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;
	•	ubiquitous and easy consumer accessibility to media playback capability;
	•	access to distribution channels necessary to achieve broad distribution and use of products;
	•	the availability of valuable, compatible and marketable content for delivery over the Internet;
	•	the ability to license or develop, support and distribute secure formats and digital rights management systems for digital media delivery, particularly music and video, which includes the ability to convince consumer electronics makers to adopt our technology and the willingness of content providers to use our digital rights management technology;
	•	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;
	•	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; and
	•	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 digital delivery infrastructure.systems.

     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, players, encoders, digital rights management, codecs and other technology and services related to digital distribution of media. 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, tools and digital rights management products by bundling them with its Windows operating systems, including Windows NT and Windows XP, 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 and services and affect usage of our competing products and formats. 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, use and bundling contracts for its media delivery technologies and products with third parties, such as ISPs, content delivery networks, content providers, entertainment and media companies, VARs and OEMs, including third parties with whom we have relationships. Microsoft has also invested significant 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. Such arrangements, together with Microsoft’s aggressive marketing of its Windows operating systems, server products and digital media products, may reduce our share of the streaming media and digital distribution markets. While courts have ruled that several of Microsoft’s practices violated relevant laws related to illegal maintenance of monopoly power, court remedies to date have had only

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Microsoft’s Windows Media Player competes with our media player products. We expect that by leveraging its monopoly position in operating systems and tying streaming or digital media into its operating systems and its Web browser, Microsoft will distribute substantially more copies of the Windows Media Player in the future than it has in the past and may be able to attract more users and content providers to use its streaming or digital media products. In addition, Microsoft does not document or expose all of the interfaces that would allow our products to take full advantage of the features and functionality of Windows XP that it makes available to the Windows Media Player. Microsoft’s Windows Media Player

     We also competes with the personal music management features of the RealOne Player. The Windows Media Player supports the Windows Media format, but not RealNetworks’ media formats. Microsoft also licenses various Windows Media Technology applications for authoring, delivering and playing digital media intended to compete with our system software products, 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 Windows servers, whereas we offer versions of our competitive servers for sale. Microsoft bundles its Windows Media Server product with its server operating systems. In some cases, Microsoft has conditioned 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 and Sony Corporation in the market for digital rights management technologies. Sony’s recent acquisition of digital rights management patents from Intertrust in conjunction with Philips Electronics indicates that Sony may increase its focus on competing with us in the market for digital rights management technology.

     Microsoft also competes with us in attempting to acquire from broadcasters and other owners high quality or popular content to promote and deliver such content in Microsoft’s formats, in some cases on an exclusive or preferential basis. This may harm both our systems software businesses and our player businesses. 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 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 content, and to provide incentives to content providers to prepare their content in Microsoft’s formats. Microsoft’s commitment to and presence in the media delivery industry has increased and we believe that Microsoft will continue to increase competitive pressure in the overall market for streaming media and media distribution.

     In addition to Microsoft, we face 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. Apple has also enlisted the open source code community to assist its development of competitive products. Other than Microsoft and Apple, we have other competitors in the streaming media systems business,

     While some of which have greater resources than us.

     We do not believe that completeindustry standards have emergedbeen specified with respect to non-PC wireless and cable-based systems, though participantsthese standards have not had a significant market impact in those industries generally express support for the evolutionterms of industry-wide standards which may disfavor proprietary solutions.mobile media consumer usage. Likewise, no single company has yet gained a dominant position in the mobile device market. However, certain third party products and services in these marketsthis market support our technology, and certain products and services support our competitors’ technologies, especially Microsoft, which can use its monopoly position in the operating system

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Intellectual Property

     As of December 31, 2002,2003, we had 4556 registered U.S. trademarks or service marks, and had applications pending for several more U.S. trademarks. We also have several unregistered trademarks. In addition, we have several foreign trademark registrations and pending applications. Many of our marks begin with the word “Real” (such as RealOne,RealPlayer, 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, 2002,2003, we had 2024 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, 2002,2003, we had 689740 full-time employees and seven4 part-time employees, 602583 of whom were based at our executive offices in Seattle, Washington, 6372 of whom were based at RealNetworks’our offices in Australia, Brazil, Canada, France, Germany, Hong Kong, Japan, China, Mexico, Singapore South Korea and the United Kingdom, and 3189 of whom were based at other locations. None of our employees are subject to a collective bargaining agreement, and we believe that our relations with our employees are good.

Position on Charitable Responsibility

     In periods where we achieve profitability, (excluding the effects of goodwill and other acquisition charges), we intend to donate 5% of our annual pre-tax net income to charitable organizations, which will reduce our net income for those periods. The non-profit RealNetworks Foundation manages our charitable giving efforts. We attempt to encourage employee giving by using a portion of our intended contribution to match charitable donations made by employees.

