##### 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 1934For the Quarterly Period Ended March 31, 2007ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For 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
   Large accelerated filer þ
    
    Accelerated filer o
    
    Non-accelerated filer o
 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
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    30Part II. Other InformationItem 1. Legal Proceedings
    
    
    30Item 1A. Risk Factors
    
    
    31Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    41Item 3. Default Upon Senior Securities
    
    
    42Item 4. Submission of Matters to a Vote of Security Holders
    
    
    42Item 5. Other Information
    
    
    42Item 6. Exhibits
    
    
    42Signature
    
    
    43EXHIBIT 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 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    511,212
    
    
    $
    525,232Short-term investments
    
    
    152,199
    
    
    
    153,688Trade accounts receivable, net of allowances for doubtful accounts and sales returns
    
    
    56,038
    
    
    
    65,751Deferred costs, current portion
    
    
    3,298
    
    
    
    1,643Deferred tax assets, net, current portion
    
    
    891
    
    
    
    891Prepaid expenses and other current assets
    
    
    22,373
    
    
    
    21,990Total current assets
    
    
    746,011
    
    
    
    769,195Equipment, software, and leasehold improvements:Equipment and software
    
    
    84,456
    
    
    
    83,587Leasehold improvements
    
    
    30,271
    
    
    
    29,665Total equipment, software, and leasehold improvements, at cost
    
    
    114,727
    
    
    
    113,252Less accumulated depreciation and amortization
    
    
    67,833
    
    
    
    65,509Net equipment, software, and leasehold improvements
    
    
    46,894
    
    
    
    47,743Restricted cash equivalents
    
    
    15,500
    
    
    
    17,300Equity investments
    
    
    17,835
    
    
    
    22,649Other assets
    
    
    5,983
    
    
    
    5,148Deferred tax assets, net, non-current portion
    
    
    27,150
    
    
    
    27,150Other intangible assets, net
    
    
    100,507
    
    
    
    105,109Goodwill
    
    
    310,735
    
    
    
    309,122Total assets
    
    $
    1,270,615
    
    
    $
    1,303,416LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    40,795
    
    
    $
    52,097Accrued and other liabilities
    
    
    116,379
    
    
    
    104,328Deferred revenue, current portion
    
    
    26,793
    
    
    
    24,137Accrued loss on excess office facilities, current portion
    
    
    4,522
    
    
    
    4,508Total current liabilities
    
    
    188,489
    
    
    
    185,070Deferred revenue, non-current portion
    
    
    3,468
    
    
    
    3,440Accrued loss on excess office facilities, non-current portion
    
    
    9,036
    
    
    
    9,993Deferred rent
    
    
    4,388
    
    
    
    4,331Deferred tax liabilities, net, non-current portion
    
    
    23,132
    
    
    
    27,076Convertible debt
    
    
    100,000
    
    
    
    100,000Other long-term liabilities
    
    
    7,425
    
    
    
    3,740Total liabilities
    
    
    335,938
    
    
    
    333,650Shareholders equity:Preferred stock, $0.001 par value, no shares issued and outstandingSeries A: authorized 200 shares
    
    
    
    
    
    
    Undesignated series: authorized 59,800 shares
    
    
    
    
    
    
    Common stock, $0.001 par value authorized 1,000,000 shares; issued and outstanding154,108 shares in 2007 and 163,278 shares in 2006
    
    
    154
    
    
    
    162Additional paid-in capital
    
    
    722,049
    
    
    
    791,108Accumulated other comprehensive income
    
    
    17,502
    
    
    
    23,485Retained earnings
    
    
    194,972
    
    
    
    155,011Total shareholders equity
    
    
    934,677
    
    
    
    969,766Total liabilities and shareholders equity
    
    $
    1,270,615
    
    
    $
    1,303,416
  3




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REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(In thousands, except per share data)
 Three Months endedMarch 31,2007
    
    
    2006Net revenue (A)
    
    $
    129,472
    
    
    $
    86,602Cost of revenue (B)
    
    
    45,943
    
    
    
    26,753Gross profit
    
    
    83,529
    
    
    
    59,849Operating expenses:Research and development
    
    
    23,479
    
    
    
    18,099Sales and marketing
    
    
    49,700
    
    
    
    36,083General and administrative
    
    
    17,354
    
    
    
    13,226Loss on excess office facilities
    
    
    
    
    
    
    738Subtotal operating expenses
    
    
    90,533
    
    
    
    68,146Antitrust litigation benefit, net
    
    
    (60,747
    )
    
