ITEM 2. 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. We have identified a number of these forward-looking statements in the section below entitled “Special Note Regarding Forward-Looking Statements.” 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.

OVERVIEW

     RealNetworks 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 Web. In 1999, we extended our media delivery platform to include a digital music management system that allows consumers to acquire, record, store, organize and play their personal music collections on PCs and digital playback devices and are extending it further to allow consumers to enjoy streaming and digital media content via mobile networks and devices.

     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 Web sites. 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. RealPlayer GoldPass gives subscribers access to a combination of premium software, services and content updated monthly. In December 2000, we released RealSystem iQ, a new foundational architecture for digital media delivery which greatly increases the reliability of Internet broadcasts, scales to large audiences, and provides greatly 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. The RealSystem Media Commerce Suite is intended to provide a universal platform for secure distribution of digital movies, music, and other content.

     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 GoldPass subscription services, broadcast hosting services we provide through our Real Broadcast Network, and consulting services we offer to our customers.

     •     Advertising revenues, which are derived from the sale of advertising on our Web sites and the placement and distribution of RealChannels, LiveStations and advertising and promotional buttons and links included in the RealPlayer and the RealJukebox products.

     In January 2000, we acquired NetZip, Inc. (NetZip), a privately-held developer and provider of Internet download management and utility software. In December 2000, we acquired Aegisoft Corp. (Aegisoft), a developer of secure digital media software. Both transactions were accounted for using the purchase method of accounting.

RESULTS OF OPERATIONS

REVENUES

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     Software License Fees. Software license fees were $28.1 million for the quarter ended June 30, 2001, a decrease of 26% from $38.0 million for the quarter ended June 30, 2000. Software license fees were $57.7 million for the six months ended June 30, 2001, a decrease of 20% from $72.1 million for the six months ended June 30, 2000. We believe the decreases were due primarily to a significant reduction in equity funding of new and Internet-related businesses in the second half of 2000 and the first half of 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 has contributed to certain of our customers and potential customers going out of business 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 the first and second quarters of 2001. Additionally, we have focused our consumer promotional activities to feature GoldPass subscription service, which has characteristics of longer-term, recurring subscription revenue, unlike our software product offerings that generate one-time, non-recurring revenue. Additionally, software license fees for the quarter and six months ended June 30, 2000 included $2.6 million and $5.2 million, respectively, related to a three-year license agreement we entered into with Microsoft which expired in the quarter ended June 30, 2000. There was no such revenue in the quarter or six months ended June 30, 2001.

     Service Revenues. Service revenues were $15.1 million for the quarter ended June 30, 2001, an increase of 18% from $12.8 million for the quarter ended June 30, 2000. Service revenues were $30.4 million for the six months ended June 30, 2001, an increase of 27% from $23.9 million for the six months ended June 30, 2000. The increase in service revenues was primarily attributable to our GoldPass subscription services, which we introduced in August 2000, partially offset by decreases in other product offerings including content hosting revenues. GoldPass accounted for approximately $5.9 million of revenue for the quarter ended June 30, 2001 and $10.1 million for the six months ended June 30, 2001.

     Advertising. Advertising revenues were $4.7 million for the quarter ended June 30, 2001, a decrease of 60% from $11.8 million for the quarter ended June 30, 2000. Advertising revenues were $10.2 million for the six months ended June 30, 2001, a decrease of 50% from $20.2 million for the six months ended June 30, 2000. The decrease in advertising revenues was due to a decline in the demand for Internet advertising, which resulted in lower average advertising rates, and caused certain promotional contracts not to be renewed. In addition, certain of our advertising customers have ceased operations.

GEOGRAPHIC REVENUES

     International revenues represented 31% of total net revenues for the quarter ended June 30, 2001, compared to 28% for the quarter ended June 30, 2000 (excluding revenues from the Microsoft license agreement). Revenues generated in Europe were 14% of total net revenues for the quarters ended June 30, 2001 and 2000, (excluding revenues from the Microsoft license agreement), and revenues generated in Asia and the rest of the world were 17% of total net revenues for the quarter ended June 30, 2001 and 14% of total net revenues for the quarter ended June 30, 2000 (excluding revenues from the Microsoft license agreement). International revenues represented 31% of total net revenues for the six months ended June 30, 2001, compared to 26% for the six months ended June 30, 2000 (excluding revenues from the Microsoft license agreement). Revenues generated in Europe were 16% of total net revenues for the six months ended June 30, 2001, and 13% of total net revenues for the six months ended June 30, 2000 (excluding revenues from the Microsoft license agreement), and revenues generated in Asia and the rest of the world were 15% of total net revenues for the six months ended June 30, 2001 and 13% of total net revenues for the six months ended June 30, 2000 (excluding revenues from the Microsoft license agreement). The increase in international revenues as a percentage of total net revenues is primarily due to the fact that international revenues decreased at a slower rate than domestic revenues for the quarter and six months ended June 30, 2001. At June 30, 2001, accounts receivable due from European and Asian customers represented approximately 24% of total 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. We expect that international revenues will increase over time in both absolute dollars and as a percentage of total net revenues. The costs of domestic and international revenues are substantially the same.

