##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the Quarterly Period Ended March 31, 2008
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the transition period from                      to
 Commission file number 0-23137
 RealNetworks, Inc.
 (Exact name of registrant as specified in its charter)
 Washington
    
    91-1628146(State of incorporation)
    
    (I.R.S. Employer Identification Number)2601 Elliott Avenue, Suite 1000Seattle, Washington
    
    98121(Address of principal executive offices)
    
    (Zip Code)
 (206) 674-2700  (Registrants telephone number, including area code)
 þ o
  þ Large accelerated filer
    
    o Accelerated filer
    
    o Non-accelerated filer  (Do not check if a smaller reporting company)
    
    o Smaller reporting company
 o þ




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##### 



TABLE OF CONTENTS
 PagePart I. Financial InformationItem 1. Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    32Item 4. Controls and Procedures
    
    
    33Part II. Other InformationItem 1. Legal Proceedings
    
    
    33Item 1A. Risk Factors
    
    
    34Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    43Item 3. Default Upon Senior Securities
    
    
    43Item 4. Submission of Matters to a Vote of Security Holders
    
    
    43Item 5. Other Information
    
    
    43Item 6. Exhibits
    
    
    43Signature
    
    
    44EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 March 31,
    
    
    December 31,2008
    
    
    2007ASSETSCurrent assets:Cash and cash equivalents
    
    $
    478,737
    
    
    $
    476,697Short-term investments
    
    
    60,892
    
    
    
    79,932Trade accounts receivable, net of allowances for doubtful accounts and sales returns
    
    
    72,718
    
    
    
    84,674Deferred costs, current portion
    
    
    7,149
    
    
    
    6,408Prepaid expenses and other current assets
    
    
    29,760
    
    
    
    33,845Total current assets
    
    
    649,256
    
    
    
    681,556Equipment, software, and leasehold improvements, at cost:Equipment and software
    
    
    116,899
    
    
    
    109,621Leasehold improvements
    
    
    30,789
    
    
    
    30,632Total equipment, software, and leasehold improvements, at cost
    
    
    147,688
    
    
    
    140,253Less accumulated depreciation and amortization
    
    
    89,401
    
    
    
    83,756Net equipment, software, and leasehold improvements
    
    
    58,287
    
    
    
    56,497Restricted cash equivalents
    
    
    15,518
    
    
    
    15,509Equity investments
    
    
    9,125
    
    
    
    9,976Other assets
    
    
    13,909
    
    
    
    10,161Deferred tax assets, net
    
    
    41,176
    
    
    
    40,913Other intangible assets, net
    
    
    97,904
    
    
    
    107,677Goodwill
    
    
    347,848
    
    
    
    353,153Total assets
    
    $
    1,233,023
    
    
    $
    1,275,442LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    46,228
    
    
    $
    56,160Accrued and other liabilities
    
    
    100,800
    
    
    
    114,136Deferred revenue, current portion
    
    
    40,308
    
    
    
    39,564Related party payable
    
    
    8,299
    
    
    
    17,241Convertible debt
    
    
    100,000
    
    
    
    100,000Accrued loss on excess office facilities, current portion
    
    
    4,171
    
    
    
    3,389Total current liabilities
    
    
    299,806
    
    
    
    330,490Deferred revenue, non-current portion
    
    
    1,874
    
    
    
    2,663Accrued loss on excess office facilities, non-current portion
    
    
    5,688
    
    
    
    7,311Deferred rent
    
    
    4,637
    
    
    
    4,518Deferred tax liabilities, net, non-current portion
    
    
    20,227
    
    
    
    22,060Other long-term liabilities
    
    
    10,402
    
    
    
    13,683Total liabilities
    
    
    342,634
    
    
    
    380,725Minority interest in Rhapsody America ($67.1 million redemption value at March 31, 2008)
    
    
    14,678
    
    
    
    19,613Shareholders 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 1,000,000 shares; issued and outstanding
142,562 shares in 2008 and 142,298 shares in 2007
    
    
    142
    
    
    
    142Additional paid-in capital
    
    
    660,581
    
    
    
    653,904Accumulated other comprehensive income
    
    
    9,236
    
    
    
    17,732Retained earnings
    
    
    205,752
    
    
    
    203,326Total shareholders equity
    
    
    875,711
    
    
    
    875,104Total liabilities and shareholders equity
    
    $
    1,233,023
    
    
    $
    1,275,442
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REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
 Quarters endedMarch 31,2008
    
    
    2007Net revenue (A)
    
    $
    147,563
    
    
    $
    129,472Cost of revenue (B)
    
    
    55,393
    
    
    
    45,943Gross profit
    
    
    92,170
    
    
    
    83,529Operating expenses:Research and development
    
    
    25,006
    
    
    
    23,479Sales and marketing
    
    
    53,596
    
    
    
    49,700Advertising with related party
    
    
    7,340
    
    
    
    General and administrative
    
    
    17,084
    
    
    
    17,354Restructuring costs
    
    
    686
    
    
    
    Subtotal operating expenses
    
    
    103,712
    
    
    
    90,533Antitrust litigation benefit, net
    
    
    
    
    
    
    (60,747
    )Total operating expenses, net
    
    
    103,712
    
    
    
    29,786Operating (loss) income
    
    
    (11,542
    )
    
    
    53,743Other income (expenses):Interest income, net
    
    
    4,958
    
    
    
    9,102Equity in net loss of investments
    
    
    (91
    )
    
    
    (132
    )Minority interest in Rhapsody America
    
    
    8,615
    
    
    
    Gain on sale of interest in Rhapsody America
    
    
    3,726
    
    
    
