................................... 20 Business................................................................... 21 Selling Shareholders....................................................... 35 Plan of Distribution....................................................... 36 Legal Matters.............................................................. 38 Experts.................................................................... 38 Where You Can Find More Information........................................ 38 Index to Consolidated Financial Statements................................. F-1
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- 26,666 Shares RealNetworks, Inc. Common Stock ---------------- PROSPECTUS ---------------- , 1999 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The fees and expenses incurred by the Registrant in connection with the distribution are payable by the Registrant and, other than filing fees, are estimated as follows: Securities and Exchange Commission registration fee.............. $ 616 Nasdaq filing fee for listing additional shares.................. 534 Printing and engraving expenses.................................. 10,000 Legal fees and expenses.......................................... 14,000 Accounting fees and expenses..................................... 10,000 Miscellaneous fees and expenses.................................. 6,850 ------- Total.......................................................... $42,000 =======
ITEM 15. INDEMNIFICATION OF OFFICERS AND DIRECTORS. Sections 23B.08.500 through 23B.08.600 of the Washington Business Corporation Act (the "WBCA") authorize a court to award, or a corporation's board of directors to grant, indemnification to directors and officers on terms sufficiently broad to permit indemnification under certain circumstances for liabilities arising under the Securities Act of 1933, as amended (the "Securities Act"). The Registrant's Bylaws provide for indemnification of the registrant's directors, officers, employees and agents to the maximum extent permitted by Washington law. The directors and officers of the Registrant also may be indemnified against liability they may incur for serving in that capacity pursuant to a liability insurance policy maintained by the Registrant for such purpose. Section 23B.08.320 of the WBCA authorizes a corporation to limit a director's liability to the corporation or its shareholders for monetary damages for acts or omissions as a director, except in certain circumstances involving intentional misconduct, knowing violations of law or illegal corporate loans or distributions, or any transaction from which the director personally receives a benefit in money, property or services to which the director is not legally entitled. The registrant's Restated Articles of Incorporation contain provisions implementing, to the fullest extent permitted by Washington law, such limitations on a director's liability to the Registrant and its shareholders. The Registrant has entered into certain indemnification agreements with its officers and directors. The indemnification agreements provide the Registrant's officers and directors with indemnification to the maximum extent permitted by the WBCA. The Investor Rights Agreement (Exhibit 4.4 hereto) provides for indemnification by the selling shareholders of the Registrant and its executive officers and directors, and by the Registrant of the selling shareholders, for certain liabilities, including liabilities arising under the Securities Act, in connection with matters specifically provided in writing by the selling shareholders for inclusion in this Registration Statement. II-1 ITEM 16. EXHIBITS. The following exhibits are filed with this Registration Statement:
Exhibit Number Description ------- ----------- 4.1 Restated Articles of Incorporation, incorporated herein by reference to Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. 4.2 Designation of Rights and Preferences of Series A Preferred Stock, incorporated herein by reference to Exhibit A to the Shareholder Rights Plan, dated as of December 4, 1998, between the Registrant and ChaseMellon Shareholder Services, L.L.C., filed as Exhibit 1 to the Registrant's Registration Statement on Form 8-A, dated as of December 14, 1998. 4.3 Shareholder Rights Plan, dated as of December 4, 1998, between the Registrant and ChaseMellon Shareholder Services, L.L.C., incorporated herein by reference to the Registrant's Registration Statement on Form 8-A, dated as of December 14, 1998. 4.4 Investor Rights Agreement, dated as of March 31, 1999, between the Registrant and the former shareholders of Ultisoft Inc. 5.1 Opinion of Perkins Coie LLP. 23.1 Consent of Perkins Coie LLP (included in Exhibit 5.1). 23.2 Consent of KPMG LLP. 24.1 Power of Attorney (included on page II-4 of this Registration Statement under the caption "Signatures").