DEFERRED REVENUE

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     Deferred revenue is comprised of the unrecognized revenue related to support contracts, prepayments under OEM arrangements, 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 build-out. Because many of the agreements related 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 $20.3 million and $26.9 million at June 30, 2001 and December 31, 2000, respectively. If, in the future, we enter into agreements with more established companies, we may not require these prepayments and as such, we anticipate our deferred revenue balances may decline as a result.

COST OF REVENUES

     Cost of Software License Fees. Cost of software license fees includes costs of product media, duplication, manuals, packaging materials, amounts paid for licensed technology, and fees paid to third-party vendors for order fulfillment. Cost of software license fees was $2.2 million for the quarter ended June 30, 2001, a decrease of 45% from $4.0 million for the quarter ended June 30, 2000, and decreased as a percentage of software license fees to 8% for the quarter ended June 30, 2001 from 10% for the quarter ended June 30, 2000. Cost of software license fees was $4.1 million for the six months ended June 30, 2001, a decrease of 51% from $8.3 million for the six months ended June 30, 2000, and decreased as a percentage of software license fees to 7% for the six months ended June 30, 2001 from 12% for the six months ended June 30, 2000. The decrease in costs was due primarily to lower sales volumes and the expiration of certain royalty agreements. The decrease in the percentage of software license fees was due to shifts in product mix.

     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 subscription service offering. Cost of service revenues was $6.0 million for the quarter ended June 30, 2001, an increase of 68% from $3.6 million for the quarter ended June 30, 2000, and increased as a percentage of service revenues to 40% for the quarter ended June 30, 2001 from 28% for the quarter ended June 30, 2000. Cost of service revenues was $11.1 million for the six months ended June 30, 2001, an increase of 81% from $6.1 million for the six months ended June 30, 2000, and increased as a percentage of service revenues to 37% for the six months ended June 30, 2001 from 26% for the six months ended June 30, 2000. The increase in costs was primarily due to the introduction of our GoldPass subscription service in August 2000 and related costs of content, including our agreements with Major League Baseball (MLB) and the National Basketball Association (NBA). The fixed costs associated with the MLB and NBA contracts are expensed over the contract term. The increase in the percentage of service revenues was due in part to shifts in product mix towards GoldPass.

     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 Web sites and ad delivery services. Cost of advertising was $1.7 million for the quarter ended June 30, 2001, a decrease of 25% from $2.2 million for the quarter ended June 30, 2000, but increased as a percentage of advertising revenues to 36% for the quarter ended June 30, 2001 from 19% for the quarter ended June 30, 2000. Cost of advertising was $3.5 million for the six months ended June 30, 2001, a decrease of 8% from $3.8 million for the six months ended June 30, 2000, but increased as a percentage of advertising revenues to 35% for the six months ended June 30, 2001 from 19% for the six months ended June 30, 2000. The decrease in costs was due primarily to lower sales volumes and the expiration of certain advertising contracts. The increase in the percentage of advertising revenues was due to cost of advertising decreasing at a lower rate than the decrease in advertising revenues, due to certain fixed costs associated with our Web sites and related directory services.

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 is generally not established until substantially all development is complete. We believe that significant investment in research and development is a critical factor in attaining our strategic objectives and, as a result,

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we expect research and development expenses to continue to increase in future periods. Research and development expenses, excluding non-cash stock compensation, were $14.4 million for the quarter ended June 30, 2001, an increase of 9% from $13.3 million for the quarter ended June 30, 2000, and increased as a percentage of total net revenues to 30% for the quarter ended June 30, 2001 from 21% for the quarter ended June 30, 2000. Research and development expenses, excluding non-cash stock compensation, were $31.1 million for the six months ended June 30, 2001, an increase of 25% from $24.9 million for the six months ended June 30, 2000, and increased as a percentage of total net revenues to 32% for the six months ended June 30, 2001 from 21% for the six months ended June 30, 2000. The increase in expenses was primarily due to increases in internal development personnel and related costs, consulting expenses and contract labor related to the development of new technology and products and enhancements made to existing products. The increase as a percentage of total net revenues was primarily a result of the decrease in net revenues while expenses were increasing.

   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 $18.2 million for the quarter ended June 30, 2001, a decrease of 33% from $27.0 million for the quarter ended June 30, 2000, and decreased as a percentage of total net revenues to 38% for the quarter ended June 30, 2001 from 43% for the quarter ended June 30, 2000. Sales and marketing expenses, excluding non-cash stock compensation, were $38.5 million for the six months ended June 30, 2001, a decrease of 22% from $49.6 million for the six months ended June 30, 2000, and decreased as a percentage of total net revenues to 39% for the six months ended June 30, 2001 from 43% for the six months ended June 30, 2000. The decreases in expenses were due to a decrease in advertising and marketing expenses and decreased advertising, promotions and expenses related to our overall corporate branding and marketing. In addition, the annual RealNetworks Conference was held in the second quarter in 2000. The 2001 RealNetworks Conference will be held in the third quarter. The decreases in percentage of total net revenues were primarily a result of cost saving measures that reduced sales and marketing expenses more rapidly than the rate of the decline in net revenues.

