Edgar Filing: REALNETWORKS INC

e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the Quarterly Period Ended September 30, 2009


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

For the transition period from to

Commission file number 0-23137

RealNetworks, Inc.

(Exact name of registrant as specified in its charter)


Washington		91-1628146
(State of incorporation)		(I.R.S. Employer Identification Number)

2601 Elliott Avenue, Suite 1000
Seattle, Washington		98121
(Address of principal executive offices)		(Zip Code)

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

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer þ

Accelerated filer o

Non-accelerated filer o
(Do not check if a smaller reporting company)

Smaller reporting company 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 number of shares of the registrant’s Common Stock outstanding as of October 29, 2009 was 134,834,383.

TABLE OF CONTENTS


	Page
Part I. Financial Information		3
Item 1. Financial Statements		3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3. Quantitative and Qualitative Disclosures About Market Risk		40
Item 4. Controls and Procedures		41
Part II. Other Information		41
Item 1. Legal Proceedings		41
Item 1A. Risk Factors		43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		54
Item 3. Default Upon Senior Securities		54
Item 4. Submission of Matters to a Vote of Security Holders		54
Item 5. Other Information		54
Item 6. Exhibits		55
Signature		56
EX-31.1
EX-31.2
EX-32.1
EX-32.2

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,
	2009			2008
ASSETS
Current assets:
Cash and cash equivalents	$	204,777		$	232,968
Short-term investments		168,420			137,766
Trade accounts receivable, net of allowances for doubtful accounts and sales returns		67,060			70,201
Deferred costs, current portion		5,383			4,026
Prepaid expenses and other current assets		31,388			34,599

Total current assets		477,028			479,560

Equipment, software, and leasehold improvements, at cost:
Equipment and software		147,430			135,788
Leasehold improvements		31,003			30,719

Total equipment, software, and leasehold improvements, at cost		178,433			166,507
Less accumulated depreciation and amortization		119,903			103,500

Net equipment, software, and leasehold improvements		58,530			63,007
Restricted cash equivalents and investments		13,700			14,742
Equity investments		21,768			18,582
Other assets		4,180			3,775
Deferred costs, non-current portion		8,945			6,120
Deferred tax assets, net, non-current portion		9,867			9,236
Other intangible assets, net		12,761			18,727
Goodwill		—			175,264

Total assets	$	606,779		$	789,013

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	39,264		$	36,575
Accrued and other liabilities		111,295			118,688
Deferred revenue, current portion		35,812			39,835
Related party payable		8,007			13,155
Accrued loss on excess office facilities, current portion		4,338			4,317

Total current liabilities		198,716			212,570
Deferred revenue, non-current portion		1,933			1,961
Accrued loss on excess office facilities, non-current portion		—			2,893
Deferred rent		4,534			4,614
Deferred tax liabilities, net, non-current portion		859			1,379
Other long-term liabilities		11,027			11,660

Total liabilities		217,069			235,077

Noncontrolling interest in Rhapsody America		5,440			378
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 134,823 shares in 2009 and 134,354 shares in 2008		135			134
Additional paid-in capital		664,052			642,705
Accumulated other comprehensive loss		(40,420	)		(48,729	)
Retained deficit		(239,497	)		(40,552	)

Total shareholders’ equity		384,270			553,558

Total liabilities and shareholders’ equity	$	606,779		$	789,013

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)


	Quarters Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Net revenue (A)	$	140,264		$	151,955		$	416,762		$	452,166
Cost of revenue (B)		53,686			62,164			165,321			173,202

Gross profit		86,578			89,791			251,441			278,964

Operating expenses:
Research and development		29,425			31,076			86,907			85,147
Sales and marketing		39,573			55,080			125,531			161,730
Advertising with related party		7,941			15,153			22,229			31,733
General and administrative		13,039			15,453			55,208			50,874
Impairment of goodwill		—			—			175,583			—
Restructuring and other charges		877			—			1,671			686

Total operating expenses		90,855			116,762			467,129			330,170

Operating loss		(4,277	)		(26,971	)		(215,688	)		(51,206	)

Other income (expenses):
Interest income, net		1,253			2,865			3,190			11,198
Equity in net loss of investments		(273	)		(226	)		(1,197	)		(424	)
Gain on sale of equity investments, net		604			—			809			222
Gain on sale of interest in Rhapsody America		—			7,405			—			14,502
Other income (expense), net		(888	)		818			(482	)		1,636

Other income (expenses), net		696			10,862			2,320			27,134

Loss before income taxes		(3,581	)		(16,109	)		(213,368	)		(24,072	)
Income taxes		(686	)		(728	)		(3,445	)		(8,436	)

Net loss		(4,267	)		(16,837	)		(216,813	)		(32,508	)
Net loss attributable to noncontrolling interest in Rhapsody America		5,787			12,337			17,868			29,129

Net income (loss) attributable to common shareholders	$	1,520		$	(4,500	)	$	(198,945	)	$	(3,379	)

Basic net income (loss) per share available to common shareholders	$	0.00		$	(0.03	)	$	(1.50	)	$	(0.02	)
Diluted net income (loss) per share available to common shareholders	$	0.00		$	(0.03	)	$	(1.50	)	$	(0.02	)
Shares used to compute basic net income (loss) per share available to common shareholders		134,793			141,975			134,531			142,611
Shares used to compute diluted net income (loss) per share available to common shareholders		134,978			141,975			134,531			142,611
Comprehensive income (loss):
Net loss	$	(4,267	)	$	(16,837	)	$	(216,813	)	$	(32,508	)
Unrealized holding losses (gains) on short-term and equity investments, net of income taxes		70			(1,841	)		3,868			(2,130	)
Foreign currency translation gains (losses)		3,223			(38,759	)		4,441			(59,090	)

Comprehensive loss		(974	)		(57,437	)		(208,504	)		(93,728	)
Net loss attributable to noncontrolling interest		5,787			12,337			17,868			29,129

Comprehensive income (loss) attributable to common shareholders	$	4,813		$	(45,100	)	$	(190,636	)	$	(64,599	)


(A) Components of net revenue:
License fees	$	23,621		$	28,394		$	74,189		$	82,762
Service revenue		116,643			123,561			342,573			369,404

	$	140,264		$	151,955		$	416,762		$	452,166

(B) Components of cost of revenue:
License fees	$	8,113		$	11,137		$	27,228		$	31,139
Service revenue		45,573			51,027			138,093			142,063

	$	53,686		$	62,164		$	165,321		$	173,202

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


	Nine Months Ended
	September 30,
	2009			2008
Cash flows from operating activities:
Net loss	$	(216,813	)	$	(32,508	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		22,881			38,032
Stock-based compensation		15,545			17,475
Loss on disposal of equipment, software, and leasehold improvements		302			157
Equity in net loss of investments		1,197			198
Gain on sale of equity investments, net		(809	)		(222	)
Impairment of goodwill		175,583			—
Excess tax benefit from stock option exercises		(9	)		(108	)
Accrued loss on excess office facilities		(2,872	)		(2,537	)
Deferred income taxes		545			2,640
Gain on sale of interest in Rhapsody America		—			(14,502	)
Accrued restructuring and other charges		(3,786	)		—
Other		39			111
Net change in certain operating assets and liabilities, net of acquisitions:
Trade accounts receivable		4,363			12,696
Prepaid expenses and other assets		2,072			(26,066	)
Accounts payable		1,276			(16,766	)
Accrued and other liabilities		(16,006	)		386

Net cash used in operating activities		(16,492	)		(21,014	)

Cash flows from investing activities:
Purchases of equipment, software, and leasehold improvements		(11,445	)		(24,807	)
Purchases of short-term investments		(124,043	)		(151,378	)
Proceeds from sales and maturities of short-term investments		93,389			130,136
Purchases of other intangible assets		—			(1,808	)
Decrease in restricted cash equivalents and investments		1,042			776
Payment of acquisition costs, net of cash acquired		(3,324	)		(10,192	)
Purchase of equity investments		(2,000	)		(4,500	)
Proceeds from sales of equity investments		1,014			1,225

Net cash used in investing activities		(45,367	)		(60,548	)

Cash flows from financing activities:
Net proceeds from sale of common stock under employee stock purchase plan and exercise of stock options		819			8,834
Payments of convertible debt obligations		—			(100,000	)
Excess tax benefit from stock option exercises		9			108
Net proceeds from sales of interest in Rhapsody America		26,912			31,640
Repurchase of common stock		—			(23,062	)

Net cash provided by (used in) financing activities		27,740			(82,480	)

Effect of exchange rate changes on cash and cash equivalents		5,928			(7,512	)

Net decrease in cash and cash equivalents		(28,191	)		(171,554	)
Cash and cash equivalents, beginning of period		232,968			476,697

Cash and cash equivalents, end of period	$	204,777		$	305,143

Supplemental disclosure of cash flow information:
Cash received from income tax refunds	$	7,432		$	—
Cash paid for income taxes	$	4,749		$	11,170

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2009 and 2008

Note 1. 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 unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned and majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to 2009 and 2008 amounts to conform to the current presentation. The Company has evaluated subsequent events through the date and time the financial statements were issued on October 30, 2009.

On August 20, 2007, RealNetworks and MTV Networks, a division of Viacom International Inc. (MTVN), created Rhapsody America LLC (Rhapsody America) to jointly own and operate a business-to-consumer digital audio music service. RealNetworks held a 51% interest in Rhapsody America as of September 30, 2009. Rhapsody America’s financial position and operating results have been consolidated into RealNetworks’ financial statements since its formation in August 2007. The noncontrolling interest’s proportionate share of income (loss) is included in noncontrolling interest in Rhapsody America in the unaudited condensed consolidated statements of operations and comprehensive income (loss). MTVN’s proportionate share of equity is included in noncontrolling interest in Rhapsody America in the unaudited condensed consolidated balance sheets.

The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of the Company’s management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for any subsequent quarter or for the year ending December 31, 2009. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

Revenue Recognition. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. The product is considered delivered to the customer once it has been shipped and title and risk of loss have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. For online sales the product is considered delivered at the time the product is made available, digitally, to the end user.

The Company recognizes revenue on a gross or net basis. 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 recognizes 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 recognizes revenue on a net basis.

In the Company’s direct to consumer business segments, which include: Music, Games and Media Software and Services, it derives revenue through (1) subscriptions, (2) sales of content downloads, software and licenses, and (3) the sale of advertising and the distribution of third-party products on its websites and in the Company’s games.

Consumer subscription products are paid in advance, typically for monthly, quarterly or annual duration. Subscription revenue is recognized ratably over the related subscription time period. Revenue from sales of content downloads, software and licenses is recognized at the time the product is made available, digitally, to the end user. Revenue generated from advertising on the Company’s websites and from advertising and the distribution of third-party products included in its products is recognized as revenue at the time of delivery.

The Company’s business-to-business Technology Products and Solutions segment generates revenue by providing services that enable wireless carriers to deliver audio and video content to their customers and through sales of software licenses and products and related support and other services.

Revenue generated from services provided to wireless carriers that enable the delivery of audio and video content to their customers is recognized as the services are provided. Setup fees to build these services are recognized ratably upon launch of the service over the remaining expected term of the service.

A portion of the revenue related to the sale of software licenses and products and related support and other services is recorded as unearned due to undelivered elements including, in some cases, post-delivery support and the right to receive unspecified upgrades or enhancements on a when-and-if-available basis. The amount of revenue allocated to undelivered elements is based on the vendor specific objective evidence of fair value for those elements using the residual method or relative fair value method. Unearned revenue due to undelivered elements is recognized ratably on a straight-line basis over the related products’ life cycles.

Accounting for Gains on Sale of Subsidiary Stock. Effective January 1, 2009, the Company adopted Statement of Financial Accounting Standards No. 160, Non-controlling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS 160) which was primarily codified into FASB ASC 810 — Consolidation (ASC 810). Current guidance requires the difference between the carrying amount of the parent’s investment in a subsidiary and the underlying net book value to be recorded as an equity transaction. The Company elected to recognize any such gain in its consolidated statement of operations prior to January 1, 2009.

Noncontrolling Interests. The Company records noncontrolling interest expense (benefit) which reflects the portion of the earnings (losses) of majority-owned entities which are applicable to the noncontrolling interest partners in the consolidated statement of operations. Redeemable noncontrolling interests that are redeemable at either fair value or are based on a formula that is intended to approximate fair value follow the Company’s historical disclosure only policy for the redemption feature, and the current redemption amount of the redeemable noncontrolling interests is disclosed in Note 4. Redeemable noncontrolling interests that are redeemable at either a fixed price or are based on a formula that is not akin to fair value are reflected as an adjustment to income (loss) attributable to common shareholders based on the difference between accretion as calculated using the terms of the redemption feature and the accretion entry for a hypothetical fair value redemption feature with the remaining amount of accretion to redemption value recorded directly to equity. Noncontrolling interest expense (benefit) is included within the condensed consolidated statements of operations and comprehensive income (loss) for the quarters and nine months ended September 30, 2009 and 2008.

As of September 30, 2009 and December 31, 2008, the Company’s noncontrolling interests solely related to redeemable noncontrolling interests in Rhapsody America. See Note 4 for further discussion of the redeemable noncontrolling interest treatment.

Note 2. Recent Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the quarter and nine months ended September 30, 2009, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, that are of significance, or potential significance to the Company.

Effective January 1, 2009, the Company adopted SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)) which was primarily codified into FASB Accounting Standards Codification (ASC) 805, Business Combinations (ASC 805). Under current guidance, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequent to the acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. The current guidance is effective on a prospective basis for all business combinations for which the acquisition date is on or after January 1, 2009, with the exception of the accounting for valuation allowances on deferred taxes and acquired contingencies. With the adoption of the current guidance, any tax related adjustments associated with acquisitions that closed prior to January 1, 2009 will be recorded through income tax expense, whereas the previous accounting treatment would require any adjustment to be recognized through goodwill. The adoption of the current guidance had no impact on the Company’s consolidated financial statements as of, and for the quarter and nine months ended September 30, 2009.

Effective January 1, 2009, the Company adopted, FASB Staff Position (FSP) No. 142-3, Determination of the Useful Life of Intangible Assets (FSP No. 142-3) which was primarily codified into FASB ASC 350, Intangibles — Goodwill and Other (ASC 350). The current guidance amends the factors considered in developing renewal or extension assumptions used to determine the useful life

of a recognized intangible asset. The current guidance also requires enhanced disclosures when an intangible asset’s expected future cash flows are affected by an entity’s intent and/or ability to renew or extend the arrangement. The adoption did not have a material impact on the Company’s consolidated results of operations or financial condition as of, and for the quarter and nine months ended September 30, 2009.

Effective January 1, 2009, the Company implemented Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS 160) which was primarily codified into FASB ASC 810 — Consolidation (ASC 810). This standard changed the accounting for and reporting of noncontrolling interest (previously called minority interest) in the consolidated financial statements. Upon adoption, certain prior period amounts have been reclassified to conform to the current period financial statement presentation. These reclassifications have no effect on the Company’s previously reported financial position or results of operations. Refer to Note 4, Rhapsody America, and Note 13, Earnings per Share, of this report for additional information on the adoption.

Effective January 1, 2009, the Company adopted FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (FSP 14-1) which was primarily codified into FASB ASC 470 — Debt (ASC 470). Current guidance specifies that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate and requires retrospective application for all periods presented. The adoption did not have a material impact on the Company’s consolidated results of operations or financial condition for all periods presented.

Effective April 1, 2009, the Company adopted SFAS No. 165, Subsequent Events (SFAS 165) which was primarily codified into FASB ASC 855 — Subsequent Events (ASC 855). The current guidance is intended to establish general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date.

Effective April 1, 2009, the Company adopted FSP No. 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2 and 124-2) which was primarily codified into FASB ASC 320 — Investments — Debt and Equity Securities (ASC 320). The current guidance provides new guidance on the recognition and presentation of an other-than-temporary impairments, as well as extends certain annual disclosure requirements to interim periods. The adoption did not have a material impact on the Company’s financial position or results of operations.

Effective September 30, 2009, the Company adopted SFAS No. 168, The FASB Accounting Standards Codification (Codification) and the Hierarchy of Generally Accepted Accounting Principles- a replacement of Financial Statement No. 162 (SFAS 168) which was primarily codified into FASB ASC 105 — Generally Accepted Accounting Principles. Current guidance establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with generally accepted accounting principles in the United States. The adoption did not have a material impact on the Company’s consolidated results of operations or financial condition for all periods presented.

In September 2009, the FASB ratified Accounting Standards Update (ASU) 2009-13 (ASU 2009-13) (previously Emerging Issues Task Force (EITF) Issue No. 08-1, Revenue Arrangements with Multiple Deliverables (EITF 08-1)). ASU 2009-13 superseded EITF 00-21 and addresses criteria for separating the consideration in multiple-element arrangements. ASU 2009-13 will require companies to allocate the overall consideration to each deliverable by using a best estimate of the selling price of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price. ASU 2009-13 will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption will be permitted. The Company is currently evaluating the potential impact, if any, of the adoption of ASU 2009-13 on its consolidated results of operations and financial condition and whether it will adopt the standard early.

In September 2009, the FASB ratified ASU 2009-14 (ASU 2009-14) (previously EITF No. 09-3, Certain Revenue Arrangements That Include Software Elements). ASU 2009-14 modifies the scope of Software Revenue Recognition to exclude (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. ASU 2009-14 has an effective date that is consistent with ASU 2009-13. The Company is currently evaluating the potential impact, if any, of the adoption of ASU 2009-14 on our consolidated results of operations and financial condition and whether it will adopt the standard early.

Note 3. Stock-Based Compensation

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. The Company recognizes compensation cost related to options granted on a straight-line basis over the applicable vesting period.

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. 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. 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.

The fair value of options granted was determined using the Black-Scholes model and the following weighted-average assumptions:


	Quarters						Nine Months
	Ended September 30,						Ended September 30,
	2009			2008			2009			2008
Expected dividend yield		0	%		0	%		0	%		0	%
Risk-free interest rate		2.02	%		2.95	%		1.75	%		2.65	%
Expected life (years)		4.2			4.2			4.2			4.2
Volatility		63	%		45	%		63	%		45	%

Recognized stock-based compensation expense is as follows (in thousands):


	Quarters				Nine Months
	Ended September 30,				Ended September 30,
	2009		2008		2009		2008
Cost of revenue	$	309	$	696	$	1,302	$	1,592
Research and development		1,788		2,247		5,846		6,307
Sales and marketing		1,099		1,458		3,364		4,798
General and administrative		1,532		1,554		5,033		4,778

Total stock-based compensation expense	$	4,728	$	5,955	$	15,545	$	17,475

No stock-based compensation was capitalized as part of the cost of an asset during the quarters or nine months ended September 30, 2009 or 2008. As of September 30, 2009, $22.6 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 2.1 years.

Note 4. Rhapsody America

Formation

On August 20, 2007, RealNetworks and MTVN created Rhapsody America to jointly own and operate a business-to-consumer digital audio music service. Under the Rhapsody America venture agreements:

	•		RealNetworks contributed its Rhapsody service subscribers, RadioPass subscribers, cash, 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. In February 2009, RealNetworks and MTVN signed an amendment to the

			Rhapsody America venture agreement to true-up the original fair values contributed to the venture. The amendment reduced the MTVN note payable from $230.0 million to $213.8 million over the same five-year term. 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.

			Effective January 1, 2009, the Company adopted SFAS 160 (primarily codified into ASC 810) which requires the appreciation of gains on the sale of non-controlling interest to be recorded as an equity transaction. Prior to the adoption of SFAS 160, the Company elected to recognize any such gain in the consolidated statement of operations in accordance with SAB 51 (primarily codified into FASB ASC 810 — Consolidation). MTVN made payments of $17.0 million and $31.4 million during the quarter and nine months ended September 30, 2008, respectively. As a result, RealNetworks realized and recorded gains in the condensed consolidated statements of operations for the quarter and nine months ended September 30, 2008 of $8.7 million and $16.0 million, respectively, as all of the gain criteria were met. During the quarter and nine months ended September 30, 2009, MTVN made payments of $7.4 million and $21.9 million, respectively, for which the sale of ownership interests in Rhapsody America have been reflected as an equity transaction and $3.8 million and $11.2 million, respectively, have been recorded directly to shareholders’ equity. As of September 30, 2009, $91.3 million in payments have been made on the note since the formation of Rhapsody America.

Call/Put Rights

Pursuant to the terms of the Rhapsody America limited liability company agreement, RealNetworks has the right to purchase from MTVN, and MTVN has a right to require RealNetworks to purchase, MTVN’s interest in Rhapsody America. The Company has evaluated the terms of the call and put rights under applicable accounting literature, and concluded that neither of these rights represent freestanding financial instruments or derivatives that should be accounted for separately.