ITEM 17. UNDERTAKINGS. A.The undersigned Registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) to include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) to reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; and (iii) to include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) That, for purposes of determining any liability under the Securities Act, each filing of the Registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the Registration Statement shall be deemed to be a new registration statement relating to the II-2 securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. B.Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in Item 15 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against liabilities (other than the payment of the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-3 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on this 28th day of July, 1999. RealNetworks, Inc. /s/ Paul Bialek By: _________________________________ Paul Bialek Senior Vice President--Finance and Operations and Chief Financial Officer POWER OF ATTORNEY Each person whose individual signature appears below hereby authorizes and appoints Robert Glaser and Paul Bialek, and each of them, with full power of substitution and resubstitution and full power to act without the other, as his true and lawful attorney-in-fact and agent to act in his name, place and stead and to execute in the name and on behalf of each person, individually and in each capacity stated below, and to file, any and all amendments to this Registration Statement, including any and all post-effective amendments and amendments thereto and any registration statement relating to the same offering as this Registration Statement that is to be effective upon filing pursuant to Rule 462(b) under the Securities Act of 1933, as amended, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in fact and agents, and each of them, full power and authority to do and perform each and every act and thing, ratifying and confirming all that said attorneys-in- fact and agents or any of them or their or his substitute or substitutes may lawfully do or cause to be done by virtue thereof. IN WITNESS WHEREOF, each of the undersigned has executed this Power of Attorney as of the date indicated. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed by the following persons in the capacities indicated on July 28, 1999.
Signature Title --------- ----- /s/ Robert Glaser Chief Executive Officer, Chairman of the ______________________________________ Board and Treasurer (Principal Executive Robert Glaser Officer and Chairman of the Board) /s/ Paul Bialek Senior Vice President--Finance and ______________________________________ Operations and Chief Financial Officer Paul Bialek (Principal Financial and Accounting Officer) /s/ Edward Bleier Director ______________________________________ Edward Bleier /s/ James Breyer Director ______________________________________ James Breyer /s/ Bruce Jacobsen Director ______________________________________ Bruce Jacobsen /s/ Mitchell Kapor Director ______________________________________ Mitchell Kapor
II-4 Schedule II--Valuation and Qualifying Accounts RealNetworks, Inc. and Subsidiaries Years Ended December 31, 1998, 1997 and 1996 (In thousands)
Balance Charged Balance at to Costs at End Beginning and Costs and of Description of Period Expenses Deduction Period ----------- --------- -------- --------- ------- Year ended December 31, 1996: Valuation accounts deduced from assets: Allowance for doubtful accounts receivable and sales returns......... $ 130 $ 563 $ (310) $ 383 Valuation allowance for deferred tax assets............................... 493 1,335 -- 1,828 ====== ====== ======= ======= Year ended December 31, 1997: Valuation accounts deduced from assets: Allowance for doubtful accounts receivable and sales returns......... 383 2,294 (1,848) 829 Valuation allowance for deferred tax assets............................... 1,828 4,613 -- 6,441 ====== ====== ======= ======= Year ended December 31, 1998: Valuation accounts deduced from assets: Allowance for doubtful accounts receivable and sales returns......... 829 4,632 (4,295) 1,166 Valuation allowance for deferred tax assets............................... $6,441 $9,855 $ -- $16,296 ====== ====== ======= =======
S-1 EXHIBIT INDEX
Exhibit Number Description - ------- ----------- 4.1 Restated Articles of Incorporation, incorporated herein by reference to Exhibit 3.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. 4.2 Designation of Rights and Preferences of Series A Preferred Stock, incorporated herein by reference to Exhibit A to the Shareholder Rights Plan, dated as of December 4, 1998, between the Registrant and ChaseMellon Shareholder Services, L.L.C., filed as Exhibit 1 to the Registrant's Registration Statement on Form 8-A, dated as of December 14, 1998. 4.3 Shareholder Rights Plan, dated as of December 4, 1998, between the Registrant and ChaseMellon Shareholder Services, L.L.C., incorporated herein by reference to the Registrant's Registration Statement on Form 8-A, dated as of December 14, 1998. 4.4 Investor Rights Agreement, dated as of March 31, 1999, between the Registrant and the former shareholders of Ultisoft Inc. 5.1 Opinion of Perkins Coie LLP. 23.1 Consent of Perkins Coie LLP (included in Exhibit 5.1). 23.2 Consent of KPMG LLP. 24.1 Power of Attorney (included on page II-4 of this Registration Statement under the caption "Signatures").
