##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
 For the Quarterly Period Ended September 30, 2007
 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
    
    91-628146(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 o 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
    
    23Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    37Item 4. Controls and Procedures
    
    38Part II. Other InformationItem 1. Legal Proceedings
    
    38Item 1A. Risk Factors
    
    39Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    51Item 3. Default Upon Senior Securities
    
    51Item 4. Submission of Matters to a Vote of Security Holders
    
    51Item 5. Other Information
    
    51Item 6. Exhibits
    
    52Signature
    
    53EXHIBIT 10.1EXHIBIT 10.2EXHIBIT 10.3EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 September 30,
    
    
    December 31,2007
    
    
    2006ASSETSCurrent assets:Cash and cash equivalents
    
    $
    197,738
    
    
    $
    525,232Short-term investments
    
    
    392,625
    
    
    
    153,688Trade accounts receivable, net of allowances for doubtful accounts and sales returns
    
    
    80,734
    
    
    
    65,751Deferred costs, current portion
    
    
    6,280
    
    
    
    1,643Deferred tax assets, net, current portion
    
    
    224
    
    
    
    891Prepaid expenses and other current assets
    
    
    27,235
    
    
    
    21,990Total current assets
    
    
    704,836
    
    
    
    769,195Equipment, software, and leasehold improvements:Equipment and software
    
    
    102,337
    
    
    
    83,587Leasehold improvements
    
    
    30,496
    
    
    
    29,665Total equipment, software, and leasehold improvements, at cost
    
    
    132,833
    
    
    
    113,252Less accumulated depreciation and amortization
    
    
    78,676
    
    
    
    65,509Net equipment, software, and leasehold improvements
    
    
    54,157
    
    
    
    47,743Restricted cash equivalents
    
    
    15,500
    
    
    
    17,300Equity investments
    
    
    7,814
    
    
    
    22,649Other assets
    
    
    7,967
    
    
    
    5,148Deferred tax assets, net, non-current portion
    
    
    37,584
    
    
    
    27,150Other intangible assets, net
    
    
    109,681
    
    
    
    105,109Goodwill
    
    
    337,406
    
    
    
    309,122Total assets
    
    $
    1,274,945
    
    
    $
    1,303,416LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    54,241
    
    
    $
    52,097Accrued and other liabilities
    
    
    119,128
    
    
    
    104,328Deferred revenue, current portion
    
    
    38,601
    
    
    
    24,137Related party payable
    
    
    8,025
    
    
    
    Accrued loss on excess office facilities, current portion
    
    
    3,398
    
    
    
    4,508Total current liabilities
    
    
    223,393
    
    
    
    185,070Deferred revenue, non-current portion
    
    
    2,815
    
    
    
    3,440Accrued loss on excess office facilities, non-current portion
    
    
    7,563
    
    
    
    9,993Deferred rent
    
    
    4,503
    
    
    
    4,331Deferred tax liabilities, net, non-current portion
    
    
    23,634
    
    
    
    27,076Convertible debt
    
    
    100,000
    
    
    
    100,000Other long-term liabilities
    
    
    9,884
    
    
    
    3,740Total liabilities
    
    
    371,792
    
    
    
    333,650Minority interest in Rhapsody America
    
    
    7,685
    
    
    
    Shareholders equity:Preferred stock, $0.001 par value, no shares issued and outstanding
Series A: authorized 200 shares
    
    
    
    
    
    
    Undesignated series: authorized 59,800 shares
    
    
    
    
    
    
    Common stock, $0.001 par value authorized 1,000,000 shares; issued and outstanding
147,512 shares in 2007 and 163,278 shares in 2006
    
    
    148
    
    
    
    162Additional paid-in capital
    
    
    680,594
    
    
    
    791,108Accumulated other comprehensive income
    
    
    14,085
    
    
    
    23,485Retained earnings
    
    
    200,641
    
    
    
    155,011Total shareholders equity
    
    
    895,468
    
    
    
    969,766Total liabilities and shareholders equity
    
    $
    1,274,945
    
    
    $
    1,303,416
  3




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(In thousands, except per share data)
 Three Months ended
    
    
    Nine Months endedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net revenue (A)
    
    $
    145,095
    
    
    $
    93,676
    
    
    $
    410,738
    
    
    $
    269,687Cost of revenue (B)
    
    
    56,644
    
    
    
    28,389
    
    
    
    151,786
    
    
    
    81,788Gross profit
    
    
    88,451
    
    
    
    65,287
    
    
    
    258,952
    
    
    
    187,899Operating expenses:Research and development
    
    
    26,528
    
    
    
    18,344
    
    
    
    75,012
    
    
    
    55,127Sales and marketing
    
    
    52,812
    
    
    
    37,560
    
    
    
    152,593
    
    
    
    111,604Advertising with related party
    
    
    7,747
    
    
    
    
    
    
    
    7,747
    
    
    
    General and administrative
    
    
    16,750
    
    
    
    14,043
    
    
    
    51,167
    
    
    
    41,586Loss on excess office facilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    738Subtotal operating expenses
    
    
    103,837
    
    
    
    69,947
    
    
    
    286,519
    
    
    
    209,055Antitrust litigation benefit, net
    
    
    
    
    
    
    (61,861
    )
    
    
    (60,747
    )
    
    
    (159,554
    )Total operating expenses, net
    
    
    103,837
    
    
    
    8,086
    
    
    
    225,772
    
    
    
    49,501Operating (loss) income
    
    
    (15,386
    )
    