   General and Administrative

     General and administrative expenses consist primarily of salaries and related personnel costs, and fees for professional and temporary services. General and administrative expenses were $5.3 million for the quarter ended June 30, 2001, a decrease of 27% from $7.3 million for the quarter ended June 30, 2000, and decreased as a percentage of total net revenues to 11% for the quarter ended June 30, 2001 from 12% for the quarter ended June 30, 2000. General and administrative expenses were $10.7 million for the six months ended June 30, 2001, a decrease of 24% from $14.2 million for the six months ended June 30, 2000 and decreased as a percentage of total net revenues to 11% for the six months ended June 30, 2001 from 12% for the six months ended June 30, 2000. The decreases in expenses were primarily due to decreased litigation defense costs. The decrease as a percentage of total net revenues was primarily due to general and administrative expenses being reduced at a faster rate than the rate of the decline in net revenues.

   Goodwill Amortization, Acquisition Charges and Stock-Based Compensation

     Stock-based compensation for the quarters ended June 30, 2001 and 2000 was a benefit of $(25.0) million and an expense of $25.7 million, respectively. Goodwill amortization and acquisition charges for the quarters ended June 30, 2001 and 2000 were $12.5 million and $12.1 million, respectively. Stock-based compensation expense for the six months ended June 30, 2001 and 2000 was a benefit of $(10.3) million and an expense of $44.3 million, respectively. Goodwill amortization and acquisition charges for the six months ended June 30, 2001 and 2000 were $25.2 million and $21.1 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 the quarter and six months ended June 30, 2001 was primarily due to the voluntary resignation of certain former NetZip employees. These resignations resulted in the Company repurchasing approximately 738,000 shares of its common stock for an immaterial amount. The net effect of this repurchase was that the Company recorded a reversal of previously recorded stock-based compensation expense of $25.4 million. As a result, the Company recorded a benefit related to the reversal of accrued stock compensation of $(25.4 million) for the quarter ended June 30, 2001 and $(10.0 million) for the six months ended June 30, 2001. No future stock compensation expense related to the NetZip acquisition will be recognized.

   Loss on Excess Office Facilities

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     In October 2000, the Company entered into a 10-year lease agreement for additional office space for its corporate headquarters. During the quarter ended June 30, 2001, the Company re-evaluated its facilities requirements. As a result, the Company decided to attempt to sublet all of this office space and recorded a loss of $16.6 million representing approximately $9.2 million of rent and operating expenses over the remaining life of the lease, net of expected sublease income and approximately $7.4 million for the write-down of leasehold improvements to their estimated fair value. As of June 30, 2001, $8.3 million is accrued for the loss on the sublease.

OTHER INCOME, NET

     Other income, net consists primarily of interest earnings on our cash, cash equivalents and short-term investments, equity in the net loss of MusicNet, and impairment of certain equity investments.

     For the quarter and six months ended June 30, 2001, interest income declined from the comparable periods in 2000. The decreases were primarily due to lower effective interest rates and lower investment balances.

     For the quarter and six months ended June 30, 2001, equity in net losses of MusicNet were approximately $0.9 million. In April 2001, MusicNet, which previously was a subsidiary of the Company, issued additional shares of capital stock reducing the Company’s ownership interest in MusicNet to 40%. Beginning with the quarter ended June 30, 2001, the Company’s investment in MusicNet is accounted for under the equity method of accounting.

     The Company periodically evaluates whether any declines in fair value of its investments are other-than-temporary. This evaluation consists of a review of qualitative and quantitative factors. For investments with publicly quoted market prices, these factors include the time period and extent that the quoted market price is less than its accounting basis. The Company considers additional factors to determine whether declines in fair value are other-than-temporary, such as the investee’s financial condition, results of operations and operating trends. The evaluation also considers publicly available information regarding the investee companies. For investments in private companies with no quoted market price, the Company considers similar qualitative and quantitative factors and also considers the implied value from any recent rounds of financing completed by the investee. Based upon an evaluation of the facts and circumstances at June 30, 2001, the Company determined that an other-than-temporary impairment had occurred for two of its investments. These other-than-temporary declines were recorded to reflect these investments at fair value as of June 30, 2001, and resulted in a loss of $22.8 million in the quarter and six months ended June 30, 2001, of which $14.5 million was reclassified to the consolidated statements of operations from accumulated other comprehensive loss.

INCOME TAXES

     For the quarter and six months ended June 30, 2001, we recorded an income tax benefit due primarily to the future tax benefit to be received on the loss on excess office facilities when the losses become deductible for income tax purposes. During the same periods, we also recorded a loss for other-than-temporary impairments on investments. We did not record a related income tax benefit for this loss, which can only be utilized to offset future capital gains, as we currently do not have any significant sources of capital gain income.