    Other income, net
    
    
    768
    
    
    
    467Other income, net
    
    
    17,976
    
    
    
    9,437Income before income taxes
    
    
    6,434
    
    
    
    63,180Income taxes
    
    
    (4,008
    )
    
    
    (23,219
    )Net income
    
    $
    2,426
    
    
    $
    39,961Basic net income per share
    
    $
    0.02
    
    
    $
    0.25Diluted net income per share
    
    $
    0.02
    
    
    $
    0.22Shares used to compute basic net income per share
    
    
    142,491
    
    
    
    161,350Shares used to compute diluted net income per share
    
    
    154,736
    
    
    
    178,053Comprehensive (loss) income:Net income
    
    $
    2,426
    
    
    $
    39,961Unrealized holding losses on short-term and
equity investments, net of income taxes
    
    
    (434
    )
    
    
    (3,056
    )Foreign currency translation losses
    
    
    (8,062
    )
    
    
    (2,927
    )Comprehensive (loss) income
    
    $
    (6,070
    )
    
    $
    33,978
 (A) Components of net revenue:License fees
    
    $
    25,755
    
    
    $
    21,837Service revenue
    
    
    121,808
    
    
    
    107,635$
    147,563
    
    
    $
    129,472(B) Components of cost of revenue:License fees
    
    $
    9,388
    
    
    $
    8,292Service revenue
    
    
    46,005
    
    
    
    37,651$
    55,393
    
    
    $
    45,943
  4




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REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Quarters EndedMarch 31,2008
    
    
    2007Cash flows from operating activities:Net income
    
    $
    2,426
    
    
    $
    39,961Adjustments to reconcile net income to net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    12,971
    
    
    
    9,933Stock-based compensation
    
    
    5,489
    
    
    
    5,685Loss on disposal of equipment, software, and leasehold improvements
    
    
    75
    
    
    
    41Equity in net loss of investments
    
    
    91
    
    
    
    132Excess tax benefit from stock option exercises
    
    
    (50
    )
    
    
    (294
    )Accrued loss on excess office facilities
    
    
    (841
    )
    
    
    (943
    )Deferred income taxes
    
    
    (939
    )
    
    
    (3,944
    )Minority interest
    
    
    (8,615
    )
    
    
    Gain on sale of interest in Rhapsody America
    
    
    (3,726
    )
    
    
    Other
    
    
    32
    
    
    
    26Net change in certain operating assets and liabilities
    
    
    (18,202
    )
    
    
    11,492Net cash (used in) provided by operating activities
    
    
    (11,289
    )
    
    
    62,089Cash flows from investing activities:Purchases of equipment, software, and leasehold improvements
    
    
    (7,203
    )
    
    
    (3,839
    )Purchases of short-term investments
    
    
    (49,798
    )
    
    
    (55,432
    )Proceeds from sales and maturities of short-term investments
    
    
    68,838
    
    
    
    57,124Purchases of other intangibles assets
    
    
    
    
    
    
    (2,038
    )Decrease (increase) in restricted cash equivalents
    
    
    (9
    )
    
    
    1,800Payment of acquisition costs, net of cash acquired
    
    
    (6,011
    )
    
    
    Proceeds from sales of equity investments
    
    
    350
    
    
    
    Net cash (used in) provided by investing activities
    
    
    6,167
    
    
    
    (2,385
    )Cash flows from financing activities:Net proceeds from sale of common stock under employee stock purchase plan and exercise of
stock options
    
    
    1,072
    
    
    
    3,776Excess tax benefit from stock option exercises
    
    
    50
    
    
    
    294Net proceeds from sales of interest in Rhapsody America
    
    
    7,406
    
    
    
    Repurchase of common stock
    
    
    
    
    
    
    (78,481
    )Net cash (used in) provided by financing activities
    
    
    8,528
    
    
    
    (74,411
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (1,366
    )
    
    
    687Net increase (decrease) in cash and cash equivalents
    
    
    2,040
    
    
    
    (14,020
    )Cash and cash equivalents, beginning of period
    
    
    476,697
    
    
    
    525,232Cash and cash equivalents, end of period
    
    $
    478,737
    
    
    $
    511,212Supplemental disclosure of cash flow information:Cash paid for income taxes
    
    $
    1,336
    
    
    $
    4,526Supplemental disclosure of non-cash investing and financing activities:Accrued acquisition consideration
    
    $
    
    
    
    $
    4,364
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REALNETWORKS, INC. AND SUBSIDIARIES
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarter Ended March 31, 2008 and 2007
 Note 1. Summary of Significant Accounting Policies
 Description of Business.
  Basis of Presentation.
     Revenue Recognition. Software Revenue Recognition; Software Revenue Recognition with Respect to Certain Arrangements Accounting for Performance of Construction-Type and Certain Production-Type Contracts Revenue Recognition in Financial Statements Reporting
Revenue Gross as a Principal versus Net as an Agent; Revenue Arrangements
with Multiple Deliverables
   6




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Accounting for Taxes Collected From Customers
 Accounting for Gains on Sale of Subsidiary Stock.
 Note 2. Recent Accounting Pronouncements
 Business Combinations
 Noncontrolling Interest in Consolidated
Financial Statements
 Note 3. Stock-Based Compensation
 Share-Based Payment
 7




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Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans
   Quarters EndedMarch 31,2008
    
    2007Expected dividend yield
    
    
    0
    %
    
    
    0
    %Risk-free interest rate
    
    
    2.45
    %
    
    
    4.7
    %Expected life (years)
    
    
    4.2
    
    
    