    
    (39,835
    )Total operating expenses, net
    
    
    29,786
    
    
    
    28,311Operating income
    
    
    53,743
    
    
    
    31,538Other income (expenses):Interest income, net
    
    
    9,102
    
    
    
    7,979Equity in net loss of investments
    
    
    (132
    )
    
    
    Other income, net
    
    
    467
    
    
    
    117Other income, net
    
    
    9,437
    
    
    
    8,096Income before income taxes
    
    
    63,180
    
    
    
    39,634Income taxes
    
    
    (23,219
    )
    
    
    (14,751
    )Net income
    
    $
    39,961
    
    
    $
    24,883Basic net income per share
    
    $
    0.25
    
    
    $
    0.15Diluted net income per share
    
    $
    0.22
    
    
    $
    0.14Shares used to compute basic net income per share
    
    
    161,350
    
    
    
    160,887Shares used to compute diluted net income per share
    
    
    178,053
    
    
    
    176,923Comprehensive income:Net income
    
    $
    39,961
    
    
    $
    24,883Unrealized holding losses on short-term and
equity investments, net of income taxes
    
    
    (3,056
    )
    
    
    (7,821
    )Foreign currency translation gains (losses)
    
    
    (2,927
    )
    
    
    367Comprehensive income
    
    $
    33,978
    
    
    $
    17,429(A) Components of net revenue:License fees
    
    $
    21,837
    
    
    $
    22,636Service revenue
    
    
    107,635
    
    
    
    63,966$
    129,472
    
    
    $
    86,602(B) Components of cost of revenue:License fees
    
    $
    8,292
    
    
    $
    9,861Service revenue
    
    
    37,651
    
    
    
    16,892$
    45,943
    
    
    $
    26,753
  4




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REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Three Months EndedMarch 31,2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    39,961
    
    
    $
    24,883Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    9,933
    
    
    
    4,252Stock-based compensation
    
    
    5,685
    
    
    
    3,638Equity in net loss of investments
    
    
    132
    
    
    
    Loss on disposal of equipment, software, and leasehold improvements
    
    
    41
    
    
    
    77Excess tax benefit from stock option exercises
    
    
    (294
    )
    
    
    Accrued loss on excess office facilities
    
    
    (943
    )
    
    
    (702
    )Deferred income taxes
    
    
    (3,944
    )
    
    
    12,882Other
    
    
    26
    
    
    
    29Net change in certain operating assets and liabilities, net of acquisitions
    
    
    11,492
    
    
    
    (47,088
    )Net cash provided by (used in) operating activities
    
    
    62,089
    
    
    
    (2,029
    )Cash flows from investing activities:Purchases of equipment, software, and leasehold improvements
    
    
    (3,839
    )
    
    
    (2,568
    )Purchases of short-term investments
    
    
    (55,432
    )
    
    
    (58,884
    )Proceeds from sales and maturities of short-term investments
    
    
    57,124
    
    
    
    55,180Purchases of other intangibles assets
    
    
    (2,038
    )
    
    
    Decrease in restricted cash equivalents
    
    
    1,800
    
    
    
    Cash used in acquisitions, net of cash acquired
    
    
    
    
    
    
    (6,799
    )Net cash used in investing activities
    
    
    (2,385
    )
    
    
    (13,071
    )Cash flows from financing activities:Net proceeds from sale of common stock under employee stock purchase plan and exercise of
stock options
    
    
    3,776
    
    
    
    7,614Excess tax benefit from stock options exercises
    
    
    294
    
    
    
    Repurchase of common stock
    
    
    (78,481
    )
    
    
    (76,988
    )Net cash used in financing activities
    
    
    (74,411
    )
    
    
    (69,374
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    687
    
    
    
    669Net decrease in cash and cash equivalents
    
    
    (14,020
    )
    
    
    (83,805
    )Cash and cash equivalents, beginning of period
    
    
    525,232
    
    
    
    651,971Cash and cash equivalents, end of period
    
    $
    511,212
    
    
    $
    568,166Supplemental disclosure of cash flow information:Cash paid for income taxes
    
    $
    4,526
    
    
    $
    8,921Supplemental disclosure of non-cash investing and financing activities:Accrued acquisition consideration
    
    $
    4,364
    
    
    $
    2,000Accrued acquisition costs
    
    $
    
    
    