EX-4.4 2 INVESTOR RIGHTS AGREEMENT EXHIBIT 4.4 INVESTOR RIGHTS AGREEMENT This Investor Rights Agreement (this "Agreement") is made and entered into as of March 31, 1999 (the "Effective Date"), by and between RealNetworks, Inc., a Washington corporation ("RealNetworks"), and Mark Comish and Michael Comish (collectively, the "Shareholders" and each individually a "Shareholder"), who immediately prior to the effective time of the Merger (as such term is defined below) represented all of the shareholders of Ultisoft Inc., an Oregon corporation (the "Company"). RECITALS A. RealNetworks, the Company, Vegas Acquisition Corp. (the "Purchaser") and the Shareholders have entered into an Agreement and Plan of Merger (the "Merger Agreement") dated as of March 31, 1999, pursuant to which Purchaser will merge with and into the Company in a reverse triangular merger, with the Company to be the surviving corporation of the Merger (the "Merger"). B. As a condition precedent to the consummation of the Merger, each of the Shareholders shall execute this Investor Rights Agreement pursuant to which the Shareholders shall be granted certain registration rights with respect to the shares of the common stock of RealNetworks, par value $0.001 per share (together with associated preferred stock purchase rights pursuant to the Shareholder Rights Plan, dated as of December 4, 1998, between RealNetworks and ChaseMellon Shareholder Services, L.L.C., the "RealNetworks Common Stock"), that are issued to the Shareholders in the Merger (the "Merger Shares"), subject to the terms and conditions set forth in this Agreement. C. Capitalized terms used herein and not otherwise defined shall have the meaning set forth in the Merger Agreement. NOW, THEREFORE, in consideration of the above recitals and the mutual covenants hereinafter set forth, the parties hereto hereby agree as follows: 1. REGISTRATION RIGHTS 1.1 Definitions For purposes of this Section 1: (a) Registration. The terms "register," "registered" and "registration" refer to a registration effected by preparing and filing a registration statement on Form S-3 (or such analogous substitute or replacement form as the SEC (as defined below) shall have then approved) with the SEC in compliance with the Securities Act of 1933, as amended (the "Securities Act"), and the declaration or ordering of effectiveness of such registration statement by the SEC. (b) Registrable Securities. The term "Registrable Securities" means: fifty percent (50%) of (i) the Merger Shares and (ii) any shares of RealNetworks Common Stock issued as a dividend or other distribution with respect to, or in exchange for or in replacement of, the Merger Shares. The number of Registrable Securities as to which each Shareholder shall have the right to register for resale pursuant to this Agreement is as set forth in Exhibit A hereto. (c) Prospectus. The term "Prospectus" shall mean the prospectus included in any Registration Statement filed pursuant to the provisions hereof, as amended or supplemented by any prospectus supplement (including, without limitation, any prospectus supplement with respect to the terms of the offering of any portion of the Registrable Securities covered by such Registration Statement), and all other amendments and supplements to the Prospectus, including post-effective amendments, and all material incorporated by reference or deemed to be incorporated by reference in such Prospectus. (d) Holder. For purposes of this Agreement, the term "Holder" means any person owning of record Registrable Securities that have not been sold to the public pursuant to an effective Registration Statement. (e) SEC. The term "SEC" means the U.S. Securities and Exchange Commission. 1.2 Registration (a) Initial Registration. Upon written request signed by all of the Shareholders and delivered to RealNetworks within 15 days following the Effective Time, RealNetworks shall prepare and file with the SEC within 45 days following the Effective Time, and use its best efforts to have declared effective as soon as practicable thereafter, a registration statement on Form S- 3 (the "Registration Statement") providing for the resale by the Holders of all the Registrable Securities then owned by the Holders in accordance with the manner of sale provisions set forth in Rule 144(f) under the Securities Act or otherwise in customary brokerage transactions on the Nasdaq National Market or other public market on which shares of RealNetworks Common Stock are traded. RealNetworks shall use its best efforts to keep the Registration Statement effective, pursuant to the rules, regulations or instructions under the Securities Act applicable to such Registration Statement, until the earlier of (i) the tenth trading day following the date on which the Registration Statement is declared effective by the SEC, and (ii) the date upon which all Registrable Securities have been sold or distributed by the Holders (the "Effectiveness Period"). Notwithstanding the foregoing, RealNetworks shall not be obligated to seek effectiveness of the Registration Statement