    
    57,201
    
    
    
    33,180
    
    
    
    138,398Other income (expenses):Interest and other, net
    
    
    7,290
    
    
    
    10,618
    
    
    
    24,457
    
    
    
    27,978Gain on sale of equity investment
    
    
    
    
    
    
    
    
    
    
    132
    
    
    
    2,286Equity in net loss of investments
    
    
    
    
    
    
    
    
    
    
    (132
    )
    
    
    Minority interest in Rhapsody America
    
    
    6,466
    
    
    
    
    
    
    
    6,466
    
    
    
    Gain on sale of interest in Rhapsody America
    
    
    7,946
    
    
    
    
    
    
    
    7,946
    
    
    
    Other income, net
    
    
    38
    
    
    
    242
    
    
    
    990
    
    
    
    432Other income, net
    
    
    21,740
    
    
    
    10,860
    
    
    
    39,859
    
    
    
    30,696Income before income taxes
    
    
    6,354
    
    
    
    68,061
    
    
    
    73,039
    
    
    
    169,094Income taxes
    
    
    (2,012
    )
    
    
    (25,908
    )
    
    
    (27,409
    )
    
    
    (63,180
    )Net income
    
    $
    4,342
    
    
    $
    42,153
    
    
    $
    45,630
    
    
    $
    105,914Basic net income per share
    
    $
    0.03
    
    
    $
    0.26
    
    
    $
    0.30
    
    
    $
    0.66Diluted net income per share
    
    $
    0.03
    
    
    $
    0.24
    
    
    $
    0.27
    
    
    $
    0.59Shares used to compute basic net income per share
    
    
    149,667
    
    
    
    160,578
    
    
    
    154,670
    
    
    
    160,466Shares used to compute diluted net income per share
    
    
    163,094
    
    
    
    178,913
    
    
    
    169,840
    
    
    
    178,551Comprehensive income:Net income
    
    $
    4,342
    
    
    $
    42,153
    
    
    $
    45,630
    
    
    $
    105,914Unrealized holding gains (losses) on short-term and
equity investments, net of income taxes
    
    
    (3,228
    )
    
    
    28
    
    
    
    (8,947
    )
    
    
    (12,887
    )Foreign currency translation gains (losses)
    
    
    1,206
    
    
    
    388
    
    
    
    (453
    )
    
    
    1,760Comprehensive income
    
    $
    2,320
    
    
    $
    42,569
    
    
    $
    36,230
    
    
    $
    94,787(A) Components of net revenue:License fees
    
    $
    23,869
    
    
    $
    22,528
    
    
    $
    67,918
    
    
    $
    68,014Service revenue
    
    
    121,226
    
    
    
    71,148
    
    
    
    342,820
    
    
    
    201,673$
    145,095
    
    
    $
    93,676
    
    
    $
    410,738
    
    
    $
    269,687(B) Components of cost of revenue:License fees
    
    $
    8,436
    
    
    $
    9,675
    
    
    $
    24,610
    
    
    $
    28,865Service revenue
    
    
    48,208
    
    
    
    18,714
    
    
    
    127,176
    
    
    
    52,923$
    56,644
    
    
    $
    28,389
    
    
    $
    151,786
    
    
    $
    81,788
  4




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REALNETWORKS, INC. AND SUBSIDIARIES
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 Nine Months EndedSeptember 30,2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    45,630
    
    
    $
    105,914Adjustments to reconcile net income to net cash (used in) provided by operating activities:Depreciation and amortization
    
    
    32,865
    
    
    
    12,480Stock-based compensation
    
    
    17,291
    
    
    
    12,332Loss on disposal of equipment, software, and leasehold improvements
    
    
    275
    
    
    
    76Equity in net loss of investments
    
    
    132
    
    
    
    Gain on sale of equity investment
    
    
    (132
    )
    
    
    (2,286
    )Accrued loss on excess office facilities
    
    
    (3,540
    )
    
    
    (2,640
    )Unrealized gain on trading securities
    
    
    (5,426
    )
    
    
    Deferred income taxes
    
    
    (13,224
    )
    
    
    56,508Purchases of trading securities
    
    
    (270,000
    )
    
    
    Minority
interest in Rhapsody America
    
    
    (6,466
    )
    
    
    Gain on sale of interest in Rhapsody America
    
    
    (7,946
    )
    
    
    Other
    
    
    72
    
    
    
    73Net change in certain operating assets and liabilities, net of acquisitions
    
    
    3,658
    
    
    
    (48,496
    )Net cash (used in) provided by operating activities
    
    
    (206,811
    )
    
    
    133,961Cash flows from investing activities:Purchases of equipment, software, and leasehold improvements
    
    
    (19,051
    )
    
    
    (9,316
    )Purchases of short-term investments
    
    
    (117,762
    )
    
    
    (177,868
    )Proceeds from sales and maturities of short-term investments
    
    
    154,251
    
    
    
    156,006Purchases of other intangibles assets
    
    
    (2,723
    )
    
    
    Proceeds from sale of equity investments
    
    
    1,615
    
    
    
    2,286Purchases of equity investments
    
    
    
    
    
    
    (834
    )Decrease in restricted cash equivalents
    
    
    1,800
    
    
    
    Cash used in acquisitions, net of cash acquired
    
    
    (25,316
    )
    
    
    (7,086
    )Net cash used in investing activities
    
    
    (7,186
    )
    
