UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K/A

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to  

RealNetworks, Inc.

Washington		91-1628146
(State of incorporation)		(I.R.S. Employer Identification Number)
2601 Elliott Avenue, Suite 1000
Seattle, Washington		98121
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (206) 674-2700

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class		Name of Each Exchange on Which Registered
Common Stock, Par Value $0.001 per share		The NASDAQ Stock Market LLC
Preferred Share Purchase Rights		The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None
(Title of Class)

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act Yes o No þ

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ       Accelerated filer o       Non-accelerated filer o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     The aggregate market value of the Common Stock held by non-affiliates of the registrant was $1,137,327,118 on June 30, 2006, based on the closing price of the Common Stock on that date, as reported on the Nasdaq Global Select Market.⁽¹⁾

     The number of shares of the registrant’s Common Stock outstanding as of May 15, 2007 was 154,328,479.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the registrant’s Proxy Statement relating to the registrant’s 2007 Annual Meeting of Shareholders to be held on or about June 25, 2007 are incorporated by reference into Part III of this Report.

 

 

TABLE OF CONTENTS

		Page
PART II
Item 8. Financial Statements and Supplementary Data			2
PART III
Item 10. Directors, Executive Officers and Corporate Governance			35
Item 11. Executive Compensation			35
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters			35
Item 13. Certain Relationships and Related Transactions, and Director Independence			36
Item 14. Principal Accountant Fees and Services			36
PART IV
Item 15. Exhibits and Financial Statement Schedules			36
Signatures			40
Exhibit Index			41
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

EXPLANATORY NOTE

RealNetworks, Inc. (also referred to as the “Company,” “we,” or “our”) is filing this Amendment No. 1 (the “Amendment No. 1”) to our Form 10-K for the fiscal year ended December 31, 2006 (the “Form 10-K”), originally filed with the Securities and Exchange Commission on March 1, 2007, for the purpose of:

•

amending the cover page to indicate that our preferred share purchase rights are registered pursuant to Section 12(b) of the Securities Exchange Act of 1934, as amended,

•

amending the cover page to indicate that shares of our common stock and our preferred share purchase rights are registered on the NASDAQ Stock Market LLC,

•

correcting a typographical error in the date of the Report of Independent Registered Public Accounting Firm relating to management’s assessment of internal control over financial reporting appearing in Item 9A of the Form 10-K to reflect the report date of February 26, 2007,

•

revising the cover page and Items 10, 11, 12, 13 and 14 of Part III to reflect the date of our 2007 annual meeting of shareholders will be June 25, 2007, and

•

revising Items 10, 11, 13 and 14 of Part III to conform the description of the sections of the Proxy Statement for RealNetworks’ Annual Meeting of Shareholders scheduled to be held on or around June 25, 2007 incorporated by reference into these Items to what appears in such Proxy Statement filed with the Securities and Exchange Commission on May 15, 2007.

We are also updating the signature page, the Exhibit Index in Item 15 of Part IV and appearing after the signature page and Exhibits 23.1, 31.1, 31.2, 32.1 and 32.2.

Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the complete text of Item 8 of Part II, as amended, and Items 10, 11, 12, 13 and 14 of Part III, as amended, is set forth below. The information set forth in our financial statements and the footnotes thereto in this Amendment No. 1 has not been modified or updated in any way from the information in our financial statements and the related footnotes included in the Form 10-K. This Amendment No. 1 speaks as of the original filing date of the Form 10-K and reflects only the changes to the cover page, Item 8 of Part II, Items 10, 11, 12, 13 and 14 of Part III and Item 15 of Part IV discussed above. No other information included in the Form 10-K, including the information set forth in Part I, has been modified or updated in any way.

PART II.

Item 8. Financial Statements and Supplementary Data

REALNETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		December 31,
		2006				2005
ASSETS
Current assets:
Cash and cash equivalents		$	525,232			$	651,971
Short-term investments			153,688				129,356
Trade accounts receivable, net of allowances for doubtful accounts and sales returns of $2,490 in 2006 and $2,973 in 2005			65,751				16,721
Deferred costs, current portion			1,643				—
Deferred tax assets, net, current portion			891				54,204
Prepaid expenses and other current assets			21,990				11,933
Total current assets			769,195				864,185
Equipment, software, and leasehold improvements, at cost:
Equipment and software			83,587				56,402
Leasehold improvements			29,665				27,964
Total equipment, software, and leasehold improvements			113,252				84,366
Less accumulated depreciation and amortization			65,509				51,228
Net equipment, software, and leasehold improvements			47,743				33,138
Restricted cash equivalents			17,300				17,300
Equity investments			22,649				46,163
Other assets			5,148				2,397
Deferred tax assets, net, non-current portion			27,150				19,147
Other intangible assets, net of accumulated amortization of $16,637 in 2006 and $9,850 in 2005			105,109				7,337
Goodwill			309,122				123,330
Total assets		$	1,303,416			$	1,112,997
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	52,097			$	11,397
Accrued and other liabilities			104,328				112,340
Deferred revenue, current portion			24,137				25,021
Accrued loss on excess office facilities, current portion			4,508				4,623
Total current liabilities			185,070				153,381
Deferred revenue, non-current portion			3,440				276
Accrued loss on excess office facilities, non-current portion			9,993				13,393
Deferred rent			4,331				4,018
Deferred tax liabilities, net, non-current portion			27,076				—
Convertible debt			100,000				100,000
Other long-term liabilities			3,740				196
Total liabilities			333,650				271,264
Commitments and contingencies
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 163,278 shares in 2006 and 166,037 shares in 2005			162				166
Additional paid-in capital			791,108				805,067
Deferred stock-based compensation			—				(19	)
Accumulated other comprehensive income			23,485				26,724
Retained earnings			155,011				9,795
Total shareholders’ equity			969,766				841,733
Total liabilities and shareholders’ equity		$	1,303,416			$	1,112,997

See accompanying notes to consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