until the Pooling Period (as herein defined) has been satisfied. (b) Restrictions on Purchasers and S-3 Registrations. Notwithstanding any other provision of this Section 1.2, the Company may postpone for up to ninety (90) days the filing or the effectiveness of a Registration Statement, or prohibit or suspend the use of such -2- Registration Statement, if the Company's Chief Executive Officer delivers a written certification to each Holder of the Registrable Securities requested to be included therein stating either that (i) the Company's Board of Directors has declared that such registration would not be in the best interests of the Company or (ii) the Company proposes to file, within such ninety (90) day period, another Registration Statement for shareholders other than the Holders, in which case, the Registrable Securities shall be included in such Registration Statement; provided that in any such event, the Effectiveness Period shall be extended by the length of any such postponement. (c) Expenses. All brokers' commissions, stock transfer taxes and similar charges, and legal fees and disbursements of counsel for the selling Holders shall be borne by the Shareholders. All other expenses incurred in connection with the Registration Statement shall be borne by RealNetworks; provided, however, that the Shareholders agree to reimburse RealNetworks for the first $20,000 in legal fees and associated costs (including filing fees and printing fees) expended by RealNetworks in connection with the drafting and filing of the Registration Statement. 1.3 Obligations of RealNetworks If required to effect the registration of any Registrable Securities under this Agreement, RealNetworks shall, as expeditiously as reasonably possible: (a) Prepare promptly and file with the SEC the Registration Statement as provided in Section 1.2(a), which Registration Statement (including any amendments or supplements thereto and Prospectuses contained therein) shall not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein, or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading, and cause such Registration Statement to become effective as soon as practicable. (b) Prepare promptly and file with the SEC such amendments and supplements to such Registration Statement and the Prospectus used in connection with such Registration Statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition prior to the expiration of the Effectiveness Period of the Registration Statement of all securities covered by such Registration Statement. (c) Furnish to the Holders such number of copies of a Prospectus and such other documents and legal opinions as reasonably requested in order to facilitate the disposition of the Registrable Securities owned by such Holders that are included in such registration. (d) Use its best efforts to register and qualify the securities covered by such Registration Statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided, however, that -3- RealNetworks shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. (e) Notify the Holders promptly (i) of any request by the SEC or any other federal or state governmental authority during the Effectiveness Period of the Registration Statement for amendments or supplements to such Registration Statement or related Prospectus or for additional information, (ii) of the issuance by the SEC or any other federal or state governmental authority of any stop order suspending the effectiveness of the Registration Statement or the initiation of any proceedings for that purpose, and (iii) of the receipt by RealNetworks of any notification with respect to the suspension of the qualification or exemption from qualification of any of the Registrable Securities for sale in any jurisdiction or the initiation or threatening of any proceeding for such purpose. 1.4 Furnish Information It shall be a condition precedent to the obligations of RealNetworks to take any action pursuant to Section 1.2 that each Holder shall furnish to RealNetworks such information regarding Holder, the Registrable Securities held by such Holder and the intended method of disposition of such securities as shall be required to timely effect the registration of such Holder's Registrable Securities. 1.5 Indemnification (a) Incident to any Registration Statement and subject to applicable law, RealNetworks will indemnify and hold harmless each Holder (including its respective directors, officers, members, employees and agents), and each person who controls any of them within the meaning of Section 15 of the Securities Act or Section 20 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and the rules and regulations promulgated thereunder, from and against any and all losses, claims, damages, expenses and liabilities, joint or several (including any investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claim asserted), to which they, or any of them, may become subject under the Securities Act, the Exchange Act or other federal or state statutory law or regulation, at common law or otherwise, insofar as such