Available Information

     Our corporate Internet address iswww.realnetworks.com. We make available free of charge onwww.realnetworks.comour annual, quarterly and current reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. However, the information found on our Web site is not part of this or any other report.

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     We lease our corporate headquartersthree separate principal properties in the United States, two of which are located in Seattle, Washington.Washington and one which is located in San Francisco, California. The lease for our corporate headquarters, located in Seattle, commenced on April 1, 1999 and expires on March 31, 2011, with an option to renew for either a three- orthree-or a ten-year period. As of December 31, 2002,At this location we lease approximately 280,000 square feet at an average monthly rent of approximately $566,000. In addition,$472,000. At a second location in Seattle, we lease approximately 133,000 square feet of additional office space in a second location in Seattle, Washington at an average monthly rent of approximately $381,000 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 attempt to sublet all of this office space for the remainder of

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     See “Notes to Consolidated Financial Statements — Commitments and Contingencies” (Note 12)14C) for information regarding legal proceedings.

     No matters were submitted to a vote of RealNetworks’ shareholders during the fourth quarter of its fiscal year ended December 31, 2002.2003.

Executive Officers of the Registrant

     The executive officers of RealNetworks as of March 15, 20038, 2004 were as follows:

     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 of RealNetworks since February 2003. From February 2001 to February 2003, Mr. Jacobson served as President and Chief Operating Officer of RealNetworks. 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.

     MARTIN PLAEHN has served as Executive Vice President, Products and Services of RealNetworks since June 2003. Mr. Plaehn served as Senior Vice President, Software Products from February 2003 to June 2003, and from September 1999 to February 2003, Mr. Plaehn served as Senior Vice President, Media Systems of RealNetworks. 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. 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.

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     PHILLIP BARRETTRICHARD WOLPERT has served as Chief Strategy Officer of RealNetworks since June 2003. From September 2000 to June 2003, Mr. Wolpert served as the Strategic Advisor of RealNetworks. From 1998 to September 2000, Mr. Wolpert served as the partner in charge of Internet and technology ventures for The Yucaipa Companies, a private investment firm. From 1996 to 1998, Mr. Wolpert served as President of Disney Online, a business unit of the Walt Disney Internet Group, where he was responsible for the company’s business and creative strategy. Mr. Wolpert holds a B.S. degree from UCLA.

     ROY GOODMAN has served as Senior Vice President, Chief Financial Officer and Treasurer of RealNetworks since FebruarySeptember 2003. From JulyApril 2000 to FebruaryJanuary 2003, Mr. BarrettGoodman served as Senior Vice President-Consumer ProductsChief Financial Officer of RealNetworks.Juniper Financial Corporation, a company engaged in the issuance of credit cards. From July 19981980 to JulyMay 2000, Mr. Barrett servedGoodman was employed by Heilig-Meyers, a publicly traded home-furnishings retailer, serving as Senior Vice President — Media Technologies of RealNetworks,Chief Financial Officer from January 1997 to July 1998, he served as Senior Vice President — Media Systems of RealNetworks, and2000. Mr. Goodman holds a B.S. in Finance 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 UniversityVirginia Tech and an M.S. in Computer SciencesMBA from the University of Wisconsin, Madison.

     MERRILL BROWN has served as Senior Vice President-RealOne Services since August 2002. From August 1996 to June 2002, Mr. Brown was employed by MSNBC.com, an online news service, most recently serving as Senior Vice President and Editor-in-Chief. From 1994 to 1996, Mr. Brown served as a media and communications consultant to several media ventures, including Time Inc., NBC and U.S. West. From 1990 to 1994, Mr. Brown held the position of Senior Vice President, Corporate and Program Development for Court TV. Mr. Brown has also served as Editor-in-Chief at Channels Magazine and as a business writer and correspondent for The Washington Post. Mr. Brown holds a B.A. in Political Science from Washington University, St. Louis.Richmond.

     KELLY JO MACARTHUR has served as Senior Vice President and Chief of Staff of RealNetworks since January 2003. Ms. MacArthur held the positions of Senior Vice President, Legal and Business Affairs, General Counsel and Corporate Secretary of RealNetworks from April 2000 to January 2003, and 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 graduatedsumma cum laudefrom the University of Illinois at Champaign-Urbana and holds a J.D. from Harvard Law School.