    4.1Volatility
    
    
    45
    %
    
    
    42
    %
  Quarters EndedMarch 31,2008
    
    
    2007Cost of service revenue
    
    $
    234
    
    
    $
    159Research and development
    
    
    1,913
    
    
    
    1,772Sales and marketing
    
    
    1,908
    
    
    
    2,387General and administrative
    
    
    1,434
    
    
    
    1,367Total stock-based compensation expense
    
    $
    5,489
    
    
    $
    5,685
  Note 4. Rhapsody America
 Formation
  
    
    RealNetworks contributed its Rhapsody service subscribers, RadioPass subscribers,
cash of $16.4 million, contracts, revenue from existing Rhapsody subscribers, marketing
materials, player hardware, rhapsody.com and related URLs, certain liabilities, and
distribution arrangements in exchange for a 51% equity interest in Rhapsody America.
RealNetworks also licensed certain assets to Rhapsody America, including Rhapsody
content, Rhapsody technology, the Rhapsody brands and related materials.
    
    MTVN contributed its URGE service subscribers, cash, contracts, marketing materials,
and revenue from existing URGE subscribers, certain liabilities, plus the note payable
described below, in exchange for a 49% equity interest in Rhapsody America. MTVN has
also licensed certain assets to Rhapsody America, including URGE content, brands and
related materials.
    
    In addition to the assets described above, MTVN also contributed a $230 million
five-year note payable in consideration for acquiring MTVNs interest in the venture.
Rhapsody America must use the proceeds from the note solely to purchase advertising from
MTVN. As MTVN makes payments on the note, Rhapsody America records equity and
RealNetworks realizes an immediate appreciation in the carrying value of the Companys
interests in the venture and recognizes a gain if the gain is reasonably assured in
accordance with SAB 51. MTVN made payments of $7.2 million
during the quarter ended March 31, 2008 and RealNetworks realized and recorded a gain of
$3.7 million as a result as all of the SAB 51 gain criteria were met. As of March 31,
2008, $32.2 million in payments were made on the note since the formation of Rhapsody
America.
 8




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Trade Name and Trademarks
    
    $
    4,000Existing Technology
    
    
    1,900Existing Subscribers
    
    
    1,680Total Identifiable Intangible Assets
    
    $
    7,580
   Call/Put Rights
    9




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Note 5. Fair Value Measurements
 Fair Value Measurement Effective
Date of FASB Statement No. 157
   
    
    Level 1: Observable inputs such as quoted prices in active markets for identical
assets or liabilities
    
    Level 2: Inputs other than quoted prices that are observable for the asset or
liability, either directly or indirectly; these include quoted prices for similar assets
or liabilities in active markets and quoted prices for identical or similar assets or
liabilities in markets that are not active
    
    Level 3: Unobservable inputs that reflect the reporting entitys own assumptions
  Fair
Value Measurements as of March 31, 2008(in thousands)
    
    Total
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3Cash equivalentsMoney market funds
    
    $
    393,484
    
    
    $
    393,484
    
    
    $
    
    
    
    $
    Short-term investmentsCorporate notes and bonds
    
    
    33,074
    
    
    
    33,074
    
    
    
    
    
    
    
    U.S. government agency securities
    
    
    27,818
    
    
    
    27,818
    
    
    
    
    
    
    
    Equity investmentsPublicly traded investments
    
    
    7,249
    
    
    
    7,249
    
    
    
    
    
    
    
    $
    461,625
    
    
    $
    461,625
    
    
    $
    
    
    
    $
    
  10




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Note 6.
    
    Cash, Cash Equivalents, Trading Securities, Short-Term Investments, and Restricted Cash
Equivalents
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCash and cash equivalents:Cash
    
    $
    85,253
    
    
    $
    
    
    
    $
    
    
    
    $
    85,253Money market mutual funds
    
    
    393,484
    
    
    
    
    
    
    
    
    
    
    
    393,484Total cash and cash equivalents:
    
    
    478,737
    
    
    
    
    
    
    
    
    
    
    
    478,737Short-term investments:Corporate notes and bonds
    
    
    34,058
    
    
    
    41
    
    
    
    (1,025
    )
    
    
    33,074U.S. Government agency securities
    
    
    27,588
    
    
    
    230
    
    
    
    
    
    
    
    27,818Total short-term investments:
    
    
    61,646
    
    
    
    271
    
    
    
    (1,025
    )
    
    
    60,892Total cash, cash equivalents and short-term investments
    
    $
    540,383
    
    
    $
    271
    
    
    $
    (1,025
    )
    
    $
    539,629Restricted cash equivalents
    
    $
    15,518
    
    
    $
    
    
    
    $
    
    
    
    $
    15,518
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCash and cash equivalents:Cash
    
    $
    105,615
    
    
    $
    
    
    
    $
    
    
    
    $
    105,615Money market mutual funds
    
    
    198,148
    
    
    
    
    
    
    
    
    
    
    
    198,148Corporate notes and bonds
    
    
    172,934
    
    
    
    
    
    
    
    
    
    
    
    172,934Total cash and cash equivalents
    
    
    476,697
    
    
    
    
    
    
    
    
    
    
    
    476,697Short-term investments:Corporate notes and bonds
    
    
    43,552
    
    
    
    
    
    
    
    (981
    )
    
    
    42,571U.S. Government agency securities
    
    
    37,296
    
    
    
    65
    
    
    
    
    
    
    
    37,361Total short-term investments
    
    
    80,848
    
    
    
    65
    
    
    
    (981
    )
    
    
    79,932Total cash, cash equivalents, and short-term investments
    
    $
    557,545
    
    
    $
    65
    
    
    $
    (981
    )
    