		Years Ended December 31,
		2006				2005				2004
Net revenue(A)		$	395,261			$	325,059			$	266,719
Cost of revenue(B)			124,108				98,249				92,207
Loss on content agreement			—				—				4,938
Gross profit			271,153				226,810				169,574
Operating expenses:
Research and development			77,386				70,731				52,066
Sales and marketing			165,602				130,515				96,779
General and administrative			57,332				50,697				31,538
Loss on excess office facilities			738				—				866
Subtotal operating expenses			301,058				251,943				181,249
Antitrust litigation (benefit) expenses, net			(220,410	)			(422,500	)			11,048
Total operating expenses (benefit)			80,648				(170,557	)			192,297
Operating income (loss)			190,505				397,367				(22,723	)
Other income (expenses):
Interest income, net			37,622				14,511				4,452
Gain on sale of equity investments			2,286				19,330				—
Equity in net income (loss) of investments			326				(1,068	)			(4,351	)
Impairment of equity investments			(3,116	)			(266	)			(450	)
Other income (expenses)			130				(331	)			597
Other income, net			37,248				32,176				248
Income (loss) before income taxes			227,753				429,543				(22,475	)
Income taxes			(82,537	)			(117,198	)			(522	)
Net income (loss)		$	145,216			$	312,345			$	(22,997	)
Basic net income (loss) per share		$	0.90			$	1.84			$	(0.14	)
Diluted net income (loss) per share		$	0.81			$	1.70			$	(0.14	)
Shares used to compute basic net income (loss) per share			160,973				169,986				168,907
Shares used to compute diluted net income (loss) per share			179,281				184,161				168,907
Comprehensive income (loss):
Net income (loss)		$	145,216			$	312,345			$	(22,997	)
Unrealized gain (loss) on investments:
Unrealized holding (losses) gains, net of tax			(14,399	)			17,864				7,557
Adjustments for gains reclassified to net income (loss)			—				(4,052	)			(53	)
Foreign currency translation gains (losses)			11,160				(1,677	)			(99	)
Comprehensive income (loss)		$	141,977			$	324,480			$	(15,592	)
(A) Components of net revenue:
License fees		$	90,684			$	80,785			$	71,706
Service revenue			304,577				244,274				195,013
		$	395,261			$	325,059			$	266,719
(B) Components of cost of revenue:
License fees		$	37,089			$	33,770			$	28,206
Service revenue			87,019				64,479				64,001
		$	124,108			$	98,249			$	92,207

See accompanying notes to consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

		Years Ended December 31,
		2006				2005				2004
Cash flows from operating activities:
Net income (loss)		$	145,216			$	312,345			$	(22,997	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			20,980				16,243				14,643
Stock-based compensation			18,151				128				695
Deferred income taxes			54,986				107,208				—
Impairment of equity investments			3,116				266				450
Loss on disposal of property, software, and leasehold improvements			276				—				—
Excess tax benefit from stock option exercises			(39,183	)			—				—
Accrued loss on excess office facilities			(3,515	)			(6,244	)			(4,799	)
Gain on sale of equity investments			(2,286	)			(19,330	)			(561	)
Equity in net (income) loss of investments			(326	)			1,068				4,351
Accrued loss on content agreement			—				(2,917	)			2,917
Other			97				804				1,592
Changes in certain assets and liabilities, net of acquisitions:
Trade accounts receivable			(7,962	)			(1,479	)			(3,314	)
Prepaid expenses and other current assets			(3,126	)			(3,409	)			1,258
Accounts payable			4,276				44				3,577
Accrued and other liabilities			(21,800	)			59,826				12,810
Deferred revenue			2,020				(3,800	)			(3,599	)
Net cash provided by operating activities			170,920				460,753				7,023
Cash flows from investing activities:
Purchases of equipment, software, and leasehold improvements			(13,808	)			(13,782	)			(10,018	)
Purchases of short-term investments			(204,841	)			(153,491	)			(293,560	)
Sales and maturities of short-term investments			180,973				168,358				324,512
Purchases of intangible and other assets			—				(1,125	)			(4,839	)
Decrease (increase) in restricted cash equivalents			—				2,851				(198	)
Proceeds from sale of equity investments			2,286				19,530				572
Purchases of cost based investments			(834	)			(647	)			—
Cash used in acquisitions, net of cash acquired			(257,841	)			(14,705	)			(10,477	)
Net cash (used in) provided by investing activities			(294,065	)			6,989				5,992
Cash flows from financing activities:
Net proceeds from sales of common stock under employee stock purchase plan and exercise of stock options			54,929				20,361				8,489
Repayment of long-term note payable			—				(648	)			—
Excess tax benefit from stock option exercises			39,183				—				—
Repurchase of common stock			(98,876	)			(54,321	)			—
Net cash (used in) provided by financing activities			(4,764	)			(34,608	)			8,489
Effect of exchange rate changes on cash			1,170				(589	)			(106	)
Net (decrease) increase in cash and cash equivalents			(126,739	)			432,545				21,398
Cash and cash equivalents, beginning of year			651,971				219,426				198,028
Cash and cash equivalents, end of year		$	525,232			$	651,971			$	219,426
Supplemental disclosure of cash flow information:
Cash paid during the year for income taxes		$	16,487			$	149			$	415
Supplemental disclosure of non-cash investing and financing activities:
Accrued acquisition consideration		$	2,000			$	—			$	—
Payable for repurchase of common stock		$	—			$	5,116			$	—
Common stock and options to purchase common stock issued in business combinations		$	—			$	—			$	20,901

See accompanying notes to consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

														Notes								Accumulated
										Additional				Receivable				Deferred				Other				Retained				Total
		Common Stock								Paid-In				from				Stock-Based				Comprehensive				Earnings				Shareholders’
		Shares				Amount				Capital				Shareholders				Compensation				Income				(Deficit)				Equity
Balances, December 31, 2003			164,197			$	164			$	639,369			$	(58	)		$	(620	)		$	7,184			$	(279,553	)		$	366,486
Common stock issued for:
Exercise of stock options and employee stock purchase plan			3,423				4				8,485				—				—				—				—				8,489
Business combination			3,007				3				20,898				—				(222	)			—				—				20,679
Notes receivable retired			(8	)			—				(41	)			48				—				—				—				7
Amortization of deferred stock compensation			—				—				—				—				695				—				—				695
Shares issued for director payments			7				—				41				—				—				—				—				41
Unrealized gain on investments, net of income tax			—				—				—				—				—				7,557				—				7,557
Adjustments for gains reclassified to net loss			—				—				—				—				—				(53	)			—				(53	)
Translation adjustment			—				—				—				—				—				(99	)			—				(99	)
Net loss			—				—				—				—				—				—				(22,997	)			(22,997	)
Balances, December 31, 2004			170,626				171				668,752				(10	)			(147	)			14,589				(302,550	)			380,805
Common stock issued for exercise of stock options and employee stock purchase plan			4,056				3				20,358				—				—				—				—				20,361
Common shares repurchased			(8,642	)			(8	)			(54,313	)			—				—				—				—				(54,321	)
Notes receivable retired			(18	)			—				(26	)			10				—				—				—				(16	)
Amortization of deferred stock compensation			—				—				—				—				128				—				—				128
Shares issued for director payments			15				—				91				—				—				—				—				91
Unrealized gain on investments, net of income tax			—				—				—				—				—				17,864				—				17,864
Adjustments for gains reclassified to net income			—				—				—				—				—				(4,052	)			—				(4,052	)
Translation adjustment			—				—				—				—				—				(1,677	)			—				(1,677	)
Net deferred tax adjustment			—				—				170,205				—				—				—				—				170,205
Net income			—				—				—				—				—				—				312,345				312,345
Balances, December 31, 2005			166,037				166				805,067				—				(19	)			26,724				9,795				841,733
Common stock issued for exercise of stock options and employee stock purchase plan			9,067				8				54,921				—				—				—				—				54,929
Common shares repurchased			(11,836	)			(12	)			(98,864	)			—				—				—				—				(98,876	)
Shares issued for director payments			10				—				97				—				—				—				—				97
Stock-based compensation			—				—				18,132				—				19				—				—				18,151
Unrealized loss on investments, net of income tax			—				—				—				—				—				(14,399	)			—				(14,399	)
Translation adjustment			—				—				—				—				—				11,160				—				11,160
Tax benefit from stock option exercises			—				—				11,755				—				—				—				—				11,755
Net income			—				—				—				—				—				—				145,216				145,216
Balances, December 31, 2006			163,278			$	162			$	791,108			$	—			$	—			$	23,485			$	155,011			$	969,766