     MARTIN PLAEHNDAN SHEERAN has served as Senior Vice President-Software ProductsPresident, Marketing of RealNetworks since FebruaryJune 2003. From SeptemberAugust 2001 to June 2003, Mr. Sheeran served as Vice President, Media Systems Marketing of RealNetworks. From 1999 to February 2003,August 2001, Mr. PlaehnSheeran served as Senior Vice President — Media Systems of RealNetworks.Worldwide Sales and Marketing of nCUBE, a provider of on-demand media systems and digital advertising systems for cable operators and telecommunications network providers. From April 19961994 to August 1999, Mr. PlaehnSheeran 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 ExecutiveSenior Vice President, Product Management at SkyConnect, a provider of Business and Product Development and was a member ofdigital video management solutions for the Board of Directors of Wavefront Technologies Inc., which was acquired by Silicon Graphics in 1995.cable television industry. 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. PlaehnSheeran holds a B.AB.S. in the School of Foreign Service,cum laude, from theGeorgetown University, of California San Diego and is a graduate of UCSD’s Executive Program for Scientists and Engineers.an M.B.A. from Northwestern University.

     CARLA STRATFOLD has served as Senior Vice President-NorthPresident, 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 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. TURNERROBERT KIMBALL has served as Senior Vice President, FinanceLegal and Operations, Chief Financial OfficerBusiness Affairs, General Counsel and TreasurerCorporate Secretary of RealNetworks since October 2001. From December 2000 to October 2001,January 2003. Mr. Turner served as President, Chief Operating Officer and Secretary, andKimball held the positions of Associate General Counsel of RealNetworks from AprilMarch 1999 to December 2000, as SeniorApril 2001, and Vice President, Legal and Business Affairs of Operations, Chief Financial Officer and Secretary of BSQUARE Corporation, a company engagedRealNetworks from May 2001 to January 2003. Before joining RealNetworks 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 theKimball was Senior Vice PresidentAttorney and Manager of Operations and Chief Financial Officer of RadiSys Corporation, a manufacturer and designer of computers. Between July 1982 and September 1995,Business Relations for IBM Global Services. Mr. Turner was employed by PricewaterhouseCoopers LLP, an accounting firm, most recently as a director in

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PART II.

     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.

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     The following table sets forth for the periods indicated the high and low sale prices for our common stock, as adjusted for stock splits.stock. 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, 20022003

Year Ended December 31, 20012002

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

     As of March 20, 2003,10, 2004, there were approximately 756801 holders of record of our common stock. Most shares of our common stock are held by brokers and other institutions on behalf of shareholders.

     The information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Form 10-K.

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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 to Consolidated Financial Statements included elsewhere in this report.

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(A)	For the yearyears ended December 31, 2003 and 2002, this amount includes only stock-based compensation. As of January 1, 2002, the Company adopted new accounting standard SFAS 142, which requires that goodwill no longer be amortized but instead tested at least annually for impairment.

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     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, Inc. is athe leading global providercreator of network-delivered digital media services and the technology that enables digital media creation, distributionsoftware. Consumers use our services and consumption. Our company is at the center of the intersection between technologysoftware to find, play, purchase and digital content.

     Our strategy is to drive the creation of a market for subscription-based digital audiomanage free and video content online, and we believe we are positioned to benefit from this market in three primary ways: (1) as an electronic retailer ofpremium digital content, to consumers; (2) as a business-to-business services provider to third parties who wish to distribute their content to consumers via digital networks;including music, video and (3) as a supplier of the underlying technology needed by content owners andgames. Broadcasters, network operators, media companies and enterprises use our products and services to create and distributedeliver digital content. Since our inceptionmedia to PCs, mobile phones and consumer electronics devices.

     We have been a pioneer in the development of technology for the transmission of digital media over the Internet, and we have helpedused this technology leadership to create a large ecosystembase of consumers, network operators and content owners who use our products and services to create, send and receive both free and paid content. Our strategy is to continue to grow and leverage this base of users to drive the creation of a market for premium digital audio and video content online and generate profitable revenue from this market in two primary ways:

	(1) as a creator, packager and seller of software and digital content to consumers; and
	(2) as a supplier of the underlying technology and business to business services to content owners and network operators to create and distribute digital content.

     Over the last three years, our core business has evolved to address changing dynamics in our industry. We initially developed our business as a leading provider of software technology for the delivery and playback of digital media content over digital networks, and became a leader in that market. We have recently leveraged our technology leadership position and large technology user base to define and develop new markets and businesses predicated on digital media technology. These new businesses principally involve paid digital media content. We have aggressively pursued development of these new businesses, through both internal initiatives and strategic acquisitions of businesses and technologies. As these new businesses have developed, the focus of our core business, including our promotional efforts, has shifted toward these markets and has resulted in significant increases in the number of subscribers to our service offerings. This shift in focus and number of subscribers is reflected in our results of operations in the following primary ways:

	•	A significant increase in service revenues, including primarily consumer subscription services;
	•	A significant increase in revenues in our video, music and games businesses; and
	•	A higher percentage of our total revenues relating to the above areas of our business.