     During the quarter and six months ended June 30, 2001, we did not recognize income tax expense as a result of reductions in the valuation allowance for deferred tax assets. As of June 30, 2001, we had net operating loss carryforwards of approximately $427 million, substantially all of which result from employee stock options, the realization of which will increase shareholders’ equity.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

     In July 2001, the FASB issued Statement No. 141, “Business Combinations”, and Statement No. 142, “Goodwill and Other Intangible Assets”. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for

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impairment in accordance with SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”.

     The Company is required to adopt the provisions of Statement 141 immediately. Any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement 142.

     Statement 141 will require, upon adoption of Statement 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in prior purchase business combinations, and to make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period.

     In connection with the transitional goodwill impairment evaluation, Statement 142 will require the Company to perform an assessment of whether there is an indication that goodwill and equity-method goodwill is impaired as of the date of adoption. To accomplish this the Company must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. The Company will then have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit’s carrying amount. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and the Company must perform the second step of the transitional impairment test. In the second step, the Company must compare the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with Statement 141, to its carrying amount, both of which would be measured as of the date of adoption. This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss will be recognized as the cumulative effect of a change in accounting principle in the Company’s statement of operations.

     Because of the extensive effort needed to comply with adopting Statements 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company’s financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle.

LIQUIDITY AND CAPITAL RESOURCES

     Net cash used in operating activities was $0.6 million for the six months ended June 30, 2001 and net cash provided by operating activities was $29.1 million for the six months ended June 30, 2000. Net cash used in operating activities for the six months ended June 30, 2001 resulted primarily from net loss of $43.6 million, an increase in prepaid expenses and other assets of $1.6 million, decreases in deferred revenue of $8.5 million and accrued and other liabilities of $3.7 million, partially offset by non-cash charges of $15.2 million for goodwill amortization, acquisition charges, and stock- based compensation, $22.8 million for impairment on investments, $15.7 million from the loss on excess office facilities and depreciation and amortization of $6.0 million. Net cash provided by operating activities for the six months ended June 30, 2000 resulted primarily from net loss of $46.0 million offset by $65.4 million of goodwill amortization, acquisition charges, and stock based compensation, an increase in deferred revenue of $8.6 million, an increase in accrued and other liabilities of $4.7 million, and depreciation and amortization of $3.9 million.

     Net cash used in investing activities was $37.0 million for the six months ended June 30, 2001. This was primarily the result of the net purchase of short-term investments and equipment and leasehold improvements. Net cash used in investing activities was $64.8 million for the six months ended June 30, 2000. This was primarily a result of purchases

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of long-term investments of $29.3 million, net purchases of short-term investments, and purchases of equipment and leasehold improvements.

     Net cash provided by financing activities was $6.2 million and $10.3 million for the six months ended June 30, 2001 and 2000, respectively. In both periods, net cash provided by financing activities was a result of net proceeds from the exercise of stock options.

     At June 30, 2001, we had $358 million in cash, cash equivalents, short-term investments and restricted cash equivalents and our principal commitments consisted of obligations under operating leases. Since our inception, we have experienced a substantial increase in our capital expenditures.

     In January 1998, we entered into a lease agreement for a new location for our corporate headquarters. The lease commenced on April 1, 1999 and expires on April 1, 2011, with an option to renew the lease for either a three-or ten-year period. In October 2000, we entered into a 10-year lease agreement for additional office space for our corporate headquarters. During the quarter ended June 30, 2001, we re-evaluated our office space needs and subsequently decided to attempt to sublet all of this additional office space.

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

     We conduct our operations in ten primary functional currencies: the United States dollar, the Japanese yen, the British pound, the French franc, the euro, the Mexican peso, the Brazilian real, the Australian dollar, the Hong Kong dollar and the German mark. Historically, neither fluctuations in foreign exchange rates nor changes in foreign economic conditions have had a significant impact on our financial condition or results of operations. We currently do not hedge the majority of our foreign currency exposures and are therefore subject to the risk of exchange rate fluctuations. We invoice our international customers primarily in U.S. dollars, except in Japan, France, Germany and the United Kingdom, where we invoice our customers primarily in yen, euros and pounds, respectively. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Our exposure to foreign exchange rate fluctuations also arises from intercompany payables and receivables to and from our foreign subsidiaries. Foreign exchange rate fluctuations did not have a material impact on our financial results for the quarters or six months ended June 30, 2001 and 2000.

     On January 1, 1999, the participating member countries of the European Union converted to a common currency, the euro. On that same date they established fixed conversion rates between their existing sovereign currencies and the euro. Even though legacy currencies are scheduled to remain legal tender in the participating countries as denominations of the euro until January 1, 2002, the participating countries will no longer be able to direct independent interest rates for the legacy currencies. The authority to set monetary policy will now reside with the new European Central Bank. We do not anticipate any material impact from the euro conversion on our financial information systems, which currently accommodate multiple currencies. Due to numerous uncertainties, we cannot reasonably estimate the effect that the euro conversion issue will have on our pricing or market strategies or the impact, if any, it will have on our financial condition and results of operations.