    
    (36,812
    )Cash flows from financing activities:Net proceeds from sale of common stock under employee stock purchase plan and exercise of
stock options
    
    
    14,058
    
    
    
    41,976Net proceeds from sales of interest in Rhapsody America
    
    
    15,007
    
    
    
    Repurchase of common stock
    
    
    (142,150
    )
    
    
    (98,869
    )Net cash used in financing activities
    
    
    (113,085
    )
    
    
    (56,893
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (412
    )
    
    
    830Net increase (decrease) in cash and cash equivalents
    
    
    (327,494
    )
    
    
    41,086Cash and cash equivalents, beginning of period
    
    
    525,232
    
    
    
    651,971Cash and cash equivalents, end of period
    
    $
    197,738
    
    
    $
    693,057Supplemental disclosure of cash flow information:Cash paid for income taxes
    
    $
    28,750
    
    
    $
    14,181Supplemental disclosure of non-cash investing and financing activities:Accrued acquisition costs
    
    $
    310
    
    
    $
    Accrued acquisition consideration
    
    $
    8,596
    
    
    $
    2,079
  5




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REALNETWORKS, INC. AND SUBSIDIARIES
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As of September 30, 2007 and 2006 and for the Three and Nine
Month Periods Then Ended
 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
 Accounting for Gains on Sale of Subsidiary Stock. Accounting for the Sales of Stock of a Subsidiary
 Reclassifications.
 Note 2. Recent Accounting Pronouncements
 Accounting for
Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109. Accounting for Income Taxes
  7




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
   Fair Value Measurements
 The Fair Value Option for Financial Assets and
Financial Liabilities
 Note 3. Stock-Based Compensation
 Share-Based Payment Accounting for Stock Appreciation Rights and Other Variable
Stock Option or Award Plans
   Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006Expected dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Risk-free interest rate
    
    
    4.44
    %
    
    
    5.02
    %
    
    
    4.56
    %
    
    
    4.91
    %Expected life (years)
    
    
    4.1
    
    
    
    4.3
    
    
    
    4.1
    
    
    
    4.3Volatility
    
    
    42.1
    %
    
    
    49.1
    %
    
    
    42.1
    %
    
    
    48.8
    %
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Cost of service revenue
    
    $
    208
    
    
    $
    57
    
    
    $
    520
    
    
    $
    148Research and development
    
    
    1,740
    
    
    
    1,878
    
    
    
    5,153
    
    
    
    4,565Sales and marketing
    
    
    2,395
    
    
    
    1,920
    
    
    
    6,985
    
    
    
    4,713General and administrative
    
    
    1,641
    
    
    
    1,166
    
    
    
    4,633
    
    
    
    2,906Total stock-based compensation expense
    
    $
    5,984
    
    
    $
    5,021
    
    
    $
    17,291
    
    
    $
    12,332
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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Note 4. Rhapsody America
 Formation
  
    
    RealNetworks contributed its Rhapsody service subscribers, certain 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 No. 51. As of September 30, 2007, $8.0 million in payments were made on
the note and RealNetworks realized and recorded a gain of $4.1 million during the three
months ended September 30, 2007 as all of the SAB No. 51 gain criteria were met.
   Trade Name and Trademarks
    
    $
    4,000Existing Technology
    
    
    1,900Existing Subscribers
    
    
    1,680Total Identifiable Intangible Assets
    
    $
    7,580
   9




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Call
and Put Rights
 Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity
   Note 5. Business Combinations
 Business Combinations During 2007
     Cash paid at acquisition
    
    $
    12,795Estimated direct acquisition costs
    
    
    902Total
    
    $
    13,697
   Current assets
    
    $
    5,110Property and equipment
    
    
    2,351Intangible assets subject to amortization:Technology
    
    
    1,760Customer relationships
    
    
    1,610Goodwill
    
    
    10,212
 10




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Total assets acquired
    
    
    21,043Current liabilities
    
    
    (7,346
    )Net assets acquired
    
    $
    13,697
    
   Cash paid at acquisition
    
    $
    10,745Estimated direct acquisition costs
    
    
    468Total
    
    $
    11,213
   Current assets
    
    $
    5,409Property and equipment
    
    
    265Other long-term assets
    
    
    109Intangible assets subject to amortization:Customer relationships
    
    
    3,270Technology
    
    
    2,545Tradenames and trademarks
    
    
    287Non-compete agreements
    
    
    80Goodwill
    
    
    2,852Total assets acquired
    
    
    14,817Current liabilities
    
    
    (1,761
    )Net deferred tax liabilities
    
    
    (1,472
    )Other long-term liabilities
    
    
    (371
    )Total liabilities assumed
    
    
    (3,604
    )Net assets acquired
    
    $
    11,213
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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
   Business Combinations During 2006
       
    
   Cash paid at acquisition
    
    $
    7,922Additional payments related to initial purchase price
    
    
    2,000Additional accruals and payments for achievement of
performance criteria and modification of the purchase
agreement
    
    
    12,471Direct acquisition costs
    
    
    293Total
    
    $
    22,686
   Current assets
    
    $
    1,830Property and equipment
    
    
    166
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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 Intangible assets subject to amortization:Distributor and customer relationships
    
    
    1,290Technology and games
    
    
    570Tradenames and trademarks
    
    
    560Non-compete agreements
    
    
    180Goodwill
    
    
    20,639Total assets assumed
    
    
    25,235Current liabilities
    
    
    (1,781
    )Net deferred tax liabilities
    
    
    (768
    )Total liabilities assumed
    
    
    (2,549
    )Net assets acquired
    
    $
    22,686
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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 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
    