     Despite the growth of our consumer subscription businesses, our overall results have been substantially affected over the last three years by weaker demand for our business software products and services. The weak demand for our business products during this period has been caused primarily by Microsoft’s continuing practice of bundling its competing Windows Media Player and server software for free with its Windows NT operating system products, which we believe is an illegal practice, and also by general macroeconomic conditions. These factors resulted in cutbacks in capital and information technology spending by our

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	•	A decline in demand for our business products and services resulting in declines in related revenues;
	•	Personnel reduction and related charges in 2002 and 2001; and
	•	Losses on excess office facilities in 2003, 2002 and 2001.

     We report revenues and cost of revenues in three categories:

	•	Software license fees, which primarily includeinclude: revenues from sales of premium versions of our RealPlayer Plus and RealJukeboxrelated products; sales of third-party products and content such as game downloads and music copying or “burning;” and sales of our media delivery system software, including RealServer and Helix system software and related authoring and publishing tools, both directly to customers and indirectly through original equipment manufacturer (OEM) channels, and sales of third-party products, including games. The English language version of our RealPlayer Plus and RealJukebox Plus products, which have previously contributed to software license fees, are now combined in our RealOne subscription offering, the revenue from which is included in service revenues.channels;
	•	Service revenues, which primarily includeinclude: revenues from digital media subscription services such as RealOne SuperPass, MusicPass, RadioPass, Rhapsody, GamePass and GamePass,stand-alone and add-on subscriptions; revenues from support and maintenance services that we sell to customers who purchase our RealPlayer Plus, RealJukebox Plus, and media delivery system software including RealServer and Helix system software, and related authoring and publishing tools,products; revenues from broadcast hosting services we provide through our Real Broadcast Network andservices; revenues from consulting services we offer to our customers.customers; and revenues from distribution of third party software; and
	•	Advertising revenues which are derived from sales of advertising on our Web sites and consumer software and within the media streams that we host on behalf of our corporate customers.

16     In August 2003, we acquired all of the outstanding securities of Listen. Listen operates an on-demand streamed music subscription service for which it charges monthly subscription fees. It also provides its subscribers with the ability to burn compact discs for which it charges a per-track fee. The results of Listen’s operations are included in our consolidated financial statements since the date of acquisition and impact the comparability of the 2003 financial information when compared to 2002.

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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

     The preparation of our 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. Our critical accounting policies and estimates are as follows:

	•	Revenue recognitionrecognition;
	•	Estimating sales returns and the allowance for doubtful accountsaccounts;
	•	Estimating losses on excess office facilitiesfacilities;
	•	Determining whether declines in the fair value of investments are other-than-temporary and estimating fair market value of investments in privately held companiescompanies;

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	•	Valuation of goodwillgoodwill; and
	•	Valuation of deferred income tax assetsassets.

     Revenue Recognition.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

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     WeFor software related products and services, 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. Some of our software arrangements include consulting implementation services sold separately under consulting engagement contracts. Consulting revenues from these arrangements are generally accounted for separately from new software license revenues because the arrangements qualify as service transactions as defined in SOP 97-2. Revenues for consulting services are generally recognized as the services are performed.

     In addition, for transactions not falling under the scope of SOP 97-2, our revenue recognition policies are in accordance with Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 104, “Revenue Recognition,” which was issued on December 17, 2003 and supersedes SAB 101, Revenue Recognition in Financial Statements. The adoption of SAB 104 did not materially affect our revenue recognition policies, or our results of operations, financial position or cash flows.

     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 whichthat 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.the customer. For service and advertising revenues, delivery typically occurs as the services are being performed.

     At the time of each transaction, we assess whether the fee associated with our revenue transactionstransaction is fixed and determinable and whether or not collection is probable. 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 forconsider the fee asto not beingbe 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 probable, we defer revenue until the time collection becomes probable, 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 the arrangement’s 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

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     If specific objective evidence does not exist for an undelivered element in a software arrangement, which may include distribution or other term-based arrangements in which the license fee includes support during the arrangement term, revenue is recognized over the term of the support period commencing upon delivery of our technology to the customer.

     Revenue from software license agreements with OEMs 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

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     Service revenues include payments under support and upgrade contracts, RealOne mediaand Rhapsody subscription services, 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 as the services are performed.

     Fees generated from advertising are recognized as advertising is delivered over the termsterm of the contracts.contract. 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 our 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 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. Similarly, we must make estimates of the uncollectibility of our accounts receivables. We specifically analyze the age of accounts receivable and analyze historical bad debts, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Significant judgments and estimates must be made and used in connection with establishing allowances 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 madewere to make different judgments or utilizedutilize different estimates. Similarly, we must make estimates of the uncollectibility of our accounts receivables. We specifically analyze the age of accounts receivable and analyze historical bad debts, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.