    $
    287
  5




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REALNETWORKS, INC. AND SUBSIDIARIES
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Months Ended March 31, 2007 and 2006
 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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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
    Accounting for Taxes Collected From Customers
 Note 2.       Recently Adopted Accounting Pronouncement
 Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109. Accounting for Income Taxes
   Note 3.       Stock-Based Compensation
 Share-Based Payment Accounting for Stock Appreciation Rights and Other Variable
Stock Option or Award Plans
  7




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Three MonthsEnded March 31,2007
    
    2006Expected dividend yield
    
    
    0
    %
    
    
    0
    %Risk-free interest rate
    
    
    4.7
    %
    
    
    4.65
    %Expected life (years)
    
    
    4.1
    
    
    
    4.3Volatility
    
    
    42
    %
    
    
    48
    %
  Three Months EndedMarch 31,2007
    
    
    2006Cost of service revenue
    
    $
    159
    
    
    $
    50Research and development
    
    
    1,772
    
    
    
    1,369Sales and marketing
    
    
    2,387
    
    
    
    1,359General and administrative
    
    
    1,367
    
    
    
    860Total stock-based compensation expense
    
    $
    5,685
    
    
    $
    3,638
  Note 4.       Business Combinations
   Business Combination During the Quarter Ended March 31, 2006.
     8




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Cash paid at acquisition
    
    $
    7,922Additional future payments related to initial purchase price
    
    
    2,000Additional payments for achievement of performance criteria
    
    
    4,364Estimated direct acquisition costs
    
    
    293Total
    
    $
    14,579
   Current assets
    
    $
    1,830Property and equipment
    
    
    166Other intangible assets subject to amortization:Distributor and customer relationships
    
    
    1,290Technology and games
    
    
    570Tradenames and trademarks
    
    
    560Non-compete agreements
    
    
    180Goodwill
    
    
    12,532Total assets acquired
    
    
    17,128Current liabilities
    
    
    (1,781
    )Net deferred tax liabilities
    
    
    (768
    )Total liabilities acquired
    
    
    (2,549
    )Net assets acquired
    
    $
    14,579
   Note 5.       Allowance for Doubtful Accounts Receivable and Sales Returns
  Allowance ForDoubtfulAccounts
    
    
    SalesReceivable
    
    
    ReturnsBalances, December 31, 2006
    
    $
    1,101
    
    
    $
    1,389Additions charged to expenses/revenue
    
    
    30
    
    
    
    1,273Amounts written off
    
    
    (31
    )
    
    
    (1,460
    )Balances, March 31, 2007
    
    $
    1,100
    
    
    $
    1,202
  9




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Note 6.       Equity Investments
   March 31, 2007
    
    
    December 31, 2006Carrying
    
    
    
    
    
    
    CarryingCost
    
    
    Value
    
    
    Cost
    
    
    ValuePublicly traded investments
    
    $
    913
    
    
    $
    15,553
    
    
    $
    913
    
    
    $
    20,235Privately held investments
    
    
    1,879
    
    
    
    2,282
    
    
    
    1,879
    
    
    
    2,414Total equity investments
    
    $
    2,792
    
    
    $
    17,835
    
    
    $
    2,792
    
    
    $
    22,649
 Note 7.       Other Intangible Assets
  Gross
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    72,426
    
    
    $
    6,454
    
    
    $
    65,972Developed technology
    
    
    36,681
    
    
    
    11,407
    
    
    
    25,274Patents, trademarks and tradenames
    
    
    7,077
    
    
    
    3,086
    
    
    
    3,991Service contracts and other
    
    
    6,707
    
    
    
    1,437
    
    
    
    5,270Total other intangible assets, March 31, 2007
    
    $
    122,891
    
    
    $
    22,384
    
    
    $
    100,507
  Gross
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    73,061
    
    
    $
    3,386
    
    
    $
    69,675Developed technology
    
    
    36,891
    
    
    
    9,981
    
    
    
    26,910Patents, trademarks and tradenames
    
    
    7,114
    
    
    
    2,226
    
    
    
    4,888Service contracts and other
    
    
    4,680
    
    
    
    1,044
    
    
    
    3,636Total other intangible assets, December 31, 2006
    
    $
    121,746
    
    
    $
    16,637
    
    
    $
    105,109
   2007 (remaining nine months)
    
    $
    17,5982008
    
    
    21,1022009
    
    
    19,1292010
    
    
    15,0832011
    
    
    10,302Thereafter
    
    
    17,293Total
    
    $
    100,507
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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Note 8.       Goodwill
  Balance, December 31, 2006
    