These call and put rights are exercisable upon the occurrence of certain events any time after January 1, 2011 and during certain periods in each of 2012, 2013 and 2014 and every two years thereafter, and are not exercisable any time prior to January 1, 2011. If MTVN exercises its put right, RealNetworks has the right to pay a portion of the purchase price for MTVN’s interest in cash and shares of RealNetworks capital stock, subject to certain maximum amounts, with the balance (if any) to be paid with a note. If RealNetworks exercises its call right, MTVN has the right to demand payment of part of the purchase price for its membership interest in shares of RealNetworks’ capital stock. If a portion of the purchase price for MTVN’s interest is payable in shares of RealNetworks’ capital stock, such shares could consist of RealNetworks’ common stock representing up to 15% of the outstanding shares of RealNetworks’ common stock immediately prior to the transaction, and shares of our non-voting stock representing up to an additional 4.9% of the outstanding shares of RealNetworks’ common stock immediately prior to the transaction, representing a maximum total of 19.9% of RealNetworks’ capital stock. If RealNetworks pays a portion of the purchase price for MTVN’s membership interest in shares of RealNetworks’ common stock and non-voting stock, RealNetworks other shareholders’ voting and economic interests in RealNetworks could be diluted, and MTVN will become one of RealNetworks’ significant shareholders.

The redemption prices of MTVN’s interest in Rhapsody America under both the call and put rights are calculated based on the provisions within the limited liability agreement, as amended, are impacted by the total appraised value of Rhapsody America and assume repayment of the $213.8 million five-year note payable from MTVN. Once the call right becomes exercisable, the redemption price of MTVN’s interest in Rhapsody America under the call right will be equal to the greater of $213.8 million or the appraised value of MTVN’s interest in Rhapsody America at the redemption date.

Once the put right becomes exercisable, the redemption price of MTVN’s interest in Rhapsody America under the put right will be based on a formula that is dependent on the appraised value of Rhapsody America. If the appraised value of Rhapsody America at that time is equal to or greater than $436.3 million, the implied fair value of the venture at its inception, then the exercise price of the put is equal to the appraised value. If the appraised value of Rhapsody America at the redemption date is less than $436.3 million, then the exercise price of the put includes a preferred return due to MTVN.

For the period from August 20, 2007 (inception of the venture) through September 30, 2008, the Company determined that the value of the Rhapsody America venture had not declined from its initial implied fair value and assessed the probability that the put would include a preferred return as remote. The formula that determined that put redemption amount was considered to approximate fair value for this period. However, beginning with the fourth quarter of 2008, the current appraised value of Rhapsody America was determined to have declined to the point where the Company has determined that the likelihood of the put triggering the preferred

return when exercisable was no longer remote and considered the put formula to no longer approximate fair value. Beginning with the fourth quarter of 2008, the Company has accounted for the noncontrolling interest as having a fixed price redemption feature.

The hypothetical current redemption price of MTVN’s interest in Rhapsody America under the put right at September 30, 2009, before consideration of the remaining payments due on the note, was approximately $27.1 million. The current redemption price has been adjusted under the formula in the limited liability agreement for the remaining outstanding amounts due of $122.5 million on the note payable as of September 30, 2009. The Company has elected to accrete any excess of the redemption value over the carrying amount as an adjustment to income attributable to common shareholders and has adjusted earnings per share for the current quarter’s accretion of the difference between accretion as calculated using the terms of the redemption feature and the accretion entry for a hypothetical fair value redemption feature. For the quarter and nine months ended September 30, 2009, the Company increased the noncontrolling interest on the Condensed Consolidated Balance Sheets by $3.9 million and $5.8 million, respectively, of which, $0.9 million and $2.8 million was an adjustment to income attributable to common shareholders for the purposes of calculating earnings per share during the quarter and nine months ended September 30, 2009, respectively. See Note 13, Earnings Per Share, for more information on this item. For 2008, this amount was nominal to the condensed consolidated financial statements.

Noncontrolling interest rollforward

Activity in noncontrolling interest and equity attributable to common shareholders is as follows (in thousands):


	Noncontrolling interest			Total Equity
Balances, December 31, 2007	$	19,613		$	875,104
Net income (loss)		(29,129	)		(3,379	)
Contribution and other transactions with owners		15,813			—
Unrealized holding losses on short-term and equity investments, net of taxes		—			(2,130	)
Foreign currency translation losses		—			(59,090	)
Stock-based transactions and compensation expense, net of taxes		—			1,965

Balances, September 30, 2008	$	6,297		$	812,470


	Noncontrolling interest			Total Equity
Balances, December 31, 2008	$	378		$	553,558
Net loss		(17,868	)		(198,945	)
Contribution and other transactions with owners		17,140			10,998
Accretion of MTVN’s equity interest in Rhapsody Amercia		3,015			(3,015	)
Accretion of MTVN’s preferred return in Rhapsody Amercia		2,775			(2,775	)
Unrealized holding losses on short-term and equity investments, net of taxes		—			3,868
Foreign currency translation losses		—			4,441
Stock-based transactions and compensation expense, net of taxes		—			16,140

Balances, September 30, 2009	$	5,440		$	384,270

Note 5. Fair Value Measurements

The Company measures certain financial assets at fair value on a recurring basis, including cash equivalents, short-term investments, and equity investments. The fair value of these financial assets was determined based on three levels of inputs:

	•		Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities

	•		Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active

	•		Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions

Items Measured at Fair Value on a Recurring Basis

The following table presents information about the Company’s financial assets that have been measured at fair value (in thousands) on a recurring basis as of September 30, 2009 and December 31, 2008 and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value.


	Fair Value Measurements as of
	September 30, 2009
	Total		Level 1		Level 2		Level 3
			(In thousands)
Cash equivalents
Money market funds	$	148,752	$	148,752	$	—	$	—
Short-term investments
Corporate notes and bonds		86,957		86,957		—		—
U.S. government agency securities		81,463		81,463		—		—
Equity investments
Publicly traded investments		16,476		16,476		—		—

Total	$	333,648	$	333,648	$	—	$	—


	Fair Value Measurements as of
	December 31, 2008
	Total		Level 1		Level 2		Level 3
			(In thousands)
Cash equivalents
Money market funds	$	157,063	$	157,063	$	—	$	—
U.S. government agency securities		4,292		4,292		—		—
Short-term investments
U.S. government agency securities		84,330		84,330		—		—
Corporate notes and bonds		53,436		53,436		—		—
Equity investments
Publicly traded investments		13,903		13,903		—		—

Total	$	313,024	$	313,024	$	—	$	—

Investments in marketable securities classified as short-term investments and equity investments of public companies are measured at fair value using quoted market prices and are classified within Level 1 of the valuation hierarchy. The Company carries its equity investments in private companies at cost and no fair value is derived The Company has consistently applied these valuation techniques in all periods presented.

Items Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities of the Company are measured at estimated fair value on a non-recurring basis. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). The Company performed a valuation of its goodwill as of June 30, 2009 using Level 3 inputs and recorded goodwill impairment charges of $175.6 million during the quarter and six months ended June 30, 2009. See “Note 10. Goodwill” for a description of the inputs, valuation techniques and other information used to determine the fair value of the Company’s goodwill as of June 30, 2009 and the related impairments.

Note 6. Cash, Cash Equivalents, Trading Securities, Short-Term Investments, and Restricted Cash Equivalents and Investments

Cash, cash equivalents, trading securities, short-term investments, and restricted cash equivalents and investments as of September 30, 2009 consist of the following (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
Cash and cash equivalents:
Cash	$	56,025	$	—	$	—		$	56,025
Money market mutual funds		148,752		—		—			148,752

Total cash and cash equivalents:		204,777		—		—			204,777

Short-term investments:
Corporate notes and bonds		86,288		873		(204	)		86,957
U.S. Government agency securities		81,325		167		(29	)		81,463

Total short-term investments:		167,613		1,040		(233	)		168,420

Total cash, cash equivalents and short-term investments	$	372,390	$	1,040	$	(233	)	$	373,197

Restricted cash equivalents and investments	$	13,700	$	—	$	—		$	13,700

Cash, cash equivalents, short-term investments, and restricted cash equivalents as of December 31, 2008 consist of the following (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
Cash and cash equivalents:
Cash	$	71,613	$	—	$	—	$	71,613
Money market mutual funds		156,803		260		—		157,063
U.S. government agency securities		4,203		89		—		4,292

Total cash and cash equivalents		232,619		349		—		232,968


			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
Short-term investments:
Corporate notes and bonds		54,685		154		(1,403	)		53,436
U.S. Government agency securities		83,920		410		—			84,330

Total short-term investments		138,605		564		(1,403	)		137,766

Total cash, cash equivalents, and short-term investments	$	371,224	$	913	$	(1,403	)	$	370,734

Restricted cash equivalents	$	14,742	$	—	$	—		$	14,742

At September 30, 2009 and December 31, 2008, restricted cash equivalents and investments represent cash equivalents and short-term investments pledged as collateral against two letters of credit for a total of $13.7 million and $14.7 million, respectively, in connection with two lease agreements.

Realized gains or losses on sales of available-for-sale securities for the quarters and nine months ended September 30, 2009 and 2008 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 investments at September 30, 2009 are as follows (in thousands):


	Amortized		Estimated
	Cost		Fair Value
Within one year	$	32,589	$	32,705
Between one year and five years		133,504		134,182
Between five years and fifteen years		1,520		1,533

Total available-for-sale investments	$	167,613	$	168,420

Note 7. Allowance for Doubtful Accounts Receivable and Sales Returns

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


	Allowance For
	Doubtful
	Accounts			Sales
	Receivable			Returns
Balances, December 31, 2008	$	3,532		$	1,099
Additions charged to expenses		725			1,207
Amounts written off		(1,778	)		(1,254	)

Balances, September 30, 2009	$	2,479		$	1,052

Two customers accounted for 23% and 10% of trade accounts receivable, respectively, as of September 30, 2009. As of December 31, 2008, one customer accounted for 20% of trade accounts receivable. No one customer accounted for more than 10% of total revenue during the quarters and nine months ended September 30, 2009 and 2008.

Note 8. Equity Investments

As of September 30, 2009 and December 31, 2008, the carrying value of equity investments in publicly traded companies primarily relates to J-Stream Inc., a Japanese media services company, and LoEn Entertainment, Inc., a Korean digital music distribution company. These equity investments are accounted for as available-for-sale. The market for these investments is relatively limited and the share price is volatile. Although the carrying value of the total equity investments was $21.8 million at September 30, 2009, there can be no assurance that any gain can be realized through the disposition of these shares.

Summary of equity investments is as follows (in thousands):


	September 30, 2009				December 31, 2008
			Carrying				Carrying
	Cost		Value		Cost		Value
Publicly traded investments	$	10,765	$	16,476	$	10,765	$	13,903
Privately held investments		7,109		5,292		5,695		4,679

Total equity investments	$	17,874	$	21,768	$	16,460	$	18,582

Note 9. Other Intangible Assets

Other intangible assets at September 30, 2009 consist of the following (in thousands):


	Gross		Accumulated
	Amount		Amortization		Net
Customer relationships	$	35,875	$	26,335	$	9,540
Developed technology		29,637		26,840		2,797
Patents, trademarks and tradenames		6,628		6,523		105
Service contracts and other		6,026		5,707		319

Total other intangible assets	$	78,166	$	65,405	$	12,761

Other intangible assets at December 31, 2008 consist of the following (in thousands):


	Gross		Accumulated
	Amount		Amortization		Net
Customer relationships	$	34,004	$	21,705	$	12,299
Developed technology		28,673		23,849		4,824
Patents, trademarks and tradenames		8,556		7,176		1,380
Service contracts and other		3,711		3,487		224

Total other intangible assets	$	74,944	$	56,217	$	18,727

Amortization expense related to other intangible assets during the quarter and nine months ended September 30, 2009 was $2.1 million and $6.6 million, respectively. Amortization expense related to other intangible assets during the quarter and nine months ended September 30, 2008 was $6.5 million and $20.4 million, respectively.

As of September 30, 2009, estimated future amortization of other intangible assets is as follows (in thousands):


2009 (remaining three months)	$	2,135
2010		4,464
2011		2,281
2012		2,014
2013		1,609
Thereafter		258

Total	$	12,761

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparing their carrying amount to future undiscounted cash flows the assets are expected to generate. If long-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value. The Company did not record any impairments to long-lived assets during the quarters and nine months ended September 30, 2009 or 2008.

The impairment analysis of long-lived assets is based upon estimates and assumptions relating to the Company’s future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in the Company’s business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of the Company’s long-lived assets could result in the need to perform an impairment analysis in future periods which could result in a significant impairment.

Note 10. Goodwill

Changes in goodwill are as follows (in thousands):


Balance, December 31, 2008	$	175,264
Effects of foreign currency translation		319
Impairment of goodwill		(175,583	)

Balance, September 30, 2009	$	—

Goodwill is required to be tested for impairment annually and if an event or conditions change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company performs its annual goodwill impairment test during its fiscal fourth quarter.

A two step process is used to test for goodwill impairment. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of each reporting unit to its carrying value including existing goodwill. Goodwill is considered impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment from the first step, a second step is performed to determine the amount of the impairment. This involves calculating the implied fair value of goodwill by allocating the fair value of the reporting unit to all assets and liabilities other than goodwill and comparing it to the carrying amount of goodwill. The Company has four reporting units: Music, Technology Products and Solutions, Games, and Media Software and Services.

The impairment analysis of goodwill is based upon estimates and assumptions relating to the Company’s future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.

The Company determined that a triggering event had occurred during the quarter ended June 30, 2009, warranting an interim impairment analysis of goodwill. During the impairment analysis, the Company determined that the implied fair value of goodwill was zero for each of its reporting units. As a result, the Company impaired $175.6 million, the remaining amount of its goodwill, during the quarter ended June 30, 2009. No impairments were recognized in either the quarter or nine months ended September 30, 2008.

Note 11. Accrued and Other Liabilities

Accrued and other liabilities consist of (in thousands):


	September 30,		December 31,
	2009		2008
Royalties and other fulfillment costs	$	49,108	$	55,247
Employee compensation, commissions and benefits		19,872		21,679
Sales, VAT and other taxes payable		15,862		16,801
Legal fees and contingent legal fees		4,920		3,290
Other		21,533		21,671

Total	$	111,295	$	118,688

Note 12. Loss on Excess Office Facilities

The accrued loss of $4.3 million for estimated future losses on excess office facilities located near the Company’s corporate headquarters in Seattle Washington at September 30, 2009, is shown net of expected future sublease income of $2.7 million, which was committed under sublease contracts at the time of the estimate. The Company regularly evaluates the market for office space in the cities where it has operations. If the market for such space declines further in future periods, the Company may have to revise its estimates further, which may result in additional losses on excess office facilities.

A summary of activity for accrued loss on excess office facilities is as follows (in thousands):


Accrued loss on excess office facilities, December 31, 2008	$	7,210
Less amounts amortized from the accrued loss on excess office facilities		(2,872	)

Accrued loss on excess office facilities, September 30, 2009		4,338

Note 13. Earnings Per Share

Basic net income (loss) available to common shareholders per share is computed by dividing net income (loss) attributable to common shareholders less any accretion from MTVN’s preferred return in Rhapsody America by the weighted average number of common shares outstanding during the period. Diluted net income (loss) available to common shareholders per share is computed by dividing net income (loss) attributable to common shareholders less any accretion from MTVN’s preferred return in Rhapsody America by the weighted average number of common and dilutive potential common shares outstanding during the period. Share

counts used to compute basic and diluted net income available to common shareholders per share are calculated as follows (in thousands):


	Quarters Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Net income (loss) available to common shareholders:
Net income (loss) attributable to common shareholders	$	1,520		$	(4,500	)	$	(198,945	)	$	(3,379	)
Less accretion of MTVN’s preferred return in Rhapsody America		(925	)		—			(2,775	)		—

Net income (loss) available to common shareholders	$	595		$	(4,500	)	$	(201,720	)	$	(3,379	)

Weighted average common shares outstanding used to compute basic net income (loss) per share available to common shareholders		134,793			141,975			134,531			142,611
Dilutive potential common shares:
Stock options and restricted stock		185			—			—			—

Shares used to compute diluted net income (loss) per share available to common shareholders		134,978			141,975			134,531			142,611

Basic net income (loss) per share available to common shareholders	$	0.00		$	(0.03	)	$	(1.50	)	$	(0.02	)
Diluted net income (loss) per share available to common shareholders	$	0.00		$	(0.03	)	$	(1.50	)	$	(0.02	)

During the quarter and nine months ended September 30, 2009, 37.6 million and 38.5 million shares of common stock, respectively, potentially issuable from stock options were excluded from the calculation of diluted net income per share because of their antidilutive effect. During the quarter and nine months ended September 30, 2008, 32.1 million shares of common stock potentially issuable from stock options were excluded from the calculation of diluted net income per share because of their antidilutive effect.

Note 14. Commitments and Contingencies

Borrowing Arrangements. The Company’s subsidiary, WiderThan, has entered into lines of credit with two Korean domestic banks with an aggregate maximum available limit of $1.7 million at interest rates of approximately 2.9% over the rate earned on the underlying deposits. During the quarter and nine months ended September 30, 2009, the Company did not draw on these lines of credit and there were no balances outstanding as of September 30, 2009 or December 31, 2008.

WiderThan uses corporate charge cards issued by a Korean domestic bank with an aggregate line of credit of up to $4.3 million. The charged amounts are generally payable in the following month depending on the billing cycle and are included in accounts payable in the accompanying unaudited condensed consolidated balance sheets. In general, the term of the arrangement is one year, with automatic renewal in April of each year. The arrangement may be terminated in writing by mutual agreement between the bank and the Company. The Company is not subject to any financial or other restrictive covenants under the terms of this arrangement.

WiderThan has a letter of credit of up to $1.0 million with a Korean domestic bank for importing goods, with one-year maturity (renewable every April), which bears interest at 2.5% over the London Inter-Bank Offer Rate (LIBOR). Borrowings under this letter of credit are collateralized by import documents and goods being imported under such documentation. To the extent that the Company has any outstanding balance, the Company is subject to standard covenants and notice requirements under the terms of this facility, such as covenants to consult with the lender prior to engaging in certain events, which include, among others, mergers and acquisitions or sale of material assets or to furnish certain financial and other information. The Company is not, however, subject to any financial covenant requirements or other restrictive covenants that restrict the Company’s ability to utilize this facility or to obtain financing elsewhere. During the quarter and nine months ended September 30, 2009, the Company did not draw on the letter of credit and there was no balance outstanding as of September 30, 2009 or December 31, 2008.

WiderThan has purchase guarantees amounting to $0.9 million from Seoul Guarantee Insurance which guarantees payments for one year under certain supply contracts the Company has with a customer in Korea.

Litigation. On June 29, 2009, MCS Music America, Inc. (MCS Music), and other plaintiffs for whom MCS Music administers copyrights, filed suit for copyright infringement against the Company, Yahoo! Inc. and Microsoft Corporation in U.S. District Court for the Middle District of Tennessee. The complaint asserts that the Company’s Rhapsody music service offers certain compositions for distribution without a license and asks for statutory damages for infringement of the copyrights relating to those compositions. The Company is actively exploring settlement of these claims.

On September 30, 2008, the Company filed a declaratory action against Disney Enterprises, Inc., Paramount Pictures Corp., Sony Pictures Entertainment, Inc., Twentieth Century Fox Film Corp., NBC Universal, Inc., Warner Bros. Entertainment, Inc., Viacom, Inc. (collectively, the “Studios”) and the DVD Copy Control Association (DVD CCA) in the Northern District of California relating to the Company’s RealDVD product (the “RealDVD Litigation”), which, among other things, allows consumers to securely store DVD content on their hard drives. On the same day, various movie studios filed suit against the Company in the Central District of California. The Company’s suit asks the court to find that the RealDVD product does not breach the license agreement that the Company entered into with the DVD CCA. The movie studios’ suit alleges that by offering the RealDVD product, RealNetworks has violated the Digital Millennium Copyright Act. The DVD CCA has filed a counterclaim against the Company alleging that the Company breached its license with the DVD CCA by developing RealDVD. The movie studios’ suit was subsequently transferred to the Northern District of California. In October 2008, the movie studios obtained a temporary restraining order (TRO) requiring the Company to cease distribution of its RealDVD product. In April and May 2009, the Court held a preliminary injunction hearing to address the movie studios’ claim that RealDVD should not be sold pending a final judicial determination of the underlying claims between the parties. On August 11, 2009, the Court granted the movie studios’ motion for a preliminary injunction, which enjoined the Company from selling or otherwise distributing RealDVD to the public. On September 10, 2009, the Company filed a notice of appeal on this ruling with the U.S. Court of Appeals for the Ninth Circuit.

