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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

REALNETWORKS, INC.
(Exact Name of Registrant as Specified in Its Charter)

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

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

None

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

Common Stock, Par Value $0.001 per share
(Title of Class)

     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 [X] No [   ]

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

     The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing price on March 4, 2002, as reported on NASDAQ, was $717,686,157.(1)

     The number of shares of the registrant’s Common Stock outstanding as of March 4, 2002 was 158,811,753.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the registrant’s Proxy Statement relating to the registrant’s 2002 Annual Meeting of Shareholders to be held on or about June 6, 2002 are incorporated by reference into Part III of this Report.

     (1)  Excludes shares held of record on that date by directors, executive officers and 10% shareholders of the registrant. Exclusion of such shares should not be construed to indicate that any such person directly or indirectly possesses the power to direct or cause the direction of the management of the policies of the registrant.

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PART I.

     This Annual Report on Form 10-K 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, 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. 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 the section of Item 1 entitled “Intellectual Property,” in Item 3 entitled “Legal Proceedings” and in the sections entitled “Factors That May Affect Our Business, Future Operating Results and Financial Condition” and “Special Note Regarding Forward-Looking Statements.” 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.

ITEM 1. Business

Overview

     RealNetworks, Inc. was incorporated in 1994 and is a leading global provider of software products and services for Internet media delivery. We pioneered the development of streaming media systems that enable the creation, real-time delivery and playback of audio, video and multimedia content on the Internet and we continue to develop and market software products and services designed to enable users of personal computers and other consumer electronic devices to send and receive audio, video and other multimedia services using the Web. We believe that we have established a leadership position in the worldwide market for these systems, with more than 250 million unique registered users of our RealPlayer and RealOne Player products, more than 130 million of which are located outside the U.S. We believe our RealJukebox product is one of the most popular digital music jukebox systems worldwide, with more than 75 million unique registered users. In addition, we believe that more than 85% of all Web pages that contain streaming media use RealAudio, RealVideo, or other RealNetworks formats. In December 2001, we launched RealOne, which incorporates our RealPlayer and RealJukebox products together in a new version of our player products, the RealOne Player. In addition to the features found in the RealPlayer and RealJukebox, the RealOne Player contains a media browser and value-added services to create an immersing, multi-dimensional media experience for consumers.

     The broad acceptance of the Internet as a means of content delivery and consumption, combined with continuing advances in broadband and wireless technology, has greatly increased the practicality and popularity of delivering rich media to consumers and within enterprises. It has also moved the Internet closer to becoming a truly mass medium. To capture this market opportunity, our business strategy has focused on building end-to-end solutions for customers which combine integration of systems software, managed hosting services and consulting services. A core part of this strategy has been building a universal platform for Internet media delivery — one that is capable of delivering media in any format, over any operating system, to any device anywhere. Our current system software, RealSystem iQ, embodies this approach and enables content providers to deliver high quality Internet audio and video to consumers with high levels of scalability, reliability and flexibility. We have also formed strategic alliances with leading manufacturers of chips, servers, personal computers, and wireless and personal music devices, as well as other consumer electronic devices, to incorporate our streaming and downloadable media technology in their products. These relationships help reinforce our leadership position in end-to-end Internet media delivery.

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     Because of the size of our worldwide user base, we also have a unique ability to pool consumer demand on a very large scale. Accordingly, we have developed a variety of products and services to connect content providers, broadcasters and advertisers with that user base. These products and services include our RealOne subscription service, which offers subscribers an all-in-one package of premium software, services and premium content. Our strategy is to continue to develop new distribution channels and technologies for content providers and broadcasters to reach our audience of more than 250 million unique registered users with high quality streaming media programming.

Consumer Media Delivery Products and Services

     RealPlayer. Our RealPlayer player products enable users to listen to and view content from Web sites. In 1995, we launched our first version of the RealPlayer that provides basic functions such as play, stop, fast-forward, rewind and volume adjustment and customizable navigational tools and services for easy and personalized access to multimedia content. Since that time, RealPlayer has been available to consumers as a free download from our Web site and also through bundling with third-party products. We also sell our premium RealPlayer Plus player product, which contains additional features beyond those found in the free version, including clearer, sharper audio and video, high-fidelity audio quality with a graphic equalizer and picture quality controls such as contrast, brightness and tint. The RealPlayer also contains a radio tuner feature that enables users to access and listen to hundreds of Internet and terrestrial radio stations. We have developed localized versions of the RealPlayer product for use in 11 foreign languages.

     RealJukebox. In 1999, we released our RealJukebox digital music player product. RealJukebox is a comprehensive product that enables consumers to acquire, record, store, organize and play their personal music collections from a PC. Music can be sorted by a number of categories, including artist, song title, genre and type of file, and consumers can create personal playlists by dragging and dropping songs. Consumers can acquire music for playback in the RealJukebox from a number of different sources, including free promotional music downloads, purchased Internet music downloads and music purchased through links to online music retailers. Consumers can also record CDs onto their hard disks at high speeds using their choice of several high-quality recording formats. RealJukebox plays back a number of high-quality digital audio formats, including RealAudio 8.0, MP3, Liquid Audio, Sony’s ATRAC3 and a2b, and enables users to transfer their music to portable digital playback devices manufactured by RealNetworks’ partners and other portable storage solutions. RealJukebox includes information services that provide access to CD information from an online music database, including track name, artist, album and genre. Since its launch in 1999, RealJukebox has been available to consumers as a free download from our Web site and also through bundling with third-party products. We also sell our premium RealJukebox Plus, which contains additional features beyond the free version, including a graphic equalizer and a higher MP3 encoding rate. Users with CD-RW drives can also create their own custom CDs for personal use with RealJukebox Plus. We have developed localized versions of the RealJukebox for use in 11 foreign languages.

     RealOne Player. In December 2001, we released the beta version of our RealOne Player, the newest version of our player products that incorporates features of our RealPlayer and RealJukebox products together in a single player product. The RealOne Player contains a new user interface and functions designed to increase the consumer’s ability to discover, play and manage digital media. The RealOne Player blends the functions of the RealPlayer and the RealJukebox together with a Web browser and a content discovery window to create a three-pane user interface that enables consumers to create their own personalized media experience by navigating between media playback, related links and Web sites. The RealOne Player enables consumers to play a wide variety of digital media, including streaming and downloaded content, CDs, MP3s, and Internet radio stations, and currently supports over 50 media formats. The RealOne Player also offers users increased digital music management capability, including a “Now Playing” list that provides a flexible means of creating audio and video playlists from content in the users media library or on the Internet. The RealOne Player also contains integrated

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CD burning functions and support for a wide variety of portable devices that enable consumers to make their music collection portable.

     RealOne Subscription Services. In August 2000, we launched RealPlayer GoldPass, a for-pay media subscription service available to our RealPlayer Plus customers. RealPlayer GoldPass provided subscribers access to a combination of premium software, services and content updated monthly. In December 2001, we launched RealOne, the successor to our GoldPass subscription service. Members of RealOne have access to premium subscription content and are able to take advantage of certain enhanced features of the RealOne Player such as theater mode for video, faster CD ripping and high-end video and audio controls. RealOne provides a single source for consumers to access popular news, sports, music and entertainment online, while allowing content providers the ability to offer exclusive access to content and to potentially profit from multiple e-commerce opportunities. The RealOne service contains new integrated and premium programming from a wide variety of content providers, including ABCNEWS.com, CBS SURVIVOR INSIDER, CNN, E! Networks, FoxSports.com, MLB Advanced Media, the NBA and NASCAR.

     RealOne Player users are also eligible to subscribe to RealOne Music, a commercial service offering high-quality, reliable downloads and streams of content from major and independent record labels. RealOne Music is based on an online music distribution platform developed by MusicNet, Inc., a joint venture we formed in 2001 with four leading media companies to create a platform for online music subscription services. Our RealOne Music service allows members to download and stream tracks or entire albums from a selection of over 75,000 songs. Members of RealOne Music also receive RealOne Radio, which offers a variety of exclusive stations with ad-free music programming, and advanced music services such as discographies, album art, and music recommendations. RealOne Music also integrates with the RealOne Player to permit members to combine music from MusicNet with their existing collections, compile personalized playlists of downloaded or streaming tracks, listen to favorites and discover new music.

     Games; RealArcade. Since March 2000, we have offered a wide variety of digital games for preview, free trials and purchase through the Real.com Web site. In May 2001, we launched the successor to our Real.com Games Web site, RealArcade, an all-in-one, free game service offering consumers the ability to find, acquire, manage and play PC-based games, and which also includes direct access to an online gaming community. The RealArcade service is available for free download and makes a wide variety of games available for preview, free trials and purchase.

     Third Party Accessories. We make third party products available for trial and for sale as plug-ins to our products from the Accessories links on our Real.com Web site.

System Software Products and Services

     RealSystem iQ. Our current system software, RealSystem iQ, is a universal platform for Internet media delivery. RealSystem iQ is a standards-based, end-to-end system architecture that can provide a single common platform for Internet media delivery — permitting Internet media delivery from multiple platforms, in multiple media formats, from narrowband audio to high fidelity broadband video. Our media delivery solutions are designed to optimize the delivery of multimedia and other digital content over the Internet, corporate intranets and virtual private networks. Our solutions are based on open industry standards and work with a broad range of operating systems, hardware platforms, network environments and media types.

     RealSystem iQ’s NeuralCast Technology operates at multiple levels to deliver both live and on-demand media, and is designed to optimize end-viewer quality through server and encoder redundancy, reduction of network congestion and flexible deployment. Through distributed network configurations of interconnected RealSystem Servers, NeuralCast Technology enables servers to broadcast into the network, receive content from other servers, and deliver media to vast audiences. In addition, RealSystem iQ is designed to transport and

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deliver over 50 media types, including RealAudio, RealVideo, MP3, MPEG-4 and Flash, as well as to deliver Apple QuickTime content to QuickTime clients. RealSystem iQ also provides an extensible architecture to enable next-generation media playback devices, including wireless mobile devices, game consoles and broadband-ready set-top boxes. The major software components of RealSystem iQ are RealSystem Server 8.0, RealSystem Proxy 8.0, RealSystem Producer 8.5, and the family of RealOne Players.