    $
    309,122Increases for payments due to Zylom
    
    
    4,364Adjustments to purchase price for WiderThan
    
    
    (1,296
    )Effects of foreign currency translation
    
    
    (1,455
    )Balance, March 31, 2007
    
    $
    310,735
 Note 9.       Accrued and Other Liabilities
  March 31,
    
    
    December 31,2007
    
    
    2006Royalties and other fulfillment costs
    
    $
    29,922
    
    
    $
    29,968Income taxes payable
    
    
    22,174
    
    
    
    8,455Employee compensation, commissions and benefits
    
    
    19,815
    
    
    
    25,244Sales, VAT and other taxes payable
    
    
    13,529
    
    
    
    13,364Legal fees and contingent legal fees
    
    
    3,193
    
    
    
    4,075Accrued charitable donations
    
    
    2,107
    
    
    
    2,048Other
    
    
    25,639
    
    
    
    21,174Total
    
    $
    116,379
    
    
    $
    104,328
 Note 10.       Loss on Excess Office Facilities
    Accrued loss on excess office facilities, December 31, 2006
    
    $
    14,501Less amounts paid on accrued loss on excess office facilities, net of sublease income
    
    
    (943
    )Accrued loss on excess office facilities, March 31, 2007
    
    
    13,558Less current portion
    
    
    4,522Accrued loss on excess office facilities, non-current portion
    
    $
    9,036
 Note 11.       Repurchase of Common Stock
  11




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Note 12.       Earnings Per Share
  Three Months Ended March 31,2007
    
    
    2006Weighted average common shares outstanding used to
compute basic net income per share
    
    
    161,350
    
    
    
    160,887Dilutive potential common shares:Stock options and restricted stock
    
    
    5,953
    
    
    
    5,286Convertible debt
    
    
    10,750
    
    
    
    10,750Shares used to compute diluted net income per share
    
    
    178,053
    
    
    
    176,923
  Note 13.       Commitments and Contingencies
 Borrowing Arrangements
    Litigation
  12




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
      Note 14.       Segment Information
  13




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Disclosure
About Segments of an Enterprise and Related Information
  Three Months Ended March 31,2007
    
    
    2006United States
    
    $
    84,554
    
    
    $
    65,700Republic of Korea
    
    
    18,399
    
    
    
    Europe
    
    
    17,710
    
    
    
    13,905Rest of the World
    
    
    8,809
    
    
    
    6,997Total net revenue
    
    $
    129,472
    
    
    $
    86,602
  
    
    Consumer Products and Services segment primarily includes revenue
from: digital media subscription services such as Rhapsody,
RadioPass, GamePass and SuperPass; sales and distribution of
third-party software and services; sales of digital content such
as music and game downloads; sales of premium versions of our
RealPlayer and related products; and advertising. These products
and services are sold and provided primarily through the Internet
and the Company charges customers credit cards at the time of
sale. Billing periods for subscription services typically occur
monthly, quarterly or annually, depending on the service
purchased.
 
    
    Technology Products and Solutions segment includes revenue from:
sales of ringback tone, music-on-demand, video-on-demand,
messaging, and information services; sales of our media delivery
system software, including Helix system software and related
authoring and publishing tools, both directly to customers and
indirectly through original equipment manufacturer (OEM) channels;
support and maintenance services that we sell to customers who
purchase our software products; broadcast hosting services; and
consulting and professional services we offer to our customers.
These products and services are primarily sold to corporate
customers.
  Three Months Ended March 31,2007
    
    
    2006Consumer products and services
    
    $
    85,040
    
    
    $
    74,811Technology products and solutions
    
    
    44,432
    
    
    
    11,791Total net revenue
    
    $
    129,472
    
    
    $
    86,602
  Three Months Ended March 31,2007
    
    
    2006Music
    
    $
    34,127
    
    
    $
    28,918Media Software and services
    
    
    27,011
    
    
    
    27,277Games
    
    
    23,902
    
    
    
    18,616Total consumer products and services revenue
    
    $
    85,040
    
    
    $
    74,811
  March 31,
    
    
    December 31,2007
    
    
    2006United States
    
    $
    171,716
    
    
    $
    172,846Republic of Korea
    
    
    248,373
    
    
    
    256,032Europe
    
    
    31,072
    
    
    
    26,807Rest of the World
    
    
    6,975
    
    
    
    6,289Total long-lived assets
    
    $
    458,136
    
    
    $
    461,974
 14




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  March 31,
    
    
    December 31,2007
    
    
    2006United States
    
    $
    563,426
    
    
    $
    621,532Republic of Korea
    
    
    335,971
    
    
    