On May 13, 2009, the Company moved to amend its complaint against the Studios in the RealDVD Litigation to add claims that the Studios and DVD CCA conspired to violate, and have violated, state and federal antitrust laws by, among other things, unlawfully eliminating competition in the market for technology that enables a consumer to make a lawful, secure backup copy of a DVD. The Company has filed similar counterclaims against the DVD CCA. In both instances, the Company is seeking injunctive relief to stop the anticompetitive activity, and has also asked for monetary damages. The Company’s motion to amend was granted by the Court. On June 29, 2009, the DVD CCA moved to dismiss the Company’s antitrust counterclaims, and the Studios filed a motion to dismiss the Company’s antitrust counterclaims on September 8, 2009. The hearing on those motions was held on October 26, 2009 and the Company is awaiting the Court’s ruling.

In June 2008, the Company initiated an arbitration action in Seattle, Washington against VeriSign, Inc., to seek resolution of disputes regarding the proper interpretation of an Alliance Agreement entered into between the parties dating back to 2001. VeriSign asserted various counterclaims against the Company, including claims that the Company breached the Alliance Agreement and tortiously interfered with VeriSign’s prospective and existing business relationships and its proposed sale of certain business units. On May 7, 2009, the Arbitrator issued a ruling denying the Company’s claims for relief and granting VeriSign’s claims, including VeriSign’s tortious interference claims. Subsequent to that ruling, the Arbitrator further ruled that the limitation of liability clause contained in the Alliance Agreement does not apply to the potential damages VeriSign incurred. In response, VeriSign filed an amended statement of damages seeking a material amount in damages. A hearing to address VeriSign’s claimed damages began on July 13, 2009 and was adjourned on July 15. On September 10, 2009, the Arbitrator issued a Supplemental Order re: Scheduling and Actions for Final Resolution which set further hearings on damages which were completed on October 12-14, 2009. In that Order, the Arbitrator also determined that VeriSign had failed to prove that RealNetworks caused any damages relating to VeriSign’s claim of tortious interference with its proposed sale of certain business units but allowed further evidence regarding VeriSign’s claims of tortious interference with prospective and existing business relationships. The evidentiary hearings have now been concluded and the Company expects the Arbitrator to issue a final decision in the near future. In August 2009, RealNetworks also filed a motion to vacate the Arbitrator’s interim awards relating to declaratory and injunctive relief in Federal District Court in New York City. That motion is currently under consideration by the federal court. The Company continues to believe that the limitation of liability clause in the Alliance Agreement should apply to limit the amount of VeriSign’s claimed monetary damages and that the Arbitrator does not have jurisdiction over tort claims. No assurance can be made as to the final outcome of the disputes until all rulings are final and all avenues of review have been exhausted, but the Company could ultimately be required to pay damages to VeriSign in an amount that may be material to the Company’s financial condition and results of operations. The Company intends to continue to defend itself vigorously with respect to this matter.

On April 25, 2007, a lawsuit was filed by Greenville Communications, LLC in Greenville, Mississippi against a number of cell phone carriers, including the Company’s partners T-Mobile USA, Inc. and Alltel Corporation, alleging that they infringe its patents by providing ringback tone services. The Company agreed to indemnify T-Mobile and Alltel against the claims based on an indemnity that is claimed to be owed by Real’s subsidiary, WiderThan. On August 27, 2007, the Company’s motion to transfer this matter to the District of New Jersey was granted. The parties have briefed claim construction, but the case has been stayed pending reexamination of the patents at issue. The Company disputes the plaintiff’s allegations regarding both the validity of its patents and its claims of infringement against the Company’s partners.

also been subject to industry-wide settlement negotiations. A partial settlement was reached with respect to on-demand streaming and tethered downloads between the Digital Media Association (DiMA), the Recording Industry Association of America (RIAA) and the National Music Publishers Association (NMPA). This settlement, along with CRB’s determination on rates for full downloads, physical products and ringtones, was published by the CRB, and after some modifications by the U.S. Copyright Office, was collectively published as the CRB’s final determination in the Federal Register. The rate for ringtones and the imposition of a late fee on certain royalty payments contained in the final determination have been appealed by the RIAA. Finally, the Company has been involved in a proceeding in the Southern District of New York to determine a royalty rate for the public performance of music contained in the American Society of Composers, Authors and Publishers (ASCAP) catalogue. In April 2008, the district court issued a preliminary ruling that sets forth, among other things, a methodology to be used to calculate the royalties owed to ASCAP and subsequently issue additional rulings. After working with ASCAP to make a final determination of amounts due under the court’s rulings, the Company reached a partial agreement with ASCAP on January 12, 2009. The Company believes it has sufficiently accrued for expected royalties under the agreement, but the Company plans to appeal some aspects of the court’s rulings that underlie the agreement, and the rulings remain subject to appeal and challenge by other participants.

From time to time the Company is, and expects to continue to be, subject to legal proceedings and claims in the ordinary course of its business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, including those described above, even if not meritorious, could force the Company to spend significant financial and managerial resources. The Company is not aware of any other legal proceedings or claims that the Company believes will have, individually or taken together, a material adverse effect on the Company’s business, prospects, financial condition or results of operations. However, the Company may incur substantial expenses in defending against third-party claims and certain pending claims are moving closer to trial. The Company expects that its potential costs of defending these claims may increase as the disputes move into the trial phase of the proceedings. In the event of a determination adverse to the Company, the Company may incur substantial monetary liability, and/or be required to change its business practices. Either of these could have a material adverse effect on the Company’s financial position, results of operations and cash flows.

Note 15. Segment Information

The Company reports four business segments based on factors such as how the Company manages its operations and how its Chief Operating Decision Maker reviews results. The Company’s Chief Operating Decision Maker is considered to be the Company’s CEO Staff (CEOS), which includes the Company’s Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Executive Vice Presidents and Senior Vice Presidents. The CEOS reviews financial information presented on both a consolidated basis and on a business segment basis, accompanied by disaggregated information about products and services and geographical regions for purposes of making decisions and assessing financial performance. The CEOS reviews discrete financial information regarding profitability of the Company’s Music, Games, Media Software and Services and Technology Products and Solutions segments and, therefore, the Company reports these as operating segments. The accounting policies used to derive segment results are generally the same as those described in Note 1.

The Music segment includes the operations of Rhapsody America as well as the aspects of the Company’s music business not included as part of Rhapsody America. The revenue and costs from these businesses include: digital music subscription services, such as Rhapsody and RadioPass, and sales of digital music content and advertising. These products and services are sold and provided primarily through the Internet, and the Company charges customers’ credit cards at the time of sale. Billing periods for subscription services typically occur monthly, quarterly or annually, depending on the service purchased.

The Games segment primarily includes revenue from the sale of individual games on the Company’s websites RealArcade.com, GameHouse.com and Zylom.com; the sale of games subscription services; advertising through the Company’s games websites; the sale of games through syndication on partner sites; and sales of games through wireless carriers.

The Media Software and Services segment primarily includes revenue from sales of the Company’s SuperPass premium subscription service; sales of RealPlayer Plus and related products; sales and distribution of third-party software products; and all advertising other than that related directly to the Company’s Music and Games businesses.

The Technology Products and Solutions segment includes revenue and costs from: sales of application services such as ringback tones, music-on-demand, video-on-demand, messaging, and information services; sales of media delivery system software and licenses, including Helix system software and related authoring and publishing tools, directly to customers and indirectly through original equipment manufacturer channels; sales of support and maintenance services to customers who purchase software products; sales of broadcast hosting services; and sales of consulting and professional services. These products and services are primarily sold to corporate customers.

Amounts that are not included within the above segment descriptions are shown below as Reconciling Amounts. Included within these amounts are items such as interest income.

Segment net income (loss) attributable to common shareholders for the quarter ended September 30, 2009 is as follows (in thousands):


							Media
							Software and		Technology Products		Reconciling
	Music			Games			Services		and Solutions		Amounts			Consolidated
Net revenue	$	38,765		$	29,491		$	24,580	$	47,428	$	—		$	140,264
Cost of revenue		23,720			7,728			4,090		18,148		—			53,686

Gross profit		15,045			21,763			20,490		29,280		—			86,578
Operating expenses		25,150			27,081			13,249		25,535		(160	)		90,855

Operating income (loss)		(10,105	)		(5,318	)		7,241		3,745		160			(4,277	)
Total non-operating income, net		—			—			—		—		696			696

Income (loss) before income taxes		(10,105	)		(5,318	)		7,241		3,745		856			(3,581	)
Income taxes		—			—			—		—		(686	)		(686	)

Net income (loss)		(10,105	)		(5,318	)		7,241		3,745		170			(4,267	)

Net income (loss) attributable to noncontrolling interest in Rhapsody America		5,787			—			—		—		—			5,787

Net income (loss) attributable to common shareholders	$	(4,318	)	$	(5,318	)	$	7,241	$	3,745	$	170		$	1,520

Segment net income (loss) attributable to common shareholders for the nine months ended September 30, 2009 is as follows (in thousands):


							Media
							Software and			Technology Products			Reconciling
	Music			Games			Services			and Solutions			Amounts			Consolidated
Net revenue	$	123,270		$	92,088		$	64,189		$	137,215		$	—		$	416,762
Cost of revenue		75,965			25,093			10,387			53,876			—			165,321

Gross profit		47,305			66,995			53,802			83,339			—			251,441
Impairment of goodwill		37,029			41,247			46,776			50,531			—			175,583
Other operating expenses		81,640			80,993			51,615			77,384			(86	)		291,546

Operating income (loss)		(71,364	)		(55,245	)		(44,589	)		(44,576	)		86			(215,688	)
Total non-operating income, net		—			—			—			—			2,320			2,320

Income (loss) before income taxes		(71,364	)		(55,245	)		(44,589	)		(44,576	)		2,406			(213,368	)
Income taxes		—			—			—			—			(3,445	)		(3,445	)

Net income (loss)		(71,364	)		(55,245	)		(44,589	)		(44,576	)		(1,039	)		(216,813	)

Net income (loss) attributable to noncontrolling interest in Rhapsody America		17,868			—			—			—			—			17,868

Net income (loss) attributable to common shareholders	$	(53,496	)	$	(55,245	)	$	(44,589	)	$	(44,576	)	$	(1,039	)	$	(198,945	)

Segment net income (loss) attributable to common shareholders for the quarter ended September 30, 2008 is as follows (in thousands):


							Media
							Software		Technology Products			Reconciling
	Music			Games			and Services		and Solutions			Amounts			Consolidated
Net revenue	$	41,591		$	34,200		$	24,531	$	51,633		$	—		$	151,955
Cost of revenue		23,787			10,251			4,539		23,587			—			62,164

Gross profit		17,804			23,949			19,992		28,046			—			89,791
Operating expenses		42,355			28,412			16,064		29,719			212			116,762

Operating income (loss)		(24,551	)		(4,463	)		3,928		(1,673	)		(212	)		(26,971	)
Total non-operating income, net		7,405			—			—		—			3,457			10,862

Income (loss) before income taxes		(17,146	)		(4,463	)		3,928		(1,673	)		3,245			(16,109	)
Income taxes		—			—			—		—			(728	)		(728	)

Net income (loss)		(17,146	)		(4,463	)		3,928		(1,673	)		2,517			(16,837	)

Net income (loss) attributable to noncontrolling interest in Rhapsody America		12,337			—			—		—			—			12,337

Net income (loss) attributable to common shareholders	$	(4,809	)	$	(4,463	)	$	3,928	$	(1,673	)	$	2,517		$	(4,500	)

Segment net income (loss) attributable to common shareholders for the nine months ended September 30, 2008 is as follows (in thousands):


							Media
							Software		Technology Products			Reconciling
	Music			Games			and Services		and Solutions			Amounts			Consolidated
Net revenue	$	116,840		$	100,943		$	80,178	$	154,205		$	—		$	452,166
Cost of revenue		65,999			29,543			12,222		65,438			—			173,202

Gross profit		50,841			71,400			67,956		88,767			—			278,964
Operating expenses		107,978			79,737			46,400		94,683			1,372			330,170

Operating income (loss)		(57,137	)		(8,337	)		21,556		(5,916	)		(1,372	)		(51,206	)
Total non-operating income, net		14,502			—			—		—			12,632			27,134

Income (loss) before income taxes		(42,635	)		(8,337	)		21,556		(5,916	)		11,260			(24,072	)
Income taxes		—			—			—		—			(8,436	)		(8,436	)

Net income (loss)		(42,635	)		(8,337	)		21,556		(5,916	)		2,824			(32,508	)

Net income (loss) attributable to noncontrolling interest in Rhapsody America		29,129			—			—		—			—			29,129

Net income (loss) attributable to common shareholders	$	(13,506	)	$	(8,337	)	$	21,556	$	(5,916	)	$	2,824		$	(3,379	)

The Company’s customers consist primarily of end users located in the U.S., Europe and various foreign countries. Revenue by geographic region is as follows (in thousands):


	Quarters Ended				Nine Months Ended
	September 30,				September 30,
	2009		2008		2009		2008
United States	$	95,758	$	102,363	$	283,109	$	302,430
Europe		23,773		27,151		69,907		78,514
Rest of the World		20,733		22,441		63,746		71,222

Total net revenue	$	140,264	$	151,955	$	416,762	$	452,166

Long-lived assets, consisting of equipment, software, leasehold improvements, other intangible assets, and goodwill by geographic region are as follows (in thousands):


	September 30,		December 31,
	2009		2008
United States	$	54,067	$	163,730
Republic of Korea		7,831		51,508
Europe		6,485		37,315
Rest of the World		2,908		4,445

Total long-lived assets	$	71,291	$	256,998

Net assets by geographic location are as follows (in thousands):


	September 30,		December 31,
	2009		2008
United States	$	342,826	$	437,565
Republic of Korea		10,427		64,824
Europe		21,219		45,845
Rest of the World		9,798		5,324

Total net assets	$	384,270	$	553,558

Goodwill is assigned to the Company’s segments as follows (in thousands):


	September 30,		December 31,
	2009		2008
Music	$	—	$	37,029
Games		—		41,526
Media Software and Services		—		46,776
Technology products and solutions		—		49,933

Total goodwill	$	—	$	175,264

Note 16. Related Party Transactions

Transactions with MTVN. As part of the formation of Rhapsody America, MTVN contributed a $230 million five-year note payable in partial consideration for acquiring MTVN’s interest in the venture. In February 2009, RealNetworks and MTVN signed an amendment to the Rhapsody America venture agreement which reduced the amount payable under the MTVN note to $213.8 million over the original five-year term. During the quarter and nine months ended September 30, 2009, Rhapsody America received $7.4 million and $21.9 million in cash as note payments and spent $7.9 million and $22.2 million, respectively, in advertising with MTVN. During the quarter and nine months ended September 30, 2008, Rhapsody America received $17.0 million and $31.4 million in cash as note payments and spent $15.2 million and $31.7 million, respectively, in advertising with MTVN.

The Company also agreed to grant options to acquire shares of RealNetworks, Inc. common stock to Rhapsody America employees as part of the venture with MTVN and has included the expense associated with these options in its statement of operations and comprehensive income. MTVN’s share of the expense associated with the stock options granted to Rhapsody America employees is calculated based on its ownership percentage and is billed directly by the Company to MTVN under a separate agreement. The Company charged $0.1 million and $0.5 million to MTVN during the quarter and nine months ended September 30, 2009, respectively, related to stock options expense incurred during those periods. The Company charged $0.2 million to MTVN during the quarter and nine months ended September 30, 2008, related to stock options expense incurred during those periods.

The Company also provides various support services, including items such as facilities, information technology systems, personnel and overhead, directly to Rhapsody America. The allocation of other support service costs are based on various measures depending on the service provided, including employee headcount, time employees spend on providing services to Rhapsody America, server usage or number of users of a service. The allocations of these costs are billed directly to Rhapsody America. The Company has treated these allocations as intercompany transactions and all such transactions were eliminated in consolidation.

Transactions with LoEn Entertainment, Inc. During the fourth quarter of 2008, the Company paid $9.9 million to acquire approximately 11% of the outstanding shares of LoEn Entertainment, Inc. (LoEn). The Company paid market price for approximately 2.8 million common shares of LoEn which are traded on the Korean Securities Dealers Automated Quotations. The Company’s investment in LoEn is treated as an equity investment of a public company and is marked-to-market each period with resulting gains/losses recognized in equity as unrealized holding gains/losses on investment. During the quarter and nine months ended September 30, 2009, the Company recorded revenue from LoEn of approximately $3.3 million and $9.2 million, respectively. This revenue consisted primarily of sales of application service provider services, which includes sales of ringback tones, music-on-demand, video-on-demand, and inter-carrier messaging services. Associated with these transactions, RealNetworks also recorded accounts receivable of approximately $3.0 million as of September 30, 2009. Accounts payable and cost of revenue balances associated with LoEn as of and for the quarter and the nine months ended September 30, 2009 were nominal.

Note 17. Repurchase of Common Stock

In May 2008, the Company’s Board of Directors authorized a share repurchase program for the repurchase of up to an aggregate of $50.0 million of its outstanding common stock. During the quarter ended September 30, 2008, the Company purchased 3.6 million shares of its common stock at an average cost of $6.36 per share for an aggregate value of $23.0 million. The Company purchased a total of 3.8 million shares of its common stock at an average cost of $6.39 per share for an aggregate value of $24.5 million during the nine months ended September 30, 2008. There were no shares repurchased during the quarter and nine months ended September 30, 2009. All of the previously authorized share repurchase programs were completed prior to 2009.

Note 18. Income Taxes

As of December 31, 2008, the Company had $10.5 million of unrecognized tax benefits. The total amount of unrecognized tax benefits that would have affected the Company’s effective tax rate if recognized was $9.5 million. The Company has filed formal and informal claims with the Internal Revenue Service for the years 2001-2007, primarily related to Extraterritorial Income Exclusion of $32.4 million and previously acquired net operating losses of $17.1 million. As of September 30, 2009 the total amount of

unrecognized tax benefits is $60.0 million. The total amount of unrecognized tax benefits that would affect the Company’s effective tax rate if recognized is approximately $34.9 million due to the fact that the Company currently has a partial valuation allowance.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of September 30, 2009 and December 31, 2008, the Company had approximately $1.9 million and $1.4 million of accrued interest and penalties related to uncertain tax positions, respectively. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision. The Company does not anticipate that total unrecognized tax benefits will significantly change within the next twelve months.

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. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:

	•		future revenues, income and other taxes, tax benefits, net income (loss) per diluted share, acquisition costs and related amortization, and other measures of results of operations;

	•		the potential outcomes and effects of claims and legal proceedings, including those relating to RealDVD and our ongoing arbitration with VeriSign, on our business, prospects, financial condition or results of operations;

	•		the effects of our past acquisitions and expectations for future acquisitions;

	•		plans, strategies and expected opportunities for future growth, increased profitability and innovation;

	•		the creation of new strategic partnerships and broadening of existing strategic partnerships and the prospects for growth and profitability as a result of such partnerships;

	•		the expected financial position, performance, growth and profitability of our businesses and the availability of resources;

	•		the cash position, performance, 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;

	•		our intention to separate our Games business and to distribute shares of the newly created games company to our shareholders;

	•		our expected introduction of new products and services across our businesses;

	•		the effects of legislation, regulations, administrative proceedings, court rulings, settlement negotiations and other factors that may impact music publishing royalty rates;

	•		impacts of competition and certain customer relationships on the future financial performance and growth of our businesses;

	•		the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations;

	•		the impairment of our assets and anticipated effects on our financial condition or results of operations; and

	•		the effect of economic and market conditions on our business, prospects, financial condition or results of operations.

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

We are a leading creator of digital media services and software. Our mission is to deliver world class digital entertainment — music, games or video — wherever and whenever consumers want them. Consumers use our services and software, such as Rhapsody, RealArcade and RealPlayer to find, play, purchase and manage digital music, games and video. Businesses use our digital media applications and services to create, secure and deliver digital media to their customers via PCs, mobile phones, portable music players and other consumer electronics devices. These customers include broadcasters, cable and wireless communication companies, media companies and enterprises, such as AT&T and Verizon in the U.S., Vodafone in Europe, and SK Telecom in Korea.

Our strategy is to continue to (1) develop technology that provides meaningful differentiation to our chosen markets in digital entertainment services; (2) build a direct relationship with, and grow, our worldwide user base and use feedback from our customers to rapidly innovate and improve our products; and (3) create strong business partnerships with device makers, media companies, service providers and other distribution channels and leverage those partnerships to drive scale and profitability. We intend to continue to expand our products and services beyond the personal computer to mobile devices and to create compelling digital media experiences on a variety of entertainment devices.