     RealSystem Servers. Our server technology allows broadcasters and content providers to broadcast live or on-demand audio, video and other multimedia programming to large numbers of simultaneous users with varying Internet or intranet connection speeds. We sell our server technology based on units deployed, features, and concurrent audiences served, and we offer a variety of server products to meet the varying needs and requirements of broadcasters and content providers. RealSystem Server 8.0 supports the delivery of QuickTime content to QuickTime clients, providing content delivery networks and broadcasters the opportunity to consolidate their media delivery infrastructure with one system architecture.

     The RealSystem Server 8.0 line has delivered significant improvements in scalability, reliability and redundancy over previous versions. RealSystem Server Basic, available for free download, supports up to 25 concurrent users of live and on-demand multimedia broadcasts. RealSystem Server Plus is designed for hobbyists and small- to medium-sized businesses. It supports 60 concurrent users and is available in both Internet and intranet configurations.

     RealSystem Server Professional is designed for use primarily by content delivery networks, enterprises reaching external audiences, broadcasters, Internet service providers (ISPs), distance learning providers and large Web sites. It supports large audiences through satellite multicast as well as the Neuralcast Technology that is provided by RealSystem iQ. We also customize this server solution for particular applications. For example, we offer features that are designed and priced specifically for educational institutions or teachers, and features that enable ISPs to host the streaming media content of their customers.

     RealSystem Server Enterprise is designed for corporate, government and education intranets. Popular applications include live executive broadcasts at company meetings, sales force training and enterprise learning. Other enterprise tools deployed in conjunction include the RealPlayer Enterprise, which is optimal for corporate managed desktops, and the RealPlayer Intranet Administrator, a configuration tool used to manage these players.

     Optional RealSystem Server Extensions include the Authentication Extension to help ensure site security, user name and password or to enable pay-per-view broadcasting and to support back-end credit card and transaction-processing systems and the Advertising Extension, which enables in-stream advertising insertion and rotation of banner and streaming media advertising into streaming media content while integrating with existing ad-serving software and solutions.

     RealSystem Proxy. RealSystem Proxy is a middle-of-the-network technology, placed between an origin RealSystem Server and our player products in order to minimize incoming bandwidth requirements. RealSystem Proxy accepts live streams from other servers and re-serves the data stream to end-users, acting as a live stream repeater, and eliminating redundant data transmission of live streams. RealSystem Proxy is integrated with a cache, either a simple encrypted storage system or a third-party integrated Web cache, to provide similar functionality for on-demand content. This allows a stream to reach a player without having to traverse the entire delivery chain from the origin server. Our proxy/cache products, both our retail versions and those available through OEM partners, are used in conjunction with, and do not replace, RealSystem Servers.

     Media Creation Tools. We offer a variety of products that enable content and presentations to be created prior to distribution over RealSystem iQ. Our media creation tools are offered both for download from the RealNetworks.com Web site and in product bundles from third parties. RealSystem Producer is a widely distributed multimedia creation and publishing tool that allows consumers to convert a wide variety of media

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formats to RealMedia formats. RealSlideshow allows users to combine pictures with voice commentary and/or music, including MP3 support, to create a slide show experience on a Web site. RealPresenter integrates with Microsoft PowerPoint and allows users to convert PowerPoint slides into audio and video enhanced Web broadcasts for access by a workgroup. Basic versions of RealSystem Producer, RealSlideshow and RealPresenter are available to content creators as free downloads from our Web site. We also make advanced or Plus versions of each of these products available for purchase from our Web site by professionals and other consumers who require more sophisticated media creation features and capabilities.

     Media Commerce Suite. In June 2001, we launched the RealSystem Media Commerce Suite, a set of products and services for the secure licensing, delivery and rights management of digital media. The RealSystem Media Commerce Suite attempts to satisfy a variety of requirements of digital media commerce in a consumer-friendly fashion. The Media Commerce Suite provides a flexible business model support for subscription, purchase, rental, video-on-demand, confidential enterprise applications, and other models and back-end system interoperability with clearinghouse payment systems, retail storefronts, databases, customer relationship management software, and other essential commerce systems. The Media Commerce Suite is also designed to provide end-to-end security throughout the media’s product lifecycle, from packaging to distribution to enjoyment by the audience and a choice of media delivery methods, including streaming, download, peer-to-peer distribution, and physical media.

     Software Development Kits. RealNetworks makes software development kits (known as SDKs) available for free download and licensing to software developers. SDKs allow developers to create new software products that are compatible with and complementary to RealSystem iQ. The RealSystem iQ SDK describes programming interfaces and processes by which a developer may build plug-ins for the RealSystem Server and RealPlayer products. The RealSystem portable device SDK allows development of RealJukebox plug-ins for portable devices. The RealSystem Producer SDK similarly describes interfaces and processes, and includes object code, which enables a developer to build a tool that encodes RealNetworks file formats. The RealSystem Proxy SDK enables the creation of proxy products that integrate with the RealSystem. RealNetworks also makes available toolkits to create visualizations and skins for RealJukebox. Our SDKs have been used by hundreds of developers to develop applications.

     Real Broadcast Network. Real Broadcast Network is our managed broadcast service through which we provide hosting services on behalf of broadcasters, enterprises and content providers. Through Real Broadcast Network, we provide full turnkey services, including the hardware, software, personnel, network connectivity and bandwidth necessary to enable businesses to deliver live, scheduled and on-demand programming over the Internet. Real Broadcast Network’s distributed architecture is designed to improve Internet broadcasts by routing consumers to the nearest broadcast hub on the Internet or within an ISP. Real Broadcast Network offers a wide range of proprietary customer applications used by radio stations, TV stations, cable networks, enterprises and financial services companies such as streaming advertising insertion and replacement.

Advertising

     We market and sell advertising on our Web sites and client software. Our primary Web presence consists of two Web sites, Real.com and RealNetworks.com. The Real.com site showcases our premium software and subscription service offerings, including RealOne, RealOne Music and RealArcade. Real.com Guide is also a part of the Real.com family of Web sites. Real.com Guide offers visitors the ability to search for and locate multimedia content on the Internet and in our RealOne subscription service. We have developed localized versions of the Real.com Guide for use in 10 foreign languages. The RealNetworks.com Web site includes information for and downloads of RealNetworks products and services, corporate information, and special interest areas for RealNetworks partners and third party developers. The RealNetworks.com Web site presents an opportunity for advertisers to reach information system professionals and Web developers who are looking for information and tools on streaming media development. Our RealOne products and services offer mass reach to

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advertisers as well as contextually relevant and demographically segmented targeting opportunities to Internet advertisers. RealOne, as an advertising platform, combines the broadcast capabilities of television with the direct response attributes of the Internet to deliver an interactive brand experience to the end user.

Technology

     Our media delivery solutions are designed to optimize the creation, delivery and playback of multimedia and other digital content over the Internet, corporate intranets and virtual private networks. Our solutions are based on open industry standards and work with a broad range of operating systems, hardware platforms, network environments and media types.

     RealSystem iQ is designed to intelligently deliver content while providing a high degree of reliability and flexibility. Previous technologies relied on origin servers to distribute media streams to intermediate edge servers and then to consumers. RealSystem iQ with Neuralcast Technology fundamentally changes this “one-way” approach of origin-to-edge distribution. By creating honeycombs of distributed interconnected servers, RealSystem iQ enables servers to broadcast into the network, receive content from any other server, and deliver media to end users. Neuralcast Technology provides a uniform foundation for routing media from one server to many via standard network protocols. In addition, the architecture of RealSystem iQ can enable the transport and delivery of all Internet media types.

     Content delivery networks and enterprises are capable of achieving near-100% reliability by utilizing RealSystem iQ’s forward error correcting technology and its ability to send redundant media streams over different parallel network segments. RealSystem iQ’s terrestrial delivery capabilities are complemented by the integrated support of satellite delivery technology within one distributed network architecture. With RealSystem iQ, media content can be transmitted up to a satellite and then multicast simultaneously to numerous RealSystem Servers located at ISPs and other content delivery locations, thus enabling larger, and more efficient broadcasts.

     RealSystem iQ enables significant enterprises and content delivery networks to distribute stream capacity at times of heavy traffic and to adjust to usage spikes. RealSystem iQ attempts to meet the demands of large and emerging broadcasters by providing a single standards-based media delivery system that supports a broad range of media types and is configurable for any network. The system allows customers to reduce business risk by interoperating with a wide variety of back-end systems, platforms and applications. By supporting narrowband and broadband content, radio and music as well as high-quality video content can be broadcast over a single Internet media delivery system. RealSystem iQ facilitates consolidation of media delivery infrastructures through its support of more than 50 media types, including RealAudio, RealVideo, Apple’s QuickTime, Flash 4, MPEG-4 and streaming MP3.

     RealSystem iQ architecture is also designed to enable media delivery to devices beyond the PC to expand the reach of the Internet. As consumer device adoption grows, the structure of RealSystem iQ is able to address the media delivery needs of those devices and networks. In addition, RealSystem iQ provides the base framework enabling peer-to-peer relationships between individual content delivery networks. RealSystem iQ builds on previous technologies pioneered by RealNetworks to ensure an optimized experience for digital media delivery and includes the following features:

•

SureStream transport technology enables reliable and continuous end-user playback by scaling dynamically to deliver high-quality RealAudio and RealVideo to users at the varying connection rates found under real-world network conditions. SureStream technology utilizes bi-directional communication that enables the server and player to communicate during transmission regarding the bandwidth and quality of the user’s connection to optimize the transmission.