losses, claims, damages or liabilities arise out of or are based on (i) any untrue statement or alleged untrue statement of a material fact contained in such Registration Statement (including any related Prospectus, or any amendment or supplement to such Registration Statement or Prospectus), (ii) any omission or alleged omission to state in such document a material fact required to be stated in it or necessary to make the statements in it not misleading, or (iii) any violation by RealNetworks of the Securities Act, any state securities or "blue sky" laws or any rule or regulation thereunder in connection with such registration, provided that RealNetworks will not be liable to the extent that such loss, claim, damage, expense or liability arises from and is based on an untrue statement or omission or alleged untrue statement or omission made in reliance on and in conformity with -4- information furnished in writing to RealNetworks by such Holder or controlling person expressly for use in such Registration Statement. With respect to such untrue statement or omission or alleged untrue statement or omission in the information furnished in writing to RealNetworks by such Holder expressly for use in such Registration Statement, such Holder will indemnify and hold harmless RealNetworks (including its directors, officers, members, employees and agents), each other Holder (including its respective directors, officers, employees and agents), and each person who controls any of them within the meaning of Section 15 of the Securities Act or Section 20 of the Exchange Act, from and against any and all losses, claims, damages, expenses and liabilities, joint or several, to which they, or any of them, may become subject under the Securities Act, the Exchange Act or other federal or state statutory law or regulation, at common law or otherwise to the same extent provided in the immediately preceding sentence. In no event, however, shall the liability of a Holder for indemnification under this Section 1.5(a) exceed the lesser of (i) that proportion of the total of such losses, claims, damages or liabilities indemnified against equal to the proportion of the total Registrable Securities sold under such Registration Statement which is being sold by such Holder or (ii) the proceeds received by such Holder from its sale of Registrable Securities under such Registration Statement. (b) If the indemnification provided for in Section 1.5(a) above for any reason is held by a court of competent jurisdiction to be unavailable to an indemnified party in respect of any losses, claims, damages, expenses or liabilities referred to therein, then each indemnifying party under this Section 1.5, in lieu of indemnifying such indemnified party thereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages, expenses or liabilities (i) in such proportion as is appropriate to reflect the relative benefits received by RealNetworks and the other selling Holders from the offering of the Registrable Securities or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the other selling Holders in connection with the statements or omissions which resulted in such losses, claims, damages, expenses or liabilities, as well as any other relevant equitable considerations. The relative benefits received by RealNetworks and the selling Holders shall be deemed to be in the same respective proportions as the net proceeds from the offering (before deducting expenses) received by RealNetworks and the selling Holders, in each case as set forth in the table on the cover page of the applicable prospectus, bear to the aggregate public offering price of the Registrable Securities. The relative fault of RealNetworks and the selling Holders shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by RealNetworks or the selling Holders and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. RealNetworks and the Holders agree that it would not be just and equitable if contribution pursuant to this Section 1.5(b) were determined by pro rata or per capita allocations or by any other method of allocation which does not take account of the equitable considerations referred to in the first sentence of this Section 1.5(b). -5- In no event, however, shall a Holder be required to contribute any amount under this Section 1.5(b) in excess of the lesser of (i) that proportion of the total of such losses, claims, damages or liabilities indemnified against equal to the proportion of the total Registrable Securities sold under such Registration Statement which is being sold by such Holder or (ii) the proceeds received by such Holder from its sale of Registrable Securities under such Registration Statement. No person found guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. (c) The amount paid or payable by an indemnified party as a result of the losses, claims, damages and liabilities referred to in this Section 1.5 shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. The indemnification and contribution provided for in this Section 1.5 will remain in full force and effect regardless of any investigation made by or on behalf of the indemnified parties or any officer, director, employee, agent or controlling person of the indemnified parties. 