We manage our business, and correspondingly report segment revenue and profit (loss), based on four segments: Music, Games, Media Software and Services, and Technology Products and Solutions, each of which is described further below under “Revenue by Segment” and “Costs of Revenue by Segment.” Our Music business is conducted primarily through Rhapsody America, a joint venture with the MTVN division of Viacom International, Inc.

In the quarter ended September 30, 2009, our total revenue declined 8%, or $11.7 million, to $140.3 million compared with $152.0 million in the quarter ended September 30, 2008. This decline was primarily due to declines in revenue in our Music, Games and Technology Products and Solutions segments totaling $2.8 million, $4.7 million and $4.2 million, respectively. The decline in revenue in our Music segment during the quarter was largely due to a decrease in the number of subscribers to our Music subscription services and a decline in the demand for online advertising, and the decline in our Games segment was primarily due to decreased revenue from our games. The decline in the quarter ended September 30, 2009, from the year-earlier period also resulted from changes in foreign currency exchange rates across our businesses of approximately $3.6 million most of which affected our Technology Products and Solutions segment. As in recent prior periods, volatility in foreign exchange rates, particularly in the euro and Korean won, continued to impact our revenue. We expect the comparability of our period-over-period operating results to continue to be impacted by the volatility of foreign currency exchange rates in future periods. See “Results of Operations-Revenue by Segment” below for further explanations of changes in our segment revenue for the quarter and the nine months ended September 30, 2009.

In our consumer segments, which include our Music, Games and Media Software and Services segments, we derive revenue through (1) subscriptions, (2) sales of content downloads, software and licenses, and (3) the sale of advertising and the distribution of third-party products on our websites and in our games. In the quarter ended September 30, 2009, we derived 56% of our total consumer revenue from subscriptions, 21% from sales of content downloads, software and licenses, and 23% from advertising and the distribution of third party products. In the third quarter of 2008, we derived 58% of our total consumer revenue from subscriptions, 23% from content downloads, software and licenses, and 19% from advertising and the distribution of third party products. In our business-to-business Technology Products and Solutions segment, we generate revenue primarily by providing services that enable wireless carriers to deliver audio and video content to their customers and through sales of software licenses and products and related support and other services to broadband and mobile carriers. In the third quarter of 2009, we derived 82% of our Technology Products and Solutions revenue from application service provider (ASP) services provided to wireless carriers, and 18% from software licenses and services. In the third quarter of 2008, we derived 77% of our Technology Products and Solutions revenue from ASP services, and 23% from software licenses and services.

In the quarter ended June 30, 2009, we also recorded an impairment to our goodwill within each of our reporting units of an aggregate $175.6 million. Additional details about the valuation of our goodwill, the impairment analysis and related information is included below in “Results of Operations-Impairment of Goodwill.”

We believe that our operating results continue to be impacted by the uncertainty and adverse conditions in the global economy. The economic downturn has resulted in declines in overall consumer and corporate spending as well as consumer access to credit, and the digital entertainment products and services we provide are generally considered discretionary purchases for consumers. As a result, we may continue to experience softening in consumer demand and increased price-sensitivity for our products and services, including the products and services we provide indirectly to consumers through our business customers. A continuation of these trends is expected to adversely affect our revenue growth in future periods.

As of September 30, 2009, we had cash, cash equivalents and short-term investments of $373.2 million and $13.7 million in restricted cash. We intend to use our strong cash position to seek acquisition opportunities to further our strategic initiatives, to make selective internal investments in new products or technologies and to enhance our competitive position. In recent years, we have focused our acquisition efforts principally on target companies that provide (1) technologies and products complementary to ours in order to accelerate and supplement our research and development efforts, (2) distribution of our products and services into new geographies, (3) significant new customers and (4) existing or a reasonably expected ability to achieve profitability.

In May 2008, we announced our intent to separate our casual games business into an independent company and to distribute shares of the newly created games company to our shareholders. In February 2009, we announced that we postponed work with our outside advisors, stopped external spending on the proposed transaction and wrote off the capitalized transaction-related costs in the fourth quarter of 2008. While we still intend to create a separate games company, current conditions do not support such a transaction.

Critical Accounting Policies and Estimates

The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Our critical accounting policies and estimates are as follows:

	•		Revenue recognition;

	•		Estimating music publishing rights and music royalties;

	•		Estimating 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 long-lived assets;

	•		Valuation of goodwill;

	•		Stock-based compensation;

	•		Noncontrolling interest;

	•		Accounting for gains on sale of subsidiary stock; and

	•		Accounting for income taxes.

Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. The product is considered delivered to the customer once it has been shipped

and title and risk of loss have been transferred. For most of our product sales, these criteria are met at the time the product is shipped. For online sales the product is considered delivered at the time the product is made available, digitally, to the end user.

We recognize revenue on a gross or net basis. In most arrangements, we contract directly with end user customers, is the primary obligor and carries all collectibility risk. In such arrangements, we recognize revenue on a gross basis. In some cases, we utilize third-party distributors to sell products or services directly to end user customers and carries no collectibility risk. In such instances, we recognize revenue on a net basis.

In our direct to consumer business segments, which include: Music, Games and Media Software and Services, we derive revenue through (1) subscriptions, (2) sales of content downloads, software and licenses, and (3) the sale of advertising and the distribution of third-party products on its websites and in our games.

Consumer subscription products are paid in advance, typically for monthly, quarterly or annual duration. Subscription revenue is recognized ratably over the related subscription time period. Revenue from sales of content downloads, software and licenses is recognized at the time the product is made available, digitally, to the end user. Revenue generated from advertising on our websites and from advertising and the distribution of third-party products included in our products is recognized as revenue at the time of delivery.

Our business-to-business Technology Products and Solutions segment generates revenue by providing services that enable wireless carriers to deliver audio and video content to their customers and through sales of software licenses and products and related support and other services.

Estimating Music Publishing Rights and Music Royalty Accruals. We must make estimates of amounts owed related to our music publishing rights and music royalties for our domestic and international music services. Material differences may result in the amount and timing of our expense for any period if management made different judgments or utilized different estimates. Under copyright law, we may be required to pay licensing fees for digital sound recordings and compositions we deliver. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory licenses where voluntary negotiations are unsuccessful, by arbitration. There are certain geographies and agencies for which we have not yet completed negotiations with regard to the royalty rate to be applied to the current or historic sales of our digital music offerings. Our estimates are based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies. While we base our estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates under different assumptions or conditions.

Estimating Recoverability of Deferred Costs. We defer costs on projects for service revenue 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 hardware and software from third parties and payroll costs for our employees and other third parties.

We recognize such costs in accordance with our 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 in accordance with the percentage of completion calculation. For revenue recognized ratably over the term of the contract, costs are recognized ratably over the term of the contract, commencing on the date of revenue recognition. At each balance sheet date, we review 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.

Estimating Allowances for Doubtful Accounts and Sales Returns. We make estimates of the uncollectible portion of our accounts receivable. We specifically analyze the age of accounts receivable and historical bad debts, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Similarly, we make estimates of potential future product returns related to current period revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowance. Significant judgments and estimates are made and used in connection with establishing allowances for doubtful accounts and sales returns in any accounting period. Material differences may result in the amount and timing of our revenue for any period if we were to make different judgments or utilize different estimates or actual future experience was different from the judgments and estimates.

Estimating Losses on Excess Office Facilities. We made significant estimates in determining the appropriate amount of accrued loss on excess office facilities. If we made different estimates, our loss on excess office facilities could be significantly different from that recorded, which could have a material impact on our operating results. Our original estimate has been revised in previous periods in response to changes in market conditions for commercial real estate in the area where the excess office facilities are located, or to reflect negotiated changes in sublease rates charged to occupying tenants.

Impairment of Investments. We periodically evaluate whether any declines in the fair value of our investments are other-than-temporary. Significant judgments and estimates are made to assess whether an other-than-temporary decline in fair value of investments has occurred and to estimate the fair value of investments in privately held companies. Material differences may result in the amount and timing of any impairment charge if we were to make different judgments or utilize different estimates or actual future experience was different from the judgments and estimates.

Valuation of Long-Lived Assets. Long-lived assets consist primarily of property, plant and equipment, as well as amortizable intangible assets acquired in business combinations. Long-lived assets are amortized on a straight line basis over their estimated useful lives. We review long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If long-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value. The impairment analysis of long-lived assets is based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of our long-lived assets could result in the need to perform an impairment analysis in future interim periods which could result in a significant impairment. While we believe our estimates and assumptions are reasonable, due to their complexity and subjectivity, these estimates and assumptions could vary period to period.

Valuation of Goodwill. We assess the impairment of goodwill on an annual basis, in our fourth quarter, or whenever events or changes in circumstances indicate that the fair value of the reporting unit to which goodwill relates is less than the carrying value. We consider a synthesis of the following important factors that could trigger an impairment review include the following:

	•		poor economic performance relative to historical or projected future operating results;

	•		significant negative industry, economic or company specific trends;

	•		market and interest rate risk;

	•		changes in the manner of our use of the assets or the plans for our business; and

	•		loss of key personnel.

In addition, we perform a reconciliation of our market capitalization plus a reasonable control premium to the aggregated implied fair value of all of our reporting units.

If we were to determine that the fair value of a reporting unit was less than its carrying value, including goodwill, based upon the annual test or the existence of one or more of the above indicators of impairment, we would measure impairment based on a comparison of the implied fair value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of

goodwill is determined by allocating the fair value of a reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the goodwill of the reporting unit. To the extent the carrying amount of reporting unit goodwill is greater than the implied fair value of reporting unit goodwill, we would record an impairment charge for the difference. Judgment is required in determining our reporting units and assessing fair value of the reporting units.

The impairment analysis of goodwill is based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.

Stock-Based Compensation. Stock-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by the Black-Scholes option-pricing model and is recognized as expense over the requisite service period, which is the vesting period. The Black-Scholes model requires various highly judgmental assumptions including volatility in our common stock price and expected option life. If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense may differ materially in the future from the amounts recorded in our consolidated statement of operations. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. Prior to January 1, 2006, we measured compensation expense for our employee stock-based compensation plans using the intrinsic value method. When the exercise price of our employee stock options was equal to the market price of the underlying stock on the date of the grant, no compensation expense was recognized.

Noncontrolling Interests. We record noncontrolling interest expense (benefit) which reflects the portion of the earnings (losses) of majority-owned entities which are applicable to the noncontrolling interest partners in the consolidated statement of operations. Redeemable noncontrolling interests that are redeemable at either fair value or are based on a formula that is intended to approximate fair value follow our historical disclosure only policy for the redemption feature, and the current redemption amount of the redeemable noncontrolling interests is disclosed in Note 4 to the condensed consolidated financial statements. Redeemable noncontrolling interests that are redeemable at either a fixed price or are based on a formula that is not akin to fair value are reflected as an adjustment to income attributable to common shareholders based on the difference between accretion as calculated using the terms of the redemption feature and the accretion entry for a hypothetical fair value redemption feature with the remaining amount of accretion to redemption value recorded directly to equity. Noncontrolling interest expense (benefit) is included within the consolidated statement of operations and comprehensive income (loss).

As of September 30, 2009, and December 31, 2008, respectively, our noncontrolling interests solely related to redeemable noncontrolling interest in Rhapsody America. See Note 4 of our condensed consolidated financial statements for further discussion of the redeemable noncontrolling interest treatment.

Accounting for Gains on Sale of Subsidiary Stock. Effective January 1, 2009, we adopted Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS 160) which was primarily codified into FASB ASC 810 — Consolidation (ASC 810). Current guidance requires the difference between the carrying amount of the parent’s investment in a subsidiary and the underlying net book value to be recorded as equity transactions. We elected to recognize any such gain in our consolidated statement of operations prior to January 1, 2009.

Accounting for Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities and for operating losses and tax credit carryforwards. 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. We must make assumptions, judgments and estimates to determine current provision for income taxes, deferred tax assets and liabilities and any valuation allowance to be recorded against deferred tax assets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

Each reporting period we must periodically assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefit in the statement of operations and comprehensive income. Factors we consider in making such an assessment include, but are not limited to past performance and our expectation of future taxable income, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our investments and other assets.

We have not provided for U.S. deferred income taxes or withholding taxes on certain non-U.S. subsidiaries’ undistributed earnings. These earnings are intended to be permanently reinvested in operations outside of the U.S. If these amounts were distributed to the U.S., in the form of dividends or otherwise, we could be subject to additional U.S. income taxes. It is not practicable to determine the U.S. federal income tax liability or benefit on such earnings due to the availability of foreign tax credits and the complexity of the computation if such earnings were not deemed to be permanently reinvested.

We file numerous consolidated and separate income tax returns in the United States Federal, state, local, and foreign jurisdictions. With few exceptions, we are no longer subject to United States Federal, state, local, or foreign income tax examinations for years before 1993. We are currently subject to United States Federal and various state audits for certain tax years subsequent to 1993.

Results of Operations

Revenue by Segment

Revenue by segment is as follows (dollars in thousands):


	Quarters Ended							Nine Months Ended
	September 30,							September 30,
	2009		Change			2008		2009		Change			2008
Music	$	38,765		(7	)%	$	41,591	$	123,270		6	%	$	116,840
Games		29,491		(14	)		34,200		92,088		(9	)		100,943
Media Software and Services		24,580		—			24,531		64,189		(20	)		80,178
Technology Products and Solutions		47,428		(8	)		51,633		137,215		(11	)		154,205

Total net revenue	$	140,264		(8	)%	$	151,955	$	416,762		(8	)%	$	452,166

Revenue by segment as a percentage of total net revenue is as follows:


	Quarters Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Music		28	%		27	%		30	%		26	%
Games		21			23			22			22
Media Software and Services		17			16			15			18
Technology Products and Solutions		34			34			33			34

Total net revenue		100	%		100	%		100	%		100	%

Music. Music revenue primarily includes revenue from sales of our Rhapsody and RadioPass subscription services; sales of digital music content through our MP3 music store; and advertising through our music websites. These products and services are sold and provided primarily through the Internet and distribution partners, and we charge customers’ credit cards at the time of sale. We charge our subscription customers either monthly, quarterly or annually, depending on the service purchased. In the quarter ended September 30, 2009, subscription revenue comprised 79% of total Music revenue, sales of music downloads comprised 14%, and advertising and other revenue comprised 7%, compared with 77%, 13% and 10%, respectively, in the quarter ended September 30, 2008. For the nine months ended September 30, 2009, subscription revenue comprised 81% of total Music revenue, sales of music downloads comprised 14%, and advertising and other revenue comprised 5%, compared with 79%, 13% and 8%, respectively, in the nine months ended September 30, 2008.

In the quarter ended September 30, 2009, total Music revenue declined to $38.8 million, or 7%, from $41.6 million in the year-earlier quarter due to declines in subscription revenue and advertising revenue. Revenue from our subscription music services fell 5%, to $30.5 million in the quarter ended September 30, 2009, compared with $32.2 million in the quarter ended September 30, 2008. The decline in subscription revenue was primarily driven by a decrease in the number of subscribers to our Rhapsody service. Advertising

revenue in the quarter declined by 30% to $2.8 million from $4.0 million due to a decline in demand for online advertising and for sponsorship revenue. No other single factor contributed materially to the change in total Music revenue during the period.

During the nine months ended September 30, 2009, total Music revenue increased to $123.3 million, or 6%, from $116.8 million in the year-earlier period due to increases in subscription revenue and sales of music downloads. Revenue from our subscription music services rose 9%, to $99.5 million in the nine months ended September 30, 2009, compared with $91.6 million in the year-earlier period. Subscription revenue growth was primarily driven by an increase in subscribers from the launch of the Rhapsody service with Verizon Wireless in the middle of 2008 and the one-time migration of Yahoo! Music Unlimited subscribers to our Rhapsody music service, which was completed during the third quarter of 2008. Revenue from digital music tracks sold during the nine months ended September 30, 2009, rose to $17.6 million from $14.9 million, an increase of 18%, largely due to increased purchases from our MP3 store by consumers since its re-launch on June 30, 2008. These increases were partially offset by a decline in advertising revenue of 41% to $6.1 million from $10.3 million due to a reduction in demand for online advertising and for sponsorship revenue. No other single factor contributed materially to the change in total Music revenue during the period.

Games. Games revenue primarily includes revenue from the sale of individual games on our websites RealArcade.com, GameHouse.com and Zylom.com; sales of games subscription services; advertising through our games websites; the sale of games through syndication on partner sites; and sales of games through wireless carriers. In the quarter ended September 30, 2009, sales of game downloads comprised 42% of total Games revenue; subscription revenue comprised 38%; and advertising and other revenue comprised 20%, compared with 45%, 34%, and 21%, respectively, in the quarter ended September 30, 2008. In the nine months ended September 30, 2009, sales of game downloads comprised 43% of total Games revenue; subscription revenue comprised 37%; and advertising and other revenue comprised 20%, compared with 46%, 33%, and 21%, respectively, in the year-earlier period.

Total Games revenue decreased by 14% to $29.5 million during the quarter ended September 30, 2009, compared with $34.2 million for the same quarter ended 2008. Revenue from sales of games declined 20% to $12.3 million in the third quarter of 2009 from $15.4 million in the third quarter of 2008, largely due to lower average sales prices for games sold on our websites. Games revenue from advertising decreased 17% to $6.0 million in the quarter ended September 30, 2009, from $7.3 million in the year-earlier quarter due to a decline in demand for online advertising. No other single factor contributed materially to the change in total Games revenue during the period.

During the nine months ended September 30, 2009, total Games revenue decreased by 9% to $92.1 million compared with $100.9 million for the same period ended 2008. This decrease was partially offset by revenue associated with our acquisition of Trymedia (consummated on April 1, 2008), which contributed approximately $3.6 million during the first quarter of 2009. Revenue from sales of games, which includes materially all the revenue contributed from the acquisition of Trymedia, declined 16% to $39.1 million in the nine months ended September 30, 2009, from $46.6 million in the year-earlier period, largely due to lower average sales prices for games sold on our websites. Games revenue from advertising decreased 11% to $18.5 million in the nine months ended September 30, 2009, from $20.8 million in the year-earlier quarter due to a decline in demand for online advertising. No other single factor contributed materially to the change in total Games revenue during the period.

Media Software and Services. Media Software and Services revenue primarily includes revenue from sales of our SuperPass premium subscription service; sales of RealPlayer Plus and related products; distribution of third-party software products; and all advertising other than that related directly to our Music and Games businesses. In the quarter ended September 30, 2009, subscription revenue comprised 44%, advertising and other revenue comprised 49%, and sales of RealPlayer Plus and related products comprised 7% of total Media, Software and Services revenue, compared with 58%, 35% and 7%, respectively, in the year-earlier quarter. In the nine months ended September 30, 2009, subscription revenue comprised 50%, advertising and other revenue comprised 41%, and sales of RealPlayer Plus and related products comprised 9% of total Media, Software and Services revenue, compared with 54%, 39% and 7%, respectively, in the year-earlier period.

Total Media Software and Services revenue was materially unchanged during the quarter ended September 30, 2009, compared with the quarter ended September 30, 2008. During the quarter there was a 24% decline in revenue from our subscription services to $10.7 million compared with $14.1 million in the year-earlier quarter driven primarily by a decrease in the number of subscribers to our SuperPass premium subscription service. This decrease was offset by a 41% increase in advertising and other revenue to $12.2 million compared with $8.6 million in the quarter ended September 30, 2008 resulting from an increase in the distribution of third party products. Revenue from the distribution of third party products in the current period was positively impacted by a one-time adjustment of approximately $1.7 million related to a renegotiation of a contract with a third party vendor . No other single factor contributed materially to the change in total Media Software and Services revenue during the period.

During the nine months ended September 30, 2009, total Media Software and Services revenue declined 20% to $64.2 million compared with $80.2 million in the year-earlier period. This decrease was due primarily to a 27% decline in revenue from our subscription services to $31.9 million during the nine months ended September 30, 2009, compared with $43.5 million in the year-earlier period. The prior-year period benefited from a special run of CBS’s Big Brother program, which attracted an increase in sign-ups to our SuperPass service. Advertising and other revenue also declined 14% to $26.6 million from $30.9 million as compared with the nine months ended September 30, 2008, resulting from a decline in the distribution of third party products as well as reduced demand for online advertising. No other single factor contributed materially to the change in total Media Software and Services revenue during the period.