    $
    556,629Restricted cash equivalents
    
    $
    15,509
    
    
    $
    
    
    
    $
    
    
    
    $
    15,509
     Amortized
    
    
    EstimatedCost
    
    
    Fair ValueWithin one year
    
    $
    41,221
    
    
    $
    41,479Between one year and five years
    
    
    20,425
    
    
    
    19,413Total available-for-sale investments
    
    $
    61,646
    
    
    $
    60,892
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Note 7. Allowance for Doubtful Accounts Receivable and Sales Returns
  Allowance ForDoubtfulAccounts
    
    
    SalesReceivable
    
    
    ReturnsBalances, December 31, 2007
    
    $
    1,117
    
    
    $
    1,338Additions charged to expenses/revenue
    
    
    228
    
    
    
    643Amounts written off
    
    
    (51
    )
    
    
    (762
    )Balances, March 31, 2008
    
    $
    1,294
    
    
    $
    1,219
  Note 8. Equity Investments
   March 31, 2008
    
    
    December 31, 2007Carrying
    
    
    
    
    
    
    CarryingCost
    
    
    Value
    
    
    Cost
    
    
    ValuePublicly traded investments
    
    $
    933
    
    
    $
    7,249
    
    
    $
    933
    
    
    $
    8,085Privately held investments
    
    
    2,740
    
    
    
    1,876
    
    
    
    2,740
    
    
    
    1,891Total equity investments
    
    $
    3,673
    
    
    $
    9,125
    
    
    $
    3,673
    
    
    $
    9,976
 Note 9. Other Intangible Assets
  Gross
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    77,553
    
    
    $
    18,169
    
    
    $
    59,384Developed technology
    
    
    47,847
    
    
    
    20,766
    
    
    
    27,081Patents, trademarks and tradenames
    
    
    13,728
    
    
    
    5,812
    
    
    
    7,916Service contracts and other
    
    
    6,648
    
    
    
    3,125
    
    
    
    3,523Total other intangible assets
    
    $
    145,776
    
    
    $
    47,872
    
    
    $
    97,904
  Gross
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    80,435
    
    
    $
    15,273
    
    
    $
    65,162Developed technology
    
    
    48,173
    
    
    
    18,539
    
    
    
    29,634Patents, trademarks and tradenames
    
    
    13,833
    
    
    
    5,000
    
    
    
    8,833Service contracts and other
    
    
    6,815
    
    
    
    2,767
    
    
    
    4,048Total other intangible assets
    
    $
    149,256
    
    
    $
    41,579
    
    
    $
    107,677
  12




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2008 (remaining nine months)
    
    $
    19,5472009
    
    
    23,6222010
    
    
    18,7702011
    
    
    13,1352012
    
    
    11,981Thereafter
    
    
    10,849Total
    
    $
    97,904
 Note 10. Goodwill
  Balance, December 31, 2007
    
    $
    353,153Decreases for the reduction of liabilities assumed
related to the acquisition of Sony NetServices GmbH
    
    
    (538
    )Effects of foreign currency translation
    
    
    (4,767
    )Balance, March 31, 2008
    
    $
    347,848
 Note 11. Accrued and Other Liabilities
  March 31,
    
    
    December 31,2008
    
    
    2007Royalties and other fulfillment costs
    
    $
    36,750
    
    
    $
    37,554Employee compensation, commissions and benefits
    
    
    21,457
    
    
    
    21,639Income taxes payable
    
    
    892
    
    
    
    1,819Sales, VAT and other taxes payable
    
    
    15,168
    
    
    
    18,156Legal fees and contingent legal fees
    
    
    2,739
    
    
    
    3,439Other
    
    
    23,794
    
    
    
    31,529Other
    
    $
    100,800
    
    
    $
    114,136
 Note 12. Loss on Excess Office Facilities
   Accrued loss on excess office facilities, December 31, 2007
    
    $
    10,700Less amounts amortized from the accrued loss on excess office facilities
    
    
    (841
    )Accrued loss on excess office facilities, March 31, 2008
    
    
    9,859Less current portion
    
    
    4,171Accrued loss on excess office facilities, non-current portion
    
    $
    5,688
 Note 13. Repurchase of Common Stock
  13




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##### Table of Contents



Note 14. Earnings Per Share
  Quarters EndedMarch 31,2008
    
    
    2007Weighted average common shares outstanding used to
compute basic net income per share
    
    
    142,491
    
    
    
    161,350Dilutive potential common shares:Stock options and restricted stock
    
    
    1,495
    
    
    
    5,953Convertible debt
    
    
    10,750
    
    
    
    10,750Shares used to compute diluted net income per share
    
    
    154,736
    
    
    
    178,053
  Note 15. Commitments and Contingencies
 Borrowing Arrangements
    14




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##### Table of Contents



Litigation
     Note 16. Segment Information
  15




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##### Table of Contents



Technology Products
    
    
    ReconcilingMusic
    
    
    Consumer
    
    
    and Solutions
    
    
    Amounts
    
    
    ConsolidatedNet revenue
    
    $
    38,079
    
    
    $
    58,207
    
    
    $
    51,277
    
    
    $
    
    
    
    $
    147,563Cost of revenue
    
    
    21,519
    
    
    
    12,613
    
    
    
    21,261
    
    
    
    
    
    
    
    55,393Gross profit
    
    
    16,560
    
    
    
    45,594
    
    
    
    30,016
    
    
    
    
    
    
    
    92,170Operating expenses
    
    
    32,971
    
    
    
    37,632
    
    
    
    32,186
    
    
    
    923
    
    
    