    314,106Europe
    
    
    27,071
    
    
    
    26,298Rest of the World
    
    
    8,209
    
    
    
    7,830Total net assets
    
    $
    934,677
    
    
    $
    969,766
  March 31,
    
    
    December 31,2007
    
    
    2006Consumer products and services
    
    $
    135,739
    
    
    $
    131,997Technology products and solutions
    
    
    174,996
    
    
    
    177,125Total goodwill
    
    $
    310,735
    
    
    $
    309,122
   Consumer Products
    
    
    Technology Products
    
    
    Reconcilingand Services
    
    
    and Solutions
    
    
    Amounts
    
    
    ConsolidatedNet revenue
    
    $
    85,040
    
    
    $
    44,432
    
    
    $
    
    
    
    $
    129,472Cost of revenue
    
    
    27,814
    
    
    
    18,129
    
    
    
    
    
    
    
    45,943Gross profit
    
    
    57,226
    
    
    
    26,303
    
    
    
    
    
    
    
    83,529Antitrust litigation benefit, net
    
    
    
    
    
    
    
    
    
    
    (60,747
    )
    
    
    (60,747
    )Other operating expenses
    
    
    61,795
    
    
    
    28,738
    
    
    
    
    
    
    
    90,533Operating income (loss)
    
    
    (4,569
    )
    
    
    (2,435
    )
    
    
    60,747
    
    
    
    53,743Total non-operating income, net
    
    
    
    
    
    
    
    
    
    
    9,437
    
    
    
    9,437Income (loss) before income taxes
    
    $
    (4,569
    )
    
    $
    (2,435
    )
    
    $
    70,184
    
    
    $
    63,180
  Consumer Products
    
    
    Technology Products
    
    
    Reconcilingand Services
    
    
    and Solutions
    
    
    Amounts
    
    
    ConsolidatedNet revenue
    
    $
    74,811
    
    
    $
    11,791
    
    
    $
    
    
    
    $
    86,602Cost of revenue
    
    
    24,750
    
    
    
    2,003
    
    
    
    
    
    
    
    26,753Gross profit
    
    
    50,061
    
    
    
    9,788
    
    
    
    
    
    
    
    59,849Loss on excess office facilities
    
    
    
    
    
    
    
    
    
    
    738
    
    
    
    738Antitrust litigation benefit, net
    
    
    
    
    
    
    
    
    
    
    (39,835
    )
    
    
    (39,835
    )Other operating expenses
    
    
    53,879
    
    
    
    13,529
    
    
    
    
    
    
    
    67,408Operating income (loss)
    
    
    (3,818
    )
    
    
    (3,741
    )
    
    
    39,097
    
    
    
    31,538Total non-operating income, net
    
    
    
    
    
    
    
    
    
    
    8,096
    
    
    
    8,096Income (loss) before income taxes
    
    $
    (3,818
    )
    
    $
    (3,741
    )
    
    $
    47,193
    
    
    $
    39,634
 15




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Note 15.       Subsequent Event
  16




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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, net income per diluted share, acquisition costs and related amortization, and other
measures of results of operations;
 
    
    the effects of acquiring WiderThan, including our position as a technology services provider for leading wireless carriers;
 
    
    Plans, strategies and expected opportunities for growth, increased profitability and innovation in 2007 and future years;
 
    
    the expected growth and profitability of our Technology Products and Solutions business;
 
    
    the financial performance and growth of our games business, including future international growth;
 
    
    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 2007 and our focus on the integration of completed acquisitions;
 
    
    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 .
 Overview
    17




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##### Table of Contents




    
    Consumer Products and Services segment primarily includes revenue
from: digital media subscription services such as Rhapsody,
RadioPass, GamePass and SuperPass; sales and distribution of
third-party software and services; sales of digital content such
as music and game downloads; sales of premium versions of our
RealPlayer and related products; and advertising. This segment
primarily includes sales of these products directly to consumers
and also includes sales of these products through distribution
partners such as broadband service providers and retailers.
 