     Accrued Loss On Excess Office Facilities.We have made significant estimates in determining the appropriate amount of accrued loss on excess office facilities. If we made different estimates, our loss on excess office facilities would be significantly different from that recorded, which could have a material impact on our operating results. We have revised our original estimate twicethree times in the last two years, increasing the accrual for loss on excess office facilities both times.each time. These first two revisions were in both cases the result of changes in the market for commercial real estate where we operate. The third revision, which took place in 2003, was the Seattle, Washington area.result of adding an additional tenant at a sublease rate lower than the rate used in previous estimates. If the market for such space declines further in future periods, we may have to revise our estimates, which may result in additional losses on excess office facilities. The significant factors we considered in making our estimateestimates are discussed in the section entitled “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

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

	•	poor economic performance relative to historical or projected future operating resultsresults;
	•	significant negative industry, economic or company specific trendstrends;
	•	changes in the manner of our use of the assets or the plans for our businessbusiness; and
	•	loss of key personnelpersonnel.

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     If we were to determine that the fair value of a reporting unit was less than its carrying value, including goodwill, based upon the annual test or the existence of one or more of the above indicators of impairment, we would measure impairment based on a comparison of the implied fair value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating the fair value of a reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of reporting unit goodwill. To the extent the carrying amount of reporting unit goodwill is greater than the implied fair value of reporting unit goodwill, we would record an impairment charge for the difference. Judgment is required in determining what our reporting units are for the purpose of assessing fair value compared to carrying value.

     There waswere no impairment chargecharges for goodwill in 2002.2003, 2002 or 2001.

     Valuation of Deferred Income Tax Assets.In accordance with generally accepted accounting principles, we must periodically assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent that recovery is not likely, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefits in the statement of operations. Factors we consider in making such an assessment include, but are not limited to, past performance and our expectation of future taxable income, macro-economic conditions and issues facing our industry, existing contracts, backlog, our ability to project future results and any appreciation of our investments and other assets.

     As of December 31, 2001, we had recorded net deferred tax assets of $5.6 million. Due to the net losses incurred during the year ended December 31, 2002, difficult economic conditions facing our industry and our customers and declines in the fair value of our investments, we determined that it was appropriate to increase our valuation allowance to reduce our net deferred tax assets as of December 31, 2002 to zero. Those conditions have not changed materially during 2003 and, therefore our gross deferred tax assets at December 31, 2003 of $235 million are reduced to zero by a full valuation allowance.

Revenues

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     Software License Fees.Software license fees were $72.8 million in 2002, a decrease of 33% from $108.6 million in 2001. This decrease is due in part to focusing our consumer promotional activities to feature our digital media subscription services. In June 2002, we also launched a European edition of our RealOne subscription service. Both of these factors have resulted in a shift of revenue from software license fees to service revenues. Additionally, the English language version of our RealOne Player Plus and RealJukebox Plus products, which have previously contributed significantly to software license fees, are now combined in our RealOne subscription offering, the revenue from which is included in service revenues. While we continue to sell a successor software product, RealOne Player Plus, on a stand-alone basis, we promote our RealOne subscription offerings (which include the RealOne PlayerPlus) as our primary offerings in a substantial majority of our marketing channels.

     We also believe that theThe decrease in software license fees in 2003 was due primarily to continued cutbackslower revenue from certain of our business software products, including revenue from our OEM partners and decreased sales of our premium consumer license products. The decrease in capital and information technology spendingrevenues in 2003 was partially offset by revenues from increased sales of our customers and potential customers caused by macroeconomic conditions and that these macroeconomic conditions resulted in decreased system software sales. In particular, customersto mobile and potential customers inwireless infrastructure companies as well as revenues from the systems software and telecommunication industries have become increasingly cautious in their buying decisions dueon-line sale of individual songs resulting from the inclusion of the operations of Listen since the date of acquisition. See “Overview” for a description of the general factors we believe contributed to economic trends specific to those industries. In addition, Microsoft has continued to bundle its competing Windows Media Player and server software for free with its operating system products, causing certain potential customers to adopt Microsoft’s media delivery products.the decreased sales. We believe the macroeconomic environment and competition from Microsoft, including Microsoft’s conduct described below in “Factors that may Affect our Business, Future Operating Results and Financial Condition,”those factors have negatively impacted sales to and the ratecustomers in a variety of adoption of our systems software products by,

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     Softwaresoftware license fees, were $108.6 millioncombined in 2001,our RealOne subscription offerings starting in 2002, the revenue from which is included in service revenues. While we continued to sell a decrease of 27% from $148.1 millionsuccessor software product, on a stand-alone basis, we promoted our subscription offerings (which included the RealPlayer Plus at no extra charge) as our primary offerings 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 directly impacted both our customers and potential customers. The reduced availability of funding contributed to certainmajority of our customers and potential customers ceasing operations and others experiencing difficult financial situations. We believe that this environment also resultedmarketing channels.