     We believe that our current cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

FACTORS THAT MAY AFFECT OUR BUSINESS, FUTURE OPERATING RESULTS AND FINANCIAL CONDITION

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

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WE HAVE A LIMITED OPERATING HISTORY, WHICH MAKES IT DIFFICULT TO EVALUATE OUR BUSINESS

     We were incorporated in February 1994 and have a limited operating history. We have limited financial results on which you can assess our future success. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies in new and rapidly evolving markets, such as streaming media software, media delivery systems and electronic commerce.

     To address the risks and uncertainties faced by our business, we must:

     •     establish and maintain broad market acceptance of our products and services and convert that acceptance into direct and indirect sources of revenues;

     •     maintain and enhance our brand name;

     •     continue to timely and successfully develop new products, product features and services and increase the functionality and features of existing products;

     •     successfully respond to competition from Microsoft and others, including competition from emerging technologies and solutions; and

     •     develop and maintain strategic relationships to enhance the distribution, features and utility of our products and services.

     Our business strategy may be unsuccessful and we may be unable to address the risks we face in a cost-effective manner, if at all. If we are unable to successfully address these risks our business will be harmed.

WE HAVE A HISTORY OF LOSSES

     We have incurred significant losses since our inception. As of June 30, 2001, we had an accumulated deficit of approximately $188.5 million. While we had net income in 1999, we had a net loss for the year ended December 31, 2000 and the quarter and six months ended June 30, 2001, and we may not continue our historical growth or generate sufficient revenues to be profitable on a quarterly or annual basis in the future. We devote significant resources to developing, enhancing, selling and marketing our products and services. As a result, we will need to generate significant revenues to be profitable in the future.

OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY, WHICH WOULD LIKELY CAUSE OUR STOCK PRICE TO FLUCTUATE

     As a result of our limited operating history and the rapidly changing and uncertain nature of the markets in which we compete, our quarterly and annual revenues and operating results are likely to fluctuate from period-to-period, and period-to-period comparisons are not likely to be meaningful. These fluctuations are caused by a number of factors, many of which are beyond our control. Our future operating results could fall below the expectations of public market analysts or investors, which would likely significantly reduce the market price of our common stock. Fluctuations in our operating results will likely increase the volatility of our stock price.

     Our research and development and sales and marketing efforts, and other business expenditures generally, are partially based on predictions regarding certain developments for media delivery and digital media distribution. To the extent that these predictions prove inaccurate, our revenues may not be sufficient to offset these expenditures, and our operating results may be harmed.

     In recent periods, many Internet-related companies have experienced financial difficulties, in part as a result of their inability to access capital from financial markets. This has directly or indirectly impacted our current and prospective customers. The result is that some of these companies have ceased operations, some are continuing to experience financial difficulty, and sales cycles for some of our customers and potential customers have become longer than in the past. In addition, we continue to be impacted by the current near-term effects of a capital spending slowdown and general economic downturn, a trend that has been ongoing since the second half of 2000. In the event that a substantial number of our current or potential customers experience financial difficulties in the future, our ability to increase or maintain sales to such customers will be adversely affected and our ability to generate revenues from these companies will also be adversely impacted.

     Since the launch of GoldPass in August 2000, we have focused our promotional activities to feature GoldPass, which has characteristics of longer-term, recurring

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subscription revenue, rather than product offerings that generate short-term, non-recurring revenue. This transition from one-time software sales to recurring subscriptions may not be successful and could harm our near-term operating results and future business prospects.

WE MAY BE UNABLE TO SUCCESSFULLY COMPETE WITH MICROSOFT AND OTHER COMPANIES IN THE MEDIA DELIVERY MARKET

     The market for software and services for media delivery over the Internet is relatively new, constantly changing and intensely and increasingly 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. Increased competition could hurt our business and the trading price of our stock.

     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. Other changes we have to make in response to competition could cause us to expend significant financial and other resources, disrupt our operations, strain relationships with partners, or release products and enhancements before they are thoroughly tested, any of which could harm our operating results and stock price.

     We believe that the primary factors on which we compete 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 intellectual property 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.

     Our failure to adequately address any of the above factors could harm our business and operating results.

     Microsoft Corporation is a principal competitor in the development and distribution of streaming media and media distribution technology. Microsoft currently competes with

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us in the market for streaming media servers and players, digital rights management, 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 streaming media and media distribution.

     Microsoft distributes its competing streaming media server, player and tools products by bundling them with its Windows operating systems at no additional charge. While we also provide free downloads of certain of our products, including players, servers and tools, 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 streaming media products with third parties such as Internet Service Providers (“ISPs”), content delivery networks, online service providers, content providers, entertainment companies, media companies, broadcasters, value-added resellers and original equipment manufacturers, including third parties with whom we have relationships. Microsoft has also invested significant sums of money in or has provided substantial financial incentives 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, or content suppliers to withhold desirable media content from us or end users of our products. Such arrangements, together with Microsoft’s aggressive marketing of Windows operating systems and of its streaming media products, may reduce our share of the streaming media and digital distribution market.