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	•		Buffering ensures continuous delivery by caching data packets and requesting retransmission of any missing packets.
	•		Error-Mitigation reduces performance degradation by reconstructing lost data packets based on approximations regarding adjacent or closely related data packets.
	•		Smart Networking allows a server to automatically select the appropriate transmission protocol depending on current network conditions and the presence of firewalls or proxies when streaming content to the player.
	•		Video-Optimized Transmission incorporates technologies that reduce unnecessary repetition of redundant background data in neighboring video frames, and reduces the amount of video content being streamed if video performance is degraded during a given transmission. This technology instead focuses on maintaining the continuity of the audio stream, which is often more central to the user experience.

     In addition, RealSystem iQ builds on industry standards, implementing Real Time Streaming Protocol, a standard client/server protocol for streaming media. RealSystem iQ also supports Synchronized Multimedia Integration Language (SMIL), which enables rich, multi-screen content to be delivered over a typical modem connection. SMIL allows content creators to easily synchronize their media presentations with a wide range of media, including voice, music, visual effects, text and graphics, to produce audio-visual content using a simple text editor.

     Technologies Enabling Large-Scale Delivery of Streamed Multimedia to Enterprises and Access ISPs. To boost the scalability, reliability and flexibility of specialized networks, such as enterprise and ISP networks, RealNetworks provides RealSystem Proxy 8.0. RealSystem Proxy 8.0, another component of RealSystem iQ, allows enterprises and ISPs to manage inbound bandwidth, reducing costs and ensuring media delivery quality through intelligent management of live and on-demand content requested by users in these networks. RealSystem Proxy 8.0 is particularly suited for organizations that have a large amount of digital media flowing into or over their network. RealSystem Proxy technologies available directly from RealNetworks and from third party licensees enable widespread and efficient distribution of multimedia content by moving the data closer to the end user. RealSystem Proxy technology enables ISPs and enterprises to greatly reduce bandwidth and infrastructure costs, and provides a more compelling experience for the user.

     Codecs. RealSystem iQ uses multiple compression/decompression algorithms (or codecs) to translate time-based, data-intensive content such as audio, video or animation data into discrete data packets and then broadcasts (or streams) the packets from a server to a client, such as the RealPlayer. The client then reassembles the packets in the correct order and allows a user to play back the streaming media content in real time without waiting to download. The compression process enables the data to be streamed to the player even in very low bandwidths (14.4 kbps) or congested network environments by reducing the amount of data to be streamed. We have licensed and integrated Intel’s streaming Web video technology into our RealVideo 8.0 technology, enabling a substantial improvement in consumer experience, and providing opportunities to introduce new classes of programming that were not practical with prior generations of video technologies because streaming video users did not have sufficient access to bandwidth. Additionally, broadcasters are able to deliver download-and-play video programming that delivers quality comparable to broadcast television. RealVideo 8.0 delivers VHS quality at 400kbps and near DVD quality at 800kbps. We have also licensed and integrated Sony’s ATRAC3 code technology as part of RealAudio 8.0. Developed in part through a strategic alliance with Sony Corporation, RealAudio 8.0 offers a single audio solution that delivers consumers CD-quality playback at 64kbps. Some of our other codecs use technology licensed from third parties, and we are also continuously engaged in research and development of our own codec technology.

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     Digital Rights Management. We recently released our Media Commerce Suite set of products and services to enable the secure licensing, delivery and rights management of digital media. Our Media Commerce Suite products are built on RealSystem iQ and extend our RealSystem and RealPlayer architecture to accommodate the incorporation of a wide range of rights management systems. The Media Commerce Suite is designed to integrate into a wide variety of existing infrastructures and back-end systems to support a broad set of business models, including purchase, rental, video-on-demand and subscription services.

Research and Development

     We devote a substantial portion of our resources to developing new products, enhancing existing products, expanding and improving our fundamental streaming technology and strengthening our technological expertise. During the years ended December 31, 2001, 2000 and 1999, we expended approximately 30%, 24% and 29%, respectively, of our total net revenues on research and development activities. As of December 31, 2001, RealNetworks had 327 full-time employees, or approximately 41% of our work force, engaged in research and development activities.

Sales, Marketing and Distribution

     We believe that any individual or company that desires to send, support or receive multimedia content over the Internet is a potential customer. To reach as many of these potential customers as possible, we sell and distribute our products and services through several distribution channels, both directly (over the Internet and through a sales force) and indirectly (through original equipment manufacturers (OEMs), value added resellers (VARs) and other distributors). As of December 31, 2001, we had 344 full-time employees, or approximately 43% of our work force, engaged in sales and marketing activities.

     Electronic Commerce. Substantially all of the products we sell can be purchased and delivered directly from our Web sites. Our Web sites provide us with a low-cost, globally accessible sales channel that is available 24 hours per day, seven days per week.

     Direct Sales Force. Our direct sales force primarily markets and sells our server products and services to enterprise, infrastructure and media customers. We also have an advertising sales force that markets and sells advertising on our Web sites and client software. We have subsidiaries and offices in several other countries, which market and sell our products outside the United States and we use a third party advertising representation firm to sell international advertising inventory.

     OEMs and VARs. We have entered into various distribution relationships with third parties pursuant to which our products and technologies are incorporated into, bundled with or offered with third-party products for delivery by the third party directly or indirectly to end users. For example, we have recently entered into distribution agreements with Compaq Computer Corp. to pre-install our RealOne Player software on all Compaq-branded computers that are intended for sale to non-corporate end users, and with Intel Corp. to distribute our RealOne Player software on physical media together with Intel's shipments of PC desktop boards to so-called “whitebox,” or generic, PC manufacturers.

     Sales Through Other Distributors. We sell our software systems and services to other distributors, including hardware server companies, content aggregators, ISPs and other hosting providers that redistribute or provide end users access to our streaming technology from their Web sites and systems. We have agreements with many popular software and hardware companies and Web sites to distribute our products as a click-through or to bundle our player products into their applications and software.

     RealPartner Program. Our RealPartner Program provides development tools, training and technical assistance, and marketing opportunities to individuals and companies who work with our streaming media technology. Members of the program include independent software vendors, who are creating and marketing RealAudio- or RealVideo-enabled software or hardware products; professional services agencies that are building interactive, multimedia-rich Web sites for clients; VARs who resell our products on a stand-alone basis or as a

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part of a custom, integrated system; and ISP hosting providers who use RealServers and offer streaming media hosting to their customers. There are more than 5,000 members in the RealPartner Program.

     Marketing Programs. Our marketing programs are aimed at increasing brand awareness, stimulating market demand and educating potential customers about the economic opportunities in delivering multimedia content over the Internet. We have a number of marketing initiatives, including:

	•		Showcasing our various products and solutions in trade shows, conferences and seminars;
	•		Providing product-specific information through our Web sites;
	•		Promoting and co-promoting special events with our broadcast partners;
	•		Advertising products and services in print and electronic media;
	•		Advertising and marketing our RealOne services to our end users; and
	•		Sponsoring our annual RealNetworks Conference.

Customers

     Our customers include businesses and consumers located throughout the world. Sales to customers outside the United States, primarily in Asia and Europe, were approximately 29%, 27% and 21% of total net revenues in the years ended December 31, 2001, 2000 and 1999, respectively.

Customer Support

     Our customers have a choice of support options depending on the level of service desired and the nature of the products acquired. We provide customer support through our customer relations department and through third-party contractors. Customers can access a technical support hotline to receive answers to inquiries or initiate e-mail inquiries and we provide an online database of technical information for customer self-service. We also offer the RealNetworks Platinum Services which provides 24-hour, seven days per week support and dedicated on-site support to our major RealSystem customers. As of December 31, 2001, we employed 24 full-time technical and customer support representatives, approximately 3% of our work force, to respond to customer requests for support.

Competition

     The market for software and services for media delivery over the Internet is relatively new, constantly changing and intensely competitive. As media delivery evolves into a central component of the Internet experience, more companies are entering the market for, and expending increasing resources to develop, media delivery software and services. We expect that competition will continue to intensify.

     Many of our current and potential competitors have longer operating histories, greater name recognition, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. In addition, new competitors with potentially unique or more desirable products or services are entering the market all the time. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology franchise. Price concessions or the emergence of other pricing or distribution strategies or technology solutions of competitors may diminish our revenues, impact our margins or lead to a reduction in our market share, any of which will harm our business.

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     We believe that the primary competitive factors in the media delivery market include:

	•		the quality, reliability, price and licensing terms of the overall media delivery solution;
	•		access to distribution channels necessary to achieve broad distribution and use of products;
	•		the availability of content for delivery over the Internet;
	•		the ability to license or develop and support secure formats and digital rights management systems for digital media delivery, particularly music and video;
	•		the ability to license and support popular and emerging media formats for digital media delivery in a market where competitors may control the intellectual property rights for these formats;
	•		the size of the active audience for streaming and digital media and its appeal to content providers and advertisers;
	•		features for creating, editing and adapting content for the Internet;
	•		ease of use and interactive user features in products;
	•		scalability of streaming media and media delivery technology and cost per user;
	•		the ability to obtain any necessary patent rights underlying important streaming media and digital distribution technologies that gain market acceptance;
	•		compatibility with new and existing media formats, and with the user’s existing network components and software systems;
	•		the build-out and deployment of broadband infrastructures and technologies; and
	•		challenges caused by bandwidth constraints and other limitations of the Internet infrastructure.

     Media Technologies. Microsoft is a principal competitor in the development and distribution of digital media and media distribution technology. Microsoft currently competes with us in the market for digital media servers and players, digital rights management, and other technology and services related to digital distribution of media, and has announced its intention to compete with our RealOne service in the market for subscription services. Microsoft’s commitment to and presence in the media delivery industry has increased and we expect that Microsoft will continue to increase competitive pressure in the overall market for digital media and media distribution.