Service Revenues.The increase in customers 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 ourservice revenues in 2001. Additionally, we have focused our consumer promotional activities2003 was primarily attributable to featuregrowth in subscribers to our digital media subscription services, which has resultedpartially offset by decreases in a shiftother service offerings including support and upgrades. The increases in subscribers were primarily due to the inclusion of the operations of Listen since the date of acquisition as well as growth in our other subscription offerings including RadioPass, GamePass, and stand-alone subscriptions such as sports and entertainment content due to the evolution of our revenues from software license fees to service revenues. Thesecore business as described in “Overview.” Our subscription services have characteristics of longer-term, recurring revenue, unlike our software product offerings that typically generate one-time, non-recurring revenue, exclusiveaccounted for approximately $107.1 million and $75.5 million of service revenues in 2003 and 2002, respectively. The reasons for increases in subscription revenues are described in more detail in “Revenue By Product Type — Consumer Subscription Services” below. We believe the decreased revenues in our other service offerings, including support arrangements. Additionally, software license fees for 2000 included $5.2 million relatedand upgrades, are due primarily to a three-year license agreement we entered into with Microsoft which expiredthe factors described above in the quarter ended June 30, 2000. There was no such Microsoft-related revenue in 2001.“Overview.”

Service Revenues. Service revenues were $103.2 million in 2002, an increase of 59% from $64.7 million in 2001.     The increase in service revenues in 2002 was primarily attributable to growth in subscribers to our digital media subscription services, partially offset by decreases in other service offerings including content hosting revenues. Also,revenues due to the factors described above in “Overview.” In addition, in June 2002, we launched the European edition of our RealOne subscription service. Our subscription services accounted for approximately $75.5 million and $28.2 million of service revenues in 2002 and 2001, respectively. Reasons for the increase

Advertising.The decrease in subscription services revenues are described in more detail in “Revenues By Product Type — Consumer Subscription Services” below. We believe the decreasedadvertising revenues in 2003 was due in part to our other service offerings, including content hosting, are due primarily to competitionremoval of paid advertising from Microsoftcertain Web pages and the macro-economic and industry-specific conditions described above in “Software License Fees.”

     Service revenues were $64.7 million in 2001, an increaseincreased use of 23% from $52.5 million in 2000. The increase during 2001 was primarily attributableour advertising space to the continued growth ofpromote our digital media subscription services. Revenue related to digital media subscription services 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.”

     Advertising.Advertising revenues were $6.8 million in 2002, a decrease of 57% from $15.6 million in 2001. We believe theThe decrease in advertising revenues in 2002 was due in part to the continued depressed environment for Internet advertising, which resulted in lower volumes and lower average advertising rates. We also believe the focusThe removal of our promotional and marketing efforts to more prominently feature our digital media subscription offerings contributed to the decrease in advertising revenues, as we removed paid advertising from certain of our Web pages and usedthe increased use of our advertising space to promote our digital media subscription services. Advertising revenues were $15.6 million in 2001, a decrease of 62% from $40.9 million in 2000. The decrease was primarily dueservices also contributed to a decline in the demand for Internet advertising, and advertising in general. 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 ceased operations.decrease.

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Revenues by Product Type

     Consumer Software and Related Services.Consumer software and related services revenues are derived fromrevenue consists of sales of our RealOne Player Plus, RealJukeboxRealPlayer Plus and other related products, revenuesrevenue from support and maintenance services that we sell to customers who purchase these products, sales and salesdistribution of third-party software products including games.and content such as game downloads and music burning. These products and services are sold primarily through the Internet, and we charge customers’ credit cards at the time of sale. Consumer software and related services revenues were $31.3 milliondecreased in 2003 and 2002 a decrease of 33% from $47.0 million in 2001. Consumer software and related services revenues were $47.0 million in 2001, a decrease of 41% from $79.3 million in 2000. The decreases wereprimarily due in part to a change in focus of our consumer promotional activities to feature our digital media subscription services over our traditional consumer products, as well as competition from Microsoftthe general factors described in “Revenues — Software License Fees”“Overview” above.

     Additionally, as discussed in “Revenues — Software License Fees” above, the English language editions of our RealOne PlayerRealPlayer Plus and RealJukebox Plus products, which havehad previously contributed significantly to consumer software and related services revenues, are nowwere combined in our RealOne subscription offering during 2002, the revenue from which is included in consumer subscription services. In June 2002, we also launched a European edition of our RealOne subscription service which also contributed to the shift from consumer software and related services revenue to consumer subscription services revenue.

