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

                                    FORM 10-K

(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
    of 1934.
                     For the fiscal year ended June 30, 2001

                                       or

[_] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934.
                For the transition period from            to

                          Commission file no. 333-64483

                                   ----------

                            DIVA Systems Corporation
             (Exact name of Registrant as specified in its charter)

                                   ----------

                  Delaware                                   94-3226532
      (State or other jurisdiction of                     (I.R.S. Employer
       incorporation or organization)                  Identification Number)

             800 Saginaw Drive
          Redwood City, California                             94063
  (Address of principal executive offices)                   (Zip Code)

       Registrant's telephone number, including area code: (650) 779-3000

                                   ----------

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

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

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

     The aggregate market value of the Registrant's Common Stock, par value
$.001 per share, held by non-affiliates of the Registrant as of June 30, 2001,
based upon the fair market value of $4.50 per share as determined by our Board
of Directors, was approximately $12,045,366. For purposes of this disclosure,
shares of Common Stock held by persons who hold more than 5% of the outstanding
shares of Common Stock and shares held by named officers and directors of the
Registrant have been excluded because such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily conclusive
for other purposes.

     The number of shares of Registrant's classes of Common Stock outstanding at
August 31, 2001 was:

              Title of each Class
              -------------------
              Common Stock, $.001 par value               18,230,671
              Class C Common Stock, $.001 par value          857,370

================================================================================

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                            DIVA SYSTEMS CORPORATION

                                    FORM 10-K

                            YEAR ENDED JUNE 30, 2001

                                TABLE OF CONTENTS

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                                                PART I

Item 1.  Business ...................................................................................       3
Item 2.  Properties .................................................................................      11
Item 3.  Legal Proceedings ..........................................................................      12
Item 4.  Submission of Matters to a Vote of Security Holders ........................................      12

                                               PART II

Item 5.  Market for the Registrant's Common Stock and Related Stockholder Matters ...................      13
Item 6.  Selected Financial Data ....................................................................      13
Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations ......      14
Item 8.  Financial Statements and Supplementary Data ................................................      31
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .......      54

                                               PART III

Item 10.  Directors and Executive Officers of the Registrant ........................................      55
Item 11.  Executive Compensation ....................................................................      57
Item 12.  Security Ownership of Certain Beneficial Owners and Management ............................      61
Item 13.  Certain Relationships and Related Party Transactions ......................................      62

                                               PART IV

Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K ..........................      63
</TABLE>

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                                     PART I

Item 1.  Business

     This Business section and other parts of this Annual Report on Form 10-K
contain forward-looking statements that involve risks and uncertainties. Our
actual results may differ materially from the results discussed in the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those discussed below and in "Management's Discussion
and Analysis of Financial Condition and Results of Operations." The
forward-looking statements contained herein are made as of the date hereof, and
we assume no obligation to update such forward-looking statements or to update
reasons actual results could differ materially from those anticipated in such
forward-looking statements. Forward-looking statements are statements identified
with an asterisk (*) and statements which can be identified by the use of
forward looking terminology such as "estimates", "projects", "anticipates",
"expects", "intends", "believes" or the negative thereof or other variations
thereon or comparable terminology or by discussions of strategy that involve
risks and uncertainties. References to "DIVA", "we", "us", "our" or the
"Company" in this Annual Report refers to DIVA Systems Corporation.

Overview

     We are a leading provider of interactive, on-demand television products and
services. Our video-on-demand service operates on industry-standard digital
set-top boxes and operating systems, providing a flexible and cost-effective
interactive television solution for cable and other broadband network operators,
which we refer to as network operators. We have commercially deployed our
video-on-demand service with several network operators in North America. In
addition to our video-on-demand products and services we developed and beta
tested an interactive program guide as a stand-alone product. To date we have
neither commercially deployed nor are we actively marketing our interactive
program guide technology. On June 30, 2001 we ceased further development
activities related to our interactive program guide technology and reduced our
development workforce accordingly.

     Our video-on-demand service allows digital cable television subscribers to
select movies and other content for immediate viewing. Choosing from thousands
of DIVA-licensed movie and video titles, network operators can offer their
digital subscribers in-home access to a selection of hundreds of titles,
including new release feature films, classic films, children's programming and
other special interest programming, each with pause, rewind and fast-forward
controls. We are enhancing our core technology to support subscription based
video-on-demand viewing, time shifted television and interactive targeted
advertising. We believe that as the market for interactive television services
evolves, we can capitalize on these opportunities, as well as on new services
such as television-based e-commerce.

     We have current deployments of our video-on-demand service at selected AT&T
Communications, Charter Communications and Insight Communications systems. In
February 2001, we amended our agreement with Insight to expand our
video-on-demand services to all of Insight's approximate 930,000 basic
subscribers in several Midwestern states, including Illinois, Kentucky, Indiana
and Ohio. In June 2001, we amended our agreement with Charter to expand our
video-on-demand services to a total of 1.7 million of Charter's basic
subscribers by May 2004. The amended agreement with Charter covers several major
markets, including cable systems in Los Angeles, Atlanta, St. Louis and Fort
Worth. AT&T, Charter and Insight are, respectively, the first, fourth and eighth
largest cable operators in the United States. In addition, we continue to pursue
deployment agreements with other major cable operators in the United States. We
are currently developing a video-on-demand capability for ntl, the largest cable
operator in the United Kingdom. We are also pursuing other international
opportunities, primarily in Western Europe. *

Market Opportunity

     The home entertainment industry, which includes cable television, direct
broadcast satellite, pay-per-view and video rentals, is a large and growing
market. The reach and popularity of television has increased substantially over
time, resulting in television becoming the primary form of home entertainment.
This popularity has largely been driven by the emergence of new technologies and
delivery systems for television programming that have provided consumers with
increased choice and control of their viewing options. According to Veronis,
Suhler & Associates, consumer spending on television-based home entertainment is
expected to grow from $61 billion in 2000 to $78 billion in 2004. * According to
industry analysts, in 2000 approximately $21.6 billion of this market was
comprised of videotape rentals and sales and $2.1 billion was comprised of
pay-per-view.

     In the United States, cable operators have been the traditional suppliers
of multi-channel video home entertainment to consumers. However, alternative
providers such as direct broadcast satellite operators, cable overbuilders,
broadband telecommunications providers and even utility power companies have
begun to challenge the cable industry monopolies. Today, the primary competitors
to cable operators are direct broadcast satellite operators such as DirecTV and
EchoStar, which offer consumers more programming choice, as well as digital
video and sound. The typical direct broadcast satellite offering includes 100
video channels, 30 digital music channels and up to 55 channels dedicated to
near-video-on-demand services, as compared to the significantly fewer number of
channels that are offered on traditional analog cable systems. In addition,
direct broadcast satellite operators have begun to improve their competitive
position by carrying local television stations and introducing interactive
services. The increased choice and quality of direct broadcast satellite
offerings have attracted consumers. According to industry reports, there are
currently more than 15.3 million direct broadcast satellite subscribers in the
United States and an estimated 290,000 new subscribers are added each month. As
direct broadcast satellite providers and other competitors seek to increase
penetration of their services, they present a growing threat to the cable
television industry.

     To compete with these alternative providers of multi-channel programming
services, cable operators have embarked on new service initiatives requiring
cable network upgrades and the wide-scale deployment of digital set-top boxes.
At the end of 2000, it was estimated that cable operators had upgraded
approximately 73% of their cable plant to two-way-capable hybrid fiber coaxial
plant. In addition, in 2000, cable operators in the United States more than
doubled their deployment of digital set-top boxes to approximately 10 million
subscribers. Industry analysts predict that digital set-top box deployment will
grow from 10 million at the end of 2000 to between 30 and 40 million by the end
of 2004. The deployment of digital set-top boxes, coupled with these network
enhancements has enabled cable operators to offer new services to their
subscribers, including digital programming and interactive, on-demand television
services such as video-on-demand. We believe digital programming coupled with
video-on-demand allows cable operators to offer subscribers a superior product
to that offered by the direct broadcast satellite operators. Direct broadcast
satellite operators cannot currently offer video-on-demand services due to
bandwidth and scalability limitations.

     The recent rollout of digital set-top boxes and two-way cable plant has
made the deployment of video-on-demand and other interactive services possible.
Video-on-demand can be delivered through the industry standard digital set-top
boxes now being deployed by network operators, which eliminates the need to
purchase additional in-home equipment to provide these services. The economics
of video-on-demand has improved dramatically through advances in microprocessor
power and the rapid decline in storage costs for network operators.

DIVA Benefits

     We believe that video-on-demand television products and services provide
cable and other broadband network operators with the following benefits:

     Compelling On-Demand Entertainment. Our video-on-demand services offer
subscribers immediate access to hundreds of viewing choices including feature
films, children's programming and specialty shows. This service combines anytime
start convenience, pause, fast forward and rewind control with high-quality
digital picture and sound at prices comparable to home video rentals. Our
video-on-demand service eliminates inconvenient trips to the video store, late
return fees and tape rewind charges.

     Significant Revenue Opportunity. We believe our video-on-demand services
provide a platform that enables network operators to generate greater revenue in
two ways; from both increased customer penetration for their digital cable
offerings and significant incremental revenue from orders for on-demand movies
and other programming. We believe that network operators can recover the
incremental capital costs to implement the DIVA video-on-demand solution in less
than one year solely from the additional revenues generated by movie purchases.*

     Comprehensive and Flexible Service Offering. Our comprehensive offering has
been field-proven and, accordingly, reduces both the time-to-market and the
operational challenges associated with implementing interactive television
services. We offer a core suite of software products and services that enable
and manage the network operator's video-on-demand system. These products and
services include:

     . automated video asset management;

     . a full-motion, easy-to-use, on-screen navigator;

                                       -3-

<PAGE>

     .    programming and entertainment services represented by thousands of
          licensed video titles;

     .    hardware products including the video server; and

     .    the ability to provide a network operator-branded service.

     Network operators can select either this end-to-end solution or any of the
individual components depending upon their needs. We believe that this
flexibility is attractive to a wide range of network operators.

     Sophisticated Back-Office Solution. Our back-office solutions integrate
billing with an audit trail for network operator revenue recognition, studio
contract royalty reporting and market research. This gives the network operator
the ability to offer its customers a variety of subscriptions, packages and
promotions without requiring an overhaul of existing billing systems. We have
successfully integrated our on-demand television services with the systems
provided by the three largest cable billing companies. We also have developed a
highly automated video asset management system to track and manage a large array
of video content. This database system tracks a title from acquisition through
distribution and provides payment details and other critical information for
content providers.

     Flexible Architecture. Our architecture is designed to scale to support
thousands of titles and serve even the largest cable systems. Our software and
hardware products can integrate with major digital broadcast platforms including
Motorola and Scientific-Atlanta in the United States and PACE in Europe. Our
video-on-demand application requires minimal processing power and memory within
the set-top box, and can be activated remotely, eliminating the need for an
on-site installer visit. In addition, our application allows the cable operator
to offer multiple digital services on today's set-top boxes. We are also
integrating our services with set-top box software provided by Liberate,
Microsoft, OpenTV and Power TV.

DIVA Strategy

     Our objective is to be the leading provider of interactive, on-demand
television products and services for cable and other broadband network
operators. Our strategy includes the following key elements:

     Leverage our first mover advantage. Our goal is to leverage our position as
the first provider of a commercially deployed video-on-demand system to become
the leading provider of a wide range of interactive, on-demand television
services. Our extensive field experience has allowed us to gather practical
feedback on our system and its technology and develop a solution that is not
only compelling to consumers, but also scalable and flexible from the network
operator's perspective.

     Aggressively expand our customer base. We plan to continue to build
relationships with cable and other network operators in order to maximize our
share of video-on-demand subscribers. * We have designed our services to be
attractive to network operators seeking to increase their digital penetration.
Our ability to achieve significant market share will allow us to leverage our
platform in order to develop and offer new services. *

     Enhance and expand our products and services. We have spent five years and
over $120 million to develop our comprehensive software and hardware solution
for video-on-demand. We plan to continue to aggressively invest in technology in
order to enhance our current service offerings as well as to develop additional
new services, including time shifted television, interactive targeted
advertising and television-based e-commerce. *

     Pursue industry relationships. We will continue to develop industry
relationships with leading broadband network hardware and software vendors in
order to ensure interoperability of our products and services, as well as
maintain and expand relationships with our 33 content providers, including major
Hollywood studios. We plan to establish commercial relationships with additional
content providers in order to provide the broadest array of programming to
viewers. *

     Adapt our technology and services for other broadband networks. We have
designed our video-on-demand services for the hybrid fiber/coaxial networks
deployed by the cable television industry. Recently, other telecommunications
companies have begun rapid deployment of broadband networks based on digital
subscriber line, or DSL, technology. We are currently developing an interface
for this technology to provide these companies with a video-on-demand solution
when their networks are prepared to support high-capacity transmission. We also
plan to expand our service offering to the Internet environment as the Internet
develops into a sufficiently reliable transmission medium to deliver
broadcast-quality video to both the television and personal computer. *

                                       -4-

<PAGE>

     Penetrate global markets. We believe there is a significant demand for our
products and services in Europe. * The majority of Western European cable
networks are two-way capable. European cable operators are rapidly deploying
digital set-top boxes to provide interactive services to compete with direct
broadcast satellite operators. We plan to pursue international opportunities to
deploy our on-demand products and services and increase our worldwide customer
base. We currently have a deployment agreement with ntl and we are in discussion
with other large broadband network operators, including providers of cable
television and DSL services. We are developing the interfaces to enable our
system to work with European standards. *

DIVA Products

   Video-On-Demand

     At the core of our video-on-demand system is a suite of software and
hardware products. Together, these products can be used to deliver a wide array
of interactive, on-demand television services. Our software is grouped into two
broad categories: system manager software through which the network operator
manages the video-on-demand system and navigation software that permits viewers
to search for and select video-on-demand content. Our hardware products include
video servers and network access equipment.

     Our system manager software manages video servers and network access
equipment. It provides interfaces for billing, content management and an
operator's customer management system. We offer software applications that
manage video content from acquisition through encoding, distribution,
exhibition, archiving and destruction. We also provide detailed billing
information for the content providers.

     Our navigation software, the navigator, is a cable viewer's interface with
our video-on-demand system. Our navigator is operated through a standard cable
television remote control and allows a viewer to locate, browse and preview
movies by title, genre or new release prior to purchase. A viewer can access
free movie previews as well as movie information screens that display MPAA
ratings, run-time, lead actors and price. A movie-saver feature allows the
viewer to exit a title at any time, watch other video-on-demand programs or
broadcast television and return to the exact point of previous exit at a later
time during the video-on-demand rental period. Our navigator also allows a
viewer the opportunity to set parental controls and spending and rating limits.

     Our current DIVA Video Server 5000 (DVS5000) delivers unique video content
streams to individual set-top boxes on an on-demand basis. Each server
installation is capable of scaling up to 50,000 video-on-demand streams and
storing up to 10,000 titles. Multiple video servers can be networked with
integrated optical fiber connections to expand the content selection and provide
traffic management within a single cable system. The DVS5000 has low power
consumption needs and small floor space requirements, making it well suited for
co-location in cable headends. Each server module provides high speed (1 gigabit
per second) streaming capacity and is comprised of commercially available
processor modules and storage modules.

     We are currently completing the development of the next generation of DIVA
Video Servers, the DVS6000. The DVS6000 is the industry's first non-proprietary
video-on-demand server solution. Each server integrates off-the-shelf hardware
from a variety of server manufacturers with DIVA's server software. The DVS6000
is backward compatible with the DVS5000 and will support high stream volumes,
while using minimal power consumption and space. Our DVS6000 is adaptable to
all-content formats and outputting standards, including DVB-ASI and Gigabit
Ethernet.

   New Product Developments

     We are developing the capability to offer new on-demand television
services. * Our product developments include:

     .    Time shifted television-- This service takes advantage of the storage
          and streaming capability of the video-on-demand server to store
          broadcast content providing customers with on-demand access to
          individual programs or entire channels at any time. Time shifted
          television will provide equivalent functionality to a personal digital
          video recorder without the need to plan ahead or purchase additional
          hardware. Time shifting will enable a viewer to start watching a
          television program from the beginning, after its original broadcast
          had begun and, if desired, fast forward to catch up to the live
          broadcast. *

                                       -5-

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     .   Interactive targeted advertising--The availability of digital set-top
         boxes with a video-on-demand service platform supports many new and
         potentially profitable advertising opportunities. Some examples include
         targeted advertisements in broadcast programming, video advertising
         within our navigator and interactive infomercials.*

     .   Television-based electronic commerce--The development of set-top boxes
         that have the ability to browse the Web offers the opportunity to
         enable e-commerce on the television. When combined with an on-demand
         service platform, television-based e-commerce services will use full
         motion, full screen, customer-controlled video to create compelling
         interactive commerce sites. Examples include the sale of movie tickets
         with video previews and purchase of CDs while viewing music videos.*

Video-on-Demand Customer Support Services

     We provide a suite of specific tools, management systems, software
applications and operational procedures to support our video-on-demand system.
Our customer support services have been developed over a number of years and
have been deployed in the field during the last four years.

     Programming. We provide a wide variety of movies and videos to be used with
our video-on-demand delivery system. Selections include thousands of titles
licensed from 33 content providers. Our video library is comprised of new
releases, library titles, classics, children's programming and special interest
titles, as well as popular cable channel programming. We currently have
commitments from studios to receive new releases in the same window as direct
broadcast satellite and pay-per-view services, typically 30 to 60 days after
release to the home video market. Major studios typically release an aggregate
of 15 to 25 new titles to the pay-per-view market window per month. In addition,
we have agreements with providers of popular video and television programming to
provide a wide selection of children's programming. We also provide encoding,
quality assurance, content and preview preparation for licensed programming.

     Video Asset Management. We distribute our content on optical disks and
support content distribution over satellite and terrestrial networks and on
digital linear tape. Providing an effective video-on-demand service requires a
comprehensive service programming capability that supports distribution,
packaging and promotion of thousands of titles at multiple headends over a wide
geographic area. We have developed real-time tracking systems to monitor, manage
and report the various stages of video content from the supplier to the
video-on-demand server, including encoding, scheduling, distribution, content
introduction, play, removal/destruction and royalty calculations.

     Back Office. We have developed integrated billing interfaces with all of
the major cable billing system providers in the United States. These interactive
interfaces provide the network operator with the flexibility to charge
video-on-demand purchases on a single integrated cable bill or to pass the
purchase data to another third party billing agency. Additionally, our
sophisticated billing product is the only video-on-demand product capable of
commercially implementing subscription video-on-demand. Another major feature of
our billing interface is the ability to offer video services based on selected
combinations of cable subscription packages. This feature, called contingent
subscriptions, provides the network operator with the ability to offer its cable
subscribers video-on-demand capabilities for the specific cable channels to
which they subscribe. We have also developed a data warehouse for the collection
and analysis of key video-on-demand activities. Our data warehouse gives a
network operator the ability to measure and modify its video-on-demand offerings
to increase sales performance and customer satisfaction.

     Operations Support. We work with our customers to help specify technology
requirements for video-on-demand and to integrate our video-on-demand platform
with the operators' digital cable offering. Since video-on-demand system
reliability is a critical factor in sustaining a high level of customer
satisfaction, we offer secure and redundant data network connections to each of
the network operator's video-on-demand sites. Our Network Operations Center,
located in King of Prussia, Pennsylvania, provides the network operator with
24-hours a day, seven days a week monitoring and problem resolution for all
video-on-demand server connections.

Customers and Commercial/Deployments

     We have entered into multi-year agreements with three domestic operators of
cable television systems: AT&T, Charter and Insight, and one international
operator, ntl. Our agreements provide for deployment of our video-on-demand
software and hardware products, as well as video-on-demand support services, at
various locations
                                       -6-

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throughout the U.S. and the United Kingdom. Our hardware and software products
are currently commercially deployed in 20 systems in the following markets:

Cable Operator                                      Markets
--------------                                      -------

Charter.......................  Greater Atlanta area, GA; Los Angeles, CA;
                                Slidell, LA; Dallas/Ft. Worth, TX; St. Louis,
                                MO; Spartanburg, SC; Hickory, NC

Insight ......................  Rockford, IL; Columbus, OH; Evansville, IN;
                                Cincinnati, OH; Louisville, KY; Kokomo, IN;
                                Anderson, IN

AT&T .........................  Atlanta, GA; Los Angeles, CA

     Our contract with each network operator is different, reflecting its
selections from our suite of video-on-demand products and services. Under the
AT&T, Charter and Insight contracts, the cable operator purchases our
video-on-demand hardware and licenses our video-on-demand software. Each of
their selections relating to customer support services varies, as does the
method of calculating the payments DIVA receives for such support services. In
2001, we expanded our relationship with Insight and Charter and have amended our
contract with each operator to reflect this expansion of products and services.
As a result, our agreement with Insight now covers all of Insight's
approximately 930,000 basic subscribers, and our agreement with Charter covers a
total of 1.7 million of Charter's basic subscribers. The Insight contract has a
term of five years, the AT&T contract has a term of four years, and our
agreement with Charter terminates on May 31, 2004.

     Under our contract with ntl, we have an agreement for multiple systems
subject to achieving certain milestones. ntl will purchase video-on-demand
hardware and license video-on-demand software from us, and we will provide
video-on-demand support services to ntl on a fee for service basis.

     We are in active discussions with other large network operators that are
evaluating deployment of video-on-demand systems. We believe many of these
operators will deploy video-on-demand services at one or more of their systems,
and are likely to use multiple vendors. * Based on these initial deployments,
they will evaluate whether to do larger scale deployments in more of their
systems.

Industry Relationships

     We have established relationships with leading industry participants,
including content providers, manufacturers of digital set-top boxes, providers
of application managers and set-top box operating systems and billing system
providers. We received an investment of $7.0 million from General Instrument
(subsequently acquired by Motorola) in December 1999. We entered into
development arrangements with OpenTV in March and April 2000 to integrate our
video-on-demand system into OpenTV's interactive television software platform.
In conjunction with these arrangements, OpenTV made a $5.0 million investment in
our company. We also entered into a development agreement with Liberate in May
2000 to integrate our video-on-demand system into Liberate's interactive
television software platform. In a separate transaction, Liberate made a $4.0
million investment in our company. In addition, in May 2000, we received an
investment of $5.0 million from Starz Encore Group LLC (Starz Encore), a wholly
owned subsidiary of Liberty Media Group. Starz Encore is the largest provider of
cable and satellite-delivered premium movie channels in the United States. Most
recently, we received an investment of $5 million from Charter Communications in
September 2000.

     Content Providers. We receive content from 33 content providers, including
Warner Bros. (including New Line Cinema, Turner and Warnervision), Universal
Pictures (including Polygram), Dreamworks, HBO, ESPN, PBS, The Disney Channel,
Discovery Networks, Artisan and New City Releasing.