     Microsoft distributes its competing streaming media server, player and tools products by bundling them with its Windows operating systems and servers at no additional cost or otherwise making them available free of charge. Microsoft’s practices have caused, and may continue to cause, pricing pressure on our revenue generating products. Microsoft’s practices have led in some cases, and could continue to lead to, longer sales cycles, decreased sales, loss of existing and potential customers and reduced market share. In addition, we believe that Microsoft has used and may continue to use its monopoly position in the computer industry and its financial resources to secure preferential or exclusive distribution and bundling contracts for its media delivery technologies and products with third parties such as ISPs, content delivery networks, online service providers,

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content providers, entertainment companies, media companies, broadcasters, VARs and OEMs, including third parties with whom we have relationships. Microsoft has also invested significant sums of money in, has provided substantial financial incentives to, or offered or conditioned placement on or through the Windows operating system, the Internet Explorer Web browser and Microsoft’s MSN service to certain of our current and potential customers and content suppliers, and we expect this trend to continue, which may cause such customers to stop using or reduce their use of our products and services and which may cause those content suppliers to withhold desirable media content from us or end users of our products and services. Such arrangements, together with Microsoft’s aggressive marketing of its Windows operating systems and digital media products, may reduce our share of the streaming media market and digital distribution market.

     Microsoft’s Windows Media Player competes with our media player products. Certain versions of the Windows Media Player are available for download from Microsoft’s Web site for free, and the Windows Media Player is integrated into Microsoft’s recently introduced Windows XP operating system and the Windows 98, Windows 2000 and Windows ME operating systems, the Internet Explorer Web browser, and Microsoft’s MSN service. With Windows XP, Microsoft no longer offers a stand-alone version of the latest version of Windows Media Player, which is commingled into Windows XP so that it cannot be removed by OEMs or end users. Windows XP, a significant focus of which is media delivery, gives very prominent and persistent placement to Microsoft’s Windows Media Player, Windows Media Guide, music services, and other media delivery services in the operating system and on the end user’s desktop. In some cases, the Windows Media Player may override default playback settings set by end users or by us. New versions of Internet Explorer and MSN Explorer also prominently feature and promote Windows Media. We expect that by leveraging its monopoly position in operating systems and tying streaming or digital media into its operating system and its Web browser, Microsoft will distribute substantially more copies of the Windows Media Player, and attract more content providers to use Microsoft’s technology in the future than it has in the past and may be able to attract more users to its streaming or digital media products. In addition, Microsoft does not allow our products to take full advantage of the features and functionality of Windows XP that it makes available to the Windows Media Player. In light of Microsoft’s efforts and dominant position in operating systems, our market position may be difficult to sustain.

     Microsoft’s Windows Media Player also competes with our RealJukebox products and with the personal music management features of the RealOne Player. Microsoft has also invested in other digital distribution technologies that compete with RealJukebox and with the RealOne Player. The Windows Media Player supports the Windows Media format, but not RealNetworks’ media formats. Microsoft also licenses Windows Media Technologies 7, a platform for authoring, delivering and playing digital media intended to compete with RealSystem, and supports and promotes other third party products competitive to our products. In addition, Microsoft provides servers that support Windows Media Technologies at no additional cost to customers who purchase its servers, whereas we offer most versions of our competitive servers for sale. In some cases, Microsoft conditions use of the Windows Media Digital Rights Management and security technologies supported by Windows XP to support for Windows Media formats and use of Windows Media Player and servers. We compete with Microsoft in the market for digital rights management technologies. We expect Microsoft and other competitors to devote significantly greater resources to product development in the music management and digital media categories in the future.

     Microsoft also competes with us to attract broadcasters and owners of high quality or popular content to promote and deliver such content in Microsoft’s formats, in some cases on an exclusive or preferential basis. While we have rights to play back certain content in Microsoft formats through our player products under a limited set of conditions, we may not secure necessary rights from Microsoft to enable our products to play back all such content or content in Microsoft’s newest formats at all, or on commercially reasonable terms. Our player products may be disadvantaged if they cannot play content in Windows Media formats or content that is secured by the Windows Media Digital Rights Management technology, or if such content providers do not also make their content available in RealNetworks’ media formats using digital rights management systems supported by us. In some cases, we believe Microsoft uses its financial resources and monopoly leverage to obtain rights to such

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content, and to incent content providers to prepare their content in Microsoft’s formats. In addition, Microsoft has recently announced its intention to compete with our RealOne subscription service, and may use similar incentives to induce content providers to offer content for its proposed subscription service. We believe that Microsoft’s commitment to and presence in the media delivery industry has increased and that Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution.

     In addition to Microsoft, we face increasing competition from other companies that develop and market streaming media products. For example, Apple Computer offers the QuickTime streaming media technology, including a free media player and a free streaming media server, and licenses for free source code to the server under the conditions of Apple’s end user license agreement. Apple also offers competitive music management software and hardware. We expect that Apple will devote significant resources to developing and marketing digital media systems, and will continue to compete vigorously with us in the marketplace. Apple has enlisted the open source code community to assist its development of competitive products. Companies such as AOL Time Warner and Yahoo! and many smaller competitors also offer various products that compete with our player products and content subscription services. In connection with the deployment of RealSystem iQ in AOL’s Internet service, we also licensed our RealPlayer technology to AOL for use with its own Internet service application. Such licensing may impact the number of end users of our player products if AOL users only use AOL applications. As more companies enter the market with products that compete with our servers, players and tools, the competitive landscape could change rapidly to our disadvantage.

     We do not believe that clear standards have emerged with respect to non-PC wireless and cable-based systems. Likewise, no one company has gained a dominant position in the mobile device market. However, certain products and services in these markets support our technology, and certain support our competitors’ technology, especially Microsoft, which can use its monopoly position in the operating system business and other financial resources to gain access to these markets, potentially to the exclusion of us. Other companies’ products and services or new standards may emerge in any of these areas, which could reduce demand for our products or render them obsolete.

     Our streaming media and media delivery products also face competition from “fast download” media delivery technologies such as AVI, QuickTime and MP3. We also face competition from peer-to-peer file sharing services, which allow computer users to connect with each other and directly access and copy many types of program files, including music and other media, from one another’s hard drives, such as Napster, Gnutella, Morpheus and KaZaA, and a variety of other similar services that have arisen since certain services of Napster were shut down by court order. Such services allow consumers to directly access an expansive array of free content without relying on content providers to make the content available for streaming or digital download, and without relying on products such as the RealPlayer or RealJukebox to be able to play, record and store such content. These services also compete with our for-pay RealOne Music subscription service. Other fast download or non-streaming IP-based content distribution methods are likely to emerge and could compete with our products and services, which could harm our business.

     Subscription Services. In August 2000, we introduced our RealPlayer GoldPass subscription service, which provided customers access to a combination of premium software, services and content in exchange for a monthly fee. In December 2001, we launched RealOne, the successor to our GoldPass subscription service, which incorporates our RealPlayer and RealJukebox products together in a new version of our player products, the RealOne Player. Members of RealOne have access to premium subscription content and are able to take advantage of certain enhanced features of the RealOne Player. RealOne competes with both traditional and online entertainment service providers and we anticipate increasing competition for online subscription service revenues from a wide range of companies, including AOL Time Warner, Microsoft and Yahoo!. Many of these providers have significantly more resources, including access to content, and experience in providing subscription or similar services to customers. In order to increase our subscription service revenues, we must continue to obtain premium digital content in order to increase subscriptions and overall customer satisfaction.

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To date, a limited amount of premium digital content has been made available for delivery over the Internet that can only be accessed through a for-pay service and not for free.

     In conjunction with the release of the RealOne Player and our RealOne subscription service, we also released our RealOne Music service, a for-pay, limited usage music subscription service. Our music subscription services will face competition from traditional offline music distribution competitors and from other new online music services, including pressplay, a joint venture formed between two leading media companies that are not participants in MusicNet, and the Rhapsody music service recently launched by Listen.com. Competing services, like pressplay and Rhapsody, may be able to obtain more or better music content than MusicNet, or may be able to license such content on more favorable terms than MusicNet. RealOne Music also faces competition from “free” peer-to-peer services.

     Media Hosting. Our media hosting service, the Real Broadcast Network, competes with a variety of companies that provide streaming media hosting and broadcast services. These companies include Akamai, Digital Island, Yahoo! Broadcast Services and other emerging broadcast networks. Some of these competitors have cost or other advantages over our services and offer other services which Real Broadcast Network does not offer, such as Web page hosting or broadcast hosting in media formats not supported by Real Broadcast Network. Some of our media hosting competitors are also customers on whom we rely to help drive product download traffic to our Web sites through their broadcast events. We also sell servers and tools to competitors that compete with Real Broadcast Network.

     Web Site Destinations, Content and Advertising. Our Web sites and the Real.com Network compete for user traffic and Internet advertising revenues with a wide variety of Web sites, Internet portals and ISPs. In particular, aggregators of audio, video and other media, such as Yahoo! Broadcast Services and Microsoft’s Windows Media Guide, compete with us.

Intellectual Property

     As of December 31, 2001, we had 41 registered U.S. trademarks or service marks, and had applications pending for an additional 20 U.S. trademarks. We also have several unregistered trademarks. In addition, RealNetworks has several foreign trademark registrations and pending applications. Many of our marks begin with the word “Real” (such as RealSystem, RealAudio and RealVideo). We are aware of other companies that use “Real” in their marks alone or in combination with other words, and we do not expect to be able to prevent all third-party uses of the word “Real” for all goods and services.

     As of December 31, 2001, we had 17 U.S. patents and numerous patent applications on file relating to various aspects of our technology. We are continuously preparing additional patent applications on other current and anticipated features of our technology.

     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. These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology, or may not prevent the development and design by others of products or technologies similar to or competitive with those we develop.