    
    Technology Products and Solutions segment includes revenue from:
sales of ringback tone, music-on-demand, video-on-demand,
messaging, and information services; sales of our media delivery
system software, including Helix system software and related
authoring and publishing tools, both directly to customers and
indirectly through original equipment manufacturer (OEM) channels;
support and maintenance services that we sell to customers who
purchase our software products; broadcast hosting services; and
consulting and professional services we offer to our customers.
 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; and
 
    
    Accounting for income taxes.
 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
   18




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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.
 19




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##### Table of Contents



Impairment of Investments.
 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 Income Taxes.
  20




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##### Table of Contents



Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109. Accounting for Income Taxes
    Revenue by Segment
  2007
    
    
    Change
    
    
    2006Consumer products and services
    
    $
    85,040
    
    
    
    14
    %
    
    $
    74,811Technology products and solutions
    
    
    44,432
    
    
    
    277
    
    
    
    11,791Total net revenue
    
    $
    129,472
    
    
    
    50
    %
    
    $
    86,602
  2007
    
    
    2006Consumer products and services
    
    
    66
    %
    
    
    86
    %Technology products and solutions
    
    
    34
    
    
    
    14Total net revenue
    
    
    100
    %
    
    
    100
    %
 Consumer Products and Services.
 21




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##### Table of Contents



Technology Products and Solutions.
  Consumer Products and Services Revenue
  2007
    
    
    Change
    
    
    2006Music
    
    $
    34,127
    
    
    
    18
    %
    
    $
    28,918Media software and services
    
    
    27,011
    
    
    
    (1
    )
    
    
    27,277Games
    
    
    23,902
    
    
    
    28
    
    
    
    18,616Total consumer products and services revenue
    
    $
    85,040
    
    
    
    14
    %
    
    $
    74,811
 Music.
 Media Software and Services.
 Games.
 22




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##### Table of Contents



Geographic Revenue
  2007
    
    
    Change
    
    
    2006United States
    
    $
    84,554
    
    
    
    29
    %
    
    $
    65,700Republic of Korea
    
    
    18,399
    
    
    
    n/a
    
    
    
    Europe
    
    
    17,710
    
    
    
    27
    
    
    
    13,905Rest of the world
    
    
    8,809
    
    
    
    26
    
    
    
    6,997Total net revenue
    
    $
    129,472
    
    
    
    50
    %
    
    $
    86,602
 Games Music
 Revenue
  2007
    
    
    Change
    
    
    2006License fees
    
    $
    21,837
    
    
    
    (4
    )%
    
    $
    22,636Service revenue
    
    
    107,635
    
    
    
    68
    
    
    
    63,966Total net revenue
    
    $
    129,472
    
    
    
    50
    %
    
    $
    86,602
  2007
    
    
    2006License fees
    
    
    17
    %
    
    
    26
    %Service revenue
    
    
    83
    
    
    
    74Total net revenue
    
    
    100
    %
    
    
    100
    %
 License Fees.
 Service Revenue.
 Deferred Revenue
  23




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##### Table of Contents



Cost of Revenue by Segment
  2007
    
    
    Change
    
    
    2006Consumer products and services
    
    $
    27,814
    
    
    
    12
    %
    
    $
    24,750Technology products and solutions
    
    
    18,129
    
    
    
    805
    
    
    
    2,003Total cost of revenue
    
    $
    45,943
    
    
    
    72
    %
    
    $
    26,753
  2007
    
    2006Consumer products and services
    
    
    33
    %
    
    
    33
    %Technology products and solutions
    
    
    41
    
    
    
    17Total cost of revenue
    
    
    35
    
    
    
    31
 Cost of Consumer Products and Services.
 Cost of Technology Products and Solutions.
 Cost of Revenue
  2007
    
    
    Change
    
    
    2006License fees
    
    $
    8,292
    
    
    
    (16
    )%
    
    $
    9,861Service revenue
    
    
    37,651
    
    
    
    123
    
    
    
    16,892Total cost of revenue
    
    $
    45,943
    
    
    
    72
    %
    
    $
    26,753
  2007
    
    2006License fees
    
    
    38
    %
    
    
    44
    %Service revenue
    
    
    35
    
    
    
    26Total cost of revenue
    
    
    35
    
    
    
    31
 Cost of License Fees.
 Cost of Service Revenue.
 24




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##### Table of Contents



Operating Expenses
 Research and Development
  2007
    
    Change
    
    2006Research and development
    
    $
    23,479
    
    
    
    30
    %
    
    $
    18,099As a percentage of total net revenue
    
    
    18
    %
    
    
    
    
    
    
    21
    %
  Sales and Marketing
  2007
    
    Change
    
    2006Sales and marketing
    
    $
    49,700
    
    
    
    38
    %
    
    $
    36,083As a percentage of total net revenue
    
    
    38
    %
    
    
    
    
    