Technology Products and Solutions. Technology Products and Solutions revenue is derived from the sale of products and ASP services that enable communications businesses to distribute digital media content to PCs, mobile phones, and other non-PC devices. ASP revenue comprises revenue from sales of ringback tones, music-on-demand, video-on-demand, and inter-carrier messaging services, primarily sold to wireless carriers. Software, and services revenue consists of sales of Helix system software and related authoring and publishing tools, digital rights management technology, messaging gateways, and consulting services, and support and maintenance services that we sell to mobile carriers and broadband communications companies. These products and services are primarily sold to corporate, government and educational customers. We do not require collateral from our customers, but we often require payment before or at the time products and services are delivered. Many of our customers are given standard commercial credit terms, and for these customers we do not require payment before products and services are delivered. In the quarter ended September 30, 2009, ASP revenue comprised 82% of total Technology Products and Solutions revenue, and software and services revenue comprised 18%, compared with 77% and 23%, respectively, in the year-earlier period. For the nine months ended September 30, 2009, ASP revenue comprised 79% of total Technology Products and Solutions revenue, and software and services revenue comprised 21%, compared with 78% and 22%, respectively, in the year-earlier period.

Total Technology Products and Solutions revenue declined to $47.4 million, or 8%, in the quarter ended September 30, 2009, compared with $51.6 million in the year-earlier quarter and declined during the nine months ended September 30, 2009 to $137.2 million, or 11% compared with $154.2 million in the year-earlier period. These declines were primarily due to a decline in the exchange rate for the Korean won as well as a decline in revenue derived from minimum revenue guarantees associated with an ASP customer contract. The rise in the value of the U.S. dollar against the Korean won negatively affected third quarter 2009 and nine months ended September 30, 2009, revenue by approximately $2.4 million and $13.0 million, respectively, across both our ASP and software and services revenues. No other single factor contributed materially to the change in total Technology Products and Solutions revenue during the periods.

Geographic Revenue

Revenue by geographic region is as follows (dollars in thousands):


	Quarters Ended							Nine Months Ended
	September 30,							September 30,
	2009		Change			2008		2009		Change			2008
United States	$	95,758		(6	)%	$	102,363	$	283,109		(6	)%	$	302,430
Europe		23,773		(12	)		27,151		69,907		(11	)		78,514
Rest of the world		20,733		(8	)		22,441		63,746		(10	)		71,222

Total net revenue	$	140,264		(8	)%	$	151,955	$	416,762		(8	)%	$	452,166

Revenue in the U.S. declined 6% to $95.8 million for the quarter ended September 30, 2009, compared with $102.4 million in the year-earlier quarter. The decrease was due primarily to a reduction in revenue of games as well as our Games and SuperPass subscription service of approximately $2.2 million and $2.7 million. During the nine months ended September 30, 2009, revenue in the U.S. declined 6% to $283.1 million compared with $302.4 million in the year-earlier period. This decrease was due primarily to a reduction in revenue of our games, advertising and related revenue, and SuperPass subscription service of approximately $3.8 million, $13.0 million and $9.6 million, respectively, partially offset by increases in Music subscription revenue of approximately $12.3 million. See the sections “Revenue by Segment — Media Software and Services”, “Revenue by Segment — Games” and “Revenue by Segment — Music” above for further discussion of these changes.

Revenue in Europe decreased 12% to $23.8 million from $27.2 million in the quarter ended September 30, 2009, compared with the year-earlier quarter. During the nine months ended September 30, 2009, revenue in Europe decreased 11% to $69.9 million from $78.5 million compared with the year-earlier period. These decreases were due primarily to a decline in revenue derived from minimum revenue guarantees associated with an ASP customer contract of approximately $1.9 million and $8.3 million during the

quarter and nine months ended September 30, 2009, respectively. See the section “Revenue by Segment -Technology Products and Solutions” above for further discussion of these changes.

Revenue in the rest of world declined 8% to $20.7 million from $22.4 million for the quarter ended September 30, 2009, compared with the year-earlier quarter. During the nine months ended September 30, 2009, revenue in the rest of world declined 10% to $63.7 million from $71.2 million compared with the year-earlier period. These decreases were due primarily to foreign currency fluctuations of the U.S. dollar against the Korean won which negatively affected third quarter 2009 revenue by approximately $2.4 million and revenue for the nine months ended September 30, 2009, by approximately $13.0 million. See the section “Revenue by Segment — Technology Products and Solutions” above for further discussion of these changes.

License Fees and Service Revenue

We also present our revenue based on License fees and Service revenue as set forth below (dollars in thousands):


	Quarters Ended							Nine Months Ended
	September 30,							September 30,
	2009		Change			2008		2009		Change			2008
License fees	$	23,621		(17	)%	$	28,394	$	74,189		(10	)%	$	82,762
Service revenue		116,643		(6	)		123,561		342,573		(7	)		369,404

Total net revenue	$	140,264		(8	)%	$	151,955	$	416,762		(8	)%	$	452,166

License fees and Service revenue as a percentage of total revenue are as follows:


	Quarters Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
License fees		17	%		19	%		18	%		18	%
Service revenue		83			81			82			82

Total net revenue		100	%		100	%		100	%		100	%

License Fees. License fees primarily include revenue from sales of content such as game licenses and digital music tracks; sales of our media delivery system software; sales of premium versions of our RealPlayer and related products and messaging gateways to mobile carriers. License fees include revenue from all of our reporting segments.

License fees decreased 17% to $23.6 million during the quarter ended September 30, 2009, compared with $28.4 million in the quarter ended September 30, 2008. The decrease was primarily due to a decline in revenue from the sale of games totaling approximately $3.0 million. No other single factor contributed materially to the change in total License fees during the period.

During the nine months ended September 30, 2009, License fees decreased 10% to $74.2 million, compared with $82.8 million in the year-earlier period. The decrease was primarily due to a decline in revenue from the sale of games and media system delivery software totaling approximately $8.6 million. No other single factor contributed materially to the change in total License fees during the period.

Service Revenue. Service revenue primarily includes revenue from sales of digital media subscription services such as SuperPass, Rhapsody, RadioPass, GamePass and FunPass; sales of ASP services as described in the section “Revenue — Technology Products and Solutions”; distribution of third-party software; and advertising. Service revenue includes revenue from all of our reporting segments.

Service revenue declined 6% to $116.6 million during the quarter ended September 30, 2009, compared with $123.6 million in the quarter ended September 30, 2008. The decrease was primarily due to a decline in revenue from SuperPass subscriptions and from our Music subscription services totaling approximately $3.4 million and $1.7 million, respectively. In addition, revenue from our ASP and other services from our Technology Products and Solutions segment declined approximately $3.1 million due primarily to the change in exchange rates for the Korean won. These declines were partially offset by a $1.1 million increase in advertising and other revenue across our consumer segments due primarily to an increase in the distribution of third party products. No other single factor contributed materially to the change in total Service revenue during the period.

During the nine months ended September 30, 2009, Service revenue declined 7% to $342.6 million, compared with $369.4 million in the year-earlier period. The decrease was primarily due to a decline in advertising and other revenue across our consumer segments and in revenue from SuperPass subscriptions totaling approximately $10.8 million and $11.7 million, respectively. In addition,

revenue from our ASP and other services from our Technology Products and Solutions segment declined approximately $12.9 million due primarily to the change in exchange rates for the Korean won. These declines were partially offset by a $9.0 million increase in revenue from subscription music services. No other single factor contributed materially to the change in total Service revenue during the period.

Deferred Revenue

Deferred revenue consists of unrecognized revenue and prepayments related to application services, unearned subscription services, support contracts, prepayments under OEM arrangements and other prepayments for which the earnings process has not been completed. Total deferred revenue at September 30, 2009, was $37.7 million compared with $41.8 million at December 31, 2008. Substantially all of the decrease in deferred revenue was due to the recognition of revenue from prepayments previously received from wireless carriers for applications to deliver our ASP services. No other single factor contributed materially to the change during the period.

Cost of Revenue by Segment

Cost of revenue by segment is as follows (dollars in thousands):


	Quarters Ended							Nine Months Ended
	September 30,							September 30,
	2009		Change			2008		2009		Change			2008
Music	$	23,720		(0	)%	$	23,787	$	75,965		15	%	$	65,999
Games		7,728		(25	)		10,251		25,093		(15	)		29,543
Media Software and Services		4,090		(10	)		4,539		10,387		(15	)		12,222
Technology Products and Solutions		18,148		(23	)		23,587		53,876		(18	)		65,438

Total cost of revenue	$	53,686		(14	)%	$	62,164	$	165,321		(5	)%	$	173,202

Cost of revenue as a percentage of segment revenue is as follows:


	Quarters Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
Music		61	%		57	%		62	%		56	%
Games		26			30			27			29
Media Software and Services		17			19			16			15
Technology Products and Solutions		38			46			39			42

Total cost of revenue		38	%		41	%		40	%		38	%

Cost of Music Revenue. Cost of Music revenue consists primarily of cost of content and delivery of the content included in our music subscription service offerings; royalties paid on sales and streams of music; hardware devices and accessories; and fees paid to third-party vendors for support services.

Total cost of Music revenue remained relatively unchanged during the quarter ended September 30, 2009, compared with the year-earlier period. During the quarter ended September 30, 2009, we experienced a shift in subscribers of our music subscription offerings. We increased the number of subscribers to our Rhapsody To Go subscription product, which has a lower margin than our other subscription offerings, which lost a greater number of subscribers. This shift in subscribers resulted in the costs associated with providing our music subscriptions to increase during the quarter ended September 30, 2009, by approximately $1.9 million. The increase of cost of Music revenue was offset by a decline in the sales of music tracks of approximately $1.2 million. No other single factor contributed materially to the change during the period. Cost of Music revenue as a percentage of Music revenue increased due to a shift in revenue as mentioned above.

During the nine months ended September 30, 2009, cost of Music revenue increased 15% to $76.0 million compared with $66.0 million during the year-earlier period. The increase was primarily due to the increased average number of subscribers to our Rhapsody music services during the nine months ended September 30, 2009, compared with the year-earlier period resulting in increased content costs of approximately $10.4 million. No other single factor contributed materially to the change during the period. Cost of Music revenue as a percentage of Music revenue increased due to a shift in revenue to lower margin subscription services.

Cost of Games Revenue. Cost of Games revenue consists primarily of royalties paid on sales of games and subscription service offerings; and fees paid to third-party vendors for support services.

Cost of Games revenue decreased 25% to $7.7 million during the quarter ended September 30, 2009, compared with $10.3 million during the quarter ended September 30, 2008. During the nine months ended September 30, 2009, cost of Games revenue decreased 15% to $25.1 million compared with $29.5 million during the year-earlier period. A decline in royalty costs in proportion to royalty revenue accounted for materially all of the decline in cost of Games revenue during each of the periods.

Cost of Media Software and Services Revenue. Cost of Media Software and Services revenue consists primarily of cost of royalties and delivery of content included in our SuperPass subscription service offerings; amounts paid for licensed technology; and fees paid to third-party vendors for support services.

Cost of Media Software and Services revenue declined 10% to $4.1 million from $4.5 million for the quarter ended September 30, 2009, compared with the quarter ended September 30, 2008. A decline in the number of subscribers accounted for materially all of the decline in cost of Media Software and Services revenue. Cost of Media Software and Services revenue as a percentage of revenue decreased in the quarter ended September 30, 2009, due to an increase in revenue from higher-margin items, such as distribution of third-party software and advertising, as a percentage of total revenue.

Cost of Media Software and Services revenue declined 15% to $10.4 million from $12.2 million for the nine months ended September 30, 2009, compared with the year earlier period. Content costs for SuperPass were higher in the prior year primarily as a result of the additional content costs associated with the special run of CBS’s Big Brother program, which accounted for materially all of the decline in cost of Media Software and Services revenue.

Cost of Technology Products and Solutions. Cost of Technology Products and Solutions revenue includes amounts paid for licensed technology; costs of product media, fees paid to mobile service carriers and third-party vendors for order fulfillment; cost of personnel providing support and consulting services, and expenses incurred in providing our ASP hosting services.

Cost of Technology Products and Solutions revenue decreased 23% to $18.1 million during the quarter ended September 30, 2009, compared with $23.6 million in the year-earlier quarter, and decreased 18% to $53.9 million in the nine months ended September 30, 2009 compared with $65.4 million in the year-earlier period. The decreases were due primarily to a reduction in intangible asset amortization associated with impairments taken in the fourth quarter of 2008 of approximately $1.2 million and $3.8 million for the quarter and nine months ended September 30, 2009, respectively. In addition, costs to provide content for our ASP services declined in proportion to the related revenue for both the quarter and nine months ended September 30, 2009, compared with the year-earlier periods. No other single factor contributed materially to the change during the period.

Cost of License and Service Revenue

Cost of revenue is as follows (dollars in thousands):


	Quarters Ended							Nine Months Ended
	September 30,							September 30,
	2009		Change			2008		2009		Change			2008
License fees	$	8,113		(27	)%	$	11,137	$	27,228		(13	)%	$	31,139
Service revenue		45,573		(11	)		51,027		138,093		(3	)		142,063

Total cost of revenue	$	53,686		(14	)%	$	62,164	$	165,321		(5	)%	$	173,202

Cost of revenue as a percentage of related revenue is as follows:


	Quarters Ended						Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008
License fees		34	%		39	%		37	%		38	%
Service revenue		39			41			40			38

Total cost of revenue		38	%		41	%		40	%		38	%

Cost of License Fees. Cost of license fees includes royalties paid on sales of games, music and other third-party products; amounts paid for licensed technology; and amortization of acquired technology.

Cost of license fees declined 27% to $8.1 million from $11.1 million during the quarter ended September 30, 2009, compared with the quarter ended September 30, 2008, due to a reduction in content costs associated with the sale of games by approximately $1.2 million, as well as a decrease in royalties paid on the sale of digital music tracks of approximately $1.2 million. No other single factor contributed materially to the changes during the period.

During the nine months ended September 30, 2009, cost of license fees declined 13% to $27.2 million from $31.1 million during the year-earlier period due to lower content costs associated with the sale of games of approximately $1.9 million. No other single factor contributed materially to the changes during the period.

Cost of Service Revenue. Cost of service revenue includes the cost of content and delivery of the content included in our digital media subscription and mobile service offerings; cost of in-house and contract personnel providing support; amortization of acquired technology; fees for consulting services; and royalties and expenses incurred in providing our ASP hosting services. Content costs are expensed over the period the content is available to our subscription services customers.

Cost of service revenue decreased 11% to $45.6 million during the quarter ended September 30, 2009, compared with $51.0 million in the quarter ended September 30, 2008. The decrease was due primarily to decreased costs related to the amortization of intangibles associated with impairments taken in the fourth quarter of 2008 of approximately $1.2 million, as well as a decrease in costs to provide content for our ASP services in proportion to the related revenue also contributed to the overall decrease in cost of service revenue for the quarter ended September 30, 2009. These decreases were partially offset by increased content costs resulting from the increased number of subscribers to our Rhapsody music subscription services of approximately $1.9 million. No other single factor contributed materially to the changes during the period. Cost of service revenue as a percentage of service revenue for the quarter ended September 30, 2009, decreased due to the one-time adjustment as mentioned above.

During the nine months ended September 30, 2009, cost of service revenue decreased 3% to $138.1 million compared with $142.1 million in the year-earlier period. The decrease was due primarily to decreased costs related to the amortization of intangibles associated with impairments taken in the fourth quarter of 2008 of approximately $3.8 million, decreased content costs related to our SuperPass subscription service of approximately $2.4 million, and a decrease in costs to provide content for our ASP services in proportion to the related revenue contributed to the overall decrease in cost of service revenue for the nine months ended September 30, 2009. These decreases were partially offset by increased content costs resulting from the increased number of subscribers to our Rhapsody music subscription services of approximately $10.4 million. No other single factor contributed materially to the changes during the period. Cost of service revenue as a percentage of service revenue for the nine months ended September 30, 2009, increased due to the increased concentration of revenue derived from services versus advertising, which has higher margins.

Operating Expenses

Research and Development

Research and development expenses consist primarily of salaries and related personnel costs, expense associated with stock-based compensation, and consulting fees associated with product development. To date, all research and development costs have been expensed as incurred because technological feasibility for software products is generally not established until substantially all development is complete. Research and developments costs and changes are as follows (dollars in thousands):


	Quarters Ended									Nine Months Ended
	September 30,									September 30,
	2009			Change			2008			2009			Change			2008
Research and development	$	29,425			(5	)%	$	31,076		$	86,907			2	%	$	85,147
As a percentage of total net revenue		21	%					20	%		21	%					19	%

Research and development expenses, including non-cash stock-based compensation, were materially unchanged from the quarter and nine months ended September 30, 2009 compared with the year-earlier periods.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries and related personnel costs, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, credit card fees, subscriber acquisition costs, consulting fees, trade show expenses, advertising costs and costs of marketing collateral. Sales and marketing costs and changes are as follows (dollars in thousands):


	Quarters Ended									Nine Months Ended
	September 30,									September 30,
	2009			Change			2008			2009			Change			2008
Sales and marketing	$	39,573			(28	)%	$	55,080		$	125,531			(22	)%	$	161,730
As a percentage of total net revenue		28	%					36	%		30	%					36	%

Sales and marketing expenses, including non-cash stock-based compensation, decreased 28% to $39.6 million in the third quarter of 2009 from $55.1 million in the third quarter of 2008 and decreased 22% to $125.5 million in the nine months ended September 30, 2009 compared to $161.7 million in the year-earlier period. The decreases were primarily due to a reduction in personnel and related costs of approximately $6.0 million and $15.8 million, as well as a decrease in marketing and other professional services expenses of approximately $8.8 million and $15.5 million during the quarter and nine months ended September 30, 2009, respectively. Further contributing to the decrease were lower costs associated with the amortization of intangibles of approximately $2.4 million and $7.9 million during the quarter and nine months ended September 30, 2009, respectively, due to impairment costs taken in the fourth quarter of 2008. No other single factor contributed materially to these changes during the period.

Advertising with Related Party

On August 20, 2007, RealNetworks and MTVN jointly created Rhapsody America. MTVN owns 49% of Rhapsody America. Under the joint venture agreement, as amended, Rhapsody America is obligated to purchase $213.8 million in advertising and related integrated marketing on MTVN cable channels over the term of the agreement. During the quarter and nine months ended September 30, 2009, Rhapsody America spent $7.9 million and $22.2 million in advertising with MTVN, respectively. During the quarter and nine months ended September 30, 2008, Rhapsody America spent $15.2 million and $31.7 million in advertising with MTVN, respectively.

General and Administrative

General and administrative expenses consist primarily of salaries and related personnel costs, fees for professional and temporary services and contractor costs, stock-based compensation, and other general corporate costs. General and administrative costs and changes are as follows (dollars in thousands):


	Quarters Ended									Nine Months Ended
	September 30,									September 30,
	2009			Change			2008			2009			Change			2008
General and administrative	$	13,039			(16	)%	$	15,453		$	55,208			9	%	$	50,874
As a percentage of total net revenue		9	%					10	%		13	%					11	%

General and administrative expenses, including non-cash stock-based compensation, decreased 16% to $13.0 million in the quarter ended September 30, 2009 compared with the year-earlier period. The decrease was due primarily to a reduction in personnel and related costs of approximately $0.8 million. During the nine months ended September 30, 2009, general and administrative expenses, including non-cash stock-based compensation, increased 9% to $55.2 million compared with $50.9 million in the year-earlier period. The increased expenses for the nine month period ended September 30, 2009, were primarily due to increases in legal and other professional services expenses of approximately $7.5 million partially offset by a reduction in personnel and related costs of approximately $1.5 million. No other single factor contributed materially to the increases during the periods.

Impairment of Goodwill

Goodwill is required to be tested for impairment annually and if an event or conditions change that would more likely than not reduce the fair value of a reporting unit below its carrying value. We perform our annual goodwill impairment test during our fiscal fourth quarter.

A two step process is used to test for goodwill impairment. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of each reporting unit to its carrying value including existing goodwill. Goodwill is considered impaired if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of impairment from the first step, a second step is performed to determine the amount of the impairment. This involves calculating the implied fair value of goodwill by allocating the fair value of the reporting unit to all assets and liabilities other than goodwill and comparing it to the carrying amount of goodwill. We have four reporting units; Music, Technology Products and Solutions, Games, and Media Software and Services.

We determined that a triggering event had occurred during the quarter ended June 30, 2009, warranting an interim impairment analysis of goodwill. During the impairment analysis, we concluded that the implied fair value of goodwill was zero for each of our reporting units. As a result, we recorded impairments of $175.6, the remaining amount of our goodwill, during the quarter ended June 30, 2009. No impairments were recognized in either the quarter or nine months ended September 30, 2008.