Employees

     At December 31, 2001, RealNetworks had 800 full-time employees and seven part-time employees, 689 of whom were based at RealNetworks’ executive offices in Seattle, Washington, 84 of whom were based at RealNetworks’ offices in Australia, Brazil, Canada, France, Germany, Hong Kong, Japan, Mexico, Singapore, South Korea and the United Kingdom, and 34 of whom were based at other locations. None of RealNetworks’

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employees are subject to a collective bargaining agreement, and RealNetworks believes that its relations with its employees are good.

Position on Charitable Responsibility

     For the year ended December 31, 2001, we set aside 5% of our pre-tax net income (before goodwill amortization, acquisition charges, and stock-based compensation charges) for donations to charity. If we sustain pro forma profitability, we intend to donate approximately 5% of our annual pre-tax net income (before goodwill amortization, acquisition charges, and stock-based compensation charges) to charitable organizations. We have incorporated the RealNetworks Foundation to manage our charitable giving efforts. RealNetworks hopes to encourage employee giving by using a portion of its intended contribution to match charitable donations made by employees.

ITEM 2. PROPERTIES

     RealNetworks leases its corporate headquarters which are located in Seattle, Washington. The lease commenced on April 1, 1999 and expires on March 31, 2011, with an option to renew for either a three- or a ten-year period. As of December 31, 2001, RealNetworks leased approximately 280,000 square feet at an average monthly rent of approximately $575,000. In addition, RealNetworks leases approximately 133,000 square feet of additional office space in a second location in Seattle, Washington at an average monthly rent of $400,000 under a lease which commenced on October 1, 2000 and which expires on September 30, 2010. In 2001, we re-evaluated our facilities requirements and as a result, decided to sublet all of this office space for the remainder of the term of our lease.

ITEM 3. LEGAL PROCEEDINGS

     See Notes to Consolidated Financial Statements — Commitments and Contingencies (Note 12) for information regarding legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of RealNetworks’ shareholders during the fourth quarter of its fiscal year ended December 31, 2001.

EXECUTIVE OFFICERS OF THE REGISTRANT

     The executive officers of RealNetworks as of February 15, 2002 were as follows:

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     ROBERT GLASER has served as Chairman of the Board and Chief Executive Officer of RealNetworks since its inception in February 1994, and as Treasurer from February 1994 to April 2000. He also serves as RealNetworks’ Policy Ombudsman, with the exclusive authority to adopt or change the editorial policies of RealNetworks as reflected on its Web sites or in other communications or media in which RealNetworks has a significant editorial or media voice. Mr. Glaser holds a B.A. and an M.A. in Economics and a B.S. in Computer Science from Yale University.

     LAWRENCE JACOBSON has served as President and Chief Operating Officer of RealNetworks since February 2001. From January 2000 to January 2001, Mr. Jacobson served as President and Chief Operating Officer of Ticketmaster Corporation, the leading ticketing services company. From 1990 to January 2000, Mr. Jacobson was employed at News Corporation, a global media and distribution company, where he held various positions within its subsidiaries, most recently serving as President of the FOX Television Network. Mr. Jacobson holds a B.A. in Economics from Harvard College and an M.B.A. from Harvard Business School.

     PHILLIP BARRETT has served as Senior Vice President-Consumer Products of RealNetworks since August 2000. From July 1998 to July 2000, Mr. Barrett served as Senior Vice President — Media Technologies of RealNetworks, from January 1997 to July 1998, Mr. Barrett served as Senior Vice President — Media Systems of RealNetworks, and from November 1994 to January 1997 he served as Vice President — Software Development of RealNetworks. From March 1986 to October 1994, Mr. Barrett was a Development Group Manager at Microsoft, where he led development efforts for Windows 386, Windows 3.0 and Windows 3.1. Mr. Barrett holds an A.B. in Mathematics from Rutgers University and an M.S. in Computer Sciences from the University of Wisconsin, Madison.

     KELLY JO MACARTHUR has served as Senior Vice President, Legal and Business Affairs, General Counsel and Corporate Secretary of RealNetworks since April 2000, and as Vice President and General Counsel of RealNetworks from October 1996 to April 2000. From 1995 to 1996, Ms. MacArthur served as General Counsel and Director of Business Affairs for Compton’s NewMedia, Inc. From 1989 to 1994, Ms. MacArthur was an attorney with the firm of Sidley & Austin in Chicago. Ms. MacArthur graduated summa cum laude from the University of Illinois at Champaign-Urbana and holds a J.D. from Harvard Law School.

     MARTIN PLAEHN has served as Senior Vice President — Media Systems of RealNetworks since September 1999. From April 1996 to August 1999, Mr. Plaehn served as President of Viewpoint Digital and as its Chairman and CEO until its acquisition by Computer Associates in October 1998. From 1990 to 1996, Mr. Plaehn served as Executive Vice President of Business and Product Development and was a member of the Board of Directors of Wavefront Technologies Inc., which was acquired by Silicon Graphics in 1995. Mr. Plaehn started his career as a software developer at General Atomic Company in 1978, ISSCO Graphics in 1980, and Template Graphics Software from 1982 to 1990. Mr. Plaehn holds a B.A from the University of California San Diego and is a graduate of UCSD’s Executive Program for Scientists and Engineers.

     CARLA STRATFOLD has served as Senior Vice President-North American Sales of RealNetworks since May 2001. From December 1998 to March 2000, Ms. Stratfold served as Vice President of Business Development of BackWeb Technologies Ltd., a provider of Internet communication infrastructure software. From 1988 to November 1998, Ms. Stratfold was employed by Oracle Corporation, a leading supplier of software

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for information management, where she held various positions, most recently serving as Vice President of Product Sales and Marketing. Ms. Stratfold holds a B.S. in Political Science from Washington State University.

     BRIAN V. TURNER has served as Senior Vice President, Finance and Operations, Chief Financial Officer and Treasurer of RealNetworks since October 2001. From December 2000 to October 2001, Mr. Turner served as President, Chief Operating Officer and Secretary, and from April 1999 to December 2000, as Senior Vice President of Operations, Chief Financial Officer and Secretary of BSQUARE Corporation, a company engaged in the development, marketing and support of a variety of software products and services for the development and deployment of intelligent computing devices. From September 1995 to April 1999, Mr. Turner served as the Senior Vice President of Operations and Chief Financial Officer of RadiSys Corporation, a manufacturer and designer of computers. Between July 1982 and September 1995, Mr. Turner was employed by PricewaterhouseCoopers LLP, an accounting firm, most recently as a director in Corporate Finance. Mr. Turner holds a B.A. degree in international political science and a B.B.A. in accounting from the University of Washington.

PART II.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

     RealNetworks’ common stock has been traded on the Nasdaq National Market under the symbol “RNWK” since the Company’s initial public offering in November 1997. There is no assurance that any quantity of the common stock could be sold at or near reported trading prices.

     The following table sets forth for the periods indicated the high and low sale prices for our common stock, as adjusted for stock splits. These quotations represent prices between dealers and do not include retail markups, markdowns or commissions and may not necessarily represent actual transactions.

Year Ended December 31, 2001

Year Ended December 31, 2000

     We have not paid any cash dividends and do not intend to pay any cash dividends in the foreseeable future.

     As of March  4, 2002, there were approximately 705 holders of record of our common stock. Most shares of our common stock are held by brokers and other institutions on behalf of shareholders.

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Recent Sales of Unregistered Securities

     Between October 1, 2001 and December 31, 2001, RealNetworks has issued and sold unregistered securities as follows:

(1)

A warrant for the purchase of an aggregate of 533 shares of Common Stock having an exercise price of $22.3125 was issued to a service provider in November 2001 pursuant to a contractual agreement.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

     The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes included elsewhere in this report.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The discussion in this report contains forward-looking statements that involve risks and uncertainties. RealNetworks’ actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Factors that May Affect Our Business, Future Operating Results and Financial Condition,” included elsewhere in this Report. You should also carefully review the risk factors set forth in other reports or documents that RealNetworks files from time to time with the Securities and Exchange Commission, particularly Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. You should also read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included in this report.

Overview

     RealNetworks is a leading global provider of software products and services for Internet media delivery. We develop and market software products and services designed to enable users of personal computers and other consumer electronic devices to send and receive audio, video and other multimedia services using the World Wide Web.

     We were incorporated in February 1994 and were in the development stage until July 1995, when we released the commercial version of RealAudio Version 1.0, the first version of our RealPlayer products. In August 1996, we began selling RealPlayer Plus, a premium version of our RealPlayer product. Since its initial release, RealPlayer has been available for download free of charge from our websites. In December 1997, we released the commercial version of RealSystem Version 5.0, a streaming media solution that included RealAudio and RealVideo technology. In September 1999, we released the commercial versions of RealJukebox and RealJukebox Plus, a personal music management system. In August 2000, we released the gold version of RealPlayer 8, RealJukebox 2, RealDownload 4 and launched RealPlayer GoldPass, a for-pay media subscription service available to RealPlayer Plus customers. In December 2000, we released RealSystem iQ, a new foundational architecture for digital media delivery which increases the reliability of Internet broadcasts, scales to large audiences, and provides enhanced flexibility and cost-effectiveness for media delivery network deployments. In March 2001, we introduced RealArcade, a new end-to-end platform for the digital distribution of PC games benefiting both developers and consumers. In June 2001, we launched RealSystem Media Commerce Suite, a platform for Internet media commerce that is intended to provide a universal platform for secure distribution of digital movies, music, and other content. In December 2001, we launched RealOne, the successor to our GoldPass service, which incorporates our RealPlayer and RealJukebox products together with a new media browser and value-added services to create an immersing, multi-dimensional media experience for consumers.