    $
    67,433
    
    
    $
    
    
    
    $
    
    
    
    $
    67,433Money market mutual funds
    
    
    99,205
    
    
    
    
    
    
    
    
    
    
    
    99,205Corporate notes and bonds
    
    
    31,100
    
    
    
    
    
    
    
    
    
    
    
    31,100Total cash and cash equivalents
    
    
    197,738
    
    
    
    
    
    
    
    
    
    
    
    197,738Trading securities:Money market mutual fund
    
    
    270,000
    
    
    
    5,426
    
    
    
    
    
    
    
    275,426Available-for-sale investments:Corporate notes and bonds
    
    
    42,673
    
    
    
    14
    
    
    
    (527
    )
    
    
    42,160U.S. Government agency securities
    
    
    74,987
    
    
    
    52
    
    
    
    
    
    
    
    75,039Total available-for-sale investments
    
    
    117,660
    
    
    
    66
    
    
    
    (527
    )
    
    
    117,199Total short-term investments
    
    
    387,660
    
    
    
    5,492
    
    
    
    (527
    )
    
    
    392,625Total cash, cash equivalents,
trading securities, and short-term
investments
    
    $
    585,398
    
    
    $
    5,492
    
    
    $
    (527
    )
    
    $
    590,363Restricted cash equivalents
    
    $
    15,500
    
    
    $
    
    
    
    $
    
    
    
    $
    15,500
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueCash and cash equivalents:Cash
    
    $
    108,415
    
    
    $
    
    
    
    $
    
    
    
    $
    108,415Money market mutual funds
    
    
    231,634
    
    
    
    
    
    
    
    
    
    
    
    231,634Corporate notes and bonds
    
    
    182,184
    
    
    
    
    
    
    
    
    
    
    
    182,184U.S. Government agency securities
    
    
    2,999
    
    
    
    
    
    
    
    
    
    
    
    2,999Total cash and cash equivalents
    
    
    525,232
    
    
    
    
    
    
    
    
    
    
    
    525,232Short-term investments:U.S. Government agency securities
    
    
    153,520
    
    
    
    188
    
    
    
    (20
    )
    
    
    153,688Total short-term investments
    
    
    153,520
    
    
    
    188
    
    
    
    (20
    )
    
    
    153,688Total cash, cash equivalents, and short-term investments
    
    $
    678,752
    
    
    $
    188
    
    
    $
    (20
    )
    
    $
    678,920Restricted cash equivalents
    
    $
    17,300
    
    
    $
    
    
    
    $
    
    
    
    $
    17,300
     14




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Amortized
    
    
    EstimatedCost
    
    
    Fair ValueWithin one year
    
    $
    89,665
    
    
    $
    89,718Between one year and five years
    
    
    27,995
    
    
    
    27,481Total available-for-sale investments
    
    $
    117,660
    
    
    $
    117,199
 Note 7. Allowance for Doubtful Accounts Receivable and Sales Returns
  Allowance ForDoubtfulAccounts
    
    
    SalesReceivable
    
    
    ReturnsBalances, December 31, 2006
    
    $
    1,101
    
    
    $
    1,389Additions charged to expenses/revenue
    
    
    216
    
    
    
    2,977Amounts written off
    
    
    (275
    )
    
    
    (2,996
    )Balances, September 30, 2007
    
    $
    1,042
    
    
    $
    1,370
  Note 8. Equity Investments
   September 30, 2007
    
    
    December 31, 2006Carrying
    
    
    
    
    
    
    CarryingCost
    
    
    Value
    
    
    Cost
    
    
    ValuePublicly traded investments
    
    $
    913
    
    
    $
    6,880
    
    
    $
    913
    
    
    $
    20,235Privately held investments
    
    
    1,552
    
    
    
    934
    
    
    
    1,879
    
    
    
    2,414Total equity investments
    
    $
    2,465
    
    
    $
    7,814
    
    
    $
    2,792
    
    
    $
    22,649
 Note 9. Other Intangible Assets
  Gross
    
    
    AccumulatedAmount
    
    
    Amortization
    
    
    NetCustomer relationships
    
    $
    80,284
    
    
    $
    12,084
    
    
    $
    68,200Developed technology
    
    
    43,522
    
    
    
    16,102
    
    
    
    27,420Patents, trademarks and tradenames
    
    
    13,651
    
    
    
    4,078
    
    
    
    9,573Service contracts and other
    
    
    6,867
    
    
    
    2,379
    
    
    
    4,488Total other intangible assets
    
    $
    144,324
    
    
    $
    34,643
    
    
    $
    109,681
 15




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  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
    
    $
    121,746
    
    
    $
    16,637
    
    
    $
    105,109
   2007 (remaining three months)
    
    $
    6,9402008
    
    
    26,0352009
    
    
    23,1752010
    
    
    19,0142011
    
    
    12,066Thereafter
    
    
    22,451Total
    
    $
    109,681
 Note 10. Goodwill
  Balance, December 31, 2006
    
    $
    309,122Increases for accruals and payments related to the acquisition of Zylom
    