See accompanying notes to consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Description of Business and Summary of Significant Accounting Policies

     Description of Business. RealNetworks, Inc. and subsidiaries (RealNetworks or Company) is a leading global provider of network-delivered digital media products and services. The Company also develops and markets software products and services that enable the creation, distribution and consumption of digital media, including audio and video.

     Inherent in the Company’s business are various risks and uncertainties, including limited history of certain of its product and service offerings and its limited history of offering premium subscription services on the Internet. The Company’s success will depend on the acceptance of the Company’s technology, products and services and the ability to generate related revenue.

     Basis of Presentation. The consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The Company acquired 99.7% of WiderThan Co., Ltd. during the quarter ended December 31, 2006. The accompanying financial statements include 100% of the financial results of WiderThan beginning October 31, 2006. The minority interest in the earnings of WiderThan for the period November 1, 2006 to December 31, 2006 was nominal.

     Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

     Cash, Cash Equivalents, and Short-Term Investments. The Company considers all short-term investments with a remaining contractual maturity at date of purchase of three months or less to be cash equivalents.

     The Company has classified as available-for-sale all marketable debt and equity securities for which there is determinable fair market value and there are no restrictions on the Company’s ability to sell. Available-for-sale securities are carried at fair value, based on quoted market prices, with unrealized gains and losses reported as a separate component of shareholders’ equity, net of applicable income taxes. All short-term investments have remaining contractual maturities of two years or less. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in other income, net. Realized and unrealized gains and losses on available-for-sale securities are determined using the specific identification method.

     Trade Accounts Receivable. Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on analysis of historical bad debts, customer concentrations, customer credit-worthiness and current economic trends. The Company reviews its allowance for doubtful accounts quarterly. Past due balances over 90 days and specified other balances are reviewed individually for collectibility. All other balances are reviewed on an aggregate basis. Account balances are written off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers.

     Concentration of Credit Risk. Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, and accounts receivable. The Company maintains its cash and cash equivalents with high credit quality financial institutions. Short-term investments consist of U.S. government and government agency securities and corporate notes and bonds. The Company derives a significant portion of its revenue from a large number of individual subscribers spread globally. The Company also derives revenue from several large customers. If the financial condition or results of operations of any one of the large customers deteriorates substantially, the Company’s operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. The Company does not generally require collateral and maintains reserves for estimated credit losses on customer accounts when considered necessary.

     Deferred costs. The Company defers costs on projects for service revenues and system sales. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

hardware and software from third parties and payroll and related costs for employees and other third parties. Deferred costs are capitalized during the implementation period.

     The Company recognizes such costs in accordance with its revenue recognition policy by contract. For revenue recognized under the completed contract method, costs are deferred until the products are delivered, or upon completion of services or, where applicable, customer acceptance. For revenue recognized under the percentage of completion method, costs are recognized as products are delivered or services are provided. For revenue recognized ratably over the term of the contract, costs are also recognized ratably over the term of the contract, commencing on the date of revenue recognition. At each balance sheet date, the Company reviews its deferred costs, to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue or if actual deferred costs exceed contractual revenue.

     Long-term portion of deferred costs have been included in other assets in the accompanying consolidated balance sheets.

     Depreciation and Amortization. Depreciation and amortization of equipment, software, and leasehold improvements are computed using the straight-line method over the lesser of the estimated useful lives of the assets or the lease term. Approximate useful life of equipment and software is three years and for leasehold improvements is two to ten years.

     Depreciation expense during the years ended December 31, 2006, 2005, and 2004 was $13.5 million, $10.3 million, and $9.8 million, respectively.

     Equity Investments. The cost method is used to account for equity investments in companies in which the Company holds less than a 20 percent voting interest, does not exercise significant influence, and the related securities do not have a quoted market price.

     Other Intangible Assets. Other intangible assets consist primarily of the fair value of customer agreements and contracts, developed technology, patents, trademarks and tradenames acquired in business combinations. Other intangible assets are amortized on a straight line basis over three to seven years, which approximates their estimated useful lives.

     Goodwill. Goodwill represents the excess of the purchase price over the fair value of identifiable tangible and intangible assets acquired and liabilities assumed in business combinations. Goodwill is tested at least annually for impairment and more frequently if events and circumstances indicate that it might be impaired. The annual impairment test is performed in the fourth quarter of the Company’s fiscal year. Factors the Company considers important which could trigger an impairment review include the following:

•

poor economic performance relative to historical or projected 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.

     Long-Lived Assets. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of the assets to the estimated undiscounted future cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value estimated on discounted future cash flows.

     Fair Value of Financial Instruments. At December 31, 2006, the Company had the following financial instruments: cash and cash equivalents, short-term investments, accounts receivable, accounts payable, accrued liabilities, and convertible debt. The carrying value of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximates their fair value based on the liquidity of these financial instruments or based on their short-term nature. Short-term investments are carried at fair value based on quoted market prices. The fair value of convertible debt, which has a carrying value of $100.0 million, was $125.7 million and $97.2 million at December 31, 2006 and 2005, respectively.

     Research and Development. Costs incurred in research and development are expensed as incurred. Software development costs are required to be capitalized when a product’s technological feasibility has been established through the date the product is available for general release to customers. The Company has not capitalized any software development costs, as technological feasibility is generally not established until a working model is completed, at which time substantially all development is complete.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

     Revenue Recognition. The Company recognizes revenue in accordance with the following authoritative literature: AICPA Statement of Position (SOP) No. 97-2, Software Revenue Recognition; SOP No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements; SOP No. 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts; Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements; Financial Accounting Standards Board’s (FASB) Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables; and EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent. Generally the Company recognizes revenue when there is persuasive evidence of an arrangement, the fee is fixed or determinable, the product or services have been delivered and collectibility of the resulting receivable is reasonably assured.