     Consumer Subscription Services.Consumer subscription services revenues consistrevenue consists of our digital media subscription services, including RealOne SuperPass, RadioPass, MusicPass, GoldPassRhapsody, GamePass and stand-alone and add-on subscriptions. These services are sold primarily through the Internet, and we charge the customers’ credit cards at the time of sale. Billing periods for our consumer subscription services occur monthly, quarterly or annually, depending on the service purchased. ConsumerThe increases in consumer subscription services revenues were $75.5 million in 2002, an increase of 167% from $28.2 million in 2001. Consumer subscription services revenues were $28.2 million in 2001, an increase of 1,322% from $2.0 million in 2000. The increasesduring 2003 were primarily attributable to the increased focus of our promotional activities on our digital media subscription services,general factors described above in “Overview” and specifically, due to the introduction ofgrowth in new subscription services and the related increase in paying subscribers. We also believe that the continuedsubscribers as well as an increase in exclusive and premium content available to our digital media subscribers has resulted in a broader reach among consumers, thereby leading to greater consumer adoption rates and higher revenues. For example, newly available on our subscription services in 2002 is contentrevenues from partners such as ABCNEWS.com, NASCAR, CBS, CNN, E! Networks, FOXSports.com and others.the inclusion of the operations of Listen since the date of acquisition. Additionally, in June 2002 we launched a European edition of our RealOne subscription service with premium content from brand name European partners such as BBC and Champions League Soccer from UEFA, Big Brother 3, CNN Europe and MTV Europe. We believe the launch of our European edition of our RealOne subscription service will continue a shift from consumer software and related services revenue to consumer subscription services revenue in the European market. Additionally, GoldPass, our first consumer subscription offering, was launched in the third quarter of 2000, and therefore our GoldPass-related revenues in 2000 do not represent a full year of revenue for comparison purposes. Our subscription services offerings represent a relatively new business model for Internet media delivery and a new business model for us and, to date, we have not faced significant direct competition with these offerings. We cannot predict with accuracy how these subscription offerings will perform in the future, at what rate subscription revenues will grow, if at all, or the nature or potential impact of anticipated competition. We believe that the increase in consumerUEFA. Consumer subscription services revenues on a percentage basis over the preceding year waswere substantially lower in 20022003 than in 20012002 primarily because in 2002 we arewere in the early phases of developing our subscription business and, therefore, the base of revenues was smaller in 20002001 than in 2001.2002. See “2002“2003 Quarterly Revenue” for a discussion of recent quarterly period trends in subscription services revenues.

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Advertising.See “Revenues — Advertising” above for analysis.

     Systems.Business Products and Services. Systems revenues areBusiness products and services revenue is derived from salesthe licensing of our media delivery system software, including RealServer and Helix system software and related authoring and publishing tools,

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Consumer Products and Services Revenues

A further analysis of our consumer products and services revenues is as follows:

Video, Consumer Software and Other.Video, consumer software and other revenue includes primarily revenues from our RealOne and stand alone subscription services, RealPlayer Plus and related products, revenue from support services that we sell to customers who purchase these products, and sales and distribution of third-party software products and all advertising other than that related directly to games. See “Revenues — Consumer Subscription Services” and “Revenues — Consumer Software and Related Services” above for analysis.

     Advertising.Music.AdvertisingMusic revenue primarily includes revenues were $6.8 millionfrom our RadioPass and Rhapsody subscription services and sales of music content. The increase is due to the introduction and subsequent growth of our RadioPass service in the fourth quarter of 2002 a decreaseand the inclusion and subsequent growth of 57%the operations of Listen during the third quarter of 2003. We believe the growth is due to the increased focus of our marketing efforts on our music offerings and the broader acceptance of paid on-line music services.

Games.Games revenue primarily includes revenues from $15.6 milliongame downloads through our RealArcade service and from our GamePass subscription service and related advertising. The increases are due to the introduction and subsequent growth of our GamePass subscription service in 2001. Advertising revenues were $15.6 million in 2001, a decreasethe fourth quarter of 62% from $40.9 million in 2000. See “Revenues — Advertising” above for analysis.2002. We believe the growth is due to increased focus of our marketing efforts on our games business and the addition of new game titles to our RealArcade and GamePass offerings.