    
    12,471Adjustments to purchase price for WiderThan
    
    
    (1,296
    )Purchase of additional shares of WiderThan
    
    
    1,160Increase due to current year acquisitions
    
    
    12,962Effects of foreign currency translation
    
    
    2,987Balance, September 30, 2007
    
    $
    337,406
 Note 11. Accrued and Other Liabilities
  September 30,
    
    
    December 31,2007
    
    
    2006Royalties and other fulfillment costs
    
    $
    33,746
    
    
    $
    29,968Employee compensation, commissions and benefits
    
    
    22,348
    
    
    
    25,244Income taxes payable
    
    
    9,256
    
    
    
    8,455Sales, VAT and other taxes payable
    
    
    13,854
    
    
    
    13,364Legal fees and contingent legal fees
    
    
    3,062
    
    
    
    4,075Accrued charitable donations
    
    
    281
    
    
    
    2,048Other
    
    
    36,581
    
    
    
    21,174Total
    
    $
    119,128
    
    
    $
    104,328
 Note 12. Loss on Excess Office Facilities
  16




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
   Accrued loss on excess office facilities, December 31, 2006
    
    $
    14,501Less amounts paid on accrued loss on excess office facilities, net of sublease income
    
    
    (3,540
    )Accrued loss on excess office facilities, September 30, 2007
    
    
    10,961Less current portion
    
    
    3,398Accrued loss on excess office facilities, non-current portion
    
    $
    7,563
 Note 13. Repurchase of Common Stock
   Note 14. Earnings Per Share
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Weighted average common shares outstanding used to
compute basic net income per share
    
    
    149,667
    
    
    
    160,578
    
    
    
    154,670
    
    
    
    160,466Dilutive potential common shares:Stock options and restricted stock
    
    
    2,677
    
    
    
    7,585
    
    
    
    4,420
    
    
    
    7,335Convertible debt
    
    
    10,750
    
    
    
    10,750
    
    
    
    10,750
    
    
    
    10,750Shares used to compute diluted net income per share
    
    
    163,094
    
    
    
    178,913
    
    
    
    169,840
    
    
    
    178,551
  Note 15. Commitments and Contingencies
 Borrowing Arrangements
 17




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
     Litigation
    18




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
    Note 16. Segment Information
 Disclosures about Segments of an Enterprise and Related Information
    19




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REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
     Technology Products
    
    
    ReconcilingMusic
    
    
    Consumer
    
    
    and Solutions
    
    
    Amounts
    
    
    ConsolidatedNet revenue
    
    $
    37,658
    
    
    $
    54,166
    
    
    $
    53,271
    
    
    $
    
    
    
    $
    145,095Cost of revenue
    
    
    20,891
    
    
    
    10,326
    
    
    
    25,427
    
    
    
    
    
    
    
    56,644Gross profit
    
    
    16,767
    
    
    
    43,840
    
    
    
    27,844
    
    
    
    
    
    
    
    88,451Other operating expenses
    
    
    33,426
    
    
    
    36,782
    
    
    
    33,428
    
    
    
    201
    
    
    
    103,837Operating income (loss)
    
    
    (16,659
    )
    
    
    7,058
    
    
    
    (5,584
    )
    
    
    (201
    )
    
    
    (15,386
    )Total non-operating income, net
    
    
    14,412
    
    
    
    
    
    
    
    
    
    
    
    7,328
    
    
    
    21,740Income (loss) before income taxes
    
    $
    (2,247
    )
    
    $
    7,058
    
    
    $
    (5,584
    )
    
    $
    7,127
    
    
    $
    6,354
  Technology Products
    
    
    ReconcilingMusic
    
    
    Consumer
    
    
    and Solutions
    
    

Amounts
    
    
    ConsolidatedNet revenue
    
    $
    108,586
    
    
    $
    155,393
    
    
    $
    146,759
    
    
    $
    
    
    
    $
    410,738Cost of revenue
    
    
    59,570
    
    
    
    28,890
    
    
    
    63,326
    
    
    
    
    
    
    
    151,786Gross profit
    
    
    49,016
    
    
    
    126,503
    
    
    
    83,433
    
    
    
    
    
    
    
    258,952Other operating expenses
    
    
    82,412
    
    
    
    104,503
    
    
    
    97,062
    
    
    
    (58,205
    )
    
    
    225,772Operating income (loss)
    
    
    (33,396
    )
    
    
    22,000
    
    
    
    (13,629
    )
    
    
    58,205
    
    
    
    33,180Total non-operating income, net
    
    
    14,412
    
    
    
    
    
    
    
    
    
    
    
    25,447
    
    
    
    39,859Income (loss) before income taxes
    
    $
    (18,984
    )
    
    $
    22,000
    
    
    $
    (13,629
    )
    
    $
    83,652
    
    
    $
    73,039
  Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Music
    
    $
    37,658
    
    
    $
    30,375
    
    
    $
    108,586
    
    
    $
    89,411Consumer
    
    
    54,166
    
    
    
    52,122
    
    
    
    155,393
    
    
    
    145,339Technology Products and Services
    
    
    53,271
    
    
    
    11,179
    
    
    
    146,759
    
    
    
    34,937Total net revenue
    
    $
    145,095
    
    
    $
    93,676
    
    
    $
    410,738
    
    
    $
    269,687
 20




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006United States
    
    $
    91,281
    
    
    $
    69,433
    
    
    $
    263,870
    
    
    $
    201,675Europe
    
    
    22,150
    
    
    
    15,895
    
    
    
    60,382
    
    
    
    45,725Republic of Korea
    
    
    20,591
    
    
    
    
    
    
    
    57,875
    
    
    
    Rest of the World
    
    
    11,073
    
    
    