     Consumer subscription products are paid in advance, typically for monthly, quarterly or annual periods. Subscription revenue is recognized ratably over the related subscription period. Revenue from sales of downloaded individual tracks, albums and games are recognized at the time the music or game is made available, digitally, to the end user.

     The Company has arrangements whereby customers pay one price for multiple products and services and in some cases, involve a combination of products and services. For arrangements with multiple deliverables, revenue is recognized upon the delivery of the individual deliverables in accordance with EITF Issue No. 00-21. In the event that there is no objective and reliable evidence of fair value of the delivered items, the revenue recognized upon delivery is the total arrangement consideration less the fair value of the undelivered items. The Company applies significant judgment in establishing the fair value of multiple elements within revenue arrangements.

     The Company recognizes revenue on a gross or net basis, in accordance with EITF Issue No. 99-19. In most arrangements, the Company contracts directly with end user customers, is the primary obligor and carries all collectibility risk. In such arrangements the Company reports the revenue on a gross basis. In some cases, the Company utilizes third-party distributors to sell products or services directly to end user customers and carries no collectibility risk. In such instances the Company reports the revenue on a net basis.

     The Company recognizes revenue for its software products pursuant to the requirements of SOP No. 97-2, as amended by SOP No. 98-9. If the Company provides consulting services that are considered essential to the functionality of the software products, both the software product revenue and services revenue are recognized under contract accounting in accordance with the provisions of SOP No. 81-1. Revenue from these arrangements is either recognized under the percentage of completion method based on the ratio of direct labor hours incurred to total projected labor hours, or on the completed contract method based on customer specific arrangement. Revenue from software license agreements with original equipment manufacturers (OEM) is recognized when the OEM delivers its product incorporating the Company’s software to the end user.

     Revenue generated from advertising appearing on the Company’s websites and from advertising included in its products is recognized as revenue as the delivery of the advertising occurs.

     Advertising Expenses. The Company expenses the cost of advertising and promoting its products as incurred. Such costs are included in sales and marketing expense and totaled $51.2 million in 2006, $40.0 million in 2005, and $13.0 million in 2004.

     Foreign Currency. The functional currency of the Company’s foreign subsidiaries is the local currency of the country in which the subsidiary operates. Assets and liabilities of foreign operations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. The net gain or loss resulting from translation is shown as translation adjustment and included in accumulated other comprehensive income in shareholders’ equity. Income and expense accounts are translated into U.S. dollars using average rates of exchange. Gains and losses from foreign currency transactions are included in the consolidated statements of operations. There were no significant gains or losses on foreign currency transactions in 2006, 2005, and 2004.

     Derivative Financial Instruments. The Company conducts business internationally in several currencies. As such, it is exposed to adverse movements in foreign currency exchange rates. A portion of these risks are managed through the use of financial derivatives, but fluctuations could impact the Company’s results of operations and financial position. The Company’s foreign currency risk management program reduces, but does not entirely eliminate, the impact of currency exchange rate movements.

     Generally, the Company’s practice is to manage foreign currency risk for the majority of material short-term intercompany balances through the use of foreign currency forward contracts. These contracts require the Company to exchange currencies at rates agreed upon at the contract’s inception. Because the impact of movements in currency exchange rates on forward contracts offsets the related impact on the short-term intercompany balances, these financial instruments help alleviate the risk that might otherwise result from certain changes in currency exchange rates. The Company does not designate its foreign exchange forward contracts related to short-term intercompany accounts as hedges and, accordingly, the Company adjusts these instruments to fair value through results of

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

operations. However, the Company may periodically hedge a portion of its foreign exchange exposures associated with material firmly committed transactions and long-term investments.

     All derivatives, whether designated in hedging relationships or not, are recorded on the balance sheet at fair value. If the derivative is designated a hedge, then depending on the nature of the hedge, changes in fair value will either be recorded immediately in results of operations, or be recognized in accumulated other comprehensive income until the hedged item is recognized in results of operations.

     The following foreign currency contracts were outstanding and recorded at fair value as of December 31, 2006 (in thousands):

										Contract
		Contract Amount								Amount				Unrealized
		(Local Currency)								(US Dollars)				Gain/(Loss)
British Pounds (GBP) (contracts to receive GBP/pay US$)		GBP					250			$	492			$	2
Japanese Yen (JPY) (contracts to receive JPY/pay US$)		JPY					28,000			$	238			$	(2	)

     The following foreign currency contracts were outstanding and recorded at fair value as of December 31, 2005 (in thousands):

										Contract
		Contract Amount								Amount				Unrealized
		(Local Currency)								(US Dollars)				Gain/(Loss)
British Pounds (GBP) (contracts to receive GBP/pay US$)		GBP					1,000			$	1,736			$	(15	)
Euro (EUR) (contracts to pay EUR/receive US$)		EUR					1,260			$	1,514			$	23
Japanese Yen (JPY) (contracts to receive JPY/pay US$)		JPY					30,000			$	251			$	4

     No derivative instruments which were designated as hedges for accounting purposes were outstanding at December 31, 2006 and 2005.

     Income Taxes. The Company computes income taxes using the asset and liability method, under which deferred income taxes are provided for temporary differences between financial reporting basis and tax basis of the Company’s assets and liabilities and operating loss and tax credit carryforwards. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled.

     Stock-Based Compensation. Effective January 1, 2006, the Company adopted the provisions of, and began accounting for stock-based compensation in accordance with, Statement of Financial Accounting Standards (SFAS) No. 123R – revised 2004, Share-Based Payment, which replaced SFAS 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees. Under the fair value provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards under SFAS No. 123R, consistent with that used for pro forma disclosures under SFAS No. 123. The Company utilized the modified prospective transition method, which requires that stock-based compensation expense be recorded for all new and unvested stock options and employee stock purchase plan shares that are ultimately expected to vest as the requisite service is rendered beginning on January 1, 2006, the first day of the Company’s 2006 fiscal year. Stock-based compensation expense for awards granted prior to January 1, 2006 is based on the grant date fair-value as determined under the pro forma provisions of SFAS No. 123.

     Prior to January 1, 2006, the Company had elected to apply the disclosure-only provisions of SFAS No. 123. Accordingly, the Company accounted for stock-based compensation transactions with employees using the intrinsic value method prescribed in APB No. 25 and related interpretations. Compensation cost for employee stock options was measured as the excess, if any, of the fair value of the Company’s common stock at the date of grant over the stock option exercise price. Compensation cost for awards to non-employees was based on the fair value of the awards in accordance with SFAS No. 123. Furthermore, the Company recognized compensation cost related to fixed employee awards on an accelerated basis over the applicable vesting period using the methodology described in FASB Interpretation (FIN) No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.