2. OBLIGATIONS OF THE SHAREHOLDERS 2.1 Representations and Warranties of the Shareholders Each Shareholder represents with respect to himself that: (a) Good Title. (i) Such Shareholder owns, beneficially and of record, the shares of capital stock of the Company listed opposite such Shareholder's name on Exhibit A hereto, (ii) such shares of capital stock of the Company are free and clear of any lien, encumbrance, adverse claim, mortgage, pledge, deed of trust, security interest, charge, restriction on sale or transfer (other than restrictions imposed by applicable securities laws), preemptive right, option or other adverse claim or interest of any kind, (iii) such Shareholder has all necessary power, right and authority to enter into this Agreement and each of the agreements, certificates, instruments and documents executed or delivered pursuant to the terms of the Merger Agreement by such Shareholder and to consummate the transactions contemplated hereby and thereby and (iv) this Agreement has been duly authorized, executed and delivered by Shareholder and is a legal, valid and binding obligation of Shareholder, enforceable in accordance with its terms. (b) Ability to Bear Risk. Such Shareholder is in a financial position to hold the RealNetworks Common Stock for an indefinite period of time and is able to bear the economic risk and withstand a complete loss of his investment in the RealNetworks Common Stock. (c) SEC Documents. Such Shareholder acknowledges that he has received and had the opportunity to review to such Shareholder's satisfaction the materials -6- disseminated by Company in connection with the written consent or special meeting of Shareholders to approve the Merger and the transactions contemplated thereby, including those filings and reports of RealNetworks filed with the SEC since the completion of RealNetworks's most recent fiscal year, consisting of RealNetworks's Annual Report on Form 10-K for the fiscal year ending December 31, 1997 (the "Form 10-K"), its Quarterly Reports on Form 10-Q filed after the date of the Form 10-K, all Form 8-Ks filed after the date of the Form 10-K, the press release dated January 26, 1999 with respect to certain financial results for the year ended December 31, 1998 and its Proxy Statement relating to its 1998 Annual Meeting of Shareholders. (d) Professional Advice. Such Shareholder has obtained, to the extent that he deems necessary, professional advice with respect to the risks inherent in acquiring the RealNetworks Common Stock, the financial condition of RealNetworks and the suitability of an investment in the RealNetworks Common Stock in light of such Shareholder's financial condition and investment needs. (e) Sophistication. Such Shareholder, either alone or with the assistance of his professional advisors, is a sophisticated investor, is able to fend for himself in the transactions contemplated by this Agreement relating to the RealNetworks Common Stock and has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment in the RealNetworks Common Stock. (f) Accredited Investor. Except as set forth on Schedule A hereto, such Shareholder is an "accredited investor" as defined in Rule 501(a) of Regulation D under the Securities Act (an "Accredited Investor"). (g) Investment for Own Account. The RealNetworks Common Stock is being acquired by such Shareholder for investment for his account, not as a nominee or agent, and not with a view to the distribution of any part thereof; such Shareholder has no present intention of selling, granting any participation in or otherwise distributing any of the RealNetworks Common Stock in a manner contrary to the Securities Act or to any applicable state securities or Blue Sky law, nor does Shareholder have any contract, undertaking, agreement or arrangement with any person or entity to sell, transfer or grant a participation to such person or entity with respect to any of the RealNetworks Common Stock. (h) Restricted Securities. Such Shareholder acknowledges that the RealNetworks Common Stock has not been and will not prior to issuance be registered under the Securities Act and that the RealNetworks Common Stock is characterized under the Securities Act as "restricted securities" and, therefore, cannot be sold or transferred until such sale or transfer is registered under the Securities Act as provided in this Agreement or an exemption from such registration is available. -7- (i) Exemption Reliance. Such Shareholder has been advised that the RealNetworks Common Stock is being issued under this Agreement pursuant to exemptions from applicable federal and state securities laws, and that RealNetworks's reliance on such exemptions is predicated in part on such Shareholder's representations contained herein. (j) Residence. For purposes of the application of state securities laws, each Shareholder is a resident of the state of Oregon. (k) Legend. Each Holder understands that prior to