    103,712Operating income (loss)
    
    
    (16,411
    )
    
    
    7,962
    
    
    
    (2,170
    )
    
    
    (923
    )
    
    
    (11,542
    )Total non-operating income, net
    
    
    12,341
    
    
    
    
    
    
    
    
    
    
    
    5,635
    
    
    
    17,976Income (loss) before income taxes
    
    $
    (4,070
    )
    
    $
    7,962
    
    
    $
    (2,170
    )
    
    $
    4,712
    
    
    $
    6,434
  Technology Products
    
    
    ReconcilingMusic
    
    
    Consumer
    
    
    and Solutions
    
    
    Amounts
    
    
    ConsolidatedNet revenue
    
    $
    34,127
    
    
    $
    50,913
    
    
    $
    44,432
    
    
    $
    
    
    
    $
    129,472Cost of revenue
    
    
    18,875
    
    
    
    9,128
    
    
    
    17,940
    
    
    
    
    
    
    
    45,943Gross profit
    
    
    15,252
    
    
    
    41,785
    
    
    
    26,492
    
    
    
    
    
    
    
    83,529Operating expenses
    
    
    24,949
    
    
    
    32,907
    
    
    
    30,538
    
    
    
    (58,608
    )
    
    
    29,786Operating income (loss)
    
    
    (9,697
    )
    
    
    8,878
    
    
    
    (4,046
    )
    
    
    58,608
    
    
    
    53,743Total non-operating income, net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,437
    
    
    
    9,437Income (loss) before income taxes
    
    $
    (9,697
    )
    
    $
    8,878
    
    
    $
    (4,046
    )
    
    $
    68,045
    
    
    $
    63,180
 16




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##### Table of Contents



Quarters EndedMarch 31,2008
    
    
    2007United States
    
    $
    99,169
    
    
    $
    84,554Europe
    
    
    24,167
    
    
    
    17,710Republic of Korea
    
    
    13,320
    
    
    
    18,399Rest of the World
    
    
    10,907
    
    
    
    8,809Total net revenue
    
    $
    147,563
    
    
    $
    129,472
  March 31,
    
    
    December 31,2008
    
    
    2007United States
    
    $
    186,152
    
    
    $
    186,665Republic of Korea
    
    
    218,010
    
    
    
    235,728Europe
    
    
    91,896
    
    
    
    87,181Rest of the World
    
    
    7,943
    
    
    
    7,753Total long-lived assets
    
    $
    504,001
    
    
    $
    517,327
  March 31,
    
    
    December 31,2008
    
    
    2007United States
    
    $
    580,004
    
    
    $
    576,994Republic of Korea
    
    
    215,000
    
    
    
    228,153Europe
    
    
    85,696
    
    
    
    79,410Rest of the World
    
    
    9,651
    
    
    
    10,160Total net assets
    
    $
    890,351
    
    
    $
    894,717
  March 31,
    
    
    December 31,2008
    
    
    2007Music
    
    $
    37,029
    
    
    $
    37,029Consumer
    
    
    132,827
    
    
    
    129,621Technology products and solutions
    
    
    177,992
    
    
    
    186,503Total goodwill
    
    $
    347,848
    
    
    $
    353,153
 Note 17. Related Party Transactions
 Transactions with MTVN.
 17




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Note 18. Subsequent Events
  18




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain
forward-looking statements that have been made pursuant to the provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are based on current expectations,
estimates, and projections about RealNetworks industry, products, managements beliefs, and
certain assumptions made by management. Words such as anticipates, expects, intends,
plans, believes, seeks, estimates, and similar expressions are intended to identify
forward-looking statements. Forward-looking statements include statements with respect to:
 
    
    future revenues, income taxes, tax benefits, net income per diluted share, acquisition costs and
related amortization, and other measures of results of operations;
    
    the effects of our acquisitions, including WiderThan, Sony NetServices GmbH and Exomi
Oy, and our position as a technology services provider for leading wireless carriers;
    
    plans, strategies and expected opportunities for growth, increased profitability and
innovation in 2008 and future years;
    
    the creation of new strategic partnerships and broadening
of existing strategic partnerships and the advantages and growth we will
achieve as a result of such partnerships (including in connection
with our Games, Music and Technology Products and Solutions
businesses);
    
    the expected growth and profitability of our Technology Products and Solutions
business;
    
    the governance, management, accounting and integration of our Rhapsody America
venture;
    
    the dilutive impact on our shareholders if the call or put rights contained in the
limited liability agreement for Rhapsody America are exercised and result in the
issuance of additional shares of our common stock;
    
    the financial performance and growth of our Games business, including future
international growth;
    
    RealNetworks intention to separate its games business,
distribute shares of the newly created games company to its
shareholders, the potential sale of up to 20% of the shares of the
new games company in an initial public offering and the anticipated
tax-free nature of the proposed transactions;
    
    the migration of our Media Software and Services businesses from general purpose
subscription businesses toward premium services and free-to-consumer services, the
popularity of the RealPlayer and our expected introduction of new products and
innovations in our Media Software and Services business;
    
    our ability to grow our Music business, including opportunities for us to become the
platform of choice for the consumer electronics industry, the integration of our
Rhapsody DNA into the digital devices of an expanding list of partners and our plans to
introduce additional innovations;
    
    the effect of future interoperability on our Music business, the significance of
growth opportunities in the digital music market and our expectations for short-term
progress and long-term success in our Music business;
    
    our financial position and the availability of resources;
    
    our expectations regarding acquisition activity in 2008 and our focus on the
integration of completed acquisitions;
    
    our relationships with our employees;
    
    future competition; and
    
    the degree of seasonality in our revenue.
 These statements are not guarantees of future performance and actual actions or results may
differ materially. These statements are subject to certain risks, uncertainties and assumptions
that are difficult to predict, including those noted in the documents incorporated herein by
reference. Particular attention should also be paid to the cautionary language in section Item 1
of Part II entitled Legal Proceedings and Item 1A of Part II entitled Risk Factors.
RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result
of new information, future events or otherwise, unless required by law. Readers should, however,
carefully review the risk factors included in other reports or documents filed by RealNetworks from
time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on
Form 10-Q and any Current Reports on Form 8-K .
 19