We report revenues in three categories:

•		Software license fees, which include revenues from sales of our RealPlayer Plus, RealJukebox Plus, RealEntertainment Center Plus, RealServers and related authoring and publishing tools, both directly to customers and indirectly through OEM channels, and sales of third-party products, including games.
•		Service revenues, which include revenues from support and maintenance services that we sell to customers who purchase our RealPlayer Plus, RealJukebox Plus, RealEntertainment Center Plus, RealServers and related authoring and publishing tools, RealPlayer Gold Pass/RealOne subscription services, including our RealOne Music subscription service, broadcast hosting services we provide through our Real Broadcast Network and consulting services we offer to our customers.
•		Advertising revenues, which are derived from sales of advertising on our Web sites and client software and within the media streams that we host on behalf of our corporate customers.

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     The following table sets forth certain financial data for the periods indicated as a percentage of total net revenues:

Critical Accounting Policies and Estimates

     Our critical accounting policies and estimates are as follows:

	•		Revenue recognition
	•		Estimating sales returns and the allowance for doubtful accounts
	•		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 and goodwill

     Revenue recognition. We report our revenue in three categories (i) license revenue, which includes software license fees sold both directly to customers and indirectly through OEM channels, and third party software license fees, including games, (ii) services revenue which includes software maintenance and support, GoldPass/RealOne subscription services, training, consulting and broadcast hosting services, and (iii)

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advertising revenue, which results from our selling of advertising on our Web sites and within the media streams we host on behalf of our corporate customers. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of our revenue for any period if our management made different judgments or utilized different estimates.

     We recognize revenue pursuant to the requirements of Statement of Position No. 97-2, “Software Revenue Recognition” (SOP 97-2), as amended by Statement of Position No. 98-9, “Software Revenue Recognition with Respect to Certain Arrangements.” Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, collectibility is probable and the arrangement does not require significant customization of the software.

     For all sales, except those completed via credit card transactions through the Internet, we use either a binding purchase order or signed agreement, depending on the nature of the transaction, as evidence of an arrangement. For sales made via the Internet, we use the customer’s authorization to charge their credit card as evidence of an arrangement. Sales through our distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction by transaction basis.

     For software license fees in single element arrangements and multiple element arrangements which do not include customization or consulting services, delivery typically occurs when the product is made available to the customer for download or when products are shipped to customers. For service and advertising revenues, delivery typically occurs when services have been performed.

     At the time of each transaction, we assess whether the fee associated with our revenue transactions is fixed and determinable and whether or not collection is reasonably assured. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, is based upon a variable matrix such as a minimum level of distribution or is subject to refund, we account for the fee as not being fixed and determinable. In these cases, we defer revenue and recognize it when it becomes due and payable.

     We assess the probability of collection based on a number of factors, including past transaction history with the customer and the current financial condition of the customer. We do not request collateral from our customers but often require payments before or at the time products and services are delivered. If we determine that collection of a fee is not reasonably assured, we defer revenue until the time collection becomes reasonably assured, which is generally upon receipt of cash.

     For multiple element arrangements, when Company-specific objective evidence of fair value exists for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered elements in the arrangement, we recognize revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, we defer revenue for the fair value of its undelivered elements such as consulting services and product support and upgrades, and recognize the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software licenses, when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support and upgrades of standard products for which no installation or customization is required based upon the amounts we charge when support and upgrades are sold separately. Company-specific objective evidence is established for consulting and installation services based on the hourly rates we charge for our employees when they are performing these services provided we have the ability to accurately estimate the hours required to complete a project based upon our experience with similar projects. For multiple element arrangements involving installation

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or customization, Company specific objective evidence is established for support and maintenance arrangements if our customers have an optional annual renewal rate specified in the arrangement and the rate is substantive.

     If specific objective evidence does not exist for an undelivered element in a software arrangement, which, for us, typically relates to the development of complex content delivery networks which include software licenses, consulting services and product support, revenue is recognized over the term of the support period commencing upon delivery of our technology to the customer. In these cases, delivery is defined as when the content delivery network is installed and operating in accordance with contract specifications.

     Revenue from software license agreements with original equipment manufacturers (OEM) is recognized when the OEM delivers its product incorporating our software to the end user. In the case of prepayments received from an OEM, we typically recognize revenue based on the actual products sold by the OEM. If we provide ongoing support to the OEM in the form of future upgrades, enhancements or other services over the term of the contract, revenue is recognized ratably over the term of the contract.

     Service revenues include payments under support and upgrade contracts, GoldPass and RealOne media subscription services, and fees from consulting services and streaming media content hosting. Support and upgrade revenues are recognized ratably over the term of the contract, which typically is twelve months. Media subscription service revenues are recognized ratably over the period that services are provided. Other service revenues are recognized when the services are performed.

     Fees generated from advertising are recognized as advertising is delivered over the terms of the contracts. We may guarantee a minimum number of advertising impressions, click-throughs or other criteria on our Web sites or products for a specified period. To the extent these guarantees are not met, we defer recognition of the corresponding revenues until guaranteed delivery levels are achieved.

     Sales returns and the allowance for doubtful accounts. The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Specifically, we must make estimates of potential future product returns related to current period product 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 and other allowances. Significant judgments and estimates must be made and used in connection with establishing reserves for sales returns and the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our revenue for any period if we made different judgments or utilized different estimates. Similarly, we must make estimates of the uncollectability of our accounts receivables. We specifically analyze the age of accounts receivable and analyze historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.

     Loss on excess office facilities. During the year, we made significant estimates in determining the appropriate loss to recognize in recording our loss on excess office facilities. The significant factors we considered in making our estimate are discussed in “Loss on excess office facilities.”

     Impairment of investments. As part of the process of preparing our consolidated financial statements we periodically evaluate whether any declines in the fair value of our investments are other-than-temporary. Significant judgments and estimates must be 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. See “Other income (expense), net” for a discussion of the factors we considered in evaluating whether declines in fair value of our investments were other-than-temporary and the factors we considered in estimating the fair value of investments in private companies.

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     Valuation of long-lived assets and goodwill. We assess the impairment of long-lived assets and enterprise goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

	•		our market capitalization relative to net book value;
	•		poor economic performance relative to expected historical or projected future operating results;
	•		significant negative industry, economic or company specific trends; and
	•		changes in the manner of our use of the assets or the plans for our business;

     If we were to determine that the carrying value of goodwill may not be recoverable based upon the existence of one or more of the above indicators of impairment, we measure impairment based on a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

     In 2002, Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” became effective and as a result, we will cease to amortize goodwill. In lieu of amortization, we are required to perform an initial impairment review of our goodwill in 2002 and an annual impairment review thereafter.

     We currently do not expect to record an impairment charge upon completion of the initial impairment review. However, there can be no assurance that at the time the review is completed a material impairment charge will not be recorded.

Revenues

     Software License Fees. Software license fees were $108.6 million in 2001, a decrease of 27% from $148.1 million in 2000. We believe the decrease was due in part to continuing cutbacks in capital and information technology spending by our customers and potential customers as a result of global economic conditions. We further believe the decrease was due to a significant reduction in equity funding of new and Internet-related businesses in 2001. We believe that this reduced funding impacted, either directly or indirectly, Internet-related and other technology-centric businesses, which thereby impacted both our customers and potential customers. The reduced availability of funding has contributed to certain of our customers and potential customers ceasing operations and others experiencing difficult financial situations. We believe that this environment has also resulted in current and potential customers delaying or foregoing purchases and has caused sales cycles for some customers to take longer than in the past. These factors negatively impacted our revenues in 2001. Additionally, we have focused our consumer promotional activities to feature our GoldPass and RealOne subscription services, which has resulted in a shift of our revenues from software license fees to service revenues. These subscription services have characteristics of longer-term, recurring revenue, unlike our software product offerings that often generate one-time, non-recurring revenue, exclusive of service and support arrangements. This has also resulted in a decrease in our software license fees. Additionally, software license fees for 2000 included $5.2 million related to a three-year license agreement we entered into with

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Microsoft Corporation in June 1997, which expired in the quarter ended June 30, 2000. There was no such Microsoft-related revenue in 2001.

     Software license fees were $148.1 million in 2000, an increase of 63% from $90.6 million in 1999. The increase was due primarily to a greater volume of products sold as a result of growth in the demand for media delivery on the Internet and the introduction of new products. Revenues also increased during 2000 as a result of sales of our products to companies deploying content distribution networks and increased distribution of our products associated with new OEM agreements. In addition, we introduced new products in 2000 including RealEntertainment Center Plus and RealDownload, a product associated with our acquisition of NetZip, Inc. Software license fees for 2000 and 1999 included $5.2 million and $10.3 million, respectively, related to our three-year license agreement with Microsoft discussed above.

     Service Revenues. Service revenues were $64.7 million in 2001, an increase of 23% from $52.5 million in 2000. The increase during 2001 was primarily attributable to the continued growth of our GoldPass subscription services, which was renamed RealOne in the fourth quarter of 2001. Revenue related to GoldPass/RealOne was $28.2 million in 2001 compared to $2.0 million in 2000. This increase was partially offset by decreases in other service offerings, including content hosting services and support and maintenance services. We believe the decrease in these other service offerings was due to the economic and market conditions described in the above section entitled “Software License Fees.” Service revenues were $52.5 million in 2000, an increase of 98% from $26.5 million in 1999. The increase during 2000 was primarily attributable to increased sales of support and upgrade contracts to customers deploying our server products in content distribution networks, a larger installed base of our server products, increases in streaming media hosting services, and the introduction of our GoldPass subscription services in the third quarter of 2000.

     Advertising. Advertising revenues were $15.6 million in 2001, a decrease of 62% from $40.9 million in 2000. The decrease was primarily due to a decline in the demand for Internet advertising, as well as the overall unfavorable advertising market in 2001. This reduced demand resulted in lower average advertising rates. Additionally, certain longer-term promotional and advertising contracts were not renewed and some of our advertising customers and potential customers have ceased operations. Advertising revenues were $40.9 million in 2000, an increase of 189% from $14.1 million in 1999. The increase was due to increased traffic on our Web sites, the increased effectiveness of our advertising sales force, higher average advertising rates, and revenue associated with increased sales and distribution of RealChannels, LiveStations, search functionality, and other advertisements and promotional links included in our RealPlayer and RealJukebox software products.