the effectiveness of the Registration Statement certificates or other instruments representing any of the Registrable Securities acquired by Holder will bear legends substantially similar to the following, in addition to any other legends required by federal or state laws: THE SECURITIES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY APPLICABLE STATE LAW, AND NO INTEREST THEREIN MAY BE SOLD, DISTRIBUTED, ASSIGNED, OFFERED, PLEDGED OR OTHERWISE TRANSFERRED UNLESS (a) THERE IS AN EFFECTIVE REGISTRATION STATEMENT UNDER SUCH ACT COVERING ANY SUCH TRANSACTION INVOLVING THESE SECURITIES OR (b) THE COMPANY RECEIVES AN OPINION OF LEGAL COUNSEL FOR THE HOLDER OF THESE SECURITIES (CONCURRED IN BY LEGAL COUNSEL FOR THE COMPANY) STATING THAT SUCH TRANSACTION IS EXEMPT FROM REGISTRATION, OR THE COMPANY OTHERWISE SATISFIES ITSELF THAT SUCH TRANSACTION IS EXEMPT FROM REGISTRATION. Each holder agrees that, in order to ensure and enforce compliance with the restrictions imposed by applicable law and those referred to in the foregoing legends, or elsewhere herein, RealNetworks may, prior to the effectiveness of the Registration Statement, issue appropriate "stop transfer" instructions to its transfer agent, if any, with respect to any certificate or other instrument representing Registrable Securities, or if RealNetworks transfers its own securities, that it may make appropriate notations to the same effect in RealNetworks's records. 2.2 Investor Questionnaire Each Shareholder who is not an Accredited Investor shall complete and execute an Investor Questionnaire in the form attached hereto as Exhibit B. -8- 2.3 Further Restrictions on Resale Each Shareholder covenants to and agrees with RealNetworks that he will not sell, transfer or otherwise reduce his financial risk with respect to any shares of RealNetworks Common Stock until such time as financial results covering at least 30 days of combined operations of the Company and RealNetworks have been published within the meaning of Section 20.01 of the SEC's Codification of financial reporting policies, which shall include, without limitation, a press release or other public filing or announcement (the "Pooling Period"). 3. ASSIGNMENT The registration rights of a Holder under Section 1 hereof may not be assigned. 4. GENERAL PROVISIONS 4.1 Notices Any notice or demand desired or required to be given hereunder shall be in writing given by personal delivery, certified or registered mail, confirmed facsimile transmission, or overnight courier service, in each case addressed as respectively set forth below or to such other address as any party shall have previously designated by such a notice. The effective date of any notice or request shall be the date of personal delivery, four days after the date of mailing by certified or registered mail, the date on which successful facsimile transmission is confirmed, or the date undertaken for delivery by a reputable overnight courier service, as the case may be, in each case properly addressed as provided herein and with all charges prepaid. If to RealNetworks: RealNetworks, Inc. 1111 Second Avenue Suite 2900 Seattle, WA 98101 Attention: General Counsel Fax: (206) 674-2695 with a copy to: Perkins Coie LLP 1201 Third Avenue, 40th Floor Seattle, Washington 98101 Attention: Scott L. Gelband Fax: 206/583-8500 If to the Shareholders: -9- At their respective addresses set forth on Exhibit A attached hereto. with a copy to: Brophy, Mills, Schmor, ,Gerking & Brophy, LLP 201 W. Main Street, Suite 5A Medford, OR 97501 Attention: Lee A. Mills Fax: (541) 772-7249 4.2 Severability If any term or other provision of this Agreement is invalid, illegal or incapable of being enforced by any rule of law, or public policy, all other conditions and provisions of this Agreement shall nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any manner adverse to any party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in a mutually acceptable manner in order that the transactions contemplated hereby be consummated as originally contemplated to the fullest extent possible. 4.3 Entire Agreement This Agreement, the Merger Agreement and each of the agreements, certificates, instruments and documents to be executed or delivered pursuant to the terms of the Merger Agreement constitute the entire agreement among the parties with respect to the subject matter hereof and thereof and supersede all prior agreements and undertakings, both written and oral, among the parties, or any of them, with respect to the subject matter hereof and thereof. 4.4 Successors and Assigns Subject to the provisions of Section 3, the provisions of this Agreement shall inure to the benefit of, and shall be binding upon, the successors and permitted assigns of the parties hereto. 