    8,348
    
    
    
    28,611
    
    
    
    22,287Total net revenue
    
    $
    145,095
    
    
    $
    93,676
    
    
    $
    410,738
    
    
    $
    269,687
  September 30,
    
    
    December 31,2007
    
    
    2006United States
    
    $
    180,731
    
    
    $
    172,846Republic of Korea
    
    
    245,423
    
    
    
    256,032Europe
    
    
    66,972
    
    
    
    26,807Rest of the World
    
    
    8,118
    
    
    
    6,289Total long-lived assets
    
    $
    501,244
    
    
    $
    461,974
  September 30,
    
    
    December 31,2007
    
    
    2006United States
    
    $
    585,289
    
    
    $
    621,532Republic of Korea
    
    
    237,117
    
    
    
    314,106Europe
    
    
    72,973
    
    
    
    26,298Rest of the World
    
    
    7,774
    
    
    
    7,830Total net assets
    
    $
    903,153
    
    
    $
    969,766
  September 30,
    
    
    December 31,2007
    
    
    2006Music
    
    $
    37,029
    
    
    $
    37,029Consumer
    
    
    110,093
    
    
    
    94,968Technology products and solutions
    
    
    190,284
    
    
    
    177,125Total goodwill
    
    $
    337,406
    
    
    $
    309,122
 Note 17. Related Party Transactions
 Transactions with MTVN
 21




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##### Table of Contents



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
    Note 18. Subsequent Event
  22




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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, Sony NetServices GmbH (SNS), and Exomi Oy (Exomi),
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 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;
 
    
    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, planned capital expenditures, and the availability of capital
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
    23




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##### Table of Contents




  Revenue by Segment and Costs of Revenue by Segment
 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;
    
    Accounting for gains on sale of subsidiary stock; and
    
    Accounting for income taxes.
 24




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##### Table of Contents



Revenue Recognition Software Revenue Recognition; Arrangements; SOP No. 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts;
      Music Publishing Rights and Music Royalty Accruals
 Recoverability of Deferred Costs
  25




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##### Table of Contents



Allowances for Doubtful Accounts and Sales Returns
 Accrued Loss on Excess Office Facilities
 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
 26




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##### Table of Contents



Accounting for Gains on Sale of Subsidiary Stock
 Accounting for Income Taxes
      27




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##### Table of Contents



Revenue by Segment
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006Music
    
    $
    37,658
    
    
    
    24
    %
    
    $
    30,375
    
    
    $
    108,586
    
    
    
    21
    %
    
    $
    89,411Consumer
    
    
    54,166
    
    
    
    4
    
    
    
    52,122
    
    
    
    155,393
    
    
    
    7
    
    
    
    145,339Technology Products and Solutions
    
    
    53,271
    
    
    
    377
    
    
    
    11,179
    
    
    
    146,759
    
    
    
    320
    
    
    
    34,937Total net revenue
    
    $
    145,095
    
    
    
    55
    %
    
    $
    93,676
    
    
    $
    410,738
    
    
    
    52
    %
    
    $
    269,687
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Music
    
    
    26
    %
    
    
    32
    %
    
    
    26
    %
    
    
    33
    %Consumer
    
    
    37
    
    
    
    56
    
    
    
    38
    
    
    
    54Technology Products and Solutions
    
    
    37
    
    
    
    12
    
    
    
    36
    
    
    
    13Total net revenue
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 Music
  Consumer
  Technology Products and Solutions
 28




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##### Table of Contents



Consumer Revenue
  Three Months
    
    
    Nine Months EndedEnded September 30,
    
    
    September 30,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006Games
    
    
    28,820
    
    
    
    28
    %
    
    
    22,536
    
    
    
    77,617
    
    
    
    24
    %
    
    
    62,349Media Software and Services
    
    
    25,346
    
    
    
    (14
    )
    
    
    29,586
    
    
    
    77,776
    
    
    
    (6
    )
    
    
    82,990Total consumer products and services revenue
    
    $
    54,166
    
    
    
    4
    %
    
    $
    52,122
    
    
    $
    155,393
    
    
    
    7
    %
    
    $
    145,339
 Games
  Media Software and Services
  Geographic Revenue
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006United States
    
    $
    91,281
    
    
    
    31
    %
    
    $
    69,433
    
    
    $
    263,870
    
    
    
    31
    %
    
    $
    201,675Europe
    
    
    22,150
    
    
    
    39
    
    
    
    15,895
    
    
    
    60,382
    
    
    
    32
    
    
    
    45,725Republic of Korea
    
    
    20,591
    
    
    
    n/a
    
    
    
    
    
    
    
    57,875
    
    
    
    n/a
    
    
    
    Rest of the world
    
    
    11,073
    
    
    
    33
    
    
    
    8,348
    
    
    
    28,611
    
    
    
    28
    
    
    
    22,287Total net revenue
    
    $
    145,095
    
    
    
    55
    %
    
    $
    93,676
    
    
    $
    410,738
    
    
    
    52
    %
    
    $
    269,687
 29




---



##### Table of Contents



Revenue by Segment
 Revenue
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006License fees
    
    $
    23,869
    
    
    
    6
    %
    
    $
    22,528
    
    
    $
    67,918
    
    
    
    (0
    )%
    
    $
    68,014Service revenue
    
    
    121,226
    
    
    
    70
    
    
    
    71,148
    
    
    
    342,820
    
    
    
    70
    
    
    