Revenues by Product Type

     Consumer. Consumer revenues are derived from sales of our RealPlayer Plus, RealJukebox Plus, RealEntertainment Center Plus products, revenues from support and maintenance services that we sell to customers who purchase these products, and third-party products, including games. Consumer revenues were $47.0 million in 2001, a decrease of 41% from $79.3 million in 2000. We believe the decrease was primarily due to the change in focus of our promotional activities to feature our GoldPass and RealOne subscription services, which has resulted in a shift of our revenues from consumer revenue to subscription services revenue.

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These subscription services have characteristics of longer-term, recurring revenue, unlike our software product offerings that typically generate one-time, non-recurring revenue, exclusive of service and support arrangements. Consumer revenue was $79.3 million in 2000, an increase of 34% from $59.2 million in 1999. We believe the increase in 2000 was due primarily to a greater volume of products sold as a result of growth in the demand for media delivery on the Internet and the introduction of new products.

     Subscription Services. Subscription services revenues, which consists of our GoldPass and RealOne subscription services, were $28.2 million in 2001, an increase of 1322% from $2.0 million in 2000. The increase during 2001 was primarily attributable to the continued growth of our GoldPass subscription services, which were renamed RealOne in the fourth quarter of 2001. Additionally, GoldPass was launched in the third quarter of 2000, and therefore the GoldPass-related revenues in 2000 do not represent a full year of revenue for comparison purposes. Since its initial launch, we have increasingly focused our promotional activities to feature our GoldPass and RealOne subscription services, leading to greater consumer adoption rates and higher revenues. There were no subscription services revenues in 1999. Our subscription services offerings represent a relatively new business model for Internet media delivery and a new business model for us. We cannot predict how these subscription offerings will perform in the future or at what rate subscription revenues will grow, if at all.

     Systems. Systems revenues are derived from sales of our RealServers and related authoring and publishing tools, support and maintenance services that we sell to customers who purchase these products, broadcast hosting services we provide through our Real Broadcast Network and consulting services we offer to our customers. Systems revenues were $98.1 million in 2001, a decrease of 18% from $119.3 million in 2000. We believe the decrease during 2001 was due in part to continuing cutbacks in capital and information technology spending by our customers and potential customers as a result of global economic conditions. Additionally, there was a significant reduction in equity funding of new and Internet-related businesses in 2001 which impacted, either directly or indirectly, Internet-related and other technology-centric businesses, which thereby directly impacted both our customers and potential customers. The reduced availability of funding has contributed to certain of our customers and potential customers ceasing operations and others experiencing difficult financial situations. We believe that this environment has also resulted in current and potential customers delaying or foregoing purchases and has caused sales cycles for some customers to take longer than in the past. Additionally, systems revenues for 2000 included $5.2 million related to a three-year license agreement we entered into with Microsoft in June 1997, which expired in the quarter ended June 30, 2000. There was no such Microsoft-related revenue in 2001.

     Systems revenues were $119.3 million in 2000, an increase of 106% from $57.8 million in 1999. The increase during 2000 was primarily attributable to higher revenues from sales of our products and related support and upgrade contracts to customers deploying our server products in content distribution networks, a larger installed base of our server products and increases in streaming media hosting services. Systems revenues for 2000 and 1999 included $5.2 million and $10.3 million, respectively, related to our three-year license agreement with Microsoft discussed above.

     Advertising. Advertising revenues were $15.6 million in 2001, a decrease of 62% from $40.9 million in 2000. Advertising revenues were $40.9 million in 2000, an increase of 189% from $14.1 million in 1999. See “Revenues— Advertising” above for analysis.

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Geographic Revenues

     International revenues represented 29% of total net revenues in 2001, 27% in 2000 and 21% in 1999. International revenues increased as a percentage of total net revenues in 2001 and 2000 primarily because we continued to release versions of our products in additional international languages and to open new sales offices in other countries. Revenues generated in Europe were 15% of total net revenues in 2001, 14% of total net revenues in 2000 and 12% of total net revenues in 1999, and revenues generated in Asia were 10% of total net revenues in 2001, 9% of total net revenues in 2000 and 8% of total net revenues in 1999. At December 31, 2001, accounts receivable due from international customers represented approximately 32% of trade accounts receivable. The functional currency of our foreign subsidiaries is the local currency of the country in which the subsidiary operates. Results of operations of our foreign subsidiaries are translated from local currency into U.S. dollars based on average monthly exchange rates. We currently do not hedge the majority of our foreign currency exposures and therefore are subject to the risk of changes in exchange rates. The costs of both domestic and international revenues are substantially the same.

Deferred Revenues

     We had deferred revenue of $46.8 million as of December 31, 2001, a decrease of $4.4 million from $51.3 million as of December 31, 2000. Deferred revenues primarily result from our systems business. The decrease is due to the timing of cash prepayments under certain existing contracts and an overall decrease in volume of new systems contracts. Revenue from contracts with customers developing content delivery networks is generally recognized over the term of the arrangement commencing upon the customer’s deployment of our technology in their network build-out. Many of these agreements were entered into with content delivery networks with limited operating histories and as such, we have historically required prepayments from such customers. The cash prepayments associated with these contracts are recorded as deferred revenue and amounted to $27.2 million and $26.9 million at December 31, 2001 and 2000, respectively. If we enter into similar agreements in the future with more established companies, we may not require these prepayments and our deferred revenue balances may decline as a result. The remaining balance of deferred revenue is comprised of the unrecognized portion of support contracts, prepayments under OEM arrangements, and other prepayments for which the earnings recognition process has not been completed.

Cost of Revenues

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     Cost of Software License Fees. Cost of software license fees includes costs of product media, duplication, manuals, packaging materials, amounts paid for licensed technology, fees paid to third-party vendors for order fulfillment and royalties paid on sales of games and other third-party products. Cost of software license fees was $8.0 million in 2001, a decrease of 44% from $14.3 million in 2000, and decreased as a percentage of software license fees to 7% from 10% in 2000. The decreases for 2001 were primarily due to lower sales volumes and the expiration of certain royalty agreements. Cost of software license fees was $14.3 million in 2000, an increase of 10% from $13.0 million in 1999, but decreased as a percentage of software license fees to 10% from 14% in 1999. The increase in costs for 2000 was due primarily to higher sales volumes. The decreases in percentage terms for both periods were due primarily to the expiration of certain royalty agreements and a reduction in per unit fulfillment costs.

     Cost of Service Revenues. Cost of service revenues includes the cost of in-house and contract personnel providing support and consulting services, expenses incurred in providing our streaming media hosting services and cost of content included in our GoldPass/RealOne subscription service offerings. Cost of service revenues was $23.9 million in 2001, an increase of 62% from $14.7 million in 2000, and increased as a percentage of service revenues to 37% from 28% in 2000. The increase in costs was primarily due to costs associated with content included in our GoldPass/RealOne subscription service, introduced in August 2000, as well as increased customer service and technical support costs associated with our subscription services. Costs of content include our agreements with Major League Baseball, the National Basketball Association, ABCNEWS.com, CBS SURVIVOR INSIDER, CNN, E! Networks, FOXSports.com and other providers of subscription services media content. The costs associated with the content agreements are expensed over the contract terms. Cost of service revenues was $14.7 million in 2000, an increase of 124% from $6.6 million in 1999, and increased as a percentage of service revenues to 28% from 25% in 1999. The increase in costs in 2000 was primarily due to increased staff and contract personnel to provide services to a greater number of customers, including consulting and streaming media hosting customers, increased bandwidth costs as a result of increased streaming media hosting services, expansion of customer service and technical support into international regions, and support costs related to the introduction of new products and services including RealDownload, Real Entertainment Center, and our GoldPass subscription service. The increases in percentage terms in both periods were due to shifts in product mix towards our GoldPass/RealOne subscription services, which are characterized by relatively higher costs of revenues than our other service offerings.

     Our GoldPass/RealOne subscription services are a relatively new and growing portion of our business. This subscription services business is characterized by relatively higher costs of revenues than our other products and services, primarily due to the cost of licensing media content for these services. As a result, if this portion of our business continues to grow, we anticipate that our cost of service revenues may grow at an increased rate relative to net revenues and thereby may lead to reductions in our gross margins in the future.

     Cost of Advertising. Cost of advertising includes the cost of personnel associated with maintenance of programming services, content creation and maintenance, fees paid to third parties for content included in our websites and ad delivery services. Cost of advertising was $6.3 million in 2001, a decrease of 34% from $9.6 million in 2000, but increased as a percentage of advertising revenues to 41% from 24% in 2000. The decrease in costs was primarily due to lower sales volumes, the expiration of certain advertising contracts and shifting programming personnel to other areas of our business. The increase in percentage terms in 2001 was due to fixed expenses decreasing at a slower rate than the decrease in revenues. Cost of advertising was $9.6 million in 2000, an increase of 231% from $2.9 million in 1999, and increased as a percentage of advertising revenues to 24% from 21% in 1999. The increase in costs for 2000 was primarily due to increases in the quality and quantity of content available on our Web sites and cosmetic enhancements made to existing Web sites. The increase in percentage terms in 2000 was due to fixed expenses increasing at a faster rate than the increase in advertising revenues.