     At December 31, 2006, the Company had six stock-based employee compensation plans, which are described more fully in Note 13.

     Net Income (Loss) Per Share. Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

by the weighted average number of common and dilutive potential common shares outstanding during the period. As the Company had a net loss in 2004, basic and diluted net loss per share are the same for the year. Potentially dilutive securities outstanding were not included in the computation of diluted net loss per common share because to do so would have been anti-dilutive. The share count used to compute basic and diluted net income (loss) per share is calculated as follows (in thousands):

		Years Ended December 31,
		2006				2005				2004
Weighted average shares outstanding			160,973				169,986				169,056
Less restricted shares			—				—				149
Shares used to compute basic net income (loss) per share			160,973				169,986				168,907
Dilutive potential common shares:
Stock options and restricted stock			7,558				3,425				—
Convertible debt			10,750				10,750				—
Shares used to compute diluted net income (loss) per share			179,281				184,161				168,907

     Approximately 8.5 million and 4.7 million shares of common stock potentially issuable from stock options during the years ended December 31, 2006 and 2005, respectively, are excluded from the calculation of diluted net income per share because of their antidilutive effect.

     Accumulated Other Comprehensive Income. The Company’s accumulated other comprehensive income as of December 31, 2006 and 2005 consisted of unrealized gains (losses) on marketable securities and foreign currency translation gains (losses). The tax effect of unrealized gains (losses) on investments and the foreign currency translation gains (losses) has been taken into account, if applicable.

     The components of accumulated other comprehensive income are as follows (in thousands):

		December 31,
		2006				2005
Unrealized gains on investments, including taxes of $5,243 in 2006 and $13,592 in 2005		$	14,318			$	28,717
Foreign currency translation adjustments			9,167				(1,993	)
Accumulated other comprehensive income		$	23,485			$	26,724

     Reclassifications. Certain reclassifications have been made to the 2004 and 2005 consolidated financial statements to conform to the 2006 presentation.

     New Accounting Pronouncements. In June 2005, the FASB ratified EITF Issue No. 05–06, Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination. Issue No. 05–06 provides that the amortization period used for leasehold improvements acquired in a business combination or purchased after the inception of a lease be the shorter of (a) the useful life of the assets or (b) a term that includes required lease periods and renewals that are reasonably assured upon the acquisition or the purchase. The provisions of Issue No. 05–06 are effective on a prospective basis for leasehold improvements purchased or acquired beginning in the second quarter of fiscal 2006. Adoption of Issue No. 05-06 did not have a material effect on the Company’s consolidated financial statements.

     In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of FIN No. 48 to have a material impact on its consolidated financial statements.

     In June 2006, the FASB ratified the consensus reached on EITF Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation). The scope of Issue No. 06-3 includes any transaction-based tax assessed by a governmental authority that is imposed concurrent with or subsequent to a revenue-producing transaction between a seller and a customer. The scope does not include taxes that are based on gross receipts or total revenues imposed during the inventory procurement process. Gross versus net income statement classification of that tax is an accounting policy decision and a voluntary change would be considered a change in accounting policy requiring the application of SFAS No. 154, Accounting Changes and Error Corrections. The following disclosures will be required for taxes within

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

the scope of this issue that are significant in amount: (1) the accounting policy elected for these taxes; and (2) the amounts of the taxes reflected gross (as revenue) in the income statement on an interim and annual basis for all periods presented. Issue No. 06-3 is effective for interim and annual periods beginning after December 15, 2006. The Company does not expect the adoption of Issue No. 06-3 to have a material impact on its consolidated financial statements.

     In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements. SAB No. 108 requires analysis of misstatements using both an income statement approach and a balance sheet approach in assessing materiality and provides for a one–time cumulative effect transition adjustment. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have a material effect on the Company’s consolidated financial statements.

     In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. This statement is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company is currently assessing the impact of SFAS No. 157 on its consolidated financial statements.

Note 2. Stock-Based Compensation

     Effective January 1, 2006, the Company adopted the provisions of, and began accounting for stock-based compensation in accordance with, SFAS No. 123 – revised 2004, Share-Based Payment, which replaced SFAS 123, Accounting for Stock-Based Compensation and supersedes APB No. 25, Accounting for Stock Issued to Employees. Under the fair value provisions of this statement, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards under SFAS No. 123R, consistent with that used for pro forma disclosures under SFAS No. 123. The Company utilized the modified prospective transition method, which requires that stock-based compensation expense be recorded for all new and unvested stock options and employee stock purchase plan shares that are ultimately expected to vest as the requisite service is rendered beginning on January 1, 2006, the first day of the Company’s 2006 fiscal year. Stock-based compensation expense for awards granted prior to January 1, 2006 is based on the grant date fair-value as determined under the pro forma provisions of SFAS No. 123.

     The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, including the contractual terms, vesting schedules and expectations of future employee behavior. During the year ended December 31, 2006, expected stock price volatility is based on a combination of historical volatility of the Company’s stock for the related expected term and the implied volatility of its traded options. Prior to the adoption of SFAS No. 123R, expected stock price volatility was estimated using only historical volatility. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to the expected term of the stock options. The Company has not paid dividends in the past.

     In accordance with SFAS No. 123R the Company presents excess tax benefits from the exercise of stock-based compensation awards as a financing activity in the consolidated statement of cash flows for periods in which an excess tax benefit is recorded. As a result of the implementation of SFAS No. 123R, cash benefit of $39.2 million was recorded during the year ended December 31, 2006 which resulted in a decrease in cash provided by operating activities and a decrease in cash used in financing activities.

     The Company recognizes compensation cost related to stock options granted prior to the adoption of SFAS No. 123R on an accelerated basis over the applicable vesting period using the methodology described in FIN No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans. The Company recognizes compensation cost related to options granted subsequent to the adoption of SFAS No. 123R on a straight-line basis over the applicable vesting period. At December 31, 2006, the Company had options outstanding under six stock-based compensation plans. The Company issues new shares of its common stock to satisfy stock option exercises.

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

     Stock-based compensation expense recognized in the Company’s consolidated statements of operations is as follows (in thousands):

		Year Ended
		December 31, 2006
Cost of service revenue		$	257
Research and development			6,512
Sales and marketing			7,152
General and administrative			4,230
Total stock-based compensation expense		$	18,151

     No stock-based compensation was capitalized as part of the cost of an asset as of December 31, 2006. As of December 31, 2006, $41.2 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock options is expected to be recognized over a weighted-average period of approximately two years.