     Set-Top Box Manufacturers. We have agreements to facilitate integration of
our video-on-demand products and services with digital set-top boxes being
delivered by Motorola, Scientific-Atlanta and PACE Technologies. We

                                       -7-

<PAGE>

believe operators plan to obtain digital set-top boxes from multiple vendors.
Our current video-on-demand deployments are on both Motorola and
Scientific-Atlanta digital set-top boxes.

     Providers of Application Managers and Set-Top Box Operating Systems. We are
working with Liberate, Microsoft, OpenTV and Power TV to interface our
video-on-demand system with their technology. In March and April 2000, we
entered into development arrangements with OpenTV to integrate our
video-on-demand service and interactive program guide into OpenTV's interactive
television software platform. In May 2000, we also entered into a development
agreement with Liberate to integrate our video-on-demand system into Liberate's
interactive television software platform. We are committed to working with the
leading companies developing technology for the digital cable tiers so that our
products and services can be implemented seamlessly with their systems.

     Billing System Providers. We have worked with each of Convergys, CSG and
DST Innovis (formerly CableData) to develop interfaces so that our services
integrate with their billing systems. We believe these companies provide billing
for all of the major cable operators in the United States and over 90% of the
subscriber base.

Sales and Marketing

     Our primary sales objective is to secure long-term agreements with major
network operators. Our sales activities are conducted from our headquarters in
Redwood City, California and are supported by our senior management and
technical personnel. Our sales efforts typically involve detailed business and
technical presentations and sometimes require us to respond to very specific
requests for proposals from our prospective customers. The sales cycle is
lengthy because of the level of customer analysis and long term nature of our
customer contracts.

     After a contract is entered into, our customer support organization is
responsible for the execution and project management of deploying our
video-on-demand system at the local customer site. The local account managers
and their teams oversee the installation, integration, training and marketing
for all system deployments. Our marketing effort continues after deployment,
when we provide our customers with consultation and assistance in designing
consumer marketing tools, packaging and price strategies, market research and
developing local marketing efforts.

     We use a variety of marketing programs to build market awareness of our
company, our brand name and our products and services, as well as to attract
potential customers. As a key marketing initiative, we participate at the major
industry trade shows and take an active role in the major industry standards
organizations. Our marketing programs also include advertising, market research,
product strategy updates with industry analysts, public relations activities,
direct mail programs, seminars and speaking engagements.

Technology

     We have spent six years developing our video-on-demand service platform.
Our video-on-demand solution has an open architecture, which readily integrates
with the leading digital cable platforms. Our video-on-demand technology
platform includes the DIVA System Manager, the DIVA Video Server, the DIVA
Digital Link, and the DIVA Programming Scheduler.

  DIVA System Manager

     Our DIVA System Manager is the suite of software that operates our
on-demand television services. Key features include:

     . an interface that enables a video-based menu;

     . content management with automated introduction and updates of content;

     . remote operating, monitoring and troubleshooting;

     . an intelligent billing module that recognizes different packages and
       promotions;

     . open billing interfaces to traditional cable billing companies;

                                       -8-

<PAGE>

     . video streaming traffic management; and

     . flexible advertisement insertion.

  The DIVA Video Server

     Our current DVS5000 delivers unique video content streams to individual
set-top boxes on an on-demand basis. Each server installation is capable of
scaling up to 50,000 video-on-demand streams and storing up to 10,000 titles.
Multiple video servers can be networked with integrated optical fiber
connections to expand the content selection and provide traffic management
within a single cable system. The DVS5000 has low power consumption needs and
small floor space requirements, making it well suited for co-location in cable
headends. Each server module provides high speed (1 gigabit per second)
streaming capacity and is comprised of commercially available processor modules
and storage modules. The storage modules contain state-of-the-art fiber channel
disk drives.

     We are currently completing the development of the next generation of DIVA
Video Servers, the DVS6000. The DVS6000 is the industry's first non-proprietary
video-on-demand server solution. Each server integrates off-the-shelf hardware
from a variety of server manufacturers with DIVA's server software. The DVS6000
is backward compatible with the DVS5000 and will support high stream volumes,
while using minimal power consumption and space. Our DVS6000 is adaptable to
all-content formats and outputting standards, including DVB-ASI and Gigabit
Ethernet.

  The DIVA Digital Link

     Our modular DIVA Digital Link (DDL) converts video streams from the server
into a format that can be distributed over a cable plant to viewers. It also
limits access to authorized users of on-demand television services. Some of the
key features include small size, low cost, scalability and compatibility with
video-on-demand encryption and conditional access standards. To date our DDL
product has been proprietary. However, going forward we plan to outsource this
product from a third party vendor. *

  The DIVA Programming Scheduler

     We have developed a unique set of support applications that facilitate the
management of the programming to a large number of distributed video servers.
These elements include our programming scheduler, commerce software for managing
royalty payments, and title and rights management software.

Technology Development

     Our technology development efforts are focused on developing and enhancing
our video-on-demand products and services. We believe that we will need to
continue to make significant investments in engineering and development to
remain competitive, to assure our products and services are integrated with
industry standards and to offer new services and enhancements to our customers.*

     We are continuing to devote substantial resources to improving our core
software and hardware technologies including:

     . reductions in the size and cost, and increases in the storage capacity,
of our video servers; and

     . increases in the number of simultaneous video streams that can be
accessed from each video server.

     We are working to ensure that our video-on-demand platform will
interoperate with the broadband delivery platforms that we believe will deliver
video-on-demand services in the future, including next generation digital
set-top boxes. * Another key development area at this time is the migration of
our video-on-demand platform to support DSL providers and Internet service
providers as the Internet technology develops over time into a sufficiently
reliable transmission medium to deliver broadcast quality video.

     We are also developing enhancements to provide the system capability to
offer new on-demand television services, including time shifted television
through video servers with pause, fast forward and rewind functionality,
interactive targeted advertising and television-based e-commerce.

                                       -9-

<PAGE>

     Our engineering and development expenses were $24.3 million, $27.1 million
and $31.4 million in fiscal years ended June 30, 1999, 2000 and 2001,
respectively. We currently have 89 employees engaged in engineering and
development activities.

Manufacturing and Production

     We have an arrangement with a large contract manufacturer for the
production of our hardware products. Our contract manufacturer has several
plants in the United States and Europe. Using a contract manufacturing
arrangement allows us to both concentrate our efforts on the design and
development of our products and services, and manage our capital resources more
efficiently. We currently do not have a contract with this manufacturer and
operate on a purchase order basis. The components used in our hardware products
are generally available from a number of sources. While we have not experienced
any shortages to date, we could be subject to component shortages in the future,
which could delay delivery of our hardware products or increase costs.

     We have an internal manufacturing department that develops the
manufacturing tests used by the contract manufacturer. Prior to customer
shipment of our hardware products, we perform system integration and quality
assurance and load content at our facilities. We outsource the encoding of the
content we provide to our customers to companies that specialize in the
preparation of digital content.

     As our hardware platform migrates toward the DVS6000, we will become
substantially less dependent on our current contract manufacturer and will rely
more on off-the-shelf hardware manufacturers. We believe that our current
contract manufacturer has the capacity to meet our anticipated volume. * In the
event that the current contract manufacturer is unable or unwilling to continue
to support our requirements, we believe that there is ample capacity in the
contract manufacturing industry to meet our needs. * However, we could require
time to transition to a new manufacturer during which we may be unable to
provide hardware products to our customers on a timely basis.

Competition

     The market for interactive, on-demand television products and services and
in-home video entertainment is very competitive, quickly evolving and subject to
rapid technological change. Principal competitive factors include each
competitor's degree of system integration, system performance, price, customer
support, system capacity, content availability, software availability,
reliability and integration with industry digital platforms.

     Although other companies sell individual components that are similar to
specific DIVA products, we are not aware of any other company that sells all of
the components required to deliver end-to-end, interactive, on-demand
television. As a result, we believe a network operator using a competitor's
systems must buy hardware and software products from more than one source. In
addition, the operator must integrate these hardware and software components so
that they operate together as an end-to-end system capable of delivering
interactive services to viewers' homes.

     We group our direct competitors into three categories: server
manufacturers, software providers and system integrators. Server manufacturers
include Concurrent Computer, nCUBE and SeaChange. Software providers that offer
similar products include Prasara and Scientific-Atlanta. Companies that provide
system integration services or perform their own integration include Time Warner
and Scientific-Atlanta.

     We also face competition from indirect competitors, including personal
video recorder technology providers (for example, TiVo, Replay and Ultimate TV),
direct broadcast satellite providers (including BSkyB, DirecTV and EchoStar),
companies developing video streaming technologies and other service providers
(for example, Yes Television, Intertainer and VideoNet).

     Video-on-demand services, including ours, depend on the availability of
movies and video content, including a favorable access window for new releases.
We face competition for timely access to content from the home video rental
market.

     Viewers have several options for in-home video entertainment and
interactive, on-demand television. They can purchase content from their local
cable television or broadband telecommunications company, obtain content over
satellite, the Internet or regular telephone lines, rent or purchase videos or
use a personal video recorder to record

                                      -10-

<PAGE>

and store television programming for replay on-demand. We expect direct and
indirect competition in the market for video-on-demand services to intensify in
the future.

Intellectual Property

     Our ability to compete is based in part on our technology, which we regard
as proprietary. We rely on a combination of patent, trademark, trade secret,
copyright and contract law to establish and protect our technology. As of
September 12, 2001, we have exclusive rights to 28 issued U.S. and 9 issued
international patents, 5 allowed U.S. patents, 106 pending U.S. applications, 4
pending U.S. provisional applications and 120 pending international
applications. We believe our patent portfolio represents a significant
intellectual property position that covers key aspects of our technology. In
particular, the portfolio covers aspects of our system architecture, server
technology, navigation and user interface technology, interactive program guide,
video encoding techniques, and network-related technology. We cannot be sure
that any patents will issue from any of the pending applications or that if they
do, that they will have claims of sufficient breadth to protect our technology.
Additionally, we cannot be sure that our issued patents will not be invalidated
or designed-around by competitors. If our patents fail to protect our
technology, it may be easier for competitors to offer equivalent or superior
products and services.

     We typically enter into confidentiality agreements with our employees,
consultants and independent contractors and, where possible and applicable, with
our customers, vendors and industry partners to control access to and
distribution of the information we consider confidential. It is possible that
despite these measures, a third party may copy or otherwise obtain and use our
confidential information without our authorization. In addition, it is possible
for a third party to develop similar technology through independent means.

     Effective patent, trademark, trade secret and copyright protection may be
unavailable or limited in certain foreign countries. Also, litigation may be
necessary to enforce our intellectual property rights or to determine the scope
or validity of third party proprietary rights. Such litigation could cost a
substantial amount, divert our resources and harm our business.

     From time to time, we receive notices of claims of infringement of third
parties proprietary rights, and it is possible that we could also receive claims
for indemnification resulting from infringement claims. Regardless of the
validity or successful assertion of such claims, we may incur significant costs
and a diversion of resources with respect to the defense of any claims brought,
which could have a material adverse effect on our business.

Government Regulation

     In the United States, the Federal Communications Commission, or FCC, has
broad jurisdiction over network operators. The FCC does not regulate us, but
requirements imposed on network operators could force us to undertake
development that would consume significant resources and require changes to our
products and services. If we do not change our products so that they comply with
FCC rules, or if our products are not integrated with ones that comply with FCC
requirements, our products and services will not be broadly deployed, and our
business will suffer.

     In addition, video-on-demand services in Canada and in the United Kingdom
and other European Union member countries are licensed in a variety of ways. We
are seeking to determine how best to offer our video-on-demand products and
services in these countries. We may not be able to obtain distribution rights to
movie titles in non-U.S. jurisdictions under regulatory and financial
arrangements acceptable to us.

Employees

     As of June 30, 2001, we had 265 employees. None of our employees are
currently represented by a labor union. We believe that we have a good
relationship with our employees.

Item 2. Properties

     Our principal facilities are located in Redwood City, California, where we
currently lease approximately 82,000 square feet. The term of this lease runs
through June 1, 2007 with two five-year renewal options. We lease 22,600 square
feet of office space in Princeton, New Jersey. The term of this lease runs
through November 1, 2001 and we plan to extend this lease for three to five
years. We also maintain small offices in King of Prussia, Pennsylvania and

                                       -11-

<PAGE>

London, England. We believe that suitable additional or alternative space
adequate to serve our foreseeable needs would be available on commercially
reasonable terms, if necessary.

Item 3. Legal Proceedings

     We are not a party to any material litigation at the present time.

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

     None.

                                       -12-

<PAGE>


                                     PART II

Item 5.  Market for the Registrant's Common Stock and Related Stockholder
         Matters

     There is no established public trading market for our common stock. As of
June 30, 2001 there were approximately 328 holders of our common stock and
approximately 200 holders of record of our preferred stock.

     We have not paid any dividends since our inception and do not intend to pay
any dividends on our capital stock in the foreseeable future. We anticipate that
we will retain all future earnings, if any, for use in our operations and
expansion of the business. In addition, the terms of the indenture agreement
related to our 12-5/8% Senior Discount Notes due 2008 restrict our ability to
pay dividends on, or make distributions with respect to, our capital stock.

     During the fiscal year ended June 30, 2001, we issued and sold an aggregate
of 470,221 shares of Common Stock to employees and consultants pursuant to
exercises of options under our 1995 Stock Plan and our 1998 Stock Plan for an
aggregate purchase price of $519,300 and $53,700, respectively. These issuances
were deemed exempt from registration under the Securities Act of 1933, as
amended, in reliance upon Rule 701 promulgated thereunder. In addition, during
the year ended June 30, 2001 we issued and sold 555,556 shares of Series F
Preferred Stock to a strategic investor for an aggregate purchase price of
$5,000,000. This issuance was deemed exempt from registration under the
Securities Act of 1933, as amended, in reliance upon Section 4(2) therein.

Item 6. Selected Financial Data:

<TABLE>
<CAPTION>
                                                            Year Ended June 30,
                                                   -----------------------------------
                                                      1999         2000         2001
                                                   ---------    ---------    ---------
                                                   (in thousands, except per share data)
<S>                                                <C>          <C>          <C>
Consolidated Statement of Operations Data:
Revenue ........................................   $     293    $   1,957    $  18,481
Cost of revenue ................................       8,159        8,524       24,039
                                                   ---------    ---------    ---------
Negative gross margin ..........................       7,866        6,567        5,558
                                                   ---------    ---------    ---------
Operating expenses:
   Operations ..................................       8,162        6,684        5,614
   Engineering and development .................      24,321       27,080       31,444
   Sales and marketing .........................       5,707        8,159        6,784
   General and administrative ..................      15,843       21,380       24,243
   Depreciation and amortization ...............      19,305        6,826        5,886
   Warrant expense .............................          --        2,075          782
   Amortization of stock compensation ..........         738        2,583        3,776
                                                   ---------    ---------    ---------
Total operating expenses .......................      74,076       74,787       78,529
                                                   ---------    ---------    ---------
Operating loss .................................      81,942       81,354       84,087
                                                   ---------    ---------    ---------
Other (income) expense, net:
Interest income ................................      (8,645)      (6,057)      (3,618)
Gain on sale of investments ....................          --           --      (24,421)
Interest expense ...............................      33,967       39,016       39,413
                                                   ---------    ---------    ---------
Total other (income) expense, net ..............      25,322       32,959       11,374
                                                   ---------    ---------    ---------
Net loss .......................................   $ 107,264    $ 114,313    $  95,461
Accretion/(decrement) of redeemable warrants and
   issuance of redeemable put warrants .........         969       16,888       (1,642)
                                                   ---------    ---------    ---------
Net loss attributable to common stockholders ...   $ 108,233    $ 131,201    $  93,819
                                                   =========    =========    =========
Basic and diluted net loss per share:
Net loss .......................................   $    6.31    $    7.29    $    4.96
                                                   =========    =========    =========

Shares used in per share computations ..........      17,147       17,987       18,886
                                                   =========    =========    =========
</TABLE>

                                       -13-

<PAGE>

<TABLE>
<CAPTION>
                                                                Year Ended June 30,
                                                       -----------------------------------
                                                         1999          2000         2001
                                                       ---------    ----------    --------
                                                                  (in thousands)
<S>                                                    <C>          <C>          <C>
Consolidated Balance Sheet Data:
Cash, cash equivalents, and short-term investments...  $ 130,737    $  92,682    $  33,315
Accounts Receivable .................................         --          264       15,090
Inventory ...........................................      2,663        3,143       15,947
Property and equipment, net .........................      9,792       12,648       12,433
Total assets ........................................    154,264      119,487       82,809
Notes payable .......................................    275,564      312,815      355,517
Redeemable warrants .................................      2,108        7,007        5,364
Total stockholders' deficit .........................   (127,413)    (225,386)    (309,013)
</TABLE>

____________________________

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

     The following discussion of our financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements and the related notes included elsewhere in this Form 10-K. This
discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results may differ materially from the results
discussed in the forward-looking statements. Factors that might cause such a
difference include, but are not limited to, those discussed below. The
forward-looking statements contained herein are made as of the date hereof, and
we assume no obligation to update such forward-looking statements or to update
the reason actual results may differ materially from those anticipated in such
forward-looking statements. Forward-looking statements are statements identified
with an asterisk (*). All forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
cautionary statements set forth below and in "--Factors Affecting Operating
Results."

Overview

     We are a leading provider of interactive, on-demand television products and
services. Our video-on-demand service operates on industry-standard digital
set-top boxes and operating systems, providing a flexible and cost-effective
interactive television solution for cable and other broadband network operators,
which we refer to as network operators. We have commercially deployed our
video-on-demand service with several network operators in North America. In
addition to our video-on-demand products and services we developed and beta
tested an interactive program guide as a stand-alone product. To date, we have
neither commercially deployed nor are we actively marketing our interactive
program guide technology. On June 30, 2001 we ceased further development
activities related to our interactive program guide technology and reduced our
development workforce accordingly. Since our inception, we have devoted
substantially all of our resources to developing our video-on-demand and other
interactive products and services, establishing industry relationships, carrying
out marketing activities, negotiating deployment agreements and establishing the
operations necessary to support the commercial deployment of our video-on-demand
products and services.

     Through June 30, 2001, we generated minimal revenues and incurred
significant losses and substantial negative cash flow, primarily due to
engineering and development expenditures and other costs required to develop our
video-on-demand products and services. Since our inception through June 30,
2001, we have an accumulated deficit of $453.1 million and have not achieved
profitability on a quarterly or annual basis. We expect to continue to incur
substantial net losses and negative cash flow for at least the next few years,
requiring us to raise additional capital. In addition we have limited cash
reserves and uncertainty exists concerning our ability to raise additional
capital and continue as a going concern. * Our historical revenues and
expenditures are not necessarily indicative of, and should not be relied upon as
an indicator of, revenues that may be attained or expenditures that may be
incurred by us in future periods. *

                                       -14-

<PAGE>

Revenues

     Revenue is comprised of three components: product revenue resulting from
the sale of our video-on-demand hardware platform; licensing revenue resulting
from the licensing of our system software and navigator applications; and
service revenue resulting from programming services and operational support
services.

     Our contracts are generally multiple-element arrangements with a network
operator involving a combination of video-on-demand hardware products, licenses
for system software and navigator applications, and selected content and
operational services. As a result, we recognize revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2
(SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9 (SOP
98-9), "Software Revenue Recognition, with Respect to Certain Arrangements." SOP
97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative fair
values of the elements. The fair value of an element must be based on vendor
specific objective evidence, which generally is determined by the price charged
when the element is sold separately. SOP 98-9 requires recognition of revenue
using the residual method in a multiple element arrangement when fair value does
not exist for one or more of the delivered elements in the arrangement. Under
the residual method, the total fair value of the undelivered elements is
deferred and subsequently recognized in accordance with SOP 97-2.

     Prior to January 2001, all hardware and software elements were deliverable
over the term of the contract and evidence of the fair value of the individual
elements in our agreements did not exist. As a result, upon the delivery of our
video-on-demand hardware products, revenue was recognized to the extent of the
cost of these hardware products and any remaining product revenue was amortized
on a straight-line basis over the remaining term of the agreement. We recognized
license revenues over the term of the agreement based on the number of
subscribers.

     All of our installations since January 1, 2001 have been made under
agreements whereby all hardware and software elements are delivered upon
completion of installation and the training of network operator personnel.
Accordingly, for the six months ended June 30, 2001, we recognized product
revenue and licensing revenue upon completion of the equipment installation at a
customer's site, which includes technical training, according to the residual
method. Consequently, the fair value of the maintenance element, determined by
the maintenance renewal fee, is deferred and amortized over the maintenance
period, which is generally one year.

     We provide services on a fee-for-service basis, whereby service revenue is
recognized when the services are performed. If the services are provided on a
revenue sharing basis, service revenue is recognized based on program purchases
by subscribers.

     Operating Expenses

     Cost of Product Revenues. Cost of revenue consists of contract
manufacturing costs, component and material costs, warranty costs, and other
direct product expenditures associated specifically with the sale of our
video-on-demand hardware and software products. We expect our cost of revenue to
increase in the future due to increased sales volume of our video-on-demand
hardware and software products. *

     Cost of Service Revenues. Cost of service revenue consists of license fees
paid to content providers, costs related to the acquisition and production of
digitally encoded programming content, duplication and distribution expenses and
other expenditures associated specifically with content management.

     Operations. Operations expense includes the cost of field operations, both
for initial launches and for ongoing support of our installed video-on-demand
systems. These costs include personnel and other costs for technical support,
customer service training, installation, launch support, and maintenance costs.
In addition, operations expense includes personnel and other costs which support
our ongoing manufacturing relationships for our video-on-demand hardware
products with third-party manufacturers.

     Engineering and Development. Engineering and development expense consists
of salaries, consulting fees, prototype hardware and other costs to support
product development. Our engineering and development efforts involve ongoing
system software development, hardware development, system integration and new
technology. To date, the most substantial portion of our operating expenses has
been engineering and development expense. We expect to continue to incur
significant engineering and development expenditures as we continue to enhance
our video-on-demand products and services. * We believe these expenditures are
necessary to remain competitive, to

                                       -15-

<PAGE>

assure that our products and services comply with industry standards and to
offer new products and services to our customers.

     Sales and Marketing. To date, our sales and marketing expense has consisted
of the costs of marketing our video-on-demand products and services to network
operators and their customers. It also includes costs related to business
development and marketing personnel, travel expenses, trade shows, consulting
fees and promotional costs. We expect that direct marketing costs will not
represent a significant component of total sales and marketing expense, as most
network operators will take responsibility for marketing video-on-demand
services to their subscribers. * To the extent we provide these services, they
will likely be performed under individual service agreements with the network
operators and, accordingly, the related expenses will fluctuate with revenues.
Our future sales and marketing costs will consist primarily of market
development and product management expenses. *

     General and Administrative. General and administrative expense consists
primarily of salaries and related expenses of management and administrative
personnel, professional fees and general corporate and administrative expenses.
In addition, general and administrative expense includes costs associated with
the development, support and growth of our management information system
infrastructure. We expect that general and administrative expense will continue
to represent a significant component of our total operating expenses in order to
support the expansion of our business activities. *

     Depreciation and Amortization. Depreciation and amortization expense
includes depreciation of property and equipment, including our video-on-demand
hardware. Generally, depreciation is calculated using the straight-line method
over the estimated useful lives of the assets, which range from three to five
years. Historically, depreciation expense has been a significant component of
our operating expenses. This resulted from the significant investment in capital
equipment necessary to deploy our end-to-end video-on-demand service. We expect
depreciation expense to decrease as a component of operating expense in the
future as network operators purchase the various video-on-demand hardware
components directly from us. *

     Warrant Expense. Warrant expense represents the cost of the warrants issued
to customers and to strategic business partners based on their estimated fair
value, as determined using the Black-Scholes option pricing model, at the
earlier of the grant date or the date it becomes probable that the warrants will
be earned.