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Overview
            20




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##### Table of Contents



Critical Accounting Policies and Estimates
  
    
    Revenue recognition;
    
    Estimating music publishing rights and music royalty accruals;
    
    Recoverability of deferred costs;
    
    Estimating allowances for doubtful accounts and sales returns;
    
    Estimating losses on excess office facilities;
    
    Determining whether declines in the fair value of investments are other-than-temporary
and estimating fair market value of investments in privately held companies;
    
    Valuation of other intangible assets;
    
    Valuation of goodwill;
    
    Stock-based compensation;
    
    Minority interest;
    
    Accounting for gains on sale of subsidiary stock; and
    
    Accounting for income taxes.
    
    Accounting for taxes collected from customers.
 Revenue Recognition. Software Revenue Recognition; Software Revenue Recognition with Respect to Certain Arrangements Accounting for
Performance of Construction-Type and Certain Production-Type Contracts Revenue Recognition in Financial
Statements Revenue Arrangements with Multiple Deliverables; Reporting
Revenue Gross as a Principal versus Net as an Agent
   21




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##### Table of Contents



Music Publishing Rights and Music Royalty Accruals.
 Recoverability of Deferred Costs.
  Allowances for Doubtful Accounts and Sales Returns.
 Accrued Loss on Excess Office Facilities.
 Impairment of Investments.
 22




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##### Table of Contents



Valuation of Other Intangible Assets.
 Valuation of Goodwill.
 
    
    poor economic performance relative to historical or projected future operating results;
    
    significant negative industry, economic or company specific trends;
    
    changes in the manner of our use of the assets or the plans for our business; and
    
    loss of key personnel.
  Stock-Based Compensation. Share-Based Payment Accounting for Stock Issued to Employees
 Minority Interests. Consolidated
Financial Statements
 Accounting for Gains on Sale of Subsidiary Stock. Accounting for the Sales of
Stock of a Subsidiary
 23




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##### Table of Contents



Accounting for Income Taxes.
     Accounting
for Taxes Collected From Customers.
 Revenue by Segment
  Quarters EndedMarch 31,2008
    
    
    Change
    
    
    2007Music
    
    $
    38,079
    
    
    
    12
    %
    
    $
    34,127Consumer
    
    
    58,207
    
    
    
    14
    
    
    
    50,913Technology Products and Solutions
    
    
    51,277
    
    
    
    15
    
    
    
    44,432Total net revenue
    
    $
    147,563
    
    
    
    14
    %
    
    $
    129,472
  Quarters EndedMarch 31,2008
    
    
    2007Music
    
    
    26
    %
    
    
    27
    %Consumer
    
    
    39
    
    
    
    39Technology Products and Solutions
    
    
    35
    
    
    
    34Total net revenue
    
    
    100
    %
    
    
    100
    %
 Music.
 24




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##### Table of Contents



Consumer.
  Technology Products and Solutions.
  Consumer Revenue
  Quarters Ended March 31,2008
    
    
    Change
    
    
    2007Games
    
    
    31,798
    
    
    
    33
    %
    
    
    23,902Media Software and Services
    
    
    26,409
    
    
    
    (2
    )
    
    
    27,011Total consumer products and services revenue
    
    $
    58,207
    
    
    
    14
    %
    
    $
    50,913
 Games.
  25




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##### Table of Contents



Media Software and Services.
  Geographic Revenue
  Quarters EndedMarch 31,2008
    
    
    Change
    
    
    2007United States
    
    $
    99,169
    
    
    
    17
    %
    
    $
    84,554Europe
    
    
    24,167
    
    
    
    36
    
    
    
    17,710Republic of Korea
    
    
    13,320
    
    
    
    (28
    )
    
    
    18,399Rest of the world
    
    
    10,907
    
    
    
    24
    
    
    
    8,809Total net revenue
    
    $
    147,563
    
    
    
    14
    %
    
    $
    129,472
 Revenue by Segment
 License
and Service Revenue
  Quarters EndedMarch 31,2008
    
    
    Change
    
    
    2007License fees
    
    $
    25,755
    
    
    
    18
    %
    
    $
    21,837Service revenue
    
    
    121,808
    
    
    
    13
    
    
    
    107,635Total net revenue
    
    $
    147,563
    
    
    
    14
    %
    
    $
    129,472
  Quarters EndedMarch 31,2008
    
    
    2007License fees
    
    
    17
    %
    
    
    17
    %Service revenue
    
    
    83
    
    
    
    83Total net revenue
    
    
    100
    %
    
    
    100
    %
 License Fees.
 26




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##### Table of Contents



Service Revenue.
 Deferred Revenue
  Cost of Revenue by Segment
  Quarters EndedMarch 31,2008
    
    
    Change
    
    
    2007Music
    
    $
    21,519
    
    
    
    14
    %
    
    $
    18,875Consumer
    
    
    12,613
    
    
    
    38
    
    
    
    9,128Technology products and solutions
    
    
    21,261
    
    
    
    19
    
    
    