     Prior to the adoption of SFAS No. 123R, the Company measured compensation expense for its employee stock-based compensation plans using the intrinsic value method prescribed by APB No. 25. The Company applied the disclosure provisions of SFAS No. 123 as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure as if the fair-value-based method had been applied in measuring compensation expense. Under APB No. 25, when the exercise price of the Company’s employee stock options was equal to the market price of the underlying stock on the date of the grant, no compensation expense was recognized.

     The following table presents the impact of the Company’s adoption of SFAS No. 123R on selected line items from the consolidated statement of operations during the year ended December 31, 2006 (in thousands, except per share data):

		As Reported				If Reported
		Following				Following
		SFAS 123(R)				APB No. 25
Operating income		$	190,505			$	208,637
Income before income taxes			227,753				245,885
Net income		$	145,216			$	156,777
Basic net income per share		$	0.90			$	0.97
Diluted net income per share		$	0.81			$	0.87

     The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123R to stock-based employee compensation during the years ended December 31, 2005 and 2004 (in thousands, except per share data):

		Year Ended				Year Ended
		December 31, 2005				December 31, 2004
Net income (loss) as reported		$	312,345			$	(22,997	)
Plus: stock-based employee compensation expense included in reported net income, net of related tax effects			128				695
Less: stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects			(14,860	)			(21,227	)
Pro forma net income (loss)		$	297,613			$	(43,529	)
Net income (loss) per share:
Basic — as reported		$	1.84			$	(0.14	)
Diluted — as reported		$	1.70			$	(0.14	)
Basic — pro forma		$	1.75			$	(0.26	)
Diluted — pro forma		$	1.62			$	(0.26	)

     For further information related to the Company’s equity compensation plans see Note 13.

Note 3. Business Combinations

     Business Combinations in 2006.

     Zylom Media Group B.V.

     On January 31, 2006, the Company acquired all of the outstanding securities of Zylom Media Group B.V. (Zylom) in exchange for $7.9 million in cash payments, including $293,000 in direct acquisition related costs consisting primarily of professional fees. The Company is also obligated to pay an additional $2.0 million, through individual payments of $1.0 million on the first and second anniversaries of the acquisition date.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

     Additionally, the Company may be obligated to pay up to $10.9 million over a three-year period, dependent on whether certain performance criteria are achieved. Such amounts are not included in the initial aggregate purchase price and, to the extent earned, will be recorded as goodwill when the performance criteria are achieved.

     Zylom is located in Eindhoven, The Netherlands and is a distributor, developer, and publisher of PC-based games in Europe. The Company believes that combining Zylom’s assets and distribution network with the Company’s downloadable, PC-based games assets and distribution platform will enhance the Company’s presence in the European games market. The results of Zylom’s operations are included in the Company’s condensed consolidated financial statements starting from the date of acquisition.

     A summary of the purchase price for the acquisition is as follows (in thousands):

Cash paid at acquisition		$	7,922
Additional future payments related to initial purchase price			2,000
Estimated direct acquisition costs			293
Total		$	10,215

     The aggregate purchase consideration has been allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective estimated fair values as summarized below. The respective estimated fair values were determined by a third-party appraisal at the acquisition date and resulted in excess purchase consideration over the net tangible and identifiable intangible assets acquired of $8.2 million. Goodwill in the amount of $8.2 million is not deductible for tax purposes.

     A summary of the allocation of the purchase price is as follows (in thousands):

Current assets		$	1,830
Property and equipment			166
Other intangible assets subject to amortization:
Technology and games			570
Tradenames and trademarks			560
Distributor and customer relationships			1,290
Non-compete agreements			180
Goodwill			8,168
Total assets acquired			12,764
Current liabilities			(1,781	)
Net deferred tax liabilities			(768	)
Total liabilities acquired			(2,549	)
Net assets acquired		$	10,215

     Technology/Games and Tradenames/Trademarks have weighted average estimated useful lives of three years. Distributor and customer relationships have weighted average estimated useful lives of approximately five years. Non-compete agreements have a weighted average estimated useful life of four years. All of the other intangible assets are being amortized over their estimated useful life on a straight line basis.

     Pro forma results are not presented, because they are not material to the Company’s overall financial statements.

     WiderThan Co., Ltd.

     Pursuant to a Combination Agreement with WiderThan Co., Ltd. (WiderThan) dated September 12, 2006, the Company acquired approximately 94.6% and 99.7% of the outstanding common shares and American Depository Shares (ADSs) of WiderThan for $17.05 per common share and per ADSs in cash effective October 31, 2006 and November 28, 2006, respectively. Additionally, the Company incurred $6.0 million in direct acquisition related costs consisting primarily of professional fees and other costs directly related to the acquisition for a total purchase price of $342.7 million.

     WiderThan is a leading provider of ringback tones, music-on-demand, and other mobile entertainment services to wireless carriers principally in the Republic of Korea and the U.S., and other countries in Asia and Europe. The Company believes that combining WiderThan and its business will enhance the Company’s digital entertainment products and services offerings and accelerate its reach around the world. The results of WiderThan operations are included in the Company’s consolidated financial statements starting from the closing date of October 31, 2006. The minority interest in the earnings of WiderThan for the period November 1, 2006 to December 31, 2006 was nominal.

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

     A summary of the purchase price for the acquisition is as follows (in thousands):

Cash		$	336,652
Direct acquisition costs			6,036
Total purchase price		$	342,688

     The total purchase consideration has been allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective estimated fair values as summarized below. The respective estimated fair values were determined by an independent third-party appraisal at the acquisition date and resulted in excess purchase consideration over the net tangible and identifiable intangible assets acquired of $166.9 million. Goodwill in the amount of $166.9 million is not deductible for tax purposes.

     A summary of the preliminary allocation of the purchase price is as follows (in thousands):

Current assets		$	144,732
Property and equipment			11,148
Other long-term assets			4,407
Other intangible assets subject to amortization:
Customer relationships			67,000
Developed technology			24,000
Tradenames and trademarks			3,800
Service contracts			3,400
Goodwill			166,925
Total assets acquired			425,412
Current liabilities			(55,885	)
Long-term liabilities			(1,110	)
Net deferred tax liabilities			(25,729	)
Total liabilities acquired			(82,724	)
Net assets acquired		$	342,688

     Customer relationships have a weighted average estimated useful life of seven years. Developed technology has an average estimated useful life of four years. Tradenames and trademarks have a weighted average estimated useful life of three years. Service contracts have a weighted average estimated useful life of three years. All of the other intangible assets are being amortized over their estimated useful life on a straight line basis.