     Amortization of Deferred Stock Compensation. Deferred stock compensation
represents the difference between the estimated fair value of our common stock
for accounting purposes and the option exercise price of such options at the
grant date.

     Other Income and Expense. Other income and expense primarily consists of
interest income and interest expense. Interest income consists of earnings on
cash, cash equivalents and short-term investments. Gain on sale of investments
consists of proceeds from the sale of an investment in common stock held by us.
Interest expense consists primarily of accreted interest on our outstanding debt
and revaluation of redeemable put warrants.

Results of Operations

Comparison of Years Ended June 30, 2001, 2000, and 1999

     Revenues

     Total revenues were $18.5 million for the fiscal year ended June 30, 2001
(fiscal 2001), $2.0 million for the fiscal year ended June 30, 2000 (fiscal
2000) and $293,000 for the fiscal year ended June 30, 1999 (fiscal 1999).

     Product Revenues. Product revenue was $11.2 million for fiscal 2001 and
$1.4 million for fiscal 2000. Since we did not begin selling our video-on-demand
hardware products until fiscal 2000, we did not record product revenue for
fiscal 1999. The increase in product revenue from fiscal 2000 to fiscal 2001 is
a result of a significant increase in the number of system deployments, which
occurred primarily during the third and fourth quarters of fiscal 2001.

     License Revenues. License revenue was $4.9 million for fiscal 2001 and
$46,000 for fiscal 2000. Since we did not begin licensing our video-on-demand
system software until fiscal 2000, we did not record license revenues for fiscal
1999. License revenue is the fee for our system manager software and navigator
application. The increase in

                                       -16-

<PAGE>

license revenue from fiscal 2000 to fiscal 2001 is a result of a significant
increase in the number of system deployments during the third and fourth
quarters of fiscal 2001.

     Service Revenues. Service revenue was $2.4 million for fiscal 2001,
$531,000 for fiscal 2000 and $293,000 for fiscal 1999. The increase in service
revenue from fiscal 2000 to fiscal 2001 was primarily due to the recognition of
revenue resulting from an adaptive engineering agreement with a network operator
and an increase in video-on-demand subscribers under revenue sharing
arrangements.

     Operating Expenses

     Cost of Product Revenues. Cost of product revenues was $18.7 million for
fiscal 2001 and $4.2 million for fiscal 2000. We did not record cost of product
revenues for fiscal 1999. The increase in the cost of revenue from fiscal 2000
to fiscal 2001 resulted from the increased sales volume of our video-on-demand
products. Included in our cost of product revenues for fiscal 2001 was a charge
for excess and obsolete inventory of $3.6 million. Included in our cost of
product revenues for fiscal 2000 was an inventory write-down of $2.6 million
related to our first generation video-on-demand hardware.

     Cost of Service Revenues. Cost of service revenues was $5.4 million for
fiscal 2001, $4.3 million for fiscal 2000 and $8.2 million for fiscal 1999. The
increase in cost of service revenues from fiscal 2000 to fiscal 2001 was
primarily attributable to an increase in the number of commercially deployed
subscribers and in the acquisition of new titles in our content library. The
decrease from fiscal 1999 to fiscal 2000 was attributable to reduced labor and
personnel costs and other related program production service costs. In addition,
we had reduced the number of trailers, previews, promotions, and other encoding
related costs, which resulted in a reduction of overall expenditures in this
area during fiscal 2000.

     Operations. Operations expense was $5.6 million for fiscal 2001, $6.7
million for fiscal 2000 and $8.2 million for fiscal 1999. The decrease in
operations expense from fiscal 2000 to fiscal 2001 was due primarily to the
allocation of certain costs related to the manufacturing of our video-on-demand
hardware products to cost of product revenues. The decrease in operations
expense from fiscal 1999 to fiscal 2000 was the result of our decision to
discontinue the manufacture of our own proprietary set-top box in the third
quarter of fiscal 1999. As a result of that decision, our manufacturing
operations expense was lower in fiscal 2000.

     Engineering and Development. Engineering and development expense was $31.4
million for fiscal 2001, $27.1 million for fiscal 2000 and $24.3 million for
fiscal 1999. The increase in engineering and development expense from fiscal
2000 to fiscal 2001 was primarily attributable to charges for obsolete
engineering and development assets of approximately $3.6 million related to our
VOD products and $2.7 million related to our interactive program guide
technology. Also included in engineering and development expense for fiscal 2001
is $678,000 in charges related to the shutdown of development activities related
to the Company's interactive program guide. The increase in engineering and
development expense from fiscal 1999 to fiscal 2000 was attributable to the
hiring of additional engineering and development personnel and outside
consultants and other engineering expenses in connection with the further
development and enhancement of our video-on-demand technology. In addition, the
increase during this period included expenditures for the development of new
products and services such as our interactive program guide technology and
integration activities related to digital broadcast platforms and middleware
applications required for deployment by network operators.

     Sales and Marketing. Sales and marketing expense was $6.8 million for
fiscal 2001, $8.2 million for fiscal 2000 and $5.7 million for fiscal 1999. The
decrease in sales and marketing expense from fiscal 2000 to fiscal 2001 was
primarily due to a decrease in marketing and promotional activities. The primary
items contributing to the increase from fiscal 1999 to fiscal 2000 were
promotional expenditures in connection with our commercial deployments,
continued business development activities and product management costs.

     General and Administrative. General and administrative expense was $24.2
million for fiscal 2001, $21.4 million for fiscal 2000 and $15.8 million for
fiscal 1999. The increase in general and administrative expense from fiscal 2000
to fiscal 2001 was primarily due to an increase in legal costs attributable to
the Company's interactive program guide and video-on demand intellectual
property, along with an increase in legal costs and other professional services
associated with filing the Company's S-1 registration statement and debt
restructuring activities. Also contributing to the increase during this period
were costs related to personnel expenses such as recruitment and benefits.
General and administrative expense increased from fiscal 1999 to fiscal 2000 as
a direct result of the growth in all phases of our operations. The increase
during this period included increased rent expense due to the

                                       -17-

<PAGE>

relocation of our corporate headquarters to a new facility in September 1999,
and increased international business development expense, including the
operations of an office in the United Kingdom.

     Depreciation and Amortization. Depreciation and amortization expense was
$5.9 million for fiscal 2001, $6.8 million for fiscal 2000 and $19.3 million for
fiscal 1999. The decrease in depreciation and amortization expense from fiscal
2000 to fiscal 2001 is attributable to an increase in fully depreciated assets
and lower capital expenditures for property and equipment. The decrease from
fiscal 1999 to fiscal 2000 is primarily the result of approximately $9.1 million
in write-downs recorded in the quarter ended June 30, 1999 related to older,
prototype video-on-demand hardware. In addition, approximately $2.7 million of
previously capitalized equipment was transferred to inventory during this
period.

     Warrant Expense. Warrant expense was $782,000 for fiscal 2001 and $2.1
million for fiscal 2000. There were no similar warrant expenditures in fiscal
1999. Warrant expense relates to the costs associated with warrants issued to
customers and strategic business partners. Charges for fiscal 2001, fiscal 2000
and future periods depend, in part, on the achievement of specified performance
milestones by such customers and partners.

     Amortization of Deferred Stock Compensation. Amortization of deferred
compensation expense was $3.8 million in fiscal 2001, $2.6 million in fiscal
2000 and $738,000 in fiscal 1999. The increase in deferred compensation expense
between fiscal 1999, fiscal 2000 and fiscal 2001 is related to increased stock
options granted to employees and consultants and an increase in the estimate of
the fair value of our common stock for accounting purposes over the option
exercise price at the date of the grant. We expect to continue to grant options
to employees, which may result in an increase in deferred stock-based
compensation that will be amortized over the applicable vesting periods of the
options.

     Other Income and Expenses. Interest income was $3.6 million for fiscal
2001, $6.1 million for fiscal 2000 and $8.6 million for fiscal 1999. The
decrease in interest income between fiscal 1999, fiscal 2000 and fiscal 2001 is
the result of a decrease in cash and cash equivalent balances which were
invested in short-term interest bearing accounts and a decrease in short-term
investments. Gain on sale of investments was $24.4 million for fiscal 2001, and
is attributable to the sale of shares of PMC-Sierra, Inc. common stock that we
previously had acquired. Interest expense was $39.4 million, $39.0 million and
$34.0 million for fiscal 2001, fiscal 2000 and fiscal 1999, respectively.
Included in interest expense for fiscal 2001 is a gain on the revaluation of
redeemable put warrants of $4.7 million due to a lower estimated fair market
value of our common stock.

Provision for Income Taxes

     We have not provided for or paid federal income taxes due to our net
losses. As of June 30, 2001, we had net operating loss carryforwards of
approximately $267.5 million to offset future income subject to federal income
taxes and $115.2 million available to offset future California taxable income.
As of June 30, 2001, we also had net operating loss carryforwards in various
other states. The extent to which such loss carryforwards can be used to offset
future taxable income may be limited because of ownership changes pursuant to
Section 382 of the Internal Revenue Code of 1986, as amended.

Liquidity and Capital Resources

     From our inception through June 30, 2001, we have financed our operations
primarily through the gross proceeds of private placements totaling
approximately $108.3 million of equity and $250.0 million of high yield debt
securities, net of repayments. As of June 30, 2001, we had cash and cash
equivalents and short-term investments totaling $33.3 million.

     Net cash used in our operating activities was $83.2 for fiscal 2001, $58.2
million for fiscal 2000 and $53.6 million for fiscal 1999. The net cash used in
operations during these periods was primarily due to net losses (adjusted for
depreciation and amortization expense, amortization of issuance costs and the
discount accretion on notes payable and amortization of deferred stock
compensation and warrant expense). In addition, in fiscal 2001 operating cash
was affected by inventory purchases, increased accounts receivable and gain on
sale of investments. Net cash used for investing activities was primarily
attributable to net activity in short-term and other investments and
acquisitions of property and equipment of $5.7 million for fiscal 2001, $8.0
million for fiscal 2000 and $13.5 million for fiscal 1999. Property and
equipment in fiscal 2000 and fiscal 1999 consisted primarily of video-on-demand
hardware and general capital equipment associated with our growth. This
equipment was retired in fiscal

                                      -18-

<PAGE>

2001. During fiscal 2001, we took several actions to address our declining cash
position, including a 15% headcount reduction in our workforce in March 2001 and
the shutdown of development activities related to our interactive program guide
technology in June 2001. We are contemplating additional measures to reduce our
operating expenses and working capital requirements on a going forward basis;
however, there can be no assurance that such actions can be implemented or, if
implemented, will be successful.

     Net cash provided by financing activities for fiscal 2001 was $5.0 million
consisting primarily of funds raised by issuing preferred stock to Charter
Communications. For fiscal 2000, net cash provided by financing activities was
$28.1 million consisting primarily of $27.0 million raised by issuing preferred
stock to General Instrument (subsequently acquired by Motorola), Open TV, ntl,
Liberate and Starz Encore. For fiscal 1999 net cash provided by financing
activities was $291,000, primarily reflecting stock option exercises. On
February 19, 1998, we received $250.0 million in gross proceeds from an offering
of 463,000 units consisting of senior discount notes with an aggregate principal
amount at maturity of $463.0 million and warrants to purchase an aggregate of
2,778,000 shares of common stock. The net proceeds from the offering of the
notes were approximately $199.9 million, after deducting placement fees and
other offering costs, the extinguishment of all the subordinated discount notes
issued in a previous offering and a premium paid in connection with the early
extinguishment of these notes. In connection with the offering, we allocated
approximately $18.1 million of the proceeds to the warrants.

     The notes are senior unsecured indebtedness, and rank pari passu with our
unsubordinated unsecured indebtedness. The notes will be senior to subordinated
indebtedness, but effectively will be subordinated to any future secured
indebtedness at least to the extent of the collateral of such indebtedness.

     The indenture governing our senior discount notes imposes operating and
financial restrictions on our subsidiaries and us. These restrictions in certain
cases significantly limit or prohibit our ability directly and through our
subsidiaries to incur additional indebtedness, create liens upon assets, apply
the proceeds from the disposal of assets, make investments, make dividend
payments and other distributions on capital stock and redeem capital stock.
These covenants have limited our ability to perform certain activities in the
past and may limit our ability to finance our operations or engage in other
business activities that may be in our best interest in the future.

     The senior discount notes were sold at a significant discount, and must be
repaid at maturity on March 1, 2008. Commencing September 1, 2003, we will be
required to make semi-annual interest payments of $29.2 million. There are no
principal payments due on the senior discount notes prior to maturity on March
1, 2008. We have had a number of discussions with a committee of holders of our
senior discount notes, which committee represents over 50% of the outstanding
senior discount notes, and with their financial and legal advisors. To date
these discussions have focused on a restructuring of our senior discount notes
and our future funding requirements. We have also approached several other
potential strategic and financial partners about raising additional capital to
fund our operations. There can be no assurance that such discussions will result
in a restructure of our outstanding indebtedness or any additional funding
commitment.

     We expect to require significant working capital and incur significant
operating expenses in the future. * Working capital requirements include
inventory expenditures for our video-on-demand products and general capital
expenditures associated with our anticipated growth. Our working capital needs
will, in part, be determined by the rate at which network operators purchase and
introduce our video-on-demand products and services. In addition to working
capital, we intend to make significant expenditures for continued development
and enhancement of our video-on-demand technology, development of new services
and other expenses associated with the delivery of our video-on-demand products
and services. * Our actual cash requirements may vary from expectations and will
depend on numerous factors and conditions, many of which are outside of our
control.

     We believe our cash, cash equivalents and short-term investments will be
sufficient to fund our operations through March 31, 2002. * Thereafter, we will
need to raise additional funds through debt or equity financing, selling assets,
or entering into strategic relationships, and there can be no assurance that we
will be able to perform any of the foregoing on favorable terms, or at all. * We
may also need to raise additional funds in order to respond to unforeseen
technological or marketing hurdles or to take advantage of unanticipated
opportunities. Although we are currently pursuing initiatives to raise
additional funds, we have no present commitments or arrangements assuring us of
any additional capital and there can be no assurance that we will be able to
obtain additional capital on acceptable terms, or at all. Failure to
successfully address our ongoing liquidity requirements will have a material
adverse effect upon our business. In the event that we are unable to obtain
additional capital, we will be required to take actions that will harm our
business and our ability to achieve sufficient cash flow to service our
indebtedness, including, potentially, ceasing certain or all of our operations.
To the extent we raise additional cash by issuing equity securities, our
existing stockholders will be diluted.

                                      -19-

<PAGE>

Recent Accounting Pronouncements

     In September 2000, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard (Statement) No. 140, "Accounting for
the Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". Statement No. 140 is effective for transfers occurring after March
31, 2001 and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. The adoption of
Statement No. 140 has not had a material impact on the Company's consolidated
results of operations or financial position.

     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, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. 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 estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with
Statement 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 and Statement 142 effective January 1, 2002. Furthermore, goodwill
and intangible assets determined to have an indefinite useful life acquired in a
purchase business combination completed after June 30, 2001, but before
Statement 142 is adopted in full 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 and
tested for impairment in accordance with the appropriate pre-Statement 142
accounting requirements prior to the adoption of Statement 142.

     As of the date of adoption, the Company does not expect to have any
unamortized goodwill in the balance sheet nor does it expect the adoption of
Statements 141 and 142 to have a material impact on its financial position or
results of operations.

Factors Affecting Operating Results

Our ability to continue as a "going concern" is uncertain

     Our consolidated financial statements have been prepared on the assumption
that we will continue as a going concern, which contemplates the realization of
assets and liquidation of liabilities in the normal course of business. The
independent accountants' report on our financial statements as of and for the
fiscal year ended June 30, 2001, included herein, includes an explanatory
paragraph which states that since inception we have incurred net operating
losses and negative cash flows, and working capital and stockholders' deficits,
that raise substantial doubt about our ability to continue as a going concern.
Investors in our securities should review carefully the report of KPMG, LLP. We
expect our losses and negative cash flow to continue at least into calendar
2003, which will require us to obtain additional capital. It is uncertain
whether we will be able to such obtain additional capital on acceptable terms,
or at all. Further, if future financing requirements are satisfied through the
issuance of equity or debt securities, investors may experience significant
dilution in terms of their percentage interest in DIVA. Commencing on September
1, 2003, we will be required to make cash interest payments on our outstanding
senior notes. In addition, we believe our cash, cash equivalents and short-term
investments will only be sufficient to satisfy our cash requirements through
March 31, 2002. * In the event that we are unable to successfully commercially
deploy our video-on-demand products and services and implement our business
strategy, obtain additional capital or generate sufficient operating cash flows
to fund our working capital needs and make interest payments on our outstanding
debt, we may be unable to continue as a going concern.

                                      -20-

<PAGE>

If we do not obtain additional funds in the near future, we will be required to
take actions that will harm our business, including potentially ceasing certain
or all of our operations.

     We will require additional funds in order to continue the development,
sale, licensing and provisioning of our video-on-demand products and services
and, commencing on September 1, 2003, to make cash interest payments on our
indebtedness. We have made and expect to continue to make significant
investments in working capital in order to fund development activities, sell our
video-on-demand products and services and fund operations. We expect to continue
to incur significant operating losses and expect that our operating cash flow
will be negative for at least into calendar 2003. We believe our cash, cash
equivalents and short-term investments will be sufficient to fund our operations
through March 31, 2002. * Thereafter, we will need to raise additional funds
through debt or equity financing, selling assets, or entering into strategic
relationships, and there can be no assurance that we will be able to perform any
of the foregoing on favorable terms, or at all. * We may also need to raise
additional funds in order to respond to unforeseen technological or marketing
challenges or to take advantage of unanticipated opportunities. In addition to
our recent discussions with a committee of holders of our senior discount notes,
we have also approached several potential strategic and financial partners about
raising additional capital to fund our operations. We currently have no
commitments or arrangements assuring us of any additional funds and there can be
no assurance that we will be able to obtain additional capital on acceptable
terms, or at all. * Failure to successfully address our ongoing liquidity
requirements will have a material adverse effect upon our business. In the event
that we are unable to obtain additional capital, we will be required to take
actions that will harm our business and our ability to achieve sufficient cash
flow to service our indebtedness, including, potentially, ceasing certain or all
of our operations. To the extent we raise additional cash by issuing equity
securities, our existing stockholders will be diluted.


We will require a significant amount of cash to service our indebtedness, and
our ability to generate cash depends on many factors beyond our control

     We expect to continue to generate substantial net losses and negative cash
flow for the next few years. We may be unable to achieve a level of cash flow
from operations sufficient to permit us to pay the principal and interest on our
current indebtedness and any additional indebtedness we may incur. The senior
discount notes were sold at a significant discount and must be repaid at
maturity on March 1, 2008. Commencing September 1, 2003, we will be required to
make semi-annual interest payments of $29.2 million. Our ability to make
scheduled debt service payments will depend upon our ability to achieve
significant and sustained growth in our cash generated from operations and to
complete necessary additional financing.

     If we are unable to generate sufficient cash from operations to service our
indebtedness, we will be required to restructure or refinance such indebtedness
or raise additional capital through additional debt or equity financing, selling
assets, or entering into strategic relationships. There can be no assurance that
we will be able to perform any of the foregoing on favorable terms, or at all.
In the event that we are unable to restructure or refinance our indebtedness or
obtain additional capital, we will be required to take actions that will harm
our business, including, potentially, ceasing certain or all of our operations.
We have had a number of discussions with a committee of holders of our senior
discount notes, which committee represents over 50% of our outstanding senior
discount notes, and their financial and legal advisors. To date, these
discussions have focused on a restructuring of our senior discount notes and our
future funding requirements. There can be no assurance that such discussions
will result in a restructuring of our outstanding indebtedness or any additional
funding commitment. We have also approached several other potential strategic
and financial partners about raising capital to fund our operations. There can
be no assurance that these potential investors will provide any additional
funding. We may not be able to effect any new financing strategy or funding
commitments on satisfactory terms, if at all. If we fail to satisfy our
obligations with respect to our indebtedness, this could result in a default
under the indenture governing our senior discount notes. In the event of a
default, the holders of indebtedness would have enforcement rights, including
the right to accelerate the debt and the right to commence an involuntary
bankruptcy proceeding against us. Absent successful commercial deployments of
our interactive products and services, ongoing technical development and
enhancement of our solution and significant growth of our cash flow or other
successful attempts to raise cash such as the sale of assets or equity or debt
financing, we would not be able to service our indebtedness.

Our leverage is substantial and will increase, making it more difficult to
respond to changing business conditions

     We are highly leveraged. As of June 30, 2001 we had senior discount notes
payable of approximately $355.5 million. The senior discount notes accrete at
the rate of 12 5/8% per annum, compounded semi-annually. The senior discount
notes were sold at a significant discount and must be repaid at maturity on
March 1, 2008 at the aggregate par value of $463.0 million. The degree to which
we are leveraged could have important consequences to us and our investors,
including, but not limited to, the following:

                                      -21-

<PAGE>

 .    our ability to obtain additional financing in the future for working
     capital, operating expenses in connection with system deployments,
     development and enhancement of our video-on-demand products and services,
     capital expenditures, acquisitions and other general corporate purposes may
     be materially limited or impaired;

 .    our cash flow, if any, will not be available for our business because a
     substantial portion of our cash flow must be dedicated to the payment of
     principal and interest on our indebtedness;

 .    the terms of future permitted indebtedness may limit our ability to redeem
     our outstanding senior discount notes in the event of a change of control;
     and

 .    our high degree of leverage may make us more vulnerable to economic
     downturns, may limit our ability to withstand competitive pressures and may
     reduce our flexibility in responding to changing business and economic
     conditions.

Our indebtedness contains restrictive covenants that could significantly limit
our ability to engage in business activities that may be in our best interest

     The indenture governing our senior discount notes imposes operating and
financial restrictions on our subsidiaries and us. These restrictions in
specified cases significantly limit or prohibit our ability to:

 .    incur additional indebtedness;

 .    create liens upon assets;

 .    apply the proceeds from the disposal of assets;

 .    make investments;

 .    make dividend payments and other distributions on capital stock; and

 .    redeem capital stock.

     These covenants have limited our ability to perform certain activities in
the past and may limit our ability to finance our operations or engage in other
business activities that may be in our best interest in the future.