    201,673Total net revenue
    
    $
    145,095
    
    
    
    55
    %
    
    $
    93,676
    
    
    $
    410,738
    
    
    
    52
    %
    
    $
    269,687
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006License fees
    
    
    16
    %
    
    
    24
    %
    
    
    17
    %
    
    
    25
    %Service revenue
    
    
    84
    
    
    
    76
    
    
    
    83
    
    
    
    75Total net revenue
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 License Fees.
 Service Revenue.
 Deferred Revenue
  30




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##### Table of Contents



Cost of Revenue by Segment
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    2007Music
    
    $
    20,891
    
    
    $
    59,570Consumer
    
    
    10,326
    
    
    
    28,890Technology products and solutions
    
    
    25,427
    
    
    
    63,326Total cost of revenue
    
    $
    56,644
    
    
    $
    151,786
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2007Music
    
    
    55
    %
    
    
    55
    %Consumer
    
    
    19
    
    
    
    19Technology products and solutions
    
    
    48
    
    
    
    43Total cost of revenue
    
    
    39
    %
    
    
    37
    %
 Cost of Music.
 Cost of Consumer.
 Cost of Technology Products and Solutions.
  Cost of Revenue
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006License fees
    
    $
    8,436
    
    
    
    (13
    )%
    
    $
    9,675
    
    
    $
    24,610
    
    
    
    (15
    )%
    
    $
    28,865Service revenue
    
    
    48,208
    
    
    
    158
    
    
    
    18,714
    
    
    
    127,176
    
    
    
    140
    
    
    
    52,923Total cost of revenue
    
    $
    56,644
    
    
    
    100
    %
    
    $
    28,389
    
    
    $
    151,786
    
    
    
    86
    %
    
    $
    81,788
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2006
    
    2007
    
    2006License fees
    
    
    35
    %
    
    
    43
    %
    
    
    36
    %
    
    
    42
    %Service revenue
    
    
    40
    
    
    
    26
    
    
    
    37
    
    
    
    26Total cost of revenue
    
    
    39
    %
    
    
    30
    %
    
    
    37
    %
    
    
    30
    %
 31




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##### Table of Contents



Cost of License Fees.
 Cost of Service Revenue.
 Operating Expenses
 Research and Development
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Research and development
    
    $
    26,528
    
    
    
    45
    %
    
    $
    18,344
    
    
    $
    75,012
    
    
    
    36
    %
    
    $
    55,127As a percentage of total net revenue
    
    
    18
    %
    
    
    
    
    
    
    20
    %
    
    
    18
    %
    
    
    
    
    
    
    20
    %
   Sales and Marketing
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006Sales and marketing
    
    $
    52,812
    
    
    
    41
    %
    
    $
    37,560
    
    
    $
    152,593
    
    
    
    37
    %
    
    $
    111,604As a percentage of total net revenue
    
    
    36
    %
    
    
    
    
    
    
    40
    %
    
    
    37
    %
    
    
    
    
    
    
    41
    %
 32




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##### Table of Contents



General and Administrative
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    Change
    
    2006
    
    2007
    
    Change
    
    2006General and administrative
    
    $
    16,750
    
    
    
    19
    %
    
    $
    14,043
    
    
    $
    51,165
    
    
    
    23
    %
    
    $
    41,586As a percentage of total net revenue
    
    
    12
    %
    
    
    
    
    
    
    15
    %
    
    
    12
    %
    
    
    
    
    
    
    15
    %
   Advertising with Related Party
  Loss on Excess Office Facilities
  33




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##### Table of Contents



Antitrust Litigation Benefit, Net
  Other Income, Net
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2007
    
    
    Change
    
    
    2006
    
    
    2007
    
    
    Change
    
    
    2006Interest and other, net
    
    $
    7,290
    
    
    
    (31
    )%
    
    $
    10,618
    
    
    $
    24,457
    
    
    
    (13
    )%
    
    $
    27,978Gain on sale of equity investments
    
    
    
    
    
    
    n/a
    
    
    
    
    
    
    
    132
    
    
    
    (94
    )
    
    
    2,286Equity in net loss of investments
    
    
    
    
    
    
    n/a
    
    
    
    
    
    
    
    (132
    )
    
    
    n/a
    
    
    
    Minority interest in Rhapsody America
    
    
    6,466
    
    
    
    n/a
    
    
    
    
    
    
    
    6,466
    
    
    
    n/a
    
    
    
    Gain on sale of interest in Rhapsody America
    
    
    7,946
    
    
    
    n/a
    
    
    
    
    
    
    
    7,946
    
    
    
    n/a
    
    
    
    Other income, net
    
    
    38
    
    
    
    (84
    )
    
    
    242
    
    
    
    990
    
    
    
    129
    
    
    
    432Other income, net
    
    $
    21,740
    
    
    
    100
    %
    
    $
    10,860
    
    
    $
    39,859
    
    
    
    30
    %
    
    $
    30,696
   Income Taxes
  34




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##### Table of Contents



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
  September 30,
    
    December 31,2007
    
    2006Working capital
    
    $
    481,443
    
    
    $
    584,125Cash, cash equivalents, trading
securities, and short-term investments
    
    
    590,363
    
    
    
    678,920Restricted cash
    
    
    15,500
    
    
    
    17,300
  35




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##### Table of Contents



September 30,
    
    September 30,2007
    
    2006Cash (used in) provided by operating activities
    
    $
    (206,811
    )
    