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Operating Expenses

  Research and Development

     Research and development expenses consist primarily of salaries and related personnel costs, consulting fees associated with product development and costs of technology acquired from third parties to incorporate into products currently under 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 development expenses, excluding non-cash stock compensation, were $55.9 million in 2001, a decrease of 3% from $57.8 million in 2000, but increased as a percentage of total net revenues to 30% from 24% in 2000. The decrease in expenses was primarily due to a reduction in personnel and contract labor in July 2001 and increased efficiencies as part of an overall plan to control costs. These reductions were partially offset by expenses related to the development of new technology and products. New product developments in 2001 included RealArcade, the RealSystem Media Commerce Suite and the release of the RealOne Player and the related RealOne subscription service. The increase in percentage terms was primarily a result of expenses decreasing at a slower rate than the decrease in net revenues in 2001. Research and development expenses, excluding non-cash stock compensation, were $57.8 million in 2000, an increase of 51% from $38.4 million in 1999, but decreased as a percentage of total net revenues to 24% from 29%. The increase in expenses was primarily due to increases in internal development personnel, related personnel costs, consulting expenses and contract labor related to the development of new technology and products and enhancements made to existing products. New product developments in 2000 included RealSystem iQ and RealVideo 8. In 2000, we also made enhancements to existing products, including RealPlayer 8, RealJukebox 2 and RealDownload 4. The decrease in percentage terms was primarily a result of expenses increasing at a slower rate than the increase in net revenues in 2000.

  Sales and Marketing

     Sales and marketing expenses consist primarily of salaries and related personnel costs, sales commissions, consulting fees, trade show expenses, advertising costs and costs of marketing collateral. Sales and marketing expenses, excluding non-cash stock compensation, were $73.1 million in 2001, a decrease of 28% from $101.2 million in 2000, and decreased as a percentage of total net revenues to 39% from 42% in 2000. The decrease in expenses for 2001 was primarily due to reductions in personnel and contract labor and decreases in advertising and marketing expenses as part of an overall plan to control costs. These reductions were partially offset by costs associated with opening sales offices in Korea and Singapore. The decrease in percentage terms was a result of cost saving measures that reduced sales and marketing expenses more rapidly than the rate of the decline in net revenues in 2001. Sales and marketing expenses, excluding non-cash stock compensation, were $101.2 million in 2000, an increase of 89% from $53.5 million in 1999, and increased as a percentage of total net revenues to 42% from 41% in 1999. The increase in expenses was due to the expansion of our direct sales and marketing organization, the creation of additional foreign and domestic sales offices, increased trade show attendance, increased costs associated with our annual conference, advertising and

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marketing expenses associated with the launch of new products and increased advertising, promotions and expenses related to our overall corporate branding and marketing. The increase in percentage terms was a result of expenses increasing at a faster rate than the increase in net revenues in 2000.

  General and Administrative

     General and administrative expenses consist primarily of salaries, related personnel costs, and fees for professional and temporary services. General and administrative expenses were $20.6 million in 2001, a decrease of 26% from $27.8 million in 2000, and decreased as a percentage of total net revenues to 11% from 12% in 2000. The decrease in expenses was primarily due to a reduction in personnel and decreased litigation defense costs. The decrease in percentage terms was due to expenses decreasing at a faster rate than the decrease in net revenues. General and administrative expenses were $27.8 million in 2000, an increase of 70% from $16.4 million in 1999, and remained constant at 12% of total net revenues. The increase in expenses in 2000 was primarily due to increased personnel costs and professional fees, litigation costs, and charitable contributions of 5% of our pre-tax net income (excluding amortization of goodwill, acquisition charges and stock-based compensation).

  Goodwill Amortization, Acquisition Charges and Stock-Based Compensation

     In August 1999, we acquired Xing Technology Corporation (Xing), a provider of standards-based digital audio and video encoding and decoding technology, including MP3 software. We issued approximately 1.5 million shares of our common stock in exchange for all of the outstanding shares of Xing capital stock. The acquisition was accounted for using the pooling of interests method of accounting and, accordingly, our consolidated financial statements include the accounts of Xing for 1999 as if Xing had always been a part of RealNetworks.

     In January 2000, we acquired NetZip, Inc. (NetZip), a developer and provider of Internet download management and utility software. We issued approximately 1.6 million shares of our common stock in exchange for all outstanding shares of NetZip common stock. The acquisition was accounted for using the purchase method of accounting and, accordingly, the results of NetZip’s operations are included in our consolidated financial statements since the date of acquisition. The purchase price was allocated to the fair value of the acquired assets and assumed liabilities based on their fair values at the date of the acquisition. Of the total purchase price, $127.9 million was allocated to goodwill, and $0.9 million was allocated to tangible assets. Goodwill has been amortized over its estimated life of three years. Based on new accounting standards, the treatment of goodwill in 2002 and future periods will differ from historical accounting practices. See the section below entitled “Impact of recently issued accounting standards.”

     In connection with the NetZip acquisition, we incurred approximately $5.0 million in acquisition-related expenditures. These expenditures included $3.2 million in relocation payments and retention bonuses for NetZip employees, and $1.8 million in professional fees and other costs. As of December 31, 2001, substantially all of these costs had been paid. The cost of the retention bonuses was recognized as an operating expense over the related service period.

     In connection with our acquisition of NetZip, we also issued approximately 1.8 million shares of common stock to certain former stockholders of NetZip that were subject to forfeiture pursuant to the terms of

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restricted stock agreements entered into with each such stockholder. The restricted stock agreements provided that such common stock was subject to forfeiture over a period of 30 months beginning in January 2000 if such stockholders did not remain employed by RealNetworks. The value of $144 million for such shares of common stock was being amortized over the related forfeiture period. In April 2001, we repurchased approximately 738,000 shares of our common stock from these former NetZip stockholders for a nominal amount. We also released certain shares from the restrictions in the restricted stock agreements, making them no longer subject to repurchase. The net effect of this repurchase and release was that we recorded a reversal of previously recorded stock-based compensation expense of $(25.4) million. As a result, in 2001 we recorded a net benefit related to the reversal of accrued stock compensation of $(10.0) million. No future stock compensation expense related to the NetZip acquisition will be recognized.

     In December 2000, we acquired Aegisoft Corp. (Aegisoft), a developer of secure digital media software. We issued approximately 0.9 million shares of our common stock in exchange for all of the outstanding shares of Aegisoft capital stock. The acquisition was accounted for using the purchase method of accounting and, accordingly, the results of Aegisoft’s operations are included in our consolidated financial statements since the date of acquisition. The purchase price was allocated to the fair value of the acquired assets and assumed liabilities based on their fair values at the date of the acquisition. Of the total purchase price, $11.0 million was allocated to goodwill, and $0.1 million to identifiable tangible assets. Goodwill has been amortized over its estimated life of three years. Based on new accounting standards, the treatment of goodwill in 2002 and future periods will differ from historical accounting practices. See the section below entitled “Impact of recently issued accounting standards.”

     In connection with the Aegisoft acquisition, we incurred approximately $1.3 million in acquisition-related expenditures. These expenditures included $0.6 million in relocation payments for Aegisoft employees and $0.7 million in professional fees and other costs. As of December 31, 2001, substantially all of the costs had been paid. The cost of the relocation bonuses was recognized as an operating expense over the related service period.

     In connection with the acquisition of Aegisoft, we also issued approximately 0.3 million shares of common stock to certain former stockholders of Aegisoft that are subject to forfeiture over a period of three years pursuant to the terms of restricted stock agreements entered into with each such stockholder. The restricted stock agreements provided that such common stock is subject to forfeiture if such stockholders do not remain employed with RealNetworks. The value of $2.3 million for such shares of common stock is being amortized over the related forfeiture period.

     Stock-based compensation was a benefit of $(9.5) million for 2001, an expense of $96.6 million for 2000 and $0 for 1999. Stock-based compensation related to research and development was a benefit of $(9.5) million for 2001, an expense of $92.2 million for 2000 and $0 for 1999. Stock-based compensation related to sales and marketing was a benefit of $(42,000) in 2001, an expense of $4.5 million in 2000 and $0 for 1999. Goodwill amortization expense and acquisition charges for 2001, 2000 and 1999 were $50.2 million, $45.4 million and $3.5 million, respectively. While the changes between periods are due partly to the timing of acquisitions, particularly with respect to goodwill, the benefit related to stock-based compensation for 2001 was primarily due to the voluntary resignation of certain former NetZip employees from RealNetworks.

  Loss on excess office facilities

     In October 2000, we entered into a 10-year lease agreement for additional office space located near our corporate headquarters in Seattle, Washington. During the quarter ended June 30, 2001, we re-evaluated our facilities requirements and as a result, decided to permanently sublet all of this office space for the remaining term of our lease. We recorded a loss of $16.6 million representing approximately $9.6 million of rent and

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operating expenses over the remaining life of the lease, net of estimated sublease income and approximately $7.0 million for the write-down of leasehold improvements to their estimated fair value. During the quarter ended September 30, 2001, the market for Seattle, Washington office space significantly deteriorated, sublease rates declined significantly from earlier estimates and many prospective tenants elected to defer their decisions to lease additional facilities. As a result, we re-evaluated our earlier estimates and recorded an additional loss on excess office facilities of $5.6 million during the quarter ended September 30, 2001. For 2001, the aggregate loss on excess office facilities including the write-down of leasehold improvements was $22.2 million. Our estimates are based upon many factors including projections of sublease rates and the time period required to locate tenants. Although we believe our estimates are reasonable, additional losses may result if our actual experience differs from our projections. As of December 31, 2001, $12.4 million of the loss is included in accrued loss on excess office facilities.

  Personnel reduction and related charges

     In July 2001, we reduced our staffing levels by approximately 15% and recorded a charge of approximately $3.9 million to reflect costs associated with implementing the staff reduction. These costs were primarily related to severance payments, but also included other miscellaneous costs such as professional fees and outplacement services for terminated employees, all of which were incurred as of December 31, 2001. During the fourth quarter of 2001, we re-evaluated our estimates of costs associated with the staff reduction, and, as a result, reduced previously recorded costs by $0.3 million. Accordingly, the total cost of our personnel reduction and related charges was $3.6 million in 2001. Approximately $0.3 million of these costs were included in accrued and other liabilities as of December 31, 2001.

Other income (expense), net