We are an early stage company with limited revenues and a history of losses, we
expect to continue to incur substantial losses and negative cash flow and we may
never achieve or sustain profitability

     We are an early stage company with limited commercial operating history. We
have generated revenues of $20.8 million and have incurred net losses of $453.1
million from our inception through June 30, 2001. We expect to continue to incur
substantial losses and experience substantial negative cash flow for at least
the next few years as we continue to develop our operations capability and sell
and license our video-on-demand products and services. We do not expect to
generate substantial revenues unless and until our video-on-demand products and
services are deployed at a significant number of additional cable systems and a
significant number of viewers access our video-on-demand and other interactive
services enabled by our technology. If we do not achieve and sustain
profitability in the future, we may be unable to continue our operations.

     Our prospects should be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in new and rapidly evolving markets. Our
future success depends on a number of factors, including the following:

 .    the extent to which cable operators deploy digital set-top boxes;

 .    our ability to enter into agreements for the sale and license of our
     video-on-demand products and services to cable operators;

 .    the extent to which consumers accept and use interactive, on-demand
     television enabled by our video-on-demand products and services;

                                      -22-

<PAGE>

 .    our ability to continue integrating our software and hardware with other
     digital applications and services selected by network operators in the
     United States and internationally, including set-top boxes, application
     managers and set-top box operating systems, cable system components and
     electronic program guides;

 .    the extent to which third-party cable equipment suppliers integrate their
     headend products with our equipment and reduce the cost and physical space
     requirements for their equipment;

 .    our ability to further reduce the physical space requirements for our video
     server and other headend equipment;

 .    our ability to continue technical development of our video server, our
     access equipment, our service software and our other video-on-demand system
     components in order to reduce their manufacturing cost and enhance their
     functionality;

 .    our ability to operate existing contracted video-on-demand deployments with
     acceptable system performance and viewer acceptance; and

 .    our ability to outsource, on favorable economic terms, certain hardware and
     service components to third parties, some of whom may be competitors, so
     that we can continue to provide our video-on-demand solution.

Because we have a limited operating history, we have limited historical
financial data on which to base planned operating expenses, and investors may
find it difficult to evaluate our business and future prospects

     Our limited operating history makes it very difficult to evaluate our
business and future prospects. As a result of our limited operating history, it
is difficult for us to accurately forecast our revenues, and we have limited
meaningful historical financial data on which to base planned operating
expenses. We are unable to accurately forecast our revenues because:

 .    we participate in an emerging market;

 .    several of our current video-on-demand deployment agreements with network
     operators are for selected systems, and we are unable to predict whether
     they will be expanded to cover additional systems;

 .    changes in cable operators' financial condition or priorities may result in
     delayed or slowed deployments under existing or future agreements;

 .    we cannot predict the rate at which cable subscribers will accept and
     utilize video-on-demand;

 .    we expect to sign new sales, service and licensing agreements on an
     irregular basis, if at all, and there may be long periods of time during
     which we do not enter into new agreements or expanded arrangements; and

 .    we have a lengthy sales cycle, which makes it difficult to forecast the
     quarter during which a sale will occur.

We expect our financial results to fluctuate significantly because we depend on
a small number of relatively large orders and other factors

     Our quarterly operating results will fluctuate significantly in the future
as a result of a variety of factors, either alone or in combination. In the
short term, we expect our quarterly revenues to be significantly dependent on a
small number of relatively large orders for our products and services. As a
result, our quarterly operating results may fluctuate significantly if we are
unable to complete one or more substantial sales in any given quarter. Factors
that will affect our quarterly results, many of which are outside our control,
include:

 .    the timing of deployments by network operators of our video-on-demand
     products and services;

 .    competitive pressure, which may cause us to change our pricing structures;
     and

 .    demand for and viewer acceptance of video-on-demand and other interactive
     services.

                                      -23-

<PAGE>

     A significant portion of our operating expenses are relatively fixed and
necessary to develop our business. These expenses are largely independent of the
revenue generated in any given quarter from sales of products and services to
network operators. To the extent that increased expenses are not subsequently
followed by increased revenues, our operating results will suffer. If revenue
falls below expectations in any quarter, the adverse impact of the revenue
shortfall on operating results in that quarter may be increased by our inability
to adjust fixed spending to compensate for the shortfall.

     Due to these and other factors, we believe that period-to-period
comparisons of our operating results may not be meaningful or indicative of
future performance. You should not rely on our results for any one quarter as an
indication of our future performance. It is likely that in some future quarters
or years our operating results will fall below the expectations of securities
analysts or investors.

If we do not achieve broad deployment of our video-on-demand products and
services, our business will not grow

     Our future success depends in large part on our ability to sell our digital
video-on-demand products and services to a broad base of cable systems, on terms
that will generate a profit. We believe that most network operators will deploy
interactive platforms purchased from more than one supplier. Accordingly, we
believe that network operators will initially commit a limited number of their
cable systems to two or more competitors in order to evaluate their interactive
products and services. We believe that cable operators will not commit to broad
deployments of our video-on-demand solution until they have completed evaluation
of our products and services as well as those of competitors. Our ability to
achieve broad network operator deployments will depend on our success in
demonstrating that:

 .    our interactive products and services are reliable and scalable and
     integrate with products and services provided by other industry suppliers
     chosen by the network operator;

 .    video-on-demand is a compelling consumer product and viewers will purchase
     video-on-demand content at prices and in quantities that will justify the
     network operator's investment in our video-on-demand products and services
     rather than alternative entertainment services such as pay-per-view and
     near-video-on-demand;

 .    our video-on-demand products are compatible with industry standards as they
     evolve; and

 .    our technology enables the network operator to add new revenue-generating
     services.

     If we are unable to persuade network operators to purchase our products or
services and deploy video-on-demand and other interactive services broadly in
their cable systems, the growth of our business will suffer.

If the existing commercial deployments of our video-on-demand service with
network operators are not expanded, our results of operations and our reputation
will suffer

     Our existing deployments with Charter and AT&T currently serve a small
percentage of each company's basic subscriber base. These network operators may
not continue these deployments beyond the terms of our existing agreements, and
they may choose not to broadly deploy our video-on-demand solution in existing
or additional cable systems. In the past, we had limited scope video-on-demand
trials with other network operators that did not result in broad deployments. If
we are unable to add a substantial number of cable systems to the existing
contracts with the network operators currently deploying our products and
services, and if video-on-demand is not broadly deployed in each cable system
under contract, our results of operations will suffer. In addition, our
reputation and our ability to enter into agreements with other network operators
could be impaired.

Our products and services will not achieve widespread adoption unless network
operators deploy digital set-top boxes and roll out and market video-on-demand
service to subscribers, all of which are beyond our control

     Our ability to achieve widespread adoption of our video-on-demand products
and services depends on a number of other factors, many of which are beyond our
control, including:

 .    the rate at which network operators upgrade deploy digital set-top boxes;

                                      -24-

<PAGE>

 .    the ability of network operators to provide timely and effective marketing
     campaigns coordinated with the launch of video-on-demand;

 .    the ability of network operators to maintain their cable infrastructure and
     headends in accordance with system specifications provided by us;

 .    the success of network operators in marketing video-on-demand service;

 .    the prices that network operators set for video-on-demand movies and other
     content and for installation or activation of video-on-demand service;

 .    the speed at which network operators can complete the installations
     required to initiate service for new subscribers;

 .    the quality of customer and technical support provided by us, network
     operators, and by other third parties whose products are integrated with
     ours; and

 .    the availability and quality of content delivered to subscribers through a
     video-on-demand service.

We expect rapid technological developments to occur in our industry and,
accordingly, must continue to enhance our current products as well as develop
new technologies, or competitors could render our products and services obsolete

     We expect rapid technological developments to occur in the market for
interactive home video entertainment products and services. As a result, we have
modified and expect to continue to modify our engineering and development plans.
These modifications have resulted in delays and increased costs. Furthermore, we
expect that we will be required to continue to enhance our current interactive
products and services and develop and introduce increased functionality and
performance to keep pace with technological developments and consumer
preferences. In addition, we may not be successful in developing and marketing
product and service enhancements or new services that respond to technological
and market changes, and we may experience difficulties that could delay or
prevent the successful development, introduction and marketing of such new
product and service enhancements. Our failure to successfully develop these
products could harm our business. We have encountered delays in product
development, service integration and field tests, and other difficulties
affecting both software and hardware components of our system and our ability to
operate successfully over hybrid fiber-coaxial plant. In addition, many of our
competitors have substantially greater resources than us to devote to further
technological and new product development. Technological and market changes or
other significant developments by our competitors may render our video-on-demand
products and services obsolete.

Our lengthy sales cycle may cause fluctuations in our operating results

     We believe that the purchase of our products and services involves a
significant commitment of capital and other resources by a network operator. In
many cases, the decision to purchase our products and services requires network
operators to change their established business practices and conduct their
business in new ways. As a result, we need to educate network operators on the
use and benefits of our products and services, which can require significant
time and resources without necessarily resulting in revenues. In addition,
network operators generally must consider a wide range of other issues before
committing to purchase and incorporate our technology into their offerings and
obtain approval at a number of levels of management. Our sales cycle has ranged
from six months to a number of years. Our lengthy sales cycle limits our ability
to forecast the timing and amount of specific sales.

The market for our video-on-demand products and services is intensely
competitive, and our current and potential competitors have significantly
greater resources than we do. Consequently, we may not be able to compete
effectively, which would harm our operating results

     Competition in both the video-on-demand market and the broader market for
in-home video entertainment is intense and subject to rapid technological
change. We expect competition in the market for video-on-demand products and
services to intensify in the future. We categorize our video-on-demand
competitors as follows:

                                      -25-

<PAGE>

 .    server manufacturers, such as Concurrent, nCUBE and SeaChange;

 .    software providers, such as Prasara and Scientific-Atlanta; and

 .    system integrators, such as Time Warner and Scientific-Atlanta.

     We provide products and services that compete in all three categories.
Although none of our video-on-demand competitors offer products and services in
all of these categories, some of them may form alliances in order to develop an
integrated end-to-end video-on-demand system that may be more attractive to
network operators and their subscribers than ours. Some of our video-on-demand
competitors have long-standing business relationships with network operators and
may be able to use those relationships to gain a competitive advantage over us.
In addition, we may pursue strategic partnerships in order to decrease our
operating and capital expenditures on a going forward basis, which may include
outsourcing certain of the elements necessary to deploy our video-on-demand
solution to third parties, including our competitors. To the extent that any
outsourced element fails to perform to specification or is subject to
manufacturing or other delays, the performance, reliability and market
acceptance of our video-on-demand solution may be impaired. These factors may
adversely affect our ability to compete effectively, even against the
competitors to which elements of our video-on-demand solution may be outsourced.

     In addition to video-on-demand competitors, we compete in the market for
in-home video entertainment. We believe our competitors fall into three groups:

 .    companies that provide in-home video entertainment over cable networks,
     including providers of pay-per-view and near-video-on-demand;

 .    companies that deliver in-home video entertainment over networks, such as
     regular telephone lines, digital subscriber lines, or DSL, satellite or the
     Internet, and some providers of video streaming technology; and

 .    companies that enable the viewer to store and access content on an
     "on-demand" basis, including providers of personal video recorders, such as
     TiVo, UtlimateTV and Replay TV, and companies that rent and sell
     videotapes.

     Many of our competitors and potential competitors have longer operating
histories, greater name recognition and significantly greater financial,
technical, marketing and distribution resources than we have. As a result, they
may be able to respond to new or emerging technologies and changes in customer
requirements faster than we do. They may also be able to devote greater
resources to the development, promotion and sale of their products and services
and may do so in a more effective manner. We may be unable to compete
successfully against current or future competitors, and competitive pressures
that we face may harm our business.

If we fail to manage our growth effectively, our ability to implement our
business strategies may be limited

     In order to execute our business strategy, we must meet aggressive
engineering, integration, product delivery and installation targets. The growth
in our business has placed and is expected to continue to place significant
demands on our management, operating, development, third party manufacturing,
assembly, test and financial and accounting resources. Our ability to manage
growth effectively will require continued implementation of and improvements to
our operating, manufacturing, development and financial and accounting systems
and will require us to expand and continue to train and manage our employee
base. These demands likely will require the addition of new management personnel
and the development of additional expertise by existing management personnel.
Our systems, procedures or controls or financial resources may be inadequate to
support our operations, and our management may be unable to keep pace with this
growth. If we are unable to manage our growth effectively, our business ability
to successfully implement our business strategies will suffer.

If we are unable to adequately protect or enforce our intellectual property
rights, we could suffer competitively, incur costly litigation expenses or lose
valuable assets

     Our future success depends, in part, on our ability to protect our
intellectual property and maintain the proprietary nature of our technology
through a combination of patents, licenses and other intellectual property
arrangements. We have been awarded patents and have filed applications and
intend to file additional applications

                                      -26-

<PAGE>

for patents covering various aspects of our video-on-demand products and
services. Any patents issued may be challenged, invalidated or circumvented, and
the rights granted under any patents might not provide proprietary protection to
us. We may not be successful in maintaining these proprietary rights, and our
competitors may independently develop or patent technologies that are
substantially equivalent or superior to our technologies. To the extent we
integrate our products with those of third parties, including competitors, we
may be required to disclose or license intellectual property to those companies,
and these companies could appropriate our technology or otherwise improperly
exploit the information gained through this integration. If we believe third
parties are infringing our intellectual property, we may be forced to expend
significant resources enforcing our rights or suffer competitive injury.

If third parties claim that we infringe their intellectual property, our ability
to use some technologies and products could be limited, and we may incur
significant costs to resolve these claims

     From time to time, we have received notices from third parties claiming
infringement of intellectual property rights. Although we do not believe that we
infringe any third party's intellectual property rights, we could encounter
similar claims or litigation in the future. Because patent applications in the
United States are not publicly disclosed until the patent has been issued,
applications may have been filed that, if issued as patents, would relate to our
products. In addition, we have not completed a comprehensive patent search
relating to the technology used in our video-on-demand products and services.

     Parties making claims of infringement may be able to obtain injunctive or
other equitable relief that could effectively block our ability to provide our
products and services in the United States and internationally and could result
in an award of substantial damages. In the event of a successful claim of
infringement, our customers and we may be required to obtain one or more
licenses from third parties, which may not be available at a reasonable cost or
at all. The defense of any lawsuit could result in time consuming and expensive
litigation regardless of the merits of such claims, and damages, license fees,
royalty payments and restrictions on our ability to provide our video-on-demand
products or services, any of which could harm our business.

We rely on several sole or limited source suppliers and manufacturers, and our
production will be seriously harmed if these suppliers and manufacturers are not
able to meet our demand and alternative sources are not available

     We subcontract manufacturing of our hardware to a single contract
manufacturer. We do not have a contract with this manufacturer and operate on a
purchase order basis. Because of the complexity of our hardware components,
manufacturing and quality control are time-consuming processes. Our contract
manufacturer may be unable to meet our requirements in a timely and satisfactory
manner, and we may be unable to find or maintain a suitable relationship with
alternate qualified manufacturers. Our reliance on a third-party manufacturer
involves a number of additional risks, including the absence of guaranteed
capacity and reduced control over delivery schedules, quality assurance,
production yields and costs. In the event we are unable to obtain such
manufacturing on commercially reasonable terms, our production would be
seriously harmed.

     Various subassemblies and components used in our video server and access
equipment are procured from single sources and others are procured only from a
limited number of sources. Consequently, we may be adversely affected by
worldwide shortages of components, significant price increases, reduced control
over delivery schedules, and manufacturing capability, quality and cost.
Although we believe alternative suppliers of products, services, subassemblies
and components are available, the lack of alternative sources could harm our
ability to deploy our video-on-demand systems. Manufacturing lead times can be
as long as nine months for some critical components. Therefore, we may require
significant working capital to pay for such components well in advance of both
hardware orders and revenues. Moreover, a prolonged inability to obtain
components could harm our business and could result in damage to network
operator relationships.

     Various software elements used in our products are licensed from single
providers. Consequently, we may be adversely affected by significant price
increases, claims that such licensed software infringes the intellectual
property of other third parties, or failure of licensors to update their
products or offer updated products at a reasonable cost. Although we believe
alternative suppliers of software products are available, the lack of
alternative sources could harm our ability to sell, maintain or update our
interactive products and services.

                                      -27-

<PAGE>

If we are unable to acquire programming content on reasonable terms, our ability
to derive revenues from video-on-demand deployments will be limited

     In those network operator deployments where we provide programming content,
our success will depend, in part, on our ability to obtain access to sufficient
movies (including new releases and library titles), special interest videos and
other programming content on commercially acceptable terms. Although we have
entered into arrangements with major movie studios and other content providers,
we may not be able to continue to obtain the content. In addition, for content
we do procure, we may not be able to make the content available to
video-on-demand customers during the segment of time available to other
video-on-demand providers and to programmers such as pay-per-view providers.
Studios may require us to make prepayments prior to the time that customers pay
for viewing a title or require us to enter into long-term contracts with
significant minimum payments. Further, studios may increase the license fees
currently charged to us. If we are unable to obtain timely access to content on
commercially acceptable terms, our ability to obtain revenue from deployments
where we provide content will be limited. Further, to the extent that major
movie studios pursue announced efforts to restrict or eliminate content made
available for video-on-demand delivery, video-on-demand as a product may not be
broadly deployed, and all providers of video-on-demand products and services,
including us, may not be able to sell interactive products and services to
network operators. If availability of compelling video-on-demand content,
including first run movies, is restricted or eliminated, the ability for us to
obtain revenue from sales of interactive products and services may be
significantly limited.

Competition for qualified personnel is intense in technology industries such as
ours, and we may not be able to maintain or expand our business if we are unable
to hire and retain sufficient technical, sales, marketing and managerial
personnel

     Competition for qualified personnel in technology industries is intense,
particularly in Silicon Valley. We may not be able to attract and retain
qualified personnel in the future. If we are unable to hire and retain
sufficient technical, sales and marketing and managerial personnel, our business
will suffer. Our future success depends in part on the continued service of our
key engineering, sales, marketing, manufacturing, finance and executive
personnel. If we fail to retain and hire a sufficient number and type of
personnel, we will not be able to maintain and expand our business.

We intend to expand our video-on-demand products and services internationally
and these efforts may not be successful in generating revenues sufficient to
offset the associated expense

     International deployments may require adaptation of our products to perform
on technical platforms that may differ depending on the country in which our
interactive products and services are deployed. We expect to expend significant
financial, operational and managerial resources to do so. If our revenues from
international operations do not meet our expectations, our operating results
will be adversely affected. We face risks inherent in conducting business
internationally, including:

 .    unexpected changes in regulatory requirements and tariffs that may be
     imposed on our services;

 .    difficulties and costs of staffing and managing international operations;

 .    differing technology standards and difficulties in obtaining export and
     import licenses;

 .    longer payment cycles, difficulties in collecting accounts receivable and
     longer collection periods;

 .    political and economic instability;

 .    fluctuations in currency exchange rates;

 .    imposition of currency exchange controls;

 .    potentially adverse tax consequences; and

 .    reduced protection for intellectual property rights in some countries.

                                      -28-

<PAGE>

     Any of these factors could adversely affect our international operations
and, consequently, our business and operating results. Specifically, our failure
to manage our international growth successfully could result in higher operating
costs than anticipated, or could delay or preclude our ability to generate
revenues in key international markets.

Network operators are subject to government regulations that could require us to
change our products and services

     In the United States, the Federal Communications Commission, or FCC, has
broad jurisdiction over network operators. The FCC does not regulate us, but
requirements imposed on network operators could force us to undertake
development that would consume significant resources and require changes to our
products and services. If we do not change our products so that they comply with
FCC rules, or if our products are not integrated with ones that comply with FCC
requirements, our products and services will not be broadly deployed, and our
business will suffer.

     In addition, video-on-demand services in Canada and in the United Kingdom
and other European Union members are licensed in a variety of ways. We are
seeking to determine how best to offer our video-on-demand products and services
in Canada, the United Kingdom and other European Union countries. We may not be
able to obtain distribution rights to movie titles in non-U.S. jurisdictions
under regulatory and financial arrangements acceptable to us.

Insiders have significant influence over our efforts

     Our major stockholders and directors, together with entities affiliated
with them, own approximately 74% of our outstanding Common Stock (assuming
conversion of all outstanding Preferred Stock into Common Stock) at June 30,
2001. Accordingly, these stockholders have significant influence over our
affairs. This concentration of ownership could have the effect of delaying or
preventing a change in control of DIVA.

Forward-Looking Statements

     The statements contained in the "Factors Affecting Operating Results"
section that are not historical facts are "forward-looking statements," which
can be identified by the use of forward-looking terminology such as "estimates,"
"projects," "anticipates," "expects," "intends," "believes," or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties. These forward-looking
statements, including statements regarding market opportunity, deployment plans,
market acceptance, our business models, capital requirements, anticipated net
losses and negative cash flow, revenue growth, anticipated operating
expenditures and product development plans are only estimates or predictions and
cannot be relied upon. No assurance can be given that future results will be
achieved; actual events or results may differ materially as a result of risks
facing us or actual results differing from the assumptions underlying such
statements. Such risks and assumptions include, but are not limited to, those
discussed in this "Factors Affecting Operating Results" section, which could
cause actual results to vary materially from the future results indicated,
expressed or implied in such forward-looking statements. We disclaim any
obligation to update information contained in any forward-looking statement.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market Risk Disclosures

     The following discussion about our market risk disclosures contains
forward-looking statements. Forward-looking statements are subject to risks and
uncertainties. Actual results could differ materially from those discussed in
the forward-looking statements. We are exposed to market risk related to changes
in interest rates and foreign currency exchange rates.

                                      -29-

<PAGE>

Interest Rate Sensitivity

     We maintain a short-term investment portfolio consisting mainly of income
securities with an average maturity of less than one year. These
available-for-sale securities are subject to interest rate risk and will fall in
value if market interest rates increase. We have the ability to hold our fixed
income investments until maturity and therefore, we would not expect our
operating results or cash flows to be affected to any significant degree by the
effect of a sudden change in market interest rates on our securities portfolio.*

     Our short-term investments have generally been available-for-sale. Gross
unrealized gains and losses were not significant as of June 30, 2001.

     The following table presents the principal amounts and related
weighted-average yields for our fixed rate investment portfolio (in thousands,
except average yields) at June 30, 2001.

                                               Carrying            Average
                                                Amount               Yield
                                              ----------           --------
U.S. government obligations                   $   12,797             4.05%
Commercial paper                                   1,047             4.25%
Certificates of deposits                           2,172             3.44%
Money market instruments                           3,131             3.08%
Auction rate preferred stock certificates         14,168             4.47%
                                              ----------

                  Total                           33,315


Included in cash and cash equivalents             19,146
Included in short-term investments                14,169
                                              ----------

                                              ==========
                  Total                       $   33,315
                                              ==========


     Foreign Currency Risks

     We believe that our exposure to currency exchange fluctuation risk is
insignificant because our transactions with international vendors are generally
denominated in U.S. dollars, which is considered to be the functional currency
for our company and subsidiaries. The currency exchange impact on intercompany
transactions for fiscal 2001 was $224,000.