     Microsoft’s Windows Media Player competes with our RealPlayer products. The Windows Media Player is available for download from Microsoft’s Web site for free, and is integrated into features of Microsoft’s Internet Explorer Web browser, the Windows 98, Windows 2000 and Windows ME operating systems. Microsoft has indicated that it plans to bundle the Windows Media Player into the upcoming new version of Windows (Windows XP), and that it will not offer a stand-alone version of updated versions of Windows Media Player. Windows XP, a significant focus of which is media delivery and which gives prominent and persistent placement to Microsoft’s Windows Media Player, Windows Media Guide, and other media delivery services, is scheduled to be released later this year. 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 to its streaming or digital media products. In addition, it is unclear to what extent Microsoft will allow us to take full advantage of the features of the operating system which enable our products to function at their full capacity. 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 Microsoft has invested in other digital distribution technologies that compete with RealJukebox. 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. 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 RealPlayer and RealJukebox products, 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. RealJukebox and/or RealPlayer may be disadvantaged if they cannot play content in Windows Media formats or 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 content. 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 are developing and marketing streaming media products. For example, Apple Computer offers

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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 Computer’s end user license agreement. We expect that Apple Computer will devote more resources to developing and marketing streaming media systems, and will continue to compete vigorously with us in the marketplace. Apple Computer has also enlisted the open source code development 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 RealPlayer and RealJukebox products. 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 RealPlayer end users if AOL users only use their 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.

     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 recently emergent and rapidly accepted 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 and Gnutella. Such services allow consumers to directly access 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. 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.

WE MAY BE UNABLE TO SUCCESSFULLY COMPETE IN OTHER PARTS OF OUR BUSINESS

      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 Yahoo! Broadcast Services (formerly Broadcast.com), Akamai and other emerging broadcast networks. Some of these competitors 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. We may not establish or sustain our competitive position in this market segment. Some 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 companies that compete with Real Broadcast Network. If our relationship with these companies becomes more competitive, such companies may reduce their level of usage and purchases of our products or services.

      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 our Real.com Guide. We also compete with traditional media such as television, radio and print for a share of advertisers’ total advertising budgets. Our advertising sales force and infrastructure are still in early stages of development relative to those of many of our competitors. We cannot be certain that advertisers will place advertising with us or that revenues derived from such advertising will be meaningful. Recent slowdowns in funding for Internet-related companies have had a negative effect on Internet advertising markets. Internet advertising revenues across the industry have decreased substantially since the second half of 2000 and our advertising revenues declined sequentially in the first half of 2001 from the previous year. In addition, certain of our advertising customers have ceased operations. If we lose advertising customers, fail to attract new customers, are forced to reduce advertising rates or otherwise modify our rate structure to retain or attract customers, or if we lose Web site traffic, our business could be harmed.

      GoldPass. We recently introduced the RealPlayer GoldPass subscription service, which provides customers access to a combination of premium software, services and content, updated monthly, in exchange for a monthly fee. The GoldPass subscription service is a relatively unproven business model for delivering media over the Internet and is a new business model for us. It is also too early to predict whether GoldPass will be accepted by consumers. GoldPass competes with both traditional and online entertainment service providers. Many of these providers have significantly more resources and experience in providing such 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. Failure to obtain such content or to successfully market our GoldPass services to our end users could harm our business.

      Electronic Commerce. To compete successfully in the electronic commerce market, we must attract sufficient traffic to our Web sites by offering high-quality, competitively

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priced, desirable merchandise in a compelling, easy-to-purchase format. In addition, we must successfully leverage our existing user base to develop the market for our products and services. We may not compete successfully in the growing and rapidly changing market for electronic commerce. Our failure to do so could harm our business.

     Increased competition may also result in price reductions, reduced margins, loss of customers, and a change in our business and marketing strategies, any of which could harm our business.

OUR INDUSTRY IS EXPERIENCING CONSOLIDATION THAT MAY INTENSIFY COMPETITION

     The Internet and media distribution industries have recently experienced substantial consolidation and a proliferation of strategic transactions. We expect this consolidation and strategic partnering to continue. Acquisitions or strategic relationships could harm us in a number of ways. For example:

     •     competitors could acquire or enter into relationships with companies with which we have strategic relationships and discontinue our relationship, resulting in the loss of distribution opportunities for our products and services or the loss of certain enhancements or value-added features to our products and services;

     •     competitors could obtain exclusive access to desirable multimedia content and prevent that content from being available in our formats, thus decreasing the use of our products and services to distribute and experience the content that audiences most desire, and hurting our ability to attract advertisers to our Web sites and product offerings;

     •     suppliers of important or emerging technologies could be acquired by a competitor or other company which could prevent us from being able to utilize such technologies in our offerings, and disadvantage our offerings relative to those of competitors;

     •     a competitor could be acquired by a party with significant resources and experience that could increase the ability of the competitor to compete with our products and services; and

     •     other companies with related interests could combine to form new, formidable competition, which could preclude us from obtaining access to certain markets or content, or which could dramatically change the market for our products and services.

     Any of these results could put us at a competitive disadvantage which could cause us to lose customers, revenue and market share. They could also force us to expend greater resources to meet the competitive threat, which could also harm our operating results.