4.5 Governing Law This Agreement shall be governed by, and construed in accordance with, the laws of the State of Washington applicable to contracts executed in and to be performed in that State. All actions and proceedings arising out of or relating to this Agreement shall be heard and determined in any Washington state or federal court thereof. -10- 4.6 Third Parties This Agreement shall be binding upon and inure solely to the benefit of each party hereto, and nothing in this Agreement, express or implied, is intended to or shall confer upon any other person any right, benefit or remedy of any nature whatsoever under or by reason of this Agreement. 4.7 Headings The descriptive headings contained in this Agreement are included for convenience of reference only and shall not affect in any way the meaning or interpretation of this Agreement. 4.8 Specific Performance Each of the parties acknowledges and agrees that the other parties hereto would be damaged irreparably in the event any of the provisions of this Agreement are not performed in accordance with their specific terms or otherwise are breached. Accordingly, each of the parties hereto agrees the other parties hereto will be entitled to an injunction to prevent breaches of the provisions of this Agreement and to enforce specifically this Agreement and the terms and provisions of this Agreement (including the indemnification provisions hereof) in any competent court having jurisdiction over the parties, in addition to any other remedy to which they might be entitled at law or in equity. 4.9 Counterparts This Agreement may be executed and delivered in one or more counterparts, and by the different parties hereto in separate counterparts, each of which when executed and delivered shall be deemed to be an original but all of which taken together shall constitute one and the same agreement. To expedite the process of entering into this Agreement, the parties acknowledge that Transmitted Copies of this Agreement will be equivalent to original documents until such time as original documents are completely executed and delivered. "Transmitted Copies" will mean copies that are reproduced or transmitted via photocopy, facsimile or other process of complete and accurate reproduction and transmission. 4.10 Amendment of Rights This Agreement may not be amended except by an instrument signed by RealNetworks and the Shareholders. -11- IN WITNESS WHEREOF, the parties hereto have entered into and signed this Agreement as of the date and year first above written. REALNETWORKS, INC. By: /s/ Paul Bialek ---------------- Name: Paul Bialek Its: Senior Vice President, Finance and Operations and Chief Financial Officer SHAREHOLDERS By: /s/ Mark Comish ---------------- Name: Mark Comish By: /s/ Michael Comish ------------------- Name: Michael Comish -12- EXHIBIT A List of Shareholders
Number of Shares of Number of Shares of Number of Registrable Accredited Capital Stock of RealNetworks Common Securities Subject to Investor Name and Address Company Held Stock Held Section 1 hereof Status - -------------------------- --------------------- --------------------- ----------------------- ------------------ Michael Comish 60 16,000 8,000 Non-accredited Mark Comish 40 10,667 5,333 Non-accredited
-13- EX-5.1 3 OPINION OF PERKINS COIE LLP EXHIBIT 5.1 [Perkins Coie LLP Letterhead] July 28, 1999 RealNetworks, Inc. 2601 Elliott Avenue Seattle, WA 98121 Re: Registration Statement on Form S-3 Ladies and Gentlemen: We have acted as counsel to you in connection with the preparation of a Registration Statement on Form S-3 (the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), which you are filing with the Securities and Exchange Commission with respect to the resale of up to 26,666 shares of common stock, par value $0.001 per share (the "Shares"). We have examined the Registration Statement and such documents and records of the Company and other documents as we have deemed necessary for the purpose of this opinion. Based on the foregoing, we are of the opinion that the Shares have been duly authorized and are validly issued, fully paid and nonassessable. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement and any amendment thereto, including any and all post- effective amendments, and to the reference to our firm in the Prospectus of the Registration Statement under the heading "Legal Matters." In giving such consent, we do not admit that we are in the category of persons whose consent is required under Section 7 of the Securities Act. Very truly yours, Perkins Coie LLP EX-23.2 4 CONSENT OF KPMG Exhibit 23.2 CONSENT AND REPORT OF INDEPENDENT AUDITORS The Board of Directors RealNetworks, Inc.: The audits referred to in our report dated January 21, 1999, except for Note 10(a), which is as of May 10, 1999, included the related financial statement schedule for each of the years in the three-year period ended December 31, 1998, included in the registration statement. This financial statement schedule is the responsibility of the Company's management. our responsibility is to express an opinion on the financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We consent to the use of our reports included herein and to the reference to our firm under the headings "Selected Financial Data" and "Experts" in the prospectus. KPMG LLP Seattle, Washington July 28, 1999 -----END PRIVACY-ENHANCED MESSAGE-----