    
    42
    %
  General and Administrative
  2007
    
    Change
    
    2006General and administrative
    
    $
    17,354
    
    
    
    31
    %
    
    $
    13,226As a percentage of total net revenue
    
    
    13
    %
    
    
    
    
    
    
    15
    %
  25




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##### Table of Contents



Loss on Excess Office Facilities
    Antitrust Litigation Benefit, Net
  Other Income, Net
  2007
    
    
    Change
    
    
    2006Interest income, net
    
    $
    9,102
    
    
    
    14
    %
    
    $
    7,979Equity in net loss of equity investments
    
    
    (132
    )
    
    
    n/a
    
    
    
    Other income, net
    
    
    467
    
    
    
    299
    
    
    
    117Other income, net
    
    $
    9,437
    
    
    
    17
    %
    
    $
    8,096
   26




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##### Table of Contents



Income Taxes
  Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109. Accounting for Income Taxes
    New Accounting Pronouncements
 Fair Value Measurements
 The Fair Value Option for Financial Assets and
Financial Liabilities
 Liquidity and Capital Resources
  March 31,
    
    
    December 31,2007
    
    
    2006Working capital
    
    $
    557,522
    
    
    $
    584,125Cash, cash equivalents, and short-term
investments
    
    
    663,411
    
    
    
    678,920Restricted cash
    
    
    15,500
    
    
    
    17,300
 27




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##### Table of Contents



March 31,
    
    
    March 31,2007
    
    
    2006Cash provided by (used in) operating activities
    
    $
    62,089
    
    
    $
    (2,029
    )Cash used in investing activities
    
    
    (2,385
    )
    
    
    (13,071
    )Cash used in financing activities
    
    
    (74,411
    )
    
    
    (69,374
    )
          28




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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.
 Foreign Currency Risk.
   29




---



##### Table of Contents



Item 4.       Controls and Procedures
 Evaluation of Disclosure Controls and Procedures.
 Changes in Internal Controls.
 
 PART II. OTHER INFORMATION
 
 Item 1.       Legal Proceedings
     30




---



##### Table of Contents



Item 1A. Risk Factors
  Risks Related To Recent Development
 Our recent acquisition of WiderThan could expose us to new risks, disrupt our business, and
adversely impact our results of operations.
  Our businesses may be adversely affected by developments affecting the South Korean economy amid
increased tensions with North Korea.
   31




---



##### Table of Contents



Risks Related to Our Consumer Products and Services Business
 Future growth of our online consumer businesses may not keep pace with recently realized growth
rates; any slowdown in growth would negatively impact our overall operating results.
  We are experiencing greater fluctuations in revenue due to seasonality than at any time in our
past, and we expect this trend to continue.
  The success of our subscription services businesses depends upon our ability to increase
subscription revenue.
  Our digital content subscription business, and our online music services in particular, depend on
our continuing ability to license compelling content on commercially reasonable terms.
  Music publishing royalty rates for music subscription services are not yet fully established; a
determination of high royalty rates could negatively impact our operating results.
  32




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##### Table of Contents



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.
  Our consumer businesses face substantial competitive challenges that may prevent us from being
successful in those businesses.
 Music.
 Media Software and Services.
 Games.
 We may not be successful in maintaining and growing our distribution of digital media products.
  33




---



##### Table of Contents



The success of our music services depend, in part, on interoperability with our customers music
playback hardware.
  Risks Related to Our Technology Products and Solutions Business
 Our traditional system software business has been negatively impacted by the effects of our
competitors and our settlement agreement with Microsoft may not improve sales of our system
software products.
  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.
  Contracts with our carrier customers subject us to significant risks that could negatively impact
our revenue from application services.
    34




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##### Table of Contents



Our carrier customers could begin developing some or all of our carrier applications services on
their own, which could result in the loss of future revenues.
  The mobile entertainment market is highly competitive.
  Our Helix open source initiative is subject to risks associated with open source technology.
  Our patents may not improve our business prospects.
  Risks Related to Our Business in General
 Our operating results are difficult to predict and may fluctuate, which may contribute to
fluctuations in our stock price.
  Our settlement agreement with Microsoft may not improve our business prospects.
  35




---



##### Table of Contents



Our products and services must compete with the products and services of strong or dominant
competitors.
  