WE MAY NOT BE SUCCESSFUL IN THE MARKET FOR DOWNLOADABLE MEDIA AND LOCAL MEDIA DELIVERY

     The market for products such as RealJukebox is relatively new and still evolving. We may be unable to develop a revenue model or sufficient demand to take advantage of the market opportunity and it is too soon to determine whether consumers will adopt RealJukebox as their primary application to play, record, download and manage their digital music. Even if RealJukebox achieves a high degree of market acceptance, it may not achieve a high level of use, which would lead to a low rate of upgrade sales and electronic commerce opportunities.

There are a number of competitive products on the market that offer certain of the features offered by RealJukebox. These products include WinAmp Player, MusicMatch Jukebox, Sonique Player, Liquid Audio Player, AOL 6.0 and Windows Media Player. Because free versions are available for all of these competing products, our ability to sell RealJukebox upgrades, and the prices we charge, may be affected. Given the size and importance of the general market for music distribution, competitors will likely release additional products that directly compete with RealJukebox, which could harm our business. Our competitors may develop new features and technology not available in RealJukebox, including advanced codecs and digital rights management technology, which could harm our business.

     RealJukebox also faces competition from the emergence of widespread peer-to-peer file sharing services and programs like Napster and Gnutella. Our inability to achieve widespread acceptance for our digital music architecture and RealJukebox or to create new revenue streams from the new market segments, including digital music content, could harm the prospects for our business.

     We have announced that RealJukebox supports or will support a variety of audio formats, including RealAudio G2, MP3, Liquid Audio, Windows Media Audio and IBM’s EMMS. However, technical formats and consumer preferences evolve very rapidly, and we may be

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unable to adequately address consumer preferences or fulfill the market demand to the extent it exists. In addition, we must provide digital rights management solutions and other security mechanisms in order to address concerns of content providers, and we cannot be certain that we can develop, license or acquire such solutions, or that content licensors or consumers will accept them.

We have had long-term relationships with recording companies, including major record labels, many of which offer their streaming content in our formats. However, recording companies and music publishers, including those with whom we have a relationship, may not make their desirable content available for download or playback in formats supported by RealJukebox or may make the cost of licensing such content prohibitive, may impose technical restrictions designed to secure intellectual property rights that may impact the user experience or demand for RealJukebox, or may refrain from or delay participating in promotional opportunities with respect to RealJukebox.

     In addition, we have recently announced the formation of a joint venture called MusicNet with three leading media companies to create a platform for online music subscription services. We have also entered into an agreement with MusicNet to license the MusicNet platform for sale to our own customers. The business models and market for online music subscription services are new and unproven. If these new online music subscription services do not achieve market acceptance our business prospects could be harmed.

WE RELY ON CONTENT PROVIDED BY THIRD PARTIES TO INCREASE MARKET ACCEPTANCE OF OUR PRODUCTS AND SERVICES

     If third parties do not develop or offer compelling content to be delivered over the Internet, or grant necessary licenses to us or our customers to distribute or perform such content, our business will be harmed and our products and services may not achieve or sustain broad market acceptance. We rely on third-party content providers, such as radio and television stations, record labels, media companies, Web sites and other companies, to develop and offer content in our formats that can be delivered using our server products and played back using our player products. We also rely on third-party content for our GoldPass subscription service. We cannot guarantee that third-party content providers will continue to rely on our technology or offer compelling content in our formats to encourage and sustain broad market acceptance of our products. Their failure to do so would harm our business.

     While we have a number of short-term agreements with third parties to provide content from their Web sites in our formats, most third parties are not obligated to develop or offer content using our technology. In addition, some third parties have entered into and may in the future enter into agreements with our competitors, principally Microsoft, to develop or offer all or a substantial portion of their content in our competitors’ formats. Microsoft has substantially more resources than us that may enable it to secure preferential and even exclusive relationships with content providers. There could be less demand for and use of our products if Microsoft or another competitor were to secure preferential or exclusive relationships with the leading content providers, Web sites or broadcasters.

     Our success also depends on the availability of third-party content, especially music, that users of our RealJukebox product can lawfully and easily access, record and play back. Our products may not achieve or sustain market acceptance if third parties are unwilling to offer their content for free download or purchase by users of RealJukebox. Current concerns regarding the secure distribution of music over the Internet are causing content owners to delay or refuse to make content available for distribution.

WE MAY NOT SUCCESSFULLY DEVELOP NEW PROJECTS AND SERVICES

     Our growth depends on our ability to continue to develop leading edge media delivery and digital distribution products and services. Our business and operating results would be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues to offset development costs. We may not timely and successfully identify, develop and market new product and service opportunities. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability.

     Because the markets for our products and services are changing rapidly, we must develop new offerings quickly. We have experienced development delays and cost overruns in our development efforts in the past and we may encounter such problems in the future. Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements. Our products also may contain undetected errors that could cause increased development costs,

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loss of revenues, adverse publicity, reduced market acceptance of the products or lawsuits by customers.