     As of December 31, 2006 the Company had not made a final determination to maintain WiderThan Americas, Inc., currently a wholly-owned subsidiary of WiderThan, as a direct subsidiary of WiderThan or as a direct subsidiary of RealNetworks, Inc. The determination of the final structure may impact the amount of deferred tax liability and goodwill, therefore the allocation of the purchase price, if the decision is made within a reasonable time from the date of acquisition.

     The following unaudited pro forma financial information presents the combined results of operations of the Company and WiderThan as if the acquisition had occurred as of the beginning of the periods presented. The unaudited pro forma financial information is not intended to represent or be indicative of the consolidated results of operations of the Company that would have been reported had the acquisition been completed as of the beginning of the periods presented, and should not be taken as representative of the future consolidated results of operations of the Company (in thousands, except per share data).

		Year Ended				Year Ended
		December 31, 2006				December 31, 2005
Net revenue		$	500,017			$	423,412
Net income		$	153,688			$	301,570
Basic net income per share		$	0.95			$	1.77
Diluted net income per share		$	0.86			$	1.64

     Pro forma net income for year ended December 31, 2006 excludes $23.1 million of acquisition related charges recorded by WiderThan prior to the acquisition.

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

     Atrativa Latin America Ltda.

     On November 21, 2006, the Company acquired all of the outstanding securities of Atrativa Latin America Ltda. (Atrativa) in exchange for $3.8 million in cash payments, including $224,000 in direct acquisition related costs consisting primarily of professional fees.

     Atrativa is located in Sao Paolo, Brazil, and is a distributor of online and downloadable casual games. The Company believes leveraging Atrativa’s distribution network in Latin America will strengthen the Company’s leadership position in the casual games market. The results of Atrativa’s operations are included in the Company’s condensed consolidated financial statements starting from the date of acquisition.

     A summary of the purchase price for the acquisition is as follows (in thousands):

Cash		$	3,600
Direct acquisition costs			224
Total purchase price		$	3,824

     The total purchase consideration has been allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective estimated fair values as summarized below. The respective estimated fair values were determined by an independent third-party appraisal at the acquisition date and resulted in excess purchase consideration over the net tangible and identifiable intangible assets acquired of $4.2 million. Goodwill in the amount of $4.2 million is not deductible for tax purposes.

     A summary of the allocation of the purchase price is as follows (in thousands):

Current assets		$	77
Property and equipment			10
Other long-term assets			3
Other intangible assets subject to amortization:
Customer relationships			650
Supplier relationships			150
Tradenames and trademarks			120
Goodwill			4,220
Total assets acquired			5,230
Current liabilities			(124	)
Long-term liabilities			(969	)
Net deferred tax liabilities			(313	)
Total liabilities acquired			(1,406	)
Net assets acquired		$	3,824

     Customer relationships have a weighted average estimated useful life of three years. Supplier relationships have a weighted average estimated useful life of four years. Tradenames and trademarks have a weighted average estimated useful life of three years. All of the other intangible assets are being amortized over their estimated useful life on a straight line basis.

     Pro forma results are not presented, as they are not material to the Company’s overall financial statements.

     Business Combination in 2005.

     On May 6, 2005, the Company acquired all of the outstanding securities of Mr. Goodliving Ltd. (Mr. Goodliving) in exchange for $15.6 million in cash payments, including $534,000 in direct acquisition related costs consisting primarily of professional fees. In addition, the Company may be obligated to pay up to $1.6 million over a four-year period to certain Mr. Goodliving employees in the form of a management incentive bonus if certain performance criteria are achieved. Such amounts are not included in the purchase price and, to the extent earned, are being recorded as compensation expense over the related employment periods. The accrued compensation cost related to this plan was $374,000 and $300,000 during the years ended December 31, 2006 and 2005, respectively, and is included in the consolidated balance sheet in accrued and other liabilities.

     Mr. Goodliving is a developer and publisher of mobile games located in Helsinki, Finland. The Company believes that combining Mr. Goodliving’s assets and distribution network with the Company’s downloadable, PC-based games assets and

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

distribution platform will enhance the Company’s entry into the mobile games market. The results of Mr. Goodliving’s operations are included in the Company’s consolidated financial statements starting from the date of acquisition.

     A summary of the purchase price for the acquisition is as follows (in thousands):

Cash		$	15,089
Direct acquisition costs			534
Total purchase price		$	15,623

     The total purchase consideration has been allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective estimated fair values as summarized below. The respective estimated fair values were determined by an independent third-party appraisal at the acquisition date and resulted in excess purchase consideration over the net tangible and identifiable intangible assets acquired of $12.8 million. Goodwill in the amount of $12.8 million is not deductible for tax purposes. Pro forma results are not presented, as they are not material to the Company’s overall financial statements.

     A summary of the allocation of the purchase price is as follows (in thousands):

Current assets		$	1,624
Property and equipment			10
Other intangible assets subject to amortization:
Technology and games			1,460
Tradenames and trademarks			400
Distributor and customer relationships			1,500
Goodwill			12,745
Total assets acquired			17,739
Current liabilities			(756	)
Net deferred tax liabilities			(497	)
Long-term notes payable			(863	)
Total liabilities acquired			(2,116	)
Net assets acquired		$	15,623

     Technology and Games have a weighted average estimated useful life of two years. Tradenames and trademarks have a weighted average estimated useful life of four years. Distributor and customer relationships have a weighted average estimated useful life of five years.

     Business Combination in 2004.

     In January 2004, the Company acquired all of the outstanding securities of GameHouse, Inc. (GameHouse) in exchange for $9.1 million in cash payments, including an estimated future payment of $100,000 to cover certain tax obligations of the selling shareholders, and 3.0 million shares and options to acquire 300,000 shares of its common stock valued at $20.9 million. The value assigned to the stock portion of the purchase price was $6.40 per share based on the average closing price of the Company’s common stock for the five days beginning two days prior to and ending two days after January 26, 2004 (the date of the Agreement and Plan of Merger). Options issued were valued based on the Black-Scholes options pricing model. Included in the purchase price is $350,000 in direct acquisition related costs consisting primarily of professional fees. Certain former GameHouse shareholders are eligible to receive up to $5.5 million over a four-year period, payable in cash or, at the Company’s discretion, in its common stock valued in that amount provided they remain employed by the Company during such period. Under the Agreement, the Company may be obligated to pay up to $1.0 million over a four-year period to certain GameHouse employees in the form of a management incentive plan. Such amounts were not included in the total purchase price and, to the extent earned, were being recorded as compensation expense over the related employment periods. As eligible GameHouse employees are no longer employed by the Company no such payments under the Agreement will be made.