Other Income (Expenses), Net

Other income, net consists primarily of: interest income on our cash, cash equivalents, and short-term investments, which are net of interest expense from amortization of offering costs related to our convertible debt and equity in net loss of investments. Other income, net and quarter-over-quarter changes are as follows (dollars in thousands):


	Quarters Ended									Nine Months Ended
	September 30,									September 30,
	2009			Change			2008			2009			Change			2008
Interest income, net	$	1,253			(56	)%	$	2,865		$	3,190			(72	)%	$	11,198
Equity in net loss of investments		(273	)		21			(226	)		(1,197	)		182			(424	)
Gain on sale of equity investments, net		604			n/a			—			809			264			222
Gain on sale of interest in Rhapsody America		—			(100	)		7,405			—			(100	)		14,502
Other income, net		(888	)		(209	)		818			(482	)		(129	)		1,636

Other income, net	$	696			(94	)%	$	10,862		$	2,320			(91	)%	$	27,134

Other income (expense), net declined during the quarter and nine months ended September 30, 2009, due primarily to lower interest income, and the change in accounting that resulted in no longer recording a gain on the sale of a noncontrolling interest in Rhapsody America. See “Notes to Unaudited Condensed Consolidated Financial Statements — Rhapsody America” (Note 4). Lower interest income resulted from lower average cash and investments combined with lower average interest rates.

Income Taxes

During the quarters ended September 30, 2009 and 2008, we recognized income tax expense of $0.7 million and $0.7 million, respectively, related to U.S. and foreign income taxes. During the nine months ended September 30, 2009 and 2008, we recognized income tax expense of $3.4 million and $8.4 million, respectively, related to U.S. and foreign income taxes. The decrease in income tax expense and in tax expense as a percentage of pre-tax loss during the nine months ended September 30, 2009, was the result of net loss compared to net income in the same period of the prior year combined with losses not benefited in certain U.S. and foreign jurisdictions. The increase in income tax expense as a percentage of pre-tax income during the quarter ended September 30, 2009 compared to tax expense as a percentage of pre-tax loss in the same quarter of the prior year was the result of greater income in certain jurisdictions and a decrease in losses not benefitted in certain U.S. and foreign jurisdictions. Tax expense was also negatively impacted by the non-deductible portion of the goodwill impairment of $175.2 million during the nine months ended September 30, 2009.

As of December 31, 2008, we had $10.5 million of unrecognized tax benefits. The total amount of unrecognized tax benefits that would have affected our effective tax rate if recognized was $9.5 million. We have filed formal and informal claims with the Internal Revenue Service for the years 2001-2007, primarily related to Extraterritorial Income Exclusion of $32.4 million and previously acquired net operating losses of $17.1 million. As of September 30, 2009 the total amount of unrecognized tax benefits is $60.0 million. The total amount of unrecognized tax benefits that would affect our effective tax rate if recognized is approximately $34.9 million due to the fact that we currently have a partial valuation allowance.

We recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of September 30, 2009 and December 31, 2008, we have approximately $1.9 million and $1.4 million of accrued interest and penalties related to uncertain tax positions, respectively. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision. We do not anticipate that total unrecognized tax benefits will significantly change within the next twelve months.

We file numerous consolidated and separate income tax returns in the United States Federal, state, local, and foreign jurisdictions. With few exceptions, we are no longer subject to United States Federal, state, local, or foreign income tax examinations for years before 1993. We are currently under U.S. Federal audit for the consolidated group RealNetworks, Inc. and Subsidiaries for the year ended December 31, 2007. RealNetworks, Inc. and its combined subsidiaries are also under audit by the California Franchise Tax

Board for the years ended December 31, 2005 and 2006, and by the State of New York for the years ended December 31, 2005 through 2007.

New Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the quarter and nine months ended September 30, 2009, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the year ended December 31, 2008, that are of significance, or potential significance to us.

Effective January 1, 2009, we adopted, FSP No. 142-3, Determination of the Useful Life of Intangible Assets (FSP No. 142-3) which was primarily codified into FASB ASC 350, Intangibles — Goodwill and Other (ASC 350). The current guidance amends the factors considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The current guidance also requires enhanced disclosures when an intangible asset’s expected future cash flows are affected by an entity’s intent and/or ability to renew or extend the arrangement. The adoption did not have a material impact on our consolidated results of operations or financial condition.

Effective January 1, 2009, we adopted SFAS No. 141 (revised 2007), Business Combinations (SFAS 141(R)) which was primarily codified into FASB Accounting Standards Codification (ASC) 805, Business Combinations (ASC 805). Under current guidance, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequent to the acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. The current guidance is effective on a prospective basis for all business combinations for which the acquisition date is on or after January 1, 2009, with the exception of the accounting for valuation allowances on deferred taxes and acquired contingencies under SFAS 109. With the adoption of the current guidance, any tax related adjustments associated with acquisitions that closed prior to January 1, 2009 will be recorded through income tax expense, whereas the previous accounting treatment would require any adjustment to be recognized through goodwill. The adoption of the current guidance had no impact on our consolidated financial statement as of and for the quarter and nine months ended September 30, 2009.

Effective January 1, 2009, we implemented Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS 160) which was primarily codified into FASB ASC 810 — Consolidation (ASC 810). This standard changed the accounting for and reporting of minority interest (now called noncontrolling interest) in our consolidated financial statements. Upon adoption, certain prior period amounts have been reclassified to conform to the current period financial statement presentation. These reclassifications have no effect on our previously reported financial position or results of operations. Refer to Note 4, Rhapsody America, and Note 13, Earnings per Share, of this Form 10-Q for additional information on the adoption.

Effective January 1, 2009, the Company adopted FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (FSP 14-1) which was primarily codified into FASB ASC 470 — Debt (ASC 470). Current guidance specifies that the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) be separately accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate and requires retrospective application for all periods presented. The adoption did not have a material impact on our consolidated results of operations or financial condition for all periods presented.

Effective April 1, 2009, we adopted SFAS No. 165, Subsequent Events (SFAS 165) which was primarily codified into FASB ASC 855 — Subsequent Events (ASC 855). The current guidance is intended to establish general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date.

Effective April 1, 2009, we adopted FSP No. 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2 and 124-2) which was primarily codified into FASB ASC 320 — Investments — Debt and Equity Securities (ASC 320). The current guidance provides new guidance on the recognition and presentation of an other-than-temporary impairments, as well as extends certain annual disclosure requirements to interim periods. The adoption did not have a material impact on our financial position or results of operations.

Effective September 30, 2009, we adopted SFAS No. 168, The FASB Accounting Standards Codification (Codification) and the Hierarchy of Generally Accepted Accounting Principles- a replacement of Financial Statement No. 162 (SFAS 168) which was primarily codified into FASB ASC 105 — Generally Accepted Accounting Principles. Current guidance establishes the FASB Accounting Standards Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with generally accepted accounting principles in the United States. The adoption did not have a material impact on our consolidated results of operations or financial condition for all periods presented.

In September 2009, the FASB ratified Accounting Standards Update (ASU) 2009-13 (ASU 2009-13) (previously Emerging Issues Task Force (EITF) Issue No. 08-1, Revenue Arrangements with Multiple Deliverables (EITF 08-1)). ASU 2009-13 superseded EITF 00-21 and addresses criteria for separating the consideration in multiple-element arrangements. ASU 2009-13 will require companies to allocate the overall consideration to each deliverable by using a best estimate of the selling price of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price. ASU 2009-13 will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 and early adoption will be permitted. We are currently evaluating the potential impact, if any, of the adoption of ASU 2009-13 on our consolidated results of operations and financial condition and whether we will adopt the standard early.

In September 2009, the FASB ratified ASU 2009-14 (ASU 2009-14) (previously EITF No. 09-3, Certain Revenue Arrangements That Include Software Elements). ASU 2009-14 modifies the scope of Software Revenue Recognition to exclude (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. ASU 2009-14 has an effective date that is consistent with ASU 2009-13. We are currently evaluating the potential impact, if any, of the adoption of ASU 2009-14 on our consolidated results of operations and financial condition and whether we will adopt the standard early.

Liquidity and Capital Resources

The following summarizes working capital, cash, cash equivalents, short-term investments, and restricted cash (in thousands):


	September 30,		December 31,
	2009		2008
Working capital	$	278,312	$	266,990
Cash, cash equivalents, and short-term investments		373,197		370,734
Restricted cash		13,700		14,742

Cash, cash equivalents, and short-term investments were materially unchanged from December 31, 2008.

The following summarizes cash flows (in thousands):


	Nine Months Ended
	September 30,
	2009			2008
Cash used in operating activities	$	(16,492	)	$	(21,014	)
Cash used in investing activities		(45,367	)		(60,548	)
Cash provided by financing activities		27,740			(82,480	)

Cash used in operating activities consisted of net loss adjusted for certain non-cash items including depreciation, amortization, stock-based compensation, purchases of trading securities, deferred income taxes, noncontrolling interests, gain on sale of interest in Rhapsody America, and the effect of changes in certain operating assets and liabilities, net of acquisitions.

Cash used in operating activities in the nine months ended September 30, 2009, was $16.5 million and consisted of a net loss of $216.8 million, adjustments for cash provided by non-cash items of $208.6 million and cash used in activities related to changes in certain operating assets and liabilities, net of acquisitions, of $8.3 million. Adjustments for cash provided by non-cash items primarily consisted of $175.6 million of impairments of goodwill, $22.9 million of depreciation and amortization expense and $15.5 million of stock-based compensation, partially offset by $3.8 million for payments made related to our restructuring and other impairments, which were accrued for in the fourth quarter of 2008.

Changes in certain operating assets and liabilities, net of acquisitions, in the nine months ended September 30, 2009 primarily consisted of uses of cash from the decrease in accrued and other liabilities of $16.0 million primarily related to reductions in accrued royalties and other fulfillment costs as well as a reduction in amounts payable to MTVN for related party advertising incurred during the quarter ended September 30, 2009 as compared to the quarter ended December 31, 2008. These uses of cash were partially offset by a decrease in accounts receivable of $4.4 million related to the timing of customer collections.

Cash used in operating activities in the nine months ended September 30, 2008 was $21.0 million and consisted of a net loss of $32.5 million, adjustments for non-cash items provided by operations of $41.2 million and cash used in activities related to certain operating assets and liabilities, net of acquisitions, of $29.8 million. Adjustments for non-cash items primarily consisted of $38.0 million of depreciation and amortization expense, $17.5 million of stock-based compensation and $2.6 million of deferred income taxes, partially offset by $14.5 million of gain on sale of interest in Rhapsody America.

Changes in certain operating assets and liabilities, net of acquisitions, in the nine months ended September 30, 2008, primarily consisted of an increase of $26.1 million in prepaid expenses and other assets due primarily to increases in deferred costs and prepaid royalties and a decrease in accounts payable of $16.8 million due primarily to a decrease in payments to third party content providers, partially offset by a decrease in accounts receivable of $12.7 million related to decreases in revenue associated with our systems integration business.

In the nine months ended September 30, 2009, investing activities used cash primarily for purchases of equipment, software, and leasehold improvements of $11.4 million and acquisition costs of $3.3 million, from the last payment of accrued anniversary and performance payments relating to the acquisition of Zylom. Purchases, net of sales and maturities, of short-term investments used cash of $30.7 million during 2009. In the nine months ended September 30, 2008, investing activities used cash primarily for purchases of equipment, software, and leasehold improvements of $24.8 million and acquisition costs of $10.2 million, net of cash acquired from the acquisition of Trymedia, and the payment of anniversary and performance costs relating to the acquisition of Zylom, which were previously accrued. Purchases, net of sales and maturities, of short-term investments used cash of $21.2 million during 2008.

Financing activities provided cash from the proceeds of sales of interests in Rhapsody America of $26.9 million in 2009 and $31.6 million in 2008. Sales of common stock under our employee stock purchase plan and exercise of stock options of also provided cash of $8.8 million in 2008. The repurchase of our common stock of $23.1 million in addition to the payments on our convertible debt obligations of $100.0 million were the primary uses of cash during the nine months ended September 30, 2008.

We currently have no planned significant capital expenditures for 2009 other than those in the ordinary course of business. In the future, we may seek to raise additional funds through public or private equity financing, or through other sources such as credit facilities. The sale of additional equity securities could result in dilution to our shareholders. In addition, in the future, we may enter into cash or stock acquisition transactions or other strategic transactions that could reduce cash available to fund our operations or result in dilution to shareholders.

The downturn in the economy could result in negative impacts to our liquidity arising from lower interest income in future periods due to the continued decline in interest rates, an increased risk that we may not be able to access cash balances held in U.S. or foreign financial institutions or that investments in debt securities issued by financial institutions may be rendered worthless due to the nationalization or failure of such financial institutions, and an increased inability to sell the securities and the institutional money market funds we hold as short-term investments. These risks and the potential impact of these risks on our financial condition and results of operations are discussed further below in “Risk Factors — Risks Related to Our Business in General.” If any of these risks are realized, we may experience a material adverse impact on our financial condition and results of operations in future periods.

Our contractual obligations include office leases and contractual payments due to content and other service providers. We believe that our current cash, cash equivalents, and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

We do not hold derivative financial instruments or equity securities in our short-term investment portfolio. Our cash equivalents and short-term investments consist of high quality securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one non-U.S. Government or non-U.S. Agency issue or issuer to a maximum of 5% of the total portfolio. These securities are subject to interest rate risk and will decrease in value if interest rates increase. Because we have historically had the ability to hold our fixed income investments until maturity, we do not expect our operating results or cash flows to be significantly affected by a sudden change in market interest rates in our securities portfolio.

We conduct our operations in ten primary functional currencies: the U.S. dollar, the Korean won, the Japanese yen, the British pound, the Euro, the Mexican peso, the Brazilian real, the Australian dollar, the Hong Kong dollar, and the Singapore dollar. Historically, neither fluctuations in foreign exchange rates nor changes in foreign economic conditions have had a significant impact on our financial condition or results of operations. We currently do not hedge the majority of our foreign currency exposures and are therefore subject to the risk of exchange rate fluctuations. We invoice our international customers primarily in U.S. dollars, except in Korea, Japan, Germany, France, the United Kingdom and Australia, where we invoice our customers primarily in won, yen, euros, pounds, and Australian dollars, respectively. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Our exposure to foreign exchange rate fluctuations also arises from intercompany payables and receivables to and from our foreign subsidiaries.

Off-Balance Sheet Agreements

Our only significant off-balance sheet arrangements relate to operating lease obligations for office facility leases and other contractual obligations related primarily to minimum contractual payments due to content and other service providers.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discussion about our market risk involves forward-looking statements. All statements that do not relate to matters of historical fact should be considered forward-looking statements. Actual results could differ materially from those projected in any forward-looking statements.

Interest Rate Risk. Our exposure to interest rate risk from changes in market interest rates relates primarily to our short-term investment portfolio. We do not hold derivative financial instruments or equity investments in our short-term investment portfolio. Our short-term investments consist of high quality debt securities as specified in our investment policy. Investments in both fixed and floating rate instruments carry a degree of interest rate risk. The fair value of fixed rate securities may be adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Additionally, a declining rate environment creates reinvestment risk because as securities mature the proceeds are reinvested at a lower rate, generating less interest income. Due in part to these factors, our future interest income may be adversely impacted due to changes in interest rates. In addition, we may incur losses in principal if we are forced to sell securities that have declined in market value due to changes in interest rates. Because we have historically had the ability to hold our short-term investments until maturity and the substantial majority of our short-term investments mature within one year of purchase, we would not expect our operating results or cash flows to be significantly impacted by a sudden change in market interest rates. There have been no material changes in our investment methodology regarding our cash equivalents and short-term investments during the quarter ended September 30, 2009. Based on our cash, cash equivalents, short-term investments, and restricted cash equivalents at September 30, 2009, a hypothetical 10% increase/decrease in interest rates would increase/decrease our annual interest income and cash flows by approximately $0.1 million.

Investment Risk. As of September 30, 2009, we had investments in voting capital stock of both publicly traded and privately-held technology companies for business and strategic purposes. Our investments in publicly traded companies are accounted for as available-for-sale, carried at current market value and are classified as long-term as they are strategic in nature. We periodically evaluate whether any declines in fair value of our investments are other-than-temporary based on a review of qualitative and quantitative factors. For investments with publicly quoted market prices, these factors include the time period and extent by which its accounting basis exceeds its quoted market price. We consider additional factors to determine whether declines in fair value are other-than-temporary, such as the investee’s financial condition, results of operations, and operating trends. The evaluation also considers publicly available information regarding the investee companies. For investments in private companies with no quoted market price, we consider similar qualitative and quantitative factors as well as the implied value from any recent rounds of financing completed by the investee. Based upon an evaluation of the facts and circumstances during the quarters ended September 30, 2009 and 2008, we determined that no additional other-than-temporary decline in fair value had occurred and therefore no impairment charges were recorded.

Foreign Currency Risk. We conduct business internationally in several currencies. As such, we are exposed to adverse movements in foreign currency exchange rates.

Our exposure to foreign exchange rate fluctuations arise in part from: (1) translation of the financial results of foreign subsidiaries into U.S. dollars in consolidation; (2) the remeasurement of non-functional currency assets, liabilities and intercompany balances into U.S. dollars for financial reporting purposes; and (3) non-U.S. dollar denominated sales to foreign customers. A portion of these risks is managed through the use of financial derivatives, but fluctuations could impact our results of operations and financial position.

Generally, our practice is to manage foreign currency risk for the majority of material short-term intercompany balances through the use of foreign currency swaps. These contracts require us 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. We do not designate our foreign exchange forward contracts related to short-term intercompany accounts as hedges and, accordingly, we adjust these instruments to fair value through results of operations. However, we may periodically hedge a portion of our foreign exchange exposures associated with material firmly committed transactions, long-term investments, highly predictable anticipated exposures and net investments in foreign subsidiaries. Some of our unhedged exposures are reconciled through our statement of operations on a mark-to-market basis each quarter, so to the extent we continue to experience adverse economic conditions, we may record losses related to such unhedged exposures in future periods that may have a material adverse effect on our financial condition and results of operations.

Our foreign currency risk management program reduces, but does not entirely eliminate, the impact of currency exchange rate movements.

In aggregate, our foreign currency denominated assets are greater than our foreign currency denominated liabilities. Primarily as a result of the U.S. dollar strengthening against the Korean won and euro in 2008, we recorded a reduction to our reported net assets of approximately $59.1 million as reflected in Accumulated Other Comprehensive Income (Loss) for the nine months ended September 30, 2008. During the nine months ended September 30, 2009, we recorded an increase to our reported net assets of approximately $4.4 million

Additionally, we have cash balances denominated in foreign currencies which are subject to foreign currency fluctuation risk. The majority of our foreign currency denominated cash is held in Korean won and euros. A hypothetical 10% increase or decrease in the Korean won and euro relative to the U.S. dollar from September 30, 2009 would result in an unrealized gain or loss of approximately $3.7 million.

Foreign currency transaction gains and losses were not material for the quarters and nine months ended September 30, 2009 and 2008.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. Based on an evaluation as of the end of the period covered by this report, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act (1) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Controls. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On June 29, 2009, MCS Music America, Inc. (MCS Music), and other plaintiffs for whom MCS Music administers copyrights, filed suit for copyright infringement against us, Yahoo! Inc. and Microsoft Corporation in U.S. District Court for the Middle District of Tennessee. The complaint asserts that our Rhapsody music service offers certain compositions for distribution without a license and asks for statutory damages for infringement of the copyrights relating to those compositions. We are actively exploring a settlement of these claims.

On September 30, 2008, we filed a declaratory action against Disney Enterprises, Inc., Paramount Pictures Corp., Sony Pictures Entertainment, Inc., Twentieth Century Fox Film Corp., NBC Universal, Inc., Warner Bros. Entertainment, Inc., Viacom, Inc. (collectively, the “Studios”) and the DVD Copy Control Association (DVD CCA) in the Northern District of California relating to the

Company’s RealDVD product (the “RealDVD Litigation”), which, among other things, allows consumers to securely store DVD content on their hard drives. On the same day, various movie studios filed suit against us in the Central District of California. Our suit asks the court to find that the RealDVD product does not breach the license agreement that we entered into with the DVD CCA. The movie studios’ suit alleges that by offering the RealDVD product, we have violated the Digital Millennium Copyright Act. The DVD CCA has filed a counterclaim against us alleging that we breached the license with the DVD CCA by developing RealDVD. The movie studios’ suit was subsequently transferred to the Northern District of California. In October 2008, the movie studios obtained a temporary restraining order (TRO) requiring us to cease distribution of the RealDVD product. In April and May 2009, the Court held a preliminary injunction hearing to address the movie studios’ claim that RealDVD should not be sold pending a final judicial determination of the underlying claims between the parties. On August 11, 2009, the Court granted the movie studios’ motion for preliminary injunction, which enjoined us from selling or otherwise distributing RealDVD to the public. On September 10, 2009, we filed a notice of appeal on this ruling with the U.S. Court of Appeals for the Ninth Circuit.