    
    reduced prices, revenue and margins;
 
    
    increased expenses in responding to competitors;
 
    
    loss of current and potential customers, market share and market power;
 
    
    lengthened sales cycles;
 
    
    degradation of our stature and reputation in the market;
 
    
    changes in our business and distribution and marketing strategies;
 
    
    changes to our products, services, technology, licenses and business practices, and other disruption of our operations;
 
    
    strained relationships with partners; and
 
    
    pressure to prematurely release products or product enhancements.
  Failure to develop and introduce new products and services that achieve market acceptance could
result in a loss of market opportunities and negatively affect our operating results.
  Microsoft is one of our strongest competitors, and employs highly aggressive tactics against us.
  If our products are not able to support the most popular digital media formats, our business will
be substantially impaired.
  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.
   36




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##### Table of Contents



Our industry is experiencing consolidation that may cause us to lose key relationships and
intensify competition.
   Acquisitions involve costs and risks that could harm our business and impair our ability to realize
potential benefits from acquisitions.
    
    
    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;
 
    
    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.
 Our strategic investments may not be successful and we may have to recognize expenses in our income
statement in connection with these investments.
  We need to develop relationships and technical standards with manufacturers of non-PC media and
communication devices to grow our business.
  37




---



##### 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 unable to adequately protect our proprietary rights and may face risks associated with
third-party claims relating to our intellectual property.
  38




---



##### Table of Contents




    
    our applications for patents and trademarks relating to our business may not be granted and, if granted, may be challenged or
invalidated;
 
    
    our efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology;
 
    
    our efforts may not prevent the development and design by others of products or technologies similar to, competitive with, or
superior to those we develop; or
 
    
    another party may obtain a blocking patent, thus requiring us to either obtain a license or design around the patent in order
to continue to offer the contested feature or service in our products.
  We may be subject to market risk and legal liability in connection with the data collection
capabilities of our products and services.
  We account for employee stock options using the fair value method, which may have a material
adverse affect on our results of operations.
 Share Based Payment
 We may be subject to assessment of sales and other taxes for the sale of our products, license of
technology or provision of services.
   39




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##### Table of Contents



We may be subject to additional income tax assessments.
  We donate a portion of our net income to charity.
  Risks Related to the Securities Markets and Ownership of Our Common Stock
 Our directors and executive officers beneficially own approximately 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.
   40




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##### Table of Contents



We are exposed to potential risks from legislation requiring companies to evaluate controls under
Section 404 of the Sarbanes-Oxley Act of 2002.
  Certain material weaknesses in internal controls of WiderThan were identified as of December 31,
2005; if we fail to remediate and maintain an effective system of internal controls at WiderThan we
may be unable to accurately report our financial results or reduce our ability to prevent or detect
fraud, and investor confidence may be affected.
  
    
    WiderThan did not retain accounting staff with sufficient depth
and skill in the application of U.S. GAAP commensurate with the
reporting requirements of a U.S. registrant;
 
    
    WiderThan did not have effective controls over establishing and
maintaining accounting policies related to revenue recognition;
and
 
    
    WiderThan did not maintain effective controls, including
monitoring, over the financial close and reporting process.
Specifically, WiderThan relied heavily on the use of spreadsheet
programs during the financial close process and did not have
adequately designed controls to ensure the completeness, accuracy,
and restricted access to such spreadsheets.
  Our stock price has been volatile in the past and may continue to be volatile.
  41




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##### Table of Contents



Financial forecasting of our operating results will be difficult because of the changing nature of
our products and business, and our actual results may differ from forecasts.
  
 Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds
 (a)
    
    During the quarter ended March 31, 2007, the Company issued and sold unregistered securities as
follows:
 (1)
    
    On March 30, 2007, the Company issued an aggregate of 3,374 shares of Common
Stock to three non-employee directors as compensation for board service during the first
quarter of 2007 pursuant to the RealNetworks, Inc. Director Compensation Stock Plan.
The aggregate value of the shares was $26,000. The shares were issued in reliance on
Section 4(2) under the Securities Act of 1933, as amended, on the basis that the
transactions did not involve a public offering.
 (b)
    
    Not applicable(c)
    
    Purchases of Equity Securities by the Issuer and Affiliated Purchasers
   Total Number ofShares Repurchased
    
    Average Price PaidPeriod
    
    (in thousands)
    
    Per Share2/1/2007  2/28/2007
    
    
    2,000
    
    
    $
    8.423/1/2007  3/31/2007
    
    
    7,818
    
    
    
    7.88Total
    
    
    9,818
    
    
    $
    7.99
  
 Item 3.       Default Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote for Security Holders
  
 Item 5. Other Information
 None
 
 Item 6.       Exhibits
  42




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##### Table of Contents



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