                                      -30-

<PAGE>

Item 8.  Financial Statements and Supplementary Data

                                                                    Page

Independent Auditors' Report....................................     32

Consolidate Balance Sheets .....................................     33

Consolidated Statement of Operations ...........................     34

Consolidated Statement of Stockholders' Deficit ................     35

Consolidated Statement of Cash Flows ...........................     36

Notes to Consolidated Statement Financial Statements ...........     37


                                      -31-

<PAGE>

                          Independent Auditors' Report

The Board of Directors
DIVA Systems Corporation:

     We have audited the accompanying consolidated balance sheets of DIVA
Systems Corporation and subsidiaries (the Company) as of June 30, 2000 and
2001, and the related consolidated statements of operations, stockholders'
deficit, and cash flows for each of the years in the three-year period ended
June 30, 2001. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

     We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of DIVA Systems
Corporation as of June 30, 2000 and 2001, and the results of their operations
and their cash flows for each of the years in the three-year period ended June
30, 2001, in conformity with accounting principles generally accepted in the
United States of America.

     The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1 to the consolidated financial statements, the Company has suffered recurring
losses from operations, has a net capital deficiency, and believes it will not
be able to fund its operations beyond March 31, 2002 based on existing cash,
cash equivalents and short term investments. These matters raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.

/s/ KPMG LLP

Mountain View, California
July 27, 2001

                                      -32-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                           Consolidated Balance Sheets
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                                          June 30,
                                                                                  -----------------------
                                     Assets                                          2000         2001
                                                                                  ----------   ----------
<S>                                                                               <C>          <C>
Current assets:
    Cash and cash equivalents                                                     $  66,253    $  19,146
    Short-term investments                                                           26,429       14,169
    Accounts receivable                                                                 264       15,090
    Inventory                                                                         3,143       15,947
    Prepaid expenses and other current assets                                         3,520          775
                                                                                  ---------    ---------

          Total current assets                                                       99,609       65,127

Property and equipment, net                                                          12,648       12,433
Debt issuance costs, net                                                              6,500        4,652
Deposits and other assets                                                               596          597
Intangible assets, net                                                                  134           --
                                                                                  ---------    ---------

       Total assets                                                               $ 119,487    $  82,809
                                                                                  =========    =========

       Liabilities, Redeemable Warrants, and Stockholders' Deficit

Current liabilities:
    Accounts payable                                                              $   5,121    $  14,440
    Other current liabilities                                                         4,441        5,127
    Deferred revenue                                                                  1,015        2,126
    Current portion of capital lease obligation                                         676          738
                                                                                  ---------    ---------
      Total current liabilities                                                      11,253       22,431

Notes payable                                                                       312,815      355,517
Redeemable put warrants                                                              11,989        7,326
Long-term portion of lease payable                                                    1,029          292
Deferred rent                                                                           780          892
                                                                                  ---------    ---------
           Total liabilities                                                        337,866      386,458
                                                                                  ---------    ---------
Redeemable warrants                                                                   7,007        5,364
                                                                                  ---------    ---------

Commitments and contingencies

Stockholders' deficit:
Preferred stock, $0.001 par value; 80,000,000 shares authorized
     in 2000 and 2001, respectively; 24,495,463, and 25,120,851
     shares issued and outstanding as of June 30, 2000, and 2001,
     respectively; (liquidation preference of $125,567 and $130,636
     as of June 30, 2000 and 2001, respectively)                                         24           25
Common stock, $0.001 par value; 165,000,000 shares authorized
     in 2000 and 2001, respectively; 18,615,618 and 19,086,839
     shares issued and outstanding as of June 30, 2000 and 2001,
     respectively                                                                        19           19
 Additional paid-in capital                                                         138,211      147,682
 Deferred compensation                                                               (5,954)      (3,592)
 Accumulated deficit                                                               (357,686)    (453,147)
                                                                                  ---------    ---------

              Total stockholders' deficit                                          (225,386)    (309,013)
                                                                                  ---------    ---------
          Total liabilities, redeemable warrants, and stockholders' deficit       $ 119,487    $  82,809
                                                                                  =========    =========
</TABLE>

     See accompanying notes to consolidated financial statements.

                                       -33-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                      Consolidated Statements of Operations
                      (in thousands, except per share data)


<TABLE>
<CAPTION>
                                                                      Years ended June 30,
                                                      ------------------------------------------------------
                                                           1999                2000               2001
                                                     ----------------   -----------------   ----------------
<S>                                                  <C>                <C>                 <C>
Revenue:
   Product                                            $             --   $           1,380   $        11,173
   License                                                          --                  46             4,917
   Service                                                         293                 531             2,391
                                                      ----------------   -----------------   ---------------

         Total revenues                                            293               1,957            18,481

Cost of revenues:
   Cost of product revenue                                          --               4,224            18,656
   Cost of service revenue                                       8,159               4,300             5,383
                                                      ----------------   -----------------   ---------------

         Total cost of revenues                                  8,159               8,524            24,039
                                                      ----------------   -----------------   ---------------

Negative gross margin                                            7,866               6,567             5,558
                                                      ----------------   -----------------   ---------------
Operating expenses:
   Operations                                                    8,162               6,684            5,614
   Engineering and development                                  24,321              27,080           31,444
   Sales and marketing                                           5,707               8,159            6,784
   General and administrative                                   15,843              21,380           24,243
   Depreciation and amortization                                19,305               6,826            5,886
   Warrant expense                                                  --               2,075              782
   Amortization of stock compensation                              738               2,583            3,776
                                                      ----------------   -----------------   --------------

         Total operating expenses                               74,076              74,787           78,529
                                                      ----------------   -----------------   --------------

         Operating loss                                         81,942              81,354           84,087
                                                      ----------------   -----------------   --------------
Other (income) expense, net:

   Interest income                                              (8,645)             (6,057)          (3,618)
   Gain on sale of investments                                      --                  --          (24,421)
   Interest expense                                             33,967              39,016           39,413
                                                      ----------------   -----------------   --------------
         Total other expense, net                               25,322              32,959           11,374
                                                      ----------------   -----------------   --------------
         Net loss                                              107,264             114,313           95,461

Accretion/(Decrement)  of redeemable warrants
and issuance of redeemable put warrants                            969              16,888           (1,642)
                                                      ----------------   -----------------   --------------
         Net loss attributable to
           common stockholders                        $        108,233         $  131,201    $       93,819
                                                      ================   ================    ==============

Basic and diluted net loss per share:                 $           6.31   $           7.29    $         4.96
                                                      ================   ================    ==============

Shares used in per share computation                            17,147             17,987            18,886
                                                      ================   ================    ==============
</TABLE>

See accompanying notes to the consolidated financial statements.

                                      -34-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                Consolidated Statements of Stockholders' Deficit
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                                                                          Additional
                                                                               Preferred stock          Common stock        paid-in
                                                                           ---------------------------------------------
                                                                              Shares      Amount     Shares      Amount     capital
                                                                           ------------  -------  ------------  --------  ----------
<S>                                                                        <C>           <C>      <C>           <C>       <C>
Balances as of June 30, 1998                                                21,372,287       21    17,200,178      17       115,759



Accretion of redeemable warrants                                                    --       --            --      --          (969)
Deferred compensation expense on stock option issuances                             --       --            --      --         1,986
Amortization of deferred compensation expense                                       --       --            --      --            --
Exercise of common stock options                                                    --       --       278,120      --           305
Issuance of common stock in June 1999 at $3.35 per share as
  compensation for services                                                         --       --        30,650      --           103
Repurchase of common stock                                                          --       --       (45,374)     --           (20)
Exercise of Series AA preferred stock options                                   17,996       --            --      --             6
Net loss                                                                            --       --            --      --            --

                                                                            ----------     ----    ----------    ----     ---------
Balances as of June 30, 1999                                                21,390,283       21    17,463,574      17       117,170



Accretion of redeemable warrants                                                    --       --            --      --        (4,899)
Issuance of put warrants associated with the 1996 notes                             --       --            --      --       (11,989)
Deferred compensation expense on stock option issuances                             --       --            --      --         7,289
Amortization of deferred compensation expense                                       --       --            --      --            --
Exercise of common stock options                                                    --       --     1,171,215       2         1,562
Sales of Series E, F and G preferred stock in December, April and May
2000 at $9.00 per share, net of issuance costs                               3,000,002        3            --      --        26,997
Repurchase of common stock                                                         (57)      --       (19,171)     --           (12)
Exercise of Series AA preferred stock options                                  105,235       --            --      --            18
Issuance of warrants                                                                --       --            --      --         2,075
Net loss                                                                            --       --            --      --            --

                                                                            ----------     ----    ----------    ----     ---------
Balances as of June 30, 2000                                                24,495,463     $ 24    18,615,618    $ 19     $ 138,211



Accretion of redeemable warrants                                                    --       --            --      --         1,642
Deferred compensation expense on stock option issuances                             --       --            --      --         1,414
Amortization of deferred compensation expense                                       --       --            --      --            --
Exercise of common stock options                                                    --       --       471,221      --           575
Sales of Series F in September 2001 at $9.00 per share, net of
  issuance costs                                                               555,556        1            --      --         4,999
Exercise of Series AA preferred stock options                                    1,840       --            --      --             1
Exercise of Series B preferred stock options                                    67,992       --            --      --            58
Issuance of warrants                                                                --       --            --      --           782
Net loss                                                                            --       --            --      --            --

                                                                            ----------     ----    ----------    ----     ---------
Balances as of June 30, 2001                                                25,120,851     $ 25    19,086,839    $ 19     $ 147,682
                                                                            ==========     ====    ==========    ====     =========

<CAPTION>
                                                                                                                 Total
                                                                               Deferred      Accumulated     stockholders'

                                                                             compensation      deficit          deficit
                                                                            -----------------------------------------------
<S>                                                                         <C>              <C>             <C>
Balances as of June 30, 1998                                                           --       (136,109)         (20,312)



Accretion of redeemable warrants                                                      --             --             (969)
Deferred compensation expense on stock option issuances                           (1,986)            --               --
Amortization of deferred compensation expense                                        738             --              738
Exercise of common stock options                                                      --             --              305
Issuance of common stock in June 1999 at $3.35 per share as
  compensation for services                                                           --             --              103
Repurchase of common stock                                                            --             --              (20)
Exercise of Series AA preferred stock options                                         --             --                6
Net loss                                                                              --       (107,264)        (107,264)

                                                                              ----------     ----------       ----------
Balances as of June 30, 1999                                                      (1,248)      (243,373)        (127,413)



Accretion of redeemable warrants                                                      --             --           (4,899)
Issuance of put warrants associated with the 1996 notes                               --             --          (11,989)
Deferred compensation expense on stock option issuances                           (7,289)            --               --
Amortization of deferred compensation expense                                      2,583             --            2,583
Exercise of common stock options                                                      --             --            1,564
Sales of Series E, F and G preferred stock in December, April and May
2000 at $9.00 per share, net of issuance costs                                        --             --           27,000
Repurchase of common stock                                                            --             --              (12)
Exercise of Series AA preferred stock options                                         --             --               18
Issuance of warrants                                                                  --             --            2,075
Net loss                                                                              --       (114,313)        (114,313)

                                                                              ----------     ----------       ----------
Balances as of June 30, 2000                                                  $   (5,954)    $ (357,686)      $ (225,386)



Accretion of redeemable warrants                                                      --             --            1,642
Deferred compensation expense on stock option issuances                           (1,414)            --               --
Amortization of deferred compensation expense                                      3,776             --            3,776
Exercise of common stock options                                                      --             --              575
Sales of Series F in September 2001 at $9.00 per share, net of
  issuance costs                                                                      --             --            5,000
Exercise of Series AA preferred stock options                                         --             --                1
Exercise of Series B preferred stock options                                          --             --               58
Issuance of warrants                                                                  --             --              782
Net loss                                                                              --        (95,461)         (95,461)

                                                                              ----------     ----------       ----------
Balances as of June 30, 2001                                                  $   (3,592)    $ (453,147)      $ (309,013)
                                                                              ==========     ==========       ==========
</TABLE>


See accompanying notes to consolidated financial statements.

                                      -35-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES
                      Consolidated Statements of Cash Flows
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                                                     Years ended June 30,
                                                                                        --------------------------------------------
                                                                                           1999             2000            2001
                                                                                        ------------     ------------    -----------
<S>                                                                                     <C>              <C>             <C>
Cash flows from operating activities
   Net loss                                                                               $(107,264)      $(114,313)      $ (95,461)
   Adjustments to reconcile net loss to net
      cash used in operating activities:
        Depreciation and amortization                                                        19,305           6,826           5,886
        Loss on disposition of property and equipment                                         1,264            --              --
        Inventory write down                                                                   --             2,626           3,887
        Amortization of debt issuance costs and
          accretion of discount on notes payable                                             33,943          38,902          39,887
        Issuance of stock for services                                                          103            --              --
        Amortization of deferred stock compensation                                             738           2,583           3,776
        Warrant expense                                                                        --             2,075             782
        Gain on sale of investments                                                            --              --           (24,421)
        Changes in operating assets and liabilities:
          Accounts receivable                                                                  --              (264)        (14,826)
          Inventory                                                                            --            (2,550)        (16,691)
          Other assets                                                                       (1,368)         (1,424)          2,745
          Accounts payable                                                                     (263)          2,337           9,319
          Other current liabilities                                                             (79)          3,220             686
          Deferred rent                                                                        --               780             112
          Deferred revenue                                                                     --             1,015           1,111
                                                                                          ---------       ---------       ---------

             Net cash used for operating activities                                         (53,621)        (58,187)        (83,208)
                                                                                          ---------       ---------       ---------

Cash flows from investing activities:
    Purchases of property and equipment                                                     (13,497)         (8,055)         (5,663)
    Proceeds from the sale of investments                                                      --              --            24,421
    Purchase of short-term investments                                                     (113,072)        (27,749)        (21,670)
    Proceeds from the sale of short-term investments                                        101,589          42,818          33,930
    Proceeds from the sale of assets                                                           --                69             125
                                                                                          ---------       ---------       ---------

             Net cash provided (used) by investing activities                               (24,980)          7,083          31,143
                                                                                          ---------       ---------       ---------

Cash flows from financing activities:
    Issuance of preferred stock, net                                                           --            27,000           5,000
    Exercise of stock options                                                                   311           1,582             633
    Repurchase of stock                                                                         (20)            (12)           --
    Payments on capital lease                                                                  --              (415)           (675)
    Payments on notes payable                                                                  --               (37)           --
                                                                                          ---------       ---------       ---------

             Net cash provided by financing activities                                          291          28,118           4,958
                                                                                          ---------       ---------       ---------

Net decrease in cash and cash equivalents                                                   (78,310)        (22,986)        (47,107)

Cash and cash equivalents at beginning of year                                              167,549          89,239          66,253
                                                                                          ---------       ---------       ---------

Cash and cash equivalents at end of year                                                  $  89,239       $  66,253       $  19,146
                                                                                          =========       =========       =========

Supplemental disclosures of cash flow information:
    Noncash investing and financing activities:
      Issuance / revaluation of put warrants associated with the 1996 notes               $    --         $  11,989       $   4,663
                                                                                          =========       =========       =========
      Accretion / (decrement) of redeemable warrants                                      $     969       $   4,899       $  (1,642)
                                                                                          =========       =========       =========
      Deferred compensation associated with
        stock option activity                                                             $   1,986       $   7,289       $   1,414
                                                                                          =========       =========       =========
      Transfer of property and equipment to inventory                                     $   2,663       $     556       $    --
                                                                                          =========       =========       =========
      Equipment acquired under capital lease obligations                                  $    --         $   2,120       $    --
                                                                                          =========       =========       =========
    Interest paid                                                                         $       5       $     114       $     124
                                                                                          =========       =========       =========
</TABLE>

See accompanying notes to consolidated financial statements.

                                      -36-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(1) Description of Business and Summary of Significant Accounting Policies


(a) Description of Business

    DIVA Systems Corporation (the Company) is a leading provider of interactive,
video-on-demand products and services. The Company was incorporated on June 15,
1995.

    To date the Company has incurred significant operating losses and will
require substantial additional funds in order to continue the development, sale,
licensing and provisioning of its video-on-demand products and services. In
addition, commencing on September 1, 2003, the Company is required to make cash
interest payments on its indebtedness. The Company has made and expects to
continue to make significant investments in working capital in order to fund
development activities, sell its video-on-demand products and services and fund
operations. The Company expects to continue to incur significant operating
losses and expects that its operating cash flow will be negative for at least
the next few years. The Company believes its cash, cash equivalents and
short-term investments will be sufficient to fund its operations through March
31, 2002. Thereafter, the Company will need to raise additional funds to support
its operations by raising debt or equity financing, selling assets, or entering
into strategic relationships. The Company is currently engaged in discussions
and activities to raise additional funds. However at the present time there are
no commitments or arrangements assuring it of any future equity or debt
financing.

    During fiscal 2001, the Company took several actions to address its
declining cash position, including a 15% headcount reduction in its workforce in
March 2001 and the shutdown of development activities related to its interactive
program guide technology in June 2001. The Company is contemplating additional
measures to reduce its operating expenses and working capital requirements on a
going forward basis; however, there can be no assurance that such actions can be
implemented or, if implemented, will be successful. In addition, the Company has
had a number of discussions with a committee of holders of its senior discount
notes, which committee represents over 50% of the outstanding senior discount
notes, and their financial and legal advisors. To date, these discussions have
focused on a restructuring of the Company's senior discount notes and its future
funding requirements. There can be no assurance that such discussions will
result in a restructuring of the Company's outstanding indebtedness or any
additional funding commitment.

(b) Principles of Consolidation

    The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries in the United States, Canada and
the United Kingdom. All significant intercompany accounts and transactions have
been eliminated in consolidation.

(c) Cash, Cash Equivalents, and Short-Term Investments

    Cash and cash equivalents consist of cash and highly liquid investments such
as money market funds and commercial paper with maturities at date of purchase
of less than 90 days.

    Management determines the appropriate classification of investment
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. As of June 30, 2000 and 2001, all investment securities were
designated as "available-for-sale." Available-for-sale securities are carried at
fair value based on quoted market prices,

                                      -37-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2001 and 2000

with unrealized gains and losses, net of related deferred income taxes, reported
as a component of accumulated other comprehensive income in stockholders'
equity.

    Realized gains and losses and declines in value judged to be other than
temporary on available-for-sale securities are included in the consolidated
statement of operations. There have been no declines in value judged to be other
than temporary through June 30, 2001. The cost of securities is based on the
specific identification method. Interest and dividends on securities classified
as available-for-sale are included in interest income.

(d) Inventories

    Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Provisions to reduce the carrying value of
obsolete, slow moving and nonusable inventory to net realizable value are
charged to either operations or cost of revenues.

(e) Property and Equipment

    Property and equipment are recorded at cost less accumulated depreciation.
Depreciation is calculated using the straight-line method over the estimated
useful lives of the respective assets, generally three to five years. Leasehold
improvements are amortized over the shorter of the estimated useful life or the
related lease term.

(f) Debt Issuance Costs

    Underwriting, legal and accounting fees associated with the issuance of the
notes payable are being amortized to interest expense using the effective
interest method over the term of the notes. Amortization expense in 1999, 2000,
and 2001 was $1,409,000, $1,613,000, and $1,849,000, respectively.

(g) Impairment of Long-Lived Assets

    The Company evaluates its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset might
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the asset exceeds the fair value of the asset. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
costs to sell.

(h) Stock-Based Compensation

    The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans. Deferred stock based compensation is
amortized on an accelerated basis, in accordance with the provisions of the
Financial Accounting Standard Board Interpretation No 28 (FIN 28) over the
vesting period of the applicable options. The Company uses fair value to account
for non-employee stock-based transactions.

                                      -38-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(i) Basic and Diluted Net Loss Per Share

    Basic and diluted net loss per share is computed using net loss adjusted for
the accretion of the redeemable warrants (see Note 3) and the weighted-average
number of outstanding shares of common stock. Potential common and preferred
shares that could dilute earnings per share in future periods but which have
been excluded from the determination of diluted net loss per share because the
effect of such shares would have been anti-dilutive are as follows:

<TABLE>
<CAPTION>
                                                         June 30,
                                     ------------------------------------------------
                                         1999               2000              2001
                                     ------------      -------------      -----------
    <S>                             <C>               <C>                <C>


    Common stock options .........      7,875,745          7,915,921        8,514,980
    Common stock warrants ........      4,862,800          6,196,067        6,195,068
    Preferred stock ..............     21,390,283         24,495,463       25,120,851
    Preferred stock options ......        243,592            102,016           43,468
    Preferred stock warrants .....      2,298,906          3,087,794        2,538,888
</TABLE>


(j) Revenue Recognition

    The Company's contracts are generally multiple-element arrangements with a
network operator involving a combination of video-on-demand hardware products,
licenses for system software and navigator applications and selected content and
operational services. The Company recognizes revenue in accordance with the
American Institute of Certified Public Accountants Statement of Position 97-2
(SOP 97-2), "Software Revenue Recognition," and Statement of Position 98-9 (SOP
98-9), "Software Revenue Recognition, with Respect to Certain Transactions." SOP
97-2 generally requires revenue earned on software arrangements involving
multiple elements to be allocated to each element based on the relative fair
values of the elements. The fair value of an element must be based on vendor
specific objective evidence, which is generally determined by the price charged
when the element is sold separately. SOP 98-9 requires recognition of revenue
using the residual method in a multiple element arrangement when fair value does
not exist for one or more of the delivered elements in the arrangement. Under
the residual method, revenue for the undelivered elements is deferred and
subsequently recognized in accordance with SOP 97-2.

    The Company adopted Staff Accounting Bulletin No. 101, "Revenue Recognition
in Financial Statements" (SAB 101) as amended by SAB 101A and 101B as of April
1, 2001, which provides guidance on the recognition, presentation and disclosure
of revenue in financial statements filed with the Securities and Exchange
Commission. SAB 101 outlines the basic criteria that must be met to recognize
revenues and provides guidance for disclosure related to revenue recognition
policies. The adoption of SAB 101 did not have a material impact on the
Company's consolidated financial position or its results of operations.

    Prior to January 2001, all hardware and software elements were deliverable
over the term of the contract and evidence of the fair value of the individual
elements in our agreements did not exist. As a result, upon the delivery of the
Company's video-on-demand hardware products, revenue was recognized to the
extent of the cost of these hardware products. Any remaining product revenue was
amortized on a straight-line basis over the remaining term of the agreement. The
Company recognized license revenues over the term of the agreement based on the
number of subscribers.

                                      -39-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     All of the Company's installations since January, 2001 have been made under
agreements whereby all hardware and software elements are delivered upon
completion of installation and the training of cable network personnel.
Accordingly, the Company has recognized product revenue and licensing revenue
upon completion of the equipment installation at a customer's site, which
includes completion of technical training, according to the residual method.
Consequently, the fair value of the maintenance element, determined by the
maintenance renewal fee, is deferred and amortized over the maintenance period,
which is generally one year.