    $
    133,961Cash used in investing activities
    
    
    (7,186
    )
    
    
    (36,812
    )Cash used in financing activities
    
    
    (113,085
    )
    
    
    (56,893
    )
          36




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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.
   37




---



##### 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
    38




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##### Table of Contents



Item 1A. Risk Factors
  Risks Related to Our Music, Games and Media Software and Services Businesses
 We require the consent of Viacom International Inc. with respect to certain matters in the
governance and management of our Rhapsody America joint venture. Any disagreement with Viacom on
such matters may have an adverse impact on the business, results of operations and financial
condition of Rhapsody America and, consequently, our business.
  
    
    authorizing the annual operating budget and making capital expenditures in excess of a
certain percentage over the budgeted amount for capital expenditures;
    
    making any unbudgeted loan or investment not in the ordinary course of business in
excess of a certain amount;
    
    entering into certain material agreements;
    
    the issuance, sale or repurchase of Rhapsody Americas membership interests;
    
    declaring of or making any distribution by Rhapsody America;
    
    engaging in any business other than the business (and reasonable extensions thereof)
contemplated in the business plan of Rhapsody America;
    
    merging, consolidating or reorganizing Rhapsody America; acquiring or selling assets not
in the ordinary course of business in excess of a certain amount; or acquiring or selling
businesses valued in excess of a certain amount;
    
    commencement or settlement of any material litigation other than in the ordinary course
of business;
    
    entering into any transaction with a value in excess of a certain amount with our
affiliates or affiliates of MTVN; and
    
    the appointment of a new general manager if the existing general manager is required to
resign as a result of Rhapsody America not meeting certain financial tests.
   39




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##### Table of Contents



The integration strategy we plan to implement with respect to the assets that have been combined in
Rhapsody America may fail or be less successful than anticipated and the management of these assets
creates operational complexities.
   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 stockholders voting and economic interests in
us, and may require us to pay MTVN a price that exceeds the appraised value of their proportionate
interest in Rhapsody America.
  Future growth of our online music, games and media software and services businesses may not keep
pace with recently realized growth rates; any slowdown in growth would negatively impact our
overall operating results.
  The success of our subscription services businesses depends upon our ability to increase
subscription revenue.
  40




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##### Table of Contents



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.
  RealPlayer 11 may not achieve consumer or market acceptance and may be subject to legal challenge.
   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.
  41




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##### Table of Contents



Our music, games and media software and services 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.
  The success of music services offered through Rhapsody America depend, in part, on interoperability
with our customers music playback hardware.
  42




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##### Table of Contents



Risks Related to Our Technology Products and Solutions Business
 Recent acquisitions in our Technology Products and Solutions business 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.
   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.
  43




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##### Table of Contents



Contracts with our carrier customers subject us to significant risks that could negatively impact
our revenue from application services.
    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.
  44




---



##### Table of Contents



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.
  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.
  45




---



##### Table of Contents



We are experiencing greater fluctuations in revenue due to seasonality than at any time in our
past, and we expect this trend to continue.
  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.
   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.
  46




---



##### 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.
 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.
  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.
  47




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##### Table of Contents



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.
   
    
    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.
  48




---



##### Table of Contents



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.
    We may be subject to additional income tax assessments.
  We donate a portion of our net income to charity.
  49




---



##### Table of Contents



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.
    We are exposed to potential risks from legislation requiring companies to evaluate controls under
Section 404 of the Sarbanes-Oxley Act of 2002.
  50




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##### Table of Contents



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.
  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
  
 Item 3. Default Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  51




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##### Table of Contents



Item 6. Exhibits
  ExhibitNumber
    
    Description10.1
    
    Transaction, Contribution and Purchase Agreement dated as of August 20, 2007 among Rhapsody America LLC,
RealNetworks, Inc., RealNetworks Digital Music of California, Inc., Viacom International Inc. and DMS Holdco
Inc.10.2
    
    Limited Liability Company Agreement of Rhapsody America LLC dated as of August 20, 2007 among RealNetworks,
Inc., RealNetworks Digital Music of California, Inc., Viacom International Inc. and DMS Holdco Inc.10.3
    
    Stockholder Agreement by and between Viacom International Inc. and RealNetworks, Inc. dated as of August 20, 200731.1
    
    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
 
 
    
    Portions of this exhibit are omitted and were filed separately with the Securities and Exchange
Commission pursuant to the Companys application requesting confidential treatment under Rule 24b-2
of the Securities Exchange Act of 1934, as amended. 52




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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) 53




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##### Table of Contents



INDEX TO EXHIBITS
 ExhibitNumber
    
    Description10.1
    
    Transaction, Contribution and Purchase Agreement dated as of August 20, 2007 among Rhapsody America LLC,
RealNetworks, Inc., RealNetworks Digital Music of California, Inc., Viacom International Inc. and DMS Holdco
Inc.10.2
    
    Limited Liability Company Agreement of Rhapsody America LLC dated as of August 20, 2007 among RealNetworks,
Inc., RealNetworks Digital Music of California, Inc., Viacom International Inc. and DMS Holdco Inc.10.3
    
    Stockholder Agreement by and between Viacom International Inc. and RealNetworks, Inc. dated as of August 20, 200731.1
    
    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
 
 
    
    Portions of this exhibit are omitted and were filed separately with the Securities and Exchange
Commission pursuant to the Companys application requesting confidential treatment under Rule 24b-2
of the Securities Exchange Act of 1934, as amended. 54