On May 13, 2009, we moved to amend our complaint against the Studios in the RealDVD Litigation to add claims that the Studios and DVD CCA conspired to violate, and have violated, state and federal antitrust laws by, among other things, unlawfully eliminating competition in the market for technology that enables a consumer to make a lawful, secure backup copy of a DVD. We have filed similar counterclaims against the DVD CCA. In both instances, we are seeking injunctive relief to stop the anticompetitive activity, and are also asking for monetary damages. Our motion to amend was granted by the Court. On June 29, 2009, the DVD CCA moved to dismiss our antitrust counterclaims, and the Studios filed a motion to dismiss our antitrust counterclaims on September 8, 2009. The hearing on those motions was held on October 26, 2009, and we are awaiting the Court’s ruling.

In June 2008, we initiated an arbitration action in Seattle, Washington against VeriSign, Inc., to seek resolution of disputes regarding the proper interpretation of an Alliance Agreement entered into between the parties dating back to 2001. VeriSign asserted various counterclaims against us, including claims that we breached the Alliance Agreement and tortiously interfered with VeriSign’s prospective and existing business relationships and its proposed sale of certain business units. On May 7, 2009, the Arbitrator issued a ruling denying our claims for relief and granting VeriSign’s claims, including VeriSign’s tortious interference claims. Subsequent to that ruling, the Arbitrator further ruled that the limitation of liability clause contained in the Alliance Agreement does not apply to the potential damages VeriSign incurred. In response, VeriSign filed an amended statement of damages seeking a material amount in damages. A hearing to address VeriSign’s claimed damages began on July 13, 2009 and was adjourned on July 15. On September 10, 2009, the Arbitrator issued a Supplemental Order re: Scheduling and Actions for Final Resolution which set further hearings on damages which were completed on October 12-14, 2009. In that Order, the Arbitrator also determined that VeriSign had failed to prove that we caused any damages relating to VeriSign’s claim of tortious interference with its proposed sale of certain business units but allowed further evidence regarding VeriSign’s claims of tortious interference with prospective and existing business relationships. The evidentiary hearings have now been concluded and we expect the Arbitrator to issue a final decision in the near future. In August 2009, we also filed a motion to vacate the Arbitrator’s interim awards relating to declaratory and injunctive relief in Federal District Court in New York City. That motion is currently under consideration by the federal court. We continue to believe that the limitation of liability clause in the Alliance Agreement should apply to limit the amount of VeriSign’s claimed monetary damages and that the Arbitrator does not have jurisdiction over tort claims. No assurance can be made as to the final outcome of the disputes until all rulings are final and all avenues of review have been exhausted, but we could ultimately be required to pay damages to VeriSign in an amount that may be material to our financial condition and results of operations. We intend to continue to defend ourselves vigorously with respect to this matter.

On April 25, 2007, a lawsuit was filed by Greenville Communications, LLC in Greenville, Mississippi against a number of cell phone carriers, including our partners T-Mobile USA, Inc. and Alltel Corporation, alleging that they infringe its patents by providing ringback tone services. We agreed to indemnify T-Mobile and Alltel against the claims based on an indemnity that is claimed to be owed by our subsidiary, WiderThan. On August 27, 2007, our motion to transfer this matter to the District of New Jersey was granted. The parties have briefed claim construction, but the case has been stayed pending reexamination of the patents at issue. We dispute the plaintiff’s allegations regarding both the validity of its patents and its claims of infringement against our partners.

In April 2007, the Copyright Royalty Board (CRB) issued a decision setting new royalty rates for the use of sound recordings in Internet radio from 2006 through 2010. These rates were appealed and then affirmed by the D.C. Circuit Court of Appeals on July 10, 2009, except with respect to the minimum royalty rate per station, which has been remanded to the CRB. In a separate proceeding regarding international radio rates, on September 29, 2009, we filed briefs with the CRB with respect to royalty rates for the period 2011 through 2015. Additionally, in another separate proceeding, the CRB held hearings to determine mechanical royalty rates associated with the statutory license for digital phonorecord deliveries, including streams and tethered downloads. These rates have also been subject to industry-wide settlement negotiations. A partial settlement was reached with respect to on-demand streaming and tethered downloads between the Digital Media Association (DiMA), the Recording Industry Association of America (RIAA) and the National Music Publishers Association (NMPA). This settlement, along with CRB’s determination on rates for full downloads, physical products and ringtones, was published by the CRB, and after some modifications by the U.S. Copyright Office, was collectively published as the CRB’s final determination in the Federal Register. The rate for ringtones and the imposition of a late fee on certain royalty payments contained in the final determination have been appealed by the RIAA. Finally, we have been involved in a proceeding in the Southern District of New York to determine a royalty rate for the public performance of music contained in the American Society of Composers, Authors and Publishers (ASCAP) catalogue. In April 2008, the district court issued a preliminary ruling that sets forth, among other things, a methodology to be used to calculate the royalties owed to ASCAP and subsequently issued additional rulings. After working with ASCAP to make a final determination of amounts due under the court’s rulings, we reached a

partial agreement with ASCAP on January 12, 2009. We believe we have sufficiently accrued for expected royalties under the agreement, but we plan to appeal some aspects of the court’s rulings that underlie the agreement, and the rulings remain subject to appeal and challenge by other participants

From time to time we are, and expect to continue to be, subject to legal proceedings and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. These claims, including those described above and in Note 14 to the financial statements included in this report, even if not meritorious, could force us to spend significant financial and managerial resources. We are not aware of any other legal proceedings or claims that we believe we will have, individually or taken together, a material adverse effect on our business, prospects, financial condition or results of operations. However, we may incur substantial expenses in defending against third-party claims and certain pending claims are moving closer to trial. We expect that its potential costs of defending these claims may increase as the disputes move into the trial phase of the proceedings. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our financial position and results of operations.

Item 1A. Risk Factors

You should carefully consider the risks described below together with all of the other information included in this quarterly report on Form 10-Q. The risks and uncertainties described below are not the only ones facing our company. If any of the following risks actually occurs, our business, financial condition or operating results could be harmed. In such case, the trading price of our common stock could decline, and investors in our common stock could lose all or part of their investment.

Risks Related to Our Music, Games and Media Software and Services Businesses

Our Music, Games and Media Software and Services businesses face substantial competitive and other challenges that may prevent us from being successful in, and negatively impact future growth in, those businesses.

Many of our current and potential competitors in our Music, Games and Media Software and Services businesses have longer operating histories, greater name recognition, more employees and significantly greater resources than we do. Our competitors across the breadth of our product lines in these businesses include a number of large and powerful companies, such as Apple, Amazon.com and Microsoft. To effectively compete in the markets for our Music, Games and Media Software and Services businesses, we may experience the following consequences, any of which would adversely affect our operating results and the trading price of our stock:

	•		reduced prices or margins,

	•		loss of current and potential customers, or partners and potential partners who provide content we distribute to our customers,

	•		changes to our products, services, technologies, licenses or business practices or strategies,

	•		lengthened sales cycles,

	•		pressure to prematurely release products or product enhancements, or

	•		degradation in our stature and reputation in the market.

In addition, we face the following competitive risks relating to our Music, Games and Media Software and Services businesses:

Music. Our online music services offered through our Rhapsody America joint venture with MTVN face significant competition from traditional offline music distribution competitors and from other online digital music services, as well as online theft or “piracy.” Some of these competing online services have spent substantial amounts on marketing and have received significant media attention, including Apple’s iTunes music download service, which it markets closely with its popular iPod line of portable digital audio players and its iPhone. Microsoft also offers premium music services in conjunction with its Windows Media Player and also markets a portable music player and related download software and music service called Zune. We also expect increasing competition from online retailers such as Amazon.com, online community websites such as MySpace.com and Facebook.com, as well as other providers of free, ad-supported music services, some of whom are successfully growing consumer awareness of their services. Our online music services also face significant competition from “free” peer-to-peer services which allow consumers to directly access a wide variety of unlicensed content. Enforcement efforts have not effectively shut down these services and the ongoing presence of these “free” services substantially impairs the marketability of legitimate services like ours. To compete in this crowded market, we develop and work with partners to develop new and often unique marketing programs designed to build awareness of our music products and

services and to attract subscribers. However, many of these marketing programs are unproven and may result in significant expenses we may not recoup due to the program’s failure to increase awareness or the number of subscribers to our music services. Rhapsody America may not be able to compete effectively in this highly competitive and rapidly evolving market, which may negatively impact the future growth of our Music business.

Games. Our RealArcade, GameHouse, and Zylom branded services compete with other online aggregators and distributors of online and downloadable casual PC games. Some of these competitors have high volume distribution channels and greater financial resources than we do. Our Games business also competes with many other smaller companies that may be able to adjust to market conditions faster than us. We also face an increasingly price competitive casual games market, and some of our competitors may be able to compete on price more effectively than us. We expect competition to intensify in this market from these and other competitors and no assurance can be made that we will be able to continue to grow our revenue. Our development studios compete primarily with other developers of online, downloadable and mobile casual PC games and must continue to develop popular and high-quality game titles and to execute on opportunities to expand the play of our games on a variety of non-PC platforms to maintain our competitive position and help maintain the growth of our Games business.

Media Software and Services. Our media software and services (primarily our SuperPass subscription service) face competition from existing competitive alternatives and other emerging services and technologies, such as user generated content services like YouTube and alternative streaming media playback technologies including Microsoft Windows Media Player and Adobe Flash. Content owners are increasingly marketing their content on their own websites rather than licensing to other distributors such as us. We face competition in these markets from traditional media outlets such as television, radio, CDs, DVDs, videocassettes and others. We also face competition from emerging Internet media sources and established companies entering into the Internet media content market, including Time Warner’s AOL subsidiary, NBC Universal, Microsoft, Apple, Adobe, Yahoo! and broadband internet service providers. We expect this competition to continue to be intense as the market and business models for Internet video content mature and more competitors enter these new markets. Competing services may be able to obtain better or more favorable access to compelling video content than us, may develop better offerings than us and may be able to leverage other assets or technologies to promote or distribute their offerings successfully. If we are unable to compete successfully, the future growth of our Media Software and Services business will be negatively impacted. In addition, our overall ability to sell subscription services depends in part on the use of RealNetworks’ formats on the Internet, and declines in the use of our formats may negatively affect our subscription revenue and increase costs of obtaining new subscribers. Both Microsoft and Adobe are aggressively seeking to grow their format usage.

The success of our subscription services businesses depends upon our ability to increase subscription revenue and to license compelling content on commercially reasonable terms.

Our operating results could be adversely impacted by the loss of subscription revenue, including the revenue generated from the online music services offered by our Rhapsody America joint venture. Internet subscription businesses are a relatively new media delivery model, and we cannot predict with accuracy our long-term ability to maintain or increase subscription revenue. Subscribers may cancel their subscriptions to our services for many reasons, including a perception that they do not use the services sufficiently or that the service does not provide enough value, a lack of attractive or exclusive content generally or as compared with competitive service offerings (including Internet piracy), or because customer service issues are not satisfactorily resolved. In recent periods, we have seen an increase in the number of gross customer cancellations of our subscription services due in part to an increasingly large subscriber base, an increase in involuntary credit card cancellations resulting in termination of service and increased prevalence and awareness of alternative “free” on-demand streaming music services. In addition, we must continue to obtain compelling digital media content for our video, music, and games services in order to maintain and increase usage and overall customer satisfaction for these products. Our online music service offerings available through our Rhapsody America venture depend on music licenses from the major music labels and publishers, and the failure to renew these licenses under terms that are commercially reasonable and acceptable to us would harm Rhapsody America’s ability to generate revenues from its subscription services.

Music publishing royalty rates for music subscription services offered through RealNetworks and Rhapsody America are not yet fully established; an unexpected modification or application of settlement terms could negatively impact our operating results.

Publishing royalty rates associated with music subscription services in the U.S. and abroad are not fully established and public performance licenses are negotiated individually with performance rights organizations (PROs). A court issued several rulings that set forth how royalties are to be calculated and address other matters relating to the application of the new rates to be paid to one of the PROs, the American Society of Composers, Authors and Publishers (ASCAP). After working with ASCAP to make a final

determination of amounts owed under the court’s rulings, we reached a partial agreement with ASCAP on January 12, 2009. While we believe we have sufficiently accrued for expected royalties to be paid under the agreement, we plan to appeal some aspects of the court’s rulings that underlie the agreement, and the rulings remain subject to appeal and challenge by other participants. We also have license agreements to reproduce musical compositions with the Harry Fox Agency, an agency that represents music publishers, and with many independent music publishers as required in the creation and delivery of on-demand streams and tethered downloads, but these license agreements generally do not include final royalty rates. The license agreements anticipate industry-wide agreement on rates, which was reached among the Digital Media Association (DiMA), the Recording Industry Association of America (RIAA) and the National Music Publishers Association (NMPA). This settlement, along with the determination by the Copyright Royalty Board (CRB) on rates for full downloads, physical products and ringtones, was published by the CRB, and after some modifications by the U.S. Copyright Office, was collectively published as part of the CRB’s final determination in the Federal Register. The rate for ringtones and the imposition of a late fee on certain royalty payments contained in the final determination have been appealed by the RIAA. If terms of the settlement are modified or applied in a manner that we do not expect, we could incur increased expenses that could negatively impact our operating results. The publishing rates associated with our international music streaming services are also not yet determined and may be higher than our current estimates.

Copyright Royalty Board decisions regarding Internet radio royalties and minimum payments could result in material expenses that would harm our operating results and our ability to provide popular radio services.

Our RealDVD PC application is currently the subject of pending litigation, and we could incur significant expenses or be further prevented from selling RealDVD.

On September 30, 2008, we announced the availability of RealDVD, a PC application that allows consumers to store, manage and play their DVDs on their computers. On the same day, we filed a motion for declaratory judgment against the DVD Copy Control Association and Disney Enterprises, Inc., Paramount Pictures Corp., Sony Pictures Entertainment, Inc., Twentieth Century Fox Film Corp., NBC Universal, Inc., Warner Bros., Entertainment, Inc. and Viacom, Inc. seeking a determination that, among other things, our RealDVD product complies with the DVD Copy Control Association’s license agreement. Various movie studios filed suit against us alleging that RealDVD violates the Digital Millennium Copyright Act (DMCA) and also asked for and were granted a temporary restraining order preventing us from selling RealDVD until a full preliminary injunction hearing could be held. On August 11, 2009, the movie studios were granted their motion for a preliminary injunction, which enjoined us from selling or otherwise distributing RealDVD to the public. On September 10, 2009, we filed a notice of appeal on this ruling with the U.S. Court of Appeals for the Ninth Circuit. These claims could be costly and time-consuming to assert and defend and could require us to pay significant litigation expenses or damages or result in a permanent injunction against the sale of RealDVD, any of which would harm our operating results.

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

We cannot predict whether consumers will continue to download and use our digital media products consistent with past usage, especially in light of the fact that Microsoft bundles its competing Windows Media Player with its Windows operating system and the popularity of the Adobe Flash format. Our inability to maintain continued high volume distribution of our digital media products could hold back the growth and development of related revenue streams from these market segments, including the distribution of third-party products and sales of our subscription services, and therefore could harm our business and our prospects.

Our Rhapsody America joint venture may not have sufficient funds to continue to support its current operations.

We and MTVN have formed Rhapsody America LLC, a Delaware limited liability company, which is currently 51% owned by us (through a wholly owned subsidiary) and 49% owned by MTVN (through a wholly owned subsidiary). Rhapsody America has generated losses since its inception in 2007 and may not have sufficient funds to continue to support its current operations in the near term. Currently, neither we nor MTVN have any contractual obligations to fund Rhapsody America’s operations further. We cannot provide assurance that Rhapsody America will be able to obtain additional funds on acceptable terms from us, MTVN or any other third party funding source. If Rhapsody America does not obtain additional funding in the near term and/or substantially restructure

its operations, it will not be able to continue its current operations. To the extent Rhapsody America experiences a decline in its business operations or incurs liabilities resulting from a lack of liquidity, our business and operating results would be materially harmed.

We face risks with respect to certain matters in the governance and management of our Rhapsody America joint venture and the integration and operation of assets that have been combined to form Rhapsody America.

We and MTVN agreed to terms and conditions regarding the governance and management of Rhapsody America as part of the formation of Rhapsody America. We are entitled to appoint the general manager to manage the day-to-day operations of Rhapsody America. Rhapsody America is governed by a limited liability company agreement which, among other things, requires unanimous approval of the members for certain key operational activities, such as adopting a budget and authorizing certain capital expenditures, and for significant company events, such as mergers, asset sales, distributions, affiliate transactions and issuance, sale and repurchase of membership interests of Rhapsody America. If we are not able to agree with MTVN on any of those items, if the members are unable to agree on any other significant operational or financial matter requiring approval of the members, or if there is any event that adversely impacts our relationship with MTVN, the business, results of operations and financial condition of Rhapsody America may be adversely affected and, consequently, our business may suffer. In addition, MTVN may have or develop economic or other business interests or goals that are inconsistent with our or Rhapsody America’s business interests or goals.

Neither we nor the current management of Rhapsody America has extensive experience in managing and operating complex joint ventures of this nature, and the integration and operational activities may strain our internal resources, distract us from managing our day-to-day operations, and impact our ability to retain key employees in Rhapsody America. The nature of our and MTVN’s contributions of services and assets to Rhapsody America required detailed cost allocation agreements that are complex to implement and manage and may result in significant costs that could adversely affect our operating results. The allocation of these support service costs is based on various measures depending on the service provided, and require significant internal resources. Many of the allocation methodologies are complicated, which may result in inaccuracies in the total charges to be billed to Rhapsody America. In addition, the variable nature of these costs to be allocated to Rhapsody America may result in fluctuations in the period-over-period results of our Music business.

We and MTVN have certain contractual rights relating to the purchase and sale of MTVN’s membership interest in Rhapsody America that may be settled in part through the issuance of additional shares of our capital stock, which would dilute our other shareholders’ voting and economic interests in us, and may require us to pay MTVN a price that exceeds the appraised value of its proportionate interest in Rhapsody America.

Pursuant to the terms of the Rhapsody America limited liability company agreement, we have a right to purchase from MTVN, and MTVN has a right to require us to purchase, MTVN’s membership interest in Rhapsody America. These call and put rights are exercisable upon the occurrence of certain events and during certain periods in each of 2012, 2013 and 2014 and every two years thereafter and may be settled, in part, through the issuance of shares of our capital stock, subject to specified limitations. If a portion of the purchase price for MTVN’s membership interest is payable in shares of our capital stock, such shares could represent up to 15% of the outstanding shares of our common stock immediately prior to the transaction. In addition, we may also be obligated to issue shares of our non-voting stock representing up to an additional 4.9% of the outstanding shares of our common stock immediately prior to the transaction. If we pay a portion of the purchase price for MTVN’s membership interest in shares of our common stock and non-voting stock, our other shareholders’ voting and economic interests in us will be diluted, and MTVN will become one of our significant shareholders. In certain situations, if MTVN exercises its right to require us to purchase its membership interests in Rhapsody America, we may be required to pay MTVN a price that provides a return to MTVN that is potentially significantly higher than the appraised value of MTVN’s proportionate interest in Rhapsody America, and as a result, we would pay greater than fair value to acquire MTVN’s interest.

Risks Related to Our Technology Products and Solutions Business

Contracts with our carrier customers subject us to significant risks that could negatively impact our revenue or otherwise harm our operating results.

We derive a material portion of our revenue from carrier application services. Many of our carrier application services contracts provide for revenue sharing arrangements, but we have little control over the pricing decisions of our carrier customers. Furthermore, most of these contracts do not provide for guaranteed minimum payments or usage levels. Because most of our carrier customer contracts are nonexclusive, it is possible that our wireless carriers could purchase similar application services from third parties, and

cease to use our services in the future. As a result, our revenue derived under these agreements could be substantially reduced depending on the pricing and usage decisions of our carrier customers.

In addition, none of our carrier application services contracts obligates our carrier customers to market or distribute any of our applications. Despite the lack of marketing commitments, revenue related to our application services is, to a large extent, dependent upon the marketing and promotion activities of our carrier customers. In addition, many of our carrier contracts are short term and allow for early termination by the carrier with or without cause. These contracts are therefore subject to renegotiation of pricing or other key terms that could be adverse to our interests, and leave us vulnerable to non-renewal by the carriers. The loss of carrier customers, a reduction in marketing or promotion of our applications, or the termination, non-renewal or renegotiation of contract terms that are less favorable to us would likely result in the loss of future revenues from our carrier application services.

Finally, certain of our carrier contracts obligate us to indemnify the carrier customer for certain liabilities and losses incurred by them, including liabilities resulting from third party claims for damages that arise out of the use of our technology. These indemnification terms provide us with certain procedural safeguards, including the right to control the defense of the indemnified party. We have accepted tenders of indemnification from two of our carrier customers related to one pending patent infringement proceeding, and we are vigorously defending them. This pending proceeding or future claims against which we may be obligated to defend our carrier customers could result in paying amounts pursuant to these obligations that could materially harm our operating results.