Geographic Revenues

     International revenues represented 27% of total net revenues in 2003, 28% of total net revenues in 2002, and 29% of total net revenues in 2001, and 27%2001. Revenues generated in Europe were 16% of total net revenues in 2000. Revenues generated in Europe were2003 and 15% of total net revenues in 2002 and 2001, and 14%revenues generated in Asia were 10% of total net revenues in 2000, and revenues generated in Asia were2003, 11% of total net revenues in 2002, and 10% of total net revenues in 2001, and 9% of total net revenues in 2000.2001. International revenues decreased as a percentage of total net revenues in 2003 and 2002 primarily due to the increased U.S.-based

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Deferred Revenues

     Deferred revenue is comprised of the unrecognized revenue related to support contracts, prepayments under OEM arrangements, unearned subscription services revenue and other prepayments for which the earnings process has not been completed. 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. Because many of the agreements relatedDeferred revenue at December 31, 2003 was $35.7 million compared to the content delivery networks have been with companies that have had limited operating histories, we have historically required prepayments from such customers to mitigate our credit risk. Cash prepayments associated with these contracts are recorded as deferred revenue and amounted to $24.0 million and $27.2$44.2 million at December 31, 2002 and 2001, respectively.2002. The decrease in deferred revenue related to these contracts during

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Cost of Revenues

     Cost of Software License Fees.Cost of software license fees includes royalties paid on sales of games, music and other third-party products, amounts paid for licensed technology, costs of product media, duplication, manuals, packaging materials, amounts paid for licensed technology,and fees paid to third-party vendors for order fulfillment and royalties paid on sales of games and other third-party products.fulfillment. Cost of software license fees was $6.9 millionin 2003 increased by 44% from 2002 and increased as a percentage of software license fees to 16% from 9% in 2002. The increases in costs both in dollars and as a percentage of software license fees for 2003 were primarily due to the licensing costs associated with music burns revenue resulting from the inclusion of the operations of Listen since the date of acquisition, as well as costs of revenue related to custom development work and an increase in royalties resulting from a shift in product mix towards products with higher royalties.

     Cost of software license fees decreased 14% in 2002 a decrease of 14% from $8.0 million incompared to 2001 and increased as a percentage of software license fees to 9% from 7% in 2001. The decrease in costs for 2002 was primarily due to lower sales volumes. The lower sales volumes reduced royalty and other product fulfillment costs such as shipping and packaging costs. The increase in cost of software license fees as a percentage of software license fees revenue was due to a lower percentageamount of software license fee revenue arising from systemsbusiness software licenses, which typically have higher margins than other components of software license fees. 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 decrease in costs was due primarily to lower sales volumes and the expiration of certain royalty agreements. The decrease in percentage terms was due primarily to the expiration of certain royalty agreements and a reduction in per unit fulfillment costs as a result of more efficient packaging.

     Cost of Service Revenues.Cost of service revenues includes the cost of content, and delivery of the content, included in our digital media subscription service offerings, cost of in-house and contract personnel providing support and consulting services, and expenses incurred in providing our streaming media hosting and delivery services. Cost of service revenues increased 37% in 2003 from 2002 and increased as a percentage of service

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     Cost of service revenues increased 73% in 2002 an increase of 73% from $23.9 million in 2001 and increased as a percentage of service revenues to 40% in 2002 from 37% in 2001. The increase in costs was primarily due to costs associated with content included in our digital media subscription services, which have fixed and variable components, as well as increased customer service and technical support costs associated with the growth of our subscription services. The costs of content are expensed over the periods the content is available to our subscription services customers. The increase in percentage terms is due to shifts in product mix towards our digital media subscription services, which are characterized by relatively higher costs of revenues than our other 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 digital media subscription services, introduced in August 2000, as well as increased customer service and technical support costs associated with our subscription services.

     Our digital media subscription services, including the services of Listen, are a relatively new and growing portion of our business and, to date, have been characterized by relatively higher costs of revenuesrevenue than our other products and services, primarily due to the cost of licensing media content to provide these services. As a result, if this portion of our business continues to grow as a percentage of revenues, we anticipate thatrevenue, our cost of service revenuesrevenue may

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     Cost of Advertising.Cost of advertising includes the cost of personnel associated with maintenance of programming services, content creation and maintenance and advertising delivery services. Cost of advertising was $2.1 milliondecreased 19% in 2003 from 2002, and decreased as a percentage of advertising revenues to 27% in 2003 from 32% in 2002. Cost of advertising decreased 66% in 2002 a decrease of 66% from $6.3 million in 2001, and decreased as a percentage of advertising revenues to 32% in 2002 from 41% in 2001. The decreasedecreases in costs waswere primarily due to lower sales volumes and shifting programming personnel to other areas of our business. The decreasedecreases in percentage terms waswere due to costs decreasing at a faster rate than the decrease in advertising revenues. 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 was due to fixed expenses decreasing at a lower rate than the decrease in advertising revenues.

Operating Expenses