     GameHouse is a developer, publisher and distributor of downloadable PC and mobile games. The Company believes that combining GameHouse’s assets with its subscription games service and downloadable games distribution platform will strengthen the Company’s position in the PC games market. The results of GameHouse’s operations are included in the Company’s condensed consolidated financial statements starting from the date of acquisition.

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

     The purchase price for the acquisition is as follows (in thousands):

Cash		$	9,131
Fair value of common stock and options issued			20,901
Direct acquisition costs			350
Total purchase price		$	30,382

     The total purchase price has been allocated to the assets and liabilities acquired, including identifiable intangible assets, based on their respective estimated fair values by an independent third-party appraisal as summarized below. The respective estimated fair values were determined as of the acquisition date and resulted in excess purchase consideration over the net tangible and identifiable intangible assets acquired of $21.9 million. Goodwill in the amount of $21.9 million is not deductible for tax purposes. Pro forma results are not presented, as they are not material to the Company’s overall financial statements.

     A summary of the allocation of the purchase price is as follows (in thousands):

Current assets		$	1,315
Property and equipment			82
Other intangible assets subject to amortization:
Technology and games			5,200
Tradename			1,600
Customer list			400
Goodwill			21,894
Current liabilities			(331	)
Deferred stock compensation			222
Net assets acquired		$	30,382

     Technology and games have a weighted average estimated useful life of two years. Tradename and customer list have a weighted average estimated useful life of four years.

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

Note 4. Cash, Cash Equivalents, Short-Term Investments, and Restricted Cash Equivalents

     Cash, cash equivalents, short-term investments, and restricted cash equivalents as of December 31, 2006 consist of the following (in thousands):

						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost				Gains				Losses				Fair Value
Cash and cash equivalents:
Cash		$	108,415			$	—			$	—			$	108,415
Money market mutual funds			231,634				—				—				231,634
Corporate notes and bonds			182,184				—				—				182,184
U.S. Government agency securities			2,999				—				—				2,999
Total cash and cash equivalents			525,232				—				—				525,232
Short-term investments:
U.S. Government agency securities			153,520				188				(20	)			153,688
Total short-term investments			153,520				188				(20	)			153,688
Total cash, cash equivalents, and short-term investments		$	678,752			$	188			$	(20	)		$	678,920
Restricted cash equivalents		$	17,300			$	—			$	—			$	17,300

     Cash, cash equivalents, short-term investments, and restricted cash equivalents as of December 31, 2005 consist of the following (in thousands):

						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost				Gains				Losses				Fair Value
Cash and cash equivalents:
Cash		$	2,455			$	—			$	—			$	2,455
Money market mutual funds			587,256				—				—				587,256
Corporate notes and bonds			49,234				—				—				49,234
U.S. Government agency securities			13,026				—				—				13,026
Total cash and cash equivalents			651,971				—				—				651,971
Short-term investments:
U.S. Government agency securities			129,658				—				(302	)			129,356
Total short-term investments			129,658				—				(302	)			129,356
Total cash, cash equivalents, and short-term investments		$	781,629			$	—			$	(302	)		$	781,327
Restricted cash equivalents		$	17,300			$	—			$	—			$	17,300

     At December 31, 2006, restricted cash equivalents represent cash equivalents pledged as collateral against two letters of credit for a total of $17.3 million in connection with two lease agreements.

     Realized gains or losses on sales of available-for-sale securities for 2006, 2005, and 2004 were not significant.

     Changes in estimated fair values of short-term investments are primarily related to changes in interest rates and are considered to be temporary in nature.

     The contractual maturities of available-for-sale debt securities at December 31, 2006 are as follows (in thousands):

		Amortized				Estimated
		Cost				Fair Value
Within one year		$	120,909			$	120,945
Between one year and two years			32,611				32,743
Total short-term investments		$	153,520			$	153,688

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued

Note 5. Allowance for Doubtful Accounts Receivable and Sales Returns

     Activity in the allowance for doubtful accounts receivable is as follows (in thousands):

		Years Ended December 31,
		2006				2005				2004
Balance, beginning of year		$	1,340			$	1,145			$	1,278
Additions charged to expenses			596				377				527
Amounts written off			(835	)			(182	)			(660	)
Balance, end of year		$	1,101			$	1,340			$	1,145

     Activity in the allowance for sales returns is as follows (in thousands):

		Years Ended December 31,
		2006				2005				2004
Balance, beginning of year		$	1,633			$	2,141			$	1,580
Additions charged to revenue			4,898				6,560				8,528
Amounts written off			(5,142	)			(7,068	)			(7,967	)
Balance, end of year		$	1,389			$	1,633			$	2,141

     At December 31, 2006 one international customer accounted for 25% of trade accounts receivable. At December 31, 2005 no one customer accounted for more than 10% of trade accounts receivable.

     No one customer accounted for more than 10% of total revenue during the years ended December 31, 2006, 2005, and 2004.

Note 6. Deferred Costs

     Deferred costs, consisting of costs being amortized over the respective contract lives, are as follows (in thousands):

		December 31,
		2006
Deferred costs		$	2,170
Less current portion			1,643
Deferred costs, non-current portion		$	527

     No deferred costs were recorded at December 31, 2005.

Note 7. Equity Investments

     The Company has certain equity investments that are accounted for under the cost method of accounting. The cost method is used to account for equity investments in companies in which the Company holds less than a 20 percent voting interest, does not exercise significant influence, and for which the related securities do not have a quoted market price.

     The Company has certain equity investments in publicly traded companies in which the Company holds less than a 20 percent voting interest. The investments are accounted for at market value. Changes in the market value of the investments are recognized as unrealized gains (losses), net of income tax, and are recorded in the accompanying consolidated balance sheets as a component of accumulated other comprehensive income.

     During the quarter ended March 31, 2006, the Company established Beijing RealNetworks Technology Co., Ltd, a Wholly Owned Foreign Entity (WOFE) which operates an Internet retail website in the People’s Republic of China (PRC) in cooperation with a PRC affiliate. The results of operations of the WOFE have been included in the Company’s consolidated results since the establishment date of the WOFE. The PRC regulates the WOFE’s business through regulations and license requirements restricting: (i) the scope of foreign investment in the Internet, retail and delivery sectors; (ii) Internet content; and (iii) the sale of certain media products. In order to meet the PRC local ownership and regulatory licensing requirements, the WOFE’s business is operated through a PRC affiliate which is owned by nominee shareholders who are PRC nationals and RealNetworks employees. The WOFE does not own any capital stock of the PRC affiliate, but is the primary beneficiary of future losses or profits through contractual rights. As a result, the Company consolidates the results of the PRC affiliate in accordance with FIN No. 46R, Consolidation of Variable Interest Entities. The net assets and operating results for the PRC affiliate were not significant during the year ended December 31, 2006.

REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — continued