    17,940Total cost of revenue
    
    $
    55,393
    
    
    
    21
    %
    
    $
    45,943
  Quarters EndedMarch 31,2008
    
    
    2007Music
    
    
    57
    %
    
    
    55
    %Consumer
    
    
    22
    
    
    
    18Technology products and solutions
    
    
    41
    
    
    
    40Total cost of revenue
    
    
    38
    %
    
    
    35
    %
 Cost
of Music.
 Cost
of Consumer.
 Cost of Technology Products and Solutions.
 27




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##### Table of Contents



Cost
of License Fees and Service Revenue
  Quarters EndedMarch 31,2008
    
    
    Change
    
    
    2007License fees
    
    $
    9,388
    
    
    
    13
    %
    
    $
    8,292Service revenue
    
    
    46,005
    
    
    
    22
    
    
    
    37,651Total cost of revenue
    
    $
    55,393
    
    
    
    21
    %
    
    $
    45,943
  Quarters EndedMarch 31,2008
    
    2007License fees
    
    
    36
    %
    
    
    38
    %Service revenue
    
    
    38
    
    
    
    35Total cost of revenue
    
    
    38
    %
    
    
    35
    %
 Cost of License Fees.
 Cost of Service Revenue.
 Operating Expenses
 Research and Development
  Quarters EndedMarch 31,2008
    
    Change
    
    2007Research and development
    
    $
    25,006
    
    
    
    7
    %
    
    $
    23,479As a percentage of total net revenue
    
    
    17
    %
    
    
    
    
    
    
    18
    %
 28




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##### Table of Contents



Sales and Marketing
  Quarters EndedMarch 31,2008
    
    Change
    
    2007Sales and marketing
    
    $
    53,596
    
    
    
    8
    %
    
    $
    49,700As a percentage of total net revenue
    
    
    36
    %
    
    
    
    
    
    
    38
    %
  General and Administrative
  Quarters EndedMarch 31,2008
    
    Change
    
    2007General and administrative
    
    $
    17,084
    
    
    
    (2
    )%
    
    $
    17,354As a percentage of total net revenue
    
    
    12
    %
    
    
    
    
    
    
    13
    %
  Advertising with Related Party
  Antitrust Litigation Benefit, Net
  29




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Other Income, Net
  Quarters EndedMarch 31,2008
    
    
    Change
    
    
    2007Interest income, net
    
    $
    4,958
    
    
    
    (46
    )%
    
    $
    9,102Equity in net loss of investments
    
    
    (91
    )
    
    
    31
    
    
    
    (132
    )Minority interest in Rhapsody America
    
    
    8,615
    
    
    
    n/a
    
    
    
    Gain on sale of interest in Rhapsody America
    
    
    3,726
    
    
    
    n/a
    
    
    
    Other income, net
    
    
    768
    
    
    
    64
    
    
    
    467Other income, net
    
    $
    17,976
    
    
    
    90
    %
    
    $
    9,437
  Income Taxes
    New Accounting Pronouncements
 Fair Value Measurement Effective
Date of FASB Statement No. 157
  30




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##### Table of Contents



Liquidity and Capital Resources
  March 31,
    
    December 31,2008
    
    2007Working capital
    
    $
    349,450
    
    
    $
    351,066Cash, cash equivalents, and short-term investments
    
    
    539,629
    
    
    
    556,629Restricted cash
    
    
    15,518
    
    
    
    15,509
   March 31,
    
    March 31,2008
    
    2007Cash (used in) provided by operating activities
    
    $
    (11,289
    )
    
    $
    62,089Cash
provided by (used) in investing activities
    
    
    6,167
    
    
    
    (2,385
    )Cash
provided by (used in) financing activities
    
    
    8,528
    
    
    
    (74,411
    )
      31




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##### Table of Contents



Off-Balance Sheet Agreements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk.
 Investment Risk.
 32




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##### Table of Contents



Foreign Currency Risk.
     
 Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures.
 Changes in Internal Controls.
 
 PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
   33




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##### Table of Contents



Item 1A. Risk Factors
  Risks Related to Our Recently Announced Separation of Our Games Business
 On May 8, 2008 we announced our intention to separate our global games business into an independent
company and to distribute shares of the newly created games company to our shareholders. We also
indicated that we may precede the spin-off with an initial public offering and sale of up to 20% of
the shares of the games company. If such transactions are not completed, our
stock price and business may be adversely affected.
   Our games business represents a significant portion of our business and a spin-off or initial
public offering of the games business may cause our operating results to suffer and may cause our
revenues, income and stock price to decline.
   The separation and possible initial public offering of the games business is a substantial
undertaking that may disrupt RealNetworks ongoing business and may increase expenses, which may
affect RealNetworks results of operations or financial condition.
  34




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Risks Related to Our Music and Consumer Businesses
 Our music and consumer businesses face substantial competitive challenges that may prevent us from
being successful in, and negatively impact future growth in, those businesses.
  
    
    reduced prices or margins,
    
    loss of current and potential customers, market share and market power,
    
    changes to our products, services, technologies, licenses or business practices or
strategies,
    
    lengthened sales cycles,
    
    pressure to prematurely release products or product enhancements, or
    
    degradation in our stature and reputation in the market.
  Music.
 Media Software and Services.
 Games.
 The success of our subscription services businesses depends upon our ability to increase
subscription revenue and to license compelling content on commercially reasonable terms.
   Music publishing royalty rates for music subscription services offered through RealNetworks and
Rhapsody America are not yet fully established; a determination of high royalty rates could
negatively impact our operating results.
  An appeal of, or other industry settlement relating to, the April 2007 Copyright Royalty Board
decision regarding Internet radio royalties and minimum payments could result in material expenses
that would harm our operating results and our ability to provide popular radio services.