     The Company provides services on a fee-for service basis, whereby service
revenue is recognized when the services are performed. If the services are
provided on a revenue sharing basis, service revenue is recognized based on
program purchases by subscribers.

     The Company provides limited warranty rights to its customers. Estimated
warranty obligations are provided by charges to operations in the period in
which the related revenue is recognized. To date, the estimated warranty
obligations have not been considered significant.

(k)  Engineering and Development

     Engineering and development costs, including payments made in conjunction
with research and development arrangements, are charged to operations as
incurred.

(l)  Use of Estimates

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

(m)  Income Taxes

     The Company accounts for income taxes using an asset and liability approach
that results in the recognition of deferred tax assets and liabilities for the
expected future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. The measurement of deferred
tax assets is reduced, if necessary, by a valuation allowance for any tax
benefits whose future realization is uncertain.

(n)  Fair Value of Financial Instruments

     The carrying amount of certain financial instruments, including cash, cash
equivalents, and short-term investments, as well as accounts receivable, other
current liabilities and obligations under capital leases, approximated fair
values as of June 30, 2001, due to the relatively short maturity of these
instruments. The Company's notes payable are held by a number of financial
institutions and are not publicly traded. The Company estimates that the fair
value of the notes payable as of June 30, 2001, based on limited dealer
transactions, approximated $64.8 million.

(o)  Other Comprehensive Income

     The Company had no items of other comprehensive income in all periods
presented.

                                       -40-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES


                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001


(p)  Derivative Instruments and Hedging Activities

     On July 1, 2001, the Company adopted the provisions of Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities" as amended by SFAS 137 and 138. SAFS 133
establishes accounting and reporting standards for derivative instruments and
hedging activities and requires that all derivatives be recognized either as
assets or liabilities at fair value. If certain conditions are met, a derivative
may be specifically designated and accounted for as (a) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows
of a forecast transaction, or (c) a hedge of a foreign currency exposure of a
net investment in a foreign operation, an unrecognized firm commitment, an
available for sale security, or a foreign currency denominated forecast
transaction. If the derivative is designated as a hedging instrument, depending
on the nature of the exposure being hedged, changes in fair value will either be
offset against the change in fair value of the hedged asset, liability, or firm
commitment through earnings, or recognized in other comprehensive income until
the hedged item is recognized in earnings. Derivatives or portions of
derivatives that are not designated as hedging instruments are adjusted to fair
value through earnings and are recognized in the period of change in their fair
value.

     The adoption of SFAS 133 has not had a material effect on the Company's
consolidated financial position or results of operations.


(q)  Recent Accounting Pronouncements

     In September 2000, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 140, "Accounting for the Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities". SFAS No. 140 is effective for transfers
occurring after March 31, 2001 and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
adoption of SFAS No. 140 has not had a material impact on the Company's
consolidated results of operations or financial position.

     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, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. 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 estimable useful
lives be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance with FAS
Statement 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 and
Statement 142 effective July 1, 2002. Furthermore, goodwill and intangible
assets determined to have an indefinite useful life acquired in a purchase
business combination completed after June 30, 2001, but before Statement 142 is
adopted in full 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 and tested for
impairment in accordance with the appropriate pre-Statement 142 accounting
requirements prior to the adoption of Statement 142.

                                       -41-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     As of the date of adoption, the Company does not expect to have any
unamortized goodwill in the balance sheet nor does it expect the adoption of
Statements 141 and 142 to have a material impact on its financial position or
results of operations.

(2)  Financial Statement Details

(a)  Cash, Cash Equivalents and Short-Term Investments

     As of June 30, 2000 and 2001, the fair value of the securities was at gross
amortized cost. The fair value of securities available for sale is as follows
(in thousands):

                                                             June 30,
                                                       ------------------
                                                         2000       2001
                                                       -------    -------
     U.S. government obligations ....................  $27,019    $12,797
     Commercial paper ...............................   45,459      1,047
     Certificates of deposits .......................    2,079      2,172
     Money market instruments .......................    1,225      3,131
     Auction rate preferred stock certificates ......   16,900     14,168
                                                       -------    -------
          Total .....................................  $92,682    $33,315
                                                       =======    =======

     Included in cash and cash equivalents ..........  $66,253    $19,146
     Included in short-term investments .............   26,429     14,169
                                                       -------    -------
          Total .....................................  $92,682    $33,315
                                                       =======    =======


(b)  Inventories

     A summary of inventory is as follows (in thousands):

                                                             June 30,
                                                       ------------------
                                                          2000      2001
                                                       -------    -------
     Raw materials ..................................  $   911    $ 5,243
     Work-in-process ................................    2,232      3,743
     Finished goods .................................       --      6,961
                                                       -------    -------
          Total......................................  $ 3,143    $15,947
                                                       =======    =======

                                      -42-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(c) Property and Equipment

    A summary of property and equipment is as follows (in thousands):


                                                                  June 30,
                                                            -------------------
                                                              2000        2001
                                                            -------     -------
     Furniture and fixtures ............................... $   817     $ 2,684
     Office equipment .....................................     819         404
     Servers and related hardware .........................  10,110       7,791
     Computer and other equipment .........................  16,564       7,767
     Leasehold improvements ...............................   4,147       3,198
     Construction-in-progress .............................     507       1,101
                                                            -------     -------
                                                             32,964      22,945
     Less accumulated depreciation and amortization .......  20,316      10,512
                                                            -------     -------
                                                            $12,648     $12,433
                                                            =======     =======


    Property and equipment includes $2,120 of fixed assets held under capital
    leases at both June 30, 2000 and 2001 respectively.

(d) Other Current Liabilities

    A summary of other current liabilities is as follows (in thousands):

                                                                   June 30,
                                                             -------------------
                                                              2000        2001
                                                             ------      ------
     Accrued compensation .................................  $1,989      $3,635
     Other accrued liabilities ............................   2,452       1,492
                                                             ------      ------
            Total .........................................  $4,441      $5,127
                                                             ======      ======

                                      -43-

<PAGE>




                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(3)  Notes Payable

     In May 1996, the Company completed a debt offering for $47,000,000 of
subordinated discount notes (the "1996 Notes") due May 15, 2006. The 1996 Notes
consisted of 47,000 units of one note and one warrant to purchase 40.4 shares of
common stock at $0.005 per share (the 1996 Warrants). The 1996 Notes were
subordinated to all existing and future indebtedness of the Company.

     Pursuant to a warrant agreement dated May 15, 1996 by and between the
Company and the Bank of New York as the warrant agent, in the event that the
Company did not complete an initial public offering prior to May 15, 2000, the
Company was required to issue on May 15 (to registered warrant holders as of May
1, 2000) additional warrants exercisable in the aggregate into shares of the
Company's common stock representing 5% of the outstanding common stock of the
Company on a fully diluted basis, as defined in the warrant agreement.

     The Company believes that the warrant agreement provides that the number of
additional warrants to be issued should be computed based on the Company's
capitalization on May 15, 1996. Accordingly, additional warrants totaling
1,333,268 with a fair value on issuance of $12.0 million have been issued to the
warrant holders. This has been recorded as an adjustment to additional paid in
capital in fiscal year 2000. Since the warrants are redeemable by the Company,
under certain conditions, a corresponding liability of $12.0 million has been
recorded in the consolidated financial statements in fiscal year 2000. The value
of the redeemable warrants is re-measured each period based on the current fair
value of the shares of common stock into which they are convertible and, a
corresponding charge or credit is recorded in the income statement to reflect
the increase or decrease in value.

     The Company has been advised by certain of the warrant holders that they
believe the warrant agreement should be interpreted to calculate the 5%
additional warrants based on the Company's capitalization at May 15, 2000. If a
May 15, 2000 calculation date were to be used, this would require the issuance
of an additional 1,639,801 warrants. The Company has had discussions with
representatives of the warrant holders regarding this claim, but has not reached
a resolution. To the extent that such resolution, when reached, results in the
issuance of additional warrants, the Company would record an additional
adjustment to additional paid in capital.

     On February 19, 1998, the Company completed a debt offering for
$463,000,000 of 12-5/8% Senior Discount Notes (the "1998 Notes") due March 1,
2008. The 1998 Notes consist of 463,000 units, of which 404,998 were offered for
sale and 58,002 were offered in exchange for all of the 1996 Notes. Each unit
consists of one 1998 Note due 2008 and three warrants each to purchase two
shares of the Company's common stock at $0.005 per share (the "1998 Warrants").
The 1998 Notes are senior unsecured indebtedness of the Company and rank pari
passu with any future unsubordinated unsecured indebtedness and will be senior
to any future subordinated indebtedness of the Company.

     The 1998 Notes were issued at a substantial discount of $212,980,000. Cash
interest payments will commence on September 1, 2003 at the rate of 12 5/8% per
annum.

                                       -44-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     Pursuant to a warrant agreement dated as of February 19, 1998 by and
between the Company and The Bank of New York as the warrant agent, upon the
occurrence of certain consolidations and mergers and assets sales and subject to
certain conditions and limitations, the Company will be required to offer to
repurchase all outstanding 1998 Warrants at the Repurchase Price, as defined.

     The effective interest rate of the 1998 Notes, reflecting the allocation
for warrants and costs associated with the debt offering, is 14.1%. The 1998
Notes are callable at a declining premium after March 1, 2003, after which the
Company may redeem in whole or in part the 1998 Notes prior to March 1, 2003, by
paying a specified premium over the accreted principal value. The redemption
premiums are as follows, during the period commencing March 1 of such year:

                    Year                             Percentage
                    ----                             ----------
                    2002                               104.20%
                    2003                               102.10%
                    2004 and thereafter                100.00%


     Notes payable consists of the following 1998 note components (in
thousands):

                                                          June 30,
                                                ---------------------------
                                                   2000              2001
                                                ---------         ---------
     Principal .........................        $ 463,000         $ 463,000
     Discount ..........................         (231,037)         (231,037)
     Amortized Discount.................           80,852           123,554
                                                ---------         ---------
          Total ........................        $ 312,815         $ 355,517
                                                =========         =========

(4) Income Taxes

     The reconciliation between the amount computed by applying the U.S. federal
statutory tax rate of 34% to loss before income taxes and the actual provision
for income are as follows (in thousands):

<TABLE>
<CAPTION>

                                                                          Year ended June 30,
                                                                        ---------------------
                                                                          2000         2001
                                                                        --------   ----------
<S>                                                                     <C>        <C>
     Income tax expense at statutory rate ............................  $ (38,929) $ (32,457)
     Net operating losses and temporary differences for which no
         benefit is currently recognized .............................     38,916     29,908
     Other ...........................................................         13      2,549
                                                                        ---------  ---------
          Total ......................................................  $      --  $      --
                                                                        =========  =========
</TABLE>

                                      -45-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are as follows
(in thousands):

<TABLE>
<CAPTION>
                                                                                                       June 30,
                                                                                                ----------------------
                                                                                                   2000         2001
                                                                                                ---------    ---------
     <S>                                                                                        <C>          <C>
     Deferred Tax assets:
       Loss carryovers and deferred start-up expenditures ....................................   $  87,866    $ 101,502
       State tax credit carryforwards ........................................................       5,671        7,220
       Debt financing costs ..................................................................      35,717       35,848
       Stock Compensation ....................................................................       1,448        3,888
       Accruals, reserves, and other .........................................................       6,593        4,838
       Fixed assets ..........................................................................       3,080        2,305
                                                                                                 ---------    ---------
            Total gross deferred tax assets ..................................................     140,375      155,601
     Valuation allowance .....................................................................    (140,317)    (155,601)
                                                                                                 ---------    ---------
     Deferred tax assets, net of valuation allowance .........................................          58           --
     Deferred tax liabilities ................................................................         (58)          --
                                                                                                 ---------    ---------
            Net deferred tax asset ...........................................................   $      --    $      --
                                                                                                 =========    =========
</TABLE>

     Because the Company has incurred significant net losses and the realization
of its deferred tax assets is dependent upon the Company's ability to
successfully develop and market its video-on-demand service, a valuation
allowance has been recorded against all such deferred tax assets. The valuation
allowance increased $15,285,000 from June 30, 2000 to June 30, 2001.

     As of June 30, 2001, the Company has cumulative net operating loss
carryforwards for federal income tax purposes of approximately $267,550,000,
available to reduce future income subject to income taxes. The federal net
operating loss carryforwards expire beginning in 2008 through 2021. As of June
30, 2001, the Company has cumulative California net operating losses of
approximately $115,203,000, which can be used to offset future income subject to
California taxes. The California tax loss carryforwards will expire beginning in
2004 through 2010. As of June 30, 2001, the Company also has net operating loss
carryforwards in various other states, which will expire in various years.

     As of June 30, 2001, the Company has federal research tax credit
carryforwards for income tax return purposes of approximately $5,504,000
available to reduce future income taxes. The federal research credit
carryforwards expire beginning in 2008 through 2021. As of June 30, 2001, the
Company has unused California research credit carryforwards of approximately
$2,600,000. The California research credits carry forward indefinitely until
utilized.

     Federal and state tax laws impose restrictions on the utilization of net
operating loss and tax credit carryforwards in the event of an "ownership
change" as defined by the Internal Revenue code. The Company has not yet
determined to what extent these provisions will restrict its ability to utilize
its net operating loss and tax credit carryforwards pursuant to these
provisions.

                                      -46-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES


                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(5)  Preferred Stock

     The Company has authorized 80,000,000 shares of preferred stock as of June
30, 2001, of which the following are designated as issued and outstanding:


                               Shares Designated   Shares Issued and Outstanding
                             --------------------- -----------------------------
Series:
  AA ....................          3,750,000                 3,423,670
  A .....................            205,600                   205,600
  BB ....................          2,475,000                        --
  B .....................          4,493,748                 3,487,834
  C .....................          6,918,600                 6,168,600
  D .....................          8,517,352                 8,279,589
  E .....................          1,166,666                   777,778
  F .....................          2,500,000                 2,222,224
  G .....................          5,000,000                   555,556
                             --------------------- -----------------------------
      Totals ............         35,026,966                25,120,851
                             ===================== =============================

--------------------------------------------------------------------------------
     The rights, preferences, and privileges of these series of preferred stock
are explained below.

(a)  Conversion

     Each share of preferred stock is convertible into common stock at the
option of the holder at a rate of one share of common stock for each share of
preferred stock, subject to adjustment to protect against dilution. Each share
of Series E, F, and G preferred stock shall automatically be converted into
shares of common stock immediately prior to the closing of an underwritten
public offering of at least $9.00 per share and an aggregate offering price of
not less than $15,000,000. Each share of Series D preferred stock shall
automatically be converted into shares of common stock immediately prior to the
closing of an underwritten public offering of at least $6.80 per share and an
aggregate offering price of not less than $15,000,000. Each share of Series C
preferred stock shall automatically be converted into shares of common stock
immediately prior to the closing of an underwritten public offering of at least
$5.00 per share and an aggregate offering price of not less than $15,000,000.
Each share of Series A and B preferred stock shall automatically be converted
into shares of common stock immediately prior to the closing of an underwritten
public offering of at least $2.00 per share and an aggregate offering price of
not less than $10,000,000. Each share of Series AA and BB preferred stock shall
automatically be converted into shares of common stock immediately prior to the
closing of an underwritten public offering with an aggregate offering price of
not less than $15,000,000. The Company has reserved 25,120,851 shares of common
stock in the event of conversion.

(b)  Liquidation Preferences

     In the event of liquidation or sale of the Company, distributions to the
Company's stockholders shall be made in the following manner: first, $5.72 per
share for Series D preferred stock and $4.205 per share for Series C preferred
stock; then $0.855 per share for Series B preferred stock; then $9.00 per share
for Series E, F and G preferred stock; then $0.50 per share for Series A
preferred stock; then $6.50 per share for Series AA preferred stock; and then
$8.00 per share for Series BB preferred stock. The holders of preferred stock
are further entitled to any remaining assets which will be distributed ratably
among the holders of Class C common stock (see Note 7), common stock, and
preferred stock on an "as if converted" basis after payment of preferential
amounts to the holders of Class C common stock, common stock, and Class B common
stock.

                                      -47-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(c)  Voting

     Holders of preferred stock are entitled to one vote for each share of
common stock into which such shares can be converted.

(d)  Dividends

     In any fiscal year, the Company's Board of Directors may declare
noncumulative cash dividends out of legally available assets at the rates of
$0.03, $0.055, $0.25, $0.345, $0.54, $0.54, $0.54, $0.39 and $0.48 per share for
Series A, B, C, D, E, F, G, AA and BB preferred stock, respectively. If
declared, such dividends must be paid before any dividends on common stock. The
holders of Series E, D and C preferred stock have preference and priority to any
payment of any dividend on Series A, B, and AA preferred stock and common stock.
The holders of Series B preferred stock have preference and priority to any
payment of any dividend on Series A and AA preferred stock and common stock. The
holders of Series A preferred stock have preference and priority to any payment
of any dividend on Series AA preferred stock and common stock. The holders of
Series AA preferred stock have preference and priority to any payment of any
dividend on common stock. As of June 30, 2000 and 2001, no dividends had been
declared.

(6)  Common Stock

     The Company has authorized 165,000,000 shares of common stock as of June
30, 2001, of which two shares have been designated Class B common stock and
857,370 shares have been designated Class C common stock. As of June 30, 2001,
18,229,469 shares of common stock and 857,370 shares of Class C common stock
were issued and outstanding. The relative designations, rights, preferences, and
restrictions of the Class B and C common stock are as follows:

(a)  Conversion

     Each share of Class C common stock is convertible into common stock at the
option of the holder at a rate of one share of common stock for each share of
Class C common stock, subject to adjustment to protect against dilution. Each
share of Class C common stock shall automatically be converted into shares of
common stock immediately prior to the closing of an underwritten public offering
of at least $2.00 per share and an aggregate offering price of not less than
$10,000,000.

(b)  Liquidation Preferences

     In the event of any liquidation and after payment to all holders of
preferred stock of their full preferential amounts, the holders of Class C
common stock shall be paid $0.82 per share. If there are insufficient funds to
distribute among all holders of Class C common stock, then the entire remaining
assets shall be distributed among the holders of Class C common stock on a pro
rata basis. After payment to the holders of Class C common stock, then the
holders of common stock shall be entitled to $0.025 per share. After payment to
the holders of common stock, the holders of Class B common stock shall be
entitled to $5.00 per share. Any remaining assets shall be distributed to all
holders of Series A, B, and C preferred stock, Class C common stock, and common
stock on a pro rata basis, based on the number of shares of common stock on an
"as if converted" basis.

                                      -48-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(c)  Dividends

     No dividends shall be paid on any share of common stock unless a dividend
is paid on shares of Series A, B, C, D, E, F, G, AA and BB preferred stock.

(7)  Options and Warrants

(a)  Options and Warrants

     In connection with the issuance of the 1996 Notes the fair value of the
common stock warrants was determined to be $285,000 using the Black-Scholes
option pricing model with the following assumptions: Expected life of 10 years;
Volatility of 50%; Dividend yield of 0%; Risk-free rate of 6%. Each warrant
entitles the holder to purchase 40.4 shares of common stock for $0.005 per
share. The warrants expire on the earlier of an exercise event, as defined, or
10 years from the date of issuance. The initial carrying value of the warrants
is increased by periodic accretions so that the carrying amount will equal the
fair market value at the time the put option is exercisable.

     In June 1996, the Company's Board of Directors granted warrants to key
contractors to purchase 71,000 shares of the Company's common stock at a price
of $2.00 per share. The term of these warrants is 10 years, and these warrants
only become exercisable upon the earlier of 5 years from the date of grant or
upon the closing of an initial public offering of the Company's stock or an
acquisition of the Company. During the year ended June 30, 1998, warrants to
purchase 5,000 shares of the Company's common stock were canceled. In October
1996, the Company issued warrants to an employee to purchase 1,000,000 shares of
Series C preferred stock at $4.21 per share. These warrants are immediately
exercisable and expire in 5 years. In August 1997, warrants to purchase 650,000
shares were canceled.

     In October 1996, the Company also issued warrants to purchase 200,000
shares of Series C preferred stock at $4.21 per share to a vendor for
consideration of future marketing services. These warrants vest at a rate of 5%
every three months starting after October 1996. The term of these warrants is
five years from the date of issue.

     In October 1996, the Company also issued warrants to purchase 200,000
shares of Series C preferred stock at $4.21 per share to a customer. These
warrants are exercisable in full upon the occurrence of certain events. The
terms of the warrants are 10 years from the date of issue. In April 2000, all of
these warrants were cancelled because they failed to vest. In October 1997, the
Company issued warrants to purchase 200,000 shares of Series D preferred stock
at $5.72 per share to a customer. The warrants are immediately exercisable and
expire 5 years from date of issue. Each warrant entitles the holder to purchase
two shares of common stock for $0.005 per share for an aggregate of 2,778,000
shares of common stock. The warrants are exercisable beginning one year after
the closing date of the 1998 Notes and expire upon maturity of the 1998 Notes.

     In May 1998, the Company's Board of Directors granted warrants to
consultants to purchase 20,000 shares of the Company's common stock at a price
of $4.00 per share. The term of these warrants is 10 years, and these warrants
only become exercisable upon the earlier of 5 years from the date of grant or
upon the closing of an initial public offering of Company's common stock or an
acquisition of the Company. In November 1998, the Company's Board of Directors
granted warrants to an employee to purchase 650,000 shares of the Company's
common stock at a price of $8.00 per share. The term of these warrants is 10
years from the date of issue. These warrants vested at a rate of 50,000 shares
every three months starting August 1998. In March 1999, the employee was
terminated and unvested warrants to purchase 550,000 shares were canceled.

                                      -49-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     In December 1998, in connection with a deployment agreement, the Company
undertook to grant warrants to purchase a maximum of 2,200,000 shares of a new
series of preferred stock, convertible one for one to common stock upon the
earlier of either an initial public offering of the Company's stock or an
acquisition of the Company at an exercise price of $8.00 per share. The warrants
only become exercisable upon the customer meeting certain service deployment
milestones. The Company is valuing the warrants using the Black-Scholes model as
of each interim date until the achievement of certain milestones have been met.
The resulting valuation is being amortized over a period from granting of the
warrant and ending on the date of the expected achievement of the milestones. In
December 1999, the deployment agreement was terminated and the obligation to
grant these warrants terminated.

     In June 1999, in connection with a deployment agreement, the Company
undertook to grant warrants to purchase 275,000 shares of Series BB preferred
stock to a customer at an exercise price of $8.00 per share. The warrants become
exercisable upon the customer's achievement of certain annual milestones, over a
period of 3 years. Prior to June 30, 2001, the Company valued these warrants
using the Black-Scholes model at each interim date until the criteria have been
met. During the years ended June 30, 2000 and 2001 the Company recognized
expenses of $513,000 and $81,000 respectively, in connection with this
agreement, which represents the customer's progress towards achieving the
milestones. As of June 30, 2001 all current milestones had been achieved.