Our ongoing arbitration proceeding with VeriSign, Inc. could ultimately result in a damages award in favor of VeriSign that may be material to our financial condition and results of operations.

The mobile entertainment market is highly competitive.

The market for mobile entertainment services, including ringback tone and music-on-demand solutions, is highly competitive. Current and potential future competitors include major media companies, Internet portal companies, content aggregators, wireless software providers and other pure-play wireless entertainment publishers. In connection with music-on-demand in particular, we may in the future compete with current providers of music-on-demand services for online or other non-mobile platforms, some of which have greater financial resources than we do. In addition, the major music labels may demand more aggressive revenue sharing arrangements or impose an alternative business model less favorable to us. Furthermore, while most of our carrier customers do not offer internally developed application services that compete with ours, if our carrier customers begin developing these application services internally, we could be forced to lower our prices or increase the amount of service we provide in order to maintain our business with those carrier customers. Increased competition has in the past resulted in pricing pressure, forcing us to lower the selling price of our services.

A majority of the revenue that we generate in our Technology Products and Solutions business is dependent upon our relationship with a few customers, including SK Telecom; any deterioration of these relationships could materially harm our business.

We generate a significant portion of our revenue from sales of our mobile entertainment services to a few of our mobile carrier customers, including SK Telecom, a leading wireless carrier in South Korea. In the near term, we expect that we will continue to

generate a significant portion of our total revenue from these customers, particularly SK Telecom. If these customers fail to market or distribute our applications or terminate their business contracts with us, or if our relationships with these customers deteriorate in any significant way, we may be unable to replace the affected business arrangements with acceptable alternatives. Furthermore, our relationship with SK Telecom may be affected by the general state of the economy of South Korea. Failure to maintain our relationships with these customers could have a material negative impact on our revenue and operating results.

Our traditional system software licensing business has been negatively impacted by competitive factors, and we may not experience improved sales of our system software products.

We believe that our traditional system software sales have been negatively impacted primarily by the competitive effects of Microsoft, which markets and often bundles its competing technology with its market leading operating systems and server software. Although the settlement agreement we entered into with Microsoft relating to our claims regarding Microsoft’s anticompetitive practices contained substantial cash payments to us and a series of technology agreements, Microsoft will continue to be an aggressive competitor with our traditional systems software business. We cannot be sure whether the portions of the settlement agreement designed to limit Microsoft’s ability to leverage its market power will be effective, and we cannot predict when, or if, we will experience increased demand for our system software products in a way that improves our operating results or shareholder return on an investment in our stock.

Risks Related to Our Business in General

Our operating results are difficult to predict and may fluctuate, which may contribute to volatility in our stock price.

The trading price for our common stock has been volatile, ranging from $1.97 to $5.12 per share during the 52-week period ended September 30, 2009. As a result of the rapidly changing markets in which we compete, our operating results may fluctuate from period-to-period, which may continue to contribute to the volatility of our stock price. In past periods, our operating results have been affected by personnel reductions and related charges, charges relating to losses on excess office facilities, and impairment charges for certain of our equity investments, goodwill and other long-lived assets. Our operating results may be adversely affected by similar or other charges or events in future periods, including, but not limited to:

	•		impairments of long-lived assets,

	•		integrating and operating newly acquired businesses and assets,

	•		the seasonality of our business, which has experienced increased revenues in the fourth quarter of our fiscal year, and

	•		the general difficulty in forecasting our operating results and metrics, which could result in actual results that differ significantly from expected results.

Certain of our expense decisions (for example, research and development and sales and marketing efforts) are based on predictions regarding business and the markets in which we compete. Fluctuations in our operating results, particularly when experienced beyond what we expected, could cause the trading price of our stock to continue to fluctuate.

Uncertainty and adverse conditions in the economy could have a material adverse impact on our business, financial condition and results of operations.

The national and global economic downturn has resulted in a decline in overall consumer and corporate spending, declines in consumer and corporate access to credit, fluctuations in foreign exchange rates, declines in the value of assets and increased liquidity risks, all of which could materially impact our business, financial condition and results of operations. We provide digital entertainment services to consumers, and payment for our products and services may be considered discretionary on the part of many of our current and potential customers. As a result, consumers considering whether to purchase our products or services may be influenced by macroeconomic factors that affect consumer spending such as unemployment, continuing increases in fuel costs, conditions in the residential real estate and mortgage markets and access to credit. To the extent conditions in the economy remain uncertain or the economy continues to deteriorate, our business could be impacted as customers choose to leave our services, to reduce their service level or to stop purchasing our products. In addition, our efforts to attract new customers may be adversely affected. Declines in consumer spending may also negatively impact our business customers, including our mobile carrier customers, who may experience decreases in demand for the services we provide that are offered to their subscribers. We are also experiencing a decline in advertising revenue as businesses are reducing their sales and marketing spending in response to the contracting economy. A significant decrease

in the demand for our products or services or declines in our advertising revenue could have a material adverse impact on our operating results and financial condition.

Uncertainty and adverse economic conditions may also lead to a decreased ability to collect payment for our products and services due primarily to a decline in the ability of consumers to use or access credit, including through credit cards, which is how most of our customers pay for our products and services. We also expect to continue to experience volatility in foreign exchange rates, which could negatively impact the amount of revenue and net assets we record in future periods. The functional currency of our foreign subsidiaries is the local currency of the country in which each subsidiary operates. We translate our subsidiaries’ revenues into U.S. dollars in our financial statements, and continued volatility in foreign exchange rates, particularly if the U.S. dollar strengthens against the euro or the Korean won, may result in lower reported revenue. If economic conditions continue to deteriorate or remain uncertain for a sustained period of time, we may also record additional impairments to our assets in future periods. Economic conditions may also negatively impact our liquidity due to (1) declines in interest income, (2) an increased risk that we may not be able to access cash balances held in U.S. or foreign financial institutions or that our investments in debt securities issued by financial institutions may become worthless due to the nationalization or failure of such financial institutions, and (3) decreased ability to sell the securities and the institutional money market funds we hold as short-term investments. In addition, the decline in the trading price of shares of our common stock may make it difficult to use our common stock as purchase price consideration for future acquisitions and to raise funds through equity financings. If any of these risks are realized, we may experience a material adverse impact on our financial condition and results of operations.

New products and services may not achieve market acceptance or may be subject to legal challenge that could negatively affect our operating results.

The process of developing new, and enhancing existing, products and services is complex, costly and uncertain. Our business depends on providing products and services that are attractive to subscribers and consumers, which, in part, is subject to unpredictable and volatile factors beyond our control, including end-user preferences and competing products and services. Any failure by us to timely respond to or accurately anticipate consumers’ changing needs and emerging technological trends could significantly harm our current market share or result in the loss of market opportunities. In addition, we must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether our predictions will accurately reflect consumer demand for our products and services, which may result in no return or a loss on our investments. Furthermore, new products and services may be subject to legal challenge. Responding to these potential claims may require us to enter into royalty and licensing agreements on unfavorable terms, require us to stop distributing or selling, or to redesign our products or services, or to pay damages.

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 success depends on the continued employment of certain executive officers and key employees, including Robert Glaser, our founder, Chairman of the Board and Chief Executive Officer. The loss of the services of Mr. Glaser or other key executive officers or employees could harm our business.

Our success is also dependent upon our ability to identify, attract and retain highly skilled management, technical, and sales personnel, both in our domestic operations and as we expand internationally. Qualified individuals are in high demand and competition for such qualified personnel in our industry is intense, and we may incur significant costs to retain or attract them. There can be no assurance that we will be able to attract and retain the key personnel necessary to sustain our business or support future growth.

Acquisitions involve costs and risks that could harm our business and impair our ability to realize potential benefits from acquisitions.

As part of our business strategy, we have acquired technologies and businesses in the past and expect that we will continue to do so in the future. In the period from 2006 through the second quarter of 2008, we completed the acquisition of substantially all of WiderThan and the acquisitions of Sony NetServices GmbH, Exomi Oy, Game Trust Inc. and substantially all of the assets of Trymedia Systems, Inc. The failure to adequately manage the costs and address the financial, legal and operational risks raised by acquisitions of technology and businesses could harm our business and prevent us from realizing the benefits of the acquisitions.

Acquisition-related costs and financial risks related to completed and potential future acquisitions may harm our financial position, reported operating results, or stock price. Previous acquisitions have resulted in significant expenses, including amortization of purchased technology, amortization of acquired identifiable intangible assets and the incurrence of non-cash charges for the

impairment of goodwill and other intangible assets in the fourth quarter of 2008, which are reflected in our operating expenses. New acquisitions and any potential additional future impairment of the value of purchased assets, including goodwill, could have a significant negative impact on our future operating results.

Acquisitions also involve operational risks that could harm our existing operations or prevent realization of anticipated benefits from an acquisition. These operational risks include:

	•		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.

An impairment in the carrying value of our long-lived assets could adversely affect our financial condition and results of operations.

Long-lived assets consist primarily of equipment, software and leasehold improvements, as well as amortizable intangible assets acquired in business combinations. Long-lived assets are amortized on a straight line basis over their estimated useful lives. We review long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. If the carrying amount of an asset is not recoverable, an impairment loss is recognized based on the excess of the carrying amount of the long-lived asset over its respective fair value, which is generally determined as the present value of estimated future undiscounted cash flows. During the quarter ended December 31, 2008, we concluded that the net book value related to certain intangible assets exceeded the fair value attributable to such intangible assets. As a result, we recorded charges of $57.6 million as impairments of long-lived assets within our consolidated statements of operations and comprehensive income in 2008. No such impairments were recognized in either the quarter or nine months ended September 30, 2009.

The impairment analysis of long-lived assets is based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of our long-lived assets could result in the need to perform an impairment analysis in future interim periods which could result in a significant impairment. While we believe our estimates and assumptions are reasonable, due to their complexity and subjectivity, these estimates and assumptions could vary period to period.

We need to develop relationships and technical standards with manufacturers of non-PC media and communication devices and interoperability of our services with these devices to grow our business.

Access to the Internet through devices other than a PC, such as personal digital assistants, cellular phones, television set-top devices, game consoles, Internet appliances and portable music and games devices has increased dramatically and is expected to continue to increase. If a substantial number of alternative device manufacturers do not license and incorporate our technology and services into their devices, we may fail to capitalize on the opportunity to deliver digital media to non-PC devices which could harm our business prospects. In addition, in order for our services, in particular, the digital music services offered through Rhapsody America, to continue to grow, we must design services that interoperate effectively with a variety of hardware devices. To achieve this

interoperability, we and Rhapsody America depend on significant cooperation with manufacturers of these products and with software manufacturers that create the operating systems for such hardware devices to achieve our objectives. If we do not successfully make our products and technologies compatible with emerging standards and the most popular devices used to access digital media or successfully design our service to interoperate with the music playback devices that our customers own, we may miss market opportunities and our business and results will suffer.

We may be unable to adequately protect our proprietary rights or leverage our patent portfolio, and may face risks associated with third-party claims relating to our intellectual property.

Our ability to compete partly depends on the superiority, uniqueness and value of our patent portfolio and other technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. However, our efforts to protect our intellectual property rights may not assure our ownership rights in our intellectual property, protect or enhance the competitive position of our products and services or effectively prevent misappropriation of our technology. As disputes regarding the validity and scope of patents or the ownership of technologies and rights associated with streaming media, digital distribution, and online businesses are common and likely to arise in the future, we may be forced to litigate to enforce or defend our patents and other intellectual property rights or to determine the validity and scope of other parties’ proprietary rights, enter into royalty or licensing agreements on unfavorable terms or redesign our product features and services. Any such dispute would likely be costly and distract our management, and the outcome of any such dispute could fail to improve our business prospects or otherwise harm our business.

From time to time we receive claims and inquiries from third parties alleging that our technology may infringe the third parties’ proprietary rights, especially patents. Third parties have also asserted and most likely will continue to assert claims against us alleging infringement of copyrights, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition or violations of privacy rights. Currently we are investigating or litigating a variety of such pending claims, some of which are described in Note 14 to the financial statements included in this report.

Our business and operating results will suffer if our systems or networks fail, become unavailable, unsecured or perform poorly so that current or potential users do not have adequate access to our products, services and websites.

Our ability to provide our products and services to our customers and operate our business depends on the continued operation and security of our information systems and networks. A significant or repeated reduction in the performance, reliability, security or availability of our information systems and network infrastructure could harm our ability to conduct our business, and harm our reputation and ability to attract and retain users, customers, advertisers and content providers. We have on occasion experienced system errors and failures that caused interruption in availability of products or content or an increase in response time. Problems with our systems and networks could result from our failure to adequately maintain and enhance these systems and networks, natural disasters and similar events, power failures, HVAC failures, intentional actions to disrupt our systems and networks and many other causes. The vulnerability of a large portion of our computer and communications infrastructure is enhanced because much of it is located at a single leased facility in Seattle, Washington, an area that is at heightened risk of earthquake, flood, and volcanic events. Many of our services do not currently have fully redundant systems or a formal disaster recovery plan, and we may not have adequate business interruption insurance to compensate us for losses that may occur from a system outage.

The growth of our business is dependent in part on successfully implementing our international expansion strategy.

Our international operations involve risks inherent in doing business on an international level, including difficulties in managing operations due to distance, language, and cultural differences, different or conflicting laws and regulations, taxes, and exchange rate fluctuations. Any of these factors could harm operating results and financial condition. Our foreign currency exchange risk management program reduces, but does not eliminate, the impact of currency exchange rate movements.

We may be subject to market risk and legal liability in connection with the data collection capabilities of our products and services.

Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate. To provide better consumer experiences and to operate effectively, our products send information to our servers. Many of the services we provide also require that a user provide certain information to us. We have an extensive privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client and server products. Any failure

by us to comply with our posted privacy policy and existing or new legislation regarding privacy issues could impact the market for our products and services, subject us to litigation, and harm our business.

We may be subject to assessment of sales and other taxes for the sale of our products, license of technology or provision of services.

Currently we do not collect sales, value-added tax (VAT), transactional or other taxes on the sale of our products, license of technology or provision of services in states and countries other than those in which we have offices, employees or other taxable presence. However, one or more states or foreign countries may seek to impose sales, VAT, transactional or other tax collection obligations on us in the future. A successful assertion by one or more states or foreign countries that we should be collecting sales, VAT, transactional or other taxes on the sale of our products, licenses of technology, provision of services or from our Internet commerce activities could result in substantial tax liabilities for past sales, discourage customers from purchasing our products from us or otherwise substantially harm our business.

Currently, decisions by the U.S. Supreme Court restrict the ability of states to force remote sellers to collect state and local sales and use taxes. However, a number of states and the U.S. Congress have been considering various initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on products and services sold through the Internet. If these initiatives are successful, we could be required to collect and remit sales and use taxes in additional states. States are also continuing to define the taxability of digital goods. Taxation of digital goods is subject to complex evolving tax rules that could result in additional taxation of our products and services. The imposition of additional tax obligations related to our business activities by state and local governments could materially adversely affect our operating results, create administrative burdens for us and decrease our future sales.

In those countries where we have taxable presence, we collect VAT on sales of “electronically supplied services” provided to European Union residents, including software products, games, data, publications, music, video and fee-based broadcasting services. The collection and remittance of VAT subjects us to additional currency fluctuation risks.

We may be subject to additional income tax assessments.

We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes, income taxes payable, and net deferred tax assets. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in our historical financial statements. An audit or litigation can result in significant additional income taxes payable in the U.S. or foreign jurisdictions which could have a material adverse effect on our financial condition and results of operations.

Risks Related to Our Previously Announced Separation of Our Games Business

We announced our intention to separate our global Games business into an independent company and to distribute shares of the newly created games company to our shareholders. If such transactions are postponed for a significant period of time or not completed, our stock price and business may be adversely affected, and we may not realize the anticipated benefits of the separation transactions.

In May 2008, we announced our intention to separate our global Games business into an independent company and to distribute shares of the newly created games company to our shareholders. In February 2009, we announced that we postponed work with our outside advisors, stopped external spending on the proposed transactions and wrote off the capitalized transaction-related costs in the fourth quarter of 2008. While we still intend to create a separate games company, current conditions do not support the separation transactions.

In addition, our business and operations may be harmed to the extent there is customer or employee uncertainty surrounding the future direction of our product and service offerings and strategy for our Games business. Even if we resume working with our outside advisors on the separation transactions, we may not complete the transactions, which are subject to a number of factors including business and market conditions, the final approval of our board of directors, the effectiveness of a registration statement, the receipt of a favorable letter ruling from the Internal Revenue Service and the execution of inter-company agreements. If the separation transactions are not completed, we and our shareholders will not realize the anticipated financial, operational and other benefits from such transactions.

Risks Related to the Securities Markets and Ownership of Our Common Stock

Our directors and executive officers beneficially own more than 38% 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.

Our executive officers, directors and affiliated persons beneficially own more than 38% of our common stock. Robert Glaser, our Chief Executive Officer and Chairman of the Board, beneficially owns more than 38% of our common stock himself. As a result, our executive officers, directors and affiliated persons will have significant influence to:

	•		elect or defeat the election of our directors;

	•		amend or prevent amendment of our articles of incorporation or bylaws;

	•		effect or prevent a merger, sale of assets or other corporate transaction; and

	•		control the outcome of any other matter submitted to the shareholders for vote.

Management’s stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of RealNetworks, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price.

Provisions of our charter documents, Shareholder Rights Plan, and Washington law could discourage our acquisition by a third-party.

Our articles of incorporation provide for a strategic transaction committee of the board of directors. Without the prior approval of this committee, and subject to certain limited exceptions, the board of directors does not have the authority to:

	•		adopt a plan of merger;

	•		authorize the sale, lease, exchange or mortgage of 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.

In addition, Mr. Glaser has special rights under our articles of incorporation to appoint or remove members of the strategic transaction committee at his discretion that could make it more difficult for RealNetworks to be sold or to complete another change of control transaction without Mr. Glaser’s consent.

RealNetworks has also entered into an agreement providing Mr. Glaser with certain contractual rights relating to the enforcement of our charter documents and Mr. Glaser’s roles and authority within RealNetworks.

We have adopted a shareholder rights plan, which was amended and restated in December 2008, that provides that shares of our common stock have associated preferred stock purchase rights. The exercise of these rights would make the acquisition of RealNetworks by a third-party more expensive to that party and has the effect of discouraging third parties from acquiring RealNetworks without the approval of our board of directors, which has the power to redeem these rights and prevent their exercise.

Washington law imposes restrictions on some transactions between a corporation and certain significant shareholders. The foregoing provisions of our charter documents, shareholder rights plan, our agreement with Mr. Glaser, and Washington law, as well as our charter provisions that provide for a classified board of directors and the availability of “blank check” preferred stock, could have the effect of making it more difficult or more expensive for a third-party to acquire, or of discouraging a third-party from attempting to acquire, control of us. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable

(b) Not applicable

Item 3. Default Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

An annual meeting of shareholders (Annual Meeting) of the Company was held on September 21, 2009. The matters voted on at the Annual Meeting and votes cast on such matters were as follows:

The election of one Class 2 director to serve until the 2011 Annual Meeting of Shareholders and one Class 3 director to serve until the 2012 Annual Meeting of Shareholders, or until each such director’s earlier retirement, resignation or removal, or at the election of his successor.


	For		Withheld
Directors Elected:
Pradeep Jotwani (Class 2)		86,624,492		35,325,662
Robert Glaser (Class 3)		85,435,512		36,514,642

The terms of the following directors continued after the Annual Meeting:

Eric A. Benhamou

Edward Bleier

Jonathan D. Klein

Kalpana Raina

The approval of amendments to the RealNetworks, Inc. 2005 Stock Incentive Plan, as amended and restated, the RealNetworks, Inc. 2000 Stock Option Plan, as amended and restated, and the RealNetworks, Inc. 1996 Stock Option Plan, as amended and restated, including (among other amendments) to permit a one-time stock option exchange program for eligible employees other than directors and Section 16 officers.


	Votes
For		91,419,562
Against		6,395,767
Broker non-votes		21,006,120
Abstain		3,128,705

The ratification of the appointment of KPMG LLP as the Company’s registered public accounting firm for the fiscal year ended December 31, 2009.


	Votes
For		119,751,396
Against		1,418,580
Broker non-votes		—
Abstain		780,178

Item 5. Other Information

None

Item 6. Exhibits

Exhibits Required by Item 601 of Regulation S-K


Exhibit
Number		Description

31.1		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 2002

31.2		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 2002

32.1		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 2002

32.2		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

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on October 30, 2009.


REALNETWORKS, INC.
By:	/s/ Michael Eggers
	Michael Eggers
	Title:	Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

INDEX TO EXHIBITS


Exhibit
Number		Description

31.1		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 2002

31.2		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 2002

32.1		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 2002

32.2		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