THE RATE STRUCTURE OF SOME OF OUR ADVERTISING AND SPONSORSHIP ARRANGEMENTS SUBJECTS US TO FINANCIAL RISK

     We generate advertising revenues in part through sponsored services and placements by third parties in our products and on our Web sites, in addition to banner advertising. We may receive sponsorship fees or a portion of transaction revenues in return for minimum levels of user impressions to be provided by us. These arrangements expose us to potentially significant financial risks in the event our usage levels decrease, including the following:

     •     the fees we are entitled to receive may be adjusted downwards;

     •     we may be required to “make good” on our obligations by providing alternative services;

     •     the sponsors may not renew the agreements or may renew at lower rates; and

     •     the arrangements may not generate anticipated levels of shared transaction revenues, or sponsors may default on the payment commitments in such agreements.

     Accordingly, any leveling off or decrease of our user base or the failure to generate anticipated levels of shared transaction revenues could result in a meaningful decrease in our revenue levels. To the extent that our advertisers are experiencing slow-downs in their businesses or tighter resources to fund advertising, our anticipated revenue results could be harmed. Recent slowdowns in funding for Internet-related companies have had a negative effect on Internet advertising markets. Internet advertising revenues across the industry have decreased substantially in the second half of 2000 and our advertising revenues declined sequentially in the first half of 2001 from the previous year. In addition, certain of our advertising customers have ceased operations.

WE DEPEND ON KEY PERSONNEL WHO MAY NOT CONTINUE TO WORK FOR US

     Our success substantially depends on the continued employment of our executive officers and key employees, particularly Robert Glaser, our founder, chairman of the board and chief executive officer. The loss of the services of Mr. Glaser or any of our other executive officers or key employees could harm our business. If any of these individuals were to leave RealNetworks, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor obtains the necessary training and experience. A number of our key employees have reached or will soon reach the five-year anniversary of their RealNetworks hiring date and, as a result, will have become or will shortly become fully vested in their initial stock option grants. While most personnel are typically granted additional five-year stock options subsequent to their hire date to provide additional incentive to remain at RealNetworks, the initial option grant is typically the largest and an employee may be more likely to leave our employ upon completion of the vesting period for the initial option grant. None of our executive officers has a contract that guarantees employment. Other than a $2 million insurance policy on the life of Mr. Glaser, we do not maintain “key person” life insurance policies. If we do not succeed in retaining and motivating existing personnel, our business could be harmed.

OUR FAILURE TO ATTRACT, TRAIN OR RETAIN HIGHLY QUALIFIED PERSONNEL COULD HARM OUR BUSINESS

     Our success also depends on our ability to attract, train and retain qualified personnel in all areas, especially those with management and product development skills. In particular, we must hire additional experienced management personnel to help us continue to grow and manage our business, and skilled software engineers to further our research and development efforts. At times, we have experienced difficulties in hiring personnel with the proper training or experience, particularly in technical areas. Competition for qualified personnel is intense, particularly in high-technology centers such as the Pacific Northwest, where our corporate headquarters are located. If we do not succeed in attracting new personnel or retaining and motivating our current personnel, our business could be harmed.

     In making employment decisions, particularly in the Internet and high-technology industries, job candidates and even our current personnel often consider the value of stock options they may receive in connection with their employment. As a result of recent volatility in our stock price, we may be disadvantaged in competing with companies that have not experienced similar volatility or that have not yet sold their stock publicly.

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WE MAY NOT SUCCESSFULLY MANAGE OUR GROWTH

     We cannot successfully implement our business model if we fail to manage our growth. Since our inception, we have rapidly and significantly increased our number of employees and expanded our operations domestically and internationally. Managing this substantial expansion has historically placed a significant strain on our management, operational and financial resources. If we do not successfully manage this growth, our business could be harmed. In response to recent economic conditions, we reduced our staffing levels by approximately 140 employees in July 2001.

POTENTIAL ACQUISITIONS INVOLVE RISKS WE MAY NOT ADEQUATELY ADDRESS

     As part of our business strategy, we have acquired technologies and businesses in the past, and intend to continue to do so in the future. The failure to adequately address the financial, legal and operational risks raised by acquisitions of technology and businesses could harm our business. Acquisition or business combination transactions are accompanied by a number of significant risks. Financial risks related to acquisitions may harm our financial position, reported operating results or stock price, and include:

     •     potentially dilutive issuances of equity securities;

     •     use of cash resources;

     •     the incurrence of additional debt and contingent liabilities;

     •     large write-offs and difficulties in assessment of the relative percentages of in-process research and development expense that can be immediately written off as compared to the amount which must be amortized over the appropriate life of the asset; and

     •     amortization expenses related to goodwill and other intangible assets.

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

     •     difficulties in assimilating the operations, products, technology, information systems and personnel of the acquired company;

     •     diversion of management’s attention from other business concerns and the potential disruption of our ongoing business;

     •     the difficulty of incorporating acquired technology or content and rights into our products and services and unanticipated expenses related to such integrations;

     •     impairment of relationships with our employees, affiliates, advertisers and content providers;

     •     inability to maintain uniform standards, controls, procedures and policies;

     •     the assumption of known and unknown liabilities of the acquired company;