     In December 1999, the Company entered into a development agreement with a
strategic business partner. In conjunction with this agreement, the Company
granted a warrant to purchase 388,888 shares of Series E Preferred Stock
exercisable at $9.00 per share. The warrant expires the earlier of December 14,
2004 or under certain conditions as a result of a merger or acquisition of the
Company. The warrant becomes exercisable in accordance with the achievement of
certain milestones in the development agreement. As of June 30, 2001, none of
the milestones has been met. During the year ended June 30, 2000 the Company has
recognized a charge of $891,000 and during the year ended 2001 the Company has
recognized a credit of $105,000 in connection with these warrants, which
cumulatively represents the total value of the warrants calculated using the
Black-Scholes model and which has been fully amortized at June 30, 2001.

     In May 2000, the Company granted warrants to purchase 400,000 shares of
Series F Preferred Stock to a customer in connection with a deployment agreement
at a price of $9.00 per share. The life of the agreement is three years.
Warrants to purchase 50,000 shares of Series F Preferred Stock vested on the
execution of the deployment agreement in May 2000 and the Company recorded
expenses of $284,000 in fiscal 2000. The remaining 350,000 warrants become
exercisable upon the customer's achievement of certain milestones at the end of
the three year term. The Company is valuing these warrants using the
Black-Scholes model at each interim date until the criteria have been met. As of
June 30, 2001 the Company recognized expenses of $568,000 in connection with
this agreement, which represents the customer's progress towards achieving the
milestones.

     In September 2000, the Company granted warrants to purchase 450,000 shares
of Series F Preferred Stock to a customer in connection with a deployment
agreement at a price of $9.00 per share. The life of the agreement is four
years. Warrants to purchase 100,000 shares of Series F Preferred Stock vested on
the execution of the deployment agreement in September 2000 and the Company
recorded expenses of $259,000 in fiscal 2001. The remaining 350,000 warrants
become exercisable upon the customer's achievement of certain milestones during
the four year term. The Company recorded expenses of $59,000 in fiscal 2001
related to these warrants. The Company is valuing these warrants using the
Black-Scholes model at each interim date until the criteria have been met.

                                      -50-

<PAGE>
                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     In November 2000, the Company granted warrants to purchase 25,000 shares of
Series F Preferred Stock to a customer in connection with a deployment trial at
a price of $9.00 per share. Warrants to purchase 25,000 shares of Series F
Preferred Stock vested on the execution of the deployment trial in November 2000
and the Company recorded expenses of $40,000 in fiscal 2001.

(b)  Stock Plans

     In August 1995, the Company adopted the 1995 Stock Plan (the 1995 Plan)
under which incentive stock options and nonstatutory stock options may be
granted to employees and consultants of the Company. An aggregate of 9,200,000
shares of common stock is reserved for issuance under the 1995 Plan. The
exercise price for incentive stock options is at least 100% of the fair market
value on the date of grant for employees owning less than 10% of the voting
power of all classes of stock and at least 110% of the fair market value on the
date of grant for employees owning more than 10% of the voting power of all
classes of stock. For nonstatutory stock options, the exercise price is at least
110% of the fair market value on the date of grant for employees owning more
than 10% of the voting power of all classes of stock and at least 85% for
employees owning less than 10% of the voting power of all classes of stock.
Options generally expire in 10 years; however, they may be limited to 5 years if
the optionee owns stock representing more than 10% of the Company. Vesting
periods are determined by the Company's Board of Directors and generally provide
for ratable vesting over 4 to 5 years. Vesting periods are determined by the
Company's Board of Directors and generally provide that options vest ratably
each quarter over either a four or five year term. For newly hired employees
receiving their initial grants of options, an amount of options equivalent to
two ratable quarters vests at six months, with the remainder vesting each
quarter thereafter. For Directors, 25% of the number of options covered by the
grant vest after one year, with the remainder vesting 6.25% each quarter
thereafter.

     In August 1995, the Company granted immediately exercisable nonstatutory
stock options to the founders of the Company, subject to repurchase by the
Company at a rate equivalent to the vesting schedule of each option. As of June
30, 1999, 2000 and 2001, 277,380, 119,206 and 35,922 shares, respectively, were
subject to repurchase.

     In April 1998, in connection with the merger of Sarnoff Real Time
Corporation (SRTC), the Company assumed the SRTC 1998 Stock Plan (the 1998 Plan)
and reserved 380,767 shares of its common stock for issuance through incentive
stock options and nonstatutory stock options granted pursuant to the 1998 Plan
to employees, directors, and consultants who formerly worked for SRTC. The terms
of the 1998 Plan are substantially identical to the terms of the 1995 Plan.

     In April 1998, in connection with the merger of SRTC, the Company reserved
276,792 shares of its Series AA preferred stock for issuance upon exercise of
options to purchase common stock of SRTC, which were assumed by the Company.
Each option assumed by the Company continues to be subject to the terms and
conditions, including vesting, set forth in the original SRTC option plan. All
stock options have 10-year terms and vest ratably over 4 years from the date of
grant. During the year ended June 30, 2000 and 2001, 33,038 and 1,840 options
were exercised, respectively.

     In connection with the acquisition of SRTC in April 1998, 75% of the
Company's Series AA Preferred Stock issuable in exchange for outstanding SRTC
shares was deposited into an escrow account. Such escrow shares were to be
distributed on the annual anniversaries of the closing of the merger. On April
1, 2001, the Company released the third and final escrow amount of 317,428
shares of the Company's Series AA Preferred Stock.

     The Board of Directors is entitled in its discretion to grant options ("Out
of Plan Options") with vesting periods that are different from the standard
five-year period and with variable exercise prices. In a limited number of
instances, the Compensation Committee has exercised its discretion and has
granted options with both shorter and longer vesting periods than the standard
four or five-year vesting period and at variable exercise prices. There were
2,580,000 options outstanding as of June 30, 2001.

                                      -51-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

(c) Accounting for Stock-Based Compensation

    During the years ended June 30, 1999, 2000 and 2001, the Company recorded
deferred stock-based compensation of $1,986,000, $7,289,000 and $1,414,000
respectively, which is being amortized on an accelerated basis in accordance
with FIN 28 over the vesting periods of the related options. Amortization
expense recognized in the year ended June 30, 1999, 2000 and 2001 totaled
approximately $738,000, $2,583,000 and $3,776,000, respectively. The Company
considered the cash sales of preferred stock in determining the fair value of
its common stock. Compensation cost related to grants to non-employees in 1999,
2000 and 2001 was not material. Had compensation cost for the Company's
stock-based compensation plan been determined consistent with SFAS No. 123, the
Company's pro forma net loss would have been increased to approximately
$107,964,000, $114,912,000 and $96,848,000 for the years ended June 30, 1999,
2000, and 2001.

     Pro forma net loss reflects only options granted since July 1, 1996.
Therefore, the full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net loss amounts presented
above because compensation cost is reflected over the options' vesting period of
five years and compensation cost for options granted prior to July 1, 1996, is
not considered.

    The fair value of each option is estimated on the date of grant using the
minimum value method with the following weighted-average assumptions:

                                                  Years ended June 30,
                                         --------------------------------------
                                           1999             2000         2001
                                           ----             ----         ----
     Expected life....................   3.18 years      3.50 years  3.50 years
     Risk-free interest rate..........   4.99%           5.77%       6.00%


    A summary of the status of the Company's common stock option plans follows:

<TABLE>
<CAPTION>
                                    1999                               2000                                    2001
                        ----------------------------      -------------------------------        -------------------------------
                                         Weighted-                             Weighted-                           Weighted-
                                          average                               average                              average
                                          exercise                              exercise                             exercise
                          Shares           price             Shares              price              Shares            price
                        -----------    -------------      ------------    ---------------        -----------     ---------------
<S>                     <C>           <C>                <C>             <C>                    <C>             <C>
Outstanding at
    beginning of year     5,200,260    $        1.13         7,875,745    $          2.30          7,915,921     $          2.79
       Granted            4,044,695             3.58         2,182,605               3.49          4,594,914                5.21
       Exercised           (278,120)            1.10        (1,171,215)              1.33           (470,221)               1.22
       Canceled          (1,091,090)            1.74          (971,214)              2.19         (3,525,634)               3.52
                        -----------                       ------------                           -----------
Outstanding at
    end of year           7,875,745             2.30         7,915,921               2.79          8,514,980                3.87
                        ===========                       ============                           ===========
Options exercisable
    at end of year        2,051,175             1.23         2,616,184               2.13          3,921,775                3.44
                        ===========                       ============                           ===========
Weighted-average fair
    value of options
    granted during the
    year at market                              0.54                                 0.71                                   0.96
</TABLE>


                                      -52-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001



    The following table summarizes information about common stock options
outstanding as of June 30, 2001:

<TABLE>
<CAPTION>
                                              Outstanding                                        Exercisable
                      ----------------------------------------------------------  ----------------------------------------
                                            Weighted-average
                                               remaining
                                            contractual life    Weighted average                        Weighted-average
   Exercise Prices     Number Outstanding       (years)          exercise price    Number exercisable    exercise price
--------------------- --------------------  -----------------   ----------------  -------------------- -------------------
<S>                   <C>                   <C>                 <C>               <C>                  <C>
 $0.05   -  $1.25          1,247,110              5.68                0.80             1,005,900              0.76
  2.40   -   3.35          2,804,743              7.61                3.09             1,325,731              2.97
  4.50   -   8.00          4,463,127              9.32                5.23             1,590,144              5.52
                      ----------------------------------------------------------------------------------------------------
  0.05   -   8.00          8,514,980              8.22                3.87             3,921,775              3.44
                      ----------------------------------------------------------------------------------------------------
</TABLE>

(8) Commitments and Contingencies

(a) Leases

    The Company leases its facilities under non-cancelable operating leases. In
addition, the Company subleases a portion of its Redwood City, California
facility. The future minimum lease payments pursuant to these leases and the
related sublease income are as follows (in thousands):

      Year Ending June 30,           Operating leases   Sublease income
      --------------------           -----------------  ----------------
      2002                             $      3,294        $     1,638
      2003                                    3,376              1,705
      2004                                    3,418                248
      2005                                    3,393                 --
      2006 and thereafter                     6,641                 --
                                     -----------------  ----------------
      Operating lease expense and
      sublease income                  $     20,122        $     3,591
                                     =================  ================

    Total rent expense for the years ended June 30, 1999, 2000, and 2001 was
$1,593,000, $3,921,000 and $2,990,000 respectively. Rent expense in the year
ended June 30, 2001 was reduced by sub-lease income of $1,436,000

(b) Litigation

    The Company is a party to certain claims arising out of the normal conduct
of its business. While the ultimate resolution of such claims against the
Company cannot be predicted with certainty, management expects that these
matters will not have a material adverse effect on the consolidated financial
position, results of operations, or cash flows of the Company.

(9) Segment Information

    The Company has adopted the provisions of SFAS No. 131, Disclosure About
Segments of an Enterprise and Related Information. SFAS 131 establishes
standards for the reporting by public business enterprises of information about
operating segments, products and services, geographic areas, and major
customers. The method for determining what information to report is based on the
way that management organizes the operating segments within the Company for
making operating decisions and assessing financial performance.

                                      -53-

<PAGE>

                    DIVA SYSTEMS CORPORATION AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                             June 30, 2000 and 2001

     The Company's chief operating decision-maker is considered to be the
Company's Chief Executive Officer. The CEO reviews financial information
presented on a consolidated basis accompanied by disaggregated information about
revenue by geographic region for purposes of making operating decisions and
assessing financial performance. The consolidated financial information reviewed
by the CEO is identical to the information presented in the accompanying
consolidated statement of operations. Therefore, the Company has one reportable
segment. The Company's revenues and accounts receivable, as of and for the year
ended June 30, 2001 were derived primarily from 2 major customers. Those
customers accounted for 88% of total revenues and 86% of total accounts
receivable. One customer accounted for 54% and the second customer accounted for
34% of revenues and 61% and 25% of accounts receivable, respectively.

    As of June 30, 2001 essentially all of the Company's assets were located in
the United States, and all of its revenues were generated in the United States.

(10) Quarterly Data (unaudited) (in thousands, except per share amounts):

<TABLE>
<CAPTION>
2001                          1/st/ Quarter     2/nd/ Quarter       3/rd/ Quarter      4/th/ Quarter
----                          -------------     -------------       -------------      -------------
<S>                          <C>               <C>                 <C>               <C>
Revenue                         $     385         $  1,093           $    6,954          $   10,049

Net operating loss                 20,120           20,548               20,982              22,437

Net loss                           11,807           18,658               31,271              33,725
                             ===============   ==============      ===============   =================

Net loss per share              $     .50         $   1.01           $     1.67          $     1.78
                             ===============   ==============      ===============   =================

2000                          1/st/ Quarter     2/nd/ Quarter       3/rd/ Quarter      4/th/ Quarter
----                          -------------     -------------       -------------      -------------

Revenue                         $      68         $  1,047           $      584          $      258

Net operating loss                 15,908           17,259               22,937              25,250

Net loss                           23,661           25,528               35,566              46,446
                             ===============   ==============      ===============   =================

Net loss per share              $    1.36         $   1.44           $     1.95          $     2.51
                             ===============   ==============      ===============   =================
</TABLE>

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

None.

                                      -54-

<PAGE>


                                    PART III

Item 10.   Directors and Executive Officers of the Registrant

     Set forth below are the names, ages, and positions of our directors and
executive officers as of August 31, 2001. All directors hold office until their
successors are duly elected and qualified and all executive officers hold office
at the pleasure of the Board of Directors.

<TABLE>
<CAPTION>
              Name                 Age                                      Position
-------------------------------    ---    ------------------------------------------------------------------------------
<S>                                <C>    <C>
Paul M. Cook                       77     Chairman of the Board
Hendrik A. Hanselaar               55     President and Chief Executive Officer
Christopher W. Goode               49     Executive Vice President, Engineering and Chief Technology Officer
Stephanie A. Storms                51     Senior Vice President, General Counsel and Secretary
William M. Scharninghausen         45     Senior Vice President, Finance and Administration, and Chief Financial Officer
Robert B. Snow                     35     Executive Vice President and Chief Operating Officer
Steven Brookstein                  48     Senior Vice President, Sales and Marketing
John W. Goddard (1)                60     Director
Jules Haimovitz (2)                50     Director
John A. Rollwagen (1) (2)          60     Director
David F. Zucker                    39     Director
Stephen E. Silva                   41     Director
</TABLE>

(1)  Member of compensation committee
(2)  Member of audit committee

     Paul M. Cook has served as our Chairman of the Board since he founded DIVA
in 1995. He was the Chief Executive Officer until February 1999. Mr. Cook
founded Raychem Corporation, a Fortune 500 industrial company, in 1957 and
served as Chief Executive Officer for 33 years before retiring in 1990. Mr. Cook
was Chairman of the Board of SRI, a contract research firm, from December 1993
to July 1998 and has served as a member of its board of directors from 1987 to
1999. Mr. Cook is also Chairman of the Board of Sarnoff Corporation, a
subsidiary of SRI.

     Hendrik (Henk) A. Hanselaar has served as our President and Chief Executive
Officer and as a director since September 2000. Prior to joining us, Mr.
Hanselaar served as Managing Partner at Hamilton Technology Ventures LLC and led
a strategic planning and development practice for broadband communications
companies from 1998 to 2000. From 1997 to 1998, Mr. Hanselaar served as Chief
Executive Officer of FUBA Communications Systems GmbH, a leading German supplier
of cable headend and transmission equipment acquired by General Instrument in
1998 and which is now a unit of Motorola. From 1991 to 1996, Mr. Hanselaar
served as Chief Executive Officer and director of TV/COM International, a global
provider of digital broadband communications systems. From 1987 through 1991,
Mr. Hanselaar was Senior Vice President of General Atomics, a San Diego based
diversified technology company. Additionally, Mr. Hanselaar's experience
included sales, marketing and finance with both NV Philips and Citibank N.A. in
Europe and the United States.

     Christopher W. Goode has served as our Executive Vice President,
Development since April 1999 and Chief Technology Officer since July 1997. From
July 1997 to April 1999, Mr. Goode served as Senior Vice President, Engineering,
and from October 1995 to July 1997 as Vice President, Development. Prior to
joining us, Mr. Goode was Executive Vice President, Research and Development at
Raynet Corporation, a developer of fiber-to-the-curb networks. Prior to joining
Raynet, Mr. Goode held senior technical positions at Alcatel and ITT Corporation
over a 16-year period.

     Stephanie A. Storms has served as our Senior Vice President, General
Counsel since July 1999 and Secretary since March 1998. From December 1996 to
July 1999, Ms. Storms served as Vice President and General Counsel. Prior to
joining DIVA, she was Deputy General Counsel of Viacom, Inc. and Vice President
of Viacom Cable, a division of Viacom, Inc. Ms. Storms held positions with
various cable industry trade groups in conjunction with her employment with
Viacom; she served on the board of directors of the California Cable Television
Association and the legal committee of the National Cable Television
Association. Prior to joining Viacom Cable in 1987, Ms. Storms was Vice

                                      -55-

<PAGE>

President and Assistant General Counsel of American Television and
Communications Corp., the cable television subsidiary of Time Inc. Before that,
she was an attorney with the law firm of Adams, Duque & Hazeltine in Los
Angeles, California.

     William M. Scharninghausen has served as our Senior Vice President, Finance
and Administration since April 2000 and has served as Chief Financial Officer
since January 1999. From June 1997 to April 2000, Mr. Scharninghausen served as
our Vice President, Finance and Administration. Prior to joining DIVA, he was
Corporate Controller and Chief Accounting Officer of StarSight Telecast, Inc., a
developer of interactive television guides, from April 1993 to June 1997. Prior
to joining StarSight, Mr. Scharninghausen held various finance and accounting
positions with Lucas Film Ltd./LucasArts Entertainment Company, Orion Pictures
Corporation and Twentieth Century Fox Film Corporation. Mr. Scharninghausen is a
certified public accountant.

     Robert E. "Buddy" Snow, Jr. has served as Executive Vice President and
Chief Operating Officer since October 2000. Mr. Snow oversees our key internal
and external operations, product management and marketing functions. Mr. Snow
served as our Senior Vice President, Product Management from April 2000 to
October 2000. Prior to joining us, Mr. Snow was Senior Director of the cable
modem business for Motorola Broadband Communications Sector (MBCS), formerly
General Instrument, from 1997 to April 2000. At MBCS, Mr. Snow was responsible
for all aspects of domestic and international marketing, engineering and product
development for the modem line. Prior to MBCS, Mr. Snow spent eight years at
Apple Computer in various engineering management positions.

     Steve Brookstein has served as Senior Vice President, Sales, Marketing and
Corporate Communications since August 2001. He is responsible for developing and
implementing DIVA's corporate sales and marketing strategies, both domestically
and worldwide. Prior to joining DIVA, Mr. Brookstein served as Senior Vice
President, General Manager for Excite@Home's broadband cable access subscription
business from October 1999 to August 2001. Prior to joining Excite@Home, Mr.
Brookstein spent nine years with Comcast Cable Communications, as the Senior
Vice President of Marketing and a Regional Senior Vice President. Earlier in his
career, Brookstein spent 13 years in a variety of management positions at
several New York-based advertising firms, including Young & Rubicam; Penchina,
Selkowitz; Wells, Rich, and Greene; and Ogilvy & Mather.

     John W. Goddard has served as a director since January 1997. From 1980 to
July 1996, he served as President and Chief Executive Officer of Viacom Cable, a
division of Viacom, Inc. From 1966 to 1980, Mr. Goddard held various management
positions at Tele-Vue Systems, Viacom Cable's predecessor, and then at Viacom
Cable. Mr. Goddard has held various positions within the cable television
industry, including Chairman of the National Cable Television Association and
President of the California Cable Television Association, and currently serves
as a director of CableLabs, TCI Satellite Entertainment, Inc., Phoenix Star,
Inc., Bend Cable Communications and the Walter Kaitz Foundation.

     Jules Haimovitz has served as a director since December 1996 and currently
serves as Special Consultant to the Chairman and Chief Executive Officer at MGM
Networks, Inc. From June 1999 to July 2001, Mr. Haimovitz served as President of
MGM Networks, Inc. Mr. Haimovitz was employed by us as an Executive Vice
President from December 1996 to July 1997, and again from August 1998 to March
1999. From June 1997 to July 1998, Mr. Haimovitz served as President and Chief
Operating Officer of King World Productions. Prior to that he was President and
Chief Executive Officer of ITC Entertainment Group. Mr. Haimovitz has served on
the board of directors of Video Jukebox Network and Orion Pictures Corporation.
From 1987 to 1992, Mr. Haimovitz served as President and Chief Operating Officer
of Spelling Entertainment Inc. and was also a member of its board of directors.
From 1976 to 1987, Mr. Haimovitz served in various senior executive positions
with Viacom, Inc.

     John A. Rollwagen has served as a director since December 1995. He was
Chairman of SRTC prior to its acquisition by us in January 1998. Mr. Rollwagen
is an investor and business advisor specializing in information technology and
served as a venture partner of St. Paul Venture Capital, LLC from 1993 to 1999.
From 1981 to 1993 Mr. Rollwagen served as Chairman and Chief Executive Officer
of Cray Research, Inc., an international supplier of supercomputers. From 1977
to 1981, Mr. Rollwagen served as Cray Research's President. Mr. Rollwagen
currently serves as a director of Computer Network Technology, Inc. and Sarnoff
Corporation.

     David F. Zucker has served as a director since February 1999. He currently
serves as the Chief Executive Officer of Skillgames LLC, a New York based
entertainment Company owned by the Walt Disney Company and Walker Digital. He
was our President and Chief Executive Officer from February 1999 to September
2000. Prior to joining us, Mr. Zucker served in a number of senior management
positions with The Walt Disney Company and its subsidiaries. He served as
Executive Vice President of ESPN and Managing Director, ESPN International from
August 1998 to February

                                      -56-

<PAGE>

1999. From December 1995 to August 1998, Mr. Zucker served as Senior Vice
President and General Manager, ESPN International, and from September 1994 to
December 1995 as Senior Vice President of ESPN International. Prior to 1994, Mr.
Zucker served as ESPN's Vice President, Programming for two years. Before
joining ESPN, Mr. Zucker had served in a number of management positions within
Capital Cities/ABC, Inc.

     Steve Silva has served as a director since September 2000. He currently
serves as Senior Vice President, Corporate Development and Technology for
Charter Communications, Inc. Mr. Silva joined Charter in April 1995 as Director,
Billing Services. From April 1998 to September 1999, Mr. Silva served as Vice
President, New Product Development at Charter. In September 1999, he was
promoted to Senior Vice President, Corporate Development and Technology. Prior
to joining Charter, Mr. Silva served in many roles for Cable Data. He also
currently serves as a director of Charter Communications JV, LLC.

Board of Directors

     Our Board of Directors current consists of eight members. Each directors
holds office until his or her term expires or until his or her successor is duly
elected and qualified. Our certificate of incorporation and bylaws provides for
the division of our board of directors into three classes, each class being as
nearly equal in number as possible, with director in each class serving for the
three-year term, and on class being elect each year by our stockholders at the
annual meeting.