35



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##### Table of Contents





We may not be successful in maintaining and growing our distribution of digital media products.




36



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##### Table of Contents



We face risks with respect to certain matters in the governance and management of our Rhapsody
America joint venture and the integration and operation of assets that have been combined to form
Rhapsody America.
   We and MTVN have certain contractual rights relating to the purchase and sale of MTVNs membership
interest in Rhapsody America that may be settled in part through the issuance of additional shares
of our capital stock, which would dilute our other shareholders voting and economic interests in
us, and may require us to pay MTVN a price that exceeds the appraised value of its proportionate
interest in Rhapsody America.
  Risks Related to Our Technology Products and Solutions Business
 A majority of the revenue that we generate in South Korea is dependent upon our relationship with
SK Telecom, the largest wireless carrier in Korea; any deterioration of this relationship could
materially harm our business.
  37




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##### Table of Contents



Contracts with our carrier customers subject us to significant risks that could negatively impact
our revenue or otherwise harm our operating results.
    The mobile entertainment market is highly competitive.
  Our
traditional system software licensing business has been negatively
impacted by competitive factors, and we may not experience improved sales of our system software products.
  Risks Related to Our Business in General
 Our operating results are difficult to predict and may fluctuate, which may contribute to
volatility in our stock price.
  38




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##### Table of Contents




    
    our inability to realize SAB No. 51 gains in future periods
    
    impairments of goodwill and other long-lived assets,
    
    integrating and operating newly acquired businesses and assets,
    
    the seasonality of our business, which has experienced increased revenues in the fourth
quarter of our fiscal year, and
    
    the general difficulty in forecasting our operating results and metrics, which could
result in actual results that differ significantly from expected results.
  New products and services may not achieve market acceptance or may be subject to legal challenge
that could negatively affect our operating results.
  We depend upon our executive officers and key personnel, but may be unable to attract and retain
them, which could significantly harm our business and results of operations.
   Acquisitions involve costs and risks that could harm our business and impair our ability to realize
potential benefits from acquisitions.
  39




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##### Table of Contents




    
    difficulties and expenses in assimilating the operations, products, technology,
information systems, and/or personnel of the acquired company;
    
    retaining key management or employees of the acquired company;
    
    entrance into unfamiliar markets, industry segments, or types of businesses;
    
    operating and integrating acquired businesses in remote locations;
    
    integrating and managing businesses based in countries in which we have little or no
prior experience;
    
    diversion of management time and other resources from existing operations to integration
activities for acquired businesses;
    
    impairment of relationships with employees, affiliates, advertisers or content providers
of our business or acquired business; and
    
    assumption of known and unknown liabilities of the acquired company, including
intellectual property claims.
 We need to develop relationships and technical standards with manufacturers of non-PC media and
communication devices and interoperability of our services with these devices to grow our business.
  We may be unable to adequately protect our proprietary rights or leverage our patent portfolio, and
may face risks associated with third-party claims relating to our intellectual property.
  40




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##### Table of Contents



Our business and operating results will suffer if our systems or networks fail, become unavailable,
unsecured or perform poorly so that current or potential users do not have adequate access to our
products, services and websites.
  Our network is subject to security risks that could harm our business and reputation and expose us
to litigation or liability.
  The growth of our business is dependent in part on successfully implementing our international
expansion strategy.
  We may be subject to market risk and legal liability in connection with the data collection
capabilities of our products and services.
  We may be subject to assessment of sales and other taxes for the sale of our products, license of
technology or provision of services.
   41




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##### Table of Contents



We may be subject to additional income tax assessments.
  Risks Related to the Securities Markets and Ownership of Our Common Stock
 Our directors and executive officers beneficially own more than one third of our stock, which gives
them significant control over certain major decisions on which our shareholders may vote, may
discourage an acquisition of us, and any significant sales of stock by our officers and directors
could have a negative effect on our stock price.
  
    
    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.
  Provisions of our charter documents, Shareholder Rights Plan, and Washington law could discourage
our acquisition by a third-party.
  
    
    adopt a plan of merger;
    
    authorize the sale, lease, exchange or mortgage of assets representing more than 50% of
the book value of our assets prior to the transaction or 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.
     42




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Default Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
  ExhibitNumber
    
    Description31.1
    
    Certification of Robert Glaser, Chairman and Chief Executive
Officer of RealNetworks, Inc., Pursuant to Exchange Act Rules
13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer of RealNetworks, Inc., Pursuant to
Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Robert Glaser, Chairman and Chief Executive
Officer of RealNetworks, Inc., Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
200232.2
    
    Certification of Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer of RealNetworks, Inc., Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 43




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##### Table of Contents



SIGNATURE
  REALNETWORKS, INC.By:
    /s/ Michael EggersMichael EggersTitle:
    Senior Vice President, Chief Financial
Officer and Treasurer(Principal Financial and
Accounting Officer) 44




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##### Table of Contents



INDEX TO EXHIBITS
 ExhibitNumber
    
    Description31.1
    
    Certification of Robert Glaser, Chairman and Chief Executive
Officer of RealNetworks, Inc., Pursuant to Exchange Act Rules
13a-14(a) and 15d-14(a), as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer of RealNetworks, Inc., Pursuant to
Exchange Act Rules 13a-14(a) and 15d-14(a), as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Robert Glaser, Chairman and Chief Executive
Officer of RealNetworks, Inc., Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
200232.2
    
    Certification of Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer of RealNetworks, Inc., Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 45