Director Compensation

     Except for grants of stock options, our directors generally do not receive
compensation for services provided as a director, for committee participation or
for special assignment of the Board of Directors. We reimburse expenses incurred
in attending Board and committee meetings.

Item 11.  Executive Compensation

     The following table sets forth, for the three fiscal years ended June 30,
2001, 2000 and 1999 the compensation earned, awarded, or paid to our Chief
Executive Officer and the four other most highly compensated executive officers
who were serving as executive officers as of June 30, 2001 who earned more than
$100,000 in salary and bonuses during the fiscal year ended June 30, 2001, whom
we refer to collectively, as the named executive officers.

                           Summary Compensation Table

<TABLE>
<CAPTION>
                                                                  Annual Compensation     Long-Term Compensation
                                                      Fiscal  ---------------------------    Awards Securities
            Name and Principal Position                Year     Salary         Bonus       Underlying Options(1)
----------------------------------------------------  ------  ---------------------------  ---------------------
<S>                                                   <C>     <C>          <C>            <C>
Hendrik A. Hanselaar ...............................   2001   $  291,667   $  641,668(2)      2,500,000
President and Chief Executive Officer                  2000         --           --                --
                                                       1999         --           --                --

Stephanie A. Storms ................................   2001      290,000       50,750            15,000
Senior Vice President, General Counsel and Secretary   2000      206,249         --              43,000
                                                       1999      236,952         --               9,300

Robert  E. Snow, Jr ................................   2001      275,000       68,750           150,000
Chief Operating Officer                                2000         --           --                --
                                                       1999         --           --                --

Christopher W. Goode ...............................   2001      266,200       33,275           100,000
Executive Vice President, Development, and Chief       2000      256,415         --              20,000
Technical Officer                                      1999      229,061         --              48,900

Ian Jefferson ......................................   2001      240,000       50,000            65,000
Vice President, World Wide Sales                       2000         --           --                --
                                                       1999         --           --                --
</TABLE>

(1) No SARs were granted during the fiscal year

(2) Includes a $350,000 acceptance bonus paid in connection with Mr. Hanselaar's
    initial employment and a $291,667 annual performance bonus paid in
    connection with the achievement of certain annual goals set by our Board of
    Directors.

                                      -57-

<PAGE>

                        Option Grants in Last Fiscal Year

     The following table shows information regarding stock options granted to
the named executive officers during the fiscal year ended June 30, 2001. All
options were granted at an exercise price that was either equal to or greater
than the fair market value of the underlying securities as determined by our
Board of Directors on the date of grant.

<TABLE>
<CAPTION>
                                                Percent of                                   Potential Realizable Value at
                                 Number of    Total Options/                                      Assumed Annual Rates of
                                 Securities    SARs Granted                                    Stock Price Appreciation
                                 Underlying    To Employees    Exercise or                       For Option Term($)(3)
                                Options/SARs     In Fiscal      Base Price      Expiration   ------------------------------
            Name                Grant (#)(1)      Year(2)         ($/sh)           Date            5%             10%
---------------------------- ---------------- -------------- --------------- --------------- --------------  --------------
<S>                          <C>              <C>            <C>             <C>             <C>             <C>
Hendrik A. Hanselaar            1,000,000            22%           6.00          11/16/10      1,330,026       5,671,841
Hendrik A. Hanselaar              500,000            11%           8.00          11/16/10       (334,987)      1,835,921
Hendrik A. Hanselaar            1,000,000            22%           4.50          11/16/10      2,830,026       7,171,841
Stephanie A. Storms                15,000             *            4.50           9/28/10         42,450         107,578
Robert E. Snow, Jr.                75,000             *            4.50           7/19/10        212,252         537,888
Robert E. Snow, Jr.                23,263             *            4.50          11/16/10         65,835         166,839
Robert E. Snow, Jr.                51,737             *            4.50          11/16/10        146,417         371,050
Christopher W. Goode               54,344             *            4.50            9/8/10        153,795         389,747
Christopher W. Goode               45,656             *            4.50            9/8/10        129,208         327,438
Ian Jefferson                      65,000             *            4.50          11/16/10        183,952         466,170
</TABLE>
-----------------
*    Less than 1%
(1)  Options granted under the 1995 Stock Plan generally become exercisable at a
     rate of 10% of the shares subject to the option at the end of the first six
     months and 5% of the shares subject to the option at the end of each
     three-month period thereafter, so long as the individual is employed by us.
(2)  We granted options to purchase 4,594,914 shares of Common Stock during
     fiscal year 2001.
(3)  Potential realizable value is based on the assumption that the price of the
     Common Stock appreciates at the annual rate shown, compounded annually,
     from the date of grant until the end of the option term. The values are
     calculated in accordance with rules promulgated by the Securities and
     Exchange Commission and do not reflect our estimate of future stock price
     appreciation.

           Aggregated Option Exercises in Fiscal Year 2001 and Fiscal
                             Year-End Option Values

     The following table sets forth for the named executive officers'
exercisable and unexercisable options held by them as of June 30, 2001. Other
than options granted to Hendrik A. Hanselaar, all options granted to these
executive officers in the last fiscal year were granted under our 1995 Stock
Plan, as amended. All options were granted at an exercise price that was either
equal to or greater than the fair market value of the underlying securities as
determined by our Board of Directors on the date of grant.

     The value of unexercised in-the-money options is based on a price of $4.50
per share, the fair market value of our common stock on June 30, 2001, as
determined by our Board of Directors, minus the per share exercise price,
multiplied by the number of shares underlying the option.


<TABLE>
<CAPTION>
                                      Number of Securities         Value of Unexercised
                                     Underlying Options/SARs     In-the-Money Options/SARs
                                     At Fiscal Year-End (#)      At Fiscal Year-End ($)(1)
                                  ----------------------------- -----------------------------
              Name                 Exercisable   Unexercisable   Exercisable   Unexercisable
--------------------------------  ------------- --------------- ------------- ---------------
<S>                               <C>           <C>             <C>           <C>
Hendrik A. Hanselaar                 1,250,000     1,250,000             --             --
Stephanie A. Storms                    116,377        62,123       $381,399       $105,436
Robert E. Snow, Jr.                     27,941       122,059             --             --
Christopher W. Goode                   197,944       193,356        637,560        347,895
Ian Jefferson                            8,125        56,875             --             --
</TABLE>

____________________
(1)  Based on the fair market value of our Common Stock at fiscal year end,
     $4.50 per share (as determined by the Company's Board of Directors), less
     the exercise price payable for such shares.

                                      -58-

<PAGE>

Employment Agreements and Change-In-Control Arrangements

        Pursuant to a written Employment Agreement with Hendrik A. Hanselaar
effective as of September 1, 2000, Mr. Hanselaar was employed as President and
Chief Executive Officer at a salary of $350,000 per year, subject to periodic
increases by our Board of Directors. Mr. Hanselaar may also be entitled to an
annual performance bonus of up to 200% of his base salary based on meeting or
exceeding certain annual goals set by our Board of Directors. He also received a
$350,000 acceptance bonus in connection with his initial employment. Mr.
Hanselaar was also granted an option to purchase 1,000,000 shares of our common
stock at an exercise price of $4.50 per share, an second option to purchase
1,000,000 shares of our common stock at an exercise price of $6.00 per share,
and a third option to purchase 500,000 shares of our common stock at an exercise
price of $8.00 per share. Subject to continued employment, each option is
exercisable cumulatively to the extent of 12.5% of the total number of shares
subject to such option on March 1, 2000, and an additional 6.25% of the total
shares subject to such option at the end of each three month period thereafter.
Each of the options shall become fully exercisable on the earlier of six months
from the date of a change of control of DIVA, as defined in the Employment
Agreement, or the termination of Mr. Hanselaar's employment by the Company
without cause, or if he constructively terminated, after the date of a change of
control.

        Options granted under our 1995 Stock Plan provide that in the event of a
change of control, as defined in the underlying option agreement, the options
are accelerated and become fully exercisable six months after the change of
control or earlier in the event the optionee's employment is involuntarily
terminated without cause or the option is not assumed.

Compensation Committee Interlocks and Insider Participation

        The compensation committee consists of two outside directors, John W.
Goddard and John A. Rollwagen. The compensation committee reviews and recommends
to the Board of Directors the salaries, incentive compensation and benefits of
our officers and administers our stock plans. Neither of the members of the
compensation committee is currently, or has ever been at any time since our
formation, one of our officers or employees, nor has served as a member of the
Board of Directors or compensation committee of any entity that has one or more
officers serving as a member of our Board of Directors or compensation
committee.

Incentive Stock Plans

1995 Stock Plan

        Our 1995 Stock Plan has been approved by our Board of Directors and
stockholders. The 1995 Stock Plan provides for the granting to employees
(including officers) of qualified "incentive stock options" within the meaning
of Section 422 of the Code, and for the granting to employees (including
officers and directors) and consultants of nonqualified stock options. The 1995
Stock Plan also provides for the granting of restricted stock. As of June 30,
2001, options to purchase an aggregate of 5,687,021 shares were outstanding and
2,813,381 shares remained available for future grants.

        The 1995 Stock Plan is administered by our Board of Directors or a
committee appointed by the Board. Options granted to new employees generally
vest at a rate of 12.5% of the shares subject to the option at the end of the
first six months and 6.25% of the shares subject to the option at the end of
each three-month period thereafter and generally expire ten years from the date
of grant. Bonus or incentive options granted to employees vest at a rate of
6.25% of the shares subject to the option at the end of each three month period
after the date of grant and also generally expire ten years from such date.
Options granted to outside directors vest at the rate of 25% of the shares at
the end of the first year and 6.25% of the shares at the end of each quarter
thereafter. Options granted to outside directors and certain other employees are
immediately exercisable, subject to a repurchase right held by DIVA that lapses
in accordance with the vesting schedule of the options.

        In the event of a merger of DIVA with or into another corporation or the
sale of substantially all of our assets, all outstanding options shall be
assumed or an equivalent option substituted by the successor corporation. In the
event a successor corporation refuses to assume or substitute for the options,
the exercisability of shares subject to options under the 1995 Stock Plan shall
be accelerated. In such event, we will notify the holders of outstanding options
that such options are fully exercisable, and all options not exercised will then
terminate 15 days after the date of such notice. See "--Employment Agreements
and Change-in-Control Arrangements."

                                      -59-

<PAGE>

1998 Stock Plan

        In April 1998, in connection with the acquisition of SRTC, we assumed
the SRTC 1998 Stock Plan and reserved 380,767 shares of our common stock for
issuance through incentive stock options and nonstatutory stock options granted
pursuant to the 1998 Stock Plan to employees, directors, and consultants who
formerly worked for SRTC. In April 1998, all options under the 1998 Stock Plan
were granted at an exercise price of $2.40. As of June 30, 2001, options to
purchase 247,959 shares of common stock remained outstanding under the 1998
Stock Plan. The terms of the 1998 Stock Plan are substantially identical to the
terms of the 1995 Stock Plan.

        In addition, in connection with the acquisition of SRTC, all options to
purchase shares of SRTC capital stock were assumed and converted into options to
purchase shares of DIVA capital stock. As of June 30, 2001, options to purchase
43,468 shares of Series AA preferred stock at a weighted average exercise price
of $0.35 remained outstanding.

                                      -60-

<PAGE>
Item 12.  Security Ownership of Certain Beneficial Owners and Management

     The following table sets forth certain information regarding beneficial
ownership of our common and preferred stock as of June 30, 2001 by (i) each of
our directors, (ii) each of our named executive officers, a (iii) each person
who beneficially owns more than 5% our common stock or preferred stock and (iv)
all directors and executive officers as a group.

<TABLE>
<CAPTION>
                                                          Percent                 Percent     Percent
                                              Number of  Ownership    Number of  Ownership   Ownership
                                              Shares of     Of        Shares of     Of        Of Total
                                               Common     Common      Preferred   Preferred    Voting
              Beneficial Owner                Stock(1)    Stock(2)      Stock     Stock(2)    Stock(2)
-------------------------------------------   --------   ---------   ----------  ---------    --------
<S>                                           <C>        <C>         <C>         <C>          <C>
Paul M. Cook(3) ...........................   7,175,967     37.1%      911,880      3.6%       18.2%
800 Saginaw Drive
Redwood City, CA 94063

Acorn Ventures, Inc.(4) ...................   2,467,917     12.7%    2,405,973      9.6%       11.0%
1309 114th Avenue, S.E.
Suite 200
Bellevue, WA 98004

SRI International(5) ......................   2,413,084     12.7%    2,063,134      8.2%       10.1%
333 Ravenswood Avenue
Menlo Park, CA 94025

Putnam Funds and Accounts(6) ..............   1,612,616      7.8%    2,568,582     10.2%        9.1%
One Post Office Square
Boston, MA 02109

Merrill Lynch Global Allocation Fund, Inc..       --         --      4,000,000     15.9%        9.0%
800 Scudder's Mill Road
Plainsboro, NJ 08530

Chris Larson ..............................       --          --     3,300,000     13.1%        7.5%

Hendrick A. Hanselaar(7) ..................   1,280,000      6.3%         --         --         2.8%

David Zucker(8) ...........................     900,000      4.5%         --         --         2.0%

Jules Haimovitz(9) ........................     232,892      1.2%      350,000      1.4%        1.3%

Stephan Silva(10) .........................        --        --        555,556      2.2%        1.3%

John A. Rollwagen(11) .....................     210,552      1.1%      254,966      1.0%        1.1%

Stephanie A. Storms(12) ...................     166,312      *            --         --         *

Robert Snow(13) ...........................      89,062      *           --          --         *

Christopher W. Goode(14) ..................      79,242      *            --         --         *

John W. Goddard(15) .......................      40,000      *            --         --         *

Ian Jefferson(16) .........................      12,186      *            --         --         *

All directors and executive officers as a
 Group (11 persons)(17) ...................   9,980,877     46.0%    2,072,402      8.1%       25.6%
</TABLE>

----------

                                       -61-

<PAGE>
*    Less than 1%.

(1)  Does not include shares of Common Stock issuable upon conversion of
     Preferred Stock.
(2)  Based on 19,086,839 shares of Common Stock and 25,120,851 shares of
     Preferred Stock outstanding as of June 30, 2001. Beneficial ownership is
     determined in accordance with the rules of the Securities and Exchange
     Commission. In computing the number of shares beneficially owned by a
     person and the percentage ownership of that person, shares of Common Stock
     subject to options or warrants held by that person that are currently
     exercisable or exercisable within 60 days of June 30, 2001 deemed
     outstanding. Such shares, however, are not deemed outstanding for the
     purposes of computing the percentage ownership of each other person. Except
     as indicated in the footnotes to this table and pursuant to applicable
     community property laws, the stockholder named in the table has sole voting
     and investment power with respect to the shares set forth opposite such
     stockholder's name.
(3)  Includes (i) 6,786,700 shares of Common Stock, 62,500 shares of Series A
     Preferred Stock, 352,816 shares of Series B Preferred Stock, 59,500 shares
     of Series C Preferred Stock and 437,064 shares of Series D Preferred Stock
     beneficially owned by the Paul and Marcia Cook Living Trust dated April 12,
     1992 (the "Cook Trust"), 4,000 of which we can repurchase at cost, which
     rights lapse based on continued performance of services; (ii) 140,000
     shares of Common Stock beneficially owned by two trusts of which Mr. Cook
     is trustee; (iii) warrants to purchase 146,160 shares of Common Stock
     exercisable within 60 days of June 30, 2001; and (iv) options to purchase
     13,750 shares of Common Stock exercisable within 60 days of June 30, 2001.
(4)  Includes (i) warrants to purchase 235,517 shares of Common Stock
     exercisable within 60 days of June 30, 2001; (ii) options to purchase
     40,000 shares of Common Stock exercisable within 60 days of June 30, 2001;
     and (iii) 273,142 shares of Series B Preferred Stock held by an affiliate.
(5)  Includes 413,084 shares of Common Stock and 2,063,134 shares of Series AA
     Preferred Stock held by Sarnoff Corporation, a wholly-owned subsidiary of
     SRI.
(6)  Includes 1,006,330 shares of Series C Preferred Stock and 1,562,252 shares
     of Series D Preferred Stock held by funds or accounts managed by Putnam
     Investment Management, Inc., the Putnam Advisory Company, Inc., and Putnam
     Fidelity Trust Company. Voting and dispositive power is shares between each
     such fund or account and its respective advisor. Also includes warrants to
     purchase 1,612,616 shares of Common Stock exercisable within 60 days of
     June 30, 2001.
(7)  Includes options to purchase 1,280,000 shares of common stock exercisable
     within 60 days of June 30, 2001.
(8)  Includes options to purchase 900,000 shares of Common Stock exercisable
     within 60 days of June 30, 2001.
(9)  Includes (i) a warrant to purchase 350,000 shares of Series C Preferred
     Stock exercisable within 60 days of June 30, 2001; (ii) a warrant to
     purchase 100,000 shares of Common Stock exercisable within 60 days of June
     30, 2001; and (iii) options to purchase 4,500 shares of Common Stock
     exercisable within 60 days of June 30, 2001.
(10) Includes 555,556 shares of Series F Preferred Stock held by Charter
     Communications Holding Company, LLC, a subsidiary of Charter
     Communications, Inc. Mr. Silva is an executive officer of Charter
     Communications, Inc. and a director of Charter Communications JV, LLC, a
     subsidiary of Charter Communications Holding Company, LLC.
(11) Includes (i) 125,472 shares of Series B Preferred Stock held in the name of
     Norwest Bank Minnesota, N.A., as trustees of the John A. Rollwagen
     Self-Directed IRA; (ii) 4,250 shares of Common Stock that we can repurchase
     at cost, which rights lapse based on continued performance of services.
(12) Includes options to purchase 166,312 shares of Common Stock exercisable
     within 60 days of June 30, 2001.
(13) Includes options to purchase 89,062 shares of Common Stock exercisable
     within 60 days of June 30, 2001.
(14) Includes options to purchase 79,242 shares of Common Stock exercisable
     within 60 days of June 30, 2001.
(15) Includes (i) warrants to purchase 7,500 shares of common stock exercisable
     within 60 days of June 30, 2001; and (ii) options to purchase 8,500 shares
     of common stock exercisable within 60 days of June 30, 2001.
(16) Includes options to purchase 12,186 shares of Common Stock exercisable
     within 60 days of June 30, 2001.
(17) Includes (i) warrants to purchase 243,017 shares of common stock
     exercisable within 60 days of June 30, 2001; (ii) warrants to purchase
     350,000 shares of Series C Preferred Stock exercisable within 60 days of
     June 30, 2001; and (iii) options to purchase 2,393,216 shares of common
     stock exercisable within 60 days of June 30, 2001.

Item 13.  Certain Relationships and Related Party Transactions

     None.

                                      -62-

<PAGE>
                                     PART IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

   (a)  The following documents are filed as a part of this Report.

        1.  Financial Statements and Financial Statement Schedules.

            See Index to Financial Statements at Item 8 on page 32 of this
            report.

        2.  Exhibits

 Exhibit
  Number                            Description
  ------                            -----------
    3.1        Amended and Restated Certificate of Incorporation. (1)
    3.2        Amended and Restated Bylaws. (1)
    4.1        Indenture dated as of February 19, 1998 between the Company and
               The Bank of New York, including form of Senior Discount Note Due
               2008. (1)
    4.2        Specimen  12-5/8% Senior Discount Note Due 2008, Series B (1)
   10.1*       Form of Indemnification Agreement entered into between the
               Company and all executive officers and directors. (1)
   10.2*       Employment Agreement effective as of September 1, 2000 between
               the Company and Hendrik A. Hanselaar.
   10.3*       1995 Stock Plan and forms of agreements used thereunder. (1)
   10.4        Registration Rights Agreement dated as of February 19, 1998 among
               the Company and the Initial Purchasers. (1)
   10.5        Warrant Agreement dated as of February 19, 1998 between the
               Company and The Bank of New York. (1)
   10.6        Warrant Registration Rights Agreement dated as of February 19,
               1998 among the Company and the Initial Purchasers. (1)
   10.7        Warrant Registration Rights Agreement dated as of May 15, 1996,
               as amended, by and among the Company, Smith Barney Inc. and
               Toronto Dominion Securities (USA) Inc. (1)
   10.8        Warrant Agreement dated as of May 15, 1996 between the Company
               and The Bank of New York. (1)
   10.9        Amended and Restated Stockholders Rights Agreement dated August
               23, 2000 among the Company and certain of its stockholders. (2)
   10.10       Lease Agreement between Seaport Centre Associates, LLC and the
               Company dated January 20, 1999. (3)
   21.1        Subsidiaries of the Company. (2)
   24.1        Power of Attorney (included on page 64)

_______________________

*    Designated management contracts or compensatory plans, contracts or
     arrangements required to be filed as exhibits pursuant to Item 14(c) of
     Form 10-K

(1)  Incorporated by reference our Registration Statement on Form S-4 filed
     September 29, 1998, as amended (No. 333-64483)
(2)  Incorporated by reference to our Annual Report on Form 10-K for the fiscal
     year ended June 30, 2000.
(3)  Incorporated by references to our Quarterly Report on Form 10-Q for the
     quarter ended December 31, 1998.

     (b) Reports on Form 8-K.
         None.

     (c) Exhibits
         See Item 14(a) above.

                                      -63-

<PAGE>

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: September 28, 2001
                                   DIVA SYSTEMS CORPORATION


                                   By: /s/  WILLIAM M. SCHARNINGHAUSEN
                                       ----------------------------------------
                                            William M. Scharninghausen
                                            Senior Vice President, Finance and
                                            Administration, and Chief Financial
                                            Officer

                                POWER OF ATTORNEY

     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints William M. Scharninghausen and Stephanie
A. Storms, jointly and severally, as his true and lawful attorneys-in-fact and
agents, each with the power of substitution, for him in any and all capacities,
to sign any and all amendments to this Report on Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith, with
the Securities and Exchange Commission, hereby ratifying and confirming all that
said attorneys-in-fact and agents, or his substitute or substitutes, may do or
cause to be done by virtue hereof.

     Pursuant to the requirements of the Securities Act of 1934, this Report on
Form 10-K has been signed below by the following persons on behalf of the
Registrant on the 28th day of September 2001 in the capacities indicated.


<TABLE>
<CAPTION>
                    Signature                                          Title
                    ---------                                          -----
<S>                                         <C>
/s/ William M. Scharninghausen              Senior Vice President, Finance and Administration, and Chief
---------------------------------------     Financial Officer (Principal Financial and Accounting Office)
     (William M. Scharninghausen)

/s/ Paul M. Cook                            Chairman of the Board and Director
---------------------------------------
            (Paul M. Cook)

/s/ John W. Goddard                         Director
---------------------------------------
          (John W. Goddard)

/s/ Jules Haimovitz                         Director
---------------------------------------
          (Jules Haimovitz)

/s/ John A. Rollwagen                       Director
---------------------------------------
         (John A. Rollwagen)

/s/ David F. Zucker                         Director
---------------------------------------
          (David F. Zucker)

/s/ Steven E. Silva                         Director
---------------------------------------
          (Steven E. Silva)
</TABLE>

                                      -64-